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 June 29, 2002
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 [ ]
As of June 29, 2002, 29,583,826 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
June 29, 2002 and December 29, 2001................................. 3
Consolidated Statements of Operations
for the Three Months and Six Months ended
June 29, 2002 and June 30, 2001..................................... 4
Consolidated Statements of Cash Flows
for the Six Months ended June 29, 2002
and June 30, 2001................................................... 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.......... 13
PART II: OTHER INFORMATION
Item 1. Legal Proceedings................................................... 14
Item 2. Changes in Securities and Use of Proceeds........................... 14
Item 3. Defaults Upon Senior Securities..................................... 14
Item 4. Submission of Matters to a Vote of Security Holders................. 14
Item 5. Other Information................................................... 14
Item 6. Exhibits and Reports on Form 8-K.................................... 15
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)
JUNE 29, DECEMBER 29,
2002 2001
------------- -------------
ASSETS
Current assets:
Cash and cash equivalents $ 15,356 $ 16,375
Marketable securities (note 2) 10,639 -
Accounts receivable, net of allowance for doubtful
accounts of $311, and $311, respectively 2,704 2,623
Inventories (note 3) 10,967 8,086
Prepaid expenses 4,174 3,588
------------- -------------
Total current assets 43,840 30,672
Property and equipment, net 29,231 30,882
Other assets (note 4) 3,839 5,882
------------- -------------
Total assets $ 76,910 $ 67,436
============= =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 13 $ 28
Accounts payable 15,426 15,216
Accruals:
Sales returns 3,510 3,624
Compensation and benefits 8,792 7,179
Taxes and withholding 2,311 3,032
Consumer prepayments 4,148 1,263
Other 4,239 4,069
------------- -------------
Total current liabilities 38,439 34,411
Long-term debt, less current maturities (note 4) 7,266 17,109
Accrued warranty costs 4,744 5,030
Other liabilities 4,104 4,114
------------- -------------
Total liabilities 54,553 60,664
------------- -------------
Shareholders' equity: (note 4)
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
29,583,826 and 18,302,307 shares issued and outstanding, 296 183
respectively
Additional paid-in capital 91,352 81,687
Accumulated deficit (69,291) (75,098)
------------- -------------
Total shareholders' equity 22,357 6,772
------------- -------------
Total liabilities and shareholders' equity $ 76,910 $ 67,436
============= =============
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
---------------------------- ----------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Net sales $ 77,281 $ 62,742 $ 158,476 $ 128,198
Cost of sales 24,677 22,428 51,071 46,039
------------- ------------- ------------- -------------
Gross margin 52,604 40,314 107,405 82,159
------------- ------------- ------------- -------------
Operating expenses:
Sales and marketing 41,437 37,394 85,608 81,568
General and administrative 8,026 5,954 15,235 12,967
Store closings and asset impairments 157 142 209 488
------------- ------------- ------------- -------------
Total operating expenses 49,620 43,490 101,052 95,023
------------- ------------- ------------- -------------
Operating income (loss) 2,984 (3,176) 6,353 (12,864)
------------- ------------- ------------- -------------
Other income (expense):
Interest income 37 40 104 115
Interest expense (537) (254) (1,123) (352)
Other, net 79 (140) 125 (142)
------------- ------------- ------------- -------------
Other income (expense), net (421) (354) (894) (379)
------------- ------------- ------------- -------------
Income (loss) before income taxes 2,563 (3,530) 5,459 (13,243)
Income tax (benefit) expense - - (348) 115
------------- ------------- ------------- -------------
Net income (loss) $ 2,563 $ (3,530) $ 5,807 $ (13,358)
============= ============= ============= =============
Net income (loss) per share (note 5) - basic $ 0.13 $ (0.19) $ 0.31 $ (0.74)
============= ============= ============= =============
Weighted average shares - basic 19,690 18,119 19,038 18,087
============= ============= ============= =============
Net income (loss) per share (note 5) - diluted $ 0.08 $ (0.19) $ 0.19 $ (0.74)
============= ============= ============= =============
Weighted average shares - diluted 34,415 18,119 33,848 18,087
============= ============= ============= =============
See accompanying notes to consolidated financial statements.
4
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
SIX MONTHS ENDED
------------------------------
JUNE 29, JUNE 30,
2002 2001
-------------- --------------
Cash flows from operating activities:
Net income (loss) $ 5,807 $(13,358)
Adjustments to reconcile net income (loss) to
net cash provided by (used in) operating activities:
Depreciation and amortization 4,701 4,994
Loss on disposal of assets 216 496
Change in operating assets and liabilities:
Accounts receivable, net (81) 681
Inventories (2,881) 2,130
Prepaid expenses (586) 90
Other assets 1,347 (75)
Accounts payable 210 1,743
Accrued sales returns (114) (666)
Accrued compensation and benefits 1,613 (277)
Accrued taxes and withholding (721) (345)
Accrued consumer prepayments 2,884 (282)
Other accrued liabilities 243 (263)
Accrued warranty costs (358) (25)
Other liabilities (10) 397
-------------- --------------
Net cash provided by (used in) operating activities 12,270 (4,760)
-------------- --------------
Cash flows from investing activities:
Purchases of property and equipment (2,916) (2,367)
(Investment in) sales of marketable securities (10,639) 3,950
-------------- --------------
Net cash (used in) provided by investing activities (13,555) 1,583
-------------- --------------
Cash flows from financing activities:
Principal payments on debt (20) (18)
Proceeds from issuance of common stock 286 191
Net proceeds from issuance of long-term debt - 10,354
-------------- --------------
Net cash provided by financing activities 266 10,527
-------------- --------------
(Decrease) increase in cash and cash equivalents (1,019) 7,350
Cash and cash equivalents, at beginning of period 16,375 1,498
-------------- --------------
Cash and cash equivalents, at end of period $ 15,356 $ 8,848
============== ==============
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
June 29, 2002 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 June 29, 2002 and
December 29, 2001 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
December 29, 2001. Operating results for the Company on a quarterly basis may
not be indicative of operating results for the full year.
(2) MARKETABLE SECURITIES
Marketable securities at June 29, 2002 consist of United States government
obligations, municipal bonds and certificates of deposits with a maturity
greater than 90 days from the date of purchase. The Company classifies its debt
and marketable equity securities as held-to-maturity. Held-to-maturity
securities are carried at amortized cost. Securities held at June 29, 2002
carried an amortized cost of $10.6 million and a fair value of $10.7 million.
(3) INVENTORIES
Inventories consist of the following (in thousands):
JUNE 29, DECEMBER 29,
2002 2001
-------------- --------------
Raw materials $ 3,585 $1,824
Work in progress 181 26
Finished goods 7,201 6,236
-------------- --------------
$10,967 $8,086
============== ==============
(4) LONG-TERM DEBT
In June 2001, the Company issued $11 million in principal amount of its senior
secured notes (the "Notes") in a private placement. In addition, at the time of
the original issuance of the Notes the holders of the Notes received warrants to
purchase 4.4 million shares of the Company's common stock for $1.00 per share.
The warrants expire in June 2006 and are subject to standard anti-dilution
protections. On June 22, 2002 the Notes were converted into 11 million shares of
common stock under mandatory conversion provisions of the Note agreement. As a
result of this conversion, $9.5 million ($11 million in debt net of $1.5 million
of unamoritized deferred costs associated with debt issuance classified as other
assets on the Company's Consolidated Balance Sheet) has been reclassified as
common stock and additional paid-in capital.
The Company's debt includes $5 million of senior secured debt financing (the
"Debt"). The Debt has a five-year maturity and bears interest at 12% per annum.
The Debt is subject to certain financial covenants consisting primarily of
achieving minimum EBITDA levels. The Company was in compliance with the
financial covenants at June 29, 2002.
The Company has outstanding a non-interest bearing subordinated convertible
debenture ("debenture") with a principal amount of $4 million. The debenture is
due November 10, 2005 and convertible at any time into 727,272 shares of the
Company's common stock for $5.50 per share.
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) 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
------------------------------ ------------------------------
JUNE 29, 2002 WEIGHTED PER WEIGHTED PER
------------- NET AVERAGE SHARE NET AVERAGE SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
--------- --------- -------- --------- --------- --------
Net income $ 2,563 $ 5,807
BASIC EPS
Net income attributable to common shareholders 2,563 19,690 $ 0.13 5,807 19,038 $ 0.31
--------- --------- ======== --------- --------- ========
EFFECT OF DILUTIVE SECURITIES
Options - 1,904 - 1,629
Common stock warrants - 2,964 - 2,752
Convertible debt 254 9,857 563 10,429
--------- --------- --------- ---------
DILUTED EPS
Net income attributable to common shareholders
plus assumed conversions $ 2,817 34,415 $ 0.08 $ 6,370 33,848 $ 0.19
========= ========= ======== ========= ========= =========
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------ ------------------------------
JUNE 30, 2001 WEIGHTED PER WEIGHTED PER
------------- NET AVERAGE SHARE NET AVERAGE SHARE
LOSS SHARES AMOUNT LOSS SHARES AMOUNT
--------- --------- -------- --------- --------- --------
Net loss $(3,530) $(13,358)
--------- ---------
BASIC AND DILUTED EPS
Net loss attributable to common shareholders $(3,530) 18 ,119 $(0.19) $(13,358) 18,087 $(0.74)
========= ========= ======== ========= ========= =========
Additional potentially dilutive securities outstanding during the three months
ended June 29, 2002 and June 30, 2001, of 2,896 and 4,459, respectively, and the
six months ended June 29, 2002 and June 30, 2001, of 3,282 and 4,362,
respectively, have been excluded from the EPS calculations because the effect on
the calculation would have been anti-dilutive.
(6) LITIGATION
In June of 1999, the Company and certain of its former officers and directors
were named as defendants in a class action lawsuit filed in U.S. District Court
in Minnesota. The suit, filed on behalf of purchasers of the Company's common
stock between December 4, 1998 and June 7, 1999, alleges that the Company and
the named former directors and officers failed to disclose or misrepresented
certain information concerning the Company in violation of federal securities
laws. The Company believes that the suit is without merit and has vigorously
defended the matter.
In June of 2002, the Company consented to an agreement in principle negotiated
by the Company's insurance carrier to settle this litigation. The settlement
involves no cash or other payment obligation by the Company, and no admission of
liability or wrongdoing by the Company. The settlement remains subject to
negotiation of a definitive settlement agreement and approval of the court.
The Company is involved in other various 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.
7
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(7) RISKS AND UNCERTAINTIES
The Company has supplier relationships with UPS, Conseco and WorldCom, who are
in labor negotiations or experiencing liquidity concerns creating the potential
for significant negative impact on our business in the event of any disruption
or discontinuation of service. We are currently developing contingency plans to
mitigate the risks associated with these supplier relationships.
We have a significant reliance upon UPS for delivery of our products to
customers. UPS is currently in labor negotiations. No assurance can be given
that UPS will be able to avert labor difficulties or that UPS will not otherwise
experience difficulties in meeting our requirements in the future. Any
significant delay on deliveries to customers or increase in freight charges may
have a material adverse effect on our business, financial condition and
operating results. On July 16, 2002 UPS reported a tentative agreement had been
reached pending approval by the union represented workers.
We offer our qualified customers an unsecured revolving credit arrangement to
finance purchases from us through a private label consumer credit facility
provided by Conseco Bank, Inc. (the "Bank"). The Bank's parent, Conseco Inc.,
has experienced financial and liquidity issues which could jeopardize the
ability of the Bank to continue to provide consumer credit financing for our
customers. Termination of our agreement with the Bank, or any material change to
the terms of our agreement with the Bank or in the availability or terms of
credit for our customers from the Bank, or any delay in securing replacement
credit sources, could have a material adverse effect on our business, sales,
results of operations and financial condition.
We have a reliance upon MCI WorldCom to provide the long distance service for
our direct selling channel and customer service lines as well as communication
between our stores, manufacturing facilities and corporate offices. On July 21,
2002 WorldCom filed voluntary petitions for reorganization under Chapter 11 of
the U.S. Bankruptcy Code. Any disruption, discontinuation of service, delay in
establishing an alternative provider at a time of disruption, or material change
in rates could have a material adverse effect on our business, sales, customer
service, results of operations and financial condition.
8
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED HEREIN. THIS
QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. YOU CAN
IDENTIFY FORWARD-LOOKING STATEMENTS BY THOSE THAT ARE NOT HISTORICAL IN NATURE,
PARTICULARLY THOSE THAT USE TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD,"
"EXPECTS," "ANTICIPATES," "CONTEMPLATES," "ESTIMATES," "BELIEVES," "PLANS,"
"PROJECTS," "PREDICTS," "POTENTIAL" OR "CONTINUE" OR THE NEGATIVE OF THESE OR
SIMILAR TERMS. THESE STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY'S
HISTORICAL EXPERIENCE AND ITS PRESENT EXPECTATIONS OR PROJECTIONS. IMPORTANT
FACTORS KNOWN TO SELECT COMFORT THAT COULD CAUSE SUCH MATERIAL DIFFERENCES ARE
IDENTIFIED AND DISCUSSED IN PART I, ITEM 1 OF OUR ANNUAL REPORT ON FORM 10-K FOR
THE FISCAL YEAR ENDED DECEMBER 29, 2001, WHICH DISCUSSION IS INCORPORATED HEREIN
BY REFERENCE. THESE IMPORTANT FACTORS INCLUDE:
o GENERAL AND INDUSTRY ECONOMIC TRENDS,
o CONSUMER CONFIDENCE,
o THE EFFECTIVENESS AND EFFICIENCY OF OUR ADVERTISING AND PROMOTIONAL
EFFORTS,
o CONSUMER ACCEPTANCE OF OUR PRODUCTS AND SLEEP TECHNOLOGY,
o INDUSTRY COMPETITION,
o OUR DEPENDENCE ON SIGNIFICANT SUPPLIERS OR SINGLE SOURCES OF SUPPLY,
o OUR SUPPLIER RELATIONSHIPS WITH UPS, CONSECO, AND WORLDCOM, WHO ARE IN
LABOR NEGOTIATIONS OR EXPERIENCING LIQUIDITY CONCERNS AND THE POTENTIAL FOR
SIGNIFICANT NEGATIVE IMPACT ON OUR BUSINESS IN THE EVENT OF ANY DISRUPTION
OR DISCONTINUATION OF SERVICE, AND
o RISKS AND UNCERTAINTIES DETAILED FROM TIME TO TIME IN THE COMPANY'S FILINGS
WITH THE SEC, INCLUDING THE COMPANY'S ANNUAL REPORT ON FORM 10-K AND OTHER
PERIODIC REPORTS FILED WITH THE SEC.
THE COMPANY HAS NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY OF THE
FORWARD-LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q.
OVERVIEW
Select Comfort(R) is the leading manufacturer and retailer of premium quality,
innovative adjustable-firmness air-beds and other sleep related products.
We generate revenue by selling our products through four complementary
distribution channels. Three of these channels, retail, direct marketing and
e-commerce, are Company-owned and sell directly to consumers, while our
wholesale channel sells to leading bedding retailers and the QVC shopping
channel. Sales directly to consumers through Company-owned channels generally
generate higher gross margins than sales through our wholesale channels because
we capture both the manufacturer and retailer margins. For wholesale and
company-owned sales we record revenue at the time product is shipped to our
customer, except when mattresses are delivered and set up by our home delivery
employees, in which case revenue is recorded at the time the mattress is
delivered and set up in the home. We reduce sales at the time revenue is
recognized for estimated returns.
The proportion of our total net sales, by dollar volume, from each of these
channels is summarized as follows:
Three Months Ended Six Months Ended
-------------------- --------------------
6/29/02 6/30/01 6/29/02 6/30/01
--------- --------- --------- ---------
Stores 73% 75% 74% 78%
Direct Call Center 15% 15% 15% 15%
E-commerce 5% 3% 4% 3%
Wholesale 7% 7% 7% 4%
9
Our Company-owned retail store locations are summarized as follows:
Three Months Ended Six Months Ended
-------------------- --------------------
6/29/02 6/30/01 6/29/02 6/30/01
--------- --------- --------- ---------
Beginning of period 324 326 328 333
Opened 2 3 3 5
Closed (5) (2) (10) (11)
--------- --------- --------- ---------
End of period 321 327 321 327
========= ========= ========= =========
Company-owned stores include leased space within 20 Bed, Bath & Beyond stores as
of June 29, 2002 and 24 at June 30, 2001. We anticipate opening 12 stores and
closing 3 stores during the last six months of 2002. Comparable store sales
increased (decreased) for the three months ended June 29, 2002 and June 30, 2001
by 21.3% and (3.6)%, respectively. Comparable store sales increased (decreased)
for the six months ended June 29, 2002 and June 30, 2001 by 18.6% and (5.2)%,
respectively.
In 2002 our goal is to deliver profitable full year results and re-establish
growth, driven by the following four strategic priorities:
o BUILDING CONSUMER AWARENESS - we plan to continue to build awareness of our
unique bed and Sleep Number(R) brand by expanding advertising. In
comparison to 2001 advertising spending in the first half of 2002 increased
13%. We plan to spend over 50% more on advertising in the second half of
2002 as compared to the second half of 2001 and will include increases in
national advertising and stores supported by local TV and radio.
o EXPANDING PROFITABLE DISTRIBUTION - we plan to continue to improve and
expand our distribution. Our Company-owned retail store base will be
expanded with selective store additions and a pilot of new store design and
remodels (7 stores). Wholesale distribution will also be expanded with new
distribution through 13 Sleep America stores, in the third quarter, after
having added approximately 40 Sleep Train stores in the second quarter of
2002.
o IMPROVING PRODUCT QUALITY, INNOVATION AND SERVICE LEVELS - we will continue
to improve our products. Our track record of continuous improvement and
innovation in beds will be continued in the second half of 2002.
Accessories both for the top of the bed and under bed use will be expanded
in the second half of 2002 as well.
o RIGHTSIZING OUR COST STRUCTURE - we will continue to apply the cost
disciplines employed during our turnaround - looking to improve operating
margins by identifying additional cost savings and maintaining cost
increases below sales growth rates.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as percentages of net sales.
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
JUNE 29, JUNE 30, JUNE 29, JUNE 30,
2002 2001 2002 2001
------------- ------------- ------------- -------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 31.9 35.7 32.2 35.9
------------- ------------- ------------- -------------
Gross margin 68.1 64.3 67.8 64.1
------------- ------------- ------------- -------------
Operating expenses:
Sales and marketing 53.6 59.6 54.0 63.6
General and administrative 10.4 9.5 9.6 10.1
Store closings and asset impairments 0.2 0.3 0.2 0.4
------------- ------------- ------------- -------------
Total operating expenses 64.2 69.4 63.8 74.1
------------- ------------- ------------- -------------
Operating income (loss) 3.9 (5.1) 4.0 (10.0)
Other income (expense), net (0.6) (0.5) (0.6) (0.3)
------------- ------------- ------------- -------------
Income (loss) before income taxes 3.3 (5.6) 3.4 (10.3)
Income tax expense (benefit) 0.0 0.0 (0.3) 0.1
------------- ------------- ------------- -------------
Net income (loss) 3.3% (5.6)% 3.7% (10.4)%
============= ============= ============= =============
10
COMPARISON OF THREE MONTHS ENDED JUNE 29, 2002 WITH THREE MONTHS ENDED JUNE 30,
2001
Operating income for the second quarter 2002 totaled $3.0 million compared to an
operating loss of $3.2 million for the second quarter of 2001. The improvement
in profitability was a direct result of 23% higher sales and successful
execution of cost restructuring efforts.
NET SALES
Net sales increased 23.3% to $77.3 million for the three months ended June 29,
2002 from $62.7 million for the three months ended June 30, 2001, due to an
increase in mattress unit sales and higher average selling prices resulting
primarily from improvements in product mix, lower discounts and lower return
rates. The increase in net sales by sales channel was attributable to (i) a $9.8
million increase in sales from Company-owned retail stores, including an
increase in comparable store sales of $9.7 million, (ii) a $2.1 million increase
in direct marketing sales, (iii) a $1.6 million increase in sales through the
Company's e-commerce channel and (iv) a $1.1 million increase in sales from the
Company's wholesale channel.
GROSS MARGIN
Gross margin increased to 68.1% for the three months ended June 29, 2002 from
64.3% for the three months ended June 30, 2001, primarily due to lower cost
promotional offerings, improved mix and reductions in manufacturing costs
resulting from improved quality, greater manufacturing leverage, reduced
warranty costs and savings in processing returned product.
SALES AND MARKETING
Sales and marketing expenses increased 10.6% to $41.4 million for the three
months ended June 29, 2002 from $37.4 million for the three months ended June
30, 2001 and decreased as a percentage of net sales to 53.6% from 59.6% for the
comparable prior year period. The increase was primarily due to increased
investments in media and sales based compensation. The decrease as a percentage
of net sales was attributable to greater leverage in media, media production and
other marketing expenses. In addition, fixed selling expenses have been reduced
and leveraged across a higher sales base.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 33.3% to $8.0 million for the
three months ended June 29, 2002 from $6.0 million for the three months ended
June 30, 2001 and increased as a percentage of net sales to 10.4% from 9.5% for
the prior year period. The increase in general and administrative expenses in
total and as a percentage of net sales was due primarily to accrued incentive
compensation based on Company performance.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense increased $15,000 to $157,000 for the
three months ended June 29, 2002 from $142,000 for the three months ended June
30, 2001. In 2002, the expense includes $98,000 related to store closures and
$59,000 related to the write-off of unusable fixtures due to store remodels.
OTHER INCOME (EXPENSE), NET
Other expense increased $67,000 to approximately $421,000 for the three months
ended June 29, 2002 from $354,000 for the three months ended June 30, 2001. The
increase is primarily due to interest expense from long-term debt.
INCOME TAX (BENEFIT) EXPENSE
There was no income tax expense for the three months ended June 29, 2002 and
June 30, 2001.
COMPARISON OF SIX MONTHS ENDED JUNE 29, 2002 WITH SIX MONTHS ENDED JUNE 30, 2001
Operating income for the six months ended 2002 totaled $6.4 million compared to
an operating loss of $12.9 million for the six months ended 2001. The
improvement in profitability was a direct result of 24% higher sales and
successful execution of cost restructuring efforts.
NET SALES
Net sales increased 23.6% to $158.5 million for the six months ended June 29,
2002 from $128.2 million for the six months ended June 30, 2001, due to an
increase in mattress unit sales and higher average selling prices resulting
primarily from improvements in product mix. The increase in net sales by sales
channel was attributable to (i) a $17.7
11
million increase in sales from Company-owned retail stores, including an
increase in comparable store sales of $18.0 million, (ii) a $5.2 million
increase in direct marketing sales, (iii) a $2.9 million increase in sales
through the Company's e-commerce channel and (iv) a $4.5 million increase in
sales from the Company's wholesale channel.
GROSS MARGIN
Gross margin increased to 67.8% for the six months ended June 29, 2002 from
64.1% for the six months ended June 30, 2001, primarily due to lower cost
promotional offerings, improved mix and reductions in manufacturing costs
resulting from improved quality, greater manufacturing leverage, reduced
warranty costs and savings in processing returned product.
SALES AND MARKETING
Sales and marketing expenses increased 4.9% to $85.6 million for the six months
ended June 29, 2002 from $81.6 million for the six months ended June 30, 2001
and decreased as a percentage of net sales to 54.0% from 63.6% for the
comparable prior-year period. The decrease as a percentage of net sales was
attributable primarily to greater leverage in media, media production and other
marketing expenses. In the first quarter 2001 we introduced the Sleep Number ad
campaign, launching initial markets with heavy advertising spending, and
developed the creative material to support the ongoing campaign. In addition,
fixed selling expenses have been reduced and leveraged across a higher sales
base.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 16.9% to $15.2 million for the six
months ended June 29, 2002 from $13.0 million for the six months ended June 30,
2001 and decreased as a percentage of net sales to 9.6% from 10.1% for the
comparable prior-year period. The increase was primarily a result of accrued
incentive compensation based on Company performance. The decrease in general and
administrative expenses as a percentage of net sales was due to leverage across
a higher sales base.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense decreased $279,000 to $209,000 for
the six months ended June 29, 2002 from $488,000 for the six months ended June
30, 2001. In 2002, the expense includes $150,000 related to store closures and
$59,000 related to the write-off of unusable fixtures due to store remodels. In
2001, the expense included $150,000 related to store closures and $338,000
related primarily to the write-off of unusable fixtures for merchandising of our
sleeper sofa products and for unusable leased space.
OTHER INCOME (EXPENSE), NET
Other expense increased $515,000 to approximately $894,000 for the six months
ended June 29, 2002 from $379,000 for the six months ended June 30, 2001. The
increase is primarily due to interest expense from long-term debt initiated in
June and September of 2001.
INCOME TAX (BENEFIT) EXPENSE
Income tax (benefit) expense changed $463,000 as compared to the six months
ended June 30, 2001. The $348,000 income tax benefit for the six months ended
June 29, 2002 was due to a federal tax law change in the first quarter of 2002
allowing for the carryback of certain losses to prior periods, while the Company
recorded $115,000 of income tax expense in the six month period ended June 30,
2001.
LIQUIDITY AND CAPITAL RESOURCES
Historically, our primary source of liquidity has been the sale of equity
securities. Our most recent source of capital has been from the completion of
our $11.0 million convertible debt offering in June 2001 and $5.0 million senior
secured term debt financing completed in September 2001. The $11.0 million in
convertible debt was converted to equity in the second quarter of 2002. In
addition, we generated cash from operations for the full year in 2001 and during
the first half of 2002. Substantially all of our assets are pledged as
collateral for the senior secured debt offering. We are currently pursuing a
bank revolving line of credit. While not necessary for short- or long-term
liquidity needs, this line would provide additional cash flexibility. Barring
any unexpected significant external or internal developments, we expect current
cash balances on hand and cash generated from operations to be sufficient to
meet our short-term and long-term liquidity needs.
Net cash provided by operating activities for the six months ended June 29, 2002
was approximately $12.3 million and consisted primarily of the net income
adjusted for non-cash expenses, decreases in other assets and increases in
accrued compensation and benefits and other accrued liabilities, partially
offset by increases in inventories. The inventory
12
increase is primarily a function of timing of purchases and size of QVC shows.
The increase in accrued compensation is a result of increases in incentive pay
accruals. The increase in accrued liabilities is related to the timing of cash
received on customer orders in advance of customer shipments at the end of the
quarter. Net cash used in operating activities for the six months ended June 30,
2001 was approximately $4.8 million and consisted primarily of the net loss
adjusted for non-cash expenses, partially offset by decreases in inventories and
increases in accounts payable. The increase in accounts payable related
primarily to the deferral of certain supplier payments during the first half of
2001. These deferrals have subsequently been paid. Decreases in inventory
balances were a result of specific initiatives to reduce inventory balances at
our manufacturing locations.
Net cash used in investing activities was approximately $13.6 million for the
six months ended June 29, 2002. Net cash provided by investing activities was
$1.6 million for the six months ended June 30, 2001. Investing activities
consisted primarily of purchases of property and equipment for new retail stores
and information technology system development costs. In 2002 we invested $10.6
million of cash in short-term marketable securities, while in 2001 we liquidated
$4.0 million of marketable securities to support continuing operations.
Net cash provided by financing activities was approximately $266,000 for the six
months ended June 29, 2002 from the issuance of common stock, net of debt
repayments and $10.5 million for the six months ended June 30, 2001 which
consisted primarily of net proceeds from issuance of long-term debt.
At June 29, 2002, we had net operating loss carryforwards ("NOLs") for federal
income tax purposes of approximately $34.2 million expiring between the years
2003 and 2022. We have not recorded any value in our Consolidated Balance Sheet
for the potential future benefit of these NOLs, or for additional deferred tax
assets. As a result of the Company's improved financial performance, the Company
in future quarters may restore its deferred tax asset currently valued at
approximately $22.6 million and recognize an income tax benefit in the Statement
of Operations.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's debt obligations at June 29, 2002, of $5 million carry fixed
interest rates of 12%. As this instrument bears interest at a fixed rate over
the life of the instrument, the Company does not believe it has significant
exposure to interest rate risk.
Other financial instruments that potentially subject the Company to
concentrations of credit risk consist principally of investments. The
counterparties to the agreements consist of government agencies and various
major corporations of high credit standing. The Company does not believe there
is significant risk of non-performance by these counterparties because the
Company limits the amount of credit exposure to any one financial institution
and any one type of investment.
13
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In June of 1999, the Company and certain of its former officers and directors
were named as defendants in a class action lawsuit filed in U.S. District Court
in Minnesota. The suit, filed on behalf of purchasers of the Company's common
stock between December 4, 1998 and June 7, 1999, alleges that the Company and
the named former directors and officers failed to disclose or misrepresented
certain information concerning the Company in violation of federal securities
laws. The Company believes that the suit is without merit and has vigorously
defended the matter. In June 2002, the Company consented to an agreement in
principle negotiated by the Company's insurance carrier to settle this
litigation. The settlement involves no cash or other payment obligation by the
Company, and no admission of liability or wrongdoing by the Company. The
settlement remains subject to negotiation of a definitive settlement agreement
and approval of the court.
The Company is involved in other various 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our Annual Meeting of Shareholders was held on May 17, 2002. The
following individuals were elected as Directors of the Company at the
Annual Meeting to serve for terms of three years expiring at the 2005
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:
Christopher P. Kirchen
Shares For 17,025,565
Shares Withheld 21,886
Jean-Michel Valette
Shares For 17,027,810
Shares Withheld 19,641
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:
TERM EXPIRES
NAME
Patrick A. Hopf 2003
Ervin R. Shames 2003
Thomas J. Albani 2004
David T. Kollat 2004
William R. McLaughlin 2004
14
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
--------
EXHIBIT
NUMBER DESCRIPTION
------- -----------
99.1 Certification
99.2 Certification
(b) REPORTS ON FORM 8-K
-------------------
During the quarter ended June 29, 2002, the Company filed five
Current Reports on Form 8-K. The Report consisted of the
following:
(i) Current Report filed April 4, 2002, announcing first quarter
net sales for March 30, 2002.
(ii) Current Report filed April 16, 2002, announcing comments on
unaudited results for the first quarter ended March 30,
2002.
(iii)Current Report filed May 16, 2002, announcing information
presented at the Annual Meeting on May 15, 2002.
(iv) Current Report filed June 26, 2002, announcing the
conversion of $11 million in convertible notes.
(v) Current Report filed June 28, 2002, announcing the
settlement of the shareholder litigation.
15
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 12, 2002 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)
16
EXHIBIT INDEX
EXHIBIT NUMBER DESCRIPTION LOCATION
-------------- ----------- --------
99.1 Certification......................... Filed herewith.
99.2 Certification......................... Filed herewith.