Sleep Number Corp (SNBR) 2010 Q1 法說會逐字稿

Welcome to Select Comfort's first quarter 2010 earnings conference call. All lines have been placed in a listen-only mode until the question-and-answer session. Today's call is being recorded. If anyone has any objections you may disconnect at this time. I would like to introduce Mr. Mark Kimball, General Counsel. Sir, you may begin.

Thank you, Kelly. Good afternoon and welcome to the Select Comfort Corporation first quarter 2010 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, 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 website at selectcomfort.com. Please refer to the details set forth in our news release to access the replay on our website. Please also refer to our news release for a reconciliation of certain non-GAAP financial measures included in the release or that may be discussed on this call.

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.

Good afternoon. And thank you for joining us for our review of Select Comfort's first quarter performance and outlook for the remainder of the year. Earlier today we reported strong first quarter results with improved performance across all measures. Revenue was up 13% versus prior year, led by an increase in same store sales of 29%. Net operating profit was $14.2 million versus $300,000 in prior year, with a margin of 9%, a first quarter record.

And our cash balance at the end of March was just under $45 million with no debt and a new credit agreement in place. We are very pleased with the quality of our quarter's results. Not only did we deliver against our stated priority of increasing profit in an uncertain environment, but also we achieved solid top line growth and momentum. There are three points that I'd like to emphasize today that influence the unique long term potential of Select Comfort.

The first relates to demand. Consumer demand for our unique product and total customer experience is strong and growing stronger.

Second is discipline. We will continue to focus on cost control and margin expansion, selectively increasing spend on what's proven to drive more immediate results.

And third is our long term outlook. Because of our improved financial strength and performance, we now have some flexibility and are pursuing investment in long term growth initiatives that build on our competitive advantages.

First, let's start with demand. Consumer interest in our unique and life changing product is increasing, as is our confidence in our ability to sustain this positive momentum. We've now experienced five consecutive quarters of improved sales trends with increased marketing and selling margin leverage which reflects both the quality and sustainability of our improvements. Given our results and our strong belief in our product and our programs, we have raised our outlook for the year as indicated in our release.

The first quarter was an important test of our ability to sustain growth against improving year ago trends. During the first quart of last year, while the economic outlook was quite uncertain, we had started to see improvement in same store sales trends as we enhanced our value proposition which included both repositioning the entire product line and reformulating our promotional strategy. We also returned to the fundamentals of our advertising and media in the first quarter of 2009 which we believe also contributed to improving trends. And these strategies were refined throughout 2009 and into the first quarter of 2010, delivering consistent improvement in same store sales trends, including this past quarter, which is when we began lapping prior year improvements.

We believe that during the quarter we benefited not only from strong execution and innovation but also from an improved consumer environment. We will continue to control what we can control, improving our core programs to take advantage of market growth, which our unique vertically integrated business model allows us to do well.

And second, let's focus on discipline. We remain cautious in our outlook for the economy and disciplined yet flexible in our approach to investments. Though there are clear signs of stabilization in the past few quarters, we believe the concerns around employment, housing and interest rates suggest that we must continue our tight controls on fixed costs and not invest too far ahead on variable or discretionary spending.

However, despite a conservative approach, we are fundamentally a growth oriented company looking to improve more people's lives and to invest further in proven opportunities. For example, during the first quarter we tested, proved and accelerated new marketing and sales approaches. This included incremental local market spending for accelerated development in key markets, and it also included increasing national advertising support around specific consumer holiday periods. And given the positive test results, we invested an incremental $2.5 million versus prior year to both offset media inflation and to fuel incremental growth. We did this successfully in the quarter, leveraging total marketing and sales expense for a 380 basis point improvement.

We will continue to apply this learning going forward and increase marketing spend as sales increase.

Third and last is our focus on our long term outlook. We have made important progress rebuilding our financial strength, which has allowed us to advance longer term initiatives to bolster our core advantages and contribute to sustained growth. Our long term company objective is to become the new standard in sleep, by elevating and individualizing the total customer experience. We firmly believe we can deliver individualized solutions and experiences like no other manufacturer or retailer in the mattress and sleep industry.

We are focused on differentiating ourselves not only with our product, but also in how we engage our customers -- for example, through marketing, the selling experience, product service, and postpurchase customer engagement. We are pleased with early consumer response to our efforts, and are confident that this unique total experience will distinguish the Sleep Number brand from others, leading to increased customer satisfaction, referral and repeat and ultimately profitable growth.

To that end we have identified four areas of focus that will allow us to elevate our customer experience and become the new standard in sleep. The four areas include product and service, brand, distribution and culture.

In the area of product and service, we already have the most innovative bed that uniquely meets customers' needs for individualized comfort. That said, we are committed to making our fundamental product design even better, and with stabilized financial conditions we are also able to look at more innovative product development opportunities. We also are developing our young yet powerful brands. Next year the Sleep Number brand turns ten years old and we continue to refine our messages around what we stand for and what makes us different -- personalized comfort, pain relief and best bed for couples. We also are driving consistency of our message across all our marketing and sales materials.

And on the distribution front, our emphasis over the past year has been on doing more with less, consolidating around our core company owned channels and exiting stores that did not fit our long term market development plans. We are now investing to improve execution and performance across our current store base, advancing our unique in-store experience for our customers with an outcome of continued same store growth and leverage. For example, consider Ray Roberts, a store manager in our Philadelphia DMA. One of his customers recently took their time to write the following to me.

"At first, I wasn't sure what to expect when I walked into your store. After meeting Ray, wow, that all changed in seconds. Our time spent at your store was a very different experience. Both my wife and I saw Ray as a down to earth people person liking his job and truly caring about our sleep comfort needs. We see him as one of a kind." This is what we mean by setting a new standard in customer experience.

Finally, and perhaps obvious from this letter, I can't say enough about the importance of our team. Our employees and culture are driven by our passion and commitment to improve people's lives and to make our Company better. Our employees have truly fueled the innovation and execution resulting in our improved performance and they will continue to be even more important going forward as we further develop our unique customer experience.

So this was another solid quarter of progress for our Company. We are continuing to deliver on all metrics to accelerate profitable growth in the near term and raising the bar our customer experience in order to drive sustained profitable growth for years to come. And now I'll turn the call over to Jim.

Thanks, Bill. As Bill noted we're very pleased with our results as we continue to improve sales, profit, and balance sheet strength and flexibility. Earnings per share growth was very strong, increasing to $0.14 per share compared to a $0.06 per share loss in the prior year. More significant is our operating earnings growth from essentially breakeven a year ago to $14.2 million this year. $14 million profit improvement was delivered on an increase in sales of $18 million and reflects the flow through margin on those incremental sales as well as improvements to our gross profit rate.

On a sequential basis profit gains were also in line with our expectations relative to the $21 million increase in sales from Q4 to Q1. While the first quarter is one of our more productive from a profitability standpoint, the 9% operating margin in the quarter demonstrates that we can achieve our full year target rate of 10% or more in the coming years, as we are beginning to approach or achieve our leverage targets in each financial statement line item. Our gross margin of 62.1% is in line with our long term target and 350 basis points above year ago numbers. The improvement compared to a year ago comes from manufacturing and logistics productivity gains realized during our turnaround as well as refinement of our promotional programs, which have resulted in some ASP growth related to product mix.

Selling and marketing expenses were 44.4% of sales, 380 basis points better than a year ago. Marketing costs, which included a 16% increase in media spend, were 17.4% of sales or 40 basis points better than a year ago. And selling expenses were 27% of sales, 340 basis points better than a year ago, as we begin to leverage a leaner fixed cost structure. Sales compensation levels were higher than normalized run rates, reflecting our strong sales performance. Selling expense leverage will benefit the most from future sales growth.

G&A expenses were 8.3% of sales, 130 basis points better than a year ago, and in line with our longer term targets. These gains were particularly impressive since incentive compensation was $2 million higher than normalized run rates due to our first quarter performance.

Finally, interest expense of $1.7 million relates to the charge off of deferred costs associated with our previous credit agreement. Interest expense in future quarters should be nominal.

We are also very pleased with our cash flow performance. EBITDA in the quarter totaled $18.3 million compared to $6.3 million in the first quarter last year. On a 12 month trailing basis, our EBITDA totaled $54.3 million, increasing cash balances to nearly $45 million. As Bill noted, we have raised our earnings outlook for the year, increasing our guidance to between $0.45 and $0.50 per diluted share. This increase reflects better than planned performance in the first quarter as well as an improved sales outlook for the balance of the year. And while we remain cautious about the macro economic factors, our sales outlook is based on recent sales trends and assumes no improvement or degradation in the coming months. We continue to expect same store sales growth in each quarter of 2010 although it will be a slowing trend as we lap higher comparisons from a year ago.

Our revised guidance includes the impact of more than 10 million or 20% incremental shares, yet reflects a year over year improvement in as adjusted earnings per share of between 80% and 100%. While this performance demonstrates continued improvement in our business trends, more importantly, it represents solid progress to our longer term goals of a strong balance sheet along with consistent sales growth and operating margins of 10% or more.

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

Thanks, Jim. To summarize, we are pleased with our strong performance in the first quarter, which is based on solid execution, bolstered somewhat by an improved macro economic environment. Our immediate priority is to deliver consistent profit improvement in this uncertain environment. We are demonstrating that we can generate strong profit and cash flow on moderate increases in sales. In going forward, our focus is on leveraging what is unique to our Company. We believe that our product, business model and culture are one of a kind and advantaged. We are excited to have the opportunity to further enhance our strong platform for longer term growth and expansion. We continue to believe that this is an opportune time to learn about Select Comfort. It is also a time to begin looking ahead at our Company's unique advantages and long term growth potential.

Thank you for your time and consideration. I'd like now to turn the call over to Kelly for questions.

Thank you. (Operator Instructions) First question is from Budd Bugatch with Raymond James.

Good evening Bill, Jim and Mark. This is actually Chad filling in for Budd. Let me just first start by congratulating you guys on another very good quarter. First question if I may, when you talk about the outlook for this year, in terms of revenue, you talked about continuation of the current sales trends, adjusted for normal seasonality. Could you remind us, how do we think about normal seasonality for this business? I know looking back in past years, in some years Q1 was the peak, in some Q3. How do we think about that hierarchy?

Well, the soft point in the seasonality continues to be the second quarter when we don't get the benefit of mall traffic or the normal mattress seasonality. So there's a normal step down in the second quarter. It's a good question about what's normal seasonality. But I think if you go back a few years what you see is that first quarter is a strong quarter, third quarter and fourth quarter are both strong quarters although probably a little bit lower from a sales standpoint than the first quarter. And I think the other, just the other consideration when you go back and look historically is that you go back three or four years, and we were having pretty significant store growth which would bolster the third and fourth quarter sales at least in comparisons to first quarter. And obviously this year we won't have any store growth but I think going forward we will again. So hopefully that provides a little color.

Okay. That's actually very helpful. Thank you. And looking at the gross margin line, the year over year improvement was terrific but it did dip a little bit sequentially despite higher volumes. Could you help me understand kind of the mechanics of what drove that? I know it looked like AUSP was maybe down a bit sequentially but just help walk me through that movement.

Yes, sequential basis I think we were down about 60 basis points from the fourth quarter. And it's really the -- we had some cost increases late in the fourth quarter, on a couple of our components. And as much as anything it's kind of a flow through of that. That was the major factor.

Okay. And along those lines, how are you thinking about those input or commodity costs as we go through the balance of the year?

We are seeing some increases in oil prices and some pressure. I think for right now we're just keeping an eye on it, and continue to execute as we can to try to mitigate any increases that we might see over the balance of the year.

Do you still anticipate a slight improvement in full year gross margin or are we thinking flattish?

I think first quarter is pretty representative of how we think about the year.

Okay. Last question and I'll defer to others in the queue. If I calculate it right I got media spending at about 11.5% of sales. I know you've talked before about managing that up towards 12%. How do we look at that for the balance of the year? Is it going to increase as a percentage of sales? Or do you have a specific dollar target in mind?

You are right about the 11.5% in the quarter. And in that 11.5% to 12% is how we're thinking about media for the full year. So as a percentage of sales it might be a little bit higher over the balance of the year but I think it is something that will continue to increase spend as we continue to see sales growth.

Great. Well thanks for taking my questions. Congratulations again.

Thank you.

The next question is from Mark Rupe of Longbow Research.

Hey guys. Congratulations on the quarter. As far as the operating margin performance obviously it was a record for the first quarter, and you are butting up on that 10%. I would assume, assuming the industry holds and you continue to perform well, you'd be up on that really fast. At some point in time will you maybe update kind of your longer term thoughts on that line or if -- as it relates to whether it's gross, a little bit gross or is it going to be more leveraged on the selling and G&A line as you look kind of out?

I think as Jim said in his comments we expect the most leverage coming forward to come out of that sales line, Mark.

Okay. Go ahead.

As you are thinking about it though and as we think about long term, a 9% margin in the first quarter and from a selling marketing standpoint we do think we still have opportunities. So when we think out a couple of years, certainly an operating margin above 10% is certainly very cheap.

Yes, no question, given where we are at in the sales cycle or industry cycle here. As far as the -- kind of the propensity to grow, how disciplined are you going to be as far as -- obviously there was a five year period years ago where you grew a lot of the store base. I'm assuming there's still some low hanging fruit on some holes in distribution or store locations. Are you going to attack those this year? Is that part of some of the Cap Ex?

To a certain extent yes, there certainly are opportunities for us to fill out markets. I think there are also opportunities that we talked about in the past that the combination of closing an underperforming store and opening another store in a similar geographic area that we think can perform better are all ways for us to continue to generate that sales or sales increase. The balance of the year we'll see a little bit of a net store decline, but as we get into 2011 and forward we will start building the store base back.

Okay. Perfect. Congrats again. Thank you.

The next question is from Brad Thomas of KeyBanc Capital Markets.

Thanks, good afternoon, Bill and Jim. Let me add my congratulations as well.

Thank you.

Just looked like Cap Ex moved up a little bit from $10 million, I think, to $15 million. I apologize. I missed a bit of it there. Anything specifically that incremental spend is going to be associated with?

There are some things that we are evaluating. You are right. We did kind of bump the target up a little bit with the increase -- improved performance. There are a few things that we're evaluating around improving the overall store experience as well as we still, I think we've mentioned before, we've got some brand inconsistency in the stores that we would like to get updated. So a lot of it is really focused on improving the brand image and the customer experience and in really improving our performance that way.

Okay. And when we think about that spend and some of your Cap Ex over the next year or two, should we think about that as sort of a maintenance spend that's maybe a little bit deferred from last year's low level of Cap Ex or is there sort of a more offensive opportunity associated with that investment?

I guess the way I would answer that is a little bit of both. I mean, there is certainly, there is certainly some catch up on some things that we've been wanting to do for some time. And there are things that we think will improve the overall performance of the business but they are a little bit longer term return which is why we've deferred them to this point. But I think we do see them as offensive in really consistency of brand. And also we are looking at a little bit of some test in some new stores as well. So it's a little bit of working back to a more aggressive stance on the Cap Ex.

I believe the average selling price was up year over year more than any time in the last five or six quarters or so. Could you just talk a little bit more about what's going on within different price points and how much of that is consumer spending trends in general versus some of the promotional initiatives you have in place right now?

Yes, Brad. The year over year is more a function of what happened last year than current. Last year we had, we were still really learning how to do the promotional strategy and emphasizing our value, and what we learned over time is how to help people trade up to higher price points. And that's really what we've seen gone on with this Q1 versus a year ago Q1. What we're seeing in the ongoing sequential basis is really not a very significant change in the mix. It's been pretty steady over time.

Okay. Just lastly, with one more quarter under our belt here, any new thoughts in terms of the recapture rate that you are seeing from store closures and from the exit of the wholesale business?

Those numbers have continued to stay pretty consistent. We are seeing that from the store closures we continue to get a 30% to 40% transfer into existing stores. And I would say that the markets where we've exited those wholesale relationships have been some of our better performing markets. So we're very pleased with the results of both of those actions.

Great, congratulations again.

Your next question is from John Baugh of Stifel Nicolaus.

Good afternoon and my congratulations as well. I was curious, did you change -- when you looked at the quarter year over year, was there a difference in the discounting? Or did you promote a higher end bed than what you did last year? A little color around that, please.

As I was saying, John, what we did, I would say is we balanced our, through 2009 we learned a lot about having a strong entry level price promotion and then offering it in the middle family of our products as well as up at the high series. Last year in the first quarter we really had more of just a focus on the entry level price point. So that's the change that I would say that happened year over year. And we kind of learned it through 2009.

Okay. And then, Jim, you mentioned two items -- one was comp and I can't remember the other -- as being, quote, above normal. How do I think about that in terms of the year and either a number or a percentage of revenue? In other words, did you accrue something in bonus unusually high in the first quarter that's not going to repeat in the latter quarter, or -- help me with that.

It's a good question. The two points were both related to incentive compensation, the first one being on the sales side and in selling expenses, that our performance was very good in the stores. And so we had more incentive compensation than maybe the normal run rate would. So even with that, we had really good strong leverage in selling expenses. But that's an item that hopefully we continue to see that good strong performance. And if so we'll continue to have a little bit higher compensation.

Similar answer on the incentive compensation on the G&A side. We refer to a number that is higher than normal. What that really means is that we're accruing our bonuses, our incentive compensation at above 100% payouts because we are running above kind of where our targets are. So the balance of the year will be dependent on how we run in those sequential quarters. But it is something that when you start looking at it on a year over year basis in 2011, if you get back to 100%, there's some opportunity on the cost side.

Okay. So if you actually shrink back to 100%, you'd actually see some leverage because you're above 100% in terms of like the bonus payout.

That's correct.

Okay. And then you said interest expense would be nominal. What's nominal mean?

Well, we have some fees but we don't expect to be borrowed. So we've got some fees on some LCs and we have some normal facility fees. So, you're talking maybe in the $100,000 range on a quarterly basis.

Now, are you still committed through the end of the calendar 2010 to close these stores and have the net shrink? Or does the results that you are seeing in the economy sort of move up the time frame of opening stores? And if you are not going to do it in 2010, what's the preliminary thinking about 2011 in terms of how many stores we could ballpark range to open?

Two questions. The first one relative to are we committed to closing the stores we've talked about. I think that's always a little bit of a moving target. We don't make a final decision on stores until we need to make a decision. So it is somewhat open.

Having said that, there's really two drivers to store closings that we're looking at. One is just strictly overall sales performance. And there are still certainly a number of stores that we would see closing on that basis.

The second factor, though, is also more strategic and more geographic with -- on a market to market basis where we feel as if we're overstored and have an opportunity to reshape the market from a store distribution standpoint. So, those are the two considerations. We'll continue to make those considerations up until the point we actually have a time to make that decision. But at this point, we still look at ending the year in that 380 to 390 store range.

We haven't talked about, haven't given a specific number with regard to 2011. But I guess, two comments I would make. First of all is we would expect store count to increase next year. And second of all, I would say that it will also be on a -- certainly on a more conservative pace. That's probably the wrong term because I think we're looking for aggressive growth but we see the -- we do see trade areas being an important consideration and we want to be more selective on our real estate choices. So, in years where we've opened 50 or 60 stores a year, we will not be at that pace. It will be on a more considered pace.

John, just one quick point to add to what Jim said is, our focus is much more on same store growth at this point. We believe we've got a lot of opportunity there. We ended this quarter just at about $1.1 million as an average. We've got a ways to go to hit our historic peak. That was $1.5 million. And it's driving that same store growth that's going to be the real fundamental driver here. The store additions is important, it's gravy, but the same store growth is our primary focus.

Right. That's good. And then will the share count go up? Will there be more options coming into the money with the price of the stock up, or is that going to -- is that 55 million, slightly higher. What should we use?

Yes, I think relative to the first quarter hopefully there will be some more that come into the money. The full year number that we gave of, at the end of the year, last year of 56 million, I think is still a good number to think about for the full year.

Okay. And then in light of the increased profitability, and strong cash flow, update us number one on where you think free cash flow will be for the year. And you'll end the year with a considerable cash balance, [being] conservative, but I'm just curious as to what, if any, board discussions have been had about the capital structure. Thank you.

With regard to the second question on the capital structure, I mean, that is something that we're beginning to talk about but I think we're still a ways away and we still feel as if funding internal growth to the Company and continuing to build the strength of the balance sheet are priorities for the near term.

From a free cash flow standpoint for the full year, I think it's really more a matter of just backing off of that that earnings guidance of $0.45 to $0.50 and then just knowing that we've got, you know, in the range of $20 million of noncash, and you know, what we've talked about. $15 million of Cap Ex. From a working capital standpoint, we did a pretty good job last year of really leveraging the balance sheet. We continue to be focused there, but on a full year basis, on a full year basis would continue to expect to see some improvements but not dramatic changes over the course of the year.

I'm sorry, what was the Cap Ex number again?

Up to about $15 million this year.

Up to $15 million. Okay. Thank you.

(Operator Instructions) There are no further questions at this time.

If there are no further questions at this time then we'll conclude the call. We wish to thank you all for joining us and we look forward to reporting further in our second quarter results. Thank you.

Thank you for participating in today's conference call. You may now disconnect.