Sleep Number Corp (SNBR) 2007 Q2 法說會逐字稿

Hello and welcome to the Select Comfort second quarter 2007 earnings conference call. All participants will be on listen only until the question and answer session. (OPERATOR INSTRUCTIONS) This conference call is being recorded for replay purposes by the request of Select Comfort. Now I'd like to turn the conference over to your host, Mr. Mark Kimball, sir you may begin.

Thank you. Good afternoon, and welcome to the Select Comfort Corporation's second quarter 2007 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 Bill McLaughlin, our Chairman and Chief Executive Officer, and Jim Raabe, our Senior Vice President and Chief Financial Officer. In a moment I'll turn the call over to Bill, and following Bill and Jim's prepared remarks, we will 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.

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 10K 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. Good afternoon and thank you for joining us today. I think the best way to convey my perspective on our business is to share with you the essence of the progress report that I recently communicated with our employees.

Our second quarter's number represent what I believe will prove to be an important inflection point in our business performance. When we first outlined our agenda for 2007, back in February, we anticipated our growth would begin to rebound around mid year, as industry trends stabilized and our first half initiatives took hold. Well, that time is upon us now. And while still early, I'm pleased with the signs of progress. We saw strengthening sales performance throughout the second quarter, and those trends have extended into the first few weeks of the third quarter.

In the past few months four accomplishments stand out that position us to better serve our customers, and to deliver our growth objectives that we're committed to. First, we're in the middle of launching the highest quality, most technically advanced beds ever available. Simply put, they represent the very best beds available to customers ever. Our top end, the 7000 and 9000 models were relaunched in mid-June with exciting product enhancements including new comfort materials and temperature regulating fabrics. The new versions of our model 3000, 4000 and 5000 beds are ready in the wings with sales opportunities in July available to customers on our current close out offers. And these new beds are planned to all be in our 460 stores by early August.

All of our new models emphasize enhanced comfort layer materials, and several feature significant advancements in temperature regulation. Initial consumer and sales team reception has been very encouraging. Each of our new models has an exciting customer story. Not only are they the best products that we've ever made, but they also reflect the ideas and desires of our consumers and our sales team, demonstrating our unique insight from selling directly to our customers and our dedication to customer satisfaction. These advancements, concurrent with meeting the demands of the new fire retardant regulations, were made possibly by our investments in product development, as well as advancements in other functions from purchasing to quality and engineering.

Less visible is the second accomplishment, that of quality improvement. We have always been committed to quality but our six Sigma programs are now allowing us to put low incident, but frustrating and costly issues, on a path to near zero defect levels. Again, there are many cross functional teams involved in this important work, but our six Sigma leadership team is now almost fully staffed, and we are actively engaged in training to broaden this level of capability throughout our entire organization. The six Sigma team first focused on improving our proprietary air control systems. Their work has resulted in several new component designs that have reduced initial claims by more than 30% in the past few months. Improving customer satisfaction while lowering costs and expanding competitive advantage. Our six Sigma teams working with R&D and sales can also take pride in the fact that their work has resulted in a 50 basis point reduction in return rates in the past 30 days. Like so many areas of our business, focused effort is paying off.

Third, we need to make consumers aware of our new and improved products and unique selling and service environment through our marketing and in store activities. At next week's analyst day event, scheduled for August 2, you'll learn more about the work that Shelly [Ibach] and her team are doing to improve our in store experience. This remains our single largest opportunity, and we have seen improvements in several areas that we expect to be even stronger in the months to come. Recent improvements include the sales and marketing teams have been redesigning our promotion and marketing calendars to have one common look and feel, and to strengthen our marketing presence around key holiday time periods, starting in August.

We have found a way to get greater advertising coverage by shifting regional advertising to national with the same impressions at lower cost, and that started in June. And our sales leadership program redesign is now implemented across all of our company controlled stores, allowing our store managers to better focus on making their teams successful, and increasing the incentives to grow. Shelly will share more on these advances in next week's meetings.

Finally, work during the past few months on our media message has confirmed both the strength of the Sleep Number bed as well as consumers' interest in learning more about how and why Sleep Number works, and where to find this revolutionary new product. We currently are developing marketing programs to answer these questions, and expect to have clear direction set by year end. In the meantime, we're focused on called attention to our new product offerings and our store locations.

Fourth is the progress being made on our various infrastructure initiatives. Logistics is an important part of our two plant system, and our hub and spoke implementation is already having positive effect on our controls and gross margin performance. Our logistics team continues to implement the foundation of hub and spoke. We just opened our tenth hub last week, and we remain on track to have all 13 of the planned hub locations operational by year end, which is phase one the project. In phase two, planned for 2008, our hub and spoke implementation will be tested to reduce delivery times, creating a valuable customer service initiative that will further enhance the significance of this important initiative.

And our SAP project is also advancing, with a dedicated effort of over 40 Select Comfort employees. While it's a large undertaking, I'm convinced that this investment will be worth it in the end, giving us an IT platform that will support our company's growth for many, many years, and provide the means to support point of sales transactions in multiple languages and currencies as we prepare to expand internationally. The time to launch is ours to manage as we can and will, and we will take the time required to insure quality and full testing of the new system before we implement it.

As I said earlier, I'm pleased with the signs of progress. During these past few quarters as our performance under pressure, I've been impressed with our people. They've remained focused on our mission to improve people's lives, working to make Select Comfort an industry leader and a great place to work. Through May industry trend data suggests U.S. mattress sales are growing at about 2% in units and 4% in revenue. Historically, we've grown at two to three times the market rate, and that's our opportunity. If we continue to remain focused on surpassing our customers' expectations, and effectively building our brand and retail presence, then we'll be successful in our goals.

We now start a new segment of our journey, well positioned and committed to recover the growth that our customers and shareholders deserve. That concludes my prepared remarks, and I'll now turn the call over to Jim Raabe, our Chief Financial Officer, to review this quarter's performance in greater detail. Jim?

Thanks Bill. As Bill noted, sales growth is our key issue. While a challenging quarter, we are encouraged by improving sales trends which began during the quarter, and have continued into July. With second quarter volume challenges, we are focused on margin improvements while investing in enhanced capabilities. These factors were understood when we provided our full year outlook in June, and we are therefore making no change to that outlook.

Second quarter sales were in line with the expectations we communicated in our business update on June 13. While we recognize second quarter earnings were below Wall Street consensus estimates, these earnings were in line with our internal forecast and our full year outlook. I will therefore begin be reiterating our full year net sales outlook of between $840 and $860 million, and our full year earnings outlook of between $0.87 and $0.93 per diluted share. These targets equate to net sales growth of between 10% and 15%, and earnings per share growth of between 33% and 47% over the balance of the year, and we are comfortable with these growth rate assumptions.

The projected second half improvement in sales implied in this outlook reflects the impact of first and second half initiatives that Bill outlined, including new product introductions and improved execution of sales and marketing, as well as more consistent levels of media investment and easier company and macro comparisons for the remainder of the year. As noted earlier, we have experienced some improving sales trends over recent weeks and months, consistent with this outlook.

Second half earnings per share growth targets are higher than sales growth targets, reflecting approximately $6 million of asset write offs included in the back half of 2006 earnings, and the favorable impact of share count reductions due to our share repurchase program.

With respect to second quarter results we are certainly not pleased with the decline in earnings per share or the de-leverage of operating margins that accompanied our lower sales volumes. However, in keeping with the long term approach to managing our business, we have continued to invest in growth and productivity programs that we believe will benefit investors. We are pleased that year to date we have achieved most of the operational objectives that we had set for the company at the start of the year. From a product perspective we had a heavy agenda of product introductions and FR regulatory changes to make this quarter, and the results speak for themselves. With gross margins up 80 basis points compared to the second quarter of last year despite lower sales on year over year basis, and significantly better than the 59% gross margin rate that we guided to when we reported first quarter results. The gross margin favorability, which now extends to six consecutive quarters of year-over-year gross margin rate improvement, reflects several factors again this quarter, including improved product quality and costs. Included in that is lower warranty and return trends as an outcome of six Sigma programs, global sourcing efficiencies and the continued rollout of our hub and spoke initiative, and our decision to sequence our FR launch as we did, introducing FR compliant beds to our retail partners in March and delaying the exposure to higher cost FR compliant materials in our core line until June.

Our company owned gross margin percentage in the second quarter totaled 63.4%, little changed from the 63.7% we delivered in the first quarter of this year. The cost to convert all the display beds in our stores to FR compliant models added approximately $1.2 million to costs this quarter, and the use of FR compliant materials in manufacturing will now be a permanent part of our cost structure. The inclusion of FR costs for the entire quarter will add some pressure to gross margins on a go forward basis. At the same time we remain confident that full year gross margin percentage will be at or above last year's level of 60.9%.

From an operating perspective, the continued growth in our store base and increased media spending resulted in higher sales and marketing costs, which, with lower sales volumes, offset the gross margin improvement. We added 13 net new company owned stores in the second quarter, including six stores featuring the new store design that emphasizes accessory sales at the front of the store. We believe this new store design can increase traffic and gain exposure for the innovative new features we bring to market over time, and as we accelerate the pace of new product innovation. The economics of this new store design will be evaluated in coming months as these new stores serve to validate the traffic and sales trend data we measured from our initial pilot store, which opened in the fourth quarter of 2006.

Media spending totaled $25.2 million, an increase of $2.6 million over last year's spending level, and included investments in the Cure for Tired campaign. This campaign has not provided a sufficient return on investment in our tests. We expect full-year media in 2007 will be approximately $110 million. We continue to look to media to raise awareness and increase store traffic with a great deal of work underway to synchronize our promotional sales and marketing messages to drive sales over the balance of the year.

We do expect to leverage SG&A expenses in the second half of 2007 and have already put some cost saving initiatives in place at our headquarters in order to accomplish this objective.

R&D spending also increased to $1.4 million in the second quarter, representing 8/10s of 1% on a net sales basis. With our emphasis on new product innovation, we expect R&D to total between $6.5 million and $7 million for the full year 2007.

We continue to operate efficiently this quarter, with a cash conversion cycle improving by seven days, compared to the second quarter of last year. While receivables and inventories may remain low in both periods, the improvement primarily reflects increased mix of media in the total payables balance.

The conversion to the payables payment turns in the second half of the year should further enhance our negative working capital operating model.

From a balance sheet perspective, cash and marketable securities totaled $12.7 million with $10 million in short-term debt as of June 30th. We returned an additional $51.5 million to shareholders in the second quarter, buying back another 3 million shares of stock and we have continued to remain active since quarter end, buying back another 1.2 million shares thus far in the third quarter.

We currently have $225 million available under our share repurchase authorization. We take an intrinsic value approach to our buy back program and we'll continue to be opportunistic, likely leading to further utilization of our borrowing capacity in the third quarter.

As we look out over the balance of the year, we are working on those things that can help to improve performance in the near-term while laying the foundation for long-term growth. I invite you to join our Analyst Day web cast for a more in-depth review of our plans. Our long-term opportunities remain significant and we are working hard to build on the positive momentum in our business.

That concludes my portion of today's call. Maggie, I would now like to open the call for questions.

(OPERATOR INSTRUCTIONS).

And our first question comes from Tony Dikas of Piper Jaffray.

Hi, good afternoon, guys. A couple of questions; you know, we've seen some management departures in the first part of the year. Has it been difficult to retain some of your other key employees or sales people? First question.

Second question, it looks like to hit the low end of your current guidance, you're going to need an approximately 5% positive comp in the second half of the year. What - and maybe just a little more color on what gives you that trend. And, I don't know if you can - what gives you that confidence and maybe if you - you know, comment a little bit on the trends in July. Have they been positive comps thus far?

And, the third question, maybe just a little update on how performance has been with some of your regional partners.

Jim, I'll take the first one and then you can jump in. The first question was about retention, basically, and the turnover that we had in the early part of the year was - some of it was planned and some of it was not planned. But they both focused, pretty significantly, on the current trends. So, neither was a real surprise.

And we have not had that issue extending anywhere else in the organization. Sales retention and management retention have been basically on track. Actually, we continue to do some pretty neat bench building in certain areas. As I said in my comments, the six Sigma team is just about complete. And, we're adding some very important SAP resources as well and we're working on sales leadership positions as well. So, the attraction side has been very selective but positive.

Tony, with regard to your second question, kind of on the, kind of, the make up of the sales growth from the second half, as consistent with the first half and with the last couple of quarters, extending back into the last couple of years, about 7% to 9% of our growth is coming from new stores. And beyond that, between e-commerce, other distribution, our commercial channels, those types of things, we don't need a same-store growth number as high as 5%. I mean we're looking at a kind of a relatively neutral growth from those types of channels necessary, in order to get to the lower part of our guidance from a sales standpoint.

So, I think, as we noted, the sales favorability, or the favorable sales trends that we began experiencing in the second quarter have extended into the third quarter. And so there are certainly trends that indicate that we're on the right path in getting back to the growth rates that we need in order to achieve those.

And I will also state that that certainly is the low end of our longer-term expectations. So, it's really just getting back on track for that.

Your third quarter, regarding retail partners, I think our retail partner program continues as it is. I think our primary focus right now is on our company owned channels, retail direct in e-commerce. Retail partners is a supplemental channel to those cores and we're managing it to be just that, capturing those customers that are maybe not aware of the product. And that's essentially the way we're approaching it as not being a significant piece of our business, going forward. And it has not been significant to this point, either.

Okay and then just a quick follow up; on the media spend, it was up quite a bit in the quarter. Maybe just a little more color on that. Was part of that related to reworking of the message? Or was that actual media spend?

The media numbers that we spoke to were media dollars that were spent. So, the $25.2 million and the $2.6 million were invested media and media that was aired in the quarter. And, some of that was dedicated to the introduction and the cure for tired campaign. So, there was certainly a piece of it that we look at as not being significant from a contribution to the quarter overall.

And then the - did I hear you correctly that the reworked marketing initiatives will be kind of an August roll out?

Well, the reworked retail activation pieces, which to us is all of the newspaper, the in-store collateral, the radio; some of those things will be, Tony, we are continuing to work on the broader campaign. And that, I said, I would expect to see us have more finalized by year-end.

Okay. Say, thanks, guys.

Our next question comes from Jeff Stein, of KeyBanc Capital markets.

Bill, a couple of questions; wondering if, you know, obviously, there's been a headwind from the economy and a weak housing market. But wondering, you know, if you could just kind of explain the widening gap between yourselves and one of your other specialty competitors that reported yesterday. And, wondering if it, in your view, is it an execution issue, with respect to the widening gap? Or, is there just a growing preference by consumers for foam products?

We believe that growth drivers are largely in our control. There clearly has been some headwind, as you said. But we believe that it is more of an execution issue, an execution opportunity on our side.

Product marketing and sales are clearly the differentials. And I don't think there is as much of an issue of us vs. some of the foam products, in that our channels of distribution are so different, there isn't that head-to-head. And there's clearly no indication that customers have any less preference for our product. In fact, satisfaction continues to grow on that.

So, I think it's really down to us on execution of getting that awareness level out there. And, we're looking forward to doing that now, particularly with the product news that we have in the market to talk about. That's a great opportunity to talk to customers in a different way that we've been able to over the last year.

Okay, and the improving trend that you are seeing in sales, beginning in the second quarter and now extending into the third quarter, is that a function of actually seeing a lift? Or, is it just the fact that you are getting to go up against easier comparisons?

It is - well, we're going against easier comparisons and, as we said at the beginning of the year, we expected to see the turnaround start here at the midpoint of the year. That said, we're seeing continued pickup in our sales as well, on a relative basis. And, we believe that's due to the execution that we got going on in the store and with some of our already adjusted marketing materials.

Yes and, one question for Jim. Wondering, Jim; you're looking at a drop in G&A spending in second quarter, year-over-year. Is that a sustainable level as we move into the back half of the year?

The G&A number in the second quarter is probably a little lower than what you're going to see. Some of that has to do with kind of incentive compensation accruals, relative to performance. So, I think that as you look forward and as you're looking at your models, I would expect to see something more in line with kind of what we had in Q1, kind of in that $17 million range, from a G&A, for, you know, in the balance of the year.

Thank you.

Our next question comes from Todd Schwartzman, of Sidoti & Company.

Sidoti; thank you. Could you refresh my memory, please? Maybe highlight some of the key features and benefits of Spoke and Hub - Hub and Spoke?

Yes. The background on that is, we have two plants to cover the United States, basically. And so, from those two plants, we have two options. It depends on how the consumer buys the bed. If it's UPS, then the UPS trucks pick the product up at the hubs; I mean - I'm sorry; at the plants.

For all the home delivery, then you have to get that product out and then disseminate it to the homes. In the past, we did that through a series of over 100 cross docks. And so it was very inefficient shipping of product from a plant to a cross dock.

By consolidating to 13 hubs, then we can run full trucks between plants and those hubs, which does a couple things in terms of cost efficiency but also service and then in control of those products. So, the primary Phase-I objective here is controlling the product; better information about where the product is at all times and at actually a lower cost model.

It then sets up the foundation to go into the future and look at actually shortening some of our service times to our customers.

How many cross docks have been shuttered thus far and how many will be, ultimately, either consolidated or closed by the end of this first season?

Boy, I don't have the numbers exactly, but we have, as I said earlier, we have now opened 10 of the 13. And, with every one that we open, we close all of the cross docks in that area. So, at least, we are well over three quarters of the way through the process.

Great and when, approximately, did that integration begin?

The first one was opened, I believe, at the end of last year. And then, we've kind of been on a consistent path up until this point, with, again, three to go before the end of the third quarter, or the fourth quarter.

Okay. Also, could you maybe talk about some of the new comfort materials you'll be incorporating in the beds? For example, the temperature regulating materials, does that adjust to body temperature? Could you just walk us through the benefits there?

Yes. There are a couple of benefits to this new product line. One is we are using different foam - or comfort materials through the products. We use a product called Intralux, which is proprietary to Select Comfort. It's a latex-like foam. And that'll be in all of the beds, as well as a different quilting foam for the top.

And then on the fabrics, they are all upgraded for, particularly, breathability, and then two of the models do have -- well one of the models has a temperature regulating material, which is what your question was about, which actually does interact with your body's temperature. If you're hot it has the ability to reduce the temperature several degrees, which is noticeable. Then another one has proprietary material to Select Comfort, which really enhances the breathability of that product, and that's on our most popular. So we've got high expectations for both of those.

Then the other thing we didn't mention, I don't believe, in the call, was that we're bringing some of those proprietary materials into our accessory line as well. So it will be a total package going to the consumer.

That body temperature reducing capability, is that passive, does that require any work?

It's passive.

Okay. In terms of R&D, how much, on a percentage basis maybe, how much of the total goes toward non-mattress products, speaking of accessories?

Virtually none. As we buy, we outsource or purchase all of our accessory items, so our R&D is focused on bed and foundation development. We do have an investment in quality assurance and some other areas that support accessories, but the R&D line is toward beds.

One final housekeeping issue. Second quarter effective tax rate of 39.8% was higher than the 38 I was looking for. How should we think about the full year tax rate? Thanks.

You should think of the full year tax rate from about 38.4 rate, that's the year to date rate through the second quarter, and the increase really reflects the elimination of tax advantaged investments now that we're kind of into a net cash, slight debt position.

Thank you.

Our next question comes from Matt Nemer of Thomas Weisel Partners.

Hi, this is actually Kate Messmer for Matt Nemer. My first question, I was just wondering if you guys could provide any color on how the industry appears to be handling FR, if there was a high level of discounting around the deadline, and if that has continued, or if there are any specific types of mattresses or different mattress manufacturers that are being more aggressive with their discounting.

I think your question is a good one, in the way you asked it, because I'm not sure what you can ascribe to the FR transition versus market conditions. What we have seen is different levels of discounting rates by different manufacturers, different manufacturers focusing on different price point levels, and I think you've seen that in all of the industry trends. We have not changed our promotion policies as all really, we're still a percentage of sales basis, our historic spending level. We are focusing on the product quality and now the product news.

Okay. Just following up on that, have you seen many of the smaller manufacturers maybe cutting back on their production or any of the retailers struggling with this, trying to handle the transition.

You know we haven't so much seen that impact, but again, we're focusing more on our retail stores, and what we're doing in our retail stores.

Okay, great. And then my second question, this relates to your retail stores, do you have any data on how mall traffic has performed at your locations during the quarter? I was just curious if this might be a potential driver in relation to your under performance relative to the industry numbers.

I don't have that data, and the data that we do get is lagged by several months. I mean I think the general trend has not been for strong mall traffic, but I do not have updated data through the second quarter.

Okay, thanks. And then this is sort of a question on your sales and marketing expense. Even excluding media and D&A, I'm showing that these expenses were up about 395 basis points in the quarter versus up about 125 basis points last quarter. And I realize your comps went from negative 11 to negative 14, but it seems like a big move in some of those other sales and marketing expense items. Were there any one time items or anything to explain that?

No one time items in the quarter to speak of. The increases, primarily as you noted, it's the lower volume on what is a higher store base as well as some slightly higher media expenses. And as we noted on the call our approach tends to be we're investing for the long term, and so in those times we're going to see a little bit of that de-leverage, but I think we're confident we will get that back as we go forward and the growth resumes.

All right, great. Thanks so much.

Our next question comes from Steve Colbert of Canaccord Adams.

Hey guys, good afternoon. What share count is implied in your guidance?

The share count that is implied basically assumes share repurchases through what we have accomplished through July. So it's the share count at the end of the quarter, keeping in mind that the three million that we repurchased in the second quarter, it was purchased throughout the quarter so that's an averaging. And then as we noted another 1.2 million shares purchased in July. Beyond that it basically assumes kind of nominal levels. It does not assume any elevated level of repurchasing. I'm not saying we won't do that, it's not what we've incorporated into our guidance.

Okay. Can you give us the June ending share count number?

I can give you roughly a number, but I don't know like what share exercises were in the quarter. But the number would have been about 45.6 million outstanding, and then obviously added to that would be any exercises plus just the normal EPS share calculation adding back diluted effect of options and those types of things.

Okay that's helpful. Thanks. Then do you know the aggregate value of the store lease obligations? You mentioned you may want to pick up some leverage. What level of leverage would you be comfortable with if you did lean on that for the buy back?

The, I think that the aggregate value of the leases that we have outstanding is pretty similar to -- from kind of a capital view is very similar to what most retailers are, not exceedingly high or low, it's kind of in mid point. From the standpoint of debt willing to undertake, I think the only comment that I would make is that we do have a revolver outstanding for $100 million, and we do have the ability to increase that to $175 million, and that's been in place for over 12 months now.

Okay. And then finally if you could just make any comments on mix in the quarter, was it relative stable? What did you see there?

No significant change of mix in the quarter.

Okay, that's it for me. Thanks guys.

Our next question comes from Steve Denault from Northland Securities.

Good afternoon everybody. Hoping to get a little bit more clarity on a couple of things Jim. You made reference to your guidance implying, or enabling flattish comps to hit it. Are you referencing the back half of the year or the full year?

Referencing the back half of the year.

Okay. And correct me if I'm wrong here. It sounds like, from an improving comp standpoint that you reference, from an absolute basis it sounds like there's sequential improvement with the new product launches, but on a relative basis each given week relative to the prior week and the prior year I'm assuming it's still negative, but it's an improving trend. Is that correct?

Beyond what we've said I think we can't really say much more than that other than we were obviously in a very difficult situation in the first quarter and entering into the second quarter. As you noted, and as we noted in our call, we've seen improvement since that time. To get to the low end of the guidance we don't need much more than kind of a flat typish comp for the back half of the year. But beyond that there's not much more I can comment on with regard to the absolute comp level at this point.

Okay. And one final question. It sounds like the new media message is being reconfigured and you hopefully have of it cleared up by the end of the year. Between now and then what will consumers see via television? What will the message be?

TV Steve, what we're doing is going to the original Sleep Number campaign that has been proven, and then there is some of the Dreams campaign that we've got still in a couple of different markets. Importantly, as I mentioned in my notes, we have found a way to go on a more national basis and that original 30 second Sleep Number campaign had not been seen other than in our local markets. So by going national we're hitting a significant number of customers for the first time with that campaign. Then the same message is going into the markets that we're local marketing, if that makes sense.

No, that does make sense. So I'm trying to remember, what did people tend to see on a national basis, what message was it?

It was really, on a national basis all they were getting before was the Lindsey Wagner infomercials.

Oh, okay. That's helpful. Thank you.

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

Good afternoon everyone. Can you comment, to follow that up a little bit, can you comment in terms of the temperature, the new products in terms of body temperature, are you going to advertise that nationally? Or what's your marketing plans for that product differentiation?

Well first of all, if I step back a little bit, this is the third improvement of the product line that we've made in the last seven years. The other product improvements we've always just rolled out and relied on in store marketing. This will be the first time we have supported our new product launch with marketing, and it's because we've really got significant improvements to talk about that make sense to the consumers.

We will be doing this through all of the newspaper and radio, and then some of the national TV will be tagged. So some of the national Lindsey Wagner infomercials will be tagged, talking about product news.

Okay. And this is the first time you've supported new product news with this type of marketing?

Yes.

Okay, what has been, in terms of previous product improvements in terms of up tick by the consumer? I mean how quickly do you know -- I'm just trying to get a sense of reaction time in terms of what you see. How long can you tell if it's working?

Well this gets to a relative versus an absolute basis, because the nice thing about having your own stores is you hear pretty quickly, especially if it's not working. The early read on the top two models that we've launched has been very, very favorable. From an absolute, what's the absolute lift basis that I don't really know. That could take months to really --

And what I would add is, kind of going back to Bill's comments earlier, we have done product refreshes in the past, but not to the significance of this type, through our R&D teams, product development teams have really done a great job of identifying some things that we believe are meaningful to the customer. And in the past it's been a little bit more superficial. So I think we're encouraged certainly, excited to kind of see what the response is.

And how long have those new products been in all of the stores, just (inaudible)?

Well, the top two models, the 7000 and the 9000, were mid-June. And the bulk of the line, the 3000, 4000 and the 5000 will be in the stores by August 1st.

Okay. And so, if you - pardon me?

No. They are not in the stores now. They will be put in the stores by August 1st.

So, when you had referenced improving sales trends through, you know, later June and into July, and you look back at what's changed, say, vs. two or three months ago, I mean, are the new products the biggest reason for that change? Or, what would you ascribe the improvement to be? And, would you ascribe that improvement to be more material?

No, I think it gets down to some product influence, certainly, with our sales force able to talk about those two new products. I think Shelly and her team have done a great job getting refocused on just what's the in-store message, the selling process; some tweaking of the promotional structure.

It's really back to an earlier question on execution and we're executing much better in our stores and we now have that product to talk about. But the full effect of it, really, we won't know until after the August launch.

Okay, and final question; on the body-regulating product, is that something you could buy as an accessory? Or, do you have to buy it with one of the new models?

It will be launched as an accessory mattress pad and some pillow protectors as well to help with that.

And when will that occur?

That's in August as well.

Okay, thank you.

Our next question comes from Edward Yruma, of J.P. Morgan.

Hi, thanks very much for taking my question. Can you talk a little bit - I'm very interested in your improvement in sales trends. I know you talked about it a bit but can you talk about the gross margin trends in your quarter? Did you say commensurate with compression gross margins as maybe you promoted a little bit more toward the tail end of the quarter?

We really haven't changed a promotion dollar that we're spending against the sales. As Bill said, we've made some adjustments to the promotions but that's really coordination, timing, communication; those types of things.

And, you know, we've tested a few different things but we're not spending additional dollars vs. what we've done historically against those types of promotional efforts.

Got you. I think, in the past, you pointed to a 10-to-15 point difference between kind of the gross margins on a 3000, vs. the 9000. Has added material and content to the 7000 and 9000 changed that margin profile?

No. We still have pretty dramatically better margins on the upper end than we have on the entry (level).

Got you. One final question; I notice that the contribution from your stores is one of the lowest, I think, through the first quarter of '06. Has there been any change in the maturation profile of your new stores? And, do you see that changing going forward? Thank you.

No, I think the sales trends really are affected by the selling process and the marketing. I continue to believe we don't have a (immature) market or store. It's really just about our execution in those different markets.

Great; thank you.

Our next question comes from Jack Murphy of William Blair.

Afternoon; I wonder if you could talk a little bit about the retail partner program, any changes that are taking place there? And the drag that you've seen from that in prior quarters, has that been trending down at all? Is that improving?

No real changes, at this point from the overall performance of the program. So, I don't think there's anything really new from that standpoint.

Okay and you also just briefly mentioned, toward the end, I think, of Bill's remarks about the SAP implementation. I wonder if you could give us a little more sense on timing and how you feel about cost, to date, on that and just sort of a forward look on when you might think, best guess, for completion on that?

Yes. A couple of comments on that; as we've said, we're still targeting early part of 2008. So, it'll be somewhere, most likely, in that second quarter. Costs, to date, are on track and we do not see any further write off potential at this time. We feel like we did a good job projecting that at the end of last year. But all the other costs are online.

Okay, thanks.

Our next question comes from John Baugh, of Stifel Nicolaus.

Thanks. Two things; is there going to be any impact from "discontinuing" the 3000, 4000, 5000 series? Or, would that be negligible?

Yes, one of the great things about our model, John, is we do make product just in time. So, there is really no write off exposure of finished goods products. There could be some cleanup of certain in-process material, but it would be very negligible.

Okay. And then, on the reworking the new campaign, obviously the last one didn't work. What are you going to do differently in terms of testing the program to, you know, before you "roll it out?" or go with it that you didn't do this last time? Or, how, in any measure, are you going to go through this process differently from the last?

Well, we've got a small team that I'm very, very actively involved in leading. Basically, we're going back to understand the essence of the sleep number campaign and focusing on spending a lot more time with consumers, understanding what it is they're looking for. And what we've learned so far, and it's really pretty straightforward, is that they're very interested and appreciative of the sleep number concept. So that the what is clear.

They don't understand how it works or where to go find it. And so, with that clear direction, I think we're in a lot better shape, going forward, in terms of figuring out the next phase of the campaign. And then we will be clearly testing with consumers as we go on to each stage of that.

Just to interrupt for one second; we have time for one or two more questions. So, Maggie, if you could hold it to one or two questions here.

Our next question comes from Greg McKinley of Dougherty.

Yes, thank you. Could you guys talk a little bit about how you're advertising and marketing campaign? Any changes around that, in terms of how you look at it supporting new stores and new markets, wholesale partners, vs. company-owned stores?

I know, there's going to be a bit of a message change, but is there any tactical change around actually supporting, you know, a market or a couple specific locations as they come online in a market?

Well, one other element of the new campaign that we are looking at, Greg, is clearly making consumers - helping consumers to be aware of our stores. A lot of our research is showing that over 50% of the people who are aware of a sleep number are not aware that we have stores. And so, a big part of the campaign has to be to call attention to the stores and the unique benefits that those stores offer.

In terms of local market development, or support of new store openings, we've already been doing a pretty good job of focusing local marketing efforts around new store openings. And that's been a big part of the success of our new store program.

With Shelly onboard and her team, we are starting to look at more market-by-market opportunities. But that'll come later, once we get the national program going in the direction we'd like it to.

Okay, and then, I know someone asked this earlier, but I just want to understand; what were your consumers seeing, from a marketing standpoint, both locally and nationally, of late? And then, what is - I know you mentioned the dreams campaign and the sleep number campaign, can you just run us through one more time, where were they seeing certain of your marketing messages? And how will that be shifting? I guess, by national vs. regional?

Again, nationally, you had, basically, the Lindsey Wagner Direct Campaign. And that continues to work well. But it never - but then, there were only 36 markets that had the local emphasis of TV or some of the other radio spots.

What we've now gone to is virtually everything is either national Lindsey or national the 30 second original sleep number spots with a couple of markets getting dreams, because we're trying to do some incremental learning on that. That's from a TV standpoint.

Then, you've got the national overlay of radio; you've got the local DJs and then, importantly, around the key promotional holidays, the Labor Day coming up as an example, is where we get into local newspaper and that's where we can really do a good job of store location, calling out store locations and we'll be hitting that hard.

Okay; thank you.

And our last question comes from Joan Storms of Wedbush Morgan.

Good afternoon; thank you. All right, I guess we've talked a lot about the marketing. So, I'm wondering what your differentiated retail strategy is going to be? And, if that's part of the problem?

I'm not sure there's a problem as much as there's an opportunity there, Joan. And that is that a lot of people don't understand - aren't aware of where to buy a sleep number bed. Particularly, if, on a national basis, all they had seen was our direct marketing on TV, they didn't know that we had stores. And so that - the big opportunity is to bring awareness to the stores. And then, once in the stores, we've got great product; great sales people.

And, here the new product design that Jim talked about, we believe, has a lot of opportunity to take that unique in-store experience even up a notch. And, we'll talk about that more in the Analyst Day next week.

Okay and then the new products that are coming out, the accessories, those new private label products, those will be out in the stores in August?

Yes. I don't know what you're referring to on the private label side. We don't have a private label; it's all Select Comfort products. But, the new bedding line will be complete in the markets in August. The top two models are already in the market. And then the accessories will be in the market in August as well.

Okay. I want to say, like, on the marketing thing, I mean, the old sleep number commercials, I think, we see them all the time in L.A. I mean, I don't know where they're going in New York, but it sort of catches your attention. (Inaudible).

Yes. Well, it's when we got back into this and started to assess what our options were for really reestablishing the growth path that we believe we can be on, we look at that early campaign as very effective. And that's what we are going to be building from, as we go forward here.

Well excellent. Thank you very much.

Okay. Thank you all for your attention.

I would now like to turn the conference back over to Mr. Kimball for any closing remarks.

We would just like to thank you all for joining us and we look forward to the call next quarter. Thank you very much.

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