Tandy Leather Factory Inc (TLF) 2006 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Tandy Leather Factory's second quarter 2006 earnings conference call.

[OPERATOR INSTRUCTIONS]

It is now my pleasure to turn the floor over to your hose, Shannon Greene. Ma'am the floor is yours.

Thank you.

Before Mr. Thompson takes the floor today, I want to call your attention to the fact that these conversations will contain forward-looking statements to the extent Tandy Leather Factory management speaks today of any future events or makes other forward-looking statements, you are reminded of the inherent uncertainties of looking into the future, that there are risks to Tandy Leather Factory that could prevent these events from occurring in the manner foreseen.

Please see Tandy Leather Factory's Form 10K for 2005 for a discussion of some of these risks. Copies of the documents are available through the SEC's EDGAR system or from the Company's Investor Relations office. Also statements made today by management of Tandy Leather Factory are made at this moment and Tandy Leather Factory and its management disclaim any duty to the update of those statements.

I'd like to turn the call over to your host, Mr. Wray Thompson.

Thanks, Shannon. Thank you for joining us for our second quarter 2006 earnings conference call. I'm Wray Thompson, CEO of Tandy Leather Factory and I'm joined by our Chief Financial Officer, Shannon Greene.

Overall we're pleased with our second quarter results as we've stated previously our goal for 2006 is to grow earnings faster than our sales and we accomplished that again this quarter. Compared to the second quarter of '05, consolidated sales increased 10% and income from operations increased 28%.

Furthermore, our consolidated gross profit margins improved to 57.7 an improvement of 1% over the second quarter of '05. Our financial position is solid as evidenced by our balance sheet and our assets total more than $30 million as of the end of June and our cash position is increased by 72%, since the end of '05.

Our inventory is up by 1.2 million since December. Although our trade accounts payable has grown by the same amount.

Our wholesale leather craft division posted a sales gain of 1% this quarter. The wholesale centers and our national account both each reported a 2% gain for the quarter. Offset somewhat by the conversion of one wholesale center to a retail store.

Gross profit improved again this quarter and operating margin increased by 44%. Our retail Leathercraft division continues to generate solid revenue growth from the old stores as well as the new ones.

The Tandy Leather retail store chain grew from 46 to 61 during the trailing 12 months ended June '06. Sales are up 27% in this quarter over last year.

We've opened 11 new stores as of June 30, five of which were opened during the second quarter. And we're still maintaining our commitment of funding this growth from internal cash flow.

Gross margins declined almost 1% and our operating margin dropped by slightly more than 1%. The slide in operating margin was expected due to setup expenses associated with five stores opened during the quarter. We believe the investment in the opening of these stores now will pay off by year end.

I'll now turn the call over to Shannon to give you further financial details. Shannon?

Thank you, Wray.

Before I get into the financial details I will remind those of you who are new to our company of the structure of our operations and the terminology associated with it. When we talk about the wholesale Leathercraft division we're talking about the 29 wholesale distribution centers operating under the trade name, The Leather Factory and our national account sales group.

National account generally refers to the larger retail craft chains. The retail Leathercraft division, consists of the Tandy Leather retail store chains. There were 61 retail stores in the chain as of June 30th.

We opened one more store in July which gets us to the 12 stores opened in 2006 and a total of 62 stores in the chain. We did convert one Leather Factory wholesale center to a Tandy Leather retail store in January of this year. That store is included in the number of new retail stores opened this year.

With that said we'll get to the numbers. Second quarter consolidated sales increased 10%. Current quarter sales were $13.4 million compared to last year's second quarter sales of $12.2 million. Wholesale Leathercraft sales were $7.7 million this quarter compared to $7.6 million a year ago an increase of 1.1%.

Breaking it down further the wholesale distribution centers posted a 2.4% sales increase reporting sales of $6.4 million, compared to $6.3 million in the second quarter of '05. Our national account sales group posted a 1.9% sales increase for the quarter reporting sales of $1.3 million compared to $1.2 million last year.

We've mentioned before that national accounts is not a primary focus point for us and it continues to become a smaller part of the business as we further the expansion of the retail store chain. However, we are cautiously optimistic that we can continue to achieve reasonable sales growth from this customer group if we're successful in presenting new product ideas to their buyers.

Our retail Leathercraft division reported sales of $5.2 million compared to last year's sales of $4.1 million, an increase of 37%. Sales from the 19 new stores were $837,000 this quarter, the 42 comparable stores posted sales of $4.3 million, an increase of 7.5% over last year.

Consolidated gross profit margin for the quarter was 57.7% improving over last year's gross profit margin of 56.6%. Wholesale Leathercraft gross profit margin improved from 54.8% to 57.3%.

Retail Leathercraft gross profit margin declined from 62.4% for the second quarter '05 to 61.5% for the second quarter '06. Consolidated operating expenses were $6 million or 45% of sales in the current quarter, compared to $5.5 million or 45.8% of sales last year.

As expected we gave up a little bit of operating margin due to the number of stores open in the quarter. We do anticipate our operating margin to improve by year-end.

Wholesale Leathercraft reported operating expenses totaling 41.2% of its sales versus 43.6% last year, retail Leathercraft reported operating expenses totaling 52.6% of its sales currently compared to 52.2% last year.

Income from operations was $1.7 million for the quarter, up $377,000 or 28.5% compared to the second quarter of '05. Wholesale Leathercraft operating margin was 16.1% for the quarter, retail Leathercraft operating margin was 8.9% for the quarter.

Now for the six month results. Consolidated sales were up 11.7% over the same period last year. 2006 sales are $27.8 million compared to 2005 sales of $24.9 million.

Wholesale Leathercraft sales are $16.1 million this year, versus $15.6 million a year ago, an increase of 3.6%. Retail Leathercraft sales are $10.7 million compared to last year of $8.4 million an increase of 28%.

Consolidated gross profit margin for the year is 56.9%, up from last year's margin of 56.5%. Wholesale Leathercrafts gross profit margin increased to 56.3% this year compared to 55.1% last year and retail Leathercraft gross profit margin is 60.9% currently versus 62.2% last year.

While we're still achieving gross profit margin improvement on a consolidated basis you probably noticed that retail Leathercraft's gross profit margin is down for the quarter and the year. Several things are happening there that is worth mentioning.

First we're encouraging the retail stores to stock and sell more leather. Tandy stores historically have not carried a lot of leather in their stores and yet leather is generally what gets customers in the door. It is our lowest margin item. So as the retail stores sell more leather, their margins have the potential to decline some.

On the flip side it has the potential to increase sales volume and customer base. We believe giving up a little on gross margin for increased sales volume and a larger customer base is a good strategy as long as you don't take it too far.

Secondly, gross margins in the second and third quarters in our retail Leathercraft division are a report card, so to speak of our ability to predict cost fluctuations. Our retail selling processes are set in conjunction with the production of our annual catalog every October, and it is very difficult to change those prices during the life of that catalog.

We have to predict cost fluctuations accurately in order to maintain margins. If our margins hold or increase then we did a good job of estimating cost fluctuations for the year. If margins suffer, then we didn't predict as well.

Our next catalog comes out in October of this year. It will have the new prices in it and we should recover some of the margin lost during the second and third quarters.

Consolidated operating expenses were $12.1 million or 43.5% of sales in the current year compared to $11.1 million or 44.9% of sales last year. Wholesale Leathercraft reported operating expenses totaling 39.2% of its sales versus 42% last year.

Retail Leathercraft reported operating expenses totaling 51.9% of its sales currently compared to 52.7% last year. Income from operations is $3.7 million this year, an increase compared to year to date 2005 of 29.4%.

Some specifics regarding the Tandy stores for the second quarter. The stores opened in 2002. There were 14 stores, their sales in the second quarter of '06 were $1.6 million, their gross profit percentage 62.2%, and their operating income was 13%. On a year-to-date basis, for those same 16 stores, their sales are $3.5 million, gross profit is 61.5%, operating income is 13%.

For the stores opened in 2003, there were 12 stores, their sales for the second quarter '06 are $1.1 million, gross profit of 62.2%, operating at an income of 10.4%, on a year-to-date basis those sales are $2.3 million, gross profit of 61.7%, operating income of 10.4%.

For the stores opened in 2004, there were 16 stores, their sales for this current quarter were $1.5 million, gross profit margin 61.1%. Operating income 9.3%. On a year-to-date basis those sales are $3.2 million, gross profit percentage is 60.4%, operating income is 10.3%.

For the stores open in 2005, there are eight. Their sales for the current quarter of $499,000, their gross profit margin is 60.4%, they have an operating loss of 0.8%. On a year-to-date basis their sales are $1 million, gross profit percentage is 59.7%, and their operating loss is 0.6%.

For the second quarter of '06, average monthly sales per store was $30,000. The stores open in 2002 had average monthly sales of $39,000 per store, the 2003 stores averaged $31,000 per store, the 2004 stores averaged $31,000 per store and the 2005 stores averaged $21,000 per store. Compared to second quarter of '05, these averages continue to demonstrate the stores' ability to strengthen as they mature.

For the first six months of 2006 we've got 15 stores with operating losses as of the end of June totaling $223,000. 10 of the 15 stores are new, opened in 2006 and their combined loss totaled $164,000. Of the other five, two were opened in 2004, their combined loss is $9,000, three were opened in 2005 and their loss is $50,000.

For the second quarter by itself, there were 14 stores with operating losses totaling $135,000. 9 of the 14 stores were opened in 2006 and ended the quarter with a combined loss of $104,000.

The same two stores from 2004 were unprofitable in the quarter with a combined loss of $6,000 and the three stores opened in 2005, have a combined operating loss for the quarter of $25,000.

Strictly from a numbers perspective the problem with the 2004 stores appears to be an expense issue. Both stores are generating sufficient sales to be profitable.

The 2005 stores have still got sales problems. They're not generating enough revenue to support their operating expenses. Our store operations team is focusing a great deal of effort to get these stores headed in the right direction.

Wholesale Leathercraft results for the second quarter, again there are 29 wholesale centers, their second quarter sales were $7.7 million, gross profit of 57.3%, operating income of 16.1%.

On a year-to-date basis their sales are $16.1 million, gross profit percentage is 56.3%, operating income is 17.1%. All 29 wholesale centers posted year to date profits as of the end of June.

So to summarize, we are generally pleased with our second quarter results. As we stated previously our second and third quarters tend to be our weaker quarters from a revenue perspective.

In addition, when you consider that we opened all of our 12 new stores in the first half of the year, and still achieved solid improvement in our operating margins, I think it provides further evidence that our expansion strategy is working well. We've got our work cut out for us for the third quarter from the revenue side.

July sales were not as strong as we would have liked. August is probably going to be tough, too. However, we've got some things in the works that should give us a strong September which will put us where we want to be for the quarter.

As was the case last year, I expect our inventory to increase in the third quarter. As of June 30the we had almost $2 million in merchandise on its way to us from overseas. For comparison purposes, last year at that time we had inventory on the way of $650,000.

We'll be stocking for what we hope is a strong fourth quarter, as a result I don't expect big increases in cash throughout the third quarter but if fourth quarter produces well as we expect we should turn that inventory back into cash by year-end.

I'll turn the call back over to Wray.

Thanks, Shannon.

Well, for the most part, we've done well for the first half of '06, solid revenues and better operating efficiency. We believe we're executing well and don't have any reason to change our retail expansion plans.

We've opened the 12 stores we committed to in '06 and our focus for the rest of the year will be to get those new stores producing strong sales and profits. I'll add a little bit to Shannon's comment about the third quarter.

We've said several times that our second and third quarters are the weakest quarters. Second quarter turned out okay. And by the time we get to the end of the third quarter I think you're going to find out it will be fine, too.

Where the concern comes in, is in the timing. July sales are not going to be as strong as you would all like. The big gains just weren't there.

August has the potential for new similar results. I would encourage you to think longer term than month-to-month. September should make up for whatever perceived shortfall there is in the July and August revenue numbers. We're not changing our '06 guidance at this point.

Our earnings' estimate--I've lost it. Is $53 to $56 million and our earnings estimate is $0.40 to $0.44 per fully diluted share, assuming there was diluted shares outstanding of approximately 11 million shares.

In summary, we'll continue to execute our growth strategy and as a result we believe that '06 will be another year of solid financial performance. We're ready to take questions.

[OPERATOR INSTRUCTIONS]

And we take the first question from Michelle Sachs.

[OPERATOR INSTRUCTIONS]

And we'll take the first question from Matt Miller, sir, your line is live.

Wray and Shannon, good morning.

Good morning. How are you?

Very well. I have a question, Shannon, you mentioned your intentions with building up the inventory again here in the second half.

Still when I look at it it appears as though the cash is going to still be pretty strong. I wonder what your thoughts are over the next six to eight months as that builds with what to do with all that cash?

Well, we talk about several options on a continuous basis. Frankly, we're not doing anything too aggressive at this point just because of what we do expect to do with inventory purchases over the next three or four months, three months, in particular. For fourth quarter.

But you should see cash--I don't expect it to really decrease much in the third quarter and we may see a little bit of increase. I think where you're really going to see the cash come in is in the fourth quarter and into the first of next year. What to do with it?

We are always looking for opportunities to purchase product in bulk at reduced prices, that opportunity doesn't come up a lot but it does occassionally particularly with leather. We all believe that we should have some reserve is a bad word, but some amount of cash that is available for these unexpected opportunities, purchasing opportunities, as they arise.

We talk in the board meetings about the possibility of beginning a dividend program. I don't think that would be a bad idea to pay shareholders with some of the cash. We talk every board meeting about a possible stock buy-back we argue a lot about whether that is the right thing to do, the wrong thing to do, the timing, what that does to the flow, liquidity, etc. But that is always on the table as a possibility as well.

We still don't have any firm plans. I can't say effective March 1st we're going to start doing this, but those are off the top of my head those are three possibilities that are on the table all the time.

Acquisitions, there are some opportunities out there from the acquisition standpoint. They're not significant dollar wise. We're not talking millions and millions of dollars. So--but we're always looking for those type of opportunities as well.

So, I mean I think any one of those four particularly an acquisition issue, an opportunity and a inventory purchasing opportunity, those I think are more realistic, more likely in the short-term than a dividend or stock buy-back at this point.

All right. Great. And just one additional question.

I did notice that the Cushman segment as small as it is, swung to a small operating loss there in the quarter. I wonder if you have any thoughts on the future of that asset?

We're making some changes with regard--you're right, it is extremely small and we don't hardly ever talk about it. We did some juggling of some of their operations and kind of doing some restructure.

That is a bad term, too. That means in accounting circles a lot of things. But just from an operations standpoint we made some changes, created a loss for us so far. I think that's going to be fixed over the course of the last six months of the year. Again, Matt, I think we've talked about this before.

Right.

It's not--it's not a part of--a real big part, it's never going to be a big part of our business. If we could come up with a way, an opportunity, to sell it, to do something different, we certainly would, but we're not going to give it away.

And if some of the operational changes that we are working on, if those--if those create better sales volume and better profitability, maybe that is the potential for a buyer becomes little bit more realistic.

I don't think anybody is going to be real interested in looking at it from a purchase standpoint at this point until we can get stronger sales volume, in particular, and better margins, hopefully we're doing the right things with it even on a very small basis to see some improvement in that over the last six months of this year and into next , that it will either become a nice little profitable sideline business for us, or it will be something that could potentially be sold to somebody at a reasonable price.

Great. Thank you so much. Congratulations on a good quarter.

Thanks.

Bye.

Thank you. We'll take the next question from Robert Strauss, your line is live.

Hi, guys, just a couple of quick questions. Shannon, I think you had stated that you expect operating margins to improve by year-end.

Can you talk a little bit about that run rate and if you expect the majority of that improvement in the fourth quarter or even towards the back half of the fourth quarter? Just give us a little bit of perspective on the timing of that.

I absolutely do. The fourth quarter and late into the quarter we have--I think this is our fifth year of opening retail stores and we've done it different every year. We've never put all of the stores openings--we've never front loaded them as much as we did this year.

We have done it on purpose to position those stores in the markets that they're in to produce well in the fourth quarter. So I expect--I don't think we're going to gain much operating margin improvement particularly on the retail side in the third quarter, just because it's not a big production quarter for us.

But I think that by investing and taking a little bit of hit on the operating margin in the first half of the year, particularly when we get to fourth quarter, I expect that those stores that we opened and the drag on operating income, that they created for us in the first part of the year, we should make up, recover and exceed then for the last half of the year.

We're going to try it this way. If it doesn't work, then I guess when we start stores in '07, we'll spread them out a little bit more. But I really think if you get into markets early enough before the big season comes, which we're saying is fourth quarter, they should really produce well for us in the last quarter and we've already done all of the investments. So now it is just a matter of raking in the profits.

And this is of course is beyond the fourth quarter as well setting up from an operating margin standpoint '07, as potentially having some strength on that line.

Absolutely. Obviously the more time that goes by, the older the stores get, they still get stronger and stronger as they move forward.

So if we open a store, for example, in November or December, yeah, their operating expenses--they start over with their operating expenses in January 1, of course, but they still only have been open for 30 or 60 days so their revenue doesn't run as well. They still have to build into the next year.

I'm hoping--we're hoping that by opening all of these stores in--by July 1, basically, that they've got six months this year to really get going, should have a strong fourth quarter and it should position them well before going into '07 to you really begin to contribute nicely to the overall margins.

Another topic. You clearly spoke about some pressure on your margins especially on the retail side, and also the pricing effect as you have new prices in catalogs every year in October.

Could you just tell us a little bit more about the different retail product areas that are causing some of that pressure?

Yes, Robert, I think I can help there. We have made a concentrated effort to encourage the Tandy retail stores to be more aggressive in selling leather. We feel like leather is what is the best way to draw our customer into the store.

However, leather is one of the lower gross margin items that we sell. Now we think we've done a good job of getting the managers more acclimated to stocking and showing leather to create a little more interest in their trade area.

But as long as we're promoting the bulk sales of leather that gives us more volume and should create more interest in Leathercraft, I think we could expect to see that it will affect the margins at the retail end.

Is there anything in your recent history that gives you confidence that as you sell more leather to draw more traffic in and to increase the sales volume of the stores, that your managers will also be successful in complimenting those sales with higher margin product?

Well, I think that's just an ongoing process. You've got--we have a program whereby we try to teach the managers that when they sell a piece of leather, knowing that it is a low gross, there is 100 other items that they can sell with it, with proper selling techniques, if they know what tools the customer needs, normally the tools run 70 gross, the dyes that they need, instruction sheets, instruction books, all those items carry a very high gross.

Where you might see a problem with a gross profit slip, is they get excited about making a sale of a side of leather that is good but at a lower margin if they don't add some items to it. So I think that's just the same old instructional course. Teach them to sell higher grossed items with their leather.

Okay, last question. Regarding store managers, one of the things that you have spoken about is how important good store managers are, and the training of those store managers, especially for new stores.

Given that you have opened a good amount of stores in the first half of '06, how is the process going in terms of reestablishing store manager trainees for future store openings, whether it be in the coming six months or for that matter, 2007?

Robert, we just keep an ongoing program running, trying to keep new--our new hires in the system, put them in stores where we've got a good manager, that knows how to teach them. I think Shannon has come up with a number, how many have we got in training?

We've got, Robert, as of July 25th, we've got 16 trainees in the system. They are in terms of their ready-to-goness, if that is such a term, we've got several that are available immediately as soon as the store's open.

The oldest one out is a March 1, 2007, ready to go type of schedule. So basically between now and March of '07, we've got 16 that are--will be--either are or will be ready to go.

Okay. Sounds good to me. Keep up the good work, guys. Good luck.

Thanks, Robert.

Thank you very much, ladies and gentlemen.

[OPERATOR INSTRUCTIONS]

Do you have any closing comments you would like to finish with?

On behalf of Shannon Greene and myself and the management team in Fort Worth, we appreciate your time spent with us today and your continued interest in our company. We encourage you and welcome your calls at any time. Have a nice day.

Thank you very much, ladies and gentlemen. This does conclude your conference call. You may disconnect your lines and have a wonderful day.