UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 30, 2000
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to __________________.
COMMISSION FILE NO. 0-25121
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SELECT COMFORT CORPORATION
(Exact name of registrant as specified in its charter)
MINNESOTA 41-1597886
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
6105 TRENTON LANE NORTH
MINNEAPOLIS, MINNESOTA 55442
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (763) 551-7000
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.01 PAR VALUE
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
As of March 28, 2001, 18,055,633 shares of Common Stock of the Registrant
were outstanding, and the aggregate market value of the Common Stock of the
Registrant as of that date (based upon the last reported sale price of the
Common Stock at that date as reported by the Nasdaq National Market System),
excluding outstanding shares beneficially owned by directors and executive
officers, was $16,500,517.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-K incorporates by reference
information (to the extent specific sections are referred to herein) from the
Registrant's Proxy Statement for its 2001 Annual Meeting (the "2001 Proxy
Statement").
TABLE OF CONTENTS
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PART I.........................................................................2
ITEM 1. BUSINESS...........................................................2
General...................................................................2
Business and Growth Strategy..............................................2
Products..................................................................5
Retail Stores.............................................................6
Direct Marketing Operations...............................................7
E-Commerce................................................................8
Marketing and Advertising.................................................9
Consumer Education and Customer Service..................................10
Manufacturing and Distribution...........................................10
Suppliers................................................................11
Intellectual Property....................................................11
Competition..............................................................11
Consumer Credit Arrangements.............................................12
Governmental Regulation..................................................12
Employees................................................................12
Certain Risk Factors.....................................................13
ITEM 2. PROPERTIES........................................................20
ITEM 3. LEGAL PROCEEDINGS.................................................20
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY.................................22
PART II.......................................................................21
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SHAREHOLDER MATTERS...............................................23
Number of Record Holders; Dividends......................................24
Use of Proceeds from Initial Public Offering.............................24
ITEM 6. SELECTED FINANCIAL DATA...........................................25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.........................................26
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.........32
ITEM 8. FIANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................32
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..........................................32
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PART III......................................................................30
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................33
Directors, Executive Officers, Promoters and Control Persons.............33
Section 16(a) Beneficial Ownership Reporting Compliance..................33
ITEM 11. EXECUTIVE COMPENSATION............................................33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT........................................................33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................33
PART IV.......................................................................34
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
8-K...............................................................34
Index to Consolidated Financial Statements...............................31
Index to Consolidated Financial Statement Schedules......................31
Exhibits.................................................................32
Reports on Form 8-K......................................................33
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Our fiscal year ends on the Saturday closest to December 31, and unless the
context otherwise requires, all references to years in this Form 10-K refer to
our fiscal years. All references to "Select Comfort," "the Company," "we" or
"us" herein include our wholly owned subsidiaries, Select Comfort Direct
Corporation, Select Comfort Retail Corporation, Direct Call Centers, Inc.,
Select Comfort SC Corporation and selectcomfort.com corporation.
Select Comfort(R), Sleep Number(R), Comfort Club(R), Sleep Better on
Air(R), Sleep Insurance(R), The Sleep Number Bed by Select Comfort(TM) The Sleep
Number Store by Select Comfort(TM), Firmness Control System(TM), Select Comfort
Sofa Sleepaire(TM), Select Comfort Sofa Sleepaire Collection(TM) and the
Company's stylized logos are trademarks and/or service marks of the Company.
ii
PART I
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This Form 10-K contains certain forward-looking statements. For this
purpose, any statements contained in this Form 10-K that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing, words such as "may," "will," "expect," "believe," "anticipate,"
"estimate" or "continue" or comparable terminology are intended to identify
forward-looking statements. These statements by their nature involve substantial
risks and uncertainties, and actual results may differ materially depending on a
variety of factors, including those set forth under the heading below entitled
"Certain Risk Factors."
ITEM 1. BUSINESS
GENERAL
Select Comfort is the leading manufacturer, specialty retailer and direct
marketer of premium quality, innovative adjustable-firmness beds and other
sleep-related products. We believe we are revolutionizing the mattress industry
by offering a differentiated product through a variety of service-oriented
distribution channels.
Our products address broad-based consumer sleep problems, resulting in a better
night's sleep. In comparison with traditional mattress products, our proprietary
Sleep Number beds utilize adjustable air chamber technology to more naturally
contour to the body, thereby generally providing:
- - better spinal alignment,
- - reduced pressure points,
- - greater relief of lower back pain,
- - greater overall comfort, and
- - better quality sleep.
Our Firmness Control System allows customers to independently customize each
side of the Sleep Number bed to their ideal level of firmness, comfort and
support.
Unlike traditional mattress manufacturers, we have historically sold our
products directly to consumers through three controlled, complementary and
service-oriented distribution channels:
- - RETAIL, including company-operated retail stores and leased departments
within larger retail stores,
- - DIRECT MARKETING, including a company-operated call center, and
- - E-COMMERCE, through our Web site at selectcomfort.com.
In 2000, we began to develop wholesale relationships with a leading home
furnishings retailer and with the QVC shopping channel.
At December 30, 2000, our retail operations included 333 stores in 45 states,
including 25 leased departments within larger retail stores.
Select Comfort was incorporated in Minnesota in February 1987. Our principal
executive office is located at 6105 Trenton Lane North, Minneapolis, Minnesota
55442. Our telephone number is (763) 551-7000.
BUSINESS AND GROWTH STRATEGY
Following the arrival of William R. McLaughlin as the Company's new President
and CEO at the end of the first quarter of fiscal 2000, we have focused on five
primary strategic priorities: (i) building consumer awareness, (ii) rightsizing
our cost structure, (iii) improving our sales conversion effectiveness, (iv)
pursuing alternative distribution channels, and (v) continuously improving
product quality, innovation and service levels. Each of these
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strategic priorities is discussed in greater detail below.
BUILDING AWARENESS. Lack of awareness among the broad consumer audience of our
brand, product benefits and store locations has been our most significant
barrier to growth. Though we have incurred significant cumulative advertising
spending over the last few years, and we have a large customer base and
extraordinary customer satisfaction ratings and referrals, we have had
relatively low levels of consumer awareness of our brand, product benefits and
store locations. We generally see a close correlation between consumer awareness
levels in a market (due to factors such as the length of our presence in the
market, our cumulative advertising spending, store density per population and
word-of-mouth referrals) and our share of overall mattress sales in the market.
As a result, our current marketing efforts are focused on increasing consumer
awareness through appealing to a broader demographic audience with advertising
and other marketing programs that showcase the unique features and benefits of
our product.
Historically, our marketing personnel had been spread across our various sales
channels. Early in 2000, we laid the groundwork for developing integrated,
consistent and efficient marketing messages by consolidating our marketing
personnel into one organization.
In mid-2000, we renewed our relationship with New York-based advertising agency
Messner Vetere Berger McNamee Schmetterer/Euro RSCG to help us design and
implement a breakthrough brand and marketing program. In the second half of
2000, working with this agency, the marketing team focused its efforts on the
repositioning of our product, brand and marketing messages around our Sleep
Number bed. Our Sleep Number campaign focuses on the unique features and
benefits of our product: individualized and adjustable firmness, comfort and
support to provide a perfect nights sleep. This message has broader appeal than
many of our traditional marketing messages, is being delivered through the
broader reach of prime time TV in selected markets, and is targeted at a broader
demographic audience. We launched our Sleep Number campaign in two pilot markets
in January 2001 and in six of our largest markets in February 2001, with
encouraging initial results. See "-Marketing and Advertising."
RIGHTSIZING OUR COST STRUCTURE. In 2000, we began to implement initiatives to
bring our cost structure in line with our sales volumes, with the ultimate
objective of making our core bed business profitable at 2000 sales volumes and
to enable funding of awareness building marketing programs. Specific actions
taken to improve our cost structure include:
- - Termination of non-core business initiatives, including catalog, road show
and event marketing, and expenses related to investment in the initial
launch of the sofa sleeper product line and relaunch of the Company's web
site,
- - Rebalancing of manufacturing between our three plant locations,
- - Selling expense savings from reducing our sales infrastructure by closing
27 under-performing retail stores and our direct call center in South
Carolina, and by streamlining retail management and store staffing levels,
- - Corporate general and administrative expense savings from reductions in
corporate staff and consolidating our two Minneapolis offices,
- - Logistics cost savings from systems and packaging improvements to enable
shipping with Fed Ex as well as UPS,
- - Product cost reductions with equal or superior quality and reduced product
returns, and
- - Promotional discount reductions through improved program design and
controls.
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In 2001, we are continuing to aggressively pursue additional cost saving
opportunities. In April of 2001, we ceased manufacturing in our Minneapolis,
Minnesota, plant. This plant will continue to function as a center for
processing returns and warranty and replacement parts, and as a cross-dock for
regional distribution. We reduced our workforce by 76 positions in April 2001
from the cessation of manufacturing in Minneapolis and from unrelated reductions
in our corporate staff.
IMPROVING SALES CONVERSION. To improve the effectiveness of our sales conversion
process, we have developed and are implementing a variety of initiatives,
including:
- - awareness building programs that are designed to drive more knowledgeable
and motivated consumers to our points of distribution,
- - a simplified and close-oriented selling process focused on the unique
features and benefits of our product and the value proposition that our
product delivers,
- - enhancement of the consumer's in-store experience through the use of tools
that better demonstrate the benefits of our products,
- - improvements in the appearance of our products,
- - changes in our direct marketing call center strategy to drive more traffic
to our retail stores,
- - offering different and more creative financing alternatives for our
customers,
- - expanding our home delivery, assembly and mattress removal capability to
additional markets,
- - compensation and incentive plans that are more highly commission-driven and
close-oriented, and
- - changes in our promotional schedule to better leverage key consumer
shopping dates.
ALTERNATIVE DISTRIBUTION CHANNELS. An important element of our growth strategy
is to increase opportunities for consumers to become aware of, and to purchase,
our products. In 2000, we tested two additional avenues for awareness and
distribution.
In September 2000, we established our first wholesaling relationship with
Gabberts, a leading home furnishings retailer in Minneapolis/St. Paul and Dallas
metropolitan areas. In 2001, we are seeking to expand our relationship with
Gabberts and to develop similar wholesaling relationships with other leading
home furnishings retailers in additional markets. We believe that these
relationships may enable us to leverage our advertising spending in key markets.
In October 2000, we tested the offering of our products on the QVC television
shopping channel with a one hour program. This successful test led to an
additional one-hour program in December 2000 and three hours in early March of
2001, each of which resulted in sales exceeding our expectations. We plan to
expand our relationship with QVC in 2001, which we believe will increase overall
consumer awareness of our product and brand in addition to providing an
important sales channel.
INNOVATION AND CONTINUOUS PRODUCT LINE AND SERVICE LEVEL IMPROVEMENT. We believe
that our future success will depend in part on our ability to continue to lead
the mattress industry in innovation and to continue to improve our product line
and service levels. In 2000, we reinvigorated our research and development
capability to focus on continuous product improvements to deliver:
- - new and enhanced consumer benefits,
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- - improved product quality, and
- - reduced product or delivery costs.
In the second half of 2000, we introduced our new line of foundations that
provide both new and enhanced consumer benefits over the previous generation of
foundations, as well as reduced product delivery costs. In addition, we have
recently introduced new ticking for improved appearance of our Classic and Elite
models.
In November 2000, we acquired the assets of SleepTec, Inc., the innovator and
manufacturer of our sofa sleeper product. Until April 2001, we have been
devoting a portion of our product development resources to improving the
features, benefits and quality of this product line for a relaunch in the second
half of 2001. In April 2001, consistent with our cost reduction efforts and in
order to focus our resources on our core product line, we delayed the relaunch
of this product line beyond 2001.
We have taken initial steps toward providing in-home delivery, assembly and
mattress removal throughout the continental United States. To date, in-home
delivery and assembly has been provided through our retail channel and is
currently provided in connection with approximately 6% of our sales. We began
testing mattress removal during the fourth quarter of 2000 and expect to offer
this service in additional markets in 2001.
PRODUCTS
BEDS. Select Comfort offers four different Sleep Number bed models. Each bed
comes in standard mattress sizes, ranging from twin to California king, as well
as a waterbed replacement model. In addition, all Sleep Number beds feature a
patented single- or dual-air chamber. The dual chamber allows each side of the
mattress to be adjusted independently with the Firmness Control System for
personalized comfort and support.
Our Imperial and Ultra Series of mattresses feature a patented wireless remote
control with a digital display of the user's Sleep Number, which reflects the
level of firmness and allows the consumer to easily adjust and readjust the
firmness level to their personal preference. This feature is also available with
our Classic and Elite Series of beds for an additional charge.
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 comfortable,
durable Belgian Damask covering which combines cotton and/or rayon for comfort
and durability.
The contouring and support of a Sleep Number mattress works best with a
specially designed foundation from Select Comfort. 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. It
is designed with interlocking panels for maximum structural integrity, as well
as high-density polymer side panels and lateral support beams for additional
support. And unlike traditional box springs, the foundation can be easily moved
around corners and up and down stairs. The Select Comfort foundation is made of
100 percent recyclable material.
Sleep Number beds can be quickly assembled by customers through a simple
tool-free process. Furthermore, because air is the primary support material of
the mattress, Sleep Number beds do not lose their shape or support over time
like traditional mattresses and box springs. Each bed is accompanied with
instructional product brochures and easy-to-follow assembly instructions, is
certified by Underwriter's Laboratories and is backed by a 20-year limited
warranty and our 30 Night Trial and Better Night's Sleep Guarantee. We have
historically offered our customers a 90-night in-home trial period under which
the customer may return the bed within the first 90 days for a refund. The
5
customer is obligated to pay the return shipping charge. Effective May 29, 2001,
we plan to shorten our in-home trial period to 30 days.
ACCESSORY PRODUCTS. In addition to mattresses and matching foundations, we offer
a line of accessory products, including bed frames and a line of high quality
mattress pads and specialty pillows, all designed to provide superior comfort
and better quality sleep.
SOFA SLEEPERS. In 2000, we introduced a line of sofa sleepers with air-supported
mattresses in select markets. This product offers significant advantages over
traditional sofa sleeper products, including an 11-inch thick air supported
mattress that provides all the benefits of adjustable and individualized
comfort, firmness and support. In November 2000, we acquired the assets of
SleepTec, Inc., the innovator and manufacturer of our sofa sleeper product.
Until April 2001, we have been devoting a portion of our product development
resources to improving the features, benefits and quality of this product line
for a relaunch in the second half of 2001. In April 2001, consistent with our
cost reduction efforts and in order to focus our resources on our core product
line, we delayed the relaunch of this product line beyond 2001.
PRODUCT ENGINEERING. We maintain an active engineering department that
continuously seeks to enhance our knowledge of sleep science and to improve
current product performance and benefits. Through customer surveys and consumer
focus groups, we seek feedback on a regular basis to help enhance our products.
Since the introduction of our first bed, we have continued to improve and expand
our product line, including quieter Firmness Control Systems, remote control
gauges with digital settings, more luxurious fabrics and covers, new generations
of foams and foundation systems and enhanced border walls. Our research and
development expenses were $.9 million for 2000, $1.9 million for 1999 and $1.6
million for 1998.
RETAIL STORES
Since our first retail stores were opened in 1992, an increasing percentage of
our net sales has occurred at our retail stores, and retail store sales now
account for a majority of our net sales. At December 30, 2000, we had 333 stores
in 45 states, including 25 leased departments. In 2001, we currently plan to
close at least 14 under-performing retail locations and to open approximately 13
retail stores.
STORE ENVIRONMENT. Our previous store design featured novel visual images on the
walls in order to command attention to our innovative products. In 2000 we
adopted a new store design with a bedroom-like setting intended to convey a
sense of sophistication and quality that reinforces Select Comfort's brand image
as synonymous with sleep solutions. We remodeled approximately 66 of our stores
with this updated retail store design in 2000. In connection with the launch of
our Sleep Number campaign in two markets in January and six of our largest
markets in February, the store marquees in these markets were changed to "The
Sleep Number Store." Internal signage in all of our stores nationwide has been
changed to support the Sleep Number brand and product message. Our retail stores
are principally showrooms, averaging approximately 900 square feet, with several
display models from our line of air beds and a full display of our branded
accessories.
Our sales professionals play an important role in creating an inviting and
informative retail environment. These professionals receive extensive training
regarding the features and benefits of our proprietary technology and products
as well as on the overall importance of sleep quality. This enables them to more
effectively introduce consumers to our products, emphasize the features and
benefits that distinguish Select Comfort beds from traditional mattresses,
determine the consumers' needs, encourage consumers to experience the comfort
and support of Sleep Number beds and answer questions regarding our products.
6
SITE SELECTION. In selecting new store sites, we generally seek high-traffic
mall locations of approximately 800 to 1,200 square feet within malls in major
metropolitan and regional areas. We conduct extensive analyses of potential
store sites and base our selection on a number of factors, including the
location within the mall, demographics of the trade area, the specifications of
the mall (including size, age, sales per square foot and the location of the
nearest competitive mall), the perceived strength of the mall's anchor stores,
the performance of other specialty retail tenants in the mall, the number of
direct marketing inquiries received from the area surrounding the mall, store
density of existing stores and marketing and advertising plans in the respective
markets. Clustering of retail stores within a metropolitan retail market is a
key consideration in order to leverage our advertising.
MARKETING AND ADVERTISING. We historically have supported some of our multiple
store markets with media primarily focused on the use of radio personalities. In
connection with the Sleep Number campaign in selected markets, we have broadened
our media reach and target audience through drive-time radio prime-time TV and
periodic newspaper inserts. The Sleep Number campaign has to-date been
introduced in two pilot markets and in six of our strongest markets, in terms of
sales and store density, to best leverage the media spending. In addition, our
integrated approach to marketing across our multiple channels is designed to
deliver consistent messages about our Sleep Number beds and to direct customers
to our retail stores.
We also support new store openings with mailings to direct response inquiries
and potential prospects in the market, and in some markets with print and radio
advertisements.
MANAGEMENT AND EMPLOYEES. Our stores are currently organized into six regional
areas and 39 geographic districts, with approximately eight to 10 stores in each
district. Each regional sales director oversees approximately seven geographic
districts. Each district has a district sales manager who is responsible for the
sales and operations and who reports to a regional sales director. The district
sales managers frequently visit stores to review merchandise presentation, sales
force product knowledge, financial performance and compliance with operating
standards. The typical staff of a Select Comfort store consists of one store
manager and two full-time sales professionals. In order to maintain high
operating standards, we recruit store managers who typically have one to four
years of experience as a store manager in specialty retailing. Our sales
professionals devote substantially all of their efforts to sales and customer
service, which includes helping customers and generating and responding to
inquiries. In addition, to promote consumer education, ensure customer
satisfaction and generate referrals, the sales professionals place follow-up
calls to customers who have made recent purchases or inquiries.
TRAINING AND COMPENSATION. All store personnel receive comprehensive on-site
training on our technology and sleep expertise, the features and benefits of our
beds, sales and customer service techniques and operating policies and
guidelines. Initial training programs are reinforced through detailed product
and operating manuals and periodic performance appraisals. All store sales
professionals receive base compensation and are entitled to commissions based on
individual and store-wide performance. In 2001, our compensation program will be
more heavily commission-based, which we believe will enable us to attract and
retain more sales-oriented store professionals. Regional sales directors,
district sales managers and store managers are eligible to receive, in addition
to their base compensation, incentive compensation for the achievement of
performance objectives by the stores within their responsibility.
DIRECT MARKETING OPERATIONS
Many consumers' initial exposure to the Select Comfort Sleep Number bed is
through our direct marketing operations. Typically, an interested consumer will
respond to one of our advertisements by calling our toll-free number.
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On this call, one of our direct marketing sales professionals captures
information from the consumer, begins the consumer education process, takes
orders, or, if appropriate, sends a thorough information packet or directs the
consumer to our other distribution channels (retail or e-commerce). The direct
marketing operations are conducted by knowledgeable and well-trained sales
professionals, including a group of over 30 sales professionals who field
incoming direct marketing inquiries, and over 10 sales professionals who make
outbound calls to consumers who have previously contacted us. The direct
marketing operations also include a database marketing department that is
responsible for the mailing of product and promotional information to direct
response inquiries. We maintain a database of information on approximately 6.6
million inquiries, including customers who have purchased a bed from us.
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 at various
intervals. Recently, the direct marketing channel has relied heavily on
nationally syndicated radio personalities, such as Paul Harvey and Rush
Limbaugh, and has expanded print and direct mail programs. Our direct marketing
operations continually monitor the effectiveness and efficiency of our
advertising through tracking the cost per inquiry and cost per order of our
advertising, and use sophisticated media buying techniques to improve
efficiency.
Our direct marketing operations also support our other distribution channels
through referrals, as well as mailings to direct marketing inquiries in selected
markets in advance of retail store openings and events. As our base of retail
stores has expanded, our direct marketing sales professionals have increasingly
been able to refer direct marketing inquiries to a convenient retail store
location, improving the process of converting inquiries into sales and providing
the consumer with a choice of service venues.
E-COMMERCE
Our Web site at selectcomfort.com provides consumers with a wide array of useful
information as well as the convenience to order our products online or to call
to order 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 research and science,
- - our products and the benefits they provide,
- - store locations and other means to contact us and experience our products,
- - customer testimonials,
- - customer service information, and
- - current sales and promotional events.
Our e-commerce channel has also focused on developing relationships with online
shopping malls and other sales portals and affiliates.
We launched our redesigned Web site in the second half of 2000 with an updated
look and feel that is attractive, professional and reinforces the Select Comfort
brand image. The redesigned site allows greater functionality to provide more
personalization, guided selling, dynamic content and promotions and a more
robust online shopping experience. The site is maintained through a content
management system that allows for efficient management of Web site content as
well as technical maintenance.
Earlier this year we launched a new site, sleepnumber.com, to support the Sleep
Number brand in the advertising test markets. The site offers visitors the
opportunity to estimate their Sleep Number online and includes a store locator
to encourage them to visit a store to find their Sleep Number on a Sleep Number
bed.
On March 28, 2001, we launched another site, beds.com, to increase awareness of
the Sleep Number bed and air-supported sleep systems as
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an important bed category. The target audience is shoppers at any point in the
mattress consideration process. Beds.com provides mattress comparisons between
types of beds (from innerspring to water), leading brands, important mattress
features to look for, price and value and includes tips for choosing the right
mattress. The site also provides specific information on the Sleep Number bed
and links to selectcomfort.com for additional information. The beds.com site
will be advertised on our online shopping portals and we intend to monitor
traffic to the site and the impact on awareness levels and sales. Our goal is to
increase awareness of our product category and its unique benefits, bringing the
Sleep Number bed into the consideration set for people currently in the mattress
shopping cycle.
MARKETING AND ADVERTISING
Lack of awareness among the broad consumer audience of our brand, product
benefits and store locations has historically been our most significant barrier
to growth. Despite significant cumulative advertising spending over the last few
years, and our large customer base with extraordinary customer satisfaction
ratings and referrals, we generally have relatively low levels of consumer
awareness. Although awareness levels are higher in certain markets, our national
brand awareness has only been about 3%, compared with 40% to 60% or more for
some of our competitors offering traditional innerspring mattresses. Our current
marketing efforts are therefore directed at increasing consumer awareness
through a broader message, focused on the unique features and benefits of our
product, delivered through broader reach media and appealing to a broader
demographic audience.
In the second half of 2000, our marketing team focused on the repositioning of
our product, brand and marketing messages around the unique and proprietary
features and benefits of our Sleep Number bed. The Sleep Number bed offers
adjustable and individualized firmness and a numerical representation of the
consumer's ideal level of firmness, comfort and support to provide a perfect
night's sleep. The architecture of the Sleep Number marketing campaign is that
knowing your Sleep Number is the key to a perfect night's sleep; you can only
find your Sleep Number on a Sleep Number bed; and you can only purchase a Sleep
Number bed at The Sleep Number Store by Select Comfort. This architecture is
designed to build strong brand, product and store awareness.
We believe this Sleep Number message enables consumers to more quickly
understand the unique benefits of our product and has broader appeal than many
of our traditional marketing messages.
In early 2001, a new integrated advertising campaign was introduced into eight
test markets, and has produced favorable initial, in comparison with
non-advertised markets.
Through the broader reach of prime-time TV and drive-time radio, the Sleep
Number messages are targeted at a broader demographic audience than we have
traditionally reached. The campaign includes five 30-second TV spots run at
prime time on local network affiliates, seven 30-second radio spots, with
periodic newspaper advertising for urgency messages. We are testing various
levels of spending and media mixes with this advertising during 2001.
We have plans to roll this campaign to more markets in 2001, depending on the
efficiency and effectiveness we see from the initial markets.
Though the initial focus of the Sleep Number campaign is on our retail stores,
through the integration of our marketing messages across all of our channels,
the Sleep Number repositioning is company-wide, including our direct and
e-commerce channels. Retail store marquees have been changed to "The Sleep
Number Store" only in the eight markets with full media support. Internal
signage in all of our stores has been changed to support the Sleep Number brand
and message.
The Sleep Number campaign is being funded by reductions in other less efficient
advertising and
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by reductions in promotional discounts that do not contribute to brand, product
or store awareness levels. In total, year 2001 marketing expenditures are
planned to be lower than the year 2000, despite this new initiative.
Though it is too soon to draw definitive conclusions regarding the effectiveness
and efficiency of the Sleep Number campaign from the initial markets, early
results indicate significant additional product and brand awareness, as well
significant additional store traffic and sales in comparison with non-advertised
markets.
CONSUMER EDUCATION AND CUSTOMER SERVICE
We are committed to achieving our goal of world class customer satisfaction and
service. We intend to achieve this goal through a variety of means designed to:
- - educate consumers on the benefits of Select Comfort products,
- - deliver superior quality products,
- - maximize our direct relationship with consumers,
- - maximize convenience for the consumer, and
- - respond quickly to consumer needs and inquiries.
We believe that educating consumers about the features and benefits of our
products is critical to the success of our marketing and sales efforts, and we
devote considerable time and resources to training programs for our sales
professionals. Our retail stores and our web site also provide customers with
the latest information on sleep research and science and the benefits of our
products.
Our controlled distribution channels optimize our direct contact with customers
and allow us to respond quickly to customer service inquiries and enhance
customer satisfaction. Our multiple distribution channels also enhance the
convenience for the consumer to purchase products through a variety of venues.
In addition, we have been testing the offering of in-home delivery, assembly and
mattress removal services in selected markets. We are developing plans to
ultimately provide these services nationwide across all of our distribution
channels in order to increase overall sales and enhance customer satisfaction.
We maintain an in-house customer service department of over 40 customer service
representatives who receive extensive training in sleep technology and all
aspects of our products and operations. Our customer service representatives
field customer calls and also interact with each of our retail stores to address
customer questions and concerns raised with retail sales professionals. The
customer service department makes outbound calls to new customers during our in
home trial phase to answer questions and provide solutions to possible problems
in order to enhance customer education, build customer satisfaction and reduce
returns.
MANUFACTURING AND DISTRIBUTION
Our manufacturing operations are located in Minneapolis, Minnesota, Columbia,
South Carolina, and Salt Lake City, Utah. These operations consist of quilting
and sewing of the fabric covers for our beds, assembly of Firmness Control
Systems and final assembly and packaging of mattresses and foundations from
contract manufactured components. In April 2001, we discontinued manufacturing
in our Minneapolis location. We will continue to process returns and warranty
claims in this location, but manufacturing of our beds will occur only in our
Columbia and Salt Lake City plants. We believe we have sufficient capacity in
these plants to meet anticipated increases in demand for the foreseeable future.
We manufacture beds to meet orders rather than to stock inventory, which enables
us to maintain lower levels of inventory. As we expand our home delivery and
assembly services, we may use regional distribution centers that would stock
inventory to fill orders on a more expedited basis. Orders are currently shipped
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from one of our three distribution centers, primarily via UPS, typically within
48 hours following order receipt, and are usually received by the customer
within five to seven business days after shipment. We are continually evaluating
alternative carriers on a national and regional basis, as well as testing
providers of in-home assembly services in selected markets.
SUPPLIERS
We currently obtain all of the materials and components used to produce our beds
from outside sources. Components for the Firmness Control Systems are obtained
from a variety of domestic sources. Quilting and ticking materials are obtained
from a supplier that produces both in Belgium and in the United States.
Components for foundation systems are obtained primarily from two domestic
sources.
Our proprietary air chambers are produced to our specifications by one Eastern
European supplier under a supply contract expiring in August 2001 (subject to
automatic renewal if neither party gives 90 days' notice of non-renewal),
pursuant to which we are obligated to purchase certain minimum quantities. We
expect to continue the relationship with the Eastern European supplier for the
foreseeable future. We believe that we would be able to procure an adequate
supply of air chambers from other sources on a timely basis if the supply
contract is terminated or the Eastern European supplier is otherwise unable to
supply air chambers.
INTELLECTUAL PROPERTY
Certain elements of the design and function of our beds and sofa sleeper
products are the subject of United States and foreign patents and patent
applications owned by us. We have 37 issued U.S. patents and 27 U.S. patent
applications pending. We also held 15 foreign patents and had 22 foreign patent
applications pending as of December 30, 2000.
The name "Select Comfort" and our logo are trademarks registered with the United
States Patent and Trademark Office. We have a number of other registered marks,
including the trademarks "Sleep Number" and "Sleep Insurance," the service marks
"Comfort Club" and "Sleep Better on Air," and a number of unregistered marks,
including the trademark "The Sleep Number Bed by Select Comfort" and the service
mark "The Sleep Number Store by Select Comfort." Several of these trademarks
have been registered, or are the subject of pending applications, in various
foreign countries. Each federally registered mark is renewable indefinitely if
the mark is still in use at the time of renewal. We are not aware of any
material claims of infringement or other challenges to our right to use our
marks.
In November 1999, we initiated a patent infringement suit against Simmons
Company and Price Manufacturing Inc. alleging that Simmons-branded air beds
manufactured by Price Manufacturing infringed three of our patents. In February
2000, we settled our suit against Simmons after Simmons terminated its license
agreement with Price Manufacturing, effectively ending Simmons' involvement with
the manufacture and sale of air beds with a hand control that are the subject of
the suit. Price Manufacturing was not a part of the settlement and we intend to
continue to prosecute our suit against Price Manufacturing.
COMPETITION
The mattress industry is highly competitive. Participants in the mattress
industry compete primarily on price, quality, brand name recognition, product
availability and product performance, including the perceived levels of comfort
and support provided by a mattress. Our beds compete with a number of different
types of mattress alternatives, including innerspring mattresses, waterbeds,
futons and other air-supported mattresses that are sold through a variety of
channels, including furniture stores, bedding specialty stores, department
stores, mass merchants, wholesale clubs, telemarketing programs, television
infomercials and catalogs. We believe that our success depends in part on
increasing consumer awareness and acceptance of our existing products and the
continuing
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introduction of products that have qualities and benefits which differentiate
our products from those offered by other manufacturers.
The traditional mattress industry is characterized by a high degree of
concentration among the four largest manufacturers of innerspring mattresses
with nationally recognized brand names, including Sealy, which also owns the
Stearns & Foster brand name, Serta, Simmons and Spring Air. The balance of the
mattress market is served by over 700 manufacturers, primarily operating on a
regional basis. Many of these competitors, and in particular the four largest
manufacturers named above, have greater financial, marketing and manufacturing
resources and better brand name recognition than we do, and sell their products
through broader and more established distribution channels.
A number of companies have begun to offer air beds in recent years, including
Simmons. There can be no assurance that these companies or any other mattress
manufacturer, including the major innerspring manufacturers named above, will
not aggressively pursue the air bed market or be successful in obtaining
significant market share of the air bed category. Any such competition by
established manufacturers or new entrants into the market could have a material
adverse effect on our business, financial condition and operating results. In
addition, should any of our competitors reduce prices on premium mattress
products, we may be required to implement price reductions in order to remain
competitive, which could have a material adverse effect on our business,
financial condition and operating results.
CONSUMER CREDIT ARRANGEMENTS
Through a private label consumer credit facility provided by Conseco Bank, Inc.
(the "Bank"), we offer our qualified customers an unsecured revolving credit
arrangement to finance purchases from us. The Bank sets the rates, fees and all
other terms and conditions of the customer accounts, including collection
policies and procedures, and is the owner of the accounts. In connection with
all purchases financed under these arrangements, the Bank pays us an amount
equal to the total amount of such purchases, net of promotional related
discounts.
We have recently been in discussions with the Bank regarding the terms under
which the Bank will continue to make this credit facility available to our
customers. As a result of these discussions, we have agreed to establish a
reserve in the amount of $1 million to protect the Bank against potential losses
from consumer returns. This reserve will be established in part from the
proceeds of our pending financing transaction and in part through a discount
from the proceeds of credit sales that we receive from the Bank. We have also
agreed that, in the event of any termination of our agreement with the Bank and
replacement of the Bank by an alternative third-party provider of consumer
financing, at the request of the Bank we will purchase the Bank's outstanding
portfolio of customer accounts for a pre-determined formula price.
GOVERNMENTAL REGULATION
Our products and our marketing and advertising practices are subject to
regulation by various federal, state and local regulatory authorities, including
the Federal Trade Commission. The mattress industry also engages in advertising
self-regulation through certain voluntary forums, including the National
Advertising Division of the Better Business Bureau. We are also subject to
various other federal, state and local regulatory requirements, including
federal, state and local environmental regulation and regulations issued by the
U.S. Occupational Safety and Health Administration.
EMPLOYEES
At December 30, 2000, we employed 1,853 persons, including 1,185 retail store
employees, 53 direct marketing employees 72 customer service employees, 327
manufacturing and distribution employees and 216 management and administrative
employees. Approximately 191 of our employees were employed on a part-
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time basis at December 30, 2000. Except for managerial employees and
professional support staff, all of our employees are paid on an hourly basis
plus commissions for sales associates. None of our employees is represented by a
labor union or covered by a collective bargaining agreement. We believe that our
relations with our employees are good.
CERTAIN RISK FACTORS
There are several important risk factors that could cause our actual results to
differ materially from those anticipated by us or which may impact any of our
forward-looking statements. These factors, and their impact on the success of
our operations and our ability to achieve our goals, include the following:
HISTORY OF OPERATING LOSSES; UNCERTAIN PROFITABILITY. Since inception, we have
incurred substantial operating losses and there can be no assurance that our
business and growth strategy will enable us to achieve profitability on a
quarterly or annual basis in future periods. Our future operating results will
depend on a number of factors, including:
- - Our ability to successfully execute the strategic initiatives outlined
above under "--Business and Growth Strategy,"
- - The efficiency and effectiveness of our Sleep Number campaign and other
marketing programs in building product and brand awareness, driving traffic
to our points of sale and in increasing sales,
- - The level of consumer acceptance of our products,
- - Our ability to fully execute and realize the benefits of the cost savings
initiatives outlined above under "--Business and Growth Strategy,"
- - Our ability to cost-effectively sell our products through wholesale or
alternative distribution channels in volumes sufficient to drive growth and
leverage our cost structure and advertising spending,
- - Our ability to continuously improve our products to achieve new and
enhanced consumer benefits, better quality and reduced costs,
- - Our ability to realize increased sales and greater levels of profitability
through our retail stores,
- - Our ability to cost-effectively close additional underperforming or
unprofitable store locations, or to negotiate rent concessions,
- - Our ability to hire, train, manage and retain qualified retail store
management and sales professionals,
- - Our ability to maintain cost-effective production and delivery of our
products,
- - Our ability to successfully expand our home delivery, assembly and mattress
removal capability on a cost-effective basis,
- - The ability of various third-party providers of delivery, assembly and
mattress removal services to provide quality services on a cost-effective
basis,
- - Our ability to successfully commercialize our sofa sleeper product line
across our distribution channels and in major markets,
- - Our ability to successfully identify and respond to emerging trends in the
mattress industry,
- - The level of competition in the mattress industry,
- - General economic conditions and consumer confidence.
There can be no assurance that we will be successful in achieving our strategic
plan or that
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this strategic plan will restore our company to historical sales growth rates or
to profitability. Failure to successfully execute any material part of our
strategic plan could have a material adverse effect on our business, financial
condition and operating results.
LIQUIDITY AND CAPITAL RESOURCES. The report of our independent accountants
contains an explanatory paragraph expressing substantial doubt about the
Company's ability to continue as a going concern as a result of our negative
cash flows and pre-tax operating losses of $26.0 million and $15.0 million in
2000 and 1999, respectively, and negative working capital of $18.2 million at
December 30, 2000. As a result of fiscal 2000 operating losses and the recent
downturn in the economy, which has adversely affected our sales trends, our
current cash flows may not be sufficient to meet our near-term liquidity needs.
Our near-term cash needs are further impacted by (i) the seasonality of our
business, with lower sales volumes historically occurring during the second
quarter, (ii) the timing of marketing and advertising expenditures, which are
higher in the early part of the year when direct marketing advertising rates are
more favorable, and (iii) working capital needs as we expand our wholesale
activities through a significant QVC sales event planned for May. Based on the
estimated cash impact of the items outlined above, offset in part by more
aggressive efforts to manage our working capital needs, we estimate that between
$2 million and $8 million of additional working capital is required during the
second and third quarters.
Since the beginning of fiscal 2000, we have undertaken efforts to substantially
reduce our cost structure as outlined above in "-- Business and Growth
Strategy." Following the recent downturn in the economy and evaluation of the
related impact on our anticipated sales volumes, we implemented further cost
saving initiatives. We expect that these cost reductions, along with efforts to
increase our product and brand awareness, improve our sales conversion
effectiveness and expand our points of distribution, will result in positive
cash flows from operations for the second half of fiscal 2001.
Since the fourth quarter of 2000, we have been pursuing $10 million or more of
working capital financing from a variety of potential sources. Due to our
traditional business model, under which we manufacture product to meet consumer
orders and maintain minimal levels of finished goods inventory, the recent
economic downturn, and recent tightening of credit markets, we have been unable
to obtain traditional asset-based financing. We therefore have recently begun
pursuing a private placement of $10 million to $12 million of senior secured
debt securities convertible into shares of our common stock together with
detachable warrants to purchase additional shares of our common stock.
Consummation of this financing as currently contemplated would result in
substantial dilution to current shareholders.
We have received non-binding indications of interest from several potential
investors for a significant portion of the minimum amount of this private
placement, and we are continuing to have discussions with other potential
investors. We believe that we will be able to consummate this financing.
However, binding commitments have not been received and significant conditions
to closing remain to be met, and therefore no assurance can be given that we
will be able to consummate this financing on satisfactory terms, or at all.
In addition to pursuing the financing described above, we have been aggressively
managing our costs and cash flow to preserve and extend our cash resources. Near
the end of 2000, we began to undertake efforts to rightsize our cost structure.
The economic downturn at the end of 2000 adversely affected sales trends,
resulting in the identification and execution of additional cost reduction
measures. Efforts included termination of non-core business initiatives, closure
of certain facilities, including one of three manufacturing facilities, one of
two administrative offices and one of two call centers, closure of 27 stores in
2000 with plans to close 14 stores in 2001,
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reduction of corporate and administrative overhead and staffing, and adjustment
of advertising, promotional and other marketing programs. We are also pursuing
programs to improve our liquidity, including negotiation of supplier and
landlord payment terms, the reduction of inventory levels and the deferral of
capital programs.
We believe that the financing mentioned above, or other alternatives that might
become available, planned and implemented cost reduction efforts and the
aggressive management of current and future cash resources will provide
sufficient working capital to fund our operations for the foreseeable future. If
for any reason we are unable to obtain additional financing, or if our cash
management efforts were not sufficient to preserve enough cash to meet our
near-term liquidity needs, we may not be able to continue as a going concern,
which may result in material asset impairment or restructuring charges, other
material adverse changes in our business, results of operations or financial
condition, or the loss by shareholders of all or a part of their investment in
the Company.
See "Management's Discussion and Analysis of Financial Condition and results of
Operations - Liquidity and Capital Resources."
EFFECTIVENESS AND EFFICIENCY OF ADVERTISING EXPENDITURES. Advertising
expenditures were $33.4 million, $43.4 million and $31.6 million in 2000, 1999
and 1998, respectively. Our overall marketing spending is being managed
downward, but with greater emphasis toward awareness-building advertising. Our
future growth and profitability will be dependent in part on the effectiveness
and efficiency of our advertising expenditures, including our ability to:
- - create greater awareness of our products and brand name,
- - determine the appropriate creative message and media mix for future
advertising expenditures,
- - effectively manage advertising costs (including creative and media) in
order to maintain acceptable costs per inquiry, costs per order and
operating margins, and
- - convert inquiries into actual orders.
No assurance can be given that our planned advertising expenditures will result
in increased sales, will generate sufficient levels of product and brand name
awareness or that we will be able to manage our advertising expenditures on a
cost-effective basis.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS. Our comparable store sales
results have fluctuated significantly in the past and these fluctuations are
likely to continue. Stores enter the comparable store calculation in their 13th
full month of operation. Our comparable store sales increases were 0.2% for
2000, 4.7% for 1999, 17.9% for 1998 and 34.6% for 1997.* Our comparable store
sales results have fluctuated significantly from quarter to quarter with
increases ranging from -4.1% to 36% on a quarterly basis for 1997 through 2000.
There can be no assurance that our comparable store sales results will not
fluctuate significantly in the future.
A variety of factors affect our comparable store sales results, including:
- - levels of consumer awareness of our products, brand name and store
locations,
- - levels of consumer acceptance of our existing and new products,
- - higher levels of sales in the first year of operations as each successive
class of new stores is opened,
- - comparable store sales performance in prior periods,
- - the maturation of our store base,
- ---------------------------
* Fiscal 1997 was a 53-week year versus 52 weeks for 1999 and 1998. Comparable
store sales for 1998 and 1997, adjusted to 52 weeks, would be 27.3% and 26.1%,
respectively.
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- - the amount, timing and relative success of promotional events, advertising
expenditures, new product introductions and product line extensions,
- - the quality and tenure of store-level managers and sales professionals,
- - the amount of competitive activity,
- - the evolution of store operations,
- - changes in the sales mix between our distribution channels, and
- - general economic conditions and consumer confidence.
Decreases in comparable store sales results could have a material adverse effect
on our business, financial condition and operating results.
QUARTERLY FLUCTUATIONS AND SEASONALITY. Our quarterly operating results may
fluctuate significantly as a result of a variety of factors, including:
- - increases or decreases in comparable store sales,
- - the timing, amount and effectiveness of advertising expenditures,
- - any increases in return rates,
- - the timing of new store openings and related expenses,
- - competitive factors,
- - net sales contributed by new stores,
- - any disruptions in third-party delivery services, and
- - general economic conditions and consumer confidence.
Our business is also subject to some seasonal influences, with lower seasonal
sales in the second quarter and heavier concentrations of sales during the
fourth quarter holiday season due to higher mall traffic.
The level of spending related to sales and marketing expenses and new store
opening costs cannot be adjusted quickly and is based, in significant part, on
our expectations of future customer inquiries and net sales. If there is a
shortfall in expected net sales or in the conversion rate of customer inquiries,
we may be unable to adjust our spending in a timely manner and our business,
financial condition and operating results may be materially adversely affected.
Our results of operations for any quarter are not necessarily indicative of the
results that may be achieved for a full year or any future quarter.
RELIANCE UPON PROVIDER OF CONSUMER CREDIT FACILITY. Through a private label
consumer credit facility provided by Conseco Bank, Inc. (the "Bank"), we offer
our qualified customers an unsecured revolving credit arrangement to finance
purchases from us. The Bank sets the rates, fees and all other terms and
conditions of the customer accounts, including collection policies and
procedures, and is the owner of the accounts. In connection with all purchases
financed under these arrangements, the Bank pays us an amount equal to the total
amount of such purchases, net of promotional related discounts.
We have recently been in discussions with the Bank regarding the terms under
which the Bank will continue to make this credit facility available to our
customers. As a result of these discussions, we have agreed to establish a
reserve in the amount of $1 million to protect the Bank against potential losses
from consumer returns. This reserve will be established in part from the
proceeds of our pending financing transaction and in part through a discount
from the proceeds of credit sales that we receive from the Bank. We have also
agreed that, in the event of any termination of our agreement with the Bank and
replacement of the Bank by an alternative third-party provider of consumer
financing, at the request of the Bank we will purchase the Bank's outstanding
portfolio of customer accounts for a pre-determined formula price.
Our agreement with the Bank also contains a provision permitting the Bank to
terminate the agreement in the event of a material adverse change in our
operations, financial condition, business or prospects. If we are unable to
obtain additional financing, no assurance can be given that the Bank will not
take action to terminate the agreement or request material changes to the
16
terms under which the Bank will continue to provide financing for our customers.
Termination of our agreement with the Bank, or any material change to the terms
of our agreement with the Bank or in the availability or terms of credit for our
customers from the Bank, could have a material adverse effect on our business,
sales, results of operations or financial condition.
RELIANCE UPON SUPPLIERS; SINGLE SOURCE OF SUPPLY OF AIR CHAMBERS; FOREIGN
SOURCES OF SUPPLY. The inability of our suppliers to meet, for any reason, our
requirements for any components of our bed products, or our requirements of sofa
sleeper products, could have a material adverse effect on our business,
financial condition and operating results. Our air chambers are currently
obtained from a single source of supply. If this supplier became unable or
unwilling for any reason to continue to supply us with air chambers, our
operations could be materially adversely affected. We currently have a supply
agreement with this single source of supply that expires in August 2001 (subject
to automatic renewal if neither party gives 90 days' notice of non-renewal), but
there can be no assurance that this single source of supply will not be
disrupted for any reason. In addition, since our air chambers and certain other
supplies are manufactured outside the United States, our operations could be
materially adversely affected by the risks associated with foreign sourcing of
materials, including:
- - political instability resulting in disruption of trade,
- - existing or potential duties, tariffs or quotas that may limit the quantity
of certain types of goods that may be imported into the United States or
increase the cost of such goods, and
- - any significant fluctuation in the value of the dollar against foreign
currencies.
With the exception of our air chambers, we have no long-term purchase contracts
or other contractual assurances of continued supply, pricing or access to
components. The inability or failure of one or more key suppliers to supply
components, the loss of one or more key suppliers or a material change in our
purchase terms could have a material adverse effect on our business, financial
condition and operating results.
RELIANCE UPON CARRIERS. Historically, we have relied almost exclusively on UPS
for delivery of our products to customers. For a significant portion of the
third quarter of 1997, UPS was unable to deliver our products within acceptable
time periods, causing delays in deliveries to customers and requiring us to use
alternative carriers. No assurance can be given that UPS will not experience
difficulties in meeting our requirements in the future. In 2000, we began to
shift a portion of our product delivery business to Federal Express. We continue
to evaluate alternative carriers on a national and regional basis, as well as
providers of in-home delivery and assembly services. There can be no assurance
that alternative carriers will be able to meet our requirements on a timely or
cost-effective basis. Any significant delay in deliveries to customers or
increase in freight charges may have a material adverse effect on our business,
financial condition and operating results.
RETURN POLICY AND PRODUCT WARRANTY. Part of our marketing and advertising
strategy focuses on providing an in-home trial period during which customers may
return their Sleep Number bed and obtain a refund of the purchase price. We plan
to shorten this in-home trial period from 90 nights to 30 nights effective as of
May 29, 2001. We believe that a 30-night trial period is competitive within our
industry and sufficient to enable consumers to experience the features and
benefits of our products. No assurance can be given, however, that this change
in policy will not have a material adverse effect on our sales volumes or return
rates. Any significant decrease in sales volumes or increase in return rates
could have a material adverse effect on our business, financial condition and
operating results. We also provide our customers with a limited 20-year warranty
on our beds. We have only been selling beds in significant quantities since
1992. There can be no assurance that our
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warranty reserves will be adequate to cover future warranty claims. Significant
warranty claims in excess of our warranty reserves could have a material adverse
effect on our business, financial condition and operating results.
SALES TAX CONSIDERATIONS. Prior to May 2000, in compliance with state and
federal tax regulations, our direct marketing and e-commerce channels did not
collect sales tax from customers residing in certain states. Industry experts
believe these regulations potentially provide a competitive advantage to direct
marketers and e-commerce companies over retailers located within these states
and who are required to collect sales tax. In connection with our provision of
in-home delivery and assembly of our products to customers through all of our
distribution channels, as well as the execution of our integrated marketing
plan, we began collecting sales tax on sales in all states. While we believe the
execution of these initiatives will positively impact the overall performance of
our company, the impact of this change could negatively impact sales.
PRODUCT DEVELOPMENT AND ENHANCEMENTS. Our growth and future success will depend
upon our ability to enhance our existing products and to develop and market new
products on a timely basis that respond to customer needs and achieve market
acceptance. There can be no assurance that we will be successful in developing
or marketing enhanced or new products, or that any such products will be
accepted by the market. Further, there can be no assurance that the resulting
level of sales of any of our enhanced or new products will justify the costs
associated with their development and marketing.
MARKET ACCEPTANCE. The U.S. mattress market is dominated by four large
manufacturers of innerspring mattresses. Our air chamber technology represents a
significant departure from traditional innerspring mattresses. The market for
air beds is continuing to evolve and the success of our products will be
dependent upon both the continued growth of this market and upon market
acceptance of our beds. The failure of our beds to achieve market acceptance for
any reason would have a material adverse effect on our business, financial
condition and operating results.
INTELLECTUAL PROPERTY PROTECTION. No assurance can be given that our current
patents or pending patent applications will provide substantial protection or
that others will not be able to develop products that are similar to or
competitive with our beds or other products. In addition, there can be no
assurance that copyright, trademark, trade secret, unfair competition and other
intellectual property laws, nondisclosure agreements and other protective
measures will preclude competitors from developing products similar to our
products or otherwise competing with us. In addition, the laws of certain
foreign countries may not protect our intellectual property rights and
confidential information to the same extent as the laws of the United States.
Although we are unaware of any basis for an intellectual property infringement
or invalidity claim against us, there can be no assurance that third parties,
including competitors, will not assert such claims against us or that, if
asserted, such claims will not be upheld. Intellectual property litigation,
which could result in substantial cost to and diversion of effort by management,
may be necessary to enforce our patents, to protect our trade secrets and
proprietary technology or to defend us against claimed infringement of the
rights of others and to determine the scope and validity of the proprietary
rights of others. There can be no assurance that we would prevail in any such
litigation or that, if it is unsuccessful, we would be able to obtain any
necessary licenses on reasonable terms or at all.
COMPETITION. The mattress industry is highly competitive. Our Sleep Number beds
compete with a number of different types of mattress alternatives, including
innerspring mattresses, waterbeds, futons and other air-supported mattresses
that are sold through a variety of channels, including furniture stores, bedding
18
specialty stores, department stores, mass merchants, wholesale clubs,
telemarketing programs, television infomercials and catalogs.
The traditional mattress industry is characterized by a high degree of
concentration among the four largest manufacturers of innerspring mattresses
with nationally recognized brand names, including Sealy, which also owns the
Stearns & Foster brand name, Serta, Simmons and Spring Air. Over 700
manufacturers, primarily operating on a regional basis serve the balance of the
mattress market. Many of these competitors, and in particular the four largest
manufacturers named above, have greater financial, marketing and manufacturing
resources and better brand name recognition than we do, and sell their products
through broader and more established distribution channels.
A number of companies have begun to offer air beds in recent years, including
Simmons. There can be no assurance that these companies or any other mattress
manufacturer, including the major innerspring manufactures named above, will not
aggressively pursue the air bed market or be successful on obtaining significant
market share of the air bed category. Any such competition by the established
manufacturers or new entrants into the market could have a material adverse
effect on our business, financial condition and operating results. In addition,
should any of our competitors reduce prices on premium mattress products, we may
be required to implement price reductions in order to remain competitive, which
could have a material adverse effect on our business, financial condition and
operating results.
SHAREHOLDER LITIGATION. Select Comfort and certain former officers and directors
have been named as defendants in a class action lawsuit filed on behalf of
shareholders in U.S. District Court in Minnesota. The named plaintiffs, who
purport to act on behalf of a class of purchasers of our common stock during the
period from December 4, 1998 to June 7, 1999, charge the defendants with
violations of federal securities laws. The suit alleges that we and the former
directors and officers failed to disclose or misrepresented certain information
concerning our business during the class period. The complaint does not specify
an amount of damages claimed. While we believe that the complaint is without
merit and intend to vigorously defend the claims, there can be no assurance that
we will be successful in defending the lawsuit. Defense of the suit could be
expensive and may create a distraction to the management team. If we are
unsuccessful in defending the suit, an adverse judgment could have a material
adverse effect on our consolidated financial condition or results of operations.
POSSIBLE DELISTING FROM NASDAQ STOCK MARKET. Our common stock is currently
quoted on the Nasdaq National Market under the symbol "SCSS." We are currently
in compliance with Nasdaq's continued listing standards, including standards for
minimum net tangible assets, public float, minimum bid price, number of
shareholders and number of market makers. If we are unable to complete our
private placement or obtain other financing, or if we are unable to successfully
implement our strategic initiatives to achieve profitability, we may not be able
to meet the financial requirements for continued listing on the Nasdaq National
Market.
In the event that our common stock were to be delisted from the Nasdaq National
Market and we were ineligible for listing on the Nasdaq SmallCap Market, our
common stock would thereafter likely be quoted in the "over-the-counter" market
and eligible to trade on the OTC bulletin board. If our common stock traded on
the OTC bulletin board, trading, if any, would be subject to the "penny stock"
rules under the Securities Exchange Act of 1934. Consequently, the liquidity of
our common stock could be impaired, not only in the number of shares that could
be bought and sold, but also through delays in the timing of the transactions,
reductions in the security analysts' and the news media's coverage of our stock,
and lower prices for our common stock than it might otherwise attain.
19
VOLATILITY IN MARKET PRICE OF COMMON STOCK. The market price of our common stock
has fluctuated significantly in the past and may do so in the future. The market
price of our common stock may fluctuate as a result of a variety of factors,
many of which are outside of our control, including without limitation the
following factors:
- - variations in quarterly operating results;
- - changes in estimates by securities analysts;
- - announcements of significant events;
- - additions or departures of key personnel; and
- - changes in market valuations of companies in our industry.
ITEM 2. PROPERTIES
We currently lease all of our existing retail store locations and expect that
our policy of leasing, rather than owning, will continue as we expand. Our store
leases generally provide for an initial lease term of 10 years with a mutual
termination option if we do not achieve certain minimum annual sales thresholds.
Generally, the store leases require us to pay minimum rent plus percentage rent
based on net sales in excess of certain thresholds, as well as certain operating
expenses.
We lease approximately 122,000 square feet of space in Minneapolis for one of
our manufacturing and distribution centers, our direct marketing call center, a
customer service center and a research and development center, which lease
expires in 2004. We also lease approximately 105,000 square feet of space in
Columbia, South Carolina, for another manufacturing and distribution center,
which lease expires in 2003. We have also leased approximately 100,800 square
feet in Salt Lake City for an additional manufacturing and distribution center,
opened in May of 1999, which lease expires in 2009. We lease another 16,100
square feet of office space in the Minneapolis area, which we have vacated. We
are in the process of seeking a sublessee for this space.
ITEM 3. LEGAL PROCEEDINGS
Select Comfort and certain former officers and directors were named as
defendants in a class action lawsuit initially filed on June 1, 1999 on behalf
of shareholders in U.S. District Court in Minnesota. The named plaintiffs, who
purport to act on behalf of a class of purchasers of our common stock during the
period from December 4, 1998 to June 7, 1999, charge the defendants with
violations of federal securities laws. The suit alleges that we and the named
directors and officers failed to disclose or misrepresented certain information
concerning our business during the class period. The complaint does not specify
an amount of damages claimed. We believe that the complaint is without merit and
intend to vigorously defend the claims.
The Company and the individual defendants brought a motion to dismiss all claims
on November 10, 1999. The motion was heard by a magistrate judge on December 21,
1999. On January 27, 2000, the magistrate recommended that the claims based on
Section 11 of the federal securities laws be dismissed. The magistrate
recommended that the motion to dismiss be denied with respect to the claims
based on Rule 10b-5 of the federal securities laws. In February 2000, both the
plaintiffs and the defendants formally objected to the magistrate's
recommendation. The objection was made to the United States District Court in
Minnesota. On May 12, 2000, the United States District Court in Minnesota
adopted the recommendation of the magistrate and denied the defendants' motion
to dismiss the Rule 10b-5 claims. The Court also adopted the recommendation of
the magistrate and dismissed the plaintiff's Section 11 claims without prejudice
and with leave to amend.
On March 31, 2000, the Company and certain of its former officers and directors
were named as defendants in a class action lawsuit filed on
20
behalf of the Company's shareholders in U.S. District Court in Minnesota
asserting identical factual allegations as the consolidated complaint described
above. The suit alleges claims based on Sections 11 and 12(a)(2) of the federal
securities laws. The complaint does not specify an amount of damages claimed.
The Company believes this complaint is without merit and intends to vigorously
defend the claims. The above two class actions were consolidated by the United
States District Court Magistrate on July 24, 2000.
On January 30, 2001, the plaintiffs made a motion to certify a class. The class
certification motion is pending. Discovery relative to this motion has begun.
We have agreed to indemnify the individual defendants and to advance reasonable
expenses of defense of the litigation to the individual defendants under
applicable Minnesota corporate law. To date, we have paid an aggregate of $3,891
to the law firm of Briggs & Morgan on behalf of defendant H. Robert Hawthorne.
We are involved in other various claims, legal actions, sales tax disputes, and
other complaints arising in the ordinary course of business. In the opinion of
management, any losses that may occur are adequately covered by insurance or are
provided for in the consolidated financial statements and the ultimate outcome
of these matters will not have a material effect on the consolidated financial
position or results of operations of the Company.
21
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers, their ages and the offices held, as of March 30,
2001, are as follows:
NAME AGE TITLE
- ----------------------------- ----- --------------------------------------------
William R. McLaughlin 44 President and Chief Executive Officer
Noel F. Schenker 47 Senior Vice President, Marketing and New
Business Development
Gregory T. Kliner 63 Senior Vice President of Operations
James C. Raabe 41 Vice President and Chief Financial Officer
Mark A. Kimball 42 Senior Vice President, Chief Administrative
Officer, General Counsel and Secretary
Michael J. Thyken 39 Vice President and Chief Information Officer
Tracey T. Breazeale 34 Senior Vice President, Special Projects
Information regarding the business experience of our executive officers is set
forth below.
WILLIAM R. MCLAUGHLIN joined Select Comfort in March 2000 as President and Chief
Executive Officer. From December 1988 to March 2000, Mr. McLaughlin served as an
executive of Pepsico Foods International in various capacities, including from
September 1996 to March 2000 as President of Frito Lay Europe, Middle East and
Africa, and from June 1993 to June 1996 as President of Grupo Gamesa, a cookie
and flour company based in Mexico.
NOEL F. SCHENKER joined Select Comfort 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., 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. Since 1996, she also has served on the Board of
Directors and Executive Committee of the Fortis Financial Group's Mutual Funds.
GREGORY T. KLINER has served as Senior Vice President of Operations of Select
Comfort since August 1995. From October 1986 to August 1995, Mr. Kliner served
as Director of Operations of the Irrigation Division for The Toro Company, a
manufacturer of lawn care and snow removal products and irrigation systems.
JAMES C. RAABE was elected as Vice President and Chief Financial Officer of
Select Comfort in April 1999. From September 1997 to April 1999, Mr. Raabe
served as Controller of Select Comfort. From May 1992 to September 1997, Mr.
Raabe served as Vice President - Finance of ValueRx, Inc., a pharmacy benefit
management provider. Mr. Raabe held various positions with KPMG LLP from August
1982 to May 1992.
MARK A. KIMBALL joined Select Comfort in May 1999 as Senior Vice President,
Chief Administrative Officer, General Counsel and Secretary. For more than five
years prior to joining Select Comfort, Mr. Kimball was a partner in the law firm
of Oppenheimer Wolff &
22
Donnelly LLP practicing in the area of corporate finance.
MICHAEL J. THYKEN joined Select Comfort in July 2000 as Vice President and Chief
Information Officer. During 1999, Mr. Thyken was Group Director of Application
Development at Jostens, a Minneapolis based manufacturer of scholastic
recognition products. From 1994 to 1999, Mr. Thyken was Director of Technical
Services for Target Stores. From 1984 to 1994, Mr. Thyken served in various
positions with IBM Corporation.
TRACEY T. BREAZEALE was hired as Senior Vice President of Strategic Planning and
Branding of Select Comfort in July 1999. 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. Ms. Breazeale was with the Boston Consulting
Group from October 1993 to July 1999, initially as a consultant and the last
three years as a manager, where she specialized on strategic and marketing
oriented projects for retail and consumer product companies.
23
PART II
--------------------
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock trades on the Nasdaq Stock Market under the symbol SCSS. The
quarterly high and low sales prices for the common stock, as reported by the
Nasdaq Stock Market, for the two most recent fiscal years follows in the table
below. These quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not necessarily represent actual transactions.
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 2000
High $2.44 $3.50 $5.50 $6.50
Low $0.96 $1.44 $2.38 $4.38
------- ------- ------- -------
Fiscal 1999
High $7.06 $9.19 $29.88 $35.25
Low $3.63 $6.00 $6.38 $20.50
------- ------- ------- -------
NUMBER OF RECORD HOLDERS; DIVIDENDS
As of March 28, 2001, there were 178 record holders of our common stock. We did
not declare or pay any cash dividends on the common stock during the fiscal
years ended December 30, 2000 or January 1, 2000 and do not anticipate paying
any cash dividends on our common stock in the foreseeable future.
USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
On September 3, 1998, we filed a Registration Statement on Form S-1 (File No.
333-62793) with the Securities and Exchange Commission, pursuant to which we
registered the offer and sale under the federal securities laws of 4,600,000
shares of common stock, including 1,677,650 shares sold by certain selling
shareholders. The SEC declared our Registration Statement effective on December
3, 1998, and the closing of the initial public offering was held on December 9,
1998. The managing underwriters were Hambrecht & Quist LLC, BankBoston Robertson
Stephens Inc., Piper Jaffray Inc. and Charles Schwab & Co., Inc.
The aggregate offering price of all shares sold in the offering was $78,200,000.
The net proceeds to Select Comfort from the sale of the shares of common stock
offered by Select Comfort was $44,643,353, after deducting the underwriting
discount of $3,477,597 and offering expenses of approximately $1,559,000. All of
the expenses incurred in connection with the initial public offering were paid
to unrelated parties or entities, except for the underwriting discount which was
given to, among others, Hambrecht & Quist LLC. Jean-Michel Valette, a director
of the Company, was a member of the general partner of H&Q Select Comfort
Investors, L.P., a related party to Hambrecht & Quist LLC.
From December 9, 1998 to December 30, 2000, the net proceeds from the offering
have been used as follows:
Repayment of long-term debt...........$15,325,480
Repurchase of our common stock.........12,692,054
Fund the build-out, start-up and
leasing of our third manufacturing
and distribution facility...............1,712,306
Fund development of warranty and
inquiry system..........................1,032,099
Fund partial expansion of our retail
store base.............................13,881,414
-------------
$44,643,353
=============
24
ITEM 6. SELECTED FINANCIAL DATA
The data presented below has been derived from the Company's consolidated
financial statements and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's consolidated financial statements and notes thereto included in
this Annual Report on Form 10-K:
YEAR ENDED (1)
--------------------------------------------------------
DEC. 30, JAN. 1, JAN. 2, JAN. 3, DEC. 28,
2000 2000 1999 1998 1996
---------- ---------- ---------- ---------- ----------
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $270,077 $273,767 $246,269 $184,430 $102,028
Gross margin 171,153 178,660 161,082 117,801 63,507
Operating income (loss)(2) (25,970) (14,793) 11,445 1,996 (3,764)
Net income (loss) before extraordinary item (37,214) (8,204) 6,636 (2,846) (3,685)
Net income (loss) (37,214) (8,204) 5,195 (2,846) (3,685)
Net income (loss) per share - diluted (3):
Net income (loss) per share before
extraordinary item (2.09) (0.45) 0.28 (1.59) (2.61)
Net income (loss) per share (2.09) (0.45) 0.19 (1.59) (2.61)
Weighted average common shares - diluted 17,848 18,300 15,928 2,353 1,753
Dividends paid per share - - - - -
SELECTED OPERATING DATA:
Stores open at period-end (4) 333 341 264 200 143
Average square footage of stores open
during period (5) 913 893 895 866 768
Sales per square foot (5) 697 721 742 666 622
Average store age (in months at period end) 41 31 27 22 15
Comparable store sales increase (6) 0.2% 4.7% 23.5% 27.3% 26.1%
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $1,498 $7,441 $45,561 $12,670 $2,422
Marketable securities 3,950 20,129 - - -
Working capital (18,176) 14,470 42,249 757 (7,809)
Total assets 64,672 95,865 106,234 57,241 29,794
Long-term debt, less current maturities 2,322 36 29 19,511 1,162
Mandatorily redeemable preferred stock - - - 27,612 27,612
Total common shareholders'equity (deficit) 16,600 52,872 70,691 (21,038) (18,216)
- -----------
(1) Except for the year ended January 3, 1998, which included 53 weeks, all
years presented included 52 weeks.
(2) Includes charges for impairment of assets of $1.9 million for the year
ended December 30, 2000 and $1.5 million for the year ended January 1,
2000. See Note 5 to the Consolidated Financial Statements.
(3) See Note 11 of Notes to Consolidated Financial Statements.
(4) Includes Select Comfort stores operated in leased departments within larger
retail stores (25 at December 30, 2000, 45 at January 1, 2000, 14 at
January 2, 1999 and one at January 3, 1998).
(5) For stores open during the entire period indicated.
(6) Stores enter the comparable store calculation in their 13th full month of
operation. The number of comparable stores used to calculate such data were
314, 262, 199, 138 and 65 for fiscal 2000, 1999, 1998, 1997 and 1996,
respectively. Reflects adjustment for additional week of sales in 1997.
Without adjusting for the additional week, comparable store sales would
have been 17.9% in 1998 and 34.6% in 1997.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD LOOKING STATEMENTS
The following discussion and analysis should be read in conjunction with the
Consolidated Financial Statements and the Notes thereto included herein. This
discussion contains forward looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. Statements that are not of historical
fact may be deemed to be forward-looking statements. Without limiting the
foregoing, words such as "may," "will," "expect," "believe," "anticipate,"
"estimate" or "continue" or comparable terminology are intended to identify
forward-looking statements. These statements by their nature involve substantial
risks and uncertainties, and actual results may differ materially depending on a
variety of factors, including those set forth above in Part I, Item 1 under the
heading entitled "Certain Risk Factors."
OVERVIEW
Select Comfort is the leading manufacturer, specialty retailer and direct
marketer of premium quality innovative air beds and sleep-related products.
Since the introduction of our first air bed product in 1987, we have focused on
improving our product, expanding our product line, building manufacturing and
distribution systems and growing our three distribution channels: retail, direct
marketing and e-commerce. Vertically integrated operations and control over
these complementary distribution channels gives us direct contact with our
customers and gives our customers multiple opportunities to purchase our
products. Sales generation is driven primarily by targeted print, radio,
television, and internet media that generate customer inquiries, as well as by
our retail store and internet presence.
Since the latter half of 2000, we have focused on five primary strategic
priorities: (i) building consumer awareness, (ii) rightsizing our cost
structure, (iii) improving our sales conversion effectiveness, (iv) pursuing
alternative distribution channels, and (v) continuously improving product
quality, innovation and service levels. Each of these strategic priorities is
discussed in greater detail above under "Business - Business and Growth
Strategy." The success of our strategy will depend on many factors and is
subject to certain risks, including the risks and uncertainties outlined above
under "Business - Certain Risk Factors."
Retail operations included 333 stores at December 30, 2000, including 25 leased
departments within larger stores, 341 stores at January 1, 2000, (including 45
leased departments) and 264 stores at January 2, 1999 (including 14 leased
departments). During 2000, we opened 19 stores and closed 27 stores. In 2001, we
currently plan to open approximately 13 additional retail stores, primarily in
existing markets, and plan to close approximately 14 underperforming stores. The
majority of the costs associated with these closings were accrued in 2000.
The Company reported comparable store sales growth of 0.2%, 4.7% and 23.5% in
2000, 1999 and 1998, respectively. Comparable store sales results have been and
will continue to be influenced by a variety of factors, including:
- - levels of consumer awareness of our products, brand name and store
locations,
- - levels of consumer acceptance of our existing and new products,
- - higher levels of sales in the first year of operations as each successive
class of new stores is opened,
- - comparable store sales performance in prior periods,
- - the maturation of our store base,
- - the amount, timing and relative success of promotional events, advertising
expenditures, new product introductions and product line extensions,
- - the quality and tenure of store-level managers and sales professionals,
- - the amount of competitive activity,
- - the evolution of store operations,
26
- - changes in the sales mix between our distribution channels, and
- - general economic conditions and consumer confidence.
Advertising expenditures were $33.4 million, $43.4 million and $31.6 million in
2000, 1999 and 1998, respectively. Advertising costs are expensed as incurred as
a component of sales and marketing expenses, although we believe that
advertising expenditures provide significant benefits beyond the period in which
they are expensed. Future advertising expenditures will depend on the
effectiveness and efficiency of the advertising in creating awareness of our
products and brand name, generating consumer inquiries and driving consumer
traffic to retail stores. Pre-opening costs associated with new retail stores
are also expensed as incurred.
We believe historical operating losses have been primarily the result of an
aggressive retail store opening strategy, a relatively immature store base,
significant marketing, advertising and product development expenditures, and the
development of a substantial corporate infrastructure to support future growth.
Future increases in net sales and the achievement of long-term profitability
will depend upon greater consumer awareness and acceptance of our air bed
products, improved effectiveness and efficiency of our marketing and advertising
expenditures, the opening and successful performance of new points of
distribution, improvement in the performance of current stores and our ability
to realize the benefits of our cost saving initiatives. There can be no
assurance that we will be able to achieve or sustain historical sales growth
rates, or to achieve profitability in the future, on a quarterly or annual
basis.
Quarterly and annual operating results may fluctuate significantly as a result
of a variety of factors, including increases or decreases in comparable store
sales, the timing, amount and effectiveness of advertising expenditures, any
changes in return rates, the timing of new store openings and related expenses,
competitive factors, net sales contributed by new stores, any disruptions in
third-party delivery services and general economic conditions and consumer
confidence. Our business is also subject to some seasonal influences, with
heavier concentrations of sales during the fourth quarter holiday season due to
increased mall traffic.
A substantial portion of operating expenses is related to sales and marketing
expenses, including costs associated with opening new stores, operating existing
stores and advertising expenditures. The level of such spending cannot be
adjusted quickly and is based, in significant part, on expectations of future
customer inquiries and net sales. Furthermore, a substantial portion of net
sales is often realized in the last month of a quarter with such net sales
frequently concentrated in the last weeks or days of a quarter, due in part to
our promotional schedule. Should the Company experience a shortfall in expected
net sales or in the conversion rate of customer inquiries, we may be unable to
adjust spending in a timely manner and our business, financial condition and
operating results may be materially adversely affected. Our historical results
of operations may not be indicative of the results that may be achieved for any
future fiscal period.
At December 30, 2000, we had net operating loss carryforwards ("NOLs") for
federal income tax purposes of approximately $31.4 million expiring between the
years 2003 and 2020. We expect that approximately $1.4 million of these NOLs
will expire unutilized due to an Internal Revenue Code (IRC) Section 382
limitation resulting from a prior ownership change. Realization of the benefit
of the deferred tax assets depends on us achieving profitability levels
sufficient to utilize the NOLs.
27
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's results
of operations expressed as percentages of net sales. Percentage amounts may not
total due to rounding.
Percentage of Net Sales
Year Ended
Dec. 30, Jan. 1, Jan. 2,
2000 2000 1999
--------- --------- ---------
Net sales 100.0% 100.0% 100.0%
Cost of sales 36.6 34.7 34.6
--------- --------- ---------
Gross margin 63.4 65.3 65.4
--------- --------- ---------
Operating expense:
Sales and marketing 61.4 59.4 52.7
General and administrative 10.8 10.7 8.0
Store closing/impairments 0.7 0.5 0.0
--------- --------- ---------
Total operating expenses 73.0 70.7 60.8
--------- --------- ---------
Operating income (loss) (9.6) (5.4) 4.7
Other income (expense), net 0.1 0.6 (2.9)
--------- --------- ---------
Income (loss) before income taxes (9.5) (4.8) 1.8
Income tax expense(benefit) 4.3 (1.8) (0.9)
--------- --------- ---------
Net income (loss) before ext, net (13.8) (3.0) 2.7
Extraordinary item (0.0) 0.0 (0.6)
--------- --------- ---------
Net income (loss) (13.8)% (3.0)% 2.1%
========= ========= =========
The operating loss in 2000 was largely due to a decline in net sales, and an
increase in operating expenses as a percentage of net sales, reflecting the
growth of our retail store selling infrastructure. The decline in net sales was
due to a number of factors. Advertising spending was reduced by $10.0 million
(23%) in 2000 compared to 1999, as the efficiency of advertising programs
declined and the Company worked to develop new creative advertising programs.
Additionally, seasonal traffic in our retail stores fell short of expectations,
due in part to a softening economic climate during the fourth quarter of 2000.
Finally, direct marketing sales declined by $24.3 million in 2000 compared to
1999, primarily due to the continued migration of the Company's sales from
direct marketing to retail stores and due to the reduction of advertising
spending in this channel. Selling expenses increased by $12.9 million resulting
in the net overall increase in operating expenses. The increase resulted
primarily from higher occupancy and compensation expenses resulting from an
increase in the number of stores open for a full year in 2000. Special charges
of $3.5 million are included in the 2000 results related to store closings,
asset impairments and severance costs related to two reductions in workforce
As noted above under "Overview" and "Business - Business and Growth Strategy,"
we have implemented several strategic initiatives that we believe will result in
improved operating results in 2001.
COMPARISON OF FISCAL 2000 AND FISCAL 1999
NET SALES
Net sales in 2000 decreased 1.3% to $270.1 million from $273.8 million in 1999.
The components of the decrease in net sales were (i) a $22.0 million increase
from the opening of 19 new retail stores during 2000 and the full year impact of
77 stores opened in 1999, (ii) a $0.4 million increase from a 0.2% increase in
comparable store sales, (iii) a $5.2 million increase in net sales from the
Company's e-commerce channel, offset by (iv) a $24.3 million decrease in direct
marketing sales and (v) a $7.0 million decrease due to the elimination of our
road show distribution channel.
GROSS MARGIN
Gross margin in 2000 decreased to 63.4% from 65.3% in 1999 primarily due to
larger discounts on promotional offerings, increased costs from processing
returned product and increased costs from the rollout of our new foundation
product, partially offset by a price increase for some of our products.
SALES AND MARKETING
Sales and marketing expenses in 2000 increased 2.0% to $166.0 million from
$162.7 million in 1999, and increased as a percentage of net sales to 61.4% in
2000 from 59.4% in 1999. The increase in the dollar amount of sales and
marketing expenses during 2000 was primarily due to (i) higher occupancy expense
related primarily to rent and depreciation expense, (ii) higher wages and
compensation expense and (iii) higher freight costs. Sales and marketing
expenses increased as a percentage of net sales primarily due to (i) lower
direct marketing sales and (ii) selling expenses in new stores increasing at a
greater rate than net sales and the expenses
28
associated with the rollout of our sofa sleeper product, partially offset by
(iii) a decrease in media spending.
GENERAL AND ADMINISTRATIVE
General and administrative expenses in 2000 were $29.2 million, equal to the
1999 expense level. Slight increases in wages and benefits expense were offset
by reductions in the use of outside services and consultants.
STORE CLOSINGS/IMPAIRMENTS
Store closing/impairment expense in 2000 was $2.0 million, up from $1.5 million
in 1999. In 2000, this expense included $1.4 million related to the relocation
of our headquarter offices and web development costs and $0.6 million related to
store closures. The expense of $1.5 million in 1999 relates almost exclusively
to store closures.
OTHER INCOME (EXPENSE), NET
Other income decreased $1.4 million to approximately $0.3 million of other
income in 2000 from $1.7 million in other income in 1999. The decrease is due to
lower cash levels affecting interest income in 2000. In addition, the
recognition of an equity loss in SleepTec following our acquisition of this
business reduced other income by $.6 million.
INCOME TAX EXPENSE (BENEFIT)
Income tax expense increased to $11.6 million for 2000 from a benefit of $4.8
million for 1999. Income tax expense increased as a result of the establishment
of an additional $21.1 million deferred tax asset valuation allowance in the
fourth quarter of 2000 resulting from uncertainties in the Company's business.
See "Liquidity and Capital Resources."
COMPARISON OF FISCAL 1999 AND FISCAL 1998
NET SALES
Net sales in 1999 increased 11.2% to $273.8 million from $246.3 million in 1998,
primarily due to an increase in unit sales. The components of the increase in
net sales were (i) a $33.6 million increase from the opening of 77 new retail
stores during 1999 and the full year impact of 64 stores opened in 1998, (ii) a
$6.8 million increase from a 4.7% increase in comparable store sales, due in
part to the continuing maturation of stores and increased advertising in
selected markets, (iii) a $4.3 million increase in net sales from the Company's
newly developed e-commerce channel, partially offset by (iv) a $15.3 million
decrease in direct marketing sales.
GROSS MARGIN
Gross margin in 1999 decreased to 65.3% from 65.4% in 1998. Reductions in cost
of sales from improved purchasing and leverage of fixed manufacturing costs over
higher unit volumes were offset by higher sales discounts.
SALES AND MARKETING
Sales and marketing expenses in 1999 increased 25.3% to $162.7 million from
$129.9 million in 1998, and increased as a percentage of net sales to 59.4% in
1999 from 52.7% in 1998. The increase in the dollar amount of sales and
marketing expenses during 1999 was primarily due to (i) the opening of 77 new
retail stores, (ii) an increase in advertising expenditures of $11.8 million and
(iii) higher commissions, percentage rents and freight expense related to higher
net sales. Sales and marketing expenses increased as a percentage of net sales
primarily due to (i) increased advertising focused on longer term sales growth
through brand and retail store awareness, (ii) lower direct marketing sales and
(iii) selling expenses in new stores increasing at a greater rate than net
sales.
GENERAL AND ADMINISTRATIVE
General and administrative expenses in 1999 increased 48.1% to $29.2 million
from $19.7 million in 1998. The increase in general and administrative expenses
was primarily due to increased spending on infrastructure to support long-term
growth plans and strategic consulting studies undertaken to determine and refine
ongoing business strategies.
STORE CLOSINGS
Store closing expense in 1999 was $1.5 million, compared with $20,000 in 1998.
Store closing expense for 1999 includes a $1.4 million charge associated with
plans to close 10 stores and other related store write-offs.
29
OTHER INCOME (EXPENSE), NET
Other income increased $8.8 million to approximately $1.8 million of other
income in 1999 from $7.0 million in other expense in 1998. The increase was
primarily due to (i) the inclusion of $5.6 million of non-cash interest expense
in 1998 relating to the change in the fair value of an outstanding put warrant
and (ii) an increase in interest income on the cash obtained from the completion
of our initial public offering in December 1998. The put provision associated
with the warrant was eliminated effective on completion of the initial public
offering.
INCOME TAX EXPENSE (BENEFIT)
Income tax benefit increased to $4.8 million in 1999 from $2.2 million in 1998
due to a decrease in taxable income in 1999.
EXTRAORDINARY ITEM
Net income in 1998 includes an extraordinary charge, net of income tax benefits,
of $1.4 million. The charge relates to the write-off of certain deferred assets
associated with our $15.0 million debt financing, which was repaid in December
1998.
LIQUIDITY AND CAPITAL RESOURCES
The report of our independent accountants contains an explanatory paragraph
expressing substantial doubt about the Company's ability to continue as a going
concern as a result of our negative cash flows. The Company has incurred pre-tax
losses from operations of $26.0 million and $15.0 million in 2000 and 1999,
respectively, and had negative working capital of $18.2 million at December 30,
2000. As a result of fiscal 2000 operating losses and the recent downturn in the
economy, which has adversely affected our sales trends, our current cash flows
may not be sufficient to meet our near-term liquidity needs. Our near-term cash
needs are further impacted by (i) the seasonality of our business, with lower
sales volumes historically occurring during the second quarter, (ii) the timing
of marketing and advertising expenditures, which are higher in the early part of
the year when direct marketing advertising rates are more favorable, and (iii)
working capital needs as we expand our wholesale activities through a
significant QVC sales event planned for May. Based on the estimated cash impact
of the items outlined above, offset in part by more aggressive efforts to manage
our working capital needs, we estimate that between $2 million and $8 million of
additional working capital is required during the second and third quarters.
Since the beginning of fiscal 2000, we have undertaken efforts to substantially
reduce our cost structure as outlined above in "Business -- Business and Growth
Strategy." Following the recent downturn in the economy and evaluation of the
related impact on our anticipated sales volumes, we implemented further cost
saving initiatives. We expect that these cost reductions, along with efforts to
increase our product and brand awareness, improve our sales conversion
effectiveness and expand our points of distribution, will result in positive
cash flows from operations for the balance of fiscal 2001.
Since the fourth quarter of 2000, we have been pursuing $10 million or more of
working capital financing from a variety of potential sources. Due to our
traditional business model, under which we manufacture product to meet consumer
orders and maintain minimal levels of finished goods inventory, the recent
economic downturn, and recent tightening of credit markets, we have been unable
to obtain traditional asset-based financing.
We therefore have recently begun pursuing a private placement of Senior Secured
Convertible Debentures in a minimum aggregate principal amount of $10 million
and a maximum aggregate principal amount of $12 million. The principal amount of
the Debentures would (i) be secured by a lien on the Company's assets
(subordinated only to up to $5 million of senior bank financing), (ii) mature
five years after the closing, (iii) bear interest at 8% payable annually in cash
and (iii) be convertible into common stock initially at the rate of $1.00 per
share, subject to anti-dilution provisions. In addition, for each $1,000,000 in
principal amount of Debentures purchased, investors would receive detachable
warrants to purchase up to 300,000 shares of common stock of the
30
Company at an initial exercise price of $1.33 per share, subject to
anti-dilution provisions. Debentures in the minimum aggregate principal amount
of $10 million and the related warrants would represent the right to acquire
more than 20% of our outstanding common stock and would therefore require
approval of our shareholders under Nasdaq rules in order to maintain our listing
on the Nasdaq Stock Market. The issuance of the Debentures would further be
subject to customary representations, warranties and covenants, including
specified events of default that may result in the acceleration of the maturity
of the Debentures, as well as certain conditions to closing, including (i) the
sale of Debentures in the minimum principal amount of $10 million, (ii) the
receipt of binding proxies from holders of more than 50% of our outstanding
shares of common stock to vote in favor of the transaction, (iii) the receipt by
our Board of Directors of a fairness opinion from an independent financial
advisor and (iv) satisfactory due diligence and the execution and delivery of
definitive documentation.
We have received non-binding indications of interest from several potential
investors for a significant portion of the minimum amount of this private
placement, and we are continuing to have discussions with other potential
investors. We believe that we will be able to consummate this financing.
However, binding commitments have not been received and significant conditions
to closing remain to be met, and therefore no assurance can be given that we
will be able to consummate this financing on the terms described above or on any
other terms.
In addition to pursuing the financing described above, we have been aggressively
managing our costs and cash flow to preserve and extend our cash resources. Near
the end of 2000, we began to undertake efforts to rightsize our cost structure.
The economic downturn at the end of 2000 adversely affected sales trends,
resulting in the identification and execution of additional cost reduction
measures. Efforts included termination of non-core business initiatives, closure
of certain facilities, including one of three manufacturing facilities, one of
two administrative offices and one of two call centers, closure of 27 stores in
2000 with plans to close 14 stores in 2001, reduction of corporate and
administrative overhead and staffing, and adjustment of advertising, promotional
and other marketing programs. We are also pursuing programs to improve our
liquidity, including negotiation of supplier and landlord payment terms, the
reduction of inventory levels and the deferral of capital programs.
We believe that the financing mentioned above, or other alternatives that might
become available, planned and implemented cost reduction efforts and the
aggressive management of current and future cash resources will provide
sufficient working capital to fund operations for the foreseeable future. If for
any reason we are unable to obtain additional financing, or if our cash
management efforts were not sufficient to preserve enough cash to meet our
near-term liquidity needs, we may not be able to continue as a going concern,
which may result in material asset impairment or restructuring charges, other
material adverse changes in our business, results of operations or financial
condition, or the loss by shareholders of all or a part of their investment in
the Company.
Historically, our primary source of liquidity has been the sale of equity
securities. We completed our initial public offering in December 1998, resulting
in net proceeds of $44.6 million, which have been used for (i) the repayment of
$15.0 million of debt, (ii) expansion of retail stores, (iii) expansion of
manufacturing capabilities, (iv) the repurchase of 1,220,000 shares of Company
common stock for $12.7 million and (v) the development of information technology
systems. The Company had negative working capital of approximately $18.2 million
at December 30, 2000, and positive working capital of $14.5 million at January
1, 2000.
Net cash used in 2000 operating activities was approximately $10.3 million and
consisted primarily of the net loss adjusted for non-cash expenses and an
increase in accounts receivable, partially offset by a decrease in income taxes
31
receivable and an increase in accounts payable. Net cash provided by 1999
operating activities was approximately $7.7 million and consisted primarily of
net loss adjusted for non-cash expenses, decreases in accounts receivable and
increases in accounts payable and accrued liabilities, partially offset by
increases in inventories and income taxes receivable. Net cash provided by
operating activities for 1998 was approximately $11.0 million and consisted
primarily of cash flows from operations before non-cash expenses, partially
offset by increases in accounts receivable and decreases in accounts payable.
Net cash provided by investing activities in 2000 was approximately $3.7
million. Net cash used in investing activities was approximately $35.8 million
and $8.9 million in the years 1999 and 1998, respectively. Investing activities
consisted of purchases of property and equipment for new retail stores in all
periods, and for 1999 also included the opening of our Utah production facility.
In 2000 we liquidated $16.2 million of marketable securities to support our
continuing operations, while in 1999 we purchased $20.1 million of marketable
securities for the investment of excess cash on hand.
Net cash provided by (used in) financing activities for 2000, 1999 and 1998 was
approximately $0.7 million, ($10.0) million, $30.7 million, respectively. Net
cash provided by financing activities in 2000 resulted from cash received from
the issuance of common stock. Net cash used in financing activities for 1999 was
due to repurchases of common stock and debt repayments, partially offset by cash
received from issuance of common stock. During 1999, the Company repurchased
1,220,000 shares of common stock for approximately $12.7 million. Net cash
provided by financing activities for 1998 consisted primarily of proceeds from
completion of our initial public offering, partially offset by debt repayments.
Financial instruments that potentially subject us to concentrations of credit
risk consist principally of investments. The counterparties to the agreements
consist of government agencies and various major corporations of high credit
standing. We do not believe there is significant risk of non-performance by
these counterparties because we limit the amount of credit exposure to any one
financial institution and any one type of investment.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Information concerning disclosure about market risk is set forth in Note 3 to
our Consolidated Financial Statements included in this report.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements are listed under item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
32
PART III
--------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The information under the captions "Election of Directors - Information About
Nominees and Directors" and "Election of Directors - Other Information About
Nominees and Directors" in our 2001 Proxy Statement is incorporated herein by
reference. The information concerning executive officers of Select Comfort is
included in this Report under Item 4a, "Executive Officers of the Company."
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The information under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in our 2001 Proxy Statement is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions "Election of Directors - Director
Compensation" and "Executive Compensation and Other Benefits" in our 2001 Proxy
Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Principal Shareholders and Beneficial
Ownership of Management" in our 2001 Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Transactions" in our 2001 Proxy
Statement is incorporated herein by reference.
33
PART IV
--------------------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page Number in
this Report
-----------
Independent Auditors' Report............................................F-1
Consolidated Balance Sheets as of December 30, 2000 and
January 1, 2000.........................................................F-2
Consolidated Statements of Operations for the years ended December
30, 2000, January 1, 2000 and January 2, 1999..........................F-3
Consolidated Statements of Shareholders' Equity for the years ended
December 30, 2000, January 1, 2000 and January 2, 1999..................F-4
Consolidated Statements of Cash Flows for the years ended December
30, 2000, January 1, 2000 and January 2, 1999...........................F-5
Notes to Consolidated Financial Statements......................F-6 to F-18
Management's Report....................................................F-19
2. INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
The following Report and financial statement schedule are included in this
Part IV and are found in this Report at the pages indicated.
Independent Auditors' Report on Schedule................................S-1
Schedule II - Valuation and Qualified Accounts..........................S-1
All other schedules are omitted because they are not applicable or the
required information is included in the consolidated financial statements
or notes thereto.
34
3. EXHIBITS
The exhibits to this Report are listed in the Exhibit Index below.
Select Comfort will furnish a copy of any of the exhibits referred to
above at a reasonable cost to any shareholder upon receipt of a written
request therefor. Requests should be sent to: Select Comfort Corporation,
6105 Trenton Lane North, Minneapolis, Minnesota 55442; Attn: Shareholder
Information.
The following is a list of each management contract or compensatory
plan or arrangement required to be filed as an exhibit to this Annual
Report on Form 10-K pursuant to Item 14(c):
1. Form of Incentive Stock Option Agreement under the 1997 Stock
Incentive Plan
2. Form of Performance Based Stock Option Agreement under the 1997 Stock
Incentive Plan
3. Employment Letter dated July 11, 1995 between the Company and Gregory
T. Kliner
4. Employment Letter dated November 12, 1997 between the Company and
Ronald E. Mayle
5. Select Comfort Profit Sharing and 401(K) Plan
6. Select Comfort Corporation 1999 Employee Stock Purchase Plan
7. Select Comfort Corporation 1990 Omnibus Stock Option Plan, as amended
and restated
8. Select Comfort Corporation 1997 Stock Incentive Plan, as amended and
restated
9. Employment Letter dated July 21, 1999 between the Company and Tracey
T. Breazeale
10. Employment Letter dated April 22, 1999 between the Company and Mark A.
Kimball
11. Executive and Key Employee Incentive Plan
12. Employment Letter dated March 3, 2000 between the Company and William
R. McLaughlin
13. Employment Letter dated July 11, 2000 between the Company and Michael
J. Thyken
14. Employment Letter dated October 27, 2000 between the Company and Noel
F. Schenker
35
(b) REPORTS ON FORM 8-K
During the quarter ended December 30, 2000, we filed one Current Report on
Form 8-K. This report was filed on November 22, 2000 to report the
acquisition by the Company of certain assets and business of SleepTec, Inc.
This Current Report on Form 8-K was amended on February 16, 2001 to include
the following financial statements:
Audited Financial Statements of SleepTec, Inc. as of December 31, 1999 and
for the year ended December 31, 1999 and the period August 13, 1997 (date
of incorporation) to December 31, 1999.
Unaudited Interim Financial Statements of SleepTec, Inc. as of September
30, 2000 and for the nine months ended September 30, 2000 and 1999.
Unaudited Pro Forma Condensed Combined Financial Information as of
September 30, 2000 and for the year ended January 1, 2000 and for the nine
months ended September 30, 2000.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SELECT COMFORT CORPORATION
Dated: April 16, 2001 By: /s/ William R. McLaughlin
------------------------------
William R. McLaughlin
President and Chief Executive Officer
(principal executive officer)
By: /s/ James C. Raabe
------------------------------
James C. Raabe
Chief Financial Officer
(principal financial and accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
- --------------------------------- ---------------------------- --------------
/s/ Patrick A. Hopf Chairman of the Board April 16, 2001
- ---------------------------
Patrick A. Hopf
/s/ William R. McLaughlin President and Chief April 16, 2001
- --------------------------- Executive Officer, Director
William R. McLaughlin
/s/ Ervin R. Shames Director April 16, 2001
- ---------------------------
Ervin R. Shames
/s/ Thomas J. Albani Director April 15, 2001
- ---------------------------
Thomas J. Albani
/s/ Christopher P. Kirchen Director April 16, 2001
- ---------------------------
Christopher P. Kirchen
37
/s/ David T. Kollat Director April 13, 2001
- ---------------------------
David T. Kollat
Director April , 2001
- ---------------------------
Jean-Michel Valette
38
SELECT COMFORT CORPORATION
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 30, 2000
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
------- ---------------------------------------------------- -------------------------------
3.1 Restated Articles of Incorporation of the Company, Incorporated by reference to
as amended.......................................... Exhibit 3.1 contained in Select
Comfort's Annual Report on Form
10-K for the fiscal year ended
January 1, 2000
(File No. 0-25121)
3.2 Restated Bylaws of the Company...................... Incorporated by reference to
Exhibit 3.2 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.1 Form of Warrant issued in connection with the sale Incorporated by reference to
of Convertible Preferred Stock, Series E............ Exhibit 4.2 contained in Select
Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.2 Form of Warrant issued in connection with the Incorporated by reference to
November 1996 Bridge Financing...................... Exhibit 4.3 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.3 Amended and Restated Registration Rights Agreement Incorporated by reference to
dated December 28, 1995............................. Exhibit 4.4 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.4 First Amendment to Series E Stock Purchase Incorporated by reference to
Agreement and Amended and Restated Registration Exhibit 4.5 contained in Select
Rights Agreement dated April 25, 1996............... Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.5 Second Amendment to Amended and Restated Incorporated by reference to
Registration Rights Agreement dated as of Exhibit 4.6 contained in Select
November 1, 1996.................................... Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.6 Second (sic) Amendment to Amended and Restated Incorporated by reference to
Registration Rights Agreement dated March 24, 1997.. Exhibit 4.7 contained in Select
Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
39
4.7 Series A Warrant effective as of March 31, 1998 Incorporated by reference to
issued to General Electric Capital Corporation...... Exhibit 4.8 contained in Select
Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.8 Convertible Subordinated Debenture dated as of Incorporated by reference to
November 10, 2000, between Select Comfort and Exhibit 4.1 contained in Select
SleepTec, Inc....................................... Comfort's Current Report on
Form 8-K filed November 22,
2000 (File No. 0-25121)
10.1 Net Lease Agreement dated December 3, 1993 between Incorporated by reference to
the Company and Opus Corporation.................... Exhibit 10.1 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.2 Amendment of Lease dated August 10, 1994 between the Incorporated by reference to
Company and Opus Corporation........................ Exhibit 10.2 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.3 Second Amendment to Lease dated May 10, 1995 between Incorporated by reference to
the Company and Rushmore Plaza Partners Limited Exhibit 10.3 contained in
Partnership (successor to Opus Corporation)......... Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.4 Letter Agreement dated as of October 5, 1995 between Incorporated by reference to
the Company and Rushmore Plaza Partners Exhibit 10.4 contained in
Limited Partnership................................. Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.5 Third Amendment of Lease, Assignment and Assumption Incorporated by reference to
of Lease and Consent dated as of January 1, 1996 Exhibit 10.5 contained in
among the Company, Rushmore Plaza Partners Limited Select Comfort's Registration
Partnership and Select Comfort Direct Corporation... Statement on Form S-1, as
amended (File No. 333-62793)
10.6 Sublease dated as of March 27, 1997 between Select Incorporated by reference to
Comfort SC Corporation and Bellsouth Exhibit 10.6 contained in
Telecommunications, Inc............................. Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.7 Supply Agreement dated August 23, 1994 between the Incorporated by reference to
Company and Supplier (1)............................ Exhibit 10.8 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
40
10.8 Major Merchant Agreement dated December 19, 1997 Incorporated by reference to
among First National Bank of Omaha and the Company, Exhibit 10.13 contained in
Select Comfort SC Corporation, Select Comfort Retail Select Comfort's Registration
Corporation and Select Comfort Direct Corporation... Statement on Form S-1, as
amended (File No. 333-62793)
10.9 Form of Incentive Stock Option Agreement under the Incorporated by reference to
1997 Stock Incentive Plan........................... Exhibit 10.16 contained in the
Company's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.10 Form of Performance Based Stock Option Agreement Incorporated by reference to
under the 1997 Stock Incentive Plan................. Exhibit 10.17 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.11 Employment Letter Agreement dated July 11, 1995 Incorporated by reference to
between the Company and Gregory T. Kliner........... Exhibit 10.20 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.12 Employment Letter Agreement dated November 12, 1997 Incorporated by reference to
between the Company and Ronald E. Mayle............. Exhibit 10.20 contained in
Select Comfort's Annual Report
on Form 10-K for the fiscal
year ended January 2, 1999
(File No. 0-25121)
10.13 Lease Agreement dated September 30, 1998 between Incorporated by reference to
the Company and ProLogis Development Services Exhibit 10.28 contained in
Incorporated........................................ Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.14 Revolving Credit Program Agreement by and between Incorporated by reference to
Green Tree Financial Corporation and Select Comfort Exhibit 10.3 contained in
Corporation (1)..................................... Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended July 3, 1999
(File No. 0-25121)
10.15 Letter of Agreement by and between Bed, Bath & Beyond Incorporated by reference to
Inc. and Select Comfort Retail Corporation (1)....... Exhibit 10.4 contained in
Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended July 3, 1999
(File No. 0-25121)
10.16 Select Comfort Profit Sharing and 401(K) Plan....... Incorporated by reference to
Exhibit 10.5 contained in
Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended July 3, 1999
(File No. 0-25121)
41
10.17 Select Comfort Corporation 1999 Employee Stock
Purchase Plan, as amended........................... Filed herewith electronically
10.18 Select Comfort Corporation 1990 Omnibus Stock Option Incorporated by reference to
Plan, as amended and restated....................... Exhibit 10.1 contained in
Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended October 2, 1999
(File No. 0-25121)
10.19 Select Comfort Corporation 1997 Stock Inventive Incorporated by reference to
Plan, as amended and restated....................... Exhibit 10.1 contained in
Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended July 1, 2000
(File No. 0-25121)
10.20 Employment Letter Agreement dated July 21, 1999 Incorporated by reference to
between the Company and Tracey T. Breazeale......... Exhibit 10.24 contained in
Select Comfort's Annual Report
on Form 10-K for the fiscal
year ended January 1, 2000
(File No. 0-25121)
10.21 Employment Letter Agreement dated April 22, 1999 Incorporated by reference to
between the Company and Mark A. Kimball............. Exhibit 10.25 contained in
Select Comfort's Annual Report
on Form 10-K for the fiscal
year ended January 1, 2000
(File No. 0-25121)
10.22 Executive and Key Employee Incentive Plan........... Filed electronically herewith
10.23 Employment Letter dated March 3, 2000 between the Incorporated by reference to
Company and William R. McLaughlin................... Exhibit 10.1 contained in
Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended April 1, 2000
10.24 Employment Letter dated July 11, 2000 between the
Company and Michael J. Thyken....................... Filed electronically herewith
10.25 Employment Letter dated October 27, 2000 between the
Company and Noel F. Schenker........................ Filed electronically herewith
10.26 Asset Purchase Agreement dated as of November 10, Incorporated by reference to
2000, among SleepTec, Inc., St. Paul Venture Capital Exhibit 2.1 contained in Select
IV, LLC, St. Paul Venture Capital V, LLC, St. Paul Comfort's Current Report on
Venture Capital VI, LLC and Select Comfort Form 8-K filed November 22,
Corporation......................................... 2000 (File No. 0-25121)
42
10.27 Letter Agreement dated as of July 1, 2000 between
Messner Vetere Berger McNamee Schmetterer/Euro RSCG
Inc. and Select Comfort Retail Corporation.......... Filed electronically herewith
21.1 Subsidiaries of the Company......................... Incorporated by reference to
Exhibit 21.1 contained in
Select Comfort's Annual Report
on Form 10-K for the fiscal
year ended January 1, 2000
(File No. 0-25121)
23.1 Independent Auditors' Consent....................... Filed electronically herewith
27.1 Financial Data Schedule............................. Filed electronically herewith
(1) Confidential treatment has been granted by the Securities and Exchange
Commission with respect to designated portions contained within document.
Such portions have been omitted and filed separately with the Securities
and Exchange Commission pursuant to Rule 24b-2 of the Securities and
Exchange Act of 1934, as amended.
43
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Select Comfort Corporation:
We have audited the accompanying consolidated balance sheets of Select
Comfort Corporation and subsidiaries (the Company) as of December 30, 2000 and
January 1, 2000 and the related consolidated statements of operations,
shareholders' equity, and cash flows for each of the fiscal years in the
three-year period ended December 30, 2000. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with 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 30, 2000 and January 1,
2000, and the results of their operations and their cash flows for each of the
fiscal years in the three-year period ended December 30, 2000 in conformity with
accounting principles generally accepted in the United States of America.
The accompanying financial statements have been prepared assuming that the
Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has incurred negative cash flows that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The financial
statements do not include any adjustments that might result from the outcome of
this uncertainty.
Minneapolis, Minnesota /s/ KPMG LLP
February 2, 2001, except with respect to Notes 1 and 10
which are as of April 12, 2001
F-1
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 30, 2000 AND JANUARY 1, 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
ASSETS 2000 1999
---------- -----------
Current assets:
Cash and cash equivalents $ 1,498 $ 7,441
Marketable securities (note 3) 3,950 20,129
Accounts receivable, net of allowance for doubtful
accounts of $264, and $305, respectively 2,693 1,056
Inventories (note 4) 11,083 11,451
Prepaid expenses 4,741 4,821
Income taxes (note 10) - 2,579
Deferred tax assets (note 10) - 6,639
---------- -----------
Total current assets 23,965 54,116
---------- -----------
Property and equipment, net (note 5) 37,063 34,823
Deferred tax assets (note 10) - 4,248
Other assets 3,644 2,176
---------- -----------
Total assets $64,672 $95,363
========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 7) $ 38 $ 51
Accounts payable 17,271 15,911
Accruals:
Sales returns 5,284 5,880
Warranty costs 7,181 5,841
Compensation, taxes and benefits 6,238 6,678
Other 6,129 5,285
---------- -----------
Total current liabilities 42,141 39,646
Long-term debt, less current maturities (note 7) 2,322 36
Other liabilities 3,609 2,809
---------- -----------
Total liabilities 48,072 42,491
---------- -----------
Shareholders' equity (notes 1, 2, 7, 8, 9, 12, and 13):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares
authorized, 17,962,689 and 17,713,247 shares issued
and outstanding, respectively 180 177
Additional paid-in capital 79,452 78,513
Accumulated deficit (63,032) (25,818)
---------- -----------
Total shareholders' equity 16,600 52,872
---------- -----------
Commitments and contingencies (notes 1, 6,and 14):
Total liabilities and shareholders' equity $64,672 $ 95,363
========== ===========
See accompanying notes to consolidated financial statements.
F-2
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 30, 2000, JANUARY 1, 2000 AND JANUARY 2, 1999
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2000 1999 1998
------------ ------------ -----------
Net sales $270,077 $273,767 $246,269
Cost of sales 98,924 95,107 85,187
------------ ------------ -----------
Gross margin 171,153 178,660 161,082
------------ ------------ -----------
Operating expenses:
Sales and marketing 165,960 162,742 129,894
General and administrative 29,211 29,213 19,723
Store closings/asset impairments (note 5) 1,952 1,498 20
------------ ------------ -----------
Total operating expenses 197,123 193,453 149,637
------------ ------------ -----------
Operating income (loss) (25,970) (14,793) 11,445
------------ ------------ -----------
Other income (expense):
Interest income 1,082 1,956 825
Interest expense (note 7) (26) (69) (7,834)
Equity in loss of affiliate (note 2) (642) - -
Other, net (66) (116) (32)
------------ ------------ -----------
Other income (expense), net 348 1,771 (7,041)
------------ ------------ -----------
Income (loss) before income taxes and
extraordinary item (25,622) (13,022) 4,404
Income tax expense (benefit) (note 10) 11,592 (4,818) (2,232)
------------ ------------ -----------
Net income (loss) before extraordinary item (37,214) (8,204) 6,636
Extraordinary item, net of tax benefit (note 7) - - (1,441)
------------ ------------ -----------
Net income (loss) $(37,214) $(8,204) $ 5,195
============ ============ ===========
Deemed dividend from revision of preferred
stock conversion rate (note 8) - - $(1,312)
Cumulative preferred dividends - - (821)
------------ ------------ -----------
Net income (loss) available to common
shareholders $(37,214) $(8,204) $ 3,062
============ ============ ===========
Net income (loss) per share - basic (note 11)
Net income (loss) before extraordinary item $ (2.09) $ (0.45) $ 1.09
Net income (loss) (2.09) (0.45) 0.74
============ ============ ===========
Net income (loss) per share - diluted (note 11)
Net income (loss) before extraordinary item $ (2.09) $ (0.45) $ 0.28
Net income (loss) (2.09) (0.45) 0.19
============ ============ ===========
See accompanying notes to consolidated financial statements.
F-3
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 30, 2000, JANUARY 1, 2000 AND JANUARY 2, 1999
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Additional Notes
Paid-in Accumulated Receivable-
Shares Amount Capital Deficit Investors Total
----------- ----------- ----------- ----------- ----------- -----------
Balance at January 3, 1998 2,477,660 $ 25 $ 1,662 $(22,307) $(418) $(21,038)
Issuance of shares in initial public
offering (note 9) 2,922,350 29 44,614 - - 44,643
Conversion of manditorily redeemable
preferred stock (note 8) 12,332,364 123 27,489 - - 27,612
Exercise of common stock options
and warrants 703,313 7 4,639 - - 4,646
Issuance of investor notes - - - - (487) (487)
Payment of investor notes - - - - 905 905
Elimination of put provision
on warrant (note 7) - - 9,215 - - 9,215
Net income - - - 5,195 - 5,195
----------- ----------- ----------- ----------- ----------- -----------
Balance at January 2, 1999 18,435,687 184 87,619 (17,112) - 70,691
----------- ----------- ----------- ----------- ----------- -----------
Exercise of common stock options
and warrants 479,855 5 3,470 - - 3,475
Repurchase of common stock (1,220,000) (12) (12,680) - - (12,692)
Employee stock purchases (note 12) 17,705 - 104 - - 104
Net loss - - - (8,204) - (8,204)
----------- ----------- ----------- ----------- ----------- -----------
Balance at January 1, 2000 as
previously reported 17,713,247 177 78,513 (25,316) - 53,374
----------- ----------- ----------- ----------- ----------- -----------
Acquisition of SleepTec, Inc. (note 2) - - - (502) - (502)
----------- ----------- ----------- ----------- ----------- -----------
Balance at January 1, 2000 17,713,247 177 78,513 (25,818) - 52,872
----------- ----------- ----------- ----------- ----------- -----------
Exercise of common stock options
and warrants 44,515 1 414 - - 415
Employee stock purchases (note 12) 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
=========== =========== =========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
F-4
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 30, 2000, JANUARY 1, 2000 AND JANUARY 2, 1999
(IN THOUSANDS)
2000 1999 1998
----------- ----------- ----------
Cash flows from operating activities:
Net income (loss) $(37,214) $(8,204) $ 5,195
Adjustments to reconcile net income (loss) to
net cash provided by operating activities:
Depreciation and amortization 8,409 6,695 5,351
Loss on disposal of assets and impaired assets 2,167 1,297 50
Extraordinary item - - 1,441
Deferred tax assets 10,887 (4,998) (5,888)
Interest expense from put warrant valuation - - 5,625
Change in operating assets and liabilities net
of effects of acquisition:
Accounts receivable, net (1,637) 9,568 (4,663)
Inventories 640 (1,315) (2,387)
Prepaid expenses 80 (773) 208
Income taxes 2,579 (3,227) 1,856
Accounts payable 1,360 3,832 (120)
Accrued sales returns (596) (141) 697
Accrued warranty costs 1,340 1,355 1,229
Accrued compensation, taxes and benefits (173) 1,835 1,694
Other accrued liabilities 537 723 (265)
Other assets 535 147 252
Other liabilities 800 863 709
----------- ----------- ----------
Net cash provided by (used in) operating activities (10,286) 7,657 10,984
----------- ----------- ----------
Cash flows used in investing activities:
Purchases of property and equipment (12,084) (13,663) (8,812)
Sales of (investments in) marketable securities 16,179 (20,129) -
Investment in affiliate (400) (2,000) -
----------- ----------- ----------
Net cash provided by (used in) investing activities 3,695 (35,792) (8,812)
----------- ----------- ----------
Cash flows from financing activities:
Principal payments on debt (16) (872) (15,999)
Repurchase of common stock - (12,692) -
Proceeds from issuance of common stock 664 3,579 46,718
----------- ----------- ----------
Net cash provided by (used in) financing activities 648 (9,985) 30,719
----------- ----------- ----------
Increase (decrease) in cash and cash equivalents (5,943) (38,120) 32,891
Cash and cash equivalents, at beginning of year 7,441 45,561 12,670
----------- ----------- ----------
Cash and cash equivalents, at end of year $ 1,498 $ 7,441 $45,561
=========== =========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (NOTE 2)
Cash paid during the year for:
Interest $ 7 $ 69 $ 1,719
Income taxes 175 2,292 1,800
Cashless exercise of stock options - - 1,483
Net tax benefit from exercise of stock options 11 1,115 493
=========== =========== ==========
See accompanying notes to consolidated financial statements.
F-5
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Select Comfort Corporation and its wholly-owned subsidiaries (the Company)
develop, manufacture, and market air beds and sleep-related products. The
Company's fiscal year ends on the Saturday closest to December 31. Fiscal years
2000, 1999 and 1998 had 52 weeks. Certain prior-year amounts have been
reclassified to conform to the current-year presentation.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant inter-company balances and transactions
have been eliminated in consolidation.
GOING CONCERN CONSIDERATIONS
The financial statements have been prepared on a going-concern basis, which
contemplates the realization of assets and the satisfaction of liabilities and
other commitments in the normal course of business. The Company has incurred
negative cash flows and has incurred pretax losses from operations of
$25,970,000 and $14,793,000 in 2000 and 1999, respectively. In addition, the
Company had negative working capital of $18,176,000 at December 30. 2000. These
factors, among others, indicate that there is a substantial doubt about the
Company's ability to continue as a going concern. These financial statements do
not include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and classification of liabilities that
might be necessary if it was unable to continue as a going concern. The
Company's continuation as a going concern is dependent, among other things, upon
obtaining positive cash flow from operations or upon its ability to raise
additional working capital.
Near the end of 2000, the Company began to undertake efforts to right size
its cost structure. The economic downturn at the end of 2000 adversely affected
sales trends, resulting in the identification and execution of additional cost
reduction measures. Efforts have included termination of non-core business
initiatives, closure of certain facilities, including one of three manufacturing
facilities, one of two administrative offices and one of two call centers,
closure of 27 stores in 2000 with plans to close 14 stores in 2001, reduction of
corporate and administrative overhead and staffing, and adjustment of
advertising, promotional and other marketing programs. The Company is also
pursuing programs to improve its liquidity, including negotiation of supplier
and landlord payment terms, the reduction of inventory levels and the deferral
of capital programs.
Since the fourth quarter of 2000, the Company has been pursuing $10 million
or more of working capital financing from a variety of potential sources. The
Company is pursuing a private placement of $10 million to $12 million of senior
secured debt securities convertible into shares of common stock together with
detachable warrants to purchase additional shares of common stock. Consummation
of this financing as contemplated could result in substantial dilution to
current shareholders. Based on discussions with potential investors in this
private placement, the Company believes that it will be able to consummate this
financing. However, firm commitments have not been received and significant
conditions to closing remain to be met, and therefore no assurance can be given
that it will be able to consummate this financing on satisfactory terms, or at
all.
While management believes that implementation of its plans to achieve
profitability and obtain additional capital will provide sufficient working
capital to fund operations for the foreseeable future, there is no assurance
that such actions will achieve positive results from operations or adequate
working capital and equity.
CASH AND CASH EQUIVALENTS
Cash and cash equivalents include highly liquid investments with original
maturities of three months or less.
INVENTORIES
Inventories include material, labor, and overhead and are stated at the
lower of cost or market. Cost is determined by the first-in, first-out method.
F-6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
PROPERTY AND EQUIPMENT
Property and equipment, carried at cost, are depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from three to seven years. Leasehold improvements are amortized over the shorter
of the life of the lease or ten years.
OTHER ASSETS
Other assets include security deposits, patents, investments, trademarks,
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.
Goodwill is being amortized using the straight-line method over a 10-year
period.
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell. The Company reviews store
assets for possible impairment considering such factors as store cash flows,
lease termination provisions, and opportunities to impact future store operating
results.
ACCRUED WARRANTY COSTS
The Company provides a 20-year warranty on air beds, the last 15 years of
which are on a prorated basis. Estimated warranty costs are provided at the time
of sale based on historical claims incurred by the Company. Given the limited
history available, actual results could differ from these estimates.
ACCRUED SALES RETURNS
Estimated sales returns are provided at the time of sale based upon
historical sales returns. Returns are allowed by the Company for 90 nights
following the sale.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying value of cash and cash equivalents and accounts receivable
approximate fair value because of the short-term maturity of those instruments.
The fair value of long-term debt approximates carrying value based on the
Company's estimate of rates that would be available to it for debt of the same
remaining maturities.
REVENUE RECOGNITION
Revenue is recognized when products are shipped to customers net of
estimated returns. The Company records shipping and handling costs as a
component of sales and marketing expense.
STOCK COMPENSATION
The Company records compensation expense for option grants under its stock
option plan if the current market value of the underlying stock at the grant
date exceeds the stock option exercise price. Pro forma disclosure of the net
income impact of applying an alternative method of recognizing stock
compensation expense over the vesting period based on the fair value of all
stock-based awards on the date of grant is presented in Note 9. The Company has
issued options to non-employees and recognized compensation expense based on the
fair market value method.
F-7
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in connection with research and development are charged to
expense as incurred. Research and development expense was $889,000, $1,865,000
and $1,638,000 in 2000, 1999 and 1998, respectively.
PRE-OPENING COSTS
Costs associated with the opening of new stores are expensed as incurred.
ADVERTISING COSTS
The Company incurs advertising costs associated with print and broadcast
advertisements. Such costs are charged to expense as incurred. Advertising
expense was $33,444,000, $43,415,000 and $31,648,000 in 2000, 1999 and 1998.
INCOME TAXES
The Company recognizes deferred tax assets and liabilities for the future
tax consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
EARNINGS PER SHARE
Basic earnings (loss) per share excludes dilution and is computed by
dividing the net income (loss) available to common shareholders by the weighted
average number of common shares outstanding during the period. Diluted earnings
(loss) per share includes dilutive potential common shares consisting of stock
options and warrants determined by the treasury stock method, and dilutive
convertible securities.
ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in conformity with
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 and disclosure of contingent assets and
liabilities at the date of the consolidated financial statements and the
reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued Statement of Financial
Accounting Standards No 133, "Accounting for Derivative Instruments and Hedging
Activities", which requires implementation during 2001. The Company has
evaluated the impact of SFAS 133 and has determined that the pronouncement will
not impact the Company's consolidated financial statements.
(2) ACQUISITION
Effective November 10, 2000, the Company completed the acquisition of
certain assets of SleepTec, Inc. ("SleepTec"), the manufacturer of the Company's
sofa sleeper product. The acquisition of SleepTec was accounted for by the
purchase method of accounting. The Company made an original investment in
SleepTec of $2,000,000 in May 1999 and accounted for the less than 20%
investment under the cost method. The subsequent acquisition in 2000 resulted in
step-acquisition treatment of the original May 1999 investment. Accordingly, the
results of operations of SleepTec for 1999, in the amount of the Company's
ownership interest (15.7%) are included as an adjustment to 1999 retained
earnings ($502,000). The results of SleepTec's operations for 2000 are included
in the Company's consolidated results as a loss in equity of affiliate
($642,000) and amortization of goodwill related to this purchase transaction is
included in general and administrative expense ($46,000).
F-8
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITION (CONTINUED)
The aggregate purchase price paid by the Company for the assets of SleepTec
consists of (i) a non-interest-bearing subordinated convertible debenture
("debenture") in the original principal amount of $4,000,000, due November 10,
2005 and convertible at any time into shares of the Company's common stock at
the rate of $5.50 per share of common stock; and (ii) $400,000 in cash. In
addition, the Company agreed to fund approximately $250,000 in a combination of
cash and equity (in the form of options to purchase shares of the Company's
common stock) payments to current and former employees of SleepTec for
transition services and severance compensation. The Company's largest
shareholder is the holder of the SleepTec debenture.
The purchase price was determined through arm's-length negotiations between
the Company and representatives of SleepTec based primarily upon the past and
projected stream of earnings of the SleepTec operations. The source of the funds
used to pay the purchase price was cash on hand at the Company and by issuance
of the debenture.
A summary of the assets acquired and the amount paid for this acquisition
is as follows (in thousands):
Inventory $272
Property, plant and equipment 544
Patents and trademarks (amortized by the
straight-line method over ten years) 50
Goodwill (amortized by the straight-line
method over ten years) 2,864
----------
Purchase price 3,730
----------
Less:
Amount previously paid for SleepTec, net
of equity losses (742)
Transaction costs, included in goodwill
balance above (318)
Value of $4,000,000 non-interest bearing
subordinated convertible debenture (2,270)
----------
Net cash paid $400
==========
The asset and liability balances noted above, excluding cash paid, are
treated as non-cash items in the statement of cash flows.
The value of the $4,000,000 non-interest bearing subordinated convertible
debenture was determined based on its net cash flows using a 12% discount rate
and a five-year term.
Unaudited pro forma results of operations for the years ended December 30,
2000, and January 1, 2000, as if the Company and SleepTec had been combined as
of the beginning of those years follows. The pro forma results include estimates
and assumptions which management believes are reasonable. However, pro forma
results do not include any cost savings or any other effects of the planned
integration of the Company and SleepTec, and are not necessarily indicative of
the results which would have occurred if the business combination had been in
effect on the dates indicated, or which may result in the future.
PRO FORMA PRO FORMA
DECEMBER 30, JANUARY 1,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2000 2000
------------ ------------
Net sales $270,479 $274,011
Net loss (19,901) (12,240)
Net loss per share - diluted (1.12) (0.67)
============ ============
F-9
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(3) 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: (in thousands):
AVERAGE
INTEREST AMORTIZED FAIR
RATE COST VALUE
---------- ---------- ---------
DECEMBER 30, 2000
Commercial paper 6.7% 3,950 3,949
-------------------------------
$ 3,950 $ 3,949
===============================
JANUARY 1, 2000
U.S. Government agencies 5.5% $ 7,244 $ 7,228
Commercial paper 5.8% 12,885 12,877
-------------------------------
$20,129 $20,105
===============================
(4) INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 30, 2000 JANUARY 1, 2000
------------------ -----------------
Raw materials $ 5,507 $ 5,753
Work in progress 60 59
Finished goods 5,516 5,639
------------------------------------
$11,083 $11,451
====================================
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
DECEMBER 30, 2000 JANUARY 1, 2000
----------------- ---------------
Leasehold improvements $35,712 $33,192
Office furniture and equipment 5,097 5,314
Production machinery and computer equipment 19,794 13,115
Property and equipment under capital lease 112 495
Other 188 1,108
Less accumulated depreciation and
amortization (23,840) (17,401)
----------------------------------
$37,063 $34,823
==================================
STORE CLOSINGS AND ASSET IMPAIRMENT CHARGES
Store closing and write off expense was $565,000, $1,498,000, and $20,000
in 2000, 1999 and 1998, respectively, associated with 16 stores, 22 stores and 1
store in 2000, 1999 and 1998 respectively.
During 2000, the Company incurred charges of $1,387,000 related to the
impairment of carrying values of certain non-store assets. These charges
included $741,000 related to relocation of the Company's headquarters and
$646,000 related to the write-off of web software design costs.
F-10
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) LEASES
The Company rents office and manufacturing space under four operating
leases which, in addition to the minimum lease payments, require payment of a
proportionate share of the real estate taxes and building operating expenses.
The Company also rents retail space under operating leases which, in addition to
the minimum lease payments, require payment of percentage rents based upon sales
levels. Rent expense was as follows:
2000 1999 1998
-------- ------- -------
Minimum rents $17,589 $15,399 $11,127
Percentage rents 1,835 1,992 1,522
------------------------------
Total $19,424 $17,391 $12,649
==============================
Equipment rent $ 1,587 $ 1,362 $ 952
==============================
The aggregate minimum rental commitments under operating leases for
subsequent years are as follows (in thousands):
2001 $15,376
2002 15,088
2003 14,311
2004 12,853
2005 11,308
Thereafter 24,143
-------------
$93,079
=============
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term obligations under notes and capital leases are as follows (in
thousands):
DECEMBER 30, 2000 JANUARY 1, 2000
----------------- ---------------
Non-interest bearing subordinated
convertible debenture for the acquisition
of certain assets of SleepTec, Inc. due
November 2005. Face amount of $4,000,000
net of $1,711,000 debt discount, with an
effective interest rate of 12% per
annum. Convertible into 727,273 shares
of common stock at the rate of $5.50 per
share (note 2). $2,289 $ -
Notes payable under capital lease agreements
for office equipment, payable in monthly
installments through April 2003, with
interest at 7.75% - 12.5% per annum. 71 87
----------------------------------
2,360 87
Less current maturities 38 51
----------------------------------
$2,322 $36
==================================
The aggregate maturities of long-term debt and capital lease obligations
for subsequent years are as follows (in thousands):
2001 $ 38
2002 28
2003 5
2004 -
2005 4,000
Thereafter -
------------
$4,071
============
F-11
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
In March 1997, the Company completed a financing under which it issued a
senior subordinated promissory note in the principal amount of $15,000,000, a
warrant to purchase 1,100,000 shares of the Company's common stock at $10.50 per
share and a warrant to purchase 1,000,000 shares of common stock at $0.01 per
share. These warrants were subsequently adjusted and combined, resulting in a
single warrant to purchase 1,315,096 shares of common stock at $8.82 per share,
exercisable at any time prior to March 31, 2005. The holder has exercised
238,998 warrants to date. This warrant includes an anti-dilution provision
resulting in warrants outstanding of 1,131,357 at $8.39 and 1,083,391 at $8.76
at December 30, 2000 and January 1, 2000, respectively.
In December 1998, the Company repaid the promissory note resulting in an
extraordinary loss of $1,441,000 from early repayment. The loss was comprised of
unamortized debt discount and issuance costs totaling $2,281,000, and net of
income tax benefits of $840,000.
The original warrant issued in the financing provided that the holder could
require repurchase of the warrant if an IPO had not been completed prior to
March 27, 2002. The repurchase amount would have been equal to the excess of the
estimated fair market value of the Company's common stock, as determined by the
warrant agreement, over the exercise price of the warrant. The Company also has
an option to repurchase the warrant if the warrant has not been exercised prior
to March 27, 2004. The warrant was recorded at fair value and recorded as
long-term debt. Changes in fair value of the warrant were reflected as interest
expense. Accordingly, the financial statements reflect interest expense of
$5,625,000 for 1998 related to this warrant.
Upon completion of the Company's initial public offering the put option on
the warrants expired and the warrants were reclassified into $9,215,000 of
additional paid-in-capital. In addition, effective upon completion of the
Company's initial public offering, warrant revaluation is no longer required and
accordingly interest expense is no longer recorded.
(8) MANDATORILY REDEEMABLE PREFERRED STOCK
Prior to completion of the Company's initial public offering in December
1998, the Company had issued and outstanding 12,091,962 shares of manditorily
redeemable preferred stock. The holders of the Series A, B, C, D, and E
mandatorily redeemable preferred stock had certain rights and preferences,
including those involving dividend participation, special voting, liquidation
preferences, antidilution rights, redemption rights and in certain cases, those
involving cumulative dividends.
In November 1998, the Company adjusted the conversion price of the Series E
Mandatorily Redeemable Preferred Stock from $8.82 per share to $8.20.The
adjustment was made in accordance with the Series E Stock Purchase Agreement and
was effective on the closing of the Company's initial public offering. The
adjustment resulted in the issuance of an additional 77,155 shares of common
stock upon conversion. For purposes of calculating net income per share in the
period in which the initial public offering was completed, net income available
to common shareholders has been reduced by $1,312,000 in 1998 for the estimated
value of additional shares issued under these antidilution provisions (note 11).
Upon completion of the Company's underwritten public offering in December
1998 the Series A, B, C, D, and E mandatorily redeemable preferred stock were
converted into an aggregate of 12,332,364 of common stock. In addition, all
rights and preferences, including those involving cumulative dividends expired.
Cumulative but undeclared and unpaid dividends have been deducted from net
income available to common shareholders in determining net income per share
(note 11).
As of January 2, 1999, there were no remaining shares of manditory
redeemable shares outstanding.
Changes in mandatorily redeemable preferred stock are as follows (dollars
in thousands):
ADDITIONAL
PAID-IN
SHARES AMOUNT CAPITAL TOTAL
------------ ---------- ----------- ---------
Balance at January 3, 1998 12,091,962 $12,692 $14,920 $27,612
Conversion to common stock 12,091,962 12,692 14,920 27,612
---------------------------------------------
Balance at January 2, 1999 - $ - $ - $ -
=============================================
F-12
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) SHAREHOLDERS' EQUITY
Effective December 4, 1998, the Company issued 2,922,350 common shares in
completion of its initial public offering resulting in net proceeds of
$44,643,000.
STOCK OPTIONS
The Board of Directors has reserved 6,300,000 shares of common stock for
options that may be granted to key employees, directors, or others under the
Company's stock option plans.
A summary of the changes in the Company's stock option plans for each of
the years in the three-year period ended December 30, 2000 is as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
------------ ---------
Outstanding at January 3, 1998 2,095,609 $ 4.98
(including 931,319 shares exercisable)
Granted 443,075 14.70
Exercised (526,880) 3.18
Canceled (208,070) 5.82
----------------------
Outstanding at January 2, 1999 1,803,734 7.77
(including 884,807 shares exercisable)
Granted 1,857,100 12.10
Exercised (448,705) 5.05
Canceled (526,776) 14.66
----------------------
Outstanding at January 1, 2000 2,685,353 9.92
(including 1,311,133 shares exercisable)
Granted 1,307,700 4.64
Exercised (44,515) 3.09
Canceled (429,267) 9.44
----------------------
Outstanding at December 30, 2000 3,519,271 $ 8.08
(including 1,726,097 shares exercisable) ======================
The following table summarizes information about options outstanding at
December 30, 2000:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
---------------------------------------------------- --------------------
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICE SHARES LIFE (YEARS) PRICE SHARES PRICE
----------------- ----------- ------------ -------- --------- ---------
$0.45 - 4.80 706,927 8.27 $3.34 335,085 $3.61
4.82 - 5.91 1,277,687 8.26 5.55 484,978 5.41
6.63 - 11.00 792,872 8.05 8.19 567,567 8.54
13.94 - 24.50 706,785 8.24 16.38 307,787 16.69
24.53 - 28.63 35,000 8.25 26.54 30,680 26.56
----------------- ----------- ------------ -------- --------- ---------
$0.45 - 28.63 3,519,271 8.21 $8.08 1,726,097 $8.48
=========== =========
F-13
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) SHAREHOLDERS' EQUITY (CONTINUED)
No compensation cost has been recognized in the consolidated financial
statements for employee stock options grants. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options under an alternative accounting method, the Company's net income (loss)
would have been adjusted as indicated below (in thousands):
2000 1999 1998
--------- --------- ---------
Net income (loss): As reported $(37,214) $ (8,204) $5,195
Pro forma $(39,673) $(11,088) $4,144
Earnings (loss) per share: As reported $ (2.09) $ (0.45) $ 1.09
Pro forma $ (2.22) $ (0.60) $ 0.73
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: expected
dividend yield-0%; expected stock price volatility-40%; risk-free interest rate-
5.9%, 6.3%, and 4.6% for 2000, 1999 and 1998 respectively; expected life of
options-3.6, 2.9 years, and 3.0 for 2000, 1999, 1998, respectively. The per
share weighted-average fair value of stock options granted during 2000, 1999 and
1998 was $1.87, $3.86 and $4.72, respectively.
WARRANTS
In April 1996, the Company issued warrants to the holders of Series E
Preferred Stock (note 8) to purchase an aggregate of 171,429 shares of Common
Stock at an exercise price of $5.25 per share. During 1998, warrants for 54,430
common shares were exercised. Warrants for 108,499 shares remained outstanding
at December 30, 2000 and January 1, 2000, respectively.
In connection with a capital lease transaction with a vendor in 1997, the
Company granted the vendor warrants to acquire 31,428 shares of the Company's
Series E convertible preferred stock at a purchase price of $10.50 per share.
The warrants are exercisable for five years beginning December 3, 1998. In
December 1998 all the Preferred Stock warrants were converted into warrants
exercisable into 40,243 shares of common stock at $8.20 per share. In February
of 1999, the vendor exercised all of these warrants.
In connection with short-term debt issued to related parties in 1996, the
Company granted warrants to purchase 71,525 shares of the Company's common stock
at a purchase price of $5.25 per share. The warrants are exercisable for ten
years from the grant date. During December 1998, warrants for 7,003 common
shares were exercised. Warrants for 64,522 shares remained outstanding at
December 30, 2000 and January 1, 2000.
In connection with an executive search in March 2000, the Company issued
warrants to purchase 40,000 shares of the Company's common stock at a purchase
price of $5.56 per share. The warrants are exercisable for five years from the
grant date. All of these warrants remained outstanding at December 30, 2000.
STOCK REPURCHASE
During 1999, the Company repurchased 1,220,000 shares for approximately
$12.7 million.
F-14
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(10) INCOME TAXES
The provision (benefit) for income taxes consists of the following (in
thousands):
2000 1999 1998
---------- --------- ---------
Current:
Federal $ - $ - $ 2,969
State 705 180 687
------------------------------
Deferred:
Federal 10,397 (4,694) (5,803)
State 490 (304) (85)
------------------------------
10,887 (4,998) (5,888)
------------------------------
Income tax expense (benefit) $11,592 $(4,818) $(2,232)
==============================
Effective tax rates differ from statutory federal income tax rates as
follows:
2000 1999 1998
---------- --------- ---------
Statutory federal income tax rate (35.0%) (35.0%) 35.0%
Nondeductible interest expense, put warrants 0.0 0.0 44.7
Change in valuation allowance 82.2 0.0 (147.0)
Effect of change in tax rate on deferred tax asset 0.0 0.0 6.7
State income taxes, net of federal benefit (1.1) (0.6) 8.9
Other (0.9) (1.4) 1.0
------------------------------
45.2% (37.0%) (50.7%)
==============================
The tax effects of temporary differences that give rise to deferred tax
assets at December 30, 2000 and January 1, 2000 are as follows (in thousands):
2000 1999
--------- ---------
Deferred tax assets:
Current:
Inventory, warranty, and returns reserves $ 5,012 $ 4,553
Allowance for doubtful accounts 100 116
Other 2,171 1,970
Long term:
Net operating loss carryforwards 11,923 3,885
Other 2,389 886
-------------------
Total gross deferred tax assets 21,595 11,410
Valuation allowance (21,595) (523)
-------------------
Total net deferred tax assets $ - $10,887
===================
At December 30, 2000, the Company had net operating loss carryforwards
("NOLs") for federal income tax purposes of approximately $31,400,000 expiring
between the years 2003 and 2020. The Company expects that approximately
$1,400,000 of these NOLs will expire unutilized due to an Internal Revenue Code
(IRC) Section 382 limitation resulting from a prior ownership change and has,
therefore, provided a valuation allowance for this portion of the carryforwards.
During the fourth quarter of fiscal 2000 the Company increased its valuation
allowance by $21,072,000 due to negative cash flows, recurring pre-tax operating
losses and the recent downturn of the economy making realization of the deferred
tax assets uncertain.
F-15
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(11) NET INCOME (LOSS) PER COMMON SHARE
The following computations reconcile net income (loss) with net income
(loss) per common share-basic and diluted (dollars in thousands, except per
share amounts).
NET PER SHARE
2000 LOSS SHARES AMOUNT
-------------------------------------------- --------- ---------- ---------
Net loss ($37,214)
---------
BASIC AND DILUTED EPS
Net loss attributable to common shareholders ($37,214) 17,848,375 ($2.09)
========= ========== =========
NET PER SHARE
1999 LOSS SHARES AMOUNT
-------------------------------------------- --------- ---------- ---------
Net loss ($8,204)
---------
BASIC AND DILUTED EPS
Net loss attributable to common shareholders ($8,204) 18,299,728 ($0.45)
========= ========== =========
NET PER SHARE
1998 INCOME SHARES AMOUNT
-------------------------------------------- --------- ---------- ---------
Net income before extraordinary item $6,636
Less: Deemed dividend from revision of
preferred stock (1,312) -
Cumulative preferred dividends (821) -
---------
BASIC EPS
Net income available to common shareholders $4,503 4,114,219 $1.09
=========
EFFECT OF DILUTIVE SECURITIES
Options - 912,448
Warrants - 654,436
Convertible preferred stock - 10,247,143
--------- ----------
DILUTED EPS
Net income attributable to common shareholders
plus assumed conversion $4,503 15,928,246 $0.28
========= ========== =========
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:
2000 1999 1998
---- ---- ----
Options 3,519,271 2,722,429 -
Common stock warrants 1,344,378 1,249,119 -
F-16
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) EMPLOYEE BENEFIT PLANS
Effective January 1, 1994, the Company adopted a profit sharing and 401(k)
plan for eligible employees. The plan allows employees to defer up to 15% of
their compensation on a pretax basis. Each year, the Company may make a
discretionary contribution equal to a percentage of the employee's contribution.
During 2000, 1999 and 1998, the Company expensed $487,000, $480,000 and
$375,000, respectively, relating to its contribution to the 401(k) plan.
EMPLOYEE STOCK PURCHASE PLAN
Effective July 30, 1999, the Company adopted an Employee Stock Purchase
Plan (the "Plan") under which 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). 204,927 and 17,705 shares were issued
during 2000 and 1999, respectively.
(13) RELATED PARTY TRANSACTIONS
The Company has entered into a consulting agreement with a director of the
Company beginning May 4, 1999. The agreement is effective for a term of two
years, provides an annual fee of $100,000 and 60,000 options vesting over three
years. In 1999, the Company expensed $44,000 relating to these options.
Effective January 2000, the director resigned from the board terminating the
agreement. An aggregate of 27,292 vested options are exercisable through May
2004.
(14) COMMITMENTS AND CONTINGENCIES
The Company and certain of its former officers and directors have been
named as defendants in a class action lawsuit filed on behalf of Company
shareholders in U.S. District Court in Minnesota. The named plaintiffs, who
purport to act on behalf of a class of purchasers of the Company's common stock
during the period from December 4, 1998 to June 7, 1999, charge the defendants
with violations of federal securities laws. The suit alleges that the Company
and the named directors and officers failed to disclose or misrepresented
certain information concerning the Company during the class period. The
complaint does not specify an amount of damages claimed. The Company believes
that the complaint is without merit and intends to vigorously defend the claims.
The Company and the individual defendants brought a motion to dismiss all
claims on November 10, 1999. The motion was heard by a magistrate judge on
December 21, 1999. On January 27, 2000, the magistrate recommended that the
claims based on Section 11 of the federal securities laws be dismissed. The
magistrate recommended that the motion to dismiss be denied with respect to the
claims based on Rule 10b-5 of the federal securities laws. In February 2000,
both the plaintiffs and the defendants formally objected to the magistrate's
recommendation. The objection was made to the United States District Court in
Minnesota. On May 12, 2000, the United States District Court in Minnesota
adopted the recommendation of the magistrate and denied the defendants' motion
to dismiss the Rule 10b-5 claims. The Court also adopted the recommendation of
the magistrate and dismissed the plaintiff's Section 11 claims without prejudice
and with leave to amend.
On March 31, 2000, the Company and certain of its former officers and
directors were named as defendants in a class action lawsuit filed on behalf of
the Company's shareholders in U.S. District Court in Minnesota asserting
identical factual allegations as the consolidated complaint described above. The
suit alleges claims based on Sections 11 and 12(a)(2) of the federal securities
laws. The complaint does not specify an amount of damages claimed. The Company
believes this complaint is without merit and intends to vigorously defend the
claims. The above two class actions were consolidated by the United States
District Court Magistrate on July 24, 2000.
F-17
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(14) COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company is a party to other various claims, legal actions, sales tax
disputes, and other complaints arising in the ordinary course of business. In
the opinion of management, any losses that may occur are adequately covered by
insurance or are provided for in the consolidated financial statements and the
ultimate outcome of these matters will not have a material effect on the
consolidated financial position or results of operations of the Company.
(15) SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a condensed summary of actual quarterly results for 2000
and 1999:
2000 Fourth Third Second First
----
Net sales $64,075 $68,056 $61,787 $76,159
Gross margin 39,054 43,185 39,901 49,013
Operating loss (6,905) (8,894) (5,391) (4,780)
Net loss (25,059) (5,692) (3,465) (2,998)
Net loss per share - diluted (1.39) (0.32) (0.19) (0.17)
1999 Fourth Third Second First
----
Net sales $68,104 $68,281 $65,750 $71,632
Gross margin 44,050 44,337 43,188 47,085
Operating income (loss) (9,939) (6,432) 200 1,378
Net income (loss) (6,042) (3,698) 348 1,188
Net income (loss) per share - diluted (0.33) (0.20) 0.02 0.06
F-18
MANAGEMENT'S REPORT
The management of Select Comfort Corporation is responsible for the preparation,
integrity and fair presentation of the consolidated financial statements
included in this annual report. The financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America and include amounts based on judgments and estimates made by management.
Management is also responsible for the preparation and accuracy of information
included in other sections of this annual report, which information is
consistent with the financial statements.
The integrity of the financial statements is based on the maintenance of an
internal control structure established by management to provide reasonable
assurance that assets are safeguarded and transactions are properly authorized,
recorded and reported. The concept of reasonable assurance is based on the
recognition that the cost of maintaining a system of internal controls should
not exceed the benefits expected to be derived. Even effective internal
controls, no matter how well designed, have inherent limitations. Management
believes that the internal control system provides reasonable assurance that
errors or irregularities that could be material to the financial statements are
prevented or would be detected and corrected in the normal course of business.
The Company engages independent auditors to examine its financial statements and
express their opinion thereon. The auditors have access to each member of
management in conducting their audits. Their report appears in this annual
report.
The Audit Committee of the Board of Directors, composed solely of non-management
directors, meets periodically with management and the independent auditors to
review internal accounting control, audit activities and financial reporting
matters. The independent auditors have full access to the Audit Committee and
meet periodically with them without management present.
/s/William R. McLaughlin /s/James C. Raabe
- ------------------------- -------------------------
William R. McLaughlin James C. Raabe
President and Chief Chief Financial Officer
Executive Officer
F-19
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Stockholders
Select Comfort Corporation:
Under date of February 2, 2001, except as to Notes 1 and 10 which are as of
April 12, 2001, we reported on the consolidated balance sheets of Select Comfort
Corporation and subsidiaries as of December 30, 2000 and January 1, 2000 and the
related statements of operations, shareholders' equity, and cash flows for each
of the years in the three-year period ended December 30, 2000, as contained in
the Annual Report on Form 10-K for the year 2000. In connection with our audits
of the aforementioned consolidated financial statements, we also audited the
related financial statement schedule as listed in the accompanying index. This
financial statement schedule is the responsibility of the Company's management.
Our responsibility is to express an opinion on this financial statement schedule
based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
The audit report on the consolidated financial statements of Select Comfort
Corporation and subsidiaries referred to above contains an explanatory paragraph
that states that the Company has negative cash flows that raise substantial
doubt about the entity's ability to continue as a going concern. The financial
statements and schedule included in the Company's 2000 Annual Report on Form
10-K do not include adjustments that might result from the outcome of this
uncertainty.
/s/ KPMG LLP
Minneapolis, Minnesota
February 2, 2001
SELECT COMFORT CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS
BALANCE AT CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING COSTS AND FROM END OF
DESCRIPTION OF PERIOD EXPENSES RESERVES PERIOD
- ------------------------------- ---------- ---------- ---------- ----------
Allowance for doubtful accounts
- 2000 $ 305 $ 531 $ 572 $ 264
- 1999 2,750 1,193 3,638 305
- 1998 1,901 2,794 1,945 2,750
Accrued warranty costs
- 2000 $5,841 $5,397 $4,057 $7,181
- 1999 4,486 5,368 4,013 5,841
- 1998 3,257 4,807 3,578 4,486
S-1