Tandy Leather Factory, Inc. — Q3 2012 Form 10-Q
Reporting period: Three and nine months ended September 30, 2012; comparisons are with the corresponding 2011 periods. The company operates wholesale, retail, and international leathercraft businesses.
Financial performance
| Metric | Q3 2012 | Q3 2011 | Nine months 2012 | Nine months 2011 |
|---|---|---|---|---|
| Net sales | $17.00 million | $15.39 million | $52.08 million | $47.20 million |
| Gross profit | $10.40 million | $9.24 million | $32.71 million | $28.61 million |
| Operating income | $645,000 | $1.22 million | $5.66 million | $4.90 million |
| Net income | $281,000 | $829,000 | $3.39 million | $3.06 million |
| Diluted EPS | $0.03 | $0.08 | $0.33 | $0.30 |
Q3 gross margin was approximately 61.2% versus 60.1%; operating margin was 3.8% versus 7.9%. The Q3 operating-income decline primarily reflected a $993,386 litigation-settlement charge. For the first nine months, gross margin was approximately 62.8% versus 60.6%, and operating margin was 10.9% versus 10.4%.
Retail sales were the main growth driver: Q3 retail sales rose 13.8% and nine-month sales rose 14.3%. Wholesale Q3 sales increased 1.5%, while national-account sales fell 46.6%. International sales increased 65.1% in Q3 and 51.1% year to date, largely due to two additional stores; the segment reported an operating loss of $30,000 for the nine-month period.
Cash flow, liquidity, and debt
- Operating cash flow was negative $4.70 million for the first nine months, versus positive $1.60 million in 2011. The principal working-capital use was a $9.75 million increase in inventory.
- Investing cash outflow was $862,000, including $1.29 million of property and equipment purchases. Financing cash outflow was $1.68 million, including a $2.54 million special dividend, partly offset by $1 million of revolver borrowings.
- Cash declined to $3.52 million from $10.77 million at year-end 2011. The current ratio was 3.9, down from 4.7.
- At September 30, debt comprised $3.16 million on the real-estate term note and $1 million on a new revolving facility. The term note bears 7.1% interest; the $4 million revolver bears LIBOR plus 2.0% and matures June 30, 2013.
- Inventory rose to $29.69 million from $19.94 million and was approximately 15% above management’s internal optimal level. Annualized inventory turnover was 2.77 times, versus 3.09 times for the comparable 2011 period.
Material changes, outlook, and risks
Despite 10.5% Q3 sales growth, net income fell 66.2%, primarily due to the litigation charge and lower other income: the 2011 quarter included $176,000 of other income, compared with a small net expense in 2012. Nine-month sales increased 10.3% and net income increased 11.1%.
The company paid a one-time $0.25-per-share dividend in April 2012. Management said it expects to fund operations, liquidity needs, and store growth with cash balances, internally generated funds, and the revolving credit facility. No specific earnings or sales guidance was provided. Management expects further international store openings, but had not identified specific locations or dates.
Management cited risks from economic weakness and consumer spending, pressure on product margins and input costs, and the execution, profitability, and currency risks of international expansion. The wage-and-hour class-action settlement remains subject to final court approval; a fairness hearing was scheduled for February 11, 2013. The company recorded the $993,386 charge in Q3 and stated that any settlement payments above the escrow balance would be reduced proportionately, with no further company liability under the agreement. Management reported effective disclosure controls and no material change in internal control over financial reporting.
Important facts for investors to verify
- Final court approval and settlement administration, including the escrow amount and any funds returned.
- Whether inventory levels normalize and cash flow improves after the substantial inventory build.
- Revolver utilization, renewal or repayment before its June 30, 2013 maturity, and cash needs following the dividend.
- Whether retail growth continues and international stores improve profitability, given lower international gross margins and year-to-date operating losses.
- The extent to which declining national-account sales and potential product-cost pressures affect wholesale growth and consolidated margins.