-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, NKC4+DfhO/ctoHJkAwVURflHEHSfvbwNAmRFgaVkpg9ievP5htdZP/fAA729O4l4 QVkh3shiV+/rTP3/6BrXsw== 0000827187-99-000022.txt : 19991117 0000827187-99-000022.hdr.sgml : 19991117 ACCESSION NUMBER: 0000827187-99-000022 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 19991002 FILED AS OF DATE: 19991116 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SELECT COMFORT CORP CENTRAL INDEX KEY: 0000827187 STANDARD INDUSTRIAL CLASSIFICATION: HOUSEHOLD FURNITURE [2510] IRS NUMBER: 410157886 STATE OF INCORPORATION: MN FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-25121 FILM NUMBER: 99756912 BUSINESS ADDRESS: STREET 1: 10400 VIKING DRIVE, SUITE 400 CITY: MINNEAPOLIS STATE: MN ZIP: 55344 BUSINESS PHONE: (612) 918-3000 10-Q 1 10-Q SELECT COMFORT CORPORATION UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended October 2, 1999 COMMISSION FILE NO. 0-25121 -------------------- SELECT COMFORT CORPORATION (Exact name of registrant as specified in its charter) MINNESOTA 41-1597886 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 10400 VIKING DRIVE, SUITE 400 MINNEAPOLIS, MINNESOTA 55344 (Address of principal executive offices) (Zip code) Registrant's telephone number, including area code: (612) 918-3000 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. X YES NO As of October 2, 1999, 18,037,043 shares of Common Stock of the Registrant were outstanding. SELECT COMFORT CORPORATION AND SUBSIDIARIES INDEX Page No. PART I: FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets October 2, 1999 and January 2, 1999............................... 3 Consolidated Statements of Operations for the Three Months and Nine Months ended October 2, 1999 and October 3, 1998............................................... 4 Consolidated Statements of Cash Flows for the Nine Months ended October 2, 1999 and October 3, 1998............................................... 5 Notes to Consolidated Financial Statements........................ 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations..................... 8 Item 3. Quantitative and Qualitative Disclosures about Market Risk........ 13 PART II: OTHER INFORMATION Item 1. Legal Proceedings............................................... 14 Item 2. Changes in Securities and Use of Proceeds....................... 14 Item 3. Defaults Upon Senior Securities................................. 14 Item 4. Submission of Matters to a Vote of Security Holders............. 14 Item 5. Other Information............................................... 14 Item 6. Exhibits and Reports on Form 8-K................................ 15 PART I: FINANCIAL INFORMATION SELECT COMFORT CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS) (UNAUDITED) OCTOBER 2, JANUARY 2, ASSETS 1999 1999 ---------- ---------- Current assets: Cash and cash equivalents $13,321 $45,561 Marketable securities 24,250 - Accounts receivable, net of allowance for doubtful accounts of $399, and $2,750, respectively (note 3) 1,578 10,624 Inventories (note 4) 11,164 10,136 Prepaid expenses 3,798 4,048 Income taxes 2,780 - Deferred tax assets 6,039 5,448 ---------- ---------- Total current assets 62,930 75,817 ---------- ---------- Property and equipment, net 35,192 29,125 Deferred tax assets 1,154 440 Other assets 2,682 852 ---------- ---------- Total assets $101,958 $106,234 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities of long-term debt $253 $930 Accounts payable 17,097 12,079 Accruals: Sales returns 5,246 6,021 Warranty costs 5,645 4,486 Compensation, taxes and benefits 5,183 4,843 Income taxes - 648 Other 4,587 4,561 ---------- ---------- Total current liabilities 38,011 33,568 Long-term debt, less current maturities 42 29 Other liabilities 2,496 1,946 ---------- ---------- Total liabilities 40,549 35,543 ---------- ---------- Shareholders' equity: Undesignated preferred stock; 5,000,000 shares authorized, no shares issued and outstanding - - Common stock, $.01 par value; 95,000,000 shares authorized, 18,037,043 and 18,435,687 shares issued and outstanding, respectively 180 184 Additional paid-in capital 80,503 87,619 Accumulated deficit (19,274) (17,112) ---------- ---------- Total shareholders' equity 61,409 70,691 ---------- ---------- Total liabilities and shareholders' equity $101,958 $106,234 ========== ========== See accompanying notes to consolidated financial statements. 3 SELECT COMFORT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) (UNAUDITED) THREE MONTHS ENDED NINE MONTHS ENDED --------------------- --------------------- OCTOBER 2, OCTOBER 3, OCTOBER 2, OCTOBER 3, 1999 1998 1999 1998 ---------- ---------- ---------- ---------- Net sales $68,281 $60,035 $205,663 $178,835 Cost of sales 23,944 20,744 71,053 62,290 ---------- ---------- ---------- ---------- Gross margin 44,337 39,291 134,610 116,545 ---------- ---------- ---------- ---------- Operating expenses: Sales and marketing 42,816 31,640 120,705 95,596 General and administrative 7,871 4,972 18,677 13,567 ---------- ---------- ---------- ---------- Total operating expenses 50,687 36,612 139,382 109,163 ---------- ---------- ---------- ---------- Operating income (loss) (6,350) 2,679 (4,772) 7,382 ---------- ---------- ---------- ---------- Other income (expense): Interest income 537 166 1,496 548 Interest expense (10) (4,256) (61) (6,992) Other, net (47) 1 (94) (1) ---------- ---------- ---------- ---------- Other income (expense), net 480 (4,089) 1,341 (6,445) ---------- ---------- ---------- ---------- Income (loss) before income taxes (5,870) (1,410) (3,431) 937 Income tax expense (benefit) (2,172) 493 (1,269) 1,348 ---------- ---------- ---------- ---------- Net loss ($3,698) ($1,903) ($2,162) ($411) ========== ========== ========== ========== Net loss per share - basic and diluted $(0.20) $(0.72) $(0.12) $(0.40) ========== ========== ========== ========== Weighted average share - basic and diluted 18,148 2,939 18,348 2,746 See accompanying notes to consolidated financial statements. 4 SELECT COMFORT CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (IN THOUSANDS) (UNAUDITED) NINE MONTHS ENDED ---------------------- OCTOBER 2, OCTOBER 3, 1999 1998 ---------- ---------- Cash flows from operating activities: Net loss ($2,162) ($411) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 4,616 3,909 Deferred tax assets (1,305) (388) Interest expense from put warrant valuation - 5,220 Change in operating assets and liabilities: Accounts receivable, net 9,046 (3,002) Inventories (1,028) (2,567) Prepaid expenses 250 (223) Income taxes (3,428) 29 Accounts payable 5,018 205 Accrued sales returns (775) 296 Accrued warranty costs 1,159 605 Accrued compensation, taxes and benefits 340 (100) Other accrued liabilities 26 (848) Other assets 150 (544) Other liabilities 550 455 ---------- ---------- Net cash provided by operating activities 12,457 2,636 ---------- ---------- Cash flows used in investing activities: Purchases of property and equipment (10,663) (6,660) Investment in marketable securities (24,250) - Investment in affiliate (2,000) - ---------- ---------- Net cash used in investing activities (36,913) (6,660) ---------- ---------- Cash flows from financing activities: Principal payments on debt (664) (739) Repurchase of common stock (10,438) - Proceeds from issuance of common 3,318 1,672 ---------- ---------- Net cash provided by (used in) financing activities (7,784) 933 ---------- ---------- Decrease in cash and cash equivalents (32,240) (3,091) Cash and cash equivalents, at beginning of period 45,561 12,670 ---------- ---------- Cash and cash equivalents, at end of period $13,321 $9,579 ========== ========== See accompanying notes to consolidated financial statements. 5 SELECT COMFORT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF FINANCIAL STATEMENT PRESENTATION The consolidated financial statements for the three months and nine months ended October 2, 1999 and October 3, 1998 of Select Comfort Corporation and subsidiaries ("Select Comfort" or the "Company"), have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly the financial position of the Company as of October 2, 1999 and January 2, 1999 and the results of operations and cash flow for the periods presented. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although management believes the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the Company's most recent audited consolidated financial statements and related notes included in the Company's Annual Report to Shareholders and its Form 10-K for the fiscal year ended January 2, 1999. Operating results for the Company on a quarterly basis may not be indicative of operating results for the full year. (2) INVESTMENT In May 1999, the Company invested $2.0 million in a less than 20% owned affiliate that will be the provider of the Company's sofa sleeper product. This investment is accounted for under the cost method. (3) ACCOUNTS RECEIVABLE Effective July 1999, we terminated our revolving third-party credit arrangement with Monogram Bank, an affiliate of General Electric Capital Corporation ("GE") and entered into a third-party credit arrangement with Green Tree Financial Corporation ("Green Tree"). These arrangements have been used to provide financing for our customers' use in purchasing our products. In connection with all purchases financed under these arrangements, the provider pays an amount equal to the total amount of purchases net of promotional discounts. The provider sets the rate, annual fees and all other terms and conditions relating to the customers' accounts, including collection policies and procedures, and is the owner of the receivables. In July 1999, Green Tree purchased substantially all of the outstanding receivables from GE. As a result of this transaction, the Company received $9.8 million that had been retained by GE and which had been included in accounts receivable. There are no retainage requirements as part of the new agreement. (4) INVENTORIES Inventories consist of the following (in thousands): OCTOBER 2, 1999 JANUARY 2, 1999 --------------- --------------- Raw materials $7,004 $6,533 Work in progress 71 67 Finished goods 4,089 3,536 --------------- --------------- $11,164 $10,136 =============== =============== 6 SELECT COMFORT CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (5) NET INCOME PER COMMON SHARE The following computations reconcile net loss with net loss per common share-basic and diluted (in thousands except per share amounts).
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------------- --------------------------------- NET PER SHARE NET PER SHARE OCTOBER 2, 1999 LOSS SHARES AMOUNT LOSS SHARES AMOUNT --------------- ---------- ---------- ---------- ---------- ---------- ---------- Net loss ($3,698) ($2,162) BASIC AND DILUTED EPS Net loss available to common shareholders ($3,698) 18,148 ($0.20) ($2,162) 18,348 ($0.12) ========== ========== ========== ========== ========== ==========
THREE MONTHS ENDED NINE MONTHS ENDED --------------------------------- --------------------------------- NET PER SHARE NET PER SHARE OCTOBER 3, 1998 LOSS SHARES AMOUNT LOSS SHARES AMOUNT --------------- ---------- ---------- ---------- ---------- ---------- ---------- Net loss ($1,903) ($411) Less: Cumulative preferred dividend (225) (675) ---------- ---------- BASIC AND DILUTED EPS Net loss available to common shareholders ($2,128) 2,939 ($0.72) ($1,086) 2,745 ($0.40) ========== ========== ========== ========== ========== ==========
(6) STOCK REPURCHASE In May 1999, the Board of Directors authorized management to repurchase up to $10 million in shares of the Company's common stock in the open market. The Company subsequently repurchased 575,000 shares for approximately $8.5 million. In August 1999, the Board of Directors authorized management to repurchase up to $4 million in shares of the Company's common stock. As of October 2, 1999 the Company had repurchased 275,000 shares for approximately $1.9 million under this program. The Company believes cash generated from operations, together with existing cash balances, will be sufficient to satisfy anticipated short-term working capital requirements and long-term liquidity needs. $2.1 million remained available under the program as of October 2, 1999. (7) LITIGATION The Company and certain of its former officers and directors have been named as defendants in a class action lawsuit filed on behalf of Company shareholders in U.S. District Court in Minnesota. The named plaintiffs, who purport to act on behalf of a class of purchasers of the Company's common stock during the period from December 4, 1998 to June 7, 1999, charge the defendants with violations of federal securities laws. The suit alleges that the Company and the named directors and officers failed to disclose or misrepresented certain information concerning the Company during the class period. The complaint does not specify an amount of damages claimed. The Company believes that the complaint is without merit and intends to vigorously defend the claims. 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THE FOLLOWING DISCUSSION AND ANALYSIS SHOULD BE READ IN CONJUNCTION WITH THE CONSOLIDATED FINANCIAL STATEMENTS AND THE NOTES THERETO INCLUDED HEREIN. THIS QUARTERLY REPORT ON FORM 10-Q CONTAINS FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. THE STATEMENTS REGARDING SELECT COMFORT CORPORATION CONTAINED IN THIS REPORT THAT ARE NOT HISTORICAL IN NATURE, PARTICULARLY THOSE THAT UTILIZE TERMINOLOGY SUCH AS "MAY," "WILL," "SHOULD," "EXPECTS," "ANTICIPATES," "ESTIMATES," "BELIEVES" OR "PLANS," OR COMPARABLE TERMINOLOGY, ARE FORWARD-LOOKING STATEMENTS BASED ON CURRENT EXPECTATIONS AND ASSUMPTIONS, AND ENTAIL VARIOUS RISKS AND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE EXPRESSED IN SUCH FORWARD-LOOKING STATEMENTS. IMPORTANT FACTORS KNOWN TO SELECT COMFORT THAT COULD CAUSE SUCH MATERIAL DIFFERENCES ARE IDENTIFIED AND DISCUSSED IN PART I, ITEM 1 OF OUR ANNUAL REPORT ON FORM 10-K FOR THE FISCAL YEAR ENDED JANUARY 2, 1999, WHICH DISCUSSION IS INCORPORATED HEREIN BY REFERENCE. SUCH IMPORTANT FACTORS INCLUDE OUR ABILITY TO CREATE PRODUCT AND BRAND NAME AWARENESS, THE EFFECTIVENESS AND EFFICIENCY OF OUR ADVERTISING, THE LEVEL OF CONSUMER ACCEPTANCE OF OUR PRODUCTS, THE NUMBER AND TIMING OF NEW RETAIL STORE OPENINGS, THE PERFORMANCE OF OUR EXISTING AND NEW RETAIL STORES, OUR ABILITY TO MANAGE OUR PLANNED RAPID STORE EXPANSION, OUR ABILITY TO MAINTAIN COST-EFFECTIVE PRODUCTION AND DELIVERY OF PRODUCTS, OUR ABILITY TO SUCCESSFULLY IDENTIFY AND RESPOND TO EMERGING TRENDS IN THE MATTRESS INDUSTRY, THE LEVEL OF COMPETITION IN THE MATTRESS INDUSTRY, AND GENERAL ECONOMIC CONDITIONS AND CONSUMER CONFIDENCE. OVERVIEW Select Comfort is the leading vertically integrated manufacturer, specialty retailer and direct marketer of innovative air beds and sleep-related products. Since the introduction of our first air bed product in 1987, management has focused on improving our product, expanding our product line, building manufacturing and distribution systems and growing our four sales channels: retail, direct marketing, event marketing and e-commerce. Vertically integrated operations and control over four separate but complementary sales channels enable us to develop and maintain direct customer relationships as well as leverage advertising dollars. Sales generation is driven primarily by targeted print, radio and television media that generate customer inquiries, as well as by our multiple, complementary distribution channels, which are designed to provide multiple opportunities for customers to purchase our products. Retail operations included 320 stores at October 2, 1999, including 32 leased departments within Bed Bath & Beyond stores, and 264 stores at January 2, 1999, including 14 leased departments. The Company plans to open a minimum of 20 retail stores during the remainder of 1999, including expansion of the leased department concept. Three of the 19 retail store openings in the third quarter of 1999 were in new markets. We have closed a total of six stores since inception. For the three months ended October 2, 1999, the Company reported comparable store sales growth of 3.6% as compared to 23.3% for the three months ended October 3, 1998. Comparable store sales increased by 7.9% for the nine months ended October 2, 1999 and 24.7% for the nine months ended October 3, 1998. Comparable store sales results have been and will continue to be influenced by a variety of factors, including levels of awareness of our products and brand name, levels of consumer acceptance of our existing and new products, our ability to successfully introduce new products and product line extensions, comparable store sales performance in prior periods, the maturation of our store base, the amount, effectiveness and efficiency of retail advertising expenditures and promotional activity, the amount of competitive activity, our ability to effectively integrate our direct and retail distribution channels, the evolution of store operations, including improvements in store design, the quality and tenure of store-level managers and sales professionals, and general economic conditions and consumer confidence. Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including increases or decreases in comparable store sales, the timing, amount and effectiveness of advertising expenditures, any changes in return rates, the timing of new store openings and related expenses, net sales contributed by new stores, any disruptions in third-party delivery services, competitive factors and general economic conditions and consumer confidence. Our business is also subject to some seasonal influences, with heavier concentrations of sales during the fourth quarter holiday season due to increased mall traffic. 8 A substantial portion of operating expenses is related to sales and marketing expenses, including costs associated with opening new stores, operating existing stores, and advertising and marketing expenditures. The level of such spending cannot be adjusted quickly and is based, in significant part, on expectations of future customer inquiries and net sales. Furthermore, a substantial portion of net sales is often realized in the last month of a quarter, with such net sales frequently concentrated in the last weeks or days of a quarter, due in part to our promotional schedule. Should the Company experience a shortfall in expected net sales or in the conversion rate of customer inquiries, we may be unable to adjust spending in a timely manner and our business, financial condition and operating results may be materially adversely affected. Our historical results of operations may not be indicative of the results that may be achieved for any future fiscal period. Results of Operations The following table sets forth, for the periods indicated, our results of operations expressed as percentages of net sales. Percentage amounts may not total due to rounding. THREE MONTHS ENDED NINE MONTHS ENDED --------------------- --------------------- OCTOBER 2, OCTOBER 3, OCTOBER 2, OCTOBER 3, 1999 1998 1999 1998 ---------- ---------- ---------- ---------- Net sales 100.0% 100.0% 100.0% 100.0% Cost of sales 35.1 34.6 34.5 34.8 ---------- ---------- ---------- ---------- Gross margin 64.9 65.4 65.5 65.2 ---------- ---------- ---------- ---------- Operating expenses: Sales and marketing 62.7 52.7 58.7 53.5 General and administrative 11.5 8.3 9.1 7.6 ---------- ---------- ---------- ---------- Total operating expenses 74.2 61.0 67.8 61.0 ---------- ---------- ---------- ---------- Operating income (loss) (9.3) 4.5 (2.3) 4.1 Other income (expense), net 0.7 (6.8) 0.7 (3.6) ---------- ---------- ---------- ---------- Income (loss) before income taxes (8.6) (2.3) (1.7) 0.5 Income tax expense (benefit) (3.2) 0.8 (0.6) 0.8 ---------- ---------- ---------- ---------- Net loss (5.4)% (3.2)% (1.1)% (0.2)% ========== ========== ========== ========== The overall decrease in operating earnings for 1999 as compared to 1998 relates to increases in operating expenses, as a percentage of net sales, to support long-term growth plans. In addition, direct marketing sales declined by $1.8 million in the third quarter of 1999 compared to the third quarter of 1998. Retail sales, which were positively influenced in those markets in which retail advertising has been expanded, were lower than expected in those markets without increased advertising. A substantial portion of the Company's operating expenses is relatively fixed on a short-term basis and is necessary for long-term growth, including increased retail advertising, certain selling expenses associated with retail store operations, direct marketing selling expenses, and general and administrative costs. The Company has also initiated several strategic studies that have added to general and administrative costs. These studies are expected to be completed in the fourth quarter of 1999. COMPARISON OF THREE MONTHS ENDED OCTOBER 2, 1999 WITH THREE MONTHS ENDED OCTOBER 3, 1998 NET SALES Net sales increased 13.7% to $68.2 million for the three months ended October 2, 1999 from $60.0 million for the three months ended October 3, 1998 primarily due to an increase in unit sales. Net sales were favorably impacted by (i) an $8.5 million increase from the opening of 76 new retail stores during the past 12 months and (ii) a $1.3 million increase from a 3.6% increase in comparable store sales, primarily due to increased advertising in selected markets. These sales increases were offset by a $1.8 million decrease in direct marketing sales. 9 GROSS MARGIN Gross margin decreased to 64.9% for the three months ended October 2, 1999 from 65.4% for the three months ended October 3, 1998 primarily due to increased costs of promotional programs and a shift in product mix to lower margin products, partially offset by improved purchasing through volume discounts and better relationships with key suppliers and improved leverage of fixed manufacturing costs over higher unit volumes. SALES AND MARKETING Sales and marketing expenses increased 35.3% to $42.8 million for the three months ended October 2, 1999 from $31.6 million for the three months ended October 3, 1998, and increased as a percentage of net sales to 62.7% from 52.7% for the comparable prior-year period. The increase in the dollar amount of sales and marketing expenses for the three month period was primarily due to (i) the opening of 76 new retail stores during the last 12 months, (ii) an increase in advertising expenditures of $4.4 million to support the Company's growth and (iii) higher commissions, percentage rents and freight expense related to the higher net sales. Sales and marketing expenses increased as a percentage of net sales primarily due to (i) increased advertising focused on longer term sales growth through brand and retail store awareness, (ii) lower direct marketing sales and (iii) selling expenses in new stores increasing at a greater rate than net sales. GENERAL AND ADMINISTRATIVE General and administrative expenses increased 58.3% to $7.9 million for the three months ended October 2, 1999 from $5.0 million for the three months ended October 3, 1998. The increase in general and administrative expenses was primarily due to increased spending on infrastructure to support long-term growth plans and strategic consulting studies undertaken to determine and refine ongoing business strategies. OTHER INCOME (EXPENSE), NET Other income increased $4.6 million to approximately $480,000 for the three months ended October 2, 1999 from ($4.1) million expense for the three months ended October 3, 1998. The increase was primarily due to (i) the inclusion of $3.7 million of non-cash interest expense in the three months ended October 3, 1998 relating to the change in the fair value of an outstanding put warrant and (ii) an increase in interest income due to the increase in cash obtained from the completion of our initial public offering in December 1998. The put provision associated with the warrant was eliminated effective on completion of the initial public offering. INCOME TAX EXPENSE (BENEFIT) Income tax benefit changed to a ($2.2) million benefit for the three months ended October 2, 1999 from $493,000 expense for the three months ended October 3, 1998 due to a decrease in taxable income in 1999, partially offset by the use of available net operating loss carryforwards in 1998. COMPARISON OF NINE MONTHS ENDED OCTOBER 2, 1999 WITH NINE MONTHS ENDED OCTOBER 3, 1998 NET SALES Net sales increased 15.0% to $205.6 million for the nine months ended October 2, 1999 from $178.8 million for the nine months ended October 3, 1998 primarily due to an increase in unit sales. Net sales were favorably impacted by (i) an $18.6 million increase from the opening of 76 new retail stores during the past 12 months and (ii) an $8.1 million increase from a 7.9% increase in comparable store sales, primarily due to the continuing maturation of stores and increased advertising in selected markets. These sales increases were offset by a $7.0 million decrease in direct marketing sales. GROSS MARGIN Gross margin increased to 65.5% for the nine months ended October 2, 1999 from 65.2% for the nine months ended October 3, 1998 due to improved purchasing through volume discounts and better relationships with key suppliers and improved leverage of fixed manufacturing costs over higher unit volumes, partially offset by an increase in costs of promotional programs. 10 SALES AND MARKETING Sales and marketing expenses increased 26.3% to $120.7 million for the nine months ended October 2, 1999 from $95.6 million for the nine-months ended October 3, 1998, and increased as a percentage of net sales to 58.7% from 53.5% for the comparable prior-year period. The increase in the dollar amount of sales and marketing expenses for the nine month period was primarily due to (i) the opening of 76 new retail stores during the last 12 months, (ii) an increase in advertising expenditures of $9.0 million to support the Company's growth and (iii) higher commissions, percentage rents and freight expense related to higher net sales. Sales and marketing expenses increased as a percentage of net sales primarily due to (i) increased advertising focused on longer term sales growth through brand and retail store awareness, (ii) lower direct marketing sales and (iii) selling expenses in new stores increasing at a greater rate than net sales. GENERAL AND ADMINISTRATIVE General and administrative expenses increased 37.7% to $18.7 million for the nine months ended October 2, 1999 from $13.6 million for the nine months ended October 3, 1998. The increase in general and administrative expenses was primarily due to increased spending on infrastructure to support long-term growth plans and strategic consulting studies undertaken to determine and refine ongoing business strategies. OTHER INCOME (EXPENSE), NET Other income increased $7.7 million to approximately $1.3 million for the nine months ended October 2, 1999 from ($6.4) million expense for the nine months ended October 3, 1998. The increase was primarily due to (i) the inclusion of $5.2 million of non-cash interest expense in the nine months ended October 3, 1998 relating to the change in the fair value of an outstanding put warrant and (ii) an increase in interest income due to the increase in cash obtained from the completion of our initial public offering in December 1998. The put provision associated with the warrant was eliminated effective on completion of the initial public offering. INCOME TAX EXPENSE (BENEFIT) Income tax expense decreased to ($1.3) million benefit for the nine months ended October 2, 1999 from $1.3 million expense for the nine months ended October 3, 1998 due to a decrease in taxable income in 1999 partially offset by the use of available net operating loss carryforwards in 1998. LIQUIDITY AND CAPITAL RESOURCES Our primary source of liquidity has been the sale of equity securities. We completed our initial public offering in December 1998, resulting in net proceeds of $44.6 million, which have been partially used for (i) the repayment of $15.0 million of debt, (ii) expansion of retail stores, (iii) the build-out of our third manufacturing plant and (iv) the repurchase of 1,065,000 shares of Company common stock for $11.8 million. The Company had working capital of approximately $24.9 million at October 2, 1999 and $42.2 million at January 2, 1999. Net cash provided by operating activities for the nine months ended October 2, 1999 was approximately $12.5 million and consisted primarily of net loss adjusted for non-cash expenses, decreases in accounts receivable as a result of the GE revolving third party credit agreement and increases in accounts payable and accrued liabilities, partially offset by increases in inventories. Net cash provided by operating activities for the nine months ended October 3, 1998 was approximately $2.6 million and consisted primarily of cash flows from operations before non-cash expenses, partially offset by increases in accounts receivable and decreases in accounts payable. Effective as of July 1999, we terminated our revolving third-party credit arrangement with Monogram Bank, an affiliate of General Electric Capital Corporation ("GE") and entered into a third-party credit arrangement with Green Tree Financial Corporation ("Green Tree"). These arrangements have been used to provide financing for our customers' use in purchasing our products. In connection with all purchases financed under these arrangements, the provider pays an amount equal to the total amount of purchases net of promotional discounts. The provider sets the rate, annual fees and all other terms and conditions relating to the customers' accounts, including collection policies and procedures, and is the owner of the receivables. In July 1999, Green Tree purchased substantially all of the outstanding receivables from GE. As a result of this transaction, we received $9.8 million that had been retained by GE and included in our accounts receivable. There are no retainage requirements as part of this new agreement. 11 Net cash used in investing activities was approximately $36.9 million for the nine months ended October 2, 1999 and $6.7 million for the nine months ended October 3, 1998. Investing activities consisted of purchases of property and equipment for new retail stores in both periods, and the investment of excess cash in marketable securities with maturities in excess of 90 days in 1999. Net cash used in financing activities was approximately $7.8 million for the nine months ended October 2, 1999 and consisted primarily of $10.4 million used to repurchase Company common stock and $0.5 million used to repay debt, offset by stock option exercises. Net cash provided by financing activities was approximately $900,000 for the nine months ended October 3, 1998 which consisted of stock option exercises net of debt repayments. In August 1999, the Board of Directors authorized management to repurchase up to $4 million in shares of the Company's common stock due to the availability of excess cash and the valuation of the Company's shares in the market. As of November 9, 1999 we had repurchased 490,000 shares for approximately $3.3 million under this authorization. We believe that cash flow generated from operations and existing cash resources will be sufficient to meet working capital and liquidity requirements for the foreseeable future as we pursue our long-term growth strategy, described in greater detail below. During 1999, through November 9, 1999, we had repurchased 1,065,000 shares for approximately $11.8 million. LOOKING FORWARD We have continued our strategic analysis of the business and have retained several consulting groups to perform studies to evaluate product positioning, marketing efforts, logistics and product distribution to be completed in the fourth quarter. The results of these studies will be a significant consideration in the refinement of our long-term strategy. We currently are executing several strategic initiatives that we believe will accelerate sales growth and improve operating results. These initiatives include (i) developing a more integrated marketing approach that will concentrate a higher percentage of advertising expenditures in our retail and e-commerce channels, (ii) increasing the number of retail distribution points for our products and (iii) expanding our product line. Store sales in markets in which we have expanded our media advertising expenditures have outperformed store sales in non-media markets. We will continue to evaluate overall advertising effectiveness and spending levels. We expect to open a minimum of 20 stores during the fourth quarter of 1999. Beyond 1999, growth in retail stores, as well as expansion into different retail venues or formats, will be based in part on findings of the ongoing strategic studies. Store openings in future years will most likely include additional mall stores and leased departments, possibly with one or more partnerships in addition to our partnership with Bed Bath & Beyond, and may include different venues or formats, including possibly strip mall stores, furniture stores, department stores or sleep stores. Product line expansion will initially be achieved through test marketing of the sofa sleeper product as well as a portable air bed. We have elected to terminate, effective as of February 1, 2000, the license agreement under which we had developed and test-marketed our adjustable frame product. We will continue to explore alternatives for development and commercialization of an adjustable frame product for our air beds, but we currently do not anticipate a broad-based rollout of an adjustable frame product in 2000. The success of our strategy will depend on many factors including (i) the effectiveness and efficiency of our advertising in creating awareness of our products and brand name and generating sales, (ii) our ability to successfully open additional stores and leased departments in new and existing markets, as well as in both existing and new venues and formats, (iii) the level of consumer acceptance of our existing and new products, (iv) our ability to successfully commercialize significant product line extensions, (v) our ability to generate consumer inquiries and drive consumer traffic to retail stores, (vi) competition in the mattress industry and (vii) general economic factors and consumer confidence. The strategic initiatives and additional business analyses are directed toward improving our long-term performance and are not expected to contribute significantly to growth in sales and earnings for the remainder of 1999, and may negatively impact earnings in the remainder of 1999 and 2000. 12 IMPACT OF YEAR 2000 STATE OF READINESS Beginning in early 1996, we included certain Year 2000 initiatives and remediation plans in our broader information systems strategic plan. In early 1998 we retained an independent consultant to assess the adequacy of Year 2000 initiatives and remediation plans. All essential information technology ("IT") systems have been inventoried and remediation plans for any Year 2000 issues have been implemented. Remediation plans included the development of Year 2000 compliant applications for order entry, customer service and point of sale systems in fall 1996. In the third quarter of 1997, we purchased and implemented an enterprise information system used in manufacturing operations, material planning, inventory management, order processing, financial management and human resources applications, which was upgraded to be Year 2000 compliant in February 1999. We purchased Year 2000 compliant upgrades to our payroll applications in 1997 and our telephone system in 1998. Year 2000 compliant upgrades for software applications for processing and tracking warranty claims and returns were implemented in October 1999. Year 2000 compliant upgrades for our customer inquiries applications have been developed and will be implemented in November 1999. With the implementation of these applications and upgrades, we expect that all core applications and IT systems will be Year 2000 compliant by the end of the fourth quarter of 1999. In August 1998, we formed a Year 2000 project team ("Year 2000 Project Team") to identify and address Year 2000 compliance matters, including significant non-IT systems which are comprised of the embedded technology used in our buildings, plant, equipment and other infrastructure. All material Year 2000 issues in non-IT systems have been inventoried and remedial action has been completed. During the first quarter of 1998, we initiated discussions with significant suppliers regarding their plans to remediate Year 2000 issues. We sent each of the significant suppliers a questionnaire inquiring as to the magnitude of their Year 2000 issues and the status of their readiness. We have received assurances from a majority of these suppliers that they will become Year 2000 compliant in a timely manner. We have not received responses from all of the third parties with which we do business. In addition to the questionnaires, a supplier certification program has been established under which suppliers must meet rigorous standards relating to quality, service, the ability to deliver materials on a timely basis and Year 2000 compliance. To date, 12 key suppliers have been certified and other authorized suppliers are in the process of seeking certification. All key suppliers, including our Eastern European supplier of air chambers, have notified us that they are or will be Year 2000 compliant during 1999. In addition to suppliers, we also rely upon governmental agencies, utility companies, telecommunication service companies and other service providers outside of our control. There can be no assurance that such governmental agencies or other third parties will not suffer a Year 2000 business disruption that could have a material adverse effect on our business, financial condition or operating results. COSTS TO ADDRESS THE YEAR 2000 ISSUE We have incurred $165,000 in 1999 to complete our remediation plans required for IT systems, including systems software costs and consulting fees. We do not anticipate incurring future significant costs. RISKS PRESENTED BY THE YEAR 2000 ISSUE If any third party who provides goods or services essential to our business activities fails to appropriately address Year 2000 issues, such failure could have a material adverse effect on our business, financial condition or operating results. For example, a Year 2000 related disruption on the part of the financial institutions which process our credit card sales could have a material adverse effect on our business, financial condition or operating results. CONTINGENCY PLANS The Year 2000 Project Team's initiatives include the development of contingency plans in the event we have not completed all remediation plans in a timely manner. In addition, the Year 2000 Project Team is in the process of developing contingency plans in the event that any third party who provides goods or services essential to our business fails to appropriately address Year 2000 issues. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK No material changes. 13 PART II: OTHER INFORMATION ITEM 1 - LEGAL PROCEEDINGS The Company and certain of its former officers and directors have been named as defendants in a class action lawsuit filed on behalf of Company shareholders in U.S. District Court in Minnesota. The named plaintiffs, who purport to act on behalf of a class of purchasers of the Company's common stock during the period from December 4, 1998 to June 7, 1999, charge the defendants with violations of federal securities laws. The suit alleges that the Company and the named directors and officers failed to disclose or misrepresented certain information concerning the Company during the class period. The complaint does not specify an amount of damages claimed. The Company believes that the complaint is without merit and intends to vigorously defend the claims. ITEM 2 - CHANGES IN SECURITIES AND USE OF PROCEEDS In May 1999, the Board of Directors authorized management to repurchase up to $10 million in shares of the Company's common stock in the open market. The Company subsequently repurchased 575,000 shares for approximately $8.5 million. In August 1999, the Board of Directors authorized management to repurchase up to an additional $4 million in shares of the Company's common stock. Through November 9, 1999, the Company has repurchased 490,000 shares for approximately $3.3 million under this program. We believe cash generated from operations, together with existing cash balances, will be sufficient to satisfy anticipated short-term working capital requirements and long-term liquidity needs. ITEM 3 - DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4 - SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 5 - OTHER INFORMATION In July 1999, the Board of Directors of the Company approved the amendment of the Company's 1990 Omnibus Stock Option Plan and 1997 Stock Incentive Plan (collectively, the "Plans") to modify the change in control provisions applicable to options granted on or after July 27, 1999. Under the Plans, a transaction constituting a "change in control" will result in the immediate vesting in full of options granted under the Plans and such options will continue to be exercisable for the remaining term of the options. Prior to the amendments approved in July 1999, the Plans provided that a transaction that would otherwise constitute a change in control would not constitute a change in control if the transaction was approved by at least a majority of the "continuity" Directors (which includes members of the Board of Directors on the effective date of the Plan and Directors nominated by such Directors for subsequent election to the Board). The foregoing provision will continue to be applicable to options issued and outstanding prior to July 27, 1999. As to options granted on or after July 27, 1999, a transaction constituting a change in control as defined under the Plans will constitute a change in control, resulting in acceleration of the vesting of options, regardless of whether the transaction has been approved by a majority of the continuity Directors. The foregoing description of the change in control provisions of the Plans is qualified in its entirety by reference to the complete text of the Plans, which are included in this filing as exhibits. 14 ITEM 6 - EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits. Exhibit Number Description ------- ----------- 10.1 1990 Omnibus Stock Option Plan, as amended and restated 10.2 1997 Stock Incentive Plan, as amended and restated 27.1 Financial Data Schedule (b) Reports on Form 8-K None. 15 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SELECT COMFORT CORPORATION /s/Patrick A. Hopf ------------------------------------- November 15, 1999 Patrick A. Hopf Chairman and Interim President and Chief Executive Officer (principal executive officer) /s/James C. Raabe ------------------------------------- James C. Raabe Chief Financial Officer (principal financial and accounting officer) 16 EXHIBIT INDEX Exhibit Number Description Location -------------- ----------------------------- ----------------------------- 10.1 Select Comfort Corporation Filed herewith electronically 1990 Option Plan, as amended and restated 10.2 Select Comfort Corporation Filed herewith electronically 1997 Option Plan, as amended and restated 27.1 Financial Data Schedule Filed herewith electronically 17 EX-10 2 SELECT COMFORT CORPORATION 1990 OPTION PLAN EXHIBIT 10.1 SELECT COMFORT CORPORATION 1990 OMNIBUS STOCK OPTION PLAN (As Amended and Restated through July 27, 1999) ARTICLE 1. ESTABLISHMENT AND PURPOSE 1.1 ESTABLISHMENT. Select Comfort Corporation (the "Company") hereby establishes a plan providing for the grant of stock options to certain eligible employees, directors and consultants of the Company and its subsidiaries. This plan shall be known as the 1990 Omnibus Stock Option Plan (the "Plan"). 1.2 PURPOSE. The purpose of the Plan is to advance the interests of the Company and its shareholders by enabling the Company and its subsidiaries to attract and retain persons of ability as employees, directors and consultants, by providing an incentive to such individuals through equity participation in the Company and by rewarding such individuals who contribute to the achievement by the Company of its long-term economic objectives. ARTICLE 2. DEFINITIONS The following terms shall have the meanings set forth below, unless the context clearly otherwise requires: 2.1 "BOARD" means the Board of Directors of the Company. 2.2 "CHANGE IN CONTROL" means an event described in Section 11.1 below. 2.3 "CODE" means the Internal Revenue Code of 1986, as amended. 2.4 "COMMITTEE" means the entity administering the Plan, as provided in Article 3 below. 2.5 "COMMON STOCK" means the common stock of the Company, par value $.0l per share, or the number and kind of shares of stock or other securities into which such Common Stock may be changed in accordance with Section 4.3 below. 2.6 "DISABILITY" means the occurrence of an event which constitutes permanent and total disability within the meaning of Section 22(e)(3) of the Code. 2.7 "ELIGIBLE PERSONS" means individuals who are (a) full-time or part-time employees (including, without limitation, officers and directors who are also employees) of the Company or any Subsidiary, (b) non-employee directors, or (c) consultants to the Company or any Subsidiary. 2.8 "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. 2.9 "FAIR MARKET VALUE" means, with respect to the Common Stock, as of any date: (a) if the Common Stock is listed or admitted to unlisted trading privileges on any national securities exchange or is not so listed or admitted but transactions in the Common Stock are reported on the NASDAQ National Market System, the mean between the reported high and low sale prices of the Common Stock on such exchange or by the NASDAQ National Market System as of such date (or, if no shares were traded on such day, as of the next preceding day on which there was such a trade); or (b) if the Common Stock is not so listed or admitted to unlisted trading privileges or reported on the NASDAQ National Market System, and bid and asked prices there for in the over-the-counter market are reported by the NASDAQ System or the National Quotation Bureau, Inc. (or any comparable reporting service), the mean of the closing bid and asked prices as of such date, as so reported by the NASDAQ System, or, if not so reported thereon, as reported by the National Quotation Bureau, Inc. (or such comparable reporting service); or (c) if the Common Stock is not so listed or admitted to unlisted trading privileges, or reported on the NASDAQ National Market System, and such bid and asked prices are not so reported, such price as the Committee determines in good faith in the exercise of its reasonable discretion. 2.10 "INCENTIVE STOCK OPTION" means a right to purchase Common Stock granted to an Optionee pursuant to Section 6.5 of the Plan that qualifies as an incentive stock option within the meaning of Section 422A of the Code. 2.11 "NON-STATUTORY STOCK OPTION" means a right to purchase Common Stock granted to an Optionee pursuant to Section 6.6 of the Plan that does not qualify as an Incentive Stock Option. 2.12 "OPTION" means an Incentive Stock Option or a Non-Statutory Stock Option. 2.13 "OPTIONEE" means an Eligible Person who receives one or more Incentive Stock Options or Non-Statutory Stock Options under the Plan. 2.14 "PERSON" means any individual, corporation, partnership, group, association or other "person" (as such term is used in Section 14(d) of the Exchange Act), other than the Company, a wholly owned subsidiary of the Company or any employee benefit plan sponsored by the Company. 2.15 "RETIREMENT" means the retirement of an Optionee pursuant to and in accordance with the regular retirement plan or practice of the Company or the Subsidiary employing the Optionee. 2.16 "SECURITIES ACT" means the Securities Act of 1933, as amended. 2.17 "SUBSIDIARY" means any corporation that is a subsidiary corporation of the Company (within the meaning of Section 425(f) of the Code). 2 2.18 "TAX DATE" means a date defined in Section 6.6(c) of the Plan. ARTICLE 3. PLAN ADMINISTRATION The Plan shall be administered by the Board or by a committee of the Board consisting of not less then two persons; provided, however, that from and after the date on which the Company first registers a class of its equity securities under Section 12 of the Exchange Act the Plan shall be administered by the Board, a majority of which Board and a majority of whom acting on any matter under the Plan shall be "disinterested persons" as defined by Rule l6b-3 of the Rules and Regulations of the Securities and Exchange Commission or by a committee consisting solely of not less than three members of the Board who are "disinterested persons" within the meaning of Rule l6b-3 of the Rules and Regulations of the Securities and Exchange Commission. Members of such a committee, if established, shall be appointed from time to time by the Board, shall serve at the pleasure of the Board and may resign at any time upon written notice to the Board. A majority of the members of such a committee shall constitute a quorum. Such a committee shall act by majority approval of its members, shall keep minutes of its meetings and shall provide copies of such minutes to the Board. Action of such a committee may be taken without a meeting if unanimous written consent thereto is given. Copies of minutes of such a committee's meetings and of its actions by written consent shall be provided to the Board and kept with the corporate records of the Company. As used in this Plan, the term "Committee" will refer either to the Board or to such a committee, if established. From and after the date on which the Company first registers a class of its equity securities under Section 12 of the Exchange Act, no member of the Committee shall be eligible, or shall have been eligible at any time within the lesser of one year or the period since the Company first registered a class of its equity securities under Section 12 of the Exchange Act, to receive an Incentive Stock Option or a Non-Statutory Stock Option under the Plan. In accordance with and subject to the provisions of the Plan, with respect to Incentive Stock Options and Non-Statutory Stock Options, the Committee shall select the Optionees from Eligible Persons; shall determine the number of shares of Common Stock to be subject to such Options granted pursuant to the Plan, the time at which such Options are granted, the Option exercise price, Option period and the manner in which each such Option becomes exercisable; and shall fix such other provisions of such Options as the Committee may deem necessary or desirable and as consistent with the terms of the Plan. The Committee shall determine the form or forms of the agreements with Optionees which shall evidence the particular terms, conditions, rights and duties of the Company and the Optionees under Options granted pursuant to the Plan. The Committee shall have the authority, subject to the provisions of the Plan, to establish, adopt and revise such rules and regulations relating to the Plan as it may deem necessary or advisable for the administration of the Plan. With the consent of the Optionee affected thereby, the Committee may amend or modify the terms of any outstanding Incentive Stock Option or Non-Statutory Stock Option in any manner, provided that the amended or modified terms are permitted by the Plan as then in effect. Without limiting the generality of the foregoing sentence, the Committee may, with the consent of the Optionee affected thereby, modify, extend, renew or accept the surrender of any outstanding Incentive Stock Option or Non-Statutory Stock Option, to the extent not previously exercised, and the Committee may authorize the grant of new Options in substitution therefor to the extent not previously exercised. 3 Each determination, interpretation or other action made or taken by the Committee pursuant to the provisions of the Plan shall be conclusive and binding for all purposes and on all persons, including, without limitation, the Company and its Subsidiaries, the shareholders of the Company, the Committee and each of the members thereof, the directors, officers and employees of the Company and its Subsidiaries, and the Optionees and their respective successors in interest (except that the Committee shall have no right to exercise any discretion with respect to Director Sock Options). No member of the Committee shall be liable for any action or determination made in good faith with respect to the Plan or any Option granted under the Plan. From and after the date on which the Company first registers a class of its equity securities under Section 12 of the Exchange Act, any member of the Board who is an Eligible Person under the Plan shall have no vote on (a) any proposed amendment to the Plan or (b) any other matter that might affect such member's individual interest under the Plan; nor shall such member's presence be counted in determining whether a quorum is present at any meeting at which a vote involving the Plan or individual rights thereunder is taken. ARTICLE 4. STOCK SUBJECT TO THE PLAN 4.1 NUMBER. The maximum number of shares of Common Stock that shall be reserved for issuance under the Plan shall be 400,000, subject to adjustment upon changes in capitalization of the Company as provided in Section 4.3 below. The maximum number of shares authorized may be increased from time to time by approval of the Board and the shareholders of the Company. Shares of Common Stock that may be issued upon exercise of Options shall be applied to reduce the maximum number of shares of Common Stock remaining available for use under the Plan. 4.2 UNUSED STOCK. Any shares of Common Stock that are subject to an Option (or any portion thereof) that lapses, expires or for any reason is terminated unexercised shall automatically again become available for use under the Plan. 4.3 CAPITAL ADJUSTMENTS. If the number of outstanding shares of Common Stock is increased or decreased or changed into or exchanged for a different number or kind of shares of stock or other securities of the Company or of another corporation by reason of any reorganization, merger, consolidation, recapitalization, reclassification, stock dividend, stock split, combination of shares, rights offering or any other change in the corporate structure or shares of the Company, the Committee (or, if the Company is not the surviving corporation in any such transaction, the board of directors of the surviving corporation) shall make appropriate adjustment as to the number and kind of securities subject to and reserved under the Plan and, in order to prevent dilution or enlargement of the rights of Optionees, the number and kind of securities subject to outstanding Options. Any such adjustment in any outstanding Option shall be made without change in the aggregate purchase price applicable to the unexercised portion of the Option but with an appropriate adjustment in the price for each share or other unit of any security covered by the Option. However, no change shall be made in the terms of any outstanding Incentive Stock Option as a result of any such change in the corporate structure or shares of the Company, without the consent of the Optionee affected thereby, that would disqualify such Incentive Stock Option from treatment under Section 422A of the Code or would 4 be considered a modification, extension or renewal of an option under Section 425(h) of the Code. ARTICLE 5. PARTICIPATION Optionees who are selected to receive grants of Incentive Stock Options or Non-Statutory Stock Options shall be those Eligible Persons who, in the judgment of the Committee, are performing, or during the term of an Option, will perform, vital services in the management, operation and development of the Company or a Subsidiary, and significantly contribute or are expected to significantly contribute to the achievement of long-term corporate economic objectives. Optionees may be granted from time to time one or more Non-Statutory Stock Options under the Plan, and Optionees who are employees of the Company or a Subsidiary may be granted from time to time one or more Incentive Stock Options under the Plan, in any case as may be determined by the Committee in its sole discretion. The number, type, terms and conditions of Options granted to various Eligible Persons need not be uniform, consistent or in accordance with any plan, whether or not such Eligible Persons are similarly situated. Upon determination by the Committee that an Option is to be granted to an Optionee, written notice shall be given such person specifying such terms, conditions, rights and duties related thereto. Each Optionee shall enter into an agreement with the Company, in such form as the Committee shall determine and which is consistent with the provisions of the Plan, specifying the terms, conditions, rights and duties of Incentive Stock Options and Non-Statutory Stock Options granted under the Plan. Options shall be deemed to be granted as of the date specified in the grant resolution of the Committee, which date shall be the date of the related agreement with the Optionee. ARTICLE 6. TERMS OF OPTIONS 6.1 GRANT OF OPTIONS. An Optionee may be granted one or more Incentive Stock Options or Non-Statutory Stock Options under the Plan, and the Committee in its sole discretion may designate whether an Option is to be considered an Incentive Stock Option or a Non-Statutory Stock Option; provided, however, that only Optionees who are employees of the Company or a Subsidiary shall be eligible to be granted Incentive Stock Options. The Committee may grant both an Incentive Stock Option and a Non-Statutory Stock Option to the same Optionee at the same time or at different times. Incentive Stock Options and Non-Statutory Stock Options, whether granted at the same or different times, shall be deemed to have been awarded in separate grants, shall be clearly identified, and in no event will the exercise of one Option affect the right to exercise any other Option or affect the number of shares of Common Stock for which any other Option may be exercised. 6.2 MANNER OF OPTION EXERCISE. An Option may be exercised by an Optionee in whole or in part from time to time, subject to the conditions contained herein and in the agreement evidencing such Option, by delivery, in person or through certified or registered mail, of written notice of exercise to the Company at its principal executive office in Maple Grove, Minnesota (Attention: Secretary), and by paying in full the total Option exercise price for the shares of Common Stock purchased. Such notice shall be in a form satisfactory to the Committee and shall specify the particular Option (or portion thereof) that is being exercised and the number of shares with respect to which the Option is being exercised. Subject to Section 9.1, 5 the exercise of the Option shall be deemed effective upon receipt of such notice and payment. As soon as practicable after the effective exercise of the Option, the Optionee shall be recorded on the stock transfer books of the Company as the owner of the shares purchased and the Company shall deliver to the Optionee one or more duly issued stock certificates evidencing such ownership. 6.3 PAYMENT OF OPTION EXERCISE PRICE. At the time of the exercise of an Incentive Stock Option or a Non-Statutory Stock Option, the Optionee may determine whether the total purchase price of the shares to be purchased shall be paid solely in cash or by transfer from the Optionee to the Company of previously acquired shares of Common Stock, or by a combination thereof. In the event the Optionee elects to pay the purchase price in whole or in part with previously acquired shares of Common Stock, the value of such shares shall be equal to their Fair Market Value on the date of exercise. The Committee may reject an Optionee's election to pay all or part of the purchase price with previously acquired shares of Common Stock and require such purchase price to be paid entirely in cash. For purposes of this Section 6.3, "previously acquired shares" shall include both shares of Common Stock that are already owned by the Optionee at the time of exercise and shares of Common Stock that are to be acquired pursuant to the exercise of the Option concerned. In its sole discretion, the Committee may determine either at the time of grant or exercise of an Incentive Stock Option or a Non-Statutory Stock Option, to permit an Optionee to pay all or any portion of the purchase price by delivery of a promissory note in form and substance acceptable to the Committee. 6.4 RIGHTS AS A SHAREHOLDER. The Optionee shall have no rights as a shareholder with respect to any shares of Common Stock covered by an Option until the Optionee shall have become the holder of record of such shares, and no adjustments shall be made for dividends or other distributions or other rights as to which there is a record date preceding the date the Optionee becomes the holder of record of such shares except as the Committee may determine pursuant to Section 4.3. 6.5 INCENTIVE STOCK OPTIONS. (a) INCENTIVE STOCK OPTION EXERCISE PRICE. The per share price to be paid by the Optionee at the time an Incentive Stock Option is exercised will be determined by the Committee, but shall not be less than (i) 100% of the Fair Market Value of one share of Common Stock on the date the Option is granted, (ii) 110% of the Fair Market Value of one share of Common Stock on the date the Option is granted if, at that time the Option is granted, the Optionee owns, directly or indirectly (as determined pursuant to Section 425(d) of the Code), more than 10% of the total combined voting power of all classes of stock of the Company, any Subsidiary or any parent corporation of the Company (within the meaning of Section 425(e) of the Code). (b) AGGREGATE LIMITATION OF STOCK SUBJECT TO INCENTIVE STOCK OPTIONS. Notwithstanding any other provision of the Plan, the aggregate Fair Market Value (determined as of the date an Incentive Stock Option is granted) of the shares of Common Stock with respect to which incentive stock options (within the meaning of Section 422A of the Code) are exercisable for the first time by an Optionee during any calendar year (under the Plan and any other incentive stock option plans of the Company, 6 any Subsidiary or any parent corporation of the Company (within the meaning of Section 425(e) of the Code)) shall not exceed $100,000. (c) DURATION OF INCENTIVE STOCK OPTIONS. The period during which an Incentive Stock Option may be exercised shall be fixed by the Committee at the time such Option is granted, but in no event shall such period exceed ten years from the date the Option is granted or, in the case of an Optionee that owns, directly or indirectly (as determined pursuant to Section 425(d) of the Code) more than 10% of the total combined voting power of all classes of stock of the Company, any Subsidiary or any parent corporation of the Company (within the meaning of Section 425(e) of the Code), five years from the date the Incentive Stock Option is granted. An Incentive Stock Option shall become exercisable at such times and in such installments (which may be cumulative) as shall be determined by the Committee at the time the Option is granted. Upon the completion of its exercise period, an Incentive Stock Option, to the extent not then exercised, shall expire. Except as otherwise provided in Articles 7 or 11, all Incentive Stock Options granted to an Optionee hereunder shall terminate and may no longer be exercised if the Optionee ceases to be an employee of the Company and all Subsidiaries or if the Optionee is an employee of a Subsidiary and the Subsidiary ceases to be a Subsidiary of the Company (unless the Optionee continues as an employee of the Company or another Subsidiary). (d) DISPOSITION OF COMMON STOCK ACQUIRED PURSUANT TO THE EXERCISE OF INCENTIVE STOCK OPTIONS. Prior to making a disposition (as defined in Section 425(c) of the Code) of any shares of Common Stock acquired pursuant to the exercise of an Incentive Stock Option granted under the Plan before the expiration of two years after the date on which the Option was granted or before the expiration of one year after the date on which such shares of Common Stock were transferred to the Optionee pursuant to exercise of the Option, the Optionee shall send written notice to the Company of the proposed date of such disposition, the number of shares to be disposed of, the amount of proceeds to be received from such disposition and any other information relating to such disposition that the Company may reasonably request. The right of an Optionee to make any such disposition shall be conditioned on the receipt by the Company of all amounts necessary to satisfy any federal, state or local withholding tax requirements attributable to such disposition. The Committee shall have the right, in its sole discretion, to endorse the certificates representing such shares with a legend restricting transfer and to cause a stop transfer order to be entered with the Company's transfer agent until such time as the Company receives the amounts necessary to satisfy such withholding requirements or until the later of the expiration of two years from the date the Option was granted or one year from the date on which such shares were transferred to the Optionee pursuant to the exercise of the Option. (e) WITHHOLDING TAXES. The Company is entitled to withhold and deduct from future wages of the Optionee, or make other arrangements for the collection of, all legally required amounts necessary to satisfy any federal, state or local withholding tax requirements attributable to any action by the Optionee, including, without limitation, a disposition of shares of Common Stock described in Section 6.5(d) above, that causes the 7 Incentive Stock Option to cease to qualify as an incentive stock option within the meaning of Section 422A of the Code. 6.6 NON-STATUTORY STOCK OPTIONS. (a) OPTION EXERCISE PRICE. The per share price to be paid by the Optionee at the time a Non-Statutory Stock Option is exercised will be determined by the Committee, but shall not be less than 85% of the Fair Market Value of one share of Common Stock on the date the Option is granted. (b) DURATION OF NON-STATUTORY STOCK OPTIONS. The period during which a Non-Statutory Stock Option may be exercised shall be fixed by the Committee at the time such option is granted, but in no event shall such period exceed 10 years and one month from the date the Option is granted. A Non-Statutory Stock Option shall become exercisable at such times and in such installments (which may be cumulative) as shall be determined by the Committee at the time the Option is granted. Upon the completion of its exercise period, a Non-Statutory Stock Option, to the extent not then exercised, shall expire. Except as otherwise provided in Articles 7 or 11, all Non-Statutory Stock Options granted hereunder to an Optionee who is an employee of the Company and all Subsidiaries shall terminate and may no longer be exercised if the Optionee ceases to be an employee of the Company or a Subsidiary or if the Optionee is an employee of a Subsidiary and the Subsidiary ceases to be a Subsidiary of the Company (unless the Optionee continues as an employee of the Company or another Subsidiary). A Non-Statutory Stock Option granted hereunder to an Optionee who is not an employee of the Company or a Subsidiary will terminate as determined by the Committee at the time of grant. (c) WITHHOLDING TAXES. (i) The Company is entitled to (aa) withhold and deduct from future wages of the Optionee, or make other arrangements for the collection of, all legally required amounts necessary to satisfy any federal, state or local withholding tax requirements attributable to the Optionee's exercise of a Non-Statutory Stock Option or otherwise incurred with respect to the Option, or (bb) require the Optionee promptly to remit the amount of such withholding to the Company before acting on the Optionee's notice of exercise of the Option. (ii) The Committee may, in its discretion and subject to such rules as the Committee may adopt, permit an Optionee to satisfy, in whole or in part, any withholding tax obligation which may arise in connection with the exercise of a Non-Statutory Stock Option either by electing to have the Company withhold from the shares of Common Stock to be issued upon exercise that number of shares of Common Stock, or by electing to deliver to the Company already-owned shares of Common Stock, in either case having a Fair Market Value, on the date such tax is determined under the Code (the "Tax Date"), equal to the amount necessary to satisfy the withholding amount due. An Optionee's election to have the Company withhold shares of Common Stock or to deliver already-owned shares of Common Stock upon 8 exercise is irrevocable and is subject to the consent or disapproval of the Committee. If the Optionee is an officer, director or beneficial owner of more than 10% of the outstanding Common Stock of the Company and at the time of exercise of the Option the Company has a class of equity securities registered under Section 12 of the Exchange Act, such election may not be made within six months of the date the Non-Statutory Stock Option is granted (unless the death or Disability of the Optionee occurs prior to the expiration of such six-month period), and must be made either six months prior to the Tax Date or between the third and twelfth business days following public release of any of the Company's quarterly or annual summary earnings statements. When shares of Common Stock are issued prior to the Tax Date to an Optionee making such an election, the Optionee shall agree in writing to surrender that number of shares on the Tax Date having an aggregate Fair Market Value equal to the tax due. ARTICLE 7. EFFECT OF TERMINATION OF EMPLOYMENT ON OPTIONS 7.1 TERMINATION OF EMPLOYMENT DUE TO DEATH, DISABILITY OR RETIREMENT. In the event an Optionee's employment is terminated with the Company and all Subsidiaries by reason of his death, Disability or Retirement, all outstanding Incentive Stock Options and Non-Statutory Stock Options then held by the Optionee shall become immediately exercisable in full and remain exercisable for a period of three months in the case of Retirement and one year in the case of death or Disability, but notwithstanding the foregoing, exercise may not occur after the expiration date of any such Option. 7.2 TERMINATION OF EMPLOYMENT FOR REASONS OTHER THAN DEATH, DISABILITY OR RETIREMENT. (a) Except as otherwise provided in Article 11 and subsection (b) below, in the event an Optionee's employment is terminated with the Company and all Subsidiaries for any reason other than his death, Disability or Retirement, all rights of the Optionee under the Plan shall immediately terminate without notice of any kind and no Incentive Stock Option or Non-Statutory Stock Option then held by the Optionee shall thereafter be exercisable. (b) Notwithstanding the provisions of Subsection (a) above, upon an Optionee's termination of employment with the Company and all Subsidiaries, the Committee may, in its sole discretion (which may be exercised before or following such termination), cause Incentive Stock Options and Non-Statutory Stock Options then held by such Optionee to become exercisable and to remain exercisable following such termination of employment in the manner determined by the Committee; provided, however, that no Option shall be exercisable after the expiration date thereof and no Incentive Stock Option may be exercisable more than three months following termination of employment. 7.3 DATE OF EMPLOYMENT TERMINATION. For purposes of the Plan, an Optionee's employment shall be deemed to have terminated on the last day of the pay period covered by the Optionee's final paycheck. Notwithstanding the foregoing, the Optionee shall not be deemed to 9 have ceased to be an employee for purposes of the Plan until the later of the 91st day of any bona fide leave of absence approved by the Company or a Subsidiary for the Optionee (including, without limitation, any layoff) or the expiration of the period of any bona fide leave of absence approved by the Company or a Subsidiary for the Optionee (including without limitation any layoff) during which the Optionee's right to reemployment is guaranteed either by statute or contract. ARTICLE 8. RIGHTS OF EMPLOYEES; OPTIONEES. 8.1 EMPLOYMENT. Nothing in the Plan shall interfere with or limit in any way the right of the Company or any Subsidiary to terminate the employment of any Eligible Person or Optionee at any time, nor confer upon any Eligible Person or Optionee any right to continue in the employ of the Company or any Subsidiary. 8.2 NONTRANSFERABILITY. No right or interest of any Optionee in an Option granted pursuant to the Plan shall be assignable or transferable during the lifetime of the Optionee, either voluntarily or involuntarily, or subjected to any lien, directly or indirectly, by operation of law, or otherwise, including execution, levy, garnishment, attachment, pledge or bankruptcy. In the event of an Optionee's death, an Optionee's rights and interest in any Options shall be transferable by testamentary will or the laws of descent and distribution, and payment of any amounts due under the Plan shall be made to, and exercise of any Options (to the extent permitted pursuant to Section 7.1) may be made by, the Optionee's legal representatives, heirs or legatees. If in the opinion of the Committee an Optionee holding any Option is disabled from caring for his or her affairs because of mental condition, physical condition or age, any payments due the Optionee may be made to, and any rights of the Optionee under the Plan shall be exercised by, such Optionee's guardian, conservator or other legal personal representative upon furnishing the Committee with evidence satisfactory to the Committee of such status. 8.3 NON-EXCLUSIVITY OF THE PLAN. Nothing contained in the Plan is intended to amend, modify or rescind any previously approved compensation plans or programs entered into by the Company. The Plan will be construed to be an addition to any and all such other plans or programs. Neither the adoption of the Plan nor the submission of the Plan to the shareholders of the Company for approval will be construed as creating any limitations on the power or authority of the Board to adopt such additional or other compensation arrangements as the Board may deem necessary or desirable. ARTICLE 9. SHARE ISSUANCE AND TRANSFER RESTRICTIONS 9.1 SHARE ISSUANCES. Notwithstanding any other provision of the Plan or any agreements entered into pursuant hereto, the Company shall not be required to issue or deliver any certificate for shares of Common Stock under this Plan (and an Option shall not be considered to be exercised, notwithstanding the tender by the Optionee of any consideration there for), unless and until each of the following conditions has been fulfilled: (a)(i) there shall be in effect with respect to such shares a registration statement under the Securities Act and any applicable state securities laws if the Committee, in its sole discretion, shall have determined to file, cause to become effective 10 and maintain the effectiveness of such registration statement; or (ii) if the Committee has determined not to so register the shares of Common Stock to be issued under the Plan, (A) exemptions from registration under the Securities Act and applicable state securities laws shall be available for such issuance (as determined by counsel to the Company) and (B) there shall have been received from the Optionee (or, in the event of death or disability, the Optionee's heir(s) or legal representative(s)) any representations or agreements requested by the Company in order to permit such issuance to be made pursuant to such exemptions; and (b) there shall have been obtained any other consent, approval or permit from any state or federal governmental agency which the Committee shall, in its sole discretion upon the advice of counsel, deem necessary or advisable. 9.2 SHARE TRANSFERS. Shares of Common Stock issued pursuant to the exercise of Options granted under the Plan may not be sold, assigned, transferred, pledged, encumbered or otherwise disposed of (whether voluntarily or involuntarily) except pursuant to registration under the Securities Act and applicable state securities laws or pursuant to exemptions from such registrations. The Company may condition the sale, assignment, transfer, pledge, encumbrance or other disposition of such shares not issued pursuant to an effective and current registration statement under the Securities Act and all applicable state securities laws on the receipt from the party to whom the shares of Common Stock are to be so transferred of any representations or agreements requested by the Company in order to permit such transfer to be made pursuant to exemptions from registration under the Securities Act and applicable state securities laws. 9.3 LEGENDS. Unless a registration statement under the Securities Act is in effect with respect to the issuance or transfer of shares of Common Stock issued under the Plan, each certificate representing any such shares shall be endorsed with a legend in substantially the following form, unless counsel for the Company is of the opinion as to any such certificate that such legend is unnecessary: THE SECURITIES EVIDENCED HEREBY HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED ("THE ACT"), OR UNDER APPLICABLE STATE SECURITIES LAWS. THESE SECURITIES HAVE BEEN ACQUIRED FOR INVESTMENT AND MAY NOT BE OFFERED FOR SALE, SOLD, ASSIGNED, TRANSFERRED, PLEDGED, ENCUMBERED OR OTHERWISE DISPOSED OF EXCEPT PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE ACT AND SUCH STATE LAWS OR PURSUANT TO AN EXEMPTION FROM REGISTRATION UNDER THE ACT AND SUCH STATE LAWS, THE AVAILABILITY OF WHICH IS TO BE ESTABLISHED TO THE SATISFACTION OF THE COMPANY. ARTICLE 10. PLAN AMENDMENT, MODIFICATION AND TERMINATION The Board may suspend or terminate the Plan or any portion thereof at any time, and may amend the Plan from time to time in such respects as the Board may deem advisable in order that Incentive Stock Options and Non-Statutory Stock Options under the Plan shall conform to any change in applicable laws or regulations or in any other respect the Board may 11 deem to be in the best interests of the Company; provided, however, that no such amendment, without approval of the shareholders of the Company, may (a) materially increase the benefits accruing to Optionees under the Plan, (b) increase the total number of shares of Common Stock as to which Options may be granted under the Plan, except as provided in Section 4.3 of the Plan, or (c) materially modify the requirements as to eligibility for participation in the Plan. No termination, suspension or amendment of the Plan shall alter or impair any outstanding Option without the consent of the Optionee affected thereby; provided, however, that this sentence shall not impair the right of the Committee to take whatever action it deems appropriate under Section 4.3. ARTICLE 11. CHANGE IN CONTROL 11.1 CHANGE IN CONTROL. For purposes of this Section 11.1, a "Change in Control" of the Company shall mean (a) the sale, lease, exchange or other transfer of all or substantially all of the assets of the Company (in one transaction or in a series of related transactions) to a corporation that is not controlled by the Company, (b) the approval by the shareholders of the Company of any plan or proposal for the liquidation or dissolution of the Company, or (c) a change in control of a nature that would be required to be reported (assuming such event has not been "previously reported") in response to Item 1(a) of the Current Report on Form 8-K, as in effect on the effective date of the Plan, pursuant to Section 13 or 15(d) of the Exchange Act, whether or not the Company is then subject to such reporting requirement; provided that, without limitation, such a Change in Control shall be deemed to have occurred at such time as (x) any Person, other than any Person who owns any shares of Common Stock on the effective date of the Plan, becomes after the effective date of the Plan the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) directly or indirectly, of 50% or more of the combined voting power of the Company's outstanding securities ordinarily having the right to vote at elections of directors or (y) individuals who constitute the Board of Directors on the effective date of the Plan cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to the effective date of the Plan whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors comprising the Board of Directors on the effective date of the Plan (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without objection to such nomination) shall be, for purposes of this clause (y) and the following sentence, considered as though such person were a member of the Board of Directors on the effective date of the Plan. Notwithstanding anything in the foregoing to the contrary, solely for purposes of any Option issued and outstanding prior to July 27, 1999, no Change in Control shall be deemed to have occurred for purposes of this Section 11.1 by virtue of any transaction which shall have been approved by the affirmative vote of at least a majority of the members of the Board of Directors on the effective date of the Plan. The foregoing sentence shall not apply to any Option granted on or after July 27, 1999. 11.2 ACCELERATION OF VESTING. If any of the events described in Section 11.1 above constituting a Change in Control of the Company shall occur, then, without any action by the Committee or the Board, all outstanding Options shall become immediately exercisable in full and shall remain exercisable during the remaining term thereof, whether or not the Optionees to whom such options have been granted remain employees of the Company or a Subsidiary or, in the case of Directors, remain members of the Board (and any Incentive Stock Options remaining 12 unexercised more than three months following termination of employment shall thereafter be deemed Non-Statutory Stock Options). 11.3 LIMITATION ON ACCELERATION OF VESTING. Notwithstanding anything in Section 11.2 above to the contrary, if, with respect to an Optionee, acceleration of the vesting of Options as provided in Section 11.2 above (which acceleration could be deemed a payment within the meaning of Section 280G(b) (2) of the Code), together with any other payments which such Optionee has the right to receive from the Company or any corporation which is a member of an "affiliated group" (as defined in Section 1504 (a) of the Code without regard to Section 1504(b) of the Code) of which the Company is a member, would constitute a "parachute payment" (as defined in Section 280G(b) (2) of the Code), the payments to such Optionee pursuant to Section 11.2 above shall be reduced to the largest amount as will result in no portion of such payments being subject to the excise tax imposed by Section 4999 of the Code. ARTICLE 12. EFFECTIVE DATE OF THE PLAN 12.1 EFFECTIVE DATE. The Plan is effective as of May 30, 1990, the date it was adopted by the Board subject to the approval of the shareholders. Options may be granted under the Plan prior to shareholder approval if made subject to shareholder approval. 12.2 DURATION OF THE PLAN. The Plan shall terminate at midnight on May 29, 2000, and may be terminated prior thereto by Board action, and no Options shall be granted after such termination. Options outstanding upon termination of the Plan may continue to be exercised in accordance with their terms. ARTICLE 13. MISCELLANEOUS 13.1 GOVERNING LAW. The Plan and all agreements hereunder shall be construed in accordance with and governed by the laws of the State of Minnesota. 13.2 GENDER AND NUMBER. Except when otherwise indicated by the context, reference to the masculine gender in the Plan shall include, when used, the feminine gender and any term used in the singular shall also include the plural. 13 EX-10 3 SELECT COMFORT CORPORATION 1997 OPTION PLAN EXHIBIT 10.2 SELECT COMFORT CORPORATION 1997 STOCK INCENTIVE PLAN (As Amended and Restated through July 28, 1999) 1. PURPOSE OF PLAN. The purpose of the Select Comfort Corporation 1997 Stock Incentive Plan (the "Plan") is to advance the interests of Select Comfort Corporation (the "Company") and its shareholders by enabling the Company and its Subsidiaries to attract and retain persons of ability to perform services for the Company and its Subsidiaries by providing an incentive to such individuals through equity participation in the Company and by rewarding such individuals who contribute to the achievement by the Company of its economic objectives. 2. DEFINITIONS. The following terms will have the meanings set forth below, unless the context clearly otherwise requires: 2.1 "BOARD" means the Board of Directors of the Company. 2.2 "BROKER EXERCISE NOTICE" means a written notice pursuant to which a Participant, upon exercise of an Option, irrevocably instructs a broker or dealer to sell a sufficient number of shares or loan a sufficient amount of money to pay all or a portion of the exercise price of the Option and/or any related withholding tax obligations and remit such sums to the Company and directs the Company to deliver stock certificates to be issued upon such exercise directly to such broker or dealer. 2.3 "CHANGE IN CONTROL" means an event described in Section 13.1 of the Plan. 2.4 "CODE" means the Internal Revenue Code of 1986, as amended. 2.5 "COMMITTEE" means the group of individuals administering the Plan, as provided in Section 3 of the Plan. 2.6 "COMMON STOCK" means the common stock of the Company, $0.01 par value, or the number and kind of shares of stock or other securities into which such common stock may be changed in accordance with Section 4.3 of the Plan. 2.7 "DISABILITY" means the disability of the Participant such as would entitle the Participant to receive disability income benefits pursuant to the long-term disability plan of the Company or Subsidiary then covering the Participant or, if no such plan exists or is applicable to the Participant, the permanent and total disability of the Participant within the meaning of Section 22(e)(3) of the Code. 2.8 "ELIGIBLE RECIPIENTS" means all employees of the Company or any Subsidiary and any non-employee directors, consultants and independent contractors of the Company or any Subsidiary. 2.9 "EXCHANGE ACT" means the Securities Exchange Act of 1934, as amended. 2.10 "FAIR MARKET VALUE" means, with respect to the Common Stock, as of any date (or, if no shares were traded or quoted on such date, as of the next preceding date on which there was such a trade or quote) (a) the mean between the reported high and low sale prices of the Common Stock if the Common Stock is listed, admitted to unlisted trading privileges or reported on any foreign or national securities exchange or on the Nasdaq National Market or an equivalent foreign market on which sale prices are reported; (b) if the Common Stock is not so listed, admitted to unlisted trading privileges or reported, the closing bid price as reported by the Nasdaq SmallCap Market, OTC Bulletin Board or the National Quotation Bureau, Inc. or other comparable service; or (c) if the Common Stock is not so listed or reported, such price as the Committee determines in good faith in the exercise of its reasonable discretion. If determined by the Committee, such determination will be final, conclusive and binding for all purposes and on all persons, including, without limitation, the Company, the shareholders of the Company, the Participants and their respective successors-in-interest. No member of the Committee will be liable for any determination regarding the fair market value of the Common Stock that is made in good faith. 2.11 "INCENTIVE AWARD" means an Option, Stock Appreciation Right, Restricted Stock Award, Performance Unit or Stock Bonus granted to an Eligible Recipient pursuant to the Plan. 2.12 "INCENTIVE STOCK OPTION" means a right to purchase Common Stock granted to an Eligible Recipient pursuant to Section 6 of the Plan that qualifies as an "incentive stock option" within the meaning of Section 422 of the Code. 2.13 "NON-STATUTORY STOCK OPTION" means a right to purchase Common Stock granted to an Eligible Recipient pursuant to Section 6 of the Plan that does not qualify as an Incentive Stock Option. 2.14 "OPTION" means an Incentive Stock Option or a Non-Statutory Stock Option. 2.15 "PARTICIPANT" means an Eligible Recipient who receives one or more Incentive Awards under the Plan. 2.16 "PERFORMANCE UNIT" means a right granted to an Eligible Recipient pursuant to Section 9 of the Plan to receive a payment from the Company, in the form of stock, cash or a combination of both, upon the achievement of established employment, service, performance or other goals. 2.17 "PREVIOUSLY ACQUIRED SHARES" means shares of Common Stock or Preferred Stock that are already owned by the Participant or, with respect to any Incentive Award, that are to be issued upon the grant, exercise or vesting of such Incentive Award. 2 2.18 "RESTRICTED STOCK AWARD" means an award of Common Stock granted to an Eligible Recipient pursuant to Section 8 of the Plan that is subject to the restrictions on transferability and the risk of forfeiture imposed by the provisions of such Section 8. 2.19 "RETIREMENT" means termination of employment or service pursuant to and in accordance with the regular (or, if approved by the Board for purposes of the Plan, early) retirement/pension plan or practice of the Company or Subsidiary then covering the Participant, provided that if the Participant is not covered by any such plan or practice, the Participant will be deemed to be covered by the Company's plan or practice for purposes of this determination. 2.20 "SECURITIES ACT" means the Securities Act of 1933, as amended. 2.21 "STOCK APPRECIATION RIGHT" means a right granted to an Eligible Recipient pursuant to Section 7 of the Plan to receive a payment from the Company, in the form of stock, cash or a combination of both, equal to the difference between the Fair Market Value of one or more shares of Common Stock and the exercise price of such shares under the terms of such Stock Appreciation Right. 2.22 "STOCK BONUS" means an award of Common Stock granted to an Eligible Recipient pursuant to Section 10 of the Plan. 2.23 "SUBSIDIARY" means any entity that is directly or indirectly controlled by the Company or any entity in which the Company has a significant equity interest, as determined by the Committee. 2.24 "TAX DATE" means the date any withholding tax obligation arises under the Code or other applicable tax statute for a Participant with respect to an Incentive Award. 3. PLAN ADMINISTRATION. 3.1 THE COMMITTEE. The Plan will be administered by the Board or by a committee of the Board. So long as the Company has a class of its equity securities registered under Section 12 of the Exchange Act, any committee administering the Plan will consist solely of two or more members of the Board who are "non-employee directors" within the meaning of Rule 16b-3 under the Exchange Act and, if the Board so determines in its sole discretion, who are "outside directors" within the meaning of Section 162(m) of the Code. Such a committee, if established, will act by majority approval of the members (but may also take action with the written consent of a majority of the members of such committee), and a majority of the members of such a committee will constitute a quorum. As used in the Plan, "Committee" will refer to the Board or to such a committee, if established. To the extent consistent with corporate law, the Committee may delegate to any officers of the Company the duties, power and authority of the Committee under the Plan pursuant to such conditions or limitations as the Committee may establish; provided, however, that only the Committee may exercise such duties, power and authority with respect to Eligible Recipients who are subject to Section 16 of the Exchange Act. The Committee may exercise its duties, power and authority under the Plan in its sole and absolute discretion without the consent of any Participant or other party, unless the Plan specifically provides otherwise. Each determination, interpretation or other action made or taken by the 3 Committee pursuant to the provisions of the Plan will be conclusive and binding for all purposes and on all persons, and no member of the Committee will be liable for any action or determination made in good faith with respect to the Plan or any Incentive Award granted under the Plan. 3.2 AUTHORITY OF THE COMMITTEE. (a) In accordance with and subject to the provisions of the Plan, the Committee will have the authority to determine all provisions of Incentive Awards as the Committee may deem necessary or desirable and as consistent with the terms of the Plan, including, without limitation, the following: (i) the Eligible Recipients to be selected as Participants; (ii) the nature and extent of the Incentive Awards to be made to each Participant (including the number of shares of Common Stock to be subject to each Incentive Award, any exercise price, the manner in which Incentive Awards will vest or become exercisable and whether Incentive Awards will be granted in tandem with other Incentive Awards) and the form of written agreement, if any, evidencing such Incentive Award; (iii) the time or times when Incentive Awards will be granted; (iv) the duration of each Incentive Award; and (v) the restrictions and other conditions to which the payment or vesting of Incentive Awards may be subject. In addition, the Committee will have the authority under the Plan in its sole discretion to pay the economic value of any Incentive Award in the form of cash, Common Stock or any combination of both. (b) The Committee will have the authority under the Plan to amend or modify the terms of any outstanding Incentive Award in any manner, including, without limitation, the authority to modify the number of shares or other terms and conditions of an Incentive Award, extend the term of an Incentive Award, accelerate the exercisability or vesting or otherwise terminate any restrictions relating to an Incentive Award, accept the surrender of any outstanding Incentive Award or, to the extent not previously exercised or vested, authorize the grant of new Incentive Awards in substitution for surrendered Incentive Awards; provided, however that the amended or modified terms are permitted by the Plan as then in effect and that any Participant adversely affected by such amended or modified terms has consented to such amendment or modification. No amendment or modification to an Incentive Award, however, whether pursuant to this Section 3.2 or any other provisions of the Plan, will be deemed to be a re-grant of such Incentive Award for purposes of this Plan. (c) In the event of (i) any reorganization, merger, consolidation, recapitalization, liquidation, reclassification, stock dividend, stock split, combination of shares, rights offering, extraordinary dividend or divestiture (including a spin-off) or any other change in corporate structure or shares, (ii) any purchase, acquisition, sale or disposition of a significant amount of assets or a significant business, (iii) any change in accounting principles or practices, or (iv) any other similar change, in each case with respect to the Company or any other entity whose performance is relevant to the grant or vesting of an Incentive Award, the Committee (or, if the Company is not the surviving corporation in any such transaction, the board of directors of the surviving corporation) may, without the consent of any affected Participant, amend or modify the vesting criteria of any outstanding Incentive Award that is based in whole or in part on the financial 4 performance of the Company (or any Subsidiary or division thereof) or such other entity so as equitably to reflect such event, with the desired result that the criteria for evaluating such financial performance of the Company or such other entity will be substantially the same (in the sole discretion of the Committee or the board of directors of the surviving corporation) following such event as prior to such event; provided, however, that the amended or modified terms are permitted by the Plan as then in effect. 4. SHARES AVAILABLE FOR ISSUANCE. 4.1 MAXIMUM NUMBER OF SHARES AVAILABLE. Subject to adjustment as provided in Section 4.3 of the Plan, the maximum number of shares of Common Stock that will be available for issuance under the Plan will be 2,500,000 shares of Common Stock. 4.2 ACCOUNTING FOR INCENTIVE AWARDS. Shares of Common Stock that are issued under the Plan or that are subject to outstanding Incentive Awards will be applied to reduce the maximum number of shares of Common Stock remaining available for issuance under the Plan. Any shares of Common Stock that are subject to an Incentive Award that lapses, expires, is forfeited or for any reason is terminated unexercised or unvested and any shares of Common Stock that are subject to an Incentive Award that is settled or paid in cash or any form other than shares of Common Stock will automatically again become available for issuance under the Plan. Any shares of Common Stock that constitute the forfeited portion of a Restricted Stock Award, however, will not become available for further issuance under the Plan. 4.3 ADJUSTMENTS TO SHARES AND INCENTIVE AWARDS. In the event of any reorganization, merger, consolidation, recapitalization, liquidation, reclassification, stock dividend, stock split, combination of shares, rights offering, divestiture or extraordinary dividend (including a spin-off) or any other change in the corporate structure or shares of the Company, the Committee (or, if the Company is not the surviving corporation in any such transaction, the board of directors of the surviving corporation) will make appropriate adjustment (which determination will be conclusive) as to the number and kind of securities or other property (including cash) available for issuance or payment under the Plan and, in order to prevent dilution or enlargement of the rights of Participants, (a) the number and kind of securities or other property (including cash) subject to outstanding Options, and (b) the exercise price of outstanding Options. 5. PARTICIPATION. Participants in the Plan will be those Eligible Recipients who, in the judgment of the Committee, have contributed, are contributing or are expected to contribute to the achievement of economic objectives of the Company or its Subsidiaries. Eligible Recipients may be granted from time to time one or more Incentive Awards, singly or in combination or in tandem with other Incentive Awards, as may be determined by the Committee in its sole discretion. Incentive Awards will be deemed to be granted as of the date specified in the grant resolution of the Committee, which date will be the date of any related agreement with the Participant. 6. OPTIONS. 5 6.1 GRANT. An Eligible Recipient may be granted one or more Options under the Plan, and such Options will be subject to such terms and conditions, consistent with the other provisions of the Plan, as may be determined by the Committee in its sole discretion. The Committee may designate whether an Option is to be considered an Incentive Stock Option or a Non-Statutory Stock Option. To the extent that any Incentive Stock Option granted under the Plan ceases for any reason to qualify as an "incentive stock option" for purposes of Section 422 of the Code, such Incentive Stock Option will continue to be outstanding for purposes of the Plan but will thereafter be deemed to be a Non-Statutory Stock Option. 6.2 EXERCISE PRICE. The per share price to be paid by a Participant upon exercise of an Option will be determined by the Committee in its discretion at the time of the Option grant; provided, however, that (a) such price will not be less than 100% of the Fair Market Value of one share of Common Stock on the date of grant with respect to an Incentive Stock Option (110% of the Fair Market Value if, at the time the Incentive Stock Option is granted, the Participant owns, directly or indirectly, more than 10% of the total combined voting power of all classes of stock of the Company or any parent or subsidiary corporation of the Company), and (b) such price will not be less than 85% of the Fair Market Value of one share of Common Stock on the date of grant with respect to a Non-Statutory Stock Option. 6.3 EXERCISABILITY AND DURATION. An Option will become exercisable at such times and in such installments as may be determined by the Committee in its sole discretion at the time of grant; provided, however, that no Option may be exercisable after 10 years from its date of grant. 6.4 PAYMENT OF EXERCISE PRICE. The total purchase price of the shares to be purchased upon exercise of an Option will be paid entirely in cash (including check, bank draft or money order); provided, however, that the Committee, in its sole discretion and upon terms and conditions established by the Committee, may allow such payments to be made, in whole or in part, by tender of a Broker Exercise Notice, Previously Acquired Shares, a promissory note (on terms acceptable to the Committee in its sole discretion) or by a combination of such methods. 6.5 MANNER OF EXERCISE. An Option may be exercised by a Participant in whole or in part from time to time, subject to the conditions contained in the Plan and in the agreement evidencing such Option, by delivery in person, by facsimile or electronic transmission or through the mail of written notice of exercise to the Company (Attention: Chief Financial Officer) at its principal executive office in Minneapolis, Minnesota and by paying in full the total exercise price for the shares of Common Stock to be purchased in accordance with Section 6.4 of the Plan. 6.6 AGGREGATE LIMITATION OF STOCK SUBJECT TO INCENTIVE STOCK OPTIONS. To the extent that the aggregate Fair Market Value (determined as of the date an Incentive Stock Option is granted) of the shares of Common Stock with respect to which incentive stock options (within the meaning of Section 422 of the Code) are exercisable for the first time by a Participant during any calendar year (under the Plan and any other incentive stock option plans of the Company or any subsidiary or parent corporation of the Company (within the meaning of the Code)) exceeds $100,000 (or such other amount as may be prescribed by the Code from time to time), such excess Options will be treated as Non-Statutory Stock Options. The determination will be made 6 by taking incentive stock options into account in the order in which they were granted. If such excess only applies to a portion of an Incentive Stock Option, the Committee, in its discretion, will designate which shares will be treated as shares to be acquired upon exercise of an Incentive Stock Option. 7. STOCK APPRECIATION RIGHTS. 7.1 GRANT. An Eligible Recipient may be granted one or more Stock Appreciation Rights under the Plan, and such Stock Appreciation Rights will be subject to such terms and conditions, consistent with the other provisions of the Plan, as may be determined by the Committee in its sole discretion. 7.2 EXERCISE PRICE. The exercise price of a Stock Appreciation Right will be determined by the Committee, in its discretion, at the date of grant but may not be less than 100% of the Fair Market Value of one share of Common Stock on the date of grant. 7.3 EXERCISABILITY AND DURATION. A Stock Appreciation Right will become exercisable at such time and in such installments as may be determined by the Committee in its sole discretion at the time of grant; provided, however, that no Stock Appreciation Right may be exercisable after 10 years from its date of grant. A Stock Appreciation Right will be exercised by giving notice in the same manner as for Options, as set forth in Section 6.5 of the Plan. 8. RESTRICTED STOCK AWARDS. 8.1 GRANT. An Eligible Recipient may be granted one or more Restricted Stock Awards under the Plan, and such Restricted Stock Awards will be subject to such terms and conditions, consistent with the other provisions of the Plan, as may be determined by the Committee in its sole discretion. The Committee may impose such restrictions or conditions, not inconsistent with the provisions of the Plan, to the vesting of such Restricted Stock Awards as it deems appropriate, including, without limitation, that the Participant remain in the continuous employ or service of the Company or a Subsidiary for a certain period or that the Participant or the Company (or any Subsidiary or division thereof) satisfy certain performance goals or criteria. 8.2 RIGHTS AS A STOCKHOLDER; TRANSFERABILITY. Except as provided in Sections 8.1, 8.3 and 14.3 of the Plan, a Participant will have all voting, dividend, liquidation and other rights with respect to shares of Common Stock issued to the Participant as a Restricted Stock Award under this Section 8 upon the Participant becoming the holder of record of such shares as if such Participant were a holder of record of shares of unrestricted Common Stock. 8.3 DIVIDENDS AND DISTRIBUTIONS. Unless the Committee determines otherwise in its sole discretion (either in the agreement evidencing the Restricted Stock Award at the time of grant or at any time after the grant of the Restricted Stock Award), any dividends or distributions (including regular quarterly cash dividends) paid with respect to shares of Common Stock subject to the unvested portion of a Restricted Stock Award will be subject to the same restrictions as the shares to which such dividends or distributions relate. In the event the Committee determines not to pay such dividends or distributions currently, the Committee will determine in its sole discretion whether any interest will be paid on such dividends or 7 distributions. In addition, the Committee in its sole discretion may require such dividends and distributions to be reinvested (and in such case the Participants consent to such reinvestment) in shares of Common Stock that will be subject to the same restrictions as the shares to which such dividends or distributions relate. 8.4 ENFORCEMENT OF RESTRICTIONS. To enforce the restrictions referred to in this Section 8, the Committee may place a legend on the stock certificates referring to such restrictions and may require the Participant, until the restrictions have lapsed, to keep the stock certificates, together with duly endorsed stock powers, in the custody of the Company or its transfer agent or to maintain evidence of stock ownership, together with duly endorsed stock powers, in a certificateless book-entry stock account with the Company's transfer agent. 9. PERFORMANCE UNITS. An Eligible Recipient may be granted one or more Performance Units under the Plan, and such Performance Units will be subject to such terms and conditions, consistent with the other provisions of the Plan, as may be determined by the Committee in its sole discretion. The Committee may impose such restrictions or conditions, not inconsistent with the provisions of the Plan, to the vesting of such Performance Units as it deems appropriate, including, without limitation, that the Participant remain in the continuous employ or service of the Company or any Subsidiary for a certain period or that the Participant or the Company (or any Subsidiary or division thereof) satisfy certain performance goals or criteria. The Committee will have the sole discretion to determine the form in which payment of the economic value of vested Performance Units will be made to the Participant (i.e., cash, Common Stock or any combination thereof) or to consent to or disapprove the election by the Participant of the form of such payment. 10. STOCK BONUSES. An Eligible Recipient may be granted one or more Stock Bonuses under the Plan, and such Stock Bonuses will be subject to such terms and conditions, consistent with the other provisions of the Plan, as may be determined by the Committee. The Participant will have all voting, dividend, liquidation and other rights with respect to the shares of Common Stock issued to a Participant as a Stock Bonus under this Section 10 upon the Participant becoming the holder of record of such shares; provided, however, that the Committee may impose such restrictions on the assignment or transfer of a Stock Bonus as it deems appropriate. 11. EFFECT OF TERMINATION OF EMPLOYMENT OR OTHER SERVICE. 11.1 TERMINATION DUE TO DEATH, DISABILITY OR RETIREMENT. Unless otherwise provided by the Committee in its sole discretion in the agreement evidencing an Incentive Award, in the event a Participant's employment or other service with the Company and all Subsidiaries is terminated by reason of death, Disability or Retirement: (a) All outstanding Options and Stock Appreciation Rights then held by the Participant that are currently exercisable by the Participant as of the time of such termination will remain exercisable for a period of one year after such termination (but in no event after the expiration date of any such Option or Stock Appreciation Right); and 8 (b) All Restricted Stock Awards, Performance Units and Stock Bonuses then held by the Participant will vest and/or continue to vest in the manner determined by the Committee and set forth in the agreement evidencing such Restricted Stock Awards, Performance Units or Stock Bonuses. 11.2 TERMINATION FOR REASONS OTHER THAN DEATH, DISABILITY OR RETIREMENT. (a) Unless otherwise provided by the Committee in its sole discretion in the agreement evidencing an Incentive Award, in the event a Participant's employment or other service is terminated with the Company and all Subsidiaries for any reason other than death, Disability or Retirement, or a Participant is in the employ or service of a Subsidiary and the Subsidiary ceases to be a Subsidiary of the Company (unless the Participant continues in the employ or service of the Company or another Subsidiary), all rights of the Participant under the Plan and any agreements evidencing an Incentive Award will immediately terminate without notice of any kind, and no Options or Stock Appreciation Rights then held by the Participant will thereafter be exercisable, all Restricted Stock Awards then held by the Participant that have not vested will be terminated and forfeited, and all Performance Units and Stock Bonuses then held by the Participant will vest and/or continue to vest in the manner determined by the Committee and set forth in the agreement evidencing such Performance Units or Stock Bonuses; provided, however, that if such termination is due to any reason other than termination by the Company or any Subsidiary for "cause," all outstanding Options or Stock Appreciation Rights then held by such Participant that are currently exercisable by the Participant as of the time of such termination will remain exercisable for a period of three months after such termination (but in no event after the expiration date of any such Option or Stock Appreciation Right). (b) For purposes of this Section 11.2, "cause" (as determined by the Committee) will be as defined in any employment or other agreement or policy applicable to the Participant or, if no such agreement or policy exists, will mean (i) dishonesty, fraud, misrepresentation, embezzlement or deliberate injury or attempted injury, in each case related to the Company or any Subsidiary, (ii) any unlawful or criminal activity of a serious nature, (iii) any intentional and deliberate breach of a duty or duties that, individually or in the aggregate, are material in relation to the Participant's overall duties, or (iv) any material breach of any employment, service, confidentiality or non-compete agreement entered into with the Company or any Subsidiary. 11.3 MODIFICATION OF RIGHTS UPON TERMINATION. Notwithstanding the other provisions of this Section 11, upon a Participant's termination of employment or other service with the Company and all Subsidiaries, the Committee may, in its sole discretion (which may be exercised at any time on or after the date of grant, including following such termination), cause Options and Stock Appreciation Rights (or any part thereof) then held by such Participant to become or continue to become exercisable and/or remain exercisable following such termination of employment or service and Restricted Stock Awards, Performance Units and Stock Bonuses then held by such Participant to vest and/or continue to vest or become free of transfer restrictions, as the case may be, following such termination of employment or service, in each 9 case in the manner determined by the Committee; provided, however, that no Option or Stock Appreciation Right may remain exercisable beyond its expiration date. 11.4 BREACH OF CONFIDENTIALITY OR NONCOMPETE AGREEMENTS. Notwithstanding anything in the Plan to the contrary, in the event that a Participant materially breaches the terms of any confidentiality or non-compete agreement entered into with the Company or any Subsidiary, whether such breach occurs before or after termination of such Participant's employment or other service with the Company or any Subsidiary, the Committee in its sole discretion may immediately terminate all rights of the Participant under the Plan and any agreements evidencing an Incentive Award then held by the Participant without notice of any kind. 11.5 DATE OF TERMINATION OF EMPLOYMENT OR OTHER SERVICE. Unless the Committee otherwise determines in its sole discretion, a Participant's employment or other service will, for purposes of the Plan, be deemed to have terminated on the date recorded on the personnel or other records of the Company or the Subsidiary for which the Participant provides employment or other service, as determined by the Committee in its sole discretion based upon such records. 12. PAYMENT OF WITHHOLDING TAXES. 12.1 GENERAL RULES. The Company is entitled to (a) withhold and deduct from future wages of the Participant (or from other amounts that may be due and owing to the Participant from the Company or a Subsidiary), or make other arrangements for the collection of, all legally required amounts necessary to satisfy any and all foreign, federal, state and local withholding and employment-related tax requirements attributable to an Incentive Award, including, without limitation, the grant, exercise or vesting of, or payment of dividends with respect to, an Incentive Award or a disqualifying disposition of stock received upon exercise of an Incentive Stock Option, or (b) require the Participant promptly to remit the amount of such withholding to the Company before taking any action, including issuing any shares of Common Stock, with respect to an Incentive Award. 12.2 SPECIAL RULES. The Committee may, in its sole discretion and upon terms and conditions established by the Committee, permit or require a Participant to satisfy, in whole or in part, any withholding or employment-related tax obligation described in Section 12.1 of the Plan by electing to tender Previously Acquired Shares, a Broker Exercise Notice or a promissory note (on terms acceptable to the Committee in its sole discretion), or by a combination of such methods. 13. CHANGE IN CONTROL. 13.1 CHANGE IN CONTROL. For purposes of this Section 13, a "Change in Control" of the Company shall mean (a) the sale, lease, exchange or other transfer of all or substantially all of the assets of the Company (in one transaction or in a series of related transactions) to a corporation that is not controlled by the Company, (b) the approval by the shareholders of the Company of any plan or proposal for the liquidation or dissolution of the Company, or (c) a change in control of a nature that would be required to be reported (assuming such event has not been "previously reported") in response to Item 1(a) of the Current Report on Form 8-K, as in 10 effect on the effective date of the Plan, pursuant to Section 13 or 15(d) of the Exchange Act, whether or not the Company is then subject to such reporting requirement; provided that, without limitation, such a Change in Control shall be deemed to have occurred at such time as (x) any Person, other than any Person who owns any shares of Common Stock on the effective date of the Plan, becomes after the effective date of the Plan the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act) directly or indirectly, of 50% or more of the combined voting power of the Company's outstanding securities ordinarily having the right to vote at elections of directors or (y) individuals who constitute the Board of Directors on the effective date of the Plan cease for any reason to constitute at least a majority thereof, provided that any person becoming a director subsequent to the effective date of the Plan whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors comprising the Board of Directors on the effective date of the Plan (either by a specific vote or by approval of the proxy statement of the Company in which such person is named as a nominee for director, without objection to such nomination) shall be, for purposes of this clause (y) and the following sentence, considered as though such person were a member of the Board of Directors on the effective date of the Plan. Notwithstanding anything in the foregoing to the contrary, solely for purposes of any Incentive Award issued and outstanding prior to July 27, 1999, no Change in Control shall be deemed to have occurred for purposes of this Section 13 by virtue of any transaction which shall have been approved by the affirmative vote of at least a majority of the members of the Board of Directors on the effective date of the Plan. The foregoing sentence shall not apply to Incentive Awards granted on or after July 27, 1999. 13.2 ACCELERATION OF VESTING. Without limiting the authority of the Committee under Sections 3.2 and 4.3 of the Plan, if a Change in Control of the Company occurs, then, unless otherwise provided by the Committee in its sole discretion either in the agreement evidencing an Incentive Award at the time of grant or at any time after the grant of an Incentive Award, (a) all outstanding Options and Stock Appreciation Rights will become immediately exercisable in full and will remain exercisable for the remainder of their terms, regardless of whether the Participant to whom such Options or Stock Appreciation Rights have been granted remains in the employ or service of the Company or any Subsidiary; (b) all outstanding Restricted Stock Awards will become immediately fully vested and non-forfeitable; and (c) all outstanding Performance Units and Stock Bonuses then held by the Participant will vest and/or continue to vest in the manner determined by the Committee and set forth in the agreement evidencing such Performance Units or Stock Bonuses. 13.3 CASH PAYMENT FOR OPTIONS. If a Change in Control of the Company occurs, then the Committee, if approved by the Committee in its sole discretion either in an agreement evidencing an Incentive Award at the time of grant or at any time after the grant of an Incentive Award, and without the consent of any Participant effected thereby, may determine that some or all Participants holding outstanding Options will receive, with respect to some or all of the shares of Common Stock subject to such Options, as of the effective date of any such Change in Control of the Company, cash in an amount equal to the excess of the Fair Market Value of such shares immediately prior to the effective date of such Change in Control of the Company over the exercise price per share of such Options. 13.4 LIMITATION ON CHANGE IN CONTROL PAYMENTS. Notwithstanding anything in Section 13.2 or 13.3 of the Plan to the contrary, if, with respect to a Participant, the acceleration 11 of the vesting of an Incentive Award as provided in Section 13.2 or the payment of cash in exchange for all or part of an Incentive Award as provided in Section 13.3 (which acceleration or payment could be deemed a "payment" within the meaning of Section 280G(b)(2) of the Code), together with any other "payments" that such Participant has the right to receive from the Company or any corporation that is a member of an "affiliated group" (as defined in Section 1504(a) of the Code without regard to Section 1504(b) of the Code) of which the Company is a member, would constitute a "parachute payment" (as defined in Section 280G(b)(2) of the Code), then the "payments" to such Participant pursuant to Section 13.2 or 13.3 of the Plan will be reduced to the largest amount as will result in no portion of such "payments" being subject to the excise tax imposed by Section 4999 of the Code; provided, however, that if a Participant is subject to a separate agreement with the Company or a Subsidiary that expressly addresses the potential application of Sections 280G or 4999 of the Code (including, without limitation, that "payments" under such agreement or otherwise will be reduced, that such "payments" will not be reduced or that the Participant will have the discretion to determine which "payments" will be reduced), then this Section 13.4 will not apply, and any "payments" to a Participant pursuant to Section 13.2 or 13.3 of the Plan will be treated as "payments" arising under such separate agreement. 14. RIGHTS OF ELIGIBLE RECIPIENTS AND PARTICIPANTS; TRANSFERABILITY. 14.1 EMPLOYMENT OR SERVICE. Nothing in the Plan will interfere with or limit in any way the right of the Company or any Subsidiary to terminate the employment or service of any Eligible Recipient or Participant at any time, nor confer upon any Eligible Recipient or Participant any right to continue in the employ or service of the Company or any Subsidiary. 14.2 RIGHTS AS A SHAREHOLDER. As a holder of Incentive Awards (other than Restricted Stock Awards and Stock Bonuses), a Participant will have no rights as a stockholder unless and until such Incentive Awards are exercised for, or paid in the form of, shares of Common Stock and the Participant becomes the holder of record of such shares. Except as otherwise provided in the Plan, no adjustment will be made for dividends or distributions with respect to such Incentive Awards as to which there is a record date preceding the date the Participant becomes the holder of record of such shares, except as the Committee may determine in its discretion. 14.3 RESTRICTIONS ON TRANSFER. Except pursuant to testamentary will or the laws of descent and distribution or as otherwise expressly permitted by the Plan, unless approved by the Committee in its sole discretion, no right or interest of any Participant in an Incentive Award prior to the exercise or vesting of such Incentive Award will be assignable or transferable, or subjected to any lien, during the lifetime of the Participant, either voluntarily or involuntarily, directly or indirectly, by operation of law or otherwise. A Participant will, however, be entitled to designate a beneficiary to receive an Incentive Award upon such Participant's death, and in the event of a Participant's death, payment of any amounts due under the Plan will be made to, and exercise of any Options (to the extent permitted pursuant to Section 11 of the Plan) may be made by, the Participant's legal representatives, heirs and legatees. 14.4 NON-EXCLUSIVITY OF THE PLAN. Nothing contained in the Plan is intended to modify or rescind any previously approved compensation plans or programs of the Company or 12 create any limitations on the power or authority of the Board to adopt such additional or other compensation arrangements as the Board may deem necessary or desirable. 15. SECURITIES LAW AND OTHER RESTRICTIONS. Notwithstanding any other provision of the Plan or any agreements entered into pursuant to the Plan, the Company will not be required to issue any shares of Common Stock under this Plan, and a Participant may not sell, assign, transfer or otherwise dispose of shares of Common Stock issued pursuant to Incentive Awards granted under the Plan, unless (a) there is in effect with respect to such shares a registration statement under the Securities Act and any applicable state or foreign securities laws or an exemption from such registration under the Securities Act and applicable state or foreign securities laws, and (b) there has been obtained any other consent, approval or permit from any other regulatory body which the Committee, in its sole discretion, deems necessary or advisable. The Company may condition such issuance, sale or transfer upon the receipt of any representations or agreements from the parties involved, and the placement of any legends on certificates representing shares of Common Stock, as may be deemed necessary or advisable by the Company in order to comply with such securities law or other restrictions. 16. PLAN AMENDMENT, MODIFICATION AND TERMINATION. The Board may suspend or terminate the Plan or any portion thereof at any time, and may amend the Plan from time to time in such respects as the Board may deem advisable in order that Incentive Awards under the Plan will conform to any change in applicable laws or regulations or in any other respect the Board may deem to be in the best interests of the Company; provided, however, that no amendments to the Plan will be effective without approval of the shareholders of the Company if stockholder approval of the amendment is then required pursuant to Section 422 of the Code or the rules of any stock exchange or Nasdaq or similar regulatory body. No termination, suspension or amendment of the Plan may adversely affect any outstanding Incentive Award without the consent of the affected Participant; provided, however, that this sentence will not impair the right of the Committee to take whatever action it deems appropriate under Sections 3.2, 4.3 and 13 of the Plan. 17. EFFECTIVE DATE AND DURATION OF THE PLAN. The Plan is effective as of March 28, 1997. The Plan will terminate at midnight on March 28, 2007, and may be terminated prior to such time to by Board action, and no Incentive Award will be granted after such termination. Incentive Awards outstanding upon termination of the Plan may continue to be exercised, or become free of restrictions, in accordance with their terms. 18. MISCELLANEOUS. 18.1 GOVERNING LAW. The validity, construction, interpretation, administration and effect of the Plan and any rules, regulations and actions relating to the Plan will be governed by and construed exclusively in accordance with the laws of the State of Minnesota, notwithstanding the conflicts of laws principles of any jurisdictions. 13 18.2 SUCCESSORS AND ASSIGNS. The Plan will be binding upon and inure to the benefit of the successors and permitted assigns of the Company and the Participants. 14 EX-27 4 EXHIBIT 27.1
5 1,000 9-MOS JAN-01-2000 JAN-03-1999 OCT-02-1999 13,321 24,250 1,977 399 11,164 62,930 51,625 16,433 101,958 38,011 0 0 0 180 61,229 101,958 205,663 205,663 71,053 71,053 0 549 61 (3,431) (1,269) (2,162) 0 0 0 (2,162) (0.12) (0.12)
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