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TLF > SEC Filings for TLF > Form 10-K on 28-Mar-2014All Recent SEC Filings

Show all filings for TANDY LEATHER FACTORY INC

Form 10-K for TANDY LEATHER FACTORY INC


28-Mar-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We intend for the following discussion to provide you with information that will assist you in understanding our financial statements, the changes in key items in those financial statements from year to year and the primary factors that accounted for those changes, as well as how particular accounting principles affect our financial statements. This discussion also provides information about the financial results of the various segments of our business so you may better understand how those segments and their results affect our financial condition and results of operations as a whole. Finally, we have identified and discussed trends known to management that we believe are likely to have a material effect on our results of operations and financial condition.

This discussion should be read in conjunction with our financial statements as of December 31, 2013 and 2012 and the three years then ended and the notes accompanying those financial statements. You are also urged to consider the information under the caption "Summary of Critical Accounting Policies."

Summary

We are the world's largest specialty retailer and wholesale distributor of leather and leathercraft-related items. Our operations are centered on operating retail and wholesale stores. We have built our business by offering our customers quality products in one location at competitive prices. The key to our success is our ability to grow our base business. We grow that business by opening new locations and by increasing sales in our existing locations. We intend to continue to expand both domestically and internationally.

We operate in three segments. First, Wholesale Leathercraft, consisting of our Leather Factory stores and our national account sales group, which sells to large national store chains, is our oldest segment with sales of $27.4 million in 2013. Historically, in normal economic conditions, this division has generally offered steady but very modest increases in sales. Sales in 2013 increased 2.0% compared to 2012, with the stores' sales increasing 4% but national account sales decreasing by 25%. Sales at our stores are showing signs of strength despite cautious consumer spending as a result of continued uncertainty in the U.S. economy. Sales to national accounts are decreasing due to our intentional decision to discontinue certain products from our product line that our national account customers purchased as these products did not produce an acceptable gross profit margin. We expect our sales to our national account customers to continue to decline.

Tandy Leather has long been known for its retail leathercraft store chain. These retail stores comprise our Retail Leathercraft segment. This segment has experienced the greatest increases in sales ($47.0 million in 2013, up from $42.6 million in 2012) and is our largest source of revenues. We expect to grow the number of stores to approximately 100 in the future from 79 stores in operation at the end of 2013. Our pace of store openings has slowed in the last several years due to the general economic conditions in the U.S. and because of the lack of personnel qualified for store manager positions. We expect to continue to open stores domestically but have not committed to a specific time frame. While the store opening schedule has slowed, we have continued to relocate existing stores as current lease terms near expiration into larger spaces so that a larger amount of product is available to customers. We believe that the increase in sales in this segment suggests that the store relocation strategy is successful.

Our International Leathercraft segment consists of company-owned stores located outside of North America. At December 31, 2013, three combination retail/wholesale stores, with one each located in the United Kingdom, Australia and Spain, comprised this segment. It is our intention to open more stores in this segment once we have a large enough customer base to support additional stores.

On a consolidated basis, gross profit margin as a percent of total net sales, a key indicator of costs, decreased minimally in 2013 compared to 2012. Operating expenses increased at a slower pace than that of sales in 2013, increasing by 4% from 2012. Operating expenses increased at a higher pace than that of sales in 2012, increasing 13% from 2011, due to the legal settlement that we recorded in the third quarter. See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.

We reported consolidated net income for 2013 of $7.3 million. Consolidated net income for 2012 and 2011 was $5.6 million and $4.7 million, respectively. We use our cash flow to fund our operations, to fund the opening of new stores and to purchase necessary property and equipment. We paid a one-time dividend in 2012 to our stockholders, totaling $2.5 million. At the end of 2013, our stockholders' equity had increased to $44.6 million from $37.5 million the previous year.

Comparing the December 31, 2013 balance sheet with the prior year's balance sheet, we increased our investment in inventory from $25.9 million to $26.3 million and total cash increased from $7.7 million to $11.1million as the result of improved net income and no dividend paid in 2013.

Net Sales

Net sales for the three years ended December 31, 2013 were as follows:

Year   Wholesale      Retail    International Total Company   Increase
      Leathercraft Leathercraft Leathercraft                 from Prior
                                                                Year
2013   $27,384,614  $46,995,902    $3,904,069   $78,284,585     7.7%
2012   $26,850,002  $42,616,546    $3,254,076   $72,720,624    10.0%
2011   $26,540,899  $37,435,832    $2,126,216   $66,102,947    10.4%

Our net sales increased by 7.7% in 2013 when compared with 2012 and increased by 10.0% in 2012 when compared with 2011. In 2013 and 2012, all three segments reported sales increases compared to the prior year.

Costs and Expenses

In general, our gross profit as a percentage of sales (our gross margin) fluctuates based on the mix of customers we serve, the mix of products we sell and our ability to source products globally. Our negotiations with suppliers for lower pricing are an on-going process, and we have varying degrees of success in those endeavors. Sales to retail customers tend to produce higher gross margins than sales to wholesale customers due to the difference in pricing levels. Therefore, as retail sales increase in the overall sales mix, higher gross margins tend to follow. Finally, there is significant fluctuation in gross margins between the various merchandise categories we offer. As a result, our gross margins can vary depending on the mix of products sold during any given time period.

For 2013, our cost of sales increased slightly as a percentage of total net sales when compared to 2012, resulting in a decrease in consolidated gross profit margin from 63.1% to 63.0%. Our 2012 cost of sales as a percentage of our total net sales decreased as a percentage of total net sales when compared to 2011, resulting in an increase in consolidated gross profit margin from 61.0% to 63.1%. Fluctuations in gross margin are primarily due to sales mix. Retail sales are at a higher gross margin than that of wholesale sales. Therefore, as retail sales increase at a faster pace than that of wholesale sales, gross margin increases accordingly.

Our gross margins for the three years ended December 31, 2013 were as follows:

  Year    Wholesale      Retail    International Total Company
         Leathercraft Leathercraft Leathercraft
  2013      67.3%        60.5%         63.3%         63.0%
  2012      67.3%        60.6%         61.7%         63.1%
  2011      61.3%        60.5%         66.9%         61.0%

Our operating expenses decreased as a percentage of total net sales to 48.6% in 2013 when compared with 50.6% in 2012. This decrease indicates that our operating expenses grew slower than our sales during this period. 2013 operating expenses were $1.3 million higher than those of 2012. Significant expense fluctuations in 2013 compared to 2012 are as follows:

Expense                       2013 amount Incr (Decr) over 2012
Employee compensation       $18.2 million          $1.5 million
Advertising and marketing    $4.9 million              $635,000
Rent & utilities             $4.5 million              $157,000
Legal and professional fees  $1.2 million              $147,000
Store relocation expenses        $260,000              $132,000
Litigation settlement          ($249,000)        ($1.2 million)


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The increase in employee compensation is due to an increase in employee headcount as well as store manager compensation. Our store managers are paid a percentage of the operating profit generated by the store they manage as additional compensation, so as store profits increase, manager compensation increases. The litigation settlement entry represents a refund to us of unclaimed monies related to the settlement of a lawsuit that was recorded in the third quarter of 2012. (See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.) Litigation expenses are generally considered corporate expenses and not attributable to a specific store or group of stores. Further, corporate, administrative and support departments are included in the Wholesale Leathercraft segment. Therefore, the entire litigation settlement expense is included in the operating expenses of the segment.

Our operating expenses increased as a percentage of total net sales to 50.6% in 2012 when compared with 49.4% in 2011. This increase indicates that our operating expenses grew faster than our sales during this period. 2012 operating expenses were $4.1 million higher than those of 2011. Significant expense fluctuations in 2012 compared to 2011 are as follows:

Expense                                       2012 amount Incr (Decr) over 2011
Employee compensation & benefits            $19.6 million          $1.6 million
Travel expense                                   $507,000              $177,000
Advertising and marketing                    $3.5 million              $571,000
Rent & utilities                             $4.4 million              $280,000
Professional fees and licenses                   $798,000            ($237,000)
Repairs and maintenance                          $435,000              $133,000
Supplies                                         $857,000              $147,000
Workers compensation and property insurance      $506,000              $184,000
Litigation settlement                            $993,000              $993,000

Other Income/Expense (net)

Other Income/Expense consists primarily of currency exchange fluctuations, interest income and interest expense. In 2013, we incurred other expenses (net) of approximately $46,000 compared to other expenses (net) of approximately $198,000 in 2012. In 2013, we received approximately $17,000 in gas royalties, earned approximately $5,100 in interest income on our cash and paid approximately $202,000 in interest expense on our bank debt. We had a currency exchange gain of approximately $41,000 in 2013 compared to a currency exchange gain of approximately $26,000 in 2012.

In 2012, we incurred other expenses (net) of approximately $198,000 compared to other expenses (net) of approximately $165,000 in 2011. In 2012, we received approximately $12,000 in gas royalties, earned approximately $9,900 in interest income on our cash and paid approximately $239,000 in interest expense on our bank debt. We had a currency exchange gain of approximately $26,000 in 2012 compared to a currency exchange loss of approximately $200 in 2011.

Net Income
During 2013, we earned net income of $7.3 million, a 30% increase over our net income of $5.6 million earned during 2012. The increase in net income was the result of the increase in sales and gross profit, partially offset by the increase in operating expenses and income tax expense.

During 2012, we earned net income of $5.6 million, an 18% increase over our net income of $4.7 million earned during 2011. The increase in net income was the result of the increase in sales and gross profit, partially offset by the increase in operating expenses and income tax expense.

Wholesale Leathercraft

The increases (or decreases) in net sales, operating income, operating income
increases (or decreases) and operating income as a percentage of sales from our
Wholesale Leathercraft stores for the three years ended December 31, 2013 were
as follows:

          Net Sales              Operating    Operating
  Year    Increase   Operating     Income    Income as a
         from Prior    Income     Increase    Percentage
            Year                 from Prior    of Sales
                                    Year
  2013      2.0%     $4,840,416    29.8%        17.7%
  2012      1.2%     $3,730,678    33.1%        13.9%
  2011      2.4%     $2,803,034     4.2%        10.6%

Wholesale Leathercraft, consisting of our 29 wholesale stores and our national account group, accounted for 35.0% of our consolidated net sales in 2013, which compares to 36.9% in 2012 and 40.2% in 2011. The decrease in this division's contribution to our total net sales is the result of the growth in Retail Leathercraft, and we expect this trend to continue while retail consumers' buying patterns continue to strengthen over that of wholesale and small businesses.

Sales in the wholesale stores increased 3.8% in 2013 compared to sales in 2012 while the 2013 sales by our national account group were down 24.9% from 2012. By customer group, sales in the wholesale stores to our retail customers increased while sales to our other customer groups declined from 2012. Our sales mix by customer group in the Wholesale Leathercraft division was as follows:

Customer Group    2013 2012 2011
Retail             41%  37%  33%
Institution         4%   4%   5%
Wholesale          44%  45%  43%
National Accounts   5%   7%  12%
Manufacturers       6%   7%   7%

100% 100% 100%

In 2013, operating income as a percentage of divisional sales improved from the prior year of 13.9% to 17.7%. Operating expenses decreased approximately $748,000 in 2013 compared to 2012. The primary reason for the operating expense decrease was the one-time charge recorded in 2012 related to the settlement of litigation that was not repeated in 2013. (See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.) Legal and professional fees increased by approximately $134,000, while employee compensation increased by approximately $853,000.

In 2012, operating income as a percentage of divisional sales improved from the prior year of 10.6% to 13.9%. Operating expenses increased approximately $867,000 in 2012 compared to 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 9 to the consolidated financial statements included in Item 8 of this Report for additional information.) Legal and professional fees decreased by approximately $271,000, while employee compensation and benefits increased by approximately $345,000 and supplies increased by approximately $122,000.

Retail Leathercraft

The increases in net sales, operating income, operating income increases (or
decreases) and operating income as a percentage of sales from our Retail
Leathercraft stores for the three years ended December 31, 2013 were as follows:

          Net Sales               Operating    Operating
  Year    Increase   Operating     Income     Income as a
         from Prior    Income   Increase from  Percentage
             Yr                  Prior Year     of Sales
  2013      10.3%    $6.026,731     10.9%        12.8%
  2012      13.8%    $5,436,745     16.8%        12.8%
  2011      15.9%    $4,656,067     28.8%        12.4%

Reflecting the growth previously discussed, Retail Leathercraft accounted for 60.0% of our total net sales in 2013, up from 58.6% in 2012 and 56.6% in 2011. Growth in net sales for our Retail Leathercraft division in 2013 resulted primarily from an increase in same store sales.


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Our sales mix by customer group in the Retail Leathercraft division was as follows:

Customer Group    2013 2012 2011
Retail             59%  60%  62%
Institution         4%   4%   5%
Wholesale          34%  33%  30%
National Accounts   0%   0%   0%
Manufacturers       3%   3%   3%

100% 100% 100%

Operating income as a percentage of sales in 2013 matched operating income as a percentage of sales in 2012 at 12.8%. Gross margin decreased slightly to 60.5% in 2013 from 60.6% in 2012. Operating expenses as a percent of sales in 2013 decreased from 47.9% for 2012 to 47.8% for 2013 as operating expenses grew at a slower pace in 2013 than that of sales.

Operating income as a percentage of sales increased to 12.8% for 2012 compared to 12.4% for 2011. Gross margin increased slightly to 60.6% in 2012 from 60.5% in 2011. Operating expenses as a percent of sales in 2012 decreased from 48.0% for 2011 to 47.9% for 2012 as operating expenses in 2012 grew at a slower pace than that of sales

We intend to continue the slow expansion of our store chain over the next several years, with plans to open two to three stores in 2014 in North America. We remain committed to a conservative expansion plan for this division that is intended to minimize risks to our profits and maintain our financial stability. In the current economic environment in the U.S., it is possible that we will change our plans for store openings in 2014 if we determine that the feasibility of additional successful openings is likely.

International Leathercraft

International Leathercraft consists of all stores located outside of North America. As of December 31, 2013, that represents three retail/wholesale combination stores with one located in the United Kingdom, one located in Australia, and one located in Spain. International Leathercraft accounted for 5.0%, 4.5% and 3.2% of our total sales in 2013, 2012 and 2011, respectively. We expect this segment to become a larger part of our total operations as our international customer base continues to grow.

The increases in net sales, operating income, operating income increases (or decreases) and operating income as a percentage of sales from our International Leathercraft stores for the three years ended December 31, 2013 were as follows:

          Net Sales               Operating    Operating
  Year    Increase   Operating    Inc/Loss       Income
         from Prior    Income    Incr (Decr)  (Loss) as a
             Yr        (Loss)    from Prior    % of Sales
                                    Year
  2013      20.0%     $399,643     1806.6%       10.2%
  2012      53.0%    $(23,418)    (109.5)%       (0.7)%
  2011      25.6%     $247,549     (23.8)%       11.6%

The operating loss in 2012 was caused by the Australia and Spain stores, simply because they were new. We intend to expand our International Leathercraft segment by opening new stores once the current stores have sufficiently built their customer bases to a level that will adequately support additional stores.

Financial Condition

At December 31, 2013, we held $11.1 million of cash, $26.3 million of inventory, accounts receivable of approximately $762,000, and $14.4 million of property and equipment. Goodwill and other intangibles (net of amortization and depreciation) were approximately $982,000 and $103,000, respectively. Net total assets were $56.4 million. Current liabilities were $8.2 million (including approximately $203,000 of current maturities of long-term debt), while long-term debt was $2.4 million. Total stockholders' equity at the end of 2013 was $44.6 million.

At December 31, 2012, we held $7.7 million of cash, $25.9 million of inventory, accounts receivable of approximately $823,000, and $11.9 million of property and equipment. Goodwill and other intangibles (net of amortization and depreciation) were approximately $991,000 and $146,000, respectively. Net total assets were $49.1 million. Current liabilities were $7.9 million (including approximately $203,000 of current maturities of long-term debt), while long-term debt was $2.9 million. Total stockholders' equity at the end of 2012 was $37.5 million.

Specific ratios on a consolidated basis at the end of each year ended December 31 were as follows:

                                               2013  2012  2011
Solvency Ratios:
                         (Cash+Accts
Quick Ratio              Rec)/Total Current     1.45  1.09  1.76
                         Liabilities
                         Total Current
Current Ratio            Assets/Total Current   4.96  4.54  4.74
                         Liabilities
Current Liabilities to   Total Current          0.18  0.21  0.21
Net Worth                Liabilities/Net Worth
Current Liabilities to   Total Current          0.31  0.30  0.36
Inventory                Liabilities/Inventory
Total Liabilities to Net Total Liabilities/Net  0.26  0.31  0.32
Worth                    Worth
Fixed Assets to Net      Fixed Assets/Net       0.32  0.32  0.30
Worth                    Worth

Efficiency Ratios:
Collection Period (Days  Accounts
Outstanding)             Receivable/Credit     32.87 40.06 42.35
                         Sales x 365
Inventory Turnover       Sales/Average          3.00  3.18  3.29
                         Inventory
Assets to Sales          Total Assets/Sales     0.72  0.68  0.69
Sales to Net Working     Sales/Current Assets   2.42  2.62  2.49
Capital                  - Current Liabilities
Accounts Payable to      Accounts               0.02  0.02  0.03
Sales                    Payable/Sales

Profitability Ratios:
Return on Sales (Profit  Net Profit After       0.09  0.08  0.07
Margin)                  Taxes/Sales
Return on Assets         Net Profit After       0.13  0.11  0.10
                         Taxes/Total Assets
Return on Net Worth      Net Profit After       0.16  0.15  0.14
(Return on Equity)       Taxes/Net Worth

Capital Resources and Liquidity

On July 31, 2007, we entered into a Credit Agreement and Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a credit facility of up to $5,500,000 to facilitate our purchase and remodel of real estate consisting of a 191,000 square foot building situated on 30 acres of land located at 1900 SE Loop 820 in Fort Worth, Texas. Proceeds in the amount of $4,050,000 were used to fund the initial purchase of the property. On April 30, 2008, that amount was rolled into a ten-year term note, and we began making monthly debt service payments in May 2008.

On July 12, 2012, we executed a Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a revolving credit facility of up to $4,000,000 for working capital purposes. The revolver bears interest at LIBOR plus 2.0% (2.2442% at December 31, 2013) and was to mature on June 30, 2013. On June 25, 2013, we executed a Note Modification Agreement which extends the maturity date of the Line of Credit Note to June 30, 2014. All other terms remain unchanged. Interest is paid monthly. The unused amount at December 31, 2013 was $4 million.

We are currently in compliance with all covenants and conditions contained in our agreements with JPMorgan Chase Bank, N.A. and have no reason to believe that we will not continue to operate in compliance with the provisions of these financing arrangements. The principal terms and conditions of the Credit Agreement are described in further detail in Note 6 to the Consolidated Financial Statements, Notes Payable and Long-Term Debt.


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Reflecting the borrowing and reduction of bank indebtedness as well as dividend payments during the periods, our financing activities for 2013, 2012 and 2011 required net cash of approximately $392,000, $2.7 million, and $200,000, respectively. The special dividend of $2.5 million paid in April 2012 was the reason for the significant increase in financing activities in 2012 compared to 2013 and 2011.

Our primary source of liquidity and capital resources during 2013 was cash flow provided by operating activities. Net cash flow from operations for 2013, 2012 and 2011 was $7.5 million, $1.9 million, and $6.6 million, respectively. The decrease in operating cash flow in 2012 was due to an increase in inventory in that year. We intentionally increased the levels of inventory maintained at our stores which accounts for the increase in inventory compared to the prior year. In 2013, cash flow from operations was generated from net income. In 2012, cash flow from operations was generated from net income, a decrease in accounts receivable, and an increase in accrued expenses, partially offset by an increase in inventory and a decrease in income taxes payable. In 2011, cash flows from operations was generated from net income, a decrease in inventory and an increase in accounts payable, partially offset by an increase in accounts receivable and a decrease in accrued expenses.

Consolidated accounts receivable decreased approximately $61,000 to $762,000 at December 31, 2013 compared to $823,000 at December 31, 2012. Average days to collect accounts decreased from 40 days in 2012 to 33 days in 2013 on a consolidated basis. We maintain a tight credit policy and have aggressively accelerated our collection efforts to ensure collectability of all customer accounts.

Inventory increased from $25.9 million at the end of 2012 to $26.3 million at December 31, 2013. We have increased the amount of inventory carried in our stores to provide our customers with greater product selection and to promote continued sales growth. We are also stocking additional inventory to support our growing International Leathercraft segment. Further, while sales remain strong, we will continue to buy large quantities of our stock leathers at special prices as those opportunities present themselves in order to relieve pressure on our gross margins. We attempt to manage our inventory levels to avoid tying up excessive capital while maintaining sufficient inventory in order to service our current customer demand as well as plan for our expected expansion. We ended the year with our total inventory on hand matching that of our internal targets for optimal inventory.

Consolidated inventory turned 3.00 times during 2013, a slight slowdown from the 2012 turns at 3.18 times. We compute our inventory turnover rates as sales divided by average inventory.

By operating division, inventory turns are as follows:

             Segment               2013 2012 2011
Wholesale Leathercraft             1.97 2.09 1.95
Retail Leathercraft                4.92 5.58 6.41
International Leathercraft         3.70 3.20 6.91

Wholesale Leathercraft stores only 4.79 5.26 6.68

Retail Leathercraft inventory turns are significantly higher than that of Wholesale Leathercraft because its inventory consists only of the inventory at the stores. The retail stores have no warehouse (backstock) inventory to include in the turnover computation as the stores get their product from the central warehouse. Wholesale Leathercraft's turns are expected to be slower because the . . .

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