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 April 3, 2004
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 April 3, 2004, 36,393,690 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
April 3, 2004 and January 3, 2004................................... 3
Consolidated Statements of Operations
for the Three Months ended
April 3, 2004 and March 29, 2003.................................... 4
Consolidated Statements of Cash Flows
for the Three Months ended
April 3, 2004 and March 29, 2003.................................... 5
Notes to Consolidated Financial Statements.......................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations....................... 9
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................................................. 17
Item 6. Exhibits and Reports on Form 8-K.................................. 17
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)
APRIL 3, JANUARY 3,
2004 2004
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 32,155 $ 24,725
Marketable securities - current (note 2) 7,674 49,322
Accounts receivable, net of allowance for doubtful
accounts of $742 and $619 10,926 6,823
Inventories (note 3) 12,803 12,381
Prepaid expenses 6,942 5,244
Deferred tax assets 7,014 6,039
------------- --------------
Total current assets 77,514 104,534
Marketable securities - non-current (note 2) 44,305 1,071
Property and equipment, net 38,155 36,134
Deferred tax assets 5,937 5,620
Other assets 3,686 3,343
------------- --------------
Total assets $169,597 $150,702
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 21,852 $ 14,773
Consumer prepayments 7,459 5,970
Accruals:
Sales returns 4,481 3,469
Compensation and benefits 12,165 16,579
Taxes and withholding 4,820 3,661
Other 5,303 6,110
------------- --------------
Total current liabilities 56,080 50,562
Accrued warranty costs 2,265 2,557
Other liabilities 5,028 4,821
------------- --------------
Total liabilities 63,373 57,940
------------- --------------
Shareholders' equity (notes 4 and 5):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
36,393,690 and 35,769,606 shares issued and outstanding, 364 358
respectively
Additional paid-in capital 111,375 104,085
Unearned compensation (2,086) (877)
Accumulated deficit (3,429) (10,804)
------------- --------------
Total shareholders' equity 106,224 92,762
------------- --------------
Total liabilities and shareholders' equity $169,597 $150,702
============= ==============
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
----------------------------
APRIL 3, MARCH 29,
2004 2003
------------- -------------
Net sales $139,963 $101,958
Cost of sales 53,929 38,057
------------- -------------
Gross profit 86,034 63,901
------------- -------------
Operating expenses:
Sales and marketing 63,720 48,917
General and administrative 10,634 8,301
Store closings and asset impairments - 74
------------- -------------
Total operating expenses 74,354 57,292
------------- -------------
Operating income 11,680 6,609
------------- -------------
Other income (expense):
Interest income 312 113
Interest expense - (88)
Other, net - 24
------------- -------------
Other income (expense), net 312 49
------------- -------------
Income before income taxes 11,992 6,658
Income tax expense 4,617 2,530
------------- -------------
Net income $ 7,375 $ 4,128
============= =============
Net income per share (note 4) - basic $ 0.20 $ 0.13
============= =============
Weighted average shares - basic 36,060 30,880
============= =============
Net income per share (note 4) - diluted $ 0.18 $ 0.11
============= =============
Weighted average shares - diluted 39,990 37,173
============= =============
See accompanying notes to consolidated financial statements.
4
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
THREE MONTHS ENDED
-----------------------------
APRIL 3, MARCH 29,
2004 2003
-------------- --------------
Cash flows from operating activities:
Net income $ 7,375 $ 4,128
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,430 2,426
Amortization of debt discount and deferred finance fees - 86
Non-cash compensation 71 -
Loss on disposal of assets and impaired assets - 74
Deferred tax (benefit) expense (1,292) 2,298
Change in operating assets and liabilities:
Accounts receivable, net (4,103) 55
Inventories (422) (365)
Prepaid expenses (1,698) (399)
Other assets (352) 29
Accounts payable 7,079 4,825
Accrued sales returns 1,012 115
Accrued compensation and benefits (4,414) (5,698)
Accrued taxes and withholding 3,997 141
Consumer prepayments 1,489 3,377
Other accruals and liabilities (892) (167)
-------------- --------------
Net cash provided by operating activities 11,280 10,925
-------------- --------------
Cash flows from investing activities:
Purchases of property and equipment (5,442) (4,740)
Investments in marketable securities (43,192) (17,803)
Proceeds from maturity of marketable securities 41,606 12,317
-------------- --------------
Net cash used in investing activities (7,028) (10,226)
-------------- --------------
Cash flows from financing activities:
Principal payments on debt - (10)
Repurchase of common stock (240) (1,834)
Proceeds from issuance of common stock 3,418 521
-------------- --------------
Net cash provided by (used in) financing activities 3,178 (1,323)
-------------- --------------
Increase (decrease) in cash and cash equivalents 7,430 (624)
Cash and cash equivalents, at beginning of period 24,725 27,176
-------------- --------------
Cash and cash equivalents, at end of period $32,155 $26,552
============== ==============
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 April 3, 2004
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 April 3, 2004 and January 3,
2004 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
January 3, 2004. Operating results for the Company on a quarterly basis may not
be indicative of operating results for the full year.
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 corporate notes and
commercial paper issued by companies with investment grade ratings. The
Company's investments have an original maturity of up to 37 months with an
average time to maturity of 18 months as of April 3, 2004. 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 April 3, 2004 carried an amortized cost of $52.0 million and
a fair value of $51.9 million.
(3) INVENTORIES
Inventories consist of the following (in thousands):
APRIL 3, JANUARY 3,
2004 2004
-------------- --------------
Raw materials $ 3,513 $ 3,715
Work in progress 98 123
Finished goods 9,192 8,543
-------------- --------------
$12,803 $12,381
============== ==============
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(4) NET INCOME PER COMMON SHARE
The following computations reconcile reported net income with net income
available to common shareholders per share-basic and diluted (in thousands,
except per share amounts):
THREE MONTHS ENDED
-------------------------------
WEIGHTED
APRIL 3, 2004 NET AVERAGE PER SHARE
------------- INCOME SHARES AMOUNT
---------- --------- ----------
Net income $ 7,375
----------
BASIC EPS
Net income available to common shareholders 7,375 36,060 $ 0.20
==========
EFFECT OF DILUTIVE SECURITIES
Options - 2,545
Common stock warrants - 1,385
---------- ---------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions $ 7,375 39,990 $ 0.18
========== ========= ==========
THREE MONTHS ENDED
-------------------------------
WEIGHTED
MARCH 29, 2003 NET AVERAGE PER 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
========== ========== ==========
Additional potentially dilutive securities totaling 51,000 and 708,000 for the
three-month periods ended April 3, 2004 and March 29, 2003, respectively, have
been excluded from diluted EPS because these securities' exercise price was
greater than the average market price of the Company's common shares.
(5) STOCK AND STOCK OPTION INCENTIVES
The Company uses the intrinsic value method of accounting for stock options.
Under this method 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.
7
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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
---------------------------
APRIL 3, MARCH 29,
2004 2003
---------------------------
Net income, as reported $ 7,375 $ 4,128
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects (674) (630)
---------------------------
Pro forma net income $ 6,701 $ 3,498
===========================
Income per share
Basic - as reported 0.20 0.13
Basic - pro forma 0.19 0.11
Diluted - as reported 0.18 0.11
Diluted - pro forma 0.17 0.10
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
------------------------------
APRIL 3, MARCH 29,
2004 2003
------------------------------
Expected dividend yield............................. 0% 0%
Expected stock price volatility..................... 55% 90%
Risk-free interest rate............................. 2.0% 2.0%
Expected life in years.............................. 3.6 3.6
Weighted-average fair value at grant date........... $10.45 $5.66
The Company issued restricted stock awards to certain employees in conjunction
with its stock-based compensation plan. The shares vest between five and ten
years from the date of issuance based on continued employment. Compensation
expense related to restricted stock awards is based upon the market price at
date of grant and is charged to earnings on a straight-line basis over the
vesting period. 153,500 shares of restricted stock were outstanding as of April
3, 2004. Total compensation expense for the period ended April 3, 2004 related
to restricted stock was $71,000. There was no related compensation expense for
the period ended March 29, 2003.
(6) 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 in the 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.
8
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 JANUARY 3, 2004, 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,
o INFLATION OF COMMODITY OR DELIVERY COSTS, 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. In addition we market and sell accessories and other sleep
related products which focus on providing personalized comfort to complement the
Sleep Number bed and provide a better night's sleep to the consumer.
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.
The proportion of our total net sales, by dollar volume, from each of our
channels is summarized as follows:
Three Months Ended
-------------------
4/3/04 3/29/03
--------- ---------
Stores 76% 79%
Direct Call Center 13% 14%
E-commerce 5% 4%
Wholesale 6% 3%
9
The growth rates of each distribution channel are as follows:
Three Months Ended
-----------------------
4/3/04 3/29/03
Channel Channel
inc (dec) inc (dec)
----------- ----------
Retail:
Comparable store sales 25% 31%
New/closed stores, net 9% 1%
Retail total 34% 32%
Direct marketing 27% 13%
E-commerce 54% 29%
Wholesale 147% (25)%
The number of company-operated retail locations is summarized as follows:
Three Months Ended
-------------------
4/3/04 3/29/03
--------- ---------
Beginning of period 344 322
Opened 9 2
Closed (2) (1)
--------- ---------
End of period 351 323
========= =========
We anticipate opening 15 to 20 new retail stores and closing 3 stores during the
remainder of 2004. We anticipate upgrading the marquee and design of
approximately 130 stores throughout the balance of the year. Company-operated
stores included leased departments within 13 Bed, Bath & Beyond stores as of
April 3, 2004 and March 29, 2003.
Our growth plans are centered on increasing the awareness of our products and
stores through expansion of media, increasing distribution - primarily through
new retail store openings, and expanding and improving our product lines. Our
primary market consists of consumers in the U.S. domestic market.
Increases in sales, along with controlling costs, have provided significant
improvement to operating income and operating margin over the past several
years. The majority of operating margin improvement has been generated through
leverage in selling expenses (increased sales through the existing store base)
and leverage of our existing infrastructure (general and administrative
expenses). We expect any future improvements in operating margin to be derived
from similar sources. Our target is to sustain sales growth rates of 15% to 25%
and sustain earnings growth rates of approximately 30%.
10
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as dollars and percentages of net sales. Figures are in
millions except per share amounts.
THREE MONTHS ENDED
-----------------------------------------------
APRIL 3, 2004 MARCH 29, 2003
------------------------- ---------------------
Net sales $140.0 100.0% $102.0 100.0%
Cost of sales 53.9 38.5% 38.1 37.3%
------------ ------------ ---------- ----------
Gross profit 86.0 61.5% 63.9 62.7%
------------ ------------ ---------- ----------
Operating expenses:
Sales and marketing 63.7 45.5% 48.9 48.0%
General and administrative 10.6 7.6% 8.3 8.1%
Store closings and asset impairments 0.0 0.0% 0.1 0.1%
------------ ------------ ---------- ----------
Total operating expenses 74.4 53.1% 57.3 56.2%
------------ ------------ ---------- ----------
Operating income 11.7 8.4% 6.6 6.5%
Other income (expense), net 0.3 0.2% 0.0 0.0%
------------ ------------ ---------- ----------
Income before income taxes 12.0 8.6% 6.6 6.5%
Income tax expense 4.6 3.3% 2.5 2.5%
------------ ------------ ---------- ----------
Net income $ 7.4 5.3% $ 4.1 4.0%
============ ============ ========== ==========
Net income per share:
Basic $ 0.20 $ 0.13
Diluted 0.18 0.11
Weighted-average number of common shares:
Basic 36.1 30.9
Diluted 40.0 37.2
NET SALES
We record revenue at the time product is shipped to our 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. We
reduce sales at the time revenue is recognized 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. Historically we have not experienced material adjustments
to the financial statements due to changes to these estimates.
COST OF SALES
Cost of sales includes costs associated with purchasing materials, manufacturing
costs and costs to deliver our products to our customers. 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. Historically we have not
experienced material adjustments to the financial statements due to changes to
these estimates.
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, delivery and manufacturing and the mix of sales between wholesale
and company-controlled distribution channels. Sales of products manufactured by
third parties, such as accessories and our adjustable foundation, generate lower
gross margins, Similarly, 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.
11
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. Advertising expense was $21.6 million
for the three months ended April 3, 2004 as compared to $14.6 million for the
three months ended March 29, 2003. Future advertising expenditures will depend
on the effectiveness and efficiency of the advertising in creating awareness of
our products and brand name, generating consumer inquiries and driving consumer
traffic to our points of sale.
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 salaries, bonus and benefits,
information hardware, software and maintenance, office facilities, insurance,
shareholder relations costs and other overhead.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expenses include charges made against
operating expenses for store related or other capital assets that have been
written-off when a store is underperforming and generating negative cash flows.
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.
QUARTERLY AND ANNUAL RESULTS
Quarterly and annual operating results may fluctuate significantly as a result
of a variety of factors, including increases or decreases in comparable store
sales, the timing, amount and effectiveness of advertising expenditures, any
changes in sales return rates or warranty experience, the timing of new store
openings and related expenses, net sales contributed by new stores, competitive
factors, any disruptions in supplies or third-party service providers and
general economic conditions, seasonality of sales and timing of QVC shows and
wholesale sales and consumer confidence. Furthermore, a substantial portion of
net sales is often realized in the last month of a quarter, due in part to our
promotional schedule and commission structure. As a result, we may be unable to
adjust spending in a timely manner, and our business, financial condition and
operating results may be significantly harmed. Our historical results of
operations may not be indicative of the results that may be achieved for any
future period.
COMPARISON OF THREE MONTHS ENDED APRIL 3, 2004 WITH THREE MONTHS ENDED
MARCH 29, 2003
NET SALES
Net sales increased 37% to $140.0 million for the three months ended April 3,
2004 from $102.0 million for the three months ended March 29, 2003, due to a 24%
increase in mattress unit sales and higher average selling prices. The average
selling price per bed set in our company controlled channels was $1,815, an
increase of approximately 15% over first quarter last year. The higher average
selling price resulted primarily from improvements in product mix. The increase
in mattress unit sales was driven predominantly by stronger than historical
growth rates in sales to QVC and other wholesale partners.
The increase in net sales by sales channel was attributable to (i) a $27.0
million increase in sales from our retail stores, including an increase in
comparable store sales of $19.8 million and an increase of $7.2 million from new
stores, net of stores closed, (ii) a $3.7 million increase in direct marketing
sales, (iii) a $2.2 million increase in sales through the Company's e-commerce
channel and (iv) a $5.1 million increase in sales from the Company's wholesale
channel.
GROSS PROFIT
Gross profit decreased to 61.5% for the three months ended April 3, 2004 from
62.7% for the three months ended March 29, 2003, primarily due to increased
sales of adjustable foundations which are not manufactured by us and carry lower
gross margins, channel mix, and increased utilization of our home delivery
services.
12
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased 30% to $63.7 million for the three months
ended April 3, 2004 from $48.9 million for the three months ended March 29, 2003
but decreased as a percentage of net sales to 45.5% from 48.0% for the
comparable prior-year period. The $14.8 million increase was primarily due to
additional media investments, sales-based incentive compensation, and increased
occupancy costs. The decrease as a percentage of net sales was comprised
primarily of a 1.1 percentage point (ppt) increase in media investments offset
by a 1.0 ppt decrease in sales compensation costs, a 1.0 ppt decrease in
occupancy costs, a 1.0 ppt decrease in other marketing costs and 0.3 ppt
decrease in field management and support costs. With additional sales growth, we
expect sales and marketing expenses as a percentage of net sales to continue to
decline as we achieve greater leverage from our base sales compensation and
occupancy costs while reinvesting some of these leverage benefits into higher
levels of media investments and training.
GENERAL AND ADMINISTRATIVE EXPENSES
General and administrative (G&A) expenses increased 28% to $10.6 million for the
three months ended April 3, 2004 from $8.3 million for the three months ended
March 29, 2003 but decreased as a percentage of net sales to 7.6% from 8.1% for
the prior-year period. The dollar increase in G&A was comprised primarily of
increased compensation expenses related to additional headcount and from
occupancy costs. We expect G&A growth rates to continue to be lower than the
rate of sales growth due to leveraging the fixed component of G&A expenses
across a higher sales base.
STORE CLOSINGS AND ASSET IMPAIRMENT EXPENSES
Store closing and asset impairment expense decreased $74,000 to $0 for the three
months ended April 3, 2004. The entire amount represents impairments related to
store closures.
OTHER INCOME (EXPENSE), NET
Other income (expense) increased $263,000 to $312,000 for the three months ended
April 3, 2004 from $49,000 for the three months ended March 29, 2003. The
improvement is primarily due to increased interest income reflecting higher
balances of invested cash.
INCOME TAX EXPENSE
Income tax expense increased $2.1 million to $4.6 million for the three months
ended April 3, 2004 from $2.5 million for the three months ended March 29, 2003.
The effective tax rate was 38.5% in 2004 and 38.0% in 2003.
LIQUIDITY AND CAPITAL RESOURCES
As of April 3, 2004, we had cash and marketable securities of $84.1 million,
$39.8 million classified as a current asset. As of January 3, 2004, cash and
marketable securities totaled $75.1 million, $74.0 million classified as
current. Net working capital totaled $21.4 million as of April 3, 2004 compared
to $54.0 million for 2003. The decrease in net working capital was due to a
shift to longer-term investments which are reported as non-current assets. The
$9.0 million improvement in cash balances was the result of generating $5.9
million of operating free cash flow ($11.3 million of cash provided by operating
activities, reduced by $5.4 million of capital expenditures) and $3.2 million of
cash provided by financing activities. Cash from financing activities was
primarily comprised of cash received from option and warrant exercises and
shares purchased by employees as part of an employee share purchase program,
offset by purchases of stock made by us as part of our ongoing common stock
repurchase program. We expect to continue to generate positive cash flows from
operations in the future, while not anticipating any significant additional
working capital requirements due to our advantaged business model which requires
low levels of inventory and other working capital assets.
We generated cash from operations for the three months ended April 3, 2004 and
March 29, 2003 of $11.3 million and $10.9 million, respectively. The $0.4
million year-to-year improvement in cash from operations resulted primarily from
improved operating income in 2004 partially offset by increases in income taxes
due, as we utilized substantially all net operating loss carryforwards ("NOLs")
in 2003, and an increase in accounts receivable balances due to QVC shows
occurring late in the first quarter.
Capital expenditures amounted to $5.4 million for the three months ended April
3, 2004, compared to $4.7 million for the three months ended March 29, 2003. In
both periods our capital expenditures related primarily to new and remodeled
retail stores and investments in information technology ("IT"). The majority of
the year over year increase in capital expenditures relates to investments in
retail stores. In the first quarter of 2004 we opened 9 retail stores, while in
the first quarter of 2003 we opened 2 stores. We anticipate opening an
additional 15 to 20 new
13
stores while upgrading the marquee and design of approximately 133 stores. We
will fund the investment in new and upgraded stores with capital generated from
operations. We expect our new stores to be cash flow positive within the first
twelve months of operation and, as a result, do not anticipate a negative effect
on net cash provided by operations.
Net cash provided by financing activities totaled $3.2 million for the three
months ended April 3, 2004, an increase of $4.5 million compared to cash used in
financing activities during the three months ended March 29, 2003. The $4.5
million increase in cash from financing activities was comprised of an increase
of $2.9 million received for exercises of stock options and warrants and for
employee purchases of common stock and a $1.6 million decrease in purchases of
common stock by us under our board-authorized common stock repurchase program.
Purchases of additional Select Comfort stock may be made from time-to-time,
subject to market conditions and at prevailing market prices, through open
market purchases. Repurchased shares will be retired and may be reissued in the
future for general corporate or other purposes. We may terminate or limit the
stock repurchase at any time.
Management believes that cash generated from operations will be a sufficient
source of liquidity for the short- and long- term and should provide adequate
capital for capital expenditures and common stock repurchases, if any. In
addition, our advantaged business model, which can operate with minimal working
capital, does not require significant additional capital to fund operations. In
2003 we obtained a $15 million bank revolving line of credit to provide
additional cash flexibility in the case of unexpected significant external or
internal developments. The line of credit is a three-year senior secured
revolving facility. The interest rate on borrowings is calculated using LIBOR
plus 1.50% to 2.25% with the incremental rate dependent on our leverage ratio,
as defined by the lender. We are subject to certain financial covenants under
the agreement, principally consisting of minimum liquidity requirements, working
capital and leverage ratios. We have remained in full compliance with the
financial covenants from the date the agreement was originated. We currently
have no borrowings outstanding under this credit agreement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions. Predicting future events is inherently an imprecise
activity and as such requires the use of judgment. Actual results may vary from
estimates in amounts that may be material to the financial statements. The
accounting policies discussed below are considered critical because changes to
certain judgments and assumptions inherent in these policies could materially
affect the financial statements.
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.
In certain instances, accounting principles generally accepted in the United
States of America allow for the selection of alternative accounting methods. Our
significant policy that involves the selection of an alternative method is
accounting for stock options.
STOCK-BASED COMPENSATION
Two alternative methods exist for accounting for stock options: the intrinsic
value method and the fair value method. We use the intrinsic value method of
accounting for stock options, and accordingly, no compensation expense has been
recognized in the financial statements for options granted to employees, or for
the discount feature of our employee stock purchase plan.
REVENUE RECOGNITION
We record revenue at the time product is shipped to our 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
We reduce sales at the time revenue is recognized 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.
14
ACCRUED WARRANTY COSTS
The estimated costs to service warranty claims of customers is included in cost
of sales. 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.
STORE CLOSING AND ASSET IMPAIRMENT EXPENSES
We evaluate our long-lived assets, including leaseholds and fixtures in existing
stores, 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.
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 our
investments 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.
In addition, our investments carry fixed interest rates which, in an increasing
interest rate environment, would result in unrealized losses in our investment
portfolio. The Company limits this interest rate risk by designating this
portfolio as "held-to-maturity" and by managing the short-term liquidity needs
of the business by matching investment duration to liquidity needs.
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 in the 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
(a) - (d) Not applicable.
(e) Registrant Purchases of Equity Securities
(C) TOTAL
NUMBER OF (D) MAXIMUM
SHARES (OR NUMBER (OR
UNITS) APPROXIMATE
PURCHASED AS DOLLAR VALUE) OF
(A) TOTAL PART OF SHARES (OR UNITS)
NUMBER OF (B) AVERAGE PUBLICLY THAT MAY YET BE
SHARES (OR PRICE PAID ANNOUNCED PURCHASED UNDER
UNITS) PER SHARE PLANS OR THE PLANS OR
PERIOD PURCHASED(1) (OR UNIT) PROGRAMS (2) PROGRAMS
-------------------- ------------- ------------ ------------- ---------------
January 4, 2004 - 140 $25.15 - $11,693,000
January 31, 2004
February 1, 2004 -
February 28, 2004 14,952 24.25 10,000 12,333,000
February 29, 2004
- April 3, 2004 274 26.92 - 15,006,000
------------- ------------- ---------------
Total 15,366 $24.31 10,000 $15,006,000
(1) Includes 5,366 shares acquired in open market transactions by the
administrator of the Company's non-qualified deferred compensation
plan in order to accommodate investment elections of plan
participants.
(2) In February 2003, the Company announced that the Board of
Directors had authorized the use of up to $12.5 million for the
repurchase of shares of the Company's common stock. This authorization
was subsequently modified to allow for the use of a formula specified
amount based on certain minimum cash levels, for the repurchase of
shares. The Audit Committee of the Board of Directors reviews, on a
quarterly basis, the authority granted as well as any repurchases
under this program. This authorization is currently not subject to
expiration.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
16
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit
Number Description
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 April 3, 2004, Current Reports on Form
8-K consisted of the following:
(i) Current Report furnished under Item 12 of Form 8-K on
January 9, 2004, announcing net sales for the fourth quarter
and full year ended January 3, 2004.
(ii) Current Report furnished under Item 7, 9, and 12 of Form 8-K
on January 14, 2004, providing slides that were presented at
an investor conference on January 14, 2004 and January 16,
2004.
(iii) Current Report furnished under Item 12 of Form 8-K on
February 10, 2004, announcing comments on results for the
fourth quarter and year-ended January 3, 2004 and earnings
guidance for first quarter 2004.
(iv) Current Report furnished under Item 12 of Form 8-K on March
1, 2004, announcing sponsorship of the Home Design Show in
Minneapolis.
(v) Current Report furnished under Item 12 of Form 8-K on March
4, 2004, announcing election of Brenda Lauderback to the
board of directors.
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SELECT COMFORT CORPORATION
/s/ William R. McLaughlin
-------------------------------------------
May 13, 2004 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)
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EXHIBIT INDEX
Exhibit Number Description
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