Earnings Call Transcript - SNBR Q2 2023

Operator, Operator

Welcome to Sleep Number's Q2 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 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, Vice President of Finance and Investor Relations

Good afternoon, and welcome to the Sleep Number Corporation's Second 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 Chris Krusmark, our Interim CFO and Chief Human Resources 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 our second quarter earnings presentation, which can be accessed on the Investor Relations page of our website. I will now turn the call over to Shelly for her comments.

Shelly Ibach, Chair, President and CEO

Good afternoon, and thank you for joining our second quarter 2023 earnings call. My Sleep IQ score was 85 last night. I'm pleased to share that today, Sleep Number announced the appointment of Francis Lee as our company's Executive Vice President and Chief Financial Officer effective August 14. Francis brings significant leadership experience in finance and strategy at Fortune 500 consumer-focused brands, including Nike and Gap, and most recently as CFO of Wise Labs, an AI-powered Smart Home innovator. At Wise, Francis increased cash flow and profitability through a business model evolution from hardware to software with recurring revenue streams that emphasize customer lifetime value. He has a proven track record in business planning, operational transformation, and capital structure. We look forward to benefiting from Francis' leadership in advancing our differentiated strategy and creating superior shareholder value. During today's call, I'll provide highlights of our second quarter performance in the context of current market conditions, describe actions we are prioritizing in 2023 to compete effectively, drive operational efficiencies, and generate cash, and share how we have positioned our business for strong earnings growth and significant value creation as demand improves. Sleep Number and the mattress industry overall have been operating in a disrupted and challenging macro environment, which has resulted in a historic contraction in demand for mattresses with six consecutive quarters at recessionary spend levels. In this environment, our demand-driving and efficiency actions delivered second quarter results that included net sales of $459 million with demand down mid-single digits. Our year-over-year demand improved seven percentage points sequentially compared with the first quarter, but was a few percentage points below our Q2 expectations of flat to down slightly. As the quarter progressed, year-over-year demand trends improved with combined May and June demand down low single digits. Gross profit rate of 57.6% was right in line with our expectations. Our ongoing cost control actions drove a $22 million year-over-year reduction in operating expenses. Earnings per share for the quarter were $0.03. Based on analyst Q2 surveys, we believe we outperformed the industry and gained market share in the quarter. As an additional reference point, industry unit levels on a trailing 12-month basis through Q1 are 14% below 2019, representing 26 million industry units compared with more than 30 million units in 2019. On the same basis, Sleep Number units are down 1% and even with chip shortages that disproportionately impacted our company in 2021 and 2022. Year-to-date, our demand has steadily improved, and we expect continued improvement in the back half with mid-single to low double-digit demand growth year-over-year. In 2023, we are focused on three priorities to deliver our financial commitments: taking market share by leveraging our brand building, innovation, and connected smart sleepers; restoring gross profit after the global supply chain disruptions; and generating increased cash flows and reducing leverage. Let me share a few examples of how we are delivering on these priorities. Life-changing innovations and world-class marketing continue to be important drivers of our top line. Climate360 Smart Bed, which launched in Q4 last year, continues to generate strong performance at the high end of our line. More than 80% of couples say one of them sleeps too hot or too cold. The Climate360 Smart Bed with active heating and cooling technology provides individualized temperature control, so each sleeper can benefit from their ideal microclimate. And our recent proof point that Climate360 sleepers can get up to 44 more minutes of restful sleep per night from using the features in this temperature balancing Smart Bed affirms its value. With the introduction of our next-generation Smart Beds, all Sleep Number Smart Beds now have temperature benefits with opening price points under $1,100. These competitively advantaged Smart Beds offer an adaptive and effortless connected sleep health experience, and the new technology platform positions us for expanded offerings in the future through digital products and services. We are efficiently managing the transition to our new Smart Bed portfolio. Our teams have planned and executed for holistic demand, unit, and margin management. In Q2, we introduced the M7 and i10, and we will complete the set of the remaining 90% of our next-gen Smart Bed portfolio in all Sleep Number stores next week, well in advance of our biggest event of the year, the Labor Day selling period. We are growing brand interest with our new Next Level advertising campaign. Since introducing the campaign in late April, we have driven positive search interest in Sleep Number compared to mid-single-digit declines for other premium brands and double-digit declines for the industry over the same period. With the start of the NFL season, we will introduce a compelling advancement of this campaign, which tested at all-time highs. We are driving media efficiency and effectiveness through optimization tools and simplified digital experiences. These initiatives are resulting in high-quality digital and store traffic while generating media leverage. Complementing these drivers of top line growth are initiatives that we expect to drive gross margin rate expansion by more than 150 basis points for the full year. In addition to higher margin mix from our new Smart Bed introductions as we move through the back half, sources of margin improvement across our operations include pricing, easing of commodity costs, steady and predictable supply, and digital efficiency tools supporting workforce planning and data management. We expect these and additional initiatives to be positive drivers of gross margin in the balance of the year and beyond. With these demand and margin drivers, we expect to generate more than $100 million in cash from operations in 2023. As we entered the third quarter, year-over-year demand trends continue to improve. Consumer sentiment is beginning to move in the right direction, and our brand indicators are strong. However, given the challenging economic environment with demand slightly behind our expectations for the first half, we have narrowed our guidance range to $1.25 to $1.75 earnings per share for the full year. Importantly, the earnings power of our strategy and business model and our significant value creation potential are as strong as ever. Even as we have navigated a period of extended disruption, we have continued to position our business for long-term growth and market share gains. On Page 12 of the supporting deck posted to the Investor Relations page on our website, we highlight our expectations for the next few years including accelerating top and bottom line growth as we execute our strategy of consumer innovation and operational advancement and as consumer sentiment improves and the industry recovers from depressed demand levels. Specifically, we expect our differentiated innovation pipeline, including the Climate360 Smart Bed and next-generation Smart Bed ecosystem with millions of highly engaged customers combined with our Next Level brand building and advanced digital capabilities to support high single-digit sales growth. We are intensely focused on expanding our gross margin rate with a goal to return it to 60% within a year and 62% over the next couple of years. Initiatives to drive margin expansion include: increased mix of higher-margin products such as Climate360 and next-gen Smart Beds; addition of new, high-margin adjacent revenue streams from our innovation pipeline, opportunities to further leverage our retail and fulfillment networks through continued unit growth, and relief in commodity and other cost pressures that we absorbed in our operations during the past few years. These margin driving efficiencies, combined with ongoing productivity improvements, are expected to return our EBITDA margins to a low double-digit rate. While our 2022 and 2023 financial performance reflects the sustained impact of external business and economic disruptions, we have effectively navigated the challenges while strengthening our brand, culture, and competitive advantages. By hitting our strategic milestones and keeping the drivers of our business intact and healthy, we are well positioned to accelerate performance and deliver superior returns to Sleep Number shareholders for years to come. Before I turn the call over to Chris, I want to thank him for his exceptional leadership as Interim CFO. We appreciate his significant contributions to the business, team, and the CFO search. Now Chris will provide additional financial details on our 2023 second quarter and first half performance and outlook for the balance of the year.

Chris Krusmark, Interim CFO and Chief Human Resources Officer

Thank you, Shelly. For the second quarter, net sales of $459 million were 16% below last year, with demand slightly below our expectations for the quarter. We leveraged our fulfillment network to deliver incremental Smart Beds from our existing backlog. As a result, we delivered nearly 77,000 Smart Bed units with an ARU of just under $6,000. Our second quarter gross profit rate of 57.6% was consistent with our expectations. Focused spending controls resulted in operating expenses of $253 million in the quarter, down $22 million versus the prior year. We delivered second quarter EPS of $0.03. As a reminder, a shortage of semiconductor chips in last year's first quarter resulted in more than $100 million of margin-rich deliveries shifting into the second quarter of 2022. This shift included our higher-priced FlexFit 3 adjustable bases and related Smart Beds. Last year's second quarter net sales, ARU gross margin, and net operating profit all benefited from this higher margin backlog reduction. This resulted in prior year second quarter EPS of $1.54 in what is traditionally our lowest sales and EPS quarter of the year. Now I'll spend a few minutes covering our year-to-date financial results before turning to our full year outlook. Year-to-date net sales declined 8% to $985 million with demand down high single digits year-over-year. The first half of 2023 included approximately $50 million of net sales benefit from the servicing of excess backlog, which was similar to the benefit in the first half of the prior year. Our year-to-date gross margin rate of 58.3% was consistent with the prior year. We offset deleverage from the net sales decline with pricing actions, easing of commodities, and ongoing operating efficiencies. Importantly, our year-to-date gross profit rate is up nearly 300 basis points from the back half of last year as we continue to recover from the disruption of chip shortages and related operating inefficiencies. We have generated net operating profit of $37 million compared with $54 million for the same period last year. The year-over-year decline in gross margin dollars was partially offset by a $36 million reduction in operating expenses. Here are specific actions we have taken year-to-date to reduce operating expenses versus the prior year. We've driven media efficiency leverage of 50 basis points for the first half of the year. We adjusted consumer financing offers to mitigate increased costs associated with this higher interest rate environment. We have slowed our store actions and are now planning net new store growth of 1% year-over-year, which is down about 10 stores versus our original plan for the year. We reduced labor costs as we optimize staffing levels, and our G&A and R&D expenses are also down versus the prior year. We generated $0.54 of EPS for the first six months of 2023 compared with $1.60 for the same period last year. Our year-to-date results include a $0.46 headwind from $13 million more in interest expense than a year ago. We generated $19 million of operating cash flow for the first six months of the year compared to $29 million for the same period last year. Turning to liquidity and leverage, we ended the quarter with $334 million of liquidity under our revolving credit facility and a leverage ratio of 4.7x EBITDA, below amended 5x covenant. Given the uncertain macro environment, we partnered with our bank group to extend the 5x EBITDA covenant through our fiscal third quarter. We continue to expect to end the year with a leverage ratio under 4x EBITDA. We have updated our 2023 full year EPS outlook to a range of $1.25 to $1.75 per share, which narrows the range by $0.25 versus our previous guidance. For the full year, we expect net sales to be down low to mid-single digits, which is approximately one to two points lower than our prior expectations. This is reflective of lower demand in the first half of the year. For the back half, we expect net sales down low single digits to up mid-single digits on improving demand as we face easier comparisons and fully benefit from next-gen Smart Bed introductions. As a reminder, year-over-year backlog changes represent a five to six point headwind in the back half of the year as we returned to normalized backlog levels at the end of the second quarter. We continue to expect at least 150 basis points of gross margin rate expansion in 2023. We expect more than $100 million in cash from operations in 2023 and positive free cash flows. Our guidance includes $0.18 of headwind in the back half of the year from an expected $5 million increase in interest expense year-over-year. We also want to provide additional clarity regarding third and fourth quarter performance expectations. For the third quarter, we expect EPS to be slightly below last year's third quarter EPS of $0.22. Specifically, we are expecting demand to be up mid- to high single digits compared to last year with net sales down low to mid-single digits due to the impact of year-over-year backlog changes. We anticipate an increase in backlog in this year's third quarter as we optimize for efficiency with our newly transformed fulfillment network, including staffing levels. Also, for the third quarter, we expect a gross margin rate of approximately 58%. This includes transition costs associated with promotional closeout activity of our existing Smart Beds and launch costs related to setting all stores with next-generation Smart Beds. For the fourth quarter, we are expecting demand to be up mid-single to low double digits with net sales up mid- to high single digits. We expect our Q4 gross margin rate to approach 60% as our margin initiatives mature. We expect to end the year with a normalized backlog.

Shelly Ibach, Chair, President and CEO

I'm extremely grateful to our highly engaged team whose commitment to our purpose is apparent every day in their innovative mindset, dedication to our stakeholders and consistent execution of our strategy. Our investments and achievement of strategic milestones along with major operational improvements, a digitally connected customer, and world-class partnerships have transformed our company, revolutionized the industry, and positioned us for significant value creation in the future. Now Chris, Dave and I will respond to your questions. Lisa, please open the line.

Operator, Operator

We'll take the first question from Bobby Griffin at Raymond James.

Bobby Griffin, Analyst

Good afternoon, everybody. Thanks for taking my questions. I guess first, and Chris, maybe I missed a few of the details there, but can we just spend a little time unpacking the acceleration in demand that's implied to kind of get to the guidance because it seems things are still running negative at least as at the end of the second quarter. And I know the comparisons get a little easier starting here in 3Q, I believe they ease by 4% or so. Is that the main function of what gives you guys the confidence in demand going back positive? Or is there some other embedded assumptions in there from the new product launches or whatnot or pricing or whatnot that helps you kind of get to that positive demand clip?

Shelly Ibach, Chair, President and CEO

Thanks for the question, Bobby. I will address this. First, we expect demand in the third quarter to increase in the mid- to high single digits, as you mentioned. We are seeing steady improvement in demand trends since the beginning of the year, although it has been slower than we initially anticipated, resulting in us trailing by a couple of points in demand as we exited the second quarter. However, we believe we gained market share through that second quarter. We outperformed every period, and demand gradually improved, with declines in the low single digits in May and June. This upward trend has continued into the third quarter, and for July so far, we have been flat compared to the previous year, aligning with our expectations as we move through the rest of the third quarter with anticipated mid- to high single-digit growth. The comparisons do play a role. Importantly, our initiatives, including product innovations, the next-gen Smart Bed implementation, and our next-level campaign, are key drivers of our demand. We're optimistic about the early signs we see. Consumer sentiment is shifting positively, our brand has favorable search numbers, and traffic is increasing as we approach our biggest event of the year. We've made substantial progress in demand trends during the first half, and we expect this momentum to carry into the second half.

Bobby Griffin, Analyst

Okay. I appreciate that, helpful. For the improvement that we saw quarter-to-date, was just to help us kind of connect the dots, was the promotional aspects in 2Q of this year relatively similar to 2Q of last year, so we can read into this improvement that we saw as real and fundamental? Or was there something different in terms of closeouts or promotional calendar that might have been impacting what we saw throughout the second quarter and into July?

Shelly Ibach, Chair, President and CEO

Well, it's a great question. And absolutely, we continue to drive promotional activity. One of the benefits of our vertical model is we can adjust and make changes pretty real time and certainly within the quarter. Closeout is a great example of that. We planned for our closeouts in the second quarter and we delivered accelerated units at the low end of our line through our closeout activity. We did not drive the top line as big as we had hoped we would here in that closeout period in the June timeframe. We saw the unit impact, very positive we did not get incremental demand lift from that. When you look at our performance and the step-up of performance, it's been progressive all year. We see it as real. I think July is another good example of that. And now we'll move into some higher ARU with our next-gen Smart Beds and continue to drive our performance going forward.

Bobby Griffin, Analyst

I appreciate the details. I'll turn it over to somebody else. Best of luck in the back half of the year.

Shelly Ibach, Chair, President and CEO

Thanks.

Brad Thomas, Analyst

Hi, good afternoon. Thanks for taking my questions. I want to ask a little bit about the Synchrony relationship and what you're seeing out of them. I believe they've been public recently about saying that they kind of selectively done some tightening where they perhaps lowered the approval rate and lower the amount that they're approving. Just curious how important they've been to you here of late and what you're seeing out of them, just given their importance to your business? Thanks.

Shelly Ibach, Chair, President and CEO

Yes. Thanks for the question, Brad. Synchrony is certainly an important partner, and our customers at Sleep Number are important to the Synchrony portfolio as well. We've made adjustments in our financing strategy which have been very favorable for us, especially from an efficiency or margin and productivity standpoint. We took on these actions in Q2, we tested into them, and we like what we're seeing. We've been able to mitigate a lot of cost increase related to interest. The programs have been effective. Our approval rates and sales conversion in financing are all in line with where we expect. So a specific answer to your question, no, we have not seen an impact based on the actions that you highlighted.

Brad Thomas, Analyst

Got you. Okay. And then just a follow-up on Bobby's earlier comment regarding demand in the back half. Can you provide some updated insights on how you're viewing the benefits from the average transaction size and your thoughts on promotions? Is there any difference in your plans compared to what you had three or six months ago?

Shelly Ibach, Chair, President and CEO

Yes. I think the promotion difference, I'll maybe start there. In Q2, we pulled forward our closeout activity closer to the start of June to drive increased units and demand, and we did drive increased units not so much on the overall top line. So that would be a good example of an adjustment. Right now as we head into the back half, we've made some adjustments to our financing plans based on what we've learned along the way. We utilize financing programs and discounts as a conversion tool. That's probably the area where we've made the adjustments. We are excited about our next-gen Smart Bed line here with the whole new portfolio and Climate360, having those important drivers of our top line, along with the advancement of the advertising. We also look at a number of leading indicators we track: traffic, sentiment, and our econometric model as well as our year-over-year, importantly, the 13-week trend. We've continued to see progression, positive progression on that 13-week trend. We also look at our performance compared to 2019, and we had a very robust almost about a 20% increase compared to 2019 in the first half. We're not expecting as high of an increase to 2019 in the back half, which gives us some room to outperform.

Operator, Operator

The next question is from Peter Keith, Piper Sandler.

Peter Keith, Analyst

Thank you. Good afternoon. Shelly, I want to dig into some more of those green shoots to get us comfortable with the demand outlook for the back half. I guess with the new product line, you have had the M7, the i10 in the marketplace now for a couple of weeks. Has the consumer reaction been positive on those newer models such that those specific models have moved up within your sales mix?

Shelly Ibach, Chair, President and CEO

Thanks for the question, Peter. Our frontline has been really excited about our new model. They have performed very well since the launch, and we're just completing the set in all stores for all next-gen Smart Beds. We're almost done; we have a few left here over the coming days. We're on track with our expectations and feel very confident about our ability and, to some degree, the ease of fully transitioning to all one line in the marketplace as we head into the Labor Day event. So we're excited about our promotional plans and feel they're right on track with where they need to be, considering price sensitivity with some consumers yet the high value that our Climate360 gives at the top of our line. Yes, we feel bullish about where we are.

Peter Keith, Analyst

Okay. So I guess, has there been a standout demand for those initial products in the market?

Shelly Ibach, Chair, President and CEO

They have performed slightly ahead of our expectations while we've been in closeout. It's small at this time because we haven't had a lot against it. So the real demonstration is now.

Peter Keith, Analyst

Okay. And then I wanted to just touch on the commodity costs, which have been a headwind for you and now a future opportunity. I think at the beginning of the year, you were expecting about $15 million to $20 million of relief or recovery. What's going on now that we're at midyear? Has anything changed? Maybe is there a little bit more relief, less relief give us an update on how that's looking?

David Schwantes, Vice President of Finance and Investor Relations

Yes. Hey Peter, this is Dave. I would say largely the commodity benefits that we expected for the year are coming in as planned. We talked about that in the first quarter. As we look at the full-year and getting to that 150 basis points of expansion, it's still really the three drivers that we talked about at the beginning of the year, which is pricing is one of them that we've taken, it's the commodity relief that we talked about, and it's the mix benefits that we're getting from having Climate360 at the high end of our line, be a growing and important part of our mix. If we look at those three drivers, there are always puts and takes each year, but those three drivers are coming in as planned. We continue to see additional opportunities on the commodity side for the back half of the year and beyond as we just kind of work through unraveling some of the pressures that we've taken on over the last couple of years.

Operator, Operator

Your next question comes from Atul Maheswari, UBS.

Atul Maheswari, Analyst

Thanks a lot for taking my questions. Shelly, I had a question about your media strategy. It sounds like media costs are down meaningfully given you're leveraging on lower sales. So do you run the risk of lowering the efficacy of the launch given historically Sleep Number and others in the industry have typically raised media spending ahead of important launches.

Shelly Ibach, Chair, President and CEO

Thank you for your question, Atul. Media plays a crucial role in driving our demand. We anticipate improved efficiency in our media compared to last year. We are in a significantly stronger position now than we were a year ago. Last year, we faced supply shortages of chips, which affected our delivery timelines and limited our product assortment. This year, we have a complete range of Smart Beds and Climate360, allowing us to drive greater efficiencies and attract more traffic and stronger search interest to our brand compared to competitors in the industry. We achieved 50 basis points of leverage in the first half and expect continued leverage in the second half as we fully support our next-generation Smart Beds. We rely on an econometric model to determine the optimal allocation of resources based on consumer sentiment and other factors, ensuring a prudent approach in the current environment as we focus on gaining market share and expanding our margins.

Atul Maheswari, Analyst

Got it. That's super helpful. Shelly, just my follow-up, it sounds like the 2023 guidance is fourth-quarter heavy. So as things stand today, if we were to understand the risk to this guidance, is the greater risk of a miss on the top line? Or is there a greater risk of a miss on the gross margin?

Shelly Ibach, Chair, President and CEO

As you think about the shape of Q3 and Q4, I'll start with both sales and margin. We expect a net sales decline for third quarter, in part due to the year-over-year backlog changes and the gross margin impact of the one-time product portfolio transition cost; they're all hitting in the third quarter. While we expect continued demand improvements, including the mid to high single-digit growth in Q3, we were a few points behind demand expectations in the second quarter, which resulted in a lower backlog heading into the third quarter. We're very focused on fulfillment efficiency, and we're expecting to build a little backlog in Q3. So we'll benefit from building backlog from the low levels that we're entering the quarter with. When you look at the fourth quarter, we expect progressive demand improvement. So Q3, up mid to high single digits, and then Q4 up mid-single digits to low double digits. This is a continuation of what we've been seeing in demand. It also contemplates our initiatives as they continue to progress and how we layer on to those initiatives throughout the months of the back half and also the compare is getting increasingly easier as we approach the fourth quarter.

Dave Schwantes, Vice President of Finance and Investor Relations

Just to add a little color on gross margin as part of your question. So the first half of the year, we did a 58.3% gross margin rate, which was right on top of what we had expected. Importantly, it was almost a 300 basis points improvement from the back half of last year. As we head into the back half of this year, we're going up against, I'll call it, a much challenged compare from the prior year. The initiatives that really help us achieve that 58.3% in the first half of the year are intact for the back half of the year. We're looking at a gross margin rate of 58% to 59%. We certainly recommend if people have a chance to go out and look at the supporting deck we put on our website that covers how we're thinking about the back half versus the first half and as compared to the back half of last year. That shows you the progression we expect in the back half of the year. The fact that we aren't expecting our gross margin rate in the back half of the year to be materially higher than the first half of the year with the initiatives intact and what we think is going to be a stronger top-line year-over-year as well.

Atul Maheswari, Analyst

Got it. Okay. That's helpful. If I could sneak in one last question. Shelly or Dave, who wants to answer it? What has been the percentage of your sales historically that have occurred through financing? And is that percentage lower or higher today?

Shelly Ibach, Chair, President and CEO

Yes. It's about 50%, and it's steady.

Seth Basham, Analyst

Thanks a lot and good afternoon. My first question is just around pricing on the new line. Can you remind us, is there a price increase that you're taking on any models that's substantial relative to the previous models?

Dave Schwantes, Vice President of Finance and Investor Relations

Yes, we introduced the new M&I models this year with a pricing increase of $100 on those models, which took effect in April. Overall, we anticipate around three to four points of benefit from pricing this year, including the increases from the new line and the effects of pricing actions we implemented last year. We made some adjustments in August and December of last year that are contributing additional benefits as we realize the full-year impact this year. So, there is a $100 increase on the top of the line, along with the additional benefits from previous actions.

Seth Basham, Analyst

Got it. Okay. And the margin richness of the new products with limited price increases. Is it a much higher margin rate that you should earn on those new products?

Dave Schwantes, Vice President of Finance and Investor Relations

I would consider it to be relatively similar, Seth, relative to the margin profile. I would just say similar.

Seth Basham, Analyst

Got it. Can you just remind us then the drivers behind the new line? What are the big changes in the features and functionality that were supposed to be cost-efficient, what else is different?

Shelly Ibach, Chair, President and CEO

You're right. I would start with that we now, with the next generation Smart Beds, have temperature features across the entire line, starting at the C2, which is just below $1,100. We're really excited about having these features, especially based on how well Climate360 has performed and the traffic that Climate360 drives to our stores. There is increased comfort and support, which has also been well received. The technology platform has much broader sensors that set up our future additional revenue streams through digital products and services. You also highlighted a larger percentage of common parts, which will help us with especially with our new assembly distribution center to be able to add more flexibility and scale in the future as we ramp up units.

Seth Basham, Analyst

Great. And my last question for now is just on the promotional environment as you head into Labor Day with this new product line. Do you think you'll have to be as promotional as you've been around other major holiday selling periods recently?

Shelly Ibach, Chair, President and CEO

We'll certainly compete aggressively as we have in the past. It won't be our closeout. Our closeout pricing was more aggressive that you saw in Q2, but we have a lot of confidence in our promotional strategy and how we're applying that throughout the Labor Day period, especially based on what we've learned in this environment and even this year in the past few months. We apply it quickly to how we're approaching the time periods, the duration, and how we're utilizing the promotional dollars and financing for optimized results from both the top and bottom line.

Operator, Operator

We'll take a follow-up from Bobby Griffin, Raymond James.

Bobby Griffin, Analyst

Hey, thanks for letting me get back in. On the progression, do we expect ARU to step up sequentially meaningfully in 2H and that's part of how we get the improvement as well in demand? So I'm just trying to connect the dots between what units demand can improve versus what dollar demand going to improve? Because it still just looks like a pretty strong step up even when you factor in the positive comparisons moving in your favor?

Dave Schwantes, Vice President of Finance and Investor Relations

Hi, Bobby, this is Dave again. If you look at the first half of the year, we had an ARU of around $5,900, a little over $5,900. That was approaching $6,000 in Q2, which is the number I used on the last call. As you look at the back half of the year, we're actually looking at an ARU that's likely going to be quite similar to the first half, around $5,900. We do expect the ARU to be stronger in Q4 than Q3. Q3 is going to have the impact of the closeout activity that we had late in Q2 at the low end of the line, in particular, which will put a little bit of pressure on ARU. I'd call Q3 may be closer to $5,800, and then I'd call Q4 around that $6,000 mark for an ARU.

Bobby Griffin, Analyst

Okay. And that's a function of the pricing, the new line and then offset by the closeouts or whatnot? Is there any mix going on there? Are you attaching more items, more beds or anything else like that or no?

Chris Krusmark, Interim CFO and Chief Human Resources Officer

If you look at year-over-year, particularly in Q3, last year didn't have any Climate360. Q3 this year will have a full quarter of Climate360. Last year, we introduced Climate360 in October, and we did have a fair amount of deliveries in the fourth quarter. But we do expect even more deliveries in the fourth quarter this year with Climate360 than we did last year, which will help the ARU year-over-year. The other thing you're going to get in both Q3 and Q4 is the benefit of the pricing actions we took. Some of the pricing we took last year was in August; some was in December. So really Q3 didn't get the full benefit of those August promotions or December from a pricing action. We expect both pricing and some mix to help us in both Q3 and Q4 to get those numbers up. So if you do the math, Bob, I just gave it to you, but the back half of last year was $5,200 per unit, which means we're looking at a number north of double-digit ARU growth for the back half of the year.

Bobby Griffin, Analyst

Yes. I appreciate the details. Thanks for letting me get the follow-up in.

Shelly Ibach, Chair, President and CEO

Great. Thank you.

Operator, Operator

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

Dave Schwantes, Vice President of Finance and Investor Relations

Thank you for joining us today. We look forward to discussing our third quarter 2023 performance with you in October. Sleep well and dream big.

Operator, Operator

And once again, that does conclude today's conference. Thank you all for your participation.