Welcome to Select Comfort's Q1 2016 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If anyone has any objections you may disconnect at this time. I would like to introduce Mr. Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to the Select Comfort Corporation First Quarter 2016 Earnings Conference Call. Thank you for joining us. I'm 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. Please also note that we have posted an updated investor presentation on our website at sleepnumber.com. I will now turn the call over to Shelley for our comments.

Good afternoon, and thank you for joining our first quarter earnings call. My average SleepIQ score in April is 78. Today, I will update you on our ERP implementation and highlight our growth initiatives for the balance of 2016. Our first quarter results were on track with our internal expectations. Net sales were $353 million, up 1% from the prior year's quarter, and earnings per share were $0.27. These results reflect the completion of our ERP implementation in the quarter. We are on target with our plans to deliver earnings per share of $1.25 to $1.45 for 2016. In the back half of the year, we expect significantly more contribution margin as we grow sales, operate the system more efficiently and deliver supply chain leverage. Customer online sentiment, referrals, traffic and related sales trends are improving consistent with our expectations. We are operating in a more sluggish economic environment, but we were still able to achieve our first quarter sales and profit goals. A few weeks ago, we started our outreach program to customers who were negatively impacted by our service levels during the ERP implementation. Our objective is to rebuild trust with Sleep Number and, ensure our customers understand that our issues have been resolved. Overall, we are very pleased with the progress we've made in the quarter. And while we still have inefficiencies and more work to do, these are opportunities in front of us. Sleep Number's transformation has been monumental and necessary, to be able to lead and adapt to the changing expectation of consumers. We are emerging from a period of deep investment that strengthened our competitive advantages and marketplace differentiation. We have fully evolved from a 1 (800) direct marketing mattress company for people with back pain, to a national consumer innovation company and the…

Thank you, Shelly. Net sales of $353 million for the quarter, were up 1% on top of 27% growth in the prior year's first quarter. The operational metrics we used to track our ERP recovery advanced largely as expected during the quarter. This performance according to plan, is an important call out. It signals the containment of ERP launch risks and improved line of sight to operating metrics post ramp up. We estimate the ERP implementation effects on sales and costs impacted Q1 earnings per share, by approximately $0.25. As expected, net sales in Q1 benefited from shipments of the high Q4 ending backlog, partially offset by lost sales we attribute to ERP challenges. Sales orders were down mid-single digits as expected for the quarter. We made solid progress improving customer delivery execution during the quarter, resulting in about 1% more volume delivered than planned. And an ending backlog in line with the prior year. This pulled forward approximately $4 million in net sales from Q2 into Q1. Specific sales metrics for the quarter include a comp sales decline of 4%, yet reflect 18% 2-year stacked comp growth. ARU of $3,978 was up 1% for the quarter, while units declined 1%. Our trailing 12-month average comp store sales of $2.4 million declined 3% versus the prior year, due to ERP impacts in Q4 '15 and the first quarter, this year. Our gross margin rate of 59.2% improved 300 basis points sequentially from Q4, but was 250 basis points below the prior year. Appeasements, labor inefficiencies, and excess freight and material costs accounted for the bulk of the year-over-year decline. Operating expenses of $189 million, up 10% versus the prior year, came in slightly favorable to plan as we managed our spending. Sales and marketing costs were up 7%, in line…

[Operator Instructions] Our first question is from Brad Thomas of KeyBanc Capital Markets.

My first question was just going to be around the cadence of the business. Obviously, there are moving parts with the ERP disruption that you're working to remedy. I think, David, you referenced overall orders in the quarter being down mid-single digits. Any more color around maybe the trend in same-store orders, and how you're feeling about orders as we move into the second quarter would be very helpful.

Brad, we're very pleased with the progression of our business, both with the ERP implementation and the corresponding trends from a operating, technical and service metrics. And we saw the correlation with our consumer response and sales progression through the quarter. As I indicated in our remarks -- in my remarks, we do see a sluggish environment, but we're able to work through that and deliver on the performance. The consumer is a bit more resistant, but -- we're positioned well with our direct-to-consumer model, sleep innovation leadership, focused on benefit-driven features. And then, also having the support of JD Powers and consumer reports and those confidence builders for the consumer. We did see some increase with our ARU in the quarter, and we're continuing to progress our marketing to be able to support the increases of sales as we move into the second quarter, along with our store actions. So for us, it's been progressive, as we've continue through the first part of the year.

And if I could add a second question on ARU up 1% in the quarter. I think this is the smallest that we had seen in a while. Obviously, a number of things you all can do to keep driving that higher in the future. But as we think about the puts and takes on ARU, what was it that has resulted in kind of a moderation growth that we're seeing here in the most recent quarter?

Yes. The ARU growth -- I mean, just overall, Brad, I mean this is the quarter that we expected, I mean coming. If you think about where we were at the start of the quarter, we weren't even up and running on the system. It wasn't until the end of January that we were fully operating the system. And then, early in February, where we delivered our first week of over 7,000 units. We operated with extended lead times all the way through the quarter until the very end of March, when we returned to normal lead time. So we're pretty pleased with delivering the quarter that we did, and certainly, right on where we expected it to be and still getting some ARU growth. We stated at as we went into the quarter that we expected most of our growth to come from units this year, with some from ARU, but we look at this on an annual basis year-over-year, and we're excited about being able to deliver some unit growth too.

Our next question is from Budd Bugatch of Raymond James.

If I could, let's just go to the second quarter, David. I think you said, you're going to be breakeven in the second quarter. Just want to make sure I kind of get where the moving parts are? Is it -- the G&A looks like it's, what, $30 million a quarter or so? Is that still at the right place? $30 million, $31 million?

Yes, that's directionally correct. But if I could give you a few other points. Just keep in mind, that Q2 is a seasonally low sales point for us. I talked about the expected $0.05 of ERP pressure in Q2. I also highlighted that we expect about $0.07 of pressure year-over-year from ERP depreciation and the LABS acquisition combined. And then, I highlighted in my prepared remarks as well, some deleverage in selling and marketing as we support our initiatives. That's contributing to about $0.06 year-over-year change. Those are the big elements.

And did you expect revenues to be up? You were at 7,000 and that would imply something over 90,000 units a quarter. Are we still at 7,000 units a week, or are we better than that?

No, our second quarter is a smallest quarter, Budd. So we don't normally talk about our weekly shipment volumes, but the point is that we still expect about $10 million of sales pressure related to the ERP implementation challenges as we rebuild our referral business. But, we -- this is exactly the kind of first half that we were expecting.

Got you. And lastly from the inventory at $81 million is up nicely year-over-year. I realize that's because you want to be able to have that in stock. Is that about where you want inventory to end quarter-to-quarter, and how about the end of the year?

Yes, Budd, I would -- with the initiative that we have underway, with make to stock, et cetera. We landed where we thought we would for the end of the first quarter. We expect Q3 to have a little bit of a bump, maybe $3 million to $5 million-ish, and maybe end about this kind of range by the end of the year.

Our next question is from John Baugh of Stifel.

It's nice to have ERP behind us. If I could just maybe ask a few things, anything you're seeing in mix changes in your business?

During the first quarter, we did have a little bit of mix movement. We primarily associate it with the fact that we were delivering our UPS ship orders on time, on normal lead time, but yet home delivery was extended 6 to 8 weeks. And so we saw a little bit of movement towards the low end of our line related to UPS shipments.

Okay. And then, Shelly, are you going to be in a position by Memorial Day to, I don't know, be back full bore on promotions, marketing, advertising, et cetera?

Absolutely, John. And we're really excited about this next ad that we're introducing to support this time period. I would say the drag we have as we go into second quarter is around our referrals and some online sentiment that's still out there on some sites that we just need more time and volume to be able to overcome that. But we're making great progress. We're actually ahead of some of the metrics that we thought we would be, internally when we look at various satisfaction and approval, referral type metrics from our customers. So we have some more building to do. But we're -- where we thought we would be, and that gives us great confidence as we head into the remaining quarters of the year.

Great. My last one is just the share count at the end of the quarter and/or maybe just a guidance where you think that falls for the year?

Great. Thank you, John.

Yes, John, we ended the first quarter with about $49 million diluted shares. I'm expecting the pace of repurchase to be aligned with, as I said, our cash flow generation in total -- a little bit, we plan to repurchase total, slightly more than our free cash flows for the year, ending in $47 million to $48 million -- 47 million to 48 million share range.

47 million to 48 million by year-end. Okay. And it was 49 million, you said, at the end of the quarter? I'm not sure, how that works with your weighted average at 48 million for the quarter. Or am I missing something?

Yes, we can take that off-line.

Our next question is from Peter Keith of Piper Jaffray.

Just a few things, just to clarify the numbers you derived at the ERP disruption. So David, last quarter you thought the gross margin would be impacted by about 150 basis points. You guys were down 250. Was that just from some of the excess rate transportation?

Yes, it really was. We had a range of expected ERP implementation of $0.25 to $0.30. We operated at the high end of that range. And that impacted largely the margin rate, more than we had expected.

Okay. And then, just kind of backing into what the sales impact was. It looks like maybe it was about $35 million to $40 million in Q1. And that would be about a 10% impact from last year's sales. Is it fair to say that you guys think you should have been comping more like mid-single digits if there had been no disruption?

Yes, that's about right.

Okay, very good. And then, the last question I have is, you guys have indicated a few times on the call here about a sluggish environment. Could you just give us some feedback on what you're seeing out there on the retail front? And maybe do you think the mattress industry has been a little bit soft for the last couple of months?

Yes, I would -- overall, it's all, you read about in retailing and I think, there are a few things contributing to it. Certainly, the macroeconomic factors, all of them have some drag on them right now. But also, the way the consumer is changing, and I think, in retail in general, there's a fair amount of commoditization with the broad ability of online purchasing. And this is where our direct-to-consumer model with exclusive distribution is a real competitive advantage. And we look forward to continuing to compete in this industry sector and the broader marketplace around sleep and health and wellness with the model that we have. For us, internally, our probably biggest pressure is referral, which we're building back. But we do see a more resistant consumer. You do have to fight for every sale, and where we have a passionate, committed frontline, who has gained a lot more confidence in the last few months with the ERP implementation behind us. And they build relationships with their customers, and that's really needed right now, because of -- the customers taking a little bit longer in their decision-making. And so those are some of the indications. It's not easy. The fish aren't jumping in the boat. But we have the model and the initiatives and the strategy to be able to compete in a variety of different marketplaces, and we're prepared for this.

Our next question is from Seth Basham of Wedbush Securities.

My first question is just around the promotional environment. You talked about the sluggishness, but can you talk about how you're reacting promotionally, whether you guys are doing anything different?

Seth, overall for the quarter, our promotions, our discounts, financing really netted out to be very similar to the prior year. We do always manage these buckets slightly differently, year-over-year, week-to-week and the variation of promotions. And we do test different tactics as well to see if, during this type of environment, does financing or dollars off, which one's more effective and how do we lean into that? But we manage the total bucket between finance and discount dollars as we approach our promotion strategy. We also operate with contingencies and we utilize different contingencies at different times, that's very much a part of our normal business practice.

As you look forward to Q2 and Memorial Day, do you expect to become more promotional? Or do you expect to have the same level of promotional impact year-over-year?

Yes, we expect to be same, very similar year-over-year.

Okay. And then I may have missed this, regarding the second quarter, did you guys specify what you think sales will be guidance wise? Are you looking for flattish year-over-year, or what's the right number we should be shooting for?

Yes, Seth, we're talking about a low single-digit first half and about a low single-digit second quarter as well.

Our next question is from Jessica Schoen from Nomura.

My first question is just a follow-up on the comments on ARU, and I want to make sure I understand what your guidance for units to be a bigger driver of sales growth than ARU through the year. If lead times in the home delivery have returned to normal and is no longer impacting some of those higher priced products, and your promotions are the same, what are the factors that's maybe keeping that ARU growth lower than it has been in years past?

We're really pleased with our ARU overall and the ability to pull on the levers both for ARU and for units. And we've had a great run with ARU. We continue to see opportunity there. We just have stated in our guidance that we are expecting more of our growth in the back half of the year to come from units rather than from ARU.

All right, understood. And then, you mentioned customer outreach. I was wondering if there's any recent metrics, understanding there's been some noise with ERP but any recent metrics on sales amongst existing versus new customers? And if there's any kind of margin implication we should be thinking about as you outreach with those customers?

Yes, a great question. With the outreach, this is the combination of both a personal note from me, along with a phone call from their sales professional. And it does include $150 bedding offer for the -- as an expression of our apology. Our #1 goal is to rebuild the trust and assured them that our issues are behind us. We have that considered in our forecast and guidance and planned it into our full year when we set our guidance.

Our next question is from Keith Hughes of SunTrust.

I have a question on the bed in a box launch. You referred to more information on the next call, will we get a definite launch date at that time?

Yes.

Okay. And just conceptually, we've seen other established companies launch bed in the box. And there really hasn't been, a lot of promotion, a lot of push on those so far by those players. Will you have a separate and specific marketing campaign around your launch?

Yes, we will, Keith, and it will be digitally focused. This is the it bed by Sleep Number. And ours is full of technology. We have adjustable firmness, comfort and support through Active Comfort technology. It quantifies sleep and makes suggestions with our SleepIQ. And it connects with the outside world, their exercise nutrition, environment, SleepIQ API. So it is very different than your typical bed in a box, in that it has technology. It is focused on a tech savvy customer who uses technology as their go to for health & wellness. Very simple, easy to order, easy to set up, delivered in 5 days. And we're very excited about what this will mean for the overall industry. And having this level of technology and value equation in this bed, in this simple execution, we're excited about the customers it will bring to the Sleep Number brand.

Second question, in your prepared comments you talked about recently 2/3 of the stores getting the ability to schedule delivery date, which is fantastic. Is that the first real benefit we're seeing from the ERP install, despite all the issues you've had.

It is Keith. And it's a benefit that we pulled forwards with the system. So it's the beginning of many.

[Operator Instructions] The next question is from Curtis Nagle of Bank of America Merrill Lynch.

Just a quick question on going back to the it bed. I guess, how should we think about a, I guess the market potential for the product, and b, what the impact could be on overall ticket, and do you think there's any risk of cannibalization, or is just a completely incremental customer for you?

Great question. We do have a slide on it bed in our new IR deck, and it's Slide #13. And we specifically call out the size of our target to 43 million customers. We do see this bed bringing in a new customer. At the same time, we understand that we could experience some cannibalization from part of the line. And I think you'll see that as we advance our innovation pipeline and introduce our next innovations that we've thought this through very carefully, and we're excited about where we are. We're excited about being on the other side of the ERP and the continued advancement of SleepIQ technology.

Our next question is from Mark Rupe of Longbow Research.

I'm sorry, is I missed, did you clarify what the first quarter media spend was?

No, Mark, we didn't say it on the call yet, but it was flat to the prior year.

In dollars?

In dollars, $45 million.

Okay, perfect. And the pacing for the second quarter, for the full year, do you have any color that you can provide on that please?

On media, we stated on the last call that we expected about a 100 basis points of leverage for the year.

Okay. And then just lastly, on R&D spend. Obviously, it picked up this year with the acquisition and everything. But what would be maybe the right level of R&D spend on a kind of go forward basis? I think you said, this year it's going to be up $12 million or so. Is that getting up to the level where you need to be? Or is it going to continue to increase in '17 as well?

Well, we expect there to be some leverage as some of the innovations flow-through. We've been spending ahead on some of the innovations to make those happen. I think 2% of net sales with some leverage over time is probably in the right level way to think about it.

There are no pending questions in queue. I would like to hand the call back to our speakers.

Thanks, again, for joining us today. We look forward to discussing our second quarter 2016 performance with you in July. Sleep well, and dream big.

Thank you. And that concludes today's conference. Thank you for participating. You may now disconnect.