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Select Comfort Corporation (NASDAQ:SCSS)

Q3 2008 Earnings Call

October 22, 2008 5:00 pm ET

Executives

Mark A. Kimball - Senior Vice President and General Counsel

William R. McLaughlin - President and Chief Executive Officer

James C. Raabe - Chief Financial Officer

Analysts

Robert Evans - Craig-Hallum Capital

John Baugh - Stifel Nicolaus & Company, Inc.

Ayria Cole

Joel Havard - Hilliard Lyons

Bill Massie

Budd Bugatch - Raymond James

Operator

Welcome to the Select Comfort third quarter 2008 earnings conference call. (Operator’s instructions) Now I would like to turn the meeting over to Mark Kimball.

Mark A. Kimball

Welcome to the Select Comfort Corporation third quarter 2008 earnings conference call. Thank you all for joining us. I am Mark Kimball, Senior Vice President and General Counsel. With me on the call are Bill McLaughlin, our President and Chief Executive Officer and Jim Raabe, our Senior Vice President and Chief Financial Officer. In a moment, I will turn the call over to Bill. Following our prepared remarks, we will open the call to your questions.

Please be advised that this telephone conference is being recorded and will be available by telephone replay. It will also be archived on our website. Please refer to the details set forth in our news release to access the replay on our website. The primary purpose of this call is to discuss the results of fiscal period just ended. However, our commentary and our responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings release and discussed in some detail in our Annual Report on Form 10-K and other periodic filings with the SEC. The company’s actual future results may vary materially.

I will now turn the call over to Bill for his comments.

William R. McLaughlin

Thank you for joining us today. Select Comfort did what we said we would do. We returned to profitability in the third quarter. At the end of the second quarter, after a difficult start to the year with two quarters of losses, we stated our goal of returning to profitability in the second half of the year, assuming normal seasonality.

We achieved our goal despite a sales environment that continued to deteriorate and that did not provide the quarter’s normal seasonal lift. While important advances were made in new products and new marketing approaches, we have not stabilized sales and share trend. Our improved results were driven primarily by gains in gross margin and reductions in expenses.

Gross margin in the quarter was 62%, improved versus both prior year and on a sequential basis. Gross margin has been an area of focus during these inflationary times with specific programs to strengthen mix and raise average selling price.

New bed models targeted mid-to-higher price points and met their mix goals and increased bedding accessories sales further supported overall gross margin.

Operating profit margin benefitted from expense restructuring and cost controls across the company. During the quarter costs decreased approximately $18.0 million versus prior year.

So in the quarter we did what we said we would do, delivering $12.0 million more in profit than each of the previous two quarters, despite battling weak sales. In spite of the progress we made and achieved in the third quarter, like all retailers, we expect significant challenges going forward.

Our sales trends deteriorated after Labor Day as the financial crisis deepened and consumers pulled back from discretionary spending. There have been a few small signs of potential improvement along the way, but in general we have no reason to believe consumer sentiment will improve any time soon.

We expect the fourth quarter will be more challenging than the third. We are doing what we can to continue to adjust our cost base and have specific plans to address what we can control and influence.

Specific initiatives in the fourth quarter and into 2009 include first, we are moving to the next phase of cost restructuring by closing additional stores. In 2008 our cost reductions have not included a significant change in our total store infrastructure. Most of the year we have operated with close to 475 stores, with new store openings similar in number to store closures that we were able to affect through natural lease expirations.

We recently concluded an evaluation to optimize our store base. The analysis was conducted market by market considering a range of projected potential volume trends and with a view to optimal footprint by market for the future. The range of potential reductions identified, we engaged a real estate consulting firm to work with us to evaluate options to cost effectively reduce our total store base and associated costs.

We are in the midst of evaluating these options and are not able to provide greater detail at this time other than to say that we expect to reduce our store count by 20 stores in the first quarter of 2009, taking advantage of lease expirations and exit clauses of underperforming stores.

Second, we believe we have additional opportunity to enhance our product cost competitiveness. Our R&D teams have been redirected to focus on design opportunities and quality improvements of current products in an effort to counter inflationary pressures of commodities and deleverage. Our goal is to provide more flexibility in our pricing and promotion, particularly at price points under $1,500 while protecting variable operating margins.

And third, we will decrease marketing expense more aggressively, targeting a percent of sales 2 points to 3 points lower than in 2008. In the quarter, we discontinued the SHeDAISY Creative. We improved cost per lead with proven direct response TV and introduced new radio focused on dual comfort and store locations in support of the Labor Day events. Results over the Labor Day period were positive but have been difficult to read since and we are not sustained through Columbus Day.

We believe pulling back to lower levels of spending is absolutely prudent as we brace for a slow holiday season and until we prove that incremental spending can deliver sales and market share improvement.

With the decision to revise marketing direction, we consolidated marketing leadership under a long-term internal leader, Tim Werner. Tim has been with Select Comfort for 12 years and for the past several years he has led our direct and e-commerce business units. Tim has important experience with the Sleep Number brand, having worked on the initial launch. His company knowledge will also be helpful in integrating brand- and traffic-building activities across the company.

For the fourth quarter Tim and his team have a strong set of programs. First, targeting our owners, emphasizing new products and accessories for the holidays. Second, working with our sales teams to emphasize the value that we have in our product line today with queen sets starting under $1,000. And third, to complete the refreshing of our direct response TV campaign for launch in early 2009.

To conclude before turning the call over to Jim, let me iterate that I am proud of our team’s results in the third quarter, achieving what we set out to do even as conditions have become more difficult. We are now planning and executing the next phase of our restructuring, anticipating continued market place changes. We expect the fourth quarter to be more difficult than the third and are doing everything that we can to reduce costs. In the end, the severity of the consumer pull-back through the holiday season and our ability to offset it will impact our ability to maintain our profitability.

I will now turn the call over to Jim for greater insight into the quarter and the outlook.

James C. Raabe

I will start by restating Bill’s initial point. In the third quarter we demonstrated our ability to return to profitability by aggressively pursuing costs and margin enhancements. While we did not benefit from normal third quarter seasonality we improved operating income by $12.0 million compared to the second quarter on a $5.0 million sales increase.

A 260 basis point increase in gross margin lead the improvement as pricing and product mix more than offset the impact of inflation. In addition, we aggressively managed fixed and discretionary spend levels.

As compared to a year ago, the consumer environment remains challenging with sales declining 26% from $213.0 million last year to $157.0 million this year. Sales in all channels declined on a year-over-year basis with comparable store sales down 27%. We experienced a strong Labor Day period indicating that the consumer will purchase during traditional holiday shopping periods, however the volatility, week-to-week, and month-to-month sales has increased.

Also as compared to a year ago, net operating profit declined from $19.1 million to $2.1 million this year. Lower sales led to the decline in profits in the quarter, partially offset by improvements in gross margins and lower fixed and variable costs.

Gross profit margins improved from 61.6% last year to 62.2% this year. Two key product initiatives drove the improvement. First, our mattress sales mix grew stronger following the introduction of our 6000 model this past spring. And second, our focus on accessory offerings in our stores and the efforts of our new accessories team resulted in higher bedding accessory sales per mattress unit as well as higher gross margin on these products.

Pricing action covered commodity cost increases for materials but did not fully cover cost increases from fuel and the deleverage from lower unit volume. Maintaining gross margins at the third quarter rate will be a challenge as we continue to face the deleverage impact of lower unit volume. And recent declines in oil costs are not yet reflected in materials cost.

We are aggressively pursuing reductions in the fixed cost infrastructure or our plants and home delivery as well as opportunities to re-engineer our product offering to offset the impact of inflation, but more importantly, to provide flexibility for pricing and promotions. We expect gross margins to remain above 60% in the fourth quarter.

Below the gross margin line, we reduced our selling, general, and administrative costs by approximately $18.0 million compared to last year. Variable costs made up roughly 1/3 of this reduction. The remainder reflects a $12.0 million reduction in infrastructure and discretionary spending, including a 14% reduction in media investments to $23.0 million in the quarter. In addition, third quarter costs includes store asset impairment charges totaling $1.5 million.

On the balance sheet, our borrowings increased to $60.0 million compared to $58.0 million last quarter. Inventory and accounts receivable balances were comparable to the second quarter while accounts payable declined, reflecting lower sales volumes and actions to reduce our cost structure.

We remain in compliance with our debt covenants. Maintaining this compliance has required, and will continue to require, proactive management of cost and cash and could be challenged if sales trends deteriorate further or cost reductions are not realized.

Cash flows from operations year-to-date are positive $12.0 million, including $2.0 million in operating cash flow for the third quarter. Our adjusted EBITDA year-to-date is a positive $4.2 million and in the quarter it was positive $10.0 million. Adjusted EBITDA for us is equal to our operating profit or loss plus add backs for non-cash costs, including depreciation, non-cash compensation, and asset impairment charges.

Cash outlays for capital expenditures year-to-date are $28.0 million and were $7.0 million in the quarter. As we look forward to 2009 we expect cash requirements for cash expenditures will be much lower than in 2008.

As Bill indicated, the outlook for the balance of the year and 2009 continues to be very challenging. Recent industry data indicating declines in consumer confidence and home sales, along with our own experience, all point to no improvement and the likelihood for worsening conditions in the fourth quarter and continued softness in 2009. I will remind you, though, that we do get an additional week in the fourth quarter of 2008.

Bill outlined our plans to manage those things within our control in the coming months and quarters, focusing on actions that are addressed, our cost structure and improve our financial flexibility, including reducing our media investment, closing additional stores, and lowering the cost of producing our products, while working to improve the effectiveness of marketing initiatives to drive consideration and purchase of our products.

We remain confident in the long-term opportunity for our product and business model and remain committed to navigating through the current economic challenges to realize that opportunity.

I would now like to turn the call back to Bill for some final comments.

William R. McLaughlin

In summary the third quarter was an important one for us as we achieved our goal of returning to profitability. However, we recognize that there is a tremendous amount of work still ahead of us as the sales environment and economic outlook have unfortunately continued to deteriorate.

We have been proactive and aggressive in confronting our issues and will continue to do so. We have specific new initiatives underway to combat the continued sales decreases we anticipate. Our team has demonstrated ability to execute and deliver results and we’re motivated by knowing that we’re helping to improve people’s lives by improving their sleep.

Our opportunity is to communicate our products’ unique solution to consumers’ needs and to have a cost structure that allows us to deliver compelling value and to sustain profitability.

Everything we are working on is designed for immediate results and to make us a stronger company for the future.

I would now like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Robert Evans - Craig-Hallum Capital.

Robert Evans - Craig-Hallum Capital

I believe you had given guidance before as it relates to second half profitability. I know you were profitable in this quarter. Do you still expect second half profitability?

William R. McLaughlin

We don’t give guidance. At the end of the second quarter we stated our goal to be profitable in the second half and we positioned that as being dependent on the normal seasonality, but we also positioned it as a second half goal. We’re doing everything we can do, as we said, to offset some of the negative trends we’ve seen to maintain the profitability, but that is not a certainty at this time.

Robert Evans - Craig-Hallum Capital

How should we think about sales and marketing spend going forward? I know you touched on this but I’m trying to get a sense, should we expect that it’s going to be managed as it relates to trying to provide profitability? How are you targeting your sales and marketing, particularly your media spending?

William R. McLaughlin

The media spending, as I mentioned, we will be trying to manage that to a couple of points lower than what we’ve been running here in 2008. Obviously that will help toward profitability but more importantly it gets in line to where we’ve historically been spending our media. We want to pull it back to that base run rate until we’ve proven that we can, on a sustained basis, spend at a higher level and get the resulting sales from that.

So for the time being I would look for that media spending to be a couple of points lower than the run rate that we’ve been running here in 2008.

Robert Evans - Craig-Hallum Capital

And if the environment stays difficult, could we expect that to be pulled back further or do you want to try to maintain at that level?

William R. McLaughlin

We really don’t have a formula on this. We adjust our marketing, one of the strengths of our marketing model is that we are not committed on spending into the future very far. So we are able to adjust it. We have been trying to use marketing to offset some of the negative consumer trends but and therefore spending at a little higher rate than we had in the past. We are going to be managing that back down to where we believe the volume is going right now.

James C. Raabe

And to that point, historically we have spent media at 12% to 13% of sales range. As Bill said, that’s run a little bit higher but we are going to move back more towards the historical levels. And we will be flexible with the sales volumes.

Robert Evans - Craig-Hallum Capital

Can you comment on sales trends towards the end of the quarter? Latter part of September, and then early fourth quarter? Give us some level of color as to how it’s gone more recently with all that has happened?

William R. McLaughlin

I would say that we’re not any different than what you’re hearing from most retailers, which was post-Labor Day it slowed a bit and certainly with the financial crisis it has gotten more difficult. Just a reminder, though, as you look at Q4 numbers, we do have the extra week. And if you recall, we saw a softening after Thanksgiving so if you’re thinking in comp terms, the comparisons get a bit easier at the back half of the quarter as well. Those are just some considerations.

Robert Evans - Craig-Hallum Capital

Would you characterize things as a gradual weakening or has it been more abrupt? During the last three to four weeks. Just trying to get a sense because retailers have been across the board here.

William R. McLaughlin

I would just say it’s notable. I mean, we’ve certainly had our sales challenges before and so I would say it certainly fell off in a more meaningful way after some of the banking crisis things occurred but I don’t know that I would say more than that.

Operator

Your next question comes from John Baugh - Stifel Nicolaus & Company, Inc.

John Baugh - Stifel Nicolaus & Company, Inc.

I was wondering if you could tell us the lease exposure, what’s the gross number? And then you discussed the flexibility of exiting some leases early. Could you give us some color on how that works and how much flexibility there is and whether there’s any plan beyond the 20 stores in Q1 for fiscal 2009?

James C. Raabe

To answer your first question, just total leases including corporate facilities as well as our store leases runs on an annualized basis, kind of mid-40s. $45.0 million or so. As we look to 2009, as we indicated, we will close approximately 20 stores with normal lease terms as well as we do have kick-out clauses in the number, really all of our leases allow us to get out of them without cost if we’re not running to kind of [inaudible] performance levels.

If you look at it in the aggregate, for 2009, there is in the range of 70 stores that through normal kick-out or exit clauses, we would have the option to terminate without cost.

John Baugh - Stifel Nicolaus & Company, Inc.

I don’t know if there is a typical example of a store closure, but how does that impact your cash flow? Any color you can give on the amount of money you save or the amount of money you have to spend in severance or some lease obligation or something.

James C. Raabe

From the standpoint of exit costs, exit costs are really in most cases we can manage them. We can move the people in the stores to stores in the same market so we are able to manage through that pretty well. There’s not a lot of inventory so there are not those types of costs that a lot of retailers have to deal with. So exit costs are really very nominal.

It’s difficult to point to a normal store closing because there is a fair amount of variability but our stores do tend to be pretty favorable from the standpoint of just a relatively low operating costs, to run small footprints, low inventory, those types of things.

But in kind of reducing the overall store base, it provides opportunities for other types of reductions, in infrastructure, media spends, those types of things. So without giving specific dollars, I think it does create some opportunities for us to kind of manage the overall cost structure of the business over the long term.

William R. McLaughlin

Let me clarify one point that I think maybe I misheard, is we have about 40 to 50 leases a year that come due on a normal cycle. And then the kick-outs that Jim referred to are if we don’t achieve a certain volume level within the first couple of years of a lease. Beyond that, then there are expenses of getting out of leases but what Jim was referring to and all that he just shared, is the normal expiration of a lease.

John Baugh - Stifel Nicolaus & Company, Inc.

And I don’t want to put words in your mouth, but if we closed 50 stores next year, would that be a cash-flow-positive event or cash-flow-negative event?

William R. McLaughlin

If it’s store closures within the normal expiration of leases it’s a cash-flow-positive.

Operator

Your next question comes from Ayria Cole.

Ayria Cole

Regarding just covenants you have on the lending side, do you foresee any opportunity to try and reduce any of the stricter clauses you have regarding cash flow on a quarterly or monthly basis going forward?

William R. McLaughlin

I think that we demonstrated that we’re proactive in both how we manage our costs and our cash relative to our banking relationships, but also we’ve had a good relationship with our banks throughout this past year, since we’ve begun the relationship, and will continue to do the things that we need to do to work them and with our cost structure to maintain compliance with our covenant. If that includes going back to the banks, if necessary, that would be something we would consider. But I think it’s just within the normal relationship that we would evaluate those types of considerations.

Ayria Cole

And secondly, can you just comment on average price points or transactions sizes in the quarter, in terms of how that was changing or not versus year-over-year or trends in 2008?

William R. McLaughlin

Our average selling price for our mattresses within our company on sales channels was a little over $1,900. That’s about an 11% increase over a year ago. I think what we’ve seen, some of that is pricing, but a good piece of that is the mix within our product line. The 6000 introduction has resulted in some step-up in the overall mix of our product line and so that’s been a positive impact from our overall margin perspective and our ASP.

Ayria Cole

And finally, for 2008, in grand total, inflationary cost increases. I’m looking mostly at material goods or energy related, are how large? And do you have any sort of guestimate for 2009 if these new lower price points for certain raw materials or energy are sustained, how much of a reduction you will have in these raw material costs?

William R. McLaughlin

That’s a tough one to answer. There have certainly been some inflationary pressure from the energy on the flow through of our commodities. We have been able to defer some of those to a certain extent. Unfortunately, the commodity prices tend to take a little bit longer to step-up with the increases but they even take longer to come down. I think we’re hopeful that as we look forward to 2009 some of the oil price declines that we have seen we can translate into better pricing in 2009. But it’s clearly a difficult environment to predict from a commodity price standpoint so I would hesitate to quote any particular numbers.

Ayria Cole

Can you give us a sense for energy costs as being how material in number relative to your sales levels?

William R. McLaughlin

It is an input to a number of components within our product makeup, from our foundations to the foam that’s in our beds and within the home delivery, the diesel prices within our home delivery. That represents somewhere in the range, those three components, of 50% of our total product costs. Obviously the oil cost is not a majority of any one of those individual components but needless to say it is a factor and it can have an impact on the overall inflationary cost of our product.

Operator

Your next question comes from Joel Havard - Hilliard Lyons.

Joel Havard - Hilliard Lyons

One question I wanted to ask following up John’s comment on real estate was if you were seeing any relief yet on rental rates and would you anticipate any as we get into 2009 on existing or on leases you intend to keep?

William R. McLaughlin

That would be some things we would look at with the people we’re working with on the real estate side to see what kind of opportunities there are. I will say that it is a difficult environment in the real estate space because the landlords are in a challenging environment as well. So it’s tough to predict but we’re looking at all the options to try to reduce our overall cost structure, on that fixed cost of the occupancy within our stores.

Joel Havard - Hilliard Lyons

Working on the cost structure is a good segue into number two here. In your priorities and outlook you talk about product cost and pricing and you focus on reducing product cost and creating price flexibility on products. Could you tell us if that means a more aggressive promotional stance and is it tied one-to-one with what you can cut out on the production end? Give us a sense, if you can, of what you are thinking and how you might respond in this kind of environment.

William R. McLaughlin

First of all, our product line today has opportunity within it just to help consumers understand the breadth of the price points that we actually offer. Many people think that our product is $3,000 or $4,000 and are surprised actually when they come in the store and learn that you can get a queen size Sleep Number bed for less than $1,000.

And then if you look at the way that our product line steps up from there, we have three models that are currently below $2,000. And what we have seen is that our mix really has not changed. It actually has gotten a little stronger in the last year, which is good news for the new products that we’ve launched at the higher price points, over $2,000.

But in this environment we believe there may be opportunity that we’re not taking full advantage of for incremental sales. And that’s what we keep looking at, is our opportunity to stabilize sales, stabilize share, and get some leverage back into our whole system, is how to maintain the higher price points but look for incremental volume at those lower price points but not sacrificing our operating margin to a degree. And that’s where we’re working on cost reductions in product and also looking at other cost opportunities in the system.

Joel Havard - Hilliard Lyons

I recognize you have a lot of levers involved in that. Would that be to say, possibly, that this is more a matter of the marketing message or focus, either media driven or in the stores, versus tweaking the product line, putting a different cover on it and calling it model X1 instead of model X?

William R. McLaughlin

First of all, I think yes, it is part of the marketing message, making sure that we are more clearly communicating the value advantages that we already offer. Secondly, though, we believe we have opportunity to test what the elasticity of demand is at some of those price points through promotional efforts, most likely. We have done that in the past, had learning in the past, but I think this is a different consumer today and we need to pursue that, support that, though, with some of the product cost reductions, and that’s back to the essence of your question, was we’re working on our product cost to give us flexibility to test different price elasticities at those lower ends without sacrificing our operating margins.

James C. Raabe

And I would say that certainly we would like to protect the margin by finding cost opportunities to kind of fund those opportunities on kind of the middle and lower price points. I wouldn’t say that we would necessarily restrict it to that. I think if we can find things that will drive incremental gross margin dollars, and that means we have to give up a little bit of gross margin percent, we will do that. But I think as Bill said, there are a couple of things going on here. We would like to fund it, and we do think we can find opportunities on the cost side of the product, but there is also some testing and understanding of really how we can drive incremental buy-ins at those price levels.

Operator

Your next question comes from Bill Massie.

Bill Massie

Regarding your advertising, you indicated sort of a couple points lower to the extent of sales, but then I think, Jim, you indicated your historical level was closer to 12% to 13%. I just want to reconcile those two things because it looks to me like this year advertising is closer to 15%. So are we talking more like a 300 basis point to 400 basis point reduction as we go forward into 2009 or more like a 200 basis point reduction?

James C. Raabe

I think the disconnect is really between Bill commenting on marketing dollars as a whole. And there is a media component to that and I was speaking more to media. I think we’re talking about really needing to be more efficient on the total marketing dollars and the whole component value with some reduction in the media as well.

Bill Massie

On your advertising spend, on your media dollars, how forward are you bought? Just to use round numbers, if it’s $100.0 million a year, at this point, right now, are you bought through the rest of the year or are you buying sort of three months in advance? Just give me some ideas how flexible the dollar commitment is in terms of your ability to dial it back at any point in time.

James C. Raabe

We’re very flexible. The answer depends a little bit on which type of media that you are talking about. For example, the bulk of our media, almost 60% of it is direct response and within that the TV part, much of it is bought just two or three weeks out. The print is bought close to two to three months out. Everything else is somewhere in between but closer to the weeks and months as opposed to half years or anything like that.

Bill Massie

I don’t want to conclude something based on what you just said, but it is fair for me to presume that if there is no sacred cow in advertising. If comps are down 35% you are not going to spend that money just because you said you would.

James C. Raabe

Right. In the third quarter we pulled back a ways as well but the timing of when you start to see things in a quarter can affect exactly how fine you can cut it on a quarter. But going into the new year now, we’re planning it at the lower rates as we talked.

Bill Massie

As to the pricing and the cost of the beds, you have had a unique history that your models seem to grow to a certain level, hit something of a plateau, and then you found the next leg of growth, in terms of communicating a more succinct message, etc. and you were able to double the revenues and really advance the branding of the company. Now we find ourselves in a similar situation, the market is particularly bad for the business and overall, and it gives you perhaps a chance to think about the third iteration, if you will of the business.

And my question, in thinking less about 2008 and less about 2009 and more about where this company will be in 4 to 5 years, do you view something like your gross margin rate, that’s 60 points of product margin, is that also a sacred cow that you feel you have to protect going forward, or are you considering a more aggressive unit expansion strategy that would allow you to essentially take the gross margin down and drive unit acceleration, in light of that comment you made about price points?

I just want to take it beyond the immediate into sort of the strategic, I guess is what I’m ultimately asking.

William R. McLaughlin

And my answer is there really are no sacred cows. What we have long believed is that there’s a balance needed here of generating awareness so you have got to fund a certain level of marketing or sales promotion activities to support awareness as both a branded company and also as a retailer. So you have to keep both of those stoked.

But I think we’re going to learn a lot here in the coming months and year about the price elasticity and as Jim said, if we have to forgive some points of gross margin to make the incremental work, we will do that.

But at this point we have already got a very good value in our product line as it exists. I think part of our marketing opportunity, sales opportunity, is to communicate the value that exists in the line today.

Bill Massie

To the comment you just made, you clearly do have value and it’s fair to say that perhaps people don’t understand that as well. But I also question whether or not part of what happens, if your average price point is still in that $2,000ish range, do you think it’s less an issue of having a product available under $1,000 and more an issue of the spreads between the products not being so wide.

I guess my point is as a retail analyst you sometimes feel like if you’re buying the lowest priced product that a company sells you’re getting their cheap product. So if the price points go $1,000, $2,000, $3,000, $4,000, people might have an aversion to the $1,000 price point, whereas if the price points went $1,000, $1,300, $1,600, $2,000, you might not have that problem.

William R. McLaughlin

All good points and that exact charge has been put in front of the task force that’s working on this because our entry level bed is a terrific bed. It’s really what the company was founded on and we need to be able to communicate that positioning more clearly.

James C. Raabe

And I would say, certainly what we have done in the past year with regard to filling in price points indicates that having appropriate spreads between the products is certainly important. We do need to do a better job of that, at the lower price points and I think when we have done some things like when we did a special edition bed back earlier in the year, which was kind of in that in-between price point, we had a lot of success with it.

So those are the things, as Bill said, we are testing and looking at and I think it is an opportunity for us.

Operator

Your next question comes from Robert Evans - Craig-Hallum Capital.

Robert Evans - Craig-Hallum Capital

Not to beat the media spending to death, but trying to get your perspective on if 12% to 13% has kind of been your historical trend, is there something magical about that level or have you made thoughts toward the 10% to 11% spending level. And if you did that do you believe it would have a long-term impact on the business, or can you give us your thoughts in terms of backing on the media spend even farther, given the current economic environment.

James C. Raabe

We are really doing a kind of bottoms-up build as we look to the new year. At least the preliminary looks at that, we are prioritizing our spending against really four buckets, the first being awareness and driving leads. Almost like you’ve got to fill up the swimming pool, then there’s the urgency around the consumer events and promotions, particularly as consumers are increasingly focused on buying around special holiday weekends. So that’s the promotion spend.

Then for us, because our owner base is so strong and so loyal and so important to referrals, that’s a bucket of spending. And then there’s a small amount in the regional development.

When we lay all of that out, you still get back to about a 13% to 14% range, but we’re going to be looking at different alternatives off that to test in different markets.

Operator

Your next question comes from Budd Bugatch – Raymond James.

Budd Bugatch - Raymond James

The structural changes at the store level, are there any of the structural or organizational changes that you can maybe address and give us some detail and then quantify some of the impacts?

William R. McLaughlin

We are always looking at our overhead structure but to be honest, that has been pretty aggressively dealt with here to date. The next phase of that will really be somewhat dependent upon how many stores we end up moving out of. That will change the workload structure that we need to support them. That’s the next biggest change.

The other changes that will come, after we have done SAP and a few of the other key implementations we have there, there will be some efficiencies generated from that as well.

Budd Bugatch - Raymond James

And is SAP still planned for next year? You were going to delay it for a year, if I remember right?

William R. McLaughlin

Yes, we delayed it to 2009. It is still scheduled for 2009. The timing of that will be somewhat dependent upon some of the other programs. We don’t want to interfere with important programs that we have stabilizing the business through the SAP launch.

Budd Bugatch - Raymond James

And hub-and-spoke is that working yet like you want it to? And what about the capacity utilization at the [inaudible] factory levels?

William R. McLaughlin

I would have to say that, as you would expect, the whole infrastructure is getting somewhat deleveraged as you go through the unit declines that we have had. We have flexibility to adjust shifts and the rest, but in general they are deleveraged. But I would say that the plants, particularly, have responded very well to that and you see that in the gross margin as they’re impacting their cost. And the hub-and-spoke similarly but the nice thing about the hub-and-spoke program is there is some flexibility built into it. We can variablize some of the numbers of hubs as an example, that we operate out of.

Budd Bugatch - Raymond James

Can you give us the individual add backs to the EBIT to get to the adjusted EBITDA?

James C. Raabe

Sure. Basically three individual components that get added back. The first one is depreciation and amortization, which in the quarter was $5.1 million, non-cash compensation was $1.2 million, and then the asset impairments was $1.5 million. That’s added back to our operating profit to get to our adjusted EBITDA.

Operator

There are no further questions.

William R. McLaughlin

Thank you for joining us and thank you for your continued support. We look forward to speaking to you again next quarter.

Operator

This concludes today’s conference call.

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Source: Select Comfort Corporation Q3 2008 Earnings Call Transcript

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