Tandy Leather Factory, Inc. — Q2 2013 Form 10-Q
Business and period: The company sells leather and leathercraft products through North American wholesale and retail stores and three international stores. This summary covers the quarter and six months ended June 30, 2013; comparative periods are 2012. Results are unaudited.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Net sales | $18.97m | $16.90m | $38.21m | $35.08m |
| Gross profit | $11.92m | $10.94m | $23.85m | $22.31m |
| Operating income | $2.35m | $2.46m | $4.97m | $5.02m |
| Net income | $1.63m | $1.54m | $3.22m | $3.11m |
| Diluted EPS | $0.16 | $0.15 | $0.32 | $0.30 |
Quarterly sales rose 12.2% and net income rose 5.8%, while operating income fell 4.8%. First-half sales increased 8.9% and net income 3.3%, but operating income declined about 1.0%. Gross margin was approximately 62.8% in Q2 (64.7% prior year) and 62.4% for the first half (63.6% prior year); the lower margin reflects customer and product mix. Operating margins were approximately 12.4% and 13.0%, respectively.
Segments: Q2 sales increased across all segments: Wholesale +7.1%, Retail +14.0%, and International +32.2%. Retail same-store sales rose 12.7%; Wholesale same-store sales rose 4.6%. Wholesale operating income declined 20% in Q2 and 19% for the first half, while Retail operating income rose 5.2% in Q2 and $224,000 for the first half. International sales grew strongly, but its gross margin declined. The company operated 29 wholesale stores, 78 North American retail stores, and three international stores at quarter-end.
Cash, liquidity and debt
At June 30, 2013, cash was $7.57m, current assets $38.46m, current liabilities $9.32m, and stockholders’ equity $40.39m. The current ratio was 4.1, down from 4.5 at year-end 2012. Inventory was $27.50m, up $1.64m from year-end and approximately 10% above management’s internal optimal inventory target. Management attributed the increase to advance purchasing ahead of expected fourth-quarter demand.
First-half operating cash flow was positive $2.23m, compared with negative $4.25m in 2012, primarily reflecting a much smaller inventory build. Investing cash outflow was $1.96m, mainly for construction of the flagship store and store fixtures and equipment. Financing cash outflow was $405,000, entirely debt repayments. Cash declined $133,000 over the period.
Long-term debt was $2.70m, including $202,500 current maturities; the secured term loan bears 7.1% interest and matures in April 2018. The $4m revolving credit facility was undrawn at June 30; its maturity was extended to June 30, 2014 and its rate was LIBOR plus 2% (2.27% at quarter-end). The company reported $107,638 of first-half interest expense.
Changes, outlook and risks
- Retail and international growth drove higher sales, but consolidated operating income was slightly lower year over year. Wholesale’s first-half sales were nearly flat, and its operating income fell materially.
- Management expects to fund operations, liquidity needs and store growth with cash, internally generated funds and the revolving facility. It expects additional international stores over time, but disclosed no specific opening dates or quantitative financial guidance.
- Management cited economic and consumer-spending uncertainty, pricing and product-cost pressure on margins, execution risks in international expansion, and foreign-currency exposure. It expects currency risk to increase with international growth.
- The FLSA and state wage-law class action was approved for settlement and dismissed with prejudice on June 28, 2013. The company recorded a roughly $312,000 benefit in Q2 for the expected unused escrow balance; approximately $312,000 was expected to be returned before year-end. The company continued to deny wrongdoing.
- Q2 Wholesale expenses included one-time costs associated with the flagship store move and opening, increased marketing and legal fees, partly offset by the settlement-related benefit. The flagship store opened in June.
- A stockholder rights plan was adopted in June 2013. Management stated disclosure controls were effective as of June 30, 2013 and reported no material change in internal control over financial reporting during the quarter.
Facts investors should verify
- Whether the inventory above management’s target converts into expected seasonal sales without markdowns or slower turnover.
- Whether Retail and International sales growth can offset Wholesale weakness while maintaining gross margins.
- The final amount and timing of the litigation escrow refund, and whether any further settlement-related costs arise.
- Capital spending needs, debt repayment, and the availability and renewal terms of the undrawn revolving facility.
- Progress, profitability and currency effects from planned international expansion; the filing provides no numerical earnings or sales guidance.