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

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

Risk Factors

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

• The occurrence of any event, change or other circumstances that could give rise to the termination of the securities purchase agreement with Sterling Partners, including without limitation any failure to obtain shareholder approval or failure to satisfy any of the conditions to closing of the proposed transaction;

• The outcome of any legal proceedings that may be instituted against us with respect to the proposed transaction with Sterling Partners;

• The risk that the proposed transaction with Sterling Partners disrupts current plans and operations and the potential difficulties in employee retention as a result of the proposed transaction;

• Other risks, including our ability to improve sales and operating results and to realize cost savings;

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

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

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

• Current general and industry economic trends and consumer confidence;

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

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

• Availability of attractive and cost-effective consumer credit options;

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

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

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

• Rising commodity costs and other inflationary pressures;

• Industry competition;

• Our ability to continue to improve our product line;

• Warranty expenses;

• Risks of pending and potentially unforeseen litigation;

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

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

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

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

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

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

Overview

Business Overview

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

We generate revenue by selling our products through four complementary distribution channels. Three of these channels: Retail, Direct Marketing and E-Commerce, are company-controlled and sell directly to consumers. Our wholesale channel sells to and through leading home furnishings retailers, specialty bedding retailers, the QVC shopping channel and to several end users such as Radisson Hotels and Resortsฎ.

Vision and Strategy

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

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

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

Results of Operations

Quarterly and Annual Results

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

Highlights

Key financial highlights for the three months ended July 4, 2009 were as follows:

• Net loss totaled $4.0 million, or ($0.09) per diluted share, compared with a net loss of $6.6 million, or ($0.15) per diluted share, for the same period one year ago. Second quarter 2009 net loss includes a $3.6 million non-cash charge related to an increase in our deferred tax valuation allowance.

• Net sales decreased 21% to $120.6 million, compared with $152.1 million for the same period one year ago, primarily due to an 11% comparable-store sales decline for our company-owned retail stores and a reduction in our store base. Comparable-store sales trends have improved relative to a decline of 29% in the fourth quarter of 2008 and a decline of 14% in the first quarter of 2009.

• Operating income improved to $1.0 million for the three months ended July 4, 2009, compared with an operating loss of $10.3 million last year due to the significant actions taken to return the Company to profitability.

• Our gross profit rate increased to 61.6% of net sales, compared with 59.6% of net sales for the same period last year.

• Sales and marketing expenses decreased 28%, or $24.3 million, from the same period one year ago.

• General and administrative expenses declined $2.4 million compared with the prior year period.

• Cash from operating activities totaled $35.6 million for the first six months of 2009, compared with $10.4 million for the same period one year ago. Operating cash flows for the first six months of 2009 included a $25.8 million refund of income taxes associated with our 2008 pre-tax loss. During the second quarter, the $25.8 million refund was used to reduce borrowings under our revolving credit facility.

• During the first six months of 2009, borrowings under our revolving credit facility decreased from $79.2 million at January 3, 2009 to $43.8 million at July 4, 2009.

• On May 26, 2009, we announced that we had entered into a securities purchase agreement with Sterling Partners, a leading growth-oriented, U.S.-based private equity firm. Under the terms of the agreement, Sterling Partners would purchase 50 million shares of common stock at $0.70 per share, for a total investment of $35.0 million. These shares would represent a 52.3 percent ownership interest in the Company. The investment is subject to shareholder approval and customary closing conditions and the Company expects the closing of the transaction to occur in late August. The Company believes there is uncertainty with respect to its ability to secure a longer-term amendment to the credit agreement without consummation of the transaction with Sterling Partners, and a likelihood of significant cost, dilution, limited financial flexibility and limited term in the event such an amendment could be secured. In conjunction with the purchase agreement, the Company's existing lenders have agreed to negotiate in good faith to amend and restate the Company's current credit agreement. The amended credit agreement would provide maximum availability of $70.0 million, include improved operating covenants and extend the maturity from June 2010 to December 2012. The amended credit agreement is subject to final lender approval and definitive documentation.

If we are unable to obtain additional capital, we may not be able to fund our operating needs and we could face a risk of default under our credit agreement.

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

                                     Three Months Ended                             Six Months Ended
                               July 4,               June 28,                July 4,               June 28,
                                2009                   2008                   2009                   2008
Net sales                $ 120.6      100.0%    $ 152.1      100.0%    $ 260.3      100.0%    $ 320.2      100.0%
Cost of sales               46.3       38.4%       61.4       40.4%      104.1       40.0%      132.7       41.4%
Gross profit                74.3       61.6%       90.6       59.6%      156.1       60.0%      187.6       58.6%

Operating expenses:
Sales and marketing         61.1       50.6%       85.4       56.2%      128.4       49.3%      176.0       55.0%
General and
administrative              11.7        9.7%       14.1        9.3%       25.0        9.6%       30.3        9.5%
Research and
development                  0.5        0.4%        0.6        0.4%        1.0        0.4%        1.5        0.5%
Asset impairment
charges                      0.1        0.1%        0.7        0.5%        0.5        0.2%        1.1        0.3%
Total operating
expenses                    73.4       60.8%      100.9       66.4%      154.9       59.5%      208.9       65.2%
Operating income
(loss)                       1.0        0.8%      (10.3 )     (6.7% )      1.2        0.5%      (21.3 )     (6.6% )
Other expense, net          (1.5 )     (1.2% )     (0.6 )     (0.4% )     (3.2 )     (1.2% )     (0.9 )     (0.3% )
Loss before income
taxes                       (0.5 )     (0.4% )    (10.9 )     (7.2% )     (2.0 )     (0.8% )    (22.2 )     (6.9% )
Income tax expense
(benefit)                    3.4        2.8%       (4.3 )     (2.8% )      4.6        1.8%       (8.4 )     (2.6% )
Net loss                 $  (4.0 )     (3.3% )  $  (6.6 )     (4.3% )  $  (6.7 )     (2.6% )  $ (13.7 )     (4.3% )




     Net loss per share:
     Basic                                       $ (0.09 ) $ (0.15 ) $ (0.15 ) $ (0.31 )
     Diluted                                     $ (0.09 ) $ (0.15 ) $ (0.15 ) $ (0.31 )
     Weighted-average number of common shares:
     Basic                                          44.8      44.1      44.8      44.1
     Diluted                                        44.8      44.1      44.8      44.1

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

                                    Three Months Ended        Six Months Ended
                                    July 4,     June 28,     July 4,    June 28,
                                     2009         2008        2009        2008
          Percent of net sales:
          Retail                        78.9%       74.5%       79.0%       76.7%
          Direct                         7.5%        8.7%        6.7%        8.1%
          E-Commerce                     5.2%        6.1%        5.3%        6.5%
          Wholesale                      8.4%       10.7%        9.0%        8.7%
          Total                        100.0%      100.0%      100.0%      100.0%

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

                                    Three Months Ended         Six Months Ended
                                  July 4,       June 28,     July 4,      June 28,
                                    2009          2008        2009          2008
       Net sales growth rates:
       Comparable stores               (11% )        (20% )      (13% )        (23% )
       Net new stores                   (5% )          5%         (3% )          6%
       Retail total                    (16% )        (15% )      (16% )        (17% )
       Direct                          (31% )        (13% )      (33% )        (24% )
       E-Commerce                      (32% )        (27% )      (33% )        (23% )
       Wholesale                       (38% )        (12% )      (16% )        (25% )
       Total net sales growth          (21% )        (15% )      (19% )        (19% )

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

                                       Three Months Ended        Six Months Ended
                                      July 4,     June 28,     July 4,     June 28,
                                       2009         2008        2009         2008
      Company-owned retail stores:
      Beginning of period                  441          481         471          478
      Opened                                 -            6           -           13
      Closed                               (21 )         (9 )       (51 )        (13 )
      End of period                        420          478         420          478
      Retail partner doors                 850          778         850          778

Comparison of Three Months Ended July 4, 2009 with Three Months Ended June 28, 2008

Net sales
Net sales decreased 21% to $120.6 million for the three months ended July 4, 2009, compared with $152.1 million for the same period one year ago. The sales decrease was due to an 11% comparable-store sales decline in our company-owned retail stores, a year-over-year decline in the number of retail stores we operated, and a decrease in wholesale, direct and E-Commerce channel sales. Total sales of mattress units decreased 24% compared to the same period one year ago and sales of other products and services decreased by 12%. The average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels decreased 2% to $1,793.

The $31.4 million net sales decrease compared with the same period one year ago was comprised of the following: (i) an $18.1 million net decrease in sales from our company-owned retail stores, comprised of an $11.3 million decrease from comparable-stores and a $6.8 million decrease from the net decline in the number of stores we operated; (ii) a $6.2 million decrease in wholesale sales; (iii) a $4.1 million decrease in direct sales; and (iv) a $3.0 million decrease in E-Commerce sales.

Gross profit
The gross profit rate increased to 61.6% of net sales for the three months ended July 4, 2009, compared with 59.6% for the same period one year ago. A majority of the gross profit rate increase was due to improved manufacturing efficiencies and actions taken to reduce supply chain and logistics costs which added approximately 2.0 percentage points ("ppt.") to our second quarter gross profit rate compared to the same period last year. During the fourth quarter of 2008 and the first six months of 2009, we resized our manufacturing and logistics operations to better align with current customer demand. In addition, an increase in the percentage of net sales from our retail distribution channel improved the second quarter gross profit rate by approximately 1.5 ppt. and lower warranty expenses improved the gross profit rate by 0.5 ppt. compared with the same period one year ago. These improvements were partially offset by an increase in promotional costs to generate customer traffic and drive sales in this more challenging macro-economic environment.

Sales and marketing expenses
Sales and marketing expenses for the three months ended July 4, 2009 decreased 28% to $61.1 million, or 50.6% of net sales, compared with $85.4 million, or 56.2% of net sales, for the same period one year ago. The $24.3 million decrease was due to the following: (i) a $17.2 million reduction in marketing expenses, reflecting a 44% decrease in media spending, compared to the same period one year ago; and (ii) a $7.1 million decrease in variable and fixed selling expenses including store compensation and benefits, occupancy expenses and store depreciation due to the net sales decline and reduced store base. The reduction in marketing expenses was primarily due to our focus on enhancing the effectiveness and efficiency of our marketing expenditures. The sales and marketing expense rate declined 5.6 ppt. compared to the same period one year ago, with the benefits from the cost reduction initiatives more than offsetting the deleveraging impact of the 21% net sales decline.

General and administrative expenses
General and administrative ("G&A") expenses decreased 17% to $11.7 million for the three months ended July 4, 2009, compared with $14.1 million for the same period one year ago. The $2.4 million decrease in G&A expenses was primarily due to reduced compensation and benefit costs resulting from workforce reductions and discretionary spending cuts. The G&A expense rate increased slightly to 9.7% of net sales for the three months ended July 4, 2009, compared with 9.3% of net sales for the same period one year ago.

Research and development expenses
Research and development ("R&D") expenses decreased to $0.5 million for the second quarter of 2009, compared with $0.6 million for the same period one year ago. The R&D expense rate of 0.4% of net sales was consistent with the prior year.

Asset impairment charges
On a quarterly basis, we review all of our stores for impairment. Other long-lived assets are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. We recognize impairment charges for the difference between the fair value and the carrying amounts of the related long-lived assets. We generally estimate the fair value of our store assets using the income approach based on the present value of cash flows expected to be generated by the assets in accordance with SFAS No. 157, Fair Value Measurements.

During the three months ended July 4, 2009, we recognized impairment charges of $0.1 million related to assets at one store expected to close prior to its normal lease termination date, and certain equipment and software. During the three months ended June 28, 2008, we determined that assets at four underperforming stores were impaired and recognized impairment charges of $0.7 million.

Other expense, net
Other expense, net was $1.5 million for the three months ended July 4, 2009, compared with $0.6 million for the same period one year ago. The $0.9 million increase in other expense, net was driven by increased interest expense from borrowings under our revolving credit facility due to higher average debt balances and increased interest rates compared to the same period one year ago.

Income tax expense (benefit)
Income tax expense was $3.4 million for the three months ended July 4, 2009, compared with an income tax benefit of $4.3 million for the same period one year ago. The effective tax rate for the three months ended July 4, 2009 was negative 654.5% compared with 39.4% for the same period one year ago. The change in the effective tax rate was due to the increase in our deferred tax valuation allowance, for certain deferred tax assets, that we recorded during the three months ended July 4, 2009 based on the guidance in SFAS No. 109, Income Taxes.

Comparison of Six Months Ended July 4, 2009 with Six Months Ended June 28, 2008

Net sales
Net sales for the first six months of fiscal 2009 decreased 19% to $260.3 million, compared with $320.2 million for the same period one year ago. The sales decrease was driven by a 13% comparable-store sales decline in our company-owned retail stores, a year-over-year decline in the number of retail stores we operated, and a decrease in direct, E-Commerce and wholesale channel sales. Total sales of mattress units decreased 18% compared to the same period one year ago and sales of other products and services decreased by 16%. The average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels was consistent with the prior year at $1,722.

The $60.0 million net sales decrease compared with the prior year was comprised of the following: (i) a $40.0 million decrease in sales from our retail stores, comprised of a $28.5 million decrease from comparable-stores and a $11.5 million decrease from the net decline in the number of stores we operated; (ii) a $8.5 million decrease in direct sales; (iii) a $6.9 million decrease in E-Commerce sales; and (iv) a $4.6 million decrease in wholesale sales.

Gross profit
The gross profit rate increased to 60.0% of net sales for the first six months of fiscal 2009, compared with 58.6% of net sales for the same period one year ago. A majority of the gross profit rate increase was due to improved manufacturing efficiencies and actions taken to reduce supply chain and logistics costs which added approximately 2.0 ppt. to our gross profit rate for the six months ended July 4, 2009, compared to the same period last year. During the fourth quarter of 2008 and the first six months of 2009, we resized our manufacturing and logistics operations to better align with current customer demand. In addition, a sales mix shift to higher-margin products and lower warranty expenses improved the gross profit rate for the six months ended July 4, 2009 by 1.3 ppt. and 0.8 ppt., respectively, compared with the same period one year ago. These improvements were partially offset by an increase in promotional costs to generate customer traffic and drive sales in this more challenging macro-economic environment.

Sales and marketing expenses
Sales and marketing expenses for the six months ended July 4, 2009 decreased to $128.4 million, or 49.3% of net sales, compared with $176.0 million, or 55.0% of net sales, for the same period one year ago. The $47.6 million decrease was primarily due to a $20.0 million (or 40%) reduction in media spending and a $13.7 million decrease in other marketing expenses, including financing, promotion and production expenses compared with the same period one-year ago. The reduction in media and other marketing expenses was mainly due to efforts to enhance the effectiveness and efficiency of our marketing expenditures. The remainder of the decrease in expenses was due to reduced fixed and variable selling expenses resulting from the reduction in our store base and the decline in sales volume. The 5.7 ppt. sales and marketing expense rate decrease was principally due to the $47.6 million expense decrease compared with the same period one year ago, partially offset by the deleveraging impact of the 19% sales decline.

General and administrative expenses
General and administrative expenses decreased to $25.0 million for the six months ended July 4, 2009, compared with $30.3 million for the same period one year ago. The $5.2 million decrease in G&A expenses was primarily due to reduced compensation and benefit costs resulting from workforce reductions, decreased depreciation expense and discretionary spending cuts, partially offset by an increase in outside consulting expenses. The G&A expense rate increased slightly to 9.6% of net sales for the six months ended July 4, 2009, compared with 9.5% of net sales for the same period one year ago.

Research and development expenses
Research and development expenses decreased to $1.0 million for the first six months of fiscal 2009, compared with $1.5 million for the same period one year ago, and decreased as a percentage of net sales to 0.4% from 0.5% as we focused . . .