| SELECT COMFORT CORP ITEM 1A RISK FACTORS We may not be able to sustain growth or profitability |
| Our net sales have grown in each of the last four fiscal years after two consecutive years of declining net sales |
| Our 18 most recent quarters have been profitable after eight consecutive quarters of losses |
| We may not be able to sustain growth or profitability on a quarterly or annual basis in future periods |
| Our future growth and profitability will depend upon a number of factors, including but not limited to: • The efficiency and effectiveness of our Sleep Number advertising campaign and other marketing programs in building product and brand awareness, driving traffic to our points of sale and increasing sales; • The level of consumer acceptance of our products, new product offerings and brand image; • Our ability to execute our retail store distribution strategy, including increasing sales and profitability through our existing stores, securing suitable and cost-effective locations for additional retail stores and cost-effectively closing under-performing store locations; • Our ability to hire, train, manage and retain qualified retail store management and sales professionals; • Our ability to secure and retain wholesale accounts on a profitable basis and to profitably manage growth in wholesale distribution, including the impact on our retail stores and other company-controlled distribution channels; • The success of our program with Radisson Hotels and Resorts in achieving planned levels of placement of our beds with the hotels and resorts and in driving consumer awareness of our product and brand; • Our ability to continuously improve our products to offer new and enhanced consumer benefits, better quality and reduced costs; • Our ability to maintain cost-effective sales, production and delivery of our products; • Our ability to secure adequate sources of supply at reasonable cost, especially considering our single sources of supply for some components and just-in-time manufacturing processes, as well as potential shortages of commodities; • Our ability to maintain sales volumes and profit margins and effectively manage the effects of inflationary pressures caused by rising fuel and commodity costs as well as fluctuating currency rates and increasing industry regulatory requirements, all of which could increase product and service costs; • Our ability to successfully expand our home delivery, assembly and mattress removal capabilities on a cost-effective basis; • Our ability to secure quality services on a cost-effective basis from third-party providers of delivery, assembly and mattress removal services; • Our ability to cost-effectively offer consumer credit options through third party credit providers; 16 _________________________________________________________________ [63]Table of Contents • The level of competition in the mattress industry and our ability to successfully identify and respond to emerging and competitive trends in the mattress industry; • General economic conditions and consumer confidence; and • Global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events |
| We may not be successful in executing our growth strategy or in sustaining profitable growth |
| Failure to successfully execute any material part of our strategic plan or growth strategy could significantly harm our business, operating results and financial condition |
| Our comparable store sales or other operating results may fluctuate significantly |
| An unanticipated decline in comparable store sales or other operating results may disappoint investors and result in a decline in our stock price |
| Our comparable store sales and other operating results have fluctuated significantly in the past |
| For example, from 1998 through 2005, our quarterly comparable store sales results ranged from a decrease of 8prca to an increase of 38prca |
| These past results may not be a meaningful indicator of future performance |
| Our comparable store sales and other operating results may fluctuate significantly in the future |
| A variety of factors affect our comparable store sales and other operating results and may contribute to fluctuations in these results in the future, including but not limited to: • Levels of consumer awareness of our products, brand name and store locations; • Levels of consumer acceptance of our existing products, new product offerings and brand image; • The efficiency and effectiveness of our Sleep Number advertising campaign and other marketing programs in building awareness of our products and brand name, in driving traffic to our store locations, and in motivating consumers to purchase our products; • Consumer shopping and mall traffic trends; • Higher levels of sales in the first year of operations as each successive class of new stores is opened; • Comparable store sales performance in prior periods; • The continuing maturation of our store base with increasing levels of average sales per store; • The amount, timing and relative success of promotional events, advertising expenditures, new product introductions and product line extensions; • The quality and tenure of store-level managers and sales professionals; • The level of competitive activity; • The timing of new store openings and related expenses; • The growth of our other distribution channels, including in particular the wholesale distribution of our products through home furnishings and specialty mattress retailers into markets with existing company-owned retail stores; • Our ability to offer effective consumer credit and other promotional offerings; • Any increases in return rates or warranty claims; • Any disruptions in third-party delivery services; and • General economic conditions and consumer confidence |
| Future fluctuations or decreases in our comparable store sales or other operating results could significantly harm our business, operating results and financial condition |
| In addition, an unanticipated decline in comparable store sales or other operating results may disappoint securities analysts or investors and result in a decline in our stock price |
| 17 _________________________________________________________________ [64]Table of Contents Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our advertising expenditures in generating consumer awareness and sales of our products |
| We are dependent on the effectiveness and efficiency of our advertising expenditures (which were approximately dlra90 million in 2005, dlra79 million in 2004, dlra60 million in 2003, dlra40 million in 2002 and dlra30 million in 2001) in generating consumer awareness and sales of our products |
| Our future growth and profitability will depend in large part upon the effectiveness and efficiency of our advertising expenditures, including but not limited to our ability to: • Create greater awareness of our products and brand name; • Drive consumer traffic to our points of distribution and to motivate consumers to purchase our products; • Develop new and effective creative messages that will resonate with consumers; • Select the right markets in which to advertise and the most effective and efficient level of spending in each of our markets; • Determine the appropriate creative message and media mix for advertising expenditures; • Effectively manage advertising costs (including creative and media) in order to maintain acceptable costs per inquiry, costs per order and operating margins; and • Convert consumer inquiries into actual orders |
| Our advertising expenditures may not generate sufficient levels of product and brand name awareness or result in increased sales |
| In addition, we may not be able to manage our advertising expenditures on a cost-effective basis to maintain acceptable operating margins |
| The mattress industry is highly competitive |
| Our business could be significantly harmed by existing competitive pressures or from one or more new entrants into the market |
| Our Sleep Number beds compete with a number of different types of mattress alternatives, including standard innerspring mattresses, foam mattresses, waterbeds, futons and other air-supported mattress products sold through a variety of channels, including home furnishings stores, specialty mattress stores, department stores, mass merchants, wholesale clubs, telemarketing programs, television infomercials and catalogs |
| The mattress industry is characterized by a high degree of concentration among the four largest manufacturers of innerspring mattresses with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand, Serta, Simmons and Spring Air |
| Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the mattress market |
| Tempur-Pedic International, Inc |
| and other companies compete in the mattress industry with foam mattress products |
| A number of mattress manufacturers, including Simmons, as well as a number of smaller manufacturers, including low-cost foreign manufacturers, have offered air beds that compete with our products |
| Many of our competitors, including in particular the four largest mattress manufacturers, have greater financial, marketing and manufacturing resources and better brand name recognition than we do and sell products through broader and more established distribution channels |
| These competitors, or new entrants into the market, may compete aggressively and gain market share with existing and new mattress products, and may pursue or expand their presence in the air bed segment of the market |
| Some competitors may engage in aggressive advertising strategies that may include false or misleading claims about competitive products and/or our products |
| Any such competition could inhibit our ability to retain or increase market share, inhibit our ability to maintain or increase prices and reduce our margins, which could significantly harm our business |
| Our products represent a significant departure from traditional innerspring mattresses and the failure of our products to achieve market acceptance would significantly harm our business, operating results and financial condition |
| We estimate that innerspring mattress sales represent approximately 80prca of all mattress sales |
| Four large manufacturers of innerspring mattresses dominate the US mattress market |
| Our air chamber technology represents a significant departure from traditional innerspring mattresses |
| Because no established market for adjustable firmness mattress products existed prior to the introduction of our products in 1988, we faced the challenge of establishing the viability of this market, as well as gaining widespread acceptance of our products |
| The market for adjustable firmness mattresses is now evolving and the 18 _________________________________________________________________ [65]Table of Contents future success of our products will depend upon both the continued growth of this market and consumer acceptance of our products |
| The failure of our products to achieve consumer acceptance for any reason would significantly harm our business, operating results and financial condition |
| Our plan to pursue additional and maintain existing wholesale relationships with home furnishings retailers, specialty mattress retailers and the QVC shopping channel may not yield the benefits we expect and may involve other risks that may harm our business |
| An important element of our growth strategy is to expand profitable distribution by increasing sales through our existing channels and by increasing opportunities for consumers to become aware of, and to purchase, our products through additional points of distribution, such as wholesale distribution |
| We have only recently established a limited number of wholesale relationships with home furnishings retailers, specialty mattress retailers and the QVC shopping channel and therefore have limited wholesale experience |
| Our wholesale relationships may not result in the intended benefits of leveraging our advertising spending and increasing our brand awareness, sales and overall market acceptance of our products |
| The success of our wholesale strategy will depend upon numerous factors, including but not limited to the following: • The ability of our personnel to adequately analyze and identify suitable wholesale distribution partners and markets in which our retail presence is under-represented; • Our ability to negotiate favorable distribution terms with our wholesale distribution partners; • Our ability and the ability of our wholesale distribution partners to adequately train, motivate and retain sales professionals who are selling our products; • Our ability to adapt our distribution and other operational and management systems to an expanded network of points of sale; • Our ability and the ability of our wholesale distribution partners to attract customers and generate sales sufficient to justify the expense of establishing the wholesale distribution relationship; and • Our ability to maintain sales growth in our company-controlled retail stores in markets in which wholesale distribution partners are added |
| We have established relationships with a limited number of home furnishings retailers and specialty mattress retailers over the last several years |
| The loss of one or more of these accounts could have a material adverse affect upon our wholesale distribution strategy and could adversely impact our ability to achieve our overall sales growth and profitability objectives |
| Any failure to achieve the objectives of our wholesale distribution strategy may significantly harm our operating results and financial condition |
| The failure of our program to place beds in Radisson Hotels and Resorts to achieve planned objectives may harm our business and adversely impact our operating results and financial condition |
| An important element of our growth strategy is to expand consumer awareness of our products and brand |
| We have recently established a relationship with Radisson Hotels and Resorts with plans to replace a majority of the 75cmam500 beds in Radisson Hotels and Resorts in the United States, Canada and the Caribbean with Sleep Number beds over the next several years |
| This program is designed in part to drive consumer awareness of our products and brand among the guests of Radisson Hotels and Resorts |
| The success of this strategy will depend upon numerous factors, including but not limited to levels of acceptance of our products among Radisson Hotels and Resorts franchisees, the execution of marketing programs in connection with this relationship, and the quality of guests’ experiences on our beds at the Radisson Hotels and Resorts |
| Any failure to achieve the objectives of our relationships with Radisson Hotels and Resorts may significantly harm our operating results and financial condition |
| We rely upon several key suppliers that are, in some instances, our sole source of supply |
| The failure of one or more of these suppliers or our other key suppliers to supply components for our products on a timely basis, or a material change in the purchase terms for our components, could significantly harm our business, operating results and financial condition |
| 19 _________________________________________________________________ [66]Table of Contents We currently obtain all of the materials and components used to produce our beds from outside sources |
| A number of components, including our proprietary air chambers, our proprietary blow-molded foundations, various components for our Firmness Control Systems, as well as foam, fabrics and zippers, are sourced from suppliers who serve as our sole source of supply for these components |
| We have a supply agreement with the supplier of our air chambers that expires in October 2007, subject to automatic annual renewal thereafter unless either party gives 365 days’ notice of non-renewal |
| We have a supply agreement with the supplier of our blow-molded foundations that expires in October 2006, subject to automatic annual renewal thereafter unless either party gives 180 days’ notice of non-renewal |
| If our relationship with the supplier of our air chambers or blow-molded foundations is terminated, we could have difficulty in replacing these sources since there are few other suppliers capable of manufacturing these components |
| We generally purchase many of our other components and raw materials centrally to obtain volume discounts and achieve economies of scale |
| We therefore obtain a large percentage of our components and raw materials from a small number of suppliers |
| We do not have any long-term purchase agreements with, or other contractual assurances of continued supply, pricing or access from, any of our suppliers, except as noted above |
| Other than our air chambers and foundations, we purchase most of our components and raw materials through purchase orders |
| If prices increase and we are unable to pass on the increase in our costs to our customers, then our operating results and financial condition may be significantly harmed |
| The loss of one or more of our key suppliers, the failure of one or more of our key suppliers to supply components to our products on a timely basis, or a material change in the purchase terms for our components could significantly harm our business, operating results and financial condition |
| We utilize “just-in-time” manufacturing processes with minimal levels of raw materials, work in process and finished goods inventories, which could leave us vulnerable to shortages of supply of key components |
| Any such shortage could result in our inability to satisfy consumer demand for our products in a timely manner and lost sales, which could significantly harm our business, operating results and financial condition |
| We generally assemble our products after we receive orders from customers utilizing “just-in-time” manufacturing processes |
| Lead times for ordered components may vary significantly and depend upon a variety of factors, such as the location of the supplier, the complexity in manufacturing the component and general demand for the component |
| Some of our components, including our air chambers, have relatively longer lead times |
| We generally maintain minimal levels of raw materials, work in process and finished goods inventories, except for our air chambers, of which we generally carry approximately six weeks of inventory |
| As a result, an unexpected shortage of supply of key components used to manufacture our products, or an unexpected and significant increase in the demand for our products, could lead to inadequate inventory and delays in shipping our beds to customers |
| Any such delays could result in lost sales, which could significantly harm our business, operating results and financial condition |
| The foreign manufacturing of our air chambers and some of our other components involves risks that could increase our costs, lead to inadequate inventory levels or delays in shipping beds to our customers, which could substantially harm our business, operating results and financial condition |
| Since our air chambers and some of our other components are manufactured outside the United States, our operations could be significantly harmed by the risks associated with foreign sourcing of materials, including but not limited to: • Political instability resulting in disruption of trade; • Existing or potential duties, tariffs or quotas that may limit the quantity of certain types of goods that may be imported into the United States or increase the cost of such goods; • Disruptions in transportation that could be caused by a variety of factors including terrorist acts, shipping delays, foreign or domestic dock strikes, customs inspections or other factors; • Any significant fluctuation in the value of the US dollar against foreign currencies; and • Economic uncertainties, including inflation |
| These factors could increase our costs of doing business with foreign suppliers, lead to inadequate inventory levels or delays in shipping beds to our customers, which could substantially harm our business, operating results and financial condition |
| If any of these or other factors were to render the conduct of any of our foreign suppliers’ businesses more difficult or 20 _________________________________________________________________ [67]Table of Contents impractical, we may have difficulty sourcing key components of our products, which could materially and adversely affect our operating results and financial condition |
| We have plans to expand our distribution internationally, which presents some additional risks to our business |
| To date, the vast majority of our sales have been made in the US and we have sold only very minimal quantities of products in foreign jurisdictions |
| In late 2005 we began to distribute our products in Canada through a Canadian-based bedding retailer and we have begun to pursue plans to enable distribution of our products in some European countries |
| Expansion of our distribution to foreign jurisdictions, and our lack of experience in international distribution, present some risks to our business, including without limitation the need to build awareness of our products and brand in new markets, the need to gain market acceptance for new products that represent a significant departure from traditional bedding products, logistical and systems complexities, different levels of protection of our intellectual property, language and cultural differences, the need to comply with additional and different regulatory requirements, foreign currency exchange risks and political instability |
| Although several members of our senior management team have significant experience in international distribution of consumer goods, as a company our experience in this area is limited |
| We plan to invest in our international infrastructure in advance of sales in international jurisdictions which may adversely impact our overall profitability |
| If we are unable to achieve consumer awareness and market acceptance for our products in foreign jurisdictions, we may not be able to achieve sales and profitability in our international operations to justify the investment |
| Increases in commodity prices, component costs and/or delivery costs could harm our profitability |
| In recent months there have been significant increases or volatility in the prices of certain commodities, including but not limited to fuel, oil, natural gas, rubber, cotton, plastic resin, chemical ingredients to foam and steel |
| Increases in prices of these commodities may result in significant cost increases related to our raw materials and product components, as well as increases in the cost of delivering our products to our customers |
| These increases in costs may require us to increase our prices, potentially adversely impacting our unit sales volumes, and may increase our costs of doing business, potentially adversely impacting our operating results and financial condition |
| More than one-third of our net sales are financed by a third party |
| The termination of our agreement with this third party, any material change to the terms of our agreement with this third party or in the availability or terms of credit offered to our customers by this third party, or any delay in securing replacement credit sources, could harm our business, operating results and financial condition |
| Our qualified customers are offered a revolving credit arrangement to finance purchases from us through a private label consumer credit facility provided by GE Money Bank |
| In December 2005 we entered into an amended and restated agreement with GE Money Bank that extends this consumer credit arrangement through February 15, 2011, subject to earlier termination upon certain events and subject to automatic extensions |
| Under this agreement, GE Money Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts |
| In connection with all purchases financed under these arrangements, GE Money Bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts |
| Any increase by GE Money Bank in the minimum customer credit ratings necessary to qualify for credit could adversely impact our sales by decreasing the number of customers who can finance purchases |
| We are liable to GE Money Bank for chargebacks arising out of (i) breach of our warranties relating to the underlying sale transaction, (ii) defective products or (iii) our failure to comply with applicable operating procedures under the facility |
| We are not liable to GE Money Bank for losses arising out of our customers’ credit defaults |
| We have the right to terminate the agreement in order to manage this consumer credit program internally at any time after 2008 |
| Upon the termination of the agreement, we have the right, but not the obligation, to purchase GE Money Bank’s portfolio of customer accounts |
| Approximately 38prca of our net sales during 2005 and 37prca of our net sales during 2004 were financed by GE Money Bank or its predecessor, Mill Creek Bank |
| Consumers that do not qualify for credit under our agreement with GE Money Bank may apply for credit under a secondary program maintained by the company through another provider |
| Termination of our agreement with GE Money Bank or with our secondary provider, any material change to the terms of our agreements with these providers or in the availability or terms of credit for our customers from these providers, or any delay in securing replacement credit sources, could harm our business, operating results and financial condition |
| 21 _________________________________________________________________ [68]Table of Contents The loss of the services of any members of our executive management team could materially and adversely impact our ability to execute our business strategy and growth initiatives and could significantly harm our business |
| We are currently dependent upon the continued services, ability and experience of our executive management team, particularly William R McLaughlin, our Chairman and Chief Executive Officer |
| McLaughlin or any other member of our executive management team could have a material adverse effect on our ability to execute our business strategy and growth initiatives and on our results of operation and financial condition |
| We do not maintain any key person life insurance on any members of our executive management team |
| Our future growth and success will also depend upon our ability to attract, retain and motivate other qualified personnel |
| If we are unable to enhance our existing products and to develop and market new products that respond to customer needs and achieve market acceptance, we may not be able to sustain our growth or profitability |
| One of our growth strategies is to continue to lead our industry in product innovation and sleep expertise by enhancing existing products and by developing and marketing new products that deliver personalized comfort and better sleep |
| We may not be successful in developing or marketing enhanced or new products that will receive acceptance in the marketplace |
| Further, the resulting level of sales from any of our enhanced or new products may not justify the costs associated with the development and marketing |
| Any failure to continue to develop and market enhanced or new products in a cost-effective manner could harm our ability to sustain our growth or profitability |
| If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology in competitive products |
| We own various US and foreign patents and patent applications related to certain elements of the design and function of our beds and related products |
| We also own several registered and unregistered trademarks and trademark applications, including in particular our Select Comfort and Sleep Number trademarks, which we believe have significant value and are important to the marketing of our products to customers |
| In addition to patents and trademarks, we rely upon copyrights, trade secrets and other intellectual property rights and we have implemented several measures to protect our intellectual property and confidential information contained in our products, such as entering into assignment of invention and nondisclosure agreements with certain of our employees |
| Our ability to compete effectively with other companies depends, to a significant extent, upon our ability to maintain the proprietary nature of our owned intellectual property and confidential information |
| Our intellectual property rights may not provide substantial protection against infringement or piracy and may be circumvented by our competitors |
| Our protective measures may not protect our intellectual property rights or confidential information or prevent our competitors from developing and marketing products that are similar to or competitive with our beds or other products |
| In addition, the laws of some foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States |
| If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology or trademarks in connection with competitive products, which could adversely affect our sales or require us to decrease our prices |
| Intellectual property litigation, which could result in substantial costs to us and the diversion of significant time and effort by our executive management, may be necessary to enforce our patents and trademarks and to protect our trade secrets and proprietary technology |
| We may not have the financial resources necessary to enforce or defend our intellectual property rights |
| We are not aware of any material intellectual property infringement or invalidity claims that may be asserted against us, however, it is possible that third parties, including competitors, may successfully assert such claims |
| The cost of defending such claims, or any resulting liability, or any failure to obtain necessary licenses on reasonable terms, may adversely impact our operating results and financial condition |
| We depend upon UPS and other carriers to deliver some of our products to customers on a timely and cost-effective basis |
| Any significant delay in deliveries to our customers could lead to increased returns and cause us to lose future sales |
| Any increase in freight charges could increase our costs of doing business and harm our profitability |
| Historically, we have relied almost exclusively on UPS for delivery of our products to customers |
| For a significant portion of the third quarter of 1997, UPS was unable to deliver our products within acceptable time periods due to a labor strike, causing delays in deliveries to customers and requiring us to use alternative carriers |
| UPS may not be able to avert labor difficulties in the future or may otherwise experience difficulties in meeting our requirements in the future |
| From 2000 to 2003, we demonstrated an ability to shift a portion of our product delivery business to FedEx, as necessary |
| In addition, we either provide directly, or contract with a third party to provide, in-home delivery, assembly and mattress removal services, 22 _________________________________________________________________ [69]Table of Contents and in 2003 expanded the availability of this service to all of our retail stores across the country |
| Despite these alternative carriers, if UPS were to experience difficulties in meeting our requirements we may not be able to deliver products to all of our customers on a timely or cost-effective basis through any one or more of these or other alternative carriers |
| Any significant delay in deliveries to our customers could lead to increased returns and cause us to lose future sales |
| Any increase in freight charges could increase our costs of doing business and harm our profitability |
| Significant and unexpected return rates under our 30-night trial period and warranty claims under our 20-year limited warranty on our beds, in excess of our returns and warranty reserves, could significantly harm our business, operating results and financial condition |
| Part of our marketing and advertising strategy focuses on providing a 30-night trial in which customers may return their beds and obtain a refund of the purchase price if they are not fully satisfied with our product |
| As we expand our sales, return rates may not remain within acceptable levels |
| A significant and unexpected increase in return rates could significantly harm our business, operating results and financial condition |
| We also provide our customers with a 20-year limited warranty on our beds |
| However, since we have only been selling beds in significant quantities since 1992, we may receive significant and unexpected claims under these warranty obligations that could exceed our warranty reserves |
| Significant warranty claims in excess of our warranty reserves could significantly harm our business, operating results and financial condition |
| We may be unable to effectively manage our growth, which could significantly harm our business, operating results and financial condition |
| Our growth strategy has placed, and will continue to place, significant strains on our management, production, information systems and other resources |
| To manage growth effectively, we must maintain a high level of manufacturing quality and efficiency, continue to enhance our operational, financial and management systems, including our database management, tracking of inquiries, inventory control and distribution systems, and expand, train and manage our employee base |
| We may not be able to effectively manage this expansion in any one or more of these areas, and any failure to do so could significantly harm our business, operating results and financial condition |
| Our management information systems may prove inadequate |
| We depend upon our management information systems for many aspects of our business |
| Some of our key software has been developed by our own programmers and this software may not be easily modified or integrated with other software and systems |
| Our business will be materially and adversely affected if our management information systems are disrupted or if we are unable to improve, upgrade, integrate or expand our systems as we execute our growth strategy |
| Damage to either of our manufacturing facilities could increase our costs of doing business or lead to delays in shipping our beds, which could result in increased returns and adversely affect future sales |
| We have two manufacturing plants, which are located in Irmo, South Carolina and in Salt Lake City, Utah |
| Unlike other mattress manufacturers, we manufacture beds to fulfill orders rather than stocking finished goods inventory |
| Therefore, the destruction or shutting down of either of our manufacturing facilities for a significant period of time as a result of fire, explosion, act of war or terrorism, flood, hurricane, tornado, typhoon, earthquake, lightning or other natural disaster could increase our costs of doing business and lead to delays in shipping our beds to customers |
| Such delays could result in increased returns and adversely affect future sales |
| Due to our make-to-order business model, these adverse consequences to our business may be greater for our company than with other mattress manufacturers |
| Significant and long-term failure of our Web site could adversely affect our net sales |
| We depend on our Web site for a certain percentage of our net sales and for advertising of our products |
| If our Web site becomes unavailable for a significant period of time due to failure of our information technology systems or the Internet, our net sales could be adversely affected |
| Our business is subject to seasonal influences and a substantial portion of our net sales is often realized in the last month or last few weeks of a quarter, due in part to our promotional schedule and commission structure |
| Because the level of our sales and marketing expense is based on our expectations of future customer inquiries and net sales and cannot be adjusted quickly, a shortfall in these expectations may harm our profitability |
| Our business is subject to some seasonal influences, with lower sales in the second quarter and higher sales during the fourth quarter holiday season due to greater mall traffic |
| Furthermore, a substantial portion of our sales is often realized in the last 23 _________________________________________________________________ [70]Table of Contents month or last few weeks of a quarter, due in part to our promotional schedule and commission structure |
| The level of our sales and marketing expenses and new store opening costs is based, in significant part, on our expectations of future customer inquiries and net sales and cannot be adjusted quickly |
| If there is a shortfall in expected net sales or in the conversion rate of customer inquiries, we may be unable to adjust our spending in a timely manner and our profitability may be significantly harmed |
| We are subject to government regulations relating to the bedding industry and to various aspects of our operations and may be required to incur expenses or to modify our operations in order to ensure compliance with these regulations |
| Our operations are subject to state and local consumer protection and other regulations relating to the bedding industry |
| These regulations vary among the states in which we do business |
| The regulations generally impose requirements as to the proper labeling of bedding merchandise, restrictions regarding the identification of merchandise as “new” or otherwise, controls as to hygiene and other aspects of product handling and sale and penalties for violations |
| Our direct marketing and e-commerce operations are or may become subject to various adopted or proposed federal and state “do not call” or “do not mail” list requirements |
| The federal Consumer Product Safety Commission and various state regulatory agencies have been considering new rules relating to fire retardancy standards for the bedding industry |
| Effective January 1, 2005, the State of California adopted a new open flame fire retardancy standard applicable to mattress products sold in California for general consumer residential use |
| In February 2006, the Consumer Product Safety Commission announced the adoption of a federal open flame fire retardancy standard similar to the California standard, which we believe will be effective nationwide in July 2007 |
| We have developed product modifications to meet the new standard, which have added costs to the modified products and require more complicated manufacturing processes, reducing our manufacturing capacity |
| A portion of our net sales consists of refurbished products that are assembled in part from components returned to us from customers |
| These refurbished products must be properly labeled and marketed as refurbished products under applicable state laws |
| Our sales of refurbished products are limited to approximately 24 states, as the remaining states do not allow the sale of refurbished mattress products |
| We are subject to federal, state and local laws and regulations relating to occupational health and safety, pollution and environmental protection |
| Our retail pricing policies and practices are subject to antitrust regulations in the United States and other jurisdictions where we may sell our products in the future |
| If any of our policies or practices were to be challenged by antitrust regulators or private parties, we could be required to devote substantial resources to respond, and any such required response could also divert the time and attention of management |
| Although we believe that we are in compliance in all material respects with these regulations and have implemented a variety of measures to promote continuing compliance, regulations may change over time and we may be required to incur expenses and/or to modify our operations in order to ensure compliance with these regulations, which could harm our operating results |
| If we are found to be in violation of any of the foregoing regulations, we could become subject to fines, penalties or other sanctions, as well as potential adverse public relations, which could materially and adversely impact our business and our operating results |
| We are subject to class action litigation alleging deceptive trade practices, fraud and breach of warranty |
| This litigation may be costly to defend, could adversely affect our operating results and, if we are unsuccessful in our defense, could subject our company to material liability |
| In October 2004, a lawsuit was filed against our company in Hennepin County District Court in the State of Minnesota by one of our customers alleging deceptive trade practices, fraud and breach of warranty related to the alleged propensity of our products to develop mold |
| The complaint sought class certification and various forms of legal and equitable relief, including but not limited to rescission and/or actual damages in an amount to be determined at trial, including interest, costs and attorney’s fees |
| In March 2005, the Court dismissed plaintiff’s false advertising claim and deceptive trade practice damage claim |
| On January 30, 2006, following reconsideration of our motion to dismiss, the Court dismissed all of plaintiff’s claims in their entirety |
| The plaintiff has the right to appeal the Court’s order dismissing the case |
| If the plaintiff chooses to pursue an appeal, we would continue to vigorously defend the litigation and the Court’s order dismissing the case, and we could incur substantial defense costs |
| It is 24 _________________________________________________________________ [71]Table of Contents also possible that similar claims may be asserted in Minnesota or other jurisdictions, which could require substantial defense costs |
| Any such claims could also divert the time and attention of our management and could result in adverse publicity, either of which could significantly harm our operating results and financial condition |
| Any adverse determination in any such litigation could also result in material liability, which could significantly harm our operating results and financial condition |
| We may face exposure to product liability claims |
| We face an inherent business risk of exposure to product liability claims in the event that the use of any of our products is alleged to have resulted in personal injury or property damage |
| In the event that any of our products proves to be defective, we may be required to recall or redesign such products |
| In 2004 we experienced increased returns and adverse impacts on sales as a result of media reports related to the alleged propensity of our products to develop mold |
| We may experience material increases in returns and material adverse impacts on sales in the event any similar media reports were to occur in the future |
| We maintain insurance against product liability claims, but such coverage may not continue to be available on terms acceptable to us and may not be adequate for liabilities actually incurred |
| A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our business |
| The loss of these endorsements, or any reduction in their effectiveness, could adversely affect our net sales and profitability |
| Our integrated marketing program depends in part on national radio personalities and spokespersons, including Paul Harvey, Rush Limbaugh and Lindsay Wagner and other nationally known personalities |
| The loss of these endorsements, or any reduction in the effectiveness of these endorsements, could adversely affect our net sales and profitability |
| The expensing of stock compensation programs required under new accounting rules effective in 2006 may have a material adverse effect on our operating results and financial condition |
| In December 2004, the Financial Accounting Standards Board issued SFAS Nodtta 123 (revised 2004) “Share-Based Payment” (“SFAS 123R”), which replaces SFAS Nodtta 123, “Accounting for Stock-Based Compensation,” (SFAS 123) |
| SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair value beginning with the first interim or annual period after December 15, 2005 |
| The pro forma disclosures we have previously made as permitted under SFAS 123 will no longer be an alternative to financial statement recognition |
| We are required to adopt SFAS 123R by the first quarter of fiscal 2006, beginning January 1, 2006 |
| Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost, and the transition method to be used at date of adoption |
| We are evaluating the requirements of SFAS 123R and expect that the adoption of SFAS 123R will have a material impact on our consolidated results of operations and earnings per share |
| Our pro forma disclosures have historically reported an annual impact to diluted earnings per share of dlra0dtta06 to dlra0dtta11 for fiscal years 2003 through 2005 |
| We expect that share-based compensation expense under SFAS 123R will reduce our diluted earnings per share by approximately dlra0dtta10 to dlra0dtta11 in 2006 |
| Additional terrorist attacks in the United States or against US targets or actual or threats of war or the escalation of current hostilities involving the United States or its allies could significantly impact our business, financial condition, operating results or stock price in unpredictable ways |
| Additional terrorist attacks in the United States or against US targets, or threats of war or the escalation of current hostilities involving the United States or its allies, or military or trade disruptions impacting our domestic or foreign suppliers of components of our products, may impact our operations, including, but not limited to, causing delays or losses in the delivery of merchandise to us and decreased sales of our products |
| These events could cause an increase in oil or other commodity prices, which could adversely affect our materials or transportation costs, including delivery of our products to customers |
| More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the US and worldwide financial markets |
| These events also could cause an economic recession in the United States or abroad |
| Any of these occurrences could have a significant impact on our business, operating results and financial condition and may result in volatility of our stock price |
| As a result of the terrorist attacks in the United States and the threat of war involving the United States, we believe many consumers have traveled less and purchased more products for their home |
| We believe these trends have contributed to an increase in our net sales |
| These trends may not continue and they may not continue to positively affect our net sales |
| 25 _________________________________________________________________ [72]Table of Contents An outbreak of Avian Flu or a pandemic, or the threat of a pandemic, may adversely impact our ability to produce and deliver our products or may adversely impact consumer demand |
| Concern has grown in recent months over the possibility of a significant or global outbreak of avian flu or a similar pandemic |
| A significant outbreak of avian flu, or a similar pandemic, or even a perceived threat of such an outbreak, could cause significant disruptions to our supply chain, manufacturing capability and distribution system that could adversely impact our ability to produce and deliver products, which could result in a loss of sales and an adverse impact on our results of operations and financial condition |
| Similarly, such events could cause significant adverse impacts on consumer confidence and consumer demand generally, which could significantly and adversely impact our sales, results of operations and financial condition |