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 31, 2001 COMMISSION FILE NO. 0-25121 -------------------- SELECT COMFORT CORPORATION (Exact name of registrant as specified in its charter) MINNESOTA 41-1597886 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 6105 TRENTON LANE NORTH MINNEAPOLIS, MINNESOTA 55442 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (763) 551-7000 Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ] As of March 31, 2001, 18,055,633 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 31, 2001 and December 30, 2000................................ 3 Consolidated Statements of Operations for the Three Months ended March 31, 2001 and April 1, 2000................................................... 4 Consolidated Statements of Cash Flows for the Three Months ended March 31, 2001 and April 1, 2000................................................... 5 Notes to Consolidated Financial Statements.......................... 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations....................... 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk.......... 13 PART II: OTHER INFORMATION Item 1. Legal Proceedings................................................. 14 Item 2. Changes in Securities and Use of Proceeds......................... 14 Item 3. Defaults Upon Senior Securities................................... 14 Item 4. Submission of Matters to a Vote of Security Holders............... 14 Item 5. Other Information................................................. 15 Item 6. Exhibits and Reports on Form 8-K.................................. 15
PART I: FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS <TABLE> SELECT COMFORT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) <CAPTION> (UNAUDITED) MARCH 31, DECEMBER 30, ASSETS 2001 2000 ------------- ------------- <S> <C> <C> Current assets: Cash and cash equivalents $ 4,532 $ 1,498 Marketable securities - 3,950 Accounts receivable, net of allowance for doubtful accounts of $283, and $264, respectively 1,376 2,693 Inventories (note 2) 9,701 11,083 Prepaid expenses 5,343 4,741 ------------- ------------- Total current assets 20,952 23,965 Property and equipment, net 35,609 37,063 Other assets 3,685 3,644 ------------- ------------- Total assets $ 60,246 $ 64,672 ============= ============= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $ 38 $ 38 Accounts payable 21,993 17,271 Accruals: Sales returns 4,887 5,284 Warranty costs 7,368 7,181 Compensation, taxes and benefits 6,501 6,238 Other 6,407 6,129 ------------- ------------- Total current liabilities 47,194 42,141 Long-term debt, less current maturities 2,409 2,322 Other liabilities 3,774 3,609 ------------- ------------- Total liabilities 53,377 48,072 ------------- ------------- Shareholders' equity: Undesignated preferred stock; 5,000,000 shares authorized, no shares issued and outstanding - - Common stock, $.01 par value; 95,000,000 shares authorized, 18,055,633 and 17,962,689 shares issued and outstanding, 181 180 respectively Additional paid-in capital 79,548 79,452 Accumulated deficit (72,860) (63,032) ------------- ------------- Total shareholders' equity 6,869 16,600 ------------- ------------- Total liabilities and shareholders' equity $ 60,246 $ 64,672 ============= ============= </TABLE> 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 31, APRIL 1, 2001 2000 ---------- ---------- Net sales $ 65,456 $ 76,159 Cost of sales 23,611 27,146 ---------- ---------- Gross margin 41,845 49,013 ---------- ---------- Operating expenses: Sales and marketing 44,174 45,273 General and administrative 7,013 8,520 Store closings/asset impairments 346 - ---------- ---------- Total operating expenses 51,533 53,793 ---------- ---------- Operating loss (9,688) (4,780) ---------- ---------- Other income (expense): Interest income 75 375 Interest expense (98) (2) Equity in loss of affiliate - (182) Other, net (2) (43) ---------- ---------- Other income (expense), net (25) 148 ---------- ---------- Loss before income taxes (9,713) (4,632) Income tax expense (benefit) 115 (1,634) ---------- ---------- Net loss $ (9,828) $ (2,998) ========== ========== Net loss per share (note 3) - basic and diluted $ (0.54) $ (0.17) ========== ========== Weighted average shares - basic and diluted 18,056 17,753 ========== ========== 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 31, APRIL 1, 2001 2000 ----------- ----------- Cash flows from operating activities: Net loss $(9,828) $(2,998) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 2,484 2,046 Loss on disposal of assets 347 69 Deferred tax assets - (1,667) Change in operating assets and liabilities: Accounts receivable, net 1,411 444 Inventories 1,382 (317) Prepaid expenses (602) 128 Income taxes - 2,188 Accounts payable 4,722 523 Accrued sales returns (397) 550 Accrued warranty costs 187 859 Accrued compensation, taxes and benefits 263 (69) Other accrued liabilities 278 194 Other assets (120) 190 Other liabilities 165 345 ----------- ----------- Net cash provided by operating activities 292 2,485 ----------- ----------- Cash flows from investing activities: Purchases of property and equipment (1,296) (3,467) Sales of (investment in) marketable securities 3,950 (1,983) ----------- ----------- Net cash provided by (used in) investing activities 2,654 (5,450) ----------- ----------- Cash flows from financing activities: Principal payments on debt (9) (32) Proceeds from issuance of common stock 97 248 ----------- ----------- Net cash provided by financing activities 88 216 ----------- ----------- Increase (decrease) in cash and cash equivalents 3,034 (2,749) Cash and cash equivalents, at beginning of period 1,498 7,441 ----------- ----------- Cash and cash equivalents, at end of period $ 4,532 $ 4,692 =========== =========== 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 31, 2001 and April 1, 2000 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 31, 2001 and December 30, 2000 and the results of operations and cash flow for the periods presented. The consolidated financial statements have been prepared on a going-concern basis, which contemplates the realization of assets and the satisfaction of liabilities and other commitments in the normal course of business. These financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts or the amounts and classification of liabilities that might be necessary if the Company is unable to continue as a going concern. The Company's continuation as a going concern is dependent, among other things, upon obtaining positive cash flow from operations or upon its ability to raise additional working capital. 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 30, 2000. Operating results for the Company on a quarterly basis may not be indicative of operating results for the full year. (2) INVENTORIES Inventories consist of the following (in thousands): MARCH 31, DECEMBER 30, 2001 2000 ------------- ------------- Raw materials $4,693 $ 5,507 Work in progress 46 60 Finished goods 4,962 5,516 ------------- ------------- $9,701 $11,083 ============= ============= (3) 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> NET PER SHARE THREE MONTHS ENDED MARCH 31, 2001 LOSS SHARES AMOUNT --------------------------------- ----------- ----------- ------------ <S> <C> <C> <C> Net loss $(9,828) ----------- BASIC AND DILUTED EPS Net loss attributable to common shareholders $(9,828) 18,056 $(0.54) =========== =========== ============= </TABLE> <TABLE> NET PER SHARE THREE MONTHS ENDED APRIL 1, 2000 LOSS SHARES AMOUNT -------------------------------- ----------- ----------- ------------ <S> <C> <C> <C> Net loss $(2,998) ----------- BASIC AND DILUTED EPS Net loss attributable to common shareholders $(2,998) 17,753 $(0.17) =========== =========== ============= </TABLE> 6
SELECT COMFORT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) LITIGATION The Company and certain of its former officers and directors have been named as defendants in a class action lawsuit filed on June 1, 1999, 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. On January 30, 2001, the plaintiffs made a motion to certify a class. The class certification motion is pending. Discovery relative to this motion has begun. The Company is a party to other various claims, legal actions, sales tax disputes, and other complaints arising in the ordinary course of business. In the opinion of management, any losses that may occur from these other matters are adequately covered by insurance or are provided for in the consolidated financial statements and the ultimate outcome of these other matters will not have a material effect on the consolidated financial position or results of operations of the Company. 7
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," "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 DECEMBER 30, 2000, WHICH DISCUSSION IS INCORPORATED HEREIN BY REFERENCE. THESE IMPORTANT FACTORS INCLUDE: o OUR ABILITY TO SECURE DEBT OR EQUITY FINANCING TO SUPPORT WORKING CAPITAL NEEDS AND GROWTH INITIATIVES; o OUR ABILITY TO SUCCESSFULLY EXECUTE OUR STRATEGIC INITIATIVES; o THE EFFICIENCY AND EFFECTIVENESS OF OUR SLEEP NUMBER CAMPAIGN AND OTHER MARKETING PROGRAMS IN BUILDING PRODUCT AND BRAND AWARENESS, DRIVING TRAFFIC TO OUR POINTS OF SALE AND IN INCREASING SALES; o THE LEVEL OF CONSUMER ACCEPTANCE OF OUR PRODUCTS; o OUR ABILITY TO FULLY EXECUTE AND REALIZE THE BENEFITS OF OUR COST SAVINGS INITIATIVES; o OUR ABILITY TO COST-EFFECTIVELY SELL OUR PRODUCTS THROUGH WHOLESALE OR ALTERNATIVE DISTRIBUTION CHANNELS IN VOLUMES SUFFICIENT TO DRIVE GROWTH AND LEVERAGE OUR COST STRUCTURE AND ADVERTISING SPENDING; o OUR ABILITY TO CONTINUOUSLY IMPROVE OUR PRODUCTS TO ACHIEVE NEW AND ENHANCED CONSUMER BENEFITS, BETTER QUALITY AND REDUCED COSTS; o OUR ABILITY TO REALIZE INCREASED SALES AND GREATER LEVELS OF PROFITABILITY THROUGH OUR RETAIL STORES; o OUR ABILITY TO COST-EFFECTIVELY CLOSE ADDITIONAL UNDERPERFORMING OR UNPROFITABLE STORE LOCATIONS, OR TO NEGOTIATE RENT CONCESSIONS; o OUR ABILITY TO HIRE, TRAIN, MANAGE AND RETAIN QUALIFIED RETAIL STORE MANAGEMENT AND SALES PROFESSIONALS; o OUR ABILITY TO MAINTAIN COST-EFFECTIVE PRODUCTION AND DELIVERY OF OUR PRODUCTS; o OUR ABILITY TO SUCCESSFULLY EXPAND OUR HOME DELIVERY, ASSEMBLY AND MATTRESS REMOVAL CAPABILITY ON A COST-EFFECTIVE BASIS, AND THE ABILITY OF VARIOUS THIRD-PARTY PROVIDERS OF DELIVERY, ASSEMBLY AND MATTRESS REMOVAL SERVICES TO PROVIDE QUALITY SERVICES ON A COST-EFFECTIVE BASIS; o OUR ABILITY TO SUCCESSFULLY IDENTIFY AND RESPOND TO EMERGING TRENDS IN THE MATTRESS INDUSTRY; o THE LEVEL OF COMPETITION IN THE MATTRESS INDUSTRY; AND o GENERAL ECONOMIC CONDITIONS AND CONSUMER CONFIDENCE. OVERVIEW Select Comfort is the leading manufacturer, specialty retailer and direct marketer of premium quality innovative adjustable-firmness beds and sleep-related products. Since the introduction of our first air bed product in 1987, we have 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 326 stores at March 31, 2001, including 24 leased departments within larger stores, and 333 stores at December 30, 2000, including 25 leased departments. We have opened two retail stores during 2001 and plan to open approximately 11 additional retail stores during the remainder of 2001. During 2000 we closed 27 stores. In the first quarter of 2001 we closed nine stores and plan to close approximately five additional underperforming retail stores throughout the balance of 2001. The majority of the costs associated with these closings were accrued in 2000. Comparable store sales growth for the three months ended March 31, 2001 and April 1, 2000 was (6.5)% and 0.2%, respectively. Comparable store sales results have been and will continue to be influenced by a variety of factors, including levels of consumer awareness of our products, brand name and store locations, levels of consumer 8
acceptance of our existing and new products, higher levels of sales in the first year of operations as each successive class of new stores is opened, comparable store sales performance in prior periods, the maturation of our store base, the amount, timing and relative success of promotional events, advertising expenditures, new product introductions and product line extensions, the quality and tenure of store-level managers and sales professionals, the amount of competitive activity, the evolution of store operations, changes in the sales mix between our distribution channels, and general economic conditions and consumer confidence. Advertising expenditures were $33.4 million, $43.4 million and $31.6 million in 2000, 1999 and 1998, respectively. 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 and brand name, generating consumer inquiries and driving consumer traffic to retail stores. We anticipate that advertising spend levels in 2001 will approximate those of 2000. 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 future growth. Future increases in net sales and the achievement of long-term profitability will depend upon greater consumer awareness and acceptance of our adjustable-firmness bed products, improved effectiveness and efficiency of our marketing and advertising expenditures, the opening and successful performance of new points of distribution, improvement in the performance of current stores and our ability to realize the benefits of our cost saving initiatives. There can be no assurance that we will be able to achieve or sustain historical sales growth rates, or to achieve 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 lower seasonal sales in the second quarter and 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 such spending cannot be adjusted quickly and is based, in significant part, on expectations of future customer inquiries and net sales. Furthermore, a substantial portion of net sales is often realized in the last month of a quarter with such net sales frequently concentrated in the last weeks or days of a quarter, due in part to our promotional schedule. Should the Company experience a shortfall in expected net sales or in the conversion rate of customer inquiries, we may be unable to adjust spending in a timely manner and our business, financial condition and operating results may be materially adversely affected. Our historical results of operations may not be indicative of the results that may be achieved for any future fiscal period. At March 31, 2001, we had net operating loss carryforwards ("NOLs") for federal income tax purposes of approximately $41.3 million expiring between the years 2003 and 2021. We expect that approximately $1.4 million of these NOLs will expire unutilized due to an Internal Revenue Code (IRC) Section 382 limitation resulting from a prior ownership change. 9
FIRST QUARTER RESULTS Net sales during the first quarter of 2001 were $65.5 million, or 14.1% lower than the prior year. Lower sales volumes were due primarily to two factors: o Slowing economic conditions reflected in consumer confidence measures and lower volumes of mall traffic. o Our lower levels of advertising spend entering 2001 as compared to 2000. Advertising during 2000 totaled $33.4 million, or 23% lower than 1999. Net loss from operations for the first quarter of 2001 totaled $9.7 million as compared to a net loss from operations of $4.8 million for the first quarter of 2000. Profitability levels have been impacted by the following factors: o Lower sales volumes. o Increased advertising in February and March. Our direct marketing advertising spend levels are higher in the first quarter to take advantage of more favorable rates and higher response levels. In addition, we began our new Sleep Number(R) marketing campaign during the first quarter, targeted toward a broader retail store customer base. Neither of these efforts have immediate impact on sales volumes. o Productivity gains. We have experienced overall improvements in our cost structure which have partially offset the effect of lower sales volumes and higher first quarter advertising. LOOKING FORWARD We remain committed to returning to profitability by year end 2001. Our strategies focus on the following: o Rightsizing our cost structure, o Building consumer awareness, o Expanding profitable distribution, and o Improving product quality, innovation and service levels. We have implemented initiatives to bring our cost structure in line with our sales volumes with the ultimate objective of making our core bed business profitable at 2000 sales volumes and to enable funding of awareness building marketing programs. To date we have identified fixed and variable cost reductions totaling $35 million, reducing our sales breakeven point by 17%. Through the first quarter of 2001 we were on track with substantially all cost savings initiatives. In addition, we have begun to advertise at levels consistent with the prior year. We believe this increased advertising support will result in stronger comparisons of year over year sales. Execution of our strategies during the first and second quarters include the following: RIGHTSIZING OUR COST STRUCTURE. The economic slowdown in the fourth quarter of 2000 and first quarter of 2001 has required that we further reduce costs to meet our profitability objectives. These further reductions included ceasing manufacturing in our Minneapolis, Minnesota plant and further reducing our corporate staff in April 2001. We reduced our workforce by 76 positions as a result of these actions. In addition, during the second quarter we launched a direct marketing outlet for the sale of refurbished products from product returns, which had previously been discarded. BUILDING AWARENESS. Initiatives to increase consumer awareness include: o Sleep Number(R) Campaign. During the first quarter we rolled out our new Sleep Number advertising campaign to 8 markets, covering 50 stores that, during 2000, represented 22% of retail sales. The campaign is designed to increase product and store awareness and drive increased traffic to our stores by focusing on our unique product benefits. We utilize prime-time TV and drive-time radio as we attempt to broaden our product appeal to an expanded target audience. o Integrated Marketing. As we continue to strive for common messages across our sales distribution channels, we have integrated the Sleep Number advertising into our direct marketing efforts. We have developed a new infomercial incorporating the Sleep Number messages, which will begin airing in the second quarter. Our national radio personalities (Rush Limbaugh and Paul Harvey) will be incorporating Sleep Number messages as well during the second quarter. Store signage and fulfillment materials have been revised to support the Sleep Number brand. 10
EXPANDING PROFITABLE DISTRIBUTION. An important element of our growth strategy is to increase opportunities for consumers to become aware of and purchase our products. o Expansion of Wholesale Distribution. During the second quarter of 2001 we will expand our existing wholesale relationship with Gabberts, a leading home furnishings retailer, from a single store in Minneapolis, to two additional stores in the Dallas metropolitan area. We are evaluating other wholesale opportunities and anticipate a limited rollout of wholesale sales into one or more selected markets during 2001. o QVC Home Shopping Channel. We continue to expand our relationship with QVC. During the first quarter of 2001 we successfully completed two QVC shows. During the second quarter we anticipate two additional shows at increased sales volumes. INNOVATION AND CONTINUOUS PRODUCT LINE AND SERVICE LEVEL IMPROVEMENT. We believe that our future success will depend in part on our ability to continue to lead the mattress industry in innovation and to continue to improve our product line and service levels. We have taken initial steps toward providing in-home delivery, assembly and mattress removal. To date, in-home delivery and assembly has been provided through our retail channel and is currently utilized in approximately 12% of our sales. We began testing mattress removal during the fourth quarter of 2000 and expect to offer this service in additional markets in 2001. During the first quarter we upgraded the mattress appearance of our entry models. We will upgrade our accessory product line early in the second quarter. 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. THREE MONTHS ENDED ----------------------- MARCH 31, APRIL 1, 2001 2000 ----------- ----------- Net sales 100.0% 100.0% Cost of sales 36.1 35.6 ----------- ----------- Gross margin 63.9 64.4 ----------- ----------- Operating expenses: Sales and marketing 67.5 59.4 General and administrative 10.7 11.2 Store closings/impairments 0.5 0.0 ----------- ----------- Total operating expenses 78.7 70.6 ----------- ----------- Operating loss (14.8) (6.3) Other income (expense), net 0.0 0.2 ----------- ----------- Loss before income taxes (14.8) (6.1) Income tax expense (benefit) 0.2 (2.1) ----------- ----------- Net loss (15.0)% (3.9)% =========== =========== COMPARISON OF THREE MONTHS ENDED MARCH 31, 2001 WITH THREE MONTHS ENDED APRIL 1, 2000 NET SALES Net sales decreased 14.1% to $65.5 million for the three months ended March 31, 2001 from $76.2 million for the three months ended April 1, 2000. The decrease in net sales was due primarily to (i) a $7.8 million decrease in direct marketing sales, (ii) a $3.3 million decrease from comparable retail stores sales in 2001 as compared to 2000, and (iii) a $0.7 million decrease in net sales from the Company's e-commerce channel, offset by an increase of $1.1 million in net sales from the Company's wholesale channel. 11
GROSS MARGIN Gross margin decreased to 63.9% for the three months ended March 31, 2001 from 64.4% for the three months ended April 1, 2000 primarily due to increased costs of processing returned product, partially offset by a decrease in our discounted promotional offerings. SALES AND MARKETING Sales and marketing expenses decreased 2.4% to $44.2 million for the three months ended March 31, 2001 from $45.3 million for the three months ended April 1, 2000, and increased as a percentage of net sales to 67.5% from 59.4% for the comparable prior-year period. The decrease in the dollar amount of sales and marketing expenses was primarily due to decreases in selling expenses associated with lower sales volumes and fewer stores, partially offset by increases in media and media production expense. Sales and marketing expenses increased as a percentage of net sales primarily due to increased media and media production expense and increased retail occupancy expenses. GENERAL AND ADMINISTRATIVE General and administrative expenses decreased 17.6% to $7.0 million for the three months ended March 31, 2001 from $8.5 million for the three months ended April 1, 2000. The decrease in general and administrative expenses was primarily due to staffing reductions and reduced occupancy expense resulting from the consolidation of our two corporate offices and costs associated with a reduction in force in 2000. OTHER INCOME (EXPENSE), NET Other income decreased $173,000 to approximately $25,000 in other expense for the three months ended March 31, 2001 from $148,000 in other income for the three months ended April 1, 2000. The decrease is due to lower cash levels affecting interest income in 2001. INCOME TAX EXPENSE (BENEFIT) Income tax expense increased $1.7 million to $115,000 for the three months ended March 31, 2001 from a $1.6 million benefit for the three months ended April 1, 2000 due to not recognizing an income tax benefit from operating losses in the three months ended March 31, 2001. 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 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. Net cash provided by operating activities for the three months ended March 31, 2001 was approximately $0.3 million and consisted primarily of increases in accounts payable and decreases in accounts receivable and inventory, partially offset by the net loss adjusted for non-cash expenses. Net cash provided by operating activities for the three months ended April 1, 2000 was approximately $2.5 million and consisted primarily of increases in accounts payable and accrued liabilities and the receipt of an income tax refund, partially offset by the net loss adjusted for non-cash expenses. Net cash provided by investing activities was approximately $2.7 million for the three months ended March 31, 2001. Net cash used in investing activities was $5.5 million for the three months ended April 1, 2000. Investing activities consisted primarily of purchases of property and equipment for new retail stores in 2001 and purchases of property and equipment for new retail stores and manufacturing facilities in 2000. In 2001 we liquidated $4.0 million of marketable securities to support continuing operations, while in 2000 we purchased $2.0 million of marketable securities for the investment of excess cash on hand. Net cash provided by financing activities was approximately $88,000 for the three months ended March 31, 2001 and $216,000 for the three months ended April 1, 2000 with proceeds from the issuance of common stock, net of debt repayments. Financial instruments that potentially subject the Company to concentrations of credit risk consist principally of investments. The counterparties to the agreements consist of government agencies and various major corporations of high credit standing. The Company does not believe there is significant risk of non-performance by these counterparties because the Company limits the amount of credit exposure to any one financial institution and any one type of investment. 12
The Company had negative working capital of approximately $26.2 million at March 31, 2001, and $18.2 million at December 30, 2000. The Company has incurred negative cash flows and has incurred pretax losses from operations of $9.7 million for the three months ended March 31, 2001 and $26.0 million for the year ended December 30, 2000. Based on these factors, among others, the Company's auditors have qualified their opinion regarding the Company's fiscal 2000 financial statements to express substantial doubt about the Company's ability to continue as a going concern. The Company's continuation as a going concern is dependent, among other things, upon obtaining positive cash flow from operations and upon its ability to raise additional working capital. Since the fourth quarter of 2000, the Company has been pursuing working capital financing from a variety of potential sources. The Company is currently pursuing a private placement of $8 million to $12 million of senior secured debt securities convertible into shares of common stock together with detachable warrants to purchase additional shares of common stock. Consummation of this financing as contemplated could result in substantial dilution to current shareholders. Based on discussions with potential investors in this private placement, the Company believes that it will be able to consummate this financing in the near term. However, firm commitments have not been received and significant conditions to closing remain to be met, and therefore no assurance can be given that it will be able to consummate this financing on satisfactory terms, or at all. The Company is also pursuing programs to improve its liquidity, including negotiation of supplier and landlord payment terms, the reduction of inventory levels and the deferral of capital programs. While management believes that implementation of its plans to achieve profitability and obtain additional capital will provide sufficient working capital to fund operations for the foreseeable future, there is no assurance that such actions will achieve positive results from operations or adequate working capital and equity. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. 13
PART II: OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS Select Comfort and certain former officers and directors were named as defendants in a class action lawsuit initially filed on June 1, 1999 on behalf of shareholders in U.S. District Court in Minnesota. The named plaintiffs, who purport to act on behalf of a class of purchasers of our 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 we and the named directors and officers failed to disclose or misrepresented certain information concerning our business during the class period. The complaint does not specify an amount of damages claimed. We believe that the complaint is without merit and intend 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. On January 30, 2001, the plaintiffs made a motion to certify a class. The class certification motion is pending. Discovery relative to this motion has begun. We have agreed to indemnify the individual defendants and to advance reasonable expenses of defense of the litigation to the individual defendants under applicable Minnesota corporate law. To date, we have paid an aggregate of $3,891 to the law firm of Briggs & Morgan on behalf of defendant H. Robert Hawthorne. We are involved in other various claims, legal actions, sales tax disputes, and other complaints arising in the ordinary course of business. In the opinion of management, any losses that may occur from these other matters are adequately covered by insurance or are provided for in the consolidated financial statements and the ultimate outcome of these other matters will not have a material effect on the consolidated financial position or results of operations of the Company. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. 14
ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits (i) Amendment to Revolving Credit Program Agreement with Conseco Bank, Inc. dated February 20, 2001. (ii) Second Amendment to Revolving Credit Program with Conseco Bank, Inc. dated April 13, 2001. (b) Reports on Form 8-K During the quarter ended March 31, 2001, the Company filed three Current Reports on Form 8-K. The Reports consisted of the following: (i) Current Report filed February 5, 2001, announcing comments on unaudited results for the fourth quarter ended December 30, 2000. (ii) Current Report filed February 20, 2001, announcing full unaudited results for the quarter and year ended December 30, 2000. (iii)Current Report filed April 16, 2001, announcing the filing of Form 10-K and final audited results for the fourth quarter and year ended December 30, 2000. 15
SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SELECT COMFORT CORPORATION /s/William R. McLaughlin -------------------------------------------- May 15, 2001 William R. McLaughlin President and Chief Executive Officer (principal executive officer) /s/James C. Raabe -------------------------------------------- James C. Raabe Chief Financial Officer (principal financial and accounting officer) 16