Tandy Leather Factory, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; fourth-quarter figures are unaudited. Tandy Leather is a specialty retailer and light manufacturer of leathercraft products, selling through company-owned stores and its website. At year-end it operated 117 North American stores and three international stores.
Financial performance and liquidity
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $83.10 million | $82.32 million | Up 0.9% |
| Gross profit | $50.58 million | $52.11 million | Down 2.9% |
| Gross margin | 60.9% | 63.3% | Down 2.4 percentage points |
| Operating income | $3.83 million | $7.24 million | Down 47.1% |
| Net income | $1.96 million | $4.45 million | Down 55.9% |
| Diluted EPS | $0.21 | $0.48 | Down $0.27 |
- Annual operating margin was approximately 4.6% versus 8.8% in 2017; net margin was approximately 2.4% versus 5.4%.
- Fourth-quarter sales were $24.74 million versus $24.50 million; the company recorded a net loss of $628,349, or $0.07 per diluted share, compared with net income of $1.67 million, or $0.18 per diluted share, in Q4 2017.
- Operating cash flow was $7.39 million in 2018 versus $2.17 million in 2017. Investing activities used $1.07 million and financing activities used $57,000. The MD&A narrative separately states operating cash flow was $6.9 million; the audited cash flow statement reports $7.388 million.
- Cash was $24.07 million, inventory $33.87 million, and total assets $76.14 million at year-end. The current ratio was 8.7, up from 8.3.
- Total debt was $8.97 million, all associated with the stock-repurchase line; $747,335 was current. The separate $6 million working-capital facility was undrawn, and the company reported compliance with its covenants. It said the repurchase debt was fully repaid in February 2019.
- Stockholders’ equity was $59.46 million. The company repurchased 243,387 shares for $1.65 million of cash-flow-statement outflow, at an average $6.79 per share. No dividends were declared.
Material changes versus 2017
- Sales improved modestly, but same-store sales in North America fell 0.4%; new and temporarily closed stores contributed $1.3 million. North American retail sales rose 1.8%, while non-retail sales fell 0.4%. International sales declined 5.5% to $3.54 million.
- Operating expenses rose $1.88 million to $46.75 million, or 56.3% of sales versus 54.5%. Drivers included new-store costs, higher labor and extended hours, store impairments, closure costs, and management-transition expenses; lower print and postage costs partly offset the increases.
- Gross profit included a $1.4 million inventory write-down for damaged, slow-moving, and excess merchandise. Management said gross margin would have been 62.6% excluding the write-down.
- International operations recorded a $354,506 operating loss, compared with a $256,995 loss in 2017. Four North American stores were impaired, generating a $285,500 charge.
- The effective tax rate increased to 47% from 38%, including approximately $401,000 of additional tax recorded in 2018 as the company finalized Tax Act accounting and tax filings. Management expects a 25%–27% effective rate going forward.
Outlook, management actions, and risks
- Following leadership changes in October 2018, management began developing a new operating model to distinguish higher-margin retail service from lower-margin wholesale and commercial business. A dedicated commercial sales team will serve those customers with direct shipments from Fort Worth.
- Management expects 2019 to involve investment and transition costs, including higher operating expenses from additional staffing, technology, and potential overlap of old and new systems. It believes these investments may support sales growth and cost savings in 2020 and beyond; these are expectations, not guarantees.
- Management shifted store decisions toward cash-flow contribution. Three underperforming locations closed by February 2019; four to six additional closures were considered likely during 2019. The company also planned to strengthen inventory management and reassess pricing, promotion, marketing, and legacy programs.
- Key risks include continued same-store and non-retail sales weakness, execution of the transformation, store cannibalization and lease obligations, online and retail competition, leather and sourcing costs, tariffs and supply-chain disruption, foreign exchange, and information-system or data-security failures. The company does not hedge inventory costs or foreign-currency exposures.
- Operating lease commitments totaled $16.74 million at year-end. The company adopted the new lease accounting standard on January 1, 2019 and estimated recognition of approximately $6.1 million in lease assets and $6.5 million in lease liabilities.
- Management reported no pending ordinary-course legal matters expected to materially affect financial position or results. It reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation.
Important facts for investors to verify
- Reconcile the MD&A’s $6.9 million operating-cash-flow statement with the audited cash flow statement’s $7.388 million.
- Track same-store sales, especially non-retail/commercial demand, and whether the new channel model improves sales and margins.
- Assess the quality and sustainability of gross margin after the $1.4 million inventory write-down, including markdowns, inventory turnover, and customer demand.
- Monitor 2019 transformation spending, store closures and lease exit costs, and whether management’s expected 2020 benefits materialize.
- Confirm the February 2019 repayment of the stock-repurchase debt and evaluate subsequent repurchases, remaining liquidity, and capital allocation.
- Review the effect of lease-standard adoption, the forecast tax rate, and any further international-store rationalization.