PART I. FINANCIAL INFORMATION
Item 2.
Management's Discussion and Analysis of Financial Condition
and Results of Operations.
Our Business
To our knowledge, we are the world's largest specialty retailer of leather and leathercraft related items (based on sales), offering a wide range of leather, quality tools, hardware, accessories, liquids, lace, kits and teaching materials. We sell our products through company-owned stores and through orders generated from our website, www.tandyleather.com. We have built our business by offering our customers a broad selection of quality products combined with knowledgeable store associates, in one location, at competitive prices.
We believe that the key to our success is our ability to profitably grow our base business. We expect to grow that business by opening new stores and by increasing sales in our existing stores. As of May 1, 2018, we have not yet opened any new stores in 2018 although we have plans to open one or two stores later this year.
We operate in two segments, based on management responsibility and store location: North America and International. As of May 1, 2018, our North America segment operates 115 company-owned stores located in 42 U.S. states and 7 Canadian provinces. We expect to grow the number of stores in North America to approximately 150 in the future. Our pace of store openings has recently picked up due to a change in strategy with a focus on growth.
Our International segment operates four company-owned stores with one located in each of Northampton, United Kingdom; Manchester, United Kingdom; Sydney, Australia; and Jerez, Spain. We expect to continue opening international stores in the future, but do not intend to open any new international stores in 2018.
As more fully disclosed in our Form 10-K for the year ended December 31, 2017, our long term strategy is to drive sustainable growth in traffic and sales through the implementation of a number of priorities with a goal of achieving 2020 financial targets of $87 - $90 million in net sales and greater than 10% operating income margins. During the first quarter of 2018, we reported a slight improvement in sales and operating income as compared to the comparable period of 2017. While that was encouraging, many of our key priorities are still being developed and we expect to see continued improvement as the year progresses.
Our customer base is diverse, with individual retail customers as our largest customer group, representing approximately 60% of our 2017 sales. The remaining 40% of our 2017 sales were to our wholesale, manufacturer and institutional groups (including horse and tack shops, Western wear, crafters, upholsterers, cobblers, auto repair, education, hospitals, prisons and other large businesses that use our products as raw materials to produce goods for resale). Generally, our retail customers provide a higher gross profit than our wholesale and manufacturer groups.
Our initiatives to increase sales include new merchandising with an expanded product line intended to grow business to our retail customers, a refocus on business development to our wholesale and manufacturer groups, improvements to our digital and e-commerce channels, as well as increasing our average ticket. We have also increased our training efforts with our store associates to strengthen their product knowledge. We believe that our store associates, armed with a solid knowledge of our extensive product line, can drive higher average tickets and traffic conversion.
We are also focusing on improving our customer experience, increasing our brand awareness, and strengthening our store performance. To help achieve those goals, in early 2017, we announced a district restructuring with our store footprint divided into fifteen districts (previously, our store footprint was divided into five regions). Each district contains six to ten stores, reporting to a district manager who is tasked with growing traffic and sales, as well as training store managers and associates to better serve our customers and succeed in today's retail environment. As of May 1, 2018, we have filled twelve of our fifteen district manager positions.
Our growth strategy has required, and is expected to continue to require, investments in our new stores, expanded inventory and merchandising, as well as operating costs for additional headcount, travel, training and marketing expenses. We believe we are investing in areas that will drive sustainable long-term growth.
Critical Accounting Policies
A description of our critical accounting policies appears in Item 7 "Management's Discussions and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2017. See Note 1 for disclosures related to our adoption of the new revenue recognition standard.
Forward-Looking Statements
Certain statements contained in this report and other materials we file with the Securities and Exchange Commission, as well as information included in oral statements or other written statements made or to be made by us, other than statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally are accompanied by words such as "may," "will," "could," "should," "anticipate," "believe," "budgeted," "expect," "intend," "plan," "project," "potential," "estimate," "continue," or "future" variations thereof or other similar statements. There are certain important risks that could cause results to differ materially from those anticipated by some of the forward-looking statements. Some, but not all, of the important risks, including, without limitation, those described below, could cause actual results to differ materially from those suggested by the forward-looking statements. Please refer also to our Annual Report on Form 10-K for fiscal year ended December 31, 2017 for additional information concerning these and other uncertainties that could negatively impact the Company. Potential factors, which could cause our actual results of operations to differ materially from those in the forward-looking statements include, among others:
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General economic conditions in the United States and abroad;
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Increased pressure on margins;
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Increases in the cost of the products we sell or a reduction in availability of those products;
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Challenges in implementing our planned expansion and district restructuring;
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Failure to hire and train qualified personnel to operate new and existing stores;
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Failure to protect our trademarks and other proprietary intellectual property rights;
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Negative impact of foreign currency fluctuations on our financial condition and results of operations;
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Information technology system failures or network disruptions;
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Significant data security or privacy breach of our information systems;
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Loss or prolonged disruption in the operation of our centralized distribution center; and
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Damage to our brand image.
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We assume no obligation to update or otherwise revise our forward-looking statements even if experience or future changes make it clear that any projected results, express or implied, will not be realized
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Results of Operations
The following tables present selected financial data for each of our segments:
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|
Quarter Ended March 31, 2018
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|
|
Quarter Ended March 31, 2017
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|
|
|
Sales
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|
|
Income from Operations
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|
|
Sales
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|
|
Income from Operations
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|
North America
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|
$
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19,317,260
|
|
|
$
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1,830,659
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|
|
$
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19,231,714
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|
|
$
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1,811,563
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|
International
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971,658
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|
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(61,698
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)
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918,131
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|
|
|
(74,072
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)
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Total
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|
$
|
20,288,918
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|
|
$
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1,768,961
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|
|
$
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20,149,845
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|
|
$
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1,737,491
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|
Consolidated net sales for the quarter ended March 31, 2018 increased $139,073, or 0.7%, compared to the same period in 2017. North America and International reported sales increases of 0.4% and 5.8%, respectively. The sales increase in North America was driven by new stores, offset by a 1.2% decline in same store sales, while the sales increase in International was primarily due to foreign currency exchange. Income from operations on a consolidated basis for the quarter ended March 31, 2018 increased by 1.8%, or $31,470, from the first quarter of 2017 primarily due to the increase in sales and gross profit, offset by an increase in operating expenses which is discussed further below.
The following table shows in comparative form our consolidated net income for the first quarters of 2018 and 2017:
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|
2018
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|
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2017
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% change
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|
Net income
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|
$
|
1,273,619
|
|
|
$
|
1,231,265
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|
|
|
3.4
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%
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Additional information follows for each segment.
North America
North America consisted of 115 stores at March 31, 2018 and 112 stores at March 31, 2017. Three new stores opened since March 31, 2017, which are as follows: Allen, TX in April 2017; and McAllen, TX and Miami, FL in May 2017. A store is categorized as "new" until it is operating for the full comparable period in the prior year.
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# Stores
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|
|
Qtr Ended
03/31/18
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|
|
# Stores
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|
|
Qtr Ended
03/31/17
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$ Change
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|
|
% Change
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|
Same store sales
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|
|
112
|
|
|
$
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18,999,312
|
|
|
|
112
|
|
|
$
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19,231,714
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|
|
$
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(232,402
|
)
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|
|
(1.2
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%)
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New store sales
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|
|
3
|
|
|
|
317,948
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|
|
|
|
|
|
|
-
|
|
|
|
317,948
|
|
|
|
100
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%
|
Total sales
|
|
|
115
|
|
|
$
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19,317,260
|
|
|
|
112
|
|
|
$
|
19,231,714
|
|
|
$
|
85,546
|
|
|
|
0.4
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%
|
The following table presents our sales mix by customer categories for the quarters ended March 31:
Customer Group
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|
2018
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|
|
2017
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|
RETAIL
(end users, consumers, individuals)
|
|
|
62
|
%
|
|
|
57
|
%
|
NON-RETAIL
(hospitals, youth organizations, resellers, distributors, businesses)
|
|
|
38
|
%
|
|
|
43
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Income from operations for North America during the quarter ended March 31, 2018 increased by 1.1% or $19,096 from the comparative 2017 quarter. An increase in gross profit of $473,045 offset by an increase in operating expenses of $453,949 contributed to the improvement in income from operations. Gross profit as a percentage of sales increased from 61.1% in the first quarter of 2017 to 63.3% in the first quarter of 2018, due to customer mix and an increase in sales of higher margin products compared to last year's first quarter. Operating expenses increased 4.6% compared to last year's comparable period. The most significant expense increases occurred in personnel, occupancy and selling costs related to the three new stores opened since the end of the first quarter last year, as well as the personnel and travel costs for twelve district managers, many of whom had not yet been placed until March and April 2017.
International
International consists of all stores located outside of North America. As of March 31, 2018 and 2017, the segment contained four stores, two of which are located in United Kingdom and one each in Australia and Spain (there were no new or closed stores during either such period). This segment's sales totaled approximately $972,000 for the first quarter of 2018, compared to approximately $918,000 in the first quarter of 2017, an increase of $54,000 or 5.9%.
The following table presents our sales mix by customer categories for the quarters ended March 31:
Customer Group
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|
2018
|
|
|
2017
|
|
RETAIL
(end users, consumers, individuals)
|
|
|
47
|
%
|
|
|
44
|
%
|
NON-RETAIL
(hospitals, youth organizations, resellers, distributors, businesses)
|
|
|
53
|
%
|
|
|
56
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Gross profit margin increased from 58.1% in 2017 to 63.5% in 2018, primarily due to price changes that were implemented in Fall 2017. International's operating expenses increased by $71,000 due to foreign currency exchange, as well as higher personnel and advertising costs. Overall, advertising and marketing expenses are this segment's largest expense, followed by employee compensation, rent, travel, and shipping costs to customers.
Other Expenses
We paid approximately $65,000 in interest on our bank debt in the first quarter of 2018, compared to $36,000 in the first quarter of 2017 due to higher interest rates and higher weighted average outstanding balance in 2018 compared to 2017.
Income Taxes
The decrease in the effective tax rate of 27% in the first quarter of 2018 compared to 28% in the prior year period is primarily due to the new lower federal rate of 21%, offset by
the addition of the new global foreign income
provision, the loss of the domestic production deduction, and a lower deferred tax benefit, primarily related to fixed assets.
Capital Resources, Liquidity and Financial Condition
We require cash principally for day-to-day operations, to purchase inventory, to finance capital investments, and to service our outstanding debt. We expect to fund our operating and liquidity needs as well as our store growth from a combination of current cash balances and internally generated funds. Our cash balances at March 31, 2018 totaled $19.3 million. In addition, we have available a $6 million line of credit, more fully described below.
In August 2015, our Board authorized a share repurchase program where we may repurchase up to 1.2 million shares of our common stock at prevailing market rates through August 2016. Subsequently, the program was amended to increase the number of shares available for repurchase to 2.2 million and to extend the program through August 2018. For the three months ended March 31, 2018, 72,400 shares were repurchased, while no shares were repurchased during the first quarter of 2017. At March 31, 2018, there are 1,078,393 shares available for repurchase under the plan.
On September 18, 2015, we executed a Promissory Note and Business Loan Agreement with BOKF, NA d/b/a Bank of Texas ("BOKF") which provided us with a line of credit facility of up to $10,000,000 for the purpose of repurchasing shares of our common stock pursuant to our stock repurchase program. On August 25, 2016, this line of credit was amended to increase the availability from $10,000,000 to $15,000,000 for the repurchase of shares of our common stock through the earlier of August 25, 2017 or the date on which the entire amount is drawn. On August 10, 2017, this line of credit was further amended to extend the drawdown period and conversion date from August 25, 2017 to August 18, 2018 to align with our stock repurchase program. During this time period, we are required to make monthly interest-only payments. At the end of this time period, we expect that the principal balance will be rolled into a 4-year term note. This Promissory Note is secured by a Deed of Trust on the real estate located at 1900 SE Loop 820, Fort Worth, Texas. For the quarter ended March 31, 2018, we drew approximately $541,000 on this line which was used to purchase 72,400 shares of our common stock. There were no amounts drawn on this line during the quarter ended March 31, 2017. At March 31, 2018, the unused portion of the line of credit was approximately $7.1 million.
Also, on September 18, 2015, we executed a Promissory Note and Business Loan Agreement with BOKF which provides us with a line of credit facility of up to $6,000,000 and is secured by our inventory. On August 10, 2017, this line of credit was amended to extend the maturity to September 18, 2019. The Business Loan Agreement contains covenants that require us to maintain a funded debt to EBITDA ratio of no greater than 1.5 to 1 and a "Fixed Charge Coverage Ratio" greater than or equal to 1.2 to 1. Both ratios are calculated quarterly on a trailing four quarter basis. For the three months ended March 31, 2018 and 2017, there were no amounts drawn on this line.
Amounts drawn under either Promissory Note accrue interest at the London interbank Eurodollar market rate for U.S. dollars (commonly known as "LIBOR") plus 1.85% (3.672% and 3.351% at March 31, 2018 and December 31, 2017, respectively).
The terms of our lines of credit contain various covenants with which we were in compliance as of March 31, 2018 and December 31, 2017.
On our consolidated balance sheet, total assets increased from $74.9 million at year-end 2017 to $75.0 million at March 31, 2018. Total stockholders' equity increased from $59.5 million at December 31, 2017 to $60.2 million at March 31, 2018, primarily due to net income earned in the first three months of 2018, offset by treasury stock purchases. Our current ratio increased from 8.3 at December 31, 2017 to 8.9 at March 31, 2018 due primarily to the increase in cash and decrease in accrued expenses and other liabilities.
As of March 31, 2018, our investment in inventory decreased by $0.5 million from year-end 2017, due to timing of purchases. We expect that our inventory levels will increase as we stock up for holiday sales, introduce new products, and invest in new stores. At March 31, 2018, average inventory per store was $187,000 compared to $176,000 at December 31, 2017 as we stocked up following the holiday season.
Accounts payable was relatively flat, at $1.4 million, from year end 2017 to March 31, 2018. Accrued expenses decreased from $5.0 million at December 31, 2017 to $3.9 million at March 31, 2018. The payment of the 2017 manager bonuses in March 2018 primarily accounted for the reduction.
During the first three months of 2018, cash flow provided by operating activities was $1.2 million, composed of net income of $1.3 million, plus $0.5 million of depreciation and amortization, offset by changes in working capital including a decrease in inventory levels and payments of 2017 bonuses.
By comparison, during the first three months of 2017, cash flow provided by operating activities was approximately $0.2 million, composed of net income of $1.2 million, plus $0.5 million of depreciation and amortization, offset by the increase in inventory of $1.2 million and payments of 2016 bonuses.
Cash flow used in investing activities totaled approximately $0.2 million and $0.6 million in the first quarter of 2018 and 2017, respectively, consisting primarily of the purchase of fixtures for new stores, store moves and remodels and computer equipment, and in 2017, vehicles and computer equipment for our new district managers.
During the first quarter of 2017, we funded $0.5 million of treasury share purchases with proceeds from our line of credit. In the comparable period in 2017, there were no financing activities.