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Executives

Mark A. Kimball - Chief Legal & Risk Officer, Senior Vice President and Secretary

Shelly R. Ibach - Chief Executive Officer, President and Director

Wendy L. Schoppert - Chief Financial Officer and Executive Vice President

Analysts

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Peter J. Keith - Piper Jaffray Companies, Research Division

Chad Bolen

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Eric Hollowaty - Stephens Inc., Research Division

Todd A. Schwartzman - Sidoti & Company, LLC

David S. MacGregor - Longbow Research LLC

G. Michael Novak - Frontier Capital Management Co., LLC

Select Comfort (SCSS) Q2 2012 Earnings Call July 18, 2012 5:00 PM ET

Operator

Welcome to the Select Comfort Second Quarter 2012 Earnings Conference Call. [Operator Instructions] I would like to introduce Mr. Mark Kimball, General Counsel. Sir, you may begin.

Mark A. Kimball

Thank you, Matt. Good afternoon, and welcome to the Select Comfort Corporation Second Quarter 2012 Earnings Conference Call. Thank you for joining us. I'm Mark Kimball, Senior Vice President and General Counsel. With me on the call today are Shelly Ibach, our President and CEO; and Wendy Schoppert, our Executive Vice President and CFO. This telephone conference is being recorded and will be available on our website at sleepnumber.com. Please refer to the details set forth in our news release to access the replay. You also can access the latest version of our investor presentation in the Investor Section of our website.

In addition, please refer to our news release for a reconciliation of certain non-GAAP financial measures included in the news release or that may be discussed on this call. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings news release and discussed in some detail in our annual report on Form 10-K and other periodic filings with the SEC. The company's actual future results may vary materially.

I will now turn the call over to Shelly for her comments.

Shelly R. Ibach

Thank you, Mark. Good afternoon, and thank you for joining our earnings call today. We're very pleased with our second quarter financial performance. Earnings per share increased 50% from a year ago to a second quarter record of $0.30. Sales increased 27% from a year ago to a second quarter record of $205 million. These results demonstrate the strength of our unique business model and integrated growth formula.

Our vertically-integrated model as a manufacturer and retailer provides multiple points of leverage to maximize operating margin, which was also a second quarter record of 12.6%. Strong cash flow allows us to self fund growth, and we remain committed to achieving the appropriate balance between seizing investment opportunities and managing risks.

Our integrated growth formula supports our long-term strategy, focused on delivering an unparalleled customer experience. We are driving traffic and conversion through our brand advertising, exclusive distribution, relationship-based selling experience and proprietary benefit-driven suite of products and services.

Again, in the second quarter, we experienced strong units in ASP growth. This validates our differentiated strategy that goes beyond selling mattresses to offering consumers a complete individualized value-added sleep experience. Therefore, we are confident in our ability to drive performance in the short and long term.

As we have previously discussed, our strategy has delivered top and bottom line growth regardless of the economic environment or changes in the competitive landscape.

In the second quarter, we increased media investment as planned by 37% over prior year. At the same time, we continued to shift media buys to more effectively reach our expanded target consumer and develop local markets. As expected, these actions resulted in the following: improved brand and store awareness; increased traffic, driving a 13% unit increase in our company-controlled channels; and advancement of our local market development strategy, including the launch of our seventh aggressive growth market at the end of the quarter.

Our #1 growth opportunity is increasing unaided awareness of Sleep Number. As we've continued to invest in marketing, we've increased unaided brand awareness from 15% to 20%, a high point for our brand. We also have seen a notable increase in unaided store awareness over the past 6 months from 6% to 8%. These awareness improvements indicate our strategies are working as planned and are important to the sustainability of Sleep Number's future growth.

Second quarter results validated the advantage of our exclusive distribution strategy. Marketing dollars are focused on increasing awareness and consideration for our brand and products, while driving traffic to our Sleep Number stores, where sleep professionals individualize our customers' sleep experience with proprietary benefit-driven products.

Our customers continue to respond positively, as indicated by record-high average sales per mattress unit in the quarter. Company-controlled ASP was also up 13% over prior year. Our average sales per comp store exceeded $2 million for the trailing 12-months in the second quarter, a 35% increase over the prior year. And our new stores average $2 million in year 1.

As we have communicated, our national distribution strategy involves local market development by optimizing existing stores and filling in current markets with new stores. In the quarter, we continued to invest in our stores by expanding and remodeling 7 mall stores and relocating another 7 stores from mall to non-mall locations.

In addition, we executed a brand refresh in 15 existing locations. We also opened 5 new non-mall Sleep Number stores. And after closing 4 mall stores, we ended the quarter with 1 net new store for a total of 381. We are on track to open 27 to 31 total net new stores for 2012.

We continue to be very pleased with the customer experience and financial results of our store actions and unique design. We expect to have approximately 50% of our stores fully on-brand by the end of the year.

One of the advantages of our vertically-integrated business model is the ability to receive unfiltered and immediate feedback from our frontline end customers everyday. These insights are directly fed to our product R&D and manufacturing team in order to develop relevant, benefit-driven products that meet the individual needs of our customers and expand our addressable market.

A great example is the launch of the new Sleep Number m9 memory foam bed on July 22. The addition of the m9 represents our ability to quickly and nimbly develop and launch products that are responsive to our customers' desires and needs. The new m9 bed joins the m7 and now comprise the Sleep Number m-Series, priced the same as our Innovation Series.

These are the only mattresses to combine memory foam with DualAir adjustable technology. Specifically, the Sleep Number m9 foam bed features exclusive LuxFit foam with superior breathability and temperature balancing qualities, which are enhanced by the ability to adjust the firmness on each side of the mattress.

The positioning speaks for itself. Memory foam just found its better half -- Sleep Number. This bed retails for $4,699 for a queen set. Since its launch earlier this year, our Sleep Number m7 memory foam bed has performed well, doubling our mix of memory foam units. The m7 brought together our popular CoolFit gel-infused foam with our DualAir technology. Going forward, we expect the m-Series to be an important part of our overall mix and continue to expand our addressable market.

We also are excited to introduce a new Sleep Number upholstered, FlexFit Series on July 22, which when combined with the Sleep Number bed, represents a fully adjustable sleep system for our customer. These adjustable bases have an elevated aesthetic and provide customers with infinite possibilities to individualize and achieve complete comfort.

Looking to the remainder of the year, we remain confident in our strategy and operational plan. We will continue to leverage our unique business model, to fund short- and long-term profitable growth while advancing our customers' experience with Sleep Number. And we remain committed to increasing shareholder value, with earnings per share growth of at least 20% per year over the next 3 years, with even higher earnings per share growth in 2012.

And now, Wendy will provide additional financial detail on the second quarter results and expectations for the remainder of the year.

Wendy L. Schoppert

Thanks, Shelly, and good afternoon, everyone. I have 3 key points to share on our call today. First, with 27% sales growth and a 25% company-controlled comp in the second quarter, our strategies and execution are clearly driving top-tier growth, even as other segments of the industry have become more competitive.

Second, with a 50% increase in second quarter earnings per share and 14 consecutive quarters of year-over-year double-digit operating profit growth, it is clear we are continuing to deliver significant bottom line leverage and shareholder value as we grow.

And third, we are increasing our 2012 earnings per share guidance, which illustrates the confidence we have as our unique business model and strategies drive sustained sales and profit growth.

Let's begin with sales. As context, our stated 3-year goal is to achieve annual comp growth of at least 10% to 12%, even as we grow store count by at least 5% to 8% per year. And our outlook for 2012 was for comp growth of at least 15%. The 25% comp in our company-controlled channels during the second quarter represents another quarter of outperformance versus these goals.

Total sales grew 27% to $205 million, a second quarter record for the company. Sales in our company-controlled channels grew 28% with balanced growth in units and total ASP, which were both up 13% year-over-year.

The company-controlled ASP increase was driven by the pricing actions we've taken over the past year, representing 6 points of the growth, as well as continued increases in both our adjustable foundation attach rates and bedding collection sales.

Our store productivity continues to strengthen as average annual sales per comp store has, for the first time in our company's history, exceeded $2 million. And at the end of the quarter, 42% of stores were above that level on a trailing 12-month basis.

As we communicated during our Investor Day in May, we now have our sights set on $3 million in average sales per comp store by 2015, and 8% of our stores were already above that level at the end of the quarter.

My second point is around bottom line leverage and profitability growth. Again, as context, our 3-year goal is to achieve at least 20% earnings per share growth per year.

Second quarter earnings per share of $0.30 was up 50%, nearly 2x the rate of sales growth. And year-to-date, adjusted earnings per share of $0.75, which excludes the $0.06 nonrecurring charge we took in the first quarter, also grew 50%.

As I've shared in the past, one of our advantages as a vertically integrated company is the breadth of opportunity we have to achieve operating leverage. For that reason, our primary profitability focus is on overall operating margin. We have a stated goal of achieving at least 15% operating margin by 2015, and our outlook for 2012 is for year-over-year operating margin expansion of at least 100 basis points.

Operating margin during the second quarter grew 170 basis points to 12.6%, and year-to-date, adjusted operating margins, excluding the first quarter nonrecurring charge, also grew 170 basis points, just 14.1%. The second quarter operating margin improvement of 170 basis points reflected leverage across the business: 180 basis points in selling, 60 basis points of gross margin improvement and 40 basis points in G&A plus R&D, which we were especially pleased to achieve in our seasonally lowest volume quarter.

This leverage was offset by 110 basis points of planned deleverage in marketing as we continue to invest in growing awareness for the Sleep Number brand. Media spend of $27 million was up 37%, and media as a percent of sales was 13.4%, consistent with our first quarter performance. Gross margin of 64.1% grew 60 basis points on a year-over-year basis in large part due to the pricing actions we've taken over the past year, and gross margin grew 150 basis points sequentially from the first quarter.

As many of you will recall, last quarter's gross margin rates was impacted by the traffic-driving closeout and relaunch of our entry-level Classic Series, as well as a variety of other factors that can fluctuate from quarter-to-quarter.

Cash and marketable securities were $155 million at the end of the second quarter, up $58 million year-over-year. Cash balances were down as planned sequentially versus the end of the first quarter as second quarter is a seasonal low point for sales and seasonal high point for cash needs.

Beyond our plan to maintain a minimum cash balance of $125 million, our #1 priority for cash continues to be investing in our profitable growth in light of the returns we are achieving in store and other investments.

During the second quarter, we had total CapEx of $13 million, which grew year-over-year, as well as sequentially from the first quarter.

As previously communicated, we also reinitiated our share repurchase program during the quarter, returning $10 million to shareholders through the repurchase of 410,000 shares of common stock. We remain committed to our objective in 2012 of keeping share count constant, which we believe will require repurchase of approximately 600,000 additional shares during the balance of the year.

One final note on cash. Our strong cash performance over the past few years has set up Sleep Number's balance sheet to be a clear competitive advantage in today's environment. Beyond our cash balance, we have no debt on our balance sheet and we have a negative working capital position that benefits us as we grow.

Regarding our outlook, we are increasing our full year 2012 GAAP EPS guidance from between $1.32 and $1.40 to between $1.35 and $1.41 including the $0.06 impact of the nonrecurring charge in the first quarter. This increases the midpoint of the range by $0.02, from $1.36 to $1.38. Excluding the nonrecurring charge, this guidance represents a 32% to 37% increase in EPS versus prior year. A reminder that our standard practice is to provide guidance that builds in only the impact of sales and profit growth initiatives that have been fully tested during prior periods.

Our earnings guidance assumes company-controlled comps of at least 15% for the remainder of 2012 and a 7% to 8% increase in store count from 381 at quarter end to between 408 and 412 by year end, which represents an increase from our previous estimated range of between 400 and 410.

Our guidance also continues to assume full year operating margin improvement of at least 100 basis points, driven primarily by selling and G&A leverage. Marketing and media in particular will remain an area of investment and gross margin rate is expected to be roughly flat for the full year.

In summary, I'll reiterate the 3 key points I made at the beginning of my comments. Our strategies and execution are driving top-tier growth rates. We are continuing to deliver significant bottom line leverage and shareholder value as we grow, and we are confident in the ability for our unique business model and strategies to drive sustained sales and profit growth.

I'll now turn it back over to Shelly for final comments.

Shelly R. Ibach

Thank you, Wendy. We are eager to answer your questions, so I will conclude prepared remarks with a thank you to our Sleep Number team for continuing to passionately improve the lives of our customers while driving profitable growth. Our second quarter results demonstrate our ability to sustain profitable market share growth despite both the concurrent competitive backdrop and a slow and uneven economic recovery. We're able to accomplish this through our unique business model, inclusive of proprietary benefit driven products, exclusive distribution and company control of all customer touch points, which provides a superior brand experience for our customer.

As we look forward to the balance of the year and beyond, we are confident in our customer-centric strategy and committed to delivering profitable growth and increased shareholder value. Again, thank you all for joining us today.

And now Wendy and I are happy to take your questions. Matt, you may now open the line.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Brad Thomas.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

It's Brad Thomas from KeyBanc Capital Markets. I wanted to just ask a little bit about the overall cadence of the quarter. I mean, as you are all well aware, there are some issues on investors' minds, a more competitive landscape that emerged kind of later in the quarter. Some data points that you got with the consumer got a little bit weaker in June. Could you just give us a little bit of update on how the quarter played out in the context of what was obviously a very, very good quarter?

Shelly R. Ibach

This is Shelly. We do not comment on the monthly trends or in-quarter trends. What we will share with you is our second quarter performance, record second quarter performance really speaks for itself. We don't have the same competitive pressures as others. Yet, we recognize the shift in the overall environment and see the price wars taking place. Our focus and our strategy is on our proprietary products with exclusive distribution and company-controlled touch points, including our brand and store experience. We focus on consumer value and benefit-driven sleep products, and we do not compete directly on price. However, we do have a good-better-best strategy that plays broadly within premium, so we certainly have that opening price point of $699 for a queen mat to attract customers to our overall Sleep Number brand strategy.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

Great. And if I could just clarify the guidance just to make sure I understand this correctly. Is it that your expectation is for both 3Q and 4Q that you would do at least 15% company-controlled comps? Am I reading that correctly?

Wendy L. Schoppert

It's Wendy. We don't give quarterly guidance. But to clarify the guidance, what I said is that we -- that our EPS guidance assumes comp increase for the remainder of the year of at least 15%.

Bradley B. Thomas - KeyBanc Capital Markets Inc., Research Division

So for the second half taken together? You don't mean for the full year average? You mean for the second half, 15%?

Wendy L. Schoppert

For the second half, correct. Yes, that's correct.

Operator

Our next question comes from Peter Keith with Piper Jaffray.

Peter J. Keith - Piper Jaffray Companies, Research Division

I actually want to follow up on one of Brad's question because it's a very sensitive topic with investors today. But on the promotional environment, clearly there's some advantages with your vertical integration. This quarter may be a little bit unique as there was a notable promotion from Tempur-Pedic, and we actually know the exact date that, that started on, which would have been May 16. Was there anything that you saw and maybe not on a sales basis, but just from like a conversion basis or traffic basis that you would have seen any impact from that specific promotion?

Shelly R. Ibach

This is Shelly, Peter. We are not experiencing direct results of either entrance or the pricing activities going on with others. And again, I'll go back to our second quarter performance, where we not only delivered a record high average sales price per mattress unit but also a balance between ASP growth and unit growth.

Peter J. Keith - Piper Jaffray Companies, Research Division

Okay, that's great to hear. That actually is a nice tie-in to my next question. Well, on that ASP growth, it was quite impressive. From what I could tell, you're actually -- you're obviously getting that lift from pricing, but your mix shift benefit of about 7% seems to be accelerating. Could you talk about what's driving that? Is it the higher rate of attachment or is it continuing to see a favorable mix shift within that set of mattresses?

Wendy L. Schoppert

It's Wendy. So I talked about with respect to the second quarter ASP increase of 13%. I talked in my remarks about the 6 points due to pricing throughout the last 12 months. A good portion of the remainder of that growth is from a very -- a higher mix of our adjustable foundations, which has continued to be a real source of performance strength for us as we've focused on that total sleep solution.

Operator

Our next question comes from Chad Bolen with Raymond James.

Chad Bolen

I wanted to ask you a little bit about the m9 introduction. I think, Shelly, in your commentary you said that the success of the m7 could actually double the mix of the memory foam in your business. Would you be willing to share what that percentage is with us now and sort of give us a framework for where you think that could go?

Shelly R. Ibach

This is Shelly. Our -- we're not sharing the details behind that at this time, and of course, we're still early in the year with the m7 and now, of course, with the introduction of the m9. We do have great confidence in the successful launch for the m9 for a number of reasons. It is an extraordinary product that has tested very well with our employees, our frontline and our customers. So it's a luxury bed. It represents the high end of our line. It's an alternative to our i10. In fact, it's the same price. We're confident about the series, and we believe this series will expand our addressable market. And I think it will be an important part going forward.

Chad Bolen

Could you give us a little color in terms of the rollout of the m9? How many floors would you expect it to get on? Is it going to be in all the stores? And obviously, you've got -- in some cases, more in some cases than others, limited floor space for display. Will you have to take other models off the floor in order to facilitate that? Or what color can you give us on that?

Shelly R. Ibach

Sure. Well, with our business model, we have a very unique rollout that is pretty seamless and in comparison to what others have to go through, quite easy. So we'll roll out on Sunday morning before store opening. And this particular m9 along with the new FlexFit Series will be on 160 floors in its complete set up. And then we have a method of showing a mini version of the bed in the remainder of the stores. So we will sell the bed in all stores, and of course, on our .com site.

Chad Bolen

Great, that's very helpful. And I had a question regarding the store count. I think you had fewer net new stores in the quarter than you had told us you expected last quarter. Was that more closings? Was it a few less openings? And then with the increase in the store count guidance for the year, just I guess, how do we think about the distribution of those net new stores in 3Q and 4Q?

Wendy L. Schoppert

Sure, this is Wendy. Actually, the store count in the second quarter is fairly consistent with our guidance. The guidance we gave was that the growth would come in the second half, and we would expect that to come in both the third quarter and fourth quarter of this year in terms of the net new stores that we will see.

Chad Bolen

Okay. And last one for me, could you just show us how many mall stores versus off-mall are you -- do you have currently?

Wendy L. Schoppert

So at the end of the quarter, we had 48 non-mall, Chad.

Operator

Our next question comes from John Baugh with Stifel, Nicolaus.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Just quickly, the new FlexFit base and the m9. Can you -- are these replacements for something else on the floor? And if so, are they higher price point replacements? And then on the FlexFit, remind me again of the choices that a consumer has of your adjustable bed frames. I can't remember if there's 2 or 3 choices.

Shelly R. Ibach

This is Shelly. I'll start and Wendy can add in here. So first of all, the m9 is an incremental bed to our line, so we have not introduced a new additional bed for some time, so it is an incremental unit. And the FlexFit, the upholstered FlexFit Series we are introducing, is a replacement. We are closing out of our existing FlexFit series and introducing this new series.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

And is that at a higher or lower ASP than the one you're closing out?

Shelly R. Ibach

Slightly higher.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Okay. And then in the ASP, which is 13%, you went through 6% and then adjustables being the bigger component of the 7%. Was the mattress price essentially flat year-over-year?

Shelly R. Ibach

No, we -- the pricing -- no, we had some increase due to the pricing, John.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Yes. Excluding pricing, though. I mean the mix in other words of the mattress didn't cause ASP to presumably [ph] go up or down?

Shelly R. Ibach

There was not a significant difference there, you're correct.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

Great. And then the last one would just be, is there anything you can share with us particularly on ad spending costs? As we approach Labor Day and the fall selling season, what's your strategy is around that and anything you'd like to share with us now about your plans on promotion advertising around Labor Day?

Shelly R. Ibach

This is Shelly again. Regarding the Labor Day period, our promotion strategy is very consistent year from year, year-over-year, and that helps us just with overall cadence in performance. So a similar approach. However, we consistently advance our learnings on our media buys and our execution of our layered media strategy. And as we test and learn and apply, we bring that forward to the next period. So greater effectiveness and efficiency with each period, and Labor Day is an important part of the third quarter.

John A. Baugh - Stifel, Nicolaus & Co., Inc., Research Division

And the cost of advertising, what do you see? How will that impact you?

Shelly R. Ibach

From a cost perspective, we've done a number of things. We anticipate, as many do, quite a bit of action in the back half here with politicals, et cetera. And so we prepared as well as we can. It's something we certainly monitor daily. But we have done some annual buys, some forward progression that has allowed us to maintain our efficiency.

Operator

Our next question comes from Eric Hollowaty with Stephens, Inc.

Eric Hollowaty - Stephens Inc., Research Division

Shelly, I think in your opening remarks, you talked about launching your seventh aggressive growth market at the end of the second quarter. Could you just refresh us on the cadence of how those are rolling out? As I recall, I think you're going to do 3 launches this year. And would this just be the first of those 3? And then you've got 2 coming in the back half that you plan to launch?

Shelly R. Ibach

Actually -- this is Shelly. This is our third this year. So we launched 2 in January, and this is our third one. And the strategy, just as a reminder, it involves 13 markets and represents about 1/3 of the U.S. bedding sales, and this is our seventh market that we launched.

Operator

Our next question comes from Todd Schwartzman with Sidoti & Company.

Todd A. Schwartzman - Sidoti & Company, LLC

A question -- on the m9, will you be displaying it side-by-side with the m7 in a mini foam section?

Shelly R. Ibach

We will have the m7 and the m9 in numerous stores. I don't know the exact number that we'll have them both side-by-side. The m7, we have also elevated the aesthetic of that model, and the price is also increasing on the m7, as of July 22, by $100.

Todd A. Schwartzman - Sidoti & Company, LLC

As of July 22?

Shelly R. Ibach

That's right. And the 2 beds have very different comfort feels, one with the CoolFit Memory Foam and the other with the LuxFit.

Todd A. Schwartzman - Sidoti & Company, LLC

So the objective would not necessarily be for people -- for consumers who don't love the price point on the 9 to down-sell to the 7 because it's just a different experience?

Shelly R. Ibach

Yes. For us, we focus on the customer's needs, and we design products that meet those needs with real, meaningful benefits to their support and comfort. So as we go through the experience with the customers, really understanding what their individual needs are and matching that with the right bed.

Todd A. Schwartzman - Sidoti & Company, LLC

Okay. And Wendy, you talked a bit about the success that you've had -- continued to have with the growing attachment rate on the foundation, the adjustable foundations. Can you quantify that for us versus a year ago?

Wendy L. Schoppert

Sure. Well, what -- we have seen some very good success here. And while we don't share specific numbers on the attach rates, what we have seen over the past couple of years is north of several hundred basis points per year of increase, and we've seen that pretty consistently, and again, saw that kind of strength in the quarter.

Todd A. Schwartzman - Sidoti & Company, LLC

Did that several hundred basis points accelerate sequentially? Or was it kind of constant from Q1 to Q2?

Wendy L. Schoppert

Well, again I'm not going to give too much detail, but we saw some very good strength in the second quarter.

Todd A. Schwartzman - Sidoti & Company, LLC

Okay. And what can you tell us? The more numbers, the better. I guess if you could quantify conversion rates, store traffic.

Shelly R. Ibach

No, we think conversion are an important part of our business because we develop and get to know our customers and really strive for a great lifelong relationship. We do not share specifics around the 2 key measurements.

Wendy L. Schoppert

What we have shared, Todd, I think as you know, is that our conversion rates are quite high and that is a key strength of our model.

Operator

Our next question comes from David MacGregor with Longbow Research.

David S. MacGregor - Longbow Research LLC

Just, while we're on the conversion rates. Is the media spend helping your conversion rates at all? If you can't quantify, can you please help us understand directionally if you're benefiting from the spend?

Shelly R. Ibach

Well, here's how we think about it. First of all, awareness is our #1 opportunity. And so it starts there with developing creative TV advertising that not only builds that awareness, but persuades the customer to visit our stores. So that's really where the whole traffic and lead aspect comes from. And we've recently, a year ago, we redefined our target customer to be a broader, a little younger and more affluent target customer who really appreciates and values products that deliver meaningful benefits. And she also has the propensity to trade up. And with our media buys, we've shifted our media buys to reach this target, and this target is about 4x larger than our previous target. And so, you could think about it that we are reaching this broader target who has a real appreciation for our brand. And as you have that more qualified customer, it means conversion once she goes to the store and that experience is meeting and exceeding her needs.

David S. MacGregor - Longbow Research LLC

Just a couple of other questions. On the commodity side, just if you could comment on commodity costs heading into the back half of the year. Are you seeing any relief? Or how should we think about that?

Wendy L. Schoppert

Sure, this is Wendy. So as we've said at the beginning of the year, we'd continued to say that we expect for the balance of the year low, single-digit commodity costs increases, with the most notable increase or most notable pressure in foam. That said, we do intend to continue to manage any of these increases with the great job that our operational team does from an efficiency standpoint and also working with our suppliers to mitigate the impact as well.

David S. MacGregor - Longbow Research LLC

Okay. And just last question. I guess I'd just be interested in kind of your thought process behind sort of the timing of the m9 introduction. And what do you think of as being kind of the size of the addressable market for that product?

Shelly R. Ibach

We haven't shared the specifics regarding the size of the opportunity on this bed. We have -- one of the things that's so unique about our business model is the ability to hear from our customers. We have 400 stores nationwide, and we can hear a direct feed from our customers and be very responsive to what they're looking for. So this product was developed from consumer insight and tested with our customer over time. We have great confidence in it as I mentioned, especially with the m7 paving its way. And we're pleased to have an m-Series with DualAir adjustability. And think that it will play very well in our overall line.

Wendy L. Schoppert

And -- this is Wendy. It's also very consistent with, as Shelly said, the way that we have changed our target customer and reaching that more affluent customer. And it might be also helpful just for me to share a bit about how our mix is evolving as well because I think it's tied in with your question. Historically, we've talked about, as we look at Classic's performance and the innovation Series, like a 30, 45, 25 type of mix. And what we're seeing or we have been seeing is some progression up from the P to the I, and that's really representative of our product innovation, but also how our customer is behaving, especially in Q2.

David S. MacGregor - Longbow Research LLC

Okay. I mean, earlier you were asked about the competitive dynamic and you didn't really want to go near that. I guess I understand why. But are you at all concerned that kind of given sort of the way the competitive forces are evolving in the bedding space right now that there's an issue developing around the pricing of Innovation and to the extent to which you can continue to take Innovation to market and get the same kind of price for it? Or are there headwinds there that we're going to have to deal with competitively going forward?

Shelly R. Ibach

All right. No, we certainly did not intend to stay away from that question at all, and really to have happy to answer any questions on this topic. I think there are a couple of things that are important to note here. First of all, Sleep Number covers a broad good-better-best within premium. Our opening price points for Sleep Number are $699 for a mat only. So as we -- we do have this new bed which happens to be at the top of our line. But keep in mind that our price range starts at $699, and we compete and focus on sleep products that are delivering real, meaningful benefits to our customers to enhance their overall sleep experience. So there is a price with that type of innovation that is highly differentiated and innovative and contributing to an improved quality of life. And we offer this breadth with good-better-best because we want to be accessible to a broad range of customers and be very relevant broadly. And our price range allows us to do that.

Operator

Our next question comes from Michael Novak with Frontier Capital.

G. Michael Novak - Frontier Capital Management Co., LLC

So my first question is on the gross margins, which as far as my model goes back, it seems to be an all-time peak despite the competitive environment that people are referring to and also selling increased frames with that. My understanding of your goal to get to 15% operating margins was sort of flattish gross margins and leverage on the other parts of the business. Are you now seeing an opportunity to perhaps expand your gross margins as well?

Wendy L. Schoppert

It's Wendy. Just -- I mean, you're right that we're very pleased with our gross margin in the second quarter, and it's consistent with the prior guidance that we gave last quarter of a roughly flat gross margin for the full year of this year. But getting to your question, as we look to 2015, we continue to believe that we have some opportunities, some continuing opportunities in gross margin. And we've talked in the past, one of our key priorities, as we just talked about, is product innovation, so there -- we'll continue to, we believe, have some pricing opportunity. But the other piece of this is that we also believe we have some continued opportunity on the operations side with continued efficiencies in manufacturing and logistics.

G. Michael Novak - Frontier Capital Management Co., LLC

Turning to the sales and marketing line, with advertising or marketing up 37%, clearly, that's helpful in driving your strong sales, but that's with minimal unit growth. So as your unit growth starts to pick up, would there be a period of deleveraging of that line as you're opening initial stores?

Wendy L. Schoppert

Well, we did have the 13% company-controlled unit growth this quarter. But to your question, the way we think about the leverage and the structure and the makeup of the leverage over the next few years, is that in the beginning of that period, really most of that upside really comes from selling because unlike some of our competitors, most of our fixed costs are in selling, so occupancy cost for example. So over time, though, what we've said is more in the long term there may be opportunities, will be opportunities to achieve leverage on the marketing line. But we would see that more at the later phase of our 5-year plan. And then really -- I was just going to add, I mean, it's really consistent with our primary goal of increasing awareness for the brand. That's our opportunity.

Operator

I'm showing no further questions at this time. [Operator Instructions]

Mark A. Kimball

Well, if there are no further questions, we will conclude the call at this time. Thanks again for joining us and for your support. We look forward to reporting further to you following the third quarter. Until then, sleep well and dream big. Thank you.

Operator

This concludes today's call. Thank you for your participation. You may now disconnect.

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