Sleep Number 10Q 2009 Q3 Quarterly report

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 3, 2009

Commission File Number: 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.)

9800 59^th Avenue North
Minneapolis, Minnesota	55442
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code:(763) 551-7000

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.

YESx NOo

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).

YESo NOo

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):


Large accelerated filer	o		Accelerated filer o
Non-accelerated filer	o	(Do not check if a smaller reporting company)	Smaller reporting company x

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YESo NOx

As of October 3, 2009, 45,589,000 shares of Common Stock of the Registrant were outstanding.

SELECT COMFORT CORPORATION
AND SUBSIDIARIES
INDEX


		Page

PART I: FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Consolidated Balance Sheets as of October 3, 2009 and January 3, 2009	3

	Condensed Consolidated Statements of Operations for the Three and Nine Months ended October 3, 2009 and September 27, 2008	4

	Condensed Consolidated Statement of Shareholders’ Deficit for the Nine Months ended October 3, 2009	5

	Condensed Consolidated Statements of Cash Flows for the Nine Months ended October 3, 2009 and September 27, 2008	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	16

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27

Item 4.	Controls and Procedures	27

PART II: OTHER INFORMATION

Item 1.	Legal Proceedings	27

Item 1A.	Risk Factors	28

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29

Item 3.	Defaults Upon Senior Securities	29

Item 4.	Submission of Matters to a Vote of Security Holders	29

Item 5.	Other Information	30

Item 6.	Exhibits	31

SIGNATURES		32

Table of Contents

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(in thousands, except per share amounts)


	(unaudited) October 3, 2009			January 3, 2009
Assets
Current assets:
Cash and cash equivalents	$	4,796		$	13,057
Accounts receivable, net of allowance for doubtful accounts of $404 and $713, respectively		2,593			4,939
Inventories		15,491			18,675
Income taxes receivable		897			25,900
Prepaid expenses		9,756			4,109
Deferred income taxes		—			1,323
Other current assets		894			1,150
Total current assets		34,427			69,153
Property and equipment, net		40,531			53,274
Deferred income taxes		—			5,941
Other assets		7,312			7,045
Total assets	$	82,270		$	135,413

Liabilities and Shareholders’ Deficit
Current liabilities:
Borrowings under revolving credit facility	$	26,300		$	79,150
Accounts payable		36,793			40,274
Customer prepayments		10,397			11,480
Accruals:
Sales returns		2,983			2,744
Compensation and benefits		14,436			14,575
Taxes and withholding		4,425			2,938
Other current liabilities		7,753			8,526
Total current liabilities		103,087			159,687
Non-current liabilities:
Warranty liabilities		5,402			5,956
Deferred income taxes		443			—
Capital lease obligations		357			621
Other long-term liabilities		11,731			10,779
Total non-current liabilities		17,933			17,356
Total liabilities		121,020			177,043

Shareholders’ deficit:
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.01 par value; 142,500 shares authorized, 45,589 and 44,962 shares issued and outstanding, respectively		456			450
Additional paid-in capital		7,048			4,417
Accumulated deficit		(46,254	)		(46,497	)
Total shareholders’ deficit		(38,750	)		(41,630	)
Total liabilities and shareholders’ deficit	$	82,270		$	135,413

See accompanying notes to condensed consolidated financial statements.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited – in thousands, except per share amounts)


	Three Months Ended						Nine Months Ended
	October 3, 2009			September 27, 2008			October 3, 2009			September 27, 2008

Net sales	$	147,470		$	157,231		$	407,731		$	477,451
Cost of sales		53,915			59,475			158,052			192,125
Gross profit		93,555			97,756			249,679			285,326

Operating expenses:
Sales and marketing		65,997			82,047			194,417			258,074
General and administrative		11,818			11,618			36,856			41,880
Research and development		436			562			1,400			2,079
Terminated equity financing costs		3,324			—			3,324			—
Asset impairment charges		—			1,477			488			2,534
Total operating expenses		81,575			95,704			236,485			304,567
Operating income (loss)		11,980			2,052			13,194			(19,241	)
Other expense, net		(1,704	)		(1,117	)		(4,951	)		(1,996	)
Income (loss) before income taxes		10,276			935			8,243			(21,237	)
Income tax expense (benefit)		3,377			(48	)		8,000			(8,496	)
Net income (loss)	$	6,899		$	983			243		$	(12,741	)

Net income (loss) per share – basic	$	0.15		$	0.02		$	0.01		$	(0.29	)
Weighted-average shares – basic		44,830			44,232			44,783			44,143

Net income (loss) per share – diluted	$	0.15		$	0.02		$	0.01		$	(0.29	)
Weighted-average shares – diluted		45,633			44,651			45,089			44,143

See accompanying notes to condensed consolidated financial statements.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Shareholders’ Deficit
(unaudited – in thousands)


					Additional Paid-In Capital
	Common Stock						Accumulated Deficit			Total
	Shares		Amount				Accumulated Deficit			Total
Balance at January 3, 2009		44,962	$	450	$	4,417	$	(46,497	)	$	(41,630	)
Exercise of common stock options		11		—		9		—			9
Tax benefit from stock-based compensation		—		—		15		—			15
Stock-based compensation		—		3		2,537		—			2,540
Issuances of common stock		616		3		70		—			73
Net income		—		—		—		243			243
Balance at October 3, 2009		45,589	$	456	$	7,048	$	(46,254	)	$	(38,750	)

See accompanying notes to condensed consolidated financial statements.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited – in thousands)


	Nine Months Ended
	October 3, 2009			September 27, 2008
Cash flows from operating activities:
Net income (loss)	$	243		$	(12,741	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		15,310			17,183
Stock-based compensation		2,540			3,337
Disposals and impairments of assets		485			2,508
Excess tax benefits from stock-based compensation		—			(17	)
Changes in deferred income taxes		7,707			(977	)
Changes in operating assets and liabilities:
Accounts receivable		2,346			11,222
Inventories		3,184			12,556
Income taxes receivable		25,003			(7,167	)
Prepaid expenses and other assets		(6,756	)		1,195
Accounts payable		3,256			(16,612	)
Customer prepayments		(1,083	)		909
Accrued sales returns		239			(447	)
Accrued compensation and benefits		(139	)		492
Accrued taxes and withholding		1,501			(313	)
Warranty liabilities		(749	)		(1,847	)
Other accruals and liabilities		(84	)		2,884
Net cash provided by operating activities		53,003			12,165

Cash flows from investing activities:
Purchases of property and equipment		(2,040	)		(28,141	)
Proceeds from sales of property and equipment		15			—
Net cash used in investing activities		(2,025	)		(28,141	)

Cash flows from financing activities:
Net (decrease) increase in short-term borrowings		(59,322	)		15,823
Proceeds from issuance of common stock		83			534
Excess tax benefits from stock-based compensation		—			17
Debt issuance costs		—			(1,472	)
Net cash (used in) provided by financing activities		(59,239	)		14,902

Decrease in cash and cash equivalents		(8,261	)		(1,074	)
Cash and cash equivalents, at beginning of period		13,057			7,279
Cash and cash equivalents, at end of period	$	4,796		$	6,205

See accompanying notes to condensed consolidated financial statements.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

1. Basis of Presentation, Liquidity and Going Concern

We prepared the condensed consolidated financial statements as of and for the three and nine months ended October 3, 2009 of Select Comfort Corporation and subsidiaries (“Select Comfort” or the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and they reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly our financial position as of October 3, 2009, and January 3, 2009 and the results of operations and cash flows for the periods presented. Our historical results of operations may not be indicative of the results that may be achieved for any future period.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with our most recent audited consolidated financial statements and related notes included in our Annual Report on Form 10-K (as amended) for the fiscal year ended January 3, 2009 and other recent current filings with the SEC. Operating results for any quarterly period may not be indicative of operating results for the full year.

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of sales, expenses and income taxes during the reporting period. Predicting future events is inherently an imprecise activity and as such requires the use of judgment. Illiquid credit markets and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in these estimates will be reflected in the financial statements in future periods. Our critical accounting policies relate to asset impairment charges, stock-based compensation, deferred income taxes, self-insured liabilities, warranty liabilities and revenue recognition.

The consolidated financial statements include the accounts of Select Comfort Corporation and our subsidiaries. All significant intra-entity balances and transactions have been eliminated in consolidation.

In 2008, following several years of generating positive net income, we realized a net loss of $70.2 million, including $34.6 million of asset impairment charges and a $26.8 million charge for the establishment of a deferred tax valuation allowance. Our 2008 operating results were significantly affected by an industry-wide decrease in consumer spending. While we generated positive operating income and cash flows during the first nine months of 2009, the decline in our 2008 operating performance and the acceleration of the decline of consumer demand during 2008 affected our liquidity.

We have taken significant actions designed to return the Company to profitability and generate positive cash flows to fund our business, including: workforce reductions, reduced capital spending, closing of 65 underperforming stores during the first nine months of fiscal 2009, supply chain cost reduction initiatives, reduced media spending, reductions in fixed and discretionary marketing and selling expenses, and ceasing all activities associated with the implementation of SAP®-based information technology applications. We also introduced lower product price points and initiated an enhanced promotional strategy designed to stabilize sales. As a result of actions taken to date, during the first nine months of 2009 we generated operating income of $13.2, million and cash flows from operating activities of $53.0 million, including $26.1 million of tax refunds associated with the carryback of our 2008 pre-tax loss.

We continue to operate under and rely on short-term waivers to comply with certain ongoing covenants associated with our $80.0 million revolving credit facility (with net aggregate availability of $50.0 million after deducting $30.0 million required by a minimum availability covenant). On October 2, 2009, we entered into a new securities purchase agreement with Sterling Partners, a private equity firm. Under the terms of the securities purchase agreement, Sterling Partners would invest $10.0 million in exchange for 2.5 million shares of Select Comfort common stock and warrants to purchase an additional 2.0 million shares of our common stock at an exercise price of $0.01 per share (see Note 11). The Company, at its option, can require Sterling Partners to make the $10.0 million investment if the Company and its lenders have agreed to an amendment of the current credit agreement that is reasonably acceptable to Sterling Partners on or prior to March 31, 2010. Sterling Partners, at its option, can elect to purchase the common stock and warrants any time until June 30, 2010. In conjunction with our improved operating results, the new securities purchase agreement and our efforts to seek additional capital, our existing lenders have agreed to negotiate in good faith to amend and restate our current credit agreement.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

Our ability to avoid default under the Credit Agreement and to obtain a longer term amendment of the Credit Agreement will be substantially dependent on our near-term business performance and may also be dependent on our ability to successfully obtain additional sources of financing. There can be no assurance that we will be able to obtain further forbearance under the Credit Agreement or to obtain a longer term amendment of the Credit Agreement.

Our ability to maintain our recent performance and continue as a going concern may be dependent on various factors, including: macro-economic trends, the ongoing execution of our plans to improve the Company’s profitability, our ability to raise additional capital including the consummation of the $10.0 million investment contemplated by the new securities purchase agreement entered into with Sterling Partners in October 2009, and the amendment of our credit facility. Some of these factors are not entirely within our control. These conditions may raise doubt about our ability to continue as a going concern.

Our financial statements have been prepared on the going concern basis, which assumes the realization of assets and liquidation of liabilities in the normal course of operations. The consolidated financial statements do not include any adjustments relating to the recoverability or classification of recorded asset amounts or the amounts or classification of liabilities should we be unable to continue as a going concern.

New Accounting Standards

In June 2009, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 168, The “FASB Accounting Standards Codification” and the Hierarchy of Generally Accepted Accounting Principles. This standard replaces SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles, and establishes only two levels of U.S. generally accepted accounting principles (“GAAP”), authoritative and nonauthoritative. The FASB Accounting Standards Codification (the “Codification”) will become the source of authoritative, nongovernmental GAAP, except for rules and interpretive releases of the SEC, which are sources of authoritative GAAP for SEC registrants. All other nongrandfathered, non-SEC accounting literature not included in the Codification will become nonauthoritative. SFAS No. 168 is effective for financial statements for interim or annual reporting periods ending after September 15, 2009. We began using the new guidelines and numbering system prescribed by the Codification when referring to GAAP in the third quarter of 2009. As the Codification was not intended to change or alter existing GAAP, it did not have any impact on our consolidated financial statements. However, it changed the referencing system for accounting standards. FASB suggests that all citations begin with “FASB ASC,” where ASC stands for Accounting Standards Codification.

In May 2009, the FASB issued FASB ASC 855,Subsequent Events (formerly SFAS No. 165, Subsequent Events). FASB ASC 855 is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. Specifically, FASB ASC 855 sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. FASB ASC 855 is effective for fiscal years and interim periods ending after June 15, 2009 and will be applied prospectively. The adoption of FASB ASC 855 in the second quarter of fiscal 2009 did not have a material impact on our consolidated financial statements.

Subsequent Events

Events that have occurred subsequent to October 3, 2009 have been evaluated through November 12, 2009, the date we filed this Quarterly Report on Form 10-Q with the Securities and Exchange Commission. There have been no subsequent events that occurred during such period that would require disclosure in this Form 10-Q or would be required to be recognized in the consolidated financial statements as of or for the three and nine months ended October 3, 2009.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

2. Inventories

Inventories consisted of the following (in thousands):


	October 3, 2009		January 3, 2009
Raw materials	$	3,363	$	4,280
Work in progress		50		99
Finished goods		12,078		14,296
Inventories	$	15,491	$	18,675

3. Debt

Credit Agreement

In June 2006, we entered into a Credit Agreement (the “Credit Agreement”) with a syndicate of banks (the “Lenders”). The Credit Agreement was amended on February 1, 2008 and on May 30, 2008 to allow greater flexibility under the existing financial covenants, provide additional financial covenants and monthly measurement of financial covenants, modify the credit limit and maturity date, increase the cost of borrowing, provide the Lenders with a collateral security interest in substantially all of our assets and those of our subsidiaries, and impose additional restrictions and covenants with respect to our operations.

The Credit Agreement, as amended to date, provides a revolving credit facility for general corporate purposes with net aggregate availability of $50.0 million (after deducting $30.0 million required by a minimum availability covenant). The Credit Agreement terminates in June 2010.

We had outstanding borrowings of $26.3 million and $79.2 million under the credit facility as of October 3, 2009 and January 3, 2009, respectively. During the first nine months of 2009 we have reduced outstanding borrowings by $52.9 million, including payments from the receipt of $26.1 million of income tax refunds associated with the carryback of 2008 losses to prior years. We also had outstanding letters of credit of $4.5 million and $5.9 million as of October 3, 2009, and January 3, 2009, respectively. Outstanding letters of credit reduce the amounts available under the credit facility. At October 3, 2009, and January 3, 2009, $19.2 million and $5.0 million, respectively, were available under this credit facility.

At October 3, 2009, borrowings under the credit facility bore interest at a floating rate and could be maintained as base rate loans (tied to the prime rate, plus a margin of up to 5.50%). We also pay certain facility and agent fees. As of October 3, 2009, and January 3, 2009, interest rates on borrowings outstanding under the Credit Agreement were 8.75% and 6.0%, respectively. We are subject to certain financial covenants under the agreement, including a maximum leverage ratio, a minimum interest coverage ratio, minimum availability, cash usage and capital expenditure limits.

Pursuant to a series of amendments and waivers under our Credit Agreement, the Lenders have waived compliance with certain financial covenants under the Credit Agreement applicable to fiscal periods ended on or about December 31, 2008 through the Waiver Termination Date, including the minimum interest coverage ratio and the maximum leverage ratio covenants. At October 3, 2009, our actual interest coverage ratio was 1.24 to 1.00 and the required ratio was not less than 1.25 to 1.00. At October 3, 2009, our leverage ratio was 1.80 to 1.00 and the required ratio was a maximum of 3.25 to 1.00. The Waiver Termination Date is the earliest to occur of (i) November 17, 2009, or (ii) the date that capital expenditures for fiscal 2009 exceed $4.0 million in the aggregate. Following the Waiver Termination Date, in the absence of a further amendment or waiver, we would not be in compliance with certain financial covenants under the Credit Agreement.

We have an agreement with GE Money Bank to offer qualified customers revolving credit arrangements to finance purchases from us (the “GE Agreement”). The GE Agreement contains certain financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio. At October 3, 2009, the required minimum interest coverage ratio was 2.00 to 1.00. Our actual interest coverage ratio was 1.24 to 1.00. At October 3, 2009, our leverage ratio was 1.80 to 1.00 and the required ratio was a maximum of 3.00 to 1.00.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

As our recent results placed us outside of these financial covenants, we were required under the terms of the GE Agreement to provide GE Money Bank with a $1.7 million letter of credit. The letter of credit is supported by our Credit Agreement and reduces the amount available under the Credit Agreement. The letter of credit covers the risk to GE Money Bank for sales returns and warranty claims should we be unable to pay these claims. Under the terms of our agreement with GE, 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. GE Money Bank may draw on this letter of credit by certifying that we have failed to fund any amounts due under the GE Agreement or have filed for (or are subject to an involuntary procedure with respect to) bankruptcy protection.

Capital Lease Obligations

We had outstanding capital lease obligations of $1.0 million and $0.8 million at October 3, 2009 and January 3, 2009, respectively. At October 3, 2009 and January 3, 2009, $0.6 million and $0.3 million, respectively, were included in other current liabilities and $0.4 million and $0.5 million, respectively, were included in capital lease obligations in our condensed consolidated balance sheets.

4. Stock-Based Compensation

We compensate officers, directors and key employees with stock-based compensation under three plans approved by our shareholders in 1990, 1997 and 2004 and administered under the supervision of our Board of Directors. Stock-based compensation awards are generally granted annually. We have awarded stock options and restricted stock, either of which can be performance based, under these plans. Stock-based compensation expense is determined based on the grant-date fair value and is recognized ratably over the vesting period of each grant, which is generally four years. Stock-based compensation expense for the three months ended October 3, 2009 and September 27, 2008, was $0.7 million and $1.2 million, respectively. Stock-based compensation expense for the nine months ended October 3, 2009 and September 27, 2008, was $2.5 million and $3.3 million, respectively.

5. Fair Value Measurements

On January 4, 2009, we adopted the provisions of FASB ASC 820,Fair Value Measurements (formerly SFAS No. 157,Fair Value Measurements), related to nonfinancial assets and liabilities on a prospective basis as required. Our nonfinancial assets relate primarily to long-lived assets and goodwill. We adopted FASB ASC 820 related to financial assets and liabilities on December 30, 2007, the beginning of fiscal 2008.

FASB ASC 820 establishes the authoritative definition of fair value, sets out a framework for measuring fair value and expands the required disclosures about fair value measurement. FASB ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (an exit price). FASB ASC 820 establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:


•	Level 1 – observable inputs such as quoted prices in active markets;
•	Level 2 – inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and
•	Level 3 – unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

Assets and liabilities that are measured at fair value on a recurring basis

At October 3, 2009, we did not have any nonfinancial assets or liabilities that required a fair-value measurement on a recurring basis. Our financial assets and liabilities requiring a fair-value measurement on a recurring basis were not significant as of October 3, 2009.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

Assets and liabilities that are measured at fair value on a non-recurring basis

Goodwill

The test for goodwill impairment is performed at least annually. Fair value is determined using a market-based approach utilizing widely accepted valuation techniques, including quoted market prices and our market capitalization. These inputs are categorized as Level 1 inputs under FASB ASC 820.

Long-Lived Assets

We review our stores for impairment on a quarterly basis. Other long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We recognize impairment charges for the difference between the fair value and the carrying amounts of the related long-lived assets. We generally estimate long-lived assets at fair value, including our retail stores, using the income approach in accordance with FASB ASC 820. The inputs used to determine fair value relate primarily to future assumptions regarding sales volumes, gross profit rates, store operating expenses and applicable probability weightings regarding future alternative uses. These inputs are categorized as Level 3 inputs under FASB ASC 820. The inputs used represent management’s assumptions about what information market participants would use in pricing the assets and are based upon the best information available at the balance sheet date.

Our projected fair value calculations reflect the recent sales trends with no improvement in macroeconomic environment for the foreseeable future. Our fair value calculations assume the ongoing availability of consumer credit and our ability to provide cost-effective consumer credit options.

The following table presents the asset impairment charges we recorded during the nine months ended October 3, 2009 and the remaining net carrying value of those impaired long-lived assets as of October 3, 2009 (in thousands):


			Fair Value Measured and Recorded At Reporting Date Using
	Net Carrying Value as of October 3, 2009		Level 1		Level 2		Level 3		Impairment Charges for the Nine Months Ended October 3, 2009
Long-lived assets	$	10	$	—	$	—	$	10	$	(488	)

Financial Assets and Liabilities not Measured at Fair Value

Certain of our financial assets and liabilities are recorded at their carrying amounts which approximate fair value, based on their short-term nature or variable interest rate. These financial assets and liabilities include cash and cash equivalents, accounts receivable, accounts payable and short-term borrowings under revolving credit facility.

6. Asset Impairment Charges

We incurred no asset impairment charges during the three months ended October 3, 2009. During the nine months ended October 3, 2009, we recognized impairment charges of $0.5 million, primarily related to assets at certain stores expected to close prior to their normal lease termination dates. The impairment charges for the nine months ended October 3, 2009 also included $70,000 of impairment charges related to equipment and software. During the three and nine months ended September 27, 2008, we determined that certain assets at underperforming stores were impaired and recognized impairment charges of $1.5 million and $2.5 million, respectively.

Asset impairment charges is one of our critical accounting estimates and requires management to make estimates about future events including sales growth rates, cash flows and asset fair values. Predicting future events is inherently an imprecise activity. If actual results are not consistent with the estimates and assumptions used in our asset impairment calculations, we may incur additional impairment charges in the near term. See Note 5,Fair Value Measurements, for further information regarding our fair value measurements for long-lived assets.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

7. Other Expense, Net

Other expense, net, consisted of the following (in thousands):


	Three Months Ended						Nine Months Ended
	October 3, 2009			September 27, 2008			October 3, 2009			September 27, 2008
Interest expense	$	(1,533	)	$	(1,302	)	$	(4,725	)	$	(2,550	)
Interest income		2			—			16			89
Capitalized interest expense		—			185			—			596
Write-off unamortized debt cost		(173	)		—			(242	)		(131	)
Other expense, net	$	(1,704	)	$	(1,117	)	$	(4,951	)	$	(1,996	)

8. Income Taxes

In the fourth quarter of 2008, due to our pre-tax loss, our expectations that macro-economic trends and consumer confidence would remain weak throughout 2009, and uncertainty regarding future taxable income, we determined that it was more likely than not that a portion of our deferred tax assets would not be realized and established a $26.8 million valuation allowance against deferred tax assets that could not be realized through taxable income earned in available carryback periods. Our deferred tax valuation allowance at October 3, 2009, and January 3, 2009, was $32.9 million and $26.9 million, respectively. If and when our operating performance improves on a sustained basis, our conclusion regarding the need for a deferred tax valuation allowance could change, resulting in the reversal of some or all of the valuation allowance in future periods.

The effective tax rates for the three and nine months ended October 3, 2009 were 32.9% and 97.1%, respectively, compared with a -5.1% and 40.0%, respectively, for the same periods one year ago. The changes in the effective tax rates for both the three and nine months ended October 3, 2009 were primarily due to changes in our deferred tax valuation allowance for certain deferred tax assets that we recorded during the first nine months of 2009 based on the guidance in FASB ASC 740,Income Taxes (formerly SFAS No. 109,Income Taxes).

Unrecognized Tax Benefits

A reconciliation of the beginning and ending amounts of unrecognized tax benefits for the nine months ended October 3, 2009 was as follows (in thousands):


	Federal and State Tax		Accrued Interest and Penalties		Gross Unrecognized Income Tax Benefits
Balance January 3, 2009	$	152	$	3	$	155
Increases related to prior-year tax positions		659		27		686
Increases related to current-year tax positions		532		—		532
Balance October 3, 2009	$	1,343	$	30	$	1,373

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

9. Net Income (Loss) per Common Share

The following computations reconcile net income (loss) per share – basic with net income (loss) per share – diluted (in thousands, except per share amounts):


	Three Months Ended				Nine Months Ended
	October 3, 2009		September 27, 2008		October 3, 2009		September 27, 2008
Net income (loss)	$	6,899	$	983	$	243	$	(12,741	)

Reconciliation of weighted-average shares outstanding:
Basic weighted-average shares outstanding		44,830		44,232		44,783		44,143
Effect of dilutive securities:
Options		378		114		64		—
Restricted shares		425		305		242		—

Diluted weighted-average shares outstanding		45,633		44,651		45,089		44,143

Net income (loss) per share – basic	$	0.15	$	0.02	$	0.01	$	(0.29	)
Net income (loss) per share – diluted	$	0.15	$	0.02	$	0.01	$	(0.29	)

We excluded potentially dilutive stock options totaling 3.6 million and 5.3 million for the three and nine months ended October 3, 2009, respectively, and 4.8 million and 5.0 million for the three and nine months ended September 27, 2008, respectively, from our diluted net income (loss) per share calculations because these securities’ exercise prices were greater than the average market price of our common shares.

In addition, we excluded certain shares of restricted stock and stock options from our diluted net income (loss) per share calculations as their inclusion would have had an anti-dilutive effect on our net income (loss) per diluted share (i.e., resulted in a lower loss per share). For the nine months ended September 27, 2008, we excluded 400,000 shares of restricted stock and 282,000 stock options.

10. Commitments and Contingencies

On April 25, 2008, a lawsuit was filed against one of our subsidiaries in Superior Court in Santa Clara County, California by one of our customers. The complaint asserted various claims related to products liability, breach of warranty, concealment, intentional misrepresentation and negligent misrepresentation and sought class certification. The complaint alleged that products sold by us prior to 2006 had a unique propensity to develop mold, alleged that the plaintiff suffered adverse health effects, and sought various forms of legal and equitable relief, including without limitation unspecified damages, punitive and exemplary damages, attorneys’ fees and costs, and injunctive relief. We removed the case to the U.S. District Court for the Northern District of California. On September 30, 2008, the Court granted our motion to dismiss and strike the purported class action claims, and allowed the plaintiff leave to amend the complaint. On October 30, 2008, the plaintiff filed a first amended complaint alleging facts similar to those asserted in the initial complaint and asserting additional claims, including antitrust and RICO claims. On June 5, 2009, the Court granted our motion to dismiss and strike the purported class action claims of the first amended complaint, and allowed the plaintiff leave to amend the complaint with respect to certain of the alleged claims. On July 6, 2009, the plaintiff filed a second amended complaint alleging facts similar to those asserted in the initial complaint limiting the purported class to California and Florida residents, and asserting claims related to negligence, product liability, breach of warranty under federal and state statutes and unfair competition under state statutes. As of October 3, 2009, no accrual had been established with respect to this matter as we believe that the complaint is without merit and we intend to continue to vigorously defend the claims.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

On April 30, 2009, a lawsuit was filed against the Company and one of its subsidiaries in United States District Court for the Northern District of Illinois by a former employee alleging that the company misclassified all non-California store managers as exempt from the overtime requirements of the Fair Labor Standards Act. The plaintiff further alleges that all Illinois store managers were similarly misclassified under the Illinois Minimum Wage Law. After an initial round of discovery, on July 27, 2009, the plaintiff filed a motion seeking permission to send notices to all similarly situated store managers informing them that they have the right to join this potential collective action lawsuit. The plaintiff’s motion remains pending before the Court. We believe that all store managers have been properly classified under both federal and state standards and we intend to vigorously defend the case. As of October 3, 2009, no accrual had been established with respect to this matter as we believe that the complaint is without merit and we intend to continue to vigorously defend the claims.

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

Warranty Liabilities

We provide a 20-year limited warranty on our adjustable-firmness beds. The customer participates over the last 18 years of the warranty period by paying a portion of the retail value of replacement parts. Estimated warranty costs are expensed at the time of sale based on historical claims rates incurred by us and are adjusted for any current trends as appropriate. Actual warranty claim costs could differ from these estimates. We classify as noncurrent those estimated warranty costs expected to be paid out in greater than one year. The activity in the accrued warranty liabilities account was as follows (in thousands):


	October 3, 2009			September 27, 2008
Balance at beginning of year	$	8,049		$	9,503
Additions charged to costs and expenses for current-year sales		3,470			4,893
Deductions from reserves		(4,525	)		(7,098	)
Changes in liability for pre-existing warranties during the current year, including expirations		306			358
Balance at end of period	$	7,300		$	7,656

Sales Returns

We accrue for sales returns at the time revenue is recognized and charge actual returns against the liability when they are received. We estimate future projected returns based on historical return rates. Our historical return policy was to allow returns for up to 30 nights following a sale. In January 2009 we modified our return policy, and now ask customers to complete the 30 night in-home trial before returning their bed to fully realize the bed’s benefits.

Our estimates of sales returns contain uncertainties as actual returns may vary from expected returns. Predicting future events is inherently an imprecise activity and may result in adjustments to net sales in future periods.

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SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements – (continued)
(unaudited)

The activity in the sales returns liability account was as follows (in thousands):


	October 3, 2009			September 27, 2008
Balance at beginning of year	$	2,744		$	3,751
Additions that reduce net sales		19,314			25,770
Deductions from reserves		(19,075	)		(26,217	)
Balance at end of period	$	2,983		$	3,304

11. Sterling Partners Transaction

On May 22, 2009, we entered into a securities purchase agreement with Sterling Partners, a private equity firm. Under the terms of that prior agreement, if our shareholders approved the transaction, Sterling Partners would have purchased 50 million shares of our common stock for a total investment of $35.0 million. During a special meeting of shareholders held August 27, 2009, our shareholders did not approve the May 2009 securities purchase agreement. During the third quarter of 2009, we expensed $3.3 million of direct, incremental costs incurred in connection with the terminated equity financing.

On October 2, 2009, the May 2009 securities purchase agreement was terminated and we entered into a new securities purchase agreement with Sterling Partners. Under the terms of the new agreement, Sterling Partners would invest $10.0 million in exchange for 2.5 million shares of our common stock and warrants to purchase an additional 2.0 million shares of our common stock at an exercise price of $0.01 per share. The Company, at its option, can require Sterling Partners to make the $10.0 million investment if the Company and its lenders have agreed to an amendment of the current credit agreement that is reasonably acceptable to Sterling Partners on or prior to March 31, 2010. Sterling Partners, at its option, can elect to purchase the common stock and warrants any time until June 30, 2010. During the third quarter of 2009, we deferred $0.9 million of direct, incremental cost incurred in connection with the October 2009 securities purchase agreement. The $0.9 million of costs are included on our October 3, 2009 balance sheet in prepaid expenses.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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


	•	Risk Factors
	•	Overview
	•	Results of Operations
	•	Liquidity and Capital Resources
	•	Outlook
	•	Off-Balance-Sheet Arrangements and Contractual Obligations
	•	Critical Accounting Policies

Risk Factors

The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included herein. This quarterly report on Form 10-Q contains certain forward-looking statements that relate to future plans, events, financial results or performance. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, among others:


•	Our ability to improve sales and operating results and to realize cost savings;

•	Our ability to fund our operations through cash flow from operations or availability under our bank line of credit or other sources, and the cost of credit or other capital resources necessary to finance operations;

•	The risk of non-compliance with financial covenants under our bank line of credit and the risk that we may not be successful in obtaining continuing waivers or other financial accommodations from our lenders;

•	The potential need to obtain additional capital through the issuance of debt or equity securities, which may significantly increase our costs or dilute our existing shareholders, and the risk that we may not be successful in obtaining additional capital that may be needed;

•	The potential acquisition by Sterling Partners of a significant number of shares of our common stock under the new securities purchase agreement, and subsequent sale in the public market, may dilute our existing shareholders;

•	Current general and industry economic trends and consumer confidence;

•	The efficiency and effectiveness of our marketing messages, advertising and promotional efforts;

•	Consumer acceptance of our products, product quality, innovation and brand image;

•	Availability of attractive and cost-effective consumer credit options, including the impact of pending changes under federal law that will restrict various forms of consumer credit promotional offerings;

•	Execution of our retail store distribution strategy, including our ability to cost-effectively close under-performing store locations;

•	Our dependence on significant suppliers, and our ability to maintain relationships with key suppliers, including several sole source suppliers;

•	The vulnerability of key suppliers to recessionary pressures, labor negotiations, liquidity concerns or other factors;

•	Rising commodity costs and other inflationary pressures;

•	Industry competition;

•	Our ability to continue to improve our product line;

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•	Warranty expenses;

•	Risks of pending and potentially unforeseen litigation;

•	Increasing government regulations, including new flammability standards for the bedding industry and new safety standards for consumer products, which have added or will add product cost pressures and have required or will require implementation of systems and manufacturing process changes to ensure compliance;

•	The adequacy of our management information systems to meet the evolving needs of our business and evolving regulatory standards applicable to data privacy and security;

•	Our ability to attract and retain senior leadership and other key employees, including qualified sales professionals; and

•	Uncertainties arising from global events, such as terrorist attacks or a pandemic outbreak, or the threat of such events.

Additional information concerning these and other risks and uncertainties is contained under the caption “Risk Factors” in our Annual Report on Form 10-K (as amended) and in this Quarterly Report.

We have no obligation to publicly update or revise any of the forward-looking statements contained in this quarterly report on Form 10-Q.

Overview

Business Overview

Select Comfort is the leading developer, manufacturer and marketer of premium-quality, adjustable-firmness beds. The air-chamber technology of our proprietary Sleep Number® bed allows adjustable firmness on each side of the mattress and provides a sleep surface that is clinically proven to provide better sleep quality and greater relief of back pain compared to traditional mattress products. In addition, we market and sell accessories and other sleep related products which focus on providing personalized comfort to complement the Sleep Number bed and provide a better night’s sleep for consumers.

We generate revenue by selling our products through four complementary distribution channels. Three of these channels: Retail, Direct Marketing and E-Commerce, are company-controlled and sell directly to consumers. Our wholesale channel sells to and through the QVC shopping channel, business partners in Canada and Australia, leading home furnishing retailers in Hawaii and Alaska, and to selected hospitality groups and institutional facilities.

Vision and Strategy

Our vision is to be a leading brand in the bedding industry, while improving people’s lives through better sleep.

We are executing against a defined strategy which focuses on the following key components:


	•	Building brand awareness and increasing store traffic through effective marketing programs;
	•	Managing our business in the current economic environment through disciplined controls over costs and cash;
	•	Accelerating product innovation to lead the industry in innovative sleep products; and
	•	Leveraging our infrastructure in order to facilitate long-term profitability.

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Results of Operations

Quarterly and Annual Results

Quarterly and annual operating results may fluctuate significantly as a result of a variety of factors, including increases or decreases in sales, the timing, amount and effectiveness of advertising expenditures, changes in sales return rates or warranty experience, the timing of store openings/closings and related expenses, changes in net sales resulting from changes in our store base, the timing of promotional offerings, competitive factors, changes in commodity costs, any disruptions in supplies or third-party service providers, seasonality of retail sales, timing of QVC shows and wholesale sales, consumer confidence and general economic conditions. Furthermore, a substantial portion of our net sales is often realized in the last month of a quarter, due in part to our promotional schedule and commission structure. As a result, we may be unable to adjust spending in a timely manner, and our business, financial condition and operating results may be significantly harmed. Our historical results of operations may not be indicative of the results that may be achieved for any future period.

Highlights

Key financial highlights for the three months ended October 3, 2009 were as follows:


	•	Net income totaled $6.9 million, or $0.15 per diluted share, compared with net income of $1.0 million, or $0.02 per diluted share, for the same period one year ago. Third quarter 2009 financial results include $3.3 million of pre-tax costs associated with the terminated equity financing agreement (see discussion below for further details).

	•	Net sales decreased 6% to $147.5 million, compared with $157.2 million for the same period one year ago, primarily due to a 14% reduction in our store base, partially offset by a 9% comparable-store sales increase. Comparable-store sales trends have continued to improve during 2009.

	•	Operating income improved to $12.0 million for the three months ended October 3, 2009, compared with $2.1 million last year, due to the significant actions taken to return the Company to profitability.

	•	Our gross profit rate increased to 63.4% of net sales, compared with 62.2% of net sales for the same period last year.

	•	Sales and marketing expenses decreased 20%, or $16.1 million, from the same period one year ago.

	•	General and administrative expenses, including research and development expenses, were essentially flat with the prior year period.

	•	Cash from operating activities totaled $53.0 million for the first nine months of 2009, compared with $12.2 million for the same period one year ago. Operating cash flows for the first nine months of 2009 included $26.1 million of income tax refunds associated with our 2008 pre-tax loss.

	•	During the first nine months of 2009, borrowings under our revolving credit facility decreased from $79.2 million at January 3, 2009 to $26.3 million at October 3, 2009.

	•	On October 2, 2009, the May 2009 securities purchase agreement with Sterling Partners was terminated and we entered into a new securities purchase agreement. Under the terms of the new securities purchase agreement, Sterling Partners would invest $10.0 million in exchange for 2.5 million shares of Select Comfort common stock and warrants to purchase 2.0 million shares of our common stock at an exercise price of $0.01 per share.

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The following table sets forth, for the periods indicated, our results of operations expressed as dollars and percentages of net sales. Figures are in millions, except percentages and per share amounts. Amounts may not add due to rounding differences.


	Three Months Ended										Nine Months Ended
	October 3, 2009					September 27, 2008					October 3, 2009					September 27, 2008
Net sales	$	147.5		100.0%		$	157.2		100.0%		$	407.7		100.0%		$	477.5		100.0%
Cost of sales		53.9		36.6%			59.5		37.8%			158.1		38.8%			192.1		40.2%
Gross profit		93.6		63.4%			97.8		62.2%			249.7		61.2%			285.3		59.8%

Operating expenses:
Sales and marketing		66.0		44.8%			82.0		52.2%			194.4		47.7%			258.1		54.1%
General and administrative		11.8		8.0%			11.6		7.4%			36.9		9.0%			41.9		8.8%
Research and development		0.4		0.3%			0.6		0.4%			1.4		0.3%			2.1		0.4%
Terminated equity financing costs		3.3		2.3%			—		0.0%			3.3		0.8%			—		0.0%
Asset impairment charges		—		0.0%			1.5		0.9%			0.5		0.1%			2.5		0.5%
Total operating expenses		81.6		55.3%			95.7		60.9%			236.5		58.0%			304.6		63.8%
Operating income (loss)		12.0		8.1%			2.1		1.3%			13.2		3.2%			(19.2	)	(4.0%	)
Other expense, net		(1.7	)	(1.2%	)		(1.1	)	(0.7%	)		(5.0	)	(1.2%	)		(2.0	)	(0.4%	)
Income (loss) before income taxes		10.3		7.0%			0.9		0.6%			8.2		2.0%			(21.2	)	(4.4%	)
Income tax expense (benefit)		3.4		2.3%			(0.1	)	0.0%			8.0		2.0%			(8.5	)	(1.8%	)
Net income (loss)	$	6.9		4.7%		$	1.0		0.6%		$	0.2		0.1%		$	(12.7	)	(2.7%	)


Net income (loss) per share:
Basic	$	0.15	$	0.02	$	0.01	$	(0.29	)
Diluted	$	0.15	$	0.02	$	0.01	$	(0.29	)
Weighted-average number of common shares:
Basic		44.8		44.2		44.8		44.1
Diluted		45.6		44.7		45.1		44.1

The percentage of our total net sales, by dollar volume, from each of our channels was as follows:


	Three Months Ended				Nine Months Ended
	October 3, 2009		September 27, 2008		October 3, 2009		September 27, 2008
Percent of net sales:
Retail		83.5%		78.9%		80.6%		77.4%
Direct		5.3%		7.7%		6.2%		8.0%
E-Commerce		4.7%		5.3%		5.1%		6.1%
Wholesale		6.5%		8.1%		8.1%		8.5%
Total		100.0%		100.0%		100.0%		100.0%

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The components of total sales growth, including comparable-store sales changes, were as follows:


	Three Months Ended						Nine Months Ended
	October 3, 2009			September 27, 2008			October 3, 2009			September 27, 2008
Net sales growth rates:
Comparable stores		9%			(27%	)		(6%	)		(24%	)
Net new stores		(10%	)		3%			(5%	)		4%
Retail total		(1%	)		(24%	)		(11%	)		(20%	)
Direct		(36%	)		(20%	)		(34%	)		(23%	)
E-Commerce		(17%	)		(42%	)		(28%	)		(29%	)
Wholesale		(25%	)		(37%	)		(19%	)		(29%	)
Total net sales growth		(6%	)		(26%	)		(15%	)		(22%	)

The numbers of company-owned retail stores and independently owned and operated retail partner doors were as follows:


	Three Months Ended						Nine Months Ended
	October 3, 2009			September 27, 2008			October 3, 2009			September 27, 2008
Company-owned retail stores:
Beginning of period		420			478			471			478
Opened		2			5			2			18
Closed		(14	)		(8	)		(65	)		(21	)
End of period		408			475			408			475
Retail partner doors		146			794			146			794

Comparison of Three Months Ended October 3, 2009 with Three Months Ended September 27, 2008

Net sales
Net sales decreased 6% to $147.5 million for the three months ended October 3, 2009, compared with $157.2 million for the same period one year ago. The sales decrease was due to a 14% year-over-year decline in the number of retail stores we operated, and a decrease in wholesale, direct and E-Commerce channel sales, partially offset by a 9% comparable-store sales increase in our company-owned retail stores. Total sales of mattress units decreased 1% compared to the same period one year ago and sales of other products and services decreased by 2%. The average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels decreased 8% to $1,768.

The $9.8 million net sales decrease compared with the same period one year ago was comprised of the following: (i) a $10.3 million decrease resulting from the net decline in the number of stores we operated, partially offset by a $9.4 million net increase in sales from our company-owned comparable retail stores; (ii) a $4.3 million decrease in direct sales; (iii) a $3.2 million decrease in wholesale sales; and (iv) a $1.4 million decrease in E-Commerce sales.

Gross profit
The gross profit rate increased to 63.4% of net sales for the three months ended October 3, 2009, compared with 62.2% for the same period one year ago. A majority of the gross profit rate increase was due to improved manufacturing efficiencies, actions taken to reduce supply chain and logistics costs, and lower fuel prices which in total added approximately 2.3 percentage points (“ppt.”) to our third quarter gross profit rate compared to the same period last year. During the fourth quarter of 2008 and the first nine months of 2009, we resized our manufacturing and logistics operations to better align with current customer demand. In addition, an increase in the percentage of net sales from our retail distribution channel and a sales mix shift to higher margin products increased the gross profit rate by approximately 1.6 ppt. These improvements were partially offset by an increase in promotional costs to generate customer traffic and drive sales in this more challenging macro-economic environment.

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Sales and marketing expenses
Sales and marketing expenses for the three months ended October 3, 2009 decreased 20% to $66.0 million, or 44.8% of net sales, compared with $82.0 million, or 52.2% of net sales, for the same period one year ago. The $16.1 million decrease was due to the following: (i) an $11.8 million reduction in marketing expenses, including a $7.3 million, or 32%, decrease in media spending, compared to the same period one year ago; (ii) a $4.3 million decrease in variable and fixed selling expenses including store compensation and benefits, occupancy expenses and store depreciation resulting from the net sales decline, reduced store base and asset impairment charges recorded in previous periods. The reduction in marketing expenses was primarily due to our focus on enhancing the effectiveness and efficiency of our marketing expenditures. The sales and marketing expense rate declined 7.4 ppt. compared to the same period one year ago, with the benefits from the cost reduction initiatives more than offsetting the deleveraging impact of the 6% net sales decline.

General and administrative expenses
General and administrative (“G&A”) expenses were essentially flat at $11.8 million for the three months ended October 3, 2009, compared with $11.6 million for the same period one year ago. Reduced compensation and benefit costs due to workforce reductions and discretionary spending cuts were offset by increased performance-based compensation resulting from the Company’s significantly improved financial results. The G&A expense rate increased to 8.0% of net sales for the three months ended October 3, 2009, compared with 7.4% of net sales for the same period one year ago.

Research and development expenses
Research and development (“R&D”) expenses decreased to $0.4 million for the third quarter of 2009, compared with $0.6 million for the same period one year ago. R&D expenses decreased as a percentage of net sales to 0.3% from 0.4% as we focused on controlling discretionary costs.

Terminated equity financing costs
On May 22, 2009, we entered into a securities purchase agreement with Sterling Partners, a private equity firm. Under the terms of that prior agreement, if our shareholders approved the transaction, Sterling Partners would have purchased 50 million shares of our common stock for a total investment of $35.0 million. During a special meeting of shareholders held August 27, 2009, our shareholders did not approve the May 2009 securities purchase agreement.

During the third quarter of 2009, we expensed $3.3 million of direct, incremental costs incurred in connection with the terminated equity financing.

Asset impairment charges
During the three months ended October 3, 2009, we recognized no impairment charges as our quarterly evaluation indicated that the carrying values of our long-lived assets were fully recoverable. During the three months ended September 27, 2008, we determined that assets at certain underperforming stores were impaired and recognized impairment charges of $1.5 million.

Other expense, net
Other expense, net was $1.7 million for the three months ended October 3, 2009, compared with $1.1 million for the same period one year ago. The $0.6 million increase in other expense, net was primarily driven by (i) the current year reduction in capitalized interest expense; (ii) the write-off of unamortized debt costs during the third quarter of 2009 due to a reduction in our revolving credit facility’s borrowing capacity; (iii) an increase in our credit facility fees and expenses; and (iv) increased interest rates compared to the same period one year ago, partially offset by (v) a lower average debt balance in the current period.

Income tax expense (benefit)
Income tax expense was $3.4 million for the three months ended October 3, 2009, compared with an income tax benefit of $48,000 for the same period one year ago. The effective tax rate for the three months ended October 3, 2009 was 32.9% compared with a negative 5.1% for the same period one year ago.

During the three months ended September 27, 2008, we recognized $0.6 million of discrete tax benefit adjustments related to research and development tax credits for prior years based on the recognition guidance outlined in FASB ASC 740,Income Taxes (formerly FASB Interpretations No. 48,Accounting for Uncertainty in Income Taxes). The effective tax rate for the three months ended October 3, 2009 reflects changes in our deferred tax valuation allowance based on the guidance in FASB ASC 740,Income Taxes (formerly SFAS No. 109,Income Taxes).

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Comparison of Nine Months Ended October 3, 2009 with Nine Months Ended September 27, 2008

Net sales
Net sales for the first nine months of fiscal 2009 decreased 15% to $407.7 million, compared with $477.5 million for the same period one year ago. The sales decrease was due to a 6% comparable-store sales decline in our company-owned retail stores, a year-over-year decline in the number of retail stores we operated, and a decrease in direct, E-Commerce and wholesale channel sales. Total sales of mattress units decreased 13% compared to the same period one year ago and sales of other products and services decreased by 12%. The average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels decreased 2% to $1,739.

The $69.7 million net sales decrease compared with the prior year was comprised of the following: (i) a $40.9 million decrease in sales from our retail stores, comprised of a $21.9 million decrease resulting from the net decline in the number of stores we operated and a $19.0 million decrease from comparable-store sales; (ii) a $12.8 million decrease in direct sales; (iii) an $8.2 million decrease in E-Commerce sales; and (iv) a $7.8 million decrease in wholesale sales.

Gross profit
The gross profit rate increased to 61.2% of net sales for the first nine months of fiscal 2009, compared with 59.8% of net sales for the same period one year ago. A majority of the gross profit rate increase was due to improved manufacturing efficiencies, lower fuel prices, and actions taken to reduce supply chain and logistics costs which in total added approximately 2.9 ppt. to our gross profit rate for the nine months ended October 3, 2009, compared to the same period last year. During the fourth quarter of 2008 and the first nine months of 2009, we resized our manufacturing and logistics operations to better align with current customer demand. In addition, a sales mix shift to higher-margin products and lower warranty expenses improved the gross profit rate for the nine months ended October 3, 2009 by 0.9 ppt. and 0.4 ppt., respectively, compared with the same period one year ago. These improvements were partially offset by an increase in promotional costs to generate customer traffic and drive sales in this more challenging macro-economic environment.

Sales and marketing expenses
Sales and marketing expenses for the nine months ended October 3, 2009 decreased to $194.4 million, or 47.7% of net sales, compared with $258.1 million, or 54.1% of net sales, for the same period one year ago. The $63.7 million decrease was primarily due to a $27.3 million (or 38%) reduction in media spending and an $18.2 million decrease in other marketing expenses, including financing, promotion and production expenses compared with the same period one-year ago. The reduction in media and other marketing expenses was mainly due to efforts to enhance the effectiveness and efficiency of our marketing expenditures. The remainder of the expense decrease was due to reduced fixed and variable selling expenses resulting from the reduction in our store base, the sales volume decline and asset impairment charges recorded in previous periods. The sales and marketing expense rate declined 6.4 ppt. compared to the same period one year ago, with the benefits from the cost reduction initiatives more than offsetting the deleveraging impact of the 15% net sales decline.

General and administrative expenses
General and administrative expenses decreased to $36.9 million for the nine months ended October 3, 2009, compared with $41.9 million for the same period one year ago. The $5.0 million decrease in G&A expenses was primarily due to reduced compensation and benefit costs resulting from workforce reductions, decreased depreciation expense and discretionary spending cuts, partially offset by increased performance-based compensation and an increase in outside consulting expenses. The G&A expense rate increased slightly to 9.0% of net sales for the nine months ended October 3, 2009, compared with 8.8% of net sales for the same period one year ago.

Research and development expenses
Research and development expenses decreased to $1.4 million for the first nine months of fiscal 2009, compared with $2.1 million for the same period one year ago, and decreased as a percentage of net sales to 0.3% from 0.4%.

During the third quarter of 2009, we expensed $3.3 million of direct, incremental costs incurred in connection with the terminated equity financing.

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Asset impairment charges
During the nine months ended October 3, 2009, we recognized impairment charges of $0.5 million related to assets at stores expected to close prior to their normal lease termination dates, and certain equipment and software. During the nine months ended September 27, 2008, we determined that certain assets at underperforming stores were impaired and recognized impairment charges of $2.5 million.

Other expense, net
Other expense, net was $5.0 million for the nine months ended October 3, 2009, compared with $2.0 million for the same period one year ago. The $3.0 million increase in other expense, net was primarily driven by (i) the current year reduction in capitalized interest expense; (ii) the increased write-off of unamortized debt costs in the current year due to a reduction in our revolving credit facility’s borrowing capacity; (iii) an increase in our credit facility fees and expenses; and (iv) increased interest rates compared to the same period one year ago, partially offset by (v) a lower average debt balance for the current year.

Income tax expense (benefit)
Income tax expense was $8.0 million for the nine months ended October 3, 2009, compared with an income tax benefit of $8.5 million for the same period one year ago. The effective tax rate for the nine months ended October 3, 2009 was 97.1% compared with 40.0% for the same period one year ago. The change in the effective tax rate was primarily due to an increase in our deferred tax valuation allowance, for certain deferred tax assets, that we recorded during the nine months ended October 3, 2009 based on the guidance in FASB ASC 740,Income Taxes (formerly SFAS No. 109,Income Taxes).

Liquidity and Capital Resources

As of October 3, 2009, we had cash and cash equivalents of $4.8 million compared with $13.1 million as of January 3, 2009. The $8.3 million decrease in cash and cash equivalents was primarily due to a $59.3 million decrease in short-term borrowing and a $2.0 million investment in property and equipment, partially offset by $53.0 million of cash provided by operating activities.

The following table summarizes our cash flows for the nine months ended October 3, 2009, and September 27, 2008 ($ in millions):


	Nine Months Ended
	October 3, 2009			September 27, 2008
Total cash provided by (used in):
Operating activities	$	53.0		$	12.2
Investing activities		(2.0	)		(28.1	)
Financing activities		(59.2	)		14.9
Decrease in cash and cash equivalents	$	(8.3	)	$	(1.1	)

Cash provided by operating activities for the nine months ended October 3, 2009, and September 27, 2008 was $53.0 million and $12.2 million, respectively. The $40.8 million year-over-year increase in cash from operating activities was comprised of a $13.0 million improvement in our net income (loss) compared to the same period one year ago, a $4.0 million increase in noncash expenses and a $23.8 million increase in cash from changes in operating assets and liabilities, including $26.1 million of income tax refunds associated with the carryback of our 2008 pre-tax loss. Other changes in operating assets and liabilities include a lower current-year decrease in accounts receivable (both years reflect lower sales volume), a lower current-year decrease in inventories (current-year includes impact resulting from the reduction in our store base; both years reflect efforts to align inventories with lower sales volume), and a current-year increase in prepaid expenses and other assets (primarily due to deferred costs related to the October 2009 securities purchase agreement with Sterling Partners, and timing of rent and advertising expenses), partially offset by a current-year increase in accounts payable (timing of payments).

During the first nine months of 2009, we invested $2.0 million in property and equipment, compared with $28.1 million for the same period one year ago. We opened two new retail stores during the first nine months of 2009, compared with 18 new retail stores opened during the same period one year ago. We have limited our purchases of property and equipment to business-critical expenditures during 2009.

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Net cash used in financing activities was $59.2 million for the nine months ended October 3, 2009, compared with $14.9 million net cash provided by financing activities for the same period one year ago. The $74.1 million increase in cash used in financing activities resulted from a $59.3 million current-year net decrease in short-term borrowings, compared with a $15.8 million net increase in short-term borrowings for the nine months ended September 27, 2008. The current-year decrease in short-term borrowings reflects the use of $26.1 million of the income tax refunds. Book overdrafts are included in the net change in short-term borrowings.

As of October 3, 2009, the remaining authorization under our stock repurchase program was $206.8 million. There is no expiration date governing the period over which we can repurchase shares. During 2008 and the nine months ended October 3, 2009, we did not purchase any shares of our common stock. We currently have no plans to repurchase our common stock.

We had outstanding borrowings of $26.3 million and $79.2 million under the credit facility as of October 3, 2009 and January 3, 2009, respectively. During the first nine months of 2009, we have reduced outstanding borrowings by $52.9 million, including payments with the receipt of $26.1 million of income tax refunds associated with the carryback of 2008 losses to prior years. We also had outstanding letters of credit of $4.5 million and $5.9 million as of October 3, 2009, and January 3, 2009, respectively. Outstanding letters of credit reduce the amounts available under the credit facility. At October 3, 2009, and January 3, 2009, $19.2 million and $5.0 million, respectively, were available under this credit facility.

We continue to operate under and rely on short-term waivers to comply with certain ongoing covenants associated with our revolving credit facility. If we fail to negotiate an acceptable credit agreement with our lenders, we would not be in compliance with the terms of the Credit Agreement and our lenders may accelerate our debt obligations under the Credit Agreement and may exercise remedies as secured creditors. If the Lenders accelerated our debt obligations or took other actions to exercise their remedies as secured creditors, or such actions were perceived as likely, our existing and potential suppliers and customers could lose confidence in our viability as an operating business. We have had discussions with the Lenders regarding potential longer term amendments of the Credit Agreement and we believe the Lenders would cooperate with us to arrive at a viable solution to our liquidity requirements. Our ability to avoid default under the Credit Agreement or to obtain a longer term amendment of the Credit Agreement will be substantially dependent on our near-term business performance and may also be dependent on our ability to successfully obtain alternative sources of financing. There can be no assurance that we would be able to obtain further forbearance under the Credit Agreement or to obtain a longer term amendment of the Credit Agreement.

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On October 2, 2009, the May 2009 securities purchase agreement was terminated and we entered into a new securities purchase agreement with Sterling Partners. Under the terms of the new agreement, Sterling Partners would invest $10.0 million in exchange for 2.5 million shares of Select Comfort common stock and warrants to purchase 2.0 million additional shares of common stock at an exercise price of $0.01 per share. The Company, at its option, can require Sterling Partners to make the $10.0 million investment if the Company and its lenders have agreed to an amendment of the current credit agreement that is reasonably acceptable to Sterling Partners on or prior to March 31, 2010. Sterling Partners, at its option, can elect to purchase the common stock and warrants any time until June 30, 2010.

Outlook

We have not recently provided full-year Company financial performance estimates. However, because of the continued volatility of macro-economic trends coupled with the state of our turn-around efforts, we are communicating our expectations for full-year 2009 earnings in a range of $0.02 to $0.08 per diluted share. Our outlook is based on information presently available and contains certain assumptions regarding future economic conditions. Differences in actual economic conditions compared with our assumptions could have a material impact on our outlook.

Looking forward to the fourth quarter, we anticipate recent sales trends to continue, with comparable-store sales growth largely offset by sales reductions from our declining store base and significantly reduced retail-partner distribution. During the fourth quarter, we will lap the most severe part of the economic downturn from a year ago, which is expected to lead to further comparable-store sales growth. Additionally, based on our reporting calendar, our fourth quarter 2008 reporting period included an additional 14th week compared to 13 weeks for the fourth quarter of 2009.

Sales assumptions for the fourth quarter of 2009 include the anticipated closing of at least eight stores and opening two additional stores. We expect to be operating slightly more than 400 stores by the end of 2009. Capital expenditures are projected to be less than $4.0 million in 2009.

Off-Balance-Sheet Arrangements and Contractual Obligations

Other than operating leases and $4.5 million of outstanding letters of credit, we do not have any off-balance-sheet financing. We do not participate in transactions that generate relationships with unconsolidated entities or financial partnerships. As of October 3, 2009, we are not involved in any unconsolidated special purpose entity transactions.

There has been no material change in our contractual obligations since the end of fiscal 2008 other than decreasing borrowings under our revolving credit facility from $79.2 million as of January 3, 2009 to $26.3 million as of October 3, 2009. See Note 3,Debt, of the Notes to our Condensed Consolidated Financial Statements. See our Annual Report on Form 10-K (as amended) for the fiscal year ended January 3, 2009 for additional information regarding our contractual obligations.

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Critical Accounting Policies

We discuss our critical accounting policies and estimates inManagement’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K (as amended) for the fiscal year ended January 3, 2009. There were no significant changes in our accounting policies since the end of fiscal 2008, other than an update to our Asset Impairment Charges policy (see below).


Description	Judgments and Uncertainties	Effect if Actual Results Differ From Assumptions
Asset Impairment Charges
Long-lived assets other than goodwill and other intangible assets, which are separately tested for impairment, are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We generally estimate fair value of long-lived assets, including our retail stores, using the income approach in accordance with FASB ASC 820,Fair Value Measurements andDisclosures (formerly SFAS No. 157,Fair ValueMeasurements). The inputs used to determine fair value relate primarily to future assumptions regarding sales volumes, gross profit rates, store operating expenses and applicable probability weightings regarding future alternative uses. These inputs are categorized as Level 3 inputs under FASB ASC 820. The inputs used represent management’s assumptions about what information market participants would use in pricing the assets and are based upon the best information available at the balance sheet date. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated fair value plus net proceeds expected from disposition of the asset (if any). When we recognize an impairment loss, the carrying amount of the asset is reduced to estimated fair value based on discounted cash flows, quoted market prices or other valuation techniques in accordance with FASB ASC 820. Assets to be disposed of are reported at the lower of the carrying amount of the asset or fair value less costs to sell. We review store assets for potential impairment based on historical cash flows, lease termination provisions and expected future store operating results. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset. Asset impairment charges totaled $0.5 million and $2.5 million for the nine months ended October 3, 2009, and September 27, 2008, respectively.During the nine months ended October 3, 2009, total impairment charges included a $0.4 million charge for long-lived assets related to nine under-performing retail store locations. As of October 3, 2009, the remaining carrying amount of the long-lived assets at these stores totaled $10,000.	Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to identify events or changes in circumstances indicating the carrying value of assets may not be recoverable, estimate future cash flows, estimate asset fair values, and select a discount rate that reflects the risk inherent in future cash flows. Expected cash flows may not be realized, which could cause long-lived assets to become impaired in future periods and could have a material adverse effect on future results of operations.	We have not made any material changes in our impairment loss assessment methodology during the past three fiscal years. As of October 3, 2009, we evaluated 32 under- performing retail stores. We did not recognize any asset impairment charges as a result of this evaluation. At October 3, 2009, the carrying amount of the long-lived assets for these stores totaled $2.8 million. We believe that our estimates and assumptions used to calculate long-lived asset impairment charges were reasonable and reflect the current economic environment. Our fair value calculations reflect the deterioration of consumer spending and the more difficult economic environment. Our fair value calculations assume the ongoing availability of consumer credit and our ability to provide cost-effective consumer credit options. The tightening of credit standards, for our customers who seek extended financing from our third party financiers, was also considered in our estimates. However, it is reasonably possible that a prolonged economic slowdown or further deterioration of consumer spending may expose us to future impairment charges that could be material. Alternatively, if consumer spending increases at a higher rate than we anticipated, impaired stores (which continue to operate) could generate higher than expected future cash flows and operating profits.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

At October 3, 2009, our short-term debt was comprised primarily of borrowings under our revolving credit facility and capital lease obligations. We do not currently manage interest rate risk on our debt through the use of derivative instruments.

Interest rates on borrowings under our revolving credit facility are based on terms negotiated with the Lenders through November 17, 2009. The credit facility’s interest rate may also be reset due to fluctuations in a market-based index, such as the prime rate. At October 3, 2009 borrowings under the credit facility bore interest at a floating rate and could be maintained as base rate loans (tied to the prime rate, plus a margin of up to 5.5%). A hypothetical 100 basis point change in the interest rate of outstanding borrowings under our credit facility as of October 3, 2009 would change our annual consolidated pre-tax income or loss by $0.3 million.

ITEM 4. CONTROLS AND PROCEDURES

Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Controls

There were no changes in our internal control over financial reporting during the fiscal quarter ended October 3, 2009, that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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ITEM 1A. RISK FACTORS

Our business, financial condition and operating results are subject to a number of risks and uncertainties, including both those that are specific to our business and others that affect all businesses operating in a global environment. Investors should carefully consider the information in this report under the heading, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and also the information under the heading, “Risk Factors” in our most recent Annual Report on Form 10-K (as amended). The risk factors discussed in the Annual Report on Form 10-K (as amended) and in this Quarterly Report on Form 10-Q do not identify all risks that we face because our business operations could also be affected by additional risk factors that are not presently known to us or that we currently consider to be immaterial to our operations.

One investor has the right to purchase a significant number of shares of our common stock, and if the investor sells such shares in the public market, the price of our common stock could decline.

On October 2, 2009, the May 2009 securities purchase agreement with Sterling Partners was terminated and we entered into a new securities purchase agreement with Sterling Partners. Under the terms of the new agreement, Sterling Partners would invest $10.0 million in exchange for 2.5 million shares of our common stock and warrants to purchase an additional 2.0 million shares of our common stock at an exercise price of $0.01 per share. The Company, at its option, can require Sterling Partners to make the $10.0 million investment if the Company and its lenders have agreed to an amendment of the current credit agreement that is reasonably acceptable to Sterling Partners on or prior to March 31, 2010. Sterling Partners, at its option, can elect to purchase the common stock and warrants any time until June 30, 2010.

We also entered into a registration rights agreement with Sterling Partners pursuant to which we are required to file with the SEC a registration statement for the resale of these shares of common stock, including the shares issuable upon exercise of the warrants. Under the registration rights agreement, until the earlier of six months after a closing date under the securities purchase agreement or we close a qualified transaction (which includes a sale of at least five percent of any class of the Company’s outstanding capital stock), Sterling Partners agreed that it will not, in any one trading day, sell registrable securities that represent more than ten percent of our average daily trading volume. We also agreed that if Sterling Partners desires to execute a block trade for more than 5,000 shares of our common stock, and such block trade would otherwise exceed ten percent of our average daily trading volume, we have a right to approve any such block trade, which approval shall not be unreasonably withheld.

If Sterling Partners sells, or the market perceives that Sterling Partners intends to sell, substantial amounts of our common stock in the public market, the market price of our common stock could decline.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS


	(a) – (b)	Not applicable.

	(c)	Issuer Purchases of Equity Securities (in thousands, except per share amounts)


Fiscal Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs⁽¹⁾		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
July 5, 2009 through August 1, 2009		—		NA		—
August 2, 2009 through August 29, 2009		—		NA		—
August 30, 2009 through October 3, 2009		—		NA		—
Total		—		NA		—	$	206,762

⁽¹⁾ On April 20, 2007, our Board of Directors authorized the company to repurchase up to an additional $250.0 million of its common stock, bringing the total availability under our share repurchase program to $290.0 million. The Finance Committee of the Board of Directors reviews repurchases under this program on a quarterly basis. There is no expiration date governing the period over which we can repurchase shares. As of October 3, 2009, the total outstanding authorization was $206.8 million. We may terminate or limit the stock repurchase program at any time. We currently have no plans to repurchase shares under this authorization.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

A Special Meeting of Shareholders was held on August 27, 2009 to enable our shareholders to vote on several proposals related to the Securities Purchase Agreement between the Company and Sterling SC Investor, LLC (“Sterling”) entered into as of May 22, 2009 (the “Initial Sterling Transaction”). Proposal 1 was for shareholders to approve the Securities Purchase Agreement in the Initial Sterling Transaction. Proposals 2 and 3 involved proposed amendments to our Third Restated Articles of Incorporation related to the Initial Sterling Transaction. As stated in our proxy statement, implementation of Proposals 2 and 3 was conditioned upon approval of the Initial Sterling Transaction, such that, if our shareholders approved Proposals 2 and/or 3, but did not approve Proposal 1, then Proposals 2 and 3 would not be implemented. If our shareholders approved Proposal 1, but did not approve Proposals 2 and 3, a condition to Sterling’s obligation to close the Initial Sterling Transaction would not have been satisfied and therefore, Sterling would have had the right, but not the obligation, to close the initial Sterling Transaction. The results were as follows:

Proposal 1. Approve the Securities Purchase Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC, pursuant to which we will issue to Sterling SC Investor, LLC 50 million shares of our common stock for $35 million;


Shares For			16,128,114
Shares Against			16,045,563
Shares Abstain			117,797
Broker Non-votes			8,771,661

The affirmative vote of holders of the greater of (i) a majority of the shares represented and entitled to vote in person or by proxy at the meeting, or (ii) a majority of the minimum number of shares entitled to vote in person or by proxy that would constitute a quorum for the transaction of business at the Special Meeting, was required for the approval of the Initial Sterling Transaction. Any broker non-votes on the Initial Sterling Transaction were treated as shares not entitled to vote on that matter, and thus were not counted in determining whether the Initial Sterling Transaction had been approved. Abstentions were treated as unvoted for purposes of determining the approval of the Initial Sterling Transaction and, as a result, had the same effect as a vote against the Initial Sterling Transaction. As a result, the proposal to approve the Initial Sterling Transaction did not receive approval of a majority of the shares represented and entitled to vote in person or by proxy at the meeting, which would have been at least 16,145,738 shares.

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Proposal 2. Approve an amendment to our Third Restated Articles of Incorporation to increase the number of authorized shares of our common stock from 142.5 million shares to 245 million shares;


Shares For			22,328,090
Shares Against			18,432,457
Shares Abstain			302,587
Broker Non-votes			0

Proposal 3. Approve an amendment to our Third Restated Articles of Incorporation to, among other things, change the voting standard for elections of directors to a plurality of the voting power of shares represented and entitled to vote on the election of directors at a duly held meeting of shareholders at which a quorum is present; and


Shares For			22,244,907
Shares Against			18,166,988
Shares Abstain			651,239
Broker Non-votes			0

Proposal 4. Approve the adjournment of the Special Meeting, if necessary or appropriate, to solicit additional proxies if there are insufficient votes at the time of the Special Meeting to approve the Securities Purchase Agreement and issuance of shares to Sterling SC Investor, LLC.


Shares For			22,288,703
Shares Against			18,438,352
Shares Abstain			336,078
Broker Non-votes			0

ITEM 5. OTHER INFORMATION

Rule 14a-8 Shareholder Proposal Deadline

It is currently anticipated that the 2010 Annual Meeting will be held on May 19, 2010, which is more than 30 days before the anniversary of the 2009 Annual Meeting of Shareholders. As a result, pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended, the Company has set a revised deadline for the receipt of any shareholder proposals submitted pursuant to Rule 14a-8 for inclusion in the Company’s proxy materials for the 2010 Annual Meeting of Shareholders. The new deadline for delivering shareholder proposals to the Company is the close of business on January 19, 2010, which date was calculated in accordance with Rule 14a-8(e) and our Bylaws. Any shareholder proposal requested to be included in the proxy materials for the 2010 Annual Meeting of Shareholders must (i) be received by our Senior Vice President, General Counsel and Secretary at the Company’s principal executive offices at 9800 59th Avenue North, Plymouth, Minnesota 55442 on or before January 19, 2010; and (ii) satisfy all of the requirements of, and not otherwise be permitted to be excluded under, Rule 14a-8 promulgated by the SEC and our Bylaws. The Company recommends that such proposals be sent by certified mail, return receipt requested.

Bylaws Deadline

In accordance with the Company’s bylaws, for director nominations or other business to be brought before the 2010 Annual Meeting of Shareholders, other than Rule 14a-8 proposals described above, written notice must be delivered no later than the close of business on or before January 19, 2010. Such notices must also comply with any other requirements of the Company’s bylaws, and should be sent to the attention of Mark A. Kimball, Senior Vice President, General Counsel and Secretary.

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ITEM 6. EXHIBITS


Exhibit Number	Description	Method of Filing

10.1	Amendment No. 12 to Credit Agreement dated as of September 4, 2009 among Select Comfort Corporation, the subsidiary borrowers from time to time party thereto, JPMorgan Chase Bank, National Association, as Administrative Agent, Bank of America, N.A., as Syndication Agent and JPMorgan Chase Bank, National Association, Bank of America, N.A., Citicorp USA, Inc., Wells Fargo Bank, National Association and Branch Banking and Trust Co., as Lenders	Incorporated by reference to Exhibit 10.1 contained in Select Comfort’s Current Report on Form 8-K filed September 9, 2009 (File No. 0-25121)







10.2	Amendment No. 13 to Credit Agreement dated as of September 22, 2009 among Select Comfort Corporation, the subsidiary borrowers from time to time party thereto, JPMorgan Chase Bank, National Association, as Administrative Agent, Bank of America, N.A., as Syndication Agent and JPMorgan Chase Bank, National Association, Bank of America, N.A., Citicorp USA, Inc., Wells Fargo Bank, National Association and Branch Banking and Trust Co., as Lenders	Incorporated by reference to Exhibit 10.1 contained in Select Comfort’s Current Report on Form 8-K filed September 24, 2009 (File No. 0-25121)







10.3	Securities Purchase Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC	Incorporated by reference to Exhibit 10.1 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)




10.4	Guarantee by Sterling Capital Partners III, LP in favor of Select Comfort Corporation	Incorporated by reference to Exhibit 10.2 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)


10.5	Settlement, Mutual Termination and General Release Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC	Incorporated by reference to Exhibit 10.3 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)




10.6	Registration Rights Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC	Incorporated by reference to Exhibit 10.4 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)


31.1	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith


31.2	Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith


32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith


32.2	Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith

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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
	(Registrant)

Dated: November 12, 2009	By:	/s/ William R. McLaughlin
		William R. McLaughlin
		Chief Executive Officer
		(principal executive officer)

	By:	/s/ James C. Raabe
		James C. Raabe
		Chief Financial Officer
		(principal financial and accounting officer)

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EXHIBIT INDEX


Exhibit Number	Description	Method of Filing

10.1	Amendment No. 12 to Credit Agreement dated as of September 4, 2009 among Select Comfort Corporation, the subsidiary borrowers from time to time party thereto, JPMorgan Chase Bank, National Association, as Administrative Agent, Bank of America, N.A., as Syndication Agent and JPMorgan Chase Bank, National Association, Bank of America, N.A., Citicorp USA, Inc., Wells Fargo Bank, National Association and Branch Banking and Trust Co., as Lenders	Incorporated by reference to Exhibit 10.1 contained in Select Comfort’s Current Report on Form 8-K filed September 9, 2009 (File No. 0-25121)

10.2	Amendment No. 13 to Credit Agreement dated as of September 22, 2009 among Select Comfort Corporation, the subsidiary borrowers from time to time party thereto, JPMorgan Chase Bank, National Association, as Administrative Agent, Bank of America, N.A., as Syndication Agent and JPMorgan Chase Bank, National Association, Bank of America, N.A., Citicorp USA, Inc., Wells Fargo Bank, National Association and Branch Banking and Trust Co., as Lenders	Incorporated by reference to Exhibit 10.1 contained in Select Comfort’s Current Report on Form 8-K filed September 24, 2009 (File No. 0-25121)







10.3	Securities Purchase Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC	Incorporated by reference to Exhibit 10.1 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)




10.4	Guarantee by Sterling Capital Partners III, LP in favor of Select Comfort Corporation	Incorporated by reference to Exhibit 10.2 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)




10.5	Settlement, Mutual Termination and General Release Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC	Incorporated by reference to Exhibit 10.3 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)




10.6	Registration Rights Agreement by and between Select Comfort Corporation and Sterling SC Investor, LLC	Incorporated by reference to Exhibit 10.4 contained in Select Comfort’s Current Report on Form 8-K filed October 5, 2009 (File No. 0-25121)




31.1	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith


31.2	Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	Filed herewith


32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith


32.2	Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith

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Constraining
Legalese
Litigous
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Sleep Number (SNBR) 10-Q2009 Q3 Quarterly report

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