Tandy Leather Factory Inc (TLF) 2007 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Tandy Leather Factory second quarter 2007 earnings conference call. At this time, all participants have been placed on a listen-only mode, and we will open the floor for your questions and comments following the presentation. It is now my pleasure to turn the floor over to your host, Shannon Greene. Ma'am, the floor is yours.

Thank you for joining us on our second quarter earnings conference call. I'm Shannon Greene, Chief Financial Officer of Tandy Leather Factory. Ron Morgan, our CEO, is here with me as well, will join me on the Q&A portion of our call. Before we get into the script, I'll 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 event or makes other forward-looking statements. You are reminded of the inherent uncertainties of looking into the future, that there are risks at Tandy Leather Factory that could prevent these events from occurring in the manner foreseen. Please see our form 10-K for 2006 for a discussion of some of the risks. Copies of these documents are available through the SEC's EDGAR system or our Investor Relations office. Statements made today by myself and Ron Morgan of Tandy Leather Factory are made as of this moment and we disclaim any duty to update those statements.

At the risk of sounding overly negative, there just aren't too many positive things to say about our performance in the second quarter. We are very disappointed that we did not do enough with expenses to compensate for the flat sales. In fact, it looks like we didn't do anything. Operating margin was down almost 60% for the quarter and 30% for the year. In my opinion, there's no way to put any type of positive spin on those kind of results. All I can tell you is that we didn't achieve the results that we wanted, and whatever effort we made was woefully short of any kind of success. Our balance sheet is in decent shape, although it's not as solid as we're used to. Our assets total $33 million as of the June, up from $32 million at the end of December. Our cash position has decreased 45% since the end of '06. Inventory's up $3 million since December. Unfortunately, trade payables has not followed suit.

Wholesale Leathercraft division posted a sales decline of 5% this quarter. The wholesale centers reported a 5% decline and our national account group reported a 23% decline for the quarter. Mid-Continent Leather Sales reports new store sales of $523,000 for the quarter. Gross profit declined about half a percentage point this quarter and operating margins fell 67%. 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 61 to 68 stores during the trailing 12 months ended June 2007. Sales are up 12% in this quarter over last year. We've opened six new stores as of June 30, two 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 2.5 points. And our operating margin dropped by almost 43%.

A quick run through of the numbers for the quarter and the year: second quarter consolidated sales matched those of last year's second quarter at $13.4 million. Wholesale Leathercraft sales were $7.2 million this quarter compared to $7.6 million a year ago, a decrease of 5.2%. Breaking it down further, the 29 same stores posted a 5% sales decrease, reporting sales of $6.1 million compared to $6.4 million in the second quarter '06. Our national account sales group posted a 23% sales decrease for the quarter, reporting sales of $860,000 compared to $1.1 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 our business as we further the expansion of the retail store chain. In addition, we stated last month that we will be losing Wal-Mart USA as a customer later this year. So it is possible that sales declines could continue for the foreseeable future.

Our Retail Leathercraft division reported sales of $5.8 million compared to last year's sales of $5.2 million, an increase of 12%. Sales from the 12 new stores were $523,000 this quarter, the 56 comparable stores posted sales of $5.3 million, an increase of 4% compared to last year. Consolidated gross profit margin for the quarter was 57.5%, improving slightly from last year's gross profit margin of 57.2%. Wholesale Leathercraft gross profit margins fell slightly from 57.3% to 57% even. Retail Leathercraft gross profit margin declined from 61.5% from the second quarter '06 to 59% for second quarter '07.

Consolidated operating expenses were $7 million or 52% of sales in the current quarter, compared to $6 million or 44.6% of sales last year. Wholesale Leathercraft reported operating expenses totaling 51% of its sales versus 41% last year. Retail Leathercraft reported operating expenses totaling 54.5% of its sales currently, compared to 52.6% last year. As our press release indicated, the significant increases in operating expenses are in personnel, advertising and marketing, and legal and professional fees. At the end of June, we have 39 more employees than at the beginning of the year. Two-thirds of those new employees are in our central warehouse and factory. I understand that our support system has to grow to meet the demand of the stores as they grow. However, I think it's safe to say that we've got something out of balance when our support system accounts for two-thirds of our new employees.

Spending money on advertising is something you will not hear us apologize for. We've said before that our advertising and marketing efforts are why we sell products. We firmly believe that if we cut back on advertising, it's a virtual guarantee that we'll lose sales and lose customers. Given the weakness in our sales, we did some extra things this first six months in hopes it would strengthen those sales. Even though it doesn't help as much as we wanted right now, we believe those efforts will pay off in the near future. Our legal and professional fees are up as we've had several unique projects going on. The acquisition of Mid-Continent Leather in February, and more recently the purchase of a building. Those are one-time expenses, so to speak, shouldn't be something that continues. We are incurring some legal fees related to trademarks, enforcement on product trademarks and also trademarking our name in foreign countries, as we begin to think more about international expansion, we believe it makes sense to protect our corporate name abroad.

Income from operations was $704,000 for the quarter, down $994,000 or 58.5%, compared to the second quarter of '06. Wholesale Leathercraft's operating margin was 5.7% for the quarter, Retail Leathercraft's operating margin was 4.6% for the quarter. For the six-month results, consolidated sales are up $78,000 or 0.3% over the same period last year. 2007 sales are $27.9 million, compared to 2006 sales of $27.8 million. Wholesale Leathercraft sales are $15.1 million this year versus $15.8 million a year ago, a decrease of 4.3%. Retail Leathercraft sales are $12.1 million compared to last year's $10.7 million, an increase of 13%.

Consolidated gross profit margin for the year is 58.4%, up from last year's margin of 56.6%. Wholesale Leathercraft's gross profit margin increased to 58% this year year compared to 56.3% last year. Retail Leathercraft's gross profit margin is 59.8% currently versus 60.9% last year. While we are still achieving gross profit margin improvement on a consolidated basis, you'll notice that retail Leathercraft's gross margin is down for the quarter and for the year. As we've discussed in previous quarters, the retail stores are selling more leather than they have historically done, which puts pressure on gross margins because leather is our lowest margin item. Also 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 prices are set in conjunction with the production of our annual catalog every October. 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 in the Retail Leathercraft division, we did a good job of estimating cost fluctuations. If margins suffer, then we didn't predict as well. Our next catalog comes out in October. It will have new prices in it, and we should recover some of the margin lost in second and third quarters.

Consolidated operating expenses are $13.6 million for the year or 49% of sales in the current year compared to $12 million or 43% of sales last year. Wholesale Leathercraft reported operating expenses totaling 46% of its sales versus 39% last year. Retail Leathercraft reported operating expenses totaling 53% of its sales currently compared to 52% last year. Income from operations is $2.6 million this year, a decrease compared to year-to-date 2006 of 29%.

Some specifics regarding the Tandy Store's performance. Second quarter results sales of $5.8 million, gross profit of 59%, operating income of 4.6%. In looking at the store performance based on the year open, gross profit margin ranged from 62 to 59% and operating income ranged from 11.5 to a loss of 1.5%. Looking at individual stores, average monthly sales ranged from $90,000 per month to $13,000 per month and operating margins range from 20% to losses of 25%. For the second quarter of '07, average monthly sales per store was $30,000. The stores opened in 2002 had average monthly sales of $39,000 per store, the 2003 stores averaged $33,000 per store, the 2004 stores averaged $32,000 per store, the 2005 stores averaged $22,000 per store, and the 2006 stores averaged $21,000 per store. These averages are better than in the second quarter of '06, which speaks well of the stores as they mature.

For the first six months of 2007, we have 14 stores with operating losses as of the end of June totaling $164,000. Seven of the 15 stores are new, opened in the last twelve months and their combined loss totaled $95,000. We have four stores opened in the first half of 2006, with a combined operating loss of $21,000. We have three that were opened in 2005 and their loss is $49,000. Of the stores with operating losses, the only ones that really concern me are the ones opened in 2005. However, I can tell you we have made manager changes in all three stores during the last 60 days and I expect we will see better performance from them going forward.

Wholesale Leathercraft, all of the 29 distribution centers posted year-to-date profits as of the end of June. Operating margins range from 1 to 18%. Mid-Continent Leather Sales, our new distribution center, acquired at the end of January, is posting average sales of $80,000. We've made some progress with this store in terms of inventory clean up and operating efficiency, but I don't expect we'll really see the benefits until we get to next year.

To summarize, I don't know what else to say but we performed miserably in the second quarter. One of the things we've talked about recently is the ability to react quickly. Our sales have been weak all year, we all know that. We've got to react faster on the expense side to get the results we want. I was pleased with our July sales, hope it's the beginning of a good quarter. We've got lots of work to do in the remaining half of the year to make up for our poor performance in the first half.

As you probably noted, the press release this morning didn't mention our 2007 guidance, which was an oversight on my part. Ron and I have talked about this a lot recently, as you can imagine, whether to adjust guidance again or not. We understand we've got to make some incredible strides in the last half of the year to compensate for the second quarter. We've made the decision to leave our 2007 guidance where it is for now. Our July sales results had an impact on that decision. I can assure you however we will be looking at it throughout the month of August once we get a feel for how August sales are going, and we'll come out whatever changes, if any, are necessary and need to be made as soon as possible.

We've been very up-front that we've got too much inventory. Unlike last year where we expected inventory to increase in the third quarter, I am expecting inventory to drop in the third quarter. We've cut our purchases back to be more in-line with our sales trend. I think we could see inventory drop by 1.5 to $2 million by the end of the third quarter. If we can do that, we should get our cash back up to the $6 million range by then as well. We are also focused on customer collections, so I'll be watching receivables closely during the third quarter, looking for a decrease in the balance by September 30.

The last thing I would say before we go to questions that we are not panicking and we are not changing our overall strategy. We've had tough times before and we'll have them again. Unfortunately, that's part of doing business. The key in my mind is how we deal with those tough times. While I expect that you are disappointed with our results so far this year, I can assure you that we are too, probably more so. What that means is we need to be smarter and work harder to get to with we want to be, and we will be as up front and straightforward as we can during the process. That concludes my prepared remarks. Operator, we will now take questions.

Thank you. (OPERATOR INSTRUCTIONS). Our first question is coming from Graeme Rein, your line is live.

Hi, Shannon.

Hello. How are you?

Good. Do you still have plans to roll out all 12 stores this year?

Yes, we do.

Are the last four -- is it four or five left?

We've got four left.

That going to be in the next month or two, or more towards the end of the year?

No. I think we will have two to announce here fairly quickly, and probably two in September. So, no, we'll get them in -- we like to get them open by October 1 in order to make sure we get as most benefit for the fourth quarter as possible. No chances to make any changes there.

How is the internet business going is it still growing at a nice clip and is it running efficiently or are there things that need to be worked out with it?

This is Ron Morgan. For the last two months, we've been real pleased. We did have some problems with it and sales were off in the first six months -- the first five, I guess. Over the last two months, it is running at a 25% increase over last year.

Okay.

We're real pleased and things are running smooth. I don't know how things get changed in that business, but things often change until you figure out what the problem was with costs slowdown in business, it takes several months. We're on track and we're not going to fire right now.

The last thing I had and I'll jump back in-line, it's kind of the first I've heard you guys mention international expansion. Can you expand on that? What are you looking at overseas and what is the time frame for thinking about moving in that direction?

We are beginning to, as I've indicated, we're beginning to at least establish our name abroad, getting it trademarked in Europe in particular, a couple of other countries. It's kind of still in the early stages of planning, but we've done enough work and research so far that we know that it takes -- it's going to take longer to get out there internationally than it does to open a store domestically. So we're just beginning to kind of get on track with that. Frankly, there's a little bit more interest, I guess, on our part a little sooner that we had originally planned. Given that, things have been, sales-wise in the states have been as tough as they have been. There are some fantastic markets out there abroad that would be very good for us, so I'm not going to jump out there and tell you we're going to open up overseas in the next month, but in the next year or two, I think that's more realistic than it was six months ago. Does that help?

Our next question is coming from Shaun Smolarz, your line is live.

Hi. Good afternoon. My first question is, could you describe the process for selecting the new headquarters, and how long was this initiative in planning?

Our lease is up on our current facility in March of -- March 31 of 2008. We are in kind of an industrial park, as you know, Shaun, spread out between four of the five buildings in this complex. Of the principal space, we are in about 120,000 feet of that. There is no more space for us. We talked about this several years ago when our lease came up before. Did it make sense to continue to lease here, pay the landlord, try to make due with the layout where we were or did it make sense to move? We looked at it, I think it was three years ago, could not find anything that would suit our needs that was in any kind of ballpark price range that we were interested in. So we basically just reupped for another couple of years with the landlord here. At that point, he had a little bit more -- he had some space that we could take, which would help.

Here we are, we're inside nine months from being in the same situation again. Our rent -- the rent goes up here every year. We are solely responsible for the maintenance and the upkeep of the space that we're in. I can't tell you how much money we've spent on replacing air conditioners, wiring the various buildings, what have you. So we probably got serious about this six months -- really serious about six or eight months ago knowing we were coming up on a year from having to decide what we're going to do. The -- John Thompson, our Senior Vice President, has really been the one that has overseen this whole process. We think that he did a really nice job finding a location for us.

It's probably 10 or 15 minutes from our current facility, which will help ensure better employee retention. That was one of our concerns, if we ended up in a place that was too far away from here, we would probably lose some employees. It's a single building. We will all be in one building. It's a little bit big for us right this minute, but I can tell you that our warehouse in particular is staging shipments to the stores inside empty trailers that the freight carriers are dropping us for us at night because they don't have any room to stage in the shipping area, it's full. So as we continue to add stores and they've got to get more and more shipments out to stores every day, they're just -- it just doesn't make a whole lot of sense for them and they're extremely inefficient trying to step over each other and load -- or put pallets together inside these empty trailers.

It's been a long process. It's come up, serious discussion over the last several years, I would say. We got real serious about it probably nine months ago, anticipating that it would be a big decision for us. We needed lots of time to make sure we found something that worked for us that was at a price that we thought was reasonable that met our needs. All of those things. So the move will be stressful. Anybody who's ever moved knows that, but we think in the long run the efficiency gained by being housed in one building versus running back and forth across the parking lot plus the space that the warehouse needs to stage shipments to the stores and receive product in from the vendors I think will pay us dividends down the road.

And we think we got a good price. We looked at buildings, totally out of the question as far as we were concerned. We didn't want to spend that kind of money. We looked at several facilities, we could have paid two or three times what we paid for this one. At the end of the day, this is going to be a good deal for us. We've got the move and setup to do, but at the end of the day, I think we'll be pleased.

In your current facility, you have a Leather Factory store, will that store stay there, will it move to the new headquarters facility?

It will stay at this present location. It's been at this location, that store, since '82, and the customers are used to it and we'll leave that store right here. And because that's more -- that new facility is a little further off the road too, it wouldn't be conducive to move a store there.

In terms of the costs, how does the interest expense on the financing, how does that compare on an annual basis versus the lease payments currently?

When we get the whole thing done and are paying -- the interest rate is 7.1% fixed over the life of the loan, we're going to pay interest only between now and the end of April. As we're moving, we've got some offices to remodel or to add, do a little bit of movement of walls, that kind of thing. We'll draw on the loan that we got from Chase up until the end of April, it will roll into a term loan at that point, and the maximum that we could borrow is $5.5 million. So assuming that we borrow the maximum with the improvements plus the purchase, you're looking at about $400,000, a little under $400,000 in interest. We are currently paying 420, 425, 430, something like that on the lease now and that will go up every April. So it's almost a wash. Interest will actually be a tad bit less, I think.

In terms of the financing, would you expect that as your cash reserve rises over time, would you use that cash to pay down the term loan?

Yes. The way we -- the way I structured it was -- starting May 1, it will be a term loan. We'll make monthly principal and interest payments. After year 5, we have the option on the anniversary date every year of prepaying 10% of the outstanding principal balance. So while we can't get to year 5 and pay the whole thing off, technically, the way that it's written, we will have the option to prepay. So yes, it's very possible that -- and somewhat expected that we will certainly take advantage of that prepayment option every year, starting in year five.

So between now and year five, there is no -- you can't really prepay?

That's correct.

Okay. My next question is, can you talk about what gives you confidence in the back half of this year?

Well, July was helpful, needless to say. We have September, October, November, December are always good months for us performance-wise. I think our stores are positioned -- the new stores that we've opened are going to be in a good position to perform well in the last half of the year. I'm not going -- I probably know where you're going, Shaun, and I know that we've got a lot of work to do, and it's got to come -- I think it's got to come from the expense side, not the sales side. Could we solve a lot of problems with a 20% sales gain, you bet, but we can't necessarily control that.

Plus we're running against -- yes, the comps should be easier this year because they weren't as strong last year. And we've spent six months dealing with the performance where we've been, got a lot of people motivated and very interested in getting this trend turned around and I think that the efforts that they've made throughout this -- particularly in the second quarter to see things get better, to do what they can, to make things get better, I think we're going to see that benefit in the third and fourth quarters.

Okay. My last question is, are there any specific areas that you could comment on in terms of the expense cutting or where you think that could go?

Yes. I'll throw a few things at you. I've got a professional fees agreement that I can make some changes to. These aren't huge numbers, but I can reduce expenses in the last half of the year for that one service agreement by $20,000. For the people that I control, I think can I cut payroll by 50 grand in the last six months of the year. If every department at corporate could cut 50 to 75 to $100,000 out of their budget in the last half of the year, we'd make up that, basically $0.06 or $0.07 that I think we're down. You mange we're unrealistic, but I think with stronger sales, if July's any indication, plus this has been a huge wake-up call, while we know what we're supposed to be doing, you talk about a slap in the face. This has kind of been very much that and we've done this before. We can -- we need to operate leaner.

If we're not going to run huge sales gains, we've got to operate leaner. I think there are some payroll dollars that we can squeeze and not be affected. I think there are some conveniences in some of the agreements and some of the services that we got that we can make adjustments in, cut back, maybe eliminate. It's not huge dollars. I can't tell we're going to cut one expense by $0.5 million, but it takes the little things, cutting a little here, a little there and I think we can make some strides, I think we can make up some of the shortfall we find ourselves here in June.

Lastly, you said in your prepared remarks about the advertising and marketing. That's not really an area where you could cut back at all in the back half of the year, right?

There's a few dollars and maybe in some of our inquiry programs, but presenting our product to the customer, no, we don't believe that that's a place you can -- I believe you can plan for a sales loss if you start planning to reduce your advertising costs and marketing cost. So that will be the last place we'll pull cost reductions down. I think our margins will also be up that third -- the fourth quarter because of putting out our new catalog in October, being able to take some increases that's happened in the last four, five, six months and passing it on to the customer.

I understand. Thank you very much.

Thanks, Shaun.

Our next question comes from Will Lyons. Your line is live.

Hi, Ron, hi Shannon.

Hi, Will.

I have a couple of questions. What sort of feedback are you getting from your big box customers, customers like Michael's. Are they reducing shelf space for leather-related items, or are they seeing a slowdown as well?

They're not really -- most of them aren't really taking the -- some of them are taking less space for Leathercraft, but they're taking less space for any item that's -- not just Leathercraft, it's any item. They're trying to consolidate some vendors, they're trying to reduce their inventory. Most all of them are having some sales problems right now and they've just been strong -- they blame most of it into the weather, the weather-related problems we've had over this [first sixth] year.

They blame a lot of it on the high prices of the gasoline. They don't really believe that people will drive X miles to a craft store when they need gasoline to go to the grocery store. They also don't believe people will spend as much on gasoline prices went up to buy craft-related items when they needed to buy what they might consider more important essentials. So their businesses are all off, but not drastic. I'm talking 3 -- I think the last time I looked, most of them were in the 3 to 5% range that they're off, which is significant dollars, and they're trying to consolidate some inventories. Does that help?

Sure, yes. Secondly, you mentioned personnel, but are there any other reasons that you've identified why it's taking longer for stores to be profitable, in general. I realize some are profitable as ever, but it seems to be taking a little longer than it used to?

Well, it did. Things slowed down a little bit in terms of profitability really with the 2006 stores. The 2007 stores actually are doing quite well. They're ahead of schedule. Of the eight we've opened so far, three or four of those -- three of those are profitable already, which I couldn't say that in the latter half of '05 and '06. We still have those three from 2005 that we've been harping on, talking about having to talk -- having to mention on every conference call, but I think those problems are solved with the change of manager and glad that that's finally been done.

Yes, things are slower, which getting profitability in late '05 and into the 2006 stores, but that's beginning to shorten again with the 2007 stores. I think we have made some changes in our grand opening efforts, advertising efforts that is helping them hit the ground running a little faster. I've been impressed with the managers that we're putting out there. They seem to be very motivated, very excited, very well trained. I think we're getting smarter about that. So, yes, back when we were first working on it in 2002, 2003, I think it slowed some, but still we're inside with the exception of a couple of those '05 stores, we're inside 12 months. As long as we're profitable inside 12 months, then we're still ahead of the game that we originally set up when we first started this.

Finally, roughly, what would you say were your, I'll call them nonrecurring expenses, major nonrecurring, you mentioned legal costs and others. Roughly, ballpark, with a do you think that was in the second quarter?

In terms of dollars?

Yes.

$150,000.

Okay. Will your legal expenses be going forward as well? Typically --

I don't think to the extent that we incurred in the second quarter or in the first half of the year. The Mid-Continent acquisition was in a sense a one-time deal. Lots of work on that because we bought the corporation as opposed to buying assets, which we don't normally do. We did some extra work, extra legal work, anytime you buy a 50-year-old company, you worry about the skeletons in the closet. We had that issue. We are spending -- and I guess this is -- to some degree, this is kind of ongoing.

We are getting more and more aggressive about enforcing our trademarks on product and there are companies out there that are knocking off our product all the time. We have our Vice President of merchandising and product development has gotten very aggressive about enforcement actions against those folks and we've got a -- we're using a very reputable law firm here in town that does a fantastic job. It will certainly reap benefits for us, not only in market perception and reputation in the industry, but some windfall in terms of settlements and things like that too. That's kind of a new -- I say new. We have periodically through our history have always enforced or tried to enforce our trademarks, but have gotten rather aggressive in the last year with that because it seems to be happening more and more.

Obviously, the build purchase is another one. We spent probably more than we needed to, but again we don't go out and buy real estate every day. Wanted to make sure we new what we were getting into. The building was built in '69. It's not a brand new building, so we had some extra environmental work testing done on it, things like that, because we wanted to know -- we wanted our eyes wide open when we walked into it. That -- that, obviously, won't be something that continues. We will continue to spend the money with the European attorneys, I guess, to get our name trademarked in various countries. There's a whole different set of rules abroad from what's done here. We think that's important, important for planning purposes and just important to protect who we are and our reputation and name in the industry.

The one-time expenses, the building acquisition, that kind of thing, we had a little bit of -- I'll be real honest. We had a little bit of extra work done on our audit this last year, had some staffing issues internally that cost us some money, that won't happen again. Just time crunch, wasn't anything anybody was doing wrong, it was just staff wasn't as prepared for the auditors at year end as they should have been, probably cost us an extra 20, $25,000. That won't happen again next year. It's kind of little stuff, Will, but it all adds up after a while and those are the kind of places where we've got to be more aggressive and make sure that those things don't happen.

Are your enforcement actions primarily in North America?

Yes.

95%. We are doing some overseas, but those are in the preliminary stages.

I see. Good luck for the rest of the year.

Thanks, Will.

Thanks.

Our next question comes from Ruthanne Roussel, your line is live.

Hello, it's Ruthanne Roussel speaking. I wanted to thank you for your candor. It is so refreshing to hear a retailer say "We are going to do something about our problems" instead of saying "it was the weather, it was this, it was that, there was a flood in Rhode Island". It's nice to hear about you.

I appreciate that. You know me, I like to tell you what it really is as opposed to trying to spin something.

Okay. Well most of my questions have been answered, but I would like to better understand how long do you think the renovations will take before the move and when will this move be taking place?

We are actually, as owners of the facility now as of July 31, we are actually leasing the building to the current occupants, the previous owners, until the end of September. We will begin renovations, have everything lined up to begin renovations October 1. The goal is to be through with that by the end of December, hope to move in the early part of first quarter of '08. We got to be out of this facility by the end of March.

Okay. Also, I would just like to understand a little better how this came about that there was this staffing imbalance that somehow the warehouse had gotten bulked up where other areas had not.

In our factory, with the opening of the -- where we make most of our small kits and Leathercraft kits, the advent of opening the new stores is putting a -- the Tandy stores, a lot of the factory wholesale centers don't sell many kits and the new Tandy stores do, as well as the camp business has been good this year and we really never got a handle on how much to make. We added about 15 employees in our factory, trying to guess right on the items to make just to fill the orders. They were very, very busy and then turn around in our warehousing, some of the problems with the -- Shannon was referring to about our space problem does cause us to have to have a few more employees, because we're having to juggle our time and almost do the shiftwork of getting orders out to our stores, our regular shipments, and it's caused a little grief. I think once we get to that new space, we'll be able to reduce some of the central units' personnel significantly, just because we've got some more space to do the daily routines and work. That help?

Yes. So in other words, because the warehouse is going to be more efficiently laid out, fewer people are going to be able to do the same work as the greater number is doing now?

Right.

All right. Thanks very much. As I said, I had a lot of other questions, but everybody else has been great about asking them for me.

Thanks, Ruthanne.

Our next question comes from Joe Blankenship. Your line is live.

Good afternoon.

Hi, Joe.

Help me understand a little bit about the decline in wholesale. You're doing a very, very good job of shifting to retail, but is that a structural change that is coming about that is creating the decline in sales there, and will that continue?

I don't believe it is. I think that historically there are some weak times in every business. In the wholesale end of it, we had a very good 2005 and 2006. It was growing and that's an old, mature business for us. This year we started off and it's just been tough. In a lot of cases, we had a large -- some of our larger small -- some of our small manufacturers are having difficulties because the retailers are reducing their inventories which is causing them to be buying less product.

Actually, in July, I think that I remember Shannon telling you in that sales -- that our business was up for the first time this year in that group -- to that group of customers. So it's really hard for us to put our finger on why it's slower than other times, because we're selling materials to small manufacturers in some cases that are dependent on orders from retailers and some of the largest retailers in the world. I do believe -- I don't believe based on July only and I'm getting a sensation right now from talking with our operations people that that run through July is continuing the first four or five days of August, so it may be that they've gotten their inventories down or changed or whatever into a position that that business might come on strong in the last six months. I'm not saying that it will, but I do anticipate it being better than it has been the past six months.

Okay, good. Last two years, third quarter's been a little dip from second quarter and then a surge in the fourth. I'm presuming that's a seasonal kind of thing, July indicating something different. Is that because of the surge in retail, or do you think -- you've already implied that you expect third quarter to be much stronger. Would you anticipate it being more than second quarter and more than third quarter of last year?

I've been doing this for 37, I guess years now, 38 years historically. The fourth quarter is by far the best. The first quarter is the second best, and the third quarter is the third best. The weakest quarter, historically, over these years, and I can track it back from whenever, the second quarter was always the weakest. Because of the way we're opening the stores in some cases, I believe it did affect our sales a little bit, our sales and profits a little bit, but it's been very unpredictable, unpredictable here in the last two or three years, but I get this feeling from studying the numbers and the customers' habits that we're going to go back to that historical pattern of a weak second quarter, a little stronger third quarter, very solid fourth quarter.

The biggest reasons that the third quarter was always one of the best quarters is because with back to school, Leathercraft in the -- there were 4-H programs that were very good, there were YMCAs get back and that's very popular, schools in general, a lot of art and industrial arts departments have Leathercraft programs. When we had no retail sales or didn't have many stores, we missed some of that business. Now we're starting to get that business again and it's starting to grow and that kind of stuff, momentum builds on it. So that's why I believe our third quarter will start representing a little stronger and profitable sales.

Okay. One more question. In dealing with the inventory increase, is there ways that you can reduce that other than just bleed off through sales? Or do you desire to?

Do what?

Are there ways to reduce the inventory other than just bleeding it through your regular sales process?

There is, but in some cases you do reduce your gross profit margins doing so. The fortunate -- the good/bad thing about our inventory is it is -- I was just this morning studying every item, looking at the items we had in stock and our inventory is up across the board. We don't have any big chunk that would worry me that I could do something about it. It's really strange. I think the last dollar item we have in our warehouse is like $150,000 item.

But the problem is for our inventory -- and this was my fault. I should have been with the buyers and went through it, but our buyers had been buying on a 10% gain for so long, every month they were buying 10% more than they had sold the year before. Early on in the last few months of last year when sales got soft, as well as this whole year, they have still been buying on an increased sales. Well, we haven't had increased sales, and that has within adding a few more dollars. Our inventory is a problem, but it's an easy-to-fix problem. We've got to reduce the items we are selling every day that are good, popular items. Most of our inventory will be in the top 300, top 100 items. It's something that every month you'll see a reduction in it as long as we don't buy more than we're selling.

Great. Well, my other questions have been answered. Thank you very much.

Thanks, Joe.

We have a follow-up coming from Shaun Smolarz. Your line is live.

My follow-up question relates to the IT issue that was identified in last month's conference call in terms of the customer relationship management software, I think on the wholesale side of the business. Do you have an update on that issue?

Shaun, we've made a lot of progress in the last 30 days and that doesn't surprise me. Once we determined what the problem was or discovered that there was a problem, I would estimate we're probably 90, 95% there in terms of now knowing where to get -- how to get -- how to know that we're getting accurate information, how to know that we've got complete information. So we've still got a little bit of work to do, but we have made incredible strides in the last 30 to 40 days.

Ron's asking me if I think it's totally fixed? No, I don't think it's totally fixed, but we're a heck of a lot smarter now than we were 60 days ago in terms of being aware that there was a problem and we have done some things that is increasing the chances of complete and accurate information. So I would say I feel 90%, 95% maybe is kind of where we are. We've got a little bit more work to do to really get the bow tied on it, but we're almost there. And I think that will helps in the last half of the year as well.

All right. Very good. Thank you very much

We have another follow-up coming from Ruthanne Roussel. Your line is live.

Just a quick follow-up question. Do you have a target level of inventory, perhaps in terms of days in inventory or some other metric?

Yes. I don't look at it in terms of days in inventory, Ruthanne, we look at it in terms of dollars. Targets in what we think the stores need to maintain to maximize sales without tying up too much working capital. And then we base the backup units, the warehouse in particular, based on those numbers, we are, at the end of June, based on -- when you look at the base at the stores. For example, let's say the wholesale stores, their base is $100,000 in inventory. The Tandy stores are $60,000 in inventory, that's their base. We look at the warehouse based on those numbers and figure out what they need to -- what the warehouse should be in order to support those inventory levels.

At the end of June, company-wide, we're about 15% over where, when you formulate that all together, we're about 15% higher than where we need to be. That translates into 5 to $10,000 per store and $1 million at the warehouse. Again, this is one of those -- we don't need one unit or one department to fix everything. Everybody needs to do a little bit. The stores have got more inventory, we like that, but they're kind of a little bit on the heavy side. If every store could cut their inventory $10,000, there's $1 million right there, life would be good and the warehouse would cut back as well.

Long answer to your short question, yes. It's kind of a -- I don't want to say it's complicated, but there's a lot of parts to it. Stores, depending on whether you're a wholesale store, retail store, get one base amount to work for. We also allow them, if they're selling an incredible amount, they also get an extra allowance for the exceptional sales. So it's kind of a messy formula, but it works, we've used it for 25 years. It works really well and it helps us know --

Long answer, short question, we're about $2.5 million more inventory based on Shannon's formula and which she's used and it's been pretty accurate in directing in the future. That's how much more inventory we got than we need at this time. Nothing that a 10% sales gain for about four months wouldn't fix.

Yes.

Okay. Thank you. That's helpful.

(OPERATOR INSTRUCTIONS). Our next question comes from [Lynn Fuchs], your line is live.

Just one question. Were you approached by a European retailer to expand in Europe? Has this come up pretty quickly?

No. No we have not been.

Thank you.

There appear to be no further questions in queue.

On behalf of Ron Morgan, myself, and the entire management team, we appreciate your time today and your continued interest in our company. We encourage and welcome your calls at any time. Have a nice day.

Thank you, ladies and gentlemen, this discuss conclude today's teleconference. You may disconnect your phone lines, and have a wonderful day.