Sleep Number Corporation

Welcome to Sleep Number's Q3 2025 earnings conference call. At this time, all participants are in a listen-only mode. As a reminder, this call is being recorded today, Wednesday, November 5th, 2025. This conference call will be available on the company's website, ir.sleepnumber.com. Please refer to today's news release to access the replay. On today's call, we have Linda Finley, President and CEO, and Bob Ryder, Interim Chief Financial Officer of Sleep Number. Before handing the call over to the company, we will review the safe harbor statement. The primary purpose of this call is to discuss the results of the fiscal period ending on September 27, 2025. Commentary and responses to questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in the company's earnings news release and discussed in some detail in the annual report on Form 10-K and other periodic filings with the SEC. The company's actual future results may vary materially. In addition, any forward-looking statements represent the company's views only as of today and should not be relied upon as representing its views as of any subsequent date. The company specifically disclaims any obligation to update these statements. Please also refer to the company's news release and SEC filings 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. I will now turn the call over to Linda Finley, Sleep Number's CEO.

Thank you, Tiffany, and good morning. I have now been on the job for over six months. My learnings thus far make me incredibly optimistic about Sleep Number's future and the ability to create significant shareholder value in the coming years. But nobody should be confused. This is a full turnaround of an inherently great company. I came to Sleep Number because I saw huge potential for the company and I remain excited about what's ahead. As in many situations like this, there were more challenges than I expected, which required us to move extremely fast to fix the business. The pace of our work, along with constraints imposed by our capital structure, has made the first six months choppy. We've accomplished a lot and we're optimistic that the work that we've accomplished positions us to execute the turnaround in 2026. Importantly, after close collaboration with our banking partners, we have secured an amendment and extension of our bank agreement through 2027. This now provides financial flexibility to focus on sales driving initiatives and execute our turnaround. Our new agreement, combined with meaningful fixed cost reductions achieved in 2025, will allow us to invest in growth in 2026, but more on these initiatives later. Q3 operating results were disappointing. I am not pleased, but we're on top of the reasons and we're moving quickly to stabilize all elements of the company. As we articulated last quarter, We were hopeful that a more efficient marketing strategy could mitigate some of the top-line headwinds associated with significantly cutting spend. Our results early in the quarter gave us confidence that this approach would be successful. However, competitive behaviors became even more aggressive than we had expected during the Labor Day period, and we did not have the financial flexibility to counter with our own messaging, which hurt our top line. We believe the new bank agreement and our fixed cost reductions will allow us to go on offense in the future. I want to take a few moments to explain why I'm confident that we can turn the top line in 2026. First, our new product initiatives will simplify our offering and should attract a broader set of new customers while building on demand from our repeat buyers. This product evolution will capitalize on Sleep Number's strong differentiators and adjustable firmness and temperature. While other brands deliver elements of what we do, we deliver it all. And in my opinion, we do it better. Second, We are refreshing our creative to focus more on product value and benefits to drive greater interest and excitement about the brand. We are deploying our dollars into more efficient, higher return channels to drive traffic to our stores and digital channels. When our customers arrive, we know they're going to like what they see. Across the organization, we are changing everything from creative to social to customer interaction. We're already seeing notable payback improvement with our new marketing initiatives. Third, we're taking a fresh look at our distribution strategy. While we continue to see big benefits in our vertically integrated model, we believe there are opportunities to expand distribution into new channels, both physical and digital. We are optimizing our store footprint and leaning into digital to meet customers where they are, while exploring selective partnerships and new routes to market. For example, next week we will host a show on HSN with an exclusive bed as part of an ongoing testing of channel opportunities. Our vertical model is still our strategic advantage, but we feel strongly that we can build on that model while retaining its strength. Finally, our substantial progress on fixed costs and our amendment agreement with our bank group means that the total marketing spend in 2026 will be slightly up compared to 2025, while still reducing our operating expenses. To put that in perspective, media investments in Q2 and Q3 of this year were down by 32%. Together, we are confident these initiatives put us on a path to stabilize our top line in 2026 while meaningfully growing our adjusted EBITDA and free cash flow. We are working with urgency and at breakneck speed. In my six months at Sleep Number, there is no part of the company that hasn't been touched. Before I turn the call to Bob, I wanted to take a moment to thank all Sleep Number team members. Their continued dedication is exemplary. They are urgently pacing, prioritizing, and executing on the things we know we're going to bring the biggest value. I'm proud to stand shoulder to shoulder with them as we continue to forge ahead to bring Sleep Number back to growth. With that, I will now turn the call over to Bob.

Thanks, Linda, and good morning, everyone. Third quarter results are certainly not where we want them to be. Profits and cash flow were well below expectations due to disappointing sales. I'll get into the details of the third quarter results in just a moment. As we shared 90 days ago, we're in the midst of a business turnaround that's comprehensive and will impact almost every aspect of the business. I want to highlight three important elements of our turnaround from a financial perspective. First, costs. We've made considerable progress on costs in 2025. Following two years of significant cost actions, we further reduced operating expenses, excluding restructuring and non-recurring costs by $115 million since the beginning of the year, and now expect to exceed our $130 million cost out target. These reductions have come from all dimensions of the business. Headcount reductions, streamlining the organization, research and development costs, selling expenses, and marketing. The goal was to reduce costs aggressively while minimizing any negative business impact. The significant reductions in Q2 and Q3 media spend, however, did have a negative impact on the top line. And as aggressive as our fixed cost reductions were, they were not enough to offset the impact of reduced sales on our high gross margin product. As such, we have reduced our full-year net sales, adjusted EBITDA, and free cash flow expectations. We're certainly not done reducing costs. There will be additional fixed cost reductions in Q4 and 2026 to further align our cost to our new lower sales base. Second, financing. we successfully executed an amendment and extension of our bank agreement, extending maturity to the end of 2027. The revised covenants and terms align with our planned turnaround trajectory and provide the flexibility to invest in specific parts of the business with strong returns. This agreement reflects lender alignment with our strategic reset and supports both near-term stability and long-term growth. Third, our commercial strategies. The greatest shareholder value will be created by implementing our commercial strategies. We have a strongly recognized brand and a highly differentiated product. But we do have room to improve. In 2026, we will be repositioning our product lineup to better resonate with the larger consumer base, execute a more efficient and effective marketing approach, and expand channels of distribution, including website improvements to drive better conversion. We've been working on this commercial reset throughout 2025, and we will see the results of these initiatives in 2026. And importantly, Our amended covenants provide us the flexibility to execute our plan. Now let me walk through our Q3 results. Net sales of 343 million were down 19.6% year over year. This decline reflects the opportunity within our product portfolio and the impact of our significant marketing and media investment reductions. Marketing efficiency continues to improve as we saw cost per acquisition decline 6% versus the prior year. However, we need to drive more traffic into both our stores and our website. We expect our marketing efforts to begin to do that in the fourth quarter. Gross profit margin was 59.9%, down 93 basis points versus last year, but up 82 basis points from Q2. The year-over-year decline was driven primarily by unit volume deleverage partially offset by favorable product mix and lower promotional activity. Operating expenses, excluding restructuring and other non-recurring costs, were $204 million, an 18% decline from 2024. This reflects the continued cost-outs we've been implementing across the organization to align with our sales reduction. We recorded $41 million in restructuring and other non-recurring costs in the quarter related to these ongoing transformation initiatives. These included severance and employee-related benefits, contract termination costs, and asset impairment charges. Approximately $30 million of these charges are non-cash and are attributable to sunsetting technology assets and closing several underperforming retail locations. Adjusted EBITDA was $13.3 million, down $14.4 million from last year. The decline was driven by lower net sales and gross profit margin compression, partially offset by lower media, fixed operating expenses, and variable selling expenses. In addition to reducing costs, We are also actively managing working capital with net year-to-date changes in inventory, accounts payable, receivables, and prepayments being a $20 million source of cash. We've also reduced year-to-day capital expenditures by approximately $5 million compared to the prior year. We acknowledge current performance is not where we expected it or where we want it to be. we remain confident that actions we are taking will result in a turnaround of demand trends. As we are resetting the business and executing elements of our own plan, we are also realistic about the timing of the impact of our actions. We now expect net sales for the year to be approximately 1.4 billion and gross profit margin of approximately 60%. The incremental cost reductions excluding restructuring and other non-recurring items are expected to result in a full year operating expenses of $825 million or $135 million less than 2024. The resulting adjusted EBITDA is now expected to be approximately $70 million with negative free cash flow of approximately $50 million. With these anticipated outcomes, we expect to be in compliance with our new debt covenants. Looking ahead to 2026, we're approaching our plan process with three key objectives. First, and most importantly, stabilize sales and return to growth after we revamp our product offering with more emphasis on serving the consumer's priorities of comfort, durability, and total value. To support that endeavor, we will continue to modernize our marketing approach, improve our website, and expand distribution into new channels. Second, continue to take fixed costs out of the business, including continued consolidation of our real estate footprint. And finally, as stated before, generate free cash flow to pay down debt. With that, I'll turn it back to the operator for questions.