Phase 4 Individual Assignment
- 1. Select Comfort Select Comfort Key Assignment Phase 4 Individual Project Joseph Ortiz Professor Jackie Russell Colorado Technical University May 6th, 2012 1
- 2. Select Comfort Select Comfort Select Comfort is a manufacturer of adjustable air-chamber mattresses branded Sleep Number beds as well as their bases and bedding accessories. They were founded more than twenty years ago and currently sell their products almost exclusively through company-owned retail stores, direct marketing, and sleepnumber.com (Investor Relations, 2012). Like many companies of the time, Select Comfort grew rapidly through the middle of the last decade until the recession hit forced them to streamline operations in order to remain viable. They do seem to have rebounded well with this newer strategy and have improved in many key areas from 2010 to 2011. This report will analyze those trends and compare them to the furniture industry. Additionally, we will examine the costs Select Comfort incurs to manufacture their beds and accessories and determine the most efficient way of recording these costs. Finally, we will conclude with the overall health of the Select Comfort company and whether any recommendations for financial improvement can be made. Ratio Analysis 2011 2010 Industry Average Current ratio 1.61 1.21 1.84 Acid-test (quick) ratio 1.09 0.89 1.31 Debt ratio 0.51 0.66 Data Unavailable Inventory turnover 12.26 12.89 5.57 Accounts receivable turnover 62.58 80.74 26.5 Return on net sales 0.081 0.052 Data Unavailable Return on total assets 0.280 0.219 0.096 Return on common stockholder’s equity 0.646 0.785 0.163 Earnings per share 1.07 0.57 Data Unavailable (CNNMoney, 2012) (Investor Relations, 2012) (Reuters, 2012) 2
- 3. Select Comfort Above, you can see the performance of Select Comfort in specific key ratios that will help us determine their ability to pay current liabilities, pay long-term debt, sell through their inventory, and collect on receivables, as well as analyze their profitability and attractiveness to investors. They can also help identify possible fraud if ratios are found to be abnormally higher than average, it could indicate that certain assets or liabilities are not being reported. With the implementation of The Sarbanes-Oxley Act of 2002, there is even greater scrutiny on companies to make accurate financial reporting to the public (Kotler & Armstrong, 2012). We will review each of these ratios on an individual level. The current ratio measures how much in current assets a company has above how much it has in current liabilities. Anything above a 1.00 indicates that the company has more than enough assets to cover its liabilities (Kotler & Armstrong, 2012). Select comfort had a current ratio of 1.61 in 2011 which was up 33% from the previous year. However, it is still below the home furnishing industry average of 1.84. This ratio represents a positive for the company. It is trending upward and although not yet at the industry average, the reason can, in part, be explained by Select Comfort’s just-in-time inventory philosophy where each bed is assembled after it is purchased, leaving low average levels of inventory, which contributes to the slightly below average current ratio. The advantage of a lower inventory level will be discussed at length in a proceeding section. The acid-test (quick ratio) is a measurement of liquidity. It analyses a company’s ability to pay its current liabilities with the cash it has on hand, plus any short-term investments and current receivables (Kotler & Armstrong, 2012). A quick ratio of 1.09 means that Select Comfort could theoretically pay all of its current liabilities if they were all to become due immediately. Their 2010 quick ratio of .89 means that in that year, they could not. The industry average of 3
- 4. Select Comfort 1.31 is significantly higher than in many other industries where the average is between .90 and 1.00 (Kotler & Armstrong, 2012). The reason for this is difficult to determine but it may be because other companies within the industry are growing sales more rapidly or paying their bills more slowly (Investing Answers, n.d.). Regardless, I think Select Comfort’s acid-test reveals a company with normal liquidity and which is trending in the right direction. The company’s debt ratio of .51 basically means that slightly more than half of their assets are financed by debt (Kotler & Armstrong, 2012). This is down significantly from 2010 where two-thirds of their assets were financed by debt. Interestingly, according to Select Comfort’s 2012 Annual report, they currently have no debt (Investor Relations, 2012). This claim is substantiated by Reuters which lists both the company’s long term debt and total debt to equity ratios as zero (Reuters, 2012). The reason for this discrepancy seems to be in the definition of debt where Select Comfort is recognizing debt only as what is owed to a bank or other lender whereas the debt ratio includes money owed in employee compensation and state and federal taxes among others. There is no industrial average for this ratio but the fact that Select Comfort was able cut their debt ratio from .66 to .51 as well as was able to claim no debt on their annual report is a positive sign. The ability for a company to be able to sell through their inventory can be measured by dividing the cost of goods sold by the average inventory level for that year (Kotler & Armstrong, 2012). Select Comfort’s inventory turnover ratio of 12.26 indicates that they are able to sell through their inventory roughly once a month. This is well above the industry average of 5.57 and is a testament to the success of Select Comfort’s just-in-time inventory system. This system, where a customer places an order through a retail site, direct order, or online purchase, and then the product is manufactured, allows the company the flexibility to keep minimal inventory in 4
- 5. Select Comfort both their warehouses and showrooms. This means that the actual inventory on hand is comprised primarily of the accessories, which includes pillows, mattress pads, sheet sets, and blankets. The advantage of this inventory structure is that available retail and warehouse space can be minimized and the company can quickly and easily produce new models based on new trends and technologies without being saddled with outdated inventory. Even the traditional drawbacks of just-in-time inventory, such as being too reliant on one supplier, are not as prevalent here because products are going straight to the consumer without going to a retailer first and there is already a consumer expectation that the bed will take time to be built. Overall, this is one of the biggest areas of strength for this company. Another strength of Select Comfort’s financials is their accounts receivable turnover ratio. This measures the ability to collect cash from customers who have made purchases on credit (Kotler & Armstrong, 2012). Select Comfort’s turnover ratio of 62.58 is more than twice the industry average of 26.5. This means that the company is doing an exceptional job of converting their receivables into cash. This could be due to the stringencies they have in place to qualify customers for financing and/or the promotional options they have in place for customers to pay within specific guidelines. In 2010, the rate was even higher at 80.74 which may have been a reaction to the credit crisis in 2008 but the fact that this number has dropped may show more willingness to lend. As long as this number stays above the industry average and doesn’t get too much higher, it should be seen as a positive. The next three ratios all measure Select Comfort’s profitability (Kotler & Armstrong, 2012). The .081 return on net sales rate means that of every $1 the company earns in sales, about 8 cents of that is profit. The second ratio, return on net assets represents how well the company is using its assets to produce a profit. Select Comfort’s return on net asset ratio of .280 has 5
- 6. Select Comfort increased from 2010 and is well above the industry average of .096. Finally, the third profitability ratio, return on common stockholder’s equity, shows how much income the company is making off of each dollar invested by the common shareholders. The company’s .646 return on equity ratio is nearly 4 times the industry average which is tremendous. These profitability ratios reveal a solid business model which is rebounding nicely from the 2008 financial meltdown. Lastly, the earnings per share (EPS) ratio is a common ratio used by investors to judge a company’s market performance (Kotler & Armstrong, 2012). The 1.07 EPS that Select Comfort reported is an increase of 88% over the previous year. While such an increase cannot be expected by investors year-over-year, management seems confident that the trend will continue, stating “we are confident in our goal to drive continued earnings-per-share growth of at least 20 percent per year over the next three years” (Investor Relations, 2012). Unfortunately, I could not locate an industry average for earnings per share but I compiled a list of five different companies within the bed and home furnishing sector to use as a comparison: Company 2011 Earnings Per Share Tempurpedic 3.18 Select Comfort 1.07 Ethan Allen 1.01 La-Z-Boy 0.45 Sealy -0.21 (CNNMoney, 2012) Based on the data, Select Comfort compares favorably to most of its competition. However, the high EPS reported by Tempurpedic shows that there is plenty of room for improvement. 6
- 7. Select Comfort Costs According to Select Comfort, their “retail stores carry significant fixed costs” (Investor Relations, 2012). These costs include the lease for the showroom space, the possible property taxes, utilities, the depreciation of floor models, and insurance costs. In addition to the almost 400 retail locations, Select Comfort also has two U.S. manufacturing plants. They share most of the same fixed costs as do the retail store but also incur the fixed cost of the actual machinery used to build the beds. In addition to these fixed costs, Select Comfort has a lot of variable costs that increase with the more products they sell. This would include the cost of the materials, the cost of the labor and machine hours to build the product, and the delivery costs to have the beds brought to the consumers after they are built. Finally, the retail employees are paid on a base + commission structure which makes their wages a mixed cost. They have a base salary that they receive regardless of how much they sell and then are paid a percentage of each sale they make. Select Comfort has four different bed series and nine different mattresses. These are offered in eight different sizes. They also offer specialty beds for RVs. In addition to the mattresses, they offer a wide variety of accessories including pillows, sheets, blankets, mattress pads, remote controls, and bed frames/legs. With the exception of the accessories, everything is built-to-order. This means that Select Comfort would be well off using some application of the Activity-Based Costing system. Because there is much more work that goes into building a mattress to a customer’s specifications than producing a blanket, the same overhead rate should not be used for all of the products. A study should be done to determine all of the cost drivers for each product and how much of each driver is needed to produce each product (Accounting Coach). This will ensure that cost levels are not skewed towards a certain product and that management can accurately price each product and identify cost-saving measures as well. 7
- 8. Select Comfort Conclusion Based on the preceding information, Select Comfort seems to be a company with solid but not exceptional financial strength. They do have an efficient model for how they run their operations including their sales channels and their inventory system. This is reflected in many of the key financial ratios we highlighted earlier where they were around or above the industry averages in most of them. They are still working to overcome the recession that started in 2008 but have reacted better than many similar companies who were also hit by the meltdown. The important thing for Select Comfort to do the in the future is continue to embrace their business model, while mixing slow but gradual growth with effective cost-cutting measures. 8
- 9. Select Comfort References Accounting Coach. (n.d.). Explanation of the Topic... activity based costing. Retrieved April 29, 2012, from Accounting Coach: http://www.accountingcoach.com/online-accounting- course/35Xpg01.html CNNMoney. (2012). Retrieved May 5, 2012, from http://money.cnn.com/ Glann, N. (2009, February 25). Mixed Costs: Differentiating the Fixed from the Variable Costs . Retrieved May 5, 2012, from Yahoo Voices: http://voices.yahoo.com/mixed-costs-differentiating-fixed- variable-2699014.html Investing Answers. (n.d.). Acid-Test. Retrieved May 5, 2012, from Investing Answers: http://www.investinganswers.com/financial-dictionary/ratio-analysis/acid-test-ratio-1225 Investor Relations. (2012, February 26). Retrieved May 5, 2012, from Sleep Number: http://www.sleepnumber.com/eng/aboutus/InvestorRelations.cfm Kotler, P., & Armstrong, G. (2012). Principles of Marketing 14th ed. Upper Saddle River, NJ: Pearson Prentice Hall. Reuters. (2012, May 4). Financials: Select Comfort Corp. (SCSS.O). Retrieved May 5, 2012, from Reuters: http://www.reuters.com/finance/stocks/financialHighlights?symbol=SCSS.O 9