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 2, 2005
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 22, 2005, 36,086,951 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 2, 2005 and January 1, 2005................................... 3
Consolidated Statements of Operations
for the Three Months ended
April 2, 2005 and April 3, 2004..................................... 4
Consolidated Statements of Cash Flows
for the Three Months ended
April 2, 2005 and April 3, 2004..................................... 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.......... 16
Item 4. Controls and Procedures............................................. 16
PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................................. 17
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds....... 17
Item 3. Defaults Upon Senior Securities................................... 17
Item 4. Submission of Matters to a Vote of Security Holders............... 18
Item 5. Other Information................................................. 18
Item 6. Exhibits.......................................................... 18
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 2, JANUARY 1,
2005 2005
------------- --------------
ASSETS
Current assets:
Cash and cash equivalents $ 24,238 $ 15,066
Marketable securities - current (note 2) 40,078 35,747
Accounts receivable, net of allowance for doubtful
accounts of $662 and $619 9,212 8,644
Inventories (note 3) 18,307 20,481
Prepaid expenses 8,362 7,375
Deferred tax assets 6,041 5,287
------------- --------------
Total current assets 106,238 92,600
Marketable securities - non-current (note 2) 36,845 40,930
Property and equipment, net 45,803 43,911
Deferred tax assets 11,494 10,755
Other assets 3,577 3,617
------------- --------------
Total assets $ 203,957 $191,813
============= ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 29,229 $ 26,267
Consumer prepayments 8,919 9,368
Accruals:
Sales returns 5,980 5,038
Compensation and benefits 15,493 13,913
Taxes and withholding 6,138 6,392
Other 7,890 8,143
------------- --------------
Total current liabilities 73,649 69,121
Long-term liabilities 8,791 8,348
------------- --------------
Total liabilities 82,440 77,469
------------- --------------
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,
36,082,919 and 35,828,222 shares issued and outstanding, 361 358
respectively
Additional paid-in capital 96,020 95,548
Unearned compensation (3,696) (1,752)
Retained earnings 28,832 20,190
------------- --------------
Total shareholders' equity 121,517 114,344
------------- --------------
Total liabilities and shareholders' equity $ 203,957 $191,813
============= ==============
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 2, APRIL 3,
2005 2004
------------- -------------
Net sales $172,832 $139,963
Cost of sales 70,735 53,929
------------- -------------
Gross profit 102,097 86,034
Operating expenses:
Sales and marketing 75,025 63,782
General and administrative 13,424 10,634
------------ ------------
Operating income 13,648 11,618
Other income:
Interest income 473 312
------------- -------------
Income before income taxes 14,121 11,930
Income tax expense 5,479 4,597
------------- -------------
Net income $ 8,642 $ 7,333
============= =============
Net income per share (note 4) - basic $ 0.24 $ 0.20
============= =============
Weighted average shares - basic 35,799 35,929
============= =============
Net income per share (note 4) - diluted $ 0.22 $ 0.18
============= =============
Weighted average shares - diluted 39,071 39,990
============= =============
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 2, APRIL 3,
2005 2004
-------------- --------------
Cash flows from operating activities:
Net income $ 8,642 $ 7,333
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 3,701 3,430
Non-cash compensation 64 71
Deferred tax (benefit) expense (1,493) (1,312)
Change in operating assets and liabilities:
Accounts receivable, net (568) (4,103)
Inventories 2,174 (522)
Prepaid expenses (987) (1,698)
Other assets 31 (352)
Accounts payable 2,962 7,179
Accrued sales returns 942 1,012
Accrued compensation and benefits 1,580 (4,414)
Accrued taxes and withholding 171 3,997
Consumer prepayments (449) 1,489
Other accruals and liabilities 190 (830)
-------------- --------------
Net cash provided by operating activities 16,960 11,280
-------------- --------------
Cash flows from investing activities:
Purchases of property and equipment (5,584) (5,442)
Investments in marketable securities (2,696) (43,192)
Proceeds from maturity of marketable securities 2,450 41,606
-------------- --------------
Net cash used in investing activities (5,830) (7,028)
-------------- --------------
Cash flows from financing activities:
Repurchase of common stock (6,911) (240)
Proceeds from issuance of common stock 4,953 3,418
-------------- --------------
Net cash (used in) provided by financing (1,958) 3,178
activities
-------------- --------------
Increase in cash and cash equivalents 9,172 7,430
Cash and cash equivalents, at beginning of period 15,066 24,725
-------------- --------------
Cash and cash equivalents, at end of period $ 24,238 $ 32,155
============== ==============
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 2, 2005
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 2, 2005 and January 1,
2005 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 U.S. generally accepted accounting
principles 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 our most recent audited
consolidated financial statements and related notes included in our Annual
Report to Shareholders and annual report on Form 10-K for the fiscal year ended
January 1, 2005. Operating results for any quarterly period may not be
indicative of operating results for the full year. Certain prior-year amounts
have been reclassified to conform to the current-year presentation.
In April 2005, the Securities and Exchange Commission (SEC) approved a new rule
that delays the effective date of SFAS No. 123 Revised, "Share-Based Payment"
requiring compensation cost for all share-based payments (including employee
stock options) to be recognized in the financial statements at fair value. Under
the SEC's rule, the provisions of the standard are now effective as of the first
quarter of fiscal 2006. We are evaluating the requirements of SFAS 123R and
expect that the adoption of SFAS 123R will have a material impact on our
consolidated results of operations and earnings per share. Our pro forma
disclosures have historically reported an annual impact to diluted earnings per
share of $0.06 to $0.11. We have not determined the specific apportionment of
cost within the consolidated statements of operations and whether adoption will
result in amounts that are similar to the current pro forma disclosures under
SFAS 123.
No additional new accounting pronouncements have been issued that are expected
to have a material effect on our financial results.
(2) MARKETABLE SECURITIES
We invest our cash in highly liquid investment grade debt instruments issued by
the US government and related agencies, municipalities and corporations with
investment grade ratings.
Our investments have an original maturity of up to 36 months with a
weighted-average time to maturity of 13 months as of April 2, 2005. Investments
with an original maturity of less than 90 days are classified as cash
equivalents. 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. Investments are
classified as held-to-maturity and carried at amortized cost. Marketable
securities held at April 2, 2005 carried an amortized cost of $76.9 million and
a fair value of $76.1 million.
(3) INVENTORIES
Inventories consist of the following (in thousands):
APRIL 2, JANUARY 1,
2005 2005
-------------- --------------
Raw materials $ 6,028 $ 8,498
Work in progress 199 170
Finished goods 12,080 11,813
-------------- --------------
$18,307 $20,481
============== ==============
6
(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 2, 2005 NET AVERAGE PER SHARE
------------- INCOME SHARES AMOUNT
---------- --------- ----------
BASIC EPS
Net income available to common $ 8,642 35,799 $ 0.24
shareholders
==========
EFFECT OF DILUTIVE SECURITIES
Options - 1,791
Common stock warrants - 1,306
Restricted Stock - 175
---------- ---------
DILUTED EPS
Net income available to common
shareholders $ 8,642 39,071 $ 0.22
plus assumed conversions
========== ========= ==========
THREE MONTHS ENDED
-------------------------------
WEIGHTED
APRIL 3, 2004 NET AVERAGE PER SHARE
------------- INCOME SHARES AMOUNT
---------- --------- ----------
BASIC EPS
Net income available to common $ 7,333 35,929 $ 0.20
shareholders
==========
EFFECT OF DILUTIVE SECURITIES
Options - 2,545
Common stock warrants - 1,385
Restricted Stock - 131
---------- ---------
DILUTED EPS
Net income available to common
shareholders $ 7,333 39,990 $ 0.18
plus assumed conversions
========== ========= ==========
Additional potentially dilutive securities totaling 741,000 and 51,000 for the
three-month periods ended April 2, 2005 and April 3, 2004, respectively, have
been excluded from diluted EPS because the exercise price was greater than the
average market price of the Company's common shares.
(5) STOCK AND STOCK OPTION INCENTIVES
Statement of Financial Accounting Standards (SFAS) No. 123 (SFAS No. 123),
"Accounting for Stock-Based Compensation" encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. We have chosen to continue to account for stock-based
compensation in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," and related interpretations.
Accordingly, no compensation cost has been recognized for fixed-price stock
options because the exercise prices of the stock options equal the market value
of our common stock at the date of grant.
7
The following table illustrates the effect on our net income and earnings per
share if we had applied the fair value recognition provision of SFAS No. 123 (in
thousands, except per share amounts):
THREE MONTHS ENDED
---------------------------
APRIL 2, APRIL 3,
2005 2004
---------------------------
Net income, as reported $ 8,642 $ 7,333
Deduct: Total stock-based employee
compensation expense determined under
fair value based method for all awards,
net of related tax effects (756) (674)
---------------------------
Pro forma net income $ 7,886 $ 6,659
===========================
Income per share
Basic - as reported $ 0.24 $ 0.20
Basic - pro forma $ 0.22 $ 0.19
Diluted - as reported $ 0.22 $ 0.18
Diluted - pro forma $ 0.20 $ 0.17
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions:
THREE MONTHS ENDED
------------------------------
APRIL 2, APRIL 3,
2005 2004
------------------------------
Expected dividend yield............. 0% 0%
Expected stock price volatility..... 80% 55%
Risk-free interest rate............. 4.0% 2.0%
Expected life in years.............. 4.0 3.6
Weighted-average fair value at
grant date.......................... $12.24 $10.45
We have issued restricted stock awards to certain employees in conjunction with
our stock-based compensation plan. The shares vest between four 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. There were 175,000 shares of restricted stock outstanding as of April 2,
2005. Total compensation expense related to restricted stock was $64,000 and
$71,000 for the three months ended April 2, 2005 and April 3, 2004,
respectively.
(6) LITIGATION
In August 2003, a lawsuit was filed against the Company in Superior Court of the
State of California, County of Ventura. This suit was filed by two former store
managers alleging misclassification of employment position and seeking class
certification. The plaintiffs have sought judgment for unpaid overtime
compensation for store managers and lost meal and break times for store managers
and other store personnel alleged to exceed $1.0 million, together with related
penalties, restitution, attorneys' fees and costs. In January 2005, we agreed to
settle all of the alleged claims for an aggregate sum of $750,000. This
settlement is subject to the approval of the court, which we plan to pursue over
the next several months. The cost of this settlement was accrued in our fiscal
2004 results of operations.
In October 2004, a lawsuit was filed against the Company in Hennepin County
District Court in the State of Minnesota by one of our customers alleging
deceptive trade practices, fraud and breach of warranty related to the alleged
propensity of our products to develop mold. The complaint seeks class
certification and various forms of legal and equitable relief, including but not
limited to rescission and/or actual damages in an amount to be determined at
trial, including interest, costs and attorney's fees. In December 2004, we filed
a motion to dismiss the claims in their entirety. The district court dismissed
plaintiff's false advertising claim and deceptive trade practice damage claim.
The court denied the motion to dismiss the remaining fraud and warranty claims,
8
and we have requested reconsideration of that portion of the court's decision.
The court's decision on plaintiff's motion seeking class certification is
pending. We believe that the complaint is without merit and intend to vigorously
defend the claims. As this case is in the early stages, the financial impact to
our company, if any, cannot be predicted.
We are 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 our consolidated
financial position or results of operations.
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 OUR HISTORICAL
EXPERIENCE AND OUR PRESENT EXPECTATIONS OR PROJECTIONS. IMPORTANT FACTORS KNOWN
TO US 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 1, 2005, WHICH DISCUSSION IS INCORPORATED HEREIN BY REFERENCE. THESE
IMPORTANT FACTORS INCLUDE, BUT ARE NOT LIMITED TO:
o OUR ABILITY TO CONTINUE TO SUCCESSFULLY EXECUTE OUR STRATEGIC INITIATIVES
AND GROWTH STRATEGY;
o THE EFFICIENCY AND EFFECTIVENESS OF OUR SLEEP NUMBER ADVERTISING CAMPAIGN
AND OTHER MARKETING PROGRAMS IN BUILDING PRODUCT AND BRAND AWARENESS,
DRIVING TRAFFIC TO OUR POINTS OF SALE AND INCREASING SALES;
o THE LEVEL OF CONSUMER ACCEPTANCE OF OUR PRODUCTS, NEW PRODUCT OFFERINGS AND
BRAND IMAGE;
o OUR ABILITY TO EXECUTE OUR RETAIL STORE DISTRIBUTION STRATEGY, INCLUDING
INCREASED SALES AND PROFITABILITY THROUGH OUR EXISTING STORES AND OUR
ABILITY TO COST-EFFECTIVELY SECURE NEW STORE LOCATIONS AND CLOSE
UNDER-PERFORMING STORE LOCATIONS;
o OUR ABILITY TO COST-EFFECTIVELY SELL OUR PRODUCTS THROUGH WHOLESALE OR
OTHER DISTRIBUTION CHANNELS IN VOLUMES SUFFICIENT TO DRIVE GROWTH AND
LEVERAGE OUR COST STRUCTURE AND ADVERTISING SPENDING;
o OUR ABILITY TO RETAIN EXISTING WHOLESALE ACCOUNTS AND TO SECURE NEW
WHOLESALE ACCOUNTS ON A PROFITABLE BASIS;
o THE SUCCESS OF OUR PROGRAM WITH RADISSON HOTELS AND RESORTS(R) IN ACHIEVING
PLANNED LEVELS OF PLACEMENT OF OUR BEDS WITH THE HOTELS AND RESORTS AND IN
DRIVING CONSUMER AWARENESS OF OUR PRODUCT AND BRAND;
o OUR ABILITY TO MAINTAIN COST-EFFECTIVE SALES, PRODUCTION AND DELIVERY OF
OUR PRODUCTS;
o OUR ABILITY TO EFFECTIVELY MANAGE THE EFFECTS OF INFLATIONARY PRESSURES
CAUSED BY RISING FUEL AND COMMODITY COSTS AS WELL AS FLUCTUATING CURRENCY
RATES, ALL WHICH COULD INCREASE PRODUCT AND SERVICE COSTS AND RESULT IN
LOWER GROSS PROFIT MARGINS;
o OUR ABILITY TO INCREASE OUR PRICES AS MAY BE NECESSARY TO MAINTAIN GROSS
MARGINS IN THE FACE OF COST PRESSURES AND CHANGING INDUSTRY REGULATORY
REQUIREMENTS;
o OUR ABILITY TO SUCCESSFULLY EXPAND OUR HOME DELIVERY, ASSEMBLY AND MATTRESS
REMOVAL CAPABILITIES ON A COST-EFFECTIVE BASIS;
o OUR ABILITY TO COST-EFFECTIVELY SECURE THIRD PARTY SERVICES FOR PRODUCT
DELIVERY, PRODUCT ASSEMBLY SERVICES AND CONSUMER CREDIT OPTIONS THROUGH
CREDIT PROVIDERS
o THE IMPACT OF OUTSTANDING LITIGATION CLAIMS, INCLUDING THE POTENTIAL IMPACT
OF ANY ADVERSE PUBLICITY;
o OUR ABILITY TO SUCCESSFULLY IDENTIFY AND RESPOND TO EMERGING AND
COMPETITIVE TRENDS IN THE BEDDING INDUSTRY;
o THE LEVEL OF COMPETITION IN THE BEDDING INDUSTRY; AND
o GENERAL ECONOMIC CONDITIONS AND CONSUMER CONFIDENCE.
WE HAVE NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY OF THE FORWARD-LOOKING
STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q.
OVERVIEW
- --------
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 designed to provide personalized comfort to complement the
Sleep Number bed and to 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, the QVC shopping channel and to several end users such as Radisson
Hotels and Resorts(R).
10
The proportion of our total net sales, by dollar volume, from each of our
channels is summarized as follows:
Three Months Ended
---------------------
4/2/05 4/3/04
--------- ---------
Stores 76% 76%
Direct Call Center 12 13
E-commerce 5 5
Wholesale 7 6
--------- ---------
Total 100% 100%
The components of sales growth, including comparable store sales increases, are
as follows:
Three Months Ended
-----------------------
4/2/05 4/3/04
Channel Channel
Increase Increase
----------- ----------
Retail:
Comparable store sales 16% 25%
New/closed stores, net 8 9
----------- ----------
Retail total 24 34
Direct marketing 17 27
E-commerce 25 54
Wholesale 37 147
----------- ----------
Total 23% 37%
The number of company-operated retail locations, including leased departments
within Bed, Bath & Beyond(R) stores, is summarized as follows:
Three Months Ended
---------------------
4/2/05 4/3/04
--------- ---------
Beginning of period 370 344
Opened 5 9
Closed (5) (2)
--------- ---------
End of period 370 351
========= =========
We anticipate opening up to 40 new retail stores during the year and to close
approximately 15 stores, including the phase-out of leased departments in Bed,
Bath & Beyond(R) stores. In the second quarter, we expect to open at least 10
new stores and close 10 stores. Anticipated store closures in 2005 include the
phase-out of 13 leased departments within Bed, Bath & Beyond(R) stores, 4 in the
first quarter and 9 in the second quarter. Sales within these locations
represent approximately 1% of company sales. We do not expect closure of these
stores will significantly impact sales or earnings.
Our growth plans are centered on increasing consumer awareness of our products
and stores through expansion of media, increasing distribution - primarily
through new retail store openings and supplemented with sales through other
mattress retailers, and through improvement and expansion of our product lines.
Our primary market consists of the sale of products directly to consumers in the
U.S. domestic market. We believe that opportunities exist longer term for sales
internationally and to commercial markets.
Increases in sales, along with controlling costs, have provided significant
improvement to our operating income and operating margin. 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 20% and annual earnings growth
rates of approximately 20% to 25%.
11
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 percentages and per share amounts.
THREE MONTHS ENDED
---------------------------------------------
APRIL 2, 2005 APRIL 3, 2004
---------------------- ---------------------
Net sales $172.8 100.0% $140.0 100.0%
Cost of sales 70.7 40.9% 53.9 38.5%
---------- ---------- ---------- ----------
Gross profit 102.1 59.1% 86.1 61.5%
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing 75.0 43.4% 63.8 45.6%
General and administrative 13.4 7.8% 10.6 7.6%
---------- ---------- ---------- ----------
Total operating expenses 88.4 51.2% 74.4 53.2%
---------- ---------- ---------- ----------
Operating income 13.7 7.9% 11.7 8.3%
Other income, net 0.4 0.3% 0.3 0.2%
---------- ---------- ---------- ----------
Income before income taxes 14.1 8.2% 12.0 8.5%
Income tax expense 5.5 3.2% 4.7 3.3%
---------- ---------- ---------- ----------
Net income $ 8.6 5.0% $ 7.3 5.2%
========== ========== ========== ==========
Net income per share:
Basic $ 0.24 $ 0.20
Diluted $ 0.22 $ 0.18
Weighted-average number of common shares:
Basic $ 35.8 $ 35.9
Diluted $ 39.1 $ 40.0
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 for products and home delivery services 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 experienced 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 our consolidated 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.
12
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
costs. We expense all store opening and advertising costs as incurred. 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 system 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, the timing
of promotional offerings, competitive factors, rising commodity costs, any
disruptions in supplies or third-party service providers, seasonality of retail
sales, timing of QVC shows and wholesale sales, consumer confidence, and general
economic conditions. 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 2, 2005 WITH THREE MONTHS ENDED APRIL 3,
2004
NET SALES
Net sales increased 23% to $172.8 million for the three months ended April 2,
2005 from $140.0 million for the three months ended April 3, 2004, due to a 16%
increase in mattress unit sales and higher average selling prices. The average
selling price per bed in our company controlled channels was $1,932, an increase
of approximately 6% over first quarter last year. The higher average selling
price resulted primarily from a price increase introduced at the beginning of
the year. The increase in mattress unit sales was driven primarily by growth in
same-store sales.
The increase in net sales by sales channel was attributable to (i) a $25.1
million increase in sales from our retail stores, including an increase in
comparable store sales of $20.9 million and an increase of $4.2 million from new
stores, net of stores closed, (ii) a $3.0 million increase in direct marketing
sales, (iii) a $1.6 million increase in sales through our e-commerce channel and
(iv) a $3.1 million increase in sales through our wholesale channel.
GROSS PROFIT
Gross profit decreased to 59.1% for the three months ended April 2, 2005 from
61.5% for the three months ended April 3, 2004, primarily due to changes in
product mix (i.e., increased percentage of our total net sales from our lower
margin products), changes in channel mix (i.e., increased percentage of our
total net sales from our lower margin channels), and increased product and
service, costs resulting from rising fuel and commodity costs and somewhat
higher warranty reserves.
SALES AND MARKETING EXPENSES
Sales and marketing expenses increased 18% to $75.0 million for the three months
ended April 2, 2005 from $63.8 million for the three months ended April 3, 2004
and decreased as a percentage of net sales to 43.4% from 45.6% for the
13
comparable prior-year period. The $11.2 million increase was primarily due to
additional media investments, sales-based incentive compensation, and increased
number of stores. The decrease as a percentage of net sales was comprised
primarily of a 0.6 percentage point (ppt) decrease in media investments and a
1.6 ppt leverage of fixed costs (occupancy, base sales compensation and certain
marketing expenses) over higher sales. With additional sales growth, we expect
sales and marketing expenses as a percentage of net sales 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 26% to $13.4 million for the
three months ended April 2, 2005 from $10.6 million for the three months ended
April 3, 2004 and increased as a percentage of net sales to 7.8% from 7.6% for
the prior-year period. The dollar increase in G&A was comprised primarily of
higher professional fees of $1.5 million, increased compensation and benefits
expenses related to additional headcount of $0.9 million, and higher information
system maintenance and depreciation costs of $0.4 million. We generally expect
future G&A growth rates to be lower than the rate of sales growth due to
leveraging the fixed component of G&A expenses across a higher sales base,
although we anticipate no leverage in 2005 assuming incentive compensation
returns to historical levels.
OTHER INCOME
Other income increased $161,000 to $473,000 for the three months ended April 2,
2005 from $312,000 for the three months ended April 3, 2004. The improvement is
primarily due to increased interest income resulting from higher average
balances of invested cash.
INCOME TAX EXPENSE
Income tax expense increased $0.9 million to $5.5 million for the three months
ended April 2, 2005 from $4.6 million for the three months ended April 3, 2004.
The effective tax rate was 38.8% in 2005 and 38.5% in 2004.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
As of April 2, 2005, we had cash and marketable securities of $101.2 million,
$64.3 million classified as a current asset. As of January 1, 2005, cash and
marketable securities totaled $91.7 million, $50.8 million classified as
current. Net working capital totaled $32.6 million as of April 2, 2005 compared
to $23.5 million as of January 1, 2005. The increase in net working capital was
due primarily to a shift to shorter-term investments which are reported as
current assets. The $9.2 million improvement in cash balances was the result of
generating $11.4 million of operating free cash flow ($17.0 million of cash
provided by operating activities, reduced by $5.6 million of capital
expenditures), offset by $2.0 million of cash used in financing activities. Cash
used in financing activities was primarily comprised of purchases of stock made
by us as part of our ongoing common stock repurchase program, offset by cash
received from option and warrant exercises and shares purchased by employees as
part of an employee share purchase program. We expect to continue to generate
positive cash flows from operations in the future, while not anticipating any
significant additional working capital requirements.
We generated cash from operations for the three months ended April 2, 2005 and
April 3, 2004 of $17.0 million and $11.3 million, respectively. The $5.7 million
year-to-year improvement in cash from operations resulted primarily from
improved operating income for the three months ended April 2, 2005 and reduced
inventories.
Capital expenditures amounted to $5.6 million for the three months ended April
2, 2005, compared to $5.4 million for the three months ended April 3, 2004. In
both periods our capital expenditures related primarily to new and remodeled
retail stores and investments in information technology. In the first three
months of 2005 we opened 5 retail stores, while in the first three months of
2004 we opened 9 stores. We anticipate opening up to 40 stores in 2005. We will
fund the investment in new and upgraded stores with cash on hand and cash
generated from operations. We expect our new stores to be cash flow positive
within the first 12 months of operations and, as a result, do not anticipate a
negative effect on net cash provided by operations.
Net cash used in financing activities totaled $2.0 million for the three months
ended April 2, 2005, compared to $3.2 million net cash provided by financing
activities for the three months ended April 3, 2004. The $5.2 million decrease
in cash from financing activities resulted from a $6.7 million increase in
repurchases of common stock offset partially by an increase of $1.5 million
received for exercises of stock options and warrants and for employee purchases
of common stock. We may make additional purchases of our common stock 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
14
reissued in the future for general corporate or other purposes. Total
outstanding authorization at April 22, 2005 was $17 million. We may terminate or
limit the stock repurchase program at any time.
Cash generated from operations should be a sufficient source of liquidity for
the short- and long- term and should provide adequate funding for capital
expenditures and common stock repurchases, if any. In addition, our 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 and expect to remain in the
foreseeable future in full compliance with the financial covenants. We currently
have no borrowings outstanding under this credit agreement.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with U.S. generally
accepted accounting principles 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 stock-based compensation, revenue
recognition, accrued sales returns, accrued warranty costs and store closing and
long-lived asset impairment expenses.
In certain instances, U.S. generally accepted accounting principles allow for
the selection of alternative accounting methods. One such significant accounting
policy involves the selection from alternative methods of accounting for stock
options.
STOCK-BASED COMPENSATION
Two alternative methods currently 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. We
will be required to change our accounting practice for stock options to the fair
value method by the first quarter of fiscal 2006. We expect that this change in
accounting policy will have a material impact on our consolidated results of
operations and earnings per share.
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.
ACCRUED WARRANTY COSTS
The estimated cost 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.
15
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 us 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. We do not believe we are exposed to significant risk of
non-performance by these counterparties because we limit the amount of credit
exposure to any one financial institution and any one type of investment.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures, as defined in Exchange Act Rule
13a-15(e), that are designed to ensure that information required to be disclosed
by us in the reports that we file or submit under the Securities Exchange Act of
1934, as amended, is recorded, processed, summarized, and reported within the
time periods specified in the Securities and Exchange Commission's rules and
forms, and that such information is accumulated and communicated to the
company's management, including its principal executive and principal financial
officers, or persons performing similar functions, as appropriate to allow
timely decisions regarding required disclosure. Our management, with the
participation of our chief executive officer and chief financial officer,
evaluated the effectiveness of the design and operation of our disclosure
controls and procedures as of the end of the period covered by this report.
Based on this evaluation, our principal executive officer and principal
financial officer concluded that our disclosure controls and procedures were
effective as of the end of the period covered by this report.
CHANGES IN INTERNAL CONTROLS
There was no change in our internal control over financial reporting that
occurred during our quarter ended April 2, 2005 that has materially affected, or
is reasonably likely to materially affect our internal control over financial
reporting.
16
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In August 2003, a lawsuit was filed against the Company in Superior Court of the
State of California, County of Ventura. This suit was filed by two former store
managers alleging misclassification of employment position and seeking class
certification. The plaintiffs have sought judgment for unpaid overtime
compensation for store managers and lost meal and break times for store managers
and other store personnel alleged to exceed $1.0 million, together with related
penalties, restitution, attorneys' fees and costs. In January 2005, the Company
agreed to settle all of the alleged claims for an aggregate sum of $750,000.
This settlement is subject to the approval of the court, which the Company plans
to pursue over the next several months. The cost of this settlement was accrued
in our fiscal 2004 results of operations.
In October 2004, a lawsuit was filed against our company in Hennepin County
District Court in the State of Minnesota by one of our customers alleging
deceptive trade practices, fraud and breach of warranty related to the alleged
propensity of our products to develop mold. The complaint seeks class
certification and various forms of legal and equitable relief, including but not
limited to rescission and/or actual damages in an amount to be determined at
trial, including interest, costs and attorney's fees. In December 2004, we filed
a motion to dismiss the claims in their entirety. The district court dismissed
plaintiff's false advertising claim and deceptive trade practice damage claim.
The court denied the motion to dismiss the remaining fraud and warranty claims,
and we have requested reconsideration of that portion of the court's decision.
The court's decision on plaintiff's motion seeking class certification is
pending. We believe that the complaint is without merit and intend to vigorously
defend the claims. As this case is in the early stages, the financial impact to
our company, if any, cannot be predicted.
We are 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 is not expected to have a material effect on our
consolidated financial position or results of operations.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(a) - (b) Not applicable.
(c) Issuer Purchases of Equity Securities
(in thousands, except per share amounts)
Total number
of Shares
Purchased
Total as Part of
Number of Publicly
Shares Average Announced
including Price Paid Plans or
Period Non-Qualified per Share Programs (1) Availability
------------------------ -------------- ------------ -------------- ---------------
Fiscal January 2005 - $17.21 - $ 5,737
Fiscal February 2005 125,118 $20.82 125,000 $18,312
Fiscal March 2005 210,434 $20.48 210,400 $17,027
-------------- --------------
Total 335,569 $20.61 335,400
(1) In February 2005, the Company's Board of Directors revised the
Company's share repurchase program. 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. As of April 22, 2005, the total outstanding
authorization remained at approximately $17.0 million.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not applicable.
17
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. 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.
18
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 10, 2005 William R. McLaughlin
Chairman 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)
19
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.
20