Tandy Leather Factory, Inc. (TLF) Q2 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2017 Tandy Leather Factory, Incorporated, Earnings Conference Call. At this time all participants are in a listen-only mode. Later we’ll conduct a question-and-answer session, and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today’s conference, Ms. Shannon Greene, Chief Executive Officer. Ma’am, please go ahead.

Thank you. Good morning, everyone, and welcome to Tandy Leather’s second quarter 2017 earnings conference call. We will be discussing our second quarter 2017 results as well as our plans and expectations for the rest of 2017. I am Shannon Greene, Chief Executive Officer, and I’m joined today by Tina Castillo, Chief Financial Officer, and Mark Angus, President. 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. I also 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, subject to certain risks and uncertainties that may cause actual results to differ materially from our forward-looking statements about those results. These 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. So as you saw in our earnings release, our results for the second quarter were positively impacted by solid year-over-year gross margin improvement, but negatively impacted by the investments we’re making in our new-store growth strategy as well as our district manager program. At the same time, our international segment came in softer than anticipated. All that said, however, our results continue to be in line with expectations. Let me first start with our new-store growth strategy. We opened three new stores this quarter: in Allen, Texas, opened in April; Miami, Florida and McAllen, Texas, both opening in May. We are excited about each of these locations since we already have a strong and established customer base in each market. In each of these cities, the populations are growing, which provides better opportunity for us to continue to expand our customer base. And for Miami and McAllen, they also offer us greater opportunities for cross-border trade. We expect that these new stores will generate positive contribution margins within their first year of operations. As for our district manager program, we continue to make good progress, with 12 of our 15 districts currently staffed. Each week our district managers report on their activities, and we are encouraged by some of the positive initiatives underway that we expect will improve the customer experience including in-store customer appreciation events, new class offerings and in-depth product training. The district managers are also aggressively working on outside business development, accompanying our local store managers on sales calls to foster our business and wholesale customer base. Again, our goals for the district manager program are not only to drive traffic in sales, but to invest in our current and future generations of store managers and associates to better serve our customers and succeed in today’s retail environment. We anticipate that it may take up to an additional 12 months for the district managers to fully gain traction and for us to begin to realize a return on that investment. On the digital front, our social media team has been very busy with several marketing and branding initiatives that focus on the handmade and makers-artisan movement that highlight Tandy’s rich creative heritage, our broad product breadth and some of our unique customers. These videos are being shown on multiple platforms, and they give us a larger audience to connect to demystify working with leather. Our featured customers are delighted with the results and the co-marketing it offers their businesses. This in turn, we believe, will result in stronger loyalty to Tandy. From a sales perspective, like many other retailers have reported, consumer spending so far this year has been soft. For us, that decline is mostly due to a lower average ticket, as our sales counts have picked up as we’ve moved through the first six months of 2017. We believe this lower average ticket is in part due to a shift in sales to our retail customers, who buy smaller amounts but more frequently. Another benefit of this customer shift is higher gross margin, which we saw this quarter over comparable. We’re working on several other promotions to drive traffic to our stores, including Red Shirt Wednesdays, where we offer our customers $5.00 off their purchase for wearing Tandy red. We’re also excited to have rolled out our First Responders Appreciation Program, which is very similar to our Military Appreciation Programs. Qualified first responders and our armed forces personnel receive discounted pricing and we expect these programs to generate new lifelong customers. On the international front, it’s been challenging in 2017 on both the top line and bottom line. Our sales have been impacted by unfavorable foreign currency translation, which Tina will quantify a little later, while our operating expenses have experienced some increases, primarily in occupancy and selling costs. We are analyzing the areas that we can control to get our financial results back on track. Overall, we continue to be cautiously optimistic for the second half of the year as we roll out new products and the strategic initiatives I’ve just updated you on take root. Now I’ll ask Tina to provide you with a run-through of the numbers for the quarter and year-to-date.

Thank you, Shannon. Before I go into details, I wanted to remind everyone that as was disclosed in our press release and last quarter, we now operate in two segments, North America and international. You may recall that prior to January 1, 2017, we operated in three 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 is no change in reporting of our consolidated financial position or results. Our second quarter consolidated sales totaling $19.3 million decreased 1.2% from last year’s second quarter sales, with North America and international segments reporting a 0.7% and 11.5% sales decline, respectively. North America contributed 96% of total sales while international contributed 4%. The sales decrease in North America consisted of a 3.4% decrease in same-store sales, offset by $447,000 in sales from 6 new stores. North America’s same-store sales decline was unfavorably impacted by an overall lower average ticket and from the effects of foreign currency translation of the Canadian dollar. All else being equal, our same-store sales decline would have been 2.9% excluding the impact of foreign currency translation. Our international leathercraft segment reported a sales decrease of 11.5%, which was due to unfavorable foreign currency translation of the U.K. pound sterling and the euro and, to a lesser extent, a decrease in sales price to our international business customers. The foreign currencies had shown weakness against the U.S. dollar, which caused our products to be more expensive, which is why we reduced our sales price to our business customers. Consolidated gross profit margin for the quarter was 66.9%, improving from 66.1% in last year’s second quarter. The improvement was the result of shifting 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 two 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 non-leather sales results in an increase or decrease in gross profit compared to the same period last year. Consolidated operating expenses this quarter increased $1.2 million or 11.8% compared to a year ago. Our 6 new stores, net of the impact of closed stores, contributed about half of this increase, while personal selling and advertising costs increases contributed to the remainder. With regard to personnel costs, our costs are higher for the increase in our store managers’ salaries and the rollout of our district manager program. Specifically, our store managers’ salaries increased as expected but were mostly offset by lower bonus accrued. With our store managers making a higher base salary, we instituted a store profit floor that must be reached before a bonus is earned. As such, our store manager total compensation is mostly unchanged, but the impact from the floor on store profit will be strongest in the first half of the year and will start to turn in the second half, and that’s when we’ll start to see the impact from the increase in store manager compensation. Income from operations was $1.7 million for the quarter or a decrease of $1.2 million from the comparable quarter in 2016. The decrease was primarily attributable to the decrease in sales and higher operating expenses. For the year-to-date, our consolidated sales totaling $39.4 million decreased 1.9% from last year’s sales for the same period. North America reported a 1.7% decline, which consisted of a same-store sales decrease of 2.4% and new store sales of $952,000, offset by the 3 stores that closed in 2016. Our international leathercraft segment reported a sales decrease of 6.6%, which was due to the decrease in sales prices to our international business customers. Consolidated gross profit margin for the year to date was 63.9%, increasing from 63.3% last year. Consolidated operating expenses this year have increased 7.1% compared to a year ago due to the investments in our new stores and our district manager program. Our effective income tax rate for the year to date was 32% compared to 35% last year, primarily due to the timing of our deferred tax position, particularly in fixed assets as book depreciation catches up with tax depreciation. We ended the quarter with total assets of $72.2 million, up $1.6 million from the end of 2016. Cash was lower by $2 million at $14.8 million versus $16.8 million at year end 2016, primarily due to an increase in inventory levels. Specifically, we’re holding $37.3 million in inventory at June 30 or $4.1 million more than at December 31 as we stock up from the holiday selling season and invest in our new stores and new products. Current liabilities decreased $682,000 while our bank debt is unchanged at $7.4 million at June 30. This debt consists solely of borrowings on the line of credit in place for our stock buyback program, for which there have been no buybacks during 2017. I’ll turn the call back over to Shannon for closing remarks.

Thanks, Tina. At this time we are not updating our guidance. Looking ahead to the last half of 2017, we are slightly behind on revenue, but our earnings are in line with expectations. We know the investments we’re making in our new stores and our district manager program will take time, but we believe that our revenues will catch up as our new stores and new products fuel top line expansion. As a reminder, our guidance is revenue between $84 million and $85 million and EPS of $0.56 to $0.58. In closing, I’d like to reiterate that while our performance year to date seems soft, we are confident that we are investing in the areas that will drive sustainable long-term growth. Like I said last quarter, this growth won’t always be a smooth and linear path, but I promise we will continue to be as transparent as possible about our business and to keep you posted on our initiatives and their progress. As always, I want to thank all of our dedicated Tandy Leather team members who work so hard to move this company forward. That concludes our prepared remarks. We appreciate your time today and your interest in Tandy Leather. Operator, we are now ready to take questions.

[Operator Instructions] Our first question comes from the line of Lance James with RBC Global Asset Management. Your line is open. Please go ahead.

Congratulations on the quarter and your rollout on new stores. I have a broader question. Just wondering how you view the competitive threat of the Amazons of the world, et cetera. You’re one of the few retailers that are actually opening new stores at this point. But I was just trying to see whether you have an online strategy or how you, whether many of your products can be purchased online from competitive entities, et cetera. How do you deal with that threat?

Sure, Lance. Mark, do you want to take that one?

We’re very fortunate, really, that we’re in a very niche market with leather craft. And the Amazon, of course, is a major threat to a lot of retailers and because of the like items that they carry. But when it comes down to really leather, we’re in a touchy-feely kind of business, and those customers really pick and choose and want to see the leather that they do, and that’s really not traditionally an online-type item. And so we continue to be -- our customers come in, they want to learn about how to do things and they want instruction and they want to kind of see everything and pick their leather and their stuff for their projects. And so we’ve really been very fortunate, and continue to be, that that particular part of it just is a non-effect for us with the Amazon part of it.

Terrific, okay. So you really have not -- as we look at your sales going forward, you would not expect much deterioration from competitive online threats, just given your product offerings and I guess the crafts done in your store?

Yes, absolutely. That’s how we feel and we really haven’t seen it. And we do stay on it and I monitor it all the time and we watch things and it’s just, we just don’t see it.

Yes, Lance, the only thing I would add to that is that I think if we’re seeing an Amazon impact, it’s probably with our small business customers, which goes along with our retail sales. Sales to retail customers continues to be strong and sales to our nonretail or our business customers tends to be off and has been for a while. But I would say I totally agree with what Mark just said, and I think the threat indirectly is that our small businesses, small business customers are struggling just because of the economy in general and how they weathered the recession. Although I know that’s been almost 10 years ago, I don’t think a lot of them have recovered. And I think they’re, from what we can tell from discussions with them, I think that’s going to be the greater threat from an Amazon or an online is the small business customers, which obviously affects us in our business-to-business sales.

Thank you. And our next question comes from the line of Jay Mondkar with Texas Undergrad. Your line is open. Please go ahead.

I had a question about the district manager program. So are there any metrics that you guys are looking at or tracking or hope to track in order to try and isolate what this effects of the district manager program is and kind of see whether or not that’s what’s actually moving the needle?

Ask your question again, James. You cut out on my phone just a little bit.

So I was just wondering, are there any metrics you’re tracking or expecting to track in order to try and isolate the effects of the district manager program and see if that’s what’s actually moving the needle as far as the overall business goes?

Yes, absolutely. So the obvious ones are store -- it’s all about store performance, which is top line growth and profitability, earnings growth. If you -- I don’t know how long you’ve been following us, but if you have been, you remember that we had a -- we had regional managers, which we had four that were basically doing the jobs that these district managers are now doing. And as you can imagine, just the logistics of 100 stores in the U.S. divided by four regionals, they’ve each got 25 to cover. They weren’t being super effective because all they could do from a time standpoint was run into a store, put out a fire and move on to the next one. So in terms of being really proactive and investing heavily in developing the store teams, which translates into better product knowledge, which customers appreciate and Tandy’s known for -- the way the store looks, the appearance, et cetera, et cetera -- they weren’t having a big effect because -- a positive effect -- because there just wasn’t enough time in the day to do that. So ultimately, the best indicator is going to be sales that are going to strengthen and profits at the store that are going to strengthen. And right now, to be totally honest, they’re doing a lot of kind of running store to store and hitting the issues that are the most significant at this point from an operations standpoint. But I don’t think it will be a lot longer that then they will be able to really be proactive in terms of investing in store personnel with regards to their product knowledge. We’ll be able to sell -- our associates will be able to sell products better if they know how to use it, what it’s used for and be able to demonstrate that use to customers, because that’s what customers expect. So at the 30,000-foot view, it’s all about sales and profit. And we believe with this closer proximity and more support from the district managers to the individual stores, it’s going to happen. And as I said, I think, at the beginning, it may be another six to 12 months before we really see a significant measurable impact. But I absolutely think, on the feedback that I’ve gotten so far, I absolutely think that’s what’s going to happen. Did that help?

In the past it seemed like -- yes, it definitely does. In the past it seemed like you guys talked about how expansion for number of stores was limited by being able to train staff and kind of get them up to this -- to the level of being able to support customers like Tandy is known for. So do you think, going forward, that’s going to remain kind of the limiting factor in terms of expansion, like being able to train associates and managers and all that?

Not like it has been in the past. Obviously, we’re moving forward, opening new stores. The district managers, because their product knowledge is strong and they’re, they’ve got a proven track record of operating successful stores. All of the district managers currently were more previous store managers for us and they ran fantastic stores. So they’re training and they’re training quickly. Everybody in the store system is working toward knowing more about product, knowing more about store operations, what it takes to manage a store, et cetera. So as you can see from our new store openings, we’re moving forward with that, and they’re training hands-on, up-close people all the time. So we’ve got good people -- more people in our management training program or on that path and working very closely to figure out where best to place people. So it’s always a challenge, personnel. Hiring the right people and getting the people in the right spots is forever a challenge. It has been as far back as you can go and probably as far into the future as you can see. But we’re, we’ve set expectations high and communicated, I think, well with the stores in terms of, "We’re going to open new stores. Who wants to be a part of that? Who wants to work toward being a store manager and how quickly can we get those people in place?" And we’ve got people that have stepped up and said, "Yeah, I’m interested and let’s go." So we’ve opened, what, 6 stores in the last 6 months and we’re on track to continue to kind of keep that pace -- 4 to 6 stores a year, we hope, going forward. And that’s a good number for us. Maybe where your question’s going is, "Why don’t you open more stores than that?" We’re still control freaks and we still like earnings and, as Tina indicated, these stores take a little while and drag on earnings for the first -- generally, the first year. So we want to be smart about the locations, we want to be smart about the personnel and get stores open in markets that can really start performing positively fairly quickly. And so it’s a very managed process, but there is a method to the madness, I guess I’d say. And we’re going to continue to do our best to execute on that.

Okay, yes, that definitely helps. Another question, what’s you-all’s future involvement with events like the Pinners Conference, and how does that drive either retail or wholesale sales? Like what does the mix look like in terms of what you’re trying to get at with those involvements?

So the Pinners Conference is -- we’re really focused -- it will perhaps produce some new wholesale customers, some business-to-business customers. But the real focus is on the female do-it-yourself, artistic, creative, crafty person, which we have not really focused on in the past. Not that we were ignoring them, but in a sense, the way our products were designed and, really, our focus was more on -- not on that group, I guess I’ll say. So what we expect and what we’ve seen so far is the continued, "Oh, my gosh, this is great. It’s a new idea. I’ve never thought about working with leather before." The conference we did in April in Atlanta, every lady that walked in to our booth was fascinated with the concept, hadn’t thought about it before. There’s not that much -- there’s just not that much out there that -- and they loved the new idea. It was like something different. It’s not scrapbooking. It’s not cake decorating. It’s not painting. It’s not that. So what we really hope to gain is a real boost to our female customer and particularly the do-it-yourself, crafty kind of professional lady that makes a lot of stuff at home and likes to do that kind of thing and gets her ideas from Pinterest, et cetera. So that’s what we have seen so far. We may pick up some wholesale customers as a result. But the low-hanging fruit there is a female retail customer, kind of a do-it-yourselfer type.

Okay. Shifting to international, what do you all see the future of international looking like? Because it seems like, at least in the past couple of quarters, it’s really been eating into your operating income. So is it kind of just ride it out or shut down stores, or what does that look like?

There are no plans to shut -- we’ve got the 4 -- we’ve got 4 international stores, 2 in the U.K., 1 in Spain, 1 in Australia. There are no plans to close those stores. And someday there will be plans to probably expand internationally, but that’s not on the short-term or even the midterm horizon at this point. The potential is very good. The dollar is, we’re struggling like most international retailers with what the dollar’s doing and what that does to the local currencies and how customers in those countries look at the pricing of our products. So that’s been a challenge in the last year or two. But similar to where the U.S. was when we started reopening Tandy stores in the early 2000s, there’s not anybody that we can find anywhere in the world that sells the product line that we sell and the concept and the business strategy that we have, which is you can come to one place and get everything that you need for your project or for whatever you’re making. Yes, there are leather companies all over the world. There are dye companies. You can go do, you can do all of that. But if you want to go to one place and get everything, plus if you’re a hobbyist or whomever, you get the instruction as well. There’s -- the market is good internationally for us because there’s not anybody else doing what we’re doing. It’s just slow, and the dollar is a challenge at times. And so we fight that. But there’s -- and it’s a very small, and it’s a very slow process, with one store in Spain that’s trying to service all of Europe with the exception of the U.K., it’s a huge market but it also takes a long time to reach a lot of different people when you’re just one local store in the southern part of Spain. So it’s a challenge but it’s not unexpected. Nothing’s happening that we are surprised about. It’s just the nature of the beast at this point. So -- but we’re looking at expenses very hard, we’re analyzing everything. Salaries outside of the U.S., or at least in those countries, are significantly higher than what we’re paying in the U.S. And so labor cost is higher and rents are higher. Everything to do business there just costs more. So we’ve been looking at selling prices, we’ve been looking at the way we approach things to see if there’s a better way, more effective way to do what we’re doing. But we still think that the market opportunity is huge. And so we’re not pulling out at this point. It will get better; I’m convinced of that. It just takes a little bit of time.

Okay. And then a last quick question. Are buybacks or dividends or anything on the radar?

Always. The buyback plan is in place and will continue to be. So there’s always the option for that when the price is at a level that the Board feels like is the right price to buy back. The discussion about dividends is a continual thing. I personally like the idea, but there are two schools of thought there about whether to pay dividends or not. But it’s always a Board discussion and the consensus changes almost on a daily basis in terms of what’s the most effective way to return value to shareholders.

Okay. You mentioned a Board. Does the recent decline in institutional ownership mean anything?

I don’t think so. I certainly don’t look at it that way. I’m trying to remember who the institution was that’s out. I think our relationships with our institutions is good for the most part. I’m in contact with them relatively often, and but this is an interesting year. Obviously, we know earnings are not going to match what they did for 2016. Right now sales, we’re behind on that as well. So we have tried to explain that as well as we can, and I think for the most part, all of our shareholders get it and understand it and believe that this is the right year for investment to really get things going in next year and going forward. So I didn’t look specifically at the large institution that sold in the last quarter or so in terms of when they got in and when they got out, but it may have been just numbers for them in terms of they’ve hit the numbers, the return that they need and they’re ready to look at something else, but not comparing.

[Operator Instructions] And I’m showing no further questions at this time, and I would like to turn the conference back over to Ms. Shannon Greene for any further remarks.

Great, thank you. Thank you, everyone, for participating in our call today. We look forward to speaking with you again next quarter. Have a great day.

Ladies and gentlemen, thank you for participating in today’s program. This does conclude the program and you may all disconnect. Everyone have a great day.