Sleep Number Corp (SNBR) 2004 Q2 法說會逐字稿

Welcome to today's Select Comfort second-quarter earnings conference call. At the (technical difficulty). Following today's presentation there will be a formal question-and-answer session. At that time instructions will be given. Until that time, all lines will remain in a listen-only mode. At the request of Select Comfort, today's conference will be recorded for instant replay purposes; any objections, one must disconnect at that time. I would now like to turn the call over to Mark Kimball, Senior Vice President, General Counsel. Sir, you may begin your call when you are ready.

Thank you. Good afternoon and welcome to the Select Comfort Corporation's second-quarter 2004 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. In a moment, I'll turn the call over to Bill, who will provide some introductory remarks. Then Jim will provide a review of our financial results in more detail on the updated guidance that we provided on July 12. Bill will make a few concluding remarks 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 non-GAAP financial measures, including a reconciliation to the most comparable GAAP measure, is available through our periodic filings with the SEC and is accessible through the investor relations section of our website at 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 to discuss our second-quarter 2004 results.

As many of you are aware, we held a special call to discuss sales on July 12 in which we expressed our long-term confidence in the business and shared that a component of our growth formula, same-store sales, came in below trends and expectations during the second quarter.

Last week's call covered a good portion of the essential information. We discussed our sales performance and analysis of what happened in the second quarter and the actions we have taken and will take to address the issues. At this point, it is clear to us that what is important is that the actions we implement lead to improved comparable store growth in the third and fourth quarters of 2004 and beyond. These data points overshadow anything that we can say today, and as such, we aim to keep our comments today brief.

Earlier this afternoon, we announced second-quarter earnings per diluted share of 15 cents compared to 12 cents in the second quarter of 2003. As we released last week, sales increased 22 percent to $124.7 million. For those of you who may have missed the call, a replay can be accessed in the investor relations section of our website at SelectComfort.com.

The fact that we were able to deliver EPS at the high-end of our guidance range, in spite of sales coming in slightly below the low-end of our guidance, demonstrates the leverage inherent in our business model, which Jim will elaborate on in a moment.

Our gross margin and the leverage that we expect from our selling and G&A expenses remain on track. This leverage also allows us to continue to invest in our growth. As planned, marketing spending increased in the second quarter to support our local market expansion initiatives. We invested $18.8 million in the Sleep Number media spending, which represents a 48 percent increase from the second quarter of 2003.

National advertising support increased 35 percent in the second quarter, and local advertising investment grew by 66 percent over a year ago as we expanded our incremental programming to 12 additional markets in the first quarter. Importantly, the shortfall in our comparable store sales growth in the second quarter was not media market-specific.

Our newer markets, where we started local advertising programs in the second half of 2003 and in early 2004, are outperforming our other media markets as we would expect. But we don't see any patterns that would indicate concern relating to our advertising message or media strategies. We continue to believe our second-quarter performance was in most part due to the issues we highlighted on our July 12 call -- consumer trends and product line changes.

Additionally, we continued to make progress on our longer-term growth initiatives, including non-mall stores, major metropolitan development and product expansion -- for example, our sofa-sleeper -- and we remain excited about their long-term potential.

We are also very excited about our distribution arrangement with the Radisson Hotels announced earlier in the second quarter. There are 249 Radisson Hotels, primarily operated by franchisees, with approximately 60,000 rooms and 90,000 beds available to the program in the United States, Canada and the Caribbean. This agreement is the first of its kind, with a major chain promoting a specific manufacturer's brand of bed to improve travelers' overall stay experience, and provides a significant opportunity for increased trial of our unique mattress by both consumers who are aware of our bed as well as those who are not.

Radisson hotels has agreed to install several beds in each franchisee-operated property to ensure access to the beds for their customers. Installation of the Sleep Number beds into these properties will begin either late in the third quarter or early in the fourth quarter of this year, with only a nominal impact on revenues and earnings for this year.

Through 2006, we expect revenues of between 40 million and $60 million. Because purchases of Sleep Number beds will be determined by the individual franchisees, the timing of installation is difficult to predict. At this time, we would expect a majority of revenues from this agreement to be split fairly evenly between 2005 and 2006, with incremental contribution to margin percentages in the single digits.

While margin is lower than that of our other channels, there are very few incremental costs to Select Comfort, and our most significant opportunity is the added exposure to consumers. In effect, this agreement serves as an innovative marketing campaign. We look forward to our relationship with Radisson and appreciate their commitment to providing travelers with a better night's sleep.

I will now turn the call over to Jim.

Thanks, Bill. I will take you through the income statement and provide some details of our second quarter performance, then I will discuss our balance sheet and conclude with a discussion of our updated guidance for 2004.

Revenue grew by 22 percent to 124.7 million, fueled by double-digit gains across our sales channels. By most standards, 22 percent sales growth, particularly in a quarter when more than a few retailers experienced softness, would be considered a tremendous success. However, we have set high standards for Select Comfort and are committed to doing better.

Our sales breakdown by channel was as follows. Retail accounted for 76.8 percent of all sales, direct represented 12.2 percent, while e-commerce and wholesale accounted for 4.5 percent and 6.4, percent, respectively. The average selling price in our company-owned channels came in at $1864 per mattress, up approximately 13 percent compared to last year.

During the quarter we opened 12 stores and closed three. We ended the quarter with 360 stores, which includes four non-mall locations. The average sales per store was $1,190,000 at quarter-end, which is 26 percent higher than a year ago -- significant positive progress and confirmation of the strength of our new store program, as a net 14 stores entered our comp base.

On our first quarter conference call we indicated the second-quarter operating margins would likely be lower than the previous year, due to our plan to keep media spending at proportionally higher levels as we build the Sleep Number brand for the long-term. Our second-quarter total sales and marketing expenses of 57.6 million rose 24.5 percent from a year ago and represented 46.2 percent of sales compared to 45.4 percent of sales in the second quarter of 2003, with higher media spending accounting for the increase.

However, the leverage in our business model enabled us to generate an operating margin of 7.4 percent, which is consistent with a year ago. I want to take a moment to emphasize this point. We continued to exercise the disciplined approach of leveraging the fixed cost of stores, selling structure and G&A, presenting considerable opportunity for immediate margin expansion that enables us to maintain or improve our margins while continuing to invest in building brand awareness.

This is demonstrated by our second-quarter results. Despite lower than expected revenue, we were able to deliver EPS at the higher-end of our EPS guidance, while increasing our media investments by 48 percent from a year ago, as planned.

Now I have a few comments on the balance sheet. Year-to-date, we have generated free cash flow of 8.3 million and ended the second quarter with cash and marketable securities of 88 million compared to 75 million at the end of 2003. Accounts receivable increased to $9.1 million, the result of QVC and other wholesale sales.

Inventories increased slightly to 14.3 million due mainly to product lineup changes requiring transition of product components. Once again, our just-in-time built-to-order business model is allowing us to manage product changes with no risk to inventory valuation, and our balance sheet remains debt free. We continue to expect to self-fund our growth with free cash flow, which we believe will generate $25 million or more of cash in 2004.

Now let's turn to our guidance. Last week, we revised our guidance for 2004 to take into consideration our second-quarter same-store growth. For 2004, the Company estimates sales of $560 million to $570 million and diluted earnings per share of 88 cents to 93 cents. The lower-end of our guidance range assumes that comparable store trends in the third and fourth quarter are similar to the second quarter, while the higher-end assumes some improvement toward desired levels, based on the initiatives we discussed on our July 12 call. We expect to continue to benefit from the operating (indiscernible) leverage in our business model.

For the third quarter of 2004 the Company estimates revenue of $144 million to $149 million and earnings per share in the range of 22 cents to 25 cents, with same-store sales growth expected to be between 15 percent and 20 percent. Please note that we expect gross margin to be in the range of 62 percent to 63 percent compared to 63.8 percent in the third quarter of 2003. This decline would stem from the airing of our largest QVC show in the third quarter this year compared to the second quarter last year, and as we have noted earlier, a higher percentage of our sales mix coming from lower margin products which are not manufactured entirely by us. Earnings per share guidance assumes a share count of 40 million shares.

Our core strategies remain intact for the remainder of the year. We discussed our product innovation plans at great lengths on our July 12 conference call, so you know that we will remain active on this front, as planned. Our plans are unchanged with respect to media, expecting to invest $80 million during 2004, up from $60 million in 2003. We expect spending in the third and fourth quarter to be relatively consistent with levels of recent quarters, and to be up approximately 30 percent over last year.

Our plans are also unchanged regarding store expansion. We expect to add a total of 30 new stores this year, focused primarily on our new local Sleep Number media markets and major metropolitan areas. We are planning to open nine new stores over the remainder of the year, primarily in September and October.

In closing, our guidance ranges continue to be in line with our goals of sustaining annual sales growth rates of 15 percent to 25 percent and earnings growth rates of 30 percent. We remain confident in our long-term growth prospects.

I'll now the turn the call back to Bill for some concluding comments.

Thanks, Jim. I would like to conclude our prepared comments by emphasizing the point that Jim just made. We believe Select Comfort is on the right track to continue revolutionizing the sleep industry and to building a great company for all constituencies. We remain confident that we can sustain our stated long-term targets of 15 to 25 percent revenue growth and 30 percent EPS growth. We look forward to updating you on the next quarterly conference call.

We will now open the call to questions for about the next 30 minutes, and we would appreciate it if you would limit your questions to a single question and then follow-up with others, as time permits. Anita, we can open the lines for questions now.

(OPERATOR INSTRUCTIONS). Laura Richardson, BB&T.

Could you guys please comment on how many local markets at this point have the heavy local advertising, which I think includes TV? And I have a follow-up on that, too.

Laura, this is Bill. I believe it's about nine markets and I know it represents about 10 percent of the U.S. households.

Nine markets with 10 percent of U.S. households actually have local TV?

I think that's right.

Well, that's even lower than I thought. But this plan is still to have some local advertising in, like, 34 markets by the end of this year?

I'm just thinking through the response to that. The full -- I took your question to be the full local support package (multiple speakers) TV, radio and newspaper and all the rest. And that is -- I think it's in that eight to nine markets and I know it's in that 10 percent of U.S. households. And your point is right that there is still a lot of room to continue building that out.

Is there some type of advertising that you would say 25 percent of the markets have? Because I thought I've heard you give that stat before too?

No -- I don't have that particular breakdown, because there are a variety of approaches to those markets; some have radio, some having TV component with nothing else. So it is designed for each market specifically.

On the same subject -- Jim, didn't you say in your prepared comments earlier that there was some difference in comps in the quarter based on what year the markets got their local media?

No. What we commented on was that those markets that we have most recently introduced the advertising in -- that being those that have had less than a year of advertising -- are certainly performing better than all other markets. And that is consistent with what we have seen in the past. But that we haven't seen any other trends within the other markets that would indicate that there's any advertising effects that are really driving some of the core performance items that we have been talking about.

So newer media markets are still performing better, is what you are saying?

Correct.

But were they as planned in the first quarter, or they were below, too, but still better than the average?

I think all of the -- certainly all of our markets as a whole have performed at below what our expectations are, in accordance with what we've said about the comps. And those items that are affecting the comps are affecting all markets across (multiple speakers).

That makes sense. The in-store stuff. And then last question and then I'll let someone else go. 34 is the number of local markets you plan to have some degree of ad support in at the end of the year?

That is correct.

Steve Denault, Northland Securities.

Was there -- can you comment at all on the more established markets like Minneapolis, Denver? What sort of trends did you see in those markets in the quarter?

We really can't comment on the specific markets. Like I said, the trends that we have seen in those markets would indicate that the comp trends that we're having are not market-specific. We continue to invest, we continue to see growing awareness. But with regard to the overall sales, I really can't go beyond what we have commented on.

Where does your absolute media spend stand at for '04 now?

For the full year we still expect it to be in that 80 million-plus range.

Are you willing to comment on Q3 trends at all?

No. We cannot comment on Q3.

David Lee (ph), Porter (ph).

Can you breakdown the media spending, what percentage of the main media was dealer media spending? I heard you mention 18.8 is one of them.

$18.8 million was the total amount of the media spend that we spent in the second quarter. Just a couple of the numbers that we have spoken to in the past is that we expect about 55 percent of our total media spend to be in national-type of media, and then about 44 percent in the more local target range. We don't see changes in that and we don't have changes, significant changes from that on a quarter-to-quarter basis.

What about advertising spending?

That is the advertising.

Can you talk a little about the ASP contribution from the adjustable foundation?

The adjustable foundation is an add-on product, and basically replaces the core foundation. And its margins are a little bit lower than our core mattress products because it is manufactured for us, so we don't get the full manufactured margins.

Okay. So -- because in the past you gave out -- (indiscernible) on the conference call you gave out the percentage of ASP contribution (indiscernible) the foundation. I'm just wondering if you still have the number handy?

No. What we have mentioned is that about 9 or 10 percent of our sales are adjustable, but not necessarily as a component of ASP. And that number has remained fairly constant.

Can you talk about (indiscernible) sales side, the different channels? You mentioned the percentage of total; can you just give the numbers? I mean, is it 100 million for retail? Is it 15 million for direct?

We give the percentages so that people can get to those numbers (multiple speakers).

If I can just ask the participants to limit their questions to one so we can get through the core questions, and then we'll have time for follow-ups.

Kyle Stults, William Smith & Company.

Could you just remind us of the major metro markets you are still under-penetrated in as far as store count, and maybe some of the markets you have moved into recently?

The primary markets -- major -- primary major metro markets that we are under-represented in are really all of them, primarily Boston and New York have received the most attention in the recent history. Boston we entered last year; New York we are just working on this year. Chicago and L.A. are two other priority markets. And I guess San Francisco we did two years ago with a (indiscernible) deal.

But I would say that in all of those markets we are still -- have a still fair distance to go before we get to a store penetration that we think is more optimal.

(OPERATOR INSTRUCTIONS). Mark Rupe, Adams Harkness.

Just a quick question. Has there been any difference or change the store management turnover, or do you anticipate -- is there any kind of link to -- do they get options or anything like that?

Kind of two questions there. Have we seen any change in store management turnover? And the answer to that would be nothing out of the historic norms. The second question is on options, and about 20 percent of our store managers do receive some form of options on a performance basis.

Greg McKinley, Dougherty.

Could you guys give us a sense for how you perceive your customers responding to some of the price adjustments made with the foundation product and the home delivery service, in terms of how it attached to a bed sale? How did that measure up against your expectations? And maybe also comment to what degree that might have impacted store sales growth.

Two questions there. The first one with regard to how our customers have responded to the price increases that we have had; there really hasn't been much of an impact. Our trends have remained pretty much on track with where we were. So there really has been -- I wouldn't attribute, certainly, any of our trends to that. Because those trends have continued to be pretty good.

Michael Cox, Piper Jaffray.

Could you comment on how many of the markets the sofa-sleeper product is in currently, and any early results that you have seen on that?

The sofa-sleeper has been expanded in four or five markets at this point. It's still very early days. And when it's in those markets it's usually in just one or two stores in each market, based on store size. And so it's too early to comment on performance.

One model-related follow-up here. You've said that your guidance is based on 40 million shares outstanding. Is that a reflection of a lower stock price, or you plan on doing some buybacks here in the second half of the year?

It is a reflection of a lower stock price.

Kenneth Walker (ph).

Long-term supporter of Select Comfort. What I'm trying to fathom is the plunge for the stock from the July 12th announcement. By the standards of retail that I know, the comp store sales are sensational. If you were in the fashion business you'd be dancing a jig. What is it in the guidance, or a lack of guidance, that is causing these violent swings? And do you even need to give guidance?

We're always disappointed when people don't recognize the long-term potential of our company. And while the second quarter we did not outperform, it was strong, as you point out.

It was very strong.

It completed our third year of consistent exceptional profitable growth. We recognize that companies rarely progress in straight lines, and that great companies grow stronger as they learn. We are just looking forward to building upon our exceptional performance. And the whole question about guidance, I think we'll just have to leave open.

Kyle Stults, William Smith & Company.

Just a quick follow-up, and thank you for taking my questions. Have you made any changes with respect to your emphasis on accessories, and what part of the overall sales mix do those constitute right now?

No significant changes. I think we've continued to improve our accessory products and merchandising and sales processes, as we have done the same on the bed side. Accessories continue to be about 8 percent of our sales.

Greg McKinley, Dougherty.

Can you comment on -- if I were to go into the stores going forward, what would I see most noticeably different in terms of your salespeople addressing more of the midrange product in your offering?

As a customer, you probably wouldn't notice a great deal of difference, other than the sales presentation probably will have a little bit more excitement, and around the entry-level items. And then the most significant change you would see now is that the 5000 model will be significantly upgraded and look consistent with the high-end of our range.

Lauri Brunner, Craig-Hallum.

Two things -- only one of them is a question. First was location; the biggest reason that three stores closed in the quarter. And then secondly, could you just go back and repeat the statements you made about margins related to the Radisson agreement? Thanks.

First question on the location being the three stores. Typically there's, I guess I would call it two primary reasons why we will close stores -- one would be a decline in the demographics around the store, and then there are other cases where we've got an outlying store in a single market that we just don't feel will get to ultimately the performance that we would like to have it get to. But for the most part, our stores are profitable overall and we have very few that we look at from that perspective. Second question on the Radisson side. As we said, we would expect revenues over the 2005, 2006 period of about $40 million to $60 million, with contribution -- incremental contribution margins in the single digits.

In the single digits, but you didn't clarify what range. Low, medium or high?

That's correct. It is a lower margin business than our core businesses, and it will have a -- it will have a positive contribution to our overall, but it will just be in those single digits.

David Lee, Porter.

Can you break out the, I guess the beds -- the 5000, 7000, 9000, just how they are selling, each one of them? And where is the shift between the mix?

Basically what I can tell you is that the 5000 typically has been a little bit more than 50 percent of our mix, the 7000 coming into the product changes that we had in the second quarter was in that 15 percent-plus range. What we have seen is that the 9000 we did not expect to be as strong as the 7000, and it's met our expectations. And the 7000 mix has also remained strong.

(OPERATOR INSTRUCTIONS).

If there are no further questions, then we will conclude the call at this time. Thank you all very much for your participation and your continued support.

I would like to thank everyone for participating in today's teleconference call, and have a great day.