Tandy Leather Factory, Inc. — Q3 2011 Form 10-Q
Business and period: The company sells leathercraft products through wholesale, retail and international operations. This unaudited report covers the quarter and nine months ended September 30, 2011; comparisons are to the same 2010 periods.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Net sales | $15.39 million | $13.64 million | $47.20 million | $42.58 million |
| Gross profit | $9.24 million | $8.18 million | $28.61 million | $25.87 million |
| Operating income | $1.22 million | $1.08 million | $4.90 million | $4.06 million |
| Net income | $829,106 | $593,905 | $3.06 million | $2.60 million |
| Diluted EPS | $0.08 | $0.06 | $0.30 | $0.25 |
| Gross margin | 60.1% | 60.0% | 60.6% | 60.8% |
Q3 sales rose 12.8% and net income 39.6%; nine-month sales increased 10.8% and net income 17.4%. Q3 operating income rose 13.6%, while nine-month operating income increased 20.9%. Retail Leathercraft was the largest growth contributor: Q3 sales increased 21.2%, including 20.3% same-store growth, and nine-month sales rose 16.8%. Wholesale sales grew more modestly; wholesale Q3 operating income fell 41.8%, primarily amid higher operating expenses. International sales also increased, with improved gross margins.
Q3 operating margin was approximately 7.9%, versus 7.9% a year earlier; nine-month operating margin was approximately 10.4%, versus 9.5%. Management cited sales growing faster than expenses in Retail as supporting improved operating profitability. Q3 other income included $145,000 of currency-related income, compared with $6,000 in Q3 2010.
Liquidity, cash flow and balance sheet
- At September 30, cash was $5.99 million and short-term certificates of deposit were $336,000. Current assets were $30.17 million and current liabilities $5.47 million; the reported current ratio was 5.5.
- Operating cash flow was $1.60 million for the first nine months, compared with cash used of $766,000 in 2010. Capital expenditures were $1.04 million; investing cash flow was positive $246,000. Financing cash use was $152,000, reflecting debt repayments.
- Total debt was $3.36 million, including $203,000 current maturities. The real-estate-secured term note bears 7.1% interest and matures in April 2018. Debt declined $152,000 from year-end.
- Inventory was $20.55 million, about 11% above management’s internal optimal targets; management attributed excess partly to bulk leather purchases and stock for international expansion. Inventory turnover was an annualized 3.09 times, versus 3.01 times for the comparable 2010 period.
- Stockholders’ equity increased to $32.65 million from $29.76 million at year-end, primarily due to earnings. No dividend was paid in the 2011 period; the $7.7 million special dividend was paid in 2010.
Outlook, risks and other notable items
The filing provides no numerical earnings or sales guidance. Management expected to fund operations, liquidity needs and store growth from cash balances and internally generated funds. A second international store opened in Sydney in October 2011; the company anticipated one to two Spain openings in Q4, with dates not finalized.
Management cautioned that results are exposed to uncertain economic conditions and consumer spending, product-cost and pricing pressure that could compress margins, and execution, profitability and currency risks from international expansion. It also noted that foreign-exchange exposure may rise as international operations grow. The company stated that Q3 and nine-month results are not necessarily indicative of full-year results.
Three former employees brought a proposed wage-and-hour class action alleging violations of federal and state laws and seeking unspecified overtime, damages, fees and costs. Trial was set for the week of May 29, 2012; the company said it could not predict liability or estimate damages and intended to defend the case vigorously. No goodwill impairment indicators were identified in the first nine months. Management reported disclosure controls were effective and no material change in internal control over financial reporting.
Important facts for investors to verify
- Whether strong Retail same-store sales and improved operating leverage continue, and whether wholesale profitability recovers.
- Inventory levels, turnover and the planned use of excess stock as international stores open.
- Execution and profitability of international expansion, including the Sydney opening and anticipated Spain stores, alongside growing foreign-currency exposure.
- Any developments, potential financial exposure or changes in status of the wage-and-hour lawsuit.
- Cash generation, debt repayments and capital allocation, including the board’s future dividend decisions.