Sleep Number Q1 2023 Earnings Call Transcript

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Provided by Quartr
April 26, 2023

There are 9 speakers on the call.

Operator

To Sleep Number's Q1 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.

Operator

Thank you. You may begin.

Speaker 1

Good afternoon and welcome to the Sleep Number Corporation First 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 Chris Krusemark, our Interim CFO and Chief Human Resources Officer. This telephone conference is being recorded and will be available on our website at sleepnumber.com.

Speaker 1

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 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 ks and other periodic filings with the SEC.

Speaker 1

The company's actual future results may vary materially. I will now turn the call over to Shelly for her comments.

Speaker 2

Good afternoon and thank you for joining our Q1 2023 earnings call. My SleepIQ score was 88 last night. Agility, resilience and ingenuity continue to be hallmarks of our Sleep Number team as we navigate macroeconomic Challenges. These traits help us execute in the current environment, while also advancing Our long term strategy. We have strategically maintained our focus on innovations that strengthen Our competitive advantages.

Speaker 2

This includes evolving our Smart Fed ecosystem into a progressive Adaptive Health and Wellness technology platform that generates a high level of engagement From our community of more than 2,500,000 smart sleepers. Their monthly average engagement With our smart bed ecosystem is greater than 80%, a best in class metric for digital products And a strong driver of future revenue potential through referrals, products and services. Our first quarter performance was consistent with our expectations. Through our team's Exceptional execution, we overcame incremental demand pressures late in the quarter as consumer sentiment dropped 5 points in March 1st February. We leveraged our fulfillment network to deliver incremental smart beds from our existing backlog.

Speaker 2

As a result, we delivered 90,000 smart beds and net sales of $527,000,000 for the quarter. After nearly 2 years of supply disruption, the consistent and steady flow of microchips has enabled us to return to more efficient operations. 1st quarter gross margin of 58.9% was up 160 basis points from a year ago as we benefited from pricing actions, modest easing in commodity prices And our newly unified more flexible supply network. Our Q1 gross margin rate also represented a 350 basis points step up from the back half of last year. Net operating profit of $26,000,000 was up $22,000,000 over prior year and earnings per share were $0.51 versus $0.09 in last year's Q1.

Speaker 2

We are intently focused on driving improved demand In Q2 and beyond, in what remains a challenge backdrop of historically low consumer sentiment. A couple of weeks ago, we kicked off a sequence of new demand drivers, starting with the presale Our next generation i10 and M7 smart beds, our new FlexFit 2 and 3 smart adjustable bases And new lifestyle furniture. These innovations are designed to help sleepers achieve their next level of sleep And realize their full potential through every stage of life. This first phase will be set in all stores by mid May. Phase 2 planned for early Q3 includes the remainder of our smart beds.

Speaker 2

This cadence enables us to optimize reduction cycle with our selling process while also being fully transitioned well ahead of Labor Day. Our next gen smart beds have advanced from our original award winning Sleep Number 360 smart beds by using insights From more than 19,000,000,000 hours of proprietary longitudinal fleet data. These groundbreaking Use embedded research grade sensors to learn each sleeper's biometrics and sleep patterns And then automatically adjust to support sleepers' changing needs. All our new smart beds will also feature Ceramic gel infused foam layers that help balance temperature to stay comfortably cool all night. In addition, the next gen smart beds benefit from our new health and wellness technology platform, which was introduced in October 2022 with our Climate 360 Smart Bed.

Speaker 2

The integration of physical and digital technologies Create our smart bed ecosystem by combining AI and machine learning algorithms to support future digital products and services. We are introducing these innovations with a new sleep next level advertising campaign This showcases one of our smart sleeper couples, award winning actress Gabrielle Union Way and her husband NBA Hall of Famer, Dwyane Wade. With more than 80,000,000 social media followers, They bring authenticity and credibility to the Smartbad features and benefits highlighted in this campaign. Our consumer research indicates strong alignment between benefit messaging, relatability And consumers' heightened interest in their improved well-being. New campaign highlights can be viewed on our Investor Relations site.

Speaker 2

While the macroeconomic environment remains challenging, Innovation is a proven demand driver. The stronger than expected sales of our Climate 360 smart bed since its introduction is a great We are building on that success with our next gen smart beds, new creative, simplified online experience And the power of more than 2,500,000 smart sleepers, our most loyal customers who drive referral and repeat sales. With these integrated initiatives and the strong execution by our purpose driven teams, We expect year over year demand trends to improve the balance of the year as we lap easier prior year comparisons, especially in the 3rd and 4th quarters. Now Chris will provide additional details on 1st quarter results and our outlook for Q2 and full year 2023.

Speaker 3

Thank you, Shelly. I would like to start by emphasizing a few points. Our first quarter results were in line with our expectations from both the top And bottom line perspective, given the current macro environment, we remain cautious in our outlook for the balance of the year, Even as we began to lap easier comparisons, our commitment to drive performance is evident with the demand initiatives Shelly outlined. We continue to operate with flexibility and agility as we navigate the current environment and are prepared to pull back on costs if conditions warrant.

Speaker 1

Now let me

Speaker 3

turn to more detailed comments on our financial results. 1st quarter net sales and delivered smart bed units were both consistent with the expectations we outlined on our February earnings call. Net sales of $527,000,000 were flat versus prior year with a comp sales decline of 2%, offset by 2 points of growth from net new store additions. We delivered 90,000 smart beds in the quarter as planned, which was 16% less than the prior year. Our first quarter ARU increased 19% versus the prior year, Which included high single digit ARU growth on a demand basis.

Speaker 3

As a reminder, a shortage of semiconductor chips In last year's Q1, impacted deliveries of our higher priced FlexFit 3 adjustable bases and related smart beds, which pressured the prior year delivered ARU. During the quarter, we reduced our excess backlog By approximately $15,000,000 and expect to return to normalized backlog levels by the end of the second quarter. Our first quarter gross margin rate of 58.9 percent was up 160 basis points versus the prior year and in line with our expectations. The 160 basis point year over year increase in our gross profit rate Included the benefit of pricing actions taken last year, product mix changes year over year and operating efficiencies Resulting from a steady flow of semiconductor chips. Our progress in 1st quarter gross margin rate Is an important milestone on our path to delivering at least 150 basis points of gross margin rate expansion in 2023.

Speaker 3

1st quarter net operating profit grew $22,000,000 year over year on net sales that were consistent with last year. This operating profit growth was driven by an $8,000,000 gross profit increase

Speaker 1

and a $14,000,000

Speaker 3

reduction And operating expenses, disciplined spending in the quarter included a year over year reduction in media spend In line with our Q1 demand expectations. G and A and R and D expenses were also down a combined $4,000,000 versus the prior year on lower headcount. 1st quarter earnings per share of $0.51 compared with $0.09 last year reflect the gross margin rate expansion and effective cost controls. We ended the quarter With $347,000,000 of liquidity under our revolving credit facility and a leverage ratio of 4 times EBITDAR below our amended 5 times covenant. We are reiterating our 2023 full year EPS outlook range of $1.25 to $2 per share.

Speaker 3

Here are a few items to highlight regarding the full year guidance and second quarter expectations. For the full year, we continue to expect net sales to be flat to down mid single digits. We continue to expect improvement in the back half of the year with net sales down low single digits to up mid single digits when we face easier comparisons and fully benefit from next gen smart bed introductions. We intend to generate more than $100,000,000 in cash from operations in 2023 and positive free cash flows And plan no share repurchases for the year. For the Q2, we are expecting demand to be flat to down low single digits compared to last year with net sales down low double digits to mid teens.

Speaker 3

As a reminder, last year's 2nd quarter net sales grew 13% year over year, benefiting from over $100,000,000 A backlog reduction in the quarter. We are expecting a net loss for the 2nd quarter in our seasonally lowest demand quarter And with an expected year over year net sales decline. I will now turn the call back to Shelly for a few closing comments Prior to opening up the call for Q and A.

Speaker 2

I'm so proud of our team for their perseverance and passion. They have enabled us to address an array of global challenges over the past 3 years while continuing to deliver life changing innovation. Our team has maintained a flexible mindset, which will allow us to capitalize on profitable opportunities throughout our business As the environment improves and to quickly pivot if external conditions worsen. Above all, Their steadfast dedication to our purpose and strategic priorities are at the heart of our commitment To deliver tangible lifelong health benefits for smart sleepers and superior value for all stakeholders. Now Chris, Dave and I will respond to your questions.

Speaker 2

Christie, please open the line.

Operator

The first question comes from the line of Bobby Griffin from Raymond James. Please go ahead.

Speaker 4

Good afternoon, everybody. Thanks for taking my questions and good job on hitting A lot of the things you laid out executing right on plan. I guess first, kind of open ended question, but I think, Chris, in your comments, you mentioned for demand in 2Q built in is flat to down low singles digits, if I heard that correct. And I think quarter to date when we last Talk was running down high single. So just curious, how exactly did the quarter shape up kind of where the demand improved and you're seeing that

Speaker 2

Great. Thank you, Bobby. And you cut out a little bit there at the end, but I think I captured majority of your question.

Speaker 4

Yes. Sorry about

Speaker 5

it. Can you

Speaker 4

repeat it? I can't tell you. I'm just curious, the quarter to date when we spoke last was down high single digits in demand. And I think the 2Q guide that you guys are talking about is getting to flat to maybe down low single digits if I heard the prepared comments correctly. So just connecting those 2 Yes.

Speaker 4

Did you see business improve throughout the quarter in 1Q and into April? Like how do we get from down high single to down flat to low?

Speaker 2

Yes. Thank you for the question. This is an important area speaking about the Shay, then I'll maybe start with a little commentary on the shape of Q1 and then we'll move into why we the demand improvement here in Q2. So for Q1, when we communicated At our on our 4th quarter year end earnings call, we were running Down high single digits, which was a big step up from where Q4 landed. And then, of course, we're pleased with delivering on Our Q1 expectations.

Speaker 2

Then with the drop in consumer sentiment from February to March drop of 5 points. We also saw increased pressure in our demand Trend in the month of March. So March ended up being tougher For us and down double digits, down low double digits. And so as we moved into April, April is on track with our expectations as Q1 was, and we have had some improvement in April. It's Early in the quarter and April is historically one of our lower months.

Speaker 2

So I think that's important to highlight. But we do expect Q2 demand to be flat to down low single digits with Positive year over year growth as we move into May June. And there are 2 big Changes that are occurring. 1 is easier comparison because of the significant drop last year Down to double digit decline in May and then that continued the balance of the year. And secondly, The initiatives, the demand driving initiatives that we have, we are just starting this sequence of demand drivers, including The full introduction of our next generation smart beds here over Q2 and early Q3 And then also our new campaign, which was just released yesterday.

Speaker 2

So our stores will all be set by mid May And that's when everything moves to a higher degree and then later in the quarter, early Q3 will introduce the balance of the line. So we're really excited with all the initiatives we have. These have been proven initiatives for Sleep Number over the years and yet recognize that this is still a very challenged environment. And We experienced that in Q1 with the banking crisis occurring, which dropped consumer Spending especially at the high end and that was a fairly abrupt change and yet there's Resilience out there with the consumer too. So we're contemplating this challenging backdrop for the balance of the year, but also recognizing The compares are a lot different, the balance of the year than they were in Q1 and we have big initiatives.

Speaker 4

Thank you. That was That was helpful. And I guess, just lastly from here before I turn it over. Can you talk a little bit about the marketing spend? You mentioned it was down in the quarter.

Speaker 4

Just How kind of you're approaching that? Have you been just pulling back across all meetings or just kind of different areas? And then As a second part of that, have you guys put any meaningful dollars behind the Climate 360 bed yet? Or is the early success in that just being driven by word-of-mouth

Speaker 2

I'll address the first part of the question and then the second. So to begin with, Yes, media is down and we expect efficiency out of our media. Last year, we were In a really difficult environment and we also did not have our full assortment and we had extended delivery windows and that You know, blasted through the full year. So we do expect our media to work more efficiently, and we're excited about the new creative And what that will mean to efficiency as well. And then and at the same time, as the environment Evolves, we will respond accordingly with our media spending.

Speaker 2

And then the second part of your question was around Climate, and we did have a fair amount of our creative execution focused on the Climate 360, and it was Absolutely a driver, of consumers wanting those temperature benefits.

Speaker 4

Thanks. I appreciate that. Best of luck.

Speaker 2

Thank you.

Operator

Your next question comes from the line of Peter Keith from Piper Jaffray Sandler.

Speaker 6

Good evening. This is Matt Edgar on for Peter. Thanks for taking our questions. First one from me is just curious on what you're seeing on input costs, whether that be With foam or transportation and how those are trending real time?

Speaker 2

Yes, Matt. We have seen some easing of commodity The cost and Dave will share some specifics.

Speaker 1

Yes. Hey, Matt. So, when we provided our guidance back in February, we did expect About $15,000,000 to $20,000,000 of commodity easing for the year. And it's great to see that here we are in Q1 and we've realized A nice ratable percentage of that commodity relief. So we're seeing some improvement.

Speaker 1

We're not banking on a lot more than the $15,000,000 to $20,000,000 this year, but part of that improvement we saw in our gross margin rate in Q1 getting to 58.9% Was tied to some of the commodity relief that we did expect.

Speaker 6

That's great to hear. And then secondly, curious on if you're seeing any impact with maybe your higher ticket sales or your adjustable base Attachment rates given kind of the higher financing costs and the pressure on consumer sentiment that you talked about in the prepared remarks. Thanks.

Speaker 2

Well, from a financing perspective, we're not seeing Pressure there from financing. We've made some adjustments in our financing to mitigate the Higher cost and those adjustments seem to be well received by our customers. And Then we've also had some strong ARU. And we From everything I've read about the consumer environment, in March, That additional hit occurred and it did impact the higher end consumer to a greater degree as broadly reported. And we did see demand pressure.

Speaker 2

So there's some correlation there.

Speaker 6

Great. Thanks for taking our questions.

Operator

Your next question comes from the line of Brad Thomas with KeyBanc Capital Markets.

Speaker 7

Hi, good afternoon. My first question was just Turnaround, gross margin, I was hoping you could talk a little bit more about the drivers here in 1Q. I know there's kind of an unusual sort of mix that you are delivering on here in the quarter. And so sort of wondering how much is the supply chain improvement versus the mix in the quarter? And then just thinking about the line of sight to how much improving supply chain costs might be a tailwind here for gross margin going forward?

Speaker 7

Thanks.

Speaker 1

Yes. Hi, Brad. Thanks for the question. So looking at Q1 specifically, the largest drivers were really as 1, we're benefiting from the pricing that we've taken over the last year. So we did take some pricing mid last year.

Speaker 1

We took some in December And cumulatively that would be the largest driver of that 160 basis points year over year. We also are seeing nice improvement In commodity prices like the question Matches asked, so that would be the 2nd biggest driver in terms of the year over year improvement. From just a product mix perspective, I wouldn't chalk a lot of it up to we did have the phenomenon last year Looking at the shifts from Q1 to Q2 where there was a more significant shift because of product mix, I wouldn't necessarily attribute a lot of what we saw into Q1 To some similar type mix changes, we did have some benefit from Climate 360 orders that were delivered in Q1, which were helpful to the overall Gross margin rate, but those really came in as expected. Maybe pivoting to how we kind of view the balance of the year. As you look at Q2 specifically, we are expecting a sequential slight sequential decline from Q1 to Q2 Coming down from that 58.9% to something in the 57% to 58% range.

Speaker 1

And really that's more a function of just normal seasonality of the business. We do have a lower unit volume traditionally in Q2. We expect that again. And the product mix can change a little bit in Q2 as well. So Nothing out of the ordinary, but we do expect a little bit of a seasonal dip in Q2.

Speaker 1

And then as you look at the back half of the year, We're expecting to see things return more where we were in Q1, so call it around that 59% level. In the back half of the year, if you're looking at year over year is where you're going to see the biggest improvement year over year because we're up against A more impacted back half of last year. So we are expecting to see significant improvement in the back half of the year. That's

Speaker 7

really helpful, Dave. Thank you. And maybe just to dovetail off of that, as we think about the ARU and $5,800 range this quarter. And if you go back to last few quarters, I mean, really pretty wide range, partly due to quarters where some of the deliveries were a little bit unusual. Is this level a good level to be thinking of as kind of building off of With the potential that keeps going higher here with the new products rolling out or how do you think about the ARU at a high level?

Speaker 1

Yes. Let me Provide a few comments on ARU because I think it is an interesting metric year over year. So if you look at Q1, ARU is up 19%. And as Chris said in his remarks, On the demand basis ARU is actually up high single digits. So we had a lot of benefit year over year from comparing to last year's Q1 When we had a shortage of chips, which impacted the ability to deliver our high end beds and our high end smart bases.

Speaker 1

So It led to a very depressed ARU last year, which we're comparing to in Q1. As you pivot to Q2,

Speaker 4

You're going

Speaker 1

to see the whipsaw that last year where we then delivered a lot of those bases and the higher end product and it led to an ARU which was $6,500 for the quarter. More specifically Brad kind of to your question, We're not giving a specific number by quarter, but I think as you look at Q2 and the balance of the year something around that $6,000 range Is appropriate. We've largely worked through the backlog. We're not looking at any major shifts as you go forward. So I think that's a reasonable number.

Speaker 1

And what that would translate into would be for the first half of the year, we are still expecting kind of a high single digit ARU growth And probably a similar growth in the back half of the year as well kind of that high single digit range, maybe a little bit higher.

Speaker 7

That's very helpful color today. Thanks so much.

Operator

Your next question comes from the line of Seth Basham with Wedbush Securities. Please go ahead.

Speaker 5

Thanks a lot and good afternoon. My question is around the new product launches. If you could give us some color as How much do you expect them to benefit your sales rate this year as well as some of the costs associated with the launches both from a Cost of goods and SG and A standpoint, that would be great.

Speaker 2

Great. Hi, Seth. Well, we do expect the integrated initiatives of the new the next gen smart beds And the new Smart Base's lifestyle furniture and the new creative, the combination of those initiatives To help improve our demand trends along with the easier compares. So we'll benefit the most as we Head into the back half when we are in when we have our full line in place. And then the cost Associated with setting all of our stores is around $6,000,000 over the 2 quarters, Q2 and Q3.

Speaker 5

Got it. And then are you planning on a material step But then advertising to support the product launches, I know you alluded to some increase, but I'm not sure if that's directly related or not.

Speaker 2

Yes. Again, we expect efficiency out of our media based on where we were last year Based on the performance and the additional headwinds that we had by not having our full assortment With the constrained semiconductor chips and the elongated delivery window. So, we You know, are benefiting from some incremental efficiency there and we expect that to continue And we'll continue to read the environment and lean in or pull back accordingly.

Speaker 5

Got it. Okay. And then my last question is just if you could remind us what compares look like from a demand standpoint in the back half of the year And how you're thinking about demand on a 2 year stack basis as they move through the balance of the year?

Speaker 2

Yes. Demand Starting in May, was down double digits for the balance of the year. One other comment I'll make about the media too Seth is just a reminder that we use this Econometrics model, which is a really effective tool for us for both the regression and predictive And has many factors built into it. So it gives us confidence about where to Place those dollars as we move forward and recognizing the changing consumer environment and also to what degree. Dave, do you want to comment on the 2 year trend and or maybe back to 2019?

Speaker 1

Yes. Seth, maybe just relative to the Specifics on 22's demand. So in the Q1, we were down mid single digits year over year. We talked a lot about the shape of that quarter previously. If you look at the last three quarters of the year, we were down double digits and the most challenging quarters We're in the back half.

Speaker 1

So we certainly saw the most significant disruption in the back half of the year. If you want to look at it Kind of on a multi year compare basis, which I think was part of your question, the compares really in the 1st part of the Relative to call it 2019, you're still looking at numbers last year that were trending call it 30% plus above 2019. And when you get to the back half of the year, those compares go down to being single digits. So There's a pretty significant trajectory change in terms of the comparison. And also a reminder, if you think about our performance in the back half of last year, We saw the most significant disruption from lack of full product assortment and having extended delivery times.

Speaker 1

It certainly ratcheted up As consumer sentiment took a hit in May. And so as we lap those numbers, we have the new product. We have the full assortment A product that in our hands, we have normalized delivery times, new marketing creative. So there's a lot of things going we think for us, but Part of that is the fact that we were even more disrupted in some cases than the industry was in what was a very difficult demand environment.

Speaker 5

Great. Thank you guys very much.

Speaker 2

Thanks, Seth.

Operator

Your next question comes from the line of Atul Mahaswari from UBS.

Speaker 8

Good evening. Thanks a lot for taking my questions. Shelly, you mentioned that there has been a further drop in consumer sentiment since the last time you provided guidance. But yet you're maintaining the back half guidance So backup demand guidance of down low single digit to up mid single digit. So my question is why not take a more conservative stance given the deteriorating And do you really need an improvement in sentiment to achieve this outlook?

Speaker 2

Yes. Thanks for the question, Atul. It's Great opportunity to clarify. The consumer sentiment, yes, did it went up In January February and then dropped 5 points in March. Since March, in April, it has went up about 2 points.

Speaker 2

Bottom line, it has stayed pressured and at historic low points. And we do expect that pressured environment. We expected it when we provided guidance Earlier and that's where it continues. It's early in the year. We have Significant changes going on in the business with the additional demand driving initiatives that we're Deploying here in Q2 and Q3 and up against the different compares.

Speaker 2

So we do expect a step up And we're also expecting the current challenged macro environment. There's going to be fluctuations. And I think that's what I was illustrating too is how sensitive the environment is, How something abrupt can occur in a day like the banking situation. And it has an impact on the consumer. Sometimes that is resolved within a few weeks And sometimes it's been longer, but this is the disruptive environment that we've been dealing with for A couple of years now, but most particularly since last May, when it dropped to historic lows.

Speaker 8

Got it. That makes sense. And Shelly, as my follow-up, to the extent demand does weaken more than What you expect, how much more room do you have to cut costs, given that you've already managed costs pretty tightly? Like what are the key areas that you Target in a slower demand environment? And at what point does it become really hard to cut costs without jeopardizing future revenues?

Speaker 2

Well, we are operating with very thorough risk management processes and mitigants. We're very clear on the cost additional cost actions that we will take if the environment worsens And the we would do so expediently. And we do have a wide range of additional Cost cuts in our view and are well prepared to execute With great flexibility and agility as we continue to navigate the environment.

Speaker 8

Understood. If I can just sneak in one last one. Sure. What's the leverage ratio do you expect to end the second quarter given The slight loss expectations that you have?

Speaker 1

Yes. So Atul, We ended Q1 at 4.0. And just to kind of reset, what we said is 4.0 at the end of Q1. We expect to end the year under 4. You're right in that if you look at last year's Q2, It was a really strong Q2 because of some of the backlog that we had flowed through the quarter.

Speaker 1

So as we drop that quarter out and put The Q2 end, we do expect the leverage ratio to go up. We did proactively go out last year To get our covenant raised to 5.0 for through Q2 and that certainly was expecting that Q2 to be A little bit softer than certainly what we did in the Q2 of 2022. And we're within that covenant range of the 5.0. We're not going to get into giving specifics of exactly where it is, but it is expected to go up and then come down throughout the rest of the year and end the year under 4.

Speaker 8

Awesome. Thank you for that and good luck with the rest of the year.

Speaker 2

Thank you, Itau.

Operator

There are no further questions at this time. I would like to turn the call back over to our host for closing remarks.

Speaker 1

Thank you for joining us today. We look forward to discussing our Q2 2023 performance with you in July. Sleep well and dream big.

Operator

This concludes today's

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