Sleep Number Takes Action to Strengthen Financial Resilience Amid Market Challenges

In our ongoing efforts to safeguard margin and cash flow, we are implementing contingency actions across the business. We are capitalizing on the robust transformational mechanisms developed over the past year. Our approach continues to focus on managing the cost of acquisition, cost to serve, and costs associated with goods, G&A, and R&D leverage. To further enhance our flexibility in facing persistent industry pressures, we proactively worked with our banking partners to amend our 2025 financial covenants. Francis will share more insights shortly.

Optimizing Media and Promotional Strategies

Although we are not satisfied with our top-line performance in this tough consumer environment, we remain committed to refining our media and promotional strategies to stimulate demand and maximize returns. Our new leaders in brand segmentation, creative development, and media initiatives are advancing quickly to leverage our strong brand equity and loyalty among customers. By harnessing deep consumer analytics, teams are optimizing engagement, traffic, and overall consumer consideration. Notably, we have identified promising developments in several key initiatives.

First, we are expanding our data-driven efforts to personalize content and messaging to reach consumers most likely to purchase now, which will lead to higher conversion rates. Second, we are maximizing our Smart Sleeper loyalty initiative. Our repeat customers serve as strong advocates who clearly recognize the value of Sleep Number smart beds and are eager to embrace our innovations. We’re enhancing our messaging to amplify their voices, which in turn bolsters credibility and engagement with new customers.

Third, we are reinforcing our relationship-based selling approach. All our sleep professionals have been recertified in our selling process and customer relationship management strategies, which supports a more personalized customer experience and improves conversion rates. Over the past 18 months, we have transformed our operating model to enhance financial resilience in this consistently weak market. These sustainable actions position our premium brand and vertically integrated business model for long-term profitable growth once market conditions improve.

Commitment to Efficiency and Innovation

As we navigate forward, we remain disciplined in our strategic execution, focusing on improving efficiency, eliminating waste, and fostering innovation to deliver value to our customers. We continuously strive for agility in responding to market conditions, taking decisive actions to prioritize cash flow, manage costs, and maintain flexibility. This ensures that Linda has a solid foundation to lead the company ahead. As I near retirement from my role as President and CEO of Sleep Number, I express my deep gratitude for the passion and commitment of the Sleep Number team, partners, and customers who have supported us through a transformative journey over the past 18 years. Together, we’ve built a cherished brand featuring industry-leading innovations and store experiences, setting the stage for sustained success.

Sleep Number will always hold a special place in my heart, and I am confident that this exceptional team will continue to fortify the company’s competitive edge. Thank you for your unwavering dedication to our shared mission and relentless focus on customer service. Building our culture together has been an honor, improving the sleep quality of nearly 16 million lives. Now, I will turn the discussion over to Francis for additional insights on our 2024 results.

Francis Lee — Chief Financial Officer

Thank you, Shelly, and good afternoon, everyone. We have made considerable strides towards building a more resilient business model in 2024. We accomplished a 190-basis point improvement in our gross margin rate for the year, despite facing greater-than-anticipated demand pressures, while simultaneously halving our initial operating cost targets for 2024. The progress in these areas helped us to offset much of the top-line pressure we encountered while strengthening the foundation of our business as the industry begins to recover.

Fourth Quarter and Full Year Financial Overview

Now, let’s delve into a detailed review of our fourth-quarter and full-year results. The fourth quarter net sales totaled $377 million, a decline of 12% compared to last year and approximately three percentage points below our expectations. As intended, our fourth quarter net sales reflected a 1 to 2 point impact from a 5% reduction in store count year over year. Our gross margin rate for the fourth quarter improved to 59.9%, an increase of 330 basis points compared to the prior year, marking the high end of our guidance for the quarter.

For the last six months of the year, our gross margin rate exceeded 60%. This increase was driven by key factors we have discussed throughout the year, including reductions in material costs, ongoing supplier negotiations for all materials, and year-over-year cost efficiencies in our home delivery and logistics operations. Additionally, the fourth quarter benefited from a favorable product mix compared to the previous year. We have aggressively pursued cost efficiencies across the business to fulfill our adjusted EBITDA commitments as we navigate a challenging macroeconomic landscape.

We successfully reduced fourth quarter operating expenses by $28 million compared to the previous year’s pre-restructuring costs, significantly exceeding our expectations. These reductions were broad-based, highlighting a year-over-year decrease in media spending, lower selling expenses stemming from reduced store count and greater labor efficiency, and a drop in R&D spending. We also recorded $4 million in restructuring costs during the fourth quarter, bringing the full-year total to $18 million. Incurred costs stemmed from downsizing our home delivery truck fleet and terminating a few additional store leases.

These restructuring actions further positioned us to reduce our fixed cost structure as we move into 2025. For the fourth quarter, we reported $26 million in adjusted EBITDA, a 43% increase from the same period last year, driven by a 330-basis point uptick in our gross margin rate and the $28 million reduction in operating expenses, more than compensating for the 12% decline in year-over-year net sales. Our full year 2024 results reflected net sales of $1.68 billion, an 11% decrease from the prior year, with demand experiencing a high single-digit downturn.

The gross margin rate increased by 190 basis points for the year, surpassing our original expectations. We also decreased operating expenses by $88 million, or 8%, for the year before restructuring costs. Adjusted EBITDA for the full year fell 6% to $120 million, primarily driven by the 11% decline in net sales, but offset by improved gross margins and significant reductions in operating expenses. Our adjusted EBITDA margin for the year stood at 7.1%, up 40 basis points from the previous year, despite de-leveraging effects stemming from the decrease in year-over-year net sales. Furthermore, we achieved $4 million in positive free cash flow for the year, an improvement of $70 million from last year.

The ongoing challenging macro environment has persisted into 2025, exerting continued pressure on consumer spending in our category. Against this backdrop, year-to-date demand remains down double digits. Over the past two years, we have made substantial progress in reshaping our cost structure, including significant fixed cost reductions and boosting our gross margins. We will continue to evolve our business to enhance efficiency while remaining responsive to the dynamic market conditions.

We are also working diligently to mitigate the impacts of recently enacted tariffs and are actively monitoring the evolving tariff situation under various scenarios. We will harness the operational strength gained over the last two years to drive further efficiency improvements.

Sleep Number Focuses on Cost Efficiency Amid Market Challenges

This year, Sleep Number is committed to examining operations throughout the organization, including a thorough review of its store fleet. The goal is to identify further opportunities for reducing both indirect costs and fixed expenses across the business. Given the current weak and fluctuating consumer environment, the company has also executed an amendment to its bank agreement. This amendment provides additional covenant flexibility through the end of 2025.

Bank Agreement Amendment Details

Originally, the leverage covenant maximum was set to revert to 4.0 times EBITDAR starting in 2025. However, the recent amendment provides temporary relief, allowing for a covenant maximum of 4.75 times EBITDAR in Q1 and Q2, decreasing to 4.5 times for Q3, and hitting 4.35 times for Q4. Further details about the bank amendment are included in the Form 8-K filed today. The company’s primary goal is to generate cash to pay down debt and diminish leverage.

Future Capital Structure Plans

Sleep Number plans to evolve its capital structure to enhance its abilities in executing strategy and increasing profitability as the market rebounds. The company is considering options for restructuring its debt this year. In light of the upcoming CEO transition, however, no financial outlook for 2025 is being provided at this time. This decision aims to allow incoming CEO Linda the freedom to assess strategies and business trends before issuing guidance for 2025 at a later date.

Acknowledging Leadership and Transition

As Shelly Radue Ibach prepares for retirement, she has been praised for her vision and dedication over the past 18 years. Her leadership style has greatly transformed the business, emphasized customer service, and advanced the mission of Sleep Number. As she steps down, operators opened the line for questions from analysts.

Questions & Answers:

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

Brad Thomas — Analyst
Hi, thanks. Good afternoon, and Shelly, best wishes for your retirement. Francis, I was hoping to get your insights on the factors influencing gross margin. It seems you’ve made significant strides in this area, despite the uncertainty before Linda’s arrival.

Francis Lee — Chief Financial Officer
Thanks for the question, Brad. As noted in my remarks, we have a strong program examining our cost structure across various areas. Key focuses include material cost reductions, supplier negotiations, and cost efficiencies. In Q4, we also experienced a shift in product mix aiding gross margins. Moving into next year, we will persistently pursue cost efficiency and leverage benefits from improvements made in the previous year as we approach 2025.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer
Thank you, Brad, and I appreciate the kind words.

Brad Thomas — Analyst
You’re welcome, well deserved. I’d like to ask if you can provide any updates on larger strategic initiatives, particularly regarding store leases that you might be considering for openings or closures, and developments leading up to Memorial Day.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer
One significant aspect, as Francis mentioned regarding gross margin, is our ClimateCool initiative, which has led to higher-margin products. The Climate series is performing beyond our expectations, indicating strong growth at the high end, which is beneficial for gross margins, although broader impacts are still required given current market conditions. We anticipate continued benefits from the climate series before we even surpass the previous year’s performance in Q4.

Brad Thomas — Analyst
Great. Thank you.

Operator:
Our next question comes from Bobby Griffin with Raymond James. Please proceed.

Alessandra Jimenez — Raymond James — Analyst
Good afternoon. This is Alessandra Jimenez filling in for Bobby Griffin. Best wishes to you, Shelly, on your retirement. I’d like to follow up on tariffs—what percentage of your cost of goods sold will the new tariffs affect? Do you have any pricing strategies in place for 2025 based on current insights?

Francis Lee — Chief Financial Officer
Yes, thanks for the question, Alessandra. The tariff situation is very dynamic, particularly since they were enacted recently. We have recognized our exposure and are actively formulating mitigation strategies, including shifting suppliers and relocating production. Currently, about one-third of our materials come from Mexico, representing our largest exposure since approximately 70% of our cost of goods sold is tied to material costs.

Shelly Radue Ibach — Chairman, President, and Chief Executive Officer
We are prepared to implement decisive pricing actions as we navigate these tariffs. We understand the impact pricing may have, especially in this pressured consumer environment.

Alessandra Jimenez — Raymond James — Analyst
Thank you for the clarity. On the topic of store count adjustments, will there be any significant effects on the 2025 top line? Additionally, what are your expectations for the recapture rate in 2024?

Francis Lee — Chief Financial Officer
We continuously evaluate our stores through openings, repositionings, remodels, and closures. In 2024, we capitalized on lease expirations effectively, which has…

# Insights on Market Trends and Online Sales Challenges: Leadership Update

As we look ahead, there are numerous opportunities for growth and expansion in specific markets. We’ve experimented with increasing the number of stores in certain areas, and we are encouraged by the transfer rates observed from these efforts, which are factored into our strategic assessments going forward.

In 2024, we anticipate a few financial pressures affecting our operations. Nonetheless, we will stick to our strategic routines and ensure that store transfers contribute effectively to our overall profitability.

Alessandra Jimenez — Raymond James — Analyst

Thank you for the information.

Operator

Our next inquiry comes from Seth Basham at Wedbush Securities. Please proceed.

Matt McCartney — Wedbush Securities — Analyst

Good evening. This is Matt McCartney in for Seth. Congratulations, Shelly, and best wishes for your retirement. I have a couple of questions.

We’ve noticed ongoing declines in our online sales channel. What changes do you believe are necessary to restore online sales to match those from in-store channels?

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

The challenges we face in online sales primarily stem from the lower-end market. As I noted, this segment has been under pressure. Recently, we conducted a promotional test for the c1 Smart Bed at $799 following the President’s event, and we witnessed a positive impact on online sales.

This illustrates our commitment to adapting in a continuously evolving and challenging consumer market. The main struggle lies within our Classic series at the entry-level pricing. However, we remain satisfied with the margins generated from our higher-end products, which are crucial for our overall strategy.

Matt McCartney — Wedbush Securities — Analyst

That context is helpful and leads into my next question. We’ve observed significant growth in average revenue per Smart Bed this quarter. Can you elaborate on the factors driving this increase between product mix and promotional efforts, and what does this suggest about our future outlook?

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

You’re correct; the increase can be attributed mainly to product mix, particularly with our Climate series, which has been a key contributor.

The impact of discounts and financing—when assessed together—has remained consistent year-over-year as a percentage of net sales. We apply our promotions differently, but overall, they’ve remained relatively flat. The success is driven mainly by higher-income customers drawn to our benefit-oriented products, who lack the purchasing pressure faced by entry-level clients.

Matt McCartney — Wedbush Securities — Analyst

Thank you for that clarity.

Operator

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

Peter Keith — Analyst

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

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

We did not specify that, but we did mention that demand was down by double digits, similar to our net sales. Consumer pressure remains significant due to a stagnant housing market, resulting in a very inefficient environment. We constantly balance optimizing profits against investing in demand, as illustrated in Q4.

For instance, we reduced our media spending by 18% year-over-year while achieving modest leverage from this spending during the quarter. While we acknowledge that our competitors might have different spending strategies, our focus at this time is to prioritize profitability. Although our demand levels are not satisfactory, our vertical business model allows us to quickly assess market efficiency and adapt our strategies accordingly.

In Q4, while we missed our sales expectations by a few points, we met our EBITDA midpoint and achieved a gross margin rate at the higher end of our forecasts. This reflects the trade-offs we are making in this challenging market.

Peter Keith — Analyst

Thank you for the insights. Looking ahead, is there a specific metric guiding your decision to increase or decrease media spending? Are you waiting for an improving market condition or specific leverage ratios?

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

We are indeed awaiting a more favorable market environment. In a typical macro setting, our industry enjoys around 25% organic traffic. A year ago, this figure was about 12%, and in the latter half of 2024, it plummeted to 8%. In certain volatile periods, we have seen it dip to as low as 4%. These metrics indicate the efficiency improvements we can expect as organic traffic returns to around 20%. Our goal is to remain responsive and proactive in addressing market shifts while continually testing and validating our initiatives.

During the early part of this year, we observed encouraging signs through events like Martin Luther King Day, but a significant downturn occurred towards the end of January and early February, impacting our expected outcomes. We remain agile and are continuing to explore initiatives aimed at driving demand efficiently.

Peter Keith — Analyst

I appreciate your transparency. Have conditions worsened in the latter part of February? Is consumer spending behavior indicating a temporary shift or a more prolonged downturn?

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

In February, we saw…

Sleep Number’s CEO Discusses Industry Demand and Future Outlook

During a recent earnings call, executives from Sleep Number addressed key financial insights and future expectations. The late February President’s event resulted in disappointing outcomes, significantly impacting the quarter’s overall performance. According to Shelly Radue Ibach, the company’s Chairman, President, and CEO, February set the tone for sales expectations, as it represents a critical selling period.

Industry Demand Insights

Dan Silverstein, an analyst from UBS, inquired about Sleep Number’s perspectives on industry demand for the year. He noted that while the company is holding off on a comprehensive full-year outlook, understanding demand dynamics could help frame potential business scenarios. Silverstein also asked if continued softness in mattress demand could further impact the company’s cost-saving strategies.

In response, Ibach indicated that prior to February, there was general optimism about potential recovery in the mattress industry, with expectations of growth by 2 to 3 percentage points this year. They anticipate that the first half will continue to face challenges, while recovery efforts might produce results in the latter half of the year. Ibach suggested that analysts might need to adjust their forecasts, taking the recent quarter’s performance into account.

Cost Management Strategies

Francis Lee, the Chief Financial Officer, elaborated on the company’s approach to managing expenses. He highlighted that since 2021, the workforce has decreased by 34%, contributing to a total of $173 million in cost reductions over two years. Lee specified that roughly half of these savings targeted fixed costs, with $85 million in 2023 and $88 million in 2024. This strategic trimming has been widespread and places the company in a strong position for future profitability, particularly when market conditions improve.

Future Financial Guidance

Silverstein then shifted the discussion towards recent amendments to Sleep Number’s credit agreements. He asked Lee if there were updated revenue parameters essential for staying compliant with the new covenants by 2025. Lee responded that more details would be shared later, noting that projections for revenue would be lowered in light of the adjusted covenant levels—specifically, an increase to 4.35 times EBITDAR by the end of 2025.

Sleep Number’s team continues to implement contingency plans as necessary, maintaining a proactive stance in fortifying their business structure against ongoing market pressures. As outlined by Ibach, the company aims to remain committed to innovation and productivity across all sectors, reinforcing their preparedness for an eventual industry rebound.

Conclusion and Next Steps

As the session concluded, Dave Schwantes, Vice President of Finance, reaffirmed the company’s commitment to transparency, inviting stakeholders to anticipate Q1 2025 results, due late next month. He ended the call on an optimistic note, emphasizing the company’s vision for sustained growth in the future.

This conference call transcript is provided by The Motley Fool, aiming to present accurate financial communication. Readers are encouraged to conduct their own due diligence by reviewing the company’s SEC filings.

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