As filed with the Securities and Exchange Commission on April 3, 2003November 20, 2009
Registration No. 333-103469333-
U.S. UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
FORM S-3PRE-EFFECTIVE
Select Comfort CorporationSELECT COMFORT CORPORATION
Minnesota | ||
(State or other jurisdiction of incorporation or organization) | 41-1597886 (I.R.S. Employer Identification |
6105 Trenton Lane9800 59th Avenue North
Minneapolis, MNMinnesota 55442
(763) 551-7000
(Address, including zip code, and telephone number,registrant’sregistrant's principal executive offices)
William R. McLaughlin
Senior Vice President, and Chief Executive Officer6105 Trenton Lane
9800 59th Avenue North
Minneapolis, MNMinnesota 55442
(763) 551-7000
(Name, address, including zip code, and telephone number,
Copies to:
Copies requested to:
Thomas R. Marek, Esq.
Oppenheimer Wolff & Donnelly LLP
45 South Seventh Street, Suite 3300
Minneapolis, Minnesota 55402-1509
(612) 607-7309
Approximate date of commencement of proposed sale to the public: As soon as practicable
From time to time after the effective date of this registration statement.Registration Statement.
If the only securities being registered on this formForm are being offered pursuant to dividend or investmentinterest reinvestment plans, please check the following box: o
If any of the securities being registered on this formForm are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box: oý
If this formForm is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:offering. o
If this formForm is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering:offering. o
If delivery ofthis Form is a registration statement pursuant to General Instruction I.D. or a post-effective amendment thereto that shall become effective upon filing with the prospectus is expected to be madeCommission pursuant to Rule 434, please462(e) under the Securities Act, check the following box:box. o
The Registrant hereby amends If this Form is a post-effective amendment to a registration statement on such datefiled pursuant to General Instruction I.D. filed to register additional securities or dates as may be necessaryadditional classes of securities pursuant to delay its effective date untilRule 413(b) under the Registrant shall fileSecurities Act, check the following box. o
Indicate by check mark whether the registrant is a further amendment which specifically states that this registration statement shall thereafter become effectivelarge accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in accordance with Section 8(a)Rule 12b-2 of the Exchange Act.
Large accelerated filer o | Accelerated filer o | Non-accelerated filer o (Do not check if a smaller reporting company) | Smaller reporting company ý |
CALCULATION OF REGISTRATION FEE
Title of Each Class of Securities to be Registered | Amount to be Registered(1) | Proposed Maximum Offering Price Per Common Share(2) | Proposed Maximum Aggregate Offering Price(3) | Amount of Registration Fee(3) | ||||
---|---|---|---|---|---|---|---|---|
Common Stock, $0.01 par value | 4,500,000(3) | $5.08 per Common Share | $22,860,000 | $1,276 | ||||
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933, AS AMENDED OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE SECURITIES AND EXCHANGE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE.
The information contained in this prospectus is not complete and may be changed. The selling shareholder named in this prospectus may not sell these securities pursuant to this prospectus until the registration statement shall become effective on such date asfiled with the Securities and Exchange Commission acting pursuantis effective. This prospectus is not an offer to said Section 8(a), may determine.sell these securities and it is not soliciting an offer to buy these securities in any state where the offer or sale is not permitted.
Subject to Completion, dated April 3, 2003SUBJECT TO COMPLETION, DATED NOVEMBER 20, 2009
PRELIMINARY PROSPECTUS
4,500,000 Shares
9800 59th Avenue North
Minneapolis, Minnesota 55442
(763) 551-7000
This prospectus relates to the resale from time to time of Select Comfort Corporation identified in this prospectus are selling 4,400,000up to 4,500,000 shares of our common stock.stock by the selling shareholder named in this prospectus. Of the 4,500,000 shares, 2,500,000 were issued pursuant to a private placement that closed on November 13, 2009, and an additional aggregate 2,000,000 shares are issuable upon the exercise of warrants issued in the private placement, which are immediately exercisable and expire on November 13, 2014. The sale of the common stock and warrants to the selling shareholder is more fully described on pages 15 to 16 of this prospectus under the heading "Selling Shareholder." We are not selling any securities under this prospectus and will not receive any of the proceeds from the sale of shares by the selling shareholder but we will incur expenses in connection with the offering.
The selling shareholder may sell the common stock being offered by this prospectus from time to time on terms to be determined at the time of sale through ordinary brokerage transactions or through any other means described in this prospectus under "Plan of Distribution." The selling shareholder may sell the shares in negotiated transactions or otherwise, at the prevailing market price for the shares or at negotiated prices. We will not be paying any underwriting discounts or commissions in this offering. One
Shares of the selling shareholders has granted the underwriters a 30-day option to purchase up to an additional 660,000 shares to cover over-allotments, if any.
Ourour common stock is quotedare traded on the Nasdaq NationalGlobal Select Market under the symbol “SCSS.” The last reported"SCSS." On November 19, 2009, the closing sale price on , 2003for our common stock was $$5.52 per share.
INVESTING IN OUR COMMON STOCK INVOLVES RISKS. SEE “RISK FACTORS” BEGINNING ON PAGE 6.
Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or determined ifpassed upon the adequacy or accuracy of this prospectus is truthful or complete.prospectus. Any representation to the contrary is a criminal offense.
The date of this prospectus is , 20032009.
ABOUT THIS PROSPECTUS | 1 | |||
PROSPECTUS SUMMARY | 2 | |||
RISK FACTORS | 4 | |||
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS | 20 | |||
USE OF PROCEEDS | 21 | |||
SELLING SHAREHOLDER | 21 | |||
PLAN OF DISTRIBUTION | 22 | |||
LEGAL MATTERS | 25 | |||
EXPERTS | 25 | |||
COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES | 25 | |||
WHERE YOU CAN FIND MORE INFORMATION | 25 | |||
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE | ||||
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As used in this prospectus, the terms “we,” “us,” “our,” the “company” and “Select Comfort” mean Select Comfort Corporation and its subsidiaries and the term “common stock” means our common stock, par value $0.01 per share.
As used in this prospectus, the term “bedding” includes mattresses, box springs and foundations and does not include bedding accessories, such as sheets, pillows, headboards, frames, mattress pads and related products.
Select Comfort®,Sleep Number®,Comfort Club®,Sleep Better on Air®,The Sleep Number Bed by Select Comfort (logo)®,Firmness Control SystemTM,Precision ComfortTM,Corner LockTM,IntraluxTM,Everybody has a Sleep NumberTM,Knowing your Sleep Number is the Key to a Perfect Night’s SleepTM,The Sleep Number Store by Select Comfort (logo)®,You can only find your Sleep Number on a Sleep Number Bed by Select Comfort,TMSelect Comfort Creator of the Sleep Number BedTM,What’s Your Sleep Number?TM and our stylized logos are trademarks and/or service marks of Select Comfort. This prospectus also contains trademarks, trade namesis a part of a registration statement that we filed with the Securities and service marks that are owned by other personsExchange Commission, or entities.
Our fiscal year ends on the Saturday closest to December 31, and, unless the context otherwise requires, all references to years in this prospectus refer to our fiscal years. Our fiscal year is based onSEC, utilizing a 52- or 53-week year. All years represented in this prospectus are 52 weeks.
"shelf" registration process. You should rely only on the information contained in or incorporated by reference into this prospectus.prospectus or any applicable prospectus supplement. The information contained in this prospectus, any applicable prospectus supplement and the documents incorporated by reference herein and therein are accurate only as of their respective dates, regardless of the time of delivery of this prospectus or any sale of a security. Our business, financial condition, results of operations and prospects may have changed since that date.
We have not, and the selling shareholder has not, authorized anyone to provide you with information different from that contained in this prospectus. Theinformation. Neither we nor the selling shareholdersshareholder are offeringmaking an offer to sell andor seeking offersan offer to buy shares of our common stock onlyunder this prospectus or any applicable prospectus supplement in jurisdictionsany jurisdiction where offers and sales arethe offer or sale is not permitted. You should not consider this prospectus to be an offer or solicitation relating to the securities in any jurisdiction in which such an offer or solicitation relating to the securities is not authorized. Furthermore, you should not consider this prospectus to be an offer or solicitation relating to the securities if the person making the offer or solicitation is not qualified to do so, or if it is unlawful for you to receive such an offer or solicitation.
This summary highlights information contained elsewhere in this prospectus. You should read the following summary together with the more detailed information concerning our company, our common stock being sold in this offering and our financial statements appearing in this prospectus and in the documentsor incorporated by reference in this prospectus. Because this is only a summary of the material information contained in this prospectus, you should read the rest ofinto this prospectus, including our consolidated financial statements and related notes, and the documents incorporated by reference in this prospectus,risk factors beginning on page 4 before you invest indeciding whether to purchase shares of our common stock. Read this entire prospectus carefully, especially the risks and uncertainties described under “Risk Factors.”
Our Company
Select Comfort Corporation was founded as a Minnesota-based corporation in 1987 by an entrepreneur who developed and manufactured adjustable firmness mattresses after considering other alternatives such as innerspring and water mattresses. Select Comfort has evolved from a specialty, niche direct marketer, to a nationwide multi-channel business with fiscal 2008 net sales of $609 million.
We are the leading developer, manufacturerOur principal business is to develop, manufacture, market, and marketer ofdistribute premium quality, adjustable-firmness beds.beds and other sleep-related accessory products. The air chamberair-chamber technology of our proprietary Sleep Number bed allows adjustable firmness on each side of the mattress and provides a sleep surface that is clinically proven to provide better sleep quality and greater relief of back pain in comparisoncompared to traditional mattress products. In addition, we market and sell accessories and other sleep-related products which focus on providing personalized comfort to complement the Sleep Number bed and provide a better night's sleep to the consumer. We have a mission-driven culture focused on serving the needs of our customers. Our mission is to improve people’speople's lives through better sleep. Our goal is to educate our consumers on the importance of a better night's sleep and our objective is to become the leading brand in the bedding industry.
Unlike traditional bedding manufacturers, we are vertically integrated from production through sales and customer service, which allows us to control quality, cost, price and presentation. Mostunique benefits of our innovative products are made-to-orderproducts.
In 1998, Select Comfort became a publicly traded company and are sold directly to consumers through our three company-controlled distribution channels: 321 retail stores, direct marketing and e-commerce. Additionally, we sell our products through wholesale relationships with home furnishings and specialty bedding retailers. Our business model allows us to maintain low levels of inventory and to generate an accelerated cash-conversion cycle, which enables us to operate with minimal or no working capital.
is listed on The U.S. wholesale bedding industry is a mature and stable industry that has experienced a compounded annual revenue growth rate of approximately 6% overNASDAQ Stock Market LLC (NASDAQ Global Select Market) under the past 10 years. U.S. retail bedding sales were approximately $7.6 billion in 2002, of which 85% consisted of traditional innerspring bedding. The top 10 bedding retailers accounted for approximately 25% of total retail sales. In 2001, furniture stores accounted for 41% of U.S. bedding retail sales and specialty sleep stores 40%, compared to 56% and 19% market shares in 1993, respectively. According toFurniture/ Today, we were the largest U.S. bedding retailer, based on 2001 sales.
Following a change in executive management in 2000, we improved our cost structure and rebranded our products and advertising, which led to significantly enhanced operating results. From 2001 to 2002, our sales grew 28% to $335.8 million and comparable store sales grew 27%. We have improved our profitability from an operating loss of $26.0 million in 2000 to operating income of $21.0 million in 2002 and achieved net income in each of the last six quarters. In 2002, we generated $28.3 million in cash flow from operations, after capital expenditures. For the foreseeable future, we believe we can achieve 15% to 25% annual net sales growth and significantly improve our operating margins.
Competitive Strengths
Our objective is to become the leading brand in the bedding industry, both in revenue share and product innovation. To achieve this goal, we intend to capitalize on the following strengths:
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Growth Strategy
We expect sales growth in the foreseeable future to be derived primarily from comparable store sales increases, opening stores in existing and new markets and adding new distribution channels. We expect to enhance our profit margin primarily by leveraging our existing infrastructure. To accomplish our growth strategy, we intend to focus on the following priorities:
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Our company was incorporated in Minnesota in 1987. Oursymbol "SCSS." Select Comfort's executive offices are located at 6105 Trenton Lane9800 59th Avenue North, Minneapolis, MN 55442. Our telephoneMinnesota 55442, and the phone number of the executive offices is (763) 551-7000. Our web site address isselectcomfort.com.When used herein, the terms "Select Comfort," "Company," "we," "us," and "our" refer to Select Comfort Corporation, including consolidated subsidiaries.
Securities Purchase Agreement
On October 2, 2009, we entered into a securities purchase agreement (the "Securities Purchase Agreement") with Sterling SC Investor, LLC, a Delaware limited liability company ("Sterling"). The information containedsigning of the Securities Purchase Agreement, together with certain other agreements between us and Sterling, was previously disclosed in Item 1.01 of our Current Report on our web site is not a partForm 8-K filed with the SEC on October 5, 2009. Copies of the Securities Purchase Agreement and the registration rights agreement entered into with Sterling in connection with the Securities Purchase Agreement (the "Registration Rights Agreement") are attached as exhibits to that previously filed Form 8-K.
On November 13, 2009, pursuant to the Securities Purchase Agreement we closed on the sale to the selling shareholder of the 2,500,000 shares of common stock and warrants to purchase an additional aggregate 2,000,000 shares of common stock and received aggregate gross proceeds of approximately $10.0 million before deduction of transaction expenses. The closing of this transaction was disclosed in our Current Report on Form 8-K filed with the SEC on November 16, 2009. This prospectus only covers offers and sales of shares of common stock by Sterling, the only selling shareholder under this prospectus.
The Offering
The numbershares of common stock and warrants issued to Sterling were offered and sold without registration under the Securities Act, or the securities laws of certain states, in reliance on the exemptions provided by Section 4(2) of the Securities Act and Rule 506 of Regulation D promulgated thereunder and in reliance on similar exemptions under applicable state laws, and the shares of common stock issuable upon exercise of the warrants will be issued pursuant to the same exemptions
or, in the case of a cashless exercise, pursuant to the exemption provided by Section 3(a)(9) of the Securities Act. In the Securities Purchase Agreement, Sterling represented to us that it qualified as an "accredited investor," as defined under Rule 501(a) of Regulation D. The shares were issued as restricted securities and the certificates representing the shares were endorsed with legends confirming that the shares had been issued without registration under the Securities Act and cannot be sold or otherwise transferred without registration under the Securities Act or an exemption from such registration requirements.
This registration statement is being filed pursuant to the Registration Rights Agreement. Pursuant to the Registration Rights Agreement, this registration statement is registering for resale the common shares issued, and the common shares issuable upon exercise of the warrants issued, to Sterling, in an offering to be made on a continuous basis pursuant to Rule 415 promulgated by the SEC pursuant to the Securities Act. We agreed to use our commercially reasonable efforts to have this registration statement declared effective as soon as practicable after the filing date of the registration statement, but in any event no later than January 27, 2009, the 75th day after the closing date of our transaction with the selling shareholder. We have agreed to keep this registration statement continuously effective pursuant to Rule 415 (subject to certain permitted suspension and black out periods) until the earliest of the first date on which the selling shareholder no longer owns any registrable securities, the first date the selling shareholder may sell all of such securities pursuant to Rule 144 under the Securities Act without limitation on volume or manner of sale, 180 days after the closing date or the date on which we terminate the registration of our common stock under Section 12 of the Securities Act, subject to extension upon the occurrence of certain events described in the Registration Rights Agreement.
Until the earlier of May 13, 2009, six months after the closing date under the Securities Purchase Agreement, or the date we close a qualified transaction (which includes a sale of at least five percent of any class of the Company's outstanding capital stock), the selling shareholder agreed that it will not, in any one trading day, sell registrable securities that represent more than ten percent of our average daily trading volume, except in a block trade of 5,000 or more shares of our common stock that will be outstanding after this offering includes 400,000 sharesis approved by us, which approval we may not unreasonably withhold.
Shelf Registration Statement
On October 13, 2009, we filed a shelf registration statement with the SEC, which became effective on November 16, 2009. We have the ability to be sold in this offering by selling shareholders upon exercise of their warrants and is based on 30,915,489 shares outstanding as of February 14, 2003, which excludes:
The underwriters have an option to purchase 660,000 additional shares of ourissue common stock, from one of the selling shareholders to cover over-allotments, if any. Except as otherwise indicated, the information in this prospectus assumes no exercise of the underwriters’ over-allotment option.
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Summary Consolidated Financial Data
The following table summarizes the consolidated statements of operations and selected operating data of our business.
Year | |||||||||||||||||||||
2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||
Consolidated Statements of Operations Data: | |||||||||||||||||||||
Net sales | $ | 335,795 | $ | 261,687 | $ | 270,077 | $ | 273,767 | $ | 246,269 | |||||||||||
Operating income (loss)(1) | 21,022 | (10,602 | ) | (25,970 | ) | (14,793 | ) | 11,445 | |||||||||||||
Net income (loss) | 37,122 | (12,066 | ) | (37,214 | ) | (8,204 | ) | 5,195 | |||||||||||||
Net income (loss) per share: | |||||||||||||||||||||
Diluted | $ | 1.09 | $ | (0.66 | ) | $ | (2.09 | ) | $ | (0.45 | ) | $ | 0.19 | ||||||||
Pro forma(2) | $ | 0.37 | $ | (0.41 | ) | $ | (0.89 | ) | $ | (0.45 | ) | $ | 0.19 | ||||||||
Shares used in calculation of diluted and pro forma net income (loss) per share(2) | 34,532 | 18,157 | 17,848 | 18,300 | 15,928 | ||||||||||||||||
Selected Operating Data: | |||||||||||||||||||||
Stores open at period end(3) | 322 | 328 | 333 | 341 | 264 | ||||||||||||||||
Average net sales per store (000’s)(4) | $ | 817 | $ | 626 | $ | 636 | $ | 644 | $ | 664 | |||||||||||
Percentage of stores with more than $1.0 million in net sales(4) | 24.1 | % | 9.8 | % | 11.8 | % | 12.6 | % | 12.6 | % | |||||||||||
Comparable store sales increase (decrease)(5) | 26.8 | % | (3.8 | )% | 0.2 | % | 4.7 | % | 23.5 | % | |||||||||||
Average square footage per store open during period(4) | 972 | 941 | 913 | 893 | 894 | ||||||||||||||||
Net sales per square foot(4) | $ | 841 | $ | 666 | $ | 697 | $ | 721 | $ | 743 | |||||||||||
Average store age (in months at period end) | 61 | 51 | 41 | 31 | 26 | ||||||||||||||||
EBITDA (000’s)(6) | $ | 30,449 | $ | 334 | $ | (15,628 | ) | $ | (6,600 | ) | $ | 16,816 |
The following table summarizes our consolidated balance sheet data as of December 28, 2002. The consolidated balance sheet data are presented on an actual basis and as adjusted to give effect to the exercise ofpreferred stock, warrants to purchase 400,000 shares of common stock, subscription rights, or any combination of such securities up to $50 million pursuant to that registration statement. We can issue these securities at our discretion in one or more separate transactions with size, price and terms to be determined at the paymenttime of our estimated offering expenses.issuance. Under the terms of the Registration Rights Agreement, we have the right to suspend dispositions of stock by Sterling for up to 30 days if we notify the selling shareholder that we are planning to enter into an agreement in connection with a "qualified financing transaction" (as contemplated by the Registration Rights Agreement), which may be executed pursuant to the shelf registration statement.
As of December 28, 2002 | ||||||||
Actual | As Adjusted | |||||||
Consolidated Balance Sheet Data: | ||||||||
Cash, cash equivalents and marketable securities | $ | 40,824 | $ | 40,994 | ||||
Working capital | 26,765 | 26,935 | ||||||
Total assets | 108,331 | 108,501 | ||||||
Long-term debt, less current maturities | 2,991 | 2,991 | ||||||
Total shareholders’ equity | 54,515 | 54,685 |
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2002 | 2001 | 2000 | |||||||||||
GAAP diluted net income (loss) per share | $ | 1.09 | $ | (0.66 | ) | $ | (2.09 | ) | |||||
Effect of: | |||||||||||||
Income tax benefit (provision) at 38% of income before tax | (0.22 | ) | 0.25 | 0.55 | |||||||||
Charges from early repayment of debt | 0.02 | — | — | ||||||||||
(Restoration) write-off of deferred tax asset | (0.52 | ) | — | 0.65 | |||||||||
Pro forma diluted net income (loss) per share | $ | 0.37 | $ | (0.41 | ) | $ | (0.89 | ) | |||||
2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||
Operating income (loss) | $ | 21,022 | $ | (10,602 | ) | $ | (25,970 | ) | $ | (14,793 | ) | $ | 11,445 | ||||||||
Store closings and asset impairments | 233 | 1,366 | 1,952 | 1,498 | 20 | ||||||||||||||||
Depreciation and amortization | 9,194 | 9,570 | 8,390 | 6,695 | 5,351 | ||||||||||||||||
EBITDA | $ | 30,449 | $ | 334 | $ | (15,628 | ) | $ | (6,600 | ) | $ | 16,816 | |||||||||
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This offeringAn investment in our common stock involves a high degree of risk. You should carefully consider the specific risks set forth below and under similar sections in the documents we incorporate by reference into this prospectus before making an investment decision. The risks and uncertainties described below, which we believe are the material risks and uncertainties of our business and this offering, as well as the other information contained in this prospectus and in the documents we incorporate by reference into this prospectus are not the only ones facing us. Additional risks and uncertainties, including any not presently known to whichus or that we refer you under the heading “Incorporation of Information We File with the SEC” before deciding whether to invest in shares ofcurrently see as immaterial, may also harm our common stock.business. If any of the following risks or uncertainties described in this prospectus, the applicable prospectus supplement or our SEC filings or any such additional risks and uncertainties actually occurs,occur, our business, results of operations, cash flows and financial condition or operating results could be significantly harmed.materially and adversely affected. In that case, the markettrading price of our common stock could decline, and you maymight lose partall or allpart of your investment.
Risks Relating to Our Business
Risks Related to Select Comfort CorporationComfort's Business and Industry
Liquidity and Capital Resources and Our Ability to Continue as a Going Concern.We may be unable to sustain growth or profitability.
�� Our net sales grew in 2002 after two consecutive yearsWe may not have adequate liquidity and capital resources to fund our operating needs and continue as a going concern. We are seeking to raise additional capital through the issuance of declining net sales. Our six most recent quarters have been profitable after eight consecutive quarters of losses. Weequity securities, which may be dilutive to our existing shareholders. If we are unable to obtain additional capital, we may not be able to fund our operating needs, and we may not be able to continue as a going concern. We also face a risk of default under our Credit Agreement. Our uncertain financial position may also disrupt relationships with our suppliers and adversely impact our sales.
Since December 2008 we have been operating under a series of short-term amendments of our credit facility pursuant to which the Lenders waived compliance with certain financial and other covenants. In the absence of these waivers, we would not have been in compliance with certain covenants under the credit facility. On November 13, 2009, we entered into an Amended and Restated Credit Agreement (the "Credit Agreement") which extends the term of our credit facility through June of 2011, subject to compliance with applicable covenants under the Credit Agreement. The Credit Agreement provides an initial aggregate commitment of $55 million, declining over time to $20 million as of December 31, 2010. Also on November 13, 2009, we consummated the sale to Sterling of 2,500,000 shares of common stock at $4.00 per share and warrants to purchase an additional aggregate 2,000,000 shares of common stock at $0.01 per share for aggregate gross proceeds to the company of $10 million. The Credit Agreement requires us to issue common stock or other equity securities yielding gross proceeds of $25 million and net proceeds of $22 million, which amounts include the $10 million received by us from Sterling under the Securities Purchase Agreement, by March 31, 2010.
We are seeking to raise additional capital through the issuance of equity securities to provide adequate liquidity to fund our operations and to avoid default under the Credit Agreement. The issuance of any additional equity securities may be dilutive to existing shareholders and we may not be successful in obtaining additional capital, which may result in a default under the Credit Agreement. A default under the Credit Agreement would enable the Lenders to seek immediate payment in full of any amounts outstanding under the Credit Agreement and to exercise various remedies as secured creditors, which may severely or completely constrain our ability to continue to operate our business as a going concern and may require us to seek protection from creditors through bankruptcy proceedings.
Our independent public accounting firm has issued an opinion on our fiscal 2008 consolidated financial statements stating that the consolidated financial statements have been prepared assuming we will continue as a going concern. The opinion further states that our losses from operations and inability to generate sufficient cash flow to meet obligations and sustain operations raise substantial doubt about our ability to continue as a going concern. This opinion, as well as our uncertain financial
position, may disrupt relationships with our suppliers, which may prevent us from obtaining necessary components, supplies or services on acceptable terms or at all, and may adversely impact consumer confidence in our ability to honor our warranty obligations, which may adversely impact our sales, profitability and financial condition.
Uncertainty of Future Growth and Profitability. Our future growth and profitability will depend on a number of factors.
After more than five consecutive years of growth in both sales and profitability through fiscal 2006, our sales and profitability declined in 2008 and 2007 versus the prior years. Through a wide range of cost reductions implemented over the last 12 months and stabilizing sales trends in the second and third quarters of fiscal 2009, we have recorded $243,000 of net earnings over the first nine months of fiscal 2009. However, we may not be able to regain growth in sales or achieve sustained improvement in profitability on a quarterly or annual basis in future periods. Our future growth and profitability will dependbe impacted by or dependent upon a number of factors, including without limitation:but not limited to:
We may not be successful in executing our growth strategy and even if we achieve our strategic plan, we may not be able to sustainor in regaining growth in sales or improvement in profitability. Failure to successfully execute any material part of our strategic plan or growth strategy could significantly harm our sales, profitability and financial condition.
Dependence on General Economic Conditions and Consumer Spending. We are highly dependent on discretionary consumer spending. Adverse trends in general economic conditions, including in particular the housing market, retail shopping patterns, consumer confidence, credit markets and employment levels, may continue to adversely affect our sales, profitability and financial condition.
The success of our business models depends to a significant extent upon discretionary consumer spending, which is subject to a number of factors, including without limitation general economic conditions, consumer confidence, the housing market, employment levels, business conditions, interest rates, availability of credit, inflation and taxation. Adverse trends in any of these economic indicators may adversely affect our sales, profitability and financial conditioncondition. Also, because a high percentage of our net sales are made on credit, any adverse impact on the availability of consumer credit or any increase in interest rates may adversely affect our sales, profitability and operating results.
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Our comparable store salesfinancial condition. We are also dependent upon the continued popularity of malls as shopping destinations and the ability of mall anchor tenants and other operating results may fluctuate significantly and an unanticipated declineattractions to generate customer traffic for our retail stores. Any decrease in comparable store sales or other operating results may disappoint investors and result in a decline in our stock price.
Our comparable store sales results and other operating results have fluctuated significantly in the past. These fluctuations may continue and thus may not be a meaningful indicator of future performance. For example, our comparable store sales results have fluctuated significantly from quarter to quarter with (decreases)/increases ranging from (7.7)% to 38.3% from 1998 through 2002. Stores enter the comparable store calculation in the 13th full month of operation. Our annual comparable store sales (decreases)/increases were 26.8% for 2002, (3.8)% for 2001 and 0.2% for 2000. Our comparable store sales and other operating results may fluctuate significantly in the future. A variety of factorsmall traffic could adversely affect our comparable store sales, resultsprofitability and other operating results, including:financial condition.
BecauseEffectiveness and Efficiency of these fluctuations, our comparable store salesMarketing and other quarterly operating results may not be a meaningful indicator of future performance. Future decreases in our comparable store sales and other operating results could significantly harm our business, financial condition and operating results. In addition, an unanticipated decline in comparable store sales and other operating results may disappoint securities analysts or investors and result in a decline in our stock price.
Advertising. Our future growth and profitability will depend in large part upon the effectiveness of our marketing messages and the efficiency of our advertising expenditures and other marketing programs in generating consumer awareness and sales of our abilityproducts.
We are highly dependent on the effectiveness of our marketing messages and the efficiency of our advertising expenditures (which were approximately $92 million in 2008, $110 million in 2007, $105 million in 2006, $89 million in 2005, and $79 million in 2004) in generating consumer awareness and sales of our products. In recent periods, including in particular 2007 and 2008, our marketing messages have not been as effective as in prior periods. If our marketing messages are ineffective or our advertising expenditures and other marketing programs are inefficient in creating awareness of our products and brand name, driving consumer traffic to select the right markets in whichour points of distribution and motivating consumers to advertise.purchase our products, our sales, profitability and financial condition may be adversely impacted.
Our advertising expenditures were $39.5 million, $29.5 millionintegrated marketing program depends in part on national radio personalities and $31.3 millionspokespersons and other nationally known personalities. The loss of these endorsements, or any reduction in 2002, 2001the effectiveness of these endorsements, or our inability to obtain additional effective endorsements, could adversely affect our sales, profitability and 2000, respectively. Our overall marketing budget is being managed with greater emphasis toward awareness-building advertising.financial condition.
Dependence on Internet Marketing Programs. Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our internet-based advertising expenditures, including our ability to:
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Our planned advertising expenditures may not result in increased sales or generate sufficient levels of productprograms and brand name awareness. We may not be able to manage our advertising expenditures on a cost-effective basis.
The bedding industry is highly competitive. If anyupon the prominence of our competitors orWeb site URLs on internet search engine results.
We believe that consumers are increasingly using the internet as a new entrant into the marketpart of their shopping experience, both to conduct pre-purchase research, particularly with significant resources aggressively pursues the air bed market, our business could be significantly harmed.
Our Sleep Number beds compete with a number of different types of bedding alternatives, including innerspring bedding, foam bedding, waterbeds, futons and other air-supported bedding that are sold through a variety of channels, including home furnishings stores, specialty bedding stores, department stores, mass merchants, wholesale clubs, telemarketing programs, television infomercials and catalogs. The bedding industry is characterized by a high degree of concentration among the four largest manufacturers with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand, Serta, Simmons and Spring Air. Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the bedding market. A number of bedding manufacturers, including Simmons, have offered air beds and some of these manufacturers have recently increased their presence in the air bed market. Many of our competitors, including in particular the four largest bedding manufacturers, have greater financial, marketing and manufacturing resources and better brand name recognition than we do and sell products through broader and more established distribution channels. These competitors or new entrants into the market may aggressively pursue the air bed market and be successful in obtaining a significant presence in the air bed market. Any such competition could significantly harm our business. In addition, should any of our competitors reduce its prices on premium bedding products, we may be requiredrespect to implement similar price reductions in order to remain competitive, which could significantly harm our financial condition and operating results.
Our plan to pursue additional or maintain existing wholesale relationships with home furnishings retailers, specialty bedding retailers and the QVC shopping channel may not yield the benefits we expect and may involve other risks that may harm our business.
An important element of our growth strategy is to expand profitable distribution by increasing sales through our existing channels and by increasing opportunities for consumers to become aware of, andhigh-end consumer durables, as well as to purchase our products through additional pointsproducts. Consumers will typically use one of distribution, such as wholesale distribution. We have only recently established a limited number of wholesale relationships with home furnishings retailers, specialty bedding retailers and the QVC shopping channel and therefore have limited wholesale experience. Our wholesale relationships may not result in the intended benefits. We also expect the gross margin from wholesale sales to be less than the gross margin we generate in our company-controlled channels. The success of our wholesale strategy will depend upon numerous factors, including the following:
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We rely upon several key suppliers that are, in some instances, our sole source of supply. The failure of one or more of these suppliers or our other key suppliers to supply components for our products on a timely basis, or a material change in the purchase terms for our components, could lead to inadequate inventory and delays in shipping our beds to customers which could lead to increased returns and cause us to lose future sales.
The major components and raw materials that we purchase for our products are air chambers, foundations, remote controls, pumps, valves, foam and fabric. We currently obtain the air chambers and foundations for our beds from single supply sources. We have a supply agreement with the supplier of our air chambers that expires in October 2006, subject to automatic annual renewal thereafter unless either party gives 365 days’ notice of non-renewal. We have a supply agreement with the supplier of our blow molded foundations that expires in October 2003, subject to automatic annual renewal thereafter unless either party gives 180 days’ notice of non-renewal. If our relationship with the supplier of our air chambers or foundations is terminated, we could have difficulty in replacing these sources since there are few other suppliers capable of manufacturing these components.
We generally purchase many of our other components and raw materials centrally to obtain volume discounts and achieve economies of scale. We therefore obtain a large percentage of our components and raw materials from a small number of suppliers. We do not have any long-term purchase agreements with, or other contractual assurances of continued supply, pricing or access from, any of our suppliers, except as noted above. Other than our air chambersinternet search engines to research products. These search engines may provide both natural search results and foundations, we purchase most of our components and raw materials through purchase orders. If prices increase and we are unable to pass on the increase in our costs to our customers, then our financial condition or operating resultspurchased listings for particular key words. In some cases, it may be significantly harmed. The lossdifficult or impossible to determine how these search engines work, particularly in the area of one or more ofnatural search, and therefore how to optimize placement on those search engines for our key suppliers, the failure of one or more of our key suppliers to supply components toWeb site URLs and other positive sites for consumers who may be searching for our products or for mattress products or retailers generally. Some of these search engines may permit competitors to bid on a timely basis, or a material changeour trademarks to obtain high placement in the purchase terms forsearch results when consumers use our components could leadtrademarks to inadequate inventory and delays in shipping our beds to customers, which could lead to increased returns and cause us to lose future sales.
We generally assembleseek information regarding our products, after we receive orders from customers. Lead times for ordered componentswhich may vary significantlycause confusion among consumers and depend upon factors, such as the location of the supplier, the complexity in manufacturing the component and general demand for the component.adversely impact our sales. Some of our components, includingcompetitors may use our air chambers, have longer lead times. We generally do not maintain large volumes of component inventory, except fortrademarks and/or publish false or misleading information on the internet regarding our air chambers, inproducts or their own products, which case we generally carry approximately four weeks of inventory.may also cause confusion among consumers and adversely impact our sales. In addition, consumers or others may post negative information regarding our products or our company on internet sites or blogs, which could adversely impact our sales.
As a result, an unexpectedour future growth and significant increaseprofitability will depend in part upon the demand for our beds could lead to inadequate inventoryeffectiveness and delays in shipping our beds to customers.
The foreign manufacturingefficiency of our air chamberson-line advertising and somesearch optimization programs in generating consumer awareness and sales of our other components involves risks that could increaseproducts, and upon our costsability to prevent competitors from misusing or infringing our trademarks or publishing false or misleading information regarding our products or their own products. If we are not successful in these efforts, our business, reputation, sales, profitability and lead to inadequate inventory and delays in shipping our beds to customers, which could lead to increased returns and cause us to lose future sales.
Since our air chambers and some of our other components are manufactured outside the United States, our operations could be significantly harmed by the risks associated with foreign sourcing of materials, including without limitation:
These factors could increase our costs of doing business with these foreign suppliers and lead to inadequate inventory and delays in shipping our beds to customers, which could lead to increased returns and cause us to lose future sales. In addition, if anyour Web site becomes unavailable for a significant period of these or other factors weretime due to render the conduct of anyfailure of our suppliers’ businesses in particular countries undesirableinformation technology systems or impractical,the Internet, our sales, profitability and financial condition and operating results could be materially adversely affected because we would have difficulty sourcing the main componentsaffected.
Table of our products.Contents
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Uncertainty of Consumer Acceptance. Our air bedsproducts represent a significant departure from traditional innerspring beddingmattresses and the failure of our bedsproducts to achieve market acceptance would significantly harm our sales, growthprofitability and profitability.financial condition.
InnerspringWe estimate that innerspring mattress sales represent approximately 85%75% or more of all mattress sales. Four large manufacturers of innerspring bedding dominate the U.S. bedding market. Our air chamber technology represents a significant departure from traditional innerspring bedding.mattresses. Because no established air bed market for adjustable firmness mattress products existed prior to the introduction of our air bedproducts in 1988, we faced the challenge of establishing the viability of this market, as well as gaining widespread acceptance of our air bed.products. The market for air bedsadjustable firmness mattresses is now evolving and theour future success of our products will depend upon both the continued growth of this market and marketincreased consumer acceptance of our air beds.products. The failure of our bedsproducts to achieve marketgreater consumer acceptance for any reason would significantly harm our sales, growthprofitability and profitability.
Dependence on Availability of Consumer CreditApproximately. More than one-third of our net sales are financed under a consumer credit program provided by a third party. The termination of our agreement with this third party,consumer credit program, any material change to the terms of our agreement with this third partyconsumer credit program or in the availability or terms of credit offered to our customers byunder this third party,consumer credit program, or any delay in securing replacement credit sources, could negatively impactharm our sales, by affecting the number of customers who can finance purchases.profitability and financial condition.
OurIn December 2005 we entered into an amended and restated agreement under which GE Money Bank offers our qualified customers are offered a revolving credit arrangement to finance purchases from usus. This agreement extends through a private label consumer credit facility provided by Mill Creek Bank, a subsidiary of Conseco Finance Corp. Mill CreekFebruary 15, 2011, subject to earlier termination upon certain events and subject to automatic extensions.
Under this agreement, GE Money Bank sets the minimum acceptable credit ratings, the interest 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, Mill CreekAny increase by GE Money Bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts. Mill Creek Bank’s right to setin the minimum customer credit ratings necessary to qualify for credit could if exercised,adversely impact our sales by affectingdecreasing the number of customers who can finance purchases. The term of this facility expires in May 2004, subject to automatic one-year renewals, unless terminated by either party upon 150 days’ notice prior to the end of the then-current term. We are liable to Mill CreekGE Money Bank for chargebackscharge-backs arising out of (i) breach of our warranties relating to the underlying sale transaction, (ii) defective products or (iii) our failure to comply with applicable operating procedures under the facility. We have provided a standby letter of credit to Mill Creek Bank in the amount of $1.0 million to protect Mill Creek Bank against potential losses from unpaid chargebacks. We are not liable to Mill CreekGE Money Bank for losses arising out of our customers’customers' credit defaults. If we replace Mill Creek
Our agreement with GE Money Bank with an alternative third-party provider of consumer financing, Mill Creek Bank could request that we purchase its portfolio ofcontains certain financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio. As our customer accounts based on a pre-determined formula, which reflects a discount to the face amountrecent results placed us outside of these accounts. Iffinancial covenants, we were to engage a replacement provider, we would likely require this new provider to purchase the portfolio from Mill Creek Bank, relieving us of our obligationsrequired under this facility.
Conseco Finance Corp., the parent corporation of Mill Creek Bank, has recently experienced financial and liquidity issues and has filed for protection under federal bankruptcy laws. Through its pending bankruptcy proceedings, Conseco Finance Corp. entered into an asset purchase agreement to sell its business and operating assets, including various assets of Mill Creek Bank. Under the terms of thisthe agreement our agreement with Mill Creek Bank would be sold to General Electric Capital Corporation, a competitor of Mill Creek Bank. This sale, which is subject to various closing conditions, is expected to close in May 2003. Upon closing, General Electric Capital Corporation could attempt to exercise discretion as currently available to Mill Creek Bank under our facility that could adversely impact our reliance on it. In the event this sale does not close as anticipated, the financial and liquidity issues being encountered by Conseco Finance Corp. could jeopardize the ability of Mill Creek Bank to continue to provide consumerGE Money Bank with a $2.7 million letter of credit financing for our customers. In that event, we would seek to secure consumer credit financing from other sources, but it may not be possible to secure such arrangements without some delay or on the same or better terms than have been available from Mill Creek Bank.as collateral security.
Approximately 32.6%37% of our net sales during 2002 and 39.8% of our net sales during 20012008 were financed by Mill CreekGE Money Bank. Consumers that do not qualify for credit under our agreement with GE Money Bank may apply for credit under a secondary program maintained by the company through another provider.
We work with GE Money Bank to structure promotional offerings related to consumer credit terms for our customers. Pending changes in federal regulations will limit the types of promotional offerings related to consumer credit that may be offered to consumers, which may adversely impact the attractiveness of our promotional offerings and may harm our sales, profitability and financial condition.
Termination of our agreement with Mill CreekGE Money Bank or with our secondary provider, any material change to the terms of our agreement with Mill Creek Bankeither of these providers, or in the availability or terms of credit for our customers from Mill Creek Bankthese providers, or any delay in securing replacement credit sources, could harm our sales.sales, profitability and financial condition.
Risks of Retail Store Distribution Strategy. Our future growth and successprofitability will depend in large part upon key personnel whom we may not be able to retain or hire. Our inability to retain or hire key personnel could significantly affect our ability to execute our business strategy.
We are currently dependent upon the continued services, abilityretail store distribution strategy, including increasing sales and experience of our executive management team, particularly William R. McLaughlin, our President and Chief Executive Officer. The loss of the services of
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Our inability to enhanceprofitability through our existing productscompany-controlled stores, which carry significant fixed costs, and develop and market new products could harm our ability to sustain our growth or profitability.
One of our growth strategies is to continue to lead our industry in product innovation and sleep expertise by enhancing existing products and by developing and marketing new products that deliver personalized comfort and better sleep. We may not be successful in developing or marketing enhanced or new products and, even if we successfully develop and market such products, the market may not accept any such products. Further, the resulting level of sales from any of our enhanced or new products may not justify the costs associated with the development and marketing. Our inability to enhance our existing products and develop and market new products could harm our ability to sustain our growth or profitability.
cost-effectively closing under-performing stores. If we are unable to protectregain growth in sales through our intellectual property,company-controlled stores, we may be required to incur significant costs to close underperforming stores, which could harm our profitability and financial condition.
Our company-controlled retail store distribution channel is our largest distribution channel and represents our largest opportunity for growth in sales and improvement in profitability. After several years of consistent growth in comparable store sales results through fiscal 2006, in 2007 we experienced a decline of 11% in our comparable stores sales versus 2006, and in 2008 we experienced a further decline of 25% in our comparable store sales versus 2007. After achieving profitability in the third quarter of 2008, our comparable store sales results declined by 29% in the fourth quarter of 2008 in comparison to fourth quarter of 2007 and we continued to see declines in comparable stores sales in the first five months of fiscal 2009. Due in part to the closure of underperforming stores in recent months, we have achieved growth in our comparable store sales versus the prior year in June of 2009 and in the third quarter of fiscal 2009. Our comparable-store sales and other operating results may fluctuate or decline significantly in the future. Many factors affect our comparable-store sales and other operating results and may contribute to fluctuations or declines in these results in the future, including but not limited to:
Future fluctuations or decreases in our comparable-store sales or other operating results could harm our sales, profitability and financial condition. We may also be required to incur significant costs to close underperforming stores if we are unable to regain growth in sales in under-performing stores. In addition, failure to regain growth in comparable-store sales or other operating results may disappoint securities analysts or investors and result in a decline in our stock price.
Dependence on Key Suppliers. We rely upon several key suppliers that are, in some instances, the only source of supply currently used by the company for particular materials or components. The failure of one or more of these suppliers or our other key suppliers to supply materials or components for our products on a timely basis, or a material change in the purchase terms for the materials or components, could harm our sales, profitability and financial condition.
We currently obtain all of the materials and components used to produce our beds from outside sources. In several cases, including our proprietary air chambers, our proprietary blow-molded foundations, our adjustable foundations, various components for our Firmness Control Systems, as well as fabrics and zippers, we have chosen to obtain these materials and components from suppliers who
serve as the only source of supply used by the company at this time. While we believe that these materials and components, or suitable replacements, could be obtained from other sources of supply, in the event that any of the company's current suppliers became unable to supply the relevant materials or components for any reason, and alternatives were not readily available from other sources of supply, our sales, profitability and financial condition could be harmed. If our relationship with either the supplier of our air chambers or the supplier of our blow-molded foundations is terminated, we could have difficulty in replacing these sources since there are relatively few other suppliers capable of manufacturing these components.
We purchase some of our materials and components through purchase orders and do not have long-term purchase agreements with, or other contractual assurances of continued supply, pricing or access from, our suppliers, except for the suppliers of our air chambers, blow-molded foundations, foam, circuit boards and various components used for our covers, including fiber, fabrics, thread and tick. If prices for our key materials or components increase and we are unable to achieve offsetting savings through value engineering or increased productivity or we are unable to increase prices to our customers, our profitability and financial condition may be harmed. The loss of one or more of our key suppliers, the failure of one or more of our key suppliers to supply materials or components on a timely basis, or a material change in the purchase terms for our components could harm our sales, profitability and financial condition.
Our uncertain financial position may also disrupt relationships with our suppliers, which may prevent us from obtaining necessary components, supplies or services on acceptable terms or at all.
Inflationary Pressures. Increases in commodity prices, component costs and/or delivery costs could harm our sales, profitability and financial condition.
Our business has been subject to significant increases or volatility in the prices of certain commodities, including but not limited to fuel, oil, natural gas, rubber, cotton, plastic resin, steel and chemical ingredients used to produce foam. Increases in prices of these commodities may result in significant cost increases for our raw materials and product components, as well as increases in the cost of delivering our products to our customers. To the extent we are unable to offset any such increased costs through value engineering and similar initiatives underway, or through price increases, our profitability and financial condition may be adversely impacted. If we choose to increase prices to offset the increased costs, our unit sales volumes could be adversely impacted.
Risks of Just-In-Time Manufacturing Processes. We utilize "just-in-time" manufacturing processes with minimal levels of raw materials, work in process and finished goods inventories, which could leave us vulnerable to shortages of supply of key components. Any such shortage could result in our inability to satisfy consumer demand for our products in a timely manner and lost sales, which could harm our profitability and financial condition.
We generally assemble our products after we receive orders from customers utilizing "just-in-time" manufacturing processes. Lead times for ordered components may vary significantly and depend upon a variety of factors, such as the location of the supplier, the complexity in manufacturing the component and general demand for the component. Some of our components, including our air chambers, have relatively longer lead times. We generally maintain minimal levels of raw materials, work in process and finished goods inventories, except for our air chambers, of which we generally carry approximately six weeks of inventory. As a result, an unexpected shortage of supply of key components used to manufacture our products, or an unexpected and significant increase in the demand for our products, could lead to inadequate inventory and delays in shipping our beds to customers. Any such delays could result in lost sales, which could harm our profitability and financial condition.
Risks of Foreign Sourcing of Materials. The foreign manufacturing of our air chambers and some of our other companies from usingcomponents involves risks that could increase our technologycosts, lead to inadequate inventory levels or delays in competitiveshipping beds to our customers, which could harm our sales, profitability and financial condition.
Since our air chambers and some of our other components are manufactured outside the United States, our operations could be harmed by the risks associated with foreign sourcing of materials, including but not limited to:
These factors could increase our costs of doing business with foreign suppliers, lead to inadequate inventory levels or delays in shipping beds to our customers, which could harm our sales, profitability and financial condition. If any of these or other factors were to render the conduct of any of our foreign suppliers' businesses more difficult or impractical, we may have difficulty sourcing key components of our products, which could adversely affect our sales, profitability and require us to decrease our prices.
Certain elements of the designDependence on UPS and function of our beds are the subject of U.S. and foreign patents and patent applications owned by us. We also own several registered and unregistered trademarks and trademark applications, including in particular our Sleep Number trademark, which we believe have significant value and are important to the marketing of our products to customers. In addition to patents and trademarks, we rely upon copyrights, trade secrets and other intellectual property rights, and we have implemented several measures to protect our intellectual property and confidential information contained in our products, such as entering into assignment of invention and nondisclosure agreements. Our ability to compete effectively with other companies depends, to a significant extent, upon our ability to maintain the proprietary nature of our owned intellectual property and confidential information. However, our intellectual property rights may not provide us substantial protection or may be circumvented by our competitors. Our protective measures may not protect our intellectual property rights or confidential information or may not prevent our competitors from developing and marketing products that are similar to or competitive with our beds or other products. In addition, the laws of some foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States. If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology in competitive products, which could adversely affect our sales and require us to decrease our prices.Other Carriers
Intellectual property litigation, which could result in substantial costs to us and the diversion of significant time and effort by our executive management, may be necessary to enforce our patents and trademarks and to protect our trade secrets and proprietary technology. We may not have the financial resources necessary to enforce or defend our intellectual property rights. Although we are unaware of any intellectual property infringement or invalidity claims asserted against us, third parties, including competitors, may assert such claims against us and, if asserted, such claims could be upheld. We may not prevail in any such litigation and, if we are unsuccessful, we may not be able to obtain any necessary licenses on reasonable terms or at all.
. We depend upon UPS and other carriers to deliver some of our products to customers on a timely and cost-effective basis. Any significant delay in deliveries to our customers could lead to increased returns and cause us to lose future sales. Any increase in freight charges could increase our costs of doing business and harm our profitability.sales, profitability and financial condition.
Historically, we have relied almost exclusivelyto a significant extent 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 due to a labor strike, causing delays in deliveries to customers and requiring us to use alternative carriers. UPS may not be able to avert labor difficulties in the future or may otherwise experience difficulties in meeting our requirements in the future. InFrom 2000 to 2003, we begandemonstrated an ability to shift a portion of our product delivery business to FedEx.FedEx, as necessary. In addition, we either provide directly, or contract with a third party to provide, in-home delivery, assembly and mattress removal services, and are in the process of increasing2003 expanded the availability of this service.service to all of our retail stores across the country. Despite these alternative carriers, if UPS were to experience difficulties in meeting our requirements, we may not be able to deliver our products to all of our customers through any one
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Significant and unexpected return rates underRisk of Damage to our 30-night trial period and warranty claims under our limited 20-year warranty on our beds, in excess of our returns and warranty reserves, could significantly harm our financial condition and operating results.Manufacturing Facilities
Part of our marketing and advertising strategy focuses on providing a 30-night trial in which customers may return their beds and obtain a refund of the purchase price if they are not 100% comfortable with our product. As we expand our sales, our return rates may not remain within acceptable levels. A significant and unexpected increase in return rates could significantly harm our business, financial condition and operating results. Our marketing and advertising strategy also includes providing our customers with a limited 20-year warranty on our beds. However, since we have only been selling beds in significant quantities since 1992, we may receive significant and unexpected claims under this warranty and our warranty reserves may not be adequate to cover future warranty claims. Significant warranty claims in excess of our warranty reserves could also significantly harm our financial condition and operating results.
We may be unable to effectively manage our growth, which could significantly harm our business, financial condition and operating results.
Our growth strategy has placed, and will continue to place, a significant strain on our management, production, information systems and other resources. To manage growth effectively, we must maintain a high level of manufacturing quality and efficiency, continue to enhance our operational, financial and management systems, including our database management, tracking of inquiries, inventory control and distribution systems, and expand, train and manage our employee base. We may not be able to effectively manage this expansion in any one or more of these areas, and any failure to do so could significantly harm our business, financial condition and operating results.
Our management information systems may prove inadequate and we are in the process of migrating our current systems to an upgraded version, which could cause interruptions in our business if this conversion does not occur smoothly.
We depend upon our management information systems for many aspects of our business. Some of our key software has been developed by our own programmers and this software may not be easily integrated with other software and systems. Our business will be materially and adversely affected if our management information systems are disrupted or if we are unable to improve, upgrade, integrate or expand upon our systems as we execute our growth strategy. We are in the process of migrating our management information systems to an upgraded version, which could cause interruptions in our business if this conversion does not occur smoothly.
. Damage to either of our manufacturing facilities could increase our costs of doing business andor lead to delays in shipping our beds, which could result in increased returns and adversely affect future sales.
We have two manufacturing plants, which are located in Columbia,Irmo, South Carolina and in Salt Lake City, Utah. WeUnlike other mattress manufacturers, we generally manufacture beds to fulfill orders rather than stocking finished goods inventory. Therefore, the destruction or shutting down of either of our
manufacturing facilities for a significant period of time as a result of fire, explosion, act of war or terrorism, flood, hurricane, tornado, typhoon, earthquake, lightning or other natural disaster could increase our costs of doing business and lead to delays in shipping our beds to customers. Such delays could result in increased returns and adversely affect future sales.
CompetitionSignificant. The mattress industry is highly competitive. Our business could be harmed by existing competitive pressures or from one or more new entrants into the market.
Our Sleep Number beds compete with a number of different types of mattress alternatives, including standard innerspring mattresses, foam mattresses, waterbeds, futons and long-termother air-supported mattress products sold through a variety of channels, including home furnishings stores, specialty mattress stores, department stores, mass merchants, wholesale clubs, telemarketing programs, television infomercials and catalogs. The mattress industry is characterized by a high degree of concentration among the three largest manufacturers of innerspring mattresses with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand, Serta and Simmons. Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the mattress market. Tempur-Pedic International, Inc. and other companies compete in the mattress industry with foam mattress products. A number of mattress manufacturers, including Sealy and Simmons, as well as a number of smaller manufacturers, including low-cost foreign manufacturers, have offered air beds that compete with our products.
We believe that many of our competitors, including in particular the three largest innerspring mattress manufacturers and Tempur-Pedic, have greater financial, marketing and manufacturing resources and better brand name recognition than we do and sell products through broader and more established distribution channels. Our stores and other company-controlled distribution channels compete with other retailers who often provide a wider selection of mattress alternatives than we offer through our channels of distribution, which may place our channels of distribution at a competitive disadvantage. These manufacturing and retailing competitors, or new entrants into the market, may compete aggressively and gain market share with existing and new mattress products, and may pursue or expand their presence in the air bed segment of the market. Some competitors may engage in aggressive advertising strategies that may include false or misleading claims about competitive products and/or our products. Any such competition could inhibit our ability to retain or increase market share, inhibit our ability to maintain or increase prices and reduce our margins, which could harm our sales, profitability and financial condition.
Need for Continuous Product Improvement. If we are unable to enhance our existing products and develop and market new products that respond to customer needs and achieve market acceptance, we may not be able to regain growth in sales or improvement in profitability.
One of our growth strategies is to continue to lead our industry in product innovation and sleep expertise by enhancing existing products and by developing and marketing new products that deliver personalized comfort and better sleep. We may not be successful in developing or marketing enhanced or new products that will receive acceptance in the marketplace. Further, the resulting level of sales from any of our enhanced or new products may not justify the costs associated with the development and marketing. Any failure to continue to develop and market enhanced or new products in a cost-effective manner could harm our ability to regain growth in sales or growth in profitability.
Adequacy of Management Information Systems. In December 2008, we abandoned plans to implement an SAP®-based enterprise-wide information technology architecture. As a result, we are currently enhancing our existing management information systems to support our existing and anticipated business needs and to comply with evolving payment card industry and state and federal regulatory standards applicable to data privacy and security. This project may take longer and may require more resources to implement than anticipated, may cause distraction of key personnel, and may cause disruptions to our business. Any of these outcomes could impair our ability to achieve critical strategic initiatives and could harm our sales, profitability and financial condition.
We depend upon our management information systems for many aspects of our business. Our current information systems architecture includes some off-the-shelf programs as well as some key software that has been developed by our own programmers, which is not easily modified or integrated with other software and systems and limits the flexibility and scalability of our information systems. Our business will be adversely affected if our management information systems are disrupted or if we are unable to improve, upgrade, integrate or expand our systems to meet business and regulatory requirements. In addition, any failure of our web sitesystems and processes to adequately protect customer information from theft or loss could adversely affectimpact our net sales.business, reputation, sales, profitability and financial condition.
Risks of Compliance with Governmental Regulations
. We are subject to a wide variety of government regulations. Any failure to comply with any of these regulations could harm our business, reputation, sales, profitability and financial condition. We may be required to incur significant expenses or to modify our operations in order to ensure compliance with these regulations. We depend on our web site forare subject to a certain percentagewide variety of government regulations relating to the bedding industry or to various aspects of our netbusiness and operations, including without limitation:
Although we believe that we are in compliance in all material respects with these regulations and have implemented a variety of measures to promote continuing compliance, regulations may change over time and we may be required to incur expenses and/or to modify our operations in order to ensure compliance with these regulations, which could harm our profitability and financial condition. If we are found to be in violation of any of the foregoing laws or regulations, we could become subject to fines, penalties, damages or other sanctions, as well as potential adverse public relations, which could adversely impact our business, reputation, sales, profitability and for advertisingfinancial condition.
Risks of Compliance with Flammability Standards. All mattresses and mattress and foundation sets, including ours, became subject to new federal flammability standards and related regulations in July 2007. Compliance with these regulations has increased our products. Ifproduct costs, has required modifications to our web site becomes unavailable for a significant periodsystems and operations and may increase the risk of timedisruptions to our business due to ongoing testing to assure compliance or due to regulatory inspections.
The federal Consumer Product Safety Commission adopted new flammability standards and related regulations which became effective nationwide in July 2007 for mattresses and mattress and foundation sets. Compliance with these requirements has resulted in higher materials and manufacturing costs for our products, and has required modifications to our information technologysystems and business operations, further increasing our costs. To the extent we are unable to offset increased costs through value engineering and similar initiatives, or Internet failure,through price increases, our netprofitability may be adversely impacted. If we choose to increase prices to offset the increased costs, our unit sales volumes could be adversely affected.impacted.
12 Compliance also requires more complicated manufacturing processes, which may reduce our manufacturing capacity and may require us to expand our manufacturing capacity sooner than otherwise anticipated.
The Consumer Product Safety Improvement Act (CPSIA) establishes new lead and phthalates content standards for certain children's products, including some mattresses. Portions of the CPSIA, including compliance with the component content standards became effective February 10, 2009. The Consumer Product Safety Commission has stayed the enforcement of the testing and certification requirements for the component testing and certification until February 10, 2010. Compliance with these regulations may increase our product costs and may require modifications to our systems and operations.
Risks of Seasonal Influences. Our business is subject to seasonal influences and a substantial portion of our net sales is often realized in the last month or last few weeks of a quarter, due in part to our promotional schedule and commission structure. Because the level ofAs our sales and marketing expense isexpenditures are largely based on our expectations of future customer inquiries and net sales, and cannot be adjusted quickly, a shortfall infailure to meet these expectations may harm our profitability.profitability and financial condition.
Our business is subject to some seasonal influences, with typically lower sales in the second quarter, and higherincreased sales during the fourth quarterselected holiday season due to greater mall traffic.or promotional periods. Furthermore, a substantial portion of our sales is often realized in the last month or last few weeks of a quarter, due in part to our promotional schedule and commission structure. The level of salesour marketing and marketingadvertising expenses and new store opening costs is based, in significant part, on our expectations of future customer inquiries and net sales and cannot be adjusted quickly. 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 sales, profitability and financial condition may be significantly harmed.
We are subject to government regulations relating to the bedding industryProduct Returns and may be required to incur expenseWarranty Claims. Significant and modifyunexpected return rates under our operations in order to ensure compliance with these regulations.
Our operations are subject to state30-night trial period, or significant and local consumer protection and other regulations relating to the bedding industry. These regulations vary among the states in which we do business. The regulations generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling and sale and penalties for violations. Although we believe that we are in substantial compliance with these regulations and have implemented a variety of measures to promote continuing compliance, we may be required in the future to incur expense and/or modifyunexpected warranty claims under our operations in order to ensure compliance with these regulations, which20-year limited warranty, could harm our operating results.sales, profitability and financial condition.
Our directPart of our marketing operationsand advertising strategy focuses on providing a 30-night trial in which customers may return their beds and obtain a refund of the purchase price if they are or may become subject to various adopted or proposed federal and state “do not call” list requirements. The Federal Trade Commission has amended its rules to provide for a national “do not call” registry. Under these new federal regulations, consumers may begin to have their phone numbers added to the national “do not call” registry beginning in July 2003. In September 2003, telemarketers will have access to the registry and will be required to scrub their call lists against the national “do not call” registry at least once every 90 days. A telemarketer may call a consumerfully satisfied with whom it has an established business relationship for up to 18 months after the consumer’s last purchase, delivery or payment even if the consumer’s name is on the national “do not call” registry. A company may also call a consumer for up to three months after the consumer makes an inquiry or submits an application to the company. In addition, if a consumer asks a company not to call, the companyour product. Return rates may not call even if there is an established business relationship.remain within acceptable levels. An unexpected increase in return rates could harm our sales, profitability and financial condition. We believealso provide our customers with a 20-year limited warranty on our beds. We may receive significant and unexpected claims under these warranty obligations that we arecould exceed our warranty reserves. Warranty claims in substantial compliance with existing requirements, and plan to comply with the new federal requirements described above when they become effective, but these requirements may be further modified over time and may adversely affect our direct marketing sales or costs.
The federal Consumer Product Safety Commission and various state regulatory agencies are considering new rules relating to fire retardancy standards for the bedding industry. The State of California plans to adopt, effective in the year 2004, new fire retardancy standards that have not yet been finally defined. If adopted, such new rules may adversely affect our costs, manufacturing processes and materials. We are developing product solutions that are intended to enable us to meet the new standards. Because the new standards have not been finally determined, however, our solutions may not enable us to meet the new standards. We expect that any required product modifications will add cost to our product.
A portionexcess of our net sales consists of refurbished products that are assembled in part from components returnedwarranty reserves could harm our profitability and financial condition.
Exposure to us from customers. These refurbished products must be properly labeled and marketed as refurbished products under applicable state laws. Our sales of refurbished products are limited to approximately 24 states, as the remaining states do not allow the sale of refurbished bedding products.
Product Liability ClaimsFailure to comply with health and safety requirements could expose us to a material liability.
We are subject to federal, state and local laws and regulations relating to occupational health and safety. We may not at all times be in compliance with all such requirements. We have made and will continue to make capital and other expenditures to comply with health and safety requirements.
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. We may face exposure to product liability.liability claims.
We face an inherent business risk of exposure to product liability claims in the event that the use of any of our products resultsis alleged to have resulted in personal injury or property damage. In the event that any of our products proves to be defective, we may be required to recall or redesign such products. In 2004 and in 2008, we experienced increased returns and adverse impacts on sales, as well as product liability litigation, as a result of media reports related to the alleged propensity of our products to develop mold. We may experience material increases in returns and material adverse impacts on sales or additional litigation in the event any similar media reports were to occur in the future. We maintain insurance against product liability claims, but such coverage may not continue to be available on terms acceptable to us orand may not be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our business.
Protection of Our Intellectual Property. If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology in competitive products.
We depend upon endorsements by national radio personalitiesown various U.S. and foreign patents and patent applications related to promotecertain elements of the design and function of our beds and related products. We also own several registered and unregistered trademarks and trademark applications, including in particular our Select Comfort and Sleep Number trademarks, which we believe have significant value and are important to the marketing of our products to customers. In addition to patents and trademarks, we rely upon copyrights, trade secrets and other intellectual property rights and we have implemented several measures to protect our intellectual property and confidential information contained in our products, such as entering into assignment of invention and nondisclosure agreements with certain of our employees. Our ability to compete
effectively with other companies depends, to a significant extent, upon our ability to maintain the lossproprietary nature of whichour owned intellectual property and confidential information. Our intellectual property rights may not provide substantial protection against infringement or piracy and may be circumvented by our competitors. Our protective measures may not protect our intellectual property rights or confidential information or prevent our competitors from developing and marketing products that are similar to or competitive with our beds or other products. In addition, the reductionlaws of some foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States. If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology or trademarks in effectiveness ofconnection with competitive products, which could adversely affect our sales.
Our integrated marketing program dependsIntellectual property litigation, which could result in partsubstantial costs to us and the diversion of significant time and effort by our executive management, may be necessary to enforce our patents and trademarks and to protect our trade secrets and proprietary technology. We may not have the financial resources necessary to enforce or defend our intellectual property rights.
We are not aware of any material intellectual property infringement or invalidity claims that may be asserted against us, however, it is possible that third parties, including competitors, may successfully assert such claims. The cost of defending such claims, or any resulting liability, or any failure to obtain necessary licenses on national radio personalities, including Paul Harveyreasonable terms, may adversely impact our sales, profitability and Rush Limbaugh.financial condition.
Dependence on Management and Other Key Employees. The loss of either Paul Harveythe services of any members of our executive management team could adversely impact our ability to execute our business strategy and growth initiatives and could harm our business.
We are currently dependent upon the continued services, ability and experience of our executive management team, particularly William R. McLaughlin, our Chief Executive Officer. The loss of the services of Mr. McLaughlin or Rush Limbaugh or a reductionany other member of our executive management team could have an adverse effect on our ability to execute our business strategy and growth initiatives and on our sales, profitability and financial condition. We do not maintain any key person life insurance on any members of our executive management team. Our future growth and success will also depend upon our ability to attract, retain, and motivate other qualified personnel.
Risks of International Distribution. Through relationships with other parties, we distribute products in Canada and Australia, which presents some additional risks to our business.
To date, the vast majority of our sales have been made in the effectivenessU.S. and we have sold only very minimal quantities of their endorsement couldproducts in foreign jurisdictions. In late 2005 we began to distribute our products in Canada through an independent retailer. In late 2007 we entered into relationships with an Australian-based manufacturer and an Australian-based retailer to begin distribution of Sleep Number beds in Australia and New Zealand. Our lack of experience in international distribution presents some risks to our business, including without limitation the need to build awareness of our products and brand in new markets, the need to gain market acceptance for new products that represent a significant departure from traditional bedding products, logistical and systems complexities, different levels of protection of our intellectual property, language and cultural differences, the need to comply with additional and different regulatory requirements, foreign currency exchange risks, and political instability.
Although several members of our senior management team have significant experience in international distribution of consumer goods, as a company our experience in this area is limited. The current economic environment and its impact on our business has limited our ability to invest in our international infrastructure, which may adversely affectimpact the sales and profitability of our sales.international
operations, as well as the timing of additional international expansion. If we are unable to achieve consumer awareness and market acceptance for our products in foreign jurisdictions, we may not be able to achieve sufficient sales and profitability in our international operations to justify the investment.
Risks of Terrorist Attacks. Additional terrorist attacks in the United States or against U.S. targets, or actualacts of war or threats of war or the escalation of current hostilities involving the United States or its allies could significantlyadversely impact this offering, our business,sales, profitability, financial condition operating results or stock price in unpredictable ways.
Additional terrorist attacks in the United States or against U.S. targets, actualor acts of war or threats of war or the escalation of current hostilities involving the United States or its allies, or military or trade disruptions impacting our domestic or foreign suppliers of components toof our products, may adversely impact this offering and our operations, including, among other things,but not limited to, causing delays or losses in the delivery of merchandise to us and decreased sales of our products. These events could cause an increase in oil or other commodity prices, which could adversely affect our materials or transportation costs, including the costs of delivery of our products to customers. More generally, any of these events could causeadversely impact consumer confidence and spending to decrease or result in increased volatility in the U.S. and worldwide financial markets. These events also could cause, or deepen and prolong, an economic recession in the United States or abroad. Any of these occurrences could have a significantan adverse impact on this offering, our business,sales, profitability and financial condition, and operating results and may result in volatility of our stock price.
AsRisks of Pandemic. An outbreak of H1N1 (Swine Flu), Avian Flu or a result of the terrorist attacks in the United States andpandemic, or the threat of war involving the United States, we believe many consumers have traveled lessa pandemic, may adversely impact our ability to produce and purchased moredeliver our products for their home. We believe these trends have contributed to an increase in our net sales. These trends may not continue or may not continueadversely impact consumer demand.
Concern has grown recently over the possibility of a significant or global outbreak of H1N1 (swine flu), avian flu or a similar pandemic. A significant outbreak of H1N1 (swine flu), avian flu, or a similar pandemic, or even a perceived threat of such an outbreak, could cause significant disruptions to positively affect our netsupply chain, manufacturing capability and distribution system that could adversely impact our ability to produce and deliver products, which could result in a loss of sales or we may not be able to sustainand adversely impact on our current netprofitability and financial condition. Similarly, such events could adversely impact consumer confidence and consumer demand generally, which could adversely impact our sales, levels.
Risks Related to this Offeringthe Common Shares
Price FluctuationsOur stock price may be volatile and your investment in our common stock could suffer a decline in value.
. The sales price of our common stock historically has fluctuated between $0.45 and $35.25 since our initial public offering in December 1998.experienced significant price fluctuations, which may make it difficult for you to resell the common stock.
The market price of our common stock historically has experienced and may fluctuatecontinue to experience significant price fluctuations similar to those experienced by the broader stock market in the future as a result of a variety of factors, many of which are outside of our control, including the following factors:
Such fluctuations may also be the result of changes in the trading characteristics that prevail in the market for our common stock, including low trading volumes, trading volume fluctuations and other similar factors that are particularly common among highly volatile securities of companies such as ours.recent years. In addition, the U.S. equity markets have from time to time experienced significant price and volume fluctuations that have particularly affected the market prices for
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We may incur significant costs from additional class action litigation ifearnings of our stock price is volatile.
Following periods of large price declinescustomers or competitors; and conditions in the public marketeconomy in general or the mattress industry in particular, including increased competitive or pricing pressures in our industry.
NASDAQ Listing Requirements. Failure to satisfy NASDAQ Global Select Market listing requirements may result in our common stock being removed from listing on the NASDAQ Global Select Market.
Our common stock is currently listed on the NASDAQ Global Select Market under the symbol "SCSS." For continued inclusion on the NASDAQ Global Select Market, we must generally maintain, among other requirements, either (a) shareholders' equity of at least $10 million, a minimum closing
bid price of $1.00 per share and a company’smarket value of our public float of at least $5 million; or (b) market capitalization of at least $50 million, a minimum closing bid price of $1.00 per share and a market value of our public float of at least $15 million. Though we currently meet these requirements, we did not fully meet these requirements earlier in 2009. If we fail to meet these requirements for at least 30 consecutive trading days at any time in the future, our common stock holderscould be at risk of thatbeing removed from listing on the NASDAQ Global Select Market. If our common stock were removed from listing on the NASDAQ Global Select Market, our common stock may institute securities class action litigation againstbe transferred to the company that issuedNASDAQ Capital Market if we satisfy the stock. We became subject to such a suit in 1999. We agreed to a settlement of this suit in 2002, and final approval oflisting criteria for the terms of the settlement was obtained in February 2003. If any of our shareholders were to bring another similar type of lawsuit against us, even if the lawsuit is without merit, we could incur substantial costs defending the lawsuit. The lawsuit also could divert the time and attention of our management, which would hurt our business. Any adverse determination in litigation that requires us to pay an amount in excess of our insurance coverage could significantly harm our financial condition and operating results.
Future salesNASDAQ Capital Market, or trading of our common stock may be conducted in the publicover-the-counter market could adversely affectin the so-called "pink sheets" or, if available, the National Association of Securities Dealer's "Electronic Bulletin Board." Consequently, broker-dealers may be less willing or able to sell and/or make a market in our common stock, which may make it more difficult for shareholders to dispose of, or to obtain accurate quotations for the price of, our common stock. Removal of our common stock from listing on the NASDAQ Global Select Market may also make it more difficult for us to raise capital through the sale of our securities.
Dilution. If additional financing is required, you may suffer dilution of your investment. We are seeking to raise additional capital through the issuance of equity securities, which may result in dilution to existing shareholders.
Our Amended and Restated Credit Agreement requires us to raise a minimum of an additional $15 million in gross proceeds to the company through the sale of equity securities by March 31, 2010. Beyond the requirements of the Amended and Restated Credit Agreement, we may require additional capital to provide adequate liquidity to operate our business, respond to competitive pressures or take advantage of unanticipated opportunities. Our ability to raise fundsobtain such capital, and the terms under which we may be able to obtain such capital, will depend in new equity offerings.
We cannot predictpart upon prevailing capital market conditions, as well as the effect, if any, that future salesperformance of our business. If additional capital is raised through the issuance of shares of our common stock or other equity securities, you may suffer additional dilution.
Presence of Large Shareholders. A limited number of shareholders control a significant amount of the availability for future salevoting power of sharesour common stock.
As of October 19, 2009, the four largest beneficial owners of our common stock, or securities convertible into or exercisable for our common stock will have on the market priceincluding Sterling, had beneficial ownership of approximately 40% of our common stock prevailing from time to time. Sale, or the availability for sale, of substantial amounts of common stock by our existing shareholders pursuant to an effective registration statement or under Rule 144, through the issuance of shares of common stock upon the exercise of stock options or the perception that such sales or issuances could occur, could decrease prevailing market prices for our common stock and could materially impair our future ability to raise capital through an offering of equity securities.
We have a significant number of options, warrants and convertible debentures to acquire shares of our common stock that will adversely affect any diluted earnings per share calculation and that when exercised will dilute existing shareholders and could decrease the market price of our common stock.
As of February 14, 2003, we had outstanding options, warrants and convertible debentures to acquire 10,745,428 shares of our common stock at various prices ranging from $0.45 to $28.63, with a weighted average exercise price of $3.41. We will also continue to issue equity securities under our equity compensation plans which will continue to adversely affect any diluted earnings per share calculation. In addition to the dilution our existing shareholders will experience once these options and warrants are exercised and convertible debentures are converted and the potential impact on the market price of our common stock from the sale of these shares in the public market, the existence of these rights to acquire shares have a dilutive impact in the calculation of diluted earnings per share.
Concentration of ownership among our existing directors, officers and principal shareholders may prevent new investors from influencing significant corporate decisions.
Upon completion of this offering, our directors, officers and principal shareholders will beneficially own, in the aggregate, approximately 32.9% of our outstanding common stock. As a result, these shareholders will be able to continue to exercise controlsignificant influence over all matters requiring shareholder approval, including the election of directors, any amendments to our articles of incorporation and approval of significant corporate transactions. ThisThese shareholders may exercise this influence even if they are opposed by our other shareholders. Without the consent or approval of these shareholders, we could havebe prevented from entering into transactions (including the effect of delaying or preventing a change of controlacquisition of our company and will make some transactions difficultby third parties) that may be viewed as beneficial to us or impossible withoutour other shareholders. In addition, this significant concentration of stock ownership may adversely affect the supporttrading price of theseour common stock if investors perceive disadvantages in owning stock in a company with significant minority shareholders.
Sales of Common StockProvisions. Sales of a substantial number of shares of our common stock in the public market, including the shares offered under this prospectus and under other registration statements, could lower our stock price and impair our ability to raise funds in new stock offerings.
If our shareholders sell substantial amounts of our common shares, the market price of our common shares could decrease. We have 48,088,705 common shares outstanding as of November 16, 2009. In addition, we may sell additional common shares in subsequent offerings. On November 13, 2009, we issued 2,500,000 common shares, as well as warrants to purchase 2,000,000 common shares, to Sterling. As a result, as of November 16, 2009, Sterling beneficially owned approximately 9.0% of our
common shares. Under this registration statement, we are registering the resale of the common shares, including the common shares underlying the warrants, issued to Sterling.
We cannot predict the size of future issuances of common shares or the effect, if any, that future issuances and sales of common shares, including the shares offered under this registration statement, other registration statements, and shares available for resale under Rule 144 under the Securities Act, or the perception that such sales could occur, may have on the market price of our common shares or our ability to raise additional capital through the sale of equity securities. With any additional issuance of common shares, investors will suffer dilution and we may experience dilution in our earnings per share.
Limitations of Charter Provisions and Applicable Law. Our charter and corporate documents and Minnesota law could discourage or preventmake a takeover even if an acquisition would be beneficialof our company more difficult and expensive, which may prevent certain changes in control and limit the market price of our common stock.
Our charter and corporate documents and Minnesota law make a takeover of our company more difficult and expensive, which may prevent certain changes in control and limit the market price of our common stock. Our charter, bylaws, certain corporate documents and sections 671 and 673 of the Minnesota Business Corporation Act contain provisions that might enable our management to our shareholders.
Provisionsresist a takeover of our company. Provisions in our amended and restated articles of incorporation and ouramended and restated bylaws may discourage, delay or prevent a merger or acquisition involving us that our shareholders may consider favorable. For example, our amended and restated articles of Minnesota law mayincorporation authorize five million undesignated shares. Without shareholder approval, our board of directors has the authority to create a class or series of shares from the undesignated shares and to set the terms of the class or series, including voting and dividend rights. With these rights, it could be more difficult for a third party to acquire us. In addition, our amended and restated articles of incorporation provide for a staggered board of directors, with directors serving for three-year terms, with approximately one-third of the directors coming up for re-election each year. Having a staggered board will make it more difficult for a third party to obtain control of our board of directors through a proxy contest, which may be a necessary step in some respectsany acquisition of us that is not favored by our board of directors. In addition, we have entered into change in control agreements with certain of our executive officers which entitle these officers to causecertain benefits if they are terminated in connection with a change in control of our company. The existence of these provisions could discourage or prevent a change in control of our company, and replace incumbent management. For example, our restated articles of incorporation and restated bylaws provide for a classified board of directors. With a classified board of directors, at least two annual meetings of shareholders, instead of one, will generally be required to effect a change in the majority of the board. As a result, a provision relating to a classified board may discourage proxy contests for the election of directors or purchases of a substantial block of our common stock because its provisions could prevent
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Lack of Dividend IncomeBecause we. We do not intend to paydeclare dividends you will benefit from an investment inon our common stock only if it appreciates in value.after this offering.
We have never declaredcurrently intend to retain all of our future earnings, if any, to repay any existing liabilities and to finance the expansion and growth of our business and, therefore, do not anticipate declaring or paid anypaying cash dividends on our common stock since becoming a public company. We currently intend to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future. As a result, any returnAny payment of cash dividends on your investment in our common stock must comewill be at the discretion of our board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, outstanding indebtedness, plans for expansion, restrictions imposed by our lenders, if any, and other factors deemed relevant by our board of directors. Currently, our Amended and Restated Credit Agreement restricts us from increases in the fair market value and trading pricepaying cash dividends, except under certain circumstances. Therefore, you should not expect to receive dividend income from shares of our common stock. Our common stock may not appreciate in value after this offering or the price may decrease below the price at which you purchased your shares.
INFORMATIONSPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This prospectus contains or incorporates by reference certain forward-looking statements within the meaning of Section 27A of the Private Securities Litigation Reform Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. The forward-looking1995. For this purpose, any statements are principally contained in the sections “Prospectus Summary,” “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” These statements involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or impliedincorporated by the forward-looking statements. Forward-looking statements include but are not limited to:
In some cases, you can identify forward-looking statements by terms such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” and similar expressions intended to identify forward-looking statements. You should read statements that contain these words carefully because they discuss our future expectations, contain projections of our future results of operations or of our financial condition, or state other “forward-looking” information but are not statements of fact. We believe that it is important to communicate our future expectations to our investors. However, therehistorical fact may be events in the future that we are not abledeemed to accurately predict or control and that may cause our actual results to differ materially from the expectations we describe in our forward-looking statements. You are cautioned that allbe forward-looking statements, including but not limited to projections of revenues, results of operations, financial condition or other financial items; any statements of plans, strategies and objectives of management for future operations; any statements regarding proposed new products, services or developments; any statements regarding future economic conditions, prospects or performance; statements of belief and any statement or assumptions underlying any of the foregoing. We try to identify forward-looking statements in this report and elsewhere by using words such as "may," "will," "should," "could," "expect," "anticipate," "believe," "estimate," "plan," "project," "predict," "intend," "potential," "continue" or the negative of these or similar terms.
Our forward-looking statements speak only as of the date made and by their nature involve substantial risks and uncertainties, including, among others, such factors as our ability to fund our operations through cash flow from operations or availability under our bank line of credit or other sources, and the cost of credit or other capital resources necessary to finance operations; the risk of non-compliance with financial covenants under our bank line of credit and the risk that we may not be successful in obtaining continuing waivers or other financial accommodations from our lenders should they become necessary; the potential need to obtain additional capital through the issuance of debt or equity securities, which may significantly increase our costs or dilute our existing shareholders, and the risk that we may not be successful in obtaining additional capital that may be needed; current general and industry economic trends; consumer confidence; the effectiveness of our marketing messages; the efficiency of our advertising and promotional efforts; consumer acceptance of our products, product quality, innovation and brand image; availability of attractive and cost-effective consumer credit options; execution of our retail store distribution strategy, including our ability to cost-effectively close under-performing store locations; our dependence on significant suppliers, and our ability to maintain relationships with key suppliers, including several-sole source suppliers; the vulnerability of key suppliers to recessionary pressures, labor negotiations, liquidity concerns or other factors; rising commodity costs and other inflationary pressures; industry competition; our ability to continue to improve our product line; warranty expenses; risks of pending and potentially unforeseen litigation; increasing government regulations, including new flammability standards for the bedding industry and new safety standards for consumer products, which have or will add product cost pressures and have or will require implementation of systems and manufacturing process changes to ensure compliance; the adequacy of our management information systems to meet the evolving needs of our business and evolving regulatory standards applicable to data privacy and security; our ability to attract and retain senior leadership and other key employees, including qualified sales professionals; and uncertainties arising from global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events. We refer you to the section entitled "Risk Factors" included elsewhere in this prospectus and in the accompanying prospectus supplement and under similar sections in the documents we incorporate by reference into this prospectus. Our actual results may differ materially depending on a variety of factors and these risks and uncertainties are not exclusive. Further information concerning the company and our business, including factors that potentially could materially affect our financial results or condition, may emerge from those discussed as a result of varioustime to time, including factors including those factors described in the “Risk Factors” section ofthat we may consider immaterial or do not anticipate at this prospectus. You shouldtime.
We wish to caution readers not to place undue reliance on ourany forward-looking statement and to recognize that forward-looking statements are predictions of future results, which may not occur as anticipated. We assume no obligation to update forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. BeforeWe advise you, investhowever, to consult any further disclosures we make on related subjects in our Annual Report on Form 10-K, in our quarterly reports on Form 10-Q, and current reports on Form 8-K that we file with or furnish to the Securities and Exchange Commission.
We will not receive any proceeds from the sale of shares of our common stock you should be aware thatby the occurrenceselling shareholder.
The selling shareholder will pay any underwriting discounts and commissions incurred by the selling shareholder. We will reimburse the selling shareholder for up to $50,000 of expenses incurred by it for legal services in connection with registrations, filings and qualifications relating to the shares. We will bear all other costs, fees and expenses incurred by us in effecting the registration of the events describedshares covered by this prospectus, including, without limitation, all registration and filing fees and fees and expenses of our counsel and our accountants.
On October 2, 2009, we entered into a Securities Purchase Agreement with the selling shareholder named below pursuant to which we agreed to sell an aggregate of 2,500,000 shares of our common stock, along with warrants to purchase an additional aggregate 2,000,000 shares of our common stock. The warrants are immediately exercisable and expire on November 13, 2014.
On November 13, 2009, we closed on the sale to the selling shareholder of shares of common stock and warrants to purchase shares of common stock under the Securities Purchase Agreement. We received aggregate gross proceeds of $10 million in connection with the sale of the shares and warrants to Sterling, before deduction of transaction expenses. This prospectus covers, among other things, the offer and sale by the selling shareholder listed below of up to 4,500,000 shares of common stock, including the shares issued to the selling shareholder pursuant to the Securities Purchase Agreement and the shares issuable to the selling shareholder upon exercise of the warrants.
We are registering the above-referenced shares to permit the selling shareholder to resell the shares in the “Risk Factors” sectionmanner contemplated under the "Plan of Distribution."
The selling shareholder may sell some, all or none of their shares. We do not know how long the selling shareholder will hold the shares before selling them. We currently have no agreements, arrangements or understandings with the selling shareholder regarding the sale of any of the shares other than the Securities Purchase Agreement, the Registration Rights Agreement and elsewherethe warrants. The shares offered by this prospectus may be offered from time to time by the selling shareholder.
The following table sets forth the name of the selling shareholder, the number of shares owned by the selling shareholder, the number of shares that may be offered under this prospectus by the selling shareholder and the number of shares of our common stock to be owned by the selling shareholder after this offering is completed, assuming that all offered shares are sold as contemplated herein. The number of shares in the column "Number of Common Shares Registered for Sale Hereby" represents all of the shares that such selling shareholder may offer under this prospectus. Except as otherwise disclosed in this prospectus could harm(or as disclosed in any document incorporated by reference) including information incorporated herein by reference, the selling shareholder has no, and within the past three fiscal years has not had, any position, office or other material relationship with us.
Ownership is based upon information provided by the selling shareholder and a Schedule 13G filed with the SEC by the selling shareholder. The percentages of shares owned after the offering are based on 48,088,075 shares of our business, financial condition, operating resultscommon stock outstanding as of November 16, 2009. In computing the number of shares beneficially owned by, and prospects.the percentage ownership of, the selling shareholder, all of the 2,000,000 shares of our common stock issuable upon exercise of the warrants are considered outstanding.
17 The selling shareholder may have sold or transferred, in transactions exempt from the registration requirements of the Securities Act, some or all of their shares since the date on which the information in the table is presented. Information about the selling shareholder may change over time. Information
regarding the selling shareholder may change from time to time. Any such changed information will be set forth in supplements to this prospectus if required.
| Number of Common Shares Beneficially Owned Prior to the Offering | Number of Common Shares Registered for Sale Hereby | Number of Common Shares Beneficially Owned After the Offering | |||||||||||||
---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
Name of Selling Shareholder | Number | Percentage | Number | Number | Percentage | |||||||||||
Sterling SC Investor, LLC(1)(2) | 4,500,000 | 9.0 | % | 4,500,000 | — | — |
USE OF PROCEEDS
We are registering the shares of common stock issued, and the shares of common stock issuable upon exercise of the warrants, to the selling shareholder to permit the resale of these shares of common stock by the selling shareholder from time to time after the date of this prospectus. We will not receive any of the proceeds from the sale by the selling shareholder of the shares of common stock. We will bear all fees and expenses incident to our obligation to register the shares of common stock.
The selling shareholder may sell all or a portion of the shares of common stock beneficially owned by them and offered hereby from time to time directly or through one or more underwriters, broker-dealers or agents. If the shares of common stock are sold through underwriters, broker-dealers or agents, the selling shareholder will be responsible for any discounts, concessions or commissions. The shares of common stock may be sold on any national securities exchange or quotation service on which the securities may be listed or quoted at the time of sale, in the over-the-counter market or in transactions otherwise than on these exchanges or systems or in the over-the-counter market and in one or more transactions at fixed prices, at prevailing market prices at the time of the sale, at varying prices determined at the time of sale, or at negotiated prices. These sales may be effected in transactions, which may involve crosses or block transactions. The selling shareholder may use any one or more of the following methods when selling shares:
The selling shareholder also may resell all or a portion of the shares in open market transactions in reliance upon Rule 144 under the Securities Act, as permitted by that rule, or Section 4(1) under the Securities Act, if available, rather than under this prospectus, provided that it meets the criteria and conforms to the requirements of those provisions.
Broker-dealers engaged by the selling shareholder may arrange for other broker-dealers to participate in sales. If the selling shareholder effects such transactions by selling shares of common stock to or through underwriters, broker-dealers or agents, such underwriters, broker-dealers or agents may receive commissions in the form of discounts, concessions or commissions from the selling shareholder or commissions from purchasers of the shares of common stock for whom they may act as agent or to whom they may sell as principal (which discounts, concessions or commissions as to particular underwriters, broker-dealers or agents may be in excess of those customary in the types of transactions involved to the extent permitted by applicable law).
In connection with sales of the shares of common stock or otherwise, the selling shareholder may enter into hedging transactions with broker-dealers or other financial institutions, which may in turn engage in short sales of the shares of common stock in the course of hedging in positions they assume. The selling shareholder may also sell shares of common stock short, and if such short sale shall take place after the date that this Registration Statement is declared effective by the Commission, the selling shareholder may deliver shares of common stock covered by this prospectus to close out the short positions and to return borrowed shares in connection with such short sales. The selling shareholder may also loan or pledge shares of common stock to broker-dealers that in turn may sell such shares, to the extent permitted by applicable law. The selling shareholder may also enter into option or other transactions with broker-dealers or other financial institutions or the creation of one or more derivative securities that require the delivery to such broker-dealer or other financial institution of shares offered underby this prospectus, bywhich shares such broker-dealer or other financial institution may resell pursuant to this prospectus (as supplemented or amended to reflect such transaction). Notwithstanding the foregoing, the selling shareholders.
DIVIDEND POLICY
Weshareholder have never declared or paid any cash dividendsbeen advised that they may not use shares registered on our common stock. We currently intendthis registration statement to retain our future earnings, if any, to finance the expansion of our business and do not expect to pay any cash dividends in the foreseeable future.
PRICE RANGE OF COMMON STOCK
Our common stock is quoted on the Nasdaq National Market and trades under the symbol “SCSS.” The following table sets forth the high and lowcover short sales prices per share of our common stock as reportedmade prior to the date the registration statement, of which this prospectus forms a part, has been declared effective by the Nasdaq National MarketSEC.
The selling shareholder may, from time to time, pledge or grant a security interest in some or all of the shares of common stock owned by them and, if they default in the performance of their secured obligations, the pledgees or secured parties may offer and sell the shares of common stock from time to time pursuant to this prospectus or any amendment to this prospectus under Rule 424(b)(3) or other applicable provision of the Securities Act, amending, if necessary, the list of selling shareholder to include the pledgee, transferee or other successors in interest as selling shareholder under this prospectus. The selling shareholder also may transfer or donate the shares of common stock in a gift,
distribution or other non-sale related transfer, in which case the transferees, donees, pledgees or other successors in interest will be the selling beneficial owners for purposes of this prospectus. If any of the shares of common stock offered for sale pursuant to this prospectus are sold other than pursuant to a sale under this prospectus, then subsequent holders could not use this prospectus until a post-effective amendment or prospectus supplement is filed, naming such holders.
The selling shareholder and any broker-dealer or agents participating in the distribution of the shares of common stock may be deemed to be "underwriters" within the meaning of Section 2(11) of the Securities Act in connection with such sales. In such event, any commissions paid, or any discounts or concessions allowed to, any such broker-dealer or agent and any profit on the resale of the shares purchased by them may be deemed to be underwriting commissions or discounts under the Securities Act. We know of no existing arrangements between the selling shareholder and any broker-dealer or other agent relating to the sale or distribution of the shares of common stock. We have not engaged any broker-dealer or agent in connection with the distribution of the shares of common stock.
The selling shareholder has informed the Company that it is not a registered broker-dealer or an affiliate of a registered broker-dealer and, at the time it entered into the Securities Purchase Agreement providing for the periods indicated.
High | Low | |||||||
Year Ended December 29, 2001 | ||||||||
First Quarter | $ | 2.44 | $ | 1.13 | ||||
Second Quarter | 1.68 | 0.45 | ||||||
Third Quarter | 1.71 | 0.81 | ||||||
Fourth Quarter | 2.11 | 0.89 | ||||||
Year Ended December 28, 2002 | ||||||||
First Quarter | $ | 4.57 | $ | 1.93 | ||||
Second Quarter | 6.99 | 3.77 | ||||||
Third Quarter | 6.22 | 3.81 | ||||||
Fourth Quarter | 10.20 | 5.29 | ||||||
Year Ending January 3, 2004 | ||||||||
First Quarter (through February 26, 2003) | $ | 12.13 | $ | 8.55 |
On February 26, 2003,purchase of the highshares and low sales pricethe warrants from us, did not have any written or oral agreement or understanding, directly or indirectly, with any person to distribute the common stock. Upon the Company being notified in writing by the selling shareholder that any material arrangement has been entered into with a broker-dealer for the sale of our common stock onthrough a block trade, special offering, exchange distribution or secondary distribution or a purchase by a broker or dealer, a supplement to this prospectus will be filed, if required, pursuant to Rule 424(b) under the Nasdaq National Market was $9.08 per shareSecurities Act, disclosing (i) the name of each such selling shareholder and $8.55 per share, respectively. Theof the participating broker-dealer(s), (ii) the number of record holdersshares involved, (iii) the price at which such shares of our common stock as of February 14, 2003 was approximately 189.
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CAPITALIZATION
The following table sets forth our capitalization at December 28, 2002, on an actual basis and as adjusted to give effect(vi) other facts material to the exercisetransaction. The selling shareholder may indemnify any broker-dealer that participates in transactions involving the sale of warrantsthe shares of common stock against certain liabilities, including liabilities arising under the Securities Act.
Under the securities laws of some states, the shares of common stock may be sold in such states only through registered or licensed brokers or dealers. In addition, in some states the shares of common stock may not be sold unless such shares have been registered or qualified for sale in such state or an exemption from registration or qualification is available and is complied with.
At any time a particular offer of the shares of common stock is made by the selling shareholder, we will file a revised prospectus or prospectus supplement, if required. Such prospectus supplement or post-effective amendment will be filed with the SEC to purchase 400,000reflect the disclosure of required additional information with respect to the distribution of the shares of common stock. Pursuant to the Registration Rights Agreement, we may suspend the sale of shares by the selling shareholder pursuant to this prospectus for certain periods of time for certain reasons, including if the prospectus is required to be supplemented or amended to include additional material information.
The selling shareholder and any other person participating in such distribution will be subject to applicable provisions of the Securities Exchange Act of 1934, as amended, and the rules and regulations thereunder, including, without limitation, Regulation M of the Exchange Act, which may limit the timing of purchases and sales of any of the shares of common stock by the selling shareholder and any other participating person. Regulation M may also restrict the ability of any person engaged in the distribution of the shares of common stock to engage in market-making activities with respect to the shares of common stock. All of the foregoing may affect the marketability of the shares of common stock and the paymentability of our estimated offering expenses. This table shouldany person or entity to engage in market-making activities with respect to the shares of common stock.
There can be read in conjunction with our Consolidated Financial Statements and Notes thereto included elsewhere in this prospectus.
December 28, 2002 | ||||||||||
Actual | As Adjusted | |||||||||
Cash, cash equivalents and marketable securities | $ | 40,824 | $ | 40,994 | ||||||
Current maturities of long-term debt | $ | 11 | $ | 11 | ||||||
Non-interest bearing convertible subordinated debenture | 2,991 | 2,991 | ||||||||
Total debt | 3,002 | 3,002 | ||||||||
Shareholders’ equity: | ||||||||||
Undesignated preferred stock; 5,000,000 shares authorized, no shares issued or outstanding | — | — | ||||||||
Common stock, $0.01 par value; 95,000,000 shares authorized, 30,727,101 shares issued and outstanding, actual and 31,127,101 shares issued and outstanding, as adjusted | 307 | 311 | ||||||||
Additional paid-in capital | 92,184 | 92,580 | ||||||||
Accumulated deficit | (37,976 | ) | (38,206 | ) | ||||||
Total shareholders’ equity | 54,515 | 54,685 | ||||||||
Total capitalization | $ | 57,517 | $ | 57,687 | ||||||
The above table excludes 10,185,194 and 9,785,194no assurance that the selling shareholder will sell any or all of the shares of common stock issuable upon exerciseregistered pursuant to the registration statement, of outstanding warrants and stock options atwhich this prospectus forms a weighted average exercise pricepart.
We will pay all expenses of $3.23 and $3.32 per share on an actual and as adjusted basis, respectively. The table also excludes 727,272the registration of the shares of common stock issuablepursuant to the Registration Rights Agreement, including, without limitation, Securities and Exchange Commission filing fees and expenses of compliance with state securities or "blue sky" laws. The selling shareholder will pay all underwriting discounts and selling commissions, if any, and any related legal expenses incurred by it in excess of $50,000. We will indemnify the selling shareholder against certain liabilities, including liabilities under the Securities Act, in accordance with the Registration Rights Agreement, or the selling shareholder will be entitled to contribution. We may be indemnified by the selling shareholder against civil liabilities, including liabilities under the Securities Act, that may arise from any written information furnished to us by the selling shareholder specifically for use in this prospectus, in accordance with the related Registration Rights Agreement, or we may be entitled to contribution.
The validity of the shares of common stock offered by this prospectus will be passed upon conversionfor us by Oppenheimer Wolff & Donnelly LLP, Minneapolis, Minnesota.
The consolidated financial statements and financial statement schedule of a $4.0 million principal amount subordinated convertible debenture, convertible at $5.50 per share, outstandingSelect Comfort Corporation and subsidiaries as of January 3, 2009 and December 28, 2002.
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SELECTED CONSOLIDATED FINANCIAL DATA
The table below shows selected consolidated financial data and selected operating data for our last five years. The consolidated statement of operations data for each of the fiscal years in the three-year period ended December 28, 2002January 3, 2009, and management's assessment of the consolidated balance sheet data at December 28, 2002effectiveness of internal control over financial reporting as of January 3, 2009 have been incorporated by reference herein in reliance upon the report of KPMG LLP, independent registered public accounting firm, incorporated by reference herein, and December 29, 2001 are derived from our auditedupon the authority of said firm as experts in accounting and auditing.
The audit report covering the January 3, 2009 consolidated financial statements included elsewhere in this prospectus. The consolidated statement of operations data for each ofcontains an explanatory paragraph that states that the fiscal years in the two-year period ended January 1, 2000 and the consolidated balance sheet data at December 30, 2000, January 1, 2000 and January 2, 1999 are derivedCompany's losses from our audited consolidated financial statements not included in this prospectus. Historical results are not necessarily indicative of future results.
The following selected consolidated financial data should be read in conjunction with our Consolidated Financial Statements and Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” included elsewhere in this prospectus.
Year | |||||||||||||||||||||
2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||
Consolidated Statements of Operations Data: | |||||||||||||||||||||
Net sales | $ | 335,795 | $ | 261,687 | $ | 270,077 | $ | 273,767 | $ | 246,269 | |||||||||||
Gross profit | 209,999 | 154,477 | 154,476 | 163,847 | 147,884 | ||||||||||||||||
Operating expenses: | |||||||||||||||||||||
Sales and marketing | 155,890 | 138,417 | 149,283 | 147,929 | 116,696 | ||||||||||||||||
General and administrative | 32,854 | 25,296 | 29,211 | 29,213 | 19,723 | ||||||||||||||||
Store closings and asset impairments | 233 | 1,366 | 1,952 | 1,498 | 20 | ||||||||||||||||
Operating income (loss)(1) | 21,022 | (10,602 | ) | (25,970 | ) | (14,793 | ) | 11,445 | |||||||||||||
Net income (loss) | 37,122 | (12,066 | ) | (37,214 | ) | (8,204 | ) | 5,195 | |||||||||||||
Net income (loss) per share: | |||||||||||||||||||||
Basic | $ | 1.51 | $ | (0.66 | ) | $ | (2.09 | ) | $ | (0.45 | ) | $ | 0.74 | ||||||||
Diluted | $ | 1.09 | $ | (0.66 | ) | $ | (2.09 | ) | $ | (0.45 | ) | $ | 0.19 | ||||||||
Pro forma(2) | $ | 0.37 | $ | (0.41 | ) | $ | (0.89 | ) | $ | (0.45 | ) | $ | 0.19 | ||||||||
Shares used in calculation of net income (loss) per share (2): | |||||||||||||||||||||
Basic | 24,549 | 18,157 | 17,848 | 18,300 | 4,114 | ||||||||||||||||
Diluted and pro forma(2) | 34,532 | 18,157 | 17,848 | 18,300 | 15,928 | ||||||||||||||||
Consolidated Balance Sheet Data: | |||||||||||||||||||||
Cash, cash equivalents and marketable securities | $ | 40,824 | $ | 16,375 | $ | 5,448 | $ | 27,570 | $ | 45,561 | |||||||||||
Working capital | 26,765 | (3,739 | ) | (12,431 | ) | 14,470 | 42,249 | ||||||||||||||
Total assets | 108,331 | 67,436 | 64,672 | 95,363 | 106,234 | ||||||||||||||||
Long-term debt, less current maturities | 2,991 | 17,109 | 2,322 | 36 | 29 | ||||||||||||||||
Total shareholders’ equity | 54,515 | 6,772 | 16,600 | 52,872 | 70,691 | ||||||||||||||||
Selected Operating Data: | |||||||||||||||||||||
Stores open at period end(3) | 322 | 328 | 333 | 341 | 264 | ||||||||||||||||
Stores opened during period | 15 | 11 | 19 | 79 | 65 | ||||||||||||||||
Stores closed during period | 21 | 16 | 27 | 2 | 1 | ||||||||||||||||
Average net sales per store (000’s)(4) | $ | 817 | $ | 626 | $ | 636 | $ | 644 | $ | 664 | |||||||||||
Percentage of stores with more than $1.0 million in net sales(4) | 24.1 | % | 9.8 | % | 11.8 | % | 12.6 | % | 12.6 | % | |||||||||||
Comparable store sales increase (decrease)(5) | 26.8 | % | (3.8 | )% | 0.2 | % | 4.7 | % | 23.5 | % | |||||||||||
Average square footage per store open during period(4) | 972 | 941 | 913 | 893 | 894 | ||||||||||||||||
Net sales per square foot(4) | $ | 841 | $ | 666 | $ | 697 | $ | 721 | $ | 743 | |||||||||||
Average store age (in months at period end) | 61 | 51 | 41 | 31 | 26 | ||||||||||||||||
EBITDA (000’s)(6) | $ | 30,449 | $ | 334 | $ | (15,628 | ) | $ | (6,600 | ) | $ | 16,816 |
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2002 | 2001 | 2000 | |||||||||||
GAAP diluted net income (loss) per share | $ | 1.09 | $ | (0.66 | ) | $ | (2.09 | ) | |||||
Effect of: | |||||||||||||
Income tax benefit (provision) at 38% of income before tax | (0.22 | ) | 0.25 | 0.55 | |||||||||
Charges from early repayment of debt | 0.02 | — | — | ||||||||||
(Restoration) write-off of deferred tax asset | (0.52 | ) | — | 0.65 | |||||||||
Pro forma diluted net income (loss) per share | $ | 0.37 | $ | (0.41 | ) | $ | (0.89 | ) | |||||
2002 | 2001 | 2000 | 1999 | 1998 | |||||||||||||||||
Operating income (loss) | $ | 21,022 | $ | (10,602 | ) | $ | (25,970 | ) | $ | (14,793 | ) | $ | 11,445 | ||||||||
Store closings and asset impairments | 233 | 1,366 | 1,952 | 1,498 | 20 | ||||||||||||||||
Depreciation and amortization | 9,194 | 9,570 | 8,390 | 6,695 | 5,351 | ||||||||||||||||
EBITDA | $ | 30,449 | $ | 334 | $ | (15,628 | ) | $ | (6,600 | ) | $ | 16,816 | |||||||||
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MANAGEMENT’S DISCUSSION AND ANALYSIS
Overview and Critical Accounting Policies
We are the leading developer, manufacturer and marketer of premium quality, adjustable-firmness beds. The air chamber technology of our proprietary Sleep Number bed allows adjustable firmness on each side of the mattress and provides a sleep surface that is clinically proven to provide better sleep quality and greater relief of back pain compared to traditional mattress products.
Our critical accounting policies relate to revenue recognition, accrued sales returns, accrued warranty costs and impairment of long-lived assets and long-lived assets to be disposed of by us. The effect of these policies on our financial statements is incorporated in the discussion below.
We generate revenue by selling our products through four complementary distribution channels. Three of these channels, retail, direct marketing and e-commerce, are company-controlled and sell directly to consumers. Our wholesale channel sells to leading home furnishings retailers, specialty bedding retailers and the QVC shopping channel.
Revenue recognition. We record revenue at the time product is shipped to the customer, except when beds are delivered and set up by our home delivery employees, in which case revenue is recorded at the time the bed is delivered and set up in the home.
Accrued sales returns. We reduce sales at the time revenue is recognized for estimated returns. This estimate is based on historical return rates, which are reasonably consistent from period to period. If actual returns vary from expected rates, revenue in future periods is adjusted, which could have a material adverse effect on future results of operations.
Channel sales. The proportion of our total net sales, by dollar volume, from each of our channels during the last three years is summarized as follows:
2002 | 2001 | 2000 | ||||||||||
Retail | 77% | 78% | 79% | |||||||||
Direct marketing | 14% | 15% | 18% | |||||||||
E-commerce | 4% | 3% | 3% | |||||||||
Wholesale | 5% | 4% | 0% |
The number of company-operated retail locations during the last three years is summarized as follows:
2002 | 2001 | 2000 | ||||||||||
Beginning of year | 328 | 333 | 341 | |||||||||
Opened | 15 | 11 | 19 | |||||||||
Closed | (21 | ) | (16 | ) | (27 | ) | ||||||
End of year | 322 | 328 | 333 | |||||||||
We anticipate opening 20 to 30 new retail stores and expect to close approximately five stores in 2003. Company-operated stores included leased departments within 13, 22 and 25 Bed, Bath & Beyond stores as of the end of 2002, 2001 and 2000, respectively.
Comparable store sales increased (decreased) by 26.8%, (3.8)% and 0.2% in 2002, 2001 and 2000, respectively. In 2002, total net sales and comparable store sales were positively affected by the increased investment in advertising and improved product mix that resulted from improvements in our product line, the design of our promotional programs and improvements in our selling process.
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Cost of sales includes costs associated with purchasing materials, manufacturing costs and delivering our products to our customers. In 2002, we elected to reclassify costs associated with the delivery of our products to customers from sales and marketing expenses to cost of sales. As a result of this change, cost of sales increased and sales and marketing expenses decreased. This change in classification does not affect operating income or net income.
Accrued warranty costs. Cost of sales also includes estimated costs to service warranty claims of customers. This estimate is based on historical claim rates during the warranty period. Because this estimate covers an extended period of time, a revision of estimated claim rates could result in a significant adjustment of estimated future costs of fulfilling warranty commitments. An increase in estimated claim rates could have a material adverse effect on future results of operations.
Our gross profit margin is dependent on a number of factors and may fluctuate from quarter to quarter. These factors include the mix of products sold, the level at which we offer promotional discounts to purchase our products, the cost of materials and manufacturing and the mix of sales between wholesale and company-controlled distribution channels. Sales directly to consumers through company-controlled channels generally generate higher gross margins than sales through our wholesale channels because we capture both the manufacturer’s and retailer’s margin.
Sales and marketing expenses include advertising and media production, other marketing and selling materials such as brochures, videos, customer mailings and in-store signage, sales compensation, store occupancy costs and customer service. In 2002, we elected to reclassify costs associated with the delivery of our products to customers from sales and marketing expenses to cost of sales. As a result of this change, cost of sales increased and sales and marketing expenses decreased. This change in classification does not affect operating income or net income. Store opening costs are expensed as incurred and advertising costs are expensed the first time the advertisement is aired.
Advertising expense was $39.5 million in 2002, $29.5 million in 2001 and $31.3 million in 2000. 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 our points of sale. We anticipate that full year advertising expenditures in 2003 will approximate $50 million.
General and administrative expenses include costs associated with management of functional areas, including information technology, investor relations, risk management and research and development. Costs include salary, bonus and benefits, information hardware, software and maintenance, office facilities, insurance and shareholder relations costs and other overhead.
Store closing and asset impairment expenses
We evaluate our long-lived assets, including leaseholds and fixtures in existing stores and stores expected to be remodeled, based on expected cash flows through the remainder of the lease term after considering the potential impact of planned operational improvements and marketing programs. Expected cash flows may not be realized, which could cause long-lived assets to become impaired in future periods and could have a material adverse effect on future results of operations. Store assets are written off when we believe these costs will not be recovered through future operations.
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Results of Operations
The following table sets forth, for the periods indicated, our results of operations expressed as percentages of net sales.
2002 | 2001 | 2000 | ||||||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost of sales | 37.5 | 41.0 | 42.8 | |||||||||||
Gross profit | 62.5 | 59.0 | 57.2 | |||||||||||
Operating expenses: | ||||||||||||||
Sales and marketing | 46.4 | 52.9 | 55.3 | |||||||||||
General and administrative | 9.8 | 9.7 | 10.8 | |||||||||||
Store closings and asset impairments | 0.1 | 0.5 | 0.7 | |||||||||||
Total operating expenses | 56.3 | 63.1 | 66.8 | |||||||||||
Operating income (loss) | 6.3 | (4.0 | ) | (9.6 | ) | |||||||||
Other income (expense), net | (0.4 | ) | (0.6 | ) | �� | 0.1 | ||||||||
Income (loss) before income taxes and extraordinary loss | 5.9 | (4.6 | ) | (9.5 | ) | |||||||||
Income tax (benefit) expense | (5.3 | ) | 0.0 | 4.3 | ||||||||||
Income (loss) before extraordinary loss | 11.2 | (4.6 | ) | (13.8 | ) | |||||||||
Extraordinary loss, net of tax | (0.1 | ) | 0.0 | 0.0 | ||||||||||
Net income (loss) | 11.1 | % | (4.6 | )% | (13.8 | )% | ||||||||
Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including increases or decreases in comparable store sales, the timing, amount and effectiveness of advertising expenditures, any changes in sales return rates or warranty experience, the timing of new store openings and related expenses, net sales contributed by new stores, competitive factors, any disruptions in supplies or third-party service providers and general economic conditions and consumer confidence. Furthermore, a substantial portion of net sales is often realized in the last month of a quarter, due in part to our promotional schedule and commission structure. As a result, we may be unable to adjust spending in a timely manner, and our business, financial condition and operating results may be significantly harmed. Our historical results of operations may not be indicative of the results that may be achieved for any future period.
Comparison of 2002 and 2001
Net sales in 2002 increased 28% to $335.8 million from $261.7 million in 2001 due to a 15% increase in mattress unit sales and higher average selling prices resulting primarily from improvements in product mix and lower return rates. The increase in net sales by sales channel was attributable to (i) a $54.9 million increase in sales from company-controlled retail stores, including an increase in comparable store sales of $52.9 million, (ii) a $7.9 million increase in direct marketing sales, (iii) a $5.9 million increase in sales from our wholesale channel and (iv) a $5.4 million increase in sales from our e-commerce channel.
Gross profit margin increased to 62.5% in 2002 from 59.0% in 2001 primarily due to improved product sales mix, savings in processing returned product, reduced product delivery costs, reduced warranty claim rates resulting from improved product quality and greater manufacturing leverage.
Sales and marketing expenses in 2002 increased 13% to $155.9 million from $138.4 million in 2001, but decreased as a percentage of net sales to 46.4% in 2002 from 52.9% in 2001. The $17.5 million increase was primarily due to
24
General and administrative (G&A) expenses increased 30% to $32.9 million in 2002 from $25.3 million in 2001. Of the increase, $5.9 million was due to additional incentive compensation costs resulting from our improved performance, with the remaining increase primarily resulting from an increased investment in information technology. We expect G&A growth rates to be lower in the future due to planned lower incentive compensation costs.
Store closing and asset impairment expenses in 2002 were $0.2 million compared to $1.4 million in 2001. In 2002, the entire amount represented impairments related to store closures. In 2001, the expenses included $1.0 million related to store closures and $0.4 million related primarily to the write-off of unusable fixtures for the merchandising of our sleeper sofa products.
Other expense decreased $0.2 million to approximately $1.3 million in 2002 from $1.5 million in 2001. The decrease was primarily due to an increase in interest income from our improved cash position, partially offset by increased interest expense associated with our senior secured debt. This debt was paid off in December 2002.
Income tax benefit was $17.8 million in 2002 as compared to zero in 2001. The $17.8 million income tax benefit for 2002 was the result of recording a non-recurring, non-operating, non-cash addition to earnings due to the expected realization of tax benefits from net operating loss carryforwards and other deferred tax assets. We expect to begin recording income tax expense at an estimated rate of 38% during 2003.
Comparison of 2001 and 2000
Net sales in 2001 decreased 3% to $261.7 million from $270.1 million in 2000 due primarily to a decrease in mattress unit sales and lower average selling prices. The average selling price per mattress set declined slightly as a result of lower selling prices for products sold to QVC and wholesale customers, slightly offset by higher average selling prices in our company-controlled distribution channels. The change in net sales was attributable to (i) an $8.5 million decrease in sales from company-controlled retail stores, including a decrease in comparable store sales of $7.7 million, (ii) an $8.6 million decrease in direct marketing sales, (iii) a $9.1 million increase in sales from our wholesale channel and (iv) a $0.1 million increase in sales from our e-commerce channel.
Gross profit margin in 2001 increased to 59.0% from 57.2% in 2000 primarily due to reduced warranty claim rates resulting from improved product quality, savings in processing returned product and improved product sales mix, partially offset by increased product delivery costs.
Sales and marketing expenses in 2001 decreased 7% to $138.4 million from $149.3 million in 2000 and decreased as a percentage of net sales to 52.9% in 2001 from 55.3% in 2000. The $10.9 million decrease in expenses and the decrease as a percentage of net sales were primarily due to reductions in promotional and fulfillment materials, reduced sales support staffing and lower retail occupancy costs, partially offset by increases in media production expense.
25
General and administrative expenses decreased 13% to $25.3 million in 2001 from $29.2 million in 2000. The $3.9 million decrease was primarily due to staffing reductions and reduced occupancy expense resulting from the consolidation of our two corporate offices.
Store closing and asset impairment expenses in 2001 were $1.4 million compared to $2.0 million in 2000. In 2001, the expenses included $1.0 million related to store closures and $0.4 million related primarily to the write-off of unusable fixtures for merchandising of our sleeper sofa products. In 2000, the expenses included $1.4 million related to the write-off of assets associated with the relocation of our headquarter offices, the write-off of web development costs and $0.6 million related to store closures.
Other expense changed $1.8 million to approximately $1.5 million in 2001 from $0.3 million of other income in 2000. The change was primarily due to $1.4 million of interest expense from long-term debt and lower interest income due to lower cash levels in 2001.
Income tax expense decreased $11.6 million to $0.0 million in 2001 from $11.6 million in 2000. Income tax expense decreased as a result of not recognizing an income tax benefit from operating losses in 2001 and from the write-off of $21.6 million of net deferred tax assets in 2000.
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Quarterly Results of Operations
The following table sets forth, by quarter, statement of operations and percentage of net sales data for the two most recent years. Sales are subjectinability to some seasonal influences, with lower sales in the second quarter and higher sales during the fourth quarter holiday season due primarily to increased mall traffic. Results of any period are not necessarily indicative of results for a full year (in thousands, except per share amounts).
2002 | 2001 | ||||||||||||||||||||||||||||||||
Quarter | Quarter | ||||||||||||||||||||||||||||||||
Dec. | Sept. | June | Mar. | Dec. | Sept. | June | Mar. | ||||||||||||||||||||||||||
Statement of Operations: | |||||||||||||||||||||||||||||||||
Net sales | $ | 92,263 | $ | 85,056 | $ | 77,281 | $ | 81,195 | $ | 69,341 | $ | 64,148 | $ | 62,742 | $ | 65,456 | |||||||||||||||||
Cost of sales | 34,584 | 30,915 | 29,340 | 30,957 | 26,965 | 25,434 | 26,800 | 28,011 | |||||||||||||||||||||||||
Gross profit | 57,679 | 54,141 | 47,941 | 50,238 | 42,376 | 38,714 | 35,942 | 37,445 | |||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||||
Sales and marketing | 40,309 | 39,199 | 36,774 | 39,608 | 32,815 | 32,806 | 33,022 | 39,774 | |||||||||||||||||||||||||
General and administrative | 8,534 | 9,085 | 8,026 | 7,209 | 7,044 | 5,285 | 5,954 | 7,013 | |||||||||||||||||||||||||
Store closings and asset impairments | — | 24 | 157 | 52 | 858 | 20 | 142 | 346 | |||||||||||||||||||||||||
Total operating expenses | 48,843 | 48,308 | 44,957 | 46,869 | 40,717 | 38,111 | 39,118 | 47,133 | |||||||||||||||||||||||||
Operating income (loss) | 8,836 | 5,833 | 2,984 | 3,369 | 1,659 | 603 | (3,176 | ) | (9,688 | ) | |||||||||||||||||||||||
Other income (expense), net | (268 | ) | (120 | ) | (421 | ) | (473 | ) | (709 | ) | (376 | ) | (354 | ) | (25 | ) | |||||||||||||||||
Income (loss) before income taxes and extraordinary loss | 8,568 | 5,713 | 2,563 | 2,896 | 950 | 227 | (3,530 | ) | (9,713 | ) | |||||||||||||||||||||||
Income tax benefit (expense) | (477 | ) | 17,891 | — | 348 | 115 | — | — | (115 | ) | |||||||||||||||||||||||
Income (loss) before extraordinary loss | 8,091 | 23,604 | 2,563 | 3,244 | 1,065 | 227 | (3,530 | ) | (9,828 | ) | |||||||||||||||||||||||
Extraordinary loss, net of tax | (380 | ) | — | — | — | — | — | — | — | ||||||||||||||||||||||||
Net income (loss) | $ | 7,711 | $ | 23,604 | $ | 2,563 | $ | 3,244 | $ | 1,065 | $ | 227 | $ | (3,530 | ) | $ | (9,828 | ) | |||||||||||||||
Net income (loss) per share: | |||||||||||||||||||||||||||||||||
Basic | $ | 0.25 | $ | 0.80 | $ | 0.13 | $ | 0.18 | $ | 0.06 | $ | 0.01 | $ | (0.19 | ) | $ | (0.54 | ) | |||||||||||||||
Diluted | $ | 0.21 | $ | 0.69 | $ | 0.08 | $ | 0.11 | $ | 0.04 | $ | 0.01 | $ | (0.19 | ) | $ | (0.54 | ) | |||||||||||||||
Pro forma | $ | 0.15 | $ | 0.10 | $ | 0.05 | $ | 0.06 | $ | 0.03 | $ | 0.01 | $ | (0.12 | ) | $ | (0.34 | ) | |||||||||||||||
Weighted average common shares: | |||||||||||||||||||||||||||||||||
Basic | 30,488 | 29,634 | 19,690 | 18,386 | 18,274 | 18,179 | 18,119 | 18,056 | |||||||||||||||||||||||||
Diluted and pro forma | 36,636 | 34,203 | 34,415 | 33,059 | 30,869 | 18,953 | 18,119 | 18,056 | |||||||||||||||||||||||||
Percentage of Net Sales: | |||||||||||||||||||||||||||||||||
Net sales | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | |||||||||||||||||
Cost of sales | 37.5 | 36.3 | 38.0 | 38.1 | 38.9 | 39.6 | 42.7 | 42.8 | |||||||||||||||||||||||||
Gross profit | 62.5 | 63.7 | 62.0 | 61.9 | 61.1 | 60.4 | 57.3 | 57.2 | |||||||||||||||||||||||||
Operating expenses: | |||||||||||||||||||||||||||||||||
Sales and marketing | 43.7 | 46.1 | 47.6 | 48.8 | 47.3 | 51.1 | 52.6 | 60.8 | |||||||||||||||||||||||||
General and administrative | 9.2 | 10.7 | 10.4 | 8.9 | 10.2 | 8.2 | 9.5 | 10.7 | |||||||||||||||||||||||||
Store closings and asset impairments | 0.0 | 0.0 | 0.2 | 0.1 | 1.2 | 0.0 | 0.2 | 0.5 | |||||||||||||||||||||||||
Total operating expenses | 52.9 | 56.8 | 58.2 | 57.8 | 58.7 | 59.4 | 62.3 | 72.0 | |||||||||||||||||||||||||
Operating income (loss) | 9.6 | 6.9 | 3.8 | 4.1 | 2.4 | 1.0 | (5.0 | ) | (14.8 | ) | |||||||||||||||||||||||
Other income (expense), net | (0.3 | ) | (0.1 | ) | (0.5 | ) | (0.6 | ) | (1.0 | ) | (0.6 | ) | (0.6 | ) | (0.0 | ) | |||||||||||||||||
Income (loss) before income taxes and extraordinary loss | 9.3 | 6.8 | 3.3 | 3.6 | 1.4 | 0.4 | (5.6 | ) | (14.8 | ) | |||||||||||||||||||||||
Income tax benefit (expense) | (0.5 | ) | 21.0 | 0.0 | 0.4 | 0.2 | 0.0 | 0.0 | (0.2 | ) | |||||||||||||||||||||||
Income (loss) before extraordinary loss | 8.8 | 27.8 | 3.3 | 4.0 | 1.5 | 0.4 | (5.6 | ) | (15.0 | ) | |||||||||||||||||||||||
Extraordinary loss, net of tax | (0.4 | ) | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | 0.0 | ||||||||||||||||||||||||
Net income (loss) | 8.4 | % | 27.8 | % | 3.3 | % | 4.0 | % | 1.5 | % | 0.4 | % | (5.6 | )% | (15.0 | )% | |||||||||||||||||
Pro forma diluted net income (loss) per share reflects the effects on net income from specific non-recurring items and from the recognition of an income tax benefit (provision) for years where a regular tax provision, at a rate of 38%, was not recorded. Generally accepted accounting principles (GAAP) did not allow us to reduce net income for income tax expense in 2002 or to provide an income tax benefit in 2001. Because we expect to record income tax in future
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2002 | 2001 | ||||||||||||||||||||||||||||||||
Quarter | Quarter | ||||||||||||||||||||||||||||||||
Dec. | Sept. | June | Mar. | Dec. | Sept. | June | Mar. | ||||||||||||||||||||||||||
GAAP diluted net income (loss) per share | $ | 0.21 | $ | 0.69 | $ | 0.08 | $ | 0.11 | $ | 0.04 | $ | 0.01 | $ | (0.19 | ) | $ | (0.54 | ) | |||||||||||||||
Effect of: | |||||||||||||||||||||||||||||||||
Income tax benefit (provision) at 38% of income before tax | $ | (0.08 | ) | $ | (0.07 | ) | $ | (0.03 | ) | $ | (0.05 | ) | $ | (0.01 | ) | $ | (0.00 | ) | $ | 0.07 | $ | 0.20 | |||||||||||
Charges from early repayment of debt | $ | 0.02 | — | — | — | — | — | — | — | ||||||||||||||||||||||||
(Restoration) of deferred tax asset | — | $ | (0.52 | ) | — | — | — | — | — | — | |||||||||||||||||||||||
Pro forma diluted net income (loss) per share | $ | 0.15 | $ | 0.10 | $ | 0.05 | $ | 0.06 | $ | 0.03 | $ | 0.01 | $ | (0.12 | ) | $ | (0.34 | ) | |||||||||||||||
Liquidity and Capital Resources
We generated cash from operations of $36.1 million in 2002 ($28.3 million of cash was generated after our $7.8 million investment in property and equipment). Historically, our primary source of capital has been from external sources, most recently from the completion of our $11.0 million convertible debt offering in June 2001 and our $5.0 million senior secured term debt financing in September 2001. The $11.0 million in convertible debt was converted to equity in the second quarter of 2002 and the $5.0 million of senior debt was prepaid in December 2002 with cash generated from operations. In February 2003, our board of directors approved an expanded share repurchase program of up to $12.5 million. We are currently pursuing a new bank revolving line of credit. While it is not currently anticipated that this line will be necessary for short- or long-term liquidity needs, the line would provide additional cash flexibility. Barring any unexpected significant external or internal developments, we expect current cash balances on hand and cash flow generated from operations to be sufficient to meet our short-term and long-term liquidity needs.
Net cash provided by (used in) operating activities in 2002, 2001 and 2000 was $36.1 million, $0.4 million and ($10.3) million, respectively. Net cash provided by operating activities in 2002 consisted primarily of net income adjusted for non-cash expenses and an increase in accrued compensation and benefits, partially offset by an increase in prepaid expenses. The increase in accrued compensation and benefits was due primarily to higher incentive compensation costs resulting from improved company performance, which were paid in early 2003. Prepaid expenses increased in 2002 primarily due to the timing of payments related to marketing and advertising expenditures.
Net cash provided by operating activities in 2001 consisted primarily of a decrease in inventories and prepaid expenses, partially offset by the net loss adjusted for non-cash expenses and a decrease in accounts payable and accrued sales returns. Inventory levels were reduced in 2001 as a result of two primary activities: (i) the closure of one of our manufacturing plants and (ii) a focus on reducing supplier lead-times, resulting in lower in-stock raw material levels required at our manufacturing plants. Prepaid expenses were reduced in 2001 as a result of lower prepaid advertising levels, consistent with the timing and form of media placements at the end of 2001 versus those in place at the end of 2000. The decrease in accounts payable in 2001 was due primarily to a decrease in the number of stores open at the end of 2001 and to extended payment terms being in place with some of our key suppliers at the end of 2000. The terms with those key suppliers had normalized at the end of 2001. The balance in our accrued sales returns in 2001 decreased as a result of the change in our sales return policy from 90 days at the end of 2000 to 30 days at the end of 2001. The shorter return period resulted in a smaller balance of sales that had not yet been returned at the end of 2001.
Net cash used in 2000 operating activities consisted primarily of the net loss adjusted for non-cash expenses and an increase in accounts receivable, partially offset by an increase in accounts payable. The increase in accounts
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Net cash provided by (used in) investing activities for 2002, 2001 and 2000 was ($21.5) million, ($0.9) million and $3.7 million, respectively. Investing activities consisted of purchases of property and equipment related to investment in information technology and the opening of new retail stores in all periods. In 2002, we made investments of $24.8 million in marketable securities and had $11.1 million of marketable securities mature. In 2001 and 2000, we liquidated $4.0 million and $16.2 million, respectively, of marketable securities to support our continuing operations. In 2003, we expect to open 20 to 30 new retail stores and to remodel approximately 100 stores. Our anticipated capital investment related to our new stores and remodeling is expected to be approximately $11.0 million. Total capital expenditures are expected to be approximately $18.0 million in 2003. We expect our new stores to be cash flow positive within the first 12 months of operation and, as a result, are not expected to have a significant negative effect on net cash provided by operations.
Net cash provided by (used in) financing activities for 2002, 2001 and 2000 was ($3.9) million, $15.4 million and $0.6 million, respectively. Net cash used in financing activities in 2002 resulted primarily from the repayment of our $5.0 million of senior secured debt. The total cash used in financing activities in 2002 was partially offset by cash received from the issuance of common stock related to the exercise of options and warrants. Net cash provided by financing activities in 2001 resulted from the issuance of common stock and from the financing of $11.0 million of convertible debt and $5.0 million of senior secured term debt. Fees and expenses of $1.0 million were netted against the proceeds from debt issuances. Net cash provided by financing activities in 2000 resulted from cash received from the issuance of common stock.
Our liquidity is impacted by minimum cash payment commitments resulting from long-term debt outstanding and operating leases. The table below outlines those minimum cash commitments, during the periods indicated (in thousands):
Payments Due By Period | ||||||||||||||||||||
<1 | 1 - 3 | 3 - 5 | >5 | |||||||||||||||||
Total | Year | Years | Years | Years | ||||||||||||||||
Long-term debt | $ | 4,011 | $ | 11 | $ | 4,000 | $ | — | $ | — | ||||||||||
Operating leases | 76,519 | 15,641 | 27,853 | 21,037 | 11,988 | |||||||||||||||
Total | $ | 80,530 | $ | 15,652 | $ | 31,853 | $ | 21,037 | $ | 11,988 | ||||||||||
In addition, we have secured a $1.0 million stand-by letter of credit with cash.
At December 28, 2002, we had net operating loss carryforwards for federal income tax purposes of approximately $20.9 million, of which $103,000 will expire between 2003 and 2006 and the remainder will expire between 2020 and 2021. We have recorded a valuation allowance of $641,000 for capital loss carryforwards that are not likely to be utilized within the applicable carryforward periods.
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BUSINESS
Our Business
We are the leading developer, manufacturer and marketer of premium quality, adjustable-firmness beds. The air chamber technology of our proprietary Sleep Number bed allows adjustable firmness on each side of the mattress and provides a sleep surface that is clinically proven to provide better sleep quality and greater relief of back pain in comparison to traditional mattress products.
Unlike traditional bedding manufacturers, we are vertically integrated from production through sales and customer service, which allows us to control quality, cost, price and presentation. We sell our innovative products through four distribution channels:
Most of our products are made-to-order and are sold directly to consumers through our company-controlled distribution channels: retail, direct marketing and e-commerce. Our consumer-driven and service-oriented business model enables us to understand and respond quickly to consumer trends and preferences. In addition, our business model allows us to maintain low levels of inventory and to generate an accelerated cash-conversion cycle, which enables us to operate with minimal or no working capital.
We believe that consumers are increasingly focused on sleep quality, along with nutrition and exercise, as an important component of overall health. The National Sleep Foundation reported in 2002 that 74% of American adults are experiencing a sleeping problem a few nights a week or more and 66% of adults believe that their sleep surface is very important to them, with 89% agreeing that a better quality mattress provides a better night’s sleep. Our target customers are primarily between the ages of 25 and 54 with household incomes in excess of $50,000 per year. Since our inception, we have sold approximately 1.5 million beds and have achieved high levels of customer satisfaction. From consumer inquiries and customers, we have compiled a database of approximately 8,600,000 profiles that can be used for marketing and research.
Following a change in executive management in 2000, we improved our cost structure and rebranded our products and advertising, which led to significantly enhanced operating results. From 2001 to 2002, our sales grew 28% to $335.8 million and comparable store sales grew 27%. We have improved our profitability from an operating loss of $26.0 million in 2000 to operating income of $21.0 million in 2002 and achieved net income in each of the last six quarters. In 2002, we generated $28.3 million in cash flow from operations after capital expenditures.
Our mission is to improve people’s lives through better sleep and our objective is to become the leading brand in the bedding industry. For the foreseeable future, we believe we can achieve 15% to 25% annual net sales growth and significantly improve our operating margins. In addition, we believe our efficient business model will generate sufficient cash flow to self-finance our growthmeet obligations and liquidity requirements.
Industry
The U.S. wholesale bedding industry is a mature and stable industry that has experienced a compounded annual revenue growth rate of approximately 6% over the past 10 years. We believe that growth in wholesale unit sales, which has been approximately 2% over this period, has been primarily duesustain operations raises substantial doubt about its ability to population growth, an increase in the number of homes, including secondary residences, and an increase in the number of beds per home. We believe growth in average wholesale prices, which has been approximately 4% over this period, was a result of a shift to larger and higher quality beds, which are typically more expensive. We believe this trend toward higher price points is caused by a demographic
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Domestic Wholesale Bedding Sales
Source: International Sleep Products Association
U.S. wholesale bedding sales were approximately $4.8 billion in 2002. According toFurniture/ Today, the four largest manufacturers, Sealy, Serta, Simmons and Spring Air, accounted for 60.5% of wholesale bedding sales in 2001.
U.S. retail bedding sales were approximately $7.6 billion in 2002, of which 85% consisted of traditional innerspring bedding. The retail bedding market is fragmented, with the top 10 retailers accounting for approximately 25% of total sales in 2001. Bedding is sold to consumers through a variety of channels. According to the International Sleep Products Association, in 2001, furniture stores accounted for 41% of U.S. bedding sales, down from 56% in 1993; specialty sleep stores 40%, up from 19% in 1993; and department stores 11%, at the same level as 1993, with factory-direct outlets, warehouse clubs and other retail outlets accounting for the balance.
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The following chart lists the largest U.S. bedding retailers, based on 2001 sales:
2001 Bedding Sales | ||||||||
Rank | Company | (in millions) | ||||||
1 | Select Comfort | $ | 242.1 | |||||
2 | Federated Department Stores | 235.0 | ||||||
3 | The Mattress Firm | 220.0 | ||||||
4 | The Mattress Discounters | 218.0 | ||||||
5 | Sam’s Club | 200.0 | ||||||
6 | Sleepy’s | 199.0 | ||||||
7 | Mattress Giant | 174.0 | ||||||
8 | May Department Stores | 130.0 | ||||||
9 | Berkshire Hathaway (furniture division) | 120.0 | ||||||
10 | Rooms to Go | 120.0 | ||||||
11 | JC Penney | 103.0 | ||||||
12 | Art Van | 100.0 | ||||||
13 | Rockaway Bedding | 94.0 | ||||||
14 | Dial-A-Mattress | 90.0 | ||||||
15 | Levitz Home Furnishings | 70.0 | ||||||
16 | The Sleep Train | 66.0 | ||||||
17 | Sleep Fair/ Mattress Warehouse | 63.0 | ||||||
18 | Sears | 60.0 | ||||||
19 | Havertys | 55.0 | ||||||
20 | Costco | 55.0 | ||||||
21 | Slumberland | 50.0 | ||||||
22 | Value City | 47.0 | ||||||
23 | Sit ‘n Sleep | 46.9 | ||||||
24 | Rhodes | 45.0 | ||||||
25 | W.S. Badcock | 42.0 |
Source:Furniture/ Today (August 2002)
Competitive Strengths
Our objective is to become the leading brand in the bedding industry, both in revenue share and product innovation. To achieve this goal, we intend to capitalize on the following strengths:
Our proprietary Sleep Number bed was designed on the basis of sleep research and is clinically proven to provide better sleep quality and greater relief of back pain in comparison to traditional mattress products. Unlike traditional mattresses made from innersprings, our innovative Sleep Number bed uses proprietary air-chamber technology that allows each side of the mattress to be easily adjusted on a hand-held remote control that digitally displays an individual’s Sleep Number. A Sleep Number is a number from zero to 100 that represents a sleeper’s ideal level of comfort, firmness and support. Our Sleep Number bed offers dual comfort control for couples, allowing either sleeper to adjust the mattress firmness on each side of the bed. Our research indicates that 9 of 10 couples sleep at different Sleep Number settings, making the dual comfort control feature a compelling differentiator from standard bedding offerings.
Clinical research has shown that people who sleep on a Sleep Number bed fall asleep faster and experience deeper sleep with fewer disturbances than those sleeping on a traditional innerspring mattress. The gentle and conforming support of the air chambers in our Sleep Number beds provides more proper spinal alignment and relief from uncomfortable pressure points that can cause tossing and turning and poor-quality sleep. The capability of our Sleep Number bed to address consumer sleep problems is further evidenced by the more than 25,000 testimonials we have received from our customers over the years.
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Our Sleep Number beds are priced competitively with other premium mattress products and are also more durable than traditional innerspring products, resulting in a stronger value proposition for the consumer. Because our Sleep Number bed does not depend on metal coils or springs for its support structure, it maintains its shape and support better over time than traditional innerspring mattresses. Independent durability testing has shown our Sleep Number bed to withstand more than 20 years of simulated use.
In January 2001, we successfully repositioned our product and advertising messages, creating the Sleep Number brand and a new multi-media advertising campaign to increase awareness of our innovative, proprietary beds. The brand message hierarchy of the Sleep Number campaign is clear and proprietary:
This branding strategy allowed our advertising and consumer communication to focus on our bed’s distinguishing and proprietary feature, personalized comfort, as represented by the digital Sleep Number readout on the bed’s hand-held remote control. In addition to rebranding our product in 2001, we broadened our demographic and media reach by targeting adults 25-54 years old with a message of improved sleep quality. The Sleep Number brand was launched through our first-ever prime-time television advertising campaign, which invited consumers to visit their local Select Comfort retail store to find their personal Sleep Number. By focusing on the unique Sleep Number setting of an individual, the campaign quickly conveys the concept of our bed’s comfort customization. The Sleep Number brand and positioning have been integrated into all of our sales channels and throughout our internal and external communication programs.
Although we have less than 5% unaided awareness nationally, average unaided awareness of our Sleep Number brand reached 15% by the end of 2002 in the eight markets where the Sleep Number campaign was launched beginning in early 2001. In these markets, we experienced annual comparable store sales growth in the range of 26% to 38% in 2002. Our Sleep Number campaign is now in a total of 20 markets.
Our Sleep Number campaign is efficient as well as effective. During 2002, while overall media investment rose 34% to nearly $40 million, marketing expensecontinue as a percent of net sales declined to 20% in 2002 from 22% in 2001 and 24% in 2000, before our Sleep Number advertising campaign was introduced.
Unlike traditional bedding manufacturers, which primarily sell through third-party retailers, we generate approximately 95% of our net sales through company-controlled distribution channels: retail, direct marketing and e-commerce. This distribution model enables us to control the selling process to ensure that the unique benefits of our product are effectively presented to consumers, to maintain direct contact with our customers and to capture both the manufacturer’s and retailer’s margin.
Our company-controlled distribution channels are staffed by high-quality, well-trained and passionate sales professionals who are Sleep Number bed owners. Our retail channel comprised 77% of our net sales in 2002. We operate 321 stores in 46 states, which allows consumers to easily experience our products and find their personal Sleep Number. Our direct marketing call center and our web site atselectcomfort.com provide national sales coverage, including markets not yet served by one of our retail stores. Our web site can be used as a product research tool, a place to purchase or as a means to locate our nearest retail store. Through these various channels, we maintain close contact with consumers, who provide us with important feedback for product improvement and innovation.
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Unlike traditional bedding manufacturers and retailers that are dependent on a stock of finished-goods inventory to fill orders, we employ a make-to-order manufacturing process. Through our long-term relationships with high-quality suppliers, which have been selected through a rigorous certification and review process, we have implemented a just-in-time materials supply system. This operating model enables us to maintain low levels of inventory and to generate an accelerated cash-conversion cycle, which allows us to operate with minimal or no working capital. In 2002, our manufacturing inventory turn was 20x. Our make-to-order manufacturing process allows us to introduce new or enhanced products without generating significant obsolete or clearance-priced finished-goods inventory. As a result of our flexible and modular production process, we estimate that we can double our current production volume in our existing manufacturing facilities with minimal capital investment.
Our efficient operating model extends from manufacturing to our stores with no regional warehousing. Our unique air chamber technology allows our beds to be packed in boxes and shipped via UPS or Fed Ex directly from our manufacturing plants to our customers, anywhere in the United States, which lowers our distribution costs. Consumers also appreciate the ease of handling and moving our bed, particularly through hallways and tight spaces.
Our stores serve as showrooms for our Sleep Number bed, without the need for any on-hand bed inventory. This low inventory model allows us to generate increased sales volume from existing retail floor space without a corresponding increase in working capital. In 2002, our retail inventory turn was 25x, and the average net sales per store was approximately $817,000 compared to approximately $626,000 in 2001.
Growth Strategy
We expect sales growth in the foreseeable future to be derived primarily from comparable store sales increases, opening stores in existing and new markets and adding new distribution channels. We expect to enhance our profit margin primarily by leveraging our existing infrastructure. To accomplish our growth strategy, we intend to focus on the following priorities:
Our most significant barrier to growth has been a lack of awareness of our innovative, high quality product among the broad consumer audience. With less than 5% unaided brand awareness nationally, we have significant opportunity for growth through increasing awareness of the Sleep Number brand, our innovative products and our store locations. Through long-established advertising and marketing programs, the most recognized bed brands have built national unaided awareness to 53% (Sealy), 33% (Serta) and 19% (Simmons).
Our Sleep Number campaign was introduced regionally in early 2001, and in 2002 received substantially more national advertising, particularly on national cable television, using a new infomercial and several direct-response advertisements to drive awareness of our Sleep Number bed. Our proven national radio campaign with Paul Harvey and Rush Limbaugh is being augmented by national television advertising with a new infomercial and several new direct response ads to build national awareness of our Sleep Number bed. As of January 2002, the Sleep Number Bed by Select Comfort became a national sponsor of National Public Radio’sPrairie Home Companion show hosted by Garrison Keillor. We believe increased national advertising in 2003 will further increase consumer brand awareness to profitably generate traffic and sales at our stores, call center and web site.
Our national campaign is augmented by regional advertising that continues to expand. We are currently in 20 markets that cover approximately 27% of the U.S. population and 46% of our current retail sales. This regional campaign includes a custom mix by market of prime-time and infomercial television, drive-time radio and newspaper advertisements. In 2002, we continued to drive strong sales growth in the eight markets where this campaign was launched in early 2001, with comparable store sales increases ranging from 33% to 63% in the fourth quarter of 2002. These markets are among our more mature and developed markets, reinforcing our belief that our brand awareness will continue to grow over time with additional advertising investment. We believe substantial opportunity exists in broadening the reach of this campaign into other metropolitan markets.
Due to our multi-channel and direct-to-consumer sales model, we are able to cost effectively implement an integrated multi-media advertising program, both on a national and local-market basis. Our fully integrated direct
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We plan to expand profitable distribution primarily by:
Comparable store sales growth will be comprised of both an increase in the number of units sold and an increase in the average revenue per transaction. This growth will be driven by increased advertising, improvements in our selling process, our enhanced, performance-based sales compensation plan and improved quality and training of our sales professionals. An increase in average revenue per transaction will be driven by continued product innovation in our higher-priced bed models and continued development of our accessory line. In addition, in 2003, we plan to remodel 100 of our older stores to a newer design with improved Sleep Number branding and product presentation. In order to expand our appeal to a broader consumer market, we are increasing the availability of our convenient home delivery and assembly services and extended financing offers.
Supported by our proven advertising strategy and store economics, we are in a position to add a program of profitable store expansion to our growth initiatives. We now have at least one Select Comfort retail store in 119 Designated Market Areas in the United States, which represent 85% of total U.S. household population. However, in many of those markets, including major cities such as Boston, Los Angeles and New York, we do not have a sufficient number of stores in relation to the size of the local population to allow us to realize an economic return on advertising. These understored markets are the focus of our store opening plans in 2003.
In the past two years, we have begun to develop our wholesale sales channel, providing consumers additional opportunities to become aware of and to purchase our Sleep Number bed. Our wholesale channel sells to a limited number of home furnishings retailers and specialty bedding retailers in selected markets and to consumers via the QVC shopping channel. This channel allows us to expand our points of sale more quickly and with lower capital expenditure by leveraging our brand building advertising.
Our goal is to continue to lead the industry in product innovation and sleep expertise by developing and marketing products that deliver personalized comfort and better sleep. We focus our research and development resources on enhancing performance of our core product line, improving quality and reducing costs. In 2002, we introduced more new products and product enhancements than in any other year of our history. We improved the appearance, function and sleep-surface comfort of every bed in our product line, which we expect to benefit from in 2003. Sales of the newly re-designed Sleep Number 5000 and 7000 models, our two higher-end product offerings, increased as a percentage of our product mix by eight percentage points in 2002 compared to 2001.
Our strategy is to maintain a pipeline of benefits-driven product innovation, introducing a new product or refreshing an existing model each quarter. Following a successful test market in the third quarter of 2002, we are currently in a national rollout of our Precision Comfort adjustable foundation product, which allows consumers to
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As a result of improving our cost structure in 2000 and 2001, we believe we are well-positioned to generate profitable growth. Over this period, we eliminated over $25 million from our cost structure and reduced the number of units we must sell in a year to become profitable by nearly 20%. While undertaking this cost reduction program, we have preserved our capacity to support growth, introduced a new media campaign and reinvigorated product development.
These successful cost-containment measures continue to allow us to leverage our fixed cost structure and realize improved operating margins through sales growth. Our goal is to generate sales growth of 15% to 25% annually, while containing general and administrative expense growth at less than half that rate and leveraging the fixed costs of our retail stores. We intend to maintain marketing and advertising investment at approximately 20% of net sales to build our brand and generate sales growth. We expect 2003 operating income margin to increase to at least 7% and believe we can achieve operating income margins of 10% to 12% within a three-year horizon.
Once we have more thoroughly penetrated the U.S. bedding market, our longer-term goal is to extend our brand through new product introductions, new market segments and international markets. For example:
History
We were founded in 1987 by an entrepreneur working in the innerspring mattress industry who believed adjustable air chamber technology provided better support and reduced pressure points in comparison with other bedding products. In the early 1990s, we began to market an air bed directly to consumers through traditional direct marketing and opened our own call center. We opened our first retail store in the Minneapolis area in 1992. Since then, we have grown to 321 retail stores in 46 states. We developed our third company-controlled distribution channel, e-commerce, in 1999. We added a wholesale distribution channel in late 2000.
From mid-1999 to mid-2001, we experienced operating losses. In 2000, we recruited William R. McLaughlin as our President and Chief Executive Officer. Mr. McLaughlin has been instrumental in planning and executing our improved operating and growth strategy. As part of this strategy, we implemented cost containment initiatives to return our company to profitability while preserving our capacity to support growth. In 2001, we launched our Sleep Number brand campaign to generate sales growth.
Our Products
We sell a proprietary line of beds under the Sleep Number brand that features an adjustable air chamber mattress. A Sleep Number is a number from zero to 100 representing an individual’s ideal level of comfort, firmness and support.
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We offer four different Sleep Number bed models. Each bed comes in standard mattress sizes, ranging from twin to king, as well as some specialty sizes. All Sleep Number beds feature high quality, vulcanized rubber air chambers that are highly durable. Because air is the primary support material of the mattress, Sleep Number beds do not lose their shape or support over time like traditional innerspring bedding.going concern. The dual chambers allow each side of the mattress to be independently adjusted with our Firmness Control System for personalized comfort and support. Our Firmness Control System features a compact air compressor with a handheld remote that is used to fill the bed’s air chamber and regulate its firmness. The Firmness Control System for our Sleep Number bed is certified by Underwriter’s Laboratories (UL).
The air chambers of a Sleep Number bed are surrounded on all sides by a high-density foam perimeter to provide strong edge support. For added comfort, we offer a plush pillowtop option with an extra cushion of support designed to cradle the body. All Sleep Number mattresses are enclosed by a comfortable, durable Belgian Damask covering. Our covers are sewn in our plants in the United States.
Our entry-level model, the Sleep Number 3000, is 7 1/2 inches in total mattress thickness for the traditional-style sleep surface and 9 inches for the European pillowtop style. It comes standard with our Firmness Control System, with two wired remote controls that allow touch-button firmness adjustment. An optional upgrade to the digital Sleep Number remote control is available.
Our Sleep Number 4000 is our first model to feature our fully gusseted pillowtop style and the Sleep Number Firmness Control System as standard. A single, wired remote control with digital display is used to set each side of the bed to each individual’s preferred Sleep Number. Our Sleep Number 4000 model has added sleep-surface cushioning and is 8 1/2 inches in total mattress thickness for the traditional style and 10 inches for the pillowtop style.
Our best-selling model is the Sleep Number 5000, which features more comfort padding and fiberfill loft, a higher-quality, satin-feel rayon Belgian Damask mattress fabric and our patent-pending Corner Lock system for crisp corner support. Our Sleep Number 5000 features the whisper-quiet Deluxe Sleep Number Firmness Control System, and comes with either one wireless or two wired digital remote controls for easy Sleep Number adjustment. Our Sleep Number 5000 is 10 inches in total mattress thickness for the traditional style and 12 1/2 inches for the pillowtop style.
Our top-of-the-line Sleep Number 7000 model incorporates the Deluxe Sleep Number Firmness Control System and the Corner Lock system is 14 inches in mattress thickness and is available exclusively as a Duvet-style pillowtop, covered in Belgian Damask fabric. Our Sleep Number 7000 features three layers of interior foam, including Hypersoft quilting foam and a 3-inch layer of our exclusive Intralux foam, for added comfort, support and resiliency.
Our current retail prices for our beds (excluding foundations) range as follows:
Sleep Number Model | Twin | Full/Double | Queen | King | ||||||||||||||
3000 | $300-560 | $500-650 | $500-700 | $700-900 | ||||||||||||||
4000 | $500-700 | $700-900 | $800-1,000 | $1,100-1,300 | ||||||||||||||
5000 | $700-1,000 | $950-1,150 | $1,100-1,300 | $1,400-1,600 | ||||||||||||||
7000 | $1,900 | N/A | $2,300 | $2,650 |
These prices are subject to promotional offerings that can result in pricing at 10% to 15% below these listed retail prices. We offer a slightly different series of Sleep Number bed models to our wholesale partners. We do not control the prices at which our wholesale partners sell our Sleep Number beds to their customers.
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The contouring and support of a Sleep Number mattress work best with our specially designed, proprietary foundation. Used in place of a box spring, this durable foundation is uniquely designed to complement the air chambers and maintain a consistent support surface for the life of the bed. Our foundation is designed with interlocking panels for maximum structural integrity, as well as high-density polymer side panels and lateral support beams for additional support. Unlike traditional box springs, our foundation can be disassembled and easily moved through hallways, tight spaces and up and down stairs. Through certain wholesale partners, we offer a wood foundation. The current retail prices of our foundations range from $200 to $550, depending upon the size of the bed.
We recently introduced our Precision Comfort adjustable foundation, which allows consumers to adjust their bed position at both the head and feet using a handheld remote . We believe consumers will appreciate the adjustable foundation’s comfort benefits, flexibility, therapeutic rest and pressure relief. The current retail prices of our adjustable foundations range from $1,200 to $2,400, depending upon the size of the bed.
In addition to our mattresses and foundations, we offer a line of accessory bedding products, including specialty pillows, mattress pads, comforters, sheets and bed frames. The specialty pillows, which come in a variety of sizes, materials and firmness, are designed to provide personalized comfort and better quality sleep. We recently introduced a number of new accessories, including our Imperial Mattress Pad, a luxury mattress pad filled with down resilient fiber; our Dual-Weight Merino wool blanket, exclusively made for us by Faribault Woolen Mills; and our Dual-Control Heated Mattress Pad, with 21 temperature settings that allow each sleeper to customize personal warmth levels.
Our unique product design allows us to ship our beds in a modular format to customers throughout the United States by UPS or FedEx. We regularly review our package sizes to take advantage of more favorable shipping rates. Informational product brochures and easy-to-follow assembly instructions accompany each Sleep Number bed, which can be quickly and easily assembled by the customer through a simple, tool-free process. For an additional fee between $75 and $100, the customer can take advantage of our home delivery, assembly and mattress removal services. At the end of 2002, these services were available through approximately 80% of our retail stores, in certain markets by a third-party provider. We plan ultimately to offer this service in all of the markets served by our stores. Delivery typically takes between 10 and 14 days from the date of order.
Each of our Sleep Number beds comes with our 30 Night In-Home Trial and Better Night’s Sleep guarantee which allows consumers 30 nights at home to make sure they are 100% comfortable with our bed. If the consumer is not completely satisfied, we will authorize the return of the bed and a refund. The consumer is responsible for the return shipping costs. Each of our Sleep Number beds is backed by a 20-year Limited Warranty. We believe that due to our unique design and craftsmanship, our Sleep Number bed is built to last 20 years or more.
Our Distribution Channels
We generate revenue by selling our products through four complementary distribution channels. Three of these channels, retail, direct marketing and e-commerce, are company-controlled and sell directly to consumers. We also sell through a wholesale channel to leading home furnishings retailers, specialty bedding retailers and the QVC shopping channel. Our wholesale strategy is to expand our points of sale more quickly in selected markets with lower capital expenditures than opening new retail stores. In addition, our wholesale strategy allows us to leverage our advertising and increase brand awareness in large markets where it would otherwise not be cost effective for us to spend advertising dollars.
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Our retail stores accounted for 77% of our net sales in 2002 and 78% of our net sales in 2001. We currently operate 321 stores in 46 states, including 13 leased departments within other retail stores. Our stores are principally mall-based showrooms, averaging approximately 1,000 square feet and displaying four models of our Sleep Number beds and a full selection of our branded accessories. Our store design incorporates a bedroom-like setting intended to convey a sense of sophistication and quality that reinforces our Sleep Number brand name as synonymous with sleep solutions. We intend to remodel approximately 100 of our older stores in 2003 to the current design standard. 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 Sleep Number beds and accessories, the overall importance of sleep quality and our newly developed, standardized selling process.
Many consumers’ initial exposure to our Sleep Number bed is through our direct marketing operations. Interested consumers respond to our print, radio and cable television advertisements by calling our toll-free number. Our direct marketing sales professionals capture information from the consumer, begin the consumer education process, take the order, or, if appropriate, send an information packet. Our direct marketing operations also include a database marketing department that is responsible for segmentation and analysis of our database to direct the mailing of product and promotional information in response to inquiries. We maintain a database of approximately 8,600,000 inquiries, including customers. In 2001, we established a “Factory Direct” outlet through our direct marketing channel, allowing us to selectively market returned products that we have refurbished where allowed by law and to sell discontinued models.
Our web site atselectcomfort.com provides consumers with a wide array of useful information as well as the convenience of ordering our products online or calling and ordering from one of our internet-dedicated sales professionals. 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 science and research, our products and the benefits they provide. Our web site also directs consumers to our store locations and provides other means to contact us. Our e-commerce department has also focused on developing relationships with online shopping malls and other sales portals. Our web site incorporates a look and feel that is attractive and professional and reinforces the Select Comfort and Sleep Number brand images. Consumers can access our web site through two other sites,sleepnumber.com andbeds.com.
We are selectively building wholesale relationships with home furnishings retailers and specialty bedding retailers. These wholesale relationships increase our points of sale with lower capital requirements and we believe will allow us to leverage our advertising spending in key markets. Since September 2000, we have tested wholesale distribution through home furnishings retailers. Since July 2002, our Sleep Number bed has been featured in 40 Sleep Train stores in California. Sleep Train is the first large scale, multi-store specialty bedding retailer to offer our Sleep Number bed outside of our company-controlled stores. In August 2002, we began to sell our Sleep Number bed through Sleep America, a 19-store specialty retailer in the Phoenix and Tucson markets. We plan to selectively pursue additional distribution through other wholesale partners.
Since October 2000, we have successfully offered our products through periodic segments on the QVC shopping channel. Our Sleep Number bed was named QVC’sHome Innovation Product Concept of the Year at QVC’s 2001 QStar Awards. We believe that our distribution through QVC has increased overall consumer awareness of our Sleep Number brand in addition to providing us with an important sales outlet.
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Store Operations
Average net sales per store were approximately $817,000 in 2002 and $626,000 in 2001, with average sales per square foot of approximately $840 in 2002 and $670 in 2001. For 2001, our sales per square foot were the fourth highest among all bedding and furniture retailers according to a May 2002Furniture/ Today survey. New stores opened in 2002 are expected to average approximately $800,000 of net sales in the first year of operations. Approximately 24% of our stores generated sales of over $1.0 million in 2002.
Our investment to open a new store is approximately $140,000, including inventory. We target new stores to be cash flow positive within 12 months with a payback of the initial cash investment in less than 24 months. Our stores breakeven on a four-wall cash flow basis with approximately $525,000 of net sales. Our four-wall cash flow is calculated as gross profit generated from store sales less store expenses and advertising, without deduction of depreciation expenses. We plan to open 20 to 30 new retail stores in 2003 primarily to fill out existing markets in order to leverage brand awareness and advertising.
We cluster retail stores within a metropolitan market in order to leverage our advertising. In selecting new store sites, we generally seek high-traffic locations of approximately 800 to 1,200 square feet within malls in metropolitan areas. We conduct extensive analyses of potential store sites and base our selection on a number of factors, including the location within the mall, the 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 store density of existing stores and our marketing and advertising plans in the respective markets. We intend to test store locations in select strip centers and lifestyle-oriented shopping centers in 2003.
Our stores are currently organized into four regional areas and 34 districts, with seven to 12 stores in each district, depending on geographical dispersion. Each regional sales director oversees eight or nine districts. Each district has a district sales manager who is responsible for sales and operations and reports to the regional sales director. The district sales managers frequently visit stores to review merchandise presentation, sales force product knowledge, financial performance and compliance with operating standards. The typical staff of one of our new stores consists of one store manager and two full-time sales professionals. Store staffing expands as store sales volume grows. Our sales professionals devote substantially all of their efforts to sales and customer service, which includes helping customers and responding to inquiries.
All store personnel receive comprehensive on-site training on our technology and sleep expertise, the features and benefits of our 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 and bonuses based on individual and their store’s performance. Early in 2002, we introduced a redesigned retail sales professional compensation program that is more focused on individual performance and more heavily commission driven, which we believe will enable us to attract and retain quality, sales-oriented store professionals. Regional sales directors, district sales managers and store managers are eligible to receive, in addition to their base compensation, bonuses for the achievement of performance objectives.
Marketing and Advertising
Lack of awareness among the broad consumer audience of our brand, product benefits and store locations historically has been our most significant barrier to growth. The new Sleep Number advertising campaign was introduced early in 2001 to support our retail stores in selected markets through our first comprehensive multi-media
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In the direct marketing channel, our advertising message is communicated through targeted print and radio advertisements, use of infomercials and short-form direct TV advertising and through product brochures, videos and other product and promotional materials mailed in response to consumer inquiries. The direct marketing channel has relied heavily on our advertising through nationally syndicated radio personalities, such as Paul Harvey and Rush Limbaugh, and print and direct mail programs. We are continuing to increase our advertising investment on national cable TV, predominantly purchased at advantageous direct response media rates. This provides a base of awareness upon which local retail store advertising cumulatively builds. Our direct marketing operations continually monitor the effectiveness and efficiency of our advertising by tracking the cost per inquiry and cost per order of our advertising.
The Sleep Number positioning was integrated into our marketing messages across all of our distribution channels during 2001. To support our direct marketing channel, a new 30-minute infomercial, a pool of two-minute short-form television spots and new print advertisements were created around the Sleep Number positioning. Likewise, the messaging on our web site, in promotional material and on QVC broadcasts was successfully transitioned to focus on our Sleep Number bed. We have increased our 1-800 advertising on national cable TV as an economical means of increasing national brand awareness for our Sleep Number bed. Through our dedicated call center, we are able to provide the inquiring consumer more information or send a video and brochure. Although total media expenditure is planned to increase by 25% to approximately $50 million in 2003, we have significant opportunity to increase effective investment in the future, with the proven result of driving incremental awareness, traffic and purchases.
All owners of our beds are members of our Comfort Club, our customer loyalty program designed primarily to reward our owners for recommending our beds. Each time a customer purchases a bed, the referring member receives a $50 coupon for purchase of our products, with increasing benefits for multiple referrals. In 2002, approximately 23,000 beds were sold through referrals from our Comfort Club members.
Operations
We have two manufacturing plants, one located in Columbia, South Carolina, and the other in Salt Lake City, Utah. The manufacturing operations in South Carolina and Utah consist of quilting and sewing of the fabric covers for our beds and final assembly and packaging of mattresses and foundations from contract manufactured components. In addition, our electrical Firmness Control System is assembled from contract manufactured components in our Salt Lake City plant. In April 2001, we discontinued manufacturing in our Minneapolis location and have since used this facility to process returns and warranty claims.
We manufacture beds to fulfill orders rather than stocking inventory, which enables us to maintain lower levels of finished goods inventory and operate with no regional warehousing. Orders are currently shipped from our manufacturing facilities, primarily via UPS, typically within 48 hours following order receipt, and are usually received by the customer within 5 to 10 business days after shipment. We are continually evaluating alternative carriers on a national and regional basis, as well as expanding our in-home assembly services in selected markets.
We currently obtain all of the materials and components used to produce our beds from outside sources. Components for the Firmness Control System 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. Components for our foundations are obtained from one domestic source.
Our proprietary air chambers are produced to our specifications by one Eastern European supplier, which has been our sole source of supply of air chambers since 1994. Under our agreement with this supplier, we are obligated to
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Our proprietary foundations are produced to our specifications by one domestic supplier under an agreement that expires in October 2003. This agreement is subject to automatic annual renewal unless either party gives 180 days’ notice of its intention not to renew the agreement. We expect to continue this supplier relationship for the foreseeable future.
All of the suppliers that produce unique or proprietary products for us have in place either contingency or disaster recovery plans or redundant production capabilities in other locations in order to safeguard against any unforeseen disasters. We review these plans and sites on a regular basis to ensure the supplier’s ability to maintain uninterrupted supply of materials and components.
Our research and development department continuously seeks to improve current product performance and benefits based on sleep science. 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 bed, we have continued to improve and expand our product line, including a quieter Firmness Control System, remote controls 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 $0.9 million in 2002, $1.1 million in 2001 and $0.9 million in 2000.
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. Our customer service department also makes outbound calls to new customers during our in-home trial phase to provide solutions to possible problems in order to enhance customer education, build customer satisfaction and reduce returns.
Through a private label consumer credit facility provided by Mill Creek Bank, a subsidiary of Conseco Finance Corp., our qualified customers are offered a revolving credit arrangement to finance purchases from us. Mill Creek Bank sets the minimum acceptable credit ratings, the interest 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, Mill Creek Bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts.
Mill Creek Bank’s right to set the minimum customer credit ratings could, if exercised, impact sales by affecting the number of customers who can finance purchases. The term of this facility expires in May 2004, subject to automatic one-year renewals, unless terminated by either party upon 150 days’ notice prior to the end of the then-current term. We are liable to Mill Creek Bank for chargebacks arising out of (i) breach of our warranties relating to the underlying sale transaction, (ii) defective products or (iii) our failure to comply with applicable operating procedures under the facility. We have provided a standby letter of credit to Mill Creek Bank in the amount of $1.0 million to protect Mill Creek Bank against potential losses from unpaid chargebacks. We are not liable to Mill Creek Bank for credit losses arising out of our customers’ credit defaults. If we replace Mill Creek Bank with an alternative third-party provider of consumer financing, Mill Creek Bank could request that we purchase its portfolio of our customer accounts based on a pre-determined formula, which reflects a discount to the face amount of these accounts. If we were to engage a replacement provider, we would likely require this new provider to purchase the portfolio from Mill Creek Bank, relieving us of our obligations under this facility.
Conseco Finance Corp., the parent corporation of Mill Creek Bank, has recently experienced financial and liquidity issues and has filed for protection under federal bankruptcy laws. Through its pending bankruptcy proceedings, Conseco
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Competition
The bedding industry is highly competitive. Participants in the bedding 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 beds compete with a number of different types of bedding alternatives, including innerspring bedding, foam bedding, waterbeds, futons and other air-supported bedding that are sold through a variety of channels, including home furnishing stores, specialty bedding stores, department stores, mass merchants, wholesale clubs, telemarketing programs, television infomercials and catalogs. We believe that our success depends in part on increasing consumer awareness and acceptance of our existing products and the continuing introduction of product improvements or new products with features or benefits that differentiate our products from those offered by other manufacturers.
Innerspring bedding sales represent approximately 85% of all bedding sales. The traditional bedding industry is characterized by a high degree of concentration among the four largest manufacturers of innerspring bedding with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand name, Serta, Simmons and Spring Air. Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the bedding market.
Facilities
We currently lease all of our existing retail store locations and expect that our policy of leasing, rather than owning stores, will continue as we expand our store base. Our store leases generally provide for an initial lease term of 7 to 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.
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The following table provides information regarding the 321 stores we currently operate in the following 46 states:
We lease approximately 122,000 square feet in Minneapolis that includes our corporate headquarters, our direct marketing call center, our customer service group, our research and development department and a distribution center that accepts returns and processes warranty claims. This lease expires in 2004 and contains two five-year renewal options. We have subleased 20,000 square feet of our Minneapolis facility through March 2003. We also lease two additional manufacturing and distribution centers in Columbia, South Carolina and Salt Lake City, Utah of approximately 105,000 square feet and approximately 101,000 square feet, respectively. We lease the Columbia facility through February 2008, with a five-year renewal option thereafter, and the Salt Lake City facility through April 2009. We lease another 16,100 square feet of office space in the Minneapolis area through April 2004, which we have vacated, and a portion of which we have subleased to a third party.
Intellectual Property
We hold various U.S. and foreign patents and patent applications regarding certain elements of the design and function of our products, including air control systems, remote control systems, air chamber features, border wall and corner piece systems, foundation systems and features related to sofa sleepers with air mattresses, as well as other technology. We have 22 issued U.S. patents, expiring at various points between January 2005 and March 2020, and four U.S. patent applications pending. We also hold 16 foreign patents and 14 foreign patent applications pending. Notwithstanding these patents and patent applications, we cannot assure you that these patent rights will provide substantial protection or that others will not be able to develop products that are similar to or competitive with our products. To our knowledge, no third party has asserted a claim against us alleging that any element of our product infringes or otherwise violates any intellectual property rights of any third party.
“Select Comfort” and“Sleep Number” are trademarks registered with the U.S. Patent and Trademark Office. Applications for our new“Select Comfort” logos with the double arrow design have been approved for registration and published for opposition. We have a number of other registered marks, including“The Sleep Number Bed by Select
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Governmental Regulation
Our operations are subject to state and local consumer protection and other regulations relating to the bedding industry. These regulations vary among the states in which we do business. The regulations generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling and sale and penalties for violations.
Our direct marketing operations are or may become subject to various adopted or proposed federal and state “do not call” list requirements. The Federal Trade Commission has amended its rules to provide for a national “do not call” registry. Under these new federal regulations, consumers may begin to have their phone numbers added to the national “do not call” registry beginning in July 2003. In September 2003, telemarketers will have access to the registry and will be required to scrub their call lists against the national “do not call” registry at least once every 90 days. A telemarketer may call a consumer with whom it has an established business relationship for up to 18 months after the consumer’s last purchase, delivery or payment even if the consumer’s name is on the national “do not call” registry. A company may also call a consumer for up to three months after the consumer makes an inquiry or submits an application to the company. In addition, if a consumer asks a company not to call, the company may not call even if there is an established business relationship.
The federal Consumer Product Safety Commission and various state regulatory agencies are considering new rules relating to fire retardancy standards for the bedding industry. The State of California plans to adopt, effective in the year 2004, new fire retardancy standards that have not yet been finally defined. If adopted, such new rules may adversely affect our costs, manufacturing processes and materials. We are developing product solutions that are intended to enable us to meet the new standards. Because the new standards have not been finally determined, however, no assurance can be given that our solutions will enable us to meet the new standards. We expect that any required product modifications will add cost to our product.
A portion of our net sales consists of refurbished products that are assembled in part from components returned to us from customers. These refurbished products must be properly labeled and marketed as refurbished products under applicable state laws. Our sales of refurbished products are limited to approximately 24 states, as the balance of the states do not allow the sale of refurbished bedding products.
We believe we are in substantial compliance with each of these governmental regulations.
Information Systems
We use technology to support our business and reduce operating costs, enhance our customer experience and provide information to manage our business. We use technology platforms from market leaders such as Oracle, Microsoft, Dell, Sun and Cisco to run both packaged applications and internally developed systems. We have purchased upgraded replacements for the majority of our technology infrastructure over the past several years as equipment has come off of lease.
Our major systems include an in-store point of sale (POS), a retail portal system, direct marketing and customer service in-bound/out-bound telemarketing systems, e-commerce systems, retail partners support systems and Oracle ERP systems. Our in-store retail systems include one or two POS systems in each store, based on sales volume. The POS terminals are connected via a secured Internet connection back to our enterprise systems. That same communication connection is used to provide the stores with access to store productivity and reporting systems via our retail portal. The retail, direct marketing, customer service, e-commerce and retail partner applications are interfaced together to provide a fully integrated view of our customer and their activities across sales channels. Our Oracle based ERP applications include modules in support of our finance, human resources and manufacturing operations. We are currently upgrading our Oracle applications to the 11i version to provide significantly more flexibility, functionality and productivity cost savings.
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We use a combination of primarily internal employees, supplemented by consultants and contractors, to deliver and maintain our technology systems and assets. Outsourcing is occasionally used for cost effectiveness or strategic reasons. We have a tested disaster recovery plan in place.
Employees
At December 28, 2002, we employed 1,805 persons, including 1,046 retail store employees, 54 direct marketing sales employees, 66 customer service employees, 273 manufacturing employees, 181 home delivery employees and 185 management and administrative employees. Approximately 164 of our employees were employed on a part-time basis at December 28, 2002. 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 is represented by a labor union or covered by a collective bargaining agreement. We believe that our relations with our employees are good.
Legal Proceedings
In June 1999, we and certain of our former officers and directors were named as defendants in a class action lawsuit filed in U.S. District Court in Minnesota. The suit, filed on behalf of purchasers of our common stock between December 4, 1998 and June 7, 1999, alleges that we and the named former directors and officers failed to disclose or misrepresented certain information concerning our company in violation of federal securities laws. We believe that the suit is without merit and have vigorously defended the matter.
We have consented to a settlement of this litigation negotiated by our insurance carrier. The settlement is covered by insurance and involves no cash or other payment obligation by us, and no admission of liability or wrongdoing by us. The settlement will not have any impact on our results of operations or financial condition. On February 28, 2003, the settlement agreement received final approval from the U.S. District Court for the District of Minnesota.
We are involved in other various claims, legal actions, sales tax disputes and other complaints arising in the ordinary course of business. In the opinion of management, any losses that may occur from these other matters are adequately covered by insurance or are provided for in our consolidated financial statements and financial statement schedule do not include any adjustments that might result from the ultimate outcome of thesethat uncertainty.
COMMISSION POSITION ON INDEMNIFICATION FOR SECURITIES ACT LIABILITIES
Insofar as indemnification for liabilities arising under the Securities Act may be permitted to our directors, officers and controlling persons pursuant to the provisions of our articles of incorporation, or otherwise, we have been informed that in the opinion of the SEC such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable.
WHERE YOU CAN FIND MORE INFORMATION
We are subject to the reporting requirements of the Exchange Act and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other matters will not haveinformation with the SEC. Copies of our reports, proxy statements and other information can be read and copied at:
SEC Public Reference Room
100 F Street NE
Washington, D.C. 20549
Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a material effectWeb site that contains reports, proxy statements and other
information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC's home page athttp://www.sec.gov.
Our corporate Internet Web site ishttp://www.selectcomfort.com. Through a link to a third-party content provider, our corporate Web site provides free access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after electronic filing with the SEC. These documents are posted on our consolidated financial positionWeb site athttp://www.selectcomfort.com—select the "About Select Comfort" link and then the "SEC Filings" link. The information contained on our Web site or resultsconnected to our Web site is not incorporated by reference into this prospectus and should not be considered part of operations.
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MANAGEMENT
Executive Officers and Directors
Our executive officers and directors are as follows:
Sleep | ||||||||||
Name | Age | Number | Position | |||||||
William R. McLaughlin | 46 | 55 | Director, President and Chief Executive Officer | |||||||
Keith C. Spurgeon | 48 | 90 | Senior Vice President, Sales | |||||||
Noel F. Schenker | 49 | 35 | Senior Vice President, Marketing and New Business Development | |||||||
Gregory T. Kliner | 65 | 35 | Senior Vice President, Operations | |||||||
James C. Raabe | 42 | 25 | Senior Vice President and Chief Financial Officer | |||||||
Mark A. Kimball | 44 | 35 | Senior Vice President, Human Resources and Legal, General Counsel and Secretary | |||||||
Michael J. Thyken | 41 | 45 | Senior Vice President and Chief Information Officer | |||||||
Tracey T. Breazeale | 36 | 25 | Senior Vice President, Special Projects | |||||||
Patrick A. Hopf(1) | 53 | 35 | Chairman of the Board | |||||||
Thomas J. Albani(2) | 60 | 90 | Director | |||||||
Christopher P. Kirchen(3) | 60 | 35 | Director | |||||||
David T. Kollat(2) | 64 | 40 | Director | |||||||
Michael A. Peel(2) | 53 | 45 | Director | |||||||
Trudy A. Rautio(3) | 50 | 45 | Director | |||||||
Ervin R. Shames(2)(1) | 62 | 35 | Director | |||||||
Jean-Michel Valette(3) | 42 | 35 | Director |
William R. McLaughlin joined our company 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, Inc., a snack food company and subsidiary of PepsiCo, Inc., 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, S.A. de C.V., a cookie and flour company based in Mexico.this prospectus.
Keith C. Spurgeon joinedWe also make available, free of charge on our company as Senior Vice President, Sales in February 2002. From September 2000 to February 2002, Mr. Spurgeon served as an independent business consultant. From 1996 to September 2000, he was ChairmanWeb site, the charters of the Board and Chief Executive Officer of Zany Brainy, Inc., a retailer of educational toys and books for children. Zany Brainy filed for Chapter 11 bankruptcy protection in May 2001. He served as Vice President-Asia/ Australia at Toys “R” Us, Inc. from 1991 to 1996 after holding various management positions from 1986 to 1991. Mr. Spurgeon began his career at Jewel Food Stores.
Noel F. Schenker joined our company as Senior Vice President, Marketing and New Business Development in November 2000. Ms. Schenker served as Senior Vice President of Marketing and Strategic Planning at Rollerblade, Inc., a sporting goods company, from 1992 to 1996, and as an independent consultant from 1996 to 2000. She was with The Pillsbury Company from 1981 to 1992, serving as Vice President of Marketing for the Green Giant business.
Gregory T. Kliner joined our company as Senior Vice President, Operations in 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, snow removal products and irrigation systems.
James C. Raabe has served as Senior Vice President and Chief Financial Officer since April 1999. From September 1997 to April 1999, Mr. Raabe served as our Controller. From May 1992 to September 1997, he served as
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Mark A. Kimball has served as Senior Vice President, Human Resources and Legal, General Counsel and Secretary since July 2000. From May 1999 to July 2000, Mr. Kimball served as our Senior Vice President, Chief Administrative Officer, General Counsel and Secretary. For more than five years prior to joining us, Mr. Kimball was a partner in the law firm of Oppenheimer Wolff & Donnelly LLP practicing in the area of corporate finance.
Michael J. Thyken has served as Senior Vice President and Chief Information Officer since July 2001. From July 2000 to July 2001, Mr. Thyken served as Vice President and Chief Information Officer. During 1999, he was Group Director of Application Development at Jostens, a manufacturer of scholastic recognition products. From 1994 to 1999, Mr. Thyken was Director of Technical Services for Target Stores, then a division of Dayton Hudson Corporation, a department store retailer. From 1984 to 1994, Mr. Thyken served in various positions with IBM Corporation.
Tracey T. Breazeale has served as Senior Vice President, Special Projects since February 2001. From July 1999 to February 2001, Ms. Breazeale served as our Senior Vice President of Strategic Planning and Branding. In February 2001, Ms. Breazeale’s work schedule was reduced to 25% of full time and her title was changed to Senior Vice President, Special Projects. She 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 Ms. Breazeale specialized in strategic and marketing oriented projects for retail and consumer product companies.
Patrick A. Hopf has served as Chairman of the Board of Directors since April 1999 and has served as a member of our board of directors since December 1991. Mr. Hopf also served as our Chairman of the Board of Directors from August 1993 to April 1996. Since April 2002, Mr. Hopf has been the President of Symmetry Growth Capital LLC, a venture capital firm. From August 1988 to February 2002, he was President of St. Paul Venture Capital, Inc., a venture capital firm, and from February 2002 to December 2002, he was Executive Vice President of St. Paul Venture Capital, Inc. From August 1988 to January 1999, Mr. Hopf served as Vice President of St. Paul Fire and Marine Insurance Company. Mr. Hopf also serves as a director of a number of privately held companies.
Thomas J. Albani has served as a member of our board of directors since February 1994. Mr. Albani served as President and Chief Executive Officer of Electrolux Corporation, a manufacturer of premium floor care machines, from June 1991 to May 1998. From September 1984 to April 1989, he was employed by Allegheny International Inc., a home appliance manufacturing company, in a number of positions, most recently as Executive Vice President and Chief Operating Officer. Mr. Albani also serves as a director of Igloo Products Corporation.
Christopher P. Kirchen has served as a member of our board of directors since December 1991. Mr. Kirchen is currently Managing General Partner of BEV Capital, a venture capital partnership that he co-founded in March 1997. From 1986 to December 2002, he was a General Partner of Consumer Venture Partners, a former investor in our company. Mr. Kirchen also serves as a director of a number of privately held companies.
David T. Kollat has served as a member of our board of directors since February 1994. Mr. Kollat has served as President and Chairman of 22 Inc., a research and consulting company for retailers and consumer goods manufacturers, since 1987. From 1976 until 1987, he served in various capacities for The Limited, a women’s apparel retailer, including Executive Vice President of Marketing and President of Victoria’s Secret Catalogue. Mr. Kollat also serves as a director of The Limited, Inc., Wolverine World Wide, Inc., Big Lots, Inc. and Cone Mills Corporation, as well as a number of privately held companies.
Michael A. Peel has served as a member of our board of directors since February 19, 2003. Mr. Peel has served as Senior Vice President, Human Resources and Corporate Services of General Mills, Inc., a manufacturer and marketer of packaged consumer foods, since 1991. From 1977 to 1991, Mr. Peel served in various capacities for PepsiCo, Inc., including as Senior Vice President, Human Resources for PepsiCo Worldwide Foods from 1987 to 1991.
Trudy A. Rautio has served as a member of our board of directors since December 2002. Ms. Rautio has served as Executive Vice President and Chief Financial Officer of Carlson Consumer Group, a division of Carlson Companies, Inc., a marketing, business and leisure travel and hospitality company, since 1997. From 1993 until 1997, she served in various capacities for Jostens, Inc., including as Senior Vice President Finance from 1994 until 1997. From 1982 until
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Ervin R. Shames has served as a member of our board of directors since April 1996. From April 1996 to April 1999, Mr. Shames served as our Chairman of the Board of Directors. Since January 1995, Mr. Shames has served as an independent management consultant to consumer goods and services companies, advising on management and marketing strategy. Since 1996, he has been a visiting lecturer at the University of Virginia’s Darden Graduate School of Business. From December 1993 to January 1995, he served as the Chief Executive Officer of Borden, Inc. and was President and Chief Operating Officer of Borden, Inc. from July 1993 until December 1993. Mr. Shames serves as a director of Online Resources Corporation and Choice Hotels.
Jean-Michel Valette has served as a member of our board of directors since October 1994. Mr. Valette is an independent adviser to branded consumer companies. From August 1998 to May 2000, Mr. Valette served as President and Chief Executive Officer of Franciscan Estates, Inc., a Napa Valley winery. He was a Managing Director of Hambrecht & Quist LLC, an investment banking firm, from October 1994 to August 1998 and served as a Senior Analyst at Hambrecht & Quist LLC from November 1992 to October 1994. Hambrecht & Quist LLC was one of the underwriters of our initial public offering. Mr. Valette also serves as a director of The Boston Beer Company, Peet’s Coffee and Tea, Inc. and Golden State Vintners, Inc., as well as a number of privately held companies.
Board Composition
Our board of directors is divided into three classes, each of whose members serve for a staggered three-year term. The terms of Patrick A. Hopf, Trudy A. Rautio and Ervin R. Shames expire at our 2003 annual meeting of shareholders. The terms of Thomas J. Albani, David T. Kollat and William R. McLaughlin expire at our 2004 annual meeting of shareholders. The terms of Christopher P. Kirchen, Michael A. Peel and Jean-Michel Valette expire at our 2005 annual meeting of shareholders.
Board Committees
Our board of directors has an Audit Committee, aManagement Development and Compensation Committee, and a Corporate Governance and Nominating Committee.
The Audit Committee provides assistance to our board of directors in satisfying its fiduciary responsibilities relating to our accounting, auditing, operating and reporting practices, and reviews our annual financial statements, the selection and work of our independent certified public accountants and the adequacy of internal controls for compliance with corporate policies and directives. The Audit Committee consists of Messrs. Valette and Kirchen and Ms. Rautio. The Audit Committee met or took action by written consent on six occasions during 2002.
The Compensation Committee reviews general programs of compensation and benefits for all of our employees, makes recommendations to our board of directors concerning such matters as compensation to be paid to our officers and directors, and administers our stock option and incentive plans, pursuant to which stock options and other incentive awards may be granted to eligible employees, officers, directors and consultants. The Compensation Committee consists of Messrs. Albani, Kollat, Peel and Shames. The Compensation Committee met on three occasions during 2002.
The Corporate Governance and Nominating Committee develops and recommendsFinance Committee, as well as the Corporate Governance Principles, toCode of Business Conduct and Stock Ownership Guidelines. These documents are posted on our boardWeb site athttp://www.selectcomfort.com—select the "About Select Comfort" link and then the "Corporate Governance" link.
Copies of directors to govern our board, its committees, our company and our employees, identifies and recommends to our board individuals qualified to become members of our board, and develops and oversees the annual board and board committee evaluation process. The Corporate Governance and Nominating Committee consists of Messrs. Hopf and Shames. The Corporate Governance and Nominating Committee met on four occasions during 2002.
Director Compensation
All of our non-employee directors receive an annual retainer of $25,000, each committee chair receives additional compensation of $5,000 per year and each memberany of the Audit Committee receives additional compensationabove referenced information will also be made available, free of $5,000 per year.charge, upon written request to:
49Select Comfort Corporation
Investor Relations Department
9800 59th Avenue North
Plymouth, Minnesota 55442
INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE
EachThe SEC allows us to incorporate into this prospectus information we file with the SEC in other documents. The information incorporated by reference is considered to be part of our newly elected non-employee directors is eligiblethis prospectus and information we later file with the SEC will automatically update and supersede this information. We incorporate by reference the documents listed below and any future filings made with the SEC under Sections 13(a), 13(c), 14 and 15(d) of the Exchange Act, as amended, until the termination of the offering. The documents we have incorporated by reference are:
Notwithstanding the above, information that is "furnished" to the fair market value of our common stock onSEC shall not be incorporated by reference or deemed to be incorporated by reference into this prospectus or the date of grant. These initial options become exercisable in equal monthly increments overrelated registration statement.
We will provide, without charge, to each person, including any beneficial owner, to whom a 24-month period, so long as the director remains a director of our company. After the vestingcopy of this initial grant, eachprospectus is delivered, upon written or oral request of our non-employee directors is eligible for an annual grant, subjectsuch person, a copy of any or all of the documents incorporated by reference in this prospectus, other than exhibits to actionsuch documents unless such exhibits are specifically incorporated by our board of directors and coincidentreference into such documents. Requests may be made in writing or by telephoning: the Company's Secretary at Select Comfort Corporation, 9800 59th Avenue North, Minneapolis, MN 55442, (763) 551-7000.
You should read the information in this prospectus together with the annual meetinginformation in the documents incorporated by reference. Any statement contained in a document incorporated or deemed to be incorporated herein by reference will be deemed to be modified or superseded for purposes of shareholders, of options to purchase 10,000 shares of our common stock at an exercise price equalthis prospectus to the fair market valueextent that a statement contained herein or any other subsequently filed document that is deemed to be incorporated herein by reference modifies or supersedes the statement. Any statement so modified or superseded will not be deemed, except as so modified or superseded, to constitute a part of our common stock on the datethis prospectus.
All of our directors are reimbursed for travel expenses for attending meetings of our board of directors and any board committees.
Our directors who are our employees do not receive additional compensation for their services as directors.
CERTAIN TRANSACTIONS
Director Relationships
Patrick A. Hopf, our Chairman of the Board of Directors, was an Executive Vice President of St. Paul Venture Capital, Inc. from February 2002 to December 2002. Mr. Hopf was a Managing Member of St. Paul Venture Capital IV, LLC from January 1997 to December 2002 and St. Paul Venture Capital V, LLC from January 1999 to December 2002, and a Managing Director of SPVC Management VI, LLC, the Managing Member of St. Paul Venture Capital VI, LLC from October 2000 to December 2002. St. Paul Venture Capital IV, LLC, St. Paul Venture Capital V, LLC, St. Paul Venture Capital VI, LLC, St. Paul Venture Capital Affiliates Fund I, LLC (each of which funds is managed by St. Paul Venture Capital, Inc.) and St. Paul Fire and Marine Insurance Co. (whose holdings are managed by St. Paul Venture Capital, Inc.) are significant shareholders of ours, and various St. Paul entities are selling shareholders in this offering. Mr. Hopf is a member of the investment committee responsible for the voting and acquisition and disposition of Select Comfort shares held by each of the St. Paul entities. Mr. Hopf has a continuing financial interest in the funds managed by the investment committee.
PROSPECTUS
SELECT COMFORT CORPORATION
4,500,000 shares
Common Stock
, 2009
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 14. Other Expenses of directors, was a general partner of Consumer Venture Associates II, L.P., which is the general partner of Consumer Venture Partners II, L.P., a former significant shareholder of ours.
Registration Rights Agreement
Several holders of our common stockIssuance and warrants to purchase shares of our common stock, including certain directors and holders of more than 5% of our common stock, have demand and incidental registration rights covering certain such shares held by them pursuant to a Registration Rights Agreement dated June 6, 2001 among us and the other parties thereto.
Private Placement of 8% Senior Secured Convertible Notes and WarrantsDistribution
In June 2001, we completed a private placement of 8% senior secured convertible notes in the aggregate principal amount of $11.0 million, convertible into an aggregate of 11.0 million shares of our common stock, together with warrants to purchase an aggregate of 4.4 million shares of our common stock at an exercise price of $1.00 per share. St. Paul Venture Capital VI, LLC purchased $4.1 million of the 8% senior secured convertible notes. BWSJ Corporation, a company in which William R. McLaughlin has an ownership interest, purchased $1.0 million of the notes. Three of our independent directors, including Thomas J. Albani, Ervin R. Shames and Jean-Michel Valette, each purchased $50,000 of the notes. All of these notes were automatically converted into shares of our common stock in June 2002.
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PRINCIPAL AND SELLING SHAREHOLDERS
The following table sets forth information as of February 14, 2003 regarding the beneficial ownership of our common stock by:
The information has been adjustedexpenses to reflectbe incurred and payable by the sale of our common stockRegistrant, in this offering. The information assumes no exerciseconnection with the offering of the underwriters’ over-allotment option.
Information with respect to beneficial ownership has been furnished by each director, officer or greater than 5% shareholder, as the case may be. Except as otherwise noted below, the address for each person listed on the table is c/o Select Comfort Corporation, 6105 Trenton Lane North, Minneapolis, MN 55442.
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Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission, which generally attribute beneficial ownership of securities to persons who possess sole or shared voting power or investment power with respect to those securities and includes shares of common stock issuable pursuant to the exercise of stock options or warrants thatthis Registration Statement. All amounts shown are immediately exercisable or exercisable within 60 days of February 14, 2003. These shares are deemed to be outstanding and to be beneficially owned by the person holding those options or warrantsestimates, except for the sole purposeSEC registration fee.
SEC Registration Fee | $ | 1,276 | |||
Selling Shareholder Legal Fees and Expenses | $ | 50,000 | |||
Registrant Legal Fees and Expenses | $ | 20,000 | |||
Accounting Fees and Expenses | $ | 8,000 | |||
Transfer Agent Fees | $ | 0 | |||
Printing and Engraving | $ | 0 | |||
Miscellaneous | $ | 0 | |||
*Total | $ | 79,276 |
Item 15. Indemnification of computing the percentage ownership of that person, but are not treated as outstanding for the purpose of computing the percentage ownership of any other person. Unless otherwise indicated, the persons or entities identified in this table have sole votingDirectors and investment power with respect to all shares shown as beneficially owned by them, subject to applicable community property laws.Officers
Beneficial Ownership | Beneficial Ownership | |||||||||||||||||||
Before Offering | Shares | After Offering | ||||||||||||||||||
to be | ||||||||||||||||||||
Name of Beneficial Owner | Shares | Percent | Sold | Shares | Percent | |||||||||||||||
The St. Paul Companies, Inc. (1) | 12,928,304 | 38.5 | % | 4,000,000 | 8,928,304 | 26.6 | % | |||||||||||||
St. Paul Fire and Marine Insurance Company (2) | 4,983,775 | 16.1 | % | 1,541,907 | 3,441,868 | 11.1 | % | |||||||||||||
St. Paul Venture Capital IV, LLC (3) | 339,026 | 1.1 | % | 104,890 | 234,136 | * | ||||||||||||||
St. Paul Venture Capital V, LLC (4) | 1,856,616 | 5.8 | % | 574,496 | 1,282,120 | 4.0 | % | |||||||||||||
St. Paul Venture Affiliates Fund I, LLC (5) | 275 | * | 85 | 190 | * | |||||||||||||||
St. Paul Venture Capital VI, LLC (6) | 5,748,612 | 17.7 | % | 1,778,622 | 3,969,990 | 12.2 | % | |||||||||||||
NorthBay Partners, L.L.C. (7) | 1,735,000 | 5.9 | % | 0 | 1,735,000 | 5.9 | % | |||||||||||||
Renaissance US Growth Investment Trust PLC (8) | 500,000 | 1.6 | % | 200,000 | 300,000 | 1.0 | % | |||||||||||||
BFS US Special Opportunities Trust PLC (9) | 600,000 | 1.9 | % | 200,000 | 400,000 | 1.3 | % | |||||||||||||
William R. McLaughlin (10) | 653,515 | 2.1 | % | 0 | 653,515 | 2.1 | % | |||||||||||||
Mark A. Kimball (11) | 255,033 | * | 0 | 255,033 | * | |||||||||||||||
Gregory T. Kliner (12) | 209,588 | * | 0 | 209,588 | * | |||||||||||||||
Noel F. Schenker (13) | 127,118 | * | 0 | 127,118 | * | |||||||||||||||
Keith C. Spurgeon (14) | 27,562 | * | 0 | 27,562 | * | |||||||||||||||
Tracy T. Breazeale (15) | 141,033 | * | 0 | 141,033 | * | |||||||||||||||
James C. Raabe (16) | 170,994 | * | 0 | 170,994 | * | |||||||||||||||
Michael Thyken (17) | 129,960 | * | 0 | 129,960 | * | |||||||||||||||
Patrick A. Hopf (18) | 108,016 | * | 0 | 108,016 | * | |||||||||||||||
Thomas J. Albani (19) | 130,651 | * | 0 | 130,651 | * | |||||||||||||||
Christopher P. Kirchen (20) | 271,541 | * | 0 | 271,541 | * | |||||||||||||||
David T. Kollat (21) | 90,651 | * | 0 | 90,651 | * | |||||||||||||||
Michael A. Peel (22) | 833 | * | 0 | 833 | * | |||||||||||||||
Trudy A. Rautio (23) | 3,333 | * | 0 | 3,333 | * | |||||||||||||||
Ervin R. Shames (24) | 338,056 | 1.1 | % | 0 | 338,056 | 1.1 | % | |||||||||||||
Jean-Michel Valette (25) | 114,156 | * | 0 | 114,156 | * | |||||||||||||||
All directors and executive officers as a group (16 persons) (26) | 2,772,040 | 8.4 | % | 0 | 2,772,040 | 8.4 | % |
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DESCRIPTION OF CAPITAL STOCK
Our authorized capital stock consists of 95,000,000 shares of common stock and 5,000,000 shares of undesignated preferred stock. The following description summarizes information about our capital stock. You can obtain more comprehensive information about our capital stock by consulting our restated articles of incorporation and restated bylaws, as well as the Minnesota Business Corporation Act.
Common Stock
As of February 14, 2003, there were 30,915,439 shares of our common stock issued and outstanding, held of record by approximately 189 shareholders. The holders of our common stock are entitled to one vote for each share held of record on all matters submitted to a vote of shareholders and are not entitled to cumulate votes. Subject to preferences that may be applicable to any outstanding shares of undesignated preferred stock, holders of common stock are entitled to receive ratably such dividends as may be declared by our board of directors out of funds legally available therefor. Upon liquidation, dissolution or winding up of our company, the holders of our common stock are entitled to share ratably in all assets that are legally available for distribution after payment of all debts and other liabilities and subject to the prior rights of any holders of the outstanding shares of undesignated preferred stock. The holders of our common stock have no preemptive, subscription, redemption, sinking fund or conversion rights. All outstanding shares of common stock are fully paid and nonassessable.
Undesignated Preferred Stock
As of the date of this prospectus, no shares of undesignated preferred stock were issued and outstanding. Under Minnesota law, no action by our shareholders is necessary, and only action by our board of directors is required, to authorize the issuance of any of the shares of undesignated preferred stock. Subject to certain limitations, our board of directors is empowered to establish and to designate the name of each class or series of the shares of undesignated preferred stock and to set the terms of such shares (including terms with respect to redemption, sinking fund, dividend, liquidation, preemptive conversion and voting rights and preferences). Our board of directors can issue shares of such class or series to, among other individuals, the holders of another class or series of undesignated preferred stock or to the holders of our common stock. Accordingly, our board of directors, without shareholder approval, could issue undesignated preferred stock with dividend, voting and conversion rights that could adversely affect the rights of the holders of common stock. The undesignated preferred stock may have the effect of discouraging an attempt, through acquisition of a substantial number of shares of our common stock, to acquire control of our company with a view to effecting a merger, sale or exchange of assets or a similar transaction. We have no present plans to issue any shares of undesignated preferred stock.
Options and Warrants
As of February 14, 2003, we had outstanding options to purchase an aggregate of 5,296,425 shares of common stock at a weighted average exercise price of $5.12 per share, 3,091,958 of which were exercisable as of such date. The remaining average contractual life of the outstanding options is 7.3 years and the expiration dates of such options range from June 2003 to January 2013. As of February 14, 2003, we had outstanding warrants to purchase an aggregate of 4,721,731 shares of common stock at a weighted average exercise price of $1.18 per share, all of which were exercisable as of such date. The remaining average contractual life of the outstanding warrants is 7.0 years and the expiration dates of such warrants range from May 2004 to June 2011. All outstanding options and warrants provide for antidilution adjustments in the event of certain mergers, consolidations, reorganizations, recapitalizations, stock dividends, stock splits or other changes in our corporate structure. Certain of the outstanding warrants provide for antidilution adjustments if we sell any shares of capital stock or securities exercisable for or convertible into shares of capital stock for less than the exercise price of the warrants. Holders of the outstanding warrants have certain demand and incidental registration rights with respect to the shares issuable upon exercise of the warrants. See “— Registration Rights.”
Registration Rights
The holders of outstanding shares of common stock purchased in our Series B, C, D and E preferred stock financings and our 1996 and 1997 bridge loan financings completed prior to the initial public offering of our common
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All of these registration rights are subject to specified conditions and limitations, among them the right of the underwriters of an offering to limit the number of shares included in the registration and our right to postpone the filing of any registration statement or not to include in any registration statement registrable securities that are freely tradable under Rule 144(k) under the Securities Act. In addition, the demand registration rights are subject to minimum aggregate offering amounts, $5,000,000 in the case of a Form S-1 and $500,000 in the case of a Form S-3 registration statement, and a minimum percentage of registrable securities that is required to assert the rights. Furthermore, we are not required to effect up to more than four demand registrations on Form S-3 during any 12 month period and up to four demand registrations on Form S-1. In general, we will bear all fees, costs and expenses of such registrations, other than underwriting discounts and commissions. All of these registration rights either have been complied with or waived with respect to this offering. The registration rights held by the holders of 4,000,000 shares of common stock and warrants to purchase an aggregate of 400,000 shares of common stock will terminate upon the completion of this offering since such registrable shares will have been registered and sold by the holders in this offering.
Provisions with Potential Anti-Takeover Effect
We are subject to the provisions of Sections 302A.671 and 302A.673 of the Minnesota Business Corporation Act. These anti-takeover provisions may eventually operate to deny shareholders the receipt of a premium on their common stock and may also have a depressive effect on the market price of our common stock. In general, Section 302A.671 provides that the shares of a corporation acquired in a “control share acquisition” have no voting rights unless voting rights are approved by the shareholders in a prescribed manner. A “control share acquisition” is defined as an acquisition of beneficial ownership of shares that would, when added to all other shares beneficially owned by the acquiring person, entitle the acquiring person to have voting power of 20% or more in the election of directors. Section 302A.673 prohibits a public corporation from engaging in a “business combination” with an “interested shareholder” for a period of four years after the date of the transaction in which the person became an interested shareholder, unless the business combination is approved in a prescribed manner. A “business combination” includes mergers, asset sales and other transactions. An “interested shareholder” is a person who is the beneficial owner, of 10% or more of the corporation’s voting stock. Reference is made to the detailed terms of Sections 302A.671 and 302A.673 of the Minnesota Business Corporation Act. Our restated articles of incorporation provide for a classified board of directors serving staggered terms of three years. In addition, shareholders are not entitled to cumulative voting in the election of directors and may not remove a director without cause. The restated articles of incorporation also require the approval of two-thirds of the outstanding voting power of the company entitled to vote in the event of any sale or merger of the company. The authorization of undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change control of our company. The foregoing provisions of our restated articles of incorporation andStatutes Chapter 302A, the Minnesota Business Corporation Act may have(the "Corporation Act"). Section 302A.521 of the effect of deterring hostile takeovers or delaying changesCorporation Act provides in control of management of our company.
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Limitation on Liability of Directors and Indemnification
Our restatedsubstance that, unless prohibited by its articles of incorporation limit the liability of our directors to the fullest extent permitted by the Minnesota Business Corporation Act. Specifically, our directors will not be personally liable for monetary damages for breach of fiduciary duty as directors, except liability for (i) any breach of the duty of loyalty to us or our shareholders, (ii) acts or omissions not in good faith or that involve intentional misconduct orbylaws, a knowing violation of law, (iii) dividends or other distributions of corporate assets that are in contravention of certain statutory or contractual restrictions, (iv) violations of certain Minnesota securities laws, or (v) any transaction from which the director derivescorporation must indemnify an improper personal benefit. Liability under federal securities law is not limited by our restated articles of incorporation. We also maintain a directors and officers insurance policy pursuant to which our directors and officers are insured against liability for certain actions in their capacity as directors and officers. The Minnesota Business Corporation Act requires that we indemnify any director, officer or employeedirector who is made or threatened to be made a party to a proceeding by reason of the former or present official capacity of the person against judgments, penalties, fines, including, without limitation, excise taxes assessed against the person with respect to an employee benefit plan, settlements, and reasonable expenses, including attorneys' fees and disbursements, incurred by such person in connection with the proceeding, if certain statutory standardscriteria are met. “Proceeding” meansThese criteria, all of which must be met by the person seeking indemnification, are (a) that such person has not been indemnified by another organization or employee benefit plan for the same judgments, penalties, fines, including, without limitation, excise taxes assessed against the person with respect to an employee benefit plan, settlements, and reasonable expenses, including attorneys' fees and disbursements, incurred by the person in connection with the proceeding with respect to the same acts or omissions; (b) that such person must have acted in good faith; (c) that no improper personal benefit was obtained by such person and such person satisfied certain statutory conflicts of interest provisions, if applicable; (d) that in the case of a threatened, pendingcriminal proceeding, such person had no reasonable cause to believe that the conduct was unlawful; and (e) that, in the case of acts or completed civil, criminal, administrative, arbitrationomissions occurring in such person's performance in an official capacity, such person must have acted in a manner such person reasonably believed was in the best interests of the corporation or, investigative proceeding, including a derivative action in our name. Referencecertain limited circumstances, not opposed to the best interests of the corporation. In addition, Section 302A.521, subd. 3 requires payment by the Registrant, upon written request, of reasonable expenses in advance of final disposition in certain instances. A decision as to required indemnification is made to the detailed termsby a majority of the Minnesota indemnification statute, Section 302A.521disinterested board of directors present at a meeting at which a disinterested quorum is present, or by a designated committee of disinterested directors, by special legal counsel, by the Minnesota Business Corporation Act, fordisinterested shareholders, or by a complete statementcourt.
Our Third Restated Articles of such indemnification rights. Our restated articlesIncorporation provide that each of incorporationour past and present directors, officers, employees, or agents, and each person who serves or may have served at our restated bylaws also requirerequest as a director, officer, employee or agent of another corporation or employee benefit plan and their respective heirs, administrators and executors, will be indemnified by us to provide indemnificationin accordance with, and to the fullest extent permissible under, the provisions of Chapter 302A of the Minnesota Statutes, as amended.
II-1
Our Restated Bylaws provide that the indemnification statute. Insofarwill cover all expenses incurred by an indemnified person, including attorneys' fees and other expenses of litigation and all liabilities and losses incurred by the indemnified person in connection with a proceeding in which they are made a party, threatened to be made a party to, or is involved in or called as a witness because the indemnified person is our director, officer or representative. If authorized by our board of directors, we will pay for reimbursable expenses in advance of the final disposition of a proceeding if we receive an undertaking from the indemnified party that such person will repay the amount advanced if it is ultimately determined that the person is not entitled to be indemnified by us.
In the event that a claim for indemnification foragainst these liabilities arising under(other than the Securities Act may be permitted to directors, officerspayment of expenses incurred or personspaid by a director, officer or controlling our company pursuant toperson in a successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the foregoing provisions,securities being registered, we are aware thatwill, unless in the opinion of our counsel the Securities and Exchange Commission, suchmatter has been settled by controlling precedent, submit to the court of its appropriate jurisdiction the question whether indemnification by us is against public policy as expressed in the Securities Act and will be governed by the final adjudication of such issue.
There is therefore unenforceable.no pending litigation or proceeding involving any of our directors, officers, employees or other agents as to which indemnification is being sought, nor are we aware of any pending or threatened litigation that may result in claims for indemnification by any director, officer, employee or other agent.
Transfer Agent and Registrar Item 16. Exhibits
The Transfer Agent and Registrarfollowing is a complete list of exhibits filed as a part of this Registration Statement, which Exhibits are incorporated herein.
Exhibit Number | Description of Exhibit | ||
---|---|---|---|
3.1 | Third Restated Articles of Incorporation of the Company, as amended(1) | ||
3.2 | Articles of Amendment to Third Restated Articles of Incorporation of the Company(2) | ||
3.3 | Restated Bylaws of Select Comfort Corporation(3) | ||
5.1 | Opinion of Oppenheimer Wolff & Donnelly LLP** | ||
10.1 | Registration Rights Agreement, dated October 2, 2009, by and among Select Comfort Corporation and Sterling SC Investor, LLC(4) | ||
23.1 | Consent of KPMG LLP, Independent Registered Public Accounting Firm** | ||
23.2 | Consent of Oppenheimer Wolff & Donnelly LLP (included in Exhibit 5.1) |
II-2
57
UNDERWRITING Item 17. Undertakings
General
Thomas Weisel Partners LLC, U.S. Bancorp Piper Jaffray Inc., Adams, Harkness & Hill, Inc. and Craig-Hallum Capital Group LLCThe undersigned registrant hereby undertakes:
(a)(1) To file, during any period in which offers or sales are acting as representativesbeing made, a post-effective amendment to this registration statement:
(i) To include any prospectus required by Section 10(a)(3) of the underwritersSecurities Act of 1933;
(ii) To reflect in this offering. Subject to the terms and conditionsprospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in an underwriting agreement, eachthe registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the underwriters named below has severally agreedestimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to purchase from the selling shareholdersRule 424(b) if, in the aggregate, number of shares of common stockthe changes in volume and price represent no more than 20% change in the maximum aggregate offering price set forth opposite its name below:
The underwriting agreement provides that(iii) To include any material information with respect to the obligationsplan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement;
provided, however, that:
paragraphs (a)(1)(i), (a)(1)(ii) and (a)(1)(iii) above do not apply if the registration statement is on Form S-3 or Form F-3 and the information required to be included in a post-effective amendment by those paragraphs is contained in reports filed with or furnished to the Commission by the registrant pursuant to Section 13 or 15(d) of the several underwritersSecurities Exchange Act of 1934 that are subjectincorporated by reference in the registration statement, or is contained in a form of prospectus filed pursuant to various conditions, including approval of legal matters by counsel. The natureRule 424(b) that is part of the underwriters’ obligations commits them to purchase and payregistration statement.
(2) That, for allthe purpose of the shares of common stock listed above ifdetermining any are purchased.
The underwriting agreement provides that we and the selling shareholders will indemnify the underwriters against liabilities specified in the underwriting agreementliability under the Securities Act of 1933, as amended, or will contributeeach such post-effective amendment shall be deemed to payments that the underwriters may be required to makea new registration statement relating to these liabilities.the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.
Craig-Hallum Capital Group LLC, one(3) To remove from registration by means of a post-effective amendment any of the representativessecurities being registered which remain unsold at the termination of the underwriters, was organized and registered as a broker-dealer in August 2002. Since August 2002, Craig-Hallum has not acted as a lead manager, co-manager or member of the underwriting syndicate with respect to any filed public offerings of equity securities. Craig-Hallum does not have any material relationship with us or any of our officers, directors or other controlling persons, except with respect to its contractual relationship with us pursuant to the underwriting agreement entered into in connection with this offering.
Thomas Weisel Partners LLC expects to deliver(4) That, for the sharespurpose of common stock to purchasers on or about , 2003.
Over-Allotment Option
The selling shareholders have granted a 30-day over-allotment option to the underwriters to purchase up to a total of 660,000 additional shares of our common stock from the selling shareholders at the public offering price, less the underwriting discounts payable by the selling shareholders, as set forth on the cover page of this prospectus. If the underwriters exercise this option in whole or in part, then each of the underwriters will be separately committed, subject to conditions described in the underwriting agreement, to purchase the additional shares of our common stock in proportion to their respective commitments set forth in the table above.
Commissions and Discounts
The underwriters propose to offer the shares of common stock directly to the public at the public offering price set forth on the cover page of this prospectus and at this price less a concession not in excess of $ per share of common stock to other dealers specified in a master agreement among underwriters that are members of the National Association of Securities Dealers, Inc. The underwriters may allow, and the other dealers specified may reallow, concessions, not in excess of $ per share of common stock to these other dealers. After this offering, the offering price, concessions and other selling terms may be changed by the underwriters. Our common stock is offered subject to receipt and acceptance by the underwriters and to the other conditions, including the right to reject orders in whole or in part.
58
The following table summarizes the compensation to be paid to the underwriters by the selling shareholders and the proceeds, before expenses, payable to the selling shareholders:
We estimate that the expenses of this offering payable by us, exclusive of the underwriting discount, will be approximately $230,000.
Indemnification of Underwriters
We and the selling shareholders will indemnify the underwriters against some civil liabilities, including liabilitiesdetermining liability under the Securities Act of 1933 to any purchaser:
(i) If the registrant is relying on Rule 430B:
No Sales of Similar Securities
The underwriters will require some of our directors, officers and shareholders to agree not to offer, sell, agree to sell, directly or indirectly, or otherwise dispose of any shares of our common stock or any securities convertible into or exchangeable for shares of our common stock without the prior written consent of Thomas Weisel Partners LLC for a period of 90 days after the date of this prospectus, other than gifts of our common stock provided that the donees agree to be bound by the foregoing terms, transfers of our common stock to trusts provided that the trustees agree to be bound by the foregoing terms and transactionsreliance on Rule 430B relating to shares acquired in open market transactions after the completion of this offering.
We have agreed that, for a period of 90 days after the date of this prospectus, we will not, without the prior written consent of Thomas Weisel Partners LLC, offer, sellan offering made pursuant to Rule 415(a)(1)(i), (vii), or otherwise dispose of any shares of our common stock or any securities convertible into or exercisable or exchangeable for our common stock, except for the shares of our common stock issuable upon exercise of options, warrants and convertible securities outstanding on the date of this prospectus and the shares of our common stock that are issued or options or other incentive awards that are granted under our employee benefit plans.
Nasdaq National Market Listing
Our common stock is quoted on the Nasdaq National Market under the symbol “SCSS.”
Short Sales, Stabilizing Transactions and Penalty Bids
In order to facilitate this offering, persons participating in this offering may engage in transactions that stabilize, maintain or otherwise affect the market price of our common stock during and after this offering. Specifically, the underwriters may engage in the following activities in accordance with the rules of the Securities and Exchange Commission.
Short sales involve sales by the underwriters of a greater number of shares than they are required to purchase in this offering. Covered short sales are made in an amount not greater than the underwriters’ option to purchase additional shares from the selling shareholders in this offering. The underwriters may close out any covered short position by either exercising their option to purchase shares or purchasing shares in the open market. In determining the source of shares to close out the covered short position, the underwriters will consider, among other things, the price of shares available for purchase in the open market as compared to the price at which they may purchase shares
59
The underwriters may make bids for or purchases of the shares(x) for the purpose of pegging, fixing or maintainingproviding the priceinformation required by Section 10(a) of the shares, so long as stabilizing bids do not exceed a specified maximum.
If the underwriters purchase sharesSecurities Act of 1933 shall be deemed to be part of and included in the open market in a stabilizing transaction or syndicate covering transaction, they may reclaim a selling concession from the underwriters and selling group members who sold those sharesregistration statement as part of this offering. Stabilization and syndicate covering transactions may cause the price of the sharesearlier of the date such form of prospectus is first used after effectiveness or the date of the first contract of sale of securities in the offering described in the prospectus. As provided
II-3
in Rule 430B, for liability purposes of the issuer and any person that is at that date an underwriter, such date shall be deemed to be higher than it would bea new effective date of the registration statement relating to the securities in the absenceregistration statement to which that prospectus relates, and the offering of these transactions. The imposition of a penalty bid might also have an effect onsuch securities at that time shall be deemed to be the price of the shares if it discourages presales of the shares.
The transactions above may occur on the Nasdaq National Market,initial bona fide offering thereof. Provided, however, that no statement made in the over-the-counter market or otherwise. If these transactions are commenced, they may be discontinued without notice at any time.
Passive Market Making
In connection with this offering, the underwriters may engage in passive market making transactions in our common stock on the Nasdaq National Market in accordance with Rule 103 of Regulation M under the Exchange Act during a period before the commencement of offers or sales of common stock and extending through the completion of distribution. A passive market maker must display its bid at a price not in excess of the highest independent bid of that security. However, if all independent bids are lowered below the passive market maker’s bid, that bid must then be lowered when specified purchase limits are exceeded.
LEGAL MATTERS
An opinion has been delivered by Oppenheimer Wolff & Donnelly LLP, Minneapolis, Minnesota to the effect that the shares of our common stock being offered by this prospectus will, when sold as contemplated in this prospectus, be validly issued, fully paid and non-assessable. Various legal matters related to this offering will be passed upon for the underwriters by Morgan, Lewis & Bockius LLP, New York, New York.
EXPERTS
The consolidated financial statements and schedule of Select Comfort Corporation and subsidiaries as of December 28, 2002 and December 29, 2001, and for each of the years in the three-year period ended December 28, 2002, included in this prospectus have been so included in reliance upon the reports of KPMG LLP, independent accountants, upon the authority of said firm as experts in accounting and auditing.
WHERE YOU CAN FIND MORE INFORMATION
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (the SEC). You may read and copy any reports, statements and other information we file with the SEC at the SEC’s public Reference Room at 450 Fifth Street, N.W., Washington, D.C., 20549. You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Our SEC filings are also available on the SEC’s Internet site as part of the EDGAR database (http://www.sec.gov).
We have filed with the SEC a registration statement on Form S-3 (including the exhibits and schedules thereto) under the Securities Act and the rules and regulations thereunder for the registration of our common stock offered hereby. Thisor prospectus that is part of the registration statement. Thisstatement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus does not contain allthat is part of the informationregistration statement will, as to a purchaser with a time of contract of sale prior to such effective date, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such effective date; or
60
INCORPORATION OF INFORMATION WE FILE WITH THE SEC
The SEC allows us to incorporate by reference(5) That, for the information we file with them, which means:
We incorporate by reference the documents listed below which were filed with the SECregistrant under the Securities Exchange Act of 1934, as amended, or1933 to any purchaser in the Exchange Act:initial distribution of the securities:
We are also incorporating by reference all other reportsThe undersigned registrant undertakes that we file within a primary offering of securities of the SECundersigned registrant pursuant to Section 13(a), 13(c), 14 or 15(d)this registration statement, regardless of the Exchange Act between the date of this prospectus and the termination of this offering.
You should rely only on information contained or incorporated by reference in this prospectus. We have not authorized any other person to provide you with different information. If anyone provides you with different or inconsistent information, you should not rely on it. We are not making an offerunderwriting method used to sell thesethe securities in any jurisdiction whereto the offerpurchaser, if the securities are offered or sale is not permitted.
You may request a copysold to such purchaser by means of any of the filings referredfollowing communications, the undersigned registrant will be a seller to above (excluding exhibits) at no cost by contacting us at Select Comfort Corporation, 6105 Trenton Lane North, Minneapolis, MN 55442, (763) 551-7498.
61
INDEX TO FINANCIAL STATEMENTS
F-1
INDEPENDENT AUDITORS’ REPORT
The Board of Directorsthe purchaser and Shareholders
We have audited the accompanying consolidated balance sheets of Select Comfort Corporation and subsidiaries (the Company) as of December 28, 2002 and December 29, 2001 and the related consolidated statements of operations, shareholders’ equity, and cash flows for each(i) Any preliminary prospectus or prospectus of the fiscal years in the three-year period ended December 28, 2002. 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 auditing standards generally accepted in the United States of America. 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 December 28, 2002 and December 29, 2001, and the results of their operations and their cash flows for each of the fiscal years in the three-year period ended December 28, 2002 in conformity with accounting principles generally accepted in the United States of America.
Minneapolis, Minnesota
F-2
SELECT COMFORT CORPORATION
Consolidated Balance Sheets
2002 | 2001 | ||||||||||
Assets | |||||||||||
Current assets: | |||||||||||
Cash and cash equivalents | $ | 27,176 | $ | 16,375 | |||||||
Marketable securities — current (note 2) | 12,146 | — | |||||||||
Accounts receivable, net of allowance for doubtful accounts of $340 and $311, respectively | 3,270 | 2,623 | |||||||||
Inventories (note 3) | 8,980 | 8,086 | |||||||||
Prepaid expenses | 5,467 | 3,588 | |||||||||
Deferred tax assets (note 8) | 12,955 | — | |||||||||
Total current assets | 69,994 | 30,672 | |||||||||
Marketable securities — non-current (note 2) | 1,502 | — | |||||||||
Property and equipment, net (note 4) | 28,977 | 30,882 | |||||||||
Deferred tax assets (note 8) | 4,352 | — | |||||||||
Other assets | 3,506 | 5,882 | |||||||||
Total assets | $ | 108,331 | $ | 67,436 | |||||||
Liabilities and Shareholders’ Equity | |||||||||||
Current liabilities: | |||||||||||
Current maturities of long-term debt (note 6) | $ | 11 | $ | 28 | |||||||
Accounts payable | 16,508 | 15,216 | |||||||||
Accruals: | |||||||||||
Sales returns | 3,181 | 3,624 | |||||||||
Compensation and benefits | 13,666 | 7,179 | |||||||||
Taxes and withholding | 2,779 | 3,032 | |||||||||
Consumer prepayments | 1,964 | 1,263 | |||||||||
Other | 5,120 | 4,069 | |||||||||
Total current liabilities | 43,229 | 34,411 | |||||||||
Long-term debt, less current maturities (note 6) | 2,991 | 17,109 | |||||||||
Warranty costs | 3,626 | 5,030 | |||||||||
Other liabilities | 3,970 | 4,114 | |||||||||
Total liabilities | 53,816 | 60,664 | |||||||||
Shareholders’ equity (notes 6, 7 and 10): | |||||||||||
Undesignated preferred stock; 5,000,000 shares authorized, no shares issued and outstanding | — | — | |||||||||
Common stock, $0.01 par value; 95,000,000 shares authorized, 30,727,101 and 18,302,307 shares issued and outstanding, respectively | 307 | 183 | |||||||||
Additional paid-in capital | 92,184 | 81,687 | |||||||||
Accumulated deficit | (37,976 | ) | (75,098 | ) | |||||||
Total shareholders’ equity | 54,515 | 6,772 | |||||||||
Commitments and contingencies (notes 1, 5 and 11): | |||||||||||
Total liabilities and shareholders’ equity | $ | 108,331 | $ | 67,436 | |||||||
See accompanying notes to consolidated financial statements.
F-3
SELECT COMFORT CORPORATION
Consolidated Statements of Operations
2002 | 2001 | 2000 | ||||||||||||
Net sales | $ | 335,795 | $ | 261,687 | $ | 270,077 | ||||||||
Cost of sales (note 1) | 125,796 | 107,210 | 115,601 | |||||||||||
Gross profit | 209,999 | 154,477 | 154,476 | |||||||||||
Operating expenses: | ||||||||||||||
Sales and marketing (note 1) | 155,890 | 138,417 | 149,283 | |||||||||||
General and administrative | 32,854 | 25,296 | 29,211 | |||||||||||
Store closings and asset impairments (note 4) | 233 | 1,366 | 1,952 | |||||||||||
Total operating expenses | 188,977 | 165,079 | 180,446 | |||||||||||
Operating income (loss) | 21,022 | (10,602 | ) | (25,970 | ) | |||||||||
Other income (expense): | ||||||||||||||
Interest income | 571 | 237 | 1,082 | |||||||||||
Interest expense (note 6) | (1,655 | ) | (1,362 | ) | (26 | ) | ||||||||
Equity in loss of affiliate | — | — | (642 | ) | ||||||||||
Other, net | (198 | ) | (339 | ) | (66 | ) | ||||||||
Other income (expense), net | (1,282 | ) | (1,464 | ) | 348 | |||||||||
Income (loss) before income taxes and extraordinary loss | 19,740 | (12,066 | ) | (25,622 | ) | |||||||||
Income tax (benefit) expense (note 8) | (17,762 | ) | — | 11,592 | ||||||||||
Income (loss) before extraordinary loss | 37,502 | (12,066 | ) | (37,214 | ) | |||||||||
Extraordinary loss from early extinguishment of debt, net of tax of $234 (note 6) | (380 | ) | — | — | ||||||||||
Net income (loss) | $ | 37,122 | $ | (12,066 | ) | $ | (37,214 | ) | ||||||
Basic net income (loss) per share (note 9): | ||||||||||||||
Income (loss) before extraordinary loss | $ | 1.53 | $ | (0.66 | ) | $ | (2.09 | ) | ||||||
Extraordinary loss from early extinguishment of debt | (0.02 | ) | — | — | ||||||||||
Net income (loss) per share — basic | $ | 1.51 | $ | (0.66 | ) | $ | (2.09 | ) | ||||||
Weighted average common shares — basic | 24,549 | 18,157 | 17,848 | |||||||||||
Diluted net income (loss) per share (note 9): | ||||||||||||||
Income (loss) before extraordinary loss | $ | 1.10 | $ | (0.66 | ) | $ | (2.09 | ) | ||||||
Extraordinary loss from early extinguishment of debt | (0.01 | ) | — | — | ||||||||||
Net income (loss) per share — diluted | $ | 1.09 | $ | (0.66 | ) | $ | (2.09 | ) | ||||||
Weighted average common shares — diluted | 34,532 | 18,157 | 17,848 | |||||||||||
See accompanying notes to consolidated financial statements.
F-4
SELECT COMFORT CORPORATION
Consolidated Statements of Shareholders’ Equity
Additional | |||||||||||||||||||||
Paid-in | Accumulated | ||||||||||||||||||||
Shares | Amount | Capital | Deficit | Total | |||||||||||||||||
Balance at January 1, 2000 | 17,713,247 | $ | 177 | $ | 78,513 | $ | (25,818 | ) | $ | 52,872 | |||||||||||
Exercise of common stock options (note 7) | 44,515 | 1 | 136 | — | 137 | ||||||||||||||||
Issuance of common stock warrants | — | — | 278 | — | 278 | ||||||||||||||||
Employee stock purchases (note 10) | 204,927 | 2 | 525 | — | 527 | ||||||||||||||||
Net loss | — | — | — | (37,214 | ) | (37,214 | ) | ||||||||||||||
Balance at December 30, 2000 | 17,962,689 | 180 | 79,452 | (63,032 | ) | 16,600 | |||||||||||||||
Exercise of common stock options (note 7) | 694 | — | 1 | — | 1 | ||||||||||||||||
Issuance of common stock warrants | — | — | 1,868 | — | 1,868 | ||||||||||||||||
Employee stock purchases (note 10) | 338,924 | 3 | 366 | — | 369 | ||||||||||||||||
Net loss | — | — | — | (12,066 | ) | (12,066 | ) | ||||||||||||||
Balance at December 29, 2001 | 18,302,307 | 183 | 81,687 | (75,098 | ) | 6,772 | |||||||||||||||
Exercise of common stock options (note 7) | 166,238 | 2 | 279 | — | 281 | ||||||||||||||||
Exercise of common stock warrants | 1,046,344 | 10 | (10 | ) | — | — | |||||||||||||||
Conversion of convertible debt (note 6) | 11,000,000 | 110 | 9,382 | — | 9,492 | ||||||||||||||||
Employee stock purchases (note 10) | 212,212 | 2 | 846 | — | 848 | ||||||||||||||||
Net income | — | — | — | 37,122 | 37,122 | ||||||||||||||||
Balance at December 28, 2002 | 30,727,101 | $ | 307 | �� | $ | 92,184 | $ | (37,976 | ) | $ | 54,515 | ||||||||||
See accompanying notes to consolidated financial statements.
F-5
SELECT COMFORT CORPORATION
Consolidated Statements of Cash Flows
2002 | 2001 | 2000 | ||||||||||||||
Cash flows from operating activities: | ||||||||||||||||
Net income (loss) | $ | 37,122 | $ | (12,066 | ) | $ | (37,214 | ) | ||||||||
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: | ||||||||||||||||
Depreciation and amortization | 9,194 | 9,570 | 8,390 | |||||||||||||
Amortization of debt discount and deferred finance fees | 1,279 | 512 | 19 | |||||||||||||
Loss on disposal of assets and impaired assets | 548 | 1,687 | 2,167 | |||||||||||||
Deferred tax (benefit) expense | (17,307 | ) | — | 10,887 | ||||||||||||
Change in operating assets and liabilities: | ||||||||||||||||
Accounts receivable | (647 | ) | 70 | (1,637 | ) | |||||||||||
Inventories | (894 | ) | 2,926 | 640 | ||||||||||||
Prepaid expenses | (1,879 | ) | 2,023 | 80 | ||||||||||||
Other assets | 1,441 | (2,244 | ) | 535 | ||||||||||||
Accounts payable | 1,292 | (2,055 | ) | 1,360 | ||||||||||||
Accrued compensation and benefits | 6,487 | 1,154 | (182 | ) | ||||||||||||
Other accruals and liabilities | (492 | ) | (1,163 | ) | 4,669 | |||||||||||
Net cash provided by (used in) operating activities | 36,144 | 414 | (10,286 | ) | ||||||||||||
Cash flows from investing activities: | ||||||||||||||||
Purchases of property and equipment | (7,802 | ) | (4,859 | ) | (12,084 | ) | ||||||||||
Investments in marketable securities | (24,780 | ) | — | — | ||||||||||||
Proceeds from maturity of marketable securities | 11,132 | 3,950 | 16,179 | |||||||||||||
Investment in affiliate | — | — | (400 | ) | ||||||||||||
Net cash (used in) provided by investing activities | (21,450 | ) | (909 | ) | 3,695 | |||||||||||
Cash flows from financing activities: | ||||||||||||||||
Principal payments on long-term debt | (5,022 | ) | (38 | ) | (16 | ) | ||||||||||
Proceeds from issuance of common stock | 1,129 | 370 | 664 | |||||||||||||
Net proceeds from long-term debt | — | 15,040 | — | |||||||||||||
Net cash (used in) provided by financing activities | (3,893 | ) | 15,372 | 648 | ||||||||||||
Increase (decrease) in cash and cash equivalents | 10,801 | 14,877 | (5,943 | ) | ||||||||||||
Cash and cash equivalents, at beginning of year | 16,375 | 1,498 | 7,441 | |||||||||||||
Cash and cash equivalents, at end of year | $ | 27,176 | $ | 16,375 | $ | 1,498 | ||||||||||
Supplemental Disclosure of Cash Flow Information | ||||||||||||||||
Cash paid during the year for: | ||||||||||||||||
Interest | $ | 1,655 | $ | 182 | $ | 7 | ||||||||||
Income taxes | 495 | 188 | 175 | |||||||||||||
Non-cash impact of conversion of debt to equity | 9,492 | — | — |
See accompanying notes to consolidated financial statements.
F-6
SELECT COMFORT CORPORATION
Notes to Consolidated Financial Statements
(1) Business and Summary of Significant Accounting Policies
Select Comfort Corporation and its wholly-owned subsidiaries (the Company) is the leading developer, manufacturer and marketer of premium quality, adjustable-firmness beds. The Company’s fiscal year ends on the Saturday closest to December 31.
Fiscal years 2002, 2001 and 2000 each had 52 weeks. Certain prior-year amounts have been reclassified to conformundersigned registrant relating to the current-year presentation. In particular, the Company has elected to reclassify costs associated with delivery of its products to customers, from sales and marketing expense to cost of sales. As a result of this change in presentation, cost of sales increased and sales and marketing expenses decreased by $17,134,000 and $16,677,000 in 2001 and 2000, respectively. This change in classification does not affect operating income or net income.
The consolidated financial statements include the accounts of Select Comfort Corporation and its subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation.
Cash and cash equivalents include highly liquid investments with original maturities of three months or less. The Company had $1,000,000 of its cash and cash equivalents securing a standby letter of credit at December 28, 2002.
Investments with an original maturity of greater than 90 days are classified as marketable securities. Marketable securities include highly liquid investment grade debt instruments issued by the U.S. government and related agencies and municipalities and commercial paper issued by companies with investment grade ratings. The Company’s investments have an original maturity of up to 24 months. Marketable securities with a remaining maturity of greater than one year are classified as long-term.
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, 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, 10 years or the date a store remodel is expectedoffering required to be completed.
Other assets include security deposits, patents, investments, trademarks, debt issuance costs and goodwill. Patents and trademarks are amortized using the straight-line method over periods ranging from 10 to 17 years. Debt issuance costs are amortized using the straight-line method over the term of the debt.
F-7
Notes to Consolidated Financial Statements — (Continued)
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.
The Company records compensation expense for option grants under its stock option plan if the current market value of the underlying stock at the grant date exceeds the stock option exercise price. Pro forma disclosure of the impact on net earnings (loss) 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 7. If the Company issues options to non-employees, compensation expense is recognized based on the fair market value method.
Costs incurred in connection with research and development are charged to expense as incurred. Research and development expense was $936,000, $1,086,000 and $889,000 in 2002, 2001 and 2000, respectively.
Costs associated with the opening of new stores are expensed as incurred.
The Company incurs advertising costs associated with print and broadcast advertisements. Such costs are charged to expense the first time the advertisement airs. Advertising expense was $39,477,000, $29,451,000 and $31,265,000 in 2002, 2001 and 2000, respectively.
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. A valuation allowance is recognized against any portion of deferred tax assets when realization of the deferred tax asset is not considered more likely than not.
Basic earnings (loss) per share excludes dilution and is computed by dividing the net income (loss) attributable to common shareholders by the weighted average number of common shares during the period. Diluted earnings (loss) per share includes potentially dilutive common shares consisting of stock options and warrants determined by the treasury stock method and dilutive convertible securities.
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial
F-8
Notes to Consolidated Financial Statements — (Continued)
statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Critical accounting policies consist of the following:
Revenue is recognized at the time of shipment to customers for products shipped with outside, third party carriers. Revenue is recognized at the time of delivery for products delivered through our company-controlled home delivery system. In both cases, revenue is recognized net of estimated returns.
The Company reviews its long-lived assets, certain identifiable intangibles, and goodwill 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.
The Company reviews store assets for possible impairment considering such factors as estimated store cash flows, lease termination provisions, and opportunities to impact future store operating results.
The test for goodwill impairment is a two-step process, and is performed on at least an annual basis. The first step is a comparison of the fair value of the reporting unit with its carrying amount, including goodwill. If this step reflects impairment, then the loss would be measured as the excess of recorded goodwill over its implied fair value. Implied fair value is the excess of fair value of the reporting unit over the fair value of all identified assets and liabilities.
Beginning in 2002, the Company stopped amortizing goodwill according to SFAS Statement 142 “Goodwill and Other Intangible Assets.” As a result, no amortization expense for goodwill was recorded in 2002. The carrying value of goodwill as of December 28, 2002 was $2,850,000. In 2001 and 2000, the Company recorded goodwill amortization expense of $374,000 ($0.02 per share) and $22,000 ($0.00 per share), respectively.
The Company provides a 20-year warranty on adjustable-firmness beds, the last 18 years of which are on a pro rated basis. Estimated warranty costs are expensed at the time of sale based on historical claims incurred by the Company. Actual warranty claim costs could differ from these estimates. The Company classifies as non-current those estimated warranty costs expected to be paid out in greater than one year. As of December 28, 2002, $3,626,000 of the accrued warranty costs was considered long-term. The activity in the accrued warranty liability account is as follows (in thousands):
Additions | ||||||||||||||||
Balance at | Charged to | |||||||||||||||
Beginning of | Costs and | Deductions | Balance at | |||||||||||||
Year | Expenses | from Reserves | End of Year | |||||||||||||
2002 | $ | 6,287 | $ | 2,433 | $ | 3,540 | $ | 5,180 | ||||||||
2001 | 7,181 | 2,708 | 3,602 | 6,287 | ||||||||||||
2000 | 5,841 | 5,397 | 4,057 | 7,181 |
F-9
Notes to Consolidated Financial Statements — (Continued)
Estimated sales returns are provided at the time of sale based upon historical sales returns. Returns are allowed by the Company for 30 nights following the sale.
The Financial Accounting Standards Board has issued statement SFAS 146 “Accounting for Costs Associated with Exit or Disposal Activities.” Statement 146 revises the timing of when costs associated with an exit or disposal activity are recognized. This statement requires that an entity recognize the liability for a cost associated with an exit or disposal activity when the liability is incurred, rather than at the date of an entity’s commitment to an exit plan as was previously allowed. The Company will account for any exit or disposal activities after December 28, 2002 under SFAS 146.
(2) Marketable Securities
Securities classified as held to maturity, which consist of securities that management has the ability and intent to hold to maturity, are carried at amortized cost and are summarized as follows as of December 28, 2002 (in thousands):
Effective | Amortized | |||||||||||
Interest Rate | Cost | Fair Value | ||||||||||
Corporate securities | 2.3 | % | $ | 501 | $ | 501 | ||||||
U.S. government agencies | 2.0 | 10,098 | 10,139 | |||||||||
Commercial paper | 1.4 | 3,049 | 3,052 | |||||||||
$ | 13,648 | $ | 13,692 | |||||||||
(3) Inventories
Inventories consist of the following (in thousands):
December 28, | December 29, | |||||||
2002 | 2001 | |||||||
Raw materials | $ | 2,669 | $ | 1,824 | ||||
Work in progress | 88 | 26 | ||||||
Finished goods | 6,223 | 6,236 | ||||||
$ | 8,980 | $ | 8,086 | |||||
(4) Property and Equipment
Property and equipment are summarized as follows (in thousands):
December 28, | December 29, | |||||||
2002 | 2001 | |||||||
Leasehold improvements | $ | 37,638 | $ | 36,551 | ||||
Office furniture and equipment | 4,083 | 3,496 | ||||||
Production machinery and computer equipment | 25,827 | 21,256 | ||||||
Less accumulated depreciation and amortization | (38,571 | ) | (30,421 | ) | ||||
$ | 28,977 | $ | 30,882 | |||||
F-10
Notes to Consolidated Financial Statements — (Continued)
Store closings and write-off expense was $233,000, $1,029,000 and $565,000 in 2002, 2001 and 2000, respectively.
In 2001 and 2000, the Company incurred charges of $337,000 and $1,387,000, respectively, related(ii) Any free writing prospectus relating to the impairment of carrying values of certain non-store assets. In 2001, these charges related primarily to the write-off of unusable fixtures for merchandising of sleeper sofa products. In 2000, these charges included $741,000 related to asset write-offs resulting from the relocation of the Company’s headquarters and $646,000 related to the write-off of web site software design costs.
(5) 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 (in thousands):
2002 | 2001 | 2000 | ||||||||||
Minimum rents | $ | 16,213 | $ | 16,069 | $ | 17,589 | ||||||
Percentage rents | 3,085 | 1,561 | 1,835 | |||||||||
Total | $ | 19,298 | $ | 17,630 | $ | 19,424 | ||||||
Equipment rent | $ | 1,913 | $ | 2,003 | $ | 1,587 | ||||||
The aggregate minimum rental commitments under operating leases for subsequent years are as follows (in thousands):
2003 | $ | 15,641 | ||
2004 | 14,401 | |||
2005 | 13,452 | |||
2006 | 12,018 | |||
2007 | 9,019 | |||
Thereafter | 11,988 | |||
$ | 76,519 | |||
F-11
Notes to Consolidated Financial Statements — (Continued)
(6) Long-Term Debt
Long-term obligations under notes and capital leases are as follows (in thousands, except share and per share amounts):
December 28, 2002 | December 29, 2001 | |||||||
8% senior subordinated convertible notes due June 2006 (the Notes). Face amount of $11,000 net of $925 debt discount in 2001, with interest payable annually. Convertible into 11,000,000 shares of common stock at the rate of $1.00 per share | $ | — | $ | 10,075 | ||||
12% senior secured debt due September 2006 (the Debt). Face amount of $5,000 net of $616 debt discount in 2001, with interest payable monthly | — | 4,384 | ||||||
Non-interest bearing subordinated convertible debenture due November 2005. Face amount of $4,000 net of $1,009 debt discount, with an effective interest rate of 12% per annum. Convertible into 727,272 shares of common stock at the rate of $5.50 per share | 2,991 | 2,645 | ||||||
Other | 11 | 33 | ||||||
3,002 | 17,137 | |||||||
Less current maturities | 11 | 28 | ||||||
$ | 2,991 | $ | 17,109 | |||||
The Notes were converted to 11,000,000 shares of common stock at the rate of $1.00 per share in 2002. The Debt was prepaid in 2002. All deferred financing costs were written off in connection with the early repayment of the Debt and have been reflected as an extraordinary loss.
The aggregate maturities of long-term debt for subsequent years are as follows (in thousands):
2003 | $ | 11 | ||
2004 | — | |||
2005 | 4,000 | |||
$ | 4,011 | |||
(7) Shareholders’ Equity
The Board of Directors has reserved 9,300,000 shares of common stock for options that may be granted to key employees, directorsoffering prepared by or others under the Company’s stock option plans. Options available for grant at December 28, 2002 were 1,365,846.
F-12
Notes to Consolidated Financial Statements — (Continued)
A summary of the changes in the Company’s stock option plans for each of the years in the three-year period ended December 28, 2002 is as follows:
Weighted | |||||||||
Average | |||||||||
Shares | Exercise Price | ||||||||
Outstanding at January 1, 2000 (including 1,311,133 shares exercisable) | 2,685,353 | $ | 9.92 | ||||||
Granted | 1,307,700 | 4.64 | |||||||
Exercised | (44,515 | ) | 3.09 | ||||||
Canceled | (429,267 | ) | 9.44 | ||||||
Outstanding at December 30, 2000 (including 1,726,097 shares exercisable) | 3,519,271 | 8.08 | |||||||
Granted | 1,766,900 | 1.03 | |||||||
Exercised | (694 | ) | 1.01 | ||||||
Canceled | (628,453 | ) | 8.74 | ||||||
Outstanding at December 29, 2001 (including 2,034,877 shares exercisable) | 4,657,024 | 5.32 | |||||||
Granted | 952,600 | 3.26 | |||||||
Exercised | (166,238 | ) | 1.69 | ||||||
Canceled | (123,267 | ) | 3.97 | ||||||
Outstanding at December 28, 2002 (including 2,980,786 shares exercisable) | 5,320,119 | $ | 5.09 | ||||||
The following table summarizes information about options outstanding at December 28, 2002:
Options Outstanding | Options Exercisable | |||||||||||||||||||
Average Remaining | Weighted | Weighted | ||||||||||||||||||
Contractual Life | Average | Average | ||||||||||||||||||
Range of Exercise Price | Shares | (years) | Exercise Price | Shares | Exercise Price | |||||||||||||||
$0.45 - 1.00 | 398,887 | 7.79 | $ | 0.99 | 142,804 | $ | 0.97 | |||||||||||||
1.01 - 2.75 | 2,107,216 | 8.59 | 1.75 | 898,538 | 1.64 | |||||||||||||||
2.76 - 7.00 | 1,798,796 | 6.52 | 5.22 | 1,164,224 | 5.23 | |||||||||||||||
7.01 - 14.00 | 398,245 | 6.40 | 8.38 | 368,245 | 8.28 | |||||||||||||||
14.01 - 28.63 | 616,975 | 6.28 | 16.69 | 406,975 | 17.33 | |||||||||||||||
$0.45 - 28.63 | 5,320,119 | 7.40 | $ | 5.09 | 2,980,786 | $ | 5.97 | |||||||||||||
No compensation cost has been recognized in the consolidated financial statements for employee stock option grants or the discount feature of the Company’s employee stock purchase plan. Had the Company determined compensation cost based on the fair value at the grant date for its stock options and employee stock purchase plan under an alternative accounting method, the Company’s net income (loss) would have been adjusted as outlined below (in thousands, except per share amounts):
2002 | 2001 | 2000 | ||||||||||||
Net income (loss): | As reported | $ | 37,122 | $ | (12,066 | ) | $ | (37,214 | ) | |||||
Pro forma | $ | 34,593 | $ | (15,239 | ) | $ | (39,763 | ) | ||||||
Income (loss) per share — basic: | As reported | $ | 1.51 | $ | (0.66 | ) | $ | (2.09 | ) | |||||
Pro forma | $ | 1.41 | $ | (0.84 | ) | $ | (2.23 | ) | ||||||
Income (loss) per share — diluted: | As reported | $ | 1.09 | $ | (0.66 | ) | $ | (2.09 | ) | |||||
Pro forma | $ | 1.02 | $ | (0.84 | ) | $ | (2.23 | ) |
F-13
Notes to Consolidated Financial Statements — (Continued)
The fair value of each option grant is estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions:
2002 | 2001 | 2000 | ||||||||||
Expected dividend yield | 0 | % | 0 | % | 0 | % | ||||||
Expected stock price volatility | 90 | % | 90 | % | 40 | % | ||||||
Risk-free interest rate | 2.0 | % | 4.9 | % | 5.9 | % | ||||||
Expected life in years | 3.6 | 3.5 | 3.6 | |||||||||
Weighted-average fair value at grant date | $ | 2.02 | $ | 0.34 | $ | 1.87 |
The Company has issued warrants to various holders with outstanding issuances at December 28, 2002 summarized below:
Warrants | ||||||||||||
Warrant Type | Exercise Price | Outstanding | Expiration Date | |||||||||
2001 Senior Secured Convertible Notes Financing | 1.00 | 3,380,000 | 6/6/11 | |||||||||
2001 Senior Secured Debt Financing | 1.02 | 922,819 | 9/26/06 | |||||||||
Miscellaneous other warrants | 1.20 - 5.56 | 562,256 | 5/17/04 - 6/6/11 | |||||||||
$1.00 - 5.56 | 4,865,075 | 5/17/04 - 6/6/11 | ||||||||||
The warrants issued in conjunction with the Notes and Debt were valued at $1,100,000 and $600,000, respectively, and were reflected in additional paid-in capital in the statement of shareholders’ equity. The associated debt discount was amortized as interest expense over the term of the debt until the related debt was converted or was repaid (note 6).
Miscellaneous other warrants consist of warrants issued to various parties in lieu of cash payments. The value of these warrants was recognized as compensation expense with an offset to shareholders’ equity utilizing the Black-Scholes pricing model with assumptions reflecting the market rates at the time of warrant issuance.
(8) Income Taxes
The (benefit) provision for income taxes consists of the following (in thousands):
2002 | 2001 | 2000 | |||||||||||
Current: | |||||||||||||
Federal | $ | — | $ | — | $ | — | |||||||
State | (340 | ) | — | 705 | |||||||||
(340 | ) | — | 705 | ||||||||||
Deferred: | |||||||||||||
Federal | (12,739 | ) | — | 10,397 | |||||||||
State | (4,683 | ) | — | 490 | |||||||||
(17,422 | ) | — | 10,887 | ||||||||||
Income tax (benefit) expense | $ | (17,762 | ) | $ | — | $ | 11,592 | ||||||
F-14
Notes to Consolidated Financial Statements — (Continued)
Effective tax rates differ from statutory federal income tax rates as follows:
2002 | 2001 | 2000 | ||||||||||
Statutory federal income tax rate | 35.0 | % | (35.0 | )% | (35.0 | )% | ||||||
Change in valuation allowance | (123.3 | ) | 31.4 | 82.2 | ||||||||
State income taxes, net of federal benefit | (1.8 | ) | — | (1.1 | ) | |||||||
Other | 0.1 | 3.6 | (0.9 | ) | ||||||||
(90.0 | )% | 0.0 | % | 45.2 | % | |||||||
The tax effects of temporary differences that give rise to deferred tax assets at December 28, 2002 and December 29, 2001 are as follows (in thousands):
2002 | 2001 | ||||||||||
Deferred tax assets: | |||||||||||
Current: | |||||||||||
Net operating loss carryforwards | $ | 7,904 | $ | — | |||||||
Inventory, warranty and returns reserves | 3,208 | 3,849 | |||||||||
Allowance for doubtful accounts | 129 | 118 | |||||||||
Other | 2,164 | 2,409 | |||||||||
Long term: | |||||||||||
Net operating loss carryforwards | 29 | 15,662 | |||||||||
Depreciation | 3,765 | 2,624 | |||||||||
Other | 749 | 516 | |||||||||
Total gross deferred tax assets | 17,948 | 25,178 | |||||||||
Valuation allowance | (641 | ) | (25,178 | ) | |||||||
Total net deferred tax assets | $ | 17,307 | $ | — | |||||||
During 2002, the Company recorded a reduction in the valuation allowance of $24,537,000. The reduction in the valuation allowance follows the Company’s return to profitability as a result of cost restructuring efforts in 2000 and 2001 and an increase in sales in 2002. The Company believes that it is more likely than not that it will generate sufficient taxable income to utilize its deferred tax assets, including net operating loss carryforwards, within any applicable carryover periods.
At December 28, 2002, the Company had net operating loss carryforwards for federal income tax purposes of approximately $20,900,000, of which $103,000 will expire between 2003 and 2006, with the remainder expiring between 2020 and 2021. The Company has recorded a valuation allowance of $641,000 for a capital loss carryforward that likely will not be utilized within its applicable carryforward period.
F-15
Notes to Consolidated Financial Statements — (Continued)
(9) Net Income (Loss) per Common Share
The following computations reconcile net income (loss) per share-basic with net income (loss) per share-diluted (in thousands, except share and per share amounts).
Net | Per Share | ||||||||||||
2002 | Income | Shares | Amount | ||||||||||
Basic EPS | |||||||||||||
Net income: | $ | 37,122 | 24,549,459 | $ | 1.51 | ||||||||
Effect of Dilutive Securities | |||||||||||||
Options | — | 1,882,807 | |||||||||||
Common stock warrants | — | 2,885,441 | |||||||||||
Convertible debt | 563 | 5,214,286 | |||||||||||
Diluted EPS | |||||||||||||
Net income plus assumed conversions | $ | 37,685 | 34,531,993 | $ | 1.09 | ||||||||
Net | Per Share | ||||||||||||
2001 and 2000 | Loss | Shares | Amount | ||||||||||
Basic and Diluted EPS | |||||||||||||
Net loss: | |||||||||||||
2001 | $ | (12,066 | ) | 18,157,005 | $ | (0.66 | ) | ||||||
2000 | $ | (37,214 | ) | 17,848,375 | $ | (2.09 | ) |
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:
2002 | 2001 | 2000 | ||||||||||
Options | 1,870,220 | 4,657,024 | 3,519,271 | |||||||||
Common stock warrants | 40,000 | 6,124,529 | 1,344,378 | |||||||||
Convertible debt | 727,272 | 11,727,272 | 727,272 |
(10) Employee Benefit Plans
Under the Company’s profit sharing and 401(k) plan eligible employees may defer up to 15% of their compensation on a pre-tax basis. Each year, the Company may make a discretionary contribution equal to a percentage of the employee’s contribution. During 2002, 2001 and 2000, the Company expensed $485,000, $119,000 and $487,000, respectively, relating to its contribution to the 401(k) plan. During 2002, the Company issued 81,778 shares for its discretionary contribution.
Under the Company’s Employee Stock Purchase Plan, employees can purchase Company common stock at a discount of 15% based on the average price of the stock on the last business day of the offering period (calendar-quarter.) The Company issued 145,434, 338,924 and 204,927 shares during 2002, 2001 and 2000, respectively.
(11) Commitments and Contingencies
In June 1999, the Company and certain of its former officers and directors were named as defendants in a class action lawsuit filed in U.S. District Court in Minnesota. The suit, filed on behalf of purchasersthe undersigned registrant or used or referred to by the undersigned registrant;
(iii) The portion of any other free writing prospectus relating to the offering containing material information about the undersigned registrant or its securities provided by or on behalf of the Company’s
F-16
Notes to Consolidated Financial Statements — (Continued)
common stock between December 4, 1998 and June 7, 1999, alleges that the Company and the named former directors and officers failed to disclose or misrepresented certain information concerning the Company in violation of federal securities laws. The Company believes that the suit is without merit and has vigorously defended the matter.
The Company has consented to a settlement of this litigation negotiated(iv) Any other communication that is an offer in the offering made by the Company’s insurance carrier. The settlement is covered by insurance and involves no cash or other payment obligation by the Company and no admission of liability or wrongdoing by the Company. The settlement is not expected to have any impact on the Company’s results of operations or financial condition.
On December 13, 2002, the settlement agreement received preliminary approval from the U.S. District Court for the District of Minnesota. The Court issued an order setting February 28, 2003 for a hearing for final approval of the settlement agreement. At the hearing for final approval, the Court will hear any objectionsundersigned registrant to the settlement or its terms.purchaser.
The Company is involved in other various claims, legal actions, sales tax disputes and other complaints arising in the ordinary course of business. In the opinion of management, any losses that may occur from these other matters are adequately covered by insurance or are provided for in the consolidated financial statements and the ultimate outcome of these other matters will not have a material effect on the consolidated financial position or results of operations of the Company.
The following is a condensed summary of actual quarterly results for 2002 and 2001 (in thousands, except per share amounts):
2002 | December | September | June | March | ||||||||||||
Net sales | $ | 92,263 | $ | 85,056 | $ | 77,281 | $ | 81,195 | ||||||||
Gross profit | 57,679 | 54,141 | 47,941 | 50,238 | ||||||||||||
Operating income | 8,836 | 5,833 | 2,984 | 3,369 | ||||||||||||
Income before extraordinary loss | 8,091 | 23,604 | 2,563 | 3,244 | ||||||||||||
Net income | 7,711 | 23,604 | 2,563 | 3,244 | ||||||||||||
Income per share before extraordinary loss — diluted | 0.22 | 0.69 | 0.08 | 0.11 | ||||||||||||
Net income per share — diluted | 0.21 | 0.69 | 0.08 | 0.11 |
2001 | December | September | June | March | ||||||||||||
Net sales | $ | 69,341 | $ | 64,148 | $ | 62,742 | $ | 65,456 | ||||||||
Gross profit | 42,376 | 38,714 | 35,942 | 37,445 | ||||||||||||
Operating income (loss) | 1,659 | 603 | (3,176 | ) | (9,688 | ) | ||||||||||
Net income (loss) | 1,065 | 227 | (3,530 | ) | (9,828 | ) | ||||||||||
Net income (loss) per share — diluted | $ | 0.04 | $ | 0.01 | $ | (0.19 | ) | $ | (0.54 | ) |
F-17
Shares
Thomas Weisel Partners LLC
PART II
INFORMATION NOT REQUIRED IN PROSPECTUS
Item 14. Other Expenses of Issuance and Distribution
The aggregate estimated expenses (except the SEC registration fee and NASD filing fee, which are actual expenses) to be paid by us in connection with this offering are as follows:
SEC registration fee | $ | 3,611 | |||
NASD filing fee | 4,963 | ||||
Blue sky fees and expenses | 10,000 | ||||
Accounting fees and expenses | 50,000 | ||||
Legal fees and expenses | 75,000 | ||||
Printing expenses | 75,000 | ||||
Transfer agents’ fees | 3,500 | ||||
Miscellaneous | 7,926 | ||||
Total | $ | 230,000 | |||
None of the expenses listed above will be borne by the selling shareholders.
Item 15. Indemnification of Directors and Officers
Minnesota Statutes, Section 302A.521 provides that a Minnesota business corporation shall indemnify any director, officer, employee or agent of the corporation made or threatened to be made a party to a proceeding, by reason of the former or present official capacity (as defined) of the person, against judgments, penalties, fines, settlements and reasonable expenses incurred by the person in connection with the proceeding if certain statutory standards are met. “Proceeding” means a threatened, pending or completed civil, criminal, administrative, arbitration or investigative proceeding, including one by or in the right of the corporation. Section 302A.521 contains detailed terms regarding such right of indemnification and reference is made thereto for a complete statement of such indemnification rights.
Our restated articles of incorporation and our restated bylaws also require us to provide indemnification to directors and officers to the fullest extent of the Minnesota indemnification statute.
We also maintain a directors’ and officers’ insurance policy pursuant to which our directors and officers are insured against liability for certain actions in their capacity as directors and officers.
Item 16. Exhibits
* Previously filed.
II-1
Item 17. Undertakings
The undersigned registrant hereby undertakes that, for(b) For purposes of determining any liability under the Securities Act of 1933, each filing of the registrant’sregistrant's annual report pursuant to Sectionsection 13(a) or Sectionsection 15(d) of the Securities Exchange Act of 1934 (and, where applicable, each filing of an employee benefit plan’splan's annual report pursuant to Sectionsection 15(d) of the Securities Exchange Act of 1934) that is incorporated by reference in thisthe registration statement willshall be deemed to be a new registration statement relating to the securities offered herein,therein, and the offering of such securities at that time willshall be deemed to be the initial bona fide offering thereof.thereof
II-4
(c) Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions described in Item 15 above, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act of 1933 and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Securities Act of 1933 and will be governed by the final adjudication of such issue.
The undersigned(d) (1) For purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and contained in a form of prospectus filed by the registrant hereby undertakes that:
(2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. | |
II-2II-5
Pursuant to the requirements of the Securities Act of 1933, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements forof filing on Form S-3 and has duly caused this amendmentregistration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Minneapolis, State of Minnesota on April 3, 2003.November 20, 2009.
Select Comfort Corporation | ||||
By: | /s/ WILLIAM R. MCLAUGHLIN |
President and Chief Executive Officer (Principal Executive Officer) | ||||
By: | /s/ JAMES C. RAABE Senior Vice President and Chief Financial Officer ( |
Pursuant to the requirements of the Securities Act of 1933, this amendmentregistration statement has been signed as of April 3, 2003 by the following persons in the capacities indicated.indicated, on November 20, 2009.
Signature | Title | Date | |||||
---|---|---|---|---|---|---|---|
/s/ WILLIAM R. MCLAUGHLIN William R. McLaughlin | President and Chief Executive Officer | November 20, 2009 | |||||
/s/ JAMES C. RAABE James C. Raabe | Senior Vice President and Chief Financial Officer | November 20, 2009 | |||||
/s/ THOMAS J. ALBANI Thomas J. Albani | Director | November 20, 2009 | |||||
Christine M. Day | Director | November 20, 2009 | |||||
/s/ STEPHEN L. GULIS, JR. Stephen L. Gulis, Jr. | Director | November 20, 2009 | |||||
/s/ CHRISTOPHER P. KIRCHEN Christopher P. Kirchen | Director | November 20, 2009 | |||||
/s/ DAVID T. KOLLAT David T. Kollat | Director | November 20, 2009 |
Signature | Title | Date | ||
---|---|---|---|---|
Director | ||||
November 20, 2009 | ||||
Michael A. Peel | Director | November 20, 2009 | ||
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Ervin R. Shames | Director | |||
November 20, 2009 | ||||
/s/ JEAN-MICHEL VALETTE Jean-Michel Valette | Director | November 20, 2009 |
Exhibit Number | Description of Exhibit | ||
---|---|---|---|
3.2 | Articles of Amendment to Third Restated Articles of Incorporation of the Company(2) | ||
3.3 | Restated Bylaws of Select Comfort Corporation(3) | ||
5.1 | Opinion of Oppenheimer Wolff & Donnelly LLP** | ||
10.1 | Registration Rights Agreement, dated October 2, 2009, by and among Select Comfort Corporation and Sterling SC Investor, LLC(4) | ||
23.1 | Consent of KPMG LLP, Independent Registered Public Accounting Firm** | ||
23.2 | Consent of Oppenheimer Wolff & Donnelly LLP (included in Exhibit 5.1) |
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