Welcome to Select Comfort’s Q1 2014 Earnings Conference Call. (Operator Instructions) Today’s conference call is being recorded. If anyone has any objections, you may disconnect at this time. And now I would like to introduce Mr. Dave Schwantes, Senior Director of Investor Relations. Thank you. You may begin.

Thank you. Good afternoon, and welcome to the Select Comfort Corporation first 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 new Senior Vice President and CFO. Since David only joined our company last week, Shelly will be handling the comments today. 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 for a reconciliation of certain non-GAAP financial measures included in the news release or that maybe discussed on this call. We acknowledge that markets are closed tomorrow and we apologize for any inconvenience that may cause you. Management will be available for investor calls this evening and all day tomorrow. 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.

Thanks, Dave. Good afternoon everyone and thank you for joining our first quarter earnings call. First, I would like to welcome our new CFO, David Callen. His financial and leadership experience at a vertically integrated company like Ethan Allen will be advantageous to us as we advance our strategic plans. I am also pleased to announce that Patricia Dirks has joined the Sleep Number team from Target Corporation to lead our human capital efforts. We are excited to have these two experienced business partners round out our strong senior management team. Our first quarter performance was consistent with our expectations in the outlook provided on our February call. As previously communicated, we expect full year 2014 EPS to be consistent with the prior year. We also indicated that expenses in investments associated with the most significant new product and marketing advancements in the company’s history would impact earnings in the first half of this year. These actions combined with our market development initiatives and systems infrastructure investments position the company for long-term profitable growth, as we strengthen our most important competitive advantages, proprietary products, exclusive distribution and end-to-end customer experience. I will start with a high level financial overview before providing an update on our business initiatives. Our net sales grew 7% to $276 million with EPS of $0.31. Comparable store sales increased 2% versus prior year. Company-controlled channel sales grew 9% comprised of an 8% increase in ASPs and 1% from mattress unit growth. On the February call, I highlighted our three strategic growth drivers, which includes product innovation, marketing effectiveness and local market development. I will begin with product innovation. As we discussed over the past year, a critical lynchpin of our strategy has been to invest in the product innovation and technology that deliver meaningful fleet benefits…

Thank you. (Operator Instructions) And our first question comes from Mr. Peter Keith, Piper Jaffray. Sir, your line is open.

Thank you. Actually, this is Jon Berg on for Peter Keith. Thanks a lot for taking our questions. Based on our pricing work, it looks like you have taken up prices really across the bedding line, but I guess this is a little bit surprising to us just given that it appears that your comp units appear to be down on a year-over-year basis. Are you comfortable with your units per store continuing to trend down even though you are taking price up?

Pricing is related to our ASP and we had an ASP growth of 8% in the quarter and that was on top of a 14% growth last year first quarter. The comp units, you are right, we had a 1% unit comp in the quarter, Jon and so that would translate to the comp units being down. Our initiatives of course are focused on improving unit growth as well as ASP growth. And that’s what we expect from our new media and marketing initiatives along with the product innovation.

Okay, that’s really helpful, Shelly. And looking at the beds, they look great by the way, too, but just thinking about those initiatives and kind of how they play out throughout this year, I mean, is there a quarter where you can really maybe point us to where you expect to see some kind of inflection in the comp units?

As I stated we just launched our new product innovations at the end of February and advanced our advertising campaign in early March, focused on those product innovations and we had our strongest month in both sales and units in the month of March. And we look forward to continuing to move forward with these initiatives and giving you an update after the second quarter.

Okay, thank you. And then just one last quick one, just forgetting about the extra week you have got in Q4, I guess how do you view the rest of the year from a comp comparison standpoint what quarter do you think you may have the most favorable comparison?

From a sales perspective we have been focused on 13 week trend and so one of our learning from last year with some of the volatility that we have been seeing is that year-over-year compare may not layout exactly as you would expect it to and I think the first quarter is probably a great example of that where none of us expected the tremendous amount of store closings that we had in the month of February and that would have been our easiest compare and in fact with all the unexpected weather implications that became our tougher month of the quarter. We see that heavily tied to the unexpected weather implications, so building off our 13 week trend we expected business to progress each quarter as the year unfolds with both the combination of our initiatives and the 53rd week.

Okay, great. Thanks a lot and good luck on the rest of the year.

Thanks, Jon.

And next we have Mr. John Baugh with Stifel. Your line is open.

Thank you and good afternoon. I have got several questions. I wonder if we could just start with a couple of balance sheet items inventories they were up not a lot invested I know in inventories, but they were up significantly year-over-year I think I calculated 44% and they were up 10% sequentially is there anything going on there Shelly?

Yes, the inventory increase is of course the normal actions of our stores, but it’s also heavily tied to the product set. And our turns continued to be very healthy and this is more of a timing issue with the product innovation sets and the backlog.

Okay. And likewise on payables they were significantly down year-over-year almost $17 million was that a timing incident or any changes in terms up there with any customers?

That was related to a timing…

So John, the biggest thing there is really just the timing of payments. This is Dave. So nothing really major there. A lot of this is where our payable cycles cuts off at the end of the quarter, so nothing real major difference.

And welcome Dave, thank you. Customer prepayments up 15% year-over-year that certainly implies that March was particularly strong as you commented, is that weather or is that the impact of the new product and marketing maybe both anyway to (decipher)?

Great question, John. This is where it’s difficult to tease out the individual variables some of it could be related to the weather recovery what I will share with you is we saw consistency, nice strong performance throughout the month and we did see a strong correlation with our brand metrics and our new advertisings with the product innovations.

Thank you. And then you opened 17 stores and closed 14 that’s a lot of action, is that just timing or should we think that you are going to get a little more aggressive with the off-mall openings and mall closings?

It was consistent with what our plan was John and this is part of our real estate strategy where we have been improving our real estate and executing many remodels as you can tell by the number of store actions of 114 from the past year yet only a net increase of about 30 stores. So we’ve been reallocating many locations and that would involve a close and open. Now when we reallocate within a mall that remain a common store, but when we move outside of a mall would be a close and open.

Okay. So is there anyway to think Shelly about a gross number for the year in terms of openings or moving to a different mall I guess would be included in that as well off-mall, but is there anyway to think about a gross number?

Yes. We expect between 460 and 470 stores by year end.

Okay. But is there anyway that’s a net number of closures. Is there anyway to get ahead around how many new ones are included in that net result?

Sure, 50 to 60.

Right. Thank you. And my final question is just I noticed in the 10-K that your sales people and/or support sales in terms of head count was down 3% year-over-year and your store count was up 7%. I was just curious is there any change in your staffing thoughts and/or any changes in the compensation methodology for sales people? Thank you.

Hi, John. This is actually Dave Schwantes not Dave Callen so just for the record. But so actually I think John the data point that you’re speaking to in the 10-K that we disclosed on head count is actually up 2% in terms of the store personnel and versus you mentioned the growth in store. So it was a little bit lower. I think we did have a little bit lower on average head count per store at the end of the year versus the prior year but it was consistent with our overall plan. So it was down on a head comp per store but it actually was up 2% year-over-year in terms of the total headcount.

And if you changed your compensation methodology at all?

No, it really tied more to being efficient with our dollars as we went into fourth quarter and holding on adding headcount.

Thank you, and good luck.

Thank you.

And our next question comes from Brad Thomas, KeyBanc Capital. Sir your line is open.

Hey great thanks. Good afternoon Shelly, good afternoon Dave. Just wanted to ask a few questions first on some of the line items of the model for this year? I think in the – at the fourth quarter call there had been guidance for the gross margin for the year to be flat to up. Is that still what you would expect Shelly?

Yes, hi Brad. We will have a better read on this certainly after second quarter, but for second quarter we expect 62 similar to Q1 probably in the range of 62% to 63% for the year, again, one of the better indications of how the new product innovations are mixing as we get through second quarter.

Okay. And then in terms of G&A I think the guidance before had been $80 million for the year. Is that a number you’re still thinking of?

Yes, still consistent with that number.

Okay. And I think you all had quantified about $7 million of incremental expense in the first half. Is that something you’re still looking for and give us s sense at how far we’re through that $7 million?

Yes, it was 7 - $6 million in Q1 and $2 million in Q2.

Okay, great. And then just the last high level question, someone else touched on this earlier but I think in a refresh of the CE line you’ve raised the price on the C3 and the C4 you’re kind of two of your three lowest price models. And so just in light of the fact that tickets have been still strong for you but the units haven’t been as strong. Maybe could you talk about what your opportunities are to maybe close more sales at those lower price points? Can you push on the promotional lever a little bit faster despite the fact that the list price is higher, how you’re thinking about customers, is they’re a little more sensitive with that price?

Right. Well I am glad you brought this question out, this is exactly right. We’re strengthening our value equation across the entire line while introducing the X12 at the high-end and bringing a lot of focus to the brand by a broader consumer base, in fact, the target that we have been striving to reach. We are also opening up the funnel at the low end with a much stronger C series than we have ever had before who are really excited about the increased support and comfort that these new beds provide. And we do see this in combination with our new advertising focused on introducing our all new C series as a method to be able to drive incremental units. And we will look forward to giving you an update on that in second quarter, but certainly, our results so far although early are consistent with our testing and with our beliefs.

Good. Alright, well thank you so much and best of luck.

Thanks.

And our next question comes from Mr. Budd Bugatch, Raymond James. Sir, your line is open.

Hi, this is Bobby actually filling in for Budd. Thank you for taking my questions today.

Hi, Bobby.

Thank you. My first question is about the new stores, were they all with all the net new stores off-mall stores?

We had 1 mall and 16 non-malls, Bobby.

Okay, thank you. And then can maybe you provide a little bit of color on the performance of the non-mall versus mall performance and whether or not the new off-mall stores are tracking to the efficiency you have seen out of them so far that you expect?

The answer to the latter is yes. And the performance with mall and non-mall, we continue to be pleased with both. Our average revenue on an annual basis is about the same with the two formats. And we do see the occupancy expense favorability in our non-malls, which we expect to be around 15%.

So the profitability for the non-mall stores is probably trending a little bit better than mall performance?

Yes, that’s correct.

Alright. And then real quick just on a modeling question, I couldn’t quite get the ad spending for the year, I am showing roughly around $38 million ad spending in Q1 of last year about 14.7% of sales, what exactly were you referencing for ad spending in this quarter?

Yes, I did not say the specific ad spend in the quarter. I mentioned that we were up slightly. Our spend was $39 million.

Okay, I appreciate it. That’s it from my questions and best of luck going forward.

Yes, thanks Bobby.

Our next question comes from Mr. Todd Schwartzman, Sidoti. Sir, your line is open.

Hi, Shelly. Hi, Dave. What is the – regarding the X12, what is the timeline for gauging the success of X12 and for considering rolling out beyond those initial nine test markets?

Yes, Todd. We are – so, first of all, our pilot is giving us the information that we were looking for and is primarily designed to help us with operational and selling prospects. And overall, we are really happy with what we are experiencing with the X12 and the role it’s playing for the brand and certainly the markets it’s in. And we will continue to read the performance and respond operationally and be moving forward here in the coming months.

Got it.

Not probably avoid answering those very specific timing just competitively.

Sure, sure. It makes sense. Have you heard any mention in a little while of accessory attachment rates? How have the accessory attachment rates historically varied by price point of the bed that was purchased along with these other items? And was there any discernible trend on that front in the first quarter?

Yes, as far as the bedding collection attach rates with the various beds across the line, we continue to see fair amount of consistencies. And that’s really driven by our selling process. So it’s not necessarily attached to the specific models.

But do you track by price point to just kind of gauge whether there is a more linear versus exponential increase as you go up the line – the bed line by price point?

Yes, we do. We track by price point as well as by customer.

Right. So you just don’t disclose those rates by link?

No, we don’t share that granularity.

Okay. And it is – is it typically what you would expect?

As far as the specific attaches by models?

Yes, with the higher end – with the higher end consumer, the buyer of the more luxury product, if you will, attaching more to the purchase than the more entry level price points?

Yes, it does vary based on consumer need. I think you probably see the difference a little bit more with the C series compared to the rest of the line.

Okay. And Shelly, you talked about the change in the return policy to anniversary in the third quarter, I just want to make sure I am clear on this. Was the change put in place last third quarter or second quarter?

It was at the end of second quarter, actually very late in April, but from an accrual perspective that really took shape as of third quarter. So, you really need to – when you are doing your model look at the full second quarter before we annualize.

Got it. Okay, thank you very much.

You’re welcome. Thank you, Todd.

And our next question comes from Ms. Joan Storms, Wedbush Securities. Ma’am, Your line is open.

Thank you. Good afternoon guys.

Hi, Joan.

So, Shelly, if you could just clarify us just the controlled – the company controlled comp was up 2% or are you saying it was up 9%? I was trying to figure out the ASPs were up 8%, unit growth or units up 1%?

Yes, hi Joan. This is Dave. So, what Shelly…

I don’t want you to clarify.

That’s fine, that’s fine. What Shelly mentioned is that the – our total net sales growth was actually up 7% for the quarter, that’s the total number, but if you look just at our company-owned channels, they were up 9%. And that 9% was made up of 8% from ASP and 1% from unit growth.

I see what you are saying. Okay, so like the wholesale part was negative, so that’s what brought the total down?

And it was dilutive to the overall growth rate.

Okay, got it. Well, what’s going on with that channel? It’s down a little bit and is it just a shift in the QVC stuff or?

Yes. I mean, first of all, it’s small, it’s less than – it’s about 4% of our total. And we do have fluctuations between quarters and that’s what transpired here.

Okay. And then I don’t know if you can comment at all any update on the DualTemp, it seems like there still should be the customer brand awareness for that product is still very low?

Yes, you are right it’s still a significant opportunity. And in this quarter, Joan, we were very focused on our new advertising campaigns and did not focus on the DualTemp. So it was a smaller contributing factor because of the lack of advertising for it in the quarter, but we continue to be really pleased with the product. And our customers are absolutely thrilled on this product. So it’s a great opportunity for us as we move forward.

It cannot be incorporated into the new ad campaign in any form or fashion?

Yes, absolutely.

Okay. So as far as new products, there is a lot going on in the first quarter and that’s – I am assuming that’s sort of the bulk of what you are going to be seeing and then focusing on to the rest of the year?

Right.

Okay. And on the marketing effectiveness, could you, I don’t know if we have talked about it the last quarter or two, but you are marketing your 13 markets that you have targeted, where are we in that process? And are those markets still making progress towards your goals?

Yes, the 13 market aggressive growth strategy. So where we are is the first original four markets have now moved into the fourth year. So they have surpassed their three-year aggressive growth strategy and we experienced a doubling of profit in those markets and just a little less than doubling the market share which was one of our targeted goals and also surpass our revenue expectations. We are very pleased with the strategy beyond those four we have five other markets in various stages of the strategy. We did launch one new market this year.

Okay. Next year you will be launching the rest of it?

(indiscernible) and then we have the four left over the next few years. Yes. And we are certainly dealing with some big markets right now.

Okay. And then just one quick last question on the media mix that you talked about what did you do different sort of year-over-year I mean I know last year the first quarter was really tough because the switch to the single agency and things are really out of the line but what are the new things that you are seeing good response to?

Right now in the first quarter we are in testing with – so we have a core basic formula that we are executing tie to the formula then we have a numerous tests going on to be able to more efficiently reach our broader target and also moving media to more productive media. And so testing and then in the second quarter we will advance those tests. We had obviously February was a typical month for us to read with all the weather impact and that was when and we had the bulk of our media spend so that did not help our specificity on the test, but we also did not expect the (50) basis points media leverage in the quarter. So combination of the tests along with the new creative and then you think about the fact that February was the month we spent the most of our media and it really wasn’t able to come fruition, it’s encouraging, it’s encouraging to see where our tests are at.

I guess that’s it for now. Thank you very much.

Great, thank you Joan.

Our next question comes from Mr. Josh Borstein, Longbow Research. Sir your line is open.

Hi, Shelly and David and welcome David. Just a few questions for you, on the you did mention that March was one of your better months or the best months in the quarter, you also mentioned on the last call that January you will back up to mid-single digit. So was the March same store comp stronger than the January comp that you had mentioned was up mid-single digits?

That’s right Josh.

Okay, so that just implies that February, which I think you mentioned was actually an easy comp just because of the weather issues though it will turn out to be a sour month because of that?

Yes, that’s correct although we were still up in February.

Well, I see, okay. Alright that’s helpful. Thank you for that. And then just on the Sleep IQ that you are currently testing in nine markets and now offering separately from the x12, any early read on how that’s performing or what the list price is and when you may chose to roll that out to a larger audience?

Yes, the list price Josh is $300 with a Sleep Number bed, so that’s an attached item for us and it’s in the same nine pilot markets as the x12 and same learnings going on around our selling process and operational and again very pleased with the technology and the consumer response.

And is that something that a person with an existing Sleep Number bed can get or is that something that they buy with their new bed?

Well, I will tell you Josh my Sleep IQ score was at 78 last night and my bed is a few years old.

And were you happy with that 78 score that…?

I was. Yes, I like those 70s and 80s are really good.

And then just a last one for me back to the DualTemp do you think there is a seasonality to that product where people who buy it prefer more for the cooling part or for the heating part?

Yes, we do believe there is – with everything we had going on this first quarter, it’s part of the reason why we wanted to be able to read our other advertising more clearly. And so we backed off a little bit while we drove some of the other advertising, but it’s also still very early for us with this product, we really like what we see overall.

(indiscernible). And actually just one more on the extra cost you discussed and that you had mentioned because of the weather issue. Can you quantify that at all?

Yes. So it’s about $425,000 in the quarter.

Terrific. I appreciate it. Thanks and good luck.

Thank you.

And our next question comes from Mr. Keith Hughes, SunTrust. Sir your line is open.

Thank you. You had mentioned earlier getting your store plans you will be at about 460 stores. At the end of the year you are getting close to the roughly 475, 480 peak given 2007 for the recession. Are you planning to go above that number, is that a ceiling number, what are your views longer term there?

Yes, longer term our views are probably somewhere around 500 to 550 range.

And can you give me an update in terms of non-mall stores where we were at the end of the quarter?

At the end of Q1 for non-malls we’re at 152.

During that you told that it’s 16 to the quarter. Is that correct?

Yes, so it’s about 34%.

34%, okay. Given how is one question earlier in the call I talked about that the week same-store unit numbers that you’ve seen.

Yes.

Would you consider a strategy where you top out on the stores to just accelerate the move out of the mall, it seems to be really doing wonders with ticket and we might see a change of how unit perform per store?

Yes. When we compare our non-malls and malls we have a similar revenue performance overall which is highly correlated with our unit performance. So we’re very pleased with many of our mall store performance. Clearly our number one opportunity is brand awareness and also driving traffic and risk brand awareness comes traffic and market share and that’s what we’re focused on is improving that marketing effectiveness to be able to drive traffic and increase the brand awareness and we’re confident that unit increases will come with it. We liked the flexibility that having both the successful mall and non-mall store delivers and also the average revenue we see the continued growth in average revenue in both mall and non-mall. We’re not seeing ceiling in that and we’re seeing some strong expressions in both formats and it gives us good confidence and continuing to progress with both.

I am sorry. And your answer is you see a lot more revenue per store on the non-mall than the mall. Is that correct?

No Keith it’s about the same. So very yes it’s the same. The average revenue on an annual basis is the same. Leads and conversion are different by format but times out to be the same average revenue.

Okay. Thank you.

Jenny, are there additional call or questions?

Our next question comes from Ms. Jessica Schoen, Nomura Securities. Your line is open.

Hi, good afternoon.

Hi, how are you?

Hi, Jessica.

My question is on the 8% ASP increase. I was wondering if you could talk about how each mix shift pricing increases and the attached rates of both adjustable basis or the bedding collection were all driving that 8% growth?

Yes, the growth was primarily two things. It would be pricing associated with the product innovation and the other half would be primarily associated with attached for the quarter of the FlexFit and FlexTop.

Okay. And then would you say there is anything to call out as far as the mix and kind of the velocity of sales at the different pricing segments within your line?

Yes, it’s too early with the product innovation with just a few weeks and I think we’ll have a lot more clarity on that this next quarter. And then February of course played in a way that would be unexpected just because we had too many store closures, etcetera that you know I am sure it probably impacted our ability to drive through additional units with our close-outs. So, probably some suppression there.

Makes sense. And then you just said I think 34% of your store base was off-mall. Can you give us, remind us or give us an update as far as where you are in the full repositioning of the real estate portfolio, how much is there to go both on relocation and remodeling?

Sure, great. It’s a great question. By the end of the year we expect to be probably around 40% with our non-mall and from a remodel and reposition I think we’re at 75% by the end of the year, 80% a good strong 80% so the majority in the portfolio will be complete.

Great. Thank you so much for taking my question.

You bet.

(Operator Instructions) And we have a question from Mr. Rob Longnecker, Jovetree. Sir your line is open.

I want to ask you guys about the balance sheet. You guys have been cash flow positive for at least four years now and you’ve been sitting on this kind of like $100 million and plus balance of cash ever since. And I am wondering at some point are you guys going to start returning some of that capital to shareholders?

Yes. Our cash strategy is focused on first and foremost managing the business to remain above our stated $125 million. And..

Right. But – could you justify that $125 million because that just seems – it seems like that’s designed for like the (indiscernible) have been falling on current conditions?

Yes, the $125 million is based of our learnings over a multiple number of years with the company with – it’s a business that leverages tremendously and can also work the other way. So the $125 million has been our threshold from an operating perspective and the cash strategy second priority is focused on prioritizing investments toward our long-term growth strategy which we expect to deliver a strong return to our shareholders and finally as share repurchase program and we continue to execute that share repurchase.

When I look back and look at your historical cash flow is it looks like the worst quarter you’ve ever had was like a negative $10 million or $15 million a quarter announced back in 2007. So it just seems like you guys are way too conservative with what you think your cash balance should be?

Thank you for your feedback on that. We went through some very challenging cash years in 2008 and 2009. And we today remain debt free and that’s how we spend operating these last few years and the $125 million is also puts us in a position that we’re able to continue to invest in our business when we have a suppressed top-line and last year will be a great example of that where we did not deliver the sales we had expected. But we are working on such important initiatives to be able to support our long-term growth strategy and it allowed us to be able to continue to invest in our product innovation and our local market development in a way that is positioning us today to be able to outpace growth expectations in the future and that’s the strategy behind the cash balance. We’re also positioned for opportunities and we seized a couple of those last year, one small acquisition and we appreciate the position to be able in this time of building our long-term growth to be able to seize those opportunities.

You might want to take a little bit more about your shareholders because dividend or material buyback really be appreciated?

And we’re very focused on our shareholders and that is why we brought forth innovations that we just did to be able to support the long-term viability of the business and increase shareholder value over time. But we do appreciate your feedback and thank you very much for sharing your thoughts on this.

Thank you.

Thank you.

And our next question comes from Mr. Josh Borstein, Longbow Research. Sir, your line is open.

Just a quick follow-up on one of the questions I had earlier on the January comp, just trying to get a feel for the cadence again in the quarter, January was up mid single-digits, March you said was better than that and February was still positive. How you get to that 2% comp? Is it just that Presidents Day is so meaningful that it boosts the importance of February in the quarter?

Yes. I mean, February with the Presidents event, the majority of the month is definitely very meaningful. The other consideration on this Josh is the backlog and just the timing of backlog versus orders.

Okay. Could you explain how the backlog affects the comp?

It would be timing of where the revenue recognized by quarter. So, the numbers that I am sharing, we shared about January the mid single-digit comp reversed to actual orders placed as well as March. So there is always a little timing difference between the months. And it’s more apparent, obviously with February being such a big month tied to Presidents. But you – this specificity of understanding the orders in the comps will give you the shape of the quarter.

Okay, great. Thank you.

Yes.

And there are no further questions on the phone at this time.

Great, thank you.

Thank you again for joining us today. We look forward to discussing our second quarter 2014 performance with you in mid-July.