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 September 27, 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 September 27, 2003, 33,643,716 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
September 27, 2003 and December 28, 2002............................ 3
Consolidated Statements of Operations
for the Three Months and Nine Months ended
September 27, 2003 and September 28, 2002........................... 4
Consolidated Statements of Cash Flows
for the Nine Months ended September 27, 2003
and September 28, 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.......... 15
Item 4. Disclosure Controls and Procedures.................................. 15
PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................................... 16
Item 2. Changes in Securities and Use of Proceeds........................... 16
Item 3. Defaults Upon Senior Securities..................................... 16
Item 4. Submission of Matters to a Vote of Security Holders................. 16
Item 5. Other Information................................................... 16
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)
SEPTEMBER 27, DECEMBER 28,
2003 2002
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 53,288 $ 27,176
Marketable securities - current (note 2) 16,033 12,146
Accounts receivable, net of allowance for doubtful
accounts of $356 and $340 6,202 3,270
Inventories (note 3) 11,376 8,980
Prepaid expenses 4,988 5,467
Deferred tax assets 5,707 12,955
------------- --------------
Total current assets 97,594 69,994
Marketable securities - non-current (note 2) - 1,502
Property and equipment, net 35,598 28,977
Deferred tax assets 5,337 4,352
Other assets 3,351 3,506
------------- --------------
Total assets $141,880 $108,331
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 11
Accounts payable 23,067 16,508
Accruals:
Sales returns 4,145 3,181
Compensation and benefits 13,842 13,666
Taxes and withholding 4,776 2,779
Customer prepayments 6,302 1,964
Warranty costs 1,837 1,554
Other 5,258 3,566
------------- --------------
Total current liabilities 59,227 43,229
Long-term debt, less current maturities (note 4) - 2,991
Accrued warranty costs 2,755 3,626
Other liabilities 4,338 3,970
------------- --------------
Total liabilities 66,320 53,816
------------- --------------
Shareholders' equity (notes 5 and 7):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
33,643,716 and 30,727,101 shares issued and outstanding, respectively 336 307
Additional paid-in capital 97,927 92,184
Unearned compensation (843) -
Accumulated deficit (21,860) (37,976)
------------- --------------
Total shareholders' equity 75,560 54,515
------------- --------------
Total liabilities and shareholders' equity $141,880 $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 NINE MONTHS ENDED
---------------------------- -----------------------------
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 27, SEPTEMBER 28,
2003 2002 2003 2002
------------- ------------- -------------- --------------
Net sales $117,400 $ 85,056 $321,351 $243,532
Cost of sales 42,447 30,915 119,424 91,212
------------- ------------- -------------- --------------
Gross profit 74,953 54,141 201,927 152,320
------------- ------------- -------------- --------------
Operating expenses:
Sales and marketing 53,279 39,199 148,480 115,581
General and administrative 10,144 9,085 27,654 24,320
Store closings and asset impairments 8 24 67 233
------------- ------------- -------------- --------------
Total operating expenses 63,431 48,308 176,201 140,134
------------- ------------- -------------- --------------
Operating income 11,522 5,833 25,726 12,186
------------- ------------- -------------- --------------
Other income (expense):
Interest income 148 178 398 407
Interest expense (15) (278) (156) (1,401)
Other, net 2 (20) 26 (20)
------------- ------------- -------------- --------------
Other income (expense), net 135 (120) 268 (1,014)
------------- ------------- -------------- --------------
Income before income taxes 11,657 5,713 25,994 11,172
Income tax (expense) benefit (4,430) 17,891 (9,878) 18,239
------------- ------------- -------------- --------------
Net income $ 7,227 $ 23,604 $ 16,116 $ 29,411
============= ============= ============== ==============
Net income per share (note 5 and 6) - basic $ 0.22 $ 0.80 $ 0.50 $ 1.30
============= ============= ============== ==============
Weighted average shares - basic 33,528 29,634 32,142 22,570
============= ============= ============== ==============
Net income per share (note 5 and 6) - diluted $ 0.18 $ 0.69 $ 0.42 $ 0.88
============= ============= ============== ==============
Weighted average shares - diluted 39,576 34,203 38,929 33,941
============= ============= ============== ==============
See accompanying notes to consolidated financial statements.
4
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
-----------------------------
SEPTEMBER 27, SEPTEMBER 28,
2003 2002
-------------- --------------
Cash flows from operating activities:
Net income $ 16,116 $ 29,411
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 8,251 6,768
Amortization of debt discount and deferred finance fees 130 543
Non-cash compensation 52 -
Loss on disposal of assets and impaired assets 69 249
Deferred tax assets 6,263 (17,526)
Change in operating assets and liabilities:
Accounts receivable, net (2,932) (140)
Inventories (2,396) (1,077)
Prepaid expenses 479 (1,149)
Other assets 129 1,412
Accounts payable 6,559 4,689
Accrued compensation and benefits 176 3,774
Customer prepayments 4,338 2,570
Other accruals and liabilities 4,433 (1,143)
-------------- --------------
Net cash provided by operating activities 41,667 28,381
-------------- --------------
Cash flows from investing activities:
Purchases of property and equipment (14,915) (5,203)
Investments in marketable securities (19,117) (23,605)
Proceeds from maturity of marketable securities 16,732 8,047
-------------- --------------
Net cash used in investing activities (17,300) (20,761)
-------------- --------------
Cash flows from financing activities:
Principal payments on debt (11) (22)
Repurchase of common stock (1,834) -
Proceeds from issuance of common stock 3,590 427
-------------- --------------
Net cash provided by financing activities 1,745 405
-------------- --------------
Increase in cash and cash equivalents 26,112 8,025
Cash and cash equivalents, at beginning of period 27,176 16,375
-------------- --------------
Cash and cash equivalents, at end of period $ 53,288 $ 24,400
============== ==============
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 and nine months ended
September 27, 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
September 27, 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.
In May 2003, the Financial Accounting Standards Board's Emerging Issues Task
Force (EITF) reached consensus on EITF Issue No. 00-21, REVENUE ARRANGEMENTS
WITH MULTIPLE DELIVERABLES. EITF 00-21 provides revenue recognition guidance for
arrangements with multiple deliverables, and the criteria to determine if the
items in a multiple deliverable agreement should be accounted for separately.
The Issue became effective for revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. The Company has analyzed the impact of
EITF 00-21 and concluded that its implementation did not have a material effect
on the Company's revenue recognition practices or financial results.
No additional new accounting pronouncements have been issued that are expected
to have a material effect on the Company's financial results.
(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 17 months with an average time to maturity of 5
months as of September 27, 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. Marketable securities held
at September 27, 2003 carried an amortized cost of $16.0 million and a fair
value of $16.1 million.
(3) INVENTORIES
Inventories consist of the following (in thousands):
SEPTEMBER 27, DECEMBER 28,
2003 2002
-------------- --------------
Raw materials $ 2,730 $2,669
Work in progress 92 88
Finished goods 8,554 6,223
-------------- --------------
$11,376 $8,980
============== ==============
The Company's finished goods inventory, as of September 27, 2003 was comprised
of $3.3 million of finished beds, including deliveries to customers in transit
for those customers who have selected to utilize home delivery services, and
retail display beds, $3.1 million of finished components that are ready for
assembly for the completion of beds, and $2.2 million of retail accessories.
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) LONG-TERM DEBT
In May 2003, the Company entered into an agreement with Bank of America, N.A.
for a $15 million three-year senior secured revolving credit facility. The
interest rate on borrowings will be calculated using LIBOR plus 1.5% to 2.25%.
The rate that is incremental to LIBOR will be determined based on the Company's
leverage ratio. The Company is subject to certain financial covenants under the
agreement, principally consisting of minimum liquidity requirements, working
capital and leverage ratios. The Company has remained in full compliance with
the financial covenants from the time of the agreement through September 27,
2003. The Company has had no borrowings against the credit facility.
In November 2000, the Company completed the acquisition of certain assets of
SleepTec, Inc. A portion of the purchase price was a non-interest-bearing
subordinated convertible debenture ("debenture") with an original principal
amount of $4,000,000, due November 10, 2005 and convertible at any time into
727,272 shares of the Company's common stock at the rate of $5.50 per share. In
May 2003, the holder elected to convert the debt into the 727,272 shares of
common stock. As a result of this conversion, $3.1 million ($4 million in debt
net of $0.9 million unamortized debt discount) has been reclassified as common
stock and additional paid-in capital.
(5) 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 NINE MONTHS ENDED
-------------------------------- --------------------------------
WEIGHTED WEIGHTED
SEPTEMBER 27, 2003 NET AVERAGE PER SHARE NET AVERAGE PER SHARE
------------------ INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
Net income $ 7,227 $ 16,116
---------- ----------
BASIC EPS
Net income available to common shareholders 7,227 33,528 $ 0.22 16,116 32,142 $ 0.50
========== ==========
EFFECT OF DILUTIVE SECURITIES
Options - 3,001 - 2,693
Common stock warrants - 3,047 - 3,733
Convertible debt - - 81 361
---------- ---------- ---------- ----------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions $ 7,227 39,576 $ 0.18 $ 16,197 38,929 $ 0.42
========== ========== ========== ========== ========== ==========
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------------- --------------------------------
WEIGHTED WEIGHTED
SEPTEMBER 28, 2002 NET AVERAGE PER SHARE NET AVERAGE PER SHARE
------------------ INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ---------- ---------- ---------- ---------- ----------
Net income $ 23,604 $ 29,411
---------- ----------
BASIC EPS
Net income available to common shareholders 23,604 29,634 $ 0.80 29,411 22,570 $ 1.30
========== ==========
EFFECT OF DILUTIVE SECURITIES
Options - 1,743 - 1,654
Common stock warrants - 2,826 - 2,765
Convertible debt - - 563 6,952
---------- ---------- ---------- ----------
DILUTED EPS
Net income available to common shareholders plus $23,604 34,203 $ 0.69 $29,974 33,941 $ 0.88
========== ========== ========== ========== ========== ==========
Additional potentially dilutive securities totaling 73,000 and 163,000 for the
three-and nine-month periods ended September 27, 2003, have been excluded from
diluted EPS because these 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
(6) PRO FORMA NET INCOME AND NET INCOME PER SHARE
The Company's net income and net income per share under Generally Accepted
Accounting Principles (GAAP) for 2003 should be compared to 2002 net income and
net income per share on a pro forma, after-tax basis to improve comparability
between the periods. During the three-month period ended September 28, 2002, the
Company recorded a non-recurring, non-cash addition to earnings of $17.9 million
reflecting the expected future tax benefits from net operating loss
carry-forwards and other deferred tax assets. In addition, GAAP did not allow
the Company to reduce its income for income tax expense in 2002, while 2003
results reflect a reduction in income for income taxes. A reconciliation of net
income and diluted net income per share (as determined in accordance with GAAP)
to pro forma net income and pro forma diluted net income per share is as follows
(in thousands, except per share amounts):
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 28, SEPTEMBER 28,
2002 2002
------------------ ------------------
RECONCILIATION OF GAAP NET INCOME TO PRO FORMA NET INCOME:
GAAP net income $ 23,604 $ 29,411
Income tax provision at 38% of income before tax (2,171) (4,245)
Restoration of deferred tax assets and other income tax benefits (17,891) (18,239)
------------------ ------------------
Pro forma net income $ 3,542 $ 6,927
================== ==================
THREE MONTHS NINE MONTHS
ENDED ENDED
SEPTEMBER 28, SEPTEMBER 28,
2002 2002
------------------ ------------------
RECONCILIATION OF GAAP DILUTED NET INCOME PER SHARE TO
PRO FORMA DILUTED NET INCOME PER SHARE:
GAAP diluted net income per share $ 0.69 $ 0.88
Income tax provision at 38% of income before tax (.07) (.12)
Restoration of deferred tax assets and other income tax benefits (.52) (.54)
------------------ ------------------
Pro forma diluted net income per share $ 0.10 $ 0.22
================== ==================
(7) STOCK AND STOCK OPTION INCENTIVES
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. The following pro forma information
regarding net income and net income per share, required by SFAS No. 123
"Accounting for Stock Based Compensation", has been determined as if the Company
had accounted for its employee stock options under the fair value method of that
statement (in thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 27, SEPTEMBER 28,
2003 2002 2003 2002
---------------------------- ----------------------------
Net income, as reported $ 7,227 $ 23,604 $ 16,116 $ 29,411
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (655) (371) (1,518) (1,238)
------------- ------------- ------------ -------------
Pro forma net income $ 6,572 $ 23,233 $ 14,598 $ 28,173
Income per share
Basic - as reported 0.22 0.80 0.50 1.30
Basic - pro forma 0.20 0.78 0.45 1.25
Diluted - as reported 0.18 0.69 0.42 0.88
Diluted - pro forma 0.17 0.68 0.38 0.85
8
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
THREE MONTHS ENDED NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 27, SEPTEMBER 28,
2003 2002 2003 2002
---------------------------- ----------------------------
Expected dividend yield............................ 0% 0% 0% 0%
Expected stock price volatility.................... 90% 90% 90% 90%
Risk-free interest rate............................ 2.0% 2.0% 2.0% 2.0%
Expected life in years............................. 3.6 3.6 3.6 3.6
Weighted-average fair value at grant date.......... $11.68 $2.90 $6.96 $1.90
On February 24, 2003 the Company issued 100,000 shares of restricted stock to
certain key employees. The shares vest over ten years based on continued
employment. There was no restricted stock forfeited for the nine months ended
September 27, 2003. Compensation expense related to restricted stock awards is
based upon market price at date of grant and is charged to earnings on a
straight-line basis over the period of restriction. Total compensation expense
related to restricted stock was $22,000 and $52,000 for the three and nine month
periods ended September 27, 2003, respectively.
(8) LITIGATION
On August 13, 2003, a lawsuit was filed against the Company in Superior Court of
the State of California, County of Ventura. The suit was subsequently amended on
September 18, 2003. This suit was filed by two former store managers alleging
misclassification of employment position and seeking class certification. The
complaint seeks judgment for unpaid overtime compensation alleged to exceed
$1,000,000, together with related penalties, restitution, attorneys' fees and
costs. We are investigating the allegations in the complaint and intend to
vigorously defend this litigation. As this case is only in the very early stages
of discovery, the financial impact to the Company, if any, cannot be predicted.
The Company is involved in various other 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.
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 UNCERTAINTIES ARISING FROM DOMESTIC AND GLOBAL EVENTS,
o CONSUMER CONFIDENCE AND SPENDING,
o THE EFFECTIVENESS OF OUR ADVERTISING AND PROMOTIONAL EFFORTS,
o ADVERTISING RATES,
o CONSUMER ACCEPTANCE OF OUR PRODUCTS AND SLEEP TECHNOLOGY,
o INDUSTRY COMPETITION,
o OUR ABILITY TO SECURE SUITABLE RETAIL LOCATIONS,
o WARRANTY EXPENSES,
o CALIFORNIA WAGE AND HOUR LITIGATION,
o OUR DEPENDENCE ON SIGNIFICANT SUPPLIERS OR SINGLE SOURCES OF SUPPLY,
o THE VULNERABILITY OF ANY SUPPLIERS TO RECESSIONARY PRESSURES, LIQUIDITY
CONCERNS OR OTHER FACTORS,
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(R) 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. The effect
of these policies on our financial statements is incorporated into 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
The proportion of our total net sales, by dollar volume, from each distribution
channel is summarized as follows:
Three Months Ended Nine Months Ended
-------------------- --------------------
9/27/03 9/28/02 9/27/03 9/28/02
--------- --------- --------- ---------
Stores 79% 78% 78% 76%
Direct Call Center 13% 14% 14% 15%
E-commerce 4% 5% 4% 4%
Wholesale 4% 3% 4% 5%
The number of company-operated retail locations is summarized as follows:
Three Months Ended Nine Months Ended
-------------------- --------------------
9/27/03 9/28/02 9/27/03 9/28/02
--------- --------- --------- ---------
Beginning of period 332 321 322 328
Opened 12 4 24 7
Closed (1) (2) (3) (12)
--------- --------- --------- ---------
End of period 343 323 343 323
========= ========= ========= =========
We anticipate opening 3 new retail stores and closing 3 stores during the fourth
quarter of 2003. We remodeled 87 stores in the first nine months of 2003 and
anticipate remodeling approximately 7 more stores throughout the balance of the
year. Company-operated stores included leased departments within 13 Bed, Bath &
Beyond stores as of September 27, 2003 and 20 at September 28, 2002. The Bed,
Bath & Beyond agreement is renewable annually. We are currently in the process
of evaluating the arrangement.
Comparable store sales (stores open 13 months or more), including remodeled
stores as noted above, increased over prior year by 31.6% and 32.0%, for the
three months ended September 27, 2003 and September 28, 2002, respectively.
Comparable store sales increased by 31.9% and 22.7%, for the nine months ended
September 27, 2003 and September 28, 2002, 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. We expense all store opening and advertising costs as incurred, except
for production costs and advance payments, which are deferred and expensed from
the time the advertisement is first run.
11
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, shareholder
relations costs and other overhead.
IMPAIRMENT OF LONG-LIVED ASSETS AND ASSETS TO BE DISPOSED OF. 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 NINE MONTHS ENDED
---------------------------- ----------------------------
SEPTEMBER 27, SEPTEMBER 28, SEPTEMBER 27, SEPTEMBER 28,
2003 2002 2003 2002
------------- ------------- ------------- -------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 36.2 36.3 37.2 37.5
------------- ------------- ------------- -------------
Gross profit 63.8 63.7 62.8 62.5
------------- ------------- ------------- -------------
Operating expenses:
Sales and marketing 45.4 46.1 46.2 47.4
General and administrative 8.6 10.7 8.6 10.0
Store closings and asset impairments 0.0 0.0 0.0 0.1
------------- ------------- ------------- -------------
Total operating expenses 54.0 56.8 54.8 57.5
------------- ------------- ------------- -------------
Operating income 9.8 6.9 8.0 5.0
Other income (expense), net 0.1 (0.1) 0.1 (0.4)
------------- ------------- ------------- -------------
Income before income taxes 9.9 6.8 8.1 4.6
Income tax (expense) benefit (3.7) 21.0 (3.1) 7.5
------------- ------------- ------------- -------------
Net income 6.2% 27.8% 5.0% 12.1%
============= ============= ============= =============
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 27, 2003 WITH THREE MONTHS ENDED
SEPTEMBER 28, 2002
NET SALES
Net sales increased 38% to $117.4 million for the three months ended September
27, 2003 from $85.1 million for the three months ended September 28, 2002, due
to an 18% increase in mattress unit sales, and higher average selling prices
resulting primarily from improvements in product mix, and new product sales,
predominantly adjustable foundations. The increase in net sales by sales channel
was attributable to (i) a $26.3 million increase in sales from
Company-controlled retail stores, including an increase in comparable store
sales of $20.6 million, (ii) a $2.8 million increase in direct marketing sales,
(iii) a $1.2 million increase in sales through the Company's e-commerce channel
and (iv) a $2.1 million increase in sales from the Company's wholesale channel.
GROSS PROFIT
Gross profit increased to 63.8% for the three months ended September 27, 2003
from 63.7% for the three months ended September 28, 2002, primarily due to
improved product cost as a result of product sales mix improvements, partially
offset by higher warranty expenses. In third quarter 2002, warranty expense and
warranty reserves were reduced following continued improvements in claim rates
due to product quality improvements, resulting in a 0.7% improvement in gross
margins.
12
SALES AND MARKETING
Sales and marketing expenses increased 36% to $53.3 million for the three months
ended September 27, 2003 from $39.2 million for the three months ended September
28, 2002 but decreased as a percentage of net sales to 45.4% from 46.1% for the
comparable prior-year period. The increase in expense was primarily due to
additional media investments, sales-based incentive compensation, and increased
occupancy costs. The decrease as a percentage of net sales was attributable to
greater leverage in fixed selling expenses, including occupancy costs, partially
offset by increases in advertising spending as a percent of net sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 12% to $10.1 million for the three
months ended September 27, 2003 from $9.1 million for the three months ended
September 28, 2002 but decreased as a percentage of net sales to 8.6% from 10.7%
for the prior-year period. The increase in general and administrative expenses
was due primarily to accrued incentive compensation as a result of Company
performance and additional headcount. 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 decreased $16,000 for the three
months ended September 27, 2003 from $24,000 for the three months ended
September 28, 2002. In 2003, the entire $8,000 represents impairments related to
store closures.
OTHER INCOME (EXPENSE), NET
Other income (expense) changed by $255,000 to income of $135,000 for the three
months ended September 27, 2003 from an expense of $120,000 for the three months
ended September 28, 2002. The improvement is primarily due to reduced interest
expense following the elimination of $16 million of debt in 2002.
INCOME TAX (EXPENSE) BENEFIT
Income tax (expense) benefit changed $22.3 million to an income tax expense of
$4.4 million for the three months ended September 27, 2003 from $17.9 million in
income tax benefit for the three months ended September 28, 2002. The increase
in income tax expense was due to recording income tax expense at an estimated
rate of 38% in 2003. The $17.9 million income tax benefit for the three months
ended September 28, 2002 was the result of recording a non-recurring, non-cash
addition to third quarter earnings, due to the expected realization of tax
benefits from net operating loss carry-forwards and other deferred tax assets.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 27, 2003 WITH NINE MONTHS ENDED
SEPTEMBER 28, 2002
NET SALES
Net sales increased 32% to $321.4 million for the nine months ended September
27, 2003 from $243.5 million for the nine months ended September 28, 2002, due
to a 16% increase in mattress unit sales, and higher average selling prices
resulting primarily from improvements in product mix, and new product sales,
predominantly adjustable foundations. The increase in net sales by sales channel
was attributable to (i) a $67.2 million increase in sales from
Company-controlled retail stores, including an increase in comparable store
sales of $57.4 million, (ii) a $6.5 million increase in direct marketing sales,
(iii) a $3.0 million increase in sales through the Company's e-commerce channel
and (iv) a $1.3 million increase in sales from the Company's wholesale channel.
GROSS PROFIT
Gross profit increased to 62.8% for the nine months ended September 27, 2003
from 62.5% for the nine months ended September 28, 2002, primarily due to
improved product cost as a result of product sales mix improvements, partially
offset by the increased cost of product delivery.
SALES AND MARKETING
Sales and marketing expenses increased 28% to $148.5 million for the nine months
ended September 27, 2003 from $115.6 million for the nine months ended September
28, 2002 but decreased as a percentage of net sales to 46.2% from 47.4% for the
comparable prior-year period. The increased expense was primarily due to
additional media investments, sales-based incentive compensation, and increased
occupancy and 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.
13
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 14% to $27.7 million for the nine
months ended September 27, 2003 from $24.3 million for the nine months ended
September 28, 2002 but decreased as a percentage of net sales to 8.6% from 10.0%
for the prior-year period. The increase in general and administrative expenses
was due primarily to accrued incentive compensation as a result of Company
performance and additional headcount. 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 decreased $166,000 to $67,000 for the
nine months ended September 27, 2003 from $233,000 for the nine months ended
September 28, 2002. In 2003, the entire $67,000 represents impairments related
to store closures.
OTHER INCOME (EXPENSE), NET
Other income (expense) changed by $1.3 million to income of $268,000 for the
nine months ended September 27, 2003 from an expense of $1.0 million for the
nine months ended September 28, 2002. The improvement is primarily due to
reduced interest expense following the elimination of $16 million of debt in
2002.
INCOME TAX (EXPENSE) BENEFIT
Income tax (expense) benefit changed $28.1 million to an income tax expense of
$9.9 million for the nine months ended September 27, 2003 from an income tax
benefit of $18.2 million for the nine months ended September 28, 2002. The
increase in income tax expense was due to recording income tax expense at an
estimated rate of 38% in 2003. The $18.2 million income tax benefit for the nine
months ended September 28, 2002 was primarily the result of recording a $17.9
million non-recurring, non-cash addition to 2002 earnings, due to the expected
realization of tax benefits from net operating loss carry-forwards and other
deferred tax assets.
LIQUIDITY AND CAPITAL RESOURCES
We generated cash from operations of $41.7 million in the first nine months of
2003. Historically, our primary source of capital has been from external
sources. Our most recent sources of external funding were 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. More recently, our capital
has been funded internally with cash generated from operations. 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, but haven't
repurchased any additional shares during the second and third quarters of 2003.
We recently obtained a $15 million 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 does 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 nine months ended September
27, 2003 was $41.7 million and consisted primarily of our net income adjusted
for non-cash expenses and increases in accounts payable, other accruals and
liabilities, and accrued customer prepayments. Cash increases were partially
offset by increases in accounts receivable and inventory. Accounts payable
increased as a result of the additional commitments made to advertising in 2003
and timing of payments related thereto. The increase in other accruals and
liabilities is primarily attributable to increases in accrued percentage rent
resulting from store sales growth, taxes payable as we accrue for expected tax
payments, and accrued sales returns due to the increase in sales volume. The
increase in accrued customer prepayments is related to the timing of cash
received on customer orders in advance of delivery of customer shipments at the
end of the quarter. The increase in accounts receivable is related to timing
primarily as it relates to cash settlements on sales financed by our third-party
credit provider, and QVC shows. The increase in inventory is primarily the
result of an increased level of home delivery shipments and the recognition of
the related inventory in transit. Net cash provided by operating activities for
the nine months ended September 28, 2002 was approximately $28.4 million and
consisted primarily of our net income adjusted for non-cash expenses, increases
in accounts payable, accrued compensation and benefits, and accrued customer
prepayments. Accounts payable increased as a result of timing and the additional
commitments made to advertising in 2002. The increase in accrued compensation
was the result of increases in incentive pay accruals. The increase in accrued
customer prepayments was related to the timing of cash received on customer
orders in advance of delivery of customer shipments at the end of the quarter.
14
Net cash used in investing activities was $17.3 million for the nine months
ended September 27, 2003. Investing activities consisted primarily of
investments in marketable securities and purchases of property and equipment for
87 remodeled and 24 new retail stores, and development costs for information
technology systems for the nine months ended September 27, 2003. In 2003, we
made net investments in marketable securities of $2.4 million. The net cash used
in investing activities for the nine months ended September 28, 2002 was $20.8
million. In 2002 we invested in $15.6 million of marketable securities, and we
also invested $5.2 million in purchases of property and equipment. In the
remaining three months of 2003, we expect to open 3 new retail stores and to
remodel approximately 7 additional stores. Our capital expenditures are expected
to total 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 new store openings to have a significant negative effect on net cash
provided by operations.
Net cash provided by financing activities was $1.7 million for the nine months
ended September 27, 2003 from the proceeds from the issuance of common stock
from the exercise of various options and warrants, offset by the repurchase of
common stock. Net cash provided by financing activities for the nine months
ended September 28, 2002 was $405,000.
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
As of the end of the period covered by this report, we conducted an evaluation,
under the supervision and with the participation of our President and Chief
Executive Officer, and our Senior Vice President and Chief Financial Officer, of
our disclosure controls and procedures. Based on this evaluation, these officers
concluded that our disclosure controls and procedures are effective in
recording, processing, summarizing and reporting information necessary to
satisfy our disclosure obligations under the Securities Exchange Act of 1934.
15
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
On August 13, 2003, a lawsuit was filed against the Company in Superior Court of
the State of California, County of Ventura. The suit was subsequently amended on
September 18, 2003. This suit was filed by two former store managers alleging
misclassification of employment position and seeking class certification. The
complaint seeks judgment for unpaid overtime compensation alleged to exceed
$1,000,000, together with related penalties, restitution, attorneys' fees and
costs. We are investigating the allegations in the complaint and intend to
vigorously defend this litigation. As this case is only in the very early stages
of discovery, the financial impact to the Company, if any, cannot be predicted.
The Company is involved in various other 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit
Number Description
------- -----------
10.1 Employment Letter dated July 23, 2003 from the Company
to Scott F. Peterson
31.1 Certification of CEO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
32.1 Certification of CEO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
32.2 Certification of CFO pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
(b) Reports on Form 8-K
During the quarter ended September 27, 2003, Current Reports on
Form 8-K consisted of the following:
(i) Current Report furnished under Item 9 of Form 8-K on
July 3, 2003, announcing net sales for the second quarter
ended June 28, 2003.
16
(ii) Current Report furnished under Item 9 of Form 8-K on
July 11, 2003, providing comments on product notification.
(iii) Current Report furnished under Item 9 of Form 8-K on
July 15, 2003, announcing results for the second quarter
ended June 28, 2003.
(iv) Current Report furnished under Item 9 of Form 8-K on
August 5, 2003, announcing new senior vice president of
human resources.
(v) Current Report furnished under Item 9 of Form 8-K on
August 11, 2003, announcing sale of shares by St. Paul
Venture Capital.
(vi) Current Report furnished under Item 9 of Form 8-K on
September 8, 2003, announcing revised guidance for the
third quarter ending September 27, 2003.
(vii) Current Report furnished under Item 7, 9, and 12 of Form
8-K on September 10, 2003, providing slides that were
presented at a meeting of analysts on September 10, 2003
17
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
-------------------------------------------
October 31, 2003 William R. McLaughlin
President and Chief Executive Officer
(principal executive officer)
/s/ James C. Raabe
-------------------------------------------
James C. Raabe
Senior Vice President and Chief Financial Officer
(principal financial and accounting officer)
18
EXHIBIT INDEX
Exhibit Number Description
-------------- -----------
10.1 Employment Letter dated July 23, 2003 from the
Company to Scott F. Peterson.
31.1 Certification of CEO pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO pursuant to Section 302 of
the Sarbanes-Oxley Act of 2002.
32.1 Certification of CEO pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
32.2 Certification of CFO pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
19