================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------------
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 29, 2001
[ ] 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
--------------------
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. [X]
As of March 22, 2002, 18,449,096 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 $40,001,430.
DOCUMENTS INCORPORATED BY REFERENCE
Part III of this Annual Report on Form 10-K incorporates by reference
information (to the extent specific sections are referred to herein) from the
Registrant's Proxy Statement for its 2002 Annual Meeting (the "2002 Proxy
Statement").
================================================================================
TABLE OF CONTENTS
--------------------
PART I.........................................................................2
ITEM 1. BUSINESS...........................................................2
General...................................................................2
Competitive Strengths.....................................................3
Business and Growth Strategy..............................................3
Products..................................................................5
Marketing and Advertising.................................................6
Retail Stores.............................................................7
Direct Marketing Operations...............................................9
E-Commerce................................................................9
Wholesale................................................................10
Consumer Education and Customer Service..................................10
Manufacturing and Distribution...........................................11
Suppliers................................................................11
Intellectual Property....................................................11
Competition..............................................................12
Consumer Credit Arrangements.............................................13
Governmental Regulation..................................................13
Employees................................................................13
Recent Financing Transactions............................................13
Certain Risk Factors.....................................................15
ITEM 2. PROPERTIES........................................................22
ITEM 3. LEGAL PROCEEDINGS.................................................22
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY.................................23
PART II.......................................................................25
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
SHAREHOLDER MATTERS...............................................25
Number of Record Holders; Dividends......................................25
ITEM 6. SELECTED FINANCIAL DATA...........................................26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS.........................................27
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.........32
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.......................32
i
ITEM 9. CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE..........................................32
PART III......................................................................33
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................33
Directors, Executive Officers, Promoters and Control Persons.............33
Section 16(a) Beneficial Ownership Reporting Compliance..................33
ITEM 11. EXECUTIVE COMPENSATION............................................33
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT....33
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................33
PART IV.......................................................................34
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K...34
Index to Consolidated Financial Statements...............................34
Index to Consolidated Financial Statement Schedules......................34
Exhibits.................................................................35
Reports on Form 8-K......................................................36
--------------------
OUR FISCAL YEAR ENDS ON THE SATURDAY CLOSEST TO DECEMBER 31, AND UNLESS THE
CONTEXT OTHERWISE REQUIRES, ALL REFERENCES TO YEARS IN THIS FORM 10-K REFER TO
OUR FISCAL YEARS. ALL REFERENCES TO "SELECT COMFORT(R)," "THE COMPANY," "WE" OR
"US" HEREIN INCLUDE OUR WHOLLY OWNED SUBSIDIARIES, SELECT COMFORT DIRECT
CORPORATION, SELECT COMFORT RETAIL CORPORATION, DIRECT CALL CENTERS, INC.,
SELECT COMFORT SC CORPORATION AND SELECTCOMFORT.COM CORPORATION.
SELECT COMFORT(R), SLEEP NUMBER(R), COMFORT CLUB(R), SLEEP BETTER ON
AIR(R), SLEEP INSURANCE(R), THE SLEEP NUMBER BED BY SELECT COMFORT(TM) THE SLEEP
NUMBER STORE BY SELECT COMFORT(TM), FIRMNESS CONTROL SYSTEM(TM), SELECT COMFORT
SOFA SLEEPAIRE(TM), SELECT COMFORT SOFA SLEEPAIRE COLLECTION(TM) AND THE
COMPANY'S STYLIZED LOGOS ARE TRADEMARKS AND/OR SERVICE MARKS OF THE COMPANY.
ii
PART I
--------------------
THIS ANNUAL REPORT ON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS
WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. FOR
THIS PURPOSE, ANY STATEMENTS CONTAINED IN THIS ANNUAL REPORT ON FORM 10-K THAT
ARE NOT STATEMENTS OF HISTORICAL FACT MAY BE DEEMED TO BE FORWARD-LOOKING
STATEMENTS, INCLUDING WITHOUT LIMITATION PROJECTIONS OF RESULTS OF OPERATIONS,
REVENUES, FINANCIAL CONDITION OR OTHER FINANCIAL ITEMS; ANY STATEMENTS OF PLANS,
STRATEGIES AND OBJECTIVES OF MANAGEMENT FOR FUTURE OPERATIONS; ANY STATEMENTS
REGARDING PROPOSED NEW PRODUCTS, SERVICES OR DEVELOPMENTS; ANY STATEMENTS
REGARDING FUTURE ECONOMIC CONDITIONS, PROSPECTS OR PERFORMANCE; STATEMENTS OF
BELIEF AND ANY STATEMENT OR ASSUMPTIONS UNDERLYING ANY OF THE FOREGOING. WITHOUT
LIMITING THE FOREGOING, WORDS SUCH AS "MAY," "WILL," "SHOULD," "EXPECTS,"
"ANTICIPATES," "CONTEMPLATES," "ESTIMATES," "BELIEVES," "PLANS," "PROJECTS,"
"PREDICTS," "POTENTIAL" OR "CONTINUE" OR THE NEGATIVE OF THESE OR COMPARABLE
TERMINOLOGY ARE INTENDED TO IDENTIFY FORWARD-LOOKING STATEMENTS.
THESE FORWARD-LOOKING STATEMENTS BY THEIR NATURE INVOLVE SUBSTANTIAL RISKS
AND UNCERTAINTIES, AND ACTUAL RESULTS MAY DIFFER MATERIALLY DEPENDING ON A
VARIETY OF FACTORS, INCLUDING, AMONG OTHER THINGS, GENERAL AND INDUSTRY ECONOMIC
TRENDS, CONSUMER CONFIDENCE, THE EFFECTIVENESS AND EFFICIENCY OF OUR ADVERTISING
AND PROMOTIONAL EFFORTS, CONSUMER ACCEPTANCE OF OUR PRODUCTS AND SLEEP
TECHNOLOGY, INDUSTRY COMPETITION, OUR DEPENDENCE ON SIGNIFICANT SUPPLIERS,
INCLUDING UNITED PARCEL SERVICE (UPS) FOR DELIVERY OF OUR SLEEP SYSTEMS AND
CONSECO FINANCE FOR EXTENSION OF CONSUMER CREDIT, AND THE VULNERABILITY OF ANY
SUCH SUPPLIERS TO RECESSIONARY PRESSURES, LABOR NEGOTIATIONS, LIQUIDITY CONCERNS
OR OTHER FACTORS, THE POTENTIAL DILUTION FROM THE ISSUANCE OF ADDITIONAL SHARES
FROM FINANCINGS COMPLETED IN 2001 AND OUR ABILITY TO MAINTAIN COMPLIANCE WITH
LISTING REQUIREMENTS OF NASDAQ, AS WELL AS THE RISK FACTORS LISTED FROM TIME TO
TIME IN THE COMPANY'S FILINGS WITH THE SEC, INCLUDING IN PARTICULAR THE ITEMS
DISCUSSED IN GREATER DETAIL BELOW UNDER THE HEADING "CERTAIN RISK FACTORS."
ITEM 1. BUSINESS
GENERAL
Select Comfort(R) 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 Sleep Number(R) bed was designed on the basis of sleep research, and in
clinical studieS has been shown to improve sleep quality. In comparison with
traditional mattress products, our proprietary Sleep Number(R) beds utilize
adjustable air chamber technology to more naturally contour to the body, thereby
generally providing:
- - better spinal alignment,
- - reduced pressure points,
- - greater relief of lower back pain,
- - greater overall comfort, and
- - better quality sleep.
Our Firmness Control System(TM) allows customers to independently customize each
side of the Sleep Number(R) bed to their ideal level of firmness, comfort and
support.
We sell our products through four complementary distribution channels. Unlike
traditional mattress manufacturers, the vast
2
majority of our sales have historically been made directly to consumers through
three Company-owned and service-oriented distribution channels (Retail, Direct
Marketing and E-commerce). All of our distribution channels include:
- - RETAIL, including 328 company-operated retail stores and leased departments
within larger retail stores in 46 states,
- - DIRECT MARKETING, including a company-operated call center,
- - E-COMMERCE, through our Web site at SELECTCOMFORT.COM, and
- - WHOLESALE, through leading home furnishings retailers and over the QVC
shopping channel. Sales through the wholesale channel represented 4% of net
sales in 2001.
In 2001, we completed two significant financing transactions, raising an
aggregate of $16 million to meet our working capital requirements. These
financing transactions are described below under "--Recent Financing
Transactions."
COMPETITIVE STRENGTHS
We have developed a number of key competitive strengths, including:
- - PRODUCT SUPERIORITY. Our line of adjustable firmness mattresses was
designed on the basis of sleep research, and in clinical studies has been
shown to improve sleep quality. We have patents or pending patent
applications for various aspects of our Sleep Number(R) beds, a well
developed supply chain with scale and expertise, and an active research and
development group that continues to strive for innovative leadership in our
industry.
- - BRAND IDENTITY. The Select Comfort(R)and Sleep Number(R)brand identities
are associated with product superiority and innovation.
- - MULTIPLE, COMPLEMENTARY AND CONTROLLED DISTRIBUTION CHANNELS. Our
distribution channels give our customers multiple, convenient opportunities
to purchase our products. These channels also provide direct contact with
our customers, enabling us to better understand and respond to consumer
desires. Our Company-owned distribution channels are staffed by high
quality, well trained and passionate sales professionals.
- - BASE OF CUSTOMERS AND INQUIRIES. We have an installed base of approximately
1.2 million customers with very high levels of customer satisfaction. We
have also developed a database of approximately 8.2 million consumer
inquiries.
BUSINESS AND GROWTH STRATEGY
In the second half of 2000 and throughout 2001, we focused on four primary
strategic priorities: (i) building consumer awareness, (ii) rightsizing our cost
structure, (iii) expanding profitable distribution and (iv) continuously
improving product quality, innovation and service levels. Our progress against
these strategic priorities is discussed in greater detail below.
BUILDING CONSUMER 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. 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.
Early in 2001, we launched the repositioning of our product, brand and marketing
messages around our Sleep Number(R) bed. Our Sleep Number(R) campaign focuses on
the unique features anD benefits of our product: individualized and adjustable
firmness, comfort
3
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(R) campaign early in 2001
with encouraging initial results. See "--Marketing and Advertising."
RIGHTSIZING OUR COST STRUCTURE. In 2001, we continued to implement initiatives
to bring our cost structure in line with our sales volumes, resulting in the
achievement of profitability in the second half of the year on modest sales
increases over the second half of 2000. Specific cost savings initiatives
implemented in late 2000 and in 2001 have included:
- - Termination of non-core business initiatives,
- - Rebalancing of manufacturing between our three plant locations,
- - Selling expense savings from closing under-performing retail stores and our
direct call center in South Carolina, and by streamlining retail management
and store staffing levels,
- - Corporate general and administrative expense savings from reductions in
corporate staff and consolidating our two Minneapolis offices,
- - Logistics cost savings from systems and packaging improvements to enable
shipping with Fed Ex as well as UPS,
- - Product cost reductions with equal or superior quality and reduced product
returns, and
- - Promotional discount reductions through improved program design and
controls.
EXPANDING PROFITABLE DISTRIBUTION. An important element of our growth strategy
is to expand profitable distribution by increasing sales through our existing
channels and by increasing opportunities for consumers to become aware of, and
to purchase, our products through additional points of distribution. During
2001, we developed a new selling process and a new compensation plan that is
more heavily based on individual performance and more heavily commission driven,
in each case designed to improve sales performance through our retail sales
channel.
In 2001, we also expanded two key avenues of wholesale distribution that were
initially tested in 2000. 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 expanded our
relationship with Gabberts to include distribution through its two stores in
Dallas. Also in 2001, we established a wholesaling relationship with Benchmark,
a leading home furnishings retailer in the Kansas City market. In 2002, we plan
to pursue similar wholesaling relationships with mattress or home furnishings
retailers in additional markets on a selective basis. We believe that these
relationships may enable us to leverage our advertising spending in key markets.
In October 2000, we successfully tested the offering of our products on the QVC
television shopping channel with a one-hour program. This test led to additional
successful segments on QVC throughout 2001. We believe that our distribution
through QVC has increased 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 return to profitable operations has been due in part to our ability to
continue to lead the mattress industry in innovation and to continue to improve
our product line and service levels. In 2000 and 2001, we reinvigorated our
research and development capability to focus on continuous product improvements
to deliver:
4
- - new and enhanced consumer benefits,
- - improved product quality, and
- - reduced product or delivery costs.
In 2001, we introduced significant improvements to the quality, performance and
appearance of our core product line while reducing overall product costs.
Also during 2001, we expanded our in-home delivery, assembly and mattress
removal services to be available at 127 (or approximately 39%) of our retail
stores as of the end of 2001. We plan to ultimately offer this service
throughout the continental United States and through each of our Company-owned
distribution channels.
In 2002, we plan to build on the success of this strategic direction and
continue our efforts to:
- - Build consumer awareness through the expansion of the Sleep
Number(R)advertising campaign,
- - Control costs and leverage our infrastructure while investing in proven
programs and systems,
- - Expand profitable distribution, both through growth of our wholesale
distribution channel and through improvement of the effectiveness and
efficiency of our current Company-owned distribution channels,
- - Drive further product enhancements and innovation, including the re-launch
of our best-selling model, the Sleep Number(R) 5000, and the ultra-premium
Sleep Number(R) 7000, and
- - Expand customer services, including in particular our home delivery,
assembly and mattress removal services.
PRODUCTS
BEDS. Select Comfort(R) offers four different Sleep Number(R) bed models. Each
bed comes in standard mattress sizes, ranging from twin to king, as well as some
specialty sizes. In addition, all Sleep Number(R) beds feature high quality,
vulcanized rubber air chambers that are highly durable. The dual chambers allow
each side of the mattress to be adjusted independently with the Firmness Control
System(TM) for personalized comfort and support. Because air is the primary
support material of the mattress, Sleep Number(R) beds do not lose their shape
or support over time like traditional mattresses and box springs.
The components for the Firmness Control System(TM) are contract manufactured to
our specifications through our highly developed supply chain.
Our higher-end bed models - the Sleep Number(R) 5000 and 7000 - feature a
patented wireless remote control with a digital display of the user's Sleep
Number(R), the preferred mattress firmness setting selected by the consumer.
This digital feature is also available with the Sleep Number(R) 3000 and 4000
bed models for an additional charge.
The air chambers of a Sleep Number(R) 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(R) mattresses are enclosed by a comfortable,
durable Belgian Damask covering which combines cotton and/or rayon for comfort
and durability. Our covers are sewn in our plants in the United States to our
specifications.
The contouring and support of a Sleep Number(R) mattress works best with a
specially designed, proprietary foundation from Select Comfort.(R) 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
5
designed with interlocking panels for maximum structural integrity, as well as
high-density polymer side panels and lateral support beams for additional
support. Unlike traditional box springs, the Select Comfort(R) foundation can be
easily moved around corners and up and down stairs. Our foundation is made of
100% recyclable material.
Informational product brochures and easy-to-follow assembly instructions
accompany each Sleep Number(R) bed, which can be quickly and easily assembled by
the customer through a simple, tool-free process. Alternatively, the customer
can take advantage of our home delivery, assembly and mattress removal services
where available. The Sleep Number(R) bed 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. In mid-2001, we shortened our in-home trial
period from 90 days to 30 days, which helped to reduce return rates and their
associated costs.
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. In 2001, we added several new offerings to the
accessory line, and made accessory sales an integrated component of our sales
process and compensation structure.
SOFA SLEEPERS. In 2000, we introduced a line of sofa sleepers with air-supported
mattresses in select markets. This product offered 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.
Consistent with our cost reduction efforts and in order to focus our resources
on our core product line, we ceased the marketing and sale of this product line
early in 2001. We have worked to improve the features, benefits and quality of
this product line for a later re-launch. We currently plan to re-launch this
product line sometime after 2002.
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 a quieter Firmness Control System,(TM) remote
control gauges with digital settings, more luxurious fabrics and covers, new
generations of foams and foundation systems and enhanced border walls. Our
research and development expenses were $1.1 million in 2001, $0.9 million in
2000, and $1.9 million in 1999.
MARKETING AND ADVERTISING
Lack of awareness among the broad consumer audience of our brand, product
benefits and store locations historically has been our most significant barrier
to growth. In 2001, increasing consumer awareness became the primary focus of
our marketing efforts, leading to a complete repositioning of our product,
branding and consumer communication.
Featuring the Sleep Number Bed by Select Comfort,(TM) new advertising and media
strategies were employed beginning early in 2001. The Sleep Number(R) campaign
consciously focused on broadening the message, the target audience and the types
of media employed, while developing a memorable and proprietary way of
intriguing the consumer about our product. The architecture of the Sleep
Number(R) campaign is that "Everybody has a Sleep Number,(R)" thaT "Knowing Your
Sleep Number(R) is the Key to a Perfect Night's Sleep," and that you can only
find your Sleep Number(R) on a Sleep Number Bed by Select Comfort(TM) at
specific locations. WE believe this message enables consumers to more quickly
understand the unique aspects of
6
our product, and to keep our brand name top of mind.
We historically have supported our multiple-store markets with media
advertising, primarily focused on the use of radio personalities. The new Sleep
Number(R) advertising campaign was introduced early in 2001 to support our
retail stores in selected markets through our first comprehensive multi-media
retail campaign employing prime-time TV, drive-time radio and newspaper support.
We launched the campaign in two pilot markets in January 2001 and in six of our
largest markets in February 2001, simultaneously integrating Sleep Number(R)
signage and messaging into our retail store locations. We are also in the
process of extending the reach of our successful radio personality endorsement
advertising program on a local and national level.
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. The direct marketing channel has relied heavily on nationally
syndicated radio personalities, such as Paul Harvey and Rush Limbaugh, and 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.
The Sleep Number(R) positioning was integrated into all marketing messages
across all channels during the course of 2001. To support our direct marketing
channel, a new 30-minute infomercial, a pool of two-minute short-form television
spots and new print advertisements were created around the Sleep Number(R)
positioning, with positive lead-generation and financial results. Likewise, the
messaging on our web site, in promotional material and on QVC broadcasts was
successfully transitioned to focus on the Sleep Number(R) bed. During recent
months, we have substantially increased our exposure in national cable TV
advertising, using 1-800 advertising as an economical means of increasing
national brand awareness for the Sleep Number(R) bed. Through our dedicated call
center, we are able to provide the inquiring consumer more information, to send
a video and brochure, or to direct the caller to the closest local retail store.
As of January 2002, the Sleep Number Bed by Select Comfort(TM) became a national
sponsor of National Public Radio's Prairie Home Companion show hosted by
Garrison Keillor.
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 29, 2001, we had 328 stores
in 46 states, including 22 leased departments in Bed, Bath and Beyond (BBB)
stores. Our agreement with BBB is scheduled to expire at the end of January
2003, subject to renewal by mutual agreement of the parties. We do not
anticipate that our financial results will be significantly affected by any
decision regarding renewal of this agreement. We anticipate that the number of
stores open will not change significantly in 2002.
STORE ENVIRONMENT. Our retail stores are principally showrooms, averaging
approximately 900 square feet, with several display models from our line of beds
and a full display of our branded accessories. 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 retail
store design in 2000. In connection with the launch of our Sleep Number(R)
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 by
Select Comfort.(TM)" Internal signage in all of our stores
7
nationwide has been changed to support the Sleep Number(R) brand and product
message. We performed minimal remodeling in 2001 as we focused on other
operating needs, but in 2002 we plan to bring many of the remaining 120
older-look stores up to the most current design standard.
Our sales professionals play an important role in creating an inviting and
informative retail environment. These professionals receive extensive training
regarding the features and benefits of our proprietary technology and products,
the overall importance of sleep quality and our newly developed, standardized
selling process. This enables them to more effectively introduce consumers to
our products, emphasize the features and benefits that distinguish Sleep
Number(R) beds from traditional mattresses, determine the consumers' needs,
encourage consumers to experience the comfort and support of Sleep Number(R)
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, 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.
MANAGEMENT AND EMPLOYEES. Our stores are currently organized into four regional
areas and 34 geographic districts, with seven to 12 stores in each district,
depending on geographical dispersion. Each regional sales director oversees
approximately eight or nine 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(R) 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 and
bonuses based on individual and store-wide performance. Early in 2002, we
introduced a redesigned retail sales professional compensation program that is
more heavily based on individual performance and more heavily commission driven,
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.
8
DIRECT MARKETING OPERATIONS
Many consumers' initial exposure to the Sleep Number(R) bed is through our
direct marketing operations. Typically, an interested consumer will respond to
one of our advertisements by calling our toll-free number. On this call, one of
our direct marketing sales professionals captures information from the consumer,
begins the consumer education process, takes orders, or, if appropriate, sends a
thorough information packet or directs the consumer to a nearby retail store.
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 8.2
million inquiries, including customers who have purchased a bed from us.
In 2001, we established a new strategy in our direct marketing channel,
developing a Factory Direct outlet through the mail, allowing us to selectively
market promotionally priced products and factory refurbished product where
allowed by law.
Our direct marketing operations also support our other distribution channels
through referrals, as well as mailings to direct marketing inquiries in selected
markets in advance of retail store openings and events. As our base of retail
stores has expanded, our direct marketing sales professionals have increasingly
been able to refer direct marketing inquiries to a convenient retail store
location, improving the process of converting inquiries into sales and providing
the consumer with a choice of service venues.
E-COMMERCE
Our Web site at SELECTCOMFORT.COM provides consumers with a wide array of useful
information as well as the convenience to order our products online or to call
to order from one of our internet-dedicated sales professionals. Since building
the capability to take online orders in May 1999, our e-commerce channel has
continued to add functionality and content to educate consumers regarding:
- - sleep research and science,
- - our products and the benefits they provide,
- - store locations and other means to contact us and experience our products,
- - customer testimonials,
- - customer service information, and
- - current sales and promotional events.
Our e-commerce channel has also focused on developing relationships with online
shopping malls and other sales portals and affiliates, a strategy expanded in
2001 based on its success in driving traffic.
Our Web site incorporates a look and feel that is attractive and professional,
and which reinforces the Select Comfort(R) brand image. The site allows
functionality to provide a personalized, guided selling process with dynamic
content and a robust online shopping experience.
We also launched two additional sites, SLEEPNUMBER.COM, to support the Sleep
Number(R) brand in the advertising test markets and BEDS.COM, to increase
awareness of the Sleep Number(R) bed and air-supported sleep systems as an
important bed category. SLEEPNUMBER.COM offers visitors the opportunity to
estimate their Sleep Number(R) online and includes a store locator to encourage
them to visit a store to find their Sleep Number(R) on a Sleep Number(R) bed.
BEDS.COM provides tips for choosing the right mattress, comparisons between
types of beds (from innerspring to water), and information on leading brands,
key product features and benefits. The site also provides detailed information
on the Sleep Number(R) bed. Both
9
SLEEPNUMBER.COM and BEDS.COM will become part of our main Web site,
SELECTCOMFORT.COM, during 2002. We have experienced increased site traffic and
on-line sales from these and new Web site strategies in 2001, even while we
directed an increased number of consumers to our retail stores through
prominently placed on-line store locators.
WHOLESALE
We have begun, on a highly selective basis, building relationships with
furniture and mattress retailers. Initiating these wholesale relationships is
expected to provide two key benefits:
- - accelerating the rate at which we can add distribution points with limited
capital requirements, and
- - enabling us to leverage our advertising spending in key markets.
We are evaluating this distribution strategy by pursuing wholesale relationships
with mattress or home furnishing retailers in selected markets.
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 expanded our relationship with Gabberts to
include distribution through its two stores in Dallas. Also in 2001, we
established a wholesaling relationship with Benchmark, a leading home
furnishings retailer in the Kansas City market. In 2002, we plan to pursue
similar wholesaling relationships on a highly selective basis.
In October 2000, we successfully tested the offering of our products on the QVC
television shopping channel with a one-hour program. This test led to additional
successful segments on QVC throughout 2001. In December 2001, the Sleep
Number(R) bed was named QVC's Home Innovation Product Concept of the Year at
QVC's 2001 QStar Awards. We believe that our distribution through QVC has
increased overall consumer awareness of our product and brand in addition to
providing an important sales channel.
CONSUMER EDUCATION AND CUSTOMER SERVICE
We are committed to achieving our goal of world class customer satisfaction and
service. We intend to achieve this goal through a variety of means designed to:
- - educate consumers on the benefits of Select Comfort(R)products,
- - deliver superior quality products,
- - maximize our direct relationship with consumers,
- - maximize convenience for the consumer, and
- - respond quickly to consumer needs and inquiries.
We believe that educating consumers about the features and benefits of our
products is critical to the success of our marketing and sales efforts, and we
devote considerable time and resources to training programs for our sales
professionals. Our retail stores and our web site also provide customers with
the latest information on sleep research and science and the benefits of our
products.
Our controlled distribution channels optimize our direct contact with customers
and allow us to respond quickly to customer service inquiries and enhance
customer satisfaction. Our multiple distribution channels also enhance the
convenience for the consumer to purchase products through a variety of venues.
During 2001, we expanded our in-home delivery, assembly and mattress removal
services to be available at 127 (or approximately 39%) of our retail stores as
of the end of 2001. We plan to ultimately offer this service throughout the
continental United States and through each of our Company-owned distribution
channels in
10
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. The manufacturing operations in South
Carolina and Utah consist of quilting and sewing of the fabric covers for our
beds and final assembly and packaging of mattresses and foundations from
contract manufactured components. In addition, the electrical Firmness Control
System(TM) is assembled from contract manufactured components in our Salt Lake
City plant. In April 2001, we discontinued manufacturing in our Minneapolis
location, and have since that time used this facility to process returns and
warranty claims. We may resume assembly and packing operations in the Minnesota
facility in the future as necessary to meet demand. We believe we have
sufficient capacity in these plants to meet anticipated increases in demand for
the foreseeable future.
We manufacture beds to meet orders rather than to stock inventory, which enables
us to maintain lower levels of inventory. As we expand our home delivery and
assembly services, we may use regional distribution centers that would stock
inventory to fill orders on a more expedited basis. Orders are currently shipped
from one of our manufacturing facilities, 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 System(TM) 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. All of the suppliers who produce unique or proprietary products for
Select Comfort(R) have in place either contingency or disaster recovery plans or
redundant production capabilities in other locations in order to safeguard
against any unforeseen disasters. Select Comfort(R) reviews these plans and
sites on a regular basis to ensure the supplier's ability to maintain
uninterrupted supply of materials and components.
Our proprietary air chambers are produced to our specifications by one Eastern
European supplier under a supply agreement that has been in place since 1994.
Under this agreement, we are obligated to purchase certain minimum quantities.
This agreement is subject to review and renewal on an annual basis. We expect to
continue the relationship with the Eastern European supplier for the foreseeable
future. Alternative production sites have been identified as part of this
supplier's disaster recovery program in the event of any unforeseen disaster
that would impact its ability to maintain uninterrupted supply of 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 22 issued U.S. patents and 5 U.S. patent
11
applications pending. We also hold 13 foreign patents and 22 foreign patent
applications pending.
The name "Select Comfort(R)" 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(R)" and "Sleep Insurance(R)," the
service marks "Comfort Club(R)" and "Sleep Better on Air(R)," and a number of
unregistered marks, including the trademark "The Sleep Number Bed by Select
Comfort(TM)" and the service mark "The Sleep Number Store by Select
Comfort(TM)." 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 were the subject
of the suit. Price Manufacturing was not a part of the settlement. In January of
2002 we obtained a default judgment in our favor against Price Manufacturing in
the amount of $150,000, but we do not believe that our prospects for collection
are good as the defendant does not appear to be financially viable.
COMPETITION
The mattress industry is highly competitive. Participants in the mattress
industry compete primarily on price, quality, brand name recognition, product
availability and product performance, including the perceived levels of comfort
and support provided by a mattress. Our beds compete with a number of different
types of mattress alternatives, including innerspring mattresses, waterbeds,
futons and other air-supported mattresses that are sold through a variety of
channels, including furniture stores, bedding specialty stores, department
stores, mass merchants, wholesale clubs, telemarketing programs, television
infomercials and catalogs. We believe that our success depends in part on
increasing consumer awareness and acceptance of our existing products and the
continuing introduction of product improvements or new products with features or
benefits that 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. Numerous other
manufacturers primarily operating on a regional basis serve the balance of the
mattress market.
A number of companies, including Simmons, one of the four large innerspring
mattress manufacturers, as well as a number of smaller manufacturers, have begun
to offer air beds in recent years. Several of these air bed manufacturers have
increased their presence in the market in recent years. We believe that our
products offer features and benefits that will enable us to compete effectively
against these other air bed and innerspring mattress companies.
Many of these competitors, and in particular the four largest innerspring
mattress 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. There
can be no assurance that any of these competitors 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
12
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 established a reserve in the amount of $1 million to protect
the Bank against potential losses from consumer returns. We have also agreed
that, in the event of any termination of our agreement with the Bank and
replacement of the Bank by an alternative third-party provider of consumer
financing, at the request of the Bank we will purchase the Bank's outstanding
portfolio of customer accounts for a pre-determined formula price.
GOVERNMENTAL REGULATION
Our products and our marketing and advertising practices are subject to
regulation by various federal, state and local regulatory authorities, including
the Federal Trade Commission. The mattress industry also engages in advertising
self-regulation through certain voluntary forums, including the National
Advertising Division of the Better Business Bureau. We are also subject to
various other federal, state and local regulatory requirements, including
federal, state and local environmental regulation and regulations issued by the
U.S. Occupational Safety and Health Administration.
EMPLOYEES
At December 29, 2001, we employed 1,626 persons, including 1,040 retail store
employees, 55 direct marketing employees, 66 customer service employees, 256
manufacturing employees, 45 home delivery employees and 164 management and
administrative employees. Approximately 148 of our employees were employed on a
part-time basis at December 29, 2001. 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.
RECENT FINANCING TRANSACTIONS
In 2001, we completed two significant financing transactions, raising an
aggregate of $16 million to meet our working capital requirements:
SENIOR SECURED CONVERTIBLE NOTES. In a private placement completed in June of
2001, we issued Senior Secured Convertible Notes (the "Notes") in the aggregate
principal amount of $11 million, convertible at a price of $1.00 per share into
an aggregate of 11,000,000 shares of our common stock, together with warrants to
purchase an aggregate of 4,400,000 shares of our common stock at an exercise
price of $1.00 per share. The warrants expire in June of 2011.
The Notes bear interest at the rate of 8% per year, payable in cash on each
anniversary of the issuance of the Notes. The Notes are due and payable in full
after five years, and may only be prepaid with the consent of the holders of 67%
of the principal amount of the outstanding Notes. The Notes are secured by a
lien on substantially all of the Company's and its subsidiaries' assets.
The principal amount of the Notes is convertible into shares of the common stock
of the Company at any time at the option of the
13
holders, at the rate of $1.00 per share of common stock. The principal amount of
the Notes is subject to automatic conversion into shares of the Company's common
stock, at the rate of $1.00 per share of common stock (i) any time after the
first anniversary of the issuance of the Notes, provided that the market price
of the common stock has equaled or exceeded $4.00 per share (as adjusted for
stock splits, stock dividends, recapitalizations and the like) for a period of
at least 10 out of 20 consecutive trading days after the first anniversary or
(ii) in the event that the holders of at least 67% of the outstanding principal
amount of the Notes consent to such conversion.
The conversion price of the Notes is subject to proportional adjustment for
stock splits, stock dividends, recapitalizations and the like. The conversion
price of the Notes is also subject to standard antidilution provisions to
protect the holders of the Notes in the event of the issuance by the Company of
shares of common stock or rights to purchase shares of common stock below the
effective conversion price. If triggered, these antidilution provisions would
result in the downward adjustment of the conversion price and a corresponding
increase in the number of shares issuable upon conversion of the Notes. The
warrants issued in connection with the Notes contain similar antidilution
provisions.
The Notes and the related warrants were issued pursuant to a Note Purchase
Agreement containing customary representations, warranties, covenants and
conditions. Without limiting the foregoing, the Note Purchase Agreement provides
that, subject to certain exceptions, as long as the Notes remain outstanding,
consent of the holders of 67% of the Notes and warrants, would be required for:
- - Any amendment to the articles or bylaws of the Company that would have an
adverse impact on the Notes;
- - Any redemption of any shares of capital stock of the Company;
- - Any payment of a dividend on any shares of capital stock of the Company;
- - Any merger, other corporate reorganization or sale of control of the
Company, or any transaction in which all or any substantial part of the
assets of the Company are sold or licensed on an exclusive basis;
- - Any liquidation, dissolution or winding up of the Company;
- - The incurrence by the Company of debt (other than up to $5 million of
senior debt financing);
- - The granting by the Company of liens on its assets (except for certain
permitted liens); and
- - The making by the Company of any loans, investments or guaranties.
The Note Purchase Agreement contains customary events of default, upon which (i)
the interest rate on the Notes would be increased by 3% per year and (ii) the
holders of the Notes would have the right to accelerate payment of the Notes.
Events of default include, without limitation, payment defaults, covenant
defaults, material misrepresentations, cross-defaults, bankruptcy and
insolvency, and change in control of the Company.
Except in the event of a public offering of Common Stock, or the grant or
exercise of options to or by employees, directors or consultants of the Company,
or the exercise or conversion of warrants or convertible securities existing as
of the date of issuance of the Notes and certain other exceptions, the holders
of the Notes, for a period of five years, have a 15-day right of first refusal
on the sale of any additional shares of capital stock or rights to purchase
capital stock of the Company to maintain their pro rata ownership.
The holders of the Notes and related warrants are entitled to certain demand and
incidental (or
14
"piggyback") registration rights that are exercisable beginning in June of 2002.
These registration rights give the holders certain customary rights to have the
shares of common stock issuable upon conversion of the Notes or exercise of the
warrants registered by the Company for resale under applicable federal and state
securities laws. See "--Certain Risk Factors-- Dilution from Recent Financing
Transactions; Shares Eligible for Future Sale."
SENIOR SECURED LOAN. In September 2001, we obtained a senior secured loan from
Medallion Capital, Inc. in the amount of $5 million at an interest rate of 12%
per annum (the "Senior Secured Loan"). Interest only is payable monthly over the
first two years. Interest and principal is payable monthly over years three
through five, based on a ten-year amortization rate. The remaining principal
balance is payable in full at the end of five years. This loan is secured by a
first priority security interest in substantially all of the Company's and its
subsidiaries' assets. The lender also received common stock purchase warrants to
acquire up to 922,819 shares of our common stock at an exercise price of $1.02
per share, subject to standard antidilution protections in the event of the
issuance by the Company of shares or rights to purchase shares at a price below
the exercise price of the warrants. The warrants expire in September 2006. The
shares issuable upon exercise of the warrants are also entitled to certain
incidental (or "piggyback") registration rights. These registration rights give
the holders certain customary rights to have the shares registered by the
Company for resale under applicable federal and state securities laws. See
"--Certain Risk Factors-- Dilution from Recent Financing Transactions; Shares
Eligible for Future Sale."
Under the Loan Agreement pursuant to which the Senior Secured Loan was made, the
Company is subject to certain financial and other covenants and customary
default terms giving the lender the right to accelerate payment of the Senior
secured Loan or to increase the interest rate to 19% per annum. The Company is
currently, and expects to remain, in full compliance with the covenants and
other provisions of the Loan Agreement.
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 without limitation
the following:
HISTORY OF OPERATING LOSSES; UNCERTAIN PROFITABILITY. Since inception, we have
incurred substantial operating losses. Though we achieved profitable operations
in the second half of 2001, there can be no assurance that our business and
growth strategy will enable us to sustain profitability on a quarterly or annual
basis in future periods. Our future operating results will depend on a number of
factors, including without limitation:
- - Our ability to continue to successfully execute the strategic initiatives
outlined above under "--Business and Growth Strategy,"
- - The efficiency and effectiveness of our Sleep Number(R) campaign and other
marketing programs in building product and brand awareness, driving traffic
to our points of sale and in increasing sales,
- - The level of consumer acceptance of our products,
- - Our ability to continue to realize the benefits of the cost savings
initiatives outlined above under "--Business and Growth Strategy,"
- - Our ability to cost-effectively sell our products through wholesale or
alternative distribution channels in volumes sufficient to drive growth and
leverage our cost structure and advertising spending,
15
- - Our ability to realize increased sales and greater levels of profitability
through our retail stores,
- - Our ability to cost-effectively close additional underperforming or
unprofitable store locations, or to negotiate rent concessions,
- - Our ability to hire, train, manage and retain qualified retail store
management and sales professionals,
- - Our ability to continuously improve our products to achieve new and
enhanced consumer benefits, better quality and reduced costs,
- - Our ability to maintain cost-effective production and delivery of our
products,
- - Our ability to successfully expand our home delivery, assembly and mattress
removal capability on a cost-effective basis,
- - The ability of various third-party providers of delivery, assembly and
mattress removal services to provide quality services on a cost-effective
basis,
- - Our ability to successfully identify and respond to emerging trends in the
mattress industry,
- - The level of competition in the mattress industry, and
- - 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 sustained 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.
EFFECTIVENESS AND EFFICIENCY OF ADVERTISING EXPENDITURES. Advertising
expenditures were $36.5 million in 2001, $36.1 million in 2000 and $44.4 million
in 1999, respectively. Our overall marketing spending is being managed 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 without limitation our ability to:
- - create greater awareness of our products and brand name,
- - determine the appropriate creative message and media mix for future
advertising expenditures,
- - effectively manage advertising costs (including creative and media) in
order to maintain acceptable costs per inquiry, costs per order and
operating margins, and
- - convert inquiries into actual orders.
No assurance can be given that our planned advertising expenditures will result
in increased sales, will generate sufficient levels of product and brand name
awareness or that we will be able to manage our advertising expenditures on a
cost-effective basis.
FLUCTUATIONS IN COMPARABLE STORE SALES RESULTS. Our comparable store sales
results have fluctuated significantly in the past and these fluctuations are
likely to continue. Stores enter the comparable store calculation in their 13th
full month of operation. Our comparable store sales (decreases)/increases were
(3.8)% for 2001, 0.2% for 2000, 4.7% for 1999 and 17.9% for 1998. Our comparable
store sales results have fluctuated significantly from quarter to quarter with
(decreases)/increases ranging from (7.7)% to 36% on a quarterly basis for 1997
through 2001. There can be no assurance that our comparable store sales results
will not fluctuate significantly in the future.
16
A variety of factors affect our comparable store sales results, including
without limitation:
- - levels of consumer awareness of our products, brand name and store
locations,
- - levels of consumer acceptance of our existing and new products,
- - higher levels of sales in the first year of operations as each successive
class of new stores is opened,
- - comparable store sales performance in prior periods,
- - the maturation of our store base,
- - the amount, timing and relative success of promotional events, advertising
expenditures, new product introductions and product line extensions,
- - the quality and tenure of store-level managers and sales professionals,
- - the amount of competitive activity,
- - the evolution of store operations,
- - changes in the sales mix between our distribution channels, and
- - general economic conditions and consumer confidence.
Decreases in comparable store sales results could have a material adverse effect
on our business, financial condition and operating results.
QUARTERLY FLUCTUATIONS AND SEASONALITY. Our quarterly operating results may
fluctuate significantly as a result of a variety of factors, including without
limitation:
- - increases or decreases in comparable store sales,
- - the timing, amount and effectiveness of advertising expenditures,
- - any increases in return rates,
- - the timing of new store openings and related expenses,
- - competitive factors,
- - net sales contributed by new stores,
- - any disruptions in third-party delivery services, and
- - general economic conditions and consumer confidence.
Our business is also subject to some seasonal influences, with lower seasonal
sales in the second quarter and heavier concentrations of sales during the
fourth quarter holiday season due to higher mall traffic.
The level of spending related to sales and marketing expenses and new store
opening costs cannot be adjusted quickly and is based, in significant part, on
our expectations of future customer inquiries and net sales. If there is a
shortfall in expected net sales or in the conversion rate of customer inquiries,
we may be unable to adjust our spending in a timely manner and our business,
financial condition and operating results may be materially adversely affected.
Our results of operations for any quarter are not necessarily indicative of the
results that may be achieved for a full year or any future quarter.
RELIANCE UPON PROVIDER OF CONSUMER CREDIT FACILITY. Through a private label
consumer credit facility provided by Conseco Bank, Inc. (the "Bank"), we offer
our qualified customers an unsecured revolving credit arrangement to finance
purchases from us. The Bank sets the rates, fees and all other terms and
conditions of the customer accounts, including collection policies and
procedures, and is the owner of the accounts. In connection with all purchases
financed under these arrangements, the Bank
17
pays us an amount equal to the total amount of such purchases, net of
promotional related discounts. We have established a reserve in the amount of $1
million as collateral to protect the Bank against potential losses from consumer
returns. 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.
The Bank has recently experienced financial and liquidity issues which could
jeopardize the ability of the Bank to continue to provide consumer credit
financing for our customers. In that event, the Company would seek to secure
consumer credit financing from other sources, but it may not be possible to
secure such arrangements without some delay or on the same or better terms than
have been available from the Bank. 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, or any delay in
securing replacement credit sources, could have a material adverse effect on our
business, sales, results of operations or financial condition.
The Bank's financial and liquidity issues could also jeopardize the $1 million
reserve that we have provided as collateral to protect the bank against
potential losses from consumer returns. As collateral, this reserve should not
be construed as an asset of the Bank subject to the claims of its creditors. No
assurance can be given, however, that any bankruptcy or other court may not take
a contrary view, or that the Company may not encounter expenses or delays in
recovering all or any portion of this reserve account.
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 2002 (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 without limitation:
- - political instability resulting in disruption of trade,
- - existing or potential duties, tariffs or quotas that may limit the quantity
of certain types of goods that may be imported into the United States or
increase the cost of such goods, and
- - any significant fluctuation in the value of the dollar against foreign
currencies.
With the exception of our air chambers, we have no long-term purchase contracts
or other contractual assurances of continued supply, pricing or access to
components. The inability or failure of one or more key suppliers to supply
components, the loss of one or more key suppliers or a material change in our
purchase terms could have a material adverse effect on our business, financial
condition and operating results.
RELIANCE UPON CARRIERS. Historically, we have relied almost exclusively on UPS
for delivery of our products to customers. For a significant portion of the
third quarter of 1997, UPS was unable to deliver our products within acceptable
time periods due to a labor strike, causing delays
18
in deliveries to customers and requiring us to use alternative carriers. UPS
will be in labor negotiations again in 2002, and no assurance can be given that
UPS will be able to avert labor difficulties or that UPS will not otherwise
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(R) bed and obtain a refund of the purchase price.
Effective as of May 29, 2001, we shortened this in-home trial period from 90
nights to 30 nights. We believe that a 30-night trial period is competitive
within our industry and sufficient to enable consumers to experience the
features and benefits of our products. Any significant decrease in sales volumes
or increase in return rates resulting from this change in policy 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.
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 the market will accept any such
products. 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. Four large manufacturers of innerspring mattresses dominate
the U.S. mattress market. 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
19
property litigation, which could result in substantial cost to and diversion of
effort by management, may be necessary to enforce our patents, to protect our
trade secrets and proprietary technology or to defend us against claimed
infringement of the rights of others and to determine the scope and validity of
the proprietary rights of others. There can be no assurance that we would
prevail in any such litigation or that, if it is unsuccessful, we would be able
to obtain any necessary licenses on reasonable terms or at all.
COMPETITION. The mattress industry is highly competitive. Our Sleep Number(R)
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. Numerous other
manufacturers, primarily operating on a regional basis, serve the balance of the
mattress market.
A number of companies, including Simmons, one of the four large innerspring
mattress manufacturers, as well as a number of smaller manufacturers, have begun
to offer air beds in recent years. Several of these air bed manufacturers have
increased their presence in the market in recent years. We believe that our
products offer features and benefits that will enable us to compete effectively
against these other air bed and innerspring mattress companies.
Many of these competitors, and in particular the four largest innerspring
mattress 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. There
can be no assurance that any of these competitors 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(R) 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
20
"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. In the
event of any change in any of the foregoing that did not enable us to continue
to meet these standards, the Nasdaq Stock Market could take action to delist our
stock from trading on the Nasdaq Stock Market.
In the event that our common stock were to be delisted from the Nasdaq National
Market and we were ineligible for listing on the Nasdaq SmallCap Market, our
common stock would thereafter likely be quoted in the "over-the-counter" market
and eligible to trade on the OTC bulletin board. If our common stock traded on
the OTC bulletin board, trading, if any, would be subject to the "penny stock"
rules under the Securities Exchange Act of 1934. Consequently, the liquidity of
our common stock could be impaired, not only in the number of shares that could
be bought and sold, but also through delays in the timing of the transactions,
reductions in the security analysts' and the news media's coverage of our stock,
and lower prices for our common stock than it might otherwise attain.
DILUTION FROM RECENT FINANCING TRANSACTIONS; SHARES ELIGIBLE FOR FUTURE SALE.
Investors in the financing transactions completed by the Company in 2001 and
described above under "--Recent Financing Transactions," have rights to acquire
approximately 16.6 million shares of the common stock of the Company at an
effective price of $1.00 (or slightly above $1.00 for some of these shares).
Commencing in June of 2002, the holders of the rights to acquire these shares
also have certain registration rights permitting them to require the Company to
register such shares with the SEC for resale in the public market. In addition,
many of these shares will be eligible for resale in the public market, subject
to the limitations of Rule 144 under the Securities Act of 1933 beginning in
June of 2002. In addition, there are outstanding options, warrants and other
rights to acquire approximately 6.6 million shares of the Common Stock at
various prices ranging from $0.45 to $28.63, with a weighted average exercise
price of $4.88. The vast majority of these shares are eligible for resale in the
public market upon issuance pursuant to an effective registration statement or
are entitled to registration rights requiring the Company to register such
shares for resale in the public market. All such shares, if issued, will be
eligible for resale in the public market either without restriction or subject
to the limitations of Rule 144 under the Securities Act of 1933. The sale of
substantial amounts of these shares in the public market could adversely affect
the market price of the Company's common stock and could impair the Company's
ability to raise capital in the future through the sale of its equity
securities.
In addition to the potential impact on the market price of the Company's common
stock from the sale of these shares in the public market, the existence of these
rights to acquire shares are taken into account by the Company in determining
earnings per share. Under the treasury stock method of calculating earnings per
share, any rights to acquire shares at a price below the current market price
are assumed to be exercised and the proceeds used to buy back shares at the
current market price. As a result, the existence of these rights to acquire
shares of the Company's common stock will adversely impact the Company's
earnings per share.
VOLATILITY IN MARKET PRICE OF COMMON STOCK. The market price of our common stock
has fluctuated significantly in the past and may do so in the future. The market
price of our common stock may fluctuate as a result of a variety of factors,
many of which are outside of our control, including without limitation the
following factors:
- - variations in quarterly operating results;
- - changes in estimates by securities analysts;
- - announcements of significant events;
21
- - additions or departures of key personnel; and
- - changes in market valuations of companies in our industry.
ITEM 2. PROPERTIES
We currently lease all of our existing retail store locations and expect that
our policy of leasing, rather than owning, will continue as we expand. Our store
leases generally provide for an initial lease term of 7 to10 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 have subleased 20,000 square feet of our Minneapolis
manufacturing space to a subtenant through September 2002. 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 seeking a sublessee for this
space.
ITEM 3. LEGAL PROCEEDINGS
In June of 1999, the Company and certain of its former officers and directors
were named as defendants in a class action lawsuit filed in U.S. District Court
in Minnesota. The suit, filed on behalf of purchasers of the Company's common
stock between December 4, 1998 and June 7, 1999, alleges that the Company and
the named former directors and officers failed to disclose or misrepresented
certain information concerning the Company in violation of federal securities
laws. In March of 2000, the same defendants were named in another class action
lawsuit asserting factual allegations identical to the first suit. Neither of
the suits specified an amount of damages claimed. The U.S. District Court
consolidated the two class actions in July of 2000.
In September of 2001, the consolidated case was certified to proceed as a class
action on behalf of purchasers of the Company's common stock issued under or
traceable to the Company's initial public offering prospectus dated December 4,
1998 and purchasers of the Company's common stock in the open market during the
period from December 4, 1998 through June 7, 1999.
The Company believes that the suit is without merit and intends to vigorously
defend the claims. Discovery has been underway since mid-2001.
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 $4,591
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.
22
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
Our executive officers, their ages and the offices held, as of March 30,
2002, are as follows:
NAME AGE TITLE
- --------------------- ---- ---------------------------------------------------
William R. McLaughlin 45 President and Chief Executive Officer
Keith C. Spurgeon 47 Senior Vice President of Sales
Noel F. Schenker 48 Senior Vice President, Marketing and New
Business Development
Gregory T. Kliner 64 Senior Vice President of Operations
James C. Raabe 42 Senior Vice President and Chief Financial Officer
Mark A. Kimball 43 Senior Vice President, Human Resources and Legal,
General Counsel and Secretary
Michael J. Thyken 40 Senior Vice President and Chief Information Officer
Tracey T. Breazeale 35 Senior Vice President, Special Projects
Information regarding the business experience of our executive officers is
set forth below.
WILLIAM R. MCLAUGHLIN joined Select Comfort(R) in March 2000 as President and
Chief Executive Officer. From December 1988 to March 2000, Mr. McLaughlin served
as an executive of Pepsico Foods International in various capacities, including
from September 1996 to March 2000 as President of Frito Lay Europe, Middle East
and Africa, and from June 1993 to June 1996 as President of Grupo Gamesa, a
cookie and flour company based in Mexico.
KEITH C. SPURGEON joined Select Comfort(R)as Senior Vice President, Sales in
February, 2002. Mr. Spurgeon was Chairman of the Board and Chief Executive
Officer of Zany Brainy, a retailer of educational toys and books for children,
from 1996 to 2000. He served as Vice President-Asia/Australia at Toys R Us, Inc.
from 1991 to 1996 after holding various management positions from 1986 to 1991.
Mr. Spurgeon began his career at Jewel Food Stores.
NOEL F. SCHENKER joined Select Comfort(R) as Senior Vice President, Marketing
and New Business Development in November, 2000. Ms. Schenker served as Senior
Vice President of Marketing and Strategic Planning at Rollerblade, Inc., from
1992 to 1996, and as an independent consultant from 1996 to 2000. She was with
The Pillsbury Company from 1981 to 1992, serving as Vice President of Marketing
for the Green Giant business. Since 1996, she also has served on the Board of
Directors and Executive Committee of the Fortis Financial Group's Mutual Funds.
GREGORY T. KLINER has served as Senior Vice President of Operations of Select
Comfort(R) since August 1995. From October 1986 to August 1995, Mr. Kliner
served as Director of Operations of the Irrigation Division for The Toro
Company, a manufacturer of lawn care and snow removal products and irrigation
systems.
JAMES C. RAABE has served as Chief Financial Officer of Select Comfort(R)since
April 1999. From September 1997 to April 1999, Mr. Raabe served as Controller of
Select Comfort(R). From
23
May 1992 to September 1997, Mr. Raabe served as Vice President - Finance of
ValueRx, Inc., a pharmacy benefit management provider. Mr. Raabe held various
positions with KPMG LLP from August 1982 to May 1992.
MARK A. KIMBALL joined Select Comfort(R) in May 1999 as Senior Vice President,
Chief Administrative Officer, General Counsel and Secretary. In 2000, he was
named Senior Vice President, Human Resources and Legal. For more than five years
prior to joining Select Comfort(R), Mr. Kimball was a partner in the law firm of
Oppenheimer Wolff & Donnelly LLP practicing in the area of corporate finance.
MICHAEL J. THYKEN joined Select Comfort(R)in July 2000 as Vice President and
Chief Information Officer. During 1999, Mr. Thyken was Group Director of
Application Development at Jostens, a Minneapolis based manufacturer of
scholastic recognition products. From 1994 to 1999, Mr. Thyken was Director of
Technical Services for Target Stores. From 1984 to 1994, Mr. Thyken served in
various positions with IBM Corporation.
TRACEY T. BREAZEALE was hired as Senior Vice President of Strategic Planning and
Branding of Select Comfort(R) in July 1999. In February 2001, Ms. Breazeale's
work schedule was reduced to 25% of full time, and her title was changed to
Senior Vice President, Special Projects. Ms. Breazeale was with the Boston
Consulting Group from October 1993 to July 1999, initially as a consultant and
the last three years as a manager, where she specialized on strategic and
marketing oriented projects for retail and consumer product companies.
24
PART II
--------------------
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Our common stock trades on the Nasdaq Stock Market under the symbol SCSS. The
quarterly high and low sales prices for the common stock, as reported by the
Nasdaq Stock Market, for the two most recent fiscal years follows in the table
below. These quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission, and may not necessarily represent actual transactions.
FOURTH THIRD SECOND FIRST
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
FISCAL 2001
High $2.08 $1.62 $1.65 $2.44
Low $0.90 $0.84 $0.50 $1.25
------- ------- ------- -------
FISCAL 2000
High $2.44 $3.50 $5.50 $6.50
Low $0.96 $1.44 $2.38 $4.38
------- ------- ------- -------
NUMBER OF RECORD HOLDERS; DIVIDENDS
As of March 22, 2002, there were 175 record holders of our common stock. We did
not declare or pay any cash dividends on the common stock during the fiscal
years ended December 29, 2001 or December 30, 2000 and do not anticipate paying
any cash dividends on our common stock in the foreseeable future.
25
ITEM 6. SELECTED FINANCIAL DATA
The data presented below has been derived from the Company's consolidated
financial statements and should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
the Company's consolidated financial statements and notes thereto included in
this Annual Report on Form 10-K:
YEAR ENDED (1)
--------------
DEC. 29, DEC. 30, JAN. 1, JAN. 2, JAN. 3, DEC. 28, DEC. 30, DEC. 31,
2001 2000 2000 1999 1998 1996 1995 1994
--------- --------- --------- --------- --------- --------- --------- ---------
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $261,687 $270,077 $273,767 $246,269 $184,430 $102,028 $68,629 $30,472
Gross margin 171,611 171,153 178,660 161,082 117,801 63,507 39,796 19,420
Operating income (loss)(2) (10,602) (25,970) (14,793) 11,445 1,996 (3,764) (4,589) (3,297)
Net income (loss) before extraordinary item (12,066) (37,214) (8,204) 6,636 (2,846) (3,685) (4,560) (3,371)
Net income (loss) (12,066) (37,214) (8,204) 5,195 (2,846) (3,685) (4,560) (3,371)
Net income (loss) per share - diluted (3):
Net income (loss) per share before
extraordinary item (0.66) (2.09) (0.45) 0.28 (1.59) (2.61) (3.16) (2.65)
Net income (loss) per share (0.66) (2.09) (0.45) 0.19 (1.59) (2.61) (3.16) (2.65)
Weighted average common shares - diluted 18,157 17,848 18,300 15,928 2,353 1,733 1,444 1,274
Dividends paid per share - - - - - - - -
SELECTED OPERATING DATA:
Stores open at period-end (4) 328 333 341 264 200 143 68 35
Average square footage of stores open
during period (5) 941 913 893 895 866 768 703 642
Sales per square foot (5) 666 697 721 742 666 622 611 442
Average store age (in months at period end) 52 41 31 27 22 15 15 12
Comparable store sales (decrease)
increase (6) (3.8)% 0.2% 4.7% 23.5% 27.3% 26.1% 59.8% 57.6%
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents $16,375 $1,498 $7,441 $45,561 $12,670 $2,422 $6,862 $3,770
Marketable securities - 3,950 20,129 - - - - -
Working capital (3,739) (12,431) 14,470 42,249 757 (7,809) 2,734 2,614
Total assets 67,436 64,672 95,865 106,234 57,241 29,794 23,838 14,243
Long-term debt, less current maturities 17,109 2,322 36 29 19,511 1,162 40 77
Mandatorily redeemable preferred stock - - - - 27,612 27,612 27,625 18,669
Total common shareholders' equity (deficit) 6,772 16,600 52,872 70,691 (21,038) (18,216) (14,779) (10,592)
-------------------
(1) Except for the year ended January 3, 1998, which included 53 weeks, all years presented included 52 weeks.
(2) Includes charges for impairment of assets of $1.8 million, $1.9 million and $1.5 million for the year ended December 29, 2001,
December 30, 2000 and January 1, 2000, respectively. See Note 5 to the Consolidated Financial Statements.
(3) See Note 10 of Notes to Consolidated Financial Statements.
(4) Includes Select Comfort(R) stores operated in leased departments within larger retail stores (22 at December 29, 2001, 25 at
December 30, 2000,45 at January 1, 2000, 14 at January 2, 1999 and one at January 3, 1998).
(5) For stores open during the entire period indicated.
(6) Stores enter the comparable store calculation in their 13th full month of operation. The number of comparable stores used to
calculate such data were 317, 314, 262, 199, 138, 65, 32 and 13 for fiscal 2001, 2000,1999, 1998, 1997, 1996, 1995 and 1994
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.
26
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD LOOKING STATEMENTS
THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ WITH THE CONSOLIDATED
FINANCIAL STATEMENTS AND RELATED NOTES. THIS DISCUSSION CONTAINS FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. 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," "PROJECTS," "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
DEPENDING ON A VARIETY OF FACTORS INCLUDING THOSE SET FORTH ABOVE IN PART I,
ITEM 1 UNDER THE HEADING TITLED "CERTAIN RISK FACTORS."
OVERVIEW
Select Comfort(R) is the leading manufacturer and retailer of premium quality,
innovativE adjustable-firmness air-beds and other sleep related products.
We generate revenue by selling our products through four complementary
distribution channels. Three of these channels, retail, direct marketing and
e-commerce, are company owned and sell directly to consumers, while our
wholesale channel sells to leading furniture retailers and the QVC shopping
channel. We record revenue at the time product is shipped to the customer,
except when mattresses are delivered and set up by our home delivery employees,
in which case revenue is recorded at the time the mattress is delivered and set
up in the home. We reduce sales at the time revenue is recognized for estimated
returns. This estimate is based on historical return rates, which are reasonably
consistent from period to period. If actual returns vary from expected rates,
revenue in future periods is adjusted, which could have a material adverse
effect on future results of operations.
The proportion of our total net sales, by dollar volume, from each of these
channels during the last three fiscal years is summarized as follows:
YEAR ENDED
----------------------------
DEC. 29, DEC. 30, JAN. 1,
2001 2000 2000
-------- -------- --------
Stores 78% 78% 72%
Direct Call Center 15% 18% 27%
E-commerce 3% 3% 1%
Wholesale 4% - -
Our Company-owned retail store locations during the last three fiscal years are
summarized as follows:
YEAR ENDED
----------------------------
DEC. 29, DEC. 30, JAN. 1,
2001 2000 2000
-------- -------- --------
Beginning of period 333 341 264
Opened 11 19 79
Closed (16) (27) (2)
-------- -------- --------
End of period 328 333 341
======== ======== ========
Company-owned stores include leased space within 22 Bed, Bath & Beyond stores as
of December 29, 2001, 25 at December 30, 2000 and 45 at January 1, 2000. We
anticipate that the number of stores open will not change significantly in 2002.
Comparable store sales (decreased) increased by (3.8)%, 0.2% and 4.7% in 2001,
2000 and 1999, respectively. Sales volumes and comparable store sales were
negatively affected by the downturn in economic conditions during 2001 as
reflected by consumer confidence measures and lower volumes of mall traffic, and
by world events late in the year. Sales are subject to some seasonal influences,
with lower sales levels in the second quarter and heavier concentrations of
sales during the fourth quarter holiday season due to increased mall traffic.
Cost of sales consists of costs associated with purchasing materials and
manufacturing our
27
products. Cost of sales also includes estimated costs to service warranty claims
of customers. This estimate is based on historical claim rates during the
warranty period. Because this estimate covers an extended period of time, a
revision of estimated claim rates could result in a significant adjustment of
estimated future costs of fulfilling warranty commitments, which could have a
material adverse effect on future results of operations. Our gross margins are
dependent on a number of factors, and may fluctuate from quarter to quarter.
These factors include the mix of products sold, the level to which we offer
promotional discounts to purchase our products, the cost of materials and
manufacturing and the mix of sales between wholesale and company owned
distribution channels. Sales directly to consumers through company owned
channels generally generate higher gross margins than sales through our
wholesale channels because we capture both the manufacturer and retailer
margins.
Sales and marketing costs include advertising and media production, other
marketing and selling materials such as brochures, videos, customer mailings and
in-store signage, sales compensation and store occupancy costs, and customer
service and shipping and delivery costs to customers. Store opening costs are
expensed as incurred and advertising costs are expensed at the time the
advertising is run. We evaluate our long-lived assets, including store
leaseholds and fixtures, based on expected cash flows through the remainder of
the lease term after considering the potential impact of planned operational
improvements and marketing programs. Expected cash flows may not be realized,
which could cause long-lived assets to become impaired in future periods and
could have a material adverse effect on future results of operations. Store
assets are written off when we believe these costs will not be recovered through
future operations.
Advertising spending during the last three fiscal years is summarized as follows
(in 000's):
YEAR ENDED
----------------------------
DEC. 29, DEC. 30, JAN. 1,
2001 2000 2000
-------- -------- --------
Advertising $36,516 $36,111 $44,446
Future advertising expenditures will depend on the effectiveness and efficiency
of the advertising in creating awareness of our products and brand name,
generating consumer inquiries and driving consumer traffic to our points of
sale. We anticipate that full year advertising spend levels in 2002 will be
slightly higher than in 2001.
General and administrative costs include all other costs not directly related to
manufacturing, selling or marketing.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, our results of
operations expressed as percentages of net sales. Percentage amounts may not
total due to rounding.
PERCENTAGE OF NET SALES
YEAR ENDED
DEC. 29, DEC. 30, JAN. 1,
2001 2000 2000
-------- -------- --------
Net sales 100.0% 100.0% 100.0%
Cost of sales 34.4 36.6 34.7
-------- -------- --------
Gross margin 65.6 63.4 65.3
-------- -------- --------
Operating expense:
Sales and marketing 59.4 61.4 59.4
General and administrative 9.5 10.8 10.7
Store closing/impairments 0.7 0.7 0.5
-------- -------- --------
Total operating expenses 69.6 73.0 70.7
-------- -------- --------
Operating loss (4.0) (9.6) (5.4)
Other income (expense), net (0.6) 0.1 0.6
-------- -------- --------
Loss before income taxes (4.6) (9.5) (4.8)
Income tax expense (benefit) 0.0 4.3 (1.8)
-------- -------- --------
Net loss (4.6)% (13.8)% (3.0)%
======== ======== ========
For 2001, our goal was to return to profitability, driven by the following
strategic priorities:
- - Building consumer awareness,
- - Rightsizing our cost structure,
- - Expanding profitable distribution, and
- - Improving product quality, innovation and service levels.
During 2001 we implemented initiatives designed to bring our cost structure in
line with our sales volumes, with the ultimate objective of
28
making our core bed business profitable at sales volumes equal to those achieved
in 2000.
These cost reduction measures included:
- - Closing one of three manufacturing plants, one of two call centers and
consolidating two administrative offices,
- - Closing over 40 under-performing stores,
- - Reducing overall staffing, including approximately 20% of field sales
support and approximately 12% of administrative staffing,
- - Discontinuing our catalog sales channel and deferring the rollout of our
sofa sleeper product,
- - Restructuring our promotional programs and developing more efficient
programs to utilize in-store signage and customer fulfillment materials,
and
- - Developing a program to resell returned products to targeted markets.
The successful implementation of these measures is a key reason why we returned
to profitability in the second half of 2001.
Quarterly and annual operating results may fluctuate significantly as a result
of a variety of factors, including increases or decreases in comparable store
sales, the timing, amount and effectiveness of advertising expenditures, any
changes in sales return rates or warranty experience, the timing of new store
openings and related expenses, net sales contributed by new stores, competitive
factors, any disruptions in supplies or third-party delivery services and
general economic conditions and consumer confidence. 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. As a result, 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.
COMPARISON OF FISCAL 2001 AND FISCAL 2000
NET SALES
Net sales in 2001 decreased 3.1% to $261.7 million from $270.1 million in 2000
due primarily to a decrease in mattress unit sales. The average selling price
per mattress set declined slightly as a result of lower selling prices for
products sold to QVC and wholesale customers, slightly offset by higher average
selling prices in our core product line. The components of the decrease in net
sales dollars were (i) an $8.5 million decrease in sales from Company-owned
retail stores, including a decrease in comparable store sales of $7.7 million,
(ii) an $8.6 million decrease in direct marketing sales, offset by (iii) a $9.1
million increase in net sales from the Company's wholesale channel and (iv) $0.1
million increase from the Company's e-commerce channel.
GROSS MARGIN
Gross margin in 2001 increased to 65.6% from 63.4% in 2000 primarily due to
lower cost promotional offerings and reductions in manufacturing costs resulting
from reduced warranty costs and savings in processing returned product.
SALES AND MARKETING
Sales and marketing expenses in 2001 decreased 6.2% to $155.6 million from
$166.0 million in 2000, and decreased as a percentage of net sales to 59.4% in
2001 from 61.4% in 2000. The $9.4 million decrease was primarily due to lower
sales, reductions in media expenditures and promotional and fulfillment
materials, and reduced sales support staffing, partially offset by increases in
media production expense. The reduction in sales and marketing expenses as a
percentage of net sales was primarily due to reduced promotion and fulfillment
expenses and reduced sales support staffing, partially offset by increased media
production expenses.
29
GENERAL AND ADMINISTRATIVE
General and administrative expenses decreased 15.1% to $24.8 million in 2001
from $29.2 million in 2000. The $4.4 million decrease was primarily due to
staffing reductions, reduced occupancy expense resulting from the consolidation
of our two corporate offices, and severance costs associated with a reduction in
force in 2000.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense in 2001 was $1.8 million compared to
$2.0 million in 2000. In 2001, the expense included $1.0 million related to
store closures and $0.8 million related primarily to the write-off of unusable
fixtures for merchandising of our sleeper sofa products and for unusable leased
space. In 2000, this expense included $1.4 million related to the relocation of
our headquarter offices and web development costs and $0.6 million related to
store closures.
OTHER INCOME (EXPENSE), NET
Other income (expense) changed $1.8 million to approximately $1.5 million of
other expense in 2001 from $0.3 million in other income in 2000. The change is
primarily due to $1.4 million of interest expense from long-term debt and lower
interest income due to lower cash levels in 2001.
INCOME TAX EXPENSE (BENEFIT)
Income tax expense decreased $11.6 million to $0 in 2001 from $11.6 million in
2000. Income tax expense decreased as a result of not recognizing an income tax
benefit from operating losses in 2001 and from the write off of net deferred tax
assets in 2000.
COMPARISON OF FISCAL 2000 AND FISCAL 1999
NET SALES
Net sales in 2000 decreased 1.3% to $270.1 million from $273.8 million in 1999.
The components of the decrease in net sales were (i) a $22.0 million increase
from the opening of 19 new retail stores during 2000 and the full year impact of
77 stores opened in 1999, (ii) a $0.4 million increase from a 0.2% increase in
comparable store sales, (iii) a $5.2 million increase in net sales from the
Company's e-commerce channel, offset by (iv) a $24.3 million decrease in direct
marketing sales and (v) a $7.0 million decrease due to the elimination of our
road show distribution channel.
GROSS MARGIN
Gross margin in 2000 decreased to 63.4% from 65.3% in 1999 primarily due to
larger discounts on promotional offerings, increased costs from processing
returned product and increased costs from the rollout of our new foundation
product, partially offset by a price increase for some of our products.
SALES AND MARKETING
Sales and marketing expenses in 2000 increased 2.0% to $166.0 million from
$162.7 million in 1999, and increased as a percentage of net sales to 61.4% in
2000 from 59.4% in 1999. The $3.3 million increase was primarily due to (i)
higher occupancy expense related primarily to rent and depreciation expense,
(ii) higher wages and compensation expense and (iii) higher freight costs. Sales
and marketing expenses increased as a percentage of net sales primarily due to
(i) lower direct marketing sales and (ii) selling expenses in new stores
increasing at a greater rate than net sales and the expenses associated with the
rollout of our sofa sleeper product, partially offset by (iii) a decrease in
media spending.
GENERAL AND ADMINISTRATIVE
General and administrative expenses in 2000 were $29.2 million, equal to the
1999 expense level. Slight increases in wages and benefits expense were offset
by reductions in the use of outside services and consultants.
STORE CLOSINGS AND ASSET IMPAIRMENTS
Store closing and asset impairment expense in 2000 was $2.0 million, up from
$1.5 million in 1999. In 2000, this expense included $1.4 million related to the
relocation of our headquarter offices and web development costs and $0.6 million
related to store closures. The expense of $1.5 million in 1999 relates almost
exclusively to store closures.
OTHER INCOME (EXPENSE), NET
Other income decreased $1.4 million to approximately $0.3 million of other
income in
30
2000 from $1.7 million in other income in 1999. The decrease is due to lower
cash levels affecting interest income in 2000. In addition, the recognition of
an equity loss in SleepTec following our acquisition of this business reduced
other income by $0.6 million.
INCOME TAX EXPENSE (BENEFIT)
Income tax expense increased to $11.6 million for 2000 from a benefit of $4.8
million for 1999. Income tax expense increased as a result of the establishment
of an additional $21.1 million deferred tax asset valuation allowance in the
fourth quarter of 2000.
LIQUIDITY AND CAPITAL RESOURCES
Historically, our primary source of liquidity has been the sale of securities.
Our most recent source of capital has been from the issuance of our $11.0
million convertible notes (the "Notes") in June 2001 and $5.0 million senior
secured term debt financing (the "Debt") completed in September 2001. In
addition to these financings, we generated cash from operations during 2001, and
in particular during the third and fourth quarters of 2001. As all of our assets
are pledged as collateral for the Debt and the Notes, the Company presently has
little or no ability to obtain additional debt financing. We expect current cash
balances on hand and cash generated from operations to be sufficient to meet our
liquidity needs for the foreseeable future.
Net cash provided by (used in) operating activities in 2001, 2000 and 1999 was
$0.4 million, ($10.3) million and $7.7 million. Net cash provided by operating
activities in 2001 consisted primarily of a decrease in inventories and prepaid
expenses, partially offset by the net loss adjusted for non-cash expenses and a
decrease in accounts payable and accrued sales returns. Inventory levels were
reduced in 2001 as a result of two primary activities: 1) the closure of one of
our manufacturing plants and 2) a focus on reducing supplier lead-times
resulting in lower in-stock raw material levels required at our manufacturing
plants. Prepaid expenses were reduced in 2001 as a result of lower prepaid
advertising levels, consistent with the timing and form of media placements at
the end of 2001 vs. those in place at the end of 2000. The decrease in accounts
payable in 2001 was due primarily to a decrease in the number of stores open at
the end of 2001 and due to extended payment terms being in place with some of
our key suppliers at the end of fiscal 2000. The terms with those key suppliers
had normalized at the end of 2001. The balance in our accrued sales returns in
2001 has decreased as a result of the change in our sales return policy from
90-days at the end of 2000 to 30-days at the end of 2001. The shorter return
period results in a smaller balance of sales that had not yet been returned at
the end of 2001.
Net cash used in 2000 operating activities consisted primarily of the net loss
adjusted for non-cash expenses and an increase in accounts receivable, partially
offset by a decrease in income taxes receivable and an increase in accounts
payable. The increase in accounts receivable at the end of 2000 was primarily
due to the timing of credit card settlements. Income taxes receivable decreased
as a result of the write-off of our current and deferred tax assets at the end
of 2000. Payables increased at the end of 2000 due to additional retail stores
being open as of year-end and extended payment terms with supplier, as discussed
earlier.
Net cash provided by 1999 operating activities 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. The decrease in accounts receivable at
the end of 1999 was a result of a change to our consumer credit financing
program. At the end of 1998, certain cash balances were retained by the credit
provider, whereas at the end of 1999, after a new credit financing agreement was
in place, these retention amounts were no longer required and resulted in a
decrease to accounts receivable. Increases in accounts payable, accrued
liabilities and inventory balances was due primarily to an increase in the
number of retail stores open at the end of 1999 vs. 1998. Increases in income
taxes receivable was due
31
primarily to a federal tax refund and the utilization of NOL carrybacks.
Net cash provided by (used in) investing activities for 2001, 2000 and 1999 was
($0.9) million, $3.7 million and ($35.8). Investing activities consisted of
purchases of property and equipment for new retail stores in all periods, and
for 1999 also included the opening of our Utah production facility. In 2001 and
2000 we liquidated $4.0 million and $16.2 million, respectively, of marketable
securities to support our continuing operations, while in 1999 we purchased
$20.1 million of marketable securities for the investment of excess cash on
hand.
Net cash provided by (used in) financing activities for 2001, 2000 and 1999 was
$15.4 million, $0.6 million and ($10.0) million, respectively. Net cash provided
by financing activities in 2001 resulted from the issuance of common stock and
from the financing of $11.0 million of convertible debt and $5.0 million of
senior secured term debt. Fees and expenses of $1.0 million were netted against
the proceeds from debt issuances. Net cash provided by financing activities in
2000 resulted from cash received from the issuance of common stock. 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.
Our liquidity is impacted by minimum cash payment commitments resulting from
long-term debt outstanding and operating leases. The table below outlines those
minimum cash commitments, during the periods indicated (in thousands):
PAYMENTS DUE BY PERIOD
------------------------------------------------
LESS GREATER
THAN 1 1 - 2 3 - 4 THAN 4
TOTAL YEAR YEARS YEARS YEARS
-------- -------- -------- -------- --------
Long-term debt $ 20,033 28 49 4,598 15,358
Operating leases 15,103 14,523 25,518 27,461 82,605
-------- -------- -------- -------- --------
Total $102,638 15,131 14,572 30,116 42,819
======== ======== ======== ======== ========
At December 29, 2001, we had net operating loss carryforwards ("NOLs") for
federal income tax purposes of approximately $41.2 million expiring between the
years 2003 and 2021. We have not recorded any value in our Consolidated Balance
Sheet for the potential future benefit of NOL's.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Financial instruments that potentially subject us to concentrations of credit
risk consist principally of investments and long-term debt. The counterparties
to our investment agreements consist of government agencies and various major
corporations of high credit standing. We do not believe there is significant
risk of non-performance by these counterparties because we limit the amount of
credit exposure to any one financial institution and any one type of investment.
Our Notes and Debt bear interest rates that are fixed and not subject to market
interest rate fluctuations. Our Notes and Debt are not subject to any early call
provisions. We are subject to financial covenants on our Debt that require us to
maintain minimum cash flow from operations. We were in compliance with those
covenants at year-end 2001 and anticipate that we will meet covenant
requirements for the foreseeable future.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The consolidated financial statements are listed under item 14 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
32
PART III
--------------------
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The information under the captions "Election of Directors -- Information About
Nominees and Directors" and "Election of Directors -- Other Information About
Nominees and Directors" in our 2002 Proxy Statement is incorporated herein by
reference. The information concerning executive officers of Select Comfort(R) is
included in this Report under Item 4a, "ExecutivE Officers of the Company."
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The information under the caption "Section 16(a) Beneficial Ownership Reporting
Compliance" in our 2002 Proxy Statement is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information under the captions "Election of Directors -- Director
Compensation" and "Executive Compensation and Other Benefits" in our 2002 Proxy
Statement is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information under the caption "Principal Shareholders and Beneficial
Ownership of Management" in our 2002 Proxy Statement is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information under the caption "Certain Transactions" in our 2002 Proxy
Statement is incorporated herein by reference.
33
PART IV
--------------------
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page Number in
this Report
--------------
Independent Auditors' Report.......................................F-1
Consolidated Balance Sheets as of December 29, 2001 and
December 30, 2000..................................................F-2
Consolidated Statements of Operations for the years ended
December 29, 2001, December 30, 2000 and January 1, 2000...........F-3
Consolidated Statements of Shareholders' Equity for the years
ended December 29, 2001, December 30, 2000 and January 1, 2000.....F-4
Consolidated Statements of Cash Flows for the years ended
December 29, 2001, December 30, 2000 and January 1, 2000...........F-5
Notes to Consolidated Financial Statements.................F-6 to F-15
Management's Report...............................................F-16
2. INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES
The following Report and financial statement schedule are included in
this Part IV and are found in this Report at the pages indicated.
Independent Auditors' Report on Schedule...........................S-1
Schedule II - Valuation and Qualified Accounts.....................S-1
All other schedules are omitted because they are not applicable or the
required information is included in the consolidated financial
statements or notes thereto.
34
3. EXHIBITS
The exhibits to this Report are listed in the Exhibit Index below.
Select Comfort(R)will furnish a copy of any of the exhibits referred
to above at a reasonable cost to any shareholder upon receipt of a written
request therefor. Requests should be sent to: Select Comfort Corporation,
6105 Trenton Lane North, Minneapolis, Minnesota 55442; Attn: Shareholder
Information.
The following is a list of each management contract or compensatory
plan or arrangement required to be filed as an exhibit to this Annual
Report on Form 10-K pursuant to Item 14(c):
1. Form of Incentive Stock Option Agreement under the 1997 Stock
Incentive Plan
2. Form of Performance Based Stock Option Agreement under the 1997 Stock
Incentive Plan
3. Employment Letter dated July 11, 1995 between the Company and Gregory
T. Kliner
4. Select Comfort Profit Sharing and 401(K) Plan
5. Select Comfort Corporation 1999 Employee Stock Purchase Plan
6. Select Comfort Corporation 1990 Omnibus Stock Option Plan, as amended
and restated
7. Select Comfort Corporation 1997 Stock Incentive Plan, as amended and
restated
8. Employment Letter dated July 21, 1999 between the Company and Tracey
T. Breazeale
9. Employment Letter dated April 22, 1999 between the Company and Mark A.
Kimball
10. Executive and Key Employee Incentive Plan
11. Employment Letter dated March 3, 2000 between the Company and William
R. McLaughlin
12. Employment Letter dated July 11, 2000 between the Company and Michael
J. Thyken
13. Employment Letter dated October 27, 2000 between the Company and Noel
F. Schenker
35
(b) REPORTS ON FORM 8-K
During the quarter ended December 29, 2001, the Company filed three Current
Reports on Form 8-K. The Reports consisted of the following:
- Current Report filed October 9, 2001, announcing securing of
additional financing.
- Current Report filed October 16, 2001, announcing unaudited results
for the third quarter ended September 29, 2001.
36
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
SELECT COMFORT CORPORATION
Dated: March 28, 2002 By: /s/ William R. McLaughlin
----------------------------------------------
William R. McLaughlin
President and Chief Executive Officer
(principal executive officer)
By: /s/ James C. Raabe
----------------------------------------------
James C. Raabe
Chief Financial Officer
(principal financial and accounting officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
NAME TITLE DATE
- ---- ----- ----
/s/ Patrick A. Hopf Chairman of the Board March 28, 2002
- -----------------------------
Patrick A. Hopf
/s/ William R. McLaughlin President and Chief Executive March 28, 2002
- ----------------------------- Officer, Director
William R. McLaughlin
/s/ Ervin R. Shames Director March 28, 2002
- -----------------------------
Ervin R. Shames
/s/ Thomas J. Albani Director March 28, 2002
- -----------------------------
Thomas J. Albani
/s/ Christopher P. Kirchen Director March 28, 2002
- -----------------------------
Christopher P. Kirchen
37
/s/ David T. Kollat Director March 28, 2002
- -----------------------------
David T. Kollat
/s/ Jean-Michel Valette Director March 28, 2002
- -----------------------------
Jean-Michel Valette
38
SELECT COMFORT CORPORATION
EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
FOR THE YEAR ENDED DECEMBER 30, 2000
EXHIBIT
NO. DESCRIPTION METHOD OF FILING
------- ----------- ----------------
3.1 Restated Articles of Incorporation of the Company, Incorporated by reference to
as amended.......................................... Exhibit 3.1 contained in Select
Comfort's Annual Report on Form
10-K for the fiscal year
ended January 1, 2000 (File No.
0-25121)
3.2 Restated Bylaws of the Company...................... Incorporated by reference to
Exhibit 3.2 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.1 Form of Warrant issued in connection with the sale Incorporated by reference to
of Convertible Preferred Stock, Series E............ Exhibit 4.2 contained in Select
Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.2 Form of Warrant issued in connection with the Incorporated by reference to
November 1996 Bridge Financing...................... Exhibit 4.3 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
4.3 Convertible Subordinated Debenture dated as of Filed electronically herewith
November 10, 2000, between Select Comfort and St.
Paul Venture Capital V, LLC.........................
4.4 Form of Note issued under the Note Purchase Incorporated by reference to
Agreement........................................... Exhibit 10.2 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended June 30, 2001 (File No.
0-25121)
4.5 Form of Warrant issued under the Note Purchase Incorporated by reference to
Agreement........................................... Exhibit 10.3 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended June 30, 2001 (File No.
0-25121)
39
4.6 Registration Rights Agreement dated June 6, 2001 by Incorporated by reference to
and among Select Comfort Corporation and the Exhibit 10.7 contained in
securityholders named therein....................... Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended June 30, 2001
(File No. 0-25121)
4.7 Common Stock Purchase Warrant issued to Medallion Incorporated by reference to
Capital, Inc. under the Loan Agreement of September Exhibit 10.3 contained in
28, 2001............................................ Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended September 29,
2001 (File No. 0-25121)
10.1 Net Lease Agreement dated December 3, 1993 between Incorporated by reference to
the Company and Opus Corporation.................... Exhibit 10.1 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.2 Amendment of Lease dated August 10, 1994 between the Incorporated by reference to
Company and Opus Corporation........................ Exhibit 10.2 contained in the
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.3 Second Amendment to Lease dated May 10, 1995 between Incorporated by reference to
the Company and Rushmore Plaza Partners Limited Exhibit 10.3 contained in
Partnership (successor to Opus Corporation)......... Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.4 Letter Agreement dated as of October 5, 1995 between Incorporated by reference to
the Company and Rushmore Plaza Partners Exhibit 10.4 contained in
Limited Partnership................................. Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.5 Third Amendment of Lease, Assignment and Assumption Incorporated by reference to
of Lease and Consent dated as of January 1, 1996 Exhibit 10.5 contained in
among the Company, Rushmore Plaza Partners Limited Select Comfort's Registration
Partnership and Select Comfort Direct Corporation... Statement on Form S-1, as
amended (File No. 333-62793)
10.6 Sublease dated as of March 27, 1997 between Select Incorporated by reference to
Comfort SC Corporation and Bellsouth Exhibit 10.6 contained in
Telecommunications, Inc............................. Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.7 Supply Agreement dated August 23, 1994 between the Incorporated by reference to
Company and Supplier (1)............................ Exhibit 10.8 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
40
10.8 Major Merchant Agreement dated December 19, 1997 Incorporated by reference to
among First National Bank of Omaha and the Company, Exhibit 10.13 contained in
Select Comfort SC Corporation, Select Comfort Retail Select Comfort's Registration
Corporation and Select Comfort Direct Corporation... Statement on Form S-1, as
amended (File No. 333-62793)
10.9 Form of Incentive Stock Option Agreement under the Incorporated by reference to
1997 Stock Incentive Plan........................... Exhibit 10.16 contained in the
Company's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.10 Form of Performance Based Stock Option Agreement Incorporated by reference to
under the 1997 Stock Incentive Plan................. Exhibit 10.17 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.11 Employment Letter Agreement dated July 11, 1995 Incorporated by reference to
between the Company and Gregory T. Kliner........... Exhibit 10.20 contained in
Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.12 Lease Agreement dated September 30, 1998 between Incorporated by reference to
the Company and ProLogis Development Services Exhibit 10.28 contained in
Incorporated........................................ Select Comfort's Registration
Statement on Form S-1, as
amended (File No. 333-62793)
10.13 Revolving Credit Program Agreement by and between Incorporated by reference to
Green Tree Financial Corporation and Select Comfort Exhibit 10.3 contained in
Corporation (1)..................................... Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended July 3, 1999
(File No. 0-25121)
10.14 Letter of Agreement by and between Bed, Bath & Incorporated by reference to
Beyond Inc. and Select Comfort Retail Corporation (1) Exhibit 10.4 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended July 3, 1999 (File No.
0-25121)
10.15 Select Comfort Profit Sharing and 401(K) Plan....... Incorporated by reference to
Exhibit 10.5 contained in
Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended July 3, 1999
(File No. 0-25121)
10.16 Select Comfort Corporation 1999 Employee Stock Incorporated by reference to
Purchase Plan, as amended........................... Exhibit 10.17 contained in
Select Comfort's Annual Report on
Form 10-K for the fiscal year
ended December 30, 2000 (File
No. 0-25121)
41
10.17 Select Comfort Corporation 1990 Omnibus Stock Option Incorporated by reference to
Plan, as amended and restated....................... Exhibit 10.1 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended October 2, 1999 (File No.
0-25121)
10.18 Select Comfort Corporation 1997 Stock Inventive Incorporated by reference to
Plan, as amended and restated through May 1, 2001... Exhibit 10.8 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended June 30, 2001 (File No.
0-25121)
10.19 Employment Letter Agreement dated July 21, 1999 Incorporated by reference to
between the Company and Tracey T. Breazeale......... Exhibit 10.24 contained in
Select Comfort's Annual Report on
Form 10-K for the fiscal year
ended January 1, 2000 (File No.
0-25121)
10.20 Employment Letter Agreement dated April 22, 1999 Incorporated by reference to
between the Company and Mark A. Kimball............. Exhibit 10.25 contained in
Select Comfort's Annual Report on
Form 10-K for the fiscal year
ended January 1, 2000 (File No.
0-25121)
10.21 Executive and Key Employee Incentive Plan........... Incorporated by reference to
Exhibit 10.22 contained in
Select Comfort's Annual Report
on Form 10-K for the fiscal
year ended December 30, 2000
(File No. 0-25121)
10.22 Employment Letter dated March 3, 2000 between the Incorporated by reference to
Company and William R. McLaughlin................... Exhibit 10.1 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended April 1, 2000 (File No.
0-25121)
10.23 Employment Letter dated July 11, 2000 between the Incorporated by reference to
Company and Michael J. Thyken....................... Exhibit 10.24 contained in
Select Comfort's Annual Report on
Form 10-K for the fiscal year
ended December 30, 2000 (File
No. 0-25121)
10.24 Employment Letter dated October 27, 2000 between the Incorporated by reference to
Company and Noel F. Schenker........................ Exhibit 10.25 contained in
Select Comfort's Annual Report on
Form 10-K for the fiscal year
ended December 30, 2000 (File
No. 0-25121)
42
10.25 Asset Purchase Agreement dated as of November 10, Incorporated by reference to
2000, among SleepTec, Inc., St. Paul Venture Capital Exhibit 2.1 contained in Select
IV, LLC, St. Paul Venture Capital V, LLC, St. Paul Comfort's Current Report on
Venture Capital VI, LLC and Select Comfort Form 8-K filed November 22, 2000
Corporation......................................... (File No. 0-25121)
10.26 Letter Agreement dated as of July 1, 2000 between Incorporated by reference to
Messner Vetere Berger McNamee Schmetterer/Euro RSCG Exhibit 10.27 contained in
Inc. and Select Comfort Retail Corporation.......... Select Comfort's Annual Report
on Form 10-K for the fiscal year
ended December 30, 2000 (File
No. 0-25121)
10.27 Amendment to Revolving Credit Program Agreement with Incorporated by reference to
Conseco Bank, Inc. dated February 20, 2001.......... Exhibit 10.1 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended March 31, 2001 (File No.
0-25121)
10.28 Second Amendment to Revolving Credit Program with Incorporated by reference to
Conseco Bank, Inc. dated April 13, 2001............. Exhibit 10.2 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended March 31, 2001 (File No.
0-25121)
10.29 Note Purchase Agreement dated as of June 1, 2001 by Incorporated by reference to
and among Select Comfort Corporation and the Exhibit 10.1 contained in
Purchasers named therein............................ Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended June 30, 2001
(File No. 0-25121)
10.30 Security Agreement dated June 6, 2001 executed by Incorporated by reference to
Select Comfort Corporation in favor of St. Paul Exhibit 10.4 contained in
Venture Capital VI, LLC............................. Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended June 30, 2001
(File No. 0-25121)
10.31 Pledge Agreement dated June 6, 2001 executed by Incorporated by reference to
Select Comfort Corporation in favor of St. Paul Exhibit 10.5 contained in
Venture Capital VI, LLC............................. Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended June 30, 2001
(File No. 0-25121)
10.32 Patent and Trademark Security Agreement dated June Incorporated by reference to
6, 2001 executed by Select Comfort Corporation in Exhibit 10.6 contained in
favor of St. Paul Venture Capital VI, LLC........... Select Comfort's Quarterly
Report on Form 10-Q for the
quarter ended June 30, 2001
(File No. 0-25121)
43
10.33 Loan Agreement dated September 28, 2001 by and among Incorporated by reference to
Select Comfort Corporation, Select Comfort Retail Exhibit 10.1 contained in
Corporation, Select Comfort Direct Corporation, Select Comfort's Quarterly
Select Comfort SC Corporation, Direct Call Centers, Report on Form 10-Q for the
Inc., selectcomfort.com corporation and Medallion quarter ended September 29,
Capital, Inc........................................ 2001 (File No. 0-25121)
10.34 Promissory Note issued to Medallion Capital, Inc. Incorporated by reference to
under the Loan Agreement of September 28, 2001...... Exhibit 10.2 contained in
Select Comfort's Quarterly Report
on Form 10-Q for the quarter
ended September 29, 2001 (File
No. 0-25121)
10.35 Security Agreement dated September 28, 2001 by and Incorporated by reference to
among Select Comfort Corporation, Select Comfort Exhibit 10.4 contained in
Retail Corporation, Select Comfort Direct Select Comfort's Quarterly
Corporation, Select Comfort SC Corporation, Direct Report on Form 10-Q for the
Call Centers, Inc., selectcomfort.com corporation quarter ended September 29,
and Medallion 2001 (File No. 0-25121)
Capital, Inc........................................
10.36 Patent and Trademark Security Agreement dated Incorporated by reference to
September 28, 2001 by and among Select Comfort Exhibit 10.5 contained in
Corporation, Select Comfort Retail Corporation, Select Comfort's Quarterly
Select Comfort Direct Corporation, Select Comfort SC Report on Form 10-Q for the
Corporation, Direct Call Centers, Inc., quarter ended September 29,
selectcomfort.com corporation and Medallion Capital, 2001 (File No. 0-25121)
Inc.................................................
10.37 Subordination Agreement dated September 28, 2001 by Incorporated by reference to
and among Select Comfort Corporation, each of its Exhibit 10.6 contained in
subsidiary corporations, Medallion Capital, Inc. and Select Comfort's Quarterly
the Subordinated Lenders named therein.............. Report on Form 10-Q for the
quarter ended September 29,
2001 (File No. 0-25121)
21.1 Subsidiaries of the Company......................... Incorporated by reference to
Exhibit 21.1 contained in
Select Comfort's Annual Report
on Form 10-K for the fiscal
year ended January 1, 2000
(File No. 0-25121)
23.1 Independent Auditors' Consent....................... Filed electronically herewith
- -----------------
(1) Confidential treatment has been granted by the Securities and Exchange
Commission with respect to designated portions contained within document. Such
portions have been omitted and filed separately with the Securities and Exchange
Commission pursuant to Rule 24b-2 of the Securities and Exchange Act of 1934, as
amended.
44
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders
Select Comfort Corporation:
We have audited the accompanying consolidated balance sheets of Select
Comfort Corporation and subsidiaries (the Company) as of December 29, 2001 and
December 30, 2000 and the related consolidated statements of operations,
shareholders' equity, and cash flows for each of the fiscal years in the
three-year period ended December 29, 2001. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Select
Comfort Corporation and subsidiaries as of December 29, 2001 and December 30,
2000, and the results of their operations and their cash flows for each of the
fiscal years in the three-year period ended December 29, 2001 in conformity with
accounting principles generally accepted in the United States of America.
/s/ KPMG LLP
Minneapolis, Minnesota
January 31, 2002
F-1
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 29, 2001 AND DECEMBER 30, 2000
(IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)
2001 2000
---------- ----------
ASSETS
Current assets:
Cash and cash equivalents $16,375 $ 1,498
Marketable securities (note 3) - 3,950
Accounts receivable, net of allowance for doubtful
accounts of $311 and $264, respectively 2,623 2,693
Inventories (note 4) 8,086 11,083
Prepaid expenses 3,588 4,741
---------- ----------
Total current assets 30,672 23,965
---------- ----------
Property and equipment, net (note 5) 30,882 37,063
Other assets 5,882 3,644
---------- ----------
Total assets $67,436 $64,672
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities of long-term debt (note 7) $ 28 $ 38
Accounts payable 15,216 17,271
Accruals:
Sales returns 3,624 5,284
Compensation and benefits 7,179 6,025
Taxes and withholding 3,032 3,175
Other 5,332 4,603
---------- ----------
Total current liabilities 34,411 36,396
Long-term debt, less current maturities (note 7) 17,109 2,322
Warranty costs 5,030 5,745
Other liabilities 4,114 3,609
---------- ----------
Total liabilities 60,664 48,072
---------- ----------
Shareholders' equity (notes 1, 2, 7, 8, 10, and 11):
Undesignated preferred stock; 5,000,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value; 95,000,000 shares
authorized, 18,302,307 and 17,962,689 shares issued
and outstanding, respectively 183 180
Additional paid-in capital 81,687 79,452
Accumulated deficit (75,098) (63,032)
---------- ----------
Total shareholders' equity 6,772 16,600
---------- ----------
Commitments and contingencies (notes 1, 6 and 12):
Total liabilities and shareholders' equity $67,436 $64,672
========== ==========
See accompanying notes to consolidated financial statements.
F-2
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 29, 2001, DECEMBER 30, 2000 AND JANUARY 1, 2000
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
2001 2000 1999
---- ---- ----
Net sales $261,687 $270,077 $273,767
Cost of sales 90,076 98,924 95,107
------------ ------------ ------------
Gross margin 171,611 171,153 178,660
------------ ------------ ------------
Operating expenses:
Sales and marketing 155,551 165,960 162,742
General and administrative 24,836 29,211 29,213
Store closings and asset impairments (note 5) 1,826 1,952 1,498
------------ ------------ ------------
Total operating expenses 182,213 197,123 193,453
------------ ------------ ------------
Operating loss (10,602) (25,970) (14,793)
------------ ------------ ------------
Other income (expense):
Interest income 237 1,082 1,956
Interest expense (notes 7 and 8) (1,362) (26) (69)
Equity in loss of affiliate (note 2) - (642) -
Other, net (339) (66) (116)
------------ ------------ ------------
Other income (expense), net (1,464) 348 1,771
------------ ------------ ------------
Loss before income taxes (12,066) (25,622) (13,022)
Income tax expense (benefit) (note 9) - 11,592 (4,818)
------------ ------------ ------------
Net loss $(12,066) $(37,214) $ (8,204)
============ ============ ============
Net loss per share - basic and diluted (note 10) $ (0.66) $ (2.09) $ (0.45)
============ ============ ============
Weighted average shares outstanding - basic and
diluted (note 10) 18,157 17,848 18,300
============ ============ ============
See accompanying notes to consolidated financial statements.
F-3
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
YEARS ENDED DECEMBER 29, 2001, DECEMBER 30, 2000 AND JANUARY 1, 2000
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
ADDITIONAL
PAID-IN ACCUMULATED
SHARES AMOUNT CAPITAL DEFICIT TOTAL
------ ------ ------- ------- -----
Balance at January 2, 1999 18,435,687 $184 $87,619 $(17,112) $70,691
Exercise of common stock options (note 8) 448,705 5 2,255 - 2,260
Issuance and exercise of common stock warrants 31,150 - 1,215 - 1,215
Repurchase of common stock (1,220,000) (12) (12,680) - (12,692)
Employee stock purchases (note 11) 17,705 - 104 - 104
Net loss - - - (8,204) (8,204)
Acquisition of SleepTec, Inc. (note 2) - - - (502) (502)
------------ ----------- ----------- ----------- -----------
Balance at January 1, 2000 17,713,247 177 78,513 (25,818) 52,872
------------ ----------- ----------- ----------- -----------
Exercise of common stock options (note 8) 44,515 1 136 - 137
Issuance of common stock warrants (note 8) - - 278 - 278
Employee stock purchases (note 11) 204,927 2 525 - 527
Net loss - - - (37,214) (37,214)
------------ ----------- ----------- ----------- -----------
Balance at December 30, 2000 17,962,689 180 79,452 (63,032) 16,600
------------ ----------- ----------- ----------- -----------
Exercise of common stock options (note 8) 694 - 1 - 1
Issuance of common stock warrants (note 8) - - 1,868 - 1,868
Employee stock purchases (note 11) 338,924 3 366 - 369
Net loss - - - (12,066) (12,066)
------------ ----------- ----------- ----------- -----------
Balance at December 29, 2001 18,302,307 $183 $81,687 $(75,098) $ 6,772
============ =========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
F-4
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 29, 2001, DECEMBER 30, 2000 AND JANUARY 1, 2000
(IN THOUSANDS)
2001 2000 1999
---------- ---------- ----------
Cash flows from operating activities:
Net loss $(12,066) $(37,214) $(8,204)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 10,082 8,409 6,695
Loss on disposal of assets and impaired assets 1,687 2,167 1,297
Deferred tax assets - 10,887 (4,998)
Change in operating assets and liabilities net
of effects of acquisition:
Accounts receivable, net 70 (1,637) 9,568
Inventories 2,926 640 (1,315)
Prepaid expenses 2,023 80 (773)
Other assets (2,244) 535 147
Income taxes - 2,579 (3,227)
Accounts payable (2,055) 1,360 3,832
Accrued sales returns (1,660) (596) (141)
Accrued compensation and benefits 1,154 (182) 1,770
Accrued taxes and withholding (143) 1,139 297
Other accrued liabilities 1,029 (593) 491
Accrued warranty costs (894) 1,340 1,355
Other liabilities 505 800 863
---------- ---------- ----------
Net cash provided by (used in) operating activities 414 (10,286) 7,657
---------- ---------- ----------
Cash flows from investing activities:
Purchases of property and equipment (4,859) (12,084) (13,663)
Sales of (investments in) marketable securities 3,950 16,179 (20,129)
Investment in affiliate - (400) (2,000)
---------- ---------- ----------
Net cash (used in) provided by investing activities (909) 3,695 (35,792)
---------- ---------- ----------
Cash flows from financing activities:
Principal payments on debt (38) (16) (872)
Repurchase of common stock - - (12,692)
Proceeds from issuance of common stock 370 664 3,579
Net proceeds from long-term obligations 15,040 - -
---------- ---------- ----------
Net cash provided by (used in) financing activities 15,372 648 (9,985)
---------- ---------- ----------
Increase (decrease) in cash and cash equivalents 14,877 (5,943) (38,120)
Cash and cash equivalents, at beginning of year 1,498 7,441 45,561
---------- ---------- ----------
Cash and cash equivalents, at end of year $ 16,375 $ 1,498 $ 7,441
========== ========== ==========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (note 2)
Cash paid during the year for:
Interest $ 182 $ 7 $ 69
Income taxes 188 175 2,292
Net tax benefit from exercise of stock options - 11 1,115
Non-cash impact of:
Financing discount - warrant value 1,695 - -
Other warrant and option issuance 173 278 -
Asset dispositions 263 - -
See accompanying notes to consolidated financial statements.
F-5
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS
Select Comfort Corporation and its wholly-owned subsidiaries (the Company)
develop, manufacture, and market premium quality, innovative adjustable-firmness
beds and other sleep-related products. The Company's fiscal year ends on the
Saturday closest to December 31.
Fiscal years 2001, 2000 and 1999 had 52 weeks. Certain prior-year amounts
have been reclassified to conform to the current-year presentation. In
particular, accrued warranty costs have been divided between current liabilities
and long-term liabilities, consistent with the expected timing of when warranty
claims will be satisfied.
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,
debt issuance costs and goodwill. Patents and trademarks are amortized using the
straight-line method over periods ranging from 10 to 17 years. Debt issuance
costs are amortized using the straight-line method over the term of the debt.
Goodwill is being amortized using the straight-line method over a 10-year
period.
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 at the time of shipment to customers for products
shipped with outside, third party carriers. Revenue is recognized at the time of
delivery for products delivered through our company-owned home delivery system.
In both cases, revenue is recognized net of estimated returns. The Company
records shipping and handling costs as a component of sales and marketing
expense.
STOCK COMPENSATION
The Company records compensation expense for option grants under its stock
option plan if the current market value of the underlying stock at the grant
date exceeds the stock option exercise price. Pro forma disclosure of the impact
on the net loss of applying an alternative method of recognizing stock
compensation expense over the vesting period based on the fair value of all
stock-based awards on the date of grant is presented in Note 8. The Company has
issued options to non-employees and recognized compensation expense based on the
fair market value method.
F-6
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in connection with research and development are charged to
expense as incurred. Research and development expense was $1,086,000, $889,000
and $1,865,000 in 2001, 2000 and 1999, respectively.
PRE-OPENING COSTS
Costs associated with the opening of new stores are expensed as incurred.
ADVERTISING COSTS
The Company incurs advertising costs associated with print and broadcast
advertisements. Such costs are charged to expense the first time the
advertisement runs. Advertising expense was $36,516,000, $36,111,000 and
$44,446,000 in 2001, 2000 and 1999.
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. A valuation allowance is
recognized against any portion of deferred tax assets when realization of the
deferred tax asset is uncertain.
EARNINGS PER SHARE
Basic earnings (loss) per share excludes dilution and is computed by
dividing the net income (loss) attributable to common shareholders by the
weighted average number of common shares outstanding during the period. Diluted
earnings (loss) per share includes potentially dilutive common shares consisting
of stock options and warrants determined by the treasury stock method, and
dilutive convertible securities.
ACCOUNTING ESTIMATES
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities, 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. Significant estimates consist
primarily of the following:
IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF
The Company reviews its long-lived assets and certain identifiable
intangibles for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be recoverable. Recoverability of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the assets exceeds the
fair value of the assets. Assets to be disposed of are reported at the lower of
the carrying amount or fair value less costs to sell. The Company reviews store
assets for possible impairment considering such factors as estimated store cash
flows, lease termination provisions, and opportunities to impact future store
operating results.
ACCRUED WARRANTY COSTS
The Company provides a 20-year warranty on adjustable-firmness beds, the
last 15 years of which are on a prorated basis. Estimated warranty costs are
expensed at the time of sale based on historical claims incurred by the Company.
Actual warranty claim costs could differ from these estimates.
F-7
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
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 30 nights
following the sale.
NEW ACCOUNTING PRONOUNCEMENTS
The Financial Accounting Standards Board has issued statement SFAS 142
"Goodwill and Other Intangible Assets." Statement 142 replaces the requirement
to amortize goodwill and intangible assets with indefinite lives with a
requirement for an annual impairment test. The Company must adopt SFAS 142 at
the beginning of fiscal 2002. The Company evaluated the impact of SFAS 142 at
December 29, 2001, and determined that the new accounting standards would not
have had a material impact on the Company's consolidated financial statements.
(2) ACQUISITION
Effective November 10, 2000, the Company completed the acquisition of
certain assets of SleepTec, Inc. ("SleepTec"), the manufacturer of the Company's
sofa sleeper product. The acquisition of SleepTec was accounted for by the
purchase method of accounting. The Company made an original investment in
SleepTec of $2,000,000 in May 1999 and accounted for the less than 20%
investment under the cost method. The subsequent acquisition in 2000 resulted in
step-acquisition treatment of the original May 1999 investment. Accordingly, the
results of operations of SleepTec for 1999, in the amount of the Company's
ownership interest (15.7%) are included as an adjustment to 1999 retained
earnings ($502,000). The results of SleepTec's operations for 2000 are included
in the Company's consolidated results as a loss in equity of affiliate
($642,000) and amortization of goodwill related to this purchase transaction is
included in general and administrative expense ($46,000).
The aggregate purchase price paid by the Company for the assets of SleepTec
consists of (i) a non-interest-bearing subordinated convertible debenture
("debenture") in the original principal amount of $4,000,000, due November 10,
2005 and convertible at any time into shares of the Company's common stock at
the rate of $5.50 per share of common stock; and (ii) $400,000 in cash. In
addition, the Company funded approximately $250,000 in a combination of cash and
equity (in the form of options to purchase shares of the Company's common stock)
payments to current and former employees of SleepTec for transition services and
severance compensation. The Company's largest shareholder is the holder of the
SleepTec debenture.
The purchase price was determined through arm's-length negotiations between
the Company and representatives of SleepTec based primarily upon the past and
projected stream of earnings of the SleepTec operations. The source of the funds
used to pay the purchase price was cash on hand at the Company and by issuance
of the debenture.
A summary of the assets acquired and the amount paid for this acquisition
is as follows (in thousands):
Inventory $272
Property, plant and equipment 544
Patents and trademarks (amortized by the
straight-line method over ten years) 50
Goodwill (amortized by the straight-line
method over ten years) 2,864
------------
Purchase price 3,730
------------
Less:
Amount previously paid for SleepTec, net of equity losses (742)
Transaction costs, included in goodwill balance above (318)
Value of $4,000,000 non-interest bearing
subordinated convertible debenture (2,270)
------------
Net cash paid $400
============
F-8
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(2) ACQUISITION (CONTINUED)
The asset and liability balances noted above, excluding cash paid, are
treated as non-cash items in the statement of cash flows.
The value of the $4,000,000 non-interest bearing subordinated convertible
debenture was determined based on its net cash flows using a 12% discount rate
and a five-year term.
(3) MARKETABLE SECURITIES
Securities classified as held to maturity, which consist of securities that
management has the ability and intent to hold to maturity, are carried at
amortized cost. Securities held at December 30, 2000, included commercial paper
with an average interest rate of 6.7% and amortized cost and fair value of
$3,950,000.
(4) INVENTORIES
Inventories consist of the following (in thousands):
DECEMBER 29, 2001 DECEMBER 30, 2001
----------------- -----------------
Raw materials $1,824 $5,507
Work in progress 26 60
Finished goods 6,236 5,516
------------------------------------
$8,086 $11,083
====================================
(5) PROPERTY AND EQUIPMENT
Property and equipment are summarized as follows (in thousands):
DECEMBER 29, 2001 DECEMBER 30, 2001
----------------- -----------------
Leasehold improvements $36,551 $35,712
Office furniture and equipment 3,496 5,209
Production machinery and computer equipment 21,256 19,982
Less accumulated depreciation and amortization (30,421) (23,840)
------------------------------------
$30,882 $37,063
====================================
STORE CLOSINGS AND ASSET IMPAIRMENT CHARGES
Store closing and write off expense was $1,029,000, $565,000 and $1,498,000
in 2001, 2000 and 1999, respectively.
In 2001 and 2000, the Company incurred charges of $797,000 and $1,387,000,
respectively, related to the impairment of carrying values of certain non-store
assets. In 2001 these charges included $337,000 related primarily to the
write-off of unusable fixtures for merchandising of sleeper sofa products and
$460,000 for excess leased space. In 2000 these charges included $741,000
related to relocation of the Company's headquarters and $646,000 related to the
write-off of web software design costs.
F-9
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(6) LEASES
The Company rents office and manufacturing space under four operating
leases which, in addition to the minimum lease payments, require payment of a
proportionate share of the real estate taxes and building operating expenses.
The Company also rents retail space under operating leases which, in addition to
the minimum lease payments, require payment of percentage rents based upon sales
levels. Rent expense was as follows (in thousands):
2001 2000 1999
---- ---- ----
Minimum rents $16,069 $17,589 $15,399
Percentage rents 1,561 1,835 1,992
-----------------------------
Total $17,630 $19,424 $17,391
=============================
Equipment rent $2,003 $1,587 $1,362
=============================
The aggregate minimum rental commitments under operating leases for
subsequent years are as follows (in thousands):
2002 $15,103
2003 14,523
2004 13,248
2005 12,270
2006 10,372
Thereafter 17,089
-----------
$82,605
===========
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS
Long-term obligations under notes and capital leases are as follows (in
thousands):
DECEMBER 29, 2001 DECEMBER 30, 2001
----------------- -----------------
8% senior subordinated convertible notes due
June 2006 ("Notes"). Face amount of
$11,000,000 net of $925,000 debt
discount, with interest payable
annually. Convertible into 11,000,000
shares of common stock at the rate of
$1.00 per share. $10,075 $ -
12% senior secured debt due September 2006
("Debt"). Face amount of $5,000,000 net
of $616,000 debt discount, with interest
payable monthly. 4,384 -
Non-interest bearing subordinated
convertible debenture due November 2005.
Face amount of $4,000,000 net of
$1,355,000 debt discount, with an
effective interest rate of 12% per
annum. Convertible into 727,273 shares
of common stock at the rate of $5.50 per
share (note 2). 2,645 2,289
Capital lease obligations for office
equipment, payable in monthly
installments through April 2003, with
interest at 7.75% - 9% per annum. 33 71
------------------------------------
17,137 2,360
Less current maturities 28 38
------------------------------------
$17,109 $2,322
====================================
F-10
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)
The Notes and Debt described above are secured by substantially all of the
Company's assets. The Notes are subordinate only to the Debt. The Company is
subject to financial covenants relating to minimum cash flow requirements for
the Debt noted above. The Company was in compliance with these financial
covenants as of December 29, 2001. Warrants were issued by the Company in
conjunction with these financings (note 8).
The aggregate maturities of long-term debt and capital lease obligations
for subsequent years are as follows (in thousands):
2002 $ 28
2003 49
2004 281
2005 4,317
2006 15,358
-----------
$20,033
===========
(8) SHAREHOLDERS' EQUITY
STOCK OPTIONS
The Board of Directors has reserved 9,300,000 shares of common stock for
options that may be granted to key employees, directors, or others under the
Company's stock option plans.
A summary of the changes in the Company's stock option plans for each of
the years in the three-year period ended December 29, 2001 is as follows:
WEIGHTED
AVERAGE
EXERCISE
SHARES PRICE
------ -----
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
Granted 1,307,700 4.64
Exercised (44,515) 3.09
Canceled (429,267) 9.44
----------------------
Outstanding at December 30, 2000 (including 1,726,097 shares exercisable) 3,519,271 8.08
Granted 1,766,900 1.03
Exercised (694) 1.01
Canceled (628,453) 8.74
----------------------
Outstanding at December 29, 2001 (including 2,034,877 shares exercisable) 4,657,024 $ 5.32
======================
F-11
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) SHAREHOLDERS' EQUITY (CONTINUED)
The following table summarizes information about options outstanding at
December 29, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------------------------------------------- -----------------------
AVERAGE WEIGHTED WEIGHTED
REMAINING AVERAGE AVERAGE
CONTRACTUAL EXERCISE EXERCISE
RANGE OF EXERCISE PRICE SHARES LIFE (YEARS) PRICE SHARES PRICE
----------------------- ------ ------------ ----- ------ -----
$0.45 - 1.00 444,110 8.78 $ 0.99 34,849 $ 0.84
1.01 - 1.51 1,306,222 9.46 1.04 206,059 1.04
1.60 - 5.25 1,078,871 6.83 4.11 725,814 4.34
5.43 - 7.47 1,041,467 8.00 6.23 532,404 6.45
7.50 - 28.63 786,354 7.11 15.32 535,751 15.31
----------------------- ----------- ------------ ----------- ----------- ----------
$0.45 - 28.63 4,657,024 8.06 $ 5.32 2,034,877 $ 7.39
=========== ===========
No compensation cost has been recognized in the consolidated financial
statements for employee stock options grants. Had the Company determined
compensation cost based on the fair value at the grant date for its stock
options under an alternative accounting method, the Company's net loss would
have been adjusted as indicated below (in thousands, except per share amounts):
2001 2000 1999
---- ---- ----
Net loss: As reported $(12,066) $(37,214) $ (8,204)
Pro forma $(15,175) $(39,673) $(11,088)
Loss per share: As reported $ (0.66) $ (2.09) $ (0.45)
Pro forma $ (0.70) $ (2.22) $ (0.60)
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions:
2001 2000 1999
---- ---- ----
Expected dividend yield 0% 0% 0%
Expected stock price volatility 90% 40% 40%
Risk-free interest rate 4.9% 5.9% 6.3%
Expected life in years 3.5 3.6 2.9
Weighted-average fair value at grant date $0.34 $1.87 $3.86
WARRANTS
The Company has issued warrants to various holders with outstanding
issuances at December 29, 2001 summarized below:
EXERCISE WARRANTS
WARRANT TYPE PRICE OUTSTANDING EXPIRATION DATE
- ----------------------------------------------- ------------- ----------- -----------------
1996 Series E Preferred Stock Financing $3.21 183,995 12/28/05
1996 Bridge Loan Financing $3.21 105,528 11/7/06 - 4/28/07
2001 Senior Secured Convertible Notes Financing $1.00 4,400,000 6/6/11
2001 Senior Secured Debt Financing $1.02 922,819 9/26/06
Miscellaneous other warrants $1.00 - $5.56 512,187 5/17/04 - 6/6/11
------------- ----------- -----------------
$1.00 - $5.56 6,124,529 5/17/04 - 6/6/11
===========
F-12
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(8) SHAREHOLDERS' EQUITY (CONTINUED)
The warrants issued in conjunction with the Notes and Debt were valued at
$1,100,000 and $600,000, respectively, and are reflected in additional paid-in
capital in the statement of shareholders' equity. The associated debt discount
is being amortized as interest expense over the term of the debt.
Miscellaneous other warrants consist of warrants issued to various parties
for services rendered in lieu of cash payments. The value of these warrants was
recognized as compensation expense with an offset to shareholders' equity
utilizing the Black-Scholes pricing model with assumptions reflecting the market
rates at the time of warrant issuance.
(9) INCOME TAXES
The benefit (provision) for income taxes consists of the following (in
thousands):
2001 2000 1999
---- ---- ----
Current:
Federal $ - $ - $ -
State - 705 180
-------------------------------
- 705 180
-------------------------------
Deferred:
Federal - 10,397 (4,694)
State - 490 (304)
-------------------------------
- 10,887 (4,998)
-------------------------------
Income tax benefit (expense) $ - $11,592 $(4,818)
===============================
Effective tax rates differ from statutory federal income tax rates as
follows:
2001 2000 1999
---- ---- ----
Statutory federal income tax rate (35.0%) (35.0%) (35.0%)
Change in valuation allowance 31.4 82.2 -
State income taxes, net of federal benefit - (1.1) (0.6)
Other 3.6 (0.9) (1.4)
-------------------------------
0.0% 45.2% (37.0%)
===============================
The tax effects of temporary differences that give rise to deferred tax
assets at December 29, 2001 and December 30, 2000 are as follows (in thousands):
2001 2000
---- ----
Deferred tax assets:
Current:
Inventory, warranty, and returns reserves $ 3,849 $ 5,012
Allowance for doubtful accounts 118 100
Other 2,409 2,171
Long term:
Net operating loss carryforwards 15,662 11,923
Other 3,140 2,389
--------------------
Total gross deferred tax assets 25,178 21,595
Valuation allowance (25,178) (21,595)
--------------------
Total net deferred tax assets $ - $ -
====================
F-13
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(9) INCOME TAXES (CONTINUED)
At December 29, 2001, the Company had net operating loss carryforwards
("NOLs") for federal income tax purposes of approximately $41,200,000 expiring
between the years 2003 and 2021. The Company has recorded a valuation allowance
for 100% of the deferred tax asset due to recurring pre-tax losses and the
current uncertainty of utilizing the deferred tax asset.
(10) NET LOSS PER COMMON SHARE
The following computations reconcile net loss with net loss per common
share-basic and diluted (dollars in thousands, except per share amounts).
NET PER SHARE
BASIC AND DILUTED EPS LOSS SHARES AMOUNT
---- ------ ------
Net loss attributable to common shareholders:
2001 ($12,066) 18,157,005 ($0.66)
2000 ($37,214) 17,848,375 ($2.09)
1999 ($ 8,204) 18,299,728 ($0.45)
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 loss per common share would not have been dilutive:
2001 2000 1999
---- ---- ----
Options 4,657,024 3,519,271 2,685,353
Common stock warrants 6,124,529 1,344,378 1,249,119
Convertible debt 11,727,272 727,272 -
(11) EMPLOYEE BENEFIT PLANS
Effective January 1, 1994, the Company adopted a profit sharing and 401(k)
plan for eligible employees. The plan allows employees to defer up to 15% of
their compensation on a pretax basis. Each year, the Company may make a
discretionary contribution equal to a percentage of the employee's contribution.
During 2001, 2000 and 1999, the Company expensed $119,000, $487,000 and
$480,000, respectively, relating to its contribution to the 401(k) plan.
EMPLOYEE STOCK PURCHASE PLAN
Effective July 30, 1999, the Company adopted an Employee Stock Purchase
Plan (the "Plan") under which employees can purchase Company common stock at a
discount of 15% based on the average price of the stock on the last business day
of the offering period (calendar-quarter.) 338,924, 204,927 and 17,705 shares
were issued during 2001, 2000 and 1999, respectively.
(12) COMMITMENTS AND CONTINGENCIES
In June of 1999, the Company and certain of its former officers and
directors were named as defendants in a class action lawsuit filed in U.S.
District Court in Minnesota. The suit, filed on behalf of purchasers of the
Company's common stock between December 4, 1998 and June 7, 1999, alleges that
the Company and the named former directors and officers failed to disclose or
misrepresented certain information concerning the Company in violation of
federal securities laws. In March of 2000, the same defendants were named in
another class action lawsuit asserting factual allegations identical to the
first suit. Neither of the suits specified an amount of damages claimed. The
U.S. District Court consolidated the two class actions in July of 2000.
In September of 2001, the consolidated case was certified to proceed as a
class action on behalf of purchasers of the Company's common stock issued under
or traceable to the Company's initial public offering prospectus dated December
4, 1998 and purchasers of the Company's common stock in the open market during
the period from December 4, 1998 through June 7, 1999.
F-14
SELECT COMFORT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(12) COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company believes that the suit is without merit and intends to
vigorously defend the claims. Discovery has begun.
The Company has 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. Through the end of the
current fiscal year, the Company has paid an aggregate of $4,591 to the law firm
of Briggs & Morgan on behalf of defendant H. Robert Hawthorne.
The Company is involved in other various claims, legal actions, sales tax
disputes, and other complaints arising in the ordinary course of business. In
the opinion of management, any losses that may occur from these other matters
are adequately covered by insurance or are provided for in the consolidated
financial statements and the ultimate outcome of these other matters will not
have a material effect on the consolidated financial position or results of
operations of the Company.
(13) SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)
The following is a condensed summary of actual quarterly results for 2001
and 2000 (in thousands, except per share amounts):
2001 FOURTH THIRD SECOND FIRST
----
Net sales $69,341 $64,148 $62,742 $65,456
Gross margin 46,496 42,956 40,314 41,845
Operating income (loss) 1,659 603 (3,176) (9,688)
Net income (loss) 1,065 227 (3,530) (9,828)
Net income (loss) per share - diluted 0.04 0.01 (0.19) (0.54)
2000 FOURTH THIRD SECOND FIRST
----
Net sales $64,075 $68,056 $61,787 $76,159
Gross margin 39,054 43,185 39,901 49,013
Operating loss (6,905) (8,894) (5,391) (4,780)
Net loss (25,059) (5,692) (3,465) (2,998)
Net loss per share - diluted (1.39) (0.32) (0.19) (0.17)
F-15
MANAGEMENT'S REPORT
The management of Select Comfort Corporation is responsible for the preparation,
integrity and fair presentation of the consolidated financial statements
included in this annual report. The financial statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America and include amounts based on judgments and estimates made by management.
Management is also responsible for the preparation and accuracy of information
included in other sections of this annual report, which information is
consistent with the financial statements.
The integrity of the financial statements is based on the maintenance of an
internal control structure established by management to provide reasonable
assurance that assets are safeguarded and transactions are properly authorized,
recorded and reported. The concept of reasonable assurance is based on the
recognition that the cost of maintaining a system of internal controls should
not exceed the benefits expected to be derived. Even effective internal
controls, no matter how well designed, have inherent limitations. Management
believes that the internal control system provides reasonable assurance that
errors or irregularities that could be material to the financial statements are
prevented or would be detected and corrected in the normal course of business.
The Company engages independent auditors to examine its financial statements and
express their opinion thereon. The auditors have access to each member of
management in conducting their audits. Their report appears in this annual
report.
The Audit Committee of the Board of Directors, composed solely of non-management
directors, meets periodically with management and the independent auditors to
review internal accounting control, audit activities and financial reporting
matters. The independent auditors have full access to the Audit Committee and
meet periodically with them without management present.
/s/William R. McLaughlin /s/James C. Raabe
William R. McLaughlin James C. Raabe
President and Chief Chief Financial Officer
Executive Officer
F-16
INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE
The Board of Directors and Stockholders
Select Comfort Corporation:
Under date of January 31, 2002 we reported on the consolidated balance
sheets of Select Comfort Corporation and subsidiaries as of December 29, 2001
and December 30, 2000 and the related statements of operations, shareholders'
equity, and cash flows for each of the years in the three-year period ended
December 29, 2001, as contained in the Annual Report on Form 10-K for the year
2001. In connection with our audits of the aforementioned consolidated financial
statements, we also audited the related financial statement schedule as listed
in the accompanying index. This financial statement schedule is the
responsibility of the Company's management. Our responsibility is to express an
opinion on this financial statement schedule based on our audits.
In our opinion, such financial statement schedule, when considered in
relation to the basic consolidated financial statements taken as a whole,
presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Minneapolis, Minnesota
January 31, 2002
SELECT COMFORT CORPORATION AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(IN THOUSANDS)
ADDITIONS
BALANCE AT CHARGED TO DEDUCTIONS BALANCE AT
BEGINNING COSTS AND FROM END OF
DESCRIPTION OF PERIOD EXPENSES RESERVES PERIOD
------------------------------- ---------- ---------- ---------- ----------
Allowance for doubtful accounts
- 2001 $ 264 $ 582 $ 535 $ 311
- 2000 305 531 572 264
- 1999 2,750 1,193 3,638 305
Accrued warranty costs
- 2001 $ 7,181 $ 2,708 $ 3,602 $ 6,287
- 2000 5,841 5,397 4,057 7,181
- 1999 4,486 5,368 4,013 5,841
S-1