Select Comfort Corporation Form 10-Q for period ended March 29, 2008

Table of Contents



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, 2008

 

Commission File Number: 0-25121

 

____________________

 


SELECT COMFORT CORPORATION

(Exact name of registrant as specified in its charter)

 

Minnesota

(State or other jurisdiction of

incorporation or organization)

41-1597886

(I.R.S. Employer

Identification No.)

 

 

9800 59th Avenue North

Minneapolis, Minnesota

(Address of principal executive offices)

55442

(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 o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x  

Accelerated filer o  

Non-accelerated filer o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act).
YES
o    NO x

 

As of April 25, 2008, 44,894,600 shares of Common Stock of the Registrant were outstanding.

 

 




SELECT COMFORT CORPORATION

AND SUBSIDIARIES

 

INDEX

 

 

 

 

PART I:  FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

Page

 

 

 

 

Condensed Consolidated Balance Sheets as of March 29, 2008 and December 29, 2007

3

 

 

 

 

Condensed Consolidated Statements of Operations for the Three Months ended March 29, 2008 and March 31, 2007

4

 

 

 

 

Condensed Consolidated Statement of Shareholders’ Equity for the Three Months ended March 29, 2008

5

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Three Months ended March 29, 2008 and March 31, 2007

6

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

11

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

18

 

 

 

Item 4.

Controls and Procedures

18

 

 

 

PART II: OTHER INFORMATION

 

 

 

 

Item 1.

Legal Proceedings

19

 

 

 

Item 1A.

Risk Factors

19

 

 

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

20

 

 

 

Item 3.

Defaults upon Senior Securities

20

 

 

 

Item 4.

Submission of Matters to a Vote of Security Holders

20

 

 

 

Item 5.

Other Information

20

 

 

 

Item 6.

Exhibits

20

 

 

 

SIGNATURES

 

21

 

 




Table of Contents

PART I:   FINANCIAL INFORMATION

 

ITEM 1.  FINANCIAL STATEMENTS

 

SELECT COMFORT CORPORATION AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(in thousands, except per share amounts)

 

 

 

(unaudited)

March 29,
2008

 

December 29,
2007

 

Assets

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

6,203

 

$

7,279

 

Accounts receivable, net of allowance for doubtful accounts of $1,126 and $876, respectively

 

 

7,488

 

 

18,902

 

Inventories

 

 

25,655

 

 

32,517

 

Prepaid expenses

 

 

11,065

 

 

9,816

 

Deferred income taxes

 

 

6,552

 

 

6,796

 

Other current assets

 

 

2,868

 

 

3,833

 

Total current assets

 

 

59,831

 

 

79,143

 

Property and equipment, net

 

 

83,811

 

 

80,409

 

Deferred income taxes

 

 

27,445

 

 

25,543

 

Other assets

 

 

3,749

 

 

5,394

 

Total assets

 

$

174,836

 

$

190,489

 

 

 

 

 

 

 

 

 

Liabilities and Shareholders’ Equity

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Borrowings under revolving credit facility

 

$

43,475

 

$

37,890

 

Accounts payable

 

 

52,575

 

 

69,775

 

Customer prepayments

 

 

9,299

 

 

8,327

 

Accruals:

 

 

 

 

 

 

 

Sales returns

 

 

3,456

 

 

3,751

 

Compensation and benefits

 

 

17,459

 

 

14,865

 

Taxes and withholding

 

 

3,921

 

 

4,812

 

Other current liabilities

 

 

7,953

 

 

9,723

 

Total current liabilities

 

 

138,138

 

 

149,143

 

 

 

 

 

 

 

 

 

Non-current liabilities:

 

 

 

 

 

 

 

Warranty liabilities

 

 

6,705

 

 

6,747

 

Capital lease obligations

 

 

410

 

 

 

Other long-term liabilities

 

 

11,583

 

 

10,473

 

Total non-current liabilities

 

 

18,698

 

 

17,220

 

Total liabilities

 

 

156,836

 

 

166,363

 

 

 

 

 

 

 

 

 

Shareholders’ equity:

 

 

 

 

 

 

 

Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding

 

 

 

 

 

Common stock, $0.01 par value; 142,500 shares authorized, 44,834 and 44,597 shares issued and outstanding, respectively

 

 

448

 

 

446

 

Additional paid-in capital

 

 

1,005

 

 

 

Retained earnings

 

 

16,547

 

 

23,680

 

Total shareholders’ equity

 

 

18,000

 

 

24,126

 

Total liabilities and shareholders’ equity

 

$

174,836

 

$

190,489

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

SELECT COMFORT CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(unaudited – in thousands, except per share amounts)

 

 

Three Months Ended

 

 

March 29,
2008

 

March 31,
2007

 

Net sales

$

168,165

 

$

216,509

 

Cost of sales

 

71,239

 

 

82,341

 

Gross profit

 

96,926

 

 

134,168

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

Sales and marketing

 

90,600

 

 

98,138

 

General and administrative

 

16,161

 

 

17,619

 

Research and development

 

874

 

 

1,584

 

Asset impairment charges

 

333

 

 

 

Total operating expenses

 

107,968

 

 

117,341

 

Operating (loss) income

 

(11,042

 

16,827

 

Other (expense) income, net

 

(246

 

394

 

(Loss) income before income taxes

 

(11,288

 

17,221

 

Income tax (benefit) expense

 

(4,155

 

6,544

 

Net (loss) income

$

(7,133

$

10,677

 

 

 

 

 

 

 

 

Net (loss) income per share – basic

$

(0.16

$

0.21

 

Weighted average shares – basic

 

44,058

 

 

49,713

 

 

 

 

 

 

 

 

Net (loss) income per share – diluted

$

(0.16

$

0.21

 

Weighted average shares – diluted

 

44,058

 

 

51,798

 

 

See accompanying notes to condensed consolidated financial statements.

 

 











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SELECT COMFORT CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statement of Shareholders’ Equity

(unaudited – in thousands)

 

 

 

Common Stock

 

Additional
Paid-In

Capital

 

Retained

Earnings

 

Total

 

Shares

 

Amount

Balance at December 29, 2007

 

44,597

 

$

446

 

$

 

$

23,680

 

$

24,126

 

Exercise of common stock options

 

19

 

 

 

 

34

 

 

 

 

34

 

Tax benefit from stock-based compensation

 

 

 

 

 

3

 

 

 

 

3

 

Stock-based compensation

 

 

 

 

 

813

 

 

 

 

813

 

Issuances of common stock

 

218

 

 

2

 

 

155

 

 

 

 

157

 

Net loss

 

 

 

 

 

 

 

(7,133

)

 

(7,133

)

Balance at March 29, 2008

 

44,834

 

$

448

 

$

1,005

 

$

16,547

 

$

18,000

 

 

 

See accompanying notes to condensed consolidated financial statements.

 












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SELECT COMFORT CORPORATION AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited – in thousands)

 

 

 

Three Months Ended

 

 

 

March 29,
2008

 

March 31,
2007

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net (loss) income

 

$

(7,133

$

10,677

 

Adjustments to reconcile net (loss) income to net cash provided by operating activities:

 

 

 

 

 

 

 

Depreciation and amortization

 

 

5,858

 

 

6,803

 

Stock-based compensation

 

 

813

 

 

2,072

 

Excess tax benefits from stock-based compensation

 

 

(2

)

 

(756

)

Disposals and impairments of assets

 

 

339

 

 

10

 

Changes in deferred income taxes

 

 

(1,658

)

 

1

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Accounts receivable

 

 

11,414

 

 

(2,380

)

Inventories

 

 

6,862

 

 

(915

)

Prepaid expenses and other assets

 

 

1,352

 

 

(478

)

Accounts payable

 

 

(4,777

 

10,016

 

Customer prepayments

 

 

972

 

 

653

 

Accrued sales returns

 

 

(295

 

872

 

Accrued compensation and benefits

 

 

2,607

 

 

(2,378

)

Accrued taxes and withholding

 

 

(888

 

4,587

 

Warranty liabilities

 

 

(59

)

 

(386

)

Other accruals and liabilities

 

 

(796

 

(873

)

Net cash provided by operating activities

 

 

14,609

 

 

27,525

 

 

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Purchases of property and equipment

 

 

(10,274

)

 

(8,395

)

Proceeds from sales and maturity of marketable debt securities

 

 

 

 

29,796

 

Net cash (used in) provided by investing activities

 

 

(10,274

 

21,401

 

 

 

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Net decrease in short-term borrowings

 

 

(5,591

 

(370

)

Repurchases of common stock

 

 

 

 

(43,825

)

Proceeds from issuance of common stock

 

 

178

 

 

1,170

 

Excess tax benefits from stock-based compensation

 

 

2

 

 

756

 

Net cash used in financing activities

 

 

(5,411

)

 

(42,269

)

 

 

 

 

 

 

 

 

(Decrease) increase in cash and cash equivalents

 

 

(1,076

)

 

6,657

 

Cash and cash equivalents, at beginning of period

 

 

7,279

 

 

8,819

 

Cash and cash equivalents, at end of period

 

$

6,203

 

$

15,476

 

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

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SELECT COMFORT CORPORATION AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

 

1.   Basis of Financial Statement Presentation

 

We prepared the condensed consolidated financial statements as of and for the three months ended March 29, 2008 of Select Comfort Corporation and subsidiaries (“Select Comfort” or 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, 2008, and December 29, 2007 and the results of operations and cash flows for the periods presented. Our historical results of operations may not be indicative of the results that may be achieved for any future period.

 

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with our most recent audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007. Operating results for any quarterly period may not be indicative of operating results for the full-year.

 

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of sales and expenses during the reporting period. Predicting future events is inherently an imprecise activity and as such requires the use of judgment. Future results could be materially affected if actual results differ from these estimates and assumptions. Critical accounting policies consist of asset impairment charges, stock-based compensation, self-insured liabilities, warranty liabilities and revenue recognition.

 

New Accounting Pronouncements

We adopted the provisions of Statement of Financial Accounting Standard (“SFAS”) No. 157, “Fair Value Measurements” on December 30, 2007, the beginning of our 2008 fiscal year. SFAS No. 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that prioritizes the information used to develop those assumptions. Under the standard, fair value measurements are separately disclosed by level within the fair value hierarchy. SFAS No. 157, as originally issued, was effective for fiscal years beginning after November 15, 2007, with early adoption permitted. However, on February 12, 2008, the FASB issued FASB Staff Position (“FSP”) FAS 157-2, which deferred the effective date of SFAS No. 157 for one year, as it relates to nonfinancial assets and liabilities. Accordingly, our adoption related only to financial assets and liabilities. At December 30, 2007, and March 29, 2008, we had no financial assets or liabilities which required a fair value measurement on a recurring basis.

 

We adopted the provisions of SFAS No. 159, “The Fair Value Option for Financial Assets and Liabilities – Including an Amendment of FASB Statement No. 115” on December 30, 2007, the beginning of our 2008 fiscal year. SFAS No. 159 permits us to choose to measure certain financial assets and liabilities at fair value that are not currently required to be measured at fair value (the “Fair Value Option”). Election of the Fair Value Option is made on an instrument-by-instrument basis and is irrevocable. At the adoption date, unrealized gains and losses on financial assets and liabilities for which the Fair Value Option has been elected are reported as a cumulative adjustment to beginning retained earnings. We did not elect the Fair Value Option. If we had elected the Fair Value Option for certain financial assets and liabilities, we would report unrealized gains and losses due to changes in their fair value in net income at each subsequent reporting date. The adoption of this statement had no impact on our consolidated financial statements.

 

2.   Marketable Debt Securities

 

Through December 30, 2006, we classified our marketable debt securities as “held-to-maturity” in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities.” We historically valued our marketable debt securities at amortized cost based upon our intent and ability to hold these securities to maturity.

 

On March 23, 2007, all marketable debt securities carried at an amortized cost of $67.8 million with an unrealized net loss of $250,000 were transferred from “held-to-maturity” classification to “available-for-sale” classification. Investments classified as “available-for-sale” are carried at fair market value. The classification change was made to increase liquidity and fund our common stock repurchase program. Based on the change in classification, we reduced both the carrying value of our marketable

 

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Table of Contents

debt securities and shareholders’ equity (accumulated other comprehensive loss) by $250,000 on the date the securities were transferred to “available-for-sale” classification.

 

During the first quarter of fiscal 2007 and subsequent to the classification change, marketable debt securities with a cost of $16.2 million were sold and a realized loss of $5,000 was recognized. At March 31, 2007, $229,000 of unrealized net losses related to our marketable debt securities were included in accumulated other comprehensive loss on our consolidated balance sheet.

 

We did not hold any marketable debt securities at March 29, 2008, or December 29, 2007.

 

3.   Inventories

 

Inventories consisted of the following (in thousands):

 

 

 

March 29,
2008

 

December 29,
2007

 

Raw materials

 

$

7,498

 

$

10,685

 

Work in progress

 

 

176

 

 

225

 

Finished goods

 

 

17,981

 

 

21,607

 

Inventories

 

$

25,655

 

$

32,517

 

 

4.   Debt

Credit Agreement

In June 2006, we entered into a five-year Syndicated Credit Agreement (the “Credit Agreement”) with a syndicate of banks (the “Lenders”). The Credit Agreement provides for a $100.0 million senior unsecured revolving credit facility available to be used by us for general corporate purposes. Borrowings available under the credit facility can be increased by an additional amount up to $75.0 million. The Credit Agreement terminates in 2011.

 

At March 29, 2008, borrowings under the credit facility bore interest at a floating rate and could be maintained as base rate loans (tied to the prime rate or the federal funds rate plus 0.6%) or as Eurocurrency rate loans tied to LIBOR, plus a margin up to 0.6% depending on our leverage ratio, as defined. We also pay certain facility and agent fees. We are subject to certain financial covenants under the agreement principally consisting of maximum leverage and minimum interest coverage ratios.

 

We had outstanding borrowings of $43.5 million and $37.9 million, under the credit facility as of March 29, 2008, and December 29, 2007, respectively. As of March 29, 2008, and December 29, 2007, interest rates on borrowings outstanding under the Credit Agreement were 3.6% and 5.2%, respectively. Amounts outstanding under letters of credit reduce the amount available under this facility. At March 29, 2008, and December 29, 2007, $54.5 million and $62.1 million, respectively, were available under this credit facility.

 

Effective February 1, 2008, the Credit Agreement related to our revolving credit facility was amended to revise the permissible minimum interest coverage ratio and, as of the end of the first quarter of fiscal 2008, we were in full compliance with all financial covenants. We currently believe, however, that we may fall out of compliance with certain of the financial covenants under the Credit Agreement at the end of the second quarter of fiscal 2008 or thereafter. We are currently working with our lenders to amend the Credit Agreement to provide greater flexibility and to reduce the risk of future noncompliance with the financial covenants. While we believe we can negotiate an acceptable amendment, there can be no assurance that we will be successful in obtaining a satisfactory amendment of the Credit Agreement that will provide sufficient flexibility under the financial covenants. In addition, any amendment of the Credit Agreement may significantly increase the cost of credit provided under the credit facility and related expenses, which may adversely impact our profitability. Failure to obtain an amendment of the Credit Agreement could have a material adverse effect on our liquidity and on our ability to conduct our business.

 

Whether or not we are successful in obtaining an amendment of the Credit Agreement, we may need to or may choose to seek additional capital through the issuance of debt or equity securities. The issuance of any additional debt securities could materially and adversely impact our profitability and financial condition. The issuance of additional equity securities could be substantially dilutive to our existing shareholders.

 

Our agreement under which GE Money Bank offers to our qualified customers a revolving credit arrangement to finance purchases from us (the “GE Agreement”) contains the same financial covenants that are in the Credit Agreement as now in effect. If we were to fall out of compliance with the covenants in the GE Agreement, GE Money Bank could request that we provide collateral in the form of a letter of credit, which would further constrain our liquidity. We are currently working with GE Money Bank to amend the GE Agreement to provide greater flexibility and to reduce the risk of future noncompliance with the financial covenants, consistent with the amendments being discussed under the Credit Agreement. There can be no assurance, however, that we will be successful in obtaining a satisfactory amendment of the GE Agreement. If it becomes necessary to provide a letter of credit under the GE Agreement and we are unable to supply a satisfactory letter of credit, GE Money Bank could take action to terminate the GE Agreement. Termination of the GE Agreement, or any material change to the terms of the GE Agreement, or in the availability or terms of credit for our customers under the GE Agreement, or any delay in securing replacement credit sources, could have a material adverse effect on our sales, profitability and financial condition.

 

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Capital Lease

During the first quarter of fiscal 2008, we entered into a capital lease totaling $562,000 for certain computer equipment. At March 29, 2008, $152,000 was included in other current liabilities and $410,000 was included in capital lease obligations in our consolidated balance sheet.

 

5.   Repurchases of Common Stock

 

On April 20, 2007, our Board of Directors authorized the repurchase of up to an additional $250.0 million. We did not repurchase any shares during the three months ended March 29, 2008. We repurchased and retired 2,359,000 shares through open market purchases at a cost of $42.8 million (based on trade dates), respectively, during the three months ended March 31, 2007. As of March 29, 2008, the remaining authorization under our share repurchase program was $206.8 million. There is no expiration date governing the period over which we can repurchase shares.

 

6.   Stock-Based Compensation

 

We compensate officers, directors and key employees with stock-based compensation under three plans approved by our shareholders in 1990, 1997 and 2004 and administered under the supervision of our Board of Directors. Stock-based compensation awards are generally granted annually during the first quarter. We have awarded stock options, performance shares and restricted stock under these plans. Stock-based compensation expense is determined based on the grant-date fair value and is recognized ratably over the vesting period of each grant, which is generally four years. Stock-based compensation expense for the three months ended March 29, 2008, and March 31, 2007, was $813,000 and $2.1 million, respectively. The year-over-year decline in stock-based compensation expense was primarily due to an increase in our estimated forfeiture rates resulting from recent workforce reductions.

 

7.   Asset Impairment Charges

 

During the three months ended March 29, 2008, we determined that certain store assets at two underperforming stores were impaired and recognized an impairment charge of $333,000 for the difference between the fair value and the carrying amount. We did not record any asset impairment charges during the three months ended March 31, 2007.

 

8.   Other (Expense) Income, Net

 

Other (expense) income, net, consisted of the following (in thousands):

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

 

March 29,
2008

 

March 31,
2007

 

Interest income

 

 

 

 

 

 

 

$

88

 

$

623

 

Interest expense

 

 

 

 

 

 

 

 

(516

)

 

(224

Capitalized interest expense

 

 

 

 

 

 

 

 

182

 

 

 

Realized loss on sales of marketable debt securities

 

 

 

 

 

 

 

 

 

 

(5

Other (expense) income, net

 

 

 

 

 

 

 

$

(246

$

394

 

 

 













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9.   Net (Loss) Income per Common Share

 

The following computations reconcile net (loss) income per share – basic with net (loss) income per share – diluted (in thousands, except per share amounts):

 

 

 

 

 

Three Months Ended

 

 

 

 

 

 

 

March 29,
2008

 

March 31,
2007

 

Net (loss) income

 

 

 

 

 

 

 

$

(7,133

$

10,677

 

 

Reconciliation of weighted-average shares outstanding:

 

 

 

 

 

 

 

 

 

 

Basic weighted-average shares outstanding

 

 

 

 

 

 

 

 

44,058

 

 

 

49,713

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

 

 

 

 

Options

 

 

 

 

 

 

 

 

 

 

1,879

 

Warrants

 

 

 

 

 

 

 

 

 

 

1

 

Restricted shares

 

 

 

 

 

 

 

 

 

 

205

 

 

Diluted weighted-average shares outstanding

 

 

 

 

 

 

 

 

44,058

 

 

51,798

 

 

Net (loss) income per share – basic

 

 

 

 

 

 

 

$

(0.16

)

$

0.21

 

Net (loss) income per share – diluted

 

 

 

 

 

 

 

$

(0.16

$

0.21

 

 

For the three months ended March 29, 2008, and March 31, 2007, respectively, we excluded potentially dilutive stock options totaling 3.9 million and 1.4 million from diluted net (loss) income per share because these securities’ exercise prices were greater than the average market price of our common shares. In addition, for the three months ended March 29, 2008, we excluded 312,000 shares of restricted stock and 561,000 stock options from diluted net (loss) income per share as their inclusion would have had an anti-dilutive effect on our net loss per diluted share.

 

10.   Commitments and Contingencies

 

We are involved in various legal proceedings arising in the ordinary course of business. In the opinion of management, any losses that may occur from these matters are adequately covered by insurance or are provided for in the consolidated financial statements if the liability is probable and estimable in accordance with generally accepted accounting principles. The ultimate outcome of these matters are not expected to have a material effect on our consolidated results of operations or financial position. We expense legal costs for these matters as incurred.

 

11.   Subsequent Event – Legal Proceedings

 

On April 25, 2008, a lawsuit was filed against one of our subsidiaries in Superior Court in Santa Clara County, California by one of our customers. The complaint asserts various claims related to products liability, breach of warranty, concealment, intentional misrepresentation and negligent misrepresentation and seeks class certification. The complaint alleges that products sold by us prior to 2006 had a unique propensity to develop mold, alleges that the plaintiff suffered adverse health effects, and seeks various forms of legal and equitable relief, including without limitation unspecified damages, punitive and exemplary damages, attorneys’ fees and costs, and injunctive relief. As of May 8, 2008, no accrual had been established as we believe that the complaint is without merit and intend to vigorously defend the claims.

 







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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in seven sections:

 

 

Risk Factors

 

Overview

 

Results of Operations

 

Liquidity and Capital Resources

 

Outlook

 

Off-Balance-Sheet Arrangements and Contractual Obligations

 

Critical Accounting Policies

 

Risk Factors

 

The following discussion and analysis should be read in conjunction with the Condensed 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 our historical experience and our present expectations or projections. Important factors known to us that could cause such material differences are identified and discussed in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 29, 2007, which discussion is incorporated herein by reference. These important factors include, but are not limited to:

 

Marketing Effectiveness and Efficiency – the effectiveness of our marketing messages and the efficiency of our advertising expenditures and other marketing programs in building product and brand awareness, driving traffic to our points of sale and increasing sales;

 

Consumer Acceptance – the level of consumer acceptance of our products, new product offerings and brand image;

 

Liquidity and Capital Resources – our ability to obtain sufficient liquidity and capital resources to fund our operations and the increasing cost of credit;

 

Need for Continuous Product Improvement – our ability to continuously improve our products to offer new and enhanced consumer benefits, better quality and reduced costs;

 

Competition – the level of competition in the mattress industry and our ability to successfully identify and respond to emerging and competitive trends in the mattress industry;

 

Execution of Our Retail Distribution Strategy – our ability to execute our retail store distribution strategy, including increasing sales and profitability through our existing stores, securing suitable and cost-effective locations for additional retail stores and cost-effectively closing under-performing store locations;

 

International Growth – our ability to cost-effectively execute plans to expand our distribution internationally;

 

Consumer Credit – the availability of consumer credit and our ability to provide cost-effective consumer credit options;

 

Sources of Supply – our ability to secure adequate sources of supply at reasonable cost, especially considering our single sources of supply for some components and just-in-time manufacturing processes, as well as potential shortages of commodities;

 

Inflationary Pressures – rising fuel and commodity costs, as well as fluctuating currency rates and increasing industry regulatory requirements, which may increase our cost of goods and may adversely impact our profitability or our ability to maintain sales volumes to the extent that we choose to increase prices;

 

Impact of Federal Flame Retardancy Standards – new federal flame retardancy standards for mattress products effective since mid-2007, which have added compliance costs to our business and have added risks of non-compliance, which could disrupt our business;

 

 

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Management Information Systems – our current management information systems, which may not adequately meet the requirements of our evolving business, and our ability to successfully implement our planned SAP®-based enterprise-wide information technology architecture;

 

Retention of Senior Leadership and other Key Employees – our ability to retain senior leadership and other key employees, including qualified retail store management and sales professionals, in the wake of recent business performance that has not met our expectations;

 

General Economic Conditions and Consumer Confidence – adverse trends in general economic conditions, including in particular the housing market, retail trends and consumer confidence, and the possibility of an economic recession; and

 

Global Events – global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events.

 

We may not be successful in executing our growth strategy or in regaining growth in sales or growth in profitability. Failure to successfully execute any material part of our strategic plan or growth strategy could harm our sales, profitability and financial condition.

 

We have no obligation to publicly update or revise any of the forward-looking statements contained in this quarterly report on Form 10-Q.

 

Overview

 

Business Overview

 

Select Comfort 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. In addition, we market and sell accessories and other sleep related products which focus on providing personalized comfort to complement the Sleep Number bed and provide a better night’s sleep for consumers.

 

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 and through leading home furnishings retailers, specialty bedding retailers, the QVC shopping channel and to several end users such as Radisson Hotels and Resorts®.

 

Vision and Strategy  

 

Our vision is to be a leading brand in the bedding industry, while improving people’s lives through better sleep.

 

We are executing against a defined strategy which focuses on the following key components:

 

 

Building brand awareness and increasing store traffic through effective marketing programs;

 

Prudently managing our business in the current economic environment through disciplined controls over costs and cash;

 

Accelerating product innovation to lead the industry in innovative sleep products; and

 

Leveraging our infrastructure in order to facilitate long-term profitable growth.

 

Results of Operations

 

Quarterly and Annual Results

 

Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including increases or decreases in sales, the timing, amount and effectiveness of advertising expenditures, any changes in sales return rates or warranty experience, the timing of new store openings and related expenses, net sales contributed by new stores, the timing of promotional offerings, competitive factors, changes in commodity costs, any disruptions in supplies or third-party service providers, seasonality of retail sales, timing of QVC shows and wholesale sales, consumer confidence and general economic conditions. Furthermore, a substantial portion of our net sales is often realized in the last month of a quarter, due in part to our promotional schedule and commission structure. As a result, we may be unable to adjust spending in a timely manner, and our business, financial condition

 

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and operating results may be significantly harmed. Our historical results of operations may not be indicative of the results that may be achieved for any future period. 

 

Highlights

 

Key financial highlights for the three months ended March 29, 2008 were as follows:

 

 

Net loss totaled $7.1 million, or $0.16 per diluted share, compared with net income of $10.7 million or $0.21 per diluted share, for the same period one year ago.

 

 

Net sales decreased 22% to $168.2 million, compared with $216.5 million for the same period one year ago, primarily due to a 25% comparable-store sales decline for our company-owned retail stores, partially offset by 34 net new company-owned retail stores opened in the past 12 months.

 

 

Our gross profit rate decreased to 57.6% of net sales, compared with 62.0% of net sales for the same period last year. The gross profit rate decrease was primarily due to higher commodity costs, increased material costs for compliance with new fire retardancy standards and for our new bed line launched last year, the deleveraging impact of a 22% sales decrease, and a sales mix shift to lower margin products.

 

 

Sales and marketing expenses increased to 53.9% of net sales, compared with 45.3% of net sales for the same period one year ago. The rate increase was primarily due to the deleveraging impact of a 25% comparable-store sales decrease.

 

 

General and administrative expenses declined $1.4 million compared with the prior year, but increased to 9.6% of net sales compared with 8.1% of net sales for the same period one year ago.

 

 

Cash from operating activities totaled $14.6 million, compared with $27.5 million for the same period one year ago.

 

 

 














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The following table sets forth, for the periods indicated, our results of operations expressed as dollars and percentages of net sales. Figures are in millions, except percentages and per share amounts. Amounts may not add due to rounding differences.

 

 

 

Three Months Ended

 

 

 

March 29, 2008

 

March 31, 2007

 

Net sales

 

$

168.2

 

100.0%

 

$

216.5

 

100.0%

 

Cost of sales

 

 

71.2

 

42.4%

 

 

82.3

 

38.0%

 

Gross profit

 

 

96.9

 

57.6%

 

 

134.2

 

62.0%

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Sales and marketing

 

 

90.6

 

53.9%

 

 

98.1

 

45.3%

 

General and administrative

 

 

16.2

 

9.6%

 

 

17.6

 

8.1%

 

Research and development

 

 

0.9

 

0.5%

 

 

1.6

 

0.7%

 

Asset impairment charges

 

 

0.3

 

0.2%

 

 

 

0.0%

 

Total operating expenses

 

 

108.0

 

64.2%

 

 

117.3

 

54.2%

 

Operating (loss) income

 

 

(11.0

)

(6.6%

)

 

16.8

 

7.8%

 

Other (expense) income, net

 

 

(0.2

)

(0.1%

)

 

0.4

 

0.2%

 

 

 

 

 

 

 

 

 

 

 

 

 

(Loss) income before income taxes

 

 

(11.3

)

(6.7%

)

 

17.2

 

8.0%

 

Income tax (benefit) expense

 

 

(4.2

)

(2.5%

)

 

6.5

 

3.0%

 

Net (loss) income

 

$

(7.1

)

(4.2%

)

$

10.7

 

4.9%

 

 

 

 

 

 

 

 

 

 

 

 

 

Net (loss) income per share:

 

 

 

 

 

Basic

 

$  (0.16)

 

$  0.21

 

Diluted

 

$  (0.16)

 

$  0.21

 

Weighted-average number of common shares:

 

 

 

 

 

Basic

 

44.1

 

49.7

 

Diluted

 

44.1

 

51.8

 

 

The percentage of our total net sales, by dollar volume, from each of our channels was as follows:

 

 

 

Three Months Ended

 

 

 

March 29,
2008

 

March 31,
2007

 

Percent of sales:

 

 

 

 

 

Retail

 

78.7%

 

76.1%

 

Direct

 

7.5%

 

8.7%

 

E-Commerce

 

6.9%

 

6.6%

 

Wholesale

 

6.9%

 

8.6%

 

Total

 

100.0%

 

100.0%

 

 

The components of total sales growth, including comparable-store sales changes, were as follows:

 

 

 

Three Months Ended

 

 

 

March 29,
2008

 

March 31,
2007

 

Sales growth rates:

 

 

 

 

 

Comparable-store sales

 

(25%

)

(11%

)

Net new stores

 

5%

 

10%

 

Retail total

 

(20%

)

(1%

)

Direct

 

(32%

)

(11%

)

E-Commerce

 

(19%

)

27%

 

Wholesale

 

(37%

)

37%

 

Total sales growth

 

(22%

)

2%

 

 

 

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The number of company-operated retail stores and independently owned and operated retail partner doors was as follows:

 

 

 

Three Months Ended

 

 

 

March 29,
2008

 

March 31,
2007

 

 

 

 

 

 

 

Company-owned retail stores:

 

 

 

 

 

Beginning of period

 

478

 

442

 

Opened

 

7

 

7

 

Closed

 

(4

)

(2

)

End of period

 

481

 

447

 

 

 

 

 

 

 

Retail partner doors

 

774

 

841

 

 

Comparison of Three Months Ended March 29, 2008 with Three Months Ended March 31, 2007

 

Net sales

Net sales decreased 22% to $168.2 million for the three months ended March 29, 2008, compared with $216.5 million for the same period one year ago. The sales decrease was due to a 25% comparable-store sales decline in our company-owned retail stores and a decrease in wholesale, direct and E-Commerce channel sales, partially offset by sales from 34 net new company-owned retail stores opened in the past 12 months. Total sales of mattress units decreased 25% compared to the same period one year ago, and the average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels decreased 4% to $1,630, while sales of other products and services decreased by 9%.

 

The $48.3 million net sales decrease compared with the same period one year ago was comprised of the following: (i) a $32.6 million net decrease in sales from our company-owned retail stores, comprised of a $40.0 million decrease from comparable-stores and a $7.4 million increase from new stores, net of stores closed; (ii) a $6.9 million decrease in wholesale sales; (iii) a $6.1 million decrease in direct marketing sales; and (iv) a $2.7 million decrease in E-Commerce sales.

 

Gross profit

The gross profit rate decreased to 57.6% of net sales for the three months ended March 29, 2008, compared with 62.0% for the same period one year ago. Approximately 3.2 percentage points (“ppt”) of the gross profit rate decline was driven by higher commodity costs, increased production costs for our new line of beds and fire-retardant products launched last year, and the deleveraging impact of a 22% sales decrease which resulted in the under utilization of production lines until late in the quarter. A sales mix shift to lower margin products reduced the gross profit rate by approximately 1.1 ppt. Increased use of promotional discount offers and higher warranty expenses reduced the first quarter gross profit rate by 0.7 ppt and 0.6 ppt, respectively, compared to the same period one year ago. These items were partially offset by an increase in the percentage of net sales from higher gross margin channels which increased the gross profit rate by approximately 1.2 ppt compared with the same period one year ago.

 

Sales and marketing expenses

Sales and marketing expenses for the three months ended March 29, 2008 decreased 8% to $90.6 million, or 53.9% of net sales, compared with $98.1 million, or 45.3% of net sales, for the same period one year ago. The $7.5 million decrease was primarily due to a $7.4 million reduction in media spending compared with the same period one-year ago, reduced promotional financing offers, and lower percentage rents due to the net sales decline, partially offset by operating costs associated with 34 net new stores opened in the past twelve months. The 8.6 ppt sales and marketing expense rate increase was principally due to the deleveraging impact of a 25% comparable-store sales decline, partially offset by a $7.5 million expense decrease compared with the same period one year ago. The 23% reduction in media spending compared with the same period one year ago resulted from our decision to delay media investments until the launch of our new marketing campaign late in the quarter.

 

General and administrative expenses

General and administrative (“G&A”) expenses decreased 8% to $16.2 million for the three months ended March 29, 2008, compared with $17.6 million for the same period one year ago. The $1.4 million decrease in G&A expenses was primarily due to a workforce reduction, including reduced stock-based compensation expense, partially offset by $1.2 million in current-year severance related costs. The year-over-year decline in stock-based compensation expense was primarily due to an increase in our estimated forfeiture rates resulting from recent workforce reductions.

 

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Research and development expenses

Research and development (“R&D”) expenses decreased to $0.9 million for the first quarter of fiscal 2008 compared with $1.6 million for the same period one year ago, and decreased as a percentage of net sales to 0.5% from 0.7% for the comparable prior-year period. The prior year’s first quarter included additional R&D expenses related to the development of new fire retardant products and an upgrade of our entire line of bed models.

 

Asset impairment charges

During the three months ended March 29, 2008, we determined that certain store assets at two underperforming stores were impaired and recognized an impairment charge of $0.3 million for the difference between the fair value and the carrying amount. There were no asset impairment charges for the same period one year ago.

 

Other (expense) income, net

Other expense was $0.2 million for the three months ended March 29, 2008, compared with $0.4 million of other income for the same period one year ago. The $0.6 million decrease was driven by lower average cash and investment balances compared with the same period one year ago, which resulted in reduced interest income and increased interest expense from borrowings under our revolving line of credit.

 

Income tax (benefit) expense

Income tax benefit was $4.2 million for the three months ended March 29, 2008, compared with income tax expense of $6.5 million for the same period one year ago. The effective tax rate was 36.8% for the first quarter of fiscal 2008 and 38.0% for the same period one year ago. The effective tax rate in fiscal 2008 was impacted by a reduced state income tax benefit.

 

Liquidity and Capital Resources

 

As of March 29, 2008, we had cash and cash equivalents of $6.2 million compared with $7.3 million as of December 29, 2007. The $1.1 million decrease in cash and cash equivalents was primarily due to $10.3 million of capital expenditures and a $5.6 million decrease in short-term borrowings, partially offset by $14.6 million of cash provided by operating activities.

 

The following table summarizes our cash flows for the three months ended March 29, 2008, and March 31, 2007 ($ in millions):

 

 

 

Three Months Ended

 

 

 

March 29,
2008

 

March 31,
2007

 

Total cash provided by (used in):

 

 

 

 

 

 

 

Operating activities

 

$

14.6

 

$

27.5

 

Investing activities

 

 

(10.3

)

 

21.4

 

Financing activities

 

 

(5.4

)

 

(42.3

)

Decrease in cash and cash equivalents

 

$

(1.1

)

$

6.7

 

 

Cash provided by operating activities for the three months ended March 29, 2008, and March 31, 2007 was $14.6 million and $27.5 million, respectively. The $12.9 million year-over-year decrease in cash from operating activities was comprised of a $17.8 million decline in net (loss) income and a $2.8 million decrease in adjustments to reconcile net (loss) income to cash provided by operating activities, partially offset by a $7.7 million increase in cash from changes in operating assets and liabilities. The year-over-year decrease in adjustments to reconcile net (loss) income to cash provided by operating activities was the result of lower depreciation and amortization, reduced stock-based compensation expense compared with the same period one year ago, and a net current-year increase in deferred tax assets. The increase in cash from changes in operating assets and liabilities was due to a current-year decrease in accounts receivable (timing of wholesale sales and receipts), a current-year decrease in inventories, and a current year increase in accrued compensation and benefits (prior-year’s first quarter reduction included payment of fiscal 2006 bonus), partially offset by a current-year decrease in accounts payable (timing of payments and reduced inventory levels), and reduced accrued taxes and withholding (decline in pre-tax net (loss) income compared with same period one year ago).

 

Net cash used in investing activities was $10.3 million for the three months ended March 29, 2008 compared with net cash provided by investing activities of $21.4 million for the same period one year ago. The $31.7 million decrease in net cash (used in) provided by investing activities was principally due to zero proceeds from the sales and maturities of marketable debt securities for the first three months of fiscal 2008, compared with $29.8 million of proceeds from the sales and maturities of marketable debt securities for the same period one year ago, as we liquidated our marketable securities in fiscal 2007 to fund common stock repurchases. During the first three months of fiscal 2008, we invested $10.3 million in property and equipment, compared to $8.4 million for the same period one year ago. In both periods, our capital expenditures related primarily to new and remodeled retail stores and investments in information technology. The year-over-year increase in capital expenditures was primarily due to

 

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additional costs related to our implementation of SAP. We opened seven new retail stores during the first three months of fiscal 2007 and fiscal 2008.

 

Net cash used in financing activities was $5.4 million for the three months ended March 29, 2008, compared with $42.3 million for the same period one year ago. The $36.9 million decrease in cash used in financing activities resulted from $43.8 million of common stock repurchases for the first three months of fiscal 2007 compared with no repurchases for the current year, partially offset by a $1.0 million reduction in proceeds from the issuance of common stock related to stock options and employee purchases, and a $5.6 million decrease in short-term borrowings during the current-year compared to a net $0.4 million reduction in short-term borrowings for the same period one year ago. Book overdrafts are included in the net change in short-term borrowings.

 

On April 20, 2007, our Board of Directors authorized the company to repurchase up to an additional $250 million of its common stock. In the third quarter of fiscal 2007, we curtailed our share repurchases following the tightening of credit markets and the continued deterioration in the general economic environment. We believe that returning to a debt-free balance sheet and maintaining the greatest level of flexibility to pursue actions that drive the long-term growth of the business are the best use of capital and the most prudent course of action at this time. As of March 29, 2008, the remaining authorization under our stock repurchase program was $207 million. There is no expiration date governing the period over which we can repurchase shares.

 

In 2006, we obtained a $100 million bank revolving credit facility for general corporate purposes including the funding of any short-term cash needs or investment opportunities. This credit facility is a five-year senior unsecured revolving facility expiring June 2011. Effective February 1, 2008, we amended the Credit Agreement. Borrowings under the amended credit facility bear interest at a floating rate and may be maintained as base rate loans tied to the greater of the prime rate or the federal funds rate plus 0.6%, or as Eurocurrency rate loans tied to LIBOR, plus a margin up to 0.6% depending on our leverage ratio, as defined in our Credit Agreement. We are subject to certain financial covenants under the Credit Agreement, principally consisting of interest coverage and leverage ratios. We had borrowings of $43.5 million and $37.9 million, outstanding under the credit facility as of March 29, 2008, and December 29, 2007, respectively.

 

Cash generated from operations and existing credit facilities are expected to be a sufficient source of liquidity for the short- and long-term and should provide adequate funding for capital expenditures. In addition, our business model, which can operate with minimal working capital, does not require significant additional capital to fund operations and organic growth. However, we may elect to seek additional sources of capital to fund growth initiatives, or if a prolonged or more severe economic downturn impacts our ability to meet our financial covenants.

 

Effective February 1, 2008, the Credit Agreement related to our revolving credit facility was amended to revise the permissible minimum interest coverage ratio and, as of the end of the first quarter of fiscal 2008, we were in full compliance with all financial covenants. We currently believe, however, that we may fall out of compliance with certain of the financial covenants under the Credit Agreement at the end of the second quarter of fiscal 2008 or thereafter. We are currently working with our lenders to amend the Credit Agreement to provide greater flexibility and to reduce the risk of future noncompliance with the financial covenants. While we believe we can negotiate an acceptable amendment, there can be no assurance that we will be successful in obtaining a satisfactory amendment of the Credit Agreement that will provide sufficient flexibility under the financial covenants. In addition, any amendment of the Credit Agreement may significantly increase the cost of credit provided under the credit facility and related expenses, which may adversely impact our profitability. Failure to obtain an amendment of the Credit Agreement could have a material adverse effect on our liquidity and on our ability to conduct our business.

 

Whether or not we are successful in obtaining an amendment of the Credit Agreement, we may need to or may choose to seek additional capital through the issuance of debt or equity securities. The issuance of any additional debt securities could materially and adversely impact our profitability and financial condition. The issuance of additional equity securities could be substantially dilutive to our existing shareholders.

 

Our agreement under which GE Money Bank offers to our qualified customers a revolving credit arrangement to finance purchases from us (the “GE Agreement”) contains the same financial covenants that are in the Credit Agreement as now in effect. If we were to fall out of compliance with the covenants in the GE Agreement, GE Money Bank could request that we provide collateral in the form of a letter of credit, which would further constrain our liquidity. We are currently working with GE Money Bank to amend the GE Agreement to provide greater flexibility and to reduce the risk of future noncompliance with the financial covenants, consistent with the amendments being discussed under the Credit Agreement. There can be no assurance, however, that we will be successful in obtaining a satisfactory amendment of the GE Agreement. If it becomes necessary to provide a letter of credit under the GE Agreement and we are unable to supply a satisfactory letter of credit, GE Money Bank could take action to terminate the GE Agreement. Termination of the GE Agreement, or any material change to the terms of the GE Agreement, or in the availability or terms of credit for our customers under the GE Agreement, or any delay in securing replacement credit sources, could have a material adverse effect on our sales, profitability and financial condition.

 

Outlook

 

We do not plan to provide specific earnings guidance for fiscal 2008. However, summarized below are key business drivers and trends, which we believe will assist investors and analysts in understanding and analyzing our business.

 

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We anticipate that macro-economic pressures will continue throughout the current fiscal year. We expect net losses to continue for the second fiscal quarter of this year, the seasonal low point for sales, with earnings improving in the second half of the current fiscal year as seasonally higher sales periods return and the benefits of cost reduction initiatives and media spending begin to take effect. Results for fiscal 2008 will benefit from a fifty-third week in the fourth quarter.

We anticipate that inflationary costs from oil and foreign currency exchange will be offset in part by higher selling prices on select products. Gross profit rates are expected to improve slightly for the balance of the current fiscal year. We anticipate that overall spending on media, selling and marketing will be in-line with 2007 over the balance of the current fiscal year. We also expect general and administrative expenses to be slightly lower than in fiscal 2007.

We are forecasting fiscal 2008 capital expenditures of approximately $30.0 million for new stores, store remodels, SAP implementation, and certain manufacturing and logistics investments, compared to $43.5 million in fiscal 2007. We expect to operate approximately 485 retail locations at the end of fiscal 2008.

Finally, we will continue to pursue initiatives that could improve sales and profitability. These initiatives include analyzing our existing manufacturing, distribution and retail operations. As a result, in future periods, we may incur restructuring expenses or asset impairment charges.  

Off-Balance-Sheet Arrangements and Contractual Obligations

 

Other than operating leases, we do not have any off-balance-sheet financing. We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships. As of March 29, 2008, we are not involved in any unconsolidated special purpose entity transactions.

 

There has been no material change in our contractual obligations since the end of fiscal 2007 other than increasing borrowings under our revolving credit facility from $37.9 million as of December 29, 2007 to $43.5 million as of March 29, 2008. See Note 4, Debt, of the Notes to our Condensed Consolidated Financial Statements. See our Annual Report on Form 10-K for the fiscal year ended December 29, 2007 for additional information regarding our contractual obligations.

 

Critical Accounting Policies

 

We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 29, 2007. There were no significant changes in our accounting policies since the end of fiscal 2007.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

At March 29, 2008, our short-term debt was comprised primarily of borrowings under our revolving line of credit. We do not currently manage interest rate risk on our debt through the use of derivative instruments.

 

Borrowings under our revolving credit facility are currently not subject to material interest rate risk. The credit facility’s interest rate may be reset due to fluctuations in a market-based index, such as the prime rate, federal funds rate or LIBOR. A hypothetical 100 basis point change in the interest rate of outstanding borrowings under our credit facility as of March 29, 2008 would change our annual consolidated pre-tax income or loss by $0.4 million.

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed by us in the reports we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer (principal executive officer) and Chief Financial Officer (principal financial officer), to allow timely decisions regarding required disclosure. We have established a Disclosure Committee, consisting of certain members of management, to assist in this evaluation. The Disclosure Committee meets on a regular quarterly basis, and as needed.

 

Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act of 1934), at March 29, 2008. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, at March 29, 2008, our disclosure controls and procedures were effective.

 

 

 

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Changes in Internal Controls

 

There was no change in internal control over financial reporting during the fiscal quarter ended March 29, 2008, that has materially affected, or is reasonably likely to materially affect our internal control over financial reporting.

 

PART II: OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

On April 25, 2008, a lawsuit was filed against one of our subsidiaries in Superior Court in Santa Clara County, California by one of our customers. The complaint asserts various claims related to products liability, breach of warranty, concealment, intentional misrepresentation and negligent misrepresentation and seeks class certification. The complaint alleges that products sold by us prior to 2006 had a unique propensity to develop mold, alleges that the plaintiff suffered adverse health effects, and seeks various forms of legal and equitable relief, including without limitation unspecified damages, punitive and exemplary damages, attorneys’ fees and costs, and injunctive relief. We believe that the complaint is without merit and intend to vigorously defend the claims.

 

We are involved from time to time in various other legal proceedings arising in the ordinary course of our business, including primarily commercial, employment and intellectual property claims. In accordance with generally accepted accounting principles in the United States, we record a liability in our consolidated financial statements with respect to any of these matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. With respect to these other matters, we believe that we have valid defenses to claims asserted against us and we do not expect the outcome of these other matters to have a material effect on our results of operations or financial position. Litigation, however, is inherently unpredictable, and it is possible that the ultimate outcome of one or more claims asserted against us could adversely impact our results of operations or financial position.

 

ITEM 1A. RISK FACTORS

 

Our business, financial condition and operating results are subject to a number of risks and uncertainties, including both those that are specific to our business and others that affect all businesses operating in a global environment. Investors should carefully consider the information in this report under the heading, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and also the information under the heading, “Risk Factors” in our most recent Annual Report on Form 10-K. The risk factors discussed in the Annual Report on Form 10-K and in this Quarterly Report on Form 10-Q do not identify all risks that we face because our business operations could also be affected by additional risk factors that are not presently known to us or that we currently consider to be immaterial to our operations.

 

We face a risk of non-compliance with certain financial covenants in our Credit Agreement and related credit arrangements and may need to obtain additional capital through the issuance of debt or equity securities.

 

Effective February 1, 2008, the Credit Agreement related to our revolving credit facility was amended to revise the permissible minimum interest coverage ratio and, as of the end of the first quarter of fiscal 2008, we were in full compliance with all financial covenants. We currently believe, however, that we may fall out of compliance with certain of the financial covenants under the Credit Agreement at the end of the second quarter of fiscal 2008 or thereafter. We are currently working with our lenders to amend the Credit Agreement to provide greater flexibility and to reduce the risk of future noncompliance with the financial covenants. While we believe we can negotiate an acceptable amendment, there can be no assurance that we will be successful in obtaining a satisfactory amendment of the Credit Agreement that will provide sufficient flexibility under the financial covenants. In addition, any amendment of the Credit Agreement may significantly increase the cost of credit provided under the credit facility and related expenses, which may adversely impact our profitability. Failure to obtain an amendment of the Credit Agreement could have a material adverse effect on our liquidity and on our ability to conduct our business.

 

Whether or not we are successful in obtaining an amendment of the Credit Agreement, we may need to or may choose to seek additional capital through the issuance of debt or equity securities. The issuance of any additional debt securities could materially and adversely impact our profitability and financial condition. The issuance of additional equity securities could be substantially dilutive to our existing shareholders.

 

Our agreement under which GE Money Bank offers to our qualified customers a revolving credit arrangement to finance purchases from us (the “GE Agreement”) contains the same financial covenants that are in the Credit Agreement as now in effect. If we were to fall out of compliance with the covenants in the GE Agreement, GE Money Bank could request that we provide collateral in the form of a letter of credit, which would further constrain our liquidity. We are currently working with GE Money Bank to amend the GE Agreement to provide greater flexibility and to reduce the risk of future noncompliance with the financial covenants, consistent with the amendments being discussed under the Credit Agreement. There can be no assurance, however, that we will be successful in obtaining a satisfactory amendment of the GE Agreement. If it becomes necessary to provide a letter of credit under the GE Agreement and we are unable to supply a satisfactory letter of credit, GE Money Bank could take action to terminate the GE Agreement. Termination of the GE Agreement, or any material change to the terms of the GE Agreement, or in the availability or terms of credit for our customers under the GE Agreement, or any delay in securing replacement credit sources, could have a material adverse effect on our sales, profitability and financial condition.

 

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a) – (b)

Not applicable.

 

 

 

 

(c)

Issuer Purchases of Equity Securities
(in thousands, except per share amounts)

 

 

Fiscal Period

 

Total Number of Shares Purchased

 

Average Price Paid per Share

 

Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs(1)

 

Approximate Dollar
Value of Shares that
May Yet Be
Purchased Under
the Plans or Programs

 

January 2008

 

 

NA

 

 

 

 

 

February 2008

 

 

NA

 

 

 

 

 

March 2008

 

 

NA

 

 

 

 

 

Total

 

 

NA

 

 

 

$206,762

 

 (1) On April 20, 2007, our Board of Directors authorized the company to repurchase up to an additional $250 million of its common stock. The Finance Committee of the Board of Directors reviews repurchases under this program on a quarterly basis. There is no expiration date governing the period over which we can repurchase shares. We may terminate or limit the stock repurchase program at any time.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

ITEM 5. OTHER INFORMATION

 

Not applicable.

 

ITEM 6. EXHIBITS

 

Exhibit
Number


Description


Method of Filing

 

 

 

10.1

Amendment No. 2 to Credit Agreement, dated as of February 1, 2008

Incorporated by reference to Exhibit 10.2
contained in Select Comfort’s
Current Report on Form 8-K filed
February 7, 2008

10.2

Second Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement, dated as of February 1, 2008

Incorporated by reference to Exhibit 10.3
contained in Select Comfort’s
Current Report on Form 8-K filed
February 7, 2008

10.3

Letter Agreement between William R. McLaughlin and Select Comfort Corporation dated as of February 21, 2008

Incorporated by reference to Exhibit 10.1
contained in Select Comfort’s
Current Report on Form 8-K filed
February 21, 2008

31.1

Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed herewith

31.2

Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed herewith

32.1

Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

Filed herewith

32.2

Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

Filed herewith

 

 

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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

 

(Registrant)

 

 

 

Dated: May 8, 2008

By:

/s/ William R. McLaughlin

 

 

 

William R. McLaughlin

 

 

Chief Executive Officer
(principal executive officer)

 

 

 

 

By:

/s/ James C. Raabe

 

 

 

James C. Raabe

 

 

Chief Financial Officer
(principal financial and accounting officer)

 

 














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EXHIBIT INDEX

 

Exhibit Number

 

Description

 

Method of Filing

 

 

 

10.1

Amendment No. 2 to Credit Agreement, dated as of February 1, 2008

Incorporated by reference to Exhibit 10.2
contained in Select Comfort’s
Current Report on Form 8-K filed
February 7, 2008

10.2

Second Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement, dated as of February 1, 2008

Incorporated by reference to Exhibit 10.3
contained in Select Comfort’s
Current Report on Form 8-K filed
February 7, 2008

10.3

Letter Agreement between William R. McLaughlin and Select Comfort Corporation dated as of February 21, 2008

Incorporated by reference to Exhibit 10.1
contained in Select Comfort’s
Current Report on Form 8-K filed
February 21, 2008

31.1

Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed herewith

31.2

Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Filed herewith

32.1

Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

Filed herewith

32.2

Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350

Filed herewith

 

 













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