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Select Comfort Corporation (NASDAQ:SCSS)

Investor Day

May 8, 2012 11:15 AM ET

Executives

Edwin Boon – VP, IR and Corporate Strategy

Shelly Ibach – COO and EVP, Sales and Merchandising

Kathy Roedel – EVP, Product and Service; Chief Technology and Services Officer

Wendy Schoppert – EVP and CFO

Analysts

Brad Thomas – KeyBanc

Budd Bugatch – Raymond James

Keith Hughes – SunTrust

Mark Greenfield – Sigma Capital

John Baugh – Stifel Nicolaus

Joshua Pollard – Goldman Sachs

Tom Bodor – UBS

David MacGregor – Longbow Research

Joan Storms – Wedbush Securities

Rick Fradin – Rail-Splitter Capital

David Ricci – William Blair

Kenneth Gau – Waddell

Sean Matlock – Kennedy Capital

Ethan Steinberg – Friess

Eric Hollowaty – Stephens Inc

Todd Schwartzman – Sidoti & Company

Edwin Boon

Good morning. My name is Edwin Boon. I am Vice President, Investor Relations and Corporate Strategy. And my Sleep Number setting is a 50.

Thank you for coming to our presentation portion of Sleep Number Investor Day. Thank you for the opportunity to discuss our company with you, such an exciting company and we’re just starting. We hope that you really love the store visit today. Isn’t it a great store? Thank you for joining us on the webcast as well. Shortly, I’ll share highlights of our growth strategy with you and then we’ll follow that up with questions and answer session.

Our speakers today include Shelly Ibach, our current Chief Operating Officer, and Incoming President and Chief Executive Officer; Kathy Roedel, our Executive Vice President and Chief Technology & Service Officer; and Wendy Schoppert, our Executive Vice President and Chief Financial Officer. Please note that the recording and slides used in today’s presentation will be available in the Investor Relations section of our website at sleepnumber.com.

Please refer to the appendix of the presentation for a reconciliation of certain non-GAAP financial measures included in the presentation, or that may be discussed by management today. Today’s presentation, as well as our answers to your questions, may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in the forepart of the presentation and discussed in some detail in our Annual Report on Form 10-K and other filings with the SEC. The company’s actual future results may vary materially.

Now, let’s get started.

Shelly Ibach

Welcome. I’m Shelly Ibach and my Sleep Number is 35. Today we will answer the question why Sleep Number. One of my favorite Sleep Number stories is from just two weeks ago at our Presidents Circle, which is an annual summit of our top performers from across the country. Such diversity there, we had on one had a 16-year veteran with Sleep Number, a Store Manager who’s still setting records and then we had a first-year sleep professional selling over $1 million in his first year.

The comment thread with all of the top performers is their passion about improving people’s lives and their desire to help one another be successful. This mission-based team is focused on improving customers’ lives through individual Sleep Number experiences. This is the foundation of our company and what is really creating a great, great company for all constituents, employees, shareholders, suppliers and customers.

Thank you for joining us for a store visit today. We thought it was appropriate to begin the day at the heart of where everything happens, the magic of our store, where the interaction between the Sleep Professional and the store and the product and the customer all come together. We are unleashing Sleep Number’s growth through the strength of our integrated customer-focused strategy, our proprietary products, and our exclusive distribution, and our unique business model.

We are on the path to achieve our goal of more than doubling our 2011 sales and expanding operating margin to more than 15% by 2015. In my over 30-year retail career I have never been more confident about a strategy as I am about our strategy right now at Sleep Number. This confidence comes from our knowledge of the product combined with the unparalleled customer experience that we are delivering. And with our development, it just keeps getting better.

Manufacturers and retailers work hard every day to be relevant for their customers. At Sleep Number we had the unique ability to take a single concept and execute it in a fully integrated manner from pre-purchase to purchase, the product and service experience followed by continued brand engagement through subsequent communications and purchases. Who else can do this? Who else has control over every aspect of their brand experience?

It starts with a truly unique product, coupled with company-controlled retail experience. How many unique brand experiences are there like this, especially in large undifferentiated industries like the mattress industry? And we are just getting started.

The industry dynamic favors Sleep Number’s growth. For context setting let’s quickly review the industry, over $12 billion at retail, with projected growth of 7.1% over the next two years. Non-innerspring is clearly outpacing the industry growth. In fact, over the last eight quarters non-innerspring has accounted for 86% of the unit and 78% of the overall mattress industry growth.

With this pace, we are seeing the non-innerspring segment at an inflection point and expect continued share growth. In addition, there has been strong growth in premium, mattress price points greater than $1000. Premium now represents 47% of the industry sales, up from 41% in 2008. We believe Sleep Number is helping drive these shifts in the industry, and we are uniquely positioned to benefit from them with our premium non-innerspring product and exclusive distribution.

We are early in our growth journey and approximately, with just approximately 5% market share and less than 2% unit market share. And we are well positioned to continue to accelerate investment in our unique product and distribution. Consideration of the non-innerspring is now similar to innerspring, indicating the adoption of innerspring-alternative products. This consideration comparison is even more impressive given the fact that non-innerspring has been comprised of primarily premium price points to this point.

The consideration shift is consistent with the consumer trends related to health and wellness. Consumers are seeking quality products and contributing positively to well being. Our exclusive, or company-controlled, distribution allows us to lean into this opportunity and not be at risk of losing selling floor presidents who are focused on our product due to increased competition in the category. We don’t have that risk.

Sleep Number’s vision is to become the new standard in Sleep by individualizing Sleep experiences. Let me take a minute and speak to the individualizing. Consistent with the trends that we’ve all experienced in coffee, with Starbucks and Peet’s and Nespresso and some of those other brands, and the trends that we’ve seen with Apple, individualization is a key trend and that’s what Sleep Number has always been and is about, individualizing the experience which is broader than just the mattress for our customer. It’s inclusive of understanding what the customer desires and what their needs are and matching it with product that gives them a fully integrated Sleep experience.

To realize this vision, we’ve established five long-term goals. Our growth strategies support these consumer-centric goals and we will communicate our progress against these goals on a regular basis. As you may expect, our first goal is about awareness. Everyone will know Sleep Number and how it will improve their life.

And our second goal is about product. Innovative Sleep Number products will move society forward with meaningful consumer benefits. And our third one about distribution, Sleep Number will be easy to find and our customers will be able to interact with us how and when they want. And the fourth one, of course, is about the integrated experience. Customers will love Sleep Number and enthusiastically recommend Sleep Number to family and friends.

And finally and importantly, our fifth goal is about our advantaged business model. Leveraging our unique business model to fund innovation and growth will benefit our customers, our employees and our shareholders. Our strategy is integrated and focused on the customer. The best and most iconic retail brands today enable shoppers to succeed at interacting with the brand at every touch point and provide a consistent brand experience. This is what we are building at Sleep Number.

Our number one growth opportunity is awareness. While our bed was invented 25 years ago, our Sleep Number brand was developed just 11 years ago. And until 2010, we operated under two brands, Sleep Number and Select Comfort. Today we are all Sleep Number. Our August of 2011 study indicated our unaided brand awareness with just 15%. While this was a high point for us, it was less than half to a quarter of other leading mattresses brands. Our integrated growth formula was developed to address this challenge and we’ve made progress.

We’re broadening awareness through a powerful combination of redefining our target customer, persuasive creative advertising, increased media reach, effectiveness, and investment. So let’s review this in greater detail. First just this past year, midpoint in the year, we broadened our addressable customer by over four times. Our younger, more aspirational customer, who is now 30 to 54 years old, is our new target, and includes the prime mattress buying years of 30 to 45 years, has higher income and the propensity to trade up, is seeking an aspirational fit and values individualization.

Next, to address our low brand awareness of 15% and our store unaided store awareness of 6%, we developed a Sleep Number experience advertising campaign that delivers persuasive messages about our Sleep Number bed, store, customer experience, and our Sleep Professionals.

Let’s review a 60-second spot we aired during the successful February Presidents’ event. In this spot feature – go ahead let’s look at it.

(Video Presentation)

That spot features not only our brand messages, but also a strong value and urgency message that we use during our key consumer periods to drive traffic. This is a consistent promotional strategy that we’ve been executing against for the last three years. So, now let’s take a look at a 30-second ad that features our brand message and a product introduction. And this is from January.

(Video Presentation)

To support our awareness challenge and reach a broader target customer with these persuasive ads, we made a game-changing shift in our media strategy last year. Historically, we relied almost exclusively on direct marketing with some targeted local advertising. This media strategy was narrow and focused on a need-state older customer. Today our media strategy is still layered, but it is focused on national, broad reach and local market development, with a singular brand message.

This strategy not only reaches our target customer, it supports all stores across the nation, resulting in growth in 2011 in all markets, regardless of what stage of development they were in. The graph here is representative of the direction in shifts, important to note that we continue to evolve and develop our advertising and media strategy as we learn. So this is a migration plan. We have not arrived, so to speak.

To be clear, on this important migration, I’ve used the four box here to illustrate the shift and the changes in our advertising strategy. To summarize, we’ve moved from a 2- to a 28-minute infomercial, that you may see at 3:00 in the morning, focused on back pain and telling you the customer to call 1-800, to a 30- to 60-second brand experience spots that may show up on CNN, CNBC, or Bravo Housewives.

These ads are focused on consumer benefits, as you just saw, and are driving consumers to sleepnumber.com or our Sleep Number Store. And they share – these ads are very consistent with what we’ve seen here, and we’ve been constantly iterating and improving their overall effectiveness and persuasiveness.

So in addition to record sales and profit results, we’ve been delivering, and our awareness is moving. Our unaided awareness grew five points, from 15% to 20%, since August of 2011, while other leading brands remained relatively flat to their recent history. This is the first significant increase we have experienced in our history, and it is, of course, the highest point for us in unaided awareness.

So what does this mean? We see unaided awareness as an important indicator of sustainable market share growth. As you can see on the chart, our unaided awareness did not grow in 2006 to 2007 time period, yet our sales increased 17% in 2006. However, without the increased awareness, we were not able to sustain our growth at that time.

Our market experience has shown us that awareness is a leading indicator of share growth. While not always linear, this chart illustrates not only a correlation of awareness and market share growth, but it also indicates leading markets still have the opportunity for additional growth. In summary our key awareness advantage is our consumer trend support, Sleep Number’s premium non-innerspring individualized positioning, low awareness as an early stage growth company, integrated growth formula that is building awareness and delivering a singular brand message.

Our second goal is Innovative Sleep Number products will move society forward with real consumer benefits. Consumer attitudes are shifting as they become educated on high quality personalized sleep products that deliver real benefits to improve their lives, which means they are moving towards innovative technologies like Sleep Number.

Our innovation is driven by consumer trends, insights and research. Our core product line is individualized. We will continue to build on the trend and broaden consumers’ experience while accelerating growth through product commercialization. In the past 12 months, we’ve re-launched our entire product line with a signature look to elevate our value.

We’ve introduced the AirFit Adjustable Pillow and the m7 memory foam bed. As you experienced at our Sleep Number store today, all Sleep Number beds feature the unique and innovative dual air technology. This technology allows customers to adjust the bed on each side for ideal comfort, or establish their Sleep Number.

In independent studies, 89% of test participants reported improved sleep quality with a Sleep Number bed. We offer eight core beds and cover good, better and best within the premium category with prices that start at $999 for a queen set. Our bed line is designed and crafted in the U.S., and we have two plants and just-in-time inventory to make the order.

We are further individualizing customer sleep experiences with our proprietary solution-based bedding collection and adjustable base, which we call the FlexFit. Our family of products also broadens consideration in addressable market to increase awareness and consideration driving increased traffic to stores. The adjustable AirFit Pillow was positioned as the most innovative gift of the year in fourth quarter, and was a great example to this effect.

And finally, our family of Sleep Number products has been a source of meaningful growth. Over the past two years while our bed average sales grew modestly, we increased average sale price by 47% in bedding collection and adjustable basis. This higher transaction size resulted in increased sales and gross margin dollars.

However, source products have slightly lower gross margin rates than our manufactured products. But importantly, our unique business model leverages the increased sales in margin dollars to deliver higher operating margin dollars and rates, since they require minimal incremental selling, marketing and G&A investment.

So, key advantages of our innovative products include DualAir technology that individualizes Comfort, proprietary family of sleep products with exclusive distribution proven to improve quality sleep and loved by our customers. Our third goal, Sleep Number will be easy to find and customers will interact with us how and when they want, supports our awareness in unique product goals with exclusive distribution.

As a national retailer, we are leveraging our existing footprint of about 380 stores in 45 states and sleepnumber.com, while taking an aggressive approach to local market development to improve both brand and store awareness. The path to at least $1.5 billion by 2015 is comprised of optimizing existing stores and adding new stores in underdeveloped markets. The unique and exclusive Sleep Number store experience produces higher store productivity than traditional mattress retailers.

As a retailer, we must compete effectively on a local basis while building our brand nationally. Our aggressive growth strategy is designed to more than double market share profitably in our target markets within three years. We’ve identified 13 of our large underdeveloped markets to apply this strategy to. When we introduced this strategy in 2011 these markets represented a third of U.S mattress sales, yet only 24% of Sleep Number sales.

This strategy involved a breakthrough level of media to achieve adequate local share of voice, a media plan that is customized for the individual market and inclusive of digital, TV, radio and out of home, a rapid real estate optimization including store remodels, repositions and new stores to deliver an in-store experience for our customers, and an accelerated store team development and hiring process. We piloted four of these markets in 2011 and they are now in year two.

We plan to launch at least three more in 2012 and the remaining six markets by the end of 2014. The green line on the graph represents the higher-than-expected results we experienced in pilot markets in 2011, two to three times our company growth. 2012, or year two performance, is early, but we are very pleased with what we are seeing so far.

Let me share some specific actions and results so you can better understand this important strategy. This is one of the aggressive growth markets that we launched in 2011. We increased the local media by four times. We optimized stores, remodeling and re-positioning four stores. We opened two non-malls, increasing our store count by 20%. We invested in our store team development, recruiting, and hiring and we achieved unprecedented results as you can see from the chart, growing awareness six points, market share by 50%, sales by 71%, and profit by 74% in year one.

We plan to invest capital in our current national and retail stores to support the expected growth previously discussed. To increase store visibility and real estate flexibility, we introduced the non-mall format in 2011, opening 20 locations. We are very pleased with the results and we expect to have over 70 of the non-malls by year end. As you know from the store we visited earlier today, the non-mall store offers a great opportunity to reposition an existing mall to a stronger trade area that may not be served by a mall.

We will also invest in our mall stores, repositioning to higher visible locations. Our new store design is supporting our unique brand experience of individualization, and we expect to have nearly 50% of our stores fully on brand by year end. Remodeling and repositioning existing stores is resulting in larger, higher volume stores and improved productivity and shopping experiences.

We plan to grow our net new stores by 5% to 8% annually beginning this year. One of the benefits of having exclusive company-controlled distribution with a premium brand is that you’re a destination retailer. We have a disciplined approach to our store density and location selections, which helps us build higher store volumes and a lower overall fixed structure for a more profitable and sustainable business model. For example, in this sample market map here, we have one mall store in this market and sales volume of $2.5 million. We know who our customers are and where they live and how far they drive to shop at our store, and in this case as illustrated by the red dots.

Our tools and approach the real estate selection allows us to be confident in adding a new store. And in this case it will be a non-mall store, building awareness and generating additional sales. From a density perspective, we believe this market could be adequately served with our destination and exclusive distribution with these two stores, as you can see by this chart.

By the way of comparison, a different approach to this market could be to operate six to eight, stores like a market competitor. In these stores, they have an average of $1 million. Their six stores will produce the same volume as our two stores. Clearly the two stores have significant less fixed operating costs, therefore higher profit.

In addition to our real estate selection and exclusive distribution, our new Sleep Number store design is accentuating our selling process and experiential customer journey just as you experienced today. Our mission-based team focuses on developing a relationship with our customer as only Sleep Number can do, by controlling all of our touch points and Kathy will speak about that in a few minutes. All aspects of our strategy lead consumers to our store, where we can deliver the most individualized experience. This integrated strategy is resulting in increased store productivity.

The graph here shows the progression in average sales per store. Average sales per comp store are now $1.9 million. We have consistent comp growth in the various tiers and progressive four-wall profit, by tier, with an average profit in $2 million stores greater than $600,000. 36% of stores are now producing sales greater than $2 million, and we have not yet experienced a cap in sales volume for any of our Sleep Number stores.

Wendy will share additional details about selling and marketing leverage. So, the key advantages of our distribution strategy are our national premium brand mattress retailer, having exclusive controls, company-controlled distribution, our unique relationship based customer experience, which is a perfect transition to Kathy Roedel who will talk about our next goal of experience.

Kathy Roedel

Good morning. I’m Kathy Roedel and my Sleep Number setting is a 35. Shelly just described how Sleep Number is unleashing our growth by building awareness for our brand and stores, introducing innovative new products and making Sleep Number easy to find with our integrated distribution strategy. I’ll talk about our fourth element of growth and where it all comes together for our customers.

Our fourth company goal is that everyone will love their Sleep Number experience and enthusiastically recommend us to their friends and families. Our customers experience Sleep Number with our sales team, our delivery service, the product, customer service and throughout their lifetime ownership experience. As both a cross-channel retailer and manufacturer, only Sleep Number owns the entire end-to-end customer experience. Only Sleep Number can innovate across every touch point for the benefit of our customers, and only Sleep Number can deliver an unparalleled brand experience to drive repeat and referral sales.

Let’s take a look at the advantage we have over typical retailers and manufacturers. Manufacturers are focused on innovating their product, supply chain, and brand marketing. Retailers are focused on sales, service and promotional marketing. Most often, retailers and manufacturers are not optimizing each other’s innovations, but rather are working in their own silos and sometimes even at cross purposes. Only Sleep Number can innovate for our customers with speed and clarity and control the brand experience at every touch point.

I’d like to introduce you to our customer, Valerie. She is 40. She is an art director for an advertising firm. She’s a fitness enthusiast. She’s married and a mother of two.

Here’s how Valerie experiences Sleep Number. Valerie has been in the market for a new mattress. But like many, she dreads shopping for one until a friend tells her that she should check out Sleep Number. Research shows that general mattress consumers experience strong negative emotions about that purchase experience. They fear making a mistake. They’re confused over so many offerings and importantly, they lack trust in their sales people.

In fact in a recent study of factors influencing a purchase decision, consumers listed the influence of their mattress salesperson dead last. Sleep Number uses regular, integrated customer feedback to design and continuously innovate our store experience, which you saw today in our Oak Brook store. We’re able to test and apply learning to create a purchase experience like no other in the industry.

So what do consumers like Valerie say about their experience with us? They tell us that the top two reasons for purchase are the connection they make with their sales professional and the benefits of dual air adjustability in our bed. It’s no surprise that Sleep Number customers are more than twice as willing to refer friends and family to Sleep Number than the two leading multi-brand mattress retailers. So, Valerie chooses the perfect bed and bedding for her and her husband. Sleep Number products are uniquely positioned to deliver her an individualized sleep experience.

In addition to traditional research for product innovation, we tap into almost two million yearly conversations in our sales and service contact centers and with the insights of our sales professionals and delivery team from across the country. And we use that direct customer voice to innovate and launch new products that uniquely meet customers’ needs and wants with clarity and speed.

We developed our breakthrough AirFit Adjustable Pillow based on owner insights and moved from concept to launch in nine months. The results were tremendous. We doubled our AirFit unit projections and pillow attach was up 175% in Q4 of last year. We also relaunched our entire line of beds, eight in total, with improved comfort and a signature branded look in two launches, July of 2011 and January of 2012. When we launch new beds we are able to transform all 380 stores literally over a weekend. With all new products on the floor, new in-store merchandising and sales, service and delivery training and this is process that takes months for our competitors.

So when was the last time you had something like a washing machine, or a sofa, or a bed delivered to your house? How was that experience for you? Was it memorable or just okay? Well, for Valerie, her delivery was an extension of her purchase experience. In our industry, delivery people work for the retailer and often deliver a range of brands. But our team delivers only our beds, and in fact, we have many service team members who have delivered over 25,000 Sleep Number beds in their career.

With over 200,000 annual interactions, our delivery service team is an important extension of our product, quality, manufacturing, and customer service teams. Other mattress manufacturers will never get the kind of rich product and customer information we get from our delivery team. Our customers are excited about receiving their Sleep Number bed, and our delivery team keeps that excitement alive by helping customers get comfortable, by reliving that wow movement when they found their Sleep Number in one of our stores.

When Valerie’s bed arrives, she is so excited watching our technician Andrew put it together for her and at the end, he helped get comfortable and find her Sleep Number again. And then he told her that tomorrow after sleeping on her Sleep Number bed, she’d feel 10 years younger. Valerie tells her friends at work the next day how excited she is to have her new Sleep Number bed.

We have millions of Sleep Number owners,, ranging from the ones who purchased their bed 25 years ago to those like Valerie who slept in their Sleep Number bed just last night. And our customer service team is there for all of them providing our customers with service where, when and how she wants, via a phone call, email, live chat and social media. Our customer service team provides a special experience for our customers. We hire people with service in their DNA that shows in the way they interact with our customers. Many are former caregivers, nurses, servers, even have a few first responders.

We’ve received thousands of testimonial letters for customers who tell us that customer service team took amazing care of them and reinforced their feelings about Sleep Number. My favorite testimonial story is a recent one, a woman who drove all the way from Wisconsin to our headquarters in Minneapolis carrying two home-baked pies that she baked for Jenna, the sleep specialist who take care of her. And we think of customer service as a growth driver and not a cost center. We consider every time a customer contacts us as an opportunity to gain valuable feedback for innovation and to reengage them with our brand.

So Valerie is now an owner, or an insider, as we call her. During the past 25 years, we’ve improved the lives of more than 7 million people. Because of our unique business model and ownership of all customer touch points, only Sleep Number can build relationships and create a differentiated ownership experience. On any given day, we are directly and individually reengaging with our customers providing them opportunities to reconnect with Sleep Number, like our Inner Circle owner loyalty program, special Bedding Collection offers that bring insiders back to our stores, and of course create customer service.

We reach out to customers through one to one marketing through digital communications and social media programs that often include exclusive offers and events. As an example, in the month prior to launching the AirFit Adjustable Pillow, we sent a special offer to a small segment of our customers. So before they were even efficiently available we had sold 500 pillows. More importantly, we had a pool of customer testimonial, influential blogger reviews, and a broad sharing of product information on social platforms like Facebook and Twitter. They created interest and started selling our product for us through their communities and word of mouth.

Creating new innovation and making improvements in our end-to-end customer experience is an area where we have invested and will continue to invest. We are creating communities of passionately loyal owners who have rewarded us with $200 million of repeat and referral growth since 2009. As we bring more people to Sleep Number and delight them with our unmatched customer experience, we expect that growth to continue.

So now I’ll close with those key advantages of our fourth company goal, that only Sleep Number owns the entire end-to-end customer experience. Only Sleep Number can innovate across every touch point to the benefit of our customers, and only Sleep Number can deliver an unparalleled brand experience to drive repeat and referral sales.

So let’s check back in with Valerie and see what she has to say about her Sleep Number experience. I’ll read it for you. Starting with the experience of purchasing the bed at the store, the manager listened to my concerns and needs and he made excellent suggestions to help me make the best decision and selection, no pressure but extremely helpful. This was a big purchase for me, and I appreciated the very knowledgeable and professional sales person. Then the actual sleeping experience, well let’s just say I love my bed. The sheets are luxurious. The pillow is perfect and best of all, the bed itself is providing the best sleep experience ever. And I do tell everyone about it. I think that knowing I can adjust the number depending on my needs is so cool. I love it. Did I say that already?

So, now I’d like to introduce Wendy Schoppert, our CFO to review our fifth company goal leveraging our business model. Wendy?

Wendy Schoppert

Well good morning, everyone. I’m Wendy Schoppert and my Sleep Number setting is a 35. Well, you’ve heard quite a bit about our growth strategy from both Shelly and Kathy. And I will share now how the strategy has driven our recent results and how it’s expected to drive shareholder value into the future.

So, our investment proposition is fairly simple. We are delivering and are committed to continue delivering top tier rates of sales growth. Our goal is to more than double our sales from 2011 to at least $1.5 billion by 2015. The leverage inherent in our vertically integrated business model gives us confidence in our goal of at least 15% operating margin by 2015, and we’re doing all of this while still generating significant cash, allowing us to self-fund our growth with no debt.

Our company entered a new chapter of its growth this year. Last year, our primary financial goals were to fully restore margins and to build our cash balance above our minimum needs of $125 million. We exceeded these goals with a record operating margin of 12.2% and a yearend cash and securities balance of $146 million.

But we also accomplished something else last year, and that was proving out our formula for sustained growth. And for that reason, you are seeing us invest more aggressively in these programs this year, with increased investment in marketing and distribution, which have already begun to drive industry leading rates of comp sales growth, as evidenced by the Q1 results we reported last month.

I won’t spend too much on this slide, as you have all witnessed our turnaround since the 2008-2009 downturn, as we more than quadrupled our EPS from 2009 to 2011. However, there are a couple of points I’ll make. First, our sales growth has all been organic, with a store base that has remained essentially flat. Our success was driven by the way our programs drove higher store productivity, as measured by average sales per store, more on that in a minute.

Second, we learned the power of focusing on just a few key strategies centered around our core business of selling sleep products directly to the consumer in the U.S. This allows us to successfully execute our growth plan and at the same time keep our fixed costs in check, in other words, to achieve a healthy balance between top line sales growth and bottom line leverage.

As we project sales growth for the next four years, taking into consideration the strategies that Shelly and Kathy just described, we expect to at least double the size of our business to $1.5 billion by 2015, a 19% CAGR. This is consistent with our outlook for 5% to 8% annual store growth, plus comp growth of at least 15% for the remainder of 2012 and at least 10% to 12% thereafter. We expect roughly half of this growth to come from increasing average sales per store, as we increase awareness through our marketing efforts, continue to optimize our distribution, and increase focus on product innovation. The other half is expected to come from net new store growth, particularly as we continue to fill in existing markets.

We see a lot of retailers achieve their growth primarily through store counts. I’d like to highlight the growth element that makes us unique, which is the expanded productivity of our existing store base as we build consumer demand. By the end of this year, we expect to have more than doubled our average sales per store over the past three years, from $1 million in 2009 to over $2 million this year.

Our growth plan calls for us to add at least another $1 million, or 50%, to average sales per store by 2015. So why are we so confident we can accomplish this? Well Shelly and Kathy have shared our programs with you. I’ll share a couple of financial perspectives that help to underscore the opportunity.

First is the fact that our stores are relatively low transaction volume stores, with plenty of capacity left. We used to talk about the impact of one additional bed per store per week, but as you’ve learned today, our product offering is much broader than beds alone. So I’ll highlight the impact of one additional customer per store per week, which will add $140,000 in sales per store annually, or over $50 million in total annual sales. This means that each store, on average, only needs to add seven customers per week to reach our 2015 goal as we continue to drive increased awareness across our store base.

Second, as of the end of Q1, 6% of our comp stores were already generating over $3 million in sales on a trailing 12-month basis. And importantly, we have over 15% of our comp stores on track to generate over $3 million in annual sales by the end of this year. Finally, our top stores that are generating $4 million to $6 million in annual sales are still achieving strong comps while comfortably serving this level of customer traffic.

Moving to gross margins, it’s important to note that we are focused on both gross margin rates and gross profit dollars. From a rate perspective, we’re pleased with 170-basis point growth over the past two years.

And we expect to reach at least 65% gross margins by 2015 as the result of two key drivers. One is the pricing opportunity as we bring new innovative products to market that are meaningful to our customers. The second is the opportunity we have for continued efficiency improvements in our operations, particularly in the area of logistics. Our outlook assumes that we may choose to invest in customer policy enhancements in support of our customer experience goals that could lead to one-time charges like the one we took in Q3 of last year. These decisions are based on rigorous customer insight and must meet our financial return hurdle rates.

Our gross margin rates will vary quarter to quarter. We’ve had some follow-up question since our Q1 call about the year-over-year decline in our gross margin rate last quarter. And in light of some of the competition-related comments made within the industry of late, I will provide further insight into the drivers of our Q1 gross margin and how we think about gross margin for the remainder of the year.

Our Q1 gross margin was primarily impacted by product mix changes resulting from two planned actions we took. And with everyone in the same room and via webcast at the same time, let me be clear that neither of these actions was in response to any external or competitive factors. First, we closed out and re-launched our entry level classic series, completing the planned transition to our branded signature look.

Second, we sold a product on QVC that had a lower margin rate and what we sold on QVC the prior year. Both of these product offers had a higher consumer response than we expect it, as reflected in our greater than 20% mattress unit increase during the quarter. There were also a variety of smaller factors that put pressure on gross margin and were unique to Q1, which are detailed in our Form 10-Q. These factors were partially offset by the favorable impact of pricing actions and operational and volume efficiencies.

As we look to the remainder of the year, we expect to continue to benefit from pricing and operational efficiencies, but we have built in some modest raw material cost increases. We currently expect full year gross margin rate to be roughly flat year over year, despite the Q1 decline. As always, we are striving to improve upon this performance and will keep you updated.

One last note on gross margin is that we have a balanced approach to driving both gross margin rate and gross profit dollars. One example that brings this to life is the growth of our sourced products, like adjustable foundations and bedding collections. These products generally lower our overall gross margin rate, but add incremental gross profit dollars and create additional leverage of our sales, marketing and G&A expenses to increase operating margin dollars and rate, while expanding our relationship with our customers.

Now to selling and marketing leverage, we are investing in media and other marketing initiatives to broaden awareness and accelerate growth. With around 70% of selling expenses being fixed, however, the leverage we’ve been achieving in selling has more than offset any marketing de-leverage. In fact, selling and marketing improved by 490 basis points over the past two years. Our goal through 2015 is to achieve additional leverage in selling and marketing, combined. As we grow, our national media should become more efficient and we expect selling to continue to be a source of leverage as we drive higher average sales per store.

G&A and R&D combined has been a source of leverage over the past two years, but we expect the leverage rate to moderate as we begin to invest in growth. For example, we plan to increase our investment in product innovation in order to drive our long-term growth, which will require an increase in R&D spending. And with respect to G&A, we are beginning to build our infrastructure for growth including investment in people, as well as depreciation associated with higher CapEx spending.

The last few slides have demonstrated that as a vertically integrated company, we have multiple sources of leverage. Our focus is on maximizing overall operating margins and we expect to add at least another 100 basis points to our operating margin rate this year, to a record 13.2% plus, which would be around 900 basis points higher than 2009. We are committed to achieving our goal of at least 15% operating margin by 2015, which will require, on average, around 60 basis points of growth per year from 2013 to 2015.

Well, I’ve outlined where in the P&L we expect the leverage to come from, and the last few slides actually add up to a 16% operating margin by 2015. There may be shifts in the pace of leverage we experience amongst gross margin selling and marketing, G&A and R&D. In other words, our ultimate measure of success is overall revenue and operating margin, more so than the individual components that drive them.

We also use flow through rates, or incremental operating profit, as a percent of incremental sales to measure our progress on accelerating operating margins. Our success in achieving at least a 15% operating margin by 2015 will be driven by our average flow-through rates over the next four years, combined with how much incremental sales we generate during this period at this higher incremental margin rate. Our progression since recovering from the economic crisis has resulted in some wide swings in flow-through rate. What you don’t see on the chart on the left is that from 2003 to 2006, the period leading up to the downturn, our average flow-through rate was only 11%. We then have a few years of a lot of negative numbers, as many of you will recall, and what you see in 2010 is a very high flow-through of 46%, which was driven by the deep cost reductions we made across the board as we stabilized the company coming out of the crisis.

As we fast forward to this year, it’s important to understand the drivers of the change in flow-through rate versus 2011. The decrease from 28% is almost entirely driven by investments in our fixed marketing and selling expenses, which have both short- and long-term benefits. Variable flow-through, including media, is in the high 30s both years, and G&A plus R&D of our incremental sales is relatively stable year over year. It’s our investment in important growth areas like new stores, remodeled, repositions, store personnel to support our record sales per store, consumer insight, and media production that are driving these year-over-year change.

Now many of you will ask about the flow through range in 2012. This is driven by the range of possibilities for our sales growth for the remainder of the year. Our current GAAP EPS guidance for 2012 of $1.32 to $1.40 assumes a flow-through rate of between 18% and 19%. And if we exceed our sales outlook, we expect to achieve between 20% and 21% flow-through or higher. We also expect some seasonal variability, with lower flow-through in seasonally low quarters and higher flow through in seasonally high quarters.

Our growth plan between now and 2015 calls for flow-through rates of approximately 20%. And we believe we can exceed this level as we get to the out-years and begin to benefit from our long-term investments. This flow-through outlook is consistent with our operating margin outlook of at least 15% by 2015, which can go even higher if we exceed $1.5 billion of sales by 2015. In summary, flow-through level is about balancing our short-term goals with investments for the long-term, and we believe we are striking the right balance.

Our performance and business model are generating significant cash flow and as a result we are self-funding our growth. We are generating record levels of EBITDA, and as many of you know, we have a negative cash conversion cycle and negative working capital position that work in our favor as we grow. We have established a $125 million minimum cash balance for 2012, and beyond that, our number one priority for cash is to invest in the profitable growth of Sleep Number, given the high returns on capital we are achieving.

Our cash balance has been increasing, even as we increase investments in CapEx. We plan to double CapEx this year to approximately $50 million, largely to fund distribution developments, as well as enhance our customer information systems. Lastly, we initiated our planned share buyback about 10 days ago, and as of the end of the day yesterday, we had bought back shares totaling approximately $1.6 million. Our objective, as previously communicated, is to buy back enough shares in 2012 to maintain our share count at approximately 57 million shares, which we estimate at approximately 1 million shares to be repurchased.

We’ve not spoken specifically around our cash deployment strategy beyond 2012, but we will continue to prioritize our high return growth investments and, as always, make decisions that are in the best long-term interest of our shareholders.

So in closing, our investment proposition is clear, and our growth momentum continues. Top tier sales growth, combined with margin acceleration and cash generation, self funding our growth with no debt. We reiterate our expectation of generating at least 20% EPS growth beyond 2012 as we did last quarter, with pro forma EPS up 50%. We look forward to keeping you updated on our continued progress.

I’d now like to turn it back over to Shelly for some closing comments before we open the session up for Q&A.

Shelly Ibach

Thank you, Wendy. When you have consumer and industry trends that favor your proprietary products, and exclusive distribution, your unique business model, and mission-based culture, you can then begin to deliver the unparalleled experience that we are at Sleep Number and begin to unleash your growth.

We have a talented and experienced team working together to support one strategy, one mission, one vision, and one overall brand. Thank you to the Sleep Number team and thank you to Bill McLaughlin for leading us to this position of improving over seven million lives. Bill sends his greetings and his confidence in our go-forward strategy.

So again, why that number? I am confident that we have answered that question today and that we’ve demonstrated how unleashing growth will deliver more shareholder value. We are on our path to over $1.5 billion in sales and greater than a 15% operating margin by 2015.

Thank you for your time and your attention today and we’re eager to move into Q&A and answer whatever questions you have. Edwin, would you like to lead us?

Question-and-Answer Session

Edwin Boon

Thank you, Shelly, Kathy and Wendy. We will now open the Q&A session. Please raise your hand, state your name, your company, and limit your questions to two or three. Gabby or Becky will hand out a microphone to you. We would like to know who has the first question.

Brad Thomas – KeyBanc

Is this on? Can you hear me? Yes, it’s Brad Thomas with KeyBanc. I wanted to just – first of all, I’ll ask about the marketing side of things. It seems like that awareness issue is really what can drive sales higher. How sophisticated do you think you are today in that marketing spend and how in tune are you? And are you going to know when you’ve hit that point where you’re going a little bit too far on the marketing dollars, if you could just a give us a little more context I’d appreciate it?

Shelly Ibach

Sure, thank you Brad. Well, first of all, awareness as you mentioned is has been our number one growth opportunity. We’re really pleased with the progress that we’ve made moving some 15% unaided awareness to 20% from August 2011 to earlier this year. So, we’re definitely on the right track. We’ve advanced our sophistication around our entire media strategy. It is an integrated strategy. There is a combination of direct, local and national. We have a variety of measurements and the effectiveness of our reach and frequency is very consistent with our sales performance. While we plan our media strategy well in advance, and 12 months in advance, we do iterate within the quarter and have a fair amount of flexibility.

Part of our media strategy is to develop our local market and have a significant investment in these aggressive growth markets. And so we see the immediate correlation between our sales and profit and market share growth in these markets and can understand what that looks like. The spend there, while it’s a heavy-up in the first year, it’s a static spend over year two and year three. So, it really moves into a strategy that holds that media spend and then adjusts it after that third for sustainability.

So, we do have a formula in each regard that we measure in a number of ways. We also are a lead-in conversion business, which gives us a tremendous amount of understanding of the correlation between our media spend and how that’s performing through leads conversion as well as sales and then reach and frequency. So, we’re quite confident in the formula. At the same time, we’re always testing and learning and advancing and continuing to optimize our performance.

The final thing I’ll say is, while we’re investing media right now, we’re still leveraging that sales and marketing line. And in the future, as we continue to develop our sales in the national, we will – in these aggressive growth markets, we will then gain a greater efficiency for media. So, it’s not a target number that we feel we need to spend overall. It’s the correlation of building the awareness and consideration of the overall brand and increasing our sales throughout the country and that media leverage will come in the next few years.

Budd Bugatch – Raymond James

Hi, Budd Bugatch. I’d like to just piggy back on that question, it was the first question. You on page 13 kind of break out the differential between national, local and direct response, and if I read it right and it’s – is it right, is it fair to assume it’s like 35%, 35%, 30% between the three? Is that in the right realm of the break-out for advertising?

Shelly Ibach

Yeah, the graph is bit directional there. The national and local is 60% and 40%, and then, I’m sorry I don’t have the chart right in front of me.

Budd Bugatch – Raymond James

Okay. And as you look down the road, do you see that changing much as you look into 2013, 2014, 2015?

Shelly Ibach

We will continue to migrate. So what you’re seeing there is the local market development is fairly substantial as we focus on these 13 markets. So you’re going to see that for the next few years as we work through these 13 markets that represent a third of the mattress sales in the U.S. And that national will balance with that local, and the local will get smaller as well as the direct marketing.

Budd Bugatch – Raymond James

Okay. And just as on my second question, could you talk a little bit about the attachment rate now for sourced product as an overall for the company and where that can go over the next couple of years? Where do you think it can go, obviously that’s partly execution?

Shelly Ibach

Sure, Budd. We are very pleased with our overall product experience for our customer and really look define a new market, a market of sleep solutions and it is broader than the mattress and includes the adjustable, as well as the bedding collection. So you can see in one of the graphs where we’re showing that ASP growth, we do see transactions increasing as a result of the bedding collection. So it is driving repeat business in our stores, so we see this as a continued source of growth over time.

Budd Bugatch – Raymond James

Any numbers?

Shelly Ibach

We have not heard target number on it, but we do expect continuous growth. Right now we’re at about 12% penetration for our bedding collection.

Kathy Roedel

And I would just add that for the bedding collection, we look at it less on attach and more in terms of sales penetration, so percent of total sales. For the adjustable foundation, we do measure that on an attach base, and Shelly’s right. What we’ve shared is that we’ve seen a steady increase in the sales penetration of bedding collections. And then with respect to the adjustable foundation attach rate, we’ve seen at least several hundred basis points of growth per year as we focused on that important piece of business.

Budd Bugatch – Raymond James

Okay.

Keith Hughes – SunTrust

It’s Keith Hughes from SunTrust. If you look at your promotional calendar for the rest of this year, how does it compare to last year, and how does it compare to what you started off the year with? Have there been changes?

Shelly Ibach

Thanks for the question. The question is about promotional strategy and how has that changed from the start of the year and how does it look for the remainder of the year? Our promotion strategy is very consistent with the last few years. So we do plan our promotion strategy about 12 months in advance, and then we lock down on it as we move into two quarters out. We have not changed our promotion strategy from the beginning of the year, from our original plan. As we move into this quarter, there’s absolutely no change. There is no change to our Memorial plans. We are very, very steady. It’s the exact plan that we set forth in the year, and no change to last year either.

Mark Greenfield – Sigma Capital

Hi, Mark Greenfield, Sigma Capital. I’m kind of building on what Keith said. How do you guys have confidence you can continue to expand gross margins with price increases when you have competitors that are cutting prices and kind of it’s an unprecedented promotional environment. So just going from the next couple of years, couple of hundred basis points of gross margin expansion, can you expand on your confidence there? Thanks.

Shelly Ibach

Sure. Well first of all, with our strategy, with proprietary product and exclusive distribution, we’re not in the same realm as our competitors competing on price, so or competing for floor space. We focus on selling the value of the bed as you experienced in the store today. Our challenge, and our big competitive challenge, is around awareness and as we build awareness, we drive traffic to our stores. And we have high confidence and high conversion, that we will deliver that improved sleep experience once they’re at our stores.

From a pricing perspective, we do not compete on price. You will see us always speak to our opening price points. Because we do have a good, better, best strategy within premium, it’s important from a value equation that the customers understand that our beds start at just $999. So therefore, we’re talking about that price, but that’s really the only price we focus on. During the consumer periods, we do have a value urgency strategy for that customer who is in the market right now, but that again, that is about driving traffic to Sleep Number and building our awareness.

Mark Greenfield – Sigma Capital

Got you. And then just building on that, in terms of how isolated you are from the rest of your competition, do you see volatility in the month to month in your sales depending on if there’s a big competitor launch or when the ITSA data kind of goes up and down, do you guys see the same impact on your own sales?

Shelly Ibach

We do not see the volatilities with some competitor product launch, and we certainly – and we’ll say that we are not seeing any change right now at all in the consumer behavior. And with over 400 stores nationally, and that direct line of visibility to understand exactly how your performance is from day in and day out and from all of your sleep professionals on the floor, we are experiencing absolutely no change right now in any behavior. And as we think about things competitively, from a pricing perspective, we were in a far more competitive dynamic pricing environment a few years ago. And we’ve been able to continue to grow our premium price points in the non-innerspring and really see these consumer trends focusing on health and wellness and better quality beds as working in our favor.

Kathy Roedel

I’d like to just add one more comment to that from a pricing standpoint, just building on my comments about that. And that is we talked about our three growth drivers of building awareness, optimizing our distribution, as well product and product innovation. And historically the first two, awareness and distribution, have really been the key priorities for us and so one of the things you should expect to see from us over the next one to three years is a really an increase in the investment and focus on product and new product innovation. So that’s the other piece that’s unique to our strategy that gives us confidence.

Mark Greenfield – Sigma Capital

Thanks. I’m not even sure how to ask the question, but what I’m curious on your thoughts are as far as the store base going through the maturation that you laid out as far as how the sales grow per store. If you just take a static picture of the store base, don’t have the stores coming in or maybe incorporate the new stores coming in, what does that do to your comps just on that maturation driver? That make sense?

Shelly Ibach

I think what I heard is that you’re wondering about the existing stores that are not being repositioned or remodeled and how are they performing.

Mark Greenfield – Sigma Capital

Yeah. I guess does it have – just how the stores are maturing right now and moving into higher sales per store, does that have a positive or a negative bias on the store comps optically, or I guess how it’s going to affect the calculation?

Shelly Ibach

Not sure I fully understand your question, but what we are experiencing is positive comps throughout our store base. So, I think someone made the comment that – I guess it was Wendy in her presentation talked about our larger volume stores, and also more mature stores are delivering very positive comps as well as other stores. So we are seeing positive comps throughout the portfolio.

Mark Greenfield – Sigma Capital

Okay, I’ll go back and work on asking that, but I’m also curious how the store base – you said it’s growing, was it 5% to 7%, this year?

Shelly Ibach

The net new store count will grow 5% to 8%.

Mark Greenfield – Sigma Capital

5% to 8%. So when we think about your top line, I assume that’s 5% to 8% less you have to grow on the comps to sort of keep that same revenue trajectory. Are the margin implications for that positive or negative to the gross or operating margin, if that’s a greater percentage of what’s driving your revenue growth?

Kathy Roedel

Yeah. I don’t see that as a major driver to margins, no. And just building on the previous point, one of the reasons we’re seeing this consistent growth is the growth in national media. Because you can’t just compartmentalize a specific type of store that’s performing better than others. We’re seeing the strength in this growth across the board, across geographies, across age of store, because we are investing more in that national media.

Shelly Ibach

And one other comment, our new stores are opening at an average of $2 million, so that is uncharacteristic of most retailers to have that kind of first store performance, and that is consistent.

Mark Greenfield – Sigma Capital

Okay, just last one on that, is the guidance – and this is part of what’s probably creating some of the concern in the capital markets. But the guidance of 15% – and I know it’s plus, but if I use the 15%, does imply some deceleration from the tremendous Q1 you just had. Is there something with – somebody asked about the schedule of marketing and promotions – is there something you see on the calendar year that would cause some deceleration in demand?

Shelly Ibach

No, we have confidence in our strategy and as we’ve laid out our strategy, we’re early in our growth, in our growth stage, as a company. So our guidance just a few months ago, early in the year and that’s what we’ve shared so far.

Edwin Boon

I think we had a question up front here.

John Baugh – Stifel Nicolaus

Thank you. John Baugh with Stifel Nicolaus. Could you discuss maybe over the last three years, how much of an annual year’s revenues are done around the promotional holiday events, and has that changed up or down?

Shelly Ibach

I’m not sure if we’ve shared those specific numbers, from a competitive perspective probably not. However, what I will say is we’ve continued to grow our business in both the consumer periods as well as in the non-consumer periods. So we’re pleased with our growth throughout the total business.

John Baugh – Stifel Nicolaus

And then you shared the unaided brand awareness. Have you done the store awareness figure as well and how has that changed?

Shelly Ibach

Yes the unaided store awareness moved from like 2% or 3% to 5% a year ago, and the unaided store awareness remains at 5%. However, the – 5% to 6% and the total store awareness has moved. And this is an important metric, because total store awareness is a leading indicator of the unaided awareness. Now we focus primarily on the unaided, but we did have a nice movement at six points in our total awareness on stores. So we’re on the right track and expect some improvement there.

Kathy Roedel

And just to follow up, I mean John, we see that as one of our most significant opportunities, calling out the store awareness. You all were in the store this morning, and you understand when we generate that traffic and get people into our store, we have very high conversion rates. And I think you all could see why from what you experienced, but that is, that’s a key growth opportunity for us going forward and why we’re investing so much in awareness.

John Baugh – Stifel Nicolaus

Yeah and I guess, as a follow-up to that, I was curious, are you able to attract in areas where you’ve opened a non-mall store, what that store awareness number is doing versus areas where you haven’t done that?

Shelly Ibach

Yes, we do track it. We do track it by markets and we do have a fair amount of visibility regarding all those metrics. And we have confidence in our strategy to continue to progress with both non-malls and malls, and be able to have that flexible real estate strategy to not only give us the visibility outside of malls, but also to be where our target consumer is shopping, and to be able to position the store in those areas that can optimize that local market development, and that our high consumer traffic areas with our demographics like you saw today at the Oak Brook store.

Edwin Boon

Question up front there.

Joshua Pollard – Goldman Sachs

Thank you for taking my question. Joshua Pollard, Goldman Sachs. My first question is around your strategy in a more recessionary environment. I hate to breakout the glad party, but I just want to understand how you guys have game planned for if bedding sales were to decline, what would be the store’s strategy then, how you guys would approach your gross margins, and how you guys would ultimately approach the business if things aren’t as rosy?

Shelly Ibach

Great, thanks for the question. I’ll start and then hand it over to Wendy to follow up. First of all, this is something – this is an area with recession that we have developed a graduate degree in here over the last few years at Sleep Number, so we welcome this question and feel very confident in our ability to weather whatever macro condition we’re faced with. And, as we unraveled our strategy a few years ago, it was there that we really developed critical learning and rebuilt a strategy and a business model with a lower fixed cost structure to give us flexibility regardless of where that macro is at.

And then from there, we developed a growth formula that is integrated and has been delivering consistent performance over the last 13 quarters, regardless of where the consumer sentiment is at and regardless of the volatility in the marketplace that we have that ability because of having that vertical business and the proprietary product along with the exclusive distribution and control over how we market and how we execute our promotional strategy. And that tremendous flexibility and lower fixed cost structure prepares us very well.

Part of our strategy of driving higher average sales per store is for this very reason, to give us that higher profit per store, the lower fixed cost structure, and the ability to grow without being dependent and adding new store growth. The fact that we added $500,000 in increased revenues per store in 2011, in 12 months, gave us another $175 million of growth without additional store count. Now, keep in mind we plan to add stores and we know we’re understored right now and underdeveloped, but I think it’s a great example of our flexibility in good times or bad.

Wendy Schoppert

I would just add a couple of things there from a financial standpoint. We can flex up or down very quickly on things like media that I think Shelly covered. Couple of other things, though, is we have lowered our break-even sales and the gap between actual sales and break-even sales has been widening. That’s something that we continue to focus on, but it’s a big difference on where we sit today versus where we sat going into this most recent downturn. And the last thing I’ll say is one of my key priorities is making sure that we stay disciplined with that minimum cash balance and that is a safety net as well.

Joshua Pollard – Goldman Sachs

I guess on the – two quick follow-ups, one is on the store account. Would you guys use a recessionary environment as an opportunity to take advantage of cheaper real estate? Or will we see you guys scale back on your stores in that environment? So you guys in a tougher environment going to push forward or go into slow down?

And then my second question is for those of us who are new to this Select Comfort/Sleep Number story, I wanted to understand when should we be expecting you all to be more promotional? And I think you called it a value urgency strategy, when should we expect those? I’m thinking Presidents Day, Fourth of July, Memorial Day, Labor Day, but are they any other periods where, given everything that’s going on around this concept of pricing, where we should expect to see you guys pushing that strategy? Thank you.

Shelly Ibach

Regarding the promotional strategy, as we stated, we plan out our promotional strategy about 12 months in advance. Our promotional strategy has been consistent for three years. We do continue to tweak and optimize small things, but basically we’re very confident in the strategy we have in place and we’ll continue with that for sometime as we’re building demand for the brand and building awareness.

Value and urgency, we focus on during the consumer event, big consumer events period, the holidays that you mentioned. In the mattress industry, that’s where more consumers are out in the mode of intending to purchase. And so we’ll come forth with that urgency to drive traffic to our stores. And again, the traffic once you’re at a Sleep Number store, our focus is on understanding you as a customer and individualizing your sleep experience. So, we focus on the product and understanding the customer’s needs and matching the product.

Tom Bodor – UBS

Hi, this is Tom Bodor from UBS O’Connor. Shelly, you spoke early on about expanding the target demographic market, and I’m thinking mainly in terms of the age group. I know you had a couple of other factors, but can you – do you have any metrics that you share on the success, either it’s the unaided awareness for the younger component of that age group or sales or any other metrics that point to the success you’ve had in broadening that?

Shelly Ibach

Great. Well, thanks for the question. The question’s around broadening our target customer, which we redefined last year and expanded to really a four times addressable broader target. And then we moved on media to match, so our results have been pretty apparent in our sales overall as we have broadened. In addition, we see the results in our reach and effectiveness with, for this target, as well as we do have all of our brand metrics that we measure, not only for the broader brand but also against the specific targets. So, we haven’t shared those specifics, but it’s a great way to understand our awareness, our consideration, the health of the brand in many different aspects, and we – in the first six months of last year, which we saw that measurement start to move against this target. So we’re pleased with our early progress.

Edwin Boon

Next question.

David MacGregor – Longbow Research

Yes, good morning, David MacGregor with Longbow Research. Can you talk about the extent to which the economics of your strategy change as you go after major metro markets like New York City or Los Angeles? Are those markets in your 13 target markets and do you – I guess the question is to what extent do you need growth in those markets to meet your 2015 goal?

Shelly Ibach

So the question was about New York and L.A. and if we need a certain level of growth to meet our 2015 goal. So we do not share specifically what markets are in the ‘13, for competitive reasons. We have the 13 identified, and we’ve shared that they represent about a third of the U.S. The markets that are in the 13 that we’ve launched – so, so far we’ve launched six markets are all performing beyond what our expectations are, so we’re very pleased with the performance with these markets. And we’re confident in our 2015 and 2012 has plans and where we’re at. Our strategy is part of the 2015 guidance and that we have high confidence in being able to deliver that. Anything you would add?

Kathy Roedel

I would just add that it really speaks to the importance of the national media and I spoke to this a little bit, but those markets tend to be very costly to go into as we all know from a local standpoint. And so our move into national and the way that we’ve been increasing our investments in national is actually really setting up this opportunity quite nicely. And as we are able to bring in some of those larger markets, it allows us to really leverage that investment of national media. And that is yes, it’s something that we see happening again in the out years of this 2012 to 2015 period that we’re speaking of.

Budd Bugatch – Raymond James

Just a follow-up question, Budd Bugatch with Raymond James. You, I think, are debitizing users of a net promoter score and I didn’t hear anything about that today. Can you kind of talk about how that’s tracked and what you’re finding from that particular metric?

Shelly Ibach

Can you hear me. Okay, thanks. Sorry, Budd. Yeah, we do use the net promoter score and just could I just see a show hands how many people are familiar with net promoter score, NPS? A lot of people, great. So, you know that this is becoming a more and more accepted measure of customer loyalty. It really revolves around the question based on your experience with the brand, how likely are you to refer a friend or a colleague to the brand, and you will give your response on a score of zero to 10.

If you score it zero to six, you’re called a detractor. If you’re seven or an eight, you’re a passive or neutral, and if you’re a nine or a 10, you’re called a promoter. So the net promoter score is the number, the percent of 9s and 10s, minus the percent of zero through sixes and that becomes your net promoter score.

And so we’ve been using the net promoter score as part our tracking of how well all of our investments in our customers experience are actually resulting in measurable, trackable, loyalty growth. And we’ve been working on that since the beginning of 2010 and in a very focused way, and then broadening that across the entire enterprise where people everywhere in Select Comfort, all of the Sleep Number team will know how do they impact the customer experience and customer loyalty on a daily basis.

We’re enabling ourselves with investments in systems that allow us to have real-time feedback to our front line so that they can either do service recovery or promoter activation. And so we’re very excited about the net promoter score. It’s a very good companion with Six Sigma, really helps you measurably drive that loyalty and we see a terrific tie with our strong repeat referral.

Budd Bugatch – Raymond James

Sure. And without giving us the number and what – maybe you’re reluctant to do that, can you tell us the change in the net promoter score over that time and can you report that kind of on a quarterly basis what the changes are to your NPS?

Shelly Ibach

So, we have not shared our NPS number. That said, we’ve seen dramatic growth in the areas where we’ve been focusing over the last two years. And I will say that when you think about top tier companies in NPS, the best of the best are kind of in that 50 and above. Apple tends to be up in the high 80s, Amazon.com some of those are like that. And so, we are already a top tier company in NPS, and we will continue to grow that as we really invest in our customer experience now and over time.

Joan Storms – Wedbush Securities

Joan Storms, from Wedbush Securities. Kathy, this is probably going to be your question, but may be also Wendy. On the buckets of the 200, 300 basis points in gross margin to get to your 15% operating margin goal, given the fact that we were anticipating some gross margin expansion this year and now it’s going to look to be closer to flattish, are those buckets still intact and what are they? Where are they coming from?

Kathy Roedel

Yeah, so just to make sure I understand the question, Joan. You’re wondering where we will get that, that 200.

Joan Storms – Wedbush Securities

Right. So things like manufacturing, efficiencies, et cetera.

Wendy Schoppert

Yeah, so I’ll just reiterate the two key drivers that we talk about, excuse me, one is pricing as I mentioned earlier. As we continue to really focus on product innovation and actually focus more than we have over the past few years, we see pricing as an opportunity. And then the second one, which Kathy could elaborate on, is our opportunity to increase our operational efficiency.

And, just before I hand it to Kathy on this one, one example is I lead the IT team, and during the downturn, we really were not able to invest a lot in our systems, the IT systems that drive, that we need to drive some of the process changes to drive some of these efficiencies. We’re obviously in a position to do that now and that is part of our plan over the next three years.

Shelly Ibach

And so what I would say is over the last several years – I’ll talk backward and then forward. Over the past several years, our supply chain team has been very committed to and very successful in driving some very helpful productivity gains. For instance, we are getting unit output out of two shifts in our operations today that used to take us three shifts, and that is all just – that is good old fashion, variable and fixed cost productivity programs that we will continue to work on. And those will generate considerable productivity.

And then as Wendy said, as we continue to invest in processes and technology, that allows us to really re-imagine our supply chain. And at all points we’ll be focused on how do we deliver a better, faster customer experience, better service levels, more productivity. It’s also a help for capacity as well as our management of cash, so we’re bullish.

Joan Storms – Wedbush Securities

Okay, thanks. And then, just a quick follow up on the marketing, as you’ve transitioned to doing more national and a lot of that has been around the longer holiday weekends and key selling periods and you’re starting to anniversary that, probably from the past like 18 months, are you seeing any sort of differential or sort of build-up as to anniversarying that and coordinating that with how much more you need to spend in those markets?

Shelly Ibach

Great. So the question is as we anniversary the national media spend what’s the impact. I think first quarter would be a great example. We launched our national broad reach initially last year in 2011 for the Presidents event and as you know in first quarter of this year, we had a 36% increase. We did invest more in media, about 48% more. That was both an investment in national, with the addition of more weeks outside of the big consumer events, but also with local market development, so that’s primarily where that increase came from. We have continued to refine our measurements, back to Brad’s very first question, with our media and we have improved our efficiency, our effectiveness and reach each and every quarter. And so we apply those learnings, and I think the first quarter speaks for itself.

Edwin Boon

Another question right there.

Rick Fradin – Rail-Splitter Capital

Hi, it’s Rick Fradin with Rail-Splitter Capital. You mentioned early in the presentation that we may sort of be at an inflection point in terms of consumer acceptance of the premium mattresses. I wonder if you could give us your perspective on maybe how big the market is, how many households might ultimately own a premium mattress. And if I heard it right in the presentation, the 7.5 million insiders, I think you might have called it, is that a good estimate for how many select comfort mattresses are in households today?

Shelly Ibach

So the first question was about the inflection point, and the inflection point was on consideration for non-innerspring, I think you said premium. It really was – it’s an inflection point for non-innerspring, and we see this as based on the increase from non-innerspring over the past couple of years. There’s clearly a shift going on and perhaps the industry is considered mattresses overall and the separation between innerspring and non-innerspring becomes less of a factor and it really is more of premium and non-premium split.

Having said that, the premium is close to half of the overall market, and the consumer trends would indicate that consumers are more than ever before looking for product that is more than just a sleeping surface. But it is – the availability and the research availability on the Internet allows consumers to be able to understand the features and benefits to a greater degree and that is in our favor, and certainly we’re benefiting from that. And we also believe that speaking to the consumer about what the benefits from the Sleep Number bed and sleep experience is also help drive these trends. The 7.5 million lives improved, it is a calculation, and it is not speaking to the specific units, more from a competitive perspective.

David Ricci – William Blair

Perhaps along the same line of Rick’s question – this is David Ricci, William Blair. Many consumers, perhaps the majority of households, can’t afford $1,000 for a mattress. So, I’m just curious if you have plans for that group or whether you prefer to just kind of focus more on the premium or affluent households over time?

Shelly Ibach

Sure. So, the question’s are we going to lower prices really below the premium and we play wide good, better, best within premium. And that’s where we are focused with – our strategy is focus on our core growth and core growth around this segment beginning at $999 at this time, along with our bedding collection and adjustable foundations and other sleep products. You will see us continue to innovate product and bring forth product that speaks to consumer benefits, as we talked about in the presentation.

David Ricci – William Blair

Along those lines, if I were to walk into your store in 2015 or 2017, would the product on the floor be much different than what’s on the floor today?

Shelly Ibach

We do strongly believe in evolution and staying ahead of the consumer trends and anticipating what the consumer needs and wants, even before she realizes it. So you will see us be quite aggressive on continuing to lead the consumer and lead the product category with innovative product that contributes to improved sleep experiences.

Kenneth Gau – Waddell

Hi, Kenneth Gau, Waddell. I know you’re confident in terms of that you can operate independently of the environment, because you have a proprietary brand and unique distribution, but I’m kind of wondering with that said, how would you characterize the current competitive environment versus maybe the last couple years, and do you believe that there is any type of constrains that might get people to be – act more rationally in the backdrop? I mean maybe it doesn’t affect you in sales, but I suppose it could affect you in the multiple that you can hold as a stock. So I’m just kind of curious on any kind of just general observations or description of kind of what is going on that’s causing the dynamic that we’re seeing today.

Shelly Ibach

Sure, well the question’s really about what’s going on with the mattress industry causing the dynamic today. First of all, I’m just really happy you’re all here so that we can share our strategy. So, our strategy is a different strategy than others have and with the proprietary product and the exclusive distribution, and the focused consumer-centric strategy delivering it in the stores like you experienced earlier today, and the advantaged business model, it is unique and it is very consumer-centric.

We are not impacted and certainly have not experienced anything right now in the marketplace any different than we have been over time. So, the volatility that you’re speaking of seems to be more focused on entrance into foam, perhaps some commoditizing of foam as a category like there is with innerspring.

So, there’s some shifting and dynamics going on there with some of the manufacturers and retailers. That is not today impacting the consumer to our visiting Sleep Number in any way. We do not see any change going on right now, no downward movement, no change to the kind of performance and strategies that we’ve been speaking of.

Sean Matlock – Kennedy Capital

Sean Matlock from Kennedy Capital. I had a question on your new non-mall stores and the one we were at today, you said it had the best performance in 18 years of being open once you moved it from the mall. I’m wondering how much of that is from traffic. How much of that is from conversion, and if traffic is flat or up, how are you doing that while foot traffic around the store is down?

Shelly Ibach

So, I think the question was for the store that we were at today, how is the traffic and conversion?

Sean Matlock – Kennedy Capital

And in general, my assumption is that all the non-mall stores are having improvements while they’ve moved off the mall is my understanding of what’s happened. So, I’m just wondering if that’s more traffic or conversion, and if traffic is flat to up how are you doing that without having the higher foot traffic near the store?

Shelly Ibach

Great, okay. So, a couple of things, first of all, when we go into a market with our local market development, we are focused on optimizing that market. If we are moving out of the mall, it’s because we have a more optimal location or set of dynamics. It’s this flexible real estate strategy. So, the one you were in today is a great example where the mall did not have the strength of the demographics that we were in – it was the Yorktown Mall – that the location for the non-mall did. So in this particular case, we have a very high conversion in our non-mall, very high, as you would expect from a motivated, more considered mattress shopper. And we do enjoy some higher traffic in our mall stores, with people who are walking in for bedding collection or just curious as they walk by.

So, we are seeing a somewhat higher conversion in our non-malls than our malls and somewhat higher mall traffic in our mall stores than our non-malls. In the end, it works out to be very similar. So, the malls that we’re in that are very strong for us, which the majority of them are, are very successful as well as the non-malls, a very similar performance in the end between that traffic and conversion. Having said that, part of what’s driving the traffic in the non-malls, certainly as we move our awareness, but also the store visibility and also being near other competitors and where the customer expects to find us are all contributing to the traffic.

Ethan Steinberg – Friess

It’s Ethan Steinberg at Friess. A couple things, the store growth is – the net store growth is all or can you give us some sense of how much is going to be stand-alone versus mall-based?

Shelly Ibach

Yes, the store growth will be a combination of mall and non-mall, again based on what the specific needs and to the right moves are for a specific market. And today our portfolio is obviously our installed base is all mall, so far more mall we have communicated that here by the end of the year we’ll have over 70 non-mall. And so there will be some shift into the non-mall. As leases mature in malls, we may relocate to a larger location within a mall and remodel there, or we may choose to move to a non-mall location.

Ethan Steinberg – Friess

So they are actually growing faster than the net store growth?

Shelly Ibach

The non-mall?

Ethan Steinberg – Friess

Yeah.

Shelly Ibach

Yes, at this time they are.

Ethan Steinberg – Friess

Okay. And then, Wendy, did you say that you bought 1.6 million shares in the last week?

Wendy Schoppert

No I didn’t. I said $1.6 million worth of shares.

Eric Hollowaty – Stephens Inc

Hi, Eric Hollowaty, Stephens Inc. Research. The adjustable firmness feature of your products suite is obviously a key competitive differentiator for you. I was wondering if you could share any insights from your consumer research on whether that customizable feature of your product suite resonates as well with people without sleep partners as those with.

Shelly Ibach

Well, with our adjustable firmness, we offer both a single chamber or a double chamber. However, the majority of our sales are obviously on the dual, the double chamber. And the feature of adjustability is important for all customers, whether they’re single or sleeping with a partner. So we, in our research, see a high response to the fact of the adjustability with the mattress.

Eric Hollowaty – Stephens Inc

Yeah, just following up on that, is that because you found that consumers’ firmness preferences tend to change over time, or I’d love a better understanding of how that actually happens.

Shelly Ibach

Well, a couple of things, first of all, and Kathy mentioned it in her presentation, that understanding the science behind the bed is one of the top two factors that really lead to purchase within our store experience. And when you really go through and understand the science, which you saw a little bit on today, you gain that understanding of the support for you as an individual. And it’s pretty difficult to be able to go into a store and lie down on a regular mattress and know that this is the right mattress for you, it’s the right support.

And with our bed, you really can’t make a mistake. You can go into the store and find your sleep number and go home and change your number over time. Pete Bils, who is on our team, shared last night that he’s a marathon runner. And so his regular sleep number is a 30, but on weekends after he runs 20 miles, he sleeps on 70. So that feature is important to some people. Other people, that’s their number and it stays there. So again, it’s really about that individuality. I think from a customer perspective, they love the idea of not making a mistake and being able to go home and adjust that to have the very best night’s sleep.

Edwin Boon

Okay. We are almost out of time, one or two questions.

Todd Schwartzman – Sidoti & Company

Hi, Todd Schwartzman, Sidoti & Company. Shelly, you spoke before to the more motivated nature of the consumer at the non-mall stores. Can you speak to the attachment rates, accessories, pillows and such, in mall versus non-mall? And also maybe, are you starting to skew towards pillows and maybe away from the higher priced foundations as far as a source of incremental margin?

Shelly Ibach

Great, well thanks for the question. When we moved to non-malls and started our pilot in early 2011, that was one of the questions we really wanted to understand, is how would the bedding collection do in the non-mall. Because we knew it worked really well in malls with the traffic and having it at the front of the store. And what we have found is it also works really well for us in our non-malls. And part of that is in the store design, we have a little bit more room and we’ve been able to create these high-tech and low-tech interactive presentations, and it’s very easy for the customer to understand it quite quickly.

And therefore, as we set up that solution for them and enhance their sleep experience, they are converting with the bedding collections. So, it’s doing very well in our non-malls and better than we had expected. Importantly, for us it really is all about the Sleep Number bed. The Sleep Number bed is the center piece, and we will continue to focus and continue to drive our performance with the total sleep experience. But the bed is a key part of our strategy, and it will remain and continue to be a focus of growth for us.

Edwin Boon

We have one last question.

Unidentified Analyst

(Inaudible) Red Capital. Thanks for taking my question. On one of the slides, you showed the growth differential between the year one, 2011 markets and how they’ve evolved kind of two to three times greater than the total company sales. I guess in Q1 of this past year, what was that growth differential there for those 2011 store bases?

Shelly Ibach

I believe you’re speaking to the aggressive growth strategy.

Todd Schwartzman – Sidoti & Company

Correct.

Shelly Ibach

Where we have four markets from last year in year two and then recently introduced two new markets into that strategy. We have not broken apart that these stores or this strategy represents a certain percentage of our growth. What we will share is we gave a specific example of the results of our year one markets in the presentation, and our new markets are on track and performing better than our expectations as we move into the launch of the two new markets.

Todd Schwartzman – Sidoti & Company

Thank you.

Edwin Boon

Great. Well, thank you all for coming. We were very happy to share our exciting company with you.

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