Sleep Number - Q4 2023

Transcript

Operator (participant)

Welcome everyone to Sleep Number's Q4 and full year 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. Thank you. You may begin.

Dave Schwantes (VP of Finance and Investor Relations)

Good afternoon, and welcome to the Sleep Number Corporation fourth 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 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.

Shelly Ibach (Chair, President, and CEO)

Good afternoon, everyone, and thank you for joining our 2023 year-end earnings call. My SleepIQ score was 84 last night. While the consumer demand environment remains challenging for our industry, the swift actions we took to improve demand and reduce costs allowed us to make important progress in the fourth quarter. We are continuing to transform our operating model to improve our financial resilience through the broad-based restructuring actions we discussed with you last quarter. As we streamline our cost structure and strengthen our balance sheet, we are poised for accelerating growth as the mattress industry demand environment improves. Importantly, our long-term opportunity remains intact as we lead through this transformation.

During today's call, I'll start with some observations on the industry and macroeconomic environment, then focus my comments on our performance in the three strategic imperatives for repositioning our business, which are: competing effectively, restoring profit margins, and paying down debt. Following my remarks, Francis will provide further details on our 2023 financial results and 2024 outlook. Many of the macroeconomic challenges we discussed during our last call persisted in the fourth quarter. Low consumer sentiment, slower new home purchases, and elevated interest rates continued to pressure demand for our category. Additionally, consumer purchasing power continues its steady downward trend. We estimate that mattress units in 2023 were below 2015 levels and down more than 25% from their 2020 peak.

Per capita spending on mattresses is also nearing historic lows, approaching levels not experienced since 2008-2009 Great Recession. Although we are seeing some indications that the consumer environment may stabilize in the coming year, the mattress industry remains in a historic recession. Considerations like price and perceived value continue to drive consumer purchasing decisions, which remain highly responsive to external factors and events that are disruptive for the mattress industry. This challenging demand environment continued to weigh on our financial results in the fourth quarter, though we slightly outperformed our demand and cost reduction expectations. For the fourth quarter, net sales of $430 million were down 14% from the prior year, with demand down low single digits.

For the full year, our net sales were $1.89 billion, a year-over-year decline of 11%, with demand down high single digits. Against this backdrop, we executed several actions to strengthen our competitive positioning, which is our first strategic imperative. With consumers' heightened focus on price and value and scrutiny of every purchase, we prioritize actions to increase her consideration and conversion. We sharpened our marketing messages to emphasize our differentiated benefits of adjustable firmness and temperature, promoting the value of your best sleep every night and for every budget. We renegotiated with our media partners to improve impressions per dollar spent, optimized the media mix, and reflighted media in Q4, resulting in improved traffic and media ROI. We refined our promotional strategy and selling process to focus on smart beds first, before communicating the additional benefits of our smart, adjustable bases.

This approach is resonating with today's consumer, who is acutely focused on value. Our vertically integrated model allows us to stay close to the customer and adjust our marketing strategy and coordinate our in-store and online experience in real time. We also drove greater brand awareness through our partnership with the NFL. Our Why Choose a Sleep Number Smart Bed campaign, featuring Justin Jefferson and Ja'Marr Chase, increased purchase consideration with NFL fans, who represent approximately half of the U.S. population. Since implementing these actions, our demand trajectory improved significantly to a low single-digit year-over-year decline in the fourth quarter, compared with a double-digit decline in Q3. We also drove positive unit growth on a demand basis in the fourth quarter for the first time since the third quarter of 2021. With this demand performance, we expect that we outperformed the industry in the fourth quarter.

With our second strategic imperative, we are taking steps to reduce costs across our business and restore margins. During the third quarter, we began aggressively executing our contingency plans to align our discretionary costs with the softer demand environment. In the fourth quarter, we established operating mechanisms and tools to accelerate our restructuring efforts and drive sustainable change across the organization. We have initiated dozens of work streams, with program charters, timelines, and weekly reporting to promote accountability, continuous progress, and recognition as benefits are realized. I'm proud of our team's energy and efforts in executing this cost reduction roadmap and identifying and validating new opportunities. Broadly, our cost reduction initiatives fell into four categories: cost of customer acquisition, including streamlining vendors and indirect spend based on capability and cost. Cost to serve our customers, such as condensing services, outsourcing functions, and increasing digital support assets for greater efficiency.

COGS leverage through value engineering, including an exhaustive material cost reduction program, and R&D leverage as we reprioritize R&D spend to accelerate near-term innovation while driving greater efficiency. We are also realizing the benefits of the workforce restructuring actions taken in the fourth quarter, which reduced the number of team members to approximately 4,100 at the end of 2023, 7% lower than in 2019. Together, these efforts enabled us to reduce our operating expenses in the fourth quarter before restructuring costs by $24 million, $5 million more than we had planned. For the full year, we reduced operating expenses by $85 million.

With our team's commitment to the execution of our cost improvement roadmap, we expect $40 million-$45 million of in-year cost reductions in 2024, and expect full year operating expenses to be $125 million-$130 million below 2022 levels. As a result of this restructuring, we will have a leaner, more efficient business model with higher margins and stronger cash flow as industry trends improve. We also remain intently focused on restoring our gross margin rate to our historical average in the low 60s in a normalized demand environment. In 2023, we grew gross margin rate by 80 basis points while navigating a double-digit decline in our net sales as the mattress industry experienced its second consecutive year of recession.

In 2024, we are targeting approximately 100 basis points of gross margin rate expansion from the cost improvement initiatives I highlighted earlier. We expect the mattress industry to remain under pressure in 2024, and our outlook for the year reflects that assumption. Thus, we continue to prioritize liquidity and paying down debt, our third strategic imperative. In the third quarter of 2023, we took steps aimed at enhancing our financial flexibility, including working with our bank group to amend our financial covenants. Reducing our outstanding credit line balance and related financial leverage remain key priorities for us in 2024 and beyond. The actions we have taken to date and have underway are making Sleep Number a stronger, more durable business.

As we realize additional benefits of our cost management strategy in 2024, we expect to generate $60 million-$80 million in positive free cash flow and intend to use this cash to pay down debt. We also expect depreciation to be significantly greater than CapEx. With our focus on cash flow generation and paying down debt, we plan to reduce capital expenditures in 2024 by roughly half to approximately $30 million. 2023 was a challenging year. We have initiated fundamental changes to transform our business, and we have more work to do. That said, our long-term opportunities, supported by our consumer innovation strategy, remain strong. Sleep remains one of the areas in which consumers have the most unmet needs. According to the CDC, 1/3 of U.S. adults report they usually get less than the recommended amount of sleep.

Not getting enough sleep is linked with many chronic diseases and conditions, which threaten our nation's health. In a recent McKinsey Future of Wellness survey, sleep ranked as one of the highest wellness priorities among consumers, who indicated they are looking for data-driven, science-backed solutions that empower them to take more control over their health outcomes. Our competitive advantages, including our connected physical and digital sleep wellness platform, network of millions of Smart Sleepers, vertically integrated operating model, and purpose-driven team member culture, uniquely position Sleep Number to solve the many untapped opportunities related to sleep across the continuum of care. The foundation of our differentiated long-term value proposition in our smart bed wellness is our smart bed wellness platform, which provides an individually customized, adjustable, and responsive sleep experience.

By effortlessly adjusting to sleepers' unique needs, our smart beds help millions of people achieve more restful sleep every night. In fact, 94% of smart bed sleepers report benefiting from better quality sleep compared with sleeping on a non-smart bed. Our innovative technology, supported by a robust portfolio of over 800 patents and patents pending worldwide, is a key differentiator in a consolidating and commoditizing market. These unique assets empower us to protect and take market share even in a difficult environment. Additionally, our proprietary ecosystem of loyal Smart Sleepers continues to grow, reaching nearly 3 million at the end of 2023, and their advocacy of our brand is an important element of our future growth. Our innovation roadmap supports ongoing engagement initiatives within this ecosystem. For example, in the fourth quarter, we integrated our loyalty rewards program and customer support into the Sleep Number App.

In 2024, Smart Sleepers will also be able to shop within the app. Our average monthly engagement rate of 80% is best in class for digital products. This high engagement with our sleep wellness platform increases customer lifetime value and drives lower cost customer acquisition through referrals. Our vertically integrated operating model enables margin efficiency opportunities, which are amplified with scale through our smart bed ecosystem and optimized fulfillment network. Our culture of individuality and well-being, reinforced by our team members' dedication to our mission, is a vital factor in our successful business model transformation, continued innovation, and profitable growth. We are prepared for accelerating growth as the mattress industry environment improves. I am grateful for our team's resilience and strong execution as we work together to build a more sustainable business and capitalize on opportunities to deliver meaningful value for our shareholders.

With that, I'll turn the call over to Francis, who will provide more details on our 2023 financial results and 2024 guidance.

Francis Lee (CFO)

Thank you, Shelly, and good afternoon. As we close fiscal year 2023 and have started the new year, our teams have shown agility and diligence as we work to build a more durable operating model and greater financial resilience. As we navigated a pullback in demand for the industry over the last couple of years, the important actions we are taking will lead to a stronger foundation for our business, which will enable accelerating profitability as the industry backdrop improves. In my comments today, I will focus my remarks in three primary areas: one, review of our fourth quarter and full year results; two, progress we have made in our cost restructuring and impacts to our 2024 financial outlook; and three, key assumptions underlying our 2024 guidance. Let's move on to a review of our fourth quarter and full year results.

Fourth quarter net sales of $430 million were down 14% versus last year. Demand for the quarter was down low single digits and slightly better than our expectations of a mid-single-digit demand decline. Year-over-year changes in backlog drove a majority of the net sales decline. Our fourth quarter gross margin of 56.6% was up 190 basis points year over year and included the benefit from pricing actions taken over the past 12 months and improvement in commodity prices. These benefits are partially offset by increased promotional offers aimed at budget and value-conscious consumers and fixed cost deleverage from a year-over-year decline in delivered units. We also faced year-over-year gross margin rate pressure related to the mix of FlexFit Smart Adjustable Bases, as we had the full good, better, best assortment of FlexFit Smart Bases in 2023.

In 2022, the smart beds portfolio was limited to higher-margin product due to semiconductor chip constraints. We were ahead of plan with cost reduction actions in the fourth quarter, with operating expenses, pre-restructuring costs, down $24 million year-over-year. We are making broad-based cost cuts across the entire business, impacting all areas of our operating cost structure. We recorded $16 million of restructuring costs in the quarter versus our original 2023 estimate of $10 million. This included the acceleration of a few store closures late in the quarter. With the advancement of our cost initiatives, we estimate our 2024 restructuring costs will be approximately $12 million. As a reminder, restructuring costs are reported as a separate line item in our financial statements, and we will continue to provide an as-adjusted EPS figure for comparative purposes.

We generated $18 million of EBITDA in the quarter versus $23 million last year, primarily due to the year-over-year net sales decline, partially offset by a higher gross margin rate and year-over-year operating expense reductions. Our 2023 full year results included net sales of $1.89 billion, down 11% versus prior year, with demand down high single digits for the year. Our gross margin rate increased 80 basis points for the year. We reduced operating expenses by $85 million, or 7% year-over-year, prior to the $16 million of restructuring costs. We reported a full year diluted loss per share of $0.68 and a full year as-adjusted loss per share of $0.14, excluding $16 million of restructuring costs recorded in the fourth quarter.

Adjusted EBITDA declined 14% to $127 million, compared to $148 million last year, driven by the net sales decline, partially offset by a higher gross margin rate and ongoing operating expense reductions. Now, let me discuss in a little more detail the important work we are doing to adjust our cost structure in support of a more durable business model and financial resilience. With the change in demand trends in the third quarter, we have been executing accelerated cost reduction actions across the business to strengthen our financial position as we continue to navigate the ongoing challenging demand environment for the mattress industry. These efforts contributed to the $85 million year-over-year reduction in operating expenses in 2023, and our plans for an additional $40 million-$45 million operating expense reduction for 2024.

This will result in a two-year cost reduction total of $125 million-$130 million. Our operational transformation work is progressing with velocity, and we have established operating mechanisms to promote and build sustainable change across the organization. Each initiative we are implementing has been developed with a projected range of cost improvement and relative risk assessment. Some of the specific cost actions we have taken include: workforce reductions across the organization as we enter 2024, with 25% less team members than in 2021. Reducing our cost to serve customers through service simplification programs, adjusting hours, outsourcing, and increasing digital customer support assets. Given the down market environment, we also seized the opportunity to reduce our store density in selected markets and accelerate the closing of lower-performing stores with natural lease expirations.

This includes closing stores where we had been testing store proximity in selected markets. In each case, we carefully considered the opportunity to transfer sales to other stores in the same DMA or online to minimize lost sales while reducing overall fixed cost-store costs and increasing total DMA profit. We expect the net impact of store closures to be about a 1-point drag to the 2024 net sales growth, and we expect to end 2024 with 25-30 fewer stores compared to 2023. We also continue to drive gross margin improvement actions across the business. These actions include value engineering, material cost reductions, and driving additional efficiencies through our manufacturing and home delivery network. We expect to grow our gross margin rate by approximately 100 basis points in 2024.

As we move into 2025, we expect to realize additional cost savings as we annualize the 2024 cost actions. Now, let me turn to 2024. As Shelly mentioned, we built our 2024 plans on the assumption that the industry does not experience any material recovery in 2024, despite having experienced two years of recessionary demand levels. While the mattress industry is likely at bottoming levels, we feel it is prudent to plan our cost structure on the basis of no improvement in demand levels this year. For our 2024 outlook, we are providing adjusted EBITDA as a primary guidance metric. As we transform our business to a more durable business operating model, we see adjusted EBITDA as the best way to communicate our performance and the earnings power of our business.

Adjusted EBITDA is a key metric we are using to track our transformation progress, and in particular, cash generation to pay down debt. Let me unpack some of the specific assumptions included in our 2024 outlook. The outlook assumes net sales are down mid-single digits for the year, with a low single-digit demand decline. Our net sales guidance assumes 3 percentage points of headwind from year-over-year backlog changes and 1 percentage point from net store closures. We expect net sales to be down high single digits in the first half of the year, based on tougher comparisons, followed by low single-digit growth for the back half of the year. We expect a majority of approximately 100 basis points of gross margin rate expansion in 2024 to be in the back half of the year.

Key drivers include further reductions in our material costs through product value engineering and ongoing supplier negotiations. We are also expecting benefit from further optimization of our fulfillment network, including facility closures and using temporary labor where it makes sense. Headwinds for the year include fixed cost deleverage from slightly declining delivered units for the year. We expect operating expenses to be down $40 million-$45 million versus last year, with the cost savings spread across the P&L. We are estimating restructuring costs of approximately $12 million to be incurred in 2024, with approximately $10 million of the costs falling in Q1. We expect interest expense of approximately $45 million for the year. The above assumptions support our Adjusted EBITDA outlook range for the year of $125 million-$145 million.

We remain intently focused on liquidity and balance sheet strength, and expect to meet our liquidity needs for 2024 from operating cash flow and our existing credit facility. We expect to generate $90 million-$110 million of operating cash flow, with $30 million of planned capital expenditures. This results in $60 million-$80 million of free cash flow for the year, which we intend to use to pay down our credit line. Working capital changes are expected to be a source of cash in 2024 versus a significant use of cash the last two years. We expect non-cash charges to be a combined $90 million or similar to 2023 levels. We also want to provide some clarity regarding our first quarter 2024 performance expectations.

We are expecting net sales to be down approximately 10% versus the prior year's quarter, including 3-4 points of headwind from year-over-year backlog changes. We expect first quarter adjusted EBITDA to be just over $30 million. Our outlook for 2024 provides appropriate clearance against the revised bank covenants put in place last quarter. The new bank agreement and related covenants have provided increased flexibility to enable us to restructure the business and navigate the demand environment in 2024. We expect our debt to EBITDA leverage to peak in Q2 of this year and end the year below 3.75x, under our covenant levels. As the industry recovers, we see a significant opportunity for our business to accelerate.

By building a more durable operating model with greater financial resilience, we are transforming our business to deliver profitability and free cash flows across the highs and lows of the mattress industry cycle. We are at a cycle low right now and expect to generate $60 million-$80 million of free cash flow this year. As we continue to benefit from the cost optimization initiatives underway, we expect our gross margin rate to return to 60%+ and low double-digit EBITDA margins as industry unit trends return to more normalized levels. With that, Lisa, please open the line for questions.

Operator (participant)

Thank you, sir. And everyone, if you would like to ask a question today, please press star one on your telephone keypad. Once again, that is star one if you have a question. We'll take the first question from Bobby Griffin, Raymond James.

Bobby Griffin (Director)

Good afternoon, everybody. Thanks for taking my questions.

Shelly Ibach (Chair, President, and CEO)

Bobby-

Bobby Griffin (Director)

And appreciate all the detail, all the details given, around the moving parts for 2024. So I guess first, when we spoke last, we were talking about some of the store closures to, to strengthen the store portfolio. And maybe you've done a few so far, so can you, can you give us a little detail on what you're seeing on recapture rates as you're closing some of these stores?

Shelly Ibach (Chair, President, and CEO)

Yeah, Bobby, thanks for the question. You know, first, it's early on that, but what we have is a very detailed store transfer strategy to be able to capture those sales and expect, you know, approximately 45%-50% of the sales to transfer. We, you know, focus on the total DMA and positive profitability for the DMA. And we've, you know, we have a lot of historical experience on store transfer. And then, you know, over the years, as we've been executing our portfolio, you know, to keep a very current retail strategy of stores and online, you know, we look at the DMAs, we relocate stores, you know, we understand how to, you know, capture the consumer digitally and pull her through and develop relationships.

You know, we're bullish on what we can do here, and therefore expect, you know, only one point of pressure due to our net stores this year.

Bobby Griffin (Director)

Okay. That's helpful. And I guess, Shelly, maybe to kind of step back and talk a little bit on 4Q and some of the changes you've got put into place. I mean, pretty notable change in where the demand was. I think we ended 3Q running down low double digits and then ended 4Q running down low single digits. So can we talk about the progression and what you saw as you kind of moved some of the advertising or different initiatives? Because that is a pretty sizable change against comparisons that were roughly about the same last year.

Shelly Ibach (Chair, President, and CEO)

Yeah, thanks. Thanks, Bobby. You know, we did make better progress in both generating demand and reducing costs than we had expected in the fourth quarter. You know, regarding demand, you know, it was about strengthening our competitive positioning. You know, we had a low single-digit decline for the quarter. Pretty consistent performance across the three months. And, you know, we took many actions, integrated actions, in the back half of at the end of September and heading into October, which it focused on messaging, media, selling process, and promotions. And, you know, these, the integrated work led to improved brand metrics and also, you know, traffic and media ROI and therefore our demand performance.

Bobby Griffin (Director)

How is, I mean, how has the demand trended so far in 2024? You know, there's been a lot of comments out there that the industry unfortunately took a step back in, in January with some winter weather as well as February. So just curious if you can kind of tell us how things are trending, year to date for you.

Shelly Ibach (Chair, President, and CEO)

Sure. You know, this speaks to the highly reactive consumer that I spoke about in my prepared remarks. You're right. You know, it's been widely reported that January demand trends for the mattress industry were very challenging, including the weather impact, but it was also a pullback in spending across the category, and we saw that from the consumer and, you know, probably tied to purchasing power. We were also impacted by these same factors in January and had a double-digit decline in January. February has returned to a low single-digit decline for us, including a low single-digit growth over the President's weekend, which, you know, I think is probably a little better than, you know, what I'm hearing for the industry.

We're forecasting Q1 demand to be down mid-single digits, with Q1 net sales down 10% year-over-year. Then in the back half of the year, we expect a low single-digit growth as we lap easier compares, particularly against Q3.

Bobby Griffin (Director)

Okay. I appreciate that detail. I'll jump back in the queue and turn it over to others. But thank you, and best of luck here.

Shelly Ibach (Chair, President, and CEO)

Thank you, Bobby.

Operator (participant)

A reminder, it is star one if you would like to ask a question. We'll go to Brad Thomas, KeyBanc Capital Markets.

Brad Thomas (Managing Director)

Hi, good afternoon. Thanks for taking my question. Shelly, I was wondering if you could just talk a little bit about some of the product and promotional strategies you think might be most effective for you all in this current backdrop. What, if anything, are you planning to do from a product standpoint, and how much of the line might be changing out there this year?

Shelly Ibach (Chair, President, and CEO)

Hi, Brad. Thanks. You know, I'll start with our consumer innovation strategy, you know, which, you know, reshapes really what it's consumers should be expecting out of their bed. You know, we, you know, we see our smart bed, our smart bed platform continuing to set pace for this category and certainly for the consumer. We continue to have value-added solutions that not only deliver the highest quality sleep. You know, our platform also has the opportunity with digital innovation to solve many untapped opportunities in the future around, you know, sleep and the continuum of care. So, you know, we continue to focus on setting pace there, and we'll compete aggressively in this marketplace to, you know, to win the consumer with delivering the highest quality sleep.

You asked specifically about some of the messaging and promotion strategy that's resonating and, you know, we still are operating with a scrutinizing consumer in the marketplace, and we worked on, you know, took a lot of actions in the third and fourth quarter to be able to refine our messaging, to be able to re-reach this consumer, you know, break through with a strong value equation. And, you know, we're, we're liking what we're seeing. And I think, you know, as we competed here in the month of February and over the President's Weekend, we're seeing the advancement of our work from Q4, you know, to effectively reach the consumer.

Specifically, you know, this is one of the advantages around our vertical model, where we're able to integrate our plans and look at total variable margin, inclusive of promotional dollars, financing, and media investments, and structure our promotional plan accordingly, being able to, you know, manage discounts in a way that drives higher mix... which we're seeing, as well as, you know, attach and overall, you know, focused on optimizing our variable margin and still delivering media efficiency in a challenged environment.

Brad Thomas (Managing Director)

That's helpful, Shelly. And just to follow up on that, you know, I don't know that we can totally tell as we look through some of the items you disclosed, 'cause there's some issues with comparability and everything, but you know, ARU ticked down a little bit from where it's been the last several quarters. Gross margins up, but the comparisons, you know, play into it. And then you mentioned the units, you know, going positive. I guess all of this maybe implies that you got a bit more promotional here. Is that accurate? Did you get more promotional? And is that gonna be a strategy that you push on more in 2024 to drive the business?

Shelly Ibach (Chair, President, and CEO)

Yeah, thanks for asking those, you know, additional specific questions. We did in Q4, you can see that in our ARU, and then, as you noted, you know, units were positive and offset that. You know, but for us, even though ARU was up, we were a few hundred below what where we were forecasting. And we've continued to iterate and, you know, really happy with the progression since that time. And, you know, right on, you know, what we would expect right now in February, and for the President's Weekend, where, you know, we're, you know, seeing some, you know, some good movement in ARU, and at the same time, you know, having units fairly flattish. So, you know, it's advancing. And at, you know, if you look at...

I think specifically for the President's Weekend, if you look at our discounts, you may look at it by model and say, "Oh, the discounts are higher," but that was designed to drive mix up. So again, you know, fully loaded, variable margin, using discounts to drive mix, using financing differently. We look at discounts and financing as a total bucket. You know, we actually have year-over-year reduction in dollars and in some, you know, favorability in the variable margin.

Brad Thomas (Managing Director)

That's very helpful, Shelly. Thank you so much. I'll turn it over to others. Good luck.

Shelly Ibach (Chair, President, and CEO)

Thanks.

Operator (participant)

Then we'll go back to Bobby Griffin, Raymond James.

Bobby Griffin (Director)

Hey, guys. Thanks for letting me back in here. Shelly, just to clarify, the positive unit comment in 4Q, is that on a demand basis, so excluding the moving parts with the backlog year-over-year?

Shelly Ibach (Chair, President, and CEO)

Yes, demand basis. Thank you for-

Bobby Griffin (Director)

Okay.

Shelly Ibach (Chair, President, and CEO)

Thank you for clarifying that.

Bobby Griffin (Director)

Yeah, okay.

Shelly Ibach (Chair, President, and CEO)

My comments here about, you know, ARU and demand and our current performance here in the quarter, it's all demand related.

Bobby Griffin (Director)

Okay, that's helpful. And Francis or David, is the backlog comparison largely just a 1Q and, or 1Q issue, or is it gonna impact all the quarters in 2024?

Francis Lee (CFO)

Hey, Bobby, thanks for asking. We have the backlog comparison will largely impact the front half of the year and be weighted toward Q1 for 2024.

Bobby Griffin (Director)

Okay. And then I want to circle back, I think-

Francis Lee (CFO)

Bobby, Bobby, I'll just add to that.

Bobby Griffin (Director)

Yeah.

Francis Lee (CFO)

So if you think about the first half of the year, we're probably looking at about, as Shelly said, a 3-4 point drag on net sales growth year-over-year with the backlog changes. The back half of the year, it's probably less than 1 point the way we see it now.

Bobby Griffin (Director)

Okay, just pure backlog headwinds. Okay.

Francis Lee (CFO)

Yeah, pure backlog headwinds. It's exclusively really focused on the first half of the year.

Bobby Griffin (Director)

Okay. And then the second part is that part of the reason the gross margin progression is kind of different than maybe we would have expected with all the expansion in 2H? Or is there some other things going on inside gross margins that are impacting the timing throughout the year?

Francis Lee (CFO)

Yeah, I think the underlying gross margin shifts will be largely to the timing of some of these cost initiatives that we're putting in place through the the work and the programs that we've put, been putting in for our cost improvement and profitability improvement overall. I'll say that, you know, I've been here for several months now, and as a new CFO, one of my top priorities is to build a more durable operating model. And we've left no stone unturned as we look across all elements of our cost structure and with Gross Margin and the initiatives we're putting in place. Some of those will take hold at in the second half of the year and be annualizing and give us even more benefit in 2025.

Bobby Griffin (Director)

Okay. And then I guess lastly for me is just, you know, you guys are tightening up on CapEx to drive cash flow and pay down debt, and that, you know, obviously is the right strategy. Just curious, what is getting pulled out of CapEx to see it go down to $30 million versus some of the historical rates? What are we deferring and, you know, things like that?

Francis Lee (CFO)

Yeah. Our CapEx is around $30 million this year. It's about half of what it's been in the last couple of years. In addition to store closures, we're also being more thoughtful about store openings. And we're focusing the rest of the CapEx on some critical tech spend for our key systems.

Shelly Ibach (Chair, President, and CEO)

I would

Bobby Griffin (Director)

Okay

Shelly Ibach (Chair, President, and CEO)

... just add, so it's really a slowdown, a slowdown of, of-

Bobby Griffin (Director)

Mm-hmm

Shelly Ibach (Chair, President, and CEO)

... store expansion and a slowdown of, you know, some of our infrastructure.

Bobby Griffin (Director)

Okay, that's helpful. That's what I was looking for. I appreciate you guys letting me ask some additional questions. Best of luck here in the first quarter.

Francis Lee (CFO)

Thank you.

Operator (participant)

At this time, there are no further questions. I'll hand the call back to the management team for any additional or closing remarks.

Dave Schwantes (VP of Finance and Investor Relations)

Thank you for joining us today. We look forward to discussing our first quarter 2024 performance with you in April. Sleep well and dream big.

Operator (participant)

Again, everyone, that does conclude this conference. Thank you for your participation.