Welcome to Select Comfort’s Q2 2014 Earnings Conference Call. (Operator Instructions) This call is being recorded. If anyone has any objections, you may disconnect at this time. I would like to introduce Dave Schwantes, Senior Director of Investor Relations. Thank you. You may begin.

Thank you. Good afternoon, and welcome to the Select Comfort Corporation second 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. 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. 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 and good afternoon everyone. Our second quarter results reflect the important role of innovation in our strategy. We are prioritizing investments and benefit driven in operations, such as Sleep IQ technology which adds value to customer’s life. We have begun to gain attraction from our growth initiative as demonstrated in our second quarter results. Here are a few financial highlights. Net sales grew 13% to $235 million, comp sales increased 7% and EPS declined 11% to $0.16. We remained confident that the combination of proprietary product exclusive distributions and end-to-end customer experience will translate to sustained profitable growth in value creation for our shareholder. Results are beginning to reflect the investments we’ve made in building our competitive advantage this past two years, including the most significant product in marketing introductions in our history. EPS was consistent with our second quarter expectations and the top line growth represented more favorable consumer response as planned for the quarter. Due to the quarterly update on our 2014 growth initiative which includes, product innovations, marketing effectiveness and local market development. First, we’ll share highlights from our product innovation initiative. We had a great true quarter as we deploy our newest product technology and establish the foundation for transformational sleep experience. We expect these innovations to be a catalyst for increasing brand awareness by attracting a broader consumer target. During the quarter we introduced both the x12 bed and Sleep IQ technology nationwide, following the nine pilot markets launched earlier this year. Sleep IQ technology is now available on all Sleep Number bed for an additional $299. This proprietary sense of technology works directly with our DualAir chamber to provide individualized sleep. Sleep IQ technology tracks and monitors your sleep without the need for any wearable devices, communicate how you slept via…

Thank you, Shelly. Good afternoon everyone. Before I discuss the second quarter results, I would like to take a minute to say how glad I am to be a part of this very impressive business. It’s a great time to join such a capable and passionate team and to be part of the next stage of the company’s transformation. It is especially rewarding to see the team’s hard work on the initiative Shelly discussed, really paying off with 13% outline growth. It is a nice way to begin my first official earnings call. With that, I will get right to it. Net sales for the second quarter grew 13%, $235 million. The increase was comprised of 7% comparable sales growth and 6% from new and relocated non-comp stores. During the quarter, we opened 16 new stores and relocated within mall another 16 stores, updating them with more productive store design. We also closed eight stores during the quarter including seven that were relocated from mall to non-mall locations in the same market. Our trailing 12 months average store sales per comp store in Q2 was $2.1 reflecting improved productivity. As expected, we ended the quarter with 451 stores and plan to end the year with 460 to 470 stores. Another way we look at the composition of sales growth is through our ASP and unit mattress. For us ASP devised our company control net sales by the number of mattress units we shipped during the period. Others used ASP to refer changes in average selling price or price increases. To avoid confusion and help underscore value of this metric to our business without changing the calculation in any way, going forward we will refer to it as average revenue for mattress unit or ARU. ARU for the second quarter was…

Thank you, David. The consumer excitement with our new innovations is apparent in our top line results, we are learning quickly, yet recognize it will take time to build demand and optimize operating efficiencies associated with our innovations, to this end I want the thank the Sleep Number team for their modesty and dedication to improving our customers’ lives. We remain cautiously optimistic about our expectations for the balance of the year and are confident that our customer focus strategy will result in increased shareholder value. Thank you for your interest and we now welcome your questions. Angie you can open up the line for questions.

Thank you, (Operator Instructions) our first question comes from Josh Borstein with Longbow Research, your line is open.

Hi, Shelly. And welcome, David. Thank you for taking my questions here. Just a point of clarification -- the unit decline of 3% -- was that on the same-store sales comp of 7% that you had mentioned?

Yes, it is.

Okay. Great. And then, the average revenue per mattress unit increased 17% and it looks like in past environments where you saw nice ASP you also saw a nice gross margin. This quarter some of the nice ASP and gross margins came in a little bit later than I had modeled. I think you had mentioned 130 basis points hit in relation to sourcing and some other things. But was there anything else in particular with respect to gross margin this quarter?

Well, the 130 basis point impact was relative to our internal expectation and about half of that was related to the inefficiencies that was related to the greater mix of the source product that we’re referring to. Those were really the big impacts other than what I mentioned in my prepared remarks.

Okay. So looking at gross margin for 3Q, what might we expect? What kind of product mix to you anticipate that should either help or hurt gross margin?

Well, we don’t particularly get into the details of it but I can tell you that we expect our ARU to continue to be strong and we continue to expect that our traffic and units will improve.

Okay, great. And then just one more from me -- with respect to the guidance, should we still anticipate $80 million for G&A, sales and marketing to approximate 46% of sales? Sales and marketing looks like it's trending below that, as does R&D.

Okay so on the sales and marketing side, you know we came in at 45.3% for the half and I think that’s a good reflection for what we expect in the second half of the year, that is compared to our previous guidance of 46% for the full year so we’re pleased with our ability to be able to provide a little bit additional leverage in the back half. Regarding the G&A and R&D expenses they were delevered by a 110 basis points in the second quarter but the second quarter run rate in terms of dollars for the G&A portion can be a good guide for your model for Q3 and Q4 in the back half, while R&D I would say look at the back half of last year as your guide for R&D.

Okay, that's very helpful. And then just last, as a piece of that, the ad spend -- I think you had mentioned for the second half expect 100 points of -- 100 basis points lower. Is that year-over-year?

Yes, the 100 basis points leverage from media spending is versus the prior year in the second half.

Okay, great. I appreciate all the color there. I'll hop back in the queue. Thank you.

Thanks, Josh.

Thank you. Brad Thomas from KeyBanc Capital Markets, your line is open.

I wanted to just ask a little bit more about your expectations for sales. This was the best quarter for sales in well over a year. The comparisons do get a bit tougher the next two quarters. How were trends as you exited 2Q and what sort of trajectory are you all modeling into the back half?

Hi, Brad, thank you for your comments and question, yes the sales comparison was certainly easier in the first half and we have a tougher comparison as we look at the second half, you know we continue to focus on delivering our, reiterate our full year guidance at a $1.07 and you know we’re exiting with a little stronger sales related to our new innovations than we had expected. So some greater momentum on the top-line, but increased pressure on the bottom-line with some of the operational inefficiencies that we’ve experienced or probably more related to the stores’ product and increased mix of the FlexFit theory. And we do expect we have a 10% sales increase in the first half and we expect to do a little better than that as we move into the second half including the 53rd week.

Okay, great. And then just with respect to the new creative and the new commercials that you all have, can you talk about how well you can track if that (ph) is starting to influence the traffic in your stores?

Well, as I stated in my remarks that we really have a three-pronged attack to our marketing efficiency and seeing some good progress in all three areas specifically to the creative, the creative messaging is more effective than our prior messaging and we can see that related to both the testing that we did on a particular campaign before they went into market compared to the actual results we’re seeing, as well as various brand metrics and ad awareness and response from the consumer. So we do have numerous low level metrics that give us good color around that. But at the same time it’s still not as robust consumer environment then and I think you can see that in the industry, as well as in our business from a traffic perspective. And we gave you the unit comparison to ISPA, just so you can get a sense of where we are compared to the overall industry. And we do expect to continue to make some progress in units, but it’s going to take more time. In the meantime, we’re really pleased with the average revenue per unit growth that we’re able to deliver with this particular business model.

Okay great. Congratulations again and good luck in the second half.

Thank you.

Thanks a lot.

Thank you. Budd Bugatch from Raymond James, your line is open.

Yes, congratulations on the quarter. Good afternoon, David, and good afternoon, Shelley. I guess my question really goes a little bit to Josh's question. The units were down, I think, 2.6% if my math is right, overall, were down around 10%, which would make sense on the plus 7% -- on a comp basis. So ticket was up about 17% or ARU, as you are calling it, was up 17%. Can you give us a feel of maybe the mix of ticket and ARU as you go through the second half of the year? How do you think about that? You said it would be more balanced or you would see improvement in traffic and I know that's an opportunity. But what does your crystal ball say to you?

The difference between Budd; ARU and units as far as the sales compensation in that, was that right?

Yes ma’am.

We continue to see a strong ARU growth or expect to see a strong ARU growth tied with how the innovations have performed thus far. We do anticipate continuing to make this in unit progress, but we’re also up against some big closeouts from prior year particularly around our performance theory which is our higher penetrated theory in the line that we know we have a little bit of a headwind there, but we have covered our compares. So it will see progress, but slow. So ARU is really where we see the growth coming from.

I’m sorry David. Go ahead.

Yes. I just wanted to correct something I mentioned earlier that I said I think to Josh’s question he was asking comp and I was referring to, I was referring to total company-operated sales channel when I said that 3% decline in units. I just…

Yes, sir. If you do have implied units per average stores, it's down around 10%, if our math is right. So, Shelly, to make sure I understand, you had $3700 per ARU in the second quarter. Are you saying sequentially we will see that grow, or year over year we will see that grow, or both?

Year-over-year.

Year-over-year, okay. And to get to your 10% for the second half, if I did that right on the media spend, and media spend looks like it could go up to give you that leverage somewhere close to $80 million in the second half. Is that the right way to think about it?

We do that a little bit of an additional media spend here in the second half itself in that neighborhood, yes.

Yes. It was $77 million last year in the second half, so it should be up a little bit this year to get to that 100 basis points of leverage?

That's right, Budd.

Okay. And the G&A -- I understand, David, the run rate -- I take it that includes the same accrual for incentive comp that was an issue for me, anyway, last quarter. Is that fair?

Yes, it does Budd. That's correct.

Okay. Well, great. Congratulation on the quarter, very nice to see positive numbers and we look forward to chatting with you again.

Thanks Budd.

Thank you. John Baugh from Stifel, your line is open.

Thank you. Good afternoon. And welcome, Dave. Hello, Dave and Shelly. My comments or questions -- could we start off with where we are mall versus off-mall currently and then where do you think we might be at the end of the year and then how many relocations are going to occur as well? Thank you.

For off-mall or non-mall as we reference that 36% at the end of Q2, a 164 stores and then at the end of Q4, will be about 40%, John or 183 at that time.

But how are you thinking about that number or are you thinking about it three, four, five years from now?

What we have stated in the past is somewhere in that 40% to 50% considering that we are at about 40% here at the end of the year, it’s probably in that 50% area.

And can you give us any more color or updates on the performance of off-mall versus mall? Or are the malls doing better as you have got more and more of them relocated to better locations within the mall or you've gotten out of a lot of the bad mall locations so the malls that are left are better performing?

Yes, we are pleased with what we have going on in the local market development in both formats both mall and non-mall, so we continue to be pleased there with a similar average revenue by formats. And absolutely when we relocate out of more challenged malls into a strong, feasible location for our non-mall we are very happy with the lift that we are getting in that particular case. But we also have many examples and very pleased with the mall relocations within the mall, improving the location and move into a slightly larger store design, especially with the advancement we have made in the experiential store design, has been very strong for us. So, we are pleased with portfolio. We do see a little bit of seasonality difference in the non-mall, so we are learning about that particularly a little lower sales in Q4 and little stronger in Q1 and some slight improvement as well in Q2 in the non-mall but again net-net we are seeing total similar revenue. You still have an upside in occupancy over time in the non-mall, so that’s gives an extra edge.

Right, thanks for that. And then could you maybe delve into the inefficiencies you are talking about? What precisely are they? Is it air freighting stuff or you may have had production problems? And when does that sort of get behind us?

Thanks for the question. It’s associated with our source product and early demand, I mean better demand than we expected out of the gate and so you are absolutely right that resulted in air freighting some of the products. We have moved some of the manufacturing of our sourced product in-house. And we have some complications just working through that with the level of demand and we will work through. We are making great progress. It’s going to take us few more months before we are up to our full efficiency. We also speak to our manual processes, so it’s a little cumbersome right now but nothing we are overly concerned about. It’s growing pain. This is a good kind of preference to have.

It is. Actually, if you could help us as we think about Labor Day and just maybe tell us -- you mentioned you didn't do the Classic Series here on Memorial Day. Just help us. You mentioned the clearing out of P Series happened -- that won't happen. Any of the apples-to-oranges comparisons as we reconvene three months from now and talk about Labor Day that we should be aware of? Thank you.

John on Labor Day, we won’t get into a lot of specificity but we will execute our formula that we have been very consistent on particularly during the Labor Day event and so no real surprises or changes there. We did not do the Classic special edition in Memorial Day mostly because we have just launched a new classic series and our overall focus is on driving growth, revenue and profit growth that’s our number one priority and our strategy is consumer focused. We are focused on how to deliver for benefits to our consumer that’s not unit focus but I am also not saying units aren’t important to us but really we are focused on what’s important to our customer.

Thank you. Todd Schwartzman from Sidoti & Company. Your line is open. Todd Schwartzman - Sidoti & Company: A couple of things -- was there any evidence that perhaps some sales were pushed into Q2 from the first quarter due to the weather?

Yes, we had a strong performance throughout Q2 and when we look at weather going back to Q1 it was primarily in February with some spill over into March which still fell in the first quarter. So as far as April goes it’s hard to say about March but with this particular quarter I would say no. Todd Schwartzman - Sidoti & Company: Okay. I know its early still in terms of the rollout of the x12. But initially I wonder if you could share some insight as far as consumers who came into stores with the intention of looking at or perhaps purchasing the x12. What portion of them bought any mattress at all and what portion of them ultimately bought the x12?

I’ll speak through that in general terms with some of our competitors perspective that the x12 is playing the role that so far that we anticipated and desired in our strategy explain a halo for the brand, it’s certainly has gained a tremendous amount of CRs and media that we really like. It’s a great way for our customers to experience our integrated technologies in one bed. And then they can decide from there what are the most important features and benefits that make sense for each customer as depending on what their sleep needs are. So we have found it very effective to have in our store our expectations, our performance compared to expectations on the x12 are slightly ahead of where we thought our sales would be and overall we see it playing the role we expected, we’re happy. Todd Schwartzman - Sidoti & Company: Sounds good. And on the supply chain issue, what components or materials or maybe its accessories -- what is actually at the heart of the matter in the near-term?

What’s at the heart of this would be more complicated product, it stores some more complicated product and we brought some of the manufacturing in house which for the short-term created a change and a bit more complication. And we’re certainly working through our processes and simplifying and making great progress and again it’s not a significant issue but it did create some pressure on our growth margin rates here in the quarter as we mentioned. Todd Schwartzman - Sidoti & Company: And did that pertain to a specific product or products?

Yes it was primarily related with our stores products the FlexFit. And that margin rate pressure had a lot to do with the mix and the demand of the stores product and then also hide in with some operational inefficiencies that we just hadn’t anticipated in the quarter, learning and advancements of our innovations. Todd Schwartzman - Sidoti & Company: Okay. And lastly, is there any long-term goal for ARU that you would care to share with us?

No, what I believe is important to take away is the cover of the combination of product innovation and the selling process. And what that means with the customer focus strategy is as long as we’re delivering products with meaningful benefits. And in the case of the innovations that we’re introducing right now, they also round our core products. So they are not taking away from the core they’re adding to the core. And they are actually stimulating the core product. They just think about it that way, that’s where is the tremendous growth comes from for our business model in ARU which is just very different than if you have a strategy that’s focused on unit growth in order to get your revenue growth. Neither way right or wrong but this is our strategy and what we view is very powerful overall. In the end we want and expect ourselves to deliver on both ARU growth and end unit growth and over a longer period of time as we have delivered in the past been a good balance with units and ARU is important to us.

Thank you. Jessica Schoen from Nomura. Your line is open.

My first question is about the Classic special edition that you mentioned discontinuing the promotion in Memorial Day. And I was wondering if there's any kind of idea you can give us about the unit trends in the quarter excluding that kind of unusual impact or maybe on a sequential basis how it compared to some of the trends you saw in the first quarter.

Absolutely the Classic special addition as we calculated and most of that was the normalization would have been with the unit trends we accounted for 3 to 4 points of units decline in the quarter due to not having the Classic special addition.

Okay. Got it.

And I think I would also say that it’s important to note the overall revenue and profits growth so again focusing on what we view as important for our customer.

Absolutely. My second question is a follow-up on the mall relocations that took place in the quarter. I was wondering if there's any other information you can give us on that general remodeling program, maybe how many you've done or if you have seen an impact, how many more stores are slated for that type of relocation rather than off-mall and maybe some of the expense, too.

Sure, I am just taking a look at that right now for 2014 our mall repositions. Jessica let me just follow up with you on that here in the looks like we have three in the third quarter and one in the fourth quarter for the mall repositions and we have two in the first half.

Okay. And then I guess just one other question on the expectations for the remainder of the year on the top line that you have already touched on a little bit, even though some of your performance this quarter exceeded some of your internal expectations on revenue growth. As you look to the back half of the year, is there anything from a consumer or macro perspective that you think gives you the most caution in bringing that expectation up?

Yes, if you just look at the overall retail environment in total, it continues, you continue to see quite low results than you saw that in April, May and in June with low single digits comp across the Board and it continues difficult or the slow recovery in the macro environment with less than inflation that was intended by the federal direction here. And so until we see some stronger macro signs we continue to cautious in this environment.

Understood. Thank you so much for taking the questions.

Peter Keith from Piper Jaffray. Your line is open.

It's actually Jon Berg on for Peter tonight. Just a question on the use of interest-free financing in the quarter for you guys -- how impactful do you think that was on maybe some of these attachments of your new products? And do you think it's a dynamic that can continue?

Yes. We utilize finance offers and promo offers fairly interchangeably. We view our dollars off and our financing at conversion tools in our particular business model. So at time we’ll utilize a finance offer or cash offer or some combination of the two. We will always test and advance our thinking around finance and what are the terms that are most important to our customer where our customer is most responsive. And that changes overtime, we had a very consistent strategy here for many years in how we execute our promotions that we continue to test into finance offers a year later on this environment changes and the consumer changes. And so overall our net-net is very similar year-over-year but we are financing right on par with where we were a year ago and so our discount dollar but no [indiscernible] change.

Thank you, Shelly. That's helpful. And then looking at your prepayments at the end of Q2, I guess they are up quite a bit. I know that's probably an early indicator on the quarter. But wouldn't you think that would be indicative of comp acceleration here early in Q3?

Yes, Jon I think that what you’ve seen there is the power of small numbers that’s over a small number from the prior year. So it only express that’s a small portion of the business that hasn’t been delivered again so I wouldn’t read to look at that business.

Okay. And then I know you gave just a little bit of high level attachment commentary last year when you guys launched the DualTemp. But just curious if you guys would be willing to give anything high level as far as attachment goes with the Sleep IQ product you just launched and how successful that has been as far as how many people have purchased the bed and the Sleep IQ product.

It’s early, I mean we’ve just rolled out here in June but we are really happy with the initial results, it’s exceeding our expectations and we will not share specifics about this.

Thank you. Joan Storms from Wedbush Securities. Your line is open.

So I might have missed part of this, and I apologize. So directionally on the gross margin for the second half compared to the second quarter we would look for an improvement due to the -- some improvement in the operations which you had talked about. And then on the sales and marketing you continue to see about 100 basis points of leverage overall in the second half. And then in the G&A -- I think I missed that portion. Why was that little bit higher -- I don't know; it was higher than my model.

Okay, so it’s where we planned in G&A first of all and it reflects the digital website we launched in the quarter and we talked about that in the last quarter as well. And you recall from the last quarter, we also mentioned in the first quarter, we had benefitted from a $1.2 million stock comp benefit. But what I said regarding using kind of building your model for the back half, you could use the G&A dollars from Q2 as an indicator for Q3 and for Q4.

Okay, so be it pretty similar.

Right.

So it creates pretty flat dollar wise?

Correct.

And then on the gross margin -- so the FlexFit has been pretty successful. So that's a mix shift that might still be because you haven't anniversaried that, still a little bit of a headwind. But then you have probably some better operational efficiencies to offset that.

Right. And here you are speaking about growth, margin rate in the back half and potentially, some increased sales as well. So if you think about it, little more pressure on margin rate than we had anticipated at the beginning of the year with the price mix as it’s materializing, and at the same time, maybe giving us more growth on the top line.

And then when you anticipate on the units versus the average ticket or whatever, the A -- average. Yes. So -- and I know it's still tough out there and retail trends are still sort of choppy. But would we think about still having just higher to get a little bit lower units for the rest of the year and then hope for some improvement in 2015?

What we said was we expect ARU to continue to be strong and units -- we continue to expect that we will make progress with traffic and units in the back half.

Thank you. Keith Hughes from SunTrust. Your line is open.

A couple questions -- number one, you talked about bringing these new successful products in-house in terms of production. I think I heard that correctly. Specifically which ones are you referring to?

Yes, Keith I was referring to a part of our flex goods.

Okay, so one of the components or…

Yeah, that’s it. And we’re not going to go into a lot of details there, but that’s added to some of our talents in the quarter with a significant initial demand as well.

Okay. And the second question -- we've seen these same-store unit declines for six, seven quarters now. And based on your earlier comments it sounds like ticket is where we are going to see the gains for Select Comfort for the foreseeable future. At what point do you consider slowing the store openings? You are doing an excellent job with customers as you get them in the store, but the units just continues to be a troubling trend.

Two things is that are important to we did low the number of openings for this year from where our original projection was at. And as we move forward with our local market development, we’re already in the majority of the markets that we’re entering. So there is -- it does not include our start up cost, there is not -- we don’t incur incremental marketing expenses with opening the store. We also continue to experience less than 15% at cannibalization in the total market when we open a new store in the existing market where we’re entering. And we are right now continuing to improve our productivity and our average revenue per store, and this quarter we ended at over 2.1 million average revenue per store and our first year of course is quite strong when opened a new store as well. And our return is less than 18 to 24 months on our new store cost, so strong ROI strong performance of both new stores and eight distinct stores in the market without having incremental marketing cost associated with it, and so the net-net and developing now the market and increasing our availability for our customer making it easier for our customer to get to our store is additive. And we have obviously invested against our strategy initiatives for long-term sustainable profitable growth and we’re very confident that we’ve been investing in the right places mostly innovations and market development and of course the infrastructure.

Okay, final question -- on product launches, do you anticipate any new mattress unit launches in the second half of the year that you are willing to speak about at this point?

We obviously just launched the Memory Foam series this week. We do have another launch this month. We are launching a new DualTemp yet this month on July 28 and this DualTemp will not only work on as a layer on every mattress brand that it will also work on any adjustable base.

Thank you. (Operator Instructions) Our next question comes from Josh Borstein from Longbow Research.

Sorry if I missed this, but in terms of the guidance are you still forecasting low single-digit same-store sales growth for the year?

We didn’t comment further on the guidance for same-store sales. We just talked about sales in general.

Okay are you willing to update that or is that something we should still be using or not?

We’re still very committed to the $1.07, Josh that’s where our outlook is. As I mentioned earlier, we’re right now at a 10% growth here for the first half as we move into the second quarter and we do expect -- we expect to do better than we did the first half including the 53rd week. And we also have performed better on the top-line on our new innovation, but we also have additional margin pressure.

That’s helpful, and on that 7% comp, are you able to breakout metrics of ASP in units?

Again, Josh, we did not provide additional on the comp-store side. In total, I said, the unit decline was 3% for our company controlled sales. And Josh just to add into that too is, we historically don’t see a larger differential in the ASP growth between comp and non-comp stores, so you can kind of use that in your thinking as well.

Thank you. I would like to turn the call back over to the Company for closing remark.

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

Sleep Well and Dream Big.