Tandy Leather Factory, Inc. is one of the world’s largest specialty retailers of leather and leathercraft-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, hardware, supplies, kits and teaching 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.
Tandy Leather has been introducing people to leatherworking for over 100 years. Our stores have been and continue 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 provideswebsites provide 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, including a growing international customer base. For many of our retail and web customers, leatherworking evolves from a passion to a trade. Our commercial divisionCommercial 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.
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.
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 FIFO 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.
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. Rent expense is recorded in operating expenses. The net adjustment between rent expense and the actual cash paid during the fiscal year has been recorded as accrued expenses and other liabilities in the accompanying consolidated balance sheets.
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 Statementsconsolidated statements of Operationsoperations and Comprehensive Income (Loss)comprehensive income (loss).
The 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 operating lease assets for impairment when evidence exists that the carrying value of an asset group, including a lease asset, may not be recoverable.
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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 differing 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 extent it is more-likely-than-not that all or a portion of 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,March 31, 2023 and 2022 and 2021
The following table presents selected financial data:
| | | Three Months Ended September 30, | | | Three Months Ended March 31, | |
| (in thousands) | | 2022 | | 2021 | | $ Change | | % Change | | | 2023 | | | 2022 | | | $ Change | | | % Change | |
| Net sales | | $ | 19,057 | | | $ | 19,281 | | | $ | (224 | ) | | | (1.2 | )% | |
| Sales | | | $ | 20,360 | | $ | 20,500 | | $ | (140 | ) | | (0.7 | )% |
| Gross profit | | | 11,596 | | | | 11,089 | | | | 507 | | | | 4.6 | % | | 11,819 | | 11,931 | | (112 | ) | | (0.9 | )% |
| Gross margin percentage | | | 60.8 | % | | | 57.5 | % | | | | | | | 3.3 | % | | 58.1 | % | | 58.2 | % | | | | (0.1 | )% |
| Operating expenses | | | 10,620 | | | | 11,078 | | | | (458 | ) | | | (4.1 | )% | | | 10,838 | | | 11,102 | | | (264 | ) | | | (2.4 | )% |
| Income from operations | | $ | 976 | | | $ | 11 | | | $ | 965 | | | | 8,772.7 | % | | $ | 981 | | $ | 829 | | $ | 152 | | | 18.3 | % |
Net Sales
Consolidated net sales for the quarter ended September 30, 2022March 31, 2023 decreased $0.2$0.1 million, or 1.2%0.7%, 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 andresulting from ongoing uncertainty related to global political, economic and public health concerns.other uncontrollable factors.
Our store footprint consisted of 104102 and 106 stores at September 30,March 31, 2023 and March 31, 2022, and September 30, 2021, respectively.
Since January 1, 2022,2023, we closed one store in San Bruno,Baldwin Park, CA in March 2022, and one store in Oxnard, CA, in July 2022. 2023. 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 increaseddecreased by $0.5$0.1 million, or 4.6%0.9%, compared to the same period in 2021,2022, and our gross margin percentage for the quarter ended September 30, 2022 increased to 60.8% compared to 57.5% inMarch 31, 2023 remained relatively the corresponding priorsame 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 storesover year at approximately 58%.
Operating expenses
| | | Three Months Ended September 30, | | | | | | | Three Months Ended March 31, | |
| (in thousands) | | 2022 | | 2021 | | $ Change | | % Change | | | 2023 | | 2022 | |
| Operating expenses | | $ | 10,620 | | $ | 11,078 | | $ | (458 | ) | | (4.1 | )% | | $ | 10,838 | | $ | 11,102 | |
| Non-routine items related to restatement | | | - | | | (124 | ) | | | 124 | | (100.0 | )% | | | - | | | (77 | ) |
| Adjusted operating expenses | | $ | 10,620 | | $ | 10,954 | | $ | (334 | ) | | (3.0 | )% | | $ | 10,838 | | $ | 11,025 | |
| | | | | | | | | | | | | | | |
| Operating expenses % of sales | | 55.7 | % | | 57.5 | % | | | | | | | 53.2 | % | | 54.2 | % |
| Adjusted operating expenses % of sales | | 55.7 | % | | 56.8 | % | | | | | | | 53.2 | % | | 53.8 | % |
Operating expenses decreased $0.5$0.3 million or 4.1%2.4% compared to the corresponding prior year period, primarily as a result of a decrease in RSU and bonus expense of $0.5 million, a decrease in services purchased of $0.2 million, a decrease in software costsexpenses of $0.1 million, and a decrease in stock compensationcontract labor of $0.3 million, offset by an increase in salary expense of $0.1 million offsetdriven 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, which exclude the non-routine items related to the restatement, decreased $0.3 million or 3.0% for the reasons noted above.higher retail wages. 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 accounting costs associated with the restatement.
Income Taxes
Our effective tax rate for the three months ended September 30, 2022March 31, 2023 was 26.3%29.5% compared to 13.0%23.4% for the same period in 2021.2022. 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 deferred tax assets, and differences in tax rates in foreign jurisdictions.
Nine months Ended September 30, 2022 and 2021
The following table presents selected financial data:
| | | 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
Consolidated net sales for the nine months ended September 30, 2022 decreased $1.3 million, or 2.2%, compared to the same period in 2021. 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, 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 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 decreased by $0.5 million, or 1.5%, compared to the same period in 2021, and our gross margin percentage for the nine months ended September 30, 2022 increased to 58.7% compared to 58.3% in the corresponding prior year period. The gross margin rate remains relatively the same 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 bonus 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, which exclude the non-routine items related to the restatement, increased $1.0 million, for the reasons 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 accounting costs associated with the restatement.
Income Taxes
Our effective tax rate for the nine months ended September 30, 2022 was 26.3% compared to 23.1% 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 deferred tax 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. We expect to fund our operating and liquidity needs primarily from a combination of current cash balances and cash generated 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 as of September 30, 2022March 31, 2023 totaled $3.1$8.6 million.
On January 3, 2023, the Company entered into a credit agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A. Under the Credit Agreement, the bank will provide the Company a credit facility of up to $5,000,000 on standard terms and conditions, including affirmative and negative covenants set forth in the Credit Agreement. As security for the credit facility, the Company has pledged as collateral certain of its assets, including the Company’s cash in deposit accounts, inventory and equipment. As of the date of this filing, no funds had been borrowed under this facility.
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 repaid this loan in full.
Share Repurchase Program and Share Repurchase
On August 9, 2020, the Board of Directors approved a new program to repurchase up to $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,March 31, 2023, $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, 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 repurchases 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 $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 the repurchase, 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 of our common stock, par value $0.0024 in a private transaction separate from ourdirect share repurchase program. The purchase price was $3.35 per share for a totaltransactions were separately authorized by our Board of $1.7 million. The closing ofDirectors and did not reduce the repurchase took place on February 1, 2021, and these shares were subsequently cancelled. Priorremaining amount authorized to be repurchased under the repurchase, the shares represented approximately 5.5% of our outstanding common stock.plans described above.
Cash Flows
| | | For the Nine Months Ended September 30, | | | Three Months Ended March 31, | |
| (amounts in thousands) | | 2022 | | 2021 | | | 2023 | | | 2022 | |
| Net cash used in operating activities | | $ | (3,957 | ) | | $ | (2,028 | ) | |
| Net cash provided by operating activities | | | $ | 797 | | | $ | 277 | |
| Net cash used in investing activities | | | (825 | ) | | | (512 | ) | | (87 | ) | | (164 | ) |
| Net cash used in financing activities | | | (2,198 | ) | | | (1,700 | ) | | - | | | (4 | ) |
| Effect of exchange rate changes on cash and cash equivalents | | | (125 | ) | | | (3 | ) | | | (39 | ) | | | 71 | |
| Net decrease in cash and cash equivalents | | $ | (7,105 | ) | | $ | (4,243 | ) | |
| Net increase in cash and cash equivalents | | | $ | 671 | | $ | 180 | |
| | | Three Months Ended March 31, | |
| (amounts in thousands) | | 2023 | | | 2022 | |
| Net cash provided by operating activities | | $ | 795 | | | $ | 277 | |
| Net cash used in investing activities | | | (87 | ) | | | (164 | ) |
| Net cash used in financing activities | | | - | | | | (4 | ) |
| Effect of exchange rate changes on cash and cash equivalents | | | (38 | ) | | | 71 | |
| Net increase in cash and cash equivalents | | $ | 670 | | | $ | 180 | |
For the ninethree months ended September 30, 2022,March 31, 2023, cash from operations used $4.0generated $0.8 million driven by a net investment in inventoryincome of $4.5$0.7 million, a net reduction in lease liabilities of $2.5 million, and net change in income taxnon-cash 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$1.4 million, including depreciation, amortization, and stock-based compensation, a net decreasereduction in inventory of $2.0$2.4 million that includes adjustments, offset by a reduction to working capital including a net $2.8 million decrease in accounts payable and accrued expenses,liabilities mostly due to bonus accrual and contract liabilities, and a net decreasereduction in lease liability payments of $0.2 million in accounts receivable and other changes in operating assets and liabilities.$0.9 million. We invested $0.8$0.1 million in capital expenditure primarily related to system implementations. Cash used in financing activities was primarily due to the purchase of 359,500 shares of our common stock for $5.00 per share, or $1.8 million, from two institutional shareholders of the Company in a private transaction. We also paid off our loan with Banco Santander S.A. in Spain for $0.4 million during the second quarter.modifications and improvements. The activities above, in addition to the effect of exchange rate changes, resulted in a net decreaseincrease in cash of $7.1$0.7 million.
For the ninethree months ended September 30, 2021,March 31, 2022, cash from operations used $2.0generated $0.3 million driven by net income of $1.3$0.7 million, non-cash expenses of $3.8$1.5 million, including depreciation, amortization, and stock-based compensation, a federal income tax refundnet reduction in inventory of $1.0$0.4 million, relatedmostly offset by a reduction to the 2019 tax year, and $1.0working capital including a $1.4 million of other changes in operating assets and liabilities mostly due to an increasedecrease in accounts payable and accrued liabilities of $0.9and a $0.1 million and more than offset by the net buildup of inventory of $6.6 millionincrease in accounts receivable, and a reduction in lease liabilities of $2.6$0.8 million. We invested $0.5$0.2 million in capital expenditureexpenditures primarily related to system implementations. Cash used in financing activities was primarily due to the purchase of 500,000 shares of our common stock for $3.35 per share, or $1.7 million, from an institutional shareholder of the Company in a private transaction. The activities above, in addition to the effect of exchange rate changes, resulted in a net decreaseincrease in cash of $4.2 million$0.2 million.
| Item 4. | Controls and Procedures. |
Evaluation of Disclosure Controls and Procedures
As part of the filing of this Form 10-Q for the period ended September 30, 2022,March 31, 2023, our management, with the participation of our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), evaluated the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”). As a result of this evaluation, our CEO and CFO concluded that our disclosure controls and procedures were not effective due 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 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, 2022March 31, 2023 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;oversight; (ii) organizational structure, delegation of authority and responsibilities;responsibilities; (iii) segregation of duties;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;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;issues; (ii) selecting and implementing information technology and related systems supportive to our internal control over financial reporting;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 activitiesactivities.. 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;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, continuecontinues to work with expert accounting consultants and our Audit Committee to design and implement both a short- termshort-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:
DuringSince 2020, 2021 and through the filing date of this Form 10-Q we have taken the following measures, among others:
Replaced critical roles within our accounting team with full-time employees with expertise in GAAP accounting, SEC reporting and disclosure, internal audit and internal controls;
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;
Implemented a new point-of-sale system for most of our stores that is fully integrated with our new ERP system. The remaining two stores will be converted in 2023;
| 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;
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| 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;
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| 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) ;
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| 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.
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Implemented new accounting processes and procedures aligned with our new ERP system that incorporate best practices to minimize errors and putting into action control activities that will prevent misstatements and that address appropriate segregation of duties;
Updated process narrative documentation in the following areas: (i) fixed assets and lease accounting, (ii) information technology (IT) governance, and (iii) HR and payroll;
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 individual responsible for each control, 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);
Established a greater sense of accountability by requiring sub-certifications below the CEO 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;
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| 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;
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| 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;
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| 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;
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| 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;
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| 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
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| 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.
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Ongoing recruitment and hiring of permanent, qualified public-company accounting personnel;
Converting remaining stores onto our new point-of-sale system;
Continuing to implement new accounting procedures and activities aligned with our new ERP system that improve upon the reliability of financial reporting and the preparation of financial statements in accordance with GAAP;
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;
Continuing to refine and improve narrative documentation in particular in the following areas: (i) financial reporting, (ii) inventory, (iii) purchasing and accounts payable, (iv) revenue, (v) general accounting, treasury, and financial planning & analysis, and (vi) tax;
Periodically reviewing 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;
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
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. |
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.
Regular periodic communications from the CEO 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.
| ■ | 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.
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| ■ | 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.
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| ■ | Regular performance evaluations to include position-specific criteria for functional competence, including performance of internal control responsibilities.
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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 conductinghave conducted detailed working sessions to document our current and prior finance and accounting policies, procedures, and step-by-step activities. These sessions are expected to identifyhave identified 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.Completing the implementation of our new point-of-sale system, which is fully integrated with our ERP system. 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. Continuing to implement newly-designed processes, structures, delegation of authority and controls, in accordance with the COSO Framework, including: |
| ■ | 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.
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| ■ | Creating and implementing newly-designed processes, structures, delegation of authority and controls, in accordance with the COSO Framework, including:
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| o | Quarterly updates for the CFOour Controller regarding upcoming accounting pronouncement and proposed changes to GAAP accounting standards, tax regulations, and other requirements that may impact the Company’s financial reporting;reporting; |
| o | Timely reviews each quarter of the most significant accounting estimates and judgements;judgments; |
| o | Validation of results through detailed variance analyses and reconciliation of account balances performed on a timely basis;basis; |
| o | Monthly business review of actual financial performance compared to forecasts with participation from leadership across the organization;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 eliminatedeliminating 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.CEO. 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
As 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 93most of our U.S. stores with the remaining 12 stores to be converted during the remainder of 2022.in early 2023. Although we had not fully remediated all material weaknesses in our internal control over financial reporting as of September 30,December 31, 2022, as the phased implementation of this system continues, we are experiencing certain changes to 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. |
The information contained in Note 6, Commitments and Contingencies to the Condensed Consolidated Financial Statements included in Part I, Item 1 of this Report is hereby incorporated into this Item 1 by reference.
Item 1A.1 A. | Risk Factors. |
Our Risk Factors are discussed fully in our Annual Report on Form 10-K for the fiscal year ended December 31, 20212022 and incorporated herein by reference.
| Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds. |
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table provides information about purchases we have made of our common stock during the quarter ended September 30, 2022:March 31, 2023:
| 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.
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| (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.
|
| 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 | |
January 1 – January 31, 2023 | | | — | | | | — | | | | — | | | $ | 4,997,000 | |
February 1 – February 28, 2023 | | | — | | | | — | | | | — | | | $ | 4,997,000 | |
March 1 – March 31, 2023 | | | — | | | | — | | | | — | | | $ | 4,997,000 | |
Total | | | — | | | | — | | | | — | | | | | |
Exhibit Number | Description |
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3.1 | |
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3.2 | |
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3.3 | |
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| Certificate of Amendment of Certificate of Incorporation, dated March 1, 2023 |
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4.1 | |
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10.1 | |
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10.2 | |
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10.3 | |
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10.4 | |
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10.5 | |
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10.6 | |
| |
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10.8 | |
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10.9 | |
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14.1 | |
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21.1 | |
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| 13a-14(a) or 15d-14(a) Certification by Janet Carr,the Chief Executive Officer. |
| |
| Officer pursuant to Rule 13a-14(a) or 15d-14(a) Certification by Cindy McSpadden, interim Chief Financial Officer.under the Securities Exchange Act of 1934, as amended. |
| | |
| Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.2022. |
| | |
*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. |
SIGNATURES
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, 2022May 15, 2023 | By: | /s/ Janet Carr |
| | Janet Carr |
| | Chief Executive Officer |
| |
Date: November 14, 2022 | By: /s/ Cindy McSpadden
|
| Cindy McSpadden |
| Interim Chief Financial Officer |
33
