UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

☒
☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the ~~Quarterly Period Ended September~~quarterly period ended March 28, ~~2019~~

2020

☐
☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 000-25121

SLEEP NUMBER CORPORATION

(Exact name of registrant as specified in its charter)

~~Minnesota~~	~~41-1597886~~
Minnesota		41-1597886
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1001 Third Avenue South

Minneapolis ~~Minnesota~~

Minnesota

55404

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (763) 551-7000

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common Stock, par value $0.01 per share

SNBR

Nasdaq Global Select Market

Indicate by check mark whether the ~~Registrant~~registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the ~~Registrant~~registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ~~Yes~~x☒ NO ☐¨

Indicate by check mark whether the ~~Registrant~~registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the ~~Registrant~~registrant was required to submit such files). Yes ~~Yes~~x☒ NO ☐¨

Indicate by check mark whether the ~~Registrant~~registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer

☒

Accelerated filer

☐

Non-accelerated filer

☐

Smaller reporting company

☐

Emerging growth company

☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐¨

Indicate by check mark whether the ~~Registrant~~registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES ☐ NO ☒x

As of ~~September~~March 28, ~~2019, 28,427,000~~2020, 27,636,000 shares of the ~~Registrant’s~~registrant’s Common Stock were outstanding.

Table of contents

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

INDEX

Table of contents

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(unaudited - in thousands, except per share amounts)

September 28,
2019

December 29,
2018

Assets

Current assets:

Cash and cash equivalents

$
1,545

$
1,612

Accounts receivable, net of allowance for doubtful accounts of $753 and
   $699, respectively

25,541

24,795

Inventories

86,508

84,882

Prepaid expenses

10,997

8,009

Other current assets

35,002

31,559

Total current assets

159,593

150,857

Non-current assets:

Property and equipment, net

201,755

205,631

Operating lease right-of-use assets

321,048

—

Goodwill and intangible assets, net

73,772

75,407

Other non-current assets

46,154

38,243

Total assets

$
802,322

$
470,138

Liabilities and Shareholders’ Deficit

Current liabilities:

Borrowings under revolving credit facility

$
213,700

$
199,600

Accounts payable

151,357

144,781

Customer prepayments

39,824

27,066

Accrued sales returns

23,833

19,907

Compensation and benefits

39,383

27,700

Taxes and withholding

24,699

18,380

Operating lease liabilities

57,912

—

Other current liabilities

52,361

51,234

Total current liabilities

603,069

488,668

Non-current liabilities:

Deferred income taxes

3,927

4,822

Operating lease liabilities

293,333

—

Other non-current liabilities

66,480

86,198

Total liabilities

966,809

579,688

Shareholders’ deficit:

Undesignated preferred stock; 5,000 shares authorized, 0
   shares issued and outstanding

—

—

Common stock, $0.01 par value; 142,500 shares authorized, 28,427 and
   30,868 shares issued and outstanding, respectively

284

309

Additional paid-in capital

—

—

Accumulated deficit

(164,771
)

(109,859
)
Total shareholders’ deficit

(164,487
)

(109,550
)
Total liabilities and shareholders’ deficit

$
802,322

$
470,138


	March 28, 2020		December 28, 2019
Assets
Current assets:
Cash and cash equivalents	$	239,213	$	1,593
Accounts receivable, net of allowance for doubtful accounts of $1,067 and $898, respectively	7,170		19,978
Inventories	82,021		87,065
Prepaid expenses	13,492		15,335
Other current assets	30,889		36,397
Total current assets	372,785		160,368

Non-current assets:
Property and equipment, net	194,707		197,421
Operating lease right-of-use assets	323,770		327,017
Goodwill and intangible assets, net	72,681		73,226
Other non-current assets	49,871		48,011
Total assets	$	1,013,814	$	806,043

Liabilities and Shareholders’ Deficit
Current liabilities:
Borrowings under revolving credit facility	$	446,003	$	231,000
Accounts payable	132,939		134,594
Customer prepayments	25,816		34,248
Accrued sales returns	22,273		19,809
Compensation and benefits	27,292		40,321
Taxes and withholding	27,490		22,171
Operating lease liabilities	60,210		59,561
Other current liabilities	53,054		53,070
Total current liabilities	795,077		594,774

Non-current liabilities:
Deferred income taxes	9,142		3,808
Operating lease liabilities	294,548		298,090
Other non-current liabilities	70,956		68,802
Total liabilities	1,169,723		965,474

Shareholders’ deficit:
Undesignated preferred stock; 5,000 shares authorized, 0 shares issued and outstanding	—		—
Common stock, $0.01 par value; 142,500 shares authorized, 27,636 and 27,961 shares issued and outstanding, respectively	276		280
Additional paid-in capital	—		—
Accumulated deficit	(156,185)		(159,711)
Total shareholders’ deficit	(155,909)		(159,431)
Total liabilities and shareholders’ deficit	$	1,013,814	$	806,043

See accompanying notes to condensed consolidated financial statements.

Table of contents

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(unaudited - in thousands, except per share amounts)

Three Months Ended

Nine Months Ended

September 28,
2019

September 29,
2018

September 28,
2019

September 29,
2018

Net sales

$
474,778

$
414,779

$
1,257,186

$
1,119,750

Cost of sales

178,388

164,262

481,377

442,868

Gross profit

296,390

250,517

775,809

676,882

Operating expenses:

Sales and marketing

213,133

188,458

568,799

511,481

General and administrative

35,098

29,385

102,466

89,947

Research and development

9,007

7,353

25,440

21,146

Total operating expenses

257,238

225,196

696,705

622,574

Operating income

39,152

25,321

79,104

54,308

Interest expense, net

3,131

1,836

8,968

3,814

Income before income taxes

36,021

23,485

70,136

50,494

Income tax expense

7,967

5,228

12,384

7,945

Net income

$
28,054

$
18,257

$
57,752

$
42,549

Basic net income per share:

Net income per share – basic

$
0.96

$
0.53

$
1.93

$
1.18

Weighted-average shares – basic

29,085

34,231

29,859

36,204

Diluted net income per share:

Net income per share – diluted

$
0.94

$
0.52

$
1.88

$
1.15

Weighted-average shares – diluted

29,796

35,039

30,688

37,077


	Three Months Ended
	March 28, 2020		March 30, 2019
Net sales	$	472,566	$	426,445
Cost of sales	170,435		164,212
Gross profit	302,131		262,233

Operating expenses:
Sales and marketing	207,744		186,827
General and administrative	31,072		34,323
Research and development	10,501		8,376
Total operating expenses	249,317		229,526
Operating income	52,814		32,707
Interest expense, net	2,344		2,609
Income before income taxes	50,470		30,098
Income tax expense	11,330		4,680
Net income	$	39,140	$	25,418

Basic net income per share:
Net income per share – basic	$	1.40	$	0.83
Weighted-average shares – basic	27,858		30,620

Diluted net income per share:
Net income per share – diluted	$	1.36	$	0.80
Weighted-average shares – diluted	28,772		31,738

See accompanying notes to condensed consolidated financial statements.

Table of contents

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Shareholders’ ~~(Deficit) Equity~~

Deficit

(unaudited - in thousands)

Common Stock

Additional
Paid-in

Accumulated

Shares

Amount

Capital

Deficit

Total

Balance at December 29, 2018

30,868

$
309

$
—

$
(109,859
)

$
(109,550
)
Net income

—

—

—

25,418

25,418

Exercise of common stock options

151

2

2,834

—

2,836

Stock-based compensation

364

3

3,635

—

3,638

Repurchases of common stock

(1,170
)

(12
)

(6,469
)

(40,501
)

(46,982
)
Balance at March 30, 2019

30,213

$
302

$
—

$
(124,942
)

$
(124,640
)
Net income

—

—

—

4,280

4,280

Exercise of common stock options

115

1

2,158

—

2,159

Stock-based compensation

99

1

4,249

—

4,250

Repurchases of common stock

(1,104
)

(11
)

(6,407
)

(36,933
)

(43,351
)
Balance at June 29, 2019

29,323

$
293

$
—

$
(157,595
)

$
(157,302
)
Net income

—

—

—

28,054

28,054

Exercise of common stock options

33

—

757

—

757

Stock-based compensation

10

—

4,146

—

4,146

Repurchases of common stock

(939
)

(9
)

(4,903
)

(35,230
)

(40,142
)
Balance at September 28, 2019

28,427

$
284

$
—

$
(164,771
)

$
(164,487
)

	Common Stock						Additional Paid-in			Retained Earnings (Accumulated
	Shares			Amount			Capital			Deficit)			Total				Common Stock					Additional Paid-in Capital			Accumulated Deficit			Total
Balance at December 30, 2017		38,813		$	388		$	—		$	88,768		$	89,156											Accumulated Deficit			Total
																	Shares	Amount				Additional Paid-in Capital		Additional Paid-in Capital			Accumulated Deficit		Total
Balance at December 28, 2019																Balance at December 28, 2019	27,961	$	280	$	—			Additional Paid-in Capital			Accumulated Deficit		Total
Net income		—			—			—			20,548			20,548		Net income	—	—		—		39,140			39,140
Exercise of common stock options		68			1			856			—			857		Exercise of common stock options	167	1		3,282		—			3,283
Stock-based compensation		211			2			3,082			—			3,084		Stock-based compensation	396	4		2,047		—			2,051
Repurchases of common stock		(2,149	)		(22	)		(3,938	)		(73,688	)		(77,648	)	Repurchases of common stock	(888)	(9)		(5,329)		(35,614)			(40,952)
Balance at March 31, 2018		36,943		$	369		$	—		$	35,628		$	35,997
Net income		—			—			—			3,744			3,744
Exercise of common stock options		56			—			739			—			739
Stock-based compensation		43			1			3,657			—			3,658
Repurchases of common stock		(2,149	)		(21	)		(4,396	)		(60,875	)		(65,292	)
Balance at June 30, 2018		34,893		$	349		$	—		$	(21,503	)	$	(21,154	)
Net income		—			—			—			18,257			18,257
Exercise of common stock options		33			—			488			—			488
Stock-based compensation		7			—			3,356			—			3,356
Repurchases of common stock		(1,717	)		(17	)		(3,844	)		(51,438	)		(55,299	)
Balance at September 29, 2018		33,216		$	332		$	—		$	(54,684	)	$	(54,352	)

Balance at March 28, 2020																Balance at March 28, 2020	27,636	$	276	$	—	$	(156,185)		$	(155,909)


	Common Stock					Additional Paid-in Capital		Accumulated Deficit		Total
	Shares	Amount
Balance at December 29, 2018	30,868	$	309	$	—	$	(109,859)	$	(109,550)
Net income	—	—		—		25,418		25,418
Exercise of common stock options	151	2		2,834		—		2,836
Stock-based compensation	364	3		3,635		—		3,638
Repurchases of common stock	(1,170)	(12)		(6,469)		(40,501)		(46,982)










Balance at March 30, 2019	30,213	$	302	$	—	$	(124,942)	$	(124,640)

See accompanying notes to condensed consolidated financial statements.

Table of contents

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited - in thousands)

Nine Months Ended

September 28,
2019

September 29,
2018

Cash flows from operating activities:

Net income

$
57,752

$
42,549

Adjustments to reconcile net income to net cash provided by
operating activities:

Depreciation and amortization

46,267

46,655

Stock-based compensation

12,034

10,098

Net gain on disposals and impairments of assets

(409
)

(17
)
Deferred income taxes

(895
)

7,263

Changes in operating assets and liabilities:

Accounts receivable

(746
)

(4,816
)
Inventories

(1,626
)

(6,682
)
Income taxes

535

(13,777
)
Prepaid expenses and other assets

(8,065
)

5,195

Accounts payable

45,051

26,007

Customer prepayments

12,758

18,351

Accrued compensation and benefits

11,763

(2,685
)
Other taxes and withholding

5,784

4,265

Other accruals and liabilities

9,629

2,044

Net cash provided by operating activities

189,832

134,450

Cash flows from investing activities:

Purchases of property and equipment

(46,757
)

(34,012
)
Proceeds from sales of property and equipment

2,577

174

Net cash used in investing activities

(44,180
)

(33,838
)

Cash flows from financing activities:

Repurchases of common stock

(139,178
)

(198,239
)
Net (decrease) increase in short-term borrowings

(11,270
)

94,147

Proceeds from issuance of common stock

5,752

2,084

Debt issuance costs

(1,023
)

(1,014
)
Net cash used in financing activities

(145,719
)

(103,022
)

Net decrease in cash and cash equivalents

(67
)

(2,410
)
Cash and cash equivalents, at beginning of period

1,612

3,651

Cash and cash equivalents, at end of period

$
1,545

$
1,241


	Three Months Ended
	March 28, 2020		March 30, 2019
Cash flows from operating activities:
Net income	$	39,140	$	25,418
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization	15,371		15,743
Stock-based compensation	2,051		3,638
Net gain on disposals and impairments of assets	(22)		(433)
Deferred income taxes	5,334		824
Changes in operating assets and liabilities:
Accounts receivable	12,808		6,182
Inventories	5,044		1,568
Income taxes	5,798		4,208
Prepaid expenses and other assets	7,478		(5,283)
Accounts payable	11,282		5,857
Customer prepayments	(8,432)		3,452
Accrued compensation and benefits	(13,157)		1,750
Other taxes and withholding	(479)		1,254
Other accruals and liabilities	2,725		3,958
Net cash provided by operating activities	84,941		68,136

Cash flows from investing activities:
Purchases of property and equipment	(10,351)		(19,743)
Proceeds from sales of property and equipment	25		2,571
Net cash used in investing activities	(10,326)		(17,172)

Cash flows from financing activities:
Repurchases of common stock	(41,445)		(55,656)
Net increase in short-term borrowings	201,170		2,955
Proceeds from issuance of common stock	3,283		2,836
Debt issuance costs	(3)		(1,015)
Net cash provided by (used in) financing activities	163,005		(50,880)

Net increase in cash and cash equivalents	237,620		84
Cash and cash equivalents, at beginning of period	1,593		1,612
Cash and cash equivalents, at end of period	$	239,213	$	1,696

See accompanying notes to condensed consolidated financial statements.

Table of Contents

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

1. Business and Summary of Significant Accounting Policies

Business & Basis of Presentation

We prepared the condensed consolidated financial statements as of and for the three ~~and nine~~ months ended ~~September~~March 28, ~~2019~~2020 of Sleep Number Corporation and our 100%-owned subsidiaries (Sleep Number or the Company), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and they reflect, in the opinion of management, all normal recurring adjustments necessary to present fairly our financial position as of ~~September~~March 28, ~~2019~~2020 and December ~~29, 2018,~~28, 2019, and the consolidated results of operations and cash flows for the periods presented. Our historical and quarterly consolidated results of operations may not be indicative of the results that may be achieved for the full year or any future period.

Additionally, based on the duration and severity of the current global situation involving the novel coronavirus (COVID-19) pandemic, including but not limited to general economic conditions, consumer confidence, store closings mandated by federal, state or local authorities and possible supply chain disruptions, the extent to which COVID-19 will impact our business and our consolidated financial results will depend on future developments, which are highly uncertain and cannot be predicted.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to such rules and regulations. These condensed consolidated financial statements should be read in conjunction with our most recent audited consolidated financial statements and related notes included in our Annual Report on Form 10-K for the fiscal year ended December ~~29, 2018~~28, 2019 and other recent filings with the SEC.

The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires us to make estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements, and the reported amounts of sales, expenses and income taxes during the reporting period. Predicting future events is inherently an imprecise activity and, as such, requires the use of judgment. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. In addition, during the current environment involving COVID-19, predicting future events will be especially challenging for management. Changes in these estimates will be reflected in the consolidated financial statements in future ~~periods.~~periods and could be material. Our critical accounting policies consist of stock-based compensation, goodwill and indefinite-lived intangible assets, warranty liabilities and revenue recognition.

The condensed consolidated financial statements include the accounts of Sleep Number Corporation and our 100%-owned subsidiaries. All significant intra-entity balances and transactions have been eliminated in consolidation.

New Accounting Pronouncements

~~Recently Adopted~~

Accounting Guidance Not Yet Adopted

~~Effective December 30, 2018 (beginning of fiscal 2019), we adopted ASC~~

In April 2020, the Financial Accounting Standards Board (FASB) issued a Staff Q&A, Topic 842 ~~Leases, using~~and 840: Accounting For Lease Concessions Related to the ~~modified-retrospective approach. We have chosen~~Effects of the ~~effective date as~~COVID-19 Pandemic. To provide clarity in response to the ~~date of initial application and have applied~~COVID-19 pandemic crisis, the ~~new guidance~~FASB staff believes that it would be acceptable for entities to ~~all existing leases.~~

~~The new guidance establishes a right-of-use (ROU) model that requires us~~make an election to ~~recognize an ROU asset and~~account for lease ~~liability on the balance sheet for all leases with a term longer than 12 months. We have elected the following practical expedients and accounting policies~~concessions related to the ~~adoption~~effects of the ~~new lease standard:~~

•COVID-19 pandemic consistent with how those concessions would be accounted for under Topic 842 as though enforceable rights and obligations for those concessions existed (regardless of whether those enforceable rights and obligations for the concessions explicitly exist in the contract).

~~We did not reassess our prior conclusions about lease identification, lease classification and initial direct costs;~~

•

~~We did not elect the use of hindsight;~~

•

~~We adopted an accounting policy for short-term leases allowing us to not recognize ROU assets and lease liabilities for leases with a term of 12 months or less; and~~

•

~~We elected the option to not separate lease and non-lease components for all of our leases.~~

In accordance with the new guidance on December 30, 2018, we recorded $299 million of net operating lease ROU assets and $327 million of operating lease liabilities ($52 million recorded in current operating lease liabilities and $275 million in non-current operating lease liabilities). Deferred rent and lease incentive liabilities associated with historical operating leases totaling $28 million were reclassifiedConsequently, for concessions related to the ~~operating~~effects of the COVID-19 pandemic, we will not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract and can elect to apply or not apply the lease ~~ROU assets~~modification guidance in Topic 842 to those contracts. This election is available for concessions related to the effects of the COVID-19 pandemic that do not result in a substantial increase in the rights of the lessor or our obligations as the lessee. For example, this election is available for concessions that result in the total payments required by ~~ASC Topic 842.~~the modified contract being substantially the same as or less than total payments required by the original contract. The ~~adoption~~FASB staff expects that reasonable judgment will be exercised in making those determinations. Some concessions will provide a deferral of payments with no substantive changes to the consideration in the original contract. A deferral affects the timing, but the amount of the ~~new guidance had no impact on accumulated deficit, net income or net cash provided~~consideration is substantially the same as that required by ~~operating activities. At December 30, 2018, our finance ROU assets and lease liabilities were not significant.~~

~~See Note 6,~~ ~~Leases~~,the original contract. The staff expects that there will be multiple ways to account for ~~further information.~~

those deferrals, none of which the staff believes are more preferable than the others. Two of those methods are:

Table of Contents

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

a.Account for the concessions as if no changes to the lease contract were made. Under that accounting, a lessor would increase its lease receivable, and a lessee would increase its accounts payable as receivables/payments accrue. In its income statement, a lessor would continue to recognize income, and a lessee would continue to recognize expense during the deferral period.

b.Account for the deferred payments as variable lease payments.

We are evaluating the effect of the new guidance on our condensed consolidated financial statements and related disclosures, and plan to select election method b. above. Under this election, deferred payments would be treated as variable rent payments, resulting in an adjustment to expense in the period in which they arise.

2. Fair Value Measurements

At ~~September~~March 28, 2020 and December 28, 2019, ~~and December 29, 2018,~~ we had $8$9 million and $6$8 million, respectively, of debt and equity securities that fund our deferred compensation plan and are classified in other non-current assets. We also had corresponding deferred compensation plan liabilities of $9 million and $8 million at March 28, 2020 and ~~$6 million at September~~December 28, 2019, ~~and December 29, 2018,~~ respectively, which are included in other non-current liabilities. The majority of the debt and equity securities are Level 1 as they trade with sufficient frequency and volume to enable us to obtain pricing information on an ongoing basis. Unrealized gains/(losses) on the debt and equity securities offset those associated with the corresponding deferred compensation plan liabilities.

3. Inventories

Inventories consisted of the following (in thousands):


	September 28, 2019		December 29, 2018			March 28, 2020		December 28, 2019
Raw materials	$	5,782	$	4,549	Raw materials	$	4,905	$	6,231
Work in progress		130		3	Work in progress	81		31
Finished goods		80,596		80,330	Finished goods	77,035		80,803
	$	86,508	$	84,882		$	82,021	$	87,065

4. Goodwill and Intangible Assets, Net

Goodwill and Indefinite-Lived Intangible Assets

Goodwill was $64 million at ~~September~~March 28, ~~2019~~2020 and December ~~29, 2018.~~28, 2019. Indefinite-lived trade name/trademarks totaled $1.4 million at ~~September~~March 28, ~~2019~~2020 and December ~~29, 2018.~~

28, 2019.

Definite-Lived Intangible Assets

The gross carrying amount of our developed technologies was $19 million at ~~September~~March 28, ~~2019~~2020 and December ~~29, 2018.~~28, 2019. Accumulated amortization was $12 million and $11 million at March 28, 2020 and ~~$9 million at September~~December 28, 2019, ~~and December 29, 2018,~~ respectively.

Amortization expense for both the three months ended ~~September~~March 28, ~~2019~~2020 and ~~September 29, 2018,~~March 30, 2019, was $0.5 million. ~~Amortization expense~~Annual amortization for ~~both the nine months ended September 28, 2019 and September 29, 2018 was $1.6 million.~~

definite-lived intangible assets for subsequent years are as follows (in thousands):


	March 28, 2020
2020 (excluding the three months ended March 28, 2020)	$	1,668
2021	2,181
2022	2,181
2023	1,209
Thereafter	—
Total future amortization for definite-lived intangible assets	$	7,239

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SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

5. Credit Agreement

Our revolving credit facility as of March 28, 2020, had a net aggregate availability of $450 ~~million~~million. The credit facility is for general corporate purposes and to meet our seasonal working capital ~~requirements and to repurchase our stock.~~requirements. The credit agreement provides the lenders with a collateral security interest in substantially all of our assets and those of our subsidiaries and requires us to comply with, among other things, a maximum leverage ratio (4.5x) and a minimum interest coverage ratio (3.0x). Under the terms of the credit agreement, we pay a variable rate of interest and a commitment fee based on our leverage ratio. The credit agreement ~~includes an accordion feature which allows us to increase the amount of the credit facility from $450 million to $600 million, subject to lenders' approval. The credit agreement~~ matures in February 2024. We were in compliance with all financial covenants as of ~~September~~March 28, ~~2019.~~

2020.

On March 17, 2020, we borrowed an additional $262 million under our credit agreement, which represented all remaining amounts then available under the credit agreement. The additional borrowings were undertaken as a precautionary measure to provide increased liquidity and preserve financial flexibility in light of current disruption and uncertainty resulting from the COVID-19 pandemic.

The following table summarizes our borrowings under the credit facility ($ in thousands):


	September 28, 2019			December 29, 2018				March 28, 2020			December 28, 2019
Outstanding borrowings	$	213,700		$	199,600		Outstanding borrowings	$	446,003		$	231,000
Outstanding letters of credit	$	3,497		$	3,497		Outstanding letters of credit	$	3,997		$	3,497
Additional borrowing capacity	$	232,803		$	96,903		Additional borrowing capacity	$	—		$	215,503
Weighted-average interest rate		3.9	%		4.2	%	Weighted-average interest rate	2.9		%	3.5		%

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes~~

On April 3, 2020, we amended the credit agreement to ~~Condensed Consolidated Financial Statements~~

~~(unaudited)~~

add a 364-day term loan facility up to an aggregate commitment of $75 million under our credit agreement for a total commitment amount of $525 million, with another $75 million available under our accordion (subject to lenders' approval). We fully drew down the term loan and secured an initial interest rate of approximately 3.27%, which is equal to the one-month LIBOR rate plus the applicable margin based on the then-current total leverage ratio. In addition, the amendment: (a) increases the floor for loans based on LIBOR to at least 0.75% and (b) prohibits the use of proceeds of the revolving loan, term loan or letters of credit under the credit agreement, as amended, to make capital distributions (as defined in the credit agreement, as amended, to include, among other items, dividends and share repurchases). No financial covenants were amended. The additional borrowings were undertaken as a precautionary measure to provide increased liquidity and preserve financial flexibility in light of current disruption and uncertainty resulting from the COVID-19 pandemic. Proceeds may be used in the future for working capital and other general corporate purposes permitted by the credit agreement, as amended.

6. Leases

We lease our retail, office and manufacturing space under operating leases which, in addition to the minimum lease payments, may require payment of a proportionate share of the real estate taxes and certain building operating expenses. While our local market development approach generally results in long-term participation in given markets, our retail store leases generally provide for an initial lease term of five to 10 years. Our office and manufacturing leases provide for an initial lease term of up to 15 years. In addition, our mall-based retail store leases may require payment of variable rent based on net sales in excess of certain thresholds. Certain leases may contain options to extend the term of the original lease. The exercise of lease renewal options is at our sole discretion. Lease options are included in the lease term only if exercise is reasonably certain at lease commencement. Our lease agreements do not contain any material residual value guarantees. We also lease vehicles and certain equipment under operating leases with an initial lease term of three to five years.

~~We determine if an arrangement is a lease at inception. Beginning in 2019 in conjunction with our adoption of ASC Topic 842,~~

~~Leases~~
~~, right-of-use (ROU) assets and operating lease liabilities are recognized at the lease commencement date based on the estimated present value of future lease payments over the lease term. Most of our leases do not provide an implicit interest rate nor is the rate available to us from our lessors. As an alternative,~~ we use our estimated incremental borrowing rate, which is derived from information available at the lease commencement date, including publicly available data, in determining the present value of lease payments.

Our operating lease costs include facility, vehicle and equipment lease costs, but exclude variable lease costs. Operating lease costs are recognized on a straight-line basis over the lease term, after consideration of rent escalations and rent holidays. The lease term for purposes of the calculation begins on the earlier of the lease commencement date or the date we take possession of the property. During lease renewal negotiations that extend beyond the original lease term, we estimate straight-line rent expense based on current market conditions. Variable lease costs are recorded when it is probable the cost has been incurred and the amount iscan be reasonably ~~estimable.~~estimated. Future payments for real estate taxes and certain building operating expenses for which we are obligated are not included in operating lease costs. Leases with an initial term of 12 months or less are not recorded on the balance sheet as an ROU asset or operating lease liability. We recognize operating lease costs for these short-term leases, primarily small equipment leases, on a straight-line basis over the lease term.

At ~~September~~March 28, ~~2019,~~2020, our finance ~~ROU~~right-of-use assets and lease liabilities were not significant.

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SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Operating lease costs were as follows (in thousands):


	Three Months Ended		Nine Months Ended			Three Months Ended
	September 28, 2019		September 28, 2019			March 28, 2020		March 30, 2019
Operating lease costs⁽¹⁾	$	21,583	$	63,719	Operating lease costs⁽¹⁾	$	22,949	$	21,056
Variable lease costs	$	466	$	1,387	Variable lease costs	$	12	$	499

⁽¹⁾	~~Includes short-term lease costs which are not significant.~~

___________________________

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

⁽¹⁾Includes short-term lease costs which are not significant.

The maturities of operating lease liabilities as of ~~September~~March 28, ~~2019,~~2020, were as follows (in thousands):

2019 (excluding the nine months ended September 28, 2019)

$
21,045

2020

79,652

2021

72,354

2022

64,339

2023

54,970

2024

43,393

Thereafter

110,847

Total lease payments⁽¹⁾

446,600

Less: Interest

95,355

Present value of operating lease liabilities⁽²⁾

$
351,245

⁽¹⁾	~~Total lease payments exclude $51 million of legally binding minimum lease payments for leases signed but not yet commenced.~~

⁽²⁾	~~Includes the current portion of $58 million for operating lease liabilities.~~


2020 (excluding the three months ended March 28, 2020)⁽¹⁾	63,309
2021	78,083
2022	69,672
2023	59,702
2024	47,918
2025	39,059
Thereafter	88,488
Total lease payments⁽²⁾	446,231
Less: Interest	91,473
Present value of operating lease liabilities⁽³⁾	$	354,758

~~The aggregate future commitments under~~

___________________________

⁽¹⁾Subsequent to March 28, 2020, we renegotiated certain operating leases asto defer approximately $3 million in lease payments from 2020 to future periods in response to store closings mandated by federal, state or local authorities and other economic issues related to COVID-19.

⁽²⁾Total lease payments exclude $62 million of ~~December 30, 2018, were expected to be as follows (in thousands):~~

legally binding minimum lease payments for leases signed but not yet commenced.

2019

$
78,337

2020

73,331

2021

66,491

2022

59,515

2023

51,076

Thereafter

149,318

Total lease payments⁽¹⁾

$
478,068

⁽³⁾Includes the current portion of $60 million for operating lease liabilities.

⁽¹⁾	~~Total lease payments include $62 million of legally binding minimum lease payments for leases signed but not yet commenced.~~

Other information related to operating leases was as follows:

~~September 28,~~

~~2019~~

~~Weighted-average remaining lease term (years)~~

~~6.7~~

~~Weighted-average discount rate~~

~~7.3%~~


	March 28, 2020		December 28, 2019
Weighted-average remaining lease term (years)	6.5		6.6
Weighted-average discount rate	7.1	%	7.2	%

Nine Months Ended

(in thousands)

September 28,
2019

Cash paid for amounts included in present value of operating lease liabilities

$
60,512

Right-of-use assets obtained in exchange for operating lease liabilities⁽¹⁾

$
53,230

⁽¹⁾	~~See Note 1,~~ ~~Recently Adopted Accounting Guidance, which discusses the impact of our initial adoption of the new lease standard.~~


	Three Months Ended
(in thousands)	March 28, 2020		March 30, 2019
Cash paid for amounts included in present value of operating lease liabilities	$	21,469	$	19,757
Right-of-use assets obtained in exchange for operating lease liabilities	$	10,954	$	16,153

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SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

7. Repurchases of Common Stock

Repurchases of our common stock were as follows (in thousands):

Three Months Ended

Nine Months Ended

September 28,
2019

September 29,
2018

September 28,
2019

September 29,
2018

Amount repurchased under Board-approved share
repurchase program

$
40,000

$
55,000

$
120,900

$
195,000

Amount repurchased in connection with the vesting of
employee restricted stock grants

142

299

9,575

3,239

Total amount repurchased

$
40,142

$
55,299

$
130,475

$
198,239


	Three Months Ended
	March 28, 2020		March 30, 2019
Amount repurchased under Board-approved share repurchase program	$	38,111	$	40,900
Amount repurchased in connection with the vesting of employee restricted stock grants	2,841		6,082
Total amount repurchased (based on trade dates)	$	40,952	$	46,982

~~Effective as~~

As of ~~September 29, 2019,~~March 28, 2020, the remaining authorization under our ~~board approved an increase in our total remaining~~Board-approved share repurchase ~~authorization to $500~~program was $437 million.

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

In light of the uncertainty surrounding the impact of COVID-19, we have suspended all share repurchases under our Board-approved share repurchase program.

8. Revenue Recognition

Deferred contract assets and deferred contract liabilities are included in our condensed consolidated balance sheets as follows (in thousands):


	September 28, 2019		December 29, 2018			March 28, 2020		December 28, 2019
Deferred Contract Assets included in:					Deferred Contract Assets included in:
Other current assets	$	22,765	$	20,553	Other current assets	$	24,408	$	23,568
Other non-current assets		32,758		29,456	Other non-current assets	35,078		33,782
	$	55,523	$	50,009		$	59,486	$	57,350

September 28,
2019

December 29, 2018

Deferred Contract Liabilities included in:

Other current liabilities

$
33,885

$
32,395

Other non-current liabilities

44,088

42,194

$
77,973

$
74,589


	March 28, 2020		December 28, 2019
Deferred Contract Liabilities included in:
Other current liabilities	$	34,515	$	34,204
Other non-current liabilities	46,512		44,970
	$	81,027	$	79,174

During the three months ended ~~September~~March 28, ~~2019~~2020 and ~~September 29, 2018,~~March 30, 2019, we recognized revenue of $9$10 million and $8$9 million, respectively, that ~~was~~were included in the deferred contract liability ~~balance~~balances at the beginning of the respective periods. During the nine months ended September 28, 2019 and September 29, 2018, we recognized revenue of $25 million and $22 million, respectively, that was included in the deferred contract liability balance at the beginning of the respective periods.

Revenue from goods and services transferred to customers at a point in time accounted for approximately 98% of our revenues for both the three ~~and nine~~ months ended ~~September~~March 28, ~~2019~~2020 and ~~September 29, 2018.~~

March 30, 2019.

Net sales from each of our channels was as follows (in thousands):


	Three Months Ended				Nine Months Ended					Three Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019		September 29, 2018			March 28, 2020		March 30, 2019
Retail	$	437,871	$	383,886	$	1,158,096	$	1,026,808	Retail	$	435,357	$	392,226
Online and phone		34,520		28,686		89,695		81,580	Online and phone	35,917		29,763
Company-Controlled channel		472,391		412,572		1,247,791		1,108,388	Company-Controlled channel	471,274		421,989
Wholesale/Other channel		2,387		2,207		9,395		11,362	Wholesale/Other channel	1,292		4,456
Total	$	474,778	$	414,779	$	1,257,186	$	1,119,750	Total	$	472,566	$	426,445

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SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

Obligation for Sales Returns

The activity in the sales returns liability account was as follows (in thousands):


	Nine Months Ended							Three Months Ended
	September 28, 2019			September 29, 2018				March 28, 2020		March 30, 2019
Balance at beginning of year	$	19,907		$	19,270		Balance at beginning of year	$	19,809	$	19,907
Additions that reduce net sales		60,962			57,296		Additions that reduce net sales	22,258		21,726
Deductions from reserves		(57,036	)		(56,031	)	Deductions from reserves	(19,794)		(21,676)
Balance at end of period	$	23,833		$	20,535		Balance at end of period	$	22,273	$	19,957

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

9. Stock-Based Compensation Expense

Total stock-based compensation expense was as follows (in thousands):


	Three Months Ended				Nine Months Ended					Three Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019		September 29, 2018			March 28, 2020		March 30, 2019
Stock awards	$	3,527	$	2,759	$	10,256	$	8,247	Stock awards	$	1,405	$	3,033
Stock options		619		597		1,778		1,851	Stock options	646		605
Total stock-based compensation expense		4,146		3,356		12,034		10,098
Total stock-based compensation expense ⁽¹⁾									Total stock-based compensation expense ⁽¹⁾	2,051		3,638
Income tax benefit		984		802		2,948		2,454	Income tax benefit	496		898
Total stock-based compensation expense, net of tax	$	3,162	$	2,554	$	9,086	$	7,644	Total stock-based compensation expense, net of tax	$	1,555	$	2,740

⁽¹⁾Decrease in 2020 stock-based compensation expense reflects the cumulative impact of the change in the expected achievements of certain performance targets.

10. Profit Sharing and 401(k) Plan

Under our profit sharing and 401(k) plan, eligible employees may defer up to 50% of their compensation on a pre-tax basis, subject to Internal Revenue Service limitations. Each pay period, we may make a discretionary contribution equal to a percentage of the employee’s contribution. During the three months ended ~~September~~March 28, ~~2019~~2020 and ~~September 29, 2018,~~March 30, 2019, our contributions, net of forfeitures, were ~~$1.5 million. During the nine months ended September 28, 2019 and September 29, 2018, our contributions, net of forfeitures, were $4.5~~$1.6 million and ~~$4.2~~$1.5 million, respectively.

Effective May 2020, we suspended making discretionary 401(k) plan contributions for the remainder of fiscal year 2020.

11.Net Income per Common Share

The components of basic and diluted net income per share were as follows (in thousands, except per share amounts):


	Three Months Ended				Nine Months Ended					Three Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019		September 29, 2018			March 28, 2020		March 30, 2019
Net income	$	28,054	$	18,257	$	57,752	$	42,549	Net income	$	39,140	$	25,418
Reconciliation of weighted-average shares outstanding:									Reconciliation of weighted-average shares outstanding:
Basic weighted-average shares outstanding		29,085		34,231		29,859		36,204	Basic weighted-average shares outstanding	27,858		30,620
Dilutive effect of stock-based awards		711		808		829		873	Dilutive effect of stock-based awards	914		1,118
Diluted weighted-average shares outstanding		29,796		35,039		30,688		37,077	Diluted weighted-average shares outstanding	28,772		31,738
Net income per share – basic	$	0.96	$	0.53	$	1.93	$	1.18	Net income per share – basic	$	1.40	$	0.83
Net income per share – diluted	$	0.94	$	0.52	$	1.88	$	1.15	Net income per share – diluted	$	1.36	$	0.80

For the three ~~and nine~~ months ended ~~September~~March 28, ~~2019~~2020 and ~~September 29, 2018,~~March 30, 2019, anti-dilutive stock-based awards excluded from the diluted net income per share calculations were immaterial.

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SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

12. Commitments and Contingencies

Warranty Liabilities

The activity in the accrued warranty liabilities account was as follows (in thousands):


	Nine Months Ended							Three Months Ended
	September 28, 2019			September 29, 2018				March 28, 2020		March 30, 2019
Balance at beginning of year	$	10,389		$	9,320		Balance at beginning of year	$	11,345	$	10,389
Additions charged to costs and expenses for current-year sales		8,033			9,275		Additions charged to costs and expenses for current-year sales	2,628		3,192
Deductions from reserves		(8,159	)		(8,461	)	Deductions from reserves	(2,779)		(3,127)
Changes in liability for pre-existing warranties during the current year, including expirations		1,189			177		Changes in liability for pre-existing warranties during the current year, including expirations	297		1,166
Balance at end of period	$	11,452		$	10,311		Balance at end of period	$	11,491	$	11,620

Legal Proceedings

We are involved from time to time in various legal proceedings arising in the ordinary course of our business, including primarily commercial, product liability, employment and intellectual property claims. In accordance with U.S. generally accepted accounting principles, we record a liability in our consolidated financial statements with respect to any of these matters when it is both probable that a liability has been incurred and the amount of the liability can be reasonably estimated. If a material loss is reasonably possible but not known or probable, and may be reasonably estimated, the estimated loss or range of loss is disclosed. With respect to currently pending legal proceedings, we have not established an estimated range of reasonably possible material losses either because we believe that we have valid defenses to claims asserted against us, the proceeding has not advanced to a stage of discovery that would enable us to establish an estimate, or the potential loss is not material. We currently do not expect the outcome of pending legal proceedings to have a material effect on our consolidated results of operations, financial position or cash flows. Litigation, however, is inherently unpredictable, and it is possible that the ultimate outcome of one or more claims asserted against us could adversely impact our consolidated results of operations, financial position or cash flows. We expense legal costs as incurred.

On September 18, 2018, two former Home Delivery team members filed suit, now venued in Superior Court in Fresno County, California, alleging representative claims on a purported class action basis under the California Labor Code Private Attorney General Act. While the two representative plaintiffs were in the Home Delivery workforce, the Complaint does not limit the purported plaintiff class to that group. The plaintiffs allege that Sleep Number failed or refused to adopt adequate practices, policies and procedures relating to wage payments, record keeping, employment disclosures, meal and rest breaks, among other claims, under California law. The Complaint sought damages in the form of civil penalties and plaintiffs’ attorneys’ ~~fees, and expressly disclaims the recovery of any purported individual specific relief or underpaid wages.~~fees. The parties ~~tentatively reached~~have executed a settlement agreement pending Court approval, which includes the settlement and release of certain additional related ~~claims.~~claims that are contained in a consolidated complaint currently pending in San Diego County Superior Court. We intend to continue vigorously defending this matter in the event itthe Court does not ~~settle.~~

approve the settlement.

On March 27, 2018, Level Sleep, LLC (Level Sleep) filed a patent infringement lawsuit against Sleep Number in the Federal District Court for the Eastern District of Texas. In its Complaint, Level Sleep claims that Sleep Number infringed two patents owned by Level Sleep, U.S. Patent Nos. 6,807,698 and 7,036,172 (the ~~“Patents”)~~Patents), by, among other things, making, using, offering for sale, or selling within the United States, and/or importing into the United States, beds with sleep surfaces having foam with multiple zones in the longitudinal direction. Level Sleep has asserted that five non-360^® beds no longer sold and two current non-360 beds infringe the Patents. Level Sleep seeks damages in the form of a reasonable royalty. Sleep Number has asserted that the Patents are invalid and that our products do not infringe the Patents. ~~The case is scheduled for trial~~On January 14, 2020, the Court granted summary judgment in ~~February 2020.~~favor of Sleep Number, finding that Sleep Number’s products do not infringe the Patents. Level Sleep has filed a notice of appeal of the Court’s summary judgment order. We intend to continue vigorously ~~defend~~defending this matter.

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SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

13. COVID-19 Pandemic

The COVID-19 pandemic and ensuing government restrictions have resulted in the temporary closure of most of our retail stores since mid-March. The pandemic has impacted our revenue growth and will adversely impact our financial performance. The length and severity of the reduction in consumer demand due to the pandemic and the impact on our future financial performance remains uncertain.

In response to the pandemic, we have taken decisive actions to focus on the health and safety of our team members and customers, strengthening our liquidity, cash flows and financial position, and mitigating the future impact on our operations and financial performance. See Item 2. Management's Discussion and Analysis of Financial Conditions and Results of Operations and Part II: Item 1A. Risk Factors for additional discussion on the COVID-19 pandemic and the impact on our business.

Index

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is intended to provide a reader of our condensed consolidated financial statements with a narrative from the perspective of management on our financial condition, results of operations, liquidity and certain other factors that may affect our future results. Our MD&A is presented in ~~seven~~eight sections:

•	~~Risk Factors~~

•	~~Company Overview~~

•	~~Results of Operations~~

•	~~Liquidity and Capital Resources~~

•	~~Non-GAAP Data~~

•	~~Off-Balance-Sheet Arrangements and Contractual Obligations~~

•	~~Critical Accounting Policies~~

Risk Factors

•Business Overview

•COVID-19 Pandemic - Impact on our Business

•Results of Operations

•Liquidity and Capital Resources

•Non-GAAP Data Reconciliations

•Off-Balance-Sheet Arrangements and Contractual Obligations

•Critical Accounting Policies

Forward-Looking Statements and Risk Factors

The discussion in this Quarterly Report contains certain forward-looking statements that relate to future plans, events, financial results or performance. You can identify forward-looking statements by those that are not historical in nature, particularly those that use terminology such as “may,” “will,” “should,” “could,” “expect,” “anticipate,” “believe,” “estimate,” “plan,” “project,” “predict,” “intend,” “potential,” “continue” or the negative of these or similar terms. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from our historical experience and our present expectations or projections. These risks and uncertainties include, among others:

•	~~Current and future general and industry economic trends and consumer confidence;~~

•	~~The effectiveness of our marketing messages;~~

•Current and future general and industry economic trends and consumer confidence;

~~The efficiency of our advertising and promotional efforts;~~

•Risks inherent in outbreaks of pandemics or contagious disease, including the COVID-19 pandemic;

~~Our ability to execute our Company-Controlled distribution strategy;~~

•The effectiveness of our marketing messages;

~~Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;~~

•The efficiency of our advertising and promotional efforts;

~~Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;~~

•Our ability to execute our Company-Controlled distribution strategy;

~~Industry competition, the emergence of additional competitive products and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;~~

•Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;

~~The potential for claims that our products, processes, advertising, or trademarks infringe the intellectual property rights of others;~~

•Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;

~~Availability of attractive and cost-effective consumer credit options;~~

•Industry competition, the emergence of additional competitive products and the adequacy of our intellectual property rights to protect our products and brand from competitive or infringing activities;

~~Our manufacturing processes with minimal levels of inventory, which may leave us vulnerable to shortages in supply;~~

•Claims that our products, processes, advertising, or trademarks infringe the intellectual property rights of others;

Our dependence on significant suppliers and third parties and our ability to maintain relationships with key suppliers or third parties, including several sole-source suppliers or providers of services;

•Availability of attractive and cost-effective consumer credit options;

~~Rising commodity costs and other inflationary pressures;~~

•	~~Risks inherent in global sourcing activities, including tariffs and the potential for~~•Our manufacturing processes with minimal levels of inventory, which may leave us vulnerable to shortages in supply;

•Our dependence on significant suppliers and third parties and our ability to maintain relationships with key suppliers or third-parties, including several sole-source suppliers or providers of services;

~~Risks of disruption in the operation of any of our main manufacturing facilities or assembly facilities;~~

•Rising commodity costs and other inflationary pressures;

~~Increasing government regulation;~~

•Risks inherent in global sourcing activities, including tariffs, outbreaks of pandemics or contagious diseases, strikes and the potential for shortages in supply;

~~Pending or unforeseen litigation and the potential for adverse publicity associated with litigation;~~

•Risks of disruption in the operation of any of our main manufacturing facilities or assembly facilities;

~~The adequacy of our and third-party information systems to meet the evolving needs of our business and existing and evolving risks and regulatory standards applicable to data privacy and security;~~

•Increasing government regulation;

~~The costs and potential disruptions to our business related to upgrading our information systems;~~

•Pending or unforeseen litigation and the potential for adverse publicity associated with litigation;

The vulnerability of our and third-party information systems to attacks by hackers or other cyber threats that could compromise the security of our systems, result in a data breach or disrupt our business;

•The adequacy of our and third-party information systems to meet the evolving needs of our business and existing and evolving risks and regulatory standards applicable to data privacy and security;

~~Our ability to attract, retain and motivate qualified management, executive and other key team members, including qualified retail sales professionals and managers.~~

•The costs and potential disruptions to our business related to upgrading our information systems;

•The vulnerability of our and third-party information systems to attacks by hackers or other cyber threats that could compromise the security of our systems, result in a data breach or disrupt our business; and

•Our ability to attract, retain and motivate qualified management, executive and other key team members, including qualified retail sales professionals and managers.

Additional information concerning these, and other risks and uncertainties is contained under the caption “Risk Factors” below in Part II: Item 1A of this Quarterly Report on Form 10-Q and under the same caption in our Annual Report on Form 10-K.

We have no obligation to publicly update or revise any of the forward-looking statements contained in this Quarterly Report on Form 10-Q.

Index

Business Overview

~~Index~~

~~Company Overview~~

~~Sleep Number Corporation, based~~As a purpose driven company in ~~Minneapolis, Minnesota, was founded in 1987. We are listed on The Nasdaq Stock Market LLC (Nasdaq Global Select Market) under the symbol “SNBR.”~~

health and wellness, Sleep Number is the leader in sleep innovation. Our vertically integrated business model and role as the exclusive designer, manufacturer, marketer, retailer and servicer of Sleep Number^® beds ~~and the leader in sleep innovation. We~~allows us to offer ~~our customers~~consumers high-quality, individualized sleep solutions and ~~services, including a complete line of Sleep Number beds, bases and bedding accessories.~~ services.

We are ~~also the pioneer and leader in biometric sleep innovation and tracking. Our proprietary SleepIQ~~^® ~~technology, the operating system of the 360~~^® ~~smart bed, works with our proprietary algorithms and artificial intelligence~~committed to ~~track user’s sleep patterns and biometric changes. SleepIQ allows each bed to use the sleeper’s own data to automatically and effortlessly adjust the bed’s firmness,~~ delivering ~~proven quality sleep.~~

~~Our relentless focus on developing benefit-driven innovation for our customers is resulting in~~ superior shareholder value ~~as we: (i) increase~~by: (1) increasing consumer demand; ~~(ii) leverage~~(2) leveraging our business model; and ~~(iii) deploy~~(3) deploying capital efficiently.

COVID-19 Pandemic - Impact on our Business

Health and Safety of our Team Members and Customers. As the COVID-19 pandemic has developed, we have taken numerous steps to support our team members and customers in practicing social distancing. In addition, we have implemented numerous other practices in our stores, manufacturing facilities and operations based on the Centers for Disease Control and Prevention’s (CDC) recommendations.

Expense Management. With the reduction in revenue growth, we have, and will continue to implement cost cutting actions, including:

•We furloughed nearly 40% of our team members with another 30% working reduced hours.

•A significant amount of our team members’ compensation depends on Company performance against pre-determined goals and changes in shareholder value. Our CEO will not receive any cash compensation for the balance of the year through a 50% deferral and exchanging all remaining salary for restricted stock units. In addition, our board and most of our leadership team reduced their cash compensation in exchange for restricted stock units. All team members’ compensation has been meaningfully reduced through variable compensation programs and other actions.

•We temporarily suspended our 401(k) match and selected other employee benefit programs.

•We reduced our sales and marketing expenses, and temporarily suspended virtually all discretionary projects across the company.

•We are negotiating rent deferrals and abatements for stores closed due to COVID-19.

Liquidity, Cash Flows and Financial Position. We have taken the following actions to preserve cash, increase liquidity and strengthen our financial position:

•Drew down the remaining availability under our revolving credit facility on March 17, 2020. Cash and cash equivalents at March 28, 2020 totaled $239 million.

•Added $75 million of additional cash on April 3, 2020 through an incremental 364-day term loan under our credit facility’s $150 million accordion.

•Suspended share repurchases for the remainder of 2020.

•Reduced 2020 planned capital expenditures to approximately $35 million versus $59 million in 2019.

CARES Act. On March 27, 2020, the President signed the Coronavirus Aid, Relief, and Economic Security Act (the CARES Act) into law. The CARES Act includes the following relief, among others:

•Amended federal tax laws to permit 100% bonus depreciation for eligible qualified improvement property placed in service by the taxpayer after December 31, 2017 and before January 1, 2023.

•Employers are eligible for a 50 percent refundable payroll tax credit on wages paid up to $10,000 during the crisis. The credit would be available to employers whose businesses were disrupted due to virus shutdowns and those that had a decrease in gross receipts of 50 percent or more when compared to the same quarter last year. The credit can be claimed for employees who are retained but not currently working due to the crisis for firms with more than 100 employees.

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•Provides for deferred payment of the employer portion of social security taxes through the end of 2020, with 50% of the deferred amount due December 31, 2021 and the remaining 50% due December 31, 2022. This will provide us with additional liquidity during 2020.

Results of Operations

Quarterly and Year-to-Date Results

Quarterly and year-to-date operating results may fluctuate significantly as a result of a variety of factors, including increases or decreases in sales, timing, amount and effectiveness of advertising expenditures, changes in sales return rates or warranty experience, timing of investments in growth initiatives and infrastructure, timing of store openings/closings and related expenses, changes in net sales resulting from changes in our store base, timing of new product introductions and related expenses, timing of promotional offerings, competitive factors, changes in commodity costs, disruptions in supplies or third-party service providers, seasonality of retail and bedding industry sales, consumer confidence and general economic conditions. In addition, based on the duration and severity of the current global situation involving the COVID-19 pandemic, the extent to which our business and our condensed consolidated financial results are impacted, will depend on future developments, which are highly uncertain and cannot be predicted. Therefore, our historical results of operations may not be indicative of the results that may be achieved for any future period.

Highlights

Financial highlights for the ~~period~~three months ended ~~September~~March 28, ~~2019~~2020 were as follows:

•

Net sales for the three months ended September 28, 2019 increased 14% to $475 million, compared with $415 million for the same period one year ago. Net sales for the three months ended September 29, 2018 were impacted by an approximately $24 million shift in sales from our third quarter to our fourth quarter.

•	The 14% net sales increase resulted from a 10% comparable sales increase in our Company-Controlled channel and a 5 percentage point (ppt.) increase in sales from 33 net new stores opened in the past 12 months. For additional details, see the components of total net sales change on page 14.

•The COVID-19 pandemic and ensuing government restrictions have resulted in the temporary closure of most of our retail stores since mid-March. We have taken decisive action to manage liquidity and costs through the challenging economic environment caused by the COVID-19 pandemic. For additional details, see "COVID-19 Pandemic - Impact on our Business" above.

Sales per store (Company-Controlled channel sales for stores open at least one year, including online and phone sales) on a trailing twelve-month basis for the period ended September 28, 2019 totaled $2.9 million, 8% higher than the same period one year ago.

•Net sales for the three months ended March 28, 2020 increased 11% to $473 million, compared with $426 million for the same period one year ago.

Operating income for the three months ended September 28, 2019 was $39 million, an increase of 55%, or $14 million, from the prior-year period. Our operating income rate increased to 8.2% of net sales, compared with 6.1% of net sales for the same period last year. The prior-period's operating income and operating income rate were affected by the sales shift highlighted above.

•The 11% net sales increase resulted from a 7% comparable sales increase in our Company-Controlled channel and 5 percentage points (ppt.) of sales growth from 26 net new stores opened in the past 12 months. For additional details, see the components of total net sales change on page 17.

The current-period's operating income and operating income rate were positively impacted by the 14% increase in net sales and a 2.0 ppt. improvement in the gross profit rate. The 2.0 ppt. gross profit rate improvement was primarily due to three factors: (i) a favorable sales mix of high-margin products; (ii) the elimination of prior year’s product transition costs; and (iii) current-period manufacturing and supply chain efficiency gains, and benefit-driven product price increases.

•Sales per store (Company-Controlled channel sales for stores open at least one year, including online and phone sales) on a trailing twelve-month basis for the period ended March 28, 2020 totaled $2.9 million, 7% higher than the same period one year ago.

Net income for the three months ended September 28, 2019 increased 54% to $28 million, compared with $18 million for the same period one year ago. Earnings per diluted share were $0.94, up 81% compared with $0.52 last year.

•Operating income for the three months ended March 28, 2020 was $53 million, an increase of 61%, or $20 million, compared with $33 million in the prior-year period. Our operating income rate increased to 11.2% of net sales, compared with 7.7% of net sales for the same period last year.

~~Cash provided by operating activities for the nine months ended September 28, 2019 increased by $55 million to $190 million, compared with $134 million for the same period one year ago.~~

•Operating income and our operating income rate for the three months ended March 28, 2020 were positively impacted by the 11% increase in net sales and a 2.4 ppt. improvement in the gross profit rate. The 2.4 ppt. gross profit rate improvement was primarily due to three factors: (i) a favorable sales mix of higher-margin products; (ii) reduced warranty expenses; and (iii) current-period manufacturing efficiency gains. In addition, operating income for the current-year period included a $6.2 million reduction in broad-based incentive compensation, partially offset by $2.6 million of COVID-19 disruption related payroll expenses.

~~At September 28, 2019, we ended the quarter with $214 million of borrowings under our $450 million revolving credit facility.~~

•During the three-months ended March 28, 2020, we continued to prioritize investments in near- and long-term growth drivers, including a 25% increase in our innovation driving R&D expenses.

During the three months ended September 28, 2019, we repurchased 0.9 million shares of our common stock under our Board-approved share repurchase program at a cost of $40 million (based on trade date, at an average of $42.77 per share). Effective as of September 29, 2019, our Board approved an increase in the remaining authorization under our Board-approved share repurchase program to $500 million.

•Net income for the three months ended March 28, 2020 increased 54% to $39 million, compared with $25 million for the same period one year ago. Earnings per diluted share were $1.36, up 70% compared with $0.80 last year.

•Cash provided by operating activities for the three months ended March 28, 2020 increased by $17 million, or 25%, to $85 million, compared with $68 million for the same period one year ago.

•Cash and cash equivalents at March 28, 2020 totaled $239 million, including drawing down the then remaining availability under our revolving credit facility on March 17, 2020 in response to the COVID-19 pandemic. At March 28, 2020, we had $446 million of borrowings under our revolving credit facility. On April 3, 2020, we entered into a $75 million 364-day term loan under our credit facility and drew down the full amount.

Index

The following table sets forth our results of operations expressed as dollars and percentages of net sales. Figures are in millions, except percentages and per share amounts. Amounts may not add due to rounding differences.


		Three Months Ended								Nine Months Ended									Three Months Ended
		September 28, 2019				September 29, 2018				September 28, 2019				September 29, 2018					March 28, 2020						March 30, 2019
Net sales		$	474.8	100.0	%	$	414.8	100.0	%	$	1,257.2	100.0	%	$	1,119.8	100.0	%	Net sales	$	472.6	100.0	%	$	426.4	100.0	%
Cost of sales			178.4	37.6	%		164.3	39.6	%		481.4	38.3	%		442.9	39.6	%	Cost of sales	170.4		36.1	%	164.2		38.5	%
Gross profit			296.4	62.4	%		250.5	60.4	%		775.8	61.7	%		676.9	60.4	%	Gross profit	302.1		63.9	%	262.2		61.5	%
Operating expenses:																		Operating expenses:
Sales and marketing			213.1	44.9	%		188.5	45.4	%		568.8	45.2	%		511.5	45.7	%	Sales and marketing	207.7		44.0	%	186.8		43.8	%
General and administrative			35.1	7.4	%		29.4	7.1	%		102.5	8.2	%		89.9	8.0	%	General and administrative	31.1		6.6	%	34.3		8.0	%
Research and development			9.0	1.9	%		7.4	1.8	%		25.4	2.0	%		21.1	1.9	%	Research and development	10.5		2.2	%	8.4		2.0	%
Total operating expenses			257.2	54.2	%		225.2	54.3	%		696.7	55.4	%		622.6	55.6	%	Total operating expenses	249.3		52.8	%	229.5		53.8	%
Operating income			39.2	8.2	%		25.3	6.1	%		79.1	6.3	%		54.3	4.9	%	Operating income	52.8		11.2	%	32.7		7.7	%
Interest expense, net			3.1	0.7	%		1.8	0.4	%		9.0	0.7	%		3.8	0.3	%	Interest expense, net	2.3		0.5	%	2.6		0.6	%
Income before income taxes			36.0	7.6	%		23.5	5.7	%		70.1	5.6	%		50.5	4.5	%	Income before income taxes	50.5		10.7	%	30.1		7.1	%
Income tax expense			8.0	1.7	%		5.2	1.3	%		12.4	1.0	%		7.9	0.7	%	Income tax expense	11.3		2.4	%	4.7		1.1	%
Net income		$	28.1	5.9	%	$	18.3	4.4	%	$	57.8	4.6	%	$	42.5	3.8	%	Net income	$	39.1	8.3	%	$	25.4	6.0	%

Net income per share:																		Net income per share:
Basic		$	0.96			$	0.53			$	1.93			$	1.18			Basic	$	1.40			$	0.83
Diluted		$	0.94			$	0.52			$	1.88			$	1.15			Diluted	$	1.36			$	0.80

Weighted-average number of common shares:	Weighted-average number of common shares:																	Weighted-average number of common shares:
Basic			29.1				34.2				29.9				36.2			Basic	27.9				30.6
Diluted			29.8				35.0				30.7				37.1			Diluted	28.8				31.7

The percentage of our total net sales, by dollar volume, from each of our channels was as follows:


	Three Months Ended						Nine Months Ended							Three Months Ended
	September 28, 2019			September 29, 2018			September 28, 2019			September 29, 2018				March 28, 2020		March 30, 2019
Company-Controlled channel		99.5	%		99.5	%		99.3	%		99.0	%	Company-Controlled channel	99.7	%	99.0	%
Wholesale/Other channel		0.5	%		0.5	%		0.7	%		1.0	%	Wholesale/Other channel	0.3	%	1.0	%
Total		100.0	%		100.0	%		100.0	%		100.0	%	Total	100.0	%	100.0	%

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The components of total net sales change, including comparable net sales changes, were as follows:


	Three Months Ended						Nine Months Ended							Three Months Ended
	September 28, 2019			September 29, 2018			September 28, 2019			September 29, 2018				March 28, 2020		March 30, 2019
Sales change rates:													Sales change rates:
Retail comparable-store sales ⁽¹⁾		9	%		(1	%)		7	%		0	%	Retail comparable-store sales ⁽¹⁾	6	%	5	%
Online and phone		20	%		10	%		10	%		11	%	Online and phone	21	%	6	%
Company-Controlled comparable sales change ⁽¹⁾		10	%		0	%		8	%		1	%	Company-Controlled comparable sales change ⁽¹⁾	7	%	5	%
Net opened/closed stores		5	%		3	%		5	%		3	%	Net opened/closed stores	5	%	5	%
Total Company-Controlled channel		15	%		3	%		13	%		4	%	Total Company-Controlled channel	12	%	10	%
Wholesale/Other channel		8	%		(21	%)		(17	%)		(31	%)	Wholesale/Other channel	(71	%)	(3	%)
Total net sales change		14	%		3	%		12	%		4	%	Total net sales change	11	%	10	%

⁽¹⁾	Stores are included in the comparable-store calculations in the 13th full month of operations. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base.

___________________________

⁽¹⁾~~Index~~Stores are included in the comparable-store calculations in the 13th full month of operations. Stores that have been remodeled or repositioned within the same shopping center remain in the comparable-store base.

Other sales metrics were as follows:

Three Months Ended

Nine Months Ended

September 28,
2019

September 29,
2018

September 28,
2019

September 29,
2018

Average sales per store ⁽¹⁾ ($ in thousands)

$
2,858

$
2,635

Average sales per square foot ⁽¹⁾

$
1,029

$
977

Stores > $2 million in net sales ⁽²⁾

70
%

62
%

Stores > $3 million in net sales ⁽²⁾

28
%

23
%

Average revenue per mattress unit – Company-
Controlled channel ⁽³⁾

$
4,788

$
4,387

$
4,837

$
4,432

⁽¹⁾	~~Trailing-twelve months Company-Controlled comparable sales per store open at least one year.~~

⁽²⁾	~~Trailing-twelve months for stores open at least one year (excludes online and phone sales).~~


	Three Months Ended
	March 28, 2020			March 30, 2019
Average sales per store ⁽¹⁾ ($ in thousands)	$	2,932		$	2,744
Average sales per square foot ⁽¹⁾	$	1,040		$	1,003
Stores > $2 million in net sales ⁽²⁾	71		%	66		%
Stores > $3 million in net sales ⁽²⁾	32		%	26		%
Average revenue per mattress unit – Company-Controlled channel ⁽³⁾	$	4,884		$	4,804

⁽³⁾	~~Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.~~

___________________________

⁽¹⁾Trailing-twelve months Company-Controlled comparable sales per store open at least one year.

⁽²⁾Trailing-twelve months for stores open at least one year (excludes online and phone sales).

⁽³⁾Represents Company-Controlled channel total net sales divided by Company-Controlled channel mattress units.

The number of retail stores operating was as follows:


	Three Months Ended						Nine Months Ended							Three Months Ended
	September 28, 2019			September 29, 2018			September 28, 2019			September 29, 2018				March 28, 2020	March 30, 2019
Beginning of period		594			565			579			556		Beginning of period	611	579
Opened		15			9			47			33		Opened	8	15
Closed		(7	)		(5	)		(24	)		(20	)	Closed	(8)	(9)
End of period		602			569			602			569		End of period	611	585

Index

Comparison of Three Months Ended ~~September~~March 28, ~~2019~~2020 with Three Months Ended ~~September 29, 2018~~March 30, 2019

Net sales

Net sales for the three months ended ~~September~~March 28, ~~2019~~2020 increased by ~~$60~~$46 million, or ~~14%~~11%, to ~~$475~~$473 million, compared with ~~$415~~$426 million for the same period one year ago. ~~Net sales for~~The COVID-19 pandemic and ensuing government restrictions have resulted in the ~~three months ended September 29, 2018 were impacted by an approximately $24 million shift in sales from~~temporary closure of most of our ~~third quarter to~~retail stores since mid-March. For additional details, see "COVID-19 Pandemic - Impact on our ~~fourth quarter.~~

Business" above.

The ~~14%~~11% net sales increase resulted from a ~~10%~~7% comparable sales increase in our Company-Controlled channel and 5 percentage points (ppt.) of sales growth from 3326 net new stores opened in the past 12 months.

For additional details, see the components of total net sales change on page 17.

The ~~$60~~$46 million net sales increase compared with the same period one year ago was comprised of the following: (i) a ~~$37~~$30 million increase in our Company-Controlled comparable net sales; and (ii) a ~~$23~~$19 million increase resulting from net store openings. Wholesale/Other channel sales ~~increased~~decreased slightly year-over-year. Company-Controlled mattress unit sales increased 5%10% compared with the prior year. Average revenue per mattress unit in our Company-Controlled channel totaled ~~$4,788,~~$4,884, a 9%2% increase compared with ~~$4,387~~$4,804 in the prior-year period.

Gross profit

Gross profit of ~~$296~~$302 million increased by ~~$46~~$40 million, or ~~18%~~15%, compared with ~~$251~~$262 million for the same period one year ago. The gross profit rate improved to ~~62.4%~~63.9% of net sales for the three months ended ~~September~~March 28, ~~2019,~~2020, compared with ~~60.4%~~61.5% for the prior-year comparable period. The current-year gross profit rate increase of ~~2.0~~2.4 ppt. was primarily due to three factors: (i) a favorable sales mix of ~~high-margin~~higher-margin products (1.2 ppt.); (ii) ~~the elimination of prior year’s product transition costs and temporary inefficiencies associated with operating two supply chains (0.7~~reduced warranty expenses (0.5 ppt.); and (iii) current-period manufacturing ~~and supply chain~~ efficiency gains ~~and benefit-driven product price increases (0.6 ppt.). These three positive factors were partially offset by: (i) increased tariff costs~~ (0.3 ~~ppt.); and (ii) customer delivery cost inflation (0.2~~ ppt.). In addition, our gross profit rate will fluctuate from quarter to quarter due to a variety of other factors, including ~~warranty expenses,~~ return and exchange costs, and performance-based incentive compensation.

~~Index~~

Sales and marketing expenses

Sales and marketing expenses for the three months ended ~~September~~March 28, ~~2019~~2020 were ~~$213~~$208 million, or ~~44.9%~~44.0% of net sales, compared with ~~$188~~$187 million, or ~~45.4%~~43.8% of net sales, for the same period one year ago. The ~~0.5~~ 0.2ppt. ~~decrease~~increase in the sales and marketing expense rate was ~~primarily~~mainly due ~~to the expense leverage from the 14% increase in net sales; partially offset by an~~to: (i) a 16% increase in media expenses that drove additional customer traffic to our sales channels, including stores, online and ~~phone.~~

phone; and (ii) COVID-19 disruption related payroll costs; partially offset by (iii) the expense leverage from the 11% increase in net sales.

General and administrative expenses

General and administrative (G&A) expenses totaled ~~$35~~$31 million, or ~~7.4%~~6.6% of net sales, for the three months ended ~~September~~March 28, ~~2019,~~2020, compared with ~~$29~~$34 million, or ~~7.1%~~8.0% of net sales, in the prior-year period. The ~~$5.7~~$3.3 million ~~increase~~decrease in G&A expenses consisted primarily of: (i) a ~~$4.3~~$5.0 million ~~increase~~decrease in employee compensation primarily resulting from a year-over-year ~~increase~~decrease in performance-based incentive compensation; ~~and~~partially offset by (ii) a ~~$1.1~~$1.7 million increase in professional ~~fees.~~fees and other expenses. The G&A expense rate ~~increased~~decreased by ~~0.3~~1.4 ppt. in the current-year period, compared with the same period one year ago due to the items discussed above ~~partially offset~~and by the leveraging impact of the ~~14%~~11% net sales increase.

Research and development expenses

Research and development (R&D) expenses increased by ~~22%~~25% to $9$11 million for the three months ended ~~September~~March 28, ~~2019,~~2020, compared with $7$8 million for the same period one year ago. The R&D expense rate for the three months ended ~~September~~March 28, ~~2019~~2020 increased to ~~1.9%~~2.2% of net sales, compared with ~~1.8%~~2.0% of net sales for the prior year. The spending level increase supports our consumer innovation strategy.

Interest expense, net

Interest expense, net ~~increased~~decreased to ~~$3.1~~$2.3 million for the three months ended ~~September~~March 28, ~~2019,~~2020, compared with ~~$1.8~~$2.6 million for the same period one year ago. The ~~$1.3~~$0.3 million ~~change~~decrease was ~~due to our planned increase~~mainly driven by a reduction in the weighted-average interest rate on borrowings ~~under our revolving credit facility. At September~~outstanding during the three months ended March 28, ~~2019, we ended the quarter with $214 million of borrowings under our revolving credit facility,~~2020 compared with ~~$136 million~~the same period one year ago.

Index

Income tax expense

Income tax expense totaled ~~$8.0~~$11 million for the three months ended ~~September~~March 28, ~~2019,~~2020, compared with ~~$5.2~~$5 million last year. The effective income tax rate for the three months ended ~~September~~March 28, ~~2019~~2020 was ~~22.1%~~22.4%, compared with ~~22.3%~~15.5% for the comparable period last ~~year.~~ ~~Both periods benefited from: (i) the recognition of additional tax credits; and (ii) stock-based compensation excess tax benefits.~~

~~Comparison of Nine Months Ended September 28, 2019 with Nine Months Ended September 29, 2018~~

~~Net sales~~

~~Net sales for the nine months ended September 28, 2019 increased by $137 million, or 12%, to $1.3 billion, compared with $1.1 billion for the same period one~~ year, ~~ago.~~ ~~Net sales for the nine months ended September 29, 2018 were impacted by an approximately $24 million shift in sales from our third quarter to our fourth quarter.~~

The 12% net sales increase resulted from an 8% comparable sales increase in our Company-Controlled channel and 5 percentage points (ppt.) of sales growth from 33 net new stores opened in the past 12 months.

The $137 million net sales increase compared with the same period one year ago was comprised of the following: (i) an $80 million increase in our Company-Controlled comparable net sales; and (ii) a $59 million increase resulting from net store openings. Wholesale/Other channel sales decreased slightly year-over-year. Company-Controlled mattress unit sales increased 3% compared with the prior year. Average revenue per mattress unit in our Company-Controlled channel totaled $4,837, a 9% increase, compared with $4,432 in the prior-year period.

~~Gross profit~~

Gross profit of $776 million for the nine months ended September 28, 2019 increased by $99 million, or 15%, compared with $677 million for the same period one year ago. The gross profit rate improved to 61.7% of net sales, compared with 60.4% for the prior-year comparable period. The current-year gross profit rate improvement of 1.3 ppt. was primarily due to three factors: (i) current-period manufacturing and supply chain efficiency gains, and benefit-driven product price increases (0.8 ppt.); (ii) the elimination of

~~Index~~

prior year’s product transition costs (0.8 ppt.); and (iii) a favorable sales mix of high-margin products (0.2 ppt.). These three positive factors were partially offset by: (i) increased tariff costs (0.3 ppt.); and (ii) customer delivery cost inflation (0.2 ppt.). In addition, our gross profit rate will fluctuate from quarter to quarter due to a variety of other factors, including warranty expenses, return and exchange costs, and performance-based incentive compensation.

~~Sales and marketing expenses~~

Sales and marketing expenses for the nine months ended September 28, 2019 were $569 million, or 45.2% of net sales, compared with $511 million, or 45.7% of net sales, for the same period one year ago. The 0.5 ppt. decrease in the sales and marketing expense rate was primarily due to the expense leverage from the 12% increase in net sales, partially offset by an increase in media expenses that drove additional customer traffic to our sales channels, including stores, online and phone.

~~General and administrative expenses~~

General and administrative (G&A) expenses totaled $102 million, or 8.2% of net sales, for the nine months ended September 28, 2019, compared with $90 million, or 8.0% of net sales, in the prior-year period. The $12.5 million increase in G&A expenses consisted of the following: (i) a $8.1 million increase in employee compensation primarily resulting from a year-over-year increase in performance-based incentive compensation; (ii) a $2.8 million increase in professional fees; and (iii) a $1.6 million net increase in miscellaneous other expenses. The G&A expense rate increased by 0.2 ppt. in the current-year period, compared with the same period one year ago due to the items discussed above, partially offset by the leveraging impact of the 12% net sales increase.

~~Research and development expenses~~

Research and development (R&D) expenses increased by 20% to $25 million for the nine months ended September 28, 2019, compared with $21 million for the same period one year ago. The R&D expense rate for the nine months ended September 28, 2019 increased to 2.0% of net sales, compared with 1.9% of net sales for the prior year. The spending level increase supports our consumer innovation strategy.

~~Interest expense, net~~

Interest expense, net increased to $9.0 million for the nine months ended September 28, 2019, compared with $3.8 million for the same period one year ago. The $5.2 million increase was due to our planned increase in borrowings under our revolving credit facility and the year-over-year increase in LIBOR rates. At September 28, 2019, we ended the quarter with $214 million of borrowings under our revolving credit facility, compared with $136 million one year ago.

~~Income tax expense~~

Income tax expense totaled $12.4 million for the nine months ended September 28, 2019, compared with $7.9 million last year. Both periods benefited from discrete tax items. The effective income tax rate for the nine months ended September 28, 2019 was 17.7% reflecting higher stock-based compensation excess tax benefits additional tax credits and the favorable resolution of a tax matter. The effective tax rate for the nine months ended September 29, 2018 was 15.7% reflecting the changes associated with the Tax Cuts and Jobs Act, including a $2.9 million increase in the ~~2017 provisional tax benefit in the second-quarter 2018 and stock-based compensation excess tax benefits.~~

prior-year period.

Liquidity and Capital Resources

Managing our liquidity and capital resources is an important part of our commitment to deliver superior shareholder value. The COVID-19 pandemic and ensuing government restrictions have resulted in the temporary closure of most of our retail stores since mid-March. We have taken the following decisive actions to manage liquidity and capital resources through the challenging economic environment caused by the COVID-19 pandemic:

•On March 17, 2020, we drew down an additional $262 million under our credit agreement, which represented all remaining amounts then available under the facility.

•On April 3, 2020, we added a $75 million 364-day term loan under our credit agreement for a total commitment amount of $525 million, with another $75 million available under our accordion (subject to lenders' approval). We fully drew down the term loan and secured an initial interest rate of approximately 3.27%, which is equal to the one-month LIBOR rate plus the applicable margin based on the then-current total leverage ratio. No financial covenants were amended.

•The $262 million and $75 million draws against our credit facility will provide increased liquidity and preserve financial flexibility in consideration of the disruption and uncertainty resulting from the COVID-19 pandemic. Proceeds may be used in the future for working capital and other general corporate purposes as permitted by the credit agreement.

•On April 8, 2020, we announced additional efforts to preserve cash and manage expenses in response to the COVID-19 pandemic including, among other things, discontinuing share repurchases, reducing capital expenditures and negotiating rent deferrals and abatements for stores closed due to COVID-19. We furloughed nearly 40% of our team members with another 30% working reduced hours. Our CEO will not receive any cash compensation for the balance of the year through a 50% deferral and exchanging all remaining salary for restricted stock units. In addition, our Board of Directors and most of our leadership team reduced their cash compensation in exchange for restricted stock units. All team members’ compensation has been meaningfully reduced through variable compensation programs and other actions. We are temporarily suspending the Company's 401(k) match and selected other benefit programs. We also reduced our sales and marketing expenses, and temporarily suspended virtually all discretionary projects.

Our primary sources of liquidity are the $239 million of cash and cash equivalents on our balance sheet at March 28, 2020, the $75 million that we drew down on April 3, 2020 under our credit facility and future cash flows provided by operating ~~activities~~activities. Our cash and cash ~~available under our $450 million revolving credit facility. The~~equivalents, the cash generated from ~~ongoing~~future operations and cash available under our revolving credit facility (subject to lenders' approval) are expected to be adequate to maintain operations, and fund anticipated expansion and strategic initiatives for the foreseeable future.

~~As of September 28, 2019, cash and cash equivalents totaled $2 million. Available borrowing capacity under our revolving credit facility was $233 million at September 28, 2019.~~

Changes in the cash and cash equivalents during the three months ended March 28, 2020 primarily consisted of ~~$190~~$85 million of cash provided by operating activities ~~which was~~and a $201 million increase in short-term borrowings, that were partially offset by ~~$47~~$10 million of cash used to purchase property and equipment, and ~~$139~~$41 million of cash used to repurchase our common stock (based on settlement, ~~$130~~$38.6 million under our Board-approved share repurchase program and $9$2.8 million in connection with the vesting of employee restricted stock grants).

~~Index~~

The following table summarizes our cash flows ($ in millions). Amounts may not add due to rounding differences:


	Three Months Ended
	March 28, 2020		March 30, 2019
Total cash provided by (used in):
Operating activities	$	84.9	$	68.1
Investing activities	(10.3)		(17.2)
Financing activities	163.0		(50.9)
Net increase in cash and cash equivalents	$	237.6	$	0.1

Nine Months Ended

September 28,
2019

September 29,
2018

Total cash provided by (used in):

Operating activities

$
189.8

$
134.5

Investing activities

(44.2
)

(33.8
)
Financing activities

(145.7
)

(103.0
)
Net decrease in cash and cash equivalents

$
(0.1
)

$
(2.4
)

Cash provided by operating activities for the ~~nine~~three months ended ~~September~~March 28, ~~2019~~2020 was ~~$190~~$85 million, compared with ~~$134~~$68 million for the ~~nine~~three months ended ~~September 29, 2018.~~March 30, 2019. Significant components of the year-over-year change in cash provided by operating activities included: (i) a ~~$15~~$14 million increase in net income for the ~~nine~~three months ended ~~September~~March 28, ~~2019,~~2020, compared with the same period one year ago; (ii) a ~~$19 million fluctuation in accounts payable with both periods impacted by business changes and timing of payments; (iii) a $14~~$15 million fluctuation in accrued compensation and benefits that primarily resulted from year-over-year changes in company-wide performance-based incentive compensation that was accrued and paid in the two comparable periods (higher incentive

Index

compensation paid in ~~2018~~2020 and lower incentive compensation accrued in the first ~~nine~~three months of ~~2018)~~2020); ~~(iv) a $14 million fluctuation in income taxes reflecting the changes associated with the Tax Cuts and Jobs Act; and (v)~~(iii) a $13 million fluctuation in prepaid expenses and other assets with both periods impacted by the timing of rent payments and changes in business ~~activities.~~

activities; and (iv) a $12 million fluctuation in customer prepayments due to the business disruptions resulting from the COVID-19 pandemic and ensuing government restrictions in the second-half of March 2020.

Net cash used in investing activities to purchase property and equipment was ~~$47~~$10 million for the ~~nine~~three months ended ~~September~~March 28, ~~2019,~~2020, compared with ~~$34~~$20 million for the same period one year ago. The year-over-year ~~increase~~decrease was primarily due to the timing of cash flows associated with new and remodeled stores’ property and equipment.

Based on the expected economic impact of COVID-19, we plan to reduce capital expenditures for 2020 to approximately $35 million versus $59 million in 2019.

Net cash provided by financing activities was $163 million for the three months ended March 28, 2020, compared with $51 million net cash used in ~~financing~~investing activities ~~was $146 million for the nine months ended September 28, 2019, compared with $103 million~~ for the same period one year ago. During the ~~nine~~three months ended ~~September~~March 28, ~~2019,~~2020, we repurchased ~~$139~~$41 million of our stock (based on settlement ~~$130~~dates, $38.6 million under our Board-approved share repurchase program and $9$2.8 million in connection with the vesting of employee restricted stock awards), compared with ~~$198~~$56 million during the same period one year ago. Short-term borrowings ~~were reduced~~increased by ~~$11~~$201 million during the current-year period due to a $215 million increase in borrowings under our revolving credit facility to $446 million, partially offset by a decrease in book overdrafts which are included in the net change in short-term borrowings. Short-term borrowings ~~partially offset~~increased by $3 million during the prior-year period due to a ~~$14~~$19 million increase in borrowings under our revolving credit facility to ~~$214 million. Short-term borrowings increased by $94 million during the prior-year period due to a $111 million increase in borrowings under our revolving credit facility to $136~~$219 million, partially offset by a decrease in book overdrafts.

Under our Board-approved share repurchase program, we repurchased ~~3.0~~0.8 million shares at a cost of ~~$121~~$38 million (based on trade ~~date, at~~dates, an average of ~~$40.19~~$49.42 per share) during the ~~nine~~three months ended ~~September~~March 28, ~~2019.~~2020. During the ~~nine~~three months ended ~~September 29, 2018,~~March 30, 2019, we repurchased ~~5.9~~1.0 million shares at a cost of ~~$195~~$41 million (an average of ~~$32.93~~$39.36 per share). ~~Effective as of September 29, 2019, our Board approved an increase in the~~The remaining authorization under our Board-approved share repurchase program ~~to $500~~at March 28, 2020 was $437 million. There is no expiration date governing the period over which we can repurchase shares.

In February 2019, we amended our revolving credit facility to increase our net aggregate availability from $300 million to $450 million. We maintained the accordion feature, which allows us to increase the amountlight of the ~~credit facility from $450 million to $600 million, subject to lenders' approval. The amended credit facility matures in February 2024. There were no other significant changes to~~uncertainty surrounding the ~~credit agreement’s terms and conditions.~~

impact of COVID-19, we have suspended all share repurchases under our Board-approved share repurchase program.

As of ~~September~~March 28, ~~2019,~~2020, we had ~~$214~~$446 million of borrowings under our credit facility and $3$4 million in outstanding letters of credit. ~~Our available borrowing capacity was $233 million.~~ The credit agreement provides the lenders with a collateral security interest in substantially all of our assets and those of our subsidiaries and requires us to comply with, among other things, a maximum leverage ratio (4.5x) and a minimum interest coverage ratio (3.0x). Under the terms of the credit agreement we pay a variable rate of interest and a commitment fee based on our leverage ratio. The credit facility is for general corporate purposes and to meet our seasonal working capital ~~requirements and to repurchase our stock.~~requirements. As of ~~September~~March 28, ~~2019,~~2020, the weighted-average interest rate on borrowings under the credit facility was ~~3.9%~~2.9% and we were in compliance with all financial covenants.

We have an agreement with Synchrony Bank to offer qualified customers revolving credit arrangements to finance purchases from us (Synchrony Agreement). The Synchrony Agreement contains financial covenants consistent with our credit facility, including a maximum leverage ratio and a minimum interest coverage ~~ratio.~~ratio consistent with our credit agreement. As of ~~September~~March 28, ~~2019,~~2020, we were in compliance with all financial covenants.

Under the terms of the Synchrony Agreement, Synchrony Bank sets the minimum acceptable credit ratings, the interest rates, fees and all other terms and conditions of the customer accounts, including collection policies and procedures, and is the owner of the accounts. As the accounts are owned by Synchrony Bank, at no time are the accounts purchased or acquired from us. We are not liable to Synchrony Bank for our customers’ credit defaults.

Index

~~Index~~

Non-GAAP Data

Reconciliations

Earnings before Interest, Taxes, Depreciation and Amortization (Adjusted EBITDA)

We define earnings before interest, taxes, depreciation and amortization (Adjusted EBITDA) as net income plus: income tax expense, interest expense, depreciation and amortization, stock-based compensation and asset impairments. Management believes Adjusted EBITDA is a useful indicator of our financial performance and our ability to generate cash from operating activities. Our definition of Adjusted EBITDA may not be comparable to similarly titled definitions used by other companies. The table below reconciles Adjusted EBITDA, which is a non-GAAP financial measure, to the comparable GAAP financial measure.

Our Adjusted EBITDA calculations are as follows (in thousands):


	Three Months Ended				Trailing-Twelve Months Ended					Three Months Ended						Trailing-Twelve Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019		September 29, 2018			March 28, 2020		March 30, 2019		March 28, 2020		March 30, 2019
Net income	$	28,054	$	18,257	$	84,742	$	58,340	Net income	$	39,140	$	25,418	$	95,567	$	74,409
Income tax expense		7,967		5,228		21,421		12,064	Income tax expense	11,330		4,680		25,313		15,834
Interest expense		3,131		1,836		11,064		4,044	Interest expense	2,357		2,610		11,338		7,994
Depreciation and amortization		14,963		15,483		61,155		61,658	Depreciation and amortization	15,253		15,637		61,026		61,673
Stock-based compensation		4,146		3,356		13,348		14,052	Stock-based compensation	2,051		3,638		15,070		11,966
Asset impairments		29		30		150		135	Asset impairments	3		139		49		235
Adjusted EBITDA	$	58,290	$	44,190	$	191,880	$	150,293	Adjusted EBITDA	$	70,134	$	52,122	$	208,363	$	172,111

Free Cash Flow

Our “free cash flow” data is considered a non-GAAP financial measure and is not in accordance with, or preferable to, “net cash provided by operating activities,” or GAAP financial data. However, we are providing this information as we believe it facilitates analysis for investors and financial analysts.

The following table summarizes our free cash flow calculations (in thousands):


	Nine Months Ended				Trailing-Twelve Months Ended					Three Months Ended						Trailing-Twelve Months Ended
	September 28, 2019		September 29, 2018		September 28, 2019		September 29, 2018			March 28, 2020		March 30, 2019		March 28, 2020		March 30, 2019
Net cash provided by operating activities	$	189,832	$	134,450	$	186,922	$	131,003	Net cash provided by operating activities	$	84,941	$	68,136	$	205,965	$	150,420
Subtract: Purchases of property and equipment		46,757		34,012		58,260		56,228	Subtract: Purchases of property and equipment	10,351		19,743		49,847		56,453
Free cash flow	$	143,075	$	100,438	$	128,662	$	74,775	Free cash flow	$	74,590	$	48,393	$	156,118	$	93,967

Index

~~Index~~

Non-GAAP Data Reconciliations (continued)

Return on Invested Capital (ROIC)

(dollars in thousands)

ROIC is a financial measure we use to determine how efficiently we deploy our capital. It quantifies the return we earn on our invested capital. Management believes ROIC is also a useful metric for investors and financial analysts. We compute ROIC as outlined below. Our definition and calculation of ROIC may not be comparable to similarly titled definitions and calculations used by other companies. The tables below reconcile net operating profit after taxes (NOPAT) and total invested capital, which are non-GAAP financial measures, to the comparable GAAP financial measures:


	Trailing-Twelve Months Ended							Trailing-Twelve Months Ended
	September 28, 2019			September 29, 2018				March 28, 2020			March 30, 2019
Net operating profit after taxes (NOPAT)							Net operating profit after taxes (NOPAT)
Operating income	$	117,224		$	74,427		Operating income	$	132,203		$	98,234
Add: Rent expense ⁽¹⁾		85,807			77,797		Add: Rent expense ⁽¹⁾	89,237			81,949
Add: Interest income		4			21		Add: Interest income	15			4
Less: Depreciation on capitalized operating leases ⁽²⁾		(21,821	)		(20,012	)	Less: Depreciation on capitalized operating leases ⁽²⁾	(22,883)			(20,815)
Less: Income taxes ⁽³⁾		(44,298	)		(34,751	)	Less: Income taxes ⁽³⁾	(47,453)			(38,490)
NOPAT	$	136,916		$	97,482		NOPAT	$	151,119		$	120,882
Average invested capital							Average invested capital
Total deficit	$	(164,487	)	$	(54,352	)	Total deficit	$	(155,909)		$	(124,640)
Add: Long-term debt ⁽⁴⁾		214,482			136,683
Add: Capitalized operating lease obligations ⁽⁵⁾		686,456			622,376
Less: Cash greater than target ⁽⁴⁾							Less: Cash greater than target ⁽⁴⁾	(113,397)			—
Add: Long-term debt ⁽⁵⁾							Add: Long-term debt ⁽⁵⁾	446,733			219,533
Add: Capitalized operating lease obligations ⁽⁶⁾							Add: Capitalized operating lease obligations ⁽⁶⁾	713,896			655,592
Total invested capital at end of period	$	736,451		$	704,707		Total invested capital at end of period	$	891,323		$	750,485
Average invested capital ⁽⁶⁾	$	743,271		$	710,325
Return on invested capital (ROIC) ⁽⁷⁾		18.4	%		13.7	%
Average invested capital ⁽⁷⁾							Average invested capital ⁽⁷⁾	$	790,420		$	732,890
Return on invested capital (ROIC) ⁽⁸⁾							Return on invested capital (ROIC) ⁽⁸⁾	19.1		%	16.5		%

⁽¹⁾	~~Rent expense is added back to operating income to show the impact of owning versus leasing the related assets.~~

___________________________

^{(2)⁽¹⁾Rent expense is added back to operating income to show the impact of owning versus leasing the related assets.}

Depreciation is based on the average of the last five fiscal quarters' ending capitalized operating lease obligations (see note 6) for the respective reporting periods with an assumed thirty-year useful life. This life assumption is based on our long-term participation in given markets though specific retail location lease commitments are generally 5 to 10 years at inception. This is subtracted from operating income to illustrate the impact of owning versus leasing the related assets.

^{(3)⁽²⁾Depreciation is based on the average of the last five fiscal quarters' ending capitalized operating lease obligations (see note 6) for the respective reporting periods with an assumed thirty-year useful life. This life assumption is based on our long-term participation in given markets though specific retail location lease commitments, which are generally 5 to 10 years at inception. This is subtracted from operating income to illustrate the impact of owning versus leasing the related assets.}

~~Reflects annual effective income tax rates, before discrete adjustments, of 24.4% and 26.3% for 2019 and 2018, respectively.~~

^{(4)⁽³⁾Reflects annual effective income tax rates, before discrete adjustments, of 23.9% and 24.2% for 2020 and 2019, respectively.}

~~Long-term debt includes existing finance lease liabilities.~~

^{(5)⁽⁴⁾Cash greater than target is defined as cash, cash equivalents and marketable debt securities less customer prepayments in excess of $100 million.}

A multiple of eight times annual rent expense is used as an estimate for capitalizing our operating lease obligations. The methodology utilized aligns with the methodology of a nationally recognized credit rating agency.

^{(6)⁽⁵⁾Long-term debt includes existing finance lease liabilities.}

~~Average invested capital represents the average of the last five fiscal quarters' ending invested capital balances.~~

^{(7)⁽⁶⁾A multiple of eight times annual rent expense is used as an estimate for capitalizing our operating lease obligations. The methodology utilized aligns with the methodology of a nationally recognized credit rating agency.}

~~ROIC equals NOPAT divided by average invested capital.~~

⁽⁷⁾Average invested capital represents the average of the last five fiscal quarters' ending invested capital balances.

⁽⁸⁾ROIC equals NOPAT divided by average invested capital.

Note - Our ROIC calculation and data are considered non-GAAP financial measures and are not in accordance with, or preferable to, GAAP financial data. However,

we are providing this information as we believe it facilitates analysis of the Company's financial performance by investors and financial analysts.

GAAP - generally accepted accounting principles in the U.S.

~~Index~~

Off-Balance-Sheet Arrangements and Contractual Obligations

As of ~~September~~March 28, ~~2019,~~2020, we were not involved in any unconsolidated special purpose entity transactions. Other than our $3$4 million in outstanding letters of credit, we do not have any off-balance-sheet financing.

There have been no material changes in our contractual obligations, other than in the ~~ordinary course of business,~~amendment to our credit agreement, since the end of fiscal ~~2018.~~2019. See Note 5, Credit Agreement, of the Notes to our Condensed Consolidated Financial Statements for information regarding our credit agreement. See our Annual Report on Form 10-K for the fiscal year ended December ~~29, 2018~~28, 2019 for additional information regarding our other contractual obligations.

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Critical Accounting Policies

We discuss our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December ~~29, 2018.~~28, 2019. There were no significant changes in our critical accounting policies since the end of fiscal ~~2018.~~

2019 other than adding goodwill and indefinite-lived intangible assets as a critical accounting policy.

Description

Judgments and Uncertainties

Effect if Actual Results
Differ from Assumptions

Goodwill and Indefinite-Lived Intangible Assets

Goodwill represents the excess of cost over the fair value of identifiable net assets of businesses acquired. Our indefinite-lived intangible assets include trade names/trademarks.

See Note 1, Business and Summary of Significant Accounting Policies, and Note 5, Goodwill and Intangible Assets, Net, to the Notes to Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of the 2019 Annual Report on Form 10-K, for a complete discussion of our goodwill and indefinite-lived intangible assets.

The determination of fair value involves uncertainties because it requires management to make assumptions and to apply judgment to estimate industry and economic factors and the profitability of future business strategies. Management’s assumptions also include projected revenues, operating profit levels and discount rates, as well as consideration of any other factors that may indicate potential impairment.

In the fourth quarter of fiscal 2019, management completed its annual goodwill and other indefinite-lived intangible asset impairment tests and determined there was no impairment. We believe our assumptions and judgments used in estimating cash flows and determining fair value were reasonable. However, unexpected changes to such assumptions and judgments could affect our impairment analyses and future results of operations, including an impairment charge that could be material. There have been no significant changes for the quarter ended March 28, 2020.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are exposed to changes in market-based short-term interest rates that will impact our net interest expense. If overall interest rates were one percentage point higher than current rates, our annual net income would decrease by ~~$1.6~~$3.4 million based on the ~~$214~~$446 million of borrowings under our revolving credit facility at ~~September~~March 28, ~~2019.~~2020. We do not manage the interest-rate volatility risk of borrowings under our credit facility through the use of derivative instruments.

ITEM 4. CONTROLS AND PROCEDURES

Conclusions Regarding the Effectiveness of Disclosure Controls and Procedures

We maintain disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), that are designed to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including its principal executive officer and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management, with the participation of our principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this quarterly report.

Changes in Internal Control

There were no changes in our internal control over financial reporting during the fiscal quarter ended ~~September~~March 28, ~~2019,~~2020, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Index

~~Index~~

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

On September 18, 2018, two former Home Delivery team members filed suit, now venued in Superior Court in Fresno County, California, alleging representative claims on a purported class action basis under the California Labor Code Private Attorney General Act. While the two representative plaintiffs were in the Home Delivery workforce, the Complaint does not limit the purported plaintiff class to that group. The plaintiffs allege that Sleep Number failed or refused to adopt adequate practices, policies and procedures relating to wage payments, record keeping, employment disclosures, meal and rest breaks, among other claims, under California law. The Complaint sought damages in the form of civil penalties and plaintiffs’ attorneys’ fees, and expressly disclaims the recovery of any purported individual specific relief or underpaid wages. The parties tentatively reached a settlement pending Court approval, which includes the settlement and release of certain additional related claims. We intend to continue vigorously defending this matter in the event it does not settle.

ITEM 1A. RISK FACTORS

~~Our~~

In addition to the risks discussed below and other information set forth in this Quarterly Report on Form 10-Q, our business, financial condition and operating results are subject to a number of risks and uncertainties, including both those that are specific to our business and others that affect all businesses operating in a global environment. Investors should carefully consider the information in this report under the heading, Management’s Discussion and Analysis of Financial Condition and Results of Operations and also the information under the heading, Risk Factors in our most recent Annual Report on Form 10-K. The risk factors discussed in the Annual Report on Form 10-K and in this Quarterly Report on Form 10-Q do not identify all risks that we face because our business operations could also be affected by additional risk factors that are not presently known to us or that we currently consider to be immaterial to our operations.

The COVID-19 pandemic has had, and is expected to continue to have, an adverse effect on our business and our financial results.

The outbreak of the COVID-19 pandemic has created significant volatility, uncertainty and economic disruption, which is adversely affecting our business operations and our financial results. As the COVID-19 pandemic continues, consumer fear about becoming ill with the virus and recommendations and/or mandates from federal, state and local authorities to close certain businesses, stay at home, practice social distancing or self-quarantine have increased resulting in the temporary closure of the majority of our stores nationwide since mid-March. These actions have adversely affected our business, operations, demand for our product, traffic to our stores, and macroeconomic factors that affect us, such as consumer confidence and spending which have, in turn resulted in a loss of sales and profits. With most of our retail store locations across the country temporarily closed and our delivery operations adversely impacted, we have shifted to scale our digital capabilities including: remote retail selling, customer service, private appointments, flexible work schedules, solutions for contactless delivery, and remote access for team members across the country. We may further restrict the operations of our stores, delivery operations, and manufacturing and distribution facilities if we deem this necessary or if recommended or mandated by authorities and these measures could have a further material impact on our sales and profits.

In addition, we expect to incur increased costs in our response to the pandemic, including, but not limited to, costs incurred to implement the operational changes described above and certain payments to or other costs relating to team members who are not working during the pandemic.

In response to the significant reduction in customer visits to, and spending at, our stores caused by COVID-19, we have taken actions to maintain liquidity including:

•discontinuing share repurchases;

•reducing capital expenditures;

•negotiating rent deferrals and abatements for stores closed due to COVID-19;

•furloughing nearly 40% of our team members and reducing the working hours of another 30% of our team members;

Index

•CEO, board members and most of our leadership team deferred all or a portion of their cash compensation for the balance of the year in exchange for restricted stock units;

•meaningfully reducing all team members’ compensation through variable compensation programs and other actions;

•temporarily suspending our 401(k) match and selected other employee benefit programs;

•reducing our sales and marketing expenses; and

•temporarily suspending virtually all discretionary projects across the company.

It is possible that our cost reduction efforts may be insufficient to maintain adequate liquidity. Also, if we do not respond appropriately to the pandemic, or if customers do not perceive our response to be adequate for a particular region or our company as a whole, we could suffer damage to our reputation and our brand, which could continue to adversely affect our business and financial results in the future.

We are highly dependent on the effectiveness of our marketing messages and the efficiency of our advertising expenditures in generating consumer awareness and sales of our products. In light of our reduced marketing expenses and adjustments to our marketing messages due to COVID-19, we may not be as successful in developing effective messages and achieving efficiency in our advertising expenditures.

Our business depends heavily on the uninterrupted operation of our two main manufacturing plants located in Irmo, South Carolina and Salt Lake City, Utah as well as our assembly distribution centers, two of which are co-located at the manufacturing plants and others located in Baltimore, Maryland and the greater Los Angeles, California area. Our business also depends on the successful operation of our bedding collection fulfillment center in Brooklyn Park, Minnesota and headquarters in Minneapolis, Minnesota. The operation of all of our facilities is critically dependent on our team members who staff these locations, and COVID-19 could directly threaten or impact their health and/or ability to work, and, therefore, adversely affect the operations of our facilities. In addition, governmental mandates or recommendations in these jurisdictions could limit or adversely impact our ability to continue these operations.

COVID-19 also impacted, and may continue to impact, our retail stores, home delivery operations, logistics, and domestic and foreign supply chain, including raw materials and components we source from third parties, particularly as a result of governmental mandates or recommendations.

Our temporary suspension of virtually all discretionary spending across the company and the inability or limitations of certain suppliers, both domestic and foreign, to operate due to governmental mandates or recommendations has delayed and may continue to delay the introduction of new product lines.

We have seen, and may continue to see, significant deterioration in macroeconomic factors that typically affect us, such as consumer confidence and spending.

The extent and duration of the impact of COVID-19 on our business, operations, and financial results will also depend on future developments, including the duration and spread of the outbreak, governmental mandates and recommendations, and the related impact on consumer confidence and spending, all of which are highly uncertain and unpredictable.

Index

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

(a) – (b) Not applicable.

Fiscal Period

Total Number
of Shares
Purchased⁽¹⁾⁽²⁾

Average Price
Paid per Share

Total Number of
Shares Purchased
as Part of Publicly
Announced Plans
or Programs⁽¹⁾

Approximate
Dollar Value of
Shares that May
Yet Be Purchased
Under the Plans
or Programs⁽³⁾

June 30, 2019 through July 27, 2019

290,864

$
41.37

290,203

$
92,995,000

July 28, 2019 through August 24, 2019

280,514

$
45.34

279,600

80,316,000

August 25, 2019 through September 28, 2019

367,256

$
41.91

365,450

65,000,000

Total

938,634

$
42.77

935,253

$
65,000,000

~~(1)~~

~~Under our Board-approved share repurchase program, we repurchased 935,253 shares of our common stock at a cost of $40 million (based on trade dates) during the three months ended September 28, 2019.~~

~~(2)~~

~~In connection with the vesting of employee restricted stock grants, we also repurchased 3,381 shares of our common stock at a cost of $142 thousand during the three months ended September 28, 2019.~~


Period	Total Number of Shares Purchased⁽¹⁾⁽²⁾	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs⁽¹⁾	Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs⁽³⁾
December 29, 2019 through January 25, 2020	240,764	$	48.10	238,900	$	463,993,000
January 26, 2020 through February 22, 2020	224,831	$	54.37	224,400	$	451,795,000
February 23, 2020 through March 28, 2020	422,589	$	40.58	307,886	$	436,889,000
Total	888,184	$	46.11	771,186	$	436,889,000

~~(3)~~

Effective as of September 29, 2019, our Board approved an increase in the total remaining share repurchase authorization to $500 million. There is no expiration date governing the period over which we can repurchase shares under our Board-approved share repurchase program. Any repurchased shares are constructively retired and returned to an unissued status.

___________________________

⁽¹⁾Under our Board-approved $500 million share repurchase program (effective September 29, 2019), we repurchased 771,186 shares of our common stock at a cost of $38 million (based on trade dates) during the three months ended March 28, 2020.

⁽²⁾In connection with the vesting of employee restricted stock grants, we also repurchased 116,998 shares of our common stock at a cost of $2.8 million during the three months ended March 28, 2020.

⁽³⁾There is no expiration date governing the period over which we can repurchase shares under our Board-approved share repurchase program. Any repurchased shares are constructively retired and returned to an unissued status. In light of the uncertainty surrounding the impact of COVID-19, we have suspended all share repurchases under our Board-approved share repurchase program.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.

Index

~~Index~~

ITEM 6. EXHIBITS


Exhibit Number		Description
~~10.1~~ 10.1*		~~Third~~Second Amendment to ~~Lease~~Amended and Restated Credit and Security Agreement, dated ~~August 27, 2019 between the Company and IPT SALT LAKE CITY DC II LLC (successor in interest to CLFP – SLIC 8, L.P.)~~
~~10.2~~	~~Form~~as of ~~Non-Statutory Stock Option Award Agreement (Employee) under the~~April 3, 2020 among Sleep Number Corporation, ~~Amended~~U.S. Bank National Association and ~~Restated 2010 Omnibus Incentive Plan~~the several banks and other financial institutions from time to time party thereto
~~10.3~~ 31.1*		~~Form of Performance Adjusted Restricted Stock Unit Award Agreement (ROIC) (Senior Team) under the Sleep Number Corporation Amended and Restated 2010 Omnibus Incentive Plan~~
~~10.4~~	~~Form of Performance Adjusted Restricted Stock Unit Award Agreement under the Sleep Number Corporation Amended and Restated 2010 Omnibus Incentive Plan~~
~~10.5~~	~~Form of Restricted Stock Unit Award Agreement (Non-Employee Director) under the Sleep Number Corporation Amended and Restated 2010 Omnibus Incentive Plan~~
~~10.6~~	~~Form of Restricted Stock Unit Award Agreement (3-Year Ratable Vest) under the Sleep Number Corporation Amended and Restated 2010 Omnibus Incentive Plan~~
~~10.7~~	~~Form of Restricted Stock Unit Award Agreement (3-Year Cliff Vest) under the Sleep Number Corporation Amended and Restated 2010 Omnibus Incentive Plan~~
~~10.8~~	~~Form of Non-Statutory Stock Option Award Agreement (Non-Employee Director) under the Sleep Number Corporation Amended and Restated 2010 Omnibus Incentive Plan~~
~~31.1~~	Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
~~31.2~~ 31.2*		Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
~~32.1~~ 32.1*		Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
~~32.2~~ 32.2*		Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350
~~101.INS~~ 101.INS*		XBRL Instance Document – the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document
~~101.SCH~~ 101.SCH*		XBRL Taxonomy Extension Schema Document
~~101.CAL~~ 101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
~~101.DEF~~ 101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
~~101.LAB~~ 101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
~~101.PRE~~ 101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document
~~104~~ 104*		Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)

* Filed Herewith

Index

~~Index~~

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934, the ~~Registrant~~registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

~~SLEEP NUMBER CORPORATION~~

~~(Registrant)~~

SLEEP NUMBER CORPORATION

(Registrant)

~~Dated:~~

~~October 25, 2019~~

~~By:~~

Dated:

May 1, 2020

By:

/s/ Shelly R. Ibach

Shelly R. Ibach

Chief Executive Officer

(principal executive officer)

~~Shelly R. Ibach~~

By:

~~Chief Executive Officer~~

~~(principal executive officer)~~

~~By:~~

/s/ Robert J. Poirier

Robert J. Poirier

Chief Accounting Officer

(principal accounting officer)

	~~Page~~
					Page

PART I: FINANCIAL INFORMATION					1

Item 1.			Financial Statements (unaudited)	1
			Condensed Consolidated Balance Sheets	1
			Condensed Consolidated Statements of Operations	2
			Condensed Consolidated Statements of Shareholders' ~~(Deficit) Equity~~Deficit	3
			Condensed Consolidated Statements of Cash Flows	4
			Notes to Condensed Consolidated Financial Statements	5
Item 2.			Management’s Discussion and Analysis of Financial Condition and Results of Operations	12 13
Item 3.			Quantitative and Qualitative Disclosures About Market Risk	21 23
Item 4.			Controls and Procedures	21 23

PART II: OTHER INFORMATION				22	24

Item 1.			Legal Proceedings	22 24
Item 1A.			Risk Factors	22 24
Item 2.			Unregistered Sales of Equity Securities and Use of Proceeds	23 26
Item 3.			Defaults Upon Senior Securities	23 26
Item 4.			Mine Safety Disclosures	23 26
Item 5.			Other Information	23 26
Item 6.			Exhibits	24 27
SIGNATURES				25
		28

	September 28, 2019			December 29, 2018
Assets
Current assets:
Cash and cash equivalents	$	1,545		$	1,612
Accounts receivable, net of allowance for doubtful accounts of $753 and $699, respectively		25,541			24,795
Inventories		86,508			84,882
Prepaid expenses		10,997			8,009
Other current assets		35,002			31,559
Total current assets		159,593			150,857

Non-current assets:
Property and equipment, net		201,755			205,631
Operating lease right-of-use assets		321,048			—
Goodwill and intangible assets, net		73,772			75,407
Other non-current assets		46,154			38,243
Total assets	$	802,322		$	470,138

Liabilities and Shareholders’ Deficit
Current liabilities:
Borrowings under revolving credit facility	$	213,700		$	199,600
Accounts payable		151,357			144,781
Customer prepayments		39,824			27,066
Accrued sales returns		23,833			19,907
Compensation and benefits		39,383			27,700
Taxes and withholding		24,699			18,380
Operating lease liabilities		57,912			—
Other current liabilities		52,361			51,234
Total current liabilities		603,069			488,668

Non-current liabilities:
Deferred income taxes		3,927			4,822
Operating lease liabilities		293,333			—
Other non-current liabilities		66,480			86,198
Total liabilities		966,809			579,688

Shareholders’ deficit:
Undesignated preferred stock; 5,000 shares authorized, 0 shares issued and outstanding		—			—
Common stock, $0.01 par value; 142,500 shares authorized, 28,427 and 30,868 shares issued and outstanding, respectively		284			309
Additional paid-in capital		—			—
Accumulated deficit		(164,771	)		(109,859	)
Total shareholders’ deficit		(164,487	)		(109,550	)
Total liabilities and shareholders’ deficit	$	802,322		$	470,138

	Common Stock						Additional Paid-in			Accumulated
	Shares			Amount			Capital			Deficit			Total
Balance at December 29, 2018		30,868		$	309		$	—		$	(109,859	)	$	(109,550	)
Net income		—			—			—			25,418			25,418
Exercise of common stock options		151			2			2,834			—			2,836
Stock-based compensation		364			3			3,635			—			3,638
Repurchases of common stock		(1,170	)		(12	)		(6,469	)		(40,501	)		(46,982	)
Balance at March 30, 2019		30,213		$	302		$	—		$	(124,942	)	$	(124,640	)
Net income		—			—			—			4,280			4,280
Exercise of common stock options		115			1			2,158			—			2,159
Stock-based compensation		99			1			4,249			—			4,250
Repurchases of common stock		(1,104	)		(11	)		(6,407	)		(36,933	)		(43,351	)
Balance at June 29, 2019		29,323		$	293		$	—		$	(157,595	)	$	(157,302	)
Net income		—			—			—			28,054			28,054
Exercise of common stock options		33			—			757			—			757
Stock-based compensation		10			—			4,146			—			4,146
Repurchases of common stock		(939	)		(9	)		(4,903	)		(35,230	)		(40,142	)
Balance at September 28, 2019		28,427		$	284		$	—		$	(164,771	)	$	(164,487	)

2019 (excluding the nine months ended September 28, 2019)	$	21,045
2020		79,652
2021		72,354
2022		64,339
2023		54,970
2024		43,393
Thereafter		110,847
Total lease payments⁽¹⁾		446,600
Less: Interest		95,355
Present value of operating lease liabilities⁽²⁾	$	351,245

2019	$	78,337
2020		73,331
2021		66,491
2022		59,515
2023		51,076
Thereafter		149,318
Total lease payments⁽¹⁾	$	478,068

Fiscal Period	Total Number of Shares Purchased⁽¹⁾⁽²⁾		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs⁽¹⁾		Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs⁽³⁾
June 30, 2019 through July 27, 2019		290,864	$	41.37		290,203	$	92,995,000
July 28, 2019 through August 24, 2019		280,514	$	45.34		279,600		80,316,000
August 25, 2019 through September 28, 2019		367,256	$	41.91		365,450		65,000,000
Total		938,634	$	42.77		935,253	$	65,000,000