-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, G1CZZWSUATN/fOfzA6DpfgZTIa+DwkHka8bB3guAYn3HlGVzeurOJW/k+A4rcl/e 1cUjKqQjqF9Fq+EkXmYGxw== 0000827187-03-000013.txt : 20030509 0000827187-03-000013.hdr.sgml : 20030509 20030509172639 ACCESSION NUMBER: 0000827187-03-000013 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20030329 FILED AS OF DATE: 20030509 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SELECT COMFORT CORP CENTRAL INDEX KEY: 0000827187 STANDARD INDUSTRIAL CLASSIFICATION: HOUSEHOLD FURNITURE [2510] IRS NUMBER: 410157886 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-25121 FILM NUMBER: 03691119 BUSINESS ADDRESS: STREET 1: 6105 TRENTON LANE NORTH CITY: MINNEAPOLIS STATE: MN ZIP: 55442 BUSINESS PHONE: 7635517000 10-Q 1 a2003_1stqtr10q.txt 2003 1ST QUARTER 10-Q 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 March 29, 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 March 29, 2003, 30,875,904 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 March 29, 2003 and December 28, 2002............................... 3 Consolidated Statements of Operations for the Three Months ended March 29, 2003 and March 30, 2002................................................. 4 Consolidated Statements of Cash Flows for the Three Months ended March 29, 2003 and March 30, 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......... 14 Item 4. Disclosure Controls and Procedures................................. 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................................................ 15 Item 6. Exhibits and Reports on Form 8-K................................. 16 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) MARCH 29, DECEMBER 28, 2003 2002 ------------- ------------- ASSETS Current assets: Cash and cash equivalents $ 26,552 $ 27,176 Marketable securities - current (note 2) 14,306 12,146 Accounts receivable, net of allowance for doubtful accounts of $367 and $340 3,215 3,270 Inventories (note 3) 9,345 8,980 Prepaid expenses 5,866 5,467 Deferred tax assets 10,235 12,955 ------------- ------------- Total current assets 69,519 69,994 Marketable securities - non-current (note 2) 4,828 1,502 Property and equipment, net 31,225 28,977 Deferred tax assets 4,774 4,352 Other assets 3,469 3,506 ------------- ------------- Total assets $113,815 $108,331 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 1 $ 11 Accounts payable 21,333 16,508 Accruals: Sales returns 3,296 3,181 Compensation and benefits 7,968 13,666 Taxes and withholding 2,920 2,779 Customer prepayments 5,341 1,964 Other 5,085 5,120 ------------- ------------- Total current liabilities 45,944 43,229 Long-term debt, less current maturities 3,077 2,991 Accrued warranty costs 3,533 3,626 Other liabilities 3,931 3,970 ------------- ------------- Total liabilities 56,485 53,816 ------------- ------------- Shareholders' equity (notes 4 and 6): Undesignated preferred stock; 5,000,000 shares authorized, no shares issued and outstanding - - Common stock, $.01 par value; 95,000,000 shares authorized, 30,875,904 and 30,727,101 shares issued and outstanding, 309 307 respectively Additional paid-in capital 90,869 92,184 Accumulated deficit (33,848) (37,976) ------------- ------------- Total shareholders' equity 57,330 54,515 ------------- ------------- Total liabilities and shareholders' equity $113,815 $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 ---------------------------- MARCH 29, MARCH 30, 2003 2002 ------------- ------------- Net sales $101,958 $ 81,195 Cost of sales 38,057 30,957 ------------- ------------- Gross profit 63,901 50,238 ------------- ------------- Operating expenses: Sales and marketing 48,917 39,608 General and administrative 8,301 7,209 Store closings and asset impairments 74 52 ------------- ------------- Total operating expenses 57,292 46,869 ------------- ------------- Operating income 6,609 3,369 ------------- ------------- Other income (expense): Interest income 113 67 Interest expense (88) (586) Other, net 24 46 ------------- ------------- Other income (expense), net 49 (473) ------------- ------------- Income before income taxes 6,658 2,896 Income tax expense (benefit) 2,530 (348) ------------- ------------- Net income $ 4,128 $ 3,244 ============= ============= Net income per share (note 4 and 5) - basic $ 0.13 $ 0.18 ============= ============= Weighted average shares - basic 30,880 18,386 ============= ============= Net income per share (note 4 and 5) - diluted $ 0.11 $ 0.11 ============= ============= Weighted average shares - diluted 37,173 33,059 ============= ============= See accompanying notes to consolidated financial statements. 4 SELECT COMFORT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) THREE MONTHS ENDED ---------------------------- MARCH 29, MARCH 30, 2003 2002 ------------- ------------- Cash flows from operating activities: Net income $ 4,128 $ 3,244 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization 2,426 2,169 Amortization of debt discount and deferred finance fees 86 216 Loss on disposal of assets 74 56 Deferred tax benefit 2,298 - Change in operating assets and liabilities: Accounts receivable, net 55 1,564 Inventories (365) (803) Prepaid expenses (399) (144) Other assets 29 (3) Accounts payable 4,825 3,373 Accrued compensation and benefits (5,698) (1,282) Other accruals and liabilities 3,466 2,163 ------------- ------------- Net cash provided by operating activities 10,925 10,553 ------------- ------------- Cash flows from investing activities: Purchases of property and equipment (4,740) (1,367) Investments in marketable securities (17,803) (5,557) Proceeds from maturity of marketable securities 12,317 - ------------- ------------- Net cash used in investing activities (10,226) (6,924) ------------- ------------- Cash flows from financing activities: Principal payments on debt (10) (11) Repurchase of common stock (1,834) - Proceeds from issuance of common stock 521 93 ------------- ------------- Net cash (used in) provided by financing activities (1,323) 82 ------------- ------------- (Decrease) increase in cash and cash equivalents (624) 3,711 Cash and cash equivalents, at beginning of period 27,176 16,375 ------------- ------------- Cash and cash equivalents, at end of period $26,552 $20,086 ============= =============
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 ended March 29, 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 March 29, 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 16 months with an average time to maturity of 8 months as of March 29, 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 March 29, 2003 carried an amortized cost of $19.1 million and a fair value of $19.2 million. (3) INVENTORIES Inventories consist of the following (in thousands): MARCH 29, DECEMBER 28, 2003 2002 -------------- -------------- Raw materials $2,668 $2,669 Work in progress 50 88 Finished goods 6,627 6,223 -------------- -------------- $9,345 $8,980 ============== ============== 6 SELECT COMFORT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) 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 ------------------------------ WEIGHTED PER MARCH 29, 2003 NET AVERAGE SHARE INCOME SHARES AMOUNT ---------- --------- --------- Net income $ 4,128 ---------- BASIC EPS Net income available to common shareholders 4,128 30,880 $ 0.13 ========= EFFECT OF DILUTIVE SECURITIES Options - 2,932 Common stock warrants - 2,634 Convertible debt 54 727 ---------- --------- DILUTED EPS Net income available to common shareholders plus assumed conversions $ 4,182 37,173 $ 0.11 ========== ========= ========= THREE MONTHS ENDED ------------------------------ WEIGHTED PER MARCH 30, 2002 NET AVERAGE SHARE INCOME SHARES AMOUNT ---------- --------- --------- Net income $ 3,244 ---------- BASIC EPS Net income available to common shareholders 3,244 18,386 $ 0.18 ========= EFFECT OF DILUTIVE SECURITIES Options - 1,256 Common stock warrants - 2,417 Convertible debt 309 11,000 ---------- --------- DILUTED EPS Net income available to common shareholders plus assumed conversions $ 3,553 33,059 $ 0.11 ========== ========= ========= Additional potentially dilutive securities ("securities") totaling 708,000 for the three month period ending March 29, 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 (5) PRO FORMA NET INCOME The Company's net income and earnings per share under Generally Accepted Accounting Principles (GAAP) for 2003 should be compared to 2002 net income and earnings per share on a pro forma, after-tax basis to improve comparability between the periods. GAAP did not allow the Company to reduce its earnings for income tax expense in 2002, while 2003 results reflect a reduction in earnings for income taxes. A reconciliation of net income and diluted earnings per share (as determined in accordance with GAAP) to pro forma net income and diluted earnings per share is as follows: THREE MONTHS ENDED MARCH 30, 2002 --------------- RECONCILIATION OF GAAP NET INCOME AND PRO FORMA NET INCOME: GAAP net income $ 3,244 Income taxes - adjusted to 38% effective rate (1,448) --------------- Pro forma net income $ 1,796 =============== THREE MONTHS ENDED MARCH 30, 2002 --------------- RECONCILIATION OF GAAP DILUTED EARNINGS PER SHARE TO PRO FORMA DILUTED EARNINGS PER SHARE: GAAP diluted earnings per share $ .11 Effect of income taxes at 38% (.05) --------------- Pro forma diluted earnings per share $ .06 =============== (6) STOCK OPTION VALUATION 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. Had the Company determined compensation cost based on the fair value at the grant date for its stock options and employee stock purchase plan under an alternative accounting method, the Company's net income would have been adjusted as outlined below (in thousands, except per share amounts): THREE MONTHS ENDED ------------------------- MARCH 29, MARCH 30, 2003 2002 ------------------------- Net income:.....................As reported $ 4,128 $ 3,244 Pro forma 3,498 2,476 Income per share -- basic:......As reported 0.13 0.18 Pro forma 0.11 0.13 Income per share -- diluted:....As reported 0.11 0.11 Pro forma 0.10 0.08 The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions: THREE MONTHS ENDED ------------------------- MARCH 29, MARCH 30, 2003 2002 ------------------------- Expected dividend yield 0% 0% Expected stock price volatility 90% 90% Risk-free interest rate 2.0% 2.0% Expected life in years 3.6 3.6 Weighted-average fair value at grant date $ 5.66 $ 1.73 8 SELECT COMFORT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (7) LITIGATION In June 1999, the Company and certain of its former officers and directors were named as defendants in a class action lawsuit filed in U.S. District Court in Minnesota. The suit, filed on behalf of purchasers of the Company's common stock between December 4, 1998 and June 7, 1999, alleges that the Company and the named former directors and officers failed to disclose or misrepresented certain information concerning the Company in violation of federal securities laws. The Company believes that the suit is without merit and has vigorously defended the matter. The Company consented to a settlement of this litigation negotiated by the Company's insurance carrier. The settlement is covered by insurance and involves no cash or other payment obligation by the Company and no admission of liability or wrongdoing by the Company. The settlement did not have any impact on the Company's results of operations or financial condition. On February 28, 2003, the settlement agreement received final approval from the U.S. District Court for the District of Minnesota, resulting in the dismissal with prejudice of the plaintiffs' complaint. The Company is involved in other various claims and legal actions 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) RISKS AND UNCERTAINTIES Our qualified customers are offered a revolving credit arrangement to finance purchases from us through a private label consumer credit facility provided by Mill Creek Bank, a subsidiary of Conseco Finance Corp. Conseco Finance Corp. has recently experienced financial and liquidity issues and has filed for protection under federal bankruptcy laws. Through its pending bankruptcy proceedings, Conseco Finance Corp. entered into an asset purchase agreement to sell its business and operating assets, including various assets of Mill Creek Bank. Under the terms of this agreement, our agreement with Mill Creek Bank would be sold to General Electric Capital Corporation, a competitor of Mill Creek Bank. This sale, which is subject to various closing conditions, is expected to close in the next several months. In the event this sale does not close as anticipated, the financial and liquidity issues being encountered by Conseco Finance Corp. could jeopardize the ability of Mill Creek Bank to continue to provide consumer credit financing for our customers. In that event, we would seek to secure consumer credit financing from other sources, but it may not be possible to secure such arrangements without some delay or on the same or better terms than have been available from Mill Creek Bank. Termination of our agreement with Mill Creek Bank, any material change to the terms of our agreement with Mill Creek Bank or in the availability or terms of credit for our customers from Mill Creek Bank or any delay in securing replacement credit sources, could harm our sales. 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 CONSUMER CONFIDENCE AND SPENDING, o THE EFFECTIVENESS AND EFFICIENCY OF OUR ADVERTISING AND PROMOTIONAL EFFORTS, o ADVERTISING RATES, o CONSUMER ACCEPTANCE OF OUR PRODUCTS AND SLEEP TECHNOLOGY, o INDUSTRY COMPETITION, o OUR DEPENDENCE ON SIGNIFICANT SUPPLIERS OR SINGLE SOURCES OF SUPPLY, 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 in 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 CHANNEL SALES. The proportion of our total net sales, by dollar volume, from each of these channels is summarized as follows: Three Months Ended -------------------- 3/29/03 3/30/02 --------- --------- Stores 79% 75% Direct Call Center 14% 15% E-commerce 4% 4% Wholesale 3% 6% The number of company-operated retail locations is summarized as follows: Three Months Ended -------------------- 3/29/03 3/30/02 --------- --------- Beginning of period 322 328 Opened 2 1 Closed (1) (5) --------- --------- End of period 323 324 ========= ========= We anticipate opening 20 to 30 new retail stores and closing three to five stores during the remainder of 2003. We remodeled 45 stores in the first quarter of 2003 and anticipate remodeling approximately 60 more stores throughout the balance of the year. Company-operated stores included leased departments within 13 Bed, Bath & Beyond stores as of March 29, 2003 and 20 at March 30, 2002. Comparable store sales, including remodeled stores as noted above, increased over prior year, for the three months ended March 29, 2003 and March 30, 2002 by 30% and 15%, 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 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 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. 11 STORE CLOSING AND ASSET IMPAIRMENT EXPENSES 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 ----------------------------- MARCH 29, MARCH 30, 2003 2002 -------------- -------------- Net sales 100.0% 100.0% Cost of sales 37.3 38.1 -------------- -------------- Gross profit 62.7 61.9 -------------- -------------- Operating expenses: Sales and marketing 48.0 48.8 General and administrative 8.1 8.9 Store closings and asset impairments 0.1 0.1 -------------- -------------- Total operating expenses 56.2 57.8 -------------- -------------- Operating income 6.5 4.1 Other expense, net 0.0 (0.6) -------------- -------------- Income before income taxes 6.5 3.6 Income tax (expense) benefit (2.5) 0.4 -------------- -------------- Net income 4.0% 4.0% ============== ============== COMPARISON OF THREE MONTHS ENDED MARCH 29, 2003 WITH THREE MONTHS ENDED MARCH 30, 2002 NET SALES Net sales increased 26% to $102.0 million for the three months ended March 29, 2003 from $81.2 million for the three months ended March 30, 2002, due to higher average selling prices resulting primarily from improvements in product mix and lower return rates and a 15% increase in Company-controlled channel mattress unit sales, partially offset by a 36% decrease in mattress unit sales in the wholesale channel due to quarterly timing of QVC shows. In total, mattress unit sales increased 10% for the three months ended March 29, 2003. The increase in net sales by sales channel was attributable to (i) a $19.4 million increase in sales from Company-controlled retail stores, including an increase in comparable store sales of $18.0 million, (ii) a $1.6 million increase in direct marketing sales and (iii) a $0.9 million increase in sales through the Company's e-commerce channel, offset by a decrease of $1.1 million in sales from the Company's wholesale channel. GROSS PROFIT Gross profit increased to 62.7% for the three months ended March 29, 2003 from 61.9% for the three months ended March 30, 2002, primarily due to improved sales channel mix and improved product mix. 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 23% to $48.9 million for the three months ended March 29, 2003 from $39.6 million for the three months ended March 30, 2002 but decreased as a 12 percentage of net sales to 48.0% from 48.8% for the comparable prior-year period. The increase was primarily due to additional media investments, sales-based incentive compensation, and increased 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 $8.3 million for the three months ended March 29, 2003 from $7.2 million for the three months ended March 30, 2002 but decreased as a percentage of net sales to 8.1% from 8.9% for the prior-year period. The increase in general and administrative expenses was due primarily to additional headcount, and accrued incentive compensation as a result of Company performance. 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 increased $22,000 to $74,000 for the three months ended March 29, 2003 from $52,000 for the three months ended March 30, 2002. In 2003, the entire $74,000 represents store impairment charges. OTHER INCOME (EXPENSE), NET Other income (expense) changed $522,000 to income of $49,000 for the three months ended March 29, 2003 from an expense of $473,000 for the three months ended March 30, 2002. The improvement is primarily due to reduced interest expense following 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 $2.5 million for the three months ended March 29, 2003 from a $0.3 million income tax benefit for the three months ended March 30, 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 March 30, 2002. LIQUIDITY AND CAPITAL RESOURCES We generated cash from operations of $10.9 million in the first three 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 are currently pursuing a new 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 would 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 three months ended March 29, 2003 was $10.9 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. Accounts payable increased as a result of timing and the additional commitments made to advertising in 2003. 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 quarter. Net cash provided by operating activities for the three months ended March 30, 2002 was $10.6 million and consisted primarily of net income adjusted for non-cash expenses, increases in accounts payable and other accrued liabilities and decreases in accounts receivable, partially offset by decreases in accrued compensation and benefits and increases in inventories. The decrease in our accounts receivable and increase in accounts payable and inventory is primarily a function of the timing and size of QVC shows. The decrease in accrued compensation is a result of annual incentive compensation payments made during the quarter. Net cash used in investing activities was $10.2 million for the three months ended March 29, 2003. Investing activities consisted primarily of investments in marketable securities and purchases of property and equipment for 45 remodeled and 2 new retail stores, and development costs for information technology systems for the three months ended March 29, 2003. In 2003, we made net investments in marketable securities of $5.5 million. The net cash used in investing activities for the three months ended March 30, 2002 was $6.9 million. In 2002 we invested in $5.6 million of marketable securities, and we also invested $1.4 million in purchases of property and equipment. In 13 the remaining nine months of 2003, we expect to open 20 to 30 new retail stores and to remodel approximately 60 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. Net cash used in financing activities was $1.3 million for the three months ended March 29, 2003 primarily from the repurchase of common stock. Net cash provided by financing activities for the three months ended March 30, 2002 was $82,000. 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. (a) Within 90 days prior to the filing of this Quarterly Report on Form 10-Q, the Company's President and Chief Executive Officer ("CEO") and the Company's Chief Financial Officer ("CFO") carried out an evaluation of the effectiveness of the Company's disclosure controls and procedures. Based upon this evaluation, the CEO and CFO concluded that the Company's disclosure controls and procedures are effective in: o accumulating and communicating information to the Company's management, including the CEO and CFO, to allow timely decisions regarding required disclosure; and o recording, processing, summarizing and reporting information required to be included in the Company's periodic reports filed with the SEC in a timely manner. (b) There were no significant changes in the Company's internal controls or in other factors that could significantly affect internal controls subsequent to the date of the evaluation described above. 14 PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS In June 1999, the Company and certain of its former officers and directors were named as defendants in a class action lawsuit filed in U.S. District Court in Minnesota. The suit, filed on behalf of purchasers of the Company's common stock between December 4, 1998 and June 7, 1999, alleges that the Company and the named former directors and officers failed to disclose or misrepresented certain information concerning the Company in violation of federal securities laws. The Company believes that the suit is without merit and has vigorously defended the matter. The Company consented to a settlement of this litigation negotiated by the Company's insurance carrier. The settlement is covered by insurance and involves no cash or other payment obligation by the Company and no admission of liability or wrongdoing by the Company. The settlement did not have any impact on the Company's results of operations or financial condition. On February 28, 2003, the settlement agreement received final approval from the U.S. District Court for the District of Minnesota, resulting in the dismissal with prejudice of the plaintiffs' complaint. The Company is involved in other various claims and legal actions 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 Not applicable. 15 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS. EXHIBIT NUMBER DESCRIPTION ------- ----------- 99.1 Certification 99.2 Certification (b) REPORTS ON FORM 8-K During the quarter ended March 29, 2003, the Company filed five Current Reports on Form 8-K. The Reports consisted of the following: (i) Current Report furnished under Item 9 of Form 8-K on January 8, 2003, announcing net sales for the fourth quarter and full year ended December 28, 2002. (ii) Current Report furnished under Item 9 of Form 8-K on February 4, 2003, announcing comments on results for the fourth quarter and year-ended December 28, 2002 and earnings guidance for first quarter 2003. (iii)Current Report furnished under Item 9 of Form 8-K on February 21, 2003, announcing election of Michael Peel to the board of directors. (iv) Current Report furnished under Item 9 of Form 8-K on February 27, 2003, announcing stock repurchase program and earnings guidance for 2003. (v) Current Report furnished under Item 9 of Form 8-K on February 27, 2003, announcing registered offering by its selling shareholders. 16 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 ------------------------------------------- May 9, 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) 17 Certification by Chief Executive Officer I, William R. McLaughlin, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Select Comfort Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 9, 2003 /s/William R. McLaughlin ---------------------------------------- William R. McLaughlin President and Chief Executive Officer 18 Certification by Chief Financial Officer I, James C. Raabe, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Select Comfort Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: May 9, 2003 /s/James C. Raabe ---------------------------------------- James C. Raabe Senior Vice President and Chief Financial Officer 19 EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION LOCATION -------------- ----------- -------- 99.1 Certification........................ Filed herewith. 99.2 Certification........................ Filed herewith. 20 Exhibit 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. ss.1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Select Comfort Corporation (the "Company") on Form 10-Q for the period ended March 29, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, William R. McLaughlin, Chief Executive Officer of the Company, solely for the purposes of 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, does hereby certify that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/William R. McLaughlin ---------------------------- William R. McLaughlin Chief Executive Officer May 9, 2003 21 Exhibit 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. ss.1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Select Comfort Corporation (the "Company") on Form 10-Q for the period ended March 29, 2003 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), the undersigned, James C. Raabe, Chief Financial Officer of the Company, solely for the purposes of 18 U.S.C. ss.1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, does hereby certify that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. /s/James C. Raabe ---------------------------- James C. Raabe Chief Financial Officer May 9, 2003 22 -----END PRIVACY-ENHANCED MESSAGE-----