Sleep Number Corporation

Welcome to Sleep Number's Q2 2024 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 Swantas, Vice President of Finance and Investor Relations. Thank you. Dave, you may begin.

Good afternoon and welcome to Sleep Number Corporation's second quarter 2024 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. We also want to refer you to the updated version of our investor presentation, which is available on the investor relations section of our website. I will now turn the call over to Shelly for her comments.

Good afternoon, everyone, and thank you for joining us. My Sleep IQ score was 86 last night. In October of last year, we communicated plans to transform our operating model to improve financial resilience and profitability in a range of economic environments. These transformative initiatives, coupled with the industry leading innovation we continue to bring to market, position us to accelerate our performance and profitability as the industry recovers. Through the first half of 2024, We are slightly ahead of our expectations for both growth margin rate expansion and adjusted EBITDA, despite facing a tougher sales environment than we anticipated. My comments today will highlight the actions we are taking to improve our operating margins and generate cash to pay down debt, the financial results of our actions, including the favorable impact on both near-term performance and the long-term durability of our operating model, and the ongoing intense focus we have on recalibrating our business for the difficult demand environment that the bedding industry continues to face. As a reminder, we previously communicated 2024 full-year financial targets related to restoring our margins, which included adjusted EBITDA of $125 to $145 million, additional operating cost reductions of $40 to $45 million, which are on top of the $85 million of reductions we delivered in 2023, and approximately 100 basis points of gross margin rate expansion. We are on track with each of these goals. Through the first six months of 2024, we reduced operating expenses $44 million versus the prior year. We drove 60 basis points of gross margin rate expansion year over year, and we generated $9 million of free cash flow as planned, a $21 million improvement from last year. Our better than expected adjusted EBITDA for the first half of 2024 was driven by sustainable improvement in our cost base across our operations, including reductions in material costs, efficiency improvements in our logistics and fulfillment networks, and reductions in operating expenses supported by lower store operating costs and ongoing diligent G&A expense management. We are aggressively managing four principal areas that are within our control, including cost of acquisition, cost to serve, cost of goods sold, and G&A R&D leverage. Cost of acquisition is benefiting from greater precision in media and promotional investment, driven by expanding our AI-based models into our sales decision tools, and further segmenting our media targeting to deliver more efficient demand generation. In Cost to Serve, we have outsourced select operational activities and further leveraged third-party expertise in information technology and services. These operating model changes give us additional flexibility in supporting peak volumes in our customer contact centers and home delivery operations. In cost of goods, we have driven efficiencies in our procurement process, manufacturing, and end-to-end fulfillment by introducing new best-in-class operating practices based on extensive assessments and cost controls. In G&A and R&D expense management, we have incorporated additional rigor to streamline our organizational design remove inefficiencies, and increase productivity. All these initiatives are contributing to our ability to achieve our 2024 EBITDA and cash flow targets. When market growth inevitably returns to normal levels, the important business improvements we are now implementing will enable us to capitalize on our innovation leadership and accelerate our profitable growth. delivering increased value to shareholders. The mattress industry demand environment remains challenging amid low consumer sentiment, a notable decline in home sales, and pressures on consumer purchasing power that include higher cost of living and interest rates that are reducing personal savings, tight consumer credit, and uncertainty related to geopolitical events and the upcoming U.S. election. With pinched wallets, consumers are spending more on essential items like food and clothing while reducing or delaying purchases of discretionary, durable items such as furniture and home furnishings. Mattress industry sales for 2024 are estimated around 25 million mattress units compared to a normalized level of about 32 million units based on long-term history and per capita spending trends. Our second quarter demand performance represents a slight sequential improvement from first quarter. These results remained more pressured than we expected and were largely aligned with the reported industry trends. The scrutinizing consumer continues to concentrate their purchases during holiday promotional events like Memorial Day. As a result, we delivered both sales and unit growth in May, which was our strongest demand month since the start of the industry recession in February 2022. Based on our first half demand performance and current industry and economic forecast for the remainder of the year, we now expect our demand in the back half of the year to be flat to down low single digits versus our prior estimate of low single digit growth. This outlook still represents a sequential improvement from our first half demand performance, which was down mid single digits. We expect this improvement to result from easier compares, especially in the third quarter, higher media investments than the first half, and other demand-driving initiatives we've implemented and honed over the last three quarters. These media and selling strategies are focused on leading with differentiated benefits of our superior innovations, including adjustable firmness and temperature, starting at a value-orientated cost of $9.99 with our C1 smartbed, amplifying our differentiated smartbed message, applying our model's predictive capabilities to shift investment efficiently into higher traffic driving media, activating our loyal customer base for increased referral and repeat sales through social advocacy, and driving conversion through improved sales training and execution excellence focused on our relationship-based approach. As we enter the fourth quarter, We also expect to benefit from the introduction of an exciting new smart bed called Climate Cool, which addresses a specific sleep need of customers. More than two-thirds of sleepers report sleeping too hot or experiencing temperature fluctuation during the night. The new Climate Cool smart bed that builds on our successful Climate 360 smart bed technology actively cools by drawing warm air away from your body this is very different than competitors products to push air through warm foam or use water to cool in fact the climate cool smart bed cools over 20 times faster than competitors products and like our climate 360 smart bed climate cool effortlessly adjusts and actively cools up to 15 degrees on each side of the bed for each sleeper's ideal firmness and sleep temperature. Additionally, the ClimateCool smart bed features scientifically proven cooling program routines which are designed to provide deeper, more comfortable sleep. Sleepers can choose from these cooling programs or they can personalize for their needs. Sleepers will also be able to see the results in their Sleep Number app along with other sleep health insights. Our teams accelerated the commercialization of this revolutionary innovation to the fourth quarter of this year as part of our margin improvement initiative. In the current pressure demand environment, we are forecasting sales of climate cool to come primarily from positive mix shifts, which we expect to contribute 20 to 30 basis points of accretion to our fourth quarter gross margin rate. The queen size climate cool smart bed with integrated base will be priced at $54.99. Our extensive analytical rigor and deliberate business improvement actions are restoring margins and generating cash despite a persistently prolonged mattress industry recession. While 2024 demand remains pressured our gross margin improvement supports our full-year adjusted EBITDA guidance range of $125 million to $145 million. In our updated investor relations presentation available on our website, we illustrate the significant upside we expect for Sleep Number's business as the mattress category recovers. Industry units have contracted to 2016 unit levels and are currently around 6 to 7 million units below expected consumption levels. With the actions we've taken in assuming the industry returns to normalized demand levels of nearly 32 million units, we would expect to realize more than $500 million of incremental net sales and about $175 million of incremental adjusted EBITDA compared to current performance levels. In a more normalized mattress industry environment, the actions we have taken to transform our operating model position us to achieve adjusted EBITDA margins in the mid-teens and free cash flow of more than $200 million annually. I want to express my deepest appreciation to our Sleep Number team for your tenacity, and ingenuity in navigating this challenging environment and for your shared belief in our purpose. Your commitment and strong execution of our operating model transformation has resulted in sustainable cost and gross margin improvement. Now, Francis will provide additional details about our performance and outlook for the year.