Welcome to Sleep Number's Q4 and Full Year 2020 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. [Operator Instructions] I would like to introduce Dave Schwantes, Vice President of Finance and Investor Relations. You may begin.

Good afternoon and welcome to the Sleep Number Corporation Fourth Quarter 2020 Earnings Conference Call. Thank you for joining us. I am Dave Schwantes, Vice President of Finance and Investor Relations. With me today are Shelly Ibach, our President and CEO; and David Callen, our Chief Financial Officer. This telephone conference is being recorded and will be available on our website at sleepnumber.com. Please refer to the details in our news release to access the replay. Please also refer to our news release for a reconciliation of certain non-GAAP financial measures and supplemental financial information included in the news release or that may be discussed on this call. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings news release and discussed in some detail in our annual report on Form 10-K and other periodic filings with the SEC. The company's actual future results may vary materially. I will now turn the call over to Shelly for her comments.

Good afternoon and welcome to our 2020 fourth quarter earnings call. My SleepIQ score was 86 last night. Quality sleep is vital to our health and wellness. It affects our physical mental and emotional well-being. It helps boost immunity, increases energy and improves recovery. It is life changing. Sleep Number 360 smart beds benefit our overall health and wellness by improving our restful time of asleep. Sleep Number is a beloved brand. Our team's deep relationship with customers is grounded in our culture of individuality and well-being. The result is more than 13 million lives improved and sustainable profitable growth. We are delivering long-term strategic and financial performance because of our differentiated strategy and vertically integrated business model. Our current five-year total shareholder return is greater than 600%. Over the past five fiscal years, we delivered compound annual growth rates of 9% in sales 15% in EBITDA and 38% in earnings per share. Our 2020 ROIC was 25% more than 14 points higher than five years ago. At the inception of our consumer innovation strategy in 2012, we position digital health at the core of our product and customer experience. This strategy combined with subsequent strategic investment is fueling our profitable growth. Our core business supports our purpose of improving the health and well-being of society through proven quality sleep. Consumer trends that we have long anticipated were accelerated by the global pandemic in the past year resulting in three structural shifts. First, consumers are prioritizing well-being their own and that of their families. And they now better understand the strong link between sleep and overall health and wellness. Second, consumers are adapting digital products and services at a much higher rate and they are increasingly relying on digital health solutions. And third, consumers have a heightened preference for brands…

Thank you, Shelly. Exceptional execution in the pandemic year was an outcome of the innovation philosophy that pervades our business. Faced with the most serious of threats from COVID-19 followed quickly by explosive demand resurgence, our team streamlined processes and embraced digital capabilities across the company. We are truly working differently. The result efficiencies were achieved in 2020 that we had not expected for another year or two. 2020 was as the saying goes an overnight success 10 years in the making made possible by the culture of problem solving and innovation embraced at Sleep Number. Despite the more than 100% increase in our share price for the last year, we believe execution of our sleep science and technology-enabled strategies and digitally advantaged business will deliver significant upside for all stakeholders. The groundwork for our 2020 performance began years ago with an understanding that proven quality sleep is highly correlated with health and well-being. This strategic clarity reinforced by disciplined investment in growth enablers and growth drivers produced average top line expansion of 9% in 2017 through 2019 with average three-year EPS increases of 35%, nearly four times the top line growth. In 2020, our teams added to this multiyear top decile performance with another year of 9% top line growth and an explosive 81% growth in EPS a multiple of nine times the rate of top line expansion. We have been creating superior value for years and continue to drive for breakthrough performance in 2021 and beyond. Before talking more about the future, let's review our 2020 results. Net sales grew 9% to nearly $1.86 billion. Excluding $41 million from the extra week, net sales grew 7% for the year despite the 20% year-over-year decline in the COVID-19 affected second quarter. Net sales growth in Q4 accelerated to 29%…

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

Hey. Good afternoon. Great results, everyone. You had mentioned a couple of times on the call your use of marketing dollars and the ability to have automation and machine learning to target specific customers. And I was hoping you could unpack that a little bit with some more detail. Is that a new capability that perhaps has emerged here in the back half of 2020? Could you give us a more granular example? And furthermore, does this marketing allow you to expand the demographic of your customer base versus where it's trended historically?

Great. Thank you, Peter. I'll start with the latter part of your question first. Yes, absolutely. It has helped us expand broaden our target customer and who we're bringing into the brand and who's purchasing and -- so that has definitely widened with the advancement of our digital capabilities. As you probably recall we brought in-house our digital capabilities a few years ago. So this is one of those examples of us progressing our strategic initiatives each and every quarter and seeing the year-over-year double-digit demand increases as a result of that behaviour. And this is just a great example because it all stemmed off the internal digital capabilities. And as we've been advancing them each quarter, we've incorporated this ecosystem and built on an ecosystem that connects with the highest potential consumer, brings her into the funnel, hold her all the way through, however, she wants to engage and shop with us. We convert then we have ongoing engagement with our SleepIQ technology. Then that customer becomes part of our insider group and becomes an advocate for the brand. The engagement continues to deepen as we advance the health and wellness benefits like our circadian rhythm or nighttime HRV and that will amplify. And it's a bit of, what we call, the flywheel or building on the digital ecosystem. And every -- as we add data, the algorithm continues to strengthen and get smarter and to be more and more effective. And this is what gives us confidence as we look out over the horizon and build off the consumer shift that has happened and the trends, but how our innovations and our product and our strategy, all continue to build in the future. So looking at our road map and how all of this builds value over time, is what gives us great confidence in delivering superior value to our stakeholders.

Okay. If I could ask a quick follow-up on that. You talked about the expanding or broadening customer base, are there specific examples? Maybe is it geographic or even various ages that are new to you?

Yes. Well, first of all, you can see it in the 29% unit growth in the fourth quarter. But we've added a younger -- some great growth in that adding another five to eight years on the younger part of the curve.

Okay, great. If I could pivot to maybe a financial question for David, two-fold. It looks like you're probably still running with a backlog going into Q1. I was hoping you could quantify that for us. And then secondly, as you know, a lot of your peers in the industry have been raising prices rather prolifically. You guys have not. So, kind of wondering how you feel about your pricing position right now? And are there any planned price increases embedded within that guidance?

Yes. Peter, you're right. We do have higher demand in the fourth quarter, which resulted in some of our deliveries that are going to move into 2021. That probably is about 4% to 5% of the growth four to five points of the growth that I highlighted for 2021. As far as pricing, we have pricing in select models built into our 2021 plans and continue to have pricing power across the line based on our innovations. You know that historically, we've taken an average of about 3% benefit driven pricing per year. It's been a little lighter than that recently maybe half of that, but we certainly have that power within our business model.

Okay, sounds great. Thanks a lot and good luck.

Thank you.

Your next question will come from the line of Bobby Griffin of Raymond James. Please go ahead.

Good afternoon, everybody. Thank you for taking my questions. And congrats to you and the rest of the team on managing an unprecedented and challenging year. Shelly, first I want to circle back to your comments about the additional kind of partnerships with SleepIQ and maybe hopefully you can expand on a little bit of that a little. And where do you kind of see over the five-year time frame or a long-term time frame the potential for SleepIQ? Is there any monetization potential or subscription-type potential or any type of different partnerships that we, on the sell-side or the buy-side might not be thinking from, because your data does stand out as pretty unique in the industry and the amount of sleep nights you're not registering with more and more customers each day?

Bobby thanks for the question. You're absolutely right. And we're sharing how significant this data is with our position right now on sleep sessions and our sleep fleet. This is such an important area where we're extending our leadership into connected health. So if you think about the past number of years, as we brought the smart bed to the marketplace and introduced the market of sleep and helped people understand the link between sleep and their overall health and wellness, now we'll be extending that to connected health. And I think some of the good indications would be the circadian rhythm and the nighttime HRV. These are measurements that really help you now optimize your day and then our upcoming release will be around daytime alertness. So that's the beginning. We're investing significantly in this area scaling and investing in multi-sensory capabilities as we broaden our competitive moat. So yes to all of the above. There's great potential in the future. And we consider smart beds as our baseline and everything will evolve and build off that smart bed as a platform.

Thank you. And David for the quarter, can you offer a little bit more detail on the sales and marketing leverage? Was that media-driven or the non-media portion of that line item? And then as a second follow-up to that, when we look at 2021, understanding that there's a lot of moving parts in predicting this with this environment is very difficult. But what have you assumed in terms of the mix of the business that comes back marketing levels or the non-marketing portions? And anything to help us kind of get a little bit of flavour around the drivers in the P&L to get to that $6 number you're targeting.

Yes Bobby that -- it's an important dynamic for sure. And that's why we're advising that we use a two-year growth off of the 29 -- our 2019 performance for your modelling purposes. Pretty excited about delivering again in 2021, at least 300 basis points of NOP margin expansion versus 2019. A significant portion of that did come from sales and marketing. As I highlighted, we expect to hold onto a lot of those gains because we learned how to work differently. We are going to lean into our growth drivers in any event. We're going to be building out 40 to 50 stores for example in 2021 and yet still delivering that kind of operating profit margin expansion on a two-year basis. And included in that not only our near-term growth drivers like marketing and our stores but we're going to be leaning in again in 2021 with our R&D spending.

Okay. That was helpful. I’ll jump back in the queue. Thank you again and best of luck to you in the first quarter.

Thanks a lot, Bobby.

[Operator Instructions] Our next question will come from Curtis Nagle of Bank of America. Please go ahead.

Good evening. Thanks very much. Just wanted to I guess follow-up on Bobby's point there, in terms of the sales and marketing. Yes just kind of wondering if something I don't know has permanently changed in terms of the structure or the amount of sales and marketing you've run through as a percent of revenue. Basically, at least as far back as my model goes, it's been running at about a 45% rate on average, dropped to 41.5% I think in 2020. Clearly there's been terrific volume growth put through and some efficiencies. But kind of thinking about when demand in the industry and perhaps for you guys normalizes a little bit, how should we think about S&M and where that could go? Would it go up? Or what's the structure?

Great. Curtis, I'll start, and David can add some additional colour. I think we could hear your question. It was a little bit muffled. But it does all start with demand. And I spoke about the digital ecosystem and being able to target high-value consumers more efficiently and to pull these customers through all the way to conversion. So the strengthening of our digital ecosystem is very important for that efficiency and that is a big source of leverage on this line. If you think about it holistically, all the way from acquisition to how we have ongoing engagement with the customer, the advocacy, and also the conversion through our sleep professionals and our new capabilities of selling from anywhere. So it's all integrated. It is a big advantage of our vertically integrated business model and our consumer innovation strategy, because it starts with the consumer and all of our initiatives are integrated. And so the leverage pulls through, as we advance and continue to invest in our digitization.

Okay. Got it. Just as a follow-up, maybe just talk through at least theoretically, some of the assumptions for higher tickets for 2021. Just kind of thinking through at least what I think are the puts and takes, launching the mid entry-level beds. Looking at the past couple of quarters, it's sort of been flattish. Maybe there's some offset, I guess to the positive, but be running less online business and more in stores which David should help. But, if you could just kind of walk us through kind of, how you're thinking about that and if there any other components that are important.

Well, for sure, Curtis. It starts with our in-store experience, frankly. We -- while we have new -- coming out with the new C series and the new p series and yes those are further down the line, and would impact ARU in a vacuum. That's not how things actually work. We create excitement over the brand. And then, the in-store experience and online experience now, moves the customer to the product that best suits their needs. And in fact that generally drives a fairly strong ARU, like you've seen here in 2020. We do, as I said intend to have some pricing in there as well. That will contribute to the ARU, that we're expecting to grow in 2021.

All right. Thanks very much.

Thank you.

Our next question will come from the line of Atul Maheswari from UBS. Please go ahead.

Good evening. Thanks a lot for taking my question. I also had a question on the sales and marketing line. And given that this metric now is so much better, than what it used to be in the past. So, could you highlight some of the efficiencies that you've unlocked that's driving these gains? And do you think that your S&M margin could trend even lower, in the next few years? And if so, what will drive that?

Well, we've learned how to work a lot differently across the business. First and foremost, we've embraced a lot of digital capabilities. We've talked about the selling from anywhere, and some of the workforce management tools that we've put in place. Also we've found ways to be more efficient on the marketing side. And we grew marketing 4% in 2020. So compared to, our top line growth -- or media, excuse me 4%. And compared to our top line growth of 9% for the year of course, we've got a lot of leverage out of -- on that line. And Shelly highlighted how the digital capabilities on that front are really contributing to efficient, attract and capture of new customers. So, yes we believe that there's opportunity going forward. However, media and marketing capabilities are a fuel for this company. We're going to lean into them.

One other add, would be the productivity of the stores. We've talked about now surpassing over $3 million per store inclusive of our online sales. We had over 100%, increase in online. We expect to continue to benefit from growing our online sales in addition, to growing our store sales. And super excited about, having 10 stores over $6 million and one store over $7 million. I mean, that's a significant productivity and leverage point. And we continue to see growth in our markets, across the country in stores.

Great. Thank you.

Thanks, Atul.

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

Thank you for joining us today. We look forward to discussing our first quarter 2020 performance with you, in April. Sleep well. And dream big.

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