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BEDTIME BONANZA

Select Comfort rises from slumber, turning profit and opening stores

BY KAREN M. KROLL

It is doubtful that executives at mattress store chain Select Comfort were sleeping any too well not so long ago, given the company’s net losses for 1998, 2000 and 2001. They’re surely snoozing more soundly now, though: Sales last year soared 36 percent from 2002, hitting $458 million.

“They’re one of the real success stories of 2003,” said Robert A. Michaels, president of General Growth Properties. “It was a breakaway year for Select Comfort.”

The Minneapolis-based chain of 343 stores plans to open between 25 and 30 new stores this year and to keep growing at the rate of about 10 percent of its store base annually, says Keith Spurgeon, senior vice president of sales.

Select Comfort is the manufacturer and primary retail channel of the Sleep Number bed, a mattress with adjustable firmness (hence the “sleep number” moniker) that uses air chambers rather than coil springs.

Select Comfort says it holds 5 percent of the $8 billion mattress market that is dominated by four manufacturers: Sealy, Serta, Simmons and Spring Air. Together, those four control about 80 percent of the market, says Steve Denault, senior research analyst at Craig-Hallum Capital Group, Minneapolis (Craig-Hallum makes a market in Select Comfort securities.)

Low consumer awareness combined with high expenses were behind Select Comfort’s poor showing, company officials say. Many people assumed the company’s products were just for elderly people or those with back pain, says Spurgeon. President and CEO Bill McLaughlin, who took over in March 2000, is determined to change that image and much besides to sustain the company’s revival. (Before joining Select Comfort, McLaughlin was head of the international division of Plano, Texas-based snack-food company Frito-Lay.)

“He’s been the chief architect of the turnaround,” said Laura Richardson, principal of equity research at Boston-based Adams, Harkness & Hill. (Select Comfort is an investment banking client of Adams, Harkness.)

Select Comfort plans to expand its store base by 10 percent a year, opening units in malls and lifestyle centers.

McLaughlin shut a plant and call center, strengthened the company’s just-in-time manufacturing processes and moved the corporate staff to less expensive offices. He and his colleagues negotiated with suppliers to stretch payments and reduced the use of pricing discounts and promotions.

In June 2001 management worked with Select Comfort’s bankers to raise $11 million in a private investment in public equity deal. Later that summer the company raised an additional $5 million in subordinated debt.

Equally important, McLaughlin focused on marketing improvements. “He bet the company on our ability to communicate the concept of the Sleep Number and the benefits of better sleep,” said Spurgeon. The advertising budget, which was $30 million in 2001, grew to $40 million in 2002 and to $60 million in 2003; it will probably reach $80 million this year.

“The beds appeal to baby boomers with aching backs,” said Paula Rosenblum, retail research director at AMR Research in Boston.

There’s nothing cheap about the mattresses. A king-size costs more than $2,000, similar to a top-line traditional coil-spring mattress.

“It’s a product that needs marketing, because it’s so expensive,” said Dane F. Smith, CLS, Dallas-based senior vice president of leasing at The Macerich Co. (Select Comfort’s price points are similar to those on higher-end traditional mattresses.)

Select Comfort stores do well in middle- as well as upper-middle-income areas in spite of the price tags, say industry analysts and landlords.

“It’s pretty much a concept that goes across the board in terms of the regional malls we have,” said General Growth’s Michaels. Select Comfort has stores in about half of the 160 malls General Growth owns and/or manages.

“While the vast majority of our stores are found in traditional malls, we believe that our differentiated product and powerful marketing position us as a destination retailer,” said McLaughlin. “Therefore, we believe that nonmall locations can be successful, and we are currently testing them in several markets.”

The average store measures between 1,000 and 1,200 square feet and brings in about $1 million in revenue. Some stores do better. In the company’s home base of Minneapolis and St. Paul, stores generate about $2 million to $3 million in annual revenue, with one topping $4 million.

In the future, company executives will look further at lifestyle centers, says Spurgeon. The chain is currently represented in two of them: The Shoppers at Arbor Lakes, Maple Grove, Minn.; and The Shops at Boardwalk, Kansas City, Mo.

“We regard that as possibly an exciting growth venue,” Spurgeon said. These lifestyle center stores are a bit bigger, about 2,000 square feet, to capture shoppers’ attention. As a result, the company is able to showcase a larger selection.

At this point, in addition to the major markets, Select Comfort stores can also be found in a few smaller ones, such as Little Rock, Ark., and Boise, Idaho.

From here the strategy is to “fill in major metro areas in order to leverage our marketing dollars,” said Spurgeon. The company opened five stores in the Boston area last summer, after closing one existing unit.

“We go in and aggressively add stores and support them with full advertising,” said Spurgeon. “We’re seeing tremendous results,” he adds, though he declined to provide numbers. Neither will he identify the specific cities Select Comfort is eyeing. He did say, “New York, Los Angeles and Chicago are key markets for all retailers, and we haven’t finished our program in any of those cities.”

Sleep Number beds are also available at about a dozen Bed Bath & Beyond and 55 Sleep Train stores in California and 22 Sleep America outlets in Arizona. “It’s a good way to supplement where we don’t have store coverage and a good way to leverage our marketing,” said Spurgeon. In addition, customers can order these beds online or through the QVC shopping channel, which, together, account for about 15 percent of sales, he says.

How much could Select Comfort reasonably grow? Richardson of Adams, Harkness says 600 stores is doable, and company officials second that. At its planned annual growth rate of 10 percent, Select Comfort is likely to hit that number by 2010.

Not everyone is as sanguine about Select Comfort’s ambitions, however.

“They’re accustomed to operating and marketing in a mall environment,” said Adam Epstein, president of New York City-based consulting firm Site Analytics Co. “Now they’re starting to run out.”

The danger is that the company will have to look beyond ‘A’ centers and risk diluting its brand. It also faces an uphill struggle overcoming people’s tendency to buy coil-spring mattresses, which have a 150-year head start in the market, observers say. Then, too, the price tag could tend to be dissuasive.

Beyond all these, some other company could develop a competing product, though Select Comfort has patented key features of its Sleep Number.

Perhaps investor expectations may be the biggest threat, as Richardson says. “The better you are,” she said, “the more the investing community expects of you.”

In March Select Comfort traded at $26.62 (up from about $10 a year before). Earnings per share were expected to hit 67 to 69 cents, nearly double the 37-cent figure for 2002. And the fourth quarter of 2003 was the company’s 10th profitable quarter in a row, while same-store sales jumped 28 percent. So maybe equity investors have little reason to be disappointed.

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