Sleep Number Corporation

Numbers quarter three 2022 earnings conference call. All lines have been placed in a listen only mode until the question and answer session. Today's call is being recorded. If anyone has any objections, you may disconnect at this time. I would like to introduce Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

Good afternoon and welcome to the Sleep Number Corporation third quarter 2022 earnings conference call. Thank you for joining us. I am Dave Schwanes, Vice President of Finance and Investor Relations. With me today are Shelley Eibach, our Chair, 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 thank you for joining our third quarter 2022 earnings call. My Sleep IQ score was 77 last night. Our purpose, combined with our culture of individuality and well-being, are competitive strengths. They drive high team engagement, best-in-class commitment, and effort to perform. These attributes are essential in this challenging macro environment. Today, we'll provide an update on how macro and supply challenges are pressuring our 2022 results and the factors causing a shortfall to prior expectations. We'll also describe actions we're taking to reduce costs in this inflationary environment, preserve our balance sheet flexibility, navigate supply constraints, and strengthen demand. And I'll highlight how we're sustaining strong grant help and judiciously prioritizing strategic initiatives that will enable us to outperform as the environment improves. External business conditions worsened in the third quarter, which had a direct implication for our results and outlook. Third quarter net sales were $541 million, a decline of 16% from 2021 because of constrained supply of semiconductor chips and consumer sentiment near record lows. Q3 operating profit was $13 million, reflecting significant gross margin pressure, with operating expenses down $27 million. Third quarter earnings per diluted share were 22 cents, better than we previously guided with the additional pressures. We expect the consumer environment to remain challenging for the balance of the year and into 2023. In addition, several years into the pandemic, single threaded global supply chains built for specialization and cost optimization remain fragile and easily destabilized by events as simple as an equipment failure or as significant as a geopolitical shock, COVID lockdown, or natural disaster. With global inventory of semiconductors depleted, uneven, and interrupted shift flow continues to affect sweep number delivery timelines and volumes, operating efficiency, and forecasts. Based on these ongoing pressures, we have revised our 2022 EPS outlook to $1.50 to $2. Our strong balance sheet enables us to operate effectively through this volatility while also maintaining our long-term focus. Additionally, we are taking deliberate steps to reduce further costs and preserve future financial flexibility in this operating environment. David will provide more financial details in his remarks, but first I'll share the actions we are taking to improve demand as we navigate the constrained and uneven flow of semiconductor chips from our supplier. Our demand in Q3 was down 16%. Which was lower than expected as consumers purchase closer to need have an elongated consideration and favor extraordinary value, we also believe that operating without our full assortment of products and long lead times are hampering demand. In this environment, our actions have produced mixed results, for example. We had strong results over the Labor Day weekend when consumer need was the highest but experienced weaker than expected results both before and after the holiday. Here's what we have learned. Our econometric model continues to be an important tool. It suggests that the low consumer sentiment and mattress category variables indicate a 15% headwind. While the consumer is understandably cautious in the current economic environment, our brand health remains very strong and our customer loyalty is stellar. Digital traffic is near prior year levels, down 2%, but the consumer is slow to take additional steps leading to purchase. Therefore, we've focused on actions such as significant value offers referral and repeat sales and communicating our strong health and wellness benefits to drive potential customers deeper into the purchase funnel. Because we have not been able to procure enough semiconductor chips, one of our headwinds is our inability to offer customers a good and better assortment of Flexbit adjustable smart bases. As the macro environment has deteriorated, These chip shortage implications on our product offerings and the delivery timing limitations have had an adverse impact on the efficiency and effectiveness of our demand actions. With our balanced short and long-term focus and guided by our purpose, we continue to prioritize life-changing sleep innovations that position us to generate renewed demand growth once conditions improve. On October 4th, we introduced the greatest innovation in our history, the Climate 360 smart bed, which we pre-sold to our smart sleeper community. While Climate 360 represents, as expected, a small part of our overall portfolio, we're really excited to see the early sales of this smart bed. Climate 360 addresses being too hot or too cold during sleep with active cooling and heating. This is meaningful, as 80% of couples say one of them sleeps too hot or too cold. In addition to warming your feet to help you fall asleep faster, this innovative smart bed uses ambient air to create a personalized microclimate. It is designed to work with your body's natural sleep cycles to balance your temperature for deeper, better sleep. Remaining focused on innovation that improves quality sleep even as we take deliberate actions to address near-term weakness in demand is what sustains our strong brand health and smart sleeper engagement. We have almost 2.4 million active smart sleepers engaging with our smart beds, representing over 2 billion sleep sessions and more than 17 billion hours of longitudinal sleep data. Our monthly average user engagement with the sleep health features of our smart beds remains near all-time highs. With Climate 360, we implemented our new smart bed platform with technology that will support our entirely new portfolio. We expect a fully transition to this new smart bed platform starting in Q2 2023. Importantly, our newest smart beds are designed with fewer components and they utilize newer, more readily available semiconductor chips. These innovations are critical to our ability to move beyond the persistent supply chain disruptions caused by current chip inventory issues while also driving demand. Our teams are tenacious in their pursuit of solutions that improve demand, margin, and supply. With the expected chip flow in December and into 2023, we plan to restore our good and better assortment of Flexbit smart adjustable bases in January. By the end of this year we will achieve a major milestone with the completion of our multi-year journey to 100 pre-assembled smart beds. Next year we will continue to improve rapid recovery when there are changes to customer orders and advance efforts to reduce supply chain inefficiency. Improving our gross margin rate is a key initiative for 2023 and beyond. Our purpose to improve the health and well-being of society through higher quality sleep inspires our team every day to navigate the difficult business conditions precipitated by the current macro environment. Their adaptability, resourcefulness, and unrelenting persistence are remarkable and greatly appreciated. We continue to prioritize actions to navigate the current external challenges while pursuing significant strategic long-term opportunities. We are strengthening our brand in competitive modes, delivering compelling value to consumers, pioneering new life-changing sleep innovations, and advancing our potential for future profitable growth as the economy recovers. Now David will provide additional detail on the third quarter in outlook for the remainder of the year.