Welcome to Sleep Number's Q4 and Full Year 2024 Earnings Conference Call. [Operator Instructions] Today's call is being recorded. If anyone has 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.

Good afternoon and welcome to the Sleep Number Corporation fourth 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. I will now turn the call over to Shelly for her comments.

Good afternoon, everyone. My SleepIQ score was 84 last night. As noted in our press release, the independent directors of our Board have unanimously selected Linda Findley as the company's new President and CEO. She will join Sleep Number in that role on April 7. The independent directors and I are confident that Linda is the right leader to guide the company through its next phase of growth. She will conduct the next earnings call and we'll share more about her background, perspectives on Sleep Number and the path forward. During today's call, I'll share highlights of our 2024 performance, including important progress we made during the year to restructure the business and position it for accelerating returns as the industry recovers. Then Francis will provide further details on our fourth quarter and full year 2024 financial results. The mattress industry faced an extremely challenging demand environment throughout 2024, a trend that has persisted into the first quarter of 2025. U.S. mattress volumes for 2024 were estimated at 24 million units which is the lowest level since 2015. Historically low consumer sentiment and high interest rates have led to the lowest housing turnover in 30 years. Inflation and economic uncertainty continue to suppress discretionary spending. Since initiating our operating model transformation in the back half of 2023, we have implemented structural changes to reduce fixed expenses, enhance margins and cash flow and strengthen financial resilience across market cycles. Driven by our team's high level of commitment and disciplined execution, we further advanced our operating model transformation throughout 2024, delivering a 43% year-over-year increase in fourth quarter adjusted EBITDA. For the full year, adjusted EBITDA was $120 million, in line with the midpoint of our most recent guidance. Key drivers of this performance included gross margin rate improvement and operating cost…

Thank you, Shelly and good afternoon, everyone. We made significant progress toward building a more resilient business model in 2024. We drove a 190 basis point improvement in our gross margin rate for the year, even with greater-than-planned demand pressure while also cutting our 2024 operating costs by double our original targets. The important progress we made in these 2 areas allowed us to offset a majority of the top line pressure for the year while building a stronger foundation for the business as the industry recovers. Now let's turn to a more detailed review of our fourth quarter and full year results. Fourth quarter net sales of $377 million were down 12% versus last year and approximately 3 percentage points below our expectations. As planned, our fourth quarter net sales included 1 to 2 points of pressure due to a 5% reduction in stores year-over-year. Our fourth quarter gross margin rate of 59.9% was up 330 basis points versus the prior year and at the high end of the guidance we provided for the quarter. Our gross margin rate for the last 6 months of the year was over 60%. Our fourth quarter gross margin rate increase was driven by the same key drivers we have been highlighting all year, including material cost reductions, ongoing supplier negotiations for all material components and year-over-year cost efficiencies in our home delivery and logistics operations. The fourth quarter also benefited from favorable product mix year-over-year. We have aggressively executed cost efficiencies across the business to deliver on our adjusted EBITDA commitments as we continue to navigate a challenging macro environment. We reduced fourth quarter operating expenses by $28 million versus the prior year pre-restructuring costs which was well above our expectations for the quarter. Fourth quarter operating expense reductions were broad-based, including…

[Operator Instructions] Our first question will come from the line of Brad Thomas with KeyBanc Capital Markets.

Shelly, all the best as you move into retirement. Francis, I was hoping to ask you a question on just some of the gross margin puts and takes. You all have done some really good work on improving gross margin, understanding that things are a bit up in the air before Linda joins. Can you just help us think about the runway that you still have and some of the levers that you've been pulling to improve margins?

Yes. Brad, thanks for the question. As highlighted in my prepared remarks and as we've been indicating all year, we have a robust program in place to examine all of our costs that looks across so many different opportunities. The broad buckets, as shared in my prepared remarks, are around material cost reductions, supplier negotiations, cost efficiencies. And in Q4, we saw some product mix also aiding with that. As we go into next year, we're going to continue to drive the muscle that we have toward relentlessly pursuing cost efficiency. And we'll also benefit from some of the benefits that came in partial year last year that should anniversary into 2025.

Well deserved. And then maybe just one more follow-up on the big picture here, again, understanding that we'll get more details on thinking about strategies and initiatives as the year unfolds here. Is there any more road map maybe that you could share with us in terms of dynamics like store leases [ph] where you're on the hook for an opening or ones that you're thinking of closing or products that will be hitting the floor as we approach Memorial Day, anything that's kind of locked and loaded on the horizon that almost certainly should happen that we should keep in mind as we think about the quarters ahead here?

Brad, I think one highlight and Francis alluded to it when he highlighted mix being a part of the gross margin rate goodness. If you recall, we introduced our ClimateCool and have focused on our Climate series. which is higher margin and that was part of the objective with the ClimateCool bed. But that series is certainly outperforming our expectations. We're growing at the top and losing at the bottom. So the pressure is at the bottom end of our line and the strength is at the top and that's good for gross margin rate but obviously not as broad as it needs to be to be driving our overall performance in this really weak market. We expect to benefit from that Climate series here in the first 3 quarters before we even lap the fourth quarter.

Our next question comes from the line of Bobby Griffin with Raymond James.

This is Alessandra Jimenez on for Bobby Griffin. And Shelly, we wish you all the best in your retirement. First, I wanted to quickly follow up on tariffs. Can you remind us how much of cost of goods sold would be subject to the recently implemented tariffs? And based on what we know today, do you have any pricing actions planned for 2025?

Yes. Alessandra it's nice to talk to you again. Obviously, the tariff situation right now is a highly dynamic situation with the enactment of them happening just yesterday. And certainly, it's news that we've been aware of and have been examining and putting in place mitigation plans to shift suppliers, move production to other companies and other countries, I'm sorry and look across all of our business. Our exposure -- our largest exposure comes from Mexico which has about 1/3 of our materials from there. And as a reminder, about 70% of our cost of goods sold relates to material costs.

And you also asked about pricing. We'll be decisive with pricing and other actions as we work hard here. We have been and we'll continue to mitigate whatever we can on tariffs. And we also know that pricing has an impact on the top line which it's already a really pressured consumer for this discretionary category. So very well aware of that and thinking about it holistically.

That's really helpful. And then maybe just a follow-up on the store count rationalization. Is there any carryover impact to 2025 top line that we should keep in mind? And then what are you seeing for a recapture rate in 2024?

Yes. So our evaluation of our stores is part of our routine process where we are executing store openings, repositions, remodels and closures. Certainly, in 2024, we took advantage of some lease renewals -- lease expirations that were coming up as well as opportunities around some stores where we experimented with putting more stores in certain markets. And the transfer rate that we've seen on those we're -- we've definitely been pleased with and are part of all of our consideration. I think as you -- and they totaled a couple of points of pressure in 2024. So we'll continue to run our playbook and our routine processes and obviously, maximizing store transfer plays into our overall profitability equation.

Our next question comes from the line of Seth Basham with Wedbush Securities.

This is Matt McCartney on for Seth. Congratulations, Shelly. I wish you the best in your retirement. Just a quick couple of questions here. We've seen another quarter of outsized declines in the online channel. Just wondering what do you think needs to be done there to get online back to at least parity with the store channel?

Yes. It's really coming from the low end. I highlighted already that we've had pressure on the low end and that's -- that's what you're seeing online and you may have noticed we just recently did a test. It was the week after President's event to just understand what that would mean for us to promote the c1 Smart Bed at $799 [ph] and it did make a difference in our online sales. So just an example, we keep iterating in this changing and weak consumer market that's pretty inefficient. And that's the biggest pressure is at the opening price point of the line, the Classic series. But we like the margin that we're getting at the high end of the line that ultimately need both.

Great. Okay. That kind of segues into my next question then. So just on average revenue per Smart Bed, you saw some really nice growth there in the quarter. Just wondering if you could break down the drivers there between mix and promotions that had an impact and then the outlook going forward?

Yes. You're right. It's primarily mix. As I highlighted, the Climate series, that's the major driver there. If you look at discounts and financing which we look at the 2 buckets together in totality and we're flat year-over-year as a percent to net sales. But it does come out a little differently in how we apply those promotions but we manage the entire bucket fairly flat. The -- yes, the driver is definitely the series. Moving up the line, we're having success with a higher income customer who is very interested in benefit-driven products and doesn't have the same level of purchasing power pressure that the opening price point customer does.

Our next question comes from the line of Peter Keith with Piper Sandler.

And Shelly, I also wish you the best in retirement. Quickly, I was wondering, did you guys give a demand comp for Q4?

We did not. We highlighted that -- I believe we highlighted that it was down double digits, the same as net sales. And I'll maybe just take a moment to touch on that further. We -- the consumer is pressured. Housing is frozen. The environment is very inefficient. We're continuously making trade-offs between optimizing profit and investing in demand. And Q4 is an example of that. We reduced our media spend, Peter, by 18% year-over-year and we saw modest leverage on our media spend in the quarter and we recognize that other competitors may be spending in this more inefficient environment. For us, we're prioritizing the profit and that's where we're focused right now. Obviously, we're not satisfied with where our demand is. But with our vertical model, we can see the consumer efficiency or lack of efficiency very quickly and we're making decisions that tie to delivering the ROI. And for us in the fourth quarter, we missed our sales expectation by a few points but we were able to deliver the midpoint of our EBITDA in the quarter and drove a gross margin rate at the top end of our expectations. So it's a good example of the kind of trade-offs that we're making right now in this pretty tough marketplace.

Okay. I appreciate all the feedback there. And maybe just looking forward, I can appreciate it's a very tough environment. What -- I guess, are there certain metrics that you're looking at when you could begin to pivot back towards trying to take share or just simplistically increasing media spend rather than decreasing. Are you waiting for what you feel is a good environment? Or is it a certain leverage ratio? What are you kind of looking for to give you those indications to spend more?

Yes, definitely waiting for a more efficient environment. And I'll just share the context of where the category is at right now. The -- in a normalized macro environment, the industry benefits from about 25% organic category traffic. A year ago, that organic traffic was running at 12%. In the back half of 2024, it dropped to 8%. And when we see volatility like we did at the end of January, early February, that can go down as low as 4%. And so when you think about the organic traffic returning to 20%, that's 10% to 12% efficiency improvement. So we are looking for a more efficient market so that we can -- as we're striving to optimize our profits, we're not just sitting here waiting. We're certainly iterating every single quarter and we can see it really quickly. And a good example would be in this first quarter, early January through the Martin Luther King event, we were seeing the improvement that we were expecting and hoping for. And then there was a big shift at the end of January, early February. And at, of course, the wrong time as we're heading into the President's event. And we respond quickly but you can't always -- you don't always have as much runway as you wish you did. But we're ready. And in the meantime, we're testing and iterating into key initiatives like I described in my prepared remarks and finding the places where we can drive more demand but doing so in an efficient way. And we've got some good green shoots and we need to scale them.

Okay. I appreciate that feedback. And maybe the last question, I appreciate the transparency on the current quarter. It actually aligns exactly with what we're hearing out there but I think you're being a little more transparent than other companies. Has things in recent weeks even gotten worse? In other words, is the back half of February worse than the front half? Everyone is trying to figure out if this change in consumer spending is temporary or maybe a sign of things deteriorating.

Well, February, inclusive of the President's event which fell pretty late in the month, it does. It really comprises the most important selling period for the quarter. So how February goes kind of -- that's how the quarter goes. So I think it's too soon to say yet about March. But February was the President's event and we're obviously disappointed in it.

[Operator Instructions] Our next question will come from the line of Dan Silverstein with UBS.

Our first question is, understanding the company is waiting to provide a detailed full year outlook. Could you at least help us with any expectations you have around industry demand this year to frame the potential scenarios for the business? And then on that note, if mattress demand remains soft this year, how much further opportunity is there to drive expense savings just given the large absolute amount you guys have realized over the past 2 years?

Yes. Thanks for the question. On industry demand, what we had heard prior to February was that everyone was expecting some industry recovery, maybe a couple -- 2, 3 points this year with the majority of a pressured front half and the growth coming in the back half. It's really how -- similar to how we were thinking about the shape of the year, expecting the front half to be more pressured with easier comparison improvement from initiatives in market in the back half. I suspect if someone were to reforecast at this point, they're going to look at this first quarter and first half with a little more pressure and perhaps be more conservative on the full year as a result.

Dan, I can answer your question, too, as we look toward the rest of the year, we've been managing our cost structure progressively over the past couple of years. We noted, for example, our team member count, for example, is down 34% versus 2021. And our 2-year cost reductions totaled $173 million across '23 and '24, where we took out about half of that being fixed costs, about $85 million of cost in 2023, $88 million in 2024. And those have been broad-based across the business. We're going to continue to operate with additional contingency plans to the extent additional actions are required. And that's certainly a muscle we've built.

Yes. That's across the 4 categories. It's the entire business where we're focused and really led -- it speaks to the commitment and the innovation of the team and led to us delivering a far bigger number with more pressured top line here in 2024 and we expect to continue to perform in that manner.

And maybe just one follow-up for Francis. With the amendments to the credit agreement, is there a revenue base that you can share as a minimum level for 2025 to stay within the new covenants at the end of the year? I know last quarter, it was like $1.7 billion or so. Any update there? Or this will come later?

This will come later. I think it's probably tied into guidance but I'll share that as we arrived at the covenant levels, we factored in our own expectations for the year and it will provide appropriate cushion for us in 2025.

And I would just add to that, Dan, keep in mind that when we said the 1.7, that was based on the covenants returning to that 4.0x EBITDAR level for '25. So we have them graduating down but now the covenant level by the end of '25 would be 4.35x EBITDAR. So obviously, the revenue number would be lower than the 1.7 to stay within the covenants.

And that will conclude our question-and-answer session. I'll turn the call back over to the company for any closing comments.

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

This concludes today's call. Thank you all for joining. You may now disconnect.