Sleep Number Corporation Price & Performance (SNBR)

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 84 last Finley as the company's new President and CEO. She will join Sleep Number in that role on April 7. The independent directors and I are confident that Linda is the right leader to guide the company through its next phase of growth will conduct the next earnings call and will share more about her background, perspectives on fleet number and the path forward. During today's call, I'll share highlights of our 2024 performance, including important progress we made during the year to restructure the business and position it for accelerating returns as the industry recovers. Then Frances will provide further details on our fourth quarter and full year 2024 financial results. The mattress industry faced an extremely challenging demand environment throughout 2024.

A trend that has persisted into the first quarter of twenty twenty five. U. S. Mattress volumes for 2024 were estimated at 24,000,000 units which is the lowest level since 2015. Historically low consumer sentiment and high interest rates have led to the lowest housing turnover in thirty years. Inflation, and economic uncertainty continue to suppress discretionary spending Since initiating our operating model transformation, in the back half of twenty twenty three, we have implemented structural changes to reduce fixed expenses, enhanced margins and cash flow. And strengthened financial resilience across market cycles. Driven by our team's high level of commitment and disciplined execution we further advanced our operating model transformation throughout 2024 delivering a 43% year over year increase in fourth quarter adjusted EBITDA. For the full year, adjusted EBITDA was $120,000,000 in line with the midpoint of our most recent guidance. Key drivers of this performance included gross margin rate improvement, and operating cost reductions in 2024 [indiscernible] targets. Q4 gross margin reached 59.9% at the top end of our internal expected range.

Resulting in a full year gross margin of fifty nine point six percent one hundred and ninety basis point increase over 2023 and nearly double our improvement target of 100 basis points that we communicated at the beginning of the year. The ongoing improvement in operational efficiency resulted in a $28,000,000 year over year With the 2024 full year cost reductions of $88,000,000 Q4 net sales declined 12% year over year to $377,000,000 slightly below our expectations. We remain focused on maximizing EBITDA and generating cash. Which requires demand driving trade offs in this difficult consumer environment. Year over year in the fourth quarter and 9% for the full year bringing us back to 2019 levels. Despite these pressures, this disciplined approach enabled us to reach the midpoint of our EBITDA guidance. Highlighting the financial resilience we've enabled in this weak market. The consumer environment took a sharp downward turn in late January twenty twenty five, with consumer sentiment dropping further in February. Consumer sentiment is now 12 points lower than it was year ago. Consumer purchasing power also weakened after the Fed held interest rates flat potential tariffs were announced and inflation concerns returned. Declines were seen across all consumer metrics and demographics, with a significant 19% drop in buying conditions for durables.

As key macro factors macroeconomic factors like consumer sentiment, housing and purchasing power worsened over the past month, so did search interest in the mattress category, impacting our Presidents' Day event.

The largest sales period in the first half of the year. In response, our teams have implemented contingency actions throughout the business to protect margin and cash flow leveraging the robust transformational mechanisms we established over the past year. We remain disciplined in managing cost of acquisition, cost to serve, cost of goods and G and A R and D leverage. [indiscernible] Additionally, we have proactively worked with our bank group to amend our twenty twenty five financial covenants to ensure flexibility in navigating ongoing industry pressure. Francis will share further details shortly. Well, we are certainly not satisfied with our top line performance in this challenging consumer landscape, Our new leaders in brand segment are rapidly advancing the initiatives that leverage our strong brand equity, and loyal customer base. Using deep consumer analytics our teams are refining strategies to optimize engagement, traffic and consideration. We have seen green shoots in the following key initiatives. First, we are expanding data driven efforts to reach consumer segments most likely to purchase now by using personalized content and messaging for higher conversion. Second, we are leveraging Smart Sleeper loyalty. Our repeat customers are strong advocates who deeply understand the value of Sleep Number Smart Beds in our quick to embrace our innovations, We are refining our messaging to amplify their voices enhancing credibility and engagement with new customers.

Third, we are strengthening our relationship based selling We have recertified all sleep professionals on our selling process and customer relationship management strategies. Supporting a more personalized customer experience and improved conversion. In summary, over the past eighteen months, we've transformed our operating model to enhance financial resilience in this persistently weak market. These sustainable actions position our premium brand and vertically integrated business model for long term profitable growth once the market recovers. We remain disciplined in executing our strategy focusing on improving efficiency, eliminating waste and driving innovation to deliver value to our customers. Are constantly striving for greater agility, in response to market conditions and are taking decisive actions to prioritize cash, manage costs and maintain flexibility ensuring Linda has a strong foundation in place to lead the company forward. As I prepare to retire from my role as President and CEO of Sleep Number, I am filled with gratitude for the passion and commitment of the Sleep Number team. Partners and customers who have supported our company's transformational journey over the past eighteen years. We've built a beloved brand with industry leading innovations and store experiences that have positioned the company for sustained success, Fleet number will always be in my heart and I know this great team will continue to build a competitively advantaged company Thank you for your unwavering dedication to our shared purpose and relentless focus on our serving our customers.

It has been an honor to build our culture together and improve nearly 16,000,000 lives through higher quality sleep. Now Frances will provide additional details on our 2024 results.

Thank you, Shelly, and good afternoon, everyone. We made significant progress toward building a more resilient business model in 2024. We drove a 190 basis point improvement in our gross margin rate [indiscernible] even with greater than planned demand pressure, while also cutting our 2024 operating costs by double our original targets, The important progress we made in these two areas allowed us to to offset a majority of the top line pressure for the year while building a stronger foundation for the business as the industry recovers. Now let's turn to a more detailed review of our fourth quarter and full year results. Fourth quarter net sales of $377,000,000 were down 12% versus last year and approximately three percentage points below our expectations. As planned, our fourth quarter net sales in stores year over year. Our fourth quarter gross margin rate of 59.9% up three thirty basis points versus the prior year and at the high end of the guidance we provided for the quarter. Our gross margin rate for the last six months of the year was over 60%. Our fourth quarter gross margin rate increase was driven by the same key drivers we have been highlighting all year, including material cost reductions, ongoing supplier negotiations for all material components and year over year cost efficiencies in our home delivery and logistics operations.

The fourth quarter also benefited from favorable product mix year over year. We have aggressively executed cost efficiencies across the business to deliver on our adjusted EBITDA commitments as we continue to navigate the challenging macro environment.

We reduced fourth quarter operating expenses by $28,000,000 versus the [indiscernible] pre restructuring costs which was well above our expectations for the quarter. Fourth quarter operating expense reductions were broad based including a year over year reduction in media spending, lower selling expenses as we benefited from lower store count and labor efficiency and lower R and D spending. We recorded an additional $4,000,000 of restructuring costs in the fourth quarter bringing our full year total to $18,000,000 The fourth quarter restructuring costs included buyout and impairment costs related to the downsizing of our home delivery truck fleet as well as the buyout of a few additional store leases. These additional restructuring actions allowed us to further reduce our fixed cost structure heading into 2025. For the fourth quarter, we generated $26,000,000 of adjusted EBITDA, a 43% increase versus the same period last year as we drove a three thirty basis point increase in our gross margin rate and reduced operating expenses by $28,000,000 more than offsetting the impact of the 12% year over year net sales decline. Our 2024 full year results included net sales of $1,680,000,000 down 11% versus prior year with demand down high single digits for the year.

Our gross margin rate increased 190 basis points for the year, which was well above our original expectations. We reduced operating expenses by $88,000,000 or 8% for the year prior to restructuring costs. Full year adjusted EBITDA declined 6% to $120,000,000 driven by the 11% net sales decline.

Partially offset by a higher gross margin rate and significant operating expense reductions. Our full year adjusted EBITDA margin of 7.1% was up 40 basis points versus the prior year despite deleverage from the year over year net sales decline. We also drove $4,000,000 of positive free cash flow for the year which was up $70,000,000 from the prior year. The challenging macro environment has continued into 2025 and kept pressure on the consumer and related spending for our category. Against this backdrop, our demand year to date remains down double digits We have made significant and important progress in reshaping our cost structure over the past two years including significant fixed cost reductions and improving our gross margins. We will continue to transform our business to create greater efficiency while being highly responsive to the dynamic environment. We are also working to mitigate and offset impacts of the recently enacted tariffs and are actively monitoring the fluid tariff situation across various scenarios. We will use the muscle we have developed over the last two years to drive additional operating efficiencies across the organization this year. This will include an ongoing review of our store fleet along with opportunities to further reduce both indirect costs and fixed costs across the business.

Given the weak and dynamic nature of the consumer environment, we have also executed an amendment to our bank agreement to provide additional covenant flexibility through the end of twenty twenty five. Beginning in 2025, the leverage covenant maximum was set to return to 4.0x EBITDAR through the balance of the bank agreement, which expires at the end of twenty twenty six. The amendment extends our net covenant relief which includes a covenant maximum of 4.75 times EBITDAR in Q1 and Q2 4.5x for Q3 and 4.35x for Q4. More details regarding the bank amendment can be found in the eight ks we filed today. Our top priority remains to generate cash to pay down debt and reduce leverage. We will continue to evolve our capital structure to put us in the best position to execute our strategy and deliver accelerating profits as the market recovers. This includes options we are currently exploring to restructure our debt this year. Given the impending CEO transition, are not providing a financial outlook for 2025 at this time. We want to give Linda the time and flexibility necessary to evaluate our strategies and business prior to issuing 2025 financial guidance at a later date.

Shelly, as you plan to retire, I want to express my gratitude for your vision and commitment to improving lives through individualizing sleep experiences for the last eighteen years. You have transformed the business inspired our teams, and created a culture that is dedicated to serving our customers and advancing the mission of Sleep Number. Thank you. With that, operator, please open the line for questions. Our first question will come from the line of Brad Thomas with KeyBanc Capital Markets. Hi, thanks. Good afternoon and Shelly, all the best. As you move into retirement. Francis, I was hoping to ask you a question on just some of the gross margin puts and takes. You all have done some really good work on improving gross margin. Understanding that things are a bit up in the air before Linda joins. Can you just help us think about the runway that you still have and some of the levers that you've been pulling to improve margins? Yes. Hi, Brad. Thanks for the question. As highlighted in my prepared remarks and as we've been indicating all year, we have a robust program in place to examine all of our costs that looks across so many different opportunities.

The broad buckets as shared in my prepared remarks are around material cost reductions, supplier negotiations, cost efficiencies, And in Q4, we saw some product mix also aiding with that. As we go into next year, we're going to [indiscernible] to drive the muscle that we have toward relentless efficiency. And we'll also benefit from some of the benefits that came in partial year last year that should anniversary 2025. And thank you, Brett. For the good wishes. You're welcome. Well deserved. And then maybe just one more follow-up on the big picture here, again, understanding that we'll get more details on thinking about strategies and initiatives as the year unfolds here, Is there any more road map maybe that you could share with us in terms of dynamics like door leases where you're on the hook for an opening or ones that you're thinking of closing or products that will be hitting the floor as we approach Memorial Day, anything that's kind of locked and loaded on the horizon that's almost certainly should happen. We should keep in mind as we think about the quarters ahead here? Brad, I think one highlight and Francis alluded to it when he highlighted mix being a part of the gross margin rate goodness If you recall, we introduced our climate cool and have focused on our climate series.

Which is higher margin and that was part of the objective with with the climate cool bed. But that series is certainly outperforming our expectations. We're We're growing at the top and losing at the bottom. So So the pressure is at the bottom end of our line and and the strength is at the top and that's good for gross margin rate, but obviously not as broad as it needs to be to be driving our overall performance in this really weak market. And we expect to benefit from that climate series here in the first March before we even lap the fourth quarter. Great. Thank you very much.

Our next question comes from the line of Bobby Griffin with Raymond James. Please go ahead.

Good afternoon. This is Alessandra Jimenez on for Bobby Curran. Thank you for taking our questions.

First, I wanted to quickly follow-up on tariffs. Can you remind us how much of cost of goods sold would be subject to the recently implemented tariffs?

And based on what we know today, do you have any pricing actions planned for 2025?

Yes. Thanks, Alexander. It's nice to talk to you again. Obviously, the tariff situation right now is highly dynamic situation with the enactment of them happening just yesterday and certainly, it's news that we've been aware of and have been Examining and putting in place mitigation plans to shift suppliers, move production to other companies and other countries, I'm sorry, and look across all of our business. Our exposure our largest exposure comes from Mexico. Which has about a third of our materials from there. And as a reminder, about 70% of our cost of goods go cost of goods sold And you also asked about pricing. Will We'll be decisive with with pricing and other actions as we work hard here, we have been and will continue to mitigate whatever we we can on tariffs. And we also know that pricing has impact on the top line, which it's already a really pressured consumer for this discretionary category. So very well aware of that and thinking about it holistically.

Thank you. That's really helpful. And then maybe just a follow-up on the Door count rationalization, is there any carryover impact to 2025 top line that we should keep in mind? And then what are you seeing for a recapture rate in 2024?

Yes. So our evaluation of our stores is part of our routine process where we are executing store openings, repositions, remodels and closures. Certainly in 2024, we took advantage of some lease renewals lease expirations that were coming up as well as opportunities around around some stores where we experimented with putting more stores in certain markets. And the transfer rate that we've seen on those, we're we've definitely been pleased with and are part of all of our consideration think as you and they totaled a couple of points of pressure in twenty twenty 'twenty four. So we'll continue to run our playbook in a routine process and obviously maximizing store transfer plays into our overall profitability equation.

Our next question comes from the line of Seth Basham with Wedbush Securities.

Hi, good evening. This is Matt McCartney on for Seth. Congratulations, Shelly. I wish you the best in your retirement. Just quick couple of questions here. We've seen another quarter of outsized declines in the online channel. Just wondering what do you think needs to be done there to get online back to at least parity with the store channel? [indiscernible] It's really coming from the low end. I highlighted already that we've had pressure on the low end and that's that's what you're seeing on online. You may have noticed we just recently did a test with the week after President's event to just just understand what that would mean for us to promote the C1 smart bed at $7.99 and it did make a difference in our online sales. So just an example, keep iterating in this changing and weak consumer market that's pretty pretty inefficient and that's that's the biggest pressure is that the opening price point of the line, the classic series. But we like the margin that we're getting at the high end of the line. That ultimately need both. Great. Okay. That kind of segues into my next question then. So just on average revenue per smart bed, you saw some really nice growth there in the quarter.

Just wondering if you could break down the drivers there between mix, and promotions that had an impact and then the outlook going forward?

Yes. You're right. It's primarily mix. As I highlighted, the climate series that's that's the major driver there.

If you look at discounts and financing, which we we look at the two buckets together, in totality and we're flat year over year as a percent to net sales. It does come out a little differently in how we apply those promotions, but we manage the entire bucket fairly flat [indiscernible] Yes, the driver is definitely the series. Moving up the line we're having success with a higher income customer who is very interested in benefit driven products and doesn't have the same level of purchasing power pressure that the opening price point customer does.

It's very helpful. Appreciate it.

Our next question comes from the line of Peter Keith with Piper Sandler. Please go ahead.

Hi, thank you very much. And Shelley also wish you the best in retirement. Quickly, I was wondering did you guys give a demand comp for Q4?

We did not. We highlighted that I believe we highlighted that it was down double digits the same as as net sales.

And I'll maybe just take a moment to touch on that further. We The consumer is pressured housing is frozen, the environment is very inefficient, We're continuously making trade offs between optimizing profit and investing in demand.

And Q4 is a an example of that.

We reduced our media spend, Peter, by 18% year over year. And we saw modest leverage on our media spend in the quarter. We recognize that other competitors may be spending in this more inefficient environment. For us, we're prioritizing [indiscernible] the profit, and that's where we're focused right now. Obviously, we're not satisfied with where our demand is. But with our vertical model, we can see the consumer efficiency or lack of efficiency very quickly and we're making decisions that tie to delivering the ROI and for us in in the fourth quarter, we missed our sales expectation by a few points. But we were able to deliver the midpoint of our EBITDA in the quarter and drove a gross margin rate at the top end of our expectations. So it's a good example of the kind of trade offs that we're making right now. In this tough marketplace.

Okay. Appreciate all this the feedback there. And maybe just looking forward, I can appreciate, is it very tough environment. [indiscernible] I guess are there certain metrics that you're looking at when you could begin to pivot back towards trying to take share or just simplistically increasing media spend than rather than decreasing? Are you waiting for what you feel is a a good environment? Or is it a certain leverage ratio? What What do you kind of looking forward to give you those indications to spend more.

And definitely waiting for a more efficient environment. Now I'll just share the context of where the category is at right now. In a normalized macro environment, the industry benefits from about 25% [indiscernible] A year ago, that organic traffic was running at 12% In the back half of 2024, it dropped to 8% And when we see volatility like we did at the January, early February, that can go down as low as 4%.

And so when you think about the organic traffic returning to 20%, that's 10% to 12% efficiency improvement So we are looking for a more can as we're striving to optimize our profits, just sitting here waiting. We're certainly iterating every single quarter and we can see it really quickly. And a good example would be in this first quarter, early January through the Martin Luther King event, we were seeing the improvement that we were expecting and hoping for. And then there was a big shift. At the January, early February.

And at of course, the wrong time as we're heading into the President's event, and we respond quickly but you can't always you don't always have as much runway as you wish you did. But we're ready and in the meantime, we're testing and iterating into key initiatives like I described in my prepared remarks. Prepared remarks and finding the places where we can drive more demand but doing so in an efficient way. And we've got some good green shoots and we need to scale them.

Okay. I appreciate that feedback. And maybe the last question, I appreciate the transparency on the current quarter It actually aligns exactly with what we're hearing out there but I think you're being a little more transparent than other companies. Has things in recent weeks even gotten worse? In other words, if like is the back half of February worse than the front half? Everyone's trying to figure out if this change in consumer spending is temporary or maybe a sign of things deteriorating?

Well, February inclusive of the President's event, which fell pretty late in in the month, it does. It really comprises the most important selling period for the quarter. So how February goes kind of that's how the quarter goes. So I think it's too soon to say yet about March. But February was the President's event and we're obviously disappointed in it.

Okay. Very good. Thank you so much.

You bet.

Our next question will come from the line of Dan Silverstein with UBS. Please go ahead.

Good afternoon and thanks for taking our questions. Our first question is understanding the company is waiting to provide a detailed full year outlook. Could you at least help us with any expectations you have around industry demand this year to frame the potential scenarios for the business? And then on that note, if mattress demand remains soft this year, how much further opportunity is there to drive expense savings just given the large absolute amount you guys have realized over the past two years?

Yes, thanks for the question. On Indus demand, what we what we had [indiscernible] Heard prior to February was said everyone was expecting some industry recovery, maybe a couple two, three points this year with the majority of the pressured front half and the growth coming in the back half. It's really how similar to how we were thinking about the shape of the year expecting the front half to be more pressured with easier compares improvement from market in the back half. I suspect if someone were to reforecast at this point, they're going to look at this first quarter and first half with a little more pressure and perhaps be more conservative on the full year as a result.

Dan, I can answer your question too as we look toward the rest of the year. We've been managing our cost structure progressively over the past couple of years.

We noted, for example, our team member count, for example, is down 34% versus twenty twenty one. And our two year cost reductions totaled $173,000,000 across $23,000,000 and 24.

About $85,000,000 of cost in 2023, dollars $88,000,000 in 2020 We're going to continue to operate with additional contingency plans to the extent additional actions are required and that's certainly a muscle we built and we we're not done with that as we have this mindset of continuing to drive durability into [indiscernible] which really places us in a great position for when the industry rebounds to come back with accelerating profits. [indiscernible] Yes, that's across the four categories. It's the entire business where we're focused and really led it speaks to the commitment and innovation of the team and and led to us delivering a far bigger number [indiscernible] 2024 and we expect to continue to perform in that manner. Thank you. And maybe just one follow-up for Francis. With the amendments to the credit agreement, is there a revenue base that you can share as a minimum level for 2025 to stay within the new covenant at the end of the year? I know last quarter it was like $1,700,000,000 or so Any update there or this will come later? This will come later. I think it's probably tied into guidance, but I'll share that as we arrived at the covenant levels, we factored in our own expectations for the year and it will provide appropriate cushion for us in 2025.

Thank you. And I would just I would just add to that, Dan. Keep in mind that when we said the 1.7 that was based on the covenants returning to that four point zero times EBITDAR level for '25. So We haven't graduating down, but now the covenant level by the end of twenty twenty five would be 4.35 times EBITDAR. So Obviously, the revenue number would be lower than the 1.7.

Thank you. Let's stay within the covenants. Yes.

And that will conclude our question and answer session. I'll turn the call back over to the company for any closing comments.

Thank you for joining us today. We look forward to sharing our Q1 twenty twenty five results with you late next month. Sleep well and dream big.