Sleep Number Corp (SNBR) 2005 Q2 法說會逐字稿

[OPERATOR INSTRUCTIONS] I'd like to turn the call over to our host, Mr. Mark Kimball, SVP and General Counsel. Sir, you may begin.

Thank you. Good afternoon and welcome to the Select Comfort Corporation's second quarter 2005 earnings conference call. Thank you all for joining us.

I'm Mark Kimball, SVP and General Counsel, and with me on the call are our President and CEO, Bill McLaughlin, and our SVP and CFO Jim Raabe. In a moment, I'll turn the call over to Bill, who will provide some introductory remarks. Then Jim will provide a review of our financial results and more detail on the outlook for 2005. Bill will make a few concluding remarks before we open the call to your questions.

Please be advised that this telephone conference is being recorded and will be available by telephone replay and will also be archived on our website. Please refer to the details set forth in our press release to access the replay on our website.

Before we begin, we would like to note that in recent quarters we have experienced some attempts by individuals to obtain information from our sales professionals in the field, at times under false pretenses. We regularly advise our sales professionals to be careful not to disclose any financial or other confidential information. We would appreciate your restraint from seeking information from our personnel in the field so as not to create any distractions or to place them in a difficult position.

The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary includes, and our responses to your questions may include, certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings release and discussed in some detail in our annual report on Form 10-K and other periodic filings with the SEC. The company's actual future results may vary materially.

In addition, our commentary and our responses to your questions may include references to certain non-GAAP financial measures in order to provide the most meaningful information and to improve comparability between periods. Information required to be disclosed about these non-GAAP measures, including a reconciliation to the most comparable GAAP measure, is available through our period filings with the SEC and is accessible through the investor relations section of our website at selectcomfort.com.

I will now turn the call over to Bill for his comments.

Thanks, Mark, and good afternoon and thank you for joining us. Earlier today we announced our second quarter results. I'm pleased to report that we had a strong quarter and that we are making good progress on our key initiatives for continuing long-term, profitable growth.

In the quarter, sales increased 24% and earnings per share 43%, both above the growth rates that we strive to consistently deliver long term. We remain optimistic about the programs we have planned for the balance of the year and have raised our guidance range for the year.

We knew going into the second quarter that it would be challenging versus prior year. Last year in the second quarter we increased advertising 48% versus prior year, breaking from our historic pattern of allocating marketing funds in line with seasonality. Our intent last year was to test smoothing brand-building efforts and to support the aggressive expansion of local market development. Last year in the second quarter we also launched a new high-end model, the 9000, which boosted average selling price a year ago. So the bar was set high a year ago, particularly on the top line.

By plan, this year in the second quarter we returned to our historic allocation of approximately 21% of the planned annual media budget in the second quarter, which meant our marketing spending was held flat to prior year. Promotional spending was also held in line with historic spending rates.

With that background and perspective, you can understand our enthusiasm to see same-store sales growth of 9% in units and 11% in revenue and total sales growth of 24% in the quarter. Our growth continues to be fueled by a great and unique product that consumers are discovering from their friends and through our advertising and our expanding distribution.

Jim will provide more details on our growth by channel. In my opinion, the key takeaways from the second quarter revenue growth include solid same-store unit growth on flat advertising support, reflecting brand strengthening and an outstanding effort by our sales team, which continues to develop and improve, differentiating themselves with consumers. Exciting progress developing outside our company-owned channels, particularly in retail partners. While our company stores and direct and e-commerce channels are 93% of our sales and critical elements to building our brand, consumer satisfaction and protection from competition, we believe that select partners can help us further advance our brand, our share and our convenience for our consumers.

In the third quarter, we will extend our successful 3-year relationship with Sleep Train in California to their Mattress Discounter chain of 50-plus stores, also in the California market.

Further, in the third quarter, we will initiate tests with 2 of the largest retail bedding chains -- Sleepy's on the East Coast and Mattress Firm in the South. Our initial pilots will be with 45 of each chain's stores and, if mutually successful, we could expand chain-wide to include over 500 stores in the future.

Our semi-exclusive commitment to these partners in their markets enables us to work together to build the Sleep Number brand, to satisfy customers and to maximize incremental growth opportunity and share by market. We've learned a lot over the past 3 years working with retail partners and we are looking forward to testing our program with 2 new and important partners in the coming months.

In addition to retail partners, our Radisson partnership also made significant progress in the quarter with high levels of guest and property satisfaction. Radisson initiated advertising featuring the Sleep Number bed in June in 15 markets.

The third key takeaway from this-- from our second quarter growth performance is the good news that we have room to improve. We are delivering solid growth nationally, yet a few of our larger markets were basically flat to prior year in sales. We believe the solution to reestablishing consistent growth in these markets will be to-- will take some time as we develop new marketing approaches and address specific market opportunities. Restoring growth to these markets is a priority and will add an additional source of upside potential.

We are also pleased with our progress on profitability in the quarter. We continue to realize our proven leverage in selling and G&A, though G&A has increased a bit versus prior year as we are anticipating higher levels of company-wide bonus this year than last. We've initiated actions that we believe will begin to stabilize and improve gross margins going forward.

At the end of the quarter, the last week of June, we increased the price of our home delivery service. We had tested-- we had test marketed this move for 2 months and the results nationally have matched our expectations. This move, from $99 to $149, better positions us to deal with rising fuel prices. In recent months our home delivery team has made outstanding progress in service levels and is providing a service, from in-home delivery and setup, to removal and disposal of the old mattress, that our values-- that our consumers value.

We continue to generate cash in addition to that required to fund our growth. While our first priority is the fund the business expansion, we do continue to take advantage of what we believe to be attractive opportunities to repurchase our stock. Over the last 18 months we have opportunistically repurchased more than 1.7 million shares for approximately $33 million, effectively reducing share count for earnings per share purposes while increasing our overall cash balances.

So it was a good quarter, one in which we made progress on the top line and the bottom line. In the quarter we also welcomed 3 new members of our senior management team, each of whom brings talents and experience that will help us continue to advance. We also recently added a board member, Steve Gulis, the CFO of Wolverine World Wide, and a proven financial expert with strong operating and growth experience. So the team is shaping up well for the next stage of our journey.

Before I elaborate on our future opportunities, let me ask Jim to discuss performance, opportunities and the outlook with you a bit more-- in a bit more detail.

Thank you, Bill. I'll review the income statement and provide some details of our second quarter performance, then I will discuss our balance sheet and conclude with a discussion of updated guidance for 2005.

As Bill noted, sales in the second quarter increased by more than 20% and earnings per share increased by more than 40% as compared to a year ago. We're extremely pleased that despite various hurdles over the past several quarters we've-- we have generated consistent sales growth, improved operating margins and continued generation of cash to support added value to our shareholders.

Our sources of sales growth are in line with our core strategy. Same-store sales growth increased by 11%. New stores added 4% to consolidated sales growth and new channels of distribution, including wholesale channels, retail partners and Radisson, grew by 88%.

Our same-store growth of 11% is a significant step forward. While slightly lower than recent quarters, the growth comes in a quarter when our media investment was flat to year-over-year. The growth demonstrates the appeal of our differentiated product and the strength of our business model where we interact directly with consumers.

We will begin increasing our media investment again in the third quarter, in line with consumer buying patterns.

Average sales per store open more than a year increased 12% from a year ago to $1,330,000.

We also continue to execute on our distribution expansion strategy. During the second quarter we opened 8 stores and closed 9 and ended the quarter with 369 stores, including 10 non-mall locations.

All of the store closures were lease departments in Bed, Bath & Beyond. We are now completely out of Bed, Bath & Beyond stores and we believe our second quarter performance affirms our belief that the termination of our partnership with Bed, Bath & Beyond had no material effect on our results.

New stores continued to perform above expectations and, on average, are generating nearly $1 million in the first year of sales.

Sales in our direct marketing and e-commerce sales channels have also performed well, with sales increases of 24% and 32%, respectively, in the second quarter.

Unit sales in company-owned channels increased by 14%, with average sales per mattress increasing by 5% to $1953 per unit. The increase stems mainly from price increases initiated at the beginning of 2005 and growth in accessories as accessory sales per bed increased by 21% in the quarter.

Channel growth and other key sales statistics are included in the supplemental attachment to our sales release.

The third component of our sales growth is new channels of distribution. Wholesale sales grew by 88% compared to a year ago and contributed 6 percentage points to the consolidated sales growth rate. Bed installations in Radisson hotels were the greatest contributor to sales in non-company-owned channels in the second quarter. Approximately 18% of Radisson beds are now Sleep Number beds and response among Radisson guests continues to be very favorable.

Our retail partner sales also continue to grow. We maintain significant share of sales within the partners that we sell through and, equally important, our company-operated stores continue to grow as we build awareness in these markets for the Sleep Number bed.

Sales through QVC, the third most significant wholesale channel, were somewhat disappointing in the second quarter. Longer term, we expect QVC-- QVC sales to be important, but not a significant source of growth.

We are also pleased with our progress in operating margin and feel we are positioned to continue improving. Our operating margins in the quarter increased to 7.9% compared to 7.3% in the second quarter last year, benefiting from the significant operating leverage in our selling and marketing expenses. Our operating margins were also consistent with the first quarter, a significant achievement considering the seasonally lower sales in the second quarter.

During the second quarter, gross margins came in at 57.9%, 380 basis points lower than a year ago. Consistent with the first quarter, the decline in gross margin is attributable to, first, the addition of Radisson to our sales mix, which counted for 150 basis points of the gross margin decrease; second, a mix shift owing to strong growth at our retail partners in a higher proportion of our more moderately priced bed models; and third, inflationary pressures, especially fuel costs.

Consistent with prior years, wholesale sales in the second quarter were a greater percentage of overall sales, nearly 10%. The higher percentage of these lower margin sales contributed to the sequential decline in gross margins. While we expect gross margins will improve over the balance of the year, we do anticipate continued cost pressure, particularly related to oil.

The gross margin decline was more than offset by continued leverage of marketing and selling expenses, which improved by 490 basis points to 41.4% of net sales in the second quarter of 2005. Leverage within our existing store base continues to be a significant contributor to margin improvement. In addition, we held media spending flat with a year ago. Media was in line with our plan at 12.5% of sales, which is also in line with our expectations for the balance of the year.

G&A expenses as a percentage of sales rose to 8.6% from 8.1% in 2004, owing to increases in incentive compensation. The nature of our company-wide bonus program adds volatility to G&A expenses on a quarterly basis. We expect G&A as a percentage of sales to approximate 8% of sales for fiscal 2005.

With sales increases and improvements in operating margins, we are also generating significant cash. Year-to-date cash from operations totaled $19.4 million. Net of capital expenditures, our free cash from operations totaled $8 million. At quarter end, cash and marketable securities totaled $93 million.

Looking at the balance sheet, we do feel we have opportunities to improve our working capital, particularly with inventory levels, which increased in the second quarter as we prepare for our largest QVC show of the year in August and for the addition of retail partners in the third quarter.

In addition to self funding our growth in 2005 as we did in 2004, we continue to evaluate uses of our cash to increase shareholder value. We have continued to opportunistically repurchase company stock. In the second quarter we purchased 245,000 shares for $5.5 million at an average share price of $22.35 per share. We plan to continue purchasing stock and currently have $5 million available for stock repurchase, an amount that we expect will increase during the third quarter under our formula-based, board-authorized program.

Now let's turn to our guidance. Before I discuss the specific outlook, I want to emphasize that it is not advisable to extrapolate any single quarter's performance into expectations for that year. As we have stated before, our business can be somewhat volatile on a quarter-to-quarter basis, which is logical, given that we sell a consumer durable with low purchase frequency and a make-to-order business model limiting forward insight. We set annual targets and budgets and run our business to achieve these annual goals.

Furthermore, bear in mind that we do not provide specific quarterly guidance, so it is not a given that when we beat consensus expectations we will raise our annual guidance. If business trends seem to warrant a change in our annual forecast and if we exceed our own expectations we will raise our guidance.

That being said, we are increasing our full-year 2005 earnings guidance by $0.02 to a range of $1.00 to $1.08 per share. Over the long term we expect to sustain sales growth rates of at least 15% to 20% with same-store growth between 7% to 12%, leveraging the business model with earnings growth rates of at least 20% to 25%.

In 2005 we expect that same-store sales growth could exceed the high end of our 7% to 12% target range and that total sales will exceed our 2005 target range of 18% to 20%. Our same-store growth expectations reflect primarily unit growth with a slowing rate of growth in average selling prices. As noted in our year-end release, the components of our sales growth targets are same-store growth of 7% to 12%, new distribution growth of 5% to 8% and growth from Radisson of 2% to 4%.

We are optimistic about our sales trends we have experienced early in the year and recognize that we will be lapping lower costs for the balance of the year. We are cautious, however, in projecting potential impact of energy cost volatility and the potential for a difficult consumer environment as interest rates rise and consumer confidence fluctuates.

In support of our sales growth, we plan to increase year-over-year media by more than 15% in the second half of the year. We also plan to aggressively expand distribution with 26 new stores planned for the balance of the year. In addition, as noted earlier, we will add 140 new retail partner doors in the third quarter with fourth quarter additions as yet undetermined.

The mix of wholesale and company-owned channel sales and possible additional fuel cost increases will continue to pressure gross margins. We are currently targeting gross margin of 58% or more for the remainder of the year. Selling and marketing will be the core source of margin improvement and we expect operating margins for the year to improve compared to 2004.

With that overview, I will turn the call back to Bill for his closing comments.

Thanks, Jim. Over the past years we have delivered a constant high level of profitable growth. There have been a few bumps in the road, but we've stuck to our plans and demonstrated our passion and persistence to satisfy our customers.

5 years ago, when our revenue was around $250 million and we were not yet profitable, we set our sights on $1 billion in revenue with more than 12% operating margin and we're confident that we have the product, strategies and team to reach that goal in the next 3 to 5 years. And then we'll set our sights even higher.

There remains a tremendous opportunity for us to further advance and differentiate our product and product line, to expand distribution and to further advantage our service and supply chain and to be a great place to work and build careers. Today our share is less than 6% of bed sales at retail nationally and our potential and goals is to be a leader in the industry, which will require at least doubling this share, which we have proven that we can achieve in some of our lead markets.

We have a leadership team comprised of Select Comfort veterans and impressive new additions that is energized and excited to take on the challenge. Our business model is as unique as our product. Our balance sheet is stronger than any of our competitors and we are able to self fund our expansion and to pursue opportunities as they are identified and to weather a storm, if need be.

Importantly, we control our distribution and consumer contact, allowing us to manage growth and respond to competitive threats. We are very focused on the long term opportunity of becoming a leader in the way that the world sleeps and we will get there by continuing to deliver strong and consistent growth, profitably.

We are looking forward to the second half of the year. Advertising is planned to return to 15% versus prior year. We plan to add over 25 new stores in the second half of the year, our most aggressive expansion in over 5 years. We'll pilot distribution with several more important high-potential retail partners, as discussed previously, with Sleepy's and Mattress Firm. And our new leaders of marketing, operations and new business will be setting their agendas for the next several years.

Before we sign off and get back to work, Lisa (ph), we can take a few questions. Please limit your questions to one or two in order to give equal opportunity to everyone on the call. There will likely be time for a second round of questions if you have more questions.

Thank you for your cooperation and, Lisa, we'll now open the lines for questions.

Thank you, sir. [OPERATOR INSTRUCTIONS] Bob Evans, Craig-Hallum Capital.

Congratulations on a nice quarter. Can you comment on your new retail partners. You said it was 45 stores per partner, is that correct? 145 all in?

Well, it's 45 each for Sleepy's and Mattress Firm and it's a little over 50 for Mattress Discounters.

OK. And how should we view that in terms of revenue targets for retail partners? What's the right range to think about?

I think in the long term, Bob, we believe that retail partners can be 10% to 20% of our-- of our revenue base. In the short term, we've got the whole startup-- startup curve to go through with all 3 of these new partners.

And, again, what I would add, Bob, is they do start-- they'll start immediately at the beginning of the quarter, so there is a bit of a phase-in, as Bill mentioned. I think the other factor to consider is when we set our guidance early in the year, we did anticipate that there would be-- there would be growth of retail partner doors during the course of the year. So this is not incremental to what our initial-- or what our full-year plans were.

OK. Fair enough. And one other question. On the Radisson, how far along are you in your shipment process to where your plan is for this year? And when is that-- when is that revenue recognized when shipped to Radisson, just to be clear?

The second-- the answer to the second question is the revenue is recognized when the beds are shipped to Radisson.

Is it-- but that's not necessarily when they're actually in-- I mean, are they shipped and then immediately put in by Radisson, or Radisson may have them in their inventory and then ultimately they get put in by them? I'm just wondering if there's a lag effect, is my--

There really isn't-- I mean, there's an in-transit lag, but it's nominal. I mean, it's days until they get into the Radisson. We are at about 18% of the total-- total beds that Radisson has at this point.

OK. And when would you expect to be fully implemented?

Well, the roll out is-- Radisson has up to 2-plus years to kind of meet their longer-term targets. There are annual numbers, annual targets, but they're on track to them.

OK. I'm just wondering what they are relative to the annual target if you can-- is that something you could share, how far along to this year's annual target?

That isn't a number that we have-- that we have spoken to.

Greg McKinley, Dougherty and Company.

Can you guys give us a little commentary on what you're seeing in the promotional environment for the products? What, if any, changes Select made during the quarter to drive business volume from, I guess, maybe a product discount or a financing standpoint? And then, I guess, my second question would be, could you guys give us a little color on, obviously, there's a lot of noise in the market about competing products hitting the channel from Simmons with the trade show in Vegas this week? How, if at all, might that end up competing in some of the retail partners that you're targeting?

Why don't I take a shot at that, Greg, and then Jim can jump in.

On the first question, the promotional environment, we have not done anything significantly different between our normal price discounts and financing other than, as we mentioned at the beginning of the year, that we were going to focus on more holiday periods, which we did in the past quarter. For example, we had a Father's Day event which we had not done as significantly in the past.

But we're just taking the same number of dollars that we would have spent on promotion and financing and spreading them a little differently, trying to really take advantage of the holidays and particularly those that are more gift-giving type opportunities as people are demonstrating interest in that with a Sleep Number bed.

In terms of the competition, Select Comfort has always been confident with direct competition. It actually brings increased awareness and credibility to our segment and as the leader of the segment, we felt-- we feel like we have benefited from that in the past.

Your question, I believe, dealt with retail partner reaction to Simmons and I think it's pretty clear that leading bed retailers continue to be attracted by our product and our program. They see the key advantages being a proven product with refined quality, a brand that is requested by customers and an organization that is both experienced and dedicated to that technology.

So we haven't seen the product yet from Simmons and Boyd. We do understand that it is being contract manufactured for Simmons by Boyd, which will, we believe, limit some of the flexibility that Simmons would have in both pricing and ability to support the product.

OK.

And this is the first time that Simmons will be using their dedicated sales force with that product. I'm not sure how that fits with their other priorities, but we'll watch that.

OK. So just-- just to restate it, your comment on the promotional environment, Bill, is more that it's a channel-shift issue rather than maybe lower margins at the product level in your retail channel? Is that what caused sort of the year-over-year change here? It's a greater emphasis on wholesale rather than a lowering of product margins in your retail channel?

It's-- well, Greg, this is Jim and it is certainly not promotional. As Bill said, we haven't made any promotional changes. What we saw in the gross margin shift from Q1 to Q2 I wouldn't even necessarily say it was a change in focus from a channel standpoint. It was, as much as anything, related to the fact that from a seasonality standpoint consumer buying of mattresses is at its lowest point in the second quarter.

This is pretty typical for us and, as a result, we just have a higher percentage of our sales that are in those lower margin mattresses such as-- with Radisson, in particular, and QVC and those types of things. It just makes them a bigger piece, which drives the margins. And, as we said, we do anticipate that we'll see improvement in the margins going forward because-- for those same reasons.

Steve Denault, Northland Securities.

It feels sort of like directionally the-- in terms of '05 guidance, revenue guidance remains somewhat unchanged from last-- last time we spoke. Where-- where is the change and what enables you to feel better about upping the EPS guidance? Any change in assumptions there?

There isn't-- the main change is the performance in the second quarter. I think we continue to feel confident, not only in the performance that we had but the outlook that we see for the balance of the year. They're certainly-- we're certainly still dealing with all of the uncertainties that we did at the beginning of the year with kind of the consumer environment, but I think that what we've demonstrated in the first 2 quarters is the performance has been good first quarter, when we were lapping very difficult comps, second quarter when we really readjusted our media spend. And now, going forward, we'll-- we'll go back to a more normal pattern.

So I think being successful in the first couple of quarters with those hurdles gives us the confidence going forward as we get more on our normal path.

Have you guys had any new learnings on the media perspective as you've kind of reined in the local media campaign?

I'd say it's-- well, first of all, we really haven't reined it in. We're actually spending the same amount as we did last year. It's just on a percent of sales basis we just brought it back from the levels that it was a year ago. And so we're still spending the money on both a national level and at a local level and getting good results out of both.

It's too early right now with Doug Collier being new, our new SVP of marketing. We've got everything under evaluation, as you'd expect with a new person arriving, and it is too early to get any read on that.

How about the Minneapolis market? Is it back to sort of the national average from a comp perspective?

Well, as we said on the call, I think that we have some points in our larger markets yet. I think we feel like we're making good progress, but I think there is real opportunity in those markets to see improvement going forward.

[inaudible]

I just wanted to follow up on that. In your prepared remarks you did say that there were some markets where you did not see growth. I take it that Minneapolis is one of those. Can you talk a little bit more about what some of those markets might be? Are they relatively mature markets or are they some of your-- your newer markets, specifically New York and Los Angeles?

We will-- they are-- they tend to be a little bit more on the mature side, but it's a really limited number of markets. We have more mature markets that continue to grow very strongly and then we have others that are not performing as well and we're looking at those markets. But I wouldn't necessarily kind of attribute it to any particular pattern, because some of our larger markets continue to be our strongest growth markets.

But the markets that aren't growing tend to be more mature, is that correct?

I'd say generally, but not in all cases.

Joan Storms, Wedbush Morgan.

With regards to the Radisson contract, if they started advertising in June in 15 markets, any feedback on that? And how will that expand, going forward?

Joan, the advertising in the 15 markets was how they had planned it and I don't-- I'm not familiar enough with how those markets were selected. The interesting thing with hospitality advertising is you really-- it's hard to track because the people that are hearing the advertising are then traveling. And so we don't really know where the stays are and then we also don't know where-- how that all tracks back to the purchases.

So there-- it will not-- my understanding is, it will not be expanding beyond what they had planned. They had a fixed amount planned for the year and they are on track to execute that and in those 15 markets.

Is the advertising driving unit orders from the franchisees?

I mean, the franchisees-- Well, first of all, let me clarify one thing is that the advertising being done by Radisson is being paid for by Radisson. So it is their plans. They could-- they could continue it, stop it, accelerate it. It's their call. But right now it looks like it's all per plan.

The franchisees' order pattern is really driven by a lot of different things. The-- how recently they bought new beds, what some of their other remodel plans are and so the order pattern is just flowing against that.

OK. And then did you-- and I think I missed this on the call. How far are you through in the-- I know someone asked it, with the Radisson contract, to say, like, the 90,000 beds, whatever it is.

We are-- there are-- 18% of Radisson beds are now Sleep Number beds.

OK, great. And then, Jim, on the-- on the wholesale, if you're going to take the whole portion of the business up a total, between the partners and Radisson, et cetera, of about 88%, should we be looking for a similar kind of increase over the next couple of quarters?

I guess what I would say is I think that-- over the last couple of quarters we have run Radisson-- excuse me, Radisson wholesale, retail partners, all of those types of things, have generally been running in that 5% to 6% of business, of our total business. It's probably going to start running more consistently in that 9% to 10% range.

David Lee (ph), Porter (ph).

Congratulations on the quarter. Two questions. First, can you just repeat spending on advertising and the other media? Second, you closed 9 stores. That's the most you have closed since 2002. Can you just give me-- give some sort of rationale behind it? And that's it.

Basically the media spending in the second quarter was basically flat to prior year at about $19 million and we did close more stores, David (ph), in the quarter, but the bulk of that was because of the closure of Bed, Bath & Beyond, as we had previously announced. And we are now completely out of the Bed, Bath & Beyond stores.

Oh, OK. So what's the other media spending?

The media spend will be up about 15% on a year-over-year basis for the balance of the year.

Michael Cox, Piper Jaffray.

Thanks a lot for taking my questions and congratulations on the quarter. My first question is on the comments you made regarding the Sleepy's and Mattress Firm and the new wholesale partners. Could you give an explanation of the semi-exclusive arrangement and then touch on the different products or the SKUs that you plan to introduce to those channels?

Michael, when I mentioned semi-exclusive, what we generally do is try to select a partner per market per segment of bed distribution. So, for example, in a market we might have a specialty bedding retailer and a furniture store, as well as our stores, but we wouldn't go to multiple of--multiple furniture stores or multiple specialty sleep stores. So that's what the semi-exclusive means.

And the reason for that is we believe that that allows us to work most effectively to build the brand in a way that is incremental in a market and we're pretty selective in the partners and the agreements that we have with those partners in choosing that.

In terms of the models that we will be working with, it's basically the same product line as we've been working with our retail partners and that line is called the Personal Preference One, Two, Three, Four, Five and all of these partners-- Well, the Sleepy's and the Mattress Firm will tend to be at the higher end of those product lines. The Mattress Discounter in California is a bit at the lower end of that line because their-- their other chain, their Sleep Train, who is our partner, focuses on the higher end.

OK and just out of curiosity is that 2 to 3 SKUs per store is what you look for on that?

Yes. 2 to 3 SKUs per store.

OK. Then one final followup here on the-- on the fuel cost pressure on the gross margin, last quarter you quantified that. Is there any way you could quantify that here in this quarter?

Not at this time. It was-- it has fluctuated kind of over the course of the quarter and it flows through at a number of different points, but I don't have a specific number.

Mark Rupe, Adams Harkness.

Just a quick question. Any chance there's any correlation between the flat media spend in the quarter and the flat growth in some of the-- some more of your mature markets?

This is Bill. I wouldn't say that at this point. I think we've still got an awful lot of work going on with good work going with Consumer Insight trying to really understand the consumer trends in these markets. I think it's as much a function of an opportunity to talk to consumers in a different-- in a different way in those markets.

OK. And then real fast, lastly, on the Sleepy's test, is that different-- I mean, obviously, they have a huge presence in New York City and I'm just curious to see if that's kind of a change in strategy for your New York City plan as it relates to Sleep Train being not as big in San Francisco?

No, I don't think, Mark, it would be a change in strategy, because I think we feel-- in all of our markets we feel that our-- that our own stores will be a significant contributor. We have said we look for the dominant retailer for the mattresses within the various markets and certainly Sleepy's fits that category on the East Coast. So they're kind of the natural fit from that standpoint.

Laura Richardson, BB&T.

I was wondering if you could give a little more color, guys, on the ad spending. Is it-- is there going to be any difference in that 15% growth rate between Q3 and Q4 and how-- how you're planning to spread out that increase by media? And especially with the-- with the wholesale partnerships if there's any co-op advertising responsibility from you that is included in there? Thanks.

The ad spending is up at least 15% in both of the quarters going forward, so I don't think there's any significant in the spread of that, Laura. In terms of the mix, it will-- as we shared at the beginning of this year, our emphasis is a bit more on national and so that's where most of that growth will come. We'll still have the same levels of local spending, more or less, that we had a year ago, but the incremental will be more on national advertising.

Oh and the third part of the question was on co-op. I am just no familiar enough on either of the contracts, but generally we are moving away from a co-op requirement. If we choose to spend more in a market, we'll spend it.

OK. So like the Healthy Back Store, when they're including you in their newspaper ads, they're paying for that?

Yes.

Well, that doesn't hurt. And then I forgot to ask. Because Jim said something in his prepared remarks that sounded like there is some flexibility in the ad budget should you want to go after more sales or, I guess, need to cut back on the spending for any reason. Is there that kind of flexibility?

I wouldn't say that there's anything really built into the plan. We have been spending to our plan. The amounts that we're planning on spending are consistent with what we had planned from the beginning of the year. I think we always have a-- we have always demonstrated kind of a long-term view and when we outperform our sales, we will consider expanding the media spend. If we don't feel that the media is being effective, we will consider pulling back to a certain extent. But I wouldn't say anything beyond that.

OK. And I just thought of one other thing on media, too. Should cost and availability be better second half of this year than they were last year?

You mean media rates?

Yes.

Could be, but as we said last year, Laura, we have the ability to move between different media types pretty well with our direct model and so I don't believe we're factoring in any major change in the efficiency of that spend.

I think if you would-- with the elections last year, there was a very short period of time where we kind of moved dollars out of that spot, but I wouldn't say rates, as a whole, are that significantly different.

OK. But-- well, there may be more availability, then, just not competing with all the political advertising?

And that's one of the reasons-- that's one of the reasons why we feel that we can spend more at the national level effectively in the balance of this year is that those rates do look attractive.

At this time we do have time for one more question. Greg McKinley, Dougherty & Company.

As a quick followup, Jim, could you just-- you commented on media being up 15% in the second half, is it fair to say your view would be that that is the case on a quarterly basis or are you talking just about a 6-month period?

It will be up more than 15% in both the third quarter and the fourth quarter.

OK. And then your comments around gross margin in the second half. I missed those. I'm sorry.

What we'd-- what we indicated was that we expect the margins to be at least 58% and maybe more in the second half.

OK.

We see improvement over what we saw in Q2.

At this time we'll conclude our second quarter conference call. We thank you all very much for joining us and we look forward to bringing you the next update in September. Thank you.

Thank you. This concludes today's teleconference. You may disconnect at this time and thank you for your participation.