Tandy Leather Factory Inc (TLF) 2017 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Tandy Leather Factory Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Ms. Shannon Greene, Chief Executive Officer. You may begin.

Thank you. Good morning, everyone, and welcome to Tandy Leather Factory's 2017 Earnings Conference Call. We will be discussing our fourth quarter and fiscal year 2017 results as well as providing an update on our strategic plan and our 2018 guidance. I am Shannon Greene, CEO, and I'm joined today by Tina Castillo, CFO. Mark Angus, our President, who normally joins us on these calls is not available to participate in today's call.

Before we get started, our earnings release and related SEC filings are available on our Investor Relations section of our website, and a replay of this webcast will be available later today. Also, I need to remind everyone that there may be forward-looking statements on the call today. Statements would include words like expect, believe, anticipate, plan, intend, target, or words with similar meaning, and are based on our beliefs and expectations and are subject to certain risks and uncertainties, that may cause actual results to differ materially from our forward-looking statements about those results. The risks are detailed in our various filings with the SEC, such as the most recent Form 10-K and 10-Q as well as in news releases and other communications. We do not undertake to update or revise any forward-looking statements, which speak only as of the time they are made.

I'm very pleased to be hosting this call today. I know for some of you, since we know longer report monthly sales results, it probably feels like a long time has passed since our last earnings call back in November, and yet we've completed our busiest season. So thank you for your patience, support and interest in Tandy Leather. I believe this is great timing for me to share my thoughts as we wrap up one year and begin another.

As you saw in our earnings release, we completed a solid fourth quarter, with a sales increase of 1.7%, and excluding the impact of tax reform, an adjusted earnings per share of $0.22. Not only did we see improvement to our top line, our gross margins also improved, contributing to a 5.4% increase to gross profit, which allowed us to be at the top end of our fourth quarter guidance range.

Tina will take you more in depth through the financials. But before she does, I'd like to highlight that, as we enter 2018, we are working diligently to improve our execution on our key operating priorities and to refine our long-term strategy. We've said in prior calls that our long-term strategy to drive sustainable growth in traffic and sales has 3 key objectives: improve our customer experience; increase our brand awareness; and strengthen our financial performance. To achieve those objectives, we announced several initiatives in early 2017, including a new store growth strategy, a new district manager structure, an increase in our U.S. store manager base salary, the collaboration with the Pinners Conference and Expo and a rollout of new military and first responder loyalty program.

This morning, I'll walk you through the cost impact, how we're measuring our progress and effectiveness and what we're doing to improve on our execution.

In 2017, we opened 3 new stores and reopened 1 that we had closed temporarily in early 2016. We didn't open any new stores in the fourth quarter. Excluding corporate allocations, the cost impact from the 4 new stores plus the 3 stores that were opened in fourth quarter 2016 added $1.3 million of operating expenses in 2017 for personnel, occupancy, selling and store opening costs. These same-stores generated $2.4 million in sales. Frankly, we're glad these stores are positively contributing on a cash basis, but we expected better performance more quickly. We haven't changed our new growth strategy, but we are tweaking the timing of our 2018 new store plans ever so slightly to ensure that the new store format that we have implemented has a little more time to prove its validity. What that means is that we're still planning to open 2 to 3 new stores in 2018, but those openings are expected to occur in the third and fourth quarters, rather than in the second and third quarters. Meanwhile, we are watching the newer stores' performance very closely and robustly supporting them in their efforts to develop a solid customer base, with additional marketing, sales development training and class schedule suggestions.

As for our district manager structure, we currently have 12 of our 15 districts staffed, with the latest district manager having been -- just been placed within the past week. And the cost of this program in 2017 was roughly $1.1 million for personnel and travel. Our goals with the district manager program are not only to drive traffic and sales, but to train and proactively support our store managers and associates to better serve our customers, which is critical for success in today's retail environment. This structure not only allows us to have a faster execution of strategy, but also provides additional career path options for our employees. We believe some of the improvement in the fourth quarter was the result of the groundwork these district managers have been laying. Nevertheless, there's still some fine-tuning to the program, which we are evaluating to continue to ensure an appropriate return on investment.

In December 2016, we increased our U.S. store manager base salaries by 40% to comply with the then-expected FLSA minimum salaries. As a result of the change in White House administration, that requirement was delayed at the last minute and is still being evaluated by the Department of Labor. However, we maintain the increased base salaries as our store managers are essential to our mission and vision. With a higher base salaries, we believe we are better equipped to attract and recruit these key employees, particularly in a tightening labor market. The net cost of this increase in base salary for 2017 was $0.2 million, as we also made changes to the U.S. store manager bonus program. I'm happy to report that we are well positioned for success as our store manager positions are 100% filled, and we have a solid backlog of managers in training, something we haven't enjoyed in quite a while.

Starting late in 2016, we rolled out -- we announced the rollout of our military appreciation program. In June 2017, we expanded that program to include first responders. These programs give eligible customers discounted pricing. The programs have been very well received. At the end of 2016, we had just over 900 members in these programs. Today, we have over 44,000. Sales to this group has nearly doubled in 2017, and we believe this is a large part of why we've seen sales improvements to our retail customer group.

In 2017, we collaborated with the Pinners Conference and Expo, which hosted 2-day events in 4 U.S. cities, focused on crafting classes and shopping with thousands of woman in DIYs in attendance. We hosted 4 leather-crafting classes at each of the 4 conferences and had over 1,500 conference attendees participating in those classes. Given the success of this collaboration, we have agreed to be Pinners' title sponsor for 2018, which has grown to 6 U.S. cities and will allow us to continue to target a new group of potential loyal lifetime customers. The first conference in 2018 is in San Diego in mid-April.

While I believe we are making good progress toward accomplishing our goals, we must improve our execution to step up our financial performance.

After Tina provides you with a run-through of the numbers, I'll give our 2018 guidance and some of the other strategic initiatives we're undertaking. Tina?

Thank you, Shannon. Before I go into the details, I wanted to remind everyone that as was disclosed in our press release, in the past 3 calls, we now operate in 2 segments, North America and International. You may recall that prior to January 1, 2017, we operated in 3 segments: wholesale, retail, and International. To better reflect how management analyzes the business and allocates resources, we combined wholesale and retail into North America effective January 1, 2017, while our International reporting segment remains the same. All prior year data discussed throughout this call has been recast to conform to the new reporting segment structure, and there's no change in the reporting of our consolidated financial position or results.

Our fourth quarter consolidated sales totaling $24.5 million increased 1.7% from last year's fourth quarter sales, with our North America segment reporting a 2.1% increase offset by an 8% decrease in our International segment. North America contributed 96% of fourth quarter 2017 total sales, while International contributed the remaining 4%. The $490,000 improvement in our North America fourth quarter sales was primarily due to $679,000 in contributions from the 7 new stores opened or reopened since October 2016, offset by a 0.8% decrease in same-store sales. This decrease in same-store sales were the lowest we've seen all year, but consistent with the overall trend of our customer mix shifting from nonretail to retail. Sales to our business customers declined by 5% in the fourth quarter, while sales to our retail customers increased by 7%. The $88,000 decrease in International fourth quarter sales was primarily due to overall softness across all of our overseas locations, despite the weakened U.S. dollar.

Consolidated gross profit margin for the quarter was 62.4%, improving from 60.2% in last year's fourth quarter. The improvement was the result of a shift [in customers], with more retail than business sales, as well as product mix, with more higher-margin products sold. As a reminder, generally speaking, our gross profit is affected by 2 things: sales mix by customer; and sales mix by product. More specifically, the ratio of retail versus nonretail sales and the ratio of leather versus nonleather sales results in the increase or decrease in gross profit compared to the same period last year.

Consolidated operating expenses this quarter increased $1,137,000 or 10.4% compared to a year ago. Costs associated with our district manager structure contributed to about half of this increase, while our 7 new or reopened store contributed about 30% of the increase. The remaining increase was from higher personnel, occupancy, selling and advertising cost increases.

Income from operations was $3.2 million for the quarter or a decrease of $360,000 from the comparable quarter in 2016. Included in fourth quarter 2017's results was a $341,000 charge for tax reform, primarily due to $805,000 of transition in withholding tax on the deemed repatriation of certain foreign earnings offset by a $464,000 benefit from remeasuring our deferred tax position at the new corporate lower income tax rate. This charge has been based on reasonable estimates and our current interpretation of the new tax reform that could change as new guidance is issued by regulators and as we finalize underlying tax calculations.

For the fiscal 2017, our consolidated sales totaling $82.3 million decreased 0.7% from last year's sales. North America reported a 0.6% decline, which consisted of a same-store sales decrease of 2.3% and new and newly reopened stores sales of $1.3 million offset by 3 stores that closed in 2016. Our International segment reported a sales decrease of 3.3%, which was primarily due to weakness in our Australia operations.

Consolidated gross profit margin for 2017 was 63.3%, improving from 62.4% last year, due to a shift in customers, with more retail than business, as well as product mix, with more higher-margin products sold. Consolidated operating expenses this year had increased 8.4% compared to a year ago due to the investments in our new stores and our district manager program. Our effective income tax rate for 2017 was 38% compared to 37% last year. We ended the quarter with total assets of $74.9 million, up $4.3 million from the end of 2016. Cash was higher by $1.5 million at $18.3 million at year-end 2017 versus $16.8 million a year ago. This increase was primarily due to $3.2 million of operating income, less $1.7 million in CapEx.

Current liabilities decreased $1.3 million, while our bank debt is unchanged at $7.4 million. This debt consists solely of borrowings on line of credit in place for our stock repurchase program, for which there have been no repurchases during 2017.

Now I'll turn the call back over to Shannon, who will provide our 2018 guidance and update you more on our strategic initiatives.

Thanks, Tina. So looking into 2018, we estimate sales to be in the $82 million to $84 million range, fully diluted EPS in the range of $0.63 to $0.68 based on 9.3 million of average shares outstanding and an effective tax rate of 21%. As of the end of February, sales are roughly 2% higher than at the end of February last year. Our top line forecast includes a flat to 2% same-store sales improvement plus the addition of 2 more stores. Our bottom line forecast assumes a flat to slight decrease in our gross profit margin, as we increase our efforts to grow sales to our business customers and add higher ticket but lower margin products to further expand our product lineup. From an OpEx standpoint, we expect a slight reduction in overall dollars spent, as we make changes to our advertising and marketing spend and other home-office costs. As for the 21% effective tax rate, that's our best estimate at the current time. We are still evaluating the impact of the new taxes on certain foreign sourced income as well as the impact of eliminating the domestic manufacturing deduction and limitations on certain business deductions. So our estimated effective tax rate may need revision as we get additional guidance and clarification to the new reg.

Looking at our inventory levels. We do expect there will be continued investment as we expand our merchandising for higher-ticket products.

Regarding our 2018 capital expenditures, we're expecting CapEx to be approximately $1 million to $1.2 million to cover new store openings, 6 store relocations, an enterprise data analytics platform to help drive more insightful data and analytics as well as routine computer replacement.

Looking out even further than 2018, we believe our long-term strategy to drive sustainable growth in traffic and sales will achieve fiscal year 2020 financial targets approaching $90 million in net sales and a return to greater than 10% operating income margins. We are focused on several key initiatives, including growing sales by increasing our average ticket. In 2017, our average ticket was $77.43 compared to $85.71 in 2016, which reflects the decline in our sales to our business customers, who tend to buy more per ticket than our retail customers. We plan to introduce some higher-ticket items over the next 18 months, which will improve our average ticket size. We are also expanding our store hours for our customers' convenience. We tested extended store hours in December, which was well received. And starting March 1, we updated our hours of operations that we're -- so that we're open a little later on Tuesdays, Thursdays and Saturdays. We're also considering testing opening on Sundays by midyear.

We're also laser-focused on improving our stores overall financial performance, with an initial focus on correcting underperforming stores. We are currently evaluating the steps necessary to return these stores to positive performance metrics. We're also working on improving our pay-for-performance culture and enhanced training initiatives for our associates, especially with the labor market tightening as it is. We are focused on marketing an education innovation, including new classes and formats, and maximizing channels, including print, digital and e-commerce, to attract new customers while retaining our established customers.

As you can see, we are not standing still. We know that we have many initiatives in play, and we are determined to make the necessary changes to continue to position Tandy Leather as the first choice in all things leather.

As always, I want to publicly thank all of our dedicated Tandy Leather team members, who worked so hard to move this company forward.

That concludes our prepared remarks. We very much appreciate your time today and your interest in Tandy Leather. Operator, we are now ready to take questions.

(Operator Instructions) We do have our first question from the line of [George Kelly]. He is a private investor with the company.

Just a couple questions for you. So first it sounds like the kind of same-store sales trend has improved versus what you were seeing in 2017. My question is just how -- what's your view of the consumer these days? Does it seem like people are more healthy in your stores? Does it seem like there's a more sort of buoyant consumer environment?

Absolutely. We experienced improvement in our sales -- top line to our retail -- what we classify as our retail customers, throughout 2017. In fact, that's frankly what carried us offset by the decline in sales to our nonretail or our business customers. We're making a concerted effort to be attractive and interesting to a younger set of customers. Part of that's what we're doing with Pinners and part of that's just the environment we're trying to create in our stores. We're making a concerted effort to improve the quality of the classes. We got -- it's all about -- in my opinion, it's all about creating the experience that appeals to not only our legacy customers, but a new group of customers, which, frankly, means that they're younger. And I think our district managers are having -- are playing a key role in helping the stores see the vision and create that type of atmosphere. We're also, if you pay any attention to our Facebook page and Instagram and YouTube, we're really working on that as well to update it and modernize it some. I'll admit there's still some videos that look like there were done probably in the '50s, and they may have been. Who knows? But social media, we're really trying to refresh that and keep a contemporary feel to it. So I think all of that contributes to a growth in our retail sales and a growth in expansion of the type of customer that's interested in shopping with us.

Okay. Got you. That's helpful. Next question, it sounds like you're reviewing the practices and trying to improve on some of the underperforming stores. So the question for you is, can you remind me about International profitability? And how committed if -- those stores, I think, they've lagged the U.S. business and how -- whatever you can say about your sort of attitude towards the International store base, how committed you are there.

We are absolutely committed to the stores, not to the point that it's stupid. But the opportunity internationally for us to be successful is very high. But just like it was similar -- just like in the U.S., there's no one that we're aware of anywhere in the world that does what we do: a chain of stores dedicated to promoting leathercraft through education, the one-stop shop concept, et cetera, et cetera. So the potential is out there, and we're seeing good things on the International front. The disadvantage that they have is, like let's take Australia, for example, there's only one store in Australia and it's a big continent. So part of where they're lagging is the ability to pull -- because their market's so big, they're not going to get customers from Western Australia to come over and take a class because it's clear on the other side of continent, it would be like San Francisco to New York. So they do a lot of web order. They do a lot of mail order. That personal touch to customers is -- they can grow their local market that way, of course, but the potential to reach beyond -- the personal touch beyond their small -- their local market is virtually impossible at this point. So our approach is, obviously, we have to connect with those customers via e-mail, via social media, via the sales flyers, but it just takes longer. And you don't -- I mean, customers, as you know, on the web, customers come and go. So we have -- it's just going to be a slower process because they don't have the footprint that we do here, so to develop that local neighborhood kind of feel in a very large market. Europe is the same way. Obviously, the same-store is servicing customers in France and Germany and Belgium and Italy, all over Continental Europe. Well, again, we don't have a lot of customers that are going to come from France into our store to take a class. So it's a different dynamic, and it's a different thought process. And we're continuing to tweak it with the advertising methods and efforts that we make in -- as much as we hate to say this in the U.S., what works in the U.S. doesn't always work everywhere else. And I think that's part of what we're working on with the International is just because it works here in the U.S. with the 105 stores across the country, it doesn't work the same in -- for a single store in a country or on a continent. And so we've got to market, and the efforts need to be different. But again, the potential is there to open a lot more stores than what we have. We just want to be -- we -- because they're far away, because it's a different market, we want to make sure that these stores -- we want to do everything we can to give them the tools to be super successful. And I'm absolutely -- I absolutely believe that will happen. It just takes -- it's just taking longer.

Okay. Got you. And then last question for me. I guess it's a 2-part question about your cash. And so you mentioned on the -- in your prepared remarks, $1 million to $1.2 million in CapEx this year. So the first part of the question is, is that a good run rate going forward? And then second question is that, the numbers, as I see it, there's a lot of -- you have a lot of cash on your balance sheet and very strong free cash flow. Why is it best to have that cash on your balance sheet? Are there other sort of places, a dividend or share repurchase -- or how do you think about that stuff?

Sure. So CapEx, I think the last couple of years, the $1 million to $1.5 million in CapEx is about right. So -- and I don't see anything on the horizon that's going to change that. So when you think out years -- in 2 and 3 and 4 years from now, based on what we know right now, I don't see that changing any -- certainly not increasing. We're just not CapEx intensive fortunately. So hopefully, that answers that first question. The cash, I can tell you that it's a topic on -- at the board meetings all the time. We have a fairly new board. It's a very important -- capital allocation is a very important topic for them. And we probably tend to enroll -- probably always carry more cash on the balance sheet than a lot of people think is necessary because it allows us the flexibility to make large leather purchases, in particular, when opportunities arise. And if anybody has following us for any length of time, you hear us talking and -- you've heard us talking over the years about these, what I call, opportunity buys, there will be an overrun from -- at a tannery and they will call us, and obviously -- basically, trying to fire sale it, trying to liquidate it and turn it into cash as quickly as possible. And they know depending on what it is, most of those tanneries know if they'll call us and it's something that generally in our wheelhouse, we'll buy it, and they also know that we'll pay for it quickly. So having -- and as a result, that helps support gross profit margins, et cetera, because we get to purchase those overruns or those large lots generally cheaper than if we were just doing standard POs. So there's some flexibility, some advantage -- competitive advantage for us being able to do that. However, the rest of that question, whether it's a share repurchase or a dividend, those are options that are discussed and considered continually by the board. We do have a share repurchase plan in place right now, has been for several years. I think we've -- we didn't purchase any shares in 2017 just because the price was -- the market price was higher than what we were willing to pay for it. But in 2015, 2016, I think, we repurchased 1.1 million shares or 1.2 million shares. And we have the ability through the stock repurchase plans to purchase another 2 million? I think, it's 2 million shares. So that's available and just kind of sits there. At any point in time, that we could get the shares at a reasonable price, we certainly would. We have paid. As you probably know, we have paid several large special dividends in the past. There are, I guess, pros and cons of doing that versus a quarterly dividend. But I can assure you that the board is looking at that every board meeting, and capital allocation is a huge issue, so that we know that we are utilizing and making the most of the cash that we have available, returning it to shareholders or being able to invest it in something back in the business that's going to grow value.

(Operator Instructions) Our next question comes from the line of [Peter Mark] with [Mark Capital Management].

Just 2 quick kind of follow-up questions. One, just you mentioned real quickly, just in terms of the -- having store openings on Sundays. Is that -- currently, is that being done in any kind of the stores? I kind of missed that. And then secondly, just in the longer-term guidance, 2020 targets you have a bullet point there on the -- providing more incentive-based compensation to associates. Any -- what are kind of some of the specific tweaks you guys are thinking about there?

Sure. So with regards to the store hours, no, none of our stores are opened on Sundays right now. Historically, we've been open Monday through Saturday, closing at 6 during the week and 4:00 on Saturdays. We are now -- as of March 1, we are now staying open till 8:00 on Tuesdays and Thursdays and staying open till 6 on Saturdays, so added 2 hours to those days. We also, we're opening at 10 now instead of 9, which has no impact, I don't think to anyone. So -- but staying open later Tuesdays, Thursdays and Saturdays with the idea that customers who work full time, obviously, get off of work at 5:00 or 6:00. If we were closing at 6, they couldn't get by the store during the week and then come on Saturday. So, so far, and this just started March 1, the momentum as we've had 3 days of that, we started March 1, I think, was Thursday and then Saturday and Tuesday, 2 days ago, we'll see what the night looks like. But the -- but those extra 2 hours, the sales are growing as we've moved through the month so far. And we're getting really good feedback from customers that having the ability to come in after work on Tuesdays and Thursdays is great and then Saturdays, a little bit later. Our plans are -- with that is we kind of get everybody stable. We may start doing -- we can do classes in the evenings, again, for customers who can't get there during the day or can't get there before 6:00, we're also towing with the idea of maybe doing a national class, and so that on a particular Tuesday night, every store is teaching the exact same class. We can advertise it, we can potentially webcast it, we can do a lot of things. So, so far we're just barely into the extended hours starting March 1, but it has been good so far for the 3 days that we've got data for it. We are considering adding Sundays to the lineup. We -- Tandy, to my knowledge has never been open on a Sunday. I don't know why that was, back when the stores first started back in the '50s, but that's neither here nor there. Again, Sunday proves to be a strong retail shopping day. I anticipate it would be a half day, may be noon to 5, something like that. So we've got a -- obviously, that will create some staffing issues and things adding -- going to the seventh day. But we're looking at it because we think we may be missing an opportunity to pick up additional sales and service customers by not being open on Sunday.

Sure. Incentives, just any tweak? You've kind of highlighted at that in the prepared remarks and just any other details you can provide on what...

Sure. Well, I will tell you that my personal opinion and I guess I should say this isn't necessarily the opinion of the total management and board, but I think our associates -- I think we're in good shape with our store managers, that increase -- the salary increases that they got at the end of December, while painful this first year because it was a large increase, I think, we are, as I said, much better positioned to attract employees at that level based on the salary. I still think that our associates are underpaid, and that's not a problem that can get fixed quickly. We are not typical retail, and that we don't hire seasonal in the fall and fourth quarter like a lot of retailers do, because the -- our most successful employees are those that understand and know how to use our products and why we -- what tool does what and what leather you're going to need for whatever project. And most -- the average person out there doesn't walk around with that knowledge. I compare it to if I had to go sell shoes, I could, because I wear them and I buy them all the time just like everybody else. I could talk about shoes, asking somebody to explain what an edge beveler does, if you've never seen it and you've never seen it work, the average person's not going to know anything about that. So while we are retail and we are hiring retail associates, there is a -- there is an additional requirement, and it's on-the-job training, of course, that goes into being really successful. As a result, I think our associates tend to be underpaid. I think the hourly rates that we're paying are lower than particularly as some markets get more and more competitive minimum wages are going up, people can be there -- that news is coming out all the time of companies that are raising their starting rates for their associates, Target's done it, WalMart's done it, all of that. So given that we can't go in and fix all of that immediately without some sort of drastic financial impact, we're looking for other ways to incentivize and reward the employees for success. And it's little -- right now it's little things like incentive contests, we're working on sales gains and gross profit margin improvement and memberships sold, Military Appreciation Program members gained, those kinds of things and doing very small kind of incentives. But so there are contests within the store system, within districts, within regions. At the end of the day, I guess, it doesn't help them pay their rent, but it rewards them on a small scale for positive contribution. And so -- and from the feedbacks that -- we did a couple of things in the fourth quarter, very small things, they really rally behind it and they really get involved and the feedback has been really good. So we're going to -- to start with, that's kind of what we're focused on is small incentives, generally noncash awards, whether it's logo shirts or Tandy sweatshirts, all sorts of things that they -- and, of course, the bragging rights that goes out. So it's very small and virtually no cost as far as really an expense, but it gets the associates involved in the process and in the success of the store. The manager gets it already because of his bonus program. The more profitable he is, the larger his bonus is. So he is kind of already taken care of. But it's the hourly associates that are critical to the operation. The manager can't do it all by himself, creating that good customer experience. So we're trying to do some small kind of quiet, subtle things that gets the associates involved and then rewards them for contributions to success. And based on feedback so far, it's good. We will continue to develop that. And I hope over time, we can continue to raise the starting hourly rate. It varies by market, of course, and cost-of-living situations. But we ask a lot of our associates in terms of their commitment to learning the product and teaching the classes, et cetera. And I personally believe we need to do a better job of rewarding them for that. It's just a very large issue. So we've got to start small.

Thank you. And I'm not showing any further questions at this time.

Very good. Thank you all for participating in our earnings conference for today. We look forward to speaking with you again next quarter. Have a great day.

Ladies and gentlemen, this does conclude the program. You may now disconnect.