Welcome to Select Comfort's Q3 2016 Earnings Conference Call. All lines have been placed in a listen-only mode, until the question-and-answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would like to introduce Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to the Select Comfort Corporation third quarter 2016 earnings conference call. Thank you for joining us. I am Dave Schwantes, Vice President of Finance and Investor Relations. With me today are Shelly Ibach, our President and CEO; and David Callen, our Senior Vice President and CFO. This telephone conference is being recorded and will be available on our website, at sleepnumber.com. Please refer to the details in our news release to access the replay. Please also refer to our news release for a reconciliation of certain non-GAAP financial measures and supplemental financial information included in the news release, or that may be discussed on this call. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings news release and discussed in some detail in our Annual Report on Form 10-K, and other periodic filings with the SEC. The company's actual future results may vary materially. I will now turn the call over to Shelly for her comments.

Thanks Dave. Good afternoon and thank you for joining our call today. My SleepIQ score last night was 90. We made important progress across the company in the quarter. Today I’ll cover the highlights of our performance, the environment and our outlook for the remainder of the year. In the third we delivered the earnings per share we planned of $0.56 despite softer than expected sales. Net sales were $368 million down 2% from last year. With our new ERP platform greater customer order visibility, disciplined and more efficient processes we were able to offset top-line pressure with operating leverage. While we didn’t get the sale step-up we expected our operational execution generated strong cash flow and higher than planned operating profit rates. Year-to-date we’ve generated a record $145 million of operating cash flows and continue to expect a record year of the EBITDA. With the capital investment needed in the business following our transformation we’ve delivered a 52% increase in free cash flow year-to-date. The economic environment has worsened with intense customer distraction. From a demand perspective we’ve experienced periods of both strength and weakness, for example, we had a record Labor Day performance followed by softness since that time. Accordingly we’ve reduced our expectations for fourth quarter sales by $25 million and lowered our full year EPS outlook range to a $1.15 to a $1.25. For context this implies high single digit sales growth at the midpoint for the full year and fourth quarter EPS of $0.35. Looking ahead we’re confident that the business model we’ve built and our strategic initiative will deliver high single digit sales growth and leverage both the P&L and balance sheet. The market place is changing, but consolidation in the traditional part of the market and a proliferation of bed-in-a-box digital marketers. From…

Thank you, Shelly. The heavy lifting of our transformation is behind us. We have built an advantage business with innovative differentiated products, highly productive retail and importantly a relevant direct-to-consumer relationship. The investments we have made the past four years are delivering results in an unsteady consumer environment. We are well positioned to accelerate profits and cash generations. The seasonally high volumes during our third quarter validated our new ERP platform. I am happy to say that it performed well and provided visibility and granularity we have never had before. While we have targeted areas for continued improvement, the ERP delivered as promised in our largest volume quarter of the year. Net sales of $368 million were softer than planned and 2% below the prior year third quarter when we pulled forward $10 million in shipments ahead of our ERP launch. Shelly highlighted the pressure is on sales for the quarter. For additional perspective especially given the impacts of the ERP over the last 12 months, it's helpful to also locate our sales on a two year basis. Compared with 2014 our current Q3 net sales grew 14%. Year-to-date our 2016 sales are up 17% versus 2014 even when you exclude the $21 million backlog benefit from Q1 this year. These are important reference points as we talk later about our guidance for the balance of 2016. Now I will review specific sales metrics for our third quarter. Both our average revenue per mattress unit or ARU and our company controlled units were flat to the prior year. On a two year stack basis, units grew 7% up from 5% in Q2. Comp sales declined 8% or 5% adjusting for the prior year sales pull forward. Our trailing 12 month average comp store sales of $2.2 million declined 12% versus…

Yes, thank you. [Operator Instructions] And our first question comes from Mr. Peter Keith of Piper Jaffray. Sir, your line is open.

Thanks. Actually this is Jon on for Peter tonight. Our first question is just along the lines of Q4, in the implied comp guidance I think you gave some two year stack numbers there on the total growth but Dave is there anything that you can give us as far as what we should be expecting for comp for Q4?

Sure. It's in the mid 40s, yes, strange number because of Q4 last year but that's directionally where it lands on a math basis.

Okay. And based on your commentary it sounds like ERP is completely behind you at this point. Now we saw a couple of things online from employees and customers that look like there was maybe some blips around Labor Day, but I guess you guys are saying there was nothing and you guys are completely clear that now?

Yes right. Jon, the Labor Day period is the highest volume period of the year. And you are going to see challenges from time to time that come through but we are very pleased with how this system is operating. We certainly have areas that we are targeting for improvement and we will continue to get some benefits that we have yet achieved, but we are really pleased with the ERP system.

Okay, great. And then just lastly I guess what contributed to the ARUB and a little bit lower year-over-year in Q3 and then, I think last quarter you talked about having a stable ARU for the entire year versus 2015. So I guess does that still implies kind of down ARU again in Q4 is that correct?

I believe that what we said was we expected the growth to come from units primarily and ARU slightly flat. That's still what we expect for the year.

Okay, great. Thanks a lot guys. Good luck in the fourth quarter.

Thanks John.

Thank you. Next question is coming from Bud Bugatch of Raymond James. Sir, your line is open.

Hi guys this is Bobby filling in for Bud, thank you for taking my questions.

Hi Bobby.

David can just comment real quickly on what you are seeing out of the store cannibalization now that you guys are kind of accelerating the store growth again. Is the metric similar to what they have been in the past?

Yes, thanks Bobby. The reality of our store growth is that about 30% of the new stores are in new markets and our cannibalization rate is in-line with what we said in the past which is about 20%.

Okay. Perfect I appreciate that extra color. Also on the consumer weakness that you and Shelly both discussed, is it relatively even across the country or is there pockets where you are seeing a more of an impact?

Yes, great question. It is even. It's highly correlated with the distractions associated with things like the Olympics or we certainly saw with the conventions and now with this very unusual election uncertainty that we are experiencing. So tied to those pockets of time period and as I stated some great strengthen between.

Okay and then lastly from me. Beside just that albeit cost and more difficult getting the message out there given the election, was there any other major changes in kind of the media that took place during the quarter, your media spending or your message?

No and that's a great question and I highlighted the importance of our hardworking, TV and the productivity that we continue to see there more of the traditional media buying. We do see the opportunity as is falling in the area of digital and that's why we are so excited about the initiatives that we have been working on and where we chose to take the time when the consumer wasn't responding to progress the initiative on quality and knowing that we are going to get the greater payback in that area and it's also where the sustainability will come from to be sitting here today, having the direct-to-consumer model being able to trap digital behavior all the way through to a store unit sale. I am not aware of other retailers who have that capability right now and something we have been working on and are really excited about the progress we made in Q3 and are anxious to put it to work much harder for us in Q4 and beyond.

Thank you and then I guess lastly just to touch on the direct-to-consumer, I did notice that direct and e-commerce was up 23% year-over-year, I think that was one of the largest growth numbers we had in some time. Was that just early success of the IT Bed, was there anything else there driving that?

Yes, what really drove that number through the quarter was the improvement we made online. I mentioned one of our digital initiatives is improvement to sleepnumber.com, which is both making it easier for the customer to navigate, buying their nearest store but it also simplifies the actual transaction. If that came very late in the quarter, so this was attributed to the important changes we are making online.

I appreciate you guys answering my questions, best of luck in the fourth quarter.

Thanks you.

Thanks Bobby.

Thank you. Next question is coming from John Baugh of Stifel. Sir, your line is open.

Hello, good evening. Thanks for taking my questions. Could you tell us with the election here on November 8, what sort is the plan in the fourth quarter, do we lay low up to that point and then increase spend thereafter and we got to see the mix of media just meaningfully two digital within Q4 or maybe you can related that to where it's been in the past?

Yes, thanks John. I won’t be real specific because I know that competitors pay close attention to where and when we apply our media. But, we do continue to expect media to be around 14% of sales for the full year and certainly plan to lean into the initiative that we have been developing here in the third quarter. You can kind of draw it from there. And regarding the actual mix, we continue to have high productivity in returns from our TV advertising. So, no significant change in overall mix events, speaking to digital being our second most important media type for sometime but you can imagine that that's also with the advancement of our initiatives where we intend to push some gap.

Okay. And then regarding ERP and I think the goals to get deliveries down to a week and I appreciate that Labor Day is unusual period or maybe the goal wasn't to hit that in the timeframe, but any update on where we are in getting that goal?

Yes, thanks John. The real goal is to improve the customers experience and we have been doing that dramatically with in-store scheduling and Shelly highlighted that now we are setting up there sleepIQ app in the store so the consumer is now able to track the delivery right on the app. That's a major improvement from where we were and discussions about delivery windows or having a follow up phone call to get their delivery scheduled all of those things have - are things in the past and so the consumer experience is already a lot better. We are continuing to work on speed to delivery but we are also sensibly balancing that with the cost to get there. So there is more to come on that. We are still targeting cutting our delivery time in half by next year at this time.

Okay. And then, I guess maybe a final question for you Shelly. There are numerous data points around the wealthier consumers slowing spending. And I am just curious whether you can delineate how much is distractions, elections, etcetera versus a change perhaps in your customer base whether you can see or sense anything in your research? Thank you.

Yes. Another great question, John. From what we are seeing who is purchasing the composition of those different customers [indiscernible] from demographic, psychographic has not - we are not seeing any real change in those category. So we are not able to see anything outside of understanding the more resistant consumer, distracted consumer that we have been talking about.

Okay. Thank you. Good luck.

Thank you.

Thank you. Our next question is coming from Seth Basham with Wedbush Securities. Your line is open.

Thanks a lot for taking my question. The first thing I would like to address is just the cadence of sales growth through the quarter. I think you mentioned that things were pretty well till Labor Day and then fell off, so was it appropriate to assume that you are tracking for mid single digit sales growth through Labor Day and the reversal came merely thereafter?

Yes, I think I gave the example of Labor Day and after, but looking at the full quarter consistent with what we have been seeing all year, we have been talking about a choppy environment since week one. And we continue to see that in the quarter and the more intense consumer distraction has certainly been with the election uncertainty as of late. But when there is distraction like the Olympics or the conventions we also saw some softness in those periods and then strength around them.

Got it. So is there anything that you can pin point that may have changed the trend after Labor Day? Was there distracting event that occurred and persisted? Is it simply the election media?

That's what we see externally. I mean there certainly been a lot of social pressure overall. We’ve all been seeing the news on different distractions in that area too that's been dominating the media as well.

Got it. And as you look at the mix of sales by product line in the quarter, was there any significant shifts to point to?

Yes. I would say that our mix overall we saw a tick up in the lower end of our business.

Got it and anything to point to there, driving that is worth noting?

No.

Alright. And then, last question is just around credit. Have you seen any change in the use of credit purchase here products this quarter relatively to last couple?

So financing I do think is important than probably a little more important to the consumer right now. We continue to look at our dollars often financing as the total bucket for conversion and certainly no meaningful change in the quarter for us in that area. But I would say there is more paper ability toward financing. And you can view that competitively as well.

Understood, if I can just squeeze in one more. I know you are not ready to provide guidance for 2017, but can you help us frame it in terms of how to think about what your underlying earnings are for 2016 and what the capabilities are at the mall to grow off that base?

Yes. What I would say again Seth is that our model is designed to and our long term guidance was based on high single digit top-line growth, mid teen operating profit drop through rates, leveraging the model, accretive share repurchases and those are the same elements that we are looking to drive and deliver in 2017. We will certainly be talking about our 2017 guidance on Q4 as we normally do.

Great, thanks a lot.

I would just add on, our competitive advantages that we have been investing in are really coming from a place of strength as we move into 2017 with our market development progressed this year so significantly and the combination of the innovations both the IT Bed and what we intend to reveal at Investor Day for 2017 and beyond we are really excited about how the innovation in the store and the direct-to-consumer model and being able to connect with the customer digitally all that plays in favor of the consumer trends that are transpiring and we have invested in the right places for this time and certainly believe we are taking share right now and intent to continue to.

Understood. Thank you very much and good luck.

Thanks Seth.

Thank you. Next question is coming from Mr. Brad Thomas of KeyBanc. Sir your line is open.

Yes, thank you. Just a few follow-up questions from me, just on the topic of credit. Obviously, we have seen some issues for some more sub-prime type companies and I think earlier this year tighten a bit in terms of their guidance. How are approval rates trending for you anything different you are seeing in terms of approval rates?

You know what, our approval rates have been very strong. They continue to be very strong Brad. We also haven't seen any higher delinquencies at least we are hearing from our third party provider that they are not seeing any higher delinquencies. They love our customer and we continue to see really strong approval rates.

Great. And then the follow-up on the IT Bed, I know it's very early but any color that you are able to provide on how they are performing when in-store. How the rest of your assortment is performing when the IT Bed is on the floor next to other models?

We just had our stores a week ago, so it is very early on that front and that certainly nothing that we can point to. One thing I will share with you is 100% of our sales so far have been new customers to our brand.

That's great. And then, I guess just lastly I look forward to hearing all the details in a few weeks at your Analyst Day. But as we think about the potential to drive 275 in earnings, could you just remind us the same store sales assumptions that would be necessary to drive that? Thank you.

Yes, thanks Brad. Half of the, we said long term we expect about half of our growth to come from comp stores and half to come from new stores.

Okay. Thank you so much. Look forward to seeing you in few weeks.

Okay. Great. Thanks.

Thank you. Next question is coming from Curtis Nagle of Bank of America. Your line is open.

Hello, Lindy do you have somebody on the line?

Curtis Nagle?

Sorry about that. Can you hear me now.

Okay. One moment. Go ahead Mr. Nagle. Mr. Nagle your line is open.

Lindy why don't we go to the next caller and then Curtis can jump back in the queue.

Okay. Thank you. Next question is coming from Mr. Keith Hughes of SunTrust, your line is open.

Yes. Thank you. And two questions. Number one on the IT Bed, have you done any marketing specifically around this product or do you plan to do any sort of give us an idea of how much in the format and then I have a follow-up after that?

Yes Keith, we have done a very low spend right now. All digital and it will be digital and we are not going to quantify it from a competitive perspective.

So I know you are just getting start in this product now, but at what point would you ramp it up? Is there sales number you would have to hit or what - obviously it's in the test phase at this point but what would be the marker to get your more aggressive on?

Yes, we have been using this first few weeks to validate and learn a number of aspects and so far it's really been more about validating and to understand the actual style of marketing from an awareness and consideration and we have what we need at this point. We’ve couple more data points over the next few weeks, but we are pretty ready to go.

Okay. Second question on short count sorry really 540 or so by the end of this year. I remember sometime ago and this has been a while, 550 number count thrown out as a goal. So, I guess my question moving forward is do you still expect to grow stores over the next several years at least in the range, growth range of what we’ve seen or is it going to, is it going to tail off?

Yes. Great question especially in light of the 11% growth that we are talking about this year. When we issued our long term guidance coming out of 2014, we talked about for 2019 with the 275 that is assumed 600 to 650 stores with 5% to 7% net new stores growth on average over that time period and that still a fair way to think about it today.

Okay and just finally on that number getting to that number 6 to 650, is that something driven by demographic or store per head or what makes that a number you think is achievable?

Yes, well it's first of all it's always a number that we are constantly iterating against. We take our approach as a market development approach and we constantly re-evaluate and test numerous different scenarios both from an individual store and a market development perspective especially with the changing consumer and believing that more and more customers will become comfortable with purchasing online. We do see our strategy as agile from the perspective of planned NQ of both aspects. So we went into this with targeting one store per population of 350 to 500,000 and that considers our target of 30 to 54 year old with household income of greater than 75,000.

Okay. Thank you.

Yes. Thank you.

Thank you. Next question is coming from Mark Rupe of Longbow Research. Your line is open.

Hi, good evening Shelly is there anything you can share with respect to just sticking on top of stores here between the various format, between mall and off-mall as it relates to kind of a comp performance?

Yes. We’ve had similar performance with non-mall and mall. Now we have been tracking heavier towards non-mall which you can see now that number is over 50% it's focused by market depending on where the best retail dynamics are in that marketplace from our view along with the opportunity we have from economics on to actual lease and the return over time on that investment. There is a little more favorability with non-mall from an occupancy percent.

Okay. Perfect and then on the test on the stores, the 50 stores that you are testing IT Beds in metrics that you are testing on, is there anything over and above the obvious incremental expenditure just to a lower price rate, is there any other metrics that you are looking at?

Yes. We are looking at a number of factors on - we sell a lot of - we sell beds today that we don't show on the floor so we want to understand this one in relation to, does it need to be on the floor or not. Is there cannibalization overall to the lower end of the line by having it in store or on the flip side does it hurt ourselves to not have it in the store and it's interesting to look at our research and research by others as well. If you observe online brands whether they are in the mattress industry or outside of it, they are only online for about a minute and then they are looking for physical location. So we see our position as highly advantage to be in the direct-to-consumer with 500 stores in 49 states. This is really how the consumer wants to shop today. She wants to have the availability to view and try out the product if she so desires. At the same time, this is the best product, the best mattress there is to purchase online because it's adjustable. And you can change the firmness so it really works perfectly for everybody. So we like where we are at. We are interested. We want to make sure we take this time to learn about the 50 stores and those particular markets to see add advantages one way or another and then we have our follow on innovation pipeline next year which should be complementary to everything we are learning right now.

Perfect. Thanks. Good luck.

Thanks.

Thank you. Next question is coming from Michael Lasser of UBS your line is open.

Hello this is actually [indiscernible] filling in for Michael Lasser, thanks a lot for taking our questions. So one of your competitors noted that the cutback on promotion during the quarter which kind of hurt them. So I guess my question is that were you able to gain some additional share during any period this quarter because your primary competitor was not as promotional?

Well, I would just characterize that we do believe we took share in the quarter. We believe we are going to be taking share here for the full year. But the data is not out yet to help us understand that. But we certainly believe we did.

Okay, great, thank you.

Thanks.

Thank you. And at this time there are no further questions, I would now like to hand the call back to Select Comfort for final remarks.

Thanks again for joining us today. We look forward to discussing our fourth quarter 2016 performance with you next year. Sleep well and dream big.

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