SNBR - NASDAQ

Welcome to Sleep Number’s Q4 and Full Year 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 fourth quarter 2023 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 Chair, President and CEO; and Francis 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 and thank you for joining our 2023 year-end earnings call. My SleepIQ score was 84 last night. While the consumer demand environment remains challenging for our industry, the swift actions we took to improve demand and reduce costs allowed us to make important progress in the fourth quarter. We are continuing to transform our operating model to improve our financial resilience through the broad-based restructuring actions we discussed with you last quarter. As we streamline our cost structure and strengthen our balance sheet, we are poised for accelerating growth as the mattress industry demand environment improves. Importantly, our long-term opportunity remains intact as we lead through this transformation. During today's call, I'll start with some observations on the industry and macroeconomic environment, then focus my comments on our performance in the three strategic comparatives for repositioning our business, which are competing effectively, restoring profit margins, and paying down debt. Following my remarks, Francis will provide further details on our 2023 financial results and 2024 outlook. Many of the macroeconomic challenges we discussed during our last call persisted in the fourth quarter. Low consumer sentiment, slower new home purchases, and elevated interest rates continued to pressure demand for our category. Additionally, consumer purchasing power continues its steady downward trend. We estimate that mattress units in 2023 were below 2015 levels and down more than 25% from their 2020 peak. Per capita spending on mattresses is also nearing historic lows, approaching levels not experienced since the 2008-2009 great recession. And although we are seeing some indications that the consumer environment may stabilize in the coming year, the mattress industry remains in a historic recession. Considerations like price and perceived value continue to drive consumer purchasing decisions, which remain highly responsive to external factors and events that are disruptive for the mattress industry. This challenging demand environment continued to weigh on our financial results in the fourth quarter, though we slightly outperformed our demand and cost reduction expectations. For the fourth quarter, net sales of $430 million were down 14% from the prior year with demand down low single digits. For the full year, our net sales were $1.89 billion, a year-over-year decline of 11 % with demand down high single digits. Against this backdrop, we executed several actions to strengthen our competitive positioning, which is our first strategic comparative. With consumers heightened focus on price and value in scrutiny of every purchase, we prioritize actions to increase her consideration and conversion. We sharpened our marketing messages to emphasize our differentiated benefits of adjustable firmness and temperature, promoting the value of your best sleep every night and for every budget. We renegotiated with our media partners to improve impressions per dollar spent, optimize the media mix, and reflighted media in Q4, resulting in improved traffic and media ROI. We refined our promotional strategy and selling process to focus on smart beds first before communicating the additional benefits of our smart adjustable bases. This approach is resonating with today's consumer who is acutely focused on value. Our vertical integrated model allows us to stay close to the customer and adjust our marketing strategy and coordinate our in-store and online experience in real time. We also drove greater brand awareness through our partnership with the NFL. Our Why Choose a Sleep Number Smart Bed campaign featuring Justin Jefferson and Ja'Marr Chase increased purchase consideration with NFL fans who represent approximately half of the U.S. population. Since implementing these actions, our demand trajectory improved significantly to a low single-digit year-over-year decline in the fourth quarter compared with a double-digit decline in Q3. We also drove positive unit growth on a demand basis in the fourth quarter for the first time since the third quarter of 2021. With this demand performance, we expect that we outperformed the industry in the fourth quarter. With our second strategic comparative, we are taking steps to reduce costs across our business and restore margins. During the third quarter, we begin aggressively executing our contingency plans to align our discretionary costs with the software demand environment. In the fourth quarter, we established operating mechanisms and tools to accelerate our restructuring efforts and drive sustainable change across the organization. We have initiated dozens of work streams with program charters, timelines, and weekly reporting to promote accountability, continuous progress, and recognition as benefits are realized. I'm proud of our team's energy and efforts in executing this cost reduction roadmap and identifying and validating new opportunities. Broadly, our cost reduction initiatives fell into four categories, costs of customer acquisition, including streamlining vendors and indirect spend based on capability and cost, cost to serve our customers, such as condensing services, outsourcing functions, and increasing digital support assets for greater efficiency. COGS leverage through value engineering, including an exhaustive material cost reduction program. And R&D leverage as we reprioritize R&D spends to accelerate near-term innovation while driving greater efficiency. We are also realizing the benefits of the workforce restructuring actions taken in the fourth quarter, which reduced the number of team members to approximately 4100 at the end of 2023, 7% lower than in 2019. Together, these efforts enabled us to reduce our operating expenses in the fourth quarter before restructuring costs by $24 million, $5 million more than we had planned. For the full year, we reduced operating expenses by $85 million. With our team's commitment to the execution of our cost improvement roadmap, we expect $40 million to $45 million of in-year cost reductions in 2024, and expect full year operating expenses to be $125 million to $130 million below 2022 levels. As a result of this restructuring, we will have a leaner, more efficient business model with higher margins and stronger cash flow as industry trends improve. We also remain intently focused on restoring our gross margin rate to our historical average in the low 60s in a normalized demand environment. In 2023, we grew gross margin rate by 80 basis points, while navigating a double-digit decline in our net sales as the mattress industry experienced its second consecutive year of recession. In 2024, we are targeting approximately 100 basis points of gross margin rate expansion from the cost improvement initiatives I highlighted earlier. We expect the mattress industry to remain under pressure in 2024, and our outlook for the year reflects that assumption. Thus, we continue to prioritize liquidity and paying down debt, our third strategic imperative. In the third quarter of 2023, we took steps aimed at enhancing our financial flexibility, including working with our bank group to amend our financial covenants. Reducing our outstanding credit line balance and related financial leverage remain key priorities for us in 2024 and beyond. The actions we have taken to date and have underway are making Sleep Number a stronger, more durable business. As we realize additional benefits of our cost management strategy in 2024, we expect to generate $60 million to $80 million in positive free cash flow and intend to use this cash to pay down debt. We also expect depreciation to be significantly greater than CapEx. With our focus on cash flow generation and paying down debt, we plan to reduce capital expenditures in 2024 by roughly half to approximately $30 million. 2023 was a challenging year. We have initiated fundamental changes to transform our business, and we have more work to do. That said, our long-term opportunity supported by our consumer innovation strategy remains strong. Sleep remains one of the areas in which consumers have the most unmet needs. According to the CDC, one-third of U.S. adults report they usually get less than the recommended amount of sleep. Not getting enough sleep is linked with many chronic diseases and conditions, which threaten over 800 patents and patents pending worldwide is a key differentiator in a consolidating and commoditizing market. These unique assets empower us to protect and take market share even in a difficult environment. Additionally, our proprietary ecosystem of loyal smart sleepers continues to grow, reaching nearly 3 million at the end of 2023, and their advocacy of our brand is an important element of our future growth. Our innovation roadmap supports ongoing engagement initiatives within this ecosystem. For example, in the fourth quarter, we integrated our loyalty rewards program and customer support into the Sleep Number app, and in 2024, smart sleepers will also be able to shop within the app. Our average monthly engagement rate of 80% is best-in-class for digital products. This high engagement with our sleep wellness platform increases customer lifetime value and drives lower cost customer acquisition through referrals. Our vertically integrated operating model enables margin efficiency opportunities, which are amplified with scale through our smart bed ecosystem and optimized fulfillment networks. In our culture of individuality and well-being reinforced by our team members, dedication to our mission is a vital factor in our successful business model transformation, continued innovation, and profitable growth. We are prepared for accelerating growth as the mattress industry environment improves. I am grateful for our team's resilience and strong execution as we work together to build a more sustainable business and capitalize on opportunities to deliver meaningful value for our shareholders. With that, I'll turn the call over to Francis, who will provide more details on our 2023 financial results and 2024 guidance.

Thank you, Shelly, and good afternoon. As we close fiscal year 2023 and have started the New Year, our teams have shown agility and diligence as we work to build a more durable operating model and greater financial resilience. As we navigated a pullback in demand for the industry over the last couple of years, the important actions we are taking will lead to a stronger foundation for our business, which will enable accelerating profitability as the industry backdrop improves. In my comments today, I will focus my remarks in three primary areas. One, review of our fourth quarter and full year results, two, progress we have made in our cost restructuring and impacts to our 2024 financial outlook, and three, key assumptions underlying our 2024 guidance. Let's move on to a review of our fourth quarter and full year results. Fourth quarter net sales of $430 million were down 14% versus last year. Demand for the quarter was down low single digits and slightly better than our expectations of a mid-single-digit demand decline. Year-over-year changes in backlog drove a majority of the net sales decline. Our fourth quarter gross margin of 56.6% was up 190 basis points year-over-year and included the benefit from pricing actions taken over the past 12 months and improvement in commodity prices. These benefits are partially offset by increased promotional offers aimed at budget and value-conscious consumers and fixed cost de-leverage from a year-over-year decline in delivered units. We also faced year-over-year gross margin rate pressure related to the mix of FlexFit smart adjustable bases as we had the full, good, better, best assortment of FlexFit smart bases in 2023. In 2022, the smart base portfolio was limited to higher margin product due to semiconductor chips constraints. We were ahead of plan with cost reduction actions in the fourth quarter with operating expenses, pre-restructuring costs, down $24 million year-over-year. We are making broad-based cost cuts across the entire business impacting all areas of our operating cost structure. We recorded $16 million of restructuring costs in the quarter versus our original 2023 estimate of $10 million. This included the acceleration of a few store closures late in the quarter. With the advancement of our cost initiatives, we estimate our 2024 restructuring costs will be approximately $12 million. As a reminder, restructuring costs are reported as a separate line item in our financial statements and we will continue to provide an as-adjusted EPS figure for comparative purposes. We generated $18 million of EBITDA in the quarter versus $23 million last year primarily due to the year-over-year net sales decline, partially offset by a higher gross margin rate, and year-over-year operating expense reductions. Our 2023 full-year results included net sales of $1.89 billion down 11% versus prior year with demand down high single digits for the year. Our gross margin rate increased 80 basis points for the year. We reduced operating expenses by $85 million or 7% year-over-year prior to the $16 million of restructuring costs. We reported a full year diluted loss per share of $0.68 and a full year as-adjusted loss per share of $0.14 excluding $16 million of restructuring costs recorded in the fourth quarter. Adjusted EBITDA declined 14% to $127 million compared to $148 million last year driven by the net sales decline, partially offset by a higher gross margin rate, and ongoing operating expense reductions. Now let me discuss in a little more detail the important work we are doing to adjust our cost structure in support of a more durable business model and financial resilience. With the change in demand trends in the third quarter, we have been executing accelerated cost reduction actions across the business to strengthen our financial position as we continue to navigate the ongoing challenging demand environment for the mattress industry. These efforts contributed to the $85 million year-over-year reduction in operating expenses in 2023 and our plans for an additional $40 million to $45 million operating expense reduction for 2024. This will result in a two-year cost reduction total of $125 million to $130 million. Our operational transformation work is progressing with velocity and we have established operating mechanisms to promote and build sustainable change across the organization. Each initiative we are implementing has been developed with a project projected range of cost improvement and relative risk assessment. Some of the specific cost actions we have taken include workforce reductions across the organization as we enter 2024 with 25% less team members than in 2021, reducing our cost to serve customers through service simplification programs, adjusting hours, outsourcing, and increasing digital customer support assets. Given the down market environment, we also seized the opportunity to reduce our store density in selected markets and accelerate the closing of lower performing stores with natural lease expirations. This includes closing stores where we had been testing store proximity in selected markets. In each case, we carefully considered the opportunity to transfer sales to other stores in the same DMA or online to minimize lost sales while reducing overall fixed store costs and increasing total DMA profit. We expect the net impact of store closures to be about a one point drag to the 2024 net sales growth and we expect to end 2024 with 25 to 30 fewer stores compared to 2023. We also continue to drive gross margin improvement actions across the business. These actions include value engineering, material cost reductions, and driving additional efficiencies through our manufacturing and home delivery network. We expect to grow our gross margin rate by approximately 100 basis points in 2024. As we move into 2025, we expect to realize additional cost savings as we annualize the 2024 cost actions. Now let me turn to 2024. As Shelly mentioned, we built our 2024 plans on the assumption that the industry does not experience any material recovery in 2024, despite having experienced two years of recessionary demand levels. While the mattress industry is likely at bottoming levels, we feel it is prudent to plan our cost structure on the basis of no improvement in demand levels this year. For our 2024 outlook, we are providing adjusted EBITDA as a primary guidance metric. As we transform our business to a more durable operating model, we see adjusted EBITDA as the best way to communicate our performance and the earnings power of our business. Adjusted EBITDA is a key metric we are using to track our transformation progress, and in particular, cash generation to pay down debt. Let me unpack some of the specific assumptions included in our 2024 outlook. The outlook assumes net sales are down mid-single digits for the year with a low single-digit demand decline. Our net sales guidance assumes three percentage points of headwind from year-over-year backlog changes and one percentage point from net store closures. We expect net sales to be down high single digits in the first half of the year, based on tougher comparisons followed by low single-digit growth for the back half of the year. We expect a majority of approximately 100 basis point of gross margin rate expansion in 2024 to be in the back half of the year. Key drivers include further reductions in our material costs through product value engineering and ongoing supplier negotiations. We are also expecting benefit from further optimization of our fulfillment network, including facility closures and using temporary labor where it makes sense. Headwinds for the year include fixed cost de-leverage from slightly declining delivered units for the year. We expect operating expenses to be down $40 million to $45 million versus last year with the cost savings spread across the P&L. We are estimating restructuring costs of approximately $12 million to be incurred in 2024 with approximately 10 million of the costs falling in Q1. We expect interest rates of approximately $45 million for the year. The above assumption support our adjusted EBITDA outlook range for the year of $125 million to $145 million. We remain intently focused on liquidity and balance sheet strength and expect to meet our liquidity needs for 2024 from operating cash flow in our existing credit facility. We expect to generate $90 million to $110 million of operating cash flow with $30 million of planned capital expenditures. This results in $60 million to $80 million of free cash flow for the year which we intend to use to pay down our credit line. Working capital changes are expected to be a source of cash in 2024 versus a significant use of cash the last two years. We expect non-cash to be a combined $90 million or similar to 2023 levels. We also want to provide some clarity regarding our first quarter 2024 performance expectations. We are expecting net sales to be down approximately 10% versus the prior year's quarter including three to four points of headwind from year-over-year backlog changes. We expect first quarter adjusted EBITDA to be just over $30 million. Our outlook for 2024 provides appropriate clearance against the revised bank covenants put in place last quarter. The new bank agreement and related covenants have provided increased flexibility to enable us to restructure the business and navigate the demand environment in 2024. We expect our debt to EBITDA leverage to peak in Q2 of this year and end the year below 3.75x under our covenant levels. As the industry recovers we see a significant opportunity for our business to accelerate. By building a more durable operating model with greater financial resilience we are transforming our business to deliver profitability and free cash flows across the highest and lowest of the mattress industry cycle. We are at a cycle low right now and expect to generate $60 million to $80 million of free cash flow this year. As we continue to benefit from the cost optimization initiatives underway we expect our gross margin rate to return to 60% plus and low double digit EBITDA margins as industry unit trends return to more normalized levels. With that Lisa, please open the line for questions.