Sleep Number Corporation (NASDAQ:SNBR) Q1 2024 Earnings Call Transcript

Sleep Number Corporation (NASDAQ:SNBR) Q1 2024 Earnings Call Transcript April 24, 2024

Sleep Number Corporation beats earnings expectations. Reported EPS is $0.03, expectations were $-0.41. Sleep Number Corporation isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Welcome to Sleep Number's Q1 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 Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

Dave Schwantes: Good afternoon, and welcome to the Sleep Number Corporation first quarter 2024 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. We also want to refer you to the latest 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.

Shelly Ibach: Good afternoon, everyone, and thank you for joining us. My SleepIQ score last night was 90. Since our last earnings call in February, our team members have consistently demonstrated resourcefulness while executing our three strategic comparatives competing effectively, restoring margins and increasing cash generation to pay down debt. As this work to transform our operating model continues, the industry-wide challenges that we have faced over the last two years also persist. Our actions are positioning Sleep Number for greater resilience across a range of macroeconomic and industry environments. First quarter results are largely as we expected, and we are reiterating our full year adjusted EBITDA guidance. During today's call, I'll provide a brief context on the consumer environment, share our first quarter performance highlights and describe ongoing actions we are taking to deliver on our commitments.

Following my remarks, Francis will provide further details on our performance. The mattress industry remains in a historic recession with demand for the category likely down mid-single digits for the first quarter after incurring two previous years of double-digit mattress unit declines. While consumer sentiment is showing signs of improvement, the consumers' purchasing power is limited due to elevated interest rates and record-high credit card debt. As a result, consumers continue to scrutinize their spending and make near-term decisions based primarily on need, price and perceive value and they are deferring higher ticket durable purchases. These factors contributed to consumer purchasing volatility throughout the first quarter. We experienced our strongest demand in February, driven by the President's Day selling period and the weakest demand in January impacted by weather.

For the quarter overall, our demand was down mid-single digits. In the first quarter, we generated net sales of $470 million, down 11% from the prior year compared to the 10% decline we expected. Despite the pressured sales climate, our strong execution resulted in better-than-expected first quarter adjusted EBITDA of $37 million. Against this backdrop, we prioritize actions that efficiently activate consumer interest and demand while lowering our customer acquisition costs compared to prior year. These precise real-time adjustments to our marketing and selling strategies led to improved adjusted EBITDA margin performance. We have focused our efforts on three areas. First, consumer attitudinal segments to optimize our media strategy and lower our costs while maintaining impressions and increasing traffic.

Next, marketing messaging to convey more clearly the differentiated benefits of our smart beds. Our new Why Choose Sleep Number campaign highlights our leadership in adjustable firmness, active individualized temperature benefits, the value of our smart beds for every budget and claims of high customer satisfaction with our smart beds, including our J.D. Power number 1 ranking for mattresses purchased in-store. The campaign is resonating with consumers and our brand health metrics are strong on consideration, value perception of the affordability of Sleep Number smart beds and brand trust particularly among premium and tenders. And finally, actions that drive conversion by helping customers select the right smart bed for their budget before they consider the additional benefits of a smart adjustable base.

By continuing to test, learn and adjust our online experience, promotional strategy and selling process, we are generating a more profitable sales mix across all our digital and in-store touch points. These actions drove a lower promotional spend and a higher mix in the first quarter, resulting in a gross margin rate that was better than we expected. The efficiency improvements we have implemented over the past two quarters are meeting the revenue and margin targets established in the different tests. With this validation, we are now beginning to scale these actions for accelerated impact. We will accomplish this goal by leveraging our current econometric model used to inform media channel mix and investment levels and the predictive capabilities of our new elasticity model used to guide our promotional strategies in a range of consumer environments.

Our teams have also developed a new smart bed that we plan to launch by the third quarter. The c1 smart bed will be priced at $9.99 every day. We expect a strong value equation of smart adjustability starting under $1,000 to resonate with the scrutinizing consumer. In addition, we will be taking $200 in pricing on our c2 smart bed. These actions strengthen our competitive position and support more efficient demand generation, particularly among value-conscious consumers. Our second strategic imperative is restoring margins. We are continuing to target operating cost improvements of $40 million to $45 million in 2024 on top of the $85 million we realized in 2023, as a result, we expect 2024 operating expenses to be $125 million to $130 million below 2022 levels.

We also remain intently focused on returning our gross margin rate to our historical average in the low 60s and expect our actions to restore our adjusted EBITDA margin to mid-double digits as industry demand normalizes. To deliver on these operating expense and margin improvements, we are driving sustainable change across the organization in four principal areas; cost of customer acquisition, cost to serve customers, cost of goods sold and G&A R&D leverage. During the first quarter, we made tangible progress in each of these categories; including reductions in customer acquisition costs through the advancement of our predictive analytics, reductions in our cost to serve customers through self-service offerings, outsourcing strategies and component sustainability efforts and reductions in our cost of goods through structured sourcing strategies with additional flexibility in product and logistics.

These actions will drive improved 2024 results, as well as process new capabilities that will enable performance improvements in future years. Increasing cash generation to pay down debt is our third strategic priority. In the first quarter, our adjusted EBITDA performance led to free cash flow generation of $24 million compared to $3 million for the same period last year. As we realize the benefits of our operating model transformation through 2024, we expect to generate $60 million to $80 million of free cash flow. Despite the persistent near-term headwinds, our long-term growth opportunity remains intact. As illustrated in the Investor Relations deck we posted to our website last month. Sleep remains one of the top health and wellness priorities of consumers and also one of the areas in which they have the most unmet needs.

Sleep Number is uniquely positioned in the industry to address consumer barriers to quality sleep, help solve critical sleep health challenges and improve lives through proven quality sleep. Company culture is an important contributor to performance and Sleep Number's exceptional culture is the result of our 4,000 team member's purpose-driven commitment. Thank you to our teams and partners for your passion, teamwork and innovative mind-set as we find new ways to compete effectively, restore margins and generate robust free cash flow. We continue to focus on delivering value for our shareholders as we capitalize on the implementation of our durable operating model, the industry's gradual recovery in our strategic progression as a sleep wellness technology company.

With that, I'll turn the call over to Francis, who will provide more details on our first quarter results and full year guidance.

Francis Lee: Thank you, Shelly, and good afternoon, everyone. I will focus my remarks today on three primary areas. One; review of our first quarter results; two, on-going progress we are making in our cost restructuring efforts and three our 2024 outlook. Our results for the first quarter came in largely as expected, with adjusted EBITDA a little higher than planned and net sales a couple of million dollars below expectations. Now let me unpack more details regarding our first quarter results. First quarter net sales of $470 million were down 11% versus last year. Our net sales growth for the quarter included 4 points of headwind from year-over-year backlog changes. Our delivered units were down 9% for the quarter with our ARU down 1% versus prior year.

Restoring our gross margin rate to higher levels is a key priority for the company, and we were pleased with the progress we made in the first quarter. Our first quarter gross margin of 58.7% was above our expectations and a meaningful improvement from the back half of last year. We continue to identify and execute cost efficiency initiatives across the organization, including in our cost of goods sold. We also continue to make meaningful progress in driving efficiencies in our business, and we're ahead of plan in the first quarter. Operating expenses, pre-restructuring costs were down $24 million versus prior year. Cost reductions were broad-based, including reductions in selling and marketing expenses and R&D. We continue to target $40 million to $45 million of operating expense reductions for the year.

We recorded $10.6 million of restructuring costs in the quarter and expect approximately $3 million of additional restructuring costs for the balance of the year. As a reminder, restructuring costs are reported as a separate line item in our financial statements and we have also provided an as adjusted EPS figure in our financial statements for comparative purposes. We generated $37 million of adjusted EBITDA in the quarter versus $49 million last year, primarily due to the year-over-year net sales decline. Our first quarter adjusted EBITDA was slightly ahead of expectations as we benefited from the acceleration of our cost efficiency initiatives. A key focus for us in 2024 is to generate free cash flow to reduce our outstanding credit line balance, even with the expectation of a modest sales decline for the year.

For the first quarter, we generated $24 million of free cash flow compared with $3 million last year. The $21 million increase in free cash flow year-over-year included a $15 million improvement in operating cash flow combined with a $6 million reduction in CapEx spending. For the full year, we expect to generate free cash flow of $60 million to $80 million which we intend to use to pay down our credit line. Now let me provide an update on the on-going work we are doing in support of a more durable operating model. The mechanisms we put in place to promote and build sustainable change are enabling us to meet our operational transformational goals. Our initiatives and efforts are resulting in greater operating efficiency and financial resilience.

We have progressed strategic sourcing initiatives across materials and logistics that have lowered our total cost of goods, services, simplification programs with increased digital assets for customer self-service options are lowering our cost to serve. We have also implemented new stringent practices around indirect costs in support of sustained G&A leverage. Our store actions are on track with our expectations and there are no material changes to the plan for the year that we communicated last quarter. As a reminder, we expect the net impact of store actions to be about a 1-point drag to 2024 net sales growth, and we expect to end 2024 with approximately 30 fewer stores compared to 2023. Our gross margin improvement actions are progressing.

We are focusing on durable operating activities that drive value engineering for our products, material cost reductions and additional efficiencies through our manufacturing and home delivery network. Let me turn to an update on our 2024 outlook and a reminder on key assumptions included in our projected performance for the year. The demand environment remains challenging, and we continue to focus on the things we can control. We have built our operating expense plans for the year on the basis of the industry not experiencing any material recovery in 2024 despite undergoing two-plus years of recessionary demand levels. We are reiterating our 2024 full year adjusted EBITDA outlook range of $125 million to $145 million. Here are a few items to highlight regarding the full year guidance and second quarter expectations.

We continue to expect net sales to be down mid-single digits for the year with a low single-digit demand decline. We are still assuming three percentage points of headwind from year-over-year backlog changes and one percentage point from net store actions. We expect sales growth to improve throughout the year with low single-digit net sales growth expected in the back half of the year against easier comparisons. We continue to expect a majority of the approximately 100 basis points of gross margin rate expansion in 2024 to be in the back half of the year. We are estimating restructuring costs of approximately $14 million for the year, slightly higher than our prior estimate of $12 million. Our debt-to-EBITDAR ratio was 4.2x at the end of the first quarter compared to our covenant maximum of 5.0x for the quarter.

We continue to expect our debt-to-EBITDAR leverage to peak in Q2 and end the year below 3.75x. We also wanted to provide some clarity regarding our second quarter 2024 performance expectations. We are expecting net sales to be down high single digits versus the prior year second quarter, including five to six points of headwind from year-over-year backlog changes. We expect second quarter adjusted EBITDA to be $20 million to $25 million. I want to thank the entire team for the rigor and tenacity they have exhibited as we make important changes to our business for a more durable operating model while positioning ourselves to rebound with pace when the demand environment improves. We look forward to sharing our ongoing progress with you as we proceed throughout the year.

With that, Operator, please open the line for questions.

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