Select Comfort Corporation Business Information, Profile, and History

Company Perspectives:

Once Upon A Time ... Over a decade ago we started a revolution in sleep. We knew there had to be a better way to build beds. A way that didn't rely on inferior methods like metal springs or water. We knew there had to be a way to give people (including ourselves) a better night's sleep. We found the answer in Air. Our revolutionary Select Comfort Air Beds are the result of endless research and testing.

History of Select Comfort Corporation

Select Comfort Corporation, the industry leader in air bed technology, designs, manufactures, and markets a line of mattresses with adjustable firmness, mattress foundations, and sleep-related accessories. Through aggressive marketing, Select Comfort carved out a niche for air mattresses but remained well behind the pack of four industry-leading mattress makers.

Seeking Sound Sleep: 1987-91

Seeking a better night's sleep, Minneapolis businessman Robert A. Walker designed a new mattress. On the outside, it looked like a conventional mattress, but the inside was filled with a series of adjustable air chambers instead of steel springs. Walker spent more than a decade, working out of his garage, perfecting the air bed and recruiting friends to test it for comfort. Having worked for a mattress maker in the 1960s, Walker approached bed manufacturers with the product, but they were not interested. Stymied, Walker now had to put some other experience into play. During the 1980s he had helped other inventors bring product to market.

Walker sold his mattresses directly to department stores and other retail outlets, but they proved to be slow movers. First of all, retailers carried the mattresses of a number of name brand manufacturers, many with multimillion-dollar advertising budgets. Customers asked for those products by name. In addition, salespeople generally were accustomed to pitching low prices, not high customer benefits--Walker's new style of mattress appealed to higher-income people with back problems. From 1987, the founding year of Select Comfort Corporation, to 1991, annual sales remained below the $1 million mark and losses piled up.

On the upside, the mattress received national attention through articles in Bedroom and Playboy magazines and as a prize offering on the 'Wheel of Fortune' game show. On the other end of the spectrum, purchases by the U.S. military for troops fighting in the Gulf War and serving elsewhere overseas provided about 50 percent of sales--the collapsible bed was economical to ship.

Walker, in a February 1991 Star Tribune article, touted his mattress as an 'evolutionary step in bedding,' claiming it provided a better cushioning than either springs or water. Even though the founder remained confident in the quality of his product, the company itself was running out of air. Cash-starved Walker needed to sell more mattresses. They retailed for $400 to $1,000.

Venture Capital Money Broadens Distribution: 1991-93

When Walker realized that Minnesota-based NordicTrack had hit the jackpot through direct marketing, he started looking for backers to make the switch. The cross-country ski exercise machines had cracked a venue traditionally confined to low-price items. Walker felt that his bed, which could be shipped entirely by UPS, would find market success this way as well. After several attempts, Walker finally sold the controlling interest in his company to a group of three venture capital firms. Lead investor Minnesota-based St. Paul Venture Capital Inc., along with Cherry Tree Ventures, also in Minnesota, and Connecticut-based Consumer Venture Partners put down $4.6 million, according to a 1993 Corporate Report Minnesota article recounting the 1991 sale.

The new owners hired consumer products manager Mark L. de Naray to run the company; Walker stepped aside as CEO and president but remained on as vice-president of research and development. De Naray had last worked for Canadian-based Magic Pantry Foods and Minnesota-based Pillsbury. 'The last thing we needed was someone from the mattress industry who would bring a traditional approach,' St. Paul Venture Capital's Patrick A. Hopf recalled in a 1995 Twin Cities Business Monthly article. 'It's a traditionally sleepy industry used to selling commodity products for low prices. Ours is a product that features a totally new way of sleeping, and our whole marketing thrust is one featuring benefits.'

Ads hit national newspapers and magazines in November 1991 and produced an immediate growth spurt. The new management group realized that, despite the positive gains, about half its potential market just would not buy a bed sight unseen, regardless of informational videos and a 90-day return policy. Select needed some retail outlets. At first, upscale mall owners were reluctant to bring in a store selling a single brand of mattress: it just was not done. Beds were sold in furniture stores or department stores. The company opened a kiosk in a suburban St. Paul shopping center in 1992. The test run was a success--the kiosk drew hundreds of shoppers. Additional venture capital money allowed Select to open more kiosks and small retail showrooms, including one in the gigantic Mall of America. Sales well exceeded that elusive million-dollar mark in 1992.

At year end 1993, the number of company-owned retail outlets reached 18, including kiosks. Sales were $13.6 million, or triple the previous year's $4.4 million. Direct marketing accounted for 80 percent of the figure, primarily gleaned through ads in more than 100 consumer magazines, according to a 1994 Minneapolis/St. Paul CityBusiness article. To support the growing retail side of the business, Select began looking for its first ad agency. Select faced some barriers to gaining a significant share of the $5 billion mattress market, including perceptions that air beds were merely recreational items for swimming or camping.

Telemarketing and retail sales efforts were supported by strong word-of-mouth referrals. Select encouraged this by offering customers $50 for each referral that resulted in a sale. Referrals accounted for ten percent of annual revenue.

Pumped Up Expansion Drive: 1994-98

Since 1991, nearly $12 million in venture capital&mdashout half from St. Paul Venture Capital--had been pumped into the company. An additional $6 million in venture capital came in during the third quarter of 1994 to help drive expansion. By the end of the year, Select had 35 company-owned permanent stores, and sales had more than doubled to $30 million.

Inc. magazine placed Select in the number 69 slot on its 1994 list of the nation's fastest-growing private companies. Yet Select held less than one percent of the mattress market. Sealy, Simmons, Serta, and Spring Air brands controlled nearly 60 percent. Major air bed competitor Comfortaire, established in 1981, generated sales of nearly $20 million. Other air bed marketers were selling beds originally designed to hold water but then converted to air when the market peaked.

Eager to broaden awareness of its product, Select experimented with a number of marketing techniques. The company displayed beds at the Twin Cities international airport. Bed and breakfasts and small hotels used Select Comfort mattresses and offered customers the chance to view a video about the bed. There were infomercials and radio personality endorsements. Select Comfort 'road shows'--displays and presentations in hotels--tested the potential for retail outlets in other cities.

During 1994 and 1995, Select made the move from a small entrepreneurial company to a large business. The board membership was indicative of the direction the company was heading. It included: Ken Macke, former Dayton Hudson CEO; John Scully, former chair of Apple Computer and PepsiCo; Tom Albani, president and CEO of Electrolux; and David Kollat, former president of Victoria's Secret. In addition to opening stores at a rapid pace, Select developed new products and line extensions, such as a wireless remote firmness control system and a lightweight mattress foundation.

Mid-year 1996, Select opened its 100th store. The company held the number six spot on Inc.'s fastest-growing list. On the year, sales topped $100 million. For the first time, retail matched direct sales, each at 45 percent; road shows brought in the remaining ten percent. Select Comfort President and CEO De Naray left the company a few months into the new year. Under his leadership, Select Comfort had become the fifth largest U.S. mattress maker, as well as the third largest bedding retailer, operating 145 stores in more than 40 states and employing well more than 1,000 people.

Overall, most of the 800-plus domestic mattress manufacturers remained small, community-based operations, and an estimated 90 to 95 percent of them produced inner spring mattresses. Water beds, futons, adjustable beds, and air mattresses comprised the remaining five to ten percent. The top four manufacturers still controlled about 60 percent of the estimated $7 billion market. Trying to take a bite out of their share of the pie, Select earmarked $28 million for a national ad campaign during 1997. The company also opened a second manufacturing plant. The South Carolina operation was positioned to serve not just the Southeast but the whole East Coast.

Select Goes Public: 1999

Sales leaped to $184 million in 1997 and then to $246 million in 1998. Select stood poised for a public offering. The company planned to use the proceeds to pay down some long-term debt, add retail stores and a third manufacturing/distribution plant, and, possibly, acquire other business operations. Select sold four million shares of stock at $17 per share in the January 1999 initial public offering (IPO). Charles Schwab & Co., as a first time co-manager for an IPO, used its own version of direct mail to bring aboard investors. The brokerage mailed more than a quarter million postcards to Select Comfort customers who also had Schwab accounts. According to a January 1999 Business Week article, the technique helped boost the proceeds.

Select Comfort also broke some new ground when it established an e-commerce subsidiary in April 1999, becoming the first major mattress maker to do so. Selectcomfort.com planned links to furnishing stores and health/wellness web sites. In another development, Select was making an entry into Bed Bath & Beyond stores. The lease agreement allowed for up to 150 Select Comfort departments in various superstore locations by the end of 2001. Unfortunately, the feeling of optimism surrounding the company was about to end.

Select Comfort's stock price had risen by 50 percent within a month of its offering. 'Analysts love the firm, with a universal `buy' rating among those who follow it,' wrote Adam Weintraub in a 1999 CityBusiness article. But Select management changes and aggressive plans to overtake the industry leaders coupled with media reports questioning the validity of Select's 'good night's sleep' studies resulted in shareholder jitters. The stock dropped below its offering price by mid-May.

Downplaying the stock woes, Select pushed forward. The company was about to move from six to 16 retail markets. A new sofa sleeper product was on tap--Select had invested $2 million in the manufacturer. But Select Comfort was not going to rest easy. Select stock fell again, to less than half its offering price, after the company announced a drop-off in sales growth and possible second quarter losses. Some stockholders filed lawsuits against the company, claiming management had been aware of the downturn earlier but withheld the information. Select denied the claims.

Making its second top management change in a three-month period, Hopf took over as interim CEO. The company managed to show a slight profit in the second quarter, but overall sales rose by only nine percent, down from 22 percent the previous quarter.

Strategically, Select had begun to depend on advertising to drive sales in the slow growth market--on average people changed homes more often than mattresses. The company spent around $32 million, or an equivalent of about 15 percent of sales, on advertising in 1998. By comparison, Sealy spent $15 million or two percent of its $891 million in sales, according to a 1999 Star Tribune article by Susan Feyder. Select projected ad budgets of $45 million for 1999 and $70 million for the year 2000. On a side note, other air bed makers benefited from the product awareness Select created with its advertising dollars.

Select Comfort stock dropped off again in the wake of third quarter losses. The company brought in outside consultants to help turn things around by tackling problems with product positioning, marketing, and distribution. Select also implemented a stock repurchase plan.

New Game Plan for Year 2000

Near year-end 1999, Select was still without a permanent CEO. Hopf said the company was considering offering lower-priced beds through wholesale channels. Although sales of mattresses costing more than $1,000 were on the rise, the high-end segment produced less than 12 percent of total industry sales. The largest manufacturers sold the majority of their product through furniture stores and bedding specialty stores.

Late in December, Select announced a strategic change in business operations and marketing. 'I think the realization was that maybe we had the wrong goal,' Hopf said in a December 1999 Star Tribune article. 'Our goal should really be to maximize shareholder value. If we can do that by having slower sales growth but increasing profitability, that's the way we should go.'

A slowdown in store openings, some store closures, deemphasis of the slogan 'the air bed company,' a new focus on technology, plus wholesale distribution comprised key elements of the new game plan. The store openings pullback was of particular significance since rapid expansion had been a key part of the company's goal to overtake the four industry leaders. Select opened 194 outlets in 1997, 54 in 1998, and 47 in 1999. A planned 45 openings were scaled back to 15 for 2000.

Select ended 1999 with stock trading in the $4 to $5 range. The company changed its ticker symbol in early January 2000 to SCSS ('Select Comfort Sleep Solutions') from AIRB to coincide with the change in strategic direction. Net sales of $273.8 million represented an increase of 11 percent over 1998, but the company reported a net loss of $8.2 million or 45 cents a share in 1999. The company netted $5.2 million a year earlier. Store closings and consulting fees contributed to the deficit. Comparable store sales rose an anemic five percent on the year versus 24 percent in 1998.

Keeping a watchful eye on competition--big mattress makers were starting to roll out their own air beds--Select filed a patent infringement lawsuit against Simmons and the maker of an air bed with hand controls. In early 2000, the larger company agreed to end its licensing agreement for the product. Select held 24 issued or pending patents in the United States.

Select Comfort faced the new millennium with 341 retail stores, including 45 leased departments in the Bed Bath & Beyond stores. During 2000, Select planned to expand home delivery and assembly capability, continue the rollout of sleeper sofa products, remodel some existing stores, and possibly expand its online venues. Cris Carter, a six-time pro-bowl player for the Minnesota Vikings, had signed an endorsement agreement--the company had used other sports figures for promotion in the past. Investors, shareholders, and management alike would probably be tossing and turning, waiting to see if the new plan would produce a check in the win column.

Principal Competitors: Sealy Inc.; Serta Inc.; Simmons Co.; Spring Air Co.; Park Place Corporation (Comfortaire).

Chronology

• Key Dates:

• 1987: Select Comfort Corporation is formed to make and sell air beds.
• 1991: Inventor/founder sells controlling interest to a venture capital consortium.
• 1992: Retail stores are added.
• 1996: Company opens 100th store and tops $100 million in sales.
• 1999: Initial public offering of Select Comfort stock.