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Sleep Number (NASDAQ:SNBR) Surprises With Q4 Sales, Stock Soars


Full Report / February 22, 2024

Bedding manufacturer and retailer Sleep Number (NASDAQ:SNBR) reported Q4 FY2023 results exceeding Wall Street analysts' expectations, with revenue down 13.7% year on year to $429.5 million. It made a GAAP loss of $1.12 per share, down from its loss of $0.24 per share in the same quarter last year.

Sleep Number (SNBR) Q4 FY2023 Highlights:

  • Revenue: $429.5 million vs analyst estimates of $420.8 million (2.1% beat)
  • EPS: -$1.12 vs analyst expectations of -$0.88 (27.5% miss)
  • Free Cash Flow was -$49.88 million compared to -$60.63 million in the same quarter last year
  • Gross Margin (GAAP): 56.6%, up from 54.7% in the same quarter last year
  • Same-Store Sales were down 15% year on year
  • Store Locations: 672 at quarter end, increasing by 2 over the last 12 months
  • Market Capitalization: $254.7 million

Known for mattresses that can be adjusted with regards to firmness, Sleep Number (NASDAQ:SNBR) manufactures and sells its own brand of bedding products such as mattresses, bed frames, and pillows.

The core customer is typically a homeowner who cares about quality sleep and has strong preferences when it comes to mattress feel. These customers can include a married couple where one spouse prefers a softer mattress whereas the other prefers a firmer one–Sleep Number offers mattresses where each half’s firmness can be adjusted. These customers can also include those who want more data on their sleep quality–Sleep Number offers smart mattress technology that can register movement and interpret sleep depth.

Sleep Number stores are fairly small, roughly 4,000 square feet. They are typically located in suburban shopping centers or retail districts. The stores feature products in bedroom-like settings to create an inviting atmosphere. Trying out mattresses is encouraged given how important it is for customers to find the right firmness and feel.

A dynamic unique to Sleep Number and other mattress retailers is how infrequently the average consumer is in the market for a new bed or mattress–roughly five to ten years. On the other hand, these purchases tend to be pretty big-ticket in nature, and Sleep Number products are on the more costly end of the price spectrum given the technology features.

Home Furniture Retailer

Furniture retailers understand that ‘home is where the heart is’ but that no home is complete without that comfy sofa to kick back on or a dreamy bed to rest in. These stores focus on providing not only what is practically needed in a house but also aesthetics, style, and charm in the form of tables, lamps, and mirrors. Decades ago, it was thought that furniture would resist e-commerce because of the logistical challenges of shipping large furniture, but now you can buy a mattress online and get it in a box a few days later; so just like other retailers, furniture stores need to adapt to new realities and consumer behaviors.

Bedding and mattress competitors include Tempur Sealy (NYSE:TPX), Leggett & Platt (NYSE:LEG), and Purple Innovation (NASDAQ:PRPL).

Sales Growth

Sleep Number is a small retailer, which sometimes brings disadvantages compared to larger competitors that benefit from economies of scale.

As you can see below, the company's annualized revenue growth rate of 2.7% over the last four years (we compare to 2019 to normalize for COVID-19 impacts) was weak , but to its credit, it opened new stores and grew sales at existing, established stores.

Sleep Number Total Revenue

This quarter, Sleep Number's revenue fell 13.7% year on year to $429.5 million but beat Wall Street's estimates by 2.1%. Looking ahead, Wall Street expects revenue to decline 5.7% over the next 12 months.

Number of Stores

A retailer's store count is a crucial factor influencing how much it can sell, and store growth is a critical driver of how quickly its sales can grow.

When a retailer like Sleep Number is opening new stores, it usually means it's investing for growth because demand is greater than supply. As of the most recently reported quarter, Sleep Number operated 672 total retail locations, in line with its store count a year ago.

Sleep Number Operating Retail Locations

Over the last two years, the company has generally opened new stores and averaged 3.7% annual growth in its physical footprint, which is decent and on par with the broader sector. With an expanding store base and demand, revenue growth can come from multiple vectors: sales from new stores, sales from e-commerce, or increased foot traffic and higher sales per customer at existing stores.

Same-Store Sales

Sleep Number's demand within its existing stores has barely increased over the last eight quarters. On average, the company's same-store sales growth has been flat.

Sleep Number Year On Year Same Store Sales Growth

In the latest quarter, Sleep Number's same-store sales fell 15% year on year. This decline was a reversal from the 2% year-on-year increase it posted 12 months ago. We'll be keeping a close eye on the company to see if this turns into a longer-term trend.

Gross Margin & Pricing Power

Sleep Number has best-in-class unit economics for a retailer, enabling it to invest in areas such as marketing and talent to stay one step ahead of the competition. As you can see below, it's averaged an exceptional 57.2% gross margin over the last two years. This means the company makes $0.57 for every $1 in revenue before accounting for its operating expenses. Sleep Number Gross Margin (GAAP)

Sleep Number's gross profit margin came in at 56.6% this quarter, marking a 1.9 percentage point increase from 54.7% in the same quarter last year. This margin expansion is a good sign in the near term. If this trend continues, it could signal a less competitive environment where the company has better pricing power, less pressure to discount products, and more stable input costs (such as distribution expenses to move goods).

Operating Margin

Operating margin is a key profitability metric for retailers because it accounts for all expenses keeping the lights on, including wages, rent, advertising, and other administrative costs.

In Q4, Sleep Number generated an operating profit margin of negative 4.6%, down 4.7 percentage points year on year. Conversely, the company's gross margin actually increased, so we can assume the reduction was driven by weaker cost controls or operating leverage on fixed costs.

Sleep Number Operating Margin (GAAP)

Zooming out, Sleep Number was profitable over the last two years but held back by its large expense base. Its average operating margin of 2.3% has been paltry for a consumer retail business. On top of that, Sleep Number's margin has slightly declined, on average, by 2 percentage points year on year. This shows Sleep Number has faced some speed bumps.

EPS

Earnings growth is a critical metric to track, but for long-term shareholders, earnings per share (EPS) is more telling because it accounts for dilution and share repurchases.

In Q4, Sleep Number reported EPS at negative $1.12, down from negative $0.24 in the same quarter a year ago. This print unfortunately missed Wall Street's estimates, but we care more about long-term EPS growth rather than short-term movements.

Sleep Number EPS (GAAP)

Between FY2019 and FY2023, Sleep Number's adjusted diluted EPS dropped 63.9%, translating into 22.5% annualized declines. In a mature sector such as consumer retail, we tend to steer our readers away from companies with falling EPS. If there's no earnings growth, it's difficult to build confidence in a business's underlying fundamentals, leaving a low margin of safety around the company's valuation (making the stock susceptible to large downward swings).

On the bright side, Wall Street expects the company's earnings to grow over the next 12 months, with analysts projecting an average 162% year-on-year increase in EPS.

Cash Is King

If you've followed StockStory for a while, you know that we emphasize free cash flow. Why, you ask? We believe in the end, cash is king, and you can't use accounting profits to pay the bills.

Sleep Number burned through $49.88 million of cash in Q4, representing a negative 11.6% free cash flow margin. The company increased its cash burn by 17.7% year on year.

Sleep Number Free Cash Flow Margin

Over the last two years, Sleep Number's capital-intensive business model and demanding reinvestment strategy have consumed many company resources. Its free cash flow margin has averaged negative 2.5%, weak for a consumer retail business. Furthermore, Sleep Number's margin has averaged year-on-year declines of 1.9 percentage points. Investors likely aren't thrilled about the company's margin trajectory and would hope to see a reversal soon.

Return on Invested Capital (ROIC)

EPS and free cash flow tell us whether a company was profitable while growing revenue. But was it capital-efficient? A company’s ROIC explains this by showing how much operating profit a company makes compared to how much money the business raised (debt and equity).

Although Sleep Number hasn't been the highest-quality company lately because of its poor top-line performance, it historically did an excellent job investing in profitable business initiatives. Its five-year average ROIC was 23%, impressive for a retailer.

The trend in its ROIC, however, is often what surprises the market and drives the stock price. Unfortunately, Sleep Number's ROIC over the last two years averaged 19.5 percentage point decreases each year. We like what management has done historically but are concerned its ROIC is declining, perhaps a symptom of waning business opportunities to invest profitably.

Key Takeaways from Sleep Number's Q4 Results

Although Sleep Number missed analysts' EPS estimates from a GAAP perspective, its adjusted EPS beat by a wide margin (loss of $0.58 per share vs estimates of a $0.88 per share loss). The adjustment added back $16 million of restructuring costs the company recorded during the quarter, which was related to the planned cost-cutting initiatives management is executing; in 2024, the company expects to save $40-45 million in operating expenses.

We also enjoyed seeing Sleep Number exceed analysts' revenue expectations this quarter. That likely relieved investors as the mattress industry remains in a downturn. Looking ahead, management expects the industry to remain pressured but shared free cash flow guidance that significantly beat Wall Street's estimates ($70 million vs estimates of $48 million). Overall, this was a mixed quarter for Sleep Number, but its free cash flow guidance was impressive. The stock is up 9.5% after reporting and currently trades at $12.1 per share.

Is Now The Time?

Sleep Number may have had a tough quarter, but investors should also consider its valuation and business qualities when assessing the investment opportunity.

We cheer for all companies serving consumers, but in the case of Sleep Number, we'll be cheering from the sidelines. Its revenue growth has been uninspiring over the last four years, and analysts expect growth to deteriorate from here. And while its impressive gross margins are a wonderful starting point for the overall profitability of the business, the downside is its poor same-store sales performance has been a headwind. On top of that, its declining EPS over the last four years makes it hard to trust.

Sleep Number's price-to-earnings ratio based on the next 12 months is 25.9x. While we've no doubt one can find things to like about Sleep Number, we think there are better opportunities elsewhere in the market. We don't see many reasons to get involved at the moment.

Wall Street analysts covering the company had a one-year price target of $12 per share right before these results (compared to the current share price of $12.10).

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