Tandy Leather Factory Inc (TLF) 2015 Q3 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Tandy Leather Factory Third Quarter 2015 Earnings Conference Call.

At this time, all participants are in a listen-only mode. Later, there will be a question-and-answer session and instructions will follow at that time.

(Operator Instructions).

As a reminder, today's call is being recorded.

I would now like to turn the conference over to Shannon Greene, Chief Financial Officer. Ma'am, you may begin.

Thank you. Good afternoon, everyone, and thank you for joining us for our Third Quarter of 2015 Earnings Conference Call. I'm Shannon Greene, Chief Financial Officer of Tandy Leather Factory and I'm joined by John Thompson, our Chief Executive Officer, and Mark Angus, our Senior Vice President.

Before I begin, I call your attention to the fact that these conversations will contain forward-looking statements to the extent we speak today of any future event or make 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 our Form 10-K for 2014 and subsequent Form 10-Q for a discussion of some of these risks. Copies of these documents are available through the SEC's EDGAR system and from our Investor Relations office. Also, statements made today by us as Management of Tandy Leather Factory are made as of this moment and we disclaim any duty to the update of those statements.

Our third quarter results, while not what we have grown accustomed to in recent years, did not catch us by surprise. It has been a tough year on a lot of fronts. But even despite the quarterly results, we are right on target with our financial projections. As of September 30th, compared to last year, our sales are up approximately 2%, while earnings were down 23%.

Gross profit margin is down but is still comfortably over 60%. We ended the quarter with $7.2 million in cash and $35 million in inventory. We paid off our debt on our corporate headquarters approximately 2-1/2 years early and incurred a $200,000 prepayment penalty as a result. That penalty, which was recorded in the third quarter, was essentially the same as the interest we would have paid for the remainder of the term. We also initiated a stock repurchase plan in August and we have borrowed $3.7 million this quarter, the proceeds of which were used to repurchase approximately 5% of our stock.

Now, for the numbers from today's press release. Our third quarter consolidated sales decreased 0.3% or $61,000. Current quarter sales were $19.4 million compared to last year's third quarter sales of $19.4 million. Also, Leathercraft sales were $6.1 million this quarter, down 3% from $6.3 million in the third quarter last year. The same stores posted a 1% decrease, reporting sales of $6.1 million compared to $6.2 million in the third quarter 2014.

Our Retail Leathercraft Division reported sales of $12.3 million, a 2% increase over last year's third quarter sales of $12.1 million. The same stores posted a 0.6% sales increase and the two new stores opened after October last year added quarterly sales of $193,000.

Our International Leathercraft segment, which as of September 30th, consisted of three stores located outside of North America, reported sales of $913,000 for the quarter compared to $1.1 million in last year's third quarter, down 13%. All three stores have been open for more than year, so the same store sales loss is also 13%.

Our international operations continue to be negatively impacted by the currency exchange rate. If the current rate were the same as a year ago, this segment would have reported a 2% sales gain rather than a 13% sales decline. Consolidated gross profit margin for the quarter was 61.1%, down from last year's third quarter margin of 62.7%.

Wholesale Leathercraft's gross profit margin was 68.3%, a very slight improvement over last year's third quarter margin of 68.1%. Retail Leathercraft's gross profit margin was 57.7% compared to 59.4% in last year's third quarter. International Leathercraft's gross profit margin for the third quarter was 58.6%, down from 68.6% last year.

Consolidated operating expenses were $10 million or 51.5% of sales in the current quarter compared to $9.7 million or 50.1% of sales last year, an increase of $255,000 or 3%. Wholesale Leathercraft reported operating expenses totaling 57.2% of its sales versus 52.2% last year. Retail Leathercraft reported operating expenses totaling 48.6% of its sales compared to 48.9% last year, and International Leathercraft's operating expenses for the quarter were 52.5% of its sales compared to 51% last year.

Income from operations was $1.9 million for the quarter, down 24% or $597,000 compared to the third quarter 2014's operating income of $2.5 million. On a year-to-date basis, consolidated sales increased 2%. 2015 sales were $59.9 million compared to 2014 sales of $58.9 million.

Wholesale Leathercraft sales were $19.2 million this year, down $341,000 or 2% from last year's sales of $19.6 million. The decrease is the result of a 2% same-store sales gain with sales this year of $19.2 million compared to $18.8 million last year, offset by 100% sales decline for national accounts. No sales this year versus $349,000 in 2014. As a reminder, sales to national account customers ended in April of 2014.

Our Retail Leathercraft Division reported sales of $38 million, a 5% gain over last year's sales of $36.2 million. Sales from the three new stores were $908,000 so far this year versus $225,000 last year. The 79 comparable stores posted sales of $37.1 million, an increase of 3% compared to last year's sales of $36 million.

Our International Leathercraft segment reported sales of $2.7 million so far this year compared to $3.1 million last year, a decline of 14%. As was the case for the third quarter, the negative impact of the currency exchange rate this year compared to a year ago was significant. With consistent exchange rates, this segment will be reporting 2015 sales matching that of 2014.

Consolidated gross profit margin for the year was 62.1%, a decrease from 2014's gross profit margin of 63.9%. Wholesale Leathercraft's gross profit margin was 68% this year, decreasing from 69% last year. Retail Leathercraft's gross profit margin declined from 60.7% last year to 59.3% this year. International Leathercraft's gross profit margin decreased from 63.9% last year to 62.1% this year.

Consolidated operating expenses increased $1.1 million or 4%, to $30.6 million or 51.2% of sales in the current year compared to $30 million or 50.2% of last year's sales. Wholesale Leathercraft's reported operating expenses totaling 54.5% of its sales compared to 51.6% of sales last year. Retail Leathercraft reported operating expenses totaling 49.1% of its sales currently matching that of 2014. International Leathercraft reported operating expenses totaling 56.1% of its sales this year compared to 53.2% last year.

On a consolidated basis, the most significant operating expense increases were in employee benefits, depreciation, advertising and marketing and store rent and utilities. Income from operations was $6.6 million, down $1.5 million or 19% compared to 2014.

Looking at our balance sheet, at September 30th, 2015 compared to year end 2014, total assets are down $273,000 and current assets are down $346,000. Cash increased $3.4 million to $7.2 million at the end of September. Inventory increased $2.2 million.

Current liabilities decreased $1.5 million for the decrease in short-term debt of $3.7 million, which is the payoff of all of our Chase Bank debt, partially offset by an increase in accounts payable and accrued expenses. A more relevant comparison to balance sheet might be September 2015 to September 2014. Comparing those, cash is up almost 50%, while inventory is down $4.3 million or 11%. Current liabilities decreased $5.2 million due to the decrease in short-term debt of $6.2 million which is a payoff of our line of credit, partially offset by the increase in accounts payables and accrued expenses.

Our current ratio is 5:2. EBITDA for the first three quarters of 2015 was $7.8 million. There are six Tandy stores with operating losses as of the end of September totaling $85,000. All of our leather factory and international stores are profitable as of September 30th.

A few more things before we go to questions. We announced our October sales last week and the news was not great. We are in a much different place this year than last year. We were fortunate that those opportunity buys would be so much to support gross profit margins were in abundance last year. While we were concerned about having too much inventory at this time a year ago, that record inventory level turned into record sales in the fourth quarter.

Looking at this year, we have been trying to catch up to last year's inventory levels all year and it's clear that it's not going to happen. We are into the fourth quarter with 10% less inventory than we had at this time last year. That, coupled with the fact that sales have been less than stellar all year, suggest that our fourth quarter sales aren't going to be setting any new records.

There is no way to know if this year's sales would be better have we had the same level of inventory investment as last year. It's difficult to say with any certainty what's going on in the market overall, but based on the feedback we're getting from our customers, there's a strong sense of cautiousness in their spending and that has nothing to do with how much inventory we have or don't have on our shelves.

Finally, I know I sound like a broken record, but our international operation is not doing as poorly as it appears on paper. The sales decline compared to a year ago is the result of the currency exchange rate fluctuation this year versus last year. With that said, we raised our selling prices in our international markets on October 1st to compensate for these changes in exchange rates and expect to encounter some resistance from customers at least temporarily.

On a positive note, we opened our second store in the U.K. last month. The new store is located in Manchester and is off to a great start. It will focus on the continued development of customers in Northern England, Scotland and Ireland, while the other U.K. store located in North Hampton will focus on the Southern half of England.

We will be glad to see 2015 come to an end as this has been a challenging year for us on many fronts. However, even with those challenges, there is no question that we will be profitable, just not quite as profitable as last year.

That concludes our prepared remarks. Operator, we're now ready to take questions.

(Operator Instructions)

Our first question is from Mike Nery with Nery Asset Management. You may begin.

Hello. A couple of questions. So what were shares out at the end of the quarter and what is the rate on the line of credit?

Shares outstanding at the end of the quarter were 9.7 million shares, I think 9,753,000, actually. And you're talking interest rate?

Yes.

LIBOR +185. So, about 2.05 at this point.

Excellent. OK, great. Let me just say I think it's a great move to buy back stock. You have a very strong balance sheet, your stock is cheap and you're doing it in a low interest rate. I think it's a good move and I appreciate the fact that you're actually getting some stock done.

Can you talk a little bit more about international? Thanks for giving the clarity on the 2% in constant currency basis. When do margins internationally come back to normal given the price increases that we have put through or do they at these exchange rates?

Mike, historically we opened the first U.K. store in 2008 and if you look at gross profit margins of that store plus the others that have been added, they're always higher than what we do in the U.S. and Canada. The reason for that primarily is because we sell a lot more of the non-leather items, all the tools and hardware there, more so than we sell the leather. You know how the product mix works and the gross profit margins that are earned on the non-leather stuff versus leather.

As long as they're in ratio, their sales mix is as heavily-weighted toward non-leather as it is. Their margins are always going to be higher than what we're normally used to in the U.S. and Canada, but it's strictly a matter of how much leather they sell in relationship to the tools and the hardware that they sell, the non-leather stuff.

Right. So when do they get back to more normal operating margins? You mentioned the price increase October 1st. When do we get to the point where these are generating nice operating profits for us again?

Well, the stores are profitable. We're obviously spending an awful lot of money on advertising doing trade shows and heavy investment there because even in having a store that opened in 2008, it's still a new market. I think you'll see some improvement from October 1. One of the things that we were probably slow to do based on currency exchange rate is change prices in our international market throughout the year. So the increases that occurred on October 1 were fairly significant, especially for us.

I'll be real honest, there's been some sticker shock on the part of the customers because the increase was as significant as it was, instead of adjusting prices that all along. We held them, sacrificed the margin as a result, but decided that the rates weren't getting any better any time soon so we made those adjustments on October 1st.

There's going to be some sticker shock, but customers will come around. We'll do what we can to continue to work with them as they get used to it. Then I think you'll see things get better in terms of margins because now the rates or the prices that we're charging over there are more in line with what they really should be based on converting the USD prices to their local currency.

So this year, international, I think has averaged about a 5% operating margin, last year was 13%. Next year, we should start seeing more normal operating margins, maybe not at 13% yet, but significantly better than where they are?

I think so.

OK. Then can you talk a little about margins in the U.S. and what we're doing to kind of improve or maintain margins. You've done a good job in the past at cutting cost where you need to and I just want to find out what your thoughts and plans are for next year.

Hi, Mike. It's Mark. Well, like we've talked before in the past calls, this whole year we've not seen a lot of those opportunity purchases and opportunity buys, at least in leather, that we've seen in the past. Although they're coming through them, we're getting some, we're not getting them in great abundance like we were very fortunate of getting last year.

The hopes are that those constraints won't be there come the first part of next year. We're seeing an improvement in it. We're seeing an improvement going into the first of next year. As for our regular line of merchandise there's really nothing wrong with that, everything is good. It basically just boils down to just those opportune buys in that leather field.

If we can see some more of that in greater quantity come on the market, and you know we're out there all the time looking for it, then that's what you're going to see bring those margins back a little bit. Even though a slight drop to that is very little, that is the area in which it's happening from. We know exactly what it is.

I'd also add, Mike, that in terms of expenses, when we analyze what's going on with our expenses, the big increases relative to a year ago are advertising. Well, you're not going to see us make significant cuts in advertising because if we do that, we guarantee ourselves of a sales decline. Employee comp, we're trying to manage the headcount in stores appropriately, so that we have sufficient staff to work the stores and also be out doing demonstrations and trade shows and all of that.

So you're seeing an increase in employee comp. But again, cutting that means the stores can't do trade shows and be out doing demonstrations, et cetera, because we've got to have sufficient people in the stores to cover the stores. Those are probably the two biggest operating expense increases, but those aren't really good areas to cut.

Yes, we're looking at everything that we can certainly get rid of as far as expenses go, but improving the gross profit margin with stronger sales and better gross profit margin, a lot of that would fix itself. The margin you're looking for would be there on an operating margin line. There's just not a lot of dollars to cut elsewhere in terms of when we look at expenses compared to where we were a year ago. It is employees and advertising.

I think 99% of retailers right now would love to have down inventory year-over-year, so I know you guys are missing some of the great deals in the buys, but your balance sheet is in very good shape. So, thanks very much.

Thank you.

Thank you. (Operator Instructions).

Our next question comes from Tom McCrohan with Five Roads Capital. You may begin.

Hi, Shannon. Hi, Mark. Thanks for the guidance or the feedback from the quarter. I had a few questions to start with on accounting issues. If you provide discounts or incentives, does any of that flow to marketing or does it lower your gross margin?

No, it lowers. It's a debit to sales, discount for affecting sales, it's not down below.

OK, thanks. One thing I'm just going to do is figure out how your profitability would look if you were a LIFO reporter and I was hoping you could give me the tools to do that. So, I guess the first question is the IMF publishes rawhide price data. Is that a decent proxy for how much it costs you to buy leather?

That report?

Yes.

Not really, because again, when we look at buying leather, we're actually getting the price from the tanneries including whatever it cost them to produce the leather. Normally that's about the only thing you're saving when you switch countries or buy from different countries is the labor. Pretty much everything is equal to everybody. Say for instance, if they're buying U.S. hide in China or Mexico or in South America and then tanning them, the only difference because the chemicals cost the same is the labor to produce them and the freight.

I see. OK. In the last few months, have you been in an inflationary environment on leather prices or deflationary. What's that been like?

Yes, we've seen a quite a run-up in hide prices. You know it's probably been the highest it's been in 30 years. But now we're seeing it go the other way and it happens every time the market runs up, and then it'll run out of steam when people stop buying and it'll drop back the other way and we're seeing drops of 25% to 35%.

It happens every time. For us, it means you're selling hides now or hand leather at maybe lower prices. But the thing is that it usually brings more people back to the market that maybe dropped out before. You're just not making as many gross profit dollars per hide as you were before.

Yes, that makes sense. OK.

It offers more volume and luckily for us, it kind of goes hand-in-hand with what Mark was saying. When you get more people back in the market then there also becomes more odd lots on the market. So, it kind of helps us in other way. If more people come back and start producing them, we'll probably find more odd lots that we can jump into that will also help our sales.

Yes, that makes sense. OK. What portion of your cost of goods sold is the raw leather?

You're talking hides? You're talking finished leather, right? When you say raw leather?

Yes.

I looked that up. All right, so listen close. 2015, of our sales mix we're doing 41% of our sales in leather, 59% is the non-leather for 2015 year-to-date. Cost of goods, leather makes up 57% of our cost of goods, while the non-leather cost of goods is 43%. So, 41% of our sales accounts for 57% of our cost of goods.

Yes, that's helpful. OK. Do you think you can give me sort of a rough sense of how much of an impact you would have over the last12 months if you were a LIFO reporter to your net income?

Gosh. I don't know. I mean prices haven't changed that drastically. I don't think at any given point that it would have a huge impact. I mean maybe, I'm kind of guessing here, but maybe $0.01 or $0.02 on EPS, but maybe. But it wouldn't be any more than that. You don't see big adjustments or big price swings, no matter what's going on. We either buy extra when we think prices are going up as far as leather goes or we hold off if they go the other way. Then on the non-leather, the tools and hardware and all that, those prices don't change by any even measurable amount. $0.01 or $0.02 on something on an item but not enough to have any significant impact I don't think.

OK. I think I'll jump back in the line in case other people have questions. Thanks.

Yes.

Thank you. I'm currently showing no further questions at this time. I would like to turn the call back over to Shannon Greene for closing remarks.

Very good. On behalf on Jon Thompson, Mark Angus and myself, thank you for your participation in today's call. Have a great day.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day.