Sleep Number Corp (SNBR) 2014 Q3 法說會逐字稿

Welcome to Select Comfort's Q3 2014 earnings conference call. (Operator Instructions). Today's call is being recorded. If anyone has any objections, you may disconnect at this time.

I would now like to introduce Dave Schwantes, Senior Director of Investor Relations. Thank you. You may begin.

Thank you, Angie. Good afternoon, and welcome to Select Comfort Corporation third-quarter 2014 earnings conference call. Thank you for joining us. I am Dave Schwantes, Senior Director of Investor Relations. With me today are Shelly Ibach, our President and CEO; and David Callen, our Senior Vice President and CFO.

This telephone conference is being recorded, and will be available on our website at SleepNumber.com. Please refer to the details in our news release to access the replay.

Please also refer to our news release where a reconciliation of certain non-GAAP financial measures, included in the news release or that may be discussed on this call. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and 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 news 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 Shelly for her comments.

Thank you, Dave. Good afternoon, everyone. Last night, my SleepIQ score was an 85. Our performance in the third quarter reflects the power of our consumer-driven innovation strategy. Revenues in the quarter grew 23% to $323 million. Comparable store sales grew 16%, and earnings per share increased 22% to $0.44.

The investment in our integrated model of proprietary sleep innovations, exclusive distribution, and end-to-end customer experience are beginning to show their potential. This is encouraging, and we expect that the initiatives we are implementing will further improve our profitability.

We also expect that our strategy will lead to superior financial results as we execute on a larger scale. Today I will highlight the progress we have made against our growth initiatives, and then outline our capital allocation priorities.

Let's begin with product innovation. Late in the second quarter, we introduced SleepIQ technology nationwide, across our entire mattress line. SleepIQ works directly with our DualAir chambers, integrating knowledge with adjustability. This integration is at the sweet spot of consumer technology trends, and a great illustration of how we are distancing ourselves from traditional transactional mattress peers.

We are using connectivity through technology to fundamentally increase the differentiated benefits we offer our customers. We are taking the concept of individualizing sleep experiences to another level. While we are still in the early days of our technology innovation, consumer response has been enthusiastic. We expect continued progress to result in significant value creation for our shareholders.

In the third quarter, sales of our new products and core Sleep Number beds exceeded internal expectations. Average revenue per mattress unit, ARU, grew 13% versus prior year to $3,733. And Company-controlled mattress units grew 10% versus prior year, including positive comp unit growth.

The role of our innovation is to strengthen the core bed portfolio; and, together, they build our differentiated platform of individualized comfort. The Sleep Number Bed was recently highlighted as one of the best of 2014 products and brands by a leading consumer magazine. The report spoke to our consumer benefits, and gave us both a Best Value and Best Buy award.

A key attribute of our strategy is that we are able to achieve growth from either ARU or units; and, ideally, from the combination of the two, as we experienced this quarter. Our average revenue per mattress unit, or ARU, measures our consumers' response to our product innovations and retail experience. It is comprised of Company-controlled channel sales from all our products, divided by mattress units.

Specifically, ARU include sales of the mattress, FlexFit adjustable base, and Sleep Number bedding collection. It also includes pricing, which is generally associated with new product features and/or benefits.

Our 13% ARU growth reflects 4 points of pricing and the impact of the most robust array of product innovations in our history. We see unit growth as an indicator of our marketing effectiveness in driving traffic to our brand, and we expect quarterly fluctuations resulting from our promotional strategy and macroeconomic conditions. We are committed to growing unit share, which today is less than 2% of industry units.

Looking to the fourth quarter, we are expanding our SleepIQ technology platform beyond iOS to also be compatible with Android devices. In addition, as of November 3, SleepIQ technology will be available for $499 to current customers who purchased their Sleep Number bed after 2008.

Moving to our second growth initiative, we again advanced our marketing effectiveness. Results exceeded internal expectations for both traffic and advertising leverage. The combination of our new Know Better Sleep campaign and improved media buying has been effective in reaching our broader target customer.

Unique visitors to our website were up 46% for the quarter, which translated to growth in store traffic, units, and revenue. We increased media spending by 9% in the quarter, while leveraging media 170 basis points over prior-year. While we are continuing these marketing initiatives in the fourth quarter, we remain cautious about this consumer period, which has been particularly challenging for us the past two years.

Finally, we continue to benefit from our exclusive distribution development. We had same-store comp growth of 16%, while new stores added 8 points of growth in the third quarter. Increasing average sales per store is a key source of sustainable, profitable growth for our Company. We have built brand equity through remodels, expansions, and relocations while growing our store base.

Improving our real estate footprint has contributed to delivering record sales of $2.2 million per comp store for the trailing 12 months. In fact, our sales per square foot productivity ranks in the top 10 of all US retailers, at over $1,000 per foot. This is a strong achievement when you consider that we have increased our average store size by over 38% to 2,200 square feet versus two years ago.

In short, our growth initiatives are hitting the mark. Our results demonstrate the importance of targeted investments in two ways: first, when we advertise effectively and deliver innovations that matter, consumers respond. Second, as we continue to scale our business, our legacy infrastructure is not sufficiently agile to handle accelerated growth with precision and speed. This was evident in the quarter, as our demand grew beyond expectations. Our supply chain processes require too much manual intervention, and impacted some of our customers in the quarter.

This is an important area of opportunity for us. To that end, we are midway through a multi-year ERP implementation that will deliver an agile infrastructure for scale. Importantly, our organic growth prospects enable us to self-fund these critical infrastructure improvements while still maintaining capital priorities and driving profit growth.

Recognizing the progress in our strategy and our shareholder viewpoints, we recently completed a thorough review of our capital structure in conjunction with our Board and independent financial advisers. We are committed to finding the right balance between growing the business, returning capital to shareholders, and managing risk in uncertain environments. Bottom line: our goal is to drive shareholder value on both a short- and long-term basis.

With that in mind, our priorities for use of cash are as follows. Our number-one priority remains to invest in our innovation roadmap and a scalable infrastructure. We expect our disciplined deployment of investments will deliver improving returns on invested capital, which is projected to be in the mid-teens for the next 3 to 5 years.

Our second priority for cash is to maintain a minimum of $100 million cash and securities, net of customer deposits. This will provide adequate liquidity to enable us to meet our operating needs, including long-term lease commitments; continue to invest in our strategic growth initiatives, even in the face of an economic downturn; and pursue strategic opportunities as they may arise.

Our third priority is returning cash to shareholders through an ongoing flexible stock repurchase program. We understand the importance of capital return to our shareholders, and have increased our share buyback authorization to $250 million. In addition, we plan to increase our ongoing share buyback activity by as much as 50% beginning in the fourth quarter. With the consumer's responsiveness to our strategy, we see value in our shares.

In summary, the combination of proprietary innovations and an exclusive shopping experience are powerful differentiators. We expect our strengthening results to build market share and sustain profitable growth.

Here are five reasons why: our customer relationship leads to benefit-driven innovations that are additive to our core business. Our national scale is resulting in advertising efficiency and increased traffic. Our customer experience and selling process continue to result in high conversion. Our highly productive stores continue to increase average sales and profit per store as we fill in new locations. Our customer loyalty continues to be a strength and outcome of our vertical model.

With that, I will turn the call over to David to highlight additional financial details from the quarter, and provide perspective on our fourth-quarter outlook.

Thank you, Shelly. Good afternoon, everyone. As Shelly discussed, our record sales of $323 million in the third quarter represents 23% growth over the prior year. Earnings per diluted share grew 22% over the prior year to $0.44. Results were ahead of internal expectations, and as anticipated, returned us to year-over-year bottom-line growth.

We are strengthening our long-term relationships with our customers through connectivity, like SleepIQ technology. Our customers now interact with our brand every day, which is a powerful advantage. This ongoing exchange with our customers through SleepIQ is creating a growing source of future income.

While generating cash immediately, SleepIQ revenues and certain direct costs are deferred to our balance sheet. As a result, our third-quarter reported net sales exclude $4 million of SleepIQ technology sales, and $0.02 of earnings per share. The deferrals will be recognized over the useful life of the product, currently estimated to be five years. Our comments and metrics going forward reflect these deferrals.

Comp store sales grew 16% over the prior year in Q3, and new stores added 8% of the growth in the quarter. Both metrics accelerated from the second quarter, and demonstrate how the disciplined spending and investments in key growth initiatives are driving shareholder value.

Traffic to our stores also improved during the quarter, which drove a 10% increase in deliveries of our Company-controlled mattress units. Our trailing-12-month sales per comp store grew to a record $2.2 million. While a $2.2 million store delivers four-wall profit of approximately $800,000, a $3 million store contributes profits of approximately $1.2 million.

We continue to target average sales per store of $3 million in more than 550 stores in the United States, while strengthening our online customer experience. 14% of our stores currently generate greater than $3 million in annual sales compared to 10% a year ago. In the third quarter we entered three new markets, including one additional state, while developing 13 of our existing markets. Total store actions included 10 new stores, three remodels and expansions, and three relocations. We ended the quarter with 460 stores, and plan to end 2014 with 463 stores.

Our disciplined, market-based development approach leads to market share gains and sustainable, profitable growth. Our site selection process combines art with science, utilizing our proprietary customer prospecting model to evaluate each market. This process contributes to increasing productivity of existing stores while adding new stores, with cannibalization rates of less than 20%. Over the past three years we have increased our average sales per comp store 38%, while improving the real estate and store experience of over 250 stores. We continue to achieve a payback on our new store actions of approximately 2 years.

Gross profit of $199 million for the quarter grew 19% on record sales. A higher mix of our new FlexFit adjustable base series contributed meaningfully to the gross profit growth, and to our 61.4% gross margin rate. While up 70 basis points sequentially, gross margin was 50 basis points lower than expected. High demand in the quarter strained our legacy infrastructure and supply chain. Our team worked heroically, but inefficient manual processes are impacting the business as we scale. These constraints underscore the importance of building new capabilities and systems.

We are midway through a multi-year plan to build key business processes and to replace our nearly 20-year-old core operating system. This is a large undertaking that will support the key processes of our vertically integrated business for many years to come. Approximately $30 million of our $80 million in capital spending this year is to support this project.

Our 2015 guidance, which we will provide next quarter, will include estimates for CapEx, launch costs, and depreciation associated with this implementation. We plan to go live with our new technology platforms one year from now. This infrastructure is critical to enable scale for growth by streamlining our operations, and therefore improving our customers' experience.

We expect our Q4 gross margin rate to be slightly better than Q4 last year. Improvements to processes will benefit the business in 2015 and accelerate in 2016 as our new systems and related processes mature.

Total operating expenses of $163 million leveraged 100 basis points as a percentage of net sales during the quarter to 50.5%. Sales and marketing expenses of $138 million, or 42.6% of net sales, were levered 230 basis points versus the prior year. This included the higher-than-expected 170 basis points of leverage from media spending. We expect Q4 media leverage to be less than Q3.

Remaining operating expenses for the quarter of $25 million, or 7.8% of net sales, deleveraged by 120 basis points as a percent of net sales, compared to the prior year. This spending increase reflects our efforts to build the infrastructure to support our growing business. We expect similar G&A and R&D spending in Q4 to Q3.

Diluted earnings per share for the third quarter were $0.44, up 22% versus $0.36 the prior year. We raised our 2014 full-year EPS outlook to $1.12 from $1.07 previously. Please keep in mind that the 53rd week this fiscal year adds an estimated $0.05 of EPS in the fourth quarter. Excluding the 53rd week, the implied fourth-quarter EPS would reflect a 42% growth over the prior year.

Our new outlook reflects strong customer response to our marketing, product innovation, and store experience, balanced with continued gross margin impacts from sourced products and process inefficiencies; continued investment and spending on growth drivers, operating capabilities, and infrastructure, including our new ERP platforms, to sustainably support our growth; and appropriate caution in the fourth quarter, given the continued mixed signals regarding the overall macroeconomic environment and a less predictable consumer period.

Year-to-date, we have generated $136 million in cash from operations compared to $90 million the prior year to date. We ended this seasonally high cash quarter with $177 million in cash and securities, or $148 million, net of customer prepayments. Our $49 million in inventories ended lower than we expected. To support our initiatives, we plan to increase our inventories to approximately $55 million by the end of 2014. Cash and securities, net of customer deposits, are expected to be approximately $15 million lower than the prior year-end.

During the quarter, we thoroughly reviewed our capital structure in conjunction with near-term and long-range strategic and financial plans. This includes consideration of capital spending plans and $250 million in operating lease commitments. With the goal of superior value creation over time, we aligned on the cash deployment priorities Shelly outlined today. We concluded that our capital structure and plans are appropriate to provide strong returns to shareholders as we execute our organic growth strategy. This structure and strategy have enabled us to invest in the business while returning $100 million, or nearly 100%, of our free cash flows to shareholders since our share repurchase program began in Q2 of 2012.

The confidence we have in our plans is illustrated by the increased $250 million share repurchase authorization, and our commitment to repurchase up to $60 million of our outstanding shares per year.

It is gratifying to see the strong results arising from the hard work of our Sleep Number team. That said, we have significant opportunities ahead. We expect our disciplined investment and spending approach to deliver sustainable, profitable growth.

With that, I will turn the call back to Shelly for closing comments.

I'd like to close by thanking our Sleep Number team for their unwavering dedication to our mission of improving lives by individualizing sleep experiences. The third-quarter performance begins to reflect the impact of our growth initiatives. We expect our consumer-focused innovation strategy and capital priorities to deliver sustainable value for shareholders.

We appreciate your attention. David and I now welcome your questions.

Angie, would you please open the line for questions?

(Operator Instructions). Josh Borstein, Longbow.

Congrats on a nice quarter here. Just to begin, most impressively, you returned to positive unit growth on a same-store sales basis, I think for the first time in seven quarters. What has changed for you? To what do you attribute the turnaround to? And can we expect positive unit growth in 4Q as well?

Hi, Josh. As we have communicated, we see units tied to generating traffic, which comes from marketing effectiveness. And we have progressed our growth initiatives, marketing effectiveness, each and every quarter this year. And the third quarter represents the advancements of our effectiveness. It's a combination of our creative, along with our media buying. And we see the marketing effectiveness result in traffic, which generates units. Therefore, we had the 10% unit growth and the comp positive unit growth.

As we think about the fourth quarter, we -- on the top line, as we look at fourth quarter, we are looking at a 20% or greater sales increase. And of course, that's inclusive of the 53rd week, which we estimate to be about 8% of growth. At the same time, we are being prudent, because we had a more challenging time in the fourth quarter. It's a less predictable consumer time period for our business. And we've yet to prove out our initiatives in being able to drive unit growth in this time period.

We remain very confident in the ARU growth, with the innovations that we've put forth this year. And we're anxious to learn how our marketing initiatives will apply to traffic during the fourth quarter; and, therefore, unit growth.

Okay, thank you. I appreciate the color there. And then just a question on gross margin. You talked about the gross margin being driven lower by mix, and also the higher logistics costs to meet the increased demand. Could you break out how much was due to logistics, and if you expect that to repeat here in 4Q?

Sure. We see the impact from the logistics costs as being about 50 basis points in the quarter. We are expecting our Q4 gross margin to be slightly better than Q4 last year, as we expect some of that pressure to continue into the fourth quarter this year, and expect some improvements in our processes to help us in 2015 and beyond.

Okay. And the negative mix issue from the increase in bases, obviously it's a good problem to have; may bring the rate down, but brings your dollars up. Is there something structurally different, do you think, with gross margin going forward, now that people seem to be buying more bases?

So, you're right. The 19% increase in our gross profit dollars was directly tied to the growth that we're having, which is driven largely by our FlexFit adjustable bases, as we commented on. So, we're expecting that we'll be able to continue that trend going forward.

Great. I will defer to others. Thanks again, and good luck.

John Baugh, Stifel.

Thank you, and my congratulations as well. Nice quarter. Questions, let's see. First of all, I noticed customer deposits were up almost twice last year at the end of the quarter. Does that indicate some additional strength later in the quarter? Or help me to understand that number.

Hey, John, thanks for the question. We, as we talked about, some of the high demand we saw the third quarter impacted some of our lead times, our delivery times. But the customer deposits reflect a very short window of our business, and it's not correlated to sales growth in the next quarter.

Okay. What were the new markets you entered? You mentioned, I think, three. And help us think about store openings, by market, going forward.

We're going to have to get back to you on the specific locations, John. We'll take that off-line.

Okay. Any update, Shelly, on brand and store awareness? I know how key that is to driving traffic. It sounds like those numbers maybe got better. Anything you can give us?

Yes, John. We're in-market with that study right now. The last read we had on our brand unaided awareness, which is probably the number you're asking about, was in January of this year, and it was 20. We certainly have strong metrics around brand regard with the business. But they are smaller metrics.

Understood. And then back on the gross margin question, you gave us help on some of the inefficiencies. And those, I guess, will mitigate through time. But is there any kind of guide relative to the 62% to 64% range you've been the last couple of years prior to this year, in terms of all of these -- SleepIQ things, adjustables -- all these things are impacting that number. In terms of a goal to think about longer-range where you'd like to get back to, once the inefficiencies are behind you?

John, we've been talking about the importance of the gross profit dollars; and gross margin rate is also important to us. We expect some improvement in that area, but we're not providing longer-term guidance in that regard. What we are providing is some perspective that we're expecting our returns on invested capital over time to increase to the mid-teens from the 15% we saw last year.

John, one other thing to think about regarding gross margin, because you are right -- our business is evolving, and it's an important evolution. The innovations that we're bringing forth all attach back to our core bed line. So they are additive in the area of ARU, and you are seeing that in our ARU growth. But they also stimulate the core business, and you can see that in our repeat and reverse sales. And you know the strength of the margin with the core business. So when we can build the business in an additive way, that's a good, healthy opportunity and challenge for us. And we're pretty pleased with what that looks like going forward.

And then, ultimately, as we improve our infrastructure, where we are experiencing some margin pressure right now -- like the 50 basis points that we didn't expect here in the quarter -- that will come back to us as we install our ERP, and begin to benefit in 2016 from that install and the agility that we have with the new systems.

Thanks for taking my questions, and good luck.

Budd Bugatch, Raymond James.

Let me ask just a couple of detailed questions. David, any accrual for incentive comp above what you would have originally expected for the year in -- I guess it would be in G&A, if I'm not mistaken, or maybe it's all through a couple of other expense buckets, too.

Sure, Budd. With the higher-than-expected performance, there has been some incremental Company-wide incentive compensation accrual. It amounted to about $0.01 in (multiple speakers).

About $0.01, okay. And is there a way to walk through the gross margin change? I know you gave us the 50 basis points. I think gross margin was down -- I think -- it was about 170 basis points or -- from year-over-year. Can we get a walk from that? And are there other items in terms of what the mix ratio was, and some of the other factors?

Sure, Budd. That's largely driven by the higher mix of our FlexFit adjustable bases.

So has that got any -- so that is pretty much the entire balance?

Yes, exactly, beyond the 50 basis points we talked about already.

Okay, terrific. That's good. And the attachment rate, it's got to be some impressive number on that FlexFit. I'd hazard a guess, but I'm singeing my own eyebrows out. What can you say about the attachment rate? Is it the highest ever, Shelly?

Budd, I think this is a great example of the power of innovative products and our exclusive shopping environment.

Okay (laughter).

So, yes, that's high.

Okay, fine. And I guess, finally for me, is you said 550 stores. Any timeframe on that? And what's the percentage now of stores on-mall, off-mall?

Regarding the on-mall, we ended -- non-mall stores at the end of the third quarter were 38%. We're expecting that to be about 40% by the time we get to the end of the year. And we haven't given timeline guidance for the 550.

Okay. And if I heard Shelly right, the revenue guess for the fourth quarter is in the $275 million to $280 million range, up 20% versus year-over-year or something. Is that the way we heard that?

Yes, Budd.

Okay.

We're calling that at least a 20% --.

Okay. Allrighty. Thank you very much, and good luck on the rest of the year.

Jessica Mace, Nomura Securities.

Congratulations on a great quarter. My first question is about a comment you made regarding the mixed signals from the overall consumer environment. And I was wondering if you could talk about your strong results in the context of that environment, and maybe any factors that might point us to market share gains.

And then as a follow-up to that, I know you were up against some promotions or some significant discounts from last quarter in this quarter, and any moving pieces we should be aware of going into next quarter.

Yes, sure. Thanks, Jessica. Regarding the macro, we all hear the news every day. And there are amount of different macroeconomic indicators out there that lead to both confidence and caution. And we view the fourth quarter having been a little less predictable these last two years regarding specific consumer behavior. But at the same time, we are confident in our growth initiatives, and we look forward to applying them to the fourth quarter, and specifically being able to read them in this different environment that does not possess a major market share event.

Having said that, our trends in the third quarter -- and we had strong performance throughout the quarter, and certainly very much so in the 21-day Labor Day event period. So we've had strong growth throughout, and our traffic has resulted from our marketing effectiveness and the advancements we've made there. So we, on the flip side, have strong confidence going into the quarter. But it's yet to be proven in this different type of environment.

The last part of your question was around, did we take market share? We certainly anticipate that we did. We've yet to hear from some of our other peers. We will know more here in the next couple of weeks. But we would expect that our 16% comp at retail would be one of the top retail performances.

Great. Thank you very much. My second question is just on the comment you made about the logistics in the quarter, and the 50 basis points that you should get back over time. When you say that the ERP platform will go live a year from now, is there any way for us to think about, from now until then, how we can think about those logistical issues? Thanks again.

I think one way to think about it would be our guidance on March, on here, for the fourth quarter, that we expect it to be slightly up from prior year.

I wanted to let John Baugh know that the three locations that we opened in the quarter -- new markets that we opened were in El Paso, Texas; Columbus, Mississippi; and Cheyenne, Wyoming, which is the first one in that state, which made our 47th state that we're in.

Brad Thomas, KeyBanc.

Let me add my congratulations, as well, on a great quarter here. I want to just follow up on the question about the investments and the systems. And I think you answered it in the previous question, but just to follow up more directly, what are the points here that we'll start to see some return on these investments, and some capabilities that you can start to leverage, rather than perhaps them offsetting quarters like this where you have trouble fulfilling all of the orders, for example?

Yes, thanks, Brad. It's an important question, and it's something that was important to me when I first joined Select Comfort. It's a large project, and one that I really wanted to get my hands around. The primary objectives for the project, the reasons for doing it, aren't so much about the returns on the investment, though they will help deliver those over time, along with the improved ROICs that I talked about earlier. But they are really to help us establish the kind of agility that we need as we scale this business.

They are enablers, they are process improvers, but we definitely see the opportunity for us to gain efficiencies. But those are really going to come primarily in 2016 and beyond, as we mature those systems and the processes that go along with it.

Great. And then regarding the investments, I know you're not ready to give formal guidance yet for 2015. But just if we try to think about it directionally, could you maybe characterize 2015, and if it's a year where maybe there some moderation year-over-year in the rate of investment growth? Or do you think there's another step-up and another incremental drag that we could get on earnings? If you are in a position, we would love any comments you can make on 2015.

Sure. We are expecting similar CapEx investments in 2015 as we have in 2014, which is the $80 million that we've highlighted.

And, again, they will be supporting primarily both stores as well as the infrastructure we spoke to.

Great. And then just one more housekeeping item, if I could. Could you comment a little bit more about SleepIQ? And do you have any color that you could give on the attachment rate, or how much that's adding to sales would be wonderful.

Well, first of all, our customer is excited about SleepIQ. It's a wonderful thing to be able to understand exactly how you slept the night before, and to have a bed that you can adjust in correlation with that knowledge, and to be able to make other adjustments in your life to be able to improve your quality of sleep. SleepIQ provides that specific information to consumers so that they know what they can do.

So, very strong consumer feedback. While we don't speak specifically to the attach of any one of our innovations, we're quite pleased with the role that SleepIQ is playing for both the business and in the consumer's life, and their response.

Great, thanks so much.

Peter Keith, Piper.

Great quarter. Shelly, I wanted to ask about your comment regarding the marketing effectiveness. Clearly, something has changed here in the quarter, where we love the positive unit comp; traffic has gotten better. You are attributing it to marketing effectiveness. Can you give us an idea of maybe how it became more effective? Did something change within the marketing? A little more detail there would be helpful.

Sure, Peter. This really goes back to what we've been -- everything we've been talking about all year. So, starting in January, at the very beginning of January, we put in test around our media buying, as well as launched our new creative. And each quarter we've been advancing both the creative and our media buying with our learnings. And as we moved into the third quarter, we had six months of learnings under our belt and progressed the media buy, as well as increased the media buy by 9% in the quarter.

And as you know, we have also increased our leverage each quarter to speaking to that effectiveness. The third quarter was the result of the continued advancement. A couple of other specifics around that media that I can add, Peter. If you recall, over a year ago, we added some strong analytics that helps us with the predictability of our media buy, and how the weight that we're placing on each media type. So that's been an underlying source of the testing and learning and advancing. And we've become quite proficient at what that mix looks like in combination with more effective creative.

Regarding the specific creative, the creative is effective in reaching our broad target. So all segments of our target are responding to the creative, which features our innovations.

Okay. That's helpful detail. Thank you. And then I wanted to ask about the ARU increase, up 13%. It's impressive. It was up a lot in Q2. Could you give us an understanding about what are the key drivers behind that, so we can understand maybe the go-forward trend better?

Sure. When you dimensionalize the sales, looking at the ARU and the units, you can see that our growth is coming from both our innovations as well as our traffic: 13% from innovations, including 4 points of pricing, and then 10% from the increased traffic. Again, last quarter, we also had strong ARU growth. You can see the actual dollar amount of average revenue per unit increased again this quarter. We're now over $3,700. And last quarter's growth included 6 points of pricing, while this quarter included 4. So the accelerated dollar growth is really coming from the innovations. And keep in mind, we introduced the majority of our innovations in Q2. SleepIQ came in at the end of Q2; but, of course, that's not in this number.

Yes. To make sure I've got the numbers right, so it was 6% pricing benefit in Q3?

No, in Q2.

Q2, okay, that's what I -- (multiple speakers). 4% in Q3; and so, with a 13% ARU gain, that the balance was innovations like SleepIQ.

Correct.

Well, yes. SleepIQ (multiple speakers) not in the number, so it would be the remaining innovations.

Right. As we talked about, the SleepIQ is deferred. The revenue from SleepIQ is deferred to our balance sheet.

It's primarily related to FlexFit, FlexTop, the other innovations that we've been introducing this year. And of course, as I stated, SleepIQ plays a role in stimulating the overall core mattress line, as well. And we're really pleased with our overall mix in the Classic Series, the Performance Series, and the Innovation Series, including the x12.

Okay, that's great detail. I appreciate it. And I wanted to get one question into David. So you're clearly not talking about out-year guidance, which is understandable. But -- so you talked about maybe there are some changes in the mix in the business. Can we think about how the business is ramping to a contribution margin going forward? It seems like you are starting to get better on that metric. How can we think about that settling out, looking out 12 months?

Well, we've talked to the expectations for Q4 at this point, and we're expecting a meaningfully larger contribution margin in Q4. But we, as you pointed out, aren't talking about guidance for 2015 and beyond at this point, but we'll certainly provide that next quarter.

Okay. That's fair enough. Thanks a lot, and congratulations.

(Operator Instructions). Keith Hughes, SunTrust.

A couple of questions. The deferral of income and expenses on SleepIQ, is that just for this quarter, or does that continue in future periods?

The long-term relationship that we have with our customer, and the ongoing exchange of information with them is resulting in the accounting treatment of -- we have multiple deliverable accounting. And so the ongoing revenue will be deferred. We are expecting the useful life of the deferral, at the moment, to be five years. But that it will evolve and be trued up as we learn.

And so it will just come out ratably during that period. Is that correct?

That's correct, yes. And it's creating a long-term source of income for the Company.

When will it start to come back on as revenue? Will that start as early as the fourth quarter?

It has already started. But because it's a five-year deferral, the amount isn't that meaningful at this point.

Okay. It looks like you are going to grow the store base about 5% or so this year. I know you have a 550 (technical difficulty). Is 5% a rough, rough growth rate we would see for the next year or two?

We're not commenting about the pace of adding our stores, but we do have that 550 target that we've commented on.

Okay. And looking (technical difficulty) many people have asked about the unit -- mattress unit growth. Is there any sort of metric you can give us around this pickup in units for you? How much of these various innovations -- or how much of the increased units are coming with those sort of sales attached to it? I don't want a percentage; but is it a large number, a small number? Something, anything would be helpful.

I think the best way to think about it would be that our units were up 10% in the quarter, while our average revenue per unit was up 13% in the quarter. So the attachment is growing while the unit growth is growing. And so there's a strong relationship there, which all ties back to the strength of our in-store experience and proprietary products.

I think the driver, in the questions that I know I'm getting, is that you've had that sales per unit number has been good really for the entire year. We've now just started seeing the units move in the direction you want them to move. What sort of happened in the third quarter?

Yes, again, we view the unit performance closely related to our marketing effectiveness. And we've been very diligent, starting well over a year ago, about progressing our marketing, both media buying and our creative. So we launched SleepIQ with new creatives at the end of June, just as we entered the third quarter. So this has been progressive, each and every quarter.

Okay, thank you.

Thank you. At this time, I'd like to hand the call back to the Company for closing remarks.

Thank you again for joining us today. We look forward to discussing our fourth-quarter performance with you early next year. Sleep well, and dream big.

Thank you. That does conclude today's conference. Thank you for your participation. You may now disconnect from the audio portion.