TANDY LEATHER FACTORY, INC. The Business and Strategy
Tandy Leather Factory, Inc. is one of the world's largest specialty retailers of leather and leathercraft-related items. Founded in 1919 inFort Worth, Texas , and organized in 2005 as aDelaware corporation, the Company introduced leathercrafting to millions of American and later Canadian and other international customers and has built a track record as the trusted source of quality leather, tools, hardware, supplies, kits and teaching materials for leatherworkers everywhere. Today, our mission remains to build on our legacy of inspiring the timeless art and trade of leatherworking. What differentiates Tandy from the competition is our high brand awareness and strong brand equity and loyalty, our network of retail stores that provides convenience, a high-touch customer service experience, and a hub for the local leathercrafting community, and our 100-year heritage. We believe that this combination of qualities is unique to Tandy and gives the brand competitive advantages that are difficult for others to replicate. We sell our products primarily through company-owned stores, through orders generated from our global websites, and through direct account representatives in our commercial division. We also manufacture leather lace, cut leather pieces and most of the do-it-yourself kits that are sold in our stores and on our websites. We also offer production services to our business customers such as cutting ("clicking"), splitting, and some assembly. We maintain our principal offices at1900 Southeast Loop 820 ,Fort Worth, Texas 76140. As ofSeptember 30, 2022 , the Company operates a total of 104 retail stores. There are 93 stores inthe United States ("U.S ,"), ten stores inCanada and one store inSpain . Tandy Leather has been introducing people to leatherworking for over 100 years. Our stores have been and continue to be our competitive advantage: where our consumers learn the craft in classes, open table, and from the expertise of our store staff, where they can touch, feel and test the product, and where they can connect and commune with others passionate about leather. Our website provides inspiration, detailed product descriptions and specifications, educational information and videos, and a convenient place to also purchase product - especially for those who are far from our retail stores, including a growing international customer base. For many of our retail and web customers, leatherworking evolves from a passion to a trade. Our commercial division is tailored to the needs of those customers who build businesses around leather. With dedicated direct account representatives, a direct-from-our-warehouse shipping model, bulk and volume-based competitive pricing, customized product development, and production and pre-production services, we are building long-term, strategic relationships with our largest customers.
Our focus over the last three years has been on three broad strategic initiative areas:
1. Improving our brand proposition, with both retail and commercial customers
2. Rebuilding our foundation - the talent, processes, tools and systems needed to
serve these customers
3. Position us for long-term growth - creating the vision and roadmap for the
future
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COVID-19 and Economic Conditions
At the time of filing this Form 10-Q, the American and world economies have been acutely affected by a combination of factors arising from both the COVID-19 pandemic and the war resulting from the invasion ofUkraine by Russian military forces. The current impacts of these events include (but are not limited to) levels of inflation that are the highest in theU.S. in more than 40 years, highly volatile fuel prices, an extremely tight labor market with rising wages and competition to attract qualified workers, supply chain disruption, rising rent and other occupancy costs and increases in interest rates. Purchases of non-essential, discretionary products tend to decline in periods of uncertainty regarding future economic prospects, such as the current one, as disposable income declines. The Company believes that these events have continued to dampen its sales throughSeptember 2022 . The future remains uncertain, and continued increased labor, freight, product and other costs as well as weakening customer demand could have a negative impact on the Company's future financial performance.
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 year endedDecember 31, 2021 . Revenue Recognition. Our revenue is earned from sales of merchandise and generally occurs via three methods: (1) at the store counter, (2) shipment of product generally via web sales, and (3) sales of product directly to commercial customers. We recognize revenue when we satisfy the performance obligation of transferring control of product merchandise over to a customer. At the store counter, our performance obligation is met, and revenue is recognized when a sales transaction occurs with a customer. When merchandise is shipped to a customer, our performance obligation is met, and revenue is recognized when control passes to the customer. Shipping terms are normally free on board ("FOB") shipping point and control passes when the merchandise is shipped to the customer. Sales tax and comparable foreign tax are excluded from net sales, while shipping charged to our customers is included in net sales. Net sales are based on the amount of consideration that we expect to receive, reduced by estimates for future merchandise returns. The sales return allowance is based each year on historical customer return behavior and other known factors and reduces net sales and cost of sales, accordingly. Under our sales returns policy, merchandise may be returned, under most circumstances, up to 60 days after date of purchase. As merchandise is returned, the company records the sales return against the sales return allowance. We record a gift card liability for the unfulfilled performance obligation on the date we issue a gift card to a customer. We record revenue and reduce the gift card liability as the customer redeems the gift card. In addition, for gift card breakage, we recognize a proportionate amount for the expected unredeemed gift cards over the expected customer redemption period, which is one year. Inventory. Inventory is stated at the lower of cost (first-in, first-out) or net realizable value. Finished goods held for sale include the cost of merchandise purchases, the costs to bring the merchandise to ourTexas distribution center, warehousing and handling expenditures, and distributing and delivering merchandise to our stores. These costs include depreciation of long-lived assets utilized in acquiring, warehousing and distributing inventory. Manufacturing inventory including raw materials and work-in-process is valued on a first-in, first-out basis using full absorption accounting which includes material, labor, and other applicable manufacturing overhead. Carrying values of inventory are analyzed and, to the extent that the cost of inventory exceeds the net realizable value, provisions are made to reduce the carrying amount of the inventory. 18
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We regularly review all inventory items to determine if there are (i) damaged
goods (e.g., for leather, excessive scars or damage from ultra-violet ("UV")
light), (ii) items that need to be removed from our product line (e.g.,
slow-moving items, inability of a supplier to provide items of acceptable
quality or quantity, and to maintain freshness in the product line) and (iii)
pricing actions that need to be taken to adequately value our inventory at the
lower of cost or net realizable value.
Since the determination of net realizable value of inventory involves both
estimation and judgement with regard to market values and reasonable costs to
sell, differences in these estimates could result in ultimate valuations that
differ from the recorded asset.
The majority of inventory purchases and commitments are made in U.S. dollars in
order to limit the Company's exposure to foreign currency fluctuations. Goods
shipped to us are recorded as inventory owned by us when the risk of loss shifts
to us from the supplier. Inventory is physically counted twice annually in the
Texas distribution center. At the store level, inventory is physically counted
each quarter. Inventory is then adjusted in our accounting system to reflect
actual count results.
Leases. We lease certain real estate for our retail store locations and
warehouse equipment for our Texas distribution center, both under long-term
lease agreements. Starting in 2019, with the adoption of Accounting Standards
Update ("ASU") 2016-02, Leases (Topic 842), once we have determined an
arrangement is a lease, at inception we recognize a lease asset and lease
liability at commencement date based on the present value of the lease payments
over the lease term.
For our operating leases, the present value of our lease payments may include:
(1) rental payments adjusted for inflation or market rates, and (2) lease terms
with options to renew the lease when it is reasonably certain we will exercise
such an option. The exercise of lease renewal options is generally at our
discretion. Payments based on a change in an index or market rate are not
considered in the determination of lease payments for purposes of measuring the
related lease liability. We discount lease payments using our incremental
borrowing rate based on information available as of the measurement date.
We recognize rent expense related to our operating leases on a straight-line basis over the lease term.
For finance leases, our right-of-use assets are amortized on a straight-line basis over the earlier of the useful life of the right-of-use asset or the end of the lease term with rent expense recorded to operating expenses. We adjust the lease liability to reflect lease payments made during the period and interest incurred on the lease liability using the effective interest method. The incurred interest expense is recorded in interest expense on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss). The depreciable life of related leasehold improvements is based on the shorter of the useful life or the lease term. We also perform interim reviews of our lease assets for impairment when evidence exists that the carrying value of an asset group, including a lease asset, may not be recoverable.
None of our lease agreements contain contingent rental payments, material residual value guarantees or material restrictive covenants. We have no sublease agreements and no lease agreements in which we are named as a lessor.
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Impairment of Long-Lived Assets. We evaluate long-lived assets on a quarterly
basis to identify events or changes in circumstances ("triggering events") that
indicate the carrying value of certain assets may not be recoverable. Upon the
occurrence of a triggering event, right-of-use ("ROU") lease assets, property
and equipment and definite-lived intangible assets are reviewed for impairment
and an impairment loss is recorded in the period in which it is determined that
the carrying amount of the assets is not recoverable. The determination of
recoverability is made based upon the estimated undiscounted future net cash
flows of assets grouped at the lowest level for which there are identifiable
cash flows independent of the cash flows of other groups of assets with such
cash flows to be realized over the estimated remaining useful life of the
primary asset within the asset group. The Company determined the lowest level
of identifiable cash flows that are independent of other asset groups to be
primarily at the individual store level. If the estimated undiscounted future
net cash flows for a given store are less than the carrying amount of the
related store assets, an impairment loss is determined by comparing the
estimated fair value with the carrying value of the related assets. The
impairment loss is then allocated across the asset group's major classifications
which in this case are operating lease assets and property and equipment.
Triggering events at the store level could include material declines in
operational and financial performance or planned changes in the use of assets,
such as store relocation or store closure. This evaluation requires management
to make judgements relating to future cash flows, growth rates and economic and
market conditions. The fair value of an asset group is estimated using a
discounted cash flow valuation method.
Stock-based Compensation. The Company's stock-based compensation relates
primarily to restricted stock unit ("RSU") awards. Accounting guidance requires
measurement and recognition of compensation expense at an amount equal to the
grant date fair value. Compensation expense is recognized for service-based
stock awards on a straight-line basis or ratably over the requisite service
period, based on the closing price of the Company's stock on the date of grant.
The service-based awards typically vest ratably over the requisite service
period, provided that the participant is employed on the vesting date. The
total compensation expense is reduced by actual forfeitures as they occur over
the requisite service period of the awards. Performance-based RSUs vest, if at
all, upon the Company satisfying certain performance targets. The Company
records compensation expense for awards with a performance condition when it is
probable that the condition will be achieved. If the Company determines it is
not probable a performance condition will be achieved, no compensation expense
is recognized. If the Company changes its assessment in a subsequent period and
concludes it is probable a performance condition will be achieved, the Company
will recognize compensation expense ratably between the period of the change in
assessment through the expected date of satisfying the performance condition for
vesting. If the Company subsequently assesses that it is no longer probable
that a performance condition will be achieved, the accumulated expense that has
been previously recognized will be reversed. The compensation expense ultimately
recognized, if any, related to performance-based awards will equal the grant
date fair value based on the number of shares for which the performance
condition has been satisfied. We issue shares from authorized shares upon the
lapsing of vesting restrictions on RSUs. We do not use cash to settle equity
instruments issued under stock-based compensation awards. The payment of the
employees' tax liability for a portion of the vested shares are satisfied by
withholding shares with a fair value equal to the tax liability.
Income Taxes. Income taxes are estimated for each jurisdiction in which we
operate. This involves assessing current tax exposure together with temporary
differences resulting from differing treatment of items for tax and financial
statement accounting purposes. Any resulting deferred tax assets are evaluated
for recoverability based on estimated future taxable income. To the extent it
is more-likely-than-not that all or a portion of a deferred tax asset will not
be realized, a valuation allowance is recorded. Our evaluation regarding
whether a valuation allowance is required or should be adjusted also considers,
among other things, the nature, frequency, and severity of recent losses,
forecasts of future profitability and the duration of statutory carryforward
periods. Deferred tax assets and liabilities are measured using the enacted tax
rates in effect in the years when those temporary differences are expected to
reverse. The effect on deferred taxes from a change in tax rate is recognized
through continuing operations in the period that includes the enactment date of
the change. Changes in tax laws and rates could affect recorded deferred tax
assets and liabilities in the future. A tax benefit from an uncertain tax
position may be recognized when it is more-likely-than-not that the position
will be sustained upon examination, including resolutions of any related appeals
or litigation processes, based on the technical merits. Income tax positions
must meet a more-likely-than-not recognition threshold to be recognized. We
recognize tax liabilities for uncertain tax positions and adjust these
liabilities when our judgement changes as a result of the evaluation of new
information not previously available. Due to the complexity of some of these
uncertainties, the ultimate resolution may result in a payment that is
materially different from the current estimate of the tax liabilities. These
differences will be reflected as increases or decreases to income tax expense
and the effective tax rate in the period in which new information becomes
available. We recognize interest and/or penalties related to all tax positions
in income tax expense. To the extent that accrued interest and penalties do not
ultimately become payable, amounts accrued will be reduced and reflected as a
reduction of the overall income tax provision in the period that such
determination is made. We may be subject to periodic audits by the Internal
Revenue Service and other taxing authorities. These audits may challenge
certain of our tax positions, such as the timing and amount of deductions and
allocation of taxable income to the various jurisdictions.
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Results of Operations
Three Months Ended
The following table presents selected financial data:
Three Months Ended September 30,
(in thousands) 2022 2021 $ Change % Change
Net sales $ 19,057 $ 19,281 $ (224 ) (1.2 )%
Gross profit 11,596 11,089 507 4.6 %
Gross margin percentage 60.8 % 57.5 % 3.3 %
Operating expenses 10,620 11,078 (458 ) (4.1 )%
Income from operations $ 976 $ 11 $ 965 8,772.7 %
Net Sales
Consolidated net sales for the quarter ended September 30, 2022 decreased $0.2
million , or 1.2%, compared to the corresponding prior year period. We believe
the decrease in sales was due to continued weaker consumer demand as a result of
inflation and ongoing uncertainty related to global political, economic and
public health concerns.
Our store footprint consisted of 104 and 106 stores at
SinceJanuary 1, 2022 , we closed one store inSan Bruno, CA inMarch 2022 , and one store inOxnard, CA , inJuly 2022 . We evaluate a number of factors when determining whether to close existing stores, including the 4-wall cash flow trend and longer-term projection for the store, the long-term sales trend, ongoing cost of store operations, date of lease expiration, quality of the store and location, and the size and potential of the trade area including proximity to other existing stores, among other variables. We use similar factors to determine whether to open new stores.
Gross Profit
Gross profit increased by$0.5 million , or 4.6%, compared to the same period in 2021, and our gross margin percentage for the quarter endedSeptember 30, 2022 increased to 60.8% compared to 57.5% in the corresponding prior year period. The higher gross margin rate was due to a combination of factors, including product and customer mix shifts and stronger full-priced selling in combination with our relatively slow inventory turns, high number of SKUs and high number of inventory locations including 104 retail stores. 21
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Operating expenses
Three Months Ended September 30,
(in thousands) 2022 2021 $ Change % Change
Operating expenses $ 10,620 $ 11,078 $ (458 ) (4.1 )%
Non-routine items related to restatement - (124 ) 124 (100.0 )%
Adjusted operating expenses $ 10,620 $
10,954
Operating expenses % of sales 55.7 % 57.5 % Adjusted operating expenses % of sales 55.7 %
56.8 %
Operating expenses decreased$0.5 million or 4.1% compared to the corresponding prior year period, primarily as a result of a decrease in bonus expense of$0.5 million , a decrease in services purchased of$0.2 million , a decrease in software costs of$0.1 million and a decrease in stock compensation expense of$0.1 million offset by mainly an increase in total salaries of$0.4 million and an increase in total insurance and other taxes of$0.1 million . Adjusted operating expenses, which exclude the non-routine items related to the restatement, decreased$0.3 million or 3.0% for the reasons noted above. Adjusted operating expenses excluding non-routine items as shown above is a non-GAAP measure, included here to provide additional information regarding the Company's financial performance on a recurring basis. Non-routine items are primarily legal and accounting costs associated with the restatement.
Income Taxes
Our effective tax rate for the three months endedSeptember 30, 2022 was 26.3% compared to 13.0% for the same period in 2021. Our effective tax rate differs from the federal statutory rate primarily due toU.S. state income tax expense, expenses that are nondeductible for tax purposes, the change in our valuation allowance associated with our deferred tax assets, and differences in tax rates in foreign jurisdictions.
Nine months Ended
The following table presents selected financial data:
Nine Months Ended September 30,
(in thousands) 2022 2021 $ Change % Change
Net sales $ 57,967 $ 59,241 $ (1,274 ) (2.2 )%
Gross profit 34,028 34,556 (528 ) (1.5 )%
Gross margin percentage 58.7 % 58.3 % 0.4 %
Operating expenses 32,959 32,856 103 0.3 %
Income from operations $ 1,069 $ 1,700 $ (631 ) (37.1 )%
Net Sales
Consolidated net sales for the nine months ended September 30, 2022 decreased
$1.3 million , or 2.2%, compared to the same period in 2021. We believe the
decrease in sales was due to continued weaker consumer demand as a result of
inflation and ongoing uncertainty related to global political, economic and
public health concerns, coupled with comparison to prior year COVID-era stimulus
payments that fueled sales.
Since January 1, 2022 , we closed one store in San Bruno, CA in March 2022 , and
one store in Oxnard, CA , in July 2022 . We did not open any new stores for the
first nine months of 2022. We evaluate a number of factors when determining
whether to close existing stores, including the 4-wall cash flow trend and
longer-term projection for the store, the long-term sales trend, ongoing cost of
store operations, date of lease expiration, quality of the store and location,
and the size and potential of the trade area including proximity to other
existing stores, among other variables. We use similar factors to determine
whether to open new stores.
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Gross Profit
Gross profit decreased by$0.5 million , or 1.5%, compared to the same period in 2021, and our gross margin percentage for the nine months endedSeptember 30, 2022 increased to 58.7% compared to 58.3% in the corresponding prior year period. The gross margin rate remains relatively the same due to a combination of factors, including product and customer mix shifts, stronger full-priced selling with a combination of our relatively slow inventory turns, high number of SKUs and high number of inventory locations including 104 retail stores. Operating expenses Nine Months Ended September 30, (in thousands) 2022 2021 $ Change % Change Operating expenses$ 32,959 $ 32,856 $ 103 0.3 % Non-routine items related to restatement (246 ) (1,157 ) 911 (78.7 )% Adjusted operating expenses$ 32,713 $ 31,699 $ 1,014 3.2 % Operating expenses % of sales 56.9 % 55.5 % Adjusted operating expenses % of sales 56.4 %
53.5 %
Operating expenses were flat compared to the corresponding prior year period, mostly as a result of a decrease in bonus expense by$1.1 million and a decrease in contract labor by$1.1 million offset mainly by an increase in salaries by$1.1 million , an increase in travel and meeting expenses related to our store manager conference by$0.4 million , an increase in selling expenses of$0.2 million , an increase in office supplies of$0.2 million , an increase in total services purchased of$0.2 million , and an increase in digital marketing of$0.1 million . Adjusted operating expenses, which exclude the non-routine items related to the restatement, increased$1.0 million , for the reasons noted above. Adjusted operating expenses excluding non-routine items as shown above is a non-GAAP measure, included here to provide additional information regarding the Company's financial performance on a recurring basis. Non-routine items are primarily legal and accounting costs associated with the restatement.
Income Taxes
Our effective tax rate for the nine months endedSeptember 30, 2022 was 26.3% compared to 23.1% for the same period in 2021. Our effective tax rate differs from the federal statutory rate primarily due toU.S. state income tax expense, expenses that are nondeductible for tax purposes, the change in our valuation allowance associated with our deferred tax assets, and differences in tax rates in foreign jurisdictions.
Capital Resources, Liquidity and Financial Condition
We require cash principally for day-to-day operations, to purchase inventory and to finance capital investments. We expect to fund our operating and liquidity needs primarily from a combination of current cash balances and cash generated from operating activities. Any excess cash will be invested as determined by our Board of Directors in accordance with its approved investment policy. Our cash balances as ofSeptember 30, 2022 totaled$3.1 million . 23
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Debt Agreements
During the second quarter of 2020, the Company borrowed$0.4 million from Banco Santander S.A. under theInstitute of Official Credit Guarantee for Small andMedium-sized Enterprises in order to facilitate the continuation of employment and to attenuate the economic effects of the COVID-19 virus. This loan was provided for by the Spanish government as part of a COVID-19 relief program. During the second quarter of 2022, we repaid this loan in full.
Share Repurchase Program and Share Repurchase
OnAugust 9, 2020 , the Board of Directors approved a program to repurchase up to$5.0 million of the Company's common stock betweenAugust 9, 2020 andJuly 31, 2022 . This program expired inJuly 2022 . As ofDecember 31, 2021 , the full$5.0 million of our common stock remained available for repurchase under this program. OnAugust 8, 2022 , the Board of Directors approved a new program to repurchase up to$5.0 million of the Company's common stock between that date andAugust 31, 2024 . As ofSeptember 30, 2022 ,$5.0 million remained available for repurchase under this new program. OnApril 11, 2022 , we entered into an agreement with two institutional shareholders of the Company, to repurchase 359,500 shares of our common stock, par value$0.0024 in a private transaction. The purchase price was$5.00 per share for a total of$1.8 million . The closing of the repurchases took place onApril 22, 2022 , and these shares were subsequently cancelled. Prior to the repurchase, the shares represented approximately 4.2% of our outstanding common stock. OnDecember 8, 2021 , we entered into an agreement with an institutional shareholder of the Company, to repurchase 212,690 shares of our common stock, par value$0.0024 in a private transaction. The purchase price was$5.00 per share for a total of$1.1 million . The closing of the repurchase took place onDecember 16, 2021 , and these shares were subsequently cancelled. Prior to the repurchase, the shares represented approximately 2.4% of our outstanding common stock. OnJanuary 28, 2021 , we entered into an agreement with an institutional shareholder of the Company, to repurchase 500,000 shares of our common stock, par value$0.0024 in a private transaction separate from our share repurchase program. The purchase price was$3.35 per share for a total of$1.7 million . The closing of the repurchase took place onFebruary 1, 2021 , and these shares were subsequently cancelled. Prior to the repurchase, the shares represented approximately 5.5% of our outstanding common stock.
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