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 ý☒ NO o

☐

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 ý☒ NO o

☐

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 ~~definition~~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	ý ☒	Accelerated filero	☐
Non-accelerated filer	o ☐	Smaller reporting companyo	☐
		Emerging growth companyo	☐

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.o

☐

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

☒

As of ~~September~~June 29, ~~2018, 33,216,000~~2019, 29,323,000 shares of the Registrant’s Common Stock were outstanding.

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

INDEX

		Page

		~~Page~~

PART I: FINANCIAL INFORMATION		1

Item 1.	Financial Statements (unaudited) ~~(unaudited)~~	1
	Condensed Consolidated Balance Sheets	2 1
	Condensed Consolidated Statements of ~~Operation~~Operationss	3 2
	Condensed Consolidated Statements of Shareholders' (Deficit) Equity	4 3
	Condensed Consolidated Statements of Cash Flows	5 4
	Notes to Condensed Consolidated Financial Statements	6 5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	13 12
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	22 21
Item 4.	Controls and Procedures	22 21

PART II: OTHER INFORMATION		23 22

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

PART I: FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

(unaudited - in thousands, except per share amounts)

	June 29, 2019			December 29, 2018
Assets
Current assets:
Cash and cash equivalents	$	1,684		$	1,612
Accounts receivable, net of allowance for doubtful accounts of $717 and $699, respectively		19,581			24,795
Inventories		87,859			84,882
Income taxes receivable		3,259			—
Prepaid expenses		14,314			8,009
Other current assets		31,939			31,559
Total current assets		158,636			150,857

Non-current assets:
Property and equipment, net		202,280			205,631
Operating lease right-of-use assets		316,958			—
Goodwill and intangible assets, net		74,317			75,407
Other non-current assets		43,722			38,243
Total assets	$	795,913		$	470,138

Liabilities and Shareholders’ Deficit
Current liabilities:
Borrowings under revolving credit facility	$	281,500		$	199,600
Accounts payable		117,343			144,781
Customer prepayments		30,473			27,066
Accrued sales returns		17,766			19,907
Compensation and benefits		29,960			27,700
Taxes and withholding		10,608			18,380
Operating lease liabilities		56,167			—
Other current liabilities		48,720			51,234
Total current liabilities		592,537			488,668

Non-current liabilities:
Deferred income taxes		5,543			4,822
Operating lease liabilities		290,880			—
Other non-current liabilities		64,255			86,198
Total liabilities		953,215			579,688

Shareholders’ deficit:
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding		—			—
Common stock, $0.01 par value; 142,500 shares authorized, 29,323 and 30,868 shares issued and outstanding, respectively		293			309
Additional paid-in capital		—			—
Accumulated deficit		(157,595	)		(109,859	)
Total shareholders’ deficit		(157,302	)		(109,550	)
Total liabilities and shareholders’ deficit	$	795,913		$	470,138

September 29,
2018
December 30,
2017
Assets

Current assets:

Cash and cash equivalents $ 1,241

$ 3,651
Accounts receivable, net of allowance for doubtful accounts of $579 and $714, respectively 24,128

19,312
Inventories 90,980

84,298
Income taxes receivable 1,229
—
Prepaid expenses 9,772

17,565
Other current assets 31,007

27,665
Total current assets 158,357

152,491

Non-current assets:

Property and equipment, net 199,452

208,646
Goodwill and intangible assets, net 75,952

77,588
Deferred income taxes —
2,625
Other non-current assets 36,307

30,484
Total assets $ 470,068

$ 471,834

Liabilities and Shareholders’ (Deficit) Equity

Current liabilities:

Borrowings under revolving credit facility $ 135,800
$ 24,500
Accounts payable 138,735

129,194
Customer prepayments 46,118

27,767
Accrued sales returns 20,535
19,270
Compensation and benefits 31,988

34,602
Taxes and withholding 15,951

24,234
Other current liabilities 49,858

46,822
Total current liabilities 438,985

306,389

Non-current liabilities:

Deferred income taxes 4,638
—
Other non-current liabilities 80,797

76,289
Total liabilities 524,420

382,678

Shareholders’ (deficit) equity:

Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding —

—
Common stock, $0.01 par value; 142,500 shares authorized, 33,216 and 38,813 shares issued and outstanding, respectively 332

388
Additional paid-in capital —

—
(Accumulated deficit) retained earnings (54,684 )
88,768
Total shareholders’ (deficit) equity (54,352 )
89,156
Total liabilities and shareholders’ (deficit) equity $ 470,068

$ 471,834

See accompanying notes to condensed consolidated financial statements.

~~Index~~

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Operations

(unaudited - in thousands, except per share amounts)

	Three Months Ended						Six Months Ended
	June 29, 2019			June 30, 2018			June 29, 2019		June 30, 2018
Net sales	$	355,963		$	316,338		$	782,408	$	704,971
Cost of sales		138,777			127,450			302,989		278,606
Gross profit		217,186			188,888			479,419		426,365

Operating expenses:
Sales and marketing		168,839			151,106			355,666		323,023
General and administrative		33,045			28,828			67,368		60,562
Research and development		8,057			6,868			16,433		13,793
Total operating expenses		209,941			186,802			439,467		397,378
Operating income		7,245			2,086			39,952		28,987
Interest expense, net		3,228			1,453			5,837		1,978
Income before income taxes		4,017			633			34,115		27,009
Income tax (benefit) expense		(263	)		(3,111	)		4,417		2,717
Net income	$	4,280		$	3,744		$	29,698	$	24,292

Basic net income per share:
Net income per share – basic	$	0.14		$	0.10		$	0.98	$	0.65
Weighted-average shares – basic		29,873			36,138			30,247		37,191

Diluted net income per share:
Net income per share – diluted	$	0.14		$	0.10		$	0.95	$	0.64
Weighted-average shares – diluted		30,531			36,844			31,134		38,096

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Net sales $ 414,779
$ 402,646
$ 1,119,750
$ 1,081,218
Cost of sales 164,262
149,181
442,868
404,675
Gross profit 250,517
253,465
676,882
676,543

Operating expenses:

Sales and marketing 188,458
174,800
511,481
488,564
General and administrative 29,385
32,645
89,947
95,233
Research and development 7,353
6,991
21,146
20,950
Total operating expenses 225,196
214,436
622,574
604,747
Operating income 25,321
39,029
54,308
71,796
Other expense, net 1,836
248
3,814
668
Income before income taxes 23,485
38,781
50,494
71,128
Income tax expense 5,228
13,178
7,945
21,842
Net income $ 18,257
$ 25,603
$ 42,549
$ 49,286

Basic net income per share:

Net income per share – basic $ 0.53
$ 0.63
$ 1.18
$ 1.18
Weighted-average shares – basic 34,231
40,755
36,204
41,740
Diluted net income per share:

Net income per share – diluted $ 0.52
$ 0.62
$ 1.15
$ 1.16
Weighted-average shares – diluted 35,039
41,515
37,077
42,559

See accompanying notes to condensed consolidated financial statements.

~~Index~~

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

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

(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	)

	Common Stock						Additional Paid-in			Retained Earnings (Accumulated
	Shares			Amount			Capital			Deficit)			Total
Balance at December 30, 2017		38,813		$	388		$	—		$	88,768		$	89,156
Net income		—			—			—			20,548			20,548
Exercise of common stock options		68			1			856			—			857
Stock-based compensation		211			2			3,082			—			3,084
Repurchases of common stock		(2,149	)		(22	)		(3,938	)		(73,688	)		(77,648	)
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	)

Common Stock
Additional
Paid-in
Capital

Retained
Earnings
(Accumulated
Deficit)
Total
Shares Amount
Balance at December 30, 2017 38,813
$ 388
$ —
$ 88,768
$ 89,156
Net income —
—
—
42,549
42,549
Exercise of common stock options 157
1
2,083
—
2,084
Stock-based compensation 261
3
10,095
—
10,098
Repurchases of common stock (6,015 ) (60 ) (12,178 ) (186,001 ) (198,239 )
Balance at September 29, 2018 33,216
$ 332
$ —
$ (54,684 ) $ (54,352 )

See accompanying notes to condensed consolidated financial statements.

~~Index~~

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

(unaudited - in thousands)

	Six Months Ended
	June 29, 2019			June 30, 2018
Cash flows from operating activities:
Net income	$	29,698		$	24,292
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		31,187			31,089
Stock-based compensation		7,888			6,742
Net (gain) loss on disposals and impairments of assets		(431	)		15
Deferred income taxes		721			7,212
Changes in operating assets and liabilities:
Accounts receivable		5,214			(2,753	)
Inventories		(2,977	)		(5,943	)
Income taxes		(9,195	)		(19,075	)
Prepaid expenses and other assets		(8,580	)		8,242
Accounts payable		12,408			(4,859	)
Customer prepayments		3,407			369
Accrued compensation and benefits		2,348			(9,944	)
Other taxes and withholding		(1,836	)		(2,608	)
Other accruals and liabilities		495			(3,648	)
Net cash provided by operating activities		70,347			29,131

Cash flows from investing activities:
Purchases of property and equipment		(33,896	)		(21,341	)
Proceeds from sales of property and equipment		2,571			70
Net cash used in investing activities		(31,325	)		(21,271	)

Cash flows from financing activities:
Repurchases of common stock		(99,684	)		(142,940	)
Net increase in short-term borrowings		56,758			133,253
Proceeds from issuance of common stock		4,995			1,596
Debt issuance costs		(1,019	)		(1,013	)
Net cash used in financing activities		(38,950	)		(9,104	)

Net increase (decrease) in cash and cash equivalents		72			(1,244	)
Cash and cash equivalents, at beginning of period		1,612			3,651
Cash and cash equivalents, at end of period	$	1,684		$	2,407

Nine Months Ended
September 29,
2018 September 30,
2017
Cash flows from operating activities:
Net income $ 42,549
$ 49,286
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization 46,655
46,000
Stock-based compensation 10,098
11,809
Net (gain) loss on disposals and impairments of assets (17 ) 229
Deferred income taxes 7,263
3,729
Changes in operating assets and liabilities:
Accounts receivable (4,816 ) (1,402 )
Inventories (6,682 ) (4,191 )
Income taxes (13,777 ) (147 )
Prepaid expenses and other assets 5,195
(1,713 )
Accounts payable 26,007
33,325
Customer prepayments 18,351
13,722
Accrued compensation and benefits (2,685 ) 15,277
Other taxes and withholding 4,265
758
Other accruals and liabilities 2,044
9,372
Net cash provided by operating activities 134,450
176,054

Cash flows from investing activities:
Purchases of property and equipment (34,012 ) (37,613 )
Proceeds from sales of property and equipment 174
36
Net cash used in investing activities (33,838 ) (37,577 )

Cash flows from financing activities:

Repurchases of common stock (198,239 ) (120,158 )
Net increase in short-term borrowings 94,147
(6,194 )
Proceeds from issuance of common stock 2,084
3,040
Debt issuance costs (1,014 ) (10 )
Net cash used in financing activities (103,022 ) (123,322 )

Net (decrease) increase in cash, cash equivalents and restricted cash (2,410 ) 15,155
Cash, cash equivalents and restricted cash, at beginning of period 3,651
14,759
Cash, cash equivalents and restricted cash, at end of period $ 1,241
$ 29,914

See accompanying notes to condensed consolidated financial statements.

~~Index~~

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~~six months ended ~~September~~June 29, ~~2018~~2019 of Sleep Number Corporation and 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~~June 29, ~~2018~~2019 and December ~~30, 2017~~,29, 2018, 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.

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 ~~30, 2017~~29, 2018 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. Changes in these estimates will be reflected in the consolidated financial statements in future periods. 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

~~Adoption of ASC Topic 230,~~ ~~Restricted Cash~~

Effective December ~~31, 2017,~~30, 2018 (beginning of fiscal 2019), we adopted ASC Topic ~~230,~~ ~~Restricted Cash~~842, Leases, which requires amounts generally described as restricted cash and restricted cash equivalents be included with cash and cash equivalents when reconciling the total beginning and ending amounts for the periods shown on the statement of cash flows. Amounts for prior periods have been retrospectively adjusted to conform to the current period presentation.

~~Adoption of ASC Topic 606,~~ ~~Revenue from Contracts with Customers~~

~~On December 31, 2017, we adopted ASC Topic 606,~~ ~~Revenue from Contracts with Customers,~~ using the modified retrospective method applied to those contracts which were not completed as of December 30, 2017. Results for reporting periods beginning after December 30, 2017 are presented under the new guidance, while prior period amounts are not restated.

The cumulative effect of the changes made to our consolidated balance sheet as of December 31, 2017 resulting from the adoption of the new revenue guidance was not material and did not impact opening retained earnings. The impact on the timing of net sales for the three and nine months ended September 29, 2018, as a result of applying the new guidance, was not material.

Practical expedients and exemptions permissible under ASC Topic 606 that we elected are as follows: we do not disclose the value of unsatisfied performance obligations for (i) contracts with an original expected length of one year or less; and (ii) contracts for which we recognize revenue at the amount to which we have the right to invoice for services performed.

~~See Note 2,~~ ~~Revenue Recognition,~~ ~~for further details regarding our revenue recognition policy.~~

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

~~Accounting Guidance Issued but Not Yet Adopted as of September 29, 2018~~

~~We are the lessee under various agreements for facilities, equipment and vehicles that are currently accounted for as operating leases. In February 2016, the FASB issued ASC Topic 842,~~ ~~Leases~~, that requires most leases to be recognized on the balance sheet and expands disclosure requirements. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.

~~This new guidance is effective for us beginning December 30, 2018 (fiscal 2019). The provisions of this new guidance require a~~ modified-retrospective ~~approach, with elective reliefs. The new guidance will apply to all leases existing at the date of initial application.~~approach. We have ~~the option to choose either (1)~~chosen the effective date ~~or (2) the beginning of the earliest comparative period presented in the financial statements~~ as the date of initial ~~application. We expect to adopt~~application and have applied the new ~~standard using the effective date option.~~

guidance to all existing leases.

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

•

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 ~~expect to recognize additional~~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 ~~corresponding~~$275 million in non-current operating lease liabilities). Deferred rent and lease incentive liabilities associated with historical operating leases totaling $28 million were reclassified to the operating lease ROU assets of approximately $300 million based on the present value of the remaining minimum rental payments for existing operating leases. This amount will vary based on the interest rates in effect upon adoption and any new leases we enter into or exit from prior to adoption.

as required by ASC Topic 842. The new guidance provides a number of optional practical expedients in transition. We expect to elect the package of practical expedients, which permits us to not reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. We do not expect to elect the use of hindsight. The new guidance also provides practical expedients for an entity’s ongoing accounting. We expect to elect the short-term lease recognition exemption for all leases that qualify, primarily small equipment leases. This means, for those leases that qualify, we will not recognize ROU assets or lease liabilities, and this includes not recognizing ROU assets or lease liabilities for existing short-term leases of those assets in transition. We also expect to elect the practical expedient option to not separate lease and non-lease components for all of our leases.

~~We will be providing significant new disclosures about our leasing activities and are in the process of implementing a new lease accounting system in connection with the adoption. We also expect that~~ adoption of the new guidance ~~will require changes to our internal controls over financial reporting. We continue to evaluate the effect of the new standard~~had no impact on ~~our consolidated financial statements and related disclosures.~~

~~2. Revenue Recognition~~

~~We recognize revenue when control of the promised goods~~accumulated deficit, net income or services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Revenue recognized excludes sales taxes. Amounts billed to customers for delivery and setup are included in net ~~sales. For most products, we receive payment before, or promptly after, the products or services are delivered to the customer.~~

~~Our beds sold with SleepIQ~~^® technology contain multiple performance obligations including the bed and SleepIQ hardware and software. We analyze our multiple performance obligation(s) to determine whether they are distinct and can be separated or whether they must be accounted for as a single performance obligation. We determined that the beds sold with the SleepIQ technology have two performance obligations consisting of: (i) the bed; and (ii) SleepIQ hardware and software. SleepIQ hardware and software are not separable as the hardware and related software are not sold separately and the software is integral to the hardware’s functionality. We determine the transaction price for multiple performance obligations based on their relative standalone selling prices. The performance obligation related to the bed is satisfied at a point in time. The performance obligation related to SleepIQ technology is satisfied over time based on the ongoing access and usagecash provided by the customer of software essential to the functionality of SleepIQ technology. The deferred revenue and costs related to SleepIQ technology are recognized on a straight-line basis over the product’s estimated life of four years because our inputs are generally expended evenly throughout the performance period.

operating activities. At ~~September 29, 2018 and~~ December 30, ~~2017, we had deferred contract~~2018, our finance ROU assets and lease liabilities of $73 million and $73 million, of which $32 million and $30 million are included in other current liabilities, respectively, and $41 million and $43 million are included in other non-current liabilities, respectively, in our consolidated balance sheets. We also had deferred contract assets of $48 million and $43 million, of which $20 million and $17 million are included in other current assets, respectively, and $28 million and $26 million are

were not significant.

See Note 6, Leases, for further information.

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

~~included in other non-current assets, respectively, in our consolidated balance sheets. During the three~~

2. Fair Value Measurements

At June 29, 2019 and ~~nine months ended September~~December 29, 2018, we ~~recognized revenue of $8~~had $7 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% and 98% of our revenues for the three and nine months ended September 29, 2018, respectively.

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

Three Months Ended Nine Months Ended
September 29,
2018 September 29,
2018
Retail $ 383,886
$ 1,026,808
Online and phone 28,686
81,580
Company-Controlled channel 412,572
1,108,388
Wholesale/Other channel 2,207
11,362
Total $ 414,779
$ 1,119,750

~~Obligation for Sales Returns~~

We accept sales returns during a 100-night trial period. Accrued sales returns represents a refund liability for the amount of consideration that we do not expect to be entitled to because it will be refunded to customers. The refund liability estimate is based on historical return rates and is adjusted for any current trends as appropriate. Each reporting period we remeasure the liability to reflect changes in the estimate, with a corresponding adjustment to net sales. The activity in the sales returns liability account was as follows (in thousands):

Nine Months Ended
September 29,
2018 September 30,
2017
Balance at beginning of year $ 19,270
$ 15,222
Additions that reduce net sales 57,296
55,720
Deductions from reserves (56,031 ) (52,494 )
Balance at end of period $ 20,535
$ 18,448

~~3. Fair Value Measurements~~

~~At September 29, 2018 and December 30, 2017, we had~~ $6 ~~million and $4~~ 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 $7 million and $6 million at June 29, 2019 and ~~$4 million at September~~December 29, 2018, ~~and December 30, 2017,~~ 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):

	June 29, 2019		December 29, 2018		��
Raw materials	$	6,534	$	4,549
Work in progress		199		3
Finished goods		81,126		80,330
	$	87,859	$	84,882

September 29,
2018 December 30,
2017
Raw materials $ 4,862
$ 6,577
Work in progress 136
170
Finished goods 85,982
77,551
$ 90,980
$ 84,298

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

4. Goodwill and Intangible Assets, Net

Goodwill and Indefinite-Lived Intangible Assets

Goodwill was $64 million at ~~September~~June 29, ~~2018~~2019 and December ~~30, 2017.~~29, 2018. Indefinite-lived trade name/trademarks totaled $1.4 million at ~~September~~June 29, ~~2018~~2019 and December ~~30, 2017.~~

29, 2018.

Definite-Lived Intangible Assets

The ~~following table provides the~~ gross carrying amount ~~and related accumulated amortization~~ of our ~~definite-lived intangible assets (in thousands):~~

September 29, 2018 December 30, 2017

Gross Carrying
Amount

Accumulated
Amortization

Gross Carrying
Amount

Accumulated
Amortization
Developed technologies $ 18,851
$ 8,341
$ 18,851
$ 6,705
Trade names/trademarks 101
101
101
101
$ 18,952
$ 8,442
$ 18,952
$ 6,806

developed technologies was $19 million at June 29, 2019 and December 29, 2018. Accumulated amortization was $10 million and $9 million at June 29, 2019 and December 29, 2018, respectively.

Amortization expense for the three months ended ~~September~~June 29, ~~2018~~2019 and ~~September~~June 30, ~~2017,~~2018, was $0.5 ~~million and $0.5 million, respectively.~~million. Amortization expense for the ~~nine~~six months ended ~~September~~June 29, 2019 and June 30, 2018, ~~and September 30, 2017,~~ was ~~$1.6 million and $2.7 million, respectively.~~

6.$1.1 million.

5. Credit Agreement

Our ~~$300~~$450 million credit facility is for general corporate purposes, ~~and is also utilized~~ to meet our seasonal working capital ~~requirements.~~requirements and to repurchase our stock. 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.~~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 ~~$300~~$450 million to ~~$450~~$600 million, subject to lenders' approval. The credit agreement matures in February ~~2023.~~2024. We were in compliance with all financial covenants as of ~~September~~June 29, ~~2018.~~

2019.

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

	June 29, 2019			December 29, 2018
Outstanding borrowings	$	281,500		$	199,600
Outstanding letters of credit	$	3,497		$	3,497
Additional borrowing capacity	$	165,003		$	96,903
Weighted-average interest rate		4.2	%		4.2	%

September 29,
2018 December 30,
2017
Outstanding borrowings $ 135,800
$ 24,500
Outstanding letters of credit $ 3,450
$ 3,150
Additional borrowing capacity $ 160,750
$ 125,500
Weighted-average interest rate 4.0 % 3.1 %

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

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 is reasonably estimable. 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 a 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 June 29, 2019, our finance ROU assets and lease liabilities were not significant.

Operating lease costs were as follows (in thousands):

	Three Months Ended		Six Months Ended
	June 29, 2019		June 29, 2019
Operating lease costs⁽¹⁾	$	21,079	$	42,136
Variable lease costs	$	423	$	921

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

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

(unaudited)

The maturities of operating lease liabilities as of June 29, 2019, were as follows (in thousands):

2019 (excluding the six months ended June 29, 2019)	$	40,752
2020		76,056
2021		68,532
2022		60,889
2023		52,339
2024		41,107
Thereafter		104,731
Total lease payments⁽¹⁾		444,406
Less: Interest		97,359
Present value of operating lease liabilities⁽²⁾	$	347,047

⁽¹⁾	Total lease payments exclude $55 million of legally binding minimum lease payments for leases signed but not yet commenced.

~~(unaudited)~~

⁽²⁾	Includes the current portion of $56 million for operating lease liabilities.

The aggregate future commitments under operating leases as of December 30, 2018, were expected to be as follows (in thousands):

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

⁽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:

June 29,

2019

Weighted-average remaining lease term (years)

6.8

Weighted-average discount rate

7.4%

	Six Months Ended
(in thousands)	June 29, 2019
Cash paid for amounts included in present value of operating lease liabilities	$	39,941
Right-of-use assets obtained in exchange for operating lease liabilities⁽¹⁾	$	36,543

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

7. ~~Repurchase~~Repurchases of Common Stock

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

	Three Months Ended				Six Months Ended
	June 29, 2019		June 30, 2018		June 29, 2019		June 30, 2018
Amount repurchased under Board-approved share repurchase program	$	40,000	$	65,000	$	80,900	$	140,000
Amount repurchased in connection with the vesting of employee restricted stock grants		3,351		292		9,433		2,940
Total amount repurchased	$	43,351	$	65,292	$	90,333	$	142,940

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Amount repurchased under Board-approved share repurchase program $ 55,000
$ 40,000
$ 195,000
$ 115,000
Amount repurchased in connection with the vesting of employee restricted stock grants 299
64
3,239
5,158
Total amount repurchased $ 55,299
$ 40,064
$ 198,239
$ 120,158

As of ~~September~~June 29, ~~2018,~~2019, the remaining authorization under our Board-approved share repurchase program was ~~$270~~$105 million. ~~There is no expiration date governing~~

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 consolidated balance sheets as follows (in thousands):

	June 29, 2019		December 29, 2018
Deferred Contract Assets included in:
Other current assets	$	21,726	$	20,553
Other non-current assets		30,930		29,456
	$	52,656	$	50,009

	June 29, 2019		December 29, 2018
Deferred Contract Liabilities included in:
Other current liabilities	$	33,053	$	32,395
Other non-current liabilities		42,340		42,194
	$	75,393	$	74,589

During both the ~~period over which~~three months ended June 29, 2019 and June 30, 2018, we ~~can repurchase shares. Any repurchased shares are constructively retired~~recognized revenue of $8 million that was included in the deferred contract liability balance at the beginning of the respective periods. During the six months ended June 29, 2019 and ~~returned~~June 30, 2018, we recognized revenue of $17 million and $16 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 ~~an unissued status.~~customers at a point in time accounted for approximately 98% and 97% of our revenues for the three months ended June 29, 2019 and June 30, 2018, respectively. Revenue from goods and services transferred to customers at a point in time accounted for approximately 98% of our revenues for both the six months ended June 29, 2019 and June 30, 2018.

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

	Three Months Ended				Six Months Ended
	June 29, 2019		June 30, 2018		June 29, 2019		June 30, 2018
Retail	$	327,999	$	286,853	$	720,225	$	642,922
Online and phone		25,412		24,927		55,175		52,894
Company-Controlled channel		353,411		311,780		775,400		695,816
Wholesale/Other channel		2,552		4,558		7,008		9,155
Total	$	355,963	$	316,338	$	782,408	$	704,971

Obligation for Sales Returns

The ~~cost of stock repurchases is first charged~~activity in the sales returns liability account was as follows (in thousands):

	Six Months Ended
	June 29, 2019			June 30, 2018
Balance at beginning of year	$	19,907		$	19,270
Additions that reduce net sales		37,543			36,555
Deductions from reserves		(39,684	)		(39,298	)
Balance at end of period	$	17,766		$	16,527

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to ~~additional paid-in capital. Once additional paid-in capital is reduced to zero, any additional amounts are charged to (accumulated deficit) retained earnings.~~

8.Condensed Consolidated Financial Statements

(unaudited)

9. Stock-Based Compensation Expense

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

	Three Months Ended				Six Months Ended
	June 29, 2019		June 30, 2018		June 29, 2019		June 30, 2018
Stock awards	$	3,696	$	2,996	$	6,729	$	5,488
Stock options		554		662		1,159		1,254
Total stock-based compensation expense		4,250		3,658		7,888		6,742
Income tax benefit		1,066		896		1,964		1,652
Total stock-based compensation expense, net of tax	$	3,184	$	2,762	$	5,924	$	5,090

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Stock awards $ 2,759
$ 3,339
$ 8,247
$ 10,059
Stock options 597
594
1,851
1,750
Total stock-based compensation expense 3,356
3,933
10,098
11,809
Income tax benefit 802
1,314
2,454
3,968
Total stock-based compensation expense, net of tax $ 2,554
$ 2,619
$ 7,644
$ 7,841

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~~ June 29, ~~2018~~2019 and ~~September~~June 30, ~~2017~~,2018, our contributions, net of forfeitures, were ~~$1.5~~$1.5 million and ~~$1.4~~$1.3 million,, respectively. During the ~~nine~~six months ended ~~September~~June 29, ~~2018~~2019 and ~~September~~June 30, ~~2017,~~2018, our contributions, net of forfeitures, were ~~$4.2~~$3.0 million and ~~$3.9~~$2.7 million, respectively.

~~10. Other Expense, Net~~

~~Other expense, net, consisted of the following (in thousands):~~

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Interest expense $ 1,836
$ 278
$ 3,817
$ 748
Interest income —
(30 ) (3 ) (80 )
Other expense, net $ 1,836
$ 248
$ 3,814
$ 668

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

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				Six Months Ended
	June 29, 2019		June 30, 2018		June 29, 2019		June 30, 2018
Net income	$	4,280	$	3,744	$	29,698	$	24,292
Reconciliation of weighted-average shares outstanding:
Basic weighted-average shares outstanding		29,873		36,138		30,247		37,191
Dilutive effect of stock-based awards		658		706		887		905
Diluted weighted-average shares outstanding		30,531		36,844		31,134		38,096
Net income per share – basic	$	0.14	$	0.10	$	0.98	$	0.65
Net income per share – diluted	$	0.14	$	0.10	$	0.95	$	0.64

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Net income $ 18,257
$ 25,603
$ 42,549
$ 49,286

Reconciliation of weighted-average shares outstanding:

Basic weighted-average shares outstanding 34,231
40,755
36,204
41,740
Dilutive effect of stock-based awards 808
760
873
819
Diluted weighted-average shares outstanding 35,039
41,515
37,077
42,559

Net income per share – basic $ 0.53
$ 0.63
$ 1.18
$ 1.18
Net income per share – diluted $ 0.52
$ 0.62
$ 1.15
$ 1.16

For the three and ~~nine~~six months ended ~~September~~June 29, ~~2018~~2019 and ~~September~~June 30, ~~2017,~~2018, anti-dilutive stock-based awards excluded from the diluted net income per share calculations were immaterial.

~~12. Income Taxes~~

As a result of the enactment of the Tax Cuts and Jobs Act (TCJA), we recorded a provisional tax benefit of $1.7 million in the fourth quarter of 2017 based on our initial analysis of the TCJA using the best information and estimates available. During the second quarter 2018, we updated our provisional tax benefit based on new information, including a tax planning analysis, and recorded an additional $2.9 million provisional tax benefit.

~~Due~~

SLEEP NUMBER CORPORATION

AND SUBSIDIARIES

Notes to the significant complexity of the TCJA, anticipated further guidance from the U.S. Treasury, the potential for additional guidance from the SEC/ FASB, or other new information becoming available, our provisional tax benefit may be further adjusted during 2018. Our provisional estimate is expected to be finalized no later than the fourth quarter of 2018. Further guidance and additional information regarding the TCJA may also impact our 2018 effective income tax rate, exclusive of any adjustment to the provisional tax benefit.

~~13.~~Condensed Consolidated Financial Statements

(unaudited)

12. Commitments and Contingencies

Warranty Liabilities

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

	Six Months Ended
	June 29, 2019			June 30, 2018
Balance at beginning of year	$	10,389		$	9,320
Additions charged to costs and expenses for current-year sales		5,003			6,106
Deductions from reserves		(5,591	)		(5,790	)
Changes in liability for pre-existing warranties during the current year, including expirations		1,418			132
Balance at end of period	$	11,219		$	9,768

Nine Months Ended
September 29,
2018 September 30,
2017
Balance at beginning of year $ 9,320
$ 8,633
Additions charged to costs and expenses for current-year sales 9,275
8,627
Deductions from reserves (8,461 ) (6,625 )
Changes in liability for pre-existing warranties during the current year, including expirations 177
(708 )
Balance at end of period $ 10,311
$ 9,927

~~SLEEP NUMBER CORPORATION~~

~~AND SUBSIDIARIES~~

~~Notes to Condensed Consolidated Financial Statements~~

~~(unaudited)~~

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, ~~in the United States,~~ 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 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 ~~additional~~ losses either because we believe that we have valid defenses to claims asserted against us or the proceeding has not advanced to a stage of discovery that would enable us to establish an estimate. We currently do not expect the outcome of ~~these matters~~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 January 12, 2015, Plaintiffs David and Katina Spade commenced a purported class action lawsuit in New Jersey state court against Sleep Number alleging that Sleep Number violated New Jersey consumer statutes by failing to provide to purchasing consumers certain disclosures required by the New Jersey Furniture Regulations. It is undisputed that plaintiffs suffered no actual damages or in any way relied upon or were impacted by the alleged omissions. Nonetheless, on behalf of a purported class of New Jersey purchasers of Sleep Number beds and bases, plaintiffs seek to recover a $100 statutory fine for each alleged omission, along with attorneys’ fees and costs. Sleep Number removed the case to the United States District Court for the District of New Jersey, which subsequently granted Sleep Number’s motion to dismiss. Plaintiffs appealed to the United States Court of Appeals for the Third Circuit, which certified two questions of law to the New Jersey Supreme Court relating to whether plaintiffs who have suffered no actual injury may bring claims. The New Jersey Supreme Court accepted the certified questions and on April 16, 2018, ruled in our favor on one of the two questions, holding that a consumer only has standing to bring a claim under the relevant statute if the consumer has been harmed by the defendant's conduct. The Third Circuit has remanded the case to the federal district court, which, in turn, allowed plaintiffs to amend their complaint. We believe, however, that plaintiffs’ amended complaint does not cure the statutory claim as instructed by the Third Circuit, but instead asserts fraud-based claims that were previously dismissed and which lack merit. We will file a motion to dismiss the amended complaint.

On September 18, 2018, two former Home Delivery ~~Technician, Donald Cassels, and former Field Services Delivery Assistant, Jose Cadenas,~~employees filed suit, now venued in Superior Court in ~~San Francisco~~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 ~~plaintiffs purport to represent all former and current Sleep Number employees in the State of California aggrieved by the alleged practices. The~~ Complaint seeks damages in the form of civil penalties and ~~plaintiff’s~~plaintiffs’ attorneys’ fees, and expressly disclaims the recovery of any purported individual specific relief or underpaid wages. On October 8, 2018, after Sleep Number raised issues with the plaintiff’s choice of venue, the parties filed a joint stipulation to transfer venue from the Superior Court in San Francisco County to Superior Court in Fresno County. Sleep Number believes plaintiff’s purported claims are without merit and intendsWe intend to vigorously defend this matter.

On March 27, 2018, Level Sleep, LLC 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”), 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 in February 2020 and is in the pre-trial discovery process. We intend to vigorously defend this matter.

Index

~~Index~~



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

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 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

~~Company Overview~~

~~Results of Operations~~

~~Liquidity and Capital Resources~~

~~Non-GAAP Data~~

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

~~Critical Accounting Policies~~

~~Risk Factors~~

The ~~following~~ discussion ~~and analysis should be read~~ in ~~conjunction with the Condensed Consolidated Financial Statements and the Notes thereto included herein. This quarterly report on Form 10-Q~~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;

~~The effectiveness of our marketing messages;~~

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

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

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

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

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

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

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

~~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;~~

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

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

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

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

•	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;

~~Shortages in supply due to “just-in-time” manufacturing processes with minimal levels of inventory utilized for some of our products, or due to global shortages of electronic componentry;~~

•	Rising commodity costs and other inflationary pressures;

~~Our dependence on significant suppliers and our ability to maintain relationships with key suppliers, including several sole-source suppliers;~~

•	Risks inherent in global sourcing activities, including tariffs and the potential for shortages in supply;

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

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

~~Risks inherent in global sourcing activities, including tariffs and the potential for shortages in supply;~~

•	Increasing government regulation;

~~Risks of disruption in the operation of either of our two main manufacturing facilities;~~

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

~~Increasing government regulation and the costs of compliance and risks of non-compliance with existing and new regulations;~~

•	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;

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

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

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

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

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

The vulnerability of our management 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 employees, including qualified retail sales professionals and managers.~~

Additional information concerning these, and other risks and uncertainties is contained under the caption “Risk Factors” 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~~Quarterly Report on Form 10-Q.

Index

Company Overview

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

~~Our mission~~

Sleep Number is ~~to improve lives by individualizing sleep experiences. Our vision is to become one of the world's most beloved brands~~

by delivering an unparalleled sleep experience. We plan to achieve this by executing our Consumer Innovation Strategy, which includes three significant competitive advantages: proprietary sleep innovations, lifelong customer relationships and exclusive retail distribution.

~~We have a direct-to-consumer, vertically integrated business model and are~~ the exclusive designer, manufacturer, marketer, retailer and servicer of Sleep Number ~~360~~^® ~~smart beds. As a leading~~ beds and the leader in sleep ~~technology company, we~~innovation. We offer ~~consumers proven quality sleep through~~our customers high-quality, individualized sleep solutions and services, including a complete line of Sleep Number ~~360 smart~~ beds, bases and bedding accessories. We are also the pioneer and leader in biometric sleep ~~tracking~~innovation and ~~automatic adjustability.~~tracking. Our proprietary SleepIQ^® technology, ~~is a~~the operating system of the 360^® smart bed, works with our proprietary ~~sensor technology that tracks~~algorithms and artificial intelligence to track user’s sleep patterns and biometric changes. SleepIQ allows each ~~individual’s sleep and uses algorithms~~bed to use the sleeper’s own data to automatically and effortlessly adjust the ~~comfort level of each sleeper by working directly with~~bed’s firmness, delivering proven quality sleep.

Our relentless focus on developing benefit-driven innovation for our bed’s DualAir™ system. Through daily digital interactions that build lifelong relationships, SleepIQ technology also communicates how you slept and provides insights on what adjustments you can make to optimize your sleep and improve your daily life. Sleep Number also offers FlexFit™ adjustable bases, and Sleep Number^® ~~pillows, sheets and other bedding products. As a national specialty mattress retailer, we provide~~ customers ~~a cohesive experience across our Sleep Number~~^® ~~stores, online at SleepNumber.com or via phone at (800)753-3768.~~

~~We are committed to delivering~~is resulting in superior shareholder value, ~~through three primary drivers of earnings per share growth: increasing~~

as we: (i) increase consumer ~~demand, leveraging~~demand; (ii) leverage our business ~~model~~model; and ~~deploying~~(iii) deploy capital efficiently. ~~As the sleep innovation leader, we drive~~

~~growth through effective brand marketing, our proprietary innovations and a differentiated retail experience.~~

We generate revenue by marketing our innovations to new and existing customers, and selling products directly to consumers through Stores, Online, Chat and Phone, which we reference as our Company-Controlled channel. We also have a small Wholesale business in the United States.

We are the only vertically integrated, direct-to-consumer national bed manufacturer/retailer in the U.S. We have two manufacturing plants that distribute Sleep Number products. We provide premium in-home installation and setup, and maintain an in-house customer service department. This integration enables operational synergies and efficiencies, and a strong working capital position. Vertical integration allows us to build a long-term loyal customer relationship as we service the consumer through the full purchase and ownership cycle. This relationship with our customer creates a productive cycle of referral and repeat business.

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, the 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, the timing of new product introductions and related expenses, the timing of promotional offerings, competitive factors, changes in commodity costs, any disruptions in supplies or third-party service providers, seasonality of retail and bedding industry sales, consumer confidence and general economic conditions. 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 ended ~~September~~June 29, ~~2018~~2019 were as follows:

•
•	Net sales for the three months ended ~~September~~June 29, ~~2018~~2019 increased 3%13% to ~~$415~~$356 million, compared with ~~$403~~$316 million for the same period one year ago. ~~Net~~The 13% net sales increase resulted from an 8% comparable sales increase in our Company-Controlled channel and a 5 percentage point (ppt.) increase in sales from 29 net new stores opened in the past 12 months.

•	Our revolutionary Sleep Number 360^® smart beds have driven double-digit demand growth for four consecutive quarters (transition completed in July 2018), including the 13% net sales increase in the second quarter of 2019.

•	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 June 29, 2019, totaled $2.8 million, 6% higher than the same period one year ago.

•

Operating income for the three months ended ~~September~~June 29, ~~2018~~2019 was $7 million, an increase of $5 million from the prior-year period. Our operating income rate increased to 2.0% of net sales, compared with 0.7% of net sales for the same period last year. The current-period's operating income and operating income rate were ~~negatively affected by~~positively impacted by: (i) the elimination of prior year’s transition costs and temporary inefficiencies associated with operating two supply chains to support the product line transition; (ii) current-period efficiency gains and pricing; and (iii) expense leverage resulting from the 13% net sales increase. These favorable items were partially offset by: (i) absorption of increased tariff costs and delivery cost inflation; (ii) an ~~approximately $24 million shift~~increase in ~~sales from our third quarter~~media and promotional expenses that drove additional customer traffic to our ~~fourth quarter as a result of~~sales channels, including stores, online and phone; (iii) higher incentive-based compensation resulting from the strong ~~consumer demand later in the quarter after~~year-to-date financial performance; and (iv) higher research and development spending to support our ~~completed transition to all Sleep Number 360~~^® ~~smart beds; our new marketing campaign called "This is Not a Bed™", and our differentiated direct-to-consumer retail experience.~~ innovation pipeline.

•

Net ~~sales~~income for the three months ended ~~September 30, 2017~~June 29, 2019 increased 14% to $4.3 million, compared with $3.7 million for the same period one year ago. Earnings per diluted share were ~~affected by: (i) an approximately $25~~$0.14, up 40% compared with $0.10 last year. The prior-year period included a one-time tax planning benefit of $2.9 million, ~~shift in sales from our second quarter to our third quarter as~~or $0.08 per diluted share, associate with the Tax Cuts and Jobs Act. The current-year period included stock-based compensation excess tax benefits and a ~~result~~favorable resolution of a ~~delay in deliveries~~tax matter totaling $0.04 per diluted share.

~~Index~~

•	Cash provided by operating activities for the six months ended June 29, 2019 increased by $41 million to $70 million, compared with $29 million for the same period one year ago.

and shipments related to an inventory shortage from a new supplier, and (ii) temporary disruptions from hurricanes during our Labor Day sales event that reduced third-quarter net sales by an estimated $12 to $15 million.

•	At June 29, 2019, we ended the quarter with $282 million of borrowings under our $450 million revolving credit facility.

The 3% sales increase resulted from 3 percentage points (ppt.) of growth from sales generated by 16 net new stores opened in the past 12 months. Company-Controlled comparable sales for the three months ended September 29, 2018 were consistent with the prior-year period.

•

During the three months ended June 29, 2019, we repurchased 1.0 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 $38.69 per share). As of June 29, 2019, the remaining authorization under our Board-approved share repurchase program was $105 million.

Sales per store (Company-Controlled channel sales for stores open at least one year) on a trailing twelve-month basis for the period ended September 29, 2018 totaled $2.6 million, 3% higher than the same period one-year ago.

Operating income for the three months ended September 29, 2018 was $25 million, a $14 million decrease from $39 million for the prior-year period. Our operating income rate decreased to 6.1% of net sales, compared with 9.7% of net sales for the same period last year. The current-period's operating income and operating income rate were impacted by the sales shifts discussed above and a lower gross profit rate, partially mitigated by operating expense controls.

~~Net income for the three months ended September 29, 2018 was $18 million, or $0.52 per diluted share, compared with $26 million, or $0.62 per diluted share, for the same period last year.~~

Cash provided by operating activities totaled $134 million for the nine months ended September 29, 2018, compared with $176 million for the comparable period one year ago. Significant drivers of the year-over-year change in operating cash flows included the timing of performance-based incentive compensation payments and expenses, fluctuations in income taxes due to changes associated with the Tax Cuts and Jobs Act, and the year-over-year decline in net income. Investing activities for the current-year period included $34 million of property and equipment purchases, compared with $38 million for the same period last year.

~~At September 29, 2018, cash and cash equivalents totaled $1 million and we ended the quarter with $136 million of borrowings under our $300 million revolving credit facility.~~

In the third quarter of 2018, we repurchased 1.7 million shares of our common stock under our Board-approved share repurchase program at a cost of $55 million (an average of $32.22 per share). As of September 29, 2018, the remaining authorization under our Board-approved share repurchase program was $270 million.

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										Six Months Ended
	June 29, 2019					June 30, 2018					June 29, 2019				June 30, 2018
Net sales	$	356.0		100.0	%	$	316.3		100.0	%	$	782.4	100.0	%	$	705.0	100.0	%
Cost of sales		138.8		39.0	%		127.5		40.3	%		303.0	38.7	%		278.6	39.5	%
Gross profit		217.2		61.0	%		188.9		59.7	%		479.4	61.3	%		426.4	60.5	%
Operating expenses:
Sales and marketing		168.8		47.4	%		151.1		47.8	%		355.7	45.5	%		323.0	45.8	%
General and administrative		33.0		9.3	%		28.8		9.1	%		67.4	8.6	%		60.6	8.6	%
Research and development		8.1		2.3	%		6.9		2.2	%		16.4	2.1	%		13.8	2.0	%
Total operating expenses		209.9		59.0	%		186.8		59.1	%		439.5	56.2	%		397.4	56.4	%
Operating income		7.2		2.0	%		2.1		0.7	%		40.0	5.1	%		29.0	4.1	%
Interest expense, net		3.2		0.9	%		1.5		0.5	%		5.8	0.7	%		2.0	0.3	%
Income before income taxes		4.0		1.1	%		0.6		0.2	%		34.1	4.4	%		27.0	3.8	%
Income tax (benefit) expense		(0.3	)	(0.1	)%		(3.1	)	(1.0	)%		4.4	0.6	%		2.7	0.4	%
Net income	$	4.3		1.2	%	$	3.7		1.2	%	$	29.7	3.8	%	$	24.3	3.4	%
Net income per share:
Basic	$	0.14				$	0.10				$	0.98			$	0.65
Diluted	$	0.14				$	0.10				$	0.95			$	0.64
Weighted-average number of common shares:
Basic		29.9					36.1					30.2				37.2
Diluted		30.5					36.8					31.1				38.1

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Net sales $ 414.8
100.0 % $ 402.6
100.0 % $ 1,119.8
100.0 % $ 1,081.2
100.0 %
Cost of sales 164.3
39.6 % 149.2
37.1 % 442.9
39.6 % 404.7
37.4 %
Gross profit 250.5
60.4 % 253.5
62.9 % 676.9
60.4 % 676.5
62.6 %

Operating expenses:
Sales and marketing 188.5
45.4 % 174.8
43.4 % 511.5
45.7 % 488.6
45.2 %
General and administrative 29.4
7.1 % 32.6
8.1 % 89.9
8.0 % 95.2
8.8 %
Research and development 7.4
1.8 % 7.0
1.7 % 21.1
1.9 % 21.0
1.9 %
Total operating expenses 225.2
54.3 % 214.4
53.3 % 622.6
55.6 % 604.7
55.9 %
Operating income 25.3
6.1 % 39.0
9.7 % 54.3
4.9 % 71.8
6.6 %
Other expense, net 1.8
0.4 % 0.2
0.1 % 3.8
0.3 % 0.7
0.1 %
Income before income taxes 23.5
5.7 % 38.8
9.6 % 50.5
4.5 % 71.1
6.6 %
Income tax expense 5.2
1.3 % 13.2
3.3 % 7.9
0.7 % 21.8
2.0 %
Net income $ 18.3
4.4 % $ 25.6
6.4 % $ 42.5
3.8 % $ 49.3
4.6 %

Net income per share:

Basic $ 0.53

$ 0.63
$ 1.18
$ 1.18

Diluted $ 0.52

$ 0.62
$ 1.15
$ 1.16

Weighted-average number of common shares:

Basic 34.2

40.8
36.2
41.7

Diluted 35.0

41.5
37.1
42.6

~~Index~~

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

	Three Months Ended						Six Months Ended
	June 29, 2019			June 30, 2018			June 29, 2019			June 30, 2018
Company-Controlled channel		99.3	%		98.6	%		99.1	%		98.7	%
Wholesale/Other channel		0.7	%		1.4	%		0.9	%		1.3	%
Total		100.0	%		100.0	%		100.0	%		100.0	%

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Company-Controlled channel 99.5 % 99.3 % 99.0 % 98.5 %
Wholesale/Other channel 0.5 % 0.7 % 1.0 % 1.5 %
Total 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						Six Months Ended
	June 29, 2019			June 30, 2018			June 29, 2019			June 30, 2018
Sales change rates:
Retail comparable-store sales ⁽¹⁾		9	%		8	%		7	%		1	%
Online and phone		2	%		19	%		4	%		12	%
Company-Controlled comparable sales change ⁽¹⁾		8	%		9	%		7	%		2	%
Net opened/closed stores		5	%		3	%		4	%		3	%
Total Company-Controlled channel		13	%		12	%		11	%		5	%
Wholesale/Other channel		(44	%)		(29	%)		(23	%)		(33	%)
Total net sales change		13	%		11	%		11	%		4	%

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Sales change rates:

Retail comparable-store sales⁽¹⁾
(1 %) 5 % 0 % 1 %
Online and phone 10 % 9 % 11 % 17 %
Company-Controlled comparable sales change 0 % 5 % 1 % 2 %
Net opened/closed stores 3 % 6 % 3 % 8 %
Total Company-Controlled channel 3 % 11 % 4 % 10 %
Wholesale/Other channel (21 %) (65 %) (31 %) (38 %)
Total net sales change 3 % 9 % 4 % 8 %

⁽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⁾ 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.

Index

Other sales metrics were as follows:

	Three Months Ended						Six Months Ended
	June 29, 2019			June 30, 2018			June 29, 2019		June 30, 2018
Average sales per store ⁽¹⁾ ($ in thousands)	$	2,800		$	2,645
Average sales per square foot ⁽¹⁾	$	1,015		$	985
Stores > $2 million in net sales ⁽²⁾		69	%		63	%
Stores > $3 million in net sales ⁽²⁾		28	%		23	%
Average revenue per mattress unit – Company-Controlled channel ⁽³⁾	$	4,945		$	4,508		$	4,868	$	4,459

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Average sales per store⁽¹⁾($ in thousands)
$ 2,635
$ 2,567

Average sales per square foot⁽¹⁾
$ 977
$ 985

Stores > $1 million in net sales⁽²⁾
98 % 98 %
Stores > $2 million in net sales⁽²⁾
62 % 59 %
Average revenue per mattress unit –
Company-Controlled channel⁽³⁾
$ 4,387
$ 4,385
$ 4,432
$ 4,239

⁽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).

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

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

⁽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						Six Months Ended
	June 29, 2019			June 30, 2018			June 29, 2019			June 30, 2018
Beginning of period		585			558			579			556
Opened		17			11			32			24
Closed		(8	)		(4	)		(17	)		(15	)
End of period		594			565			594			565

Three Months Ended Nine Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Beginning of period 565
549
556
540
Opened 9
6
33
30
Closed (5 ) (2 ) (20 ) (17 )
End of period 569
553
569
553

~~Index~~

Comparison of Three Months Ended ~~September~~June 29, ~~2018~~2019 with Three Months Ended ~~September~~June 30, ~~2017~~

2018

Net sales

Net sales ~~increased 3% to $415 million~~ for the three months ended ~~September~~June 29, ~~2018,~~2019 increased by $40 million, or 13%, to $356 million, compared with ~~$403~~$316 million for the same period one year ago. Net sales for the three months ended September 29, 2018 were negatively affected by an approximately $24 million shift in sales from our third quarter to our fourth quarter as a result of strong consumer demand later in the quarter after our completed transition to all Sleep Number 360^® smart beds; our new marketing campaign called "This is Not a Bed™", and our differentiated direct-to-consumer retail experience. Net sales for the three months ended September 30, 2017 were affected by: (i) an approximately $25 million shift in sales from our second quarter to our third quarter as a result of a delay in deliveries and shipments related to an inventory shortage from a new supplier, and (ii) temporary disruptions from hurricanes during our Labor Day sales event that reduced third-quarterThe 13% net ~~sales by an estimated $12 to $15 million.~~

~~The 3%~~ sales increase resulted from 3an 8% comparable sales increase in our Company-Controlled channel and 5 percentage points (ppt.) of sales growth from ~~sales generated by 16~~29 net new stores opened in the past 12 months. ~~Company-Controlled comparable~~

Our revolutionary Sleep Number 360 smart beds have driven double-digit demand growth for four consecutive quarters (transition completed in July 2018), including the 13% net sales increase in the second quarter of 2019. The Sleep Number 360 smart bed won 13 awards at CES 2017, including being named the Best of Innovation Honoree in the Home Appliance category. It also received the 2018 Edison Silver Award for breakthrough product design and innovation in the ~~three months ended September 29, 2018 were consistent with the prior year period.~~

Wellness Technology category.

The ~~$12~~$40 million net sales increase compared with the same period one year ago was comprised of the following: (i) a ~~$14~~$25 million increase ~~resulting from net store openings; partially offset by (ii) a $1 million decrease~~ in our Company-Controlled comparable net sales; and ~~(iii)~~(ii) a $1$17 million ~~decrease in~~increase resulting from net store openings. Wholesale/Other channel ~~sales.~~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 ~~$4,387, consistent~~$4,945, a 10% increase compared with $4,508 in the ~~prior year.~~

prior-year period.

Gross profit

Gross profit of ~~$251~~$217 million ~~decreased~~increased by $3$28 million, or 1%15%, compared with ~~$253~~$189 million for the same period one year ago. The gross profit rate ~~was 60.4%~~improved to 61.0% of net sales for the three months ended ~~September~~June 29, ~~2018,~~2019, compared with ~~62.9%~~59.7% for the prior-year comparable period. The current-year gross profit rate ~~decline~~increase of ~~2.5~~1.3 ppt. was primarily due to two ~~factors in about equal proportion:~~factors: (i) ~~closeout sales of our prior line of classic series beds;~~current-period manufacturing and supply chain efficiency gains, and benefit-driven product price increases (1.0 ppt.); and (ii) ~~a higher mix~~the elimination of ~~lower-margin sourced products, including FlexFit™ adjustable bases that integrate well~~prior year’s product transition costs and temporary inefficiencies associated with ~~our 360~~^® ~~smart beds.~~operating two supply chains (0.8 ppt.). These two 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~~June 29, ~~2018 increased to $188~~2019 were $169 million, or ~~45.4%~~47.4% of net sales, compared with ~~$175~~$151 million, or ~~43.4%~~47.8% of net sales, for the same period one year ago. The ~~2.0~~0.4 ppt. ~~change~~decrease in the sales and marketing expense rate was primarily ~~resulted~~due to the expense leverage from ~~increased sales~~the 13% increase in net sales; partially offset by an increase in media and ~~marketing~~promotional expenses ~~including our new campaign called "This is Not a Bed™",~~ that drove ~~strong order growth during the back-half of the third-quarter 2018. A significant portion of the third-quarter order growth will be included in net sales after delivery of the orders~~additional customer traffic to our ~~customers in the fourth-quarter 2018 (see Net~~ sales ~~discussion above).~~

channels, includes stores, online and phone.

General and administrative expenses

General and administrative (G&A) expenses totaled ~~$29~~$33 million, or ~~7.1%~~9.3% of net sales, for the three months ended ~~September~~June 29, ~~2018,~~2019, compared with ~~$33~~$29 million, or ~~8.1%~~9.1% of net sales, in the prior-year period. The ~~$3.3~~$4.2 million ~~decrease~~increase in G&A expenses consisted ~~primarily~~ of the following: (i) a ~~$1.9~~$1.7 million ~~decrease~~increase in employee compensation primarily resulting from a year-over-year ~~decrease~~increase in performance-based incentive compensation; ~~and~~ (ii) a ~~$1.4~~$1.2 million increase in professional fees; and (iii) a $1.3 million net ~~decrease~~increase in miscellaneous other expenses. The G&A expense rate ~~decreased~~increased by ~~1.0~~0.2 ppt. in the current-year period compared with the same period one year ago due to the ~~decrease in expenses~~items discussed above, ~~and~~partially offset by the leveraging impact of the 3%13% net sales increase.

~~Income tax expense~~

~~Income tax expense was $5.2~~

Research and development expenses

Research and development (R&D) expenses increased by 17% to $8 million for the three months ended ~~September~~June 29, ~~2018,~~2019 compared with ~~$13.2~~$7 million infor the same period one year ago. The ~~effective income tax~~R&D expense rate for the three months ended ~~September~~June 29, ~~2018 decreased~~2019 increased to ~~22.3% from 34.0%~~2.3% of net sales compared with 2.2% of net sales for the ~~comparable period, reflecting the impact from the Tax Cuts and Jobs Act, including the reduction in the federal corporate income tax rate from 35%~~prior year. The spending level increase supports our consumer innovation strategy.

Interest expense, net

Interest expense, net increased to ~~21%. The effective tax rate~~$3.2 million for the ~~current-year period also benefited from: (i) the recognition of additional tax credits; and (ii) stock-based compensation excess tax benefits. See Note 12,~~ ~~Income Taxes, for further information.~~

~~Index~~

~~Comparison of Nine Months Ended September 29, 2018 with Nine Months Ended September 30, 2017~~

~~Net sales~~

~~Net sales increased 4% to $1.12 billion for the nine~~three months ended ~~September~~June 29, ~~2018,~~2019, compared with ~~$1.08 billion~~$1.5 million for the same period one year ago. The $1.8 million change was due to our planned increase in borrowings under our revolving credit facility and the year-over-year increase in LIBOR rates. At June 29, 2019, we ended the quarter with $282 million of borrowings under our revolving credit facility compared with $183 million one year ago.

Income tax benefit

Income tax benefit was $0.3 million for the three months ended June 29, 2019, compared with a $3.1 million benefit last year. Both periods benefited from discrete tax items. The current-year period included stock-based compensation excess tax benefits and a favorable resolution of a tax matter totaling $1.3 million, or $0.04 per diluted share. The prior-year period included a one-time tax planning benefit of $2.9 million, or $0.08 per diluted share, associated with the new Tax Cuts and Jobs Act.

Comparison of Six Months Ended June 29, 2019 with Six Months Ended June 30, 2018

Net sales

Net sales for the ~~nine~~six months ended ~~September~~June 29, ~~2018 were negatively affected~~2019 increased by ~~an approximately $24~~$77 million, ~~shift in sales from our third quarter~~or 11%, to ~~our fourth quarter as a result of strong consumer demand later in the quarter after our completed transition to all Sleep Number 360~~^® ~~smart beds; our new marketing campaign called "This is Not a Bed™", and our differentiated direct-to-consumer retail experience. Net sales~~$782 million, compared with $705 million for the ~~nine months ended September 30, 2017 were affected by temporary disruptions from hurricanes during our Labor Day sales event that reduced third quarter~~same period one year ago. The 11% net sales ~~by an estimated $12 to $15 million.~~

~~The~~increase resulted from a 7% comparable sales ~~change was comprised of 3~~increase in our Company-Controlled channel and 4 percentage points (ppt.) of sales growth from ~~sales generated by 16~~29 net new stores opened in the past 12 ~~months and a 1% comparable~~months.

Our revolutionary Sleep Number 360 smart beds have driven double-digit demand growth for four consecutive quarters (transition completed in July 2018), including the 11% net sales increase ~~in our Company-Controlled channel, partially offset by a decrease in Wholesale/Other channel sales.~~

for the six months ended June 29, 2019.

The ~~$39~~$77 million net sales increase compared with the same period one year ago was comprised of the following: (i) a ~~$31~~$43 million increase in our Company-Controlled comparable net sales; and (ii) a $36 million increase resulting from net store ~~openings; and (ii) a $13 million increase in sales from our Company-Controlled comparable sales; partially offset by (iii) a $5 million decrease in~~openings. Wholesale/Other channel ~~sales. Sales of~~sales decreased slightly year-over-year. Company-Controlled mattress ~~units were in line~~unit sales increased 2% compared with the ~~prior-year period.~~prior year. Average revenue per mattress unit in our Company-Controlled channel ~~increased by 5%.~~

totaled $4,868, a 9% increase compared with $4,459 in the prior-year period.

Index

Gross profit

Gross profit of ~~$677~~$479 million for the ~~nine~~six months ended ~~September~~June 29, ~~2018 was consistent~~2019 increased by $53 million, or 12%, compared with ~~$677~~$426 million for the ~~comparable~~same period one year ago. The gross profit rate ~~decreased~~improved to ~~60.4%~~61.3% of net sales, ~~for the first nine months of 2018,~~ compared with ~~62.6%~~60.5% for the prior-year comparable period. The current-year gross profit rate ~~decline~~increase of ~~2.2~~0.8 ppt. was primarily due ~~to:~~to two factors: (i) ~~1.3~~current-period manufacturing and supply chain efficiency gains, and benefit-driven product price increases (0.9 ppt. ~~from~~); and (ii) the elimination of prior year’s product transition costs and temporary inefficiencies associated with operating two supply chains (0.7 ppt.). These two positive factors were partially offset by: (i) a higher mix of lower-margin sourced products, including FlexFit™ adjustable ~~bases;~~bases that integrate well with our 360 smart beds (0.3 ppt); (ii) increased tariff costs (0.3 ppt.); and ~~(ii) 0.8~~(iii) delivery cost inflation (0.2 ppt. ~~resulting primarily from transition costs associated with operating two product lines, including higher logistics expenses.~~). 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~~six months ended ~~September~~June 29, ~~2018 increased to $511~~2019 were $356 million, or 45.5% of net sales, compared with ~~$489~~$323 million, or 45.8% of net sales, for the same period one year ~~ago, and increased to 45.7% of net sales compared with 45.2% of net sales last year.~~ago. The ~~0.5~~0.3 ppt. ~~increase~~decrease in the sales and marketing expense rate was ~~mainly~~primarily due to ~~increased~~the expense leverage from the 11% increase in net sales; partially offset by an increase in media ~~spending to support our new campaign called "This is Not a Bed™", including spending~~and promotional expenses that drove ~~strong order growth during the three months ended September 29, 2018. A significant portion of the third-quarter order growth will be included in net sales after delivery of the orders~~additional customer traffic to our ~~customers in the fourth-quarter 2018 (see Net~~ sales ~~discussion above).~~

channels, including stores, online and phone.

General and administrative expenses

General and administrative (G&A) expenses totaled ~~$90~~$67 million, or ~~8.0%~~8.6% of net sales, for the ~~nine~~six months ended ~~September~~June 29, ~~2018,~~2019, compared with ~~$95~~$61 million, or ~~8.8%~~8.6% of net sales, in the prior-year period. The $5$6.8 million ~~decrease~~increase in G&A expenses consisted ~~primarily~~ of the following: (i) a ~~$2.7~~$3.8 million ~~decrease~~increase in employee compensation primarily resulting from a year-over-year ~~decrease~~increase in performance-based incentive compensation; ~~and~~ (ii) a ~~$2.6~~$1.9 million increase in professional fees; and (iii) a $1.1 million net ~~decrease~~increase in miscellaneous other expenses. The G&A expense rate ~~decreased by 0.8 ppt. in the current-year period compared~~of 8.6% was consistent with the same period one year ago ~~due to~~as the ~~expense decreases~~increases discussed above ~~and~~were offset by the leveraging impact of the 4%11% net sales ~~increase (see Net sales commentary above).~~

~~Income tax expense~~

~~Income tax expense was $8~~increase.

Research and development expenses

Research and development (R&D) expenses increased by 19% to $16 million for the ~~nine~~six months ended ~~September~~June 29, ~~2018,~~2019 compared with ~~$22~~$14 million for the same period one year ago. The R&D expense rate for the six months ended June 29, 2019 increased to 2.1% of net sales compared with 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 to $5.8 million for the six months ended June 29, 2019, compared with $2.0 million for the same period one year ago. The $3.9 million change was due to our planned increase in borrowings under our revolving credit facility and the year-over-year increase in LIBOR rates. At June 29, 2019, we ended the quarter with $282 million of borrowings under our revolving credit facility compared with $183 million one year ago.

Income tax expense

Income tax expense was $4.4 million for the six months ended June 29, 2019, compared with $2.7 million last year. Both periods benefited from discrete tax items. The effective income tax rate for the six months ended June 29, 2019 was 12.9% reflecting stock-based compensation excess tax benefits and the favorable resolution of a tax matter. The effective tax rate for the ~~nine~~six months ended ~~September 29,~~June 30, 2018 was ~~15.7% compared with 30.7% for the prior-year period~~10.1% reflecting the changes ~~associate~~associated with the Tax Cuts and Jobs Act, including a $2.9 million increase in the 2017 provisional tax benefit, ~~that was recorded in the second-quarter 2018. Both periods' tax expense~~ and ~~effective tax rates included~~ stock-based compensation excess tax benefits. ~~See Note 12,~~ ~~Income Taxes, for further information.~~

~~Index~~

Liquidity and Capital Resources

Managing our liquidity and capital resources is an important part of our commitment to deliver superior shareholder value. Our primary sources of liquidity are cash flows provided by operating activities and cash available under our ~~$300~~$450 million revolving credit facility. 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 and strategic initiatives for the foreseeable future.

As of ~~September~~June 29, ~~2018~~,2019, cash and cash equivalents totaled ~~$1.2 million~~ ~~compared with~~ ~~$3.7 million~~ ~~as of~~ ~~December 30, 2017~~.$2 million. Available borrowing capacity under our revolving credit facility was ~~$161~~$165 million at ~~September~~June 29, ~~2018. The $2.4 million~~ ~~decrease~~2019. Changes in the cash and cash equivalents ~~and restricted cash was~~ primarily ~~due to $134~~consisted of $70 million of cash provided by operating activities and a ~~$94~~$57 million increase in short-term borrowings which ~~was more than~~were offset by ~~$34~~$34 million of cash used to purchase

Index

property and equipment, and ~~$198~~$100 million of cash used to repurchase our common stock ~~($195~~(based on settlement, $90 million under our Board-approved share repurchase program and $3$10 million in connection with the vesting of employee restricted stock grants).

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

	Six Months Ended
	June 29, 2019			June 30, 2018
Total cash provided by (used in):
Operating activities	$	70.3		$	29.1
Investing activities		(31.3	)		(21.3	)
Financing activities		(39.0	)		(9.1	)
Net increase (decrease) in cash and cash equivalents	$	0.1		$	(1.2	)

Nine Months Ended
September 29,
2018 September 30,
2017
Total cash provided by (used in):
Operating activities $ 134.5
$ 176.1
Investing activities (33.8 ) (37.6 )
Financing activities (103.0 ) (123.3 )
Net (decrease) increase in cash, cash equivalents and restricted cash $ (2.4 ) $ 15.2

Cash provided by operating activities for the ~~nine~~six months ended ~~September~~June 29, ~~2018~~2019 was ~~$134~~$70 million compared with ~~$176~~$29 million for the ~~nine~~six months ended ~~September~~June 30, ~~2017.~~2018. Significant components of the year-over-year change in cash provided by operating activities included: (i) ~~an $18~~a $5 million increase in net income for the six months ended June 29, 2019 compared with the same period one year ago; (ii) a $17 million fluctuation in prepaid expenses and other assets with both periods impacted by the timing of rent payments and changes in business activities; (iii) a $17 million fluctuation in accounts payable with both periods impacted by business changes and timing of payments; and (iv) a $12 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 ~~(lower~~(higher incentive compensation paid in ~~2017;~~2018 and lower incentive compensation accrued in the first ~~nine~~six months of 2018); and (ii) a $14 million fluctuation in income taxes reflecting the changes associate with the Tax Cuts and Jobs Act, including the reduction in the federal corporate income tax rate from 35% to 21% and associated tax planning.

Net cash used in investing activities to purchase property and equipment was $34 million for the ~~nine~~six months ended ~~September~~June 29, ~~2018,~~2019, compared with ~~$38~~$21 million for the same period one year ago.

The year-over-year increase was primarily due to the timing of cash flows associated with new and remodeled stores’ property and equipment.

Net cash used in financing activities was ~~$103~~$39 million for the ~~nine~~six months ended ~~September~~June 29, ~~2018,~~2019, compared with ~~$123~~$9 million for the same period one year ago. During the ~~nine~~six months ended ~~September~~June 29, ~~2018,~~2019, we repurchased ~~$198~~$100 million of our stock ~~($195~~(based on settlement, $90 million under our Board-approved share repurchase program and $3$10 million in connection with the vesting of employee restricted stock awards) compared with ~~$120~~$143 million ~~($115 million under our Board-approved share repurchase program and $5 million in connection with the vesting of employee restricted stock awards)~~ during the same period one year ago. Short-term borrowings ~~increased~~changed by ~~$94~~$57 million during the current-year period ~~primarily~~ due to ~~the~~an $82 million increase in borrowings under our revolving credit facility to ~~$136~~$282 million, partially offset by a decrease in book overdrafts which are included in the net change in short-term borrowings.

Under our Board-approved share repurchase program, we repurchased ~~5.9~~2.1 million shares at a cost of ~~$195~~$81 million ~~(an~~(based on trade date, at an average of ~~$32.93~~$39.02 per share) during the ~~nine~~six months ended ~~September~~June 29, ~~2018.~~2019. During the ~~nine~~six months ended ~~September~~June 30, ~~2017,~~2018, we repurchased ~~4.3~~4.2 million shares at a cost of ~~$115~~$140 million (an average of ~~$26.52~~$33.22 per share). As of ~~September~~June 29, ~~2018,~~2019, the remaining authorization under our Board-approved share repurchase program was ~~$270~~$105 million. There is no expiration date governing the period over which we can repurchase shares.

In February ~~2018,~~2019, we amended our revolving credit facility to increase our net aggregate availability from ~~$153~~$300 million to ~~$300~~$450 million. We maintained the accordion feature which allows us to increase the amount of the credit facility from ~~$300~~$450 million to ~~$450~~$600 million, subject to lenders' approval. The amended credit facility matures in February 2024. There were no other significant changes to the credit ~~agreement's~~agreement’s terms and conditions.

As of ~~September~~June 29, ~~2018,~~2019, we had ~~$136~~$282 million of borrowings under our credit facility and $3 million in outstanding letters of credit. Our available borrowing capacity was ~~$161~~$165 million. ~~We were in compliance with all financial covenants. The credit facility matures in February 2023.~~ 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

~~Index~~

~~ratio.~~ 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 is utilized~~ to meet our seasonal working capital ~~requirements.~~

requirements and to repurchase our stock. As of June 29, 2019, the weighted-average interest rate on borrowings under the credit facility was 4.2%, 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. As of ~~September~~June 29, ~~2018,~~2019, 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.

Index

Non-GAAP Data

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 ~~(dollars in~~(in thousands):

	Three Months Ended						Trailing-Twelve Months Ended
	June 29, 2019			June 30, 2018			June 29, 2019		June 30, 2018
Net income	$	4,280		$	3,744		$	74,945	$	65,686
Income tax (benefit) expense		(263	)		(3,111	)		18,682		20,014
Interest expense		3,229			1,454			9,769		2,486
Depreciation and amortization		15,328			15,326			61,675		60,945
Stock-based compensation		4,250			3,658			12,558		14,629
Asset impairments		1			85			151		327
Adjusted EBITDA	$	26,825		$	21,156		$	177,780	$	164,087

Three Months Ended
Trailing-Twelve
Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Net income $ 18,257
$ 25,603
$ 58,340
$ 60,573
Income tax expense 5,228
13,178
12,064
25,731
Interest expense 1,836
278
4,044
935
Depreciation and amortization 15,483
14,770
61,658
60,404
Stock-based compensation 3,356
3,933
14,052
14,498
Asset impairments 30
222
135
267
Adjusted EBITDA $ 44,190
$ 57,984
$ 150,293
$ 162,408

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 ~~(dollars in~~(in thousands):

	Six Months Ended				Trailing-Twelve Months Ended
	June 29, 2019		June 30, 2018		June 29, 2019		June 30, 2018
Net cash provided by operating activities	$	70,347	$	29,131	$	172,756	$	112,931
Subtract: Purchases of property and equipment		33,896		21,341		58,070		54,038
Free cash flow	$	36,451	$	7,790	$	114,686	$	58,893

Nine Months Ended
Trailing-Twelve
Months Ended
September 29,
2018 September 30,
2017 September 29,
2018 September 30,
2017
Net cash provided by operating activities $ 134,450
$ 176,054
$ 131,003
$ 182,438
Subtract: Purchases of property and equipment 34,012
37,613
56,228
56,696
Free cash flow $ 100,438
$ 138,441
$ 74,775
$ 125,742

Index

Non-GAAP Data(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
	June 29, 2019			June 30, 2018
Net operating profit after taxes (NOPAT)
Operating income	$	103,393		$	88,135
Add: Rent expense ⁽¹⁾		84,210			76,215
Add: Interest income		4			50
Less: Depreciation on capitalized operating leases ⁽²⁾		(21,310	)		(19,640	)
Less: Income taxes ⁽³⁾		(40,319	)		(43,934	)
NOPAT	$	125,978		$	100,826
Average invested capital
Total deficit	$	(157,302	)	$	(21,154	)
Add: Long-term debt ⁽⁴⁾		282,308			183,405
Add: Capitalized operating lease obligations ⁽⁵⁾		673,680			609,720
Total invested capital at end of period	$	798,686		$	771,971
Average invested capital ⁽⁶⁾	$	750,375		$	705,575
Return on invested capital (ROIC) ⁽⁷⁾		16.8	%		14.3	%

⁽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 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⁾	Reflects annual effective income tax rates, before discrete adjustments, of 24.2% and 30.3% for 2019 and 2018, respectively.

Trailing-Twelve
Months Ended
September 29,
2018 September 30,
2017
Net operating profit after taxes (NOPAT)
Operating income $ 74,427
$ 87,108
Add: Rent expense⁽¹⁾
77,797
72,260
Add: Interest income 21
129
Less: Depreciation on capitalized operating leases⁽²⁾
(20,012 ) (18,384 )
Less: Income taxes⁽³⁾
(34,751 ) (46,004 )
NOPAT $ 97,482
$ 95,109

Average invested capital
Total equity $ (54,352 ) $ 104,297
Add: Long-term debt⁽⁴⁾
136,683
—
Add: Capitalized operating lease obligations⁽⁵⁾
622,376
578,080
Total invested capital at end of period $ 704,707
$ 682,377
Average invested capital⁽⁶⁾
$ 710,325
$ 689,467
Return on invested capital (ROIC)⁽⁷⁾
13.7 % 13.8 %

⁽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.

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

⁽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.

⁽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 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 26.3% and 32.6% for 2018 and 2017, respectively.~~

⁽⁴⁾ Long-term debt includes existing capital lease obligations, if applicable. In conjunction with increasing our revolving credit facility to $300 million in the first quarter of 2018, we include borrowings under that agreement, including borrowings classified as short term.

⁽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.

Index

~~Index~~

Off-Balance-Sheet Arrangements and Contractual Obligations

As of ~~September~~June 29, ~~2018~~,2019, we were not involved in any unconsolidated special purpose entity transactions. Other than our ~~operating leases and~~ $3 million in outstanding letters of credit, we do not have any off-balance-sheet financing.

There ~~has~~have been no material changes in our contractual obligations, other than in the ordinary course of business, since the end of fiscal ~~2017~~.2018. See Note 6, 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 ~~30, 2017~~29, 2018 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 December ~~30, 2017. Other than the adoption of the new revenue recognition guidance as described in Note 1,~~ ~~Business and Summary of Significant Accounting Policies and~~ ~~Note 2, Revenue Recognition,~~ ~~there~~29, 2018. There were no ~~other~~ significant changes in our critical accounting policies since the end of fiscal ~~2017~~.

2018.

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$2.1 million based on the ~~$136~~$282 million of borrowings under our revolving credit facility at ~~September~~June 29, ~~2018.~~2019. We do not manage ~~our investment~~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 ~~Controls~~

Control

There were no changes in our internal control over financial reporting during the fiscal quarter ended ~~September~~June 29, ~~2018~~,2019, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

Index

PART II: OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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.

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⁾
March 31, 2019 through April 27, 2019		712,184	$	41.00		644,733	$	119,050,000
April 28, 2019 through May 25, 2019		185,556	$	34.47		184,600		112,686,000
May 26, 2019 through June 29, 2019		206,204	$	37.59		204,489		105,000,000
Total		1,103,944	$	39.27		1,033,822	$	105,000,000


(1)
~~(a) – (b)~~	~~Not applicable.~~
~~(c)~~	~~Issuer Purchases of Equity Securities~~

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⁾
July 1, 2018 through July 28, 2018 561,339
$ 30.45
553,630
$ 308,139,000
July 29, 2018 through August 25, 2018 569,662
30.54
569,304
290,750,000
August 26, 2018 through September 29, 2018 585,823
35.51
584,325
270,000,000
Total 1,716,824
$ 32.21
1,707,259
$ 270,000,000


⁽¹⁾	Under our Board-approved $500 million share repurchase program, we repurchased ~~1,707,259~~1,033,822 shares of our common stock at a cost of ~~$55~~$40 million (based on trade dates) during the three months ended ~~September~~June 29, ~~2018~~. 2019.

(2)	In connection with the vesting of employee restricted stock grants, we also repurchased ~~9,565~~70,122 shares of our common stock at a cost of ~~$0.3~~$3 million during the three months ended ~~September~~June 29, ~~2018.~~2019.

(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.

Index

~~Index~~

ITEM 6. EXHIBITS


Exhibit Number		Description
~~Exhibit~~ ~~Number~~ 31.1		~~Description~~	~~Method of Filing~~
~~31.1~~		Certification of CEO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	~~Filed herewith~~
31.2		Certification of CFO pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	~~Filed herewith~~
32.1		Certification of CEO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	~~Furnished herewith~~⁽¹⁾
32.2		Certification of CFO pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350	~~Furnished herewith~~⁽¹⁾
~~101~~ 101.INS		~~The following financial information from~~ XBRL Instance Document – the ~~Company's Quarterly Report on Form 10-Q for~~instance document does not appear in the ~~period ended September 29, 2018, filed with~~Interactive Data File because its XBRL tags are embedded within the SEC on November 2, 2018, formatted in eXtensible Business Reporting Language: (i) Condensed Consolidated Balance Sheets as of September 29, 2018 and December 30, 2017; (ii) Condensed Consolidated Statements of Operations for the three and nine months ended September 29, 2018 and September 30, 2017; (iii) Condensed Consolidated Statement of Shareholders' (Deficit) Equity for the nine months ended September 29, 2018; (iv) Condensed Consolidated Statements of Cash Flows for the nine months ended September 29, 2018 and September 30, 2017; and (v) Notes to Condensed Consolidated Financial Statements.Inline XBRL document
101.SCH	~~Filed herewith~~	XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

⁽¹⁾ This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Act of 1934, as amended, (15 U.S.C. 78r) or otherwise subject to the liability of that section. Such exhibit will not be deemed to be incorporated by reference into any document filed under the Securities Act of 1933, as amended, or under the Securities Exchange Act of 1934, as amended, except as otherwise expressly stated in any such filing.

Index

~~Index~~

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:	August 6, 2019	By:	/s/ Shelly R. Ibach
		~~SLEEP NUMBER CORPORATION~~
		~~(Registrant)~~

~~Dated:~~	~~November 2, 2018~~	~~By:~~	~~/s/~~ Shelly R. Ibach
			~~Shelly R. Ibach~~
			Chief Executive Officer
			(principal executive officer)

		By:	/s/ Robert J. Poirier
			Robert J. Poirier
			Chief Accounting Officer
			(principal accounting officer)

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		55404
(Address of principal executive offices)		(Zip Code)



	September 29, 2018			December 30, 2017
Assets
Current assets:
Cash and cash equivalents	$	1,241		$	3,651
Accounts receivable, net of allowance for doubtful accounts of $579 and $714, respectively	24,128			19,312
Inventories	90,980			84,298
Income taxes receivable	1,229			—
Prepaid expenses	9,772			17,565
Other current assets	31,007			27,665
Total current assets	158,357			152,491

Non-current assets:
Property and equipment, net	199,452			208,646
Goodwill and intangible assets, net	75,952			77,588
Deferred income taxes	—			2,625
Other non-current assets	36,307			30,484
Total assets	$	470,068		$	471,834

Liabilities and Shareholders’ (Deficit) Equity
Current liabilities:
Borrowings under revolving credit facility	$	135,800		$	24,500
Accounts payable	138,735			129,194
Customer prepayments	46,118			27,767
Accrued sales returns	20,535			19,270
Compensation and benefits	31,988			34,602
Taxes and withholding	15,951			24,234
Other current liabilities	49,858			46,822
Total current liabilities	438,985			306,389

Non-current liabilities:
Deferred income taxes	4,638			—
Other non-current liabilities	80,797			76,289
Total liabilities	524,420			382,678

Shareholders’ (deficit) equity:
Undesignated preferred stock; 5,000 shares authorized, no shares issued and outstanding	—			—
Common stock, $0.01 par value; 142,500 shares authorized, 33,216 and 38,813 shares issued and outstanding, respectively	332			388
Additional paid-in capital	—			—
(Accumulated deficit) retained earnings	(54,684		)	88,768
Total shareholders’ (deficit) equity	(54,352		)	89,156
Total liabilities and shareholders’ (deficit) equity	$	470,068		$	471,834



	Three Months Ended				Nine Months Ended
	September 29, 2018		September 30, 2017		September 29, 2018		September 30, 2017
Net sales	$	414,779	$	402,646	$	1,119,750	$	1,081,218
Cost of sales	164,262		149,181		442,868		404,675
Gross profit	250,517		253,465		676,882		676,543

Operating expenses:
Sales and marketing	188,458		174,800		511,481		488,564
General and administrative	29,385		32,645		89,947		95,233
Research and development	7,353		6,991		21,146		20,950
Total operating expenses	225,196		214,436		622,574		604,747
Operating income	25,321		39,029		54,308		71,796
Other expense, net	1,836		248		3,814		668
Income before income taxes	23,485		38,781		50,494		71,128
Income tax expense	5,228		13,178		7,945		21,842
Net income	$	18,257	$	25,603	$	42,549	$	49,286

Basic net income per share:
Net income per share – basic	$	0.53	$	0.63	$	1.18	$	1.18
Weighted-average shares – basic	34,231		40,755		36,204		41,740
Diluted net income per share:
Net income per share – diluted	$	0.52	$	0.62	$	1.15	$	1.16
Weighted-average shares – diluted	35,039		41,515		37,077		42,559



	Common Stock					Additional Paid-in Capital			Retained Earnings (Accumulated Deficit)			Total
	Shares		Amount			Additional Paid-in Capital			Retained Earnings (Accumulated Deficit)			Total
Balance at December 30, 2017	38,813		$	388		$	—		$	88,768		$	89,156
Net income	—		—			—			42,549			42,549
Exercise of common stock options	157		1			2,083			—			2,084
Stock-based compensation	261		3			10,095			—			10,098
Repurchases of common stock	(6,015	)	(60		)	(12,178		)	(186,001		)	(198,239		)
Balance at September 29, 2018	33,216		$	332		$	—		$	(54,684	)	$	(54,352	)



	September 29, 2018				December 30, 2017
	Gross Carrying Amount		Accumulated Amortization		Gross Carrying Amount		Accumulated Amortization
Developed technologies	$	18,851	$	8,341	$	18,851	$	6,705
Trade names/trademarks	101		101		101		101
	$	18,952	$	8,442	$	18,952	$	6,806



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⁾
July 1, 2018 through July 28, 2018	561,339	$	30.45	553,630	$	308,139,000
July 29, 2018 through August 25, 2018	569,662	30.54		569,304	290,750,000
August 26, 2018 through September 29, 2018	585,823	35.51		584,325	270,000,000
Total	1,716,824	$	32.21	1,707,259	$	270,000,000