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 3, 1999
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: (612) 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. |X| YES | | NO
As of July 3, 1999, 18,192,975 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 3, 1999 and January 2, 1999................................. 3
Consolidated Statements of Operations
for the Three Months and Six Months ended July 3, 1999
and July 4, 1998................................................. 4
Consolidated Statements of Cash Flows
for the Six Months ended July 3, 1999
and July 4, 1998................................................. 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............ 15
Item 5. Other Information.............................................. 16
Item 6. Exhibits and Reports on Form 8-K............................... 17
PART I: FINANCIAL INFORMATION
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
July 3, January 2,
Assets 1999 1999
---------- ----------
Current assets:
Cash and cash equivalents $22,737 $45,561
Marketable securities 9,127 -
Accounts receivable, net of allowance for
doubtful accounts of $1,286, and
$2,750, respectively (note 3) 12,010 10,624
Inventories (note 4) 11,688 10,136
Prepaid expenses 3,667 4,048
Income taxes 1,346 -
Deferred tax assets 5,818 5,448
---------- ----------
Total current assets 66,393 75,817
---------- ----------
Property and equipment, net 33,039 29,125
Deferred tax assets 551 440
Other assets 2,843 852
---------- ----------
Total assets $102,826 $106,234
========== ==========
Liabilities and Shareholders' Equity
Current liabilities:
Current maturities of long-term debt $418 $930
Accounts payable 14,496 12,079
Accruals:
Sales returns 5,233 6,021
Warranty costs 5,385 4,486
Compensation, taxes and benefits 4,445 4,843
Income taxes - 648
Other 4,149 4,561
---------- ----------
Total current liabilities 34,126 33,568
Long-term debt, less current maturities - 29
Other liabilities 2,352 1,946
---------- ----------
Total liabilities 36,478 35,543
---------- ----------
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, 18,192,975 and 18,435,687 shares
issued and outstanding, respectively 182 184
Additional paid-in capital 81,741 87,619
Accumulated deficit (15,575) (17,112)
---------- ----------
Total shareholders' equity 66,348 70,691
---------- ----------
Total liabilities and shareholders' equity $102,826 $106,234
========== ==========
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 3, JULY 4, JULY 3, JULY 4,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Net sales $65,750 $60,129 $137,382 $118,800
Cost of sales 22,562 20,466 47,109 41,546
---------- ---------- ---------- ----------
Gross margin 43,188 39,663 90,273 77,254
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing 37,400 31,695 77,889 63,956
General and administrative 5,588 4,302 10,806 8,595
---------- ---------- ---------- ----------
Total operating expenses 42,988 35,997 88,695 72,551
---------- ---------- ---------- ----------
Operating income 200 3,666 1,578 4,703
---------- ---------- ---------- ----------
Other income (expense):
Interest income 420 156 959 382
Interest expense (16) (1,204) (51) (2,736)
Other, net (51) (2) (47) (2)
---------- ---------- ---------- ----------
Other income (expense), net 353 ( 1,050) 861 ( 2,356)
---------- ---------- ---------- ----------
Income before income taxes 553 2,616 2,439 2,347
Income tax expense 205 706 902 855
---------- ---------- ---------- ----------
Net income $348 $1,910 $1,537 $1,492
========== ========== ========== ==========
Net income per share (note 3) -
Basic $0.02 $0.60 $0.08 $0.39
Diluted $0.02 $0.11 $0.08 $0.07
========== ========== ========== ==========
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 3, July 4,
1999 1998
---------- ----------
Cash flows from operating activities:
Net income $1,537 $1,492
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 2,833 2,520
Deferred tax assets (481) (245)
Interest expense from put warrant valuation - 1,540
Change in operating assets and liabilities:
Accounts receivable, net (1,386) (2,351)
Inventories (1,552) (2,097)
Prepaid expenses 381 566
Income taxes (1,994) 696
Accounts payable 2,417 (1,503)
Accrued sales returns (788) 3
Accrued warranty costs 899 482
Accrued compensation, taxes and benefits (398) (277)
Other accrued liabilities (412) (1,398)
Other assets (3) (493)
Other liabilities 406 292
---------- ----------
Net cash provided by (used in)
operating activities 1,459 (773)
---------- ----------
Cash flows used in investing activities:
Purchases of property and equipment (6,735) (3,993)
Investment in marketable securities (9,127) -
Investment in affiliate (2,000) -
---------- ----------
Net cash used in investing activities (17,862) (3,993)
---------- ----------
Cash flows from financing activities:
Principal payments on debt (541) (487)
Repurchase of common stock (8,506) -
Proceeds from issuance of common stock 2,626 1,315
---------- ----------
Net cash provided by (used in)
financing activities (6,421) 828
---------- ----------
Decrease in cash and cash equivalents (22,824) (3,938)
Cash and cash equivalents, at beginning of period 45,561 12,670
---------- ----------
Cash and cash equivalents, at end of period $22,737 $8,732
========== ==========
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 3, 1999 and July 4, 1998 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 3, 1999 and January 2, 1999 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 generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations, although
management believes the disclosures are adequate to make the information
presented not misleading. These consolidated financial statements should be read
in conjunction with the Company's most recent audited 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 2, 1999. Operating results for the
Company on a quarterly basis may not be indicative of operating results for the
full year.
(2) INVESTMENT
In July 1999, the Company invested $2.0 million in a less than 20% owned
affiliate which will be the provider of the Company's sofa sleeper product.
(3) ACCOUNTS RECEIVABLE
In July 1999, the Company terminated its revolving third-party credit
arrangement with Monogram Bank, an affiliate of General Electric Capital
Corporation ("GE") and entered into a third-party credit arrangement with Green
Tree Financial Corporation ("Green Tree"). These arrangements have been used to
provide financing for customers' use in purchasing products. In connection with
all purchases financed under these arrangements, the provider pays an amount
equal to the total amount of purchases net of promotional discounts. The
provider sets the rate, annual fees and all other terms and conditions relating
to the customers' accounts, including collection policies and procedures, and is
the owner of the receivables. There are no retainage requirements as part of
this new agreement.
(4) INVENTORIES
Inventories consist of the following (in thousands):
JULY 3, 1999 JANUARY 2, 1999
--------------- ---------------
Raw materials $7,197 $6,533
Work in progress 133 67
Finished goods 4,358 3,536
--------------- ---------------
$11,688 $10,136
=============== ===============
6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(5) NET INCOME PER COMMON SHARE
The following computations reconcile net income with net income per common
share-basic and diluted (dollars in thousands, except per share amounts).
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 $0.06 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
========== ========== ========== ========== ========== ==========
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------------------- ---------------------------------
NET PER SHARE NET PER SHARE
JULY 4, 1998 INCOME SHARES AMOUNT INCOME SHARES AMOUNT
------------ ---------- ---------- ---------- ---------- ---------- ----------
Net income $1,910 $1,492
Less: Cumulative preferred dividend (225) (450)
---------- ----------
BASIC EPS
Net income available to common shareholders 1,685 2,821 $0.60 1,042 2,649 $0.39
---------- ---------- ========== ---------- ---------- ==========
EFFECT OF DILUTIVE SECURITIES
Warrants - 668 - 485
Convertible preferred stock - 11,235 - 11,235
Options - 877 - 963
---------- ---------- ---------- ----------
DILUTED EPS
Net income available to common shareholders
plus assumed conversions $1,685 15,600 $0.11 $1,042 15,332 $0.07
========== ========== ========== ========== ========== ==========
7
(6) STOCK REPURCHASE
In May 1999, the Board of Directors authorized management to repurchase up to
$10 million in shares of the Company's common stock in the open market. The
Company subsequently repurchased 575,000 shares for approximately $8.5 million.
In August 1999, the Board of Directors authorized management to repurchase up to
$4 million in shares of the Company's common stock. 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.
(7) LITIGATION
The Company and certain of its current and former officers and directors have
been named as defendants in seven essentially identical lawsuits seeking class
action status 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 January 25, 1999
to June 7, 1999, charge the defendants with violations of federal securities
laws. The suits allege that the Company and the named directors and officers
failed to disclose or misrepresented financial information concerning the
Company during the class period. The complaints do not specify an amount of
damages claimed. The Company believes that the complaints are without merit and
intends to vigorously defend the claims.
8
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. The statements
regarding Select Comfort Corporation contained in this report that are not
historical in nature, particularly those that utilize terminology such as "may,"
"will," "should," "expects," "anticipates," "estimates," "believes" or "plans,"
or comparable terminology, are forward-looking statements based on current
expectations and assumptions, and entail various risks and uncertainties that
could cause actual results to differ materially from those expressed in such
forward-looking statements. 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 2, 1999,
which discussion is incorporated herein by reference. Such important factors
include our ability to create product and brand name awareness, the
effectiveness and efficiency of our advertising, the level of consumer
acceptance of our products, the number and timing of new retail store openings,
the performance of our existing and new retail stores, our ability to manage our
planned rapid store expansion, our ability to successfully identify and respond
to emerging trends in the mattress industry, the level of competition in the
mattress industry, general economic conditions and consumer confidence, and our
ability to maintain cost-effective production and delivery of products.
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 four sales channels:
retail, direct marketing, event marketing and e-commerce. Vertically integrated
operations and control over four separate but complementary sales channels
enable us to develop and maintain direct customer relationships as well as
leverage advertising dollars. Sales generation is driven primarily by targeted
print, radio and television media that generate customer inquiries, as well as
by our multiple, complementary distribution channels, which are designed to
provide multiple opportunities for customers to purchase our products.
Retail operations included 302 stores at July 3, 1999, including 27 leased
departments within larger retail stores (26 in Bed Bath & Beyond stores) and 264
stores at January 2, 1999, including 14 leased departments. The Company plans to
open a minimum of 48 retail stores during the remainder of 1999, including
expansion of the leased department concept. Seven of the 27 retail store
openings in the second quarter of 1999 were in new markets. We have closed a
total of five stores since inception.
Historically, the Company has experienced strong comparable store sales growth,
reporting an increase of 7.6% for the three months ended July 3, 1999 and 16.7%
for the three months ended July 4, 1998. Comparable store sales increased by
10.2% for the six months ended July 3, 1999 and 25.5% for the six months ended
July 4, 1998. The Company believes this performance is due to increased
awareness of our brand and product benefits, the relatively young age of the
store base and increased emphasis by the Company on the retail distribution
channel. This emphasis has resulted in (i) increased retail advertising in
certain multiple store markets, (ii) the evolution of retail store operations,
including improvements in store design, and (iii) the closer integration of
direct marketing and retail distribution channels. Comparable store sales
results in the future will be influenced by a variety of factors, including our
ability to create product and brand name awareness, the effectiveness and
efficiency of our advertising, our ability to drive consumer traffic to retail
stores and the level of consumer acceptance of our products.
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,
net sales contributed by new stores, any disruptions in third-party delivery
services, competitive factors 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.
9
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 and marketing expenditures. The level of such 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.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, our results of
operations expressed as percentages of net sales. Percentage amounts may not
total due to rounding.
THREE MONTHS ENDED SIX MONTHS ENDED
--------------------- ---------------------
JULY 3, JULY 4, JULY 3, JULY 4,
1999 1998 1999 1998
---------- ---------- ---------- ----------
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 34.3 34.0 34.3 35.0
---------- ---------- ---------- ----------
Gross margin 65.7 66.0 65.7 65.0
---------- ---------- ---------- ----------
Operating expenses:
Sales and marketing 56.9 52.7 56.7 53.8
General and administrative 8.5 7.2 7.9 7.2
---------- ---------- ---------- ----------
Total operating expenses 65.4 59.9 64.6 61.1
---------- ---------- ---------- ----------
Operating income 0.3 6.1 1.1 4.0
Other income (expense), net 0.5 (1.7) 0.6 (2.0)
---------- ---------- ---------- ----------
Income before income taxes 0.8 4.4 1.8 2.0
Income tax expense 0.3 1.2 0.7 0.7
---------- ---------- ---------- ----------
Net income 0.5% 3.2% 1.1% 1.3%
========== ========== ========== ==========
The overall decrease in operating earnings for 1999 as compared to 1998 relates
to increases in operating expenses, as a percentage of net sales, to support
long-term growth plans. Direct marketing sales declined by $4.9 million in the
second quarter of 1999 compared to the second quarter of 1998. Retail sales,
which were positively influenced in those markets in which retail advertising
has been expanded, were lower than expected in those markets without increased
advertising. A substantial portion of the Company's operating expenses is
relatively fixed on a short-term basis and is necessary for long term growth,
including increased retail advertising, certain selling expenses associated with
retail store operations, direct marketing selling expenses, and increased
general and administrative costs.
COMPARISON OF THREE MONTHS ENDED JULY 3, 1999 WITH THREE MONTHS ENDED JULY 4,
1998
NET SALES
Net sales increased 9.3% to $65.8 million for the three months ended July 3,
1999 from $60.1 million for the three months ended July 4, 1998 primarily due to
an increase in unit sales. The components of the increase in net sales for the
three month period were (i) an $8.2 million increase associated with the opening
of 78 new retail stores during the past 12 months and (ii) a $2.5 million
increase associated with an increase of 7.6% in comparable store sales resulting
primarily from the continuing maturation of stores, which were offset by a $4.9
million decrease in direct marketing sales.
10
GROSS MARGIN
Gross margin decreased to 65.7% for the three months ended July 3, 1999 from
66.0% for the three months ended July 4, 1998 primarily due to an increase in
promotional programs, offset by improved purchasing through volume discounts and
better relationships with key suppliers, and improved leverage of fixed
manufacturing costs over higher unit volumes.
SALES AND MARKETING
Sales and marketing expenses increased 18.0% to $37.4 million for the three
months ended July 3, 1999 from $31.7 million for the three months ended July 4,
1998, and increased as a percentage of net sales to 56.9% from 52.7% for the
comparable prior year period. The increase in the dollar amount of sales and
marketing expenses for the three month period was primarily due to (i) the
opening of 78 new retail stores during the last 12 months, (ii) increased
advertising expenditures to support the Company's growth and (iii) higher
commissions, percentage rents and freight expense related to the higher net
sales. Sales and marketing expenses increased as a percentage of net sales
primarily due to (i) increased advertising focused on longer term sales growth
through brand and retail store awareness, (ii) lower direct marketing sales and
(iii) selling expenses in new stores increasing at a greater rate than net
sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 29.9% to $5.6 million for the
three months ended July 3, 1999 from $4.3 million for the three months ended
July 4, 1998. The increase in general and administrative expenses was primarily
due to increased spending on research and development and to provide retail and
information technology infrastructure to support long-term growth plans.
OTHER INCOME (EXPENSE), NET
Other income increased $1.4 million to approximately $353,000 for the three
months ended July 3, 1999 from ($1.0) million expense for the three months ended
July 4, 1998. The increase was primarily due to (i) the inclusion of $600,000 of
non-cash interest expense in the three months ended July 4, 1998 relating to the
change in the fair value of an outstanding put warrant and (ii) an increase in
interest income due to the increase in cash obtained from the completion of our
initial public offering in December 1998. The put provision associated with the
warrant was eliminated effective on completion of the initial public offering.
Future periods will not require the recording of non-cash interest expense
associated with the put warrant.
INCOME TAX EXPENSE
Income tax expense decreased to $205,000 for the three months ended July 3, 1999
from $706,000 for the three months ended July 4, 1998 due to a decrease in
taxable income in 1999, partially offset by the use of available net operating
loss carryforwards in 1998.
COMPARISON OF SIX MONTHS ENDED JULY 3, 1999 WITH SIX MONTHS ENDED JULY 4, 1998
NET SALES
Net sales increased 15.6% to $137.4 million for the six months ended July 3,
1999 from $118.8 million for the six months ended July 4, 1998. The increase in
net sales for the six month period was attributable to (i) a $16.6 million
increase associated with the opening of 78 new retail stores during the past 12
months, (ii) a $6.7 million increase associated with an increase of 10.2% in
comparable store sales resulting primarily from the continuing maturation of
stores and (iii) a $5.3 million decrease in direct marketing sales.
GROSS MARGIN
Gross margin increased to 65.7% for the six months ended July 3, 1999 from 65.0%
for the six months ended July 4, 1998 due to (i) improved purchasing through
volume discounts and better relationships with key suppliers and (ii) improved
leverage of fixed manufacturing costs over higher unit volumes.
11
SALES AND MARKETING
Sales and marketing expenses increased 21.8% to $77.9 million for the six months
ended July 3, 1999 from $64.0 million for the six months ended July 4, 1998, and
increased as a percentage of net sales to 56.7% from 53.8% for the comparable
prior year period. The increase in the dollar amount of sales and marketing
expenses for the six month period was primarily due to (i) the opening of 78 new
retail stores during the last 12 months, (ii) increased advertising expenditures
to support the Company's growth and (iii) higher commissions, percentage rents
and freight expense related to higher net sales. Sales and marketing expenses
increased as a percentage of net sales primarily due to (i) increased
advertising focused on longer term sales growth through brand and retail store
awareness, (ii) lower direct marketing sales and (iii) selling expenses in new
stores increasing at a greater rate than net sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 25.7% to $10.8 million for the six
months ended July 3, 1999 from $8.6 million for the six months ended July 4,
1998. The increase in general and administrative expenses was primarily due to
increased spending on research and development and to provide retail and
information technology infrastructure to support long-term growth plans.
OTHER INCOME (EXPENSE), NET
Other income increased $3.2 million to approximately $861,000 for the six months
ended July 3, 1999 from ($2.4) million expense for the six months ended July 4,
1998. The increase for the six month period was primarily due to (i) the
inclusion of $1.5 million of non-cash interest expense in the six months ended
July 4, 1998 relating to the change in the fair value of an outstanding put
warrant and (ii) an increase in interest income due to the increase in cash
obtained from the completion of our initial public offering in December 1998.
The put provision associated with the warrant was eliminated effective on
completion of the initial public offering. Future periods will not require the
recording of non-cash interest expense associated with the put warrant.
INCOME TAX EXPENSE
Income tax expense increased to $902,000 for the six months ended July 3, 1999
from $855,000 for the six months ended July 4, 1998 due to an increase in
taxable income in 1999 and the use of available net operating loss carryforwards
in 1998.
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) the build-out
of our third manufacturing plant and (iv) the repurchase of 575,000 shares of
Company common stock for $8.5 million in May 1999. The Company had working
capital of approximately $32.3 million at July 3, 1999 and $40.3 million at
January 2, 1999.
Net cash provided by operating activities for the six months ended July 3, 1999
was approximately $1.5 million and consisted primarily of net income adjusted
for non-cash expenses and increases in accounts payable and accrued liabilities,
partially offset by increases in accounts receivable and inventories. Net cash
used in operating activities for the six months ended July 4, 1998 was
approximately $800,000 and consisted primarily of increases in accounts
receivable, inventory and prepaid expenses and decreases in accounts payable and
accrued liabilities, partially offset by cash flows from operations before
non-cash expenses.
In July 1999, we terminated our revolving third-party credit arrangement with
Monogram Bank, an affiliate of General Electric Capital Corporation ("GE") and
entered into a third-party credit arrangement with Green Tree Financial
Corporation ("Green Tree"). These arrangements have been used to provide
financing for our customers' use in purchasing our products. In connection with
all purchases financed under these arrangements, the provider pays an amount
equal to the total amount of purchases net of promotional discounts. The
provider sets the rate, annual fees and all other terms and conditions relating
to the customers' accounts, including collection policies and procedures, and is
the owner of the receivables. In July 1999, Green Tree purchased substantially
all of the outstanding receivables from GE. As a result of this transaction, the
Company received $9.8 million that had been retained by GE and had been recorded
as accounts receivable in periods prior to July 1999. There are no retainage
requirements as part of this new agreement.
12
Net cash used in investing activities was approximately $17.9 million for the
six months ended July 3, 1999 and $4.0 million for the six months ended July 4,
1998. Investing activities consisted of purchases of property and equipment for
new retail stores in both periods. During the second quarter of 1999, we began
investing excess cash in short-term marketable securities. In addition, we
invested $2.0 million in a less than 20% owned affiliate which will be the
provider of our sofa sleeper product.
Net cash used in financing activities was approximately $6.4 million for the six
months ended July 3, 1999 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. Net cash provided by financing activities was approximately $800,000
for the six months ended July 4, 1998 which consisted of stock option exercises
net of debt repayments.
In August 1999, the Board of Directors authorized management to repurchase up to
$4 million in shares of the Company's common stock due to the availability of
excess cash and the valuation of the Company's shares in the market. We believe
that cash flow generated from operations and existing cash resources will be
sufficient to meet working capital and liquidity requirements for the
foreseeable future as we pursue our long-term growth strategy, described in
greater detail below.
LOOKING FORWARD
We have completed the initial evaluation of factors that have impacted our
recent sales and earnings performance and have outlined several strategic
initiatives that we believe will accelerate sales growth and improve operating
results. These initiatives include (i) developing a more integrated marketing
approach that will concentrate a higher percentage of advertising expenditures
in our retail and e-commerce channels, (ii) increasing the number of retail
distribution points for our products and (iii) expanding our product line. The
integrated marketing approach will focus on broadening our product and brand
awareness to a larger consumer group. Our shift in advertising focus indicates
our belief that sales growth will occur most significantly in our retail and
e-commerce channels. While direct marketing will remain a significant
contributor to our business, we will focus on optimizing the direct marketing
channel profit contribution while evaluating other direct marketing sales
opportunities, including affinity marketing programs and catalogs. The continued
increase in the number of distribution points will be achieved through
aggressive retail store growth, including expansion of the Company's leased
department concept, possibly with one or more partnerships in addition to our
partnership with Bed Bath & Beyond. Initial product line expansions will include
introduction of an adjustable bed frame and a sofa sleeper product, each with
fully adjustable air mattresses.
The success of our strategy will depend on many factors including (i) the
effectiveness and efficiency of our advertising in creating awareness of our
products and brand name, (ii) our ability to successfully open additional stores
and leased departments in new and existing markets, as well as in new and
existing formats, (iii) the level of consumer acceptance of our existing and new
products, (iv) our ability to generate consumer inquiries and drive consumer
traffic to retail stores, (v) competition in the mattress industry and (vi)
general economic factors and consumer confidence.
We continue to expand our analysis of the business, including consumer
segmentation and distribution studies to be initiated in the third quarter of
1999. The strategic initiatives and additional business analyses are directed
toward improving our long-term performance and are not expected to contribute
significantly to growth in sales and earnings for the remainder of 1999, and may
negatively impact earnings in the remainder of 1999.
IMPACT OF YEAR 2000
STATE OF READINESS Beginning in early 1996, we included certain Year 2000
initiatives and remediation plans in our broader information systems strategic
plan. In early 1998 we retained an independent consultant to assess the adequacy
of Year 2000 initiatives and remediation plans. All essential information
technology ("IT") systems have been inventoried and remediation plans for any
Year 2000 issues have been implemented. Remediation plans included the
development of Year 2000 compliant applications for order entry, customer
service and point of sale systems in fall 1996. In the third quarter of 1997, we
purchased and implemented an enterprise information system used in manufacturing
operations,
13
material planning, inventory management, order processing, financial management
and human resources applications, which was upgraded to be Year 2000 compliant
in February 1999. We purchased Year 2000 compliant upgrades to our payroll
applications in 1997 and our telephone system in 1998. Year 2000 compliant
upgrades for software applications for customer inquiries and for processing and
tracking warranty claims and returns have been developed and will be completed
in the third quarter of 1999. With the implementation of these applications and
upgrades, we expect that all core applications and IT systems will be Year 2000
compliant by the end of the third quarter of 1999.
In August 1998, we formed a Year 2000 project team ("Year 2000 Project Team") to
identify and address Year 2000 compliance matters, including significant non-IT
systems which are comprised of the embedded technology used in our buildings,
plant, equipment and other infrastructure. All material Year 2000 issues in
non-IT systems have been inventoried and remedial action has been completed.
During the first quarter of 1998, we initiated discussions with significant
suppliers regarding their plans to remediate Year 2000 issues. We sent each of
the significant suppliers a questionnaire inquiring as to the magnitude of their
Year 2000 issues and the status of their readiness. We have received assurances
from a majority of these suppliers that they will become Year 2000 compliant in
a timely manner. We have not received responses from all of the third parties
with which we do business. In addition to the questionnaires, a supplier
certification program has been established under which suppliers must meet
rigorous standards relating to quality, service, the ability to deliver
materials on a timely basis and Year 2000 compliance. To date, 12 key suppliers
have been certified and other authorized suppliers are in the process of seeking
certification. All key suppliers, including our Eastern European supplier of air
chambers, have notified us that they are or will be Year 2000 compliant during
1999.
In addition to suppliers, we also rely upon governmental agencies, utility
companies, telecommunication service companies and other service providers
outside of our control. There can be no assurance that such governmental
agencies or other third parties will not suffer a Year 2000 business disruption
that could have a material adverse effect on our business, financial condition
or operating results.
COSTS TO ADDRESS THE YEAR 2000 ISSUE
We estimate that approximately $165,000 has been incurred, through July 3, 1999,
to address Year 2000 issues. We estimate that an additional $100,000 will be
incurred in 1999 to complete our remediation plans required for IT systems,
including systems software costs and consulting fees.
RISKS PRESENTED BY THE YEAR 2000 ISSUE
If any third party who provides goods or services essential to our business
activities fails to appropriately address Year 2000 issues, such failure could
have a material adverse effect on our business, financial condition or operating
results. For example, a Year 2000 related disruption on the part of the
financial institutions which process our credit card sales could have a material
adverse effect on our business, financial condition or operating results.
CONTINGENCY PLANS
The Year 2000 Project Team's initiatives include the development of contingency
plans in the event we have not completed all remediation plans in a timely
manner. In addition, the Year 2000 Project Team is in the process of developing
contingency plans in the event that any third party who provides goods or
services essential to our business fails to appropriately address Year 2000
issues. The Year 2000 Project Team expects to conclude the development of these
contingency plans by the end of the third quarter of 1999.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
No material changes.
14
PART II: OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
In June 1999 the Company and certain of its current or former officers
and directors were named as defendants in seven essentially identical
lawsuits seeking class action status 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 January 25, 1999 to
June 7, 1999, charge the defendants with violations of federal
securities laws. The suits allege that the Company and the named
directors and officers failed to disclose or misrepresented financial
information concerning the Company during the class period. The
complaints do not specify an amount of damages claimed. The Company
believes that the allegations of the complaints are without merit and
intends to vigorously defend the claims.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
In May 1999, the Board of Directors authorized management to
repurchase up to $10 million in shares of the Company's common stock
in the open market due to the availability of excess cash and the
valuation of the Company's shares in the market. During the second
quarter, the Company repurchased 575,000 shares for approximately $8.5
million. In August 1999, the Board authorized management to repurchase
up to $4 million in shares of the Company's common stock due to the
availability of excess cash and the valuation of the Company's shares
in the market.
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 June 8, 1999.
Shareholders authorized and approved an amendment of the Company's
Articles of Incorporation to increase the maximum number of directors
from nine to twelve, with shares voted as follows:
Shares For 16,541,656
Shares Against 38,767
Shares Abstaining 65,170
The following individuals were elected at the Annual Meeting as
Directors of the Company to serve for terms of three years expiring at
the 2002 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 16,525,088
Shares Withheld 120,505
Lawrence P. Murphy
Shares For 16,524,588
Shares Withheld 121,005
Jean-Michel Valette
Shares For 16,516,186
Shares Withheld 129,407
15
The following individual was elected at the Annual Meeting as a
Director of the Company to serve for a term of one year expiring at
the 2000 Annual Meeting of Shareholders or until his successor is
elected and qualified. Shares voted in favor of this Director and
shares withheld were as follows:
William J. Lansing
Shares For 16,556,188
Shares Withheld 89,405
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
---------------- ------------
Patrick A. Hopf 2000
Ervin R. Shames 2000
Thomas J. Albani 2001
David T. Kollat 2001
In addition, H. Robert Hawthorne and Daniel J. McAthie served as
Directors and their respective terms continued after the Annual
Meeting of Shareholders, but each of them subsequently resigned from
the Board of Directors in July 1999.
Shareholders ratified the appointment of KPMG Peat Marwick LLP as the
Company's independent auditor for the fiscal year ending January 1,
2000, with shares voted as follows:
Shares For 16,377,317
Shares Against 206,558
Shares Abstaining 61,718
Shareholders approved an amendment of the Company's 1997 Stock
Incentive Plan to increase the number of shares of common stock
reserved for issuance under the plan by 1,000,000 shares from
1,500,000 shares to 2,500,000 shares, with shares voted as follows:
Shares For 13,216,598
Shares Against 2,942,530
Shares Abstaining 7,145
Broker Non-Vote 479,320
ITEM 5 - OTHER INFORMATION
In July 1999, the Company disclosed that Daniel J. McAthie resigned as
President and Chief Executive Officer of the Company. Patrick A. Hopf
has been appointed interim Chief Executive Officer. The Company has
begun a search for a new Chief Executive Officer.
16
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit
Number Description
10.1 Consulting Agreement between Select Comfort
Corporation and Lawrence P. Murphy
10.2 Employment and Consulting Agreement by and
between Select Comfort Corporation and
H. Robert Hawthorne
10.3 Revolving Credit Program Agreement by and
between Green Tree Financial Corporation and
Select Comfort Corporation (1)
10.4 Letter of Agreement by and between Bed, Bath
& Beyond Inc. and Select Comfort Retail
Corporation (1)
10.5 Select Comfort Profit Sharing and 401(K) Plan
10.6 Select Comfort Corporation 1999 Employee
Stock Purchase Plan
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None.
(1) Confidential treatment has been requested with respect to
designated portions contained within this exhibit. Such portions have
been omitted and filed separately with the Commission pursuant to Rule
406 under the Securities Act.
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/Patrick A. Hopf
-------------------------------------
August 16, 1999 Patrick A. Hopf
Chairman and Interim 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 Consulting Agreement between Select Filed herewith electronically
Comfort Corporation and Lawrence P.
Murphy
10.2 Employment and Consulting Agreement Filed herewith electronically
by and between Select Comfort
Corporation and H. Robert Hawthorne
10.3 Revolving Credit Program Agreement Filed herewith electronically
by and between Green Tree Financial
Corporation and Select Comfort
Corporation
10.4 Letter of Agreement by and between Filed herewith electronically
Bed, Bath & Beyond Inc. and Select
Comfort Retail Corporation
10.5 Select Comfort Profit Sharing and Filed herewith electronically
401(K) Plan
10.6 Select Comfort Corporation 1999 Filed herewith electronically
Employee Stock Purchase Plan
27.1 Financial Data Schedule Filed herewith electronically
(1) Confidential treatment has been requested with respect to
designated portions contained within this exhibit. Such portions have
been omitted and filed separately with the Commission pursuant to Rule
406 under the Securities Act.
19