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 July 1, 2000
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.)
10400 VIKING DRIVE, SUITE 400
MINNEAPOLIS, MINNESOTA 55344
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (952)918-3000
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
As of July 1, 2000, 17,824,764 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
July 1, 2000 and January 1, 2000................................... 3
Consolidated Statements of Operations
for the Three Months and Six Months ended July 1, 2000
and July 3, 1999................................................... 4
Consolidated Statements of Cash Flows
for the Six Months ended July 1, 2000
and July 3, 1999................................................... 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......... 14
PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................................ 15
Item 2. Changes in Securities and Use of Proceeds........................ 15
Item 3. Defaults Upon Senior Securities.................................. 15
Item 4. Submission of Matters to a Vote of Security Holders.............. 16
Item 5. Other Information................................................ 17
Item 6. Exhibits and Reports on Form 8-K................................. 17
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
JULY 1, JANUARY 1,
ASSETS 2000 2000
------------ ------------
Current assets:
Cash and cash equivalents $ 8,696 $ 7,441
Marketable securities 9,433 20,129
Accounts receivable, net of allowance for
doubtful accounts of $277, and $305, respectively 487 1,056
Inventories (note 2) 13,246 11,451
Prepaid expenses 4,772 4,821
Income taxes 352 2,579
Deferred tax assets 6,569 6,639
------------ ------------
Total current assets 43,555 54,116
Property and equipment, net 37,735 34,823
Deferred tax assets 7,912 4,248
Other assets 2,712 2,678
------------ ------------
Total assets $ 91,914 $ 95,865
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 34 $ 51
Accounts payable 16,974 15,911
Accruals:
Sales returns 5,318 5,880
Warranty costs 6,847 5,841
Compensation, taxes and benefits 5,926 6,678
Other 5,438 5,285
------------ ------------
Total current liabilities 40,537 39,646
Long-term debt, less current maturities 53 36
Other liabilities 3,235 2,809
------------ ------------
Total liabilities 43,825 42,491
------------ ------------
Shareholders' equity:
Undesignated preferred stock; 5,000,000 shares
authorized, no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares
authorized, 17,824,764 and 17,713,247 shares
issued and outstanding, respectively 178 177
Additional paid-in capital 79,193 78,513
Accumulated deficit (31,282) (25,316)
------------ ------------
Total shareholders' equity 48,089 53,374
------------ ------------
Total liabilities and shareholders' equity $ 91,914 $ 95,865
============ ============
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 SIX MONTHS ENDED
---------------------- ---------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 2000 1999
---------- ---------- ---------- ----------
Net sales $ 61,787 $ 65,750 $137,946 $137,382
Cost of sales 21,816 22,562 48,868 47,109
---------- ---------- ---------- ----------
Gross margin 39,971 43,188 89,078 90,273
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing 38,586 37,400 83,982 77,889
General and administrative 6,678 5,588 15,163 10,806
---------- ---------- ---------- ----------
Total operating expenses 45,264 42,988 99,145 88,695
---------- ---------- ---------- ----------
Operating income (loss) (5,293) 200 (10,067) 1,578
---------- ---------- ---------- ----------
Other income (expense):
Interest income 309 420 684 959
Interest expense (2) (16) (4) (51)
Other, net (68) (51) (83) (47)
---------- ---------- ---------- ----------
Other income, net 239 353 597 861
---------- ---------- ---------- ----------
Income (loss) before income taxes (5,054) 553 (9,470) 2,439
Income tax expense (benefit) (1,870) 205 (3,504) 902
---------- ---------- ---------- ----------
Net income (loss) $ (3,184) $ 348 $ (5,966) $ 1,537
========== ========== ========== ==========
Net income (loss) per share
(note 3) - basic and diluted $ (0.18) $ 0.02 $ (0.34) $ 0.08
========== ========== ========== ==========
Weighted average shares - basic 17,818 18,370 17,786 18,448
========== ========== ========== ==========
Weighted average shares - diluted 17,818 19,620 17,786 20,091
========== ========== ========== ==========
See accompanying notes to consolidated financial statements.
4
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
------------------------
JULY 1, JULY 3,
2000 1999
----------- -----------
Cash flows from operating activities:
Net income (loss) $ (5,966) $ 1,537
Adjustments to reconcile net income (loss)
to net cash provided by (used in)
operating activities:
Depreciation and amortization 4,514 2,833
Loss on disposal of assets 178 -
Deferred tax assets (3,583) (481)
Change in operating assets and liabilities:
Accounts receivable, net 569 (1,386)
Inventories (1,795) (1,552)
Prepaid expenses 49 381
Income taxes 2,227 (1,994)
Accounts payable 1,063 2,417
Accrued sales returns (562) (788)
Accrued warranty costs 1,006 899
Accrued compensation, taxes and benefits (485) (398)
Other accrued liabilities 153 (412)
Other assets (50) (3)
Other liabilities 426 406
----------- -----------
Net cash provided by (used in) operating
activities (2,256) 1,459
----------- -----------
Cash flows from investing activities:
Purchases of property and equipment (7,589) (6,735)
Investment in marketable securities 10,696 (9,127)
Investment in affiliate - (2,000)
----------- -----------
Net cash provided by (used in) investing
activities 3,107 (17,862)
----------- -----------
Cash flows from financing activities:
Principal payments on debt - (541)
Repurchase of common stock - (8,506)
Proceeds from issuance of common stock 404 2,626
----------- -----------
Net cash provided by (used in) financing
activities 404 (6,421)
----------- -----------
Increase (decrease) in cash and cash equivalents 1,255 (22,824)
Cash and cash equivalents, at beginning of period 7,441 45,561
----------- -----------
Cash and cash equivalents, at end of period $ 8,696 $ 22,737
=========== ===========
See accompanying notes to consolidated financial statements.
5
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BASIS OF FINANCIAL STATEMENT PRESENTATION
The consolidated financial statements for the three months and six months ended
July 1, 2000 and July 3, 1999 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 July 1, 2000 and January 1, 2000 and the results of operations and cash flow
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 1, 2000. Operating results for the Company on a quarterly basis may not
be indicative of operating results for the full year.
During 1999 the Securities and Exchange Commission issued Staff Accounting
Bulletin No 101, "Revenue Recognition in Financial Statements" (SAB 101). The
SEC has delayed the implementation date of SAB 101 until the Companies fiscal
2000 fourth quarter. The Company is analyzing the impact of SAB 101, but it is
not expected to have a material impact on the Company's consolidated financial
statements.
(2) INVENTORIES
Inventories consist of the following (in thousands):
JULY 1, 2000 JANUARY 1, 2000
--------------- ------------------
Raw materials $ 6,234 $ 5,753
Work in progress 69 59
Finished goods 6,943 5,639
--------------- ------------------
$ 13,246 $ 11,451
=============== ==================
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(3) NET INCOME (LOSS) PER COMMON SHARE
The following computations reconcile net income (loss) with net income (loss)
per common share-basic and diluted (in thousands except per share amounts).
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------------ -------------------------------------
NET PER SHARE NET PER SHARE
JULY 1, 2000 LOSS SHARES AMOUNT LOSS SHARES AMOUNT
---------- ----------- ----------- ---------- ----------- ------------
Net loss $(3,184) $(5,966)
BASIC AND DILUTED EPS
Net loss available to common
shareholders $(3,184) 17,818 $(0.18) $(5,966) 17,786 $(0.34)
========== =========== =========== ========== =========== ============
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------------ -------------------------------------
NET PER SHARE NET PER SHARE
JULY 3, 1999 INCOME SHARES AMOUNT INCOME SHARES AMOUNT
---------- ----------- ----------- ---------- --------- --------------
Net income $ 348 $ 1,537
BASIC EPS
Net income available to common
shareholders 348 18,370 $ 0.02 1,537 18,448 $ 0.08
---------- ----------- =========== ---------- ----------- ============
EFFECT OF DILUTIVE SECURITIES
Warrants - 649 - 764
Options - 601 - 879
---------- ----------- ---------- -----------
DILUTED EPS
Net income available to common
shareholders plus assumed
conversions $ 348 19,620 $ 0.02 $ 1,537 20,091 $ 0.08
========== =========== =========== ========== =========== ============
(4) LITIGATION
The Company and certain of its former officers and directors have been named as
defendants in a consolidated class action lawsuit filed on behalf of Company
shareholders in U.S. District Court in Minnesota. The named plaintiffs, who
purport to act on behalf of a class of purchasers of the Company's common stock
during the period from December 4, 1998 to June 7, 1999, charge the defendants
with violations of federal securities laws. The suit alleges that the Company
and the named directors and officers failed to disclose or misrepresented
certain information concerning the Company during the class period. The
complaint does not specify an amount of damages claimed. The Company believes
that the complaint is without merit and intends to vigorously defend the claims.
The Company and the individual defendants brought a motion to dismiss all claims
on November 10, 1999. The motion was heard by a magistrate judge on December 21,
1999. On January 27, 2000, the magistrate recommended that the claims based on
Section 11 of the federal securities laws be dismissed. The magistrate
recommended that the motion to dismiss be denied with respect to the claims
based on Rule 10b-5 of the federal securities laws. In February 2000, both the
plaintiffs and the defendants formally objected to the magistrate's
recommendation. The objection was made to the United States District Court in
Minnesota. On May 12, 2000, the United States District Court in Minnesota
adopted the recommendation of the magistrate and denied the defendants' motion
to dismiss the Rule 10b-5 claims.
7
The Court also adopted the recommendation of the magistrate and dismissed the
plaintiff's Section 11 claims without prejudice and with leave to amend.
On March 31, 2000, the Company and certain of its former officers and directors
were named as defendants in a class action lawsuit filed on behalf of the
Company's shareholders in U.S. District Court in Minnesota asserting identical
factual allegations as the consolidated complaint described above. The suit
alleges claims based on Sections 11 and 12(a)(2) of the federal securities laws.
The complaint does not specify an amount of damages claimed. The Company
believes this complaint is without merit and intends to vigorously defend the
claims. The above two class actions were consolidated by the United States
District Court Magistrate on July 24, 2000.
The Company is subject to various other claims, legal actions, sales tax
disputes and other complaints 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
PART I: FINANCIAL INFORMATION
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,"
"PROJECTED," "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 1, 2000, WHICH DISCUSSION IS INCORPORATED HEREIN
BY REFERENCE. THESE IMPORTANT FACTORS INCLUDE OUR ABILITY TO ACHIEVE THE
OBJECTIVES OF OUR STRATEGIC PLAN, THE LEVEL OF CONSUMER ACCEPTANCE OF OUR
PRODUCTS, OUR ABILITY TO CREATE PRODUCT AND BRAND NAME AWARENESS, THE
EFFECTIVENESS AND EFFICIENCY OF OUR MARKETING AND ADVERTISING PROGRAMS, THE
PERFORMANCE OF OUR EXISTING AND NEW RETAIL STORES, OUR ABILITY TO SUCCESSFULLY
IDENTIFY AND RESPOND TO EMERGING TRENDS IN THE MATTRESS INDUSTRY, THE LEVEL OF
COMPETITION IN THE MATTRESS INDUSTRY, OUR ABILITY TO MAINTAIN COST-EFFECTIVE
PRODUCTION AND DELIVERY OF PRODUCTS, CERTAIN SALES TAX CONSIDERATIONS AND
GENERAL ECONOMIC CONDITIONS AND CONSUMER CONFIDENCE.
OVERVIEW
Select Comfort is the leading vertically integrated manufacturer, specialty
retailer and direct marketer of innovative air beds and sleep-related products.
Since the introduction of our first air bed product in 1987, management has
focused on improving our product, expanding our product line, building
manufacturing and distribution systems and growing our three distribution
channels: retail, direct marketing and e-commerce. Vertically integrated
operations and control over these complementary distribution channels gives us
direct contact with our customers and gives our customers multiple opportunities
to purchase our products. Sales generation is driven primarily by targeted
print, radio, television, and internet media that generate customer inquiries,
as well as by our retail store and internet presence.
Retail operations included 333 stores at July 1, 2000, including 33 leased
departments within larger stores and 341 stores at January 2, 1999, including 45
leased departments. We plan to open approximately eight additional retail stores
during the remainder of 2000. From inception through July 1, 2000, we have
closed a total of 26 stores, of which 19 were closed in the first six months of
2000 (seven mall based stores, 12 leased departments). During the third quarter
of 2000, we plan to close three additional underperforming retail stores. A
significant portion of the costs associated with the store closings in 2000 was
accrued in 1999.
Comparable store sales growth for the three months ended July 1, 2000 and July
3, 1999 was (4.1)% and 7.6%, respectively. Comparable store sales growth for the
six months ended July 1, 2000 and July 3, 1999 was (1.9)% and 10.2%,
respectively. Comparable store sales results have been and will continue to be
influenced by a variety of factors, including levels of awareness of our
products and brand name, levels of consumer acceptance of our existing and new
products, our ability to successfully introduce new products and product line
extensions, comparable store sales performance in prior periods, the maturation
of our store base, the amount, effectiveness and efficiency of retail
advertising expenditures and promotional activity, the amount of competitive
activity, our ability to effectively integrate our multiple distribution
channels, the evolution of store operations, including improvements in store
design, the quality and tenure of store-level managers and sales professionals,
and general economic conditions and consumer confidence.
Annual advertising expenditures increased from $9.0 million in 1995 to $43.4
million in 1999. Advertising costs are expensed as incurred as a component of
sales and marketing expenses, although we believe that advertising expenditures
provide significant benefits beyond the period in which they are expensed.
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 retail stores.
Pre-opening costs associated with new retail stores are also expensed as
incurred.
9
We believe historical operating losses have been primarily the result of an
aggressive retail store opening strategy, a relatively immature store base,
significant marketing, advertising and product development expenditures, and the
development of a substantial corporate infrastructure to support anticipated
growth. Future increases in net sales and the achievement of long-term
profitability will depend upon greater consumer awareness and acceptance of our
air bed products, improved effectiveness and efficiency of our marketing and
advertising expenditures, the opening and successful performance of new retail
stores, improvement in the performance of current stores and our ability to
execute our stated strategic initiatives. There can be no assurance that we will
be able to achieve or sustain historical sales growth rates or profitability in
the future, on a quarterly or annual basis.
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 return rates, the timing of new store openings and related expenses,
competitive factors, net sales contributed by new stores, any disruptions in
third-party delivery services and general economic conditions and consumer
confidence. Our business is also subject to some seasonal influences, with
heavier concentrations of sales during the fourth quarter holiday season due to
increased mall traffic.
A substantial portion of operating expenses is related to sales and marketing
expenses, including costs associated with opening new stores, operating existing
stores and advertising expenditures. The level of this spending cannot be
adjusted quickly and is based, in significant part, on expectations of future
customer inquiries and net sales. Furthermore, a substantial portion of net
sales is often realized in the last month of a quarter with such net sales
frequently concentrated in the last weeks or days of a quarter, due in part to
our promotional schedule. Should the Company experience a shortfall in expected
net sales or in the conversion rate of customer inquiries, we may be unable to
adjust spending in a timely manner and our business, financial condition and
operating results may be materially adversely affected. Our historical results
of operations may not be indicative of the results that may be achieved for any
future fiscal period.
At July 1, 2000, the Company had net operating loss carryforwards for federal
income tax purposes of approximately $18.6 million expiring between the years
2003 and 2019. The Company expects that approximately $1.4 million of these
carryforwards will expire unutilized due to an Internal Revenue Code (IRC)
Section 382 limitation resulting from a prior ownership change and has,
therefore, provided a valuation allowance for this portion of the carryforwards.
The Company has not provided a valuation allowance for any other deferred tax
assets because it believes that it is more likely than not that they will be
realized.
10
LOOKING FORWARD
We are continuing to execute our strategic plan which focuses on:
o Roll out of an integrated approach to marketing including improved marketing
messages that are consistent across our distribution channels and
anticipated increased advertising for the remainder of 2000;
o Leveraging the profitability of our sales channels, with a particular
emphasis on retail store profitability;
o Development of cost effective in-home delivery, assembly and mattress
removal across all of our distribution channels;
o Continuous improvement of our core product line;
o Launching the sofa sleeper product across all of our distribution
channels; and
o Improvement of our cost structure to more effectively leverage our
infrastructure and store base.
Our integrated approach to marketing is being rolled out during the third
quarter of 2000. Marketing messages will focus on the key benefits provided by
our products and will be targeted to key consumer groups. We anticipate that
sales will increase as we increase our advertising expenditures during the third
and fourth quarters of 2000. By spending advertising more evenly over our retail
markets we believe we can improve the leverage of the largely fixed cost
structure within our stores.
We are developing market by market and store by store action plans focused on
improving the profitability of our retail store operations. We closed seven
under performing retail stores and 12 leased department locations during the
first six months of 2000. During the third quarter we plan to close three
additional underperforming retail stores. A significant portion of the costs
associated with these 2000 closures was accrued in 1999. We opened six stores
during the second quarter (a total of 10 during the first six months of 2000)
and expect to open approximately eight stores in the remainder of 2000 in
current markets where increased store density is required to leverage
advertising expenditures. In addition, we have developed a new retail store
design with a bedroom-like setting that is more consistent with our sleep
solutions oriented brand. During the first six months of 2000, 47 stores were
remodeled to incorporate this new design. We plan to remodel approximately 14
additional stores during the remainder of 2000 to incorporate this new design.
We are currently developing plans to ultimately provide in-home delivery,
assembly and mattress removal across all of our distribution channels and
throughout the continental United States. To date, in-home delivery and assembly
has been provided through our retail channel in selected markets on a test
basis. The current provider of our in-home assembly services announced its
intent to discontinue this segment of its business effective August 20, 2000. As
a result we are evaluating alternatives to providing this service to our
customers. We plan to begin testing the provision of these services through a
regional distribution center model in the second half of 2000.
Our product development efforts will focus primarily on continuous improvement
of our core line of air bed products. We believe that we have attained a
leadership position in air bed technology and intend to continue to lead the
industry in innovation.
We will launch our sofa sleeper product in 13 markets (49 additional stores)
during the third quarter. We believe that this sofa sleeper product represents a
significant advancement in the sofa sleeper market that could add incremental
sales as well as attract customers to our retail stores. Early in the third
quarter, we tested a catalog through a mailing to our installed base of
customers. Based on results of this initial catalog mailing, we do not plan to
mail a Fall catalog, however, we will continue to evaluate catalog
opportunities.
The success of our strategy will depend on many factors including (i) the
effectiveness and efficiency of our integrated marketing strategy in creating
awareness of our products and brand name and in generating sales, (ii) our
ability to enhance the profitability of our retail stores and leased
departments, (iii) our ability to manage operating costs, (iv) our ability to
successfully launch in-home delivery, assembly and mattress removal services
nationally on a cost-effective basis, (v) our ability to successfully launch the
sofa sleeper product nationally, (vi) the levels of consumer awareness and
acceptance of the sofa sleeper product, (vii) our ability to continue to improve
our core product line and differentiate our products from competitive products,
(viii) competition in the mattress and sofa sleeper markets, (ix) our ability to
successfully identify and respond to emerging trends in the mattress industry,
and (x) general economic factors and consumer confidence.
11
The strategic initiatives described above are directed toward improving our
long-term performance and are not expected to contribute significantly to growth
in sales and earnings, and may negatively impact earnings in 2000.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as percentages of net sales. Percentage amounts may not
total due to rounding.
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------- -----------------------
JULY 1, JULY 3, JULY 1, JULY 3,
2000 1999 2000 1999
----------- ----------- ----------- -----------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 35.3 34.3 35.4 34.3
----------- ----------- ----------- -----------
Gross margin 64.7 65.7 64.6 65.7
----------- ----------- ----------- -----------
Operating expenses:
Sales and marketing 62.5 56.9 60.9 56.7
General and administrative 10.8 8.5 11.0 7.9
----------- ----------- ----------- -----------
Total operating expenses 73.3 65.4 71.9 64.6
----------- ----------- ----------- -----------
Operating income (8.6) 0.3 (7.3) 1.1
Other income, net 0.4 0.5 0.4 0.6
----------- ----------- ----------- -----------
Income before income taxes (8.2) 0.8 (6.9) 1.8
Income tax expense (benefit) (3.0) 0.3 (2.5) 0.7
----------- ----------- ----------- -----------
Net income (loss) (5.2)% 0.5% (4.3)% 1.1%
=========== =========== =========== ===========
The overall decrease in operating earnings for 2000 as compared to 1999 is
primarily due to the lower sales levels and increased number of stores and
infrastructure costs in 2000. We believe the overall decline in sales was
primarily due to the reduction in advertising expenditures to 7.0 million during
the second quarter 2000 from $10.2 million in the prior year period. We reduced
spending in the current year in preparation for the introduction of new
marketing and advertising programs during the third quarter. During the second
quarter 2000 we started a staged launch of the sofa sleeper product.
COMPARISON OF THREE MONTHS ENDED JULY 1, 2000 WITH THREE MONTHS ENDED
JULY 3, 1999
NET SALES
Net sales decreased 6.0% to $61.8 million for the three months ended July 1,
2000 from $65.8 million for the three months ended July 3, 1999, primarily due
to a decrease in unit sales. The decrease in net sales was due primarily to (i)
a $7.0 million decrease in direct marketing sales, (ii) a $2.3 million decrease
in sales from the elimination of our roadshow distribution channel, (iii) a $1.7
million decrease in comparable store sales and (iv) a $600,000 decrease due to
19 closed stores in 2000, which decreases were partially offset by (i) a $6.5
million increase from increased store months in 2000 as compared to 1999 and
(ii) a $1.3 million increase in net sales from the Company's newly developed
e-commerce channel.
GROSS MARGIN
Gross margin decreased to 64.7% for the three months ended July 1, 2000 from
65.7% for the three months ended July 3, 1999 primarily due to the use of higher
discounted promotional offerings, increased costs of processing returned product
(although return rates have not increased), partially offset by a price increase
for some of our products. In May 2000, we moved some of our production
requirements from our Plymouth facility to our Salt Lake City facility in order
to better balance manufacturing capacity among our three plants. This move
resulted in the elimination of 77 manufacturing positions at the Plymouth
facility. Costs of this move had a nominally negative impact on second quarter
gross margins.
12
SALES AND MARKETING
Sales and marketing expenses increased 3.2% to $38.6 million for the three
months ended July 1, 2000 from $37.4 million for the three months ended July 3,
1999, and increased as a percentage of net sales to 62.5% from 56.9% for the
comparable prior-year period. The increase in the dollar amount of sales and
marketing expenses during 2000 was primarily due to (i) 31 additional retail
stores open in 2000 and (ii) higher freight expenses, partially offset by a
decrease in media spending. Sales and marketing expenses increased as a
percentage of net sales primarily due to (i) lower direct marketing sales and
(ii) selling expenses in new stores increasing at a greater rate than net sales,
partially offset by a decrease in media spending.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 19.5% to $6.7 million for the
three months ended July 1, 2000 from $5.6 million for the three months ended
July 3, 1999. The increase in general and administrative expenses was primarily
due to increased spending on infrastructure associated with anticipated growth.
OTHER INCOME, NET
Other income decreased by $114,000 to approximately $239,000 for the three
months ended July 1, 2000 from $353,000 in other income for the three months
ended July 3, 1999. The decrease was primarily due to lower cash levels in 2000
following repurchases of stock and capital expenditures in 1999 and 2000.
INCOME TAX EXPENSE (BENEFIT)
Income tax benefit increased to $1.9 million for the three months ended July 1,
2000 from an income tax expense of $205,000 for the three months ended July 3,
1999 due to a decrease in taxable income in 2000.
COMPARISON OF SIX MONTHS ENDED JULY 1, 2000 WITH SIX MONTHS ENDED JULY 3, 1999
NET SALES
Net sales increased 0.4% to $137.9 million for the six months ended July 1, 2000
from $137.4 million for the six months ended July 3, 1999. The increase in net
sales was due primarily to (i) a $15.7 million increase from increased store
months in 2000 as compared to 1999 and (ii) a $3.9 million increase in net sales
from the Company's newly developed e-commerce channel, which increases were
partially offset by (i) a $12.0 million decrease in direct marketing sales, (ii)
a $4.9 million decrease in sales from the elimination of our roadshow
distribution channel, (iii) a $1.6 million decrease in comparable store sales
and (iv) a $600,000 decrease due to 19 store closings in 2000.
GROSS MARGIN
Gross margin decreased to 64.6% for the six months ended July 1, 2000 from 65.7%
for the six months ended July 3, 1999 primarily due to the use of higher
discounted promotional offerings, increased costs of processing returned product
(although return rates have not increased), partially offset by a price increase
for some of our products.
SALES AND MARKETING
Sales and marketing expenses increased 7.8% to $84.0 million for the six months
ended July 1, 2000 from $77.9 million for the six months ended July 3, 1999, and
increased as a percentage of net sales to 60.9% from 56.7% for the comparable
prior-year period. The increase in the dollar amount of sales and marketing
expenses during 2000 was primarily due to (i) 31 additional retail stores open
in 2000 and (ii) higher freight expense, partially offset by a decrease in media
spending. Sales and marketing expenses increased as a percentage of net sales
primarily due to (i) lower direct marketing sales and (ii) selling expenses in
new stores increasing at a greater rate than net sales, partially offset by a
decrease in media spending.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 40.3% to $15.2 million for the six
months ended July 1, 2000 from $10.8 million for the six months ended July 3,
1999. The increase in general and administrative expenses was primarily due to
increased spending on infrastructure associated with anticipated growth and
approximately $1.0 million in costs associated with staffing reductions.
13
OTHER INCOME, NET
Other income decreased by $264,000 to approximately $597,000 for the six months
ended July 1, 2000 from $861,000 in other income for the six months ended July
3, 1999. The decrease was primarily due to lower cash levels in 2000 following
repurchases of stock and capital expenditures in 1999 and 2000.
INCOME TAX EXPENSE (BENEFIT)
Income tax benefit increased to $3.5 million for the six months ended July 1,
2000 from an income tax expense of $902,000 for the six months ended July 3,
1999 due to a decrease in taxable income in 2000.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been the sale of equity securities. We
completed our initial public offering in December 1998, resulting in net
proceeds of $44.6 million, which have been partially used for (i) the repayment
of $15.0 million of debt, (ii) expansion of retail stores, (iii) expansion of
manufacturing capabilities, (iv) the repurchase of 1,220,000 shares of Company
common stock for $12.7 million and (v) the development of information technology
systems. The Company had working capital of approximately $3.0 million at July
1, 2000, and $14.5 million at January 1, 2000.
Net cash used in operating activities for the six months ended July 1, 2000 was
approximately $2.3 million and consisted primarily of increases in inventory and
the net loss adjusted for non-cash expenses partially offset by increases in
accounts payable and receipt of an income tax refund. Net cash provided by
operating activities for the six months ended July 3, 1999 was approximately
$1.5 million and consisted primarily of cash flows from operations before
non-cash expenses, partially offset by increases in accounts receivable and
inventory.
Net cash provided by investing activities was approximately $3.1 million for the
six months ended July 1, 2000 and net cash used in investing activities was
$17.9 million for the six months ended July 3,1999. Investing activities
consisted of purchases of property and equipment for new retail stores and plant
additions in both periods and investments in store remodels in 2000. In
addition, investments in marketable securities with maturities in excess of 90
days increased in 1999 and decreased in 2000. Lastly, in 1999 the Company
invested $2.0 million in a minority owned affiliate.
Net cash provided by financing activities was approximately $404,000 for the six
months ended July 1, 2000 which consisted of stock option exercises. Net cash
used in financing activities for the six months ended July 3, 1999 was
approximately $6.4 million and consisted of $8.5 million used to repurchase
Company common stock and $0.5 million used to repay debt, offset by stock option
exercises.
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 high credit
standing. We do not believe there is 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.
We believe cash generated from operations, together with existing cash balances,
will be sufficient to satisfy anticipated short-term working capital
requirements and long-term liquidity needs.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company holds securities classified as held to maturity. These securities
have maturities of less than one year that management has the ability and intent
to hold to maturity, are carried at amortized cost and have average interest
rates of 6.1%.
14
PART II: OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
The Company and certain of its former officers and directors have been
named as defendants in a consolidated class action lawsuit filed on
behalf of Company shareholders in U.S. District Court in Minnesota. The
named plaintiffs, who purport to act on behalf of a class of purchasers
of the Company's common stock during the period from December 4, 1998
to June 7, 1999, charge the defendants with violations of federal
securities laws. The suit alleges that the Company and the named
directors and officers failed to disclose or misrepresented certain
information concerning the Company during the class period. The
complaint does not specify an amount of damages claimed. The Company
believes that the complaint is without merit and intends to vigorously
defend the claims.
The Company and the individual defendants brought a motion to dismiss
all claims on November 10, 1999. The motion was heard by a magistrate
judge on December 21, 1999. On January 27, 2000, the magistrate
recommended that the claims based on Section 11 of the federal
securities laws be dismissed. The magistrate recommended that the
motion to dismiss be denied with respect to the claims based on Rule
10b-5 of the federal securities laws. In February 2000, both the
plaintiffs and the defendants formally objected to the magistrate's
recommendation. The objection was made to the United States District
Court in Minnesota. On May 12, 2000, the United States District Court
in Minnesota adopted the recommendation of the magistrate and denied
the defendants' motion to dismiss the Rule 10b-5 claims. The Court also
adopted the recommendation of the magistrate and dismissed the
plaintiff's Section 11 claims without prejudice and with leave to
amend.
On March 31, 2000, the Company and certain of its former officers and
directors were named as defendants in a class action lawsuit filed on
behalf of the Company's shareholders in U.S. District Court in
Minnesota asserting identical factual allegations as the consolidated
complaint described above. The suit alleges claims based on Sections 11
and 12(a)(2) of the federal securities laws. The complaint does not
specify an amount of damages claimed. The Company believes this
complaint is without merit and intends to vigorously defend the claims.
The above two class actions were consolidated by the United States
District Court Magistrate on July 24, 2000.
The Company is subject to various other claims, legal actions, sales
tax disputes and other complaints arising in the ordinary course of
business. In the opinion of management, any losses that may occur from
these other matters are adequately covered by insurance or are provided
for in the consolidated financial statements, and the ultimate outcome
of these other matters will not have a material effect on the
consolidated financial position or results of operations of the
Company.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
15
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held on May 18, 2000. The
following individuals were elected at the Annual Meeting as Directors
of the Company to serve for terms of three years expiring at the 2003
Annual Meeting of Shareholders or until their successors are elected
and qualified. Shares voted in favor of these Directors and shares
withheld were as follows:
Patrick A. Hopf
Shares For 14,021,067
Shares Withheld 659,074
William J. Lansing
Shares For 14,022,596
Shares Withheld 657,545
Ervin R. Shames
Shares For 13,657,997
Shares Withheld 1,022,144
In addition to the Directors named above, the following Directors'
terms continued after the Annual Meeting and will expire at the Annual
Meeting of Shareholders in the year indicated below:
Name Term Expires
---- ------------
Thomas J. Albani 2001
David T. Kollat 2001
William R. McLaughlin 2001
Christopher P. Kirchen 2002
Jean-Michel Valette 2002
Shareholders ratified the appointment of KPMG LLP as the Company's
independent auditor for the fiscal year ending December 30, 2000, with
shares voted as follows:
Shares For 14,634,485
Shares Against 39,179
Shares Abstaining 6,477
Shareholders approved an amendment of the Company's 1997 Stock
Incentive Plan to impose a limit on the number of options that may be
granted to any participant during any fiscal year in the amount of
600,000 and to increase the number of shares of common stock reserved
for issuance under the plan by 1,000,000 shares from 2,500,000 shares
to 3,500,000 shares, with shares voted as follows:
Shares For 9,968,732
Shares Against 1,342,595
Shares Abstaining 8,527
Broker Non-Vote 3,360,287
Shareholders approved adoption of the 1999 Employee Stock Purchase
Plan, with shares voted as follows:
Shares For 11,137,727
Shares Against 174,000
Shares Abstaining 8,127
Broker Non-Vote 3,360,287
16
ITEM 5 - OTHER INFORMATION
William J. Lansing tendered his resignation from the Board of Directors
of the Company effective as of August 14, 2000 in order to devote more
of his time to other business interests. The Board of Directors and
management of the Company express their gratitude to Mr. Lansing for his
service to the Company as a member of our Board of Directors.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------
Exhibit
Number Description
------- ------------
10.1 Select Comfort Corporation 1997 Stock
Incentive Plan as amended and restated.
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
17
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
SELECT COMFORT CORPORATION
/s/William R. McLaughlin
-------------------------------------
August 15, 2000 William R. McLaughlin
President and Chief Executive Officer
(principal executive officer)
/s/James C. Raabe
-------------------------------------
James C. Raabe
Chief Financial Officer (principal
financial and accounting officer)
18
EXHIBIT INDEX
Exhibit Number Description Location
- -------------- ------------ ---------
10.1 Select Comfort Corporation Filed herewith electronically
1997 Stock Incentive Plan
as amended and restated
27.1 Financial Data Schedule Filed herewith electronically
19