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EXHIBIT 13.1
SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data)
The data presented below has been derived from the Company's consolidated
financial statements and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's consolidated financial statements and notes thereto included in
this Annual Report:
Year Ended(1)
Jan. 1, 2000 Jan. 2, 1999 Jan. 3, 1998 Dec. 28, 1996 Dec. 30, 1995
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $ 273,767 $ 246,269 $ 184,430 $ 102,028 $ 68,629
Gross margin 178,660 161,082 117,801 63,507 39,796
Operating income (loss)(2) (14,793) 11,445 1,996 (3,764) (4,589)
Net income (loss) before extraordinary item (8,204) 6,636 (2,846) (3,685) (4,560)
Net income (loss) (8,204) 5,195 (2,846) (3,685) (4,560)
Net income (loss) per share - diluted (3):
Net income (loss) per share
before extraordinary item (0.45) 0.28 (1.59) (2.61) (3.16)
Net income (loss) per share (0.45) 0.19 (1.59) (2.61) (3.16)
Weighted average common shares - diluted 18,300 15,928 2,353 1,753 1,444
Dividends paid per share -- -- -- -- --
SELECTED OPERATING DATA:
Stores open at period-end (4) 341 264 200 143 68
Average square footage of stores open
during period (5) 893 895 866 768 703
Sales per square foot (5) 721 742 666 622 611
Average store age (in months at period end) 31 27 22 15 15
Comparable store sales increase (6) 4.7% 23.5% 27.3% 26.1% 59.8%
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $ 7,441 $ 45,561 $ 12,670 $ 2,422 $ 6,862
Marketable securities 20,129 -- -- -- --
Working capital 14,470 42,249 757 (7,809) 2,734
Total assets 95,865 106,234 57,241 29,794 23,838
Long-term debt, less current maturities 36 29 19,511 1,162 40
Mandatorily redeemable preferred stock -- -- 27,612 27,612 27,625
Total common shareholders' equity (deficit) 53,374 70,691 (21,038) (18,216) (14,779)
(1) Except for the year ended January 3, 1998, which included 53 weeks, all
years presented included 52 weeks.
(2) Includes a $1.4 million dollar charge related to store closings for the year
ended January 1, 2000. See Note 5 of Notes to Consolidated Financial
Statements.
(3) See Note 11 of Notes to Consolidated Financial Statements.
(4) Includes Select Comfort stores operated in leased departments within larger
retail stores (45 at January 1, 2000, 14 at January 2, 1999 and one at
January 3, 1998).
(5) For stores open during the entire period indicated.
(6) Stores enter the comparable store calculation in their 13th full month of
operation. The number of comparable stores used to calculate such data were
262, 199, 138, 65 and 32 for fiscal 1999, 1998, 1997, 1996 and 1995,
respectively. Reflects adjustment for additional week of sales in 1997.
Without adjusting for the additional week, comparable store sales would have
been 17.9% in 1998 and 34.6% in 1997.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
The discussion in this Annual Report contains certain forward-looking
statements, such as statements of the Company's plans, objectives, expectations
and intentions. You can identify forward-looking statements by those that are
not historical in nature, particularly those that use terminology, such as
"may," "will," "should," "expects," "anticipates," "contemplates," "estimates,"
"believes," "plans," "projected," "predicts," "potential" or "continue" or the
negative of these or similar terms. These statements are subject to certain
risks and uncertainties that could cause actual results to differ materially
from the Company's historical experience and its present expectations or
projections. These risks and uncertainties include, but are not limited to,
uncertainty of the success of the Company's strategic plan, uncertain
profitability, sales tax considerations, effectiveness and efficiency of
advertising expenditures, fluctuations in comparable store sales results and
the impact of competition. Additional information concerning these risks and
uncertainties and others is contained in the Company's filings with the
Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K.
OVERVIEW
Select Comfort is the leading vertically integrated manufacturer, specialty
retailer and direct marketer of innovative air beds and sleep-related products.
Since the introduction of our first air bed product in 1987, management has
focused on improving our product, expanding our product line, building
manufacturing and distribution systems and growing our distribution channels,
which now include: retail, direct marketing and e-commerce. Vertically
integrated operations and control over these complementary distribution channels
gives us direct contact with our customers and gives our customers multiple
opportunities to purchase our products. Sales generation is driven primarily by
targeted print, radio, television and internet media that generate customer
inquiries, as well as by our retail store presence.
Retail operations included 341 stores at January 1, 2000, including 45 leased
departments within larger stores, 264 stores at January 2, 1999 (including 14
leased departments) and 200 stores at January 3, 1998 (including one leased
department). We plan to open approximately 20 additional retail stores in 2000,
primarily in existing markets. From inception through January 1, 2000, we had
closed seven stores. In 2000, we plan to close approximately 10 underperforming
retail stores and 12 leased department locations. A substantial majority of the
costs associated with these closings was accrued in 1999.
The Company reported comparable store sales growth of 4.7%, 23.5% and 27.3%
in 1999, 1998 and 1997, respectively (comparable store sales amounts have been
adjusted to reflect 52 weeks in fiscal 1997 consistent with all other periods).
Comparable store sales results have been and will continue to be influenced by a
variety of factors, including levels of awareness of our products and brand
name, levels of consumer acceptance of our existing and new products, our
ability to successfully introduce new products and product line extensions,
comparable store sales performance in prior periods, the maturation of our store
base, the amount, effectiveness and efficiency of retail advertising
expenditures and promotional activity, the amount of competitive activity, our
ability to effectively integrate our multiple distribution channels, the
evolution of store operations, including improvements in store design, the
quality and tenure of store-level managers and sales professionals, and general
economic conditions and consumer confidence.
Advertising expenditures increased from $9.0 million in 1995 to $43.4 million
in 1999. Advertising costs are expensed as incurred as a component of sales and
marketing expenses, although we believe that advertising expenditures provide
significant benefits beyond the period in which they are expensed. Pre-opening
costs associated with new retail stores are expensed as incurred. Future
advertising expenditures will depend on the effectiveness and efficiency of the
advertising in creating awareness of our products and brand name, generating
consumer inquiries and driving consumer traffic to retail stores. Although
advertising expenditures are expected to continue to increase in the foreseeable
future, such increases are expected to be at a lower rate than historical
increases.
We believe historical operating losses have been primarily the result of an
aggressive retail store opening strategy, a relatively immature store base,
significant marketing, advertising and product development expenditures, and the
development of a substantial corporate infrastructure to support future growth.
Future increases in net sales and the achievement of long-term profitability
will depend upon greater consumer awareness and acceptance of our air bed
products, improved effectiveness and efficiency of our marketing and advertising
expenditures, the opening and successful performance of new retail stores,
improvement in the performance of current stores and our ability to execute our
stated strategic initiatives. There can be no assurance that we will be able to
achieve or sustain historical sales growth rates or profitability in the future,
on a quarterly or annual basis.
Quarterly and annual operating results may fluctuate significantly as a
result of a variety of factors, including
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increases or decreases in comparable store sales, the timing, amount and
effectiveness of advertising expenditures, any changes in return rates, the
timing of new store openings and related expenses, competitive factors, net
sales contributed by new stores, any disruptions in third-party delivery
services and general economic conditions and consumer confidence. Our business
is also subject to some seasonal influences, with heavier concentrations of
sales during the fourth quarter holiday season due to increased mall traffic.
A substantial portion of operating expenses is related to sales and marketing
expenses, including costs associated with opening new stores, operating existing
stores and advertising expenditures. The level of such spending cannot be
adjusted quickly and is based, in significant part, on expectations of future
customer inquiries and net sales. Furthermore, a substantial portion of net
sales is often realized in the last month of a quarter with such net sales
frequently concentrated in the last weeks or days of a quarter, due in part to
our promotional schedule. Should the Company experience a shortfall in expected
net sales or in the conversion rate of customer inquiries, we may be unable to
adjust spending in a timely manner and our business, financial condition and
operating results may be materially adversely affected. Our historical results
of operations may not be indicative of the results that may be achieved for any
future fiscal period.
In connection with our March 1997 $15.0 million debt financing, a warrant
with a put feature was issued. This put feature required that the warrant be
recorded at fair value as long-term debt. Furthermore, any change in the fair
value of this warrant has been reflected as interest expense, resulting in
non-cash interest expense of $5.6 million and $3.3 million during 1998 and 1997,
respectively. The put feature of this warrant was eliminated upon the closing of
the December 1998 initial public offering, resulting in the reclassification of
the warrant liability from long-term debt to common shareholders' equity. There
will be no further interest expense associated with the warrant.
Net income (loss) as reported was ($8.2) million and $5.2 million for 1999
and 1998, respectively, resulting in net income (loss) per share of ($0.45) and
$0.19, respectively. Pro forma net income, which reflects adjustments for
non-recurring, non-cash items associated with the repayment of debt and put
warrant interest expense referred to above, as well as an income tax benefit of
$4.7 million associated with the elimination of the Company's deferred tax
valuation allowance, was $7.6 million in 1998. Pro forma net income per share,
which reflects these non-recurring, non-cash adjustments, as well as adjustments
related to undeclared and unpaid dividends, was $0.45 in 1998.
At January 1, 2000, the Company had net operating loss carry-forwards for
federal income tax purposes of approximately $10.2 million, of which it expects
to be able to use approximately $8.8 million.
LOOKING FORWARD
We have begun to execute a new strategic plan that was developed in part as a
result of studies performed in the second half of 1999 by independent consulting
firms in various parts of the business, including product positioning,
marketing, distribution and logistics. The strategic plan focuses on:
- - Development of an integrated approach to marketing with improved marketing
messages that are consistent across our distribution channels;
- - Leveraging the profitability of our sales channels, with a particular
emphasis on retail store profitability;
- - Providing in-home delivery, assembly and mattress removal across all of our
distribution channels;
- - Continuous improvement of our core product line; and
- - Introducing the sofa sleeper product across all of our distribution
channels.
Our integrated approach to marketing will be rolled out in the middle of 2000
with messages focused on the key benefits provided by our products, as well as
messages targeted to key consumer groups. Marketing messages will be consistent
across all channels and designed to optimize our multiple, complementary
distribution channels.
We are developing market by market and store by store action plans focused on
improving the profitability of our retail store operations. We are currently
implementing plans to close approximately 10 underperforming retail stores and
approximately 12 leased department locations. We expect to open approximately 20
stores during 2000 in current markets where increased store density is required
to leverage advertising expenditures. In addition, we have developed a new
retail store design with a bedroom like setting that is more consistent with our
sleep solutions oriented brand. We plan to remodel 80 to 100 stores in 2000 to
incorporate this new design.
In February 2000, we eliminated our road show distribution channel and
approximately 15% of our corporate and administrative positions. The road show
channel
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sold in markets with no retail stores and accounted for less than 3% of sales.
The Company will continue to focus on event marketing through home shows, state
fairs and similar venues.
We are currently developing plans to ultimately provide in-home delivery,
assembly and mattress removal across all of our distribution channels and
throughout the continental United States. Currently, in-home delivery and
assembly is provided through our retail channel in selected markets on a test
basis.
Our product development efforts will be focused primarily on continuous
improvement of our core line of air bed products. We believe that we have
attained a leadership position in air bed technology and intend to continue to
lead the industry in innovation. We have elected to terminate the license
agreement under which we had developed and test-marketed our adjustable frame
product.
One product line extension that we intend to introduce later this year is the
sofa sleeper product with an air supported mattress. This product is currently
available in a limited number of our retail sites. We believe that this sofa
sleeper product represents a significant advancement in the sofa sleeper market
that could add incremental sales as well as attract customers to our retail
stores.
The success of our strategy will depend on many factors including (i) the
effectiveness and efficiency of our integrated marketing strategy in creating
awareness of our products and brand name and in generating sales, (ii) our
ability to enhance the profitability of our retail stores and leased
departments, (iii) our ability to manage operating costs, (iv) our ability to
successfully launch in-home delivery, assembly and mattress removal services
nationally on a cost-effective basis, (v) our ability to successfully launch the
sofa sleeper product, (vi) the levels of consumer awareness and acceptance of
the sofa sleeper product, (vii) our ability to continue to improve our core
product line and differentiate our products from competitive products, (viii)
competition in the mattress and sofa sleeper markets, and (ix) general economic
factors and consumer confidence.
The strategic initiatives described above are directed toward improving our
long-term performance and are not expected to contribute significantly to growth
in sales and earnings in the first six months of 2000, and may negatively impact
earnings in 2000.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the Company's
results of operations expressed as percentages of net sales. Percentage amounts
may not total due to rounding.
PERCENTAGE OF NET SALES
YEAR ENDED
JAN. 1, 2000 JAN. 2, 1999 JAN 3, 1998
Net sales 100.0% 100.0% 100.0%
Cost of sales 34.7 34.6 36.1
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Gross margin 65.3 65.4 63.9
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Operating expenses:
Sales and marketing 59.4 52.7 53.8
General and administrative 10.7 8.0 8.9
Store closings 0.5 0.0 0.0
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Total operating expenses 70.7 60.8 62.8
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Operating income (loss) (5.4) 4.7 1.1
Other income (expense), net 0.6 (2.9) (2.5)
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Income (loss) before
income taxes (4.8) 1.8 (1.5)
Income tax expense (benefit) (1.8) (0.9) 0.1
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Net income (loss) before
extraordinary item, net (3.0) 2.7 (1.5)
Extraordinary item 0.0 (0.6) 0.0
----------------------------------
Net income (loss) (3.0)% 2.1% (1.5)%
----------------------------------
The overall decrease in operating earnings for 1999 as compared to 1998
relates to increases in operating expenses, as a percentage of net sales, to
support long-term growth plans. Lower sales growth was due to a number of
factors. Increased retail advertising, which was effective in the early part of
the year, did not drive sufficient sales as it was added to new markets during
the last half of the year. Retail sales were lower than expected in those
markets without increased advertising. Finally, direct marketing sales declined
by $15.3 million in 1999 compared to 1998. Costs increased during 1999 to
support anticipated growth. Infrastructure costs, including general and
administrative expenses and costs associated with the opening and operation of
77 new stores during 1999, exceeded sales growth necessary to support these
costs. Special charges of $5.1 million were incurred relating to store closings,
termination of our adjustable frame development agreement and consulting and
professional fees for the development and initial stages of implementation of
the Company's strategic plan. We have begun to implement several strategic
initiatives that we believe will begin to improve operating results in the
second half of 2000.
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COMPARISON OF YEAR ENDED JANUARY 1, 2000 AND
JANUARY 2, 1999
Net sales
Net sales increased 11.2% to $273.8 million for 1999 from $246.3 million for
1998, primarily due to an increase in unit sales. The components of the increase
in net sales were (i) a $33.6 million increase from the opening of 77 new retail
stores during 1999 and the full year impact of 64 stores opened in 1998, (ii) a
$6.8 million increase from a 4.7% increase in comparable store sales, due in
part to the continuing maturation of stores and increased advertising in
selected markets, (iii) a $4.3 million increase in net sales from the Company's
newly developed e-commerce channel, partially offset by (iv) a $15.3 million
decrease in direct marketing sales.
Gross margin
Gross margin decreased to 65.3% for 1999 from 65.4% for 1998. Reductions in
cost of sales from improved purchasing and leverage of fixed manufacturing costs
over higher unit volumes were offset by higher sales discounts.
Sales and marketing
Sales and marketing expenses increased 25.3% to $162.7 million for 1999 from
$129.9 million for 1998, and increased as a percentage of net sales to 59.4%
from 52.7% for the comparable prior-year period. The increase in the dollar
amount of sales and marketing expenses during 1999 was primarily due to (i) the
opening of 77 new retail stores, (ii) an increase in advertising expenditures of
$11.8 million and (iii) higher commissions, percentage rents and freight expense
related to higher net sales. Sales and marketing expenses increased as a
percentage of net sales primarily due to (i) increased advertising focused on
longer term sales growth through brand and retail store awareness, (ii) lower
direct marketing sales and (iii) selling expenses in new stores increasing at a
greater rate than net sales.
General and administrative
General and administrative expenses increased 48.1% to $29.2 million for 1999
from $19.7 million for 1998. The increase in general and administrative expenses
was primarily due to increased spending on infrastructure to support long-term
growth plans and strategic consulting studies undertaken to determine and refine
ongoing business strategies.
Store Closings
Store closing expense was $1,498,000 for 1999 up from $20,000 for 1998. Store
closing expense for 1999 includes a $1,404,000 charge associated with plans to
close 22 stores and other related store write-offs.
Other income (expense), net
Other income increased $8.8 million to approximately $1.8 million of other
income for 1999 from $7.0 million in other expense for 1998. The increase was
primarily due to (i) the inclusion of $5.6 million of non-cash interest expense
in 1998 relating to the change in the fair value of an outstanding put warrant
and (ii) an increase in interest income on the cash obtained from the completion
of our initial public offering in December 1998. The put provision associated
with the warrant was eliminated effective on completion of the initial public
offering.
Income tax expense (benefit)
Income tax benefit increased to $4.8 million for 1999 from $2.2 million for
1998 due to a decrease in taxable income in 1999.
Extraordinary Item
Net income in 1998 includes an extraordinary charge, net of income tax
benefits, of $1.4 million. The charge relates to the write-off of certain
deferred assets associated with our $15.0 million debt financing, which was
repaid in December 1998.
COMPARISON OF YEAR ENDED JANUARY 2, 1999 AND
JANUARY 3, 1998
Net sales
Net sales increased 33.5% to $246.3 million for 1998 from $184.4 million for
1997, primarily due to an increase in unit sales. The components of the increase
in net sales were (i) a $29.1 million increase associated with the opening of 64
new retail stores during 1998 and the full year impact of 57 stores opened in
1997, (ii) a $22.0 million increase associated with an increase of 23.5% in
comparable store sales over the comparable period of the prior year, resulting
primarily from the continuing maturation of stores, offset by an estimated $4.4
million in comparable store sales in the 53rd week in 1997 and (iii) a $14.6
million increase in direct marketing sales. For a significant portion of the
third quarter of 1997, due to a UPS work stoppage, UPS was unable to deliver the
Company's products within acceptable time periods,
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causing delays in deliveries to customers and requiring the Company to use
alternative carriers. Also, during this period, the Company converted its
manufacturing and financial operations to a new integrated information system.
These factors resulted in higher than normal customer returns and canceled
orders, lower order volumes and substantially increased freight charges, which
the Company estimates negatively impacted its operating income by approximately
$3.9 million in the second half of 1997, principally incurred in the third
quarter.
Gross margin
Gross margin increased to 65.4% in 1998 from 63.9% in 1997 primarily due to
improved purchasing through volume discounts and better relationships with key
suppliers and improved leverage of fixed manufacturing costs over higher unit
volumes as well as reduced costs from the UPS strike in 1997.
Sales and marketing
Sales and marketing expenses increased 30.9% to $129.9 million in 1998 from
$99.2 million in 1997, and decreased slightly as a percentage of net sales to
52.7% in 1998 from 53.8% in 1997. The increase in the dollar amount of sales and
marketing expenses was primarily due to (i) the opening of 64 new retail stores
during 1998, (ii) an increase in advertising expenditures of $3.4 million and
(iii) higher commissions, percentage rents and freight expense related to the
higher net sales. The decrease in sales and marketing expenses as a percentage
of net sales was primarily due to improved leverage on advertising expenditures.
General and administrative
General and administrative expenses increased 19.5% to $19.7 million in 1998
from $16.5 million in 1997, but decreased as a percentage of net sales to 8.0%
in 1998 from 8.9% in 1997. The increase in the dollar amount of general and
administrative expenses was primarily due to increased spending to provide
infrastructure to support overall net sales growth. The decrease in general and
administrative expenses as a percentage of net sales was primarily due to
improved leverage of fixed costs over the increase in net sales.
Other income (expense), net.
Other expense increased $2.3 million to $7.0 million of other expense in 1998
from $4.7 million of other expense in 1997 primarily due to the inclusion of
$5.6 million of non-cash interest expense in 1998 relating to the change in the
fair value of an outstanding put warrant compared with $3.3 million in 1997. The
put provision associated with the warrant was eliminated effective on completion
of the initial public offering.
Income tax expense (benefit)
Income tax expense decreased to a $2.2 million benefit in 1998 from a $0.1
million expense in 1997 primarily due to a $4.7 million benefit in 1998
associated with the recognition of deferred tax assets. The benefit was
partially offset by income tax expense associated with taxable income in 1998.
Income tax expense in 1997 was limited due to the use of net operating losses to
offset taxable income.
Extraordinary Item
Net income in 1998 includes an extraordinary charge, net of income tax
benefits, of $1.4 million. The charge relates to the write-off of certain
deferred assets associated with our $15.0 million debt financing, which was
repaid in December 1998.
LIQUIDITY AND CAPITAL RESOURCES
Our primary source of liquidity has been the sale of equity securities. We
completed our initial public offering in December 1998, resulting in net
proceeds of $44.6 million, which have been partially used for (i) the repayment
of $15.0 million of debt, (ii) expansion of retail stores, (iii) the build-out
of our third manufacturing plant and (iv) the repurchase of 1,220,000 shares of
Company common stock for $12.7 million. The Company had working capital of
approximately $14.5 million at January 1, 2000, $42.2 million at January 2,
1999, and $757,000 at January 3, 1998.
Net cash provided by 1999 operating activities was approximately $7.7 million
and consisted primarily of net loss adjusted for non-cash expenses, decreases in
accounts receivable and increases in accounts payable and accrued liabilities,
partially offset by increases in inventories and income taxes receivable. Net
cash provided by operating activities for 1998 was approximately $11.0 million
and consisted primarily of cash flows from operations before non-cash expenses,
partially offset by increases in accounts receivable and decreases in accounts
payable. Net cash provided by operating activities in 1997 was approximately
$7.3 million and consisted primarily of increases in
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accounts payable, accruals and net loss adjusted for non-cash expenses,
partially offset by increases in accounts receivable, inventories and prepaid
expenses.
Effective as of July 1999, we terminated our revolving third-party credit
arrangement with Monogram Bank, an affiliate of General Electric Capital
Corporation ("GE") and entered into a third-party credit arrangement with
Conseco (formerly Green Tree Financial Corporation). These arrangements have
been used to provide financing for our customers' use in purchasing our
products. In connection with all purchases financed under these arrangements,
the provider pays an amount equal to the total amount of purchases net of
promotional discounts. The provider sets the rate, annual fees and all other
terms and conditions relating to the customers' accounts, including collection
policies and procedures, and is the owner of the receivables. In July 1999,
Conseco purchased substantially all of the outstanding receivables from GE. As a
result of this transaction, we received $9.8 million that had been retained by
GE and included in our accounts receivable. There are no similar retainage
requirements as part of the new agreement with Conseco.
Net cash used in investing activities was approximately $35.8 million, $8.9
million and $10.7 million in the years 1999, 1998 and 1997, respectively.
Investing activities consisted of purchases of property and equipment for new
retail stores in all periods, and for 1999 also included the opening of our Utah
production facility and the investment of excess cash in marketable securities
with maturities in excess of 90 days.
Net cash provided by (used in) financing activities for 1999, 1998 and 1997
was approximately ($10.0) million, $30.7 million and $13.7 million,
respectively. Net cash used in financing activities for 1999 was due to
repurchases of common stock and debt repayments, partially offset by cash
received from issuance of common stock. During 1999, the Company repurchased
1,220,000 shares of common stock for approximately $12.7 million. Net cash
provided by financing activities for 1998 consisted primarily of proceeds from
completion of our initial public offering, partially offset by debt repayments.
Net cash provided by financing activities for 1997 consisted primarily of
proceeds from debt issuances, partially offset by debt repayments.
We believe cash generated from operations will be sufficient to satisfy
anticipated working capital needs and that capital expenditure requirements
through at least the end of 2000 will be funded primarily by January 1, 2000
cash and marketable securities balances. Cash generated from operations and cash
remaining at the end of 2000 will be used to meet long-term liquidity needs,
although additional financing may be required.
Financial instruments that potentially subject the Company to concentrations
of credit risk consist principally of investments. The counterparties to the
agreements consist of government agencies and various major corporations of high
credit standing. The Company does not believe there is significant risk of
non-performance by these counterparties because the Company limits the amount of
credit exposure to any one financial institution and any one type of investment.
IMPACT OF YEAR 2000
State of Readiness
We have not experienced any disruptions related to Year 2000 issues. We will
continue to monitor systems and suppliers for Year 2000 business disruptions.
Costs to Address the Year 2000 Issue
We incurred $165,000 in 1999 to complete our remediation plans required for
information technology systems, including systems software costs and consulting
fees. We do not anticipate incurring significant additional costs in the future
relating to Year 2000 information technology issues.
Risks Presented by the Year 2000 Issue
If any third party who provides goods or services essential to our business
activities fails to appropriately address Year 2000 issues, such failure could
have a material adverse effect on our business, financial condition or operating
results. For example, a Year 2000 related disruption on the part of the
financial institutions which process our credit card sales could have a material
adverse effect on our business, financial condition or operating results. We
have not experienced any Year 2000 issues due to third parties. We will continue
to monitor suppliers for Year 2000 business disruptions.
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MANAGEMENT'S REPORT
The management of Select Comfort Corporation is responsible for the
preparation, integrity and fair presentation of the consolidated financial
statements included in this annual report. The financial statements have been
prepared in accordance with generally accepted accounting principles and include
amounts based on judgments and estimates made by management. Management is also
responsible for the preparation and accuracy of information included in other
sections of this annual report, which information is consistent with the
financial statements.
The integrity of the financial statements is based on the maintenance
of an internal control structure established by management to provide reasonable
assurance that assets are safeguarded and transactions are properly authorized,
recorded and reported. The concept of reasonable assurance is based on the
recognition that the cost of maintaining a system of internal controls should
not exceed the benefits expected to be derived. Even effective internal
controls, no matter how well designed, have inherent limitations. Management
believes that the internal control system provides reasonable assurance that
errors or irregularities that could be material to the financial statements are
prevented or would be detected and corrected in the normal course of business.
The Company engages independent auditors to examine its financial
statements and express their opinion thereon. The auditors have access to each
member of management in conducting their audits. Their report appears in this
annual report.
The Audit Committee of the Board of Directors, composed solely of
non-management directors, meets periodically with management and the independent
auditors to review internal accounting controls, audit activities and financial
reporting matters. The independent auditors have full access to the Audit
Committee and meet periodically with them without management present.
/s/ Patrick A. Hopf /s/ James C. Raabe
Patrick A. Hopf James C. Raabe
Chairman of the Board Chief Financial Officer
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Select Comfort Corporation:
We have audited the accompanying consolidated balance sheets of Select
Comfort Corporation and subsidiaries (the Company) as of January 1, 2000 and
January 2, 1999 and the related consolidated statements of operations,
shareholders' equity, and cash flows for each of the fiscal years in the
three-year period ended January 1, 2000. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Select
Comfort Corporation and subsidiaries as of January 1, 2000 and January 2, 1999,
and the results of their operations and their cash flows for each of the fiscal
years in the three-year period ended January 1, 2000 in conformity with
generally accepted accounting principles.
Minneapolis, Minnesota /s/ KPMG LLP
January 26, 2000
15
9
CONSOLIDATED BALANCE SHEETS
JANUARY 1, 2000 AND JANUARY 2, 1999
(IN THOUSANDS)
ASSETS 1999 1998
Current assets:
Cash and cash equivalents $ 7,441 $ 45,561
Marketable securities (note 2) 20,129 -
Accounts receivable, net of allowance for
doubtful accounts of $305, and $2,750, respectively (note 3) 1,056 10,624
Inventories (note 4) 11,451 10,136
Prepaid expenses 4,821 4,048
Income taxes (note 10) 2,579 -
Deferred tax assets (note 10) 6,639 5,448
---------------------
Total current assets 54,116 75,817
---------------------
Property and equipment, net (note 5) 34,823 29,125
Deferred tax assets (note 10) 4,248 440
Other assets 2,678 852
---------------------
Total assets $ 95,865 $106,234
--------------------
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 7) $ 51 $ 930
Accounts payable 15,911 12,079
Accruals:
Sales returns 5,880 6,021
Warranty costs 5,841 4,486
Compensation, taxes and benefits 6,678 4,843
Income taxes (note 10) - 648
Other 5,285 4,561
---------------------
Total current liabilities 39,646 33,568
Long-term debt, less current maturities (note 7) 36 29
Other liabilities 2,809 1,946
---------------------
Total liabilities 42,491 35,543
---------------------
Shareholders' equity (notes 7, 8, 9 and 12):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares authorized,
17,713,247 and 18,435,687 shares issued and outstanding, respectively 177 184
Additional paid-in capital 78,513 87,619
Accumulated deficit (25,316) (17,112)
---------------------
Total shareholders' equity 53,374 70,691
---------------------
Commitments (notes 6 and 14):
Total liabilities and shareholders' equity $ 95,865 $106,234
---------------------
See accompanying notes to consolidated financial statements.
16
10
CONSOLIDATED STATEMENTS OF OPERATIONS
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1999 1998 1997
Net Sales $ 273,767 $ 246,269 $ 184,430
Cost of sales 95,107 85,187 66,629
---------------------------------------------
Gross margin 178,660 161,082 117,801
---------------------------------------------
Operating expenses:
Sales and marketing 162,742 129,894 99,218
General and administrative 29,213 19,723 16,505
Store closings (note 5) 1,498 20 82
---------------------------------------------
Total operating expenses 193,453 149,637 115,805
---------------------------------------------
Operating income (loss) (14,793) 11,445 1,996
---------------------------------------------
Other income (expense):
Interest income 1,956 825 682
Interest expense (note 7) (69) (7,834) (5,234)
Other, net (116) (32) (149)
---------------------------------------------
Other income (expense), net 1,771 (7,041) (4,701)
---------------------------------------------
Income (loss) before income taxes and extraordinary item (13,022) 4,404 (2,705)
Income tax expense (benefit) (note 10) (4,818) (2,232) 141
---------------------------------------------
Net income (loss) before extraordinary item (8,204) 6,636 (2,846)
Extraordinary item, net of tax benefit (note 7) - (1,441) -
---------------------------------------------
Net income (loss) $ (8,204) $ 5,195 $ (2,846)
Deemed dividend from revision of preferred stock
conversion rate (note 8) $ - $ (1,312) $ -
Cumulative preferred dividends - (821) (900)
---------------------------------------------
Net income (loss) available to common shareholders $ (8,204) $ 3,062 $ (3,746)
---------------------------------------------
Net income (loss) per share - basic (note 11)
Net income (loss) before extraordinary item $ (0.45) $ 1.09 $ (1.59)
Net income (loss) (0.45) 0.74 (1.59)
---------------------------------------------
Net income (loss) per share - diluted (note 11)
Net income (loss) before extraordinary item $ (0.45) $ 0.28 $ (1.59)
Net income (loss) (0.45) 0.19 (1.59)
---------------------------------------------
See accompanying notes to consolidated financial statements.
17
11
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
Additional Notes
Paid-in Accumulated Receivable -
Shares Amount Capital Deficit Investors Total
Balance at December 28, 1996 1,847,146 $ 19 $ 1,226 $ (19,461) $ -- $ (18,216)
Exercise of common stock options 630,514 6 436 -- -- 442
Issuance of investor notes -- -- -- -- (418) (418)
Net loss -- -- -- (2,846) -- (2,846)
----------------------------------------------------------------------------------------
Balance at January 3, 1998 2,477,660 25 1,662 (22,307) (418) (21,038)
----------------------------------------------------------------------------------------
Issuance of shares in initial
public offering (note 9) 2,922,350 29 44,614 -- -- 44,643
Conversion of mandatorily
redeemable preferred stock
(note 8) 12,332,364 123 27,489 -- -- 27,612
Exercise of common stock options
and warrants 703,313 7 4,639 -- -- 4,646
Issuance of investor notes -- -- -- -- (487) (487)
Payment of investor notes -- -- -- -- 905 905
Elimination of put provision on
warrant (note 7) -- -- 9,215 -- -- 9,215
Net income -- -- -- 5,195 -- 5,195
----------------------------------------------------------------------------------------
Balance at January 2, 1999 18,435,687 184 87,619 (17,112) -- 70,691
----------------------------------------------------------------------------------------
Exercise of common stock options
and warrants 479,855 5 3,470 -- -- 3,475
Repurchase of common stock (1,220,000) (12) (12,680) -- -- (12,692)
Employee stock purchases (note 12) 17,705 -- 104 -- -- 104
Net loss -- -- -- (8,204) -- (8,204)
----------------------------------------------------------------------------------------
Balance at January 1, 2000 17,713,247 $ 177 $ 78,513 $ (25,316) $ -- $ 53,374
----------------------------------------------------------------------------------------
See accompanying notes to consolidated financial statements.
18
12
CONSOLIDATED STATEMENTS OF CASH FLOWS
JANUARY 1, 2000, JANUARY 2, 1999 AND JANUARY 3, 1998
(IN THOUSANDS)
1999 1998 1997
Cash flows from operating activities:
Net income (loss) $ (8,204) $ 5,195 $ (2,846)
Adjustments to reconcile net income (loss)
to net cash provided by operating activities:
Depreciation and amortization 6,695 5,351 4,030
Loss on disposal of assets and impaired assets 1,297 50 264
Extraordinary item -- 1,441 --
Deferred tax assets (4,999) (5,888) --
Interest expense from put warrant valuation -- 5,625 3,250
Change in operating assets and liabilities:
Accounts receivable, net 9,568 (4,663) (4,799)
Inventories (1,315) (2,387) (2,167)
Prepaid expenses (773) 208 (2,567)
Income taxes (3,227) 1,856 125
Accounts payable 3,832 (120) 3,026
Accrued sales returns (141) 697 2,529
Accrued warranty costs 1,355 1,229 1,221
Accrued compensation, taxes and benefits 1,835 1,694 1,426
Other accrued liabilities 724 (265) 3,704
Other assets 147 252 (565)
Other liabilities 863 709 705
---------------------------------------
Net cash provided by operating activities 7,657 10,984 7,336
---------------------------------------
Cash flows from investing activities:
Purchases of property and equipment (13,663) (8,812) (10,727)
Investment in marketable securities (20,129) -- --
Investment in affiliate (2,000) -- --
---------------------------------------
Net cash used in investing activities (35,792) (8,812) (10,727)
---------------------------------------
Cash flows from financing activities:
Proceeds from issuance of debt -- -- 16,184
Principal payments on debt (872) (15,999) (2,203)
Repurchase of common stock (12,692) -- (781)
Proceeds from issuance of common stock 3,579 46,718 439
---------------------------------------
Net cash provided by (used in) financing activities (9,985) 30,719 13,639
---------------------------------------
Increase (decrease) in cash and cash equivalents (38,120) 32,891 10,248
Cash and cash equivalents, at beginning of year 45,561 12,670 2,422
---------------------------------------
Cash and cash equivalents, at end of year $ 7,441 $ 45,561 $ 12,670
---------------------------------------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during the year for:
Interest $ 69 $ 1,719 $ 1,598
Income taxes 2,292 1,800 16
Cashless exercise of stock options -- 1,483 --
Net tax benefit from exercise of stock options 1,115 493 --
---------------------------------------
See accompanying notes to consolidated financial statements.
19
13
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business
Select Comfort Corporation and its wholly owned subsidiaries (the Company)
develop, manufacture, and market air beds and sleep-related products. The
Company's fiscal year ends on the Saturday closest to December 31. Fiscal years
1999 and 1998 had 52 weeks. Fiscal year 1997 had 53 weeks. Certain prior-year
amounts have been reclassified to conform to the current-year presentation.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All significant inter-company balances and transactions
have been eliminated in consolidation.
Cash and Cash Equivalents
Cash and cash equivalents include highly liquid investments with original
maturities of three months or less.
Inventories
Inventories include material, labor, and overhead and are stated at the
lower of cost or market. Cost is determined by the first-in, first-out method.
Property and Equipment
Property and equipment, carried at cost, are depreciated using the
straight-line method over the estimated useful lives of the assets, which range
from three to seven years. Leasehold improvements are amortized over the shorter
of the life of the lease or ten years.
Other Assets
Other assets include security deposits, patents, investments, trademarks,
and debt issuance costs. Patents and trademarks are amortized using the
straight-line method over a 17-year period and 15-year period, respectively.
Debt issuance costs are amortized using the straight-line method over the term
of the debt. In May 1999, the Company invested $2.0 million in a less than 20%
owned affiliate that will be the provider of the Company's sofa sleeper product.
This investment is accounted for under the cost method.
Impairment of Long-lived Assets and Long-lived Assets to be Disposed Of
The Company reviews its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell.
Accrued Warranty Costs
The Company provides a 20-year warranty on air beds, the last 15 years of
which are on a prorated basis. Estimated warranty costs are provided at the time
of sale of the warranted products. Estimates are based upon historical warranty
claims incurred by the Company. Given the limited history available, actual
results could differ from these estimates.
Accrued Sales Returns
Estimated sales returns are provided at the time of sale based upon
historical sales returns. Returns are allowed by the Company for 90 nights
following the sale.
Fair Value of Financial Instruments
The carrying value of cash and cash equivalents and accounts receivable
approximate fair value because of the short-term maturity of those instruments.
The fair value of long-term debt approximates carrying value based on the
Company's estimate of rates that would be available to it for debt of the same
remaining maturities.
Revenue Recognition
Revenue is recognized when products are shipped to customers net of
estimated returns.
Stock Compensation
The Company records compensation expense for option grants under its stock
option plan if the current market value of the underlying stock at the grant
date
20
14
exceeds the stock option exercise price. Pro forma disclosure of the net income
impact of applying an alternative method of recognizing stock compensation
expense over the vesting period based on the fair value of all stock-based
awards on the date of grant is presented in Note 9. The Company has issued
options to non-employees and recognized compensation expense based on the fair
market value method.
Product Development Costs
Costs incurred in connection with research and development are charged to
expense as incurred. Product development expense was $1,865,000, $1,638,000, and
$1,819,000 in 1999, 1998, and 1997, respectively.
Pre-opening Costs
Costs associated with the opening of new stores are expensed as incurred.
Direct Response Advertising Costs
The Company incurs direct response advertising costs associated with print
and broadcast advertisements. Such costs are charged to expense as incurred.
Advertising expense was $43,415,000, $31,648,000, and $28,281,000 in 1999, 1998,
and 1997.
Income Taxes
The Company recognizes deferred tax assets and liabilities for the future
tax consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.
Earnings (loss) Per Share
Basic earnings (loss) per share excludes dilution and is computed by
dividing the net income (loss) available to common shareholders by the weighted
average number of common shares outstanding during the period. Diluted earnings
(loss) per share includes dilutive potential common shares consisting of stock
options and warrants determined by the treasury stock method, and dilutive
convertible securities.
Accounting Estimates
The preparation of consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
New Accounting Pronouncements
During 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No 133, "Accounting for Derivative Instruments
and Hedging Activities". During 1999, the Financial Accounting Standards Board
issued Statement of Financial Accounting Standards No 137, which extends the
implementation of SFAS 133 until 2001 for the Company. This pronouncement is not
expected to have a material impact on the Company's consolidated financial
statements. During 1999 the Securities and Exchange Commission issued Staff
Accounting Bulletin No 101, "Revenue Recognition in Financial Statements". The
Company is analyzing the impact of this SAB on the Company's consolidated
financial statements.
(2) MARKETABLE SECURITIES
Securities classified as held to maturity, which consist of securities with
maturities of less than one year that management has the ability and intent to
hold to maturity, are carried at amortized cost, and are summarized as follows
at January 1, 2000 (in thousands):
Average Amortized Fair Value
Interest Rate Cost
U.S. Government agencies 5.5% $ 7,244 $ 7,228
Commercial paper 5.8% 12,885 12,877
--------------------------------------------
$20,129 $20,105
--------------------------------------------
21
15
(3) ACCOUNTS RECEIVABLE
The Company utilizes a third-party bank to offer its qualified customers an
unsecured revolving credit arrangement to finance purchases from the Company.
The bank sets the rates, fees and all other terms and conditions of the customer
accounts, including collection policies and procedures, and is the owner of the
accounts. In connection with all purchases financed under these arrangements,
the bank pays the Company an amount equal to the total amount of such purchases,
net of promotional related discounts. Effective July 1999, the Company
terminated its existing credit arrangement and entered into a new agreement with
another provider. The new provider purchased substantially all of the
outstanding customer receivables. As a result, the Company received $9,800,000
that had been retained by the previous provider and included in accounts
receivable. The previous bank had retained $11,350,000 as of January 2, 1999
under terms of its agreement. There are no retainage amounts as a part of the
new agreement.
(4) INVENTORIES
Inventories consist of the following (in thousands):
January 1, 2000 January 2, 1999
Raw materials $ 5,753 $ 6,533
Work in progress 59 67
Finished goods 5,639 3,536
-----------------------------------
$11,451 $10,136
-----------------------------------
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
January 1, 2000 January 2, 1999
Leasehold improvements $32,192 $24,865
Office furniture and equipment 5,314 3,079
Production machinery and
computer equipment 13,115 8,610
Property and equipment
under capital lease 495 2,963
Other 1,108 1,446
Less accumulated depreciation
and amortization (17,401) (11,838)
------------------------------
$34,823 $29,125
------------------------------
Store Closings
Store closing expense for 1999 includes a $1,404,000 charge associated with
plans to close 22 stores and other related store write-offs. Store closing
expense was $1,498,000, $20,000, and $82,000 in 1999, 1998, and 1997,
respectively.
(6) LEASES
The Company rents office and manufacturing space under four operating
leases which, in addition to the minimum lease payments, require payment of a
proportionate share of the real estate taxes and building operating expenses.
The Company also rents retail space under operating leases which, in addition to
the minimum lease payments, require payment of percentage rents based upon sales
levels. Rent expense was as follows:
1999 1998 1997
Minimum rents $15,399 $11,127 $ 8,465
Percentage rents 1,992 1,522 892
---------------------------------
Total $17,391 $12,649 $ 9,357
---------------------------------
Equipment rent $ 1,362 $ 952 $ 683
---------------------------------
The aggregate minimum rental commitments under operating leases for
subsequent years are as follows (in thousands):
2000 $ 16,313
2001 14,711
2002 14,329
2003 13,486
2004 11,978
Thereafter 30,858
--------
$101,675
--------
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term obligations under notes and capital leases are as follows (in
thousands):
January 1, 2000 January 2, 1999
Notes payable under capital
lease agreements, payable in
monthly installments through
March 2000, with interest at
9.75% - 12.5% per annum. In
connection with these notes,
the Company granted the
vendor warrants to acquire
31,428 shares of the
Company's Series E
convertible preferred
stock (note 9) $87 $959
------------------
87 959
Less current maturities 51 930
------------------
$36 $ 29
------------------
22
16
Aggregate maturities of long-term debt subsequent to January 1, 2000 are
due in 2000.
In March 1997, the Company completed a financing under which it issued a
senior subordinated promissory note in the principal amount of $15,000,000, a
warrant to purchase 1,100,000 shares of the Company's common stock at $10.50 per
share and a contingent warrant to purchase 1,000,000 shares of common stock at
$0.01 per share. These warrants were subsequently adjusted and combined,
resulting in a single warrant to purchase 1,315,096 shares of common stock at
$8.82 per share, exercisable at any time prior to March 31, 2005.
In December 1998, the Company repaid the promissory note resulting in an
extraordinary loss of $1,441,000 from early repayment. The loss was comprised of
unamortized debt discount and issuance costs totaling $2,281,000, and net of
income tax benefits of $840,000.
The original warrant issued in the financing provided that the holder could
require the Company to repurchase the warrant if an initial public offering had
not been completed prior to March 27, 2002. The repurchase amount would have
been equal to the excess of the estimated fair market value of the Company's
common stock, as determined by the warrant agreement, over the exercise price of
the warrant. The Company also has an option to repurchase the warrant if the
warrant has not been exercised prior to March 27, 2004. As required by Emerging
Issues Task Force Issue 96-13 (EITF 96-13), the warrant was recorded at fair
value and recorded as long-term debt. In addition, EITF 96-13 requires that any
change in fair value of the warrant be reflected as interest expense.
Accordingly, the financial statements reflect interest expense of $5,625,000 and
$3,250,000 for 1998 and 1997, respectively.
Upon completion of the Company's initial public offering the put option on
the warrants expired and the warrants were reclassified into $9,215,000 of
additional paid-in-capital. In addition, effective upon completion of the
Company's initial public offering, warrant revaluation is no longer required and
accordingly interest expense will no longer be recorded.
(8) MANDATORILY REDEEMABLE PREFERRED STOCK
Prior to completion of the Company's initial public offering in December
1998, the Company had issued and outstanding 12,091,962 shares of mandatorily
redeemable preferred stock. The holders of the Series A, B, C, D, and E
mandatorily redeemable preferred stock had certain rights and preferences,
including those involving dividend participation, special voting, liquidation
preferences, antidilution rights, redemption rights and in certain cases, those
involving cumulative dividends.
In November 1998, the Company adjusted the conversion price of the Series E
Mandatorily Redeemable Preferred Stock from $8.82 per share to $8.20. The
adjustment was made in accordance with the Series E Stock Purchase Agreement and
was effective on the closing of the Company's initial public offering. The
adjustment resulted in the issuance of an additional 77,155 shares of common
stock upon conversion. For purposes of calculating net income (loss) per share
in the period in which the initial public offering was completed, net income
available to common shareholders has been reduced by $1,312,000 for the
estimated value of additional shares issued under these antidilution provisions
(note 11).
Upon completion of the Company's underwritten public offering in December
1998 the Series A, B, C, D, and E mandatorily redeemable preferred stock were
converted into an aggregate of 12,332,364 of common stock. In addition, all
rights and preferences, including those involving cumulative dividends, expired.
Cumulative but undeclared and unpaid dividends have been deducted from net
income available to common shareholders in determining net income (loss) per
share (note 11).
As of January 2, 1999, there were no remaining mandatorily redeemable
shares outstanding.
23
17
Changes in mandatorily redeemable preferred stock are as follows (dollars
in thousands):
ADDITIONAL
PAID-IN
SHARES AMOUNT CAPITAL TOTAL
Balance At
January 3, 1998 12,091,962 $12,692 $14,920 $27,612
Conversion to
common
stock 12,091,962 12,692 14,920 27,612
---------------------------------------------
Balance at
January 2, 1999 - $ - $ - $ -
=============================================
(9) SHAREHOLDERS' EQUITY
Effective December 4, 1998, the Company issued 2,922,350 common shares in
completion of its initial public offering resulting in net proceeds of $44.6
million.
Stock Options
The Board of Directors has reserved 5,300,000 shares of common stock for
options that may be granted to key employees, directors, or others under the
Company's stock option plans. On March 2, 2000, the Board of Directors of the
Company approved, subject to approval by the shareholders, an increase in the
number of shares of common stock reserved for issuance to 6,300,000 shares.
A summary of the changes in the Company's stock option plans for each of
the years in the three year period ended January 1, 2000 is as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
Outstanding at December 28, 1996
(including 1,105,468 shares exercisable) 1,679,173 $2.58
Granted 1,073,750 6.20
Exercised (630,514) 0.70
Canceled (26,800) 4.29
---------------------
Outstanding at January 3, 1998
(including 931,319 shares exercisable) 2,095,609 4.98
Granted 443,075 14.70
Exercised (526,880) 3.18
Canceled (208,070) 5.82
---------------------
Outstanding at January 2, 1999
(including 884,807 shares exercisable) 1,803,734 7.77
Granted 1,857,100 12.10
Exercised (448,705) 5.05
Canceled (526,776) 14.66
---------------------
Outstanding at January 1, 2000
(including 1,311,133 shares exercisable) 2,685,353 $9.92
=====================
The following table summarizes information about options outstanding at
January 1, 2000:
OPTIONS OPTIONS
OUTSTANDING EXERCISABLE
- -------------------------------------------------- -------------------
AVERAGED WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICE SHARES LIFE (YEARS) PRICE SHARES PRICE
$ 0.45 - 4.80 235,420 5.91 $ 3.80 220,420 $ 3.78
5.25 - 6.50 641,140 7.80 5.53 462,110 5.49
6.63 - 11.00 956,117 8.72 8.27 429,688 9.10
13.94 - 17.00 757,201 6.85 15.71 155,880 15.85
23.69 - 32.25 95,475 9.21 24.98 43,035 25.72
- ----------------------------------------------------------------------
$ 0.45 - 32.25 2,685,353 7.74 $ 9.92 1,311,133 $ 8.28
======================================================================
No compensation cost has been recognized in the consolidated financial
statements for employee stock options grants and the Company's employee stock
purchase plan. Had the Company determined compensation cost based on the fair
value at the grant date for its stock options under an alternative accounting
method, the Company's net loss would have been adjusted as indicated below (in
thousands):
1999 1998 1997
Net income (loss): As reported $ (8,204) $5,195 $(2,846)
Pro forma $(11,088) $4,144 $(3,563)
The fair value of each option grant is estimated on the date of grant using
the Black-Sholes option-pricing model with the following assumptions: expected
dividend yield-0%; expected stock price volatility-40%; risk-free interest rate-
6.3% for 1999, 4.6% for 1998, and 6.4% for 1997; expected life of options- 2.9,
3.0 years, and 4.2 for 1999, 1998, and 1997, respectively. The per share
weighted-average fair value of stock options granted during 1999, 1998, and 1997
was $3.86, $4.72, and $1.92, respectively.
Warrants
In April 1996, the Company issued warrants to the holders of Series E
Preferred Stock (note 8) to purchase an aggregate of 171,429 shares of Common
Stock at an exercise price of $5.25 per share. During 1998, warrants for 54,430
common shares were exercised. Warrants for 108,499 and 116,999 shares remained
outstanding at January 1, 2000 and January 2, 1999, respectively.
24
18
In connection with a capital lease transaction with a vendor in 1997, the
Company granted the vendor warrants to acquire 31,428 shares of the Company's
Series E convertible preferred stock at a purchase price of _$10.50 per share.
The warrants are exercisable for five years beginning December 3, 1998. In
December 1998, the Preferred Stock warrants were converted into warrants to
purchase 40,243 shares of common stock at $8.20 per share. There were no
warrants outstanding at January 1, 2000.
In connection with short-term debt issued to related parties in 1996, the
Company granted warrants to purchase 71,525 shares of the Company's common stock
at a purchase price of $5.25 per share. The warrants are exercisable for ten
years from the grant date. During December 1998, warrants for 7,003 common
shares were exercised. Warrants for 64,522 shares remained outstanding at
January 1, 2000 and January 2, 1999.
Stock Repurchase
During 1999, the Company repurchased 1,220,000 shares for approximately
$12.7 million.
(10) INCOME TAXES
The provision (benefit) for income taxes consists of the following (in
thousands):
1999 1998 1997
Current:
Federal $ -- $ 2,969 $ 125
State 180 687 16
-----------------------------
180 3,656 141
-----------------------------
Deferred:
Federal (4,694) (5,803) --
State (304) (85) --
-----------------------------
(4,998) (5,888) --
-----------------------------
Income tax expense (benefit) $(4,818) $(2,232) $ 141
=============================
Effective tax rates differ from statutory federal income tax rates as
follows:
1999 1998 1997
Statutory federal income
tax rate (35.0)% 35.0% (34.0)%
Nondeductible interest
expense, put warrants 0.0 44.7 40.8
Change in valuation allowance 0.0 (147.0) (2.7)
Effect of change in tax rate
on deferred tax asset 0.0 6.7 0.0
State income taxes, net of
federal benefit (0.6) 8.9 0.4
Other (1.4) 1.0 0.7
------------------------
(37.0)% (50.7)% 5.2 %
========================
The tax effects of temporary differences that give rise to deferred tax
assets at January 1, 2000 and January 2, 1999 are as follows (in thousands):
1999 1998
Deferred tax assets:
Current:
Inventory, warranty, and returns reserves $ 4,553 $ 4,371
Allowance for doubtful accounts 116 117
Other 1,970 960
Long term:
Net operating loss carryforwards 3,885 602
Other 886 361
--------------------
Total gross deferred tax assets 11,410 6,411
Valuation allowance (523) (523)
--------------------
Total net deferred tax assets $ 10,887 $ 5,888
====================
At January 1, 2000, the Company had net operating loss carryforwards for
federal income tax purposes of approximately $10,200,000 expiring between the
years 2003 and 2019. The Company expects that approximately $1,400,000 of these
carryforwards will expire unutilized due to an Internal Revenue Code (IRC)
Section 382 limitation resulting from a prior ownership change and has,
therefore, provided a valuation allowance for this portion of the carryforwards.
The Company has not provided a valuation allowance for any other deferred tax
assets because it believes that it is more likely than not that they will be
realized.
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(11) NET INCOME (LOSS) PER COMMON SHARE
The following computations reconcile net income (loss) with net income
(loss) per common share-basic and diluted (dollars in thousands, except per
share amounts).
NET PER SHARE
1999 LOSS SHARES AMOUNT
Net loss $ (8,204)
-----------------------------------
BASIC AND DILUTED EPS
Net loss attributable to
common shareholders $ (8,204) 18,299,728 $ (0.45)
===================================
NET PER SHARE
1998 INCOME SHARES AMOUNT
Net income before
extraordinary item $ 6,636
Less: Deemed dividend from
revision of preferred
stock (1,312) --
Cumulative preferred
dividends (821) --
-----------------------------------
BASIC EPS
Net income available to
common shareholders $ 4,503 4,114,219 $ 1.09
-----------------------------------
EFFECT OF DILUTIVE SECURITIES
Options -- 912,448
Warrants -- 654,436
Convertible preferred stock -- 10,247,143
------------------------------------
DILUTED EPS
Net income attributable to
common shareholders
plus assumed conversion $ 4,503 15,928,246 $ 0.28
===================================
NET PER SHARE
1997 LOSS SHARES AMOUNT
Net loss: $ (2,846)
Less cumulative preferred
dividends (900) --
---------------------------------
BASIC AND DILUTED EPS
Net loss attributable to
common shareholder $ (3,746) 2,352,947 $ (1.59)
==================================
The following is a summary of those securities outstanding during the
respective periods which have been excluded from the calculations because the
effect on net income (loss) per common share would not have been dilutive:
1999 1998 1997
Options 634,881 - 1,679,173
Common stock warrants 495,864 - 154,023
Preferred stock warrants - - 31,428
Convertible preferred stock - - 12,091,962
Convertible preferred stock and preferred stock warrants were convertible
into 12,292,623 common shares during 1997.
(12) EMPLOYEE BENEFIT PLANS
Profit Sharing and 401(k) Plan
Effective January 1, 1994, the Company adopted a profit sharing and 401(k)
plan for eligible employees. The plan allows employees to defer up to 15% of
their compensation on a pretax basis. Each year, the Company may make a
discretionary contribution equal to a percentage of the employee's contribution.
During 1999, 1998, and 1997, the Company expensed $480,000, $375,000, and
$78,000, respectively, relating to its contribution to the 401(k) plan.
Employee Stock Purchase Plan
Effective June 10, 1999, the Company adopted an Employee Stock Purchase
Plan under which employees can purchase Company common stock at a discount of
15% through payroll deductions. Based on the average price on the last business
day of the offering period (calendar-quarter), 17,705 shares were issued at
$5.89 during 1999.
(13) RELATED PARTY TRANSACTIONS
As of April 1998, a former director and executive officer had borrowed
$425,000 from the Company. On December 10, 1998 the former director and
executive officer repaid the outstanding balance of the note.
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The Company entered into a consulting agreement with a director of the
Company beginning May 4, 1999. The agreement was effective for a term of two
years, and provided an annual fee of $100,000 and 60,000 options vesting over
three years. Effective January 2000, the director resigned from the board and
the consulting agreement was terminated. All vested options are exercisable
through May 2004.
The Company has entered into an employment and consulting agreement with a
former executive officer of the Company beginning April 19, 1999. The Company
paid $10,000 monthly for the employment services from May 1, 1999 through July
31, 1999, and has agreed to pay $8,250 per month for consulting services from
August 1, 1999 through April 30, 2001.
(14) COMMITMENTS AND CONTINGENCIES
The Company and certain of its former officers and directors have been
named as defendants in a class action lawsuit filed on behalf of Company
shareholders in U.S. District Court in Minnesota. The named plaintiffs, who
purport to act on behalf of a class of purchasers of the Company's common stock
during the period from December 4, 1998 to June 7, 1999, charge the defendants
with violations of federal securities laws. The suit alleges that the Company
and the named directors and officers failed to disclose or misrepresented
certain information concerning the Company during the class period. The
complaint does not specify an amount of damages claimed. The Company believes
that the complaint is without merit and intends to vigorously defend the claims.
The Company is a party to other various claims, legal actions, sales tax
disputes, and other complaints arising in the ordinary course of business. In
the opinion of management, any losses that may occur are adequately covered by
insurance or are provided for in the consolidated financial statements and the
ultimate outcome of these matters will not have a material effect on the
consolidated financial position or results of operations of the Company.
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(15) SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a condensed summary of actual quarterly results for 1999
and 1998:
1999 Fourth Third Second First
Net sales $68,104 $68,281 $65,750 $71,632
Gross margin 44,050 44,337 43,188 47,085
Operating income (loss) (9,939) (6,432) 200 1,378
Net income (loss) (6,042) (3,698) 348 1,188
Net income (loss) per share - diluted (0.33) (0.20) 0.02 0.06
- -------------------------------------------------------------------------------------------------------------
1998 Fourth Third Second First
Net sales $67,434 $60,034 $60,129 $58,672
Gross margin 44,537 39,291 39,663 37,591
Operating income 4,063 2,679 3,666 1,037
Net income (loss) before extraordinary item 7,047 (1,903) 1,910 (418)
Net income (loss) 5,606 (1,903) 1,910 (418)
Net income (loss) per share before extraordinary item - diluted 0.32 (0.72) 0.11 (0.26)
Net income (loss) per share - diluted 0.24 (0.72) 0.11 (0.26)
- -------------------------------------------------------------------------------------------------------------
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BOARD OF DIRECTORS EXECUTIVE OFFICERS/ CORPORATE HEADQUARTERS
MANAGEMENT TEAM
Patrick A. Hopf William R. McLaughlin Select Comfort Corporation
Chairman, Select Comfort Corporation President and 10400 Viking Drive, Suite 400
Managing General Partner, Chief Executive Officer Minneapolis, Minnesota 55344
St. Paul Venture Capital Telephone: (952) 918-3000
Tracey T. Breazeale www.selectcomfort.com
Thomas J. Albani Senior Vice President,
Former President and CEO Strategic Planning and Branding INDEPENDENT AUDITORS
Electrolux Corporation KPMG LLP
Renee M. Christensen Minneapolis, Minnesota
Christopher P. Kirchen Senior Vice President,
Managing General Partner E-Commerce REGISTER AND TRANSFER AGENT
Brand Equity Ventures Norwest Bank of Minnesota, N.A.
James D. Gaboury Stock Transfer Department
David T. Kollat Vice President, 161 North Concord Exchange
President Direct Sales P.O. Box 738
22 Inc. South St. Paul, MN 55075
Mark A. Kimball
William J. Lansing Senior Vice President, OUTSIDE COUNSEL
Chief Executive Officer Chief Administrative Officer, Oppenheimer Wolff & Donnelly LLP
NBC Internet, Inc. General Counsel and Secretary Minneapolis, Minnesota
William R. McLaughlin Gregory T. Kliner ANNUAL MEETING
President and Chief Executive Officer Senior Vice President, The Annual Meeting of Shareholders
Select Comfort Corporation Operations will be held on Thursday, May 18,
2000 at 3:00 p.m. at the Hotel Sofitel
Ervin R. Shames Ronald E. Mayle in Bloomington, Minnesota.
Independent Management Consultant Senior Vice President,
Retail
Jean-Michel Valette
President and CEO James C. Raabe
Franciscan Estates Vice President,
Chief Financial Officer
ANNUAL REPORT/FORM 10-K
Current and potential Select Comfort shareholders interested in
obtaining a copy of the Company's annual report filed on Form 10-K are invited
to contact the Company by writing to Investor Relations at its Corporate
Headquarters or calling Investor Relations at (952) 918-3190.
Shareholders and interested parties can also find information about
Select Comfort Corporation on the Worldwide Web. The Web address is
http://www.selectcomfort.com.
COMMON STOCK
Select Comfort's common stock trades on the Nasdaq Stock Market(R) under
the symbol SCSS, since the Company changed its stock symbol from AIRB effective
January 10, 2000. The quarterly high and low sales prices for the Company's
common stock as reported by the Nasdaq Stock Market,(R) for the period from the
date of our initial public offering on December 4, 1998 through the end of the
most recent fiscal year are set forth in the table below. These prices reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not necessarily represent actual transactions. Select Comfort has never paid any
cash dividends on its common stock and does not anticipate paying any cash
dividends on its common stock in the foreseeable future.
Fourth Third Second First
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Fiscal 1998
High $29.19
Low $19.63 N/A N/A N/A
------- ------- ------- -------
Fiscal 1999
High $ 7.06 $9.19 $29.88 $35.25
Low $ 3.63 $6.00 $ 6.38 $20.50
------- ------- ------- -------
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