UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A
(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
None.
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:
o better spinal alignment,
o reduced pressure points,
o greater relief of lower back pain,
o greater overall comfort, and
o 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:
o RETAIL, including company-operated retail stores and leased departments
within larger retail stores,
o DIRECT MARKETING, including a company-operated call center, and
o 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 night's 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:
o 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,
o Rebalancing of manufacturing between our three plant locations,
o 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,
o Corporate general and administrative expense savings from reductions in
corporate staff and consolidating our two Minneapolis offices,
o Logistics cost savings from systems and packaging improvements to enable
shipping with Fed Ex as well as UPS,
o Product cost reductions with equal or superior quality and reduced product
returns, and
o 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:
o awareness-building programs that are designed to drive more knowledgeable
and motivated consumers to our points of distribution,
o 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,
o enhancement of the consumer's in-store experience through the use of tools
that better demonstrate the benefits of our products,
o improvements in the appearance of our products,
o changes in our direct marketing call center strategy to drive more traffic
to our retail stores,
o offering different and more creative financing alternatives for our
customers,
o expanding our home delivery, assembly and mattress removal capability to
additional markets,
o compensation and incentive plans that are more highly commission-driven and
close-oriented, and
o 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
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capability to focus on continuous product improvements to deliver:
o new and enhanced consumer benefits,
o improved product quality, and
o 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 had 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 a 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% 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
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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 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 had 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
6
and support of Sleep Number beds and answer questions regarding our products.
SITE SELECTION. In selecting new store sites, we generally seek high-traffic
mall locations of approximately 800 to 1,200 square feet within malls in major
metropolitan and regional areas. We conduct extensive analyses of potential
store sites and base our selection on a number of factors, including the
location within the mall, demographics of the trade area, the specifications of
the mall (including size, age, sales per square foot and the location of the
nearest competitive mall), the perceived strength of the mall's anchor stores,
the performance of other specialty retail tenants in the mall, the number of
direct marketing inquiries received from the area surrounding the mall, store
density of existing stores and marketing and advertising plans in the respective
markets. Clustering of retail stores within a metropolitan retail market is a
key consideration in order to leverage our advertising.
MARKETING AND ADVERTISING. We historically have supported some of our multiple
store markets with media primarily focused on the use of radio personalities. 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 Sleep Number bed is through our direct
marketing
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operations. Typically, an interested consumer will respond to one of our
advertisements by calling our toll-free number. On this call, one of our direct
marketing sales professionals captures information from the consumer, begins the
consumer education process, takes orders, or, if appropriate, 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:
o sleep research and science,
o our products and the benefits they provide,
o store locations and other means to contact us and experience our products,
o customer testimonials,
o customer service information, and
o 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.
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On March 28, 2001, we launched another site, beds.com, to increase awareness of
the Sleep Number bed and air-supported sleep systems as 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 focused on our Sleep Number
brand was introduced into eight test markets, and has produced favorable initial
results 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
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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 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 as
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:
o educate consumers on the benefits of Select Comfort products,
o deliver superior quality products,
o maximize our direct relationship with consumers,
o maximize convenience for the consumer, and
o 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
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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 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 21 issued U.S. patents and 6 U.S. patent
applications pending. We also held 14 foreign patents and had 26 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,
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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 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.
12
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-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:
o Our ability to successfully execute the strategic initiatives outlined
above under "--Business and Growth Strategy,"
o 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,
o The level of consumer acceptance of our products,
o Our ability to fully execute and realize the benefits of the cost savings
initiatives outlined above under "--Business and Growth Strategy,"
o 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,
o Our ability to continuously improve our products to achieve new and
enhanced consumer benefits, better quality and reduced costs,
o Our ability to realize increased sales and greater levels of profitability
through our retail stores,
o Our ability to cost-effectively close additional underperforming or
unprofitable store locations, or to negotiate rent concessions,
o Our ability to hire, train, manage and retain qualified retail store
management and sales professionals,
o Our ability to maintain cost-effective production and delivery of our
products,
o Our ability to successfully expand our home delivery, assembly and mattress
removal capability on a cost-effective basis,
o The ability of various third-party providers of delivery, assembly and
mattress removal services to provide quality services on a cost-effective
basis,
o Our ability to successfully commercialize our sofa sleeper product line
across our distribution channels and in major markets,
o Our ability to successfully identify and respond to emerging trends in the
mattress industry,
13
o The level of competition in the mattress industry, and
o General economic conditions and consumer confidence.
There can be no assurance that we will be successful in achieving our strategic
plan or that 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.
14
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 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:
o create greater awareness of our products and brand name,
o determine the appropriate creative message and media mix for future
advertising expenditures,
o effectively manage advertising costs (including creative and media) in
order to maintain acceptable costs per inquiry, costs per order and
operating margins, and
o 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:
o levels of consumer awareness of our products, brand name and store
locations,
o levels of consumer acceptance of our existing and new products,
- ------------------------
* 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.
15
o higher levels of sales in the first year of operations as each successive
class of new stores is opened,
o comparable store sales performance in prior periods,
o the maturation of our store base,
o the amount, timing and relative success of promotional events, advertising
expenditures, new product introductions and product line extensions,
o the quality and tenure of store-level managers and sales professionals,
o the amount of competitive activity,
o the evolution of store operations,
o changes in the sales mix between our distribution channels, and
o 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:
o increases or decreases in comparable store sales,
o the timing, amount and effectiveness of advertising expenditures,
o any increases in return rates,
o the timing of new store openings and related expenses,
o competitive factors,
o net sales contributed by new stores,
o any disruptions in third-party delivery services, and
o 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.
16
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 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:
o political instability resulting in disruption of trade,
o 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
o 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
17
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 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
18
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
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
19
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.
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:
o variations in quarterly operating results;
o changes in estimates by securities analysts;
o announcements of significant events;
o additions or departures of key personnel; and
o 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
20
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.
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 from these other matters are adequately
covered by insurance or are provided for in the consolidated financial
statements and the ultimate outcome of these other matters will not have a
material effect on the consolidated financial position or results of operations
of the Company.
21
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
SELECT COMFORT CORPORATION
(Registrant)
Dated: May 8, 2001 By /s/ Mark A. Kimball
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Title: Senior Vice President
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