1. Basis of Presentation

We prepared the condensed consolidated financial statements as of and for the three and six months ended July 2, 2011 of Select Comfort Corporation and subsidiaries (“Select Comfort” or the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”) and they reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly our financial position as of July 2, 2011, and January 1, 2011 and the results of operations and cash flows for the periods presented. Our historical and quarterly results of operations may not be indicative of the results that may be achieved for the full year or any future period.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with our most recent audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended January 1, 2011 and other recent filings with the SEC.

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

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

Cash and Cash Equivalents

Cash and cash equivalents included highly liquid marketable debt securities of $20.0 million and $45.0 million at July 2, 2011, and January 1, 2011, respectively. Marketable debt securities included in cash and cash equivalents have an original maturity of three months or less when purchased.

Change in Accounting Principle - Cash and Cash Equivalents

At the beginning of 2011, we changed our accounting policy for payments due from financial services companies for credit card and debit card transactions. Historically, at each reporting period, we classified all credit card and debit card transactions that processed in less than seven days as cash and cash equivalents on our consolidated balance sheets. We now classify these credit card and debit card transactions as accounts receivable until the cash is received. We believe that our new policy is preferable because the presentation (i) more appropriately aligns with our view that these credit card and debit card transactions are not part of our cash management processes (i.e., these receivables are non-interest bearing and are not taken into consideration when making cash management decisions), and (ii) is more consistent with the nature of the credit card and debit card receivables, which are subject to the credit risk of the financial services companies. Our new policy resulted in the adjustment of certain amounts in our consolidated balance sheets and consolidated statements of cash flows. This change in accounting principle had no effect on our previously reported consolidated shareholders' equity or consolidated net income.

The change in accounting principle has been applied retrospectively by adjusting all previously reported amounts to conform to our new policy. A summary of the retrospective application is as follows for the periods presented in this Form 10-Q (in thousands):

	July 2, 2011							January 1, 2011
	Before Accounting Policy Change		Adjustment			As Reported		As Previously Reported		Adjustment			As Adjusted
Condensed consolidated balance sheets
Cash and cash equivalents	$	60,665	$	(3,020	)	$	57,645	$	81,361	$	(5,345	)	$	76,016
Accounts receivable		4,114		3,020			7,134		4,564		5,345			9,909

	Six months ended July 2, 2011									Six months ended July 3, 2010
	Before Accounting Policy Change			Adjustment			As Reported			As Previously Reported		Adjustment			As Adjusted
Condensed consolidated statements of cash flows
Cash flows from operating activities:
Changes in operating assets and liabilities:
Accounts receivable	$	450		$	2,325		$	2,775		$	960	$	2,636		$	3,596
Net cash provided by operating activities		31,360			2,325			33,685			25,953		2,636			28,589

Net (decrease) increase in cash and cash equivalents	$	(20,696	)	$	2,325		$	(18,371	)	$	22,161	$	2,636		$	24,797
Cash and cash equivalents, at beginning of period		81,361			(5,345	)		76,016			17,717		(5,533	)		12,184
Cash and cash equivalents, at end of period	$	60,665		$	(3,020	)	$	57,645		$	39,878	$	(2,897	)	$	36,981

Investments

Our investment portfolio is currently comprised of U.S. Treasury securities. The value of these securities is subject to market and credit volatility during the period these investments are held. We classify marketable debt securities as available-for-sale investments and these securities are stated at their estimated fair value. Our investments with current maturities of greater than three months but less than one year are recorded as marketable debt securities - current. Our investments with current maturities of more than one year are recorded as marketable debt securities – non-current. Unrealized gains and losses, net of taxes, are reported as a component of accumulated other comprehensive gain (loss). Other-than-temporary declines in market value from original cost are charged to other expense, net in the period in which the loss occurs, and a new cost basis for the security is established. In determining whether an other-than-temporary decline in the market value has occurred, we consider the duration and extent that the fair value of the investment is below its cost. There were no other-than-temporary declines in market value during the six months ended July 2, 2011.

Realized gains and losses, if any, are calculated on the specific identification method and are measured and reclassified from accumulated other comprehensive gain (loss) in the consolidated balance sheet to other expense, net in the consolidated statement of operations.

Subsequent Events

Events that have occurred subsequent to July 2, 2011 have been evaluated through the date the consolidated financial statements were issued. There have been no subsequent events that occurred during such period that would require recognition or disclosure in the condensed consolidated financial statements as of or for the period ended July 2, 2011.

New Accounting Pronouncements

In May 2011, the Financial Accounting Standards Board (“FASB”) issued new guidance regarding fair value measurements. The new guidance changes the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements to ensure consistency between U.S. GAAP and International Financial Reporting Standards (“IFRS”). This guidance also expands the disclosures for fair value measurements that are estimated using significant unobservable (Level 3) inputs. As this is a financial statement presentation issue, we do not expect the adoption of this new guidance to have a significant impact on our consolidated results of operations, financial position or cash flows. This new guidance will be effective for us beginning in the first quarter of 2012 and is to be applied on a prospective basis.

In June 2011, the FASB issued new guidance regarding the presentation of other comprehensive income. The objective of the new guidance is to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. This guidance does not change the items that are required to be reported in other comprehensive income, but changes the presentation of those items in the consolidated financial statements. As this is a financial statement presentation issue, we do not expect the adoption of this new guidance to have a significant impact on our consolidated results of operations, financial position or cash flows. This guidance will be effective for us beginning in the first quarter of 2012 and is to be applied on a retrospective basis.