Smith Leonard Furniture Executives 2007 Annual Summary

Furniture World Magazine

Overview Based on the results of our annual survey of residential furniture manufacturers and distributors, shipments in 2007 were 5.11 percent lower than shipments in 2006. Shipments in 2006 were 4.01 percent lower than shipments in 2005, which were up 3.3 percent from 2004. The 5 percent decline was in line with our monthly statistics reported in Furniture Insights which has some differences in participants. The upholstery group fared better than the case goods participants – reporting a decline of 1.87 percent after falling 3.93 percent in 2006. Our case goods participants fell 10.2 percent in 2007 after a 4.28 percent decline in 2006. The miscellaneous category fell 3.97 percent. According to our monthly survey, shipments in 2007 were off in every month compared to the same month of the prior year. Also, according to the monthly survey, 70 percent of the participants reported lower orders compared to 2006 and 76 percent reported lower shipments. Just over 25 percent of the participants reported a decline in shipments of 10 percent or more. For comparison, 60 percent of the participants reported lower shipments in 2006 compared to 2005. The trend has continued into 2008 with new orders down 8 percent for the first four months. Shipments are also down 7 percent compared to 2007. Based on our conversations with various people in the industry, the results have not improved through the early part of July. Last year at this time, we had hoped that we would begin to see some leveling off of the declines, since comparing to weak prior year results should have made it easier to halt the declines. So far, that has not happened this year. While the overall economy seems to be bumping along, the factors that affect furniture sales have mostly been negative. Gasoline and oil prices are having a major negative impact on consumers as they are not only paying more for gas, but also paying more for most everything they buy on a regular basis. The housing results continue to trend negatively although many in that industry expect that housing may have hit bottom. But even if housing is at the bottom, it will take a while for this market to settle down. There is a significant amount of inventory of both new and used homes that will likely keep prices down. A big piece, we believe, of the housing problem is not only the foreclosures (which clearly do not drive furniture sales) but also the fact that so many homeowners, who were allowed to obtain mortgages they can barely afford, found that while they may still be able to make their mortgage payments, they do not have much disposable income. And if they did, that is now being used for higher gas, food and other staples, leaving little room for furniture. Overall this economic news for consumers has led to some of the worst consumer confidence ever. June 2008’s report, according to the Conference Board’s report, was the fifth lowest reading ever. We need to keep in mind that furniture is still being sold and a lot of it. But total furniture sales have not been increasing overall. We think of it like this. The furniture sales pie is only so large and may be shrinking somewhat. Today, though, we have so many more people who are putting furniture into the pie (primarily Asian based manufacturers). We also have so many more people taking a bite out of the pie (more and more channels of distribution – according to Joe Carroll at Furniture Today – now over 80 channels). All of this seems to mean less business for many of the players. On a positive note (admittedly not many), there are some players that are performing reasonably well in spite of the slow business, and based on key statistics, there are some companies out there that have adjusted and are still making decent money. Not as much maybe as they need to be for investing the way they might want to in their businesses, but still making money. 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 improved in upholstery, offset by a slight decline in case goods, resulting in a small improvement in operating income overall. Gross profit margins improved from 19.27 percent in 2006 to 20.84 percent in 2007. Operating profits (gross profit less selling and administrative expenses) improved to 3.79 percent from 3.37 percent in 2006. 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 similar. Gross margins improved to 21.56 percent from 20.43 percent. Operating margins improved to 4.50 percent from 3.65 percent in 2006. Case Goods In the case goods category, gross profits decreased to 23.92 percent in 2007 from 24.23 percent in 2006. Both-year participants’ gross profits increased slightly to 24.49 percent from 24.25 percent. Operating income declined 4.31 percent from 5.90 percent in 2006. The decrease was created by lower margins, higher selling costs and higher administrative costs. Both-year case goods participants’ operating profits were even at 5.36 percent, reflecting the slight increase in gross margins and a small decrease in selling costs, offset by higher administrative costs. The flat operating income was mixed among the both-year participants. One half of the both-year case goods participants reported an increase in operating profits while one half reported decreased operating income. Approximately 58 percent of the participants reported higher gross margins. Most of those participants had increased selling costs while 83 percent of the participants reported increased administrative costs. Upholstery In the upholstery category, results were positive. Overall, the gross profit margin increased to 18.93 percent from 16.45 percent in 2006, and operating profit margins rose to 3.45 percent from 1.98 percent in 2006. Similar results were reported among the both-year participants. Gross margins increased for both-year participants to 19.66 percent from 17.75 percent. Operating margins improved to 3.91 percent from 2.44 percent. The improvement in operating margins was caused primarily by the 1.9 percent increase in gross margins offset by a very slight increase in selling expenses of 0.1 percent and a .33 percent increase in administrative expenses. Last year the gross profit percentages seemed very low, but were skewed by several participants who reported very low margins. This year margins were more in line with expectations, though still not in the 20 plus percent range where they need to be. It should be noted that approximately 73 percent of the both-year participants reported gross margins of 20 percent or more versus 60 percent last year. Some 41 percent of the both-year participants reported operating profits of 4 percent or more compared to 43 percent last year. Approximately 64 percent of both-year participants’ gross profit margins improved versus a 65 percent decline last year. Approximately 55 percent of the participants reported improved operating profits. While the operating profits are not where they need to be, it was nice to see so many of the participants reporting improvements in spite of lower volumes. Gross Margins In case goods, the decline in gross margins for both-year participants was attributable to a 2.3 percent increase in material costs as a percent to sales, a .16 percent increase in labor costs and a 2.7 percent decrease in overhead costs. The increase in material costs in 2007 was somewhat across the board as 75 percent of the participants reported increases. We expect that much of the increase related to higher volumes of imports as imported products at full value are reported in material costs. In addition, material costs in general were up most of the year. Direct labor was up slightly, most likely caused by the significant decrease in shipments (8.44 percent for both-year participants). Overhead was also down significantly reflecting the shift to more imported products and some plant closings. We suspect that these changes in percentages will continue. The 9.16 percent labor costs compare to 14 to 15 percent even as late as 2002 and reflect several plant closings due to decisions in some cases to move totally off shore. The reason for the decline in overhead reflects less employee benefits and other overhead costs as production is shifted, as well as the effects of plant closings for some of the participants. Even closings announced in 2006 may have had lingering effects on 2006 overhead costs. In upholstery, the improved gross margins for the both-year participants of 1.91 percent followed a 0.8 percent decline last year. The improvement was primarily attributable to a 0.6 percent decline in material costs, a 0.35 percent decrease in labor costs and a 0.96 percent decline in overhead. Overall, most of the changes in the components of costs of sales were not that significant but each of the pieces added to a nice overall improvement. Other Factors Factory payrolls, as a percent to sales, declined from 16.15 percent to 15.53 percent in 2007. In case goods, the percentage was 12.79 versus 14.84 in 2006, while upholstery was up slightly to 17.2 versus 16.91 in 2006. For both-year participants, the change was less as the case goods percentage fell from 14.23 in 2006 to 13.31 in 2007 and upholstery’s percentage fell from 17.88 to 17.14 in 2007. We expected the decline in case goods with increased imports. The decline in upholstery was partially due to the decline in direct labor, which also may have been affected by imported finished goods and kits, along with right sizing by some companies. Shipments per factory employee decreased slightly. Participants increased in the case goods category to $209,000 from $169,000 last year. Shipments per factory employee in upholstery fell to $151,000 versus $169,000 last year. Most of the increase in case goods was likely related to more imported product—allowing more products shipped with fewer employees. Operating profits per factory employee increased in 2007 to $6,378 last year from $5,696. For both-year participants, operating profits per employee were $7,827 in 2007 compared to $6,003 last year. The results between categories were somewhat different. In case goods, operating profit per factory employee decreased from $9,959 to $9,017 in 2007. In upholstery, operating profits increased to $5,199 from $3,343 in 2006. Working capital declined 0.07 percent after a 4.04 percent increase last year with the ratio of current assets to current liabilities declining slightly to 3.28 from 3.31 to 1 last year. The change was not considered significant. The change results from profits and depreciation adding to working capital while capital expenditures and long-term debt payments reduce working capital. Inventories decreased 7.94 percent after a 10.12 percent decrease last year. Inventory turns declined slightly from 5.09 times in 2006 to 4.72 in 2007, even after the reduction in inventory levels. Case goods turns declined slightly to 3.28 versus 3.53 in 2006, while upholstery turns were 6.25 times versus 6.53 last year. The decline in inventories was primarily a result of adjusting to lower volume levels and continued effects of direct shipments to retailers, increasing shipments without carrying inventories. The return on equity improved this year. Returns on equity were 10.29 percent in 2007 versus 6.20 percent in 2006, still quite below the 12.08 percent in 2002. Days sales in receivables were again very good for the year. Days sales (average daily sales divided into year-end receivables) were 40.76 in 2007 compared to 39.92 last year. Upholstery was 39.63 and case goods slipped from 38.86 to 43.46 days. National The overall economy slowed down in 2007 and continues to slow in 2008. The Real Gross Domestic Product (GDP) grew 3.9 percent in 2004, 3.2 percent in 2005, 3.3 percent in 2006 and 2.2 percent in 2007 according to the U.S. Bureau of Economic Analysis. In the fourth quarter of 2007, the growth rate was 0.6 percent. In the first quarter of 2008, the growth rate was 1.0 percent. The Conference Board’s Index of Leading Economic Indicators has declined 0.7 percent during the six months ended May 2008 after an increase of 0.1 percent in May following a small increase in April. Four of the ten components advanced in May. The positive contributors were interest rate spread, stock prices, manufacturers new orders for consumer goods and materials and manufacturers new orders for nondefense capital goods. The stock market since May 2006, has been very unstable but generally was on the rise until October 2007. Since then, the market has lost about 20 percent based on a variety of reasons—a new one almost every day. It seems that almost any news causes significant changes. The Dow has fallen to 11,300 after a high of over 14,000 October 2007. This compares to a 13,900 range about this time last year. With the recent plunge, the unstable markets continue to have a negative impact on consumer spending and now apparently affecting the high end of furniture. Consumers are not comfortable with their retirement and investment accounts declining. That tends to make consumers think twice about spending or adding to their debt loads, especially for deferrable purchases such as furniture. Our hope is that we will get rid of some of the negatives from political campaigning, but with the weak dollar and the price of oil, we are not sure when the market will show signs of recovery. Housing Existing Home Sales Sales of existing-home sales increased in May with buyers responding to lower home prices, according to the National Association of Realtors® (NAR). Existing-home sales – including single-family, townhomes, condominiums and co-ops – increased 2.0 percent to a seasonally adjusted annual rate of 4.99 million units in May from a level of 4.89 million in April, but are 15.9 percent below the 5.93 million-unit pace in May 2007. Single-family home sales rose 1.6 percent to a seasonally adjusted annual rate of 4.41 million in May from 4.34 million in April, but are 14.5 percent below the 5.16 million-unit pace in May 2007. The median existing single-family home price was $206,700 in May, which is 6.8 percent below a year ago. The national median existing-home price for all housing types was $208,600 in May, down 6.3 percent from a year ago when the median was $222,700. Lawrence Yun, NAR chief economist, said there’s still a lot of inventory in the market. “The large supply of homes on the market clearly favors buyers, and it should take several months to draw the inventory down,” he said. “Stabilization in home prices can only occur with buyers returning to the market, so we are encouraged by rising home sales, particularly in distressed markets. Foreclosures and short sales appear to be a larger part of the market, particularly in California, and are creating a drag on current home prices.” Total housing inventory at the end of May fell 1.4 percent to 4.49 million existing homes available for sale, which represents a 10.8-month supply at the current sales pace, down from a 11.2-month supply in April. “Keep in mind that the volume of home sales is the primary driver of economic activity that is tied to housing,” Yun said. “It’d be premature to say the improvement marks a turnaround. The market is fragile, so a first-time home buyer tax credit and a permanent raise in loan limits would be important steps to get the housing engine humming.” New Home Sales The June report from the U.S. Census Bureau indicated that sales of new one-family houses in May 2008 were at a seasonally adjusted annual rate of 512,000. This level was 2.5 percent below the revised April rate and was 40.3 percent below the May 2007 estimate of 857,000. (April results were 42 percent below April 2007.) The median selling price of new homes sold in May 2008 was $231,000 with the average at $311,300. The seasonally adjusted estimate of new houses for sale at the end of May was 453,000. This represents a supply of 10.9 months at the current sales rate, up from 10.6 months last month. Housing Starts The U.S. Census Bureau reported that privately owned housing starts in May were at a seasonally adjusted annual rate of 975,000. This was 3.3 percent below the revised April estimate and is 32.1 percent below the May 2007 rate of 1,436,000. Single family starts in May were at a rate of 674,000 which was 1.0 percent below April 2008. As with new home sales, the weakness was similar in all regions. Consumer Confidence The Conference Board Consumer Confidence Index which had declined in May, fell further in June. The Index now stands at 50.4 (1985 = 100) down from 58.1 in May. The Present Situation Index decreased to 64.5 from 74.2. The Expectations Index declined to 41.0 from 47.3 in May. Lynn Franco, Director of The Conference Board Consumer Research Center said, “This month’s Consumer Confidence Index is the fifth lowest reading ever. Consumers’ assessment of present-day conditions continues to grow more negative and suggests the economy remains stuck in low gear. Looking ahead, consumers’ economic outlook is so bleak that the Expectations Index has reached a new all-time low. Perhaps the silver lining to this otherwise dismal report is that Consumer Confidence may be nearing a bottom.” Unemployment Nonfarm payroll employment decreased 49,000 in May and the unemployment rate was up to 5.5 percent (4.5 percent at this time last year), according to the Bureau of Labor Statistics. Healthcare added jobs, while employment declined in construction, manufacturing and retail trade and temporary help services. Average hourly earnings rose 5 cents, or 0.3 percent, over April rates. Inflation According to the Bureau of Labor Statistics, the Consumer Price Index for all Urban Consumers (CPI-U) for May 2008 increased 0.8 percent before seasonal adjustment. The May level was 4.2 percent higher than in May 2007. On a seasonally adjusted basis, the CPI-U increased 0.6 percent in May following a 0.2 percent increase in April. The index for energy, which was basically unchanged in April, increased 4.4 percent in May. The index for petroleum-based energy advanced 5.8 percent and the index for energy services increased 2.3 percent. During the first five months of 2008, the CPI-U rose at a 4.0 percent seasonally adjusted annual rate, compared to a 4.1 percent increase for all of 2007. Petroleum-based energy costs increased at a 13.9 percent annual rate in the first five months. Retail Sales U.S. retail and food services sales for May, adjusted for seasonal variation and holiday and trading-day differences, increased 1.0 percent from April and were 2.5 percent above May 2007 according to the U.S. Census Bureau. Retail trade sales were up 1.0 percent from April as well and were 2.2 percent above last year. On an unadjusted basis, sales at furniture and home furnishings stores were off 4.1 percent from May 2007 but were up 7.3 percent over April 2008. Year-to-date, sales at these stores were off 4.4 percent. Last year at this time, sales at these stores were reported to be up 3.0 percent. Other Thoughts on Furniture These are turbulent times for the industry as a whole. As we previously mentioned, based on our survey, most of our participants have positive operating results and some have some pretty decent results. That is good news with business being off so much in total. The national economic news, though overall described as sluggish, has not been good for furniture. We continue to see retail failures and failures continue to occur at the manufacturing and distribution levels as well. We also have heard of several failures in Asia. The balancing decisions on how much to produce domestically versus imports, especially in case goods, continues. Changes, especially in China, are affecting the costs of imported goods in a big time way. The gap between pricing from China and domestic pricing continues to narrow. We think that once the economy picks back up and consumer confidence begins to rise, some of the remaining domestic players should benefit. Will domestic come back like the old days? We doubt it. But we do believe there is still demand for domestic products in both case goods and upholstery. As the gap continues to narrow, this demand should improve for those remaining. Retailer Profits We have noted for some time now that retailer profits have been squeezed in several ways. Selling cheaper products at lower prices has meant less gross profit dollars to cover substantial fixed expenses. Since lower prices generally do not cause the consumer to buy two dining room suites, or two sofas, or two master bedroom suites, it is hard to make it up on volume, especially when the competitor down the street is also selling at reduced prices. In addition, the fixed costs continue to rise, utility expenses continue to rise and in fact, with gas prices up, it costs more to run the delivery truck with 20 percent less volume. Many retailers have continued to be hurt by buying direct from foreign suppliers. In the old days, the retailer bought what he/she thought was the minimum quantity they would need, then ordered more if the sell through was good. Now, lured by lower prices, they buy containers. If the goods don’t sell through, they are stuck. Manufacturers have several distribution channels to rid themselves of overstocks. Retailers have one and that is generally the clearance center, which eats even more into profits. In addition, if they buy split containers, if sell through is good, they have to wait for replacements, sometimes disappointing customers, or worse yet, losing an order. Manufacturers’ and Distributors’ Profitability From the results of our survey, it appears that most companies who are into importing in a big way have finally figured out that the cost of importing is not just about landed costs. These companies have begun to realize that dealing with quality, overstocks and discontinued goods is expensive. Also, the costs of having people on the ground in foreign countries to ensure quality is expensive. Add to that the costs of trips overseas for various personnel adds even more cost and is also draining on the executives making the trips. We were pleased to see that many of the participants have improved their gross profit percentages to account for some of these costs that were not considered for the most part in the early days of importing. Finally At the April High Point Market, we heard a significant amount of conversation about raising prices. We believe it’s about time and hope that the price increases are enough. We even heard that several retailers were even glad to see increases as they have begun to realize the effects of selling everything on the cheap. To survive in today’s world, suppliers, manufacturers, distributors and retailers have got to charge enough for their products to make a reasonable return on their investment. All companies have to make enough to invest in new technologies, the right people and advertising to help drive business. We have said over and over that it is a shame that we all sell on price, when most consumers have no idea what a piece of furniture should sell for. In last month’s Furniture Insights, we said that we hope all in the supply chain will raise prices somewhat to sustain profitability. Then, when the consumer confidence returns and the economy gets stronger, maybe we as an industry can make reasonable profits. We realize that, as a fragmented industry, getting everyone on board is not easy. But we also believe that those who don’t make a reasonable profit, will not be here tomorrow when business improves. Our point is this, if you are having trouble selling enough at current prices, at least you should try to make a decent profit on what you are selling. We were reminded recently a comment attributed to Paul Broyhill. It goes something like this – “Demand for furniture never changes; the consumers’ ability to buy changes.” We think that certainly describes the period we are in right now. ___________________________ This report has been re-published with the permission of Smith Leonard PLLC an independent member of the BDO Seidman Alliance. Firm Profile: Founded in 1930 by BDO Seidman, LLP, the High Point, North Carolina practice was recently acquired by four individuals who have spent the majority of their 100+ year careers building the existing practice. Beginning January 1, 2007, Smith Leonard PLLC became an independent member of the BDO Seidman Alliance. Partners are Ken Smith, Darlene Leonard, Jon Glazman and Mark Bulmer. Among the firm's 32 employees are 18 CPAs. Service Area – Smith Leonard concentrates primarily in the Triad, but also services companies with domestic locations throughout North Carolina, Virginia, South Carolina and Texas. Smith Leonard has an extensive network of international relationships that helps service their clients’ needs throughout the world with locations in Asia, Europe, South America, Mexico and Canada. These companies range in revenue size of $2 million to $300 million. Practice Concentration – The majority of the client base is composed of manufacturing and distribution companies. Many of its clients are either furniture manufacturers, distributors or suppliers to the furniture industry. Smith Leonard also services companies in retail, transportation, insurance, not-for-profit entities and employee benefit plans. Smith Leonard offers a full range of accounting and consulting services including audits, compilations, reviews, tax planning and compliance. The partners and staff of Smith Leonard also assists clients in mergers, acquisitions, business consulting, cash flow projections, and tax outsourcing. Individual clients benefit from extensive experience in family wealth services including estate tax planning. The firm continues to produce monthly and annual statistics for the furniture industry. For more information call (336) 883-018 or e-Mail: ksmith@smithleonardcpas.com.