Sleep Number Corp (SNBR) 2009 Q3 法說會逐字稿

Welcome to Select Comfort's third-quarter 2009 earnings conference call. All lines have been placed in a listen-only mode until the question and answer session. Today's conference is being recorded. If anyone has any objections, you may disconnect at this time. I would now like to introduce Mr. Mark Kimball, General Counsel. Sir, you may begin.

Thank you, Sharon. Good afternoon, and welcome to the Select Comfort Corporation third-quarter 2009 earnings conference call. Thank you all for joining us. I'm Mark Kimball, Senior Vice President and General Counsel. With me on the call today 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. Following our prepared remarks we will open the call to your questions. Please be advised that this telephone conference is being recorded and will be available by telephone replay. It also will be archived on our Web site at selectcomfort.com. Please refer to the details set forth in our news release to access the replay on our Web site.

The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings 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 to discuss our third-quarter performance. We're extremely pleased with the results of the third quarter and their implications for our Company's long-term potential. We've made substantial progress since last year and look forward to discussing the implications with you.

Our immediate priority through the recession has been to manage our business for improved profitability and cash, while at the same time taking steps to reinforce and strengthen our fundamentals for eventual long-term growth.

This past year, as an early indication of the potential of our Company -- excuse me, this past quarter is an early indication of the potential of our Company in market share, profit leverage, and cash generation. As many of you know, the third quarter is historically the strongest seasonal quarter for the mattress industry and for Select Comfort. We took full advantage of it to demonstrate our flexibility and leverage potential.

In the quarter, earnings per share was $0.15 after a one-time expense of $0.05 per share related to terminated financing. This compares to earnings last year during the same period of $0.02 per share.

Same-store sales this third quarter increased 9% year over year, with total Company sales declining 6% as we consolidated distribution.

We generated positive free cash flow of $17 million in the quarter and we have now reduced our debt balance from $79 million at the start of the year to $26 million at the end of the third quarter.

Since the beginning of the year, we've shared with you our three strategic priorities designed to turn around our business in the near term and to position us for growth in the long term. These three strategic priorities remain, first, to align our costs with expected sales trends; second, to reignite the Sleep Number brand for growth; and third, to preserve cash and improve our capital structure.

For those of you who may be new to Select Comfort, let me provide some historical context. Prior to this recession, our strategy for the business centered on rapid expansion -- more stores, more points of distribution, more marketing, and more products. A positive outcome of the challenges faced by our company has been a renewed focus on fundamentals and core advantages. Simply put, we're concentrating on improving and getting more out of our core business, making it significantly stronger and more advantaged. We believe that the actions taken to refocus the Company also position us very well to both manage through this period of uncertainty and to take advantage of a sustained economic recovery when it occurs.

Now let me provide an update about our stated priorities. First, the third quarter demonstrated the impact of our cost actions that they've had on the leverage potential of our unique business model. On revenues 6% below prior year, we delivered an increase in gross margin of 120 basis points. We also improved sales and marketing expense as a percent of net sales by 740 basis points. We achieved these results because we have worked during the past two years to align our cost structure with anticipated lower sales, lowering our breakeven point by more than 30%.

And it's important to note that Select Comfort has distinct advantages versus traditional retail business models for leverage as sales increase. Our fixed costs do not need to grow as much to accommodate increased demand. Our stores are essentially showrooms and can support substantial sales expansion without increasing store size, inventory level, or making significant staffing changes. For example, while our average sales per store is approximately $1 million per year, we have similarly sized stores selling as much as $3 million per year with the addition of one or two sales professionals.

We are also learning, through our reduced marketing levels, that we may be able to leverage marketing further with growth. So early in our learning we believe the margin potential of our business, as sales increase, is greater than what we achieved at higher sales levels in the past.

Our second priority involves reigniting the Sleep Number brand, raising consumer awareness and interest in our product's unique benefits and value, to stabilize sales and to prepare for a recovery in consumer spending.

We have updated all of our marketing and sales materials, focusing on the very real consumer need for personalized comfort and separate dual adjustability, which no other mattress or sleep system can match. We also now emphasize the exclusive availability of these unique beds and accessories only at Sleep Number centers or other Company-owned channels.

Earlier in the year, we redesigned our product line to more clearly present value. Our mattress product line was simplified into three categories, and this streamlined structure features attractive entry price points for our mattress as well as clear and compelling trade-up opportunities.

We also took actions to strengthen our sales leadership and selling process, resulting in improved customer presentations and conversion rates. To ensure a consistent and unique consumer experience with a Sleep Number bed, we also came to a mutual agreement with our retail partners to discontinue distribution through their stores. And we continue to close and consolidate Company-owned stores which concentrates customer interaction on our best stores and Company sales teams.

This combination of refocused marketing, enhanced product value, and improved sales and distribution focus resulted in important progress towards stabilizing sales trends, as demonstrated by same-store growth during the quarter.

Finally, with regard to preserving cash and improving our capital structure, we made significant progress in the quarter. Capital spending was restricted to what was essential and our vertical integration and just-in-time supply processes were refined for even lower inventories and increased operating free cash flow. And going forward, we'll continue to invest behind proven growth, with the ability to self fund from operating cash flow.

This year a corporate priority also included improving our capital structure for long-term security and flexibility. We have reduced our debt exposure by 67% in the year. We continue to work with our lenders to secure a long-term financing agreement and we continue to evaluate incremental financing alternatives beyond the recently announced revised Sterling Partners investment in order to meet this objective.

So, in summary, clearly, we've made great strides in the past few months. We are confident in our future and the leverage potential that this past quarter has demonstrated. Yet we are prudently cautious in our planning and commitment of resources as we anticipate continued volatility in the economy the remainder of this year and next. We are well prepared to take advantage of opportunities and to increase our share of mattress sales, improving more people's lives as we do.

Jim will now expand on the third-quarter performance and outlook for the remainder of the year.

Thanks, Bill. As Bill noted, we reported net income of $6.9 million in the quarter, or $0.15 per diluted share. These results reflect continued progress against our stated priorities, most notably improvements in our cost structure and stabilization of sales trends. Year to date, we have improved our pretax profits by nearly $30 million. We have generated $30 million in EBITDA and reduced outstanding borrowings under our line of credit by nearly $53 million to $26.3 million.

I'd like to start by covering a few items of note before turning to our outlook.

We're extremely pleased with the 9% same-store growth reported in our retail stores. Sales remain volatile from month-to-month but have progressed in each quarter year to date. On a unit basis, the growth was even more impressive, with 21% same-store growth. The unit growth reflects our focus on value, making entry level price points more visible in our marketing and advertising materials along with more aggressive promotional activities, both continuations of efforts we began at the end of last year.

Total Company sales declined by 6% in the quarter, a significant improvement versus the 21% decline reported in the second quarter and better than recently reported industry sales trends. The overall decline in sales on a year-over-year basis reflects a reduction in our overall distribution base, including 67 fewer stores as compared to a year ago and more than 600 fewer retail partner doors. Our direct and e-commerce sales declined in the quarter as these channels are impacted to a greater extent by reduced advertising levels and the tightening of consumer credit.

In the third quarter, we reported significantly higher profits. The improvements reflect the significant cost reduction actions we've taken over the last nine months across all functional areas. Operating margins in the quarter were 8.1%, 10.4% if you exclude the $3.3 million of one-time costs associated with our terminated financing efforts.

Gross profit margins continue to improve, with third quarter margins at 63.4%. Our Company-owned channels continue to see higher margins, reflecting manufacturing and logistics productivity that more than offsets the higher discounting of our product line. The improvements also reflect a higher percentage of sales coming from higher margin Company-owned channels as we de-emphasize retail partner distribution.

Sales and marketing expenses have demonstrated the greatest leverage gains, with a 740 basis point improvement to 44.8% of sales in the third quarter. The two most significant contributors were media and store costs. Media, which at $15.6 million in the quarter, was 32% lower than a year ago, while fixed and discretionary store costs were $5.1 million or 14% lower than the same quarter a year ago.

In the third quarter, our retail sales per store were $297,000, 15% higher than in the same period a year ago. Same-store growth, as well as the closure of underperforming stores, contributed to this increase and the profit leverage that comes with it.

General and administrative costs, including research and development expenses, were essentially flat to a year ago. Reductions in infrastructure costs were offset by an increase in corporate bonuses of $2.9 million linked to performance and profit targets.

Our net debt also improved significantly, with positive EBITDA of $17.6 million and operating cash flow of $17.4 million in the quarter. Capital expenditures totaled only $2.0 million year-to-date.

We've accomplished much during these past 12 months, with significant progress in our sales trends and profitability. Yet much remains to be done in an uncertain environment.

In the fourth quarter we will lap the most severe part of the economic downturn from a year ago, which should lead to further improvements in same-store growth. The expected same-store sales growth will likely be offset by the year-to-date reductions in stores and retail partners. I would also note that the fiscal fourth quarter last year included an additional week which we will lap this year. We are managing our cost and infrastructure to the uncertainty of the consumer environment.

While we have not recently provided estimates about profit performance, we feel it is appropriate, given our turnaround and the uncertainty in the economy, to provide greater clarity around our 2009 earnings expectations. And as such, have provided estimated earnings for the full year of $0.02 to $0.08 of diluted earnings per share. As you would expect, consumer spending patterns will have a significant impact on our ability to deliver and improve on these expectations.

Our fourth-quarter 2009 benchmark indicators are as follows. Gross margins are expected to be lower than the 63.4% we experienced in the third quarter, reflecting lower seasonal sales volumes and some pricing pressure. We expect selling and marketing dollars in total to be slightly less than the $66 million in the third-quarter expenses, inclusive of approximately $16 million in media investments.

Fourth quarter G&A and R&D expenses will be slightly below the $12.3 million incurred in the third quarter, and interest expense should be lower than the $1.7 million in expense we incurred during the third quarter, reflecting lower debt levels.

We are planning for a fourth quarter income tax rate of approximately 40%, although the rate remains difficult to predict.

Full-year earnings per share is based on approximately 47 million shares outstanding, including shares to be issued under the Sterling Partners transaction, as required by accounting rules, but not any additional shares that could be issued in future financing transactions.

And finally from a CapEx standpoint, we continue to limit our expenditures to only mission-critical projects, with full-year expenditures projected at less than $4 million.

Now a few comments on the financing front. We continue to operate under short-term waivers through our credit agreement and are in negotiations with our existing bank group to put into place a more permanent credit facility. If we are successful in completing this agreement, the $10 million investment commitment from Sterling Partners should be closed at approximately the same time as the closing of this new credit facility.

In addition, we continue to believe it is advisable for the Company to seek and complete additional equity financing in order to further strengthen our balance sheet and provide additional financial flexibility. We are sensitive to the current shareholder interests and will balance the consideration of dilutive effect of new equity with the benefits that would come from a stronger balance sheet.

At this point, there is no further information regarding our financing efforts that I can provide, but we will give updates as soon as practicable.

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

Thanks, Jim. Our confidence in and commitment to becoming a leader in the mattress industry has never been stronger. We have a unique product that meets real consumer needs as no other product can; we have a unique and young brand with significant growth potential; we have a unique selling process focused on our customers' personal sleep needs; and we have a unique business model in the bedding industry, selling directly to consumers with significant profit and cash flow leverage.

We are pleased with the progress that we've made and equally enthusiastic about the opportunity in front of us. We've learned a great deal and have clear plans to continue improving our core fundamentals for growth.

I want to acknowledge and thank our employees and partners for their continued hard work and dedication. And I also want to thank our board of directors for their strong leadership and support during a challenging period.

In conclusion, we continue to navigate through uncertain times and remain steadfastly focused on our key priorities -- to improve people's lives through personalized comfort and better sleep and to deliver consistent improved performance and value to our shareholders.

Thank you, and Sharon, we would now like to take the first question.

Thank you. We will now begin the question and answer session. (Operator instructions) Our first question comes from Mr. Budd Bugatch of Raymond James & Associates. Go ahead, sir; your line is open.

Good afternoon, Bill; good afternoon, Jim. Forgive me, I'm in an airport, so it never fails that the announcements always happen when I start talking.

Yes.

First question would be the store base as you go forward. I know you're planning to close six stores in the quarter. Can you give us an indication of where you think the stores -- what looks forward after 2010?

Sure. As you said, about six stores, so we'll end the year at just over 400 share -- stores. We would expect some reduction in the store base, although certainly not as significant as what we thought. So I would expect 2010 will be in that 390, 380 range from a total store count.

And they will close kind of pro rata during the year? Will you kind of ratchet down quarter by quarter?

You know there is -- probably half of the store closures will happen very close to the end of the fiscal year, as we've looked at the stores that we see as opportunities to kind of improve the overall store base. And the rest of them will be more pro rata over the course of the year.

So is it at the end of this fiscal year or next fiscal year?

Next fiscal year. About a half of what we close will be towards the end of next year.

I got you. And I know that the store -- the retail partner program has now, I think, been terminated and I think you've got like 140 partners left or something like that, if I remember right, if I read it right. Can you give us an indication of what the fourth quarter last year, those retail partners, might have accounted for in terms of retail sales or -- in terms of sales and maybe gross margin?

From a sales standpoint, it would have been in the range of 3% to 4% of our total sales. And the margins are -- the margins on those sales are roughly two-thirds of what our retail stores are from a gross margin standpoint.

So that's what confuses me about why the fourth quarter margin will be down then year over year because you're going to have less retail partner sales. So it would seem to me that the mix would be stronger towards retail, which does have higher margins.

I think the gross margins will be higher than the fourth quarter last year. They will just be down slightly versus the third quarter this year. And that decrease in the fourth quarter versus -- the decrease in the fourth quarter versus the quarter we just completed is a combination of a little bit fewer units from a seasonal standpoint, which deleverages the manufacturing margins a little bit. We have had a few small price increases with -- that take effect in the fourth quarter. And then the other factor is our QVC activity is a little bit heavier in the fourth quarter than it is in the third quarter. So there's still an increase in the overall wholesale business in the fourth quarter relative to the third quarter, at least what we expect this year.

Okay, I understand that. One other question on kind of the sales front, can you stratify kind of the success you've had in getting that -- in terms of the new merchandising and tell us if there needs to be any tweaking in the merchandising as you would see it now?

If you're referring to the store layout, the bed line?

No. The three different classifications of merchandise --

Yes.

-- and how -- where the success has come?

Well, as Jim said, we've been focusing more on the value message. So, as you saw, our unit same-store growth was like 21% in the quarter. So, clearly, we're driving more in that Classic series. But we're also getting the step-up that we need to manage our gross margin dollars along the way. So we're feeling pretty good about the three categories and the products we have within them right now.

Okay. Thank you and good luck and congratulations on kind of weathering the storm.

Thank you.

Our next question comes from Brad Thomas of Keybanc Capital Markets. Go ahead, sir, your line is open.

Thanks, good afternoon, and let me add my congratulations on a nice quarter and some nice efforts to turn around the business.

Thanks, Brad.

Wanted to follow up on the gross margin. Jim, could you maybe give us a little bit more color on the magnitude of some of the productivity improvements that you've put into place versus the magnitude of the promotional activity that you're doing right now?

Yes. I would say that some of the productivity gain that we're seeing is related to the fact that the marg- -- the unit flow-through that we're getting. The activities that we've had from a promotional and a marketing standpoint are certainly helping the volume and the unit volume and that helps to leverage the manufacturing facilities a little bit. But the manufacturing team has been doing a great job all year long in overall managing that operation efficiently. We also got a good amount of leverage in our home delivery service with that volume flow-through as well. So those are all important factors in the margin improvement that we've gotten.

From a promotional standpoint, we've been pretty much in line in the third quarter with what we had been doing in the second quarter. So we've been pretty consistent there. So I think when you're looking sequentially at the margin improvements, most of it's coming from manufacturing. Some of it's just pure productivity, and then there's a piece of it as well that's just leverage from the increase in the volume.

Okay, great. And then as you think about your average selling price, in this third quarter you were up against a very difficult comparison, and I think an 11% increase last year that starts to moderate in the fourth quarter. How should we think about that as a benefit to your comps in the fourth quarter?

Well, I think that I would think about the average selling price in the fourth quarter as being consistent as it was in the third quarter with a slight improvement related to accessory sales. We always get a little bit more accessory sale activity in the fourth quarter. And so that will help the average selling price, at least overall from a comps standpoint. And what we see in accessory growth from third quarter to fourth quarter can be anywhere from $30 to $50 on a per unit basis improvement between third quarter and fourth quarter.

Okay, great. And then just a quick follow-up on advertising. I mean it seems like you're getting a great deal more effectiveness out of your advertising dollars. Can you just talk about how you're thinking about that process? Are there more opportunities to drive incremental efficiencies? And perhaps even how you're thinking about advertising spend in 2010 -- would you think about it on a dollar basis or as a percentage of revenue? Any color would be helpful.

Well, as you say, we are pleased with both the effectiveness and the efficiency of our advertising spending. Media is down about 30 -- just over 30%, and revenue down 6% in the quarter. We -- I think I would guide that we are basically going to continue doing what we've been doing, which is both in terms of dollars and percent of sales. So we believe, as I said, that there may be opportunities as growth is reestablished, but that's into the future, to work on taking that percent down a bit. But right now it would be more or less consistent dollars spent about the same way that we are in terms of national emphasis and DR emphasis, but all getting back to the basics of our how product is uniquely different with personalized comfort and the benefits of back pain relief and for couples.

Great. Thanks so much.

Our next question comes from Jeeva Ramaswamy from JG Funds -- or GJ Funds, excuse me. Go ahead, sir, your line is open.

Hi, good afternoon, congrats on the great quarter. My question is unemployment is still rising. It's reaching around 10%. So how do you guys feel about next year, 2010?

Yes.

Sales trends or -- whatever you guys are seeing now?

And I would say that -- and we don't -- we haven't provided guidance with regard to 2010. I would say that -- I mean, certainly we, like everyone else, is hopeful for a recovery at some time in 2010. But the way we're entering 2010 from an overall planning standpoint is to assume that it looks a lot like 2009. So, from a sales standpoint, we think there's opportunity for growth, but from an execution standpoint, we're going to manage it more conservatively.

Okay. Thank you.

(Operator instructions) I show no further questions at this time. We'll turn the call back over to Mr. Kimball. Go ahead.

Well, thank you. If there are no further questions at this time, then we will conclude the call. Thank you all for joining us and thank you for your continued support. We look forward to speaking with you again after the next quarter. Thank you.

Thank you.

This concludes today's conference. Thank you for your participation. You may now disconnect.