Tandy Leather Factory, Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. The company sells leathercraft products through company-owned stores and online. Its segments are North America and International; prior-year segment data was recast to the new structure.
Financial performance
- Q3 revenue: $18.39 million, down 1.3% from $18.63 million. Gross profit was $11.64 million, approximately flat; gross margin was 63.3% versus 62.5%.
- Q3 operating income: $650,000, down 57.8% from $1.54 million; operating margin declined to 3.5% from 8.3%. Net income was $521,000, down 47.9%; diluted EPS was $0.06 versus $0.11.
- Nine-month revenue: $57.82 million, down 1.7%. Gross profit was $36.82 million, down 1.0%; gross margin was 63.7% versus 63.2%.
- Nine-month operating income: $4.04 million, down 40.0%; operating margin was 7.0% versus 11.5%. Net income was $2.78 million, down 36.0%; diluted EPS was $0.30 versus $0.46.
- Cash flow, nine months: Operating activities used $3.34 million, versus $1.88 million provided in 2016. Inventory growth used $7.97 million; investing activities used $1.56 million, mainly for store and equipment spending. Financing provided $223,000, primarily from stock-option exercises. Cash fell $4.68 million to $12.18 million.
- Liquidity and debt: Current assets were $56.81 million and current liabilities $7.41 million; the reported current ratio was 7.7. Long-term debt was $7.37 million, including $154,000 current maturities; a further $73,000 capital-lease obligation was current. Stockholders’ equity was $57.93 million.
- Working capital: Inventory rose $7.97 million from year-end to $41.15 million. Annualized inventory turnover was 2.1 times, down from 2.2 times for the comparable 2016 period.
Changes and management commentary
- North America Q3 sales fell 1.8%; same-store sales declined 5.4%. International sales rose 9.5% in Q3, but fell 1.5% for the nine-month period.
- Management attributed weaker results mainly to higher operating expenses, including costs for new stores and the expanded district-manager structure. North American operating expenses rose 8.9% in Q3 and 7.8% for the first nine months. Management says these investments are intended to support future profitable growth.
- Retail customers increased as a share of sales, while wholesale and manufacturer sales remained weak amid e-commerce and other competition. North American gross margin improved, but International’s nine-month gross margin fell to 57.6% from 65.8%, partly due to unfavorable currency movements.
- Hurricanes caused temporary closures at nine stores in South Texas and Florida. Those stores’ sales declined 16.3% in Q3 and 6.3% for the first nine months versus the prior-year periods; management said the negative effect continued through the filing date. No significant store flooding or damage was reported.
Outlook, risks and unusual items
- Management plans continued North American store growth, targeting approximately 150 stores over time versus 115 as of November 1, 2017. It reported four openings or reopenings in 2017 to date and no planned international openings in 2017 or 2018. No numerical earnings or revenue guidance was provided.
- Management expects to fund operations and store growth using cash and internally generated funds. A $6 million inventory-secured credit line was available and undrawn; the company also had approximately $7.6 million unused under its repurchase-related credit facility. The facilities bear interest at LIBOR plus 1.85%; the $6 million facility includes financial covenants.
- The share-repurchase program allowed up to 2.2 million shares through August 2018; 1,150,793 shares remained available at September 30, 2017. No shares were repurchased in the first nine months of 2017.
- Q3 included a $42,795 net contribution from other income, versus a $39,923 net expense in Q3 2016; the company cited favorable currency fluctuations. The nine-month tax rate declined to 31% from 35%, which management attributed to reversal of its deferred tax position for fixed assets. Accelerated vesting for former directors resulted in $104,000 of compensation expense during the first nine months.
- 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, and disruption to the distribution center. No pending ordinary-course legal matter was expected to materially affect financial position or results.
- The company expects adoption of the revenue standard in 2018 to have no material financial impact, though disclosures may expand. It anticipates the lease standard will add right-of-use assets and corresponding liabilities.
Important facts for investors to verify
- Whether same-store sales weakness and the decline in wholesale and manufacturer demand persist, and whether new stores and district investments improve operating results.
- Whether hurricane-related sales pressure continues, and whether the sharp inventory build converts to sales without markdowns or further slowing in turnover.
- Cash generation and liquidity as the company funds expansion, given nine-month operating cash outflow and $7.37 million of debt.
- Compliance with credit-line covenants and the terms, availability, and potential use of the repurchase facility and share-buyback authorization.
- International margin recovery and the effects of foreign-exchange changes, alongside implementation of the new revenue and lease accounting standards.