Sleep Number Corporation (NASDAQ:SNBR) Q2 2024 Earnings Call Transcript

Sleep Number Corporation (NASDAQ:SNBR) Q2 2024 Earnings Call Transcript July 31, 2024

Operator: Welcome to Sleep Number’s Q2 2024 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. Dave, you may begin.

Dave Schwantes: Good afternoon and welcome to Sleep Number Corporation’s second 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 Shelley 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. We also want to refer you to the updated version of our investor presentation, which is available on the Investor Relations section of our website. I will now turn the call over to Shelly for her comments.

Shelly Ibach: Good afternoon, everyone, and thank you for joining us. My SleepIQ score was 86 last night. In October of last year, we communicated plans to transform our operating model to improve financial resilience and profitability in a range of economic environments. These transformative initiatives, coupled with the industry-leading innovation we continue to bring to market, position us to accelerate our performance and profitability as the industry recovers. Through the first half of 2024, we are slightly ahead of our expectations for both gross margin rate expansion and adjusted EBITDA, despite facing a tougher sales environment than we anticipated. My comments today will highlight the actions we are taking to improve our operating margins and generate cash to pay down debt, the financial results of our actions, including the favorable impact on both near-term performance and the long-term durability of our operating model, and the ongoing intense focus we have on recalibrating our business for the difficult demand environment that the bedding industry continues to face.

As a reminder, we previously communicated 2024 full-year financial targets related to restoring our margins, which included adjusted EBITDA of $125 million to $145 million, additional operating cost reductions of $40 million to $45 million, which are on top of the $85 million of reductions we delivered in 2023, and approximately 100 basis points of gross margin rate expansion. We are on track with each of these goals. Through the first six months of 2024, we reduced operating expenses $44 million versus the prior year. We drove 60 basis points of gross margin rate expansion year-over-year, and we generated $9 million of free cash flow as planned, a $21 million improvement from last year. Our better-than-expected adjusted EBITDA for the first half of 2024 was driven by sustainable improvement in our cost base across our operations, including reductions in material cost, efficiency improvements in our logistics and fulfillment networks, and reductions in operating expenses supported by lower store operating costs and ongoing diligent G&A expense management.

We are aggressively managing four principal areas that are within our control, including cost of acquisition, cost to serve, cost of goods sold, and G&A R&D leverage. Cost of acquisition is benefiting from greater precision in media and promotional investment, driven by expanding our AI-based models into our sales decision tools and further segmenting our media targeting to deliver more efficient demand generation. In cost to serve, we have outsourced select operational activities and further leveraged third-party expertise in information technology and services. These operating model changes give us additional flexibility in supporting peak volumes in our customer contact centers and home delivery operations. In cost of goods, we have driven efficiencies in our procurement process, manufacturing, and end-to-end fulfillment by introducing new best-in-class operating practices based on extensive assessments and cost controls.

In G&A and R&D expense management, we have incorporated additional rigor to streamline our organizational design, remove inefficiencies, and increase productivity. All these initiatives are contributing to our ability to achieve our 2024 EBITDA and cash flow targets. When market growth inevitably returns to normal levels, the important business improvements we are now implementing will enable us to capitalize on our innovation leadership and accelerate our profitable growth, delivering increased value to shareholders. The mattress industry demand environment remains challenging amid low consumer sentiment, a notable decline in home sales, and pressures on consumer purchasing power that include higher cost-of-living and interest rates that are reducing personal savings, tight consumer credit, and uncertainty related to geopolitical events and the upcoming U.S. election.

With pinched wallets, consumers are spending more on essential items like food and clothing while reducing or delaying purchases of discretionary, durable items such as furniture and home furnishings. Mattress industry sales for 2024 are estimated around 25 million mattress units compared to a normalized level of about 32 million units based on long-term history and per capita spending trends. Our second quarter demand performance represents a slight sequential improvement from first quarter. These results remained more pressured than we expected and were largely aligned with the reported industry trends. The scrutinizing consumer continues to concentrate their purchases during holiday promotional events like Memorial Day. As a result, we delivered both sales and unit growth in May, which was our strongest demand month since the start of the industry recession in February 2022.

Based on our first half demand performance and current industry and economic forecast for the remainder of the year, we now expect our demand in the back half of the year to be flat to down low single digits versus our prior estimate of low single digit growth. This outlook still represents a sequential improvement from our first half demand performance, which was down mid-single digits. We expect this improvement to result from easier compares, especially in the third quarter, higher media investments than the first half, and other demand driving initiatives we’ve implemented and honed over the last three quarters. These media and selling strategies are focused on leading with differentiated benefits of our superior innovations, including adjustable firmness and temperature, starting at a value-orientated cost of $9.99 with our c1 Smart Bed, amplifying our differentiated Smart Bed message, applying our model’s predictive capabilities to shift investment efficiently into higher traffic driving media, activating our loyal customer base for increased referral and repeat sales through social advocacy, and driving conversion through improved sales training and execution excellence focused on our relationship-based approach.

As we enter the fourth quarter, we also expect to benefit from the introduction of an exciting new Smart Bed called ClimateCool, which addresses a specific sleep need of customers. More than two-thirds of Sleepers report sleeping too hot or experiencing temperature fluctuation during the night. The new ClimateCool Smart Bed that builds on our successful Climate360 Smart Bed technology actively cools by drawing warm air away from your body. This is very different than competitors’ products that push air through warm foam or use water to cool. In fact, the ClimateCool Smart Bed cools over 20 times faster than competitors’ products. And like our Climate360 Smart Bed, ClimateCool effortlessly adjusts and actively cools up to 15 degrees on each side of the bed for each sleeper’s ideal firmness and sleep temperature.

Additionally, the ClimateCool Smart Bed features scientifically proven cooling program routines, which are designed to provide deeper, more comfortable sleep. Sleepers can choose from these cooling programs, or they can personalize for their needs. Sleepers will also be able to see the results in their Sleep Number app, along with other sleep health insights. Our teams accelerated the commercialization of this revolutionary innovation to the fourth quarter of this year as part of our margin improvement initiative. In the current pressure demand environment, we are forecasting sales of ClimateCool to come primarily from positive mix shifts, which we expect to contribute 20 to 30 basis points of accretion to our fourth quarter gross margin rate.

The queen size ClimateCool Smart Bed with integrated base will be priced at $54.99. Our extensive analytical rigor and deliberate business improvement actions are restoring margins and generating cash despite a persistently prolonged mattress industry recession. While 2024 demand remains pressured, our gross margin improvement supports our full year adjusted EBITDA guidance range of $125 million to $145 million. In our updated investor relations presentation available on our website, we illustrate the significant upside we expect for Sleep Numbers business as the mattress category recovers. Industry units have contracted to 2016 unit levels and are currently around 6 million to 7 million units below expected consumption levels. With the actions we’ve taken and assuming the industry returns to normalized demand levels of nearly 32 million units, we would expect to realize more than $500 million of incremental net sales and about $175 million of incremental adjusted EBITDA compared to current performance levels.

In a more normalized mattress industry environment, the actions we have taken to transform our operating model position us to achieve adjusted EBITDA margins in the mid-teens and free cash flow of more than $200 million annually. I want to express my deepest appreciation to our Sleep Number team for your tenacity and ingenuity in navigating this challenging environment and for your shared belief in our purpose. Your commitment and strong execution of our operating model transformation has resulted in sustainable cost and gross margin improvement. Now Francis will provide additional details about our performance and outlook for the year.

Francis Lee: Thank you, Shelly, and good afternoon, everyone. Our team continues to drive efficiencies throughout the business as we build greater durability and financial resilience into our operating model. These intensive efforts have led to both operating expenses and gross margin rate performance coming in better than expected for the quarter. We also drove improved cash flow for the first half of the year with free cash flow of $9 million, $21 million higher than prior year’s first half, even with pressure from the year-over-year net sales decline. Now let’s turn to a review of our second quarter results. Second quarter net sales of $408 million were down 11% versus last year and were a couple of points below our expectations.

Our net sales growth for the quarter included a mid-single-digit demand decline and six points of headwind from year-over-year backlog changes. Our delivered units decreased 8% for the quarter with our ARU down 3% versus the prior year. We remain intently focused on restoring our gross margin rate to higher levels as evidenced by the 59.1% gross margin rate delivered in the second quarter. This was up 150 basis points versus the prior year’s second quarter and ahead of our expectations. Some of the specific drivers of our year-over-year improvement for the second quarter included cost of goods sold reductions through product redesign, including reducing the number of parts for selected components, ongoing supplier negotiations for all material components.

For example, we redistributed our phone business across our partners, resulting in product cost reductions. Year-over-year cost efficiencies in our home delivery and logistics operations, including implementing a flexible labor model in our home delivery operations with the use of more external delivery partners providing cost savings and increased flexibility for peak volume periods. We have also leveraged fixed assets such as our home delivery trucks as freight shuttles during low volume periods, yielding net lower logistics costs. In addition, we switched our primary parcel provider, resulting in significant cost savings. The progress we have made in the first half of the year positions us well for a gross margin rate approaching 60% for the back half of this year.

We also made meaningful progress in reducing our operating costs, which were down $19 million versus the prior year’s second quarter before restructuring costs and down $44 million year-to-date. Cost reductions have been broad-based, including a year-over-year reduction in media, lower selling expenses as we benefit from a net store count reduction, and reduced R&D spending. We have achieved these cost reductions through systematic scrutiny and reset of our cost base across our entire operations with active cross-functional engagement throughout the company and external benchmarking. Here are some specific examples of the transformation initiatives we have taken. We expanded our self-service customer content, saving over $5 million annually.

We also rationalized technology tools used across the business to reduce total vendors and deliver $1 million of annual savings. Our R&D teams have further streamlined their costs while also supporting gross margin rate improvement initiatives. We anticipate operating expenses for the back half of the year to be in line with the prior year’s second half as we lap significant cost reductions in the back half of last year and increase our funding of media. We generated $28 million of adjusted EBITDA in the quarter compared with $35 million last year, with a year-over-year decrease due to the decline in net sales, partially offset by a higher gross margin rate, and $19 million of operating expense reductions. Our second quarter adjusted EBITDA was slightly ahead of our expectations despite net sales being a couple of points below plan.

We continue to focus on maximizing adjusted EBITDA and cash generation as demand for our category continues to bounce around bottoming levels. For the full year, we now expect free cash flow of $50 million to $70 million, which we intend to use to pay down our credit line. This is a $10 million decrease than our prior expectations, primarily due to our reduced sales guidance, which negatively impacts our working capital expectations for the year. Our updated outlook implies $40 million to $60 million of free cash flow for the second half, with an expectation of higher net income in the back half of the year, as well as expected benefit from working capital changes coming off of seasonally low levels at the end of Q2. Turning to our 2024 outlook, we are reiterating our 2024 full year adjusted EBITDA outlook range of $125 million to $145 million.

Here are a few items to highlight regarding our expectations for the remainder of the year, including some specific color about third quarter. We expect net sales to be down mid-single digits for the year. For the back half of the year, we expect both demand and net sales to be flat, to down low single digits versus the prior year, as we lap easier comparisons and benefit from demand-driving initiatives. Our full year net sales guidance continues to assume 3 percentage points of headwind from year-over-year backlog changes, and 1 percentage point of headwind from lower average store count. We expect at least 100 basis points of gross margin rate expansion in 2024, with the gross margin rate expected to approach 60% for the back half of the year.

We expect $14 million of restructuring costs for the year, with less than $2 million expected for the balance of the year. We continue to expect capital expenditures of approximately $30 million for the year, down nearly 50% from the prior year. Turning to third quarter performance, we are expecting net sales to be down low to mid-single digits versus the prior year’s third quarter, with demand flat to down low single digits and with three to four points of headwind from year-over-year backlog changes. We expect third quarter adjusted EBITDA to be $25 million to $30 million. We also want to provide an update on how we are performing against our bank covenants. Our debt-to-EBITDA ratio was 4.4x at the end of the second quarter, compared to our covenant maximum of 5.5x for the quarter.

We continue to expect our debt-to-EBITDA leverage to improve the balance of the year and end of the year below 3.75x. This includes a meaningful improvement in our trailing 12-month adjusted EBITDA, as we benefit from year-over-year improvement in our gross margin rate. As we look forward, here’s some context on how to think about our covenants in 2025. Starting in Q1 of next year, our covenant maximum will be 4.0x, and we expect to be below 3.75x entering the year. For illustrative purposes, with the changes to our cost structure and gross margin rate advancements, we would expect to remain within our leverage covenants through 2025, even if there were no material improvement in the current recessionary demand environment for our category.

Based on our current cost structure, we would require minimum net sales of approximately $1.8 billion to stay below our 4.0x covenant maximum in 2025. While the demand environment has remained soft, we continue to drive operating efficiencies in both costs of goods sold and operating expenses to maintain our full-year adjusted EBITDA guidance. We continue to maintain maximum flexibility and optionality to navigate alternative demand environments. I want to thank the entire Sleep Number team who are transforming the business and positioning us to achieve profitable growth when the demand environment improves. With that, Operator, please open the line for questions.

Q&A Session

Operator: We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from the line of Bobby Griffin with Raymond James. Bobby, your line is now open.

Bobby Griffin: I guess, Shelly, first, I wanted to maybe talk about the higher media spending. Can you just talk a little bit more about how you guys are planning the spending in light of the election coming up? And maybe if you have the data on you, kind of give us some context of how the category and kind of media trended four years ago, and just to help us kind of put all that together about the election cycle and what that could do for your media side of things.

Shelly Ibach: Great. Well, you know, the election and the media remains a bit of a volatile process in itself. But let me take a step back and talk about our media spending here in the first half and how we’re approaching the second half and overall how we’re approaching and running the business for demand in this environment. So for the first half, our media spend was down 8%. And as we approach the second half, we intend to spend media levels that are flat to prior year. So that’s an increase for us from first half of the year and how we’re spending in media. Having said that, we are focused on prioritizing media that is most effective and most efficient using our tech enabled tools that we’ve talked about. And we’re also focused on when the consumer’s there and when she’s not.

So we’re prepared to deploy increased media if the consumer is there and she’s responsive. And we will also pull back on media if she’s not. And that transpired in June. I think June or second quarter was a great example where we leaned into media during the Memorial Day event when the scrutinizing consumer was there. She is highly responsive to discounts and value right now. And we leaned in and we drove growth in both sales and units. And as we moved into June following the market share period, she disappeared. It was a very weak customer consumer environment, and we pulled back on our media. And, therefore, April and June were pretty similar at, down mid-single digits. And that’s where we ended the quarter. As we move into the back half, we expect to be flat to down low single digits from a combination of initiatives.

How we’re applying media, the easier compares, especially in Q3, and advancing the demand initiatives that we talked about. And, of course, we have our innovation leadership with ClimateCool in the fourth quarter, which is also the timing of the election, we recognize that. As I mentioned, we’re really looking at ClimateCool as a mixed shift is how we’ve built it into our expectations for the back half. Driving 20 to 30 basis points of growth margin improvement in the fourth quarter. Back to your media point around overall election. We’re going to be very agile. We have to be. And that’s how we approached it four years ago with agility and plans and contingency plans and managing this very, very closely so that we can be effective and efficient with our spend.

Bobby Griffin: Thank you. I appreciate the extra details, too, about kind of how the quarter played out. That was actually one of my questions. I guess maybe next up for me then is probably for Francis or Dave. Just kind of on the, I appreciate the details on 3Q, but the shape of the year is a little bit different than kind of consensus was modeling 3Q, let’s say. So, can you talk through kind of the big step up that you guys are implying for 4Q EBITDA and some of the drivers on that and just help us kind of unpack that kind of back end or kind of 4Q weighted side of getting into the guidance?

Francis Lee: Hey, Bobby. Yes, we can get into that for sure. Our second half outlook for our adjusted EBITDA has us flat with our guidance for the full year that we’ve outlined before. And that’s really driven by a couple of things. As we mentioned, we have gross margin rate improvement that we’ve seen in the first half and that we’ll continue to see go into the second half. And then we’ve got some increased media spending, as Shelly mentioned, which is driving the overall EBITDA story. When we look at Q3 and Q4, there’s some timing of demand that based on being closer to the half that we’ve just reshaped some of the outlook. I’ll turn to Dave and see if he has any additional commentary versus the guidance that you were asking about.

Dave Schwantes: Yes. So Bobby, I think one of the notable things is really around, I’ll say the marketing. So, we are going to be spending, our heaviest marketing is usually in Q3 to support the Labor Day event. And so, again, as Shelly said, we’re looking at our media to be somewhat flat year-over-year for the back half of the year. And I think Francis alluded to it, but if you think about some of the demand that we’re going to drive during the Labor Day event, which is our Super Bowl, it’s going to be delivered in the fourth quarter. So, you are going to see some movement there in terms of ultimately where that demand goes. And you should see a pretty big differential, if you will, in terms of that total sales and marketing expense that should go from Q3 to Q4.

So, based on our guide, the guide we provided of 25 million to 30 million for Q3, it is specifically signaling that we do expect Q4’s EBITDA to be a little stronger than Q3’s. And I would largely chalk that up to just some of that demand that’s going to be fulfilled in Q4 that we generate in Q3.

Bobby Griffin: Thank you. I appreciate the details there, and I’ll turn it over to somebody else. Best of luck here for the rest of the year.

Operator: Your next question comes from the line of Peter Keith with Piper Sander. Peter, your line is now open.

Alexia Morgan: Hi, this is Alexia Morgan on the line for Peter Keith. Thanks for taking our question. You said that consumer demand in the industry remains pressured, but we were curious on strength across your different pricing bands. Are you seeing any deviation in units or in demand between the higher-priced items and the lower-priced products?

Shelly Ibach: Thanks for the question, Alexia. Nice to meet you. We introduced the c1 in June, and that certainly played a role in our mix. We were happy with how it mixed and how the c-series mixed in the second quarter, but we were also up against the closeout of the c-series from prior years. So certainly a better margin profile this year on our c-series, but some unit pressure overall as we left the closeout. So when we think about our different series, we had positive margin from our mix overall in the second quarter. So we continued to see the initiatives that we’ve been driving the last three quarters play out and helping us move the consumer, once she’s in the store, up the line and to where we’re benefiting from a margin perspective.

Alexia Morgan: Great, thank you. And then one more. How did demand trend throughout the quarter, and has there been any change? Well, I know you talked about your view on the state of the consumer, but how did sales kind of end in the quarter, and then how are sales trending quarter-to-date?

Shelly Ibach: Yes, the shape of Q2 was very similar to the shape of Q1. In the first half, the two strong months were the market share months, the months where we had the big holiday, and that was February and May. And the other months, the shoulders of the market share events, remain weak. The scrutinizing consumers certainly focused when we have the best offers. We’re seeing that in our business, and from everything I’ve read on the industry reports, that’s what the industry is experiencing as well. So we, as I mentioned before, April and June were very similar down mid single digits, and that’s where we were for the quarter on demand. And we did have a couple points of sequential improvement from Q1, but obviously still pressured overall.

And we saw similar consumer behavior in the month of July, where July 4th was early on in the month into smaller holiday, small part of Q3, but positive July 4th, weak. And then the consumer is very weak in her activity following that event and period. And we’re looking forward to our big market share here in the third quarter, which is a large part of August and September.

Operator: Your next question comes from the line of Brad Thomas with KeyBanc Capital Markets. Brad, your line is now open.

Brad Thomas: Just a few housekeeping items, maybe more for me, if I could squeeze in a few here. The first, Shelly, I was wondering if you talked a little bit about the current outlook for stores, and how you’re thinking about potentially some incremental closures, and what, if anything, you’re seeing in terms of benefit to profitability, if you’re seeing a favorable transfer rate to other stores in the market. Just an update on how you’re seeing the benefit from those closures playing out.

Francis Lee: Hey, Brad, this is Francis. I’ll answer your stores question. We entered our Q2 with 646 stores, and we ended last year at 672. We’re progressing on our store closures. We don’t have a lot more to be at the targeted store zone where we said we would be. In terms of our performance overall, we’ve seen net transfer sales rates that were in excess of our plans. And so that certainly is a positive, both for our total sales as well as our profitability, because we’re getting more comp store sales profitability out of that type of performance.

Brad Thomas: That’s helpful, Francis. Just as a follow-up on that, has the company undergone a more rigorous real estate review at this time, when perhaps maybe pushing towards profitability that might be obtainable here with incremental closures, perhaps an analysis that hadn’t been done in some time? From having covered the company for a number of years, my recollection was there were some pretty positive benefits from a similar undertaking about 15 years ago.

Shelly Ibach: Brad, I’ll start and let Francis add on here. Just going back in time, this is a very different situation than when we rationalized our portfolio back in 2008 to 2010. At that time, we were 98% small. Average revenue was under $1 million, where right now our retail portfolio in total is very profitable. And our stores average, I think our trailing 12 months is $2.7 million. So when we embarked on this endeavor in the second half of last year, we scrutinized the portfolio with the lens of thinking about our cost structure and taking advantage of timing to be able to rationalize the portfolio of any closures that we intended to have in the coming 12 to 24 months. But, overall, we were faced with a very healthy portfolio.

This is an ongoing process of rigor that we have built into our regular management of our retail portfolio. That’s why we have such a healthy one. We do a lot of repositions every single year because the consumer and the marketplace moves in each DMA. We want to be where the consumer is and where the shopping is. And so we keep our real estate portfolio very healthy as a result of that. And when we do repositions, we get a nice lift with that. And that kind of movement has continued this year. So it’s a very different situation than we were in before.

Brad Thomas: That all makes sense, Shelly. That’s helpful to hear. I think I was just trying to extrapolate on the comment that the transfer rates ended up being favorable, that perhaps there might be a greater opportunity ahead here as you look closely at this. In any case, moving on to my next question around your partner, Synchrony, there have been many in the financial sector that have kind of talked about some incremental tightening. I was wondering if you could just comment a little bit about what you’re seeing out of Synchrony, if that’s something that’s a headwind for your business that’s different than maybe the way you would have thought about it three or six months ago, and just what you’re seeing as you rely on them as a key partner.

Francis Lee: Hi, Brad. Synchrony is a great partner of ours, and we certainly appreciate working with them. Overall, there’s no material impact to financing overall with Synchrony or with the current environment, so there’s no substantive changes to report there.

Shelly Ibach: Brad, we also have, as you know, a very high-quality customer base with Synchrony, so we over-index in their portfolio in a very favorable perspective from that aspect.

Brad Thomas: Got you. That makes sense. Okay. Thank you so much. I appreciate it.

Shelly Ibach: Yes. Brad, I wanted to comment, when you gave a little more color about your store question. Some of the closures that we took action on were some of the tests that we had been driving on density. So with our real estate portfolio, we’re always pushing against our assumptions and testing different aspects, and that certainly probably contributes to positive transfer rates as we took out numerous tests where we were pressing on density.

Operator: Your next question comes from the line of Michael Lasser with UBS. Michael, your line is now open.

Dan Silverstein: Good afternoon. This is Dan Silverstein on for Michael. Thank you so much for taking our questions. We just had two questions on how to think about how recovery plays out for both the industry and Sleep Number. How do you view the return to that long-term unit growth rate of 1% in the investor deck playing out now that we’re close to four years of consecutive unit declines? And then just related to that, how much of the operating expense savings that Sleep Number has driven recently do you view as structural versus there’s some areas you would need to reinvest in as the category backdrop improves? Thank you.

Shelly Ibach: Yes. Great questions. You’re asking about fixed and variable as we begin to recover, as Francis will cover that. You also asked about how we see that recovery as we approach the fourth year next year. Yes, we are anxious, and it’s certainly inevitable that we will return to growth in this industry and taking a pretty conservative view on page 29 of our IR deck showing that from ’05 to ’19, the industry grew about 1% in units. And so if we simply hold our share, it assumes $500 million in sales and $175 million in EBITDA, and we give an illustration there. With our transformation, we expect to be able to have increasing profitability with mid-teen EBITDA, and I mentioned the free cash flow of over $200 million annually along with that.

So certainly puts us in a much more favorable position with our transformation. Our transformation, the actions we’re taking, we’re focused on transforming our operating model, meaning finding durable ways to improve our financial resilience in a range of economic environment and also in a sustainable manner. So we’ve talked specifically in our prepared remarks about some examples of what that looks like. For example, when we move 50% of some of our services to outsourcing, so that we have greater flexibility, et cetera. We see these as sustainable actions, and you’re also right that we need to invest variable as the industry turns and we start to spend media, et cetera. And Francis can give you a little color on the fixed and variable.

Francis Lee: Yes. Hi, Dan. Nice to meet you. The operating transformation that we are undertaking is more than simply addressing costs. It’s about systematically examining how we do business. The result is that we’re getting cost out, but we’re also constantly looking for new ways to do things. We gave some examples of those. To put some dimension around this year’s cost savings, about 80% of that was fixed. 20% of that is variable. But as you think about some of the savings, for example, that I shared with you on just even the technology tools, it delivers a million dollars. That’s a million dollars of savings that we would anticipate doesn’t come back in the future. And it’s a mindset and a way of inspection of our business that we will continue to operate with that level of scrutiny.

Other examples, like changing our parcel providers, they give us a partial cost benefit this year because it was implemented partway through the year. We’re going to get even more savings next year as we put more volume through that and it covers a full year period. These savings have fixed elements, but even within the variable elements, there’s a part of greater efficiency that we’re achieving through our variable costs, even though they are variable.

Operator: Our next question comes from the line of Peter Keith with Piper Sandler. Peter, your line is open.

Peter Keith: Hi, thanks. I get two questions from Piper Sandler this evening. Maybe on the media spend, it seems to be kind of a popular topic amongst the community and how much media spend for the mattress industry is down. I know you guys look at this data pretty closely. Do you have an opinion industry-wide how much media spend is down versus, say, the pre-pandemic level of 2019?

Shelly Ibach: I do not have a data point on that specifically.

Peter Keith: Okay. My sense is, it’s down quite a bit, but that’s just a sense. Maybe you could also just talk to — go ahead.

Shelly Ibach: Well, there are far fewer companies spending dollars on media in the industry at this time as well. Then there’s also a pressure, Peter, of just a normal consumer sentiment environment where the sentiment is healthy. There’s about 12 points of pressure with the lower consumer sentiment we’re operating in. Just as a starting point, there’s 12 points of pressure. And then later on, the overall category is spend as well.

Peter Keith: Yes. Okay. And any color on some of the newer products that are less than 12 months old? I know you talked about c1 earlier, but about like Climate360, any of those. How are those resonating with consumers today?

Shelly Ibach: Yes, really well. c1 is extremely early, but it seems to be playing its role that we expected where customers are coming in, realizing that Sleep Number does offer a Smart Bed that is affordable for them. And even though we would often promote the c2 in the past at $9.99 or $10.99, this is resonating in a different way. And that’s part of the role that we wanted the c1 to play, so more to come. And then Climate360, we just continue to be very pleased with the performance. It continues to exceed our expectations. We’re super excited about our leadership in temperature overall. We have our dual temp layer at $9.99, which is available for any mattress. And you can offer customers heating and cooling with the dual temp layer.

You can purchase it for just one side of the bed, so it has a lot of flexibility. Then, of course, all of our Smart Beds now have temperature balancing features and benefits. And then the introduction of ClimateCool in the fourth quarter at $54.99. This bed actively cools and, of course, adjusts on each side and sleeps up to 15 degrees cooler. The cooling is integrated into the Smart Bed, pulls the heat away from the customer. Our front lines are so excited about this new innovation, and we think it will really resonate with consumers.

Operator: This concludes our question-and-answer session. I will now turn the conference back over to the company for closing comments.

Dave Schwantes: Thank you for joining us today. We look forward to discussing our third quarter 2024 performance with you in October. Sleep well and dream big.

Operator: This concludes today’s conference call. You may now disconnect.