SNBR 10-Q Quarterly Report Oct. 1, 2022 | Alphaminr
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SNBR 10-Q Quarter ended Oct. 1, 2022

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Income Statement
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SLEEP NUMBER CORP
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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 October 1, 2022
OR
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number: 000-25121
_______________________________________________________________________
snbr-20221001_g1.jpg
SLEEP NUMBER CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota 41-1597886
(State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.)
1001 Third Avenue South
Minneapolis, 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 (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 was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the 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 was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the 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 is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
As of October 1, 2022, 22,001,000 shares of the registrant’s Common Stock were outstanding.

SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
INDEX

Page

i | 2Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
PART I: FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(unaudited - in thousands, except per share amounts)

October 1,
2022 		January 1,
2022
Assets
Current assets:
Cash and cash equivalents $ 1,348 $ 2,389
Accounts receivable, net of allowances of $ 1,508 and $ 924 , respectively
26,747 25,718
Inventories 113,554 105,644
Prepaid expenses 21,214 18,953
Other current assets 34,803 54,917
Total current assets 197,666 207,621
Non-current assets:
Property and equipment, net 199,917 195,128
Operating lease right-of-use assets 389,524 371,133
Goodwill and intangible assets, net 68,666 70,468
Deferred income taxes 6,267 —
Other non-current assets 78,741 75,190
Total assets $ 940,781 $ 919,540
Liabilities and Shareholders’ Deficit
Current liabilities:
Borrowings under revolving credit facility $ 406,300 $ 382,500
Accounts payable 199,154 162,547
Customer prepayments 95,274 129,499
Accrued sales returns 25,651 22,368
Compensation and benefits 27,339 51,240
Taxes and withholding 31,361 22,087
Operating lease liabilities 77,243 72,360
Other current liabilities 60,949 64,177
Total current liabilities 923,271 906,778
Non-current liabilities:
Deferred income taxes — 688
Operating lease liabilities 350,370 336,192
Other non-current liabilities 104,611 100,835
Total liabilities 1,378,252 1,344,493
Shareholders’ deficit:
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding
— —
Common stock, $ 0.01 par value; 142,500 shares authorized, 22,001 and 22,683 shares issued and outstanding, respectively
220 227
Additional paid-in capital 458 3,971
Accumulated deficit ( 438,149 ) ( 429,151 )
Total shareholders’ deficit ( 437,471 ) ( 424,953 )
Total liabilities and shareholders’ deficit $ 940,781 $ 919,540

See accompanying notes to condensed consolidated financial statements.
1 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited - in thousands, except per share amounts)

Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Net sales $ 540,566 $ 640,393 $ 1,616,769 $ 1,692,965
Cost of sales 237,479 250,039 686,439 653,842
Gross profit 303,087 390,354 930,330 1,039,123
Operating expenses:
Sales and marketing 239,656 255,512 700,405 685,123
General and administrative 36,003 47,676 116,049 131,488
Research and development 14,786 14,431 46,908 43,633
Total operating expenses 290,445 317,619 863,362 860,244
Operating income 12,642 72,735 66,968 178,879
Interest expense, net 5,606 1,816 11,352 4,400
Income before income taxes 7,036 70,919 55,616 174,479
Income tax expense 2,003 17,198 13,576 31,874
Net income $ 5,033 $ 53,721 $ 42,040 $ 142,605
Basic net income per share:
Net income per share – basic $ 0.23 $ 2.29 $ 1.87 $ 5.84
Weighted-average shares – basic 22,218 23,464 22,444 24,404
Diluted net income per share:
Net income per share – diluted $ 0.22 $ 2.22 $ 1.83 $ 5.63
Weighted-average shares – diluted 22,573 24,233 22,959 25,324




















See accompanying notes to condensed consolidated financial statements.
2 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Shareholders’ Deficit
(unaudited - in thousands)

Common Stock Additional
Paid-in
Capital 		Accumulated
Deficit 		Total
Shares Amount
Balance at January 1, 2022 22,683 $ 227 $ 3,971 $ ( 429,151 ) $ ( 424,953 )
Net income — — — 2,074 2,074
Exercise of common stock options 21 — 531 — 531
Stock-based compensation 341 3 4,130 — 4,133
Repurchases of common stock ( 813 ) ( 8 ) ( 8,632 ) ( 42,358 ) ( 50,998 )
Balance at April 2, 2022 22,232 $ 222 $ — $ ( 469,435 ) $ ( 469,213 )
Net income — — — 34,933 34,933
Exercise of common stock options 2 — 54 — 54
Stock-based compensation 26 1 3,909 — 3,910
Repurchases of common stock ( 296 ) ( 3 ) ( 3,963 ) ( 8,680 ) ( 12,646 )
Balance at July 2, 2022 21,964 $ 220 $ — $ ( 443,182 ) $ ( 442,962 )
Net income — — — 5,033 5,033
Exercise of common stock options 19 — 413 — 413
Stock-based compensation 30 — 542 — 542
Repurchases of common stock ( 12 ) — ( 497 ) — ( 497 )
Balance at October 1, 2022 22,001 $ 220 $ 458 $ ( 438,149 ) $ ( 437,471 )

Common Stock Additional
Paid-in
Capital 		Accumulated Deficit Total
Shares Amount
Balance at January 2, 2021 25,390 $ 254 $ — $ ( 224,232 ) $ ( 223,978 )
Net income — — — 66,634 66,634
Exercise of common stock options 106 1 2,459 — 2,460
Stock-based compensation 314 3 6,413 — 6,416
Repurchases of common stock ( 1,346 ) ( 13 ) ( 8,872 ) ( 175,297 ) ( 184,182 )
Balance at April 3, 2021 24,464 $ 245 $ — $ ( 332,895 ) $ ( 332,650 )
Net income — — — 22,250 22,250
Exercise of common stock options 35 — 1,075 — 1,075
Stock-based compensation 22 — 5,969 — 5,969
Repurchases of common stock ( 899 ) ( 9 ) ( 7,044 ) ( 93,249 ) ( 100,302 )
Balance at July 3, 2021 23,622 $ 236 $ — $ ( 403,894 ) $ ( 403,658 )
Net income — — — 53,721 53,721
Exercise of common stock options 10 — 312 — 312
Stock-based compensation 19 — 7,316 — 7,316
Repurchases of common stock ( 1,004 ) ( 10 ) ( 7,628 ) ( 90,119 ) ( 97,757 )
Balance at October 2, 2021 22,647 $ 226 $ — $ ( 440,292 ) $ ( 440,066 )


See accompanying notes to condensed consolidated financial statements.
3 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited - in thousands)
Nine Months Ended
October 1,
2022 		October 2,
2021
Cash flows from operating activities:
Net income $ 42,040 $ 142,605
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 49,342 44,786
Stock-based compensation 8,585 19,701
Net loss (gain) on disposals and impairments of assets 274 ( 20 )
Deferred income taxes ( 6,955 ) 291
Changes in operating assets and liabilities:
Accounts receivable ( 1,029 ) ( 1,517 )
Inventories ( 11,080 ) ( 4,767 )
Income taxes 4,530 5,615
Prepaid expenses and other assets 20,082 ( 13,879 )
Accounts payable 28,889 51,543
Customer prepayments ( 34,225 ) 35,785
Accrued compensation and benefits ( 23,735 ) ( 12,725 )
Other taxes and withholding 4,744 7,636
Other accruals and liabilities ( 1,340 ) 17,630
Net cash provided by operating activities 80,122 292,684
Cash flows from investing activities:
Purchases of property and equipment ( 52,808 ) ( 49,370 )
Proceeds from sales of property and equipment 49 257
Net cash used in investing activities ( 52,759 ) ( 49,113 )
Cash flows from financing activities:
Repurchases of common stock ( 64,141 ) ( 381,496 )
Net increase in short-term borrowings 34,781 132,222
Proceeds from issuance of common stock 998 3,847
Debt issuance costs ( 42 ) ( 557 )
Net cash used in financing activities ( 28,404 ) ( 245,984 )
Net decrease in cash and cash equivalents ( 1,041 ) ( 2,413 )
Cash and cash equivalents, at beginning of period 2,389 4,243
Cash and cash equivalents, at end of period $ 1,348 $ 1,830




See accompanying notes to condensed consolidated financial statements.
4 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
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 October 1, 2022 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 October 1, 2022 and January 1, 2022, 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. In addition, based on the duration and severity of the current global situation involving the COVID-19 pandemic, the war in Ukraine, historic low consumer sentiment and other external factors, including but not limited to general economic conditions, inflation, consumer sentiment, store restrictions mandated by federal, state or local authorities and global supply chain disruptions (especially disruptive supply and flow of semiconductor chips and other electronic components), the extent to which these external factors 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 January 1, 2022 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 external factors such as COVID-19, historic low consumer sentiment and the war in Ukraine, predicting future events will be especially challenging for management. Changes in these estimates will be reflected in the consolidated financial statements in future periods and could be material. Our critical accounting policies consist of stock-based compensation, 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.

2. Fair Value Measurements

At October 1, 2022 and January 1, 2022, we had $ 16 million and $ 19 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 $ 16 million and $ 19 million at October 1, 2022 and January 1, 2022, 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.

5 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

3. Inventories

Inventories consisted of the following (in thousands):
October 1,
2022 		January 1,
2022
Raw materials $ 6,763 $ 11,752
Work in progress 92 83
Finished goods 106,699 93,809
$ 113,554 $ 105,644

4. Goodwill and Intangible Assets, Net

Goodwill and Indefinite-lived Intangible Assets

Goodwill was $ 64 million at October 1, 2022 and January 1, 2022. Indefinite-lived trade name/trademarks totaled $ 1.4 million at October 1, 2022 and January 1, 2022.

Definite-lived Intangible Assets

The gross carrying amount of our developed technologies was $ 18.4 million at October 1, 2022 and January 1, 2022. Accumulated amortization was $ 16.7 million and $ 15.5 million at October 1, 2022 and January 1, 2022. Amortization expense for both the three months ended October 1, 2022 and October 2, 2021, was $ 0.5 million. Amortization expense for both the nine months ended October 1, 2022 and October 2, 2021, was $ 1.6 million.

The gross carrying amount of our patents was $ 2.0 million at October 1, 2022 and January 1, 2022. Accumulated amortization was $ 0.5 million and $ 0.3 million at October 1, 2022 and January 1, 2022, respectively. Amortization expense for both the three months ended October 1, 2022 and October 2, 2021, was $ 55 thousand. Amortization expense for both the nine months ended October 1, 2022 and October 2, 2021, was $ 0.2 million.

Annual amortization for definite-lived intangible assets for subsequent years are as follows (in thousands):
2022 (excluding the nine months ended October 1, 2022) $ 601
2023 1,431
2024 222
2025 226
2026 222
2027 222
Thereafter 300
Total future amortization for definite-lived intangible assets $ 3,224

5. Credit Agreement

As of October 1, 2022, our credit facility had a total commitment amount of $ 825 million. The credit facility is for general corporate purposes, to meet our seasonal working capital requirements and to repurchase our stock. The credit agreement includes an accordion feature which allows us to increase the amount of the credit facility from $ 825 million to $ 1.2 billion, subject to lenders’ approval. 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 net leverage ratio ( 4.5 x) and a minimum interest coverage ratio ( 3.0 x). 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 matures in December 2026. We were in compliance with all financial covenants as of October 1, 2022.
6 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

We amended the credit agreement on October 26, 2022. The amendment, among other things, (a) provides relief from the requirement that the net leverage ratio not exceed 3.75 x for certain corporate actions including Permitted Capital Distributions for Performance or Taxes (as defined in the Credit Agreement) and certain acquisition activity; (b) increases the permissible net leverage ratio to 5.0 x for the three consecutive quarterly reporting periods ending July 1, 2023; (c) increases the commitment fee rate to 50 basis points and the margin applicable to interest rates for all borrowings by an additional 50 basis points, in each case if the net leverage ratio is greater than or equal to 4.5 x; and (d) replaces the option to borrow at an interest rate based on London Interbank Offered Rate (LIBOR) to one based on a Term SOFR Rate. The Term SOFR Rate equals the sum of (x) the Term SOFR Screen Rate (as defined in the Credit Agreement) for the applicable interest period (but in no event less than zero), plus (y) 0.10 %, plus (z) the margin based on Sleep Number’s net leverage ratio. A fee for the amendment is payable to the lenders in an amount equal to 7.5 basis points multiplied by the sum of the Revolving Credit Commitment and the outstanding amount of Term Loans (as each is defined in the Credit Agreement).

The following table summarizes our borrowings under the credit facility ($ in thousands):
October 1,
2022 		January 1,
2022
Outstanding borrowings $ 406,300 $ 382,500
Outstanding letters of credit $ 5,947 $ 3,997
Additional borrowing capacity $ 412,753 $ 438,503
Weighted-average interest rate 5.1 % 1.6 %


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 .

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 can be reasonably estimated. Future payments for real estate taxes and certain building operating expenses for which we are obligated are not included in operating lease costs.

At October 1, 2022, our finance right-of-use assets and lease liabilities were not significant.

Lease costs were as follows (in thousands):
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Operating lease costs (1)
$ 27,821 $ 24,352 $ 81,925 $ 73,623
Variable lease costs $ 54 $ 840 $ 647 $ 2,181
___________________________
(1) Includes short-term lease costs which are not significant.
7 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

The maturities of operating lease liabilities as of October 1, 2022, were as follows (1) (in thousands):
2022 (excluding the nine months ended October 1, 2022) $ 25,605
2023 99,133
2024 87,684
2025 77,399
2026 65,885
2027 50,511
Thereafter 105,869
Total operating lease payments (2)
512,086
Less: Interest 84,473
Present value of operating lease liabilities $ 427,613
___________________________
(1) Total operating lease payments exclude $ 89 million of legally binding minimum lease payments for leases signed but not yet commenced.
(2) Includes the current portion of $ 77 million for operating lease liabilities.


Other information related to operating leases was as follows:
October 1,
2022 		January 1,
2022
Weighted-average remaining lease term (in years) 6.2 6.4
Weighted-average discount rate 6.1 % 6.1 %

Nine Months Ended
(in thousands) October 1,
2022 		October 2,
2021
Cash paid for amounts included in present value of operating lease liabilities $ 74,189 $ 66,561
Right-of-use assets obtained in exchange for operating lease liabilities $ 56,048 $ 78,192

7. Repurchases of Common Stock

Repurchases of our common stock were as follows (in thousands):
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Amount repurchased under Board-approved share repurchase program $ — $ 97,046 $ 54,868 $ 364,478
Amount repurchased in connection with the vesting of employee restricted stock grants 497 711 9,273 17,763
Total amount repurchased (based on trade dates) $ 497 $ 97,757 $ 64,141 $ 382,241

As of October 1, 2022, the remaining authorization under the $ 600 million share repurchase program was $ 348 million.

8 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

8. Revenue Recognition

Deferred contract assets and deferred contract liabilities are included in our condensed consolidated balance sheets as follows (in thousands):
October 1,
2022 		January 1,
2022
Deferred contract assets included in:
Other current assets $ 27,894 $ 28,048
Other non-current assets 55,095 49,343
$ 82,989 $ 77,391

October 1,
2022 		January 1,
2022
Deferred contract liabilities included in:
Other current liabilities $ 36,160 $ 36,490
Other non-current liabilities 70,676 63,680
$ 106,836 $ 100,170

The deferred revenue and costs related to SleepIQ ® technology are currently recognized on a straight-line basis over the product's estimated life of 4.5 to 5.0 years because our inputs are generally expended evenly throughout the performance period. During the three months ended October 1, 2022 and October 2, 2021, we recognized revenue of $ 9 million and $ 8 million, respectively, that were included in the deferred contract liability balances at the beginning of the respective periods. During the nine months ended October 1, 2022 and October 2, 2021, we recognized revenue of $ 26 million and $ 22 million, respectively, that were included in the deferred contract liability balances 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 the three and nine months ended October 1, 2022 and 99 % and 98 % for the three and nine months ended October 2, 2021, respectively.

Net sales were as follows (in thousands):
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Retail stores $ 466,632 $ 565,939 $ 1,401,789 $ 1,481,780
Online, phone, chat and other 73,934 74,454 214,980 211,185
Total Company $ 540,566 $ 640,393 $ 1,616,769 $ 1,692,965

Obligation for Sales Returns

The activity in the sales returns liability account was as follows (in thousands):
Nine Months Ended
October 1,
2022 		October 2,
2021
Balance at beginning of year $ 22,368 $ 24,765
Additions that reduce net sales 79,353 69,877
Deductions from reserves ( 76,070 ) ( 66,124 )
Balance at end of period $ 25,651 $ 28,518

9 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

9. Stock-based Compensation Expense

Total stock-based compensation expense (benefit) was as follows (in thousands):
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Stock awards (1)
$ ( 435 ) $ 6,506 5,778 $ 17,533
Stock options 977 810 2,807 2,168
Total stock-based compensation expense (1)
542 7,316 8,585 19,701
Income tax benefit 133 1,835 2,112 4,906
Total stock-based compensation expense, net of tax $ 409 $ 5,481 $ 6,473 $ 14,795
___________________________
(1) Changes in stock-based compensation expense reflect 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 October 1, 2022 and October 2, 2021, our contributions, net of forfeitures, were $ 2.3 million and $ 2.0 million, respectively. During the nine months ended October 1, 2022 and October 2, 2021, our contributions, net of forfeitures, were $ 7.6 million and $ 5.7 million, respectively.

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
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Net income $ 5,033 $ 53,721 $ 42,040 $ 142,605
Reconciliation of weighted-average shares outstanding:
Basic weighted-average shares outstanding 22,218 23,464 22,444 24,404
Dilutive effect of stock-based awards 355 769 515 920
Diluted weighted-average shares outstanding 22,573 24,233 22,959 25,324
Net income per share – basic $ 0.23 $ 2.29 $ 1.87 $ 5.84
Net income per share – diluted $ 0.22 $ 2.22 $ 1.83 $ 5.63
For the three and nine months ended October 1, 2022 and October 2, 2021, anti-dilutive stock-based awards excluded from the diluted net income per share calculations were 0.5 million and 0.1 million for the three months ended October 1, 2022 and October 2, 2021, respectively, and 0.5 million and 0.1 million for the nine months ended October 1, 2022 and October 2, 2021, respectively.

10 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
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
October 1,
2022 		October 2,
2021
Balance at beginning of year $ 10,069 $ 12,152
Additions charged to costs and expenses for current-year sales 13,093 12,780
Deductions from reserves ( 13,210 ) ( 13,489 )
Changes in liability for pre-existing warranties during the current year, including expirations ( 546 ) ( 380 )
Balance at end of period $ 9,406 $ 11,063

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.

Shareholder Class Action Complaints

On December 14, 2021, purported Sleep Number shareholder, Steamfitters Local 449 Pension & Retirement Security Funds (Steamfitters), filed a putative class action complaint in the United States District Court for the District of Minnesota (the District of Minnesota) on behalf of all purchasers of Sleep Number common stock between February 18, 2021 and July 20, 2021, inclusive, against Sleep Number, Shelly Ibach and David Callen. Steamfitters alleges material misstatements and omissions in certain of Sleep Number’s public disclosures during the purported class period, in violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended (the Exchange Act). The complaint seeks, among other things, unspecified monetary damages, reasonable costs and expenses and equitable/injunctive or other relief as deemed appropriate by the District of Minnesota.

On February 14, 2022, a second purported Sleep Number shareholder, Ricardo Dario Schammas, moved for appointment as lead plaintiff in the action. On March 24, 2022, the District of Minnesota heard argument on Schammas’s motion, and subsequently appointed Steamfitters and Schammas as Co-Lead Plaintiffs (together, Co-Lead Plaintiffs). On July 19, 2022, Co-Lead Plaintiffs filed a consolidated amended complaint, which, like the predecessor complaint, asserts claims against Sleep Number, Shelly Ibach, and David Callen under Sections 10(b) and 20(a) of the Exchange Act. Co-Lead Plaintiffs purport to assert these claims on behalf of all purchasers of Sleep Number common stock between February 18, 2021 and July 20, 2021. Defendants moved to dismiss the consolidated complaint on September 19, 2022, which motion remains pending.
11 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
SLEEP NUMBER CORPORATION
AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
(unaudited)

Shareholder Derivative Complaint

On May 12, 2022, Gwendolyn Calla Moore, as the appointed representative of purported Sleep Number shareholder Matthew Gelb, filed a derivative action (the Derivative Action) in the District of Minnesota against Jean-Michel Valette, Shelly Ibach, Barbara Matas, Brenda Lauderback, Daniel Alegre, Deborah Kilpatrick, Julie Howard, Kathleen Nedorostek, Michael Harrison, Stephen Gulis, Jr., David Callen, and Kevin Brown. Moore purports to assert claims on behalf of Sleep Number for breaches of fiduciary duty, waste, and contribution under Sections 10(b) and 21(d) of the Exchange Act. Moore’s allegations generally mirror those asserted in the securities complaint described above. The Moore complaint seeks damages in an unspecified amount, disgorgement, interest, and costs and expenses, including attorneys’ and experts’ fees.

On September 13, 2022, the District of Minnesota entered a joint stipulation staying all proceedings in the Derivative Action pending the outcome of any motion to dismiss the Steamfitters consolidated amended complaint.

Stockholder Demand

On March 25, 2022, Sleep Number received a shareholder litigation demand (the “Demand”), requesting that the Board investigate the allegations in the securities class action complaint and pursue claims on Sleep Number’s behalf based on those allegations. On May 12, 2022, the Board established a special litigation committee to investigate the demand.

On October 5 and October 12, 2022, Sleep Number received two additional shareholder litigation demands, which adopted and incorporated the allegations and requests in the Demand. Both of these additional litigation demands were referred to the special litigation committee.

The special litigation committee has concluded that it would not be in the best interests of Sleep Number and its shareholders to take any of the actions requested in the demands at this time.

13. COVID-19 Pandemic

The COVID-19 pandemic impacted our 2021 and 2022 financial performance. In the first nine months of 2021, even with the COVID-19 challenges, we generated strong demand and financial performance. In the first nine months of 2022, our financial performance was impacted by: (i) the disruptive flow of semiconductor chips which affected our ability to deliver products to our customers; (ii) incremental costs from labor and material inflation, and expediting costs resulting from current-period global supply chain shortages; and (iii) record low consumer sentiment. The pandemic's future effects on our global supply chain and the potential for supply disruption (e.g., the lack or slowing of critical components caused by labor shortages or government-mandated work closures), effects on consumer demand and effects on our ongoing financial performance remains uncertain. See Part II, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations for additional discussion on the COVID-19 pandemic and the impact on our business.
12 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
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 eight sections:

• Forward-Looking Statements and 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 sentiment;
• Risks inherent in outbreaks of pandemics or contagious disease, including the COVID-19 pandemic;
• Risks inherent in global-sourcing activities, including tariffs, outbreaks of pandemics or contagious diseases, such as the COVID-19 pandemic, geo-political turmoil, acts of terrorism, global conflicts or war (such as the current war in Ukraine), strikes, labor shortages, government-mandated work closures, and the potential for shortages in supply or disruption or delay of production and delivery of materials and products in our global supply chain;
• Risks of disruption in the operation of any of our main manufacturing, distribution, logistics, home delivery, product development, or customer service facilities or operations;
• Our manufacturing processes operate 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 service providers;
• Rising commodity costs and other inflationary pressures;
• The effectiveness of our marketing messages;
• The efficiency of our advertising and promotional efforts;
• Our ability to execute our Total Retail distribution strategy;
• Our ability to achieve and maintain acceptable levels of product and service quality, and acceptable product return and warranty claims rates;
• Our ability to continue to improve and expand our product line, and consumer acceptance of our products, product quality, innovation and brand image;
• 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;
• Claims that our products, processes, advertising or trademarks infringe the intellectual-property rights of others;
• Availability of attractive and cost-effective consumer credit options;
• Increasing government regulation;
• Pending or unforeseen litigation and the potential for adverse publicity associated with litigation;
13 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION
• 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 cybersecurity;
• The costs and potential disruptions to our business related to upgrading or maintaining 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;
• Environmental risks, including increasing environmental regulation and the broader impacts of climate change such as from weather-related events; and
• Our ability, and the ability of our suppliers and vendors, 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” in Part I, Item 1A. 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.

Business Overview

Sleep Number is a company with purpose, with over 5,300 mission-driven team members who are dedicated to improving the health and wellbeing of society through higher quality sleep. We have improved more than 14 million lives and are dedicated to lifelong relationships with our smart sleepers.

Sleep Number is a leader in sleep and wellness technology. Our 360 ® smart bed platform connects the physical and digital worlds, creating an immersive, adaptive, and individualized sleep health experience. Quality sleep is vital for physical, mental, and emotional wellbeing; our smart beds deliver exceptional sleep by automatically sensing and effortlessly adjusting to the needs of each sleeper. Through partnerships with the world’s leading health and research institutions, we are advancing sleep science with our 17 billion hours of highly accurate, longitudinal sleep data from millions of sleepers in our Smart Sleeper SM community.

We continue to advance our differentiated, consumer-focused strategy through enterprise-wide initiatives that strengthen our competitive advantages. This has resulted in Sleep Number being a beloved brand with ongoing connectivity and advocacy of millions of smart sleepers. We generate revenue by marketing and selling our innovations directly to new and existing customers through our vertically integrated, exclusive, direct-to-consumer retail touch points including Stores, Online, Phone, and Chat (Total Retail). We are committed to creating long-term superior value for all stakeholders as we focus on our three performance drivers: (1) increasing consumer demand; (2) leveraging our vertically integrated business model; and (3) deploying capital efficiently.

COVID-19 Pandemic - Impact on our Business

The COVID-19 pandemic impacted our 2021 and 2022 financial performance. In the first nine months of 2021, even with the COVID-19 challenges, we generated strong demand and financial performance. In the first nine months of 2022, our financial performance was impacted by: (i) the disruptive flow of semiconductor chips which affected our ability to deliver products to our customers; (ii) incremental costs from labor and material inflation, and expediting costs resulting from current-period global supply chain shortages; and (iii) record low consumer sentiment. The pandemic's future effects on our global supply chain and the potential for supply disruption (e.g., the lack or slowing of critical components caused by labor shortages or government-mandated work closures), effects on consumer demand and effects on our ongoing financial performance remains uncertain.

14 | 3Q 2022 FORM 10-Q
SLEEP NUMBER CORPORATION

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 global supplies or third-party service providers, seasonality of retail and bedding industry sales, consumer sentiment and general economic conditions. In addition, based on the duration and severity of the current global situation involving the COVID-19 pandemic, the war in Ukraine and other external factors, including but not limited to general economic conditions, inflation, consumer sentiment, store restrictions mandated by federal, state or local authorities and global supply chain disruptions, the extent to which these external factors will impact our business and our consolidated financial results 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 three months ended October 1, 2022 were as follows:

• Net sales for the three months ended October 1, 2022 decreased 16% to $541 million, compared with $640 million for the three months ended October 2, 2021. Net sales were affected by semiconductor chip supply constraints. Demand was negatively impacted by record low consumer sentiment and constrained chip supply that limited our product offering and drove longer-than-normal lead times.
• The 16% net sales decrease consisted of a 18% comparable sales decrease in Total Retail offset by additional sales from 30 net new stores opened in the past 12 months that added 2 percentage points (ppt.) of growth. For additional details, see the components of total net sales change on page 16 .
• Sales per store (sales for stores open at least one year, Total Retail, including online, phone and chat) on a trailing twelve-month basis for the period ended October 1, 2022 totaled $3.3 million, compared with $3.7 million with the same period last year.
• Operating income for the three months ended October 1, 2022 was $13 million, compared with $73 million in the prior-year period. The $60 million decrease in operating income was driven by the 16% decrease in net sales, a 4.9 ppt. decrease in our gross profit rate and a 4.1 ppt. increase in our operating expenses rate.
• The 4.9 ppt. gross profit rate decrease was primarily due to 17% lower delivered smart bed volume, operating inefficiencies resulting from constrained and uneven flow of semiconductor chip supply, brokerage premiums for parts needed to close supply gaps, incremental costs from labor and material inflation, and an unfavorable sales mix of our smart beds. See the Gross profit discussion on page 18 for additional details.
• The 4.1 ppt. increase in our operating expenses rate was mainly due to the deleveraging impact of the 16% net sales decrease. In addition, we continued to prioritize investments in near- and long-term growth drivers, including $15 million of R&D expenses during the three months ended October 1, 2022.
• Net income for the three months ended October 1, 2022 decreased to $5 million, compared with $54 million for the same period one year ago. Net income per diluted share was $0.22, compared with $2.22 last year.
• We achieved a return on invested capital (ROIC) of 15.8% on a trailing twelve-month basis for the period ended October 1, 2022, compared with 34.6% for the comparable period one year ago.
• Cash provided by operating activities was pressured by year-over-year changes in working capital and lower net income for the nine months ended October 1, 2022 and decreased to $80 million, compared with $293 million for the same period one year ago.
• As of October 1, 2022, we had $406 million of borrowings under our revolving credit facility and available net liquidity of $413 million.


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SLEEP NUMBER CORPORATION

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
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Net sales $ 540.6 100.0 % $ 640.4 100.0 % $ 1,616.8 100.0 % $ 1,693.0 100.0 %
Cost of sales 237.5 43.9 % 250.0 39.0 % 686.4 42.5 % 653.8 38.6 %
Gross profit 303.1 56.1 % 390.4 61.0 % 930.3 57.5 % 1,039.1 61.4 %
Operating expenses:
Sales and marketing 239.7 44.3 % 255.5 39.9 % 700.4 43.3 % 685.1 40.5 %
General and administrative 36.0 6.7 % 47.7 7.4 % 116.0 7.2 % 131.5 7.8 %
Research and development 14.8 2.7 % 14.4 2.3 % 46.9 2.9 % 43.6 2.6 %
Total operating expenses 290.4 53.7 % 317.6 49.6 % 863.4 53.4 % 860.2 50.8 %
Operating income 12.6 2.3 % 72.7 11.4 % 67.0 4.1 % 178.9 10.6 %
Interest expense, net 5.6 1.0 % 1.8 0.3 % 11.4 0.7 % 4.4 0.3 %
Income before income taxes 7.0 1.3 % 70.9 11.1 % 55.6 3.4 % 174.5 10.3 %
Income tax expense 2.0 0.4 % 17.2 2.7 % 13.6 0.8 % 31.9 1.9 %
Net income $ 5.0 0.9 % $ 53.7 8.4 % $ 42.0 2.6 % $ 142.6 8.4 %
Net income per share:
Basic $ 0.23 $ 2.29 $ 1.87 $ 5.84
Diluted $ 0.22 $ 2.22 $ 1.83 $ 5.63
Weighted-average number of common shares:
Basic 22.2 23.5 22.4 24.4
Diluted 22.6 24.2 23.0 25.3

The percentage of our total net sales, by dollar volume, was as follows:
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Retail stores 86.3 % 88.4 % 86.7 % 87.5 %
Online, phone, chat and other 13.7 % 11.6 % 13.3 % 12.5 %
Total Company 100.0 % 100.0 % 100.0 % 100.0 %

The components of total net sales change, including comparable net sales changes, were as follows:
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Sales change rates:
Retail comparable-store sales (1)
(21 %) 19 % (10 %) 32 %
Online, phone and chat 0 % 0 % 3 % 11 %
Total Retail comparable sales change (1)
(18 %) 16 % (8 %) 28 %
Net opened/closed stores and other 2 % 5 % 3 % 3 %
Total Company (16 %) 21 % (5 %) 31 %
___________________________
(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.

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Other sales metrics were as follows:
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Average sales per store (1) (in thousands)
$ 3,302 $ 3,689
Average sales per square foot (1)
$ 1,093 $ 1,249
Stores > $2 million in net sales (2)
77 % 85 %
Stores > $3 million in net sales (2)
38 % 50 %
Average revenue per smart bed unit (3)
$ 5,083 $ 5,021 $ 5,416 $ 5,045
___________________________
(1) Trailing-twelve months Total Retail comparable sales per store open at least one year.
(2) Trailing-twelve months for stores open at least one year (excludes online, phone and chat sales).`
(3) Represents Total Retail net sales divided by Total Retail smart bed units.

The number of retail stores operating was as follows:
Three Months Ended Nine Months Ended
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Beginning of period 659 621 648 602
Opened 12 18 35 55
Closed (9) (7) (21) (25)
End of period 662 632 662 632

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Comparison of Three Months Ended October 1, 2022 with Three Months Ended October 2, 2021

Net sales

Net sales for the three months ended October 1, 2022 decreased by $100 million, or 16%, to $541 million, compared with $640 million for the same period one year ago. Net sales were affected by semiconductor chip supply constraints. Demand was negatively impacted by record low consumer sentiment and constrained chip supply that limited our product offering and drove longer-than-normal lead times.

The 16% net sales decrease consisted primarily of a 18% comparable sales decrease in Total Retail offset by additional sales from 30 net new stores opened in the past 12 months that added 2 percentage points (ppt.) of growth. For additional details, see the components of total net sales change on page 16 .

The $100 million net sales decrease compared with the same period one year ago was comprised of the following: (i) a $112 million decrease in our Total Retail comparable net sales; offset by (ii) a $12 million increase from net store openings. Total Retail smart bed unit sales decreased 17% compared with the prior year due to disruptive electronics supply and softer demand. Total Retail average revenue per smart bed unit increased by 1% to $5,083, compared with $5,021 in the prior-year period.

Gross profit

Gross profit of $303 million for the three months ended October 1, 2022 decreased by $87 million, or 22%, compared with $390 million for the same period one year ago. The gross profit rate declined to 56.1% of net sales for the three months ended October 1, 2022, compared with 61.0% for the prior-year comparable period.

The current-year gross profit rate decrease of 4.9 ppt. was mainly due to: (i) 17% lower delivered smart bed volume; (ii) year-over-year unfavorable product mix changes; (iii) operating inefficiencies resulting from the uneven flow of electronics supply; (iv) incremental costs from labor and material inflation including brokerage premiums to close supply gaps and expedited freight; partially offset by; (v) pricing actions taken over the past twelve months. In addition, our gross profit rate will fluctuate from quarter to quarter due to a variety of other factors, including return and exchange costs, and changes in performance-based incentive compensation.

Sales and marketing expenses

Sales and marketing expenses for the three months ended October 1, 2022 were $240 million, or 44.3% of net sales, compared with $256 million, or 39.9% of net sales, for the same period one year ago. The current-year sales and marketing expenses rate increase of 4.4 ppt. was primarily due to: (i) the deleveraging impact of the 16% net sales decline; (ii) the additional costs associated with operating 30 net new stores; (iii) higher fees associated with our customer credit-based promotional offers; and (iv) less efficient media expense although spend was down 10% year-over-year.

General and administrative expenses

General and administrative (G&A) expenses totaled $36 million, or 6.7% of net sales, for the three months ended October 1, 2022, compared with $48 million, or 7.4% of net sales, in the prior-year period. The $11.7 million decrease in G&A expenses consisted mainly of: (i) a $15.2 million decrease in employee compensation primarily resulting from a year-over-year reduction in Company-wide performance-based incentive compensation; partially offset by (ii) $1.1 million increase in technology investments; and (iii) a $2.4 million increase in other miscellaneous expenses, including professional and consulting fees. The G&A expenses rate decreased by 0.7 ppt. in the current-year period, compared with the same period one year ago due to the items discussed above, offset by the deleveraging impact of the 16% net sales decrease.

Research and development expenses

Research and development (R&D) expenses were $15 million for the three months ended October 1, 2022, consistent with the same period last year as we continued to prioritize our long-term life-changing sleep innovation initiatives.

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Interest expense

Interest expense, net increased to $6 million for the three months ended October 1, 2022, compared with $2 million for the same period one year ago. The $4 million increase was mainly driven by a higher weighted-average interest rate compared with the same period one year ago, and a higher level of outstanding borrowings during the three months ended October 1, 2022 compared with the same period in 2021.

Income tax expense

Income tax expense totaled $2.0 million for the three months ended October 1, 2022, compared with $17.2 million last year. The effective income tax rate for the three months ended October 1, 2022 was 28.5%, compared with 24.3% for the comparable period last year. Discrete tax expense was $0.3 million for the three months ended October 1, 2022, compared with discrete tax benefits of $0.6 million in last year’s third quarter.

Comparison of Nine Months Ended October 1, 2022 with Nine Months Ended October 2, 2021

Net sales

Net sales for the nine months ended October 1, 2022 decreased by $76 million, or 5%, to $1.62 billion, compared with $1.69 billion for the same period one year ago. Net sales were affected by semiconductor chip supply constraints. Demand was negatively impacted by record low consumer sentiment and constrained chip supply that limited our product offering and drove longer-than-normal lead times.

The 5% net sales decrease consisted of an 8% comparable sales decrease in Total Retail, partially offset by 3 percentage points (ppt.) of sales growth from net new stores opened in the past 12 months. For additional details, see the components of total net sales change on page 16 .

The $76 million net sales decrease compared with the same period one year ago was comprised of the following: (i) a $130 million decrease in our Total Retail comparable net sales; partially offset by (ii) a $54 million increase resulting from net store openings. Total smart bed unit sales declined 11% compared with the prior year. Average revenue per smart bed unit in Total Retail increased by 7% to $5,416, compared with $5,045 in the prior-year period.

Gross profit

Gross profit of $930 million decreased by $109 million, or 10%, compared with $1.04 billion for the same period one year ago. The gross profit rate decreased to 57.5% of net sales for the nine months ended October 1, 2022, compared with 61.4% for the prior-year comparable period.

The current-year gross profit rate decrease of 3.9 ppt. was mainly due to: (i) 11% lower delivered smart bed volume; (ii) incremental costs from labor and material inflation; (iii) operating inefficiencies resulting from the uneven flow of electronics supply and constrained deliveries; (iv) year-over-year unfavorable product mix changes; partially offset by (v) pricing actions taken over the past twelve months. Our gross profit rate will fluctuate from quarter to quarter due to a variety of other factors, including return and exchange costs and changes in performance-based incentive compensation.

Sales and marketing expenses

Sales and marketing expenses for the nine months ended October 1, 2022 were $700 million, or 43.3% of net sales, compared with $685 million, or 40.5% of net sales, for the same period one year ago. The current-year sales and marketing expenses rate increase of 2.8 ppt. was primarily due to: (i) deleveraging impact of a 5% sales decline; (ii) higher fees associated with our customer credit-based promotional offers; (iii) the additional costs associated with operating 30 net new stores; partially offset by (iv) lower variable compensation due to the negatively impacted demand.

General and administrative expenses

General and administrative (G&A) expenses totaled $116 million, or 7.2% of net sales, for the nine months ended October 1, 2022, compared with $131 million, or 7.8% of net sales, in the prior-year period. The $15 million decrease in G&A expenses consisted of: (i) an $26 million decrease in employee compensation primarily resulting from a year-over-year decrease in Company-wide performance-based incentive compensation; partially offset by (ii) a $5 million increase in technology investments; and (iv) a $6 million increase in other miscellaneous expenses including
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professional fees and travel. The G&A expenses rate decreased by 0.6 ppt. in the current-year period, compared with the same period one year ago due to the net expense reductions discussed above partially offset by the deleveraging impact of the 5% net sales decrease.

Research and development expenses

Research and development (R&D) expenses increased by 8% to $47 million for the nine months ended October 1, 2022, compared with $44 million for the same period one year ago. The R&D expense rate for the nine months ended October 1, 2022 increased to 2.9% of net sales, compared with 2.6% of net sales for the prior year. The spending level increase supports our continued prioritization in our long-term life-changing sleep innovation initiatives.

Interest expense, net

Interest expense, net increased to $11 million for the nine months ended October 1, 2022, compared with $4 million for the same period one year ago. The $7 million increase was mainly driven by a higher level of outstanding borrowings during the nine months ended October 1, 2022, compared with the same period one year ago, and a higher weighted-average interest rate compared with the same period one year ago.

Income tax expense

Income tax expense totaled $14 million for the nine months ended October 1, 2022, compared with $32 million last year. The effective income tax rate for the nine months ended October 1, 2022 increased to 24.4%, compared with 18.3% for the comparable period last year, reflecting lower stock-based compensation excess tax benefits in the current-year nine-month period.

Liquidity and Capital Resources

Managing our liquidity and capital resources is an important part of our commitment to deliver superior shareholder value over time. Our primary sources of liquidity are cash flows provided by operating activities and cash available under our $825 million revolving credit facility. As of October 1, 2022, we do not have any off-balance sheet financing other than our $6 million in outstanding letters of credit. The cash generated from ongoing operations and cash available under our revolving credit facility are expected to be adequate to maintain operations, and fund anticipated expansion, strategic initiatives and contractual obligations such as lease payments and capital commitments for new retail stores for the foreseeable future.

Changes in cash and cash equivalents during the nine months ended October 1, 2022 primarily consisted of $80 million of cash provided by operating activities and a $35 million net increase in short-term borrowings, offset by $53 million of cash used to purchase property and equipment, and $64 million of cash used to repurchase our common stock (based on settlement, $55 million under our Board-approved share repurchase program and $9 million in connection with the vesting of employee restricted stock grants).

The following table summarizes our cash flows (in millions). Amounts may not add due to rounding differences:
Nine Months Ended
October 1,
2022 		October 2,
2021
Total cash provided by (used in):
Operating activities $ 80.1 $ 292.7
Investing activities (52.8) (49.1)
Financing activities (28.4) (246.0)
Net decrease in cash and cash equivalents $ (1.0) $ (2.4)

Cash provided by operating activities for the nine months ended October 1, 2022 was $80 million, compared with $293 million for the nine months ended October 2, 2021. Significant components of the year-over-year change in cash provided by operating activities included: (i) a $101 million decrease in net income for the nine months ended October 1, 2022, compared with the same period one year ago; (ii) a $70 million fluctuation in customer prepayments due to timing of deliveries; (iii) a $34 million fluctuation in prepaid expenses and other assets due to the amount and timing of rebate payments and changes in the balance of our deferred compensation plan due to investment
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performance; (iv) a $23 million change in accounts payable with both periods impacted by business changes and timing of payments; and (v) a $19 million fluctuation in other accruals and liabilities driven by changes in the balance of our deferred compensation plan due to investment performance and changes in other miscellaneous accruals.

Net cash used in investing activities to purchase property and equipment was $53 million for the nine months ended October 1, 2022, compared with $49 million for the same period one year ago. The year-over-year increase was primarily due to the timing of cash flows associated with investments in information technology.
Net cash used in financing activities was $28 million for the nine months ended October 1, 2022, compared with $246 million for the same period last year. During the nine months ended October 1, 2022, we repurchased $64 million of our stock (based on settlement dates, $55 million under our Board-approved share repurchase program and $9 million in connection with the vesting of employee restricted stock awards), compared with $381 million during the same period one year ago. Short-term borrowings increased by $35 million during the current-year period due to a $24 million increase in borrowings under our revolving credit facility to $406 million and a $11 million increase in book overdrafts which are included in the net change in short-term borrowings. Short-term borrowings increased by $132 million during the prior-year period due to a $115 million increase in borrowings under our credit facility to $359 million and an $17 million increase in book overdrafts.
We suspended share repurchases under our Board-approved share repurchase program in the second quarter until macro economic conditions improve. We repurchased 1.0 million shares at a cost of $55 million (based on trade dates, an average of $57.46 per share) during the nine months ended October 1, 2022. During the nine months ended October 2, 2021, we repurchased 3.1 million shares at a cost of $364 million (based on trade dates, an average of $116.79 per share). There is no expiration date governing the period over which we can repurchase shares. At October 1, 2022, there was $348 million remaining authorization under our Board-approved $600 million share repurchase program.

As of October 1, 2022, we had $406 million of borrowings under our revolving credit facility. We also had $6 million in outstanding letters of credit. Net liquidity available under our credit facility was $413 million at October 1, 2022. 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). Our leverage ratio as defined in our credit agreement was 4.0x as of October 1, 2022. 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 is for general corporate purposes, to meet our seasonal working capital requirements and to repurchase our stock. As of October 1, 2022, the weighted-average interest rate on borrowings under the credit facility was 5.1% and we were in compliance with all financial covenants.

We amended the credit agreement on October 26, 2022. The amendment, among other things, (a) provides relief from the requirement that the net leverage ratio not exceed 3.75x for certain corporate actions including Permitted Capital Distributions for Performance or Taxes (as defined in the credit agreement) and certain acquisition activity; (b) increases the permissible net leverage ratio to 5.0x for the three consecutive quarterly reporting periods ending July 1, 2023; (c) increases the commitment fee rate to 50 basis points and the margin applicable to interest rates for all borrowings by an additional 50 basis points, in each case if the net leverage ratio is greater than or equal to 4.5x; and (d) replaces the option to borrow at an interest rate based on London Interbank Offered Rate (LIBOR) to one based on a Term SOFR Rate. The Term SOFR Rate equals the sum of (x) the Term SOFR Screen Rate (as defined in the credit agreement) for the applicable interest period (but in no event less than zero), plus (y) 0.10%, plus (z) the margin based on Sleep Number’s net leverage ratio. A fee for the amendment is payable to the lenders in an amount equal to 7.5 basis points multiplied by the sum of the Revolving Credit Commitment and the outstanding amount of Term Loans (as each is defined in the credit agreement).

We have an agreement with Synchrony Bank to offer qualified customers revolving credit arrangements to finance their purchases from us (Synchrony Agreement). The Synchrony Agreement contains financial covenants consistent with our credit facility as of October 1, 2022, including a maximum net leverage ratio and a minimum interest coverage ratio. As of October 1, 2022, we were in compliance with all financial covenants.

On July 15, 2022, we executed a fifth amendment to the Synchrony Agreement that extended the term from December 31, 2023 to December 31, 2028, subject to earlier termination upon certain events. 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
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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.

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
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Net income $ 5,033 $ 53,721 $ 53,181 $ 203,964
Income tax expense 2,003 17,198 15,247 44,294
Interest expense 5,606 1,816 13,196 5,214
Depreciation and amortization 17,180 14,820 64,217 59,539
Stock-based compensation 542 7,317 12,097 25,961
Asset impairments 95 23 338 154
Adjusted EBITDA $ 30,459 $ 94,895 $ 158,276 $ 339,126

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
October 1,
2022 		October 2,
2021 		October 1,
2022 		October 2,
2021
Net cash provided by operating activities $ 80,122 $ 292,684 $ 87,448 $ 285,063
Subtract: Purchases of property and equipment 52,808 49,370 70,338 58,396
Free cash flow $ 27,314 $ 243,314 $ 17,110 $ 226,667

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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
October 1,
2022 		October 2,
2021
Net operating profit after taxes (NOPAT)
Operating income $ 81,625 $ 253,472
Add: Rent expense (1)
108,457 98,839
Less: Depreciation on capitalized operating leases (2)
(27,784) (25,030)
Less: Income taxes (3)
(36,853) (78,975)
NOPAT $ 125,445 $ 248,306
Average invested capital
Total deficit $ (437,471) $ (440,066)
Add: Long-term debt (4)
406,750 359,666
Add: Capitalized operating lease obligations (5)
867,656 790,712
Total invested capital at end of period $ 836,935 $ 710,312
Average invested capital (6)
$ 791,970 $ 717,670
Return on invested capital (ROIC) (7)
15.8 % 34.6 %
___________________________
(1) Rent expense is added back to operating income to show the impact of owning versus leasing the related assets.
(2) Depreciation is based on the average of the last five fiscal quarters' ending capitalized operating lease obligations (see note 5) 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) Reflects annual effective income tax rates, before discrete adjustments, of 22.7% and 24.1% for October 1, 2022 and October 2, 2021, respectively.
(4) Long-term debt includes existing finance lease liabilities.
(5) 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) Average invested capital represents the average of the last five fiscal quarters' ending invested capital balances.
(7) 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.


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Off-Balance-Sheet Arrangements

As of October 1, 2022, we were not involved in any unconsolidated special purpose entity transactions. Other than our $6 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 since the end of fiscal 2021. 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 January 1, 2022 for additional information regarding our other contractual obligations.

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 January 1, 2022. There were no significant changes in our critical accounting policies since the end of fiscal 2021.

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 $3.1 million based on the $406 million of borrowings under our credit facility at October 1, 2022. 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 October 1, 2022, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
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PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

Our legal proceedings are discussed in Note 12, Commitments and Contingencies , Legal Proceedings , in the Notes to Condensed Consolidated Financial Statements in this Quarterly Report on Form 10-Q.

ITEM 1A. RISK FACTORS

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.

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

(a) – (b) Not applicable.
(c) Issuer Purchases of Equity Securities

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)
July 3, 2022 through July 30, 2022 350 $ 32.86 — $ 348,071,000
July 31, 2022 through August 27, 2022 400 $ 47.92 — $ 348,071,000
August 28, 2022 through October 1, 2022 11,403 $ 40.89 — $ 348,071,000
Total 12,153 $ 40.89 — $ 348,071,000
___________________________
(1) We did not purchase any shares under our Board-approved $600 million share repurchase program (effective April 4, 2021), during the three months ended October 1, 2022.
(2) In connection with the vesting of employee restricted stock grants, we repurchased 12,153 shares of our common stock at a cost of $497 thousand during the three months ended October 1, 2022.
(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.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not applicable.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

Not applicable.
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ITEM 6. EXHIBITS
Exhibit
Number 		Description
10.1*
31.1*
31.2*
32.1*
32.2*
101.INS* Inline 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* Inline XBRL Taxonomy Extension Schema Document
101.CAL* Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF* Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB* Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE* Inline XBRL Taxonomy Extension Presentation Linkbase Document
104* Cover Page Interactive Data File (formatted as inline XBRL and contained in Exhibit 101)
* Filed Herewith
(1) Portions of this exhibit have been redacted in compliance with Regulation S-K Item 601(b)(10).
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SLEEP NUMBER CORPORATION

SIGNATURES

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


SLEEP NUMBER CORPORATION
(Registrant)
Dated: November 8, 2022 By: /s/ Shelly R. Ibach
Shelly R. Ibach
Chief Executive Officer
(principal executive officer)
By: /s/ Joel J. Laing
Joel J. Laing
Chief Accounting Officer
(principal accounting officer)

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SLEEP NUMBER CORPORATION
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