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Article by DailyStocks_admin    (03-11-08 02:58 AM)

The Daily Magic Formula Stock for 03/11/2008 is Select Comfort Corp. According to the Magic Formula Investing Web Site, the ebit yield is 18% and the EBIT ROIC is >100 %.

Dailystocks.com only deals with facts, not biased journalism. What is a better way than to go to the SEC Filings? It's not exciting reading, but it makes you money. We cut and paste the important information from SEC filings for you to get started on your research on a specific company.


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BUSINESS OVERVIEW

Overview



Select Comfort Corporation was founded as a Minnesota-based corporation in 1987 by an entrepreneur who developed and manufactured adjustable firmness mattresses after considering other alternatives such as innerspring and water mattresses. Select Comfort has evolved from a specialty, niche direct marketer, to a nationwide multi-channel business with fiscal 2007 net sales of $799 million.



Our principal business is to develop, manufacture, market and distribute premium quality, adjustable-firmness beds and other sleep-related accessory products. The air-chamber technology of our proprietary Sleep Number bed allows adjustable firmness on each side of the mattress and provides a sleep surface that is clinically proven to provide better sleep quality and greater relief of back pain compared to traditional mattress products. In addition, we market and sell accessories and other sleep related products which focus on providing personalized comfort to complement the Sleep Number bed and provide a better night’s sleep to the consumer. We have a mission-driven culture focused on serving the needs of our customers. Our mission is to improve people’s lives through better sleep. Our goal is to educate our consumers on the importance of a better night’s sleep and the unique benefits of our products.



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.



Competitive Strengths



Differentiated, Superior Product



The unique benefits of our proprietary Sleep Number bed have been validated through clinical sleep research. Clinical sleep research has shown that people who sleep on a Sleep Number bed generally fall asleep faster and experience deeper sleep with fewer disturbances than those sleeping on a traditional innerspring mattress. The proprietary air-chamber technology of our Sleep Number bed allows adjustable firmness of the mattress at the touch of a button. Our dual chamber technology (two independent air chambers) allows consumers to adjust the firmness on both sides of the bed to meet each person’s individual preference. Our clinical research has shown that our bed’s sleep surface generally provides better sleep quality and greater relief of back pain in comparison with traditional innerspring mattress products.



Distinctive Brand



In 2001, we created the Sleep Number brand. This branding strategy allows our marketing communications to focus on our bed’s distinguishing and proprietary features – adjustable firmness and support for personalized comfort. This is represented by the digital Sleep Number display on the bed’s hand-held remote control, with a brand message hierarchy as follows:






A Sleep Number ® setting represents an ideal level of mattress comfort, firmness and support; and






You can only find your Sleep Number ® setting on a Sleep Number Bed by Select Comfort ™ .



Controlled Selling Environment



Over 90% of our sales are generated through our company-controlled distribution channels – Retail, Direct Marketing and E-Commerce. Our nationwide chain of retail stores provides a unique mattress shopping experience and offers a relaxed environment designed to provide education on the importance of sleep and the products that best fit consumers’ needs. Controlling the selling process enables us to ensure that the unique benefits of our products are effectively communicated to consumers. Our multiple touch-points of service, including sales, delivery and post-sale service, provide several opportunities to communicate with our customers, reinforcing the sale and enabling us to understand and respond quickly to consumer trends and preferences.



Integrated Business Process



We are a vertically-integrated business from production through sales and delivery of our products, which allows us to control quality, cost, price and presentation. The modular design of our Sleep Number bed allows a just-in-time, build-to-order production process which requires minimal inventory in our stores and manufacturing plants, resulting in reduced working capital levels. This just-in-time production process also allows our stores to serve primarily as showrooms, without requiring significant product storage capacity.



Growth Strategy



For 2006, we ranked as the 5 th largest mattress manufacturer according to the June 18, 2007 edition of Furniture/Today , with a 6% market share of industry revenue and 2% market share of industry units. We ranked as the leading U.S. bedding retailer, according to the Top-25 Bedding Retailers report in the August 13, 2007 edition of Furniture/Today . Our vision is to be a leading brand in the bedding industry.



Building Brand Awareness



Our most significant growth driver has been building brand awareness. The Sleep Number brand has been integrated into all of our sales channels and throughout our internal and external communication programs. We utilize a media mix that includes television, radio and print advertising in support of our Sleep Number marketing campaign with increasing use of Internet advertising and paid search in our media mix.



We also sell to commercial partners which increases awareness of our brand through media exposure, trial sales and word-of-mouth. These commercial partners include the QVC television shopping channel, the luxury motor home market and Radisson Hotels and Resorts ® in the U.S., Canada and the Caribbean.



Expanding Distribution



Over the long-term, we expect to operate over 600 company-owned stores in the U.S. with annual square footage growth increasing by 5% to 7% per year. We supplement our company-controlled distribution channels with sales through a limited number of leading home furnishings and specialty bedding retailers.



In 2005, we expanded our distribution network outside the U.S. with a retail partner relationship in Canada. In 2007, the Canadian retail partner relationship grew to 127 doors. During 2007, we formed a strategic alliance with two Australian-based companies to manufacture and distribute Sleep Number beds and accessories in Australia and New Zealand.

Accelerating Innovation



Our goal is to continue to lead the industry in innovative sleep products. We have historically introduced new features and benefits to our Sleep Number beds every two to three years, through a pipeline of research and development (“R&D”) activities. During 2007, we upgraded our entire line of bed models. We believe the new line represents the highest-quality, most technologically advanced beds we have ever produced. Our top-end 7000 and 9000 models were re-launched in June 2007. The new versions of our 3000, 4000 and 5000 models were introduced to all of our stores in July 2007. All of our new models emphasize enhanced comfort-layer materials, and several feature advancements in temperature balancing technology. Our 2008 innovation plans include the launch of two new mattress models which will fill in key price points in our product line-up and provide easier step-up opportunities for our sales professionals.



Leveraging our Infrastructure



Our vertically-integrated business model provides multiple sources for efficiency and leverage. Sustaining such performance over a multi-year period is based on expected scale efficiencies (fixed cost utilization) and cost containment initiatives. We also have an ongoing focus on productivity gains through a variety of programs, including the implementation of a new enterprise resource planning system in the second half of 2008, optimization of our new hub and spoke network, value engineering, marketing and sales initiatives, and a Six Sigma initiative to improve product and service quality.



Our Products



Mattress Sets



At the end of 2007, we offered five different Sleep Number bed models through our U.S. company-owned channels, including the Sleep Number 3000, 4000, 5000, 7000 and 9000. Each bed model comes in standard mattress sizes, ranging from twin to king, as well as some specialty mattress sizes. Our bed models vary in features, functionality and price. As you move up the product line, the Sleep Number bed models offer enhanced features and benefits, including higher-quality fabrics, additional cushion and padding, higher overall mattress profiles, quieter Firmness Control Systems with additional functions, temperature balancing fabrics, and wireless remote controls as a standard feature.



The contouring support of our Sleep Number beds are optimized when used with our specially designed, proprietary foundation. This durable foundation, used in place of a box spring, is a modular design that can be disassembled and easily moved through staircases, hallways and other tight spaces.



Our U.S. mattress price points range from approximately $1,000 for the entry-level Sleep Number 3000 queen-size set (mattress and foundation) to $4,000 for the luxurious Sleep Number 9000 queen-size set. Our most popular model is the 5000 queen-size set which sells for approximately $2,000. These prices are subject to promotional offerings.



Our unique product design allows us to ship our beds in a modular format to customers throughout the U.S. by United Parcel Service (“UPS”). For an additional fee, customers can take advantage of our home delivery service, which includes bed assembly and optional mattress removal services.



We also manufacture our Sleep Number beds for distribution through our retail partners. Our retail partner beds have different model numbers or names, but have similar features and benefits, and sell for similar prices.



Each of our Sleep Number beds (not including our Precision Comfort adjustable foundation) comes with a 30 night in-home trial and better night’s sleep guarantee, which allows customers 30 nights at home to make sure they are completely satisfied with the bed. The customer is responsible for the return shipping costs. Independent durability testing has shown our Sleep Number beds can withstand more than 20 years of simulated use, and each of our Sleep Number beds is backed by our 20-year limited warranty.



Accessories



In addition to our mattresses and foundations, we offer a line of accessory bedding products, including specialty pillows, mattress pads, comforters, sheets, bed foundations and leg options. The specialty pillows, available in a variety of sizes, materials and firmness levels, are designed to provide personalized comfort and better quality sleep for stomach, back or side sleepers. We also market our Personal Warmth Collection™, a group of comforters and blankets designed to be warmer on one half of the bed than the other, accommodating varying warmth preferences among couples.



Other Products and Services



In 2003, we completed the roll-out of our Precision Comfort adjustable foundation to all of our company-owned retail stores. The adjustable foundation enables consumers to raise the head or foot of the bed, and to experience the comfort of massage, using a handheld remote control.



In 2004, we introduced the Sleep Number SofaBed line into a select number of our stores in selected U.S. markets. The Sleep Number SofaBed features a queen-size Sleep Number mattress inside a sofa surround, which is available in a variety of fabrics or leather options.



Sales Distribution



Unlike traditional bedding manufacturers, which primarily sell through third-party retailers, over 90% of our net sales are through one of three company-controlled distribution channels – Retail, Direct Marketing and E-Commerce. These channels enable us to control the selling process to ensure that the unique benefits of our products are effectively presented to consumers. Our direct-to-consumer business model enables us to understand and respond quickly to consumer trends and preferences.



Our retail stores accounted for 75% of our net sales in 2007. Average net sales per company-owned store were $1,318,000 in 2007 versus $626,000 in 2001, with average sales per square foot of $1,024 in 2007 versus $666 in 2001. New stores are expected to average in excess of $1,000,000 in net sales in the first year of operations. In 2007, 73% of our stores generated net sales of over $1,000,000.



Our direct marketing call center and E-Commerce Web site provide national sales coverage, including markets not yet served by one of our retail stores, and accounted for 15% of our net sales in 2007. In addition, these channels provide a cost-effective way to market our products, are a source of information on our products and refer customers to our stores if there is one near the customer.



Beginning in 2002, we supplemented our sales through semi-exclusive relationships with selected home furnishing retailers and specialty bedding retailers. At the end of 2007, our retail program included 10 retail partners in the U.S. and Canada with a total of 891 doors, up from 353 doors at the end of 2005. Each retail partner serves a unique geographic market, which enables us to increase sales and leverage our media spending to accelerate brand awareness.



Marketing and Advertising



Awareness among the broad consumer audience of our brand, product benefits and store locations has been our most significant opportunity for growth. The Sleep Number advertising campaign was introduced early in 2001 to support our retail stores in selected markets through our first comprehensive multi-media advertising campaign using prime-time TV, national cable television, infomercials, drive-time radio and newspaper advertisements.



Since 2001, the Sleep Number brand positioning has been integrated into our marketing messages across all of our distribution channels, advertising vehicles and media types. We look to our direct response advertising on national cable TV as an economical means to generate leads for our stores. Through our dedicated call center, we are able to provide the inquiring consumer more information or send a video and brochure. Our total media spending was approximately $110 million in 2007, $105 million in 2006, and $89 million in 2005.



Owners of Sleep Number beds purchased through company-controlled channels are members of our Comfort Club, our customer loyalty program designed primarily to increase referrals and repeat purchases. Each time a referred customer purchases a bed, the referring Comfort Club member receives a $50 coupon for purchase of our products, with increasing benefits for multiple referrals. In 2007, approximately 36,000 new customers bought beds after receiving referrals from our Comfort Club members, and existing owners bought approximately 32,000 additional beds.



Qualified customers are offered revolving credit to finance purchases through a private-label consumer credit facility provided by GE Money Bank. Approximately 44% of our net sales during 2007 were financed by GE Money Bank. In 2005, we entered into an amended and restated agreement with GE Money Bank that extends this consumer credit arrangement through February 15, 2011, subject to earlier termination upon certain events and subject to automatic extensions. Under the terms of our agreement, GE Money Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts. In connection with all purchases financed under these arrangements, GE Money Bank pays us an amount equal to the total amount of such purchases, net of promotional related discounts, upon delivery to the customer. Consumers that do not qualify for credit under our agreement with GE Money Bank may apply for credit under a secondary program maintained by the company through another provider.



Operations



Manufacturing and Distribution



We have two manufacturing plants, one located in Irmo, South Carolina, and the other in Salt Lake City, Utah, which distribute products in the U.S. and Canada. 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 foundations. In addition, our electrical Firmness Control Systems are assembled in our Utah plant.



We manufacture beds 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 currently shipped from our manufacturing facilities via UPS or through our company-controlled home delivery, assembly and mattress removal service, typically within 48 hours following order receipt. Orders 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 foundations, and various components for our Firmness Control Systems, as well as fabrics and zippers, are sourced from suppliers who currently serve as our sole source of supply for these components. Beginning in 2005, we initiated work on dual and alternate sourcing, successfully introducing a second source for printed circuit boards and certain foam and fiber components. We will continue working toward dual sourcing on targeted components. However, we believe we can obtain these raw materials and components from other sources of supply in the ordinary course of business, if necessary.



Our proprietary air chambers are produced to our specifications by a sole source Eastern European supplier, which has been our sole source of supply of air chambers since 1994. Our agreement with this supplier runs through September 2011 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 foundations are produced to our specifications by a single domestic supplier under an agreement that expires in December 2010. We expect to continue this supplier relationship for the foreseeable future.



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 uninterrupted supply of materials and components.



Home Delivery Service



Select Comfort’s home delivery, assembly and mattress removal service has contributed to improving the overall customer experience. Our home delivery technicians are Sleep Number bed owners who can articulate the benefits of the bed, reinforcing the sales process and ensuring satisfied customers. Approximately 60% of beds sold through our company-owned retail stores in 2007 were delivered by our full-service home delivery team.



In 2003, we expanded the availability of our company-controlled delivery, assembly and removal services to all of our retail markets. In 2007, we continued improving our home delivery efficiency and service by consolidating over 100 individually managed cross-dock distribution locations into a new Hub and Spoke network organized around 13 regional hubs. Twelve of 13 hubs were operational as of December 2007.



Customer Service



We maintain an in-house customer service department staffed by customer service representatives who receive extensive training in sleep technology and all aspects of our products and operations. Our customer service representatives field customer calls and also interact with each of our retail stores to address customer questions and concerns. Our customer service team is part of our total quality process, facilitating early identification of emerging trends or issues. They coordinate with engineering and manufacturing to segment these issues, implement immediate solutions and provide inputs for long-term improvements to product and service design.

Research and Development



Our research and development team continuously seeks to improve product performance and benefits based on sleep science. Through customer surveys and consumer focus groups, we seek feedback on a regular basis to help enhance our products. Since the introduction of our first bed, we have continued to improve and expand our product line, including new bed models, a quieter Firmness Control System, remote controls with digital settings, more luxurious fabrics and covers, new generations of foams and foundation systems. Our research and development expenses were $5.7 million in 2007, $4.7 million in 2006, and $2.2 million in 2005.



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, in-bound and out-bound telecommunications systems for direct marketing and customer service, E-Commerce systems, retail partner support 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. Our production data center and E-Commerce Web site have recently been relocated to our new state-of-the-art corporate headquarters with redundant environmental systems. We maintain a disaster recovery plan that is tested annually.



During the second half of fiscal 2008, we plan on implementing an integrated suite of SAP®-based applications, including enterprise resources planning, retail store, customer relationship management, human capital management, strategic enterprise management, business intelligence and enterprise portal systems to replace most of our current systems. We believe this SAP ® -based IT architecture, along with best-practices-based processes and greater utilization of off-the-shelf, highly integrated packaged solutions with minimal customization and enhancement, will provide greater flexibility and functionality for our growing and evolving business model and be less expensive to maintain over the long-term.



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, and features related to sofa sleepers with air mattresses, as well as other technology. We have 24 issued U.S. patents, expiring at various dates between March 2009 and June 2022, and five U.S. patent applications pending. We also hold 31 foreign patents and 9 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. To our knowledge, no third party has asserted a claim against us alleging that any element of our product infringes or otherwise violates any intellectual property rights of any third party.



“ Select Comfort ” and “ Sleep Number ” are trademarks registered with the U.S. Patent and Trademark Office. We have a number of other registered trademarks including our “ Select Comfort ” logo with the double arrow design, “ Select Comfort Creator of the Sleep Number Bed ,” “ What’s Your Sleep Number? ,” “ Precision Comfort, ” “ The Sleep Number Bed by Select Comfort ” (logo), “ The Sleep Number Store by Select Comfort ” (logo), “ Comfort Club ” and “ Sleep Better on Air ” and “ LuxLayer .” U.S. applications are pending for a number of other marks. Several of these trademarks have been registered, or are the subject of pending applications, in various foreign countries. Each federally registered mark is renewable indefinitely as long as the mark remains in use. We are not aware of any material claims of infringement or other challenges asserted against our right to use these marks.



Industry and Competition



The U.S. bedding manufacturing industry is a mature and stable industry. According to the 2006 Annual Report by the International Sleep Products Association (ISPA), industry wholesale shipments of mattresses and foundations were estimated to be $6.8 billion in 2006, a 5% increase compared to $6.5 billion in 2005. We estimate that traditional innerspring mattresses represent approximately 77% of total U.S. bedding sales. Furniture/Today, a furniture industry trade publication, has ranked Select Comfort as the largest U.S. bedding retailer for seven consecutive years, most recently in its August 13, 2007 issue.



According to the 2006 Annual Report by ISPA, since 1984 the industry has consistently demonstrated growth on a dollar basis, with a 0.3% decline in 2001 being the only exception. Over the 5-year, 10-year and 20-year periods ended 2006, the value of U.S. wholesale bedding shipments increased at compound annual growth rates of 8.1%, 7.3% and 6.5%, respectively . We believe that industry unit growth has been primarily driven by population growth, and 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 highly fragmented and 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 three largest manufacturers of innerspring bedding with nationally recognized brand names, including Sealy, which also owns the Stearns & Foster brand name, Serta, and Simmons. Numerous other manufacturers, primarily operating on a regional or niche basis, serve the balance of the bedding market. Simmons and Sealy, as well as a number of smaller manufacturers, have offered air-bed products in recent years. Tempur-Pedic International, Inc., and a number of other mattress manufacturers, offer foam mattress products.



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.



A portion of our net sales consists of refurbished products that are assembled in part from components returned to us from customers. These refurbished products must be properly labeled and marketed as refurbished products under applicable laws. Our sales of refurbished products are limited to approximately 24 states, as other states do not allow the sale of refurbished bedding products.



The bedding industry is subject to federal fire retardancy 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, potentially reducing our manufacturing capacity. These regulations also result in higher product development costs as new products must undergo rigorous flammability testing.



Our direct marketing and E-Commerce 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.



We are subject to emerging federal, state and foreign data privacy regulations related to the safeguarding of sensitive customer and employee data, which may limit our ability to maintain or use consumer or customer information in our business.



We are subject to federal, state and foreign 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 will also be subject to similar laws in foreign jurisdictions as we further expand distribution of our products internationally.



Our retail pricing policies and practices are subject to antitrust regulations in the U.S., Canada, Australia, New Zealand and other jurisdictions where we may sell our products in the future.



We believe we are in compliance in all material respects with each of these governmental regulations.



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 2007, 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, and the loss of any one customer would not have a material impact on our business.



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



Our investment to open a new store is approximately $250,000, including inventory. We target new stores to be cash flow positive within 12 months with a payback of the initial cash investment in less than 24 months. Our stores break even on a four-wall cash flow basis with approximately $600,000 of annual net sales. Our four-wall cash flow is calculated as gross profit generated from store sales less store expenses, without deduction of depreciation expenses or indirect marketing expenses.



The component nature of our products allows our stores to serve as product showrooms for our Sleep Number beds. This aspect of our business model allows us to maintain low inventory levels which enables us to operate with minimal working capital. We have historically generated sufficient cash flows to self-fund our growth through an accelerated cash-conversion cycle. In addition, our $100 million bank revolving line of credit is available for additional working capital needs or investment opportunities. However, we may elect to seek additional sources of capital to fund growth initiatives, or if a prolonged or more severe economic downturn impacts our ability to meet our financial covenants.



Employees



At December 29, 2007, we employed 3,247 persons, including 1,691 retail sales and support employees, 214 direct marketing and customer service employees, 1,007 manufacturing and logistics employees, and 335 management and administrative employees. Approximately 190 of our employees were employed on a part-time basis at December 29, 2007. Except for managerial employees and professional support staff, all of our employees are paid on an hourly basis plus commissions for sales associates. None of our employees are represented by a labor union or covered by a collective bargaining agreement. We believe that our relations with our employees are good.

CEO BACKGROUND

Thomas J. Albani has served as a member of our Board of Directors since February 1994. Mr. Albani served as President and Chief Executive Officer of Electrolux Corporation, a manufacturer of premium floor care machines, from June 1991 to May 1998. From September 1984 to April 1989, he was employed by Allegheny International Inc., a home appliance manufacturing company, in a number of positions, most recently as Executive Vice President and Chief Operating Officer.

David T. Kollat has served as a member of our Board of Directors since February 1994. Dr. Kollat has served as President and Chairman of 22 Inc., a research and consulting company for retailers and consumer goods manufacturers, since 1987. From 1976 until 1987, he served in various capacities for The Limited, a women's apparel retailer, including Executive Vice President of Marketing and President of Victoria ' s Secret Catalogue. Dr. Kollat also serves as a director of Big Lots, Inc., The Limited, Inc. and Wolverine World Wide, Inc.

William R. McLaughlin joined our company in March 2000 as President and Chief Executive Officer and as a member of our Board of Directors. In May 2004, Mr. McLaughlin was also named Chairman of our Board of Directors. From December 1988 to March 2000, Mr. McLaughlin served as an executive of PepsiCo Foods International, Inc., a snack food company and subsidiary of PepsiCo, Inc., in various capacities, including from September 1996 to March 2000 as President of Frito-Lay Europe, Middle East and Africa, and from June 1993 to June 1996 as President of Grupo Gamesa, S.A. de C.V., a cookie and flour company based in Mexico.

Christopher P. Kirchen has served as a member of our Board of Directors since December 1991. Mr. Kirchen is currently Managing General Partner of BEV Capital, a venture capital firm that he co-founded in March 1997. From 1986 to December 2002, he was a General Partner of Consumer Venture Partners, a venture capital firm and a former investor in our company. Mr. Kirchen also serves as a director of several privately held companies.

Brenda J. Lauderback was appointed to our Board of Directors in February 2004. Ms. Lauderback served as President of the Retail and Wholesale Group for the Nine West Group, Inc., a designer and marketer of women's footwear and accessories, from May 1995 until January 1998. Ms. Lauderback also serves as a director of Big Lots, Inc., Irwin Financial Corporation, Wolverine World Wide, Inc. and Denny’s Corporation.

Michael A. Peel has served as a member of our Board of Directors since February 2003. Mr. Peel has served as Senior Vice President, Human Resources and Corporate Services of General Mills, Inc., a manufacturer and marketer of packaged consumer foods, since 1991. From 1977 to 1991, Mr. Peel served in various capacities for PepsiCo, Inc., including as Senior Vice President, Human Resources for PepsiCo Worldwide Foods from 1987 to 1991.

Jean-Michel Valette has served as a member of our Board of Directors since October 1994. Mr. Valette is an independent adviser to branded consumer companies. In April 2005, Mr. Valette was named the Chairman (non-executive) of Robert Mondavi Winery and from October 2004 to April 2005 he served as President and Managing Director of Robert Mondavi Winery. Since January 2004 he has served as Chairman of the Board of Directors of Peet’s Coffee and Tea, Inc. From August 1998 to May 2000, Mr. Valette served as President and Chief Executive Officer of Franciscan Estates, Inc., a Napa Valley winery. He was a Managing Director of Hambrecht & Quist LLC, an investment banking firm, from October 1994 to August 1998 and served as a Senior Analyst at Hambrecht & Quist LLC from November 1992 to October 1994. Mr. Valette also serves as a director of The Boston Beer Company.

Christine M. Day was appointed to our Board of Directors in November 2004. From July 2004 until February 2007, Ms. Day served as President of Asia Pacific Group, Starbucks Coffee International. Prior to holding this position, she served as Senior Vice President, Starbucks Coffee International. From 1987 to 2003, Ms. Day served in various other capacities for Starbucks, including Senior Vice President, North American Finance and Administration; Senior Vice President, North American Strategic Business Systems; and Vice President of Sales and Operations for Starbucks foodservice and licensed concepts division.

Stephen L. Gulis, Jr., was appointed to our Board of Directors in July 2005. Since April 1996, Mr. Gulis has been the Executive Vice President, CFO and Treasurer of Wolverine World Wide, Inc. (WWW). From 1988 to 1996, Mr. Gulis served in various capacities with WWW, including CFO, Vice President of Finance, and Vice President Finance and Administration of the Hush Puppies Company. Prior to joining WWW, he served six years on the audit staff of Deloitte & Touche. Mr. Gulis also serves as a director for Independent Bank Corporation.

Ervin R. Shames has served as a member of our Board of Directors since April 1996. From April 1996 to April 1999, Mr. Shames served as Chairman of our Board of Directors. In May 2004, Mr. Shames also assumed the role of Lead Director under our Corporate Governance Principles. Since January 1995, Mr. Shames has served as an independent management consultant to consumer goods and services companies, advising on management and marketing strategy. Since 1996, he has been a Lecturer at the University of Virginia's Darden Graduate School of Business. From December 1993 to January 1995, he served as the Chief Executive Officer of Borden, Inc. and was President and Chief Operating Officer of Borden, Inc. from July 1993 until December 1993. From June 1990 to June 1992, he was the Chief Executive Officer of Stride Rite Corporation and from June 1992 to July 1993 he was Stride Rite's Chairman and Chief Executive Officer. From 1967 to 1989, Mr. Shames was employed by General Foods/Altria Companies in varying capacities including the presidencies of General Foods International, General Foods USA and Kraft USA. Mr. Shames serves as a director of Online Resources Corporation, Choice Hotels International, Inc. and several privately held companies.

COMPENSATION

Base Salary . Base salaries for our executive officers are reviewed annually, shortly after the end of each fiscal year. In order to enable the company to attract and retain executive officers who will enable us to build a significantly larger enterprise, the Committee seeks to benchmark base salaries at the median of the general industry survey data, as adjusted by regression analysis to account for company size.

In addition to the broad industry market data and comparisons with the peer group noted above, the Committee considers other factors in arriving at or adjusting each executive officer’s base salary, including: (1) each executive officer’s scope of responsibilities; (2) each executive officer’s qualifications, skills and experience; (3) internal pay equity among senior executives; and (4) individual job performance, including both impact on current financial results and contributions to building longer-term competitive advantage and shareholder value. Annual increases in base salary are primarily driven by the Committee’s evaluation of individual performance.

Annual Cash Incentive Compensation . We provide annual cash incentive compensation for executive officers and other employees under our Executive and Key Employee Incentive Plan (the “Annual Incentive Plan”). The Annual Incentive Plan is designed to drive company-wide performance for the relevant fiscal year at or above our stated long-term growth and profitability objectives. Consistent with the company’s performance-based compensation philosophy, the Board seeks to set its company-wide financial performance objectives so as to achieve above-median performance relative to the company’s peer group. The Committee then seeks to set annual cash incentive targets so that achievement of above-median performance will enable the executives to achieve above-median total cash compensation.

At the beginning of each fiscal year, the Committee determines the three principal elements of the Annual Incentive Plan for the coming fiscal year: (1) the performance goals; (2) the target bonus levels, expressed as a percentage of base salary; and (3) the split between company-wide performance goals and individual performance goals (if any). Actual bonus payments are increased above the target bonus levels for results that exceed the performance goals and are decreased below the target bonus levels, and may be reduced to zero, for results that do not fully meet the goals, with the amount of the increase or decrease based on a sliding scale determined by the Committee.

• Performance Goals . The Committee determines both the type and the amount of the performance goals for each year. The Annual Incentive Plan limits the types of performance goals to quarterly or annual sales growth or volume, net operating profit before tax, cash flows, earnings per share, return on capital employed, and/or return on assets.

In the several years immediately prior to the establishment of the Annual Incentive Plan in 2001, the company had experienced stagnating growth and operating losses. As a result, since the inception of the Annual Incentive Plan, the Committee has selected company-wide annual net operating profit as the primary performance goal based on its belief that this performance measure provides a balanced focus on both revenue growth and improved profitability. For 2005 and 2006, the Committee also added company-wide unit sales growth as a secondary performance goal. For 2007, the Committee has again established company-wide net operating profit as the primary performance goal and has established an extraordinary revenue growth target as a secondary performance goal (provided that a minimum level of net operating profit as a percentage of net sales is maintained).

As noted above, the amount of the performance goals, i.e., the amount of net operating profit required to be achieved for bonuses at the target level, is designed to reflect above-median performance relative to the company’s peer group. The Committee believes that the performance goals have generally met this standard as the targets have been exceeded in three of the last five fiscal years, and have not been met in two of the last five fiscal years, while the company has significantly outperformed its industry and delivered cumulative average growth rates in net sales and earnings per share of 24% and 45%, respectively, over the last five fiscal years.

In 2005, the company achieved both competitively superior net operating profit growth of 38%, and also achieved its secondary unit sales growth target, resulting in payments at 133% of the target bonus levels described above. In 2006, the company fell short of its profit growth objective (while still achieving growth in earnings per share on a like-for-like accounting basis of 23%), and did not achieve its unit growth objective, resulting in bonus payments at 83% of the target bonus levels.

In 2006, the Committee exercised its discretion and adjusted the performance target to account for two items that were not contemplated when the annual performance targets were first established at the beginning of the year. The Committee reduced the targeted net operating profit level by approximately $1.9 million to offset a correction in warranty accruals recognized in our 2006 consolidated results of operations to include freight costs which had not been included in prior periods and by approximately $0.4 million to offset incremental expenses arising from the special five-year stock option grant to the company’s Chairman and CEO discussed in greater detail below. The Committee did not adjust the performance target for approximately $6.0 million in asset impairment charges taken during the third and fourth quarter of 2006 related to the write-off of systems development work due to the decision to pursue an SAP-based information technology architecture and the difference between the fair value and net book value of certain impaired store assets, which resulted in the reduction of bonus payments from approximately 98% of targeted levels to 83% of targeted levels.

For 2007, the Committee has established net operating profit of $90.1 million, which represents growth of 20% versus 2006 (as adjusted for the two items noted in the preceding paragraph that reduced the 2006 target), as the performance benchmark for payment of bonuses at target levels, which the Committee believes would reflect above-median pay for above-median performance. Actual results above the net operating profit goal would result in a 3.5% increase in the bonus payment for each 1% increase in net operating profit. Actual results below the net operating profit goal would result in a 2.5% decrease in bonus payment for each 1% decrease in net operating profit. The steeper slope for above-target performance reflects the Committee’s objective of payment of above-median compensation for above-median performance. If the 2007 net operating profit is at or below $75.1 million, which would represent no growth versus 2006, no incentive compensation would be payable under the Annual Incentive Plan.

The 2007 Annual Incentive Plan design also provides for an additional 15% increase in the bonus payout if net sales meet or exceed the company’s stretch objective of $1 billion (which would represent 24% top-line growth versus 2006) and net operating profit is at least 10% of net sales (versus 9% of net sales for 2006). The Committee believes that this is an effective means of aligning the entire organization behind achievement of an important strategic milestone.

• Target Bonus Levels . The target bonus level for the CEO has been set at 75% of base salary for each year since 2002. The target bonus level for each of the other named executive officers has been set at 55% of base salary for each year since 2003. These target bonus levels were initially benchmarked against high growth companies of the same size and larger and these target bonus levels are reviewed annually against these benchmarks. As noted above, these target bonus levels, when combined with the performance goals established by the Committee are designed to deliver above-median total cash compensation for above-median performance relative to the company’s peer group.

• Split between Company-Wide Goals and Individual Goals . The Annual Incentive Plan specifies that, for senior executive officers, at least 75% of any award must be based on objective company-wide performance goals and not more than 25% of any award may be based on objective individual performance goals. Since the inception of the Annual Incentive Plan, the Committee has based awards payable to senior executives entirely on objective company-wide performance goals. The Committee believes that this approach has properly focused the senior management team on delivery of common, company-wide objectives aligned with the interests of our shareholders. The Committee has elected to recognize and reward strong individual performance through merit increases in base salary and through enhanced equity awards, rather than through establishment of individual goals under the Annual Incentive Plan.

In order to enable compensation paid under our Annual Incentive Plan to qualify for an exemption from limits on deductibility of compensation in excess of $1 million under Internal Revenue Code section 162(m) and related regulations, we have chosen to submit the material terms of the performance goals under the Annual Incentive Plan to our shareholders for approval every five years. Our shareholders initially approved the material terms of these performance goals in 2001 and approved them again in 2006.

Long-Term Equity-Based Incentive Compensation . We make long-term incentive compensation available to our executive officers, as well as to many of our other employees, in the form of stock options, restricted stock awards and performance stock awards. Through the grant of these equity incentives, we seek to align the long-term interests of our executives and other employees with the long-term interests of our shareholders by creating a strong and direct linkage between compensation and shareholder return. We further seek to enable executives and other key employees to achieve significant ownership in our company, thereby improving our ability to retain executives and other key employees. As we offer no pension or defined benefit retirement plan, long-term equity-based incentive grants are an important element in enabling our employees at all levels to build savings for retirement.

Executive officers and other employees are eligible for equity-based grants upon joining the company and thereafter on an annual basis. The annual long-term equity-based awards are typically granted in late February or early March of each year, following the completion of our annual audit and release of our earnings for the prior fiscal year, and coinciding with our annual performance review process and our first quarter Board meeting.

Historically, stock option grants have been the primary form of equity-based incentives granted to our executives and other key employees. In 2003, we began to grant restricted stock awards to certain executives and other key employees for retention and recognition purposes and to further align the interests of these employees with those of our shareholders. In 2005, we began to grant performance stock awards to executive officers, vice presidents and director-level employees, with the mix of annual awards for these employees targeted at 75% in the form of stock options and 25% in the form of performance stock awards. Key employees below the director level receive equity compensation grants exclusively in the form of restricted stock. With the adoption of stock option expensing in 2006, we believe the increased use of restricted stock and performance stock provides an effective means of delivering variable, performance-based equity compensation to our employees.

Restricted stock awards represent full share grants that become fully vested and owned by the employee free of restrictions only at the end of four years from the date of grant, provided the employee continues in service with the company.

Performance stock awards are essentially similar to restricted stock awards, with the number of shares that may ultimately vest to the employee determined on the basis of the company’s performance against net operating profit targets in the year of grant. The number of shares may be increased by up to 50% or decreased by up to 75% for above or below-plan performance in the year of grant. The table below sets forth the award multipliers for each level of performance against our net operating profit goals. The performance bands set forth below have been tightened from the performance bands used in 2005 and 2006, during which no adjustments resulted for performance between 90% and 110% of the net operating profit target.

MANAGEMENT DISCUSSION FROM LATEST 10K

Business Overview



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



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



Vision and Strategy



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



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







Building brand awareness and increasing store traffic through effective marketing programs;







Prudently managing our business in the current economic environment through disciplined controls over costs and cash;







Expanding distribution, primarily through our company-owned stores, with a long-term goal of operating over 600 company-owned stores in the U.S.;







Accelerating product innovation to lead the industry in innovative sleep products; and







Leveraging our infrastructure in order to facilitate long-term profitable growth.

Results of Operations



Fiscal 2007 Summary



Financial highlights for the fiscal year ended December 29, 2007 were as follows:









Net income totaled $27.6 million, or $0.57 per diluted share, compared with $47.2 million or $0.85 per diluted share in 2006.









Net sales decreased 1% to $799.2 million, compared with $806.0 million for the prior year, primarily due to an 11% comparable-store sales decline in our company-owned retail stores, partially offset by 36 net new company-owned retail stores opened in the past 12 months.









Our 2007 gross profit rate of 60.9% was consistent with the prior year. Increased manufacturing costs to comply with the new fire retardant product regulations and increased material costs for our new bed line, were offset by continued efficiency gains in manufacturing and logistics.









Sales and marketing expenses increased to 46.6% of net sales in 2007, compared with 42.4% of net sales for the prior year. The rate increase was driven by the deleveraging impact of an 11% comparable-store sales decrease.









General and administrative expenses declined $1.0 million compared with the prior year and remained consistent as a percentage of net sales.









Cash provided by operating activities in 2007 totaled $44.0 million, compared with $59.4 million for the prior year.









During 2007, we repurchased $131.9 million or 7.6 million shares of common stock (based on trade dates) compared with $79.7 million or 3.9 million shares in 2006.



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 earnings per share amounts. Amounts may not add due to rounding differences.

Comparison of 2007 and 2006



Net Sales



Net sales in 2007 decreased 1% to $799.2 million, compared with $806.0 million in 2006. The sales decrease was due to an 11% comparable-store sales decline in our company-owned retail stores and a decrease in direct channel sales, partially offset by sales from 36 net new company-owned retail stores opened in the past 12 months and sales growth in our E-Commerce and wholesale distribution channels. Total sales of mattress units decreased 1% compared to 2006, and the average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels was essentially flat at $1,694, while sales of other product and services increased by 2%.



The $6.8 million net sales decrease compared with 2006 was comprised of the following: (i) a $12.2 million decrease in direct marketing sales and (ii) an $11.6 million net decrease in sales from our company-owned retail stores, comprised of a $66.3 million decrease from comparable-stores and a $54.7 million increase from new stores, net of stores closed, partially offset by, (iii) a $9.0 million increase in E-Commerce sales and (iv) an $8.0 million increase in wholesale sales.

Gross Profit



The gross profit rate of 60.9% in 2007 was consistent with the prior year. The gross profit rate benefited from improvements in sourcing, manufacturing productivity and our ongoing implementation of a hub-and-spoke logistics network which reduced our cost of sales. The gross profit rate also benefited from a reduction in warranty costs per unit.



These items were offset by increased costs to comply with the new open flame fire retardancy standards which became effective for all products manufactured after July 1, 2007 and increased production costs associated with our new line of beds. In addition, the gross profit rate was negatively impacted by a sales mix shift to lower margin products which reduced the gross profit rate by approximately 0.4 percentage points (“ppt”).



Sales and Marketing Expenses



Sales and marketing expenses in 2007 increased to $372.5 million, or 46.6% of net sales, compared with $341.6 million, or 42.4% of net sales in 2006. The $30.9 million expense increase was primarily due to operating costs associated with 36 net new stores opened in the past 12 months, an increased use of promotional financing offers and increased media spending. The 4.2 ppt sales and marketing expense rate increase was primarily due to the deleveraging impact of an 11% comparable-store sales decline and the $30.9 million expense increase compared with the prior year. Total media spending increased 4% compared with 2006 and was 0.7 ppt higher on a rate basis.



General and Administrative Expenses



General and administrative (“G&A”) expenses decreased $1.0 million to $64.4 million in 2007, compared with $65.4 million in 2006, and remained consistent with the prior year on a rate basis. G&A expenses were favorably impacted by a $3.7 million reduction in incentive-based compensation costs compared to the prior year, partially offset by an increase in other expenses of $2.7 million, including increased information technology expenses and occupancy costs.



Research and Development



Research and development (“R&D”) expenses increased to $5.7 million in 2007 compared with $4.7 million in 2006, and increased as a percentage of net sales to 0.7% from 0.6%. The dollar and percentage of net sales increases in R&D expenses were the result of continued investment in new product innovation and increased development costs to comply with the new open flame fire retardancy standards.



Asset Impairment Charges



Asset impairment charges decreased to $0.4 million in 2007, compared with $6.0 million in 2006. The 2007 asset impairment charges primarily related to assets at underperforming stores. The 2006 asset impairment charges included $5.4 million for abandoned software in connection with our decision to implement a new SAP® enterprise resource planning system, and $0.6 million related to assets at underperforming stores.



Other (Expense) Income, Net



Other expense was flat in 2007, compared with $3.0 million of other income in 2006. The $3.0 million decrease was driven by lower average cash and investment balances compared with 2006 which resulted in reduced interest income, increased interest expense from borrowings under our revolving line of credit to fund 2007 common stock repurchases and $0.3 million of net realized losses on the sales of marketable debt securities.



Income Tax Expense



Income tax expense decreased to $15.8 million in 2007, compared with $28.6 million in 2006. The effective tax rate was 36.5% and 37.8% in 2007 and 2006, respectively. The lower effective tax rate in 2007 was primarily due to research and development income tax credits recognized in 2007 based on federal tax law changes, and increased tax benefit related to manufacturing deductions.

MANAGEMENT DISCUSSION FOR LATEST QUARTER
Comparison of Three Months Ended September 29, 2007 with Three Months Ended September 30, 2006



Net sales

Net sales increased 3% to $213.1 million for the three months ended September 29, 2007 compared with $207.7 million for the same period one year ago. The sales increase was driven by sales from 46 net new company-owned retail stores opened in the past 12 months and sales growth in our e-commerce channel, partially offset by a 6% comparable-store sales decline in our company-owned retail stores, and a sales decrease in our direct channel. Sales of mattress units increased 1% overall compared to the same period one year ago, and the average selling price per bed (mattress sales only divided by mattress units) in our company-controlled channels increased 1% to $1,726, while sales of other products and services increased by 8%.



The $5.4 million net sales increase compared with the same period one year ago was comprised of the following: (i) a $5.0 million increase in sales from our retail stores, comprised of a $14.9 million increase from new stores, net of stores closed and a $9.9 million decrease from comparable-stores and (ii) a $3.3 million increase in e-commerce sales, partially offset by, (iii) a $2.8 million decrease in direct marketing sales and (iv) a $0.1 million decrease in wholesale sales.



Gross profit

The gross profit rate decreased to 61.6% of net sales for the three months ended September 29, 2007 as compared with 62.0% for the same period one year ago. A sales mix shift to lower margin products reduced the gross profit rate by approximately 0.4 percentage points (ppt). In addition, the third quarter of fiscal 2007 gross profit percentage included the full burden of costs for compliance with the new open flame fire retardancy standards and increased production costs associated with our new line of beds. These incremental costs were partially offset by improvements in sourcing, manufacturing productivity and our ongoing implementation of a hub-and-spoke logistics network. Finally, increased use of promotional financing offers (which increased sales and marketing expenses) in lieu of product discounts, benefited the third quarter gross profit rate by 0.2 ppt.



Sales and marketing expenses

Sales and marketing expenses for the three months ended September 29, 2007 increased 9% to $95.7 million, or 44.9% of net sales, compared with $87.7 million, or 42.2% of net sales, for the same period one year ago. The $8.0 million increase was primarily due to a higher number of stores and an increased use of promotional financing offers. The 2.7 ppt sales and marketing expense rate increase was principally due to the deleveraging impact of a 6% comparable store sales decline and the $8.0 million expense increase compared with the same period one year ago. Total media spending decreased 3% compared with the same period one year ago and was 0.7 ppt lower on a rate basis.



General and administrative expenses

General and administrative (G&A) expenses decreased 8% to $14.9 million for the three months ended September 29, 2007 compared with $16.1 million for the same period one year ago and decreased 0.8 ppt on a rate basis. The $1.3 million decrease in G&A expenses was comprised of a $1.9 million reduction in incentive-based compensation costs, partially offset by a $0.4 million increase in occupancy costs and a $0.2 million increase in other G&A expenses.



Research and development expenses

Research and development (R&D) expenses increased to $1.3 million for the third quarter of fiscal 2007 compared with $1.1 million for the same period one year ago, and increased as a percentage of net sales to 0.6% from 0.5% for the comparable prior-year period. The increase in R&D expenses was the result of continued investment in new product innovation.

Asset impairment charges

Asset impairment charges decreased to $0.2 million for the three months ended September 29, 2007, compared with $1.8 million for the same period one year ago. The fiscal 2007 third quarter asset impairment charges related to assets at two underperforming stores. The fiscal 2006 third quarter asset impairment charges included $1.2 million for abandoned software and $0.5 million related to assets at underperforming stores.



Interest (expense) income, net

Net interest expense was $0.3 million for the three months ended September 29, 2007 compared to net interest income of $0.6 million for the same period one year ago. The change was primarily due to interest expense from borrowings under our revolving line of credit to fund fiscal 2007 common stock repurchases and lower average cash and investment balances compared with the same period one year ago.



Income tax expense

Income tax expense decreased to $7.0 million for the three months ended September 29, 2007 compared with $8.6 million for the same period one year ago. The effective tax rate was 37.0% for the third quarter of fiscal 2007 and 38.1% for the same period one year ago. The third quarter of fiscal 2007 tax rate included $0.2 million of discrete tax adjustments related to the resolution of certain federal and state income tax matters.

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