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 September 30, 2000
COMMISSION FILE NO. 0-25121
--------------------
SELECT COMFORT CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1597886
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
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. X YES NO
As of September 30, 2000, 17,883,212 shares of Common Stock of the
Registrant were outstanding.
<PAGE>
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
INDEX
Page No.
PART I: FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets
September 30, 2000 and January 1, 2000............................. 3
Consolidated Statements of Operations
for the Three Months and Nine Months ended September 30, 2000
and October 2, 1999................................................ 4
Consolidated Statements of Cash Flows
for the Nine Months ended September 30, 2000
and October 2, 1999................................................ 5
Notes to Consolidated Financial Statements......................... 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations...................... 9
Item 3. Quantitative and Qualitative Disclosures about Market Risk......... 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................................................ 16
Item 6. Exhibits and Reports on Form 8-K................................. 17
<PAGE>
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
(UNAUDITED)
SEPTEMBER 30, JANUARY 1,
ASSETS 2000 2000
-------------- -------------
Current assets:
Cash and cash equivalents $ 3,109 $ 7,441
Marketable securities 9,572 20,129
Accounts receivable, net of allowance for doubtful
accounts of $208, and $305, respectively 648 1,056
Inventories (note 2) 12,030 11,451
Prepaid expenses 6,729 4,821
Income taxes 302 2,579
Deferred tax assets 6,676 6,639
-------------- -------------
Total current assets 39,066 54,116
Property and equipment, net 36,421 34,823
Deferred tax assets 11,094 4,248
Other assets 2,708 2,678
-------------- -------------
Total assets $ 89,289 $ 95,865
============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt $ 26 $ 51
Accounts payable 19,805 15,911
Accruals:
Sales returns 5,104 5,880
Warranty costs 7,036 5,841
Compensation, taxes and benefits 6,020 6,678
Other 5,099 5,285
-------------- -------------
Total current liabilities 43,090 39,646
Long-term debt, less current maturities 52 36
Other liabilities 3,365 2,809
-------------- -------------
Total liabilities 46,507 42,491
-------------- -------------
Shareholders' equity:
Undesignated preferred stock; 5,000,000 shares
authorized, no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares
authorized, 17,883,212 and 17,713,247 shares
issued and outstanding, respectively 179 177
Additional paid-in capital 79,328 78,513
Accumulated deficit (36,725) (25,316)
-------------- -------------
Total shareholders' equity 42,782 53,374
-------------- -------------
Total liabilities and shareholders' equity $ 89,289 $ 95,865
============== =============
See accompanying notes to consolidated financial statements.
3
<PAGE>
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------- -------------------------
SEPTEMBER 30, OCTOBER 2, SEPTEMBER 30, OCTOBER 2,
2000 1999 2000 1999
------------- ----------- ------------- -----------
Net sales $ 68,056 $ 68,281 $ 206,002 $ 205,663
Cost of sales 24,871 23,944 73,903 71,053
------------- ----------- ------------- -----------
Gross margin 43,185 44,337 132,099 134,610
------------- ----------- ------------- -----------
Operating expenses:
Sales and marketing 44,378 42,904 128,196 120,800
General and administrative 7,667 7,865 22,830 18,664
------------- ----------- ------------- -----------
Total operating expenses 52,045 50,769 151,026 139,464
------------- ----------- ------------- -----------
Operating loss (8,860) (6,432) (18,927) (4,854)
------------- ----------- ------------- -----------
Other income (expense):
Interest income 253 537 937 1,496
Interest expense (2) (10) (6) (61)
Other, net (31) 35 (114) (12)
------------- ----------- ------------- -----------
Other income, net 220 562 817 1,423
------------- ----------- ------------- -----------
Loss before income taxes (8,640) (5,870) (18,110) (3,431)
Income tax benefit (3,197) (2,172) (6,701) (1,269)
------------- ----------- ------------- -----------
Net loss $ (5,443) $ (3,698) $ (11,409) $ (2,162)
============= =========== ============= ===========
Net loss per share (note 4) -
basic and diluted $ (0.30) $ (0.20) $ (0.64) $ (0.12)
============= =========== ============= ===========
Weighted average shares -
basic and diluted 17,874 18,148 17,815 18,348
============= =========== ============= ===========
See accompanying notes to consolidated financial statements.
4
<PAGE>
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
--------------------------
SEPTEMBER 30, OCTOBER 2,
2000 1999
------------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net loss $ (11,409) $ (2,162)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 6,075 4,616
Loss on disposal of assets and impaired assets 1,970 -
Deferred tax assets (6,872) (1,305)
Change in operating assets and liabilities:
Accounts receivable, net 408 9,046
Inventories (579) (1,028)
Prepaid expenses (1,908) 250
Income taxes 2,277 (3,428)
Accounts payable 3,894 5,018
Accrued sales returns (776) (775)
Accrued warranty costs 1,195 1,159
Accrued compensation, taxes and benefits (391) 340
Other accrued liabilities (24) 26
Other assets (50) 150
Other liabilities 556 550
------------- ------------
Net cash provided by (used in) operating activities (5,634) 12,457
------------- ------------
Cash flows from investing activities:
Purchases of property and equipment (9,741) (10,663)
Investment in marketable securities 10,557 (24,250)
Investment in affiliate - (2,000)
------------- ------------
Net cash provided by (used in) investing activities 816 (36,913)
------------- ------------
Cash flows from financing activities:
Principal payments on debt (53) (664)
Repurchase of common stock - (10,438)
Proceeds from issuance of common stock 539 3,318
------------- ------------
Net cash provided by (used in) financing activities 486 (7,784)
------------- ------------
Decrease in cash and cash equivalents (4,332) (32,240)
Cash and cash equivalents, at beginning of period 7,441 45,561
------------- ------------
Cash and cash equivalents, at end of period $ 3,109 $ 13,321
============= ============
</TABLE>
See accompanying notes to consolidated financial statements.
5
<PAGE>
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 nine months ended
September 30, 2000 and October 2, 1999 of Select Comfort Corporation and
subsidiaries ("Select Comfort" or the "Company"), have been prepared by the
Company, without audit, pursuant to the rules and regulations of the Securities
and Exchange Commission and reflect, in the opinion of management, all normal
recurring adjustments necessary to present fairly the financial position of the
Company as of September 30, 2000 and January 1, 2000 and the results of
operations and cash flow for the periods presented.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally accepted
in the United States of America have been condensed or omitted pursuant to such
rules and regulations, although management believes the disclosures are adequate
to make the information presented not misleading. These consolidated financial
statements should be read in conjunction with the Company's most recent audited
consolidated financial statements and related notes included in the Company's
Annual Report to Shareholders and its Form 10-K for the fiscal year ended
January 1, 2000. Operating results for the Company on a quarterly basis may not
be indicative of operating results for the full year.
During 1999 the Securities and Exchange Commission issued Staff Accounting
Bulletin No 101, "Revenue Recognition in Financial Statements" (SAB 101). The
SEC has delayed the implementation date of SAB 101 until the Company's fiscal
2000 fourth quarter. In October 2000, the SEC issued additional guidance with
respect to SAB 101. The Company is analyzing the impact of SAB 101, but it is
not expected to have a material impact on the Company's consolidated financial
statements.
(2) INVENTORIES
Inventories consist of the following (in thousands):
September 30, January 1,
2000 2000
--------------- ---------------
Raw materials $ 4,878 $ 5,753
Work in progress 88 59
Finished goods 7,064 5,639
--------------- ---------------
$ 12,030 $ 11,451
=============== ===============
(3) NONRECURRING CHARGES
During the third quarter of fiscal 2000, the Company incurred certain one-time
charges of $1.4 million as the result of a review focused on reducing costs and
increasing the efficiency of its operations. The charges are primarily comprised
of costs to relocate the Company's corporate headquarters ($.6 million) and
asset impairment costs related to software design ($.7 million).
As of September 30, 2000 and January 1, 2000 there were no significant balance
sheet accruals related to nonrecurring charges. There are no significant future
cash requirements as a result of this charge.
6
<PAGE>
(4) NET LOSS PER COMMON SHARE
The following computations reconcile net loss with net loss per common
share-basic and diluted (in thousands except per share amounts).
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
----------------------------------- -----------------------------------
NET PER SHARE NET PER SHARE
SEPTEMBER 30, 2000 LOSS SHARES AMOUNT LOSS SHARES AMOUNT
------------------ ---------- ---------- ---------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net loss $ (5,443) $ (11,409)
BASIC AND DILUTED EPS
Net loss available to
common shareholders $ (5,443) 17,874 $ (0.30) $ (11,409) 17,815 $ (0.64)
========== ========== =========== ========== ========= ===========
</TABLE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
------------------------------------ -----------------------------------
NET PER SHARE NET PER SHARE
OCTOBER 2, 1999 LOSS SHARES AMOUNT LOSS SHARES AMOUNT
--------------- ---------- ---------- ----------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C>
Net loss $ (3,698) $ (2,162)
BASIC AND DILUTED EPS
Net loss available to
common shareholders $ (3,698) 18,148 $ (0.20) $ (2,162) 18,348 $ (0.12)
========== ========== =========== ========== ========= ===========
</TABLE>
(5) LITIGATION
The Company and certain of its former officers and directors have been named as
defendants in a consolidated class action lawsuit filed on behalf of Company
shareholders in U.S. District Court in Minnesota. The named plaintiffs, who
purport to act on behalf of a class of purchasers of the Company's common stock
during the period from December 4, 1998 to June 7, 1999, charge the defendants
with violations of federal securities laws. The suit alleges that the Company
and the named directors and officers failed to disclose or misrepresented
certain information concerning the Company during the class period. The
complaint does not specify an amount of damages claimed. The Company believes
that the complaint is without merit and intends to vigorously defend the claims.
The Company and the individual defendants brought a motion to dismiss all claims
on November 10, 1999. The motion was heard by a magistrate judge on December 21,
1999. On January 27, 2000, the magistrate recommended that the claims based on
Section 11 of the federal securities laws be dismissed. The magistrate
recommended that the motion to dismiss be denied with respect to the claims
based on Rule 10b-5 of the federal securities laws. In February 2000, both the
plaintiffs and the defendants formally objected to the magistrate's
recommendation. The objection was made to the United States District Court in
Minnesota. On May 12, 2000, the United States District Court in Minnesota
adopted the recommendation of the magistrate and denied the defendants' motion
to dismiss the Rule 10b-5 claims. The Court also adopted the recommendation of
the magistrate and dismissed the plaintiff's Section 11 claims without prejudice
and with leave to amend.
On March 31, 2000, the Company and certain of its former officers and directors
were named as defendants in a class action lawsuit filed on behalf of the
Company's shareholders in U.S. District Court in Minnesota asserting identical
factual allegations as the consolidated complaint described above. The suit
alleges claims based on Sections 11 and 12(a)(2) of the federal securities laws.
The complaint does not specify an amount of damages claimed. The Company
believes this complaint is without merit and intends to vigorously defend the
claims. The above two class actions were consolidated by the United States
District Court Magistrate on July 24, 2000.
7
<PAGE>
The Company is subject to various other claims, legal actions, sales tax
disputes and other complaints arising in the ordinary course of business. In the
opinion of management, any losses that may occur from these other matters are
adequately covered by insurance or are provided for in the consolidated
financial statements, and the ultimate outcome of these other matters will not
have a material effect on the consolidated financial position or results of
operations of the Company.
8
<PAGE>
PART I: FINANCIAL INFORMATION
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE
CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED HEREIN. THIS
QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE
MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. YOU CAN
IDENTIFY FORWARD-LOOKING STATEMENTS BY THOSE THAT ARE NOT HISTORICAL IN NATURE,
PARTICULARLY THOSE THAT USE TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD,"
"EXPECTS," "ANTICIPATES," "CONTEMPLATES," "ESTIMATES," "BELIEVES," "PLANS,"
"PROJECTED," "PREDICTS," "POTENTIAL" OR "CONTINUE" OR THE NEGATIVE OF THESE OR
SIMILAR TERMS. THESE STATEMENTS ARE SUBJECT TO CERTAIN RISKS AND UNCERTAINTIES
THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THE COMPANY'S
HISTORICAL EXPERIENCE AND ITS PRESENT EXPECTATIONS OR PROJECTIONS. IMPORTANT
FACTORS KNOWN TO SELECT COMFORT THAT COULD CAUSE SUCH MATERIAL DIFFERENCES ARE
IDENTIFIED AND DISCUSSED IN PART I, ITEM 1 OF OUR ANNUAL REPORT ON FORM 10-K FOR
THE FISCAL YEAR ENDED JANUARY 1, 2000, WHICH DISCUSSION IS INCORPORATED HEREIN
BY REFERENCE. THESE IMPORTANT FACTORS INCLUDE OUR ABILITY TO ACHIEVE THE
OBJECTIVES OF OUR STRATEGIC PLAN, THE LEVEL OF CONSUMER ACCEPTANCE OF OUR
PRODUCTS, OUR ABILITY TO CREATE PRODUCT AND BRAND NAME AWARENESS, THE
EFFECTIVENESS AND EFFICIENCY OF OUR MARKETING AND ADVERTISING PROGRAMS, THE
PERFORMANCE OF OUR EXISTING AND NEW RETAIL STORES, OUR ABILITY TO SUCCESSFULLY
IDENTIFY AND RESPOND TO EMERGING TRENDS IN THE MATTRESS INDUSTRY, THE LEVEL OF
COMPETITION IN THE MATTRESS INDUSTRY, OUR ABILITY TO MAINTAIN COST-EFFECTIVE
PRODUCTION AND DELIVERY OF PRODUCTS, CERTAIN SALES TAX CONSIDERATIONS AND
GENERAL ECONOMIC CONDITIONS AND CONSUMER CONFIDENCE.
OVERVIEW
Select Comfort is the leading vertically integrated manufacturer, specialty
retailer and direct marketer of innovative air beds and sleep-related products.
Since the introduction of our first air bed product in 1987, management has
focused on improving our product, expanding our product line, building
manufacturing and distribution systems and growing our three distribution
channels: retail, direct marketing and e-commerce. Vertically integrated
operations and control over these complementary distribution channels gives us
direct contact with our customers and gives our customers multiple opportunities
to purchase our products. Sales generation is driven primarily by targeted
print, radio, television, and internet media that generate customer inquiries,
as well as by our retail store and internet presence.
Retail operations included 338 stores at September 30, 2000, including 33 leased
departments within larger stores and 341 stores at January 1, 2000, including 45
leased departments. We opened 16 retail stores during 2000 and plan to open
approximately 3 additional retail stores for the remainder of the year. From
inception through September 30, 2000, we have closed a total of 26 stores, of
which 19 were closed in the first nine months of 2000 (7 mall based stores, 12
leased departments). During the fourth quarter of 2000, we plan to close 8
additional underperforming retail stores (all leased departments). In addition,
we have identified 6 mall based stores to be closed in the first half of 2001. A
significant portion of the costs associated with the store closings in 2000 was
accrued in 1999.
Comparable store sales growth for the three months ended September 30, 2000 and
October 2, 1999 was 3.7% and 3.6%, respectively. Comparable store sales growth
for the nine months ended September 30, 2000 and October 2, 1999 was 0.0% and
7.9%, respectively. Comparable store sales results have been and will continue
to be influenced by a variety of factors, including levels of awareness of our
products and brand name, levels of consumer acceptance of our existing and new
products, our ability to successfully introduce new products and product line
extensions, comparable store sales performance in prior periods, the maturation
of our store base, the amount, effectiveness and efficiency of retail
advertising expenditures and promotional activity, the amount of competitive
activity, our ability to effectively integrate our multiple distribution
channels, the evolution of store operations, including improvements in store
design, the quality and tenure of store-level managers and sales professionals,
and general economic conditions and consumer confidence.
Annual advertising expenditures increased from $9.0 million in 1995 to $43.4
million in 1999. Advertising costs are expensed as incurred as a component of
sales and marketing expenses, although we believe that advertising expenditures
provide significant benefits beyond the period in which they are expensed.
Future advertising expenditures will depend on the effectiveness and efficiency
of the advertising in creating awareness of our products
9
<PAGE>
and brand name, generating consumer inquiries and driving consumer traffic to
retail stores. Pre-opening costs associated with new retail stores are also
expensed as incurred.
We believe historical operating losses have been primarily the result of an
aggressive retail store opening strategy, a relatively immature store base,
significant marketing, advertising and product development expenditures, and the
development of a substantial corporate infrastructure to support anticipated
growth. Future increases in net sales and the achievement of long-term
profitability will depend upon greater consumer awareness and acceptance of our
air bed products, improved effectiveness and efficiency of our marketing and
advertising expenditures, the opening and successful performance of new retail
stores, improvement in the performance of current stores and our ability to
execute our stated strategic initiatives. There can be no assurance that we will
be able to achieve or sustain historical sales growth rates or profitability in
the future, on a quarterly or annual basis.
Quarterly and annual operating results may fluctuate significantly as a result
of a variety of factors, including increases or decreases in comparable store
sales, the timing, amount and effectiveness of advertising expenditures, any
changes in return rates, the timing of new store openings and related expenses,
competitive factors, net sales contributed by new stores, any disruptions in
third-party delivery services and general economic conditions and consumer
confidence. Our business is also subject to some seasonal influences, with
heavier concentrations of sales during the fourth quarter holiday season due to
increased mall traffic.
A substantial portion of operating expenses is related to sales and marketing
expenses, including costs associated with opening new stores, operating existing
stores and advertising expenditures. The level of this spending cannot be
adjusted quickly and is based, in significant part, on expectations of future
customer inquiries and net sales. Furthermore, a substantial portion of net
sales is often realized in the last month of a quarter with such net sales
frequently concentrated in the last weeks or days of a quarter, due in part to
our promotional schedule. Should the Company experience a shortfall in expected
net sales or in the conversion rate of customer inquiries, we may be unable to
adjust spending in a timely manner and our business, financial condition and
operating results may be materially adversely affected. Our historical results
of operations may not be indicative of the results that may be achieved for any
future fiscal period.
At September 30, 2000, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $26.3 million expiring between the
years 2003 and 2020. The Company expects that approximately $1.4 million of
these carryforwards will expire unutilized due to an Internal Revenue Code (IRC)
Section 382 limitation resulting from a prior ownership change and has,
therefore, provided a valuation allowance for this portion of the carryforwards.
The Company has not provided a valuation allowance for any other deferred tax
assets because it believes that it is more likely than not that they will be
realized.
The realization of net deferred tax assets ($17.8 million at September 30, 2000)
is evaluated on a quarterly basis. Realization of these assets is dependent on
the Company achieving profitability levels sufficient to utilize its net
operating loss carryforwards. The write-off of this asset may be required if we
determine that we are unable to utilize the net operating loss carryforwards. A
write-off of this asset could have a material adverse affect on the Company's
financial position and results of operations.
LOOKING FORWARD
We are continuing to execute our strategic plan which focuses on:
o Roll out of an integrated approach to marketing including improved marketing
messages that are consistent across our distribution channels;
o Leveraging the profitability of our sales channels, with a particular emphasis
on retail store profitability;
o Development of cost effective in-home delivery, assembly and mattress removal
across all of our distribution channels;
o Continuous improvement of our core product line;
o Launching the sofa sleeper product across all of our distribution channels;
and
o Improvement of our cost structure to more effectively leverage our
infrastructure and store base.
10
<PAGE>
During the third quarter of 2000 we introduced new integrated marketing
messages. Third quarter advertising spending did not have a significant impact
on sales volumes and, accordingly, we have reduced planned advertising for the
remainder of 2000 as we develop our fully integrated marketing messages for a
phased roll out beginning in January 2001. Marketing messages will focus on the
unique benefits provided by our products and are intended to appeal to a broader
consumer market than we have traditionally targeted. By spending advertising
more evenly over our retail markets we believe we can improve the leverage of
the largely fixed cost structure within our stores.
We are developing market by market and store by store action plans focused on
improving the profitability of our retail store operations. We closed 7 under
performing retail stores and 12 leased department locations during the first
nine months of 2000. During the fourth quarter we plan to close 8 additional
underperforming leased department locations. In addition, we have identified 6
mall based stores to be closed in the first half of 2001. A significant portion
of the costs associated with these 2000 closures was accrued in 1999. We opened
5 stores during the third quarter (a total of 16 during the first nine months of
2000) and expect to open approximately 3 stores in the remainder of 2000 in
current markets where increased store density is required to leverage
advertising expenditures.
In addition, we have developed a new retail store design with a bedroom-like
setting that is more consistent with our sleep solutions oriented brand. During
the first nine months of 2000, 66 stores were remodeled to incorporate this new
design. We are developing plans to remodel additional stores during 2001 to
incorporate this new design and to correspond to integrated marketing messages.
We have taken initial steps toward providing in-home delivery, assembly and
mattress removal throughout the continental United States. To date, in-home
delivery and assembly has been provided through our retail channel and
represents approximately 8% of our business. The provider of our in-home
assembly services discontinued this segment of its business effective August 20,
2000. We have reinitiated home delivery services in certain markets with
internal and contracted services during the third and fourth quarter of 2000. We
plan to begin testing mattress removal during the fourth quarter.
Our product development efforts will focus primarily on continuous improvement
of our products performance and value and will extend to other sleeping surfaces
to offer consumers a best nights sleep. We intend to continue to lead the
industry in innovation.
We launched our sofa sleeper product in 13 markets (49 additional stores) during
the third quarter. Our Sofa Sleepaire(R) represents a significant advancement in
the sofa sleeper market, and is attracting customers to our retail stores.
On October 16, 2000 we announced our intent to acquire certain assets of
SleepTec, Inc., the manufacturer of our sofa sleeper product. Manufacturing of
this product will be integrated into our Columbia, S.C. plant during the fourth
quarter. Administration of these operations will be absorbed into our existing
general and administrative functions. We anticipate this acquisition will have a
positive effect on operating results following the fourth quarter integration of
the SleepTec business. Once we have integrated operations and secured quality,
we plan to expand the distribution of Sofa Sleepaire(R).
Early in the third quarter, we tested a catalog through a mailing to our
installed base of customers. Based on results of this initial catalog mailing,
we will not mail a Fall catalog. However, we will continue to offer catalog
items on our new web site, and will evaluate catalog opportunities going
forward.
The success of our strategy will depend on many factors including (i) the
effectiveness and efficiency of our integrated marketing strategy in creating
awareness of our products and brand name and in generating sales, (ii) our
ability to enhance the profitability of our retail stores and leased
departments, (iii) our ability to manage operating costs, (iv) our ability to
successfully launch in-home delivery, assembly and mattress removal services
nationally on a cost-effective basis, (v) our ability to successfully launch the
sofa sleeper product nationally, (vi) the levels of consumer awareness and
acceptance of the sofa sleeper product, (vii) our ability to continue to improve
our core product line and differentiate our products from competitive products,
(viii) competition in the mattress and sofa sleeper markets, (ix) our ability to
successfully identify and respond to emerging trends in the mattress industry,
and (x) general economic factors and consumer confidence.
11
<PAGE>
The strategic initiatives described above are directed toward improving our
long-term performance and are not expected to contribute significantly to growth
in sales and earnings, and may negatively impact earnings in 2000.
12
<PAGE>
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as percentages of net sales. Percentage amounts may not
total due to rounding.
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
-------------------------- --------------------------
SEPTEMBER 30, OCTOBER 2, SEPTEMBER 30, OCTOBER 2,
2000 1999 2000 1999
------------- ----------- ------------- -----------
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 36.5 35.1 35.9 34.5
------------- ----------- ------------- -----------
Gross margin 63.5 64.9 64.1 65.5
------------- ----------- ------------- -----------
Operating expenses:
Sales and marketing 65.2 62.8 62.2 58.7
General and administrative 11.3 11.5 11.1 9.1
------------- ----------- ------------- -----------
Total operating expenses 76.5 74.4 73.3 67.8
------------- ----------- ------------- -----------
Operating loss (13.0) (9.4) (9.2) (2.4)
Other income, net 0.3 0.8 0.4 0.7
------------- ----------- ------------- -----------
Loss before income taxes (12.7) (8.6) (8.8) (1.7)
Income tax benefit (4.7) (3.2) (3.3) (0.6)
------------- ----------- ------------- -----------
Net loss (8.0)% (5.4)% (5.5)% (1.1)%
============= =========== ============= ===========
</TABLE>
COMPARISON OF THREE MONTHS ENDED SEPTEMBER 30, 2000 WITH THREE MONTHS ENDED
OCTOBER 2, 1999
NET SALES
Net sales decreased 0.3% to $68.1 million for the three months ended September
30, 2000 from $68.3 million for the three months ended October 2, 1999,
primarily due to a decrease in mattress unit sales offset by increases in
foundation and accessory units, pricing increases and product mix shift. The
decrease in net sales was due primarily to (i) a $7.3 million decrease in direct
marketing sales, (ii) a $1.5 million decrease in sales from the elimination of
our roadshow distribution channel and (iii) a $.6 million decrease due to 19
closed stores in 2000, which decreases were partially offset by (i) a $3.5
million increase from increased store months in 2000 as compared to 1999, (ii) a
$1.7 million increase in comparable store sales, (iii) a $2.1 million increase
in net sales from the Company's newly developed e-commerce channel and (iv) a
$1.4 million increase attributable to a higher per unit sales price and product
mix over 1999.
GROSS MARGIN
Gross margin decreased to 63.5% for the three months ended September 30, 2000
from 64.9% for the three months ended October 2, 1999 primarily due to the use
of higher discounted promotional offerings, increased costs of processing
returned product, partially offset by a price increase for some of our products.
SALES AND MARKETING
Sales and marketing expenses increased 3.4% to $44.4 million for the three
months ended September 30, 2000 from $42.9 million for the three months ended
October 2, 1999, and increased as a percentage of net sales to 65.2% from 62.8%
for the comparable prior-year period. The increase in the dollar amount of sales
and marketing expenses during 2000 was primarily due to (i) 25 additional retail
stores open in 2000, (ii) higher freight expenses, (iii) costs associated with
the write off of certain assets ($.7 million); and (iv) investment in marketing
and promotion of our sofa sleeper roll out ($1.9 million) partially offset by a
decrease in media spending. Sales and marketing expenses increased as a
percentage of net sales primarily due to (i) lower direct marketing sales, (ii)
selling expenses in new stores increasing at a greater rate than net sales, and
(iii) the third quarter impact of asset write offs and sofa sleeper rollout,
partially offset by a decrease in media spending.
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased 2.5% to $7.7 million for the three
months ended September 30, 2000 from $7.9 million for the three months ended
October 2, 1999. The decrease in general and administrative expenses
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was primarily due to a decrease in the use of outside services and consulting,
partially offset by the write off of certain assets ($.6 million).
OTHER INCOME, NET
Other income decreased by $342,000 to approximately $220,000 for the three
months ended September 30, 2000 from $562,000 in other income for the three
months ended October 2, 1999. The decrease was primarily due to lower cash
levels affecting interest income in 2000 following repurchases of stock and
capital expenditures in 1999 and 2000.
INCOME TAX BENEFIT
Income tax benefit increased to $3.2 million for the three months ended
September 30, 2000 from $2.2 million for the three months ended October 2, 1999
due to an increase in the pretax loss in 2000.
COMPARISON OF NINE MONTHS ENDED SEPTEMBER 30, 2000 WITH NINE MONTHS ENDED
OCTOBER 2, 1999
NET SALES
Net sales increased 0.2% to $206.0 million for the nine months ended September
30, 2000 from $205.7 million for the nine months ended October 2, 1999. The
increase in net sales was due primarily to (i) a $20.7 million increase from
increased store months in 2000 as compared to 1999 and (ii) a $6.3 million
increase in net sales from the Company's newly developed e-commerce channel,
which increases were partially offset by (i) a $19.7 million decrease in direct
marketing sales, (ii) a $5.6 million decrease in sales from the elimination of
our roadshow distribution channel, and (iii) a $1.4 decrease due to 19 store
closings in 2000.
GROSS MARGIN
Gross margin decreased to 64.1% for the nine months ended September 30, 2000
from 65.5% for the nine months ended October 2, 1999 primarily due to the use of
higher discounted promotional offerings, increased costs of processing returned
product, partially offset by a price increase for some of our products.
SALES AND MARKETING
Sales and marketing expenses increased 6.1% to $128.2 million for the nine
months ended September 30, 2000 from $120.8 million for the nine months ended
October 2, 1999, and increased as a percentage of net sales to 62.2% from 58.7%
for the comparable prior-year period. The increase in the dollar amount of sales
and marketing expenses during 2000 was primarily due to (i) 25 additional retail
stores open in 2000 and (ii) higher freight expense, (iii) costs associated with
the write off of certain assets ($.7 million) and (iv) investment in marketing
and promotion of our sofa sleeper roll out ($1.9 million) partially offset by a
decrease in media spending. Sales and marketing expenses increased as a
percentage of net sales primarily due to (i) lower direct marketing sales and
(ii) selling expenses in new stores increasing at a greater rate than net sales,
partially offset by a decrease in media spending.
GENERAL AND ADMINISTRATIVE
General and administrative expenses increased 22.3% to $22.8 million for the
nine months ended September 30, 2000 from $18.7 million for the nine months
ended October 2, 1999. The increase in general and administrative expenses was
primarily due to increased spending on infrastructure associated with
anticipated growth and approximately $1.0 million in costs associated with
staffing reductions.
OTHER INCOME, NET
Other income decreased by $606,000 to approximately $817,000 for the nine months
ended September 30, 2000 from $1.4 million in other income for the nine months
ended October 2, 1999. The decrease was primarily due to lower cash levels in
2000 following repurchases of stock and capital expenditures in 1999 and 2000.
INCOME TAX BENEFIT
Income tax benefit increased to $6.7 million for the nine months ended September
30, 2000 from $1.3 million for the nine months ended October 2, 1999 due to an
increase in the pretax loss in 2000.
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LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been the sale of equity securities. We
completed our initial public offering in December 1998, resulting in net
proceeds of $44.6 million, which have been partially used for (i) the repayment
of $15.0 million of debt, (ii) expansion of retail stores, (iii) expansion of
manufacturing capabilities, (iv) the repurchase of 1,220,000 shares of Company
common stock for $12.7 million and (v) the development of information technology
systems. The Company had negative working capital of approximately $4.0 million
at September 30, 2000, and positive working capital of $14.5 million at January
1, 2000.
Net cash used in operating activities for the nine months ended September 30,
2000 was approximately $5.6 million and consisted primarily of increases in
inventory and prepaid expenses and the net loss adjusted for non-cash expenses
partially offset by increases in accounts payable and receipt of an income tax
refund. Net cash provided by operating activities for the nine months ended
October 2, 1999 was approximately $12.5 million and consisted primarily of cash
flows from operations before non-cash expenses, decreases in accounts receivable
and increases in accounts payable partially offset by increases in inventory.
Net cash provided by investing activities was approximately $0.8 million for the
nine months ended September 30, 2000 and net cash used in investing activities
was $36.9 million for the nine months ended October 2, 1999. Investing
activities consisted of purchases of property and equipment for new retail
stores and plant additions in both periods and investments in store remodels in
2000. In addition, investments in marketable securities with maturities in
excess of 90 days increased in 1999 and decreased in 2000. Lastly, in 1999 the
Company invested $2.0 million in a minority owned affiliate.
Net cash provided by financing activities was approximately $486,000 for the
nine months ended September 30, 2000 which consisted primarily of stock option
exercises. Net cash used in financing activities for the nine months ended
October 2, 1999 was approximately $7.8 million and consisted of $10.4 million
used to repurchase Company common stock and $664,000 million used to repay debt,
offset by stock option exercises.
Financial instruments that potentially subject us to concentrations of credit
risk consist principally of investments. The counterparties to the agreements
consist of government agencies and various major corporations of high credit
standing. We do not believe there is significant risk of non-performance by
these counterparties because we limit the amount of credit exposure to any one
financial institution and any one type of investment.
We believe current plans for operating improvements, combined with existing cash
balances will be sufficient to satisfy anticipated short-term working capital
requirements. We are evaluating credit financing opportunities, in order to
ensure access to funding, if necessary to execute short and long term plans.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company holds securities classified as held to maturity. These securities
have maturities of less than one year that management has the ability and intent
to hold to maturity, are carried at amortized cost and have average interest
rates of 6.7%.
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PART II: OTHER INFORMATION
ITEM 1 - LEGAL PROCEEDINGS
The Company and certain of its former officers and directors have been
named as defendants in a consolidated class action lawsuit filed on
behalf of Company shareholders in U.S. District Court in Minnesota. The
named plaintiffs, who purport to act on behalf of a class of purchasers
of the Company's common stock during the period from December 4, 1998
to June 7, 1999, charge the defendants with violations of federal
securities laws. The suit alleges that the Company and the named
directors and officers failed to disclose or misrepresented certain
information concerning the Company during the class period. The
complaint does not specify an amount of damages claimed. The Company
believes that the complaint is without merit and intends to vigorously
defend the claims.
The Company and the individual defendants brought a motion to dismiss
all claims on November 10, 1999. The motion was heard by a magistrate
judge on December 21, 1999. On January 27, 2000, the magistrate
recommended that the claims based on Section 11 of the federal
securities laws be dismissed. The magistrate recommended that the
motion to dismiss be denied with respect to the claims based on Rule
10b-5 of the federal securities laws. In February 2000, both the
plaintiffs and the defendants formally objected to the magistrate's
recommendation. The objection was made to the United States District
Court in Minnesota. On May 12, 2000, the United States District Court
in Minnesota adopted the recommendation of the magistrate and denied
the defendants' motion to dismiss the Rule 10b-5 claims. The Court also
adopted the recommendation of the magistrate and dismissed the
plaintiff's Section 11 claims without prejudice and with leave to
amend.
On March 31, 2000, the Company and certain of its former officers and
directors were named as defendants in a class action lawsuit filed on
behalf of the Company's shareholders in U.S. District Court in
Minnesota asserting identical factual allegations as the consolidated
complaint described above. The suit alleges claims based on Sections 11
and 12(a)(2) of the federal securities laws. The complaint does not
specify an amount of damages claimed. The Company believes this
complaint is without merit and intends to vigorously defend the claims.
The above two class actions were consolidated by the United States
District Court Magistrate on July 24, 2000.
The Company is subject to various other claims, legal actions, sales
tax disputes and other complaints arising in the ordinary course of
business. In the opinion of management, any losses that may occur from
these other matters are adequately covered by insurance or are provided
for in the consolidated financial statements, and the ultimate outcome
of these other matters will not have a material effect on the
consolidated financial position or results of operations of the
Company.
ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3 - DEFAULTS UPON SENIOR SECURITIES
Not applicable.
ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
ITEM 5 - OTHER INFORMATION
William J. Lansing tendered his resignation from the Board of Directors
of the Company effective as of August 14, 2000 in order to devote more
of his time to other business interests. The Board of Directors
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and management of the Company express their gratitude to Mr. Lansing for
his service to the Company as a member of our Board of Directors.
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
--------
Exhibit
Number Description
--------- --------------
27.1 Financial Data Schedule
(b) Reports on Form 8-K
-------------------
None.
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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
November 14, 2000 /s/ William R. McLaughlin
----------------------------------------
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)
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EXHIBIT INDEX
Exhibit Number Description Location
---------------- ------------- -----------
27.1 Financial Data Schedule Filed herewith electronically
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