Sleep Number Corp (SNBR) 2004 Q1 法說會逐字稿

Good afternoon and thank you for standing by. At this time, all participants will be able to listen only until the question and answer portion of the conference. I'd like to introduce your conference speaker for today's call, Mr. Mark Kimball, Senior VP and General Counsel. Sir, you may begin.

Thank you, Elaine. Good afternoon and welcome to the Select Comfort Corporation first quarter 2004 earnings conference call. Thank you all for joining us. I'm 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. In a moment, I'll turn the call over to Bill who will provide some first quarter highlights. Then Jim will provide a review of our financial results and update on our expectations for 2004. Bill will conclude with an update on core strategies before we open the call to your questions.

Please be advised that this telephone conference is being recorded and will be available by telephone replay and will also be archived on our website. Please refer to the details set forth in our press release to access the replay on our website. 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.

In addition, our commentary and our responses to your questions may include references to certain non-GAAP financial measures in order to provide the most meaningful information and to improve comparability between periods. Information required to be disclosed about these non-GAAP measures, including a reconciliation of the most comparable GAAP measure is available through our periodic filings with the SEC and included in the investor relations section of our website at www.selectcomfort.com. I will now turn the call over to Bill for his comments.

Thanks Mark. Good afternoon and thank you for joining us today. Earlier this afternoon, we announced that first quarter earnings per diluted share increased 64% to 18 cents. On our last two conference calls, I've stated that execution of our proven and familiar initiatives will drive growth in 2004. And our Select Comfort team continues to execute admirably.

I would like to acknowledge and thank our team for delivering yet another quarter of strong results. In the first quarter, revenue increased 37% compared to a year ago, fueled by strong sales in all channels and a 25% gain in comparable store sales. This performance is even more impressive considering that we were up against a tough comparison of 30% same store growth in the first quarter of 2003.

Same store sales continue to grow at double-digit rates in all local media markets, even as we add stores to our more developed markets. The 12 new markets first receiving media programming in January of this year are also off to a good start. Average sales per store at the end of our first quarter totaled $1,166,000, nearly double the comparable number from just two years ago. Once again, leverage -- I'm sorry.

We, once again, leveraged the increase in sales as operating margins improved 180 basis points and net income increased 79%. Importantly, our growth continues to be self-funded and we are debt free with cash at the end of the quarter of $84 million. Before I turn the call over to Jim to provide more details of our results and updated guidance for the year, I'd like to talk about the execution of our core strategies in the first quarter. Our results clearly show that we continue to execute well. We are pleased with our progress against our strategic objectives.

First, we expanded our branded and consumer franchise. We invested $21.6 million in Sleep Number media spending, which represents 48% increase from the first quarter of 2003. National advertising support increased 32% in the first quarter. And local advertising investment grew by 77% over a year ago as we expanded our incremental programming to 12 additional markets, including some large metros such as Houston, Los Angeles, and Seattle.

Furthermore, national unaided branded awareness increased to 8% by January of this year from 4% a year ago. Second, our store expansion program remains on target with our stated goals for 2004. On April 3rd, 2004, our store count stood at 351. We opened nine new stores during the first quarter while closing two stores. We plan to open 12 additional stores in the second quarter, including five in the New York metropolitan area.

We also expanded our non-mall tests to a third location at the end of the quarter and will open a fourth in second quarter. While too early to draw firm conclusions on the long-term performance of these stores, we are pleased with the results to date and are optimistic that this format can provide flexibility to our longterm real estate plans. Third, we continue to advance product innovation. During the quarter, we prepared the launch of our new Sleep Number 9000 bed, which was introduced nationally in early April.

We developed the 9000 because we saw an opportunity to capture customers at a higher price point than our previous top-end product and continue advancing our technology and competitive advantage. We also prepared our sofa sleeper product for a single market pilot introduction in April. Both of these initiatives are off to good starts. And I'll now turn the call over to Jim Raabe to review financial results and thoughts on the balance of 2004.

Thanks Bill. As usual, I will begin my comments by taking you through the income statement and providing the details of our first quarter performance. Then I will discuss our balance sheet and conclude with updated guidance for 2004. As Bill stated, revenue grew by 35% with comparable store sales increasing 25%. Our record revenue of $140 million stemmed from strong gains in all of our sales channels. Sales in our company-owned retail stores grew 34%.

Our direct channel experienced a 27% gain in sales while e-commerce sales increased 54%. Sales to our wholesale partners rose 147%. Retail sales accounted for 76% of all sales. Direct represented 13% of the total while e-commerce and wholesale accounted for about 4% and 6%, respectively. The average selling price in our own channels came in at $1,818 per mattress, or up 16% compared to last year.

We were positively surprised in the quarter by product mix and in particular, sales of adjustable foundations, which was the most significant contributor to the increase. Accessories continue to represent 7% of our sales. Our gross margin did decline to 61.5% from 62.7% a year ago. Our sales teams are doing a very good job with their sales presentations, which is resulting in the adjustable sales -- adjustable foundation sales and home delivery penetration above our expectations.

At the same time, however, the adjustable foundation is our lower percent margin product since it is not self-manufactured and our home delivery service offers no margin at this early stage of its development. As a result, the increased revenue did not flow through as as completely to the bottom line. Both adjustable foundations and home delivery have also seen recent cost pressures due to fuel and steel increases, the latter of which had a more significant impact on our direct competitors. We will take pricing action in the second quarter on these two non-core bed items to maintain and improve margins.

One additional factor contributing to lower growth margins in the first quarter was the increase in wholesale sales which represented 6% of total sales. We had several very good shows on QVC and our retail partners continue to grow their sales of the Sleep Number beds. The leverage in our economic model allowed another improvement in operating margin from 6.5% a year ago to 8.3% in the first quarter this year.

Selling expenses and general and administrative costs continue to be the primary contributors to our leverage while we expand our awareness driving media. Now I have a few comments on our balance sheet. We generated free cash flow of about $6 million and ended the first quarter with cash in marketable securities of $84 million, compared to $75 million at the end of 2003. You'll note from our balance sheet that we've shifted a greater percentage of our cash to investment grade securities with longer term maturities while remaining very liquid.

Accounts receivable increased to $11 million, the result of a large QVC show near quarter end. While inventories remained relatively constant at $12.8 million. Inventories will continue to increase slowly, due mainly to the increasing popularity of our home delivery service and the increase in the number of our stores. If you recall, our in-transit deliveries for home delivery are classified as inventory until beds are set up in the home. Our balance sheet remains debt free.

I want to take a moment to underscore this point because we believe our balance sheet is the strongest among our closest peers. We continue to believe we can self fund our growth with our free cash flow and expect to add another $20 million of cash in 2004. Now, for our guidance. Continue performance of the Company's advertising and and growth and programs and no significant changes to U.S. economic recovery.

Mattress industry growth rates are competitive reaction to the company's recent success. The company raises its expectations to full-year EPS to 92 cents to 95 cents a share. Revenue expectations are also increased to the range of $565 million to $585 million with same-store sales growth expected to be between 20% and 25%. For the second quarter of 2004, the Company expects to generate revenue of $126 million to $131 million.

And earnings per share in the range of 13 cents to 15 cents with same store sales growth expected to be between 20 and 25%. Expected second quarter earnings do not follow our historical patterns due to several factors. First, as we noted last quarter, our largest QVC show of the year has been shifted from the second quarter to the third quarter. Second, as noted earlier in our comments, we have seen some increases in commodity prices over the last several months.

While we plan to take price increases on selected products, these increases will not take full effect until later in the quarter. And third, we have changed the pattern of our media spin versus what was done in prior years. Historically, we've lowered our media investment in the second quarter to correspond to mattress industry seasonality.

This year with the expansion of local media spending in 12 additional markets, we will sustain media exposure at proportionately higher levels during the second quarter as we build the Sleep Number brand for the longterm. The net effect is that we expect to see lower operating margins in the second quarter while continuing to expand sales and earnings. Our core strategies remain intact for the remainder of the year. We expect to invest over $80 million in media during 2004, up from $60 million in 2003.

We will expand our store distribution by between 25 and 30 new stores focused primarily on our new local Sleep Number media markets and major metropolitan areas and then also through product innovation with the introduction of the 9000 model and the sofa sleeper test in April, with improvements to the remainder of our product lineup to come over the course of the year. We continue to set guidance ranges in line with our goal of sustaining annual sales growth rates of 15 to 25% and earnings growth rates in excess of 30%. In closing, we had a strong first quarter and remain confident in our growth prospects for the full year. I'll now turn the call back to Bill for some concluding comments.

Thanks Jim. We've now delivered 11 consecutive quarters of profit and nine consecutive quarters with extraordinary revenue growth and we believe we are on the right track to continue revolutionizing the sleep industry into building a great company for all our constituencies. We're excited about our initiatives for this year.

2004 is expected to feature exciting and important advances in our strategic and competitive advantages that are important for 2004 performance and for growth for the years to come. We are enthusiastic about our new creative advertising programs and our market expansion plans, particularly in major metropolitan markets such as Boston and New York. And the results from our ongoing product innovation efforts as well. I'd like to conclude our prepared remarks by summarizing our key strengths. We have a product and a growth formula that's been proven over the past three years and that addresses a strong and growing consumer trend for personal comfort and quality sleep.

We have a small share of the national market and a significantly higher share of local markets. It is now a matter of execution and with each quarter we are proving we can execute very well. Select Comfort has a unique and advantaged business model and is the only vertically integrated major bedding company.

We manufacture Sleep Number mattresses and sell them primarily through our own retail distribution channels, provide customer support through our in-home delivery service and provide follow-up customer support to our own call center. Not only does this integrated process give us the opportunity to control quality and service at every customer touch-point, but also, it offers opportunity to continue to improve operating efficiency and to expand our profit margin. Our business model also allows for low inventory and efficient cash conversion. I've said this before, but it's worth repeating.

In 2003, we generated $458 million of sales while maintaining our inventory level below $13 million. We have very low inventory risk versus other mattress manufacturers and retailers and we believe it would take years for our competitors to replicate our business model. We are confident that we can continue to achieve our longterm objectives of 15 to 25% revenue growth and 30% EPS growth over the next several years, assuming no major economic disruption.

We continue to be positive and passionate about our growth prospects and our ability to achieve a leadership position in the sleep industry. We are focused on execution and we are well-positioned to support our growth, expansion and innovation. Thank you for joining us today and we will now turn the call over to Elaine, who will poll the audience for questions.

Thank you. At this time we are ready to begin the formal question and answer session. If you would like to ask a question, please press star 1 on your touchtone phone. You will be announced prior to asking your question. Once again, to ask a question, please press star 1. One moment please. Our first question comes from Lori Brunner from Craig Holman. You may ask your question.

Okay, thanks. Good afternoon, guys. A couple of questions. From your feedback that you're getting from the stores, who is actually buying this Sleep Number Bed in the early days? Do you have a feel for it? Is it your existing customer or are you seeing new customers that are purchasing this new bed?

Lori, I think the question pertains specifically to the model -- the new model 9000?

It does.

Yeah. The feedback we've been getting so far is that there's -- I mean, it's very early so there's -- the representation here is small. But it is basically the same flow of customers that we've been seeing so there are a few existing customers coming back to upgrade but primarily it has been new customers.

Okay, great. And then you talked about some price increases, I think, in adjustable foundations and then home delivery, is that right? And could you talk about the degree of those price increases and when will we see those?

The home -- the home delivery price increase was taken last week. And the price went from $79 to $99. And the adjustable foundation price increase is -- will take place in the next month and that will -- that I'm not in a position to share what that increase will be at this time.

Okay. And then your non-mall stores, are those -- I think you mentioned there are three of those, are they in lifestyle centers?

Yes. They are primarily -- yes, they are in lifestyle centers. We're -- the closest one here is at Arbor Lakes and Maple Grove.

Absolutely. And have you talked at all about the economics of these locations or what the potential is versus your existing mall locations?

Yes, Lori. The economics are generally similar. There are certainly different factors that affect them, these non-mall stores tend to have a larger footprint with a smaller rent per-square-foot. But the staffing is a little bit heavier because they're in more of an open air situation rather than in a mall. But the overall economics should be very similar to our mall, at least as we're rolling out. We may find, as we get more experience, that we can do some things differently. But for now we expect them to be about the same.

Okay. Great job, guys. Good luck. Thanks.

Our next question comes from Mark Rupe [ph] from Adams Harkness. You may ask your question.

Hi guys. A couple questions here. Any idea what the gross margin would have been excluding the increase in commodity prices?

No, I don't have -- I don't have that number specifically.

Okay. Of the 16% increase in ASP's, any idea how much was attributable to the adjustable foundation?

Most of it was -- I shouldn't say most of it. The biggest piece of it was related to adjustable foundations. There was also a fairly big component that continues to be just improvement in overall product mix.

And I don't know if you mentioned on the call, the media spin in Q1 overall?

The media spending in Q1 was $21.6 million.

Thanks.

Our next question comes from Joan Storms from Wedbush Morgan. You may ask your question.

Hi, good afternoon. I'm sorry. I missed the part on the growth margin decrease and you had talked a little bit about the increase in steel price, increase in gas prices. And what was the other piece of that? For the down gross margins?

It was the just the mix of precision comfort was a piece as well, and that being a lower margin product because we do not manufacture it. And the third component was the fact that wholesale was a greater percentage of our overall channel mix in the first quarter.

And also, quickly, on the 12 new markets that you've gone into for the first quarter, can you talk about your strategy there as you go throughout the year? Last year you had tied a little bit the introduction of those local campaigns to real estate openings and what the strategy is there?

I would say that the strategy with regard to the 12 is not -- is the same as it has been for our media openings over the past couple of years, which each one of those markets has reached a store density and a sales density that supports the addition of local media. We taylor that media to the individual market based on that density and the cost of media and other factors and then we continue to look for new real estate locations to continue to expand into those markets so that we can further leverage the media. Now, the New York market which we'll be adding local media to later in the year, is coming later in the year because we did want to get some additional real estate locations in place prior to turning the media on and we're -- we've made very good progress in that regard.

Great. Thank you.

Our next question is from Greg Mckinley from Dougherty & Company. You may ask your question.

Thanks. I wonder if you could just give us a little bit more color on gross margins. I know the adjustable foundation of delivery service in terms of margin percentages are negative relative to the rest of your product mix. Can you give us a little color on what happened with your four core mattress skews during the quarter? Did those margins stay stable at the product level? Or was there a more promotional environment on selling those this last quarter?

The margins on our core product remain very stable. The -- there was no more promotional aspect of our product offerings this quarter as compared to a year ago or anything out of the ordinary that we don't typicall do. So no margin changes as a result of promotional activity and no margin changes in that core lineup over all.

Okay. The media spend in Q1, I think you mentioned was like $21.6 million. Your 45% anticipated growth for Q2, does that put it at about, is it $18.3 million or so that you're expecting Q2?

It's a little bit less than $20 million, yea. It's right in that range.

Okay. And with 12 new stores opening in the second quarter, what type of grand opening expenses are you anticipating as a result of that large of a number of store openings?

Our model doesn't really include significant grand opening expenses. So as Jim said earlier, those new markets are being opened in markets primarily that have advertising, so the levels of advertising will support all of the new store openings.

Okay. As far as your price increases are concerned, are there any plans at all to touch the mattress category or the accessory category outside of the foundation and delivery service? Or is that the only place where pricing adjustments are planned?

Not -- there are no further price increases planned at this time.

Okay. Thank you.

Once again, if you would like to ask a question please press star 1. Our next question comes from Laura Richardson from BB&T Capital. You may ask your question. Ms. Richardson, your line is open. Please check your mute button. Okay.

Can you hear me now?

Yes, ma'am.

Okay, hey Jim. Hey Bill.

Hi Laura.

On the comp guidance for the second quarter, are you assuming similar ticket growth to what you saw in the first quarter?

I would say it should be in the same range, probably a little bit lower. The affect of the adjustable becomes somewhat less and there are other model lapping that continues to be somewhat less. We should get some benefit from the 9000. But probably a little bit lower than what we saw in the first quarter.

Okay, that makes sense. And then in terms of the gross margin, you're saying it should be down a little year-over-over year but not as much as in the first quarter partly because of what you said about the adjustable foundation and partly because of the price increases?

Yeah, and the other piece was the QVC piece which also affected being down and with the pricing changes that we make, we think that going forward, our -- our gross margin should move back toward our historical levels in that 62 to 63% range.

Should move back? You mean like by third and fourth quarter?

Improve in the second quarter. They should be improved in the second quarter versus the first quarter.

But still -- but still down a little bit from last year's second quarter, right?

We think they'll still be -- we think they will be in that 62 to 63% range in the second quarter and through the remainder of the year.

Okay. Thanks, Jim.

Our next question comes from Joanne Henry from Fieldstone Research. You may ask your question.

Hi, this is Lee Schupe [ph] actually for Joanne. Good afternoon, everybody. Carving off a second QVC, I just wondered if you could comment on your expectations for your wholesale business going forward? A lot of the attention in the story is focused on execution retail. But I'm curious about you expectations with respect to wholesale in that segment.

We still believe that our retail stores and our company-owned channels will continue to drive the majority of our growth. That said, we continue to be very pleased with the development of this wholesale channel as a way to extend and leverage the brand equity that we're building. QVC, as Jim said, in quarter one was very strong and we see that continuing throughout the year. And the Q2 issue that's being discussed is really just a timing issue within the QVC calendar. And our retail partners continue to grow as well and we're evaluating how to continue to strengthen those partnerships.

Are you looking to add retailers to your group of wholesalers? Do you have the guys you want?

At this point, we are -- we do not have any significant new retail partners that will be added. Though, the reason I'm hesitating a bit is we're in constant discussion with many. And our standards are pretty high and we do not see that as a major part of the growth. There may be a couple of additions in the balance of year here as we look at markets that have development opportunity.

Okay. The reason I'm asking is because you've been such a big winner here the last year-and-a-half or so, we can imagine people coming to you, wanting the product. I just wanted to get a sense of what the future of those kinds of discussions were.

Yea, that's why I was hesitating a minute ago, because you're right. We do have many, many potential partners coming to us and we are in constant discussion with quite a few, but again, our standards are pretty high and as our sales through our stores continue to increase, the need and opportunity to extend to retail partners is lessened in a lot of those core markets.

Okay. Thanks. Appreciate it.

Our next question comes from Lori Brunner from Craig Holman. You may ask your question. Lori Brunner, your line is open.

Hi. Thanks, guys. A couple of follow ups. With regards to the products you're relaunching, I was wondering if you could give us some clarity on the timeline of those relaunches.

As was the case with the 9000, both from consumer -- for consumer reasons as well as our with our store personnel, we do not announce that until we come very close to the time to announcing those changes.

Okay. And then, Jim, can you just refresh me on the economics of the home delivery business?

Basically, it is -- it has the same economics as shipping a bed by UPS. There's a cost to shipping a bed by UPS. There's a cost shipping a bed by home delivery that is higher than the UPS cost, but we have a charge to the customer that covers that difference though the net cost to Select Comfort, whether you take delivery of the bed by home delivery or by UPS is the same.

Okay. And then, with regard to the positive response that you saw from the adjustable foundation in the quarter, just wondering where the recent momentum comes from? Was it promotionally driven or did some selling techniques at the stores change? What was different during the quarter that drew more people to that product?

There was no change in the promotional structure. I think it's really a function of it's now been in many of the stores for a year and the sales pros are just increasingly comfortable with the presentation of it.

Okay, great. Thanks.

our next question is from Greg Mckinley from Dougherty & Company. You may ask your question. Mr. Mckinley, your line is open, sir. Sir, your line is open. Mr. Greg Mckinley, you may ask your question. Thank you. Once again, if you would like to ask a question, please press star 1. At this time we have no further questions.

Okay. Well, thank you very much for joining us on the call and thank you for your continued support and this will conclude the call. Thank you.