Q3 2024 Sleep Number Corp Earnings Call

To our mission and purpose, which is inspired innovations like our revolutionary smart bed and digital wellness platform.

That have improved almost 16 million lives.

These life changing innovations combined with our company's remarkable culture vertically integrated business model and operating model transformation gives me tremendous confidence in sleep number's enduring competitive advantages and stakeholder value creation.

The company also announced additional board and governance changes today, consistent with our deliberate longstanding practice of aligning the company's strategic evolution with Progressive board composition and governance.

Details of these changes are described in todays separate.

<unk> retirement relief and associated letter to shareholders.

Now shifting to our third quarter results.

Throughout the past year, we have taken ongoing actions to transform our operating model for greater financial resilience across a range of economic environments.

During the third quarter, our initiatives drove broad based efficiencies and a gross margin rate improvement to 68%, resulting in third quarter adjusted EBITDA of $28 million, which was in line with our expectations, even with persistent weak.

<unk> and consumer demand.

I am proud of our team for their agility and stellar execution in delivering these results.

First half of the year. However, our Q3 demand was largely unchanged from first half performance. The two strongest periods in the quarter were July 4th weekend, and Labor day weekend with low single digit growth.

This concentration in the biggest sale weekends with much more marked these past two years than in prior years when consumer response was spread out over the weeks leading up to the event.

This cautious shopping behavior is representative of a more scrutinizing consumer who is budget conscious needs more time to make a decision than in prior years and concentrates their purchases during promotional events for maximum value.

We expect pressured sales trends to continue in the near term with the economy U S election, and geopolitical conditions presenting ongoing uncertainty.

In this environment, we are leaning into both our strong brands and innovation superiority.

First we are deepening initiatives focused on our brand differentiators in media and marketing segmentation to more effectively reach and activate the current limited number of tenders considering mattresses.

Second we are strengthening our market leadership position and temperature balancing sleep solutions to increase customer consideration and conversion.

Earlier this month, we introduced the revolutionary climate cool smart beds.

Structure with the ongoing weak demand environment.

In the third quarter, we drove an additional $17 million in operating cost reductions year over year before restructuring costs with a year to date gross operating expense reduction of $60 million.

Third quarter operating expense reductions were broad based including lower selling expenses with 25 fewer stores versus the prior year lower marketing expenses, including paring back our media investment post labor day and reduced R&D spend.

Over the past seven quarters, we have reduced operating expenses by $145 million by year end, we expect the total operating expense reduction over the last two years to approach $160 million pre restructuring costs.

Maximizing adjusted EBITDA and free cash flow generation have remained our priorities this year.

We generated $28 million of adjusted EBITDA in the quarter up 11% versus the same period last year.

Our third quarter adjusted EBITDA margin of six 5% was up 120 basis points versus the prior year.

Driven by the 340 basis point increase in our gross margin rate.

And the $17 million reduction in operating expenses, partially offset by deleverage from the year over year net sales decline.

Our adjusted EBITDA for the quarter was in line with our guidance range of $25 million to $30 million.

For the third quarter, we generated $24 million of free cash flow, which is $29 million higher than the same period last year with year to date free cash flow up $50 million year over year for.

For the full year, we now expect free cash flow of $10 million to $20 million, which includes the expectation of 15% to $25 million negative free cash flow in the fourth quarter.

Consumer behavior that we've been talking about.

Not only are we dealing with are scrutinizing consumer, but she's also more delayed in her decision making than we've seen.

And that's been particularly persistent here in the.

The last well since since July since the latter part of July.

You know just less decisive.

Speaker Change: Yeah, very very pressured.

Speaker Change: With with all of the macro challenges.

Okay, and then secondly from me I mean, you guys have made some store portfolio changes this year closing some underperforming stores.

Speaker Change: No not.

Honestly I want to thank <unk> 25 guidance, but as we sit here today and kind of look at the store portfolio. What are your thoughts on the size of it today given the current demand environment doesn't.

Doesn't need another round or closing is there a negative four wall EBITDA stores today I mean, just help me think about how we've made progress on that with some of these closings we've had this year.

Speaker Change: Yes. Thanks for that question as we went into the year.

Overall, everyone was expecting the industry to be flattish, we expected it to be down low single digits with about a point and half of pressure from store closures and <unk>.

That's about what we still see about a point and half from store closures and we were opportunistic when we.

Decided on these store closures last year and took action around this time period, and we focused on underperforming stores stores that were part of a test on density.

We're really happy with the transfer rates, which are exceeding our expectations over over 50%.

Makes sense.

Speaker Change: And just to follow up on that approval usage comment synchrony.

Synchrony is such an important partner for you and I know you are one of their better partners is how you've always described your importance to them and what you see out of them, but if I heard you right youre, saying that the approval rates and perhaps the usage and maybe at the dollar value is being approved are those lower year over year for you with synchrony.

Speaker Change: Slightly.

Speaker Change: Okay.

Just one last housekeeping if I could.

Speaker Change: I don't think you have big China exposure, but could you characterize for us as we think about your inputs.

How much of them and how much of maybe cost of goods sold might be subject to incremental tariffs if those come to fruition next year I'm trying to.

Speaker Change: Yeah.

I met minimal, but as we've talked before and you know with the semiconductor chip challenge that we experienced a few years ago.

Speaker Change: Even a few things Ken Ken can create some pressure that was the authority to issue them, but the the overall.

It's a small percentage to the total.

Speaker Change: But it's all important.

Great. Thank you so much.

We'll move next to Peter Keith Piper Sandler.

Speaker Change: Okay.

Speaker Change: Hi.

Peter Keith: Good evening Shelly congratulations on the retirement, probably have it for a couple more quarters here, but wish you all the best of course.

Speaker Change: Thank you.

Speaker Change: Frame up.

The industry backdrop, I think we're all pretty aware that it's it's been a challenging period and is what I'm really trying to ascertain as of Q3 was actually a more challenging with first half of the year.

Shelley I think you said the demand accomplish similar to first half than for instance, I thought. It later in the script, we said it was down nine.

Versus first half, which was down mid singles so.

Maybe just a straight up question is do you think it was our worst quarter.

For the industry than than perhaps the first half of the year.

Speaker Change: Yeah.

Speaker Change: Yes, I believe we.

Speaker Change: Yes.

We see it is in line with the third quarter was in line with the first half of the year and that's how we're thinking about the fourth quarter.

<unk> demand as well and you know, where we're going to be prudent about and cautious about calling a demand improvement until until we see it.

Speaker Change:

I would characterize it as we didn't get the step up we expected we were down.

Double digits the industry was and we were for two years in third quarters that we all expected a sequential improvement and that did not happen.

So it remains very similar to the first half and you know that.

That's what we're seeing and expect to see in the fourth quarter and.

That's why we adjusted our guidance and at the same time, we continue to advance our initiatives in gross margin and EBITDA.

Speaker Change: To deliver on.

On the range that we shared.

Okay very good and then.

Pivoting over to the gross margin, which.

Was obviously quite strong for Q3. So for instance in the guidance now for gross margin to be up 150 basis points.

<unk> Q4, and turn I guess it would be up about 150, so a step down from Q3.

Or are there any initiatives that are starting to I guess get.

Laughter more challenging or just wanted to be.

Prudent on how youre thinking about the gross margin expansion.

Yes, I think for Q4, you can anticipate a gross margin rate of around 59% to 60%.

Speaker Change: Seasonally.

Our Q4 tends to be lower than Q3 sequentially, but on a year over year basis, we're going to have a significant step up versus last year's Q4.

Speaker Change: Okay.

Okay very helpful. Thanks, so much.

Speaker Change: Yeah. Thank you Peter.

We will take our next question from Michael Lasser at UBS.

Speaker Change: Yeah.

Hi, everyone. This is Dan Silverstein on for Michael Thanks for taking our question.

Speaker Change: Hello.

Gratulation Shelley as well from our team.

Just two quick questions maybe to start on <unk>. The sales guide is for fit trends to get a little bit better is that just a function of less of a backlog impact or is there any other texture there.

That you can provide just given all the distractions of the consumer will be facing.

Speaker Change: Okay.

Speaker Change: Yes, you are speaking to net sales.

Speaker Change: Yep.

Speaker Change: Yes. Thanks, Dan This is Dave So if you think about our guide for Q4.

We've talked about sales at the midpoint of the guide being down high single digits.

Year to date for the first nine months of the year were down 10.

So hi.

High single versus 10, I'd say, they're quite similar so we're not expecting any dramatic difference.

There will be probably a little less backlog pressure in Q4 than what we saw in Q3, maybe call. It a point or two so there'll be a little less backlog pressure, but overall, we arent expecting a material difference in demand trends from where we were first nine months of the year versus the fourth quarter.

Okay. Thank you and then our second question I appreciate the commentary about the revenue base needed next year to avoid triggering the debt covenants.

Speaker Change: No I understand you'll be giving 25 guidance next quarter, but I think the covenants start to kick in at four four <unk> and <unk>. So the question is a is that correct and B is there anything else you're preparing in terms of mitigating actions if demand remains.

Speaker Change: Significantly challenge or gets even a little bit worse.

Yes, your your read on the.

Speaker Change: The covenants.

Is correct.

Speaker Change: At the end of Q1.

The covenants go to four <unk> times.

So a couple of things one is with the changes to our cost structure and our gross margin rate advancements, we expect to remain within our leverage covenants through 2025.

Speaker Change: And based on our current cost structure that that is what would keep us require that minimum net sales of approximately one 7 billion.

Speaker Change: Yeah.

We continue to evaluate all of our alternatives as part of our ongoing processes to supplement <unk>.

Speaker Change: Work within our existing credit line.

But importantly, we've got a lot of the elements of our transformation in place we have made significant.

Progress against our cost structure, our gross margin rate.

These are going to be ongoing tailwind for us as we plan into the year next year.

Thanks, Dan.

Dan maybe just to add a comment on Q1. This is Dave again, so if you think about Q1.

As we go into Q1, we're going to be up against a sub 59% gross margin rate. In Q1. We're also Q1 of this year. We didn't have the benefits of all of the cost actions that we've continued to execute all year long. So we would expect exiting the year call. It.

And EBITDA ratio of around $4. One we would expect that to improve in Q1 based on just the ongoing execution of our expense initiatives and certainly exceeding last years.

I'd say this year's Q1 gross margin right. So just a couple of items to think about as we move into Q1, specifically when the covenant does dropdown to four point al.

Very helpful. Thank you.

And that concludes our Q&A session I will now turn the conference back over to the company for closing remarks.

Thank you for joining us today I.

I also want to congratulate Shelley on our retirement announcement and wish her all the best as she embarks on the next chapter in her life well deserve Shelly.

Speaker Change: Sleep, well and dream Big.

Speaker Change: Yeah.

Speaker Change: Okay.

And this concludes today's conference call you may now disconnect.

Speaker Change: Okay.

Speaker Change:

Speaker Change: Yeah.

Speaker Change: Okay.

Speaker Change: Yeah.