Welcome to Sleep Number's Q1 2021 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.

Good afternoon and welcome to the Sleep Number Corporation first quarter 2021 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 Chief Financial Officer. 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. We also want to refer you to our recently updated Investor Presentation which can be accessed on our website at sleepnumber.com. I will now turn the call over to Shelly for her comments.

Good afternoon and welcome to our first quarter earnings call. My SleepIQ score was 88 last night. Through continuous innovation across our enterprise Sleep Number is winning consumers hearts, lines, and share of wallet. We are improving life through better quality sleep while delivering exceptional value for all stakeholders. First quarter demand was more than 30% higher than prior year, which reflects broader and deeper brand relevance as we build on the accelerated shift in consumer trends towards prioritization of their health, faster adoption of digital products and services, and increased preference for brands with an authentic purpose. We see these trends continuing to benefit performance during the balance of this year and beyond. Our strategic investments in leadership in free science are propelling the advancement of 360 smart bed features that improved, repelled [ph] and drive customer engagement. In Sleep Number's culture of individuality and well being provides the foundation for our mission driven team who passionately innovate with agile learning and exceptional execution. Our first quarter performance was driven by a significant acceleration in both consumer demand and profitability. We are raising 2021 EPS guidance to at least $6.50 compared to reported EPS of $4.90 in 2020 and $2.70 in 2019. Net sales increased 20% to $568 million with demand growth accelerating from previous quarters to more than 30% year-over-year and over 40% on a two-year basis. Greater than $50 [ph] million of smart bed delivery shifted out of the first quarter due to temporary fall supply constraints. Operating income grew 45% to $76 million. EBITDA grew 39% to $97 million and EPS increased 85% to $2.51. We also had record return on invested capital of 27.6%, up 850 basis points from prior year as we continue to realize compelling value from disciplined capital deployment. To support our…

Thank you, Shelley. I'd like to add my thanks to our Sleep Number teams and business partners. We are incredibly proud of your tenacity and creativity to navigate the challenges of this pandemic. You continue to find ways every day to improve the lives of Sleep Number customers with proven quality sleep. Since our earnings call two months ago, we have further advanced our digital capabilities, business processes, and performance drivers. We introduced daytime alertness insights, completed the introduction of the new Suite Number 360 smart beds, opened two additional assembly distribution centers, and improved more than 200,000 lives. We evolved our digital marketing and consumer engagement tools and applied selling from anywhere retail capabilities when snow and ice disrupted much of the country. We protected service levels for customers by leaning into resilient supplier partnerships and efficiently expanded our revolving credit facility to $600 million through robust banking relationships. These are examples of how Sleep Number teams continuously strengthened the business, leading to greater than expected performance this year and beyond. Q1 demand drove the highest quarterly sales quarters in company history, more than 30% over the prior year, and more than 40% greater than two years ago. This accelerated demand combined with a temporary foam, chemical supply constraints, resulted in more than $50 million in deliveries shifting out of the first quarter. However, foam production is now expected to normalize by the end of Q2. We continue to be pleased with the higher than expected demand growth as consumers embrace proven quality sleep from Sleep Number. The strength and acceleration of performance has led us to raise our 2021 EPS guidance to at least $6.50. Net sales of $568 million were 20% greater than the prior year, marking the third consecutive first quarter with double-digit net sales growth.…

Absolutely. [Operator Instructions] Your first question will come from the line of Peter Keith of Piper Sandler. Please go ahead.

Hi good afternoon everyone and congrats on the continued success. Maybe just quickly follow on the comments around pricing, I did have a question there. So, the $20 million that you're taking strategically, does that more than offset the input cost inflation that you're seeing, and secondarily, couldn't you build up more than $20 million, I guess mathematically that just looks like a 1% price increase, historically you've taken 2% price increases and certainly your broader industry peers have taken substantially more, so if you could maybe dig into the pricing dynamic a little more?

Sure, Peter. Thank you for the question. We took this pricing in early March and of course, we continue to learn more every week regarding commodity pressures, and we took the pricing on selected SKUs and as you stated and we covered it is worth about $20 million. Our unique model Peter, gives us a range of options, as we manage for total operating margin in our business. And clearly we have additional and we certainly have additional pricing actions available to us and we can be quite fluid between our selling process, discounts, financing and attach. That gives us the ability to trade up the line based on our adjustments or make short-term real-time adjustments in discounting and financing. We love our competitive positioning, right now, and we have such a strong value equation compared to anyone across the board, and love the units and the acquisition we're driving, we have a lot of year in front of us. And while the $20 million, with the newer information on commodity costs gets us close, but not quite all the way. We have so many levers to be able to pull that are yet in front of us and again, we're going to focus on total operating margin. You can see the strong progress we've already made here in the first quarter and that certainly led us to raising our guidance to at least $6.50 for the full year.

Okay, that's helpful. The second question I wanted to ask, and I'm not trying to sound naive, but it's a question that we're getting a lot from investors is what's changed with Sleep Number? Clearly, there is some demand as a result of maybe COVID, and the stay at home dynamics. But at the same time, your growth has been quite spectacular. We could argue you're growing much faster than the overall industry and you're seeing very nice flow through in your model. So just big picture, what do you think is driving this elevated demand? And do you think there's some sustainability to this, even as vaccinations increase and people start spending on things outside their home?

This is an important question Peter and we're super excited. This goes back to when we fully transitioned to 360 smart beds nearly three years ago. We have now an average demand over that span of time of 14% and that's all since we transitioned to the smart beds. Along with that, we also brought our digital marketing buying capability in-house and we've been perfecting and advancing that. And if you think about algorithms and the precision that comes with them, more sleep data leads to better insights and advancement of innovations that are relevant for the consumer and at the same time, this additional data, that knowledge that we have on the marketing side also leads to more efficient and effective targeting and qualified digital traffic, which is converting at a higher level. So these two combined are driving both the demand and then of course, with the scale that's also driving the stronger flow through. And then, I have to highlight our big unlock, during COVID once the COVID pandemic hit last year, around selling from anywhere, we pivoted to a new model that is very unique to our vertical model. And that -- that was a big unlock for us in the selling and marketing expense line, which we said last year hit over 300 basis points of leverage, and that we are going to hang on to that as we moved into this year and we're certainly demonstrating that we have in that we intend to and see greater and greater efficiency. So is it sustainable? Absolutely. And this is the innovation of strategy that we set out to deliver back in 2012 is at the beginning of this transformation of the company, and here we are and I would say is it early days. This is a great opportunity to join Sleep Number and get behind us as we are early in our -- on our path of sleep innovation leadership leading to connected health.

Okay, that's a great summary. Thanks so much and good luck.

Thanks Peter.

And our next question comes from Brad Thomas of KeyBanc Capital. Please go ahead.

Hi, good afternoon, everyone. Let me add my congratulations as well on a nice start to the year here. My first question, which is going to be about your updated full year guidance, I think you'd be consensus here in 1Q by $0.68, there's $50 million of sales that you think will happen in 2Q that could have happened in 1Q and you're raising the full year by $0.50. Just to connect to that, so are there any other moving pieces as we think about the balance of the year or are you all just be conservative with flowing through this strong 1Q? Thanks.

Yes, hi thanks, Brad. As like every year, there are a lot of moving parts and we're pretty early in the year. We just gave guidance two months ago, and we've raised our guidance for the year by $0.50. We are very confident in the trajectory of the business and but we're managing both some tailwinds. We've talked about the demand side being the high end of our expectations, actually, above our high end of our expectations. And we're balancing those against some of the headwinds that we're facing with new commodity costs that we've highlighted and we're taking all of that into account as we think about the full year and we couldn't be more thrilled about the performance of our teams and the business and the way consumers are reacting to the superior sleep that they get through Sleep Number’s, products. We are also very happy with big shout out to our supply chain teams. I mean, it's been really challenging to navigate through the supply chains, challenges globally, not just ours, but this is happening across businesses everywhere. And our teams have done a phenomenal job working with our partnerships, with our suppliers, and making sure that we get more than our fair share of supply, and make sure that we're serving our customers. So, all in, we did get a bit more tax benefit in Q1 than what we had expected. That's built into the full year thinking as well. It impacted full year by about a dime compared to prior year. So, all in, we're going to use all of our levers to deliver superior financial performance, at least $6.50 of EPS, which is, as I said, more than 140% of just two years ago in 2019 when we were running clean in 2019.

Hi, Brad. I'll add on for the demand side, we continued to see momentum in demand here in Q2. It is obviously early, but I think it's important to underscore that, and we're -- we're excited about what is yet to come, thus the, raise to 6.50 here early in the year and also we recognize that people are out more, and they're spending more and that bodes well, for us. It's working great and we're excited about what that will mean for us for the remainder of the year.

That's very helpful. And then the 2Q estimate is going to be a tough one I think for all of us to get our arms around given you had stores close to not open last year. If we looked at having grown 30% versus about two years ago, and then layering on another $50 million of orders that can come in, you can get a revenue number over $500 million for 2Q. Obviously, it's a pretty big growth rate here. Can you help us get any more sense of how to think about modeling that second quarter?

Brad, you are thinking about it the right way. We talked about this year in our original guidance two months ago that for the full year about 4 to 5 points of our growth was going to be because of the strong ending backlogs that we were servicing here in the first half. We've always said that we expected more of our growth to come in the first half of the year, but we do expect growth top and bottom line every quarter versus 2019 here in 2021. So directionally, you're thinking about it the right way. It's -- we expect to have a pretty big quarter and second quarter.

Thanks so much.

Thank you.

Your next question comes from Bobby Griffin of Raymond James. Please go ahead.

Congratulations on a great first quarter. David, can I just followup on the backlog question first, and I got a longer term strategic question here. First on the backlog, that 4 to 5 points of growth call it like $80 million to $90 million bucks round number [indiscernible] or service you had shifting, so is the material [indiscernible] that backlog back down to like a normalized level [indiscernible] of if the material of the day, there's capacity issues with that we'll have to stretch out over a couple of quarters?

Yes. Hi Bobby, you're breaking up a little bit. I'm pretty sure I heard your question. So I'll do my best. But if I…

I think I'll…

No, no I’m good. I think you're asking about whether the backlog impact for the year was about $80 million to $90 million, that's directionally right. And then thinking about when that would be serviced in terms of how that would benefit our first half of the year or this year, we do expect a more normalized type of backlog, but our growth has been exceptional. And so, we are having higher backlog than we've ever had and that's just going to be the State of the Union we expect during the course of the year. That's all baked into our thinking of how we're going to deliver more than $6.50 of EPS here in this year and we plan to do even better than last years and beyond.

Yes, I guess the, that was part of the, I guess the second part of it was, if you take the 90 and you add on the 50, you get 130. Do you have enough like all the materials and the foam and everything are there and available for you to get which is a big if, I understand that, but is there enough capacity that you can get all that to float in one folder or just max, we're going have to build over a couple of quarters just because it's such [indiscernible] business I guess that…?

Yes, well, Bobby, some of that backlog was serviced clearly in first -- in the first quarter. And, what we're saying is that relative to where we started to be, we carried $50 million of deliveries out of Q1. So that's really what we think about moderating costs.

Yes, that’s helpful and then secondly and I think the long-term target [indiscernible] 52% to 54% last quarter in the slide deck [indiscernible] some of the drivers…

Okay, Bobby, I think we lost you. I can answer the question, though, that where I think you were headed. Gabriel, we're still on the line. Is that correct? I assume we just lost Bobby. Okay, so I'll go ahead and answer his question about gross margin. In our long-term slide, in our Investor Relations materials, we say 62% to 64% gross margin rate. Look, we've said this many times over the course of history that we're not going to corner ourselves by trying to chase gross margin rate. We're going to use all of the levers of our business model to pursue sustainable and superior shareholder value creation and that's through the full bottom line, that's through the full P&L. Shelly, highlighted that, we've got a lot of levers to use, not just pricing to get after covering our commodity cost pressures that we're absorbing here and in 2021, we're going to use them all. And that's a great thing with this business model that we will certainly have, we have a lot of levers at our disposal to deliver superior shareholder value. We expect to use them all here in 2021. We're not guiding to a gross margin rate. We're telling you that we are committed to delivering more than 300 basis points of net operating profit expansion versus 2019.

We're certainly not shying away from our very strong gross margin rate, and it will continue to be an important source.

So Gabriel, with that let's -- I don't know if Bobby got back on the line. We can check if he is there or we can move on to the next question.

Not quite yet. So we can move on to next question from Atul Maheswari of UBS. Please go ahead.

Good evening. Thanks a lot for taking my question. Versus your guidance two months back, you're taking up the revenue estimate by quite a bit, but you're keeping the margin expectations the same. So I guess what has changed that would cause operating leverage to be limited on faster sales growth? I understand the input cost pressures, but you are taking a pricing in response to that, so why should there be not more leverage on faster sales growth?

Well Atul, we're certainly going to drive that. The idea of being this early in the year and taking up our guidance for the year by $0.50 is a pretty significant move. We're saying at least 6.50. We think we've got levers to drive stronger performance than that, but we think that that's the right place to land, all things considered. We've talked about managing a full year and managing all of the puts and takes that happened during the course of a year. There's a ton of year left. We're thrilled with where we are. We're thrilled with demand. We're thrilled with how the company is performing, but yet, we have some uncertainties about, where the commodity cost pressures might go. We also are thinking about potentially changing consumer behaviors, we don't know. But we know that we can operate well in any environment and that's what gives us confidence about the numbers and the color that we've provided for the for the guidance today.

To be at least 6.50 of EPS reflects at least a 30% growth on a two-year basis for the full year and 300 basis points of operating margin leverage.

Sorry, the 6.50 is…

Okay. Yes, so I guess, as a follow-up to roll back the 12 months of your first quarter 2020 results I think back then you mentioned that April 2020, was down at about 50% or so. So are you able to provide a quarter to date comp for this current month it has been 20/21?

Sorry, could you repeat that question?

So I think in the month of April of 2020, I think your comps were down 50%, obviously due to the store closures. So are you able to provide a quarter to date number for this month?

Well, we don't provide a lot of insights on an interim basis, because a couple of weeks don't make up the month or a quarter. And -- but we have said that the strong growth that we saw in the first quarter has continued here and so far in the second quarter. And that is, even on a two-year basis, or three-year basis. So even that's why we provided those reference points so that you can take out the impact of COVID and the shut -- and the closed stores last year. Reflecting back on your previous comment, I just want to clarify that the two-year growth in EPS had at least 6.50 is at least 140% increase over 2019 $2.70.

Got it. Thank you and good luck with the sphere.

Okay, thanks a lot.

Your next question will come from Curtis Nagle of Bank of America. Please go ahead.

Good evening. Thanks very much. Just a couple of clarifying questions. One, just on the comment about growth in every quarter, for 4Q, does that include lapping or the impact of lapping the extra week?

The comment is about 2021 versus 2019, not '21 versus '20. And so, because of so many changing dynamics in 2020, it makes it very unusual. And it is -- I really encourage you to look at your models versus 2019, use the color that we've provided today and use it and go from there.

Okay, totally fair. And then just clarifying on the price increase, tactical, I'm not exactly sure where you're taking it, but as you just like, sort of want me looking at the MSRP [ph] beds, and I know that, usually don't sell the MSRP [ph]. But looking at that this is a quite exchange in the past. I don't know maybe since 2018. So, could you just be a little more specific about where those tactical price increases are coming from?

We were very, very laser focused on certain bed sizes and certain models and you may not see that in the list prices that you're looking at.

Okay, well, I’ll talk later. Thanks very much. I appreciate it.

Okay, you bet.

And your last question will come from Seth Basham of Wedbush. Please go ahead.

Right, and good afternoon. My first question is just thinking about the backlog again, just to make sure I'm clear. So $50 million carried out of Q1, where do you expect the backlog to be at Q2?

A more normal level. We -- and the $50 million isn't a reflection of our backlog, it's a reflection of where we thought we would be, versus where we landed. Just want to make sure that we were clear on that, right?

Okay.

To be specific…

Got it. So you don't expect any excess backlog or deliveries that are outstanding coming out in the second quarter?

Yes, directionally, we believe that our backlog will be more normalized and we are experiencing pretty phenomenal demand and that can always affect the timing of when deliveries are made. But that's how we're thinking about it, in terms of the supply chain challenges that cause hiccups, and making deliveries here in first quarter, we expect those to be resolved here in the second.

Got it. So when you are thinking about the vertically integrated model that you are -- so you have and you definitely do not have phone production, so you come into these challenges. Are there other areas with providers of yours or suppliers of yours that you've encountered challenges?

So look, this challenge isn't even the result of the foamers. It's not their problem, it's the challenge with chemical producers, and you saw that's been a trifecta of bad luck for those producers, and they are coming back online and their production capacity is very strong and we expect here in the second quarter that that's all stabilized. We've already seen some improvement in our delivery windows and our levels of service. And our first available date is about 17 days right now and that compares to normally even around 14 days. So we're not that far off right now where we normally would be. So in terms of just our broader supply chain, we have great relationships with our suppliers. We have a very flexible supply chain. We've been strategic about which parts of the business we have included in our vertical model. But these are folks that specialize in different areas and it makes sense for them to be in the business they're in and us to be in ours. But we work really closely together and we have multiple factories across the country and around the globe. So we feel good about our supply chain. It's not easy given the environment, but our teams are managing it every day.

Got it. Okay, and other areas questions I'd like to address is sales and marketing. And first on advertising, could you give any more data as to what is your advertising leverage in the quarter year-over-year to help us understand some of the moving pieces?

Yes, we leveraged in on the specific media line set, we did lever on our 20% net sales. And obviously, substantially more when you look at the demand and this is an area we're going to continue to lean into with our strong value proposition. We're really excited about the unit growth and the ARU growth in the quarter and an area of ongoing efficiency and effectiveness for us.

Maybe asked a different way, Shelly did your media spending leverage more than the rest of sales and marketing?

Total sales and marketing was higher, media leverage was a piece of it.

Yes, I'm just trying to get some color as to the key drivers there between media and your leverage on your labor force, but I guess, well, we've got that.

Well, we've touched on this a little bit before Seth, in the sense that we've -- the digital capabilities that we've put in place during the pandemic have served us extremely well. We've got a number of different tools that we're now using, including workforce management, throughout our sales for retail operations, that is improving to be extremely productive. And we'll continue to -- that's part of how we are delivering the robust net operating profit margin expansion and we look to -- we're excited about where we are and where we're headed.

In the higher demand.

It all starts with demand with this model, no doubt.

The big start.

Got it. Thank you very much. I appreciate it and best of luck.

Thanks very much, Seth.

Thank you.

We have no further questions at this time. I'll now turn the call back over to the presenters for closing remarks.

Thank you for joining us today. We look forward to discussing our second quarter 2021 performance with you in July. Sleep well and dream big.

This concludes today’s conference call. Thanks for joining. You may now disconnect.