Cover Story: RETAIL METRICS Is the Industry Performance Short Lived?

May 17, 2022  by HFBusiness Staff in Business Strategy, Industry   

The breakdown of the cost components will always equal the selling price influenced by competition. Interestingly, these distribution channels savings shifts ultimately transfer to the consumer in terms of consumer prices. The typical way of measuring is the consumer price index (CPI). Table A presents the historical furniture CPI compared to all consumer products. The furniture industry has not been able to retain the profit contribution that has resulted from these distribution shifts. This leads to the following thought process, “In 1970 I paid $300 for my sofa and $3,400 for my new high-performance Mustang. Now the price has increased for my sofa to $599, but the Mustang now demands $45,000.”

Currently, as the industry emerged from the pandemic, the pure manufacturer segment is on the negative side of performance as can be seen in Table B. While the external factors of the pandemic contributed to the traditional furniture retailer increasing dollar sales by 32.1% in 2021 from both product and transportation costs resulted in a significant volume variance and 105.6% increase in net operating income. While not being able to satisfy demand, creating a backlog of one to three months, the opportunities to increase gross margin by 2%-3% all of which went to the bottom line. The question remains, what does the future hold, both short term and long term, for the traditional retailer?

 

As the Furniture industry grew over the last 10 years, furniture stores struggled in vain to keep their share of industry growth, bowing to the pressures from online retailers, discount supercenters, and warehouse price clubs to name a few. Then came the COVID pandemic and the furniture industry (and traditional furniture stores in particular) were one of many retail segments to profit from the dramatic upheaval and growth in consumer demand.

Beginning mid-2020 through 2021 the surge in demand brought not only increased sales, but with it the illusive growth in prices that has held the industry back for decades. Between 2012 and 2020, prices for all consumer items grew 13.5%. Meanwhile, furniture prices fell 3.3% during the same period. Then in 2021, prices grew 7% for all consumer items but a significant 17% for furniture products. But prices stabilized in the first months of this year, increasing around 3% for both all consumer items and furniture.

Between 2013 and 2021 (Table A), the industry more than doubled (107%) to $157.8 billion sales in furniture and bedding. Meanwhile, total U.S. furniture store revenues increased 53% to $78.1 billion, about half the growth of the total industry. 2021 was the first year in decades that furniture store sales outpaced the total industry, 25.6% compared to 21.8%. The traditional retailers participating in the retail metrics in this article are as a group performing above the furniture store 2021 growth of 25.6%, increasing revenues 32.1% (Figure 2). See Figure 1. Methodology. The high annual growth experienced by furniture stores in 2021 is against a backdrop of pandemic-impacted lower performance in 2020, especially in the second quarter of the year. In other words, it looks great by comparison, although no one is questioning the ramp up in demand. After sales revved up in the second half of 2020, the 2021 first quarter growth slowed as is the historical seasonal trend. And although, 2021 quarterly U.S. furniture store sales continued to grow over the same quarter of the previous pandemicyear, growth went negative in the third and fourth quarters last year compared to the prior quarter in the year. Meanwhile, our retail metrics participants continued to grow sales over 2020, although at a much slower pace (Figure 3).

Retail Metrics of Participating Traditional Furniture Stores The financials of the traditional furniture retailers participating in the retail metrics tell a story of high 2021 gross profit of 50.3% and double-digit net income of 12.6%. However, this growth was not just driven by improved business performance, but rather increased volumes from higher prices.

The unknown is if these increased sales are caused by the consumer acceptance of the higher prices or the retailer’s confidence to ask for them. The question now is, will the retailer pull back as competition heats up? Price growth has been practically nonexistent for years and no one questions that furniture stores deserve the increases. And the retailer is fully aware that as volume goes down, profits will go down also. Reality began to set in the fourth quarter last year as revenues slowed to 4.3% growth over Q3. Expenses, especially salary increases across the board in sales, delivery, warehouse, service and administration, grew 3X that amount or more over Q3. Net operating income was down -17.8% 2021 Q3 to Q4.

Key Performance Indicators 2021 (Figure 5)

KPIs at their broadest levels, showed dramatic improvement in all areas for the year. The performance indicators registered improvements not seen since HFB began publishing the annual Retail Metrics in 2017. Gross profit was up to 50.4% for the year growing after the first quarter. But the quarterly progress, while still producing double-digit net income, shows a slowing of sales and rising expenses. Retailers will need to buckle their seat belts, so to speak. Performance highlights:

Sales Expense was considerably lower at 22.28% for the year, but should continue to go up as commissions are paid on the backlog. Salaries continued to accelerate throughout the year. General and Administrative Expense (G&A) fell in the second and third quarters, but jumped in the fourth quarter as administrative costs jumped. It is important to note that G&A dollars, which are predominately fixed costs regardless of sales, have not declined in volume growth, just as a percentage of revenue.

Net Operating Income, grew to 15.44% of revenue in the third quarter but fell significantly to 12.17% in the fourth quarter as salaries and expenses rose. The details of each of these indicators are discussed in detail in the graphics that follow.

Above the Line Performance (Table B) Merchandise Returns have been limited, perhaps because the consumer was initially less likely to return an item given the wait-time to order another. However, by the fourth quarter, with warehouse spaces filling up and order cancellations increasing, it became more difficult for some companies to log merchandise returns and the bookkeeping was simply swept under the rug.

Merchandise Protection Sales steadily increased throughout last year. Normally protection sales commissions are paid on delivered sales. However, with retail sales associates selling with almost two months of backlog, retailers acquiesced and began paying merchandise protection sales commissions on written sales. Delivery Income as a percent of sales fell slightly in the fourth quarter. Table B details the above the line performance. Cost of Goods Sold (% of Revenue) (Table C)

COGS declined in 2021 as retailers put higher prices/margins on goods. It remains to be seen whether furniture stores, especially larger retail chains, will have the nerve to hold prices and not start discounting.

Gross Profit on Sales as a percent of revenue is an offshoot of higher prices and stayed consistently above 50% in each quarter (Table D).

Selling Expense (% of Revenue) (Table E)

Advertising/Public Relations. In the three years prior to the pandemic, advertising/ public relations expense hovered just under 6% of total revenue. In 2021 with prices escalating and demand high, advertising expense dropped to under 4% of total revenue for the year with total dollars spent growing 19.5% (Table E). Broadcast/air advertising is still the biggest player in the group controlling 57% of advertising dollars. But broadcast/air spending as a percent of total revenues fell to 2.2% in 2021 compared to 2.5% in 2020. And as a sign of the retailer mindset in 2021, broadcast/air advertising spending continued to fall throughout the year from 2.5% of revenues in Q1 down to 1.98% in Q4. Although internet advertising still represents less than 1% of revenues, the category grew 33.5% in dollars spent in 2021. Spending on internet advertising, as a percent of sales, grew quarter to quarter throughout the year (Table E).

Sales Expense is predominately a variable expense mostly tied to sales volume. It is the only broad expense category that increased as a percent of sales in 2021, from 9.82% of revenues to 9.95% (Table E.) Sales expense was also the only major segment where dollar growth of 33.9%, exceeded sales growth of 32.1% (Table E).

The two major sales expense categories include sales commissions (79% of sales expense dollars) and to a lesser degree sales manager salaries (15% of sales expense dollars). Last year sales commissions grew 36.4% in dollars to 7.6% of revenues and sales managers salaries another 30.7% in dollars to 1.5% of revenues (Table E).

Warehouse/Delivery/Services Expense.

The total merchandise handling expense as a percent of revenues fell in 2021 in all warehouse, delivery, and services categories from 8.09% of revenues in 2020 to 7.56% in 2021 (Table E). However, in the vast majority of cases, the Q4 percent of revenues of each expense item was higher than Q1. The wages and/or contract costs for all handling expense represent about 80% of the dollar volume in the combined categories. Wages and/or contract costs for warehouse, delivery and services categories fell from 6.4% of sales in 2020 to 6.1% in 2021, but grew 25.4% in dollars.

General & Administrative

Expenses (% of Revenue) (Table F)

G & A Expenses is the largest group of fixed expenses. These accounts are those that keep the doors open, the lights on, and the place running. The category represented 14.92% of revenues in 2021, down significantly from 17.31% in percent of revenue in 2020. In the fourth quarter, G & A expenses, as a percent of revenue, climbed to 15.8% primarily as administrative expenses rose late in the year (Table F).

Information Systems. While representing less than 1% of revenues, computer specialists, equipment and software are vital components to running a business. Costs as a percent of revenues remained relatively stable throughout 2021 (Table F). Occupancy Expense. All segments of the Occupancy category -- Rent/Lease, Utilities, Real Estate/Property Taxes and Building Maintenance and Repairs fell as a percent of revenue in 2021, which goes straight to the bottom line. Coming off the pandemic, rents and lease agreement had not yet been renegotiated as all commercial real estate continued to be in a state of flux. Building maintenance and repairs increased the most in actual dollars, up 18.5% over 2020 (Table F).

Administration Expense. As a whole, administration expenses fell in 2021 compared to 2020, 9.21% to 8.33% (Table F). But this decline only lasted through the third quarter, then jumped significantly in the Q4, up from 7.45% in Q3 to 9.59% in Q4. The biggest jumps for the year were in salaries at 11.3% growth over 2020 dollars and insurance, up 22.3% (employee) and 48.6% (company insurance). Human Resources. At less than 1% of revenues, HR expenditures fell slightly as a percent of revenue in 2021 (Table F). Net Credit Expense (Table G) Credit expense (net of credit income) fell slightly as a percent of revenue in 2021 to 2.64%, continuing to decline each quarter (Table G).

Net Income (Table H) Double-digit net income reached its peak in the third quarter at 15.57% before falling to 11.70% in 2020 as revenues fell to 4.3% growth in dollars over Q3, while expenses far exceeded that increase.

PERFORMANCE BY RETAILER SALES RANGE

The traditional furniture retailers participating in this Retail Metrics article have been subdivided by annual sales ranges to offer a perspective on how the small, medium, and larger retailers managed expenses last year. The three ranges include retailers with revenues less than $25 million, $25 to $75 million, and $75 million and over. The first group represents high performing smaller retailers as well as Mom and Pop stores who have been also to survive in the economic climate of the last few years. The second group ($25 to $75 million) are single high performing stores or in some cases smaller chains. The final group ($75 million and over) are larger multi-store retailers. Figure 6 provides the detailed financial performance.

Key Performance Indicators (% of Revenue) (Figure 7)

Not surprisingly, the larger retailers $75 million and over in sales had the highest new operating income as a percent of revenues at 13.4% followed closely by mid-sized retailers ($25 to $75 million in sales) at 13.3%, and the smaller group under $25 million at 12.0%. Each of the KPIs in Figure 7 are discussed in more detail below. Above the Line (% of Revenue) (Table I)

Mid-sized retailers either had significantly more returns, or as a group they did better than their larger and smaller furniture stores logging them in (Table I).

Gross Profit on Sales

(% of Revenue) (Table K)

Smaller retailers had the highest gross profit at 51.87%, primarily due to reporting the lowest merchandise costs. Gross profit for mid-sized retailers was the lowest of the groups at 49.5%. This is primarily due to the merchandise returns discussed above along with higher freight costs, compared to the smaller and larger groups. The larger retailers finished between the two smaller groups at 50.42% gross profit on sales in 2021.

Selling Expenses (% of Revenue)

Smaller firms had by far the highest Selling Expense (24.85% of revenues) in every category – advertising, sales expense, warehouse/delivery/service and store sales expense impacting their lower net profit. Mid-sized retailers fared the best with Selling Expense of 19.53% of revenue. Larger firms were at 22.67%.

General & Administrative Expenses (% of Revenue)

(Table M) Mid-sized retailers as a group had by far the highest occupancy costs at 7.37% of revenues, compared to 5.70% for smaller firms under $25 million in sales and 4.93% for larger firms $75 million (Table M).

Net Credit Expense (Net of Credit Income) (% of Revenue)

For larger firms over $75 million in sales, credit expense exceeded credit income (Table N). Net Income Before Interest and Taxes (% of Revenue) While smaller firms under $25 million had the lowest net income at 11.83% compared to 13.93% for retailers $25 to $75 million and 12.01% for larger firms $75 million and over, no matter the size, these companies rode the wave of high consumer demand, higher prices, and double-digit profits in 2021.

Comparing Distribution Channels and a Look to the Future

While pandemic-fueled top-line growth has been nothing short of sensational for most publicly traded furniture manufacturers and retailers, the bottom line has been a different story – especially for manufacturers.

The costs of raw materials, notably foam and lumber, have been going up faster than producers can implement price increases in their system. In some instances, producers have reported getting price increases after an order has been placed at a lower price. That has caused some dicey discussions between manufacturers and retail customers who were quoted a price for their order based on the producer’s “old” raw materials costs.

“For the past five quarters, we have sought to combat ceaseless raw material and ocean freight increases with wholesale price increases of our own,” Bassett Chairman and CEO Robert Spilman said in a recent earnings announcement. “Unfortunately, our spiraling costs coupled with late shipments from our suppliers have eroded our wholesale margins as we continue to produce goods today with higher material costs than they had when the finished goods were sold months ago.” Spilman and other executives say freight increases are not limited to the cost of shipping containers – although those costs have more than quadrupled since the pandemic began. They say the higher costs also are coming from the ports, freight forwarders, domestic trucking companies and railroads, to name just a few. “All of them, to varying extents have … probably taken advantage of the current environment and started implementing either new charges or raising prices on existing charges,” Derek Schmidt, Flexsteel’s chief financial officer, said during a recent conference call with securities analysts.

The majority of Flexsteel’s products are imported, and Schmidt said the company rapidly built-up inventories throughout 2021 so their dealers wouldn’t run out of stock.

During the first quarter of Flexsteel’s fiscal year ending June 30, for example, he said the company brought in an average of 880 containers per month. That has been slashed to 250 to 300 containers per month in the first half of 2022. That will dramatically reduce freight costs, but still keep inventory levels sufficient to service dealers, Schmidt said.

“We feel that we can slow things up and still maintain really, really good service levels, he added. “We are also aligning ourselves with what we believe are the strongest, most capable freight forwarders who can effectively manage this.” Flexsteel’s numbers for the quarter ended March 31 suggest the strategy is working. After recording a net loss of $7.55 million in the previous quarter, the company swung to a profit of $5.32 million, and gross margin rebounded to 15.7 percent from 6.7 percent in the quarter ended Dec. 31. In both quarters, sales rose nearly 19%.

But Flexsteel President and CEO Jerry Dittmer noted the company still is not out of the logistics maze, noting that the most recent quarter’s operating income of $5.81 million was about 8.5% below the figure recorded in the quarter ended March 31, 2021.

“Although supply chain conditions, including logistics, remain tumultuous, our team has deployed multiple strategies to navigate cost pressures and effectively service customers despite the turbulence. In the second quarter, ancillary costs associated with ocean container logistics adversely impacted our earnings results, but we reduced those costs by over $10 million in the third quarter through sustainable process improvement and stronger alignment with preferred logistics partners,” Dittmer said. Competitors Bassett and La-Z-Boy are experiencing the same supply chain issues, of course, but because those companies own dedicated retail stores and are less reliant on imports than Flexsteel, their bottom lines have remained in the black.

For the quarter ended Jan. 22, La-Z-Boy recorded a 22 percent increase in sales to $571.6 million, while net income of $29.1 million was essentially even with the comparable quarter. Consolidated operating margin fell to 6.9 percent from 7.3% in the comparable period.

“While delivering an improved top line, the quarter was marked by greater-than-expected supply chain volatility, which had significant near-term impact on the efficiency of our manufacturing capacity ramp plans, dampening delivered sales growth and profit margins. A shortage of component parts, record levels of COVID absenteeism in January, and the challenge of hiring and training new employees at manufacturing facilities all contributed to the issues we faced as the quarter progressed,” said Melinda Whittington, president and CEO.

But Whittington also believes the supply chain issues are not long-term headaches, and says the company is continuing to make strategic investments to increase market share and drive long-term profitable growth. “Our number one priority is to improve the agility of our supply chain in this high-demand environment to increase production more quickly and efficiently,” she said. Bassett, meanwhile, saw sales rise 15.9% to $117.9 million in the quarter ended Feb. 26, and operating income rebounded with a 16.5% gain to $6.48 million, or 5.5% of sales. In the comparable quarter, operating income of $5.56 million also represented 5.5% of sales. Net income, meanwhile, jumped nearly 39% to $5.57 million or 57 cents per share. The most recent quarter reversed several quarters of declining operating income, but Spilman cautioned that supply chain issues and cost pressures have not gone away. “The aforementioned vulnerability that we have experienced regarding cost pressure remains frustrating. As we wind down our backlog over the upcoming months, the relationship between our invoice price and our production costs will more closely align,” he said, noting that the company recently implemented its sixth wholesale price increase for its upholstery lineup in the past 15 months.

The brightest spot in Bassett’s most recent quarter, however, was its companyowned retail stores. Profits tripled to $3.5 million as the stores achieved higher gross margins and were able to increase the volume of deliveries as the company’s factories whittled down their backlogs. Another legacy public company, Hooker Furnishings, is riding out the supply chain issues and increased costs in a different way. Its top line has taken a major hit in recent months because its Home Meridian division simply can’t get enough product. Home Meridian’s factories in Vietnam and Malaysia were shut down for months in the summer and fall, and they’re still having trouble catching up. The dilemma also has hurt sales in the company’s Hooker Branded segment, whose product line also is imported. Hooker’s consolidated sales fell 13.2% in the quarter ended Jan. 30, as a doubledigit sales gain in its Domestic Upholstery unit was more than offset by a 23.7% sales decline at Home Meridian and an 11.8% drop in sales at Hooker Branded.

“While we anticipate that production of imported goods will reach 100% capacity sometime during the first quarter of fiscal 2023, as we forecasted last quarter, we won’t feel the full impact of higher production until the second quarter,” said Jeremy Hoff, CEO.

Going forward, Hoff said the Domestic Upholstery and Hooker Branded segments will be “less challenged than Home Meridian” because about 70% of Home Meridian’s sales are container-direct at lower price points, which are more negatively impacted by freight costs that have tripled in the past year. However, he believes Home Meridian’s warehouse business is poised to improve because of the company’s new distribution center in Savannah, Ga.

“Incoming orders and backlogs continue to be strong in most divisions,” said Hoff. “We are concerned about ongoing global logistics constraints and economic headwinds affecting the consumer that could impact short-term demand, such as inflation, high gas prices and the war in Ukraine.”

Vertically integrated Ethan Allen, on the other hand, is weathering the supply chain storm with double-digit top- and bottom-line increases. Farooq Kathwari, the company’s long-time chairman, president and CEO, said in a recent earnings statement that the company’s verticality, coupled with mostly North American production, provides the leverage to offset many of the cost headaches.

“We were able to achieve strong margins despite an environment with escalating commodity and freight costs, product shortages, price increases and shipping delays. We are working to expand our North American manufacturing, whereby 75% of our products are made,” Kathwari said in a statement announcing earnings for the quarter ended Dec. 31. In the quarter, Ethan Allen’s retail sales leaped 24% to $179.6 million, while wholesale sales were up 14.2% to $115.9 million.

Pure-play retailer Arhaus, the furniture industry’s newest public company, is still experiencing enormous sales gains – based on the limited financial information available thus far – while the bottom line has suffered only minimally from the supply chain disruptions. Sales for the quarter ended Dec. 31 leaped 46.3% to $238.2 million its 77 brick and mortar stores and e-commerce platform performed impressively. Net income for the quarter was $8.34 million, up from just $442,000 in the same quarter in 2020. For the 2021 calendar year, sales jumped 57% 62.1% to $796.9 million and net income was up seven-fold from 2020. “2021 was a monumental year for Arhaus,” said John Reed, co-founder and CEO of Arhaus. “In addition to our record financial performance, we achieved significant operational accomplishments this past year including the opening of a nearly 500,000 square-foot distribution center and upholstery production facility in North Carolina, the start of a 230,000 square-foot expansion of our distribution and corporate office facility in Ohio, the launch of a new website to enhance our client experience and analytic capabilities, and our transition to a public company.” Arhaus went public last November, and another relative newcomer to the world of publicly traded furniture stocks is Lovesac, which sells its casual ready-to-assemble modular sofas and sectionals sofas direct to consumers and through retail stores. Lovesac’s top-line and bottom-line growth, in fact, resembled Arhaus in 2021. Sales for the quarter ended Jan. 31 rose 51.3% to $196.2 million, while net income was up 50.4% to $32.6 million. And for the year ended Jan. 31, sales jumped 55.3% to $498.2 million and net income was up more than 200% to $45.9 million.

In the most recent quarter, the company said sales jumped 59.8% at its retail showrooms, which include mobile concierges and kiosks, while internet sales rose 22.8%. In addition, comparable-store sales from its retail showrooms leaped 72.6%.

“Lovesac’s continued strong financial performance in the face of a myriad of macro and industry shifts affirms the power of our unique business model and products,” said Shawn Nelson, CEO. “Importantly, the key distinguishing attributes of this model, which include operational flexibility, highly engaged customers, innovation and a proven omni-channel approach, will only grow stronger over time as our progress along the product adoption curve steepens and word of mouth continues to gain strength. This curve will benefit further from deep stock positions that allow us to deliver and execute for our customers in a more timely manner, leading to further share gains and solidified customer loyalty.”

Also recording healthy revenue growth in recent months – not to mention some of the biggest operating margins in the home furnishings industry – is RH, the retailer formerly known as Restoration Hardware. Revenue for the fourth quarter of 2021 grew 11% – a small increase historically but jumped 32% to $3.76 billion for the 2021 calendar year. Gross margins were 50.5% for the fourth quarter and 49.4% for the year, while operating margins were a staggering 24.1% and 24.7%, respectively.

RH continues to set a new standard for financial performance in the home furnishings industry and our results now reflect those of the luxury sector as adjusted operating margin reached 25.6% in 2021, up 1,130 basis points versus 2019, reflecting the strongest two-year growth in our sector,” CEO Gary Friedman bragged in a recent letter to shareholders. “Our performance demonstrates the desirability of our elevated and exclusive product range, the connective power of our evolving ecosystem, the profitability of our fully integrated business model and the significant strategic separation created by our inspiring physical spaces.”