Select Comfort Corp.: The Shorts May Be Too Powerful

Mattress maker Select Comfort Corp. (SCSS) lowered its sales outlook for the second quarter and full year yesterday, saying its sales and marketing efforts were not providing the traffic boosts it expected. In a regulatory filing, the company said it expects unit and total dollar sales for its second quarter to be about 5 percent lower than a year ago. FY07 EPS went to $0.87-$0.93 (vs previous $1.02) with full year sales to $840 million to $860 million (vs previous $900-$915 million).

- Piper Jaffray notes that following yesterday's mid-quarter update, they are 2H07 sales from $478M to $434M. Same-store sales are tracking near -18%, below PJ estimate of -9%. The company expects same-store sales growth to return during the second half of CY07. Risks to management guidance are decidedly on the downside as PJ expects anemic growth trends to continue during the next six month period and advise shareholders to remain on the sidelines until tangible catalysts exist.

New marketing programs have not been rolled out broadly as expected during the second quarter and management plans a review of the current message to its consumers. Unfortunately, recent marketing initiatives are overly focused on the problem (lack of sleep) and not the solution (cure tired with a Sleep Number Bed). Piper thinks management may focus more on the Brand and benefits of the product, rather than trying to generate demand. They estimate a revision to the current marketing plan may take only 2-3 months to roll-out. The firm is reducing CY07 sales estimate from $891M to $830M (below guidance), and reducing EPS estimate from $1.01 to $0.88.

Piper maintains Market Perform and lowers target to $15 from $19 as fundamentals remain soft and unpredictable.

Notablecalls: This one was expected. Given what we had heard from Bed Bath & Beyond (BBBY) and the fact that the chief marketing officer left in May, there was no doubt in my mind SCSS would come short of expectations. That's also the reason why the stock was down only little over 6% in after hours action. Frankly, I believe SCSS is one of the most economically sensitive stocks out there. With price tags of around $2000-$5000, the beds are expensive, yet SCSS clearly targets the middle class consumer. A bad combo in current economic environment. Hence, the high short interest. I know at least one high profile short-seller that considers SCSS a core short.

Considering SCSS spends 45 cents on every dollar it makes on Sales & Marketing, blunders in this department are not easily forgiven. Yet, I think investors will be somewhat relieved to see CEO Bill McLaughlin step in and take charge.

Don't get me wrong. I like this company. In fact, I think SCSS may initially put together a nice bounce now that the bad news is out of the way. The $264 million repurchase program is huge, just huge compared to SCSS' $800 million market cap. According to the management, the program takes a tiered approach, significantly accelerating share repurchases if the share price declines. They are even prepared to incur debt to repurchase shares. That's bound to lend significant support to the stock price.

I just think that after couple of points of upside, the shorts will show up again, chopping the stock down.

SCSS 1-yr chart