In its 2020 10-K, Sleep Number (SNBR), a mattress brand that prefers to describe itself as a sleep solutions and services firm, disclosed that it discounts operating leases by 6.9%. This rate is significantly higher than its mattress and retail peers, which report the following discount rates in their most recent filings:

-Tempur Sealy: 4.9%
-Culp: 2.51%
-Big Lots: 6.2%

Using an inflated discount rate hide’s a firm’s true liabilities from investors.

Sleep Number reports $427.1 million in future operating lease obligations. The present value of those obligations, according to Sleep Number, is $345.2 million. However, the footnotes reveal $91 million in future lease obligations Sleep Number simply chooses not to count. The company seems to suggest keeping the liability off balance sheet is appropriate because the leases haven’t yet started:

“Total operating lease payments exclude $91 million of legally binding minimum lease payments for leases signed but not yet commenced.”

This treatment appears inconsistent with FASB’s guidance on the topic. If a lease is legally binding— as Sleep Number acknowledges— Topic 842 (ASU 2016-02) makes clear that it must be accounted for on the balance sheet:

“A lessee should recognize in the statement of financial position a liability to make lease payments (the lease liability)...”

If we add this liability back and use the blended average discount rate for Sleep Number’s peer group— 4.53%— we calculate a lease liability of $418.3 million. It means Sleep Number is understating its lease liabilities by approximately $72.8 million, or 14% of its future operational lease obligations (includes $91 million add back) or 7% of total liabilities.

The 6.9% discount rate is especially high when you consider Sleep Number’s borrowing costs fell in 2020. The company’s borrowing cost— its weighted average credit facility interest rate— is 1.5%. Investors who believe the inflated discount rate reflects poorly on management’s judgment may find the company’s product development claims just as suspect.

Separately, Sleep Number is also warning investors not to place undue reliance on its product development claims. In its 2019 10-K, Sleep Number offer boilerplate warnings regarding the types of statements that qualify as Forward Looking Statements:

“... any statements regarding proposed new products, services or developments…”

In its 2020 10-K, Sleep Number adds new language that may cause investors to more closely scrutinize the bold claims to come:

“...services or developments, including potential features of our products that may be developed in the future…”

The new language is of particular interest as the annual report is littered with new or language seemingly aimed at convincing investors that it is no longer a bed company, but a sleep-tech firm that leverages data and technology. In the most recent 10-K, Sleep Number adds or emphasizes the following language:

“Sleep science” is mentioned 12 times, up from 2 the prior year
“Innovation” is mentioned 40 times, up from 28 the prior year
“Life-changing” is mentioned 5 times, up from 2 the prior year
“Proprietary” in regard to technology is mentioned 9 times, up from 6 the prior year

Likewise, the company touts it has collected “more than 19 billion data points from...real-world sleepers” and that it has “...leveraged and learned from nine billion hours of sleep data gathered from more than one billion sleep sessions.”