Sleep Country Canada Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 8, 2024

There are 8 speakers on the call.

Operator

I would like to welcome everyone to Sleep Country's Q1 2024 Results Conference Call. Yesterday, Sleep Country released its financial results for its Q1 of fiscal 2024. A copy of the earnings disclosure is available on the Investor Relations website and includes cautionary language and about forward looking statements, risks and uncertainties, which also applies to the discussion during today's conference call. I will now turn the call over to Stuart Shafer, Preza and CEO. Please go ahead.

Speaker 1

Thank you, Joelle. Good morning, everyone, and thank you for joining us. With me today is Craig DiPrado, our Chief Financial Officer. Before we dive into the details of our Q1 performance, I would like to take a moment to reflect on our remarkable 3 decade trajectory. This year marks Sleep Country's 30th anniversary and we are proud of our evolved business model, the strength of our sleep ecosystem and our channel agnostic approach.

Speaker 1

Our unwavering commitment to innovation, operational excellence and exceptional customer experience has been the cornerstone of our legacy reflected in our strong performance and growth over the past 30 years. As we look to the future, we are invigorated and remain as dedicated as ever to help Canadians get their best night sleep. This quarter, we delivered top line positive top line revenue results supported by our strategic multi year plan and the dedication of our incredible team as we navigated in this challenging retail environment. Our Q1 revenues increased by 1.6% and our same store sales decreased by 1.6% from Q1 of last year. Our omni channel strategy continues to positively resonate with Canadians.

Speaker 1

Our brick and mortar stores continue to perform well as our e 24.5% in Q1 2024 from Q1 2023. Our Q1 2024 results underscore the success of our omni channel strategy ensuring a seamless customer experience that caters to the sleep needs of Canadians coast to coast regardless of where and how they choose to shop. We continue to see an improved gross margin by 50 basis points in Q1 2024 from Q1 last year. This increase was primarily driven by better product costing resulting from continued strategic initiatives across all our banners, including direct sourcing products while also having more control over the development and production process of our innovative products. This quarter, we did pull forward some of our advertising spend in late March.

Speaker 1

In addition, we accelerated part of our annual merchandising cycles to Q1 and as a result, we incurred incremental sales compensation costs as we moved out discontinued products to make way for this new this year's new exciting lineup. In Q1 2024, we continue to grow our retail presence opening 2 new Sleep Country stores in Etobicoke and Oshawa in Ontario and 2 new Dormez vous stores in Outremont Desaules in Quebec bringing our national store count across all banners to 305 stores. Our retail stores for Endy, Silk and Snow and the rest continue to perform well and we expect to roll out more stores under our D2C brands for the banner for the rest of this year. Our strategic initiatives of moving our D2C banners warehousing and logistics into Sleep Country's infrastructure continues to go well and we expect to see the cost synergies in the later half of this year. This quarter, we continued our important collaboration with the Canadian Mental Health Association by donating $100,000 in support of the medical well-being of Canadians.

Speaker 1

In March, we also introduced the Our Back Pledge, which generated over 100,000,000 impressions acknowledging the potential setback to Canadians' health and well-being resulting from the loss of 1 hour sleep from daylight savings time. As we look ahead to the next phase of our journey, we are proud to contribute to the sustainable future of both our company and community. In line with our commitment to environmental stewardship and to help mitigate climate change, we recently launched a partnership with Veritree to plant a tree every time we complete a Green Glove delivery. We remain committed to executing our multi year transformation while staying true to our 3 key priorities innovation, exceptional customer experience, and operational excellence, Backed by a robust and adaptable foundation built over 3 decades, we remain extremely bullish about our future and stand ready to tackle the future with confidence, stability and scalability of our sleep ecosystem. With that, I will now turn it over to Craig to discuss our financial results.

Speaker 2

Thank you, Stuart, and good morning, everyone. I am pleased to share with you our Q1 financial results. This quarter, we continued to see volatility in sales as consumers navigate through these uncertain times. Despite this pressure, we saw revenues increase by $3,200,000 or 1.6 percent from $206,500,000 in Q1 2023 to $209,700,000 in Q1 2024. This increase is mainly driven by incremental revenue earned from new stores, wrap stores opened in 2023 as well as the incremental revenue earned by Casper Canada which was acquired in Q2 last year in April 2023.

Speaker 2

This increase was partially offset by a decrease in our same store sales by 1.6%. From a channel perspective, our Q1 revenues on our e commerce platform increased 220 basis points from 22.3% in Q1 2023 to 24.5% in Q1 2024. Moving on to gross profit, our gross profit increased by $2,100,000 from $70,800,000 in Q1 20 $3,000,000 to $72,900,000 in Q1 2024. Our gross profit margin increased by 50 basis points from 34.3 percent for Q1 2023 to 34.8 percent in Q1 2024 due to higher average unit selling prices coupled with lower product costs as we continue to source merchandise more efficiently. This margin increase was partially offset by higher transportation costs, sales and distribution compensation as well as deleveraging on occupancy and depreciation expenses tied largely to the incremental costs of the Casper stores.

Speaker 2

Our improved gross margin this quarter was offset by deleveraging on our SG and A expenses. Total SG and A expenses increased by $4,700,000 from $48,100,000 in Q1 2023 to $52,800,000 in Q1 20 24. This change was mainly due to an increase in SG and A costs, which was impacted by Casper Canada, which was acquired in April 2023. In addition, there was a pull forward of marketing costs at Sleep Country in late March. These increases were partially offset by decrease in professional fees.

Speaker 2

Our EBITDA decreased by $1,900,000 from $39,700,000 in Q1 2023 to $37,800,000 in Q1 2024, which is primarily due to the increases in SG and A expenses, partially offset by improved gross profit margin. Adjusting EBITDA for LTIP, ERP and acquisition related costs, operating EBITDA decreased by $3,000,000 from $41,400,000 in Q1 2023 to $38,400,000 in Q1 2024. Operating EBITDA margin decreased by 170 basis points from 20% in Q1 2023 to 18.3% in Q1 2024. A key contributor to this decrease was also tied to the variance in normalizations on a year over year basis, which decreased by $1,100,000 causing operating EBITDA to delever by 60 basis points alone. Finance related expenses increased by $1,800,000 from $6,500,000 in Q1 2023 to $8,300,000 in Q1 2024.

Speaker 2

This increase was due to higher interest expenses on our lease obligations and senior secured credit facility impacted by higher interest rates and debt levels. These increases were partially offset by a decrease in accretion expense and lower realized losses on our share repurchase plan under the auto share purchase plan. As a reminder to the market to manage its interest rate risk, we entered into an interest rate swap in 2021 for a notional amount of $60,000,000 for a fixed interest rate of 1.1%. This interest rate swap expired on April 1, 2024 and to date, we have not replaced the swap. We expect our interest expense on our senior secured credit facility to be 100% variable for the time being as we review our options on our facility.

Speaker 2

Other expenses and income decreased by $1,100,000 from expenses of $500,000 in Q1 2023 to income of $600,000 in Q1 2024. This change was mainly due to interest income earned on the convertible note receivable and realized gains on foreign exchange, which were partially offset by unrealized losses on foreign exchange and unrealized losses on the fair value of convertible note and warrant. Income taxes decreased by $1,000,000 from Q1 2023 to Q1 2024. Our effective tax rate was comparable year over year with the decrease in income taxes being driven by the decrease in net income before taxes of $3,300,000 from $15,700,000 in Q1 2023 to $12,400,000 in Q1 2024. Net income attributable to the company decreased by $2,600,000 from $11,300,000 in Q1 2023 to $8,700,000 in Q1 2024.

Speaker 2

Adjusting net income for LTIP ERP and acquisition related costs as well as accretion expenses related to the redemption liabilities for Hush and the earn out for Silk and Snow, adjusted net income attributable to the company decreased by $3,600,000 from $13,200,000 in Q1 2023 to $9,600,000 in Q1 2024. Diluted adjusted earnings per share decreased by $0.09 from $0.37 in Q1 2023 to $0.28 in Q1 2024. The change in diluted EPS was mainly impacted by lower operating EBITDA of $0.08 higher interest rate expense on the senior secured facility and leases of 0 point 0 $6 higher depreciation and amortization of 0 point 0 $2 and partially offset by lower expenses and income of $0.03 as well as lower income taxes also at $0.03 Taking a step back and reviewing the Mistick consensus on our adjusted EPS, year over year we are down approximately $3,300,000 and this is largely tied back to the decreased EBITDA. When we look at the operating metrics for the quarter, Sleep Country continues to perform well with expanded margin of 50 basis points. This points to the effectiveness of our model and is a true reflection of whether or not we are operating better as a business and in our business activities to sell and serve our customers.

Speaker 2

This margin expansion is despite the Casper occupancy for 6 stores being completely incremental in Q1 as they were acquired in Q2 in the prior year. Additionally, with our annual switchover of our mattress lineup, we made more significant floor changes in the current year as compared to the prior year. This impacted our sales commission line year over year with higher sales associate incentive programs to move floor models demos in Q1 2024. We absorbed an additional compensation impact for the SAT holiday falling in Q1 this year as compared to Q2 in the prior year tied to the Easter weekend shift. This alone was approximately $400,000 Marketing expense is twofold, incremental dollar spend on the Casper business and a pull forward of approximately $1,000,000 in the SEC marketing from Q2 to increase the radio frequency in a lower sales environment.

Speaker 2

Lastly, moving on to G and A. In Q4, we spent $36,100,000 in G and A excluding marketing and this quarter we spent $35,500,000 The percentage of overall SG and A including marketing to sales held constant at 25.2 percent despite Q1 being seasonally the weakest quarter. As we continue to mature our D2C network, we will experience higher marketing costs and we will and as we finalize our e commerce site that we'll be rolling out in Q2, we will have pressure on our SG and A. We would point to the sequential committed dollars quarter over quarter as largely a baseline and the percentage of sales will decrease in quarters where there are higher sales and as we continue to optimize our shared services model where we expect to see an impact on the back half of twenty twenty four. Moving on to liquidity, as at March 31, 2024, our cash balance was $31,100,000 with an additional 80 $3,300,000 available to us on our credit facility.

Speaker 2

This does not include the $100,000,000 accordion also available on our credit facility. We remain confident in our business' ability to generate strong free cash flow. With the current operating environment, which remains fairly soft, we expect our leverage to remain at the current level slightly above 2x post IFRS in the coming quarters. Yesterday on May 7, 2024, the Board approved a quarterly dividend of $0.237 per share, which will be paid on May 23, 2024 to holders of common shares of record as at the close of business on sorry, close of business on May 23, 2024. The dividend rate remains unchanged from the prior quarter as we believe our dividend has been sufficiently caught up post COVID following 2 consecutive 10% increases.

Speaker 2

As noted in our outlook, we plan to open a minimum of 6 new stores as well as launch the pilots of our 4.0 store and pending the results, we intend to resume renovations in the back half of the year. We expect our 2024 CapEx additions to be in the area of $40,000,000 for this year. In regards to our NCIB, we will continue to remain opportunistic, but we'll be cautious in the first half of this year as we monitor how the economic environment evolves. Finally, we will continuously monitor for M and opportunities as we have done over the past few years and remain focused on high growth, profitable and EPS accretive companies with dynamic founders in the sleep ecosystem. The intention would be to fund any acquisitions with a mixture of cash on hand and incremental borrowing.

Speaker 2

Lastly, subsequent to the quarter in April 2024, we completed our acquisition of the remaining 32% of outstanding common shares of Hush Blankets Inc. A reminder to the market for the original agreement, Sleep Country was to purchase only 16% of the outstanding common shares in 2024 with the final acquisition of the remaining 16% of outstanding shares to be completed at 2025. We are in the process of finalizing the cash consideration for the acquisition and we expect the estimated price to be in the range of $6,000,000 to $7,000,000 Thank you. And I will now pass the call

Speaker 3

back to Stuart for closing remarks.

Speaker 1

Sorry, folks, my phone just died in the other office. Thank you, Craig. As we navigate a challenging retail environment, we are confident in our ability to deliver consistent results in 2024 and beyond. The solid foundation we've established over 3 decades coupled with our strategic vision allows us to fulfill the diverse sleep needs of our cherished customers anytime and anywhere. As we close out the Q1 of 2024, I would like to extend my gratitude to our teams, our customers and our shareholders for their continued support and look forward to executing on our 2024 plan to grow our market share as we build out our Sleep ecosystem.

Speaker 1

That's all for our comments. Over to you for questions.

Operator

Thank you. You. Your first question comes from Martin Landry with Stifel.

Speaker 4

I was wondering if you could talk a little bit about your integration processes of your recent acquisitions. You've talked about optimizing shared services, you've talked about warehouse integration. Would it be possible to quantify the synergies that you are expected to realize on all the integration work you're currently doing on your recent acquisitions?

Speaker 1

So a great question, Martin. And I'd rather punt that question to next quarter because until we see right now we're going through an overlap. So as we close out some of our 3PL relationships in terms of our distribution partnerships that we've had for our D2C brands, there's a period of overlap that we're going to experience in this quarter going into the next quarter. And the rent component which is substantial is only one component. There's a labor component that we're starting to map out exactly to see what the increase in costs will be within our distribution network to manage the additional volume at the same time offsetting the fixed expenses of closing those relationships.

Speaker 1

So we have an estimate and then Craig could discuss it with you offline maybe, but it will be more substantiated within the next probably 30 days.

Speaker 4

Okay. Is it fair to say that there are some dual operation costs right now that you're incurring in Q1 and you'll be incurring in Q2?

Speaker 1

Yes. It's already started. So for example Casper now is now as of April 1 is fully integrated into the Sleep Country network. So during Q1, there is the cost of moving the inventory over, winding down some of the old inventory, replacement and investment in our distribution centers to support it. So there was additional labor costs that we experienced as well as transportation costs in that quarter.

Speaker 1

The same thing is happening right now with Hush and soon to be Silk and Snow and Endy is also partially I would say halfway there in terms of that move. So we're ahead of schedule which we're excited about, but there is a lot of noise in those numbers right now that will be clearer by the end of Q2.

Operator

Okay. Okay, that's helpful.

Speaker 4

And I was wondering if you could discuss some of the consumer trends that you're seeing so far in Q2 in terms of consumer demand, traffic patterns, basket size, Any color would be helpful.

Speaker 1

Yes. I'm actually going to maybe add a little bit to that question because I do think it's important to talk a little bit about Q1 and I do think it's important to talk a little bit about the EPS and the EBITDA miss because we were very excited about the outcome in terms of our top line revenue in this environment. So but what we saw in Q1, January, our sales for the company were down 8%. And traditionally, we are sorry, one second please. So sorry, I'm being corrected, 8.5%.

Speaker 1

So, what we normally do is we made a strategical decision in the month January that was 100% self inflicted that negatively impacted our EBITDA and our EPS. But we were proactively reduced our SEC inventory and positioned our floors earlier in this year to benefit the busy season that was approaching that is approaching very soon. So traditionally, just so let you under the covers a little bit more, traditionally we use Q1 and Q2 to liquidate our floor models. We usually do that at a reduced price and a more expensive SPIFF component in terms of our sales commission. We normally do that every single year for the last 30 years as we introduce our new innovative product for the year.

Speaker 1

In January this year, because sales were down 8%, we decided that right after this highly promotional period, which was very busy between the end of November right up until the 1st week of January that we needed to introduce and shift our advertising calendar and push in a more aggressive promotional calendar. We didn't want to do that with the new lineup that was rolling out. So we made a decision to accelerate the liquidation of all our floor models that were going to be changed for the year, which gave us the ammunition for the promotional calendar and drive a more aggressive price point that was good for the consumers. We increased our advertising spend to support that in February and throughout March to drive a higher top line sales. We didn't we were not impacted on our lineup in on gross margin of the new lineup.

Speaker 1

And traditionally, we see a flow through of that lower margin in Q1 and Q2, which you folks don't normally see because it's blended in a normal process. So this acceleration that we strategically bid because we believe that we want to take an opportunity to be more aggressive in the marketplace and take market share, at the same time set us up with our new lineup going into the busy months. And so we're excited about that because it worked really well and a drop of 8% in January was met by a flat for February March. So and now we see we're seeing a little we did see a little bit of a tick up in terms of April, but it's very bouncy, the market. Quebec is up, BC is a little bit down, Ontario is a little bit down, the prairies is up, Saskatchewan, Manitoba is up.

Speaker 1

So it's a little bit choppy all over the place. And everything that we did, did have an impact on increasing spiffs that we usually sell over a period of time. And so it has a little bit of impact in terms of our cost to be able to move through that items, but we're very excited about where we are positioned right now.

Operator

Your next question comes from Vishal Shreedhar with National Bank. Your line is now open. Hi, thanks for taking my question. I just wanted to and

Speaker 3

I know you commented it off the top, but I wanted to get your thoughts on balance sheet and capital allocation, the dividend decision given your free cash flow generation, your balance sheet just stood out a little bit. So maybe you can give us your thoughts on where you stand and how we should think about your capital allocation priorities?

Speaker 2

Yes, I mean, we touched on it in the script, but we've got consecutive increases because we were we felt we were lagging behind the COVID pause and we held the rates in after coming out of the pause for a few quarters. So we did want to be more aggressive over the last 2 years to increase our metrics around the dividend in terms of free cash flow payout ratio and then just EPS payout ratio. And we feel that when we compare ourselves to the North American increases we've done over the last 2 years. But at this point, given the cost of borrowing and our investments in the network, felt that pausing it at this point or holding was the right decision. In terms of NCIB, we'll continue to be opportunistic.

Speaker 2

Again, we always weigh the cost of borrowing and the return that gives us to EPS versus a share price at an appropriate amount and we run sensitivities on that. So we'll have probably a better update, but it would be back half loaded just like it was last year. Last year, we did about $37,000,000 in the back half. So if we do go ahead and execute against the NCIB, the expectation would be on the back half that we'd commit capital to that. And then lastly on our CapEx, our CapEx this year is going to run-in the $40,000,000 range assuming we get most of our renovations out.

Speaker 2

But the thing is we are pausing at this point on the 4.0 store because we're rolling out 2. We're going to see how they operate. We're going to see how what the return metrics are against the investment. And then we'll decide from there if we roll out more aggressively or not on the back half with the renovation. So that's kind of our priorities.

Speaker 2

And obviously, we're always opportunistic in reviewing M and A opportunities. Obviously, there's more opportunities in a softer market because Q1 is always typically a very tight cash flow generating quarter for businesses in our industry. And so there are opportunities take a look at and we're reviewing opportunities consistently on that front as well.

Speaker 3

Okay. And maybe we can get some thoughts on in terms of the acquisition opportunities, in terms of regions of focus and products of focus?

Speaker 1

I'm sorry, is the question specifically to what are we looking at or the areas of that we're looking at? Both. Both. So as we've said before on our calls, our number one focus is to grow our market share within this industry and make sure that we take a agnostic approach to always selling the most relevant brands, as well as building out our ecosystem with our accessories. So anything that we look at, it will continue down that path in terms of how can we expand our overall mix and choice of products to our customers, how do we bring in new innovative products, how do we work with maximizing our gross margin.

Speaker 1

And so it will always be within the accessory sleep accessories as well as our mattress category. I'm not sure if that answers your question or you're asking something specific of what we're looking at.

Operator

Yes. No, I appreciate it.

Speaker 5

In terms of regions of focus, should

Speaker 3

we think there will be a tilt towards the U. S?

Speaker 1

The U. S. Has never been off the market, but and it has always been a consideration. Our focus has always been growing out our network within Canada and building what we believe has positioned us as the number one leader in the space. If an opportunity even the Casper acquisition met our requirements, we would be excited to take a look at met our requirements, we would be excited to take a look at it.

Speaker 3

Okay. And just quickly, maybe you can give us your thoughts on accelerating the Hush acquisition.

Speaker 1

Sure. So we've owned Hush now for 2 years. The integration within our organization has been fabulous. The team has been doing an amazing job. In Q4 of last year, we decided to introduce some Hush products within the Sleep Country network.

Speaker 1

The Hush products are performing exceptionally well. Consumers are gravitating to the brand and there was an earn out component on the remainder year and from an agreement that we had with our partners who were part of that earn out, we negotiated a deal that was part of the original agreement to accelerate that because we believe that we have a greater opportunity over the next year to drive a higher top line revenue growth and gross margin between the Hush building out its own model as well as Hush being introduced in our stores, which was the original plan.

Operator

Thank you.

Speaker 6

Thank you.

Operator

Your next question comes from Stephen MacLeod with BMO Capital Markets. Your line is now open.

Speaker 7

Thank you. Good morning, guys.

Speaker 1

Good Morning, Steven. Good morning.

Operator

Good morning.

Speaker 7

I just wanted to follow-up on the SG and A being higher in Q1. I know you gave some good color on the call in your prepared remarks. But I was wondering if you could break down maybe more specifically just the buckets of the impact related to the floor model changes and the marketing expenses in Q1? And then I guess as a follow-up to that, it sounds like you expect Q2 to kind of trend in a similar way and then maybe decline a little bit in Q3 and Q4. Is that the way to think about it?

Speaker 1

Yes. Well, first of all, let me apologize because there was a little bit of a fumble in terms of technical here and that we lost power. So some of my notes actually literally just turned off. But to answer it a little bit clearly, Stephen, we as you know, Q1, Q2, as I was saying, we normally traditionally sell off our floor models during this entire period. And what it does in that Q1 and Q2 period, it reduces our gross margins.

Speaker 1

It also accelerates how we pay our sales associates because our sales associates are paid on gross profits. And because we're reducing the prices, because we're trying to aggressively move out and sell floor models and offer a better price for our customers, we subsidize our sales associates earnings because they're making less gross profit by something that we call a spiff or a bonus. So what it does is it has a negative impact on an increased sales compensation line. You would normally not even notice it because it was usually blended within a Q1 and Q2 period of time, but we felt it was opportunistic to do it now because of the softer environment that we saw in January and what's a better way to create more market share and drive more customers through our doors by offering a promotion that we normally would have done over a 6 month period of time and try to drive it within a 2 month period of time. That being said, so a good portion of those models are gone.

Speaker 1

Our inventory levels for the SEC are down, I think, approximately $12,000,000 It positions us with our lineup, our 2024 lineup that we're quite excited about that all have higher gross margin abilities. And you're seeing you saw some of it in April and it's probably almost done now where it would normally typically end by the end of June. So you're going to have the benefit of it sooner in June July and even probably part of the end of May, which is the beginning of our busy season where we have more traffic, which is a lot more important to drive that gross profit in the second half of the year, as you know, in terms of our business. So we sacrificed a little bit of the Q1 for top line growth.

Speaker 2

And Stephen, just to kind of break down some of the buckets, at the gross profit margin level, we did see the pressure on compensation, as Stu pointed out, in addition to that Easter weekend flip. So there's stat pay that fell in this quarter versus last quarter. And in addition to that, we also have the occupancy cost, which is completely incremental on the 6 Casper stores that was not there in Q1 of last year. So at gross profit margin, we increased the 50 basis points despite some of those one strategic headwind and then the other one being incremental cost that was just not there in the prior year. Similarly, on the advertising spend, we're up 1,900,000 dollars I referred to the pull forward of about $1,000,000 in Sleep Country tied to pushing out those demos for models more aggressively.

Speaker 2

And then in addition to that, you've got your incremental cost of Casper again in terms of marketing dollars that was not there in the prior year. I think when we take a step back and we look to a baseline for quarters coming up, if you remove the variable cost of media or sorry, the marketing cost and you kind of take a baseline of the SG and A net of marketing costs, it's kind of a little bit of a because if we look sequentially, we're actually down in terms of dollars spent. It's a highly fixed cost area of our P and L and G and A. Thus, there are mattress recycling costs and so forth, which are variable and financing and credit card charges. But those aren't going to be a big swinger because those percentages don't shift too much.

Speaker 2

So I think in terms of a baseline for modeling going forward, we need to look at quarters sequentially around those fixed cost buckets because salaries and wages is not going to change, it's not going to go down because you've got baseline changes for hires last year rolling into this year. You do have new hires to build out the network and you have incremental labor costs of the Casper business, which again is incremental. So I just want to be clear because I think that's one area where we continue to see pressure. As a percentage of sales in the weakest quarter, we still match Q4 in terms of percentage of

Speaker 1

SG and A.

Speaker 4

Okay. And when you say

Speaker 7

you take out the variable cost for marketing dollars, is that net of the $1,000,000 from pushing forward the floor models?

Speaker 2

Yes, you could do net of that on the go forward, yes.

Speaker 1

And the $1,000,000 Stephen was not an incremental additional spend, it was a pull forward. So where we normally would have spent that $1,000,000 part of our normal promotional calendar and budget, We pulled that forward and don't plan to spend that. So that would normally have trickled into Q2 and even partially actually would all be in Q2. So we're right on target in terms of overall ad spend. This hasn't been an increase in budget in any way.

Speaker 7

Yes. Okay. Okay. No, that's helpful. And then you gave a little bit of color, Stu, around the performance of month by month.

Speaker 7

But just curious if you're able to give any color around price points or if that was a material factor in the quarter, just the differences in performance at different price points?

Speaker 1

Yes. So same story unfortunately for the past year, the below $7.50 category has been soft. But on a positive note, our digital brands accelerated this quarter in that capacity and grew, I believe market share as a percentage of sales you see. So in the Sleep Country network, that was a little bit softer, but the same pattern is normal. And our DUC brands actually accelerated a little bit.

Speaker 1

So still same patterns we saw last year. The one area that was new to us and once again self inflicted, It was our above $3,000 category because part of the pull forward was liquidating the 2023 Tempur Pedic lineup and bringing in our new exciting Tempur Pedic 2024 lineup. So we saw the above 3,000 category tick down, which we have not seen throughout the year. But again, it wasn't the consumer, we believe. We believe it was because we were just liquidating the floor models.

Speaker 1

And what happens is a floor model has to be liquidated before the new model comes on the floor. So that should recover positively in Q2. We've already started to see a little bit of signs of that.

Speaker 7

Okay. That's great. And then maybe just finally, just in terms of the liquidation the pull forward of liquidation into Q1, do you think you pulled forward sales? Or do you think that was just a customer that would have spent regardless?

Speaker 1

I think it was a customer that would have spent regardless. I think being 30 years in the business, traditionally, we have customers that wait for certain events. And when we make a lot of noise around our events like our mix and match, our floor model sales, we don't really advertise that for the 6 months. Like I said Q1 and Q2 is we normally are liquidating our floor models. We do that quietly and we don't make a lot of noise around it.

Speaker 1

So it's not as though it created a huge awareness. What it did was we chose specifically certain items to be a little bit more promotional on, and that's deciding not to be some promotional on something else. So in the eyes of the consumer, I don't think that they notice anything different except that they were coming into the store and where there would be maybe 2 or 3 floor models available to them to choose from. Now there was 10 or 12 at any given time. So it was just giving the customer a greater choice for a promotional item, but not driven not driving more traffic.

Speaker 1

That being said, I think we did outperform the market based on some of the numbers that we've been seeing from our from the market and what we're hearing in the industry because we're hearing it a lot softer than that we actually achieved. But, yes, I don't think it was a pull forward this time.

Speaker 7

Okay. That's great. Thanks, guys. Appreciate it. No problem.

Operator

Your next question comes from Brian Morrison with TD Cowen. Your line is now open.

Speaker 5

Hey, good morning, Stuart. Good morning, Craig.

Speaker 1

Good morning, Brian.

Speaker 5

I appreciate the color on the product change over the gross margin increase and reconciling the G and A cost. But if we dig a little bit under the covers here, I think that explains the comp better than expectations, but on the flip side, the revenues did come in below consensus and when I do a bridge, I don't think it's seasonality. Was there a weakness in the Casper contribution or the new store or new store format contributions? And maybe excuse me if I missed it, but it does appear the Walmart store count declined year over year. Maybe you could just go through that?

Speaker 1

Yes. So two different questions and I'm going to answer them both for you. First of all, the macro environment, there's no question that a drop of 8% in sales in January was a surprise to us. So let me just start there with the recovery that we saw in February March. So I would say most of the damage in terms of the top line happened in January.

Speaker 1

And we're actually quite pleased what we saw in February March albeit it came at a higher expense to be able to drive that traffic. But I do think we actually won, if I could say that in this environment and based on even the figures that we're delivering and I respect your question around that, but I think we actually won within that space. And I've often said recessions or slowdowns expect us to become more aggressive because our longer term aspirations is always to grow our market share and we believe that the LTV of a customer shopping through our network pays dividends beyond just the transaction that happens that day and that's what we go for. On the second part of that in terms of the Walmart, you're right, there was a couple of locations that were up for renewal, we're renovating some of our Walmart stores and expanding some of the sizes and changing the format a little bit. But that was less of a Walmart decision, more of a Casper, Endy, Silk and Snow conversation.

Speaker 1

And I alluded I think to it in the last call, we opened up those stores at mid to end of November. So it was very early to talk about it. We now have a full quarter under our belt. We're actually quite excited about what we are seeing in terms of the dollars per square foot. And so we've shifted our focus to utilize our capital to grow that network quicker for that customer segmentation for that average unit selling price over the Walmart.

Speaker 1

So it's not a vote on Walmart, it's a vote on where do we maximize our capital and get the greatest shareholder return.

Speaker 5

Okay. Thank you for that. Was the Casper contribution or the new store format contributions, were they slightly below your expectations this quarter?

Speaker 1

Well, it was a little bit so the answer to that is yes. And once again, self inflicted because we were changing out some of the old models that we inherited from Casper USA and we were bringing in the new models. And there were some delays in terms of bringing in the new models because of the covers that we were trying to get. So that was definitely one part of it. And keep in mind that the Casper is a premium collection just like Tempur Pedic is a premium collection.

Speaker 1

So the amount of volume and the amount of units that you actually transact compared to our lower end units, If you lose 1 or 2 sales on that high end because the full model isn't physically in the store or even physically available on the site, that has a greater impact on the top line revenue. So part of the economy, but I will own that it was more of our own self infliction.

Speaker 5

Yes. Okay. I mean the gross margin performance is outstanding considering the changeover.

Speaker 1

Right. And that's why we're accelerating, Brian, because just and I'm glad you just said that point because I missed it. I mean, that's the main reason why we're accelerating because our margins were performing almost 18 to 20 points better on this new collection. And so it doesn't pay for us to be sitting with the old stuff anymore. And let's just flush it out in a highly promotional time of the year and get the new products in.

Speaker 5

Very good. Last question, I guess, macro environment, you've referenced that the environment remains challenging several times. I just want to know here though, can you give a little bit more detail on what you're seeing with respect to the flow through of the Canadian consumer? Are we getting further stretched now? Or do you have any visibility as we lap a period of softer comps that we're actually getting close to a trough and then just the potential for same store sales

Speaker 1

or a

Speaker 5

comp inflection point later this year?

Speaker 1

Yes. So I often read a lot of reports from TV, Brian. So you probably know better than I, but we've seen a slowdown in discretionary spending, not just us, the entire industry has seen a slowdown in discretionary spending. It's going on 18 months now. A typical slowdown in discretionary spending from my 30 years of being in this business has ranged between 9 18 months excluding 9/11, excluding the financial crisis that we saw between 'eight and 2010.

Speaker 1

We've seen areas in our business that are accelerating, which tells me that the customer is still healthy. I will say the impact of the housing market, albeit hasn't seemed to have dropped even though everything I read about the vacancy rate, but the lack of movement, so less so the mortgages, less so if the consumers feeling confident because they still are well employed, more so we're suspecting the lack of movements because people just aren't walking away from their properties with their mortgages to get new ones, has had an impact. And I think that's impact has been throughout North America. You see the results within United States. So it's funny because the consumer when they do buy, they're still buying like I've often said that I always get concerned if I see them trading down.

Speaker 1

I'm not seeing them trading down. So it tells me they're healthy, but they are pausing a little bit on that purchase maybe because just like you and me, we don't know what is coming and when the Bank of Canada is going to cut their rates. And for sure, the pause on the moving of homes is having a little bit of an impact.

Operator

Your next question comes from John Sampaio with CIBC. Your line is open.

Speaker 6

Thank you. Good morning.

Speaker 1

Good morning, John. Good morning, John.

Speaker 6

Good color so far, but one question on strategy and then I wanted to focus on capital allocation. On strategy, in the press release, you made reference to serving a broader customer segmentation. And I wonder if you can elaborate on that. Does that mean you're looking at products with lower price points to address lower income consumers where you saw softer performance? Or is there something else to interpret with that statement?

Speaker 1

Pretty cool that you picked up on that, John. So yes and yes. So as we've gone through this transformation of our business over the last few years, as we've acquired some fabulous different brands, as we build out our merchandising and introduce innovative product. We do look at a merchandising hierarchy and a broader customer segmentation. We do believe that we play a very active role in the cycle of Canadians at every single point within their life.

Speaker 1

And we do think that Sleep Country, albeit 30 years, still is the an unbelievable machine that will continue to grow. That being said, we have some now tools in our toolbox that we didn't have before and we think it will allow us to broaden our reach in terms of serving customers, products that we haven't had before and in ways that we haven't. Take example, silken snow. The team, Albert, Kenneth and the team have been doing an exceptional job in growing out that business. A large part of that business is our sleep accessories.

Speaker 1

If you look online or visit our store in Ottawa that we opened up. It's a beautiful aesthetic collection that more Canadians are learning about. To Craig's comments earlier about marketing, we are spending more aggressively to build out the brand awareness around Silk and Snow and some of our newer brands because Canadians don't know them as well as Sleep Country and every dollar that we spend is driving an incremental trajectory within those businesses. So it's not dramatically different in what we've been saying for a while that we want to be able to serve more Canadians with more innovative products at more different price points. Watch for the brands as we build out that hierarchy and how we target our customers over time with these brands.

Speaker 6

Got it. Okay. That's helpful. And then getting to capital allocation or returning to it, I wonder why not increase the new store target for this year? You've already got 4 open, but you're sticking with the 6.

Speaker 6

Just would like to better understand that.

Speaker 1

Yes, great question. It's just securing the real estate. So Phil Bazner who oversees Hush as well as our business development and real estate has a long laundry list of locations that we are trying to open and it depends on when those locations are available. I've said in the past, we don't need to open up locations for the sake of opening. We're quite excited about the stores that we open.

Speaker 1

But timing is not us, it's with the landlords most of the cases.

Speaker 6

Understood. Okay. I wanted to come back to the dividend. I appreciate the comment so far, but I wonder if you can elaborate on it. Is the dividend expected to be revisited quarterly now?

Speaker 6

And what methods does the company want to send to investors on

Speaker 1

the dividend? Does it want

Speaker 6

to be seen as an annual dividend growth story? Is there a payout ratio that's targeted? How does this messaging, I suppose, or how are we supposed to interpret this as investors?

Speaker 1

Great question and a passionate conversation around the Board table. You should interpret it with one word, opportunity. And I think at the end of the day, our number one job, besides serving up Canadians to get a best night sleep is to maximize our total shareholder return. And in the past, our model, our Sleep Country model was a very repeatable model defined by the geography within the Canadian landscape. I think over time and especially over these last few years, we've demonstrated that we could do a great TSR by buying back our stock.

Speaker 1

We could do it by raising our dividend. We could do it by strategic types of acquisitions. And we want to make sure that we maximize our flexibility and building up a little bit of gun powder in this environment to accelerate even the question that you asked before, maybe our growth on some of our new brands to search out on M and A that we've been quite happy with what we've done so far, maybe even to reduce debt. As Craig commented, our money is no longer free. It's really opportunity and maximizing our flexibility.

Speaker 1

It's a positive message and we'll make sure that we are clear with you and our shareholders as we move forward on this.

Speaker 2

And John, just to elaborate on what we had intended to get to in terms of payout ratios. We've looked at a payout ratio to get in line with our North American peer set and we also separated Canada specifically as well. And they're averaging around 34.5 percent 36.3 percent on EPS payout ratio and we closed last year at 43.1 percent. So, and then on a free cash flow basis we're even higher. So I think it's one of these things where, we wanted to get to a spot where we were in that best in class amongst our peers.

Speaker 2

And we feel like we've definitely got there and then some. And so that's another just element in terms of the targets we were aiming to do and achieve when we rolled out this plan 2 years ago.

Speaker 6

Okay. That's good color. And then one last one on the modeling side. On the CapEx number, Craig, are we right to assume that implies the usual 1% -ish of sales towards maintenance CapEx? And if so, if you're sticking with the 6 stores target, that seems to imply over $20,000,000 towards the renovations plan.

Speaker 6

But it sounds like that's still a bit influx. So can you just help us better understand the CapEx assumptions?

Speaker 2

Yes, I think so 1%, yes. We indicate a minimum of 6 store openings and to Stu's point, if we do have additional locations come where we can open them up in this year, we'll push forward because those are the locations we've been looking to solidify. In terms of our renovations, we do always estimate around $20 per year. The one difference this year and last year, we did kind of hold back because hadn't rolled out Store 4.0. So as we look to how the Store 4.0 reacts to the renovations and the upgrades, we'll make a decision and then we'll either move fast and in line with that $20,000,000 on the back half or we'll trim it down and we'd communicate that in the next quarter.

Speaker 2

So I think it's a little bit early for us to be locking in, but I always would like conservatively modeling from a CapEx perspective. I would assume a 20 renovation placeholder for now with an update next quarter and then the minimum of 6 stores.

Speaker 1

And I'm just going to add, John, there's a lot of interesting tests that's going on right now that we are experimenting on, they're showing some very interesting results. And so before we as you noted in the past, we've done the 20 renovations. Our stores are in great shape. Like we're not a high traffic store and we don't renovate stores just to make them look prettier. We do it so that it's going to drive a higher level of incremental sales, higher basket size.

Speaker 1

And as we've demonstrated over the last 6, 7, 8 years as we renovated, our stores have gone from about 1.8 to 2.4 even with us building out the network. That being said, like one of the tests that's happening right now is there's a Silk and Snow that we opened up within a store in Ottawa. And that's about that store right now, just to give a little bit of color, that Silkenstone takes up 25% of the square footage in that store, but is delivering on 35% of the revenue of that store right now and that store is now one of the top performing stores in Ottawa. And of that 35%, 75% is cash and carry accessories, which you know our business well, is a very profitable segment. So before we just make a cookie cutter decision as we've done in the past, we're going to look very carefully at the store within the stores, the new stores, combined stores, and see where should we step on the gas quicker.

Speaker 1

And I will sacrifice or not sacrifice, put on hold renovations for growth anytime, especially if we believe that the new stores that we add to the fold is going to drive a higher rate of return. Okay. I appreciate the insights on that.

Speaker 2

I'll leave it there. Thank you.

Speaker 1

Cool. Thanks, John.

Operator

Your next question comes from Stephen MacLeod with BMO Capital Markets. Your line is now open.

Speaker 7

Open. Thanks guys. I just had one follow-up question. I was wondering if you could give a little bit color on sort of the gross margin trends you expect through the balance of the year?

Speaker 2

Yes. We continue to expect that we're going to hold at least on a year over year basis. And as we continue to optimize some of the shared services that we discussed around internalizing the DC network from 3PL into our 4 walls, We would expect a little bit of leverage on the back half for sure. I mean this quarter despite all those pressures that we did have, we still were able to increase on a year over year basis. But we want to make sure that we're managing expectations if I would peg it on a year over year level and with opportunity to grow from there and we would communicate those growth a little bit more clearly for the back half and the next quarter's call.

Speaker 2

And I think

Speaker 1

more than ever, more than ever, we've become a lot more tactical and strategical in terms of promotional pricing rather than across the board, like this example that we've done in Q1, accelerating our models, which is a promotion we call that part of our promotions. Instead of doing it across the board in terms of discounts or promotions, we worked very hard to build and maintain fabulous value products to our customers that have expanded also our gross margins And we see that path continuing by also but with also introducing specific areas to drive other categories that will drive traffic and reduce costs and promotions without impacting the longer term balance of our floor.

Operator

Ladies and gentlemen, this concludes there are no further questions at this time. I will now turn the call over to management for closing remarks.

Speaker 1

Well, thank you very much everyone for joining us for Q1. I apologize again for the technical difficulties that we had at the start of the call. We really appreciate all your support and we're looking forward to chatting with you all in Q2. Be well.

Operator

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.

Powered by Quartr
Earnings Conference Call
Sleep Country Canada Q1 2024
00:00 / 00:00