Executive Summary / Key Takeaways

• Sleep Number Corporation is undergoing a comprehensive "reset" under new leadership, leveraging its proprietary smart bed technology and direct-to-consumer model to drive a return to profitable growth amidst a challenging macroeconomic environment.
• The company is aggressively optimizing its cost structure, targeting over $130 million in operating expense reductions for 2025 compared to 2024, alongside significant marketing efficiency gains and a focus on core R&D.
• Despite a 20% year-over-year net sales decline in Q2 2025, gross profit margins remain resilient, and the company projects full-year 2025 net sales of approximately $1.45 billion with anticipated breakeven cash flow in the second half.
• Strategic initiatives include rethinking product portfolio, pricing, and exploring new distribution channels to broaden reach while maintaining strong margins, with initial results expected in 2026.
• While macroeconomic headwinds and debt covenants present challenges, management's decisive actions and focus on cash generation position Sleep Number for improved financial resilience and long-term value creation.

The Foundation of Sleep: Innovation in a Challenging Market

Sleep Number Corporation, established in 1987 as Select Comfort, has evolved into a market leader in sleep solutions, fundamentally transforming its identity in 2017 to reflect its focus on personalized sleep wellness. The company's core business revolves around the design, manufacturing, marketing, and direct-to-consumer distribution of its innovative smart beds and related bedding products. This vertically integrated model, spanning retail stores, online platforms, phone, and chat, is a cornerstone of its strategy.

At the heart of Sleep Number's offering is its differentiated smart bed technology. These beds combine unparalleled physical comfort with a highly advanced digital sleep wellness platform. Key features include signature firmness adjustability, allowing each sleeper to customize their comfort, and embedded digital sensors that automatically adjust the bed throughout the night to maintain optimal comfort. The active temperature balancing technology addresses a prevalent sleep challenge, with over two-thirds of sleepers reporting issues with being too hot or too cold. This technology is designed to provide tangible benefits, with Sleep Number beds proven to deliver up to 28 to 44 minutes of restful sleep per night. The company further enhances its product capabilities and insights by leveraging an extensive database of over 34 billion hours of longitudinal sleep data, making it the largest ongoing sleep study in the world. This data allows for continuous product improvement and personalized sleep insights. Recent innovations, such as the BreatheIQ™ digital sleep health app, developed in partnership with GEM HEALTH, aim to help millions understand and manage snoring, further extending the company's health-focused technology.

The bedding industry has faced significant headwinds, enduring a three-year recession that saw U.S. mattress unit volumes in 2024 drop to an estimated 24 million units, the lowest level since 2015. This downturn is exacerbated by persistently low consumer sentiment, elevated interest rates impacting the housing market, and inflationary pressures that have curtailed discretionary spending. In this challenging environment, Sleep Number's technological differentiation provides a crucial competitive moat. While direct competitors like Tempur Sealy International (TPX) dominate the broader mattress market with a 30-35% share through a hybrid wholesale-direct model and focus on memory foam, Sleep Number carves out a niche (5-7% market share) with its tech-driven, personalized sleep experience. Sleep Number's emphasis on real-time adjustments and biometric integration offers a qualitatively superior user experience that fosters higher customer loyalty compared to TPX's focus on material durability.

Against Purple Innovation (PRPL), another premium, tech-savvy player with a 3-5% market share, Sleep Number's AI-like sleep tracking and data integration offer a distinct advantage over Purple's gel-grid technology. While Purple boasts faster product launch cycles, Sleep Number's health-focused tech and stronger cash flow generation ($50 million in free cash flow in 2024 versus Purple's negative $20 million) provide a more stable foundation. Leggett & Platt (LEG), an indirect competitor in bedding components, highlights the cost efficiencies achievable in manufacturing, an area where Sleep Number, with its integrated smart technology, faces higher production costs. However, Sleep Number's end-to-end strategy and brand appeal aim to justify its premium pricing and differentiate it beyond component-level competition.

Operational Transformation and Financial Resilience

In response to the prolonged industry downturn and internal operational inefficiencies, Sleep Number initiated a comprehensive operating model transformation in late 2023. This strategic pivot, intensified under new CEO Linda Findley who joined in April 2025, focuses on aggressive cost management, operational streamlining, and a fundamental reset of its commercial approach. The company's Q2 2025 results reflect the early impacts of these decisive actions.

Net sales for the second quarter ended June 28, 2025, decreased 20% year-over-year to $328 million, primarily driven by lower volume and a reduced store count. Total Retail comparable sales saw a 19% decrease. For the six months ended June 28, 2025, net sales were $721 million, down 18% from the prior year. This top-line pressure was a direct consequence of intentional strategic decisions, including a significant 30% cut to Q2 year-over-year marketing spend to reset an inefficient strategy. Despite the revenue decline, the gross profit rate remained resilient at 59.1% in Q2 2025, flat year-over-year, and increased to 60.2% for the six-month period (up 1.3 percentage points). This was primarily due to year-over-year product cost reductions through value engineering and ongoing supplier negotiations, which added 1.4 percentage points to the Q2 rate and 2.3 percentage points for the six-month period. This was partially offset by an unfavorable product mix and higher warranty/return costs.

Operating expenses saw a substantial $42 million year-over-year reduction in Q2 2025, driven by lower sales and marketing, general and administrative (G&A), and research and development (R&D) expenses. For the six-month period, operating expenses decreased 14%, including a 19% lower media spend. The company has significantly increased its cost savings target, now expecting to remove over $130 million in operating expenses in 2025 compared to 2024, exceeding the prior target of $80-100 million. These reductions are broad-based, stemming from streamlining leadership layers, improving marketing efficiency, simplifying operations, and narrowing R&D focus to core platforms. Corporate management was reduced by 21% as part of an organizational redesign aimed at consolidating overlapping capabilities and eliminating redundancies.

The company's Average Revenue Per Unit (ARU) for smart beds in Total Retail increased by 1.3% to $5,880 in Q2 2025 and 2.7% to $5,940 for the six-month period. This growth is primarily attributed to a favorable product mix, particularly the strong performance of the higher-margin Climate Series beds, which are outperforming expectations and proving accretive to gross margins. This indicates that while unit volumes are down, the company is successfully selling higher-value products to its customer base.

Strategic Initiatives and Future Outlook

Sleep Number's strategic reset extends beyond cost cutting to a fundamental re-evaluation of its commercial and product strategies. The company is rethinking its product portfolio, pricing, and distribution to meet a broader customer base. This includes plans for new price points, features that enhance comfort and durability, and simpler selection processes, with initial results anticipated in 2026. Management acknowledges that in the past, the company may have "got ahead of ourselves and the consumer," focusing too far into the future and losing sight of the core value proposition of simply helping people get a great night's sleep. The renewed focus is on communicating the immediate benefits and differentiation of its current offerings.

In parallel, Sleep Number is actively exploring new distribution channels, including digital-first models, retail partnerships, and emerging platforms, while continuously evaluating its existing retail footprint of 630 stores. The goal is to build upon its strong vertical model, making every channel work harder together for the customer while maintaining a strong margin profile. This multi-channel approach is also expected to raise awareness and drive leads to its physical stores. Marketing efforts are being reshaped for greater efficiency and impact, with new Chief Marketing Officer Amber Minson leading initiatives to sharpen positioning, messaging, and leverage AI for improved customer acquisition. Early signs are positive, with a 24% increase in conversion year-over-year in Q2 2025.

From a liquidity perspective, Sleep Number had $1.3 million in cash and cash equivalents as of June 28, 2025, with $564 million in borrowings under its revolving credit facility. The company's leverage ratio was 4.60x EBITDAR, within its amended covenant maximum of 4.75x. The credit agreement was amended in March 2025 to provide additional flexibility, with the maximum Net Leverage Ratio gradually decreasing to 4.00x by 2026. Management is in active dialogue with lenders and exploring refinancing and other non-dilutive options to gain further flexibility and support growth investments. The company expects to deliver breakeven cash flow in the second half of 2025, with any positive operating cash flow prioritized for debt reduction.

For the full year 2025, Sleep Number expects net sales of approximately $1.45 billion, representing a 14% year-over-year decline. Second-half sales are projected to be roughly comparable to the first half, with the year-over-year sales rate decline moderating to 9%, partly due to softer prior-year comparisons and the benefit of a 53rd work week. Full-year operating expenses (excluding restructuring) are anticipated to be approximately $830 million, $130 million less than 2024. The gross profit margin for the second half of 2025 is expected to be approximately 61%, including mitigation of tariff impacts. The company anticipates an unmitigated tariff impact of $30 million for 2025, with $17 million expected to be offset through supply chain flexibility and supplier partnerships, leaving $13 million under evaluation for further mitigation, potentially through strategic pricing.

Risks and Investment Implications

Despite the aggressive transformation, Sleep Number faces ongoing risks. The persistent sector-level recession in the bedding industry, coupled with low consumer sentiment and high interest rates, continues to suppress discretionary spending. This macroeconomic environment makes demand generation challenging, forcing the company to make "demand-driving trade-offs" by prioritizing profit over aggressive media spend, even if competitors are spending more in an "inefficient environment." The cautious consumer behavior, characterized by delayed decision-making and concentration of purchases around promotional events, adds volatility to sales trends. Furthermore, the company's pace of strategic change is "somewhat limited and shaped by our capital structure," necessitating ongoing dialogue with lenders.

However, the investment thesis for Sleep Number hinges on its ability to execute this comprehensive reset. The company's proprietary technology, backed by billions of hours of sleep data, provides a strong competitive moat in a market increasingly valuing health and wellness. The aggressive cost reductions and focus on marketing efficiency are critical steps towards improving profitability and cash flow, even in a subdued demand environment. The strategic re-evaluation of product and distribution, while long-term, could unlock new growth avenues and broaden its addressable market. While the path to recovery is not without its bumps, Sleep Number's decisive actions to control its controllables, coupled with its unique technological advantages, position it for improved financial resilience and potential acceleration when the broader market eventually recovers. The company's commitment to generating cash and reducing debt underscores a disciplined approach to creating shareholder value.

Conclusion

Sleep Number Corporation is at a pivotal juncture, undertaking a profound strategic reset to realign its operations and market approach with current consumer realities. Under new leadership, the company is aggressively tackling its cost structure, refining its marketing for greater efficiency, and re-prioritizing its innovation pipeline to focus on core customer value. While the macroeconomic climate remains challenging, impacting top-line performance, Sleep Number's ability to maintain strong gross margins and significantly reduce operating expenses demonstrates a newfound financial resilience.

The company's differentiated smart bed technology, underpinned by extensive sleep data and continuous innovation, remains its core competitive advantage. The strategic exploration of new distribution channels and product offerings, coupled with a disciplined approach to capital management, aims to leverage this technological edge for broader market penetration and sustainable long-term growth. Investors should monitor the execution of these initiatives, particularly the impact of marketing efficiencies on demand, the success of new product introductions in 2026, and the company's progress in optimizing its capital structure. Sleep Number's journey is a testament to its commitment to adapt and thrive, positioning it to capitalize on its unique sleep wellness platform as market conditions improve.