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. To date in 2018, we have opened new stores in Austin, Texas (July 2018) and Calgary, Alberta (July 2018). We expect more North America new store openings in the future.
We operate in two segments, based on management responsibility and store location: North America and International. As of August 1, 2018, our North America segment operates 117 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 a return to greater than 10% operating income margins. During the first six months of 2018, we reported a slight improvement in sales and a record level of gross profit margin which increased operating income by 10.5% as compared to the comparable period of 2017. While encouraging, many of our key priorities are still being implemented 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. During the second quarter of 2018, we combined several districts so that there are now twelve districts instead of fifteen. As of August 1, 2018, we have filled eleven of our twelve 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 and competitive wages, 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 that could cause our actual results of operations to differ materially from those in the forward-looking statements include, among others:
Ø
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General economic conditions in the United States and abroad;
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Ø
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Increased pressure on margins;
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Ø
|
Increases in the cost of the products we sell or a reduction in availability of those products;
|
Ø
|
Challenges in implementing our planned expansion and district restructuring;
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Ø
|
Failure to hire and train qualified personnel to operate new and existing stores;
|
Ø
|
Failure to protect our trademarks and other proprietary intellectual property rights;
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Ø
|
Negative impact of foreign currency fluctuations on our financial condition and results of operations;
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Ø
|
Information technology system failures or network disruptions;
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Ø
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Significant data security or privacy breach of our information systems;
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Ø
|
Loss or prolonged disruption in the operation of our centralized distribution center; and
|
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
.
Results of Operations
Three Months Ended June 30, 2018 and 2017
The following tables present selected financial data for each of our segments:
|
|
Quarter Ended June 30, 2018
|
|
|
Quarter Ended June 30, 2017
|
|
|
|
Net Sales
|
|
|
Income from Operations
|
|
|
Net Sales
|
|
|
Income from Operations
|
|
North America
|
|
$
|
18,276,885
|
|
|
$
|
1,986,190
|
|
|
$
|
18,427,425
|
|
|
$
|
1,814,887
|
|
International
|
|
|
900,882
|
|
|
|
(4,709
|
)
|
|
|
853,345
|
|
|
|
(159,450
|
)
|
Total
|
|
$
|
19,177,767
|
|
|
$
|
1,981,481
|
|
|
$
|
19,280,770
|
|
|
$
|
1,655,437
|
|
Consolidated net sales for the quarter ended June 30, 2018 decreased $103,003, or 0.5%, compared to the same period in 2017. International reported a sales increase of 5.6%, while North America reported a sales decline of 0.8%. Income from operations on a consolidated basis for the quarter ended June 30, 2018 increased $326,044, from the second quarter of 2017 primarily due to an improvement in gross profit margins and reductions in operating expenses. As for gross profit, the improvement is a result of a continued shift in our customer base from non-retail to retail and from the mix of products sold. Our operating expenses decreased primarily due to reductions in our advertising and marketing spend, partially offset by increases in personnel and occupancy costs.
The following table shows in comparative form our consolidated net income for the second quarter of 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
|
% change
|
|
Net income
|
|
$
|
1,440,092
|
|
|
$
|
1,027,732
|
|
|
|
40.1
|
%
|
Additional information appears below for each segment (see also the information contained in Note 7 to the consolidated financial statements included in Item 1 of this Report).
North America
North America consisted of 115 stores at both June 30, 2018 and 2017, as there were no changes in our store footprint between those dates, although three new stores were opened from the beginning of 2017: Allen, TX (April 2017); Miami, FL (May 2017); and McAllen, TX (May 2017). A store is categorized as "new" until it is operating for the full comparable period in the prior year.
|
|
# Stores
|
|
|
Qtr Ended
06/30/18
|
|
|
#
Stores
|
|
|
Qtr Ended
06/30/17
|
|
|
$
Change
|
|
|
% Change
|
|
Same stores
|
|
|
112
|
|
|
$
|
17,966,357
|
|
|
|
112
|
|
|
$
|
18,292,128
|
|
|
$
|
(325,771
|
)
|
|
|
(1.8
|
%)
|
New stores
|
|
|
3
|
|
|
|
310,528
|
|
|
|
3
|
|
|
|
135,297
|
|
|
|
175,231
|
|
|
|
(130
|
%)
|
Total net sales
|
|
|
115
|
|
|
$
|
18,276,885
|
|
|
|
115
|
|
|
$
|
18,427,425
|
|
|
$
|
(150,540
|
)
|
|
|
(0.8
|
)%
|
The following table presents our sales mix by customer categories for the quarters ended June 30:
Customer Group
|
|
2018
|
|
|
2017
|
|
RETAIL
(end users, consumers, individuals)
|
|
|
59
|
%
|
|
|
57
|
%
|
NON-RETAIL (hospitals, organizations, resellers, distributors, businesses)
|
|
|
41
|
%
|
|
|
43
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Net sales decreased 0.8%, or $151,000, for the second quarter of 2018 compared to the second quarter of 2017, primarily due to increased competition to our non-retail customers who purchased lower quantities of leather compared to the comparable quarter in 2017.
Income from operations for North America during the quarter ended June 30, 2018 increased by $171,303 from the comparative 2017 quarter due to an increase in gross profit of $69,887 and a decrease in operating expenses of $101,416. Gross profit as a percentage of sales improved from 67.6% in the second quarter of 2017 to 68.5% in the second quarter of 2018, due to an increase in sales of higher margin products compared to last year's second quarter and customer mix with more retail than non-retail sales. Operating expenses decreased 1.0% compared to last year's comparable period, as we reduced our advertising and marketing spend, offset by higher personnel and occupancy costs.
International
International consists of all stores located outside of North America. As of June 30, 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 $901,000 for the second quarter of 2018, compared to approximately $853,000 in the second quarter of 2017, an increase of $48,000 or 5.6%, primarily due to favorable exchange rates and recent price increases.
The following table presents our sales mix by customer categories for the quarters ended June 30:
Customer Group
|
|
2018
|
|
|
2017
|
|
RETAIL
(end users, consumers, individuals)
|
|
|
48
|
%
|
|
|
44
|
%
|
NON-RETAIL
(hospitals, youth organizations, resellers, distributors, businesses)
|
|
|
52
|
%
|
|
|
56
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Gross profit margin increased from 52.3% in 2017 to 66.5% in 2018, primarily due to the recent price changes and shift in customer mix. International's operating expenses of $604,000 for the quarter ended June 30, 2018 were relatively flat compared to $606,000 for the quarter ended June 30, 2017, as increases due to foreign currency exchange were offset by lower 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 $78,000 in interest on our bank debt in the second quarter of 2018, compared to $54,000 in the second quarter of 2017 due to a slightly higher interest rate and higher weighted average outstanding balance in 2018 compared to 2017. We recorded income of $47,000 in the second quarter of 2018 primarily for interest income, currency fluctuations, vendor rebates and discounts earned, compared to $17,000 in the second quarter of 2017.
Income Taxes
The decrease in the effective tax rate of 26.2% in the second quarter of 2018 compared to 36.5% 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.
Six Months Ended June 30, 2018 and 2017
The following tables present selected financial data for each of our segments:
|
|
Six Months Ended June 30, 2018
|
|
|
Six Months Ended June 30, 2017
|
|
|
|
Net Sales
|
|
|
Income from Operations
|
|
|
Net Sales
|
|
|
Income from Operations
|
|
North America
|
|
$
|
37,594,145
|
|
|
$
|
3,816,849
|
|
|
$
|
37,659,139
|
|
|
$
|
3,626,450
|
|
International
|
|
|
1,872,540
|
|
|
|
(66,407
|
)
|
|
|
1,771,476
|
|
|
|
(233,522
|
)
|
Total
|
|
$
|
39,466,685
|
|
|
$
|
3,750,442
|
|
|
$
|
39,430,615
|
|
|
$
|
3,392,928
|
|
Consolidated net sales for the six months ended June 30, 2018 increased $36,070, or 0.1%, compared to the same period in 2017. International reported a sales increase of 5.7%. while North America reported a sales decline of 0.2%. Income from operations on a consolidated basis for the six months ended June 30, 2018 increased 11%, or $357,514, from the first half of 2017 primarily due to an improvement in gross margins, offset by an increase in operating expenses, primarily related to three new stores opened since the beginning of 2017, as well as investments in our district manager program.
The following table shows in comparative form our consolidated net income for the first half of 2018 and 2017:
|
|
2018
|
|
|
2017
|
|
|
% change
|
|
Net income
|
|
$
|
2,713,711
|
|
|
$
|
2,258,997
|
|
|
|
20.1
|
%
|
Additional information appears below for each segment (see also the information contained in Note 7 to the consolidated financial statements included in Item 1 of this Report).
North America
|
|
# Stores
|
|
|
Six Months Ended
06/30/18
|
|
|
#
Stores
|
|
|
Six Months Ended
06/30/17
|
|
|
$
Change
|
|
|
% Change
|
|
Same stores
|
|
|
112
|
|
|
$
|
36,965,669
|
|
|
|
112
|
|
|
$
|
37,523,842
|
|
|
$
|
(558,173
|
)
|
|
|
(1.5
|
%)
|
New stores
|
|
|
3
|
|
|
|
628,476
|
|
|
|
3
|
|
|
|
135,297
|
|
|
|
493,179
|
|
|
|
364.5
|
%
|
Total net sales
|
|
|
115
|
|
|
$
|
37,594,145
|
|
|
|
115
|
|
|
$
|
37,659,139
|
|
|
$
|
(64,994
|
)
|
|
|
(0.2
|
%)
|
The following table presents our sales mix by customer categories for the six months ended June 30:
Customer Group
|
|
2018
|
|
|
2017
|
|
RETAIL
(end users, consumers, individuals)
|
|
|
60
|
%
|
|
|
58
|
%
|
NON-RETAIL
(hospitals, organizations, resellers, manufacturers, businesses)
|
|
|
40
|
%
|
|
|
42
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Net sales decreased 0.2%, or $65,000, for the first half of 2018 compared to the first half of 2017, primarily due to increased competition to our non-retail customers, offset by fluctuations in the Canadian dollar exchange rate.
Income from operations for North America for the six months ended June 30, 2018 increased $190,399 from the comparative 2017 period. An increase in gross profit of $542,932, partially offset by an increase in operating expenses of $352,533 contributed to the improvement in income from operations. Gross profit as a percentage of sales increased from 64.3% in the first half of 2017 to 65.8% in the first half of 2018, due to an increase in sales of higher margin products, specifically less sales of leather to our non-retail customers. compared to last year's first half and customer mix. Operating expenses increased 1.7% compared to last year's comparable period. The most significant expense increases occurred in personnel, occupancy and selling costs related to three new stores opened, as well as increases in our store associate wages and higher common area maintenance costs.
International
International's sales totaled approximately $1,873,000 for the first half of 2018, compared to approximately $1,771,000 in the first half of 2017, an increase of $102,000 or 5.7%, primarily due to favorable foreign currency exchange rates and recent price increases.
The following table presents our sales mix by customer categories for the six months ended June 30:
Customer Group
|
|
2018
|
|
|
2017
|
|
RETAIL
(end users, consumers, individuals)
|
|
|
48
|
%
|
|
|
44
|
%
|
NON-RETAIL
(hospitals, organizations, resellers, manufacturers, businesses)
|
|
|
52
|
%
|
|
|
56
|
%
|
|
|
|
100
|
%
|
|
|
100
|
%
|
Gross profit margin increased from 55.3% in 2017 to 65.0% in 2018, primarily due to the recent price changes and the shift in customers from non-retail to retail. International's operating expenses increased by $70,000 due to foreign currency exchange rates, offset by cost controls in personnel and advertising expenses. Operating expenses totaled approximately $1,283,000 in the first half of 2018, up from approximately $1,213,000 in the first half of 2017.
Other Expenses
We paid approximately $143,000 in interest on our bank debt in the first six months of 2018, compared to approximately $90,000 in the first six months of 2017 due to slightly higher interest rates and higher weighted average outstanding balances in 2018 compared to 2017. We recorded income of $86,000 in the first half of 2018 primarily for interest income, currency fluctuations, vendor rebates and discounts earned, compared to $20,000 in the first half of 2017.
Income Taxes
The decrease in the effective tax rate of 26.5% in the first half of 2018 compared to 32% in the first half of 2018 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 June 30, 2018 totaled $19.0 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 2019. For the six months ended June 30, 2018, 133,295 shares were repurchased, while no shares were repurchased during the first six months of 2017. At June 30, 2018, there are 1,017,498 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. Subsequently, 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, 2018 or the date on which the entire amount is drawn. We are currently working to amend this facility to extend the drawdown period and conversion date to August 25, 2019. During this draw down period, we are required to make monthly interest-only payments. At the end of this draw down 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. During the six months ended June 30, 2018, we drew approximately $983,000 on this line which was used to purchase shares of our common stock. There were no amounts drawn on this line during the six months ended June 30, 2017. At June 30, 2018, the unused portion of the line of credit was approximately $6.6 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 six months ended June 30, 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% (3.934% and 3.351% at June 30, 2018 and December 31, 2017, respectively).
The terms of our lines of credit contain various covenants with which we were in compliance as of June 30, 2018 and December 31, 2017.
On our consolidated balance sheet, total assets increased from $74.9 million at year-end 2017 to $75.8 million at June 30, 2018. Total stockholders' equity increased from $59.5 million at December 31, 2017 to $60.9 million at June 30, 2018, primarily due to net income earned in the first six months of 2018, offset by treasury stock purchases. Our current ratio increased from 8.3 at December 31, 2017 to 8.7 at June 30, 2018 due primarily to the increase in cash and decrease in accrued expenses and other liabilities.
As of June 30, 2018, our investment in inventory increased by $0.7 million from year-end 2017, as we stocked up following the holiday sales and invested in new products. We expect that our inventory levels will continue to increase as we introduce new products and invest in new stores. At June 30, 2018, average inventory per store was $184,000 compared to $176,000 at December 31, 2017.
Accounts payable decreased slightly from $1.4 million at year end 2017 to $1.2 million at June 30, 2018 due to timing of payments. Accrued expenses decreased from $5.0 million at December 31, 2017 to $3.9 million at June 30, 2018. The payment of the 2017 manager bonuses in March 2018 primarily accounted for the reduction.
During the first six months of 2018, cash flow provided by operating activities was $1.0 million, composed of net income of $2.7 million, plus $0.9 million of depreciation and amortization, offset by changes in working capital including an increase in inventory levels and payments of 2017 bonuses.
By comparison, during the first six months of 2017, cash flow used in operating activities was approximately $1.2 million, composed of net income of $2.3 million, plus $0.9 million of depreciation and amortization, offset by an increase in inventory of $4.1 million and payments of 2016 bonuses.
Cash flow used in investing activities totaled approximately $0.4 million and $1.0 million in the first six months 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 half of 2018, we funded approximately $1.0 million of treasury share purchases with proceeds from our line of credit. In the comparable period in 2017, there were no financing activities.