Welcome to Select Comfort's Fourth Quarter and Full Year 2015 Earnings Conference Call. All lines have been placed in a listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would like to introduce Dave Schwantes, Vice President of Finance. Thank you and you may begin.

Good afternoon and welcome to the Select Comfort Corporation fourth quarter 2015 earnings conference call. Thank you for joining us. I am Dave Schwantes, Vice President of Finance and Investor Relations. With me today are Shelly Ibach, our President and CEO; and David Callen, our Senior Vice President and CFO. This telephone conference is being recorded and will be available on our website, at SleepNumber.com. Please refer to the details in our news release to access the replay. Please also refer to our news release for a reconciliation of certain non-GAAP financial measures and supplemental financial information 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.

Good afternoon and thank you for joining our call. My SleepIQ score was 77 last night. Today I will update you on our ERP challenges, impacts and actions, followed by our growth initiatives for 2016. We had a very challenging end to 2015, disappointing our customers and incurring a $0.42 per share loss in the fourth quarter. Many of our customers were negatively affected by frustrating delays and delivery reschedules as we ramped our new ERP system. For the full year net sales were up 5%, operating income declined 26% and diluted earnings per share were $0.97. These results are not acceptable to us. The transition from our patchwork legacy systems and manual processes to a fully-integrated end-to-end ERP platform, expose significant complexities. Overall, our challenges were a result of two things. First, slowing our backlog of orders too quickly at too higher volumes and second inaccurate data signaling between plants, delivery hubs and our customers. Here is where we are now. Today we are operating at much improved levels and continue to make meaningful progress each week. We've ramped plant, hubs, and home delivery capacity to support the President's Day event. This required a 40% increase in plant production, the last three weeks of January which we achieved. In mid-January we extended our home delivery lead times to four weeks and returned to normal two week lead times on UPS orders. We expect to continue longer home delivery lead times for the next four weeks as we execute heavier volumes from the President's Day event. As our performance under new system improved, our sales trends and customer service are also improving. Importantly, we have achieved each of our weekly implementation milestones since the last week of December. Looking forward we expect to be operating the system proficiently with more…

Thank you, Shelly. Good afternoon. Our Q4 financial results and execution of the ERP implementation was surely disappointing. While we got a lot of right with the system design which benefited from embedding functional experts full time on the project, we underestimated the challenges and financial impacts when things didn't go according to plan. I'll review the fourth quarter and full year numbers before sharing our expectations going forward. Please refer to the table at the end of the press release for additional details on the quarter results and 2016 outlook. Net sales of $215 million for the quarter were 33% lower than the prior year and 7% lower on a two year basis. The $107 million year-over-year net sales decline falls into four groups. The extra week of 2014, elevated cancellations, appeasements and returns, overall lost sales opportunities including the impacts on store traffic and conversion, and higher than normal level of undelivered orders at year end. Specific sales metrics for the quarter includes 30% decline in comp sales versus the prior year. We shipped 38% fewer units in Q4 this year while ARU grew 9% to $4204, and our trailing 12 month average comp store sales were $2.4 million, up 2% versus the prior year. The significant sales decline resulted in deleverage across our vertical structure. This coupled with higher than expected ERP implementation cost resulted in $30.7 million operating loss for the quarter. Key call outs include, our Q4 gross margin rate of 56.2% was 420 basis points below the prior year. Approximately 40% of the rate decline was due to sales deleverage, and 60% was driven by appeasements, labor inefficiencies, material cost and excess freight from actions taken to manage the ERP challenges. Operating expenses of $151 million were 9% below the prior year including $7…

[Operator Instructions] And our first question is from Budd Bugatch with Raymond James. Your line is now open.

Good afternoon everybody. This is Bobby filing in for Budd. I appreciate you guys taking my questions. I was hoping to just get a little bit more color on the timeframe of how the events unfolded with ERP from when we last spoke on November 4 until today. I was having trouble following along in the prepared remarks, when the big difference from plant started to impact the results.

Yes Bobby, when we last spoke on our earnings call, that was November 4, and I summarized where we thought we were at that time. As we progressed through the month, we had a line of sight of some difficulties we were having in our plants at that time. And we're on the sold, we thought of those particular issues. What began to reveal itself as we entered December, late November, we started to have increasing reschedules. And the timeframe, as we got into December when we were ramping up, we had more significant issues. The issue, the number one problem we had is the amount of volume that we put through early on. And then that ended up clouding the real root cause of our plant to hub signals. So by late December is when we knew we had to slowdown and relay very clear on root cause, our recovery plan of what it was going to take to get ourselves recovered both with the pipeline and the root cause of the issues. And we’ve had clear milestones in each week that we’ve been able to achieve since the last week of December, all the way through this week.

So the big disconnect between the plant delivery and the customers as you called in the prepared remarks occurred after November 4, it occurred in December. Is that safe to assume?

It began to show off in a small way in November and then as we continue to ramp, it became larger.

Okay. And then with January orders still being down 7% year-over-year, I guess, it’s the goal to exit 1Q with a fully - everything back on schedule. How should we think about the new goal for progression?

As I stated, we’ve been achieving each of our milestones each week, including last week delivering over 7,000 units. And that's the level we need to be at. We need to continue to deliver at least that many units each week for the remainder of the quarter. For first quarter, we expect to exit fairly flat in sales inclusive of the benefit from the backlog as we enter the quarter.

Okay. And then lastly on the backlog. How should we think about the cancellation possibilities for the backlog? I mean what were cancellation rates in December and what is your assumptions I guess, for cancellations going forward on the backlog?

They were elevated as we indicated in our - there is a table in the back of the press release. You could take a look at, but we've contemplated that in the estimate of the net sales impact. Instead of giving you a gross number, we've already incorporated that into the carry-forward amount.

Okay. I appreciate. I’ll go ahead and get back in the queue. I appreciate you guys answering my questions.

Thank you. Our next question is from John Baugh with Stifel. Your line is now open.

Thank you as well for taking my questions. Shelley, you went through some things that were important and they related to brand sentiments. I think you refer to website looks. I guess the question is simply, how do you assess - I mean, you gave the order number, how do you assess what damage was done if any for the brand and maybe you can rehash some of those numbers. And whether some of the weakness that we are seeing now or you’re seeing now is due to macros as opposed to ERP and then maybe a little more detail on President's Day, exactly what you’ve got planned or what your expectations are, are you going to have a muted kind of event because of the ERP issues you’ve had? Multiple questions I understand but, thank you.

Yes, I’ll start with the brand John. You know this is certainly been in top of mind for us as we’ve been fighting our way through and taking care of our customers and you know where we have the opportunity to go back and reconnect with all the customers who we've affected during this time. The specifics that I shared in the prepared remarks, first and foremost we always look at social sentiment which is really the online voice and as our issues are coming down that voice is beginning to change and product praise is regaining its ground as a stronger voice. We expect that trend to continue and that’s part of our milestone look each week. In addition, I think what’s really important to understand would be the long term brand metrics are consistent with pre ERPs. So we take our long term brand study three times a year, September being one of the times and January another. So we just took the study right before the ERP and the post metrics are on track with the pre ERP metrics and this is very important for consideration as we move forward. Both awareness and consideration stayed steady during those time frames and John this is consistent with the weekly read in the short term brand metrics that we’ve been reading. Of course cautiously optimistic on it but then getting the tracker information back for validation was very important. The customers who were affected is certainly were negatively impacted and have a tough social sentiment. The consumers who were considering the brand, that view of the brand and the company were still very strong and of course we’re very happy about the J.D. Power number one mattress satisfaction and we’ve seen a big impact from that already in the customers reading that voice as being the most important. And then our website traffic has been fairly steady through all this up 59% in Q4 and up 64% in January and that all has a lot to do with the fact that we did continue our media. In November we weren’t as clear about where we were at and so we did continue our media, driving people to our website and I think that has really helped us maintain the brand metrics as we go through this. For January I shared some specifics, you know our early read in February we have a little choppiness going on but yes we expected more muted President’s Day event consistent with exiting Q1 flat inclusive of the backlog benefit as I mentioned. I’m not sure on the macro John, our impact is clearly been focused on our ERP implementation, so it’s difficult to parse out any macro impact. But we do have an innovative product with high mattress satisfaction and that kind of product can breakthrough even in a more challenging macro.

Appreciate that color. And then quickly the store openings, what’s the cadence to that through the year and any kind of new market versus selling in existing markets or how do we think about where the stores are going?

That's a great question too. We have a little different cadence than normal on our new store incremental store openings this year. It’s about half and half between first half and back half and generally and specifically last year the majority of the incremental stores were in the second half. So we do get after that quite early and see that as part of our growth drivers as we go into the year. And these new locations are primarily new market entries and also aggressive growth market development where we have plenty of room for that incremental store, so minimal rest on cannibalization.

I'll defer to others. Thank you.

Thank you. And our next question is from Seth Basham with Wedbush Securities. Your line is now open.

Good afternoon. I just wanted like a couple of quick clarification, first, if we can. In terms of the sales trends that you're reporting, I think you're referring to orders for month of January down 7%, is that correct?

Yes, that's correct, Seth. It's orders.

Okay. And you expect to see for the full quarter Q1 flat year-over-year in sales dollars?

Yeah Seth, that's net sales incorporating both the benefit of the backlog carry over and the pressure that we expect from the ERP on our top line demand.

Okay. What would you say you expect in terms of orders year-over-year for the first quarter?

I think you can largely back into that based on what we've talked about. We don't generally talk about orders, we're providing a lot more specifics on this call given the circumstances but orders isn't something that we plan to give.

Okay. Fair enough. Where do you expect to cross the line then, start growing orders again on a year-over-year basis, maybe that's a better way to phrase it?

As I stated Seth, in the second quarter we expect to be exiting the second quarter, and a nice growth, more normalized growth.

Okay. I guess the last question is, just taking a step back, as you consider the issues that you experienced with ERP, was there at any point in time where you were considering point of blogging, going back to your old systems?

Absolutely not, there really was no question. The majority of the system did work, the front end worked and most of the ECI and human capital and all those different aspects of the system, it's the right system, it's the system that's going to give us the efficiency in the margin expansion that we need for this business. And as we sit here today certainly regret the implementation challenges we had but not the system. I mean this is the right system and it exposed all the complexities that we forced on our customer today that we need to get out of this business. The consumer today demands a connected, simple experience. That was not what we were able to deliver on our old systems that were completely disconnected. So this is the right system to deliver that and it will enable our growth and the achievement of our long term commitment to shareholders as we move forward.

Got it. Okay, one last question if I may. 275 in earnings power in 2019, sounds great. Can you remind us of the bridge to get there and then give a little bit more detail on how you see 100 basis point improvement driven by new products from the BAM Labs acquisition, please?

Sure, glad to. Start with the last one first. We've always expected to have benefits from this ERP implementation. What we learned during the intense work that we had in the fourth quarter was, all of the bench points where we can get margin improvement, that is going to be part of the supply chain evolution that we're attacking, making things simpler for our customer, making things simpler for our employees, taking cost out of the system in terms of the number of touch points in our network. That all contributes to that 50 to 100 basis points of improvement that we'd always been chasing, expecting to get in the back half of 2016, and we still do. The BAM Labs acquisition or SleepIQ LABS today has already proven valuable in terms of pulling forward the If Bed capabilities, and making sure that we could introduce that in January at the CES launch. We also know that there are cost reduction that we can take out of our pump directly as a result of that acquisitions that are going to be achieved in the back half of this year. So in terms of getting back to the 2017 or 2019, $2.75 EPS, when I think about this year the high end of our range is the $45 and we’re assuming - if you assumed that $0.25 of ERP pressure were the reality this year, the adjusted number will be $1.70. That would give us required 17% EPS CAGR from this point until 2019 which is exactly what it was when we introduced our long term guidance last year or in 2015 from 2014 to 2019. So we believe that we'll have the business right back on track in the back half this year.

Very good. Thank you very much.

Thank you. And our next question is from Brad Thomas with KeyBanc Capital Markets. Your line is now open.

Yes, thank you good afternoon. I wanted to ask about guidance for 2016. I think prior guidance after your third quarter call had anticipated about a $0.33 drag from investments. It looks like now that’s totaling $0.50 to $0.55, then of course we will anniversary this fourth quarter that you have just reported. I guess can you help us think a little bit about some of the puts and takes here and may be how much you think you get back later this year from disruption that you've just had as we think about your outlook for this year.

Yes, thanks Brad. The $0.25 to $0.30 of ERP drag largely from the 6 to 8 points of topline pressure I think that, that’s kind of - we’re seeing that as more of a one-off event that we will lap in 2017 in the first half. I think the - in terms of improving our profitability in the back half of this year of course we're expecting to be going off of more the adjusted basis of 2014, excluding the extra week then thinking about it in terms of just the 2015 number which is pretty hard to see through all the noise.

Got it, okay. And then just with respect to some of your measurements, your details have all been very helpful but just curious how much confidence you have and your estimate for $34 million sales impact from traffic and conversion for example just as we consider what’s been relatively choppy landscape for the consumer over the last few months?

Great question, Brad. As you would expect with the new ERP system of we had to apply a lot of additional rigor at year end to ensure the accuracy of our results and we were not in a position to provide a complete reporting on the impact of the ERP implementation tells us recently. However our controls are functioning properly, our metrics are in place. We have great visibility today. We were able to give a lot of good precession as to exactly what happened in Q4 and we provided additional details in our press release in the last table of the press release. So we feel like it's - this is a reasonable estimate, it’s our best estimate of what the impacts are going to be. We know we have incremental cost and inefficiencies as we have additional staff supporting the business as we learn to use the system proficiently with incorporated those things. We know that there are higher - some of the higher cost that we encountered in terms of handling et cetera from Q4 is going to carry forward but not nearly the levels that we had in the fourth quarter. So we scrub these numbers pretty hard and believe it’s a solid estimate.

Brad I would just add, what is very encouraging and gives us great confidence is the achievement of our milestones each week since the last week in December in all aspects of the business and that give us the steady progression. And then in addition to that understanding where the brand metrics are at and our overall fundamental on comparative position with our innovations and effective marketing and the product quality has never been stronger as noted by J.D. Power award where the portfolio is that and our digital effort. So we have quite a few drivers staffed up in our favor along with the incremental new store growth that we're getting after early in the year as we move forward and then of course we balanced that against our pressures of recovery around social media and in any referral, hangover that we have and then of course we are yet to better understand the macro. But again for us as innovation category with a benefit driven product it does help in driving through any type of macro pressure.

And just following up on the macro topic again, if we make the adjustments the $83, $84 million of sales impact the 26% drag, I think you had anticipated about $10 million when we had our third quarter call, so about a 23% drag on sales which would puts you in line may be tad versus than the mid single digit comp decline that you had talked about, am I reconciling that properly?

Yes, that sounds about right.

Great, thank you so much. Appreciate all the details.

Thank you. Our next question is from Peter Keith with Piper Jaffray. Your line is now open. Q – Unidentified Analyst: Good evening this is actually John on for Peter, thanks a lot for taking our questions. I guess first off, are you seeing any increase turnover at the sales associate level beyond what you normally see this time a year. And are you having to adjust sales goals or compensation for sales associates or anything like that and if so are those changes factored in the 2016 guidance at this point.

Yes, thank you for the question. First of all as you can imagine for us as mission driven company focused on improving our customers lives. It has been very difficult for all us for our entire team and certainly our frontline be in faced with disappointing our customer which is completely the opposite of what we strive for everyday. So we definitely had some level turnover wasn’t significantly higher but frustration as we went through it. We are company that we take care of our team. We focused on doing what’s right on behalf of our team and our customer so of course we appropriately dealt with cancellations that are outside of our teams control and that is factored into our numbers already. We had a very dedicated team with a high level of engagement and we have all been fighting through this together with a great unity and confidence as we move forward.

Okay, thanks. And then I guess my next question is just around and I know you guys don’t like to get into quarterly guidance but just given the uniqueness of the situation here can you David may be just give us a little more commentary and how you expect Q1 to play out both from a comp and margin perspectives specifically gross margin. I mean do you expect gross margins to be up sequentially or kind of inline with where they finished with the fourth quarter.

Yes, sure John glad to - we are going to benefit on the topline from the backlog carryover and we’re going to have pressure that offset that in any normalized growth. So we are expecting sales basically flat so that implies a negative comp and we expect because of the cost pressures, carry-forward we’re expecting about 150 basis points of pressure on gross margin in Q1. And as I mentioned earlier I expect three quarters of our EPS to be earned in the back half because of the introduction of additional deprecation, the labs, acquisition cost and some of these pressure from the ERP implementation.

Okay. And I guess you guys give a web growth number that I missed earlier unfortunately, was that the increase in unique visitors for Q4 or was that a different number?

Yes, that was 64% year-over-year increase of unique visitors in Q4.

In January -

That was in January, the Q4 was 59%.

Okay. So that compares for the roughly 50% growth I think you guys gave in Q2 and Q3 on a year-over-year basis.

Yes, the full year was 51.

Okay, great. And just last question from me quickly, just on the buyback and looking at your balance sheet, I mean for the fourth quarter if you look at the cash marketable securities and then net that against the prepayments which are actually high for obvious reasons. As we look into 2016 now, I know last year you said you wanted to maintain like a $100 million number based on those variables given that in Q4 I think if you net all those numbers together its actually a negative. Should we be expecting you guys, given you said you are going to be assertive on the share buyback to be taking on that to buy back stock down here?

It’s an important question John. We talked about last in the third quarter that once we get to the other side of the ERP implementation, that need for the substantial cash reserves wasn’t there anymore. So we intended to lean into our share repurchases. We intend to continue to be opportunistic in our share repurchase. We've got an unused revolver of a $100 million today that we're planning in this quarter to increase $150 but we haven’t give any indication of the phase that which we would buy back shares.

Okay, thanks a lot. Good luck in 2016.

Thank you. And our next question is from Jessica Mace with Nomura Securities. Your line is now open.

Hi, good afternoon. My first question a follow up on the cadence for store opening I just wondering if there is any risk to the heavier store openings in the first half, are you still facing some of these ERP pressures may be anything you can tell us about the new store openings from 4Q?

No, we don’t see any risk at all from the ERP pressures, especially where we are right now we are fully head of our demand right now out of our manufacturing plans and close to our efficiency in our plans and we’ve ramped up to those necessary level of deliveries then the customer service is coming in near normal at this point. So, we don’t see any impact there. I’m sorry your question on Q4 new stores.

I was just wondering if there is any color from the new store openings and impact from the ERP disruption you saw that would be relevant how we thank about Q1?

No, similar to the rest of the change.

Understood. And then my second question is about the It Bed. I was wondering if you could talk about with the product introduction at the entry level of your line what’s the strategy for the differentiation - maintaining that differentiation from some of the higher priced wide products and what kind of impact you expect on ARU for the year?

Yes from a growth perspective looking and ARU in units, we do see this growth this year is coming primarily from units with more of a flattish ARU on full year. For the It Bed, the It Bed targets a market that we currently do not necessarily attract to our brand and so we do see this as incremental targeting the millennial customer who is under certify us who focuses on tech as their health and wellness go too. And this bed delivers on those attributes. The SleepIQ advancements to our platform that we're doing in combination with the Lab that will actually flow through to our entire product line. This bed will be focused as a very simple purchase and ship online with the fast shipped, very simple product to set up and there is no hoses or firmness control system with this product but yet it still has a dual adjustability. And then we have a clear step-up going to the rest of our lines. If you recall our C2 is also 799 in a regular product line and that will be around $1000.

Great. Thanks for taking my questions.

Thank you. Our next question is from Keith Hughes with SunTrust. Your line is now open.

Thank you. Couple of questions, first you're talking about some of the pent-up demand if you will from beds in the fourth quarter coming in on the first. Can you give us any kind of indication, how many of the gross orders in the fourth quarter were cancelled and how many came through, any trending on that would be fantastic.

Sure Keith. There is a table at the back of the press release that breaks out the sales from cancellations, appeasements and returns. So that will give you some good color in that way. We know this is a time where we have some benefit in being in lower interest category and when we saw the trendlines of that customers we are impacting versus the customers considering the brand, the consideration of the brand those customers had healthy sentiment to our brand matter of fact on track with normal. This is probably a place where that is going to be beneficial as we recover from our brand challenges with the customers we impacted.

So I saw the table and so it has $34 million, is that actual $34 million of sales that were cancelled?

No, you were looking at what we are talking about here is this the footnote number two and its $26 million is that line item.

For cancelled appeasements and returns Keith.

Okay, so that is the cancelled number, so in footnote number 1.

Yes that's about 8%.

So what is the footnote number 1, is that a calculated number, I don’t understand what that is?

Yes that's relative to our expectations for the quarter.

Okay. So that's – okay so that is somewhat of a hypothetical number in terms of working on that. Okay. I guess going back to the It Bed, we still really don’t know any details of timing when the marking on that begin is there any kind of update you can give us on that?

Yes we'll speak to additional details when we’re ready to bring the bed to market which will be later this year.

So is it still a 2016 launch on that or is this closer to 2017?

No delays on in the innovation advancement.

And yes it is launched this year.

Okay. With President's Day weekend coming up, what kind of lead times are customers going to be told if they want to buy bed this weekend?

Yes, we are at a four week lead times for home delivery and two weeks lead times on UPS shipments.

All right. Thank you.

Thank you. [Operator Instructions] And our next question is from Curtis Nagle with Bank of America. Your line is now open.

Thanks very much for taking the call. Just a quick one on inventory, any guidance in terms of - I guess where should we expect it on a dollar basis or year-over-year from 4Q?

Thanks Curtis. We ended the year with about $15 million higher inventory than what we had been planning that's due to the sales missed and the higher ending backlog. We’re in good shape to service our - that backlog as well as our demand from the President's Day event. We are expecting around an average of $18 million of inventory in 2016.

Okay. Thank you very much.

Thank you. And we show no further questions on queue. I would like to turn the call back to our speakers for our closing remarks.

Thank you for joining us today. That concludes our fourth quarter conference call.