Tandy Leather Factory, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. The company sells leather and leathercraft products through company-owned stores and its website. Effective January 1, 2017, it combined its former North American wholesale and retail segments into North America; prior-period segment data was restated.
Financial performance
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Net sales | $19.28 million | $19.52 million | $39.43 million | $40.20 million |
| Gross profit | $12.90 million | $12.90 million | $25.18 million | $25.55 million |
| Operating income | $1.66 million | $2.84 million | $3.39 million | $5.20 million |
| Net income | $1.03 million | $1.82 million | $2.26 million | $3.34 million |
| Diluted EPS | $0.11 | $0.19 | $0.24 | $0.35 |
Consolidated gross margin was approximately 66.9% in Q2 versus 66.1% a year earlier, and 63.9% for the first half versus 63.6%. Operating margin declined to approximately 8.6% from 14.5% in Q2 and to 8.6% from 12.9% for the first half; net margin was approximately 5.3% versus 9.3% and 5.7% versus 8.3%, respectively.
- Cash flow: First-half operating cash use was $1.21 million, compared with $0.23 million used in 2016. Investing cash use was $1.03 million, primarily for store fixtures, remodels, and equipment. Financing provided $0.22 million, mainly from stock-option exercises.
- Liquidity and balance sheet: June 30 cash was $14.84 million; current assets were $54.74 million and current liabilities $7.56 million. Management reported a current ratio of 7.2, up from 6.5 at year-end 2016. Inventory was $37.33 million, up $4.15 million since year-end; annualized first-half inventory turnover was 2.2 times versus 2.3 times in first-half 2016.
- Debt: Total long-term debt was $7.37 million, of which $1.54 million was current. The company reported no 2017 drawdowns on either of its bank facilities. Borrowings bear interest at LIBOR plus 1.85%; the reported rate was 2.860% at June 30.
Changes and operating trends
- Q2 sales declined 1.2% year over year; first-half sales fell 1.9%. Operating income fell 42% in Q2 and 35% in the first half, while net income declined 43.6% and 32.4%, respectively.
- North American Q2 same-store sales decreased 3.4%; first-half same-store sales declined 2.4%. North America gross margin improved, but operating expenses rose with new stores, higher store-manager salaries, and the district-manager program.
- International sales declined 11.5% in Q2 and 6.6% in the first half. International gross margin fell to 52% from 77% in Q2 and to 55.3% from 69.0% for the first half, with management citing unfavorable currency rates and lower average tickets. The segment recorded operating losses of $159,450 in Q2 and $233,522 for the first half.
- Q2 consolidated gross profit was nearly unchanged despite lower sales; stronger North American gross margin was offset by weaker International results. Management attributed the operating-income decline chiefly to higher operating expenses and lower sales.
Outlook, risks, and other items
- No earnings or revenue guidance was provided. Management expects to grow North America toward approximately 150 stores; 115 were operating as of August 1, 2017. It reported more sales transactions in May and June and expected that trend to continue into the second half, supported by new products and district-manager efforts. No new International stores were planned for 2017.
- Management expects to fund operations and store growth with cash on hand and internally generated funds. It was seeking to extend the stock-buyback facility’s draw period and conversion date to August 2018; the filing describes this as work in progress, not a completed amendment.
- Risks identified include economic conditions, margin pressure and product costs or availability, execution of store expansion and district restructuring, hiring and training, foreign-exchange movements, IT or data-security disruptions, distribution-center interruptions, and brand damage. The company reported no pending ordinary-course litigation expected to materially affect its financial position or results.
- An unusual Q2 item was $104,000 of compensation expense from accelerated vesting of certain director restricted-stock awards. Management reported no goodwill impairment indicators in the first half. The company also noted that the new revenue standard was expected to be adopted in 2018 and was not expected to materially affect financial results, though disclosures could expand.
Important facts for investors to verify
- Whether North American same-store sales stabilize and new-store and district-manager investments produce profitable growth.
- Whether International sales and margins recover from currency pressure and lower average tickets.
- Whether inventory growth converts into sales without further slowing inventory turnover or pressuring cash flow.
- Status and terms of the proposed stock-buyback facility amendment, and ongoing compliance with debt covenants.
- Underlying expense trends, including personnel, occupancy, and selling costs, and whether reported margin improvements persist.