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TLF > SEC Filings for TLF > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for TANDY LEATHER FACTORY INC

Form 10-Q for TANDY LEATHER FACTORY INC


13-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.

Our Business

We are one of the world's largest specialty retailers and wholesale distributor of leather and leathercraft related items. We market our products to our growing list of customers through company-owned retail and wholesale stores. We are a Delaware corporation, and our common stock trades on the NASDAQ Global Market under the symbol "TLF." We operate our business in three segments: Wholesale Leathercraft, which operates wholesale stores in North America under the trade name, The Leather Factory, Retail Leathercraft, which operates retail stores in North America under the trade name, Tandy Leather Company, and International Leathercraft, which operates combination retail/wholesale stores outside of North America under the trade name, Tandy Leather Factory. See Note 8 to the consolidated financial statements included in Item 1 of this Report for additional information concerning our segments, as well as our foreign operations.

Our Wholesale Leathercraft segment operates 29 company-owned wholesale stores in 19 states and three Canadian provinces. These stores are engaged in the wholesale distribution of leather and related items, including leatherworking tools, buckles and belt adornments, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits to retailers, manufacturers, and end users. Our Wholesale Leathercraft segment also includes our National Account sales group, whose customers are only national craft chains.


Table of Contents
Our Retail Leathercraft segment operates company-owned Tandy Leather Company retail stores in 36 states and six Canadian provinces. Tandy Leather Company, one of the oldest and best-known suppliers of leather and related supplies used in the leathercraft industry, has been a primary leathercraft resource for decades. Tandy Leather Company's products include quality tools, leather, accessories, kits and teaching materials. In 2002, we began expanding Tandy Leather Company's industry presence by opening retail stores. As of November 1, 2012, we were operating 77 Tandy Leather Company retail stores located throughout the United States and Canada.

Our International Leathercraft segment operates 3 company-owned stores, all located outside of North America. These stores operate as combination retail / wholesale stores and consist of one store in Northampton, United Kingdom, one store in Sydney, Australia, and one store in Jerez, Spain. We expect to open additional stores outside of North America in the future, although specific locations and opening dates have not yet been determined.

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, 2011.

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 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, 2011 for additional information concerning these and other uncertainties that could negatively impact the Company.

Our business may be negatively impacted by general economic conditions and the current global financial crisis.

Our performance is subject to worldwide economic conditions and their impact on levels of consumer spending that affect not only the ultimate consumer, but also small businesses and other retailers. The United States and global economies have suffered from a prolonged recession for the past several years and as a result, consumer spending has remained depressed, and may be subject to further deterioration for the foreseeable future. Specialty retail, and retail in general, are heavily influenced by general economic cycles. Purchases of non-essential products tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income declines. During periods of economic uncertainty, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain our earnings from operations as a percentage of net sales. As a result, our operating results may be adversely and materially affected by continued downward trends or uncertainty in the United States or global economies.

Our profitability may decline as a result of increasing pressure on margins.

Our industry is subject to significant pricing pressure caused by many factors, including fluctuations in the cost of the leather and metal products that we purchase and changes in consumer spending patterns and acceptance of our products. These factors may prohibit us from passing cost increases on to customers which could cause our gross margin to decline. If our product costs increase and our sale prices do not, our future operating results could be adversely affected unless we are able to offset such gross margin declines with comparable reductions in operating costs.

We may be unsuccessful in implementing our planned international expansion, which could impair the value of our brand, harm our business and negatively affect our results of operation.

We plan to grow our net sales and net earnings from our International segment by opening stores in various international markets. As we expand outside of North America, we may incur significant costs relating to starting up, maintaining and expanding foreign operations. Costs may include, but are not limited to, obtaining locations for stores, hiring personnel, and travel expenses. We may be unable to open and operate new stores successfully and our growth may be limited, unless we are able to identify desirable sites for store locations; negotiate acceptable lease terms; hire, train and retain competent store personnel; manage inventory effectively to meet the needs and demands of customers on a timely basis; manage foreign currency risk effectively; and achieve acceptable operating margins from the new stores. We cannot be sure that we can successfully open new stores or that our new stores will be profitable.

As we continue to increase our international operations, we face the possibility of greater losses from a number of risks inherent in doing business in international markets and from a number of factors which are beyond our control, such as political instability or acts of terrorism, which disrupt trade with the countries in which our suppliers or customers are located; local business practices that do not conform to legal or ethical guidelines; restrictions or regulations relating to imports or exports; additional or increased customs duties, tariffs, taxes and other charges on imports; significant fluctuations in the value of the dollar against foreign currencies; social, legal or economic instability in the foreign markets in which we do business, which could influence our ability to sell our products in these markets; and restrictions on the transfer of funds between the United States and foreign jurisdictions.

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 September 30, 2012 and 2011

The following tables present selected financial data of each of our three
segments for the quarters ended September 30, 2012 and 2011.

                       Quarter Ended September 30,   Quarter Ended September 30,
                                  2012                          2011
                          Sales        Operating         Sales        Operating
                                         Income                         Income
                                         (Loss)
Wholesale Leathercraft  $6,242,602      $(297,897)      $6,150,138      $296,824
Retail Leathercraft      9,947,911         987,704       8,744,446       811,347
Int'l Leathercraft         810,215        (44,951)         490,837       113,666
Total Operations       $17,000,728        $644,856     $15,385,421    $1,221,837

Consolidated net sales for the quarter ended September 30, 2012 increased $1.6 million, or 10.5%, compared to the same period in 2011. All three segments contributed to the sales increase. Operating income on a consolidated basis for the quarter ended September 30, 2012 was down 47.2%, or $577,000, from the third quarter of 2011. The settlement of the litigation described in Note 7 to the consolidated financial statements included in Item 1 of this Report accounted for the decrease in operating income. The expense was recorded in our Wholesale Leathercraft segment. Our Retail Leathercraft segment reported an increase in operating income of 21.7%, offset by operating losses of 200% and 140% in our Wholesale and International Leathercraft segments, respectively.

The following table shows in comparative form our consolidated net income for the third quarters of 2012 and 2011:

2012 2011 % change
Net income $280,770 $829,106 (66.2)%

Additional information appears below for each segment.


Table of Contents
Wholesale Leathercraft

Our Wholesale Leathercraft segment consists of 29 wholesale stores and our
National Account sales group. The National Account sales group's customers
consist of only national craft chains. The following table presents the combined
sales mix by customer categories for the quarters ended September 30, 2012 and
2011:

                                                 Quarter Ended
Customer Group                                09/30/12   09/30/11
 RETAIL (end users, consumers, individuals)        33%        28%
 INSTITUTION (prisons, prisoners, hospitals,        6%         5%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       44%        44%
& tack shops, authorized dealers, etc.)
 MANUFACTURERS                                      8%         7%
 NATIONAL ACCOUNTS                                  9%        16%
                                                  100%       100%

Net sales increased 1.5%, or $92,000, for the third quarter of 2012 as follows:

                         #    Qtr Ended    Qtr Ended        $        %
                       Stores  09/30/12     09/30/11     Change    Change
Same store sales         29   $5,821,208   $5,361,239    $459,969    8.6%
National account group           421,394      788,899   (367,505) (46.6)%
Total sales                   $6,242,602   $6,150,138     $92,464    1.5%

Our same store sales increased 8.6% in the third quarter of 2012, as compared with the same period in 2011. Compared to the third quarter of 2011, we achieved sales dollar increases in all customer categories, with the exception of our National Account group. Sales to our National Account customers were down 47% for the quarter, compared to the same quarter last year. Our sales to these customers are dependent on what products we are willing to develop specifically for this group and the level of inventory we are willing to house in anticipation of orders. We have intentionally eliminated some products from our line because the gross profit margins were lower than we were willing to accept. Therefore, it is likely we will experience further sales declines to our National Account group if the product we stock is not what these customers want to purchase. Our primary focus is on sales through our stores, rather than National Accounts, as we believe our stores represent the greatest potential for continued and consistent sales growth.

Operating income for Wholesale Leathercraft during the quarter ended September 30, 2012 decreased by $595,000 from the comparative 2011 quarter, a decrease of 200%. Operating expenses as a percentage of sales were 70.6%, up $972,000 from the third quarter of 2011. The primary reason for the operating expense increase was the one-time charge of $994,000 related to the settlement of litigation. (See Note 7 to the consolidated financial statements included in Item 1 of this Report for additional information.) Other changes in operating expenses consisted of a decrease in legal fees of $100,000, an increase in employee compensation of $100,000, and a reduction in employee benefits, namely our employee health care program, of $150,000. Excluding the one-time settlement expense, operating expenses as a percentage of sales was 54.7%, down $21,000 from the third quarter of 2011.

Retail Leathercraft

Our Retail Leathercraft segment consists of 77 Tandy Leather Company retail
stores at September 30, 2012 and 2011. Net sales increased 13.8% for the third
quarter of 2012 over the same quarter last year. A store is categorized as "new"
until it is operating for the full comparable period in the prior year.

                   #    Qtr Ended    Qtr Ended        $        %
                 Stores  09/30/12     09/30/11      Change   Change
Same store sales   77   $9,947,911   $8,744,446   $1,203,465  13.8%
New store sales    -             -            -            -      -
Total sales             $9,947,911   $8,744,446   $1,203,465  13.8%

The following table presents sales mix by customer categories for the quarters ended September 30, 2012 and 2011 for our Retail Leathercraft operation:

                                                 Quarter Ended
Customer Group                                09/30/12   09/30/11
 RETAIL (end users, consumers, individuals)        60%        59%
 INSTITUTION (prisons, prisoners, hospitals,        5%         5%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       33%        33%
& tack shops, authorized dealers, etc.)
 NATIONAL ACCOUNTS                                   -          -
 MANUFACTURERS                                      2%         3%
                                                  100%       100%

The retail stores averaged approximately $43,000 in sales per month for the third quarter of 2012.

Sales to each customer group increased solidly over the third quarter of 2011, with the exception of our Manufacturer customer group. Operating income increased $176,000, or 21.7%, from the comparative 2011 quarter. Operating income as a percentage of sales also increased from 9.3% in the third quarter of 2011 to 9.9% in the third quarter of 2012. Gross profit margin declined slightly from 59.2% to 58.8%. Operating expenses as a percentage of sales decreased from 50.0% to 48.9% as expenses grew at a slower rate than that of sales during the quarter. Operating expenses increased $493,000 over the third quarter of 2011, with increases in employee compensation and benefits of $175,000, advertising and marketing expenses of $90,000, travel expense associated with store relocations of $30,000, and rent and utilities expense of $85,000 accounting for the majority of the increase.

International Leathercraft

International Leathercraft consists of all stores located outside of North America. As of September 30, 2012, the segment contained three stores with one store located in United Kingdom, one store located in Australia, and one store located in Spain. As of September 30, 2011, the segment consisted of the one store located in the United Kingdom. Net sales increased 65.1% for the third quarter of 2012 over the same quarter last year as a result of the addition of new stores. A store is categorized as "new" until it is operating for the full comparable period in the prior year.

                   #    Qtr Ended   Qtr Ended      $       %
                 Stores 09/30/12    09/30/11     Change  Change
Same store sales   1     $491,869    $490,837     $1,032   0.2%
New store sales    2      318,346           -    318,346    N/A
Total sales              $810,215    $490,837   $319,378  65.1%

Gross profit margin as a percentage of sales decreased from 66.5% in the third quarter of 2011 to 55.0% in the third quarter of 2012. The cost of goods is typically higher in these stores than that of the North American stores due to the higher freight costs incurred to get product to the stores. Further, we determine selling prices taking into consideration the currency conversion between the U.S. dollar and the local currency. Therefore, gross profit margin can fluctuate as a result of sales mix (the ratio of selling higher margin tools and supplies to lower margin leather), shipping methods (air versus ocean) when we ship merchandise to the stores, and the currency conversion rate we use to convert US dollar selling prices to local currency selling prices. Operating expenses totaled $490,000 in the third quarter of 2012, up from $212,000 in the third quarter of 2011, all attributable to the new stores' operations. Employee compensation is this division's largest expense, followed by advertising, shipping costs to customers, and rent.


Table of Contents
Other Expenses

We paid $60,000 in interest expense in the third quarter of 2012 on our debt compared to $62,000 in interest expense in the third quarter last year. Due to the reduction in cash on hand compared to last year, we earned $500 in interest income during the third quarter of 2012, down from last year's third quarter interest income earned of $15,000. We recorded expense of $18,000 during the third quarter of 2012 related to currency fluctuations from our international operations. Comparatively, in the third quarter of 2011, we recorded income of $145,000 for currency fluctuations.

Nine Months Ended September 30, 2012 and 2011

The following table presents selected financial data of each of our three
segments for the nine months ended September 30, 2012 and 2011:

                     Nine Months Ended        Nine Months Ended September
                    September 30, 2012                 30, 2011
                    Sales       Operating         Sales         Operating
                                  Income                          Income
                                  (Loss)
Wholesale         $19,678,009   $2,038,267       $19,341,919    $1,709,226
Leathercraft
Retail             30,093,864    3,655,932        26,327,904     2,857,986
Leathercraft
International       2,310,188     (30,395)         1,528,559       336,428
Leathercraft
Total Operations  $52,082,061   $5,663,804       $47,198,382    $4,903,640

Consolidated net sales for the nine months ended September 30, 2012 were up 10% compared to the same period in 2011, increasing $4.9 million. All three reporting segments contributed to the sales increase. Retail Leathercraft contributed the largest sales increase of $3.8 million, followed by International Leathercraft reporting an increase of $781,000 and Wholesale Leathercraft reporting an increase of $336,000. Operating income on a consolidated basis for the nine months ended September 30, 2012 was up 15.5% compared to the first nine months of 2011, increasing $760,000.

The following table shows in comparative form our consolidated net income for the first three quarters of 2012 and 2011:

2012 2011 % change Net income $3,394,514 $3,056,038 11.1%

Wholesale Leathercraft

Net sales increased 1.7%, or $336,000, for the first three quarters of 2012 as
follows:

                         #    Nine Months   Nine Months       $         %
                       Stores    Ended         Ended        Change   Change
                               09/30/12      09/30/11
Same store sales         29   $18,232,337   $17,133,069   $1,099,268    6.4%
National account group          1,445,672     2,208,850    (763,178) (34.6)%
Total sales                   $19,678,009   $19,341,919     $336,090    1.7%

The following table presents the combined sales mix by customer categories for the nine months ended September 30, 2012 and 2011:

                                               Nine Months Ended
Customer Group                                09/30/12   09/30/11
 RETAIL (end users, consumers, individuals)        34%        31%
 INSTITUTION (prisons, prisoners, hospitals,        5%         6%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       43%        44%
& tack shops, authorized dealers, etc.)
 MANUFACTURERS                                      8%         7%
 NATIONAL ACCOUNTS                                 10%        12%
                                                  100%       100%

Operating income for Wholesale Leathercraft for the first three quarters of 2012 increased by $329,000 from the comparative 2011 period, an improvement of 19.3%. Compared to the first nine months of 2011, operating expenses increased $804,000 for the first nine months of 2012, increasing as a percentage of sales from 52.1% to 55.3%. The primary reason for the operating expense increase was the one-time charge in the third quarter of 2012 of $994,000 related to the settlement of litigation. (See Note 7 to the consolidated financial statements included in Item 1 of this Report for additional information.) Excluding the one-time settlement expense, 2012 year-to-date operating expenses as a percentage of sales were 50.2%, down $189,000 from the same period of 2011.

Retail Leathercraft
Net sales were up 14.3% for the first nine months of 2012 over the same period
last year.

                     #    Nine Months Nine Months     $         %
                   Stores    Ended       Ended      Change    Change
                           09/30/12    09/30/11
Same (existing)     76    $29,794,423 $26,252,161 $3,542,262   13.5%
store sales
New store sales      1        299,441      75,743    223,698     N/A
Total sales               $30,093,864 $26,327,904 $3,765,960   14.3%

The following table presents sales mix by customer categories for the nine months ended September 30, 2012 and 2011 for our Retail Leathercraft operation:

                                               Nine Months Ended
Customer Group                                09/30/12   09/30/11
 RETAIL (end users, consumers, individuals)        59%        60%
 INSTITUTION (prisons, prisoners, hospitals,        5%         6%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       33%        31%
& tack shops, authorized dealers, etc.)
 NATIONAL ACCOUNTS                                   -          -
 MANUFACTURERS                                      3%         3%
                                                  100%       100%

The retail stores averaged approximately $43,000 in sales per month per store for the first nine months of 2012.

Operating income for the first nine months of 2012 increased $1.7 million from the comparative 2011 period, improving as a percentage of sales from 10.9% in the first three quarters of 2011 to 12.2% in the first three quarters of 2012. Gross margin increased slightly from 60.1% to 61.0%. Operating expenses as a percentage of sales were 48.9% in the first nine months of 2012 compared to 49.3% in the first nine months of 2012, as sales grew slightly faster than expenses.


Table of Contents
International Leathercraft

International Leathercraft consists of all stores located outside of North
America. As of September 30, 2012, the segment contained three stores with one
store located in United Kingdom, one store located in Australia, and one store
located in Spain. As of September 30, 2011, the segment consisted of the one
store located in the United Kingdom. Net sales increased 51.1% for the first
three quarters of 2012 over the same period last year. A store is categorized as
"new" until it is operating for the full comparable period in the prior year.

                   #    Nine Months Ended   Nine Months Ended       $       %
                 Stores     09/30/12            09/30/11         Change   Change
Same store sales   1           $1,507,075          $1,528,559   $(21,484)  (1.4)
New store sales    2              803,113                   -     803,113    N/A
Total sales                    $2,310,188          $1,528,559    $781,629  51.1%

Gross profit margin as a percentage of sales decreased from 65.2% in the first nine months of 2011 to 61.9% in the first nine months of 2012. Selling prices are determined based on the currency conversion between the U.S. dollar and the local currency. In addition, gross profit margin is affected by sales mix - the ratio of higher margin products (tools, supplies, etc.) to lower margin products (leather). Operating expenses totaled $1.5 million in the first three quarters of 2012, up from $660,000 in the first three quarters of 2011, all attributable to the new stores' operations. Employee compensation is this segment's largest expense, followed by advertising and marketing expenses, shipping costs to customers, and rent.

Other Expenses

We paid $176,000 in interest on our debt in the first nine months of 2012, compared to $186,000 in the first nine months of 2011. Due to the reduction in cash on hand compared to last year, we recorded $7,000 in interest income on our cash balances in the nine months ended September 30, 2012 compared to $33,000 a year ago. We recorded income of $15,000 for currency fluctuations in the first three quarters of 2012. Comparatively, in the first three quarters of 2011, we recorded income of $7,000 for currency fluctuations.

Capital Resources, Liquidity and Financial Condition

On our consolidated balance sheet, total assets were $48.7 million at September 30, 2012, up $3.2 million from $45.5 million at year-end 2011. Total stockholders' equity increased from $34.4 million at December 31, 2011 to $35.4 million at September 30, 2012, the increase being attributable to earnings in the first three quarters of this year, partially offset by the cash dividend of $2.5 million paid to stockholders in April. Our current ratio decreased from 4.7 at December 31, 2011 to 3.9 at September 30, 2012 as current liabilities grew faster than current assets.

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