Sleep Number Corp - Quarter Report: 2013 June (Form 10-Q)

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 29, 2013

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 June 29, 2013, 55,603,000 shares of the Registrant’s Common Stock were outstanding.

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INDEX



		Page

PART I: FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets	2

	Condensed Consolidated Statements of Operations	3

	Condensed Consolidated Statements of Comprehensive Income	4

	Condensed Consolidated Statement of Shareholders’ Equity	5

	Condensed Consolidated Statements of Cash Flows	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	15

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25

Item 4.	Controls and Procedures	25

PART II: OTHER INFORMATION		25

Item 1.	Legal Proceedings	25

Item 1A.	Risk Factors	25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	26

Item 3.	Defaults Upon Senior Securities	26

Item 4.	Mine Safety Disclosures	26

Item 5.	Other Information	26

Item 6.	Exhibits	27

SIGNATURES		28

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

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Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)



	(unaudited) June 29, 2013			December 29, 2012
Assets
Current assets:
Cash and cash equivalents	$	58,189		$	87,915
Marketable debt securities – current	53,787			51,264
Accounts receivable, net of allowance for doubtful accounts of $459 and $348, respectively	14,385			16,613
Inventories	34,473			35,564
Prepaid expenses	9,052			4,299
Deferred income taxes	5,398			5,401
Other current assets	10,904			9,522
Total current assets	186,188			210,578

Non-current assets:
Marketable debt securities – non-current	28,502			38,642
Property and equipment, net	105,539			79,356
Goodwill and intangible assets, net	17,288			2,881
Deferred income taxes	4,470			8,511
Other assets	4,573			2,053
Total assets	$	346,560		$	342,021

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	63,335		$	67,703
Customer prepayments	12,330			15,194
Compensation and benefits	15,990			21,597
Taxes and withholding	6,134			9,282
Other current liabilities	17,716			19,285
Total current liabilities	115,505			133,061

Non-current liabilities:
Warranty liabilities	1,673			1,457
Other long-term liabilities	15,293			13,806
Total liabilities	132,471			148,324

Shareholders’ equity:
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding	—			—
Common stock, $0.01 par value; 142,500 shares authorized, 55,603 and 55,903 shares issued and outstanding, respectively	556			559
Additional paid-in capital	20,966			33,923
Retained earnings	192,592			159,195
Accumulated other comprehensive (loss) income	(25		)	20
Total shareholders’ equity	214,089			193,697
Total liabilities and shareholders’ equity	$	346,560		$	342,021

See accompanying notes to condensed consolidated financial statements.

Index

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Condensed Consolidated Statements of Operations

(unaudited - in thousands, except per share amounts)



	Three Months Ended				Six Months Ended
	June 29, 2013		June 30, 2012		June 29, 2013			June 30, 2012
Net sales	$	207,391	$	205,219	$	465,628		$	467,602
Cost of sales	75,993		73,648		170,814			171,732
Gross profit	131,398		131,571		294,814			295,870

Operating expenses:
Sales and marketing	98,357		88,240		208,170			194,425
General and administrative	15,359		16,220		31,540			33,149
Research and development	2,560		1,256		5,116			2,546
Asset impairment charges	15		3		45			7
CEO transition (benefit) costs	—		—		(391		)	5,595
Total operating expenses	116,291		105,719		244,480			235,722
Operating income	15,107		25,852		50,334			60,148
Other income, net	78		48		169			55
Income before income taxes	15,185		25,900		50,503			60,203
Income tax expense	5,259		8,927		17,106			20,813
Net income	$	9,926	$	16,973	$	33,397		$	39,390

Basic net income per share:
Net income per share – basic	$	0.18	$	0.30	$	0.61		$	0.71
Weighted-average shares – basic	55,029		55,719		55,062			55,680
Diluted net income per share:
Net income per share – diluted	$	0.18	$	0.30	$	0.60		$	0.69
Weighted-average shares – diluted	55,987		57,394		56,101			57,367

See accompanying notes to condensed consolidated financial statements.

Index

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Condensed Consolidated Statements of Comprehensive Income

(unaudited - in thousands)



	Three Months Ended						Six Months Ended
	June 29, 2013			June 30, 2012			June 29, 2013			June 30, 2012
Net income	$	9,926		$	16,973		$	33,397		$	39,390
Other comprehensive loss – unrealized loss on available-for-sale marketable debt securities, net of income tax	(38		)	(26		)	(45		)	(38		)
Comprehensive income	$	9,888		$	16,947		$	33,352		$	39,352

See accompanying notes to condensed consolidated financial statements.

Index

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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			Additional Paid-in Capital			Retained Earnings		Accumulated Other Comprehensive Income (Loss)			Total
Balance at December 29, 2012	55,903		$	559		$	33,923		$	159,195	$	20		$	193,697
Net income	—		—			—			33,397		—			33,397
Other comprehensive loss:
Unrealized loss on available-for-sale marketable debt securities, net of tax	—		—			—			—		(45		)	(45		)
Exercise of common stock options	542		5			6,590			—		—			6,595
Tax effect from stock-based compensation	—		—			484			—		—			484
Stock-based compensation	178		2			1,990			—		—			1,992
Repurchases of common stock	(1,020	)	(10		)	(22,021		)	—		—			(22,031		)
Balance at June 29, 2013	55,603		$	556		$	20,966		$	192,592	$	(25	)	$	214,089

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 29, 2013			June 30, 2012
Cash flows from operating activities:
Net income	$	33,397		$	39,390
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	14,153			9,049
Stock-based compensation	1,992			8,370
Net gain on disposals and impairments of assets	(58		)	(12		)
Excess tax benefits from stock-based compensation	(2,837		)	(4,120		)
Deferred income taxes	4,072			(2,431		)
Changes in operating assets and liabilities, net of effect of acquisition:
Accounts receivable	2,541			3,055
Inventories	1,769			(2,450		)
Income taxes	(3,084		)	3,614
Prepaid expenses and other assets	(3,933		)	(2,474		)
Accounts payable	(1,708		)	202
Customer prepayments	(2,857		)	(1,892		)
Accrued compensation and benefits	(4,802		)	(9,085		)
Other taxes and withholding	(1,156		)	(920		)
Warranty liabilities	(571		)	(453		)
Other accruals and liabilities	(775		)	3,390
Net cash provided by operating activities	36,143			43,233

Cash flows from investing activities:
Purchases of property and equipment	(37,096		)	(22,499		)
Proceeds from maturities of marketable debt securities	23,463			10,018
Investments in marketable debt securities	(16,504		)	(45,351		)
Acquisition of business	(15,500		)	—
Investment in non-marketable equity securities	(3,000		)	—
Proceeds from sales of property and equipment	117			30
Net cash used in investing activities	(48,520		)	(57,802		)

Cash flows from financing activities:
Repurchases of common stock	(22,031		)	(14,023		)
Proceeds from issuance of common stock	6,595			1,937
Net decrease in short-term borrowings	(4,750		)	(3,349		)
Excess tax benefits from stock-based compensation	2,837			4,120
Debt issuance costs	—			(47		)
Net cash used in by financing activities	(17,349		)	(11,362		)

Net decrease in cash and cash equivalents	(29,726		)	(25,931		)
Cash and cash equivalents, at beginning of period	87,915			116,255
Cash and cash equivalents, at end of period	$	58,189		$	90,324

See accompanying notes to condensed consolidated financial statements.

Index

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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 months ended June 29, 2013 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 29, 2013, and December 29, 2012 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 29, 2012 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, 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 29, 2013 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 consolidated financial statements as of or for the period ended June 29, 2013.

2. Fair Value Measurements

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. Our financial assets are valued using market prices based on either active markets (Level 1 measurements) or less active markets (Level 2 measurements).

Our Level 1 securities include U.S. Treasury securities as they trade with sufficient frequency and volume to enable us to obtain pricing information on a consistent basis. Our Level 2 securities include U.S. Agency bonds, corporate bonds and municipal bonds whose value is determined by a third-party pricing service using inputs that are observable in the market or can be derived principally from or corroborated by observable market data such as pricing for similar securities, recently executed transactions, cash flow models with yield curves and benchmark securities.

We did not have any transfers between Level 1 and Level 2 fair value measurements during the periods presented.

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Notes to Condensed Consolidated Financial Statements

(unaudited)

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 29, 2013, and December 29, 2012, according to the valuation techniques we used to determine their fair value (in thousands):



	June 29, 2013
	Level 1		Level 2		Level 3		Total
Marketable debt securities – current
U.S. Treasury securities	$	15,015	$	—	$	—	$	15,015
Corporate bonds	—		25,206		—		25,206
U.S. Agency bonds	—		10,014		—		10,014
Municipal bonds	—		3,552		—		3,552
	15,015		38,772		—		53,787
Marketable debt securities – non-current
U.S. Treasury securities	7,503		—		—		7,503
Corporate bonds	—		10,306		—		10,306
U.S. Agency bonds	—		7,531		—		7,531
Municipal bonds	—		3,162		—		3,162
	7,503		20,999		—		28,502
	$	22,518	$	59,771	$	—	$	82,289



	December 29, 2012
	Level 1		Level 2		Level 3		Total
Marketable debt securities – current
U.S. Treasury securities	$	17,538	$	—	$	—	$	17,538
Corporate bonds	—		21,549		—		21,549
U.S. Agency bonds	—		7,586		—		7,586
Municipal bonds	—		4,591		—		4,591
	17,538		33,726		—		51,264
Marketable debt securities – non-current
U.S. Treasury securities	15,004		—		—		15,004
Corporate bonds	—		10,359		—		10,359
U.S. Agency bonds	—		10,056		—		10,056
Municipal bonds	—		3,223		—		3,223
	15,004		23,638		—		38,642
	$	32,542	$	57,364	$	—	$	89,906

At June 29, 2013, and December 29, 2012, we had $0.9 million and $1.6 million, respectively, of debt and equity securities that fund our deferred compensation plan and are classified in other assets. We also had corresponding deferred compensation plan liabilities of $0.9 million and $1.6 million at June 29, 2013, and December 29, 2012, respectively, which are included in other long-term liabilities. 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.

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Notes to Condensed Consolidated Financial Statements

(unaudited)

3. Purchase of Comfortaire

On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems. We purchased Comfortaire to progress our role as the leader in delivering innovative products as part of an individualized sleep experience, while also strengthening our competitive advantages. The acquisition price was $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. The purchase of Comfortaire's business and assets did not have a significant impact on our consolidated results of operations, cash flows or financial position.

The following table summarizes the preliminary fair value of the net assets acquired as of June 29, 2013 (in thousands):



Accounts receivable	$	365
Inventories	678
Other assets	219
Property and equipment	509
Goodwill	6,157
Intangible assets	8,638
Total assets acquired	16,566
Accounts payable	344
Warranty liabilities	658
Other liabilities	64
Total liabilities acquired	1,066
Net assets acquired	$	15,500

The goodwill and identifiable intangible assets will be deductible for income tax purposes over a 15-year period on a straight-line basis. Purchase accounting is considered preliminary, subject to revision, mainly with respect to certain working capital accounts, taxes and goodwill, as final information was not available as of June 29, 2013.

Identifiable intangible assets and estimated useful lives are as follows (in thousands):



	Estimated
	Useful Life
Developed technologies	10 years	$	4,829
Customer relationships	7 years	2,413
Trade name/trademarks	Indefinite Lived	1,396
		$	8,638

4. Marketable Debt Securities

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



	June 29, 2013
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value⁽¹⁾
U.S. Treasury securities	$	22,504	$	14	$	—		$	22,518
Corporate bonds	35,569		—		(57		)	35,512
U.S. Agency bonds	17,544		7		(6		)	17,545
Municipal bonds	6,713		1		—			6,714
	$	82,330	$	22	$	(63	)	$	82,289

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Notes to Condensed Consolidated Financial Statements

(unaudited)



	December 29, 2012
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value⁽¹⁾
U.S. Treasury securities	$	32,518	$	24	$	—		$	32,542
Corporate bonds	31,929		2		(23		)	31,908
U.S. Agency bonds	17,632		11		(1		)	17,642
Municipal bonds	7,794		20		—			7,814
	$	89,873	$	57	$	(24	)	$	89,906

Maturities of marketable debt securities were as follows (in thousands):



	June 29, 2013				December 29, 2012
	Amortized Cost		Fair Value⁽¹⁾		Amortized Cost		Fair Value⁽¹⁾
Marketable debt securities – current (due in less than one year)	$	53,798	$	53,787	$	51,238	$	51,264
Marketable debt securities – non-current (due in one to two years)	28,532		28,502		38,635		38,642
	$	82,330	$	82,289	$	89,873	$	89,906

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

During three and six months ended June 29, 2013, respectively, $17.5 million and $23.3 million of marketable debt securities matured and were redeemed at face value. During the three and six months ended June 30, 2012, $10.0 million of marketable debt securities matured and were redeemed at face value. During the six months ended June 29, 2013, there were no other-than-temporary declines in market value.

5. Inventories

Inventories consisted of the following (in thousands):



	June 29, 2013		December 29, 2012
Raw materials	$	6,230	$	5,089
Work in progress	217		236
Finished goods	28,026		30,239
	$	34,473	$	35,564

6. Goodwill and Intangible Assets

Goodwill is the difference between the purchase price of a company and the fair market value of the acquired company's net identifiable assets. Intangible assets include developed technology, trade names/trademarks and customer relationships. Definite-lived intangible assets are being amortized using the straight-line method over their estimated lives, ranging from 7-17 years. Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment using a fair value approach. Goodwill and indefinite-lived intangible assets are tested for impairment annually or when there are indicators of impairment. Definite-lived intangible assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable.

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Notes to Condensed Consolidated Financial Statements

(unaudited)

Goodwill and Indefinite-Lived Intangible Assets

The following is a rollforward of goodwill and indefinite-lived trade name/trademarks (in thousands):



	Six Months Ended				Six Months Ended
	June 29, 2013				June 30, 2012
	Goodwill		Indefinite-Lived Trade Name/ Trademarks		Goodwill		Indefinite-Lived Trade Name/ Trademarks
	Goodwill		Indefinite-Lived Trade Name/ Trademarks		Goodwill		Indefinite-Lived Trade Name/ Trademarks
Beginning balance	$	2,850	$	—	$	2,850	$	—
Comfortaire purchase	6,157		1,396		—		—
Ending balance	$	9,007	$	1,396	$	2,850	$	—

Definite-Lived Intangible Assets

The following table provides the gross carrying amount and related accumulated amortization of our definite-lived intangible assets (in thousands):



	June 29, 2013				December 29, 2012
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Developed technologies⁽¹⁾	$	5,231	$	601	$	402	$	371
Customer relationships⁽¹⁾	2,413		158		—		—
Trade names/trademarks	102		102		102		101
	$	7,746	$	861	$	504	$	472

⁽¹⁾ On January 17, 2013, in connection with the purchase of the business and assets of Comfortaire, we acquired definite-lived intangible assets, including developed technologies of $4.8 million and customer relationships of $2.4 million.

The amortization expense for definite-lived intangible assets was $0.3 million and $0.4 million for the three and six months ended June 29, 2013, respectively, and $5 thousand and $9 thousand for the three and six months ended June 30, 2012, respectively. Annual amortization for definite-lived intangible assets is expected to be $0.8 million for each of the next five years.

See Note 3, Purchase of Comfortaire, for details regarding our purchase of the business and assets of Comfortaire.

7. Debt

Credit Agreement

Our $20.0 million Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association is an unsecured revolving credit facility that matures on April 23, 2015. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20.0 million to up to $50.0 million in total availability, subject to lender approval.

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 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.

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Notes to Condensed Consolidated Financial Statements

(unaudited)

At both June 29, 2013, and December 29, 2012, $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 29, 2013 or December 29, 2012.

8. Repurchase of Common Stock

Repurchases of our common stock for the three and six months ended June 29, 2013 and June 30, 2012 were as follows (in thousands):



	Three Months Ended				Six Months Ended
	June 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Amount repurchased under Board approved share repurchase program	$	10,009	$	10,007	$	20,018	$	10,007
Amount repurchased in connection with the vesting of employee restricted stock grants	1,878		2,801		2,013		4,016
Total amount repurchased	$	11,887	$	12,808	$	22,031	$	14,023

As of June 29, 2013, the remaining authorization under our Board of Directors ("Board") approved share repurchase program was $156.7 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.

9. 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. Compensation expense, net of estimated forfeitures, is recognized ratably over the vesting period.

Stock-based compensation expense for the three and six months ended June 29, 2013 and June 30, 2012, was as follows (in thousands):



	Three Months Ended						Six Months Ended
	June 29, 2013			June 30, 2012			June 29, 2013		June 30, 2012
Stock options	$	732		$	607		1,277		2,618
Stock awards	828			798			715		5,752
Total stock-based compensation expense⁽¹⁾	1,560			1,405			1,992		8,370
Income tax benefit	(537		)	(482		)	(685	)	(2,871	)
Total stock-based compensation expense, net of tax	$	1,023		$	923		1,307		5,499

⁽¹⁾ Includes $(0.4) million and $5.6 million of CEO transition (benefit) costs for the six months ended June 29, 2013 and June 30, 2012, respectively. There were no CEO transition (benefit) costs for the three months ended June 29, 2013 or June 30, 2012.

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 Compensation Committee approved the modification of Mr. McLaughlin’s currently unvested stock awards, including performance-based stock awards. The performance-based stock awards are subject to applicable performance adjustments through 2014 based on free cash flow and actual market share growth versus performance targets. During the six months ended June 30, 2012, we incurred $5.6 million ($3.7 million, net of income tax) of non-recurring, non-cash expenses associated with these stock award modifications. During the six months ended June 29, 2013, we recorded a non-cash compensation benefit of $0.4 million ($0.3 million, net of income tax) resulting from performance-based stock award adjustments. There were no CEO transition (benefits) costs for the three months ended June 29, 2013 or June 30, 2012.

SELECT COMFORT CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

10. 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 29, 2013 and June 30, 2012 our contributions, net of forfeitures, were $0.8 million and $0.5 million, respectively. During the six months ended June 29, 2013 and June 30, 2012 our contribution net of forfeitures, were $1.5 million and $1.1 million, respectively.

11. Other Income, Net

Other income, net, consisted of the following (in thousands):



	Three Months Ended						Six Months Ended
	June 29, 2013			June 30, 2012			June 29, 2013			June 30, 2012
Interest income	$	91		$	68		196			117
Interest expense	(13		)	(20		)	(27		)	$	(62	)
Other income, net	$	78		$	48		$	169		$	55

12. 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 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Net income	$	9,926	$	16,973	$	33,397	$	39,390

Reconciliation of weighted-average shares outstanding:
Basic weighted-average shares outstanding	55,029		55,719		55,062		55,680
Effect of dilutive securities:
Options	539		1,129		613		1,099
Restricted shares	419		546		426		588
Diluted weighted-average shares outstanding	55,987		57,394		56,101		57,367

Net income per share – basic	$	0.18	$	0.30	$	0.61	$	0.71
Net income per share – diluted	$	0.18	$	0.30	$	0.60	$	0.69

We excluded potentially dilutive stock options totaling 1.3 million and 1.3 million for the three and six months ended June 29, 2013, respectively, and 0.3 million and 0.3 million for the three and six months ended June 30, 2012, 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.

SELECT COMFORT CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

13. 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 29, 2013			June 30, 2012
Balance at beginning of year	$	5,330		$	4,402
Additions that reduce net sales	23,388			22,480
Deductions from reserves	(22,963		)	(21,765		)
Acquired sales return reserve	50			—
Balance at end of period	$	5,805		$	5,117

Warranty Liabilities

During the second quarter of 2013, we extended the limited warranty on our beds to 25 years. The change is not expected to have a significant impact on our warranty expense. The customer participates over the last 23 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.

We classify as non-current 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 29, 2013			June 30, 2012
Balance at beginning of year	$	4,858		$	6,310
Additions charged to costs and expenses for current-year sales	2,113			1,832
Deductions from reserves	(2,568		)	(2,435		)
Changes in liability for pre-existing warranties during the current year, including expirations	(117		)	151
Acquired warranty reserve	658			—
Balance at end of period	$	4,944		$	5,858

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.

Index



ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in seven sections:


•	Risk Factors


•	Overview


•	Results of Operations


•	Liquidity and Capital Resources


•	Non-GAAP Data Reconciliations


•	Off-Balance-Sheet Arrangements and Contractual Obligations


•	Critical Accounting Policies

Risk Factors

The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included herein. This quarterly report on Form 10-Q contains certain forward-looking statements that relate to future plans, events, financial results or performance. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections.

These risks and uncertainties include, among others:


•	Current and future general and industry economic trends and consumer confidence;


•	The effectiveness of our marketing messages;


•	The efficiency of our advertising and promotional efforts;


•	Our ability to execute our Company-Controlled distribution strategy;


•	Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;


•	Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;


•	Industry competition, the emergence of additional competitive products, and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;


•	Availability of attractive and cost-effective consumer credit options;


•	Pending and unforeseen litigation and the potential for adverse publicity associated with litigation;


•	Our “just-in-time” manufacturing processes with minimal levels of inventory, which may leave us vulnerable to shortages in supply;


•	Our dependence on significant suppliers and our ability to maintain relationships with key suppliers, including several sole-source suppliers;


•	Rising commodity costs and other inflationary pressures;


•	Risks inherent in global sourcing activities;


•	Risks of disruption in the operation of either of our two manufacturing facilities;


•	Increasing government regulation;


•	The adequacy of our management information systems to meet the evolving needs of our business and existing and evolving regulatory standards applicable to data privacy and security;


•	The costs and potential disruptions to our business related to upgrading our management information systems;


•	Our ability to attract, retain and motivate qualified management, executive and other key employees, including qualified retail sales professionals and managers; and


•	Uncertainties arising from global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events.

Additional information concerning these and other risks and uncertainties is contained under the caption “Risk Factors” in our Annual Report on Form 10-K.

Index

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

Overview

Business Overview

We believe we are leading the industry in delivering an unparalleled sleep experience by offering consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of Sleep Number® beds and bedding. We are the exclusive manufacturer, marketer, retailer and servicer of the revolutionary Sleep Number bed, which allows individuals to adjust the firmness and support of each side at the touch of a button. We offer further personalization through our solutions-focused line of Sleep Number pillows, sheets and other bedding products.

As the only national specialty-mattress retailer, we generate revenue by selling products through two distribution channels. Our Company-Controlled channel, which includes Retail, Direct Marketing and E-Commerce, sells directly to consumers. Our Wholesale/Other channel sells to and through selected retail and wholesale customers in the United States and Australia, and the QVC shopping channel.

Mission, Vision and Strategy

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

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


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


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


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


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


•	Leveraging our unique business model to fund innovation and growth will benefit our customers, employees and shareholders.

Results of Operations

Quarterly and Annual Results

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

Highlights

Financial highlights for the three months ended June 29, 2013 were as follows:


•	Net income decreased 42% to $9.9 million, or $0.18 per diluted share, compared with net income of $17.0 million, or $0.30 per diluted share, for the same period one year ago.

•

Net sales increased 1% to $207.4 million, compared with $205.2 million for the same period one year ago. The net sales increase was primarily driven by sales from 32 net new stores opened in the past 12 months, partially offset by a 6% comparable sales decrease in our Company-Controlled channel. Changes to media buying in the first quarter of 2013 were a key contributing factor to the 6% comparable sales decline. Management took decisive action to correct the media buying issue and during the second quarter of 2013, monthly sales trends improved on a sequential basis.


•	Operating income decreased to $15.1 million, or 7.3% of net sales, for the three months ended June 29, 2013 compared with $25.9 million, or 12.6% of net sales, for the same period one year ago. The decline in operating income was primarily due to an increase in fixed sales and marketing expenses associated with new, repositioned and remodeled stores.

Index


•	Retail sales-per-store (for stores open at least one year), on a trailing twelve-month basis, increased by 4% from one year ago to $2.1 million.


•	Cash provided by operating activities totaled $36.1 million for the six months ended June 29, 2013, compared with $43.2 million for the same period one year ago.


•	At June 29, 2013, cash, cash equivalents and marketable debt securities totaled $140.5 million compared with $177.8 million at December 29, 2012, and we had no borrowings under our revolving credit facility. In the second quarter of 2013, we repurchased 471,732 shares of our common stock under our Board approved share repurchase program at a cost of $10.0 million ($21.22 per share).

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 29, 2013				June 30, 2012				June 29, 2013					June 30, 2012
Net sales	$	207.4	100.0	%	$	205.2	100.0	%	$	465.6		100.0	%	$	467.6	100.0	%
Cost of sales	76.0		36.6	%	73.6		35.9	%	170.8			36.7	%	171.7		36.7	%
Gross profit	131.4		63.4	%	131.6		64.1	%	294.8			63.3	%	295.9		63.3	%

Operating expenses:
Sales and marketing	98.4		47.4	%	88.2		43.0	%	208.2			44.7	%	194.4		41.6	%
General and administrative	15.4		7.4	%	16.2		7.9	%	31.5			6.8	%	33.1		7.1	%
Research and development	2.6		1.2	%	1.3		0.6	%	5.1			1.1	%	2.5		0.5	%
CEO transition (benefit) costs	—		0.0	%	—		0.0	%	(0.4		)	(0.1	)%	5.6		1.2	%
Asset impairment charges	—		0.0	%	—		0.0	%	—			0.0	%	—		0.0	%
Total operating expenses	116.3		56.1	%	105.7		51.5	%	244.5			52.5	%	235.7		50.4	%
Operating income	15.1		7.3	%	25.9		12.6	%	50.3			10.8	%	60.1		12.9	%
Operating income – as adjusted ⁽¹⁾	15.1		7.3	%	25.9		12.6	%	49.9			10.7	%	65.7		14.1	%
Other income, net	0.1		0.0	%	—		0.0	%	0.2			0.0	%	0.1		0.0	%
Income before income taxes	15.2		7.3	%	25.9		12.6	%	50.5			10.8	%	60.2		12.9	%
Income tax expense	5.3		2.5	%	8.9		4.3	%	17.1			3.7	%	20.8		4.5	%
Net income	$	9.9	4.8	%	$	17.0	8.3	%	$	33.4		7.2	%	$	39.4	8.4	%
Net income – as adjusted ⁽¹⁾	$	9.9	4.8	%	$	17.0	8.3	%	$	33.1		7.1	%	$	43.1	9.2	%

Net income per share:
Basic	$	0.18			$	0.30			$	0.61				$	0.71
Diluted	$	0.18			$	0.30			$	0.60				$	0.69
Diluted – as adjusted ⁽¹⁾	$	0.18			$	0.30			$	0.59				$	0.75

Weighted-average number of common shares:
Basic	55.0				55.7				55.1					55.7
Diluted	56.0				57.4				56.1					57.4


⁽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 23 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 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Company-Controlled channel	96.1	%	96.4	%	95.4	%	96.3	%
Wholesale/Other channel	3.9	%	3.6	%	4.6	%	3.7	%
Total	100.0	%	100.0	%	100.0	%	100.0	%

Index

The components of total net sales change, including comparable net sales changes, were as follows:



	Three Months Ended				Six Months Ended
	June 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Sales change rates:
Retail comparable-store sales	(7	%)	27	%	(7	%)	32	%
Direct and E-Commerce	4	%	8	%	(9	%)	13	%
Company-Controlled comparable sales change	(6	%)	25	%	(8	%)	30	%
Net store openings/closings	7	%	3	%	7	%	2	%
Total Company-Controlled channel	1	%	28	%	(1	%)	32	%
Wholesale/Other channel	7	%	11	%	23	%	19	%
Total net sales change	1	%	27	%	0	%	32	%

Other sales metrics were as follows:



	Three Months Ended						Six Months Ended
	June 29, 2013			June 30, 2012			June 29, 2013		June 30, 2012
Average sales per store⁽¹⁾ ($ in thousands)	$	2,094		$	2,012
Average sales per square foot⁽¹⁾	$	1,197		$	1,281
Stores > $1 million in net sales⁽¹⁾	98		%	98		%
Stores > $2 million in net sales⁽¹⁾	46		%	42		%
Average net sales per mattress unit – Company-Controlled channel⁽²⁾	$	3,182		$	3,087		$	3,154	$	2,889

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

⁽²⁾ Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.

The number of retail stores was as follows:



	Three Months Ended				Six Months Ended
	June 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Beginning of period	411		380		410		381
Opened	17		12		27		22
Closed	(15	)	(11	)	(24	)	(22	)
End of period	413		381		413		381

Index

Comparison of Three Months Ended June 29, 2013 with Three Months Ended June 30, 2012

Net sales

Net sales increased 1% to $207.4 million for the three months ended June 29, 2013, compared with $205.2 million for the same period one year ago. The net sales increase was primarily driven by sales from 32 net new stores opened in the past 12 months, partially offset by a 6% comparable sales decrease in our Company-Controlled channel. Changes to our media buying in the first quarter of 2013, which negatively impacted customer traffic and sales, were a key contributing factor to the 6% comparable sales decline. Management took decisive action to correct the media buying issue, and during the second quarter of 2013, monthly sales trends improved on a sequential basis.

The $2.2 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $12.6 million sales increase resulting from net new store openings, partially offset by an $11.5 million decrease in sales from our Company-Controlled comparable retail stores; (ii) a $0.6 million increase in Direct and E-Commerce sales; and (iii) a $0.5 million increase in Wholesale/Other channel sales. Company-Controlled mattress units decreased 2% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 3%.

Gross profit

The gross profit rate decreased to 63.4% of net sales for the three months ended June 29, 2013, compared with 64.1% for the prior-year period. A sales mix shift to lower-margin products, including a lower-margin special-edition mattress offered during our Memorial Day promotional event and a higher sales mix of our lower-margin bedding collection products reduced gross profit rate by 0.8 percentage points (“ppt.”) compared to the same period one year ago. This gross profit rate reduction was partially offset by supply chain efficiencies (0.4 ppt.). The remaining rate change is due to a variety of factors that can fluctuate from quarter-to-quarter, including sales return and exchange costs, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses

Sales and marketing expenses for the three months ended June 29, 2013 increased 11% to $98.4 million, or 47.4% of net sales, compared with $88.2 million, or 43.0% of net sales, for the same period one year ago. The $10.1 million expense increase was primarily due to (i) $6.0 million of incremental fixed costs associated with new, repositioned and remodeled stores; (ii) a $1.8 million, or 6%, increase in media spending; (iii) a $1.6 million increase in financing costs, as a greater percentage of our customers utilized promotional financing to purchase our products; and (iv) a $1.5 million increase in variable compensation for our store employees. These increases were partially offset by lower percentage rent. The sales and marketing expense rate increased 4.4 ppt. compared with the same period one year ago due to the factors noted above and the deleveraging impact of the 6% comparable sales decrease.

General and administrative expenses

General and administrative (“G&A”) expenses decreased $0.9 million to $15.4 million for the three months ended June 29, 2013, compared with $16.2 million in the same period one year ago, and decreased to 7.4% of net sales, compared with 7.9% of net sales last year. The $0.9 million decrease in G&A expenses was primarily due to (i) a $2.5 million decrease in performance-based incentive compensation and stock-based compensation; and (ii) a $0.4 million net decrease in miscellaneous other expenses, partially offset by (i) a $1.5 million increase in employee compensation resulting from headcount increases to support business growth initiatives, and salary and wage rate increases that were in line with inflation; and (ii) $0.5 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business. The G&A expense rate decreased by 0.5 ppt. in the current period compared with the same period one year ago due to the net reduction in expenses.

Research and development expenses

Research and development expenses for the three months ended June 29, 2013 were $2.6 million, or 1.2% of net sales, compared with $1.3 million, or 0.6% of net sales, for the same period one year ago. The $1.3 million change in R&D expenses was due to increased investments to support product innovations during the current year and the company's long-term product innovation roadmap.

Asset impairment charges

During the three months ended June 29, 2013 and June 30, 2012, we recognized asset impairment charges of $15 thousand and $3 thousand, respectively, related to certain store assets.

Other income, net

Other income, net was $0.1 million for the three months ended June 29, 2013, compared with other income, net of $48 thousand for the comparable period one year ago. The current-year improvement in other income, net was primarily due to a higher average yield on our portfolio in the current-year period, and a reduction of fees associated with our line of credit.

Index

Income tax expense

Income tax expense was $5.3 million for the three months ended June 29, 2013 compared with $8.9 million for the same period one year ago. The effective tax rate for the three months ended June 29, 2013 was 34.6%, consistent with the prior-year period rate of 34.5%.

Comparison of Six Months Ended June 29, 2013 with Six Months Ended June 30, 2012

Net sales

Net sales decreased 0.4% to $465.6 million for the six months ended June 29, 2013, compared with $467.6 million for the same period one year ago. The sales decrease was primarily driven by an 8% comparable sales decrease in our Company-Controlled channel, partially offset by sales from 32 net new stores opened in the past 12 months. Changes to our media buying in the first quarter of 2013, which negatively impacted customer traffic and sales, were a key contributing factor to the 8% comparable sales decline. Management took decisive action to correct the media buying issue, and during the second quarter of 2013, monthly sales trends improved on a sequential basis.

The $2.0 million net sales decrease compared with the same period one year ago was comprised of the following: (i) a $28.5 million decrease in sales from our Company-Controlled comparable retail stores, partially offset by a $25.7 million sales increase resulting from net new store openings; (ii) a $3.2 million decrease in Direct and E-Commerce sales; and (iii) a $4.1 million increase in Wholesale/Other channel sales. Company-Controlled mattress units decreased 10% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 9%.

Gross profit

Our 63.3% gross profit rate for the six months ended June 29, 2013 was consistent with the comparable period last year. Price increases associated with product innovation over the last 12 months positively impacted the gross profit rate by 0.7 ppt. for the six months ended June 29, 2013, compared with the same period one year ago. The current-year gross profit rate also benefited from supply chain efficiencies. A higher sales mix of our lower-margin bedding collection products reduced gross profit rate by 0.6 ppt. compared to last year. The remaining year-over-year rate change was due to a variety of factors that can fluctuate from quarter to quarter, including sales return and exchange costs, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses

Sales and marketing expenses for the six months ended June 29, 2013 increased 7% to $208.2 million, or 44.7% of net sales, compared with $194.4 million, or 41.6% of net sales, for the same period one year ago. The $13.7 million increase was primarily due to (i) an $11.1 million increase in fixed selling expenses due to new, repositioned and remodeled stores; (ii) a $4.7 million, or 7%, increase in media spending; and (iii) a $2.2 million increase in customer financing expenses, as a larger percentage of our customers took advantage of promotional financing offers. These increases were partially offset by lower percentage rent ($2.3 million) and a net decrease in miscellaneous other expenses. The sales and marketing expense rate increased 3.1 ppt. compared with the same period one year ago due to the increase in expenses noted above and the deleveraging impact of the 8% comparable sales decrease.

General and administrative expenses

General and administrative (“G&A”) expenses decreased $1.6 million to $31.5 million for the six months ended June 29, 2013, compared with $33.1 million in the prior year, and decreased to 6.8% of net sales, compared with 7.1% of net sales one year ago. The $1.6 million decrease in G&A expenses was primarily due to a $6.0 million decrease in performance-based incentive compensation and stock-based compensation, partially offset by (i) a $2.9 million increase in employee compensation resulting from headcount increases to support business growth initiatives, and salary and wage rate increases that were in line with inflation; (ii) $1.2 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business; and (iii) a $0.3 million net increase in miscellaneous other expenses. The G&A expense rate decreased by 0.3 ppt. in the current period compared with the same period one year ago due to the net reduction in expenses.

Research and development expenses

Research and development expenses for the six months ended June 29, 2013 were $5.1 million, or 1.1% of net sales, compared with $2.5 million, or 0.5% of net sales, for the same period one year ago. The $2.6 million increase was due to increased investments to support product innovations during the current year and the company's long-term product innovation roadmap.

Asset impairment charges

During the six months ended June 29, 2013 and June 30, 2012, we recognized asset impairment charges of $45 thousand and $7 thousand, respectively, related to certain store assets.

Index

CEO transition costs

Other income, net

Other income, net was $0.2 million for the six months ended June 29, 2013, compared with $0.1 million for the comparable period one year ago. The current-year improvement in other income, net was primarily due to a higher average yield on our portfolio in the current-year period, and a reduction of fees associated with our line of credit.

Income tax expense

Income tax expense was $17.1 million for the six months ended June 29, 2013, compared with $20.8 million for the same period one year ago. The effective tax rate for the six months ended June 29, 2013 decreased to 33.9% compared with 34.6% for the prior-year period. The 2013 effective tax rate was positively impacted by the retroactive reinstatement of the research and development tax credit.

Liquidity and Capital Resources

As of June 29, 2013, cash, cash equivalents and marketable debt securities totaled $140.5 million compared with $177.8 million as of December 29, 2012. The $37.3 million decrease was primarily due to $36.1 million of cash provided by operating activities offset by $37.1 million of cash used to purchase property and equipment, $18.5 million of strategic investments, including the purchase of Comfortaire (see discussion below), and $22.0 million of cash used to repurchase our common stock. The $82.3 million of marketable debt securities held as of June 29, 2013 are all highly liquid and include U.S. government and agency securities, corporate debt securities and municipal bonds.

The following table summarizes our cash flows for the six months ended June 29, 2013, and June 30, 2012 (dollars in millions). Amounts may not add due to rounding differences:



	Six Months Ended
	June 29, 2013			June 30, 2012
Total cash provided by (used in):
Operating activities	$	36.1		$	43.2
Investing activities	(48.5		)	(57.8		)
Financing activities	(17.3		)	(11.4		)
Net decrease in cash and cash equivalents	$	(29.7	)	$	(25.9	)

Cash provided by operating activities for the six months ended June 29, 2013 was $36.1 million compared with $43.2 million for the six months ended June 30, 2012. The $7.1 million year-over-year decrease in cash from operating activities was comprised of a $6.0 million decrease in net income for the six months ended June 29, 2013 compared with the same period one year ago and a $7.6 million decrease in cash from changes in operating assets and liabilities, partially offset by a $6.5 million increase in adjustments to reconcile net income to net cash provided by operating activities.

Net cash used in investing activities was $48.5 million for the six months ended June 29, 2013, compared with $57.8 million for the same period one year ago. Investing activities for the current-year period included $37.1 million of property and equipment purchases, compared with $22.5 million for the same period one year ago. Capital expenditures - primarily for new, repositioned and remodeled stores, information technology and product innovation - are projected to be approximately $70 - $80 million in 2013 compared with $51.6 million in 2012. On a net basis, we reduced our investment in marketable debt securities by $7.0 million during the six months ended June 29, 2013 compared with a net investment of $35.3 million during the comparable period one year ago. On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems, for $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. We purchased Comfortaire to progress our role as the leader in delivering innovative products as part of an individualized sleep experience, while also strengthening our competitive advantages. See Note 3, Purchase of Comfortaire, of the Notes to

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Condensed Consolidated Financial Statements for further details. Finally, we made a $3.0 million minority equity investment in one of our strategic product-development partners and committed to invest an additional $1.5 million during the remainder of 2013.

Net cash used in financing activities was $17.3 million for the six months ended June 29, 2013, compared with $11.4 million for the same period one year ago. During the six months ended June 29, 2013, we repurchased $22.0 million of our stock ($20.0 million under our Board approved share repurchase program and $2.0 million in connection with the vesting of employee restricted stock grants) compared with $14.0 million ($10.0 million under our Board approved share repurchase program and $4.0 million in connection with the vesting of employee restricted stock grants) during the same period one year ago. Changes in book overdrafts and payments on capital lease obligations 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.

During the second quarter of 2012, we reinitiated repurchasing our common stock. Our current objective is to maintain common shares outstanding at or below existing levels. Under the Board approved $290 million share repurchase program, we repurchased 930,369 shares at a cost of $20.0 million ($21.52 per share) during the six months ended June 29, 2013. During the six months ended June 30, 2012, we repurchased 409,770 shares at a cost of $10.0 million (24.42 per share). As of June 29, 2013, the remaining authorization under our Board approved share repurchase program was $156.7 million. There is no expiration date governing the period over which we can repurchase shares.

Our $20.0 million Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association is an unsecured revolving credit facility that matures April 23, 2015. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20.0 million to up to $50.0 million in total availability, subject to lender approval. As of June 29, 2013 we were in compliance with all financial covenants.

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.

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 $140.5 million of cash, cash equivalents and marketable debt securities, cash generated from ongoing operations, and cash available under our revolving credit facility are expected to be adequate to maintain operations and fund anticipated expansion and strategic initiatives for the foreseeable future.

We have an agreement with GE Capital Retail Bank to offer qualified customers revolving credit arrangements to finance purchases from us (“GE Agreement”). The GE Agreement contains certain financial covenants, including a minimum tangible net worth requirement and a minimum cash requirement. As of June 29, 2013 we were in compliance with all financial covenants.

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

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Non-GAAP Data Reconciliations

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

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



	Six Months Ended							Six Months Ended
	June 29, 2013							June 30, 2012
	As Reported		CEO Transition Benefit⁽¹⁾			As Adjusted		As Reported		CEO Transition Costs⁽¹⁾		As Adjusted


Operating income	$	50,334	$	(391	)	$	49,943	$	60,148	$	5,595	$	65,743
Other income, net	169		—			169		55		—		55
Income before income taxes	50,503		(391		)	50,112		60,203		5,595		65,798
Income tax expense/(benefit)⁽²⁾	17,106		(135		)	16,971		20,813		1,919		22,732
Net income	$	33,397	$	(256	)	$	33,141	$	39,390	$	3,676	$	43,066

Net income per share –
Basic	$	0.61	$	0.00		$	0.60	$	0.71	$	0.07	$	0.77
Diluted	$	0.60	$	0.00		$	0.59	$	0.69	$	0.06	$	0.75

Basic Shares	55,062		55,062			55,062		55,680		55,680		55,680
Diluted Shares	56,101		56,101			56,101		57,367		57,367		57,367

__________________________

⁽¹⁾ In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin’s contributions, the Compensation Committee approved the modification of Mr. McLaughlin’s currently unvested stock awards, including performance-based stock awards. The performance-based stock awards are subject to applicable performance adjustments through 2014 based on free cash flow and actual market share growth versus performance targets. During the six months ended June 30, 2012, we incurred $5.6 million ($3.7 million, net of income tax) of non-recurring, non-cash expenses associated with these stock award modifications. During the six months ended June 29, 2013, we recorded a non-cash compensation benefit of $0.4 million ($0.3 million, net of income tax) resulting from performance-based stock award adjustments.

⁽²⁾ Reflects effective income tax rates, before discrete adjustments, of 34.4% for 2013 and 34.3% for 2012.

GAAP - generally accepted accounting principles

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Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA)

We define earnings before interest, taxes, depreciation and amortization as net income plus: income tax expense, interest expense, depreciation and amortization, stock-based compensation and asset impairments (“Adjusted EBITDA”). 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 for the three months and trailing-twelve months ended June 29, 2013 and June 30, 2012 are as follows (dollars in thousands):



	Three Months Ended				Trailing-Twelve Months Ended
	June 29, 2013		June 30, 2012		June 29, 2013		June 30, 2012
Net income	$	9,926	$	16,973	$	72,101	$	71,996
Income tax expense	5,259		8,927		38,204		34,663
Interest expense	13		20		55		130
Depreciation and amortization	7,172		4,726		24,284		16,090
Stock-based compensation	1,560		1,405		3,929		11,084
Asset impairments	15		3		186		19
Adjusted EBITDA	$	23,945	$	32,054	$	138,759	$	133,982

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 operations,” 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 for the six months and trailing-twelve months ended June 29, 2013, and June 30, 2012 (dollars in thousands):



	Six Months Ended					Trailing-Twelve Months Ended
	June 29, 2013			June 30, 2012		June 29, 2013		June 30, 2012
Net cash provided by operating activities	$	36,143		$	43,233	$	93,536	$	100,594
Subtract: Purchases of property and equipment	37,096			22,499		66,190		36,441
Free cash flow	$	(953	)	$	20,734	$	27,346	$	64,153

Off-Balance-Sheet Arrangements and Contractual Obligations

As of June 29, 2013, 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 June 29, 2013.

There has been no material change in our contractual obligations since the end of fiscal 2012. See Note 7, Debt, 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 December 29, 2012 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 December 29, 2012. There were no significant changes in our critical accounting policies since the end of fiscal 2012.

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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 June 29, 2013 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 June 29, 2013, 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 June 29, 2013, 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

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
March 31, 2013 through April 27, 2013	166,240	$	18.82	166,240	$	163,602,000
April 28, 2013 through May 25, 2013	144,760	21.60		144,760	160,475,000
May 26, 2013 through June 29, 2013	243,621	23.12		160,732	156,720,000
Total	554,621	$	21.43	471,732	$	156,720,000

⁽¹⁾

Under the current Board approved $290.0 million share repurchase program, we repurchased 471,732 shares of our common stock at a cost of $10.0 million (based on trade dates) during the three months ended June 29, 2013. As of June 29, 2013, the remaining authorization under our Board approved share repurchase program was $156.7 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.


⁽²⁾	In connection with the vesting of employee restricted stock grants, we also repurchased 82,889 shares of our common stock at a cost of $1.9 million, during the three months ended June 29, 2013.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

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ITEM 6. EXHIBITS



Exhibit Number	Description	Method of Filing

10.1	Select Comfort Corporation Amended and Restated 2010 Omnibus Incentive Plan	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed May 15, 2013 (File No. 0-25121)

31.1	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith

31.2	Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith

32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith

32.2	Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith

101	The following financial information from the Company's Quarterly Report on Form 10-Q for the quarter ended ended June 29, 2013, filed with the SEC on July 26, 2013, formatted in eXtensible Business Reporting Language: (i) Condensed Consolidated Balance Sheets as of June 29, 2013 and December 29, 2012, (ii) Condensed Consolidated Statements of Operations for the three and six months ended June 29, 2013 and June 30, 2012, (iii) Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 29, 2013 and June 30, 2012, (iv) Condensed Consolidated Statement of Shareholders' Equity for the six months ended June 29, 2013, (v) Condensed Consolidated Statements of Cash Flows for the six months ended June 29, 2013 and June 30, 2012, and (vi) Notes to Condensed Consolidated Financial Statements.	Filed herewith⁽¹⁾

⁽¹⁾

Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		SELECT COMFORT CORPORATION
		(Registrant)

Dated:	July 29, 2013	By:	/s/ Shelly R. Ibach
			Shelly R. Ibach
			Chief Executive Officer
			(principal executive officer)

		By:	/s/ Robert J. Poirier
			Robert J. Poirier
			Chief Accounting Officer
			(principal accounting officer)

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EXHIBIT INDEX



Exhibit Number	Description	Method of Filing

10.1	Select Comfort Corporation Amended and Restated 2010 Omnibus Incentive Plan	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed May 15, 2013 (File No. 0-25121)

31.1	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith

31.2	Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith

32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith

32.2	Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith



101	The following financial information from the Company's Quarterly Report on Form 10-Q for the quarter ended ended June 29, 2013, filed with the SEC on July 26, 2013, formatted in eXtensible Business Reporting Language: (i) Condensed Consolidated Balance Sheets as of June 29, 2013 and December 29, 2012, (ii) Condensed Consolidated Statements of Operations for the three and six months ended June 29, 2013 and June 30, 2012, (iii) Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 29, 2013 and June 30, 2012, (iv) Condensed Consolidated Statement of Shareholders' Equity for the six months ended June 29, 2013, (v) Condensed Consolidated Statements of Cash Flows for the six months ended June 29, 2013 and June 30, 2012, and (vi) Notes to Condensed Consolidated Financial Statements.	Filed herewith⁽¹⁾

⁽¹⁾