Sleep Number Corp (SNBR) 2005 Q3 法說會逐字稿

Welcome to today's Select Comfort third quarter 2005 earnings conference call. (Operator Instructions) I'd like to introduce today's host, Mr. Mark Kimball. Sir, you may begin

Thank you. Good afternoon and welcome to the Select Comfort Corporation third quarter 2005 earnings conference call. Thank you all for joining us. I'm Mark Kimball, Senior Vice President and General Counsel. And with me on the call are our chairman and CEO, Bill McLaughlin, and our senior vice president and chief financial officer, 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 results and more detail on the outlook for the remainder of 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 Web site. Please refer to the details set forth in our press release to access the replay on our Web site. 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. I will now turn the call over to Bill for his comments.

Thanks, Mark, and good afternoon. Thank you for joining us. Earlier today we announced record results for the third quarter with sales and earnings growth rates above our long-term targets. Earnings per share climbed 50% versus year ago on a sales increase of 22%. On a year-to-date basis, sales are up 23%, profits are up 32% and earnings per share have increased 36%. Congratulations to the Select Comfort team for a great quarter and another strong year in the making.

The third quarter has always been an important time at Select Comfort. Not only is it the bedding industry's traditional peak seasonality quarter, but also, in 2001 the third quarter marked the beginning of our profitable growth. Today we celebrate 17 straight quarters of profitable growth, with three-year compounded annual average growth rates of 23% in sales and 32% in profits. What we've accomplished has come amidst a variety of challenges, some external, such as competitive entries and more recent consumer and economic concerns, and some internal, as we've met the challenge of our own growth, reaching a 12-month run rate of more than $650 million in revenues.

Throughout this history, we've stayed focused on helping customers discover our unique product and service experience and on building a great company for excellence over the long term. More on the long term later. Let's first review the third quarter. And on today's call, I'd like to highlight four points. First, is continued strong sales trends building the right way for sustainable long-term growth. Second, accelerating profit growth with margin improvement leveraging the benefits of our unique direct-to-customer business model. Third, achieving strong quarterly results while we continue to invest for the long term in innovation and system and people development. And fourth, taking advantage of our strong financial position to capitalize on opportunities.

We are building our sales the right way to sustain long-term growth. We are investing in our brand and in customer satisfaction. We are adding new stores and we are growing same store sales via more units and more satisfied customers. We have introduced new products and also selectively expanded distribution outside our company-owned stores, to increase consumer awareness in several markets well served by our retail partners.

Our key indicators in the quarter were strong and well balanced. Revenue up 22%. Same-store sales up 15% and same-store unit growth up 11%. Media up 11%, while promotion spending as a percent of sales was down 1.2 percentage points versus last year. And we've continued our disciplined distribution expansion.

Average sales per store is up 12% to $1.375 million. Net, we've added 19 stores in the quarter. We added an additional 143 doors of leading retail partners to complement our store base and our same-store growth in partner markets open for more than one year, which equaled our national average. Our relationship with QVC remains strong with a record show in the quarter. And the Radisson rollout continues on track with 27% penetration of the chain's beds and positive feedback from guests, Radisson operators and customers visiting our stores.

A few noteworthy highlights in the quarter include a month dedicated to the Ronald McDonald House Charity in which customers and employees generated a $0.5 million in cash and product donations for the charity, a record Labor Day week and a single-store record for a single day's sale set in Minneapolis and then broken in Denver. In summary, another strong quarter of sales growth by virtually every measure, and we've moved up to near 6% market share of the U.S. mattress industry revenue. And based on our demonstrated success in several key markets, we believe we can double our market share at a national level over the next five to seven years.

While revenue growth and improving more customers' lives through better sleep is our top priority and central to our purpose, we also are extremely proud of our continued progress on margin increase and productivity improvements. We're not going to share program details for competitive reasons. But, again, the key indicators are positive and the opportunities of our integrated business model are clear.

In the third quarter company-owned gross margin increased 0.7% versus a year ago and increased 0.9% versus the second quarter. We are working to improve manufacturing line speed and to reduce waste. We are leveraging our growth by working with suppliers to improve our quality and to lower costs, and we are working to improve route efficiencies with our home delivery and systems teams. These are all basic continuous improvement activities with opportunities normal to a young and developing growth company. We are also evaluation more significant reengineering opportunities, which would have more significant improvement.

Marketing and sales also improved 2.8% in the quarter versus prior year. Our sales team has leveraged same-store sales growth and overall revenue growth to generate efficiency each of the past four years. And this continued in the third quarter, gaining 1.1% of leverage year on year. And our marketing team set a goal this year to be more efficient, focusing on refining the effectiveness of our spending. In the quarter, we saw a continued increase in brand awareness with media up 11% and same-store growth up 15% versus prior year.

The quarter also demonstrated our pricing flexibility as we raised the price of our home delivery service at the beginning of the quarter to offset rising fuel costs, and we experienced no adverse long-term impact on utilization of our service. So our productivity and efficiency programs are gaining traction, which is important for dealing with the cost increases confronting our industry and for providing incremental margin to fuel future growth and for strengthening our competitive advantage.

While achieving strong quarterly sales and profit results, we also continued to invest for long-term innovation and growth. We've consistently demonstrated our commitment to the long term, investing in new markets, investing in new selling tools, investing in new systems and investing in people development.

In the third quarter, we completed a $4 million investment in pressure mapping technology for all our stores to be used as a sales tool. We're building capability for retail partner expansion and for preparing international entry. System and people development continues both to manage expansion and to provide scale for further growth. Our community support continued both with the Ronald McDonald House and several hurricane relief initiatives with contributions of beds and pillows, cash and matching gifts and the time and travel of our employees. In the third quarter, we continued to invest in our long-term development, and this is an area that we are likely to discuss with you more in the future as we ready plans for new expansion.

Finally, our financial position is strong and growing stronger. The third quarter offered an opportunity to buy back a significant number of shares. We started the year with almost $92 million in cash and investments and zero debt. After funding an estimated $30 million in CapEx we expect to generate positive free cash flow of approximately $40 million through year end.

While our primary focus is on growth and expansion, with soft valuation of our stock in the quarter, we opportunistically moved to repurchase another 1.7 million shares this quarter, bringing our repurchase program to 2.3 million shares this year, representing approximately 6% of the outstanding stock at year-end 2004. Our cash and investment balance at the end of the quarter totaled $88 million and Select Comfort remains debt-free.

In summary, we celebrate the success of another strong quarter for Select Comfort and we continue to reinvest that ensure the future strength for our shareholders. We are mindful of economic pressures and underlying consumer confidence which are considered in our guidance. To be clear, we are more confident than ever in our product, our advantage direct-to-consumer business model and in our people. Over the years we've seen Select Comfort consistently perform well in difficult market conditions and I believe it's because our strengths are brought into play. Consumers' need for an interest in better sleep is accentuated during difficult times, and our unique product, service, and value proposition is increasingly earning consumer acceptance in the market.

Our business model offers significant flexibility and we enjoy a direct dialogue with consumers which allows us to recognize and react to required changes. And the quality of our people and their passion for our product and mission for helping customers brings a level of creativity to our team that emphasizes everyone's execution on a single goal. I believe our customers recognize a level of excellence that is unmatched in the industry. Before I elaborate more on the future, I'd like to turn to Jim for further commentary on Q3 and our outlook. Jim?

Thank you, Bill. I will review the income statement and provide some details of our third quarter performance, then I will discuss our balance sheet and conclude with a discussion of updated guidance for 2005. As you can discern from Bill's comments, we're more than a bit pleased with our third quarter results with record sales of $175.8 million and 50% earnings growth to $0.30 per share. The consistency of our sales over the past several years demonstrates the strength of our growth strategies.

On top of the sales growth comes continued improvement in our profit margins in the face of challenges in the form of rising costs. These improvements demonstrate the unique advantages of our vertically integrated business model, with numerous areas of scale potential, many opportunities to gain productivity in manufacturing and logistics and pricing flexibility with a product that is appreciated for its benefits and value. Bill covered a number of key accomplishments reflected in our financial results, but let me cover a few additional points for those of you who model our business.

As Bill noted, sales in the third quarter increased by 22%, led by unit growth of 22%. We have seen little or no resistance to price increases taken at the beginning of the year and reflected in the average sales price of sales in our company-owned channels. The average sales price for those channels in the third quarter increased to -- by approximately 5% to $2,064 per unit. All channels experienced strong growth, retail sales increased by 20%, direct by 10%, e-commerce by an impressive 41% and wholesale sales increased by 48%.

I'll add a few additional comments on our most significant growth channels, retail stores and wholesale. Our retail sales growth is being built the right way for sustainable growth. Bill already mentioned the strength of our existing stores, but it bears repeating with same-store growth of 15%. Most importantly, the increase comes on media growth of only 11% and promotional spending that was actually lower as a percentage of sales than prior years. 5% of our retail growth was generated from new stores.

New store openings during 2005 were somewhat back-end loaded, resulting in 19 store openings in the third quarter. The timing of these store openings should boost sales in early 2006. In the fourth quarter of this year we will open at least five stores with no store closings planned. We expect to close the year with at least 393 stores, 17 of which are in lifestyle centers, a real estate venue that has proven to be very successful alternative to traditional malls.

Our wholesale sales increased by 48% compared to the third quarter of 2004, with contributions from three sources. First, our August QVC show was the largest in our history and demonstrates how that channel can achieve significant revenues and drive business results in other channels. Second is a continued installation of our beds in Radisson Hotels. Sleep Number beds are now installed in 27% of all Radisson rooms. And finally, sales through our retail partners continued to be an effective supplement to our retail stores.

We continue to hear questions from investors about expansion of our distribution into retail partners, which now includes 264 doors. Our retail partner relationships have been a success for both our partners and our company. In the five markets where Sleep Number beds were sold in both our own stores and retail partner locations since 2002, our sales and profits have more than doubled, while our company operated stores have averaged same-store growth of 24% annually. This proof of concept over the last several years has led us to confidently expand on the strategy with select retail partners. The increase in distribution points has proven to make purchasing a Sleep Number bed more convenient, while leveraging our media investment and increasing our share and profit. We also believe this strategy can serve as an effective defense in many leading retailers against the introduction of competitive products.

In the third quarter we initiated tests in New York in Sleepy's and in the southwest in Mattress Firm. Sales through those retailers have been on track to our expectations. We expect to make a determination on further expansion within those chains in early 2006, while continuing to identify retailers with the appropriate profile to lead to continued growth in this channel in 2006. Channel growth and other key sales statistics are included in the supplemental attachment to our sales release.

Now, let me move to operating results. Net income increased by 42% in the quarter, led by operating margins of 10.3%, 150 basis points better than the same period in 2004. Our gross margins were a particular point of improvement. Gross margins in the quarter came in at 59.6%, 70 basis points lower than a year ago, but more importantly, 170 basis points better than the second quarter. A better point of reference is company-owned channels, where gross margins have improved to 62.1% compared to 61.4% in the prior year.

The most significant contributors are productivity improvements in our plants and home delivery, somewhat better product mix, and home delivery price increase that was implemented at the end of the second quarter. The multiple leverage points in our vertically integrated model are increasingly important in this environment of rising commodity and energy prices.

We also continued to leverage our marketing and selling assessments with an improvement of 280 basis points to 41.4% of net sales in the third quarter of 2005. Leverage within our existing store base continues to be a significant contributor to margin improvement. In addition, our media spend continues to be effective and represented 12.5% of net sales in the quarter. G&A expenses did increase as a percentage of sales to 7.8% from 7.2% in 2004, due to increases in incentive compensation accruals resulting from the above expectation profit performance.

Our cash generation was particularly impressive in the third quarter. In addition to self-funding our growth in 2005 as we have over the past four years, we continued to evaluate uses of our cash to increase shareholder value. We have continued our stock repurchase program initially designed to offset new share issuances, but most recently utilized to take advantage of what we perceive to be soft valuations.

Over the past 21 months we have repurchased 3.4 million shares or nearly 10% of outstanding shares. After the repurchase of $46 million of our stock in 2005, our cash balances remain at $88 million, essentially equal to our cash at the beginning of the year. Our purchase authorization was fully utilized early in October, but will expand in the fourth quarter with further expansion of cash flows.

Now, let's turn to our guidance. We are updating our full year 2005 earnings guidance to $1.05 to $1.08 per share. We expect that same store sales growth will exceed the high end of our 7-12% target range and that total sales will exceed our 2005 target range of 18-20%. Our full-year guidance implies earnings growth in the fourth quarter at or above the high end of our long-term earnings growth target of 20-25%.

A number of factors create uncertainty in the quarter, including rising fuel and energy costs and the related potential impacts on consumer confidence, as well as the disruption of our foam supply which has been managed superbly by our operations team. These factors do not dampen our outlook for the quarter. Sales through October have been strong and we do not anticipate petroleum-related cost increases will affect our ability to achieve our 2005 guidance.

We look forward to 2006 as a year in which we will continue to grow our sales and earnings and expect strong sales and earnings growth in line with our long-term targets. We expect to be faced with continued cost pressures, but our vertically integrated business model provides many opportunities to offset potential increases and our product has proven the ability to allow pricing increases if necessary. The components of our sales growth targets in 2006 remain much the same, with same-store growth of 7-12% and new distribution growth of 6-12%, with 40-45 new stores along with the ongoing expansion of our retail partner strategy.

As the factors affecting 2006 become more clear and we finalize our plans for 2006 we will provide a more specific update of financial targets. We are confident in our abilities to achieve our targets of 15-20% sales growth and 20-25% earnings growth in 2006 and long term and are on track to achieve our goal of $1 billion in revenue and 12% or more in operating margin by 2007. With that overview, I will turn the call back to Bill for his closing comments.

Thanks, Jim. We've had an extremely successful third quarter and 2005 year to date. It looks to be another year of significant achievement for the Select Comfort team. I want to thank everyone, our people, our partners and suppliers, and our customers that have helped us deliver another milestone as we work toward our $1 billion sales goal and then beyond. Our success over the past four years is not a surprise to the Select Comfort team. We have had a consist focus on the keys to success that make us different from specialty retailers and from other mattress manufacturers.

Our core advantages have remained consistent and are growing stronger - our product, our brand, our direct-to-customer sales channels, our make-to-order supply chain and a cash-efficient business model. We continue to leverage these advantages and we are confident in our ability to grow at an accelerated pace and at a multiple of the overall bedding industry. And we believe, with continued strong performance, the many advantages of our direct-to-consumer model and our unique product will be increasingly appreciated by the investment community. Thank you for your continued support. And Paul will now open the lines for questions.

Thank you, sir. (Operator Instructions) Our first question comes from Joel Havard of BB&T Capital Markets.

Thank you. Good afternoon, guys.

Good afternoon.

First of all, could I get a little history lesson? On the Radisson program, I didn't remember that you were going to be getting into all rooms. Where do you sort of run into the fill for phase one and then grow with them?

Well, Joel, the program is intended to be a chain-wide initiative. The Sleep Number bed is the new standard within the Radisson chain.

I misunderstood, then. You do see getting into every room, as it were?

Well, you know, it is a franchise operation, and it may not be every room. But the concept is that it will be the vast majority of the rooms. And it may take some years to get to that full fill rate. But the primary focus of the program was over the first two to three years.

Got it. All right, great. That's good. Secondly, could you elaborate on this pressure-mapping technology that you're bringing to the store? What is that unit? What does it do? Do you have any - I bet you have some test data that shows the difference it makes on a per-store basis when implemented

The pressure mapping tool is a piece of technology that when a consumer lies on a bed, they can actually see their body's pressure points on a computer screen and they can see those pressure points change and dissipate as they get close to their ideal Sleep Number. And yes, we do have data on the sales effectiveness and lift. And it clearly justified the investment.

Did I hear that that was $4 million to roll out to the system? And is that in every store yet?

Yes, it is now in every one of our stores.

Okay. And did you not want to elaborate on the lift you get based on this new selling tool?

Right.

Okay. We'll put down good. Finally, on foam, can you share with us the experience you've had over the last, call it 45 days max, on the difference in poly, and then more broadly on the Select product on a foam-content basis versus a traditional inner spring?

Yes. I'll answer your second question first. That -- because there are multiple models of Select Comfort beds and a lot of different models of inner spring beds, it's hard to draw a direct correlation of the amount of impact between the products. It's more or less in the same ballpark, we believe. The experience we've had over the last 45 days, we've been communicating pretty proactively in terms of ...

Yes.

... when issues hit and how they've been progressing. We've been in clear dialogue with our suppliers. And the bottom line is that we've been able to continue with our customer service levels, and -- at least today, given the projections of how our suppliers are ramping up, we don't believe it will have any significant impact on the quarter that will prevent us from hitting the numbers that we've guided to.

Sounds like that answer was pretty carefully chosen. We do appreciate the proactive stance you all took on those releases. I want to make sure I understand. You aren't having trouble getting foam from an availability or quantity standpoint. Is that correct?

Well, the whole industry is on allocation. So we are getting foam. We are not getting as much foam as we would ideally like. But we know the schedule and we're able to work with our customers. And as Jim said, our operations team has just done a magnificent job of balancing service. So, we're not missing any customer service promises and we're keeping up with the orders.

Okay. And again, from a pricing standpoint we've heard pretty strong double digit increases from other home manufacturers. I assume you all are in that same park?

Joel, this is Jim. There are a number of factors that will come into play over the coming months. But overall, we don't see foam within the cost component to have a significant impact on our ability to meet our financial targets in the fourth quarter and we also don't see it as being -- having an effect on our outlook for 2006.

Joel, this is Bill. Just to be clear, though, we are hearing and seeing the same levels of cost increase that you're hearing for the whole industry. What I think where Jim was going is that we believe, as we've said repeatedly, we have the ability between pricing and doing some work with our suppliers and our product design, again, to meet the numbers that we have projected to.

Okay. All right, thanks, guys. Good luck.

Thank you. Our next question comes from Steve Denault of Northland Securities.

Good afternoon, everybody.

Hi Steve.

Good quarter. If I could follow up on the most recent caller's question. From a foam perspective, is foam priced per cubic foot? How do they price it?

This is Bill. I know what we've been talking about on availability is by the board foot. I can't tell you how it's priced, Steve. But we can get back to you on that.

Okay. Can you give us an update on the competitive landscape as it relates to offerings within the air category?

At least -- on the last call it was right on the heels of Simmons having launched - having announced the launch of a bed. It's interesting that to date that no one, to my knowledge, has seen that product in the market.

Okay. And how is the Minneapolis market trending?

As Jim said, our performance in the quarter was strong across all channels, all markets. And again, our same-store growth rate was 15% for the chain. And you can't do that without pretty strong support from all markets.

Okay. So, is it fair to assume established markets are trending at or above company averages? From a comp perspective?

Steve, I would just say that as Bill said, we're seeing good, consistent growth in all markets. And I can't really comment beyond that on specific markets.

Thank you.

Thank you. Our next question comes from Bob Evans from Craig-Hallum Capital.

Good afternoon and congrats on a strong execution this quarter. Can you comment a little bit more on gross margins? I know you saw a nice lift this quarter. As you look into Q4 and '06, what kind of are your thoughts in terms of gross margin trends? Is this quarter sustainable?

Well, I certainly think that we've done - and our operations team has done a great job of really building productivity, whether it be in the manufacturing side, as well as from a home delivery standpoint in just getting more efficient and effective processes. And we see those continuing. There's a lot of factors that affect gross margins overall, including product mix and some of our channel mix, but I think we feel as if - we feel that we're in a good spot from a gross margin standpoint and we feel that we can continue strong margins.

Okay.

I think the difficulty in answering your question is in the short term over the next - what's going to play out over three to six months. We have no question, we have high confidence in our ability to manage this over the long term. And again, we don't think that anything is going to happen in the short term that prevents us from delivering our numbers in total. The gross margin piece will be an interesting three to six months. But again, we believe we've got the ability to manage that well.

And is the interesting expected in the three to six months, is it basically the commodity pricing?

It's what everybody's faced with, between foam and fuel prices and natural gas, and everything everybody is dealing with. But I think we've got a lot more degrees of freedom to work with.

And is that primarily pricing flexibility in terms of what you're able to do?

Well, again, if you look at us versus just a specialty retailer, we've got many more degrees of freedom on product design and productivity and all the rest. If you look at us versus a manufacturer, we have a lot more degrees of freedom versus pricing and efficiencies in our selling process. So I think we've got the full array of options, as Jim said, and we've demonstrated over the last years our ability to work within that.

Okay. That's fair enough. I just want to make sure I heard you correctly. In terms of 2007 goals, I think $1 billion revenue and 12% operating margin, is that correct?

Yes, that's the kind of the goal we've hung out there for ourselves is to get to that $1 billion or more and 12% operating margin or better by 2007.

Is that on a full-year basis or a run-rate basis?

A full-year basis.

Full year. Okay. And also, can you comment as it relates to - you said Q4 trends were strong thus far. Obviously, there's broader macro concerns as relates to the consumer and high gas and so forth. Can you give us a bit more color as to what you're seeing and hearing from stores and customers? To some degree your results kind of fly in the face of overall macro concerns and give us a little bit more color, I guess, in terms of what you're seeing thus far in Q4.

Well, I think one other way of looking at it is just what we're doing in Q4. And I'm not - I can't recall if we've mentioned this, but we will basically be increasing our advertising about 20% over prior year in Q4. We're putting more fuel on the fire, if you will. And it was always part of the plan to do that. And it's just kind of how the numbers worked out a year ago versus the 2005 plan. But one of the things that gives us confidence going into the quarter is we do have a full arsenal of marketing activities driving it.

Plus, we've got the pressure mapping, plus we've got the store weeks working in our favor. As Jim said, I think the issue with - versus consumer confidence and all that is that, again, people are increasingly understanding the importance of sleep. They're increasingly appreciating the uniqueness of the Select Comfort product line in helping them do that, and we're getting the awareness out there building share more. So, ours is still much more of a share capture game and less, perhaps, affected by category trends.

Okay. To that end, do you have any quantifiable data in terms of what the premium mattress segment did Q -- this quarter relative to the industry?

The number won't come out for another three weeks.

The total industry will come out in another month or so. But the premium segment won't be available at that time.

Okay. All right. Thank you.

Thank you. Our next question comes from Greg McKinley of Dougherty & Company.

Thank you. In your guys prepared remarks, you obviously hit a lot on the opportunities you see in front of you to expand just profitability and operating margins at the company. And I'm wondering if you can help us measure that a little more closely. When you think about total costs incurred for not only operating expenses, but also, I'm guessing there's a fair amount of fixed cost in your gross margin as well and your cost of sales. Can you give us a sense for what the fixed variable ratio of expenses was this last quarter or where it's been recently?

Well, within our product costs in particular, the majority of the costs are variable within our product costs. But I think going back to Bill's point earlier, I think what we deal with and what we have the opportunity and the advantages to do is really dealing with this at a multiple point within the supply chain, whether it be the manufacturing side, the home delivery piece within our stores and, as Bill mentioned, also, just within product design. So, there's a lot of different places that we can deal with costs. But more importantly, increased margins throughout the chain.

Greg, if you go back and look at us historically, you see that our greatest productivity has come from sales and G&A. And I think that's what you should continue to expect, especially at same store sales growth.

Have you ever talked about where you are in terms of if you looked at total expense dollars this quarter, be it cost to sales or operating expenses? I mean, how many of those would have been there, independent of your sales volume, just to give us a sense for where that leverage opportunity can go as you start projecting some of these longer term revenue growth rates?

We do look at that. But I think more importantly is what we have continued to see is not only the fixed leverage that we get out of our stores and things like media, as we continue to grow. But like our operations team and the home delivery team have done a fabulous job of improving the variable cost component as well. The efficiency that we have in the manufacturing process, the ability - what scale gives us to allow us to negotiate with our suppliers and with the growth, we just see that continuing. So there is certainly a fixed and variable component, but we see a lot of opportunity on the variable side. And I don't want to understate the opportunity we have on the cost of goods side from that standpoint.

Yes. Okay. Performance by product line at retail - can you give us a sense, with a comp like 15%, I would imagine that implies pretty solid performance from the entry level up to the upper end lines but could you give us a sense for what parts of your product line exceeded expectations, versus others that may have just met?

From a product line standpoint, we did not see any significant change from what we have seen over the last quarters. It's been pretty consistent throughout the last couple of quarters.

Okay. Then I think, Bill, you mentioned promotional spending was down. I thought the number was 1.7%, but I really didn't catch the context of that.

1.2 percentage points, and that is as a percentage of sales. I think the important thing here is we continue to see that customers are interested in the product for the value. And we do a fair amount of moving promotions around to create a different type of sales incentive that our sales professional can offer. But from a total cost standpoint, we have, I think, you've followed us for sometime now, Greg, seen we've continued to maintain that number and over the long term have decreased it over time.

Yeah. Okay. And by that you're combining like a product discount and the finance component.

Correct.

And then, last question. I know you've emphasized a little more spending in national versus local media earlier in the year. Is that a trend that continued into Q3 and would you continue to expect that type of allocation going forward?

We have maintained our - kind of our national-local mix fairly consistently throughout the year.

Okay. All right, thanks. Good quarter.

Thank you.

Thank you. Our next question comes from David Lee (ph) of Porter (ph).

Hi, guys. How are you? Just a couple of questions. First of all, can you talk a little bit about the composition of your sales and marketing expenses? Because it looked like as a percentage of revenue - this has been the lowest in a long, long time. And can you sort of segment out what portion is discretionary and what portion isn't? And can you also emphasize, again, the promotional spending, the percentage of revenue over time, historically?

Okay. Just roughly, when we -- within our sales and marketing is our media spend, our financing costs, our compensation to our sales team and our occupancy costs within our stores. Those are the four major categories. Certainly, the occupancy and the compensation is less discretionary, just from staffing a store and overall having the store standpoint. The media is probably the biggest piece that is discretionary. And then as we mentioned earlier, the promotional aspect is one that we move around different types of promotions. But it looks about the same in dollar terms over time.

Okay. I guess, can you - I guess, in the short term, that definitely helps the leverage. But do you think it's sustainable to spend only 41% of your revenue on sales and marketing over the longer time? Because in the past you guys have been around 45%.

Well, I think what we have seen over the last four to five years is that number has continued to trend downward. And I think that we continue to expect to see leverage in that area. We've done a very good job of efficiency within our media spend over the last 12 months in particular, and just the leverage within our stores, as our stores continue to grow. And I think we do feel as if there's - there continues to be more opportunity. As Bill noted in his comments, our sales per store are about $1.375 million in the 12 months ending in September. But we have stores that are in that $3 million to $4 million range, and our entire store base continues to grow, which we'll continue to leverage.

Okay. Great. Last question --

Really, it's coming off of last year was an abnormally high year, because we were opening quite a few new markets. And so, the rate that we're getting back to still is a strong historical rate that we're spending at right now.

Okay. What about - okay, you recen -- you opened 19 stores this quarter. That's also quite a bit in a long while. Can you just talk a little bit about how this correlates to - does this have direct correlation to the big jump on the retail partner doors?

No.

No, it does not.

Okay.

You - typically our store openings are distributed fairly evenly from March through October. This year, just a function, when we sign leases, a lot of times the timing is based on when space becomes available. So this was somewhat unusual this year in having so many stores. I would expect that it will be more evenly spread over the year.

One last question. Can you just maybe follow up a little bit about - follow a little bit on the new market opportunities and location-wise, product-wise, and how you plan on going to them?

I think, just a little bit of background. We have stores in, really, every market within the United States of any size. There's a differing level of store density, and there's certainly a differing level of market share. We have - only three of our markets have a market share in excess of 15%. So, growing market share in those other markets is a combination of continued distribution expansion, both with our own stores, as well as retail partners, where appropriate. And then just continuing to grow the awareness and growing the average sales per store in those markets.

Great. Thanks, guys.

Thank you. Our next question comes from Michael Cox of Piper Jaffray.

Good afternoon, guys. Congratulations on a strong quarter.

Thank you.

Just a couple of questions on the ad spending front. Can you give us an insight into what that will look like in 2006 and if there are any new local markets planned for 2006?

Michael, it's a little early in our planning to get into 2006. But I would not expect the marketing spend rate to be - the marketing spend percentage rate to be significantly different. So again, it will be up again, versus this year in absolute dollars. And in terms of new markets, too early. As Jim said, I think we've still got an awful lot of opportunity to build out all of the existing major markets and continue to get the national leverage.

Okay. In terms of the average selling price up about $100 sequentially, just looking back over the last several quarters, this is the best that you've done on a sequential basis in quite sometime. And I was wondering is there anything particularly going on in the stores that caused this type of ASP increase in one quarter?

There isn't anything going on in the stores particularly. Home delivery was - we did have a $50 price increase in our home delivery right at the end of the second quarter. I think it was in June. And that affects about 50% of our beds in the company-owned channels. So that was certainly a contributor. But other than that, the trends were not significantly different.

Okay. And my last question revolves around the inventory line item. You continued to see a pretty sharp increase on a year-over-year basis, albeit slower than the second quarter. I was wondering if you could comment on inventory.

Yes, the inventory is higher than a year ago. It's down a little bit sequentially. I think that we still feel that there's some opportunity there. But between the growth of our stores, which there's some inventory, although not a lot of inventory in the stores, and then also, if you recall with our home delivery, we don't recognize the revenue until the bed is delivered in the home. So anything in the pipeline to the home is also counted in inventory. So, those are really the main drivers. But we did see a little bit of a sequential decline from the second, and like I said, I think we do feel there's still some opportunity there.

Okay, I guess I lied, one last quick question. On the lifestyle center stores, any indication you could give us on the results or the volumes going through that to warrant a larger store format?

I would - with regard to the lifestyle centers, I would just saw we've certainly seen very good results in, that the kind of the economics are as good, at least, as our mall-based stores. The particular attributes, I guess, that drive that are kind of a number of different places. But I think certainly store -- the footprint is certainly one aspect that can help that.

Okay. Great. Thanks a lot, guys.

Thank you. Our next question comes from Pauline Reader of Thomas Weisel Partners

Hi. You talked a little bit, Bill, I think about becoming more efficient in the marketing area. I was just wondering if you could provide a little bit more color, kind of what you're doing better there than maybe you were last year and kind of how you see that evolving going forward.

I think the major difference is, again, last year consciously we opened several new markets in both -- 13 new markets, but also, some major markets with New York and a couple of other major investments. And this year we've been focused more on building on the awareness that we had in those markets and using different mediums to do that. We will be continuing - we are investing in some analytical tools which will help us further refine the spending. But I think the key point is that what we're getting now is top-line growth approximately equal to our marketing growth, spend growth, and that's just going to help us continue to grow revenue at the same time we're able to increase the margin.

Okay. So, sorry, your comment was year-over-year. You weren't signaling more efficiencies in this quarter versus any other quarter in '06?

No, it was...

Just year-over-year?

To step back, the big picture hasn't changed, in that we continue to look at our marketing line as a variable, and that as we get ahead of our sales targets, we look to spend more and continuing to accelerate that growth. Now, to the degree we can more efficient and effective, that will just help us grow that much faster.

Okay. Thanks a lot.

Thank you. Our next question comes from Mark Rupe of Adams Harkness.

Hey, guys, good quarter. Is it fair to say that the 27% rollout to Radisson has met the first exclusivity threshold?

Whether it - I'm not even - that threshold was based on a full year number, and we've still got to see what happens in the Q4. But more importantly than that hurdle is the work that's going on between the two companies in high cooperation. Their marketing campaign has been terrific and we're seeing a lot of awareness of the product and people coming into our stores because of that. So, I think the relationship is what is as important on that exclusivity at this point. And we're happy with Radisson and I believe Radisson is pretty happy with what we're doing for them. And so I think you'll see that relationship continue. We've got to just stay focused and see that through and execute it well.

Perfect. And then, obviously, new product development this year was a little bit light. Are you satisfied with the current product lineup as you go towards your longer-term goals?

I think there's always opportunity to innovate in our product. And we've got some people focused on doing just that. But I don't think the product line in terms of complexity or expanse will change significantly. I think we'll be improving within the lines that we have.

Perfect. And then, direct was down sequentially in the quarter. I know e-commerce was up pretty strong. But even if you combine them it looks flattish going into a seasonally strong quarter. Just curious to see if there's any primary factors there.

No, I don't think there's any primary factors. I think what we will continue to see within direct is that we use the direct marketing media outlet as a broader media tool. And we increasingly see customers that respond to that direct marketing that go to our stores to buy. .So, it's really a more comprehensive multi-channel look that we take with the marketing. But as we have said in the past, direct marketing we would expect to grow, but at a slower pace, certainly, than our retail channels, which is where we really see the growth longer term.

Perfect. And then lastly, on some of the new retail partners that you're testing with now, is there any type of terms that you have in place with them that prevents discounting, or is there a minimum advertised price that you have in place?

Yes. We have a number of - within our agreements with our retail partners that - if you step back and you look at the retail partners, what we're doing is essentially offering them semi-exclusivity within the market. And from that standpoint, they're providing exclusivity to us from a standpoint of not putting other air or adjustable products in their beds. And they're also - it's in their best interest to maintain their pricing in line with ours, because we're not providing a lot of other competition for them, as is typical in the mattress industry. So we have a structure that encourages both sides to kind of play by the same rules.

Perfect. Thank you.

Thank you. Our next question comes from Chris Krueger of Miller Johnson Steichen and Kinnard.

Good afternoon, guys.

Good afternoon.

Hi. The last caller asked about the direct and e-commerce business. Just looking at the e-commerce growth of 41%, is there any particular thing that drove that growth?

I think you're seeing a couple of different things. I mean, we have certainly worked very hard at making it a great Web site for directing customers to all different channels. We have continued to work with expanding the media usage within the e-commerce site. That's done a great job. And then there's just the growing use of e-commerce. But I think one of the advantages that we have with our product is that, in particular, repeat buyers, people that are familiar with the product, they know - they don't have to go to a store to buy it. They know they can buy the product, bring it home, adjust it to their liking. And so it's a much different environment than a traditional mattress. So, we really see e-commerce as a continuing to grow at a very fast pace.

Okay. Just one other question. When you ahead to the holiday season here, are there any new - I know your product assortment has expanded over the years - any particular, call it gift-giving type of products that might be made that are new this year versus last year that could maybe help things? Any comments there?

Nothing specific, other than traditionally we have both new full-time products as well as in-and-out type products brought in around the holiday season, and that tradition will continue this year. But I don't have the - I don't think we want to get into the specific products at this time.

Okay. Thank you.

(Operator Instructions). Sir I show no further questions.

Very well. If there are no further questions at this time, then we will conclude the conference call. We thank you all very much for your participation and we look forward to your continued support in the fourth quarter. Thank you.

Thank you. That concludes today's conference call. All sites may now disconnect.