Sleep Country Canada Holdings Inc. (OTCPK:SCCAF) Q3 2022 Earnings Conference Call November 7, 2022 8:00 AM ET
Company Participants
Stewart Schaefer – President & CEO
Craig De Pratto – CFO
Conference Call Participants
Stephen MacLeod – BMO Capital Markets
Martin Landry – Stifel GMP
John Zamparo – CIBC Capital Markets
Vishal Shreedhar – National Bank Financial
Operator
Good day. I would like to welcome you to Sleep Country’s Q3 2022 Results Conference Call. On Friday, November 4, Sleep Country released financial results for the third quarter of 2022. A copy of the earnings disclosure is available on their Investor Relations website, and includes cautionary language about forward-looking statements, risks and uncertainties, which also applies to the discussion during today’s conference call.
I would now like to turn the call over to Stewart Schaefer, President and CEO. Please go ahead.
Stewart Schaefer
Thank you, Michelle, and good morning, everyone. I hope you’re all keeping well on this beautiful November morning. With me today is Craig De Pratto, our CFO. As we reflect on the quarter, the sentiment in consumer spending changed rapidly as the quarter progressed. While we still believe that the consumer remains healthy, consumer confidence has deteriorated during the period that has seen the fastest phase in interest rate hikes in decades. In light of the macro challenges, we are very proud of the sustained growth in market share that we have achieved over the past three years, as we lacked considerable growth from Q3 2020 and 2021, where we delivered a two-year stacked same-store sales growth of 25.1%. We took a step back in Q3 2022. We are pleased with our year-to-date revenue growth of 5.6% in this environment, and our three-year same-store sales stack growth of 14%. Amid rapidly shifting macro environment and inflation hitting 40-year highs, we are proud of our teams who continue to do a great job navigating our business and staying focused on our purpose-driven strategy through a very difficult environment that is filled with a lot of uncertainty. Successfully managing our inventory with the continued supply chain disruptions, coupled with a rapidly depreciating Canadian dollar, has been no easy task, but we have positioned ourselves well going into the fourth quarter. Despite our current share price that is trading at historically low valuation multiples, we are very confident in our strong balance sheet, our continued dividend growth, and the most aggressive share buyback program in our company’s history. With a proven track record as a publicly traded company, with exceptional same-store sales, revenue, EBITDA, and EPS growth since our IPO, we remain excited for our future prospects, notwithstanding the uncertain macro environment that we are all experiencing.
This quarter, we expanded our retail footprint with Sleep Country Dormez-vous store openings in St. Thomas, Ontario in August, and Griffintown in Montreal in early October, for a total store count of 288 locations. Our retail network continues to be a critical part of our multi-channel strategy, where our customers can experience our range of products with the help of our trusted sleep experts. Add to that, our beloved Hush brand, opened the first ever popup retail experience at Yorkdale Shopping Center last week, bringing its popular online sleep brand to life for customers. The in-store experience will feature a sensory Hush room for visitors to immerse themselves in Hush’s wide range of sleep improvement products. Around this time last year, we began the rollout of our Sleep Country Express stores in Walmart Super Centers across Canada. We are pleased to expand the successful pilot project with the addition of five locations in Western Canada, and two more in Ontario this year, bringing our Sleep Country Express National store count to 17 locations. With these innovative new concept stores, we extend our reach and product lineup to new customer segments. In the months ahead, we will continue to expand our footprint, build our relationship partnerships with Walmart Canada, and further enhance our in-store customer experience to strengthen our brands and reinforce our position as Canada’s leading specialty sleep retailer. Our eCommerce sales represented 18.5% of our total revenues, staying consistent with last quarter, and reinforcing the importance of our digital channels across all our brands and online partnerships. Our purpose of transforming lives through sleep continues to be our North Star. We supported Ukrainian families in need with a donation of more than $375,000 of mattresses, sheets, pillows, and bedding, to the Ukrainian Canadian Congress in Quebec. This brings our total donation of Sleep Essentials in support of community partners to $640,000. In addition, we donated $100,000 to the Canadian Mental Health Association to support our back-to-school campaign that reinforce sleep as an essential school supply. Following the release of our first environment, social, and governance ESG report in July, and our ESG strategy, we forged a partnership with BrainBox AI, a groundbreaking AI technology, to help reduce our CO2 emissions, and support our commitment to achieve our sustainability goals. Looking ahead, our sentiment around our growth plans remains bullish, as we continue to be focused on delivering our long-term strategic plan, while also building shareholder value. Thank you to our Sleep Country, Dormez-vous, Endy, and Hush teams, and all our partners for their continued commitment to our business and customers.
With that, I’ll now turn the conversation over to Craig to discuss our financial results.
Craig De Pratto
Thank you, Stewart, and good morning, everyone. We continue to be pleased with our fiscal 2022 results, with year-to-date revenue growth of 5.6%, and year-to-date diluted EPS growth of 13.2%, while we saw a decline in Q3 2022 revenues of 8.3%. This quarter, our results were impacted by a few unique dynamics. If you recall, last year in Q2, our stores were closed for approximately 33% of their normal operating days due to COVID-19 restrictions. As these restrictions eased, 115 of our stores reopened in the second half of June, and we saw an influx of written orders from the pent-up demand. A significant portion of these written orders were only delivered in Q3, which led to a shift in earned revenue from Q2 to Q3 2021. In addition, we saw the pent-up demand period for these 115 stores contribute higher than usual sales for the first four weeks of July. This dynamic had a negative impact on our Q3 2022 revenues by approximately 4%. In Q3 2022, we weren’t impacted by any store closures, and sales returned to seasonal patterns, more in line with pre-pandemic times. Our Q3 revenues were $251 million versus $273.8 million in Q3 2021. This decrease of $22.8 million or 8.3% was mainly driven by a decrease in our same-store sales by 11.1%, and partially offset by the following items. Incremental revenue earned from Hush, which we acquired in Q4 last year, two net new store openings in year-to-date 2022, 10 Walmart and Dormez-vous Express store locations, and wrap stores.
As noted earlier in the call, and as a reminder of our strong growth over the past few years, our same-store sales were comping over a two-year stack same-store sales growth from Q3 2020, and Q3 2021 of 21.5 – or 21.1%, in which we achieved a three-year same-store stacked growth of 14% for the period ended Q3 2022. Additionally, as Stewart noted earlier in the call, there were multiple macro environmental factors that negatively impacted our business, including the decline in consumer confidence, leading to certain customers to defer big ticket purchases such as mattresses to a later time. However, we believe our sustained growth in market share over the last three years, we are well positioned to capture the deferred purchases as the customers’ confidence returns and they are ready to make their sleep purchases. We expect the negative customer confidence and other macro environmental factors to continue to impact our business in Q4 of this year.
Moving on to gross profit. Our gross profit margin increased by 100 basis points from 37.5% in Q3 2021, to 38.5% in Q3 2022, mainly as a result of a series of strategic price increases, a significant portion of which was completed in the latter part of 2021, and continued into Q1 2022. The margin efficiency from higher AUSP was partially offset by the deleveraging of occupancy and depreciation expenses, and higher delivery and transportation costs, as well as higher product costs that included the abnormally high freight costs that were incurred in the latter half of 2021 and the earlier part of 2022 as a result of global supply chain challenges. Although we have started to see some relief in freight costs in our recent inventory purchases, we expect to continue to face pressure on our gross margin efficiencies in the upcoming quarters, as we continue to sell through our more expensive inventory on hand.
Total G&A expenses increased by $1 million or 2% from $48.8 million in Q3 2021, to $49.8 million in Q3 2022. The increase was primarily as a result of an increased dollar spend in media and advertising, and an increase in depreciation expenses, partially offset by lower compensation, professional fees, credit card and financing charges. As a reminder, in pre-pandemic times, Q3 was generally the quarter with our highest advertising spend during the year. In addition, the advertising expense for Hush was incremental in Q3, as we acquired the Hush business in Q4 fiscal 2021.
EBITDA decreased by $5.7 million or 8.3% from $69.4 million in Q3 2021, to $63.7 million in Q3 2022. Adjusting our EBITDA for LTIP ERP-related costs in addition to non-recurring Hush-related acquisition costs in Q3 2021, our operating EBITDA decreased by $8.1 million or 10.9% from $73.7 million in Q3 2021, to $65.6 million in Q3 2022. It should be noted that Q3 2022 normalizations of $1.9 million came in lower versus the $4.2 million in Q3 2021. This resulted in our adjusted EBITDA margin decreasing by 90 basis points year-over-year. Finance-related expenses increased by $2.3 million from $4 million in Q3 2021 to $6.3 million in Q3 2022. This change was mainly due to an increase in accretion expense for the redemption liabilities related to the Hush acquisition in Q4 2021, and was partially offset by the unrealized gain in the company’s interest rate swap.
We experienced an increase in our effective tax rate by 120 basis points from 26.9% in Q3 2021 to 28.1% in Q3 2022. This tax rate increase is mainly driven by the accretion expense for the redemption liabilities related to the Hush acquisition in Q4 2021 that is not deductible for tax purposes. Net income attributable to the company decreased by $7.6 million from $36.5 million in Q3 2021, to $28.9 million in Q3 2022. Adjusting for LTIP, ERP costs, Hush-related accretion expense, and Hush related acquisition costs in Q3 2021, adjusted net income attributable to the company decreased by 7.2 million from $39.7 million in Q3 2021 to $32.5 million in Q3 2022. Diluted earnings per share decreased by $0.19 or 19.4% from $0.98 in Q3 2021 to $0.79 in Q3 2022. Diluted adjusted earnings per share decreased by $0.18 or 16.8% from $1.07 in Q3 2021, to $0.89 in Q3 2022.
Regarding our CapEx spend for the remainder of the year, we plan on opening an additional Sleep Country store later in Q4, bringing our total new stores in 2022 to five. We plan on deferring all store renovations into the new year, as we finalize our new store design, which is in its final strides. On to some capital allocation items. On November 4, 2022, the board declared a dividend of $0.2150 per share, which is payable on November 30, 2022, to the shareholders of record at the close of business on November 21, 2022. During the third quarter, we repurchased for cancellation approximately 527,000 common shares at an average price of $26.16, for total consideration of approximately $13.8 million. On a year-to-date basis, as at September 30, 2022, we repurchased for cancellation approximately $1.36 million common shares at an average price of $26.26, for total consideration of approximately $35.8 million. And subsequent to the quarter, we continued to repurchase shares, and as at Friday, November 22 – or sorry, November 4, 2022, on a trade basis, repurchased an additional 500,000 common shares at an average price of $22.44, for total consideration of approximately $11.2 million. As Q4 progresses, we plan to continue to execute against the target we set earlier this year of deploying $50 million towards our NCIV.
Thank you, and I’ll now pass the call back to Stewart for closing remarks.
Stewart Schaefer
Thanks, Craig. Our strong performance and sustained growth in market share over the last three years, demonstrates the power and resilience of our sleep ecosystem, and our team’s ability to deliver for our customers. Despite the challenging market conditions and rapidly shifting business environment we have been operating in over the last number of months, we remain focused on executing against our strategic plan to build on our deep foundation of sleep expertise, expand our reach, grow our channels, and invest in the most innovative and expansive product assortment in Canada. Driven by our purpose and vision, we are committed to delivering profitable growth, while helping Canadians achieve their best night’s sleep in support of their health and wellbeing.
With that, we conclude our remarks and open the floor for questions.
Question-and-Answer Session
Operator
Thank you [Operator Instructions] The first question comes from Stephen MacLeod of BMO Capital Markets. Please go ahead.
Stephen MacLeod
Thank you. Good morning, guys. Just wondering if you could just give a little bit of color around sort of how you saw things evolve through the quarter. You did mention that it felt like the macro headwinds accelerated a little bit. And then maybe subsequent to the quarter, what you’re seeing on a quarter-to-date basis.
Stewart Schaefer
Sure, Steve. So, as we mentioned on our July 28 Q2 earnings, there was some choppiness that was starting to occur in July, continued again in August. I would say for most of the entire year, we’ve mentioned that our low end of our business, below $1,000, was slowing down a little bit, but the mid to high end was holding up very well. In fact, it was continuing to grow. September, we saw all metrics decrease and decrease rapidly. And I could say that we saw that continuing into the month of October.
Stephen MacLeod
Okay, I see. That’s helpful. Thank you. And then, I guess secondly, just with respect to the gross margin outlook, Craig, you mentioned you expect some pressure into Q4, and I’m just curious if you could – if you can give a little bit of maybe color around what sort of magnitude, just as you solve through those more expensive inventories that you have on hand?
Craig De Pratto
Yes. Hi, Stephen. As we look into Q4, we do expect to continue to flip over those higher priced accessory items in certain mattresses. So, I’d expect about 100-basis point downward shift or pressure in in Q4 this year.
Stephen MacLeod
Okay, that’s great. And then maybe just one more if I could. I’m not sure if you can talk about it yet, but just curious if you could give a little bit of color as to what we should expect with the new format stores that you are currently sort of finalizing the plans for.
Stewart Schaefer
So, we’re going to save most of it, but I guess a heightened experience for the customer, more tactile opportunities, and I don’t want to go too deep detail on that, an endless aisle component to expand on our accessories, more square footage for accessories, and some of the other important cultural and messaging that we think is very important in terms of our health and wellbeing strategic initiatives that will be felt through the store.
Stephen MacLeod
Great. Okay. Thanks guys. That’s it for me.
Operator
Thank you. The next question comes from Martin Landry of Stifel GMP. Please go ahead.
Martin Landry
Hi, Good morning, guys. I was wondering if you can elaborate a little bit more on the consumer dynamic that you’re seeing. I’m just trying to better understand a little bit the puts and takes in your same-store sales, and I was wondering if you can give us some details if it’s more a reduction in traffic or if it’s more a reduction in like a trade down pattern and a reduction in your average unit selling price. Just a bit of color on that would be super helpful.
Stewart Schaefer
Yep. Actually, a great question, Martin. The macro headwinds and the negative wealth effect that we’ve seen over the last few months, and especially in September and October, the one area that we always watch for is whether, to your question, are customers trading down, or are they pausing on their purchases? Believe it or not, we prefer the pause than the trading down because in past recessions, if we’re going there or slowdowns, it’s a purchase that is put off. It’s not the restaurant business or a fashion industry in terms of clothing where you miss a season, they push it off. So, if a customer trades down from a $1,500 bed to $1,000 bed and they’ve now exited the market for the next eight to 10 years, that concerns us. So, even though it’s painful when things slow down a little bit, we have not seen trading down. We have seen slower foot traffic. Our accessories still seem to hold up well. And traditionally, in past recessions ‘08, ‘09 and all the little blips that we’ve had since then, we have the mid, how should I call it, luxury purchases where people still want to engage with the brand, buy themselves a nice accessory, sleep accessory, and which is fabulous and usually returns the benefits to our business months later when consumer confidence returns.
Martin Landry
Okay, that’s helpful. I wanted to touch as well on your new store concepts. Can you tell us a little bit what kind of timing you’re thinking about in terms of rolling it out? And then, what’s going to be the pace of the rollout to your broader network?
Stewart Schaefer
So, the plan, without holding myself to it, but the plan is that it would begin in Q1, and we want to get this right. We are – I mean, our stores currently are in great shape and they’re – it’s performing very well. So, there has to be a noticeable difference in terms of the stores to make the investment always accretive to our shareholders. And I would say, this is probably going to roll out quicker than the past renovation, because our Head Of Business Development, Phil Besner, has come up with an A, B, and C model in terms of our stores, where there’ll be a certain amount of investment on our top A stores, a little less in our Bs, and little less in our Cs, but that also will change the timeline of how many stores we could rapidly do. So, again, I’ll have probably more color on the timeline, Martin, by mid next year, but we should begin to roll out in Q1.
Martin Landry
Okay. And just last question for me. I was wondering if you can discuss the performance of Hush Blankets. It’s been roughly a year since you’ve acquired it, and when we look at the website traffic, it looks like it’s down on a year-over-year basis. So, I was wondering if you can provide color on how the sales of Hush Blankets have evolved since you’ve bought it?
Stewart Schaefer
I would say that Blankets have slowed down a little bit, as expected, and a seasonable purchase. This extended warm November and October and September, has not necessarily helped our Hush Blankets or our own duvet type of business, which usually triggers – ticks up when things start getting cold. That being said, some of the other products that Hush has been introducing, other accessories like our ice sheets and our new pillows, have been flying off the shelves and we can’t even keep them in stock. And just to remind everyone that Hush is an expansion in terms of our accessory collection, where you’ll be seeing innovative sleep products being introduced over the coming year.
Martin Landry
Okay. That’s it for me. Thank you.
Operator
Thank you. The next question comes from John Zamparo of CIBC. Please go ahead.
John Zamparo
Thanks. Good morning. I wanted to start on the industry at large, and one of your US peers had suggested that unit sales in Q3 were down roughly 25%. I wonder what’s your view on how Canada performed in the quarter.
Stewart Schaefer
We don’t break out our units, but I will tell you that our units are down, not as much as 25%. It seems as though in the United States, it’s always six months before us. So, I sure hope that doesn’t happen within this landscape, and I really don’t think it will. But again, nobody has a crystal ball. In our business, which is on the mid to high end, as I said a little bit earlier, that started to slow down a little bit in this quarter and went negative on everything except the top, top tier of our mattress bands. And, but I would say on the low end, John, and I’ve mentioned this now throughout the entire year, on the low end below 1,000 and more, particularly below $500, I would probably say that unit-wise, has dropped anywhere between 15% and 20%.
John Zamparo
Okay, that’s helpful. Thanks. And when you talk about the deferral and the acceleration of that deferral purchases subsequent to the quarter, there’s a difference where value is underperforming premium. Is that fair?
Stewart Schaefer
100%. Value has been underperforming since the turn of the year. And I’m not going to say that’s not important to our business because every single range and category and price band is important to our business. Our business has always been made up of the mid to high end, and we do want our unfair share of the economy pricing. Our relationship with Walmart has helped with that, but obviously, with inflation where it is, and interest rates and just the whole negative wealth effect and stretching of the dollar, that category is the first usually to feel the impact.
John Zamparo
Okay, that’s helpful. I want to get a sense of your positioning for a potential recession. And if we look back at the period from ’07 to ’09, Sleep Country actually grew sales and EBITDA through that time. So, can you remind us, what were the tactics that led to that in that period? And then thinking about the current time, how would you plan to operate in a likely softer period for consumer spending over the next year or so?
Stewart Schaefer
Sure. In 28 years in this business, I can’t keep track of how many recessions and market corrections I lived through. All I can say is, with our strategic initiatives, the cash that we generate, our profitability, our dividend, our buybacks, and our growth prospects, we will emerge stronger and ready when the consumer confidence returns back to purchasing mattresses. Nothing is changing in terms of our strategic initiatives. And many times within recessions, we actually invest more in our brand where we believe some others may be pulling back on the one big lever, which is advertising. It has always worked well for us in terms of gaining market share. For us, it’s all about market share. We don’t – we’re not as fussed if the customer pauses. We are very fussed if we think we’re losing share from others. So, in times of recession, we do think it’s a great opportunity to take more market share.
John Zamparo
Got it. Okay. That’s helpful. And then one housekeeping question. Craig, or I think it was Stewart, your comments had referenced FX headwinds, but I wonder if you can give some sensitivity here, either what the financial impact of that was in the quarter or say what a 1% move in the Canadian dollar versus the US dollar has on the business?
Stewart Schaefer
It’s pretty hard to say because of our how our inventory is, which is our FIFO method, as well as the flow of containers. But if you consider on an annual basis, and this is probably going to make it even harder for you, John, but on an annual basis, 25% of all our purchases, and that’s – remember, a good portion of that is our accessory business, is in US dollars, including some of our partners, our mattress partners in the US like Purple. So, I don’t even want to guess, but Craig could get back to you and let us do a little work on that and give you a solid answer.
John Zamparo
Okay. That’s helpful. That’s all for me. Thank you very much.
Operator
Thank you [ Operator instructions]. The next question comes from Vishal Shreedhar of National Bank. Please go ahead.
Vishal Shreedhar
Hi. Thanks for taking my questions. I was hoping you could update us on your thoughts on acquisitions during periods of tougher market conditions. Does management still think there’s opportunity there? Is the focus preserving cash or buying back stock? How would you prioritize it?
Stewart Schaefer
Well, we’re always cautious with our cash. That’s who we are, and it served us well for the last 28 years. All that being said, we think that our balance sheet as it is the strongest in our company’s history right now, and we have a strong war chest set up. So, we are aggressively looking for opportunities, as well as returning value to our shareholders with this $50 million buyback, as well as wanting to be the ones who always increase our dividends, which hopefully in the new year, the board will approve another dividend increase. That being said, the interesting thing as you look at our stock, which is trading at real – like unjustifiable lows, so our other companies who we’ve looked at in the past that have had frothy multiples, and their multiples have come down dramatically too. And so, that does create more interesting opportunity for a company like ourselves who has the cash and the balance sheet that we do. So, we are looking and it has to be the right deal and be smart in terms of our strategic initiatives and our growth plans. So, we’re on the hunt for great companies.
Vishal Shreedhar
Can you give us your historical playbook in terms of merchandising changes, maybe changes to store growth cadence during prior periods of economic weakness?
Stewart Schaefer
Sure. Yes. Probably a big part of that would probably lead into our marketing initiatives, which we are right now in the midst of planning our 2023 marketing plans. Accessories for us, we truly believe is a lead in. It’s to engage with the customer. Never mind that’s transactional at 1,000 basis points higher, and it’s a very profitable part of our business. So, we are – and without disclosing too much to our competition, we expect to expand on certain areas within our accessory portfolio in terms of our media mix to be able to continue to engage and transact with our customers in what potentially could be a difficult 2023.
Vishal Shreedhar
Okay. So, what I was trying to get at is, should we anticipate to see maybe in 2023, I know you’re going to focus on the store retrofits, but less store growth, or maybe less marketing dollars at mattresses, maybe not chasing sales that aren’t there as much, is some way to create less pressure on the SG&A line. Is that something that management is contemplating, or is that not a prudent move in your view?
Stewart Schaefer
I’m going to say, A, we’re always aware and watching the macro environment, how things unfold. If things accelerate, it may change our perspective. At this moment, our healthy balance sheet is not suggesting that we are going to change anything strategically. In fact, we’re hoping that if we do go into a recession, and don’t get me wrong, nobody wants a recession, but if we do go into a recession, it may create greater opportunity for A properties. So, we’re looking to expand our selection of real estate just as quickly and hopefully even maybe quicker once we get our new store design underway, because that’s what’s been holding us back a little bit. And in terms of marketing, like I said on the call with John, this is a time where we believe investing in our brand is very important on the long-term in terms of growing market share.
Vishal Shreedhar
Sure. Earlier it was mentioned that there would be about 100 bps of gross margin pressure in Q4. Was that a sequential comment or a year-over-year comment?
Craig De Pratto
It is a – if you look at last year’s gross margin, it would have a little bit of a price efficiency coming through. So, I would take that as, if you look at last year’s margin, there’ll probably be about half of that on a year-over-year basis, and sequentially would be down. So, in that range of about 1% sequentially. And then year-over-year, I think that turns out to about half of that difference on a year-over-year basis.
Vishal Shreedhar
Thank you.
Operator
Thank you. There are no further questions at this time. Please continue with closing remarks.
Stewart Schaefer
So, we want to thank you all for your support and your commitment, and we look forward to having a chat with you guys at the end of Q4. Have a good day and a good winter.
Operator
Ladies and gentlemen, this does conclude your conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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