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Yesterday, shares of Select Comfort Corporation (NASDAQ: SCSS ) declined by nearly 2% to close at $24.20 while the S&P 500 rose an impressive 1.38% as news that the government shutdown would come to an end and the United States would avoid a potentially disastrous default. With such good news for investors in the market being released, did it make sense for Select Comfort to decline so much? The answer, normally, would likely be "no". However, after the market closed, the company released an announcement indicating disappointing earnings results for the period ending September 28th, 2013, a sign that the market was expecting at least a minor earnings miss.
According to the press release, the company's earnings per share (EPS) for the quarter declined to $0.36 from the $0.46 it posted for the same quarter a year ago, significantly missing the $0.43 analysts expected. As a result of its decline in profitability, shares of the mattress manufacturer fell more than 26% to $17.86 per share in afterhours trading. For the Foolish investor, this should send off warning bells because it likely means one of two things; either the company's earnings miss warrants a significant share price reduction because the news is acting as a sign that Select Comfort could see tougher times ahead, or that Mr. Market is merely overreacting to the news, which could indicate a buying opportunity for anyone willing to assume some risk.
In an effort to determine the significance of this earnings shortfall on the company's long-term operations, I decided to dig into its press release deeper than just the highlights. What I found suggests that the company does have room for improvement, but also that the story may not necessarily be as bad as it's being made out to be.
Costs Increased Significantly
For starters, while the company did report lower earnings, the reason behind this primarily has to do with two lines in its income statement; cost of sales, and sales and marketing. For the quarter, the company saw its cost of sales grow from 34.9% of sales to 36.9% due to the sale of lower margin products, and higher product returns that management attributed to customers taking advantage of a 100-day free trial on mattresses as opposed to the 30-day free trial it offered in prior years. From the sales and marketing perspective, the company saw its costs rise from 41.2% of sales to 44.9% mostly as the company increased its media exposure in an attempt to garner greater sales figures.
Based on this data, things could be better for the company, but they could also be worse. While its decision to sell a lower margin product line has been counterproductive but potentially unavoidable as the company sees a more challenging environment, the other factors behind its increased costs can be controlled pretty much at will by management. An example of this would be that management has the ability to lower its free trial back to 30 days as opposed to 100 days, while another is its ability to decrease advertising expenditures. This should point out to investors that the company's shortfall in earnings isn't all that terrible since many of the costs associated with the shortfall are reversible moving forward.
But Alas! Good News Does Exist!
Even in spite of disappointing results, there are some upsides indicated in Select Comfort's earnings release. First and foremost is that revenues for the company actually increased by 6.8% from $246.8 million in the third quarter of 2012 to $263.7 million in the same quarter this year. This is mostly chalked up to an increase in store count from 394 locations to 423, though it should be mentioned that same-store sales declined by about 1%.
In addition to increased sales, the company saw its media advertising begin to pay off, with a 34% rise in Internet search volume and a 17% rise in online sales in their media initiative's first three weeks of implementation. Though this news is good, perhaps the most appealing piece of information is that its sleepnumber.com website saw search volume balloon by 76%, which suggests that previously disengaged consumers are open to the idea of buying from Select Comfort.
How Does It Stack Up Against The Competition?
Despite the good and bad news the company has released, we still cannot forget to see how it stacks up to its peers; Mattress Firm Holding Corporation (NASDAQ: MFRM ) and Tempur Sealy International (NYSE: TPX ) .
Although the past four years have been kind to Select Comfort, with revenue increasing 71.8% from $544.2 million to $935 million and net income increasing 119.84% from $35.6 million to $78.1 million in its most recent fiscal year, it falls far short of Mattress Firm. During the same timeframe, Mattress Firm saw its revenue rise an impressive 133.1% from $434.4 million to $1.01 billion, while its net income moved from a loss of $4.7 million to a profit of $39.9 million.
Tempur Sealy also performed well, but less well than its competitors. Over the same four-year timeframe, it saw its revenue rise by 68.8%. In addition, its net income over that same time horizon rose only 25.6% as its costs of sales as a percentage of total sales have weighed heavily on the company's bottom line.
As we can see, not everything in Select Comfort's recent earnings release is doom and gloom. While it is true that the company reported an earnings miss, it is possible that the market is overlooking the good news that accompanied the bad. Regardless of the situation, it may be too soon to rush for the exits, as an improvement in margins and increased sales in the future (both driven by a change in the company's strategies and media initiatives) isn't out of the question.
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