form10-q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934

For the Quarterly Period Ended October 2, 2010

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
incorporation or organization)
 
(I.R.S. Employer
Identification No.)

9800 59th Avenue North
Minneapolis, Minnesota
 
55442
(Address of principal executive offices)
 
(Zip Code)
 
Registrant’s telephone number, including area code: (763) 551-7000
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES x NO o

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).
YES o NO o
 
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).
YES o  NO x
 
As of October 2, 2010, 55,415,000 shares of the Registrant’s Common Stock were outstanding.
 


 
 

 
 
SELECT COMFORT CORPORATION
AND SUBSIDIARIES
INDEX
 
       
Page
         
PART I: FINANCIAL INFORMATION
   
         
Item 1.
     
         
     
3
 
           
     
4
 
           
     
5
 
           
     
6
 
           
     
7
 
           
Item 2.
   
12
 
           
Item 3.
   
21
 
           
Item 4.
   
21
 
           
PART II: OTHER INFORMATION
     
           
Item 1.
   
21
 
           
Item 1A.
   
22
 
           
Item 2.
   
22
 
           
Item 3.
   
22
 
           
Item 4.
   
22
 
           
Item 5.
   
22
 
           
Item 6.
   
23
 
           
 
24
 

 
2

 
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 2,
2010
   
January 2,
2010
 
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 82,416     $ 17,717  
Accounts receivable, net of allowance for doubtful accounts of $337 and $379, respectively
    2,853       5,094  
Inventories
    16,266       15,646  
Income taxes receivable
          3,893  
Prepaid expenses
    4,602       5,879  
Deferred income taxes
    7,109       5,153  
Other current assets
    862       720  
Total current assets
    114,108       54,102  
Property and equipment, net
    32,936       37,682  
Deferred income taxes
    17,445       19,071  
Other assets
    3,958       7,385  
Total assets
  $ 168,447     $ 118,240  
                 
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Accounts payable
  $ 44,426     $ 37,538  
Customer prepayments
    10,886       11,237  
Accruals:
               
Sales returns
    3,880       2,885  
Compensation and benefits
    23,262       15,518  
Taxes and withholding
    8,804       4,528  
Other current liabilities
    11,353       7,831  
Total current liabilities
    102,611       79,537  
Non-current liabilities:
               
Warranty liabilities
    4,904       5,286  
Capital lease obligations
    239       262  
Other long-term liabilities
    10,981       10,697  
Total non-current liabilities
    16,124       16,245  
Total liabilities
    118,735       95,782  
                 
Shareholders’ equity:
               
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding
           
Common stock, $0.01 par value; 142,500 shares authorized, 55,415 and 54,310 shares issued and outstanding, respectively
    554       543  
Additional paid-in capital
    35,653       32,860  
Retained earnings (accumulated deficit)
    13,505       (10,945 )
Total shareholders’ equity
    49,712       22,458  
Total liabilities and shareholders’ equity
  $ 168,447     $ 118,240  
 
See accompanying notes to condensed consolidated financial statements.
 
 
3


SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited – in thousands, except per share amounts)
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
   
October 2,
2010
   
October 3,
2009
 
                         
Net sales
  $ 160,103     $ 147,470     $ 457,008     $ 407,731  
Cost of sales
    60,114       53,915       172,470       158,052  
Gross profit
    99,989       93,555       284,538       249,679  
                                 
Operating expenses:
                               
Sales and marketing
    68,252       65,997       201,325       194,417  
General and administrative
    14,286       11,818       40,369       36,856  
Research and development
    454       436       1,721       1,400  
Asset impairment charges
    217             217       488  
Terminated equity financing charges
          3,324             3,324  
Total operating expenses
    83,209       81,575       243,632       236,485  
Operating income
    16,780       11,980       40,906       13,194  
Other expense, net
    50       1,704       1,826       4,951  
Income before income taxes
    16,730       10,276       39,080       8,243  
Income tax expense
    6,242       3,377       14,630       8,000  
Net income
  $ 10,488     $ 6,899     $ 24,450     $ 243  
                                 
Net income per share – basic
  $ 0.19     $ 0.15     $ 0.45     $ 0.01  
Weighted-average shares – basic
    54,129       44,830       53,885       44,783  
                                 
Net income per share – diluted
  $ 0.19     $ 0.15     $ 0.44     $ 0.01  
Weighted-average shares – diluted
    55,243       45,633       55,199       45,089  
 
See accompanying notes to condensed consolidated financial statements.
 
4

 
SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statement of Shareholders’ Equity
(unaudited – in thousands)
 
   
Common Stock
      Additional
Paid-In
Capital
    (Accumulated
Deficit)/
Retained
Earnings
      Total  
Shares
   
Amount
Balance at January 2, 2010
    54,310     $ 543     $ 32,860     $ (10,945 )   $ 22,458  
Exercise of common stock options
    911       9       850             859  
Tax benefit from stock-based compensation
                557             557  
Stock-based compensation
    357       4       2,757             2,761  
Repurchases of common stock
    (163 )     (2 )     (1,371 )           (1,373 )
Net income
                      24,450       24,450  
Balance at October 2, 2010
    55,415     $ 554     $ 35,653     $ 13,505     $ 49,712  
 
See accompanying notes to condensed consolidated financial statements.
 
 
5

 
SELECT COMFORT CORPORATION AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited – in thousands)
 
   
Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
 
Cash flows from operating activities:
           
Net income
  $ 24,450     $ 243  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Depreciation and amortization
    11,313       15,310  
Stock-based compensation
    2,761       2,540  
Disposals and impairments of assets
    213       485  
Excess tax benefits from stock-based compensation
    (1,298 )      
Deferred income taxes
    (1,757 )     7,707  
Changes in operating assets and liabilities:
               
Accounts receivable
    2,241       2,346  
Inventories
    (620 )     3,184  
Income taxes
    8,657       25,003  
Prepaid expenses and other assets
    3,293       (6,756 )
Accounts payable
    5,785       3,256  
Customer prepayments
    (351 )     (1,083 )
Accrued sales returns
    995       239  
Accrued compensation and benefits
    7,744       (139
Other taxes and withholding
    1,496       1,501  
Warranty liabilities
    (137 )     (749 )
Other accruals and liabilities
    3,673       (84 )
Net cash provided by operating activities
    68,458       53,003  
                 
Cash flows from investing activities:
               
Purchases of property and equipment
    (3,521 )     (2,040 )
Proceeds from sales of property and equipment
    10       15  
Net cash used in investing activities
    (3,511 )     (2,025 )
                 
Cash flows from financing activities:
               
Net decrease in short-term borrowings
    (889 )     (59,322 )
Repurchases of common stock
    (1,373 )      
Proceeds from issuance of common stock
    859       83  
Excess tax benefits from stock-based compensation
    1,298        
Debt issuance costs
    (143 )      
Net cash used in financing activities
    (248 )     (59,239 )
                 
Increase (decrease) in cash and cash equivalents
    64,699       (8,261 )
Cash and cash equivalents, at beginning of period
    17,717       13,057  
Cash and cash equivalents, at end of period
  $ 82,416     $ 4,796  
 
See accompanying notes to condensed consolidated financial statements.
 
 
6


SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)
 
1. Basis of Presentation
 
We prepared the condensed consolidated financial statements as of and for the three and nine months ended October 2, 2010 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 2, 2010, and January 2, 2010 and the results of operations and cash flows for the periods presented. Our historical and quarterly results of operations may not be indicative of the results that may be achieved for the full year or 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 for the fiscal year ended January 2, 2010 and other recent filings with the SEC.
 
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. 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 consist of 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.
 
Fair Value
 
Cash and cash equivalents – The carrying value approximates fair value due to the short maturity of these instruments.
 
2. Inventories
 
Inventories consisted of the following (in thousands):
 
   
October 2,
2010
   
January 2,
2010
 
Raw materials
  $ 2,942     $ 3,257  
Work in progress
    63       102  
Finished goods
    13,261       12,287  
    $ 16,266     $ 15,646  
 
3. Debt
 
Credit Agreement
 
On March 26, 2010, we entered into a new credit agreement (“Credit Agreement”) with Wells Fargo Bank, National Association and terminated our prior credit agreement. The Credit Agreement provides a $20.0 million secured revolving credit facility for working capital and general corporate purposes, including up to $10.0 million available for issuances of letters of credit. Outstanding letters of credit reduce the amounts available under this credit facility. The Credit Agreement expires on July 1, 2012.
 
Any borrowings under the Credit Agreement will, at our request, be classified as either LIBOR Loans or ABR Loans (both as defined in the Credit Agreement). The rate of interest payable by us in respect of loans outstanding under the revolving credit facility is (i) with respect to LIBOR Loans, the Adjusted LIBO Rate (as defined in the Credit Agreement) for the interest period then in effect plus 3.00%, or (ii) with respect to ABR Loans, the Adjusted Base Rate (as defined in the Credit Agreement) then in effect plus 0.50%. We are subject to certain financial covenants under the Credit Agreement, including minimum fixed charge coverage ratios, maximum capital expenditure limits, minimum net worth requirements, and maintenance of an aggregate principal balance of zero under the Credit Agreement for a period of not less than 30 consecutive days in each fiscal year. The Credit Agreement is secured by a first priority security interest in our assets and those of our domestic subsidiaries.
 
 
7

 
SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - (continued)
(unaudited)
 
At October 2, 2010, $15.7 million was available under the Credit Agreement, we had no borrowings and we were in compliance with all financial covenants. At January 2, 2010, $35.5 million was available under the prior credit facility, we had no borrowings and we were in compliance with all financial covenants. As of October 2, 2010, and January 2, 2010, we had outstanding letters of credit of $4.3 million and $4.5 million, respectively.
 
Capital Lease Obligations
 
We entered into capital leases totaling $0.3 million for certain computer equipment for both the three and nine months ended October 2, 2010. We had outstanding capital lease obligations of $0.7 million and $0.8 million at October 2, 2010, and January 2, 2010, respectively. At October 2, 2010, and January 2, 2010, $0.5 million and $0.5 million, respectively, were included in other current liabilities and $0.2 million and $0.3 million, respectively, were included in capital lease obligations in non-current liabilities in our condensed consolidated balance sheets.
 
4. Stock-Based Compensation and Employee Benefits
 
Stock-Based Compensation
 
We compensate officers, directors and key employees with stock-based compensation under three plans approved by our shareholders in 1997, 2004 and 2010 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 2, 2010, and October 3, 2009, was $1.3 million and $0.7 million, respectively. Stock-based compensation expense for the nine months ended October 2, 2010, and October 3, 2009, was $2.8 million and $2.5 million, respectively.
 
Employee Benefits
 
Under our profit sharing and 401(k) plan, eligible employees may defer up to 50% of their compensation on a pre-tax basis, subject to Internal Revenue Service limitations. Each year, we may make a discretionary contribution equal to a percentage of the employee’s contribution. During the three and nine months ended October 2, 2010, our contributions, net of forfeitures, were $0.3 million and $0.7 million, respectively. There were no contributions during the first nine months of 2009.
 
5. Other Expense, Net
 
Other expense, net, consisted of the following (in thousands): 
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
   
October 2,
2010
   
October 3,
2009
 
Interest expense
  $ 69     $ 1,533     $ 749     $ 4,725  
Interest income
    (19 )     (2     (37 )     (16 )
Write-off unamortized debt cost
          173       1,114       242  
Other expense, net
  $ 50     $ 1,704     $ 1,826     $ 4,951  

 
8

 
SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - (continued)
(unaudited)
 
6. Income Taxes
 
Income tax expense was $6.2 million and $14.6 million for the three and nine months ended October 2, 2010, respectively, compared with $3.4 million and $8.0 million for the same periods one year ago. The effective tax rates for the three and nine months ended October 2, 2010 were 37.3% and 37.4%, respectively, compared with 32.9% and 97.1%, respectively, for the same periods one year ago. The effective tax rate for the three and nine months ended October 3, 2009 reflected changes in our deferred tax valuation allowance due to uncertainty regarding future taxable income. The uncertainty was resolved and the valuation allowance reversed in the fourth quarter of 2009.
 
Unrecognized Tax Benefits
 
We accrue for the effects of uncertain tax positions and the related potential penalties and interest. There were no material adjustments to our recorded liability for unrecognized tax benefits during the nine months ended October 2, 2010.
 
7. Net Income per Common Share
 
The following computations reconcile net income per share – basic with net income per share – diluted (in thousands, except per share amounts):
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
   
October 2,
2010
   
October 3,
2009
 
Net income
  $ 10,488     $ 6,899     $ 24,450     $ 243  
                                 
Reconciliation of weighted-average shares outstanding:
                               
Basic weighted-average shares outstanding
    54,129       44,830       53,885       44,783  
Effect of dilutive securities:
                               
Options
    682       378       870       64  
Restricted shares
    432       425       444       242  
                                 
Diluted weighted-average shares outstanding
    55,243       45,633       55,199       45,089  
                                 
Net income per share – basic
  $ 0.19     $ 0.15     $ 0.45     $ 0.01  
Net income per share – diluted
  $ 0.19     $ 0.15     $ 0.44     $ 0.01  
 
We excluded potentially dilutive stock options totaling 2.5 million and 2.5 million for the three and nine months ended October 2, 2010, respectively, and 3.6 million and 5.3 million for the three and nine months ended October 3, 2009, respectively, from our diluted net income per share calculations because these securities’ exercise prices were greater than the average market price of our common stock.
 
 
9

 
SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - (continued)
(unaudited)
 
8. Commitments and Contingencies
 
Sales Returns
 
The accrued sales returns estimate is based on historical return rates, which are reasonably consistent from period to period, and is adjusted for any current trends as appropriate. If actual returns vary from expected rates, sales in future periods are adjusted.
 
The activity in the sales returns liability account was as follows (in thousands):
 
   
Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
 
Balance at beginning of year
  $ 2,885     $ 2,744  
Additions that reduce net sales
    22,620       19,314  
Deductions from reserves
    (21,625 )     (19,075 )
Balance at end of period
  $ 3,880     $ 2,983  
 
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):
 
   
 Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
 
Balance at beginning of year
  $ 7,143     $ 8,049  
Additions charged to costs and expenses for current-year sales
    2,859       3,470  
Deductions from reserves
    (3,329 )     (4,525 )
Changes in liability for pre-existing warranties during the current year, including expirations
    333       306  
Balance at end of period
  $ 7,006     $ 7,300  

 
10

 
SELECT COMFORT CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - (continued)
(unaudited)
 
GE Money Bank Agreement
 
We have an agreement with GE Money Bank to offer qualified customers revolving credit arrangements to finance purchases from us (“GE Agreement”). The GE Agreement contains certain financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio. As a result of not being in compliance with the financial covenants in 2008, 2009 and in the first quarter of 2010, we were required to provide GE Money Bank with a $1.3 million letter of credit. The letter of credit covers the risk to GE Money Bank for sales returns and warranty claims should we be unable to satisfy these claims, and will remain outstanding until such time as we are in compliance with the financial covenants for three consecutive quarters. 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. As of October 2, 2010 we have been in compliance with all financial covenants for two consecutive quarters.
 
Under the terms of the GE Agreement, GE Money Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts.
 
Legal Proceedings
 
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 and moved to dismiss the plaintiff’s claims. On three occasions the Court has granted our motion to dismiss the claims and granted limited leave to the plaintiff, joined by several additional named plaintiffs, to amend the complaint. On July 21, 2010, in response to the plaintiffs’ most recent amended complaint, the Court granted our motion to dismiss the claims and dismissed all class claims with no further opportunity to amend. As of October 2, 2010, no accrual had been established with respect to this matter as we believe that the claims asserted by the plaintiffs are without merit.
 
We are involved from time to time in various other legal proceedings arising in the ordinary course of our business, including primarily commercial, product liability, employment and intellectual property claims. In accordance with generally accepted accounting principles in the United States, we record a liability in our consolidated financial statements with respect to any of these other matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. At October 2, 2010, our consolidated financial statements include reserves of $1.6 million with respect to contingent liabilities that we determined to be both probable and reasonably estimable. 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.
 
9. Subsequent Events
 
Events that have occurred subsequent to October 2, 2010 have been evaluated through the date we filed this Quarterly Report on Form 10-Q with the SEC. 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 nine months ended October 2, 2010.
 
 
11

 
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 six sections:
 
 
Risk Factors
 
Overview
 
Results of Operations
 
Liquidity and Capital Resources
 
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:
 
Current general and industry economic trends and consumer confidence;
   
The effectiveness of our marketing and sales programs, including advertising and promotional efforts;
   
Consumer acceptance of our products, product quality and brand image;
   
Our ability to continue to improve our product line, service levels and product quality;
   
Warranty obligations;
   
Availability of attractive and cost-effective consumer credit options, including the impact of recent changes in federal law that restrict various forms of consumer credit promotional offerings;
   
Execution of our retail store distribution strategy;
   
Rising commodity costs and other inflationary pressures;
   
Our dependence on significant suppliers, including several sole-source suppliers and the vulnerability of suppliers to recessionary pressures;
   
Industry competition;
   
Risks of pending and potentially unforeseen litigation;
   
Increasing government regulation;
   
The adequacy of our management information systems to meet the evolving needs of our business and evolving regulatory standards;
   
Our ability to attract and retain key employees; 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 and in this Quarterly Report.
 
 
12

 
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, wholesale customers in Alaska, Hawaii, Canada and Australia, and to selected hospitality groups and institutional facilities.
 
Vision and Strategy
 
Our vision is to become the new standard in sleep by providing individualized sleep experiences and elevating people’s expectations above the “one size fits all” solution offered by other mattress brands.
 
We are executing against a defined strategy which focuses on the following key components:
 
Accelerate profitable growth and improve consistency of performance;
 
Deliver a new standard for individualized customer experience in our industry; and
 
Further strengthen our financial position – increase our cash balance and remain debt free.
 
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 and bedding industry sales, timing of QVC shows, consumer confidence and general economic conditions. As a result, our historical results of operations may not be indicative of the results that may be achieved for any future period.
 
 
13

 
Highlights and Outlook
 
Key financial highlights and outlook for the period ended October 2, 2010 were as follows:
 
   
Net income totaled $10.5 million, or $0.19 per diluted share, compared with net income of $6.9 million, or $0.15 per diluted share, for the same period one year ago. Third quarter 2009 financial results included $3.3 million of pre-tax costs associated with the termination of a May 2009 equity financing agreement.
       
   
Net sales increased 9% to $160.1 million, compared with $147.5 million for the same period one year ago, primarily due to a 16% comparable-store sales increase in our company-owned retail stores, partially offset by a decrease in sales resulting from a reduction in our store base.
       
   
Operating income improved to $16.8 million, or 10.5% of net sales, for the three months ended October 2, 2010, compared with $12.0 million, or 8.1% of net sales, for the same period one year ago. The operating income improvement was driven by strong comparable-store sales growth and efficiency enhancements, including the reduction in our store base and termination of retail partner relationships during the third quarter of 2009. Sales-per-store, on a trailing twelve-month basis, increased by 27% to $1.25 million.
       
   
Cash provided by operating activities totaled $68.5 million for the nine months ended October 2, 2010, compared with $53.0 million for the same period one year ago. Operating cash flows for the first nine months of 2009 included a $26.1 million refund of income taxes.
       
   
As of October 2, 2010, cash and cash equivalents totaled $82.4 million and we had no borrowings under our revolving credit facility.
       
   
For the fourth quarter of 2010 we anticipate generating positive comparable-store sales and year-over-year profit improvement, although we anticipate that the rate of sales growth will slow as comparisons with the prior year become more difficult. In addition, we plan to selectively invest in key initiatives and incur incremental expenses that are expected to drive long-term growth. Our fourth quarter outlook is difficult to predict due to its emphasis on traditional holiday shopping periods and is based on a slow growth macroeconomic environment with continued volatility.
 
 
14

 
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 2, 2010
   
October 3, 2009
   
October 2, 2010
   
October 3, 2009
 
Net sales
  $ 160.1       100.0 %   $ 147.5       100.0 %   $ 457.0       100.0 %   $ 407.7       100.0 %
Cost of sales
    60.1       37.5 %     53.9       36.6 %     172.5       37.7 %     158.1       38.8 %
Gross profit
    100.0       62.5 %     93.6       63.4 %     284.5       62.3 %     249.7       61.2 %
                                                                 
Operating expenses:
                                                               
Sales and marketing
    68.3       42.6 %     66.0       44.8 %     201.3       44.1 %     194.4       47.7 %
General and administrative
    14.3       8.9 %     11.8       8.0 %     40.4       8.8 %     36.9       9.0 %
Research and development
    0.5       0.3 %     0.4       0.3 %     1.7       0.4 %     1.4       0.3 %
Asset impairment charges
    0.2       0.1 %           0.0 %     0.2       0.0 %     0.5       0.1 %
Terminated equity financing costs
          0.0 %     3.3       2.3 %           0.0 %     3.3       0.8 %
Total operating expenses
    83.2       52.0 %     81.6       55.3 %     243.6       53.3 %     236.5       58.0 %
Operating income
    16.8       10.5 %     12.0       8.1 %     40.9       9.0 %     13.2       3.2 %
Other expense, net
    0.1       0.0 %     1.7       1.2 %     1.8       0.4 %     5.0       1.2 %
Income before income taxes
    16.7       10.4 %     10.3       7.0 %     39.1       8.6 %     8.2       2.0 %
Income tax expense
    6.2       3.9 %     3.4       2.3 %     14.6       3.2 %     8.0       2.0 %
Net income
  $ 10.5       6.6 %   $ 6.9       4.7 %   $ 24.5       5.4 %   $ 0.2       0.1 %

                         
Net income per share:
                       
Basic
  $ 0.19     $ 0.15     $ 0.45     $ 0.01  
Diluted
  $ 0.19     $ 0.15     $ 0.44     $ 0.01  
Weighted-average number of common shares:
                               
Basic
    54.1       44.8       53.9       44.8  
Diluted
    55.2       45.6       55.2       45.1  
 
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 2,
2010
   
October 3,
2009
   
October 2,
2010
   
October 3,
2009
 
Percent of net sales:
                       
Retail
    86.4 %     83.5 %     84.2 %     80.6 %
Direct and E-Commerce
    9.6 %     10.0 %     10.9 %     11.3 %
Wholesale
    4.0 %     6.5 %     4.9 %     8.1 %
Total
    100.0 %     100.0 %     100.0 %     100.0 %

 
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The components of total net sales growth, including comparable-store sales changes, were as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 2,
 2010
   
October 3, 2009
   
October 2,
2010
   
October 3,
2009
 
Net sales change rates:
                       
Retail same-store sales
    16%       9%       24%       (6%)  
Direct and E-Commerce
    4%       (28%)       9%       (31%)  
Company-Controlled same-store sales change
    15%       3%       21%       (10%)  
Net store openings/closings
    (4%)       (8%)       (5%)       (4%)  
Total Company-Controlled channels
    11%       (5%)       16%       (14%)  
Wholesale
    (32%)       (25%)       (32%)       (19%)  
Total net sales change
    9%       (6%)       12%       (15%)  
 
The numbers of company-owned retail stores and independently owned and operated retail partner stores were as follows:
 
   
Three Months Ended
   
Nine Months Ended
 
   
October 2,
2010
   
October 3,
2009
   
October 2,
2010
   
October 3,
2009
 
Company-owned retail stores:
                       
Beginning of period
    395       420       403       471  
Opened
    2       2       2       2  
Closed
    (5 )     (14 )     (13 )     (65 )
End of period
    392       408       392       408  
Retail partner doors
    148       146       148       146  
 
Comparison of Three Months Ended October 2, 2010 with Three Months Ended October 3, 2009
 
Net sales
 
Net sales increased 9% to $160.1 million for the three months ended October 2, 2010, compared with $147.5 million for the same period one year ago. The sales increase was driven by a 16% comparable-store sales increase in our company-owned retail stores and a 4% increase in our direct and E-Commerce channel sales. These increases were partially offset by the decrease in sales resulting from the year-over-year decline in the number of retail stores we operated and a decrease in wholesale channel sales due in large part to our decision in the third quarter of 2009 to discontinue distribution through retail partners operating approximately 700 stores in the contiguous United States, and the timing of QVC shows. Total sales of mattress units increased 3% compared to the same period one year ago, with mattress units in company-owned distribution channels increasing by 10%. Sales of other products and services increased by 23%.
 
The $12.6 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $19.2 million increase in sales from our company-owned comparable retail stores, partially offset by a $4.1 million sales decrease resulting from the net decline in the number of stores we operated; and (ii) a $0.6 million increase in direct and E-Commerce channel sales, partially offset by (iii) a $3.1 million decrease in wholesale channel sales.
 
Gross profit
 
The gross profit rate declined to 62.5% of net sales for the three months ended October 2, 2010, compared with 63.4% for the prior year period.  The gross profit rate decrease was due to higher promotional costs to generate customer traffic and drive sales (0.5 percentage points (ppts.)), an increase in product and service costs (0.6 ppt.), and higher labor costs associated with increased performance-based incentive compensation (0.2 ppt.) which in total reduced our gross profit rate by 1.3 ppt. for the three months ended October 2, 2010, compared with the prior year period. These decreases were partially offset by improvements resulting from an increase in the percentage of net sales from our higher margin company-controlled distribution channels and leverage from the higher sales volume.
 
 
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Sales and marketing expenses
Sales and marketing expenses for the three months ended October 2, 2010 increased 3% to $68.3 million, or 42.6% of net sales, compared with $66.0 million, or 44.8% of net sales, for the same period one year ago. The $2.3 million increase was primarily due to a $1.8 million, or 12%, increase in media spending and an increase in variable selling expenses due to the higher sales volume, partially offset by a decrease in expenses resulting from the reduction in our store base. The sales and marketing expense rate declined 2.2 ppt. compared with the same period one year ago due to the leveraging impact of the 9% net sales increase and expense savings from store closures.
 
General and administrative expenses
General and administrative (“G&A”) expenses increased to $14.3 million, or 8.9% of net sales, for the three months ended October 2, 2010, compared with $11.8 million, or 8.0% of net sales, for the same period one year ago. The $2.5 million increase in G&A was mainly due to increased compensation expenses, including higher performance-based compensation resulting from our strong year-to-date financial results, and investments in key initiatives that are expected to drive long-term growth.
 
Research and development expenses
Research and development (“R&D”) expenses increased slightly to $0.5 million for the third quarter of 2010, compared with $0.4 million for the same period one year ago. R&D expenses in the current period were 0.3% of net sales, consistent with the prior year.
 
Asset impairment charges
During the three months ended October 2, 2010, we recognized impairment charges of $0.2 million related to assets at underperforming stores. During the three months ended October 3, 2009, we recognized no asset impairment charges as our quarterly evaluation indicated that the carrying values of our long-lived assets were fully recoverable.
 
Terminated equity financing costs
In May 2009, we entered into a securities purchase agreement with a private equity firm. At 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.
 
Other expense, net
Other expense, net was $0.1 million for the three months ended October 2, 2010, compared with $1.7 million for the same period one year ago. This decrease was due to reduced interest expense and other debt-related costs resulting from having no borrowings under our revolving credit facility during 2010.
 
Income tax expense
Income tax expense was $6.2 million for the three months ended October 2, 2010, compared with $3.4 million for the same period one year ago. The effective tax rate for the three months ended October 2, 2010 was 37.3% compared with 32.9% for the same period one year ago. The effective tax rate for the three months ended October 3, 2009 reflected changes in our deferred tax valuation allowance. The deferred tax valuation allowance was established in 2008 due to uncertainty regarding future taxable income. The uncertainty was resolved and the valuation allowance reversed in the fourth quarter of 2009.
 
Comparison of Nine Months Ended October 2, 2010 with Nine Months Ended October 3, 2009
 
Net sales
 
Net sales increased 12% to $457.0 million for the nine months ended October 2, 2010, compared with $407.7 million for the same period one year ago. The sales increase was due to a 24% comparable-store sales increase in our company-owned retail stores and a 9% increase in our direct and E-Commerce channel sales. These increases were partially offset by a year-over-year decline in sales due to a reduction in the number of retail stores we operated and a decrease in wholesale channel sales due in large part to our decision in the third quarter of 2009 to discontinue distribution through retail partners operating approximately 700 stores in the contiguous United States. Total sales of mattress units increased 4% compared to the same period one year ago, with mattress units in company-owned distribution channels increasing by 13%. Sales of other products and services increased by 26%.
 
The $49.3 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $73.4 million increase in sales from our company-owned comparable retail stores, partially offset by a $17.7 million sales decrease resulting from the net decline in the number of stores we operated and (ii) a $4.0 million increase in direct and E-Commerce channel sales, partially offset by (iii) a $10.4 million decrease in wholesale channel sales.
 
 
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Gross profit
The gross profit rate improved to 62.3% of net sales for the nine months ended October 2, 2010, compared with 61.2% for the prior year period. Approximately 1.8 ppt. of the gross profit rate improvement was due to logistics and manufacturing efficiencies, including material cost reductions, an increase in the percentage of net sales from our higher margin company-controlled distribution channels and leverage from the higher sales volume. These improvements were partially offset by an increase in promotional costs to generate customer traffic and drive sales, and increased performance-based compensation.
 
Sales and marketing expenses
Sales and marketing expenses for the nine months ended October 2, 2010 increased 4% to $201.3 million, or 44.1% of net sales, compared with $194.4 million, or 47.7% of net sales, for the same period one year ago. The $6.9 million increase was primarily due to a $6.5 million, or 14%, increase in media spending and an increase in variable selling expenses due to the higher sales volume, partially offset by a decrease in expenses resulting from the reduction in our store base. The sales and marketing expense rate declined 3.6 ppt. compared with the same period one year ago due to the leveraging impact of the 12% net sales increase and expense savings from store closures.
 
General and administrative expenses
General and administrative expenses increased to $40.4 million, or 8.8% of net sales, for the nine months ended October 2, 2010, compared with $36.9 million, or 9.0% of net sales, for the same period one year ago. The $3.5 million increase was due to increased performance-based incentive compensation resulting from our strong financial results during the first nine months of 2010, partially offset by reduced depreciation expenses and the absence of severance costs incurred during the same period last year. The G&A expense rate decreased by 0.2 ppt. for the nine months ended October 2, 2010, compared with the same period one year ago, primarily due to the leveraging impact of the 12% net sales increase.
 
Research and development expenses
Research and development expenses increased to $1.7 million for the nine months ended October 2, 2010, compared with $1.4 million for the same period one year ago. R&D expenses for the nine months ended October 2, 2010 were 0.4% of net sales, a slight increase compared with 0.3% for same period one year ago.
 
Asset impairment charges
During the nine months ended October 2, 2010, we recognized impairment charges of $0.2 million related to assets at underperforming stores. 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.
 
Terminated equity financing costs
In May 2009, we entered into a securities purchase agreement with a private equity firm. At 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.
 
Other expense, net
Other expense, net was $1.8 million for the nine months ended October 2, 2010, compared with $5.0 million for the same period one year ago. This decrease was primarily due to (i) reduced interest expense and other debt-related costs in the current period as we had no borrowing under our revolving credit facility during 2010, partially offset by (ii) a $1.1 million write-off of unamortized debt costs during the first quarter of 2010 as we entered into a new credit agreement on March 26, 2010 and terminated our prior credit agreement.
 
Income tax expense
Income tax expense was $14.6 million for the nine months ended October 2, 2010, compared with $8.0 million for the same period one year ago. The effective tax rate for the nine months ended October 2, 2010 was 37.4% compared with 97.1% for the same period one year ago. The effective tax rate for the nine months ended October 3, 2009 reflected an increase in our deferred tax valuation allowance due to uncertainty regarding future taxable income. The uncertainty was resolved and the valuation allowance reversed in the fourth quarter of 2009.
 
 
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Liquidity and Capital Resources
 
As of October 2, 2010, we had cash and cash equivalents of $82.4 million compared with $17.7 million as of January 2, 2010. The $64.7 million increase in cash and cash equivalents was primarily due to $68.5 million of cash provided by operating activities partially offset by a $3.5 million investment in property and equipment, and $0.2 million used in financing activities.
 
The following table summarizes our cash flows for the nine months ended October 2, 2010, and October 3, 2009 (dollars in millions). Amounts may not add due to rounding differences:
 
   
Nine Months Ended
 
   
October 2, 2010
   
October 3, 2009
 
Total cash provided by (used in):
           
Operating activities
  $ 68.5     $ 53.0  
Investing activities
    (3.5 )     (2.0 )
Financing activities
    (0.2 )     (59.2 )
Increase (decrease) in cash and cash equivalents
  $ 64.7     $ (8.3 )
 
Cash provided by operating activities for the nine months ended October 2, 2010 was $68.5 million compared with $53.0 million for the nine months ended October 3, 2009. The $15.5 million year-over-year increase in cash from operating activities was comprised of a $24.2 million improvement in our net income compared with the same period one year ago, partially offset by a $14.8 million decrease in adjustments to reconcile net income to net cash provided by operating activities and a $6.1 million decrease in cash from changes in operating assets and liabilities (nine months ended October 3, 2009 included a $26.1 million tax refund). Other changes in operating assets and liabilities included a current-year decrease in prepaid expenses and other assets compared with an increase in the prior year (current year included a refund of a security deposit due to our improved financial position; prior year included deferred financing and debt fees), a current year increase in accrued compensation and benefits due to higher incentive compensation resulting from the strong financial performance in the first nine months of 2010, and a current year increase in inventories to support the higher sales volume.
 
Investing activities for the nine months ended October 2, 2010 included $3.5 million of property and equipment purchases, compared with $2.0 million for the same period one year ago. Capital expenditures are projected to be approximately $8.0 million in 2010 compared with $2.5 million in 2009. After netting planned store openings and closings, we expect to end fiscal 2010 with approximately 392 stores.
 
Net cash used in financing activities was $0.2 million for the nine months ended October 2, 2010, compared with $59.2 million for the same period one year ago. The $59.0 million decrease in cash used in financing activities was primarily due to a $59.3 million prior-year net decrease in short-term borrowings, compared with a $0.9 million net decrease in short-term borrowings for the nine months ended October 2, 2010. As of January 2, 2010 and October 2, 2010 we had no borrowings under our line of credit compared with $26.3 million at October 3, 2009. Book overdrafts and payments on capital lease obligations are included in the net change in short-term borrowings.
 
As of October 2, 2010, 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. We currently have no plans to repurchase our common stock. We continue to focus on strengthening our financial position by increasing our cash balance and remaining debt free.
 
On March 26, 2010, we entered into a new credit agreement (“Credit Agreement”) with Wells Fargo Bank, National Association and terminated our prior credit agreement. The Credit Agreement provides a $20.0 million secured revolving credit facility for working capital and general corporate purposes, including up to $10.0 million available for issuances of letters of credit. Outstanding letters of credit reduce the amounts available under this credit facility. The Credit Agreement expires on July 1, 2012.
 
Any borrowings under the Credit Agreement will, at our request, be classified as either LIBOR Loans or ABR Loans (both as defined in the Credit Agreement). The rate of interest payable by us in respect of loans outstanding under the revolving credit facility is (i) with respect to LIBOR Loans, the Adjusted LIBO Rate (as defined in the Credit Agreement) for the interest period then in effect plus 3.00%, or (ii) with respect to ABR Loans, the Adjusted Base Rate (as defined in the Credit Agreement) then in effect plus 0.50%. We are subject to certain financial covenants under the Credit Agreement, including minimum fixed charge coverage ratios, maximum capital expenditure limits, minimum net worth requirements, and maintenance of an aggregate principal balance of zero under the Credit Agreement for a period of not less than 30 consecutive days in each fiscal year. The Credit Agreement is secured by a first priority security interest in our assets and those of our domestic subsidiaries.
 
At October 2, 2010, $15.7 million was available under the Credit Agreement, we had no borrowings and we were in compliance with all financial covenants. At January 2, 2010, $35.5 million was available under the prior credit facility, we had no borrowings, and we were in compliance with all financial covenants. As of October 2, 2010, and January 2, 2010, we had outstanding letters of credit of $4.3 million and $4.5 million, respectively.
 
 
19

 
Cash generated from operations and available under our credit facility is expected to provide sufficient operating liquidity and funding for capital expenditures for the foreseeable future. In addition, our business model, which can operate with minimal working capital, does not require significant additional capital to fund operations or organic growth.
 
We have an agreement with GE Money Bank to offer qualified customers revolving credit arrangements to finance purchases from us (“GE Agreement”). The GE Agreement contains certain financial covenants, including a maximum leverage ratio and a minimum interest coverage ratio. As a result of not being in compliance with the financial covenants in 2008, 2009 and in the first quarter of 2010, we were required to provide GE Money Bank with a $1.3 million letter of credit. The letter of credit covers the risk to GE Money Bank for sales returns and warranty claims should we be unable to satisfy these claims, and will remain outstanding until such time as we are in compliance with the financial covenants for three consecutive quarters. 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. As of October 2, 2010 we have been in compliance with all financial covenants for two consecutive quarters.
 
Under the terms of the GE Agreement, GE Money Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts.
 
Off-Balance-Sheet Arrangements and Contractual Obligations
 
Other than operating leases and $4.3 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 2, 2010, 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 2009. See Note 3, Debt, of the Notes to our Condensed Consolidated Financial Statements for information regarding our credit agreement and capital lease obligations. See our Annual Report on Form 10-K for the fiscal year ended January 2, 2010 for additional information regarding our other contractual obligations.
 
Critical Accounting Policies
 
We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended January 2, 2010. There were no significant changes in our accounting policies since the end of fiscal 2009.
 
 
20

 
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
At October 2, 2010, we had no short-term borrowings. We have not historically managed interest rate risk on our debt through the use of derivative instruments.
 
Any borrowings under our revolving credit facility are currently not subject to material interest rate risk. The credit facility’s interest rate may be reset due to fluctuations in a market-based index, such as the prime rate or LIBOR.
 
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 2, 2010, 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
 
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 and moved to dismiss the plaintiff’s claims. On three occasions the Court has granted our motion to dismiss the claims and granted limited leave to the plaintiff, joined by several additional named plaintiffs, to amend the complaint. On July 21, 2010, in response to the plaintiffs’ most recent amended complaint, the Court granted our motion to dismiss the claims and dismissed all class claims with no further opportunity to amend. As of October 2, 2010, no accrual had been established with respect to this matter as we believe that the claims asserted by the plaintiffs are without merit.
 
We are involved from time to time in various other legal proceedings arising in the ordinary course of our business, including primarily commercial, product liability, employment and intellectual property claims. In accordance with generally accepted accounting principles in the United States, we record a liability in our consolidated financial statements with respect to any of these other matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. At October 2, 2010, our consolidated financial statements include reserves of $1.6 million with respect to contingent liabilities that we determined to be both probable and reasonably estimable. 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.
 
 
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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. The risk factors discussed in the Annual Report on Form 10-K 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.
 
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 4, 2010 through July 31, 2010
   
 
NA
 
       
August 1, 2010 through September 2, 2010
   
 
NA
 
       
September 3, 2010 through October 2, 2010
   
 
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 our common stock. As of October 2, 2010, the amount remaining under this authorization was $206.8 million. There is no expiration date with respect to this repurchase authority. 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. RESERVED
 
ITEM 5. OTHER INFORMATION
 
          Not applicable.
 
 
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ITEM 6. EXHIBITS
 
Exhibit
Number
 
Description
 
Method of Filing
                 
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 3, 2010
By:
/s/ William R. McLaughlin
   
William R. McLaughlin
Chief Executive Officer
(principal executive officer)
     
 
By:
/s/ Robert J. Poirier
   
Robert J. Poirier
Chief Accounting Officer
(principal accounting officer)
 
 
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EXHIBIT INDEX
 
Exhibit
Number
 
Description
 
Method of Filing 
         
 
Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Filed herewith
         
 
Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
 
Filed herewith
         
 
Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
 
Furnished herewith
         
 
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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