Sleep Number Corp (SNBR) 2016 Q4 法說會逐字稿

Welcome to Select Comfort's Q4 2016 earnings conference call. (Operator Instructions) Today's call is being recorded. If you have any objection, you may disconnect at this time.

Now I would like to introduce Mr. Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may began.

Good afternoon and welcome to the Select Comfort Corporation fourth-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 physical 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 fourth-quarter call. My SleepIQ score last night was 80. Today I will share highlights from our 2016 performance and our key growth drivers. We are very encouraged about the year ahead and excited to launch the most significant product innovation in our 30-year history, Sleep Number 360 Smart Bed.

2016 was a year of progress and recovery for our Company. We completed our multi-year transformation, which strengthened our consumer innovation leadership and competitive advantages. The investments we've made were coordinated and paced to drive both brand demand and business leverage in a dynamic marketplace. In 2017, we expect greater leverage on lower sales growth rates, which is an important element for sustainable, profitable growth.

Despite a worsening consumer environment beginning in the third quarter, net sales increased 8% for the year to $1.3 billion, and earnings per share increased 13% to $1.10. We had positive comparable store sales for the full year as we have for the past three years with a 1% comp increase and also generated 7 percentage points of growth from new stores.

In addition, we delivered 80 basis points of gross margin improvement for the full year. Still our 2016 earnings per share were $0.05 below the low end of our guidance range as sales fell short of our internal plans.

We generated a 40% increase in operating cash flows in 2016 to a record $152 million, illustrating the strength of our business model. We also delivered a $71 million increase in free cash flows while increasing our store base 11% and returning $125 million in cash to shareholders through share repurchases. Full-year ROIC of 12.2% exceeded our weighted average cost of capital by 54%.

Turning to the fourth quarter, earnings per share were $0.25 and net sales were $313 million. While our sales grew 46% compared to the prior year's ERP impacted quarter, consumer demand was sluggish, and competitive media spending again drove up advertising costs. As a result, both our sales and earnings fell short of our plans, and our media spending did not meet our leverage expectations. Nonetheless, we are confident we gained market share for the quarter and full year.

Even with the choppiness in the consumer environment, we made steady progress in the quarter across many aspects of our business, especially with our supply chain and balance sheet. We delivered a strong fourth-quarter gross margin of 63%, which helped offset lower-than-expected media efficiency.

Other operating costs were largely in line with our expectation. Thus far in 2017, traffic sales and media effectiveness have improved and are all on target. We attribute this to both a steadier consumer environment and the improvement in our marketing initiatives.

The investments we have made all come to fruition this year with the changeover of our entire product line, the Sleep Number 360 Smart Bed. The demand potential and the pricing power associated with our innovation and controlled distribution strategy are an exciting opportunity for our brand. We see 360 Smart Beds as a significant growth driver.

The early response by the consumer and our sales team is a strong indication of potential momentum. In January, we hosted our national sales conference, and it was exciting to see our retail team's confidence and enthusiasm about this effortless sleep experience that adds so much value to each individual's wellness.

And at CES last month, we had the opportunity for thousands of consumers to experience this bed for the first time. They immediately saw the value. The 360 Smart Bed also won 13 awards, including being named by CES the Best of Innovation honoree in the home appliances category. And Brand Watch ranked Sleep Number as the 12th most talked about brand at CES of the nearly 4,000 brands represented. Sleep Number was in good company with brands like BMW, Amazon and Intel.

The 360 Smart Bed's effortless features and benefits resonated with consumers. First is the fact that the bed automatically adjusts throughout the night for the ultimate in continuous comfort and support. As sleep positions change, our responsive air technology adjusts the bed's comfort in real-time. Consumers find this level of individualization compelling.

The foot warming feature is also a big driver of consumer interest. Research shows that people fall asleep faster when their feet are warmed. SleepIQ technology knows your bedtime routine and warms the foot of your bed automatically before bedtime through rapid sleep onset technology.

And consumers are always interested in our snore solutions, especially one that is effortless. Responding to SleepIQ biometrics, the 360 Smart Bed will automatically adjust to each sleeper's ideal position. As we progress through the year, customers will be able to choose from several combinations of Sleep Number smart mattresses and bases to meet their specific needs. We expect that our phased implementation plan, which will begin in the second quarter, to result in low teens net operating profit drop through on mid to high single digit sales growth in 2017.

Sleep Number is capitalizing on two dominate consumer trends today: convenient, direct to consumer distribution and being connected to improve your health. Our marketing plans for the 360 Smart Bed will focus on these two trends as we attract new customers to our brand and engage our loyal customer base for referrals and upgrades.

We believe quality sleep is critical to wellness and essential to a healthy mind, body and soul. We are building long-term value with sustainable innovation by using our technology platforms to deliver effortless quality sleep that is connected.

Also capitalizing on the consumer convenience trend are the many new bed in a box brands, which are focusing on online purchasing and a simple delivery experience. They are driving a change in consumer behavior. Today consumers not only start their research online, they also increasingly willing to consider purchasing a mattress online and prefer to purchase directly from the brand. We see these marketplace changes as advantages for our vertical business models that is exclusively direct to consumer.

For the full year, our online and direct phone sales grew 25% and were particularly strong in the fourth quarter. Our strategy has anticipated these marketplace changes. We have positioned our business to serve today's consumer however they want to shop: online or at one of our nearly 550 Sleep Number stores nationwide. This competitive advantage is also a key growth driver. Our store experience and productivity is unmatched in retail and provides value for those customers who want to experience the product before buying. And in 2017, we expect at least 4 to 5 points of sales growth from new stores and low single digit comp growth.

Our store portfolio is healthy. Nearly 80% of our stores are less than five years old. Over 20% of our stores generate more than $3 million in sales annually with our top store over $6 million and still growing. This is a testament to our proprietary innovations and our high-performing sales teams. More than half of our stores are now located outside a mall, and we have strong sales and profit performance in both formats. Our 2017 plans include about 60 new stores and relocations.

We have appropriate flexibility in our store growth plans given the fast changing consumer and how she chooses to transact both in-store and online, and further improving our digital brand experience is a top priority in 2017 as we prepare for the rollout of the 360 Smart Bed.

In addition, we launched the IT Bed. We are excited about the promise of this product and the new customer we are attracting to Sleep Number.

As anticipated, this 25- to 34-year-old tech savvy customer is incremental and responding to our differentiated positioning. We're focused on a limited number of large markets as we test and learn prior to scaling.

And finally, the catalyst that drives our growth is marketing. At our recent Investor Day, we highlighted three strategies we're focused on: bringing new customers to the brand, optimizing media, and activating our loyal insiders. While our progress was slower than anticipated in the fourth quarter, we are seeing improvement in each initiative, and the results are building. This is an important indicator of the year ahead. We are attracting new customers to our brand and anticipate momentum with the introduction of the 360 Smart Beds. Unit growth will be a good indicator of our expanding relevance, and we expect mid-single digit unit growth in 2017.

Television continues to be our most efficient form of media followed by digital. Our in-house and data-driven digital tools are generating insight to deliver efficiencies. These capabilities are helping us overcome escalating costs for basic search terms by optimizing our digital media mix to create high-quality traffic that is more likely to result in store mattress unit sales. Results are evident in our qualified unique visitor per mattress unit measure, which has improved significantly since the first quarter of 2016. Our performance to date in 2017 is consistent with our expectations, so we are making the necessary progress for increased efficiency.

We are also gaining traction with our loyal insider base, another of our competitive advantages. Repeat and referral sales are our most profitable sales.

New innovations, especially benefit-driven products like the 360 Smart Bed, have proven to be strong growth drivers for upgrades and referrals. We will also benefit from a more effective personalized marketing strategy with our insiders.

In summary, we expect to leverage media in 2017 as we build on our learnings from the back half of 2016 while competing aggressively with all of our assets in the crowded marketplace.

We have two significant drivers of leverage in 2017 and beyond: the 360 Smart Bed and the evolution of our supply chain network. As we highlighted at our Investor Day in November, our new bed design enables us to expand margins in multiple ways, including sourcing leverage and the use of common parts.

In our supply chain operations, we are continuing to deliver ERP-enabled improvements and lean efficiencies in manufacturing, logistics and home delivery. These ongoing initiatives and the value engineering associated with the design of our new product line position us for increased profitability.

In addition, over the next two years, we will be evolving our network of plants, hubs, spokes, and home delivery to improve our customer's experience and deliver additional efficiencies in transportation and warehousing. We are committed to delivering another 30 to 50 basis points of gross margin expansion in 2017 while also providing a more convenient customer experience.

In summary, we are excited about changing lives with our revolutionary 360 Smart Beds and the opportunities we have to expand our market share and leverage our business model. We have made significant progress in 2016 towards a more agile and efficient business. With our benefit driven 360 Smart Bed and a more convenient, connected experience, we expect to be more broadly relevant and scale -- and to be a more scalable brand in 2017 and beyond.

I wanted to thank our team members whose commitment to our customers resulted in JD Power ranking Sleep Number Highest in Customer Satisfaction with mattresses in 2016, the second year in a row. We expect our strategy to deliver superior shareholder value, and our cash flows are a great indicator of this. While sales were lower than we expected in 2016, with our transformation complete, we believe we can accelerate our earnings growth going forward. We remain committed to deliver our 2019 EPS target of $2.75.

Now David will give you more details about our fourth-quarter and full-year results and our 2017 outlook.

Thank you, Shelly. Though our Q4 top-line growth was below our target, we continue to deliver operating efficiencies, which were especially evident in our gross margin expansion and cash generation. Q4 net sales of $313 million grew 46% over a challenged Q4 of 2015 and were up mid single digits on the two-year basis, excluding the extra week of 2014. The composition of our Q4 sales growth came as expected with 50% growth in Company-controlled units and 3% lower ARU.

Comp store sales grew 34% in Q4. Notably, 4 points of our comp growth versus last year came from our online and phone sales business which grew 91% in Q4 and was up 15% on a two-year basis. New stores contributed 12% of our growth in Q4. We opened 72 new stores in 2016, ending the year with 540 stores in 49 states. We look forward to leveraging our larger retail portfolio for greater productivity going forward as we move toward 600 to 650 stores by 2019 complemented by a strong online business.

Our trailing 12-month average comp store sales normalized as expected to $2.4 million, essentially even with the prior year. We continue to target average sales per store of $3 million longer-term. We see this as an important margin expansion opportunity of our strategy since comp store growth generates as much as 40% incremental four-wall profits.

Our Q4 gross margin of 63% improved 680 basis points versus the prior year. After adjusting out the ERP-related challenges from last year, we delivered efficiencies throughout our manufacturing and logistics operations at slightly favorable product mix and saw 50 basis points of favorability from incentive compensation.

And over two years since Q4 of 2014, the 260 basis points improvement shows the meaningful progress resulting from our initiatives. Our operating expenses were in line with our plans, but we did not get the leverage and higher sales we expected from our $50 million of media spend in the quarter. We held the line on spending elsewhere and incurred lower than planned incentive compensation costs for the quarter. For the full year, we posted record net sales of $1.3 billion, up 8% versus last year and $1.10 of EPS, up 13%, while absorbing net ERP impacts of $0.18.

We improved our gross margin rate in 2016 by 80 basis points, largely by accelerating ERP-enabled operating efficiencies in the back half of the year. We generated $146 million of EBITDA and record cash from operations of $152 million. We invested $58 million in highly productive capital projects, one-third less than the $86 million last year reflecting the advantage of being on the other side of our transformation. Our strong cash flows enabled a 27% increase in our share repurchases to $125 million. ROIC for the year was 12.2%, which is 54% greater than our 2016 weighted average cost of capital of 7.9% and 22% above our 10% internal hurdle rate.

2017 will be our first full year following our multi-year transformation of the business. As we tap into the consumer desire for better sleep solutions, we are uniquely positioned to accelerate profits and cash generation. In 2017, we expect to deliver $1.20 to $1.40 of diluted EPS, which includes $0.15 to $0.22 of transition costs primarily to roll out our 360 Smart Bed product line and to begin the redesign of our logistics network.

With strong awareness of the current consumer environment and the prior year ERP impacts by quarter, our EPS guidance assumes 2017 net sales will grow mid to high single digits, primarily through unit growth. We expect mid single digit growth in Q1 and mid to high single digit growth the balance of the year as we benefit from new products and closeout sales. Our EPS guidance also assumes 4% to 5% of our growth will come from new stores and comps will grow low single digits.

I would like to provide a little more detail on our two most important 2017 initiatives. With our 360 Smart Bed product line, we have planned a phased launch over the course of nine to 12 months beginning in Q2. During that time, we plan to roll out a total of seven new 360 Smart Bed models, a new integrated base and three new adjustable bases.

We are also beginning to advance our supply chain network. This initiative, which we expect to complete during the next 18 to 24 months, is to enable final assembly of mattresses in our hubs and the delivery of fully assembled mattresses to consumers' homes. 2017 one-time costs of $10 million to $15 million primarily for these two initiatives fall about 25% each in COGS and G&A with the remainder largely related to floor model changeovers in our sales and marketing expenses.

We also expect 40 to 60 basis points of gross margin rate pressure as we close out legacy products and roll out our new line the last three quarters of the year. Nevertheless, our sourcing, lean, and continuous improvement initiatives are expected to more than offset margin pressures for the year. We expect to improve our 2017 gross margin by 30 to 50 basis points on top of the 80 basis point increase in 2016. This would result in 110 to 130 basis points of gross margin improvement over two years with opportunity for more in the coming years through our value engineering by design, lean operations, and sourcing initiatives.

We continue to employ disciplined spending controls across the business which we expect to deliver modest operating expense leverage in 2017. Specifically, our plans call for sales and marketing of 44% to 45% of net sales, including at least 50 basis points of media leverage. We expect about 50 basis points of deleverage in G&A and R&D combined due largely to incentive comp, transition costs, and higher depreciation. Total depreciation and amortization is expected to increase $4 million to $5 million for the year, and we are forecasting a 2017 effective income tax rate of approximately 34.5%.

We planned our 2017 initiatives to deliver low teen operating profit flow through on incremental sales and expect to improve our operating margin by 50 to 70 basis points in 2017.

We also expect to generate record cash flows again in 2017. Our capital deployment priorities are first to invest in the business, then to maintain sufficient liquidity, including our $150 million revolver, and finally to return excess cash to shareholders through share purchases. In 2017, our capital investment projects are expected to be $50 million to $55 million with about half earmarked for 60 targeted retail store actions and the remainder split between our technology advancements, facilities, and tooling and equipment for operations. We expect our 2017 ROIC to exceed our projected 9.5% weighted average cost of capital by 35% to 45%, demonstrating the value we are creating through our consumer innovation strategy.

And finally, on the capital allocation side, we enter 2017 with $245 million remaining under our existing share repurchase authorization.

Our commitment to deliver real sleep benefits like our 360 Smart Beds do, coupled with our exclusive distribution and unique marketing capabilities, are critical tools to drive top-line growth. We expect this growth and leveraging our advantaged business model through product design, operating efficiencies, and balance sheet discipline will accelerate our profits. The combined benefits of these value drivers offer a compelling investment opportunity for our shareholders as we execute our plans.

May, at this point, please open up the line for questions.

(Operator Instructions) Budd Bugatch, Raymond James.

Yes, this is Bobby filling in for Bud. I appreciate you guys taking my questions.

Hey, Bobby.

Yes, I was hoping just to get a little bit more color on how the quarter progressed, I guess, versus your expectations from the last time we spoke. Was it centered around the election that surprised you, or was it demand throughout the quarter was a little bit surprising? Any more detail there that could help us frame how trends went through the quarter would be real helpful.

Yes, Bobby, the trends throughout the quarter were sluggish and choppy. I would describe them as worse from Q3, and there were some periods of strength like Black Friday and when we pulled some of our contingencies, but these were certainly not sustainable before the quarter.

I would also highlight that post-election, we did see some improvement. But, again, it remains sluggish, difficult to move the consumer, and choppy.

Importantly, flipping the calendar to January, we've experienced a very steady and more responsive consumer since the first of January. So from a day -- day in and day out, week after week within a market share period or outside of a market share period, and that's very encouraging as we think about the year ahead, and different than we've experienced in the last 12 months.

Shelly, what do you think changed with flipping the calendar? Did you guys do something different with your marketing message or targeting a little bit different? What exactly changed if it was sluggish throughout the fourth quarter and then all of a sudden, come January 1, things started to improve?

Yes, well, I think we all experienced the GDP worsened in Q4. Then, as Q4 progressed, we started to see some of the more macro trends coming up, but the retail environment really did not follow until January. So consumer sentiment improved to a high point, but again, we didn't see that until we got into the month of January.

For us internally, we progressed our media initiatives throughout the quarter. So we remained steady, we focused on continuing to learn and advance and strengthen our initiatives against the higher spend from the competitors, and we made progress all throughout the quarter and certainly have continued to here in the first quarter. So we're really excited as we think about launching the 360 later this year and how that will help us.

All right. Appreciate it. And Dave, the tax rate this quarter looked like it was around 25%, 26%. Was there some moving parts in there that caused that?

Yes, Bobby. There was an initiative we took on related to the BAM Labs acquisition. We had some NOLs that were trapped that we were able to take advantage of.

Was that something you guys didn't realize back in October?

It was a -- we had reserved against those NOLs, Bobby, and we did some homework and found a way to take advantage of them.

Okay. And there's nothing -- for 1Q and moving forward, we should think more of a more normalized type cadence for tax, right?

That's right. 34.5%.

I really appreciate the color. I will jump back in the queue. Best of luck going forward.

John Baugh, Stifel.

Thank you for taking my questions. Just curious, Shelly, if you had any thoughts about the developments last week between Mattress Firm and Tempur Sealy, and specific to you all, we don't know what is going to transpire there yet, I suppose. But if advertising spending for the Tempur brand specifically were to decline out into the future, how do you think that might impact you favorably or unfavorably?

Great. Well, John, as we think about this change and other changes in the mattress marketplace right now, we really believe in the combination of our innovation and direct to consumer strategy. This is why we have been investing in strengthening our competitive advantages, and we feel very strongly about being able to deliver superior shareholder value for the long-term with the strategy we are executing against. We will continue to make some big progress this year with 360.

Regarding the spend from Tempur or others, we have modeled our year ahead from a media spending, assuming the elevated levels of media spend in the fourth quarter that we experienced, and that our initiatives are tracking against that level of spend. With fluctuation, we will adjust as we did in the fourth quarter. There was a step-up in the competitive spend from third quarter to fourth quarter, and we did adjust. We may not be able to combat everything within the quarter we are in, but we're going to find our way through it, especially having a vertical model like this. You can see things and react faster and more precisely, and we are making the progress and you can see that in early 2017.

Okay. And we go back to ERP and BAM and, of course, they deleveraged and they were supposed to have leveraging positive. And then I guess we're going to do a little less store activity this year than last year, and yet the flow-through is still fairly low in the low teens. I guess we have now got additional costs with the logistics and the increased spend, I guess, on 360. Where are we in terms of accelerating that earnings growth, or do we just have a more competitive environment, and we've got to spend more on selling and marketing, and we're just not going to get the leverage that we thought, in particular to your longer range EPS target? Thank you.

Yes, thanks, John. The Labs acquisition is absolutely expected to be accretive for us this year. We are very happy with that acquisition. It's been providing us support for the new products that we are coming to market with, as well as helping us take some costs out of our products. And so we definitely feel great about that acquisition.

In terms of the flow-through rate at midteens while absorbing $10 million to $15 million of transition costs, I think that is -- we're talking about at the midpoint of our guidance an 18% increase of EPS inclusive of those costs. And these costs are necessary to make changes to the business that are going to position us for accelerated profits and growth.

In terms of just where does this leave us and trajectory to what are our long-term plans, if you take the midpoint of the guidance of $1.30 and you add the $0.18 midpoint of the transition costs which are one time in nature, you're talking about a mid-30s% growth CAGR at the EPS line to achieve our 2019 guidance. That is directionally in line with where we were at the investor conference, and the growth drivers and profitability drivers are still in place and we're leaning into them.

John, you also asked a question about the sales and marketing and if that was going to impact our expectations, then the answer would be no. We continue to expect media as we have guided all along to be around 14% of sales. We are not counting on additional leverage to achieve the $2.75 from that particular line item. And the increased competitive spend, we continue to advance and pivot with our initiatives to operate more efficiently and effectively in that type of environment. You're seeing in 2017 a little pressure on the top line based on what we know of the consumer environment sitting here today. So, therefore, we are guiding to mid to high single-digit growth. And as we improve the consumer environment, we certainly have some great momentum upside from 360 and our other initiatives.

My final quick question would just be, you still have -- I don't know the exact percentage of mall-based stores and mall traffic has been horrible. I understand that it's worse at low-end malls than high-end malls, but is there any thought here of -- as to how mall traffic is impacting you, and what is sort of the longer-term real estate plan there? Thank you.

That's a great point, John, because we really saw on impact on Q4 that we hadn't seen before, frankly. Our mall base in 2014 a few years ago was 60% of our portfolio. At the end of the year, it was 47%. We saw a shift. We were expecting Q4 sales to be 90% of our Q3 sales, which was our historic norm. What we are seeing is the shift in traffic patterns related to mall versus non-mall stores impacted that sales alignment. And so we saw an 85% relationship, and we have adjusted our models accordingly.

Thanks. Good luck.

Peter Keith, Piper Jaffray.

Just to follow up on John's question just around the flow through and the outlook for the growth, I seem to recall that this past year had about $0.30 of ERP disruption in the first half of the year. So, if we were to add that to where you finished at $1.10, we are coming out at $1.40 of normalized earnings. So just thinking about the $1.48, David, that you gave as an adjusted EPS if we add back some of the expenses, it's really not a lot of EPS growth this year. So I am wondering if there is something beyond the launches that is maybe restraining a bit of the growth opportunity off of what was a challenged 2016?

Right. Let's take a step back and talk about the elements. I highlighted that the net ERP impact was $0.18 for the year. The buildout of that is in Q1, the thing you are missing in your assumptions is that we have benefited from a higher than normal backlog that we carried into 2016. It benefited our Q1 sales by about $21 million and $0.10 of EPS. And we had -- in terms of trying to triangulate on the ERP impacts on the first half, those were -- high -- those are estimates. And I would say that in the end, we are talking to them about $0.25 in ERP impact in Q1 and $0.03 in Q2. That's where we have landed, so the net impact of all that is an $0.18 drag on 2016 earnings.

Okay. Thanks, David. And just to understand on the ERPs, as we look on a go forward basis for benefits now. So you gave the gross margin guidance of 30 to 50 basis points, and then there is some floor model clearance that is probably restraining that. What do you think -- if you can isolate operational benefits from ERP and supply chain manufacturing, etc., what do you think that looks like for this coming year, and can we see that for a couple of years?

Yes, we highlighted in our Investor Day in November that we see an opportunity of about 200 basis point of gross margin improvement at least in that one example. We, frankly, are just tapping into some of these things. There may be more. We're certainly looking for more. But we are -- the 30 to 50 basis points of margin improvement backed on the 80 basis points we achieved this year, it's a pretty healthy rate, and that does have some, as I highlighted, some transition costs, as well as some one-time pressure with the -- from closeout sales built-in during 2017. So we expect some of that to be relieved going into 2018 and beyond.

Okay. Great. One last one for me. So you should generate a fair amount of free cash flow this year. Do you have share repurchases factored into the guidance at this point?

We do. We are assuming about $0.10 of benefit from share repurchases.

Okay. Thank you very much and good luck this year.

Brad Thomas, KeyBanc.

Thanks. Good afternoon, everybody. Wanted to ask about the first quarter and any guidance you could give us in modeling the first quarter. David, as you alluded to, there is an element of a tough comparison and you being up against some deliveries that last year had slipped from 4Q into 1Q that might make a bit of a tough sales comparison. On the other hand, there were a number of appeasement costs. Any color that you can give us on how to think about the first quarter specifically?

Yes, definitely, Brad. How we're thinking about sales, first of all, is given the consumer environment that we've been operating in and what we have been seeing so far, we feel good about the mid-single-digit top-line growth expectation on a year-over-year basis, all elements included.

And then in terms of margin improvements, etc., we -- I think we are -- the run rate that we saw in Q4 benefited from lower incentive compensation than we had expected by about 50 basis points. If you take that adjusted rate into Q1, you are probably in the neighborhood. And then overall, we just -- we have some of those transition costs that I highlighted are expected to flow through. You could use it, spread it evenly throughout the year in your model. That is a reasonable approach.

Great. And then with respect to new stores, sort of an interesting time where this growth rate that you've just wrapped up 2016 with one of the highest that we've seen out of the Company. Can you just give us some color on how the new stores are performing? What level of cannibalization that they are driving to the comp, and what if any notable earnings ramifications you have from having this front-end loaded year where the store growth is so strong at the start of the year?

Yes, so we are really pleased -- we continue to be very pleased with our new store performance. It contributed 7 points to our growth in 2016. But with a cannibalization, we have assumed that it impacted our comp growth by 1.5 to 2 points.

And then, Brad, regarding the new stores for the full year, we will have the benefit of all the stores we opened in Q4, of course, for the full year so that we do expect 4 to 5 points of growth this year.

Great. Thank you so much.

Jessica Mace, Nomura.

My first question is about your forecast for unit growth next year of mid-single digits. The ARU that that implies is flat to positive. Can you give us a little color about what should go into that, whether it is the closeouts you mentioned or how the pricing of the 360 Bed will compare to your current lineup?

The unit growth has -- as I mentioned in my remarks, we are driving to bring more new customers to the brand. That is one of our key initiatives that we have been making progress against, and you'll see that in unit growth this year. We have guided that ARU would be fairly flat or -- that is one of our assumptions as we're looking ahead. At the same time, we are assuming the muted consumer environment and with some improvement there and/or momentum from 360, then we would certainly expect some ARU growth as well.

And for the long term, of course, our guidance assumes we will get growth for both units and ARU.

All right. Great. And for the unit performance in the fourth quarter, is there normalized or maybe two year growth number you can give us or maybe excluding the ERP impact from last year?

You know, Jessica, that's a little bit messy because the year before that had an extra week in it as well. So on a -- it is a little bit dicey to pull out all of the impacts.

All right.

But the year -- but the quarter -- having growth in our units in Q4 was what we expected to have. It was planned. And you recall from last year that we leaned into ARU because putting units through the system when we are -- putting up the new ERP was a strain that we were trying to avoid. And so we leaned into ARU last year. So there is a directional relationship to why our ARU in Q4 this year was a bit lower than it was last year.

Make sense. Thanks very much.

Keith Hughes, SunTrust.

Couple questions. I guess, first, I am a little confused in the last answer. I think we -- I had heard mid-single digits in terms of unit growth for the year but low single digits in terms of same-store sales. That would imply negative ticket. Is that right, or do I have the numbers wrong?

Keith, can you say that one more time? Sorry.

Yes, so is the expectation for the year that units are going to grow mid-single digits and that same-store sales would be up low single digits, implying a negative ticket for the year?

No, we are assuming ARU will be about flat.

But is that correct, units will be at mid-single digits and same-store sales up low single digits?

Yes, we are expecting the growth next year to come from units, not from ARU, and we're expecting most of the growth to come from new stores and comp stores to deliver low single digits.

So what is the delta between the two that would get the same-store sales to the low single digits?

It implies -- there is no -- it doesn't imply anything regarding our comp unit growth if that's what you are getting at, Keith.

Okay. So the mid-single-digit number is not a comp unit. That's total units across the --

That's total units. That's --

Oh, okay. Well, that's the offset. Okay. That's what confused me. Looking at the launch for the years, it was a major launch for you. When it's said and done, will the number of SKUs available be roughly the same as what we have today? Just different SKUs? Is that how it will work out?

Yes, the SKUs will be similar but different as you mentioned. So we will have consistency in our series with the C Series, the Performance Series, and the Innovation Series. But we did close out our x12s, so we will have one less bed overall. We have seven in our new line-up.

But one of the advantages, Keith, that we highlighted during the investor call is the design of the 360 beds in the common parts across the line. So there's some advantages on that side.

Okay. In terms of pricing, is the expectation for the pricing to come in similar to the models that are replacing?

Yes, we're still working on our pricing. Research and studies, right now we are just completing them. So we haven't communicated exactly how we're going to move forward. There is incredible value. We see that and it's finding that right balance between driving and optimizing the demand, along with the pricing power we have with exclusive distribution and the innovation.

Okay. Is the -- in terms of the process for you in terms of launching, how long does it take once you have made the decision to put the bed in the stores to clear out the space, get the inventory in place to be able to ship? How many weeks, months did that take?

For us, because of our -- it makes -- primarily made to order business model, we can make those changes quite quickly, especially compared to a traditional wholesale to mattress retailer. It's a matter of weeks.

Okay. Thank you.

Seth Basham, Wedbush Securities.

My first question is just understanding the guidance for the first quarter a little bit more clearly. You are looking for comps in flattish to slightly down. I guess if you are implying about 10% average store growth and contribution from that of about 60% on guidance for mid-single-digit sales growth. Is that the way to think about it?

It is, yes.

Okay. And the confidence we are seeing an improved comp rate through the year at this point time is driven by what again?

So, again, as we launch our new product line and have closeout sales of our legacy products, we have had some experience with this in the past, and we believe that there is an opportunity for us to grow higher sales in the last three quarters of the year as a result.

And Seth, I would also add what we have seen thus far in 2017 with the steadiness of the consumer behavior, the effectiveness of our marketing initiatives, and then as we get into 360, our ability to market to our loyal insider base, we have a proven formula there that has worked successfully for us through other product launches.

All right. This is quite a big innovation, quite a big launch that you have planned, and I guess you are not baking in too much of an improvement in your sales rate from this product. Is that just out of conservatism?

It is Seth. It's -- considering the environment that we were a little surprised with in Q4, certainly taking on board what we're seeing and the steadiness that we are seeing since the first of January, but giving ourselves room to be able to perform in the consumer environment that is more muted.

Okay. With all these innovations in the 360 Bed, why not take the price up? Where is your pricing power? How are you thinking about that dynamic?

We haven't said that we are not taking it up. Our prices will be similar, so directionally similar to all-in, if you add a number of features today. However, we are aware of the value. We see the pricing power of our innovation strategy and exclusive distribution, and it's matching that with creating a level of demand.

We have a phased approach to our 360 launch and this is where the nimbleness of the vertical model is very helpful as well. So we will have the additional benefit of some in-market real-time testing as well.

Okay. So when you are thinking about the ARU guidance of flat for 2017, there may be some pricing on the mattresses, but you are expecting a change or a decline in attachments of other products? Is that the way to think about it?

Well, it's -- you think about ARU, the ARU assumption we have in right now doesn't assume much for pricing. So maybe that would be a good way to answer your question.

Got it. Okay. And last question is just on the IT Bed and the Kids Bed, other innovations you guys have had in the last two years. Can you give us a little bit more insight into how you are thinking about those contributing to your growth in 2017?

Yes, our primary focus is definitely on 360, which is our core, our profitable core, and will have the biggest impact. Both the IT Bed and Kids we see as adjacent brands, adjacent markets to our core business. They take a backseat to the core. They have helped us advance many aspects of our business, and we do continue to have a robust pipeline for innovation and ways to grow our sales in the future between those adjacencies as well as international.

Got it. And can you give us an update on the tests that you guys ran with the IT Bed in 50 stores? Where are you with that and the plans for 2017?

Yes, it -- first of all, the good news is that this is -- the IT Bed is attracting an incremental customer to our brand. The 25- to 34-year-old tech savvy. There's a similar income level. A little higher income level than we had anticipated, but it is certainly additive to the core brand. We are seeing some of the customers move into -- perhaps about 30% of the customers moving into the overall Sleep Number brand, but they are still coming in through the IT Bed brand.

And the stores we have been showing the IT Bed in, I would say that the sample is still in a place where we are not seeing a significant insight that would tell us to make a change there.

So it's early. We still are benefiting from learning, and we're going to continue to prioritize 360 this year, but focus on a limited number of large markets with the IT Bed. We will set in a few more stores.

Got it. Thank you so much.

Curtis Nagle, Bank of America Merrill Lynch.

Just a quick question. If you could give a little more detail on average ticket for 4Q. I guess what was driving it down a little bit? Was it primarily promotion, the compare, or perhaps a mix? Maybe something else?

I just want to make sure that we are clear. When we talk about ARU, it is not ticket. It is our average revenue per unit. So that is a very different metric than ticket. So we don't actually disclose an average ticket. When we talk about ARU being down 3% on a quarterly basis over prior year quarter, the biggest driver there was really that, ahead of the ERP, we leaned into ARU, meaning that it was not prudent for us to push any more units through the system than necessary in our Q4 as we were launching our ERP.

In 2016.

That was in Q4 of 2016 last year. So our ARU is higher than last year as a result, and the year-over-year comparisons came down a little bit. In total for the year, 2016 was flat to the prior year ARU.

Understood. And then just thinking about store growth and your target by 2019, would it imply a reacceleration in 2018 to 2019, or how should we think about that?

We are on track with the guidance we have provided and will continue to expect between 600 and 650 stores by 2019.

Okay. And then if I can just slip one last one in. Your expectations for inventory, I guess, by store for the year.

Well, we don't typically provide that, Curtis, but I do talk about inventory in total. We ended the year with $75 million. During the middle part of the year when we were in the bulk of the transition and the product line -- the launch of the product line, we will probably have some elevated inventory maybe between $5 million and $10 million and then expect to be close to where we are now by the time we get to the end of the year.

All right. Good. Thanks very much for taking the questions.

(Operator Instructions) Michael Lasser, UBS.

You indicated that you expect to see 50 basis points of leverage from media. Where is that coming from in light of the rising customer acquisition costs and the spend you are going to be making for the new launches and the existing business?

Yes, Michael, we summarized three key initiatives at our Investor Day that we continue to work against and make progress against. One is our overall focus on our loyal insiders for repeat and referral business, which is our most efficient form of media. Also, as we advance our internal buying capabilities, and this helps us with both agility and efficiency which ultimately gets to the effectiveness.

We have been focused on search capabilities in this area, and we're expanding that now to video and social as well, all internal, which allows us to be able to move much quicker and more efficiently as we move forward. And this is where a source of the escalating cost is certainly in search on basic terms.

And then finally, some initiatives where we have been advancing against -- around our TV, find, and efficiency in that area.

Okay. My other question is on the overlap that you have with Tempur Pedic. What does your research show on the frequency that customers shop both your products and Tempur Pedic? How often are you both in the consideration set?

We haven't shared the specific research, but certainly we both offer premium products to consumers that are differentiated. Ours from a differentiation includes adjustable air and, of course, the SleepIQ technology. So we have been very progressive in our innovation agenda with our products and are delivering increased sleep benefits.

Okay. And if there is a dislocation in the market, would it make sense to increase your advertising in order to attempt to capitalize on that dislocation?

Michael, we will compete aggressively with all of our assets in this marketplace. We will compete aggressively.

Understood. Good luck.

I see no questions at this time. I will turn the call over back to the Company for any closing remarks.

Thank you for joining us today. We look forward to discussing our first-quarter 2017 performance with you in a couple of months. Sleep well and dream big.

That concludes today's conference. You may disconnect at this time. Thank you for your participation.