Sleep Number Corp (SNBR) 2015 Q4 法說會逐字稿

Welcome to Select Comfort's fourth-quarter and full-year 2015 earnings conference call.

(Operator Instructions)

Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would like to introduce Dave Schwantes, Vice President of Finance. Thank you and you may begin.

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

Please also refer to our news release for a reconciliation of certain non-GAAP financial measures and supplemental financial information included in the news release or that may be discussed on this call. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings news release and discussed in some detail in our annual report on Form 10-K and other periodic filings with the SEC. The Company's actual future results may vary materially.

I will now turn the call over to Shelly for her comments.

Good afternoon and thank you for joining our call.

My SleepIQ Score was 77 last night. Today, I will update you on our ERP challenges, impacts and actions, followed by our growth initiatives for 2016. We had a very challenging end to 2015, disappointing our customers and incurring a $0.42 per share loss in the fourth quarter. Many of our customers were negatively affected by frustrating delays and delivery reschedules as we ramped up our new ERP system. For the full year, net sales were up 5%, operating income declined 26% and diluted earnings per share were $0.97.

These results are not acceptable to us. The transition from our patchwork legacy systems and manual processes to a fully-integrated end-to-end ERP platform exposed significant complexities. Overall, our challenges were a result of two things: first, flowing our backlog of orders too quickly at too high a volume and second, inaccurate data signaling between plants, delivery hubs and our customers.

Here is where we are now. Today we are operating at much improved levels and continue to make meaningful progress each week. We've ramped up plant, hub and home delivery capacity to support the President's Day event. This required a 40% increase in plant production the last three weeks of January, which we achieved. In mid-January, we extended our home-delivery lead times to four weeks and return to normal two-week lead times on UPS orders. We expect to continue longer home-delivery lead times for the next four weeks as we execute heavier volumes from the President's Day event.

As our performance on the new system improves, our sales trends and customer service are also improving. Importantly, we have achieved each of our weekly implementation milestones since the last week of December. Looking forward, we expect to be operating the system proficiently with more normalized sales growth in the second quarter. David will speak to guidance assumptions for 2016. As challenging as the implementation has been, the system works and it is the right ERP system for our Company. It will enable our growth and superior customer experience for years to come.

Now, let's talk about the implementation challenges. When we spoke to you on the last earnings call, we had been operating on the new system for about three weeks. It was stable and we were using it across the Company but not efficiently or at normal volumes. Our front-end systems were performing relatively well and data conversion was successful. We had a site-line to issues in the plants and related customer impacts. At the time, we expected to contain the issues and be operating effectively with normal service times within the fourth quarter. What we did not yet understand was the full extent of plant and supply chain challenges as we ramped up volume, or the compounding impact on our customer-service levels.

Here is what happened and the actions we have taken to fix the problems. Early on, when it appeared things were moving relatively smoothly, we attempted to process a high number of orders through the system too soon. These order volumes, in combination with data signal problems and well-intended manual efforts, made the correction and recovery far more challenging. This caused missed and delay deliveries. By the time we fully understood our plant-to-hub signaling root cause, we had a high number of orders in queue. Resolution of these orders required manual intervention, which was time consuming and intensified work-flow challenges.

Today, we have addressed process variation, resolved our major technical issues and implemented more effective exception controls. Today plants are shipping accurately at pre-implementation levels. Hubs have improved their receiving and processing time with 80% of our hubs operating at near normal efficiency levels. Our improvements and measurements are on track to operate with normal lead times by the end of the quarter.

While the fourth quarter was dominated by our ERP implementation, it is important to highlight that 2015 was also a year of significant progress. We advanced our consumer innovation strategy and aligned our capital structure with our improving long-term risk profile. Our results prior to the ERP implementation reflected strong consumer adoption and demand for our product innovations, which are increasingly differentiated from the industry's. Sales grew 20% for the first three quarters with a 38% growth in EBITDA. Our cash generation and liquidity improved the health and sustainability of our business and enabled us to move forward with our ERP implementation.

We evolved our capital structure by establishing a $100 million credit facility and began operating with lower cash on hand. We returned significantly more cash to shareholders, increasing share repurchases to $98 million in 2015 from $45 million in 2014. Investing in our future growth continues to be our number-one capital deployment priority.

Key 2015 investments, such as the SleepIQ Labs acquisition, strengthened our competitive position. This technology platform adds agility to our innovation pipeline and customer value through our connected products. In the first four months following the acquisition, we were able to accelerate R&D on the, it bed, and introduce it at CES in January. We expect the LAB acquisition to be accretive in 2017.

Both the SleepIQ and the ERP platforms enable us to advance our product and service road map and deliver a simplified, connected quality sleep experience for our customers. The it bed is an early example of this at the entry price point of our products. Until now, our product advancements were constrained by our system and supply chain limitations. Going forward, we are able to design our products, manufacturing processes, and fulfillment capabilities in an integrated manner. This allows us to leverage our vertical model and simplify our products and service experience.

As we enter 2016, we have a company with a proven consumer innovation strategy, benefit-driven products, stores with retail-leading productivity, effective marketing, a highly engaged workforce, and an enterprise-wide platform that will enable our future growth.

While we don't normally share intra-quarter trends, it is important in the context of our ERP challenges to understand where the brand demand trends are in January. Social sentiment is improving as ERP issues dissipate. Product praise is starting to break through as a stronger voice in the past few weeks. Brand awareness and consideration, as measured by our January brand tracker data, remains consistent with pre-ERP levels. Brand affinity and perception metrics are also consistent with September results. Website traffic trends are steady. Digital traffic in January was up 64% year over year versus 59% in Q4 and sales trends our improving. January orders were on plan with an 8 percentage point trend improvement from December but still down 7% year over year.

We understand how much we've disappointed our current customers, and this is our challenge to overcome. This has been extremely difficult for us as we are mission-based people and truly dedicated to improving our customers' lives. Ultimately, we are confident in our ability to win back our customers' trust, as we demonstrate our commitment to their unparalleled sleep experience. Our team's dedication to go the distance for our customers has been nothing short of amazing. We are all anxious to wow our customers again. This is a top priority. Going forward, we expect our social sentiment to continue to improve consistent with our service level improvements and we expect to be approaching high single-digit sales growth as we exit the second quarter.

Here are the highlights and the actions we are taking to drive growth this year. First, we are advancing our "Know Better Sleep" campaign with new ads, including "The Only Bed That Moves You", which tested the highest of all of our ads to date on awareness and engagement. We are promoting the fact that JD Power ranked Sleep Number as the highest in customer satisfaction with mattresses in their first-ever mattress report. Nearly 82% of U.S. consumers are more inclined to consider a product or service if they know it received a J.D. Power award.

For the third consecutive year, Sleep Number beds placed number one and number two overall in Consumer Report's annual mattress study. This recognition has been a driver of consideration and conversion the past two years.

We are advancing our digital marketing platform an initiative that began last summer to optimize online content in real time. Initial results included three to four times efficiency and engagement improvement. We expect to leverage media by at least 100 basis points in 2016.

We are launching a new product and target market later in the year with our award-winning it bed. This product broadens our reach to the online savvy millennial customer who uses technology to improve health and wellness, specifically, a 25- to 34-year-old with an average income of $50,000. The it bed features dual adjustability, the latest SleepIQ technology, a simple online purchase and shipping experience, and is priced around $1,000. We expect the it bed to drive additional consideration for our brand and incremental unit growth.

In 2016, we plan to launch our eleventh aggressive growth market. The goal of this effort is to double market share in three years for selected large underdeveloped markets. And finally, we are accelerating new store growth. In 2011, we began executing our market development strategy which relocated existing mall stores as leases expired. Today we have 44% of our store portfolio in non-mall locations and the majority of the mall stores are now in improved locations. In 2016, our capital allocation will support opening nearly 50 incremental stores versus 25 incremental in 2015.

In closing, we are not letting our recent ERP challenges slow the positioning of the Company for sustainable profitable growth. Our commitment of delivering earnings per share of $2.75 by 2019 remains unchanged. Our consumer innovation strategy is on track and we look forward to demonstrating progress and delivering on our goals in 2016.

Now, let me turn it over to David for more detail on the quarter and full year.

Thank you, Shelly. Good afternoon. Our Q4 financial results and execution of the ERP implementation were sorely disappointing. While we got a lot right with the system design, which benefited from embedding functional experts full time on the project, we underestimated the challenges and financial impacts when things didn't go according to plan. I'll review the fourth-quarter and full-year numbers before sharing our expectations going forward. Please refer to the table at the end of the press release for additional details on the quarter results and 2016 outlook.

Net sales of $215 million for the quarter were 33% lower than the prior year and 7% lower on a two-year basis. The $107 million year-over-year net sales decline falls into four groups, the extra week of 2014, elevated cancellations, appeasements and returns, overall lost sales opportunities, including impacts on store traffic and conversion, and higher than normal level of undelivered orders at year end. Specific sales metrics for the quarter include a 30% decline in comp sales versus the prior year. We shipped 38% fewer units in Q4 this year while ARU grew 9% to $4,204 and our trailing 12-month average comp store sales were $2.4 million, up 2% versus the prior year. This significant sales decline resulted in deleverage across our vertical structure.

This, coupled with higher than expected ERP implementation costs, resulted in a $30.7 million operating loss for the quarter. Key call outs include, our Q4 gross margin rate of 56.2% was 420 basis points below the prior year. Approximately 40% of the rate decline was due to sales deleverage and 60% was driven by appeasements, labor inefficiencies, material cost and excess freight from actions taken to manage the ERP challenges. Operating expenses of $151 million were 9% below the prior year, including $7 million of cost cutting measures plus variable costs tied to lower sales. These were partially offset by expected cost increases, including $2.5 million of ERP launch costs, $2.5 million of incremental ERP depreciation, and $3.2 million of higher R&D costs, primarily from the SleepIQ Labs.

We spent $43 million on media, which is 5% below the prior year but resulted in 600 basis points of deleverage for the quarter. Our Q4 income tax rate of 31% negatively impacted our Q4 EPS by $0.02. This was due largely to our election of the bonus depreciation and R&D tax credit provisions renewed by Congress in late December. Our loss per share in Q4 was $0.42, including an estimated $0.43 of lost sales and net incremental costs from our ERP implementation challenges.

We accomplished a lot strategically in 2015, despite the disappointing fourth quarter. Full-year net sales were a record $1.2 billion, up 5% as reported, or up 7% excluding the extra week of 2014, with a two-year stacked comp growth rate of 15%. Our 11.2% ROIC for the year exceeds our 10% weighted-average cost of capital. We generated $133 million of EBITDA, or 11% of net sales for the year. We reinvested $86 million on capital projects, including $40 million on our new ERP system and $30 million on retail stores and digital platform. We invested $57 million to acquire full ownership of SleepIQ Labs. And we returned $98 million of cash to shareholders through share repurchases, including $30 million in Q4. Over the last five years, we have generated more than $0.5 billion of cash from operations. We invested 60% back into the business and returned 40% to shareholders through share repurchases, reflecting our commitment to both of these capital priorities.

On the third-quarter call, we discussed three areas of our business we have transformed: highly productive retail operations, including our stores and digital; effective marketing strategy and tools; and differentiating product innovations, including our sleep IQ technology platform. These differentiators drove 20% net sales growth and 51% EPS growth the first nine months of 2015, and are still intact.

The sequence of delivering these transformations has been purposeful and necessary, along with maintaining risk-appropriate liquidity before tackling our final and most complex challenge in Q4, the implementation of our long-needed, vertically integrated ERP system. With the capabilities of the new ERP platform, we can unlock efficiencies in our supply chain for improved profits and service. And with our transformations behind us, we have removed significant risk elements from our profile.

So what does this mean for our 2016 expectations? After a recovery period in the first half, our 2016 sales and EPS growth expectations are in line with our long-term commitment to deliver $2.75 of EPS by 2019. We expect to deliver $1.25 to $1.45 EPS in 2016, which assumes $0.25 to $0.30 of ERP implementation pressure on sales and costs, primarily in the first quarter. This assumes low-teen growth in net sales for the year, with low single-digit growth in the first half.

Please keep in mind the following for 2016. We expect approximately 6 to 8 points of pressure on net sales in the first half, largely in Q1, to be partially offset by delivery of the elevated backlog coming into the year as we return to normal lead times. We plan to deliver 50 to 100 basis points of gross margin improvement for the year as we leverage our new ERP platform for efficiencies. We expect margin pressure in the first half will be more than offset by operational improvements in the second half. It's worth noting that we have also line of sight to deliver an additional 50 to 100 basis points of margin improvement in 2017 from product innovations arising, in part, from the SleepIQ Labs acquisition in 2015.

Sales and marketing costs are expected to be 44% to 45% of net sales for the year, with deleverage in the first half more than offset by leverage in the back half of 2016. We are forecasting approximately $60 million of depreciation and amortization in 2016, an increase of $12 million year over year. The bulk of this is due to the new ERP system and flows through our G&A expense line. Our commitment to continued innovation is reflected in approximately $10 million higher R&D costs, largely from the Labs acquisition. And we are forecasting income tax rate of approximately 34.5%.

The timing of ERP related pressures, depreciation expense, and R&D costs means about three-quarters of our full-year EPS is expected to be earned in the back half of 2016. With more than 100 basis points improvement in our EBITDA margin, we expect to generate record cash from operations in 2016. We plan to invest $70 million in high-ROI capital projects, including approximately $40 million on our retail stores and digital platform. This includes adding 47 net new stores to reach 535 by year end and to continue advancing the productivity of our website. We expect ROIC to exceed 13% for the year. We also plan to continue opportunistic share repurchases that our accretive to EPS.

Maintaining appropriate liquidity, aligned with business needs, continues to be an important capital priority. We require lower cash reserves as we conclude our ERP implementation. This quarter, we plan to avail ourselves of additional low-cost-of-capital liquidity by increasing our revolver to $150 million while retaining expansion capacity for another $50 million. We appreciate the strong support from our banking partners as we continue to evolve our capital structure. Our outlook assumes a slow-growth economic environment will continue in 2016. It does not contemplate a worsening of consumer spending.

We made significant progress in 2015 on our growth drivers and on our most critical growth enabler, the new ERP system. The work has been intense and we clearly see the benefits of our actions within reach. We are well positioned to leverage the business in 2016 and deliver on our commitments to improve margin. We'd like to share our sincere thanks to our highly dedicated and motivated Sleep Number teams for the heavy lifting they continue to do for this business, our customers, and our shareholders.

Sam, please open up the line for questions.

(Operator Instructions)

Budd Bugatch, Raymond James.

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

Yes, Bobby, when we last spoke on our earnings call, that was November 4. I summarized where we thought we were at that time. As we progressed through the month, we had a line of sight to some difficulties we were having in our plants at that time and we're on the solves, we thought, on those particular issues. What began to reveal itself as we entered December, late November, we started to have increasing reschedules. The timeframe as we got into December when we were ramping up, we had more significant issues.

The issue, the number-one problem we had is the amount of volume that we put through early on, and then that ended up clouding the real root cause of our plant-to-hub signals. By late December we knew we had to slow down and relay very clear on root cause, our recovery plan of what it was going to take to get ourselves recovered, both with the pipeline and the root cause of the issues. We've had clear milestones each week that we've been able to achieve since the last week of December all the way through this week.

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

Yes, it began to show up in a small way in November. As we continued to ramp, it became larger.

Okay. With January orders still being down 7% year over year, is the goal to exit 1Q with it fully back on -- with fully everything back on schedule? Or how should we think about the new goal for progression?

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

Okay. Lastly, on the backlog, how should we think about the cancellation possibilities for the backlog? What were cancellation rates in December? What is your assumptions for cancellations going forward on the backlog?

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

Okay, okay. I appreciate -- I will go ahead and get back in the queue. I appreciate you guys answering my questions.

Thanks so much.

John Baugh, Stifel.

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

I will start with the brand, John. This has certainly been top of mind up for us as we have been fighting our way through and taking care of our customers and where we have the opportunity to go back and reconnect with all of the customers who we've affected during this time. The specifics that I shared in the prepared remarks, first and foremost, we always look at social sentiment, which is really the online voice. As our issues are coming down, that voice is beginning to change and product praise is regaining its ground as a stronger voice. We expect that trend to continue and that's part of our milestone look each week.

In addition, I think what's really important to understand would be the long-term brand metrics are consistent with pre-ERP. We take our long-term brand study three times a year, September being one of the times and January another. We just took the study right before the ERP and the post metrics are on track with the pre-ERP metrics. This is very important for consideration as we move forward. Both awareness and consideration stayed steady during those time frames.

John, this is consistent with the weekly read in the short-term brand metrics that we had been reading. Of course, cautiously optimistic on it but then getting the tracker information back for validation was very important. The customers who were effected were certainly negatively impacted and have a tough social sentiment. The consumers who were considering the brand, that view of the brand and the Company was still very strong. Of course, we're very happy about the JD Power number-one mattress satisfaction and we have seen a big impact from that already in customers reading that voice as being the most important.

And then, our website traffic has been fairly steady through all of this, up 59% in Q4 and up 64% in January. That all has a lot to do with the fact that we did continue our media. In November, we weren't as clear about where we were at and so we did continue our media, driving people to our website. I think that has really helped us maintain the brand metrics as we go through this. For January, I shared some specifics. Our early read in February, we have a little choppiness going on but, yes, we expect a more muted President's Day event consistent with exiting Q1 flat inclusive of the backlog benefit, as I mentioned.

I am not sure on the macro, John. Our impact has clearly been focused on our ERP implementation so it's difficult to parse out any macro impact. We do have an innovative product with high mattress satisfaction. That kind of product can break through, even in a more challenging macro.

Appreciate that color. And then for -- quickly, the store openings, what is the cadence of that through the year? Any kind of new market versus filling in existing markets? How do we think about where the stores are going?

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

I will defer to others. Thank you.

Thanks, John.

Seth Basham, Wedbush Securities.

Good afternoon.

Hi, Seth.

I want to make a couple of points of verification first, if we can. In terms of the sales trends that you are reporting, I think you're referring to orders for the month of January down 7%. Is that correct?

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

You expect to be for full quarter Q1 flat year over year in sales dollars?

Yes, Seth, that's net sales, incorporating both the benefit of the backlog carryover and the pressure that we expect from the ERP on top-line demand.

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

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

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

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

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

Absolutely not. There really was no question. The majority of this is done - and did work. The front end worked and most of the BI and human capital, all of those different aspects of the system. It's the right system. It's the system that's going to give us the efficiency and the margin expansion that we need for this business. As we sit here today, certainly we regret the implementation challenges we had, but not the system.

This is the right system. It exposed all the complexities that we forced on our customer today that we need to get out of this business. The consumer today demands a connected, simple experience. That was not what we were able to deliver on our old systems that were completely disconnected. This is the right system to deliver that and it will enable our growth and the achievement of our long-term commitment to shareholders as we move forward.

Got it. One last question if I may. $2.75 in earnings power in 2019 sounds great. Can you remind us of the bridge to get there and then give a little bit more detail on how you see 100 basis point improvement driven by new products from the BAM Labs acquisition, please?

Glad to. Start with the last one first. We've always expected to have benefits from this ERP implementation. What we learned during the intense work that we had in the fourth quarter was, seeing all of the pinch point where we can get margin improvement, that is going to be part of the supply chain evolution that we're attacking, making things simpler for our customer, making things simpler for our employees, taking costs out of the system in terms of the number of touch points in our network. That all contributes to that 50 to 100 basis point of improvement that we'd always been chasing, expecting to get in the back half of 2016, and we still do.

The BAM Labs acquisition, or SleepIQ Labs, today has already proven valuable in terms of pulling forward the "it bed" capabilities and making sure that we could introduce that in January at the CES launch. We also know that there are cost reductions that we can take out of our pump directly as a result of that acquisition that are going to be achieved in the back half of this year.

In terms of getting back to the 2017 -- or 2019 $2.75 EPS, when I think about this year, the high end of our range is $1.45. We are assuming, if you assumed that $0.25 of ERP pressure were the reality this year, the adjusted number would be $1.70. That will give us a required 17% EPS CAGR from this point until 2019, which is exactly what it was when we introduced our long-term guidance last year, in 2015, from 2014 to 2019. We believe that we will have the business right back on track in the back half this year.

Very good. Thank you, very much.

Thanks, Seth.

Brad Thomas, KeyBanc Capital Markets.

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

Yes, thanks, Brad. The $0.25 to $0.35 of ERP drag, largely from the six to eight points of top-line pressure, I think that, that's kind of a -- we are seeing that more of a one-off event that we will lap in 2017, in the first half. I think in terms of improving our profitability in the back-half this year, of course, we are expecting to be going off of more of the adjusted base of 2014, excluding the extra week than thinking about it in terms of just the 2015 number, which is pretty hard to see through all of the noise.

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

Yes, great question, Brad. We -- as you would expect with the new ERP system, we had to apply a lot of additional rigor at year end to ensure the accuracy of our results. We were not in a position to provide a complete reporting on the impact of the ERP implementation until just recently. However, our controls are functioning properly, our metrics are in place, we have great visibility today. We were able to give a lot of good precision as to exactly what happened in Q4. We provided additional details in our press release in the last table of the press release.

We feel like this is a reasonable estimate. It's our best estimate of what the impacts are going to be. We know we have incremental costs and inefficiencies, as we have additional staff supporting the business as we learn to use the system proficiently. We've incorporated those things. We know there are higher -- some of the higher costs that we encountered in terms of handling, et cetera, from Q4 is going to carry forward but not at nearly the level that we had in the fourth quarter. We've scrubbed these numbers pretty hard and believe it's a solid estimate.

Brad, I would just add what is very encouraging and gives us great confidence is the achievement of our milestones each week since the last week in December in all aspects of the business. That gives us a steady progression and then, in addition to that, understanding where the brand metrics are at, our overall fundamental and competitive position with our innovations and effective marketing. The product quality has never been stronger, as noted by JD Power award and where the store portfolio is at and our digital efforts. We have quite a few drivers stacked up in our favor, along with the incremental new store growth that we are getting after early in the year, as we move forward.

And then, of course, we balance that against our pressures of recovery around social media and any referral hangover that we have. And then, of course, we have yet to better understand the macro. But again, for us, as an innovation category with a benefit-driven product, it does help in driving through any type of macro pressure.

Got you. Following up on the macro topic again, if we make the adjustments, the $83 million, $84 million of sales impact, 26% drag, I think you had anticipated about $10 million when we had our third-quarter call, so about 23% drag on sales, which would put you in line, maybe a tad worse, than the mid single-digit comp guidance -- comp decline that you had talked about. Am I reconciling that properly?

Yes, that sounds about right, Brad.

Great, thank you so much. I appreciate all the details.

Yes, thank you.

Peter Keith, Piper Jaffray.

Good evening. This is actually Jon on for Peter. Thanks a lot for taking our questions. First off, are you seeing any increased turnover at the sales associate level beyond what you normally see this time of year? Are you having to adjust sales goals or compensation for sales associates or anything like that? If so, are those changes factored into 2016 guidance at this point?

Yes, thank you for the question. First of all, as you can imagine, for us as a mission-driven company focusing on improving our customer's lives, it has been very difficult for all of us, for our entire team and certainly our front line being faced with disappointing our customer which is completely the opposite of what we strive for every day. We definitely had some level of turnover. It wasn't significantly higher but, frustration as we went through it. We are a company -- we take care of our team. We focus on what's doing right on behalf of our team and our customer.

Of course, we've appropriately dealt with cancellations that are outside of our team's control. That is factored into our numbers already. We have a very dedicated team with a high level of engagement. We've all been fighting through this together with great unity and confidence as we move forward.

Okay, thanks. My next question is around -- and I know you guys don't like to get into quarterly guidance but just given the uniqueness of the situation here, can you, David, give us a little more commentary on how you expect Q1 to play out, both from a comp and margin perspective, specifically gross margin? Do you expect gross margins to be up sequentially or kind of in line with where they finished for the fourth quarter?

Yes, sure, John glad to. We are going to benefit on the top line from the backlog carryover and we are going have pressure that offsets that in any normalized growth. We are expecting sales basically flat. That implies a negative comp. We expect, because of the cost pressures carried forward, we are expecting about 150 basis points of pressure on gross margin in Q1. As I mentioned earlier, I expect three quarters of our EPS to be earned in the back-half because of the introduction of additional depreciation, the Labs acquisition costs and some of these pressures from the ERP implementation.

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

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

In January.

I'm sorry, that was in January. Q4 was 59%.

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

Yes, the full year was 51%.

Okay, great. Last question for me, quickly on the buyback and looking at your balance sheet. For the fourth quarter, if you look at the cash marketable securities and then net that against the prepayments, which were actually high for obvious reasons, as we look into 2016 now, I know last year you said you wanted to maintain $100 million number based on those variables. Given that in Q4, I think if you net all of those numbers it's actually a negative, should we be expecting you guys, given you said you were going to be assertive on the share buyback to be taking on debt to buy back stock down here?

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

Okay, thanks a lot. Good luck in 2016.

You bet. Thank you.

Jessica Mace, Nomura Securities.

Hi, good afternoon.

Hi, Jessica.

My first question is a follow-up on the cadence of the store openings. I was wondering is there any risk to the heavier store openings in the first half while you still face some of these ERP pressures? Maybe anything you could tell us about the add new store openings from 4Q?

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

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

No, no. Similar to the rest of the chain.

Understood. My second question is about the "it bed". I was wondering if you could talk about with the product introduction at entry level of your line, what is the strategy for differentiation, maintaining that differentiation from some of the higher price-point products and what kind of impact you expect on ARU for the year?

From a growth perspective looking at ARU in units, we do see the growth this year coming primarily from units with more of a flattish ARU on full year. For the "it bed", the it bed targets a market that we currently do not necessarily attract to our brand. We do see this as incremental, targeting the millennial customer, who is underserved by us, who focuses on tech as their health and wellness go-to. This bed delivers on those attributes. The SleepIQ advancements to our platform that we are doing in combination with the Labs, that will actually flow through to our entire product line. This bed will be focused as a very simple purchase and ship online, with a fast ship, very simple product to set up. There's no hoses or firmness control system with this product but yet it still has dual adjustability.

And then we have a clear step up going to the rest of our line. If you recall, our C2 is also $799 in our regular product line. The "it bed" will be around $1,000.

Great. Thanks for taking my questions.

Thanks, Jessica.

Keith Hughes, SunTrust.

Thank you. A couple questions. First, you are talking about the pent-up demand, if you will, from beds from the fourth quarter coming in on the first. Can you give us any kind of indications, how many of the gross orders in fourth quarter were canceled? How many came through? Any trending on that would be fantastic.

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

I saw the table. It has $34 million. Is that actual $34 million of sales that were canceled?

No, you're looking at -- what we are talking about here is the footnote number two. It's $26 million, is that line-item.

For cancellations, appeasements and returns, Keith.

Okay. That is the cancel number. So then footnote number one --

Yes, that's about 8%.

What is the footnote number one? Is that a calculated number? I don't understand what that is.

That's relative to our expectations for the quarter.

Okay, so that's -- okay. That's somewhat of a hypothetical number in terms of what came out. Okay. Coming back to the it bed, we still really don't know any details of timing, when the marketing of them began. Is there any kind of update you can give us on that?

Yes. We will speak to additional details when we are ready to bring the bed to market, which will be later this year.

Is it still a 2016 launch on that or the (inaudible) posted to 2017?

No, no delays on any of our innovation advancements.

And yes, it is a launch this year.

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

We are at four-week lead times for home delivery and two-week lead times on UPS shipments.

All right, thank you.

(Operator Instructions)

Curtis Nagle, Bank of America.

Thanks very much for taking the call. Just a quick one on inventory. Any guidance in terms of where should we expect it on a dollar basis or year over year come 4Q?

Thanks, Curtis. We ended the year with about $15 million higher inventory than what we had been planning. That's due to the sales miss and the higher ending backlog. We are in good shape to service that backlog, as well as our demand from the President's Day event. We are expecting around an average of $80 million of inventory in 2016.

Okay. Thank you, very much.

You bet.

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

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

Thank you, speakers. This does conclude today's call. Thank you for joining. All parties may disconnect at this time.