| Item 2. | Management’s Discussion and Analysis of Financial Condition and Results of Operations. |
The Business and AnalysisStrategy
Tandy Leather Factory, Inc. is one of Financial Condition and Results of Operations.
Our Business
We are the world’s largest specialty retailerretailers of leather and leathercraft related items, offeringleathercraft-related items. Founded in 1919 in Fort Worth, Texas, and organized in 2005 as a Delaware corporation, the Company introduced leathercrafting to millions of American and later Canadian and other international customers and has built a track record as the trusted source of quality leather, tools, leather, accessories,hardware, supplies, kits and teaching materials. materials for leatherworkers everywhere. Today, our mission remains to build on our legacy of inspiring the timeless art and trade of leatherworking.
What differentiates Tandy from the competition is our high brand awareness and strong brand equity and loyalty, our network of retail stores that provides convenience, a high-touch customer service experience, and a hub for the local leathercrafting community, and our 100-year heritage. We believe that this combination of qualities is unique to Tandy and gives the brand competitive advantages that are difficult for others to replicate.
We sell our products primarily through company-owned stores, and through orders generated from our website, www.tandyleather.com.global websites, and through direct account representatives in our commercial division. We also manufacture leather lace, cut leather pieces and most of the do-it-yourself kits that are a Delaware corporation,sold in our stores and on our common stock trades on the NASDAQ Global Market under the symbol “TLF.”websites. We have builtalso offer production services to our business by offeringcustomers such as cutting (“clicking”), splitting, and some assembly. We maintain our customers quality productsprincipal offices at 1900 Southeast Loop 820, Fort Worth, Texas 76140.
As of September 30, 2022, the Company operates a total of 104 retail stores. There are 93 stores in one location at competitive prices.
We operatethe United States (“U.S,”), ten stores in two segments: North AmericaCanada and International. 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 International remains the same. All prior year data discussed throughout this Form 10Q has been restated to conform to the new reporting segment structure. There is no change to our consolidated financial position or results.
We believe that the key to our success is our ability to profitably grow our base business. We expect to grow that business by opening new locations and by increasing sales in our existing locations. To date in 2017, we have reopened one store in Harrisburg, PASpain.
Tandy Leather has been introducing people to leatherworking for over 100 years. Our stores have been and opened newcontinue to be our competitive advantage: where our consumers learn the craft in classes, open table, and from the expertise of our store staff, where they can touch, feel and test the product, and where they can connect and commune with others passionate about leather. Our website provides inspiration, detailed product descriptions and specifications, educational information and videos, and a convenient place to also purchase product – especially for those who are far from our retail stores, in Allen, TX; Miami, FL;including a growing international customer base. For many of our retail and McAllen, TX.web customers, leatherworking evolves from a passion to a trade. Our commercial division is tailored to the needs of those customers who build businesses around leather. With dedicated direct account representatives, a direct-from-our-warehouse shipping model, bulk and volume-based competitive pricing, customized product development, and production and pre-production services, we are building long-term, strategic relationships with our largest customers.
AsOur focus over the last three years has been on three broad strategic initiative areas:
| 1. | Improving our brand proposition, with both retail and commercial customers |
| 2. | Rebuilding our foundation – the talent, processes, tools and systems needed to serve these customers |
| 3. | Position us for long-term growth – creating the vision and roadmap for the future |
COVID-19 and 7 Canadian provinces. We expect to growEconomic Conditions
At the numbertime of stores in North America to approximately 150filing this Form 10-Q, the American and world economies have been acutely affected by a combination of factors arising from both the COVID-19 pandemic and the war resulting from the invasion of Ukraine by Russian military forces. The current impacts of these events include (but are not limited to) levels of inflation that are the highest in the future. Our pace of store openings has recently picked up dueU.S. in more than 40 years, highly volatile fuel prices, an extremely tight labor market with rising wages and competition to a change in strategy with a focus on growth.
Our International Leathercraft segment operates four company-owned stores with one located in each of Northampton, United Kingdom; Manchester, United Kingdom; Sydney, Australia; and Jerez, Spain. We expect to continue opening international stores in the future, but do not intend to open any new international stores in 2017 or 2018.
Our customer base is diverse, with individual retail customers as our largest customer group, representing approximately 56% of our 2016 sales. The remaining 44% of our 2016 sales were to our wholesale, manufacturer and institutional groups (including horse and tack shops, Western wear, crafters, upholsterers, cobblers, auto repair, education, hospitals, prisonsattract qualified workers, supply chain disruption, rising rent and other large businessesoccupancy costs and increases in interest rates. Purchases of non-essential, discretionary products tend to decline in periods of uncertainty regarding future economic prospects, such as the current one, as disposable income declines. The Company believes that use our products as raw materialsthese events have continued to produce goods for resale). Generally, our retail customers provide a higher gross profit than our wholesaledampen its sales through September 2022. The future remains uncertain, and manufacturer groups.
Our initiatives to increase sales include new merchandising with an expandedcontinued increased labor, freight, product line intended to grow business to our retail customers, a refocus on business development to our wholesale and manufacturer groups, improvements to our digital and e-commerce channels,other costs as well as updates to our promotional and clearance activity. Weweakening customer demand could have also increased our training efforts with our store associates to strengthen their product knowledge. We believe that our store associates, armed with a solid knowledge of our extensive product line, can drive higher average tickets and traffic conversion.negative impact on the Company’s future financial performance.
We are also focusing on improving our customer experience, increasing our brand awareness, and strengthening our store performance. To help achieve those goals, in early 2017, we announced a district restructuring with our store footprint divided into fifteen districts (previously, our store footprint was divided into five regions). Each district contains six to ten stores, reporting to a district manager who is tasked with growing traffic and sales, as well as training store managers and associates to better serve our customers and succeed in today’s retail environment. As of November 1, 2017, we have filled eleven of our fifteen district manager positions.
Our strategy has required, and is expected to continue to require, investments in our new stores, expanded inventory and merchandising, as well as operating costs for additional headcount, travel, training and marketing expenses. We believe we are investing in areas that will drive sustainable long-term growth.
Critical Accounting Policies
A description of our critical accounting policies appears in Item 7 “Management's Discussions and Analysis of Financial Condition and Results of Operations” in our Annual Reportannual report on Form 10-K for the fiscal year ended December 31, 2016.2021.
Forward-LookingRevenue Recognition. Our revenue is earned from sales of merchandise and generally occurs via three methods: (1) at the store counter, (2) shipment of product generally via web sales, and (3) sales of product directly to commercial customers. We recognize revenue when we satisfy the performance obligation of transferring control of product merchandise over to a customer. At the store counter, our performance obligation is met, and revenue is recognized when a sales transaction occurs with a customer. When merchandise is shipped to a customer, our performance obligation is met, and revenue is recognized when control passes to the customer. Shipping terms are normally free on board (“FOB”) shipping point and control passes when the merchandise is shipped to the customer. Sales tax and comparable foreign tax are excluded from net sales, while shipping charged to our customers is included in net sales. Net sales are based on the amount of consideration that we expect to receive, reduced by estimates for future merchandise returns.
The sales return allowance is based each year on historical customer return behavior and other known factors and reduces net sales and cost of sales, accordingly. Under our sales returns policy, merchandise may be returned, under most circumstances, up to 60 days after date of purchase. As merchandise is returned, the company records the sales return against the sales return allowance.
We record a gift card liability for the unfulfilled performance obligation on the date we issue a gift card to a customer. We record revenue and reduce the gift card liability as the customer redeems the gift card. In addition, for gift card breakage, we recognize a proportionate amount for the expected unredeemed gift cards over the expected customer redemption period, which is one year.
Inventory. Inventory is stated at the lower of cost (first-in, first-out) or net realizable value. Finished goods held for sale include the cost of merchandise purchases, the costs to bring the merchandise to our Texas distribution center, warehousing and handling expenditures, and distributing and delivering merchandise to our stores. These costs include depreciation of long-lived assets utilized in acquiring, warehousing and distributing inventory. Manufacturing inventory including raw materials and work-in-process is valued on a first-in, first-out basis using full absorption accounting which includes material, labor, and other applicable manufacturing overhead. Carrying values of inventory are analyzed and, to the extent that the cost of inventory exceeds the net realizable value, provisions are made to reduce the carrying amount of the inventory.
We regularly review all inventory items to determine if there are (i) damaged goods (e.g., for leather, excessive scars or damage from ultra-violet (“UV”) light), (ii) items that need to be removed from our product line (e.g., slow-moving items, inability of a supplier to provide items of acceptable quality or quantity, and to maintain freshness in the product line) and (iii) pricing actions that need to be taken to adequately value our inventory at the lower of cost or net realizable value.
Since the determination of net realizable value of inventory involves both estimation and judgement with regard to market values and reasonable costs to sell, differences in these estimates could result in ultimate valuations that differ from the recorded asset.
The majority of inventory purchases and commitments are made in U.S. dollars in order to limit the Company’s exposure to foreign currency fluctuations. Goods shipped to us are recorded as inventory owned by us when the risk of loss shifts to us from the supplier. Inventory is physically counted twice annually in the Texas distribution center. At the store level, inventory is physically counted each quarter. Inventory is then adjusted in our accounting system to reflect actual count results.
Leases. We lease certain real estate for our retail store locations and warehouse equipment for our Texas distribution center, both under long-term lease agreements. Starting in 2019, with the adoption of Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), once we have determined an arrangement is a lease, at inception we recognize a lease asset and lease liability at commencement date based on the present value of the lease payments over the lease term.
For our operating leases, the present value of our lease payments may include: (1) rental payments adjusted for inflation or market rates, and (2) lease terms with options to renew the lease when it is reasonably certain we will exercise such an option. The exercise of lease renewal options is generally at our discretion. Payments based on a change in an index or market rate are not considered in the determination of lease payments for purposes of measuring the related lease liability. We discount lease payments using our incremental borrowing rate based on information available as of the measurement date.
We recognize rent expense related to our operating leases on a straight-line basis over the lease term.
For finance leases, our right-of-use assets are amortized on a straight-line basis over the earlier of the useful life of the right-of-use asset or the end of the lease term with rent expense recorded to operating expenses. We adjust the lease liability to reflect lease payments made during the period and interest incurred on the lease liability using the effective interest method. The incurred interest expense is recorded in interest expense on the Condensed Consolidated Statements of Operations and Comprehensive Income (Loss).
Certain statements containedThe depreciable life of related leasehold improvements is based on the shorter of the useful life or the lease term. We also perform interim reviews of our lease assets for impairment when evidence exists that the carrying value of an asset group, including a lease asset, may not be recoverable.
None of our lease agreements contain contingent rental payments, material residual value guarantees or material restrictive covenants. We have no sublease agreements and no lease agreements in which we are named as a lessor.
Impairment of Long-Lived Assets. We evaluate long-lived assets on a quarterly basis to identify events or changes in circumstances (“triggering events”) that indicate the carrying value of certain assets may not be recoverable. Upon the occurrence of a triggering event, right-of-use (“ROU”) lease assets, property and equipment and definite-lived intangible assets are reviewed for impairment and an impairment loss is recorded in the period in which it is determined that the carrying amount of the assets is not recoverable. The determination of recoverability is made based upon the estimated undiscounted future net cash flows of assets grouped at the lowest level for which there are identifiable cash flows independent of the cash flows of other groups of assets with such cash flows to be realized over the estimated remaining useful life of the primary asset within the asset group. The Company determined the lowest level of identifiable cash flows that are independent of other asset groups to be primarily at the individual store level. If the estimated undiscounted future net cash flows for a given store are less than the carrying amount of the related store assets, an impairment loss is determined by comparing the estimated fair value with the carrying value of the related assets. The impairment loss is then allocated across the asset group’s major classifications which in this reportcase are operating lease assets and other materials we file withproperty and equipment. Triggering events at the Securitiesstore level could include material declines in operational and Exchange Commission,financial performance or planned changes in the use of assets, such as well as information included in oral statementsstore relocation or other written statements madestore closure. This evaluation requires management to make judgements relating to future cash flows, growth rates and economic and market conditions. The fair value of an asset group is estimated using a discounted cash flow valuation method.
Stock-based Compensation. The Company’s stock-based compensation relates primarily to restricted stock unit (“RSU”) awards. Accounting guidance requires measurement and recognition of compensation expense at an amount equal to the grant date fair value. Compensation expense is recognized for service-based stock awards on a straight-line basis or to be made by us, other than statements of historical fact, are forward-looking statements withinratably over the meaning of Section 27Arequisite service period, based on the closing price of the Securities ActCompany’s stock on the date of 1933,grant. The service-based awards typically vest ratably over the requisite service period, provided that the participant is employed on the vesting date. The total compensation expense is reduced by actual forfeitures as amended, and Section 21Ethey occur over the requisite service period of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally are accompanied by words such as “may,” “will,” “could,” “should,” “anticipate,” “believe,” “budgeted,” “expect,” “intend,” “plan,” “project,” “potential,” “estimate,” “continue,” or “future” variations thereof or other similar statements. There areawards. Performance-based RSUs vest, if at all, upon the Company satisfying certain important risksperformance targets. The Company records compensation expense for awards with a performance condition when it is probable that could cause results to differ materially from those anticipated by somethe condition will be achieved. If the Company determines it is not probable a performance condition will be achieved, no compensation expense is recognized. If the Company changes its assessment in a subsequent period and concludes it is probable a performance condition will be achieved, the Company will recognize compensation expense ratably between the period of the forward-looking statements. Some, butchange in assessment through the expected date of satisfying the performance condition for vesting. If the Company subsequently assesses that it is no longer probable that a performance condition will be achieved, the accumulated expense that has been previously recognized will be reversed. The compensation expense ultimately recognized, if any, related to performance-based awards will equal the grant date fair value based on the number of shares for which the performance condition has been satisfied. We issue shares from authorized shares upon the lapsing of vesting restrictions on RSUs. We do not all,use cash to settle equity instruments issued under stock-based compensation awards. The payment of the important risks, including, without limitation, those described below, could cause actual resultsemployees’ tax liability for a portion of the vested shares are satisfied by withholding shares with a fair value equal to differ materiallythe tax liability.
Income Taxes. Income taxes are estimated for each jurisdiction in which we operate. This involves assessing current tax exposure together with temporary differences resulting from those suggested bydiffering treatment of items for tax and financial statement accounting purposes. Any resulting deferred tax assets are evaluated for recoverability based on estimated future taxable income. To the forward-looking statements. Please refer also to our Annual Report on Form 10-K for fiscal year ended December 31, 2016 for additional information concerning these and other uncertaintiesextent it is more-likely-than-not that could negatively impact the Company. Potential factors, which could cause our actual resultsall or a portion of operations to differ materially from those in the forward-looking statements include, among others:
Ø | General economic conditions in the United States and abroad; |
Ø | Increased pressure on margins; |
Ø | Increases in the cost of the products we sell or a reduction in availability of those products; |
Ø | Challenges in implementing our planned expansion and district restructuring; |
Ø | Failure to hire and train qualified personnel to operate new and existing stores; |
Ø | Failure to protect our trademarks and other proprietary intellectual property rights; |
Ø | Negative impact of foreign currency fluctuations on our financial condition and results of operations; |
Ø | Information technology system failures or network disruptions; |
Ø | Significant data security or privacy breach of our information systems; |
Ø | Loss or prolonged disruption in the operation of our centralized distribution center; and |
We assume no obligation to update or otherwise revise our forward-looking statements even if experience or future changes make it clear that any projected results, express or implied,a deferred tax asset will not be realized,. a valuation allowance is recorded. Our evaluation regarding whether a valuation allowance is required or should be adjusted also considers, among other things, the nature, frequency, and severity of recent losses, forecasts of future profitability and the duration of statutory carryforward periods. Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that includes the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. A tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. We recognize tax liabilities for uncertain tax positions and adjust these liabilities when our judgement changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense and the effective tax rate in the period in which new information becomes available. We recognize interest and/or penalties related to all tax positions in income tax expense. To the extent that accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period that such determination is made. We may be subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to the various jurisdictions.
Results of Operations
Three Months Ended September 30, 20172022 and 20162021
The following tables presenttable presents selected financial data for each of our segments:data:
| | | Quarter Ended Sept 30, 2017 | | | Quarter Ended Sept 30, 2016 | |
| | | Net Sales | | | Income from Operations | | | Net Sales | | | Income from Operations | |
| North America | | $ | 17,421,013 | | | $ | 649,797 | | | $ | 17,745,130 | | | $ | 1,589,071 | |
| International | | | 967,368 | | | | 478 | | | | 883,232 | | | | (49,012 | ) |
| Total | | $ | 18,388,381 | | | $ | 650,275 | | | $ | 18,628,362 | | | $ | 1,540,059 | |
| | | Three Months Ended September 30, | |
| (in thousands) | | 2022 | | | 2021 | | | $ Change | | | % Change | |
| Net sales | | $ | 19,057 | | | $ | 19,281 | | | $ | (224 | ) | | | (1.2 | )% |
| Gross profit | | | 11,596 | | | | 11,089 | | | | 507 | | | | 4.6 | % |
| Gross margin percentage | | | 60.8 | % | | | 57.5 | % | | | | | | | 3.3 | % |
| Operating expenses | | | 10,620 | | | | 11,078 | | | | (458 | ) | | | (4.1 | )% |
| Income from operations | | $ | 976 | | | $ | 11 | | | $ | 965 | | | | 8,772.7 | % |
Net Sales
Consolidated net sales for the quarter ended September 30, 20172022 decreased $239,981,$0.2 million, or 1.3%1.2%, compared to the corresponding prior year period. We believe the decrease in sales was due to continued weaker consumer demand as a result of inflation and ongoing uncertainty related to global political, economic and public health concerns.
Our store footprint consisted of 104 and 106 stores at September 30, 2022 and September 30, 2021, respectively.
Since January 1, 2022, we closed one store in San Bruno, CA in March 2022, and one store in Oxnard, CA, in July 2022. We evaluate a number of factors when determining whether to close existing stores, including the 4-wall cash flow trend and longer-term projection for the store, the long-term sales trend, ongoing cost of store operations, date of lease expiration, quality of the store and location, and the size and potential of the trade area including proximity to other existing stores, among other variables. We use similar factors to determine whether to open new stores.
Gross Profit
Gross profit increased by $0.5 million, or 4.6%, compared to the same period in 2016. International reported a sales increase of 9.5%, while North America reported a sales decline of 1.8%. Income from operations on a consolidated basis2021, and our gross margin percentage for the quarter ended September 30, 2017 decreased $889,784, from2022 increased to 60.8% compared to 57.5% in the third quarter of 2016 primarilycorresponding prior year period. The higher gross margin rate was due to a combination of factors, including product and customer mix shifts and stronger full-priced selling in combination with our relatively slow inventory turns, high number of SKUs and high number of inventory locations including 104 retail stores.
Operating expenses
| | | Three Months Ended September 30, | | | | | | | |
| (in thousands) | | 2022 | | | 2021 | | | $ Change | | | % Change | |
| Operating expenses | | $ | 10,620 | | | $ | 11,078 | | | $ | (458 | ) | | | (4.1 | )% |
| Non-routine items related to restatement | | | - | | | | (124 | ) | | | 124 | | | | (100.0 | )% |
| Adjusted operating expenses | | $ | 10,620 | | | $ | 10,954 | | | $ | (334 | ) | | | (3.0 | )% |
| | | | | | | | | | | | | | | | | |
| Operating expenses % of sales | | | 55.7 | % | | | 57.5 | % | | | | | | | | |
| Adjusted operating expenses % of sales | | | 55.7 | % | | | 56.8 | % | | | | | | | | |
Operating expenses decreased $0.5 million or 4.1% compared to the corresponding prior year period, primarily as a result of a decrease in salesbonus expense of $0.5 million, a decrease in services purchased of $0.2 million, a decrease in software costs of $0.1 million and a decrease in stock compensation expense of $0.1 million offset by mainly an increase in total salaries of $0.4 million and an increase in total insurance and other taxes of $0.1 million. Adjusted operating expenses, primarilywhich exclude the non-routine items related to the six new stores opened since October 2016,restatement, decreased $0.3 million or 3.0% for the reasons noted above. Adjusted operating expenses excluding non-routine items as well asshown above is a non-GAAP measure, included here to provide additional information regarding the additionalCompany’s financial performance on a recurring basis. Non-routine items are primarily legal and accounting costs associated with the restatement.
Income Taxes
Our effective tax rate for the three months ended September 30, 2022 was 26.3% compared to 13.0% for the same period in 2021. Our effective tax rate differs from the federal statutory rate primarily due to U.S. state income tax expense, expenses that are nondeductible for tax purposes, the change in our valuation allowance associated with our new district manager structure.deferred tax assets, and differences in tax rates in foreign jurisdictions.
The following table shows in comparative form our consolidated net income for the third quarter of 2017 and 2016:
| | | 2017 | | | 2016 | | | % change | |
| Net income | | $ | 521,414 | | | $ | 1,000,350 | | | | (47.9 | %) |
Additional information appears below for each segment (see also the information contained in Note 7 to the consolidated financial statements included in Item 1 of this Report).
North America
North America consisted of 115 stores atNine months Ended September 30, 20172022 and 109 stores at September 30, 2016. Six new stores opened since the beginning of the third quarter of 2016, with one each in Philadelphia, PA (October 2016); Lyndhurst, NJ (November 2016); Johnston, RI (December 2016); Allen, TX (April 2017); Miami, FL (May 2017); and McAllen, TX (May 2017). Our Harrisburg, PA store was temporarily closed from April 2016 through December 2016. A store is categorized as “new” until it is operating for the full comparable period in the prior year. The table below reports our net sales by store category:2021
| | | # Stores | | | Qtr Ended 09/30/17 | | | # Stores | | | Qtr Ended 09/30/16 | | | $ Change | | | % Change | |
| Same stores | | | 108 | | | $ | 16,786,811 | | | | 108 | | | $ | 17,745,130 | | | $ | (958,319 | ) | | | (5.4 | %) |
| New stores | | | 6 | | | | 518,777 | | | | | | | | - | | | | 518,777 | | | | N/A | |
| Temp closed store | | | 1 | | | | 115,425 | | | | 1 | | | | - | | | | 115,425 | | | | N/A | |
| Total net sales | | | 115 | | | $ | 17,421,013 | | | | 109 | | | $ | 17,745,130 | | | $ | (324,117 | ) | | | (1.8 | )% |
The following table presents our sales mix by customer categories for the quarters ended September 30:selected financial data:
Customer Group | 2017 | | 2016 |
RETAIL (end users, consumers, individuals) | 58% | | 55% |
INSTITUTION (prisons, prisoners, hospitals, schools, youth organizations, etc.) | 3% | | 3% |
WHOLESALE (resellers & distributors, saddle & tack shops, authorized dealers, etc.) | 35% | | 37% |
| MANUFACTURERS | 4% | | 5% |
| | 100% | | 100% |
| | | Nine Months Ended September 30, | |
| (in thousands) | | 2022 | | | 2021 | | | $ Change | | | % Change | |
| Net sales | | $ | 57,967 | | | $ | 59,241 | | | $ | (1,274 | ) | | | (2.2 | )% |
| Gross profit | | | 34,028 | | | | 34,556 | | | | (528 | ) | | | (1.5 | )% |
| Gross margin percentage | | | 58.7 | % | | | 58.3 | % | | | | | | | 0.4 | % |
| Operating expenses | | | 32,959 | | | | 32,856 | | | | 103 | | | | 0.3 | % |
| Income from operations | | $ | 1,069 | | | $ | 1,700 | | | $ | (631 | ) | | | (37.1 | )% |
Net sales decreased 1.8%, or $324,000, for the third quarter of 2017 compared to the third quarter of 2016, primarily due to the negative impact from the recent hurricanes as discussed more fully below, as well as a continued trend of lower sales to our wholesale and manufacturer groups, partially offset by higher sales to our retail customers. We believe our wholesale and manufacturer groups are buying less as their businesses are struggling from e-commerce and other competition as well as attrition, while sales to our retail group have increased due to new marketing and merchandising initiatives.Sales
We have and will continue to evaluate the impact of recent hurricanes. We have four stores in South Texas and five stores in Florida, all of which were closed during the days leading up to the hurricanes and for several days afterwards for our employees’ safety, as well as loss of power and/or ingress/egress issues, although none of our stores sustained significant flooding or damage. However, we expect that sales may continue to be negatively impacted as our customers in South Texas and Florida focus on rebuilding. For the quarter ended September 30, 2017, our sales for these nine stores declined by 16.3% as compared to the quarter ended September 30, 2016. We are seeing this trend continue through the date of this filing.
Income from operations for North America during the quarter ended September 30, 2017 decreased by $939,000 from the comparative 2016 quarter due to a decrease in gross profit of $87,000 and increase in operating expenses of $852,000. Gross profit as a percentage of sales improved from 62.7% in the third quarter of 2016 to 63.4% in the third quarter of 2017, due to an increase in sales of higher margin products compared to last year’s third quarter and customer mix with more retail than business sales. Operating expenses increased 8.9% compared to last year’s comparable period. The most significant expense increases occurred in personnel, occupancy and selling costs related to the six new stores that have opened since October 2016 as well as the increase in our store manager salaries and the investment in our district manager structure. We believe these investments in personnel and new stores are laying the foundation for future profitable growth.
International Leathercraft
International Leathercraft consists of all stores located outside of North America. As of September 30, 2017 and 2016, this segment contained four stores, two of which are located in United Kingdom and one each in Australia and Spain. This segment’s sales totaled approximately $967,000 for the third quarter of 2017, compared to approximately $883,000 in the third quarter of 2016, an increase of $84,000 or 9.5%. The increase was primarily due to higher sales in Spain and the UK from an increase in ticket counts, while Australia’s sales and ticket counts were relatively flat. Additionally, favorable exchange rates also positively impacted sales and gross profit. International’s operating expenses of $597,000 for the third quarter of 2017 increased by $28,000 compared to third quarter of 2016, primarily due to higher personnel costs from turnover at our store in Australia. Overall, advertising and marketing expenses are this segment’s largest expense, followed by employee compensation, rent, travel, and shipping costs to customers.
Other Expenses
We paid $53,000 in interest on our bank debt in the third quarter of 2017, compared to $43,000 in the third quarter of 2016 due to a slightly higher interest rate and higher weighted average outstanding balance in 2017 compared to 2016. We recorded income of $42,000 for currency fluctuations in the third quarter of 2017, compared to a $3,600 expense in the third quarter of 2016.
Income Taxes
The decrease in the effective tax rate of 25% for the third quarter of 2017 compared to 33% in the third quarter of 2016 was due to the reversal of our deferred tax position for fixed assets.
Nine Months Ended September 30, 2017 and 2016
The following tables present selected financial data for each of our segments:
| | | Nine Months Ended Sept 30, 2017 | | | Nine Months Ended Sept 30, 2016 | |
| | | Net Sales | | | Income from Operations | | | Net Sales | | | Income from Operations | |
| North America | | $ | 55,080,152 | | | $ | 4,276,247 | | | $ | 56,043,559 | | | $ | 6,644,592 | |
| International | | | 2,738,844 | | | | (233,044 | ) | | | 2,779,935 | | | | 97,148 | |
| Total | | $ | 57,818,996 | | | $ | 4,043,203 | | | $ | 58,823,494 | | | $ | 6,741,740 | |
Consolidated net sales for the nine months ended September 30, 20172022 decreased $1,004,498,$1.3 million, or 1.7%2.2%, compared to the same period in 2016. North America2021. We believe the decrease in sales was due to continued weaker consumer demand as a result of inflation and International reportedongoing uncertainty related to global political, economic and public health concerns, coupled with comparison to prior year COVID-era stimulus payments that fueled sales.
Since January 1, 2022, we closed one store in San Bruno, CA in March 2022, and one store in Oxnard, CA, in July 2022. We did not open any new stores for the first nine months of 2022. We evaluate a number of factors when determining whether to close existing stores, including the 4-wall cash flow trend and longer-term projection for the store, the long-term sales declinestrend, ongoing cost of 1.7%store operations, date of lease expiration, quality of the store and location, and the size and potential of the trade area including proximity to other existing stores, among other variables. We use similar factors to determine whether to open new stores.
Gross Profit
Gross profit decreased by $0.5 million, or 1.5%, respectively. Income from operations on a consolidated basiscompared to the same period in 2021, and our gross margin percentage for the nine months ended September 30, 2017 decreased 40%, or $2,698,537, from2022 increased to 58.7% compared to 58.3% in the corresponding prior year period. The gross margin rate remains relatively the same period in 2016 primarily due to a combination of factors, including product and customer mix shifts, stronger full-priced selling with a combination of our relatively slow inventory turns, high number of SKUs and high number of inventory locations including 104 retail stores.
Operating expenses
| | | Nine Months Ended September 30, | | | | | | | |
| (in thousands) | | 2022 | | | 2021 | | | $ Change | | | % Change | |
| Operating expenses | | $ | 32,959 | | | $ | 32,856 | | | $ | 103 | | | | 0.3 | % |
| Non-routine items related to restatement | | | (246 | ) | | | (1,157 | ) | | | 911 | | | | (78.7 | )% |
| Adjusted operating expenses | | $ | 32,713 | | | $ | 31,699 | | | $ | 1,014 | | | | 3.2 | % |
| | | | | | | | | | | | | | | | | |
| Operating expenses % of sales | | | 56.9 | % | | | 55.5 | % | | | | | | | | |
| Adjusted operating expenses % of sales | | | 56.4 | % | | | 53.5 | % | | | | | | | | |
Operating expenses were flat compared to the corresponding prior year period, mostly as a result of a decrease in salesbonus expense by $1.1 million and a decrease in contract labor by $1.1 million offset mainly by an increase in salaries by $1.1 million, an increase in travel and meeting expenses related to our store manager conference by $0.4 million, an increase in selling expenses of $0.2 million, an increase in office supplies of $0.2 million, an increase in total services purchased of $0.2 million, and an increase in digital marketing of $0.1 million. Adjusted operating expenses, primarilywhich exclude the non-routine items related to seven new stores opened since the beginning of 2016, as well as investments in our district manager structure.
The following table shows in comparative form our consolidated net incomerestatement, increased $1.0 million, for the first nine months of 2017reasons noted above. Adjusted operating expenses excluding non-routine items as shown above is a non-GAAP measure, included here to provide additional information regarding the Company’s financial performance on a recurring basis. Non-routine items are primarily legal and 2016:accounting costs associated with the restatement.
| | | 2017 | | | 2016 | | | % change | |
| Net income | | $ | 2,780,411 | | | $ | 4,342,262 | | | | (36.0 | %) |
Additional information appears below for each segment (see also the information contained in Note 7 to the consolidated financial statements included in Item 1 of this Report).Income Taxes
North America
In addition to the six new stores mentioned previously, Nyack, NY opened in March 2016 and is considered a new store in the following table of net sales by store category. Our Harrisburg, PA store was temporarily closed from April 2016 through December 2016:
| | | # Stores | | | Nine Months Ended 09/30/17 | | | # Stores | | | Nine Months Ended 09/30/16 | | | $ Change | | | % Change | |
| Same stores | | | 107 | | | $ | 53,196,638 | | | | 107 | | | $ | 54,863,405 | | | $ | (1,666,767 | ) | | | (3.0 | %) |
| New stores | | | 7 | | | | 1,562,619 | | | | 1 | | | | 622,336 | | | | 940,283 | | | | 151.1 | % |
| Closed/temp closed stores | | | 3 | | | | 320,895 | | | | 3 | | | | 557,818 | | | | (236,923 | ) | | | (42.5 | %) |
| Total net sales | | | 115 | | | $ | 55,080,152 | | | | 109 | | | $ | 56,043,559 | | | $ | (963,407 | ) | | | (1.7 | )% |
The following table presents our sales mix by customer categories for the nine months ended September 30:
Customer Group | 2017 | | 2016 |
RETAIL (end users, consumers, individuals) | 58% | | 55% |
INSTITUTION (prisons, prisoners, hospitals, schools, youth organizations, etc.) | 3% | | 3% |
WHOLESALE (resellers & distributors, saddle & tack shops, authorized dealers, etc.) | 35% | | 37% |
| MANUFACTURERS | 4% | | 5% |
| | 100% | | 100% |
Net sales decreased 1.7%, or $963,000, for the first nine months of 2017 compared to the same period in 2016, primarily due to a 3% decrease in same store sales. By customer group, sales to our wholesale and manufacturer groups have been weak as their businesses have been struggling from e-commerce and other competition as well as attrition, while sales to our retail group has increased due to new marketing and merchandising initiatives. Additionally,effective tax rate for the nine months ended September 30, 2017, our sales2022 was 26.3% compared to 23.1% for the nine stores impacted by the recent hurricanes declined by 6.3% as compared to the nine months ended September 30, 2016.
Income from operations for North America for the nine months ended September 30, 2017 decreased $2,368,000same period in 2021. Our effective tax rate differs from the comparative 2016 period. A decrease in gross profit of $125,000 and an increase in operating expenses of $2,243,000 contributed to the decline in income from operations. Gross profit as a percentage of sales increased from 63.1% in the first nine months of 2016 to 64.0% in the first nine months of 2017, due to an increase in sales of higher margin products compared to last year’s first three quarters and customer mix. Operating expenses increased 7.8% compared to last year’s comparable period. The most significant expense increases occurred in personnel, occupancy and selling costs related to the seven new stores opened as well as the increase in our store manager salaries and the investment in our new district manager structure. We believe these investments in personnel and new stores are laying the foundation for future profitable growth.
International Leathercraft
International’s sales totaled approximately $2,739,000 for the first nine months of 2017, compared to approximately $2,780,000 in the first nine months of 2016, a decrease of $41,000 or 1.5%,federal statutory rate primarily due to a lower average ticket and unfavorable foreign currency exchange ratesU.S. state income tax expense, expenses that are nondeductible for tax purposes, the change in the first nine months of the year in the UK and to a lesser extent, Spain. As discussed previously, our third quarter performance had an improvement in sales and exchange rates. The unfavorable exchange rates in the first half of the year also negatively impacted our gross profit margin which declined from 65.8% in 2016 to 57.6% in 2017. The impact of changes in foreign currency exchange rates in the UK and Spain makes our products more expensive and compresses gross profit. International’s operating expenses increased by $78,000 due to higher personnel, rent and advertising costs. Operating expenses totaled approximately $1,810,000 in the first nine months of 2017, compared to $1,732,000 in the first nine months of 2016. Overall, advertising and marketing expenses are this segment’s largest expense, followed by employee compensation, rent, travel, and shipping costs to customers.
Other Expenses
We paid approximately $143,000 in interest on our bank debt in the first nine months of 2017, compared to approximately $109,000 in the first nine months of 2016. We recorded approximately $4,700 in interest income on our cash balances in the nine months ended September 30, 2017 compared to approximately $3,600 in the nine months ended September 30, 2016. We recorded income of $27,000 for currency fluctuations in the first three quarters of 2017. Comparatively, in the first three quarters of 2016, we recorded income of $1,700 for currency fluctuations.
Income Taxes
The decrease in the effective tax rate of 31% for the nine months ended September 30, 2017 compared to 35% in 2016 was due to the reversal ofvaluation allowance associated with our deferred tax position for fixed assets.assets, and differences in tax rates in foreign jurisdictions.
Capital Resources, Liquidity and Financial Condition
We require cash principally for day-to-day operations, to purchase inventory and to finance capital investments, and to service our outstanding debt.investments. We expect to fund our operating and liquidity needs as well as our store growthprimarily from a combination of current cash balances and internallycash generated funds.from operating activities. Any excess cash will be invested as determined by our Board of Directors in accordance with its approved investment policy. Our cash balances atas of September 30, 20172022 totaled $12. 2$3.1 million. In addition,
Debt Agreements
During the second quarter of 2020, the Company borrowed $0.4 million from Banco Santander S.A. under the Institute of Official Credit Guarantee for Small and Medium-sized Enterprises in order to facilitate the continuation of employment and to attenuate the economic effects of the COVID-19 virus. This loan was provided for by the Spanish government as part of a COVID-19 relief program. During the second quarter of 2022, we have availablerepaid this loan in full.
Share Repurchase Program and Share Repurchase
On August 9, 2020, the Board of Directors approved a $6 million line of credit, more fully described below.
In August 2015, our Board authorized a share repurchase program where we mayto repurchase up to 1.2$5.0 million of the Company’s common stock between August 9, 2020 and July 31, 2022. This program expired in July 2022. As of December 31, 2021, the full $5.0 million of our common stock remained available for repurchase under this program. On August 8, 2022, the Board of Directors approved a new program to repurchase up to $5.0 million of the Company’s common stock between that date and August 31, 2024. As of September 30, 2022, $5.0 million remained available for repurchase under this new program.
On April 11, 2022, we entered into an agreement with two institutional shareholders of the Company, to repurchase 359,500 shares of our common stock, at prevailing market rates through August 2016. Subsequently,par value $0.0024 in a private transaction. The purchase price was $5.00 per share for a total of $1.8 million. The closing of the programrepurchases took place on April 22, 2022, and these shares were subsequently cancelled. Prior to the repurchase, the shares represented approximately 4.2% of our outstanding common stock.
On December 8, 2021, we entered into an agreement with an institutional shareholder of the Company, to repurchase 212,690 shares of our common stock, par value $0.0024 in a private transaction. The purchase price was amended$5.00 per share for a total of $1.1 million. The closing of the repurchase took place on December 16, 2021, and these shares were subsequently cancelled. Prior to increase the numberrepurchase, the shares represented approximately 2.4% of our outstanding common stock.
On January 28, 2021, we entered into an agreement with an institutional shareholder of the Company, to repurchase 500,000 shares availableof our common stock, par value $0.0024 in a private transaction separate from our share repurchase program. The purchase price was $3.35 per share for a total of $1.7 million. The closing of the repurchase took place on February 1, 2021, and these shares were subsequently cancelled. Prior to 2.2 million and to extend the program throughAugust 2018. repurchase, the shares represented approximately 5.5% of our outstanding common stock.
Cash Flows
| | | For the Nine Months Ended September 30, | |
| (amounts in thousands) | | 2022 | | | 2021 | |
| Net cash used in operating activities | | $ | (3,957 | ) | | $ | (2,028 | ) |
| Net cash used in investing activities | | | (825 | ) | | | (512 | ) |
| Net cash used in financing activities | | | (2,198 | ) | | | (1,700 | ) |
| Effect of exchange rate changes on cash and cash equivalents | | | (125 | ) | | | (3 | ) |
| Net decrease in cash and cash equivalents | | $ | (7,105 | ) | | $ | (4,243 | ) |
For the nine months ended September 30, 2017, no shares were repurchased, while 520,500 shares were repurchased during2022, cash from operations used $4.0 million driven by a net investment in inventory of $4.5 million, a net reduction in lease liabilities of $2.5 million, and net change in income tax expense of $0.3 million and net decrease in prepaid expenses of $0.3 million, partially offset by net income of $0.8 million, noncash expense of $4.1 million, including depreciation, amortization, and stock-based compensation, a net decrease of $2.0 million in accounts payable and accrued expenses, a net decrease of $0.2 million in accounts receivable and other changes in operating assets and liabilities. We invested $0.8 million in capital expenditure primarily related to system implementations. Cash used in financing activities was primarily due to the nine months ended September 30, 2016. At September 30, 2017, there are 1,150,793 shares available for repurchase under the plan.
On September 18, 2015, we executed a Promissory Note and Business Loan Agreement with BOKF, NA d/b/a Bankpurchase of Texas (“BOKF”) which provided us with a line of credit facility of up to $10,000,000 for the purpose of repurchasing359,500 shares of our common stock pursuant tofor $5.00 per share, or $1.8 million, from two institutional shareholders of the Company in a private transaction. We also paid off our stock repurchase program. On August 25, 2016, this line of credit was amended to increase the availability from $10,000,000 to $15,000,000loan with Banco Santander S.A. in Spain for the repurchase of shares of our common stock through the earlier of August 25, 2017 or the date on which the entire amount is drawn. On August 10, 2017, this line of credit was further amended to extend the drawdown period and conversion date from August 25, 2017 to August 18, 2018 to align with our stock repurchase program. During this time period, we are required to make monthly interest-only payments. At the end of this time period, we expect that the principal balance will be rolled into a 4-year term note. This Promissory Note is secured by a Deed of Trust on the real estate located at 1900 SE Loop 820, Fort Worth, Texas. There were no amounts drawn on this line$0.4 million during the nine months ended September 30, 2017. second quarter. The activities above, in addition to the effect of exchange rate changes, resulted in a net decrease in cash of $7.1 million.
For the nine months ended September 30, 2016, we drew approximately $3.72021, cash from operations used $2.0 million on this line whichdriven by net income of $1.3 million, non-cash expenses of $3.8 million, including depreciation, amortization, and stock-based compensation, a federal income tax refund of $1.0 million related to the 2019 tax year, and $1.0 million of other changes in operating assets and liabilities mostly due to an increase in accounts payable and accrued liabilities of $0.9 million and more than offset by the net buildup of inventory of $6.6 million and a reduction in lease liabilities of $2.6 million. We invested $0.5 million in capital expenditure primarily related to system implementations. Cash used in financing activities was usedprimarily due to repurchase approximately 520,500the purchase of 500,000 shares of our common stock. At September 30, 2017, the unused portionstock for $3.35 per share, or $1.7 million, from an institutional shareholder of the line of credit was approximately $7.6 million.
Also, on September 18, 2015, we executedCompany in a Promissory Note and Business Loan Agreement with BOKF which provides us with a line of credit facility of up to $6,000,000 and is secured by our inventory. On August 10, 2017, this line of credit was amended to extend the maturity to September 18, 2019.private transaction. The Business Loan Agreement contains covenants that require us to maintain a funded debt to EBITDA ratio of no greater than 1.5 to 1 and a Fixed Charge Coverage Ratio greater than or equal to 1.2 to 1. Both ratios are calculated quarterly on a trailing four quarter basis. For the nine month periods ended September 30, 2017 and 2016, there were no amounts drawn on this line.
Amounts drawn under either facility accrue interest at the London interbank Eurodollar market rate for U.S. dollars (commonly known as “LIBOR”) plus 1.85% (3.086% and 2.557% at September 30, 2017 and December 31, 2016, respectively).
On our consolidated balance sheet, total assets increased from $70.7 million at year-end 2016 to $74.4 million at September 30, 2017. Total stockholders’ equity increased from $53.7 million at December 31, 2016 to $57.9 million at September 30, 2017, primarily due to net income earnedactivities above, in the first nine months of 2017, the exercise of stock options and impact of foreign currency translation. Our current ratio increased from 6.5 at December 31, 2016 to 7.7 at September 30, 2017 due primarilyaddition to the increaseeffect of exchange rate changes, resulted in inventory.a net decrease in cash of $4.2 million
As of September 30, 2017, our investment in inventory increased by $8.0 million from year-end 2016, as we stocked up following the holiday sales, invested in the four new stores opened/reopened since December 31, 2016, and expanded our product line to support new marketing and merchandising initiatives. Inventory turnover reached an annualized rate of 2.1 times during the first three quarters of 2017, decreasing from 2.2 times for the same period in 2016. Inventory turnover was 2.5 times for all of 2016. We compute our inventory turns as sales divided by average inventory. At September 30, 2017, average inventory per store was $181,000, an increase of 3% compared to $175,000 at September 30, 2016.
Accounts payable increased approximately $1 million to $2.6 million at September 30, 2017 compared to $1.6 million at year-end 2016 due to the increase in inventory and timing of payments. Accrued expenses decreased from $5.9 million at December 31, 2016 to $4.6 million at September 30, 2017. The payment of the 2016 manager bonuses in March 2017 primarily accounted for the reduction.
During the first nine months of 2017, cash flow used in operating activities was $3.3 million, composed of net income of $2.8 million, plus $1.5 million of depreciation and amortization, plus $962,000 of foreign currency translation, offset by changes in working capital including purchases of inventory and payments of 2016 bonuses.
By comparison, during the first nine months of 2016, cash flow provided by operating activities was approximately $1.9 million, composed of net income of $4.3 million, plus $1.3 million of depreciation and amortization, offset by the increase in inventory of $3.5 million.
Cash flow used in investing activities totaled approximately $1.6 million and $1.4 million in the first three quarters of 2017 and 2016, respectively, consisting primarily of the purchase of fixtures for new stores, store moves and remodels and computer equipment, and in 2017, vehicles and computer equipment for our new district managers.
There was $223,000 of cash provided by financing activities in the first nine months of 2017, related to proceeds from the exercise of stock options, compared to $22,000 used in financing activities in the first nine months of 2016. In 2016, we repurchased $3.7 million of treasury stock, funded primarily through drawdowns on our line of credit with BOKF, as well as made a scheduled payment on our capital lease obligation for $6,710.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
For disclosures about market risk affecting us, see Item 7A “Quantitative and Qualitative Disclosures About Market Risk” in our Annual Report on Form 10-K for fiscal year ended December 31, 2016. We believe that our exposure to market risks has not changed significantly since December 31, 2016.
| Item 4. | Controls and Procedures. |
Item 4. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
OurAs part of the filing of this Form 10-Q for the period ended September 30, 2022, our management, team, under the supervision and with the participation of our principal executive officerChief Executive Officer (“CEO”) and our principal financial officer,Chief Financial Officer (“CFO”), evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rulein Rules 13a-15(e) promulgatedand 15d-15(e) under the Securities Exchange Act of 1934, as amended as(the “Exchange Act”). As a result of the last day of the fiscal period covered by this report, September 30, 2017. The term disclosure controls and procedures means our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including our principal executive and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officerCEO and our principal financial officerCFO concluded that as of September 30, 2017, our disclosure controls and procedures were not effective atdue to the material weaknesses described below.
Management’s Annual Report on Internal Control over Financial Reporting
Our management, including our CEO and CFO, is responsible for establishing and maintaining adequate internal control over our financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Management’s establishing and maintaining adequate internal control over financial reporting is based upon the criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (the “COSO Framework”). A system of internal control over financial reporting should be designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.
An effective internal control system, no matter how well designed, has inherent limitations, including the possibility of human error, the circumvention or overriding of controls, or fraud, and therefore can provide only reasonable assurance with respect to reliable financial reporting. Because of its inherent limitations, our internal control over financial reporting may not prevent or detect all misstatements.
A material weakness is defined as a deficiency or combination of deficiencies in internal control over financial reporting, such that there is a reasonable assurance level.possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Based on this definition, our management, with the participation of our CEO and CFO, evaluated the effectiveness and design of our internal control over financial reporting against the COSO Framework and concluded that our internal control over financial reporting was not effective as of September 30, 2022 due to material weaknesses arising from flaws in our control environment, risk oversight measures, control activities, information processing and communication and our monitoring systems, each of which is described in more detail below.
Control environment. We concluded that we did not maintain effective controls in the following areas: (i) managerial functions, procedures and oversight; (ii) organizational structure, delegation of authority and responsibilities; (iii) segregation of duties; (iv) adequacy of trained accounting and financial reporting personnel to ensure that internal control responsibilities were performed effectively, and material accounting errors were detected; and (v) maintenance and enforcement of internal control responsibilities, including holding individuals accountable for their internal control responsibilities.
Risk oversight environment. We did not maintain adequate risk oversight measures related to the (i) identification and assessment of risks that could impact achieving our objectives and (ii) identification and analysis of the potential changes that could affect our internal controls environment.
Control activities. We concluded that we did not have effective control activities in the following areas: (i) selecting and developing control activities to mitigate risks, including the development of alternative control activities that address segregation of duties issues; (ii) selecting and implementing information technology and related systems supportive to our internal control over financial reporting; and (iii) deploying control activities through policies and establishing procedures that put these policies into action, including timely review of account reconciliations and methodologies used to calculate and report financial information and results, as well as timely periodic management reviews of financial information and results that would help identify misstatements.
Information and communication. We identified deficiencies associated with information and communication within our internal control framework. Specifically, we did not effectively assign responsibility to personnel for gathering required information nor did we periodically communicate objectives and internal control responsibilities throughout the organization which contributed to inadequate documentation of processes, untimely review of account reconciliations and calculations involving judgement and delays in the accounting close cycle, hindering timely communication with management, the Board of Directors and our independent auditors.
Monitoring activities. We concluded that we did not design and implement effective monitoring activities related to (i) selecting, developing, and performing separate evaluations of our internal control over financial reporting; and (ii) evaluating and communicating internal control deficiencies in a timely manner to parties responsible for taking corrective actions.
Remediation Efforts to Address Material Weaknesses
Our management, including our CEO and CFO, continue to work with expert accounting consultants and our Audit Committee to design and implement both a short- term and a long-term remediation plan to correct the material weaknesses in our disclosure controls and procedures and our internal control over financial reporting. The following activities highlight our commitment to remediating our identified material weaknesses:
During 2020, 2021 and through the filing date of this Form 10-Q, we have taken the following measures, among others:
| i. | Replaced critical roles within our accounting team with contract accounting resources and continue to search for full-time employees with expertise in GAAP accounting, SEC reporting and disclosure, internal audit and internal controls; |
| ii. | Replaced our legacy accounting systems with an integrated enterprise resource planning (“ERP”) solution which includes general ledger, warehouse management and factory production modules designed to calculate inventory on a FIFO basis; |
| iii. | Implemented a new point-of-sale system for 93 U.S. stores that is fully integrated with our new ERP system (the remaining 12 stores will be converted during the remainder of 2022); |
| iv. | Created a risk controls matrix which includes, among other things, a comprehensive list of key and mitigating controls, a description of the risk the control is designed to mitigate, the frequency in which the control is performed, and a mapping of each control to the five COSO Framework components (control environment, risk assessment, control activities, information and communication, or monitoring activities) ; |
| v. | Established a greater sense of accountability by requiring sub-certifications below the CEO and CFO level for certain key accounting, finance and operations personnel. |
Our continuing plan and additional steps for remediation include:
| i. | Ongoing recruitment and hiring of permanent, qualified public-company accounting personnel; |
| ii. | Completing the accountability portion of our risk controls matrix once the permanent accounting team is in place in order to identify the individual responsible for each control; |
| iii. | Converting the remaining 12 stores onto our new point-of-sale system; |
| iv. | Redesigning our accounting procedures and activities to align with our new ERP system that will include built-in controls to improve upon the reliability of financial reporting and the preparation of financial statements in accordance with GAAP; |
| v. | Continuing to improve the accounting close process, including periodic review and update of our accounting close checklists for completeness of duties, accuracy of owners and deadlines to maintain accountability, timely review of account reconciliations and calculations involving judgement, and timely reporting of financial results; |
| vi. | Updating process narrative documentation in the following areas: (i) financial reporting, (ii) inventory, (iii) purchasing and accounts payable, (iv) revenue, (v) fixed assets and lease accounting, (vi) general accounting, treasury and financial planning & analysis, (vii) tax, (viii) information technology (IT) governance, and (ix) HR and payroll; |
| vii. | Periodically reviewing of our risk controls matrix and process narrative documentation to ensure changes such as personnel, information sources, processes, systems, and frequency in performing the control are properly reflected in a timely manner; |
| viii. | Reporting the progress and results of our remediation plan to the Audit Committee on a recurring basis, including the identification, status, and resolution of internal control deficiencies; and |
| ix. | Creating a comprehensive approach to regularly evaluate the operating effectiveness of our disclosure controls and procedures and our internal control over financial reporting using the COSO Framework as a guide. |
Control Environment
Our management, including our CEO and CFO, our Audit Committee and our Board of Directors have taken certain steps to set the proper tone-at-the-top in support of the Company’s values and climate to develop and maintain an effective internal control environment. These actions include:
| ■ | Recurring meetings with leadership, finance and accounting and other key functional areas to train staff on processes for oversight and emphasize each individual’s accountability for internal control compliance, and to create a pattern of regular discussion of such controls. |
| ■ | Periodic communications from the CEO, CFO and other key senior leaders on the Company’s mission, core values, Code of Business Conduct and Ethics, whistleblower policies, and each employee’s individual responsibility for internal control compliance. |
| ■ | Reorganization of the finance and accounting team to address segregation of duties issues, oversight and review of work, and recruiting and hiring qualified, competent employees with relevant experience for the roles. |
| ■ | Regular performance evaluations to include position-specific criteria for functional competence, including performance of internal control responsibilities. |
Risk Oversight Measures
We continue to identify risks and enhance risk oversight measures. In late 2019, we developed an annual strategic planning process designed to identify specific operating objectives for the organization and to conduct an assessment across the organization of the risks to meeting those objectives, including the risk of fraud. Furthermore, on a quarterly basis, management will review our periodic filings to ensure that identified risks have been appropriately disclosed. In the areas of reporting and compliance objectives, we are also developing a process to conduct monthly business reviews by functional area that would include risk assessments of reporting accuracy based on complexity and transaction levels as well as compliance with GAAP and other regulatory requirements, in order to evaluate whether our existing control activities appropriately mitigate such risks or if additional controls need to be employed.
Control Activities
We continue to redesign and implement our internal control activities. Specifically, we are conducting detailed working sessions to document our current and prior finance and accounting policies, procedures and step-by-step activities. These sessions are expected to identify specific areas that require improvement and redesign of processes, structure, authorities and controls, and those actions include:
| ■ | Completing the implementation of our new point-of-sale system, which is fully integrated with our ERP system, for our remaining 12 stores during the remainder of 2022. |
| ■ | Continuing to implement functionality in our ERP system to improve on our internal controls over financial reporting, such as implementing the ERP’s bank reconciliation module. |
| ■ | Creating and implementing newly-designed processes, structures, delegation of authority and controls, in accordance with the COSO Framework, including: |
| o | Quarterly updates for the CFO regarding upcoming accounting pronouncement and proposed changes to GAAP accounting standards, tax regulations, and other requirements that may impact the Company’s financial reporting; |
| o | Timely reviews each quarter of the most significant accounting estimates and judgements; |
| o | Validation of results through detailed variance analyses and reconciliation of account balances performed on a timely basis; |
| o | Monthly business review of actual financial performance compared to forecasts with participation from leadership across the organization; and |
| o | Establishing a disclosure committee comprised of key management throughout the different areas of the organization to evaluate the appropriateness of disclosures in the Company’s periodic filings on Forms 10-K and 10-Q and to support the CEO and CFO with the certification process. |
Information Processing and Communication
The implementation of our new ERP system eliminated the need for the topside adjustment calculations that had to be performed because our legacy systems were not integrated and many of our accounting processes were manual. This new ERP system allows us to automate certain accounting processes, reducing the risk of management override, and eliminated the need for topside adjustments outside of the system. In addition, management is developing detailed policies, procedures and internal controls related to our financial reporting and working to develop regular reporting from our new systems that can validate the quality of our data and provide accurate information to support internal and external reporting and audit requirements.
Monitoring Activities
In addition to the items noted above, as we continue to evaluate, remediate, and improve our internal control over financial reporting, our management expects to continue to implement additional measures to address control deficiencies and further refine and improve the remediation efforts described above. Specifically, we are developing a checklist of activities based on the criteria established in the COSO Framework against which we will assess the design of entity-level and activity-level controls, and the operational effectiveness of such controls. Deficiencies identified in this process will be addressed by management, including our CEO and CFO. This assessment, any deficiencies and any remedial actions will be shared and discussed with our Audit Committee and our independent auditors on a quarterly basis.
Cybersecurity
We utilize information technology for internal and external communications with vendors, customers and banks as well as systems technology for reporting and managing our operations. Loss, disruption or compromise of these systems could significantly impact operations and results. Other than temporary disruption to operations that may be caused by a cybersecurity breach, we believe cash transactions to be the primary risk for potential loss. We work with our financial institutions to take steps to minimize the risk by requiring multiple levels of authorization, encryption and other controls. The Company utilizes third party intrusion prevention and detection systems and performs periodic penetration testing to monitor its cybersecurity environment. However, the Company has not performed a formalized risk assessment to address cybersecurity risks or documented internal controls that assist in alleviating such risks.
Changes in Internal Control Over Financial Reporting
There have been no changesAs discussed in the remediation section above, we implemented the warehouse management, factory production system and general ledger systems modules as part of our new ERP system implementation which had a go-live date of September 1, 2020, and we implemented our new point-of-sale system, which is fully integrated with our ERP system, in 93 of our U.S. stores with the remaining 12 stores to be converted during the remainder of 2022. Although we had not fully remediated all material weaknesses in our internal control over financial reporting during the fiscal quarter endedas of September 30, 2017 that materially affected, or2022, as the phased implementation of this system continues, we are reasonably likelyexperiencing certain changes to materially affect,our processes and procedures which, in turn, result in changes to our internal control over financial reporting. While we expect our new ERP system to strengthen our internal financial controls by automating certain manual processes and standardizing business processes and reporting across our organization, management will continue to evaluate and monitor our internal controls as each of the affected areas evolves.
| PART II. | OTHER INFORMATION |
PART II. OTHER INFORMATION
| Item 1. | Legal Proceedings. |
Item 1. Legal Proceedings.
The information contained in Note 6, Commitments and Contingenciesto the consolidated financial statementsCondensed Consolidated Financial Statements included in Part I, Item 1 of this Report is hereby incorporated into this Item 1 by reference.
Our Risk Factors are discussed fully in our Annual Report on Form 10-K for the fiscal year ended December 31, 2021 and incorporated herein by reference.
Item 2. | Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
Purchases of Equity Securities by the Issuer and UseAffiliated Purchasers
The following table provides information about purchases we have made of Proceeds
There were no unregistered sales of equity securitiesour common stock during the quarter ended September 30, 2017. Further, there were no purchases of equity securities during the quarter ended September 30, 2017.2022:
| ISSUER PURCHASES OF EQUITY SECURITIES | |
| Period | | (a) Total number of shares purchased | | | (b) Average price paid per share | | | (c) Total number of shares purchased as part of publicly announced plans or programs | | | (d) Maximum value of shares that may yet be purchased under the plans or programs (1) (2) | |
| July 1 – July 31, 2022 | | | 600 | | | $ | 4.70 | | | | 600 | | | $ | 4,997,180 | |
| August 1 – August 31, 2022 | | | — | | | | — | | | | — | | | $ | 5,000,000 | |
| September 1 – September 30, 2022 | | | — | | | | — | | | | — | | | $ | 5,000,000 | |
| Total | | | 600 | | | $ | 4.70 | | | | 600 | | | | | |
| (1) | Represents shares which may be purchased through our previous stock repurchase program, adopted by the Company’s Board of Directors on August 9, 2020, which allowed the Company to repurchase up to $5 million value of shares of our common stock on or prior to July 31, 2022. This program expired on July 31, 2022. |
| (2) | On August 8, 2022, the Board of Directors approved a new program to repurchase up to $5.0 million of the Company’s common stock between that date and August 31, 2024. As of September 30, 2022, $5.0 million remained available for repurchase under this new program. |
Exhibit Number | | Description |
| 3.1 | | Certificate of Incorporation of The Leather Factory, Inc., and Certificate of Amendment to Certificate of Incorporation of The Leather Factory, Inc. filed as Exhibit 3.1 to Tandy Leather Factory, Inc.’s Form 10-Q filed with the Securities and Exchange Commission on August 12, 2005 and incorporated by reference herein.
|
| 3.2 | | Bylaws of The Leather Factory, Inc. (n/k/a Tandy Leather Factory, Inc.), filed as Exhibit 3.5 to the Current Report on Form 8-K filed by Tandy Leather Factory, Inc (f/k/a The Leather Factory, Inc.) with the Securities and Exchange Commission on July 14, 2004 and incorporated by reference herein.
|
| 3.3 | | Certificate of Designations of Series A Junior Participating Preferred Stock of Tandy Leather Factory, Inc. filed as Exhibit 3.1 to Tandy Leather Factory’s Inc.’s Current Report on Form 8-K filed with the Securities and Exchange Commission on June 10, 2013 and incorporated by reference herein.
|
| 10.1 | | $6,000,000 Promissory Note, dated August 10, 2017, by and between Tandy Leather Factory, Inc. and BOKF, NA dba Bank of Texas, filed as Exhibit 10.1 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 14, 2017 and incorporated by reference herein.
|
| 10.2 | | $15,000,000 Promissory Note, dated August 10, 2017, by and between Tandy Leather Factory, Inc. and BOKF, NA dba Bank of Texas, filed as Exhibit 10.2 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 14, 2017 and incorporated by reference herein.
|
| *31.1 | | 13a-14(a) or 15d-14(a) Certification by Shannon L. Greene, Chief Executive Officer.
|
| *31.2 | | 13a-14(a) or 15d-14(a) Certification by Tina L. Castillo, Chief Financial Officer and Treasurer.
|
| *32.1 | | Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
|
*101.INS | | XBRL Instance Document.
|
*101.SCH | | XBRL Taxonomy Extension Schema Document.
|
*101.CAL | | XBRL Taxonomy Extension Calculation Document.
|
*101.DEF | | XBRL Taxonomy Extension Definition Document.
|
*101.LAB | | XBRL Taxonomy Extension Labels Document.
|
*101.PRE | | XBRL Taxonomy Extension Presentation Document. |
____________ | | |
*Filed herewith.
| | |
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| TANDY LEATHER FACTORY, INC. |
| (Registrant) |
| | |
Date: November 2, 2017 | By: /s/ Shannon L. Greene3.1
|
| Shannon L. Greene |
| Chief Executive Officer |
| |
Date: November 2, 2017 | By: /s/ Tina L. Castillo
|
| Tina L. Castillo |
| Chief Financial Officer |
EXHIBIT INDEX
Exhibit
Number
| | Description
|
| 3.1 | | |
| | |
3.2 | | |
| | |
3.3 | | |
| |
4.1 | |
| | *31.1 |
10.1 | |
| 10.1 | | $6,000,000 Promissory Note, dated August 10, 2017, by and between Tandy Leather Factory, Inc. and BOKF, NA dba Bank of Texas,2013 Restricted Stock Plan, filed as Exhibit 10.1 to Tandy Leather Factory’s Quarterly Report on Form 10-Q filed with the Securities and Exchange Commission on November 14, 2013 and incorporated by reference herein. |
| |
10.2 | |
| |
10.3 | |
| |
10.4 | |
| | 10.2 |
10.5 | $15,000,000 Promissory Note,Form of Employment Agreement dated August 10, 2017, byOctober 2, 2018 between the Company and betweenJanet Carr, filed as Exhibit 10.1 to Tandy Leather Factory Inc. and BOKF, NA dba Bank of Texas, filed as Exhibit 10.2 to Tandy Leather Factory’s’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 14, 2017October 5, 2018 and incorporated by reference herein. |
| |
10.6 | |
| | *31.2 |
10.7 | |
10.8 | |
| |
10.9 | |
| |
14.1 | |
| |
21.1 | |
| |
| 13a-14(a) or 15d-14(a) Certification by Tina L. Castillo,Janet Carr, Chief Financial Officer and Treasurer.Executive Officer. |
| | |
| 13a-14(a) or 15d-14(a) Certification by Cindy McSpadden, interim Chief Financial Officer. |
| |
| Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
*101.INS | |
*101.INS | XBRL Instance Document. |
*101.SCH | |
*101.SCH | XBRL Taxonomy Extension Schema Document. |
*101.CAL | |
*101.CAL | XBRL Taxonomy Extension Calculation Document. |
*101.DEF | |
*101.DEF | XBRL Taxonomy Extension Definition Document. |
*101.LAB | |
*101.LAB | XBRL Taxonomy Extension Labels Document. |
*101.PRE | |
*101.PRE | XBRL Taxonomy Extension Presentation Document. |
*Filed herewith.
Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
____________ | TANDY LEATHER FACTORY, INC. |
| (Registrant) |
| | |
| Date: November 14, 2022 | *Filed herewith.
By: /s/ Janet Carr |
| Janet Carr |
| Chief Executive Officer |
| | |
| Date: November 14, 2022 | By: /s/ Cindy McSpadden |
| Cindy McSpadden |
| Interim Chief Financial Officer |
20
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