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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 March 29, 2003
COMMISSION FILE NO. 0-25121
____________________
SELECT COMFORT CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1597886
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6105 TRENTON LANE NORTH
MINNEAPOLIS, MINNESOTA 55442
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (763) 551-7000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES [X] NO [ ]
As of March 29, 2003, 30,875,904 shares of Common Stock of the Registrant were
outstanding.
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
INDEX
PAGE NO.
--------
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
March 29, 2003 and December 28, 2002............................... 3
Consolidated Statements of Operations
for the Three Months ended March 29, 2003
and March 30, 2002................................................. 4
Consolidated Statements of Cash Flows
for the Three Months ended March 29, 2003
and March 30, 2002................................................. 5
Notes to Consolidated Financial Statements......................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...................... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 14
Item 4. Disclosure Controls and Procedures................................. 14
PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................................ 15
Item 2. Changes in Securities and Use of Proceeds........................ 15
Item 3. Defaults Upon Senior Securities.................................. 15
Item 4. Submission of Matters to a Vote of Security Holders.............. 15
Item 5. Other Information................................................ 15
Item 6. Exhibits and Reports on Form 8-K................................. 16
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
MARCH 29, DECEMBER 28,
2003 2002
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 26,552 $ 27,176
Marketable securities - current (note 2) 14,306 12,146
Accounts receivable, net of allowance for doubtful
accounts of $367 and $340 3,215 3,270
Inventories (note 3) 9,345 8,980
Prepaid expenses 5,866 5,467
Deferred tax assets 10,235 12,955
------------- -------------
Total current assets 69,519 69,994
Marketable securities - non-current (note 2) 4,828 1,502
Property and equipment, net 31,225 28,977
Deferred tax assets 4,774 4,352
Other assets 3,469 3,506
------------- -------------
Total assets $113,815 $108,331
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 1 $ 11
Accounts payable 21,333 16,508
Accruals:
Sales returns 3,296 3,181
Compensation and benefits 7,968 13,666
Taxes and withholding 2,920 2,779
Customer prepayments 5,341 1,964
Other 5,085 5,120
------------- -------------
Total current liabilities 45,944 43,229
Long-term debt, less current maturities 3,077 2,991
Accrued warranty costs 3,533 3,626
Other liabilities 3,931 3,970
------------- -------------
Total liabilities 56,485 53,816
------------- -------------
Shareholders' equity (notes 4 and 6):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
30,875,904 and 30,727,101 shares issued and outstanding, 309 307
respectively
Additional paid-in capital 90,869 92,184
Accumulated deficit (33,848) (37,976)
------------- -------------
Total shareholders' equity 57,330 54,515
------------- -------------
Total liabilities and shareholders' equity $113,815 $108,331
============= =============
See accompanying notes to consolidated financial statements.
3
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED
----------------------------
MARCH 29, MARCH 30,
2003 2002
------------- -------------
Net sales $101,958 $ 81,195
Cost of sales 38,057 30,957
------------- -------------
Gross profit 63,901 50,238
------------- -------------
Operating expenses:
Sales and marketing 48,917 39,608
General and administrative 8,301 7,209
Store closings and asset impairments 74 52
------------- -------------
Total operating expenses 57,292 46,869
------------- -------------
Operating income 6,609 3,369
------------- -------------
Other income (expense):
Interest income 113 67
Interest expense (88) (586)
Other, net 24 46
------------- -------------
Other income (expense), net 49 (473)
------------- -------------
Income before income taxes 6,658 2,896
Income tax expense (benefit) 2,530 (348)
------------- -------------
Net income $ 4,128 $ 3,244
============= =============
Net income per share (note 4 and 5) - basic $ 0.13 $ 0.18
============= =============
Weighted average shares - basic 30,880 18,386
============= =============
Net income per share (note 4 and 5) - diluted $ 0.11 $ 0.11
============= =============
Weighted average shares - diluted 37,173 33,059
============= =============
See accompanying notes to consolidated financial statements.
4
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
----------------------------
MARCH 29, MARCH 30,
2003 2002
------------- -------------
Cash flows from operating activities:
Net income $ 4,128 $ 3,244
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 2,426 2,169
Amortization of debt discount and deferred finance fees 86 216
Loss on disposal of assets 74 56
Deferred tax benefit 2,298 -
Change in operating assets and liabilities:
Accounts receivable, net 55 1,564
Inventories (365) (803)
Prepaid expenses (399) (144)
Other assets 29 (3)
Accounts payable 4,825 3,373
Accrued compensation and benefits (5,698) (1,282)
Other accruals and liabilities 3,466 2,163
------------- -------------
Net cash provided by operating activities 10,925 10,553
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment (4,740) (1,367)
Investments in marketable securities (17,803) (5,557)
Proceeds from maturity of marketable securities 12,317 -
------------- -------------
Net cash used in investing activities (10,226) (6,924)
------------- -------------
Cash flows from financing activities:
Principal payments on debt (10) (11)
Repurchase of common stock (1,834) -
Proceeds from issuance of common stock 521 93
------------- -------------
Net cash (used in) provided by financing activities (1,323) 82
------------- -------------
(Decrease) increase in cash and cash equivalents (624) 3,711
Cash and cash equivalents, at beginning of period 27,176 16,375
------------- -------------
Cash and cash equivalents, at end of period $26,552 $20,086
============= =============
See accompanying notes to consolidated financial statements.
5
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements for the three months ended March 29, 2003
of Select Comfort Corporation and subsidiaries ("Select Comfort" or the
"Company"), have been prepared by the Company, without audit, pursuant to the
rules and regulations of the Securities and Exchange Commission and reflect, in
the opinion of management, all normal recurring adjustments necessary to present
fairly the financial position of the Company as of March 29, 2003 and December
28, 2002 and the results of operations and cash flows for the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations, although management believes the disclosures are adequate
to make the information presented not misleading. These consolidated financial
statements should be read in conjunction with the Company's most recent audited
consolidated financial statements and related notes included in the Company's
Annual Report to Shareholders and its Form 10-K for the fiscal year ended
December 28, 2002. Operating results for the Company on a quarterly basis may
not be indicative of operating results for the full year.
No new accounting pronouncements have been issued that are expected to have a
material effect on the Company's financial statements.
(2) MARKETABLE SECURITIES
The Company invests its cash in highly liquid debt instruments issued by the US
government and related agencies, municipalities and in commercial paper issued
by companies with investment grade ratings. The Company's investments have an
original maturity of up to 16 months with an average time to maturity of 8
months as of March 29, 2003. Investments with an original maturity of greater
than 90 days are classified as marketable securities. Marketable securities with
a remaining maturity of greater than one year are classified as long-term. The
Company's marketable securities are classified as held-to-maturity and are
carried at amortized cost. Securities held at March 29, 2003 carried an
amortized cost of $19.1 million and a fair value of $19.2 million.
(3) INVENTORIES
Inventories consist of the following (in thousands):
MARCH 29, DECEMBER 28,
2003 2002
-------------- --------------
Raw materials $2,668 $2,669
Work in progress 50 88
Finished goods 6,627 6,223
-------------- --------------
$9,345 $8,980
============== ==============
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) NET INCOME PER COMMON SHARE
The following computations reconcile net income with net income per common
share-basic and diluted (in thousands, except per share amounts):
THREE MONTHS ENDED
------------------------------
WEIGHTED PER
MARCH 29, 2003 NET AVERAGE SHARE
INCOME SHARES AMOUNT
---------- --------- ---------
Net income $ 4,128
----------
BASIC EPS
Net income available to common shareholders 4,128 30,880 $ 0.13
=========
EFFECT OF DILUTIVE SECURITIES
Options - 2,932
Common stock warrants - 2,634
Convertible debt 54 727
---------- ---------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions $ 4,182 37,173 $ 0.11
========== ========= =========
THREE MONTHS ENDED
------------------------------
WEIGHTED PER
MARCH 30, 2002 NET AVERAGE SHARE
INCOME SHARES AMOUNT
---------- --------- ---------
Net income $ 3,244
----------
BASIC EPS
Net income available to common shareholders 3,244 18,386 $ 0.18
=========
EFFECT OF DILUTIVE SECURITIES
Options - 1,256
Common stock warrants - 2,417
Convertible debt 309 11,000
---------- ---------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions $ 3,553 33,059 $ 0.11
========== ========= =========
Additional potentially dilutive securities ("securities") totaling 708,000 for
the three month period ending March 29, 2003, have been excluded from diluted
EPS because the securities' exercise price was greater than the average market
price of the Company's common shares.
7
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) PRO FORMA NET INCOME
The Company's net income and earnings per share under Generally Accepted
Accounting Principles (GAAP) for 2003 should be compared to 2002 net income and
earnings per share on a pro forma, after-tax basis to improve comparability
between the periods. GAAP did not allow the Company to reduce its earnings for
income tax expense in 2002, while 2003 results reflect a reduction in earnings
for income taxes. A reconciliation of net income and diluted earnings per share
(as determined in accordance with GAAP) to pro forma net income and diluted
earnings per share is as follows:
THREE MONTHS
ENDED
MARCH 30, 2002
---------------
RECONCILIATION OF GAAP NET INCOME AND PRO FORMA NET INCOME:
GAAP net income $ 3,244
Income taxes - adjusted to 38% effective rate (1,448)
---------------
Pro forma net income $ 1,796
===============
THREE MONTHS
ENDED
MARCH 30, 2002
---------------
RECONCILIATION OF GAAP DILUTED EARNINGS PER SHARE TO
PRO FORMA DILUTED EARNINGS PER SHARE:
GAAP diluted earnings per share $ .11
Effect of income taxes at 38% (.05)
---------------
Pro forma diluted earnings per share $ .06
===============
(6) STOCK OPTION VALUATION
No compensation cost has been recognized in the consolidated financial
statements for employee stock option grants or the discount feature of the
Company's employee stock purchase plan. Had the Company determined compensation
cost based on the fair value at the grant date for its stock options and
employee stock purchase plan under an alternative accounting method, the
Company's net income would have been adjusted as outlined below (in thousands,
except per share amounts):
THREE MONTHS ENDED
-------------------------
MARCH 29, MARCH 30,
2003 2002
-------------------------
Net income:.....................As reported $ 4,128 $ 3,244
Pro forma 3,498 2,476
Income per share -- basic:......As reported 0.13 0.18
Pro forma 0.11 0.13
Income per share -- diluted:....As reported 0.11 0.11
Pro forma 0.10 0.08
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
THREE MONTHS ENDED
-------------------------
MARCH 29, MARCH 30,
2003 2002
-------------------------
Expected dividend yield 0% 0%
Expected stock price volatility 90% 90%
Risk-free interest rate 2.0% 2.0%
Expected life in years 3.6 3.6
Weighted-average fair value at grant date $ 5.66 $ 1.73
8
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) LITIGATION
In June 1999, the Company and certain of its former officers and directors were
named as defendants in a class action lawsuit filed in U.S. District Court in
Minnesota. The suit, filed on behalf of purchasers of the Company's common stock
between December 4, 1998 and June 7, 1999, alleges that the Company and the
named former directors and officers failed to disclose or misrepresented certain
information concerning the Company in violation of federal securities laws. The
Company believes that the suit is without merit and has vigorously defended the
matter.
The Company consented to a settlement of this litigation negotiated by the
Company's insurance carrier. The settlement is covered by insurance and involves
no cash or other payment obligation by the Company and no admission of liability
or wrongdoing by the Company. The settlement did not have any impact on the
Company's results of operations or financial condition. On February 28, 2003,
the settlement agreement received final approval from the U.S. District Court
for the District of Minnesota, resulting in the dismissal with prejudice of the
plaintiffs' complaint.
The Company is involved in other various claims and legal actions arising in the
ordinary course of business. In the opinion of management, any losses that may
occur from these other matters are adequately covered by insurance or are
provided for in the consolidated financial statements and the ultimate outcome
of these other matters will not have a material effect on the consolidated
financial position or results of operations of the Company.
(8) RISKS AND UNCERTAINTIES
Our qualified customers are offered a revolving credit arrangement to finance
purchases from us through a private label consumer credit facility provided by
Mill Creek Bank, a subsidiary of Conseco Finance Corp. Conseco Finance Corp. has
recently experienced financial and liquidity issues and has filed for protection
under federal bankruptcy laws. Through its pending bankruptcy proceedings,
Conseco Finance Corp. entered into an asset purchase agreement to sell its
business and operating assets, including various assets of Mill Creek Bank.
Under the terms of this agreement, our agreement with Mill Creek Bank would be
sold to General Electric Capital Corporation, a competitor of Mill Creek Bank.
This sale, which is subject to various closing conditions, is expected to close
in the next several months. In the event this sale does not close as
anticipated, the financial and liquidity issues being encountered by Conseco
Finance Corp. could jeopardize the ability of Mill Creek Bank to continue to
provide consumer credit financing for our customers. In that event, we would
seek to secure consumer credit financing from other sources, but it may not be
possible to secure such arrangements without some delay or on the same or better
terms than have been available from Mill Creek Bank. Termination of our
agreement with Mill Creek Bank, any material change to the terms of our
agreement with Mill Creek Bank or in the availability or terms of credit for our
customers from Mill Creek Bank or any delay in securing replacement credit
sources, could harm our sales.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED HEREIN. THIS
QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. YOU CAN
IDENTIFY FORWARD-LOOKING STATEMENTS BY THOSE THAT ARE NOT HISTORICAL IN NATURE,
PARTICULARLY THOSE THAT USE TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD,"
"EXPECTS," "ANTICIPATES," "CONTEMPLATES," "ESTIMATES," "BELIEVES," "PLANS,"
"PROJECTS," "PREDICTS," "POTENTIAL" OR "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 THE COMPANY'S
HISTORICAL EXPERIENCE AND ITS PRESENT EXPECTATIONS OR PROJECTIONS. IMPORTANT
FACTORS KNOWN TO SELECT COMFORT THAT COULD CAUSE SUCH MATERIAL DIFFERENCES ARE
IDENTIFIED AND DISCUSSED IN PART I, ITEM 1 OF OUR ANNUAL REPORT ON FORM 10-K FOR
THE FISCAL YEAR ENDED DECEMBER 28, 2002, WHICH DISCUSSION IS INCORPORATED HEREIN
BY REFERENCE. THESE IMPORTANT FACTORS INCLUDE:
o GENERAL AND INDUSTRY ECONOMIC TRENDS,
o CONSUMER CONFIDENCE AND SPENDING,
o THE EFFECTIVENESS AND EFFICIENCY OF OUR ADVERTISING AND PROMOTIONAL
EFFORTS,
o ADVERTISING RATES,
o CONSUMER ACCEPTANCE OF OUR PRODUCTS AND SLEEP TECHNOLOGY,
o INDUSTRY COMPETITION,
o OUR DEPENDENCE ON SIGNIFICANT SUPPLIERS OR SINGLE SOURCES OF SUPPLY,
o GOVERNMENTAL REGULATION, INCLUDING ANTICIPATED FUTURE REGULATION OF DIRECT
MARKETING TELEPHONE SOLICITATIONS AND BEDDING FLAMMABILITY STANDARDS, AND
o RISKS AND UNCERTAINTIES DETAILED FROM TIME TO TIME IN THE COMPANY'S FILINGS
WITH THE SEC, INCLUDING THE COMPANY'S ANNUAL REPORT ON FORM 10-K AND OTHER
PERIODIC REPORTS FILED WITH THE SEC.
THE COMPANY HAS NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY OF THE
FORWARD-LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q.
OVERVIEW AND CRITICAL ACCOUNTING POLICIES
Select Comfort(R) is the leading developer, manufacturer and marketer of premium
quality, adjustable-firmnesS beds. The air chamber technology of our proprietary
Sleep Number bed allows adjustable firmness on each side of the mattress and
provides a sleep surface that is clinically proven to provide better sleep
quality and greater relief of back pain compared to traditional mattress
products.
Our critical accounting policies relate to revenue recognition, accrued sales
returns, accrued warranty costs and impairment of long-lived assets and
long-lived assets to be disposed of by us. The effect of these policies on our
financial statements is incorporated in the discussion below.
NET SALES
We generate revenue by selling our products through four complementary
distribution channels. Three of these channels - retail, direct marketing and
e-commerce, are Company-controlled and sell directly to consumers. Our wholesale
channel sells to leading home furnishings retailers, specialty bedding retailers
and the QVC shopping channel.
REVENUE RECOGNITION. We record revenue at the time product is shipped to the
customer, except when beds are delivered and set up by our home delivery
employees, in which case revenue is recorded at the time the bed is delivered
and set up in the home.
ACCRUED SALES RETURNS. At the time revenue is recognized, we reduce sales for
estimated returns. This estimate is based on historical return rates, which are
reasonably consistent from period to period. If actual returns vary from
expected rates, revenue in future periods is adjusted, which could have a
material adverse effect on future results of operations.
10
CHANNEL SALES. The proportion of our total net sales, by dollar volume, from
each of these channels is summarized as follows:
Three Months Ended
--------------------
3/29/03 3/30/02
--------- ---------
Stores 79% 75%
Direct Call Center 14% 15%
E-commerce 4% 4%
Wholesale 3% 6%
The number of company-operated retail locations is summarized as follows:
Three Months Ended
--------------------
3/29/03 3/30/02
--------- ---------
Beginning of period 322 328
Opened 2 1
Closed (1) (5)
--------- ---------
End of period 323 324
========= =========
We anticipate opening 20 to 30 new retail stores and closing three to five
stores during the remainder of 2003. We remodeled 45 stores in the first quarter
of 2003 and anticipate remodeling approximately 60 more stores throughout the
balance of the year. Company-operated stores included leased departments within
13 Bed, Bath & Beyond stores as of March 29, 2003 and 20 at March 30, 2002.
Comparable store sales, including remodeled stores as noted above, increased
over prior year, for the three months ended March 29, 2003 and March 30, 2002 by
30% and 15%, respectively.
COST OF SALES
Cost of sales includes costs associated with purchasing materials, manufacturing
costs and costs to deliver our products to our customers.
ACCRUED WARRANTY COSTS. Cost of sales also includes estimated costs to service
warranty claims of customers. This estimate is based on historical claim rates
during the warranty period. Because this estimate covers an extended period of
time, a revision of estimated claim rates could result in a significant
adjustment of estimated future costs of fulfilling warranty commitments. An
increase in estimated claim rates could have a material adverse effect on future
results of operations.
GROSS PROFIT
Our gross profit margin is dependent on a number of factors and may fluctuate
from quarter to quarter. These factors include the mix of products sold, the
level at which we offer promotional discounts to purchase our products, the cost
of materials and manufacturing and the mix of sales between wholesale and
company-controlled distribution channels. Sales directly to consumers through
Company-controlled channels generally generate higher gross margins than sales
through our wholesale channels because we capture both the manufacturer's and
retailer's margin.
SALES AND MARKETING EXPENSES
Sales and marketing expenses include advertising and media production, other
marketing and selling materials such as brochures, videos, customer mailings and
in-store signage, sales compensation, store occupancy costs and customer
service. Store opening costs are expensed as incurred and advertising costs are
expensed the first time the advertisement is aired.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative expenses include costs associated with management of
functional areas, including information technology, human resources, finance,
sales and marketing administration, investor relations, risk management and
research and development. Costs include salary, bonus and benefits, information
hardware, software and maintenance, office facilities, insurance and shareholder
relations costs and other overhead.
11
STORE CLOSING AND ASSET IMPAIRMENT EXPENSES
We evaluate our long-lived assets, including leaseholds and fixtures in existing
stores and stores expected to be remodeled, based on expected cash flows through
the remainder of the lease term after considering the potential impact of
planned operational improvements and marketing programs. Expected cash flows may
not be realized, which could cause long-lived assets to become impaired in
future periods and could have a material adverse effect on future results of
operations. Store assets are written off when we believe these costs will not be
recovered through future operations.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as percentages of net sales.
THREE MONTHS ENDED
-----------------------------
MARCH 29, MARCH 30,
2003 2002
-------------- --------------
Net sales 100.0% 100.0%
Cost of sales 37.3 38.1
-------------- --------------
Gross profit 62.7 61.9
-------------- --------------
Operating expenses:
Sales and marketing 48.0 48.8
General and administrative 8.1 8.9
Store closings and asset impairments 0.1 0.1
-------------- --------------
Total operating expenses 56.2 57.8
-------------- --------------
Operating income 6.5 4.1
Other expense, net 0.0 (0.6)
-------------- --------------
Income before income taxes 6.5 3.6
Income tax (expense) benefit (2.5) 0.4
-------------- --------------
Net income 4.0% 4.0%
============== ==============
COMPARISON OF THREE MONTHS ENDED MARCH 29, 2003 WITH THREE MONTHS ENDED
MARCH 30, 2002
NET SALES
Net sales increased 26% to $102.0 million for the three months ended March 29,
2003 from $81.2 million for the three months ended March 30, 2002, due to higher
average selling prices resulting primarily from improvements in product mix and
lower return rates and a 15% increase in Company-controlled channel mattress
unit sales, partially offset by a 36% decrease in mattress unit sales in the
wholesale channel due to quarterly timing of QVC shows. In total, mattress unit
sales increased 10% for the three months ended March 29, 2003. The increase in
net sales by sales channel was attributable to (i) a $19.4 million increase in
sales from Company-controlled retail stores, including an increase in comparable
store sales of $18.0 million, (ii) a $1.6 million increase in direct marketing
sales and (iii) a $0.9 million increase in sales through the Company's
e-commerce channel, offset by a decrease of $1.1 million in sales from the
Company's wholesale channel.
GROSS PROFIT
Gross profit increased to 62.7% for the three months ended March 29, 2003 from
61.9% for the three months ended March 30, 2002, primarily due to improved sales
channel mix and improved product mix. The improved channel mix was a result of a
decrease in mattress units sold in the lower margin wholesale channel. The
improved product mix occurred in our Company-controlled channels.
SALES AND MARKETING
Sales and marketing expenses increased 23% to $48.9 million for the three months
ended March 29, 2003 from $39.6 million for the three months ended March 30,
2002 but decreased as a
12
percentage of net sales to 48.0% from 48.8% for the comparable prior-year
period. The increase was primarily due to additional media investments,
sales-based incentive compensation, and increased financing costs. The decrease
as a percentage of net sales was attributable to greater leverage in fixed
selling expenses, partially offset by increases in advertising spending as a
percent of net sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 15% to $8.3 million for the three
months ended March 29, 2003 from $7.2 million for the three months ended March
30, 2002 but decreased as a percentage of net sales to 8.1% from 8.9% for the
prior-year period. The increase in general and administrative expenses was due
primarily to additional headcount, and accrued incentive compensation as a
result of Company performance. The decrease as a percentage of net sales was
attributable to greater leverage of fixed costs.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense increased $22,000 to $74,000 for the
three months ended March 29, 2003 from $52,000 for the three months ended March
30, 2002. In 2003, the entire $74,000 represents store impairment charges.
OTHER INCOME (EXPENSE), NET
Other income (expense) changed $522,000 to income of $49,000 for the three
months ended March 29, 2003 from an expense of $473,000 for the three months
ended March 30, 2002. The improvement is primarily due to reduced interest
expense following elimination of $16 million of debt in 2002, and an increase in
interest income from the Company's improved cash position.
INCOME TAX (EXPENSE) BENEFIT
Income tax (expense) benefit changed $2.9 million to an income tax expense of
$2.5 million for the three months ended March 29, 2003 from a $0.3 million
income tax benefit for the three months ended March 30, 2002. The increase in
income tax expense was due to recording income tax expense at an estimated rate
of 38% in 2003 while no such tax was recorded for the three months ended March
30, 2002.
LIQUIDITY AND CAPITAL RESOURCES
We generated cash from operations of $10.9 million in the first three months of
2003. Historically, our primary source of capital has been from external
sources, most recently from the completion of our $11.0 million convertible debt
offering in June 2001 and our $5.0 million senior secured term debt financing in
September 2001. The $11.0 million in convertible debt was converted to equity in
the second quarter of 2002 and the $5.0 million of senior debt was prepaid in
December 2002 with cash generated from operations. In February 2003, our board
of directors approved an expanded share repurchase program of up to $12.5
million. We repurchased $1.8 million of common stock in the first three months
of 2003. We are currently pursuing a new bank revolving line of credit. While it
is not currently anticipated that this line will be necessary for short- or
long-term liquidity needs, the line would provide additional cash flexibility.
Barring any unexpected significant external or internal developments, we expect
current cash balances on hand and cash flow generated from operations to be
sufficient to meet our short-term and long-term liquidity needs.
Net cash provided by operating activities for the three months ended March 29,
2003 was $10.9 million and consisted primarily of our net income adjusted for
non-cash expenses and increases in accounts payable and accrued customer
pre-payments. Cash increases were partially offset by decreases in accrued
compensation and benefits. Accounts payable increased as a result of timing and
the additional commitments made to advertising in 2003. The increase in accrued
customer prepayments is related to the timing of cash received on customer
orders in advance of customer shipments at the end of the quarter. The decrease
in accrued compensation is a result of annual incentive compensation payments
made during the quarter. Net cash provided by operating activities for the three
months ended March 30, 2002 was $10.6 million and consisted primarily of net
income adjusted for non-cash expenses, increases in accounts payable and other
accrued liabilities and decreases in accounts receivable, partially offset by
decreases in accrued compensation and benefits and increases in inventories. The
decrease in our accounts receivable and increase in accounts payable and
inventory is primarily a function of the timing and size of QVC shows. The
decrease in accrued compensation is a result of annual incentive compensation
payments made during the quarter.
Net cash used in investing activities was $10.2 million for the three months
ended March 29, 2003. Investing activities consisted primarily of investments in
marketable securities and purchases of property and equipment for 45 remodeled
and 2 new retail stores, and development costs for information technology
systems for the three months ended March 29, 2003. In 2003, we made net
investments in marketable securities of $5.5 million. The net cash used in
investing activities for the three months ended March 30, 2002 was $6.9 million.
In 2002 we invested in $5.6 million of marketable securities, and we also
invested $1.4 million in purchases of property and equipment. In
13
the remaining nine months of 2003, we expect to open 20 to 30 new retail stores
and to remodel approximately 60 additional stores. Our anticipated capital
expenditures are expected to be approximately $18 million in 2003. We expect our
new stores to be cash flow positive within the first 12 months of operation and,
as a result, do not expect a significant negative effect on net cash provided by
operations from new stores.
Net cash used in financing activities was $1.3 million for the three months
ended March 29, 2003 primarily from the repurchase of common stock. Net cash
provided by financing activities for the three months ended March 30, 2002 was
$82,000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of investments. The counterparties to the
agreements consist of government agencies and various major corporations of
investment grade credit standing. The Company does not believe there is
significant risk of non-performance by these counterparties because the Company
limits the amount of credit exposure to any one financial institution and any
one type of investment.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES.
(a) Within 90 days prior to the filing of this Quarterly Report on Form 10-Q,
the Company's President and Chief Executive Officer ("CEO") and the Company's
Chief Financial Officer ("CFO") carried out an evaluation of the effectiveness
of the Company's disclosure controls and procedures. Based upon this evaluation,
the CEO and CFO concluded that the Company's disclosure controls and procedures
are effective in:
o accumulating and communicating information to the Company's management,
including the CEO and CFO, to allow timely decisions regarding required
disclosure; and
o recording, processing, summarizing and reporting information required to be
included in the Company's periodic reports filed with the SEC in a timely
manner.
(b) There were no significant changes in the Company's internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of the evaluation described above.
14
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June 1999, the Company and certain of its former officers and directors were
named as defendants in a class action lawsuit filed in U.S. District Court in
Minnesota. The suit, filed on behalf of purchasers of the Company's common stock
between December 4, 1998 and June 7, 1999, alleges that the Company and the
named former directors and officers failed to disclose or misrepresented certain
information concerning the Company in violation of federal securities laws. The
Company believes that the suit is without merit and has vigorously defended the
matter.
The Company consented to a settlement of this litigation negotiated by the
Company's insurance carrier. The settlement is covered by insurance and involves
no cash or other payment obligation by the Company and no admission of liability
or wrongdoing by the Company. The settlement did not have any impact on the
Company's results of operations or financial condition. On February 28, 2003,
the settlement agreement received final approval from the U.S. District Court
for the District of Minnesota, resulting in the dismissal with prejudice of the
plaintiffs' complaint.
The Company is involved in other various claims and legal actions arising in the
ordinary course of business. In the opinion of management, any losses that may
occur from these other matters are adequately covered by insurance or are
provided for in the consolidated financial statements and the ultimate outcome
of these other matters will not have a material effect on the consolidated
financial position or results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable
ITEM 5. OTHER INFORMATION
Not applicable.
15
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
------- -----------
99.1 Certification
99.2 Certification
(b) REPORTS ON FORM 8-K
During the quarter ended March 29, 2003, the Company filed five
Current Reports on Form 8-K. The Reports consisted of the
following:
(i) Current Report furnished under Item 9 of Form 8-K on January
8, 2003, announcing net sales for the fourth quarter and
full year ended December 28, 2002.
(ii) Current Report furnished under Item 9 of Form 8-K on
February 4, 2003, announcing comments on results for the
fourth quarter and year-ended December 28, 2002 and earnings
guidance for first quarter 2003.
(iii)Current Report furnished under Item 9 of Form 8-K on
February 21, 2003, announcing election of Michael Peel to
the board of directors.
(iv) Current Report furnished under Item 9 of Form 8-K on
February 27, 2003, announcing stock repurchase program and
earnings guidance for 2003.
(v) Current Report furnished under Item 9 of Form 8-K on
February 27, 2003, announcing registered offering by its
selling shareholders.
16
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
/s/William R. McLaughlin
-------------------------------------------
May 9, 2003 William R. McLaughlin
President and Chief Executive Officer
(principal executive officer)
/s/James C. Raabe
-------------------------------------------
James C. Raabe
Chief Financial Officer
(principal financial and accounting officer)
17
Certification by Chief Executive Officer
I, William R. McLaughlin, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Select Comfort
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 9, 2003
/s/William R. McLaughlin
----------------------------------------
William R. McLaughlin
President and Chief Executive Officer
18
Certification by Chief Financial Officer
I, James C. Raabe, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Select Comfort
Corporation;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on our
most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 9, 2003
/s/James C. Raabe
----------------------------------------
James C. Raabe
Senior Vice President and Chief Financial Officer
19
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION LOCATION
-------------- ----------- --------
99.1 Certification........................ Filed herewith.
99.2 Certification........................ Filed herewith.
20
Exhibit 99.1
CERTIFICATION PURSUANT TO
18 U.S.C. ss.1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Select Comfort Corporation (the
"Company") on Form 10-Q for the period ended March 29, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned, William R. McLaughlin, Chief Executive Officer of the Company,
solely for the purposes of 18 U.S.C. ss.1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002, does hereby certify that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/William R. McLaughlin
----------------------------
William R. McLaughlin
Chief Executive Officer
May 9, 2003
21
Exhibit 99.2
CERTIFICATION PURSUANT TO
18 U.S.C. ss.1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Select Comfort Corporation (the
"Company") on Form 10-Q for the period ended March 29, 2003 as filed with the
Securities and Exchange Commission on the date hereof (the "Report"), the
undersigned, James C. Raabe, Chief Financial Officer of the Company, solely for
the purposes of 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, does hereby certify that:
(1) The Report fully complies with the requirements of Section 13(a) or
15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations of the
Company.
/s/James C. Raabe
----------------------------
James C. Raabe
Chief Financial Officer
May 9, 2003
22