ITEM 1. BUSINESS
The following discussion, as well as other portions of this Annual Report on Form 10-K (or statements otherwise made by the Company or on the Company’s behalf from time to time in other reports, filings with the Securities and Exchange Commission (“SEC”), news releases, conferences, World Wide Web postings or otherwise), contains forward-looking statements that reflect our plans, estimates and beliefs. Any such forward-looking statements (including, but not limited to, statements to the effect that TLF or its management “anticipates”, “plans”, “estimates”, “expects”, “believes”, “intends”, and other similar expressions) that are not statements of historical fact should be considered forward-looking statements and should be read carefully because they and involve risks and uncertainties. Any forward-looking statement speaks only as of the date on which such statement is made. We do not undertake any obligation to update or revise any forward-looking statements. Specific examples of forward-looking statements include, but are not limited to, statements regarding our forecasts of financial performance, share repurchases, store openings, capital expenditures and working capital requirements. Our actual results could materially differ from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed below and elsewhere in this Annual Report on Form 10-K and particularly in “Item 1A.
ITEM 1A. RISK FACTORS
Risks to Our Industry
Our business may be negatively impacted by general economic conditions in the United States and abroad.
Our performance is subject to worldwide economic conditions and their impact on levels of consumer spending that affect not only the ultimate consumer, but also small businesses and other retailers. Specialty retail, and retail in general, is heavily influenced by general economic cycles. Purchases of non-essential, discretionary products tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income declines. During periods of economic uncertainty, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, maintain our earnings from operations as a percentage of net sales, or generate sufficient cash flows to fund our operational and liquidity needs. The United States and global economies have suffered from economic uncertainty for the past several years. While consumer spending in the United States has stabilized recently, it could deteriorate in the future. As a result, our operating results may be adversely and materially affected by downward trends or uncertainty in the United States or global economies.
Increases in the price of leather and other items we sell or a reduction in availability of those products could increase our cost of goods and decrease our profitability.
The prices we pay our suppliers for our products are dependent in part on the market price for leather, metals, and other products. The cost of these items may fluctuate substantially, depending on a variety of factors, including demand, supply conditions, transportation costs, government regulation (such as the proposed Border Tax which would increase the cost of our imports), economic climates, political considerations, and other unpredictable factors. Leather prices world-wide have been relatively stable for the past several years although the outlook for future prices is uncertain. Increases in these costs, together with other factors, will make it difficult for us to sustain the gross margin level we have achieved in recent years and result in a decrease in our profitability unless we are able to pass higher prices on to our customers or reduce costs in other areas. Accordingly, such increases in costs could adversely affect our business and our results of operations.
Further, involvement by the United States in war and other military operations in the Middle East and other areas abroad could disrupt international trade and affect our inventory sources. Finally, livestock diseases such as mad cow could reduce the availability of hides and leathers or increase their cost. The occurrence of any of these events could adversely affect our business and our results of operations.
Risks Related to Our Business
We may be unable to sustain our financial performance or our past growth, which may have a material adverse effect on our future operating results.
We have experienced stable financial performance and modest growth in our store footprint while many other specialty retailers have experienced declining sales and losses. Our business may be similarly affected in the future. We anticipate that our future growth will depend on a number of factors, including consumer preferences, the strength and protection of our brand, the market success of our current and future products, the success of our growth strategies, and our ability to manage our future growth. Further, our future success will depend substantially on the ability of our management team to manage our growth effectively, optimizing our operational, administrative, financial, and legal procedures in order to maximize profitability. If we fail to manage our growth effectively, our future operating results could be adversely affected.
Our profitability may decline from increasing pressure on margins.
Our industry is subject to significant pricing pressure caused by many factors, including fluctuations in the cost of the leathers and metal products that we purchase and changes in consumer spending patterns and acceptance of our products. Changes in consumers’ product preferences or lack of acceptance of our products whose costs have increased may prohibit us from passing those increases on to customers which could cause our gross margin to decline. If our product costs increase and our sale prices do not, our future operating results could be adversely affected unless we are able to offset such gross margin declines with comparable reductions in operating costs.
Our growth depends on our ability to open new stores and increase comparable store sales.
One of our key business strategies is to expand our base of retail stores. If we are unable to continue this strategy, our ability to increase our sales, profitability and cash flow could be impaired. To the extent we are unable to open new stores as we anticipate, our sales growth would come only from increases in comparable store sales. Growth in profitability in that case would depend significantly on our ability to improve gross margin. We may be unable to continue our store growth strategy if we cannot identify suitable sites for additional stores, negotiate acceptable leases, or hire and train a sufficient number of qualified team members.
Our success depends on the continued protection of our trademarks and other proprietary intellectual property rights.
Our trademarks and other intellectual property rights are important to our success and competitive position, and the loss of or inability to enforce our trademark and other proprietary intellectual property rights could harm our business. We devote substantial resources to the establishment and protection of our trademark and other proprietary intellectual property rights on a worldwide basis. Despite any precautions we may take to protect our intellectual property, policing unauthorized use of our intellectual property is difficult, expensive, and time consuming, and we may be unable to adequately protect our intellectual property or determine the extent of any unauthorized use. Our efforts to establish and protect our trademark and other proprietary intellectual property rights may not be adequate to prevent imitation or counterfeiting of our products by others, which may not only erode sales of our products but may also cause significant damage to our brand name. Further, we could incur substantial costs in legal actions relating to our use of intellectual property or the use of our intellectual property by others. Even if we are successful in these actions, the costs we incur could have a material adverse effect on us.
Foreign currency fluctuations could adversely impact our financial condition and results of operations.
We generally purchase our products in U.S. dollars. However, we source a large portion of our products from countries other than the United States. The cost of these products may be affected by changes in the value of the applicable currencies. Changes in currency exchange rates may also affect the U.S. dollar value of the foreign currency denominated prices at which our international business will sell products. Furthermore, the majority of our international sales are generally derived from sales in foreign countries. This revenue, when translated into U.S. dollars for consolidated reporting purposes, could be materially affected by fluctuations in the U.S. dollar, negatively impacting our results of operations and our ability to generate revenue growth.
Our business could be harmed if we are unable to maintain our brand image.
Tandy Leather is one of the most recognized brand names in our industry. Our success to date has been due in large part to the strength of that brand. If we are unable to provide quality products and exceptional customer service to our customers, including education, which Tandy Leather has traditionally been known for, our brand name may be impaired which could adversely affect our operating results.
We may be subject to information technology system failures or network disruptions, or our information systems may prove inadequate, resulting in damage to our reputation, business operations and financial condition.
We depend on our information systems for many aspects of our business, including in designing, manufacturing, marketing and distributing our products, as well as processing transactions, managing inventory and accounting for and reporting our results. Therefore, it is critical that we maintain uninterrupted operation of our information systems. Even with our preventative efforts, we may be subject to information technology system failures and network disruptions. These may be caused by natural disasters, accidents, power disruptions, telecommunications failures, acts of terrorism or war, denial-of-service attacks, computer viruses, physical or electronic break-ins, or similar events or disruptions. System redundancy may be ineffective or inadequate, and the Company’s disaster recovery planning may not be sufficient for all eventualities. Such failures or disruptions could prevent access to the Company’s online services and preclude store transactions, as well as require a significant investment to repair or replace them. System failures and disruptions could also impede the manufacturing and shipping of products, transactions processing and financial reporting. Additionally, we may be materially adversely affected if we are unable to improve, upgrade, maintain, and expand our systems.
A significant data security or privacy breach of our information systems could affect our business.
The protection of our customer, employee and other data is important to us, and our customers and employees expect that their personal information will be adequately protected. In addition, the regulatory environment surrounding information security and privacy is becoming increasingly demanding, with evolving requirements in the various jurisdictions in which we do business. Although we have developed and implemented systems and processes that are designed to protect personal and Company information and prevent data loss and other security breaches, such measures cannot provide absolute security. Additionally, our increased use and reliance on web-based hosted (i.e., cloud computing) applications and systems for the storage, processing and transmission of information, including customer and employee information, could expose the Company, our employees and our customers to a risk of loss or misuse of such information. The Company’s efforts to protect personal and Company information may also be adversely impacted by data security or privacy breaches that occur at our third-party vendors. The Company cannot control these vendors and therefore cannot guarantee that a data security or privacy breach of their systems will not occur in the future. A significant breach of customer, employee or Company data could damage our reputation, relationships with customers, and our brand and could result in lost sales, sizable fines, significant breach-notification costs and lawsuits as well as adversely affect results of operations. The Company may also incur additional costs in the future related to the implementation of additional security measures to protect against new or enhanced data security and privacy threats, to comply with state, federal and international laws that may be enacted to address those threats or to investigate or address potential or actual data security or privacy breaches.
The loss or a prolonged disruption in the operation of the Company's centralized distribution center could adversely affect its business and operations.
The Company maintains a distribution center in Fort Worth, Texas dedicated to warehousing merchandise to handle worldwide store replenishment and process some direct-to-customer orders. Although the Company believes that it has appropriate contingency plans, unforeseen disruptions impacting our centralized distribution center for a prolonged period of time may result in delays in the delivery of merchandise to stores or in fulfilling customer orders.
Other uncertainties, which are difficult to predict and many of which are beyond our control, may occur as well and may adversely affect our business and our results of operations.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2.
ITEM 2. PROPERTIES
We lease our store locations, with the exception of our flagship store located in Fort Worth, Texas. The majority of our stores have initial lease terms of at least five years. The leases are generally renewable, with increases in lease rental rates in some cases. We believe that all of our properties are adequately covered by insurance. The properties leased by us are described in Item 1 in the description of each of our three operating segments. We own the 22,000 square foot building that houses our flagship store. Further, we own our corporate headquarters, which includes our central warehouse and manufacturing facility, sales, advertising, administrative, and executive offices. The facility consists of 191,000 square feet located on approximately 30 acres.
The following table summarizes the locations of our leased premises as of December 31, 2016:
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
See discussion of Legal Proceedings in Note 9 to the consolidated financial statements included in Item 8 of this Report.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the NASDAQ Global Market using the symbol “TLF.” The high and low trading prices for each calendar quarter during the last two fiscal years are as follows:
There were approximately 306 stockholders of record on March 22, 2017.
We did not sell any shares of our equity securities during our fiscal year ended December 31, 2016 that were not registered under the Securities Act.
We did not purchase any shares of our common stock during the fourth quarter of 2016, although we are authorized to do so through a stock purchase program permitting us to repurchase up to 2.2 million shares of our common stock at prevailing market prices. We announced the program on August 10, 2015, and it was amended on June 7, 2016 to increase the number of shares available to purchase from 1.2 million to 2.2 million and to extend the termination date from August 9, 2016 to August 9, 2017. Purchases under the program commenced on August 24, 2015 and will terminate on August 9, 2017. See Note 11 to our Financial Statements included in Item 8 of this report.
On June 9, 2014, our Board of Directors authorized a $0.25 per share special one-time cash dividend that was paid to our stockholders of record at the close of business on July 7, 2014. The dividend, totaling $2.5 million, was paid to our stockholders on August 8, 2014. Our Board of Directors will determine future cash dividends after giving consideration to our then existing levels of profit and cash flow, capital requirements, current and forecasted liquidity, as well as financial and other business conditions existing at the time. This policy is subject to change based on future industry and market conditions, as well as other factors.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data presented below are derived from and should be read in conjunction with our Consolidated Financial Statements and related notes. This information should also be read in conjunction with "Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
We intend for the following discussion to provide you with information that will assist you in understanding our financial statements, the changes in key items in those financial statements from year to year and the primary factors that accounted for those changes, as well as how particular accounting principles affect our financial statements. This discussion also provides information about the financial results of the various segments of our business so you may better understand how those segments and their results affect our financial condition and results of operations as a whole. Finally, we have identified and discussed trends known to management that we believe are likely to have a material effect on our results of operations and financial condition.
This discussion should be read in conjunction with our financial statements and the notes accompanying those financial statements included elsewhere in this Annual Report on Form 10-K. You are also urged to consider the information under the caption "Summary of Critical Accounting Policies." In addition to historical financial information, the following management's discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our results and the timing of selected events may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under “Item 1A. Risk Factors” and elsewhere in this Annual Report on Form 10-K.
Summary
We are the world's largest specialty retailer and wholesale distributor of leather and leathercraft-related items. Our operations are centered on operating retail and wholesale stores. We have built our business by offering our customers quality products in one location at competitive prices. The key to our success is our ability to grow our base business. We grow that business by opening new locations and by increasing sales in our existing locations. We intend to continue to expand both domestically and internationally.
We operate in three segments. Wholesale Leathercraft, consisting of our Leather Factory-branded stores, is our oldest segment with sales of $25.4 million in 2016. Sales in 2016 declined 5% compared to 2015, with the same stores’ sales decreasing 3%. We temporarily closed one Leather Factory store in 2016, which we reopened in January 2017.
Tandy Leather has long been known for its retail leathercraft store chain. These retail stores comprise our Retail Leathercraft segment. This segment, with our largest source of revenue, has historically experienced the greatest increases in sales, although sales had a modest decline of approximately $44,100 from 2015 to 2016. We expect to grow the number of stores to approximately 150 in the future from 84 stores in operation at the end of 2016. Our pace of store openings has recently picked up due to a change in strategy with a focus on growth. In 2017, we expect to open three or four more stores domestically.
Our International Leathercraft segment consists of company-owned stores located outside of North America. At December 31, 2016, four combination retail/wholesale stores, with two located in the United Kingdom, and one each in Australia and Spain, comprised this segment. It is our intention to open more stores in this segment once we have a sufficient customer base to support additional stores although no time frame has been set yet.
On a consolidated basis, gross profit margin (a key indicator of costs as a percent of total net sales) increased to 62.4% in 2016 from 61.9% in 2015. Operating expenses decreased at a slower pace than that of sales in 2016, decreasing 0.4% from 2015, while operating expenses increased at a faster pace than that of sales in 2015, increasing by 4% from 2014.
We reported consolidated net income for 2016 of $6.4 million. Consolidated net income for 2015 and 2014 was $6.4 million and $7.7 million, respectively. We use our cash flow to fund our operations, to fund the opening of new stores and to purchase necessary property and equipment. We paid one-time dividends in 2014 to our stockholders, totaling $2.5 million. At the end of 2016, our stockholders’ equity had increased to $53.7 million from $51.0 million the previous year.
Comparing the December 31, 2016 balance sheet with the prior year’s balance sheet, we decreased our investment in inventory from $33.6 million to $33.2 million while total cash increased from $11.0 million to $16.9 million.
Net Sales
Net sales for the three years ended December 31, 2016 were as follows:
Our net sales decreased by 1.5% in 2016 when compared with 2015 and increased by 0.9% in 2015 when compared with 2014. In 2016, our International Leathercraft segment reported sales increases compared to the prior year while our Wholesale and Retail Leathercraft segments reported a sales decline. The decline in sales in our Wholesale Leathercraft segment was due to a 3% decline in same store sales, plus the temporary closure of one of our stores. The decline in sales in our Retail Leathercraft segment was primarily due to the closure of two stores, partially offset by the four new store openings, as same store sales had only a modest improvement. The increase in sales in our International Leathercraft segment was primarily due to the full year impact of the UK store opened in October 2015, offset by the change in UK foreign currency rates between 2016 and 2015.
In 2015, our Retail segment reported a sales increase compared to the prior year, while our Wholesale segment reported a sales decrease due to the elimination of our national account customer group and our International segment reported a sales decrease due to a change in the foreign currency rates between 2015 and 2014.
Costs and Expenses
In general, our gross profit as a percentage of sales (our gross margin) fluctuates based on the mix of customers we serve, the mix of products we sell, and our ability to source products globally. Our negotiations with suppliers for lower pricing are an on-going process, for which we have varying degrees of success. Sales to retail customers tend to produce higher gross margins than sales to wholesale customers due to the difference in pricing levels. Therefore, as retail sales increase in the overall sales mix, higher gross margins tend to follow. Finally, there is significant fluctuation in gross margins between the various merchandise categories we offer. As a result, our gross margins can vary depending on the mix of products sold during any given time period.
For 2016, our cost of sales decreased as a percentage of total net sales when compared to 2015, resulting in an increase in consolidated gross profit margin from 61.9% to 62.4%. For 2015, our cost of sales increased slightly as a percentage of total net sales when compared to 2014, resulting in a decrease in consolidated gross profit margin from 62.5% to 61.9%. Fluctuations in gross margin are primarily due to customer mix and product mix. Wholesale sales are at a lower gross margin than that of retail sales. Leather sales are at a lower gross margin than that of non-leather sales. Therefore, as wholesale sales increase at a faster pace than that of retail sales, or we sell a higher percentage of leather compared to non-leather, our gross margin decreases accordingly.
Our gross margins for the three years ended December 31, 2016 were as follows:
Our operating expenses increased as a percentage of total net sales to 49.9% in 2016 when compared with 49.4% in 2015. This increase indicates that our operating expenses declined slower than our sales decline during this period. 2016 operating expenses were $0.2 million lower than those of 2015. Significant expense fluctuations in 2016 compared to 2015 are as follows:
The decrease in employee compensation is primarily due to a decrease in management bonus, offset by an increase in employee wages and headcount at the stores. For 2017, we expect that employee compensation will increase because our store manager base pay increased by 40% late in the fourth quarter of 2016 to comply with the expected FLSA overtime rules which have since been delayed. We have also added new level of middle management (district managers) in the field while reducing several store operation positions at our corporate office.
Advertising and marketing expenses decreased due to a decrease in trade shows attended, while the increase in rent and utilities is the result of store relocations in 2015, as well as the new stores that opened in 2016. We reduced spending on our discretionary expenses including store move, travel and other outside services. We expect that our travel costs will increase in 2017 with the addition of middle management in the field.
Our operating expenses increased as a percentage of total net sales to 49.4% in 2015 when compared with 48.3% in 2014. This increase indicates that our operating expenses grew faster than our sales during this period. 2015 operating expenses were $1.4 million higher than those of 2014. Significant expense fluctuations in 2015 compared to 2014 are as follows:
The increase in employee compensation is due primarily to an increase in the cost of employee benefits and an increase in employee headcount at the stores. Advertising and marketing expenses rose due to an increase in trade shows attended. The increase in rent and utilities expense is the result of the relocations of selected stores into larger space.
Other Income/Expense (net)
Other Income/Expense consists primarily of currency exchange fluctuations, interest income, and interest expense. In 2016, we incurred other expenses (net) of approximately $98,000 compared to other expenses (net) of approximately $256,000 in 2015. In 2016, we earned approximately $4,000 in interest income on our cash and paid approximately $155,000 in interest expense on our bank debt. We had a currency exchange gain of approximately $19,000 in 2016 compared to a currency exchange gain of approximately $24,000 in 2015.
In 2015, we incurred other expenses (net) of approximately $256,000 compared to other expenses (net) of approximately $150,000 in 2014. In 2015, we received approximately $7,000 in gas royalties, earned approximately $3,000 in interest income on our cash and paid approximately $330,000 in interest expense on our bank debt. We had a currency exchange gain of approximately $24,000 in 2015 compared to a currency exchange loss of approximately $13,000 in 2014.
Net Income
During 2016, we earned net income of $6.4 million, which is equal to our net income in 2015. Net income did not change because the decrease in sales were offset by decreases in cost of goods sold, operating expenses and interest expense.
During 2015, we earned net income of $6.4 million, a 17% decrease from our net income of $7.7 million earned during 2014. The decrease in net income was the result of the increase in cost of goods sold and operating expenses, partially offset by the increase in sales.
Wholesale Leathercraft
The increases (or decreases) in net sales, operating income and operating income as a percentage of sales from our Wholesale Leathercraft stores for the three years ended December 31, 2016 were as follows:
Wholesale Leathercraft, consisting of 27 wholesale stores in 2016 accounted for 30.6% of our consolidated net sales in 2016, which compares to 31.8% in 2015 and 32.7% in 2014. The decrease in this division's contribution to our total net sales is the result of the growth in Retail Leathercraft. We expect this trend to continue as we intend to open additional stores in our Retail Leathercraft segment.
Our sales mix by customer group in the Wholesale Leathercraft division was as follows:
In 2016, operating income as a percentage of sales increased from the prior year of 17.4% to 20.7%. Operating expenses decreased approximately $1.1 million in 2016 compared to 2015. The primary reason for the operating expense decrease was the decrease in the cost associated with our employee health benefit program, as well as decrease in advertising and marketing expenses, travel, store moves and other outside services.
In 2015, operating income as a percentage of sales declined from the prior year of 19.1% to 17.4%. Operating expenses increased approximately $822,000 in 2015 compared to 2014. The primary reason for the operating expense increase was the increase in the cost associated with our employee health benefit program and advertising and marketing expenses.
Retail Leathercraft
The increases (or decreases) in net sales, operating income and operating income as a percentage of sales from our Retail Leathercraft stores for the three years ended December 31, 2016 were as follows:
Reflecting the growth previously discussed, Retail Leathercraft accounted for 64.7% of our total net sales in 2016, up from 63.8% in 2015 and 62.1% in 2014. Growth in net sales for our Retail Leathercraft division in 2016 resulted from a modest increase in same store sales and new stores opened, offset by two stores closed.
Our sales mix by customer group in the Retail Leathercraft division was as follows:
Operating income as a percentage of sales in 2016 decreased to 9.3% compared to 10.6% for 2015 due to an increase in operating expenses. Gross margin was flat at 58.2% between 2016 and 2015, and decreased from 59.6% in 2014 to 58.2% in 2015. Operating expenses as a percentage of sales increased from 47.6% in 2015 to 48.9% in 2016, primarily due to the new stores’ occupancy costs, plus higher overall rent expense from 2015 store relocations.
Operating income as a percentage of sales in 2015 decreased to 10.6% compared to 11.7% for 2014 due to an increase in operating expenses, partially offset by an increase in gross profit margin. Gross margin decreased from 59.6% in 2014 to 58.2% in 2015. Operating expenses as a percentage of sales decreased minimally from 47.9% in 2014 to 47.6% in 2015 as operating expenses grew at a slightly slower pace in 2015 than that of sales.
We intend to continue the disciplined expansion of our store chain over the next several years, with plans to open three to four new stores in 2017 in North America. We remain committed to a conservative expansion plan for this division that is intended to minimize risks to our profits and maintain our financial stability. We may change our plans for store openings in 2017 and beyond if we determine that the feasibility of additional successful openings is likely.
International Leathercraft
International Leathercraft consists of all stores located outside of North America. As of December 31, 2016, that represents four retail/wholesale combination stores with two located in the United Kingdom, one located in Australia, and one located in Spain. International Leathercraft accounted for 4.7%, 4.4%, and 5.2% of our total sales in 2016, 2015, and 2014, respectively. We opened the second store in the United Kingdom in October 2015 and expect this segment to become a larger part of our total operations as our international customer base continues to grow.
The increases (or decreases) in net sales, operating income and operating income as a percentage of sales from our International Leathercraft stores for the three years ended December 31, 2016 were as follows:
Operating income as a percentage of sales decreased to 2.0% for 2016 compared to 3.3% for 2015. Gross margin increased from 60.5% in 2015 to 61.8% in 2016. Operating expenses as a percentage of sales in 2016 increased from 57.2% in 2015 to 59.8% in 2016 as operating expenses grew at a faster pace in 2016 than that of sales. The change in foreign currency exchange rates from 2015 to 2016, primarily in the UK, and the performance our stores in Europe are the primary causes of the decline in this segment.
Operating income as a percentage of sales decreased to 3.3% for 2015 compared to 13.4% for 2014. Gross margin decreased from 65.7% in 2014 to 60.5% in 2015. Operating expenses as a percentage of sales in 2015 increased from 52.3% in 2014 to 57.2% in 2015 as operating expenses grew at a faster pace in 2015 than that of sales. The change in foreign currency exchange rates from 2014 to 2015 and the expenses associated with the opening of the new store in the fourth quarter of 2015 was the primary cause of the significant decline in performance of this segment’s operating income.
We may expand our International Leathercraft segment by opening new stores once the current stores have sufficiently built their customer bases to a level that will adequately support additional stores.
Financial Condition
At December 31, 2016, we held $16.9 million of cash, $33.2 million of inventory, and $15.7 million of net property and equipment. Total assets were $70.6 million. Current liabilities were $8.2 million, while long-term debt was $6.8 million. Total stockholders’ equity at the end of 2016 was $53.7 million.
At December 31, 2015, we held $11.0 million of cash, $33.6 million of inventory, and $15.7 million of net property and equipment. Total assets were $64.6 million. Current liabilities were $8.3 million, while long-term debt was $3.6 million. Total stockholders’ equity at the end of 2015 was $51.0 million.
Specific ratios on a consolidated basis at December 31 were as follows:
Capital Resources and Liquidity
On September 18, 2015, we executed a Promissory Note and Business Loan Agreement with BOKF, NA dba Bank of Texas (“BOKF”), which provides us with a line of credit facility of up to $6,000,000 and is secured by our inventory. On August 25, 2016, this line of credit was amended to extend the maturity from September 18, 2017 to September 18, 2018. The Business Loan Agreement contains covenants that we will maintain a funded debt to EBITDA ratio of no greater than 1.5 to 1, and that we will maintain a Fixed Charge Coverage Ratio greater than or equal to 1.2 to 1. Both ratios are calculated quarterly and are based on a trailing four quarter basis.
Also on September 18, 2015, we executed a Promissory Note with BOKF, which provides us with a line of credit facility of up to $10,000,000 for the purpose of purchasing our common stock. On August 25, 2016, this line of credit was amended to increase the availability from $10,000,000 to $15,000,000 for the purchase of shares of our common stock through the earlier of August 25, 2017 or the date on which the entire amount is drawn. During this time period, we will make monthly interest-only payments. At the end of this time period, 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. For the year ended December 31, 2016, we drew approximately $3.7 million on this line of credit which was used to purchase approximately 520,500 shares of our common stock. At December 31, 2016, the unused portion of the line of credit was approximately $7.6 million.
Amounts drawn under either Promissory Note accrue interest at the London interbank Eurodollar market rate for U.S. dollars (commonly known as “LIBOR”) plus 1.85% (2.557% and 2.263% at December 31, 2016 and December 31, 2015, respectively).
On July 31, 2007, we entered into a Credit Agreement and Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a credit facility of up to $5,500,000 to facilitate our purchase of real estate consisting of a 191,000 square foot building situated on 30 acres of land located at 1900 SE Loop 820 in Fort Worth, Texas. Proceeds in the amount of $4,050,000 were used to fund the purchase of the property that is our corporate headquarters. On April 30, 2008, the principal balance was rolled into a 10-year term note with an interest rate of 7.10% per annum. We paid this note in full in September 2015 and as a result of the early payoff, we incurred a prepayment penalty in the amount of $200,000 which was included in interest expense in the third quarter of 2015.
On July 12, 2012, we executed a Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a revolving credit facility of up to $4 million, which was subsequently increased to $6 million. The note expired on September 30, 2015. There was no balance owed on the line of credit at the expiration date.
Our primary source of liquidity and capital resources during 2016 was cash flow provided by operating activities. Net cash flow from operations for 2016, 2015, and 2014 was approximately $7.5 million, $8.2 million, and $1.2 million, respectively. The decrease in operating cash flow in 2014 was due to an intentional increase in inventory.
Inventory decreased slightly from $33.6 million at the end of 2015 to $33.2 million at December 31, 2016. We attempt to manage our inventory levels to avoid tying up excessive capital while maintaining sufficient inventory in order to service our current customer demand as well as plan for our expected expansion. We ended the year with our total inventory on hand matching that of our internal targets for optimal inventory.
Consolidated inventory turned 2.48 times during 2016, a slight decline from the 2015 turns at 2.53 times. We compute our inventory turnover rates as sales divided by average inventory.
By operating division, inventory turns are as follows:
Retail and International Leathercraft inventory turns are significantly higher than that of Wholesale Leathercraft because their inventories consist only of the inventories at the stores. These segments have no warehouse (back stock) inventory to include in the turnover computation as all stores get their product from the central warehouse, which is included in the Wholesale Leathercraft segment. Wholesale Leathercraft’s turns are expected to be slower because the central warehouse inventory is part of this segment, and its inventory is held as the back stock for all of the stores.
Accounts payable totaled $1.6 million at the end of 2016, a decrease of $361,000 from $2.0 million at the end of 2015, primarily due to timing of check disbursements.
Capital expenditures totaled $1.7 million in 2016 and $2.2 million in each of 2015 and 2014, primarily related to store fixtures and computer equipment for new, moved or remodeled stores. In 2016, we opened 4 new U.S. stores and moved/remodeled 4 other stores in North America. In 2015, we opened one new store in Manchester, United Kingdom and moved/remodeled 12 stores in North America. In 2014, we opened 3 new U.S. stores and moved/remodeled 8 other stores in North America.
For 2017, we intend to open three or four more stores in North America. Computer equipment replacements will continue on an as-needed basis as the existing equipment becomes obsolete. Other plans for 2017 include partial replacement of the roof at our corporate offices as well as infrastructure related to our new district managers As such, we expect our 2017 capital expenditures will increase over 2016 capital expenditures.
In 2016, we repurchased approximately 520,500 shares of our stock, at an average price of $7.06, totaling $3.7 million. In 2015, we repurchased approximately 529,000 shares of our stock, at an average price of $7.01, totaling $3.7 million for 2015. There were no stock repurchases in 2014.
We believe that cash flow from operations will be adequate to fund our operations in 2017, while also funding our expansion plans. At this time, we know of no trends or demands, commitments, events, or uncertainties that will or are likely to materially affect our liquidity, capital resources or results of operations. In addition, we anticipate that this cash flow will enable us to meet our contractual obligations and commercial commitments. We could defer expansion plans if required by unanticipated drops in cash flow. In particular, because of the relatively small investment required by each new store, we have flexibility in when we make most expansion expenditures.
Off-Balance Sheet Arrangements
We did not have any off-balance sheet arrangements during 2016, 2015, or 2014, and we do not currently have any such arrangements.
Contractual Obligations
The following table summarizes by years our contractual obligations and commercial commitments as of December 31, 2016 (not including related interest expense):
____________________
(1)
Our stock purchase loan from Bank of Texas matures September 2021.
(2)
Our line of credit from Bank of Texas matures September 2018.
(3)
Our capital lease obligation with Cisco Systems Capital Corporation matures January 2018.
(4)
These are our leased store facilities.
Summary of Critical Accounting Policies
We strive to report our financial results in a clear and understandable manner, although in some cases accounting and disclosure rules are complex and require us to use technical terminology. We follow generally accepted accounting principles in the U.S. in preparing our consolidated financial statements which require us to make estimates and assumptions that affect our financial position and results of operations. We continually review our accounting policies, how they are applied, and how they are reported and disclosed in our financial statements. Following is a summary of our more significant accounting policies.
Revenue Recognition. We recognize revenue for over the counter sales as transactions occur and other sales upon shipment of our products, provided that there are no significant post-delivery obligations to the customer and collection is reasonably assured, which generally occurs upon shipment. Net sales represent gross sales less negotiated price allowances, product returns, and allowances for defective merchandise.
Inventory. Inventory is stated at the lower of cost or market and is accounted for on the “first in, first out” method. This means that sales of inventory treat the oldest item of identical inventory as being the first sold. In addition, we regularly reduce the value of our inventory for slow-moving or obsolete inventory. This reduction is based on our review of items on hand compared to their estimated future demand. If actual future demand is less favorable than what we project, additional write-downs may be necessary. Goods shipped to us are recorded as inventory owned by us when the risk of loss shifts to us from the supplier.
Impairment of Long-Lived Assets. We evaluate long-lived assets for indicators of impairment whenever events or changes in circumstances indicate their carrying amounts may not be recoverable. Additionally, for store assets, we evaluate the performance of individual stores for indicators of impairment and underperforming stores are selected for further evaluation of the recoverability of the carrying amounts. The evaluation of long-lived assets is performed at the lowest level of identifiable cash flows, which is at the individual store level. Impairment is determined when estimated future undiscounted cash flows associated with an asset are less than the asset’s carrying value. To date, we have not recognized any impairment of our long-lived assets.
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 recovery is deemed not likely, 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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We face exposure to financial market risks, as described below. These exposures may change over time and could have a material impact on our financial results. We do not use or invest in market risk sensitive instruments to hedge any of these risks or for any other purpose.
Foreign Currency Risk. Our primary foreign currency exposure is related to our foreign subsidiaries as those subsidiaries have local currency revenue and local currency operating expenses. Changes in the foreign currency exchange rates impact the U.S. dollar amount of revenue and expenses. See Note 12 to the Consolidated Financial Statements, Segment Information, for financial information concerning our foreign activities.
Interest Rate Risk. We are subject to market risk associated with interest rate movements on our outstanding debt which accrue interest at a rate that changes with fluctuations in the LIBOR rate. Based on the Company's level of debt at December 31, 2016, increase of one percent in the LIBOR rate would result in additional interest expense of approximately $74,000 during a twelve-month period.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Tandy Leather Factory, Inc.
Consolidated Balance Sheets
The accompanying notes are an integral part of these financial statements.
Tandy Leather Factory, Inc.
Consolidated Statements of Comprehensive Income
For the Years Ended December 31,
The accompanying notes are an integral part of these financial statements.
Tandy Leather Factory, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31,
The accompanying notes are an integral part of these financial statements.
Tandy Leather Factory, Inc.
Consolidated Statements of Stockholders' Equity
For the Years Ended December 31,
The accompanying notes are an integral part of these financial statements.
TANDY LEATHER FACTORY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 2016, 2015, and 2014
1. DESCRIPTION OF BUSINESS
Our primary line of business is the sale of leather, leather crafts, and related supplies. We sell our products via company-owned stores throughout the United States, Canada, the United Kingdom, Australia, and Spain. Numerous customers including retailers, wholesalers, assemblers, distributors, and other manufacturers are geographically disbursed throughout the world. We also have light manufacturing facilities in Texas.
2. SIGNIFICANT ACCOUNTING POLICIES
·
Management estimates and reporting
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates. Assets and liabilities with reported amounts based on significant estimates include trade accounts receivable, inventory (slow-moving), goodwill, and deferred income taxes.
·
Principles of consolidation
Our consolidated financial statements include the accounts of Tandy Leather Factory, Inc. and its wholly owned subsidiaries, The Leather Factory, L.P. (a Texas limited partnership) and its corporate partners, Tandy Leather Company, L.P. (a Texas limited partnership) and its corporate partners, Mid-Continent Leather Sales, Inc. (an Oklahoma corporation), Roberts, Cushman & Company, Inc. (a Texas corporation), The Leather Factory of Canada, Ltd. (a Canadian corporation), Tandy Leather Factory UK Limited (a UK corporation), Tandy Leather Factory Australia Pty. Limited (an Australian corporation), and Tandy Leather Factory España, S.L. (a Spanish corporation). All intercompany accounts and transactions have been eliminated in consolidation.
·
Foreign currency translation and transactions
Foreign currency translation adjustments arise from activities of our foreign subsidiaries. Results of operations are translated into U.S. dollars using the average exchange rates during the period, while assets and liabilities are translated using period-end exchange rates. Foreign currency translation adjustments of assets and liabilities are recorded in stockholders’ equity. Gains and losses resulting from foreign currency transactions are reported in the statements of income under the caption “Other (Income) Expense”, net, for all periods presented. We recognized foreign currency transaction gains (losses) of $19,000, $24,000, and ($13,900), in 2016, 2015, and 2014, respectively.
·
Revenue recognition
Our sales generally occur via two methods: (1) at the store counter, and (2) shipment by common carrier. Sales at the counter are recorded and title passes as transactions occur. Otherwise, sales are recorded and title passes when the merchandise is shipped to the customer. Shipping terms are normally FOB shipping point. Sales tax and comparable foreign tax is excluded from revenue.
We offer an unconditional satisfaction guarantee to all customers and accept all product returns. Net sales represent gross sales less negotiated price allowances, product returns, and allowances for defective merchandise.
·
Discounts
We maintain four price levels on a consistent basis: retail, wholesale, business, and distributor. Gross sales are reported after deduction of discounts. We do not pay slotting fees or make other payments to resellers.
·
Expense categories
Cost of goods sold includes inbound freight and duty charges from vendors to our central warehouse, freight and handling charges to move merchandise from our central warehouse to our stores, and manufacturing overhead, as appropriate.
Operating expenses include all selling, general and administrative costs including wages and related employee expenses (payroll taxes, health benefits, savings plans, etc.), advertising, outbound freight charges (to ship merchandise to customers), rent, and utilities.
·
Property and equipment, net of accumulated depreciation and amortization
Property and equipment are stated at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are three to ten years for equipment and machinery, seven to fifteen years for furniture and fixtures, five years for vehicles, and forty years for buildings and related improvements. Leasehold improvements are amortized over the lesser of the life of the lease or the useful life of the asset. Repairs and maintenance costs are expensed as incurred.
·
Inventory
Inventory is valued at the lower of first-in, first-out cost or market. In addition, the value of inventory is periodically reduced to net realizable value for slow-moving or obsolete inventory based on management's review of items on hand compared to their estimated future demand.
·
Impairment of long-lived assets
We evaluate long-lived assets for indicators of impairment whenever events or changes in circumstances indicate their carrying amounts may not be recoverable. Additionally, for store assets, we evaluate the performance of individual stores for indicators of impairment and underperforming stores are selected for further evaluation of the recoverability of the carrying amounts. The evaluation of long-lived assets is performed at the lowest level of identifiable cash flows, which is at the individual store level. Impairment is determined when estimated future undiscounted cash flows associated with an asset are less than the asset’s carrying value.To date, we have not recognized any impairment of our long-lived assets.
·
Earnings per share
Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period. Diluted earnings per share includes, to the extent inclusion of such shares would be dilutive to earnings per share, the effect of outstanding options and warrants, computed using the treasury stock method.
For additional disclosures regarding the restricted stock awards and the employee stock options, see Note 11. The net effect of converting stock options and restricted stock grants to purchase 90,085, 68,400, and 107,001 shares of common stock at option prices less than the average market prices has been included in the computations of diluted EPS for the years ended December 31, 2016, 2015, and 2014, respectively.
·
Goodwill and other intangibles
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Goodwill is required to be evaluated for impairment on an annual basis, absent indicators of impairment during the interim. Application of the goodwill impairment test requires exercise of judgment, including the estimation of future cash flows, determination of appropriate discount rates and other important assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit. Goodwill is not amortized, but is evaluated at least annually for impairment. We completed our annual goodwill impairment analysis as of December 31 for each of the years ended December 31, 2016, 2015, and 2014 and determined that no adjustment to the carrying value of goodwill was required.
A summary of changes in our goodwill is as follows:
Our intangible assets and related accumulated amortization consisted of the following:
Excluding goodwill, we have no intangible assets not subject to amortization under U.S. GAAP. Amortization of intangible assets of $6,442 in 2016, $40,744 in 2015, and $45,202 in 2014 was recorded in operating expenses. The weighted average amortization period is 15 years for trademarks and copyrights. Based on the current amount of intangible assets subject to amortization, we estimate amortization expense as follows for the next five years:
·
Fair value of financial Instruments
We measure fair value as an exit price, which is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, accounting standards establish a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:
Level 1 - observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2 - include other inputs that are directly or indirectly observable in the marketplace.
Level 3 - significant unobservable inputs which are supported by little or no market activity.
Classification of the financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.
Our principal financial instruments held consist of certificates of deposit, accounts receivable, accounts payable, notes payable, and long-term debt. The carrying value of certificates of deposit, accounts receivable and accounts payable approximate their fair value due to the relatively short-term nature of the accounts. The terms of the long-term debt are considered reasonable for this type of financing; therefore, the carrying amount approximates fair value.
·
Income taxes
We account for income taxes using the asset and liability method. Under this method, the amount of taxes currently payable or refundable is accrued, and deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences that currently exist between the tax basis and the financial reporting basis of our assets and liabilities.
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 position 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 judgment 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 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.
·
Share-based compensation
We have one stock option plan which permits annual stock option grants to non-employee directors with an exercise price equal to the fair market value of the shares at the date of grant and with a ten year term. These options vest and become exercisable six months from the option grant date. Under this plan, no stock options were awarded in 2016, 2015 or 2014, therefore, we did not recognize any share based compensation expense for these options during those periods.
We also have a restricted stock plan that was adopted by our Board of Directors in January 2013 and approved by our stockholders in June 2013. The plan reserves up to 300,000 shares of our common stock for restricted stock awards to our executive officers, non-employee directors, and other key employees. Awards granted under the plan may be stock awards or performance awards, and may be subject to a graded vesting schedule with a minimum vesting period of four years. The fair value of nonvested restricted common stock awards is the market value of our common stock on the date of grant. Compensation costs for these awards will be recognized on a straight-line basis over the four year vesting period.
·
Comprehensive income
Comprehensive income includes net income and certain other items that are recorded directly to Stockholders’ Equity. The Company’s only source of other comprehensive income is foreign currency translation adjustments.
·
Shipping and handling costs
All shipping and handling costs incurred by us are included in operating expenses on the statements of income. These costs totaled approximately $1,982,000, $2,012,000, and $2,046,000 for the years ended December 31, 2016, 2015, and 2014, respectively.
·
Advertising
With the exception of catalog costs, advertising costs are expensed as incurred. Catalog costs are capitalized and expensed over the estimated useful life of the particular catalog in question, which is typically twelve to eighteen months. Such capitalized costs are included in other current assets and totaled $213,000 and $181,000 at December 31, 2016 and 2015, respectively. Total advertising expense was $4,759,000 in 2016; $4,826,000 in 2015; and $4,339,000 in 2014.
·
Cash flows presentation
For purposes of the statement of cash flows, we consider all highly liquid investments with initial maturities of three months or less from the date of purchase to be cash equivalents.
·
Reclassifications
Certain reclassifications have been made to the prior year financial statements to conform to the current year presentation.
3. VALUATION AND QUALIFYING ACCOUNTS
·
Allowance for uncollectible accounts
We maintain allowances for bad debts based on factors such as the composition of accounts receivable, the age of the accounts, historical bad debt experience, and our evaluation of the financial condition and past collection history of each customer. Write-offs have historically not been material, but are evaluated for write off as they are deemed uncollectible based on a periodic review of accounts. Our allowance for doubtful accounts was approximately $2,400 and $1,700 at December 31, 2016 and 2015, respectively.
·
Sales returns and defective merchandise
Product returns are generally recorded directly against sales as those returns occur. Historically, the amount of returns is immaterial and as a result, no reserve is recorded in the financial statements.
·
Slow-moving and obsolete inventory
The majority of inventory items maintained by us have no restrictive shelf life. We review all inventory items annually to determine what items should be eliminated from the product line. Items are selected for several reasons: (1) the item is slow-moving; (2) the supplier is unable to provide an acceptable quality or quantity; or (3) to maintain a freshness in the product line. Reductions in inventory for slow-moving and obsolete inventory are recorded directly against inventory.
4. BALANCE SHEET COMPONENTS
Depreciation expense was $1,717,548, $1,520,385, and $1,391,422 for the years ended December 31, 2016, 2015, and 2014, respectively.
Loss (gain) from abandonment and/or disposal of assets, which is included in operating expenses, is as follows, by segment:
5. NOTES PAYABLE AND LONG-TERM DEBT
On September 18, 2015, we executed a Promissory Note and Business Loan Agreement with BOKF, NA dba Bank of Texas (“BOKF”), which provides us with a line of credit facility of up to $6,000,000 and is secured by our inventory. On August 25, 2016, this line of credit was amended to extend the maturity from September 18, 2017 to September 18, 2018. The Business Loan Agreement contains covenants that we will maintain a funded debt to EBITDA ratio of no greater than 1.5 to 1 and that we will maintain a Fixed Charge Coverage Ratio greater than or equal to 1.2 to 1. Both ratios are calculated quarterly and are based on a trailing four quarter basis.
Also on September 18, 2015, we executed a Promissory Note with BOKF, which provides us with a line of credit facility of up to $10,000,000 for the purpose of purchasing our common stock. On August 25, 2016, this line of credit was amended to increase the availability from $10,000,000 to $15,000,000 for the purchase of shares of our common stock through the earlier of August 25, 2017 or the date on which the entire amount is drawn. During this time period, we will make monthly interest-only payments. At the end of this time period, 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. During the year ended December 31, 2016, we drew approximately $3.7 million on this line of credit which was used to purchase approximately 520,500 shares of our common stock. At December 31, 2016, the unused portion of the line of credit was approximately $7.6 million.
Amounts drawn under either Promissory Note accrue interest at the London interbank Eurodollar market rate for U.S. dollars (commonly known as “LIBOR”) plus 1.85% (2.557% and 2.263% at December 31, 2016 and December 31, 2015, respectively).
On July 31, 2007, we entered into a Credit Agreement and Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a credit facility of up to $5,500,000 to facilitate our purchase of real estate consisting of a 191,000 square foot building situated on 30 acres of land located at 1900 SE Loop 820 in Fort Worth, Texas. Proceeds in the amount of $4,050,000 were used to fund the purchase of the property that is our corporate headquarters. On April 30, 2008, the principal balance was rolled into a 10-year term note with an interest rate of 7.10% per annum. We paid this note in full in September 2015 and as a result of the early payoff, we incurred a prepayment penalty in the amount of $200,000 which was included in interest expense in the third quarter of 2015.
On July 12, 2012, we executed a Line of Credit Note with JPMorgan Chase Bank, N.A., for a revolving credit facility of up to $4 million, which was subsequently increased to $6 million. The note expired on September 30, 2015. There was no balance owed on the line of credit at the expiration date.
At December 31, the amount outstanding under the above agreements consisted of the following:
The terms of the above lines of credit contain various covenants for which we were in compliance as of December 31, 2016 and 2015.
Scheduled maturities of the Company’s notes payable and long-term debt are as follows:
6. CAPITAL LEASE OBLIGATIONS
We lease certain telecommunication equipment under a capital lease agreement. The asset subject to the agreement totaled $227,783, of which $210,904 and $22,152 was included in Property and Equipment at December 31, 2016 and 2015, respectively, and $16,879 and $205,631 which was included in Prepaid Equipment (not placed in service) as of December 31, 2016 and 2015, respectively. Accumulated depreciation on the assets placed in service December 31, 2016 and 2015 were approximately $21,400 and $300, respectively. Amortization of the capitalized cost is charged to depreciation expense.
At December 31, the amounts outstanding under capital lease obligation consisted of the following:
7. EMPLOYEE BENEFIT AND SAVINGS PLANS
We have a 401(k) plan to provide retirement benefits for our employees. As allowed under Section 401(k) of the Internal Revenue Code, the plan provides tax-deferred salary contributions for eligible employees and allows employees to contribute a percentage of their annual compensation to the plan on a pretax basis. Employee contributions are limited to a maximum annual amount as set periodically by the Internal Revenue Code. In 2016, 2015, and 2014, we matched 100% of the pretax employee contributions on the first 3% of eligible earnings and 50% of the pretax employee contributions on the next 2% of eligible earnings that are contributed by employees.
* Due to the annual limit on eligible earnings imposed by the Internal Revenue Code
The plan allows employees who meet the age requirements and reach the plan contribution limits to make a catch-up contribution. The catch-up contributions are not eligible for matching contributions. In addition, the plan provides for discretionary matching contributions as determined by the Board of Directors. There were no discretionary matching contributions made in 2016, 2015, or 2014.
We currently offer no postretirement or postemployment benefits to our employees.
8. INCOME TAXES
The provision for income taxes consists of the following:
Income before income taxes is earned in the following tax jurisdictions:
The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities are as follows:
The effective tax rate differs from the statutory rate as follows:
We file a consolidated U.S. income tax return as well as state tax returns on a consolidated, combined, or stand-alone basis, depending on the jurisdiction. We are no longer subject to U.S. federal income tax examinations by tax authorities for years prior to the tax year ended December 2014. Depending on the jurisdiction, we are no longer subject to state examinations by tax authorities for years prior to the December 2013 and December 2014 tax years.
9. COMMITMENTS AND CONTINGENCIES
Operating Leases
We lease our store locations under lease agreements that expire on dates ranging from February 2017 to February 2026. Rent expense on all operating leases for the years ended December 31, 2016, 2015, and 2014, was $4,189,225, $3,844,641, and $3,675,788, respectively.
Future minimum lease payments under noncancelable operating leases at December 31, 2016 were as follows:
Legal Proceedings
We are periodically involved in various other litigation that arises in the ordinary course of business and operations. There are no such matters pending that we expect to have a material impact on our financial position and operating results. Legal costs associated with the resolution of claims, lawsuits, and other contingencies are expensed as incurred.
10. SIGNIFICANT BUSINESS CONCENTRATIONS AND RISK
Major Customers
Our revenues are derived from a diverse group of customers primarily involved in the sale of leathercraft. No single customer accounted for more than 1/2% of our consolidated revenues in 2016, 2015, or 2014 and sales to our five largest customers represented 1.4%, 1.3%, and 1.7%, respectively, of consolidated revenues in those years. While we do not believe the loss of one of these customers would have a significant negative impact on our operations, we do believe the loss of several of these customers simultaneously or a substantial reduction in sales generated by them could temporarily affect our operating results.
Major Vendors
We purchase a significant portion of our inventory through one supplier. Due to the number of alternative sources of supply, loss of this supplier would not have an adverse impact on our operations.
Credit Risk
Due to the large number of customers comprising our customer base, concentrations of credit risk with respect to customer receivables are limited. We do not generally require collateral for accounts receivable, but we do perform periodic credit evaluations of our customers and believe the allowance for doubtful accounts is adequate. It is our opinion that if any one or a group of customer receivable balances should be deemed uncollectable, it would not have a material adverse effect on our results of operations or financial condition.
We maintain our cash in bank deposit accounts that, at times, may exceed federally insured limits. We have not experienced any losses in such accounts. We believe we are not exposed to any significant credit risk on our cash and cash equivalents.
11. STOCKHOLDERS' EQUITY
a)
Stock Option Plan
In connection with its 2007 Director Non-Qualified Stock Option Plan for non-employee directors, there are outstanding options to purchase our common stock. The plan, which terminates in March 2017, provides for the granting of non-qualified options at the discretion of the Compensation Committee of the Board of Directors. Options are granted at the fair market value of the underlying common stock at the date of grant and vest after six months. We have reserved 100,000 shares of common stock for issuance under this plan.
All options expire ten years from date of grant and are exercisable at any time after vesting. Of the 100,000 shares available for issuance, there are 21,400 un-optioned shares available for future grants.
A summary of stock option transactions for the years ended December 31 is as follows:
The following table summarizes all of our outstanding options which are fully vested and exercisable at December 31, 2016:
Other information pertaining to option activity during the twelve month periods ended December 31 are as follows:
As of December 31, 2016, there was no unrecognized compensation cost related to non-vested stock options. Cash received from the exercise of stock options for the years ended December 31, 2016, 2015, and 2014 was $ -, $9,920 and $52,722, respectively. Because we had no awards of stock options in 2016, 2015 and 2014, we were not required to record compensation cost.
We have a restricted stock plan that was adopted by our Board of Directors in January 2013 and approved by our stockholders in June 2013. The plan reserves up to 300,000 shares of our common stock for restricted stock awards to our executive officers, non-employee directors and other key employees. Awards granted under the plan may be stock awards or performance awards, and may be subject to a graded vesting schedule with a minimum vesting period of four years, unless otherwise determined by the committee that administers the plan.
In February 2014, our Chief Executive Officer, Chief Financial Officer, and Senior Vice President were awarded restricted stock grants consisting of 9,375 shares each. In addition, four of our independent directors were awarded restricted stock grants consisting of 1,619 shares each. In February 2015, our Chief Executive Officer, Chief Financial Officer and Senior Vice President were awarded restricted stock grants consisting of 9,344 shares each. In addition, four of our independent directors were awarded restricted stock grants consisting of 1,613 shares each. In March 2016, our Chief Executive Officer and President were awarded restricted stock grants consisting of 11,765 shares each. In addition, five of our independent directors were awarded restricted stock grants consisting of 2,031 shares each. For these grants in 2016, 2015, and 2014, we recognized share based compensation expense of $199,870, $145,321, and $67,818, respectively, as a component of operating expenses.
A summary of the activity for nonvested restricted common stock awards as of December 31, 2016 and 2015 is as follows:
As of December 31, 2016, there was unrecognized compensation cost related to non-vested restricted stock awards of $374,040 which will be recognized in each of the following years as follows:
Of the 300,000 shares available for issuance, there are 197,230 shares available for future awards.
b)
Cash Dividend
On June 9, 2014, our Board of Directors authorized a $0.25 per share special one-time cash dividend to be paid to stockholders of record at the close of business on July 7, 2014. The cash dividend, totaling approximately $2.5 million, was paid to stockholders on August 8, 2014.
Our Board will determine future cash dividends after giving consideration to our then existing levels of profit and cash flow, capital requirements, current and forecasted liquidity, as well as financial and other business conditions existing at the time.
c)
Stockholder Rights Plan
On June 6, 2013, our Board of Directors authorized and declared a dividend of one preferred share purchase right (a “Right”) for each outstanding share of our common stock, par value $0.0024 per share, to stockholders of record at the close of business on June 16, 2013. Each Right entitles the registered holder to purchase from us one one-thousandth of a newly created series of preferred stock at an exercise price of $30.00 per right. The Rights are exercisable in the event any person or group acquires 20% or more of our outstanding common stock (an “Acquiring Person”), or commences a tender offer or exchange offer that would result in such person becoming an Acquiring Person. An exception is included in the Rights Plan in order to ensure that certain owners are not by virtue of their share ownership automatically deemed to be an Acquiring Person upon adoption of the plan unless any such owner subsequently accrues additional shares of our common stock and after giving effect to such acquisition owns 20% or more of our outstanding common stock. The Rights, as amended, will expire at 5:00 P.M. Eastern on June 6, 2017, unless such date is advanced or extended or unless the Rights are earlier redeemed or exchanged by our Board.
d)
Share Repurchase Program
In August 2015, our Board authorized a share repurchase program where we may repurchase up to 1.2 million shares of our common stock through August 2016. On June 7, 2016, the program was amended to increase the number of shares available to purchase from 1.2 million to 2.2 million and to extend the termination date from August 9, 2016 to August 9, 2017. In 2016, we repurchased approximately 520,500 shares of our stock, at an average price of $7.06, totaling $3.7 million. In 2015, we repurchased approximately 529,000 shares of our stock, at an average price of $7.01, totaling $3.7 million. There were no stock repurchases in 2014.
12. SEGMENT INFORMATION
We identify our segments based on the activities of three distinct operations:
a.
Wholesale Leathercraft, which consists of a chain of wholesale stores operating under the name, The Leather Factory, located in North America;
b.
Retail Leathercraft, which consists of a chain of retail stores operating under the name, Tandy Leather Company, located in North America;
c.
International Leathercraft, which sells to both wholesale and retail customers. We have four stores. One store is located in each of Northampton, United Kingdom; Sydney, Australia; Jerez, Spain; and Manchester, United Kingdom which opened in October 2015.
Our reportable operating segments have been determined as separately identifiable business units and we measure segment earnings as operating earnings, defined as income before interest and income taxes.
Net sales by geographic areas were as follows:
Geographic sales information is based on the location of the customer. Except for Canada, we had no sales to any single foreign country that was material to our consolidated net sales for the years ended December 31, 2016, 2015, and 2014. We do not have any significant long-lived assets outside of the United States.
13. RECENT ACCOUNTING PRONOUNCEMENTS
In May 2014, the FASB issued ASU No. 2014-09, which amends ASC Topic 606, “Revenue from Contracts with Customers”. The amendments in this ASU are intended to provide a more robust framework for addressing revenue issues, improve comparability of revenue recognition practices and improve disclosure requirements. The amendments in this accounting standard update are effective for interim and annual reporting periods beginning after December 15, 2016. In April 2015, the FASB issued ASU No. 2015-24, Revenue from Contracts with Customers: Deferral of the Effective Date which proposed a deferral of the effective date by one year, and on July 7, 2015, the FASB decided to delay the effective date by one year. The deferral results in the new revenue standard being effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. We are therefore required to apply the new revenue guidance beginning in our 2018 interim and annual financial statements. This ASU can be adopted either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Entities reporting under U.S. GAAP are not permitted to adopt this standard earlier than the original effective date for public entities (that is, no earlier than 2017 for calendar year-end entities.) We are currently evaluating what impact, if any, the adoption of this guidance will have on our financial condition, results of operations, cash flows and financial disclosures. Based on our procedures to date, we believe that the adoption will not have a material impact to our financial condition, results of operations or cash flows although our disclosures will be expanded. We expect to adopt ASU 2014-09 under the modified retrospective method. Given the nature of our business and that our sales generally occur at the counter or by shipment through common carrier at observable transaction prices with little, if any, variable consideration factors, we do not expect there to be significant changes to the amount and timing of revenue recognition. Finally, while we offer an unconditional right of return to our customers, this has historically been immaterial to our financial condition, results of operations and cash flows (annual gross product returns represent less than 0.5% of our net sales).
In November 2015, the FASB issued ASU 2015-17, which requires all deferred tax assets and liabilities to be classified as non-current on the balance sheet instead of separating deferred taxes into current and non-current amounts. The guidance is effective for annual and interim periods beginning after December 15, 2016, and may be adopted on either a prospective or retrospective basis. We early adopted this guidance on a retrospective basis, and there was no material impact to our financial statements or disclosures in our financial statements.
In February 2016, the FASB issued ASU 2016-02, “Leases”, a comprehensive new standard that amends various aspects of existing accounting guidance for leases, including the recognition of a right of use asset and a lease liability for leases with a duration greater than one year. The guidance is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. We have not completed our review of the new guidance; however, we anticipate that upon adoption of the standard, using a modified retrospective approach, we will recognize additional assets and corresponding liabilities related to leases on our balance sheet.
14. QUARTERLY FINANCIAL DATA (UNAUDITED)
Report of Independent Registered Public Accounting Firm
To the Board of Directors and Stockholders
Tandy Leather Factory, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Tandy Leather Factory, Inc. and Subsidiaries (the Company) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2016. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Tandy Leather Factory, Inc. and Subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with accounting principles generally accepted in the United States of America.
/s/ WEAVER AND TIDWELL, L.L.P.
Fort Worth, Texas
March 27, 2017
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A.
ITEM 9A. CONTROL PROCEDURES
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated 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) as of the end of the period covered by this report. Based upon their evaluation of these disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the date of such evaluation in ensuring that information required to be disclosed in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over our financial reporting. Our internal control system was designed to provide reasonable assurance to our management and our board of directors regarding the reliability of the preparation and fair presentation of our published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
We have assessed the effectiveness of our internal controls over financial reporting as of December 31, 2016. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commissions (COSO) in Internal Control - Integrated Framework. Based on our assessment, we believe that, as of December 31, 2016, our internal control over financial reporting is effective based on that criteria.
This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report on Form 10-K.
Changes in internal control
There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III*
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE*
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION*
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS*
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE*
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES*
* The information required by Items 10, 11, 12, 13, and 14 is or will be set forth in the definitive proxy statement relating to the 2017 Annual Meeting of Stockholders of Tandy Leather Factory, Inc., which is to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. This definitive proxy statement relates to a meeting of stockholders involving the election of directors and the portions therefrom required to be set forth in this Form 10-K by Items 10, 11, 12, 13, and 14 are incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following are filed as part of this Annual Report on Form 10-K:
1. Financial Statements
The following consolidated financial statements are included in Item 8:
·
Consolidated Balance Sheets at December 31, 2016 and 2015
·
Consolidated Statements of Comprehensive Income for the years ended December 31, 2016, 2015, and 2014
·
Consolidated Statements of Cash Flows for the years ended December 31, 2016, 2015, and 2014
·
Consolidated Statements of Stockholders' Equity for the years ended December 31, 2016, 2015, and 2014
2. Financial Statement Schedules
All financial statement schedules are omitted because the required information is not present or not present in sufficient amounts to require submission of the schedule or because the information is reflected in the consolidated financial statements or notes thereto.
3. Exhibits
The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed as part of this Annual Report on Form 10-K.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized.
TANDY LEATHER FACTORY, INC.
By:
/s/ Shannon L. Greene
Shannon L. Greene
Chief Executive Officer
Dated: March 27, 2017
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
___________
*Filed Herewith