Tandy Leather Factory, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018. Tandy is a specialty retailer of leather and leathercraft products, selling through company-owned stores and its website. It reports North America and International segments.
Financial performance
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Net sales | $19.18 million | $19.28 million | $39.47 million | $39.43 million |
| Gross profit | $13.12 million | $12.90 million | $25.96 million | $25.18 million |
| Income from operations | $1.98 million | $1.66 million | $3.75 million | $3.39 million |
| Net income | $1.44 million | $1.03 million | $2.71 million | $2.26 million |
| Diluted EPS | $0.15 | $0.11 | $0.29 | $0.24 |
- Q2 sales fell 0.5% year over year, while net income rose 40.1%. First-half sales increased 0.1% and net income increased 20.1%.
- Gross margin was approximately 68.4% in Q2 and 65.8% for the first half; operating margin was approximately 10.3% and 9.5%, respectively. Management attributed improved gross profit primarily to higher-margin product mix and a larger retail-customer share.
- Operating cash flow was $1.05 million for the first half, versus cash used of $1.21 million a year earlier. Investing cash use was $0.42 million; financing cash use was $0.01 million, including approximately $1.0 million borrowed and used for share repurchases. Cash increased to $18.96 million from $18.34 million at year-end 2017.
- At June 30, cash was $18.96 million, current assets $59.16 million, and current liabilities $6.83 million; the reported current ratio was 8.7. Inventory was $38.02 million, up $0.71 million from year-end.
- Total debt was $8.35 million, including $1.74 million classified as current. The company reported compliance with its loan covenants. Interest expense was $78,000 for Q2 and $143,000 for the first half.
- The effective tax rate declined to 26.2% for Q2 and 26.5% for the first half, versus 36.5% and 32.0% in the prior-year periods. Management cited the lower federal tax rate, partly offset by other Tax Act effects.
Material changes and segment trends
- North America sales declined 0.8% in Q2 and 0.2% for the first half. Same-store sales fell 1.8% and 1.5%, respectively; management cited competition and reduced non-retail leather purchases. North American gross margin improved to 68.5% in Q2 and 65.8% for the first half.
- International sales increased 5.6% in Q2 and 5.7% for the first half, supported by favorable currency and price increases. The segment remained loss-making at the operating level: a $4,709 loss in Q2 and a $66,407 loss for the first half, both improved from 2017.
- Operating expenses decreased in Q2, chiefly on lower advertising and marketing, but increased for the first half due in part to new stores, personnel, occupancy, and district-management investments.
- Foreign currency translation reduced comprehensive income by $294,598 in Q2 and $272,807 for the first half; the comparable 2017 periods recorded positive translation adjustments.
Outlook, risks, and unusual items
- Management’s stated 2020 targets are net sales of $87–$90 million and operating margins above 10%. It said key initiatives remain under implementation and expected continued improvement as the year progressed; this is not a specific 2018 earnings forecast.
- The company plans to expand North America from 117 stores as of August 1, 2018 toward approximately 150. Two stores opened in July 2018; management did not plan international openings in 2018. Growth requires investment in stores, inventory, staffing, training, and marketing.
- Risks identified include economic conditions, margin pressure, product cost or availability, execution of store expansion and restructuring, hiring and training, foreign exchange, IT or data-security disruption, distribution-center interruption, and brand damage. Management said market-risk exposure had not changed significantly since year-end, but foreign-currency risk may rise with international growth.
- ASC 606 adoption on January 1, 2018 resulted in a $168,311 reduction to opening retained earnings for gift-card obligations. The gift-card liability was approximately $152,543 at June 30. Management reported no significant change to revenue timing apart from gift-card accounting.
- The company had drawn $8.35 million on a $15 million share-repurchase facility, with approximately $6.6 million unused; it was working to extend the facility’s drawdown and conversion period, then expected outstanding principal to convert to a four-year term note. A separate $6 million inventory-secured credit line was undrawn. Lease accounting changes effective in 2019 are expected to add lease assets and liabilities, but the filing gives no quantified estimate.
- Management reported no pending litigation expected to materially affect financial position or results, no goodwill impairment indicators, and effective disclosure controls as of June 30.
Important facts for investors to verify
- Whether sales and same-store sales stabilize, particularly in North America, and whether higher gross margins persist without further pressure on operating expenses.
- Whether the International segment can reach operating profitability and whether currency changes continue to support reported sales.
- Execution and funding of planned store growth, inventory expansion, and related staffing and occupancy costs.
- Status and terms of the proposed extension of the share-repurchase credit facility, covenant compliance, and the effect of continued repurchases on debt and share count.
- Future cash conversion, inventory levels, and the eventual balance-sheet impact of lease-standard adoption.
- Completion of the company’s Tax Act accounting and any resulting adjustments to provisional tax amounts.