Furniture Executives, 2005 Comparative Annual Summary

Furniture World Magazine

Furniture Executives, 2005 Comparative Annual Summary After a rebound year in 2004, with growth at 5.5 percent for residential furniture manufacturers and distributors in our survey, 2005 provided some more growth in shipments—3.3 percent—according to our monthly surveys of these companies. Our annual survey, which has some difference in the make up of participants, indicated a growth rate of 3.0 percent, so the results were very similar. New orders in the monthly survey were up 2 percent. The upholstery group led the way in the annual survey with shipments increasing 4.4 percent, while the case goods group was up only 0.5 percent. The smaller group in the miscellaneous category increased almost 7.0 percent. As with 2004, the first half of the year was better than the second half, with overall shipments up slightly over 5 percent. That growth rate fell to 2.8 percent in the third quarter and was only 0.5 percent in the fourth quarter. As we have noted in Furniture Insights, there has been a wide range of results among the participants. Some 38 percent of our participants reported an increase in shipments for the year. This compared with 56 percent reporting increases in 2004. Many of the participants reported double-digit increases for the year, although there were those who also reported double-digit declines as well. About 40 percent of the participants in the monthly survey reported increased orders. For the first quarter of 2006, new orders increased 5 percent compared to the first quarter of 2005, while shipments were up 2 percent for the quarter. Based on recent conversations, business has been “spotty” at best. Some retailers had good Memorial Day sales, but others complained that the holiday sales were not good at all. Forecast Our latest projections indicate a growth in shipments of about 3 percent for 2006. These projections anticipate a growth rate in shipments of about 1.4 percent in the first half of the year. In the second half, shipments are projected to increase just over 5 percent. The last half of 2005 leading into 2006 has been an interesting time. While housing has finally started to calm down, prices remain high. With consumers buying larger, more expensive homes, while rates were low, the mortgage payments are generally higher. Add that to higher gas prices, and consumers do not have the disposable income that they had before. Consumer confidence has not been that strong, especially when looking to the future. In addition, as we have discussed before, consumers are now spending $75 to $400 a month, or more, on cell phones, internet connections, satellite radios and TV connections, cable, etc…all monies that most families were not spending a few years ago. And, these expenses are much deeper in the economy than they have ever been, as almost all families now have one or all of the above. These bills, just like mortgage payments, which are higher, utility bills (also higher due to larger houses), come every month. It used to be that a family could buy a new TV and pay for it over three to six months, and then buy something else. The cost of the items noted above are not going away and are taking $900 to $5,000 away from families’ ability to buy furniture. With all that said, furniture continues to be sold. There is no doubt that imports continue to affect the dollar amounts of furniture being sold. The number of pieces is likely up much more than the dollars. In addition, the prices of imports continues to put pressure on domestic producer prices as well, forcing prices down and keeping price increases from what they need to be. With furniture purchases deferrable, consumers can just wait until they see another deal at so much off. And we as an industry have not figured out yet how to make consumers “want” to buy. Without such desire, they will continue purchasing when they “have” to and to wait on the sales. Key Statistics Summary The results for the annual operating statistics were interesting this year. While there were some changes in participants, the overall results for profitability were less than desirable in certain categories. Gross profit margins increased slightly from 21.47 percent in 2004 to 21.64 percent in 2005. Operating profits (gross profit less selling and administrative expenses) fell from 5.26 percent to 3.69 percent. As with our surveys in the past, we have some changes in participants. In order to provide more meaningful comparisons from year-to-year, we break out some of the results for those who participated in both years (referred to as “both-year participants”) in order to have better comparisons. For both-year participants, the results were a little different. Gross margins fell slightly from 21.55 percent to 20.72 percent. Operating margins declined from 5.03 percent to 3.50 percent. Case Goods In the case goods category, gross profits increased to 25.16 percent in 2005 from 22.69 percent in 2004. Both-year participants’ gross profits increased to 22.92 percent from 21.43 percent. Operating income decreased to 5.36 percent from 6.39 percent in 2004. This was a result of better gross margins offset by higher selling expenses. Both-year case goods participants’ operating profits increased to 4.98 percent from 4.05 percent, reflecting the increase in gross margins offset by higher selling expenses. The slight increase in operating income was mixed among the both-year participants. Approximately 60 percent of the both-year case goods participants reported an increase in operating profits while 53 percent reported increased gross profit margins. Again this year, there were several participants that reported negative operating margins, but most either improved their results or turned them around. Upholstery In the upholstery category, results were also somewhat mixed. Overall, the gross profit margin decreased to 19.55 percent from 20.65 percent in 2004, but operating profit margins fell from 4.56 percent to 2.71 percent. Similar results were reported among the both-year participants. Gross margins decreased for both-year participants to 19.58 percent from 20.68 percent. Operating margins declined, falling to 2.77 percent from 4.50 percent. The decline in operating margins was caused primarily by the 1.1 percent decline in gross margins and an increase in administrative expenses of 0.56 percent. Almost one-half of the percent of both-year participants’ gross profit and operating profit margins declined. This marked two years in a row that at least half of the participants reported declines in both categories. Gross Margins In case goods, the improvement in gross margins for both year-participants was attributable to a 1.3 percent decrease in material costs, a 1.5 percent decline in labor costs offset by a 1.3 percent increase in overhead costs. The decline in material costs in 2005 of 1.3 percent offset part of the increase of 2.3 percent in 2004. We are not sure of the reasons behind this, as a majority of the participants (60 percent) actually reported increased material costs. We suspect that some of the decline may have been attributable to plant closings and discounts given in 2004 in an effort to flush excess inventories. If discounts were higher in 2004, this also would have tended to make labor costs as a percent to net sales higher. And, as we have seen for several years, increased imported products will drive down direct labor costs as the mix of imports versus domestic product shifts towards imports. The reason for the increase in overhead was not clear as over one-half the participants reported declines in overhead as a percent to sales. Some of this increase may be attributable to higher outgoing freight costs for those companies who now report freight revenues in sales and freight costs in cost of sales (based on the new accounting rules in effect for the last few years). In upholstery, the decline in gross margins for the both year-participants of 1.1 percent was primarily attributable to an increase in materials costs of 1.7 percent offset by a reduction in labor costs of 0.96 percent. The increase in material costs, we suspect, was primarily attributable to higher costs of petroleum based products (foam, certain fibers and fabrics, etc...) caused by the hurricanes and some by the effect caused by the importing of more cut-and-sewn covers which would add to material costs and reduce labor costs. The decline in labor would be attributable to the above cut-and-sewn cover issue, as well as some of the increases for material costs that were charged to customers in the form of surcharges for foam and freight. Thus, selling prices were raised for these items, but labor costs would not have increased, causing a drop in labor as a percent to sales. Overhead costs were essentially unchanged. Other Factors Factory payrolls as a percent to sales decreased in 2005 to 16.12 percent from 17.91 percent. There was a decline of 2.5 percent in case goods where those payrolls declined from 17.35 percent to 14.86 percent. The decline was similar with the both-year participants where factory payrolls declined 2.14 percent. These declines were primarily in direct labor, but indirect labor also declined about .5 percent. Upholstery factory payrolls declined from 18.24 percent to 16.87 percent. Both-year participants decreased 1.55 percent from 18.30 percent in 2004 to 16.75 percent in 2005. Again, while most of the decline was in direct labor, there was also about a .5 percent decline in indirect labor as well. We believe that the decline in factory payrolls in case goods as a percent of sales was primarily a result of the impact of imports, with sales of those products increasing, but not requiring the same amount of factory labor. Some of the decline may also be attributable to some plant closings with extra production shifted to other plants. The decrease in upholstery actually brought the percentage back in line with 2003 results. With more cut-and-sewn products coming in and more leather in the mix, we would have expected these percentages to decline. Shipments per factory employee also increased. Both year participants increased in the case goods category to $160,000 from $140,000 last year. Shipments per factory employee in upholstery for both year participants also increased with current year shipments per employee at $160,000 versus $151,000 last year. Overall, shipments per factory employee improved to $158,000 from $147,000 last year. Most of these increases likely relate to more imported product, as well as the increase in shipments—allowing more products to be made and shipped without adding employees. Operating profits per factory employee declined in 2005 from $7,751 last year to $5,839 in 2005. For both-year participants, the results were almost equal, with operating profits per employee at $5,592 in 2005 compared to $7,437 last year. The results between categories were somewhat different. In case goods, operating profit per factory employee fell from $8,968 in 2004 to $8,406. In upholstery, operating profits fell from $6,945 to $4,298 in 2005. Working capital decreased 4.33 percent after a 7.6 percent increase last year with the ratio of current assets to current liabilities decreasing slightly to 2.97 to 1 from 3.16 to 1 last year. Inventories decreased 2.35 percent after a 13.86 percent increase last year. As would be expected, inventory turns improved to 4.52 times in 2005 versus 4.28 in 2004. Case goods turns were about the same at 3.18 versus 3.20 in 2004, while upholstery turns were 5.82 times versus 5.41 last year. The return on equity increased this year. Returns on equity were 7.00 percent in 2005 versus 5.64 percent last year, but still quite below the 12.08 percent in 2002. Days sales in receivables were very good for the year. Days sales (average daily sales divided into year-end receivables) were 40.60 in 2005 compared to 46.29 last year. National The overall economy continues to move along with reasonable growth in the GDP since the second quarter of 2003. The GDP grew 3.0 percent in 2003, 4.4 percent in 2004, 3.5 percent in 2005 and first quarter 2006 estimates indicate growth of 5.3 percent. The Federal Reserve continues to worry that the economy is overheating and have fears of inflation so they continue to raise interest rates. The Conference Board’s Index of Leading Economic Indicators has decreased 0.2 percent during the six months ended May 2006 after a drop of 0.6 percent in May and declines in three of the six months in that period. Three of the ten components advanced in May. The largest negative contributor was the decline in housing permits. The stock market performed well in 2005, but since May 2006, has been very unstable. Lately it seems that anything from a broken fingernail to a fifty-cent change in a barrel of oil causes a significant change in the market. The Dow reached a high of over 11,600 in early May, then dropped below 11,000, but recently has climbed back to the 11,000 range. The unstable markets continue to have a negative impact on consumer spending. Consumers are not seeing their retirement accounts growing as they did before. That tends to make consumers think twice about spending or adding to their debt loads, especially for deferrable purchases such as furniture. Housing The housing market has finally begun to cool down. The year 2005 was another record- breaking year for housing sales. Most expected a cooling down period in 2005, but it did not materialize. Most expect to see 2006 reflect slower sales after several record-breaking years in a row. The first few months of the year are showing that trend. With interest rates edging up, the cooling off has been expected. Meanwhile, the second-home market continues to expand. The National Association of Realtors has reported that they expect the housing market to trend lower in the second and third quarters before rebounding in the fourth. Even with some slower sales, housing sales are still expected to remain at very strong levels. Home prices have continued to rise, which has some concerned that there may be a bubble in pricing. Consumer Confidence Consumer confidence, as measured by the Conference Board’s Consumer Confidence Index, rose steadily from October 2005 to April 2006 where it reached a four-year high, but fell in May. The Index at the end of May was 103.2, down from 109.8 in April. In May 2005, the index stood at 102.2. For comparison, prior to 9/11, the index was in the 115-range. The Present Situation Index in May decreased to 132.5 from 136.2. The Expectations Index fell to 83.7 from 92.3 in April. Last year in May, the Expectations Index was at 92.5. The Conference Board’s report indicated that while the Expectations Index was below last year’s levels, the current levels seem to signal economic growth in the months ahead. Lynn Franco, the Director of The Conference Board Consumer Research Center noted that, “apprehension about the short-term outlook for the economy, the labor market and consumers’ earnings potential has driven the Expectations Index down to levels not seen since the aftermath of the hurricanes last summer. In sharp contrast, consumers continue to rate current conditions favorably, although the Present Situation Index also lost ground this month (May). Looking ahead, the Expectations Index bears close watching, as it is often a harbinger of times to come.” Unemployment The unemployment rate in May 2006 stood at 4.6 percent. This compared to a 5.1 percent range at this time last year, 5.6 percent in 2004 and the mid 6 percent range in 2003. There have been gains in non-farm employment for all of 2005 and to-date in 2006. There continue to be major plant closings—in and out of the furniture industry. As plants continue to close, most reports have been concerned that much of the job growth has been in lower paying jobs. Still, the good news is that we are continuing to create jobs. As far as the industry is concerned, the Bureau of Labor Statistics noted that the industry lost over 27,000 jobs in North Carolina from 2000 to 2005. This was before recent announcements of closings by Thomasville, Lexington and Broyhill. Inflation The Consumer Price Index for All Urban Consumers (CPI-U) was at 202.5 in May 2006 and was 4.2 percent higher than May 2005. Most of the inflation pressures so far this year have related to oil prices. Unfortunately, oil goes into many products other than gasoline for vehicles. In addition, rising gasoline prices affect freight costs as well. The Federal Reserve continues to worry about inflation and has continued raising interest rates during 2006. Most expect rates to continue to increase in late June and again in August, probably a quarter point at a time. Overall inflation does not appear to be a significant issue, at least not fears of high levels of inflation as most of the inflationary pressures have been energy related, including transportation. Unfortunately, the prices at the pumps take money out of consumers’ pockets and reduce dollars available for other consumption. Other Thoughts on Furniture We made the following comment last year and believe it continues to hold true: “Furniture continues to be sold at retail. One of the tough issues relates to what impact that is having on residential furniture manufacturers. As more and more manufacturers import product and attempt to balance production versus importing, it becomes much more difficult to really gauge how U.S. companies are performing. We expect that balancing-act to continue. As it does, profitability is hurt as decisions are made as to how much domestic production a company will eventually have. As those decisions are being made, plants are likely to be run at less than capacity. Until plants are shuttered to allow more capacity to be used, or until more business is obtained to fill up the factories, profitability will be negatively affected. In addition, the cost of closing plants is not cheap.” While there are fewer and fewer case goods plants left to be shuttered, we think the closings in 2005 did impact the results. Also, the shift of some upholstery companies to imported cut-and-sewn covers or fully upholstered pieces continues to be a work in progress. So far, not that many upholstery plants have been shuttered due to imports. Retailer Profits We believe many retailers have determined that direct importing is not as favorable as it once seemed. We continue to hear more and more stories of being stuck with too much merchandise or quality and delivery problems. When these products are ordered and do not sell, retailers do not have channels to dispose of them. So they must go through clearance centers or deep discounted sales. This creates pricing issues with other products. In addition, many retailers have noted lower profits due to selling more and more lower-priced goods. Since the fixed costs are the same and margin dollars are down, profits have been squeezed. We have heard certain retailers complain that their delivery trucks, when full, have 15 to 20 percent less dollars on them than they had in the past. Since the costs to warehouse and deliver are the same, profits take a hit. Manufacturers’ Profitability Many companies have shifted to at least some importing, whether parts, cut-and-sewn covers or finished products. Most have indicated that they believe margins on these goods have improved. We know in our discussions that many importers have tried to increase these margins from the early days when it was believed that, if one did not have to worry about manufacturing inefficiencies, you could sell on a smaller margin. We think that many distributors are now realizing that the cost of imported product is much more than landed costs. Most have also seen that it is also more than just quality problems and the hassle of dealing across the ocean. Quality issues, overstocks, travel and costs associated with customer issues are very hard to measure. We find that most companies have not fully determined how much these costs really are. Anyone who has not yet ordered containers of product that did not sell through and had to be disposed of at prices below cost should be prepared to deal with that cost sooner or later. We have heard of some that have lost serious dollars with this issue. We have even talked with some who have abandoned their cut-and-sew imports programs due to the same types of issues related to overstocks or items not selling through. As we continually discuss in our monthly newsletter, Furniture Insights, while the overall business has not been that bad, it has been spotty at the retail level. Several manufacturers and distributors are continuing to grow at double-digit rates, while others are declining. With growth expected to be only at a 3 to 4 percent level, once again it is all about market share. A lot of furniture is being sold. As we always say, it’s not about selling all of it…it is about getting your share. Our econometric model forecasts growth for the residential furniture industry through 2007. The model is based on actual results through the first quarter of 2006 and may be adjusted based on future results. The forecast by quarter is as follows (in millions), with comparisons to 2004 and 2005. Quarter - 2004 - 2005 - 2006P - 2007P 1 - $6,379 - $6,628 - $6,744 - $7,080 2 - 6,657 - 7,068 - 7,148 - 7,516 3 - 6,392 - 6,569 - 6,847 - 7,184 4 - 6,692 - 6,723 - 7,122 - 7,447 Total $26,120 $26,988 $27,861 $29,227 P = Projected Household furniture shipments in 2005 increased approximately 3.3 percent according to our monthly survey. Estimated annual shipments for the last five years, as well as percent change from the prior year in current dollars, follows: Year - Volume (millions) -Increase compared to prior year 2005 - $26,988 - 3.3% 2004 - 26,120 - 5.5 2003 - 24,757 - (1.4) 2002 - 25,110 - 2.5 2001 - 24,507 - (9.5) Below is a summary of the key indicators for 2005. We continue to add new participants, which affects some of the statistics. While the change in participants did have an impact on certain line items, the overall results seem consistent with prior participants. Year - Direct Materials - Manufacturing labor - Manufacturing overhead - Total costs 2005 - $50.88 - $10.77 - $16.71 - $78.36 2004 - 50.30 - 12.01 - 16.21 - 78.53 2003 - 49.98 - 11.90 - 17.23 - 79.10 2002 - 46.79 - 13.31 - 17.50 - 77.61 2001 - 45.28 - 14.30 - 18.16 - 77.74 Total manufacturing costs as a percent of sales decreased from 78.53 to 78.36. The decrease resulted from an increase in material costs of .58 percent and an increase in overhead of .50 percent, offset by a decrease in labor of 1.24 percent. Comparing only companies who participated in both years’ surveys (in later comments referred to as “both-year participants”), material costs increased 1.21 percent, direct labor decreased 1.05 percent and overhead increased .68 percent. Within the categories, case goods material costs decreased 1.28 percent for both-year participants. Direct labor was down 1.48 percent while overhead increased 1.27 percent. As discussed earlier, the decrease in material costs was not across the board as some 60 percent of the participants reported increases in material costs. We believe that in late 2004, there was some discounting of excess merchandise in 2004 due to plant closings and attempts to generate sales by some of the participants. Lower selling prices would have caused material costs as a percent to sales to increase. If discounts were higher in 2004, labor as a percent to sales would also have been higher. That coupled with more imported product in 2005 would drive direct labor as a percent to sales down. The increase in overhead may be attributable to higher fuel costs for freight out. Over half the participants actually reported lower overhead, likely attributable to more sales of imported products. For upholstery, material costs were up 1.74 percent for both year participants, labor fell .96 percent and overhead was up slightly. The increase in material costs would likely be attributable to higher costs of petroleum-based products such as foam, poly, certain fabrics, etc…due to the problems caused by the hurricanes. While most companies tried to pass these on either as surcharges or price increases, we know that many of these were not put into effect immediately so the material price increases had to be absorbed by the manufacturers. Also, costs in many cases were changing rapidly so price increases did not keep up. Most companies had to accept the cost of material increases in order to get product. The decline in labor as a percent to sales was likely a result of a combination of factors. If selling prices were raised due to the cost of materials increases, and the cost of direct labor only increased minimally, then the direct labor as a percent to sales would decline. Also, as more imported cut-and-sewn covers were brought in, while the cost of materials might go up somewhat, the cost of direct labor would go down, as that labor would now be materials costs. Overall, 54 percent of the both-year participants experienced an increase in gross profit margins. Approximately 29 percent of the participants recorded a decline of 1 percent or more. The declines were primarily in the upholstery category, as a result of the factors discussed above. The mix of all of the categories resulted in a slight improvement in gross profit percentages of .17 percent for the industry. Both-year participants reported a .83 percent decrease, again primarily in the upholstery sector. Year - Selling - Administrative - Total 2005 - 11.37% - 6.59% - 17.95% 2004 - 10.07 - 6.14 - 16.21 2003 - 9.46 - 6.15 - 15.61 2002 - 9.27 - 6.41 - 15.69 2001 - 9.86 - 6.61 - 16.47 Selling and administrative costs as a percentage of sales increased to 17.95 percent from 16.21 last year. Selling expenses increased 1.30 percent and administrative expenses increased .45 percent. Case goods participants’ selling expenses increased 3.25 percent while upholstery participants’ selling expenses increased only .25 percent. Administrative costs were up .25 percent in the case goods category and were up .49 percent for upholstery. For both-year participants, case goods selling expenses were up .46 percent from last year and upholstery expenses were only up .07 percent. Administrative expenses for both-year case goods participants were basically flat with last year, while upholstery both-year participants were up about a half a point. Percent of sales Year - Income from operations - Incomebefore taxes 2005 - 3.69% - 2.78% 2004 - 5.26 - 3.23 2003 - 5.29 - 3.96 2002 - 6.71 - 6.00 2001 - 5.79 - 5.07 The industry decrease in operating profits made 2005 the lowest year for income from operations since 1993 when it was also 3.69 percent. For both-year participants, operating income fell even further to 3.50 percent from 5.03 percent last year. For case goods both-year participants, operating income increased to 4.98 percent from 4.05 percent. Upholstery both-year participants declined from 4.50 percent to 2.77 percent. Approximately 60 percent of the case goods both-year participants experienced an improvement in operating profits. Over 54 percent of the upholstery participants recorded a decline in operating profits. Year - Inventory turnover(average inventory to cost of sales) 2005 - 4.52 2004 - 4.28 2003 - 4.87 2002 - 4.50 2001 - 4.05 Inventory turns (computed by dividing total cost of sales by the average of beginning and end of the year inventories) increased to 4.52 turns in 2005 from 4.28 in 2004. The case goods category was about the same (3.18 versus 3.20 last year), while upholstery turns increased from 5.41 to 5.82. In the case goods category, direct import shipments to customers will improve the turnover calculation, but we believe that more participants are also carrying more inventories in an effort to better service customers. The overall improvement was primarily attributable to overall reduced inventory levels in 2005. Year - Shipments per factory employee - Change 2005 - $158,231 - 7.3% 2004 - 147,422 - 12.7 2003 - 130,799 - 6.4 2002 - 122,969 - 12.3 2001 - 109,515 - (2.3) Shipments per factory employee in 2005 increased to $158,231. The increase in shipments per factory employee was 7.3 percent following a 12.7 percent increase last year. The case goods category increased 12 percent and upholstery increased 4.4 percent. The results for both-year participants were very similar although slightly higher. Again, the effect of more imported goods and direct shipments to retailers has a positive impact on these results. Year - Number of days outstanding 2005 - 40.60 2004 - 46.29 2003 - 47.15 2002 - 46.71 2001 - 45.58 Days sales in receivables decreased to 40.60 from 46.29 which compares very favorably to recent history. As we reported last year, the demise of some of the larger retailers who demanded longer terms is likely the reason for the decline from the 1998 and 1999 levels of over 50 days. BDO Seidman serves clients through more than 35 offices and 250 independent alliance firm locations nationwide. Their Furniture Industry Services practice publishes Furniture Insights®. For more information go to http://www.bdo.com.