Sleep Number Corporation

Welcome to Sleep Number's Q3 2023 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 2023 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 Frances Lee, 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, everyone. My Sleep IQ score was 91 last night. I'm pleased to be joined on this call by our new CFO, Francis Lee. who bring significant relevant experience to Sleep Number as we evolve our operating model and maximize our competitive advantages to drive long-term shareholder value. The third quarter was challenging. As the demand trajectory abruptly changed in August and September, we acted quickly, taking immediate actions to recalibrate our sales and marketing approach, further reduce costs, and strengthen our balance sheet. As a result of these broad-based actions, we are better positioned to navigate a range of economic environments next year and fulfill our purpose of improving the health and well-being of society through higher quality sleep. During today's call, I'll focus my comments on steps we have taken to build a more durable operating model for efficient growth, increased profitability, and cash flow generation. Then Francis will provide further details on Sleep Number's financial results and guidance. As context, macro volatility continues to pressure consumers. The betting industry has now been operating at recessionary levels for two years. We estimate that industry demand was down double digits in the quarter. and mattress units on a trailing 12-month basis are below 25 million units, down nearly 20% from 2019, and at their lowest level since 2015. With sequential improvements in sleep number demand trends through the first seven months of 2023, we expected to benefit from stronger year-over-year demand trends in the back half of the year. However, industry demand weakened significantly in the quarter as consumers' purchasing power moved to the lowest on record. Consumer behavior shifted from spending selectively to scrutinizing their spending, and price to value took on heightened importance in their purchasing decisions. Our marketing, digital, and sales promotional strategies were not optimized to address this increasingly value-seeking and price-sensitive consumer behavior. Despite consumers' continued strong desire for our products, perceived affordability of the Sleep Number smart bed became a real barrier. Our year-over-year demand for the quarter declined low double digits similar to estimated Q3 performance for the industry. This decline in demand weighed on our third quarter results in 2023 outlook. Net sales of $473 million were down 13% from the prior year, representing a meaningful departure from our expectations of a low to mid single digit net sales decline. We have lowered demand expectations for the fourth quarter to a mid-single-digit decline, and we are revising full-year earnings guidance to a loss of up to 70 cents per share, including 35 cents per share of estimated restructuring costs. With the change in consumer mindset and behavior, our teams assessed, tested, and activated sharper communication of our value and differentiation to convey more clearly the affordability of our smart beds. The first iteration of our new advertising campaign was implemented in mid-September, and we are seeing progressive improvement in digital traffic as a result. The new messaging focuses on sleep numbers differentiation, the individualized experience of sense and do adjustable firmness and temperature, starting at entry-level price points. After completing additional market studies, the second iteration of this new advertising program will be implemented this week. We also simplified the online experience to allow for easier comparisons between our different SmartBeds, and we adjusted our promotional strategy and in-store experience to ensure each customer identifies and selects the smart bed that fits their household budget before we sell the entire solution. These changes contributed to improved sales conversion in October. Finally, to strengthen our competitive positioning, we reworked our media strategies and plans to focus on greater efficiency and improved ROI from our media spend based on the current marketplace dynamics. We aggressively renegotiated media deals to lower our cost while generating greater impressions among our target customers. With these changes and additional tests in market, we are holding our media spend below prior year levels and will selectively add back media dollars as we gain traction with the cautious consumer. Collectively, These actions yielded improvement in October demand to a mid-single-digit decline, which is consistent with our revised fourth quarter demand expectations. In addition to these sales and marketing initiatives, we have taken further cost actions to improve profitability and drive incremental cash flows. These actions include targeting approximately $50 million of operating expense reductions in 2024, on top of the $80 million of reductions we expect to realize in 2023. We have implemented a reduction in workforce across all areas of our business, including corporate and R&D. We don't take this action lightly. but we believe these reductions are important and necessary to align our cost structure with the ongoing challenging market conditions. We are rationalizing and optimizing our store portfolio and slowing the rate of new store openings and remodels, reducing our 2024 capital expenditures. We expect depreciation to be significantly greater than CapEx next year as we focus on cash flow generation in reducing our outstanding debt balance. And we are advancing procurement initiatives and cost efficiency strategies to lower our cost of goods sold and accelerate gross margin improvements. These initiatives include optimizing our supply chain and manufacturing operations to improve efficiency. Additionally, we have taken further steps to strengthen our balance sheet. We worked with our bank group to amend our financial covenants to provide greater flexibility through 2024. In summary, the actions we have taken position our business to generate positive free cash flow in a range of scenarios in 2024 and support our return to double-digit EBITDA margins in the next few years. Furthermore, to support effective and efficient stewardship of our resources in the current demand environment, we have also initiated targeted cuts to our R&D spending. As you know, innovation is one of our core strengths, setting new standards in the sleep industry. Over the past decade, we have built a best-in-class retail experience and introduced groundbreaking sleep solutions that transformed our company from a specialty mattress direct marketer to a digitally connected sleep wellness platform. With over 800 patents and patent applications pending worldwide, our innovation pipeline remains robust. The combination of our trademark, individualized comfort and adjustability features with AI, biometric analysis, and other digital tools creates the sleep wellness platform, which is the foundation of our long-term value proposition across the continuum of care. We already have nearly 3 million connected sleepers with an average of 80% monthly active smart bed users. This high engagement leads to increased customer lifetime value and higher referrals of new customers. We believe we can expand our market relevance beyond the traditional mattress space into wellness technology and data where there are many on tap consumer opportunities to solve persistent issues with sleep. The Sleep Number team is intently focused on improving our business performance. We are also evolving our board to broaden its mix of skills and experience to support our team's efforts. We are pleased to welcome two new directors, Steve McAdam and Hilary Schneider to our board. Steve and Hilary are accomplished public company executives and directors with extensive experience in growing and transforming businesses for value creation. We look forward to working with them towards our mutual goal of delivering superior shareholder value over time. I am deeply grateful to all our team members. especially during this challenging time, for their agility and resilience, and want to express my appreciation for their unrelenting commitment to our purpose. In addition, I want to congratulate our passionate sleep professionals on the well-deserved recognition for their exceptional service. Last week, Sleep Number earned the J.D. Power number one ranking in customer satisfaction for mattresses purchased in store and J.D. Power's top brand for price, variety of features, and warranty. I also want to acknowledge and thank our business partners and suppliers who continue to support Sleep Number as we build a more agile and flexible business. Their dedication, together with our talented team, streamlined operations and innovation pipeline position us to capitalize on future market opportunities and deliver meaningful value for our shareholders. Now, I'd like to welcome our CFO, Francis Lee, to his first earnings call with Sleep Number. Francis has extensive experience in corporate finance and strategy and a track record of evolving business models, increasing cash flow, and growing profitability at consumer-facing and technology companies. We welcome his expertise and fresh perspectives as we enter this exciting period of transformation to support sustainable, profitable growth. With that, I'll turn the call over to Francis, who will provide additional details on the quarter's results and full year guidance.