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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
OF 1934
FOR THE FISCAL YEAR ENDED JANUARY 1, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to .
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COMMISSION FILE NO. 0-25121
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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)
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").
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TABLE OF CONTENTS
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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
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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.
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PART I
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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
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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
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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.
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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
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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
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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.
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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
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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
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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,
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<PAGE> 13
- - 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
11
<PAGE> 14
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,
- ------------------------------
* Fiscal 1997 was a 53-week year versus 52 weeks for 1999 and 1998. Comparable
store sales for 1998 and 1997, adjusted to 52 weeks, would be 27.3% and
26.1%, respectively.
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<PAGE> 15
- - 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
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<PAGE> 16
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
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<PAGE> 17
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
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<PAGE> 18
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.
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<PAGE> 19
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
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
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<PAGE> 20
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.
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<PAGE> 21
PART II
--------------------
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:
<TABLE>
<S> <C>
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
===========
</TABLE>
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.
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<PAGE> 22
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.
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<PAGE> 23
PART III
--------------------
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.
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<PAGE> 24
PART IV
--------------------
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.
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<PAGE> 25
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.
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<PAGE> 26
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)
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
24
<PAGE> 27
/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
25
<PAGE> 28
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
<TABLE>
<CAPTION>
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
------------------------------------- ----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
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
</TABLE>
26
<PAGE> 29
SELECT COMFORT CORPORATION
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED JANUARY 1, 2000
<TABLE>
<CAPTION>
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
<S> <C> <C>
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)
</TABLE>
27
<PAGE> 30
<TABLE>
<S> <C> <C>
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)
</TABLE>
28
<PAGE> 31
<TABLE>
<S> <C> <C>
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)
</TABLE>
29
<PAGE> 32
<TABLE>
<S> <C> <C>
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)
</TABLE>
30
<PAGE> 33
<TABLE>
<S> <C> <C>
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
</TABLE>
- -------------------
(1) Confidential treatment has been granted by the Securities and Exchange
Commission with respect to designated portions contained within document. Such
portions have been omitted and filed separately with the Securities and Exchange
Commission pursuant to Rule 24b-2 of the Securities and Exchange Act of 1934, as
amended.
31
<PAGE> 1
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.
<PAGE> 2
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.
2
<PAGE> 3
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
3
<PAGE> 4
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:_______________________________
4
<PAGE> 5
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
5
<PAGE> 1
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
<PAGE> 1
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
<PAGE> 1
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:
<TABLE>
<CAPTION>
Year Ended(1)
Jan. 1, 2000 Jan. 2, 1999 Jan. 3, 1998 Dec. 28, 1996 Dec. 30, 1995
<S> <C> <C> <C> <C> <C>
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)
</TABLE>
(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.
8
<PAGE> 2
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
9
<PAGE> 3
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
10
<PAGE> 4
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.
<TABLE>
<CAPTION>
PERCENTAGE OF NET SALES
YEAR ENDED
JAN. 1, 2000 JAN. 2, 1999 JAN 3, 1998
<S> <C> <C> <C>
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)%
----------------------------------
</TABLE>
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.
11
<PAGE> 5
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,
12
<PAGE> 6
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
13
<PAGE> 7
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.
14
<PAGE> 8
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
15
<PAGE> 9
CONSOLIDATED BALANCE SHEETS
JANUARY 1, 2000 AND JANUARY 2, 1999
(IN THOUSANDS)
<TABLE>
<CAPTION>
ASSETS 1999 1998
<S> <C> <C>
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
---------------------
</TABLE>
See accompanying notes to consolidated financial statements.
16
<PAGE> 10
CONSOLIDATED STATEMENTS OF OPERATIONS
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
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)
---------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
17
<PAGE> 11
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
<TABLE>
<CAPTION>
Additional Notes
Paid-in Accumulated Receivable -
Shares Amount Capital Deficit Investors Total
<S> <C> <C> <C> <C> <C> <C>
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
----------------------------------------------------------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
18
<PAGE> 12
CONSOLIDATED STATEMENTS OF CASH FLOWS
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
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 --
---------------------------------------
</TABLE>
See accompanying notes to consolidated financial statements.
19
<PAGE> 13
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
20
<PAGE> 14
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):
<TABLE>
<CAPTION>
Average Amortized Fair Value
Interest Rate Cost
<S> <C> <C> <C>
U.S. Government agencies 5.5% $ 7,244 $ 7,228
Commercial paper 5.8% 12,885 12,877
--------------------------------------------
$20,129 $20,105
--------------------------------------------
</TABLE>
21
<PAGE> 15
(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):
<TABLE>
<CAPTION>
January 1, 2000 January 2, 1999
<S> <C> <C>
Raw materials $ 5,753 $ 6,533
Work in progress 59 67
Finished goods 5,639 3,536
-----------------------------------
$11,451 $10,136
-----------------------------------
</TABLE>
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
<TABLE>
<CAPTION>
January 1, 2000 January 2, 1999
<S> <C> <C>
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
------------------------------
</TABLE>
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:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
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
---------------------------------
</TABLE>
The aggregate minimum rental commitments under operating leases for
subsequent years are as follows (in thousands):
<TABLE>
<S> <C> <C>
2000 $ 16,313
2001 14,711
2002 14,329
2003 13,486
2004 11,978
Thereafter 30,858
--------
$101,675
--------
</TABLE>
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term obligations under notes and capital leases are as follows (in
thousands):
<TABLE>
<CAPTION>
January 1, 2000 January 2, 1999
<S> <C> <C>
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
------------------
</TABLE>
22
<PAGE> 16
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.
23
<PAGE> 17
Changes in mandatorily redeemable preferred stock are as follows (dollars
in thousands):
<TABLE>
<CAPTION>
ADDITIONAL
PAID-IN
SHARES AMOUNT CAPITAL TOTAL
<S> <C> <C> <C> <C>
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 - $ - $ - $ -
=============================================
</TABLE>
(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:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
<S> <C> <C>
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
=====================
</TABLE>
The following table summarizes information about options outstanding at
January 1, 2000:
<TABLE>
<CAPTION>
OPTIONS OPTIONS
OUTSTANDING EXERCISABLE
- -------------------------------------------------- -------------------
AVERAGED WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICE SHARES LIFE (YEARS) PRICE SHARES PRICE
<S> <C> <C> <C> <C> <C>
$ 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
======================================================================
</TABLE>
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):
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Net income (loss): As reported $ (8,204) $5,195 $(2,846)
Pro forma $(11,088) $4,144 $(3,563)
</TABLE>
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.
24
<PAGE> 18
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):
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
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
=============================
</TABLE>
Effective tax rates differ from statutory federal income tax rates as
follows:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
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 %
========================
</TABLE>
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):
<TABLE>
<CAPTION>
1999 1998
<S> <C> <C>
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
====================
</TABLE>
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.
25
<PAGE> 19
(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).
<TABLE>
<CAPTION>
NET PER SHARE
1999 LOSS SHARES AMOUNT
<S> <C> <C> <C>
Net loss $ (8,204)
-----------------------------------
BASIC AND DILUTED EPS
Net loss attributable to
common shareholders $ (8,204) 18,299,728 $ (0.45)
===================================
</TABLE>
<TABLE>
<CAPTION>
NET PER SHARE
1998 INCOME SHARES AMOUNT
<S> <C> <C> <C>
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
===================================
</TABLE>
<TABLE>
<CAPTION>
NET PER SHARE
1997 LOSS SHARES AMOUNT
<S> <C> <C> <C>
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)
==================================
</TABLE>
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:
<TABLE>
<CAPTION>
1999 1998 1997
<S> <C> <C> <C>
Options 634,881 - 1,679,173
Common stock warrants 495,864 - 154,023
Preferred stock warrants - - 31,428
Convertible preferred stock - - 12,091,962
</TABLE>
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.
26
<PAGE> 20
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.
27
<PAGE> 21
(15) SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a condensed summary of actual quarterly results for 1999
and 1998:
<TABLE>
<CAPTION>
1999 Fourth Third Second First
<S> <C> <C> <C> <C>
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
<S> <C> <C> <C> <C>
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)
- -------------------------------------------------------------------------------------------------------------
</TABLE>
28
<PAGE> 22
<TABLE>
<CAPTION>
BOARD OF DIRECTORS EXECUTIVE OFFICERS/ CORPORATE HEADQUARTERS
MANAGEMENT TEAM
<S> <C> <C>
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
</TABLE>
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.
<TABLE>
<CAPTION>
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
<S> <C> <C> <C> <C>
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
------- ------- ------- -------
</TABLE>
29
<PAGE> 1
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
<TABLE>
<CAPTION>
- ------------------------------------- ----------------------------------- -----------------------------------
NAME OF THE SUBSIDIARY JURISDICTION OF INCORPORATION NAME UNDER WHICH SUBSIDIARY DOES
BUSINESS
- ------------------------------------- ----------------------------------- -----------------------------------
<S> <C> <C>
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
- ------------------------------------- ----------------------------------- -----------------------------------
</TABLE>
<PAGE> 1
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
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<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
0
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)
</TABLE>
