Profit picture still sharp despite rapid acquisition - Power Retailer Tweeter Home Entertainment - Brief Article

DSN Retailing Today, Jan 7, 2002 by Laura Heller

Tweeter Home Entertainment Group until very recently was a small specialty audio retailer nestled comfortably on the East Coast. Then, in 1996, the company embarked on an ambitious acquisition program that suddenly launched Tweeter onto the national scene and grew sales nearly 675% in the five-year period that followed.

Sandy Bloomberg founded Tweeter in 1972 as a single store near Boston University. Bloomberg still serves as chairman after 30 years, but Jeff Stone was brought on board as president and coo in 1990 to help manage the company's growth. Stone was named ceo in January 2000.

Today, Stone manages a company of more than 3,500 associates and 154 stores in 20 states. Tweeter is considered one of the premier retailers of mid- to high-end consumer electronics products in the country--a profitable retailer with lots of future growth in spite of today's economy "We have grown at a rate of about 44% for the last six or seven years," said Stone. "If we grow at 22% a year, which is half the rate that we've grown for the last seven years, we'll be a $2 billion retailer by 2006."

Fueling this growth is the company's proclivity to acquire existing chains, an activity that began in earnest in May 1996 when Tweeter purchased 13-store Bryn Mawr Stereo & Video in Pennsylvania. This was just the first of nine total acquisitions that would make Tweeter a national player in the high-end CE market by the end of 2001. The company went public in July 1998.

Most of these acquisitions were small companies, often with as few as three units. By purchasing existing businesses, Tweeter gains real estate and name recognition in new markets. It then uses those stores to expand within the existing area and into neighboring markets, explained Stone. Buying a chain with just three or four stores can effectively accomplish a market entry more economically than organic expansion.

In August 2001, Tweeter announced its largest deal to date: the acquisition of Sound Advice, one of the premier high-end CE retailers in the country with 33 units in Florida and Arizona.

In spite of its newfound size, Tweeter retains its entrepreneurial spirit. Employees boast of decades with the company, most buyers and executives began on the sales floor and, according to spokeswoman Kate Monaghan, "We've never lost a store manager." The ceo doesn't even employ a secretary and makes all his own travel arrangements.

"All of us take a lot of ownership in the company," said Noah Herschman, vp of marketing. Stone describes the chain as "the biggest little hi-fi store in the country."

Born as an audio retailer, Tweeter's focus remained largely on that category for much of its existence. But with the advent of surround sound and home entertainment systems, the company expanding beyond its core categories. Today, consumers will find state-of-the-art flat screen and high-definition TVs, home entertainment systems and portable video and DVD players, in addition to the audio components and speaker systems of the first Tweeter stores.

These changes have helped fuel topline sales, while the high-end audio-heavy merchandise mix has helped maintain profitability. However, Tweeter's rapid expansion through acquisitions and the integration of new categories has put pressure on the retailer's bottom line.

For the fiscal year ended Sept. 30, 2001, sales increased 35.1% to $540.1 million from $399.9 million for the same period last year, with the increase largely due to the new stores. Earnings grew 2.7% to $16.9 million from $16.4 million for the prior year.

Income from operations as a percentage of total revenue decreased to 5.1% from 6.4% in the prior year, largely due to a decline in gross margin coupled with an increase in selling and administrative expenses as a percentage of total revenue.

While the increased SG&A expenses are due to Tweeter's rapid growth, the declining gross margin is directly tied to a product mix that now skews away from the retailer's historical highmargin audio sales and toward lowermargin video product. "Still," maintains Stone, "we're the most profitable as a percentage of sales."

Indeed, agrees Deutsche Banc Alex. Brown analyst Dan Wewer. For 2000, Tweeter had a gross margin rate of 36.8% and an operating margin of 8.4%, as compared with Best Buy's 20% gross margin and 3.9% operating margin.

Given that Tweeter doesn't participate in low-margin categories, such as computers and home office, margins will remain relatively high regardless of category shifts.

But efforts to increase the attachment rate of audio to video products are also under way. Whereas the retailer once had a 1-1 attachment ratio, management now hopes to improve the current level of 80%, according to Wewer. Tweeter is now tying in-store compensation to performance and hopes to increase same store audio sales by 25%, said Wewer.

On the growth front, Tweeter has trimmed its 2002 store opening schedule to 15 to 20 new units from a planned 35. And although many potential acquisitions remain, the company will take a much-needed breather this year. "The reality is we don't have to do acquisitions," said Stone. "We can grow our business to 350 to 400 stores just by opening them up ourselves."