Sleep Number Corp (SNBRQ) Q1 2022 Earnings Call Transcript

Welcome to Sleep Number's Q1 2022 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 objection, you may disconnect at this time. I would like to introduce Dave Schwantes, Vice President of Finance and Investor Relations. Thank you. You may begin.

Good afternoon, and welcome to the Sleep Number Corporation first quarter 2022 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 President and CEO; and David Callen, our Chief Financial Officer. This telephone conference is being recorded and will be available on our website at sleepnumber.com. Please refer to the details in our news release to access the replay. Please also refer to our news release for a reconciliation of certain non-GAAP financial measures and supplemental financial information included in the news release or that may be discussed on this call. The primary purpose of this call is to discuss the results of the fiscal period just ended. However, our commentary and responses to your questions may include certain forward-looking statements. These forward-looking statements are subject to a number of risks and uncertainties outlined in our earnings news release and discussed in some detail in our annual report on Form 10-K and other periodic filings with the SEC. The Company's actual future results may vary materially. I will now turn the call over to Shelly for her comments.

Good afternoon, and welcome to our 2022 first quarter earnings call. My SleepIQ score was 74 last night. I want to start by expressing our deep concern for the devastating impact that the war in Ukraine is having on so many lives. We are driven by our purpose to improve the health and well-being of society through higher quality sleep. As always, our primary focus is the safety and well-being of our team, serving our customers and ensuring business continuity. Since the onset of the pandemic more than 2 years ago, external factors have elevated business complexity and volatility. In this dynamic environment, we remain focused on deepening consumer relationships, and innovating for broad relevance while taking decisive actions to address near-term pressures. Our teams are highly engaged and resilient. Our competitive advantages are strong, and we have ample cash generation and liquidity to support the execution of our strategy. We remain steadfast in our commitment to fulfilling our purpose and creating long-term shareholder value. While we expected Q1 results to be significantly below last year due to supply constraints and related cost pressures, performance was additionally affected by other external factors in the quarter. The start of the war in Ukraine in late February combined with a sharp increase in gas prices and broad-based inflationary pressures affected consumer shopping behavior in March, including demand for our smart beds. While our team promptly leveraged risk mitigation plans to stimulate demand and reduce costs, first quarter performance was lower than expected. Demand for the quarter was down 3% year-over-year, net sales declined 7% to $527 million and earnings per share were $0.09. Customer preference for the features and benefits of the Sleep Number smart bed was at the high end of our line, and that led to a 20% increase in the under-delivered backlog in the first quarter. Reflecting these results and greater macro pressures, we are revising our full year 2022 EPS guidance to a range of $5 to $6. This outlook assumes flat to low single-digit growth for demand for the balance of the year and benefit from deliveries against our excess backlog. David will elaborate on our financial performance shortly. I will highlight how we are keeping consumers engaged as we service our large backlog and prioritize important strategic advancements. We are utilizing the operational levers of our advantage model to engage consumers effectively in this inefficient marketplace. With our vertical model and integrated demand planning, we are able to rapidly test, learn, apply and refine our actions. As a result, we are adjusting website and digital messaging, media promotions and financing. Recent media changes are showing improved digital traffic and we are reallocating our investments to drive even more impactful outcomes. Our brand leadership and growth flywheel based on the advocacy of lifelong relationships with our smart sleepers remain strength. Our insiders are highly engaged with our brands. We've adapted and pivoted quickly and continue to gain new insights as we respond to changing consumer shopping behaviors. I have great confidence in our passionate Sleep Number team and their tenacious pursuit of solutions that reach and serve our customers in this and all environments. In addition to demand generating tactics, we immediately reduced media and other planned spending by $10 million in the quarter. We continue to pursue additional contingencies to further drive demand and adjust costs in support of a broad range of macro scenarios. We also continue to deploy creative solutions to fulfill our demand on a timely basis, while retaining customers' trust and loyalty. As we shared during our year-end earnings call, the global impact of the Omicron variant in January resulted in ship delays that constrained deliveries at the high end of our line. For the first quarter overall, our supply allocation was in line with expectations. The global supply environment remains fluid and challenged with minimal electronics inventories. These conditions require us to maintain constant focus and real-time agility across our business. For example, in April, our digital tools flagged a signal from a large third-tier global supplier affected by China's highly restrictive COVID lockdown in Shanghai. They are currently operating at about 60% of capacity, which has resulted in a delay of chips used in our smart bed firmness control system. While we were not able to avoid business disturbance entirely, our vertically integrated digital capabilities enabled us to immediately adjust customers' smart bed delivery times to align with the new expected timing of chip receipt. In this way, our integrated business model and our real-time supply visibility enable us to discern and respond quickly to external challenges. As a result, we can continue to generate demand, manage customer expectations and retain their trust and brand loyalty. This is a significant competitive advantage. Our initiative to build a scalable, flexible and responsive supply chain that prioritizes customer experience is essential to our speed and agility in overcoming customer disruptions. We now have completed the migration of nearly 75% of our outbound logistics network. By the end of this year, we expect to complete our multi-year transition to an enterprise-wide manufacturing and assembly supply chain. This is fundamental to improving our efficiency and customer experience. No external challenges are creating near-term complexity and significant inefficiencies. Our innovative sleep solutions continue to gain relevance with consumers. The health and wellness benefits of sleep are increasing in value. Sleepers using our 360 smart bed and FlexFit technology are benefiting from almost 30 minutes more restful sleep per night, or up to 170 more hours of restful sleep per year. We are excited to share this exclusive Sleep Number benefit with consumers. Last month we also achieved another significant milestone on our roadmap to Connected Health. We published findings from a recent study that confirms that our 360 smart bed technology is comparable to the gold standard polysomnography for sleep tracking and measurement. Because of this data reliability, our smart bed could, in the future, be used for early risk detection purposes and long-term monitoring. This validation underscores our greatest value to the medical and research community and strengthens our brand reputation. Later this year, we plan to implement our newest most dynamic 360 smart bed technology platform with the introduction of the Climate360 smart bed and subsequent new line of 360 smart beds. While the external environment is certainly more challenging than we expected, we are effectively managing near-term risk and simultaneously creating long-term value by capitalizing on our competitive advantages, including introducing new innovations that support smart sleepers changing needs and provide the highest quality sleep; sustaining Sleep Number's sleep innovation, health and wellness and sleep science and research leadership position; completing the transition to our more responsive and flexible enterprise supply network, strengthening our digitization efforts to improve operating efficiency and customer experience; managing price elasticity in an environment with rising costs and promotional intensity; and proactively managing our capital and liquidity with disciplined metric-driven decisions. Our team's perseverance, resilience and unwavering commitment to our purpose has resulted in more than 14 million lives improved. And we are building a future where your smart bed will play an increasingly important role in your overall health and well-being. Now, David will provide additional financial details on our 2022 first quarter performance and outlook for the remainder of the year.

Thanks, Shelly. Today, I'll focus on three areas. First, our financial results, macro factors affecting performance and mitigating actions we're taking to offset pressures and risks. Second, the importance of supporting our innovations and demand drivers for the long-term in the face of near-term adversity, while taking actions to maintain maximum flexibility. And third, a review of key assumptions underlying our revised 2022 EPS guidance for $5 to $6, given the dynamic and challenging macro and consumer environments. Let's start with a review of macro factors that changed since our Q4 earnings call on February 23, and implications on our performance. Russia's invasion of Ukraine, the day after our earnings call, triggered international sanctions and significant spikes in the cost of petroleum, adding risk for derivative commodities, like foam and plastics. This has led to approximately $20 million of additional input cost pressures this year from commodities, fuel and inefficiencies caused by the uneven flow of chips. Consumer confidence has been impacted by the rapid inflation in gas and food prices, pressuring demand in March. This, coupled with Omicron, affected demand in January resulted in a 3% year-over-year decline in Q1 demand. We are managing the business through changes in consumer behavior, challenges of inefficient supply flow and higher input costs, while navigating geopolitical events and low consumer confidence. As a result, we have lowered our expectations for 2022 demand growth and our EPS guidance. However, our differentiated strategy is more relevant than ever, and Sleep Number teams are highly engaged in our mission to improve lives. We remain committed to long-term shareholder value creation through our highly differentiated strategy. Now let's review first quarter net sales and financial details. Net sales in the first quarter of $527 million were down 7% versus the prior year on constrained electronic supply and lower-than-expected demand. While supply constraints in the quarter were largely as expected, the mix of Sleep Number smart beds ordered in the quarter, which we call demand, was significantly more profitable than the mix of smart beds delivered. This dynamic meaningfully impacted our Q1 financials as seen in our metrics. We delivered 108,000 smart beds in the quarter, down 5% versus the prior year with ARU of $4,905, which was down 2%. Contrast this with the ARU of our Q1 demand, which increased nearly 10% versus the prior year. That is a 12-point swing in these ARU measurements, most of which is in our undelivered backlog. During the quarter, we added approximately $50 million of net sales equivalents to our excess backlog, bringing that total to approximately $200 million. Q1 gross margin of 57.3% exceeded internal plans by more than 100 basis points as deliveries were level loaded throughout the quarter and benefited from pricing actions taken to date. Pressures causing the 530 basis point decline versus the prior year included the absorption of $140 million of annualized cost increases, lower overhead absorption on 5% fewer smart beds delivered and 25% fewer adjustable bases delivered in the quarter than the prior year due to current year chip supply constraints. Q1 operating expenses increased nearly 7%, reflecting the challenges of operating a business in this fast-changing environment. In the face of worsening macro challenges in March, we curtailed Q1 planned spending by about $10 million, while prioritizing near and long-term growth drivers. Despite these cost-cutting actions, the efficiency of our Q1 demand driving spend was negatively impacted by Omicron in January and by geopolitical events and low consumer confidence in March. Still, demand in the quarter exceeded deliveries due to constrained chip supply, leading to a 20% increase in backlog since December. Constrained deliveries of our most profitable sales resulted in EPS of $0.09 for the quarter compared with expectations for $0.30 to $0.40. We have responded to the changed macro environment by trimming our spending plans and being conservative with capital deployment as we continue to support our innovations, brand support and market expansion initiatives. Our commitment to drive long-term performance is evident in the 23% increase in R&D as our teams create game-changing innovations to be launched later this year and next. We expect these new sleep solutions to fuel future demand and improve future supply by using newer chip technology and fewer components. Our differentiators, plus efficiency driving digitization and an evolved logistic network lay the foundation for superior shareholder value creation in the years ahead. However, the current operating environment is dynamic and challenging. Our updated guidance reflects lower demand, additional cost pressures and service of our backlog as we continue to chase electronics supply. Let's review key assumptions supporting our updated 2022 EPS guidance. The $5 to $6 range is based on flat to low single-digit demand growth for the balance of the year. Sufficient chip supply to service a portion of our excess backlog within the year resulting in low double-digit net sales growth, and commodity and inefficient operating cost pressures arising from the uneven flow of chips that prevent us from level loading deliveries. This will be particularly challenging in Q2 when the delayed supply of chips due to the Shanghai lockdown will constrict weekly delivery in the first 7 to 8 weeks to about half the volume expected in the final weeks of the quarter. In total, we expect to deliver fewer smart beds in Q2 than Q1, but with a much stronger profit profile, which will be partly offset by the inefficient flow of deliveries. As a result, we now expect Q2 gross margin of 57% to 58% with improvements in the back half to 58% to 60%. We also expect to generate approximately $200 million of cash from operations in 2022 as changes in demand, backlog and working capital are less favorable than the prior year. Year-end debt leverage is expected to be approximately 3x EBITDA. We are actively managing all the levers in our control to balance near-term financial risks with our opportunities to create superior value long-term. Our approach is to preserve maximum flexibility to move quickly as business conditions change. The fundamentals of our strategy and our balance sheet are strong. We continue to drive to improve lives through proven quality sleep as the means to create superior shareholder value.

Please open the lines for questions.

Hi. Thank you. Good afternoon. To start off, I have a fairly straightforward question regarding the Q1 results. You missed the EPS guidance by a significant margin, but it seemed like the supply chain performed as you anticipated. Demand worsened in March, but I would have thought you were managing the supply chain as a counterbalance. So, what was the reason for the EPS miss compared to what you communicated in mid-February?

Thanks, Peter. A couple of things. First, the demand in March was lower than we anticipated. We started noticing this shift around February 24, coinciding with the onset of the war in Ukraine. Additionally, the demand we were able to generate was primarily at the high end, which contributed to the backlog increase and the additional $50 million in net sales due to our excess backlog at the end of the quarter.

Okay. So maybe next, just on the guidance. You are calling for demand growth of flat to low single-digit for the remainder of the year. But you were negative 3% for Q1, and I think with a pretty good February, so it implies March was worse than negative 3%. So why would you be expecting demand to be getting better for the balance of the year versus where you landed the last month or two?

Yes. Peter, thank you for the clarifying questions around demand. We’ve made good progress in a rapidly evolving marketplace since the onset of the war. Immediately following the war, we were experiencing sales that included down double digits versus the prior year. And we took actions in response to the changed consumer marketplace. And with the last couple of weeks of March, we had moved that trend to down 3% to prior year and continue to make advancements and improvements as a result of the adjustments to support this particular consumer environment where the consumers were challenged with inflation. So, April is a small sample size, but we feel our guidance of flat to low single-digit growth for the balance of the year is appropriate based on what we’ve seen and the actions we’ve taken and the response from the consumer to the action.

Shelly, as a follow-up to that, could you provide maybe an explicit example of an action you’ve taken where the consumers reacted positively here?

Yes. We did a significant amount of testing and iterating and adjusting throughout the month of March. And one thing that we clearly see is strength from our insiders as well as the premium consumer being less affected, but yet wanting extraordinary value. So, the activation is there with a strong value to the premium consumer. And of course, we play broadly in the good, better, best. I don't want to share exactly the specific tactics, obviously, for competitive reasons, but yet, I’ve given you some good color there in the adjustments. And then I would also say the media adjustments that we’ve been making moving to more productive media in this marketplace. And we are seeing strong conversion, higher conversion than prior year on some of the tactics that we’ve been advancing and then, of course, the improvement in our demand.

Good afternoon, everybody. Thanks for taking my questions.

Hey, Bobby.

I just wanted to quickly maybe understand a little bit more of the earnings guide for the year better. The top line stayed unchanged, but obviously, we are going to service more of the backlog with the change in demand. But even excluding the first quarter miss, there's still a pretty big cut of over $1 plus to the earnings number for the year. And I know you called out $20 million, excuse me, of incremental commodities, but just any other big buckets that you can help size for us of what's driving that change in profitability?

Sure, Bobby. I'm happy to provide that information. The first quarter was weaker than anticipated, leading to lower net sales and EPS, which partially affects our full-year outlook. We foresee lower net sales for the year; however, the backlog should help us achieve low double-digit growth compared to last year. Previously, we expected strong demand that would allow us to avoid using the backlog for our current profit and loss. You mentioned the $20 million in cost pressures we've discussed, along with various inefficiencies related to the timing of chip arrivals affecting our deliveries. I pointed that out in the weekly delivery schedule for the second quarter. Though this approach is costly, it's essential to prioritize serving our customers in the current market conditions. All these factors have influenced our perspective for the remainder of the year.

Could you explain how addressing the backlog affects profitability? Previously, net sales guidance was projected to increase by double digits, but now you're deriving more from the backlog instead of organic demand. How does allowing the backlog to flow influence profitability compared to simply relying on demand?

Well, it's a couple of points lower, a few points lower, double-digit growth, first of all. So, the actual number has come down.

Okay.

The growth rate is lower than what we were talking about previously, Bobby.

Yes. That clarification makes sense. I apologize for any confusion. I have two follow-up questions. First, Shelly or David, do the supply chain challenges essentially delay the launch of Climate360, which is the significant launch we are discussing for 2023? My second question, and I can step back after this, is regarding the current gross margins, which are around 57%, compared to the previous expectation of 61% to 62%. There seems to be a lot happening with the numbers. Could you break down what you view as temporary pressure versus what might be long-term pressure that will take time to recover?

Bobby, I'll begin with the update on Climate360 and the new 360 line. We are on schedule for the Climate360 launch later this year. This is a significant strategic initiative that marks our transition to an expanded platform featuring a groundbreaking innovation for consumers. As we fully adopt the new platform, we will also reduce the number of components and transition to more advanced semiconductor chips. There are numerous advantages to embracing our new innovations, and we are dedicated to staying on track with these developments.

Thank you, Shelly.

And Bobby, regarding gross margin, this is crucial for our long-term direction. We took into account the pricing adjustments we've implemented so far. Last year, we recognized $140 million in annual cost pressures and adjusted our pricing by the same amount. This alone impacts our gross margin rate by approximately 400 basis points. The factors contributing to these cost pressures include an additional estimated $20 million we are currently experiencing this year. We consider about 30% of the $160 million as temporary. This includes expenses like using brokerage services to source components, which is a costly approach and not a sustainable part of our cost structure. We are also facing additional costs tied to expedited shipping both into the country and across the country to ensure timely delivery to customers, which has proven inefficient. Our manufacturing, logistics, and home delivery operations are struggling in a market with inconsistent chip supply, making it difficult to maintain a balanced workload. These issues are also contributing to the temporary challenges we face. Labor costs may take longer to stabilize, as I would describe them as somewhat permanent. However, we intend to improve efficiencies through our strategic initiatives and find ways to counteract these costs. We are committed to returning to a gross margin in the 60s, and I believe we can achieve this as an exit rate even within this year.

Thank you, David. I appreciate the details. Best of luck.

Thanks a lot, Bobby.

Your next question comes from the line of Seth Basham with Wedbush Securities. Your line is open.

Hi, this is Matt McCartney filling in for Seth. I have a couple of quick questions. How do you plan to manage advertising expenses and personnel costs in a slower demand environment? Additionally, with leverage at 3.4 times and worsening since the end of last year, it seems you may have less capacity to buy back stock at this time. Given this, can we expect media repurchases in the near to medium term?

Shelly, do you want to handle the advertising?

Sure. We have acted quickly and decisively in the first quarter to align our media spending with the current demand environment. We are also testing various methods to use media more effectively for better productivity and have identified some effective solutions that allow us to take more productive actions in this context. This involves not just reducing expenses but also changing and reallocating our efforts toward more effective strategies. Additionally, in response to the demand adjustments, we have made overall staffing changes to continue optimizing for our team members and shareholders.

Very good. Matt, I'd like to add that it's important to reflect on our actions at the beginning of the pandemic in March 2020. Our strategy then focused on protecting the business while positioning ourselves for a quick rebound. Had we not taken those steps, we couldn't have achieved the accelerated growth and profitability we experienced in the following six quarters. We are addressing the current situation similarly, as we believe our innovations are transformative and that consumers are truly interested in Sleep Number 360 smart beds. Our goal is to enhance people's sleep quality, and we are committed to improving many lives. Therefore, our focus is on safeguarding our future while investing in both long-term and short-term growth opportunities. Simultaneously, we have contingency plans ready to implement as needed throughout the year. This approach ties into our broader strategy, which begins with generating demand for our business model, as cash flow is a direct result of that. In March, we paused share repurchases due to a drop in demand, as we saw a significant decline in early March. This was a suitable response given the metrics we were observing at that time. We anticipate concluding the year with three times EBITDA leverage and generating approximately $200 million in operational cash flow. We also have considerable liquidity available on our revolver, allowing for potential share repurchases, and we will keep you informed as we move forward.

Good evening. Thanks a lot for taking my questions. Dave, I think and please correct me if I’m wrong here, but I think demand was up around mid-single-digit quarter-to-date when you guys had reported the first quarter. So really for you to end the quarter at down 3 would imply March was down low double-digit or even worse. So, a, is that a right estimate of where March was on a demand basis?

Yes, Atul. Let me just set the record straight. We had double-digit declines pretty much immediately following the invasion of the Ukraine and the pressure on consumers. We finished March with an exit rate of minus 3 for the last couple of weeks, and that’s in line with where we ended the quarter.

Got it. And are you able to share how you are tracking in April thus far on a demand basis?

Yes. Atul, April is a really small sample period with inclusive of an Easter shift as well, but we feel our guidance of flat to low single-digit growth for the balance of the year is appropriate.

Okay. My follow-up question is a key concern for investors trying to determine a reasonable earnings floor for Sleep Number and its peers. With the recent guidance cut and the lower end set at $1.05, how can we be confident that this won't be revised downward again in the upcoming quarters? Have you included an expectation of demand remaining flat or slightly increasing, and does this take into account improvements in the overall economy, or do you anticipate achieving your goals even if the economic conditions remain the same? Additionally, what assumptions did you make regarding the supply chain in this guidance? Have you factored in additional slack beyond what your suppliers are currently experiencing, considering the ongoing uncertainty?

Yes, Atul, this is indeed a difficult environment for us. We understand this and have been actively working to address the external challenges we face. We’ve made significant progress in a quickly changing marketplace and feel confident about achieving flat to low single-digit growth for the rest of the year. Adapting to engage and connect with premium consumers in this new context is crucial for us. We're in a period of testing and learning, having spent less than two months in this new landscape. We look forward to applying our strategies during higher demand periods like Memorial Day as we move ahead. The first quarter faced two major external events: the Omicron variant in January and the war that began in late February. As a result, we experienced a 3% decline in demand during that quarter. We don’t anticipate such significant external events impacting another quarter this year; however, we do view the current situation as extended. Regarding supply, we are managing various delays but have maintained steady allocations so far this year. Timing challenges have created some inefficiencies for us, yet we remain closely connected with our loyal customers, and our cancelation and return rates have remained stable. Overall brand sentiment and leadership are strong, allowing us to handle these delays effectively, benefiting from our vertical model. In our guidance, we are considering the allocations provided for this year, without anticipating additional improvements. We are aware of ongoing delays, which is reflected in the broader range of our guidance.

Atul, I will expand a bit. There's another perspective on our growth expectations that considers pricing and new distribution, such as new stores, which typically contribute mid-single digits growth. However, we are expecting a decline in unit volumes this year compared to last, and that’s something to keep in mind. Additionally, starting the year with a significant backlog supports our stability and positively impacts our financial results for the year. We’ve previously noted that we began the year with approximately $150 million in net sales from our excess backlog. As the year progresses, provided we can obtain the necessary supplies, that backlog serves as a safety net for our performance this year.

Got it. That’s all very helpful. Just one quick question on the pricing. When was the latest round of price increase has taken, and what was the amount of the increase, if you can share, please?

Yes. Last year, we implemented approximately $140 million in annualized price increases, with the most recent occurring in October. Additionally, there was a smaller price adjustment earlier in the first quarter, leading to a total of around $150 million in annualized price increases. These adjustments are being realized now as we generate new demand, all at the updated pricing.

Thanks. That’s really helpful.

Your next question comes from the line of Bradley Thomas with KeyBanc. Your line is open.

Hi Shelly, David, and Dave. I wanted to follow up on some recent demand trends. It seems the timing of your recent weakness coincides with the significant months last year when stimulus payments were made. Have you had a chance to examine that in more detail? How much do you think this has impacted you?

We certainly examined that, Brad. Considering our customer demographics, we didn't find a significant advantage. It's difficult to pinpoint, honestly. When a customer purchases a Sleep Number smart bed, they don't usually indicate that they're doing so because of a stimulus check. Additionally, we typically don't see noticeable activity correlating with the issuance of those checks, similar to what we observe around April when people start receiving their IRS refunds. We generally do not experience a spike in our performance during those times.

Brad, what we did see was a very acute change in the consumer behavior that time perfectly with the start of the war. And that progressed. And then it also showed up in the consumer sentiment and the inflation numbers in March. And that did improve slightly at the start of April in the overall consumer sentiment, but that correlation was the strongest we could see.

That’s helpful. Just along a similar vein, are you seeing anything different of late in terms of the interest in or the uptick of your financing options with Synchrony? And can you talk a little bit about if there's been any change in approval rates and how perhaps the cost of that financing may change for you with interest rates being higher?

Well, Brad, we are definitely considering the impact of rising LIBOR or increased Fed financing costs on the discount rate we share with Synchrony. However, we have a diverse range of financing options available. We typically view financing and promotions as a unified approach and manage them accordingly. Our relationship with Synchrony is strong, and we're exploring innovative ways to mitigate some of those pressures. As for changes in approval amounts or rates, we haven't observed any effects yet.

And Brad, I will add one more thing. Just some color, some specific color on March for our total bucket of promotion dollars, and financing dollars was very similar year-over-year in total. We utilized this bucket as a conversion tool versus an attract in our business, which is different than most of our competitors. So, keep that in mind and if you look at our year-over-year specific promotions or financing offers, they actually look pretty different than prior year, but yet, the total is the same. And that’s one of the advantages of our business model and the rapid testing and learning and adjusting that we make that we referenced so often. So just a little additional color there.

Good afternoon. Thanks. Just wanted to dig in again on a question on, I think, it's a 12-point delta in pricing between the delivered and the ordered beds in 1Q. I guess it's a little surprising, given an environment where demand was lower. People are worried about the economy. Like what drove that delta? Some, I guess, the new sales tactics or promotions or whatever it might be that led to higher unit conversion or higher price conversion. Could you talk on that?

Certainly, Curtis. You're referring to the 12-point difference in our ARU metrics. Specifically, there was a 2-point drop in delivered ARUs compared to a nearly 10% rise in demand ARUs. This indicates that customers are looking for the full range of features and benefits associated with our higher-end products. Consequently, they are willing to wait longer for delivery. We anticipated this situation in Q1 due to some shortages of chips necessary for our FlexFit adjustable base, specifically FlexFit #3, which includes features like foot warming that customers really appreciate. Therefore, what we are seeing is that shoppers are seeking value by opting for the higher-end models.

Okay. In terms of the negative impact, I want to clarify that you couldn't deliver the high-end beds with Flex 3. I'm trying to understand the difference between the two.

Yes, that’s exactly right. I mean, our units were down 5% and our ARU was down 2% on the delivered side. At the same time, we added $50 million worth of net sales benefit into our undelivered backlog.

I was a bit surprised to hear that higher gas prices were mentioned as a potential headwind for the quarter. I'm curious about why this would be an issue for more premium consumers. I'm not sure how to reconcile that.

Well, there are a couple of elements where I highlighted that in my remarks. One was the impact on consumers, and in terms of what they're seeing at the pump and the inflation impact that they're seeing in food prices. And so, I called that out as those were triggers that were highlighted in the consumer sentiment surveys that inflation was causing them to be more cautious. And so we saw that for sure in March in the consumer sentiment side. On our cost structure side, we absolutely have gasoline prices as an input cost for our business. We have 1,000 home delivery technicians around the country that are using vehicles to deliver our smart beds to customers' homes. And of course, fuel is a component that is part of that process.

Okay. Maybe I will follow up offline. But …

Okay. Maybe I’m missing it. So, we are happy to talk about it after. Okay. Josh, any other questions? Operator, are you there?

Yes. We do have another question. We have a question from Bobby Griffin with Raymond James. Your line is open.

Thanks. Let me ask one more quick follow-up. Dave and Shelly, I understand that predicting demand right now is quite challenging. When we consider that you are expecting demand to remain flat or slightly increase, we ended the quarter a bit lower. Is the EPS guidance more reliant on demand recovering to your desired levels, or is it more influenced by the cost factors, which are also difficult to predict? In other words, if we reach the end of the year and demand is down by 3% or 5%, similar to the trends in the first quarter, can we still achieve the guidance of $5 to $6, or would that likely push us below the guidance?

Bobby, there are a lot of levers to drive performance, and we are going to use them all. So, if demand is lower than what we expect, obviously, we have backlog to cushion some of that. We also have the opportunity within the business to control our spending differently. And all those levers are within the gamut of what we will do. So, yes, even if demand is down, I think you said low single digits, we believe we can still get to the low end of the guidance range.

Thanks, Dave. I'd like to follow up on that. The guidance does account for addressing a significant excess backlog, which I believe is currently around $200 million. Where do you expect the midpoint of guidance to land in terms of servicing that excess backlog? Would it be approximately half?

It depends on. It depends.

Yes.

It depends. I'm not trying to be elusive, Peter, but as I mentioned to Bobby, various factors can influence the situation, such as demand fluctuating and our cost structure. We will certainly see variations in supply as well. The situation can be both positive and challenging at times. I would say the midpoint of our guidance indicates that demand is in a positive position for the year. This will involve less reliance on the backlog to achieve the total, which we expect to result in low double-digit net sales growth for the year. Does that make sense? I can assist you with modeling after the call if that would help.

Yes. Maybe just one last one for while we are in a public forum. The sales are difficult to model for us right now. How should we think about Q2? I mean, are we negative? Are we positive? I have no idea.

Yes, I agree it’s challenging. I expect our unit sales in Q2 to be lower than in Q1, where we sold 108,000 units. I estimate we will sell around 90,000 to 100,000 units in Q2. However, our average revenue per unit will be significantly higher based on previous comments. Therefore, our sales and profitability will be more substantial than in a typical Q2. As we model for 2023, we will need to remind you to factor this in. The backlog service this year, along with the availability of the necessary chips for our FlexFit 3 adjustable bases, will support our Q2 deliveries. Hence, you should anticipate higher Q2 sales than you might have initially considered.

Per net sales.

Very good. Very helpful. Thanks so much.

You bet.

You bet. Thank you.

Thank you for joining us today. We look forward to discussing our second quarter 2022 performance with you in July. Sleep well and dream big.

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