Q4 2019 Earnings Call

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Correct, 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 vice president of finance major investor relations. You may begin.

Good afternoon, and welcome to the Sleep Number Corporation fourth quarter 2019 earnings conference call. Thank you for joining us. I am Dave Vice President of Finance and investor relations office with me today are Shelly ibach our president and CEO and David Cowan. Our CFO. This telephone conference is being recorded and will be available on our website at sleep number, 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. Just ended however our commentary on a 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 and some wage

Still in our annual report on form.

10K and other periodic filings with the SEC the company's actual future results May Vary materially, I will now turn the call over to Shelley for her comments.

Good afternoon, and Welcome to our call. My sleep IQ score was 82 last night consumer response to our revolutionary 360 smart beds had been exceptional driving 6 quarters consecutively of double-digit demand growth including acceleration in the fourth quarter are differentiated consumer Innovation strategy drove record results in 2019, which were near the high end of our expectations, including 11% sales growth to one point seven billion dollars with a 6% gain in Five Points from new stores 21% growth in net operating profit off 41% growth in earnings per share to $2.70 and forty four percent growth in operating cash flows to $189 million.

Executed our ambitious Vision over multiple years focusing on three performance drivers increasing consumer demand driving business Palm Beach and deploying Capital efficiently.

Building lifelong relationships with our customers while investing to ensure broad consumer relevance has resulted in sustainable profitable growth including a 5 year EPS kegger of 17% in 5 year total shareholder return of 85%

As a purpose-driven company, we remain committed to investing in the initiatives that deliver meaningful value for our customers team and communities and we expect our advantage and efficient business model combined with near and long-term investments will continue to deliver Superior returns for our shareholders.

Our 2020 420 we anticipate our performance driving initiatives will result in EPS of $3.10 a 15% increase over our record 2019 performance.

We continued our positive momentum with the strong start in 2020. Here are the Catalyst behind our performance driver's First Choice Driving consumer demand through five integrated competitive advantages proprietary sleep Innovations, longitudinal data lifelong customer relationships brand Communications and exclusive direct-to-consumer distribution. We've awakened the consumer to the importance of sleep with our 360 smart bed. We've provided a solution to effortlessly achieve proven quality sleep.

our sleep

New technology platform delivers over ten billion biometric data measurements each night these inform our Innovations and results in integrated advancements that seamlessly act on our sleepers behalf. We will continue to evolve our Sleep Number 360 smart bed at a pace that keeps consumers with highly engaged with our brand.

our sleep IQ software advancements are benefiting all customers who own this technology which we first introduced in 2014 informed by more than a $700 million sleep sessions and sleep and wellness research these ongoing updates add meaningful value to our customers sleep experience and overall will be

Our customers daily engagement with our brand via sleep IQ technology reinforces this value with personalized insights.

the result

Is increased customer retention and future revenue from referrals and repeat sales the lifelong relationship with our customers is an important strategic that is strengthened through our ability to link smart sleep to individualize Health and Wellness.

Last month at CES the largest consumer Innovation event in the world. We unveiled our next generation of 360 smart bed, which helped solve significant sleep challenges and effortlessly deliver proven quality sleep are smart beds were honored with twelve Awards during CES, including the best of innovation in the smart home category. We will begin introducing our new 360 smart bed portfolio in the second quarter off with Advanced sleep IQ capabilities that include monthly Wellness reports sleep circadian rhythm insights and heart rate variability measurement in addition. Our new smart beds feature temperature balancing layers and proprietary Comfort Technologies to provide a cooler drier sleep environment.

According to Sleep Number research temperature during sleep is an issue for 83% of people are new Sleep Number climate 360 smart bed available in the next 12 months is designed to help people fall asleep faster and stay asleep by creating smart individualized micro-climates the better off just throughout the night warming and cooling each side and working with the sleepers natural sleep cycles to provide deeper and more restful sleep.

Sleep Disorders have been declared a public health epidemic by the Center for Disease Control one in three adults suffer from a lack of adequate sleep. Is it company with purpose? We are dedicated to our mission of improving lives by individualizing Sleep experiences. We are taking on a big challenges like sleep deprivation.

On our proprietary research and Analysis of more than $25 million sleep sessions sleepers who routinely use their 360 smart bed features including sleep IQ technology can improve quality sleep by nearly one hundred hours each year. This matters Studies have shown that even 15 minutes more quality sleep per night can increase a body's ability to Stave off weight gain prevent a cold and enhance productivity. We are committed to making quality sleep the new badge of honor for society.

With the significant opportunity we have to improve people's lives through higher quality sleep. We recently entered into an extensive collaboration with the male clinic to Advanced sleep science and cardiovascular medicine by providing our unparalleled sleep knowledge and Technology to world-class clinicians and researchers were poised to make meaningful advancements to the science of sleep and health. This collaboration is a good illustration of the value of our log longitudinal data one of our competitive advantages in reinforces the efficacy of our smart bets.

And Partnerships with organizations like male clinic the nation's number one hospital and NFL to extend and amplify are bringing in a proprietary manner is an important aspect of our strategy our brand metrics indicates, especially strong Affinity with our broad NFL audience off.

With Innovation leadership and strong fundamentals across are vertically integrated business. We began leaning into our brand campaign in media spending the third quarter of 2019 to drive increased highly qualified traffic to our brand. We have successfully converted this traffic and driven five-digit demand for the last 6 quarters, including the back half of 2019, which was up against double-digit growth from the prior-year off.

Are integrated initiatives including media social digital engagement and selling process advancements are key drivers of the page demand growth which has continued into twenty-twenty.

Since December more than half of our demand growth has been driven by unit growth. We expect our initiatives to drive increases in both units. They are you with a greater performance contribution from unit growth in 2020?

Moving to our second performance driver business leverage with are tightly integrated vertical model and a culture that drives Innovation and continuous Improvement. It is exciting to be realizing accelerating benefits from our investments and initiatives.

business

Leverage priorities include advancing technology and automation to support growth enabling Innovation with an agile flexible and Kong Advantage supply chain.

Strengthening our Logistics Network to gain efficiencies and Effectiveness and implementing Total Quality Management.

These multi Yuri initiatives are delivering both margin expansion and improved customer experience.

Our third performance driver is deploying Capital efficiently, which we have also Advanced over multiple years. We generated nearly nine hundred million dollars of a greeting cash flow over the past six years including a record $189 million dollars in 2019.

Our top Capital deployment priorities remained investing in high confidence high-return growth and profit drivers maintaining appropriate quiddity and investing in Sleep Number stock where we continue to see meaningful value.

Our consumer Innovation strategy has resulted in a strong foundation for growth and profitability. We are excited to begin the next chapter of our journey as a purpose-driven company in the health and wellness space with a more broadly relevant brand expanded competitive advantages in an integrated vertical business model with digital at our core.

Thank you to our talented and highly engaged Sleep Number team and partners for your dedication to improving lives by individualizing Sleep experiences, which is giving a meaningful impact on society your passion Integrity Innovation courage and teamwork are resulting in record financial performance and Superior shareholder value creation Now David will share more details on our financials in Outlook. Thank you Shelley Long

tenacious

Please 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, We've delivered 9% compounded annual net sales growth and 29% compounded annual growth in earnings per diluted. Share. We significantly Advanced package 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 have increased spending to support our growth drivers like our revolutionary Innovations optimize 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 an 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. We've got millions more lives to improve.

Running clean and 2019 did not change our long-term mindset leaning into our near and long-term growth drivers enabled our 2019 performance including a thousand percent net sales growth 130 basis-point Improvement in gross margin, 21% operating profit growth and a 41% increase in earnings per diluted share.

Top and bottom line growth at the higher end of our expectations allowed us to accelerate spending on Innovations and marketing as our results demonstrate extracting. This way is good for shareholder value creation.

When compared to adjusted 2018 results are current year Q4 net sales grew 14% And EPS grew 41% are reported fourth-quarter. Net sales grew 7% and EPS grew 1% Please refer to the 2018 fourth-quarter, press release non-gaap reconciliation take off for details of the 24 million dollars of deliveries that shifted from Q3 into Q4 last year.

Our full-year 2019 Compass contributed six points of growth while new stores added Five Points. We ended the year with 611 stores across all 50 states song during the year. We opened 59 News stores and grew average sales per comp store plus online 6% to 2.9 Million Dollars.

Our revolutionary Innovations and proprietary retail selling process drove a 9% lift in our are you while units were up 2% for the year?

Operational Improvement initiatives drove a 130 basis-point lift in our full-year gross margin rate to 61.9% This was at the high end of our internal expectations while absorbing higher-than-expected tariffs and final mile delivery costs during the year.

Favorable product mix elimination of prior-year transition costs and improved operations and customer experience contributed to the strong gross margin rate in 2019.

Outsized top-line growth and gross margin expansion enabled additional funding of our growth initiatives throughout 2019. For example, we ratcheted up R&D spending twenty 1% for the year including accelerated growth of 25% in Q4 this funding to support longer-term growth. I'm leading to life-changing Innovations, like the new 360 smart beds. We will begin introducing next quarter while delivering a 21% increase in our net operating profit to 112 million dollars in 2019. We also absorbed more than 100 basis points of pressure across the p&l from higher incentive compensation medical claims and legal expenses.

This growth was nearly double our 11% top-line growth and reflects a 60 basis-point Improvement year-over-year. We generated 44% more cash from operations in 2019 to a record $189 and funded 30% more high-value capital projects this year to a total of $59,000. We also realize double-digit internal rate of return on the $146 million dollars. We invest it to buy Sleep Number stock are ending of leverage ratio of 2.7 times. Ebitda R is within our Target operating range of 2.5 to 3 times as planned.

Performance momentum has continued into twenty-twenty our EPS guidance of $3.10 represents a 15% increase over record 2019 earnings off while absorbing Five Points of eps growth headwinds from higher expected income tax rate and four million dollars of estimated transition costs.

We continue to run the business for full-year and long-term performance. Here's some color on performance drivers and the expected shape of twenty-twenty. We expect consumer sentiment this year to be similar with 2019. However, we believe it's prudent to plan for some consumer distraction from the Olympics and presidential election in the back half of the year off.

The coronavirus has blanketed headlines recently while we don't have immediate immediate Supply exposures. We continue to work closely with our handful of china-based suppliers to build contingency plans. We expect this Dynamic situation to become clear over the coming months.

For the 2020 fiscal year, we expect high single-digit top-line growth, including two points from the extra week.

We expect our initiatives in 2022 again Drive growth from aru and units as well as through, and new stores.

The strongest year-over-year sales and earnings growth are expected in the first and fourth quarters. The first quarter is up against the easiest to year Compares and the fourth quarter of benefit from a Labor Day calendar shift of approximately ten million dollars plus the extra fiscal week of sales of approximately Thirty million dollars. We expect continued Faith estimate of our integrated initiatives to deliver twenty-five to fifty basis points of incremental gross. Margin in twenty-twenty on top of the 130 basis-point gain in 2019. We intend again to accelerate our R&D spending as we progress through the year causing 30 to 40 basis points of deleveraging year.

with air cleared

Data-driven insights. It's the right time to invest a good portion of the estimated $0.15 extra week benefit to support our future Innovations.

Funding our initiatives and growth drivers is expected to result in modest operating profit leverage for the year.

We expect about Five Points of eps growth headwind from a 22% estimated full-year income tax rate.

This estimate includes about 3 million dollars of full-year access tax benefits from Equity accounting primarily in the first quarter.

We expect to generate approximately $190 in cash from operations and to deploy approximately $16 on capital projects primarily to expand our store bulb four to 5% in 2020.

The balance of our free cash flow is expected to be invested in Sleep Number stock as we continue to see meaningful value there. We expect to deliver high-teen roic home while operating within our targeted leverage range of 2 and 1/2 to 3 times ebitda r

The enthusiastic consumer response to our life change changing Innovations shows consumers understand there is no compromise needed when choosing the 360 smart bed each sleeper gets what they want. They each feel the benefit of the bed actually using data to effort Leah just on their behalf to deliver deeper fire quality sleep who wouldn't want one hundred more hours of proven quality sleep each year.

We look forward to raising the bar on behalf of our customers again in 2020 and to delivering strong value creation for Sleep Number investors.

The clarity that we have from having ten billion biometric measures every night from our sleepers is informing our future Innovations and give us a 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, you know, we should see that it'll be slightly less in 2020 as we leaned into these growth drivers for the long-term benefit.

Okay, I appreciate that telephone then from the Cadence of the new product introductions. Is there anything that we should keep in mind in our models as as you guys roll these out and wage was think about the size of them? Are they new products going on the floor? Is it updates just to the app and the Sleep i q system. What exactly should we be thinking as we roll through the year from a Cadence standpoint for those?

Yeah, Bobby. We're really excited about the advancement of our 360 smart beds, you know, as you recall, it was 6 and 1/2 quarters ago that we transition to all 360 smart pads. And this will be our first advancement is since we've made that, you know, big transformative move for a company. These are absolutely new 360 smart bed. These are the beds that we revealed and won so many awards with at CES and I have numerous Advanced features from both a comfort and a cooling and then also the Sleep IQ technology has advanced to a New Jersey every time we make advancements in the technology that will go to all the customers who have sleep IQ technology back to 2014.

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

Thank you. I appreciate the detail jump back in the cube. Good luck in the first quarter. Great. Thank you.

Thank you. Next we will hear from John Bell with stifel your line is open. Thank you good evening and likewise congrats on a great start the 2028. Um Jump Right In the transition cost. I think you call that 4 million is that is that new product launch or what specifically are you referencing there? That's exactly right that's related to aging roll out of our new products primarily and had a lot of experience with this. How do you think about election specifically and there was commentary around Labor Day shifting and I believe that's when we'll see some election impact. So could you walk us through a little bit how sort of Q3 looks and and what your may be anticipating is a possible headwind from from the election birth.

Advertising. Yeah, well, I'll I'll just start with you know, where we are and move move through the year. We love our brand momentum right now and I am well received our smart beds are from both the potential new customers as well as our existing customers and how life-changing, you know, this sleep is that we're really excited on the demand side and to be in our seventh quarter of of double-digit growth and as we look at the full year, you know, we expect our guidance of 3:10 a.m. Contemplates a you know, high single-digit growth as David said primarily our strongest quarters, we expect to be one, you know with the easiest to 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 would have a game.

A little bit of impact on when deliveries are made between the two quarters. So you'll see a little movement there between quarters, you know, we stay focused on the full year off.

The business for the full year and the long-term regarding the election, you know, this is always a consumer distraction. I think that's the the biggest thing John from a media perspective. You know, we're we're pretty you know, we have a lot of agility and there are lots of moves to make yes, you can get into some specific local pressure off certain areas, but you can navigate, you know around things. It's really the how distracted the consumer becomes how resistant they are to behave normally, you know, is that going to impact the Labor Day Results? I you know, I don't know but it's it's more probably a little later in in the wage order and and you know early fourth-quarter where we're going to see, you know, see that distraction from the consumer.

It's so not to put words in your mouth. But you've been better than your guidance some some level of impact potentially. Absolutely and then my last question was just around your, maybe it was David's about the the year starting out at I think about 10% pace and we're on the back end. The President's Day, which I believe is a huge event in q1. So my presumption would be that event went well and you kind of tracking for a quarter towards that 10% Plus or did read something know you did not we we consider this our seventh quarter of double-digit growth and you're right where you know deep in the quarter through the the President's Day.

Thank you.

Good luck. Thank you.

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

Yeah, thanks everyone congrats for me and good afternoon. Maybe just to follow on John's question. So, you know the sales growth Outlook an increase in a single digit. And the last time you spoke on Q3. It was mid to high single-digit with the outlet for 2020. So it's a small change but an interesting one. So is there anything behind that beyond the the strong start of the year? That's may be reshaped how you think about 20 20? Yeah, I you know, I would say Peter as we have continued to progress our initiatives, you know, each quarter, you know, these are initiatives that are integrated and we constantly are advancing them and in you know in December we we had acceleration in the fourth quarter and in December, we began to realize you know at least half of our growth from units and that has

carried through here in

Twenty-twenty but you know, I would say most importantly, you know, we we had a terrific Q4 and year and what what really matters is our long-term track record our sustainability of our performance and you know, we have high confidence in being able to continue to advance our initiatives as we have been.

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 20 that would be stronger than aru growth which would be a change from the last couple of years cuz you just kind of helped shape that for us. Is there is there something behind the this unit growth pickup or confirm? Maybe is there is the mix shift slowing with with aru to cause that that shift with stronger units?

Well, I think you know illustrating from the double-digit growth, you know here again in the fourth quarter. And and in the first quarter, you know, it's safe to say that both both met them are are strong for us. And the unit growth is absolutely a result of you know, what we've been talking about since July with all of our fundamental so strong and the the great response from consumers on our innovations 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 you know our business model and strategy is designed to benefit from both are you and unit growth over time? We continue to put up, you know growth in these metrics on an annual basis and we've you know, obviously yep.

stronger growth from a r u

with our Innovations and selling process but you know as we you know said in in Q2 and Q3, you know, we're we're putting this additional defend against the the media and we expected that to materialize the unit growth and now it is

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

Operator do you have another question for us?

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

Thanks a lot. Good afternoon. Hi, Seth. I missed part of the call. But if you could help us understand what's implied in your high school digit sales growth for 2012 from a comp standpoint. That would be helpful.

Yeah, you you should expect about an even split between Company Store contribution in the year.

Got it. Okay, so and and that isn't that high tell digit you're expecting you to increase more than you. So therefore the entire complex to be driven by, uh, you know, we expect somewhat higher unit growth than they are you but we do expect contribution from both in 2020.

Okay, I think I'm following you. And then lastly if you think about the aru opportunities going forward to dimensional lives whether or not we're going to see any benefits from our pricing or mix or attachments relatives 2019.

Yes at this is you know a really great question. When you look at overall, first of all, our strategy and business model certainly warrants. We have pricing power with our exclusive distribution and proprietary Innovations. And at the same time you can see that we're you know clearly able to drive you in a growth with out pricing as well. And I think the fourth quarter is a great example of that where you know, we had you know, fully lost any pricing from 2018 and in the fourth quarter, we drove another 7% growth and this is an outcome of how we integrate our initiatives specifically our Innovations are selling process and you know other factors in in our store process that leads to a r a r u gross

specifically

both attached and mix

and that continued attached and mix we see opportunity. We're excited about our new line and how that will contribute a new line with a higher prices than the existing line.

We haven't specifically shared the pricing of the new line yet that it's absolutely our favor to focus on attaching and mix so that we're able to you know sell more to to each customer and also repeat and drive our overall performance at a higher level and lastly your life to this topic a question that we trickling got from investors is what is your attachment way of adjustable bases right now on your mattress sales cuz there's a concern that it can't go much higher from this month after some really really strong improvements over the last couple of years. Would you care to share any comments on that topic?

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

Thanks a lot and good luck. Thank you. Thanks a lot.

operator next question

Osceola are you there?

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.

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 Bradly Thomas with keeping Capital markets. You may go ahead.

Hey, good afternoon. This is Andrew. I'm from Brad a question. We've we've been getting a lot recently is basically on competition and how you're viewing a mattress firm's re partnership with Tempur-Pedic clearly. It doesn't look like this was a significant issue in 4 q 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.

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

Great great understood and I guess my last question here is what did what your outlook was for input costs for for 2020 and how you expect these Trends may impact the margin outlook for the year.

You know Andrew it's 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 faith in some of our commodity costs. So we expect it to be basically, you know flat impact overall.

Hi great. Thanks. That's helpful. That that's all for me.

Okay. Thanks, Andrew.

Okay, I'm almost afraid to ask but Sheila are you with us? It sounds like we're having trouble. This is the operator. Are you ready for the next question? Yes. Thanks. Thank you. It comes from a tool. You may go ahead.

Good evening. Thanks a lot for taking my question is my question is also on unit and and given the strong growth in fourth-quarter. It would appear that the units probably probably decline on the same team store basis, but then it looks like you know has has has improved as far in 2020 and that should ramp were there. So I'm just trying to better understand what has changed with respect to your strategy thus far with twenty-twenty. That's the striving to improve going to drop. Yeah. Hey tool I'll handle that one cuz it's a fairly easy one. You need to remember that. We had twenty-four million dollars of delivery in 2018 that shifted from Q4 Q3 into Q4 and that's kind of messing up. Your urinalysis are adjusted a growth affects. The adjusted 2018 numbers in Q4 is 14% and half of that was from units.

Okay, that's very helpful. Thank you so much, and then as as a follow-up, how about Trends in your model, which is non mall stores. And is there any meaningful performance cab that's worth calling out and and may not have any wider than it's been in the past. Thank you.

Yeah, nothing meaningful to call out. We've continued to progress our strategy with stores outside of small now over 60% of our portfolio in in non Mall. Yeah, generally speaking the malls that were in we like and we see strong performance both in our mall and on all locations.

Thank you as a reminder. If you'd like to ask a question, please press star followed by 1 our next question is from Curtis with Bank of America. You may go ahead. Yeah, thanks very much. Just wanted to go back to Seth question for us question on the break out of the sales growth if I heard you correctly and maybe I didn't but I think you said that the contribution from Compton stores would be even and if that's the case and and you know store growth is about four and a half percent. The extra week is 2% with Medigap 4.5 in total sales tax of 11% Not a single digits or doing my math wrong.

so

Look, we're guiding to you know, high single-digit top-line growth with two about two points from the extra week. We highlighted that that was about a thirty million dollar impact off the math that we're providing, you know were is about directionally equal contribution from comp and new stores. I'm not going to split off the contribution by half a point.

Okay, and if you could just clarify how much EPS benefit you get from the next week.

Is that highlighted on the call? My comments I expected about fifteen cents benefit from that extra week. However, we're intending to invest that back into the business with accelerated spending in Iraq.

Okay. Thanks very much. Thank you bet.

Thank you. I will now turn the conference back over to the company for closing remarks. Thank you for joining us today. We look forward to discussing our first quarter 2020 performance with you in a little sleep. Well and dream big.

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