Tandy Leather Factory, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. The company operates wholesale, retail, and international leathercraft businesses. Results are unaudited; management cautions that interim results are not necessarily indicative of full-year results.
Financial performance
| Metric | Q2 2016 | Q2 2015 | First half 2016 | First half 2015 |
|---|---|---|---|---|
| Net sales | $19.52 million | $19.77 million | $40.20 million | $40.56 million |
| Gross profit | $12.90 million | $12.81 million | $25.55 million | $25.40 million |
| Gross margin | 66.1% | 64.8% | 63.6% | 62.6% |
| Operating income | $2.84 million | $2.33 million | $5.20 million | $4.72 million |
| Net income | $1.82 million | $1.51 million | $3.34 million | $2.95 million |
| Diluted EPS | $0.19 | $0.15 | $0.35 | $0.29 |
Q2 sales declined 1.3%, while operating income rose 22% and net income rose 20.8%. For the first half, sales declined about 0.9%, while operating income increased about 10% and net income increased 13.2%. Improved gross profit and lower operating expenses supported profitability despite slightly lower sales.
Segments and material changes
- Wholesale Leathercraft: Q2 sales fell 5.1% to $6.06 million, but operating income rose to $1.55 million from $0.97 million. The segment cited higher-margin product mix and lower expenses, including reduced relocation, outside-services, and advertising costs. First-half sales fell 4.3%, while operating income increased 39%.
- Retail Leathercraft: Q2 sales were nearly flat at $12.49 million; operating income fell 12.8% to $1.17 million as gross margin declined to 59.0% from 60.2%. First-half sales rose 0.4%, but operating income fell to $2.38 million from $2.74 million, with management citing less favorable customer and product mix.
- International Leathercraft: Q2 sales rose 13.8% to $0.96 million, including sales from a UK store opened in October 2015; same-store sales declined 4.9%. Operating income was $0.12 million versus $0.03 million. First-half sales rose 5.3%, while same-store sales fell 11.3%.
Cash flow, balance sheet, debt, and liquidity
- Cash was $9.84 million at June 30, down from $10.96 million at December 31, 2015. Current assets were $49.57 million and current liabilities $7.83 million; the company reported a 6.3 current ratio, up from 5.7 at year-end.
- First-half operating cash flow was a use of $0.23 million, compared with $5.13 million provided in the prior-year period. Inventory increased $2.72 million; lower accounts payable and accrued liabilities also used cash. Inventory turnover was 2.3 times annualized, versus 2.5 times in first-half 2015.
- Investing cash use was $0.87 million, primarily for equipment and store-related assets. Financing cash use was $0.02 million, reflecting $3.68 million of share repurchases funded primarily with borrowings.
- Debt totaled $7.37 million, up from $3.71 million at year-end; capital lease obligations were $0.15 million. The BOKF facilities bear interest at LIBOR plus 1.85%. The company had about $2.6 million remaining on the $10 million share-repurchase facility at June 30. Reported current maturities of long-term debt were $1.38 million.
- Stockholders’ equity was approximately $51.01 million, broadly unchanged from year-end, as first-half net income was largely offset by treasury-stock purchases. The company repurchased 520,482 shares for $3.68 million during the first half.
Outlook, risks, and other items
The company expects to fund operating needs and store growth from cash balances and internally generated funds. It did not provide numerical earnings or sales guidance and said it does not intend to open new international stores in 2016. Risks identified include economic conditions, margin pressure, product cost or availability, store expansion and staffing challenges, intellectual-property protection, foreign-currency fluctuations, and brand damage. Management expects foreign-exchange exposure to increase with international expansion.
The BOKF agreement includes a maximum funded-debt-to-EBITDA ratio of 1.5 to 1 and a minimum fixed-charge-coverage ratio of 1.2 to 1, measured quarterly on a trailing-four-quarter basis; the filing text does not provide a clear reported covenant-compliance value. Management said no pending ordinary-course legal matters were expected to materially affect financial position or operating results. Disclosure controls were deemed effective, and no material change in internal control was reported.
Important facts for investors to verify
- Whether the improvement in wholesale profitability and consolidated margins is sustainable, particularly given weaker retail margins and declining same-store sales internationally.
- Whether inventory growth and slower turnover reflect planned stocking or weaker demand, and whether working-capital use will continue.
- Debt balances, interest costs, and compliance with the BOKF financial covenants as the company continues its share-repurchase program.
- The operating performance and costs of the newer UK store, and the company’s stated decision not to open additional international stores in 2016.