Sleep Number Corp - Annual Report: 2013 (Form 10-K)

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 28, 2013


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



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

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

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



Title of each class		Name of each exchange on which registered
Common Stock, par value $.01 per share		The NASDAQ Stock Market LLC
		(NASDAQ Global Select Market)

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. YES ý NO o

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES o NO ý

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 ý NO o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES ý NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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. o

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



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

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES o NO ý

The aggregate market value of the common equity held by non-affiliates of the Registrant as of June 29, 2013, was $1,204,735,000 (based on the last reported sale price of the Registrant’s common stock on that date as reported by NASDAQ).

As of January 25, 2014, there were 54,761,000 shares of the Registrant’s Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s proxy statement to be furnished to shareholders in connection with its 2014 Annual Meeting of Shareholders are incorporated by reference in Part III, Items 10-14 of this Annual Report on Form 10-K.

As used in this Form 10-K, the terms “we,” “us,” “our,” the “Company,” and “Select Comfort” mean Select Comfort Corporation and its subsidiaries and the term “common stock” means our common stock, par value $0.01 per share.

As used in this Form 10-K, the term “bedding” includes mattresses, box springs and foundations and the term "bedding accessories" includes sheets, pillows, headboards, frames, mattress pads and related products.

Sleep Number®, Select Comfort®, Double Arrow logo, Know Better Sleep^SM, Sleep IQ™, AirFit™, Comfort.Individualized.^SM, ComfortFit®, CoolFit™, DualAir Technology Inside logo, DualAir™, DualTemp™, Comfortaire®, Dreamaire®, Firmness Control™ System, FlexFit™, Grand King®, In Balance™, IndividualFit®, Individualized Sleep Experiences®, LuxFit™, Pillow[ology]®, PillowFit®, PlushFit™, Sleep Number Inner Circle®, Take Control of Your Sleep®, Tech-e™, The Only Bed That Knows You^SM, What’s Your Sleep Number?®, our bed model names, and our other marks and stylized logos are trademarks and/or service marks of Select Comfort. This Form 10-K may also contain trademarks, trade names and service marks that are owned by other persons or entities.

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. Our fiscal year is based on a 52- or 53-week year. All years presented in this Form 10-K are 52 weeks, except for the 2008 fiscal year ended January 3, 2009, which is a 53-week year.

TABLE OF CONTENTS



PART I			2

	Item 1.	Business	2

	Item 1A.	Risk Factors	10

	Item 1B.	Unresolved Staff Comments	15

	Item 2.	Properties	16

	Item 3.	Legal Proceedings	17

	Item 4.	Mine Safety Disclosures	17

PART II			18

	Item 5.	Market for The Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities	18

	Item 6.	Selected Financial Data	20

	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	35

	Item 8.	Financial Statements and Supplementary Data	36

	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	62

	Item 9A.	Controls and Procedures	62

	Item 9B.	Other Information	62

PART III			63

	Item 10.	Directors, Executive Officers and Corporate Governance	63

	Item 11.	Executive Compensation	63

	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters	63

	Item 13.	Certain Relationships and Related Transactions, and Director Independence	63

	Item 14.	Principal Accounting Fees and Services	63

PART IV			64

	Item 15.	Exhibits, Financial Statement Schedules	64

PART I

This Annual Report on Form 10-K contains or incorporates by reference certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. For this purpose, any statements contained in or incorporated by reference into this Annual Report on Form 10-K that are not statements of historical fact may be deemed to be forward-looking statements, including but not limited to projections of revenues, results of operations, financial condition or other financial items; any statements of plans, strategies and objectives of management for future operations; any statements regarding proposed new products, services or developments; any statements regarding future economic conditions, prospects or performance; statements of belief and any statement or assumptions underlying any of the foregoing. In addition, we or others on our behalf may make forward-looking statements from time to time in oral presentations, including telephone conferences and/or Web casts open to the public, in press releases or reports, on our Internet Web site or otherwise. We try to identify forward-looking statements in this report and elsewhere by using words such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms.

Our forward-looking statements speak only as of the date made and by their nature involve substantial risks and uncertainties. Our actual results may differ materially depending on a variety of factors, including the items discussed in greater detail below under the caption “Risk Factors.” These risks and uncertainties are not exclusive and further information concerning the Company and our business, including factors that potentially could materially affect our financial results or condition, may emerge from time to time, including factors that we may consider immaterial or do not anticipate at this time.

We wish to caution readers not to place undue reliance on any forward-looking statement and to recognize that forward-looking statements are predictions of future results, which may not occur as anticipated. We assume no obligation to update forward-looking statements to reflect actual results or changes in factors or assumptions affecting such forward-looking statements. We advise you, however, to review and consider any further disclosures we make on related subjects in our quarterly reports on Form 10-Q and current reports on Form 8-K that we file with or furnish to the Securities and Exchange Commission.

ITEM 1. BUSINESS

Overview

Select Comfort Corporation, based in Minneapolis, Minnesota, was founded in 1987. We believe that we are leading the industry in delivering an unparalleled sleep experience. We offer consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of SLEEP NUMBER^® beds and bedding.

The Company is the exclusive manufacturer, marketer, retailer and servicer of the revolutionary Sleep Number bed, which allows individuals to adjust the firmness and support on each side at the touch of a button. We offer further individualization through our new sleep tracking technology, SleepIQ^TM, and a solutions-focused line of Sleep Number pillows, sheets, adjustable bases, and other bedding products, including the innovative DualTemp^TM temperature-balancing layer.

Select Comfort has evolved from a specialty, niche direct marketer, to a nationwide vertically integrated business model that includes manufacturing, retail and service with fiscal 2013 net sales of $960 million. As the only national specialty-mattress retailer, consumers can take advantage of a value added mattress-buying experience at one of our 440 SLEEP NUMBER^® retail stores across the country, online at www.SleepNumber.com, or via phone through our direct sales number at 1-888-411-2188.

In 1998, Select Comfort became a publicly traded company and is listed on The NASDAQ Stock Market LLC (NASDAQ Global Select Market) under the symbol “SCSS.” When used herein, the terms “Select Comfort,” “Company,” “we,” “us” and “our” refer to Select Comfort Corporation, including consolidated subsidiaries.

In 2009, 2010, 2011, 2012 and 2013, we generated operating income of $20.7 million, $52.4 million, $90.5 million, $119.8 million and $90.7 million, respectively. As of December 28, 2013, cash, cash equivalents and marketable debt securities totaled $145.0 million and we had no borrowings under our revolving credit facility.

On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems. We purchased Comfortaire to advance our innovation leadership in individualized comfort. The acquisition price was $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. The purchase of Comfortaire's business and assets did not have a significant impact on our consolidated results of operations, cash flows or financial position.

Proprietary Products

Sleep Number Bed

Unlike the “one-size-fits-all” solution offered by other mattress brands, the Sleep Number bed offers individualized comfort that is adjustable on each side. Our proprietary DualAir™ technology, which features two independent air chambers, allows couples to adjust firmness to their own individual preference at the touch of a button.

The unique benefits of our proprietary Sleep Number bed have been validated through clinical sleep research which has shown that participants who slept on a Sleep Number bed generally fell asleep faster, experienced more deep sleep with fewer disturbances and experienced greater relief from back pain than those sleeping on a traditional innerspring mattress.

We offer Sleep Number beds in good, better and best series to fit all budgets, with queen size mattresses starting at $699.


•	The Classic Series launched a sleep revolution with personal adjustability at an affordable price. The series includes the Sleep Number c2, c3 and c4 beds.


•	The Performance Series includes our most popular beds, featuring enhanced performance, comfort and a great value. The series includes the Sleep Number p5 and p6 beds.


•	The Innovation Series is the premier experience in personalized comfort combined with leading-edge innovations in sleep technology. The series includes the Sleep Number i8 and i10 beds.


•	The Memory Foam Series combines cradling memory foam with exclusive DualAir technology. The series includes the Sleep Number m7 bed.

In January 2014, we introduced our most advanced Sleep Number bed, the x12, at the International Consumer Electronics Show (CES). The Sleep Number x12 bed with SleepIQ™ technology is a breakthrough advancement in sleep technology, providing consumers with simple and intuitive knowledge of how they slept and what changes they can make to achieve their very best sleep. In addition to SleepIQ, the Sleep Number x12 bed combines three other new and proprietary technologies with the Company’s core DualAir™ technology to deliver the ultimate, comfortable sleep experience. These include the exclusive FlexFit™ adjustable base technology, FlexTop™ mattress design, and a communication platform that brings together all of these technologies and provides control through a single universal remote or with simple voice commands.

Sleep Number Bedding Collection

Like our Sleep Number beds, our exclusive Sleep Number^® bedding collection is a proprietary line of products that are designed to meet each individual's needs. Create Your Perfect Pillow^SM and our AirFit^™ pillow adjust to an individual's size, shape and sleeping position for more comfortable sleep. The pillows are available in our exclusive CoolFit^™ foam, memory fiber or white goose down. We also offer Create Your Perfect Comforter^SM.

In 2013, we introduced the breakthrough DualTemp™ layer, a new product that addresses one of the most significant sleep issues experienced by customers - sleeping too hot or sleeping too cold. DualTemp attracts new customers to our brand and stores while also engaging our current customers. The DualTemp layer can be used with any mattress brand.

FlexFit Adjustable Bases

We offer a full line of FlexFit™ adjustable bases which enable customers to raise the head or foot of the bed, and to experience the comfort of massage, using a handheld remote control.

Exclusive Distribution

Unlike traditional mattress manufacturers, which primarily sell through third-party retailers, over 96% of our net sales are through our Company-Controlled distribution channel (Retail, Direct Marketing and E-Commerce).

Our retail stores accounted for 89% of our net sales in 2013. Average annual net sales per comparable store have doubled since 2009 and were $2,093,000 in 2013 versus $2,164,000 in 2012, $1,721,000 in 2011, $1,295,000 in 2010 and $1,046,000 in 2009. In 2013, 96% of our stores open for a full year generated net sales over $1,000,000 and 46% of our stores open for a full year generated net sales over $2,000,000.

As of December 28, 2013, we had 440 retail stores in the U.S., and expect to end 2014 with between 460 and 470 retail stores. We are taking both a national and local market-based approach to our growth – national advertising combined with local marketing, real estate optimization and sales execution – to increase market share. We believe that through marketing and sales execution, we can continue to increase average sales per store to further leverage the profitability of our fixed cost store base.

Historically, our retail stores have been located in shopping malls. In 2010, we began operating in non-mall locations. As of December 28, 2013, 31% of our stores were in non-mall locations. The non-mall store format is typically located in highly visible, well-traveled locations and is intended to complement our existing mall-based stores. The non-mall format provides more flexibility to our real estate strategy.

Our direct marketing call center and E-Commerce website provide national sales coverage, including markets not yet served by one of our retail stores, and accounted for 7% of our net sales in 2013.

Operations

Manufacturing and Distribution

We have two manufacturing plants (one in Irmo, South Carolina and the other in Salt Lake City, Utah) which distribute Sleep Number products. The manufacturing operations in South Carolina and Utah consist of quilting and sewing of the fabric covers for our beds, and final assembly and packaging of mattresses and bases. In addition, our electrical Firmness Control™ Systems are assembled in our Utah plant.

We have one manufacturing plant in Greensboro, South Carolina which distributes Comfortaire products. The manufacturing operations consist of final assembly and packaging of mattresses and bases.

We manufacture beds primarily on a just-in-time basis to fulfill orders rather than stocking inventory, which enables us to maintain lower levels of finished goods inventory and operate with limited regional warehousing. Orders are shipped, typically within 48 hours following order receipt, from our manufacturing facilities via UPS or through our home delivery service. Products are usually received by the customer within five to 14 days from the date of order.

We obtain all of the raw materials and components used to produce our beds from outside sources. A number of components, including our proprietary air chambers, our proprietary blow-molded bases, and various components for our Firmness Control Systems, as well as fabrics and zippers, are sourced from suppliers who currently serve as our sole or primary source of supply for these components. We believe we can obtain these raw materials and components from other sources of supply, although we could experience some short-term disruption in our ability to fulfill orders in the event of an unexpected loss of supply from one of the primary suppliers. In 2005, we began identifying secondary sources in order to provide continuity of supply for various components. We will continue to utilize dual sourcing on targeted components when effective.

Our proprietary air chambers are produced to our specifications by an Eastern European supplier, which has been our primary source of supply of air chambers since 1994. Our agreement with this supplier runs through June 2016 and is thereafter subject to automatic annual renewal unless either party gives 365 days' notice of its intention not to renew the agreement. We expect to continue this supplier relationship for the foreseeable future.

Our proprietary blow-molded bases are produced to our specifications by a single domestic supplier under an agreement that expires in December 2015. We expect to continue this supplier relationship for the foreseeable future.

We have taken, and continue to take, various measures to mitigate the potential impact of an unexpected disruption in supply from any sole-source suppliers, including increasing safety stocks and identifying potential secondary sources of supply. All of the suppliers that produce unique or proprietary products for us have in place either contingency or disaster recovery plans or redundant production capabilities in other locations in order to safeguard against any unforeseen disasters. We review these plans and sites on a regular basis to ensure the supplier's ability to maintain an uninterrupted supply of materials and components.

Home Delivery Service

We offer Sleep Number Comfort Service^SM Home Delivery & Setup, which includes assembly and mattress removal. In some markets on the East Coast, we provide home delivery, assembly and mattress removal services through a third-party provider. Approximately 76% of beds sold through our Company-Controlled channel in 2013 were delivered by our full-service home delivery team or by our third-party service provider.

Customer Service

We maintain an in-house customer service department staffed by customer service specialists who receive training in sleep technology and all aspects of our products and operations. Our customer service specialists field customer calls and emails, “live chat,” and monitor social media. Our customer service team is part of our total quality process, facilitating early identification of emerging trends or issues. They coordinate with engineering, sourcing, manufacturing, and our Six Sigma team to segment these issues, implement immediate solutions and provide inputs for long-term improvements to product and service design.

Research and Development

Sleep Number uses systematic approaches to understand consumer needs as well as customers' responses to key features and benefits. Extensive consumer research is conducted from the product concept through the customer product ownership experience. Since the introduction of our first bed, we have continued to improve and expand our product lines to offer new beds and adjustable models as well as complete bedding collection assortments. Our research and development expenses were $9.5 million in 2013, $6.2 million in 2012 and $4.2 million in 2011.

Information Systems

We use information technology systems to operate, analyze and manage our business, to reduce operating costs and to enhance our customers' experience. Our major systems include an in-store point of sale system, a retail portal system, an order entry system, in-bound and out-bound telecommunications systems for direct marketing, delivery scheduling and customer service, E-Commerce systems, a data warehouse system and an enterprise resource planning system. These systems are comprised of both packaged applications licensed from various software vendors and internally developed programs. We are currently engaged in a multi-year project to upgrade our core information technology systems.

Intellectual Property

We hold various U.S. and foreign patents and patent applications regarding certain elements of the design and function of our products, including air control systems, remote control systems, air chamber features, border wall and corner piece systems, foundation systems, as well as other technology. We have 24 issued U.S. patents, expiring at various dates between July 2014 and September 2028, and 23 U.S. patent applications pending. We also hold 36 foreign patents and have six foreign patent applications pending. Notwithstanding these patents and patent applications, we cannot ensure that these patent rights will provide substantial protection or that others will not be able to develop products that are similar to or competitive with our products.

Select Comfort®, Sleep Number® and the double arrow logo are trademarks registered with the U.S. Patent and Trademark Office. We have a number of other registered trademarks including Comfortaire®, ComfortFit®, DualTemp™, Grand King®, IndividualFit®, Individualized Sleep Experiences®, Pillow[ology]®, PillowFit®, Sleep Number Inner Circle®, Take Control of Your Sleep® and What’s Your Sleep Number?®. Several trademarks are the subject of pending applications including Sleep IQ™, AirFit™, Comfort.Individualized.^SM, DualAir Technology Inside logo, Know Better Sleep^SM, LuxFit™, PlushFit™, Tech-e™ and The Only Bed That Knows You^SM. Each registered mark is renewable indefinitely as long as the mark remains in use. We also have a number of common law trademarks including CoolFit™, DualAir™, Firmness Control™ System, FlexFit™, In Balance™ and our bed model names. We are not aware of any material claims of infringement or other credible challenges asserted against us or our right to use these marks.

Industry and Competition

The U.S. bedding industry is a mature and generally stable industry. According to the International Sleep Products Association (“ISPA”), since 1984 the bedding manufacturing industry has consistently demonstrated growth on a dollar basis, with a 0.3% decline in 2001, 9.1% decline in 2008 and 9.0% decline in 2009 being the only exceptions. According to ISPA, industry wholesale shipments of mattresses and foundations were estimated to be $7.0 billion in 2013 compared to $6.8 billion in 2012. We estimate that traditional innerspring mattresses represent approximately 68% of total U.S. bedding sales (based on 2012 sales). Furniture/Today, a furniture industry trade publication, has ranked Select Comfort as the fifth largest mattress manufacturer and third largest U.S. bedding retailer for 2012, with a 5.2% market share of industry revenue and 1.6% market share of industry units.

Over the 5-year, 10-year and 20-year periods ended 2013, the value of U.S. wholesale bedding shipments increased at compound annual growth rates of 2.2%, 3.1% and 4.7%, respectively. We believe that industry unit growth has been primarily driven by

population growth, an increase in the number of homes (including secondary residences) and the increased size of homes. We believe growth in average wholesale prices resulted from a shift to both larger and higher quality beds, which are typically more expensive.

The bedding industry is very competitive. Participants in the bedding 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. There is a high degree of concentration among the largest manufacturers of innerspring bedding with nationally recognized brand names, including Sealy, Stearns & Foster, Serta and Simmons. Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the innerspring bedding market. During 2013, Tempur-Pedic completed the acquisition of Sealy and now offers an air-supported mattress. Tempur Sealy International, Inc., the fourth largest bedding manufacturer (based on 2012 sales, prior to the acquisition of Sealy), and a number of other mattress manufacturers, offer foam mattress products. Simmons and Sealy, as well as a number of smaller manufacturers, have offered air-bed products in the past. The retail bedding industry is also highly competitive. Our Company-Controlled distribution channel, which includes our retail stores, competes against regional and local specialty bedding retailers, home furnishing stores, mass merchants and national discount stores. We compete principally on the differentiation and quality of our products, customer service and value pricing.

Governmental Regulation and Environmental Matters

Our operations are subject to federal and state consumer protection and other regulations relating to the bedding industry. These regulations vary among the jurisdictions in which we do business, but generally impose requirements as to the proper labeling of bedding merchandise.

The bedding industry is subject to federal fire retardant standards developed by the U.S. Consumer Product Safety Commission, which became effective nationwide in July 2007. Compliance with these requirements has increased the cost and complexity of manufacturing our products. These regulations also result in higher product development costs as new products must undergo rigorous flammability testing.

Federal regulations adopted in 2010 restrict the types of credit-based promotional offerings that retailers are allowed to make available to consumers.

Our direct marketing and internet-based marketing operations are or may become subject to various adopted or proposed federal and state “do not call” and “do not mail” list requirements, limiting our ability to market our products directly to consumers over the telephone, by e-mail or by regular mail. Additionally, existing federal laws governing telephone and mail order sales may be extended to encompass all internet sales, imposing compliance obligations on the timing of shipments as well as provisions of refunds to consumers.

We are subject to emerging federal, state and foreign data privacy regulations related to the safeguarding of sensitive customer and employee data, which may drive increased costs in our information systems infrastructure.

We are subject to federal and state labor laws, including but not limited to laws relating to occupational health and safety, employee privacy, wages and hours, overtime pay, harassment and discrimination, equal opportunity, and employee leaves and benefits.

We are subject to federal and state laws and regulations relating to pollution and environmental protection. We may also be subject to similar laws in foreign jurisdictions if we expand our operations internationally.

Our retail pricing policies and practices are subject to antitrust regulations in the U.S., and we may become subject to similar laws in other jurisdictions where we may sell our products in the future.

We are or may become subject to various adopted or proposed federal and state laws and regulations relating to supply chain transparency with respect to the sourcing of conflict minerals and labor conditions maintained by suppliers, which may result in increased compliance costs and increased component costs.

Adopted or proposed legislation in various states would impose responsibilities with respect to end-of-life disposal of various consumer or durable goods on the manufacturers and/or retailers of such goods, including mattresses. To the extent that any such legislation becomes effective in the states in which we sell or have sold mattresses and related products, we may be required to incur significant costs and operational changes in order to comply with these requirements, which may adversely impact our profitability, cash flows and financial condition.

Although we believe that we are in compliance in all material respects with these regulations and have implemented a variety of measures to promote continuing compliance, regulations may change over time, and we may be required to incur expenses and/or to modify our operations in order to ensure compliance with these regulations, which could harm our profitability and financial condition. If we are found to be in violation of any of the foregoing laws or regulations, we could become subject to fines, penalties, damages or other sanctions, as well as potential adverse public relations, which could adversely impact our business, reputation, sales, profitability and financial condition.

We are not aware of any national or local provisions which have been enacted regulating the discharge of materials into the environment, or otherwise relating to the protection of the environment, that have materially affected, or will materially affect, our net income or competitive position, or will result in material capital expenditures. During fiscal 2013, there were no material capital expenditures for environmental control facilities, and no such material expenditures are anticipated.

Customers

No single customer accounts for 10% or more of our net sales.

Seasonality

Our business is modestly impacted by seasonal influences inherent in the U.S. bedding industry and general retail shopping patterns. The U.S. bedding industry generally experiences lower sales in the second quarter and increased sales during selected holiday or promotional periods.

Working Capital

Selling directly to our customers, with a primarily just-in-time, build-to-order production process in our plants, and with retail stores that serve mainly as showrooms, allows us to maintain low inventory levels and operate with minimal working capital requirements. We have historically generated sufficient cash flows to self-fund operations through an accelerated cash-conversion cycle. As of December 28, 2013, we had $20.0 million available under our $20.0 million credit facility which contains an accordion feature that allows us to increase the amount of the line up to $50.0 million in total availability, subject to lender approval.

Qualified customers are offered revolving credit to finance purchases through a private-label consumer credit facility provided by GE Capital Retail Bank. Approximately 40% of our net sales in 2013 were financed by GE Capital Retail Bank. Our current agreement with GE Capital Retail Bank expires February 15, 2016, subject to earlier termination upon certain events and subject to automatic extensions. We pay GE Capital Retail Bank a fee for extended credit promotional financing offers. Under the terms of our agreement, GE Capital Retail Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures. As the receivables are owned by GE Capital Retail Bank, at no time are the receivables purchased or acquired from us. We are not liable to GE Capital Retail Bank for our customers' credit defaults. In connection with all purchases financed under these arrangements, GE Capital Retail Bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts, upon delivery to the customer. Customers that do not qualify for credit under our agreement with GE Capital Retail Bank may apply for credit under a secondary program that we offer through another provider.

Employees

At December 28, 2013, we employed 2,858 persons, including 1,544 retail sales and support employees, 213 direct marketing and customer service employees, 751 manufacturing and logistics employees, and 350 management and administrative employees. Approximately 88 of our employees were employed on a part-time basis at December 28, 2013. Except for managerial employees and professional support staff, all of our employees are paid on an hourly basis (plus commissions for sales professionals). None of our employees is represented by a labor union or covered by a collective bargaining agreement. In recent periods we have focused on improving our employee engagement levels, which we believe is important to driving both organizational productivity and customer satisfaction.

Executive Officers of the Registrant

Shelly R. Ibach, 54, has served as President and Chief Executive Officer since June 2012 having previously served as Executive Vice President, Chief Operating Officer since June 2011 and as Executive Vice President, Sales & Merchandising since October 2008. Ms. Ibach joined Select Comfort as Senior Vice President, U.S. Sales - Company Owned Channels in April 2007. Prior to joining Select Comfort, Ms. Ibach was Senior Vice President and General Merchandise Manager for Macy’s home division. From 1982 to 2005, Ms. Ibach held various leadership positions within Target Corporation at Marshall Field’s Department Stores. Other key positions included Vice President - Divisional Merchandise Manager, Director of Planning and Regional Director of Stores.

Andrea L. Bloomquist, 44, has served as the Senior Vice President and Chief Product Officer for Select Comfort since June 2012 and leads product innovation including product management, development, merchandise buying and R&D for all Sleep Number products. Ms. Bloomquist was the Chief Product and Merchandising Officer from June 2011 to June 2012. Ms. Bloomquist joined Select Comfort in May 2008 as Vice President and General Merchandise Manager. Prior to joining Select Comfort, Ms. Bloomquist held leadership positions in product and merchandising at Macy’s and Marshall Field’s Department Stores for Target Corporation from 1996-2008.

Kevin K. Brown, 45, has served as the Senior Vice President and Chief Marketing Officer for Select Comfort since January 2014. Prior to joining Select Comfort in January 2014, Mr. Brown served as Group Vice President, Chief Marketing Officer for Meijer, Inc., a regional chain of retail supercenters, from 2011 to 2013. From 2007 to 2011, Mr. Brown held executive marketing leadership roles at Sears Holdings Corporation, including Vice President, Chief Marketing Officer for the home appliances business unit. From 2004 to 2006, Mr. Brown held the position of Senior Vice President, Marketing for Jo-Ann Stores, Inc. Prior to Jo-Ann Stores, he was an associate partner for Accenture.

Andrew P. Carlin, 50, has served as the Senior Vice President and Chief Sales Officer for Select Comfort since June 2012 and leads all sales channels and real estate. From May 2011 to June 2012 Mr. Carlin was the Vice President and Chief Sales Officer, and from January 2009 to May 2011 he was the Vice President of U.S. Retail Sales. Mr. Carlin joined Select Comfort in January 2008 as Regional Vice President, East Region. Prior to joining Select Comfort, Mr. Carlin spent more than 20 years in sales leadership roles for companies including Senior Vice President of Store Operations at Gander Mountain from 2003-2008, Kohl’s Department Stores from 1995-2003 and Target Corporation from 1986-1995.

Mark A. Kimball, 55, has served as Select Comfort’s Senior Vice President and Chief Legal and Risk Officer and Secretary since June 2011. From August 2003 to June 2011, Mr. Kimball held the position of Senior Vice President, General Counsel, Chief Administrative Officer and Secretary. From July 2000 to August 2003, Mr. Kimball served as Senior Vice President, Human Resources and Legal, General Counsel, Chief Administrative Officer and Secretary. From May 1999 to July 2000, Mr. Kimball served as the company’s 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 & Donnelly LLP practicing in the area of corporate finance.

Kathryn V. Roedel, 53, has served as Select Comfort’s Executive Vice President and Chief Services and Fulfillment Officer since June 2011. From October 2008 to June 2011 Ms. Roedel served as Select Comfort’s Executive Vice President, Product and Service. Ms. Roedel joined Select Comfort as the company’s Senior Vice President, Global Supply Chain in April 2005. From 2003 to March 2005, Ms. Roedel served as the General Manager, Global Supply Chain Strategy for GE Medical Systems. From 1983 to 2003, she held leadership positions within two divisions of General Electric Company, in Sourcing, Manufacturing, Quality and Service. Other key positions included General Manager, Global Quality and Six Sigma; Vice President of Technical Operations and Director/Vice President of Quality Programs for GE Clinical Services, a division of GE Medical Systems.

Wendy L. Schoppert, 47, has served as Select Comfort’s Executive Vice President and Chief Financial Officer since May 2011. From March 2008 to June 2011, Ms. Schoppert served as the company’s Senior Vice President, Chief Information Officer. She served as the company’s Senior Vice President, International from January 2007 to March 2008. Ms. Schoppert joined Select Comfort as Senior Vice President and General Manager, New Channel Development & Strategy in April 2005. From 2002 to March 2005, Ms. Schoppert led various departments within U.S. Bancorp Asset Management, most recently serving as Head of Private Asset Management and Marketing. From 1996 to 2000, she held several positions with America West Holdings Corporation, including Vice President of America West Vacations and head of the airline’s Reservations division. Prior to 1996, Ms. Schoppert held various finance-related positions at both Northwest Airlines and American Airlines. On November 12, 2013, Ms. Schoppert announced her plans to resign from her position at Select Comfort in 2014.

Available Information

We are subject to the reporting requirements of the Exchange Act and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). Copies of our reports, proxy statements and other information can be read and copied at:

SEC Public Reference Room

100 F Street NE

Washington, D.C. 20549

Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains a website that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC’s home page at http://www.sec.gov.

Our corporate Internet website is www.SleepNumber.com. Through a link to a third-party content provider, our corporate website provides free access to our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after electronic filing with the SEC. These documents are posted on our website at www.SleepNumber.com — select the “Investor Relations” link. The information contained on our website or connected to our website is not incorporated by reference into this Form 10-K and should not be considered part of this report.

We also make available, free of charge on our website, the charters of the Audit Committee, Management Development and Compensation Committee, and Corporate Governance and Nominating Committee as well as our Code of Business Conduct (including any amendment to, or waiver from, a provision of our Code of Business Conduct) adopted by our Board. These documents are posted on our website — select the “Investor Relations” link and then the “Corporate Governance” link.

Copies of any of the above referenced information will also be made available, free of charge, upon written request to:

Select Comfort Corporation

Investor Relations Department

9800 59th Avenue North

Minneapolis, MN 55442

ITEM 1A. RISK FACTORS

An investment in our common stock involves a high degree of risk. You should carefully consider the specific risks set forth below and other matters described in this Annual Report on Form 10-K before making an investment decision. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties, including risks and uncertainties not presently known to us or that we currently see as immaterial, may also harm our business. If any of these risks occur, our business, results of operations, cash flows and financial condition could be materially and adversely affected.

Current and future economic conditions could materially adversely affect our sales, profitability, cash flows and financial condition.

Our success depends significantly upon discretionary consumer spending, which is influenced by a number of general economic factors, including without limitation consumer confidence, the housing market, employment levels, interest rates, inflation, taxation and the level of customer traffic in malls and shopping centers. Adverse trends in any of these economic factors may adversely affect our sales, profitability, cash flows and financial condition.

Our future growth and profitability depends upon the effectiveness and efficiency of our marketing programs.

We are highly dependent on the effectiveness of our marketing messages and the efficiency of our advertising expenditures in generating consumer awareness and sales of our products. We have experienced a significant degree of variability in the effectiveness and efficiency of our marketing messages and advertising expenditures in recent years and may continue to experience such variability in the future. We continue to evolve our marketing strategies, adjusting our messages, the amount we spend on advertising and where we spend it, and no assurance can be given that we will be successful in developing effective messages and in achieving efficiency in our advertising expenditures.

We also believe that consumers are increasingly using the Internet as a part of their shopping experience. As a result, our future growth and profitability will depend in part on (i) the effectiveness and efficiency of our on-line advertising and search optimization programs in generating consumer awareness and sales of our products, (ii) our ability to prevent confusion among consumers that can result from search engines that allow competitors to use or bid on our trademarks to direct consumers to competitors’ websites, (iii) our ability to prevent Internet publication of false or misleading information regarding our products or our competitors’ products; and (iv) the stability of our website.

If our marketing messages are ineffective or our advertising expenditures and other marketing programs, including Internet-based programs, are inefficient in creating awareness of our products and brand name, in driving consumer traffic to our points of sale and in motivating consumers to purchase our products, our sales, profitability, cash flows and financial condition may be adversely impacted.

Our future growth and profitability depends on our ability to execute our Company-Controlled distribution strategy.

The vast majority of our sales occur through our Company-Controlled distribution channel, including our retail stores, and this Company-Controlled distribution channel represents our largest opportunity for growth in sales and improvement in profitability. Our retail stores carry significant fixed costs. We also make significant capital expenditures as we open new stores and remodel or reposition existing stores. We are highly dependent on our ability to maintain and increase sales per store to cover these fixed expenses, provide a return on our capital investments and improve our operating margins.

Our stores are largely mall-based. We depend on the continued popularity of malls as shopping destinations and the ability of mall anchor tenants and other attractions to generate customer traffic for our retail stores. Any decrease in mall traffic could adversely affect our sales, profitability, cash flows and financial condition.

Our Company-Controlled distribution strategy results in relatively few points of distribution, including 440 retail stores across the continental United States as of the end of 2013. Several of the mattress manufacturers and retailers with which we compete have significantly more points of distribution than we do, which makes us highly dependent on our ability to drive consumers to our points of distribution in order to gain market share.

Our longer term Company-Controlled distribution strategy is also dependent on our ability to renew existing store leases and to secure suitable locations for new store openings, in each case on a cost-effective basis. We may encounter higher than anticipated rents and other costs in connection with managing our retail store base, or may be unable to find or obtain suitable new locations.

Failure to achieve and maintain a high level of product quality could negatively impact our sales, profitability, cash flows and financial condition.

Our products represent a significant departure from traditional innerspring mattresses and from viscoelastic foam mattresses, which have no moving parts and do not rely on electronics and air control systems. As a result, our beds may be susceptible to failures that do not exist with traditional or viscoelastic foam mattresses. Failure to achieve and maintain acceptable quality standards could impact consumer acceptance of our products or could result in negative media and Internet reports or owner dissatisfaction that could negatively impact our brand image and sales levels.

In addition, a decline in product quality could result in an increase in return rates and a corresponding decrease in sales, or an increase in product warranty claims in excess of our warranty reserves. An unexpected increase in return rates or warranty claims could harm our sales, profitability, cash flows and financial condition.

As a consumer products company, we face an inherent risk of exposure to product liability claims in the event that the use of our products is alleged to have resulted in personal injury or property damage. In the event that any of our products proves to be defective, we may be required to recall or redesign such products. We have at times experienced increased returns and adverse impacts on sales, as well as product liability litigation, as a result of media reports related to the alleged propensity of our products to develop mold. We may experience additional adverse impacts on sales and additional litigation in the event any similar media reports were to occur in the future. We maintain insurance against some forms of product liability claims, but such coverage may not be adequate for liabilities actually incurred. A successful claim brought against us in excess of available insurance coverage, or any claim or product recall that results in significant adverse publicity against us, may have a material adverse effect on our sales, profitability, cash flows and financial condition.

Our future growth and profitability depends in part on our ability to continue to improve and expand our product line.

As described in greater detail below, the mattress industry is highly competitive, and our ability to compete effectively and to profitably grow our market share depends in part on our ability to continue to improve and expand our product line of adjustable firmness air beds and related accessory products. We incur significant research and development and other expenditures in the pursuit of improvements and additions to our product line. If these efforts do not result in meaningful product improvements or new product introductions, or if we are not able to gain widespread consumer acceptance of product improvements or new product introductions, our sales, profitability, cash flows and financial condition may be adversely affected. In addition, if any significant product improvements or new product introductions are not successful, our reputation and brand image may be adversely affected.

Significant competition in our industry could adversely affect our business.

Because of the vertical integration of our business model, our products and stores, as well as other points of sale, face significant competition with both a number of different types of mattress alternatives and a variety of retailers.

The mattress industry is characterized by a high degree of concentration among the two largest manufacturers of innerspring mattresses and viscoelastic foam mattresses. We believe that several of our competitors have greater financial, marketing and manufacturing resources and better brand name recognition than we do and sell products through broader and more established distribution channels. A number of mattress manufacturers, including several of these larger competitors, have offered adjustable firmness air beds in the past, and the largest manufacturer of viscoelastic foam mattresses recently introduced adjustable firmness air beds that compete directly with our products. We believe several of the larger mattress manufacturers may also be pursuing plans to open their own retail stores to compete directly with our retail stores.

Our Company-Controlled distribution channel competes with other retailers who generally provide a wider selection of mattress alternatives than we offer. A number of these retailers also have more points of distribution and greater brand name recognition than we do.

These manufacturing and retailing competitors, or new entrants into the market, may compete aggressively and gain market share with existing or new mattress products, and may pursue or expand their presence in the adjustable firmness air bed segment of the market. We have limited ability to anticipate the timing and scale of new product introductions, advertising campaigns or new pricing strategies by our competitors, which could inhibit our ability to retain or increase market share, or to maintain our product margins.

If we are unable to effectively compete with other bedding manufacturers and other retailers, our sales, profitability, cash flows and financial condition may be adversely impacted.

Our intellectual property rights may not prevent others from using our technology or trademarks in connection with the sale of competitive products. We may be subject to claims that our products, processes or trademarks infringe intellectual property rights of others.

We own various U.S. and foreign patents and patent applications related to certain elements of the design and function of our beds and related products. We also own several registered and unregistered trademarks and trademark applications, including in particular our Sleep Number trademarks, which we believe have significant value and are important to the marketing of our products. These intellectual property rights may not provide sufficient protection against infringement or piracy and may not prevent our competitors from developing and marketing products that are similar to or competitive with our beds or other products. Our patents are also subject to varying expiration dates. In particular, our patents related to wireless remote control systems with digital displays will expire in November of 2014 and other patents will expire on various dates through September 2028. In addition, the laws of some foreign countries may not protect our intellectual property rights and confidential information to the same extent as the laws of the United States. If we are unable to protect our intellectual property, we may be unable to prevent other companies from using our technology or trademarks in connection with competitive products, which could adversely affect our sales, profitability, cash flows and financial condition.

We may be subject to claims that our products, processes or trademarks infringe the intellectual property rights of others. The defense of these claims, even if we are ultimately successful, may result in costly litigation, and if we are not successful in our defense, we could be subject to liability for damages or royalty obligations and our sales, profitability, cash flows and financial condition could be adversely affected.

A reduction in the availability of credit to consumers generally or under our existing consumer credit programs could harm our sales, profitability, cash flows and financial condition.

A significant percentage of our sales are made under consumer credit programs through third parties. The recent economic downturn resulted in a reduction of credit available to consumers as macroeconomic factors impacted the financial position of consumers and as suppliers of credit adjusted their lending criteria. In addition, changes in federal regulations effective in 2010 placed additional restrictions on all consumer credit programs, including limiting the types of promotional credit offerings that may be offered to consumers.

GE Capital Retail Bank provides credit to our customers through a private label credit card agreement that is currently scheduled to expire on February 15, 2016, subject to earlier termination upon certain events. GE Capital Retail Bank has discretion to control the content of financing offers to our customers and to set minimum credit standards under which credit is extended to customers.

Reduction of credit availability due to changing economic conditions, changes in credit standards under our private label credit card program or changes in regulatory requirements, or the termination of our agreement with GE Capital Retail Bank, could harm our sales, profitability, cash flows and financial condition.

We utilize “just-in-time” manufacturing processes with minimal levels of inventory, which could leave us vulnerable to shortages in supply that may harm our ability to satisfy consumer demand and may adversely impact our sales and profitability.

We generally assemble our products after we receive orders from customers utilizing “just-in-time” manufacturing processes with minimal levels of raw materials, work in process and finished goods inventories. Lead times for ordered components may vary significantly. In addition, some components used to manufacture our products are provided on a sole source basis. Any unexpected shortage of materials caused by any disruption of supply or an unexpected increase in the demand for our products, could lead to delays in shipping our beds to customers. Any such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition.

We rely upon several key suppliers that are, in some instances, the only source of supply currently used by us for particular materials, components or services. A disruption in the supply or substantial increase in cost of any of these products or services could harm our sales, profitability, cash flows and financial condition.

We currently obtain all of the materials and components used to produce our beds from outside sources. In several cases, including our proprietary air chambers, our proprietary blow-molded foundations, our adjustable foundations, various components for our Firmness Control Systems, as well as fabrics and zippers, we have chosen to obtain these materials and components from suppliers who serve as the only source of supply, or who supply the vast majority of our needs of the particular material or component. While we believe that these materials and components, or suitable replacements, could be obtained from other sources, in the event of a disruption or loss of supply of relevant materials or components for any reason, we may not be able to find alternative sources of supply, or if found, may

not be found on comparable terms. If our relationship with either the primary supplier of our air chambers or the supplier of our blow-molded foundations is terminated, we could have difficulty in replacing these sources since there are relatively few other suppliers presently capable of manufacturing these components.

Similarly, we rely on UPS and other carriers to deliver some of our products to customers on a timely and cost-effective basis. Any significant delay in deliveries to our customers could lead to increased returns and cause us to lose sales. Any increase in freight charges could increase our costs of doing business and harm our sales, profitability, cash flows and financial condition.

Fluctuations in commodity prices could result in an increase in component costs and/or delivery costs.

Our business is subject to significant increases or volatility in the prices of certain commodities, including but not limited to fuel, oil, natural gas, rubber, cotton, plastic resin, steel and chemical ingredients used to produce foam. Increases in prices of these commodities or other inflationary pressures may result in significant cost increases for our raw materials and product components, as well as increases in the cost of delivering our products to our customers. To the extent we are unable to offset any such increased costs through value engineering and similar initiatives, or through price increases, our profitability, cash flows and financial condition may be adversely impacted. If we choose to increase prices to offset the increased costs, our unit sales volumes could be adversely impacted.

Our business is subject to risks inherent in global sourcing activities.

Our air chambers and some of our other components are manufactured outside the United States, and therefore are subject to risks associated with foreign sourcing of materials, including but not limited to:


•	Political instability resulting in disruption of trade;


•	Existing or potential duties, tariffs or quotas on certain types of goods that may be imported into the United States;


•	Disruptions in transportation due to acts of terrorism, shipping delays, foreign or domestic dock strikes, customs inspections or other factors;


•	Foreign currency fluctuations; and


•	Economic uncertainties, including inflation.

These factors could increase our costs of doing business with foreign suppliers, lead to inadequate inventory levels or delays in shipping beds to our customers, which could harm our sales, customer satisfaction, profitability, cash flows and financial condition.

Disruption of operations in either of our two manufacturing facilities could increase our costs of doing business or lead to delays in shipping our beds.

We have three manufacturing plants, which are located in Irmo, South Carolina, Salt Lake City, Utah and Greensboro, SC. We generally manufacture beds to fulfill orders rather than stocking finished goods inventory in our plants or stores. Therefore, the disruption of operations of either of our manufacturing facilities for a significant period of time may increase our costs of doing business and lead to delays in shipping our beds to customers. Such delays could adversely affect our sales, customer satisfaction, profitability, cash flows and financial condition.

Our manufacturing and retail operations are subject to a wide variety of government regulations which could increase costs or cause disruptions to our operations.

We are subject to a wide variety of government regulations relating to the bedding industry or to various aspects of our business and operations, including without limitation, regulations relating to the proper labeling of bedding merchandise; flammability standards applicable to mattresses; environmental and product safety regulations; consumer protection and data privacy regulations; various “do not call” or “do not mail” list requirements; labor laws, including but not limited to laws relating to occupational health and safety, employee privacy, wages and hours, overtime pay, harassment and discrimination, equal opportunity, and employee leaves and benefits; and import and export regulations.

Although we believe that we are in compliance in all material respects with these regulations and have implemented a variety of measures to promote continuing compliance, regulations may change over time, and we may be required to incur expenses and/or to modify our operations in order to ensure compliance with these regulations or we may be found to be in violation of the foregoing laws or regulations, which could harm our sales, profitability, cash flows and financial condition.

Regulatory requirements related to flammability standards for mattresses may increase our product costs and increase the risk of disruption to our business.

The federal Consumer Product Safety Commission adopted new flammability standards and related regulations which became effective nationwide in July 2007 for mattresses and mattress and foundation sets. Compliance with these requirements has resulted in higher materials and manufacturing costs for our products, and has required modifications to our information systems and business operations, further increasing our costs and negatively impacting our capacity.

These regulations require manufacturers to implement quality assurance programs and encourage manufacturers to conduct random testing of products. These regulations also require maintenance and retention of compliance documentation. These quality assurance and documentation requirements are costly to implement and maintain. If any product testing, other evidence, or regulatory inspections yield results indicating that any of our products may not meet the flammability standard, we may be required to temporarily cease production and distribution and/or to recall products from the field, and we may be subject to fines or penalties, any of which outcomes could harm our business, reputation, sales, profitability, cash flows and financial condition.

Our management information systems may not be adequate to meet the evolving needs of our business as well as existing and emerging regulatory requirements. Improvements and upgrades to our systems will be costly to implement and may take longer or require greater resources than anticipated, and may result in disruptions to our systems or business.

We depend on our management information systems for many aspects of our business. Our current information systems architecture includes some off-the-shelf programs as well as some key software that has been developed by our own programmers, using legacy programming languages that are no longer vendor-supported. Our business may be adversely affected if our management information systems are disrupted or if we are unable to improve, upgrade, integrate or expand our systems to meet the evolving needs of our business and existing and emerging regulatory requirements.

We are incurring significant capital expenditures in the pursuit of improvements and upgrades to our management information systems. These efforts may take longer and may require greater financial and other resources than anticipated, may cause distraction of key personnel, and may cause disruptions to our existing systems and our business. Any of these outcomes could impair our ability to achieve critical strategic initiatives and could adversely impact our sales, profitability, cash flows and financial condition.

Our information systems may be subject to attacks by hackers or other cyber threats that could compromise the security of our systems, which could substantially disrupt our business and could result in the breach of consumers' or employees' private data.

Our information systems contain personal information related to our customers and employees in the ordinary course of our business, such as credit card and demographic information of our customers and social security numbers and demographic information of our employees. While we maintain security measures to protect this information, a breach of these security measures, such as through third-party action, employee error, malfeasance or otherwise, could compromise the security of our customers’ and employees’ personal information. As the techniques used to breach such security measures change frequently and may not be recognized until launched against a target, we may be unable to anticipate these techniques or to implement adequate preventative measures. Any failure of our systems and processes to adequately protect customer or employee personal information from theft or loss could adversely impact our business, reputation, sales, profitability, cash flows and financial condition.

Our future growth and profitability depends in part upon our ability to attract, retain and motivate qualified personnel.

As a vertically integrated manufacturer and retailer, our future growth and profitability will depend in part upon our ability to attract, retain and motivate qualified personnel in a wide variety of areas to execute our growth strategy, including qualified management and executive personnel and qualified retail sales professionals and managers. The failure to attract, retain and motivate qualified personnel may hinder our ability to execute our business strategy and growth initiatives and may adversely impact our sales, profitability, cash flows and financial condition.

Our charter and corporate documents and Minnesota law make a takeover of our company more difficult and expensive, which may prevent certain changes in control and limit the market price of our common stock.

Our charter, bylaws, certain corporate documents and sections 671 and 673 of the Minnesota Business Corporation Act contain provisions that might enable our management to resist a takeover of our company or which may increase the cost of an acquisition of our company. Provisions in our amended and restated articles of incorporation and amended and restated bylaws may discourage, delay or prevent a merger or acquisition involving us that our shareholders may consider favorable. For example, our amended and restated articles of incorporation authorize five million undesignated shares. Without shareholder approval, our board of directors has the authority to create a class or series of shares from the undesignated shares and to set the terms of the class or series, including voting and dividend rights. With these rights, it could be more difficult for a third party to acquire us. In addition, our amended and restated articles of incorporation provide for a staggered board of directors, with directors serving for three-year terms and approximately one-third of the directors coming up for re-election each year. Having a staggered board will make it more difficult for a third party to obtain control of our board of directors through a proxy contest, which may be a necessary step in any acquisition of us that is not favored by our board of directors. In addition, we have a severance plan that may provide certain employees and executive officers with severance compensation if they are terminated in connection with a change in control of our company and stock award plans that may provide for the acceleration of vesting of incentive stock awards in the event of termination of employment or other adverse effects upon the employment terms of employees and executive officers following a change in control of our company. The existence of these provisions could discourage or prevent a change in control of our company, could make a change in control of our company more difficult and expensive and could limit the price that investors might be willing to pay in the future for shares of our common stock.

Risks of certain global events, such as terrorist attacks or a pandemic outbreak, could adversely impact our sales, profitability, financial condition or stock price.

Additional terrorist attacks in the United States or against U.S. targets, or acts of war or threats of war or the escalation of current hostilities involving the United States or its allies, or military or trade disruptions impacting our domestic or foreign suppliers of components of our products, may adversely impact our operations, causing delays or losses in the delivery of merchandise to us and decreased sales. These events could also cause an increase in oil or other commodity prices, which could adversely affect our materials or transportation costs, including the costs of delivery of our products to customers.

A significant pandemic outbreak, or a perceived threat of such an outbreak, could cause significant disruptions to our supply chain, manufacturing capability and distribution system that could adversely impact our ability to produce and deliver products, which could result in a loss of sales and adversely impact our profitability, cash flows and financial condition.

Any of these events could adversely impact consumer confidence and spending or result in increased volatility in the U.S. and worldwide financial markets. These events also could cause, or deepen and prolong, an economic recession in the United States or abroad. Any of these occurrences could have an adverse impact on our sales, profitability, financial condition or stock price.

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

ITEM 2. PROPERTIES

Retail Locations

We currently lease all of our existing retail store locations and expect that our policy of leasing stores, rather than owning stores, will continue. Our store leases generally provide for an initial lease term of five to ten years with a termination option if we do not achieve certain minimum annual sales thresholds. Generally, mall 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.

The following table summarizes the geographic location of our 440 retail stores as of December 28, 2013:



	Retail Stores		Retail Stores		Retail Stores
Alabama	4	Louisiana	7	North Carolina	12
Arizona	8	Maine	2	North Dakota	2
Arkansas	3	Maryland	11	Ohio	18
California	58	Massachusetts	5	Oklahoma	4
Colorado	11	Michigan	13	Oregon	6
Connecticut	7	Minnesota	13	Pennsylvania	18
Delaware	2	Mississippi	4	Rhode Island	1
Florida	27	Missouri	13	South Carolina	4
Georgia	14	Montana	2	South Dakota	1
Idaho	2	Nebraska	3	Tennessee	9
Illinois	19	Nevada	4	Texas	37
Indiana	11	New Hampshire	4	Utah	3
Iowa	7	New Jersey	14	Vermont	1
Kansas	4	New Mexico	3	Virginia	11
Kentucky	6	New York	12	Washington	10
				Wisconsin	10
				Total	440

Manufacturing, Distribution and Headquarters

We lease our 159,000-square-foot corporate headquarters in the Minneapolis, Minnesota area. The lease commenced in November 2007 and runs through 2017 with two five-year renewal options.

We also lease approximately 122,000 square feet in the Minneapolis, Minnesota area that includes our research and development department, and a distribution center that accepts returns, fulfills accessory orders and processes warranty claims. This lease expires in 2017 and contains one five-year renewal option.

We lease two manufacturing and distribution centers in Irmo, South Carolina and Salt Lake City, Utah of approximately 105,000 square feet and approximately 101,000 square feet, respectively. We lease the Irmo facility through February 2016, and the Salt Lake City facility through July 2015, with a five-year renewal option thereafter.

We also lease three buildings used for manufacturing purposes for our Comfortaire business in Greenville, South Carolina of approximately 65,000 total square feet. The current lease term for these three buildings runs through February 28, 2015, with a one-year renewal option thereafter.

ITEM 3. LEGAL PROCEEDINGS

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

On August 23, 2013, we filed a complaint in U.S. District Court in the District of Minnesota against Gentherm, Inc. seeking a declaratory judgment that Select Comfort be named as an assignee of certain patents asserted against Select Comfort by Gentherm or in the alternative that the asserted patents are not enforceable or are invalid or that Select Comfort and its products do not infringe any valid claim of the asserted patents. This complaint was filed after Gentherm asserted in a letter that Select Comfort’s recently introduced DualTemp™ layer product infringed certain patents owned by Gentherm. Subsequently, Gentherm filed counterclaims alleging infringement of its patents and seeking various legal and equitable remedies, including injunctive relief, treble damages and attorney’s fees. We believe the claims asserted by Gentherm are without merit, and we intend to vigorously pursue our claims and defend the claims asserted by Gentherm.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II

ITEM 5. MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Our common stock trades on The NASDAQ Stock Market LLC (NASDAQ Global Select Market) under the symbol “SCSS.” As of January 25, 2014, there were approximately 209 holders of record of our common stock. The following table sets forth the quarterly high and low sales prices per share of our common stock, at closing, as reported by NASDAQ for the two most recent fiscal years.



	First Quarter		Second Quarter		Third Quarter		Fourth Quarter
Fiscal 2013
High	$	28.22	$	25.80	$	27.55	$	26.02
Low	17.16		17.56		21.01		18.04

Fiscal 2012
High	$	33.20	$	35.24	$	33.58	$	33.16
Low	22.15		19.33		21.10		24.48

We are not restricted from paying cash dividends under our credit agreement other than customary legal and contractual restrictions. However, we have not historically paid, and have no current plans to pay, cash dividends on our common stock.

Information concerning share repurchases completed during the fourth quarter of fiscal 2013 is set forth below:



Fiscal Period	Total Number of Shares Purchased⁽¹⁾⁽²⁾	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs ⁽¹⁾	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
September 29, 2013 through October 26, 2013	141,996	$	22.43	141,660	$	143,535,000
October 27, 2013 through November 23, 2013	164,470	19.32		164,470	140,357,000
November 24, 2013 through December 28, 2013	175,102	20.87		175,102	136,702,000
Total	481,568	$	20.80	481,232	$	136,702,000

⁽¹⁾

Under the current Board-approved $290.0 million share repurchase program, we repurchased 481,232 shares of our common stock at a cost of $10.0 million (based on trade dates) during the three months ended December 28, 2013. As of December 28, 2013, the remaining authorization under our Board-approved share repurchase program was $136.7 million. There is no expiration date governing the period over which we can repurchase shares. Any repurchased shares are constructively retired and returned to an unissued status.

⁽²⁾In connection with the vesting of employee restricted stock grants, we also repurchased 336 shares of our common stock at a cost of $8 thousand, during the three months ended December 28, 2013.

Comparative Stock Performance

The graph below compares the total cumulative shareholder return on our common stock over the last five years to the total cumulative return on the Standard and Poor’s (“S&P”) 400 Specialty Stores Index and The NASDAQ Stock Market (U.S.) Index assuming a $100 investment made on January 3, 2009. Each of the three measures of cumulative total return assumes reinvestment of dividends. The stock performance shown on the graph below is not necessarily indicative of future price performance. The information contained in this “Comparative Stock Performance” section shall not be deemed to be “soliciting material” or “filed” or incorporated by reference in future filings with the SEC, or subject to the liabilities of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that we specifically request that it be treated as soliciting material or incorporate it by reference into a document filed under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN

AMONG SELECT COMFORT CORPORATION, S&P 400 SPECIALTY STORES INDEX,

AND THE NASDAQ STOCK MARKET (U.S.) INDEX



	1/3/2009		1/2/2010		1/1/2011		12/31/2011		12/29/2012		12/28/2013
Select Comfort Corporation	$	100	$	2,508	$	3,512	$	8,342	$	9,427	$	8,162
S&P 400 Specialty Stores Index	100		147		221		253		308		466
The NASDAQ Stock Market (U.S.) Index	100		140		166		164		189		269

ITEM 6. SELECTED FINANCIAL DATA

(in thousands, except per share and selected operating data, unless otherwise indicated)

The Consolidated Statements of Operations Data and Consolidated Balance Sheet Data presented below have been derived from our Consolidated Financial Statements and should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our Consolidated Financial Statements and Notes thereto included in this Annual Report on Form 10-K.



	Year
	2013			2012			2011			2010			2009			2008⁽¹⁾
Consolidated Statements of Operations Data:
Net sales	$	960,171		$	934,978		$	743,203		$	605,676		$	544,202		$	608,524
Gross profit	601,755			596,546			470,345			378,263			335,460			358,572
Operating expenses:
Sales and marketing	439,156			398,205			317,502			269,901			259,244			332,068
General and administrative	62,840			66,617			58,106			53,572			49,560			57,994
Research and development	9,478			6,194			4,175			2,147			1,973			3,374
Asset impairment charges	127			148			109			260			686			34,594
Other⁽²⁾⁽³⁾	(534		)	5,595			—			—			3,324			—
Operating income (loss)	90,688			119,787			90,453			52,383			20,673			(69,458		)
Net income (loss)	$	60,081		$	78,094		$	60,478		$	31,568		$	35,552		$	(70,177	)
Net income (loss) as adjusted⁽⁸⁾	$	59,730		$	81,748		$	60,478		$	31,568		$	11,169		$	(23,174	)
Net income (loss) per share:
Basic	$	1.10		$	1.41		$	1.10		$	0.58		$	0.78		$	(1.59	)
Diluted	$	1.08		$	1.37		$	1.07		$	0.57		$	0.77		$	(1.59	)
Diluted - as adjusted⁽⁸⁾	$	1.07		$	1.43		$	1.07		$	0.57		$	0.24		$	(0.52	)
Shares used in calculation of net income (loss) per share:
Basic	54,866			55,516			55,081			54,005			45,682			44,186
Diluted	55,803			57,076			56,432			55,264			46,198			44,186

Consolidated Balance Sheet Data:
Cash, cash equivalents and marketable debt securities⁽⁴⁾	$	145,014		$	177,821		$	146,317		$	76,016		$	12,184		$	10,987
Working capital	52,357			77,517			72,145			20,053			(25,435		)	(90,534		)
Total assets	381,765			342,021			262,657			169,957			118,240			135,413
Borrowings under revolving credit facility	—			—			—			—			—			79,150
Total shareholders’ equity (deficit)	225,220			193,697			129,391			57,977			22,458			(41,630		)

Selected Operating Data:
Stores open at period-end	440			410			381			386			403			471
Stores opened during period	71			57			19			7			4			19
Stores closed during period	41			28			24			24			72			26
Average net sales per store (000’s)⁽⁵⁾	$	2,093		$	2,164		$	1,721		$	1,295		$	1,046		$	984
Percentage of stores with more than $1.0 million in net sales⁽⁵⁾	96		%	98		%	93		%	70		%	48		%	45		%
Percentage of stores with more than $2.0 million in net sales⁽⁵⁾	46		%	49		%	24		%	7		%	2		%	2		%
Average net sales per mattress unit - Company-Controlled channel⁽⁶⁾	$	3,245		$	3,050		$	2,694		$	2,424		$	2,369		$	2,370
Company-Controlled comparable-sales (decrease) increase⁽⁷⁾	(4		)%	23		%	26		%	19		%	(4		)%	(26		)%
Average square footage per store open during period⁽⁵⁾	1,985			1,670			1,526			1,484			1,474			1,410
Net sales per square foot⁽⁵⁾	$	1,077		$	1,324		$	1,135		$	873		$	710		$	703
Average store age (in months at period-end)	102			113			113			113			102			91
Earnings before interest, depreciation and amortization (“Adjusted EBITDA”)⁽⁸⁾	$	125,020		$	150,285		$	109,180		$	69,675		$	42,289		$	(9,437	)
Free cash flows⁽⁴⁾⁽⁸⁾	$	11,294		$	49,033		$	67,519		$	64,058		$	60,717		$	(26,381	)


⁽¹⁾	Fiscal year 2008 had 53 weeks. All other fiscal years presented had 52 weeks.

⁽²⁾

In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer, would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin's contributions, the Compensation Committee approved the modification of Mr. McLaughlin's unvested stock awards, including performance-based stock awards. As a result of these modifications, we recorded incremental non-cash compensation of $5.6 million ($3.7 million, net of income tax) in 2012. The performance-based stock awards are subject to applicable performance adjustments (through 2014) based on free cash flow and actual market share growth versus performance targets. During 2013, we recorded a non-cash compensation benefit of $0.5 million ($0.4 million, net of income tax) resulting from performance-based stock award adjustments.


⁽³⁾	In 2009, we expensed $3.3 million ($2.1 million, net of income tax) of direct, incremental costs incurred in connection with a terminated equity financing transaction.

⁽⁴⁾

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. All previous periods have been restated to conform to the current year presentation.


⁽⁵⁾	For stores open during the entire period indicated.


⁽⁶⁾	Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.

⁽⁷⁾

Stores are included in the comparable sales calculation in the 13th full month of operation. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base. The number of comparable-stores used to calculate such data was 359, 348, 359, 379, 399 and 452 for 2013, 2012, 2011, 2010, 2009 and 2008, respectively. Fiscal 2008 included 53 weeks, as compared to 52 weeks for the other periods presented. Comparable sales have been adjusted and reported as if all years had the same number of weeks.


⁽⁸⁾	These non-GAAP measures are not in accordance with, or preferable to, GAAP financial data. However, we are providing this information as we believe it facilitates annual and year-over-year comparisons for investors and financial analysts. See pages 21 and 22 for the reconciliation of these non-GAAP measures to the appropriate GAAP measure.

Non-GAAP Data Reconciliations

Reported to Adjusted Statements of Operations Data

(in thousands, except per share amounts)

In addition to disclosing results that are determined in accordance with U.S. Generally Accepted Accounting Principles (“GAAP”), we also disclose non-GAAP results that exclude certain significant charges or credits. Our "as adjusted" data is considered a non-GAAP financial measure and is not in accordance with, nor preferable to, "as reported," or GAAP financial data. However, we believe that the disclosure of results excluding certain significant charges or credits provides additional insights into underlying business performance and facilitates year-over-year comparisons. Below are reconciliations of our non-GAAP financial measures to the most comparable GAAP financial measures.



	Year
	2013			2012		2011		2010		2009			2008
Net income (loss) – as reported	$	60,081		$	78,094	$	60,478	$	31,568	$	35,552		$	(70,177	)
Adjustments – net of income tax ^(1):
CEO transition (benefit) costs⁽²⁾	(351		)	3,654		—		—		—			—
Terminated equity financing costs ⁽³⁾	—			—		—		—		2,061			—
Impairments ⁽⁴⁾	—			—		—		—		—			20,163
Income tax valuation ⁽⁵⁾	—			—		—		—		(26,444		)	26,840
Net income (loss) – as adjusted	$	59,730		$	81,748	$	60,478	$	31,568	$	11,169		$	(23,174	)

Net income (loss) per share – as adjusted:
Basic	$	1.09		$	1.47	$	1.10	$	0.58	$	0.24		$	(0.52	)
Diluted	$	1.07		$	1.43	$	1.07	$	0.57	$	0.24		$	(0.52	)

Basic shares	54,866			55,516		55,081		54,005		45,682			44,186
Diluted shares	55,803			57,076		56,432		55,264		46,198			44,186


⁽¹⁾	Reflects annual effective income tax rates, before discrete adjustments, of 34.2%, 34.7%, 38.0% and 40.0% for 2013, 2012, 2009 and 2008, respectively.

⁽²⁾

In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer, would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin's contributions, the Compensation Committee approved the modification of Mr. McLaughlin's unvested stock awards, including performance-based stock awards. As a result of these modifications, we incurred incremental non-cash compensation of $5.6 million ($3.7 million, net of income tax) in fiscal year 2012. The performance-based stock awards are subject to applicable performance adjustments (through 2014) based on free cash flow and actual market share growth versus performance targets. During 2013, we recorded a non-cash compensation benefit of $0.5 million ($0.4 million, net of income tax) resulting from performance-based stock award adjustments.


⁽³⁾	In 2009, we expensed $3.3 million ($2.1 million, net of income tax) of direct, incremental costs incurred in connection with a terminated equity financing transaction.


⁽⁴⁾	Fiscal 2008 includes impairment charges for the abandonment of our plan to implement SAP^®-based applications and impairment charges in excess of $1.0 million for underperforming stores.


⁽⁵⁾	In 2008, we established a $26.8 million valuation allowance against deferred taxes based on uncertainty regarding future taxable income. In 2009, we reversed the valuation allowance against deferred taxes based on all available positive and negative evidence.

Non-GAAP Data Reconciliations (continued)

Earnings before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA)

(in thousands)

We define earnings before interest, taxes, depreciation and amortization as net income plus: income tax expense, interest expense, depreciation and amortization, stock-based compensation and asset impairments (“Adjusted EBITDA”). Management believes Adjusted EBITDA is a useful indicator of our financial performance and our ability to generate cash from operating activities. Our definition of Adjusted EBITDA may not be comparable to similarly titled definitions used by other companies. The table below reconciles Adjusted EBITDA, which is a non-GAAP financial measure, to the comparable GAAP financial measure.



	Year
	2013		2012		2011		2010		2009			2008
Net income (loss)	$	60,081	$	78,094	$	60,478	$	31,568	$	35,552		$	(70,177	)
Income tax expense (benefit)	30,930		41,911		29,942		18,922		(20,862		)	(2,566		)
Interest expense	51		91		187		1,951		5,996			3,375
Depreciation and amortization	29,599		19,735		13,493		13,012		17,681			21,635
Stock-based compensation	4,232		10,306		4,971		3,962		3,236			3,702
Asset impairments	127		148		109		260		686			34,594
Adjusted EBITDA	$	125,020	$	150,285	$	109,180	$	69,675	$	42,289		$	(9,437	)

Free Cash Flow

(in thousands)

Our “free cash flow” data is considered a non-GAAP financial measure and is not in accordance with, or preferable to, “net cash provided by operations,” or GAAP financial data. However, we are providing this information as we believe it facilitates analysis for investors and financial analysts.



	Year
	2013		2012		2011		2010		2009		2008
Net cash provided by operating activities	$	88,105	$	100,626	$	91,046	$	71,407	$	63,176	$	5,821
Subtract: Purchases of property and equipment	76,811		51,593		23,527		7,349		2,459		32,202
Free cash flow	$	11,294	$	49,033	$	67,519	$	64,058	$	60,717	$	(26,381	)

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

Forward-Looking Statements

The discussion in this Annual Report contains certain forward-looking statements that relate to future plans, events, financial results or performance. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, among others:


•	Current and future general and industry economic trends and consumer confidence;


•	The effectiveness of our marketing messages;


•	The efficiency of our advertising and promotional efforts;


•	Our ability to execute our Company-Controlled distribution strategy;


•	Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;


•	Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;


•	Industry competition, the emergence of additional competitive products, and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;


•	Availability of attractive and cost-effective consumer credit options, including the impact of recent changes in federal law that restricts various forms of consumer credit promotional offerings;


•	Pending and unforeseen litigation and the potential for adverse publicity associated with litigation;


•	Our “just-in-time” manufacturing processes with minimal levels of inventory, which may leave us vulnerable to shortages in supply;


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


•	Rising commodity costs and other inflationary pressures;


•	Risks inherent in global sourcing activities;


•	Risks of disruption in the operation of either of our two manufacturing facilities;


•	Increasing government regulation;


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


•	The costs and potential disruptions to our business related to upgrading our management information systems;


•	Our ability to attract, retain and motivate qualified management, executive and other key employees, including qualified retail sales professionals and managers; 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 the Annual Report on Form 10-K.

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


•	Overview


•	Results of Operations


•	Liquidity and Capital Resources


•	Off-Balance-Sheet Arrangements and Contractual Obligations


•	Critical Accounting Policies and Estimates


•	Recent Accounting Pronouncements

Overview

Business Overview

We believe that we are leading the industry in delivering an unparalleled sleep experience by offering consumers high-quality, innovative and individualized sleep solutions and services, which include a complete line of Sleep Number^® beds and bedding. We are the exclusive manufacturer, marketer, retailer and servicer of the revolutionary Sleep Number bed, which allows individuals to adjust the firmness and support of each side at the touch of a button. We offer further individualization through our new sleep tracking technology, SleepIQ^TM, and a solutions-focused line of Sleep Number pillows, sheets, adjustable bases, and other bedding products, including the innovative DualTemp^TM temperature-balancing layer.

Mission, Vision and Goals

Our mission is to improve lives by Individualizing Sleep Experiences.

Our vision is to become one of the world's most beloved brands by delivering an Unparalleled Sleep Experience. We plan to achieve this by executing our consumer brand strategy to advance our long-term goals and strengthen our competitive advantages.

Our long-term goals are:


•	Everyone will know Sleep Number^®;


•	Innovative Sleep Number^® products will deliver meaningful benefits;


•	Customers will easily find and interact with Sleep Number;


•	Customers will enthusiastically recommend Sleep Number; and


•	We will leverage our unique business model to fund innovation and growth.

Results of Operations

Fiscal 2013 Summary

Financial highlights for fiscal 2013 were as follows:


•	Net income decreased 23% to $60.1 million, or $1.08 per diluted share, compared with net income of $78.1 million, or $1.37 per diluted share in 2012.


•	Financial results for 2012 and 2013 included a $5.6 million charge ($3.7 million, net of income tax) and a $0.5 million benefit ($0.4 million, net of income tax), respectively, associated with the June 1, 2012 chief executive officer transition. See CEO Transition Costs on page 27 for additional details.


•	Net sales increased 3% to $960.2 million, compared with $935.0 million in 2012, primarily due to the addition of 30 net new stores partially offset by a 4% comparable sales decrease in our Company-Controlled channel.

•

Operating income for 2013 declined to $90.7 million, or 9.4% of net sales, compared with $119.8 million, or 12.8% of net sales, for the same period one year ago. Adjusted operating income (operating income excluding CEO transition (benefit) costs) decreased to $90.2 million, or 9.4% of net sales, compared with $125.4 million, or 13.4% of net sales, for the same period one year ago. The decline in operating income was primarily driven by a 1.1 percentage point decrease in our gross profit rate and a 3.1 percentage point increase in our sales and marketing expense rate. Annual retail sales-per-store for 2013 decreased by 3% from one year ago to $2.1 million (for stores open at least one year).


•	Cash provided by operating activities in 2013 totaled $88.1 million, compared with $100.6 million for the prior year.

•

At December 28, 2013, cash, cash equivalents and marketable debt securities totaled $145.0 million compared with $177.8 million at December 29, 2012, and we had no borrowings under our revolving credit facility. In 2013, we repurchased 1,828,811 shares of our common stock under our Board-approved share repurchase program at a cost of $40.0 million ($21.89 per share). As of December 28, 2013, the remaining authorization under our Board-approved share repurchase program was $136.7 million.


•	On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems, for $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. We purchased Comfortaire to advance our innovation leadership in individualized sleep comfort.

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.



	2013					2012				2011
	$			% of Net Sales		$		% of Net Sales		$		% of Net Sales
Net sales	$	960.2		100.0	%	$	935.0	100.0	%	$	743.2	100.0	%
Cost of sales	358.4			37.3		338.4		36.2		272.9		36.7
Gross profit	601.8			62.7		596.5		63.8		470.3		63.3

Operating expenses:
Sales and marketing	439.2			45.7		398.2		42.6		317.5		42.7
General and administrative	62.8			6.5		66.6		7.1		58.1		7.8
Research and development	9.5			1.0		6.2		0.7		4.2		0.6
CEO transition (benefit) costs	(0.5		)	(0.1	)	5.6		0.6		—		0.0
Asset impairment charges	0.1			0.0		0.1		0.0		0.1		0.0
Total operating expenses	511.1			53.2		476.8		51.0		379.9		51.1
Operating income	90.7			9.4		119.8		12.8		90.5		12.2
Operating income – as adjusted ⁽¹⁾	90.2			9.4		125.4		13.4		90.5		12.2
Other income, net	0.3			0.0		0.2		0.0		—		0.0
Income before income taxes	91.0			9.5		120.0		12.8		90.4		12.2
Income tax expense	30.9			3.2		41.9		4.5		29.9		4.0
Net income	$	60.1		6.3	%	$	78.1	8.4	%	$	60.5	8.1	%
Net income – as adjusted ⁽¹⁾	$	59.7		6.2	%	$	81.7	8.7	%	$	60.5	8.1	%

Net income per share:
Basic	$	1.10				$	1.41			$	1.10
Diluted	$	1.08				$	1.37			$	1.07
Diluted – as adjusted ⁽¹⁾	$	1.07				$	1.43			$	1.07

Weighted-average number of common shares:
Basic	54.9					55.5				55.1
Diluted	55.8					57.1				56.4


⁽¹⁾	This non-GAAP measure is not in accordance with, nor preferable to, GAAP financial data. However, we are providing this information as we believe it facilitates annual and year-over-year comparisons for investors and financial analysts. See page 21 for a reconciliation of this non-GAAP measure to the appropriate GAAP measure.

GAAP – generally accepted accounting principles

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



	2013		2012		2011
Company-Controlled channel	96.2	%	96.7	%	96.2	%
Wholesale/Other channel	3.8	%	3.3	%	3.8	%
Total	100.0	%	100.0	%	100.0	%

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



	Net Sales Increase/(Decrease)
	2013		2012		2011

Retail comparable-store sales⁽¹⁾	(4	%)	24	%	29	%
Direct and E-Commerce	(5	%)	9	%	(1	%)
Company-Controlled comparable sales change	(4	%)	23	%	26	%
Net store openings/closings	6	%	3	%	(1	%)
Total Company-Controlled channel	2	%	26	%	25	%
Wholesale/Other channel	18	%	10	%	(11	%)
Total net sales change	3	%	26	%	23	%

⁽¹⁾ Stores are included in the comparable-store calculation in the 13th full month of operations. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base.

Other sales metrics were as follows:



	2013			2012			2011

Average sales per store⁽¹⁾ ($ in thousands)	$	2,093		$	2,164		$	1,721
Average sales per square foot⁽¹⁾	$	1,077		$	1,324		$	1,135
Stores > $1 million in net sales⁽¹⁾	96		%	98		%	93		%
Stores > $2 million in net sales⁽¹⁾	46		%	49		%	24		%
Average net sales per mattress unit – Company-Controlled channel⁽²⁾	$	3,245		$	3,050		$	2,694

⁽¹⁾Trailing twelve months for stores included in our comparable store sales calculation.

⁽²⁾ Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.

The number of retail stores operating during the last three years was as follows:



	2013		2012		2011

Beginning of period	410		381		386
Opened	71		57		19
Closed	(41	)	(28	)	(24	)
End of period	440		410		381

Comparison of 2013 and 2012

Net sales

Net sales in 2013 increased 3% to $960.2 million, compared with $935.0 million for the same period one year ago. The sales increase was primarily driven by sales from 30 net new retail stores opened in the past 12 months, partially offset by a 4% comparable sales decline in our Company-Controlled channel. Company-Controlled mattress units decreased 4% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 6%.

The $25.2 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $53.1 million sales increase resulting from net new retail store openings and (ii) a $5.4 million increase in Wholesale/Other channel sales; partially offset by (iii) $30.0 million decrease in sales from our Company-Controlled comparable retail stores; and (iv) a $3.3 million decrease in Direct and E-Commerce sales.

Gross profit

The gross profit rate decreased to 62.7% of net sales in 2013, compared with 63.8% for the prior-year period. The 2013 sales mix shift to lower-margin products, including Memorial Day and Labor Day limited-edition mattresses and the introduction of the DualTemp layer, reduced the gross profit rate by 0.8 percentage points (“ppt.”) compared to the same period one year ago. In addition, higher sales return and exchange costs, including the second quarter 2013 move to more generous return and exchange policies, reduced the gross profit rate by 0.8 ppt. The gross profit rate was favorably impacted by 0.6 ppt. related to supply chain and manufacturing efficiencies. The rate was also impacted by a variety of factors that can fluctuate from year-to-year, including performance-based incentive compensation and warranty expenses.

Sales and marketing expenses

Sales and marketing expenses in 2013 increased 10% to $439.2 million, or 45.7% of net sales, compared with $398.2 million, or 42.6% of net sales, for the same period one year ago. The $41.0 million increase resulted from (i) a $24.6 million increase in fixed selling expenses primarily due to new, repositioned and remodeled stores; (ii) a $17.9 million, or 14%, increase in media spending; and (iii) a $5.4 million increase in customer financing expenses, as a larger percentage of our customers took advantage of promotional financing offers. These increases were partially offset by lower percentage rent of $4.0 million and a net decrease in miscellaneous other expenses. The sales and marketing expense rate increased 3.1 ppt. compared with the same period one year ago due to the increase in expenses noted above and the deleveraging impact of the 4% comparable sales decrease in our Company-Controlled channel.

General and administrative expenses

General and administrative (“G&A”) expenses decreased $3.8 million to $62.8 million in 2013, compared with $66.6 million in the prior year and decreased to 6.5% of net sales, compared with 7.1% of net sales one year ago. The $3.8 million decrease in G&A expenses was primarily due to (i) a $7.7 million decrease in performance-based incentive compensation; (ii) a $2.8 million reduction in outside professional fees, partially offset by (iii) a $4.6 million increase in employee compensation resulting from headcount increases to support business growth initiatives, and salary and wage rate increases that were in line with inflation; (iv) $1.9 million of additional depreciation expense resulting from the increase in capital expenditures; and (v) a $0.2 million net increase in miscellaneous other expenses. The G&A expense rate decreased by 0.6 ppt. in the current period compared with the same period one year ago due to the net reduction in expenses and the leveraging impact of the 3% net sales increase.

Research and development expenses

Research and development (R&D) expenses increased to $9.5 million, or 1.0% of net sales in 2013, compared with $6.2 million, or 0.7% of net sales, for the same period one year ago. The $3.3 million increase in R&D expenses was due to increased investments to support product innovations during 2013 and the Company's long-term product innovation roadmap.

CEO transition costs

In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin’s contributions to the Company, the Compensation Committee approved the modification of Mr. McLaughlin’s unvested stock awards, including performance-based stock awards. As a result of these modifications, we recorded incremental non-cash compensation of $5.6 million ($3.7 million, net of income tax) in 2012. The performance-based stock awards are subject to applicable performance adjustments through 2014 based on free cash flow and actual market share growth versus performance targets. During 2013, we recorded a non-cash compensation benefit of $0.5 million ($0.4 million, net of income tax) resulting from performance-based stock award adjustments.

Asset impairment charges

During 2013 and 2012, we recognized asset impairment charges of $0.1 million related to computer software and certain retail store assets.

Other income, net

Other income, net was $0.3 million for 2013, compared with $0.2 million for the comparable period one year ago. The current-year improvement in other income, net was primarily due to a higher average yield on our portfolio in the current-year period, and a reduction of fees associated with our line of credit.

Income tax expense

Income tax expense was $30.9 million in 2013 compared with $41.9 million for the same period one year ago. The effective tax rate for 2013 decreased to 34.0% compared with the prior-year period rate of 34.9%. The decrease in the effective tax rate primarily resulted from the retroactive reinstatement of the 2012 research and development tax credit in the first quarter of 2013. Income tax expense for 2013 includes research and development tax credits for both 2012 and 2013.

Comparison of 2012 and 2011

Net sales

Net sales in 2012 increased 26% to $935.0 million, compared with $743.2 million for the same period one year ago. The sales increase was primarily driven by a 23% comparable sales increase in our Company-Controlled channel and the sales from 29 net new retail stores opened in the past 12 months. Company-Controlled mattress units increased 12% compared to the prior-year period. Average net sales per mattress unit in our Company-Controlled channel increased by 13%.

The $191.8 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $147.5 million increase in sales from our Company-Controlled comparable retail stores and a $35.7 million sales increase resulting from net new retail store openings; (ii) a $5.8 million increase in Direct and E-Commerce sales; and (iii) a $2.8 million increase in Wholesale/Other channel sales.

Gross profit

The gross profit rate increased to 63.8% of net sales in 2012, compared with 63.3% for the prior-year period. Approximately 0.9 percentage points (“ppt.”) of the gross profit rate increase was due to price increases and product mix changes resulting from product innovations over the last 12 months. In addition, the prior-year period included a $1.6 million (0.2 ppt.) warranty charge related to customer-service reserves. These gross profit rate increases in 2012 were partially offset by a variety of factors that can fluctuate from year-to-year, including sales return and exchange costs and logistics expenses.

Sales and marketing expenses

Sales and marketing expenses in 2012 increased 25% to $398.2 million, or 42.6% of net sales, compared with $317.5 million, or 42.7% of net sales, for the same period one year ago. The $80.7 million increase was primarily due to a $35.3 million, or 39%, increase in media spending, an increase in variable selling expenses due to the higher sales volume and the additional costs associated with operating 29 net new retail stores. The sales and marketing expense rate declined 0.1 ppt. compared with the same period one year ago due to the leveraging impact of the 26% net sales increase.

General and administrative expenses

General and administrative (“G&A”) expenses increased $8.5 million to $66.6 million in 2012, compared with $58.1 million in the prior year, but decreased to 7.1% of net sales, compared with 7.8% of net sales one year ago. The $8.5 million increase in G&A expenses was primarily due to (i) a $4.2 million increase in outside consulting and legal expenses; (ii) $2.1 million of additional depreciation expense resulting from the increase in capital expenditures to support the growth of the business; (iii) a $0.6 million increase in employee compensation expenses resulting from an increase in employee headcount to support the growth of the business, and salary and wage rate increases that were in line with inflation; and (iv) a $1.6 million net increase in miscellaneous other expenses, partially offset by lower performance-based incentive compensation and stock-based compensation. The G&A expense rate decreased by 0.7 ppt. in the current period compared with the same period one year ago due to the leveraging impact of the 26% net sales increase.

Research and development expenses

Research and development expenses increased to $6.2 million, or 0.7% of net sales in 2012, compared with $4.2 million, or 0.6% of net sales, for the same period one year ago. The $2.0 million increase in R&D expenses was due to increased investments in product innovation during 2012.

CEO transition costs

In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin’s contributions to the Company, the Compensation Committee approved the modification of Mr. McLaughlin’s unvested stock awards, including performance stock awards. The performance stock awards are subject to applicable performance adjustments (through 2014) based on free cash flow and actual market share growth versus performance targets. During 2012, we incurred $5.6 million ($3.7 million, net of income tax) of non-recurring, non-cash expenses associated with these stock award modifications.

Asset impairment charges

During 2012, we recognized asset impairment charges of $0.1 million related to computer software and certain retail store assets. During 2011, we recognized asset impairment charges of $0.1 million related to production machinery, computer equipment and certain retail store assets.

Other income (expense), net

Other income, net was $0.2 million for 2012, compared with other expense, net of $33 thousand for the comparable period one year ago. The current-year improvement in other income (expense), net was primarily due to a reduction in fees associated with our line of credit, a higher average yield on our investment portfolio in the current-year period, and an increase in our average cash, cash equivalents and marketable debt securities balance in 2012 compared with the prior year.

Income tax expense

Income tax expense was $41.9 million in 2012 compared with $29.9 million for the same period one year ago. The effective tax rate for 2012 increased to 34.9% compared with the prior-year period rate of 33.1%. The 2011 effective tax rate benefited from the favorable resolution of certain prior years' income tax matters.

Liquidity and Capital Resources

As of December 28, 2013, cash, cash equivalents and marketable debt securities totaled $145.0 million compared with $177.8 million as of December 29, 2012. The $32.8 million decrease was primarily due to $88.1 million of cash provided by operating activities offset by $76.8 million of cash used to purchase property and equipment, $20.0 million of strategic investments, including the purchase of Comfortaire (see discussion below), and $42.1 million of cash used to repurchase our common stock ($40.0 million under our Board-approved share repurchase program and $2.0 million in connection with the vesting of employee restricted stock grants). Our $86.8 million of marketable debt securities held as of December 28, 2013 are all highly liquid and include U.S. government and agency securities, corporate debt securities and municipal bonds.

The following table summarizes our cash flows for the fiscal years ended December 28, 2013, and December 29, 2012 (dollars in millions). Amounts may not add due to rounding differences:



	2013			2012
Total cash provided by (used in):
Operating activities	$	88.1		$	100.6
Investing activities	(87.3		)	(112.1		)
Financing activities	(30.5		)	(16.9		)
Net decrease in cash and cash equivalents	$	(29.7	)	$	(28.3	)

Cash provided by operating activities for the fiscal year ended December 28, 2013 was $88.1 million compared with $100.6 million for the fiscal year ended December 29, 2012. The $12.5 million year-over-year decrease in cash from operating activities was comprised of an $18.0 million decrease in our 2013 net income compared with the same period one year ago, and an $5.4 million increase in adjustments to reconcile net income to net cash provided by operating activities, partially offset by a $0.1 million increase in cash from changes in operating assets and liabilities.

Investing activities for the fiscal year ended December 28, 2013 consisted of $76.8 million of property and equipment purchases, compared with $51.6 million for the same period one year ago. During 2013, we opened 71 retail stores and repositioned or remodeled 42 retail stores, while in 2012 we opened 57 retail stores and repositioned or remodeled 38 retail stores. Capital expenditures for 2014

are projected to be $70 - $80 million compared with $76.8 million in 2013. The capital expenditures for 2014 are primarily for continued investment in customer-management systems and other information technology, new retail stores, repositioned and remodeled retail stores, and investments to support product innovation initiatives. We received net proceeds of $9.4 million in marketable debt securities during the fiscal year ended December 28, 2013 compared with a net investment of $60.6 million during the comparable period one year ago. On January 17, 2013, we completed the purchase of the business and assets of Comfortaire Corporation, a manufacturer and marketer of adjustable air-supported sleep systems, for $15.5 million. Comfortaire Corporation was a privately held company with 2012 net sales of $10.5 million. We purchased Comfortaire to advance our innovation leadership in individualized comfort. See Note 3, Purchase of Comfortaire, of the Notes to Condensed Consolidated Financial Statements for further details. Finally, we made a $4.5 million minority equity investment in one of our strategic product-development partners.

Net cash used in financing activities was $30.5 million for the fiscal year ended December 28, 2013, compared with net cash used in financing activities of $16.9 million for the same period one year ago. During the fiscal year ended December 28, 2013, we repurchased $42.1 million of our stock ($40.0 million under our Board-approved share repurchase program and $2.0 million in connection with the vesting of employee restricted stock grants) compared with $34.9 million during the same period one year ago. Changes in book overdrafts and payments on capital lease obligations are included in the net change in short-term borrowings. Financing activities for both periods reflect the cash proceeds from the exercise of employee stock options along with the excess tax benefits related to stock-based compensation.

During the second quarter of 2012, we reinitiated repurchasing our common stock. Under the Board-approved $290 million share repurchase program, we repurchased 1,828,811 shares at a cost of $40.0 million ($21.89 per share) during the fiscal year ended December 28, 2013. During 2012, we repurchased 1,140,861 shares at a cost of $30.0 million ($26.32 per share) under our Board-approved share repurchase program during the fiscal year ended December 29, 2012. As of December 28, 2013, the remaining authorization under our Board-approved share repurchase program was $136.7 million. There is no expiration date governing the period over which we can repurchase shares.

Our $20.0 million Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association, as amended, is an unsecured revolving credit facility that matures August 31, 2016. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20.0 million to up to $50.0 million in total availability, subject to lender approval. As of December 28, 2013 we were in compliance with all financial covenants.

Our business model, which can operate with minimal working capital, does not require significant additional capital to fund operations or organic growth. The $145.0 million of cash, cash equivalents and marketable debt securities, cash generated from ongoing operations, and cash available under our revolving credit facility are expected to be adequate to maintain operations, and fund anticipated capital expenditures and strategic initiatives for the foreseeable future.

We have an agreement with GE Capital Retail Bank to offer qualified customers revolving credit arrangements to finance purchases from us (“GE Agreement”). The GE Agreement contains certain financial covenants, including a minimum tangible net worth requirement and a minimum cash requirement. As of December 28, 2013 we were in compliance with all financial covenants.

Under the terms of the GE Agreement, GE Capital Retail Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts.

Off-Balance-Sheet Arrangements and Contractual Obligations

As of December 28, 2013, we were not involved in any unconsolidated special purpose entity transactions. Other than our operating leases, we do not have any off-balance-sheet financing. There were no outstanding letters of credit at December 28, 2013. A summary of our operating lease obligations by fiscal year is included in the “Contractual Obligations” section below. Additional information regarding our operating leases is available in Item 2, Properties, and Note 8, Leases, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

Contractual Obligations

The following table presents information regarding our contractual obligations by fiscal year (in thousands):



	Payments Due by Period⁽¹⁾
	Total		< 1 Year		1 - 3 Years		3 - 5 Years		> 5 Years
Operating leases⁽²⁾	$	216,995	$	44,549	$	75,816	$	51,526	$	45,104
Purchase commitments	4,784		4,784		—		—		—
Total	$	221,779	$	49,333	$	75,816	$	51,526	$	45,104

⁽¹⁾Our unrecognized tax benefits, including interest and penalties, of $0.5 million have not been included in the Contractual Obligations table as we are not able to determine a reasonable estimate of timing of the cash settlement with the respective taxing authorities.

⁽²⁾At December 28, 2013, we had entered into 32 lease commitments for future retail store locations. These lease commitments provide for minimum rentals over the next five to 10 years, which if consummated based on current cost estimates, would approximate $30.9 million over the initial lease term.

Critical Accounting Policies and Estimates

Our consolidated financial statements are prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). In connection with the preparation of our financial statements, we are required to make estimates and assumptions about future events, and apply judgments that affect the reported amounts of assets, liabilities, sales, expenses and the related disclosure. Predicting future events is inherently an imprecise activity and as such requires the use of judgment. We base our assumptions, estimates and judgments on historical experience, current trends and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates and judgments to ensure that our financial statements are presented fairly and in accordance with GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material.

Our significant accounting policies are discussed in Note 1, Business and Summary of Significant Accounting Policies, of the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Management believes the accounting policies discussed below are the most critical because they require management’s most difficult, subjective or complex judgments, resulting from the need to make estimates about the effect of matters that are inherently uncertain. Management has reviewed these critical accounting policies and estimates, and related disclosures with the Audit Committee of our Board.

Our critical accounting policies and estimates relate to stock-based compensation, asset impairment charges, goodwill and indefinite-lived intangible assets, warranty liabilities and revenue recognition.



Description	Judgments and Uncertainties	Effect if Actual Results Differ From Assumptions
Stock-Based Compensation
We have stock-based compensation plans, which includes non-qualified stock options and stock awards. See Note 1, Business and Summary of Significant Accounting Policies, and Note 10, Shareholders’ Equity, to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K, for a complete discussion of our stock-based compensation programs. We determine the fair value of our nonqualified stock option awards and the resulting compensation expense at the date of grant using the Black-Scholes-Merton option-pricing model. The most significant inputs into the Black-Scholes-Merton model are exercise price, our estimate of expected stock price volatility and the expected term of the options. We determine the fair value of our performance-based stock awards at the date of grant based on the closing market price of our stock. However, the final number of shares earned and the related compensation expense is adjusted up or down to the extent the performance target is met as of the last day of the performance period. The actual number of shares that will ultimately vest ranges from 0% to 150% of the targeted amount. We evaluate the likelihood of meeting the performance targets at each reporting period and adjust compensation expense, on a cumulative basis, based on the expected achievement of each of the performance targets. For performance stock awards granted in 2013, the performance targets are net sales and operating margin and the performance period is fiscal 2015. For performance stock awards granted in 2012, the performance target is actual market share growth and the performance period is from January 2012 through December 2014. For performance stock awards granted in 2011, the performance targets were actual market share growth and free cash flow and the performance period was from January 2011 through December 2013. The actual number of shares that will ultimately vest upon completion of the service period for the 2011 performance stock awards will be 93% of the targeted amount.	Option-pricing models and generally accepted valuation techniques require management to make assumptions and to apply judgment to determine the fair value of our awards. These assumptions and judgments include estimating the volatility of our stock price, future employee forfeiture rates and future employee stock option exercise behaviors. Changes in these assumptions can materially affect the fair value estimate or future earnings adjustments. Performance-based stock awards require management to make assumptions regarding the likelihood of achieving performance targets.	We do not believe there is a reasonable likelihood that there will be a material change in the future estimates or assumptions we use to determine stock-based compensation expense. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to changes in stock-based compensation expense that could be material. In addition, if actual results are not consistent with the assumptions used, the stock-based compensation expense reported in our financial statements may not be representative of the actual economic cost of the stock-based compensation. Finally, if the actual forfeiture rates, or the actual achievement of performance targets, are not consistent with the assumptions used, we could experience future earnings adjustments. A 10% change in our stock-based compensation expense for the year ended December 28, 2013, would have affected net income by approximately $278,000 in 2013.



Description	Judgments and Uncertainties	Effect if Actual Results Differ From Assumptions
Asset Impairment Charges
Long-lived assets (other than goodwill and indefinite-lived intangible assets, which are separately tested for impairment) are evaluated for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. When evaluating long-lived assets for potential impairment, we first compare the carrying value of the asset to the asset’s estimated future cash flows (undiscounted and without interest charges). If the estimated undiscounted cash flows are less than the carrying value of the asset, we calculate an impairment loss. The impairment loss calculation compares the carrying value of the asset to the asset’s estimated fair value. We generally estimate fair value of long-lived assets, including our retail stores and definite-lived intangible assets, using the income approach, which we base on estimated future cash flows (discounted and with interest charges). The inputs used to determine fair value relate primarily to future assumptions regarding sales volumes, gross profit rates, retail store operating expenses and applicable probability weightings regarding future alternative uses. These inputs are categorized as Level 3 inputs under the fair value measurements guidance. The inputs used represent management’s assumptions about what information market participants would use in pricing the assets and are based upon the best information available at the balance sheet date. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to the estimated fair value plus net proceeds expected from disposition of the asset (if any). When we recognize an impairment loss, the carrying amount of the asset is permanently reduced to estimated fair value based on discounted cash flows, quoted market prices or other valuation techniques. Assets to be disposed of are reported at the lower of the carrying amount of the asset or fair value less costs to sell. We review retail store assets for potential impairment based on historical cash flows, lease termination provisions and expected future retail store operating results. If we recognize an impairment loss, the adjusted carrying amount of the asset becomes its new cost basis. For a depreciable long-lived asset, the new cost basis will be depreciated (amortized) over the remaining useful life of that asset.	Our impairment loss calculations contain uncertainties because they require management to make assumptions and to apply judgment to identify events or changes in circumstances indicating the carrying value of assets may not be recoverable, estimate future cash flows, estimate asset fair values, and select a discount rate that reflects the risk inherent in future cash flows. Expected cash flows may not be realized, which could cause long-lived assets to become impaired in future periods and could have a material adverse effect on future results of operations.	We have not made any material changes in our impairment loss assessment methodology during the past three fiscal years. As of December 28, 2013, all retail stores had sufficient projected future cash flows to support the carrying value of their long-lived assets. We believe that our estimates and assumptions used to determine long-lived asset impairment charges were reasonable and reflect the current economic environment. Our fair value calculations reflect current consumer spending trends. Our fair value calculations assume the ongoing availability of consumer credit and our ability to provide cost-effective consumer credit options. However, it is reasonably possible that an unexpected decline in consumer spending may expose us to future impairment charges that could be material. Asset impairment charges totaled $127,000, $148,000 and $109,000 for 2013, 2012 and 2011, respectively.



Description	Judgments and Uncertainties	Effect if Actual Results Differ From Assumptions
Goodwill and Indefinite-Lived Intangible Assets
Goodwill represents the excess of cost over the fair value of identifiable net assets of businesses acquired. Our other indefinite-lived intangible assets include trade names/trademarks. See Note 7, Goodwill and Intangible Assets, Net, for a complete discussion of our goodwill and indefinite-lived intangible assets. Our test for goodwill impairment is performed at least annually or when there are any indicators of impairment. The FASB's guidance allows us to perform either a quantitative assessment or a qualitative assessment before calculating the fair value of a reporting unit. We have elected to perform the quantitative assessment. The quantitative goodwill impairment test is a two-step process. The first step is a comparison of the fair value of the reporting unit with its carrying amount, including goodwill. If this step reflects impairment, then the loss would be measured as the excess of recorded goodwill over its implied fair value. Implied fair value is the excess of fair value of the reporting unit over the fair value of all identified assets and liabilities. Fair value is determined using a market-based approach utilizing widely accepted valuation techniques, including quoted market prices and our market capitalization. Other indefinite-lived intangible assets are assessed for impairment by comparing the carrying value of an asset with its fair value. If the carrying value exceeds fair value, an impairment loss is recognized in an amount equal to the excess.	The determination of fair value involves uncertainties because it requires management to make assumptions and to apply judgment to estimate industry and economic factors and the profitability of future business strategies. Management’s assumptions also include projected revenues and operating profit levels, as well as consideration of any other factors that may indicate potential impairment.	In the fourth quarter of fiscal 2013, management completed its annual goodwill and other indefinite-lived intangible asset impairment tests and determined there was no impairment. We believe our assumptions and judgments used in estimating cash flows and determining fair value were reasonable. However, making changes to such assumptions and judgments could materially affect our impairment analyses and future results of operations, including an impairment charge that could be material.
Warranty Liabilities
The estimated cost to service warranty and customer service claims is included in cost of sales. This estimate is based on historical trends and warranty claim rates. We regularly assess and adjust the estimate of accrued warranty claims by updating claims rates for actual trends and projected claim costs.	The majority of our warranty claims are incurred within the first year. However, our warranty liability contains uncertainties because our warranty obligations cover an extended period of time. A revision of estimated claim rates or the projected cost of materials and freight associated with sending replacement parts to customers could have a material adverse effect on future results of operations.	We have not made any material changes in our warranty liability assessment methodology during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our warranty liability. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to losses or gains that could be material. A 10% change in our warranty liability at December 28, 2013, would have affected net income by approximately $273,000 in 2013.



Description	Judgments and Uncertainties	Effect if Actual Results Differ From Assumptions
Revenue Recognition
Revenue is recognized when the sales price is fixed or determinable, collectability is reasonably assured and title passes. Amounts billed to customers for delivery and set up are included in net sales. Revenue is reported net of estimated sales returns and excludes sales taxes. We accrue for sales returns at the time revenue is recognized and charge actual returns against the liability when they are received. Our general return policy is to accept returns during a 100-night trial period. We estimate future projected returns based on historical return rates.	Our estimates of sales returns contain uncertainties as actual sales return rates may vary from expected rates, resulting in adjustments to net sales in future periods. These adjustments could have an adverse effect on future results of operations.	We have not made any material changes in the accounting methodology used to establish our sales returns allowance during the past three fiscal years. We do not believe there is a reasonable likelihood that there will be a material change in the estimates or assumptions we use to calculate our sales returns allowance. However, if actual results are not consistent with our estimates or assumptions, we may be exposed to additional losses or gains in future periods. A 10% change in our sales returns allowance at December 28, 2013 would have affected net income by approximately $621,000 in 2013.

Recent Accounting Pronouncements

None currently applicable.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Changes in the overall level of interest rates affect interest income generated from our short-term and long-term investments in marketable debt securities. If overall interest rates were one percentage point lower than current rates, our annual interest income would not change by a significant amount based on our investments in marketable debt securities as of December 28, 2013 and the current low interest-rate environment. We do not manage our investment interest-rate volatility risk through the use of derivative instruments.

As of December 28, 2013, we had no borrowings under our revolving credit facility.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Select Comfort Corporation

Minneapolis, Minnesota

We have audited the internal control over financial reporting of Select Comfort Corporation and subsidiaries (the “Company”) as of December 28, 2013, based on criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained, in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 28, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule listed in the Index at Item 15 as of and for the year ended December 28, 2013, of the Company and our report dated February 21, 2014 expressed an unqualified opinion on those consolidated financial statements and financial statement schedule.

/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota

February 21, 2014

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

Select Comfort Corporation

Minneapolis, Minnesota

We have audited the accompanying consolidated balance sheets of Select Comfort Corporation and subsidiaries (the “Company”) as of December 28, 2013, and December 29, 2012, and the related consolidated statements of operations, comprehensive income, stockholders’ equity, and cash flows for each of the three years in the period ended December 28, 2013. Our audits also included the financial statement schedule listed in the Index at Item 15. These consolidated financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the consolidated financial statements and financial statement schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits 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, such consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 28, 2013, and December 29, 2012, and the results of their operations and their cash flows for the three years in the period ended December 28, 2013, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as whole, presents fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 28, 2013, based on the criteria established in Internal Control - Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 21, 2014 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Minneapolis, Minnesota

February 21, 2014

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Consolidated Balance Sheets

December 28, 2013 and December 29, 2012

(in thousands, except per share amounts)



	2013		2012
Assets
Current assets:
Cash and cash equivalents	$	58,223	$	87,915
Marketable debt securities – current	52,159		51,264
Accounts receivable, net of allowance for doubtful accounts of $425 and $348, respectively	14,979		16,613
Inventories	40,152		35,564
Prepaid expenses	9,216		4,299
Deferred income taxes	6,936		5,401
Other current assets	7,874		9,522
Total current assets	189,539		210,578

Non-current assets:
Marketable debt securities – non-current	34,632		38,642
Property and equipment, net	129,542		79,356
Goodwill and intangible assets, net	16,823		2,881
Deferred income taxes	4,943		8,511
Other assets	6,286		2,053
Total assets	$	381,765	$	342,021

Liabilities and Shareholders’ Equity
Current liabilities:
Accounts payable	$	73,391	$	67,703
Customer prepayments	15,392		15,194
Accrued sales returns	9,433		5,330
Compensation and benefits	15,242		21,597
Taxes and withholding	12,517		9,282
Other current liabilities	11,207		13,955
Total current liabilities	137,182		133,061

Non-current liabilities:
Warranty liabilities	1,567		1,457
Other long-term liabilities	17,796		13,806
Total liabilities	156,545		148,324

Shareholders’ equity:
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding	—		—
Common stock, $0.01 par value; 142,500 shares authorized, 54,901 and 55,903 shares issued and outstanding, respectively	549		559
Additional paid-in capital	5,382		33,923
Retained earnings	219,276		159,195
Accumulated other comprehensive income	13		20
Total shareholders’ equity	225,220		193,697
Total liabilities and shareholders’ equity	$	381,765	$	342,021

See accompanying notes to consolidated financial statements.

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Consolidated Statements of Operations

Years ended December 28, 2013, December 29, 2012 and December 31, 2011

(in thousands, except per share amounts)



	2013			2012		2011
Net sales	$	960,171		$	934,978	$	743,203
Cost of sales	358,416			338,432		272,858
Gross profit	601,755			596,546		470,345

Operating expenses:
Sales and marketing	439,156			398,205		317,502
General and administrative	62,840			66,617		58,106
Research and development	9,478			6,194		4,175
CEO transition (benefit) costs	(534		)	5,595		—
Asset impairment charges	127			148		109
Total operating expenses	511,067			476,759		379,892
Operating income	90,688			119,787		90,453
Other income (expense), net	323			218		(33		)
Income before income taxes	91,011			120,005		90,420
Income tax expense	30,930			41,911		29,942
Net income	$	60,081		$	78,094	$	60,478

Basic net income per share:
Net income per share – basic	$	1.10		$	1.41	$	1.10
Weighted-average shares – basic	54,866			55,516		55,081
Diluted net income per share:
Net income per share – diluted	$	1.08		$	1.37	$	1.07
Weighted-average shares – diluted	55,803			57,076		56,432

See accompanying notes to consolidated financial statements.

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Consolidated Statements of Comprehensive Income

Years ended December 28, 2013, December 29, 2012 and December 31, 2011

(in thousands)



	2013			2012			2011
Net income	$	60,081		$	78,094		60,478
Other comprehensive (loss) income – unrealized (loss) gain on available-for-sale marketable debt securities, net of income tax	(7		)	(5		)	25
Comprehensive income	$	60,074		$	78,089		60,503

See accompanying notes to consolidated financial statements.

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Consolidated Statements of Shareholders’ Equity

Years ended December 28, 2013, December 29, 2012 and December 31, 2011

(in thousands)



	Common Stock					Additional Paid-in Capital			Retained Earnings		Accumulated Other Comprehensive Income			Total
	Shares		Amount			Additional Paid-in Capital			Retained Earnings		Accumulated Other Comprehensive Income			Total
Balance at January 1, 2011	55,455		$	555		$	36,799		$	20,623	$	—		$	57,977
Net income	—		—			—			60,478		—			60,478
Other comprehensive income:
Unrealized gain on available-for-sale marketable debt securities, net of tax	—		—			—			—		25			25
Exercise of common stock options	725		7			4,349			—		—			4,356
Tax effect from stock-based compensation	—		—			1,865			—		—			1,865
Stock-based compensation	204		2			4,969			—		—			4,971
Repurchases of common stock	(30	)	—			(371		)	—		—			(371		)
Other	43		—			90			—		—			90
Balance at December 31, 2011	56,397		$	564		$	47,701		$	81,101	$	25		$	129,391
Net income	—		—			—			78,094		—			78,094
Other comprehensive income:
Unrealized loss on available-for-sale marketable debt securities, net of tax	—		—			—			—		(5		)	(5		)
Exercise of common stock options	659		7			5,131			—		—			5,138
Tax effect from stock-based compensation	—		—			5,665			—		—			5,665
Stock-based compensation	170		1			10,305			—		—			10,306
Repurchases of common stock	(1,323	)	(13		)	(34,879		)	—		—			(34,892		)
Balance at December 29, 2012	55,903		$	559		$	33,923		$	159,195	$	20		$	193,697
Net income	—		—			—			60,081		—			60,081
Other comprehensive income:
Unrealized loss on available-for-sale marketable debt securities, net of tax	—		—			—			—		(7		)	(7		)
Exercise of common stock options	757		7			7,959			—		—			7,966
Tax effect from stock-based compensation	—		—			1,007			—		—			1,007
Stock-based compensation	160		2			4,230			—		—			4,232
Repurchases of common stock	(1,919	)	(19		)	(42,053		)	—		—			(42,072		)
Other	—		—			316			—		$	—		316
Balance at December 28, 2013	54,901		$	549		$	5,382		$	219,276	$	13		$	225,220

See accompanying notes to consolidated financial statements.

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Consolidated Statements of Cash Flows

Years Ended December 28, 2013, December 29, 2012 and December 31, 2011

(in thousands)



	2013			2012			2011
Cash flows from operating activities:
Net income	$	60,081		$	78,094		$	60,478
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	30,811			20,401			13,543
Stock-based compensation	4,232			10,306			4,971
Net loss on disposals and impairments of assets	24			115			98
Excess tax benefits from stock-based compensation	(3,831		)	(6,446		)	(2,190		)
Deferred income taxes	2,037			3,499			2,839
Changes in operating assets and liabilities, net of effect of acquisition:
Accounts receivable	1,993			(2,705		)	(3,935		)
Inventories	(3,910		)	(10,713		)	(5,204		)
Income taxes	4,395			4,299			4,445
Prepaid expenses and other assets	(3,169		)	(2,382		)	(1,976		)
Accounts payable	(3,477		)	7,114			6,913
Customer prepayments	198			1,665			585
Accrued compensation and benefits	(5,202		)	(8,108		)	5,167
Other taxes and withholding	(153		)	765			1,944
Warranty liabilities	(1,236		)	(1,454		)	566
Other accruals and liabilities	5,312			6,176			2,802
Net cash provided by operating activities	88,105			100,626			91,046

Cash flows from investing activities:
Purchases of property and equipment	(76,811		)	(51,593		)	(23,527		)
Proceeds from maturities of marketable debt securities	53,565			26,249			10,000
Investments in marketable debt securities	(44,170		)	(86,803		)	(40,021		)
Acquisition of business	(15,500		)	—			—
Investment in non-marketable equity securities	(4,500		)	—			—
Proceeds from sales of property and equipment	117			45			11
Increase in restricted cash	—			—			(2,650		)
Net cash used in investing activities	(87,299		)	(112,102		)	(56,187		)

Cash flows from financing activities:
Repurchases of common stock	(42,072		)	(34,892		)	(371		)
Proceeds from issuance of common stock	7,966			5,138			4,356
Net (decrease) increase in short-term borrowings	(223		)	6,494			(795		)
Excess tax benefits from stock-based compensation	3,831			6,446			2,190
Debt issuance costs	—			(50		)	—
Net cash (used in) provided by financing activities	(30,498		)	(16,864		)	5,380

Net (decrease) increase in cash and cash equivalents	(29,692		)	(28,340		)	40,239
Cash and cash equivalents, at beginning of period	87,915			116,255			76,016
Cash and cash equivalents, at end of period	$	58,223		$	87,915		$	116,255

Supplemental Disclosure of Cash Flow Information
Income taxes paid	$	24,253		$	34,181		$	23,778
Interest paid	$	34		$	81		$	113
Capital lease obligations incurred	$	—		$	—		$	83
Purchases of property and equipment included in accounts payable	$	3,465		$	3,817		$	1,486

See accompanying notes to consolidated financial statements.

SELECT COMFORT CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(1) Business and Summary of Significant Accounting Policies

Business & Basis of Presentation

Select Comfort Corporation and our 100%-owned subsidiaries (“Select Comfort” or the “Company”) are the exclusive manufacturer, marketer, retailer and servicer of the revolutionary Sleep Number bed, which allows individuals to adjust the firmness and support on each side at the touch of a button. We offer further individualization through our new sleep tracking technology, SleepIQ^TM, and a solutions-focused line of Sleep Number pillows, sheets, adjustable bases, and other bedding products, including the innovative DualTemp^TM temperature-balancing layer.

As the only national specialty-mattress retailer, we generate revenue by selling products through two distribution channels. Our Company-Controlled channel, which includes Retail, Direct Marketing and E-Commerce, sells directly to consumers. Our Wholesale/Other channel sells to and through selected retail and wholesale customers in the United States and Australia, and the QVC shopping channel. 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.

Fiscal Year

Our fiscal year ends on the Saturday closest to December 31. Fiscal years and their respective fiscal year ends are as follows: fiscal 2013 ended December 28, 2013; fiscal 2012 ended December 29, 2012; and fiscal 2011 ended December 31, 2011. Fiscal years 2013, 2012 and 2011 each had 52 weeks.

Use of Estimates in the Preparation of Financial Statements

The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles (“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 stock-based compensation, asset impairment charges, goodwill and indefinite-lived intangible assets, warranty liabilities and revenue recognition.

Cash and Cash Equivalents

Cash and cash equivalents include highly liquid investments with original maturities of three months or less. The carrying value of these investments approximates fair value due to their short-term maturity. Our banking arrangements allow us to fund outstanding checks when presented to the financial institution for payment, resulting in book overdrafts. Book overdrafts are included in accounts payable in our consolidated balance sheets and in net (decrease) increase in short-term borrowings in the financing activities section of our consolidated statements of cash flows. Book overdrafts totaled $13.4 million and $13.5 million at December 28, 2013, and December 29, 2012, respectively.

Marketable Debt Securities

Our investment portfolio is currently comprised of U.S. government and agency securities, corporate debt securities and municipal bonds. 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 original maturities of greater than three months but current maturities of 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 income tax, are reported as a component of accumulated other comprehensive income in our consolidated balance sheets. Other-than-temporary declines in market value, if any, from original cost are charged to other income (expense), net in the consolidated statements of operations 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

SELECT COMFORT CORPORATION

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Notes to Consolidated Financial Statements - (continued)

occurred, we consider the duration and extent that the fair value of the investment is below its cost. Realized gains and losses, if any, are calculated on the specific identification method and are measured and reclassified from accumulated other comprehensive income in our consolidated balance sheets to other income (expense), net in our consolidated statements of operations.

See Note 2, Fair Value Measurements, for more information on our fair value measurements.

Concentration of Credit Risk

Our investment policy’s primary focus is to preserve principal and maintain adequate liquidity. Our investment policy addresses the concentration of credit risk by limiting the concentration in certain investment types. Our exposure to a concentration of credit risk consists primarily of cash, cash equivalents and investments. We place our cash with high-credit quality financial institutions. We currently hold investments in U.S. government and agency securities, corporate debt securities and municipal bonds. We believe no significant concentration of credit risk exists with respect to our cash, cash equivalents and investments.

Accounts Receivable

Accounts receivable are recorded net of an allowance for expected losses and consist primarily of receivables from wholesale customers and receivables from third-party financiers for customer credit card purchases. The allowance is recognized in an amount equal to anticipated future write-offs. We estimate future write-offs based on delinquencies, aging trends, industry risk trends and our historical experience. Account balances are charged off against the allowance when we believe it is probable the receivable will not be recovered.

Inventories

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

Property and Equipment

Property and equipment, carried at cost, is depreciated using the straight-line method over the estimated useful lives of the assets. The cost and related accumulated depreciation of assets sold or retired is removed from the accounts with any resulting gain or loss included in net income in our consolidated statements of operations. Maintenance and repairs are charged to expense as incurred. Major renewals and betterments that extend useful life are capitalized.

Leasehold improvements are depreciated over the shorter of the estimated useful lives of the assets or the contractual term of the lease, with consideration of lease renewal options if renewal appears probable.

Property under capital lease is comprised of computer equipment and computer software used in our retail operations and corporate support areas.

Estimated useful lives of our property and equipment by major asset category are as follows:



Leasehold improvements	5 to 10 years
Furniture and equipment	5 to 7 years
Production machinery, computer equipment and software	3 to 7 years
Property under capital lease	3 to 4 years

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Notes to Consolidated Financial Statements - (continued)

Goodwill and Intangible Assets, Net

Goodwill is the difference between the purchase price of a company and the fair market value of the acquired company's net identifiable assets. Our intangible assets include developed technologies, trade names/trademarks and customer relationships. Definite-lived intangible assets are being amortized using the straight-line method over their estimated lives, ranging from 7-17 years.

Asset Impairment Charges

We review our long-lived assets and definite-lived intangible assets 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 the estimated fair value plus net proceeds expected from disposition of the asset (if any). When we recognize an impairment loss, the carrying amount of the asset is reduced to estimated fair value based on discounted cash flows, quoted market prices or other valuation techniques. Assets to be disposed of are reported at the lower of the carrying amount of the asset or fair value less costs to sell. We review retail store assets for potential impairment based on historical cash flows, lease termination provisions and expected future retail store operating results.

Goodwill and indefinite-lived intangible assets are not amortized, but are tested for impairment annually or when there are indicators of impairment using a fair value approach. Our test for goodwill impairment is performed at least annually or when there are any indicators of impairment. The FASB's guidance allows us to perform either a quantitative assessment or a qualitative assessment before calculating the fair value of a reporting unit. We have elected to perform the quantitative assessment. The quantitative goodwill impairment test is a two-step process. The first step is a comparison of the fair value of the reporting unit with its carrying amount, including goodwill. If this step reflects impairment, then the loss would be measured as the excess of recorded goodwill over its implied fair value. Implied fair value is the excess of fair value of the reporting unit over the fair value of all identified assets and liabilities. Fair value is determined using a market-based approach utilizing widely accepted valuation techniques, including quoted market prices and our market capitalization. Based on our 2013 quantitative assessment, we determined there was no impairment. Other indefinite-lived intangible assets are assessed for impairment at least annually, or when there are any indicators of impairment, by comparing the carrying value of an asset with its fair value. If the carrying value exceeds fair value, an impairment loss is recognized in an amount equal to the excess.

Asset impairment charges is one of our critical accounting estimates and requires management to make estimates about future events including sales growth rates, cash flows and asset fair values. Predicting future events is inherently an imprecise activity. If actual results are not consistent with the estimates and assumptions used in our asset impairment calculations, we may incur additional impairment charges. See Note 1, Business and Summary of Significant Accounting Policies – Fair Value Measurements, for a discussion of how we determine fair values.

Warranty Liabilities

We provide a 25-year limited warranty on our beds. The customer participates over the last 23 years of the warranty period by paying a portion of the retail value of replacement parts. The estimated warranty costs, which are expensed at the time of sale and included in cost of sales, are based on historical trends and warranty claim rates incurred by us and are adjusted for any current trends as appropriate. Actual warranty claim costs could differ from these estimates. We regularly assess and adjust the estimate of accrued warranty claims by updating claims rates for actual trends and projected claim costs.

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Notes to Consolidated Financial Statements - (continued)

We classify as non-current those estimated warranty costs expected to be paid out in greater than one year. The activity in the accrued warranty liabilities account was as follows (in thousands):



	2013			2012			2011
Balance at beginning of period	$	4,858		$	6,310		$	5,744
Additions charged to costs and expenses for current-year sales	4,603			4,114			4,232
Deductions from reserves	(6,070		)	(5,094		)	(4,750		)
Changes in liability for pre-existing warranties during the current year, including expirations⁽¹⁾	230			(472		)	1,084
Acquired warranty reserve	532			—			—
Balance at end of period	$	4,153		$	4,858		$	6,310


⁽¹⁾	Includes $1.6 million increase for customer-service reserves established during 2011.

Fair Value Measurements

The guidance for fair value measurements establishes the authoritative definition of fair value, sets out a framework for measuring fair value and outlines the required disclosures regarding fair value measurements. Fair value is the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. We use a three-tier fair value hierarchy based upon observable and unobservable inputs as follows:


•	Level 1 – observable inputs such as quoted prices in active markets;


•	Level 2 – inputs, other than the quoted prices in active markets, that are observable either directly or indirectly including:

◦Quoted prices for similar assets or liabilities in active markets;

◦Quoted prices for identical or similar assets in nonactive markets;

◦Inputs other than quoted prices that are observable for the asset or liability;

◦Inputs that are derived principally from or corroborated by other observable market data; and


•	Level 3 – unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions.

We generally estimate fair value of long-lived assets, including our retail stores, using the income approach, which we base on estimated future cash flows (discounted and with interest charges). The inputs used to determine fair value relate primarily to future assumptions regarding sales volumes, gross profit rates, retail store operating expenses and applicable probability weightings regarding future alternative uses. These inputs are categorized as Level 3 inputs under the fair value measurements guidance. The inputs used represent management’s assumptions about what information market participants would use in pricing the assets and are based upon the best information available at the balance sheet date.

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

Dividends

Revenue Recognition

Revenue is recognized when the sales price is fixed or determinable, collectability is reasonably assured and title passes. Amounts billed to customers for delivery and setup are included in net sales. Revenue is reported net of estimated sales returns and excludes sales taxes.

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Notes to Consolidated Financial Statements - (continued)

We accept sales returns after a 100-night trial period. The accrued sales returns estimate is based on historical return rates and is adjusted for any current trends as appropriate. If actual returns vary from expected rates, sales in future periods are adjusted.

Cost of Sales, Sales and Marketing, General and Administrative (“G&A”) and Research & Development (“R&D”) Expenses

The following tables summarize the primary costs classified in each major expense category (the classification of which may vary within our industry):



Cost of Sales		Sales & Marketing
• Costs associated with purchasing, manufacturing, shipping, handling and delivering our products to our retail stores and customers; • Physical inventory losses, scrap and obsolescence; • Related occupancy and depreciation expenses; • Costs associated with returns and exchanges; and • Estimated costs to service warranty claims of customers.		• Advertising and media production; • Marketing and selling materials such as brochures, videos, customer mailings and in-store signage; • Payroll and benefits for sales and customer service staff; • Store occupancy costs; • Store depreciation expense; • Credit card processing fees; and • Promotional financing costs.
G&A		R&D⁽¹⁾
• Payroll and benefit costs for corporate employees, including information technology, legal, human resources, finance, sales and marketing administration, investor relations and risk management; • Occupancy costs of corporate facilities; • Depreciation related to corporate assets; • Information hardware, software and maintenance; • Insurance; • Investor relations costs; and • Other overhead costs.		• Internal labor and benefits related to research and development activities; • Outside consulting services related to research and development activities; and • Testing equipment related to research and development activities. ⁽¹⁾ Costs incurred in connection with R&D are charged to expense as incurred.

Operating Leases

We rent our retail, office and manufacturing space under operating leases which, in addition to the minimum lease payments, require payment of a proportionate share of the real estate taxes and certain building operating expenses. In addition, our mall-based retail store leases may require payment of contingent rents based upon sales levels.

Rent expense is recognized on a straight-line basis over the lease term, after consideration of rent escalations and rent holidays. We record any difference between the straight-line rent amounts and amounts payable under the leases as part of deferred rent, in other current liabilities or other long-term liabilities, as appropriate. The lease term for purposes of the calculation begins on the earlier of the lease commencement date or the date we take possession of the property. During lease renewal negotiations that extend beyond the original lease term, we estimate straight-line rent expense based on current market conditions. At December 28, 2013, and December 29, 2012, deferred rent included in other current liabilities in our consolidated balance sheets was $0.5 million and $1.1 million, respectively, and deferred rent included in other long-term liabilities in our consolidated balance sheets was $5.5 million and $4.6 million, respectively.

Leasehold improvements that are funded by landlord incentives or allowances under an operating lease are recorded as deferred lease incentives, in other current liabilities or other long-term liabilities, as appropriate and amortized as reductions to rent expense over the lease term. At December 28, 2013, and December 29, 2012, deferred lease incentives included in other current liabilities in our consolidated balance sheets were $2.0 million and $1.5 million, respectively, and deferred lease incentives included in other long-term liabilities in our consolidated balance sheets were $7.2 million and $5.0 million, respectively.

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Notes to Consolidated Financial Statements - (continued)

Lease payments that depend on factors that are not measurable at the inception of the lease, such as future sales levels, are contingent rents and are excluded from minimum lease payments and included in the determination of total rent expense when it is probable the expense has been incurred and the amount is reasonably estimable. Future payments for real estate taxes and certain building operating expenses for which we are obligated are not included in minimum lease payments.

Pre-Opening Costs

Costs associated with the start-up and promotion of new retail store openings are expensed as incurred.

Advertising Costs

We incur advertising costs associated with print, digital and broadcast advertisements. Advertising costs are charged to expense when the ad first runs. Advertising expense was $144.8 million, $126.9 million and $91.6 million in 2013, 2012 and 2011, respectively. Advertising costs deferred and included in prepaid expenses in our consolidated balance sheets were $6.2 million and $0.3 million as of December 28, 2013, and December 29, 2012, respectively.

Insurance

We are self-insured for certain losses related to health and workers’ compensation claims, although we obtain third-party insurance coverage to limit exposure to these claims. We estimate our self-insured liabilities using a number of factors including historical claims experience and analysis of incurred but not reported claims. Our self-insurance liability was $6.8 million and $4.6 million at December 28, 2013, and December 29, 2012, respectively. At December 28, 2013, and December 29, 2012, $3.3 million and $2.3 million, respectively, were included in compensation and benefits and $3.5 million and $2.3 million, respectively, were included in other long-term liabilities in our consolidated balance sheets. At December 28, 2013 and December 29, 2012, we had a restricted deposit of $2.7 million with our insurer that serves as collateral for our workers’ compensation insurance obligations and was included in other current assets in our consolidated balance sheets.

Software Capitalization

For software developed or obtained for internal use, we capitalize direct external costs associated with developing or obtaining internal-use software. In addition, we also capitalize certain payroll and payroll-related costs for employees who are directly associated with the development of such applications. Capitalized costs related to internal-use software under development are treated as construction-in-progress until the program, feature or functionality is ready for its intended use, at which time depreciation commences. We expense any data conversion or training costs as incurred.

Stock-Based Compensation

We record stock-based compensation expense based on the award’s fair value at the grant date and the awards that are expected to vest. We recognize stock-based compensation expense over the period during which an employee is required to provide services in exchange for the award. We use the Black-Scholes-Merton option-pricing model to estimate the fair value of stock options and resulting compensation expense. The most significant inputs into the Black-Scholes-Merton option-pricing model are exercise price, our estimate of expected stock price volatility and the weighted-average expected life of the options. We reduce compensation expense by estimated forfeitures. Forfeitures are estimated using historical experience and projected employee turnover. We include as part of cash flows from financing activities the benefit of tax deductions in excess of recognized stock-based compensation expense.

See Note 10, Shareholders’ Equity, for additional information on stock-based compensation.

Income Taxes

We recognize 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. A valuation allowance is established for any portion of deferred tax assets that are not

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Notes to Consolidated Financial Statements - (continued)

considered more likely than not to be realized. We evaluate all available positive and negative evidence, including our forecast of future taxable income, to assess the need for a valuation allowance on our deferred tax assets.

We record a liability for unrecognized tax benefits from uncertain tax positions taken, or expected to be taken, in our tax returns. We follow a two-step approach to recognizing and measuring uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the available evidence indicates it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount which is more than 50% likely of being realized upon ultimate settlement. We consider many factors when evaluating and estimating our tax positions and tax benefits, which may require periodic adjustments and which may not accurately forecast actual outcomes.

We classify net interest and penalties on tax uncertainties as a component of income tax expense in our consolidated statements of operations.

Net Income Per Share

We calculate basic net income per share by dividing net income attributable to common shareholders by the weighted-average number of common shares outstanding during the period. We calculate diluted net income per share based on the weighted-average number of common shares outstanding adjusted by the number of potentially dilutive common shares as determined by the treasury stock method. Potentially dilutive shares consist of stock options and restricted stock.

Sources of Supply

We currently obtain materials and components used to produce our beds from outside sources. As a result, we are dependent upon suppliers that in some instances, are our sole source of supply. We are continuing our efforts to dual-source key components. The failure of one or more of our suppliers to provide us with materials or components on a timely basis could significantly impact our consolidated results of operations and net income per share. We believe we can obtain these raw materials and components from other sources of supply in the ordinary course of business, although an unexpected loss of supply over a short period of time may not allow us to replace these sources in the ordinary course of business.

(2) Fair Value Measurements

Assets and Liabilities that are Measured at Fair Value on a Recurring Basis

The fair value hierarchy requires the use of observable market data when available. In instances in which the inputs used to measure fair value fall into different levels of the fair value hierarchy, the fair value measurement has been determined based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular item to the fair value measurement in its entirety requires judgment, including the consideration of inputs specific to the asset or liability. Our financial assets are valued using market prices based on either active markets (Level 1 measurements) or less active markets (Level 2 measurements).

Our Level 1 securities include U.S. Treasury securities as they trade with sufficient frequency and volume to enable us to obtain pricing information on a consistent basis. Our Level 2 securities include U.S. Agency bonds, corporate bonds and municipal bonds whose value is determined by a third-party pricing service using inputs that are observable in the market or can be derived principally from or corroborated by observable market data such as pricing for similar securities, recently executed transactions, cash flow models with yield curves and benchmark securities.

We did not have any transfers between Level 1 and Level 2 fair value measurements during the periods presented.

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Notes to Consolidated Financial Statements - (continued)

The following tables set forth by level within the fair value hierarchy, our financial assets that were accounted for at fair value on a recurring basis at December 28, 2013, and December 29, 2012, according to the valuation techniques we used to determine their fair value (in thousands):



	December 28, 2013
	Level 1		Level 2		Level 3		Total
Marketable debt securities – current
U.S. Treasury securities	$	15,011	$	—	$	—	$	15,011
Corporate bonds	—		20,300		—		20,300
U.S. Agency bonds	—		12,025		—		12,025
Municipal bonds	—		4,823		—		4,823
	15,011		37,148		—		52,159
Marketable debt securities – non-current
U.S. Treasury securities	8,978		—		—		8,978
Corporate bonds	—		15,484		—		15,484
U.S. Agency bonds	—		7,498		—		7,498
Municipal bonds	—		2,672		—		2,672
	8,978		25,654		—		34,632
	$	23,989	$	62,802	$	—	$	86,791



	December 29, 2012
	Level 1		Level 2		Level 3		Total
Marketable debt securities – current
U.S. Treasury securities	$	17,538	$	—	$	—	$	17,538
Corporate bonds	—		21,549		—		21,549
U.S. Agency bonds	—		7,586		—		7,586
Municipal bonds	—		4,591		—		4,591
	17,538		33,726		—		51,264
Marketable debt securities – non-current
U.S. Treasury securities	15,004		—		—		15,004
Corporate bonds	—		10,359		—		10,359
U.S. Agency bonds	—		10,056		—		10,056
Municipal bonds	—		3,223		—		3,223
	15,004		23,638		—		38,642
	$	32,542	$	57,364	$	—	$	89,906

At December 28, 2013, and December 29, 2012, we had $1.1 million and $1.6 million, respectively, of debt and equity securities that fund our deferred compensation plan and are classified in other assets. We also had corresponding deferred compensation plan liabilities of $1.1 million and $1.6 million at December 28, 2013, and December 29, 2012, respectively, which are included in other long-term liabilities. The majority of the debt and equity securities are Level 1 as they trade with sufficient frequency and volume to enable us to obtain pricing information on an ongoing basis. Unrealized gains/(losses) on the debt and equity securities offset those associated with the corresponding deferred compensation plan liabilities.

(3) Purchase of Comfortaire

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Notes to Consolidated Financial Statements - (continued)

The following table summarizes the final fair value of the net assets acquired (in thousands):



Accounts receivable	$	365
Inventories	678
Other assets	248
Property and equipment	513
Goodwill	6,113
Intangible assets	8,638
Total assets acquired	16,555
Accounts payable	404
Warranty liabilities	532
Other liabilities	119
Total liabilities acquired	1,055
Net assets acquired	$	15,500

The goodwill and identifiable intangible assets will be deductible for income tax purposes over a 15-year period on a straight-line basis.

Identifiable intangible assets and the associated estimated useful lives are as follows (in thousands):



	Estimated
	Useful Life
Developed technologies	10 years	$	4,829
Customer relationships	7 years	2,413
Trade name/trademarks	Indefinite-Lived	1,396
		$	8,638

(4) Investments

Marketable Debt Securities

Investments in marketable debt securities were comprised of the following (in thousands):



	December 28, 2013
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value⁽¹⁾
U.S. Treasury securities	$	23,975	$	15	$	(1	)	$	23,989
Corporate bonds	35,804		3		(23		)	35,784
U.S. Agency bonds	19,517		10		(4		)	19,523
Municipal bonds	7,474		23		(2		)	7,495
	$	86,770	$	51	$	(30	)	$	86,791



	December 29, 2012
	Amortized Cost		Unrealized Gains		Unrealized Losses			Fair Value⁽¹⁾
U.S. Treasury securities	$	32,518	$	24	$	—		$	32,542
Corporate bonds	31,929		2		(23		)	31,908
U.S. Agency bonds	17,632		11		(1		)	17,642
Municipal bonds	7,794		20		—			7,814
	$	89,873	$	57	$	(24	)	$	89,906

⁽¹⁾ See Note 2 for discussion of fair value measurements.

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Notes to Consolidated Financial Statements - (continued)

Maturities of marketable debt securities were as follows (in thousands):



	December 28, 2013				December 29, 2012
	Amortized Cost		Fair Value⁽¹⁾		Amortized Cost		Fair Value⁽¹⁾
Marketable debt securities – current (due in less than one year)	$	52,122	$	52,159	$	51,238	$	51,264
Marketable debt securities – non-current (due in one to two years)	34,648		34,632		38,635		38,642
	$	86,770	$	86,791	$	89,873	$	89,906

⁽¹⁾ See Note 2 for discussion of fair value measurements.

During 2013, 2012 and 2011, respectively, $53.3 million, $26.0 million and $10.0 million of marketable debt securities matured and were redeemed at face value. During 2013, there were no other-than-temporary declines in market value.

Other Investments

During 2013, we made a minority equity investment in one of our strategic product-development partners. The carrying value of this investment at December 28, 2013 using the cost method is $4.5 million and is included in other assets on our consolidated balance sheet.

(5) Inventories

Inventories consisted of the following (in thousands):



	December 28, 2013		December 29, 2012
Raw materials	$	7,118	$	5,089
Work in progress	505		236
Finished goods	32,529		30,239
	$	40,152	$	35,564

Our finished goods inventory, as of December 28, 2013, was comprised of $13.4 million of finished beds, including retail display beds and deliveries in-transit to those customers who have utilized home delivery services, $11.3 million of finished components that were ready for assembly for the completion of beds, and $7.8 million of retail accessories.

Our finished goods inventory, as of December 29, 2012, was comprised of $12.6 million of finished beds, including retail display beds and deliveries in-transit to those customers who have utilized home delivery services, $10.8 million of finished components that were ready for assembly for the completion of beds, and $6.8 million of retail accessories.

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Notes to Consolidated Financial Statements - (continued)

(6) Property and Equipment

Property and equipment consisted of the following (in thousands):



	December 28, 2013			December 29, 2012
Land	$	1,999		$	1,999
Leasehold improvements	84,659			78,764
Furniture and equipment	46,226			26,957
Production machinery, computer equipment and software	106,072			89,183
Property under capital lease	1,672			1,672
Construction in progress	32,670			12,838
Less: Accumulated depreciation and amortization	(143,756		)	(132,057		)
	$	129,542		$	79,356

During 2013, 2012 and 2011, we recorded asset impairment charges of $0.1 million. The impairment charges in 2013 and 2012 were primarily related to computer software and certain retail store assets. The impairment charges in 2011 were primarily related to underperforming retail stores’ assets.

(7) Goodwill and Intangible Assets, Net

Goodwill and Indefinite-Lived Intangible Assets

The following is a roll forward of goodwill and indefinite-lived trade name/trademarks (in thousands):



	Twelve Months Ended				Twelve Months Ended
	December 28, 2013				December 29, 2012
	Goodwill		Indefinite-Lived Trade Name/ Trademarks		Goodwill		Indefinite-Lived Trade Name/ Trademarks
	Goodwill		Indefinite-Lived Trade Name/ Trademarks		Goodwill		Indefinite-Lived Trade Name/ Trademarks
Beginning balance	$	2,850	$	—	$	2,850	$	—
Comfortaire purchase	6,113		1,396		—		—
Ending balance	$	8,963	$	1,396	$	2,850	$	—

Definite-Lived Intangible Assets

The following table provides the gross carrying amount and related accumulated amortization of our definite-lived intangible assets (in thousands):



	December 28, 2013				December 29, 2012
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Developed technologies⁽¹⁾	$	5,231	$	850	$	402	$	371
Customer relationships⁽¹⁾	2,413		330		—		—
Trade names/trademarks	101		101		101		101
	$	7,745	$	1,281	$	503	$	472

⁽¹⁾ On January 17, 2013, in connection with the purchase of the business and assets of Comfortaire, we acquired definite-lived intangible assets, including developed technologies of $4.8 million and customer relationships of $2.4 million.

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Notes to Consolidated Financial Statements - (continued)

Amortization expense for definite-lived intangible assets for 2013, 2012 and 2011 was $0.8 million, $18 thousand and $23 thousand, respectively. Annual amortization expense for definite-lived intangible assets is expected to be $0.8 million for each of the next five years.

See Note 3, Purchase of Comfortaire, for details regarding our purchase of the business and assets of Comfortaire.

(8) Leases

Rent expense was as follows (in thousands):



Facility Rents:	2013		2012		2011
Minimum rents	$	41,816	$	36,104	$	32,928
Contingent rents	5,779		9,813		6,480
Total	$	47,595	$	45,917	$	39,408

Equipment Rents	$	2,694	$	2,627	$	2,469

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



2014	$	44,549
2015	39,691
2016	36,125
2017	31,101
2018	20,425
Thereafter	45,104
Total future minimum lease payments	$	216,995

(9) Debt

Credit Agreement

Our $20.0 million Credit Agreement (the “Credit Agreement”) with Wells Fargo Bank, National Association, as amended, is an unsecured revolving credit facility that matures on August 31, 2016. The Credit Agreement contains an accordion feature that allows us to increase the amount of the line from $20.0 million to up to $50.0 million in total availability, subject to lender approval.

Any borrowings under the Credit Agreement will, at our request, be classified as either LIBOR Loans or Adjusted Base Rate (“ABR”) Loans (both as defined in the Credit Agreement). The rate of interest payable by us in respect of loans outstanding under the revolving credit facility is (i) with respect to LIBOR Loans, the Adjusted LIBO Rate (as defined in the Credit Agreement) for the interest period then in effect, plus 1.25%; or (ii) with respect to ABR Loans, the ABR (as defined in the Credit Agreement) then in effect for the Daily One-Month LIBO Rate (as defined in the Credit Agreement), plus 1.50% or the prime rate. We are subject to certain financial covenants under the Credit Agreement, including minimum tangible net worth, a requirement to maintain a minimum amount of cash, cash equivalents and marketable debt securities, and to maintain at the administrative agent cash, cash equivalents and marketable debt securities equal to the amount the lenders are committed to lend under the Credit Agreement.

At both December 28, 2013, and December 29, 2012, we had no borrowings and $20.0 million was available under the Credit Agreement. We had no outstanding letters of credit as of December 28, 2013 or December 29, 2012.

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Notes to Consolidated Financial Statements - (continued)

(10) Shareholders’ Equity

Stock-Based Compensation Plans

We compensate officers, directors and key employees with stock-based compensation under three stock plans approved by our shareholders in 1997, 2004 and 2010 and administered under the supervision of our Board of Directors (“Board”). At December 28, 2013, a total of 5,956,000 shares were available for future grant under the 2010 stock plan.

Total stock-based compensation expense for 2013, 2012 and 2011, was as follows (in thousands):



	2013		2012		2011
Stock options	$	2,698	$	3,688	$	2,721
Stock awards	1,534		6,618		2,250
Total stock-based compensation expense⁽¹⁾	4,232		10,306		4,971
Income tax benefit	1,447		3,576		1,710
Total stock-based compensation expense, net of tax	$	2,785	$	6,730	$	3,261

⁽¹⁾ Includes $(0.5) million and $5.6 million of CEO transition (benefit) costs in 2013 and 2012, respectively. See CEO Transition Costs on page 57.

Stock Options

Stock option awards are granted at exercise prices equal to the closing price of our stock on the grant date. Generally, options vest proportionally over periods of two to four years and expire after 10 years. Compensation expense is recognized ratably over the vesting period.

A summary of our stock option activity for the year ended December 28, 2013 was as follows (in thousands, except per share amounts and years):



	Stock Options		Weighted- Average Exercise Price per Share		Weighted- Average Remaining Contractual Term (years)	Aggregate Intrinsic Value ⁽¹⁾
Outstanding at December 29, 2012	2,889		$	15.92	5.0	$	26,109
Granted	265		20.67
Exercised	(757	)	10.52
Canceled/Forfeited	(643	)	24.66
Outstanding at December 28, 2013	1,754		$	15.77	5.6	$	11,812

Exercisable at December 28, 2013	1,185		$	13.62	4.3	$	10,180

Vested and expected to vest at December 28, 2013	1,707		$	15.66	5.5	$	11,645


⁽¹⁾	Aggregate intrinsic value includes only those options where the current share price is equal to or greater than the share price on the date of grant.

Other information pertaining to options for the years ended December 28, 2013, December 29, 2012, and December 31, 2011 is as follows (in thousands, except per share amounts):



	2013		2012		2011
Weighted-average grant date fair value of stock options granted	$	10.57	$	14.28	$	10.91
Total intrinsic value (at exercise) of stock options exercised	$	7,726	$	12,724	$	8,295

Cash received from the exercise of stock options for the fiscal year ended December 28, 2013 was $8.0 million. Our tax benefit related to the exercise of stock options for the fiscal year ended December 28, 2013 was $2.9 million.

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Notes to Consolidated Financial Statements - (continued)

At December 28, 2013, there was $4.2 million of total stock option compensation expense related to non-vested awards not yet recognized, which is expected to be recognized over a weighted-average period of 2.0 years.

Determining Fair Value

We estimated the fair value of stock options granted using the Black-Scholes-Merton option-pricing model and a single option award approach. Descriptions of significant assumptions used to estimate the expected volatility, risk-free interest rate and expected term are as follows:

Expected Volatility – Expected volatility was determined based on implied volatility of our traded options and historical volatility of our stock price.

Risk-Free Interest Rate – The risk-free interest rate was based on the implied yield available on U.S. Treasury zero-coupon issues at the date of grant with a term equal to the expected term.

Expected Term – Expected term represents the period that our stock-based awards are expected to be outstanding and was determined based on historical experience and anticipated future exercise patterns, giving consideration to the contractual terms of unexercised stock-based awards.

The assumptions used to calculate the fair value of awards granted during 2013, 2012 and 2011 using the Black-Scholes-Merton option-pricing model were as follows:



Valuation Assumptions	2013		2012		2011
Expected dividend yield	0	%	0	%	0	%
Expected volatility	61	%	63	%	78	%
Risk-free interest rate	0.9	%	1.1	%	1.9	%
Expected term (in years)	5.7		5.6		5.0

Stock Awards

We issue stock awards to certain employees in conjunction with our stock-based compensation plan. The stock awards generally vest from two to four years based on continued employment (“time based”). Compensation expense related to stock awards is determined on the grant date based on the publicly quoted fair market value of our common stock and is charged to earnings on a straight-line basis over the vesting period. Performance stock awards are time based, however, the final number of shares earned and the related compensation expense is adjusted up or down to the extent the performance target is met as of the last day of the performance period. The actual number of shares that will ultimately vest ranges from 0% to 150% of the targeted amount. For performance stock awards granted in 2013, the performance targets are net sales and operating margin and the performance period is fiscal 2015. For performance stock awards granted in 2012, the performance target is actual market share growth and the performance period is from January 2012 through December 2014. For performance stock awards granted in 2011, the performance targets were actual market share growth and free cash flow, and the performance period was from January 2011 through December 2013. The actual number of shares that will ultimately vest upon completion of the service period for the 2011 performance stock awards will be 93% of the targeted amount. We evaluate the likelihood of meeting the performance targets at each reporting period and adjust compensation expense, on a cumulative basis, based on the expected achievement of each of the performance targets.

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Notes to Consolidated Financial Statements - (continued)

Stock award and performance stock award activity was as follows for the year ended December 28, 2013 (in thousands, except per share amounts):



	Time- Based Stock Awards		Weighted-Average Grant Date Fair Value		Performance Stock Awards		Weighted-Average Grant Date Fair Value
Outstanding at December 29, 2012	255		$	13.62	554		$	11.47
Granted	88		20.39		119		19.28
Vested	(87	)	5.50		(182	)	0.97
Canceled/Forfeited	(17	)	16.69		(30	)	15.05
Outstanding at December 28, 2013	239		$	18.86	461		$	17.39

At December 28, 2013, there was $4.0 million of unrecognized compensation expense related to non-vested stock awards, which is expected to be recognized over a weighted-average period of 1.9 years.

Repurchases of Common Stock

Repurchases of our common stock for the years ended December 28, 2013, December 29, 2012 and December 31, 2011 were as follows (in thousands):



	2013		2012		2011
Amount repurchased under Board-approved share repurchase program	$	40,037	$	30,023	$	—
Amount repurchased in connection with the vesting of employee restricted stock grants	2,035		4,869		371
Total amount repurchased	$	42,072	$	34,892	$	371

As of December 28, 2013, the remaining authorization under our Board-approved share repurchase program was $136.7 million. There is no expiration date governing the period over which we can repurchase shares. Any repurchased shares are constructively retired and returned to an unissued status.

CEO Transition Costs

In February 2012, we announced that William R. McLaughlin, then President and Chief Executive Officer, would retire from the Company effective June 1, 2012. In recognition of Mr. McLaughlin’s contributions, the Company’s Compensation Committee approved the modification of Mr. McLaughlin’s unvested stock awards, including performance stock awards. As a result of these modifications, we recorded incremental non-cash compensation of $5.6 million ($3.7 million, net of income tax) in 2012. The performance stock awards are subject to applicable performance adjustments through 2014 based on free cash flow and actual market share growth versus performance targets. During 2013, we recorded a non-cash compensation benefit of $0.5 million ($0.4 million, net of income tax) resulting from performance-based stock award adjustments.

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Notes to Consolidated Financial Statements - (continued)

Net Income per Common Share

The components of basic and diluted net income per share are as follows (in thousands, except per share amounts):



	2013		2012		2011
Net income	$	60,081	$	78,094	$	60,478

Reconciliation of weighted-average shares outstanding:
Basic weighted-average shares outstanding	54,866		55,516		55,081
Effect of dilutive securities:
Options	554		1,059		821
Restricted shares	383		501		530
Diluted weighted-average shares outstanding	55,803		57,076		56,432

Net income per share – basic	$	1.10	$	1.41	$	1.10
Net income per share – diluted	$	1.08	$	1.37	$	1.07

Additional potential dilutive stock options totaling 1,288,000, 272,000 and 1,537,000 for 2013, 2012 and 2011, respectively, have been excluded from our diluted net income per share calculations because these securities’ exercise prices were anti-dilutive (e.g., greater than the average market price of our common stock).

(11) Other Income (Expense), Net

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



	2013			2012			2011
Interest income	$	375		$	310		155
Interest expense	(52		)	(92		)	(188		)
Other income (expense), net	$	323		$	218		$	(33	)

(12) Income Taxes

Income tax expense consisted of the following (in thousands):



Current:	2013		2012		2011
Federal	$	25,091	$	34,993	$	23,481
State	3,802		3,419		3,622
	28,893		38,412		27,103
Deferred:
Federal	1,953		2,176		2,434
State	84		1,323		405
	2,037		3,499		2,839
Income tax expense	$	30,930	$	41,911	$	29,942

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Notes to Consolidated Financial Statements - (continued)

The following table provides a reconciliation between the statutory federal income tax rate and our effective income tax rate:



	2013		2012		2011
Statutory federal income tax	35.0	%	35.0	%	35.0	%
State income taxes, net of federal benefit	3.0		2.9		3.2
Manufacturing deduction	(3.2	)	(3.1	)	(2.9	)
Changes in unrecognized tax benefits	0.3		(0.2	)	(0.8	)
Other	(1.1	)	0.3		(1.4	)
Effective income tax rate	34.0	%	34.9	%	33.1	%

We file income tax returns with the U.S. federal government and various state jurisdictions. In the normal course of business, we are subject to examination by federal and state taxing authorities. We are no longer subject to federal income tax examinations for years prior to 2010 or state income tax examinations prior to 2009.

Deferred Income Taxes

The tax effects of temporary differences that give rise to deferred income taxes were as follows (in thousands):



Deferred tax assets:	2013			2012
Current:
Warranty and returns liabilities	$	4,376		$	3,040
Compensation and benefits	1,379			1,448
Deferred rent and lease incentives	857			867
Other	539			246
Long-term:
Stock-based compensation	5,944			8,061
Deferred rent and lease incentives	4,524			3,237
Warranty liabilities	605			563
Net operating loss and capital loss carryforwards	827			1,339
Other	1,111			459
Total gross deferred tax assets	20,162			19,260
Valuation allowance	(587		)	(647		)
Total deferred tax assets after valuation allowance	19,575			18,613
Deferred tax liabilities:
Long-term:
Property and equipment	7,696			4,701
Total gross deferred tax liabilities	7,696			4,701
Net deferred tax assets	$	11,879		$	13,912

At December 28, 2013, we had net operating loss carryforwards for state income tax purposes of $5.0 million which will expire between 2014 and 2033.

We evaluate our deferred income taxes quarterly to determine if valuation allowances are required. As part of this evaluation, we assess whether valuation allowances should be established for any deferred tax assets that are not considered more likely than not to be realized, using all available evidence, both positive and negative. This assessment considers, among other matters, the nature, frequency, and severity of historical losses, forecasts of future profitability, taxable income in available carryback periods and tax planning strategies. In making such judgments, significant weight is given to evidence that can be objectively verified.

SELECT COMFORT CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements - (continued)

Unrecognized Tax Benefits

Reconciliations of the beginning and ending amounts of unrecognized tax benefits for 2013, 2012 and 2011 were as follows (in thousands):



	Federal and State Tax
	2013		2012			2011
Beginning balance	$	213	$	425		$	1,354
Increases related to current-year tax positions	149		18			292
Increases related to prior-year tax positions	112		—			355
Decreases related to prior-year tax positions	—		(230		)	—
Settlements with taxing authorities	—		—			(1,506		)
Lapse of statute of limitations	—		—			(70		)
Ending balance	$	474	$	213		$	425

As of December 28, 2013, we had $0.5 million of unrecognized tax benefits, which if recognized, would affect our effective tax rate. As of December 29, 2012, we had $0.2 million of unrecognized tax benefits, which if recognized, would affect our effective tax rate. The amount of unrecognized tax benefits is not expected to change materially within the next 12 months.

In 2013, 2012 and 2011, we included $21 thousand, $20 thousand and $(0.2) million, respectively, of net penalties and interest in income tax expense. At December 28, 2013, and December 29, 2012, we had accrued interest and penalties of $22 thousand and $0.1 million, respectively.

(13) Profit Sharing and 401(k) Plan

Under our profit sharing and 401(k) plan, eligible employees may defer up to 50% of their compensation on a pre-tax basis, subject to Internal Revenue Service limitations. Each year, we may make a discretionary contribution equal to a percentage of the employee’s contribution. During 2013, 2012 and 2011, our contributions, net of forfeitures, were $3.0 million, $2.5 million and $1.8 million, respectively.

(14) Commitments and Contingencies

Legal Proceedings

SELECT COMFORT CORPORATION

AND SUBSIDIARIES

Notes to Consolidated Financial Statements - (continued)

Consumer Credit Arrangements

We refer customers seeking extended financing to certain third party financiers (“Card Servicers”). The Card Servicers, if credit is granted, establish the interest rates, fees, and all other terms and conditions of the customer’s account based on their evaluation of the creditworthiness of the customer. As the receivables are owned by the Card Servicers, at no time are the receivables purchased or acquired from us. We are not liable to the Card Servicers for our customers’ credit defaults.

Commitments

As of December 28, 2013, we had $4.8 million of inventory purchase commitments with our suppliers as part of the normal course of business. There are a limited number of supply contracts that contain penalty provisions for failure to purchase contracted quantities. We do not currently expect any payments under these provisions. At December 28, 2013, we had entered into 32 lease commitments for future retail store locations. These lease commitments provide for minimum rentals over the next five to ten years, which if consummated based on current cost estimates, would approximate $30.9 million over the initial lease term. The minimum rentals for these lease commitments have been included in the future minimum lease payments in Note 8, Leases.

(15) Summary of Quarterly Financial Data (unaudited)

The following is a condensed summary of our quarterly results for 2013 and 2012. Figures are in thousands except earnings per share amounts. Amounts may not add due to rounding differences.



2013	First		Second		Third		Fourth		Fiscal Year
Net sales	$	258,237	$	207,391	$	263,689	$	230,854	$	960,171
Gross profit	163,416		131,398		166,420		140,521		601,755
Operating income	35,227		15,107		30,699		9,655		90,688
Net income	23,471		9,926		20,259		6,425		60,081
Net income per share – diluted	0.42		0.18		0.36		0.12		1.08



2012	First		Second		Third		Fourth		Fiscal Year
Net sales	$	262,383	$	205,219	$	246,817	$	220,559	$	934,978
Gross profit	164,299		131,571		160,729		139,947		596,546
Operating income	34,296		25,852		40,225		19,414		119,787
Net income	22,417		16,973		26,209		12,495		78,094
Net income per share – diluted	0.39		0.30		0.46		0.22		1.37

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

None

ITEM 9A. CONTROLS AND PROCEDURES

Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures

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

Management’s Report on Internal Control Over Financial Reporting

Select Comfort’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a-15(f). Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Our internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

Select Comfort’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a-15(f). Management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation under these criteria, management concluded that our internal control over financial reporting was effective as of December 28, 2013. The report of Deloitte & Touche LLP, our independent registered public accounting firm, regarding the effectiveness of our internal control over financial reporting is included in this report in “Part II, Item 8, Financial Statements and Supplementary Data” under “Report of Independent Registered Public Accounting Firm.”

Fourth Quarter Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting during the quarter ended December 28, 2013 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B. OTHER INFORMATION

Not applicable.

PART III

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information under the captions “Election of Directors,” “Corporate Governance” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our Proxy Statement for our 2014 Annual Meeting of Shareholders is incorporated herein by reference. Information concerning our executive officers is included in Part I of this report under the caption “Executive Officers of the Registrant.”

We have adopted a Code of Business Conduct applicable to our directors, officers and employees (including our principal executive officer, principal financial officer and principal accounting officer). The Code of Business Conduct is available on the Investor Relations section of our website at www.SleepNumber.com. In the event that we amend or waive any of the provisions of the Code of Business Conduct applicable to our principal executive officer, principal financial officer and principal accounting officer, we intend to disclose the same on our website at www.SleepNumber.com.

ITEM 11. EXECUTIVE COMPENSATION

The information under the caption “Executive Compensation” in our Proxy Statement for our 2014 Annual Meeting of Shareholders is incorporated herein by reference.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

Stock Ownership

The information under the caption “Stock Ownership of Management and Certain Beneficial Owners” in our Proxy Statement for our 2014 Annual Meeting of Shareholders is incorporated herein by reference.

Securities Authorized for Issuance under Equity Compensation Plans

The following table summarizes information about our equity compensation plans as of December 28, 2013:

EQUITY COMPENSATION PLAN INFORMATION



Plan Category	Number of securities to be issued upon exercise of outstanding options, warrants and rights⁽¹⁾	Weighted average exercise price of outstanding options, warrants and rights		Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in the first column)
Equity compensation plans approved by security holders	1,754,000	$	15.77	5,956,000
Equity compensation plans not approved by security holders	None	Not applicable		None
Total	1,754,000	$	15.77	5,956,000


⁽¹⁾	Includes the Select Comfort Corporation 1997 Stock Incentive Plan, the Select Comfort Corporation 2004 Stock Incentive Plan and the Select Comfort Corporation 2010 Omnibus Incentive Plan.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information under the caption “Corporate Governance” in our Proxy Statement for our 2014 Annual Meeting of Shareholders is incorporated herein by reference.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information under the caption “Ratification of Selection of Independent Registered Public Accounting Firm” in our Proxy Statement for our 2014 Annual Meeting of Shareholders is incorporated herein by reference.

PART IV

ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES

(a) Consolidated Financial Statements and Schedule

(1) Financial Statements

All financial statements as set forth under Item 8 of this report

(2) Consolidated Financial Statement Schedule

The following Report and financial statement schedule are included in this Part IV:

Schedule II - Valuation and Qualifying Accounts

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

(3) Exhibits

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

We will furnish a copy of the exhibits referred to above at a reasonable cost to any shareholder upon receipt of a written request. Requests should be sent to: Select Comfort Corporation, Investor Relations Department, 9800 59th Avenue North, Minneapolis, MN 55442.

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 15(c):


1.	Select Comfort Corporation 2004 Stock Incentive Plan (Amended and Restated as of January 1, 2007)


2.	Form of Nonstatutory Stock Option Award Agreement under the 2004 Stock Incentive Plan


3.	Form of Restricted Stock Award Agreement under the 2004 Stock Incentive Plan


4.	Form of Performance Stock Award Agreement under the 2004 Stock Incentive Plan


5.	Form of Nonstatutory Stock Option Award Agreement (Subject to Performance Adjustment) under the 2004 Stock Incentive Plan


6.	Select Comfort Corporation Amended and Restated 2010 Omnibus Incentive Plan


7.	Form of Nonstatutory Stock Option Award Agreement under the 2010 Omnibus Incentive Plan


8.	Form of Restricted Stock Award Agreement under the 2010 Omnibus Incentive Plan


9.	Form of Performance Stock Award Agreement under the 2010 Omnibus Incentive Plan


10.	Select Comfort Profit Sharing and 401(K) Plan – 2007 Restatement


11.	Select Comfort Executive Investment Plan (July 1, 2012 Restatement)


12.	Employment Letter from the Company to Shelly R. Ibach dated February 9, 2007


13.	Employment Letter from the Company to Kathryn V. Roedel dated March 8, 2005


14.	Employment Letter from the Company to Wendy L. Schoppert dated March 15, 2005


15.	Employment Letter from the Company to Mark A. Kimball dated April 22, 1999


16.	Summary of Executive Health Program


17.	Summary of Executive Tax and Financial Planning Program


18.	Amended and Restated Select Comfort Corporation Executive Severance Pay Plan


19.	First Amendment to Amended and Restated Select Comfort Corporation Executive Severance Pay Plan


20.	Summary of Non-Employee Director Compensation

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



		SELECT COMFORT CORPORATION
		(Registrant)

Dated:	February 21, 2014	By:	/s/ Shelly R. Ibach
			Shelly R. Ibach
			Chief Executive Officer
			(principal executive officer)

		By:	/s/ Wendy L. Schoppert
			Wendy L. Schoppert
			Chief Financial Officer
			(principal financial officer)

		By:	/s/ Robert J. Poirier
			Robert J. Poirier
			Chief Accounting Officer
			(principal accounting officer)

POWER OF ATTORNEY

Know all persons by these presents, that each person whose signature appears below constitutes and appoints Shelly R. Ibach, Wendy L. Schoppert and Mark A. Kimball, and each of them, as such person’s true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for such person and in such person’s name, place and stead, in any and all capacities, to sign any and all amendments to this Report, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as such person might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or any of them or their or such person’s substitute or substitutes, may lawfully do or cause to be done by virtue thereof.

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 date or dates indicated.



Name	Title	Date

/s/ Jean-Michel Valette	Chairman of the Board	February 19, 2014
Jean-Michel Valette

/s/ Shelly R. Ibach	Director	February 21, 2014
Shelly R. Ibach

/s/ Daniel Alegre	Director	February 19, 2014
Daniel Alegre

/s/ Stephen L. Gulis, Jr.	Director	February 17, 2014
Stephen L. Gulis, Jr.

/s/ Michael J. Harrison	Director	February 15, 2014
Michael J. Harrison

/s/ David T. Kollat	Director	February 15, 2014
David T. Kollat

/s/ Brenda J. Lauderback	Director	February 18, 2014
Brenda J. Lauderback

/s/ Kathleen L. Nedorostek	Director	February 17, 2014
Kathleen L. Nedorostek

/s/ Michael A. Peel	Director	February 19, 2014
Michael A. Peel

SELECT COMFORT CORPORATION

EXHIBIT INDEX TO ANNUAL REPORT ON FORM 10-K

FOR THE YEAR ENDED DECEMBER 28, 2013



Exhibit No.	Description	Method of Filing

3.1	Third Restated Articles of Incorporation of the Company, as amended	Incorporated by reference to 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	Articles of Amendment to Third Restated Articles of Incorporation of the Company	Incorporated by reference to Exhibit 3.1 contained in Select Comfort's Current Report on Form 8-K filed May 16, 2006 (File No. 0-25121)

3.3	Articles of Amendment to Third Restated Articles of Incorporation of the Company	Incorporated by reference to Exhibit 3.1 contained in Select Comfort's Current Report on Form 8-K filed May 25, 2010 (File No. 0-25121)

3.4	Restated Bylaws of the Company	Incorporated by reference to Exhibit 3.1 contained in Select Comfort's Current Report on Form 8-K filed December 20, 2010 (File No. 0-25121)

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

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

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

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

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

10.6	Fourth Amendment to Lease dated June 30, 2003 between Cabot Industrial Properties, L.P. (successor to Rushmore Plaza Partners Limited Partnership) and Select Comfort Direct Corporation	Incorporated by reference to Exhibit 10.6 contained in Select Comfort's Annual report on Form 10-K for the fiscal year ended January 3, 2004 (File No. 0-25121)

10.7	Fifth Amendment to Lease dated August 28, 2006 between Cabot Industrial Properties, L.P. (successor to Rushmore Plaza Partners Limited Partnership) and Select Comfort Direct Corporation	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Quarterly report on Form 10-Q for the quarter ended September 30, 2006 (File No. 0-25121)

10.8	Lease Agreement dated as of September 19, 2002 between the Company and Blind John, LLC (as successor to Frastacky (US) Properties Limited Partnership)	Incorporated by reference to Exhibit 10.6 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 28, 2002 (File No. 0-25121)



Exhibit No.	Description	Method of Filing
10.9	Amendment Three to Lease between Select Comfort Corporation and Blind John, LLC dated February 28, 2012	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed March 2, 2012 (File No. 0-25121)

10.10	Lease Agreement dated September 30, 1998 between the Company and ProLogis Development Services Incorporated	Incorporated by reference to Exhibit 10.12 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 28, 2002 (File No. 0-25121)

10.11	Net Lease Agreement (Build-to-Suit) by and between Opus Northwest LLC, as Landlord, and Select Comfort Corporation, as Tenant, dated July 26, 2006	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Quarterly report on Form 10-Q for the quarter ended July 1, 2006 (File No. 0-25121)

10.12	Select Comfort Corporation 2004 Stock Incentive Plan (Amended and Restated as of January 1, 2007)	Incorporated by reference to Exhibit 10.16 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 30, 2006 (File No. 0-25121)

10.13	Form of Nonstatutory Stock Option Award Agreement under the Select Comfort Corporation 2004 Stock Incentive Plan	Incorporated by reference to Exhibit 10.28 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25121)

10.14	Form of Restricted Stock Award Agreement under the Select Comfort Corporation 2004 Stock Incentive Plan	Incorporated by reference to Exhibit 10.29 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25121)

10.15	Form of Performance Stock Award Agreement under the Select Comfort Corporation 2004 Stock Incentive Plan	Incorporated by reference to Exhibit 10.30 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25121)

10.16	Form of Nonstatutory Stock Option Award Agreement (Subject to Performance Adjustment) under the Select Comfort Corporation 2004 Stock Incentive Plan	Incorporated by reference to Exhibit 10.20 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 30, 2006 (File No. 0-25121)

10.17	Select Comfort Corporation Amended and Restated 2010 Omnibus Incentive Plan	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed May 15, 2013 (File No. 0-25121)

10.18	Form of Nonstatutory Stock Option Award Agreement under the 2010 Omnibus Incentive Plan	Incorporated by reference to Exhibit 10.20 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended January 1, 2011 (File No. 0-25121)

10.19	Form of Restricted Stock Award Agreement under the 2010 Omnibus Incentive Plan	Incorporated by reference to Exhibit 10.21 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended January 1, 2011 (File No. 0-25121)

10.20	Form of Performance Stock Award Agreement under the 2010 Omnibus Incentive Plan	Incorporated by reference to Exhibit 10.22 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended January 1, 2011 (File No. 0-25121)



Exhibit No.	Description	Method of Filing
10.21	Select Comfort Profit Sharing and 401(K) Plan - 2007 Restatement	Incorporated by reference to Exhibit 10.22 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 30, 2006 (File No. 0-25121)

10.22	Select Comfort Executive Investment Plan (July 1, 2012 Restatement)	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed July 2, 2012 (File No. 0-25121)

10.23	Employment Letter from the Company to Shelly R. Ibach dated February 9, 2007	Incorporated by reference to Exhibit 10.30 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 29, 2012 (File No. 0-25121)

10.24	Employment Letter from the Company to Kathryn V. Roedel dated March 8, 2005	Incorporated by reference to Exhibit 10.17 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25121)

10.25	Employment Letter from the Company to Wendy L. Schoppert dated March 15, 2005	Incorporated by reference to Exhibit 10.18 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25121)

10.26	Employment Letter from the Company to Mark A. Kimball dated April 22, 1999	Incorporated by reference to 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)

10.27	Summary of Executive Health Program	Incorporated by reference to Exhibit 10.36 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended December 31, 2005 (File No. 0-25121)

10.28	Summary of Executive Tax and Financial Planning Program	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed January 3, 2005 (File No. 0-25121)

10.29	Amended and Restated Select Comfort Corporation Executive Severance Pay Plan	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed August 21, 2008 (File No. 0-25121)

10.30	First Amendment to Amended and Restated Select Comfort Corporation Executive Severance Pay Plan	Incorporated by reference to Exhibit 10.34 contained in Select Comfort's Annual Report on Form 10-K for the fiscal year ended January 3, 2009 (File No. 0-25121).

10.31	Summary of Non-Employee Director Compensation	Filed herewith.

10.32	Master Supply Agreement dated July 16, 2013 between the Company and Supplier (1)	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Quarterly Report on Form 10-Q for the quarter ended September 28, 2013 (File No. 0-25121)

10.33	Amended and Restated Private Label Consumer Credit Card Program Agreement dated as of December 14, 2005 between GE Money Bank and Select Comfort Corporation and Select Comfort Retail Corporation (1)	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed December 20, 2005 (File No. 0-25121)



Exhibit No.	Description	Method of Filing

10.34	First Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement dated as of April 23, 2007 between GE Money Bank and Select Comfort Corporation and Select Comfort Retail Corporation	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed April 27, 2007 (File No. 0-25121)

10.35	Second Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement dated as of February 1, 2008 between GE Money Bank and Select Comfort Corporation and Select Comfort Retail Corporation	Incorporated by reference to Exhibit 10.3 contained in Select Comfort's Current Report on Form 8-K filed February 7, 2008 (File No. 0-25121)

10.36	GE Waiver and Consent dated May 21, 2009	Incorporated by reference to Exhibit 10.6 contained in Select Comfort's Current Report on Form 8-K filed May 26, 2009 (File No. 0-25121)

10.37	Ninth Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement dated June 29, 2011 ⁽¹⁾	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed July 6, 2011 (File No. 0-25121)

10.38	Tenth Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement dated July 18, 2011	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed July 22, 2011 (File No. 0-25121)

10.39	Select Comfort Corporation Non-Employee Director Deferral Plan	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed September 16, 2011 (File No. 0-25121)

10.40	Eleventh Amendment to Amended and Restated Private Label Consumer Credit Card Program Agreement dated June 18, 2012⁽¹⁾	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed June 20, 2012 (File No. 0-25121)

10.41	Credit Agreement, dated March 26, 2010, by and among Select Comfort Corporation and Wells Fargo Bank, National Association	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed March 29, 2010 (File No. 0-25121)

10.42	Amendment to Credit Agreement, dated April 23, 2012, by and among Select Comfort Corporation and Wells Fargo Bank, National Association	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed April 24, 2012 (File No. 0-25121)

10.43	Amendment to Credit Agreement, dated October 15, 2013, by and among Select Comfort Corporation and Wells Fargo Bank, National Association	Incorporated by reference to Exhibit 10.1 contained in Select Comfort's Current Report on Form 8-K filed October 18, 2013 (File No. 0-25121)

21.1	Subsidiaries of the Company	Incorporated by reference to Exhibit 21.1 contained in Select Comfort's Annual Report on Form 10-K filed February 21, 2013 (File No. 0-25121)

23.1	Consent of Independent Registered Public Accounting Firm	Filed herewith

24.1	Power of Attorney	Included on signature page

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

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



Exhibit No.	Description	Method of Filing
32.1	Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith⁽²⁾

32.2	Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	Furnished herewith⁽²⁾

101	The following financial information from the Company's Annual Report on Form 10-K for the year ended December 28, 2013, filed with the SEC on February 21, 2014, formatted in eXtensible Business Reporting Language: (i) Consolidated Balance Sheets as of December 28, 2013 and December 29, 2012; (ii) Consolidated Statements of Operations for the years ended December 28, 2013, December 29, 2012 and December 31, 2011; (iii) Consolidated Statements of Comprehensive Income for the years ended December 28, 2013, December 29, 2012 and December 31, 2011; (iv) Consolidated Statement of Shareholders' Equity for the years ended December 28, 2013, December 29, 2012 and December 31, 2011; (v) Consolidated Statements of Cash Flows for the years ended December 28, 2013, December 29, 2012 and December 31, 2011; and (vi) Notes to Consolidated Financial Statements.	Filed herewith


⁽¹⁾	Confidential treatment has been requested by the issuer 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.

⁽²⁾

This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Act of 1934, as amended, (15 U.S.C. 78r) or otherwise subject to the liability of that section. Such exhibit will not be deemed to be incorporated by reference into any document filed under the Securities Act of 1933, as amended, or under the Securities Exchange Act of 1934, as amended, except as otherwise expressly stated in any such filing.

SELECT COMFORT CORPORATION AND SUBSIDIARIES

Schedule II - Valuation and Qualifying Accounts

(in thousands)



Description	2013			2012			2011
Allowance for doubtful accounts
Balance at beginning of period	$	348		$	397		$	302
Additions charged to costs and expenses	776			246			275
Deductions from reserves	(699		)	(295		)	(180		)
Balance at end of period	$	425		$	348		$	397

Accrued sales returns
Balance at beginning of period	$	5,330		$	4,402		$	2,944
Additions charged to costs and expenses	59,656			44,284			40,449
Deductions from reserves	(55,553		)	(43,356		)	(38,991		)
Balance at end of period	$	9,433		$	5,330		$	4,402