Tandy Leather Factory, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018; comparative periods are 2017. Tandy is a specialty retailer of leather and leathercraft products, selling through company-owned stores and its website. At September 30, it operated 117 North American stores and three international stores.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $18.89 million | $18.39 million | $58.35 million | $57.82 million |
| Gross profit | $11.85 million | $11.64 million | $37.81 million | $36.82 million |
| Gross margin | 62.7% | 63.3% | 64.8% | 63.7% |
| Operating income | $315,000 | $650,000 | $4.07 million | $4.04 million |
| Net income (loss) | $(122,000) | $521,000 | $2.59 million | $2.78 million |
| Diluted EPS | $(0.01) | $0.06 | $0.28 | $0.30 |
- Q3 sales rose 2.7%, but operating income fell as operating expenses increased 5.0%; Q3 operating margin was approximately 1.7%, versus 3.5% a year earlier. The quarterly net loss reflected a $397,000 tax provision on $276,000 of pretax income, including approximately $250,000 of additional transition tax and no tax benefit recorded on certain foreign losses.
- For the first nine months, sales increased 0.9% and operating income was nearly flat. Operating expenses grew 3.0%, partly offset by improved gross profit; nine-month operating margin was approximately 7.0% in both years.
- Cash was $16.8 million at September 30, down from $18.3 million at year-end 2017. Current assets were $60.0 million and current liabilities $6.1 million; the reported current ratio was 9.8.
- Operating cash flow was negative $634,000 for the first nine months, compared with negative $3.34 million in 2017. Inventory increased $3.4 million from year-end and was the principal working-capital use. Capital spending was $888,000; cash declined $1.52 million overall.
- Total debt was $8.35 million, up from $7.37 million at year-end; cash exceeded debt. The company also reported a $6 million inventory-secured credit line with no borrowings. It said it was in compliance with its debt covenants.
Material changes and management commentary
- North American Q3 sales rose 3.6%, including 2.8% same-store growth and sales from two new stores. International sales fell 13.1%; the segment recorded a $251,000 operating loss, including approximately $130,000 in costs related to closing its Northampton, UK store.
- Retail customers increased to 59% of Q3 sales and 60% of year-to-date sales, from 57% in the comparable 2017 periods. Management attributed improved gross profit, particularly year to date, partly to this shift and a more favorable product mix. Year-to-date North American same-store sales declined 0.4%, with management citing competition among non-retail customers and weaker Canadian sales.
- On October 2, the CEO and president resigned and left the board; the filing says their departures were not related to a dispute with the company. Janet Carr was appointed CEO and joined the board. Management said it was pausing new store openings and relocations while evaluating infrastructure and organizational resources, and identified brand reinvigoration, retail experience, and recovering business customers as priorities.
- The company repurchased shares during 2018, funded in part by approximately $983,000 drawn on its stock-repurchase credit facility. The filing reports 133,302 shares purchased in the financial statements and 133,303 in MD&A; the quarterly issuer-purchase table separately reports seven shares purchased during Q3.
Outlook, risks, and unusual items
- No numerical earnings or sales guidance is provided. Management expects to fund operations, inventory, capital needs, and debt service with cash and internally generated funds. It cautions that interim results are not necessarily indicative of full-year results.
- Risks cited include economic conditions, margin pressure, product costs or availability, execution of expansion and restructuring plans, staffing, foreign currency, IT and data-security disruptions, distribution-center disruption, and brand damage. The company expects foreign-exchange exposure could increase with international operations.
- The August 2018 amendments reduced borrowing rates by 0.35 percentage points; the notes accrue interest at LIBOR plus 1.5% (3.7% at September 30). The $15 million repurchase facility had approximately $6.6 million unused. The company expects its drawn balance to convert to a four-year term note after the draw period.
- ASC 606 adoption on January 1 reduced opening retained earnings by $168,311 for outstanding gift cards; the September 30 gift-card liability was $163,285. Management reported no significant revenue-recognition change beyond gift cards. The company anticipates recognizing lease assets and liabilities when it adopts the new lease standard; it had not completed its review.
- Management reported no pending ordinary-course litigation expected to materially affect financial position or results. Disclosure controls were assessed as effective, and no material change in internal control was reported.
Important facts for investors to verify
- Whether the new CEO’s strategic review and pause on store openings or relocations change expected growth, costs, or capital allocation.
- Whether international operations can improve after the UK store closure, and whether continued foreign losses or currency movements affect consolidated results.
- Inventory growth, sales conversion, and the effect of customer mix on gross margins and cash generation.
- The source and duration of the unusually high Q3 effective tax rate, including the transition tax and foreign losses without tax benefits.
- Debt draws, covenant compliance, share repurchases, and the discrepancy in reported year-to-date shares repurchased.