Sleep Number Announces 2024 Financial Strategies and Performance Insights

Sleep Number’s management team has implemented contingency actions throughout the company to safeguard against margin and cash flow pressures. Drawing on the robust transformational mechanisms established over the past year, we remain disciplined in managing acquisition costs, service expenses, cost of goods sold, as well as General & Administrative (G&A) and Research & Development (R&D) leverage. We have proactively collaborated with our banking partners to amend our 2025 financial covenants, ensuring we have the flexibility necessary to navigate ongoing industry challenges. Francis will elaborate on these points shortly.

Performance and Strategy Adjustments

While our top-line performance in this demanding consumer environment is disappointing, we are committed to optimizing our media and promotional strategies. These efforts aim to drive demand and maximize returns. Our newly appointed leaders in brand segmentation, creativity, and media are rapidly advancing initiatives that capitalize on our strong brand equity and dedicated customer base. Leveraging deep consumer analytics, we are refining our engagement strategies, traffic generation, and consumer consideration.

To enhance performance, we are enhancing our data-driven initiatives to reach consumer segments most likely to make immediate purchases. This involves personalized content and messaging designed to boost conversion rates. Additionally, we are tapping into the loyalty of our Smart Sleeper customers—our repeat buyers—who passionately advocate for Sleep Number smart beds and readily embrace our new innovations. By amplifying their voices, we are strengthening our credibility and engagement with potential customers.

Moreover, we are enhancing our relationship-based selling initiatives. All sleep professionals have been recertified on our selling processes and customer relationship management strategies, fostering a more personalized customer experience that improves conversion rates. In summary, over the last 18 months, we have transformed our operational model to bolster financial resilience in a persistently weak market. These sustainable practices position our premium brand and vertically integrated business model for long-term profitable growth once the market recovers.

Leadership Transition and Future Focus

Our unwavering focus on strategy execution includes efforts to enhance efficiency, eliminate waste, and drive innovation, which ultimately delivers value to our customers. We are committed to maintaining agility in response to changing market conditions and are taking decisive actions to prioritize cash flow, manage costs, and retain flexibility. As I approach my retirement as President and CEO of Sleep Number, I feel immense gratitude for the dedication and commitment of the Sleep Number team, partners, and customers who have supported our transformational journey over the past 18 years. Together, we have built a beloved brand known for industry-leading innovations and retail experiences that are poised for sustainable success.

Sleep Number will always hold a special place in my heart, and I have confidence that this dedicated team will continue to build a competitive and successful company. Thank you for your relentless commitment to our shared goal of serving our customers. It has been an honor to foster our culture and enhance the lives of nearly 16 million individuals through improved sleep. Now, I hand it over to Francis for further insights on our 2024 results.

Francis Lee — Chief Financial Officer

Thank you, Shelly, and good afternoon, everyone. In 2024, we made significant strides toward creating a more resilient business model. We achieved a 190-basis point improvement in our gross margin rate for the year, despite facing higher-than-expected demand pressures. In parallel, we reduced our 2024 operating costs by double our initial targets. This progress in both areas has enabled us to mitigate most of the top-line pressure while establishing a stronger foundation as the industry recovers.

Detailed Financial Performance Review

Let’s now examine our fourth quarter and full year results in detail. For the fourth quarter, net sales totaled $377 million, reflecting a 12% decrease from the previous year, and approximately three percentage points below our expectations. Notably, our fourth-quarter net sales were impacted by a planned 5% reduction in store count year-over-year, contributing 1 to 2 percentage points to the sales decline. However, our gross margin rate for the fourth quarter improved to 59.9%, an increase of 330 basis points compared to the prior year, and it aligned with our guidance.

Our gross margin rate for the last six months of the year was over 60%. The increase in gross margin for the fourth quarter stemmed from key drivers, including reductions in material costs, ongoing negotiations with suppliers regarding all materials, and year-over-year efficiencies in home delivery and logistics operations. The favorable product mix from year to year also benefited our gross margin in the fourth quarter. We have aggressively executed cost efficiencies across the business to meet our adjusted EBITDA targets while navigating a challenging macroeconomic environment.

Operating expenses in the fourth quarter decreased by $28 million compared to the prior year’s pre-restructuring costs, surpassing our expectations. This broad-based reduction included cuts in media spending, lower selling expenses due to decreased store counts and improved labor efficiency, as well as reduced R&D expenditures. We also recorded $4 million in additional restructuring costs during the fourth quarter, totaling $18 million for the full year. These costs were primarily associated with downsizing our home delivery truck fleet and leasing buyouts for a few additional stores.

These restructuring actions have further lowered our fixed cost structure heading into 2025. For the fourth quarter, we reported $26 million of adjusted EBITDA, a 43% increase year-over-year, primarily driven by a 330-basis point rise in gross margin and a $28 million reduction in operating expenses. This effectively offset the impact of the 12% decline in year-over-year net sales. For the full year of 2024, our net sales totaled $1.68 billion, down 11% from the prior year, with demand reporting declines in the high single digits. Despite this, our gross margin rate improved by 190 basis points for the year, exceeding initial expectations.

We were able to cut operating expenses by $88 million, or 8%, for the year, excluding restructuring costs. Full year adjusted EBITDA decreased by 6% to $120 million due to the sales decline, although this was partially mitigated by higher gross margin rates and significant reductions in operating expenses. Our adjusted EBITDA margin for the full year reached 7.1%, an improvement of 40 basis points compared to the previous year, despite the pressures from declining net sales. Notably, we also generated $4 million in positive free cash flow for the year, a remarkable increase of $70 million relative to the prior year.

The challenging macro environment has persisted into 2025, exerting ongoing pressure on consumer spending within our category. Consequently, year-to-date demand continues to trend downwards in double digits. However, we have made substantial progress in reshaping our cost structure over the past two years, including significant reductions in fixed costs and improvements in gross margins. We will persist in transforming our business to achieve greater operational efficiency while remaining responsive to the dynamic market landscape.

In addition, we are actively working to address the impacts of recently enacted tariffs and are monitoring the evolving tariff situation across various scenarios. We intend to leverage the strength we’ve developed over the past two years to capture further operating efficiencies.

Sleep Number Implements Cost-Reduction Strategies Amid Market Challenges

This year, Sleep Number is focusing on a comprehensive review of its store fleet and identifying opportunities to lower indirect and fixed costs across its operations. Given the current challenging and changing consumer environment, the company has amended its bank agreement to offer additional covenant flexibility until the end of 2025.

Bank Agreement Amendment and Financial Priorities

Starting in 2025, the leverage covenant will return to a maximum of 4.0 times EBITDAR until the bank agreement expires at the end of 2026. The recent amendment allows a maximum of 4.75 times EBITDAR for the first two quarters of 2025, declining to 4.5 times in the third quarter and 4.35 times in the fourth quarter. More details on this amendment can be accessed in the 8-K filing submitted today. Our primary goal is to generate cash aimed at paying down debt and reducing leverage.

As we look ahead, our capital structure will continue to evolve to support our strategies and enhance profitability as market conditions improve. We are actively exploring options to restructure our debt this year. However, in light of the impending CEO transition, no financial outlook for 2025 will be provided at this time. We aim to grant Linda the necessary time to evaluate our strategies and market trends before releasing 2025 financial guidance later on.

I want to take a moment to thank Shelly for her incredible 18 years of leadership at Sleep Number. Her vision has not only transformed the business but has fostered a culture committed to enhancing the sleep experiences of our customers. Thank you, Shelly. Now, operator, please open the line for questions.

Questions & Answers:

Operator

[Operator instructions] Our first question comes from Brad Thomas with KeyBanc Capital Markets. Please go ahead.

Brad Thomas — Analyst

Good afternoon and best wishes to Shelly as she transitions into retirement. Francis, I would like to discuss the factors influencing your gross margin. You have made impressive strides in improving gross margins, especially with the current uncertainties before Linda’s arrival.

Could you clarify the remaining opportunities and initiatives you are pursuing to enhance margins?

Francis Lee — Chief Financial Officer

Thanks for your question, Brad. As I mentioned in my prepared remarks, we are actively working on a program to comprehensively assess our costs. Our focus areas include material cost reductions, supplier negotiations, and overall cost efficiencies.

In Q4, we noticed that product mix also positively impacted our margins. Moving into next year, we will persist in maximizing our efforts toward cost-efficient practices, benefiting further from initiatives introduced last year that will carry into 2025.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

Thank you, Brad, for your kind words.

Brad Thomas — Analyst

You’re welcome, it’s well deserved. I have a follow-up question regarding broader strategies and upcoming initiatives. Can you share any plans concerning store leases, either for openings or closures, as well as any upcoming product launches that might impact performance in the coming quarters?

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

Brad, one significant aspect is our ClimateCool series, which has exceeded expectations for sales and profitability. We are seeing growth at the higher end of our offerings and some pressure at the lower end, affecting our overall performance in this challenging market. We anticipate that the Climate series will contribute positively to our results in the first three quarters of the year before we explore further potential in the fourth quarter.

Brad Thomas — Analyst

Thank you for that insight.

Operator

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

Alessandra Jimenez — Raymond James — Analyst

Good afternoon. This is Alessandra Jimenez on behalf of Bobby Griffin. We wish you all the best in your retirement, Shelly.

I would like to follow up on the tariffs. How much of your cost of goods sold is currently impacted by the newly implemented tariffs, and do you have plans for pricing adjustments in 2025?

Francis Lee — Chief Financial Officer

Thank you, Alessandra. The tariff situation is fluid, given its recent implementation. We are actively implementing mitigation strategies, including shifting suppliers and production. Currently, about a third of our materials are sourced from Mexico, which constitutes our largest exposure. Remember that approximately 70% of our cost of goods sold is tied to material costs.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

Regarding pricing, we intend to make informed decisions to address the impact of tariffs while considering the challenging economic conditions facing consumers in this discretionary segment.

Alessandra Jimenez — Raymond James — Analyst

Thank you for the clarification. Additionally, could you provide insight into how store count adjustments might affect the 2025 top line and what recapture rates you anticipate for 2024?

Francis Lee — Chief Financial Officer

We routinely evaluate our store strategy, which encompasses openings, repositionings, remodels, and closures. For 2024, we are taking advantage of lease renewals and expirations to optimize our store footprint…

# Challenges and Strategies: Insights from Recent Earnings Call

During a recent earnings call, key executives discussed the company’s current challenges and sales strategies. They highlighted specific markets where they experimented with the placement of additional stores, noting satisfaction with transfer rates as an important element in their profitability planning.

Alessandra Jimenez — Raymond James — Analyst

Thank you for that introduction.

Operator

The next question comes from Seth Basham with Wedbush Securities. Please proceed.

Matt McCartney — Wedbush Securities — Analyst

Good evening, this is Matt McCartney standing in for Seth. Congratulations, Shelly, on your retirement. I have a couple of questions regarding recent trends.

We have noted another quarter of significant downturns in online sales. What do you believe needs to happen to bring online sales back in line with store performance?

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

The challenges primarily originate from the lower market segment. We have seen these pressures reflected in our online sales. Recently, we conducted a test that coincided with the President’s event, promoting the c1 Smart Bed at $799, which positively impacted our online sales.

This is a clear example of our iterative approach amidst a changing consumer market. Most of the pressure we face is at the opening price point of our Classic series. However, we are satisfied with the margins from our high-end offerings, which will require balancing both segments moving forward.

Matt McCartney — Wedbush Securities — Analyst

This leads directly to my next inquiry. We observed impressive growth in average revenue per Smart Bed this quarter. Could you clarify the key drivers behind this increase, especially regarding product mix and promotional effects?

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

Absolutely. The growth is largely driven by our Climate series. On the topic of discounts and financing, which we analyze collectively, we noted that this area remained flat year over year as a percentage of net sales. The overall success we’re experiencing with higher-income customers, who are less impacted by purchasing power constraints, is significant.

Matt McCartney — Wedbush Securities — Analyst

Thank you for the detailed response.

Operator

Next, we have Peter Keith from Piper Sandler. Please go ahead.

Peter Keith — Analyst

Thank you, Shelly. I also wish you the best in your retirement. Did you provide a demand comp for Q4?

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

We did not provide that specific figure but did mention that demand was down double digits similar to net sales. The current consumer is indeed under significant pressure. The housing market is stagnant, making the environment quite inefficient.

We are continuously weighing the trade-offs between maximizing profit margins and investing in demand. For Q4, we cut our media spending by 18% compared to the previous year, resulting in modest returns. Although we are not satisfied with our demand, our direct models allow us to observe consumer trends quickly to adjust our strategies effectively.

Peter Keith — Analyst

I appreciate your insight. What specific metrics guide you in deciding when to shift back toward increasing market share or media spending?

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

We are certainly looking for a more efficient market. In a typical environment, the industry sees about 25% organic traffic, but this has fallen significantly. In the second half of 2024, it dropped to just 8%. If conditions return to around 20% organic traffic, that would suggest a substantial efficiency improvement.

During early January, we felt positive indicators leading into a holiday event, but this shifted dramatically by late January. While we are prepared to respond swiftly, we recognize that we often do not have the flexibility we would prefer. In the interim, we continue testing initiatives to drive demand efficiently and have identified promising areas that require further scaling.

Peter Keith — Analyst

Thank you for that clarification. It’s reassuring to see your transparency regarding current market conditions. Have recent weekly trends continued to worsen? Is February proving to be more challenging than January?

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

February has indeed shown some challenges…

Sleep Number Reports on Industry Demand and Financial Strategies

During a recent conference call, company executives addressed concerns surrounding the important sales period that February represents, particularly influenced by the President’s event. They noted that February’s performance significantly impacts the overall quarter. Although it remains early to draw conclusions about March, the sentiment surrounding February has raised concerns.

Peter Keith — Analyst

Thank you for the insights.

Operator

[Operator instructions] The next question comes from Dan Silverstein with UBS. Please proceed.

Dan Silverstein — Analyst

Good afternoon, and I appreciate your time. My first question pertains to the company’s approach to provide a comprehensive full-year outlook. Could you share your expectations regarding industry demand for the year and how that might shape the business? Additionally, if mattress demand continues to be weak, what potential is there for further expense reductions, considering the significant savings already achieved over the past two years? Thank you.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

Thanks for your question, Dan. Prior to February, we anticipated some recovery in the industry, possibly a 2 to 3 percentage point increase this year. We expect that the first half will face challenges while the second half should see growth as market initiatives take effect. However, it’s likely that analysts will adjust their forecasts to reflect more pressure in the first half, leading to a more conservative outlook for the entire year.

Francis Lee — Chief Financial Officer

To add to that, as we consider the rest of the year, we have been systematically managing our cost structure. Notably, our team member count has decreased by 34% since 2021. Over the last two years, we achieved $173 million in cost reductions, half of which came from fixed costs—$85 million in 2023 and $88 million in 2024. These savings are widespread across the business.

We will continue to operate with contingency plans to implement further necessary actions. Building this capability is essential, and we expect to maintain a mindset focused on enhancing the durability of our business model, positioning us well for future industry rebounds and profit acceleration.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

This commitment spans all business categories and underscores our team’s dedication and innovation, which has enabled us to perform strongly despite a pressured top line here in 2024, and we anticipate maintaining this trajectory.

Dan Silverstein — Analyst

I have a follow-up question for Francis. Regarding amendments to the credit agreement, can you disclose the revenue base needed to comply with the new covenants for 2025? The previous figure discussed was around $1.7 billion. Any updates on this?

Francis Lee — Chief Financial Officer

This information will be available later, likely as part of our guidance. When we established the covenant levels, we took into account our own expectations for the year, ensuring that there will be an appropriate cushion for us in 2025.

Dan Silverstein — Analyst

Thank you.

Francis Lee — Chief Financial Officer

To clarify, when we previously mentioned the $1.7 billion figure, it was calculated against the covenants returning to a 4.0 times EBITDAR ratio for 2025. The new covenant will actually set that level at 4.35 times EBITDAR, implying that the revenue threshold will be lower than $1.7 billion to remain within compliance.

Operator

That concludes our question-and-answer session. I’ll now turn the call back to the company for any closing remarks.

Dave Schwantes — Vice President, Finance, Investor Relations, and Decision Support

Thank you all for joining us today. We look forward to sharing our Q1 2025 results with you next month. Sleep well and dream big.

Operator

[Operator signoff]

Duration: 0 minutes

Call Participants:

Dave Schwantes — Vice President, Finance, Investor Relations, and Decision Support

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer

Francis Lee — Chief Financial Officer

Brad Thomas — Analyst

Shelly Ibach — Chairman, President, and Chief Executive Officer

Alessandra Jimenez — Raymond James — Analyst

Matt McCartney — Wedbush Securities — Analyst

Peter Keith — Analyst

Dan Silverstein — Analyst

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