Shares of adjustable mattress manufacturer Sleep Number (NASDAQ: SNBR) were awake and alert late last week following the company's release of its fiscal third quarter earnings. Sleep Number's stock jumped ahead of its previous day's close by 11% on Thursday, Oct. 15, and while falling slightly on Friday, it still closed out the week with a 14% gain.
Both top- and bottom-line momentum fueled investors' enthusiasm. The company reported a year-over-year sales advance of 12% to a quarterly record of $531 million. Operating margin jumped by nearly 500 basis points to 13.1%, as Sleep Number complemented its sales strength by holding operating expenses to a slight increase. As a result, diluted earnings per share increased by 90% against third quarter 2019, to $1.79 per share.
On the surface, it might appear that Sleep Number is participating in a pandemic-related boost, along with a host of other specialty retailers. But the company's performance is deceptive; long-term shareholders should peer more deeply into this quarter's results.
Image source: Getty Images.
A transition in sales channels
It's perhaps too easy to construct a narrative around the sleep specialist's filing that's predicated on a COVID-19 boost. It's true that in this extended period of remote work, more of us are focused on wellness purchases as we spend time at home. It's also true that Sleep Number's non-store sales are exploding: Online sales leaped 111% over the comparable period in the third quarter.
However, rather than benefiting from a tilt in lifestyle preferences due to the pandemic, Sleep Number may simply be realizing the same sales acceleration it would have experienced without COVID-19, but with a higher mix of online sales. Its sales channel mix may normalize once customers feel more comfortable shopping in stores again, where they can physically try out a mattress before purchasing. This is already happening to some degree: Comparable retail store sales actually rose by 2% against the prior-year period this quarter, after falling 21% in the last sequential quarter.
Comments from CEO Shelly Ibach during last week's earnings conference call support the conjecture that Sleep Number was set for a strong quarter with or without the impact of COVID-19. Ibach pointed out that the last three months marks the third consecutive year in which Sleep Number has seen double-digit demand growth in the third quarter.
Ibach also observed that the manufacturer has enjoyed an extended demand trend since making the decision three years ago to transition its entire sleep lineup to its "360" model technology-enabled smart beds.
In any event, it's clear that both operationally and financially, Sleep Number has remained quite resilient during the pandemic. Recent supply chain improvements enabled the company to meet higher e-commerce demand without major hiccups. Even with the crush of online orders, gross margin this quarter improved by 70 basis points to 63.1%.
In addition, the company fully repaid a $75 million term loan this quarter which it had taken earlier this year as a precaution to buffer liquidity at the outset of the pandemic. From a financial perspective, Sleep Number has moved past its worst estimated impact from the pandemic.
What this means for future performance
To see Sleep Number's acceleration in sales and profit as simply an isolated, pandemic-driven phenomenon is tempting, especially in light of its climbing online sales this year. But it's a better outcome for shareholders if the consumer discretionary specialist is simply fulfilling sales within a multi-year demand trend, as its numbers seem to indicate. This decreases the risk of a post-COVID slump.
If anything, management is doubling down on the channel which has anchored the company's long-term success. Even given shutdowns and shelter-in-place orders from earlier this year, Sleep Number is on track to average a record $3 million in average sales per store in fiscal 2020. Management affirmed that it will continue to add to its store base of 596 stores at a rate of 4% to 5% annually through 2025, even as it invests in higher online and phone sales over the same period.
So, shareholders shouldn't be deceived -- sales were likely set for brisk growth this quarter regardless of the economic environment, and management is allocating resources to ensure that Sleep Number continues to move its smart mattresses in response to solid long-term demand.
10 stocks we like better than Sleep Number Corp
When investing geniuses David and Tom Gardner have a stock tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*
David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Sleep Number Corp wasn't one of them! That's right -- they think these 10 stocks are even better buys.
*Stock Advisor returns as of September 24, 2020
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.