Tandy Leather Factory, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with Q1 2017 unless noted. Tandy is a specialty retailer of leather and leathercraft products, selling through company-owned stores and its website, with North America and International operating segments.
Financial performance
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $20.29 million | $20.15 million | +0.7% |
| Gross profit | $12.84 million | $12.29 million | +4.5% |
| Operating income | $1.77 million | $1.74 million | +1.8% |
| Net income | $1.27 million | $1.23 million | +3.4% |
| Diluted EPS | $0.14 | $0.13 | Up $0.01 |
| Operating cash flow | $1.15 million | $0.16 million | Up $1.00 million |
| Capital expenditures | $0.24 million | $0.60 million | Down $0.36 million |
Gross margin was approximately 63.3% versus 61.0%, while operating expenses rose 5.0% to $11.07 million. Interest expense increased to $64,642 from $36,344, reflecting higher rates and a higher average debt balance. The effective tax rate declined to 27% from 28%.
Segments and material changes
- North America: Sales increased 0.4% to $19.32 million, but same-store sales declined 1.2%; three newer stores contributed $317,948. Operating income rose 1.1% to $1.83 million. Gross margin improved to 63.3% from 61.1%, attributed to customer mix and higher-margin product sales; operating expenses rose 4.6%.
- International: Sales increased 5.8% to $971,658, primarily reflecting foreign exchange. The segment reported an operating loss of $61,698, improved from a $74,072 loss. Gross margin increased to 63.5% from 58.1%, while operating expenses rose, including from currency effects and personnel and advertising costs.
- Retail customers represented 62% of sales versus 57% in Q1 2017; non-retail customers accounted for the balance.
- Operating cash flow improved mainly as inventory declined by $539,337, compared with a $1.20 million inventory increase in the prior-year quarter. Payments of prior-year manager bonuses were a use of cash in both periods.
Liquidity, debt, and capital
At March 31, 2018, cash was $19.25 million, current assets were $58.18 million, and current liabilities were $6.55 million; management reported a current ratio of 8.9, up from 8.3 at year-end 2017. Total debt was $7.91 million, versus $7.37 million at December 31, 2017. The company reported compliance with its debt covenants. It had no balance on its $6 million inventory-secured credit line and approximately $7.1 million unused under the stock-repurchase credit facility.
During the quarter, Tandy borrowed $540,940 and used the proceeds to repurchase 72,400 shares at an average $7.47 per share. The repurchase program had 1,078,393 shares remaining and was scheduled to end August 9, 2018. Cash increased by $915,620 during the quarter.
Outlook, commentary, and risks
- Management cited a long-term 2020 target of $87–$90 million in annual sales and operating margins above 10%. It said key growth priorities were still being developed and expected improvement as the year progressed; these are targets, not a quarterly forecast.
- The company planned one or two North American store openings in 2018, with no new international stores planned that year. Its longer-term aim was approximately 150 North American stores, compared with 115 at May 1, 2018.
- Growth initiatives include product and merchandising changes, wholesale business development, e-commerce improvements, higher average transaction values, and store-associate training. Management expects these efforts to require investment in stores, inventory, staffing, travel, training, and marketing.
- Identified risks include economic conditions, margin pressure, product cost or availability, execution of expansion and district restructuring, hiring and training, foreign exchange, IT or data-security disruptions, distribution-center interruptions, and brand damage. Management said foreign-currency exposure could increase as international operations grow.
- ASC 606 adoption on January 1, 2018 primarily changed gift-card accounting: the company recorded a gift-card liability and reduced opening retained earnings by $168,311. The March 31 liability was approximately $188,000. Management had not completed its accounting for the Tax Act and expected to finalize it within the permitted measurement period. The company anticipated recognizing additional lease assets and liabilities when adopting the new lease standard.
- The filing reported no pending ordinary-course legal matters expected to materially affect financial position or operating results. Disclosure controls were assessed as effective at a reasonable assurance level.
Important facts for investors to verify
- Whether North American same-store sales stabilize or continue to decline, and whether planned store growth produces adequate returns.
- Whether gross-margin gains persist as customer mix, pricing, and product mix change, and whether operating expenses continue to outpace sales.
- Cash generation and inventory needs, particularly ahead of holiday sales and planned expansion.
- Debt repayment and interest costs, covenant compliance, and the use and timing of remaining stock-repurchase authorization.
- Final Tax Act accounting and the balance-sheet impact of adopting the lease standard.