10-K 1 form_10-kx2015.htm 10-K 10-K


 
 
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 January 2, 2016
o
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 incorporation or organization)
 
(I.R.S. Employer Identification No.)
9800 59th Avenue 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:
Title of each class
 
Name of each exchange on which registered
Common Stock, par value $.01 per share
 
The NASDAQ Stock Market LLC
 
 
(NASDAQ Global Select Market)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. YES ý NO o
Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o   NO ý
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 ý   NO o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý NO o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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. ý
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
 
 
Accelerated filer o
Non-accelerated filer
o
(Do not check if a smaller reporting company)
 
Smaller reporting company o
Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý
The aggregate market value of the common stock held by non-affiliates of the Registrant as of July 4, 2015, was $1,518,243,000 (based on the last reported sale price of the Registrant’s common stock on that date as reported by NASDAQ).
As of January 30, 2016, there were 48,632,000 shares of the Registrant’s Common Stock outstanding.
 
 






DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s proxy statement to be furnished to shareholders in connection with its 2016 Annual Meeting of Shareholders are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K.

As used in this Form 10-K, the terms “we,” “us,” “our,” the “Company,” and “Select Comfort” mean Select Comfort Corporation and its subsidiaries and the term “common stock” means our common stock, par value $0.01 per share.

As used in this Form 10-K, the term “bedding” includes mattresses, box springs and foundations.

Sleep Number®, Select Comfort®, SleepIQ®, the Double Arrow logo, AirFit®, Bam LABS®, the “B” logo, Comfortaire®, ComfortFit®, Comfort.Individualized.®, the DualTemp logo, the DualAir Technology Inside logo, FlexTop®, IndividualFit®, Individualized Sleep Experiences®, Know Better Sleep®, LuxFit®, Pillow[ology]®, PillowFit®, PlushFit®, Probably the Best Bed in the World®, Sleep Number Inner Circle®, Tech-e®, Smart Bed Technology®, The Only Bed That Knows You®, We Make Beds Smart®, What’s Your Sleep Number?®, SleepIQ Kids™, SleepIQ LABS™, Sleep For The FutureSM, Smart Bed For Smart Kids™, It™, The It Bed™, The Only Bed That Grows With Them™, Tonight Bedtime. Tomorrow The World™, ActiveComfort™, CoolFit™, DualAir™, DualTemp™, Firmness Control™, FlexFit™, In Balance™, PartnerSnore™, the SleepIQ LABS logo, The Bed That Moves You™, our bed model names, and our other marks and stylized logos are trademarks and/or service marks of Select Comfort. This Form 10-K may also contain trademarks, trade names and service marks that are owned by other persons or entities.

Our fiscal year ends on the Saturday closest to December 31, and, unless the context otherwise requires, all references to years in this Form 10-K refer to our fiscal years. Our fiscal year is based on a 52- or 53-week year. All years presented in this Form 10-K are 52 weeks, except for the 2014 fiscal year ended January 3, 2015, which is a 53-week year.
 
 


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TABLE OF CONTENTS

PART I
 
 
 
 
 
Item 1.
 
 
 
 
 
Item 1A.
 
 
 
 
 
Item 1B.
 
 
 
 
 
Item 2.
 
 
 
 
 
Item 3.
 
 
 
 
 
Item 4.
 
 
 
 
PART II
 
 
 
 
 
Item 5.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
 
 
 
 
 
Item 6.
 
 
 
 
 
Item 7.
 
 
 
 
 
Item 7A.
 
 
 
 
 
Item 8.
 
 
 
 
 
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
 
 
 
 
Item 9A.
 
 
 
 
 
Item 9B.
 
 
 
 
PART III
 
 
 
 
 
Item 10.
 
 
 
 
 
Item 11.
 
 
 
 
 
Item 12.
 
 
 
 
 
Item 13.
 
 
 
 
 
Item 14.
 
 
 
 
PART IV
 
 
 
 
 
Item 15.


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PART I

This Annual Report on Form 10-K contains or incorporates by reference certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For this purpose, any statements contained in or incorporated by reference into this Annual Report on Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements, including but not limited to projections of revenues, results of operations, financial condition or other financial items; any statements of plans, strategies and objectives of management for future operations; any statements regarding proposed new products, services or developments; any statements regarding future economic conditions, prospects or performance; statements of belief and any statement or assumptions underlying any of the foregoing. In addition, we or others on our behalf may make forward-looking statements from time to time in oral presentations, including telephone conferences and/or Webcasts open to the public, in press releases or reports, on our Internet Website or otherwise. We try to identify forward-looking statements in this report and elsewhere by using words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms.

Our forward-looking statements speak only as of the date made and by their nature involve substantial risks and uncertainties. Our actual results may differ materially depending on a variety of factors, including the items discussed in greater detail below under the caption “Risk Factors.” These risks and uncertainties are not exclusive and further information concerning the Company and our business, including factors that potentially could materially affect our financial results or condition, may emerge from time to time, including factors that we may consider immaterial or do not anticipate at this time.

We wish to caution readers not to place undue reliance on any forward-looking statement and to recognize that forward-looking statements are predictions of future results, which may not occur as anticipated. We assume no obligation to update forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. We advise you, however, to review and consider any further disclosures we make on related subjects in our quarterly reports on Form 10-Q and current reports on Form 8-K that we file with or furnish to the Securities and Exchange Commission.

ITEM 1. BUSINESS

Overview

Select Comfort Corporation, based in Minneapolis, Minnesota, was founded in 1987. Our mission is to improve lives by individualizing sleep experiences. Our vision is to become one of the world's most beloved brands by delivering an unparalleled sleep experience. We plan to achieve this by offering benefit-driven, innovative sleep solutions to our customers through an unmatched retail experience and a carefree ownership experience.

We offer consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of SLEEP NUMBER® beds and bedding accessories. Our business has three significant competitive advantages: proprietary sleep innovations, ongoing customer relationships and exclusive distribution.

We have a vertically integrated business model and are the exclusive designer, manufacturer, marketer, retailer and servicer of a complete line of Sleep Number® beds. As the pioneer in biometric sleep monitoring and adjustability, Sleep Number is proving the connection between quality sleep and health and wellbeing. Only the Sleep Number bed offers SleepIQ® technology - proprietary sensor technology that works directly with the bed’s DualAir™ system to track and monitor each individual’s sleep. SleepIQ technology communicates how you slept and what adjustments you can make to optimize your sleep and improve your daily life. Sleep Number also offers a full line of exclusive sleep products, including FlextFit™ adjustable bases, and Sleep Number® pillows, sheets and other bedding products. As a specialty mattress retailer with stores across the nation, we offer consumers a unique, value-added retail experience at one of the more than 488 Sleep Number® stores across the country, online at SleepNumber.com, or via phone at (800) Sleep Number or (800) 753-3768.

We are committed to delivering superior shareholder value through three primary drivers of earnings per share growth: increasing demand, leveraging our business model and deploying our capital efficiently. We are the sleep innovation leader and drive growth through effective brand marketing and a differentiated retail experience.

In fiscal 2015 we generated net sales of $1.2 billion with $75 million of operating income. In 2011, 2012, 2013 and 2014, we generated operating income of $90 million, $120 million, $91 million and $102 million, respectively.


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In 1998, Select Comfort became a publicly traded company. We are listed on The NASDAQ Stock Market LLC (NASDAQ Global Select Market) under the symbol “SCSS.” When used herein, the terms “Select Comfort,” “Company,” “we,” “us” and “our” refer to Select Comfort Corporation, including consolidated subsidiaries.

In September 2015, we completed the acquisition of BAM Labs, Inc. (now operating as SleepIQ LABS), the leading provider of biometric sensor and sleep monitoring for data-driven health and wellness. The addition of SleepIQ LABS strengthens Sleep Number’s leadership in sleep innovation, adjustability and individualization. The acquisition broadens and deepens electrical, biomedical, software and backend capabilities - API (application program interface) and bio-signal analysis. Our ownership and control of biometric data advances smart, connected products that empower our customers to ‘know better sleep.’

In the fourth quarter 2015, we replaced our nearly 20-year-old legacy computer systems with a new vertically-integrated Enterprise Resource Planning (ERP) system. We experienced technical and operational issues in our plants and supply chain as we ramped up the new system, which led to delivery delays and inconveniences for our customers. The lost sales and higher costs due to increased cancellations, appeasements and returns, negatively impacted our financial results in 2015. Through the filing date of this document, we have made progress resolving technical and operational issues associated with the ERP implementation. While we continue to learn to use the new system proficiently and at higher volumes, the system is operating at near normal levels across our vertical enterprise.

Proprietary Sleep Innovations
  
Sleep Number® Bed

Unlike the “one-size-fits-all” solution offered by other mattress brands, the Sleep Number bed offers individualized comfort that is adjustable on each side of the bed. Our proprietary DualAir™ technology, which features two independent air chambers, allows couples to adjust firmness to their own individual preference at the touch of a button. Sleepers can each enjoy their ideal firmness, support and pressure-relieving comfort - their Sleep Number® setting - for deep, restful sleep.
  
The benefits of our proprietary Sleep Number bed have been validated through clinical sleep research, which has shown that participants who slept on a Sleep Number bed generally fell asleep faster, experienced more deep sleep with fewer disturbances and experienced greater relief from back pain than those sleeping on a traditional innerspring mattress.
  
We offer Sleep Number beds in good, better and best price ranges within the premium mattress category, and in a broad range of sizes, including twin, full, queen, eastern king and California king.

The Classic Series offers Sleep Number adjustability starting at $799 for a queen mattress. The series includes the Sleep Number c2 and c4 beds.
The Performance Series includes our most popular mattresses with a perfect balance of softness and pressure-relieving support. The series includes the Sleep Number p5 and p6 beds.
The Memory Foam Series is breathable and contouring. The series includes the Sleep Number m6 and m7 beds.
The Innovation Series is the ultimate in individualized comfort and temperature-balancing innovation. The series includes the Sleep Number i8 and i10 beds.
The Sleep Number x12 bed features the integration of multiple technology options including our exclusive FlexFit™ 3 adjustable base, and our breakthrough SleepIQ® technology - Probably the Best Bed in the World®.
The SleepIQ Kids™ bed features our core adjustability and SleepIQ technology to the children’s mattress market and is the only bed that adjusts with children as they grow.

In December 2015, J.D. Power announced that Sleep Number ranked highest in customer satisfaction with mattresses. The J.D. Power 2015 Mattress Satisfaction Report measured customer satisfaction with mattress purchases based on seven factors: comfort, price, support, durability, warranty, features and customer service. Sleep Number achieved an overall satisfaction index score of 878, which is 43 points above the industry average of 835. In addition, Sleep Number achieved the highest score in the price, warranty and features study factors.

SleepIQ® Technology

SleepIQ® technology was introduced on our Sleep Number x12 bed in January 2014. This breakthrough advancement in sleep technology is an illustration of Sleep Number’s innovation leadership. The Sleep Number bed is the only bed that lets you track and optimize your sleep with SleepIQ technology. Sensors work directly with Sleep Number’s proprietary Advanced DualAir™ technology to comprehensively track each person's sleep quality and provide a SleepIQ® score and other information each morning to allow the sleeper to make knowledgeable adjustments to their Sleep Number setting or daily routine. It empowers the sleeper to

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achieve their best possible sleep each night. SleepIQ technology measures your average breathing rate, average heart rate, movement, and presence in bed using a proprietary full-body algorithm to compute quality of sleep. SleepIQ technology is available on all Sleep Number beds and can also be added to Sleep Number beds purchased after 2008.

SleepIQ Kids™ Bed

In January 2015, we introduced the SleepIQ Kids™ bed, which extends Sleep Number’s core adjustability technology and SleepIQ technology to the children’s mattress market. It is the only bed that adjusts with children as they grow, using effortless technology to empower parents and children with a combination of sleep knowledge and adjustability. The SleepIQ Kids bed uses sensors that work directly with Sleep Number DualAir technology (including adjustable air chamber and Firmness Control™ system) to adjust the child’s bed for individualized comfort.

The it™ bed

In January 2016, we introduced our latest innovation, the it™ bed, at the International Consumer Electronics Show (CES). It effortlessly quantifies your sleep, connects to select applications and has predictive modeling that makes suggestions to improve your sleep. The it™ bed is designed for a millennial customer (a market segment currently underrepresented in Sleep Number sales) who believes quality sleep is essential to their health, well-being and overall performance. The it™ bed will be exclusive to Sleep Number and will be available at itbed.com for around $1,000 later in 2016. The it™ bed will feature the latest release of SleepIQ® technology, which will use adaptive algorithms and predictive modeling to recommend adjustments to daily habits and environment. It also features ActiveComfort™ technology - the it™ bed has dual, foam-filled air chambers that respond to individuals’ constantly changing needs and adjusts to an ideal level of comfort, firmness and support. The bed also includes SleepIQ® API (application program interface), which allows the bed to connect to other applications and cloud services.

Sleep Number® Bedding Collection

Our exclusive Sleep Number bedding collection is a proprietary line of sleep products that are designed to meet each individual's needs and therefore solve sleep issues. Create Your Perfect PillowSM and our AirFit® pillow adjust to an individual's size, shape and sleeping position for more comfortable sleep. The pillows are available in our exclusive CoolFit™ foam, memory fiber or goose down. We also offer Create Your Perfect ComforterSM and a wide assortment of temperature-balancing products.

In 2013, we introduced the DualTemp™ layer, a new sleep innovation that addresses one of the most significant sleep issues experienced by customers: sleeping too hot or sleeping too cold. The DualTemp layer features active air technology that allows each person to select his or her ideal temperature at the simple touch of a button. The DualTemp layer can be used with any mattress brand or adjustable base.

FlexFit™ Adjustable Base Technology

We offer a full line of FlexFit adjustable bases that enable customers to raise the head or foot of the bed, and to experience the comfort of massage, using a handheld remote control. Our PartnerSnore™ technology lets a user gently raise their partner’s head to relieve common snoring.

Exclusive Distribution
  
Unlike traditional mattress manufacturers, which primarily sell through third-party retailers, more than 98% of our net sales are directly to consumers through our Sleep Number® stores or on SleepNumber.com.
  
Over the past five years, we have strengthened our national real estate footprint through new stores, expansions and relocations. We target high-quality, convenient, visible store locations based on several factors, including each market’s overall sales potential, store geographic location, demographics and proximity to other specialty retail stores. As the exclusive distributor of Sleep Number® products with premium positioning at price points of $1,000 and up, we target one store per 350,000 - 500,000 people. This places our stores within an average radius of 10 miles, or 20-minute drive times, for most of our target customers.

Historically, our retail stores have been located only in shopping malls. In 2010, we began operating in off-mall locations. The off-mall store format complements our existing mall-based stores and provides more flexibility to our real estate strategy to best serve our customer.

Our store design and improved real estate locations support our value-added retail experience, which results in high store productivity and profitability. Our sales-per-square-foot productivity ranks in the top 10 of U.S. specialty retail brands, at nearly $1,000 per foot

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and we average more than $650,000 in annual net sales per full-time retail employee. We now have almost 20% of our store base delivering more than $3 million in annual net sales. Since 2010, we have increased our average store size by more than 64% to 2,445 square feet.

As of January 2, 2016, we had 488 retail stores in 48 U.S. states, 44% of which were in off-mall locations. We expect to grow our retail store portfolio by 10% during 2016.

Our retail stores accounted for 92% of our net sales in 2015. Average annual net sales per comparable store were $2.4 million in 2015, $2.3 million in 2014 and $2.1 million in 2013. In 2015, 99% of our stores open for a full year generated net sales over $1.0 million and 62% of our stores open for a full year generated net sales over $2.0 million. Our online and call center sales accounted for 6% of our net sales in 2015.

Marketing

We use a variety of marketing and advertising vehicles to drive customer traffic to our brand, to educate and to acquire new customers. Our marketing efforts target a broad customer demographic: 30-54 years old with greater than $75,000 household income for our core line of products. Our customers care about their own and their family's health and well-being, and know that quality sleep is a key factor.
    
Marketing drives growth in our business by building consumer awareness and consideration of our sleep innovations, and increasing traffic to our stores and website, while building our brand image. We communicate with our existing and potential new customers through a mix of national and local marketing that supports our national store portfolio. We use an integrated approach to the media mix that includes television, digital, social, radio, direct mail, email, newspaper inserts, in-store, out-of-home and public relations. We continue to align our media mix and advertising spend with our target customer, moving into more productive TV, digital and social media. In 2015, media expense represented 14.9% of net sales.

Our website is designed to promote consumer awareness and consideration and engagement for the brand, facilitate product research, generate store traffic and provide customer support and service, as well as execute online purchases. We launched a new web platform in 2014, which features a modern, responsive design with easy mobile navigation. These improvements, along with relevant digital content, help consumers learn about our brand and proprietary products, easily find our stores and shop online. Year-over-year unique visitors to sleepnumber.com increased 51 percent.

In 2014, we launched our Know Better Sleep® campaign, which features the consumer benefits of our latest sleep innovations. In 2015, we evolved our marketing and advertising, which has increased brand consideration and traffic from a broader base. Our new customer growth reflects younger, more affluent customers in addition to our historical core customer base. We introduced a new suite of TV commercials and we are benefiting from the efficiency of national, broad reach television advertising that supports our national store footprint. This efficiency helps fund local advertising for our aggressive growth and other high-potential markets.

Operations
  
Manufacturing and Distribution

We have two manufacturing plants located in Irmo, South Carolina and Salt Lake City, Utah, which distribute Sleep Number® products. 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 bases. In addition, our electrical Firmness Control™ systems are assembled in our Utah plant.

We have one manufacturing plant in Greenville, South Carolina that distributes Comfortaire® products. The manufacturing operations consist of final assembly and packaging of mattresses and bases.

We obtain all of the raw materials and components used to produce our beds from outside sources. A number of components, including our proprietary air chambers, our proprietary blow-molded foundations, our adjustable foundations, various components for our Firmness Control systems, as well as fabrics and zippers, are sourced from suppliers who currently serve as our sole or primary source of supply for these components. We believe we can obtain these raw materials and components from other sources of supply, although we could experience some short-term disruption in our ability to fulfill orders in the event of an unexpected loss of supply from one of the primary suppliers. We utilize dual sourcing on targeted components when effective.

We have taken, and continue to take, various measures to mitigate the potential impact of an unexpected disruption in supply from any sole-source suppliers, including increasing safety stocks and identifying potential secondary sources of supply. All of the suppliers that

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produce unique or proprietary products for us have in place either contingency or disaster recovery plans or redundant production capabilities in other locations in order to safeguard against any unforeseen disasters. We review these plans and sites on a regular basis to ensure the supplier's ability to maintain an uninterrupted supply of materials and components.

Historically, we manufactured beds primarily on a just-in-time basis to fulfill orders rather than stocking inventory, which enabled us to maintain lower levels of finished goods inventory and operate with limited regional warehousing. Over the past 18 months, we have migrated our fulfillment process to a hybrid "make-to-stock" model, wherein our best selling products are forward stocked in distribution centers closer to customers. Together with our new ERP system, this hybrid model will enable us to improve our customer experience with shorter delivery times. Products are generally received by the customer within five to 14 days from the date of order.
  
Home Delivery Service
  
We offer Comfort ServiceSM home delivery and setup, which includes assembly and mattress removal. In selected markets, we provide home delivery, assembly and mattress removal services through third-party providers. Approximately 83% of beds sold through our Company-Controlled channel in 2015 were delivered by our full-service home delivery team or by our third-party service providers.
  
Customer Service
  
We maintain an in-house customer service department staffed by teams of specialists that provide service and support via phone, email, “live chat” and social media. Our customer service team is central to an ongoing relationship with our customers.  Direct access to our customers is a unique advantage that also provides insights and identifies emerging trends as we strive to continuously improve our product and service quality and advance our product innovation.
  
Research and Development
  
As a consumer-driven innovation company, Sleep Number conducts extensive research to understand consumer needs. This research informs the design and delivery of our sleep innovations and our customer experience. We have a robust product development organization that fuels our innovations, and in 2015 we acquired BAM Labs, Inc. (now operating as SleepIQ LABS), a leading provider of biometric sensor and sleep monitoring for data-driven health and wellness. This is significant as consumers are rapidly adopting new digital tools and using their personal data to improve health and wellness. Technology that improves the quality of sleep and overall wellness will continue to be a top priority for Sleep Number. Our research and development expenses were $16.0 million in 2015, $8.2 million in 2014 and $9.5 million in 2013.
  
Management Information Systems
  
We use information technology systems to operate, analyze and manage our business, to reduce operating costs and to enhance our customers' experience. Our major systems include an in-store order entry system, a retail portal system, a payment processing system, in-bound and out-bound telecommunications systems for direct marketing, delivery scheduling and customer service, E-Commerce systems, a data warehouse system and an enterprise resource planning system. These systems are primarily comprised of packaged applications licensed from various software vendors plus a limited number of internally developed programs. We have recently completed a multi-year project to upgrade our core information technology systems, which we launched in October 2015. Please refer to the information set forth under the caption “Risk Factors” below for a discussion of certain risks that may be encountered in connection with the upgrade of our information technology systems.
  
Intellectual Property
  
We hold various U.S. and foreign patents and patent applications regarding certain elements of the design and function of our products, including air control systems, remote control systems, air chamber features, mattress construction, foundation systems, sensing systems, as well as other technology. We have 31 issued U.S. patents, expiring at various dates between July 2017 and March 2034, and 39 U.S. patent applications pending. We also hold 27 foreign patents and have 57 foreign patent applications pending. Notwithstanding these patents and patent applications, we cannot ensure that these patent rights will provide substantial protection or that others will not be able to develop products that are similar to or competitive with our products.
  
We have a number of trademarks and service marks registered with the U.S. Patent and Trademark Office, including Sleep Number®, Select Comfort®, SleepIQ®, the Double Arrow logo, AirFit®, Bam LABS®, the “B” logo, Comfortaire®, ComfortFit®, Comfort.Individualized.®, the DualTemp logo, the DualAir Technology Inside logo, FlexTop®, IndividualFit®, Individualized Sleep Experiences®, Know Better Sleep®, LuxFit®, Pillow[ology]®, PillowFit®, PlushFit®, Probably the Best Bed in the World®, Sleep Number Inner Circle®, Tech-e®, Smart Bed Technology®, The Only Bed That Knows You®, We Make Beds Smart®, and What’s Your Sleep Number?®. We have several trademarks that are the subject of pending applications, including SleepIQ Kids™, SleepIQ LABS™, Sleep for the FutureSM, Smart Bed For Smart Kids™, It™, The It Bed™, The Only Bed That Grows With Them™, and Tonight Bedtime. Tomorrow The World™.  Each registered mark is renewable indefinitely as long as the mark remains in use. We also have a number of common law trademarks, including ActiveComfort™, CoolFit™, DualAir™, DualTemp™, Firmness Control™, FlexFit™, In Balance™, PartnerSnore™, the SleepIQ LABS logo, The Bed That Moves You™ and our bed model names. We are not

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aware of any material claims of infringement that may be asserted against us or any material challenges that may be asserted against our right to use these marks.

Industry and Competition

The U.S. bedding industry is a mature and generally stable industry. According to the International Sleep Products Association (ISPA), since 1984 the bedding manufacturing industry has consistently demonstrated growth on a dollar basis, with a 0.3% decline in 2001, 9.1% decline in 2008 and 9.4% decline in 2009 being the only exceptions. According to ISPA, industry wholesale shipments of mattresses and foundations were estimated to be $8.0 billion in 2015 compared to $7.5 billion in 2014. We estimate that traditional innerspring mattresses represent approximately 70% of total U.S. bedding sales (based on 2014 sales). Furniture/Today, a furniture industry trade publication, has ranked Select Comfort as the fifth largest mattress manufacturer and third largest U.S. bedding retailer for 2014, with a 5.2% market share of industry revenue and 1.6% market share of industry units.

Over the 5-year, 10-year and 20-year periods ended 2015, the value of U.S. wholesale bedding shipments increased at compound annual growth rates of 6.3%, 2.1% and 4.7%, respectively. We believe that industry unit growth has been primarily driven by population growth, an increase in the number of homes (including secondary residences) and the increased size of homes. We believe growth in average wholesale prices resulted from a shift to both larger and higher-quality beds, which are typically more expensive.

Several newer competitors in the mattress industry have begun to offer “bed-in-a-box” or similar entry-level and higher-end products directly to consumers through the Internet and other distribution channels.

The bedding industry is very competitive. Participants in the bedding industry compete primarily on price, quality, brand name recognition, product availability and product performance, including the perceived levels of comfort and support provided by a mattress. There is a high degree of concentration among the largest manufacturers of innerspring bedding with nationally recognized brand names, including Tempur Sealy, Stearns & Foster, Serta and Simmons. Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the innerspring bedding market. Tempur Sealy and a number of other mattress manufacturers offer foam mattress products. The retail bedding industry is also highly competitive. Our Company-Controlled distribution channel, which includes our retail stores, competes against regional and local specialty bedding retailers, home furnishing stores, mass merchants and national discount stores. We compete principally on the differentiation and quality of our products.

Governmental Regulation and Environmental Matters

Our operations are subject to federal and state consumer protection and other regulations relating to the bedding industry and retailers generally. The bedding regulations vary among the jurisdictions in which we do business, but generally include requirements as to the proper labeling of bedding merchandise.
 
The bedding industry is subject to federal fire retardant standards developed by the U.S. Consumer Product Safety Commission, which became effective nationwide in July 2007. Compliance with these requirements has increased the cost and complexity of manufacturing our products. These regulations also result in higher product development costs as new products must undergo rigorous flammability testing.
 
We are subject to federal regulations adopted in 2010 that restrict the types of credit-based promotional offerings that retailers are allowed to make available to consumers.

Our direct marketing and internet-based marketing operations are or may become subject to various adopted or proposed federal and state “do not call” and “do not mail” list requirements, limiting our ability to market our products directly to consumers over the telephone, by e-mail or by regular mail. Additionally, existing federal laws governing telephone and mail order sales may be extended to encompass all internet sales, imposing compliance obligations on the timing of shipments as well as provisions of refunds to consumers.

We are subject to emerging federal, state and foreign data privacy regulations related to the safeguarding of sensitive customer and employee data, which may drive increased costs in our information systems infrastructure.

We are subject to federal and state labor laws, including but not limited to laws relating to occupational health and safety, employee privacy, wages and hours, overtime pay, harassment and discrimination, equal opportunity, and employee leaves and benefits.

We are subject to federal and state laws and regulations relating to pollution and environmental protection. We may also be subject to similar laws in foreign jurisdictions if we expand our operations internationally.

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Our retail pricing policies and practices are subject to antitrust regulations in the U.S., and we may become subject to similar laws in other jurisdictions where we may sell our products in the future.
  
We are or may become subject to various adopted or proposed federal and state laws and regulations relating to supply chain transparency with respect to the sourcing of conflict minerals and labor conditions maintained by suppliers, which may result in increased compliance costs and increased component costs.
  
Adopted or proposed legislation in various states would impose responsibilities with respect to end-of-life disposal of various consumer or durable goods on the manufacturers and/or retailers of such goods, including mattresses. To the extent that any such legislation becomes effective in the states in which we sell or have sold mattresses and related products, we may be required to incur significant costs and operational changes in order to comply with these requirements, which may adversely impact our profitability, cash flows and financial condition.
  
Although we believe that we are in compliance in all material respects with these regulations and have implemented a variety of measures to promote continuing compliance, regulations may change over time, and we may be required to incur expenses and/or to modify our operations in order to ensure compliance with these regulations, which could harm our profitability and financial condition. If we are found to be in violation of any of the foregoing laws or regulations, we could become subject to fines, penalties, damages or other sanctions, as well as potential adverse public relations, which could adversely impact our business, reputation, sales, profitability and financial condition.
  
We are not aware of any national or local provisions which have been enacted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, that have materially affected, or will materially affect, our net income or competitive position, or will result in material capital expenditures. During fiscal 2015, there were no material capital expenditures for environmental control facilities, and no such material expenditures are anticipated.
  
Customers
  
No single customer accounts for 10% or more of our net sales.
  
Seasonality
  
Our business is modestly impacted by seasonal influences inherent in the U.S. bedding industry and general retail shopping patterns. The U.S. bedding industry generally experiences lower sales in the second quarter and increased sales during selected holiday or promotional periods.
  
Working Capital
  
Selling directly to our customers, with a primarily hybrid "make-to-stock" production process in our plants, and with retail stores that serve mainly as showrooms, allows us to maintain low inventory levels and operate with minimal working capital requirements. We have historically generated sufficient cash flows to self-fund operations through an accelerated cash-conversion cycle. As of March 1, 2016, we had $150 million available under our $150 million credit facility (amended in February 2016) which contains an accordion feature that allows us to increase the amount of the line up to $200 million in total availability, subject to lender approval.
  
Qualified customers are offered revolving credit to finance purchases through a private-label consumer credit facility provided by Synchrony Bank. Approximately 46% of our net sales in 2015 were financed by Synchrony Bank. Our current agreement with Synchrony Bank expires December 31, 2020, subject to earlier termination upon certain events and subject to automatic extensions. We pay Synchrony Bank a fee for extended credit promotional financing offers. Under the terms of our agreement, Synchrony Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures. As the receivables are owned by Synchrony Bank, at no time are the receivables purchased or acquired from us. We are not liable to Synchrony Bank for our customers' credit defaults. In connection with all purchases financed under these arrangements, Synchrony Bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts, upon delivery to the customer. Customers that do not qualify for credit under our agreement with Synchrony Bank may apply for credit under a secondary program that we offer through another provider.
  
Employees
  
At January 2, 2016, we employed 3,484 persons, including 1,824 retail sales and support employees, 260 direct marketing and customer service employees, 974 manufacturing and logistics employees, and 426 management and administrative employees. Approximately 107 of our employees were employed on a part-time or temporary basis at January 2, 2016. Except for managerial employees and professional support staff, all of our employees are paid on an hourly basis (plus commissions for sales professionals). None of our employees is represented by a labor union or covered by a collective bargaining agreement. In recent periods we have focused on improving our employee engagement levels, which we believe is important to driving both organizational productivity and customer satisfaction.

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Executive Officers of the Registrant

SHELLY R. IBACH, 56
President and Chief Executive Officer (Joined the Company in April 2007 and was promoted to President and CEO in June 2012)
Shelly R. Ibach, SLEEP NUMBER® setting 40, is President and Chief Executive Officer (CEO) for Select Comfort (NASDAQ: SCSS). From June 2011 to June 2012, Ms. Ibach served as the company’s Executive Vice President and Chief Operating Officer and from October 2008 to June 2011, she served as Executive Vice President, Sales & Merchandising. Ms. Ibach joined the company in April 2007 as Senior Vice President of U.S. sales for company-owned channels. Before joining the company, Ms. Ibach was Senior Vice President and General Merchandise Manager for Macy’s home division. From 1982 to 2005, Ms. Ibach held various leadership and executive positions within Marshall Field’s Department Stores - Target Corporation.

MELISSA BARRA, 44
Senior Vice President, Chief Strategy and Customer Relationship Officer (Joined the Company in 2013 and was promoted to current role in January 2015)
Melissa Barra, SLEEP NUMBER® setting 30, serves as the Senior Vice President, Chief Strategy and Customer Relationship Officer. Ms. Barra was Vice President, Consumer Insights and Strategy from February 2013 to January 2015. Prior to joining Select Comfort in February 2013, Ms. Barra was Vice President, Process Reengineering Officer for Best Buy Co., Inc. from 2011 to 2012. In a dual role, she also served as Vice President, Finance, New Business Customer Solutions Group from 2010 to 2012. From 2005 to 2010, she held leadership positions in Strategic Alliances and Corporate Development for Best Buy. Prior to Best Buy, Ms. Barra held corporate finance and strategy leadership roles in companies in the US and internationally, including Grupo Futuro S.A., Citibank, and GE Capital.

ANNIE L. BLOOMQUIST, 46
Senior Vice President and Chief Product Officer (Joined the Company in 2008 and was promoted to current role in June 2012)
Annie L. Bloomquist, SLEEP NUMBER® setting 35, serves as the Senior Vice President and Chief Product Officer for Select Comfort and leads product innovation including product management, development, merchandise buying and R&D for all Sleep Number products. Ms. Bloomquist was the Chief Product and Merchandising Officer from June 2011 to June 2012. Ms. Bloomquist joined Select Comfort in May 2008 as Vice President and General Merchandise Manager. Prior to joining Select Comfort, Ms. Bloomquist held leadership positions in product and merchandising at Macy’s and Marshall Field’s Department Stores for Target Corporation from 1996 to 2008.

KEVIN K. BROWN, 47
Senior Vice President and Chief Marketing Officer (Joined the Company in 2013)
Kevin K. Brown, SLEEP NUMBER® setting 40, serves as the Senior Vice President and Chief Marketing Officer for Select Comfort. Prior to joining Select Comfort in January 2014, Mr. Brown served as Group Vice President, Chief Marketing Officer for Meijer, Inc., a regional chain of retail supercenters, from 2011 to 2013. From 2007 to 2011, Mr. Brown held executive marketing leadership roles at Sears Holdings Corporation, including Vice President, Chief Marketing Officer for the home appliances business unit. Previously, Mr. Brown held the position of Senior Vice President, Marketing for Jo-Ann Stores, Inc., from 2004 to 2006. Prior to Jo-Ann Stores, he was an associate partner for Accenture.

DAVID R. CALLEN, 49
Senior Vice President and Chief Financial Officer (Joined the Company in 2014)
David R. Callen, SLEEP NUMBER® setting 40, serves as the Senior Vice President and Chief Financial Officer for Select Comfort. Prior to joining Select Comfort in April 2014, Mr. Callen served as the Principal Financial Officer, Vice President, Finance and Treasurer for Ethan Allen Interiors, Inc., from 2007 to 2014. Previously, Mr. Callen served as Vice President of Global Finance of Phototronics, Inc., and was Corporate Controller of Johnson Outdoors, Inc.

ANDY P. CARLIN, 52
Senior Vice President and Chief Sales Officer (Joined the Company in 2008 and was promoted to current role in June 2012)
Andy P. Carlin, SLEEP NUMBER® setting 55, serves as the Senior Vice President and Chief Sales Officer for Select Comfort and leads all sales channels and real estate. From May 2011 to June 2012 Mr. Carlin was the Vice President and Chief Sales Officer, and from January 2009 to May 2011 he was the Vice President of U.S. Retail Sales. Mr. Carlin joined Select Comfort in January 2008 as Regional Vice President, East Region. Prior to joining Select Comfort, Mr. Carlin spent more than 20 years in sales leadership roles for companies including Senior Vice President of Store Operations at Gander Mountain from 2003 to 2008, Kohl’s Department Stores from 1995 to 2003 and Target Corporation from 1986 to 1995.
 

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PATRICIA A. DIRKS, 59
Senior Vice President and Chief Human Capital Officer (Joined the Company in 2014)
Patricia A. Dirks (Tricia), SLEEP NUMBER® setting 35, serves as the Senior Vice President and Chief Human Capital Officer for Select Comfort and leads all human capital functions. Prior to joining Select Comfort in April 2014, Ms. Dirks served as Senior Vice President of Organizational Effectiveness for Target Corporation. From 2004 to 2011, Ms. Dirks was Vice President Human Resources for Target Corporation. Prior to 2004, Ms. Dirks held various human resources leadership positions at Marshall Field’s Department Stores for Target Corporation, including Senior Vice President of Human Resources.

MARK A. KIMBALL, 57
Senior Vice President and Chief Legal and Risk Officer and Secretary (Joined the Company in 1999)
Mark A. Kimball, SLEEP NUMBER® setting 55, currently serves as Select Comfort’s Senior Vice President and Chief Legal and Risk Officer and Secretary. From August 2003 to June 2011, Mr. Kimball held the position of Senior Vice President, General Counsel, Chief Administrative Officer and Secretary. From July 2000 to August 2003, Mr. Kimball served as Senior Vice President, Human Resources and Legal, General Counsel, Chief Administrative Officer and Secretary. From May 1999 to July 2000, Mr. Kimball served as the company’s Senior Vice President, Chief Administrative Officer, General Counsel and Secretary. For more than five years prior to joining Select Comfort, Mr. Kimball was a partner in the law firm of Oppenheimer Wolff & Donnelly LLP practicing in the area of corporate finance.

KATHRYN V. ROEDEL, 55
Executive Vice President and Chief Services and Fulfillment Officer (Joined the Company in 2005 and was promoted to current role in October 2008)
Kathryn V. Roedel, SLEEP NUMBER® setting 35, currently serves as Select Comfort’s Executive Vice President and Chief Services and Fulfillment Officer. From October 2008 to June 2011, Ms. Roedel served as Select Comfort’s Executive Vice President, Product and Service. Ms. Roedel joined Select Comfort as the company’s Senior Vice President, Global Supply Chain in April 2005. From 2003 to March 2005, Ms. Roedel served as the General Manager, Global Supply Chain Strategy for GE Medical Systems. From 1983 to 2003, she held leadership positions within two divisions of General Electric Company, in Sourcing, Manufacturing, Quality and Service. Other key positions included General Manager, Global Quality and Six Sigma; Vice President of Technical Operations and Director/Vice President of Quality Programs for GE Clinical Services, a division of GE Medical Systems.

J. HUNTER SAKLAD, 46
Senior Vice President, Chief Information Officer (Joined the Company in 2004 and was promoted to current role in December 2012)
Hunter Saklad, SLEEP NUMBER® setting 50, is the Senior Vice President, Chief Information Officer at Select Comfort. From June 2011 to December 2012, he served as the Vice President, Consumer Insight and Strategy at Select Comfort. From March 2006 to June 2011 he was Vice President of Finance and held a variety of positions across Finance serving business partners in marketing, sales, supply chain, FP&A, investor relations and treasury. Mr. Saklad joined Select Comfort in October 2004 as Sr. Director of Finance. Prior to joining Select Comfort, Mr. Saklad held finance-leadership roles at Ford Motor Company and Visteon.




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Available Information

We are subject to the reporting requirements of the Exchange Act and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Copies of our reports, proxy statements and other information can be read and copied at:

SEC Public Reference Room
100 F Street NE
Washington, D.C. 20549

Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC’s home page at http://www.sec.gov.

Our corporate Internet website is www.SleepNumber.com. Through a link to a third-party content provider, our corporate website provides free access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after electronic filing with the SEC. These documents are posted on our website at www.SleepNumber.com — select the "About" link and then the “Investor Relations” link. The information contained on our website or connected to our website is not incorporated by reference into this Form 10-K and should not be considered part of this report.

We also make available, free of charge on our website, the charters of the Audit Committee, Management Development and Compensation Committee, and Corporate Governance and Nominating Committee as well as our Code of Business Conduct (including any amendment to, or waiver from, a provision of our Code of Business Conduct) adopted by our Board. These documents are posted on our website — select the "About Us" link, the “Investor Relations” link and then the “Corporate Governance” link.

Copies of any of the above referenced information will also be made available, free of charge, upon written request to:

Select Comfort Corporation
Investor Relations Department
9800 59th Avenue North
Minneapolis, MN 55442


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ITEM 1A. RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the specific risks set forth below and other matters described in this Annual Report on Form 10-K before making an investment decision. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties, including risks and uncertainties not presently known to us or that we currently see as immaterial, may also harm our business. If any of these risks occur, our business, results of operations, cash flows and financial condition could be materially and adversely affected.

Current and future economic conditions could materially adversely affect our sales, profitability, cash flows and financial condition.

Our success depends significantly upon discretionary consumer spending, which is influenced by a number of general economic factors, including without limitation economic growth, consumer confidence, the housing market, employment and income levels, interest rates, inflation, taxation and the level of customer traffic in malls and shopping centers. Adverse trends in any of these economic factors may adversely affect our sales, profitability, cash flows and financial condition. Continued adverse impacts from the ERP implementation may adversely affect our sales, profitability, cash flows and financial condition.

Our future growth and profitability depends upon the effectiveness and efficiency of our marketing programs.

We are highly dependent on the effectiveness of our marketing messages and the efficiency of our advertising expenditures in generating consumer awareness and sales of our products. We continue to evolve our marketing strategies, adjusting our messages, the amount we spend on advertising and where we spend it. We may not always be successful in developing effective messages, as the consumer and competition changes, and in achieving efficiency in our advertising expenditures.

Consumers are increasingly using digital tools as a part of their shopping experience. As a result, our future growth and profitability will depend in part on (i) the effectiveness and efficiency of our on-line experience including advertising and search optimization programs in generating consumer awareness and sales of our products, (ii) our ability to prevent confusion among consumers that can result from search engines that allow competitors to use or bid on our trademarks to direct consumers to competitors’ websites, (iii) our ability to prevent Internet publication of false or misleading information regarding our products or our competitors’ products; (iv) the nature and tone of consumer sentiment published on various social media sites; and (v) the stability of our website.

If our marketing messages are ineffective or our advertising expenditures and other marketing programs, including digital programs, are inefficient in creating awareness and consideration of our products and brand name, in driving consumer traffic to our website or stores, our sales, profitability, cash flows and financial condition may be adversely impacted. In addition, if we are not effective in preventing the publication of confusing, false or misleading information regarding our brand or our products, or if there was significant negative consumer sentiment on social media regarding our brand or our products, our sales, profitability, cash flows and financial condition may be adversely impacted.


Our future growth and profitability depends on our ability to execute our Company-Controlled distribution strategy.

The vast majority of our sales occur through our Company-Controlled distribution channel, including our retail stores, and this Company-Controlled distribution channel represents our largest opportunity for growth in sales and improvement in profitability. Our retail stores carry significant fixed costs. We also make significant capital expenditures as we open new stores and remodel or reposition existing stores. We are highly dependent on our ability to maintain and increase sales per store to cover these fixed expenses, provide a return on our capital investments and improve our operating margins.

Our stores are largely mall-based. We depend on the continued popularity of malls as shopping destinations and the ability of mall anchor tenants and other attractions to generate customer traffic for our retail stores. Any decrease in mall traffic could adversely affect our sales, profitability, cash flows and financial condition.

Our Company-Controlled distribution strategy results in relatively few points of distribution, including approximately 490 retail stores across the continental United States as of the end of 2015. Several of the mattress manufacturers and retailers with which we compete have significantly more points of distribution than we do, which makes us highly dependent on our ability to drive consumers to our points of distribution in order to gain market share.


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Our longer term Company-Controlled distribution strategy is also dependent on our ability to renew existing store leases and to secure suitable locations for new store openings, in each case on a cost-effective basis. We may encounter higher than anticipated rents and other costs in connection with managing our retail store base, or may be unable to find or obtain suitable new locations.

Failure to achieve and maintain a high level of product quality could negatively impact our sales, profitability, cash flows and financial condition.

Our products represent a significant departure from traditional innerspring mattresses and from viscoelastic foam mattresses, which have little or no technology and do not rely on electronics and air control systems. As a result, our beds may be susceptible to failures that do not exist with traditional or viscoelastic foam mattresses. Failure to achieve and maintain acceptable quality standards could impact consumer acceptance of our products or could result in negative media and Internet reports or owner dissatisfaction that could negatively impact our brand image and sales levels.

In addition, a decline in product quality could result in an increase in return rates and a corresponding decrease in sales, or an increase in product warranty claims in excess of our warranty reserves. An unexpected increase in return rates or warranty claims could harm our sales, profitability, cash flows and financial condition.

As a consumer innovation company with differentiated products, we face an inherent risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in personal injury or property damage. In the event that any of our products proves to be defective, we may be required to recall or redesign such products. We have at times experienced increased returns and adverse impacts on sales, as well as product liability litigation, as a result of media reports related to the alleged propensity of our products to develop mold. We may experience additional adverse impacts on sales and additional litigation in the event any similar media reports were to occur in the future. We maintain insurance against some forms of product liability claims, but such coverage may not be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our sales, profitability, cash flows and financial condition.


Our future growth and profitability depends in part on our ability to continue to improve and expand our product line.

As described in greater detail below, the mattress industry, as well as the market for sleep monitoring products, are both highly competitive, and our ability to compete effectively and to profitably grow our market share depends in part on our ability to continue to improve and expand our product line of adjustable firmness air beds, SleepIQ® technology and related accessory products. We incur significant research and development and other expenditures in the pursuit of improvements and additions to our product line. If these efforts do not result in meaningful product improvements or new product introductions, or if we are not able to gain widespread consumer acceptance of product improvements or new product introductions, our sales, profitability, cash flows and financial condition may be adversely affected. In addition, if any significant product improvements or new product introductions are not successful, our reputation and brand image may be adversely affected.

Significant competition could adversely affect our business.

Because of the vertical integration of our business model, our products and distribution channels face significant competition from both manufacturers of different types of mattresses and a variety of retailers. Our SleepIQ® technology also faces significant competition from various manufacturers and retailers of sleep tracking and monitoring products.

The mattress industry is characterized by a high degree of concentration among the largest manufacturers of innerspring mattresses and viscoelastic foam mattresses and one dominant national mattress retailer. Several newer competitors in the mattress industry have begun to offer “bed-in-a-box” or similar entry-level products directly to consumers through the Internet and other distribution channels.

Our national, exclusive distribution competes with other retailers who generally provide a wider selection of mattress alternatives than we offer. A number of these retailers also have more points of distribution and greater brand name recognition than we do.

A variety of sleep tracking and monitoring products that compete with our SleepIQ® technology have been introduced by various manufacturers and retailers, both within and outside of the traditional mattress industry.

Some of the manufacturers and retailers that we compete with have substantially greater financial, marketing and manufacturing resources and better brand name recognition than we do and sell products through broader and more established distribution channels.

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These manufacturing and retailing competitors, or new entrants into the market, may compete aggressively and gain market share with existing or new products, and may pursue or expand their presence in the adjustable firmness air bed segment of the market as well as in the market for sleep tracking and monitoring products. We have limited ability to anticipate the timing and scale of new product introductions, advertising campaigns or new pricing strategies by our competitors, which could inhibit our ability to retain or increase market share, or to maintain our product margins.

If we are unable to effectively compete with other manufacturers and retailers of mattress and sleep tracking and monitoring products, our sales, profitability, cash flows and financial condition may be adversely impacted.

Our intellectual property rights may not prevent others from using our technology or trademarks in connection with the sale of competitive products. We may be subject to claims that our products, processes or trademarks infringe intellectual property rights of others.

We own various U.S. and foreign patents and patent applications related to certain elements of the design and function of our beds and related products. We also own several registered and unregistered trademarks and trademark applications, including in particular our Sleep Number trademarks, which we believe have significant value and are important to the marketing of our products. These intellectual property rights may not provide sufficient protection against infringement or piracy and may not prevent our competitors from developing and marketing products that are similar to or competitive with our beds or other products. Our patents are also subject to varying expiration dates. In addition, the laws of some foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States. If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology or trademarks in connection with competitive products, which could adversely affect our sales, profitability, cash flows and financial condition.

We may be subject to claims that our products, processes or trademarks infringe the intellectual property rights of others. The defense of these claims, even if we are ultimately successful, may result in costly litigation, and if we are not successful in our defense, we could be subject to injunctions, liability for damages or royalty obligations and our sales, profitability, cash flows and financial condition could be adversely affected.

A reduction in the availability of credit to consumers generally or under our existing consumer credit programs could harm our sales, profitability, cash flows and financial condition.

A significant percentage of our sales are made under consumer credit programs through third parties. The recent economic downturn resulted in a reduction of credit available to consumers as macroeconomic factors impacted the financial position of consumers and as suppliers of credit adjusted their lending criteria. In addition, changes in federal regulations effective in 2010 placed additional restrictions on all consumer credit programs, including limiting the types of promotional credit offerings that may be offered to consumers.

Synchrony Bank provides credit to our customers through a private label credit card agreement that is currently scheduled to expire on December 31, 2020, subject to earlier termination upon certain events. Synchrony Bank has discretion to control the content of financing offers to our customers and to set minimum credit standards under which credit is extended to customers.

Reduction of credit availability due to changing economic conditions, changes in credit standards under our private label credit card program or changes in regulatory requirements, or the termination of our agreement with Synchrony Bank, could harm our sales, profitability, cash flows and financial condition.

We utilize “just-in-time” manufacturing processes with minimal levels of inventory, which could leave us vulnerable to shortages in supply of components that may harm our ability to satisfy consumer demand and may adversely impact our sales and profitability.

A significant percentage of our products are assembled after we receive orders from customers utilizing “just-in-time” manufacturing processes with minimal levels of raw materials, work-in-process inventories and finished goods inventories. Lead times for ordered components may vary significantly. In addition, some components used to manufacture our products are provided on a sole source basis. Any unexpected shortage of materials caused by any disruption of supply or an unexpected increase in the demand for our products, could lead to delays in shipping our beds to customers. Any such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition.


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We rely upon several key suppliers that are, in some instances, the only source of supply currently used by us for particular materials, components or services. A disruption in the supply or substantial increase in cost of any of these products or services could harm our sales, profitability, cash flows and financial condition.

We currently obtain all of the materials and components used to produce our beds from outside sources including some who are located outside the U.S. In several cases, including our proprietary air chambers, our proprietary blow-molded foundations, our adjustable foundations, various components for our Firmness Control Systems, as well as fabrics and zippers, we have chosen to obtain these materials and components from suppliers who serve as the only source of supply, or who supply the vast majority of our needs of the particular material or component. While we believe that these materials and components, or suitable replacements, could be obtained from other sources, in the event of a disruption or loss of supply of relevant materials or components for any reason, we may not be able to find alternative sources of supply, or if found, may not be found on comparable terms. If our relationship with the primary supplier of our air chambers, the supplier of our blow-molded foundations or the supplier of our adjustable foundations is terminated, we could have difficulty in replacing these sources since there are relatively few other suppliers presently capable of manufacturing these components.

Similarly, we rely on UPS and other carriers to deliver some of our products to customers on a timely and cost-effective basis. Any significant delay in deliveries to our customers could lead to increased returns and cause us to lose sales. Any increase in freight charges could increase our costs of doing business and harm our sales, profitability, cash flows and financial condition.

Fluctuations in commodity prices could result in an increase in component costs and/or delivery costs.

Our business is subject to significant increases or volatility in the prices of certain commodities, including but not limited to fuel, oil, natural gas, rubber, cotton, plastic resin, steel and chemical ingredients used to produce foam. Increases in prices of these commodities or other inflationary pressures may result in significant cost increases for our raw materials and product components, as well as increases in the cost of delivering our products to our customers. To the extent we are unable to offset any such increased costs through value engineering and similar initiatives, or through price increases, our profitability, cash flows and financial condition may be adversely impacted. If we choose to increase prices to offset the increased costs, our unit sales volumes could be adversely impacted.

Our business is subject to risks inherent in global sourcing activities.

Our air chambers and some of our other components are manufactured outside the United States, and therefore are subject to risks associated with foreign sourcing of materials, including but not limited to:
Political instability resulting in disruption of trade;
Existing or potential duties, tariffs or quotas on certain types of goods that may be imported into the United States;
Disruptions in transportation due to acts of terrorism, shipping delays, foreign or domestic dock strikes, customs inspections or other factors;
Foreign currency fluctuations; and
Economic uncertainties, including inflation.

These factors could increase our costs of doing business with foreign suppliers, lead to inadequate inventory levels or delays in shipping beds to our customers, which could harm our sales, customer satisfaction, profitability, cash flows and financial condition.

Disruption of operations in either of our two main manufacturing facilities could increase our costs of doing business or lead to delays in shipping our beds.

We have two main manufacturing plants, which are located in Irmo, South Carolina and Salt Lake City, Utah. A significant percentage of our products are assembled to fulfill orders rather than stocking finished goods inventory in our plants or stores. Therefore, the disruption of operations of either of our two main manufacturing facilities for a significant period of time may increase our costs of doing business and lead to delays in shipping our beds to customers. Such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition.

Our manufacturing and retail operations are subject to a wide variety of government regulations which could increase costs or cause disruptions to our operations.

We are subject to a wide variety of government regulations relating to the bedding industry or to various aspects of our business and operations, including without limitation, regulations relating to the proper labeling of bedding merchandise; flammability standards applicable to mattresses; environmental and product safety regulations; consumer protection and data privacy regulations; various “do

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not call” or “do not mail” list requirements; labor laws, including but not limited to laws relating to occupational health and safety, employee privacy, wages and hours, overtime pay, harassment and discrimination, equal opportunity, and employee leaves and benefits; and import and export regulations.

Although we believe that we are in compliance in all material respects with these regulations and have implemented a variety of measures to promote continuing compliance, regulations may change over time, and we may be required to incur expenses and/or to modify our operations in order to ensure compliance with these regulations or we may be found to be in violation of the foregoing laws or regulations, which could harm our sales, profitability, cash flows and financial condition.

Adopted or proposed legislation in various states would impose responsibilities with respect to end-of-life disposal of various consumer or durable goods on the manufacturers and/or retailers of such goods, including mattresses. To the extent that any such legislation becomes effective in the states in which we sell or have sold mattresses and related products, we may be required to incur significant costs and operational changes in order to comply with these requirements, which may adversely impact our profitability, cash flows and financial condition.

Regulatory requirements related to flammability standards for mattresses may increase our product costs and increase the risk of disruption to our business.

The federal Consumer Product Safety Commission adopted new flammability standards and related regulations which became effective nationwide in July 2007 for mattresses and mattress and foundation sets. Compliance with these requirements has resulted in higher materials and manufacturing costs for our products, and has required modifications to our information systems and business operations, further increasing our costs and negatively impacting our capacity.

These regulations require manufacturers to implement quality assurance programs and encourage manufacturers to conduct random testing of products. These regulations also require maintenance and retention of compliance documentation. These quality assurance and documentation requirements are costly to implement and maintain. If any product testing, other evidence, or regulatory inspections yield results indicating that any of our products may not meet the flammability standard, we may be required to temporarily cease production and distribution and/or to recall products from the field, and we may be subject to fines or penalties, any of which outcomes could harm our business, reputation, sales, profitability, cash flows and financial condition.

The implementation of a new ERP system in the fourth quarter of 2015 caused disruption to our customer delivery and service capabilities and may result in ongoing adverse impacts to our business and damage to our brand reputation.

In the fourth quarter of 2015, we implemented a new enterprise resource planning, or “ERP,” system to replace our legacy management information systems. The implementation of this new ERP system caused disruption to our customer delivery and service capabilities throughout much of the fourth quarter of 2015 and early in 2016. This disruption led to significant lost sales, inefficiencies in our business operations, negative customer sentiment in social media and potential damage to our brand reputation. These adverse impacts have continued to some degree in 2016 as we continue to implement operational improvements under the new ERP system.

Any improvements or upgrades to our management information systems that may be required to meet the evolving needs of our business as well as existing and emerging regulatory requirements may be costly to implement and may take longer or require greater resources than anticipated, and may result in disruptions to our systems or business.

We depend on our management information systems for many aspects of our business. As noted above, in the fourth quarter of 2015 we implemented a new ERP system and continue to implement operational improvements under this new system. If our new systems are disrupted in any material way, or improvements or upgrades are required to meet the evolving needs of our business and existing and emerging regulatory requirements, we may be required to incur significant capital expenditures in the pursuit of improvements or upgrades to our management information systems. These efforts may take longer and may require greater financial and other resources than anticipated, may cause distraction of key personnel, and may cause short-term disruptions to our existing systems and our business. Any of these outcomes could impair our ability to achieve critical strategic initiatives and could adversely impact our sales, profitability, cash flows and financial condition.

Our information systems may be subject to attacks by hackers or other cyber threats that could compromise the security of our systems, which could substantially disrupt our business and could result in the breach of consumers' or employees' private data.

Our information systems contain personal information related to our customers and employees in the ordinary course of our business, such as credit card and demographic information of our customers and social security numbers and demographic information of our employees. While we maintain security measures to protect this information, a breach of these security measures, such as through

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third-party action, employee error, malfeasance or otherwise, could compromise the security of our customers’ and employees’ personal information. As the techniques used to breach such security measures change frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventive measures. Any failure of our systems and processes to adequately protect customer or employee personal information from theft or loss could adversely impact our business, reputation, sales, profitability, cash flows and financial condition.

Our future growth and profitability depends in part upon our ability to attract, retain and motivate qualified personnel.

As a vertically integrated manufacturer and retailer, our future growth and profitability will depend in part upon our ability to attract, retain and motivate qualified personnel in a wide variety of areas to execute our growth strategy, including qualified management and executive personnel and qualified retail sales professionals and managers. The failure to attract, retain and motivate qualified personnel may hinder our ability to execute our business strategy and growth initiatives and may adversely impact our sales, profitability, cash flows and financial condition.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.


17



ITEM 2. PROPERTIES

Retail Locations

We currently lease all of our existing retail store locations and expect that our policy of leasing stores, rather than owning stores, will continue. We lease our retail stores under operating leases which, in addition to the minimum lease payments, require payment of a proportionate share of the real estate taxes and certain building operating expenses. Our retail store leases generally provide for an initial lease term of five to ten years. In addition, our mall-based retail store leases may require payment of contingent rent based on net sales in excess of certain thresholds. Certain retail store leases may contain options to extend the term of the original lease.

The following table summarizes the geographic location of our 488 retail stores as of January 2, 2016:
 
 
Retail
Stores

 
 
 
Retail
Stores

 
 
 
Retail
Stores

Alabama
 
7

 
Maryland
 
11

 
Oklahoma
 
4

Arizona
 
8

 
Massachusetts
 
9

 
Oregon
 
6

Arkansas
 
4

 
Michigan
 
13

 
Pennsylvania
 
18

California
 
59

 
Minnesota
 
13

 
Rhode Island
 
1

Colorado
 
11

 
Mississippi
 
5

 
South Carolina
 
7

Connecticut
 
5

 
Missouri
 
14

 
South Dakota
 
2

Delaware
 
2

 
Montana
 
2

 
Tennessee
 
10

Florida
 
30

 
Nebraska
 
3

 
Texas
 
45

Georgia
 
17

 
Nevada
 
5

 
Utah
 
4

Idaho
 
2

 
New Hampshire
 
4

 
Vermont
 
1

Illinois
 
18

 
New Jersey
 
15

 
Virginia
 
17

Indiana
 
11

 
New Mexico
 
3

 
Washington
 
11

Iowa
 
8

 
New York
 
14

 
West Virginia
 
1

Kansas
 
6

 
North Carolina
 
13

 
Wisconsin
 
11

Kentucky
 
7

 
North Dakota
 
3

 
Wyoming
 
1

Louisiana
 
7

 
Ohio
 
18

 
 
 
 
Maine
 
2

 
 
 
 
 
Total
 
488


Manufacturing, Distribution and Headquarters

We lease our 159,000-square-foot corporate headquarters in the Minneapolis, Minnesota area. The lease commenced in November 2007 and runs through 2017, with two five-year renewal options.

We also lease approximately 122,000 square feet in the Minneapolis, Minnesota area that includes our research and development department, customer service department and a distribution center that accepts returns, fulfills accessory orders and processes warranty claims. This lease expires in 2017 and contains one five-year renewal option.

We lease two manufacturing and distribution centers in Irmo, South Carolina and Salt Lake City, Utah of approximately 105,000 square feet and approximately 101,000 square feet, respectively. The Irmo facility lease runs through February 2026, with two five-year options. The landlord is constructing another building for us at the Irmo facility and once completed it will add 45,000 square feet for a total square footage of approximately 150,000 square feet. The Salt Lake City facility lease runs through July 2020, with two five-year renewal options.  

We also lease a storage facility in Salt Lake City of approximately 57,000 square feet through April 2020.

We lease three buildings used for manufacturing purposes for our Comfortaire business in Greenville, South Carolina of approximately 65,000 total square feet. The current lease term for these three buildings runs through May 2016.

We lease two sites for SleepIQ LABS. One lease is for space in Emeryville, California, of approximately 2,772 square feet which runs through June 2016. The other lease is for space in San Jose, California, of approximately 13,050 square feet which runs through August 2018 and contains one three-year renewal option.

18



ITEM 3. LEGAL PROCEEDINGS

We are involved from time to time in various legal proceedings arising in the ordinary course of our business, including primarily commercial, product liability, employment and intellectual property claims. In accordance with generally accepted accounting principles in the United States, we record a liability in our consolidated financial statements with respect to any of these matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. With respect to currently pending legal proceedings, we have not established an estimated range of reasonably possible additional losses either because we believe that we have valid defenses to claims asserted against us or the proceeding has not advanced to a stage of discovery that would enable us to establish an estimate. We currently do not expect the outcome of these matters to have a material effect on our consolidated results of operations, financial position or cash flows. Litigation, however, is inherently unpredictable, and it is possible that the ultimate outcome of one or more claims asserted against us could adversely impact our consolidated results of operations, financial position or cash flows. We expense legal costs as incurred.

On December 4, 2015, Saeid Azimpour, a consumer, filed a purported class-action lawsuit in U.S. District Court in Minnesota alleging he was fraudulently induced to purchase a down alternative pillow at a Sleep Number store based on signage that indicated that the pillow was 50% off. Plaintiff alleges that the price he paid for the pillow was not truly 50% off the price at which Sleep Number previously sold the pillow. Plaintiff asserts 10 causes of action including consumer fraud, unlawful trade practices, deceptive trade practices under Minnesota law, violation of the Minnesota false advertising law, unjust enrichment, violation of the California unfair competition law, violation of the California false advertising law and violation of the California remedies act. Plaintiff seeks to represent all individuals who “purchased one or more items from the Company advertised or priced at a discount from the original retail price at any time between December 1, 2011 and present.” Plaintiff seeks injunctive relief, damages, disgorgement and attorneys’ fees. We believe the claims asserted in this lawsuit are without merit and we intend to vigorously defend this case.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.


19



PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on The NASDAQ Stock Market LLC (NASDAQ Global Select Market) under the symbol “SCSS.” As of January 30, 2016, there were approximately 292 holders of record of our common stock. The following table sets forth the quarterly high and low sales prices per share of our common stock, at closing, as reported by NASDAQ for the two most recent fiscal years.
 
 
First
Quarter
 
Second
Quarter
 
Third
Quarter
 
Fourth
Quarter
Fiscal 2015
 
 
 
 
 
 
 
 
High
 
$
34.62

 
$
34.50

 
$
30.79

 
$
25.50

Low
 
26.43

 
29.11

 
21.34

 
20.63

 
 
 
 
 
 
 
 
 
Fiscal 2014
 
 

 
 

 
 

 
 

High
 
$
21.65

 
$
20.32

 
$
22.54

 
$
27.35

Low
 
15.67

 
17.12

 
18.98

 
20.09


We are not restricted from paying cash dividends under our credit agreement other than customary legal and contractual restrictions. However, we have not historically paid, and have no current plans to pay, cash dividends on our common stock.

Information concerning share repurchases completed during the fourth quarter of fiscal 2015 is set forth below:
Fiscal Period
 
Total Number of Shares
Purchased(1)(2)
 
Average Price Paid per Share
 
Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
 
Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs(3)
October 4, 2015 through October 31, 2015
 
213,310

 
$
22.76

 
212,817

 
$
161,589,000

November 1, 2015 through November 28, 2015
 
595,525

 
23.62

 
595,525

 
147,521,000

November 29, 2015 through January 2, 2016
 
474,843

 
23.12

 
474,843

 
136,542,000

Total
 
1,283,678

 
$
23.29

 
1,283,185

 
$
136,542,000

        
(1) 
Under the current Board-approved $250 million share repurchase program, we repurchased 1,283,185 shares of our common stock at a cost of $30 million (based on trade dates) during the three months ended January 2, 2016.
(2) 
In connection with the vesting of employee restricted stock grants, we also repurchased 493 shares of our common stock at a cost of $11 thousand during the three months ended January 2, 2016.
(3) 
There is no expiration date governing the period over which we can repurchase shares under our Board-approved share repurchase program. Any repurchased shares are constructively retired and returned to an unissued status.


20



Comparative Stock Performance

The graph below compares the total cumulative shareholder return on our common stock over the last five years to the total cumulative return on the Standard and Poor’s (“S&P”) 400 Specialty Stores Index and The NASDAQ Stock Market (U.S.) Index assuming a $100 investment made on January 1, 2011. Each of the three measures of cumulative total return assumes reinvestment of dividends. The stock performance shown on the graph below is not necessarily indicative of future price performance. The information contained in this “Comparative Stock Performance” section shall not be deemed to be “soliciting material” or “filed” or incorporated by reference in future filings with the SEC, or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that we specifically request that it be treated as soliciting material or incorporate it by reference into a document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
AMONG SELECT COMFORT CORPORATION, S&P 400 SPECIALTY STORES INDEX,
AND THE NASDAQ STOCK MARKET (U.S.) INDEX
 
 
1/1/2011
 
12/31/2011
 
12/29/2012
 
12/28/2013
 
1/3/2015
 
1/2/2016
Select Comfort Corporation
 
$
100

 
$
238

 
$
268

 
$
232

 
$
294

 
$
235

S&P 400 Specialty Stores Index
 
100

 
114

 
140

 
211

 
263

 
195

The NASDAQ Stock Market (U.S.) Index
 
100

 
99

 
114

 
162

 
187

 
200





21




ITEM 6. SELECTED FINANCIAL DATA
(in thousands, except per share and selected operating data, unless otherwise indicated)
The Consolidated Statements of Operations Data and Consolidated Balance Sheet Data presented below have been derived from our Consolidated Financial Statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and Notes thereto included in this Annual Report on Form 10-K.
 
Year
 
2015
 
2014(1)
 
2013
 
2012
 
2011
Consolidated Statements of Operations Data:
 
 
 
 
 
 
 
 
 
Net sales
$
1,213,699

 
$
1,156,757

 
$
960,171

 
$
934,978

 
$
743,203

Gross profit
740,751

 
706,850

 
601,755

 
596,546

 
470,345

Operating expenses:


 


 


 
 

 
 

Sales and marketing
550,475

 
512,007

 
439,156

 
398,205

 
317,502

General and administrative
99,209

 
84,864

 
62,967

 
66,765

 
58,215

Research and development
15,971

 
8,233

 
9,478

 
6,194

 
4,175

Other(2)

 

 
(534
)
 
5,595

 

Operating income
75,096

 
101,746

 
90,688

 
119,787

 
90,453

Net income
$
50,519

 
$
67,974

 
$
60,081

 
$
78,094

 
$
60,478

Net income per share:
 
 
 
 
 
 
 

 
 

Basic
$
0.99

 
$
1.27

 
$
1.10

 
$
1.41

 
$
1.10

Diluted
$
0.97

 
$
1.25

 
$
1.08

 
$
1.37

 
$
1.07

Shares used in calculation of net income per share:
 
 
 
 
 
 
 

 
 

Basic
51,252

 
53,452

 
54,866

 
55,516

 
55,081

Diluted
52,101

 
54,193

 
55,803

 
57,076

 
56,432

 
 
 
 
 
 
 
 
 
 
Consolidated Balance Sheet Data:
 
 
 
 
 
 
 

 
 

Cash, cash equivalents and marketable debt securities
$
36,114

 
$
166,045

 
$
145,014

 
$
177,821

 
$
146,317

Total assets
513,396

 
474,187

 
381,765

 
342,021

 
262,657

Total shareholders’ equity
222,339

 
256,907

 
225,220

 
193,697

 
129,391

 
 
 
 
 
 
 
 
 
 
Selected Operating Data:
 
 
 
 
 
 
 
 
 
Stores open at period-end
488

 
463

 
440

 
410

 
381

Stores opened during period
38

 
57

 
71

 
57

 
19

Stores closed during period
13

 
34

 
41

 
28

 
24

Average revenue per store (000’s)(3)
$
2,377

 
$
2,327

 
$
2,093

 
$
2,164

 
$
1,721

Percentage of stores with more than $1.0 million in net sales(3)
99
%
 
98
%
 
96
 %
 
98
%
 
93
%
Percentage of stores with more than $2.0 million in net sales(3)
62
%
 
59
%
 
46
 %
 
49
%
 
24
%
Average revenue per mattress unit - Company-Controlled channel(4)
$
4,028

 
$
3,671

 
$
3,245

 
$
3,050

 
$
2,694

Company-Controlled comparable-sales increase (decrease)(5)
3
%
 
12
%
 
(4
)%
 
23
%
 
26
%
Total retail square footage (at period-end) (000's)
1,214

 
1,106

 
949

 
759

 
610

Average square footage per store open during period(3)
2,445

 
2,302

 
1,985

 
1,670

 
1,526

Net sales per square foot(3)
$
980

 
$
1,025

 
$
1,077

 
$
1,324

 
$
1,135

Average store age (in months at period-end)
99

 
97

 
102

 
113

 
113

Earnings before interest, depreciation and amortization (Adjusted EBITDA)(6)
$
133,057

 
$
148,223

 
$
125,020

 
$
150,285

 
$
109,180

Free cash flows(6)
$
22,356

 
$
67,874

 
$
11,294

 
$
49,033

 
$
67,519

Return on Invested Capital (ROIC)(6)
11.2
%
 
15.1
%
 
15.1
 %
 
21.5
%
 
19.9
%
        
(1) 
Fiscal year 2014 had 53 weeks. All other fiscal years presented had 52 weeks.
(2) 
In February 2012, we announced that William R. McLaughlin, then President and CEO, would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin's contributions, the Compensation Committee approved the modification of Mr. McLaughlin's unvested stock awards, including performance-based stock awards. As a result of these modifications, we recorded incremental non-cash compensation of $5.6 million ($3.7 million, net of income tax). The performance-based stock awards were subject to applicable adjustments through 2014 based on actual performance. During 2013 we recorded a non-cash compensation benefit of $0.5 million ($0.4 million, net of income tax) resulting from performance-based stock award adjustments. There were no performance-based stock award adjustments in 2014 or 2015.
(3) 
For stores open during the entire period indicated.
(4) 
Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.
(5) 
Stores are included in the comparable sales calculation in the 13th full month of operation. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base. The number of comparable stores used to calculate such data was 442, 396, 359, 348 and 359 for 2015, 2014, 2013, 2012 and 2011, respectively. Fiscal 2014 included 53 weeks, as compared to 52 weeks for the other periods presented. Comparable sales have been adjusted and reported as if all years had the same number of weeks.
(6) 
These non-GAAP measures are not in accordance with, or preferable to, GAAP financial data. However, we are providing this information as we believe it facilitates annual and year-over-year comparisons for investors and financial analysts. See pages 23 and 24 for the reconciliation of these non-GAAP measures to the appropriate GAAP measures.

22



Non-GAAP Data Reconciliations

Earnings before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA)
(in thousands)

We define earnings before interest, taxes, depreciation and amortization (Adjusted EBITDA) as net income plus: income tax expense, interest expense, depreciation and amortization, stock-based compensation and asset impairments. Management believes Adjusted EBITDA is a useful indicator of our financial performance and our ability to generate cash from operating activities. Our definition of Adjusted EBITDA may not be comparable to similarly titled definitions used by other companies. The table below reconciles Adjusted EBITDA, which is a non-GAAP financial measure, to the comparable GAAP financial measure:
 
 
Year
 
 
2015
 
2014
 
2013
 
2012
 
2011
Net income
 
$
50,519

 
$
67,974

 
$
60,081

 
$
78,094

 
$
60,478

Income tax expense
 
24,911

 
34,134

 
30,930

 
41,911

 
29,942

Interest expense
 
160

 
53

 
51

 
91

 
187

Depreciation and amortization
 
46,916

 
38,767

 
29,599

 
19,735

 
13,493

Stock-based compensation
 
10,290

 
6,798

 
4,232

 
10,306

 
4,971

Asset impairments
 
261

 
497

 
127

 
148

 
109

Adjusted EBITDA
 
$
133,057

 
$
148,223

 
$
125,020

 
$
150,285

 
$
109,180


Free Cash Flow
(in thousands)

Our “free cash flow” data is considered a non-GAAP financial measure and is not in accordance with, or preferable to, “net cash provided by operations,” or GAAP financial data. However, we are providing this information as we believe it facilitates analysis for investors and financial analysts.
 
 
Year
 
 
2015
 
2014
 
2013
 
2012
 
2011
Net cash provided by operating activities
 
$
107,942

 
$
144,468

 
$
88,105

 
$
100,626

 
$
91,046

Subtract: Purchases of property and equipment
 
85,586

 
76,594

 
76,811

 
51,593

 
23,527

Free cash flow
 
$
22,356

 
$
67,874

 
$
11,294

 
$
49,033

 
$
67,519



23



Non-GAAP Data Reconciliations (continued)

Return on Invested Capital (ROIC)
(in thousands)

ROIC is a financial measure we use to determine how efficiently we deploy our capital. It quantifies the return we earn on our invested capital. Management believes ROIC is also a useful metric for investors and financial analysts. We compute ROIC as outlined below. Our definition and calculation of ROIC may not be comparable to similarly titled definitions and calculations used by other companies. The tables below reconcile net operating profit after taxes (NOPAT) and total invested capital, which are non-GAAP financial measures, to the comparable GAAP financial measures:
 
 
Year
 
 
2015
 
2014
 
2013
 
2012
 
2011
Net operating profit after taxes (NOPAT)
 
 
 
 
 
 
 
 
 
 
Operating income
 
$
75,096

 
$
101,746

 
$
90,688

 
$
119,787

 
$
90,453

Add: Rent expense(1)
 
62,369

 
57,605

 
50,289

 
48,543

 
41,878

Add: Interest income
 
494

 
415

 
375

 
310

 
155

Less: Depreciation on capitalized operating leases(2)
 
(16,203
)
 
(14,265
)
 
(13,095
)
 
(12,072
)
 
(10,677
)
Less: Income taxes(3)
 
(40,384
)
 
(48,900
)
 
(43,827
)
 
(54,358
)
 
(41,920
)
NOPAT
 
$
81,372

 
$
96,601

 
$
84,430

 
$
102,210

 
$
79,889

 
 
 
 
 
 
 
 
 
 
 
Average invested capital
 
 
 
 
 
 
 
 
 
 
Total equity
 
$
222,339

 
$
256,907

 
$
225,220

 
$
193,697

 
$
129,391

Less: Cash greater than target(4)
 

 
(37,319
)
 
(29,622
)
 
(62,627
)
 
(32,788
)
Add: Long-term debt(5)
 

 

 
2

 
112

 
292

Add: Capitalized operating lease obligations(6)
 
498,952

 
460,840

 
402,312

 
388,344

 
335,024

Total invested capital at end of period
 
$
721,291

 
$
680,428

 
$
597,912

 
$
519,526

 
$
431,919

Average invested capital(7)
 
$
726,756

 
$
639,118

 
$
560,133

 
$
475,159

 
$
402,240

Return on invested capital (ROIC)(8)
 
11.2
%
 
15.1
%
 
15.1
%
 
21.5
%
 
19.9
%
___________________
(1) Rent expense is added back to operating income to show the impact of owning versus leasing the related assets.

(2) Depreciation is based on the average of the last five fiscal quarters' ending capitalized operating lease obligations (see note 6) for the respective reporting periods with an assumed thirty-year useful life. This is subtracted from operating income to illustrate the impact of owning versus leasing the related assets.

(3) Reflects annual effective income tax rates, before discrete adjustments, of 33.2%, 33.6%, 34.2%, 34.7% and 34.4% for 2015, 2014, 2013, 2012 and 2011, respectively.

(4) Cash greater than target is defined as cash, cash equivalents and marketable debt securities less customer prepayments in excess of $100 million.

(5) Long-term debt includes capital lease obligations, if applicable.

(6) A multiple of eight times annual rent expense is used as an estimate for capitalizing our operating lease obligations. The methodology utilized aligns with the methodology of a nationally recognized credit rating agency.

(7) Average invested capital represents the average of the last five fiscal quarters' ending invested capital balances.

(8) ROIC equals NOPAT divided by average invested capital.

Note - Our ROIC calculation and data are considered non-GAAP financial measures and are not in accordance with, or preferable to, GAAP financial data. However, we are providing this information as we believe it facilitates analysis of the Company's financial performance by investors and financial analysts.

GAAP - generally accepted accounting principles in the U.S.

24



ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements

The discussion in this Annual Report contains certain forward-looking statements that relate to future plans, events, financial results or performance. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, among others:

Current and future general and industry economic trends and consumer confidence;
The effectiveness of our marketing messages;
The efficiency of our advertising and promotional efforts;
Our ability to execute our Company-Controlled distribution strategy;
Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;
Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;
Industry competition, the emergence of additional competitive products, and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;
Availability of attractive and cost-effective consumer credit options, including the impact of recent changes in federal law that restricts various forms of consumer credit promotional offerings;
Pending and unforeseen litigation and the potential for adverse publicity associated with litigation;
Our “just-in-time” manufacturing processes with minimal levels of inventory, which may leave us vulnerable to shortages in supply;
Our dependence on significant suppliers and our ability to maintain relationships with key suppliers, including several sole-source suppliers;
Rising commodity costs and other inflationary pressures;
Risks inherent in global sourcing activities;
Risks of disruption in the operation of either of our two main manufacturing facilities;
Increasing government regulation;
The adequacy of our management information systems to meet the evolving needs of our business and existing and evolving regulatory standards applicable to data privacy and security;
The costs and potential disruptions to our business related to upgrading our management information systems;
Our ability to attract, retain and motivate qualified management, executive and other key employees, including qualified retail sales professionals and managers; and
Uncertainties arising from global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events.

Additional information concerning these and other risks and uncertainties is contained under the caption "Risk Factors" in this Annual Report on Form 10-K.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to provide a reader of our financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in six sections:

Overview
Results of Operations
Liquidity and Capital Resources
Off-Balance-Sheet Arrangements and Contractual Obligations
Critical Accounting Policies and Estimates
Recent Accounting Pronouncements


25



Overview

Business Overview

We offer consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of SLEEP NUMBER® beds and bedding accessories. Our business has three significant competitive advantages: proprietary sleep innovations, ongoing customer relationships and exclusive distribution.

We have a vertically integrated business model and are the exclusive designer, manufacturer, marketer, retailer and servicer of a complete line of Sleep Number® beds. Only the Sleep Number bed offers SleepIQ® technology - proprietary sensor technology that works directly with the bed’s DualAir™ system to track and monitor each individual’s sleep. SleepIQ technology communicates how you slept and what adjustments you can make to optimize your sleep and improve your daily life. Sleep Number also offers a full line of exclusive sleep products, including FlextFit™ adjustable bases and Sleep Number® pillows, sheets and other bedding products.
 
We are committed to delivering superior shareholder value through three primary drivers of earnings per share growth: increasing demand, leveraging our business model and deploying our capital efficiently. We are the sleep innovation leader and drive growth through effective brand marketing and a differentiated retail experience.

We generate revenue by marketing our innovations to new and existing customers, and selling products through two distribution channels. Our Company-Controlled channel, which includes Retail, Direct Marketing and E-Commerce, sells directly to consumers. Our Wholesale/Other channel sells to and through selected retail and wholesale customers in the United States and the QVC shopping channel.

We are also the only vertically integrated manufacturer/retailer in the industry. We have two manufacturing plants that distribute Sleep Number products. We also offer mattress home delivery and installation, and maintain an in-house customer service department. This integration enables operational synergies and efficiencies, and a strong working capital position. Vertical integration allows us to build a long-term loyal customer relationship as we service the consumer through the full purchase and ownership cycle. This relationship with our customer creates a productive cycle of repeat and referral business.

Mission and Vision

Our mission is to improve lives by individualizing sleep experiences.

Our vision is to become one of the world's most beloved brands by delivering an unparalleled sleep experience. We plan to achieve this by offering benefit-driven, innovative sleep solutions to our customers through an unmatched retail experience and a carefree ownership experience.

Results of Operations
 
Fiscal 2015 Summary
 
Financial highlights for fiscal 2015 were as follows:

In the fourth quarter 2015, we replaced our nearly 20-year-old legacy computer systems with a new vertically-integrated Enterprise Resource Planning (ERP) system. We experienced technical and operational issues in our plants and supply chain as we ramped up the new system, which led to delivery delays and inconveniences for our customers. The lost sales and increases in cost of sales and operating expenses negatively impacted 2015 results by approximately $0.40 per diluted share ($0.43 per diluted share for the fourth quarter). Through the filing date of this document, we have made progress resolving technical and operational issues associated with the ERP implementation. While we continue to learn to use the new system proficiently and at higher volumes, the system is operating at near normal levels across our vertical enterprise.

Net sales for 2015 increased 5% to $1.21 billion, compared with $1.16 billion in the prior year. Company-Controlled comparable sales increased 3% and sales from 25 net new stores opened in the past 12 months. In addition, 2015 included 52 weeks compared with 53 weeks in the prior year, with the extra week benefiting fourth quarter 2014 net sales growth by approximately $24 million. During the first nine months of 2015, demand for our latest product innovations and more effective marketing drove traffic to our stores and contributed to a 20% year-to-date net sales increase. However, net sales decreased 33% in the fourth quarter compared to the prior year, reflecting approximately $84 million in sales disruptions from our ERP system implementation.
 

26



On a trailing twelve-month basis, sales per store (for stores open at least one year) increased 2.1% to $2.4 million compared with the prior-year trailing twelve-month period.

Operating income for 2015 decreased 26% to $75 million, or 6.2% of net sales, compared with $102 million, or 8.8% of net sales, for the same period one year ago. The decrease in operating income was attributable to the fourth-quarter 2015 reduction in net sales, and increases in cost of sales and operating expenses resulting from our ERP implementation challenges.

Net income decreased 26% to $51 million, or $0.97 per diluted share, compared with net income of $68 million, or $1.25 per diluted share in 2014. As noted above, our fourth-quarter 2015 ERP implementation issues negatively impacted 2015 diluted earnings per share by approximately $0.40. In addition, diluted earnings per share for 2014 benefited from the profits generated during the additional 53rd week ($0.06 per diluted share) and a favorable fourth quarter 2014 legal settlement ($0.04 per diluted share).

We achieved a return on invested capital (ROIC) of 11.2% in 2015, above our 10% cost of capital.
 
Cash provided by operating activities in 2015 totaled $108 million, compared with $144 million for the prior year.
 
At January 2, 2016, cash, cash equivalents and marketable debt securities totaled $36 million compared with $166 million at January 3, 2015, and we had no borrowings under our revolving credit facility. During 2015, we invested $86 million in capital projects, $57 million to acquire BAM Labs, Inc. (now operating as SleepIQ LABS) and returned $98 million to shareholders through share repurchases.
 
In 2015, we repurchased 3.6 million shares of our common stock under our Board-approved share repurchase program at a cost of $98 million ($27.46 per share). As of January 2, 2016, the remaining authorization under our Board-approved share repurchase program was $137 million.

In September 2015, we completed the acquisition of BAM Labs, Inc. (now operating as SleepIQ LABS) the leading provider of biometric sensor and sleep monitoring for data-driven health and wellness. The addition of SleepIQ LABS strengthens Sleep Number’s leadership in sleep innovation, adjustability and individualization. The acquisition broadens and deepens electrical, biomedical, software and backend capabilities - API (application program interface) and bio-signal analysis. Our ownership and control of biometric data advances smart, connected products that empower our customers with the knowledge to adjust for their best sleep. In connection with the acquisition, our previous equity investment was remeasured to a fair value of $12.9 million, resulting in a $3.5 million gain net of expenses, including $3.4 million of acquisition-related expenses. The remeasured fair value of our equity investment was based on the fair value of BAM Labs, Inc. at the acquisition date. The net gain of $3.5 million is included in general and administrative expenses on our consolidated statement of operations for the fiscal year ended January 2, 2016. See Note 2, Acquisition of BAM Labs, Inc., and Note 4, Investments, of the Notes to Consolidated Financial Statements for additional details.


27



The following table sets forth our results of operations expressed as dollars and percentages of net sales. Figures are in millions, except percentages and per share amounts. Amounts may not add due to rounding differences. 
 
 
2015
 
2014
 
2013
 
 
$
 
% of
Net Sales
 
$
 
% of
Net Sales
 
$
 
% of
Net Sales
Net sales
 
$
1,213.7

 
100.0
%
 
$
1,156.8

 
100.0
%
 
$
960.2

 
100.0
%
Cost of sales
 
472.9

 
39.0

 
449.9

 
38.9

 
358.4

 
37.3

Gross profit
 
740.8

 
61.0

 
706.9

 
61.1

 
601.8

 
62.7

 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
 

 
 
 
 
 
 
Sales and marketing
 
550.5

 
45.4

 
512.0

 
44.3

 
439.2

 
45.7

General and administrative
 
99.2

 
8.2

 
84.9

 
7.3

 
62.5

 
6.5

Research and development
 
16.0

 
1.3

 
8.2

 
0.7

 
9.5

 
1.0

Total operating expenses
 
665.7

 
54.8

 
605.1

 
52.3

 
511.1

 
53.2

Operating income
 
75.1

 
6.2

 
101.7

 
8.8

 
90.7

 
9.4

Other income, net
 
0.3

 
0.0

 
0.4

 
0.0

 
0.3

 
0.0

Income before income taxes
 
75.4

 
6.2

 
102.1

 
8.8

 
91.0

 
9.5

Income tax expense
 
24.9

 
2.1

 
34.1

 
3.0

 
30.9

 
3.2

Net income
 
$
50.5

 
4.2
%
 
$
68.0

 
5.9
%
 
$
60.1

 
6.3
%
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income per share:
 
 

 
 

 
 

 
 
 
 
 
 
Basic
 
$
0.99

 
 

 
$
1.27

 
 
 
$
1.10

 
 
Diluted
 
$
0.97

 
 

 
$
1.25

 
 
 
$
1.08

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Weighted-average number of common shares:
 
 

 
 

 
 
 
 
 
 
Basic
 
51.3

 
 

 
53.5

 
 
 
54.9

 
 
Diluted
 
52.1

 
 

 
54.2

 
 
 
55.8

 
 


The percentage of our total net sales, by dollar volume, from each of our channels was as follows:
 
 
2015
 
2014
 
2013
Company-Controlled channel
 
97.6
%
 
97.3
%
 
96.2
%
Wholesale/Other channel
 
2.4
%
 
2.7
%
 
3.8
%
Total
 
100.0
%
 
100.0
%
 
100.0
%


The components of total net sales growth, including comparable net sales changes, were as follows: 
 
 
Net Sales Increase/(Decrease)
 
 
2015
 
2014
 
2013
Retail comparable-store sales(1)
 
3
%
 
12
%
 
(4
%)
E-Commerce and Direct(1)
 
(4
%)
 
9
%
 
(5
%)
Company-Controlled comparable sales change(1)
 
3
%
 
12
%
 
(4
%)
Net opened/closed stores and 53rd week in 2014
 
2
%
 
10
%
 
6
%
Total Company-Controlled channel
 
5
%
 
22
%
 
2
%
Wholesale/Other channel
 
(9
%)
 
(13
%)
 
18
%
Total net sales change
 
5
%
 
20
%
 
3
%
        
(1) Stores are included in the comparable-store calculation in the 13th full month of operations. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base. Fiscal 2014 included 53 weeks, as compared to 52 weeks in fiscal 2015 and 2013. Comparable-store sales have been adjusted to remove the estimated impact of the additional week for fiscal 2014.


28



Other sales metrics were as follows: 
 
 
2015
 
2014(3)
 
2013
Average sales per store(1) ($ in thousands)
 
$
2,377

 
$
2,327

 
$
2,093

Average sales per square foot(1)
 
$
980

 
$
1,025

 
$
1,077

Stores > $1 million in net sales(1)
 
99
%
 
98
%
 
96
%
Stores > $2 million in net sales(1)
 
62
%
 
59
%
 
46
%
Average revenue per mattress unit – Company-Controlled channel(2)
 
$
4,028

 
$
3,671

 
$
3,245

        
(1) Trailing twelve months for stores included in our comparable store sales calculation.
(2) Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.
(3) Fiscal 2014 included 53 weeks, as compared to 52 weeks in fiscal 2015 and 2013. The additional week in 2014 was in the fiscal fourth quarter. Company-Controlled comparable sales metrics have been adjusted to remove the estimated impact of the additional week on those metrics.

The number of retail stores operating during the last three years was as follows:
 
 
2015
 
2014
 
2013
Beginning of period
 
463

 
440

 
410

Opened
 
38

 
57

 
71

Closed
 
(13
)
 
(34
)
 
(41
)
End of period
 
488

 
463

 
440


Comparison of 2015 and 2014

Enterprise Resource Planning (ERP) system implementation

In the fourth quarter 2015, we replaced our nearly 20-year-old legacy computer systems with a new vertically-integrated Enterprise Resource Planning (ERP) system. We experienced technical and operational issues in our plants and supply chain as we ramped up the new system, which led to delivery delays and inconveniences for our customers. The lost sales and increases in cost of sales and operating expenses negatively impacted 2015 results by approximately $0.40 per diluted share ($0.43 per diluted share for the fourth quarter). Through the filing date of this document, we have made progress resolving technical and operational issues associated with the ERP implementation. While we continue to learn to use the new system proficiently and at higher volumes, the system is operating at near normal levels across our vertical enterprise.

Net sales

Net sales in 2015 increased 5% to $1.21 billion, compared with $1.16 billion for the same period one year ago. The sales increase was driven by a 3% comparable sales increase in our Company-Controlled channel and sales from 25 net new retail stores opened in the past 12 months. During the first nine months of 2015, demand for our latest product innovations and more effective marketing drove traffic to our stores and contributed to a 20% year-to-date net sales increase. However, net sales decreased 33% in the fourth quarter compared to the prior year, reflecting approximately $84 million in sales disruptions from our ERP system implementation. In addition, 2015 included 52 weeks compared with 53 weeks in 2014, with the extra week benefiting 2014 net sales growth by approximately $24 million.
 
The $57 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $52 million increase resulting from net store openings; and (ii) a $31 million sales increase from Company-Controlled comparable sales; partially offset by (iii) an approximately $24 million sales decrease as the prior year included an extra week of net sales (52-week year 2015 vs. 53-week year 2014); and (iv) a $2 million decrease in Wholesale/Other channel sales. Company-Controlled mattress units decreased 4% compared to the prior-year period. Average revenue per mattress unit in our Company-Controlled channel increased by 10%.

Gross profit

Gross profit of $741 million increased by $34 million, or 5%, compared with the same period one year ago. The gross profit rate decreased to 61.0% of net sales for 2015, compared with 61.1% for the prior-year period. The 0.1 percentage points ("ppt.") decrease in the gross profit rate was primarily due to: (i) appeasements, labor inefficiencies, material costs and excess freight from actions taken to manage our fourth-quarter 2015 ERP issues; partially offset by: (ii) favorable product mix changes resulting from advancements in our selling process and product innovations over the last 12 months. In addition, our gross profit rate can fluctuate from year-to-year

29



due to a variety of other factors, including return and exchange costs, raw materials price fluctuations, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses

Sales and marketing expenses in 2015 increased 8% to $550 million, or 45.4% of net sales, compared with $512 million, or 44.3% of net sales, for the same period one year ago. The 1.1 ppt. decrease in the sales and marketing expense rate in the current period was mainly due to the deleveraging impact resulting from the approximately $84 million in sales disruptions associated with our fourth-quarter 2015 ERP system implementation.
 
General and administrative expenses

General and administrative (G&A) expenses increased $14 million to $99 million in 2015, compared with $85 million in the prior year and increased to 8.2% of net sales, compared with 7.3% of net sales one year ago. G&A expenses for 2015 included 52 weeks of expenses compared with 53 weeks in 2014. The $14 million increase in G&A expenses consisted of the following major components: (i) $11.6 million of ERP launch costs in 2015, including data conversion and training expenses; (ii) $4.5 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business, including our new digital website that was launched in the second quarter of 2014 and our new ERP system that was launched in the fourth quarter of 2015; (iii) $4.1 million of higher professional fees, including additional costs associated with proxy preparation, filing and consulting services; and (iv) a $2.2 million increase in miscellaneous other expenses. These increases were partially offset by: (i) a $4.9 million decrease in employee compensation, including a year-over-year reduction in company-wide performance-based incentive compensation; and (ii) a $3.5 million gain (net of acquisition-related expenses) related to our previously held minority equity investment in BAM Labs, Inc. The G&A expense rate increased by 0.9 ppt. in the current period compared with the same period one year ago due to the increase in expenses discussed above, partially offset by the leveraging impact of the 5% net sales increase.

Research and development expenses

Research and development expenses for the year ended January 2, 2016 were $16 million, or 1.3% of net sales, compared with $8 million, or 0.7% of net sales, for the same period one year ago. The $8 million increase in R&D expenses was due to increased investments to support product innovations, including $3.3 million of expenses related to SleepIQ LABS' operations (post acquisition; acquired on September 15, 2015). The $8 million increase is consistent with our long-term consumer innovation strategy.

Income tax expense

Income tax expense was $25 million for the year ended January 2, 2016, compared with $34 million for the same period one year ago. The effective tax rate for the year ended January 2, 2016 was 33.0% compared with 33.4% for the prior-year period. The decrease in the effective tax rate primarily resulted from tax planning benefits associated with the BAM Labs, Inc. acquisition gain, partially offset by a reduction in our manufacturing deduction driven by increased year-over-year bonus tax depreciation.

Comparison of 2014 and 2013

Net sales

Net sales in 2014 increased 20% to $1.16 billion, compared with $960 million for the same period one year ago. Demand for our latest product innovations and more effective marketing drove traffic to our stores and contributed to the strong sales increase. The sales increase was driven by a 12% comparable sales increase in our Company-Controlled channel and sales from 23 net new retail stores opened in the past 12 months. In addition, 2014 included 53 weeks compared with 52 weeks in the prior year, with the extra week benefiting 2014 net sales growth by approximately $24 million.
 
The $197 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $103 million sales increase from our Company-Controlled comparable retail stores; (ii) a $75 million increase resulting from net store openings; and (iii) approximately $24 million from the additional 53rd week noted above; partially offset by (iv) a $5 million decrease in Wholesale/Other channel sales. Company-Controlled mattress units increased 8% compared to the prior-year period. Average revenue per mattress unit in our Company-Controlled channel increased by 13%.

30



Gross profit

Gross profit of $707 million increased by $105 million, or 17%, compared with the same period one year ago. The gross profit rate decreased to 61.1% of net sales for 2014, compared with 62.7% for the prior-year period. The 1.6 percentage points ("ppt.") decrease in the gross profit rate was primarily due to: (i) a higher sales mix of lower-margin rate products, principally our FlexFit™ adjustable bases; and (ii) increased sales return and exchange costs, including the impact of the change in our 30-night trial policy to 100 nights in the second quarter of 2013. In addition, our gross profit rate can fluctuate from year to year due to a variety of other factors, including supply chain efficiencies, raw materials price fluctuations, warranty expenses and performance-based incentive compensation.

Sales and marketing expenses

Sales and marketing expenses in 2014 increased 17% to $512 million, or 44.3% of net sales, compared with $439 million, or 45.7% of net sales, for the same period one year ago. The 1.4 ppt. decrease in the sales and marketing expense rate in the current period was mainly due to: (i) leveraging our media spending, which increased by 9% compared with the prior-year, while net sales increased 20%; partially offset by (ii) higher depreciation and occupancy costs as we continue to invest in our exclusive distribution strategy.
 
General and administrative expenses

General and administrative (G&A) expenses increased $22 million to $85 million in 2014, compared with $63 million in the prior year and increased to 7.3% of net sales, compared with 6.6% of net sales one year ago. G&A expenses for 2014 included 53 weeks of expenses compared with 52 week in 2013. The $22 million increase in G&A expenses consistent of the following major components: (i) an $18.9 million increase in employee compensation (including company-wide performance-based incentive compensation which was not earned in the prior-year, incremental costs to enhance our IT infrastructure and expenses associated with the additional 53rd week); (ii) $2.6 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business, including our new digital website which was launched in the second quarter of 2014; and (iii) a $0.4 million increase in miscellaneous other expenses, net of a favorable legal settlement. The G&A expense rate increased by 0.8 ppt. in the current period compared with the same period one year ago due to the increase in expenses discussed above, partially offset by the leveraging impact of the 20% net sales increase.

Liquidity and Capital Resources

As of January 2, 2016, cash, cash equivalents and marketable debt securities totaled $36 million compared with $166 million as of January 3, 2015. The $130 million decrease was primarily due to $108 million of cash provided by operating activities, which was more than offset by $86 million of cash used to purchase property and equipment, $100 million of cash used to repurchase our common stock ($98 million under our Board-approved share repurchase program and $2 million in connection with the vesting of employee restricted stock grants) and $57 million to acquire the remaining capital stock of BAM Labs, Inc. (now operating as SleepIQ LABS). Our $15 million of marketable debt securities held as of January 2, 2016 are all highly liquid and include U.S. agency securities, corporate debt securities and municipal bonds.

The following table summarizes our cash flows (dollars in millions). Amounts may not add due to rounding differences:
 
 
2015
 
2014
Total cash provided by (used in):
 
 
 
 
Operating activities
 
$
107.9

 
$
144.5

Investing activities
 
(44.3
)
 
(114.4
)
Financing activities
 
(94.7
)
 
(36.3
)
Net decrease in cash and cash equivalents
 
$
(31.0
)
 
$
(6.2
)
 
Cash provided by operating activities for the fiscal year ended January 2, 2016 was $108 million compared with $144 million for the fiscal year ended January 3, 2015. Significant components of the $37 million year-over-year decrease in cash from operating activities included: (i) a $17 million decrease in our 2015 net income; (ii) a $35 million fluctuation in accrued compensation and benefits which primarily resulted from year-over-year changes in company-wide performance-based incentive compensation that was earned and reflected as a liability in 2014, with no corresponding liabilities at the end of 2013 and 2015; and (iii) the ERP implementation issues we experienced in our plants and supply chain that resulted in higher inventory levels, increased accounts receivables, increased accounts payable and higher customer prepayments.


31



Net cash used in investing activities was $44 million for the fiscal year ended January 2, 2016, compared with $114 million for the same period one year ago. Investing activities for the current-year period included $86 million of property and equipment purchases, compared with $77 million for the same period one year ago. We decreased our net investments in marketable debt securities by $98 million during the fiscal year ended January 2, 2016, compared with a net increase of $36 million during the comparable period one year ago. In September 2015, we completed the acquisition of BAM Labs, Inc. (now operating as SleepIQ LABS). We previously held a $6.0 million minority equity investment in BAM Labs, Inc. based on the cost method. In connection with the acquisition, our equity investment was remeasured to a fair value of $12.9 million and we acquired the remaining capital stock in BAM Labs, Inc. for $57.1 million for a total enterprise value of $70.0 million. See Note 2, Acquisition of BAM Labs, Inc., and Note 4, Investments, of the Notes to Consolidated Financial Statements for additional details.

Net cash used in financing activities was $95 million for the fiscal year ended January 2, 2016, compared with net cash used in financing activities of $36 million for the same period one year ago. During the fiscal year ended January 2, 2016, we repurchased $100 million of our common stock ($98 million under our Board-approved share repurchase program and $2 million in connection with the vesting of employee restricted stock grants) compared with $46 million during the same period one year ago. Changes in book overdrafts are included in the net change in short-term borrowings. Financing activities for both periods reflect the cash proceeds from the exercise of employee stock options along with the excess tax benefits related to stock-based compensation.

Under our Board-approved share repurchase program, we repurchased 3.6 million shares at a cost of $98 million ($27.46 per share) during the fiscal year ended January 2, 2016. During 2014, we repurchased 2.2 million shares at a cost of $45 million ($20.77 per share). As of January 2, 2016, the remaining authorization under our Board-approved share repurchase program was $137 million. There is no expiration date governing the period over which we can repurchase shares.

In February 2016, we amended our revolving credit facility (Credit Agreement) with a syndicate of banks (Lenders). The Credit Agreement provides a revolving credit facility for general corporate purposes with net aggregate availability of $150 million. The Credit Agreement contains an accordion feature that allows us to increase the amount of the credit facility from $150 million up to $200 million in total availability, subject to Lenders' approval. The Credit Agreement matures in February 2021.

The Credit Agreement provides the Lenders with a collateral security interest in substantially all of our assets and those of our subsidiaries and requires us to comply with, among other things, a maximum leverage ratio (4.75) and a minimum interest coverage ratio (3.00). Under the terms of the Credit Agreement, we pay a variable rate of interest and a commitment fee based on our leverage ratio. As of January 2, 2016, we had no outstanding borrowings or letters of credit and we were in compliance with all financial covenants.

Our business model, which can operate with minimal working capital, does not require significant additional capital to fund operations or organic growth. The $36 million of cash, cash equivalents and marketable debt securities, cash generated from ongoing operations, and cash available under our revolving credit facility are expected to be adequate to maintain operations, and fund anticipated capital expenditures and strategic initiatives for the foreseeable future.

We have an agreement with Synchrony Bank to offer qualified customers revolving credit arrangements to finance purchases from us (Synchrony Agreement). The Synchrony Agreement contains certain financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio. As of January 2, 2016, we were in compliance with all financial covenants.

Under the terms of the Synchrony Agreement, Synchrony Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts.

Off-Balance-Sheet Arrangements and Contractual Obligations

As of January 2, 2016, we were not involved in any unconsolidated special purpose entity transactions. Other than our operating leases, we do not have any off-balance-sheet financing. There were no outstanding letters of credit at January 2, 2016. A summary of our operating lease obligations is included in the “Contractual Obligations” section (as follows). Additional information regarding our operating leases is available in Item 2, Properties, and Note 8, Leases, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.


32



Contractual Obligations
  
The following table presents information regarding our contractual obligations (in thousands):
 
 
Payments Due by Period(1)
 
 
Total
 
< 1 Year
 
1 - 3 Years
 
3 - 5 Years
 
> 5 Years
Operating leases(2)
 
$
299,254

 
$
59,096

 
$
98,723

 
$
62,009

 
$
79,426

Purchase commitments
 
9,800

 
9,800

 

 

 

Other
 
4,600

 
4,600

 

 

 

    Total
 
$
313,654

 
$
73,496

 
$
98,723

 
$
62,009

 
$
79,426

        
(1) Our unrecognized tax benefits, including interest and penalties, of $2 million have not been included in the Contractual Obligations table as we are not able to determine a reasonable estimate of timing of the cash settlement with the respective taxing authorities.
(2) These amounts include the payments related to 42 lease commitments for future retail store locations. These lease commitments provide for minimum rentals over the next five to 11 years, which if consummated based on current cost estimates, would approximate $53 million over the initial lease term.
  
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP). In connection with the preparation of our financial statements, we are required to make estimates and assumptions about future events, and apply judgments that affect the reported amounts of assets, liabilities, sales, expenses and the related disclosure. Predicting future events is inherently an imprecise activity and as such requires the use of judgment. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.
  
Our significant accounting policies are discussed in Note 1, Business and Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Management believes the accounting policies discussed below are the most critical because they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and estimates, and related disclosures with the Audit Committee of our Board.
  
Our critical accounting policies and estimates relate to stock-based compensation, goodwill and indefinite-lived intangible assets, warranty liabilities and revenue recognition.
Description
 
Judgments and Uncertainties
 
Effect if Actual Results
Differ From Assumptions
Stock-Based Compensation
 
 
 
 
We have stock-based compensation plans, which includes non-qualified stock options and stock awards.

See Note 1, Business and Summary of Significant Accounting Policies, and Note 10, Shareholders’ Equity, to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our stock-based compensation programs.
 
Option-pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, future employee forfeiture rates and future employee stock option exercise behaviors. Changes in these assumptions can materially affect the fair value estimates or future earnings adjustments.

Performance-based stock awards require management to make assumptions regarding the likelihood of achieving performance targets.
 
We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to changes in stock-based compensation expense that could be material.

In addition, if actual results are not consistent with the assumptions used, the stock-based compensation expense reported in our financial statements may not be representative of the actual economic cost of the stock-based compensation. Finally, if the actual forfeiture rates, or the actual achievement of performance targets, are not consistent with the assumptions used, we could experience future earnings adjustments.

A 10% change in our stock-based compensation expense for the year ended January 2, 2016, would have affected net income by approximately $688,000 in 2015.

33



Description
 
Judgments and Uncertainties
 
Effect if Actual Results
Differ From Assumptions
Goodwill and Indefinite-Lived Intangible Assets
Goodwill represents the excess of cost over the fair value of identifiable net assets of businesses acquired. Our indefinite-lived intangible assets include trade names/trademarks.

See Note 1,
Business and Summary of Significant Accounting Policies and Note 7, Goodwill and Intangible Assets, Net, to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our goodwill and indefinite-lived intangible assets.
 
The determination of fair value involves uncertainties because it requires management to make assumptions and to apply judgment to estimate industry and economic factors and the profitability of future business strategies. Management’s assumptions also include projected revenues, operating profit levels and discount rates, as well as consideration of any other factors that may indicate potential impairment.
 
In the fourth quarter of fiscal 2015, management completed its annual goodwill and other indefinite-lived intangible asset impairment tests and determined there was no impairment. We believe our assumptions and judgments used in estimating cash flows and determining fair value were reasonable. However, unexpected changes to such assumptions and judgments could affect our impairment analyses and future results of operations, including an impairment charge that could be material.
Warranty Liabilities
 
 
 
 
We provide a limited warranty on most of the products we sell.

See Note 1, Business and Summary of Significant Accounting Policies, to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our warranty program and liabilities.

 
The majority of our warranty claims are incurred within the first year. However, our warranty liability contains uncertainties because our warranty obligations cover an extended period of time. A revision of estimated claim rates or the projected cost of materials and freight associated with sending replacement parts to customers could have a material adverse effect on future results of operations.

 
We have not made any material changes in our warranty liability assessment methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our warranty liability. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material.

A 10% change in our warranty liability at January 2, 2016, would have affected net income by approximately $670,000 in 2015.

Revenue Recognition
Certain accounting estimates relating to revenue recognition contain uncertainty because they require management to make assumptions and to apply judgment regarding the effects of future events.

See Note 1, Business and Summary of Significant Accounting Policies, to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our revenue recognition policies.
 
Our estimates of sales returns contain uncertainties as actual sales return rates may vary from expected rates, resulting in adjustments to net sales in future periods. These adjustments could have an adverse effect on future results of operations.
 
We have not made any material changes in the accounting methodology used to establish our sales returns allowance during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our sales returns allowance. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to additional losses or gains in future periods.

A 10% change in our sales returns allowance at January 2, 2016 would have affected net income by approximately $1.4 million in 2015.


34



Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (FASB) issued a comprehensive new revenue recognition model that requires a company to recognize revenue to depict the transfer of goods or services to a customer at an amount that reflects the consideration it expects to receive in exchange for those goods or services. This new guidance was originally effective for fiscal years beginning after December 15, 2016 and early adoption was not permitted. In July 2015, the FASB deferred the effective date from fiscal years beginning after December 15, 2016 to fiscal years beginning after December 15, 2017 (including interim reporting periods within those fiscal years). Early adoption is permitted to the original effective date of fiscal years beginning after December 15, 2016 (including interim reporting periods within those fiscal years). Companies may use either a full retrospective or a modified retrospective approach to adopt this new guidance. We are evaluating the effect of the new standard on our consolidated financial statements and related disclosures, and have not yet selected a transition method.

In November 2015, the FASB issued new guidance related to classification of deferred taxes. The new guidance requires that deferred tax liabilities and assets be classified as non-current on the balance sheet. It is effective for interim and annual periods beginning after December 15, 2016, but early adoption is permitted. We will adopt the new guidance on a retrospective basis beginning in the first quarter of fiscal 2016.

In February 2016, the FASB issued new guidance on accounting for leases and generally requires most leases to be recognized on the balance sheet. This new guidance is effective for reporting periods beginning after December 15, 2018, with early adoption permitted. The provisions of this new guidance are to be applied using a modified retrospective approach, with elective reliefs, which requires application of the new guidance for all periods presented. We are evaluating the effect of the new standard on our consolidated financial statements and related disclosures.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Changes in the overall level of interest rates affect interest income generated from our short-term and long-term investments in marketable debt securities. If overall interest rates were one percentage point lower than current rates, our annual interest income would not change by a significant amount based on our investments in marketable debt securities as of January 2, 2016 and the current low interest-rate environment. We do not manage our investment interest-rate volatility risk through the use of derivative instruments.

As of January 2, 2016, we had no borrowings under our revolving credit facility.

35



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Shareholders of
Select Comfort Corporation
Minneapolis, Minnesota

We have audited the internal control over financial reporting of Select Comfort Corporation and subsidiaries (the "Company") as of January 2, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company's internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of January 2, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule listed in the Index at Item 15 as of and for the year ended January 2, 2016, of the Company and our report dated March 1, 2016 expressed an unqualified opinion on those consolidated financial statements and the financial statement schedule.

/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
March 1, 2016

36



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and Shareholders of
Select Comfort Corporation
Minneapolis, Minnesota

We have audited the accompanying consolidated balance sheets of Select Comfort Corporation and subsidiaries (the "Company") as of January 2, 2016 and January 3, 2015, and the related consolidated statements of income, comprehensive income, shareholders' equity, and cash flows for each of the three years in the period ended January 2, 2016. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on the financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of January 2, 2016, and January 3, 2015, and the results of their operations and their cash flows for each of the three years in the period ended January 2, 2016, in conformity with accounting principles generally accepted in the United States of America. Also, 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.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company's internal control over financial reporting as of January 2, 2016, based on the criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 1, 2016 expressed an unqualified opinion on the Company’s internal control over financial reporting.


/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota
March 1, 2016



37



SELECT COMFORT CORPORATION
AND SUBSIDIARIES

Consolidated Balance Sheets
January 2, 2016 and January 3, 2015
(in thousands, except per share amounts)
 
2015
 
2014
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
20,994

 
$
51,995

Marketable debt securities – current
6,567

 
69,609

Accounts receivable, net of allowance for doubtful accounts of $1,039 and $739, respectively
29,002

 
19,693

Inventories
86,600

 
53,535

Income taxes receivable
15,284

 

Prepaid expenses
10,207

 
17,792

Deferred income taxes
15,535

 
8,786

Other current assets
13,737

 
11,185

Total current assets
197,926

 
232,595

 
 
 
 
Non-current assets:
 

 
 
Marketable debt securities – non-current
8,553

 
44,441

Property and equipment, net
204,376

 
165,453

Goodwill and intangible assets, net
83,344

 
15,986

Deferred income taxes

 
3,433

Other assets
19,197

 
12,279

Total assets
$
513,396

 
$
474,187

 
 
 
 
Liabilities and Shareholders’ Equity
 

 
 
Current liabilities:
 

 
 
Accounts payable
$
103,941

 
$
84,197

Customer prepayments
51,473

 
28,726

Accrued sales returns
20,562

 
15,262

Compensation and benefits
15,670

 
33,066

Taxes and withholding
9,856

 
10,207

Other current liabilities
23,447

 
15,594

Total current liabilities
224,949

 
187,052

 
 
 
 
Non-current liabilities:
 

 
 
Warranty liabilities
4,942

 
2,722

Deferred income taxes
12,499

 

Other long-term liabilities
48,667

 
27,506

Total liabilities
291,057

 
217,280

 
 
 
 
Shareholders’ equity:
 

 
 
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding

 

Common stock, $0.01 par value; 142,500 shares authorized, 49,402 and 52,798 shares issued and outstanding, respectively
494

 
528

Additional paid-in capital

 

Retained earnings
221,859

 
256,413

Accumulated other comprehensive loss
(14
)
 
(34
)
Total shareholders’ equity
222,339

 
256,907

Total liabilities and shareholders’ equity
$
513,396

 
$
474,187


See accompanying notes to consolidated financial statements.

38



SELECT COMFORT CORPORATION
AND SUBSIDIARIES

Consolidated Statements of Operations
Years ended January 2, 2016, January 3, 2015 and December 28, 2013
(in thousands, except per share amounts)

 
2015
 
2014
 
2013
Net sales
$
1,213,699

 
$
1,156,757

 
$
960,171

Cost of sales
472,948

 
449,907

 
358,416

Gross profit
740,751

 
706,850

 
601,755

 
 
 
 
 
 
Operating expenses:
 

 
 
 
 

Sales and marketing
550,475

 
512,007

 
439,156

General and administrative
99,209

 
84,864

 
62,433

Research and development
15,971

 
8,233

 
9,478

Total operating expenses
665,655

 
605,104

 
511,067

Operating income
75,096

 
101,746

 
90,688

Other income, net
334

 
362

 
323

Income before income taxes
75,430

 
102,108

 
91,011

Income tax expense
24,911

 
34,134

 
30,930

Net income
$
50,519