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 28, 2003
COMMISSION FILE NO. 0-25121
--------------------
SELECT COMFORT CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1597886
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6105 TRENTON LANE NORTH
MINNEAPOLIS, MINNESOTA 55442
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (763) 551-7000
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). YES [X] NO [ ]
As of June 28, 2003, 33,091,825 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 28, 2003 and December 28, 2002............................... 3
Consolidated Statements of Operations
for the Three Months and Six Months ended
June 28, 2003 and June 29, 2002................................... 4
Consolidated Statements of Cash Flows
for the Six Months ended June 28, 2003
and June 29, 2002................................................. 5
Notes to Consolidated Financial Statements........................ 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations..................... 10
Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 15
Item 4. Disclosure Controls and Procedures................................ 15
PART II: OTHER INFORMATION
Item 1. Legal Proceedings............................................... 16
Item 2. Changes in Securities and Use of Proceeds....................... 16
Item 3. Defaults Upon Senior Securities................................. 16
Item 4. Submission of Matters to a Vote of Security Holders............. 16
Item 5. Other Information............................................... 17
Item 6. Exhibits and Reports on Form 8-K................................ 17
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
JUNE 28, DECEMBER 28,
2003 2002
----------------- -----------------
ASSETS
Current assets:
Cash and cash equivalents $ 32,702 $ 27,176
Marketable securities - current (note 2) 14,654 12,146
Accounts receivable, net of allowance for doubtful
accounts of $375 and $340 6,170 3,270
Inventories (note 3) 10,846 8,980
Prepaid expenses 5,043 5,467
Deferred tax assets 7,119 12,955
----------------- -----------------
Total current assets 76,534 69,994
Marketable securities - non-current (note 2) 1,983 1,502
Property and equipment, net 34,093 28,977
Deferred tax assets 5,382 4,352
Other assets 3,499 3,506
----------------- -----------------
Total assets $121,491 $108,331
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ - $ 11
Accounts payable 20,655 16,508
Accruals:
Sales returns 3,355 3,181
Compensation and benefits 10,514 13,666
Taxes and withholding 2,546 2,779
Customer prepayments 4,381 1,964
Other 5,624 5,120
----------------- -----------------
Total current liabilities 47,075 43,229
Long-term debt, less current maturities (note 4) - 2,991
Accrued warranty costs 3,408 3,626
Other liabilities 3,911 3,970
----------------- -----------------
Total liabilities 54,394 53,816
----------------- -----------------
Shareholders' equity (notes 5 and 7):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
33,091,825 and 30,727,101 shares issued and outstanding, respectively 331 307
Additional paid-in capital 96,718 92,184
Unearned compensation (865) -
Accumulated deficit (29,087) (37,976)
----------------- -----------------
Total shareholders' equity 67,097 54,515
----------------- -----------------
Total liabilities and shareholders' equity $121,491 $108,331
================= =================
See accompanying notes to consolidated financial statements.
3
SELECT COMFORT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
Net sales $101,993 $ 77,281 $203,951 $158,476
Cost of sales 38,920 29,340 76,977 60,297
----------------- ----------------- ----------------- -----------------
Gross profit 63,073 47,941 126,974 98,179
----------------- ----------------- ----------------- -----------------
Operating expenses:
Sales and marketing 46,284 36,774 95,201 76,382
General and administrative 9,209 8,026 17,510 15,235
Store closings and asset impairments (15) 157 59 209
----------------- ----------------- ----------------- -----------------
Total operating expenses 55,478 44,957 112,770 91,826
----------------- ----------------- ----------------- -----------------
Operating income 7,595 2,984 14,204 6,353
----------------- ----------------- ----------------- -----------------
Other income (expense):
Interest income 137 37 250 104
Interest expense (53) (537) (141) (1,123)
Other, net - 79 24 125
----------------- ----------------- ----------------- -----------------
Other income (expense), net 84 (421) 133 (894)
----------------- ----------------- ----------------- -----------------
Income before income taxes 7,679 2,563 14,337 5,459
Income tax (expense) benefit (2,918) - (5,448) 348
----------------- ----------------- ----------------- -----------------
Net income $ 4,761 $ 2,563 $ 8,889 $ 5,807
================= ================= ================= =================
Net income per share (note 5 and 6) - basic $ 0.15 $ 0.13 $ 0.28 $ 0.31
================= ================= ================= =================
Weighted average shares - basic 32,018 19,690 31,449 19,038
================= ================= ================= =================
Net income per share (note 5 and 6) - diluted $ 0.12 $ 0.08 $ 0.23 $ 0.19
================= ================= ================= =================
Weighted average shares - diluted 38,778 34,415 38,492 33,848
================= ================= ================= =================
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 28, JUNE 29,
2003 2002
----------------- -----------------
Cash flows from operating activities:
Net income $ 8,889 $ 5,807
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 5,155 4,368
Amortization of debt discount and deferred finance fees 130 416
Non-cash compensation 30 -
Loss on disposal of assets 59 216
Deferred tax benefit 4,806 -
Change in operating assets and liabilities:
Accounts receivable, net (2,900) (81)
Inventories (1,866) (2,881)
Prepaid expenses 424 (586)
Other assets (10) 1,264
Accounts payable 4,147 210
Accrued compensation and benefits (3,152) 1,613
Customer prepayments 2,417 2,884
Other accruals and liabilities 168 (960)
----------------- -----------------
Net cash provided by operating activities 18,297 12,270
----------------- -----------------
Cash flows from investing activities:
Purchases of property and equipment (10,313) (2,916)
Investments in marketable securities (17,706) (12,596)
Proceeds from maturity of marketable securities 14,717 1,957
----------------- -----------------
Net cash used in investing activities (13,302) (13,555)
----------------- -----------------
Cash flows from financing activities:
Principal payments on debt (11) (20)
Repurchase of common stock (1,834) -
Proceeds from issuance of common stock 2,376 286
----------------- -----------------
Net cash provided by financing activities 531 266
----------------- -----------------
Increase (decrease) in cash and cash equivalents 5,526 (1,019)
Cash and cash equivalents, at beginning of period 27,176 16,375
----------------- -----------------
Cash and cash equivalents, at end of period $ 32,702 $ 15,356
================= =================
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 28, 2003 of Select Comfort Corporation and subsidiaries ("Select Comfort"
or the "Company"), have been prepared by the Company, without audit, pursuant to
the rules and regulations of the Securities and Exchange Commission and reflect,
in the opinion of management, all normal recurring adjustments necessary to
present fairly the financial position of the Company as of June 28, 2003 and
December 28, 2002 and the results of operations and cash flows for the periods
presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations, although management believes the disclosures are adequate
to make the information presented not misleading. These consolidated financial
statements should be read in conjunction with the Company's most recent audited
consolidated financial statements and related notes included in the Company's
Annual Report to Shareholders and its Form 10-K for the fiscal year ended
December 28, 2002. Operating results for the Company on a quarterly basis may
not be indicative of operating results for the full year.
No new accounting pronouncements have been issued that are expected to have a
material effect on the Company's financial statements.
(2) MARKETABLE SECURITIES
The Company invests its cash in highly liquid debt instruments issued by the US
government and related agencies, municipalities and in commercial paper issued
by companies with investment grade ratings. The Company's investments have an
original maturity of up to 17 months with an average time to maturity of 7
months as of June 28, 2003. Investments with an original maturity of greater
than 90 days are classified as marketable securities. Marketable securities with
a remaining maturity of greater than one year are classified as long-term. The
Company's marketable securities are classified as held-to-maturity and are
carried at amortized cost. Securities held at June 28, 2003 carried an amortized
cost of $16.6 million and a fair value of $16.7 million.
(3) INVENTORIES
Inventories consist of the following (in thousands):
JUNE 28, DECEMBER 28,
2003 2002
----------------- ----------------
Raw materials $3,188 $2,669
Work in progress 41 88
Finished goods 7,617 6,223
----------------- ----------------
$10,846 $8,980
================= ================
(4) LONG-TERM DEBT
In May 2003, the Company entered into an agreement with Bank of America, N.A.
for a $15 million three-year senior secured revolving credit facility. The
interest rate on borrowings will be calculated using LIBOR plus 2%. The
additional rate can vary from 1.5% to 2.25% based on the Company's leverage
ratio. The Company is subject to certain financial covenants under the
agreement, principally consisting of minimum liquidity requirements, working
capital and leverage ratios. The Company has remained in full compliance with
the financial covenants from the time of the agreement through June 28, 2003.
The Company has had no borrowings against the credit facility.
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
In November 2000, the Company completed the acquisition of certain assets of
SleepTec, Inc. A portion of the purchase price was a non-interest-bearing
subordinated convertible debenture ("debenture") with an original principal
amount of $4,000,000, due November 10, 2005 and convertible at any time into
727,272 shares of the Company's common stock at the rate of $5.50 per share. In
May 2003, the holder elected to convert the debt into the 727,272 shares of
common stock. As a result of this conversion, $3.1 million ($4 million in debt
net of $0.9 million unamortized debt discount) has been reclassified as common
stock and additional paid-in capital.
(5) NET INCOME PER COMMON SHARE
The following computations reconcile net income with net income per common
share-basic and diluted (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------------- -------------------------------------
JUNE 28, 2003 WEIGHTED WEIGHTED
------------- NET AVERAGE PER SHARE NET AVERAGE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------------ ------------ ----------- ----------- ----------- ------------
Net income $ 4,761 $ 8,889
------------ -----------
BASIC EPS
Net income available to common shareholders 4,761 32,018 $ 0.15 8,889 31,449 $ 0.28
=========== ============
EFFECT OF DILUTIVE SECURITIES
Options - 2,613 - 2,481
Common stock warrants - 3,787 - 4,019
Convertible debt 27 360 81 543
------------ ------------ ----------- -----------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions $ 4,788 38,778 $ 0.12 $ 8,970 38,492 $ 0.23
============ ============ =========== =========== =========== ============
THREE MONTHS ENDED SIX MONTHS ENDED
------------------------------------- -------------------------------------
JUNE 29, 2002 WEIGHTED WEIGHTED
------------- NET AVERAGE PER SHARE NET AVERAGE PER SHARE
INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------------ ------------ ----------- ----------- ----------- ------------
Net income $ 2,563 $ 5,807
------------ -----------
BASIC EPS
Net income attributable to common 2,563 19,690 $ 0.13 5,807 19,038 $ 0.31
shareholders =========== ============
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
============ ============ =========== =========== =========== ============
Additional potentially dilutive securities ("securities") totaling 643,000 and
631,000 for the three-and six-month periods ended June 28, 2003, have been
excluded from diluted EPS because the securities' exercise price was greater
than the average market price of the Company's common shares.
7
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(6) PRO FORMA NET INCOME AND NET INCOME PER SHARE
The Company's net income and net income per share under Generally Accepted
Accounting Principles (GAAP) for 2003 should be compared to 2002 net income and
net income per share on a pro forma, after-tax basis to improve comparability
between the periods. GAAP did not allow the Company to reduce its income for
income tax expense in 2002, while 2003 results reflect a reduction in income for
income taxes. A reconciliation of net income and diluted net income per share
(as determined in accordance with GAAP) to pro forma net income and diluted net
income per share is as follows (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 29, 2002 JUNE 29, 2002
------------------- -------------------
RECONCILIATION OF GAAP NET INCOME AND PRO FORMA NET INCOME:
GAAP net income $ 2,563 $ 5,807
Income taxes - adjusted to 38% effective rate (974) (2,207)
------------------- -------------------
Pro forma net income $ 1,589 $ 3,600
=================== ===================
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 29, 2002 JUNE 29, 2002
------------------- -------------------
RECONCILIATION OF GAAP DILUTED NET INCOME PER SHARE TO
PRO FORMA DILUTED NET INCOME PER SHARE:
GAAP diluted net income per share $ 0.08 $ 0.19
Effect of income taxes at 38% (.03) (.08)
------------------- -------------------
Pro forma diluted net income per share $ .05 $ .11
=================== ===================
(7) STOCK AND STOCK OPTION INCENTIVES
No compensation cost has been recognized in the consolidated financial
statements for employee stock option grants or the discount feature of the
Company's employee stock purchase plan. The following pro forma information
regarding net income and net income per share, required by SFAS No. 123
"Accounting for Stock Based Compensation", has been determined as if the Company
had accounted for its employee stock options under the fair value method of that
statement (in thousands, except per share amounts):
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------- ------------------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
2003 2002 2003 2002
----------------------------- ------------------------------
Net income:............................As reported $ 4,761 $ 2,563 $ 8,889 $ 5,807
Pro forma 4,332 1,896 7,513 4,409
Income per share -- basic:.............As reported 0.15 0.13 0.28 0.31
Pro forma 0.14 0.10 0.24 0.23
Income per share -- diluted:...........As reported 0.12 0.08 0.23 0.19
Pro forma 0.11 0.06 0.20 0.15
8
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average
assumptions:
THREE MONTHS ENDED SIX MONTHS ENDED
-------------------------------------------------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
2003 2002 2003 2002
-------------------------------------------------------------
Expected dividend yield..................... 0% 0% 0% 0%
Expected stock price volatility............. 90% 90% 90% 90%
Risk-free interest rate..................... 2.0% 2.0% 2.0% 2.0%
Expected life in years...................... 3.6 3.6 3.6 3.6
Weighted-average fair value at grant date... $ 9.13 $ 3.83 $ 6.04 $ 1.89
On February 24, 2003 the Company issued 100,000 shares of restricted stock to
certain key employees. The shares vest over ten years based on continued
employment. There was no restricted stock forfeited for the six months ended
June 28, 2003. Compensation expense related to restricted stock awards is based
upon market prices at date of grant and is charged to earnings on a
straight-line basis over the period of restriction. Total compensation expense
related to restricted stock was $30,000 for the three and six months ended June
28, 2003.
(8) LITIGATION
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, any losses that may
occur from these matters are adequately covered by insurance or are provided for
in the consolidated financial statements and the ultimate outcome of these
matters will not have a material effect on the consolidated financial position
or results of operations of the Company.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED HEREIN. THIS
QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. YOU CAN
IDENTIFY FORWARD-LOOKING STATEMENTS BY THOSE THAT ARE NOT HISTORICAL IN NATURE,
PARTICULARLY THOSE THAT USE TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD,"
"EXPECTS," "ANTICIPATES," "CONTEMPLATES," "ESTIMATES," "BELIEVES," "PLANS,"
"PROJECTS," "PREDICTS," "POTENTIAL" OR "CONTINUE" OR THE NEGATIVE OF THESE OR
SIMILAR TERMS. THESE STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY'S
HISTORICAL EXPERIENCE AND ITS PRESENT EXPECTATIONS OR PROJECTIONS. IMPORTANT
FACTORS KNOWN TO SELECT COMFORT THAT COULD CAUSE SUCH MATERIAL DIFFERENCES ARE
IDENTIFIED AND DISCUSSED IN PART I, ITEM 1 OF OUR ANNUAL REPORT ON FORM 10-K FOR
THE FISCAL YEAR ENDED DECEMBER 28, 2002, WHICH DISCUSSION IS INCORPORATED HEREIN
BY REFERENCE. THESE IMPORTANT FACTORS INCLUDE:
o GENERAL AND INDUSTRY ECONOMIC TRENDS,
o UNCERTAINTIES ARISING FROM DOMESTIC AND GLOBAL EVENTS,
o CONSUMER CONFIDENCE AND SPENDING,
o THE EFFECTIVENESS OF OUR ADVERTISING AND PROMOTIONAL EFFORTS,
o ADVERTISING RATES,
o CONSUMER ACCEPTANCE OF OUR PRODUCTS AND SLEEP TECHNOLOGY,
o INDUSTRY COMPETITION,
o OUR ABILITY TO SECURE SUITABLE RETAIL LOCATIONS,
o WARRANTY EXPENSES,
o OUR DEPENDENCE ON SIGNIFICANT SUPPLIERS OR SINGLE SOURCES OF SUPPLY,
o THE VULNERABILITY OF ANY SUPPLIERS TO RECESSIONARY PRESSURES, LIQUIDITY
CONCERNS OR OTHER FACTORS,
o GOVERNMENTAL REGULATION, INCLUDING ANTICIPATED FUTURE REGULATION OF
DIRECT MARKETING TELEPHONE SOLICITATIONS AND BEDDING FLAMMABILITY
STANDARDS, AND
o RISKS AND UNCERTAINTIES DETAILED FROM TIME TO TIME IN THE COMPANY'S
FILINGS WITH THE SEC, INCLUDING THE COMPANY'S ANNUAL REPORT ON
FORM 10-K AND OTHER PERIODIC REPORTS FILED WITH THE SEC.
THE COMPANY HAS NO OBLIGATION TO PUBLICLY UPDATE OR REVISE ANY OF THE
FORWARD-LOOKING STATEMENTS CONTAINED IN THIS QUARTERLY REPORT ON FORM 10-Q.
OVERVIEW AND CRITICAL ACCOUNTING POLICIES
Select Comfort(R) is the leading developer, manufacturer and marketer of premium
quality, adjustable-firmness beds. The air chamber technology of our proprietary
Sleep Number bed allows adjustable firmness on each side of the mattress and
provides a sleep surface that is clinically proven to provide better sleep
quality and greater relief of back pain compared to traditional mattress
products.
Our critical accounting policies relate to revenue recognition, accrued sales
returns, accrued warranty costs and impairment of long-lived assets and
long-lived assets to be disposed of by us. The effect of these policies on our
financial statements is incorporated into the discussion below.
NET SALES
We generate revenue by selling our products through four complementary
distribution channels. Three of these channels - retail, direct marketing and
e-commerce, are Company-controlled and sell directly to consumers. Our wholesale
channel sells to leading home furnishings retailers, specialty bedding retailers
and the QVC shopping channel.
REVENUE RECOGNITION. We record revenue at the time product is shipped to the
customer, except when beds are delivered and set up by our home delivery
employees, in which case revenue is recorded at the time the bed is delivered
and set up in the home.
ACCRUED SALES RETURNS. At the time revenue is recognized, we reduce sales for
estimated returns. This estimate is based on historical return rates, which are
reasonably consistent from period to period. If actual returns vary from
expected rates, revenue in future periods is adjusted, which could have a
material adverse effect on future results of operations.
10
The proportion of our total net sales, by dollar volume, from each distribution
channel is summarized as follows:
Three Months Ended Six Months Ended
----------------------- -----------------------
6/28/03 6/29/02 6/28/03 6/29/02
---------- ----------- ----------- -----------
Stores 77% 73% 78% 74%
Direct Call Center 13% 15% 13% 15%
E-commerce 4% 5% 4% 4%
Wholesale 6% 7% 5% 7%
The number of company-operated retail locations is summarized as follows:
Three Months Ended Six Months Ended
----------------------- -----------------------
6/28/03 6/29/02 6/28/03 6/29/02
---------- ----------- ----------- -----------
Beginning of period 323 324 322 328
Opened 10 2 12 3
Closed (1) (5) (2) (10)
---------- ----------- ----------- -----------
End of period 332 321 332 321
========== =========== =========== ===========
We anticipate opening 16 new retail stores and closing three to five stores
during the remainder of 2003. We remodeled 84 stores in the first half of 2003
and anticipate remodeling approximately 10 more stores throughout the balance of
the year. Company-operated stores included leased departments within 13 Bed,
Bath & Beyond stores as of June 28, 2003 and 20 at June 29, 2002.
Comparable store sales, including remodeled stores as noted above, increased
over prior year, for the three months ended June 28, 2003 and June 29, 2002 by
33.9% and 21.3%, respectively. Comparable store sales increased for the six
months ended June 28, 2003 and June 29, 2002 by 32.1% and 18.6%, respectively.
COST OF SALES
Cost of sales includes costs associated with purchasing materials, manufacturing
costs and costs to deliver our products to our customers.
ACCRUED WARRANTY COSTS. Cost of sales also includes estimated costs to service
warranty claims of customers. This estimate is based on historical claim rates
during the warranty period. Because this estimate covers an extended period of
time, a revision of estimated claim rates could result in a significant
adjustment of estimated future costs of fulfilling warranty commitments. An
increase in estimated claim rates could have a material adverse effect on future
results of operations.
GROSS PROFIT
Our gross profit margin is dependent on a number of factors and may fluctuate
from quarter to quarter. These factors include the mix of products sold, the
level at which we offer promotional discounts to purchase our products, the cost
of materials and manufacturing and the mix of sales between wholesale and
company-controlled distribution channels. Sales directly to consumers through
Company-controlled channels generally generate higher gross margins than sales
through our wholesale channels because we capture both the manufacturer's and
retailer's margin.
SALES AND MARKETING EXPENSES
Sales and marketing expenses include advertising and media production, other
marketing and selling materials such as brochures, videos, customer mailings and
in-store signage, sales compensation, store occupancy costs and customer
service. Store opening costs are expensed as incurred and advertising costs are
expensed from the first time the advertisement is aired.
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
11
management and research and development. Costs include salary, bonus and
benefits, information hardware, software and maintenance, office facilities,
insurance and shareholder relations costs and other overhead.
IMPAIRMENT OF LONG-LIVED ASSETS AND ASSETS TO BE DISPOSED OF. We evaluate our
long-lived assets, including leaseholds and fixtures in existing stores and
stores expected to be remodeled, based on expected cash flows through the
remainder of the lease term after considering the potential impact of planned
operational improvements and marketing programs. Expected cash flows may not be
realized, which could cause long-lived assets to become impaired in future
periods and could have a material adverse effect on future results of
operations. Store assets are written off when we believe these costs will not be
recovered through future operations.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as percentages of net sales.
THREE MONTHS ENDED SIX MONTHS ENDED
----------------------------------- -----------------------------------
JUNE 28, JUNE 29, JUNE 28, JUNE 29,
2003 2002 2003 2002
----------------- ----------------- ----------------- -----------------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 38.2 38.0 37.7 38.0
----------------- ----------------- ----------------- -----------------
Gross profit 61.8 62.0 62.3 62.0
----------------- ----------------- ----------------- -----------------
Operating expenses:
Sales and marketing 45.4 47.6 46.7 48.2
General and administrative 9.0 10.4 8.6 9.6
Store closings and asset impairments 0.0 0.2 0.0 0.1
----------------- ----------------- ----------------- -----------------
Total operating expenses 54.4 58.2 55.3 57.9
----------------- ----------------- ----------------- -----------------
Operating income 7.4 3.9 7.0 4.0
Other income (expense), net 0.1 (0.5) 0.1 (0.6)
----------------- ----------------- ----------------- -----------------
Income before income taxes 7.5 3.3 7.0 3.4
Income tax (expense) benefit (2.9) 0.0 (2.7) 0.2
----------------- ----------------- ----------------- -----------------
Net income 4.7% 3.3% 4.4% 3.7%
================= ================= ================= =================
COMPARISON OF THREE MONTHS ENDED JUNE 28, 2003 WITH THREE MONTHS ENDED
JUNE 29, 2002
NET SALES
Net sales increased 32% to $102.0 million for the three months ended June 28,
2003 from $77.3 million for the three months ended June 29, 2002, due to a 17%
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 $21.6 million increase in sales from
Company-controlled retail stores, including an increase in comparable store
sales of $18.8 million, (ii) a $2.0 million increase in direct marketing sales,
(iii) a $0.8 million increase in sales through the Company's e-commerce channel
and (iv) a $0.3 million increase in sales from the Company's wholesale channel.
GROSS PROFIT
Gross profit decreased to 61.8% for the three months ended June 28, 2003 from
62.0% for the three months ended June 29, 2002, primarily due to the increased
cost of product delivery partially offset by improved product cost as a result
of mix improvements.
SALES AND MARKETING
Sales and marketing expenses increased 26% to $46.3 million for the three months
ended June 28, 2003 from $36.8 million for the three months ended June 29, 2002
but decreased as a percentage of net sales to 45.4% from 47.6% for the
comparable prior-year period. The increase in expense was primarily due to
additional media investments, sales-based incentive compensation, and increased
occupancy and financing costs. The decrease as a percentage of net sales was
attributable to greater leverage in fixed selling expenses, partially offset by
increases in advertising spending as a percent of net sales.
12
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 15% to $9.2 million for the three
months ended June 28, 2003 from $8.0 million for the three months ended June 29,
2002 but decreased as a percentage of net sales to 9.0% from 10.4% for the
prior-year period. The increase in general and administrative expenses was due
primarily to accrued incentive compensation as a result of Company performance
and additional headcount. The decrease as a percentage of net sales was
attributable to greater leverage of fixed costs.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense decreased $172,000 for the three
months ended June 28, 2003 from $157,000 for the three months ended June 29,
2002. In 2003, the entire $15,000 benefit represents an adjustment to a
previously reported store impairment charge. No store assets were impaired
during the quarter ended June 28, 2003.
OTHER INCOME (EXPENSE), NET
Other income (expense) changed $505,000 to income of $84,000 for the three
months ended June 28, 2003 from an expense of $421,000 for the three months
ended June 29, 2002. The improvement is primarily due to reduced interest
expense following the elimination of $16 million of debt in 2002, and an
increase in interest income from the Company's improved cash position.
INCOME TAX (EXPENSE) BENEFIT
Income tax (expense) benefit changed $2.9 million to an income tax expense of
$2.9 million for the three months ended June 28, 2003 from $0 in income tax
expense for the three months ended June 29, 2002. The increase in income tax
expense was due to recording income tax expense at an estimated rate of 38% in
2003 while no such tax was recorded for the three months ended June 29, 2002.
COMPARISON OF SIX MONTHS ENDED JUNE 28, 2003 WITH SIX MONTHS ENDED JUNE 29, 2002
NET SALES
Net sales increased 29% to $204.0 million for the six months ended June 28, 2003
from $158.5 million for the six months ended June 29, 2002, due to a 13%
increase in mattress unit sales and higher average selling prices resulting
primarily from improvements in sales channel and product mix. The sales channel
mix improvement was a result of a 16% increase in Company-controlled channel
mattress unit sales and a 6% decrease in mattress unit sales in the wholesale
channel. The increase in net sales by sales channel was attributable to (i) a
$40.9 million increase in sales from Company-controlled retail stores, including
an increase in comparable store sales of $36.8 million, (ii) a $3.6 million
increase in direct marketing sales and (iii) a $1.7 million increase in sales
through the Company's e-commerce channel, offset by a decrease of $0.8 million
in sales from the Company's wholesale channel.
GROSS PROFIT
Gross profit increased to 62.3% for the six months ended June 28, 2003 from
62.0% for the six months ended June 29, 2002, primarily due to improved sales
channel mix and improved product mix, partially offset by the increased cost of
product delivery. The improved channel mix was a result of a decrease in
mattress units sold in the lower margin wholesale channel. The improved product
mix occurred in our Company-controlled channels.
SALES AND MARKETING
Sales and marketing expenses increased 25% to $95.2 million for the six months
ended June 28, 2003 from $76.4 million for the six months ended June 29, 2002
but decreased as a percentage of net sales to 46.7% from 48.2% for the
comparable prior-year period. The increase was primarily due to additional media
investments, sales-based incentive compensation, and increased occupancy and
financing costs. The decrease as a percentage of net sales was attributable to
greater leverage in fixed selling expenses, partially offset by increases in
advertising spending as a percent of net sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 15% to $17.5 million for the six
months ended June 28, 2003 from $15.2 million for the six months ended June 29,
2002 but decreased as a percentage of net sales to 8.6% from 9.6% for the
prior-year period. The increase in general and administrative expenses was due
primarily to accrued incentive compensation as a result of Company performance
and additional headcount. The decrease as a percentage of net sales was
attributable to greater leverage of fixed costs.
13
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense decreased $150,000 to $59,000 for the
six months ended June 28, 2003 from $209,000 for the six months ended June 29,
2002. In 2003, the entire $59,000 represents store impairment charges.
OTHER INCOME (EXPENSE), NET
Other income (expense) changed $1.0 million to income of $133,000 for the six
months ended June 28, 2003 from an expense of $894,000 for the six months ended
June 29, 2002. The improvement is primarily due to reduced interest expense
following the elimination of $16 million of debt in 2002, and an increase in
interest income from the Company's improved cash position.
INCOME TAX (EXPENSE) BENEFIT
Income tax (expense) benefit changed $5.8 million to an income tax expense of
$5.4 million for the six months ended June 28, 2003 from an income tax benefit
of $0.4 million for the six months ended June 29, 2002. The increase in income
tax expense was due to recording income tax expense at an estimated rate of 38%
in 2003 while no such tax was recorded for the six months ended June 29, 2002.
The $0.4 million 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.
LIQUIDITY AND CAPITAL RESOURCES
We generated cash from operations of $18.3 million in the first six months of
2003. Historically, our primary source of capital has been from external
sources, most recently from the completion of our $11.0 million convertible debt
offering in June 2001 and our $5.0 million senior secured term debt financing in
September 2001. The $11.0 million in convertible debt was converted to equity in
the second quarter of 2002 and the $5.0 million of senior debt was prepaid in
December 2002 with cash generated from operations. In February 2003, our board
of directors approved an expanded share repurchase program of up to $12.5
million. We repurchased $1.8 million of common stock in the first three months
of 2003. We recently obtained a new $15 million bank revolving line of credit.
While it is not currently anticipated that this line will be necessary for
short- or long-term liquidity needs, the line does provide additional cash
flexibility. Barring any unexpected significant external or internal
developments, we expect current cash balances on hand and cash flow generated
from operations to be sufficient to meet our short-term and long-term liquidity
needs.
Net cash provided by operating activities for the six months ended June 28, 2003
was $18.3 million and consisted primarily of our net income adjusted for
non-cash expenses and increases in accounts payable and accrued customer
pre-payments. Cash increases were partially offset by decreases in accrued
compensation and benefits and increases in accounts receivable and inventory.
Accounts payable increased as a result of the additional commitments made to
advertising in 2003 and timing of payments related thereto. The increase in
accrued customer prepayments is related to the timing of cash received on
customer orders in advance of customer shipments at the end of the quarter. The
decrease in accrued compensation is a result of annual incentive compensation
payments made during the first quarter. The increase in accounts receivable is
related to timing primarily as it relates to QVC shows. The increase in
inventory is primarily the result of purchases to mitigate the risk of a
potential longshoreman's strike. 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, increases in accrued
customer prepayments, accrued compensation and benefits, and decreases in other
assets, partially offset by increases in inventories. The inventory increase is
primarily a function of timing of purchases and size of QVC shows. The increase
in accrued customer prepayments is related to the timing of cash received on
customer orders in advance of customer shipments at the end of the quarter. The
increase in accrued compensation and benefits is a result of increases in
incentive pay accruals.
Net cash used in investing activities was $13.3 million for the six months ended
June 28, 2003. Investing activities consisted primarily of investments in
marketable securities and purchases of property and equipment for 84 remodeled
and 12 new retail stores, and development costs for information technology
systems for the six months ended June 28, 2003. In 2003, we made net investments
in marketable securities of $3.0 million. The net cash used in investing
activities for the six months ended June 29, 2002 was $13.6 million. In 2002 we
invested in $10.6 million of marketable securities, and we also invested $2.9
million in purchases of property and equipment. In the remaining six months of
2003, we expect to open 16 new retail stores and to remodel approximately 10
additional stores. Our anticipated capital expenditures are expected to be
approximately $18 million in 2003. We expect our new stores to be cash flow
positive within the first 12 months of operation and, as a result, do not expect
a significant negative effect on net cash provided by operations from new
stores.
14
Net cash provided by financing activities was $531,000 for the six months ended
June 28, 2003 from the proceeds from the issuance of common stock from the
exercise of various options and warrants, offset by the repurchase of common
stock. Net cash provided by financing activities for the six months ended June
29, 2002 was $266,000.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Financial instruments that potentially subject the Company to concentrations of
credit risk consist principally of investments. The counterparties to the
agreements consist of government agencies and various major corporations of
investment grade credit standing. The Company does not believe there is
significant risk of non-performance by these counterparties because the Company
limits the amount of credit exposure to any one financial institution and any
one type of investment.
ITEM 4. DISCLOSURE CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company conducted an
evaluation, under the supervision and with the participation of the principal
executive officer and principal financial officer, of the Company's disclosure
controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the "Exchange Act")). Based on this evaluation,
the principal executive officer and principal financial officer concluded that
the Company's disclosure controls and procedures are effective to ensure that
information required to be disclosed by the Company in reports that it files or
submits under the Exchange Act is recorded, processed, summarized and reported
within the time periods specified in Securities and Exchange Commission rules
and forms. There was no change in the Company's internal control over financial
reporting during the Company's most recently completed fiscal quarter that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
15
PART II: OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The Company is involved in various claims and legal actions arising in the
ordinary course of business. In the opinion of management, any losses that may
occur from these matters are adequately covered by insurance or are provided for
in the consolidated financial statements and the ultimate outcome of these
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 15, 2003. The
following individuals were elected as Directors of the Company at the
Annual Meeting to serve for terms of three years expiring at the 2006
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 26,746,588
Shares Withheld 261,718
Trudy A. Rautio
Shares For 26,887,398
Shares Withheld 120,908
Ervin R. Shames
Shares For 26,744,468
Shares Withheld 263,838
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
NAME EXPIRES
---- -------
Thomas J. Albani 2004
David T. Kollat 2004
William R. McLaughlin 2004
Christopher P. Kirchen 2005
Michael A. Peel 2005
Jean-Michel Valette 2005
Shareholders also approved the appointment of KPMG LLP, certified
public accountants, as independent auditors for the fiscal year ending
January 3, 2004. Shares voted in favor of this appointment and shares
withheld were as follows:
Shares For 26,929,969
Shares Withheld 17,467
16
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS.
EXHIBIT
NUMBER DESCRIPTION
10.1 Credit Agreement dated as of May 23, 2003
between Select Comfort Corporation and
Bank of America, N.A.
10.2 Fourth Amendment to Revolving Credit Program
Agreement with Mill Creek Bank dated
June 23, 2003.
31.1 Certification of CEO pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
32.1 Certification of CEO pursuant to Section 906
of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.
32.2 Certification of CFO pursuant to Section 906
of the Sarbanes-Oxley Act of 2002,
18 U.S.C. Section 1350.
(b) REPORTS ON FORM 8-K
During the quarter ended June 28, 2003, the Company filed
three Current Reports on Form 8-K. The Reports consisted of
the following:
(i) Current Report furnished under Item 9 of Form 8-K on
April 3, 2003, announcing net sales for the first
quarter ended March 29, 2003.
(ii) Current Report furnished under Item 9 of Form 8-K on
April 15, 2003, announcing comments on results for
the first quarter ended March 29, 2003.
(iii) Current Report furnished under Item 9 of Form 8-K on
May 9, 2003, announcing pricing of public offering.
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 12, 2003 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 Credit Agreement dated as of May 23, 2003 between Filed herewith.
Select Comfort Corporation and Bank of America N.A.
10.2 Fourth Amendment to Revolving Credit Program Agreement with Filed herewith.
Mill Creek Bank dated June 23, 2003.
31.1 Certification of CEO pursuant to Section 302 of the Filed herewith.
Sarbanes-Oxley Act of 2002.
31.2 Certification of CFO pursuant to Section 302 of the Filed herewith.
Sarbanes-Oxley Act of 2002.
32.1 Certification of CEO pursuant to Section 906 of the Furnished herewith.
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
32.2 Certification of CFO pursuant to Section 906 of the Furnished herewith.
Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350.
19