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

                         ------------------------------
                                    FORM 10-K

(Mark one)
            [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
                         SECURITIES EXCHANGE ACT OF 1934

                   FOR THE FISCAL YEAR ENDED DECEMBER 30, 2000

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

     For the transition period from ________________ to __________________.

                           COMMISSION FILE NO. 0-25121
                              --------------------

                           SELECT COMFORT CORPORATION
             (Exact name of registrant as specified in its charter)

         MINNESOTA                                             41-1597886
 (State or other jurisdiction of                            (I.R.S. Employer
  incorporation or organization)                            Identification No.)

         6105 TRENTON LANE NORTH
         MINNEAPOLIS, MINNESOTA                                55442
 (Address of principal executive offices)                   (Zip code)

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

        Securities registered pursuant to Section 12(b) of the Act: NONE

           Securities registered pursuant to Section 12(g) of the Act:

                          COMMON STOCK, $.01 PAR VALUE

     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 [ ]

     Indicate by check mark if disclosure of delinquent  filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's  knowledge,  in definitive proxy or information  statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]

     As of March 28, 2001,  18,055,633  shares of Common Stock of the Registrant
were  outstanding,  and the  aggregate  market  value of the Common Stock of the
Registrant  as of that date  (based  upon the last  reported  sale  price of the
Common  Stock at that date as reported by the Nasdaq  National  Market  System),
excluding  outstanding  shares  beneficially  owned by directors  and  executive
officers, was $16,500,517.


                       DOCUMENTS INCORPORATED BY REFERENCE

     Part III of this  Annual  Report on Form  10-K  incorporates  by  reference
information  (to the extent  specific  sections are referred to herein) from the
Registrant's  Proxy  Statement  for its 2001  Annual  Meeting  (the "2001  Proxy
Statement").



                                TABLE OF CONTENTS

                              --------------------



PART I.........................................................................2

   ITEM 1.  BUSINESS...........................................................2
     General...................................................................2
     Business and Growth Strategy..............................................2
     Products..................................................................5
     Retail Stores.............................................................6
     Direct Marketing Operations...............................................7
     E-Commerce................................................................8
     Marketing and Advertising.................................................9
     Consumer Education and Customer Service..................................10
     Manufacturing and Distribution...........................................10
     Suppliers................................................................11
     Intellectual Property....................................................11
     Competition..............................................................11
     Consumer Credit Arrangements.............................................12
     Governmental Regulation..................................................12
     Employees................................................................12
     Certain Risk Factors.....................................................13

   ITEM 2.  PROPERTIES........................................................20

   ITEM 3.  LEGAL PROCEEDINGS.................................................20

   ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY.................................22


PART II.......................................................................21

   ITEM 5.  MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED
            SHAREHOLDER MATTERS...............................................23
     Number of Record Holders; Dividends......................................24
     Use of Proceeds from Initial Public Offering.............................24

   ITEM 6.  SELECTED FINANCIAL DATA...........................................25

   ITEM 7.  MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
            AND RESULTS OF OPERATIONS.........................................26

   ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.........32

   ITEM 8.  FIANCIAL STATEMENTS AND SUPPLEMENTARY DATA........................32

   ITEM 9.  CHANGES AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
            AND FINANCIAL DISCLOSURE..........................................32

                                       i



PART III......................................................................30

   ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT................33
     Directors, Executive Officers, Promoters and Control Persons.............33
     Section 16(a) Beneficial Ownership Reporting Compliance..................33

   ITEM 11. EXECUTIVE COMPENSATION............................................33

   ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
            MANAGEMENT........................................................33

   ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS....................33

PART IV.......................................................................34

   ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM
            8-K...............................................................34
     Index to Consolidated Financial Statements...............................31
     Index to Consolidated Financial Statement Schedules......................31
     Exhibits.................................................................32
     Reports on Form 8-K......................................................33


                              --------------------

     Our fiscal year ends on the Saturday closest to December 31, and unless the
context otherwise  requires,  all references to years in this Form 10-K refer to
our fiscal years.  All  references to "Select  Comfort,"  "the Company," "we" or
"us"  herein  include  our wholly  owned  subsidiaries,  Select  Comfort  Direct
Corporation,  Select  Comfort  Retail  Corporation,  Direct Call Centers,  Inc.,
Select Comfort SC Corporation and selectcomfort.com corporation.

     Select  Comfort(R),  Sleep  Number(R),  Comfort  Club(R),  Sleep  Better on
Air(R), Sleep Insurance(R), The Sleep Number Bed by Select Comfort(TM) The Sleep
Number Store by Select Comfort(TM),  Firmness Control System(TM), Select Comfort
Sofa  Sleepaire(TM),  Select  Comfort  Sofa  Sleepaire  Collection(TM)  and  the
Company's stylized logos are trademarks and/or service marks of the Company.


                                       ii



                                     PART I

                              --------------------

     This  Form  10-K  contains  certain  forward-looking  statements.  For this
purpose,  any statements  contained in this Form 10-K that are not statements of
historical fact may be deemed to be forward-looking statements. Without limiting
the foregoing,  words such as "may," "will," "expect," "believe,"  "anticipate,"
"estimate"  or "continue"  or  comparable  terminology  are intended to identify
forward-looking statements. These statements by their nature involve substantial
risks and uncertainties, and actual results may differ materially depending on a
variety of factors,  including  those set forth under the heading below entitled
"Certain Risk Factors."

ITEM 1. BUSINESS

GENERAL
Select  Comfort  is the  leading  manufacturer,  specialty  retailer  and direct
marketer  of  premium  quality,  innovative  adjustable-firmness  beds and other
sleep-related  products. We believe we are revolutionizing the mattress industry
by  offering a  differentiated  product  through a variety  of  service-oriented
distribution channels.

Our products address broad-based consumer sleep problems,  resulting in a better
night's sleep. In comparison with traditional mattress products, our proprietary
Sleep Number beds utilize  adjustable  air chamber  technology to more naturally
contour to the body, thereby generally providing:

-    better spinal alignment,
-    reduced pressure points,
-    greater relief of lower back pain,
-    greater overall comfort, and
-    better quality sleep.

Our Firmness  Control System allows  customers to  independently  customize each
side of the Sleep  Number bed to their  ideal  level of  firmness,  comfort  and
support.

Unlike  traditional  mattress  manufacturers,  we  have  historically  sold  our
products  directly to consumers  through  three  controlled,  complementary  and
service-oriented distribution channels:

-    RETAIL,  including  company-operated  retail stores and leased  departments
     within larger retail stores,
-    DIRECT MARKETING, including a company-operated call center, and
-    E-COMMERCE, through our Web site at selectcomfort.com.

In  2000,  we began to  develop  wholesale  relationships  with a  leading  home
furnishings retailer and with the QVC shopping channel.

At December 30, 2000,  our retail  operations  included 333 stores in 45 states,
including 25 leased departments within larger retail stores.

Select  Comfort was  incorporated  in Minnesota in February  1987. Our principal
executive office is located at 6105 Trenton Lane North,  Minneapolis,  Minnesota
55442. Our telephone number is (763) 551-7000.

BUSINESS AND GROWTH STRATEGY
Following  the arrival of William R.  McLaughlin  as the Company's new President
and CEO at the end of the first  quarter of fiscal 2000, we have focused on five
primary strategic priorities:  (i) building consumer awareness, (ii) rightsizing
our cost structure,  (iii) improving our sales  conversion  effectiveness,  (iv)
pursuing  alternative  distribution  channels,  and (v)  continuously  improving
product quality, innovation and service levels. Each of these


                                       2


strategic priorities is discussed in greater detail below.

BUILDING  AWARENESS.  Lack of awareness among the broad consumer audience of our
brand,  product  benefits  and  store  locations  has been our most  significant
barrier to growth.  Though we have incurred significant  cumulative  advertising
spending  over  the  last  few  years,  and we have a large  customer  base  and
extraordinary   customer  satisfaction  ratings  and  referrals,   we  have  had
relatively low levels of consumer  awareness of our brand,  product benefits and
store locations. We generally see a close correlation between consumer awareness
levels in a market  (due to factors  such as the length of our  presence  in the
market, our cumulative  advertising  spending,  store density per population and
word-of-mouth  referrals) and our share of overall mattress sales in the market.
As a result,  our current marketing  efforts are focused on increasing  consumer
awareness through appealing to a broader  demographic  audience with advertising
and other  marketing  programs that showcase the unique features and benefits of
our product.

Historically,  our marketing  personnel had been spread across our various sales
channels.  Early in 2000,  we laid the  groundwork  for  developing  integrated,
consistent  and  efficient  marketing  messages by  consolidating  our marketing
personnel into one organization.

In mid-2000, we renewed our relationship with New York-based  advertising agency
Messner  Vetere  Berger  McNamee  Schmetterer/Euro  RSCG to help us  design  and
implement a  breakthrough  brand and  marketing  program.  In the second half of
2000,  working with this agency,  the marketing  team focused its efforts on the
repositioning  of our product,  brand and  marketing  messages  around our Sleep
Number  bed.  Our Sleep  Number  campaign  focuses  on the unique  features  and
benefits of our product:  individualized  and adjustable  firmness,  comfort and
support to provide a perfect nights sleep.  This message has broader appeal than
many of our  traditional  marketing  messages,  is being  delivered  through the
broader reach of prime time TV in selected markets, and is targeted at a broader
demographic audience. We launched our Sleep Number campaign in two pilot markets
in  January  2001 and in six of our  largest  markets  in  February  2001,  with
encouraging initial results. See "-Marketing and Advertising."

RIGHTSIZING  OUR COST STRUCTURE.  In 2000, we began to implement  initiatives to
bring  our cost  structure  in line with our sales  volumes,  with the  ultimate
objective of making our core bed business  profitable  at 2000 sales volumes and
to enable funding of awareness  building  marketing  programs.  Specific actions
taken to improve our cost structure include:

-    Termination of non-core business initiatives,  including catalog, road show
     and event  marketing,  and expenses  related to  investment  in the initial
     launch of the sofa sleeper  product line and relaunch of the  Company's web
     site,

-    Rebalancing of manufacturing between our three plant locations,

-    Selling expense savings from reducing our sales  infrastructure  by closing
     27  under-performing  retail  stores  and our direct  call  center in South
     Carolina, and by streamlining retail management and store staffing levels,

-    Corporate  general and  administrative  expense  savings from reductions in
     corporate staff and consolidating our two Minneapolis offices,

-    Logistics  cost savings from systems and packaging  improvements  to enable
     shipping with Fed Ex as well as UPS,

-    Product cost reductions with equal or superior  quality and reduced product
     returns, and

-    Promotional   discount  reductions  through  improved  program  design  and
     controls.



                                       3


In 2001,  we are  continuing  to  aggressively  pursue  additional  cost  saving
opportunities.  In April of 2001, we ceased  manufacturing  in our  Minneapolis,
Minnesota,  plant.  This  plant  will  continue  to  function  as a  center  for
processing  returns and warranty and replacement  parts, and as a cross-dock for
regional  distribution.  We reduced our  workforce by 76 positions in April 2001
from the cessation of manufacturing in Minneapolis and from unrelated reductions
in our corporate staff.

IMPROVING SALES CONVERSION. To improve the effectiveness of our sales conversion
process,  we have  developed  and are  implementing  a variety  of  initiatives,
including:

-    awareness  building programs that are designed to drive more  knowledgeable
     and motivated consumers to our points of distribution,

-    a  simplified  and  close-oriented  selling  process  focused on the unique
     features  and  benefits of our product and the value  proposition  that our
     product delivers,

-    enhancement of the consumer's  in-store experience through the use of tools
     that better demonstrate the benefits of our products,

-    improvements in the appearance of our products,

-    changes in our direct  marketing call center strategy to drive more traffic
     to our retail stores,

-    offering  different  and  more  creative  financing  alternatives  for  our
     customers,

-    expanding our home delivery,  assembly and mattress  removal  capability to
     additional markets,

-    compensation and incentive plans that are more highly commission-driven and
     close-oriented, and

-    changes  in our  promotional  schedule  to  better  leverage  key  consumer
     shopping dates.

ALTERNATIVE  DISTRIBUTION  CHANNELS. An important element of our growth strategy
is to increase  opportunities for consumers to become aware of, and to purchase,
our  products.  In 2000,  we tested two  additional  avenues for  awareness  and
distribution.

In September  2000,  we  established  our first  wholesaling  relationship  with
Gabberts, a leading home furnishings retailer in Minneapolis/St. Paul and Dallas
metropolitan  areas.  In 2001,  we are seeking to expand our  relationship  with
Gabberts and to develop  similar  wholesaling  relationships  with other leading
home  furnishings  retailers  in  additional  markets.  We  believe  that  these
relationships may enable us to leverage our advertising spending in key markets.

In October  2000,  we tested the offering of our products on the QVC  television
shopping  channel  with a one  hour  program.  This  successful  test  led to an
additional  one-hour  program in December 2000 and three hours in early March of
2001,  each of which resulted in sales  exceeding our  expectations.  We plan to
expand our relationship with QVC in 2001, which we believe will increase overall
consumer  awareness  of our  product  and  brand in  addition  to  providing  an
important sales channel.

INNOVATION AND CONTINUOUS PRODUCT LINE AND SERVICE LEVEL IMPROVEMENT. We believe
that our future  success  will depend in part on our ability to continue to lead
the mattress  industry in innovation and to continue to improve our product line
and service  levels.  In 2000,  we  reinvigorated  our research and  development
capability to focus on continuous product improvements to deliver:

-    new and enhanced consumer benefits,



                                       4


-    improved product quality, and

-    reduced product or delivery costs.

In the second  half of 2000,  we  introduced  our new line of  foundations  that
provide both new and enhanced consumer benefits over the previous  generation of
foundations,  as well as reduced product  delivery  costs. In addition,  we have
recently introduced new ticking for improved appearance of our Classic and Elite
models.

In November  2000, we acquired the assets of SleepTec,  Inc.,  the innovator and
manufacturer  of our sofa  sleeper  product.  Until  April  2001,  we have  been
devoting  a portion  of our  product  development  resources  to  improving  the
features, benefits and quality of this product line for a relaunch in the second
half of 2001. In April 2001,  consistent with our cost reduction  efforts and in
order to focus our  resources on our core product  line, we delayed the relaunch
of this product line beyond 2001.

We have taken  initial steps toward  providing  in-home  delivery,  assembly and
mattress  removal  throughout the continental  United States.  To date,  in-home
delivery  and  assembly  has been  provided  through  our retail  channel and is
currently  provided in connection with  approximately  6% of our sales. We began
testing  mattress  removal during the fourth quarter of 2000 and expect to offer
this service in additional markets in 2001.

PRODUCTS
BEDS.  Select Comfort offers four  different  Sleep Number bed models.  Each bed
comes in standard mattress sizes,  ranging from twin to California king, as well
as a waterbed  replacement  model. In addition,  all Sleep Number beds feature a
patented single- or dual-air  chamber.  The dual chamber allows each side of the
mattress to be  adjusted  independently  with the  Firmness  Control  System for
personalized comfort and support.

Our Imperial and Ultra Series of  mattresses  feature a patented wireless remote
control with a digital  display of the user's Sleep Number,  which  reflects the
level of firmness  and allows the  consumer to easily  adjust and  readjust  the
firmness level to their personal preference. This feature is also available with
our Classic and Elite Series of beds for an additional charge.

The air  chambers  of a  Sleep  Number  bed are  surrounded  on all  sides  by a
high-density  foam perimeter to provide strong edge support.  For added comfort,
we offer a plush pillowtop  option with an extra cushion of support  designed to
cradle the body.  All Sleep  Number  mattresses  are  enclosed  by  comfortable,
durable  Belgian Damask  covering which combines cotton and/or rayon for comfort
and durability.

The  contouring  and  support  of a Sleep  Number  mattress  works  best  with a
specially  designed  foundation  from  Select  Comfort.  Used in  place of a box
spring,  this durable  foundation  is uniquely  designed to  complement  the air
chambers and maintain a consistent  support  surface for the life of the bed. It
is designed with interlocking panels for maximum structural  integrity,  as well
as  high-density  polymer side panels and lateral  support beams for  additional
support.  And unlike traditional box springs, the foundation can be easily moved
around corners and up and down stairs.  The Select Comfort foundation is made of
100 percent recyclable material.

Sleep  Number  beds can be  quickly  assembled  by  customers  through  a simple
tool-free process.  Furthermore,  because air is the primary support material of
the  mattress,  Sleep  Number beds do not lose their shape or support  over time
like  traditional  mattresses  and box  springs.  Each bed is  accompanied  with
instructional  product brochures and easy-to-follow  assembly  instructions,  is
certified  by  Underwriter's  Laboratories  and is backed  by a 20-year  limited
warranty  and our 30 Night Trial and Better  Night's  Sleep  Guarantee.  We have
historically  offered our customers a 90-night  in-home trial period under which
the customer may return the bed within the first 90 days for a refund. The



                                       5


customer is obligated to pay the return shipping charge. Effective May 29, 2001,
we plan to shorten our in-home trial period to 30 days.

ACCESSORY PRODUCTS. In addition to mattresses and matching foundations, we offer
a line of accessory  products,  including  bed frames and a line of high quality
mattress pads and specialty  pillows,  all designed to provide  superior comfort
and better quality sleep.

SOFA SLEEPERS. In 2000, we introduced a line of sofa sleepers with air-supported
mattresses in select markets.  This product offers  significant  advantages over
traditional  sofa sleeper  products,  including an 11-inch  thick air  supported
mattress  that  provides  all the  benefits  of  adjustable  and  individualized
comfort,  firmness  and  support.  In November  2000,  we acquired the assets of
SleepTec,  Inc.,  the innovator and  manufacturer  of our sofa sleeper  product.
Until April  2001,  we have been  devoting a portion of our product  development
resources to improving the  features,  benefits and quality of this product line
for a relaunch in the second half of 2001.  In April 2001,  consistent  with our
cost  reduction  efforts and in order to focus our resources on our core product
line, we delayed the relaunch of this product line beyond 2001.

PRODUCT  ENGINEERING.   We  maintain  an  active  engineering   department  that
continuously  seeks to enhance  our  knowledge  of sleep  science and to improve
current product performance and benefits.  Through customer surveys and consumer
focus groups, we seek feedback on a regular basis to help enhance our products.

Since the introduction of our first bed, we have continued to improve and expand
our product line,  including  quieter Firmness  Control Systems,  remote control
gauges with digital settings, more luxurious fabrics and covers, new generations
of foams and  foundation  systems and enhanced  border  walls.  Our research and
development  expenses were $.9 million for 2000,  $1.9 million for 1999 and $1.6
million for 1998.

RETAIL STORES
Since our first retail stores were opened in 1992, an  increasing percentage  of
our net sales has  occurred  at our retail  stores,  and retail  store sales now
account for a majority of our net sales. At December 30, 2000, we had 333 stores
in 45 states,  including 25 leased  departments.  In 2001, we currently  plan to
close at least 14 under-performing retail locations and to open approximately 13
retail stores.

STORE ENVIRONMENT. Our previous store design featured novel visual images on the
walls in order to  command  attention  to our  innovative  products.  In 2000 we
adopted a new store  design  with a  bedroom-like  setting  intended to convey a
sense of sophistication and quality that reinforces Select Comfort's brand image
as synonymous with sleep solutions.  We remodeled approximately 66 of our stores
with this updated retail store design in 2000. In connection  with the launch of
our Sleep  Number  campaign  in two  markets in January  and six of our  largest
markets in February,  the store  marquees in these  markets were changed to "The
Sleep Number Store." Internal  signage in all of our stores  nationwide has been
changed to support the Sleep Number brand and product message. Our retail stores
are principally showrooms, averaging approximately 900 square feet, with several
display  models  from our line of air beds  and a full  display  of our  branded
accessories.

Our sales  professionals  play an  important  role in creating  an inviting  and
informative retail environment.  These professionals  receive extensive training
regarding the features and benefits of our  proprietary  technology and products
as well as on the overall importance of sleep quality. This enables them to more
effectively  introduce  consumers to our  products,  emphasize  the features and
benefits  that  distinguish  Select  Comfort beds from  traditional  mattresses,
determine the consumers'  needs,  encourage  consumers to experience the comfort
and support of Sleep Number beds and answer questions regarding our products.



                                       6


SITE  SELECTION.  In selecting new store sites,  we generally seek  high-traffic
mall locations of  approximately  800 to 1,200 square feet within malls in major
metropolitan  and regional  areas.  We conduct  extensive  analyses of potential
store  sites  and base our  selection  on a number  of  factors,  including  the
location within the mall,  demographics of the trade area, the specifications of
the mall  (including  size,  age,  sales per square foot and the location of the
nearest  competitive  mall), the perceived strength of the mall's anchor stores,
the  performance  of other  specialty  retail tenants in the mall, the number of
direct  marketing  inquiries  received from the area surrounding the mall, store
density of existing stores and marketing and advertising plans in the respective
markets.  Clustering of retail stores within a  metropolitan  retail market is a
key consideration in order to leverage our advertising.

MARKETING AND ADVERTISING.  We historically  have supported some of our multiple
store markets with media primarily focused on the use of radio personalities. In
connection with the Sleep Number campaign in selected markets, we have broadened
our media reach and target audience  through  drive-time radio prime-time TV and
periodic  newspaper  inserts.   The  Sleep  Number  campaign  has  to-date  been
introduced in two pilot markets and in six of our strongest markets, in terms of
sales and store density, to best leverage the media spending.  In addition,  our
integrated  approach to marketing  across our  multiple  channels is designed to
deliver consistent  messages about our Sleep Number beds and to direct customers
to our retail stores.

We also support new store  openings with mailings to direct  response  inquiries
and potential  prospects in the market, and in some markets with print and radio
advertisements.

MANAGEMENT AND EMPLOYEES.  Our stores are currently  organized into six regional
areas and 39 geographic districts, with approximately eight to 10 stores in each
district.  Each regional sales director oversees  approximately seven geographic
districts. Each district has a district sales manager who is responsible for the
sales and operations and who reports to a regional sales director.  The district
sales managers frequently visit stores to review merchandise presentation, sales
force product  knowledge,  financial  performance  and compliance with operating
standards.  The typical staff of a Select  Comfort  store  consists of one store
manager  and two  full-time  sales  professionals.  In  order to  maintain  high
operating  standards,  we recruit store  managers who typically have one to four
years of  experience  as a store  manager  in  specialty  retailing.  Our  sales
professionals  devote  substantially  all of their efforts to sales and customer
service,  which  includes  helping  customers and  generating  and responding to
inquiries.   In  addition,  to  promote  consumer  education,   ensure  customer
satisfaction and generate  referrals,  the sales  professionals  place follow-up
calls to customers who have made recent purchases or inquiries.

TRAINING AND  COMPENSATION.  All store personnel receive  comprehensive  on-site
training on our technology and sleep expertise, the features and benefits of our
beds,  sales  and  customer  service   techniques  and  operating  policies  and
guidelines.  Initial training  programs are reinforced  through detailed product
and  operating  manuals and  periodic  performance  appraisals.  All store sales
professionals receive base compensation and are entitled to commissions based on
individual and store-wide performance. In 2001, our compensation program will be
more  heavily  commission-based,  which we believe will enable us to attract and
retain  more  sales-oriented  store  professionals.  Regional  sales  directors,
district sales managers and store managers are eligible to receive,  in addition
to their  base  compensation,  incentive  compensation  for the  achievement  of
performance objectives by the stores within their responsibility.

DIRECT MARKETING OPERATIONS
Many  consumers'  initial  exposure to the Select  Comfort  Sleep  Number bed is
through our direct marketing operations.  Typically, an interested consumer will
respond to one of our advertisements by calling our toll-free number.



                                       7


On  this  call,  one  of  our  direct  marketing  sales  professionals  captures
information  from the consumer,  begins the consumer  education  process,  takes
orders, or, if appropriate,  sends a thorough  information packet or directs the
consumer to our other distribution  channels (retail or e-commerce).  The direct
marketing  operations  are conducted by  knowledgeable  and  well-trained  sales
professionals,  including  a group  of over 30  sales  professionals  who  field
incoming direct marketing  inquiries,  and over 10 sales  professionals who make
outbound  calls to  consumers  who have  previously  contacted  us.  The  direct
marketing  operations  also  include a  database  marketing  department  that is
responsible  for the mailing of product and  promotional  information  to direct
response  inquiries.  We maintain a database of information on approximately 6.6
million inquiries, including customers who have purchased a bed from us.

In the direct marketing channel, our advertising message is communicated through
targeted  print and radio  advertisements,  use of  infomercials  and short-form
direct TV advertising  and through product  brochures,  videos and other product
and promotional  materials  mailed in response to consumer  inquiries at various
intervals.  Recently,  the  direct  marketing  channel  has  relied  heavily  on
nationally  syndicated  radio  personalities,  such  as  Paul  Harvey  and  Rush
Limbaugh,  and has expanded print and direct mail programs. Our direct marketing
operations   continually   monitor  the  effectiveness  and  efficiency  of  our
advertising  through  tracking  the cost per  inquiry  and cost per order of our
advertising,   and  use   sophisticated   media  buying  techniques  to  improve
efficiency.

Our direct  marketing  operations also support our other  distribution  channels
through referrals, as well as mailings to direct marketing inquiries in selected
markets in advance of retail store  openings  and events.  As our base of retail
stores has expanded,  our direct marketing sales professionals have increasingly
been able to refer  direct  marketing  inquiries  to a  convenient  retail store
location, improving the process of converting inquiries into sales and providing
the consumer with a choice of service venues.

E-COMMERCE
Our Web site at selectcomfort.com provides consumers with a wide array of useful
information as well as the  convenience to order our products  online or to call
to order from one of our internet-dedicated sales professionals.  Since building
the  capability to take online orders in May 1999,  our  e-commerce  channel has
continued to add functionality and content to educate consumers regarding:

-    sleep research and science,
-    our products and the benefits they provide,
-    store locations and other means to contact us and experience our products,
-    customer testimonials,
-    customer service information, and
-    current sales and promotional events.

Our e-commerce channel has also focused on developing  relationships with online
shopping malls and other sales portals and affiliates.

We launched our  redesigned  Web site in the second half of 2000 with an updated
look and feel that is attractive, professional and reinforces the Select Comfort
brand image.  The redesigned site allows greater  functionality  to provide more
personalization,  guided  selling,  dynamic  content and  promotions  and a more
robust online  shopping  experience.  The site is  maintained  through a content
management  system that allows for  efficient  management of Web site content as
well as technical maintenance.

Earlier this year we launched a new site, sleepnumber.com,  to support the Sleep
Number  brand in the  advertising  test  markets.  The site offers  visitors the
opportunity  to estimate  their Sleep Number online and includes a store locator
to encourage  them to visit a store to find their Sleep Number on a Sleep Number
bed.

On March 28, 2001, we launched another site, beds.com,  to increase awareness of
the Sleep Number bed and air-supported sleep systems as



                                       8


an important bed category.  The target  audience is shoppers at any point in the
mattress consideration  process.  Beds.com provides mattress comparisons between
types of beds (from innerspring to water),  leading brands,  important  mattress
features to look for,  price and value and includes  tips for choosing the right
mattress.  The site also provides  specific  information on the Sleep Number bed
and links to  selectcomfort.com  for additional  information.  The beds.com site
will be  advertised  on our  online  shopping  portals  and we intend to monitor
traffic to the site and the impact on awareness levels and sales. Our goal is to
increase awareness of our product category and its unique benefits, bringing the
Sleep Number bed into the consideration set for people currently in the mattress
shopping cycle.

MARKETING AND ADVERTISING
Lack of  awareness  among the broad  consumer  audience  of our  brand,  product
benefits and store locations has historically been our most significant  barrier
to growth. Despite significant cumulative advertising spending over the last few
years,  and our large  customer base with  extraordinary  customer  satisfaction
ratings and  referrals,  we  generally  have  relatively  low levels of consumer
awareness. Although awareness levels are higher in certain markets, our national
brand  awareness  has only been about 3%,  compared  with 40% to 60% or more for
some of our competitors offering traditional innerspring mattresses. Our current
marketing  efforts are  therefore  directed  at  increasing  consumer  awareness
through a broader  message,  focused on the unique  features and benefits of our
product,  delivered  through  broader  reach  media and  appealing  to a broader
demographic audience.

In the second half of 2000, our marketing team focused on the  repositioning  of
our product,  brand and  marketing  messages  around the unique and  proprietary
features  and  benefits  of our Sleep  Number bed.  The Sleep  Number bed offers
adjustable and  individualized  firmness and a numerical  representation  of the
consumer's  ideal  level of  firmness,  comfort and support to provide a perfect
night's sleep. The  architecture of the Sleep Number marketing  campaign is that
knowing your Sleep Number is the key to a perfect  night's  sleep;  you can only
find your Sleep Number on a Sleep Number bed; and you can only  purchase a Sleep
Number bed at The Sleep Number Store by Select  Comfort.  This  architecture  is
designed to build strong brand, product and store awareness.

We  believe  this  Sleep  Number  message  enables  consumers  to  more  quickly
understand  the unique  benefits of our product and has broader appeal than many
of our traditional marketing messages.

In early 2001, a new integrated  advertising  campaign was introduced into eight
test  markets,   and  has  produced  favorable   initial,   in  comparison  with
non-advertised markets.

Through the broader  reach of  prime-time  TV and  drive-time  radio,  the Sleep
Number  messages are  targeted at a broader  demographic  audience  than we have
traditionally  reached.  The campaign  includes  five  30-second TV spots run at
prime time on local  network  affiliates,  seven  30-second  radio  spots,  with
periodic  newspaper  advertising  for urgency  messages.  We are testing various
levels of spending and media mixes with this advertising during 2001.

We have plans to roll this  campaign to more  markets in 2001,  depending on the
efficiency and effectiveness we see from the initial markets.

Though the initial focus of the Sleep Number  campaign is on our retail  stores,
through the  integration of our marketing  messages  across all of our channels,
the Sleep  Number  repositioning  is  company-wide,  including  our  direct  and
e-commerce  channels.  Retail  store  marquees  have been  changed to "The Sleep
Number  Store"  only in the eight  markets  with full  media  support.  Internal
signage in all of our stores has been  changed to support the Sleep Number brand
and message.

The Sleep Number  campaign is being funded by reductions in other less efficient
advertising and



                                       9


by reductions in promotional  discounts that do not contribute to brand, product
or store  awareness  levels.  In total,  year 2001  marketing  expenditures  are
planned to be lower than the year 2000, despite this new initiative.

Though it is too soon to draw definitive conclusions regarding the effectiveness
and  efficiency  of the Sleep Number  campaign from the initial  markets,  early
results indicate  significant  additional  product and brand awareness,  as well
significant additional store traffic and sales in comparison with non-advertised
markets.

CONSUMER EDUCATION AND CUSTOMER SERVICE
We are committed to achieving our goal of world class customer  satisfaction and
service. We intend to achieve this goal through a variety of means designed to:

-    educate consumers on the benefits of Select Comfort products,
-    deliver superior quality products,
-    maximize our direct relationship with consumers,
-    maximize convenience for the consumer, and
-    respond quickly to consumer needs and inquiries.

We believe  that  educating  consumers  about the  features  and benefits of our
products is critical to the success of our marketing and sales  efforts,  and we
devote  considerable  time and  resources  to  training  programs  for our sales
professionals.  Our retail stores and our web site also provide  customers  with
the latest  information  on sleep  research  and science and the benefits of our
products.

Our controlled  distribution channels optimize our direct contact with customers
and allow us to respond  quickly  to  customer  service  inquiries  and  enhance
customer  satisfaction.  Our  multiple  distribution  channels  also enhance the
convenience for the consumer to purchase  products  through a variety of venues.
In addition, we have been testing the offering of in-home delivery, assembly and
mattress  removal  services  in selected  markets.  We are  developing  plans to
ultimately  provide these  services  nationwide  across all of our  distribution
channels in order to increase overall sales and enhance customer satisfaction.

We maintain an in-house customer service  department of over 40 customer service
representatives  who  receive  extensive  training in sleep  technology  and all
aspects of our products and  operations.  Our customer  service  representatives
field customer calls and also interact with each of our retail stores to address
customer  questions  and concerns  raised with retail sales  professionals.  The
customer service  department makes outbound calls to new customers during our in
home trial phase to answer questions and provide  solutions to possible problems
in order to enhance customer education,  build customer  satisfaction and reduce
returns.

MANUFACTURING  AND  DISTRIBUTION
Our manufacturing  operations are located in Minneapolis,  Minnesota,  Columbia,
South Carolina,  and Salt Lake City, Utah. These operations  consist of quilting
and  sewing of the fabric  covers for our beds,  assembly  of  Firmness  Control
Systems and final  assembly and packaging of  mattresses  and  foundations  from
contract manufactured components.  In April 2001, we discontinued  manufacturing
in our  Minneapolis  location.  We will continue to process returns and warranty
claims in this location,  but  manufacturing  of our beds will occur only in our
Columbia and Salt Lake City plants.  We believe we have  sufficient  capacity in
these plants to meet anticipated increases in demand for the foreseeable future.

We manufacture beds to meet orders rather than to stock inventory, which enables
us to maintain  lower levels of  inventory.  As we expand our home  delivery and
assembly  services,  we may use regional  distribution  centers that would stock
inventory to fill orders on a more expedited basis. Orders are currently shipped



                                       10


from one of our three distribution centers,  primarily via UPS, typically within
48 hours  following  order  receipt,  and are usually  received by the  customer
within five to seven business days after shipment. We are continually evaluating
alternative  carriers  on a  national  and  regional  basis,  as well as testing
providers of in-home assembly services in selected markets.

SUPPLIERS
We currently obtain all of the materials and components used to produce our beds
from outside  sources.  Components for the Firmness Control Systems are obtained
from a variety of domestic sources.  Quilting and ticking materials are obtained
from a  supplier  that  produces  both  in  Belgium  and in the  United  States.
Components  for  foundation  systems are  obtained  primarily  from two domestic
sources.

Our proprietary air chambers are produced to our  specifications  by one Eastern
European  supplier under a supply  contract  expiring in August 2001 (subject to
automatic  renewal  if  neither  party  gives 90 days'  notice of  non-renewal),
pursuant to which we are obligated to purchase  certain minimum  quantities.  We
expect to continue the relationship  with the Eastern European  supplier for the
foreseeable  future.  We believe  that we would be able to  procure an  adequate
supply of air  chambers  from  other  sources  on a timely  basis if the  supply
contract is terminated or the Eastern  European  supplier is otherwise unable to
supply air chambers.

INTELLECTUAL PROPERTY
Certain  elements  of the  design  and  function  of our beds  and sofa  sleeper
products  are the  subject  of United  States  and  foreign  patents  and patent
applications  owned by us. We have 37 issued  U.S.  patents  and 27 U.S.  patent
applications  pending. We also held 15 foreign patents and had 22 foreign patent
applications pending as of December 30, 2000.

The name "Select Comfort" and our logo are trademarks registered with the United
States Patent and Trademark  Office. We have a number of other registered marks,
including the trademarks "Sleep Number" and "Sleep Insurance," the service marks
"Comfort  Club" and "Sleep Better on Air," and a number of  unregistered  marks,
including the trademark "The Sleep Number Bed by Select Comfort" and the service
mark "The Sleep Number  Store by Select  Comfort."  Several of these  trademarks
have been  registered,  or are the subject of pending  applications,  in various
foreign countries.  Each federally registered mark is renewable  indefinitely if
the  mark is  still  in use at the  time of  renewal.  We are not  aware  of any
material  claims of  infringement  or other  challenges  to our right to use our
marks.

In November  1999,  we  initiated a patent  infringement  suit  against  Simmons
Company and Price  Manufacturing  Inc.  alleging that  Simmons-branded  air beds
manufactured by Price Manufacturing  infringed three of our patents. In February
2000, we settled our suit against  Simmons after Simmons  terminated its license
agreement with Price Manufacturing, effectively ending Simmons' involvement with
the manufacture and sale of air beds with a hand control that are the subject of
the suit. Price  Manufacturing was not a part of the settlement and we intend to
continue to prosecute our suit against Price Manufacturing.

COMPETITION
The  mattress  industry  is highly  competitive.  Participants  in the  mattress
industry compete primarily on price,  quality,  brand name recognition,  product
availability and product performance,  including the perceived levels of comfort
and support provided by a mattress.  Our beds compete with a number of different
types of mattress  alternatives,  including innerspring  mattresses,  waterbeds,
futons and other  air-supported  mattresses  that are sold  through a variety of
channels,  including  furniture stores,  bedding  specialty  stores,  department
stores,  mass merchants,  wholesale clubs,  telemarketing  programs,  television
infomercials  and  catalogs.  We  believe  that our  success  depends in part on
increasing  consumer  awareness and acceptance of our existing  products and the
continuing



                                       11


introduction  of products that have qualities and benefits  which  differentiate
our products from those offered by other manufacturers.

The  traditional  mattress  industry  is  characterized  by  a  high  degree  of
concentration  among the four largest  manufacturers  of innerspring  mattresses
with nationally  recognized brand names,  including  Sealy,  which also owns the
Stearns & Foster brand name,  Serta,  Simmons and Spring Air. The balance of the
mattress market is served by over 700  manufacturers,  primarily  operating on a
regional basis.  Many of these  competitors,  and in particular the four largest
manufacturers  named above, have greater financial,  marketing and manufacturing
resources and better brand name  recognition than we do, and sell their products
through broader and more established distribution channels.

A number of companies  have begun to offer air beds in recent  years,  including
Simmons.  There can be no assurance  that these  companies or any other mattress
manufacturer,  including the major innerspring  manufacturers  named above, will
not  aggressively  pursue  the air bed  market  or be  successful  in  obtaining
significant  market  share  of the air bed  category.  Any such  competition  by
established  manufacturers or new entrants into the market could have a material
adverse effect on our business,  financial  condition and operating results.  In
addition,  should  any of our  competitors  reduce  prices on  premium  mattress
products,  we may be required to implement  price  reductions in order to remain
competitive,  which  could  have a  material  adverse  effect  on our  business,
financial condition and operating results.

CONSUMER CREDIT ARRANGEMENTS
Through a private label consumer credit facility  provided by Conseco Bank, Inc.
(the "Bank"),  we offer our qualified  customers an unsecured  revolving  credit
arrangement to finance  purchases from us. The Bank sets the rates, fees and all
other  terms and  conditions  of the  customer  accounts,  including  collection
policies and  procedures,  and is the owner of the accounts.  In connection with
all  purchases  financed  under these  arrangements,  the Bank pays us an amount
equal  to the  total  amount  of  such  purchases,  net of  promotional  related
discounts.

We have recently  been in  discussions  with the Bank  regarding the terms under
which the Bank will  continue  to make this  credit  facility  available  to our
customers.  As a result of these  discussions,  we have  agreed to  establish  a
reserve in the amount of $1 million to protect the Bank against potential losses
from  consumer  returns.  This  reserve  will be  established  in part  from the
proceeds of our pending  financing  transaction  and in part  through a discount
from the proceeds of credit  sales that we receive  from the Bank.  We have also
agreed that, in the event of any  termination of our agreement with the Bank and
replacement  of the Bank by an  alternative  third-party  provider  of  consumer
financing,  at the request of the Bank we will  purchase the Bank's  outstanding
portfolio of customer accounts for a pre-determined formula price.

GOVERNMENTAL REGULATION
Our  products  and our  marketing  and  advertising  practices  are  subject  to
regulation by various federal, state and local regulatory authorities, including
the Federal Trade Commission.  The mattress industry also engages in advertising
self-regulation  through  certain  voluntary  forums,   including  the  National
Advertising  Division  of the Better  Business  Bureau.  We are also  subject to
various  other  federal,  state and  local  regulatory  requirements,  including
federal, state and local environmental  regulation and regulations issued by the
U.S. Occupational Safety and Health Administration.

EMPLOYEES
At December 30, 2000, we employed  1,853 persons,  including  1,185 retail store
employees,  53 direct  marketing  employees 72 customer service  employees,  327
manufacturing and distribution  employees and 216 management and  administrative
employees. Approximately 191 of our employees were employed on a part-



                                       12


time  basis  at  December  30,  2000.   Except  for  managerial   employees  and
professional  support  staff,  all of our  employees are paid on an hourly basis
plus commissions for sales associates. None of our employees is represented by a
labor union or covered by a collective bargaining agreement. We believe that our
relations with our employees are good.

CERTAIN RISK FACTORS
There are several  important risk factors that could cause our actual results to
differ  materially  from those  anticipated by us or which may impact any of our
forward-looking  statements.  These factors,  and their impact on the success of
our operations and our ability to achieve our goals, include the following:

HISTORY OF OPERATING LOSSES; UNCERTAIN  PROFITABILITY.  Since inception, we have
incurred  substantial  operating  losses and there can be no assurance  that our
business  and  growth  strategy  will  enable us to achieve  profitability  on a
quarterly or annual basis in future periods.  Our future operating  results will
depend on a number of factors, including:

-    Our ability to  successfully  execute the  strategic  initiatives  outlined
     above under "--Business and Growth Strategy,"

-    The efficiency  and  effectiveness  of our Sleep Number  campaign and other
     marketing programs in building product and brand awareness, driving traffic
     to our points of sale and in increasing sales,

-    The level of consumer acceptance of our products,

-    Our ability to fully  execute and realize the  benefits of the cost savings
     initiatives outlined above under "--Business and Growth Strategy,"

-    Our ability to  cost-effectively  sell our  products  through  wholesale or
     alternative distribution channels in volumes sufficient to drive growth and
     leverage our cost structure and advertising spending,

-    Our  ability to  continuously  improve  our  products  to  achieve  new and
     enhanced consumer benefits, better quality and reduced costs,

-    Our ability to realize  increased sales and greater levels of profitability
     through our retail stores,

-    Our  ability  to  cost-effectively  close  additional   underperforming  or
     unprofitable store locations, or to negotiate rent concessions,

-    Our  ability  to hire,  train,  manage and retain  qualified  retail  store
     management and sales professionals,

-    Our  ability to  maintain  cost-effective  production  and  delivery of our
     products,

-    Our ability to successfully expand our home delivery, assembly and mattress
     removal capability on a cost-effective basis,

-    The ability of various  third-party  providers  of  delivery,  assembly and
     mattress  removal  services to provide quality services on a cost-effective
     basis,

-    Our ability to  successfully  commercialize  our sofa sleeper  product line
     across our distribution channels and in major markets,

-    Our ability to successfully  identify and respond to emerging trends in the
     mattress industry,

-    The level of competition in the mattress industry,

-    General economic conditions and consumer confidence.

There can be no assurance  that we will be successful in achieving our strategic
plan or that



                                       13


this strategic plan will restore our company to historical sales growth rates or
to  profitability.  Failure to  successfully  execute any  material  part of our
strategic plan could have a material  adverse effect on our business,  financial
condition and operating results.

LIQUIDITY  AND  CAPITAL  RESOURCES.  The report of our  independent  accountants
contains  an  explanatory  paragraph  expressing  substantial  doubt  about  the
Company's  ability to  continue as a going  concern as a result of our  negative
cash flows and pre-tax  operating  losses of $26.0  million and $15.0 million in
2000 and 1999,  respectively,  and negative  working capital of $18.2 million at
December 30, 2000.  As a result of fiscal 2000  operating  losses and the recent
downturn in the economy,  which has  adversely  affected our sales  trends,  our
current cash flows may not be sufficient to meet our near-term  liquidity needs.
Our  near-term  cash needs are further  impacted by (i) the  seasonality  of our
business,  with lower sales  volumes  historically  occurring  during the second
quarter,  (ii) the timing of marketing and advertising  expenditures,  which are
higher in the early part of the year when direct marketing advertising rates are
more  favorable,  and (iii)  working  capital  needs as we expand our  wholesale
activities  through a significant  QVC sales event planned for May. Based on the
estimated  cash  impact  of the  items  outlined  above,  offset in part by more
aggressive efforts to manage our working capital needs, we estimate that between
$2 million and $8 million of additional  working  capital is required during the
second and third quarters.

Since the beginning of fiscal 2000, we have undertaken  efforts to substantially
reduce  our  cost  structure  as  outlined  above  in "--  Business  and  Growth
Strategy."  Following the recent  downturn in the economy and  evaluation of the
related impact on our  anticipated  sales volumes,  we implemented  further cost
saving initiatives. We expect that these cost reductions,  along with efforts to
increase  our  product  and  brand  awareness,   improve  our  sales  conversion
effectiveness  and expand our points of  distribution,  will  result in positive
cash flows from operations for the second half of fiscal 2001.

Since the fourth  quarter of 2000,  we have been pursuing $10 million or more of
working  capital  financing  from a variety  of  potential  sources.  Due to our
traditional  business model, under which we manufacture product to meet consumer
orders and  maintain  minimal  levels of finished  goods  inventory,  the recent
economic downturn,  and recent tightening of credit markets, we have been unable
to obtain traditional  asset-based  financing.  We therefore have recently begun
pursuing a private  placement  of $10 million to $12  million of senior  secured
debt  securities  convertible  into  shares of our common  stock  together  with
detachable   warrants  to  purchase  additional  shares  of  our  common  stock.
Consummation  of this  financing  as  currently  contemplated  would  result  in
substantial dilution to current shareholders.

We have received  non-binding  indications  of interest  from several  potential
investors  for a  significant  portion  of the  minimum  amount of this  private
placement,  and we are  continuing  to have  discussions  with  other  potential
investors.  We  believe  that we will be  able  to  consummate  this  financing.
However,  binding commitments have not been received and significant  conditions
to closing  remain to be met, and  therefore  no assurance  can be given that we
will be able to consummate this financing on satisfactory terms, or at all.

In addition to pursuing the financing described above, we have been aggressively
managing our costs and cash flow to preserve and extend our cash resources. Near
the end of 2000, we began to undertake  efforts to rightsize our cost structure.
The  economic  downturn  at the end of 2000  adversely  affected  sales  trends,
resulting in the  identification  and  execution of  additional  cost  reduction
measures. Efforts included termination of non-core business initiatives, closure
of certain facilities,  including one of three manufacturing facilities,  one of
two administrative offices and one of two call centers,  closure of 27 stores in
2000 with plans to close 14 stores in 2001,



                                       14


reduction of corporate and administrative  overhead and staffing, and adjustment
of advertising,  promotional and other marketing programs.  We are also pursuing
programs  to improve  our  liquidity,  including  negotiation  of  supplier  and
landlord  payment terms,  the reduction of inventory  levels and the deferral of
capital programs.

We believe that the financing  mentioned above, or other alternatives that might
become  available,  planned  and  implemented  cost  reduction  efforts  and the
aggressive  management  of  current  and  future  cash  resources  will  provide
sufficient working capital to fund our operations for the foreseeable future. If
for any  reason we are  unable to obtain  additional  financing,  or if our cash
management  efforts  were not  sufficient  to  preserve  enough cash to meet our
near-term  liquidity  needs,  we may not be able to continue as a going concern,
which may result in material asset  impairment or restructuring  charges,  other
material  adverse  changes in our  business,  results of operations or financial
condition,  or the loss by shareholders of all or a part of their  investment in
the Company.

See "Management's  Discussion and Analysis of Financial Condition and results of
Operations - Liquidity and Capital Resources."

EFFECTIVENESS   AND   EFFICIENCY  OF   ADVERTISING   EXPENDITURES.   Advertising
expenditures  were $33.4 million,  $43.4 million and $31.6 million in 2000, 1999
and  1998,  respectively.  Our  overall  marketing  spending  is  being  managed
downward, but with greater emphasis toward awareness-building  advertising.  Our
future growth and  profitability  will be dependent in part on the effectiveness
and efficiency of our advertising expenditures, including our ability to:

-    create greater awareness of our products and brand name,
-    determine  the  appropriate  creative  message  and  media  mix for  future
     advertising expenditures,
-    effectively  manage  advertising  costs  (including  creative and media) in
     order to  maintain  acceptable  costs  per  inquiry,  costs  per  order and
     operating margins, and
-    convert inquiries into actual orders.

No assurance can be given that our planned advertising  expenditures will result
in increased sales,  will generate  sufficient  levels of product and brand name
awareness or that we will be able to manage our  advertising  expenditures  on a
cost-effective basis.

FLUCTUATIONS  IN COMPARABLE  STORE SALES  RESULTS.  Our  comparable  store sales
results have fluctuated  significantly  in the past and these  fluctuations  are
likely to continue.  Stores enter the comparable store calculation in their 13th
full month of operation.  Our  comparable  store sales  increases  were 0.2% for
2000,  4.7% for 1999,  17.9% for 1998 and 34.6% for 1997.* Our comparable  store
sales  results  have  fluctuated  significantly  from  quarter to  quarter  with
increases  ranging from -4.1% to 36% on a quarterly basis for 1997 through 2000.
There can be no  assurance  that our  comparable  store sales  results  will not
fluctuate significantly in the future.

A variety of factors affect our comparable store sales results, including:

-    levels  of  consumer  awareness  of our  products,  brand  name  and  store
     locations,
-    levels of consumer acceptance of our existing and new products,
-    higher levels of sales in the first year of  operations as each  successive
     class of new stores is opened,
-    comparable store sales performance in prior periods,
-    the maturation of our store base,

---------------------------
* Fiscal 1997 was a 53-week  year versus 52 weeks for 1999 and 1998.  Comparable
store sales for 1998 and 1997,  adjusted to 52 weeks,  would be 27.3% and 26.1%,
respectively.


                                       15


-    the amount, timing and relative success of promotional events,  advertising
     expenditures, new product introductions and product line extensions,
-    the quality and tenure of store-level managers and sales professionals,
-    the amount of competitive activity,
-    the evolution of store operations,
-    changes in the sales mix between our distribution channels, and
-    general economic conditions and consumer confidence.
Decreases in comparable store sales results could have a material adverse effect
on our business, financial condition and operating results.

QUARTERLY  FLUCTUATIONS AND  SEASONALITY.  Our quarterly  operating  results may
fluctuate significantly as a result of a variety of factors, including:

-    increases or decreases in comparable store sales,
-    the timing, amount and effectiveness of advertising expenditures,
-    any increases in return rates,
-    the timing of new store openings and related expenses,
-    competitive factors,
-    net sales contributed by new stores,
-    any disruptions in third-party delivery services, and
-    general economic conditions and consumer confidence.

Our business is also subject to some seasonal  influences,  with lower  seasonal
sales in the second  quarter  and  heavier  concentrations  of sales  during the
fourth quarter holiday season due to higher mall traffic.

The level of  spending  related to sales and  marketing  expenses  and new store
opening costs cannot be adjusted  quickly and is based, in significant  part, on
our  expectations  of future  customer  inquiries  and net sales.  If there is a
shortfall in expected net sales or in the conversion rate of customer inquiries,
we may be unable to adjust our  spending  in a timely  manner and our  business,
financial condition and operating results may be materially  adversely affected.
Our results of operations for any quarter are not necessarily  indicative of the
results that may be achieved for a full year or any future quarter.

RELIANCE  UPON  PROVIDER OF CONSUMER  CREDIT  FACILITY.  Through a private label
consumer credit facility  provided by Conseco Bank, Inc. (the "Bank"),  we offer
our qualified  customers an unsecured  revolving  credit  arrangement to finance
purchases  from us.  The Bank  sets the  rates,  fees and all  other  terms  and
conditions  of  the  customer  accounts,   including   collection  policies  and
procedures,  and is the owner of the accounts.  In connection with all purchases
financed under these arrangements, the Bank pays us an amount equal to the total
amount of such purchases, net of promotional related discounts.

We have recently  been in  discussions  with the Bank  regarding the terms under
which the Bank will  continue  to make this  credit  facility  available  to our
customers.  As a result of these  discussions,  we have  agreed to  establish  a
reserve in the amount of $1 million to protect the Bank against potential losses
from  consumer  returns.  This  reserve  will be  established  in part  from the
proceeds of our pending  financing  transaction  and in part  through a discount
from the proceeds of credit  sales that we receive  from the Bank.  We have also
agreed that, in the event of any  termination of our agreement with the Bank and
replacement  of the Bank by an  alternative  third-party  provider  of  consumer
financing,  at the request of the Bank we will  purchase the Bank's  outstanding
portfolio of customer accounts for a pre-determined formula price.

Our  agreement  with the Bank also contains a provision  permitting  the Bank to
terminate  the  agreement  in the  event of a  material  adverse  change  in our
operations,  financial  condition,  business or  prospects.  If we are unable to
obtain  additional  financing,  no assurance can be given that the Bank will not
take action to terminate the agreement or request  material changes to the



                                       16


terms under which the Bank will continue to provide financing for our customers.
Termination of our agreement with the Bank, or any material  change to the terms
of our agreement with the Bank or in the availability or terms of credit for our
customers from the Bank,  could have a material  adverse effect on our business,
sales, results of operations or financial condition.

RELIANCE  UPON  SUPPLIERS;  SINGLE  SOURCE OF SUPPLY  OF AIR  CHAMBERS;  FOREIGN
SOURCES OF SUPPLY.  The inability of our suppliers to meet, for any reason,  our
requirements for any components of our bed products, or our requirements of sofa
sleeper  products,  could  have a  material  adverse  effect  on  our  business,
financial  condition  and  operating  results.  Our air chambers  are  currently
obtained  from a single  source of supply.  If this  supplier  became  unable or
unwilling  for any  reason  to  continue  to supply  us with air  chambers,  our
operations could be materially  adversely  affected.  We currently have a supply
agreement with this single source of supply that expires in August 2001 (subject
to automatic renewal if neither party gives 90 days' notice of non-renewal), but
there  can be no  assurance  that  this  single  source  of  supply  will not be
disrupted for any reason. In addition,  since our air chambers and certain other
supplies are  manufactured  outside the United States,  our operations  could be
materially  adversely  affected by the risks associated with foreign sourcing of
materials, including:

-    political instability resulting in disruption of trade,
-    existing or potential duties, tariffs or quotas that may limit the quantity
     of certain  types of goods that may be imported  into the United  States or
     increase the cost of such goods, and
-    any  significant  fluctuation  in the value of the dollar  against  foreign
     currencies.

With the exception of our air chambers,  we have no long-term purchase contracts
or other  contractual  assurances  of  continued  supply,  pricing  or access to
components.  The  inability  or failure of one or more key  suppliers  to supply
components,  the loss of one or more key  suppliers or a material  change in our
purchase terms could have a material  adverse effect on our business,  financial
condition and operating results.

RELIANCE UPON CARRIERS.  Historically,  we have relied almost exclusively on UPS
for  delivery of our products to  customers.  For a  significant  portion of the
third quarter of 1997, UPS was unable to deliver our products within  acceptable
time periods,  causing delays in deliveries to customers and requiring us to use
alternative  carriers.  No assurance  can be given that UPS will not  experience
difficulties  in meeting our  requirements  in the future.  In 2000, we began to
shift a portion of our product delivery business to Federal Express. We continue
to evaluate  alternative  carriers on a national and regional  basis, as well as
providers of in-home delivery and assembly  services.  There can be no assurance
that  alternative  carriers will be able to meet our requirements on a timely or
cost-effective  basis.  Any  significant  delay in  deliveries  to  customers or
increase in freight charges may have a material  adverse effect on our business,
financial condition and operating results.

RETURN  POLICY AND  PRODUCT  WARRANTY.  Part of our  marketing  and  advertising
strategy focuses on providing an in-home trial period during which customers may
return their Sleep Number bed and obtain a refund of the purchase price. We plan
to shorten this in-home trial period from 90 nights to 30 nights effective as of
May 29, 2001. We believe that a 30-night trial period is competitive  within our
industry  and  sufficient  to enable  consumers to  experience  the features and
benefits of our products.  No assurance can be given,  however, that this change
in policy will not have a material adverse effect on our sales volumes or return
rates.  Any  significant  decrease in sales  volumes or increase in return rates
could have a material  adverse effect on our business,  financial  condition and
operating results. We also provide our customers with a limited 20-year warranty
on our beds.  We have only been selling  beds in  significant  quantities  since
1992. There can be no assurance that our



                                       17


warranty reserves will be adequate to cover future warranty claims.  Significant
warranty claims in excess of our warranty reserves could have a material adverse
effect on our business, financial condition and operating results.

SALES  TAX  CONSIDERATIONS.  Prior to May 2000,  in  compliance  with  state and
federal tax regulations,  our direct  marketing and e-commerce  channels did not
collect sales tax from customers  residing in certain states.  Industry  experts
believe these regulations  potentially provide a competitive advantage to direct
marketers and e-commerce  companies  over retailers  located within these states
and who are required to collect sales tax. In  connection  with our provision of
in-home  delivery and  assembly of our products to customers  through all of our
distribution  channels,  as well as the  execution of our  integrated  marketing
plan, we began collecting sales tax on sales in all states. While we believe the
execution of these initiatives will positively impact the overall performance of
our company, the impact of this change could negatively impact sales.

PRODUCT DEVELOPMENT AND ENHANCEMENTS.  Our growth and future success will depend
upon our ability to enhance our existing  products and to develop and market new
products on a timely  basis that  respond to customer  needs and achieve  market
acceptance.  There can be no assurance  that we will be successful in developing
or  marketing  enhanced  or new  products,  or that  any such  products  will be
accepted by the market.  Further,  there can be no assurance  that the resulting
level of sales of any of our  enhanced or new  products  will  justify the costs
associated with their development and marketing.

MARKET  ACCEPTANCE.  The  U.S.  mattress  market  is  dominated  by  four  large
manufacturers of innerspring mattresses. Our air chamber technology represents a
significant departure from traditional  innerspring  mattresses.  The market for
air beds is  continuing  to  evolve  and the  success  of our  products  will be
dependent  upon  both the  continued  growth  of this  market  and  upon  market
acceptance of our beds. The failure of our beds to achieve market acceptance for
any reason  would  have a material  adverse  effect on our  business,  financial
condition and operating results.

INTELLECTUAL  PROPERTY  PROTECTION.  No assurance  can be given that our current
patents or pending patent  applications will provide  substantial  protection or
that  others  will  not be able to  develop  products  that  are  similar  to or
competitive  with our beds or  other  products.  In  addition,  there  can be no
assurance that copyright,  trademark, trade secret, unfair competition and other
intellectual  property  laws,  nondisclosure  agreements  and  other  protective
measures will  preclude  competitors  from  developing  products  similar to our
products  or  otherwise  competing  with us. In  addition,  the laws of  certain
foreign  countries  may  not  protect  our  intellectual   property  rights  and
confidential information to the same extent as the laws of the United States.

Although we are unaware of any basis for an intellectual  property  infringement
or invalidity  claim against us, there can be no assurance  that third  parties,
including  competitors,  will not assert  such  claims  against  us or that,  if
asserted,  such claims  will not be upheld.  Intellectual  property  litigation,
which could result in substantial cost to and diversion of effort by management,
may be  necessary  to enforce  our  patents,  to protect  our trade  secrets and
proprietary  technology  or to defend us  against  claimed  infringement  of the
rights of others and to  determine  the scope and  validity  of the  proprietary
rights of others.  There can be no assurance  that we would  prevail in any such
litigation  or that,  if it is  unsuccessful,  we would  be able to  obtain  any
necessary licenses on reasonable terms or at all.

COMPETITION.  The mattress industry is highly competitive. Our Sleep Number beds
compete with a number of  different  types of mattress  alternatives,  including
innerspring  mattresses,  waterbeds,  futons and other air-supported  mattresses
that are sold through a variety of channels, including furniture stores, bedding



                                       18


specialty  stores,   department   stores,   mass  merchants,   wholesale  clubs,
telemarketing programs, television infomercials and catalogs.

The  traditional  mattress  industry  is  characterized  by  a  high  degree  of
concentration  among the four largest  manufacturers  of innerspring  mattresses
with nationally  recognized brand names,  including  Sealy,  which also owns the
Stearns  &  Foster  brand  name,  Serta,   Simmons  and  Spring  Air.  Over  700
manufacturers,  primarily operating on a regional basis serve the balance of the
mattress market.  Many of these competitors,  and in particular the four largest
manufacturers  named above, have greater financial,  marketing and manufacturing
resources and better brand name  recognition than we do, and sell their products
through broader and more established distribution channels.

A number of companies  have begun to offer air beds in recent  years,  including
Simmons.  There can be no assurance  that these  companies or any other mattress
manufacturer, including the major innerspring manufactures named above, will not
aggressively pursue the air bed market or be successful on obtaining significant
market share of the air bed category.  Any such  competition by the  established
manufacturers  or new  entrants  into the market  could have a material  adverse
effect on our business,  financial condition and operating results. In addition,
should any of our competitors reduce prices on premium mattress products, we may
be required to implement price reductions in order to remain competitive,  which
could have a material  adverse effect on our business,  financial  condition and
operating results.

SHAREHOLDER LITIGATION. Select Comfort and certain former officers and directors
have been  named as  defendants  in a class  action  lawsuit  filed on behalf of
shareholders  in U.S.  District Court in Minnesota.  The named  plaintiffs,  who
purport to act on behalf of a class of purchasers of our common stock during the
period  from  December  4, 1998 to June 7,  1999,  charge  the  defendants  with
violations of federal  securities  laws. The suit alleges that we and the former
directors and officers failed to disclose or misrepresented  certain information
concerning our business during the class period.  The complaint does not specify
an amount of damages  claimed.  While we believe  that the  complaint is without
merit and intend to vigorously defend the claims, there can be no assurance that
we will be  successful  in defending  the lawsuit.  Defense of the suit could be
expensive  and may  create  a  distraction  to the  management  team.  If we are
unsuccessful  in defending the suit, an adverse  judgment  could have a material
adverse effect on our consolidated financial condition or results of operations.

POSSIBLE  DELISTING  FROM NASDAQ  STOCK  MARKET.  Our common  stock is currently
quoted on the Nasdaq  National  Market under the symbol "SCSS." We are currently
in compliance with Nasdaq's continued listing standards, including standards for
minimum  net  tangible  assets,  public  float,  minimum  bid  price,  number of
shareholders  and  number of market  makers.  If we are unable to  complete  our
private placement or obtain other financing, or if we are unable to successfully
implement our strategic initiatives to achieve profitability, we may not be able
to meet the financial  requirements for continued listing on the Nasdaq National
Market.

In the event that our common stock were to be delisted from the Nasdaq  National
Market and we were  ineligible for listing on the Nasdaq  SmallCap  Market,  our
common stock would thereafter likely be quoted in the "over-the-counter"  market
and eligible to trade on the OTC bulletin  board.  If our common stock traded on
the OTC bulletin board,  trading,  if any, would be subject to the "penny stock"
rules under the Securities Exchange Act of 1934. Consequently,  the liquidity of
our common stock could be impaired,  not only in the number of shares that could
be bought and sold, but also through  delays in the timing of the  transactions,
reductions in the security analysts' and the news media's coverage of our stock,
and lower prices for our common stock than it might otherwise attain.



                                       19


VOLATILITY IN MARKET PRICE OF COMMON STOCK. The market price of our common stock
has fluctuated significantly in the past and may do so in the future. The market
price of our common  stock may  fluctuate  as a result of a variety of  factors,
many of which are  outside of our  control,  including  without  limitation  the
following factors:

-    variations in quarterly operating results;

-    changes in estimates by securities analysts;

-    announcements of significant events;

-    additions or departures of key personnel; and

-    changes in market valuations of companies in our industry.

ITEM 2.   PROPERTIES

We currently  lease all of our existing  retail store  locations and expect that
our policy of leasing, rather than owning, will continue as we expand. Our store
leases  generally  provide  for an initial  lease term of 10 years with a mutual
termination option if we do not achieve certain minimum annual sales thresholds.
Generally,  the store leases require us to pay minimum rent plus percentage rent
based on net sales in excess of certain thresholds, as well as certain operating
expenses.

We lease  approximately  122,000 square feet of space in Minneapolis  for one of
our manufacturing and distribution  centers, our direct marketing call center, a
customer  service  center and a research  and  development  center,  which lease
expires in 2004.  We also lease  approximately  105,000  square feet of space in
Columbia,  South Carolina,  for another  manufacturing and distribution  center,
which lease expires in 2003. We have also leased  approximately  100,800  square
feet in Salt Lake City for an additional  manufacturing and distribution center,
opened in May of 1999,  which lease  expires in 2009.  We lease  another  16,100
square feet of office space in the Minneapolis  area, which we have vacated.  We
are in the process of seeking a sublessee for this space.

ITEM 3.    LEGAL PROCEEDINGS

Select  Comfort  and  certain  former  officers  and  directors  were  named  as
defendants in a class action lawsuit  initially  filed on June 1, 1999 on behalf
of shareholders in U.S. District Court in Minnesota.  The named plaintiffs,  who
purport to act on behalf of a class of purchasers of our common stock during the
period  from  December  4, 1998 to June 7,  1999,  charge  the  defendants  with
violations of federal  securities  laws.  The suit alleges that we and the named
directors and officers failed to disclose or misrepresented  certain information
concerning our business during the class period.  The complaint does not specify
an amount of damages claimed. We believe that the complaint is without merit and
intend to vigorously defend the claims.

The Company and the individual defendants brought a motion to dismiss all claims
on November 10, 1999. The motion was heard by a magistrate judge on December 21,
1999. On January 27, 2000, the magistrate  recommended  that the claims based on
Section  11  of  the  federal  securities  laws  be  dismissed.  The  magistrate
recommended  that the  motion to dismiss  be denied  with  respect to the claims
based on Rule 10b-5 of the federal  securities  laws. In February 2000, both the
plaintiffs   and  the   defendants   formally   objected  to  the   magistrate's
recommendation.  The objection was made to the United States  District  Court in
Minnesota.  On May 12,  2000,  the United  States  District  Court in  Minnesota
adopted the  recommendation of the magistrate and denied the defendants'  motion
to dismiss the Rule 10b-5 claims.  The Court also adopted the  recommendation of
the magistrate and dismissed the plaintiff's Section 11 claims without prejudice
and with leave to amend.

On March 31, 2000, the Company and certain of its former  officers and directors
were named as defendants in a class action lawsuit filed on



                                       20


behalf  of the  Company's  shareholders  in U.S.  District  Court  in  Minnesota
asserting identical factual allegations as the consolidated  complaint described
above.  The suit alleges claims based on Sections 11 and 12(a)(2) of the federal
securities  laws. The complaint  does not specify an amount of damages  claimed.
The Company  believes this  complaint is without merit and intends to vigorously
defend the claims.  The above two class actions were  consolidated by the United
States District Court Magistrate on July 24, 2000.

On January 30, 2001, the plaintiffs made a motion to certify a class.  The class
certification motion is pending. Discovery relative to this motion has begun.

We have agreed to indemnify the individual  defendants and to advance reasonable
expenses  of  defense  of the  litigation  to the  individual  defendants  under
applicable Minnesota corporate law. To date, we have paid an aggregate of $3,891
to the law firm of Briggs & Morgan on behalf of defendant H. Robert Hawthorne.

We are involved in other various claims, legal actions,  sales tax disputes, and
other complaints  arising in the ordinary course of business.  In the opinion of
management, any losses that may occur are adequately covered by insurance or are
provided for in the consolidated  financial  statements and the ultimate outcome
of these matters will not have a material effect on the  consolidated  financial
position or results of operations of the Company.



                                       21


ITEM 4A.  EXECUTIVE OFFICERS OF THE COMPANY

     Our  executive  officers,  their ages and the offices held, as of March 30,
2001, are as follows:

             NAME              AGE                  TITLE
----------------------------- ----- --------------------------------------------
William R. McLaughlin          44   President and Chief Executive Officer

Noel F. Schenker               47   Senior Vice President, Marketing and New
                                    Business Development

Gregory T. Kliner              63   Senior Vice President of Operations

James C. Raabe                 41   Vice President and Chief Financial Officer

Mark A. Kimball                42   Senior Vice President, Chief Administrative
                                    Officer, General Counsel and Secretary

Michael J. Thyken              39   Vice President and Chief Information Officer

Tracey T. Breazeale            34   Senior Vice President, Special Projects

Information  regarding the business  experience of our executive officers is set
forth below.

WILLIAM R. MCLAUGHLIN joined Select Comfort in March 2000 as President and Chief
Executive Officer. From December 1988 to March 2000, Mr. McLaughlin served as an
executive of Pepsico Foods International in various  capacities,  including from
September  1996 to March 2000 as President of Frito Lay Europe,  Middle East and
Africa,  and from June 1993 to June 1996 as President of Grupo Gamesa,  a cookie
and flour company based in Mexico.

NOEL F. SCHENKER joined Select Comfort as Senior Vice  President,  Marketing and
New Business  Development in November,  2000. Ms. Schenker served as Senior Vice
President of Marketing and Strategic Planning at Rollerblade, Inc., from 1992 to
1996,  and as an  independent  consultant  from  1996 to 2000.  She was with The
Pillsbury Company from 1981 to 1992,  serving as Vice President of Marketing for
the  Green  Giant  business.  Since  1996,  she also has  served on the Board of
Directors and Executive Committee of the Fortis Financial Group's Mutual Funds.

GREGORY T. KLINER has served as Senior Vice  President of  Operations  of Select
Comfort since August 1995.  From October 1986 to August 1995,  Mr. Kliner served
as Director of Operations  of the  Irrigation  Division for The Toro Company,  a
manufacturer of lawn care and snow removal products and irrigation systems.

JAMES C. RAABE was  elected as Vice  President  and Chief  Financial  Officer of
Select  Comfort in April 1999.  From  September  1997 to April 1999,  Mr.  Raabe
served as Controller of Select  Comfort.  From May 1992 to September  1997,  Mr.
Raabe served as Vice  President - Finance of ValueRx,  Inc., a pharmacy  benefit
management provider.  Mr. Raabe held various positions with KPMG LLP from August
1982 to May 1992.

MARK A.  KIMBALL  joined  Select  Comfort in May 1999 as Senior Vice  President,
Chief Administrative Officer,  General Counsel and Secretary. For more than five
years prior to joining Select Comfort, Mr. Kimball was a partner in the law firm
of Oppenheimer Wolff &



                                       22


Donnelly LLP practicing in the area of corporate finance.

MICHAEL J. THYKEN joined Select Comfort in July 2000 as Vice President and Chief
Information  Officer.  During 1999, Mr. Thyken was Group Director of Application
Development  at  Jostens,   a  Minneapolis  based   manufacturer  of  scholastic
recognition  products.  From 1994 to 1999,  Mr. Thyken was Director of Technical
Services for Target  Stores.  From 1984 to 1994,  Mr.  Thyken  served in various
positions with IBM Corporation.

TRACEY T. BREAZEALE was hired as Senior Vice President of Strategic Planning and
Branding of Select Comfort in July 1999. In February 2001, Ms.  Breazeale's work
schedule  was  reduced to 25% of full time,  and her title was changed to Senior
Vice President,  Special Projects.  Ms. Breazeale was with the Boston Consulting
Group from  October 1993 to July 1999,  initially  as a consultant  and the last
three years as a manager,  where she  specialized  on  strategic  and  marketing
oriented projects for retail and consumer product companies.


                                       23



                                     PART II

                              --------------------

ITEM 5.  MARKET  FOR THE  REGISTRANT'S  COMMON  EQUITY AND  RELATED  STOCKHOLDER
     MATTERS

Our common stock  trades on the Nasdaq  Stock Market under the symbol SCSS.  The
quarterly  high and low sales  prices for the common  stock,  as reported by the
Nasdaq Stock  Market,  for the two most recent fiscal years follows in the table
below. These quotations  reflect  inter-dealer  prices,  without retail mark-up,
mark-down or commission, and may not necessarily represent actual transactions.

               Fourth  Third   Second  First
               Quarter Quarter Quarter Quarter
               ------- ------- ------- -------
Fiscal 2000
High            $2.44   $3.50   $5.50   $6.50
Low             $0.96   $1.44   $2.38   $4.38
               ------- ------- ------- -------

Fiscal 1999
High            $7.06   $9.19  $29.88  $35.25
Low             $3.63   $6.00   $6.38  $20.50
               ------- ------- ------- -------


NUMBER OF RECORD HOLDERS; DIVIDENDS
As of March 28, 2001,  there were 178 record holders of our common stock. We did
not  declare or pay any cash  dividends  on the common  stock  during the fiscal
years ended  December 30, 2000 or January 1, 2000 and do not  anticipate  paying
any cash dividends on our common stock in the foreseeable future.

USE OF PROCEEDS FROM INITIAL PUBLIC OFFERING
On September 3, 1998,  we filed a  Registration  Statement on Form S-1 (File No.
333-62793)  with the  Securities and Exchange  Commission,  pursuant to which we
registered  the offer and sale under the federal  securities  laws of  4,600,000
shares of common  stock,  including  1,677,650  shares  sold by certain  selling
shareholders.  The SEC declared our Registration Statement effective on December
3, 1998, and the closing of the initial public  offering was held on December 9,
1998. The managing underwriters were Hambrecht & Quist LLC, BankBoston Robertson
Stephens Inc., Piper Jaffray Inc. and Charles Schwab & Co., Inc.

The aggregate offering price of all shares sold in the offering was $78,200,000.
The net  proceeds to Select  Comfort from the sale of the shares of common stock
offered by Select  Comfort was  $44,643,353,  after  deducting the  underwriting
discount of $3,477,597 and offering expenses of approximately $1,559,000. All of
the expenses  incurred in connection  with the initial public offering were paid
to unrelated parties or entities, except for the underwriting discount which was
given to, among others,  Hambrecht & Quist LLC.  Jean-Michel Valette, a director
of the  Company,  was a member of the  general  partner  of H&Q  Select  Comfort
Investors, L.P., a related party to Hambrecht & Quist LLC.

From  December 9, 1998 to December 30, 2000,  the net proceeds from the offering
have been used as follows:

  Repayment of long-term debt...........$15,325,480

  Repurchase of our common stock.........12,692,054

  Fund the build-out, start-up and
  leasing of our third manufacturing
  and distribution facility...............1,712,306

  Fund development of warranty and
  inquiry system..........................1,032,099

  Fund partial expansion of our retail
  store base.............................13,881,414
                                       -------------
                                        $44,643,353
                                       =============



                                       24


ITEM 6.  SELECTED FINANCIAL DATA

The data  presented  below  has been  derived  from the  Company's  consolidated
financial  statements  and  should  be read in  conjunction  with  "Management's
Discussion and Analysis of Financial  Condition and Results of  Operations"  and
the Company's  consolidated  financial  statements and notes thereto included in
this Annual Report on Form 10-K:



                                                                  YEAR ENDED (1)
                                             --------------------------------------------------------
                                             DEC. 30,    JAN. 1,    JAN. 2,     JAN. 3,    DEC. 28,
                                                2000       2000        1999       1998        1996
                                             ----------  ---------- ----------  ---------- ----------
                                                                            
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
   Net sales                                  $270,077    $273,767   $246,269    $184,430   $102,028
   Gross margin                                171,153     178,660    161,082     117,801     63,507
   Operating income (loss)(2)                  (25,970)    (14,793)    11,445       1,996     (3,764)
   Net income (loss) before extraordinary item (37,214)     (8,204)     6,636      (2,846)    (3,685)
   Net income (loss)                           (37,214)     (8,204)     5,195      (2,846)    (3,685)
   Net income (loss) per share - diluted (3):
     Net income (loss) per share before
       extraordinary item                        (2.09)      (0.45)      0.28       (1.59)     (2.61)
     Net income (loss) per share                 (2.09)      (0.45)      0.19       (1.59)     (2.61)
   Weighted average common shares - diluted     17,848      18,300     15,928       2,353      1,753
   Dividends paid per share                          -           -          -           -          -

SELECTED OPERATING DATA:
   Stores open at period-end (4)                   333         341        264         200        143
   Average square footage of stores open
      during period (5)                            913         893        895         866        768
   Sales per square foot (5)                       697         721        742         666        622
   Average store age (in months at period end)      41          31         27          22         15
   Comparable store sales increase (6)             0.2%        4.7%      23.5%       27.3%      26.1%

CONSOLIDATED BALANCE SHEET DATA:
   Cash and cash equivalents                    $1,498      $7,441    $45,561     $12,670     $2,422
   Marketable securities                         3,950      20,129          -           -          -
   Working capital                             (18,176)     14,470     42,249         757     (7,809)
   Total assets                                 64,672      95,865    106,234      57,241     29,794
   Long-term debt, less current maturities       2,322          36         29      19,511      1,162
   Mandatorily redeemable preferred stock            -           -          -      27,612     27,612
   Total common shareholders'equity (deficit)   16,600      52,872     70,691     (21,038)   (18,216)


-----------

(1)  Except for the year ended  January 3, 1998,  which  included 53 weeks,  all
     years presented included 52 weeks.
(2)  Includes  charges  for  impairment  of assets of $1.9  million for the year
     ended  December  30, 2000 and $1.5  million  for the year ended  January 1,
     2000. See Note 5 to the Consolidated Financial Statements.
(3)  See Note 11 of Notes to Consolidated Financial Statements.
(4)  Includes Select Comfort stores operated in leased departments within larger
     retail  stores (25 at  December  30,  2000,  45 at  January 1, 2000,  14 at
     January 2, 1999 and one at January 3, 1998).
(5)  For stores open during the entire period indicated.
(6)  Stores enter the comparable  store  calculation in their 13th full month of
     operation. The number of comparable stores used to calculate such data were
     314,  262,  199, 138 and 65 for fiscal  2000,  1999,  1998,  1997 and 1996,
     respectively.  Reflects  adjustment for  additional  week of sales in 1997.
     Without  adjusting for the additional  week,  comparable  store sales would
     have been 17.9% in 1998 and 34.6% in 1997.



                                       25


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

FORWARD LOOKING STATEMENTS

The following  discussion and analysis  should be read in  conjunction  with the
Consolidated  Financial  Statements and the Notes thereto included herein.  This
discussion contains forward looking statements within the meaning of the Private
Securities  Litigation Reform Act of 1995. Statements that are not of historical
fact may be  deemed  to be  forward-looking  statements.  Without  limiting  the
foregoing,  words  such as "may,"  "will,"  "expect,"  "believe,"  "anticipate,"
"estimate"  or "continue"  or  comparable  terminology  are intended to identify
forward-looking statements. These statements by their nature involve substantial
risks and uncertainties, and actual results may differ materially depending on a
variety of factors,  including those set forth above in Part I, Item 1 under the
heading entitled "Certain Risk Factors."

OVERVIEW

Select  Comfort  is the  leading  manufacturer,  specialty  retailer  and direct
marketer of premium  quality  innovative  air beds and  sleep-related  products.
Since the  introduction of our first air bed product in 1987, we have focused on
improving our product,  expanding our product line,  building  manufacturing and
distribution systems and growing our three distribution channels: retail, direct
marketing and  e-commerce.  Vertically  integrated  operations  and control over
these  complementary  distribution  channels  gives us direct  contact  with our
customers  and  gives our  customers  multiple  opportunities  to  purchase  our
products.  Sales  generation  is driven  primarily  by  targeted  print,  radio,
television,  and internet media that generate customer inquiries,  as well as by
our retail store and internet presence.

Since  the  latter  half of 2000,  we have  focused  on five  primary  strategic
priorities:   (i)  building  consumer  awareness,   (ii)  rightsizing  our  cost
structure,  (iii) improving our sales  conversion  effectiveness,  (iv) pursuing
alternative  distribution  channels,  and  (v)  continuously  improving  product
quality,  innovation and service levels.  Each of these strategic  priorities is
discussed  in  greater  detail  above  under  "Business  -  Business  and Growth
Strategy."  The  success of our  strategy  will  depend on many  factors  and is
subject to certain risks,  including the risks and uncertainties  outlined above
under "Business - Certain Risk Factors."

Retail operations included 333 stores at December 30, 2000,  including 25 leased
departments within larger stores,  341 stores at January 1, 2000,  (including 45
leased  departments)  and 264  stores at January  2, 1999  (including  14 leased
departments). During 2000, we opened 19 stores and closed 27 stores. In 2001, we
currently plan to open  approximately 13 additional retail stores,  primarily in
existing markets, and plan to close approximately 14 underperforming stores. The
majority of the costs associated with these closings were accrued in 2000.

The Company  reported  comparable  store sales growth of 0.2%, 4.7% and 23.5% in
2000, 1999 and 1998, respectively.  Comparable store sales results have been and
will continue to be influenced by a variety of factors, including:

-    levels  of  consumer  awareness  of our  products,  brand  name  and  store
     locations,
-    levels of consumer acceptance of our existing and new products,
-    higher levels of sales in the first year of  operations as each  successive
     class of new stores is opened,
-    comparable store sales performance in prior periods,
-    the maturation of our store base,
-    the amount, timing and relative success of promotional events,  advertising
     expenditures, new product introductions and product line extensions,
-    the quality and tenure of store-level managers and sales professionals,
-    the amount of competitive activity,
-    the evolution of store operations,



                                       26


-    changes in the sales mix between our distribution channels, and
-    general economic conditions and consumer confidence.

Advertising expenditures were $33.4 million,  $43.4 million and $31.6 million in
2000, 1999 and 1998, respectively. Advertising costs are expensed as incurred as
a  component  of  sales  and  marketing  expenses,   although  we  believe  that
advertising expenditures provide significant benefits beyond the period in which
they  are  expensed.   Future  advertising   expenditures  will  depend  on  the
effectiveness  and efficiency of the  advertising  in creating  awareness of our
products and brand name,  generating  consumer  inquiries  and driving  consumer
traffic to retail stores.  Pre-opening  costs  associated with new retail stores
are also expensed as incurred.

We believe  historical  operating  losses have been  primarily  the result of an
aggressive  retail store opening  strategy,  a relatively  immature  store base,
significant marketing, advertising and product development expenditures, and the
development of a substantial corporate  infrastructure to support future growth.
Future  increases in net sales and the  achievement  of long-term  profitability
will  depend upon  greater  consumer  awareness  and  acceptance  of our air bed
products, improved effectiveness and efficiency of our marketing and advertising
expenditures,   the  opening  and  successful   performance  of  new  points  of
distribution,  improvement in the  performance of current stores and our ability
to  realize  the  benefits  of our  cost  saving  initiatives.  There  can be no
assurance  that we will be able to achieve or sustain  historical  sales  growth
rates,  or to achieve  profitability  in the future,  on a  quarterly  or annual
basis.

Quarterly and annual operating  results may fluctuate  significantly as a result
of a variety of factors,  including  increases or decreases in comparable  store
sales, the timing,  amount and  effectiveness of advertising  expenditures,  any
changes in return rates, the timing of new store openings and related  expenses,
competitive  factors,  net sales  contributed by new stores,  any disruptions in
third-party  delivery  services  and general  economic  conditions  and consumer
confidence.  Our  business is also  subject to some  seasonal  influences,  with
heavier  concentrations of sales during the fourth quarter holiday season due to
increased mall traffic.

A  substantial  portion of operating  expenses is related to sales and marketing
expenses, including costs associated with opening new stores, operating existing
stores  and  advertising  expenditures.  The  level of such  spending  cannot be
adjusted  quickly and is based,  in significant  part, on expectations of future
customer  inquiries and net sales.  Furthermore,  a  substantial  portion of net
sales is often  realized  in the last  month of a  quarter  with  such net sales
frequently  concentrated in the last weeks or days of a quarter,  due in part to
our promotional schedule.  Should the Company experience a shortfall in expected
net sales or in the conversion rate of customer  inquiries,  we may be unable to
adjust  spending in a timely  manner and our business,  financial  condition and
operating results may be materially  adversely affected.  Our historical results
of operations  may not be indicative of the results that may be achieved for any
future fiscal period.

At December 30,  2000,  we had net  operating  loss  carryforwards  ("NOLs") for
federal income tax purposes of approximately  $31.4 million expiring between the
years 2003 and 2020.  We expect that  approximately  $1.4  million of these NOLs
will  expire  unutilized  due to an  Internal  Revenue  Code (IRC)  Section  382
limitation  resulting from a prior ownership change.  Realization of the benefit
of  the  deferred  tax  assets  depends  on us  achieving  profitability  levels
sufficient to utilize the NOLs.



                                       27


RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the Company's results
of operations expressed  as percentages of net sales. Percentage amounts may not
total due to rounding.

                                     Percentage of Net Sales
                                           Year Ended

                                   Dec. 30,  Jan. 1,   Jan. 2,
                                      2000     2000      1999
                                  --------- --------- ---------
Net sales                           100.0%    100.0%    100.0%
Cost of sales                        36.6      34.7      34.6
                                  --------- --------- ---------
  Gross margin                       63.4      65.3      65.4
                                  --------- --------- ---------
Operating expense:
  Sales and marketing                61.4      59.4      52.7
  General and administrative         10.8      10.7       8.0
  Store closing/impairments           0.7       0.5       0.0
                                  --------- --------- ---------
    Total operating expenses         73.0      70.7      60.8
                                  --------- --------- ---------
Operating income (loss)              (9.6)     (5.4)      4.7
Other income (expense), net           0.1       0.6      (2.9)
                                  --------- --------- ---------
Income (loss) before income taxes    (9.5)     (4.8)      1.8
Income tax expense(benefit)           4.3      (1.8)     (0.9)
                                  --------- --------- ---------
Net income (loss) before ext, net   (13.8)     (3.0)      2.7
Extraordinary item                   (0.0)      0.0      (0.6)
                                  --------- --------- ---------
Net income (loss)                   (13.8)%    (3.0)%     2.1%
                                  ========= ========= =========

The  operating  loss in 2000 was largely  due to a decline in net sales,  and an
increase in operating  expenses as a  percentage  of net sales,  reflecting  the
growth of our retail store selling infrastructure.  The decline in net sales was
due to a number of factors.  Advertising  spending was reduced by $10.0  million
(23%) in 2000  compared  to 1999,  as the  efficiency  of  advertising  programs
declined and the Company  worked to develop new creative  advertising  programs.
Additionally,  seasonal traffic in our retail stores fell short of expectations,
due in part to a softening  economic  climate during the fourth quarter of 2000.
Finally,  direct  marketing  sales declined by $24.3 million in 2000 compared to
1999,  primarily  due to the  continued  migration of the  Company's  sales from
direct  marketing  to retail  stores  and due to the  reduction  of  advertising
spending in this channel.  Selling expenses increased by $12.9 million resulting
in the net  overall  increase  in  operating  expenses.  The  increase  resulted
primarily  from higher  occupancy and  compensation  expenses  resulting from an
increase in the number of stores open for a full year in 2000.  Special  charges
of $3.5  million are  included in the 2000  results  related to store  closings,
asset impairments and severance costs related to two reductions in workforce

As noted above under  "Overview" and "Business - Business and Growth  Strategy,"
we have implemented several strategic initiatives that we believe will result in
improved operating results in 2001.

COMPARISON OF FISCAL 2000 AND FISCAL 1999

NET SALES
Net sales in 2000 decreased 1.3% to $270.1 million  from $273.8 million in 1999.
The  components of the decrease in net sales were (i) a $22.0  million  increase
from the opening of 19 new retail stores during 2000 and the full year impact of
77 stores opened in 1999,  (ii) a $0.4 million  increase from a 0.2% increase in
comparable  store  sales,  (iii) a $5.2  million  increase in net sales from the
Company's e-commerce channel,  offset by (iv) a $24.3 million decrease in direct
marketing  sales and (v) a $7.0 million  decrease due to the  elimination of our
road show distribution channel.

GROSS MARGIN
Gross  margin in 2000  decreased  to 63.4% from 65.3% in 1999  primarily  due to
larger  discounts on  promotional  offerings,  increased  costs from  processing
returned  product and  increased  costs from the  rollout of our new  foundation
product, partially offset by a price increase for some of our products.

SALES AND MARKETING
Sales and  marketing  expenses in 2000  increased  2.0% to $166.0  million  from
$162.7  million in 1999,  and increased as a percentage of net sales to 61.4% in
2000  from  59.4% in 1999.  The  increase  in the  dollar  amount  of sales  and
marketing expenses during 2000 was primarily due to (i) higher occupancy expense
related  primarily  to rent and  depreciation  expense,  (ii)  higher  wages and
compensation  expense  and (iii)  higher  freight  costs.  Sales  and  marketing
expenses  increased  as a  percentage  of net sales  primarily  due to (i) lower
direct marketing sales and (ii) selling  expenses in new stores  increasing at a
greater rate than net sales and the expenses



                                       28


associated  with the rollout of our sofa sleeper  product,  partially  offset by
(iii) a decrease in media spending.

GENERAL AND ADMINISTRATIVE
General and  administrative  expenses in 2000 were  $29.2 million,  equal to the
1999 expense level.  Slight  increases in wages and benefits expense were offset
by reductions in the use of outside services and consultants.

STORE CLOSINGS/IMPAIRMENTS
Store closing/impairment  expense in 2000 was $2.0 million, up from $1.5 million
in 1999. In 2000,  this expense  included $1.4 million related to the relocation
of our headquarter offices and web development costs and $0.6 million related to
store closures.  The expense of $1.5 million in 1999 relates almost  exclusively
to store closures.

OTHER INCOME (EXPENSE), NET
Other  income  decreased  $1.4  million to  approximately  $0.3 million of other
income in 2000 from $1.7 million in other income in 1999. The decrease is due to
lower  cash  levels  affecting  interest  income  in  2000.  In  addition,   the
recognition  of an equity loss in SleepTec  following  our  acquisition  of this
business reduced other income by $.6 million.

INCOME TAX EXPENSE (BENEFIT)
Income tax expense  increased  to $11.6  million for 2000 from a benefit of $4.8
million for 1999.  Income tax expense increased as a result of the establishment
of an additional  $21.1 million  deferred tax asset  valuation  allowance in the
fourth quarter of 2000 resulting from  uncertainties in the Company's  business.
See "Liquidity and Capital Resources."

COMPARISON OF FISCAL 1999 AND FISCAL 1998

NET SALES
Net sales in 1999 increased 11.2% to $273.8 million from $246.3 million in 1998,
primarily  due to an increase in unit sales.  The  components of the increase in
net sales were (i) a $33.6  million  increase  from the opening of 77 new retail
stores during 1999 and the full year impact of 64 stores opened in 1998,  (ii) a
$6.8 million  increase from a 4.7% increase in  comparable  store sales,  due in
part to the  continuing  maturation  of  stores  and  increased  advertising  in
selected markets,  (iii) a $4.3 million increase in net sales from the Company's
newly developed  e-commerce  channel,  partially  offset by (iv) a $15.3 million
decrease in direct marketing sales.

GROSS MARGIN
Gross margin in 1999  decreased to 65.3% from 65.4% in 1998.  Reductions in cost
of sales from improved purchasing and leverage of fixed manufacturing costs over
higher unit volumes were offset by higher sales discounts.

SALES AND MARKETING
Sales and marketing  expenses in 1999  increased  25.3% to  $162.7 million  from
$129.9 million  in 1998,  and increased as a percentage of net sales to 59.4% in
1999  from  52.7% in 1998.  The  increase  in the  dollar  amount  of sales  and
marketing  expenses  during 1999 was  primarily due to (i) the opening of 77 new
retail stores, (ii) an increase in advertising expenditures of $11.8 million and
(iii) higher commissions, percentage rents and freight expense related to higher
net sales.  Sales and marketing  expenses increased as a percentage of net sales
primarily due to (i) increased  advertising  focused on longer term sales growth
through brand and retail store awareness,  (ii) lower direct marketing sales and
(iii) selling  expenses  in new  stores  increasing  at a greater  rate than net
sales.

GENERAL AND ADMINISTRATIVE
General and  administrative  expenses in 1999 increased  48.1% to  $29.2 million
from $19.7 million in 1998. The increase in general and administrative  expenses
was primarily due to increased  spending on  infrastructure to support long-term
growth plans and strategic consulting studies undertaken to determine and refine
ongoing business strategies.

STORE CLOSINGS
Store closing  expense in 1999 was $1.5 million,  compared with $20,000 in 1998.
Store closing  expense for 1999 includes a $1.4 million charge  associated  with
plans to close 10 stores and other related store write-offs.



                                       29


OTHER INCOME (EXPENSE), NET
Other  income  increased  $8.8  million to  approximately  $1.8 million of other
income in 1999 from $7.0  million in other  expense in 1998.  The  increase  was
primarily due to (i) the inclusion of $5.6 million of non-cash  interest expense
in 1998 relating to the change in the fair value of an  outstanding  put warrant
and (ii) an increase in interest income on the cash obtained from the completion
of our initial public  offering in December  1998. The put provision  associated
with the warrant was  eliminated  effective on completion of the initial  public
offering.

INCOME TAX EXPENSE (BENEFIT)
Income tax benefit  increased  to $4.8 million in 1999 from $2.2 million in 1998
due to a decrease in taxable income in 1999.

EXTRAORDINARY ITEM
Net income in 1998 includes an extraordinary charge, net of income tax benefits,
of $1.4 million.  The charge relates to the write-off of certain deferred assets
associated with our $15.0 million debt  financing,  which was repaid in December
1998.

LIQUIDITY AND CAPITAL RESOURCES

The report of our  independent  accountants  contains an  explanatory  paragraph
expressing  substantial doubt about the Company's ability to continue as a going
concern as a result of our negative cash flows. The Company has incurred pre-tax
losses from  operations  of $26.0  million  and $15.0  million in 2000 and 1999,
respectively,  and had negative working capital of $18.2 million at December 30,
2000. As a result of fiscal 2000 operating losses and the recent downturn in the
economy,  which has adversely  affected our sales trends, our current cash flows
may not be sufficient to meet our near-term  liquidity needs. Our near-term cash
needs are further  impacted by (i) the  seasonality of our business,  with lower
sales volumes historically  occurring during the second quarter, (ii) the timing
of marketing and advertising expenditures, which are higher in the early part of
the year when direct marketing  advertising rates are more favorable,  and (iii)
working  capital  needs  as  we  expand  our  wholesale   activities  through  a
significant  QVC sales event planned for May. Based on the estimated cash impact
of the items outlined above, offset in part by more aggressive efforts to manage
our working capital needs, we estimate that between $2 million and $8 million of
additional working capital is required during the second and third quarters.

Since the beginning of fiscal 2000, we have undertaken  efforts to substantially
reduce our cost  structure as outlined above in "Business -- Business and Growth
Strategy."  Following the recent  downturn in the economy and  evaluation of the
related impact on our  anticipated  sales volumes,  we implemented  further cost
saving initiatives. We expect that these cost reductions,  along with efforts to
increase  our  product  and  brand  awareness,   improve  our  sales  conversion
effectiveness  and expand our points of  distribution,  will  result in positive
cash flows from operations for the balance of fiscal 2001.

Since the fourth  quarter of 2000,  we have been pursuing $10 million or more of
working  capital  financing  from a variety  of  potential  sources.  Due to our
traditional  business model, under which we manufacture product to meet consumer
orders and  maintain  minimal  levels of finished  goods  inventory,  the recent
economic downturn,  and recent tightening of credit markets, we have been unable
to obtain traditional asset-based financing.

We therefore have recently begun pursuing a private  placement of Senior Secured
Convertible  Debentures in a minimum  aggregate  principal amount of $10 million
and a maximum aggregate principal amount of $12 million. The principal amount of
the  Debentures  would  (i)  be  secured  by a  lien  on  the  Company's  assets
(subordinated  only to up to $5 million of senior bank  financing),  (ii) mature
five years after the closing, (iii) bear interest at 8% payable annually in cash
and (iii) be  convertible  into common stock  initially at the rate of $1.00 per
share, subject to anti-dilution  provisions. In addition, for each $1,000,000 in
principal  amount of Debentures  purchased,  investors would receive  detachable
warrants to purchase up to 300,000 shares of common stock of the



                                       30


Company  at  an  initial   exercise  price  of  $1.33  per  share,   subject  to
anti-dilution  provisions.  Debentures in the minimum aggregate principal amount
of $10 million and the related  warrants  would  represent  the right to acquire
more  than 20% of our  outstanding  common  stock and  would  therefore  require
approval of our shareholders under Nasdaq rules in order to maintain our listing
on the Nasdaq Stock  Market.  The issuance of the  Debentures  would  further be
subject  to  customary  representations,  warranties  and  covenants,  including
specified  events of default that may result in the acceleration of the maturity
of the Debentures,  as well as certain conditions to closing,  including (i) the
sale of  Debentures  in the minimum  principal  amount of $10 million,  (ii) the
receipt  of binding  proxies  from  holders of more than 50% of our  outstanding
shares of common stock to vote in favor of the transaction, (iii) the receipt by
our Board of  Directors  of a fairness  opinion  from an  independent  financial
advisor and (iv)  satisfactory  due  diligence and the execution and delivery of
definitive documentation.

We have received  non-binding  indications  of interest  from several  potential
investors  for a  significant  portion  of the  minimum  amount of this  private
placement,  and we are  continuing  to have  discussions  with  other  potential
investors.  We  believe  that we will be  able  to  consummate  this  financing.
However,  binding commitments have not been received and significant  conditions
to closing  remain to be met, and  therefore  no assurance  can be given that we
will be able to consummate this financing on the terms described above or on any
other terms.

In addition to pursuing the financing described above, we have been aggressively
managing our costs and cash flow to preserve and extend our cash resources. Near
the end of 2000, we began to undertake  efforts to rightsize our cost structure.
The  economic  downturn  at the end of 2000  adversely  affected  sales  trends,
resulting in the  identification  and  execution of  additional  cost  reduction
measures. Efforts included termination of non-core business initiatives, closure
of certain facilities,  including one of three manufacturing facilities,  one of
two administrative offices and one of two call centers,  closure of 27 stores in
2000  with  plans  to close  14  stores  in 2001,  reduction  of  corporate  and
administrative overhead and staffing, and adjustment of advertising, promotional
and other  marketing  programs.  We are also  pursuing  programs  to improve our
liquidity,  including  negotiation of supplier and landlord  payment terms,  the
reduction of inventory levels and the deferral of capital programs.

We believe that the financing  mentioned above, or other alternatives that might
become  available,  planned  and  implemented  cost  reduction  efforts  and the
aggressive  management  of  current  and  future  cash  resources  will  provide
sufficient working capital to fund operations for the foreseeable future. If for
any  reason  we are  unable  to  obtain  additional  financing,  or if our  cash
management  efforts  were not  sufficient  to  preserve  enough cash to meet our
near-term  liquidity  needs,  we may not be able to continue as a going concern,
which may result in material asset  impairment or restructuring  charges,  other
material  adverse  changes in our  business,  results of operations or financial
condition,  or the loss by shareholders of all or a part of their  investment in
the Company.

Historically,  our  primary  source  of  liquidity  has been the sale of  equity
securities. We completed our initial public offering in December 1998, resulting
in net proceeds of $44.6 million,  which have been used for (i) the repayment of
$15.0  million of debt,  (ii) expansion  of retail  stores,  (iii) expansion  of
manufacturing  capabilities,  (iv) the repurchase of 1,220,000 shares of Company
common stock for $12.7 million and (v) the development of information technology
systems. The Company had negative working capital of approximately $18.2 million
at December 30, 2000, and positive  working capital of  $14.5 million at January
1, 2000.

Net cash used in 2000 operating  activities was approximately  $10.3 million and
consisted  primarily  of the net loss  adjusted  for  non-cash  expenses  and an
increase in accounts receivable,  partially offset by a decrease in income taxes



                                       31


receivable  and an  increase  in  accounts  payable.  Net cash  provided by 1999
operating  activities was approximately $7.7 million and consisted  primarily of
net loss adjusted for non-cash  expenses,  decreases in accounts  receivable and
increases  in  accounts  payable and accrued  liabilities,  partially  offset by
increases in  inventories  and income  taxes  receivable.  Net cash  provided by
operating  activities  for 1998 was  approximately  $11.0  million and consisted
primarily of cash flows from  operations  before  non-cash  expenses,  partially
offset by increases in accounts receivable and decreases in accounts payable.

Net  cash  provided  by  investing  activities  in 2000 was  approximately  $3.7
million.  Net cash used in investing  activities was approximately $35.8 million
and $8.9 million in the years 1999 and 1998, respectively.  Investing activities
consisted of purchases of property and  equipment  for new retail  stores in all
periods, and for 1999 also included the opening of our Utah production facility.
In 2000 we  liquidated  $16.2  million of  marketable  securities to support our
continuing  operations,  while in 1999 we purchased  $20.1 million of marketable
securities for the investment of excess cash on hand.

Net cash provided by (used in) financing  activities for 2000, 1999 and 1998 was
approximately $0.7 million,  ($10.0) million,  $30.7 million,  respectively. Net
cash  provided by financing  activities in 2000 resulted from cash received from
the issuance of common stock. Net cash used in financing activities for 1999 was
due to repurchases of common stock and debt repayments, partially offset by cash
received  from issuance of common stock.  During 1999,  the Company  repurchased
1,220,000  shares of common  stock for  approximately  $12.7  million.  Net cash
provided by financing  activities for 1998 consisted  primarily of proceeds from
completion of our initial public offering,  partially offset by debt repayments.
Financial  instruments that potentially  subject us to  concentrations of credit
risk consist  principally of investments.  The  counterparties to the agreements
consist of  government  agencies and various major  corporations  of high credit
standing.  We do not believe there is  significant  risk of  non-performance  by
these  counterparties  because we limit the amount of credit exposure to any one
financial institution and any one type of investment.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Information  concerning  disclosure  about market risk is set forth in Note 3 to
our Consolidated Financial Statements included in this report.

ITEM 8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The consolidated financial statements are listed under item 14 of this report.

ITEM  9.  CHANGES  IN AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING  AND
FINANCIAL DISCLOSURE

None.


                                       32



                                    PART III

                              --------------------


ITEM 10.  DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS AND CONTROL PERSONS
The information  under the captions  "Election of Directors - Information  About
Nominees and  Directors"  and "Election of Directors - Other  Information  About
Nominees and Directors" in our 2001 Proxy  Statement is  incorporated  herein by
reference.  The information  concerning  executive officers of Select Comfort is
included in this Report under Item 4a, "Executive Officers of the Company."

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The information under the caption "Section 16(a) Beneficial  Ownership Reporting
Compliance" in our 2001 Proxy Statement is incorporated herein by reference.

ITEM 11. EXECUTIVE COMPENSATION

The   information   under  the  captions   "Election  of  Directors  -  Director
Compensation" and "Executive  Compensation and Other Benefits" in our 2001 Proxy
Statement is incorporated herein by reference.

ITEM 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

The  information  under  the  caption  "Principal  Shareholders  and  Beneficial
Ownership of Management" in our 2001 Proxy Statement is  incorporated  herein by
reference.

ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The  information  under the  caption  "Certain  Transactions"  in our 2001 Proxy
Statement is incorporated herein by reference.


                                       33



                                     PART IV

                              --------------------

ITEM 14.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a)  1. INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                                                                  Page Number in
                                                                     this Report
                                                                     -----------
     Independent Auditors' Report............................................F-1

     Consolidated Balance Sheets as of December 30, 2000 and
     January 1, 2000.........................................................F-2

     Consolidated Statements of Operations for the years ended December
     30, 2000,  January 1, 2000 and January 2, 1999..........................F-3

     Consolidated Statements of Shareholders' Equity for the years ended
     December 30, 2000, January 1, 2000 and January 2, 1999..................F-4

     Consolidated  Statements  of Cash Flows for the years  ended  December
     30, 2000, January 1, 2000 and January 2, 1999...........................F-5

     Notes to Consolidated Financial Statements......................F-6 to F-18

     Management's Report....................................................F-19

     2. INDEX TO CONSOLIDATED FINANCIAL STATEMENT SCHEDULES

     The following Report and financial  statement schedule are included in this
     Part IV and are found in this Report at the pages indicated.

     Independent Auditors' Report on Schedule................................S-1

     Schedule II - Valuation and Qualified Accounts..........................S-1

     All other  schedules  are omitted  because they are not  applicable  or the
     required  information is included in the consolidated  financial statements
     or notes thereto.


                                       34



     3. EXHIBITS

          The exhibits to this Report are listed in the Exhibit Index below.

          Select Comfort will furnish a copy of any of the exhibits  referred to
     above at a  reasonable  cost to any  shareholder  upon receipt of a written
     request therefor.  Requests should be sent to: Select Comfort  Corporation,
     6105 Trenton Lane North,  Minneapolis,  Minnesota 55442; Attn:  Shareholder
     Information.

          The following is a list of each  management  contract or  compensatory
     plan or  arrangement  required  to be filed as an  exhibit  to this  Annual
     Report on Form 10-K pursuant to Item 14(c):

     1.   Form  of  Incentive  Stock  Option  Agreement  under  the  1997  Stock
          Incentive Plan

     2.   Form of Performance  Based Stock Option Agreement under the 1997 Stock
          Incentive Plan

     3.   Employment  Letter dated July 11, 1995 between the Company and Gregory
          T. Kliner

     4.   Employment  Letter  dated  November  12, 1997  between the Company and
          Ronald E. Mayle

     5.   Select Comfort Profit Sharing and 401(K) Plan

     6.   Select Comfort Corporation 1999 Employee Stock Purchase Plan

     7.   Select Comfort  Corporation 1990 Omnibus Stock Option Plan, as amended
          and restated

     8.   Select Comfort  Corporation  1997 Stock Incentive Plan, as amended and
          restated

     9.   Employment  Letter  dated July 21, 1999 between the Company and Tracey
          T. Breazeale

     10.  Employment Letter dated April 22, 1999 between the Company and Mark A.
          Kimball

     11.  Executive and Key Employee Incentive Plan

     12.  Employment  Letter dated March 3, 2000 between the Company and William
          R. McLaughlin

     13.  Employment  Letter dated July 11, 2000 between the Company and Michael
          J. Thyken

     14.  Employment  Letter dated October 27, 2000 between the Company and Noel
          F. Schenker



                                       35



(b)  REPORTS ON FORM 8-K

     During the quarter ended  December 30, 2000, we filed one Current Report on
     Form  8-K.  This  report  was filed on  November  22,  2000 to  report  the
     acquisition by the Company of certain assets and business of SleepTec, Inc.
     This Current Report on Form 8-K was amended on February 16, 2001 to include
     the following financial statements:

     Audited Financial Statements of SleepTec,  Inc. as of December 31, 1999 and
     for the year ended  December 31, 1999 and the period  August 13, 1997 (date
     of incorporation) to December 31, 1999.

     Unaudited  Interim Financial  Statements of SleepTec,  Inc. as of September
     30, 2000 and for the nine months ended September 30, 2000 and 1999.

     Unaudited  Pro  Forma  Condensed  Combined  Financial   Information  as  of
     September  30, 2000 and for the year ended January 1, 2000 and for the nine
     months ended September 30, 2000.


                                       36



                                   SIGNATURES

     Pursuant  to the  requirements  of  Section  13 or 15(d) of the  Securities
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


Dated:  April 16, 2001      By: /s/ William R. McLaughlin
                                ------------------------------
                                    William R. McLaughlin
                                    President and Chief Executive Officer
                                    (principal executive officer)


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

     Pursuant to the  requirements of the Securities  Exchange Act of 1934, this
Report  has  been  signed  below  by the  following  persons  on  behalf  of the
Registrant and in the capacities and on the dates indicated.

NAME                                TITLE                         DATE
---------------------------------   ----------------------------  --------------
/s/ Patrick A. Hopf                 Chairman of the Board         April 16, 2001
---------------------------
Patrick A. Hopf


/s/ William R. McLaughlin           President and Chief           April 16, 2001
---------------------------         Executive Officer, Director
William R. McLaughlin


/s/ Ervin R. Shames                 Director                      April 16, 2001
---------------------------
Ervin R. Shames


/s/ Thomas J. Albani                Director                      April 15, 2001
---------------------------
Thomas J. Albani


/s/ Christopher P. Kirchen          Director                      April 16, 2001
---------------------------
Christopher P. Kirchen


                                       37


/s/ David T. Kollat                 Director                      April 13, 2001
---------------------------
David T. Kollat


                                    Director                      April   , 2001
---------------------------
Jean-Michel Valette



                                       38



                           SELECT COMFORT CORPORATION
                   EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K
                      FOR THE YEAR ENDED DECEMBER 30, 2000



 EXHIBIT
    NO.    DESCRIPTION                                          METHOD OF FILING
 -------   ---------------------------------------------------- -------------------------------
                                                          

    3.1    Restated Articles of Incorporation of the Company,   Incorporated by reference to
           as amended.......................................... Exhibit 3.1 contained in Select
                                                                Comfort's Annual Report on Form
                                                                10-K for the fiscal year ended
                                                                January 1, 2000
                                                                (File No. 0-25121)

    3.2    Restated Bylaws of the Company...................... Incorporated by reference to
                                                                Exhibit 3.2 contained in the
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

    4.1    Form of Warrant issued in connection with the sale   Incorporated by reference to
           of Convertible Preferred Stock, Series E............ Exhibit 4.2 contained in Select
                                                                Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

    4.2    Form of Warrant issued in connection with the        Incorporated by reference to
           November 1996 Bridge Financing...................... Exhibit 4.3 contained in the
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

    4.3    Amended and Restated Registration Rights Agreement   Incorporated by reference to
           dated December 28, 1995............................. Exhibit 4.4 contained in the
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

    4.4    First Amendment to Series E Stock Purchase           Incorporated by reference to
           Agreement and Amended and Restated Registration      Exhibit 4.5 contained in Select
           Rights Agreement dated April 25, 1996............... Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

    4.5    Second Amendment to Amended and Restated             Incorporated by reference to
           Registration Rights Agreement dated as of            Exhibit 4.6 contained in Select
           November 1, 1996.................................... Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

    4.6    Second (sic) Amendment to Amended and Restated       Incorporated by reference to
           Registration Rights Agreement dated March 24, 1997.. Exhibit 4.7 contained in Select
                                                                Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

                                       39



   4.7    Series A Warrant effective as of March 31, 1998       Incorporated by reference to
          issued to General Electric Capital Corporation......  Exhibit 4.8 contained in Select
                                                                Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   4.8    Convertible Subordinated Debenture dated as of        Incorporated by reference to
          November 10, 2000, between Select Comfort and         Exhibit 4.1 contained in Select
          SleepTec, Inc.......................................  Comfort's Current Report on
                                                                Form 8-K filed November 22,
                                                                2000 (File  No. 0-25121)

   10.1   Net Lease Agreement dated December 3, 1993 between    Incorporated by reference to
          the Company and Opus Corporation....................  Exhibit 10.1 contained in
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.2   Amendment of Lease dated August 10, 1994 between the  Incorporated by reference to
          Company and Opus Corporation........................  Exhibit 10.2 contained in the
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.3   Second Amendment to Lease dated May 10, 1995 between  Incorporated by reference to
          the Company and Rushmore Plaza Partners Limited       Exhibit 10.3 contained in
          Partnership (successor to Opus Corporation).........  Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.4   Letter Agreement dated as of October 5, 1995 between  Incorporated by reference to
          the Company and Rushmore Plaza Partners               Exhibit 10.4 contained in
          Limited Partnership.................................  Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.5   Third Amendment of Lease, Assignment and Assumption   Incorporated by reference to
          of Lease and Consent dated as of January 1, 1996      Exhibit 10.5 contained in
          among the Company, Rushmore Plaza Partners Limited    Select Comfort's Registration
          Partnership and Select Comfort Direct Corporation...  Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.6   Sublease dated as of March 27, 1997 between Select    Incorporated by reference to
          Comfort SC Corporation and Bellsouth                  Exhibit 10.6 contained in
          Telecommunications, Inc.............................  Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.7   Supply Agreement dated August 23, 1994 between the    Incorporated by reference to
          Company and Supplier (1)............................  Exhibit 10.8 contained in
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

                                       40


   10.8   Major Merchant Agreement dated December 19, 1997      Incorporated by reference to
          among First National Bank of Omaha and the Company,   Exhibit 10.13 contained in
          Select Comfort SC Corporation, Select Comfort Retail  Select Comfort's Registration
          Corporation and Select Comfort Direct Corporation...  Statement on Form S-1, as
                                                                amended (File No. 333-62793)

   10.9   Form of Incentive Stock Option Agreement under the    Incorporated by reference to
          1997 Stock Incentive Plan...........................  Exhibit 10.16 contained in the
                                                                Company's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

  10.10   Form of Performance Based Stock Option Agreement      Incorporated by reference to
          under the 1997 Stock Incentive Plan.................  Exhibit 10.17 contained in
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

  10.11   Employment Letter Agreement dated July 11, 1995       Incorporated by reference to
          between the Company and Gregory T. Kliner...........  Exhibit 10.20 contained in
                                                                Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

  10.12   Employment Letter Agreement dated November 12, 1997   Incorporated by reference to
          between the Company and Ronald E. Mayle.............  Exhibit 10.20 contained in
                                                                Select Comfort's Annual Report
                                                                on Form 10-K for the fiscal
                                                                year ended January 2, 1999
                                                                (File  No. 0-25121)

  10.13   Lease Agreement dated September 30, 1998 between      Incorporated by reference to
          the Company and ProLogis Development Services         Exhibit 10.28 contained in
          Incorporated........................................  Select Comfort's Registration
                                                                Statement on Form S-1, as
                                                                amended (File No. 333-62793)

  10.14   Revolving Credit Program Agreement by and between     Incorporated by reference to
          Green Tree Financial Corporation and Select Comfort   Exhibit 10.3 contained in
          Corporation (1).....................................  Select Comfort's Quarterly
                                                                Report on Form 10-Q for the
                                                                quarter ended July 3, 1999
                                                                (File No. 0-25121)

  10.15   Letter of Agreement by and between Bed, Bath & Beyond Incorporated by reference to
          Inc. and Select Comfort Retail Corporation (1)....... Exhibit 10.4 contained in
                                                                Select Comfort's Quarterly
                                                                Report on Form 10-Q for the
                                                                quarter ended July 3, 1999
                                                                (File  No. 0-25121)

  10.16   Select Comfort Profit Sharing and 401(K) Plan.......  Incorporated by reference to
                                                                Exhibit 10.5 contained in
                                                                Select Comfort's Quarterly
                                                                Report on Form 10-Q for the
                                                                quarter ended July 3, 1999
                                                                (File No. 0-25121)


                                       41



  10.17   Select Comfort Corporation 1999 Employee Stock
          Purchase Plan, as amended...........................  Filed herewith electronically

  10.18   Select Comfort Corporation 1990 Omnibus Stock Option  Incorporated by reference to
          Plan, as amended and restated.......................  Exhibit 10.1 contained in
                                                                Select Comfort's Quarterly
                                                                Report on Form 10-Q for the
                                                                quarter ended October 2, 1999
                                                                (File  No. 0-25121)

  10.19   Select Comfort Corporation 1997 Stock Inventive       Incorporated by reference to
          Plan, as amended and restated.......................  Exhibit 10.1 contained in
                                                                Select Comfort's Quarterly
                                                                Report on Form 10-Q for the
                                                                quarter ended July  1, 2000
                                                                (File  No. 0-25121)

  10.20   Employment Letter Agreement dated July 21, 1999       Incorporated by reference to
          between the Company and Tracey T. Breazeale.........  Exhibit 10.24 contained in
                                                                Select Comfort's Annual Report
                                                                on Form 10-K for the fiscal
                                                                year ended January 1,  2000
                                                                (File  No. 0-25121)

  10.21   Employment Letter Agreement dated April 22, 1999      Incorporated by reference to
          between the Company and Mark A. Kimball.............  Exhibit 10.25 contained in
                                                                Select Comfort's Annual Report
                                                                on Form 10-K for the fiscal
                                                                year ended January 1, 2000
                                                                (File  No. 0-25121)

  10.22   Executive and Key Employee Incentive Plan...........  Filed electronically herewith

  10.23   Employment Letter dated March 3, 2000 between the     Incorporated by reference to
          Company and William R. McLaughlin...................  Exhibit 10.1 contained in
                                                                Select Comfort's Quarterly
                                                                Report on Form 10-Q for the
                                                                quarter ended April 1, 2000

  10.24   Employment Letter dated July 11, 2000 between the
          Company and Michael J. Thyken.......................  Filed electronically herewith

  10.25   Employment Letter dated October 27, 2000 between the
          Company and Noel F. Schenker........................  Filed electronically herewith

  10.26   Asset Purchase Agreement dated as of November 10,     Incorporated by reference to
          2000, among SleepTec, Inc., St. Paul Venture Capital  Exhibit 2.1 contained in Select
          IV, LLC, St. Paul Venture Capital V, LLC, St. Paul    Comfort's Current Report on
          Venture Capital VI, LLC and Select Comfort            Form 8-K filed November 22,
          Corporation.........................................  2000 (File No. 0-25121)


                                       42



  10.27   Letter Agreement dated as of July 1, 2000 between
          Messner Vetere Berger McNamee Schmetterer/Euro RSCG
          Inc. and Select Comfort Retail Corporation..........  Filed electronically herewith





  21.1    Subsidiaries of the Company.........................  Incorporated by reference to
                                                                Exhibit 21.1 contained in
                                                                Select Comfort's Annual Report
                                                                on Form 10-K for the fiscal
                                                                year ended January 1, 2000
                                                                (File No. 0-25121)

   23.1   Independent Auditors' Consent.......................  Filed electronically herewith

   27.1   Financial Data Schedule.............................  Filed electronically herewith


     (1) Confidential  treatment has been granted by the Securities and Exchange
     Commission with respect to designated  portions  contained within document.
     Such portions have been omitted and filed  separately  with the  Securities
     and  Exchange  Commission  pursuant  to Rule  24b-2 of the  Securities  and
     Exchange Act of 1934, as amended.


                                       43


                          INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
Select Comfort Corporation:

     We have  audited the  accompanying  consolidated  balance  sheets of Select
Comfort  Corporation and subsidiaries  (the Company) as of December 30, 2000 and
January  1,  2000  and  the  related  consolidated   statements  of  operations,
shareholders'  equity,  and  cash  flows  for  each of the  fiscal  years in the
three-year  period  ended  December  30,  2000.  These  consolidated   financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

     We conducted our audits in accordance  with  auditing  standards  generally
accepted in the United States of America.  Those standards  require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  An audit includes examining, on a
test basis,  evidence  supporting  the amounts and  disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made by  management,  as well as evaluating  the overall
financial  statement  presentation.   We  believe  that  our  audits  provide  a
reasonable basis for our opinion.

     In our opinion,  the consolidated  financial  statements  referred to above
present  fairly,  in all material  respects,  the  financial  position of Select
Comfort  Corporation  and  subsidiaries  as of December  30, 2000 and January 1,
2000,  and the results of their  operations and their cash flows for each of the
fiscal years in the three-year period ended December 30, 2000 in conformity with
accounting principles generally accepted in the United States of America.

     The accompanying  financial statements have been prepared assuming that the
Company  will  continue  as a  going  concern.  As  discussed  in  Note 1 to the
financial  statements,  the Company has incurred  negative cash flows that raise
substantial doubt about its ability to continue as a going concern. Management's
plans in regard to these  matters are also  described  in Note 1. The  financial
statements do not include any adjustments  that might result from the outcome of
this uncertainty.


Minneapolis, Minnesota                                        /s/ KPMG LLP
February 2, 2001, except with respect to Notes 1 and 10
          which are as of April 12, 2001

                                      F-1



                           SELECT COMFORT CORPORATION
                                AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS
                      DECEMBER 30, 2000 AND JANUARY 1, 2000
               (IN THOUSANDS, EXCEPT SHARE AND PER SHARE AMOUNTS)



                                ASSETS                                   2000         1999
                                                                      ----------  -----------
                                                                            
 Current assets:
    Cash and cash equivalents                                           $ 1,498     $ 7,441
      Marketable securities (note 3)                                      3,950      20,129
    Accounts receivable, net of allowance for doubtful
       accounts of $264, and $305, respectively                           2,693       1,056
    Inventories (note 4)                                                 11,083      11,451
    Prepaid expenses                                                      4,741       4,821
    Income taxes (note 10)                                                    -       2,579
    Deferred tax assets (note 10)                                             -       6,639
                                                                      ----------  -----------
        Total current assets                                             23,965      54,116
                                                                      ----------  -----------

 Property and equipment, net (note 5)                                    37,063      34,823
 Deferred tax assets (note 10)                                                -       4,248
 Other assets                                                             3,644       2,176
                                                                      ----------  -----------
        Total assets                                                    $64,672     $95,363
                                                                      ==========  ===========


                 LIABILITIES AND SHAREHOLDERS' EQUITY
 Current liabilities:
    Current maturities of long-term debt (note 7)                       $    38     $    51
    Accounts payable                                                     17,271      15,911
    Accruals:
      Sales returns                                                       5,284       5,880
      Warranty costs                                                      7,181       5,841
      Compensation, taxes and benefits                                    6,238       6,678
     Other                                                                6,129       5,285
                                                                      ----------  -----------
        Total current liabilities                                        42,141      39,646

 Long-term debt, less current maturities (note 7)                         2,322          36
 Other liabilities                                                        3,609       2,809
                                                                      ----------  -----------
        Total liabilities                                                48,072      42,491
                                                                      ----------  -----------

 Shareholders' equity (notes 1, 2, 7, 8, 9, 12, and 13):
   Undesignated preferred stock; 5,000,000 shares authorized,
     no shares issued and outstanding                                         -           -
   Common stock, $.01 par value; 95,000,000 shares
     authorized, 17,962,689 and 17,713,247 shares issued
     and outstanding, respectively                                          180         177
   Additional paid-in capital                                            79,452      78,513
   Accumulated deficit                                                  (63,032)    (25,818)
                                                                      ----------  -----------
        Total shareholders' equity                                       16,600      52,872
                                                                      ----------  -----------
 Commitments and contingencies (notes 1, 6,and 14):
        Total liabilities and shareholders' equity                      $64,672   $   95,363
                                                                      ==========  ===========



                 See accompanying notes to consolidated financial statements.


                                      F-2



                           SELECT COMFORT CORPORATION
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS
       YEARS ENDED DECEMBER 30, 2000, JANUARY 1, 2000 AND JANUARY 2, 1999
                    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)



                                                   2000          1999          1998
                                                ------------  ------------  -----------
                                                                    
Net sales                                        $270,077      $273,767      $246,269
Cost of sales                                      98,924        95,107        85,187
                                                ------------  ------------  -----------
   Gross margin                                   171,153       178,660       161,082
                                                ------------  ------------  -----------
Operating expenses:
   Sales and marketing                            165,960       162,742       129,894
   General and administrative                      29,211        29,213        19,723
   Store closings/asset impairments (note 5)        1,952         1,498            20
                                                ------------  ------------  -----------
       Total operating expenses                   197,123       193,453       149,637
                                                ------------  ------------  -----------
Operating income (loss)                           (25,970)      (14,793)       11,445
                                                ------------  ------------  -----------
Other income (expense):
   Interest income                                  1,082         1,956           825
   Interest expense (note 7)                          (26)          (69)       (7,834)
   Equity in loss of affiliate (note 2)              (642)            -             -
   Other, net                                         (66)         (116)          (32)
                                                ------------  ------------  -----------
       Other income (expense), net                    348         1,771        (7,041)
                                                ------------  ------------  -----------
Income (loss) before income taxes and
   extraordinary item                             (25,622)      (13,022)        4,404
Income tax expense (benefit) (note 10)             11,592       (4,818)       (2,232)
                                                ------------  ------------  -----------
Net income (loss) before extraordinary item       (37,214)       (8,204)        6,636
Extraordinary item, net of tax benefit (note 7)         -             -        (1,441)
                                                ------------  ------------  -----------
Net income (loss)                                $(37,214)      $(8,204)      $ 5,195
                                                ============  ============  ===========

Deemed dividend from revision of preferred
   stock conversion rate (note 8)                       -             -       $(1,312)
Cumulative preferred dividends                          -             -          (821)
                                                ------------  ------------  -----------
Net income (loss) available to common
   shareholders                                  $(37,214)      $(8,204)     $  3,062
                                                ============  ============  ===========
Net income (loss) per share - basic (note 11)
   Net income (loss) before extraordinary item   $  (2.09)      $ (0.45)     $   1.09
   Net income (loss)                                (2.09)        (0.45)         0.74
                                                ============  ============  ===========
Net income (loss) per share - diluted (note 11)
   Net income (loss) before extraordinary item   $  (2.09)      $ (0.45)     $   0.28
     Net income (loss)                              (2.09)        (0.45)         0.19
                                                ============  ============  ===========



              See accompanying notes to consolidated financial statements.


                                      F-3



                           SELECT COMFORT CORPORATION
                                AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
       YEARS ENDED DECEMBER 30, 2000, JANUARY 1, 2000 AND JANUARY 2, 1999
                      (IN THOUSANDS, EXCEPT SHARE AMOUNTS)




                                                                  Additional                   Notes
                                                                    Paid-in    Accumulated  Receivable-
                                           Shares       Amount      Capital      Deficit     Investors      Total
                                        -----------  -----------  -----------  -----------  -----------  -----------
                                                                                       

Balance at January 3, 1998               2,477,660         $ 25      $ 1,662     $(22,307)       $(418)    $(21,038)
   Issuance of shares in initial public
     offering (note 9)                   2,922,350           29       44,614            -            -       44,643
   Conversion of manditorily redeemable
     preferred stock (note 8)           12,332,364          123       27,489            -            -       27,612
   Exercise of common stock options
     and warrants                          703,313            7        4,639            -            -        4,646
   Issuance of investor notes                    -            -            -            -         (487)        (487)
   Payment of investor notes                     -            -            -            -          905          905
   Elimination of put provision
     on warrant (note 7)                         -            -        9,215            -            -        9,215
   Net income                                    -            -            -        5,195            -        5,195
                                        -----------  -----------  -----------  -----------  -----------  -----------
Balance at January 2, 1999              18,435,687          184       87,619      (17,112)           -       70,691
                                        -----------  -----------  -----------  -----------  -----------  -----------
   Exercise of common stock options
     and warrants                          479,855            5        3,470            -            -        3,475
   Repurchase of common stock           (1,220,000)         (12)     (12,680)           -            -      (12,692)
   Employee stock purchases (note 12)       17,705            -          104            -            -          104
   Net loss                                      -            -            -       (8,204)           -       (8,204)
                                        -----------  -----------  -----------  -----------  -----------  -----------
Balance at January 1, 2000 as
  previously reported                   17,713,247          177       78,513      (25,316)           -       53,374
                                        -----------  -----------  -----------  -----------  -----------  -----------
  Acquisition of SleepTec, Inc. (note 2)         -            -            -         (502)           -        (502)
                                        -----------  -----------  -----------  -----------  -----------  -----------
Balance at January 1, 2000              17,713,247          177       78,513      (25,818)           -       52,872
                                        -----------  -----------  -----------  -----------  -----------  -----------
   Exercise of common stock options
     and warrants                           44,515            1          414            -            -          415
   Employee stock purchases (note 12)      204,927            2          525            -            -          527
   Net loss                                      -            -            -      (37,214)           -      (37,214)
                                        -----------  -----------  -----------  -----------  -----------  -----------
Balance at December 30, 2000            17,962,689         $180      $79,452     $(63,032)       $   -     $ 16,600
                                        ===========  ===========  ===========  ===========  ===========  ===========



          See accompanying notes to consolidated financial statements.


                                      F-4



                           SELECT COMFORT CORPORATION
                                AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS
       YEARS ENDED DECEMBER 30, 2000, JANUARY 1, 2000 AND JANUARY 2, 1999
                                 (IN THOUSANDS)



                                                               2000        1999        1998
                                                            ----------- -----------  ----------
                                                                            
Cash flows from operating activities:
   Net income (loss)                                          $(37,214)    $(8,204)    $ 5,195
   Adjustments to reconcile net income (loss) to
       net cash provided by operating activities:
     Depreciation and amortization                               8,409       6,695       5,351
     Loss on disposal of assets and impaired assets              2,167       1,297          50
     Extraordinary item                                              -           -       1,441
     Deferred tax assets                                        10,887     (4,998)     (5,888)
     Interest expense from put warrant valuation                     -           -       5,625
     Change in operating assets and liabilities net
      of effects of acquisition:
       Accounts receivable, net                                 (1,637)      9,568      (4,663)
       Inventories                                                 640      (1,315)     (2,387)
       Prepaid expenses                                             80        (773)        208
       Income taxes                                              2,579      (3,227)      1,856
       Accounts payable                                          1,360       3,832        (120)
       Accrued sales returns                                      (596)       (141)        697
       Accrued warranty costs                                    1,340       1,355       1,229
       Accrued compensation, taxes and benefits                   (173)      1,835       1,694
       Other accrued liabilities                                   537         723        (265)
       Other assets                                                535         147         252
       Other liabilities                                           800         863         709
                                                            ----------- -----------  ----------
         Net cash provided by (used in) operating activities   (10,286)      7,657      10,984
                                                            ----------- -----------  ----------
Cash flows used in investing activities:
   Purchases of property and equipment                         (12,084)    (13,663)     (8,812)
   Sales of (investments in) marketable securities              16,179     (20,129)          -
   Investment in affiliate                                        (400)     (2,000)          -
                                                            ----------- -----------  ----------
         Net cash provided by (used in) investing activities     3,695     (35,792)     (8,812)
                                                            ----------- -----------  ----------
Cash flows from financing activities:
   Principal payments on debt                                      (16)       (872)    (15,999)
   Repurchase of common stock                                        -     (12,692)          -
   Proceeds from issuance of common stock                          664       3,579      46,718
                                                            ----------- -----------  ----------
         Net cash provided by (used in) financing activities       648      (9,985)     30,719
                                                            ----------- -----------  ----------

Increase (decrease) in cash and cash equivalents                (5,943)    (38,120)     32,891
Cash and cash equivalents, at beginning of year                  7,441      45,561      12,670
                                                            ----------- -----------  ----------
Cash and cash equivalents, at end of year                     $  1,498     $ 7,441     $45,561
                                                            =========== ===========  ==========

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION (NOTE 2)
 Cash paid during the year for:
     Interest                                                 $     7      $    69     $ 1,719
     Income taxes                                                  175       2,292       1,800
   Cashless exercise of stock options                                -           -       1,483
   Net tax benefit from exercise of stock options                   11       1,115         493
                                                            =========== ===========  ==========


                  See accompanying notes to consolidated financial statements.


                                      F-5



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BUSINESS

     Select Comfort Corporation and its wholly-owned  subsidiaries (the Company)
develop,  manufacture,  and  market  air beds and  sleep-related  products.  The
Company's  fiscal year ends on the Saturday closest to December 31. Fiscal years
2000,  1999  and  1998  had 52  weeks.  Certain  prior-year  amounts  have  been
reclassified to conform to the current-year presentation.

PRINCIPLES OF CONSOLIDATION

     The consolidated  financial  statements include the accounts of the Company
and its subsidiaries.  All significant  inter-company  balances and transactions
have been eliminated in consolidation.

GOING CONCERN CONSIDERATIONS

     The financial statements have been prepared on a going-concern basis, which
contemplates  the realization of assets and the  satisfaction of liabilities and
other  commitments  in the normal  course of business.  The Company has incurred
negative  cash  flows  and  has  incurred   pretax  losses  from  operations  of
$25,970,000 and  $14,793,000 in 2000 and 1999,  respectively.  In addition,  the
Company had negative  working capital of $18,176,000 at December 30. 2000. These
factors,  among others,  indicate  that there is a  substantial  doubt about the
Company's ability to continue as a going concern.  These financial statements do
not include any adjustments relating to the recoverability and classification of
recorded asset amounts or the amounts and  classification  of  liabilities  that
might  be  necessary  if it was  unable  to  continue  as a going  concern.  The
Company's continuation as a going concern is dependent, among other things, upon
obtaining  positive  cash  flow from  operations  or upon its  ability  to raise
additional working capital.

     Near the end of 2000, the Company began to undertake  efforts to right size
its cost structure.  The economic downturn at the end of 2000 adversely affected
sales trends,  resulting in the  identification and execution of additional cost
reduction  measures.  Efforts have  included  termination  of non-core  business
initiatives, closure of certain facilities, including one of three manufacturing
facilities,  one of two  administrative  offices  and one of two  call  centers,
closure of 27 stores in 2000 with plans to close 14 stores in 2001, reduction of
corporate  and   administrative   overhead  and  staffing,   and  adjustment  of
advertising,  promotional  and other  marketing  programs.  The  Company is also
pursuing  programs to improve its liquidity,  including  negotiation of supplier
and landlord  payment terms,  the reduction of inventory levels and the deferral
of capital programs.

     Since the fourth quarter of 2000, the Company has been pursuing $10 million
or more of working capital  financing from a variety of potential  sources.  The
Company is pursuing a private  placement of $10 million to $12 million of senior
secured debt  securities  convertible  into shares of common stock together with
detachable warrants to purchase additional shares of common stock.  Consummation
of this  financing  as  contemplated  could  result in  substantial  dilution to
current  shareholders.  Based on discussions  with  potential  investors in this
private placement,  the Company believes that it will be able to consummate this
financing.  However,  firm  commitments  have not been received and  significant
conditions to closing  remain to be met, and therefore no assurance can be given
that it will be able to consummate this financing on  satisfactory  terms, or at
all.

     While  management  believes  that  implementation  of its plans to  achieve
profitability  and obtain  additional  capital will provide  sufficient  working
capital to fund  operations for the  foreseeable  future,  there is no assurance
that such actions  will achieve  positive  results from  operations  or adequate
working capital and equity.

CASH AND CASH EQUIVALENTS

     Cash and cash equivalents  include highly liquid  investments with original
maturities of three months or less.

INVENTORIES

     Inventories  include  material,  labor,  and overhead and are stated at the
lower of cost or market. Cost is determined by the first-in, first-out method.


                                      F-6



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

PROPERTY AND EQUIPMENT

     Property  and  equipment,  carried  at  cost,  are  depreciated  using  the
straight-line  method over the estimated useful lives of the assets, which range
from three to seven years. Leasehold improvements are amortized over the shorter
of the life of the lease or ten years.

OTHER ASSETS

     Other assets include security deposits, patents,  investments,  trademarks,
debt issuance costs and goodwill. Patents and trademarks are amortized using the
straight-line  method over periods  ranging from 10 to 17 years.  Debt  issuance
costs are amortized  using the  straight-line  method over the term of the debt.
Goodwill  is being  amortized  using  the  straight-line  method  over a 10-year
period.

IMPAIRMENT OF LONG-LIVED ASSETS AND LONG-LIVED ASSETS TO BE DISPOSED OF

     The  Company  reviews  its  long-lived  assets  and  certain   identifiable
intangibles for impairment whenever events or changes in circumstances  indicate
that the carrying amount of an asset may not be recoverable.  Recoverability  of
assets to be held and used is measured by a comparison of the carrying amount of
an asset to future net cash flows expected to be generated by the asset. If such
assets are  considered  to be  impaired,  the  impairment  to be  recognized  is
measured by the amount by which the  carrying  amount of the assets  exceeds the
fair value of the assets.  Assets to be disposed of are reported at the lower of
the carrying  amount or fair value less costs to sell. The Company reviews store
assets for  possible  impairment  considering  such factors as store cash flows,
lease termination provisions, and opportunities to impact future store operating
results.

ACCRUED WARRANTY COSTS

     The Company  provides a 20-year  warranty on air beds, the last 15 years of
which are on a prorated basis. Estimated warranty costs are provided at the time
of sale based on historical  claims  incurred by the Company.  Given the limited
history available, actual results could differ from these estimates.

ACCRUED SALES RETURNS

     Estimated  sales  returns  are  provided  at the  time of sale  based  upon
historical  sales  returns.  Returns  are  allowed by the  Company for 90 nights
following the sale.

FAIR VALUE OF FINANCIAL INSTRUMENTS

     The carrying  value of cash and cash  equivalents  and accounts  receivable
approximate fair value because of the short-term  maturity of those instruments.
The fair  value of  long-term  debt  approximates  carrying  value  based on the
Company's  estimate of rates that would be  available to it for debt of the same
remaining maturities.

REVENUE RECOGNITION

     Revenue  is  recognized  when  products  are  shipped to  customers  net of
estimated  returns.  The  Company  records  shipping  and  handling  costs  as a
component of sales and marketing expense.

STOCK COMPENSATION

     The Company records  compensation expense for option grants under its stock
option plan if the current  market  value of the  underlying  stock at the grant
date exceeds the stock option  exercise price.  Pro forma  disclosure of the net
income  impact  of  applying  an  alternative   method  of   recognizing   stock
compensation  expense  over the  vesting  period  based on the fair value of all
stock-based  awards on the date of grant is presented in Note 9. The Company has
issued options to non-employees and recognized compensation expense based on the
fair market value method.


                                      F-7



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(1) BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

RESEARCH AND DEVELOPMENT COSTS

     Costs incurred in connection  with research and  development are charged to
expense as incurred.  Research and development expense was $889,000,  $1,865,000
and $1,638,000 in 2000, 1999 and 1998, respectively.

PRE-OPENING COSTS

     Costs associated with the opening of new stores are expensed as incurred.

ADVERTISING COSTS

     The Company incurs  advertising  costs  associated with print and broadcast
advertisements.  Such costs are  charged to  expense  as  incurred.  Advertising
expense was $33,444,000, $43,415,000 and $31,648,000 in 2000, 1999 and 1998.

INCOME TAXES

     The Company  recognizes  deferred tax assets and liabilities for the future
tax  consequences  attributable to temporary  differences  between the financial
statement  carrying  amounts  of  existing  assets  and  liabilities  and  their
respective  tax bases.  Deferred tax assets and  liabilities  are measured using
enacted  tax rates  expected  to apply to  taxable  income in the years in which
those temporary  differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.

EARNINGS PER SHARE

     Basic  earnings  (loss) per share  excludes  dilution  and is  computed  by
dividing the net income (loss) available to common  shareholders by the weighted
average number of common shares outstanding during the period.  Diluted earnings
(loss) per share includes  dilutive  potential common shares consisting of stock
options and warrants  determined  by the  treasury  stock  method,  and dilutive
convertible securities.

ACCOUNTING ESTIMATES

     The  preparation of  consolidated  financial  statements in conformity with
accounting  principles  generally  accepted  in the  United  States  of  America
requires  management to make estimates and assumptions  that affect the reported
amounts  of assets and  liabilities  and  disclosure  of  contingent  assets and
liabilities  at the  date  of the  consolidated  financial  statements  and  the
reported  amounts of revenues and expenses during the reporting  period.  Actual
results could differ from those estimates.

NEW ACCOUNTING PRONOUNCEMENTS

     The Financial  Accounting Standards Board has issued Statement of Financial
Accounting Standards No 133, "Accounting for Derivative  Instruments and Hedging
Activities",   which  requires  implementation  during  2001.  The  Company  has
evaluated the impact of SFAS 133 and has determined that the pronouncement  will
not impact the Company's consolidated financial statements.

(2) ACQUISITION

     Effective  November 10, 2000,  the Company  completed  the  acquisition  of
certain assets of SleepTec, Inc. ("SleepTec"), the manufacturer of the Company's
sofa sleeper  product.  The  acquisition  of SleepTec was  accounted  for by the
purchase  method of  accounting.  The  Company  made an original  investment  in
SleepTec  of  $2,000,000  in May  1999  and  accounted  for the  less  than  20%
investment under the cost method. The subsequent acquisition in 2000 resulted in
step-acquisition treatment of the original May 1999 investment. Accordingly, the
results of  operations  of  SleepTec  for 1999,  in the amount of the  Company's
ownership  interest  (15.7%) are  included  as an  adjustment  to 1999  retained
earnings ($502,000).  The results of SleepTec's operations for 2000 are included
in  the  Company's  consolidated  results  as a  loss  in  equity  of  affiliate
($642,000) and amortization of goodwill related to this purchase  transaction is
included in general and administrative expense ($46,000).


                                      F-8



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(2) ACQUISITION (CONTINUED)

     The aggregate purchase price paid by the Company for the assets of SleepTec
consists  of  (i)  a  non-interest-bearing  subordinated  convertible  debenture
("debenture") in the original  principal amount of $4,000,000,  due November 10,
2005 and  convertible  at any time into shares of the Company's  common stock at
the rate of $5.50 per share of  common  stock;  and (ii)  $400,000  in cash.  In
addition,  the Company agreed to fund approximately $250,000 in a combination of
cash and  equity (in the form of options  to  purchase  shares of the  Company's
common  stock)  payments  to  current  and  former  employees  of  SleepTec  for
transition   services  and  severance   compensation.   The  Company's   largest
shareholder is the holder of the SleepTec debenture.

     The purchase price was determined through arm's-length negotiations between
the Company and  representatives  of SleepTec based  primarily upon the past and
projected stream of earnings of the SleepTec operations. The source of the funds
used to pay the  purchase  price was cash on hand at the Company and by issuance
of the debenture.

     A summary of the assets  acquired and the amount paid for this  acquisition
is as follows (in thousands):

              Inventory                                      $272
              Property, plant and equipment                   544
              Patents and trademarks (amortized by the
                straight-line method over ten years)           50
              Goodwill (amortized by the straight-line
                method over ten years)                      2,864
                                                        ----------
            Purchase price                                  3,730
                                                        ----------
            Less:
              Amount previously paid for SleepTec, net
                of equity losses                             (742)
              Transaction costs, included in goodwill
                balance above                                (318)
              Value of $4,000,000 non-interest bearing
                subordinated convertible debenture         (2,270)
                                                        ----------
            Net cash paid                                    $400
                                                        ==========

     The asset and liability  balances  noted above,  excluding  cash paid,  are
treated as non-cash items in the statement of cash flows.

     The value of the $4,000,000  non-interest bearing subordinated  convertible
debenture was  determined  based on its net cash flows using a 12% discount rate
and a five-year term.

     Unaudited pro forma results of operations  for the years ended December 30,
2000,  and January 1, 2000,  as if the Company and SleepTec had been combined as
of the beginning of those years follows. The pro forma results include estimates
and assumptions  which management  believes are reasonable.  However,  pro forma
results do not  include  any cost  savings or any other  effects of the  planned
integration of the Company and SleepTec,  and are not necessarily  indicative of
the results  which would have occurred if the business  combination  had been in
effect on the dates indicated, or which may result in the future.

                                              PRO FORMA    PRO FORMA
                                             DECEMBER 30,  JANUARY 1,
    (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)     2000         2000
                                             ------------ ------------
    Net sales                                  $270,479    $274,011
    Net loss                                    (19,901)    (12,240)
    Net loss per share - diluted                  (1.12)      (0.67)
                                             ============ ============


                                      F-9



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(3) MARKETABLE SECURITIES

     Securities classified as held to maturity, which consist of securities that
management  has the  ability  and  intent to hold to  maturity,  are  carried at
amortized cost, and are summarized as follows: (in thousands):

                                     AVERAGE
                                    INTEREST  AMORTIZED    FAIR
                                      RATE       COST      VALUE
                                   ---------- ---------- ---------
         DECEMBER 30, 2000
         Commercial paper                6.7%     3,950     3,949
                                   -------------------------------
                                                $ 3,950  $  3,949
                                   ===============================

         JANUARY 1, 2000
         U.S. Government agencies        5.5%   $ 7,244   $ 7,228
         Commercial paper                5.8%    12,885    12,877
                                   -------------------------------
                                                $20,129   $20,105
                                   ===============================

(4) INVENTORIES

     Inventories consist of the following (in thousands):

                           DECEMBER 30, 2000    JANUARY 1, 2000
                           ------------------  -----------------
         Raw materials          $ 5,507            $ 5,753
         Work in progress            60                 59
         Finished goods           5,516              5,639
                           ------------------------------------
                                $11,083            $11,451
                           ====================================

(5) PROPERTY AND EQUIPMENT

     Property and equipment are summarized as follows (in thousands):

                                              DECEMBER 30, 2000  JANUARY 1, 2000
                                              -----------------  ---------------
  Leasehold improvements                            $35,712          $33,192
  Office furniture and equipment                      5,097            5,314
  Production machinery and computer equipment        19,794           13,115
  Property and equipment under capital lease            112              495
  Other                                                 188            1,108
  Less accumulated depreciation and
    amortization                                    (23,840)         (17,401)
                                              ----------------------------------
                                                    $37,063          $34,823
                                              ==================================

STORE CLOSINGS AND ASSET IMPAIRMENT CHARGES

     Store closing and write off expense was $565,000,  $1,498,000,  and $20,000
in 2000, 1999 and 1998, respectively, associated with 16 stores, 22 stores and 1
store in 2000, 1999 and 1998 respectively.

     During 2000,  the Company  incurred  charges of  $1,387,000  related to the
impairment  of  carrying  values of  certain  non-store  assets.  These  charges
included  $741,000  related to  relocation  of the  Company's  headquarters  and
$646,000 related to the write-off of web software design costs.


                                      F-10



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(6) LEASES

     The Company  rents  office and  manufacturing  space  under four  operating
leases which,  in addition to the minimum lease  payments,  require payment of a
proportionate  share of the real estate taxes and building  operating  expenses.
The Company also rents retail space under operating leases which, in addition to
the minimum lease payments, require payment of percentage rents based upon sales
levels. Rent expense was as follows:

                                2000      1999      1998
                              --------   -------   -------
Minimum rents                  $17,589   $15,399   $11,127
Percentage rents                 1,835     1,992     1,522
                             ------------------------------
Total                          $19,424   $17,391   $12,649
                             ==============================

Equipment rent                 $ 1,587   $ 1,362   $   952
                             ==============================

     The  aggregate  minimum  rental  commitments  under  operating  leases  for
subsequent years are as follows (in thousands):


                   2001                           $15,376
                   2002                            15,088
                   2003                            14,311
                   2004                            12,853
                   2005                            11,308
                   Thereafter                      24,143
                                               -------------
                                                  $93,079
                                               =============

(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS

     Long-term  obligations  under notes and  capital  leases are as follows (in
thousands):

                                              DECEMBER 30, 2000  JANUARY 1, 2000
                                              -----------------  ---------------
Non-interest bearing subordinated
   convertible debenture for the acquisition
   of certain assets of SleepTec, Inc. due
   November 2005.  Face amount of $4,000,000
   net of $1,711,000 debt discount, with an
   effective interest rate of 12% per
   annum.  Convertible into 727,273 shares
   of common stock at the rate of $5.50 per
   share (note 2).                                    $2,289           $ -
Notes payable under capital lease  agreements
   for office  equipment,  payable in monthly
   installments through April 2003, with
   interest at 7.75% - 12.5% per annum.                   71            87
                                              ----------------------------------
                                                       2,360            87
Less current maturities                                   38            51
                                              ----------------------------------
                                                      $2,322           $36
                                              ==================================

     The aggregate  maturities of long-term  debt and capital lease  obligations
for subsequent years are as follows (in thousands):

                   2001                             $  38
                   2002                                28
                   2003                                 5
                   2004                                 -
                   2005                             4,000
                   Thereafter                           -
                                                ------------
                                                   $4,071
                                                ============


                                      F-11



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(7) LONG-TERM DEBT AND CAPITAL LEASE OBLIGATIONS (CONTINUED)

     In March 1997,  the Company  completed a financing  under which it issued a
senior  subordinated  promissory note in the principal amount of $15,000,000,  a
warrant to purchase 1,100,000 shares of the Company's common stock at $10.50 per
share and a warrant to purchase  1,000,000  shares of common  stock at $0.01 per
share.  These warrants were subsequently  adjusted and combined,  resulting in a
single warrant to purchase  1,315,096 shares of common stock at $8.82 per share,
exercisable  at any time  prior to March 31,  2005.  The  holder  has  exercised
238,998  warrants to date.  This  warrant  includes an  anti-dilution  provision
resulting in warrants  outstanding  of 1,131,357 at $8.39 and 1,083,391 at $8.76
at December 30, 2000 and January 1, 2000, respectively.

     In December 1998,  the Company  repaid the promissory  note resulting in an
extraordinary loss of $1,441,000 from early repayment. The loss was comprised of
unamortized  debt discount and issuance  costs totaling  $2,281,000,  and net of
income tax benefits of $840,000.

     The original warrant issued in the financing provided that the holder could
require  repurchase  of the  warrant if an IPO had not been  completed  prior to
March 27, 2002. The repurchase amount would have been equal to the excess of the
estimated fair market value of the Company's  common stock, as determined by the
warrant agreement,  over the exercise price of the warrant. The Company also has
an option to repurchase the warrant if the warrant has not been exercised  prior
to March 27,  2004.  The  warrant  was  recorded  at fair value and  recorded as
long-term debt.  Changes in fair value of the warrant were reflected as interest
expense.  Accordingly,  the financial  statements  reflect  interest  expense of
$5,625,000 for 1998 related to this warrant.

     Upon completion of the Company's  initial public offering the put option on
the warrants  expired and the warrants  were  reclassified  into  $9,215,000  of
additional  paid-in-capital.  In  addition,  effective  upon  completion  of the
Company's initial public offering, warrant revaluation is no longer required and
accordingly interest expense is no longer recorded.

(8) MANDATORILY REDEEMABLE PREFERRED STOCK

     Prior to completion of the Company's  initial  public  offering in December
1998, the Company had issued and  outstanding  12,091,962  shares of manditorily
redeemable  preferred  stock.  The  holders  of the  Series  A, B,  C, D,  and E
mandatorily  redeemable  preferred  stock had  certain  rights and  preferences,
including those involving dividend  participation,  special voting,  liquidation
preferences,  antidilution rights, redemption rights and in certain cases, those
involving cumulative dividends.

     In November 1998, the Company adjusted the conversion price of the Series E
Mandatorily  Redeemable  Preferred  Stock  from  $8.82  per  share to  $8.20.The
adjustment was made in accordance with the Series E Stock Purchase Agreement and
was  effective on the closing of the  Company's  initial  public  offering.  The
adjustment  resulted in the issuance of an  additional  77,155  shares of common
stock upon  conversion.  For purposes of calculating net income per share in the
period in which the initial public offering was completed,  net income available
to common  shareholders has been reduced by $1,312,000 in 1998 for the estimated
value of additional shares issued under these antidilution provisions (note 11).

     Upon completion of the Company's  underwritten  public offering in December
1998 the Series A, B, C, D, and E mandatorily  redeemable  preferred  stock were
converted  into an aggregate of  12,332,364 of common  stock.  In addition,  all
rights and preferences,  including those involving cumulative dividends expired.
Cumulative  but  undeclared  and unpaid  dividends  have been  deducted from net
income  available to common  shareholders  in  determining  net income per share
(note 11).

     As of  January  2,  1999,  there  were no  remaining  shares  of  manditory
redeemable shares outstanding.

     Changes in mandatorily  redeemable  preferred stock are as follows (dollars
in thousands):

                                                            ADDITIONAL
                                                             PAID-IN
                                      SHARES      AMOUNT     CAPITAL     TOTAL
                                   ------------ ---------- ----------- ---------
     Balance at January 3, 1998     12,091,962    $12,692    $14,920    $27,612
       Conversion to common stock   12,091,962     12,692     14,920     27,612
                                   ---------------------------------------------
     Balance at January 2, 1999              -    $     -    $     -    $     -
                                   =============================================


                                      F-12



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(9) SHAREHOLDERS' EQUITY

     Effective  December 4, 1998, the Company issued  2,922,350 common shares in
completion  of  its  initial  public  offering  resulting  in  net  proceeds  of
$44,643,000.

STOCK OPTIONS

     The Board of Directors  has reserved  6,300,000  shares of common stock for
options  that may be granted to key  employees,  directors,  or others under the
Company's stock option plans.

     A summary of the changes in the  Company's  stock  option plans for each of
the years in the three-year period ended December 30, 2000 is as follows:

                                                                       WEIGHTED
                                                                        AVERAGE
                                                                       EXERCISE
                                                             SHARES      PRICE
                                                          ------------ ---------
              Outstanding at January 3, 1998                2,095,609   $ 4.98
                (including 931,319 shares exercisable)
                  Granted                                     443,075    14.70
                  Exercised                                  (526,880)    3.18
                  Canceled                                   (208,070)    5.82
                                                          ----------------------
              Outstanding at January 2, 1999                1,803,734     7.77
                (including 884,807 shares exercisable)
                  Granted                                   1,857,100    12.10
                  Exercised                                  (448,705)    5.05
                  Canceled                                   (526,776)   14.66
                                                          ----------------------
              Outstanding at January 1, 2000                2,685,353     9.92
                (including 1,311,133 shares exercisable)
                  Granted                                   1,307,700     4.64
                  Exercised                                   (44,515)    3.09
                  Canceled                                   (429,267)    9.44
                                                          ----------------------
              Outstanding at December 30, 2000              3,519,271   $ 8.08
                (including 1,726,097 shares exercisable)  ======================

     The following table  summarizes  information  about options  outstanding at
December 30, 2000:

                      OPTIONS OUTSTANDING                 OPTIONS EXERCISABLE
     ---------------------------------------------------- --------------------
                                     AVERAGE    WEIGHTED            WEIGHTED
      RANGE OF                      REMAINING    AVERAGE             AVERAGE
      EXERCISE                      CONTRACTUAL EXERCISE            EXERCISE
        PRICE             SHARES   LIFE (YEARS)   PRICE     SHARES    PRICE
     ----------------- ----------- ------------ --------  --------- ---------
       $0.45 -  4.80      706,927      8.27       $3.34    335,085    $3.61
        4.82 -  5.91    1,277,687      8.26        5.55    484,978     5.41
        6.63 - 11.00      792,872      8.05        8.19    567,567     8.54
       13.94 - 24.50      706,785      8.24       16.38    307,787    16.69
       24.53 - 28.63       35,000      8.25       26.54     30,680    26.56
     ----------------- ----------- ------------ --------  --------- ---------
       $0.45 - 28.63    3,519,271      8.21       $8.08   1,726,097   $8.48
                       ===========                                  =========


                                      F-13



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(9) SHAREHOLDERS' EQUITY (CONTINUED)

     No  compensation  cost has been  recognized in the  consolidated  financial
statements  for  employee  stock  options  grants.  Had the  Company  determined
compensation  cost  based on the  fair  value at the  grant  date for its  stock
options under an alternative  accounting method, the Company's net income (loss)
would have been adjusted as indicated below (in thousands):

                                                  2000        1999       1998
                                               ---------   ---------  ---------
     Net income (loss):          As reported   $(37,214)   $ (8,204)    $5,195
                                 Pro forma     $(39,673)   $(11,088)    $4,144

     Earnings (loss) per share:  As reported   $  (2.09)   $  (0.45)    $ 1.09
                                 Pro forma     $  (2.22)   $  (0.60)    $ 0.73

     The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following assumptions:  expected
dividend yield-0%; expected stock price volatility-40%; risk-free interest rate-
5.9%,  6.3%,  and 4.6% for 2000,  1999 and 1998  respectively;  expected life of
options-3.6,  2.9 years,  and 3.0 for 2000, 1999,  1998,  respectively.  The per
share weighted-average fair value of stock options granted during 2000, 1999 and
1998 was $1.87, $3.86 and $4.72, respectively.

WARRANTS

     In April  1996,  the  Company  issued  warrants  to the holders of Series E
Preferred  Stock (note 8) to purchase an aggregate  of 171,429  shares of Common
Stock at an exercise price of $5.25 per share.  During 1998, warrants for 54,430
common shares were exercised.  Warrants for 108,499 shares remained  outstanding
at December 30, 2000 and January 1, 2000, respectively.

     In connection with a capital lease  transaction  with a vendor in 1997, the
Company  granted the vendor  warrants to acquire  31,428 shares of the Company's
Series E convertible  preferred  stock at a purchase  price of $10.50 per share.
The warrants  are  exercisable  for five years  beginning  December 3, 1998.  In
December 1998 all the Preferred  Stock  warrants  were  converted  into warrants
exercisable  into 40,243 shares of common stock at $8.20 per share.  In February
of 1999, the vendor exercised all of these warrants.

     In connection  with  short-term debt issued to related parties in 1996, the
Company granted warrants to purchase 71,525 shares of the Company's common stock
at a purchase  price of $5.25 per share.  The warrants are  exercisable  for ten
years from the grant date.  During  December  1998,  warrants  for 7,003  common
shares were  exercised.  Warrants  for 64,522  shares  remained  outstanding  at
December 30, 2000 and January 1, 2000.

     In connection  with an executive  search in March 2000,  the Company issued
warrants to purchase  40,000 shares of the Company's  common stock at a purchase
price of $5.56 per share.  The warrants are  exercisable for five years from the
grant date. All of these warrants remained outstanding at December 30, 2000.

STOCK REPURCHASE

     During 1999, the Company  repurchased  1,220,000  shares for  approximately
$12.7 million.


                                      F-14



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(10) INCOME TAXES

     The  provision  (benefit)  for income taxes  consists of the  following (in
thousands):

                                                      2000      1999      1998
                                                  ---------- --------- ---------
                Current:
                  Federal                           $     -   $     -   $ 2,969
                  State                                 705       180       687
                                                  ------------------------------
                Deferred:
                  Federal                            10,397   (4,694)   (5,803)
                  State                                 490     (304)      (85)
                                                  ------------------------------
                                                     10,887   (4,998)   (5,888)
                                                  ------------------------------
                Income tax expense (benefit)        $11,592  $(4,818)  $(2,232)
                                                  ==============================

     Effective  tax rates  differ  from  statutory  federal  income tax rates as
follows:

                                                      2000      1999      1998
                                                  ---------- --------- ---------
Statutory federal income tax rate                    (35.0%)   (35.0%)    35.0%
Nondeductible interest expense, put warrants           0.0       0.0      44.7
Change in valuation allowance                         82.2       0.0    (147.0)
Effect of change in tax rate on deferred tax asset     0.0       0.0       6.7
State income taxes, net of federal benefit            (1.1)     (0.6)      8.9
Other                                                 (0.9)     (1.4)      1.0
                                                  ------------------------------
                                                      45.2%    (37.0%)   (50.7%)
                                                  ==============================

     The tax effects of  temporary  differences  that give rise to deferred  tax
assets at December 30, 2000 and January 1, 2000 are as follows (in thousands):

                                                                2000      1999
                                                             --------- ---------
              Deferred tax assets:
                Current:
                  Inventory, warranty, and returns reserves   $ 5,012   $ 4,553
                  Allowance for doubtful accounts                 100       116
                  Other                                         2,171     1,970
                Long term:
                  Net operating loss carryforwards             11,923     3,885
                  Other                                         2,389       886
                                                             -------------------
                    Total gross deferred tax assets            21,595    11,410
              Valuation allowance                             (21,595)     (523)
                                                             -------------------
                    Total net deferred tax assets             $     -   $10,887
                                                             ===================

     At December  30, 2000,  the Company had net  operating  loss  carryforwards
("NOLs") for federal income tax purposes of approximately  $31,400,000  expiring
between  the  years  2003 and  2020.  The  Company  expects  that  approximately
$1,400,000 of these NOLs will expire  unutilized due to an Internal Revenue Code
(IRC) Section 382 limitation  resulting from a prior  ownership  change and has,
therefore, provided a valuation allowance for this portion of the carryforwards.
During the fourth  quarter of fiscal 2000 the Company  increased  its  valuation
allowance by $21,072,000 due to negative cash flows, recurring pre-tax operating
losses and the recent downturn of the economy making realization of the deferred
tax assets uncertain.


                                      F-15



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(11) NET INCOME (LOSS) PER COMMON SHARE

     The  following  computations  reconcile  net income  (loss) with net income
(loss) per common  share-basic  and diluted  (dollars in  thousands,  except per
share amounts).

                                                     NET               PER SHARE
    2000                                            LOSS      SHARES      AMOUNT
    --------------------------------------------  --------- ---------- ---------
    Net loss                                      ($37,214)
                                                  ---------
    BASIC AND DILUTED EPS
    Net loss attributable to common shareholders  ($37,214) 17,848,375   ($2.09)
                                                  ========= ========== =========


                                                     NET               PER SHARE
    1999                                            LOSS      SHARES      AMOUNT
    --------------------------------------------  --------- ---------- ---------
    Net loss                                       ($8,204)
                                                  ---------
    BASIC AND DILUTED EPS
    Net loss attributable to common shareholders   ($8,204) 18,299,728   ($0.45)
                                                  ========= ========== =========


                                                     NET               PER SHARE
    1998                                           INCOME     SHARES      AMOUNT
    --------------------------------------------  --------- ---------- ---------
    Net income before extraordinary item            $6,636
    Less: Deemed dividend from revision of
          preferred stock                           (1,312)          -
    Cumulative preferred dividends                    (821)          -
                                                  ---------
    BASIC EPS
    Net income available to common shareholders     $4,503   4,114,219    $1.09
                                                                       =========
    EFFECT OF DILUTIVE SECURITIES
    Options                                              -     912,448
    Warrants                                             -     654,436
    Convertible preferred stock                          -  10,247,143
                                                  --------- ----------
    DILUTED EPS
    Net income attributable to common shareholders
      plus assumed conversion                       $4,503  15,928,246    $0.28
                                                  ========= ========== =========

     The  following  is a summary  of those  securities  outstanding  during the
respective  periods which have been excluded from the  calculations  because the
effect on net income (loss) per common share would not have been dilutive:

                                  2000        1999       1998
                                  ----        ----       ----
      Options                   3,519,271  2,722,429       -
      Common stock warrants     1,344,378  1,249,119       -


                                      F-16



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(12) EMPLOYEE BENEFIT PLANS

     Effective  January 1, 1994, the Company adopted a profit sharing and 401(k)
plan for  eligible  employees.  The plan allows  employees to defer up to 15% of
their  compensation  on a  pretax  basis.  Each  year,  the  Company  may make a
discretionary contribution equal to a percentage of the employee's contribution.
During  2000,  1999 and  1998,  the  Company  expensed  $487,000,  $480,000  and
$375,000, respectively, relating to its contribution to the 401(k) plan.

EMPLOYEE STOCK PURCHASE PLAN

     Effective  July 30, 1999,  the Company  adopted an Employee  Stock Purchase
Plan (the "Plan") under which  employees can purchase  Company common stock at a
discount of 15% based on the average price of the stock on the last business day
of the offering period (calendar-quarter). 204,927 and 17,705 shares were issued
during 2000 and 1999, respectively.

(13)  RELATED PARTY TRANSACTIONS

     The Company has entered into a consulting  agreement with a director of the
Company  beginning  May 4, 1999.  The  agreement is effective  for a term of two
years,  provides an annual fee of $100,000 and 60,000 options vesting over three
years.  In 1999,  the  Company  expensed  $44,000  relating  to  these  options.
Effective  January 2000, the director  resigned from the board  terminating  the
agreement.  An aggregate of 27,292 vested  options are  exercisable  through May
2004.

(14)  COMMITMENTS AND CONTINGENCIES

     The Company  and certain of its former  officers  and  directors  have been
named as  defendants  in a class  action  lawsuit  filed on  behalf  of  Company
shareholders  in U.S.  District Court in Minnesota.  The named  plaintiffs,  who
purport to act on behalf of a class of purchasers of the Company's  common stock
during the period from December 4, 1998 to June 7, 1999,  charge the  defendants
with  violations of federal  securities  laws. The suit alleges that the Company
and the named  directors  and  officers  failed to  disclose  or  misrepresented
certain  information  concerning  the  Company  during  the  class  period.  The
complaint does not specify an amount of damages  claimed.  The Company  believes
that the complaint is without merit and intends to vigorously defend the claims.

     The Company and the individual  defendants  brought a motion to dismiss all
claims on  November  10,  1999.  The motion was heard by a  magistrate  judge on
December 21, 1999.  On January 27, 2000,  the  magistrate  recommended  that the
claims  based on Section 11 of the federal  securities  laws be  dismissed.  The
magistrate  recommended that the motion to dismiss be denied with respect to the
claims based on Rule 10b-5 of the federal  securities  laws.  In February  2000,
both the  plaintiffs and the defendants  formally  objected to the  magistrate's
recommendation.  The objection was made to the United States  District  Court in
Minnesota.  On May 12,  2000,  the United  States  District  Court in  Minnesota
adopted the  recommendation of the magistrate and denied the defendants'  motion
to dismiss the Rule 10b-5 claims.  The Court also adopted the  recommendation of
the magistrate and dismissed the plaintiff's Section 11 claims without prejudice
and with leave to amend.

     On March 31,  2000,  the  Company and  certain of its former  officers  and
directors  were named as defendants in a class action lawsuit filed on behalf of
the  Company's  shareholders  in U.S.  District  Court  in  Minnesota  asserting
identical factual allegations as the consolidated complaint described above. The
suit alleges claims based on Sections 11 and 12(a)(2) of the federal  securities
laws. The complaint does not specify an amount of damages  claimed.  The Company
believes this  complaint is without  merit and intends to vigorously  defend the
claims.  The above two class  actions  were  consolidated  by the United  States
District Court Magistrate on July 24, 2000.


                                      F-17



                   SELECT COMFORT CORPORATION AND SUBSIDIARIES

             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)


(14) COMMITMENTS AND CONTINGENCIES (CONTINUED)

     The Company is a party to other various  claims,  legal actions,  sales tax
disputes,  and other complaints  arising in the ordinary course of business.  In
the opinion of management,  any losses that may occur are adequately  covered by
insurance or are provided for in the consolidated  financial  statements and the
ultimate  outcome  of  these  matters  will not have a  material  effect  on the
consolidated financial position or results of operations of the Company.

(15) SUMMARY OF QUARTERLY FINANCIAL DATA (UNAUDITED)

     The following is a condensed  summary of actual quarterly  results for 2000
and 1999:

                  2000                   Fourth     Third    Second     First
                  ----
  Net sales                             $64,075   $68,056   $61,787   $76,159
  Gross margin                           39,054    43,185    39,901    49,013
  Operating loss                         (6,905)   (8,894)   (5,391)   (4,780)
  Net loss                              (25,059)   (5,692)   (3,465)   (2,998)
  Net loss per share - diluted            (1.39)    (0.32)    (0.19)    (0.17)

                  1999                   Fourth     Third    Second     First
                  ----
  Net sales                             $68,104   $68,281   $65,750   $71,632
  Gross margin                           44,050    44,337    43,188    47,085
  Operating income (loss)                (9,939)   (6,432)      200     1,378
  Net income (loss)                      (6,042)   (3,698)      348     1,188
  Net income (loss) per share - diluted   (0.33)    (0.20)     0.02      0.06


                                      F-18



                               MANAGEMENT'S REPORT

The management of Select Comfort Corporation is responsible for the preparation,
integrity  and  fair  presentation  of  the  consolidated  financial  statements
included in this annual report.  The financial  statements have been prepared in
accordance with accounting principles generally accepted in the United States of
America and include amounts based on judgments and estimates made by management.
Management is also  responsible  for the preparation and accuracy of information
included  in  other  sections  of  this  annual  report,  which  information  is
consistent with the financial statements.

The integrity of the  financial  statements  is based on the  maintenance  of an
internal  control  structure  established  by management  to provide  reasonable
assurance that assets are safeguarded and transactions are properly  authorized,
recorded  and  reported.  The concept of  reasonable  assurance  is based on the
recognition  that the cost of maintaining a system of internal  controls  should
not  exceed  the  benefits  expected  to be  derived.  Even  effective  internal
controls,  no matter how well designed,  have inherent  limitations.  Management
believes that the internal  control system  provides  reasonable  assurance that
errors or irregularities that could be material to the financial  statements are
prevented or would be detected and corrected in the normal course of business.

The Company engages independent auditors to examine its financial statements and
express  their  opinion  thereon.  The  auditors  have  access to each member of
management  in  conducting  their  audits.  Their report  appears in this annual
report.

The Audit Committee of the Board of Directors, composed solely of non-management
directors,  meets  periodically with management and the independent  auditors to
review internal  accounting  control,  audit activities and financial  reporting
matters.  The  independent  auditors have full access to the Audit Committee and
meet periodically with them without management present.


/s/William R. McLaughlin                              /s/James C. Raabe
-------------------------                             -------------------------
William R. McLaughlin                                 James C. Raabe
President and Chief                                   Chief Financial Officer
Executive Officer



                                       F-19


          INDEPENDENT AUDITORS' REPORT ON FINANCIAL STATEMENT SCHEDULE




The Board of Directors and Stockholders
Select Comfort Corporation:


     Under date of February 2, 2001, except as to Notes 1 and 10 which are as of
April 12, 2001, we reported on the consolidated balance sheets of Select Comfort
Corporation and subsidiaries as of December 30, 2000 and January 1, 2000 and the
related statements of operations,  shareholders' equity, and cash flows for each
of the years in the  three-year  period ended December 30, 2000, as contained in
the Annual Report on Form 10-K for the year 2000. In connection  with our audits
of the aforementioned  consolidated  financial  statements,  we also audited the
related financial  statement schedule as listed in the accompanying  index. This
financial statement schedule is the responsibility of the Company's  management.
Our responsibility is to express an opinion on this financial statement schedule
based on our audits.

     In our opinion,  such  financial  statement  schedule,  when  considered in
relation  to the  basic  consolidated  financial  statements  taken  as a whole,
presents fairly, in all material respects, the information set forth therein.

     The audit report on the consolidated financial statements of Select Comfort
Corporation and subsidiaries referred to above contains an explanatory paragraph
that  states that the Company  has  negative  cash flows that raise  substantial
doubt about the entity's  ability to continue as a going concern.  The financial
statements  and schedule  included in the  Company's  2000 Annual Report on Form
10-K do not  include  adjustments  that might  result  from the  outcome of this
uncertainty.


                                                 /s/ KPMG LLP


Minneapolis, Minnesota
February 2, 2001


                   SELECT COMFORT CORPORATION AND SUBSIDIARIES
                 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
                                 (IN THOUSANDS)

                                              ADDITIONS
                                  BALANCE AT  CHARGED TO  DEDUCTIONS  BALANCE AT
                                  BEGINNING   COSTS AND   FROM        END OF
        DESCRIPTION               OF PERIOD   EXPENSES    RESERVES    PERIOD
-------------------------------   ----------  ----------  ----------  ----------
Allowance for doubtful accounts
    - 2000                        $  305       $  531      $  572       $  264
    - 1999                         2,750        1,193       3,638          305
    - 1998                         1,901        2,794       1,945        2,750

Accrued warranty costs

    - 2000                        $5,841       $5,397      $4,057       $7,181
    - 1999                         4,486        5,368       4,013        5,841
    - 1998                         3,257        4,807       3,578        4,486


                                       S-1