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Edited Transcript of SCSS earnings conference call or presentation 19-Apr-17 9:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Select Comfort Corp Earnings Call

MINNEAPOLIS Apr 21, 2017 (Thomson StreetEvents) -- Edited Transcript of Select Comfort Corp earnings conference call or presentation Wednesday, April 19, 2017 at 9:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David R. Callen

Select Comfort Corporation - CFO and SVP

* David W. Schwantes

Select Comfort Corporation - Vice President of Finance and IR

* Shelly R. Ibach

Select Comfort Corporation - CEO, President and Executive Director

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Conference Call Participants

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* Bradley Bingham Thomas

KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst

* John Allen Baugh

Stifel, Nicolaus & Company, Incorporated, Research Division - MD

* Keith Brian Hughes

SunTrust Robinson Humphrey, Inc., Research Division - MD

* Michael Lasser

UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines

* Peter Jacob Keith

Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst

* Robert Griffin

* Seth Basham

Wedbush Securities Inc., Research Division - VP of Equity Research

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Presentation

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Operator [1]

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Welcome to Select Comfort's First Quarter 2017 Earnings Conference Call. (Operator Instructions) Today's call is being recorded. (Operator Instructions).

I'd like to introduce Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

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David W. Schwantes, Select Comfort Corporation - Vice President of Finance and IR [2]

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Good afternoon, and welcome to the Select Comfort Corporation First Quarter 2017 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. 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 Shelly for her comments.

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [3]

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Thanks, Dave. Good afternoon, and thank you for joining our call today. My SleepIQ score last night was 72.

We are excited with the consumers' positive response to our brand and differentiated products. Our investments over the past few years have made us a stronger competitor, and this is evident in our first quarter results. We have built a more broadly relevant brand with an advantaged vertical business model.

The investments we've made in R&D, technology, digital and our store experience have strengthened our competitive advantages and established our innovation leadership. We believe our Sleep Number 360 smart beds will set a new standard for what people should expect from their bed. We are now more efficiently delivering a superior customer experience as a result of our innovations, new technology platforms and operational improvements.

Our first quarter results were ahead of our expectations. Net sales of $394 million increased 12% over first quarter 2016 and included 3% comp growth and 10% growth from net new stores. We had steady sales and traffic performance throughout the quarter, and we are confident we grew market share.

Our first quarter earnings per share were a record $0.56, up from last year's $0.27. EBITDA increased 49% to $56 million, while free cash flow increased 42% to $74 million. We are delivering accelerated profitability and cash generation through the initiatives and investments we've made over the past few years.

At our November Investor Day, I highlighted 4 areas that will drive sales growth for our brand, all of which played a role in our first quarter sales growth. First, we are expanding our brand reach with more efficient marketing, including stronger digital capabilities. We're also benefiting from the marketing initiatives we implemented during the fourth quarter and a steadier consumer environment. We increased media spending by 7% while leveraging 50 basis points over the prior year's first quarter. Strong referral rates from customers were also a key driver of sales and contributed to our 10% mattress unit growth in the quarter.

Traffic measured by online qualified unique visitors to our website and leads per store per day were both steady with conversion rates also ahead of our expectations. We are pleased with the results of our initiative to improve online consideration and transactions as well as customer traffic to our stores.

Our media ROI was the strongest we have achieved since we began measuring it in 2013 using an econometric model. This increased efficiency and effectiveness is being driven by a combination of marketing efforts. We are now more efficient in our television buying and continue to advance our advertising content. We have strengthened our in-house digital capabilities, resulting in faster and more effective media-buying decisions. And we are continuing to optimize the digital actions that drive higher-quality store traffic and higher conversion rates.

Our second driver of sales growth is our proprietary products, which is also one of our competitive advantages. In the quarter, we experienced strong consumer demand for our life-changing innovations. Our average revenue per mattress unit was up 2% in the quarter as we continued to grow our FlexFit adjustable base business with strong mix.

We are on track with our phased launch plans for the changeover of our product line to Sleep Number 360 smart beds. The first phase includes 2 of our beds and is planned for all stores in mid-second quarter. We have conducted numerous research projects for our 360 smart beds to inform the end-to-end customer experience. They include everything from testing, marketing, communications, pricing, design and manufacturing to home delivery and customer service.

We are currently in pilot with the 360 smart bed in a small subset of stores. And we are also in pilot with hub assembly of our 360 smart beds. We have a multiyear plan to transition bed assembly from our customers' homes to the hubs. We expect this change to increase efficiency and provide a better in-home experience for our customers.

The investments in our brand, innovations and direct-to-consumer distribution model position us for increased demand potential and pricing power. Our goal is to optimize these elements with our 360 smart beds, and our pricing structure takes this into consideration. We expect to increase consumer value and, therefore, grow market share with our differentiated products that include improved comfort, connectivity and other sleep benefits.

Our plan includes higher growth rate from attach rates of various features that will now be standard like SleepIQ technology. We expect this strategy to increase customer value, satisfaction, referral sales and, therefore, market share. We are planning only modest price increases on ancillary items.

The third driver of demand is our highly engaged insiders. I mentioned on our last call that we were gaining traction with our insiders, and these results are evident in our first quarter performance. Our customers' high satisfaction with their Sleep Number experience is resulting in increased referrals, which are our most efficient sales.

In addition, our centralized data and loyalty initiatives are contributing to more effective personalized communications with our insiders. We are using predictive analytics and machine learning to optimize our customer segments and increase conversions.

Today, we have a stronger ongoing relationship with our customers through SleepIQ technology, which is one of our key competitive advantages. SleepIQ not only improves our customers' sleep experience, it enables daily engagement with our brand.

We continue to increase value for all of our SleepIQ community through software updates. For example, earlier this month, our software release improved individualized information about our customers' nightly sleep, added simplified navigation and bed controls, and more personalized helpful hints to get the best sleep of your life.

Our final driver of increasing demand is the extraordinary retail experience associated with our exclusive distribution model, which is another competitive advantage. Our sleep professionals' dedication to their customers leads to high Net Promoter Scores, store productivity and profitability. New stores contributed 10 percentage points of growth in the quarter as we benefited from 49 net new stores that we opened over the past 12 months. Our same-store comp increased 3% in the quarter with average revenue per store for the trailing 12 months of $2.4 million. And 55% of our store portfolio is now in off-mall locations.

Our strategy is driving both positive comp and new-store growth over the long term. We continue to expect e-commerce sales to be a positive contributor to our comp sales in 2017 and future years with our direct-to-consumer distribution model.

We're on the cusp of delivering 2 new drivers of leverage for future years, the Sleep Number 360 smart bed and the evolution of our supply chain, both of which are expected to contribute to higher profitability going forward.

We are focused on becoming a lean enterprise. Our productivity increases in manufacturing combined with lean opportunities we have identified across our business give us confidence in our margin expansion goals. We delivered a 350 basis point improvement in our net operating profit rate to 9.1% in the first quarter, primarily driven by gross margin expansion and media efficiencies.

We are operating our business for the long term and continue to expect increasing profitability through the use of all 3 of our EPS drivers: top line growth, operating leverage and capital deployment.

We expect another record year of operating cash flows in 2017. In the quarter, we generated $87 million of cash from operations compared with $64 million the prior year. We continue to execute against our 3 cash priorities: investing in our growth, financial flexibility and share repurchases. We repurchased $50 million of shares in the first quarter, which was consistent with the prior year.

The investments we have made in digital capabilities, stores, products, technology and infrastructure have made us a stronger competitor with superior products and customer experiences. We expect accelerated earnings growth, cash generation and returns to shareholders in 2017.

With the strong results we posted in the first quarter, we have increased our full year 2017 earnings guidance to a range of $1.25 to $1.50 per share. We are confident in our ability to deliver on our plans and continue to make the necessary progress toward our 2019 EPS target of $2.75.

I want to thank our talented team for their dedication to our customers' experience and their commitment to improving more lives. We are all excited about our revolutionary Sleep Number 360 smart beds and the opportunities we have in front of us to gain market share.

Now David will provide more details about our first quarter performance and our outlook.

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David R. Callen, Select Comfort Corporation - CFO and SVP [4]

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Thank you, Shelly. Steady execution of our plans delivered stronger-than-expected Q1 sales growth and profits, demonstrating the power of our vertical business model. The combination of top line growth, accelerated operating leverage and efficient capital deployment contributed to strong Q1 results in an improved consumer environment.

Our initiatives continue to move the business forward on our path to $2.75 of EPS by 2019. We grew Q1 net sales 12% over the prior year to $394 million. Remember that our prior year, Q1 net sales were impacted by an estimated $40 million of ERP implementation pressures, partially offset by a $21 million backlog benefit.

Adjusting for these prior year impacts, year-over-year net sales growth would be 6%, an important lens as we think about the balance of the year sales assumptions.

As expected, most of our 12% Q1 GAAP net sales growth came through a 10% increase in company-controlled units while also expanding our ARU by 2%. Also as expected, the bulk of our growth came from net new stores, which contributed 10 points of our growth in the quarter. We ended the quarter with 546 stores in 49 states. Our comp stores sales also added to our Q1 growth with a 3% lift overall, including 1 point from our online and phone sales business, which grew 18%.

Our trailing 12-month average comp store sales were $2.4 million. We expect to move this toward an average of $3 million per store longer term with 30% to 40% incremental 4-wall profits as sales per store grow. With our powerful ERP capabilities, we're delivering an improved customer experience and a lower return rate. This and continued operational improvements have driven strong gross margins.

As expected, our Q1 rate of 62.6% improved 340 basis points versus the prior year. The benefits of our ERP in operational improvements are apparent in the 90 basis point gross margin expansion on a 2-year basis versus Q1 of 2015. We also delivered 10 points of operating expense leveraging Q1, including 50 basis points of media leverage, while increasing media spend 7% to $48 million in the quarter.

Leverage in marketing, G&A and R&D were partially offset by selling compensation deleverage. The 39% incremental operating profit flow-through rate we delivered in Q1 reflects the complete recovery from the ERP implementation challenges last year and meaningful productivity enhancements across the business. The result is a 350 basis point improvement in our net operating profit rate to 9.1% for the first quarter.

Our diluted earnings per share of $0.56 reflect a 107% increase over the prior year, which included an estimated $0.15 of net ERP pressure. Our Q1 EPS this year includes a $0.02 benefit from lower income taxes, resulting from the new stock-based compensation accounting rules.

We generated 42% more free cash flows in the quarter than the prior year quarter. Cash from operations were $87 million. We invested $13 million in high-value capital projects and used $50 million to buy back shares. Our trailing 12-month ROIC at the end of Q1 was 13.9%, up 480 basis points from this time last year and well in excess of our weighted average cost of capital.

Our 2017 updated EPS guidance range of $1.25 to $1.50 continues to include $0.15 to $0.22 of transition costs, primarily to refloor our stores with the 360 smart bed product line and for the current year costs of our logistics evolution.

Our plans continue to contemplate mid- to high single-digit sales growth the balance of the year primarily through mattress units. We assume 4 to 5 points of our growth will come from new stores and low single-digit comp store growth. We remain on track to execute a phased launch of our 360 smart beds over 9 to 12 months, beginning in Q2. This product line includes 7 new 360 smart bed models, a new integrated base and 3 new adjustable bases.

We also made progress in Q1 with our supply chain evolution. We opened a new company-operated hub adjacent to our Irmo, South Carolina, manufacturing plant and are testing final assembly of our new beds in the hub rather than in customers' homes. We are pleased with results so far. This initiative is expected to continue through 2018 and is an important enabler of efficiency and improved customer experience.

Here's a reminder of other 2017 guidance assumptions. I mentioned earlier that our EPS guidance includes $0.15 to $0.22 or $10 million to $15 million of onetime costs the balance of 2017. We expect these costs about evenly per quarter with about 25% each in COGS and G&A with the remainder in selling expenses.

We expect to improve our 2017 gross margin by 30 to 50 basis points on top of the 80 basis point increase in 2016. Our sourcing, lean and continuous improvement initiatives are expected to more than offset 40 to 60 basis points of expected margin pressure from legacy product closeout sales this year. This implies a gross margin rate just north of 62% the balance of the year.

Over the 2 years ending 2017, we're expecting to deliver 110 to 130 basis points of gross margin improvement and have line of sight to additional margin expansion opportunity in future years through our value engineering and supply chain evolution.

Our 2017 plans call for sales and marketing expenses of 44% to 45% of net sales, including at least 50 basis points of media leverage. Our guidance also assumes about 50 basis points of deleverage in G&A and R&D combined due largely to incentive comp, transition costs and about $5 million higher depreciation and amortization in 2017. G&A costs are expected to be approximately $32 million per quarter the balance of 2017.

All things considered, we're planning to improve our operating margin by at least 50 basis points in 2017 with an effective income tax rate the balance of the year of approximately 34.5%. We expect to generate record cash flows again in 2017. We're planning to invest approximately $55 million in capital projects this year with about half earmarked for 60 retail store actions, and the remainder split between our technology advancements, facilities, and tooling and equipment for operations. We expect to generate low-teen ROIC for the year, meaningfully higher than our weighted average cost of capital. And finally, we enter the second quarter of 2017 with $195 million remaining under our share repurchase authorization.

We are pleased with the start to 2017 as our initiatives deliver accelerated profits and cash flows as we knew they could. These value drivers offer a compelling investment opportunity as we execute our plans and improve people's lives through individualized sleep experiences.

Sam, at this point, we'd like to open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from John Baugh with Stifel.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [2]

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Great quarter and really pleased to see several of the metrics improve. I was wondering on a couple things jumped out at me. One was the comment about lower returns. Assuming you're not going to give us your rates of return, but any sense of magnitude? And then, can you perhaps comment on what you think is driving that?

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David R. Callen, Select Comfort Corporation - CFO and SVP [3]

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John, thanks for the question. We've talked a bit about the in-store scheduling of the home delivery that we put in place in 2016, and we said we saw at that point an improvement in the customer experience, and that has continued into Q1. We're not going to break it down, but probably, I'd say, 25% of the overall gross margin rate improvement that we've seen since 2015 pre-ERP is kind of coming from that line.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [4]

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Okay. And are you -- what are you -- what's your average delivery time from a consumer order? How has that changed?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [5]

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Well, a lot of the -- the scheduling is really customer choice. So they're in the store, and they're actually able to choose from a variety of different dates. Some close in -- some as close in as within 7 days, others 2 weeks, or sometimes they choose something longer. But overall, we still average closer to the 14 days.

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John Allen Baugh, Stifel, Nicolaus & Company, Incorporated, Research Division - MD [6]

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Okay. And you mentioned, I believe, a 10% unit increase. Can you give us some color on what beds drove that? And then, always hard to tell with your average revenue per mattress unit -- I think that was up 2%, how much that might be driven by ancillary products versus mattress unit mix?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [7]

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Sure, John. The ARU growth of 2%, the strongest driver of that growth was the growth in FlexFit attach for the quarter. And then, I mentioned that we had strong mix. So our mix is continuing to be steady and performing well, certainly one of the advantages of our selling process in our stores and how engaged our frontline is.

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Operator [8]

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Our next question is from Peter Keith with Piper Jaffray.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [9]

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Shelly, I was surprised your SleepIQ score wasn't higher this quarter versus last quarter. Let's jump into the questions. So with the sales -- the strong success of Q1, it looks like you basically kind of maintained the sales outlook for the rest of the year that you had at the beginning of the year. But I guess how do you feel right now that you're 3 months in. It sounds like you just need a better consumer backdrop, better return on media. And then maybe any insights you can give us on the early test of the 360 technology?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [10]

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Sure, Peter. Well, first of all, regarding my SleepIQ score, I want you to know my average continues to be in the 80s. So I -- still where I live most days. Regarding our guidance, you're absolutely right. The balance of the year is very similar to how we were thinking about it last quarter when we were on the call. Our updated outlook now includes the first quarter results that we just discussed. And we're also -- it's early in the year, and we aren't going to go ahead of ourselves. We see the balance of the year as planned. We have significant transitions ahead of us with the rollout of 360, but we are excited about how our initiatives are progressing. And we did still see an environment with higher competitive spend and the initiatives that we put in place in the back half of last year have continued to advance. And we're really pleased with the performance and will continue to advance them in this environment.

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David R. Callen, Select Comfort Corporation - CFO and SVP [11]

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360 test.

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [12]

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And you asked about the 360 test. So very small pilot right now. It's a great advantage of our model to be able to put it in a few stores and just work through all the different aspects of it from the overall setup to delivery. And we're happy with the results. No big surprises by any means. Really excited about the consumers' response to it in the store and how our sleep professionals have been able to quickly adapt to the change in selling process with this new innovation.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [13]

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Okay. Great. Maybe on -- speaking on the 360 dynamic, I think you're referring to some pricing. You reference that pricing on ancillary products might come up a little bit. Is that the adjustable bases?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [14]

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No, very small, like this would be small SKU or a mattress size. It may be an outlier size.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [15]

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Okay. But broadly speaking, the rollout across the line will be sort of flat with previous models?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [16]

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Yes. And keep in mind that now with the 360 smart bed, it includes SleepIQ. So the price will automatically reflect that additional pricing of the SleepIQ, and then many of the features work so closely with the FlexFit adjustable base, so we see opportunity there, too. We've added a lot of -- we've added features and benefits to the adjustable bases that we know the consumer responds very strongly to, things like Partner Snore, underbed lighting, the enclosed base design, and then as we go up the line, the foot-warming feature.

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Peter Jacob Keith, Piper Jaffray Companies, Research Division - Principal and Senior Research Analyst [17]

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Okay. Great. One last one for me. So we're in this odd dynamic right now where we have this massive floor model clearance from Mattress Firm that's going on right now. Are you guys seeing any weird activity or any disruption from that as it's taking place right now?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [18]

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No. I mentioned that it continues to be -- that we continue to experience an elevated spend from competitors. But I would say we expect that at this point. And I'm just not sure the customer understands what's going on as much as the industry or everybody else talking about it here who understands the various players. So no, we have not experienced much with the changeover.

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Operator [19]

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Our next question is from Budd Bugatch with Raymond James.

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Robert Griffin, [20]

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This is Bobby filling in for Budd. So I just want to jump back and look at the first quarter. And from a trend standpoint, did things improve throughout the quarter versus your expectations a little bit better than you expected? Or was there anything there to kind of help us understand how the progression went and why sales came in above expectations for you guys?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [21]

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Yes. Bobby, we have experienced steady and consistent performance since January week 1, both in and outside of market share events. So that's a little bit about the shape. As far as what has been driving our performance, for us, we benefited from the advancement of our marketing initiatives that we put in place in the back half of 2016, and that's in combination with the innovative products and the value-added retail experience, specifically our internal digital capabilities for more effective search and higher quality traffic. And then second, the more efficient television buying and the advancement of our creative. And third would be the insider activation, which has increased through our data mining with machine learning and personalized messages.

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Robert Griffin, [22]

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Okay. I appreciate that. And then Shelly, maybe you can just help me understand better about how the rollout for the 360 smart beds are working. It sounds like 2 beds out of the 7 will be introduced in the second quarter, and then the remaining 5 would be in 3Q and 4Q. Is that correct?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [23]

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It's a good way to think about it.

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Robert Griffin, [24]

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Okay. Has that always been -- the phased approach, has that always been the plan? And then, I guess, how do you decide? I guess, what -- is it just timing? Or are you guys looking at which beds to introduce at different times based on a different type of metric or something that you're seeing?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [25]

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Sure. First of all, yes, this has always been our time frame. We've stated 9 to 12 months in a phased approach, and we're right on track with our plans. Regarding the specific models that we have selected, it's one of the benefits of our vertical model, and there are quite a few metrics that drove the decision of our selection process. Everything from our selling process to the mix and representation of that specific model really positioning ourselves to learn as we go and balance the opportunity and any risk.

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Robert Griffin, [26]

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Okay. And then 2 last ones from me. One, the comment about FlexFit, good increase in penetration. Can you maybe provide a little bit of color of what, I guess, your guidance maybe assumes in terms of penetration do you expect? Do you expect there's still room there in terms of growth in the attachment rate? And then lastly just a quick modeling one. What is the updated guidance assumed for share count at the end of the year? It was 43 million when we last spoke.

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [27]

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Great. Well, regarding, FlexFit, yes, we do still see opportunity. We've been experiencing -- continuing to experience growth in this area as I mentioned from the 2% ARU growth. We overall have spoken about the primary driver of growth will be units for us. We continue to see ARU for the balance of the year fairly flat, so we haven't built a lot in, but we do see opportunity.

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David R. Callen, Select Comfort Corporation - CFO and SVP [28]

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And, Bobby, regarding the share count for your modeling, yes, 43 million works.

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Operator [29]

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Our next question is from Brad Thomas with KeyBanc.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [30]

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I was wondering as we think about the investments you have this year, the $0.15 to $0.22, any more color that you all could provide about how much of that might fall in 2Q versus 3Q and 4Q?

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David R. Callen, Select Comfort Corporation - CFO and SVP [31]

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Sure, Brad. I think you can plan for it about evenly by quarter. I highlighted that. We expect about 1/4 of it each in COGS and G&A and the balance in selling expenses.

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Bradley Bingham Thomas, KeyBanc Capital Markets Inc., Research Division - Director and Equity Research Analyst [32]

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Great. And then, just with respect to the guidance for the full year, I think, versus consensus you were $0.11 above -- the midpoint of your guidance goes up by about $0.075. I mean, from your perspective, was there anything maybe timing related that fell into 1Q rather than the other quarters? Or is this just you all being conservative in your outlook?

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David R. Callen, Select Comfort Corporation - CFO and SVP [33]

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With all the pieces that we're thinking about, this is the best way to plan for the year. We've got a lot of year left ahead of us. It's only the first quarter. And there's nothing that has changed significantly since when we gave guidance last quarter.

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Operator [34]

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Our next question is from Keith Hughes with SunTrust.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [35]

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Question was on the G&A spending. I believe you said $32 million per quarter for the rest of the year, $5 million higher in the third and fourth and then -- excuse me, the second and the third and then it could be more in the fourth. And I know there's some cost from the launch coming in there, but are there other numbers involved in that number? It struck me as a lot higher than I expected.

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David R. Callen, Select Comfort Corporation - CFO and SVP [36]

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Yes, Keith. Yes, Q4 -- you recall Q4 last year, we highlighted that we benefited from reversal of our incentive compensation programs, and that was weighted heavily in the back half of the year, probably about $0.15 overall in the back half last year.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [37]

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Is this going to be a more normal compensation? Is that the expectation?

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David R. Callen, Select Comfort Corporation - CFO and SVP [38]

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That's right.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [39]

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Okay. And could you repeat again on sales and marketing expense percentage number. I just missed it as you -- if you...

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David R. Callen, Select Comfort Corporation - CFO and SVP [40]

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Yes, sure. It's consistent with what we've been saying: 44% to 45% of net sales for the year.

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Keith Brian Hughes, SunTrust Robinson Humphrey, Inc., Research Division - MD [41]

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Okay. And final question, if I look at sales expense in this quarter, 43% of sales, I kind of excluded last year because there's so many things going on. I look at it versus 2 years ago, your sales were up over 2 years ago, your gross margins up. That number though is also up to the negative side. What is selling expense look like now versus 2 years ago if that's increased?

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David R. Callen, Select Comfort Corporation - CFO and SVP [42]

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The big factor in there is additional stores and occupancy costs over that 2-year period. And the compensation associated with staffing of those stores. Those are the primary -- driver of that 2-year period. Depreciation related to the stores that's what -- in terms of the occupancy as well as percent rent or any of those types of items, utilities, that kind of thing.

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Operator [43]

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Our next question is from Seth Basham with Wedbush.

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [44]

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Just to follow up on the last question regarding selling expenses as a percentage of sales for the first quarter. If media leveraged 80 -- or 50 basis points that means selling expense deleveraged 80 basis points. Why was that? And can you provide a little more color there?

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David R. Callen, Select Comfort Corporation - CFO and SVP [45]

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Sure, Seth. Glad to. You recall that last year Q1, we had a bit of a benefit from that backlog benefit, the $21 million of backlog that came into the quarter. And that caused more leverage in Q1 last year than you would have otherwise seen. And so on a year-over-year basis when you get to Q1 this year, it put some pressure on our selling expense. Now the other piece of it that I highlighted, we had overperformance versus our plans on the selling compensation side for our store personnel. And so that caused some deleverage in the quarter.

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [46]

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Got it. Okay. And as we look at the composition of ASPs for the balance of the year, looking for flattish. As we think about the next couple quarters with the closeout sales, would you expect ASPs to decline?

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David R. Callen, Select Comfort Corporation - CFO and SVP [47]

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Yes. Again, we don't talk ASPs. We talk ARU. But we do -- we're talking that we expect the growth to come from units, not from ARU. And that's a couple of different things going. The -- Shelly highlighted that we expect some benefit from some of the items that are by choice now to be embedded in the product or core, that helping ARU, and we have also highlighted that we expect some pressure from discounts on the closeout sales, and the net of that all is expected to be about flat on the ARU side.

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [48]

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Got it. Okay. Then a housekeeping question on your guidance. You're looking for 4 to 5 percentage points sales growth from net new store openings, which is up 1 point, I think, from your last guidance. Is that driven by more new stores or higher productivity of new stores that you're now expecting?

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David R. Callen, Select Comfort Corporation - CFO and SVP [49]

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It's intended to be directionally the same as what we had said before. We had some improved performance contribution in Q1, but overall, we're expecting it to be directionally the same as we had guided before.

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [50]

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Got it. Okay. And my last question is just on the 360 pricing structure. I know you're not planning on raising prices, but with all the value-added features that you're putting into this bed, why not take price on it if you're delivering more value to the consumer?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [51]

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Yes. Seth, this is a balance looking for the optimization and breaking through with our brand and incredible value to the consumer with real sleep benefits that will make a difference, and we intend to take market share. We know we have pricing opportunity as well for the future. Right now, we're focused on a very strong healthy transition and taking market share. And over time, we continue to see pricing benefiting our ARU growth at around 3% similar to what we've experienced in the past.

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [52]

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Okay. Helpful. If I could squeeze one last one in, just SleepIQ an update there how sales tests have trended there and if you've completed your test of in-store sales?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [53]

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With 360, was that, Seth -- or you said SleepIQ?

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [54]

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SleepIQ. I'm sorry. I meant the it bed.

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [55]

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The it bed. Okay. And the question is -- I'm sorry, now I have to go back to the question.

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Seth Basham, Wedbush Securities Inc., Research Division - VP of Equity Research [56]

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I'm sorry. The question is how have sales of the it bed trended? And have you completed testing of it bed sales in stores? And how have they performed?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [57]

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Yes. Our stores sales, we did increase our store rollout with a few more stores in the last quarter. We're specifically targeting 3 to 4 markets right now with the it bed and continuing to keep that incubated with a dedicated team running that brand while we prioritize the rollout of 360 in our overall core brand. But advancing our learnings, and it's becoming clearer every week about where we need to put our efforts.

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Operator [58]

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(Operator Instructions) And our next question is from Michael Lasser with UBS.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [59]

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It's on the gross margin. You obviously saw very good expansion in the first quarter. What piece of it are you expecting to fade as your guidance implies that your gross margin is not going to be up as much as it was in the first quarter?

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David R. Callen, Select Comfort Corporation - CFO and SVP [60]

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Michael, thanks for the question. I just want to remind you, first let's start out with Q4 of last year. We'd highlighted that there was about 50 basis points of the margin from last year Q4 that was due to our incentive compensation reversal. And then I highlighted in terms of this year, we continue to expect our advancements in the manufacturing operations, logistics operations and the better return rates to continue to benefit us the balance of the year. However, we're planning for some margin rate pressure from the closeout sales that we've highlighted as we transition to our entire product line to the 360 bed model.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [61]

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And is your expectation that once you get the closeout pressure done, and you anniversary this onetime issue that you could see a similar rate of gross margin expansion?

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David R. Callen, Select Comfort Corporation - CFO and SVP [62]

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Yes, definitely.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [63]

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Okay. And Shelly, you mentioned that it continues to be a very competitive environment, customer acquisition costs are on the rise. How long do you expect that to continue? And what do you expect to lead to less-competitive pressure?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [64]

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Well, I think, exactly what we're doing leads to -- and I can -- you can see that in our first quarter results. With increased customer -- competitive spending as we experienced in the third and fourth quarter, we talked about, for the fourth quarter, that we were advancing our actions to be more efficient in that increased competitive environment. And the first quarter demonstrates the advancement of those initiatives and some very strong success with our media leverage and the overall sales that we were able to drive in the quarter. And then one other question about the competitive environment, I -- I mean, I -- this is good for the industry. We have -- there are 2 big things going on. One, many new brands have surfaced online, which I think is helpful in helping consumers transact online and just become more engaged with the category overall. That's beneficial to us with our direct-to-consumer model. Secondly, just having the increased trends overall around sleep and wellness is helpful. And that's the big driver that we're most excited about, and our innovative products deliver on increased sleep benefits that tie back to wellness.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [65]

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Shelly, are you seeing any signs at all that new competitors that have sold online are starting to consolidate or even go away?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [66]

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You can see some of them phasing off with their spend in presence. Yes.

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Michael Lasser, UBS Investment Bank, Research Division - MD and Equity Research Analyst of Consumer Hardlines [67]

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Is it more of the smaller ones? Or is it less activity from some of the bigger ones?

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Shelly R. Ibach, Select Comfort Corporation - CEO, President and Executive Director [68]

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It's more of the smaller ones in our observation.

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Operator [69]

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And we show no further questions at this time. I'd like to turn the call back to our speakers for closing remarks.

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David W. Schwantes, Select Comfort Corporation - Vice President of Finance and IR [70]

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Thank you for joining us today. We look forward to discussing our second quarter 2017 performance with you in July. Sleep well and dream big.

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Operator [71]

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Thank you for participating on today's call. The conference has now ended. You may disconnect at this time.