FOR THE FISCAL YEAR ENDED JANUARY 1, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
COMMISSION FILE NO. 0-25121
SELECT COMFORT CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1597886
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10400 VIKING DRIVE, SUITE 400
MINNEAPOLIS, MINNESOTA 55344
(Address of principal executive offices) (Zip code)
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Registrant's telephone number, including area code: (952) 918-3000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
As of March 1, 2000, 17,756,216 shares of Common Stock of the Registrant were outstanding, and the aggregate market value of the Common Stock of the Registrant as of that date (based upon the last reported sale price of the Common Stock at that date as reported by the Nasdaq National Market System), excluding outstanding shares beneficially owned by directors and executive officers, was $58,560,277.
DOCUMENTS INCORPORATED BY REFERENCE
Parts II and IV of this Annual Report on Form 10-K incorporate by reference information (to the extent specific pages are referred to herein) from the Registrant's Annual Report to Shareholders for the fiscal year ended January 1, 2000 (the "1999 Annual Report"). Part III of this Annual Report on Form 10-K incorporates by reference information (to the extent specific sections are referred to herein) from the Registrant's Proxy Statement for its 2000 Annual Meeting to be held May 18, 2000 (the "2000 Proxy Statement").
PART I............................................................................................................2
ITEM 1. BUSINESS...........................................................................................2
General.....................................................................................................2
Business and Growth Strategy................................................................................2
Products....................................................................................................4
Retail Stores...............................................................................................5
Direct Marketing Operations.................................................................................6
E-Commerce..................................................................................................7
Marketing and Advertising...................................................................................7
Consumer Education and Customer Service.....................................................................7
Manufacturing and Distribution..............................................................................8
Suppliers...................................................................................................8
Intellectual Property.......................................................................................9
Competition.................................................................................................9
Consumer Credit Arrangements...............................................................................10
Governmental Regulation....................................................................................10
Employees..................................................................................................10
Certain Important Factors..................................................................................10
ITEM 2. PROPERTIES........................................................................................15
ITEM 3. LEGAL PROCEEDINGS.................................................................................16
ITEM 4. EXECUTIVE OFFICERS OF THE COMPANY....................................................................17
PART II..........................................................................................................19
Number of Record Holders; Dividends........................................................................19
Use of Proceeds from Initial Public Offering...............................................................19
PART III.........................................................................................................21
Directors, Executive Officers, Promoters and Control Persons...............................................21
Section 16(a) Beneficial Ownership Reporting Compliance....................................................21
PART IV..........................................................................................................22
Consolidated Financial Statements..........................................................................22
Consolidated Financial Statement Schedules.................................................................22
Exhibits...................................................................................................23
Reports on Form 8-K........................................................................................23
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K......................................................................27
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Our fiscal year ends on the Saturday closest to December 31, and unless the context otherwise requires, all references to years in this Form 10-K refer to our fiscal years. All references to "Select Comfort," "the Company," "we" or "us" herein include our wholly owned subsidiaries, Select Comfort
Direct Corporation, Select Comfort Retail Corporation, Direct Call Centers, Inc., Select Comfort SC Corporation and selectcomfort.com corporation.
Select Comfort(R), Sleep Number(R), Comfort Club(R), 90 Night Trial, Better Night's Sleep Guarantee, Sleep Solutions, The Sleep Solutions Company, Sleep Better on Air, The Air Bed Company and the Company's stylized logo are trademarks and/or service marks of the Company.
This Form 10-K contains certain forward-looking statements. For this purpose, any statements contained in this Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, words such as "may," "will," "expect," "believe," "anticipate," "estimate" or "continue" or comparable terminology are intended to identify forward-looking statements. These statements by their nature involve substantial risks and uncertainties, and actual results may differ materially depending on a variety of factors, including those set forth under the heading below entitled "Certain Important Factors."
ITEM 1. BUSINESS
GENERAL
Select Comfort is the leading manufacturer, specialty retailer and direct marketer of premium quality, premium priced, innovative air beds and sleep-related products. We believe we are revolutionizing the mattress industry by offering a differentiated product through a variety of service-oriented distribution channels.
Our products address broad-based consumer sleep problems, resulting in a better night's sleep. Our proprietary technology allows our air beds to more naturally contour to the body, thereby generally providing:
- better spinal alignment,
- reduced pressure points,
- greater relief of lower back pain,
- greater overall comfort, and
- better quality sleep
in comparison with traditional mattress products. A firmness control system allows customers to independently customize the firmness on each side of the Select Comfort air bed to their optimal level of comfort and support.
Unlike traditional mattress manufacturers, we sell our products directly to consumers through three controlled, complementary and service-oriented distribution channels:
- Retail, including company-operated retail stores and leased departments within larger retail stores,
- Direct Marketing, including company-operated call centers, and
- E-commerce, through our website at www.selectcomfort.com.
At January 1, 2000, our retail operations included 341 stores in 45 states, including 45 leased departments within larger retail stores. In 2000, we plan to close approximately 22 under-performing retail locations, including 12 leased departments, and to open approximately 20 new retail locations in markets we believe can support additional stores.
Select Comfort was incorporated in Minnesota in February 1987. Our principal executive office is located at 10400 Viking Drive, Suite 400, Minneapolis, Minnesota 55344. Our telephone number is (952) 918-3000.
BUSINESS AND GROWTH STRATEGY
Our strategic plan adopted at the end of 1999 is designed to leverage our competitive advantages and core strengths, which include:
- Superior Products that Provide Real Benefits to Consumers. Our products differ from traditional mattresses by addressing broad-based consumer sleep problems through the greater comfort and support of sleeping on air and through the ability to customize the firmness on each side of the mattress at the touch of a button. Through continuous improvement of our innovative air beds, we have led the growing air bed segment of the mattress industry.
- Direct Contact with Our Customers. We maintain direct contact with our customers
through each of our controlled distribution channels and through our own customer service representatives. This enables us to better understand consumer desires, to respond to those desires with product improvements and product line extensions, to enhance overall customer satisfaction and to build brand loyalty through long-term relationships with customers. We have an installed base of approximately 725,000 customers.
- Multiple Complementary Distribution Channels. Our three complementary distribution channels give consumers multiple, convenient opportunities to purchase our product, and give us advantages that many of our competitors do not have, including 341 retail stores across the continental United States, two direct marketing call centers, e-commerce capability, the ability to leverage advertising dollars across multiple channels, and a database of approximately 5.5 million inquiries.
- Dedicated, Highly Trained Employees throughout the Company. Employees throughout our company firmly believe in the superiority of our products and the real benefits provided to consumers, and are universally committed to providing a better night's sleep. Sales professionals receive extensive training in sleep research and in the features and benefits of our proprietary products. We also maintain a customer service department of over 40 employees who receive similar training and are prepared to respond to consumer questions. Our senior management team has been substantially enhanced in the last year and our new CEO, Bill McLaughlin, joined our company in late March 2000.
Building on these advantages and strengths, our strategic plan includes the following key elements:
- Integrated Marketing. Our marketing messages will emphasize the personalized sleep solutions provided by our products. These messages will be consistent across our multiple distribution channels and focused on call to action marketing, cross channel marketing and retail lead generation. We are also planning to redesign our web site and introduce a catalog to our customers.
- Focus on Retail Store Profitability. We are generating marketing plans with specific actions oriented to the circumstances in each individual retail market. We will be closing approximately 22 under-performing retail locations, including 12 leased departments, and plan to open approximately 20 retail locations in 2000. We have recently adopted a new retail store design with an environment that is more consistent with our sleep solutions oriented brand. We plan to remodel approximately 100 stores with the new design in 2000.
- In-Home Delivery, Assembly and Mattress Removal. We are developing plans to ultimately provide in-home delivery, assembly and mattress removal nationwide across each of our distribution channels. We believe that this additional service will enhance customer satisfaction and demand for our products.
- Introduce Sofa Sleeper Product. We plan to introduce a sofa sleeper product across all of our distribution channels in 2000. The sofa sleeper features an easy slide-out mechanism, rather than a heavy, folding metal frame, an 11-inch thick, fully adjustable air mattress that inflates in about one minute, and no metal bar.
- Continuous Improvement of Our Core Product Line. In order to improve customer satisfaction and strengthen our leadership position in the growing air bed segment of the mattress industry, we intend to focus
our product development efforts on our core line of air beds.
- Reduced General and Administrative Expenses and Operating Costs. In early 2000, we eliminated our Roadshow distribution channel and approximately 15% of our corporate and administrative positions. The Roadshow channel sold to smaller markets without a retail presence and accounted for a small and diminishing percentage of our sales as our retail presence and e-commerce capabilities have grown. We will continue our event marketing efforts through home shows, state fairs and similar events. We intend to continue to look for opportunities to create operating efficiencies.
PRODUCTS
Air Beds
Every Select Comfort air bed has a patented air chamber as its functioning core and comes with a patented firmness control system that allows the customer to easily and instantly customize the firmness of the mattress at the touch of a button. All of our air beds, except twin size mattresses, are available with independent air chambers for each side of the mattress, allowing customized firmness for each sleep partner. Our Imperial and Ultra Series of air beds feature a wireless remote control with a digital display of the user's "Sleep Number," which reflects the level of firmness and allows the customer to more easily adjust and readjust the firmness level to the customer's personal preference. Our air beds feature either a traditional cover or a pillowtop style cover that includes zoned foam and provides extra cushioning. The covers are constructed with sanitized and hypoallergenic Damask ticking made from blends of polyester/polypropylene or cotton/rayon, or from 100% rayon. Our air beds are manufactured in a broad array of sizes and styles, including all standard bed sizes and a waterbed replacement size that fits into a customer's existing waterbed frame. Our Ultra and Imperial models feature a "whisper quiet" air pump.
Our air beds can be assembled by customers in a simple process requiring no tools and can be moved more easily than a traditional mattress and box spring. Furthermore, because air is the primary support material of the mattress, Select Comfort air beds do not lose their shape or support over time like traditional mattresses and box springs. Each air bed is accompanied with instructional product brochures and easy to follow assembly instructions, is certified by Underwriter's Laboratories and is backed by a 20-year limited warranty and our 90 Night Trial and Better Night's Sleep Guarantee.
Foundations and Accessory Products
In addition to air beds, we offer matching foundations and a line of accessory products, including a line of bed frames and high quality mattress pads with zoned heating and specialty pillows, all of which are hypoallergenic and designed to provide comfort and better quality sleep.
We maintain an active engineering department that continuously seeks to enhance our knowledge of sleep science and to improve current product performance and benefits. Through customer surveys and consumer focus groups, we seek feedback on a regular basis to help enhance our products.
Since the introduction of our first air bed, we have continued to improve and expand our product line, including quieter firmness control systems, remote control gauges with digital settings, more luxurious fabrics and covers, new generations of foams and foundation systems and enhanced border walls. Our research and development expenses were $1.9 million for 1999, $1.6 million for 1998 and $1.8 million for 1997.
RETAIL STORES
Since our first retail stores were opened in 1992, an increasing percentage of our net sales has occurred at our retail stores, and retail store sales now account for a majority of our net sales. At January 1, 2000, we had 341 stores in 45 states, including 45 leased departments. In 2000, we plan to close approximately 22 under-performing retail locations, including 12 leased departments, and to open approximately 20 retail stores.
Store Environment. Our currently most prevalent store design, including novel visual images on the walls, was intended to command attention to our innovative products. We have recently adopted a new store design with a bedroom-like setting intended to convey a sense of sophistication and quality that reinforces Select Comfort's brand image as synonymous with sleep solutions. We plan to remodel approximately 100 of our stores with this updated retail store design in 2000. Our retail stores are principally showrooms, averaging approximately 900 square feet, with several display models from our line of air beds and a full display of our branded accessories.
Our sales professionals play an important role in creating an inviting and informative retail environment. These professionals receive extensive training regarding the features and benefits of our proprietary technology and products as well as on the overall importance of sleep quality. This enables them to more effectively introduce consumers to our products, emphasize the features and benefits that distinguish Select Comfort air beds from traditional mattresses, determine the consumers' needs, encourage consumers to experience the comfort and support of the air beds and answer questions regarding our products.
Site Selection. In selecting new store sites, we generally seek high-traffic mall locations of approximately 800 to 1,200 square feet within malls in major metropolitan and regional areas. We conduct extensive analyses of potential store sites and base our selection on a number of factors, including the location within the mall, demographics of the trade area, the specifications of the mall (including size, age, sales per square foot and the location of the nearest competitive mall), the perceived strength of the mall's anchor stores, the performance of other specialty retail tenants in the mall, the number of direct marketing inquiries received from the area surrounding the mall, store density of existing stores and marketing and advertising plans in the respective markets. Clustering of retail stores within a metropolitan retail market is a key consideration in order to leverage our advertising.
Marketing and Advertising. We historically have supported some of our multiple store markets with media primarily focused on the use of radio personalities. During 1999 we expanded this media focus to include newspaper advertising and spot radio. We expect to continue this marketing focus in 2000 to support those markets that generate the majority of our retail sales. In addition, our integrated marketing efforts will more closely align the advertising directed toward our direct marketing customers with that in the retail channel and will include national print media which is designed to increase product and store awareness.
We also support new store openings with mailings to direct response inquiries and potential prospects in the market, and in some cases with print and radio advertisements. We use local radio and print advertisements and promotional offers during high mall traffic periods, such as three-day holiday weekends, and in-store events, including live remote broadcasts and promotional contests.
Management and Employees. Our stores are currently organized into eight regional areas and 46 geographic districts, with approximately eight stores in each district. Each regional sales director oversees approximately six geographic districts. Each district has a district sales manager who is responsible for the sales and operations and who reports to a regional sales director. The district sales managers frequently visit stores to review merchandise presentation, sales force product knowledge, financial performance and compliance with operating
standards. The typical staff of a Select Comfort store consists of one store manager and two full-time sales professionals. In order to maintain high operating standards, we recruit store managers who typically have one to four years of experience as a store manager in specialty retailing. The sales professionals devote substantially all of their efforts to sales and customer service, which includes helping customers and generating and responding to inquiries. In addition, to promote consumer education, ensure customer satisfaction and generate referrals, the sales professionals place follow-up calls to customers who have made recent purchases or inquiries.
Training and Compensation. All store personnel receive comprehensive on-site training on our technology and sleep expertise, the features and benefits of our air beds, sales and customer service techniques and operating policies and guidelines. Initial training programs are reinforced through detailed product and operating manuals and periodic performance appraisals. All store sales professionals receive base compensation and are entitled to commissions based on individual and store-wide performance. Regional sales directors, district sales managers and store managers are eligible to receive, in addition to their base compensation, incentive compensation for the achievement of performance objectives by the stores within their responsibility.
Event Marketing Group. Our retail organization also manages an event marketing group that sells our products at home shows and consumer product shows, state fairs and similar events. Select Comfort sales professionals, supported by advance mailings to direct marketing inquiries, travel to such events to demonstrate our products in temporary showrooms or in booths and educate consumers about the benefits of our products.
DIRECT MARKETING OPERATIONS
Many consumers' initial exposure to the Select Comfort air bed is through our direct marketing operations. Typically, an interested consumer will respond to one of our advertisements by calling our toll-free number. On this call, one of our direct marketing sales professionals captures information from the consumer, begins the consumer education process, takes orders, or, if appropriate, directs the consumer to our other distribution channels. The direct marketing operations are conducted by knowledgeable and well-trained sales professionals, including a group of over 40 sales professionals who field incoming direct marketing inquiries, and over 35 sales professionals who make outbound calls to consumers who have previously contacted the Company. The direct marketing operations also include a database marketing department that is responsible for mailings of product and promotional information to direct response inquiries. We maintain a database of information on approximately 5.5 million inquiries, including customers who have purchased an air bed from us.
In the direct marketing channel, our advertising message is communicated through targeted print and radio advertisements, as well as through product brochures, videos and other product and promotional materials mailed in response to consumer inquiries at various intervals. As our advertising budget has expanded over the last few years, the direct marketing channel has relied heavily on nationally syndicated radio personalities, such as Paul Harvey and Rush Limbaugh, and has expanded print and direct mail expenditures. Our direct marketing operations continually monitor the effectiveness and efficiency of our advertising through tracking the cost per inquiry and cost per order of our advertising, using focus groups to evaluate the effectiveness of our advertising messages and using sophisticated media buying techniques.
Our direct marketing operations also support our other distribution channels through referrals, as well as mailings to direct marketing inquiries in selected markets in advance of retail store openings and events. As our base of retail stores has expanded, our direct marketing sales professionals have increasingly been able to refer direct marketing inquiries to a convenient
retail store location, improving the process of converting inquiries into sales and providing the consumer with a choice of service venues.
E-COMMERCE
Our web site at www.selectcomfort.com provides consumers with a wide array of useful information as well as the convenience to order our products online. Since building the capability to take online orders in May 1999, our e-commerce channel has continued to add functionality and content to educate consumers regarding:
- sleep research and science,
- our products and the benefits they provide,
- store locations and other means to contact us and experience our products,
- customer testimonials,
- customer service information, and
- current sales and promotional events.
Our e-commerce channel has also focused on developing relationships with online shopping malls and other sales portals and affiliates.
We plan to launch our redesigned web site in the second quarter of 2000 with an updated look and feel that is attractive, professional and reinforces the Select Comfort brand image. The redesigned site will also allow greater functionality to provide more personalization, guided selling, dynamic content and promotions and a more robust online shopping experience. Ultimately, we plan to have real-time keyboard to keyboard interaction between customers and our sales and customer service representatives. In the future, the site may be maintained through a remote content management system to ease maintenance and the ability to add content from outside sources. We also intend to integrate the web site with our fulfillment systems to enhance operational efficiency.
MARKETING AND ADVERTISING
The primary objective of our marketing and advertising strategy is to increase awareness of the Select Comfort brand and become recognized as the leader in sleep solutions, sleep expertise and superior quality products. Our integrated approach to marketing will emphasize consistent messages across our distribution channels with a greater emphasis on call to action and cross channel marketing. In the past, we have spent the majority of our advertising budget on direct marketing, which indirectly drove traffic to our expanding base of retail stores. In recent periods more of our advertising dollars have been, and in the future will be, dedicated to retail store lead generation.
The majority of our advertising budget is devoted to print ads in newspapers and magazines and to radio advertising with well-known national personalities, as well as local radio personalities in selected retail markets. In 2000, we intend to reduce our use of long and short-form television advertising. As our e-commerce channel expands, more advertising dollars may be devoted to Internet-based marketing programs. We also plan to launch our own catalog to our customers and inquiries. Our catalog will include an expanded selection of sleep solution oriented products including our core line of air beds and accessories, the new line of Select Comfort sofa sleepers, bedroom furnishings and a variety of other bedroom and sleep related products for the entire family.
CONSUMER EDUCATION AND CUSTOMER SERVICE
We are committed to achieving our goal of world class customer satisfaction and service. We intend to achieve this goal through a variety of means designed to:
- educate consumers on the benefits of Select Comfort products,
- deliver superior quality products,
- maximize our direct relationship with consumers,
- maximize convenience for the consumer, and
- respond quickly to consumer needs and inquiries.
We believe that educating consumers about the features and benefits of our products is critical to the success of our marketing and sales efforts, and we devote considerable time and resources to training programs for our sales professionals. Our retail stores and our web site also provide customers with the latest information on sleep research and science and the benefits of our products.
Our controlled distribution channels optimize our direct contact with customers and allow us to respond quickly to customer service inquiries and enhance customer satisfaction. Our multiple distribution channels also enhance the convenience for the consumer to purchase products through a variety of venues. In addition, we have been testing the offering of in-home delivery, assembly and mattress removal services in selected markets through national providers. We are developing plans to ultimately provide these services nationwide across all of our distribution channels in order to increase overall sales and enhance customer satisfaction.
We maintain an in-house customer service department of over 40 customer service representatives who receive extensive training in sleep technology and all aspects of our products and operations. Our customer service representatives field customer calls and also interact with each of our retail stores to address customer questions and concerns raised with retail sales professionals. The customer service department makes outbound calls to new customers during the 90 Night Trial phase to answer questions and provide solutions to possible problems in order to enhance customer education, build customer satisfaction and reduce returns.
MANUFACTURING AND DISTRIBUTION
Our manufacturing operations are located in Minneapolis, Minnesota, Columbia, South Carolina, and Salt Lake City, Utah (opened in May 1999). These operations consist of quilting and sewing of the fabric covers for our air beds, assembly of firmness control systems (only in Minneapolis) and final assembly and packaging of air beds and foundations from contract manufactured components. Our Minneapolis and Columbia plants operate on two shifts and our Salt Lake City plant operates on one shift. We believe we have sufficient capacity to meet anticipated increases in demand through the next 12 months.
We manufacture air beds to meet orders rather than to stock inventory, which enables us to maintain lower levels of inventory. As we expand our home delivery and assembly services, we may use regional distribution centers that would stock inventory to fill orders on a more timely basis. Orders are currently shipped from one of our three distribution centers, primarily via UPS, typically within 48 hours following order receipt, and are usually received by the customer within five to seven business days after shipment. We are continually evaluating alternative carriers on a national and regional basis, as well as testing providers of in-home assembly services in selected markets.
SUPPLIERS
We currently obtain all of the materials and components used to produce our air beds from outside sources. Components for the firmness control systems are obtained from a variety of domestic sources. Quilting and ticking materials are obtained from a supplier that produces both in Belgium and in the United States and components for foundation systems are obtained primarily from two domestic sources.
Our proprietary air chambers are produced to our specifications by one Eastern European supplier under a supply contract expiring in August 2000 (subject to automatic renewal if neither party gives 90 days' notice of non-renewal), pursuant to which we are obligated to purchase certain minimum quantities. We expect to continue the relationship with the Eastern European supplier for the foreseeable future. We believe that we would be able to procure an adequate supply of air chambers from other sources on a timely basis if the
supply contract is terminated or the Eastern European supplier is otherwise unable to supply air chambers.
INTELLECTUAL PROPERTY
Certain elements of the design and function of our air beds are the subject of United States and foreign patents and patent applications owned by us. We have 18 issued U.S. patents and six U.S. patent applications pending. We also held 13 foreign patents and had 19 foreign patent applications pending as of January 1, 2000.
The name "Select Comfort" and our logo are trademarks registered with the United States Patent and Trademark Office. We have a number of other registered marks, including the trademarks "Comfort Club" and "Sleep Number," the service marks "Comfort Club" and "Sleep Better on Air," and a number of unregistered marks, including the trademarks "90 Night Trial," "Better Night's Sleep Guarantee," "Sleep Solutions," "The Sleep Solutions Company" and "The Air Bed Company." We have registered several of these trademarks in numerous foreign countries and have approximately 45 trademarks registered, or the subject of pending applications, in foreign countries. Each federally registered mark is renewable indefinitely if the mark is still in use at the time of renewal. We are not aware of any material claims of infringement or other challenges to our right to use our marks.
In November 1999, we initiated a patent infringement suit against Simmons Company and Price Manufacturing Inc. alleging that Simmons-branded air beds manufactured by Price Manufacturing infringed three of our patents. In February 2000, we settled our suit against Simmons after Simmons terminated its license agreement with Price Manufacturing, effectively ending Simmons' involvement with the manufacture and sale of air beds with a hand control that are the subject of the suit. Price Manufacturing was not a part of the settlement and we intend to continue to prosecute our suit against Price Manufacturing.
COMPETITION
The mattress industry is highly competitive. Participants in the mattress industry compete primarily on price, quality, brand name recognition, product availability and product performance, including the perceived levels of comfort and support provided by a mattress. Our air beds compete with a number of different types of mattress alternatives, including innerspring mattresses, waterbeds, futons and other air-supported mattresses that are sold through a variety of channels, including furniture stores, bedding specialty stores, department stores, mass merchants, wholesale clubs, telemarketing programs, television infomercials and catalogs. We believe that our success depends in part on increasing consumer acceptance of our existing products and the continuing introduction of products that have qualities and benefits which differentiate our products from those offered by other manufacturers.
The traditional mattress industry is characterized by a high degree of concentration among the four largest manufacturers of innerspring mattresses with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand name, Serta, Simmons and Spring Air. The balance of the mattress market is served by over 700 manufacturers, primarily operating on a regional basis. Many of these competitors, and in particular the four largest manufacturers named above, have greater financial, marketing and manufacturing resources and better brand name recognition than us, and sell their products through broader and more established distribution channels.
A number of companies have begun to offer air beds. There can be no assurance that these or any other mattress manufacturer will not aggressively pursue the air bed market. Any such competition by established manufacturers or new entrants into the market could have a material adverse effect on our business, financial condition and operating results. In addition, should any of our competitors reduce
prices on premium mattress products, we may be required to implement price reductions in order to remain competitive, which could have a material adverse effect on our business, financial condition and operating results.
CONSUMER CREDIT ARRANGEMENTS
We use a third-party bank to offer our qualified customers an unsecured revolving credit arrangement to finance purchases from us. The bank sets the rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts. In connection with all purchases financed under these arrangements, the bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts. Effective July 1999, we terminated our then existing credit arrangement and entered into a new agreement with another provider. The new provider purchased substantially all of the outstanding customer receivables from the old provider. As a result of the purchase of this portfolio, we received $9.8 million that had been retained by the previous provider as security and included in our accounts receivable. The previous bank had retained $11.4 million as of January 2, 1999 under terms of its agreement. There are no retainage amounts as a part of the new agreement.
GOVERNMENTAL REGULATION
Our products and our marketing and advertising practices are subject to regulation by various federal, state and local regulatory authorities, including the Federal Trade Commission. The mattress industry also engages in advertising self-regulation through certain voluntary forums, including the National Advertising Division of the Better Business Bureau. We are also subject to various other federal, state and local regulatory requirements, including federal, state and local environmental regulation and regulations issued by the U.S. Occupational Safety and Health Administration.
EMPLOYEES
At January 1, 2000, we employed 1,979 persons, including 1,187 retail store employees, 117 direct marketing employees, 46 customer service employees, 18 road show sales professionals, 380 manufacturing and distribution employees and 277 management and administrative employees. Approximately 185 of our employees were employed on a part-time basis at January 1, 2000. Except for managerial employees and professional support staff, all of our employees are paid on an hourly basis plus commissions for sales associates. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We believe that our relations with our employees are good.
CERTAIN IMPORTANT FACTORS
There are several important factors that could cause our actual results to differ materially from those anticipated by us or which are reflected in any of our forward-looking statements. These factors, and their impact on the success of our operations and our ability to achieve our goals, include the following:
History of Operating Losses; Uncertain Profitability
Since inception, we have incurred substantial operating losses and there can be no assurance that we will achieve profitability on a quarterly or annual basis in future periods. Our future operating results will depend upon a number of factors, including:
- our ability to achieve the objectives of our strategic plan,
- the level of consumer acceptance of our products,
- our ability to create product and brand name awareness,
- the effectiveness and efficiency of our marketing and advertising,
- the performance of our existing and new retail stores,
- our ability to successfully identify and respond to emerging trends in the
mattress industry,
- the level of competition in the mattress industry,
- general economic conditions and consumer confidence, and
- our ability to maintain cost-effective production and delivery of products.
Uncertainty of Success of Strategic Plan
Until mid-1999, our net sales had grown significantly over several years, primarily as a result of an aggressive retail store growth strategy and strong comparable store sales increases. In late 1999 we adopted the new strategic plan discussed above under "Business and Growth Strategy." The success of this strategic plan to restore profitable sales growth, and the success of our company as a whole, will be dependent on a variety of factors, including:
- our ability to develop marketing programs and advertising messages that
increase awareness of our products and brand name, drive consumers to our
retail stores and increase sales,
- our ability to develop and implement market by market action plans that
improve the performance of our retail stores,
- the success of our new retail store design in attracting customers to our
stores,
- our ability to hire, train, manage and retain qualified retail store
management and sales professionals,
- our ability to successfully launch and commercialize the sofa sleeper
product across our distribution channels and in major markets,
- the ability of the suppliers of the sofa sleeper product to deliver product
to specifications on a timely basis,
- our ability to successfully launch and commercialize nationwide in-home
delivery, assembly and mattress removal services on a cost-effective basis,
- the ability of third-party providers of regional warehousing, delivery,
assembly and mattress removal services to provide quality services on a
cost-effective basis,
- our ability to use the Internet to drive sales, educate customers and
market our products,
- our ability to successfully launch and commercialize a catalog to our
installed base of customers,
- the level of consumer acceptance of our catalog products,
- the ability of third-party catalog fulfillment providers to fulfill catalog
orders on a timely basis,
- our ability to continue to improve our product line to enhance customer
acceptance and customer satisfaction, and
- our ability to manage our general and administrative expenses and our
operating costs.
There can be no assurance that we will be successful in achieving this strategic plan or that this strategic plan will restore our company to historical sales growth rates or profitability. Failure to successfully execute any material part of our strategic plan could have a material adverse effect on our business, financial condition and operating results.
Sales Tax Considerations
In compliance with state and federal tax regulations, our direct marketing and e-commerce channels have not historically collected sales tax from customers who reside in certain states. Industry experts believe these regulations potentially provide a competitive
advantage to direct marketers and e-commerce companies over retailers located within these states and who are required to collect sales tax. In connection with our plans to provide in-home delivery and assembly of our products to customers through all of our distribution channels, as well as the execution of our integrated marketing plan, we will begin collecting sales tax on sales in all states. While we believe the execution of these initiatives will positively impact the overall performance of our company, the impact of this change could negatively impact sales.
Effectiveness and Efficiency of Advertising Expenditures
Our advertising expenditures increased from $9.0 million in 1995 to $43.4 million in 1999, and are expected to continue to increase for the foreseeable future. Our future growth and profitability will be dependent in part on the effectiveness and efficiency of our advertising expenditures, including our ability to:
- create greater awareness of our products and brand name,
- determine the appropriate creative message and media mix for future
advertising expenditures,
- effectively manage advertising costs (including creative and media) in
order to maintain acceptable costs per inquiry, costs per order and
operating margins, and
- convert inquiries into actual orders.
No assurance can be given that our planned increases in advertising expenditures will result in increased sales, will generate sufficient levels of product and brand name awareness or that we will be able to manage our advertising expenditures on a cost effective basis.
Fluctuations in Comparable Store Sales Results
Our comparable store sales results have fluctuated significantly in the past and these fluctuations are likely to continue. Stores enter the comparable store calculation in their 13th full month of operation. Our comparable store sales increases were 4.7% for 1999, 17.9% for 1998 and 34.6% for 1997.* Our comparable store sales results have fluctuated significantly from quarter to quarter with increases ranging from -2.8% to 36.0% on a quarterly basis for 1997 through 1999. There can be no assurance that our comparable store sales results will not fluctuate significantly in the future.
A variety of factors affect our comparable store sales results, including:
- the level of consumer awareness of our products and brand name,
- the rate of consumer acceptance of our products,
- the higher levels of sales in the first year of operations as each
successive class of new stores is opened,
- the strong comparable store sales performance in prior periods,
- the maturation of our store base,
- the timing and relative success of promotional events, advertising
expenditures, new product introductions and product line extensions,
- a change in the sales mix between our distribution channels, and
- general economic conditions and consumer confidence.
Decreases in comparable store sales results could have a material adverse effect on our business, financial condition and operating results.
Quarterly Fluctuations and Seasonality
Our quarterly 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 increases in return rates,
- the timing of new store openings and related expenses,
- competitive factors,
- net sales contributed by new stores,
- any disruptions in third-party delivery services, and
- general economic conditions and consumer confidence.
Our business is also subject to some seasonal influences, with heavier concentrations of sales during the fourth quarter holiday season due to higher mall traffic.
The level of spending related to sales and marketing expenses and new store opening costs cannot be adjusted quickly and is based, in significant part, on our expectations of future customer inquiries and net sales. If there is a shortfall in expected net sales or in the conversion rate of customer inquiries, we may be unable to adjust our spending in a timely manner and our business, financial condition and operating results may be materially adversely affected. Our results of operations for any quarter are not necessarily indicative of the results that may be achieved for a full year or any future quarter.
Return Policy and Product Warranty
Part of our marketing and advertising strategy focuses on providing a 90 Night Trial in which customers may return the air bed and obtain a refund of the purchase price. An increase in return rates could have a material adverse effect on our business, financial condition and operating results. We also provide our customers with a limited 20-year warranty on our air beds. We have only been selling air beds in significant quantities since 1992. There can be no assurance that our warranty reserves will be adequate to cover future warranty claims, and such failure could have a material adverse effect on our business, financial condition and operating results.
Product Development and Enhancements
Our growth and future success will depend upon our ability to enhance our existing products and to develop and market new products on a timely basis that respond to customer needs and achieve market acceptance. There can be no assurance that we will be successful in developing or marketing enhanced or new products, or that any such products will be accepted by the market. Further, there can be no assurance that the resulting level of sales of any of our enhanced or new products will justify the costs associated with their development and marketing.
Market Acceptance
The U.S. mattress market is dominated by four large manufacturers of innerspring mattresses. Our air bed technology represents a significant departure from traditional innerspring mattresses. The market for air beds is continuing to evolve and the success of our products will be dependent upon both the continued growth of this market and upon market acceptance of our air beds. The failure of our air beds to achieve market acceptance for any reason would have a material adverse effect on our business, financial condition and operating results.
Reliance Upon Vendors; Single Source of Supply of Air Chambers; Foreign Sources of Supply
The inability of our suppliers to meet, for any reason, our requirements for any components of our air bed products, or our requirements of sofa sleeper products, could have a material adverse effect on our business, financial condition and operating results. Our air chambers are currently obtained from a single source of supply. If this supplier became unable or unwilling for any reason to continue to supply us with air chambers, our operations could be materially adversely affected. We currently have a supply agreement with this single source of supply that expires in August 2000 (subject to automatic
renewal if neither party gives 90 days' notice of non-renewal), but there can be no assurance that this single source of supply will not be disrupted for any reason. In addition, since our air chambers and certain other supplies are manufactured outside the United States, our operations could be materially adversely affected by the risks associated with foreign sourcing of materials, including:
- political instability resulting in disruption of trade,
- existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States or increase the cost of such goods, and
- any significant fluctuation in the value of the dollar against foreign currencies.
With the exception of our air chambers, we have no long-term purchase contracts or other contractual assurances of continued supply, pricing or access to components. The inability or failure of one or more key vendors to supply components, the loss of one or more key vendors or a material change in our purchase terms could have a material adverse effect on our business, financial condition and operating results.
Reliance Upon Carriers
Historically, we have relied almost exclusively on UPS for delivery of our products to customers. For a significant portion of the third quarter of 1997, UPS was unable to deliver our products within acceptable time periods, causing delays in deliveries to customers and requiring us to use alternative carriers. No assurance can be given that UPS will not experience difficulties in meeting our requirements in the future. We continue to evaluate alternative carriers on a national and regional basis, as well as providers of in-home delivery and assembly services. There can be no assurance that alternative carriers will be able to meet our requirements on a timely or cost-effective basis. Any significant delay in deliveries to customers or increase in freight charges may have a material adverse effect on our business, financial condition and operating results.
Intellectual Property Protection
No assurance can be given that our current pending patents will provide substantial protection or that others will not be able to develop products that are similar to or competitive with our air beds. In addition, there can be no assurance that copyright, trademark, trade secret, unfair competition and other intellectual property laws, nondisclosure agreements and other protective measures will preclude competitors from developing products similar to our products or otherwise competing with us. In addition, the laws of certain foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States.
Although we are unaware of any basis for an intellectual property infringement or invalidity claim against us, there can be no assurance that third parties, including competitors, will not assert such claims against us or that, if asserted, such claims will not be upheld. Intellectual property litigation, which could result in substantial cost to and diversion of effort by management, may be necessary to enforce our patents, to protect our trade secrets and proprietary technology or to defend us against claimed infringement of the rights of others and to determine the scope and validity of the proprietary rights of others. There can be no assurance that we would prevail in any such litigation or that, if it is unsuccessful, we would be able to obtain any necessary licenses on reasonable terms or at all.
Competition
The mattress industry is highly competitive. Our air beds compete with a number of different types of mattress alternatives, including innerspring mattresses, waterbeds, futons and other air-supported mattresses that are sold through a variety of channels, including furniture stores, bedding specialty stores, department stores, mass merchants, wholesale
clubs, telemarketing programs, television infomercials and catalogs.
The traditional mattress industry is characterized by a high degree of concentration among the four largest manufacturers of innerspring mattresses with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand name, Serta, Simmons and Spring Air. Over 700 manufacturers, primarily operating on a regional basis serve the balance of the mattress market. Many of these competitors, and in particular the four largest manufacturers named above, have greater financial, marketing and manufacturing resources and better brand name recognition than us, and sell their products through broader and more established distribution channels.
A number of companies have begun to offer air beds. There can be no assurance that these or any other mattress manufacturer will not aggressively pursue the air bed market. Any such competition by the established manufacturers or new entrants into the market could have a material adverse effect on our business, financial condition and operating results. In addition, should any of our competitors reduce prices on premium mattress products, we may be required to implement price reductions in order to remain competitive, which could have a material adverse effect on our business, financial condition and operating results.
Shareholder Litigation
Select Comfort and certain former officers and directors have been named as defendants in a class action lawsuit filed 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 former 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. While we believe that the complaint is without merit and intend to vigorously defend the claims, there can be no assurance that we will be successful in defending the lawsuit. Defense of the suit could be expensive and may create a distraction to the management team. If we are unsuccessful in defending the suit, an adverse judgment could have a material adverse effect on our consolidated financial condition or results of operations.
Volatility in Market Price of Common Stock
The market price of our common stock has fluctuated significantly in the past and may do so in the future. The market price of our common stock may fluctuate as a result of a variety of factors, many of which are outside of our control, including without limitation the following factors:
- variations in quarterly operating results;
- changes in estimates by securities analysts;
- announcements of significant events;
- additions or departures of key personnel; and
- changes in market valuations of companies in our industry.
ITEM 2. PROPERTIES
We currently lease all of our existing retail store locations and expect that our policy of leasing, rather than owning, will continue as we expand. Our store leases generally provide for an initial lease term of 10 years with a mutual termination option if we do not achieve certain minimum annual sales thresholds. Generally, the store leases require us to pay minimum rent plus percentage rent based on net sales in excess of certain thresholds, as well as certain operating expenses.
We lease approximately 122,000 square feet of space in Minneapolis for one of our
manufacturing and distribution centers, one of our direct marketing call centers, a customer service center and a research and development center, which lease expires in 2004. We lease an additional 38,000 square feet of space in Minneapolis for our corporate offices, which lease expires in 2004. We also lease approximately 105,000 square feet of space in Columbia, South Carolina, for our second manufacturing and distribution center and a direct marketing call center, which lease expires in 2003. We have also leased approximately 100,800 square feet in Salt Lake City for a third manufacturing and distribution center that opened in May of 1999, which lease expires in 2009.
ITEM 3. LEGAL PROCEEDINGS
Select Comfort and certain former officers and directors have been named as defendants in a class action lawsuit filed 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.
We and the individual defendants brought a motion to dismiss all claims on
November 10, 1999. The motion was heard by the magistrate on December 21, 1999.
On January 27, 2000, the magistrate recommended dismissal of the claims based on
Section 11 of the Federal securities laws. 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. On February 15, 2000, the parties formally objected
to the magistrate's recommendation. The objection was made to the United States
District Court in Minnesota who must issue the ruling on defendants' motion. The
Court has not yet issued its ruling.
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 $2,326 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 are adequately covered by insurance or are provided for in the consolidated financial statements and the ultimate outcome of these matters will not have a material effect on the consolidated financial position or results of operations of the Company.
ITEM 4. EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers, their ages and the offices held, as of March
31, 2000, are as follows:
NAME AGE TITLE
----------------------------- ---- -------------------------------------
William R. McLaughlin 43 President and Chief Executive Officer
Tracey T. Breazeale 33 Senior Vice President, Strategic
Planning and Branding
Renee M. Christensen 43 Senior Vice President, E-Commerce
James D. Gaboury 38 Vice President, Direct Marketing
Mark A. Kimball 41 Senior Vice President, Chief
Administrative Officer, General
Counsel and Secretary
Gregory T. Kliner 62 Senior Vice President of Operations
Ronald E. Mayle 42 Senior Vice President, Retail
James C. Raabe 40 Vice President and Chief Financial
Officer
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Information regarding the business experience of our executive officers is set forth below.
William R. McLaughlin joined Select Comfort in March 2000 as President and Chief Executive Officer. From December 1988 to March 2000, Mr. McLaughlin served as an executive of Pepsico Foods International in various capacities, including from September 1996 to March 2000 as President of Frito Lay Europe, Middle East and Africa, and from June 1993 to June 1996 as President of Grupo Gamesa, a cookie and flour company based in Mexico.
Tracey T. Breazeale has served as Senior Vice President of Strategic Planning and Branding of Select Comfort since July 1999. Ms. Breazeale was with the Boston Consulting Group from October 1993 to July 1999, initially as a consultant and the last three years as a manager, where she specialized on strategic and marketing oriented projects for retail and consumer product companies.
Renee M. Christensen has served as Senior Vice President of E-Commerce of Select Comfort since August 1999 and President of selectcomfort.com corporation since May 1999. From March 1999 to August 1999, Ms. Christensen served as Vice President of E-Commerce of Select Comfort. From May 1998 to March 1999, Ms. Christensen served as Senior Manager, Online Services for US Bancorp, a major financial institution. From July 1997 to May 1998, Ms. Christensen served as Business Development Manager, Electronic Bill Payment for Travelers Express, a financial services company. From April 1995 to July 1997, Ms. Christensen served as Vice President, Online Financial Services for Wells Fargo & Company, a major financial institution. From June 1987 to April 1995, Ms. Christensen served in various positions with Charles Schwab & Co., a brokerage firm.
James D. Gaboury was appointed Vice President, Direct Sales in December 1999. He served as Director of Direct Sales from July 1993 to April 1997; Vice President, Direct Sales from April 1997 to August 1998; and Vice President Customer Satisfaction and Direct Sales from August 1998 to December 1999.
Mark A. Kimball joined Select Comfort in May 1999 as Senior Vice President, Chief Administrative Officer, General Counsel and Secretary. For more than five years prior to
joining Select Comfort, Mr. Kimball was a partner in the law firm of Oppenheimer Wolff & Donnelly LLP practicing in the area of corporate finance.
Gregory T. Kliner has served as Senior Vice President of Operations of Select Comfort since August 1995. From October 1986 to August 1995, Mr. Kliner served as Director of Operations of the Irrigation Division for The Toro Company, a manufacturer of lawn care and snow removal products and irrigation systems.
Ronald E. Mayle has served as Senior Vice President of Retail of Select Comfort and President of Select Comfort Retail Corporation since December 1997. From October 1996 to December 1997, Mr. Mayle served as Managing Member of Management & Capital, a retail consulting firm. From May 1995 to October 1996, Mr. Mayle served as an independent retail marketing consultant, primarily to a variety of privately owned, start-up retail enterprises, advising on infrastructure and sales and marketing strategies. From April 1992 to May 1995, Mr. Mayle was Vice President of Operations of Petstuff, Inc., a subsidiary of PetsMart Inc.
James C. Raabe was elected as Vice President and Chief Financial Officer of Select Comfort in April 1999. From September 1997 to April 1999, Mr. Raabe served as Controller of Select Comfort. From May 1992 to September 1997, Mr. Raabe served as Vice President - Finance of ValueRx, Inc., a pharmacy benefit management provider. Mr. Raabe held various positions with KPMG LLP from August 1982 to May 1992.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The information under the caption "Common Stock" on the inside back cover of our 1999 Annual Report is incorporated herein by reference.
NUMBER OF RECORD HOLDERS; DIVIDENDS
As of March 1, 2000, there were 187 record holders of our common stock. We did not declare or pay any cash dividends on the common stock during the fiscal years ended January 2, 1999 or January 1, 2000.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
On September 3, 1998, we filed a Registration Statement on Form S-1 (File No. 333-62793) with the Securities and Exchange Commission, pursuant to which we registered the offer and sale under the federal securities laws of 4,600,000 shares of common stock, including 1,677,650 shares sold by certain selling shareholders. The SEC declared our Registration Statement effective on December 3, 1998, and the closing of the initial public offering was held on December 9, 1998. The managing underwriters were Hambrecht & Quist LLC, BankBoston Robertson Stephens Inc., Piper Jaffray Inc. and Charles Schwab & Co., Inc.
The aggregate offering price of all shares sold in the offering was $78,200,000. The net proceeds to Select Comfort from the sale of the shares of common stock offered by Select Comfort was $44,643,353, after deducting the underwriting discount of $3,477,597 and offering expenses of approximately $1,559,000. All of the expenses incurred in connection with the initial public offering were paid to unrelated parties or entities, except for the underwriting discount which was given to, among others, Hambrecht & Quist LLC. Jean-Michel Valette, a director of the Company, was a member of the general partner of H&Q Select Comfort Investors, L.P., a related party to Hambrecht & Quist LLC.
From December 9, 1998 to January 1, 2000, the net proceeds from the offering have been used as follows:
Repayment of long-term debt........ $15,325,480
Repurchase of our common
stock.............................. 12,692,054
Fund the build-out, start-up and
leasing of our third manufacturing
and distribution facility.......... 1,712,306
Fund development of warranty and
inquiry system..................... 1,032,099
Fund expansion of our retail
store base......................... 8,135,520
-----------
$38,897,459
===========
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ITEM 6. SELECTED FINANCIAL DATA
The financial information under the caption "Selected Consolidated Financial Data" on page 8 of our 1999 Annual Report is incorporated herein by reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The information under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" on pages 9 to 14 of our 1999 Annual Report is incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information concerning disclosure about market risk set forth in Note 2 to our Consolidated Financial Statements on page 21 of our 1999 Annual Report is incorporated herein by reference.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our Consolidated Financial Statements and Independent Auditors' Report thereon on pages 15 to 28 of our 1999 Annual Report are incorporated herein by reference.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The information under the captions "Election of Directors -- Information About Nominees and Directors" and "Election of Directors -- Other Information About Nominees and Directors" in our 2000 Proxy Statement is incorporated herein by reference. The information concerning executive officers of Select Comfort is included in this Report under Item 4a, "Executive Officers of the Company."
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The information under the caption "Section 16(a) Beneficial Ownership Reporting Compliance" in our 2000 Proxy Statement is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions "Election of Directors -- Director Compensation" and "Executive Compensation and Other Benefits" in our 2000 Proxy Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Principal Shareholders and Beneficial Ownership of Management" in our 2000 Proxy Statement is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Transactions" in our 2000 Proxy Statement is incorporated herein by reference.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(A) 1. CONSOLIDATED FINANCIAL STATEMENTS
The following Consolidated Financial Statements of Select Comfort and its subsidiaries are incorporated herein by reference from the pages indicated in Select Comfort's 1999 Annual Report:
Consolidated Financial Statements: Independent Auditors' Report 15 Consolidated Balance Sheets as of January 1, 2000 and January 2, 1999 16 Consolidated Statements of Operations for the years ended January 1, 2000, January 2, 1999 and January 3, 1998 17 Consolidated Statements of Shareholders' Equity for the years ended January 1, 2000, January 2, 1999 and January 3, 1998 18 Consolidated Statements of Cash Flows for the years ended January 1, 2000, January 2, 1999 and January 3, 1998 19 Notes to Consolidated Financial Statements 20-28 |
2. CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
Attached to this Report on page 26 is the Independent Auditors' Report, together with Schedule II -- Valuation and Qualifying Accounts.
3. EXHIBITS
The exhibits to this Report are listed in the Exhibit Index on pages 28 to 32 below.
Select Comfort will furnish a copy of any of the exhibits referred to above at a reasonable cost to any shareholder upon receipt of a written request therefor. Requests should be sent to: Select Comfort Corporation, 10400 Viking Drive, Suite 400, Minneapolis, Minnesota 55344; Attn: Shareholder Information.
The following is a list of each management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 13(a):
1. Form of Incentive Stock Option Agreement under the 1997 Stock Incentive Plan
2. Form of Performance Based Stock Option Agreement under the 1997 Stock Incentive Plan
3. Employment Letter Agreement dated July 11, 1995 between the Company and Gregory T. Kliner
4. Consulting Agreement and Stock Option Agreement dated April 1, 1996 between the Company and Ervin R. Shames
5. Employment Letter Agreement dated November 12, 1997 between the Company and Ronald E. Mayle
6. Employment and Consulting Agreement by and between Select Comfort Corporation and H. Robert Hawthorne
7. Select Comfort Profit Sharing and 401(K) Plan
8. Select Comfort Corporation 1999 Employee Stock Purchase Plan
9. Select Comfort Corporation 1990 Omnibus Stock Option Plan, as amended and restated
10. Select Comfort Corporation 1997 Stock Incentive Plan, as amended and restated
11. Employment Letter Agreement dated July 21, 1999 between the Company and Tracey T. Breazeale
12. Employment Letter Agreement dated April 22, 1999 between the Company and Mark A. Kimball
(B) REPORTS ON FORM 8-K
We did not file any Current Reports on Form 8-K during the quarter ended January 1, 2000.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities 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
Dated: March 20, 2000 By: /s/ Patrick A. Hopf
---------------------------------------------
Patrick A. Hopf
Interim President and 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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Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
/s/ Patrick A. Hopf
-------------------------- Interim President and March 20, 2000
Patrick A. Hopf Chief Executive Officer
and Chairman of the Board
/s/ Ervin R. Shames
-------------------------- Director March 27, 2000
Ervin R. Shames
/s/ Thomas J. Albani
-------------------------- Director March 27, 2000
Thomas J. Albani
/s/ Christopher P. Kirchen
-------------------------- Director March 27, 2000
Christopher P. Kirchen
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/s/ David T. Kollat -------------------------- Director March 24, 2000 David T. Kollat /s/ William J. Lansing -------------------------- Director March 23, 2000 William J. Lansing /s/ Jean-Michel Valette -------------------------- Director March 30, 2000 Jean-Michel Valette |
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Stockholders
Select Comfort Corporation:
Under date of January 26, 2000 we reported on the consolidated balance sheets of Select Comfort Corporation and subsidiaries as of January 1, 2000 and January 2, 1999 and the related statements of operations, stockholders' equity, and cash flows for each of the years in the three-year period ended January 1, 2000, as contained in the Annual Report on Form 10-K for the year 1999. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related financial statement schedule as listed in the accompanying index. This financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material aspects, the information set forth therein.
/s/ KPMG LLP
Minneapolis, Minnesota
January 26, 2000
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SELECT COMFORT CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
ADDITIONS
BALANCE AT CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING COSTS AND FROM END OF
DESCRIPTION OF PERIOD EXPENSES RESERVES PERIOD
------------------------------------- ----------- ------------ ------------ ------------
Allowance for doubtful
accounts - 1999 $2,750 $1,193 $3,638 $ 305
- 1998 1,901 2,794 1,945 2,750
- 1997 200 2,101 400 1,901
Accrued warranty
costs - 1999 $4,486 $5,368 $4,013 $5,841
- 1998 3,257 4,807 3,578 4,486
- 1997 2,036 3,274 2,053 3,257
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SELECT COMFORT CORPORATION
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JANUARY 1, 2000
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
3.1 Restated Articles of Incorporation of the Company, as amended.. Filed electronically herewith
3.2 Restated Bylaws of the Company................................. Incorporated by reference to Exhibit
3.2 contained in the Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
4.1 Form of Warrant issued in connection with the sale of Incorporated by reference to Exhibit
Convertible Preferred Stock, Series E.......................... 4.2 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
4.2 Form of Warrant issued in connection with the November 1996 Incorporated by reference to Exhibit
Bridge Financing............................................... 4.3 contained in the Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
4.3 Amended and Restated Registration Rights Agreement dated Incorporated by reference to Exhibit
December 28, 1995.............................................. 4.4 contained in the Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
4.4 First Amendment to Series E Stock Purchase Agreement and Incorporated by reference to Exhibit
Amended and Restated Registration Rights Agreement dated 4.5 contained in Select Comfort's
April 25, 1996................................................. Registration Statement on Form S-1, as
amended (File No. 333-62793)
4.5 Second Amendment to Amended and Restated Registration Rights Incorporated by reference to Exhibit
Agreement dated as of November 1, 1996......................... 4.6 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
4.6 Second (sic) Amendment to Amended and Restated Registration Incorporated by reference to Exhibit
Rights Agreement dated March 24, 1997.......................... 4.7 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
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4.7 Series A Warrant effective as of March 31, 1998 issued to Incorporated by reference to Exhibit
General Electric Capital Corporation........................... 4.8 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.1 Net Lease Agreement dated December 3, 1993 between the Company Incorporated by reference to Exhibit
and Opus Corporation........................................... 10.1 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.2 Amendment of Lease dated August 10, 1994 between the Company and Incorporated by reference to Exhibit
Opus Corporation............................................... 10.2 contained in the Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.3 Second Amendment to Lease dated May 10, 1995 between the Company Incorporated by reference to Exhibit
and Rushmore Plaza Partners Limited Partnership (successor to 10.3 contained in Select Comfort's
Opus Corporation).............................................. Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.4 Letter Agreement dated as of October 5, 1995 between Incorporated by reference to Exhibit
the Company and Rushmore Plaza Partners 10.4 contained in Select Comfort's
Limited Partnership............................................ Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.5 Third Amendment of Lease, Assignment and Assumption of Lease and Incorporated by reference to Exhibit
Consent dated as of January 1, 1996 among the Company, Rushmore 10.5 contained in Select Comfort's
Plaza Partners Limited Partnership and Select Comfort Direct Registration Statement on Form S-1, as
Corporation.................................................... amended (File No. 333-62793)
10.6 Sublease dated as of March 27, 1997 between Select Comfort SC Incorporated by reference to Exhibit
Corporation and Bellsouth Telecommunications, Inc.............. 10.6 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.7 Master Lease Agreement dated August 27, 1996 between Incorporated by reference to Exhibit
Comdisco, Inc. and the Company and Equipment 10.7 contained in Select Comfort's
Schedules VL-1 dated August 27, 1996 and VL-2 and VL-3 Registration Statement on Form S-1,
dated November 11, 1996........................................ as amended (File No. 333-62793)
10.8 Supply Agreement dated August 23, 1994 between the Company and Incorporated by reference to Exhibit
Supplier (1)................................................... 10.8 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
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10.9 Equipment Purchase and Software License Agreement dated Incorporated by reference to Exhibit
February 6, 1996 between the Company and Supplier (1).......... 10.9 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.10 Major Merchant Agreement dated December 19, 1997 among First Incorporated by reference to Exhibit
National Bank of Omaha and the Company, Select Comfort SC 10.13 contained in Select Comfort's
Corporation, Select Comfort Retail Corporation and Select Registration Statement on Form S-1, as
Comfort Direct Corporation..................................... amended (File No. 333-62793)
10.11 Form of Incentive Stock Option Agreement under the 1997 Stock Incorporated by reference to Exhibit
Incentive Plan................................................. 10.16 contained in the Company's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.12 Form of Performance Based Stock Option Agreement under the 1997 Incorporated by reference to Exhibit
Stock Incentive Plan........................................... 10.17 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.13 Employment Letter Agreement dated July 11, 1995 between the Incorporated by reference to Exhibit
Company and Gregory T. Kliner.................................. 10.20 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.14 Consulting Agreement and Stock Option Agreement dated April 1, Incorporated by reference to Exhibit
1996 between the Company and Ervin R. Shames................... 10.21 contained in Select Comfort's
Registration Statement on Form S-1, as
amended (File No. 333-62793)
10.15 Employment Letter Agreement dated November 12, 1997 between the Incorporated by reference to Exhibit
Company and Ronald E. Mayle.................................... 10.20 contained in Select Comfort's
Annual Report on Form 10-K for the
fiscal year ended January 2, 1999
(File No. 0-25121)
10.16 Lease Agreement dated September 30, 1998 between Incorporated by reference to Exhibit
the Company and ProLogis Development Services 10.28 contained in Select Comfort's
Incorporated................................................... Registration Statement on Form S-1, as
amended (File No. 333-62793)
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10.17 Employment and Consulting Agreement by and between Select Incorporated by reference to Exhibit
Comfort Corporation and H. Robert Hawthorne.................... 10.2 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended July 3, 1999
10.18 Revolving Credit Program Agreement by and between Green Tree Incorporated by reference to Exhibit
Financial Corporation and Select Comfort Corporation (1)....... 10.3 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended July 3, 1999
10.19 Letter of Agreement by and between Bed, Bath & Beyond Inc. and Incorporated by reference to Exhibit
Select Comfort Retail Corporation (1).......................... 10.4 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended July 3, 1999
10.20 Select Comfort Profit Sharing and 401(K) Plan.................. Incorporated by reference to Exhibit
10.5 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended July 3, 1999
10.21 Select Comfort Corporation 1999 Employee Stock Purchase Plan... Incorporated by reference to Exhibit
10.6 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended July 3, 1999
10.22 Select Comfort Corporation 1990 Omnibus Stock Option Plan, as Incorporated by reference to Exhibit
amended and restated........................................... 10.1 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended October 2, 1999
10.23 Select Comfort Corporation 1997 Stock Inventive Plan, as amended Incorporated by reference to Exhibit
and restated................................................... 10.2 contained in Select Comfort's
Quarterly Report on Form 10-Q for the
quarter ended October 2, 1999
10.24 Employment Letter Agreement dated July 21, 1999 Filed herewith electronically
between the Company and Tracey T. Breazeale....................
10.25 Employment Letter Agreement dated April 22, 1999 between the Filed herewith electronically
Company and Mark A. Kimball....................................
10.26 S-8 - Employee Benefit Plan.................................... Incorporated by reference to Select
Comfort's S-8(File No. 333-70493)
10.27 S-8 - Profit Sharing and 401(k) Plan........................... Incorporated by reference to Select
Comfort's S-8(File No. 333-79157)
10.28 S-8 - 1999 Employee Stock Purchase Plan........................ Incorporated by reference to Select
Comfort's S-8(File No. 333-80755)
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10.29 S-8 - 1997 Stock Incentive Plan................................ Incorporated by reference to Select
Comfort's S-8(File No. 333-84329)
13.1 Excerpts from the 1999 Annual Report to Shareholders........... Filed herewith electronically
21.1 Subsidiaries of the Company..................................... Filed herewith electronically
23.1 Independent Auditors' Consent.................................. Filed herewith electronically
27.1 Financial Data Schedule........................................ Filed herewith electronically
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EXHIBIT 3.1
THIRD RESTATED
ARTICLES OF INCORPORATION
OF
SELECT COMFORT CORPORATION
These Third Restated Articles of Incorporation supersede the Second Restated Articles of Incorporation dated August 31, 1998 and all amendments thereto.
ARTICLE I
The name of the Corporation is Select Comfort Corporation.
ARTICLE II
The registered office of the Corporation in Minnesota is 6105 Trenton Lane North, Suite 100, Minneapolis, MN 55442-3240.
ARTICLE III
The Corporation, through its Board of Directors, is authorized to issue up to
one-hundred million (100,000,000) shares of capital stock, ninety-five million
(95,000,000) of which are designated as Common Stock, five million (5,000,000)
of which are designated as the "Undesignated Preferred Stock," and all of which
shall have a par value of $0.01 per share.
The Undesignated Preferred Stock may be issued from time to time in one or more series. For each series, the Board of Directors must fix, prior to the issuance of any shares thereof, pursuant to the authority hereby expressly vested in it, a distinctive designation or title, the number of shares in each series, the voting powers (full, limited or no voting powers), the preferences and relative, participating, optional or other special rights, and the qualifications, limitations or restrictions thereof.
ARTICLE IV
The purposes of the Corporation are general business purposes and the Corporation shall possess all powers necessary to conduct any business in which it is authorized to engage, including, but not limited to, all those powers expressly conferred upon business corporations by Chapter 302A of the Minnesota Statutes, as amended, together with those powers implied therefrom.
ARTICLE V
The Corporation shall have perpetual duration.
ARTICLE VI
The affirmative vote of the holders of a majority of the voting power of the shares of capital stock represented and entitled to vote at a duly held meeting is required for an action of the shareholders, including any amendment to these Articles of Incorporation, except where Chapter 302A of the Minnesota Statutes, as amended, or these Articles of Incorporation, as amended, requires an affirmative vote of a larger majority.
ARTICLE VII
Shares of capital stock of the Corporation acquired by the Corporation shall become authorized but unissued shares and may be reissued, from time to time, at the discretion of the Corporation.
ARTICLE VIII
Except as otherwise provided in these Articles of Incorporation, as amended,
(A) The Board of Directors may from time to time, by vote of a majority of its members present at a duly held meeting, adopt, amend or repeal all or any of the Bylaws of the Corporation as permitted by Chapter 302A of the Minnesota Statutes, as amended, subject to the power of the shareholders to adopt, amend or repeal such Bylaws.
(B) The Board of Directors is authorized to accept and reject subscriptions for and to dispose of shares of authorized stock of the Corporation, including the granting of stock options, warrants and other rights to purchase stock, without action by the shareholders and upon such terms and conditions as may be deemed advisable by the Board of Directors in the exercise of its discretion, except as otherwise limited by Chapter 302A of the Minnesota Statutes, as amended.
(C) The Board of Directors is authorized to issue, sell or otherwise dispose of bonds, debentures, certificates of indebtedness and other securities, including those convertible into stock, without action by the shareholders and for such consideration and upon such terms and conditions as may be deemed advisable by the Board of Directors in the exercise of its discretion, except as otherwise limited by Chapter 302A of the Minnesota Statutes, as amended.
ARTICLE IX
Any action required or permitted to be taken at a meeting of the Board of Directors may be taken by written consent signed by all the directors; provided that, if the action is one which does not require shareholder approval, such action may be taken by written consent signed by the number of directors that would be required to take the same action at a meeting at which all directors were present.
ARTICLE X
The shareholders of the Corporation have no right to cumulate their votes in the election of directors.
ARTICLE XI
The shareholders of the Corporation have no preemptive rights in any future issuance of stock by the Corporation.
ARTICLE XII
Each director, officer, employee or agent, past and present, of the Corporation, and each person who serves or may have served at the request of the Corporation as a director, officer, employee or agent of another corporation or employee benefit plan, and their respective heirs, administrators and executors, shall be indemnified by the Corporation in accordance with, and to the fullest extent permissible under, the provisions of Chapter 302A of the Minnesota Statutes, as amended.
ARTICLE XIII
A director of the Corporation, including a person deemed to be a director under applicable law, shall not be personally liable to the Corporation or its shareholders for monetary damages for breach of fiduciary duty as a director, except to the extent provided by applicable law for (i) liability based on a breach of the duty of loyalty to the Corporation or the shareholders; (ii) liability for acts or omissions not in good faith or that involve intentional misconduct or a knowing violation of law; (iii) liability based on the payment of an improper dividend or an improper acquisition of the Corporation's shares under Section 559 of the Minnesota Business Corporation Act (Minnesota Statutes, Chap. 302A) or on violations of state securities laws under Section 80A.23 of Minnesota Statutes; or (iv) liability for any transaction from which the director derived an improper personal benefit. If Chapter 302A, the Minnesota Business Corporation Act, hereafter is amended to authorize the further elimination or limitation of the liability of directors, then the liability of a director of the Corporation, in addition to the limitation on personal liability provided herein, shall be eliminated or limited to the fullest extent permitted by any such amendment. Any repeal or modification of this Article XIII by the shareholders of the Corporation shall not adversely affect any right or protection of a director of the Corporation existing at the time of such repeal or modification.
ARTICLE XIV
The number of directors which shall constitute the entire Board of Directors shall not be less than one (1) nor more than nine (9), which number shall be determined from time to time by the Board of Directors. The Directors shall be divided into three (3) classes, as nearly equal in number as possible. The term of office of the first class shall expire at the 1999 annual meeting of the shareholders of the Corporation; the term of office of the second class shall expire at the 2000 annual meeting of the shareholders of the Corporation; and the term of office of the third class shall expire at the 2001 annual meeting of the shareholders of the Corporation. At each annual meeting of the shareholders after such classification, the number of directors equal to the number of the class whose term expires on the day of such meeting shall be elected for a term of three (3) years. Directors shall hold office until expiration of the terms for which they were elected and qualified; provided, however, that a director may be removed from office as a director at any time by the shareholders, but only for cause, and only by the affirmative vote of a majority of the outstanding voting power entitled to elect such director. If the office of any director becomes vacant by reason of death, resignation, retirement, disqualification, removal
from office, increase in the number of directors or otherwise, a majority of the remaining directors, although less than a quorum, at a meeting called for that purpose, may choose a successor, who, unless removed for cause as set forth above, shall hold office until the expiration of the term of the class for which appointed or until a successor shall be elected and qualified. This Article XIV may not be altered, amended or repealed, in whole or in part, unless authorized by the affirmative vote of the holders of not less than two-thirds of the outstanding voting power entitled to vote.
ARTICLE XV
The affirmative vote of the holders of not less than two-thirds of the outstanding voting power of the corporation entitled to vote for approval shall be required if (a) this Corporation merges or consolidates with any other corporation, or if (b) this Corporation sells or exchanges all or a substantial part of its assets to or with any other corporation, or if (c) this Corporation issues or delivers any stock or other securities of its issue in exchange or payment for any properties or assets of any other corporation, or securities issued by any other corporation, or in a merger of any subsidiary of this Corporation (80% or more of the common stock of which is held by this Corporation) with or into any other corporation; provided, however, that the foregoing shall not apply to any plan of merger or consolidation, or sale or exchange of assets, or issuance or delivery of stock or other securities which was approved (or adopted) and recommended without condition by the affirmative vote of not less than two-thirds of the directors, nor shall it apply to any such transaction solely between this Corporation and another corporation 50% or more of the voting stock of which is owned, directly or indirectly, by this Corporation. The Board of Directors shall be permitted to condition its approval (or adoption) of any plan of merger or exchange of assets, or issuance or delivery of stock or securities upon the approval of holders of two-thirds of the outstanding stock of this Corporation entitled to vote on such plan of merger or consolidation, or sale or exchange of assets, or issuance or delivery of stock or securities. This Article XV may not be altered, amended or repealed, in whole or in part, unless authorized by the affirmative vote of the holders of not less than two-thirds of the outstanding voting power entitled to vote.
IN WITNESS WHEREOF, the undersigned hereunto sets his hand this ___ day of ________________, 1998.
SELECT COMFORT CORPORATION
By:________________________________
Its:_______________________________
AMENDMENT
OF THE
ARTICLES OF INCORPORATION
OF
SELECT COMFORT CORPORATION
The undersigned, Mark A. Kimball, being the Secretary of Select Comfort Corporation (the "Corporation"), a corporation organized under and subject to the provisions of Chapter 302A, Minnesota Statutes, does hereby certify that pursuant to actions duly taken by the Board of Directors and shareholders of the Corporation, the following resolutions were adopted:
RESOLVED, That Article XIV of the Third Restated Articles of Incorporation is amended in its entirety to read as follows:
The number of directors which shall constitute the entire Board of Directors shall not be less than one (1) nor more than twelve (12), which number shall be determined from time to time by the Board of Directors. The Directors shall be divided into three (3) classes, as nearly equal in number as possible. The term of office of the first class shall expire at the 1999 annual meeting of the shareholders of the Corporation; the term of office of the second class shall expire at the 2000 annual meeting of the shareholders of the Corporation; and the term of office of the third class shall expire at the 2001 annual meeting of the shareholders of the Corporation. At each annual meeting of the shareholders after such classification, the number of directors equal to the number of the class whose term expires on the day of such meeting shall be elected for a term of three (3) years. Directors shall hold office until expiration of the terms for which they were elected and qualified; provided, however, that a director may be removed from office as a director at any time by the shareholders, but only for cause, and only by the affirmative vote of a majority of the outstanding voting power entitled to elect such director. If the office of any director becomes vacant by reason of death, resignation, retirement, disqualification, removal from office, increase in the number of directors or otherwise, a majority of the remaining directors, although less than a quorum, at a meeting called for that purpose, may choose a successor, who, unless removed for cause as set forth above, shall hold office until the expiration of the term of the class for which appointed or until a successor shall be elected and qualified. This Article XIV may not be altered, amended or repealed, in whole or in part, unless authorized by the affirmative vote of the holders of not less than two-thirds of the outstanding voting power entitled to vote.
FURTHER RESOLVED, that the Secretary of the Corporation be and hereby is authorized and directed to make, execute and acknowledge Articles of Amendment of the Corporation evidencing the amendments to the Third Restated Articles of Incorporation set forth above and to cause such Articles of Amendment to be filed for record with the Secretary of State of the State of Minnesota in the manner required by law, and to become effective upon the date of such filing.
IN WITNESS WHEREOF, I have hereunto set my hand this 8th day of June, 1999.
Mark A. Kimball Secretary
EXHIBIT 10.24
July 21, 1999
Ms. Tracey Breazeale
1518 Judson Avenue
Evanston, IL 60201
Dear Tracey:
This letter confirms a number of conversations we have had over the last few weeks.
Select Comfort has offered you and you have accepted a position as Senior Vice President of Strategic Planning and Branding. In this role, you will be responsible for development of corporate strategy, coordination of corporate branding and product management functions, and business development, particularly as it pertains to distribution channel alternatives.
Your state date is August 2, and you will report to me in my role as interim CEO and Chairman. You will be a member of the senior management team of Select Comfort.
Compensation will include:
1. A salary of $170,000 per year.
2. A $30,000 bonus potential for the remainder of calendar 1999 based on your own performance, not previously agreed upon corporate performance goals. The evaluation of this will be based upon subjective variables which we will discuss.
3. 75,000 incentive stock options which will enable you to purchase shares of Select Comfort's public stock. The plan has been sent to you under separate cover.
4. One free Select Comfort mattress set of your choosing, which will save you hours of painful and restless sleep for the rest of your life.
5. Moving expenses to Minnesota will be covered as well as temporary housing for up to three months. In addition, the Company will pay the real estate commission on the house you are selling in Evanston.
There are a series of normal employee benefits which I believe you have discussed with Karen Jones, the Vice President of Human Resources.
We are looking forward to your joining the team at Select Comfort and to the contributions you are bound to make. This is an exciting, entrepreneurial environment based on an enormous opportunity to become the leading mattress company in the country, and we are glad to have you be a part of it.
Sincerely,
Patrick A. Hopf
EXHIBIT 10.25
April 22, 1999
Mark Kimball
6 Swallow Lane
North Oaks, MN 55127
Dear Mark:
Congratulations on acceptance of our offer for the position of Senior Vice President, General Counsel, Chief Administrative Officer and Secretary, reporting to me.
You will be joining Select Comfort Corporation on May 3, 1999. Your annual salary will be $175,000 and you will participate in the Management Incentive Plan. We are waiting for final approval on the 1999 plan; however, for the Senior Vice President level, the 1998 plan was targeted at 58% of base for on-plan performance with a maximum payout of 100% if certain established criteria were met. You will also be granted Incentive Stock Options in the amount of 100,000 shares vested monthly over a 36 month period of employment at an exercise price of the market price at start date.
Select Comfort is on the brink of an exciting and challenging era and I feel with your background and skills you will be able to provide a significant contribution to our company.
As an employee of Select Comfort, you will be eligible for our company benefits the first of the month following thirty days of employment. Our benefits include; medical, dental, flex account, life insurance, supplemental life insurance, short-term disability, long-term disability, travel accident insurance, Paid Time Off (PTO) and 401(k). You will receive 19 days of Paid Time Off annually. The details of your benefits package will be reviewed in new hire orientation.
It is our expectation, that upon your acceptance and start date with Select Comfort, you will sign our formal Confidentiality and Non-Compete Agreement. In the event your employment with Select Comfort is terminated without cause, we will commit to offer you a one year severance package.
I look forward to you joining the Select Comfort team. Please contact me at
(612)551-7007 with any questions.
Sincerely,
Daniel J. McAthie
President and CEO
EXHIBIT 13.1
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
The data presented below has been derived from the Company's consolidated financial statements and should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the Company's consolidated financial statements and notes thereto included in this Annual Report:
Year Ended(1)
Jan. 1, 2000 Jan. 2, 1999 Jan. 3, 1998 Dec. 28, 1996 Dec. 30, 1995
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $ 273,767 $ 246,269 $ 184,430 $ 102,028 $ 68,629
Gross margin 178,660 161,082 117,801 63,507 39,796
Operating income (loss)(2) (14,793) 11,445 1,996 (3,764) (4,589)
Net income (loss) before extraordinary item (8,204) 6,636 (2,846) (3,685) (4,560)
Net income (loss) (8,204) 5,195 (2,846) (3,685) (4,560)
Net income (loss) per share - diluted (3):
Net income (loss) per share
before extraordinary item (0.45) 0.28 (1.59) (2.61) (3.16)
Net income (loss) per share (0.45) 0.19 (1.59) (2.61) (3.16)
Weighted average common shares - diluted 18,300 15,928 2,353 1,753 1,444
Dividends paid per share -- -- -- -- --
SELECTED OPERATING DATA:
Stores open at period-end (4) 341 264 200 143 68
Average square footage of stores open
during period (5) 893 895 866 768 703
Sales per square foot (5) 721 742 666 622 611
Average store age (in months at period end) 31 27 22 15 15
Comparable store sales increase (6) 4.7% 23.5% 27.3% 26.1% 59.8%
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 7,441 $ 45,561 $ 12,670 $ 2,422 $ 6,862
Marketable securities 20,129 -- -- -- --
Working capital 14,470 42,249 757 (7,809) 2,734
Total assets 95,865 106,234 57,241 29,794 23,838
Long-term debt, less current maturities 36 29 19,511 1,162 40
Mandatorily redeemable preferred stock -- -- 27,612 27,612 27,625
Total common shareholders' equity (deficit) 53,374 70,691 (21,038) (18,216) (14,779)
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(1) Except for the year ended January 3, 1998, which included 53 weeks, all
years presented included 52 weeks.
(2) Includes a $1.4 million dollar charge related to store closings for the year
ended January 1, 2000. See Note 5 of Notes to Consolidated Financial
Statements.
(3) See Note 11 of Notes to Consolidated Financial Statements.
(4) Includes Select Comfort stores operated in leased departments within larger
retail stores (45 at January 1, 2000, 14 at January 2, 1999 and one at
January 3, 1998).
(5) For stores open during the entire period indicated.
(6) Stores enter the comparable store calculation in their 13th full month of
operation. The number of comparable stores used to calculate such data were
262, 199, 138, 65 and 32 for fiscal 1999, 1998, 1997, 1996 and 1995,
respectively. Reflects adjustment for additional week of sales in 1997.
Without adjusting for the additional week, comparable store sales would have
been 17.9% in 1998 and 34.6% in 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The discussion in this Annual Report contains certain forward-looking statements, such as statements of the Company's plans, objectives, expectations and intentions. 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. These risks and uncertainties include, but are not limited to, uncertainty of the success of the Company's strategic plan, uncertain profitability, sales tax considerations, effectiveness and efficiency of advertising expenditures, fluctuations in comparable store sales results and the impact of competition. Additional information concerning these risks and uncertainties and others is contained in the Company's filings with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K.
OVERVIEW
Select Comfort is the leading vertically integrated manufacturer, specialty retailer and direct marketer of innovative air beds and sleep-related products. Since the introduction of our first air bed product in 1987, management has focused on improving our product, expanding our product line, building manufacturing and distribution systems and growing our distribution channels, which now include: 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 presence.
Retail operations included 341 stores at January 1, 2000, including 45 leased departments within larger stores, 264 stores at January 2, 1999 (including 14 leased departments) and 200 stores at January 3, 1998 (including one leased department). We plan to open approximately 20 additional retail stores in 2000, primarily in existing markets. From inception through January 1, 2000, we had closed seven stores. In 2000, we plan to close approximately 10 underperforming retail stores and 12 leased department locations. A substantial majority of the costs associated with these closings was accrued in 1999.
The Company reported comparable store sales growth of 4.7%, 23.5% and 27.3% in 1999, 1998 and 1997, respectively (comparable store sales amounts have been adjusted to reflect 52 weeks in fiscal 1997 consistent with all other periods). Comparable store sales results have been and will continue to be influenced by a variety of factors, including levels of awareness of our products and brand name, levels of consumer acceptance of our existing and new products, our ability to successfully introduce new products and product line extensions, comparable store sales performance in prior periods, the maturation of our store base, the amount, effectiveness and efficiency of retail advertising expenditures and promotional activity, the amount of competitive activity, our ability to effectively integrate our multiple distribution channels, the evolution of store operations, including improvements in store design, the quality and tenure of store-level managers and sales professionals, and general economic conditions and consumer confidence.
Advertising expenditures increased from $9.0 million in 1995 to $43.4 million in 1999. Advertising costs are expensed as incurred as a component of sales and marketing expenses, although we believe that advertising expenditures provide significant benefits beyond the period in which they are expensed. Pre-opening costs associated with new retail stores are expensed as incurred. 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. Although advertising expenditures are expected to continue to increase in the foreseeable future, such increases are expected to be at a lower rate than historical increases.
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 air bed products, improved effectiveness and efficiency of our marketing and advertising expenditures, the opening and successful performance of new retail stores, improvement in the performance of current stores and our ability to execute our stated strategic initiatives. There can be no assurance that we will be able to achieve or sustain historical sales growth rates or profitability in the future, on a quarterly or annual basis.
Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including
increases or decreases in comparable store sales, the timing, amount and effectiveness of advertising expenditures, any changes in return rates, the timing of new store openings and related expenses, competitive factors, net sales contributed by new stores, any disruptions in third-party delivery services and general economic conditions and consumer confidence. Our business is also subject to some seasonal influences, with heavier concentrations of sales during the fourth quarter holiday season due to increased mall traffic.
A substantial portion of operating expenses is related to sales and marketing expenses, including costs associated with opening new stores, operating existing stores and advertising expenditures. The level of 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.
In connection with our March 1997 $15.0 million debt financing, a warrant with a put feature was issued. This put feature required that the warrant be recorded at fair value as long-term debt. Furthermore, any change in the fair value of this warrant has been reflected as interest expense, resulting in non-cash interest expense of $5.6 million and $3.3 million during 1998 and 1997, respectively. The put feature of this warrant was eliminated upon the closing of the December 1998 initial public offering, resulting in the reclassification of the warrant liability from long-term debt to common shareholders' equity. There will be no further interest expense associated with the warrant.
Net income (loss) as reported was ($8.2) million and $5.2 million for 1999 and 1998, respectively, resulting in net income (loss) per share of ($0.45) and $0.19, respectively. Pro forma net income, which reflects adjustments for non-recurring, non-cash items associated with the repayment of debt and put warrant interest expense referred to above, as well as an income tax benefit of $4.7 million associated with the elimination of the Company's deferred tax valuation allowance, was $7.6 million in 1998. Pro forma net income per share, which reflects these non-recurring, non-cash adjustments, as well as adjustments related to undeclared and unpaid dividends, was $0.45 in 1998.
At January 1, 2000, the Company had net operating loss carry-forwards for federal income tax purposes of approximately $10.2 million, of which it expects to be able to use approximately $8.8 million.
LOOKING FORWARD
We have begun to execute a new strategic plan that was developed in part as a
result of studies performed in the second half of 1999 by independent consulting
firms in various parts of the business, including product positioning,
marketing, distribution and logistics. The strategic plan focuses on:
- Development of an integrated approach to marketing with improved marketing
messages that are consistent across our distribution channels;
- Leveraging the profitability of our sales channels, with a particular
emphasis on retail store profitability;
- Providing in-home delivery, assembly and mattress removal across all of our
distribution channels;
- Continuous improvement of our core product line; and
- Introducing the sofa sleeper product across all of our distribution
channels.
Our integrated approach to marketing will be rolled out in the middle of 2000 with messages focused on the key benefits provided by our products, as well as messages targeted to key consumer groups. Marketing messages will be consistent across all channels and designed to optimize our multiple, complementary distribution channels.
We are developing market by market and store by store action plans focused on improving the profitability of our retail store operations. We are currently implementing plans to close approximately 10 underperforming retail stores and approximately 12 leased department locations. We expect to open approximately 20 stores during 2000 in current markets where increased store density is required to leverage advertising expenditures. In addition, we have developed a new retail store design with a bedroom like setting that is more consistent with our sleep solutions oriented brand. We plan to remodel 80 to 100 stores in 2000 to incorporate this new design.
In February 2000, we eliminated our road show distribution channel and approximately 15% of our corporate and administrative positions. The road show channel
sold in markets with no retail stores and accounted for less than 3% of sales. The Company will continue to focus on event marketing through home shows, state fairs and similar venues.
We are currently developing plans to ultimately provide in-home delivery, assembly and mattress removal across all of our distribution channels and throughout the continental United States. Currently, in-home delivery and assembly is provided through our retail channel in selected markets on a test basis.
Our product development efforts will be focused primarily on continuous improvement of our core line of air bed products. We believe that we have attained a leadership position in air bed technology and intend to continue to lead the industry in innovation. We have elected to terminate the license agreement under which we had developed and test-marketed our adjustable frame product.
One product line extension that we intend to introduce later this year is the sofa sleeper product with an air supported mattress. This product is currently available in a limited number of our retail sites. We believe that this sofa sleeper product represents a significant advancement in the sofa sleeper market that could add incremental sales as well as attract customers to our retail stores.
The success of our strategy will depend on many factors including (i) the effectiveness and efficiency of our integrated marketing strategy in creating awareness of our products and brand name and in generating sales, (ii) our ability to enhance the profitability of our retail stores and leased departments, (iii) our ability to manage operating costs, (iv) our ability to successfully launch in-home delivery, assembly and mattress removal services nationally on a cost-effective basis, (v) our ability to successfully launch the sofa sleeper product, (vi) the levels of consumer awareness and acceptance of the sofa sleeper product, (vii) our ability to continue to improve our core product line and differentiate our products from competitive products, (viii) competition in the mattress and sofa sleeper markets, and (ix) general economic factors and consumer confidence.
The strategic initiatives described above are directed toward improving our long-term performance and are not expected to contribute significantly to growth in sales and earnings in the first six months of 2000, and may negatively impact earnings in 2000.
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.
PERCENTAGE OF NET SALES
YEAR ENDED
JAN. 1, 2000 JAN. 2, 1999 JAN 3, 1998
Net sales 100.0% 100.0% 100.0%
Cost of sales 34.7 34.6 36.1
----------------------------------
Gross margin 65.3 65.4 63.9
----------------------------------
Operating expenses:
Sales and marketing 59.4 52.7 53.8
General and administrative 10.7 8.0 8.9
Store closings 0.5 0.0 0.0
----------------------------------
Total operating expenses 70.7 60.8 62.8
----------------------------------
Operating income (loss) (5.4) 4.7 1.1
Other income (expense), net 0.6 (2.9) (2.5)
----------------------------------
Income (loss) before
income taxes (4.8) 1.8 (1.5)
Income tax expense (benefit) (1.8) (0.9) 0.1
----------------------------------
Net income (loss) before
extraordinary item, net (3.0) 2.7 (1.5)
Extraordinary item 0.0 (0.6) 0.0
----------------------------------
Net income (loss) (3.0)% 2.1% (1.5)%
----------------------------------
|
The overall decrease in operating earnings for 1999 as compared to 1998 relates to increases in operating expenses, as a percentage of net sales, to support long-term growth plans. Lower sales growth was due to a number of factors. Increased retail advertising, which was effective in the early part of the year, did not drive sufficient sales as it was added to new markets during the last half of the year. Retail sales were lower than expected in those markets without increased advertising. Finally, direct marketing sales declined by $15.3 million in 1999 compared to 1998. Costs increased during 1999 to support anticipated growth. Infrastructure costs, including general and administrative expenses and costs associated with the opening and operation of 77 new stores during 1999, exceeded sales growth necessary to support these costs. Special charges of $5.1 million were incurred relating to store closings, termination of our adjustable frame development agreement and consulting and professional fees for the development and initial stages of implementation of the Company's strategic plan. We have begun to implement several strategic initiatives that we believe will begin to improve operating results in the second half of 2000.
COMPARISON OF YEAR ENDED JANUARY 1, 2000 AND
JANUARY 2, 1999
Net sales
Net sales increased 11.2% to $273.8 million for 1999 from $246.3 million for 1998, primarily due to an increase in unit sales. The components of the increase in net sales were (i) a $33.6 million increase from the opening of 77 new retail stores during 1999 and the full year impact of 64 stores opened in 1998, (ii) a $6.8 million increase from a 4.7% increase in comparable store sales, due in part to the continuing maturation of stores and increased advertising in selected markets, (iii) a $4.3 million increase in net sales from the Company's newly developed e-commerce channel, partially offset by (iv) a $15.3 million decrease in direct marketing sales.
Gross margin
Gross margin decreased to 65.3% for 1999 from 65.4% for 1998. Reductions in cost of sales from improved purchasing and leverage of fixed manufacturing costs over higher unit volumes were offset by higher sales discounts.
Sales and marketing
Sales and marketing expenses increased 25.3% to $162.7 million for 1999 from $129.9 million for 1998, and increased as a percentage of net sales to 59.4% from 52.7% for the comparable prior-year period. The increase in the dollar amount of sales and marketing expenses during 1999 was primarily due to (i) the opening of 77 new retail stores, (ii) an increase in advertising expenditures of $11.8 million and (iii) higher commissions, percentage rents and freight expense related to higher net sales. Sales and marketing expenses increased as a percentage of net sales primarily due to (i) increased advertising focused on longer term sales growth through brand and retail store awareness, (ii) lower direct marketing sales and (iii) selling expenses in new stores increasing at a greater rate than net sales.
General and administrative
General and administrative expenses increased 48.1% to $29.2 million for 1999 from $19.7 million for 1998. The increase in general and administrative expenses was primarily due to increased spending on infrastructure to support long-term growth plans and strategic consulting studies undertaken to determine and refine ongoing business strategies.
Store Closings
Store closing expense was $1,498,000 for 1999 up from $20,000 for 1998. Store closing expense for 1999 includes a $1,404,000 charge associated with plans to close 22 stores and other related store write-offs.
Other income (expense), net
Other income increased $8.8 million to approximately $1.8 million of other income for 1999 from $7.0 million in other expense for 1998. The increase was primarily due to (i) the inclusion of $5.6 million of non-cash interest expense in 1998 relating to the change in the fair value of an outstanding put warrant and (ii) an increase in interest income on the cash obtained from the completion of our initial public offering in December 1998. The put provision associated with the warrant was eliminated effective on completion of the initial public offering.
Income tax expense (benefit)
Income tax benefit increased to $4.8 million for 1999 from $2.2 million for 1998 due to a decrease in taxable income in 1999.
Extraordinary Item
Net income in 1998 includes an extraordinary charge, net of income tax benefits, of $1.4 million. The charge relates to the write-off of certain deferred assets associated with our $15.0 million debt financing, which was repaid in December 1998.
COMPARISON OF YEAR ENDED JANUARY 2, 1999 AND
JANUARY 3, 1998
Net sales
Net sales increased 33.5% to $246.3 million for 1998 from $184.4 million for 1997, primarily due to an increase in unit sales. The components of the increase in net sales were (i) a $29.1 million increase associated with the opening of 64 new retail stores during 1998 and the full year impact of 57 stores opened in 1997, (ii) a $22.0 million increase associated with an increase of 23.5% in comparable store sales over the comparable period of the prior year, resulting primarily from the continuing maturation of stores, offset by an estimated $4.4 million in comparable store sales in the 53rd week in 1997 and (iii) a $14.6 million increase in direct marketing sales. For a significant portion of the third quarter of 1997, due to a UPS work stoppage, UPS was unable to deliver the Company's products within acceptable time periods,
causing delays in deliveries to customers and requiring the Company to use alternative carriers. Also, during this period, the Company converted its manufacturing and financial operations to a new integrated information system. These factors resulted in higher than normal customer returns and canceled orders, lower order volumes and substantially increased freight charges, which the Company estimates negatively impacted its operating income by approximately $3.9 million in the second half of 1997, principally incurred in the third quarter.
Gross margin
Gross margin increased to 65.4% in 1998 from 63.9% in 1997 primarily due to improved purchasing through volume discounts and better relationships with key suppliers and improved leverage of fixed manufacturing costs over higher unit volumes as well as reduced costs from the UPS strike in 1997.
Sales and marketing
Sales and marketing expenses increased 30.9% to $129.9 million in 1998 from
$99.2 million in 1997, and decreased slightly as a percentage of net sales to
52.7% in 1998 from 53.8% in 1997. The increase in the dollar amount of sales and
marketing expenses was primarily due to (i) the opening of 64 new retail stores
during 1998, (ii) an increase in advertising expenditures of $3.4 million and
(iii) higher commissions, percentage rents and freight expense related to the
higher net sales. The decrease in sales and marketing expenses as a percentage
of net sales was primarily due to improved leverage on advertising expenditures.
General and administrative
General and administrative expenses increased 19.5% to $19.7 million in 1998 from $16.5 million in 1997, but decreased as a percentage of net sales to 8.0% in 1998 from 8.9% in 1997. The increase in the dollar amount of general and administrative expenses was primarily due to increased spending to provide infrastructure to support overall net sales growth. The decrease in general and administrative expenses as a percentage of net sales was primarily due to improved leverage of fixed costs over the increase in net sales.
Other income (expense), net.
Other expense increased $2.3 million to $7.0 million of other expense in 1998 from $4.7 million of other expense in 1997 primarily due to the inclusion of $5.6 million of non-cash interest expense in 1998 relating to the change in the fair value of an outstanding put warrant compared with $3.3 million in 1997. The put provision associated with the warrant was eliminated effective on completion of the initial public offering.
Income tax expense (benefit)
Income tax expense decreased to a $2.2 million benefit in 1998 from a $0.1 million expense in 1997 primarily due to a $4.7 million benefit in 1998 associated with the recognition of deferred tax assets. The benefit was partially offset by income tax expense associated with taxable income in 1998. Income tax expense in 1997 was limited due to the use of net operating losses to offset taxable income.
Extraordinary Item
Net income in 1998 includes an extraordinary charge, net of income tax benefits, of $1.4 million. The charge relates to the write-off of certain deferred assets associated with our $15.0 million debt financing, which was repaid in December 1998.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been the sale of equity securities. We completed our initial public offering in December 1998, resulting in net proceeds of $44.6 million, which have been partially used for (i) the repayment of $15.0 million of debt, (ii) expansion of retail stores, (iii) the build-out of our third manufacturing plant and (iv) the repurchase of 1,220,000 shares of Company common stock for $12.7 million. The Company had working capital of approximately $14.5 million at January 1, 2000, $42.2 million at January 2, 1999, and $757,000 at January 3, 1998.
Net cash provided by 1999 operating activities was approximately $7.7 million and consisted primarily of net loss adjusted for non-cash expenses, decreases in accounts receivable and increases in accounts payable and accrued liabilities, partially offset by increases in inventories and income taxes receivable. Net cash provided by operating activities for 1998 was approximately $11.0 million and consisted primarily of cash flows from operations before non-cash expenses, partially offset by increases in accounts receivable and decreases in accounts payable. Net cash provided by operating activities in 1997 was approximately $7.3 million and consisted primarily of increases in
accounts payable, accruals and net loss adjusted for non-cash expenses, partially offset by increases in accounts receivable, inventories and prepaid expenses.
Effective as of July 1999, we terminated our revolving third-party credit arrangement with Monogram Bank, an affiliate of General Electric Capital Corporation ("GE") and entered into a third-party credit arrangement with Conseco (formerly Green Tree Financial Corporation). These arrangements have been used to provide financing for our customers' use in purchasing our products. In connection with all purchases financed under these arrangements, the provider pays an amount equal to the total amount of purchases net of promotional discounts. The provider sets the rate, annual fees and all other terms and conditions relating to the customers' accounts, including collection policies and procedures, and is the owner of the receivables. In July 1999, Conseco purchased substantially all of the outstanding receivables from GE. As a result of this transaction, we received $9.8 million that had been retained by GE and included in our accounts receivable. There are no similar retainage requirements as part of the new agreement with Conseco.
Net cash used in investing activities was approximately $35.8 million, $8.9 million and $10.7 million in the years 1999, 1998 and 1997, respectively. Investing activities consisted of purchases of property and equipment for new retail stores in all periods, and for 1999 also included the opening of our Utah production facility and the investment of excess cash in marketable securities with maturities in excess of 90 days.
Net cash provided by (used in) financing activities for 1999, 1998 and 1997 was approximately ($10.0) million, $30.7 million and $13.7 million, respectively. Net cash used in financing activities for 1999 was due to repurchases of common stock and debt repayments, partially offset by cash received from issuance of common stock. During 1999, the Company repurchased 1,220,000 shares of common stock for approximately $12.7 million. Net cash provided by financing activities for 1998 consisted primarily of proceeds from completion of our initial public offering, partially offset by debt repayments. Net cash provided by financing activities for 1997 consisted primarily of proceeds from debt issuances, partially offset by debt repayments.
We believe cash generated from operations will be sufficient to satisfy anticipated working capital needs and that capital expenditure requirements through at least the end of 2000 will be funded primarily by January 1, 2000 cash and marketable securities balances. Cash generated from operations and cash remaining at the end of 2000 will be used to meet long-term liquidity needs, although additional financing may be required.
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.
IMPACT OF YEAR 2000
State of Readiness
We have not experienced any disruptions related to Year 2000 issues. We will continue to monitor systems and suppliers for Year 2000 business disruptions.
Costs to Address the Year 2000 Issue
We incurred $165,000 in 1999 to complete our remediation plans required for information technology systems, including systems software costs and consulting fees. We do not anticipate incurring significant additional costs in the future relating to Year 2000 information technology issues.
Risks Presented by the Year 2000 Issue
If any third party who provides goods or services essential to our business activities fails to appropriately address Year 2000 issues, such failure could have a material adverse effect on our business, financial condition or operating results. For example, a Year 2000 related disruption on the part of the financial institutions which process our credit card sales could have a material adverse effect on our business, financial condition or operating results. We have not experienced any Year 2000 issues due to third parties. We will continue to monitor suppliers for Year 2000 business disruptions.
MANAGEMENT'S REPORT
The management of Select Comfort Corporation is responsible for the preparation, integrity and fair presentation of the consolidated financial statements included in this annual report. The financial statements have been prepared in accordance with generally accepted accounting principles and include amounts based on judgments and estimates made by management. Management is also responsible for the preparation and accuracy of information included in other sections of this annual report, which information is consistent with the financial statements.
The integrity of the financial statements is based on the maintenance of an internal control structure established by management to provide reasonable assurance that assets are safeguarded and transactions are properly authorized, recorded and reported. The concept of reasonable assurance is based on the recognition that the cost of maintaining a system of internal controls should not exceed the benefits expected to be derived. Even effective internal controls, no matter how well designed, have inherent limitations. Management believes that the internal control system provides reasonable assurance that errors or irregularities that could be material to the financial statements are prevented or would be detected and corrected in the normal course of business.
The Company engages independent auditors to examine its financial statements and express their opinion thereon. The auditors have access to each member of management in conducting their audits. Their report appears in this annual report.
The Audit Committee of the Board of Directors, composed solely of non-management directors, meets periodically with management and the independent auditors to review internal accounting controls, audit activities and financial reporting matters. The independent auditors have full access to the Audit Committee and meet periodically with them without management present.
/s/ Patrick A. Hopf /s/ James C. Raabe Patrick A. Hopf James C. Raabe Chairman of the Board Chief Financial Officer |
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Select Comfort Corporation:
We have audited the accompanying consolidated balance sheets of Select Comfort Corporation and subsidiaries (the Company) as of January 1, 2000 and January 2, 1999 and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the fiscal years in the three-year period ended January 1, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Select Comfort Corporation and subsidiaries as of January 1, 2000 and January 2, 1999, and the results of their operations and their cash flows for each of the fiscal years in the three-year period ended January 1, 2000 in conformity with generally accepted accounting principles.
Minneapolis, Minnesota /s/ KPMG LLP January 26, 2000 |
CONSOLIDATED BALANCE SHEETS
JANUARY 1, 2000 AND JANUARY 2, 1999
(IN THOUSANDS)
ASSETS 1999 1998
Current assets:
Cash and cash equivalents $ 7,441 $ 45,561
Marketable securities (note 2) 20,129 -
Accounts receivable, net of allowance for
doubtful accounts of $305, and $2,750, respectively (note 3) 1,056 10,624
Inventories (note 4) 11,451 10,136
Prepaid expenses 4,821 4,048
Income taxes (note 10) 2,579 -
Deferred tax assets (note 10) 6,639 5,448
---------------------
Total current assets 54,116 75,817
---------------------
Property and equipment, net (note 5) 34,823 29,125
Deferred tax assets (note 10) 4,248 440
Other assets 2,678 852
---------------------
Total assets $ 95,865 $106,234
--------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 7) $ 51 $ 930
Accounts payable 15,911 12,079
Accruals:
Sales returns 5,880 6,021
Warranty costs 5,841 4,486
Compensation, taxes and benefits 6,678 4,843
Income taxes (note 10) - 648
Other 5,285 4,561
---------------------
Total current liabilities 39,646 33,568
Long-term debt, less current maturities (note 7) 36 29
Other liabilities 2,809 1,946
---------------------
Total liabilities 42,491 35,543
---------------------
Shareholders' equity (notes 7, 8, 9 and 12):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
17,713,247 and 18,435,687 shares issued and outstanding, respectively 177 184
Additional paid-in capital 78,513 87,619
Accumulated deficit (25,316) (17,112)
---------------------
Total shareholders' equity 53,374 70,691
---------------------
Commitments (notes 6 and 14):
Total liabilities and shareholders' equity $ 95,865 $106,234
---------------------
|
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1999 1998 1997
Net Sales $ 273,767 $ 246,269 $ 184,430
Cost of sales 95,107 85,187 66,629
---------------------------------------------
Gross margin 178,660 161,082 117,801
---------------------------------------------
Operating expenses:
Sales and marketing 162,742 129,894 99,218
General and administrative 29,213 19,723 16,505
Store closings (note 5) 1,498 20 82
---------------------------------------------
Total operating expenses 193,453 149,637 115,805
---------------------------------------------
Operating income (loss) (14,793) 11,445 1,996
---------------------------------------------
Other income (expense):
Interest income 1,956 825 682
Interest expense (note 7) (69) (7,834) (5,234)
Other, net (116) (32) (149)
---------------------------------------------
Other income (expense), net 1,771 (7,041) (4,701)
---------------------------------------------
Income (loss) before income taxes and extraordinary item (13,022) 4,404 (2,705)
Income tax expense (benefit) (note 10) (4,818) (2,232) 141
---------------------------------------------
Net income (loss) before extraordinary item (8,204) 6,636 (2,846)
Extraordinary item, net of tax benefit (note 7) - (1,441) -
---------------------------------------------
Net income (loss) $ (8,204) $ 5,195 $ (2,846)
Deemed dividend from revision of preferred stock
conversion rate (note 8) $ - $ (1,312) $ -
Cumulative preferred dividends - (821) (900)
---------------------------------------------
Net income (loss) available to common shareholders $ (8,204) $ 3,062 $ (3,746)
---------------------------------------------
Net income (loss) per share - basic (note 11)
Net income (loss) before extraordinary item $ (0.45) $ 1.09 $ (1.59)
Net income (loss) (0.45) 0.74 (1.59)
---------------------------------------------
Net income (loss) per share - diluted (note 11)
Net income (loss) before extraordinary item $ (0.45) $ 0.28 $ (1.59)
Net income (loss) (0.45) 0.19 (1.59)
---------------------------------------------
|
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Additional Notes
Paid-in Accumulated Receivable -
Shares Amount Capital Deficit Investors Total
Balance at December 28, 1996 1,847,146 $ 19 $ 1,226 $ (19,461) $ -- $ (18,216)
Exercise of common stock options 630,514 6 436 -- -- 442
Issuance of investor notes -- -- -- -- (418) (418)
Net loss -- -- -- (2,846) -- (2,846)
----------------------------------------------------------------------------------------
Balance at January 3, 1998 2,477,660 25 1,662 (22,307) (418) (21,038)
----------------------------------------------------------------------------------------
Issuance of shares in initial
public offering (note 9) 2,922,350 29 44,614 -- -- 44,643
Conversion of mandatorily
redeemable preferred stock
(note 8) 12,332,364 123 27,489 -- -- 27,612
Exercise of common stock options
and warrants 703,313 7 4,639 -- -- 4,646
Issuance of investor notes -- -- -- -- (487) (487)
Payment of investor notes -- -- -- -- 905 905
Elimination of put provision on
warrant (note 7) -- -- 9,215 -- -- 9,215
Net income -- -- -- 5,195 -- 5,195
----------------------------------------------------------------------------------------
Balance at January 2, 1999 18,435,687 184 87,619 (17,112) -- 70,691
----------------------------------------------------------------------------------------
Exercise of common stock options
and warrants 479,855 5 3,470 -- -- 3,475
Repurchase of common stock (1,220,000) (12) (12,680) -- -- (12,692)
Employee stock purchases (note 12) 17,705 -- 104 -- -- 104
Net loss -- -- -- (8,204) -- (8,204)
----------------------------------------------------------------------------------------
Balance at January 1, 2000 17,713,247 $ 177 $ 78,513 $ (25,316) $ -- $ 53,374
----------------------------------------------------------------------------------------
|
See accompanying notes to consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS)
1999 1998 1997
Cash flows from operating activities:
Net income (loss) $ (8,204) $ 5,195 $ (2,846)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 6,695 5,351 4,030
Loss on disposal of assets and impaired assets 1,297 50 264
Extraordinary item -- 1,441 --
Deferred tax assets (4,999) (5,888) --
Interest expense from put warrant valuation -- 5,625 3,250
Change in operating assets and liabilities:
Accounts receivable, net 9,568 (4,663) (4,799)
Inventories (1,315) (2,387) (2,167)
Prepaid expenses (773) 208 (2,567)
Income taxes (3,227) 1,856 125
Accounts payable 3,832 (120) 3,026
Accrued sales returns (141) 697 2,529
Accrued warranty costs 1,355 1,229 1,221
Accrued compensation, taxes and benefits 1,835 1,694 1,426
Other accrued liabilities 724 (265) 3,704
Other assets 147 252 (565)
Other liabilities 863 709 705
---------------------------------------
Net cash provided by operating activities 7,657 10,984 7,336
---------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (13,663) (8,812) (10,727)
Investment in marketable securities (20,129) -- --
Investment in affiliate (2,000) -- --
---------------------------------------
Net cash used in investing activities (35,792) (8,812) (10,727)
---------------------------------------
Cash flows from financing activities:
Proceeds from issuance of debt -- -- 16,184
Principal payments on debt (872) (15,999) (2,203)
Repurchase of common stock (12,692) -- (781)
Proceeds from issuance of common stock 3,579 46,718 439
---------------------------------------
Net cash provided by (used in) financing activities (9,985) 30,719 13,639
---------------------------------------
Increase (decrease) in cash and cash equivalents (38,120) 32,891 10,248
Cash and cash equivalents, at beginning of year 45,561 12,670 2,422
---------------------------------------
Cash and cash equivalents, at end of year $ 7,441 $ 45,561 $ 12,670
---------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 69 $ 1,719 $ 1,598
Income taxes 2,292 1,800 16
Cashless exercise of stock options -- 1,483 --
Net tax benefit from exercise of stock options 1,115 493 --
---------------------------------------
|
See accompanying notes to consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Select Comfort Corporation and its wholly owned subsidiaries (the Company) develop, manufacture, and market air beds and sleep-related products. The Company's fiscal year ends on the Saturday closest to December 31. Fiscal years 1999 and 1998 had 52 weeks. Fiscal year 1997 had 53 weeks. Certain prior-year amounts have been reclassified to conform to the current-year presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All significant inter-company balances and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with original maturities of three months or less.
Inventories
Inventories include material, labor, and overhead and are stated at the lower of cost or market. Cost is determined by the first-in, first-out method.
Property and Equipment
Property and equipment, carried at cost, are depreciated using the straight-line method over the estimated useful lives of the assets, which range from three to seven years. Leasehold improvements are amortized over the shorter of the life of the lease or ten years.
Other Assets
Other assets include security deposits, patents, investments, trademarks, and debt issuance costs. Patents and trademarks are amortized using the straight-line method over a 17-year period and 15-year period, respectively. Debt issuance costs are amortized using the straight-line method over the term of the debt. In May 1999, the Company invested $2.0 million in a less than 20% owned affiliate that will be the provider of the Company's sofa sleeper product. This investment is accounted for under the cost method.
Impairment of Long-lived Assets and Long-lived Assets to be Disposed Of
The Company reviews its long-lived assets and certain identifiable intangibles for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets. Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.
Accrued Warranty Costs
The Company provides a 20-year warranty on air beds, the last 15 years of which are on a prorated basis. Estimated warranty costs are provided at the time of sale of the warranted products. Estimates are based upon historical warranty claims incurred by the Company. Given the limited history available, actual results could differ from these estimates.
Accrued Sales Returns
Estimated sales returns are provided at the time of sale based upon historical sales returns. Returns are allowed by the Company for 90 nights following the sale.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents and accounts receivable approximate fair value because of the short-term maturity of those instruments. The fair value of long-term debt approximates carrying value based on the Company's estimate of rates that would be available to it for debt of the same remaining maturities.
Revenue Recognition
Revenue is recognized when products are shipped to customers net of estimated returns.
Stock Compensation
The Company records compensation expense for option grants under its stock option plan if the current market value of the underlying stock at the grant date
exceeds the stock option exercise price. Pro forma disclosure of the net income impact of applying an alternative method of recognizing stock compensation expense over the vesting period based on the fair value of all stock-based awards on the date of grant is presented in Note 9. The Company has issued options to non-employees and recognized compensation expense based on the fair market value method.
Product Development Costs
Costs incurred in connection with research and development are charged to expense as incurred. Product development expense was $1,865,000, $1,638,000, and $1,819,000 in 1999, 1998, and 1997, respectively.
Pre-opening Costs
Costs associated with the opening of new stores are expensed as incurred.
Direct Response Advertising Costs
The Company incurs direct response advertising costs associated with print and broadcast advertisements. Such costs are charged to expense as incurred. Advertising expense was $43,415,000, $31,648,000, and $28,281,000 in 1999, 1998, and 1997.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future tax consequences attributable to temporary differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
Earnings (loss) Per Share
Basic earnings (loss) per share excludes dilution and is computed by
dividing the net income (loss) available to common shareholders by the weighted
average number of common shares outstanding during the period. Diluted earnings
(loss) per share includes dilutive potential common shares consisting of stock
options and warrants determined by the treasury stock method, and dilutive
convertible securities.
Accounting Estimates
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements
During 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No 133, "Accounting for Derivative Instruments and Hedging Activities". During 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No 137, which extends the implementation of SFAS 133 until 2001 for the Company. This pronouncement is not expected to have a material impact on the Company's consolidated financial statements. During 1999 the Securities and Exchange Commission issued Staff Accounting Bulletin No 101, "Revenue Recognition in Financial Statements". The Company is analyzing the impact of this SAB on the Company's consolidated financial statements.
(2) MARKETABLE SECURITIES
Securities classified as held to maturity, which consist of securities with maturities of less than one year that management has the ability and intent to hold to maturity, are carried at amortized cost, and are summarized as follows at January 1, 2000 (in thousands):
Average Amortized Fair Value
Interest Rate Cost
U.S. Government agencies 5.5% $ 7,244 $ 7,228
Commercial paper 5.8% 12,885 12,877
--------------------------------------------
$20,129 $20,105
--------------------------------------------
|
(3) ACCOUNTS RECEIVABLE
The Company utilizes a third-party bank to offer its qualified customers an unsecured revolving credit arrangement to finance purchases from the Company. The bank sets the rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts. In connection with all purchases financed under these arrangements, the bank pays the Company an amount equal to the total amount of such purchases, net of promotional related discounts. Effective July 1999, the Company terminated its existing credit arrangement and entered into a new agreement with another provider. The new provider purchased substantially all of the outstanding customer receivables. As a result, the Company received $9,800,000 that had been retained by the previous provider and included in accounts receivable. The previous bank had retained $11,350,000 as of January 2, 1999 under terms of its agreement. There are no retainage amounts as a part of the new agreement.
(4) INVENTORIES
Inventories consist of the following (in thousands):
January 1, 2000 January 2, 1999
Raw materials $ 5,753 $ 6,533
Work in progress 59 67
Finished goods 5,639 3,536
-----------------------------------
$11,451 $10,136
-----------------------------------
|
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
January 1, 2000 January 2, 1999
Leasehold improvements $32,192 $24,865
Office furniture and equipment 5,314 3,079
Production machinery and
computer equipment 13,115 8,610
Property and equipment
under capital lease 495 2,963
Other 1,108 1,446
Less accumulated depreciation
and amortization (17,401) (11,838)
------------------------------
$34,823 $29,125
------------------------------
|
Store Closings
Store closing expense for 1999 includes a $1,404,000 charge associated with plans to close 22 stores and other related store write-offs. Store closing expense was $1,498,000, $20,000, and $82,000 in 1999, 1998, and 1997, respectively.
(6) LEASES
The Company rents office and manufacturing space under four operating leases which, in addition to the minimum lease payments, require payment of a proportionate share of the real estate taxes and building operating expenses. The Company also rents retail space under operating leases which, in addition to the minimum lease payments, require payment of percentage rents based upon sales levels. Rent expense was as follows:
1999 1998 1997
Minimum rents $15,399 $11,127 $ 8,465
Percentage rents 1,992 1,522 892
---------------------------------
Total $17,391 $12,649 $ 9,357
---------------------------------
Equipment rent $ 1,362 $ 952 $ 683
---------------------------------
|
The aggregate minimum rental commitments under operating leases for subsequent years are as follows (in thousands):
2000 $ 16,313
2001 14,711
2002 14,329
2003 13,486
2004 11,978
Thereafter 30,858
--------
$101,675
--------
|
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term obligations under notes and capital leases are as follows (in thousands):
January 1, 2000 January 2, 1999
Notes payable under capital
lease agreements, payable in
monthly installments through
March 2000, with interest at
9.75% - 12.5% per annum. In
connection with these notes,
the Company granted the
vendor warrants to acquire
31,428 shares of the
Company's Series E
convertible preferred
stock (note 9) $87 $959
------------------
87 959
Less current maturities 51 930
------------------
$36 $ 29
------------------
|
Aggregate maturities of long-term debt subsequent to January 1, 2000 are due in 2000.
In March 1997, the Company completed a financing under which it issued a senior subordinated promissory note in the principal amount of $15,000,000, a warrant to purchase 1,100,000 shares of the Company's common stock at $10.50 per share and a contingent warrant to purchase 1,000,000 shares of common stock at $0.01 per share. These warrants were subsequently adjusted and combined, resulting in a single warrant to purchase 1,315,096 shares of common stock at $8.82 per share, exercisable at any time prior to March 31, 2005.
In December 1998, the Company repaid the promissory note resulting in an extraordinary loss of $1,441,000 from early repayment. The loss was comprised of unamortized debt discount and issuance costs totaling $2,281,000, and net of income tax benefits of $840,000.
The original warrant issued in the financing provided that the holder could require the Company to repurchase the warrant if an initial public offering had not been completed prior to March 27, 2002. The repurchase amount would have been equal to the excess of the estimated fair market value of the Company's common stock, as determined by the warrant agreement, over the exercise price of the warrant. The Company also has an option to repurchase the warrant if the warrant has not been exercised prior to March 27, 2004. As required by Emerging Issues Task Force Issue 96-13 (EITF 96-13), the warrant was recorded at fair value and recorded as long-term debt. In addition, EITF 96-13 requires that any change in fair value of the warrant be reflected as interest expense. Accordingly, the financial statements reflect interest expense of $5,625,000 and $3,250,000 for 1998 and 1997, respectively.
Upon completion of the Company's initial public offering the put option on the warrants expired and the warrants were reclassified into $9,215,000 of additional paid-in-capital. In addition, effective upon completion of the Company's initial public offering, warrant revaluation is no longer required and accordingly interest expense will no longer be recorded.
(8) MANDATORILY REDEEMABLE PREFERRED STOCK
Prior to completion of the Company's initial public offering in December 1998, the Company had issued and outstanding 12,091,962 shares of mandatorily redeemable preferred stock. The holders of the Series A, B, C, D, and E mandatorily redeemable preferred stock had certain rights and preferences, including those involving dividend participation, special voting, liquidation preferences, antidilution rights, redemption rights and in certain cases, those involving cumulative dividends.
In November 1998, the Company adjusted the conversion price of the Series E Mandatorily Redeemable Preferred Stock from $8.82 per share to $8.20. The adjustment was made in accordance with the Series E Stock Purchase Agreement and was effective on the closing of the Company's initial public offering. The adjustment resulted in the issuance of an additional 77,155 shares of common stock upon conversion. For purposes of calculating net income (loss) per share in the period in which the initial public offering was completed, net income available to common shareholders has been reduced by $1,312,000 for the estimated value of additional shares issued under these antidilution provisions (note 11).
Upon completion of the Company's underwritten public offering in December 1998 the Series A, B, C, D, and E mandatorily redeemable preferred stock were converted into an aggregate of 12,332,364 of common stock. In addition, all rights and preferences, including those involving cumulative dividends, expired. Cumulative but undeclared and unpaid dividends have been deducted from net income available to common shareholders in determining net income (loss) per share (note 11).
As of January 2, 1999, there were no remaining mandatorily redeemable shares outstanding.
Changes in mandatorily redeemable preferred stock are as follows (dollars in thousands):
ADDITIONAL
PAID-IN
SHARES AMOUNT CAPITAL TOTAL
Balance At
January 3, 1998 12,091,962 $12,692 $14,920 $27,612
Conversion to
common
stock 12,091,962 12,692 14,920 27,612
---------------------------------------------
Balance at
January 2, 1999 - $ - $ - $ -
=============================================
|
(9) SHAREHOLDERS' EQUITY
Effective December 4, 1998, the Company issued 2,922,350 common shares in completion of its initial public offering resulting in net proceeds of $44.6 million.
Stock Options
The Board of Directors has reserved 5,300,000 shares of common stock for options that may be granted to key employees, directors, or others under the Company's stock option plans. On March 2, 2000, the Board of Directors of the Company approved, subject to approval by the shareholders, an increase in the number of shares of common stock reserved for issuance to 6,300,000 shares.
A summary of the changes in the Company's stock option plans for each of the years in the three year period ended January 1, 2000 is as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
Outstanding at December 28, 1996
(including 1,105,468 shares exercisable) 1,679,173 $2.58
Granted 1,073,750 6.20
Exercised (630,514) 0.70
Canceled (26,800) 4.29
---------------------
Outstanding at January 3, 1998
(including 931,319 shares exercisable) 2,095,609 4.98
Granted 443,075 14.70
Exercised (526,880) 3.18
Canceled (208,070) 5.82
---------------------
Outstanding at January 2, 1999
(including 884,807 shares exercisable) 1,803,734 7.77
Granted 1,857,100 12.10
Exercised (448,705) 5.05
Canceled (526,776) 14.66
---------------------
Outstanding at January 1, 2000
(including 1,311,133 shares exercisable) 2,685,353 $9.92
=====================
|
The following table summarizes information about options outstanding at January 1, 2000:
OPTIONS OPTIONS
OUTSTANDING EXERCISABLE
-------------------------------------------------- -------------------
AVERAGED WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICE SHARES LIFE (YEARS) PRICE SHARES PRICE
$ 0.45 - 4.80 235,420 5.91 $ 3.80 220,420 $ 3.78
5.25 - 6.50 641,140 7.80 5.53 462,110 5.49
6.63 - 11.00 956,117 8.72 8.27 429,688 9.10
13.94 - 17.00 757,201 6.85 15.71 155,880 15.85
23.69 - 32.25 95,475 9.21 24.98 43,035 25.72
----------------------------------------------------------------------
$ 0.45 - 32.25 2,685,353 7.74 $ 9.92 1,311,133 $ 8.28
======================================================================
|
No compensation cost has been recognized in the consolidated financial statements for employee stock options grants and the Company's employee stock purchase plan. Had the Company determined compensation cost based on the fair value at the grant date for its stock options under an alternative accounting method, the Company's net loss would have been adjusted as indicated below (in thousands):
1999 1998 1997
Net income (loss): As reported $ (8,204) $5,195 $(2,846)
Pro forma $(11,088) $4,144 $(3,563)
|
The fair value of each option grant is estimated on the date of grant using the Black-Sholes option-pricing model with the following assumptions: expected dividend yield-0%; expected stock price volatility-40%; risk-free interest rate- 6.3% for 1999, 4.6% for 1998, and 6.4% for 1997; expected life of options- 2.9, 3.0 years, and 4.2 for 1999, 1998, and 1997, respectively. The per share weighted-average fair value of stock options granted during 1999, 1998, and 1997 was $3.86, $4.72, and $1.92, respectively.
Warrants
In April 1996, the Company issued warrants to the holders of Series E Preferred Stock (note 8) to purchase an aggregate of 171,429 shares of Common Stock at an exercise price of $5.25 per share. During 1998, warrants for 54,430 common shares were exercised. Warrants for 108,499 and 116,999 shares remained outstanding at January 1, 2000 and January 2, 1999, respectively.
In connection with a capital lease transaction with a vendor in 1997, the Company granted the vendor warrants to acquire 31,428 shares of the Company's Series E convertible preferred stock at a purchase price of _$10.50 per share. The warrants are exercisable for five years beginning December 3, 1998. In December 1998, the Preferred Stock warrants were converted into warrants to purchase 40,243 shares of common stock at $8.20 per share. There were no warrants outstanding at January 1, 2000.
In connection with short-term debt issued to related parties in 1996, the Company granted warrants to purchase 71,525 shares of the Company's common stock at a purchase price of $5.25 per share. The warrants are exercisable for ten years from the grant date. During December 1998, warrants for 7,003 common shares were exercised. Warrants for 64,522 shares remained outstanding at January 1, 2000 and January 2, 1999.
Stock Repurchase
During 1999, the Company repurchased 1,220,000 shares for approximately $12.7 million.
(10) INCOME TAXES
The provision (benefit) for income taxes consists of the following (in thousands):
1999 1998 1997
Current:
Federal $ -- $ 2,969 $ 125
State 180 687 16
-----------------------------
180 3,656 141
-----------------------------
Deferred:
Federal (4,694) (5,803) --
State (304) (85) --
-----------------------------
(4,998) (5,888) --
-----------------------------
Income tax expense (benefit) $(4,818) $(2,232) $ 141
=============================
|
Effective tax rates differ from statutory federal income tax rates as follows:
1999 1998 1997
Statutory federal income
tax rate (35.0)% 35.0% (34.0)%
Nondeductible interest
expense, put warrants 0.0 44.7 40.8
Change in valuation allowance 0.0 (147.0) (2.7)
Effect of change in tax rate
on deferred tax asset 0.0 6.7 0.0
State income taxes, net of
federal benefit (0.6) 8.9 0.4
Other (1.4) 1.0 0.7
------------------------
(37.0)% (50.7)% 5.2 %
========================
|
The tax effects of temporary differences that give rise to deferred tax assets at January 1, 2000 and January 2, 1999 are as follows (in thousands):
1999 1998
Deferred tax assets:
Current:
Inventory, warranty, and returns reserves $ 4,553 $ 4,371
Allowance for doubtful accounts 116 117
Other 1,970 960
Long term:
Net operating loss carryforwards 3,885 602
Other 886 361
--------------------
Total gross deferred tax assets 11,410 6,411
Valuation allowance (523) (523)
--------------------
Total net deferred tax assets $ 10,887 $ 5,888
====================
|
At January 1, 2000, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $10,200,000 expiring between the
years 2003 and 2019. The Company expects that approximately $1,400,000 of these
carryforwards will expire unutilized due to an Internal Revenue Code (IRC)
Section 382 limitation resulting from a prior ownership change and has,
therefore, provided a valuation allowance for this portion of the carryforwards.
The Company has not provided a valuation allowance for any other deferred tax
assets because it believes that it is more likely than not that they will be
realized.
(11) NET INCOME (LOSS) PER COMMON SHARE
The following computations reconcile net income (loss) with net income
(loss) per common share-basic and diluted (dollars in thousands, except per
share amounts).
NET PER SHARE
1999 LOSS SHARES AMOUNT
Net loss $ (8,204)
-----------------------------------
BASIC AND DILUTED EPS
Net loss attributable to
common shareholders $ (8,204) 18,299,728 $ (0.45)
===================================
|
NET PER SHARE
1998 INCOME SHARES AMOUNT
Net income before
extraordinary item $ 6,636
Less: Deemed dividend from
revision of preferred
stock (1,312) --
Cumulative preferred
dividends (821) --
-----------------------------------
BASIC EPS
Net income available to
common shareholders $ 4,503 4,114,219 $ 1.09
-----------------------------------
EFFECT OF DILUTIVE SECURITIES
Options -- 912,448
Warrants -- 654,436
Convertible preferred stock -- 10,247,143
------------------------------------
DILUTED EPS
Net income attributable to
common shareholders
plus assumed conversion $ 4,503 15,928,246 $ 0.28
===================================
|
NET PER SHARE
1997 LOSS SHARES AMOUNT
Net loss: $ (2,846)
Less cumulative preferred
dividends (900) --
---------------------------------
BASIC AND DILUTED EPS
Net loss attributable to
common shareholder $ (3,746) 2,352,947 $ (1.59)
==================================
|
The following is a summary of those securities outstanding during the respective periods which have been excluded from the calculations because the effect on net income (loss) per common share would not have been dilutive:
1999 1998 1997
Options 634,881 - 1,679,173
Common stock warrants 495,864 - 154,023
Preferred stock warrants - - 31,428
Convertible preferred stock - - 12,091,962
|
Convertible preferred stock and preferred stock warrants were convertible into 12,292,623 common shares during 1997.
(12) EMPLOYEE BENEFIT PLANS
Profit Sharing and 401(k) Plan
Effective January 1, 1994, the Company adopted a profit sharing and 401(k) plan for eligible employees. The plan allows employees to defer up to 15% of their compensation on a pretax basis. Each year, the Company may make a discretionary contribution equal to a percentage of the employee's contribution. During 1999, 1998, and 1997, the Company expensed $480,000, $375,000, and $78,000, respectively, relating to its contribution to the 401(k) plan.
Employee Stock Purchase Plan
Effective June 10, 1999, the Company adopted an Employee Stock Purchase Plan under which employees can purchase Company common stock at a discount of 15% through payroll deductions. Based on the average price on the last business day of the offering period (calendar-quarter), 17,705 shares were issued at $5.89 during 1999.
(13) RELATED PARTY TRANSACTIONS
As of April 1998, a former director and executive officer had borrowed $425,000 from the Company. On December 10, 1998 the former director and executive officer repaid the outstanding balance of the note.
The Company entered into a consulting agreement with a director of the Company beginning May 4, 1999. The agreement was effective for a term of two years, and provided an annual fee of $100,000 and 60,000 options vesting over three years. Effective January 2000, the director resigned from the board and the consulting agreement was terminated. All vested options are exercisable through May 2004.
The Company has entered into an employment and consulting agreement with a former executive officer of the Company beginning April 19, 1999. The Company paid $10,000 monthly for the employment services from May 1, 1999 through July 31, 1999, and has agreed to pay $8,250 per month for consulting services from August 1, 1999 through April 30, 2001.
(14) COMMITMENTS AND CONTINGENCIES
The Company and certain of its former officers and directors have been named as defendants in a class action lawsuit filed on behalf of Company shareholders in U.S. District Court in Minnesota. The named plaintiffs, who purport to act on behalf of a class of purchasers of the Company's common stock during the period from December 4, 1998 to June 7, 1999, charge the defendants with violations of federal securities laws. The suit alleges that the Company and the named directors and officers failed to disclose or misrepresented certain information concerning the Company during the class period. The complaint does not specify an amount of damages claimed. The Company believes that the complaint is without merit and intends to vigorously defend the claims.
The Company 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 are adequately covered by insurance or are provided for in the consolidated financial statements and the ultimate outcome of these matters will not have a material effect on the consolidated financial position or results of operations of the Company.
(15) SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a condensed summary of actual quarterly results for 1999 and 1998:
1999 Fourth Third Second First Net sales $68,104 $68,281 $65,750 $71,632 Gross margin 44,050 44,337 43,188 47,085 Operating income (loss) (9,939) (6,432) 200 1,378 Net income (loss) (6,042) (3,698) 348 1,188 Net income (loss) per share - diluted (0.33) (0.20) 0.02 0.06 ------------------------------------------------------------------------------------------------------------- 1998 Fourth Third Second First Net sales $67,434 $60,034 $60,129 $58,672 Gross margin 44,537 39,291 39,663 37,591 Operating income 4,063 2,679 3,666 1,037 Net income (loss) before extraordinary item 7,047 (1,903) 1,910 (418) Net income (loss) 5,606 (1,903) 1,910 (418) Net income (loss) per share before extraordinary item - diluted 0.32 (0.72) 0.11 (0.26) Net income (loss) per share - diluted 0.24 (0.72) 0.11 (0.26) ------------------------------------------------------------------------------------------------------------- |
BOARD OF DIRECTORS EXECUTIVE OFFICERS/ CORPORATE HEADQUARTERS
MANAGEMENT TEAM
Patrick A. Hopf William R. McLaughlin Select Comfort Corporation
Chairman, Select Comfort Corporation President and 10400 Viking Drive, Suite 400
Managing General Partner, Chief Executive Officer Minneapolis, Minnesota 55344
St. Paul Venture Capital Telephone: (952) 918-3000
Tracey T. Breazeale www.selectcomfort.com
Thomas J. Albani Senior Vice President,
Former President and CEO Strategic Planning and Branding INDEPENDENT AUDITORS
Electrolux Corporation KPMG LLP
Renee M. Christensen Minneapolis, Minnesota
Christopher P. Kirchen Senior Vice President,
Managing General Partner E-Commerce REGISTER AND TRANSFER AGENT
Brand Equity Ventures Norwest Bank of Minnesota, N.A.
James D. Gaboury Stock Transfer Department
David T. Kollat Vice President, 161 North Concord Exchange
President Direct Sales P.O. Box 738
22 Inc. South St. Paul, MN 55075
Mark A. Kimball
William J. Lansing Senior Vice President, OUTSIDE COUNSEL
Chief Executive Officer Chief Administrative Officer, Oppenheimer Wolff & Donnelly LLP
NBC Internet, Inc. General Counsel and Secretary Minneapolis, Minnesota
William R. McLaughlin Gregory T. Kliner ANNUAL MEETING
President and Chief Executive Officer Senior Vice President, The Annual Meeting of Shareholders
Select Comfort Corporation Operations will be held on Thursday, May 18,
2000 at 3:00 p.m. at the Hotel Sofitel
Ervin R. Shames Ronald E. Mayle in Bloomington, Minnesota.
Independent Management Consultant Senior Vice President,
Retail
Jean-Michel Valette
President and CEO James C. Raabe
Franciscan Estates Vice President,
Chief Financial Officer
|
ANNUAL REPORT/FORM 10-K
Current and potential Select Comfort shareholders interested in obtaining a copy of the Company's annual report filed on Form 10-K are invited to contact the Company by writing to Investor Relations at its Corporate Headquarters or calling Investor Relations at (952) 918-3190.
Shareholders and interested parties can also find information about Select Comfort Corporation on the Worldwide Web. The Web address is http://www.selectcomfort.com.
COMMON STOCK
Select Comfort's common stock trades on the Nasdaq Stock Market(R) under the symbol SCSS, since the Company changed its stock symbol from AIRB effective January 10, 2000. The quarterly high and low sales prices for the Company's common stock as reported by the Nasdaq Stock Market,(R) for the period from the date of our initial public offering on December 4, 1998 through the end of the most recent fiscal year are set forth in the table below. These prices reflect inter-dealer prices, without retail mark-up, mark-down or commission, and may not necessarily represent actual transactions. Select Comfort has never paid any cash dividends on its common stock and does not anticipate paying any cash dividends on its common stock in the foreseeable future.
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 1998
High $29.19
Low $19.63 N/A N/A N/A
------- ------- ------- -------
Fiscal 1999
High $ 7.06 $9.19 $29.88 $35.25
Low $ 3.63 $6.00 $ 6.38 $20.50
------- ------- ------- -------
|
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
------------------------------------- ----------------------------------- -----------------------------------
NAME OF THE SUBSIDIARY JURISDICTION OF INCORPORATION NAME UNDER WHICH SUBSIDIARY DOES
BUSINESS
------------------------------------- ----------------------------------- -----------------------------------
Select Comfort SC Corporation Minnesota Select Comfort SC Corporation
------------------------------------- ----------------------------------- -----------------------------------
Select Comfort Retail Corporation Minnesota Select Comfort Retail Corporation
------------------------------------- ----------------------------------- -----------------------------------
Select Comfort Direct Corporation Minnesota Select Comfort Direct Corporation
------------------------------------- ----------------------------------- -----------------------------------
Direct Call Centers, Inc. Minnesota Direct Call Centers, Inc.
------------------------------------- ----------------------------------- -----------------------------------
selectcomfort.com corporation Minnesota selectcomfort.com corporation
------------------------------------- ----------------------------------- -----------------------------------
|
EXHIBIT 23.1
INDEPENDENT AUDITORS' CONSENT
The Board of Directors
Select Comfort Corporation:
We consent to incorporation by reference in the registration statements on Form S-8 (No. 333-70493, No. 333-79157, No. 333-80755, and No. 333-84329) of Select Comfort Corporation, of our reports dated January 26, 2000, relating to the consolidated balance sheets of Select Comfort Corporation and subsidiaries, as of January 1, 2000, and January 2, 1999, and the related consolidated statements of operations, stockholders' equity and cash flows and the related financial statement schedule for each of the years in the three-year period ended January 1, 2000, which reports appear in the Annual Report on Form 10-K of Select Comfort Corporation for the fiscal year ended January 1, 2000.
/s/ KPMG LLP |
| ARTICLE 5 |
| MULTIPLIER: 1,000 |
| PERIOD TYPE | 12 MOS |
| FISCAL YEAR END | JAN 01 2000 |
| PERIOD START | JAN 03 1999 |
| PERIOD END | JAN 01 2000 |
| CASH | 7,441 |
| SECURITIES | 20,129 |
| RECEIVABLES | 1,361 |
| ALLOWANCES | 305 |
| INVENTORY | 11,451 |
| CURRENT ASSETS | 54,116 |
| PP&E | 52,224 |
| DEPRECIATION | 17,401 |
| TOTAL ASSETS | 95,865 |
| CURRENT LIABILITIES | 39,646 |
| BONDS | 0 |
| PREFERRED MANDATORY | 0 |
| PREFERRED | 0 |
| COMMON | 177 |
| OTHER SE | 53,197 |
| TOTAL LIABILITY AND EQUITY | 95,865 |
| SALES | 273,767 |
| TOTAL REVENUES | 273,767 |
| CGS | 95,107 |
| TOTAL COSTS | 95,107 |
| OTHER EXPENSES | 0 |
| LOSS PROVISION | 1,193 |
| INTEREST EXPENSE | 69 |
| INCOME PRETAX | (13,022) |
| INCOME TAX | (4,818) |
| INCOME CONTINUING | (8,204) |
| DISCONTINUED | 0 |
| EXTRAORDINARY | 0 |
| CHANGES | 0 |
| NET INCOME | (8,204) |
| EPS BASIC | (0.45) |
| EPS DILUTED | (0.45) |