Sleep Number Corp (SNBR) 2008 Q4 法說會逐字稿

Welcome, and thank you all for standing by. (Operator Instructions). Today's call is being recorded. If you have any objections you may disconnect at this time. I would like to introduce Mr. Mark Kimball, General Counsel. Sir, you may begin.

Thank you. Good afternoon, and welcome to the Select Comfort Corporation fourth quarter and year-end 2008 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 Bill McLaughlin, our President and Chief Executive Officer and Jim Raabe, our Senior Vice President and Chief Financial Officer. In a moment I'll turn the call over to Bill, and following Bill and Jim's prepared remarks we will open the call to your questions. Please be advised this telephone conference is being recorded and will be available by telephone replay, and will also be archived on our website at SelectComfort.com. 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. I will now turn the call over to Bill for his comments.

Thank you Mark and thank you all for joining us today. Clearly, 2008 was a difficult year for Select Comfort and for our entire industry. The softening economy and declining consumer confidence that began in late 2007 lead to a step down in demand in 2008 that continued throughout the first three quarters of the year. In the fourth quarter as economic conditions worsened, we saw an even sharper drop. As a result, we experienced the toughest selling season in our company's history. Sales declined 25% in the year and 31% in the quarter and we reported an operating loss.

We also made decisions in restructuring that lead to additional charges. In a challenging year, an important achievement was positive full year operating cash flow as a result of our aggressive actions. Jim will share a few specifics about 2008 and the fourth quarter in a minute. Many of the actions that we took in 2008 and particularly in the fourth quarter were designed to strengthen our position in 2009. Our goals for 2009 are to deliver positive operating free cash flow, and to make steady bottom line improvements.

Based on these goals, we set three objectives, against which all of our initiatives are geared. First, align costs with anticipated and actual sales trends; second, reignite the Sleep Number brand by placing greater emphasis on our products' unique differences and value; and third, preserve cash and explore alternatives to increase financial flexibility. The actions taken related to these objectives are paying off. We are still operating in a very challenging environment, and we still have significant improvements to be made; however, we're making real measurable progress, as early trends in the first quarter are encouraging. While sales remain volatile, trends year-to-date have improved versus last year and the fourth quarter. Bottom line results are ahead of plan as our actions to reduce costs have substantially lowered our losses compared to the same period last year. We expect to be cash flow positive in the first quarter.

On the cost side of the equation, our first area of concentration, we have set aggressive goals for 2009 given our outlook for continued economic weakness. To anticipate potential sales level for the coming year, we took the low point of fourth quarter 2008 for sales and assumed no improvement in trend through 2009. This implies a level of company sales similar to five or six years ago. Benchmarking our historic cost structure, we've established cost reduction targets and plans to position ourselves to be cash flow positive and to regain a path to profitability. Implementing these plans lead to the difficult decision to reduce our workforce across all levels and functions, while preserving our core competencies and key talent, and to eliminate programs that were not immediately mission critical, such as our international expansion and SAP systems upgrade. The benefits of these cost reduction actions will be seen in the first quarter and continue through the year.

Our second area of focus is reigniting the Sleep Number brand in order to cost effectively stimulate consumer demand. This remains an area of significant work and learning, yet important progress has been made, particularly in the cost effectiveness of our marketing and sales support. Our 2009 plan calls for reducing media by $30 million, other marketing and sales support by $20 million, and improving product costs by more than $10 million. Through the first two months of the year, measured media-driven leads are close to year ago levels and media spending is reduced in line with plan. We are benefiting in part from lower media costs, and we increased media allocation to more traditional direct marketing to ensure that measured lead generation while we tested it and proved other elements of our marketing mix.

Like many retailers, we are adjusting our business model to respond to a radically changed consumer mindset and are finding that consumer spending is not dead. It has just changed dramatically. We believe those who can offer products with the greatest value proposition in the current environment can still build traffic and sales and on this basis, we're having some success. So in addition to media allocation, we've concentrated on value by providing more aggressive promotions and redesigning our entire product line.

As it relates to promotions, since December, we've increased discounts as a means of both attracting and converting customers. In doing so, we've reduced our gross margin percent due to greater discounts and increased unit sales and total gross profit dollars. As it relates to product, in late February, we've relaunched our entire line of beds with a better emphasis on value. While our strategy continues to be focused on building a premium brand, we have opportunity to help consumers better understand the full range of our product offering. Our relaunched line features an entry price for a Queen Sleep Number mattress at $699 and three models with Queen sets below $1500. We also changed the model names of our products to avoid confusion around the cost of our beds.

We achieved these value objectives and also reduced the cost of goods through manufacturing process improvements and product design advancements. These lower product costs will be used to support efforts to drive demand, and will not likely show up in margin improvement. The more beds we sell, the more lives we improve and the more referrals and future trade up opportunities we create. This redesign and relaunch of our entire bed line was the largest in our history. It was executed on time and under budget. I point this out because the work was done at a difficult time by a team that is now much smaller and with many potential distractions. I also point it out to recognize the committment of the Select Comfort team and of our suppliers who supported the changes. The relaunch is also a source of confidence in our ability to continue to support significant change in improvement going forward.

Turning to our third priority of improving cash flow and increasing financial flexibility, we've also made important progress. We have a great business model for cash generation, although we clearly have less flexibility in a declining revenue environment. We have been able to maintain out low inventory levels and significantly scale back capital commitments for 2009. Improving business performance has also opened alternatives for strategic consideration. Jim has done a great job leading these efforts and will add more about liquidity in his comments.

Let me conclude by saying that as difficult as 2008 was, the Company has responded our challenges head on, with aggressive cost restructuring and a renewed emphasis on our product and our brand. Our smaller team is well focused and has the passion and confidence to succeed. We have much work in front of us and feel we're on the right path and we're making progress.

I'll now turn the call over to Jim to review our fourth quarter and full year financial results, and to provide an update on our liquidity. Jim?

Thanks, Bill. As already noted 2008 was a very difficult year. We've taken significant steps in the fourth quarter and early first quarter that are translating into improved performance. Bill has provided an overview of areas of focus and our objectives, so I'll focus my comments today on expected results and outlook. First ,I'll discuss the fourth quarter and 2008 performance. Second, I will provide some perspective about our outlook for 2009 and finally I will conclude with an update on our liquidity situation.

First a few items of note about the fourth quarter. We reported a net loss of $57 million in the quarter. This loss includes $59 million in non-cash charges including asset write-offs for our SAP implementation, store impairment and evaluation allowance for deferred taxes. Excluding these charges, the tax effected net loss would have been $11.4 million, or $0.26 per share. As a result of our recent losses, as well as the general macroeconomic outlook and our current credit situation, we received a going concern qualification from our auditors for our year-end financial statement.

Fourth quarter sales declined by 31% on a same-store sales decline of 29%. We were able to partially offset a deterioration of sales trends that began with banking crisis in October by pursuing more aggressive promotional and price point marketing, which also resulted in reduced gross margins in the quarter to 56%. We significantly reduced media investment the in the second half of the quarter. In total our media spend was $19 million, 25% less than a year ago and G & A expenses totaled $16 million. Excluding severance, SAP termination costs and financing related consulting costs, G & A would have declined by $900,000 compared to the fourth quarter a year ago.

Turning to 2009, our focus is to manage our cost structure to allow us to be free cash flow positive. As noted in the news release, we are taking actions that will reduce our fixed and discretionary costs by more than $80 million in 2009 on top of the $40 million margin enhancements we implemented in 2008. Most of these cost reductions have already been implemented, or will be in the second quarter.

Now I'd like to address key financial measures for 2009. The mattress industry is projecting sales declines of approximately 7% in 2009, while we and many of our peers are expecting larger declines. We expect unit sales to be more favorable than dollar sales as we focus on traffic and entry level price points. Pricing actions taken in the middle of 2008 will be offset by higher promotional marketing. From a gross margin perspective, we have reduced our product costs, which in normal times would improve our gross margins by several percentage points. Our plans to be more promotional than normal for the foreseeable future will offset some of these gains and lead to gross margin rates equal to or slightly better than 2008.

Media spending will be reduced by $30 million in the year or more than 30%. Early performance of these lower investment levels has been positive with little impact to media driven leads as compared to a year ago when media spend was much higher. Reducing selling expenses is more challenging because of the fixed nature of our store base. Reducing our store count is a critical step to lowering our selling costs and infrastructure support. We have already closed 29 stores in 2009 and expect to close a total of 55 stores during the year. Costs to close a store are minimal, and our sales teams are doing a very good job of insuring store closures do not significantly impact sales. To date, approximately 40% of the sales in the closed stores have been recaptured in surrounding stores. We will look for additional opportunities to close stores if it is cost effective and provides an appropriate return. Combined, we expect sales and marketing as a percentage of sales to improve by approximately 200 basis points as compared to 2008. G & A also will be reduced, with a plan for G & A of approximately $48 million in 2009.

Finally we have suspended nearly all capital expenditures. The primary contributor to our cash usage in 2008 was capital expenditures with long lead times, including new stores and IT systems, which lead to approximately $30 million in capital spending. Significant reductions to the capital spend will facilitate a return to positive free cash flow in 2009. And finally, from a liquidity standpoint, we are focused on three main areas to improve our cash position and overall capital structure.

First, is in the area of business performance. Despite our challenges, we were operating cash flow positive in 2008, and so far in 2009, we have reduced our borrowings and for the quarter, we expect to be EBITDA and free cash flow positive. In addition, in March, we received a $23 million refund for 2008 income taxes. Although the use of this refund is restricted under our credit agreement, the refund, along with improved performance early in 2009, better positions the Company to manage through the year, particularly the seasonally slower second quarter which typically requires more financial resources.

The second area of focus is with our credit agreement and our bank relationships. While we have not been in compliance with our credit agreement covenants in recent months, we have been able to obtain extensions to credit availability and waivers of those covenants. Our relationship with our banks has been positive, and we are working with them to develop a longer term solution to the current situation.

Finally, we are exploring a range of strategic and financing alternatives. While we cannot provide any detail on specific considerations or potential transactions, I can say that the Company and its Board are not limiting the options to be considered. The long term prospects of our business and the unique advantages of our product and business model remain appealing to many investors. Our financial advisors are assisting in the evaluation of any and all financing alternatives. We remain confident in the long term opportunity for Select Comfort and our prospects for successfully navigating through the current economic challenges to realize that opportunity.

I would now like to turn it back to Bill for some final comments.

Thanks, Jim. In summary, we continue to have a viable business with real potential based on our unique product that offers proven benefits as well as quality and value that's better than its ever been. We understand that we are operating in a challenging environment, and we have set aggressive actions to position the Company for positive cash flow generation in 2009. Our early results are encouraging. We expect significant improvement in both earnings and cash flow performance for the first quarter of 2009. And we will continue to execute our plans for reducing costs, reigniting the Sleep Number brand, and preserving cash and increasing financial flexibility.

Rose? We would now like to take the first question.

(Operator Instructions). Our first question comes from Chad Bolen from Raymond James. Your line is open.

Thank you. Good evening gentlemen. Can you hear me okay?

Yes.

A couple of questions. In your commentary, Jim, you said you expect gross margins to be equal or slightly better than 2008 for 2009, although it does sound like aggressive kind of promotions and mix may be unfavorable next year as you kind of continue that strategy. Could you give us I guess some of the puts and takes or sort of walk from 2008 to 2009, structural savings versus the price increases versus mix and all that and help us get a handle on how that plays out?

Sure. Well there's a couple of considerations. First of all we did take a pricing increase in the middle of last year and we benefited from in the back half but that we won't lap until the second half so that will benefit a little bit in the current year, and that was, then the second item would be our operations team has done a great job in engineering the product team has done a great job in engineering the product and working with our product line to reduce the costs. That would in normal circumstances be worth a couple hundred basis points in the gross margin, so a real strong benefit there from a cost and also the same time we think an upgrade to the product and an upgrade to the quality, and then obviously the offset to that is the promotional and mix efforts that you're speaking to. That one, I would say we're still trying to find exactly the right spot. We were very aggressive from a promotional standpoint in the fourth quarter. We've tested and learned so far through the second quarter in order to find exactly what the right level of promotional effort needs to be, but we're finding some improvements there as well, so those are the three primary contributors and I think we're making pretty good progress on that.

Great. That's very helpful and I guess just a couple of clarifications, when you're talking about next year earnings you talk about a significant improvement in earnings for Q1. I'm assuming that's compared with the adjusted $0.26 loss in Q4; is that correct?

No. That's as compared to the $10 million operating loss in the first quarter last year.

So versus Q1 08?

Yes, right.

Okay and then the year-over-year improvement for fiscal '09, that's versus the adjusted $0.51 loss for fiscal '08?

That is correct.

And I guess given all the cost savings actions and everything that you've done, could you give us sort of a breakeven sales level? What sales level will we need to be at to break even?

Well, I think, we haven't provided that number at this point, but I would suffice it to say that we're certainly anticipating a pretty significant sales decline and we're expecting to be positive cash flow free cash flow as well as overall operating cash flow positive in the year, and we certainly are striving to get to profitability for the year on that sales decline, but a lot of it is going to be just dependent on how the macro environment turns.

Sure and last question and I'll defer to others. Inventories and receivables were very low at the end of the fourth quarter. When you talk about cash flow positive for next year, what is the working capital component of that look like?

Yes, I would expect the working capital component to look very similar. The inventory level, our operations teams have done a great job as well as our store teams and managing accessory levels and our plant levels, and I think we have a pretty good process in place to keep that at those levels and manage it with the sales volume, so I wouldn't expect a lot of fluctuation from an inventory standpoint. The receivables should remain pretty low, really about the only time that we have a spike has to do with a QVC show that might be close to the month in, so any spike that we see in receivable would be very specific to a particular show, but as a whole, the inventory level should remain very similar to the levels that we have at year-end.

All right, great. Thanks guys and good luck.

Thank you. Our next question is from Joel Havard. Your line is open.

Thank you. I saw the K just filed, and this maybe detailed in there, but can you guys give sort of a conversational overview or break down rather of the two charge categories, please?

Two charge categories, one is asset impairment and the other one is the deferred tax charges. The asset impairments, there were a number of asset impairments but the two largest categories of impairments in the fourth quarter were the write-off of our SAP implementation, which was about $27 million or $28 million, and then the asset impairments that we took was right in that $4 million to $5 million range, sorry, store write-off, store impairments was $4 million to $5 million, and then the other piece is just the deferred tax valuation allowance, and that was a $20 some million charge.

Can you give, sorry for my ignorance here but can you give me a little overview of what exactly that means?

You're asking about--

On the tax, yes.

Basically, it has to do with similar considerations relative to our financial performance and our going concern opinion. It's a matter of looking at kind of where we are today and an assessment of or implications to the ability to realize the benefits of deductions that we've taken for book purposes that we've not yet taken for tax purposes. So there was a $30 million some deferred tax asset on our books at the end of the third quarter and a good part of those were written off. Now--

That makes sense.

When we get the business turned around and get back to profitability we could be to a point where we can reinstate those deferred taxes again.

Thank you. That helps guys. Good luck.

Thank you. (Operator Instructions). We do have one more question. One moment for the next question. The next question is from [Larry Crown]. Your line is open.

Hi. I was wondering if you can tell me the impact of changing the line up has had on sales.

Well, Larry, it's obviously pretty early so far here but what we have found is first of all, the best news is there was no change over disruption. Our supply chain people did a great job, as I said it was done on time and on budget. Our sales training folks had it under control and this was a big change, because we changed the model names of all of our products and so that the sales team had to be prepared and trained and comfortable with that change. In terms of sales performance as I said, it's a bit early. We've seen some very good mix improvement at the lower end of the line. We have a great product offering now at the $1500 price point, so we're getting some activity there. and then we're still working through what the balance through the rest of the line is going to be in terms of trade up from there. So early indications are no issues and we're just waiting to see what the upside is.

Thank you.

At this time I'm showing no further questions.

Well Rose. if there are no further questions at this time then we will conclude the call for today. We wish to thank you all for joining us and thank you all for your continued support. Good afternoon.

Thank you.