Sleep Number Corporation (SNBR)

Executive Summary / Key Takeaways

• Turnthrough Cost Transformation: Sleep Number has surgically removed $173 million in expenses over two years while expanding gross margins by 190 basis points, demonstrating that management can protect profitability even as sales crater 18% amid a three-year industry recession.
• Product Reset as Growth Catalyst: The Climate series is outperforming expectations, driving 4% higher average selling prices, while a simplified 2026 product lineup and expanded digital distribution aim to convert the brand's 33 billion hours of sleep data into customer acquisition.
• Liquidity Tightrope Walked: The November 2025 credit amendment extends maturities to 2027 and relaxes covenants, providing crucial breathing room, but with $580 million drawn and only $82 million available, the company remains one operational misstep from a liquidity crisis.
• Competitive Pressure in a Shrinking Pool: Tempur Sealy 's 63% revenue growth and 29.5% operating margins highlight SNBR's scale disadvantage, while Purple Innovation and Casper Sleep 's digital agility expose the cost burden of Sleep Number's 611-store footprint.
• 2026 Stabilization Hinges on Execution: Management's guidance for $1.4 billion in 2025 sales and $70 million adjusted EBITDA implies a bottoming process, but the real test is whether new products and distribution can reignite growth before cost cuts reach their limit.

Setting the Scene: A Premium Brand Caught in Industry Decline

Sleep Number Corporation, incorporated in 1987 as Select Comfort Corporation in Minneapolis, Minnesota, built its reputation on technical innovation in adjustable air-chamber beds. The company's 33 billion hours of accumulated sleep data represents a unique asset in the mattress industry, enabling continuous product improvement and personalized sleep insights. Yet this innovation heritage collides with a brutal reality: the U.S. mattress industry has been in a sector-level recession for three years, with unit volumes falling to an estimated 24 million in 2024—the lowest level since 2015. This structural downturn has transformed Sleep Number's primary challenge from market share capture to simple survival.

The company's direct-to-consumer model, anchored by 611 retail stores, was designed for growth, not retrenchment. When consumer sentiment turned sharply downward in early 2025, particularly during the critical President's Day sales period, the model's inherent fixed cost burden became a strategic liability. Management's response has been aggressive and necessary: a complete operating model transformation initiated in late 2023 that has already delivered $173 million in cost reductions, including $88 million in 2024 alone. This isn't incremental belt-tightening; it's a fundamental restructuring of the cost base to match a permanently smaller revenue footprint.

The appointment of Linda Findley as President and CEO on April 7, 2025, signals a new phase of strategic realignment. Her immediate actions—cutting corporate management by 21%, appointing Amber Minson as CMO, and refocusing R&D on core technologies—reflect a clear-eyed assessment that the company had "gotten ahead of ourselves and the consumer." This leadership change matters because it brings a customer-obsessed mindset to a company that had drifted toward technology-for-technology's-sake, losing sight of the core value proposition that built the brand.

Technology, Products, and Strategic Differentiation: Data as a Moat

Sleep Number's core technological advantage lies in its proprietary adjustable air-chamber system, enabling dual-sided firmness customization that static foam mattresses cannot replicate. This isn't merely a feature; it's a structural moat that supports premium pricing and drives the company's 60% gross margins. The ClimateCool and Climate series beds have outperformed expectations, contributing to a 4% increase in average revenue per smart bed unit to $5,995 in Q3 2025. This product mix shift added 0.7 percentage points to gross margin, demonstrating that innovation can still drive profitability even in a downturn.

The SleepIQ platform represents a second, underutilized moat. With 500,000 active sleepers contributing to the world's largest longitudinal sleep study, the company possesses data that competitors cannot replicate. This data improves products continuously and provides marketing ammunition, yet the company has historically failed to translate technical features into clear consumer benefits. Findley's strategy to "refresh creative to focus more on product value and benefits" directly addresses this gap, aiming to convert technical superiority into customer acquisition.

The upcoming 2026 product simplification initiative is the most critical technological pivot. The current product line has become too narrow, converting only a subset of website visitors despite attracting a "significantly larger audience." By driving value into more accessible price points within the premium space, the company can increase conversion without sacrificing margins. The plan capitalizes on adjustable firmness and temperature differentiators—areas where competitors cannot match Sleep Number's depth of experience.

Financial Performance: Evidence of a Turnaround Taking Shape

The financial results tell a story of successful cost defense amid revenue collapse. Net sales fell 20% to $343 million in Q3 2025, driven by a 23% decline in smart bed unit volume and a 19% drop in comparable store sales. Yet gross margin only declined 0.9 percentage points to 59.9%, a remarkable achievement that interim CFO Robert Ryder called "shockingly good." The margin resilience came from favorable product mix (0.7 ppt benefit) and lower promotional activity (0.3 ppt benefit), partially offset by higher manufacturing and logistics costs. This demonstrates that management can protect the core profitability engine even when the top line is under severe pressure.

Operating expenses tell a more nuanced story. Sales and marketing consumed 48.8% of revenue in Q3, up 0.6 percentage points year-over-year due to deleveraging from the 20% sales decline. However, absolute marketing spend fell 19%, including a 32% cut in media spend during Q2 and Q3. This reduction hurt the top line but improved marketing efficiency, with cost per acquisition declining 6% year-over-year. The trade-off was painful but necessary: with credit covenants tightening, management could only invest in marketing that paid back within the quarter. The new credit agreement changes this calculus, allowing Q4 media spend to be "only slightly down" year-over-year and setting up 2026 for increased investment.

General and administrative expenses fell to $32 million (9.3% of sales) from $33 million, while R&D dropped to $7 million from $11 million, reflecting headcount reductions and a refocus on core technologies. These cuts are sustainable because they eliminate complexity rather than muscle. As Findley noted, "Our headcount is currently now back at 2017 levels," indicating the company has reset its cost structure to a pre-growth baseline. The $39 million in restructuring charges in Q3, including $19.8 million in retail location impairments, represents the final painful steps of this reset.

The balance sheet remains the central constraint. With $580 million drawn on its credit facility and only $82 million of availability as of September 27, 2025, liquidity is tight. The November amendment extends maturities to 2027 and adjusts covenants, but the company must maintain at least $30 million in liquidity through September 2026 and meet quarterly EBITDA tests starting in Q2 2026. This creates a clear deadline: the turnaround must generate tangible cash flow within the next 18 months or the company faces another covenant breach.

Competitive Context: Scale Disadvantage in a Tough Market

Sleep Number competes in a bifurcated market where scale and specialization create divergent advantages. Tempur Sealy (TPX) International dominates with $2.1 billion in Q3 revenue (+63% year-over-year) and 29.5% operating margins, leveraging massive wholesale partnerships and international expansion. TPX's scale allows it to absorb industry downturns while Sleep Number's smaller footprint amplifies cyclical pain. More critically, TPX's diversified product portfolio spans memory foam, hybrid, and traditional innerspring mattresses, while Sleep Number's narrow focus on adjustable air beds limits its addressable market during downturns.

Purple Innovation (PRPL) presents a different threat. With $118.8 million in Q3 revenue and proprietary cooling technology, Purple targets hot sleepers—a segment where Sleep Number's air-based temperature control is less effective. Purple's -12.4% profit margin reflects its own struggles, but its direct-to-consumer model carries lower fixed costs than Sleep Number's store network. This cost structure advantage allows Purple to be more aggressive on price, pressuring Sleep Number's premium positioning.

Casper Sleep (CSPR), with approximately $580 million in trailing revenue and a pure e-commerce model, represents the digital-first future that Sleep Number is only now embracing. Casper's 51% gross margin trails Sleep Number's 60%, but its asset-light model generates positive free cash flow through working capital efficiency. Sleep Number's hybrid model, while superior for demonstrating complex products, carries the burden of 611 leases with typical 5-10 year terms, creating a fixed cost anchor that digital competitors don't face.

The competitive dynamics crystallize around two axes: product differentiation and cost structure. Sleep Number leads in adjustable firmness and sleep data integration, but lags in scale, cooling technology, and digital agility. The J.D. Power recognition for customer satisfaction—fifth time receiving this distinction—validates the product experience but hasn't translated into market share gains. As Findley acknowledged, "The competitive environment will remain intense. That's actually part of what makes this industry what it is."

Outlook, Guidance, and Execution Risk

Management's 2025 guidance projects net sales of approximately $1.4 billion and adjusted EBITDA of around $70 million, implying a second-half stabilization. The company expects to incur $135 million less in operating expenses than 2024, with additional fixed cost reductions planned for Q4 and 2026. This cost discipline is necessary but insufficient; the real test is whether new initiatives can stabilize the top line in 2026.

The product roadmap provides reason for cautious optimism. New price points and features, combined with a simplified product assortment, aim to convert the "significantly larger audience" already visiting the website. The test show on HSN with an exclusive bed represents the first step in expanding beyond the vertical retail model. As Findley explained, these new channels will "supplement—not cannibalize" the core footprint, reaching "different expanded audience segments" without sacrificing margin.

Marketing strategy is resetting from a focus on spend levels to efficiency metrics. The 32% media cuts in Q2/Q3 were a forced capitulation to covenant constraints, but the resulting 6% improvement in cost per acquisition proves the underlying efficiency gains are real. With the new credit agreement providing flexibility, Q4 media spend will be "only slightly down" year-over-year, and 2026 will see increased investment. The key insight is that Sleep Number was previously "managing to our bank debt," only investing in marketing with immediate quarterly payback. The new covenants allow for longer payback periods and more strategic investment.

The covenant schedule creates a clear timeline for execution. The Net Leverage Ratio steps down from 5.25x in Q3 2025 to 4.0x by Q3 2026, while the Interest Coverage Ratio must rise from 1.50x to 2.20x over the same period. A new quarterly minimum EBITDA test begins in Q2 2026. These requirements mean the company must not only stop the sales decline but generate consistent EBITDA growth within the next 12 months. The $30 million minimum liquidity requirement through September 2026 leaves minimal room for operational missteps.

Risks and Asymmetries

The most material risk is covenant compliance. While the November amendment provides temporary relief, the business must perform as expected or face another round of negotiations. As management warned, "If the business does not perform as expected, additional waivers or amendments...will be required, and if not obtained on commercially reasonable terms, the company will need to seek alternative financing options, which may not be available." The 5.25x leverage ratio in Q3 2025, combined with negative free cash flow of $17 million year-to-date, suggests the company is operating near its financial limits.

Consumer demand represents a second critical risk. The mattress industry recession has lasted three years, with no clear catalyst for recovery. High interest rates continue pressuring housing turnover, and inflation has eroded discretionary spending power. Management's guidance assumes demand doesn't worsen, yet the company lacks the marketing firepower to stimulate demand independently. The 32% media cuts in Q2/Q3 may have created a negative feedback loop where reduced awareness further depresses sales.

Competitive behavior adds another layer of risk. The Q3 earnings call revealed that "competitive behaviors became even more aggressive than we had expected during the Labor Day period," and Sleep Number "did not have the financial flexibility to counter with our own messaging." This dynamic—where TPX can outspend and underprice while Purple and Casper attack digitally—could persist even as Sleep Number's financial flexibility improves. The company's 23.6% estimated market share in adjustable beds provides a niche defense but doesn't guarantee growth.

On the positive side, several asymmetries could accelerate the turnaround. The Climate series' outperformance suggests product-market fit for premium features, and the 4% increase in average selling power indicates pricing power remains intact. The store optimization program has achieved "very, very high transfer rates" when closing locations, meaning the 32-store reduction hasn't significantly damaged customer access. Most importantly, the cost structure is now aligned with a lower sales base, creating operating leverage that will magnify any revenue recovery.

Valuation Context

At $8.46 per share, Sleep Number trades at an enterprise value of $1.13 billion, or 0.79 times trailing revenue of $1.44 billion. This revenue multiple sits well below Tempur Sealy's 2.89x and above Purple's 0.57x, reflecting the market's skepticism about the turnaround. The EV/EBITDA ratio of 15.29x appears reasonable only because EBITDA has been compressed to $74 million by restructuring costs and sales deleveraging; a successful turnaround would likely see this multiple contract as EBITDA expands.

The balance sheet tells a more concerning story. With a market cap of $192.8 million against $580 million in debt, the equity is effectively a call option on the company's survival. The negative book value of -$22.88 per share and current ratio of 0.19 indicate severe balance sheet stress. However, the company's 60% gross margin and positive return on assets of 1.20% demonstrate that the underlying business can generate economic value if freed from its debt burden and fixed cost structure.

Comparing operational metrics reveals the turnaround opportunity. Sleep Number's 60% gross margin exceeds Tempur Sealy's 42% and Casper's 51%, reflecting genuine product differentiation. The -0.34% operating margin compares unfavorably to Tempur Sealy's 9.32% but favorably to Purple's -5.76% and Casper's -16.65%. The key variable is operating leverage: Sleep Number's cost transformation has removed $135 million in annual expenses, and with each incremental dollar of revenue dropping through at 60% gross margin, a modest sales recovery could drive disproportionate EBITDA growth.

The valuation ultimately hinges on whether the company can generate free cash flow to pay down debt. Management has stated clearly that "our first priority for any positive operating cash flow is to pay down debt." With $82 million in revolver availability and covenant compliance tied to EBITDA performance, the next 12 months will determine whether the equity has value or the debt holders will own the business.

Conclusion

Sleep Number is executing a textbook turnaround: slashing costs, simplifying operations, and securing financing while preparing a product and distribution reset for 2026. The $173 million in cost reductions and 190 basis points of gross margin expansion prove management can control what it can control. The Climate series' success and the 4% increase in average selling price demonstrate that the brand's premium positioning remains intact despite industry headwinds.

The central thesis hinges on whether this cost discipline can buy enough time for the product and distribution initiatives to stabilize sales. The new credit agreement provides runway through 2027, but the covenant schedule demands tangible EBITDA improvement within 12 months. The competitive landscape is unforgiving—Tempur Sealy's scale and margins set a high bar, while digital-native competitors attack with lower cost structures. Yet Sleep Number's proprietary technology, 33 billion hours of sleep data, and 60% gross margins provide real assets to build upon.

For investors, the risk/reward is binary. Downside scenarios include covenant breach, liquidity crisis, and equity wipeout if sales continue declining. Upside scenarios feature operating leverage from a stabilized top line, debt paydown, and multiple expansion as the market recognizes the turnaround. The two variables that will decide the outcome are 2026 sales trajectory and covenant compliance. If Sleep Number can achieve its goal of "stabilizing our top line in 2026 while meaningfully growing adjusted EBITDA and free cash flow," the current valuation could prove a bargain. If not, the cost transformation will have merely delayed an inevitable restructuring.