Sleep Number Corp (SNBR) 2003 Q3 法說會逐字稿

Thank you for standing by. Welcome to the Select Comfort third-quarter earnings conference call. All participants will be able to listen only until the question-and-answer portion of today's conference. This conference is being recorded. If you have any objections, you may disconnect at this time. I would now like to turn the call over to Mr. Mark Kimball. Mr. Kimball you may begin.

Thank you. Good morning and welcome to the Select Comfort Corporation third-quarter 2003 earnings conference call. Thank you all for joining us. I am Mark Kimball, Senior Vice President and General Counsel and with me on the call are our President and CEO, Bill McLaughlin, and our Senior Vice President and Chief Financial Officer Jim Raabe. You should all have seen our earnings release issued earlier this morning, but if you need a copy please call Investor Relations at 763-551-7498 and a copy will be forwarded to you.

Please be advised that this telephone conference is being recorded and will be available by telephone replay and will also be archived on our web site. Please refer to the details set forth in our press release to access the replay for our web site. In a moment I will turn the call over to Bill who will share his perspective on our recent performance and our direction going forward. Jim will then provide an overview of our financial results and our expectations for the balance of 2003 and for 2004. Following these presentations, we will open the call to your questions.

Before I turn it over to Bill I will read our Safe Harbor cautionary statement. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary includes and our 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 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 it over to Bill for his comments.

Thanks, Mark, and good morning. A month ago Select Comfort held our first investor conference. We very much appreciated the effort that 25 firms made to be with us in Minneapolis and that many others made to view the webcast of the presentation and ensuing discussion. Our objective of the event was to increase understanding of the long-term potential of Select Comfort, and second, to expose the quality and capacity of our management team. Those that I talked with since seemed to better appreciate and understand our passion and excitement and confidence. They understand we believe we can revolutionize and lead the mattress industry and become one of America's icon businesses, similar to how ten years ago Starbucks developed and changed their industry.

Concepts in presentations are useful, but in the end the results must prove it out. In the third quarter was a test of sorts for Select Comfort. This year our first two quarters were impressive, each with revenue growth versus prior year over 30 percent. But a year ago our growth rates in the first two quarters of the year had been in the low 20 percent. And then jumped up to over 30 percent in Q3 and Q4. So Q3 of 2003 was a test as we were lapping year ago numbers above the 30 percent mark. The fact that this third quarter we achieved 38 percent revenue growth, anchored by 32 percent same-store growth, demonstrates the power of our business model and our team's ability to execute. A truly outstanding effort and I congratulate the entire Select Comfort team.

And Select Comfort clearly is about profitable growth. Operating income in the quarter nearly doubled versus prior year, and EPS was 80 percent better than prior year. We also generated significant cash flow in the quarter. Importantly we are delivering these consistent quarterly improvements while also investing in our future growth. Advertising spending this past quarter was over 50 percent greater than prior year, one testament of this investment. Our focus as we look forward to Q4 and to 2004 is simply on execution. Execution of our proven and familiar initiatives. I know that you'd like to hear about new initiatives, but Select Comfort has so much opportunity expanding and executing our proven programs that this is where we are concentrating our efforts, particularly in Q4.

Our feeling is that if Select Comfort consistently delivers profit growth over 30 percent for the years to come, then everyone will enjoy plenty of excitement and rewards. Quarter four is the highest traffic season in malls where our stores are located and by design we don't want significant change during this period. We want to focus on our customers taking advantage of the traffic and increased awareness of the Sleep Number Bed from advertising and word-of-mouth from the close to 3 million people now enjoying the benefits of the Sleep Number Bed. That said, we plan to continue to invest in media in the quarter four, up to 75 percent more than year ago to support continued growth in the quarter and a fast start to the new year. 2004 is pretty straightforward, as well. Advertising will continue to build. Our confidence is such that we plan to spend more aggressively upfront and manage our flexibility to pull back if in the unlikely event our returns on investment softens. Our plans call for extending our global marketing campaign to an additional 13 markets, bringing the total to over 50 percent of U.S. population receiving incremental Sleep Number advertising support.

We will continue to add stores. At this point planned at 25 to 30 new stores, possibly closing five in line stores in the normal course of business. At this point, we are planning a few of these new stores to be in non mall locations in lifestyle centers. As our experience builds with our non-Mall pilots, we will revisit the number and type of new store adds. Product innovation and quality improvements continue to be a centerpiece of our plan. As you can appreciate, there's not much that we're going to share in this area today. We believe we can achieve a 10 percent operating margin or better in 2004. The continued steady improvement will come from selling and G&A leverage, holding gross margin and marketing more or less constant as a percent of sales. Executing this plan, we believe we will continue revenue growth of 20 percent or better and deliver profit growth of at least 30 percent. Both strong goals on top of two years of accelerated expansion.

We believe that there is upside to these targets, and we will take advantage of opportunities as they present themselves. Our goal continues to be to realize the leadership potential of this business over the long term. Our 2004 plan is not only about execution of our proven strategy, but this is the heart of what will deliver the financial performance. Our plan is to include testing product expansion into sofa sleepers, channel expansion into hospitality and medical and preparing for geographic expansion outside of the U.S. However, none of these efforts are expected to significantly impact our 2004 performance. We believe we can deliver 20 percent revenue and 30 percent profit growth for years to come through our core programs.

These expansion initiatives, if successful, are insurance for the future and opportunities to further accelerate growth. The Select Comfort team is proud of our accomplishments to date, and we remain focused on improving the sleep and the lives of many, many more people going forward. We are prepared for an outstanding year end close and an equally exciting 2004. I will turn it over to Jim Raabe, Select Comfort's CFO at this point to provide more detail and after Jim's comments, then we will open the floor to questions.

We are pleased again to report strong sales and earnings growth. The 117 million of sales in the third quarter was a record for Select Comfort and represents an increase of 38 percent over the same period a year ago with all sales channels growing at a healthy rate. Operating margins continued to improve, reaching 9.8 percent of sales in the quarter and 8 percent year-to-date. We continue to build cash balances while investing in growth. Cash and marketable investments at quarter end totaled $69 million.

Our sales growth continues to be driven equally by mattress units and average selling prices. The number of mattress units sold in the quarter increased by 18 percent, and the average selling price increased by 20 percent. Approximately 40 percent of this average selling price increase is driven by mix improvements that followed the upgrade of our product line during 2002. We began lapping the most recent of these product changes this month. We expect to continue to see increases in average selling prices albeit at a somewhat lower rate. The other 60 percent of average selling price increase is attributable to adjustable foundations which we first started selling in limited markets in the fourth quarter a year ago and which now represent 5 percent of our sales. And other operational improvements, such as return rates which declined again in the third quarter, lower promotional costs and higher penetration of home delivery and assembly services.

Accessories sales remained consistent with prior year third quarter representing approximately 7 percent of our sales. Retail comparable store sales increased by 32 percent on top of a 32 percent increase in the same period last year. We achieved a significant milestone in Q3 with annual sales per store open more than 12 months now averaging more than $1 million. Forty-four percent of our stores have annual sales in excess of $1 million.

Real estate expansion contributed approximately 5 percent to sales growth in the quarter as new stores continued to track to expectation. We opened 12 stores in the quarter with 343 stores open at the end of September. We expect to end the year with a similar number of stores opening and closing two to three stores during the quarter.

Unit growth continues to be driven by increased media spend, more efficient promotional efforts and improved selling prices. Total media investment in the quarter increased to $16.2 million. In the third quarter we increased national advertising by 63 percent, and local advertising by 48 percent. Media expansion is contributing to growth in all geographic areas. Markets that first received local Sleep Number advertising in early 2001 and 2002 continue to perform well with same-store order volume growth in Q3 of 30 percent, demonstrating the sustainability of our growth formula. And our newer markets are responding well, too.

Same-store sales in the Boston market which began airing local Sleep Number advertising in August has grown consistent with what we have experienced in other markets when they first received local advertising. Total market sales in Boston nearly doubled versus year ago in the quarter, seeing the benefits of strong same-store sales plus the addition of 4 stores that opened in July.

Our operating margins improved to 9.8 percent from 6.9 percent in the third quarter of 2002. We now expect full year operating margins to approximate 9 percent. Gross margins in Q3 were 63.8 percent, reflecting strong product mix and less expensive promotional offerings. If you recall, we reported gross margins of 61.9 percent in the second quarter due to proportionately higher wholesale sales in particular our seasonally larger QVC shifts. Q3 gross margins returned to the range that we would expect going forward.

Improvements in our operating margins continued to be the result of leveraging our fixed cost structure, specifically in selling and G&A areas. These leverage points provide opportunities to continue to achieve objectives of increasing media investment and improving operating margins. Media expense as a percentage of sales increased to 13.8 percent in the third quarter.

Now a few short notes on the balance sheet. Our cash position continues to grow even as we invest in new stores, marketing and efficiency generating infrastructure projects. Inventories grew slightly because of increases in home delivery where our inventory in transit is recorded on our balance sheet until the bed is delivered to the customer. Operating free cash flow year-to-date totaled more than $25 million, and we've now utilized all of our net operating loss carryforwards. Crossing this threshold does not affect our earnings but will result in slightly lower cash flows as we begin to make larger income tax payments in the fourth quarter.

Now to our guidance. With our third-quarter earnings announcements, we are issuing updated guidance for the fourth quarter as well as new guidance for 2004. We have raised our expectations in the fourth quarter for both sales and earnings. In this last quarter of 2003 we expect sales of between 125 million and 132 million with earnings of between 22 cents and 25 cents per diluted share. These numbers reflect the incremental media spend that we announced in September, along with related sales growth. Our guidance reflects same-store growth of between 25 percent and 30 percent.

The fourth quarter of 2003 has 14 weeks, while the comparable period in 2002 and 2004 will have only 13 weeks. Our same-store sales growth rates are calculated on an equivalent week basis. We expect full year 2003 sales to exceed 445 million, with diluted earnings per share of between 64 cents and 65 cents, more than 70 percent higher than our 2002 pro forma earnings of 37 cents per share. Our expectations for 2004 are consistent with our communications over the past 18 months. We expect to sustain sales growth in excess of 20 percent and earnings growth of 30 percent or more.

Our 2004 guidance reflects company sales growth of between 20 percent and 25 percent to between 535 million and 565 million. Same-store sales are expected to grow approximately 20 percent, lapping same-store sales growth of 27 percent in 2002 and an expected 30 percent in 2003. Unit growth is expected to be the primary driver of sales growth in 2004 through same-store growth and new store openings. Supplemented by average selling price improvements although to a lesser degree than in 2003. Our retail channel will be the focus of our growth as we continue to leverage the existing fixed cost structure. Sales in retail are expected to grow approximately 25 percent in 2004 while other channels direct, e-commerce and wholesale are expected to grow at healthy low double-digit rates.

Operating margins are expected to improve between 1 and 1.5 percentage points. Our points of leverage will be similar to those in 2003, primarily selling and G&A expenses. Media as a percentage of sales is expected to grow to slightly more than 14 percent as we aggressively pursue growth in product and store awareness. Gross margins should remain in the 63 percent range. Operating leverage on top of sales growth results in an expected earnings range of 84 cents to 90 cents per share, more than 30 percent higher than our 2003 guidance. We are in the process of finalizing our internal plans for 2004 and therefore are not providing specific quarterly guidance at this time. However, approximately one-third of our 2003 earnings were earned in the first half of the year and two-thirds in the second half. We would expect a similar distribution in 2004 with Q1, Q3 and Q4 being stronger seasonally than Q2.

Over the last two years we've demonstrated Select Comfort's long-term potential in both sales and profit. We've proven our ability to deliver aggressive and consistent quarterly growth while also investing sustained long-term growth. Our business model provides a high degree of profit leverage on sales. A 1 percent change in sales can drive a 5 percent change in earnings. Our most significant discretionary expense is media which we believe provides its greatest payback over the long term. We plan to continue to aggressively invest in media expansion and will spend incrementally when performance dictates. And are prepared to pull back spending if we experience a decline below our expected return on investment.

We had a great third quarter and are looking forward to continued successes. Our 2004 plans reflect aggressive sales and earnings growth rates that provide room for additional investment and growth that we believe can be sustained for the long term. Thank you, and we will now open it up to questions.

(OPERATOR INSTRUCTIONS) Joanne Henry with Fieldstone Research.

Good morning, and congratulations on the quarter. In terms of Bed, Bath and Beyond stores, I know you've been looking at those for a while. Is it possible that you would do a wholesale -- and by that I mean a general move away from that type of store from being inside a store with general merchandise, or do you see looking at Bed, Bath and Beyond more selectively in terms of some of the stores doing really well, others maybe not the right venue for you?

We have today 13 Bed Bath stores, and they are included in our store count. Our agreement with Bed Bath is reviewed periodically both on an individual store basis and on a total basis. And we have not factored in any increase or decrease into that store count into our plans looking forward at this time, though that is always subject to change as we work through meeting with Bed Bath and Beyond's interest and ours.

Okay, so just from reading the comments in the press release I could not tell if you were a little bit foreshadowing doing something on a bigger scale regarding the Bed Bath and Beyond --.

We were just trying to clarify the point that as we were building our guidance on numbers of stores and all it was primarily focused on what we are doing in the malls and in the non mall locations. And we just haven't had any further discussions with Bed Bath and Beyond at this time.

I just want to follow-up on the non mall locations, the pilot stores, I spend more time at the Arbor Lakes store, it seems to be going really well. Can you give us a better handle on what kind of numbers you are getting or how that's looking? I know it's very early.

The question deals with Arbor Lakes, which is the first of our non mall lifestyle center pilots that we have. It's been open about a month, and its doing very well. It's meeting all of our expectations, and then last week we -- maybe it was this week -- we opened Boardwalk in Kansas City so we now have our two pilots open, and we will be monitoring the results.

Okay. Thanks a lot.

Steve Denault with Craig-Hallum Capital.

I think I heard you mention sort of a comp number for some of the more established markets, and I think it was 30 percent. Did I hear that correctly?

That's correct. The comp in the markets where we have the advertising for two to three years was at 30 percent in the third quarter.

Okay, and the Boston market itself sales had doubled and the store base went from what to what again?

The store base went from 6 to 10 and we added 4 stores. Those 4 stores were opened during the course of July. So we didn't get the full effect of those stores, and we also did not get the full effect of the advertising because that started in August.

Okay, fabulous. And if I could just ask one more. I was intrigued by the pressure mapping technology that you displayed at the analyst day. Can you give us an update on that?

The question is about pressure mapping which is an in-store selling device that we have developed in a proprietary way to be used on the Sleep Number bed, and it helps consumers visually understand how the bed is removing pressure points as they adjust to their Sleep Number. We had it in tests in nine stores, and in early -- within the next few weeks we will be expanding into I believe it is 25 stores. And we will monitor the results of that and expand beyond that next year if all continues well.

Okay, so so far so good with that.

Very strong.

Thank you.

Laura Richardson with Adams, Harkness & Hill.

I think I heard you say media spend is going to be about 14 percent of sales next year, and I was thinking way long-term, like three to five years out and wondering if there is any notion of getting that percent under 10, which would be very nice thing for profitability.

Yes, Laura, as we have said over time we believe there will be a point in time when we can start to get some leverage out of our marketing spend. We don't see that at anytime in the near future, meaning the next two to three years. But looking out further, yes, we believe we can get leverage out of the marketing and specifically the media line and not willing to put a number around that at this time. But we know that there are clearly leverage opportunities.

Just to follow-up on that, if I am thinking really long-term on you all, someday you'll probably be advertising on national TV like a lot of retailers are doing now, but you will be big enough that the added spend as a whole will be a lower percentage of sales than it is now. Is that a fair assumption?

I would characterize that as a fair way to look at our future, yes.

Okay, thanks guys. Good job this quarter.

Kyle Stoltz (ph) with William Smith Company (ph).

I just had a question on some of your longer standing markets, are you seeing any signs of maturation as far as individual stores?

No, we really haven't. Our most mature store is Minneapolis, and it continues to grow at a very strong rate.

That is all I have. Thank you.

(OPERATOR INSTRUCTIONS) Brent Rystrom with Piper Jaffray.

Could you reveal real quickly for me your share count expectations for the fourth quarter and for next year?

Yes, the fourth quarter expected share count is about 40.5 million, which will bring the full year average share count to a 39, to about 39.3 million. That is on a fully diluted basis for EPS purposes. Actual total potential shares outstanding is about 42 million. But then 2004 we would expect the EPS calculations to work off of about 41.5 million shares.

Joan Storms with Wedbush.

I just have a few quick questions. One on the sales mix during the quarter, we obviously know that retail is the driver here but you had a nice increase in the wholesale at QVC, if you could update us on that segment there. And then also what are your specific plans if you can share them with us on your focus during the fourth quarter to take advantage of the mall traffic and getting people into your stores?

The first part of your question on wholesale, and Bill will take the second piece. But just remind everybody first of all that the wholesale there is a couple of things that are going on in wholesale. First of all it's working off a very low overall base, and so we do see some on a year-over-year basis and quarterly some fairly large fluctuations just based on timing of QVC shows as well as timing of orders from existing retail partners. And that is some of what we saw in Q3, certainly that whole business is tracking along to our expectations. We did have a couple of good QVC shows in the quarter, and the retail partners are really now the two largest retail partners Sleep America and Sleep Train were really just lapping first-year results now from a year ago. So those are really the primary reasons for the increases in the wholesale in Q3. We continue to work with those relationships and try to improve that business.

In terms of the balance for the fourth quarter support program, it is quite similar to what we had done in the past. We've got a great October event already kicked off where the focus is on the second bed for people to fill out their homes for kids and guest bedrooms, and also a good tie-in with the Ronald McDonald House partners where we are continuing to improve the sleep in the lives of kids in the Ronald McDonald houses and their families. In the balance of the quarter, the emphasis continues to be on advertising to increase awareness and drive traffic to the stores. Our promotional and (indiscernible) programs, the rate of spend will be about what we've been spending, to nothing out of the ordinary there. We are actually continuing to be able to hold the line actually lower a bit and drive the sales that we need. And then in the fourth quarter we also always emphasize accessories a bit more so the pillows and blankets and all of that make great gift items. And we have significantly increased our merchandising and sales support behind those for the fourth quarter.

And then also, quickly, you increased the number of markets that you are going to expand the branding campaign to next year. We know that New York and Los Angeles are going to be a focus over the next two years. Can you share any of the other markets with us?

Not at this time for several different reasons, but what I can share is that we are continuing to use the model that we've been using to date to select those markets, primarily for payback within a year, that's how our model works on a couple of these larger major metro markets we extend the payback timeline a bit on those. But basically as our business builds and we can generate the return on the marketing, we are expanding it.

Thank you.

Laura Richardson with Adams, Harkness & Hill.

Since there were not a bazilian questions I figured I would ask about the statement in the press release on the 10 B-1 plans you all are adopting. And if you could refresh us as to how much stock some of the key executives sell, and also how much of that was money that you all put in when you joined the Company versus options granted since then? Thanks.

You know, we have a very high-quality management team that has been together for the past three years and really set the direction that has helped the company achieve the results it is now. Earlier this year we established guidelines for our senior executive team and our Board to minimum holding requirements. And all members do meet those requirements today and will even after the planned sales, we all have significant commitments to the Company. But we are now starting to take steps that begin to diversify some of our personal investments. It's a mixture, and I don't have the numbers in terms of what the exact mix is of options versus personal investments, but a lot of the sales that are happening now will be from options. In my case some of them are personal investments as well. But again, the net total of the maximum amount that will be sold under this plan over a year's time is just 20 percent. And that a lot of things have to happen right for that amount to -- its really a small amount for most of the individuals, and it's designed to start diversifying our personal investments.

It's totally fair, you guys have earned that. Just Bill, if you even have a rough number on the top of your head -- because I remember being impressed when I first met you that you did have the personal commitment not just put your career into this company, but money as well.

Well, and that was both some of my personal side but also some on my family business side, and that is that family business did make a major investment in the Company at the turnaround stage, and that is managed separately. I'm not involved with that.

So that's not part of the 10 B 1?

No, a lot of good reasons in the family and in the Company, I don't get involved with the decisions around (inaudible).

Okay, thanks.

Joanne Henry with Fieldstone Research.

QVC, timing next year, just to clear up a couple of things as we look at the quarter -- is it similar, will it be May/June for the big show again?

Joanne, it's a good question, and it's one that we just don't know yet either because it is a lot of it is obviously driven by QVC. And they don't set their calendar for a while. We are going to build our calendars basically planning on the same timetable and as things change we will have to be communicating that with you.

Okay, so for now an assumption that QVC would sit in the second quarter seems reasonable and that would be a mix change increasing wholesale in Q2 then?

Similar to what has happened this year.

Okay, thank you.

Patrick Donohue with Northland Securities.

Will you need to make any significant investments in 2004 on the equipment upgrades or expansions and specifically equipment to produce the sleeper sofa?

We are still developing the plans. We have a number of different things that we will be doing from a capital standpoint being it store, store buildout and some infrastructure building from an IT standpoint, as well as some operational plant improvement type of items. The amount that we will spend on capital hasn't finally determined, but it is somewhat higher than we communicated in the past, it will probably be up a little higher than 20 million next year. The capital specifically with regard to sofa is nominal at the most because we are working with an outside partner to help develop that product and to build the furniture piece of that.

And for 2003 can you give me a feel for where you are going to end the year for CAPEX?

Capital in 2003 will be around 18 to $19 million in total.

Thank you.

Steve Denault with Craig-Hallum Capital.

You partially answered it. The CAPEX expectations for 2004 should be something in excess of 20 million?

Yes, I would say probably work off of 20 to 25 million, in that range.

Okay.

We will finalize it in the near future and be able to communicate it that way.

Okay, and then the age-old question, what do you do with all the free cash flow?

I guess starting from the point of we don't feel as if $70 million is an unusually high number for a company that has got over $400 million in sales and growing very quickly. Our objective with the cash, though, is to manage it from the standpoint of being a growth company and maintaining the flexibility, looking for opportunities that might allow us to do things from a growth standpoint, nothing that's been identified in particular but we do want to maintain that flexibility. So for the time being we don't have specific plans, and we will continue to invest that and look for opportunities.

Thanks.

Sir, we have no further questions.

Thank you. At this point we will conclude our conference call. We thank you all very much for participating and your continued support.