Sleep Number Corporation
Q4 2019 Earnings Call Transcript

Published: 20 Feb 2020

[Operator:]

Welcome to the Sleep Number Q4 and Full Year 2019 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 Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

[Dave Schwantes:]

Good afternoon and welcome to the Sleep Number Corporation's Fourth Quarter 2019 Earnings Conference Call. Thank you for joining us. I am Dave Schwantes, Vice President of Finance and Investor Relations. With me today are Shelly Ibach, our President and CEO, and David Callen, our CFO.This telephone conference is being recorded and will be available on our website at sleepnumber.com. Please refer to the details in our news release to access the replay. Please also refer to our news release for a reconciliation of certain non-GAAP financial measures and supplemental financial information included in the news release or that may be discussed on this call.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 news 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 Shelly for her comments.

[Shelly Ibach:]

Good afternoon and welcome to our call. My SleepIQ score was 82 last night. Consumer response to our revolutionary 360 smart beds has been exceptional driving six quarters consecutively of double-digit demand growth including acceleration in the fourth quarter.Our differentiated consumer innovation strategy drove record results in 2019 which were near the high end of our expectations including, 11% net sales growth to $1.7 billion with a 6% comp gain and 5 points from new stores. 21% growth in net operating profit, 41% growth in earnings per share to $2.70 and 44% growth in operating cash flows to a $189 million.We’ve executed our ambitious vision over multiple years focusing on three performance drivers

[David Callen:]

Thank you, Shelly. Tenaciously strengthening our business over several years enabled us to run clean in 2019. In the four years since introducing our long-term $2.75 EPS target, we've delivered 9% compounded annual net sales growth and 29% compounded annual growth in earnings per diluted share. We significantly advanced our competitive advantages, the face of our financials, and the sustainability of our performance.We've invested to acquire and build growth enablers like our technology platforms. We've increased spending to support our growth drivers like our revolutionary innovations, optimized retail, and agile marketing capabilities. And we've methodically evolved our capital structure while prioritizing liquidity to support our plans.These disciplined decisions drove a 660 basis point increase in our return on invested capital in four years to 17.8%, more than double our weighted average cost of capital. The great news

[Operator:]

[Operator Instructions] Our first question comes from Bobby Griffin with Raymond James. Your line is open.

[Bobby Griffin:]

Good afternoon everybody. Congrats on a good quarter and a good year. And I appreciate you taking my questions.

[David Callen:]

Hey, Bobby.

[Shelly Ibach:]

Great. Thanks, Bobby.

[Bobby Griffin:]

So, I first wanted to just take maybe a high-level question, and when you guys look at the business today, do you think the actual natural contribution margin of the business has changed, because the dynamics of the industry, whether higher investments are required, more R&D spending? Or is the mid-teens type contribution that we've talked about in the past, something that the underlying business is achieving it is just getting offset by maybe one-time transition costs?

[David Callen:]

Hey, Bobby, it's really about where we are in our journey and the opportunities that we see. We've highlighted that investing in our growth drivers and having a long-term bias is the way we operate this business. And with the clarity that we have from having 10 billion biometric measures every night from our sleepers is informing our future innovations and give us great visibility as to what we should be spending behind.So, the flow-through rate that we're talking about I think in 2019 was 12% operating profit flow-through. We see that it will be slightly less in 2020 as we lean into these growth drivers for the long-term benefit.

[Bobby Griffin:]

Okay. I appreciate. That's helpful. And then, from the cadence of the new product introductions, is there anything that we should keep in mind in our models as you guys roll these out? And help us think about the size of them. Are the new products gone on the floor, is it updates just to the app, in SleepIQ system, what exactly should we be thinking as we roll through the year from a cadence standpoint for those?

[Shelly Ibach:]

Yes, Bobby, we are really excited about the advancement of our 360 smart beds. As you recall, it was 6.5 quarters ago that we transitioned to all 360 smart beds and this will be our first advancement since we've made that big transformative move for the company. These are absolutely new 360 smart beds.These are the beds that we revealed and won so many awards with at CES and they have numerous advanced features from both a comfort and a cooling. And then, also the SleepIQ technology has advanced too and every time we make advancements in the technology, that will go to all the customers who have SleepIQ technology back to 2014.

[David Callen:]

And then, just to tack on, Bobby, I think you asked about the timing, we're planning the roll out to start next quarter in Q2 and be completed here in 2020.

[Bobby Griffin:]

Thank you. I appreciate the detail. I'll jump back in the queue. Good luck in the first quarter.

[David Callen:]

Great.

[Shelly Ibach:]

Thank you.

[Operator:]

Thank you. Next we will hear from John Baugh with Stifel. Your line is open.

[John Baugh:]

Thank you. Good evening and likewise, congrats on a great Q4 and start to 2020. Jump right in, the transition cost, I think you called out $4 million. Is that new product launch? Or what specifically are you referencing there?

[David Callen:]

That's exactly right. That's related to the roll out of our new products.

[Shelly Ibach:]

Primarily in Q2 and Q3.

[John Baugh:]

Okay. And then, Shelly, you've had a lot of experience with this. How do you think about the election specifically, and there was commentary around Labor Day shifting and I believe that's when we'll see some election impacts. So could you walk us through a little bit how sort of Q3 looks and what you're maybe anticipating is a possible headwind from the election spend on advertising?

[Shelly Ibach:]

Yes. Well, I'll just start with where we are and move through the year. We love our brand momentum right now and how well received our smart beds are from both the potential new customers, as well as our existing customers and how life-changing this sleep is.So we are really excited on the demand side and to be in our seventh quarter of double-digit growth and as we look at the full-year, we expect our guidance of $3.10 contemplates a high single-digit growth as David said, primarily our strongest quarters we expect to be Q1 with the easiest two-year compare and then Q4 with the extra week.And yes, Labor Day is like five days later in September. So it rolls very late. So that will have a little bit of impact on when deliveries are made between the two quarters. So you'll see a little movement there between quarters. We stay focused on the full year, operate the business for the full year and the long-term.Regarding the election, this is always a consumer distraction. I think that's the biggest thing, John. From a media perspective, we're pretty – we have a lot of agility and there are lots of moves to make. Yes, you could get into some specific local pressure in certain areas. But you can navigate around things. It's really how distracted the consumer becomes, how resistant they are to behaving normally.Is that going to impact the Labor Day results? I don't know. But it's more probably a little later in the third quarter and early fourth quarter where we're going to see that distraction from the consumer.

[John Baugh:]

And so, not to put words in your mouth, but you've embedded in your guidance some, some level of impact potentially.

[Shelly Ibach:]

Absolutely.

[John Baugh:]

And then, my last question was just around your comments and maybe it was David about the year starting out, I think about it in 10% pace and we are on the back-end of President's Day, which I believe is a huge event in Q1. So, my presumption would be, that event went well and you're kind of tracking for a quarter towards that 10% plus or did I misread something?

[Shelly Ibach:]

No, you did not. We consider this our seventh quarter of double-digit growth. And you're right, we're deep in the quarter through the President's Day.

[John Baugh:]

Thank you and good luck.

[Shelly Ibach:]

Thank you.

[David Callen:]

Thanks, John.

[Operator:]

Our next question comes from Peter Keith with Piper Sandler. Your line is open.

[Peter Keith:]

Hi. Thanks everyone. Congrats from me and good afternoon.

[Shelly Ibach:]

Hi, Peter.

[Peter Keith:]

Maybe just a follow-on John's question. So, the sales growth outlook, it did increased modestly to high single-digit and last time you spoke in Q3, it was mid-to-high single-digit was the outlook for 2020. So it's a small change, but an interesting one. So is there anything behind that beyond the strong start to the year that's maybe reshaped how you think about 2020?

[Shelly Ibach:]

Yes, I would say, Peter, as we have continued to progress our initiatives each quarter, these are initiatives that are integrated and we constantly are advancing them. And in December, we had acceleration in the fourth quarter and in December, we began to realize, at least half of our growth from units. And that has carried through here in 2020. But I would say, most importantly, we had a terrific Q4 and year and what really matters is our long-term track record and the sustainability of our performance. And we have high confidence in being able to continue to advance our initiatives as we have been.

[Peter Keith:]

Okay. And you had mentioned around some of the strengthening unit growth trends. And so, just to go back to the prepared remarks, you had commented that unit growth in 2020 would be stronger than ARU growth, which would be a change from the last couple of years. Could you just kind of help shape that for us, is there something behind this unit growth pick up or conversely, maybe is there – is the mix shift slowing with ARU to cause that shift with stronger units?

[Shelly Ibach:]

Well, I think illustrating from the double-digit growth here again in the fourth quarter and in the first quarter, it's safe to say that both metrics are strong for us and the unit growth is absolutely a result of what we've been talking about since July with all of our fundamentals so strong and the great response from consumers on our innovation that we would begin accelerating our brand communication and media spend to be able to get after more customer acquisition in addition to the strong customer retention that we have.And our business model and strategy is designed to benefit from both ARU unit growth over time. We continue to put up growth in these metrics on an annual basis and we've obviously had stronger growth from ARU with our innovations and selling process. But as we said in Q2 and Q3, we are putting this additional spend against our media and we expected that to materialize to unit growth and now it is.

[Peter Keith:]

Okay. That's very interesting, helpful. I'll leave it there. Thank you very much.

[Shelly Ibach:]

Thanks.

[Dave Schwantes:]

Operator, do you have another question for us?

[Operator:]

Yes, I do. I apologize for the delay. Our next question comes from Seth Basham with Wedbush. You may proceed.

[Seth Basham:]

Thanks a lot and good afternoon.

[David Callen:]

Hey, Seth.

[Shelly Ibach:]

Hi Seth.

[Seth Basham:]

I missed part of the call, but if you could help us understand what's implied in your high-single-digit sales growth for 2020 from a comp standpoint. That would be helpful.

[David Callen:]

Yes. You should expect about an even split between comp and new store contribution in the year.

[Seth Basham:]

Got it. Okay. So and embedded in that high-single-digit, you are expecting units to increase more than ARU. So, therefore, thinking the entire comp is going to be driven by units?

[David Callen:]

We expect somewhat higher unit growth than ARU, but we do expect contribution from both in 2020.

[Seth Basham:]

Okay. I think I am following you. And then, lastly, if you think about the ARU opportunities going forward, can you dimensionalize whether or not we are going to see any benefits from pricing or mix or attachments relative to 2019?

[Shelly Ibach:]

Yes, Seth, this is a really great question. When you look at ARU overall, first of all, our strategy and business model certainly warrants – we have pricing power with our exclusive distribution and proprietary innovation. And at the same time, you can see that we are clearly able to drive unit growth without pricing, as well.And I think the fourth quarter is a great example of that where we had fully lapped any pricing from 2018 and in the fourth quarter, we drove another 7% ARU growth. And this is an outcome of how we integrate our initiatives, specifically, our innovations, our selling process, and other factors in our store process that leads to ARU growth, specifically both attach and mix. And yes, we do expect continued attach and mix. We see opportunity. We are excited about our new line and how that will contribute.

[Seth Basham:]

Got it. And the new line will come at higher prices than the existing line?

[Shelly Ibach:]

We haven't specifically shared the pricing of the new line yet. But it's absolutely our favor to focus on attaching and mix. So that we're able to sell more to each customer and also repeat and drive our overall performance at a higher level.

[Seth Basham:]

Got it. And lastly relating to this topic, a question that we frequently get from investors is, what is your attachment rate of adjustable basis right now on your mattress sales, because there is a concern that it can't go much higher from these levels after some really, really strong improvements over the last couple of years. Would you care to share any comments on that topic?

[Shelly Ibach:]

Yes, yes. I will share with you that we continue to see growth in this area. This is a strength of ours. It has been a strength of ours for many years now and we have great sight line to being able to continue to drive attach of our FlexFit basis. Obviously, it's an important contributor in the fourth quarter with our 7% ARU growth and we expect it will continue to be in the future.

[Seth Basham:]

Thanks a lot and good luck.

[Shelly Ibach:]

Thank you.

[David Callen:]

Thanks a lot.

[Shelly Ibach:]

Operator, next question.

[Dave Schwantes:]

Hello, Sheila, are you there? I apologize. It seems we are having some technical difficulties with our operator. Just please hold on the line for one minute as we get this resolved and we'll continue with the Q&A.

[Operator:]

This is the operator. Once again, I do apologize for the delay. We are ready for our next question. Our next question will come from Bradley Thomas with KeyBanc Capital Markets. You may go ahead.

[Andrew Efimof:]

Hey, good afternoon, this is Andrew on for Brad. A question we've been getting a lot recently is basically on competition and how you are viewing Mattress Firm's repartnership with the Tempur-Pedic? Clearly, it doesn't look like this is a significant issue in 4Q given your strong performance. But we were wondering how you're thinking about the partnership over the next few quarters and how that could impact your business.

[Shelly Ibach:]

Yes, Andrew, this is Shelly. We have – we're in our seventh quarter of double-digit growth that is associated with our Sleep Number 360 smart bed. And all the other initiatives that we've been driving over multiple quarters, we see great strength and have confidence in our own ability to continue to bring consumers into our brand and drive our performance.

[Andrew Efimof:]

Great, great. Understood. And I guess my last question here is, wondered what your outlook was for input costs for 2020 and how you expect these trends to impact the margin outlook for the year?

[David Callen:]

Andrew, it's kind of a push. We've got some things that are going against us, like some of our labor and so forth. But we do have some favorability in some of our commodity costs. So, we expect it to be basically flat impact overall.

[Andrew Efimof:]

All right. Great, thanks. That's helpful. That's all for me.

[David Callen:]

Okay. Thanks, Andrew. Okay, I am almost afraid to ask, but Sheila, are you with us? It sounds like we're having trouble.

[Operator:]

This is the operator. Are you ready for the next question?

[David Callen:]

Yes, thanks.

[Operator:]

Thank you. It comes from Atul Maheswari with UBS. You may go ahead.

[Atul Maheswari:]

Good evening. Thanks a lot for taking my question. So my question is also on units and given the strong ARU growth in the fourth quarter, it would appear that units probably decline on a same-store basis. But then it looks like unit growth has improved thus far in 2020 and that should ramp further. So I am just trying to better understand what has changed with respect to your strategy thus far in 2020 that's driving this improved unit growth?

[David Callen:]

Yes. Hey Atul. I'll handle that one, because it's a fairly easy one. You need to remember that we had $24 million of deliveries in 2018 that shifted from Q3 into Q4 and that's kind of messing up your – I think your analysis. Our adjusted growth against the adjusted 2018 numbers in Q4 is 14% and half of that was from units.

[Atul Maheswari:]

Okay, that's very helpful. Thank you so much. And then, as a quick follow-up, how are trends in your mall versus non-mall stores? And is there any meaningful performance cabinets worth calling out? And is that gap any wider than it's been in the past? Thank you.

[Shelly Ibach:]

Yes, nothing meaningful to call out. We've continued to progress our strategy with stores outside of malls with now over 60% of our portfolio in non-malls.

[David Callen:]

Yes, generally speaking, the malls that we are in, we like and we see strong performance both in our mall and non-mall locations.

[Atul Maheswari:]

Thanks.

[Operator:]

Thank you. [Operator Instructions] Our next question is from Curtis Nagle with Bank of America. You may go ahead.

[Curtis Nagle:]

Yes. Thanks very much. Just wanted to go back to Seth's question on the breakout of the sales growth. If I heard you correctly and maybe I didn't, I think you said that the contribution from comp and stores would be even. And if that's the case and store growth is about 4.5%, the extra week is 2%. Wouldn't that imply comps of 4.5% and total sales growth of 11%, not high single-digits? Or do I have my math wrong?

[David Callen:]

So, look, we are guiding to high-single-digit top-line growth with about two points from the extra week. We highlighted that that was about a $30 million impact. The math that we are providing is about directionally equal contribution from comp and new stores. I am not going to split the contribution by 0.5 a point.

[Curtis Nagle:]

Okay. And if you could just clarify how much EPS benefit you get from the extra week?

[David Callen:]

As I highlighted on the call, my comments I expected about $0.15 benefit from that extra week. However, we are intending to invest that back into the business with the accelerated spending in our R&D.

[Curtis Nagle:]

Okay. Thanks very much.

[David Callen:]

All right. You bet.

[Operator:]

Thank you. I will now turn the conference back over to the company for closing remarks.

[Dave Schwantes:]

Thank you for joining us today. We look forward to discussing our first quarter 2020 performance with you in April. Sleep well and dream big.

[Operator:]

Thank you. That does conclude today’s conference. Thank you for participating. You may disconnect at this time.