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Ultimate Q1 Loss Widens, Sales Off 2%

Denver — A sales shortfall in February and March, combined with the decision to aggressively reduce inventory before it became discontinued, were the primary contributors to a widening loss at high end specialty A/V retailer Ultimate Electronics during the chain’s fiscal first quarter.

Ultimate reported a net loss of $8.4 million for the three months, ended April 30, compared with a net loss of $1.4 million in the year-ago period.

Sales for the first quarter edged downward 2 percent, dropping to $152.4 million, compared with $155.7 million in the same three months in 2003. Comp-store sales for the three months decreased by 11 percent.

Gross profit margin slipped 31.5 percent from 32.7 percent, primarily due to the impact of SKU reduction in certain categories, a concentrated effort to reduce the amount of product that becomes discontinued inventory and aggressive promotions.

At the same time, expenses climbed dramatically in the first quarter, reaching 40 percent, as a percentage of sales, compared with 34.2 percent year-on-year. The retailer pinpointed fixed general and administrative expenses and payroll increases for a 5.3 percent jump as a percentage of sales in the three months. This was due to lower-than-anticipated quarterly sales, an additional seven stores opened in the second half of last year and increased costs of operating a new MIS. Also, net advertising costs and professional fees increased quarter over quarter.

“While reducing the standing levels of end-of-life cycle inventory and discontinued merchandise during the quarter had a negative effect on profitability, we expect our operating results to benefit in the second half of the year from a more profitable overall level of inventory,” said Dave Workman president/CEO. Ultimate’s inventory finished the first quarter at $113.9 million, an 8 percent increase year-over-year, but no change from the end of the previous quarter.

Workman also said he believes the retailer has resolved most of its remaining MIS issues, and should realize operating efficiencies because of this by the end of the year.

Current sales trends at Ultimate show May comps — called the toughest comparison for the second quarter — were off 6 percent. Given this difficult month, along with the sales initiatives implemented, and in light of easier monthly comparisons down the road, Ultimate expects comp-store sales for the second quarter to improve to negative low single digits, and rebound in the second half to positive mid single digits.

“With most of our operating initiatives in place, we are now focusing on fine-tuning traffic initiatives and long-term strategic initiatives that will uniquely position us in the marketplace for the future,” said Workman. In a conference call, he noted that those longer-term initiatives would encompass “some combination of new goods and services,” but wouldn’t elaborate while the mix was still being tested.

Short term, the retailer will continue to build its burgeoning builder channel business, which Workman described as a “bright spot in our business plan,” having grown from $7 million in 2003 to a projected $25 million this year. The company will also focus on reenergizing its mobile A/V business; will build its new traffic-driving DVD program up to its full 1,000-plus-title assortment by fall; and will relocate several stores and consider closing “a couple” of slower locations as they come off lease next year.

Revenue should also benefit from the introduction of Apple iPods in July, and the 13 percent increase in the average selling price of TVs that the chain has realized.

In response to an analyst’s question, Workman acknowledged that Best Buy’s new customer centricity model represents a “challenge to business” and a “new level of competition,” although what impact it will have on sales and share in overlapping markets, including Phoenix and Las Vegas, remains to be seen. Noting that certain customer centricity initiatives and Best Buy assortments mirror Ultimate’s approach to market, he stated that there’s room enough in the marketplace for a good No. 2 player.

Workman also downplayed the threat of Best Buy “pilfering” sales staff and installers, as it has reportedly done in current customer centricity markets, and which is a common practice among specialty CE retailers. Despite an effective reduction of sales staff compensation by 10 percent to 15 percent beginning in March as a result of a new commission structure, he said the earnings potential is still higher at Ultimate, “which goes a long way to keeping our people.” He said streamlining the pay scales was necessitated by the new computer system and the need for a “more efficient labor model given the competition out there.” Although Ultimate experienced a “slight” degree of defections as a result of the change, the company is showing its sales staff “ways to boost their income” and is negotiating “very aggressively” on their behalf with manufacturers for spiffs, Workman said.

In a category-by-category breakdown for the first quarter, Ultimate increased its first quarter sales percentage in the television/DBS category — by far, the retailer’s largest — to 47 percent, from 42 percent in the first three months a year earlier. The audio category held firm in the first quarter year-over-year, at 18 percent of sales.

Drops were registered in the video/DVD category, down to 12 percent in the first quarter, from 15 percent in the year-ago period, and in the mobile business, down to 8 percent, from 10 percent. Home office also showed a drop in sales in the first quarter, declining to 1 percent of overall sales, from 3 percent year-on-year. The “other” category increased to a 14 percent share, from 12 percent, year-over-year.

Workman re-iterated that 2004 represents a “turnaround year” for the chain, and that while it hasn’t been reflected in the bottom line just yet, “a lot of progress has been made in the last three months.” He added that it will take time to rebuild the chain’s sales momentum now that many of the new initiatives have been implemented, as Ultimate’s is a “word of mouth business.”