Welcome to Select Comfort's Q4 and full year 2014 Earnings Conference Call. All lines have been placed on in listen-only mode until the question-and-answer session. Today's conference call is being recorded. If anyone has any objections, you may disconnect at this time. I would like to introduce Dave Schwantes, Senior Director of Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to the Select Comfort Corporation Fourth Quarter 2014 Earnings Conference Call. Thank you for joining us. I am Dave Schwantes, Senior Director of 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 Web site 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 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've posted an updated investor presentation on our Web site at sleepnumber.com. I'll now turn the call over to Shelly for her comments.

Good afternoon, and thank you for joining us today. My SleepIQ score was a 71 last night. Today we will share highlights of our fourth quarter and full year 2014 performance, discuss priorities and key growth initiatives and provide guidance for both 2015 and long term. Our fourth quarter results demonstrate the progress we've made in advancing our consumer driven innovation strategy and leveraging our business model. Results in the quarter included net sales of $322 million, representing 40% growth versus prior year with 22%, comp sales growth, EPS of $0.35, 192% increase over prior year. These results were well ahead of our internal expectations, driven by a strong consumer response to both our core product line and new innovations. We're now well positioned to deliver sustainable, profitable growth as we continue to advance our strategic objectives. In the quarter, with innovations like SleepIQ technology and Partner Snore, combined with our core product line and differentiated retail experience drove 15% growth in ARU, or Average Revenue per mattress Unit. We also experienced increased traffic from our No Better Sleep campaign and more efficient media buying. These initiatives drove 23% Company controlled mattress unit growth, 13% after adjusting for the extra week. The ability to concurrently drive both ARU and unit growth is one of the unique advantages of our integrated strategy. Full year results were also ahead of internal expectations. Net sales of $1.16 billion grew 20% versus prior year with a 12% comp gain. Earnings per share of a $1.25 increased 15% versus prior year's $1.08. Our growth initiatives are driving improved performance and we are taking market share. The opportunity for continued revenue and profit growth is significant as our strategy and investments mature in the coming years. Here is a quick review of the three growth initiatives…

Thank you, Shelly. Good afternoon, everyone. We finished fiscal 2014 with record Q4 net sales of $322 million, 40% higher than the prior year or 29% higher excluding $24 million net sales for the extra week in the quarter. Our revenues continue to demonstrate the balanced growth of our strategy enable [ph], as seen in our comparably based sales metrics which exclude the sales in the extra week. Comp sales grew 22% while new stores added 9% of our growth. ARU of $3,866 was 15% higher than Q4 last year while strong traffic led to 13% growth in company-controlled mattress units and average sales per store for the year grew 11% to a record $2.3 million. Our growth initiatives are driving results. Shelly highlighted the impact of our innovation and marketing. I will cover how our real estate strategy is directly contributing to performance. Last quarter I discussed the application of our disciplined market-based site selection process to new stores and decisions on repositions and expansions. Today I will review how we pressed the boundaries of our assumptions through a test, learn and apply approach. We have more than a dozen real estate tests across the country, evaluating criteria such as store densification, urban market, smaller market, store size as well as visibility and co-tendency parameters. The results of these tests and learnings from the 320 stores opened or remodeled the last four years are informing our real estate decision. Improving real estate by market contributes to delivering a value-added retail experience, resulting in measurable sales and profit lift. Over the last four years, we have elevated the real estate of more than 70% of our stores, helping need to drive an 80% increase in average comp store sales over that period. It also resulted in larger stores, giving us…

In summary, our initiatives are on track with delivering growth and profitability goals in 2015 and long term. As discussed, we have a demanding year in front us as we execute our ERP systems implementation while driving growth and leveraging the business. It is nonetheless an exciting time for us as we are making significant progress for long term value creation. Thank you to our passionate Sleep Number for your dedication to delivering our goals and improving more lives. That concludes our prepared remarks and now we'd be happy to respond to questions. Jennie, please open the line for questions.

Thank you. (Operator Instructions) And our first question in queue comes from Budd Bugatch from Raymond James. Sir, your line is open.

A couple of questions and maybe you've gone over them and I've missed them because of my ears. Media spend in the quarter and the year and how did the outlook for 2015 -- can you elucidate us on that?

Yes, Budd, for the media spend in the year, we were -- or in the quarter it was $46 million Budd, and we leveraged a 190 basis points in the quarter. And as we look ahead to 2015, we expect media as a percent of sales to be very similar to 2014, which came in at 13.7%.

Okay, and if you look at gross margin going forward, that's the one area where I think you had some deleverage because of mix. How does that look going forward? I know that you don't focus on it, but unfortunately some of us in the investment community do. So help us to understand what your thinking is for 2015?

Yes, thanks Budd. We actually do focus on it a lot, and it's really important to us as well. But we're expecting -- we don't lap the introduction of our new flexible adjustable bases and so -- at the end of the first quarter. So we'll continue to have some pressure from higher mix of those products in the first quarter. We do expect for the full year to have modest gross margin rate improvement, but are happy to continue to have gross margin dollar expansion.

Okay, and this year, the 14th week or the 53rd week was really the last week of year, if I did my calendar right and you have that same week in next year. What's the week that is the comparison week that you all think is the week that you lose and what do you think is the drawdown in comparison to this year, the sales comparison?

Yes, Budd. It gets a little complicated, because our orders are different and when we are shipping products and so we modelled it out a lot of different ways and focusing in on one specific week isn't that productive. So just going out to $24 million in sales delivered in for that week as the one off item and the $0.06 of EPS is the guidance that we'll drive.

Okay I am glad that I'm not the only one that was challenged with that kind of thought process. And lastly from me, the store account for next year is like -- it's up 28 stores, and if I did math right is the Company controlled comparable somewhere around mid-single digit to get to your guidance.

Yes that’s correct.

And next we have John Baugh with Stifel. Your line is open.

Let's see, gross margins, Q4 you mentioned the Flexible Fit. Was there anything else going on? Was that a 100% of the impact.

That’s the largest driver in the quarter. We continue to have high demand and it’s -- the pressure on our supply chain continues.

Yes. And on that, I think there was a reference in the press release to that. I think you decided that around the Labor Day event. Were the sales more evenly spread out this quarter and yet you still had logistics issues? Will we have the same kind of headwind around President's Day? Help me understand that issue in more clarity.

Hey John. Relative to the gross margin rate pressure, as David stated, it correlates with the high demand of our FlexFit bases and you saw the profit growth in the quarter and the rate pressure is associated with that. Having said that, and the answer to your question about the shape of the quarter and with a 40% growth in the quarter, we had strong growth the entire quarter end. We went into the quarter confident with our initiatives and how we are driving consumer demand as we stated on our third quarter call, and we are anxious to understand how the innovation and the media effectiveness and our resale strategy with work during holiday consumer period, which is always a little less predictable. And we're obviously very pleased with how our initiatives progressed during that time frame with a very strong quarter.

Yes, congratulations on the great quarter. I was not clear on the unit number of mattresses in 4Q ex the extra week. What was that number?

The unit growth was 13%, 23% with the 53rd week or the extra week.

So was there a mix change within bedding or was it fairly stable.

With the actual deadline John.

Yes in terms of the unit mix – the 13% unit growth, did you sell as many high end beds as low end beds or was there some kind of mix influence to lower price points or not.

We had a strong ARU as well as unit and we've stated before, we co-relate units with traffic and we saw a strong traffic throughout the quarter, which we associate back to our marketing featuring the project innovations and driving traffic into our stores with strong conversion. It's really the integration of those three big initiatives and holiday work together and the ARU reflects both a strong attach, as well as actually a mix up. So we had to mix up the line plus the 13% unit growth in the quarter.

And my final question just on ERP, which can be a four letter words on times. How do you handle the risk? Do you flip the switch all at once, gradually, by regions, districts? Just sort of explain how we're going to work through this? Are we going to run dual systems? Et cetera?

So the ERP is, as I stated a critical initiative for us and as a vertically integrated Company this involves the majority of our core transactional system. Therefore it is a flip to switch out once with our structure on being both the manufacturer by chain and retailers. So all the way through the organization. Obviously with an implementation of this scale and magnitude, the testing and the preparation in the benchmarking and the rigor, the involvement of our entire organization and ownership for the execution and implementation is of paramount nature for us and is clearly one of our very top priorities as we move into the year. And we're well prepared now and we will be well prepared when we move into the actual implementation.

And next is Peter Keith from Piper Jaffray. Your line is open.

Shelly, you had commented that one of your initiatives, that seems to be working as broadening your target customer. I think in the past you’ve commented that you think you can move maybe down the aid spectrum but up the income spectrum. I was wondering if you have any quantification of that, some of the data you might be collecting around the store purchase might be able to help us understand if you’re widening that overall customer funnel?

Yes, we are widening it. Obviously with such a large base overall, if you look at the portion of young more affluent, it's small in total, but the fact is they’re coming. And they are responsive to both the creative and the media buying. Of course are creative features are innovation, and in particular we see the purchase cycle pulling through with the SleepIQ technology.

One of the new ones I just want to be clear on, so you had a reported comp of 22%, but that would not include the extra week. I believe when you provided comp guidance originally, it did have the extra week included. Is that correct?

No, when we provide comp guidance or numbers, it’s on a comparable basis. So wouldn’t include an extra week.

So 22% does not.

Correct.

22% does not. Right. Okay. And so then I think obviously you’re setting guidance for the coming year relatively close to your -- to the longer term guide, but you have some very good momentum heading into the new year with a 22% comp and now guiding the full year at five. Is there anything that you’re seeing near term that would cause this step-down or is it just you want to set an appropriate goal and then will see how the year shakes out?

Well, first of all, we do expect the Q1 to be very strong. So we’re moving into the year with confidence of the initiative that we continued to advance throughout 2014, and we expect a very strong double digit sales growth here in the first half. It has a lot to do with the back half and the back half we have -- if you in move in part we have the 53rd week from the prior year as well as our ERP implementation. And then of course we’ll be comping our 31% growth from 2014. We also in the first quarter -- late in the first quarter of 2014 is when we introduced our FlexFit and Partner Snore technology. So we started introducing all the innovations late in the first quarter and on through the second quarter. So we’re again comping those introductions as we move through the year.

And next we have Brad Thomas, KeyBanc Capital. Sir, your line is open.

I wanted to follow up on some of the questions about the ERP and I guess that at a higher level, can you give us a sense to maybe what the total rollout cost will be as this is obviously a multiyear initiative. If you have $11 million this year, what is the total rollout cost and when would that be complete?

Thanks Brad, the rollout -- the launch cost that you’re referring to are the 2015 launch cost of $11 million. We expect about 80% of those in the second half of the year, probably equally balanced in between third and fourth quarter. In terms of the capital, we -- as I highlighted in my opening remarks, our total CapEx to next year is $80 million and about $30 million of that is earmarked for this project.

Great. So just if I try to think about whether we should be thinking of these as sort of continuing operations or onetime in nature, as we move into '16, I know that's looking out further of course, but as we look out to 16, would we have to duplicate that $11 million of expense that year or is that the sort of the thing you will anniversary as we continue to move down the road?

Brad, these are onetime costs. We will have some -- about a third maybe in 2016, but those are really supply chain modules that we've been launching and we will provide you more details on 2016 as we get closer to 2016.

Perfect, very helpful. And then if I could follow up quickly on the sales side of the things, I think the Kids' bed looks very differentiated from what’s in the market and I was wondering Shelly, if you could provide us any more color on perhaps when the launch might be and what kind of benefit you all might be expecting this year from this new product?

We are very excited about the Kids' bed too, and certainly really pleased with the response from both media and consumers after the show in January. We will be launching later this year and this should be a great store. So additional traffic and unit growth for us.

And next is Joshua Borstein, Longbow Research. Sir, your line is open.

Just a few questions, one follow up on Budd's question on the gross margin. That you expect a little bit of gross margin improvement here in 2015, does that imply at all that you expect the tax rates for adjustable bases to level off this year?

As I was saying Josh, I think there's going to pressure still in Q1. However we're working hard to continuously improve our operations in the supply chain area. Largely we expect the margin benefit do come after our final deployment of our ERP systems, but we still believe that there is an opportunity to get some improvement here in 2015, modest though it may be.

And we continue to be very pleased with our attach rates on the FlexFit and will report out on how they're doing compared to our internal expectations on our call, that we are not anticipating a regression in that area.

Okay, in terms of what inning you think you are in the attach rate, where would you say you are right now?

Well, we're obviously very pleased. We had a strong ARU growth this last year. The majority of that if you look at the fourth quarter, only 3% of the ARU growth was associated with pricing and the majority of the rest was associated with the FlexFit attach and some mix, but mostly the FlexFit attach. So we're pretty happy about the growth and the progression through the year on the Flex.

Okay, great and just in terms of the mid-single digit comp guidance for 2015, how should we think about that in terms of units versus ARU?

Yes, we expect to growth from both ARU and units. We've been able to achieve that these last two quarters and we expect that again when we look out over the course of a year, obviously the strength again will be in the first quarter and therefore the first pass, we do think that ARU will probably be a little stronger than units.

Okay. And just last one for me, could you give us an update where we are for mall versus off-mall and the new store growth, how much do you expect to be off-mall? Any metrics you could share will be helpful.

Sure. The mall is 60% of our portfolio and non-mall 40%, and we will continue to advance both formats. So the non-mall will take on little higher penetration here in the coming few years.

Yes, next we have Jessica Mace, Nomura Securities. Ma'am, your line is open.

My first question is a follow up on the opportunity for the Kids' bed and I was wondering if there is anything you could share with us about that market or perhaps parent's behavior when purchasing beds for their children, maybe that you could glean from any of your current business that might be to that demographic, or any insights into what maybe quantifying the opportunity you think this new product is to you?

Well, Jessica, this is a new market adjacency for us and it is a new market in general. So we're paving way into this market. What we do know and can help quantify is that at any one point, approximately 2.5 million parents are shopping for a mattress for their child here in the U.S.

Understood, thank you. And then my other question was a clarification just on the gross margin dynamics and some of the supply chain pressure you had this quarter. I think you said modest improvement as far as your outlook for that in the next year. Just wondering if you could help us breakdown, other than the ERP implementation at the end of the year, what other kind of near term updates or improvements there might be on the side of meeting demand, or if that's more of an assumption of where you are expecting your comps for the next year?

Yes Jessica. So I think we've covered that a little bit today with -- expecting some pressure to continue in the first quarter, largely from the FlexFit attach rate while we continue to work to improve our supply chain, but the legacy systems that we have in place really are kind of keeping us from getting -- add some of the improvements that we will certainly be able to achieve once those new ERP platforms are in place.

Jessica, the other thing I would add as we think about the year ahead and we'll provide update on a quarterly basis around the FlexFit attach, just a great source as David stated a profit growth and we're expecting modest growth in that area once we get beyond Q1. And therefore we do expect some rate improvement, a slight rate improvement in the year with some of the efficiencies we're working on internally. At the same time demand continues grow with that area. That could adjust the rate, and it's really what's been happening in the last few quarters with our gross margin rate. We expected to be slightly higher in the fourth quarter than we were. That had everything to do with our incremental sales, which helped drive the 40% increase and the great profit growth in the quarter. So we'll keep you updated on quarterly basis on this point.

And next we have Keith Hughes with SunTrust. Sir your line is open.

A couple of questions. Number one, if you had mentioned -- I'm not sure if I heard this correctly, the potential in the longer term guidance, the 2019 guidance are different store formats, bigger or smaller? Is there anything you're willing to share with us on that?

Yes, we talked about the testing that we're doing with variety of aspects of our real estate strategy. We've had that testing rigor for a number of years now. So we're only pressing against a variety of assumptions, and our strategy of the consumer continues to revolve. We're really pleased with our two very productive formats that we have right now, both the mall and the non-mall. And at the same time in 2014 we did advance our store design, incorporating more technology into the customer's experience and we're happy with that. We'll continue evolve that risk, our format. But generally, right now, as we look to 2019, it includes the advancement of the real estate strategy with the two formats of mall and non-mall in approximately a similar square footage as we have today.

Okay are you anticipating a new Mattress launch here in 2015.

We’ll be launching the SleepIQ kid's bed here in 2015.

Okay nothing the mainline is going to change?

We've communicated about the Kids', and that’s our focus this year.

Okay. And then final question on the CapEx guidance for the year. How much of that is ERP and how much of that is investment for in other parts of the business.

Yes, so about $30 million of the $80 million is related to the ERP implementation, about a third is related to our stores and the rest is for other infrastructure projects.

And next is Todd Schwartzman, Sidoti & Company. Sir your line is open.

First off, in the Kids' entry, what have you -- in terms of your planning to enter that market, what have you identified as particular challenges from a sales and marketing perspective that’s unique vis-à-vis the adult line?

Well it is different, and I'm glad you're asking the question. It's a very different product, different market. You have the opportunity to of course market to the parent or the children or some combination. We have testing and advancing our product and our go to market planning based on a number of factors. And we introduced much of this as the international Consumer Electronics Show, specifically speaking to the various features and benefits of the actual product and how these smart features will adjust as the child grows and that this is a bed not only for the four to six or the seven to nine or the 10 to 12 year old, it's one bed that will adjust with them as they grow. And it's a very different product and market than we currently have and we're obviously not going to share a lot of detail about how we're going approach the market, but we're certainly considering all those opportunities in front of us.

Okay and what the about weather effect thus far in Q1? I realize it's early, but have there been any closings of note, whether it be the Midwest or the Northeast stores?

Obviously the Northeast has been fairly challenged with weather. We hear about it more in Minnesota than we do our own snow issues. So it's been a little unusual for them. But I would say it's pretty typical of a normal winter. And one of the advantages for us is that we are national. So we continue to do this business in all markets and therefore your either usually encountering or dodging weather somewhere and it somewhat evens out.

Shelly, I'm curious about the timing of your decision to put forth a five year EPS kind of plan, at a time when you’re starting the year where you’re about embark on the ERP upgrade, as John mentioned earlier, I know that ideally all goes well, but frequently that’s not necessarily the case. There are glitches along the way, things that pushed out potentially. What has changed versus a year ago? Why give this five year kind of back of envelope guideline now? What’s changed for the better in terms of your visibility or your confidence in the supply chain or any other factor that you want to call out as the rationale for talking about $2.75 in EPS?

First of all when we spoke about our long term a year ago, we stated that we intended to update it sometime in the near future, and may have even indicated at this particular time. In 2014, we initiated a number of initiatives that we had been working on throughout 2013, and this is -- now we’re approaching our second year of advancing these initiatives around our growth strategy, specifically the combination of proprietary sleep innovations, effective marketing and differentiated retail experience, and very steady in the advancement each quarter of these initiatives and how they’re working together, and the consumer has responded quite positively with increased traffic and purchasing, and you’ve been able to see that progress through the quarters. During that time, we had also been in '13 and '14 investing in these same areas in R&D, as well as our distribution strategy and our infrastructure. We continue to advance those investments. with a great deal of clarity about our strategy and how we can see our ability and the possibility for us to be able to not only leverage the business model, but also has efficient capital deployment with share count, leverage and how all those -- these three areas of growth, our income statement and our balance sheet can work together to deliver a very powerful EPS by more than doubling it over the next five years. The ERP is critical to our ability to scale with agility and to be able to expand our profitability and our evolution of our production innovation in the coming years. And yes, we’re anxious to get beyond the ERP implementation. At the same time, its part of our responsibility to think long term and deliver increased shareholder value for all of our shareholders over time. And so it’s necessary for us to embark on this and we’re accountable and responsible to get beyond it and continue to expand our EPS growth.

Yes, got that, and lastly on the share count, it looks like you bought back a little less than $17 million in Q4. What’s the assumption that’s baked into your EPS guidance?

Todd, we bought $15 million in stock in the fourth quarter. You can assume relatively a similar kind of reduction in shares in 2015 as you saw in 2014.

And then long term, as I stated one of our assumptions is that share count will be accretive to EPS.

So you’re using about 53.7 million, 53.5 million or so diluted shares for the year?

In 2015?

In 2015 it's about….

In 2015?

Yes, it’s about 53 million.

And next we have Ms. Joan Storms with Wedbush. Ma’am your line is open.

So I was wondering and I know someone asked a question earlier, but I know your focus is the Kids' this year and is going to be later in the year. Last year you introduced a number of products sort of midyear. Can we expect some new product announcements around that?

Joan, we continue to be really pleased with the innovations that we introduced in late first quarter and in second quarter last year and continue to advance all those innovations. The FlexTop, the FlexFit series, the SleepIQ. So we have a lot runway left there that we’ll continue to build on this year?

Got it, thank you. And then also on the aggressive growth market, or the aggressive growth plan, you introduced your 10th market this year. I think there is 13 total. Has that been expanded as far as the rate of introduction over a number of years?

The 13 markets are the -- we identified 13 markets originally when we kicked off the strategy in 2011 and have been advancing it since that time.

Okay. So we would look over maybe in the next couple of years for you to do the other three?

That's right. Our plan is to launch the 10th market this year and obviously things -- our pace and the investment in the spending of media and optimization of stores all comes to play in our pace for the aggressive growth rollout.

Okay, and then lastly on the ERP, how -- David, how are you going to report this? Because obviously the $1.30 includes the $0.13 and that's on a GAAP basis. Are you going to report adjusted non-GAAP EPS and is that what Thomson is going to report or how does that work? It is $1.30 or $1.43?

Yes, that's a good question Joan. And we own all of our results. As Shelly was talking about the $0.13 is incorporated in our $1.30 guidance. We will be talking about each quarter, how we're doing on the initiative. It's a very important one and we'll give you updates each quarter.

Okay, and then you may have said this, I might have missed it, what buckets does that $0.13 come out of as far, as gross margin or sales and marketing or G&A?

It's all in G&A.

It's all G&A, okay. That's all I have, thank you very much.

And there are no further questions over the phone. I will turn the call back over for closing comments.

Thank you for joining us today. We look forward to discussing our first quarter 2015 performance with you in a couple of months. Sleep well and dream big.