-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ITWe1soN7ECOTrENUADa/0filrZZGVXpKv5ezGH0ZgdR50hZEVTSABZqoFrWhNRh zDQUH7NsZjvZlJl1B4KzgA== 0000909724-03-000005.txt : 20030328 0000909724-03-000005.hdr.sgml : 20030328 20030328112800 ACCESSION NUMBER: 0000909724-03-000005 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: LEATHER FACTORY INC CENTRAL INDEX KEY: 0000909724 STANDARD INDUSTRIAL CLASSIFICATION: LEATHER & LEATHER PRODUCTS [3100] IRS NUMBER: 752543540 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-12368 FILM NUMBER: 03623303 BUSINESS ADDRESS: STREET 1: 3847 EAST LOOP STREET 2: 820 SOUTH CITY: FT WORTH STATE: TX ZIP: 76119 BUSINESS PHONE: 8174964414 MAIL ADDRESS: STREET 1: 3847 EAST LOOP STREET 2: 820 SOUTH CITY: FT WORTH STATE: TX ZIP: 76119 10-K 1 doc1.txt SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] For the transition period ________ to ________ Commission File Number 1-12368 THE LEATHER FACTORY, INC. (Exact name of registrant as specified in its charter) Delaware 75-2543540 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NUMBER) 3847 East Loop 820 South Fort Worth, Texas 76119 (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (817) 496-4414 SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ---------------------- ----------------------------------------- Common Stock, par value $.0024 American Stock Exchange SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $9,793,833 at March 11, 2003. At that date there were 10,197,961 shares of Common Stock outstanding. DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Registrant's definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 15, 2003, are incorporated by reference in Part III of this report. 1 PART I ITEM 1. BUSINESS - ------------------ As used in this Report, the terms "we," "us," "our," "TLF," "management," and the "Company" mean The Leather Factory, Inc. and its subsidiaries (unless the context indicates a different meaning). GENERAL The Leather Factory, Inc. is a Delaware corporation whose common stock trades on the American Stock Exchange under the symbol "TLF." The Company was first incorporated under the laws of the State of Colorado in 1984 and reincorporated under the laws of the State of Delaware in June 1994. We are a wholesale distributor and retailer of a broad line of leather and related products, including leather, leatherworking tools, buckles and adornments for belts, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits. We also manufacture leather lacing and kits. The Company sells its products worldwide through 27 Leather Factory stores and 19 Tandy Leather stores (as of March 31, 2003), located throughout the U.S., three combination Leather Factory/Tandy Leather stores located in Canada, and through its websites (www.leatherfactory.com) and (www.tandyleather.com). Our subsidiary, Roberts, Cushman & Co., designs and manufactures fancy hat trims directly to hat manufacturers. The Company is managed on a business entity basis, with those businesses being The Leather Factory ("Leather Factory"), Tandy Leather Company ("Tandy" or "Tandy Leather"), and Roberts, Cushman & Company, Inc. ("Cushman"). See Note 12 to the Consolidated Financial Statements, Segment Information, for financial and additional information concerning the Company's segments, as well as its foreign operations. We frequently introduce new products either through our own manufacturing capability or by purchasing from vendors. The Company holds a substantial number of copyrights for its designs. These designs have been incorporated throughout the Company's product line as a means of increasing its competitive advantage. In 2002, the Company began opening retail stores under the Tandy Leather name and had fourteen stores opened as of the end of the year. The Tandy Leather retail store concept differs from that of a traditional Leather Factory store. Tandy stores are designed to attract walk-in retail customers primarily, while Leather Factory stores, although they can and do service retail customers, generally tend to target wholesale customers including manufacturers and resellers. The Company has made numerous acquisitions in prior years, including the purchase of the six original Leather Factory stores from Brown Group, Inc. in 1985. In 1995, the Company purchased Cushman. In 1996, the Company acquired its Canadian distributor, The Leather Factory of Canada, Ltd. In November 2000, the Company acquired the operating assets of two subsidiaries of Tandycrafts, Inc. to form the Tandy Leather Company subsidiary. In 2002, Tandy Leather purchased four independent leathercraft retail stores. No single customer's purchases represent more than 10% of the Company's total sales in 2002. Approximately 5.6% of our 2002 sales were export sales. The Company's principal offices are located at 3847 East Loop 820 South, Fort Worth, Texas 76119, and its phone number is (817) 496-4414. 2 LEATHER FACTORY OPERATIONS The Leather Factory distributes its broad product line of leather and leathercraft-related products in the United States and internationally. We manufacture some of our products, while the majority of products are purchased from manufacturers. Leather Factory operations accounted for 76.3%, 77.0%, and 89.9% of the total consolidated net sales of the Company for 2002, 2001, and 2000, respectively. BUSINESS STRATEGY. We distribute Leather Factory products through 27 U.S.-based stores, three Canadian-based stores, and through our web site (www.leatherfactory.com). The location of the stores is selected based on the location of customers, so that delivery time to customers is minimized. A two-day maximum delivery time is the Company's goal. The type of premises utilized for the store locations is generally light industrial office/warehouse space in proximity to a major freeway or with other similar access. This kind of location typically offers lower rents compared to other more retail-oriented locations. Leather Factory stores offer a "one-stop shopping" concept for both leather and leathercraft materials. Our strategy is that a customer can purchase the leather and related accessories and supplies necessary to complete his project from one place. The size and configuration of the stores are planned to allow large quantities of product to be displayed in an easily accessible and visually appealing manner. Leather is displayed by the pallet where the customer can see and touch it, assessing first-hand the numerous sizes, styles, and grades offered. Leather Factory stores serve customers through various means including walk-in traffic, phone and mail order. Both wholesale and retail customers purchase from the stores. We staff Leather Factory stores with experienced managers whose compensation is tied to the operating profit of their store. Sales are generated by the selling efforts of the store personnel themselves, the aggressive use of direct mail advertising, participation by the Company at trade shows and, on a limited basis, the use of sales representative organizations. Our primary advertising efforts are through direct mail advertising aimed at specific market groups. Like most direct mail marketers, our mailing list is one of our most important assets. Over the years, we have spent considerable time and money maintaining and updating this list. As a result, we have developed what we consider to be the purest, most up-to-date, unique collection of leathercraft customers' names and purchase information found anywhere in the world. Our mailing list has been the key to our sales in the past and will continue to be the key in the future. We estimate that in 2003, we will produce and mail 35-40 different direct mail pieces from a simple black and white postcard to our 140-page full color catalog. CUSTOMERS. Leather Factory's customer base is comprised of individuals, wholesale distributors, tack and saddle shops, institutions (prisons and prisoners, schools, hospitals), western stores, craft stores and craft store chains, other large volume purchasers, manufacturers, and retailers dispersed geographically throughout the world. Wholesale sales make up the majority of our Leather Factory business, although retail sales have increased somewhat during the last several years. Generally speaking, Leather Factory's sales mix is 80% wholesale and 20% retail. We are continuing efforts to attract retail customers to Leather Factory; however, the strongest market for Leather Factory continues to be the wholesale customer. Leather Factory sales generally do not reflect significant seasonal patterns. Orders are filled as received, and Leather Factory does not have any backlogs. We maintain inventory at a level that we believe will fill most customer orders. Leather Factory's Authorized Sales Center ("ASC") program was developed to generate sales in geographical areas where we currently do not have a store without the capital investment needed to open one. An unrelated person operating an existing business who desires to become an ASC must apply with Leather Factory and upon approval, place a minimum initial order. There are also minimum annual purchase amounts set that the ASC must adhere to in order to maintain ASC status. In exchange, the ASC gets free advertising in certain sale flyers, price breaks on many products, advance notice of new products, priority shipping and handling on all orders, as well as various other benefits. Leather Factory stores service approximately 110 ASC's located throughout the United States. EXPANSION. We opened four new Leather Factory stores in 1999, and two new stores in each of the years 2000 and 2001. While we do not believe there is a significant and immediate opportunity for expansion of the Leather Factory store system in terms of opening additional stores, we do believe expansion could be achieved by acquiring companies in related areas/markets which offer synergistic aspects based on the locations and/or product lines of the businesses. 3 TANDY LEATHER OPERATIONS Tandy Leather Company bears the name of the oldest and best-known supplier of leather and related supplies used in the leathercraft industry. Established in 1919, originally as Hinkley-Tandy Leather Company, Tandy Leather has been the primary resource for over five generations of leathercrafters. This subsidiary offers a product line of quality tools, leather, accessories, kits and teaching materials. As noted above, we acquired the Tandy Leather assets in November 2000. Tandy Leather accounted for 18.6%, 17.7% and 1.9% of the total consolidated net sales of the Company for 2002, 2001, and 2000, respectively. BUSINESS STRATEGY. Tandy Leather did not own any retail stores when its assets were acquired by the Company and was operating as a catalog/mail order/Internet fulfillment house. At one time, however, Tandy Leather operated approximately 350 retail stores located throughout the United States and Canada. Believing that Tandy Leather stores are a viable vehicle for growth, we began opening Tandy Leather retail stores in 2002. As of December 31, 2002, there were 14 retail stores located in the United States. More information about the growth and expansion of the Tandy retail store chain is explained below. The retail stores serve walk-in, mail and phone order customers from convenient locations in established retail areas as well as orders generated from its website, www.tandyleather.com. The Tandy stores also service approximately 120 authorized dealers located throughout the United States. Tandy Leather stores are staffed by knowledgeable sales people whose compensation is based, in part, upon the profitability of their store. Our products are sold in Canada through the three Leather Factory stores located there. These three stores support approximately 40 Tandy Leather authorized dealers located throughout the Canadian provinces. Sales by Tandy Leather are driven through the efforts of the store staff, trade shows, our 132-page catalog and a direct marketing program that includes 35-40 different sales flyers produced annually and e-mail announcements. Tandy's mailing list is similar to that of The Leather Factory in that maintaining detailed customer history allows us to target certain customer segments in our mailings. This provides significant opportunity for sales retention and growth. Tandy Leather has long been the entry point for new customers getting into leathercraft. We continue to broaden our customer base by working with various youth organizations and institutions where people are introduced to leathercraft, as well as hosting classes in the retail stores. CUSTOMERS. Tandy's customer base is comprised mostly of individual hobbyists but also includes a number of resellers, small manufacturers, institutions and dealers. Individual retail customers are our largest customer group, representing more than 65% of Tandy Leather sales. Youth camps and schools, Authorized Dealers (similar to Leather Factory's Authorized Sales Centers) and our wholesale customers complete our customer base. Like Leather Factory, Tandy fills orders as they are received, and there is no order backlog. Tandy maintains reasonable amounts of inventory to meet these orders. Tandy's sales, when operating strictly as an order fulfillment house (phone, fax, mail, and Internet orders), are generally consistent quarter to quarter (25% per quarter). Its retail store operations historically generate slightly more sales in the 4th quarter of each year (approximately 30%) and less in the 2nd quarter (approximately 20%) while the 1st and 3rd quarters remain steady at 25%. EXPANSION. In December 2001, The Leather Factory, Inc. announced plans to expand the Tandy Leather operation through the introduction of Tandy Leather retail stores. We opened fourteen retail stores in 2002 - four by acquiring existing leathercraft stores, nine by opening new stores, and one by converting a Leather Factory store. Management expects to open a similar number of retail stores in 2003. 4 ROBERTS, CUSHMAN SUBSIDIARY Cushman is located in Long Island City, N.Y., and produces and sells headwear adornments (decorations that adorn the outside of a hat), manufacturing made-to-order trimmings for the headwear industry for over 140 years. Cushman accounted for 5.1%, 5.3%, and 8.2% of the total consolidated net sales of the Company for 2002, 2001, and 2000, respectively. BUSINESS STRATEGY. Cushman has long been considered one of the leaders in the field of headwear trimmings. It designs and manufactures exclusive trimmings for all type of hats. Trims are sold to hat manufacturers directly. Cushman does not employ an outside sales force. Instead, customers visit the facilities in New York and, with a Cushman designer, incorporate their ideas into a customized product. The customer is provided samples or photographs of each design before they leave the premises who can then use the sample as a sales tool to obtain hat orders from their customers. This "design-on-site" process is unique in the industry. CUSTOMERS. Currently, there are approximately 90 to 100 headwear manufacturers worldwide. Cushman designs and manufactures trims for over 75 of those manufacturers, supplying customized trims, as well as ribbons, buckle sets, name pins, feathers, etc. Our success in developing and maintaining long-standing relationships with our customers is due primarily to our ability to deliver quality products in a timely manner. Generally, our delivery target is three weeks or less. Cushman's backlog of in-house orders from customers as of March 14, 2003 was $180,000, which approximates one month of sales. Cushman's sales generally do not reflect significant seasonal patterns. EXPANSION. Cushman has been successful providing a very specific product line directly to headwear manufacturers. Given the current conditions, we do not believe that there is much room for expansion in the industry, other than to capture additional market share. We have considered the possibility of expanding production to other leather products. However, even though the potential products would be made from leather and therefore could be considered somehow related, we have decided that Cushman's expansion into other products is not feasible at this time. 5 ADDITIONAL INFORMATION PRODUCTS. Our core business consists of manufacturing, importing and distributing leather, traditional leathercraft materials (do-it-yourself kits, stamping sets, and leatherworking tools), craft-related items (leather lace, beads, and wearable art accessories), hardware, metal garment accessories (belt buckles, belt buckle designs, and conchos), and leather finishes. We attempt to maintain the optimum number of stock-keeping units ("SKUs") in the Leather Factory and Tandy Leather lines to balance proper stock maintenance and minimize out-of-stock situations against carrying costs involved with such an inventory level. We try to maintain higher inventories of certain imported items to ensure a continuous supply. The number of SKUs has been refined over the years by the introduction of new products and the discontinuing of selected products. The Company carries approximately 3,400 items in the current lines of leather and leather-related merchandise - 800 of which are exclusively Leather Factory products, 800 exclusively Tandy Leather and 1,800 carried by both Leather Factory and Tandy. The products manufactured by the Company generally involve cutting leather into various shapes and patterns using metal dies ("clicking"), fabrication, assembly, and packaging/repackaging tasks. Items made in Fort Worth are primarily distributed under the TejasTM brand name through our stores. Cushman's hat bands are generally made from leather, ribbon, or woven fabrics, depending on the style of hat. They are made by cutting leather and/or other materials into strips, and enhancing the trim by attaching conchos and/or three-piece buckle sets, braiding with other materials, finishing the end or borders by stitching or by lacing with leather lace. Cushman also supplies custom-designed buckles and conchos separate from the bands, feathers for dress hats, and name pins. PATENTS, COPYRIGHTS. We presently own 496 copyrights covering 605 registered works, twenty trademarks covering twenty names, and two patents covering three products. Registered trademarks include federal trade name registrations on "The Leather Factory" and "Tandy Leather Company". The trademarks expire at various times starting in 2005 and ending in 2012, but can be renewed indefinitely. Most copyrights granted or pending are on metal products, such as conchos, belt buckles, instruction books, and kits. The expiration period for the copyrights begins in 2062 and ends in 2072. The Company has patents on two belt buckles and certain leather-working equipment known as the "Speedy Embosser." The patents expire in 2011. We consider these intangibles to be valuable assets and defend them as necessary. Cushman's products are generally not copyrighted initially as hundreds of new trim designs are continually in process. Once a trim has been selected by a customer for production, has been completed for a line of hats, and has been a strong seller for the season, selected components in the trim are often transferred to Leather Factory, adapted to fit Leather Factory's product line, and copyrighted. Given that the apparel market designs and produces styles at least six months in advance of a particular season, Cushman's product design contributes to Leather Factory's development of new products as we get insight into what styles are expected to be popular in the near future. SUPPLIERS. We currently purchase merchandise and raw materials from approximately 200 vendors dispersed throughout the United States and in more than 20 foreign countries. In 2002, the ten largest vendors accounted for approximately 75% of Leather Factory's and Tandy Leather's combined purchases. Because leather is sold internationally, market conditions abroad are likely to affect the price of leather in the United States. Outbreaks of mad cow and hoof-and-mouth disease (or foot-and-mouth disease) in certain parts of the world can influence the price of leather used in our products. As such an occurrence is beyond the control of the Company, we cannot predict when and to what extent we could be affected in the future. Aside from increasing purchases when we anticipate price increases (or possibly delaying purchases if we foresee price declines), we do not attempt to hedge our inventory costs. Cushman purchases components from over 25 vendors, located predominately in the United States. In 2002, Cushman's top ten vendors (in dollars purchased) represented approximately 40% of its total purchases. Overall, we believe that our relationships with suppliers are strong and do not anticipate any material changes in these supplier relationships in the future. Due to the number of alternative sources of supply, the loss of any of these principal suppliers would not have a material impact on our operations. COMPETITION. We sell our leather and leathercraft-related products in three highly fragmented markets - leathercraft, leather accessories, and retail craft. We encounter competition in connection with certain product lines and in certain areas from different companies, but have no direct competition affecting the entire product line. We compete on price, availability of merchandise, and speed of delivery. Our size relative to most of our competitors creates competitive advantage in our ability to stock a full range of products as well as in buying merchandise. We are able to purchase in bulk and have an international network of suppliers that can provide quality merchandise at lower costs. Most of our competitors do not have the multiple sources of supply and cannot purchase sufficient quantities to compete along a broad range of products. In fact, some of our competitors are also customers, relying on us as a supplier. Our Cushman line encounters some competition. However, we are not aware of any single company whose primary product line is the same as Cushman's. Cushman's market share has grown over the years because of its reputation in the industry to deliver product timely. 6 COMPLIANCE WITH ENVIRONMENTAL LAWS Compliance by the Company with federal, state and local environmental protection laws has not had, and is not expected to have, a material effect upon capital expenditures, earnings or the competitive position of the Company. EMPLOYEES As of December 31, 2002, the Company employed 340 people, with 323 on a full-time basis. The Company is not a party to any collective bargaining agreement. Overall, management believes that relations with employees are good. Eligible employees participate in The Leather Factory, Inc. Employees' Stock Ownership Plan and Trust ("ESOP"). As of December 31, 2002, 232 employees and former employees were participants in or beneficiaries of the ESOP. The Company has the option of contributing up to 25% of eligible employees' compensation into the ESOP. Net contributions for 2002, 2001, and 2000 were 5.8%, 5.2%, and 5.9%, respectively, of eligible compensation. These contributions are used to purchase shares of the Company's Common Stock. Generally, contributions to the ESOP follow a similar pattern as overall profitability. EXECUTIVE OFFICERS OF THE REGISTRANT The following table sets forth certain information concerning the executive officers of the Company.
POSITION AND BUSINESS EXPERIENCE NAME AND AGE DURING PAST FIVE YEARS SERVED AS OFFICER SINCE ------------ -------------------------------- ----------------------- J. Wray Thompson, 71 Chief Executive Officer since June 1993. President from June 1993 to January 2001. 1993 Ronald C.Morgan, 55 President since January 2001. Chief Operating Officer since June 1993. 1993 Robin L. Morgan, 52 Vice President of Administration since June 1993. 1993 Shannon L. Greene, 37 Chief Financial Officer since May 2000. Controller from January 1998 to May 2000. Assistant Controller from September 1997 to January 1998. 2000
Mr. and Mrs. Morgan are married. All officers are elected annually by the Board of Directors to serve for the ensuing year. 7 ITEM 2. PROPERTIES. - ---------------------- The Company leases all of its premises. Detailed below are the lease terms for the Company's locations. The general character of the Leather Factory ("LF") store locations is light industrial office/warehouse space. Tandy Leather ("TAN") store locations are generally found in retail strip centers. The Company believes that all of its properties are adequately covered by insurance. The Cushman facility ("RCC") is its manufacturing facility in Long Island City, New York. The Company's Fort Worth location includes the Fort Worth Leather Factory store, the Company's central warehouse and manufacturing facility, and the sales, advertising, administrative, and executive offices. The Company also leases a 284 square-foot showroom in the Denver Merchandise Mart for $5,372 per year. This lease will expire in October 2005.
Location Total Square Feet Minimum Annual Rent * Lease Expiration Lessee Chattanooga, TN 9,040 $ 42,739 May 2004 LF Denver, CO 5,879 30,000 September 2004 LF Harrisburg, PA 6,850 40,417 March 2007 LF Fort Worth, TX 115,000 410,958 March 2008 LF Fresno, CA 5,600 44,456 March 2007 LF Des Moines, IA 4,000 30,718 April 2004 LF Phoenix, AZ 4,500 27,053 March 2006 LF Springfield, MO 6,000 24,000 July 2003 LF Spokane, WA 5,400 21,360 February 2004 LF Albuquerque, NM 5,000 31,200 October 2003 LF Salt Lake City, UT 3,485 21,600 July 2004 LF Baldwin Park, CA 7,800 53,400 March 2005 LF Tampa, FL 5,238 38,429 August 2008 LF San Antonio, TX 5,600 42,256 October 2006 LF Columbus, OH 6,000 38,461 October 2006 LF El Paso, TX 5,000 28,252 August 2003 LF Oakland, CA 8,000 54,000 December 2003 LF Grand Rapids, MI 8,000 42,968 March 2004 LF Wichita, KS 5,150 21,360 April 2004 LF New Orleans, LA 5,130 22,200 September 2003 LF Portland, OR 5,232 34,008 April 2004 LF Charlotte, NC 6,202 29,025 February 2006 LF Billings, MT 2,600 12,000 April 2004 LF Tucson, AZ 3,600 21,033 May 2004 LF Houston, TX 4,250 25,753 November 2005 LF Dallas, TX 5,040 27,600 September 2005 LF Chicago, IL 6,100 36,972 August 2006 LF Long Island City, NY 10,200 71,146 June 2003 RCC Oklahoma City, OK 3,160 20,012 December 2006 TAN Boise, ID 1,800 16,200 February 2007 TAN Sacramento, CA 1,600 22,907 April 2007 TAN East Hartford, CT 1,200 9,600 May 2007 TAN Salt Lake City, UT 1,750 21,000 May 2007 TAN Fort Worth, TX 3,000 21,600 July 2007 TAN Austin, TX 3,800 23,250 April 2005 TAN Dallas, TX 1,700 23,052 July 2007 TAN Albuquerque, NM 1,764 16,229 August 2007 TAN Las Vegas, NV 1,350 20,250 June 2007 TAN Indianapolis, IN 1,500 17,727 October 2007 TAN Peoria, IL 1,350 14,833 October 2007 TAN Memphis, TN 2,500 15,000 September 2005 TAN Tempe, AZ 1,986 38,848 October 2007 TAN Baltimore, MD 2,200 16,901 January 2008 TAN Winnipeg, Manitoba, Canada 5,712 18,376** November 2007 LF Toronto, Ontario, Canada 5,614 21,968** June 2006 LF Edmonton, Alberta, Canada 5,210 21,572** August 2007 LF ----------------- ---------------------- Totals 317,092 $ 1,682,689 ----------------- ----------------------
* Represents the average minimum annual rent over the balance of the unexpired lease term. ** As converted into U.S. dollars. 8 ITEM 3. LEGAL PROCEEDINGS. - ------------------------------ The Company is involved in litigation in the ordinary course of its business but is not currently a party to any material pending legal proceedings. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - ----------------------------------------------------------------------- There were no matters submitted to a vote of the Company's security holders during the fourth quarter of the Company's fiscal year ended December 31, 2002. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. - -------------------------------------------------------------------------------- The Common Stock of the Company is traded on the American Stock Exchange using the symbol TLF. The high and low prices for each calendar quarter during the last two fiscal years are as follows:
2002 2001 -------------- -------------- QUARTER ENDED HIGH LOW HIGH LOW - ------------- ------ ------ ------ ------ March 31 $3.850 $2.010 $1.125 $0.900 June 30 $3.500 $2.850 $2.240 $0.950 September 30 $3.240 $2.450 $3.000 $1.800 December 31 $3.500 $2.800 $2.300 $1.750
There were approximately 644 stockholders of record on March 11, 2003. There have been no cash dividends paid on the shares of the Company's Common Stock and currently dividends cannot be declared or paid without the prior written consent of Wells Fargo Minnesota, N.A., the Company's lender. The Board of Directors has historically followed a policy of reinvesting the earnings of the Company in the expansion of its business. This policy is subject to change based on future industry and market conditions, as well as other factors beyond the control of the Company. 9 ITEM 6. SELECTED FINANCIAL DATA. - ------------------------------------ The selected financial data presented below are derived from and should be read in conjunction with the Company's Consolidated Financial Statements and related notes. This information should also be read in conjunction with Item 7 - - "Management's Discussion and Analysis of Financial Condition and Results of Operations." In particular, see the information there relating to the adoption of a new accounting pronouncement in 2002. The financial impact of the acquisition of Tandy Leather Company in November 2000 is included in the information presented for 2002, 2001 and 2000. Data in prior years have not been restated to reflect acquisitions that occurred in subsequent years.
INCOME STATEMENT DATA Years Ended December 31, 2002 2001 2000 ----------------- ----------- ----------- Net sales $ 39,728,615 $37,279,262 $30,095,264 Cost of sales 18,393,914 17,934,935 15,147,547 ----------------- ------------ ----------- Gross profit 21,334,701 19,344,327 14,947,717 Operating expenses 17,202,927 15,442,359 11,702,633 ------------------ ----------- ----------- Operating income 4,131,774 3,901,968 3,245,084 Other expense 311,918 533,482 653,779 ------------------ ----------- ----------- Income (loss) before income taxes 3,819,856 3,368,486 2,591,305 Income tax provision (benefit) 1,224,868 1,362,053 1,049,985 ------------------ ----------- ----------- Income (loss) before cumulative effect of change in accounting principle 2,594,988 2,006,433 1,541,320 Cumulative effect of change in accounting principle (4,008,831) - - ------------------ ----------- ----------- Net income (loss) $ (1,413,842) $ 2,006,433 $ 1,541,320 ================== =========== =========== Earnings (loss) per share $ (0.14) $ 0.20 $ 0.16 ================== =========== =========== Earnings (loss) per share- assuming dilution $ (0.13) $ 0.19 $ 0.15 ================== =========== =========== Weighted average common shares outstanding for: Basic EPS 10,063,581 9,976,071 9,875,606 Diluted EPS 10,761,669 10,449,306 10,182,803 INCOME STATEMENT DATA YEARS ENDED DECEMBER 31, 1999 1998 ----------- ----------- Net sales $27,164,399 $22,163,994 Cost of sales 14,907,768 12,428,324 ----------- ------------ Gross profit 12,256,631 9,735,670 Operating expenses 10,346,420 8,890,045 ----------- ------------ Operating income 1,910,211 845,625 Other expense 900,304 970,340 ----------- ------------ Income (loss) before income taxes 1,009,907 (124,715) Income tax provision (benefit) 574,851 (85,524) ----------- ------------ Income (loss) before cumulative effect of change in accounting principle 435,056 (39,191) Cumulative effect of change in accounting principle - - ----------- ------------ Net income (loss) $ 435,056 $ (39,191) =========== ============ Earnings (loss) per share $ 0.04 $ (0.00) =========== ============ Earnings (loss) per share- assuming dilution $ 0.04 $ (0.00) =========== ============ Weighted average common shares outstanding for: Basic EPS 9,853,161 9,803,887 Diluted EPS 9,890,098 9,803,887
BALANCE SHEET DATA As of December 31, 2002 2001 2000 1999 1998 -------------- ----------- ----------- ----------- ----------- Total assets $ 19,675,602 $19,548,323 $19,686,079 $18,220,775 $16,029,937 -------------- ----------- ----------- ----------- ----------- Notes payable and current Maturities of long term debt 4,218,968 4,527,904 5,759,626 6,061,735 6,139,327 -------------- ----------- ----------- ----------- ----------- Notes payable and long-term Debt, net of current maturities 2,256 7,691 13,025 121,686 61,389 -------------- ----------- ----------- ----------- ----------- Total Stockholders' Equity $ 11,170,062 $12,423,671 $10,295,637 $ 8,680,425 $ 8,170,278 ============== =========== =========== =========== ===========
10 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS - -------------------------------------------------------------------------------- OF OPERATIONS. - --------------- The Company is a leading provider of leather and leathercraft-related items and headwear trims. Its products are sold worldwide through Leather Factory stores, Tandy Leather stores, the Internet, and directly to headwear manufacturers (Cushman only). RESULTS OF OPERATIONS The following tables present selected financial data by category for each of the years ended December 31, 2002, 2001 and 2000:
2002 2001 2000 ------------------------ ------------------------- ------------------------ OPERATING OPERATING OPERATING SALES INCOME SALES INCOME SALES INCOME ----------- ---------- ----------- ----------- ----------- ---------- Leather Factory stores $30,313,478 $3,742,844 $28,711,006 $3,719,517 $27,060,406 $2,991,804 Tandy Leather stores * 7,387,874 371,372 6,606,090 281,998 575,635 (43,724) Cushman 2,027,263 17,558 1,962,166 (99,547) 2,459,223 297,004 ----------- ---------- ----------- ---------- ----------- ---------- Total Operations $39,728,615 $4,131,774 $37,279,262 $3,901,968 $30,095,264 $3,245,084 =========== ========== =========== ========== =========== ========== *The Tandy Leather assets were acquired in November 2000.
11 ANALYSIS OF 2002 COMPARED TO 2001 Consolidated net sales for 2002 increased $2.4 million, or 6.6%, compared to 2001. We had sales increases in all segments this year with Leather Factory stores contributing $1.6 million to the increase, Tandy stores adding $782,000 and Cushman adding $65,000. The Company experienced an increase in operating income of 5.9% from 2001 to 2002, due primarily to a continued improvement in gross profit margins.
2002 2001 $CHANGE % CHANGE ----------- ----------- ---------- -------- Net sales $39,728,615 $37,279,262 $2,449,353 6.57% Cost of sales 18,393,914 17,934,935 458,979 2.56% ----------- ----------- ---------- -------- Gross profit 21,334,701 19,344,327 1,990,374 10.29% Operating expenses 17,202,927 15,442,359 1,760,568 11.40% ----------- ----------- ---------- -------- Operating income 4,131,774 3,901,968 229,806 5.89% Other expense 311,917 533,482 (221,565) (41.53%) ----------- ----------- ---------- -------- Income before income taxes 3,819,857 3,368,486 451,371 13.40% Income tax provision 1,224,868 1,362,053 (137,185) (10.07)% ----------- ----------- ---------- -------- Income before change in accounting principle $2,594,989 $2,006,433 $588,556 29.33% Cumulative effect of chg in accounting principle (4,008,831) - (4,008,831) N/A ----------- ----------- ---------- -------- Net income (loss) $(1,413,842) $2,006,433 $(3,420,275) N/A =========== ========== =========== --------
12 LEATHER FACTORY STORES Net sales for Leather Factory, which is comprised of 30 stores as of December 2002, increased 5.6% as follows:
2002 2001 $INCR (DECR) % INCR (DECR) ------------ ------------ ------------ ------------- Same store sales (27 stores) $29,372,715 $28,014,932 $1,357,783 4.85% % of total 96.90% 97.58% 84.73% New store sales (3 stores) 809,752 193,674 616,078 318.10% % of total 2.67% 0.67% 38.45% "Transferred to Tandy" store sales (1 store) 131,011 502,400 (371,389) (73.92)% % of total 0.43% 1.75% (23.18)% ----------- ----------- ---------- ------- Total sales $30,313,478 $28,711,006 $1,602,472 5.58% =========== =========== ========== ======= 100.00% 100.00% 100.00% ----------- ----------- ----------
We determine our sales mix based on internally-defined customer groups as follows:
CUSTOMER GROUP GROUP CHARACTERISTICS - -------------- --------------------- Retail End users, consumers, individuals Institution Prisons, prisoners, hospitals, schools, YMCA, Boy Scouts, etc. Wholesale Saddle & tack stores, resellers and distributors, dealers, etc. Craft Craft stores (individually owned) and craft store chains Midas Small manufacturers ASC Authorized Sales Centers
As the following table indicates, there was slight variation in our sales mix from 2001 to 2002. However, the majority of the sales growth in dollars was the result of increased sales in our Retail and Craft customer groups. Our Retail sales, while holding steady at approximately 20% of our total 2002 sales, increased in dollars by 19% over last year's retail sales and our Craft sales increased 15% in dollars. We experienced sales gains in most markets, the exception being minimal declines in our Wholesale and Institution groups (2% and 1% declines, respectively).
QTD 3/31/02 QTR 6/30/02 QTD 9/30/02 QTD 12/31/02 YTD 12/31/02 ----------- ----------- ----------- ------------ ------------ CUSTOMER GROUP - -------------- Retail 21% 18% 17% 27% 21% Institution 7% 8% 7% 7% 7% Wholesale 32% 34% 34% 29% 32% Craft 26% 25% 28% 20% 25% Midas 7% 8% 8% 9% 8% ASC 7% 7% 6% 8% 7% ---------- ------------ ----------- ------------ ----------- 100% 100% 100% 100% 100% ========== ============ =========== ============ ============
QTD 3/31/01 QTD 6/30/01 QTD 9/30/01 QTD 12/31/01 YTD 12/31/01 ------------ ------------ ------------ ------------- ------------- CUSTOMER GROUP - -------------- Retail 21% 16% 19% 21% 19% Institution 8% 10% 6% 6% 8% Wholesale 32% 34% 34% 38% 34% Craft 21% 28% 26% 20% 24% Midas 11% 5% 10% 7% 8% ASC 7% 7% 5% 8% 7% ---------- ------------ ------------ ------------- ------------- 100% 100% 100% 100% 100% ========== ============ ============ ============= =============
Operating income for the Leather Factory stores increased $23,000 or 0.63%. Operating expenses were up 10.04% from 2001 - with increases in personnel costs (wages and health insurance) and advertising contributing the majority of the increase. Manager bonuses were up in 2002 as well due to the increased operating profits of the stores over 2001. Gross margin as a percentage of sales improved from 52.50% for 2001 to 53.56% for 2002. We believe, generally speaking, that the Leather Factory's gross margin has little room for additional improvement due to the mix of customers it serves. We continue to negotiate with vendors for lower pricing of product that we purchase and we believe we were successful in that endeavor in most of our product categories. We will continue to look for opportunities in our purchasing efforts as those opportunities present themselves; however, we also believe that we have maximized those efforts as much as can reasonably be expected at the present time. Future fluctuations in gross margins will occur primarily as a result of the mix of the product categories sold and the correlating margins associated with those categories. Our product line is made up of approximately 2,600 items. We have further expanded our merchandise categories from those discussed in our 2001 Annual Report as follows:
MERCHANDISE CATEGORY 2002 GP % 2001 GP % - ---------------------------------------------------- --------- --------- Belt Strips and Straps 59.93% 56.26% Books, Patterns and Videos 60.99% 58.39% Buckles 62.13% 58.33% Conchos 68.43% 65.94% Craft Supplies 60.54% 57.54% Custom Tools and Hardware 56.89% 52.08% Dyes, Finishes, Glues and Supplies 53.52% 52.41% Hand Tools 55.89% 54.78% Hardware 58.33% 57.59% Kits 51.47% 46.44% Laces 47.06% 40.85% Leather 41.54% 37.73% Shoe Supplies 49.80% 45.97% Stamping Tools 60.76% 57.66% -------- -------- Leather Factory store gross profit margin (overall) 53.56% 52.50% ======== ========
13 TANDY LEATHER STORES Tandy Leather was operated strictly as an order fulfillment house for orders generated via phone, fax, mail order, and Internet in 2001. In 2002, we began the development of the retail store chain while temporarily operating the order fulfillment house. This unit was eliminated as of September 1, 2002. The fourteen retail stores opened in 2002 were as follows:
LOCATION SQ FOOTAGE MONTH OPENED - ------------------ ---------- ------------ Oklahoma City, OK (1) 3,160 January Boise, ID (1) 1,800 March Sacramento, CA 1,600 June E Hartford, CT 1,200 April Salt Lake City, UT 1,750 June Fort Worth, TX 3,000 May Austin, TX (2) 3,800 June Dallas, TX 1,700 August Albuquerque, NM 1,764 August Las Vegas, NV 1,350 August Indianapolis, IN 1,500 October Peoria, IL 1,350 October Memphis, TN (1) 2,500 October Tempe, AZ (1) 1,986 November (1) Purchased existing leathercraft store (2) Formerly a Leather Factory store
Net sales for Tandy Leather, which was comprised of 14 retail stores as of December 2002, increased 11.8% as follows:
2002 2001 $ INCR(DECR) % INCR(DECR) ----------- ----------- ------------ ------------ Order fulfillment house (closed 9/1/02) $3,605,087 $6,606,090 $(3,001,003) (45.43)% % of total 48.80% 100.00% (383.87)% New store sales (13 stores) 3,249,214 - 3,249,214 *** % of total 43.98% 0.00% 415.62% Former "Leather Factory" store sales (1 store) 533,573 - 533,573 *** % of total 7.22% 0.00% 68.25% ------------ ----------- ------------ Total sales $7,387,874 $6,606,090 $ 781,784 11.83% ============ =========== ============ 100.00% 100.00% 100.00%
We intend to continue the expansion of Tandy's retail store chain in 2003 by opening a total of 10-12 new stores throughout the year as long as the domestic retail leathercraft market can support the additional stores. Through the end of March, we have opened five stores in 2003: the Baltimore, MD store opened in January, the Tulsa, OK store opened in February, and stores in Pittsburgh, PA, Orange County, CA, and Atlanta, GA opened in March. We remain committed to a conservative growth plan that minimizes risks to the Company's profits and financial stability. We moved Tandy to a new point-of-sale software in April 2002 which allows us to track its sales mix in a similar fashion as that of the Leather Factory.
CUSTOMER GROUPS 2002 2001 - --------------- ---- ---- Retail 65% 53% ASC 8% 18% Wholesale 15% 14% Institution 12% 15% Craft * N/A Midas * N/A ---- ---- 100% 100% ==== ==== * less than 1%
On a quarterly basis in 2002, Tandy's sales mix was as follows:
CUSTOMER GROUPS Q1 Q2 Q3 Q4 - --------------- ---- ---- ---- ---- Retail 61% 57% 62% 65% ASC 15% 9% 7% 8% Wholesale 11% 16% 18% 15% Institution 12% 17% 12% 11% Craft 1% 0% * * Midas 0% 1% * * ---- ---- ---- ---- Total 100% 100% 100% 100% ==== ==== ==== ==== * less than 1%
As indicated by the percentages in the table above, Tandy's sales mix is following that of historical performance in that sales to summer camps (in our Institution customer category) is especially high in the second quarter of the year and retail sales typically rise in the fourth quarter due to the holiday shopping season. Due to the elimination of the order fulfillment house ("OFH") during the year and the introduction of the fourteen retail stores, we present the financial performance of the two operational structures separately:
OFH % STORES % TOTAL % ---------- ------- ---------- ------- ---------- ------- Net sales $3,605,087 100.00% $3,782,787 100.00% $7,387,874 100.00% Cost of sales 1,519,404 42.15% 1,473,086 38.94% 2,992,490 40.51% ---------- ---------- ---------- Gross profit 2,085,683 57.85% 2,309,701 61.06% 4,395,384 59.49% Operating expenses 2,021,976 56.09% 2,002,036 52.92% 4,024,012 54.47% ---------- ---------- ---------- Operating income $ 63,707 1.77% $ 307,665 8.14% $ 371,372 5.02% ---------- ---------- ----------
While we believe that the stores are able to improve their operating efficiency and will continue to work toward that end, we also believe that the table above proves our theory that the retail stores can operate much more efficiently than a centralized order fulfillment house. The largest expenses for the stores, as a percentage of sales, are salaries and wages, advertising, and shipping. While it is unrealistic to expect an elimination of shipping expenses (shipping product to customers) by the stores, we do expect this expense to decrease as more stores are open and our over-the-counter sales increase. 14 CUSHMAN Cushman's sales were up modestly in 2002 (3.3%) while gross profit margins increased from 28.6% to 34.6%, an improvement of 21%. We still believe Cushman is continuing to gain market share in the industry and that belief was further strengthened in 2002 as one of our main competitors went out of business in late 2002. Operating income increased from a $99,000 loss in 2001 to income of $17,000 for 2002. The elimination of goodwill amortization accounted for the improvement. Overall, we are pleased with Cushman's performance in 2002 and believe we will see continued improvement in 2003. See "Financial Condition" section below for detailed discussion regarding the effect of the change in accounting principle and the resulting write-down of Cushman's goodwill in 2002. OTHER EXPENSE AND PROVISION FOR INCOME TAXES Other expenses decreased approximately 42%. The decrease is attributable to the interest paid on our outstanding debt. While there was only a slight drop in the interest rate during 2002 compared to 2001, the average outstanding debt balance dropped significantly. Our average outstanding debt balance in 2002 was $3,600,000 while the 2001 average outstanding debt balance was $4,900,000. The provision for federal and state income taxes was 32% of 2002 income before taxes compared to 40% in 2001. The reduction results from the conversion of the operating entities from corporations to more tax-favored entities (limited partnership) in certain states in which we operate and the elimination of goodwill amortization for book purposes in 2002. 15 ANALYSIS OF 2001 COMPARED TO 2000 Consolidated net sales for 2001 increased $7.2 million, or 23.9%, compared to 2000. Tandy contributed $6.0 million to the increase as 2001 included a full year of Tandy's operations, while 2000 only included December operations. Leather Factory added an additional $1.7 million in sales in 2001, partially offset by a sales decline at Cushman of $500,000. The Company experienced an increase in operating income of 20.2% from 2000 to 2001, due primarily to an overall improvement in gross profit margins.
2001 2000 $ CHANGE % CHANGE ----------- ----------- ----------- --------- Net sales $37,279,262 $30,095,264 $7,183,998 23.87% Cost of sales 17,934,935 15,147,547 2,787,388 18.40% ---------- ----------- ----------- Gross profit 19,344,327 14,947,717 4,396,610 29.41% Operating expenses 15,442,359 11,702,633 3,739,726 31.96% ---------- ----------- ----------- Operating income 3,901,968 3,245,084 656,884 20.24% Other expense 533,482 653,778 (120,296 (18.40%) ---------- ----------- ----------- Income before income taxes 3,368,486 2,591,306 777,180 29.99% Income tax provision 1,362,053 1,049,986 312,067 29.72% ---------- ----------- ----------- Net income $2,006,433 $1,541,320 $ 465,113 30.18% =========== ========== ===========
16 LEATHER FACTORY STORES Net sales for Leather Factory, which is comprised of 30 stores as of December 2001, increased 6.1%. The four new stores opened in late 2000 and 2001 contributed a significant portion (77.8%) of the sales increase; while same store sales contributed the remainder. The majority of the overall sales increase was to our Craft customers. Our Retail sales, while holding steady at 20% of our total sales, increased in dollars by 8% over last year's retail sales. We experienced sales declines in our Institution and Midas markets, but compensated by gains in the Wholesale and ASC groups. Operating income for Leather Factory increased by $728,000 and improved the operating margin to net sales from 11.1% in 2000 to 12.9% in 2001. The increase in operating income results from improved gross profit margins as well as a slight improvement in operating efficiency. Operating expenses decreased slightly (0.42%) as a percentage of sales. Management's target for Leather Factory's operating expenses as a percentage of sales is 40% or less and that target was met for 2001. Gross margin as a percentage of sales improved by 1.75 basis points primarily as a result of the changes we made in sourcing product - purchasing from different vendors at a lower price. Leather represents approximately 40% of our inventory (in dollars) at any given time and also represents approximately 40% of our sales. However, we earn the smallest amount of gross profit margin on the leather we sell - for 2001 and 2000, gross profit margin on leather sold was approximately 38%. The improvement in our margins comes from the items sold in the other categories. 17 TANDY LEATHER ORDER FULFILLMENT Tandy Leather was acquired by the Company in November 2000; therefore our results for 2000 only included one month's operation for Tandy Leather. In 2001, Tandy operated strictly as an order fulfillment house for orders generated via phone, fax, mail order, and Internet. Our 2001 sales target was $7.0 million, based on Tandy's annual sales prior to acquisition. Tandy missed that target by $394,000. However, we discovered early in the year that some of Tandy's sales were at very low profit margins and, in a few cases, were below cost. We quickly adjusted selling prices to eliminate these low-margin sales problems and as a result, lost some sales from customers who were not willing to pay the new prices. Therefore, even though Tandy's 2001 sales were slightly below expectation, we improved gross profit margins by over 12 percentage points. Operating expenses as a percentage of sales were held virtually constant from 2000 to 2001 at 51.8%. CUSHMAN Cushman's sales were down 20% in 2001, even though we believe that we continue to gain market share from our competitors because of our commitment to timely delivery of quality product. The primary reason for this decrease is not caused by a reduction in number of trims produced, but in the type of trims produced. The popularity of the straw hat, which is a more casual hat versus the felt hat, is increasing every year due in part to straw hats being less expensive than felt and in part to the fashion trends. Historically, straw hats were worn in the spring and summer seasons while felt hats were the hat of choice in the fall and winter. Now it is acceptable to wear straw hats year round. The global warming theory may also contribute to this shift in the headwear trend as straw hats are cooler to wear than felt hats. As a result, the trims being requested by the manufacturers are made from materials other than leather. Leather trims are the most expensive, but generally are not put on straw hats. Therefore, even though we produced as many trims in 2001 as we did in 2000, the selling price of these non-leather trims is much lower than that of the leather trims. Operating income decreased significantly due primarily to a drop in gross profit margin. In 2001, we sold some trims at substantially-reduced prices for two reasons: (1) the market conditions and trends in the headwear industry in general, and (2) to clear out some of our inventory that does not fit with the fashion trends developing. We reduced our personnel costs late in 2001 to help offset the low gross profit margins. OTHER EXPENSE AND PROVISION FOR INCOME TAXES Other expenses decreased approximately 18%. The decrease is attributable to the reduction in the interest rates during 2001 compared to 2000. Our average interest rate in 2000 was 9.7% while the average interest rate in 2001 was 7.4%. In addition, there was a slight decrease in our average outstanding debt balance from $5.1 million in 2000 to $4.9 million in 2001. The provision for federal and state income taxes was 40% of 2001 pre-tax income - the same as in 2000. The dollar increase in our income tax expense results from the increase in income. 18 FINANCIAL CONDITION At December 31, 2001, we had inventory of $9.0 million and net property and equipment of $1.3 million. Goodwill and other intangibles (net of amortization and depreciation) were $4.5 million and $477,000, respectively. The Company also holds $250,000 in a leather artwork collection, most of which was created by Al Stohlman, a legendary leathercrafter. Net total assets were $19.5 million. Current liabilities were $7.1 million (including $4.5 million of current maturities of long-term debt), while long-term debt was $8,000. Total stockholders' equity at the end of 2001 had increased to $12.4 million, principally as a result of the $2.0 million of net income recorded during 2001. During 2001, net cash provided from operating activities was $2.0 million. We applied $1.2 million to reduce the outstanding balance on our credit facility described below, leaving an outstanding principal balance of $4.5 million as of December 31, 2001. As a result of various acquisitions made during our history, we had recorded goodwill on our consolidated balance sheet and had amortized this goodwill through the end of 2001. In June 2001, the Financial Accounting Standards Board ("FASB") issued a new accounting rule regarding the amortization of goodwill (SFAS No. 142, Goodwill and Other Intangible Assets). As a result of that pronouncement, effective January 1, 2002, the amortization of goodwill (and other intangible assets with indefinite lives) ceased and goodwill was subject to an impairment test based on its fair value. The majority of the goodwill ($4.5 million) as presented on our consolidated balance sheet at December 31, 2001 belonged to Cushman. Given the current trends of the industry in which Cushman operates and Cushman's financial results over the last several years, we felt it necessary to engage a business valuation firm to determine Cushman's fair value. Based on that assessment, we incurred an impairment write-down of all of the Cushman goodwill in the first quarter of 2002 in the amount of $4.0 million. The write-down was only partially offset by the Company's 2002 income before giving effect to this accounting change. Retained earnings and total stockholders' equity at the end of 2002 were $7.1 million and $11.2 million, down from $8.5 million and $12.4 million at the end of 2001. The Company does not anticipate any other similar write-downs at this time. At December 31, 2002, we owned $12.7 million of inventory and $2.0 million of property and equipment. Goodwill and other intangibles (net of amortization and depreciation) were $686,000 and $483,000, respectively and we still hold $250,000 in a leather artwork collection. Net total assets were $19.7 million. Current liabilities were $8.3 million (including $4.2 million of current maturities of long-term debt), while long-term debt was $2,000. Total stockholders' equity at the end of 2002 had decreased to $11.2 million, principally as a result of the $1.4 million net loss recorded during 2002. 19 CAPITAL RESOURCES AND LIQUIDITY On March 20, 2002, the Company entered into a Credit and Security Agreement with Wells Fargo Bank Minnesota, N.A. ("Wells Fargo"), which replaced the borrowing arrangement with Wells Fargo Business Credit, Inc. ("WFBC"). The facility matures in November 2004 and is secured by all of the assets of the Company. The Company is currently in compliance with all covenants and conditions contained in the Credit Facility and has no reason to believe that it will not continue to operate in compliance with the provisions of these financing arrangements. The principal terms and conditions of the Credit Facility are described in further detail in Note 4 Notes Payable and Long-Term Debt to the Consolidated Financial Statements. The Company borrows and repays funds under revolving credit terms as needed. Principal balances at the end of each quarter are shown below:
4TH QTR. '01 1ST QTR. '02 2ND QTR. '02 3RD QTR. '02 4TH QTR. '02 - ------------- ------------- ------------- ------------- ------------- (WFBC) (WELLS FARGO) (WELLS FARGO) (WELLS FARGO) (WELLS FARGO) $4,500,422 $2,978,645 $3,323,269 $3,899,379 $4,213,533
Total indebtedness with WFBC at the end of 2001 and with Wells Fargo at the end of 2002 are shown below:
DECEMBER 31, 2001 2002 ----------------------------- ----------------------------- WFBC WELLS FARGO ----------------------------- ----------------------------- PRINCIPAL ACCRUED INTEREST PRINCIPAL ACCRUED INTEREST ----------- ----------------- ----------- ----------------- Revolving Line $ 4,500,422 $ 19,657 $ 4,213,533 $ 15,706 =========== ================= =========== ================
The primary source of liquidity and capital resources during 2002 was cash flow provided by operating activities and our Credit and Security Agreement with Wells Fargo. Cash flows from operations for 2002 were $1.4 million. The largest portion of the operating cash flow was generated from income before the goodwill write-off. Consolidated accounts receivable decreased to $1.9 million at December 31, 2002 compared to $2.3 million at December 31, 2001. Average days to collect accounts improved from 47.86 days in 2001 to 43.54 days in 2002 on a consolidated basis. Individually, Leather Factory's days to collect was 41.52 days for 2002, an improvement over 2001 of 2.01 days. Tandy's days to collect was 34.09 days for 2002, an improvement of 17.59 days from 2001. Cushman's days to collect was 63.26 for 2002, an improvement of 11.87 days from 2001. Tandy's significant improvement in average days to collect is the result of the significant collection of delinquent accounts obtained in the Tandy Leather acquisition. Inventory increased to $12.7 million at December 31, 2002 from $9.0 million at the end of 2001. This increase was principally attributable to (1) our efforts to boost inventory in anticipation of the dock strike on the West Coast of the United States that has since ended, (2) the surge in flow of goods to us after the strike ended and the backlog of shipments unloaded, and (3) the addition of the fourteen new Tandy Leather stores in 2002. We have reduced our inventory purchases considerably in the first quarter of 2003 in order to return inventory to customary levels, although we anticipate it will be into the 2nd quarter of 2003 before the inventory begins to level out. Consolidated inventory turned 3.65 times during 2002, a slight slowdown from 2001 (4.08 times) and essentially the same as 2000 (3.64 times). Separately, Tandy Leather's 2002 and 2001 inventory turns were 8.10 times and 4.79 times, respectively. Leather Factory's inventory turned 3.20 times in 2002 and 3.96 times in 2001, and Cushman's inventory turned 4.12 times and 3.86 times in 2002 and 2001, respectively. The significant improvement in the inventory turn rate for Tandy Leather is due to the elimination of its central warehouse in September 2002 (combined into Leather Factory's warehouse). We now record only merchandise held in Tandy Leather stores as Tandy Leather inventory. Leather Factory's turns slowed slightly in 2002 because it added the Tandy Leather warehouse inventory to the goods held for the Leather Factory store system. Additionally, the increase in inventory arriving at the central warehouse in the fourth quarter adversely affected Leather Factory's inventory turns. Leather Factory store inventory turns, excluding the central warehouse inventory, were approximately 7.0 and 6.5 turns in 2002 and 2001, respectively. We compute our inventory turnover rates as sales divided by average inventory. Accounts payable increased to $1.6 million at December 31, 2002 from $1.3 million at the end of 2001. The increased inventory on hand at the end of 2002 accounted for the increase. The Company's current ratio improved at December 31, 2002 to 1.94, compared to 1.82 at December 31, 2001. If, however, accounting rules had not required the Company's debt with Wells Fargo to be classified as short-term (even though the stated maturity is in November 2004), the current ratio at December 31, 2002 would have been 3.94. The largest use of operating cash in 2002 was for debt reduction and various capital expenditures. Capital expenditures totaled $1,073,000 and $630,000 for the years ended December 31, 2002 and 2001, respectively. Capital expenditures in 2002 included approximately $600,000 in leasehold improvements for the central warehouse and factory consolidation and remodeling of the Fort Worth Leather Factory store. The following table summarizes by years our contractual obligations and commercial commitments as of December 31, 2002:
PAYMENTS DUE BY PERIODS ------------------------------------------------------------------ LESS THAN 1 - 3 CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS 4 -5 YEARS AFTER 5 YEARS - ----------------------------- -------------- --------- ----------- ---------- ------------- LONG-TERM DEBT* $ 4,213,533 - $4,213,533 - - CAPITAL LEASE OBLIGATIONS 8,002 $ 6,859 1,143 - - OPERATING LEASES 5,744,905 1,594,438 3,349,950 $ 800,517 - -------------- ---------- ---------- --------- ------------- TOTAL CONTRACTUAL OBLIGATIONS $ 9,966,440 $1,601,297 $7,564,626 $ 800,517 $ - ============== ========== ========== ========= ============= _____________ * The Company's loan from Wells Fargo matures in November 2004. The loan's maturity can be accelerated in the event of a material adverse change or upon other occurrences described in the related credit agreement.
20 CRITICAL ACCOUNTING POLICIES The analysis and discussion of our financial condition and results of operations is based upon our consolidated financial statements that have been prepared in accordance with generally accepted accounting principles in the United States (US GAAP). The preparation of financial statements in accordance with US GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. US GAAP provides the framework from which to make these estimates, assumptions and disclosures. We choose accounting policies within US GAAP that we believe are appropriate to accurately and fairly report the Company's operating results and financial position in a consistent manner. Management regularly assesses these policies in light of current and forecasted economic conditions. The Company's accounting policies are stated in Note 2 to the consolidated financial statements. We have summarized below the accounting policies that we believe are most critical to an understanding of the preparation of our financial statements. BASIS OF CONSOLIDATION. We report our financial information on a consolidated basis. Therefore, unless there is an indication to the contrary, financial information is provided for the parent company, The Leather Factory, Inc., and its subsidiaries as a whole. Transactions between the parent company and any subsidiaries are eliminated for this purpose. We own all of the capital stock of our subsidiaries, and we do not have any subsidiaries that are not consolidated. None of our subsidiaries is "off balance sheet". REVENUE RECOGNITION. We recognize revenue for retail (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. ALLOWANCE FOR ACCOUNTS RECEIVABLE. We reduce accounts receivable by an allowance for amounts that may become uncollectible in the future. This allowance is an estimate based primarily our evaluation of the customer's financial condition, past collection history, and the aging of the account. If the financial condition of any of our customers deteriorates, resulting in an impairment or inability to make payments, additional allowances may be required. 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 periodically reduce the value of our inventory for slow-moving or obsolete inventory. This reduction is based on management's review of items on hand compared to their estimated future demand. If actual future demand is less favorable than those projected by management, 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. GOODWILL. We have indicated above that a change in the accounting rules necessitated a change in 2002 in how we report goodwill on our balance sheet. As a result, we incurred an impairment write-down in the first quarter of 2002 of our investment in Cushman in the amount of $4 million. The remaining goodwill on our balance sheet is analyzed by management periodically to determine the appropriateness of its carry value. As of December 31, 2002, management has determined that the present value of the discounted estimated future cash flows of the stores associated with the goodwill is sufficient to support their respective goodwill balances. If actual results of these stores differs significantly from management's projections, such difference could affect the present value calculation in the future resulting in an impairment of all or part of the goodwill currently carried on the Company's balance sheet. 21 FORWARD-LOOKING STATEMENTS "Item 1. Business" and "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report contain forward-looking statements of management. In general, these are predictions or suggestions of future events and statements or expectations of future occurrences. There are certain important risks that could cause results to differ materially from those anticipated by some of the forward-looking statements. Some, but not all, of the important risks which could cause actual results to differ materially from those suggested by the forward-looking statements include, among other things: - - Involvement by the United States in war and other military operations in the Middle East could disrupt international trade and affect the Company's inventory sources. - - The recent slump in the economy in the United States, as well as abroad, may cause our sales to decrease or not to increase or adversely affect the prices charged for our products. Also, hostilities, terrorism or other events could worsen this condition. - - As a result of the on-going threat of terrorist attacks on the United States, consumer buying habits could change and decrease our sales. - - The prices of hides and leathers also fluctuate in normal times, and these fluctuations can affect the Company. - - If, for whatever reason, the costs of our raw materials and inventory increase, we may not be able to pass those costs on to our customers, particularly if the economy has not recovered from its downturn. - - Other factors could cause either fluctuations in buying patterns or possible negative trends in the craft and western retail markets. In addition, our customers may change their preferences to products other than ours, or they may not accept new products as we introduce them. - - We might fail to realize the anticipated benefits of the opening of Tandy Leather retail stores or other retail initiatives might not be successful. - - Tax or interest rates might increase. In particular, interest rates are likely to increase at some point from their present low levels. These increases will increase our costs of borrowing funds as needed in our business. - - Any change in the commercial banking environment may affect us and our ability to borrow capital as needed. - - Other uncertainties, which are difficult to predict and many of which are beyond the control of the Company, may occur as well. The Company does not intend to update forward-looking statements. 22 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK - --------------------------------------------------------------------------- We face exposure to financial market risks, including adverse movement in foreign current exchange rates and changes in interest rates. 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 EXCHANGE RATE RISK Our primary foreign currency exposure is related to our subsidiary in Canada. The Leather Factory of Canada, Ltd. has local currency (Canadian dollar) revenue and local currency operating expenses. Changes in the currency exchange rate impacts the U.S. dollar amount of revenue and expenses. See Note 12 to the Consolidated Financial Statements, Segment Information, for financial information concerning the Company's foreign activities. INTEREST RATE RISK We are subject to market risk associated with interest rate movements on outstanding debt. Our borrowings under the credit facility with Wells Fargo accrue interest at a rate that changes with fluctuations in the prime rate. Based on the Company's level of debt at March 15, 2003, an increase of one percent in the prime rate would result in additional interest expense of approximately $60,000 during a twelve-month period. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. - ---------------------------------------------------------- The Financial Statements and Financial Statement Schedule are filed as a part of this report. See page 22, Index to Consolidated Financial Statements. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND - -------------------------------------------------------------------------------- FINANCIAL DISCLOSURE. - ---------------------- 23 None THE LEATHER FACTORY, INC. ------------------------- INDEX TO CONSOLIDATED FINANCIAL STATEMENTS ------------------------------------------ Consolidated Balance Sheets at December 31, 2002 and 2001 25 Consolidated Statements of Income for the Years Ended December 31, 2002, 2001 and 2000 26 Consolidated Statements of Cash Flows for the Years Ended December 31, 2002, 2001 and 2000 27 Consolidated Statements of Stockholders' Equity for the Years Ended December 31, 2002, 2001 and 2000 28 Notes to Consolidated Financial Statements 29 Financial Statements Schedules for the years ended December 31, 2002, 2001 and 2000: II - Valuation and Qualifying Accounts and Reserves 41 All other schedules are omitted since the required information is not present or is not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements and notes thereto. Report of Independent Auditors 42 24 THE LEATHER FACTORY, INC. CONSOLIDATED BALANCE SHEETS
December 31, December 31, 2002 2001 ------------- -------------- ASSETS CURRENT ASSETS: Cash $ 101,557 $ 409,040 Cash restricted for payment on revolving credit facility 553,839 491,729 Accounts receivable-trade, net of allowance for doubtful accounts of $78,000 and $191,000 in 2002 and 2001, respectively 1,938,698 2,297,953 Inventory 12,695,344 9,054,269 Prepaid income taxes 55,644 - Deferred income taxes 159,090 128,111 Other current assets 672,117 479,390 -------------- -------------- Total current assets 16,176,289 12,860,492 -------------- -------------- PROPERTY AND EQUIPMENT, at cost 5,321,749 4,201,368 Less-accumulated depreciation and amortization (3,301,898) (2,858,869) -------------- -------------- Property and equipment, net 2,019,851 1,342,499 GOODWILL, net of accumulated amortization of $734,000 and $1,583,000 in 2002 and 2001, respectively 686,484 4,535,412 OTHER INTANGIBLES, net of accumulated amortization of $113,000 and $66,000, in 2002 and 2001, respectively 483,507 476,908 OTHER assets 309,471 333,012 -------------- -------------- $ 19,675,602 $ 19,548,323 ============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,594,909 $ 1,303,596 Accrued expenses and other liabilities 2,503,331 1,171,152 Income taxes payable - 52,662 Notes payable and current maturities of long-term debt 4,218,968 4,527,904 -------------- -------------- Total current liabilities 8,317,208 7,055,314 -------------- -------------- DEFERRED INCOME TAXES 186,076 61,647 NOTES PAYABLE AND LONG-TERM DEBT, net of current maturities 2,256 7,691 COMMITMENTS AND CONTINGENCIES (Note 7) - - STOCKHOLDERS' EQUITY: Preferred stock, $0.10 par value; 20,000,000 shares authorized, none issued or outstanding - - Common stock, $0.0024 par value; 25,000,000 shares authorized, 10,149,961 and 9,991,161 shares issued and outstanding at 2002 and 2001, respectively 24,360 23,979 Paid-in capital 4,163,901 4,030,508 Retained earnings 7,064,345 8,478,187 Less: Notes receivable - secured by common stock (44,003) (71,939) Accumulated other comprehensive loss (38,541) (37,064) -------------- -------------- Total stockholders' equity 11,170,062 12,423,671 -------------- -------------- $ 19,675,602 $ 19,548,323 ============== ==============
The accompanying notes are an integral part of these financial statements. 25 THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
2002 2001 2000 ------------ ------------ ----------- NET SALES $39,728,615 $37,279,262 $30,095,264 COST OF GOODS SOLD 18,393,914 17,934,935 15,147,547 ----------- ----------- ----------- Gross Profit 21,334,701 19,344,327 14,947,717 OPERATING EXPENSES 17,202,927 15,442,359 11,702,633 ----------- ----------- ----------- INCOME FROM OPERATIONS 4,131,774 3,901,968 3,245,084 OTHER EXPENSE: Interest Expense (246,878) (458,558) (617,400) Other, net (65,039) (74,924) (36,379) ----------- ----------- ----------- Total Other Expense (311,917) (533,482) (653,779) ----------- ----------- ----------- INCOME BEFORE INCOME TAXES and CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 3,819,857 3,368,486 2,591,305 PROVISION FOR INCOME TAXES 1,224,868 1,362,053 1,049,985 ----------- ----------- ----------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 2,594,989 2,006,433 1,541,320 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE (4,008,831) - - ----------- ----------- ----------- NET INCOME (LOSS) $(1,413,842) $2,006,433 $1,541,320 =========== =========== =========== NET INCOME (LOSS) PER COMMON SHARE - BASIC: Income before Cumulative Effect of Accounting Principle $ 0.26 $0.20 $0.16 Cumulative Effect of Change in Accounting Principle, net (0.40) - - ----------- ----------- ----------- NET INCOME PER COMMON SHARE $(0.14) $0.20 $0.16 =========== =========== =========== NET INCOME (LOSS) PER COMMON SHARE - DILUTED: Income before Cumulative Effect of Accounting Principle $ 0.24 $0.19 $0.15 Cumulative Effect of Change in Accounting Principle, net (0.37) - - ----------- ----------- ----------- NET INCOME PER COMMON SHARE - DILUTED $(0.13) $0.19 $0.15 =========== =========== =========== WEIGHTED AVERAGE NUMBER OF SHARES: Basic 10,063,581 9,976,181 9,875,606 Diluted 10,761,670 10,449,306 10,182,803
The accompanying notes are an integral part of these financial statements. 26 THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF CASH FLOW FOR THE YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
2002 2001 2000 ------------ ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) $(1,413,842) $2,006,433 $1,541,320 Adjustments to reconcile net income (loss) to net cash provided by operating activities - Depreciation and amortization 491,312 730,153 582,778 Loss on disposal of assets - 5,588 5,089 Amortization of deferred financing costs 37,038 45,753 44,804 Deferred income taxes (30,184) (8,135) 4,056 Other (2,502) (10,898) (4,184) Cumulative effect of change in accounting principle 4,008,831 - - Net changes in assets and liabilities, net of effects of business acquisitions: Accounts receivable-trade, net 359,255 (105,957) 368,848 Inventory (3,463,866) 151,629 1,562,274 Income taxes 16,124 (42,133) (379,467) Other current assets (192,726) 230,695 83,990 Accounts payable 291,311 (856,314) (137,686) Accrued expenses and other liabilities 1,332,179 (119,461) 230,732 ------------ ------------ ------------ Total adjustments 2,846,772 20,920 2,361,234 ------------ ------------ ------------ Net cash provided by operating activities 1,432,930 2,027,353 3,902,554 ------------ ------------ ------------ CASH FLOWS FROM INVESTING ACTIVITIES Purchase of property and equipment (1,073,515) (629,773) (377,840) Payments in connection with businesses acquired (435,747) - (2,999,159) Proceeds from sale of assets - 3,200 2,484 (Increase) decrease in other assets (14,754) (1,386) 2,519 Other intangible costs (1,625) - - ------------ ------------ ------------ Net cash used in investing activities (1,525,641) (627,959) (3,371,996) ------------ ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in revolving credit loans (286,889) (1,150,543) (167,687) Payments on notes payable and long-term debt (27,482) (105,189) (243,083) Increase in cash restricted for payment on revolving credit loans (62,110) (101,262) (72,563) Payments received on notes secured by common stock 27,936 48,400 33,077 Deferred financing costs incurred - - (25,626) Proceeds from issuance of common stock 133,774 84,099 45,000 ------------ ------------ ------------ Net cash used in financing activities (214,772) (1,224,495) (430,882) ------------ ------------ ------------ NET INCREASE (DECREASE) IN CASH (307,483) 174,899 99,676 CASH, beginning of period 409,040 234,141 134,465 ------------ ------------ ------------ CASH, end of period $101,557 $409,040 $234,141 ============ ============ ============ SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid during the period $213,791 $443,925 $572,557 Income tax paid during the period 1,254,679 1,414,404 1,424,648 NON-CASH INVESTING ACTIVITIES: Equipment acquired under capital lease financing arrangements - $18,676 -
The accompanying notes are an integral part of these financial statements. 27 THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Common Stock --------------------------------- Number Par Paid-in Retained of shares value capital earnings ------------- ----------------- ---------- --------------- BALANCE, December 31, 1999 9,853,161 $ 23,648 $3,901,740 $ 4,930,434 Payments on notes receivable secured by common stock - - - - Shares issued - stock options exercised 55,000 132 44,868 - Net income - - - 1,541,320 Translation adjustment - - - - ------------ ----------------- ---------- --------------- BALANCE, December 31, 2000 9,908,161 $ 23,780 $3,946,608 $ 6,471,754 Payments on notes receivable secured by common stock - - - - Shares issued - stock options exercised 83,000 199 83,900 - Net income - - - 2,006,433 Translation adjustment - - - - ------------ ----------------- ---------- --------------- BALANCE, December 31, 2001 9,991,161 $ 23,979 $4,030,508 $ 8,478,187 Payments on notes receivable secured by common stock - - - - Shares issued - stock options and warrants exercised 158,800 381 133,393 - Net loss - - - (1,413,842) Translation adjustment - - - - ------------ ----------------- ---------- --------------- BALANCE, December 31, 2002 10,149,961 $ 24,360 $4,163,901 $ 7,064,345 ============ ================= ========== =============== Notes Accumulated Receivable Other Comprehensive secured by Cumulative Income common stock Loss Total (Loss) -------------- ------------ ----------- ---------------- BALANCE, December 31, 1999 $ (153,416) $ (21,981) $ 8,680,425 Payments on notes receivable secured by common stock 33,077 - 33,077 Shares issued - stock options exercised - - 45,000 Net income - - 1,541,320 $ 1,541,320 Translation adjustment - (4,185) (4,185) (4,185) -------------- ------------ ----------- ---------------- BALANCE, December 31, 2000 $ (120,339) $ (26,166) $10,295,637 Comprehensive income for the year ended December 31, 2000 $ 1,537,135 ================ Payments on notes receivable secured by common stock 48,400 - 48,400 Shares issued - stock options exercised - - 84,099 Net Income - - 2,006,433 2,006,433 Translation adjustment - (10,898) (10,898) (10,898) -------------- ------------ ----------- ---------------- BALANCE, December 31, 2001 $ (71,939) $ (37,064) $12,423,671 Comprehensive income for the year ended December 31, 2001 $ 1,995,535 ================ Payments on notes receivable secured by common stock 27,936 - 27,936 Shares issued - stock options and warrants exercised - - 133,774 Net Loss - - (1,413,842) (1,413,842) Translation adjustment - (1,477) (1,477) (1,477) -------------- ------------ ----------- ---------------- BALANCE, December 31, 2002 $ (44,003) $ (38,541) $11,170,062 ============== ============ =========== Comprehensive loss for the year ended December 31, 2002 $ (1,415,319) ================
The accompanying notes are an integral part of these financial statements. 28 THE LEATHER FACTORY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2002, 2001, AND 2000 1. ORGANIZATION AND NATURE OF OPERATIONS The Leather Factory, Inc. and subsidiaries (the "Company") is engaged in the manufacture and distribution of a broad product line of leather, leathercrafts, western apparel and related accessory items. The Company operates stores throughout the United States and Canada. Numerous customers including retailers, wholesalers, assemblers, distributors and other manufacturers geographically disbursed throughout the world purchase the Company's products. The Company also has light manufacturing facilities in Texas and New York. Certain reclassifications have been made to conform the 2000 and 2001 financial statements to the presentation in 2002. The reclassifications had no effect on net income. 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES CONSOLIDATION The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly-owned. Significant intercompany accounts and transactions have been eliminated in consolidation. INVENTORY The Company's inventory is valued at the lower of first-in, first-out cost or market. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to expense when incurred. The cost of assets retired or sold and the related amounts of accumulated depreciation are removed from the accounts, and any gain or loss is included in the statement of income. Depreciation is determined using the straight-line method over the estimated useful lives as follows: Leasehold improvements 5-7 years Equipment 5-10 years Furniture and fixtures 5-7 years Automobiles 5 years Depreciation expense was $443,029, $460,741; and $358,787 for the years ended December 31, 2002, 2001 and 2000, respectively. GOODWILL In June 2001, the FASB issued Statements of Financial Accounting Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. This standard requires companies to stop amortizing goodwill and certain intangible assets with indefinite useful lives. Instead, goodwill and intangible assets deemed to have indefinite useful lives are subject to an annual review of impairment. The new standard was effective for the Company in the first quarter of 2002. Upon adoption of SFAS No. 142, the Company recorded a one-time, noncash charge of approximately $4.0 million to eliminate the carrying value of its goodwill relating to its subsidiary, Roberts, Cushman & Co., Inc. This charge is non-operational in nature and is reflected as a cumulative effect of an accounting change in the accompanying consolidated statement of income. For additional discussion on the impact of adopting SFAS No. 142, see Note 13. ADVERTISING COSTS 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 $116,611 and $162,495 at December 31, 2002 and 2001, respectively. Total advertising expense was $2,265,659 in 2002; $2,023,527 in 2001; and $1,353,520 in 2000. REVENUE RECOGNITION Retail (over the counter) sales are recorded as transactions occur and other sales are recorded when goods are shipped to customers. INCOME TAXES Deferred income taxes result from temporary differences in the basis of assets and liabilities reported for financial statement and income tax purposes. EARNINGS PER SHARE Basic earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding. Diluted earnings per share is computed by dividing income available to common stockholders by the weighted average number of common shares outstanding increased for potentially dilutive common shares outstanding during the period. The dilutive effect of stock options, warrants and their equivalents is calculated using the treasury stock method. Unearned shares, if any, held by the Employees' Stock Ownership Plan are deemed not to be outstanding for earnings per share calculations. ACCOUNTING ESTIMATES The consolidated financial statements include estimates and assumptions made by management that affect the reported amounts of assets and liabilities, the reported amounts of revenues and expenses and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. ALLOWANCE FOR DOUBTFUL ACCOUNTS The Company reduces its accounts receivable by an allowance for amounts that may become uncollectible in the future. This allowance is an estimate based primarily on the aging of the accounts as well as management's evaluation of the financial condition and past collection history of each customer. LONG-LIVED ASSETS SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, requires that long-lived assets and certain identifiable intangible assets be reviewed for impairment whenever events indicate that the carrying amount of an asset may not be recoverable. The Company determined that as of December 31, 2002 and 2001, it had no long-lived assets that met the impairment criteria of SFAS No. 144. STOCK-BASED COMPENSATION SFAS No. 123, Accounting for Stock-Based Compensation, and SFAS No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement 123 (see Note 14), establish financial accounting and reporting standards and disclosures for stock-based employee compensation plans. As permitted by SFAS No. 123, the Company has elected to continue to use Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees ("APB 25") and related Interpretations, in accounting for its stock option plans. Pro forma information regarding net income and earnings per share is required by SFAS No. 123 and SFAS No. 148 and has been determined as if the Company had accounted for its stock options under the fair value method. The fair value for these options was estimated at the date of grant using the Black Scholes option pricing model with the following weighted-average assumptions: risk-free interest rates of 3.00% in 2002; 3.50% in 2001; and 5.75% in 2000; dividend yields of 0% for all years; volatility factors of .736 for 2002, .780 for 2001, ..821 for 2000; and an expected life of the valued options of 5 years. Option valuation models require the input of highly subjective assumptions, including the expected stock price volatility, and changes in these input assumptions can materially affect the fair value estimate they produce. Because of this, it is management's opinion that existing models do not necessarily provide a reliable single measure of fair value for the Company's stock options. For pro forma disclosures, the estimated fair values determined by the model are being amortized to expense on a straight-line basis over the options vesting period as adjusted for estimated forfeitures. The Company's pro forma information follows:
2002 2001 2000 ------------ ---------- ---------- Net income (loss), as reported $(1,413,842) $2,006,433 $1,541,320 Deduct: Total stock-based employee compensation expense determined under fair based method for all awards, net of related tax effects 103,619 28,539 121,627 ------------ ---------- ---------- Pro forma net income (loss) $(1,517,461) $1,977,894 $1,419,693 ============ ========== ========== Earnings per share: Basic - as reported $ (0.14) $ 0.20 $ 0.16 Basic - pro forma $ (0.15) $ 0.20 $ 0.14 Diluted - as reported $ (0.13) $ 0.19 $ 0.15 Diluted - pro forma $ (0.14) $ 0.19 $ 0.14
FOREIGN CURRENCY TRANSLATION Foreign currency translation adjustments arise from activities of the Company's Canadian operations. 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. COMPREHENSIVE INCOME Comprehensive income represents all changes in stockholders' equity, exclusive of transactions with stockholders. The accumulated balance of foreign currency translation adjustments is presented in the consolidated financial statements as "accumulated other comprehensive income or loss". 29 3. BALANCE SHEET COMPONENTS
DECEMBER 31, 2002 2001 ----------- ---------- INVENTORY: Finished goods held for sale $11,693,868 $8,025,845 Raw materials and work in process 1,001,476 1,028,424 ----------- ---------- Total $12,695,344 $9,054,269 =========== ========== PROPERTY AND EQUIPMENT: Leasehold improvements $1,043,076 $ 470,709 Equipment 3,407,332 2,987,518 Furniture and fixtures 839,326 711,126 Autos 32,015 32,015 ----------- ---------- 5,321,749 4,201,368 Less: accumulated depreciation and amortization (3,301,898) (2,858,869) ----------- ---------- Total $2,019,851 $1,342,499 =========== ========== OTHER CURRENT ASSETS: Accounts receivable - employees $ 21,977 $ 40,550 Accounts receivable - other 23,364 29,546 Prepaid expenses 362,698 349,242 Payments on merchandise not received 264,078 54,518 Other - 5,534 ----------- ---------- Total $ 672,117 $ 479,390 =========== ========== ACCRUED EXPENSES AND OTHER LIABILITIES: Accrued bonuses $ 934,191 $ 706,696 Accrued payroll 226,501 146,730 Accrued ESOP contribution 28,100 25,000 Sales and payroll taxes payable 95,849 55,482 Inventory in transit 1,000,000 - Other 218,690 237,244 ----------- ---------- Total $2,503,331 $1,171,152 =========== ==========
30 4. NOTES PAYABLE AND LONG-TERM DEBT On March 20, 2002, the Company entered into a Credit and Security Agreement with Wells Fargo Bank Minnesota, N.A. ("Wells Fargo"), pursuant to which Wells Fargo agreed to provide a revolving credit facility of up to $7,500,000. The revolver bears interest at prime or, at the Company's option, the London interbank eurodollar market rate ("LIBOR") plus 2.60%. The agreement terminates on November 30, 2004. Proceeds of the closing of the Credit Facility were used to pay all amounts due and owing by the Company pursuant to the Credit and Security Agreement, as amended, by and between the Company and Wells Fargo Business Credit, Inc. ("WFBC"). At closing, the Company's revolving line of credit with WFBC in the principal amount of $2,980,242 was satisfied in its entirety. At December 31, 2002 and 2001, the amounts outstanding under the above agreements and other long-term debt consisted of the following:
2002 2001 ----------- ----------- Credit and Security Agreement with Wells Fargo - collateralized by all of the assets of the Company; payable as follows: Revolving Note dated March 20, 2002 in the maximum principal amount of $7,500,000 with revolving features as more fully described below - interest due monthly at prime (4.25% at December 31, 2002); matures November 30, 2004 $4,213,533 - Credit and Security Agreement with WFBC - collateralized by all of the assets of the Company; payable as follows: Revolving Note dated November 19, 1999 in the maximum principal amount of $8,500,000 with revolving features - interest due monthly - $4,500,422 Capital Lease secured by equipment - total monthly principal and interest payments of $572 at approximately 12% interest; maturing February 2004 7,691 35,173 ----------- ---------- 4,221,224 4,535,595 Less - Current maturities (see below) 4,218,968 4,527,904 ----------- ---------- $ 2,256 $ 7,691 =========== ==========
The current portion of long-term debt includes the Wells Fargo revolving credit facility although this obligation does not mature until November 30, 2004. The classification of this debt was attributable to an accounting requirement that a revolving credit agreement that includes both a subjective acceleration clause and a requirement to maintain an arrangement, whereby cash collections from the borrower's customers directly reduce the debt outstanding, to be classified as a short-term obligation (Emerging Issues Task Force Issue 95-22). A covenant of the facility is that collections from customers are to be deposited into a cash collateral account that directly pays down the revolving credit loan. The balance in this account comprises the restricted cash on the Company's balance sheet. Because of this arrangement and the fact that the debt agreement contains a clause that would allow acceleration of payment of the debt in case of a "material adverse change", this rule applies. Management does not believe that any such acceleration will occur. Pursuant to the Credit and Security Agreement with Wells Fargo, the overall combined borrowings under the revolving credit loan and outstanding balance on letters of credit is limited to a combined amount of $7,500,000. Of the $7,500,000 limit, letters of credit cannot exceed $500,000. The unused portion of the letter of credit limit can be utilized for borrowings, up to the limits imposed for the indebtedness. As of December 31, 2002, there were no letters of credit outstanding. Total borrowings under this arrangement are subject to a percentage of trade accounts receivable and inventory reduced by the outstanding balance of letters of credit and any required reserves. The unused portion of the credit facility at December 31, 2002 was $2,413,556. The terms of the Credit Facility contain various covenants which among other things require the Company to maintain a certain level of income and book net worth and limit capital expenditures. Other covenants prohibit the Company from incurring indebtedness except as permitted by the terms of the Credit Facility, from declaring or paying cash dividends upon any of its stock and from entering into any new business or making material changes in any of the Company's business objectives, purposes or operations. Scheduled maturities of the Company's notes payable and long-term debt are as follows:
2003 $4,218,968 2004 2,256 2005 - 2006 - ---------- $4,221,224 ==========
31 5. EMPLOYEE BENEFIT PLAN The Company has an Employee Stock Ownership Plan (the "Plan") for employees with at least one year of service (as defined by the Plan) and who have reached their 21st birthday. Under the Plan, the Company makes annual cash or stock contributions to a trust for the benefit of eligible employees. The trust invests in shares of the Company's common stock. The amount of the Company's annual contribution is discretionary. Benefits under the Plan are 100% vested after three years of service and are payable upon death, disability or retirement. Vested benefits are payable upon termination of employment. The Company applies Statement of Position 93-6 (SOP 93-6"), "Employers' Accounting for Employee Stock Ownership Plans," of the Accounting Standards Division of the American Institute of CPAs. During 2002, 2001, and 2000, respectively, the Company contributed $345,312; $277,892; and $249,017 in cash as current year contributions to the plan and recognized compensation expense related to these payments. The following table summarizes the number of shares held by the Plan and the market value as of December 31, 2002, 2001, and 2000:
NO. OF SHARES MARKET VALUE -------------------------- -------------------------------- 2002 2001 2000 2002 2001 2000 ------- ------- ------- ---------- ---------- -------- Allocated 956,320 895,928 808,539 $3,232,362 $1,863,530 $808,539 Unearned - - - - - - ------- ------- ------- ---------- ---------- -------- Total 956,320 895,928 808,539 $3,232,362 $1,863,530 $808,539 ======= ======= ======= ========== ========== ========
The Company currently offers no postretirement or postemployment benefits to its employees. 6. INCOME TAXES The provision for income taxes consists of the following:
2002 2001 2000 ---------- ---------- ---------- Current provision (benefit): Federal $1,078,146 $1,154,847 $ 849,994 State 51,556 218,717 191,070 ---------- ---------- ---------- 1,129,702 1,373,564 1,041,064 ---------- ---------- ---------- Deferred provision (benefit): Federal 82,014 (11,299) 7,418 State 13,152 (212) 1,503 ---------- ---------- ---------- 95,166 (11,511) 8,921 ---------- ---------- ---------- $1,224,868 $1,362,053 $1,049,985 ========== ========== ==========
The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities are as follows:
2002 2001 --------- --------- Deferred income tax assets: Allowance for doubtful accounts $28,780 $28,450 Capitalized inventory costs 115,590 90,942 Accrued expenses, reserves, and other 14,720 8,719 --------- --------- Total deferred income tax assets 159,090 128,111 --------- --------- Deferred income tax liabilities: Property and equipment depreciation 171,601 55,750 Goodwill and other intangible assets amortization 15,380 12,577 Tax effect of translation adjustment and other (905) (6,680) --------- --------- Total deferred income tax liabilities 186,076 61,647 --------- --------- Net deferred tax asset (liability) $(26,986) $66,464 ========= =========
The effective tax rate differs from the statutory rate as follows: 2002 2001 2000 ----- ----- ----- Statutory rate 34% 34% 34% State and local taxes 1% 3% 7% Non-deductible goodwill amortization 0% 2% 3% Other (3%) 1% (3%) ----- ----- ----- Effective rate 32% 40% 41% ===== ===== =====
32 7. COMMITMENTS AND CONTINGENCIES OPERATING LEASES The Company's primary office facility and warehouse are leased under a five-year lease agreement that expires in March 2008. Rental agreements for the sales/distribution units expire on dates ranging from July 2003 to August 2008. The Company's lease agreement for the manufacturing facility in Long Island City, New York, expires on June 30, 2003. Rent expense on all operating leases for the years ended December 31, 2002, 2001, and 2000, was $1,465,577, $1,299,582, and $1,106,171, respectively. CAPITAL LEASES The Company leases certain computer and warehouse equipment under capital lease agreements. Assets subject to the agreements totaling $18,651 and $365,252 and related accumulated depreciation of $4,885 and $249,470 are included in property and equipment as of December 31, 2002 and 2001, respectively. COMMITMENTS Future minimum lease payments under capital and noncancelable operating leases at December 31, 2002 were as follows:
CAPITAL OPERATING LEASES LEASES ------- ---------- Year ending December 31: 2003 $6,859 $1,594,438 2004 1,143 1,277,163 2005 - 1,114,538 2006 - 958,249 2007 and thereafter - 800,517 ------- ---------- Total minimum lease payments 8,002 $5,744,905 Less amount representing interest 311 ========== ------- Present value of net minimum capital lease payments 7,691 Less current installments of minimum capital lease payments 5,435 ------- Long-term capital lease obligations, excluding current installments $2,256 =======
LITIGATION The Company is involved in various litigation that arises in the ordinary course of its business and operations. There are no such matters pending that the Company expects to have a material impact on its financial position and results of operations. 8. SIGNIFICANT BUSINESS CONCENTRATIONS AND RISK Major Customers - ---------------- The Company's revenues are derived from a diverse group of customers primarily involved in the sale of leather crafts. While no single customer accounts for more than 10% of the Company's consolidated revenues in 2002, 2001 and 2000, sales to the Company's five largest customers represented 15%, 15% and 14%, respectively, of consolidated revenues in those years. While management does not believe the loss of one of these customers would have a negative impact on the Company's operations, it does believe the loss of several of these customers simultaneously or a substantial reduction in sales generated by them could temporarily affect the Company's operating results. Major Vendors - -------------- The Company purchases a significant portion of its inventory through one supplier. Due to the number of alternative sources of supply, loss of this supplier would not have an adverse impact on the Company's operations. Credit Risk - ------------ Due to the large number of customers comprising the Company's customer base, concentrations of credit risk with respect to customer receivables are limited. At December 31, 2002 and 2001, 20% and 23%, respectively, of the Company's consolidated accounts receivable were due from three nationally recognized retail chains. The Company does not generally require collateral for accounts receivable, but performs periodic credit evaluations of its customers and believes the allowance for doubtful accounts is adequate. It is management's opinion that if any one or a group of customer receivable balances should be deemed uncollectible, it would not have a material adverse effect on the Company's results of operations and financial condition. 33 9. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share:
2002 2001 2000 ----------- ----------- ---------- Numerator: Net income (loss) $(1,413,842) $2,006,433 $1,541,320 ---------- ---------- ---------- Numerator for basic and diluted earnings per share (1,413,842) 2,006,433 1,541,320 Denominator: Denominator for basic earnings per share - weighted-average shares 10,063,581 9,976,181 9,875,606 Effect of dilutive securities: Stock options 477,005 265,621 134,300 Warrants 221,084 207,504 172,897 ---------- ---------- ---------- Dilutive potential common shares 698,089 473,125 307,197 ---------- ---------- ---------- Denominator for diluted earnings per share - adjusted weighted-average shares and assumed conversions 10,761,670 10,449,306 10,182,803 ========== ========== ========== Basic earnings per share $ (0.14) $ 0.20 $ 0.16 =========== ========== ========== Diluted earnings per share $ (0.13) $ 0.19 $ 0.15 =========== ========== ==========
For additional disclosures regarding the employee stock options and the warrants, see Note 10. Unexercised employee and director stock options to purchase -0- and 2,000 shares of common stock as of December 31, 2002 and 2001, respectively, were not included in the computations of diluted earnings per share ("EPS") because the options' exercise prices were greater than or equal to the average market prices of the common stock and, therefore, the effect would be antidilutive. The net effect of converting stock options and warrants to purchase 762,200 and 844,000 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, 2002 and 2001, respectively. 34 10. STOCKHOLDERS' EQUITY STOCK OPTION PLANS 1995 Stock Option Plan - ------------------------- In connection with its 1995 Stock Option Plan for officers and key management employees, the Company has outstanding options to purchase its common stock. The plan provides for the granting of either qualified incentive stock options or 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 over a five-year period. The Company has reserved 1,000,000 shares of common stock for issuance under this plan. 1995 Director Non-Qualified Stock Option Plan - -------------------------------------------------- In connection with its 1995 Director Non-qualified Stock Option Plan for non-employee directors, the Company has outstanding options to purchase its common stock. The plan 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. The Company has reserved 100,000 shares of common stock for issuance under this plan. Stock Option Summary - ---------------------- All options expire ten years from the date of grant and are exercisable at any time after vesting. Of the combined 1,100,000 shares available for issuance under the two plans, at December 31, 2002, 2001 and 2000, there were 106,000; 116,000; and 587,000; respectively, in un-optioned shares reserved for future grants. A summary of stock option transactions for the years ended December 31, 2002, 2001, and 2000, is as follows:
2002 2001 2000 -------------------- ------------------ ----------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE OPTION EXERCISE OPTION EXERCISE OPTION EXERCISE SHARES PRICE SHARES PRICE SHARES PRICE -------- -------- -------- -------- -------- -------- Outstanding at January 1 846,000 $1.128 458,000 $0.814 453,000 $0.779 Granted 10,000 2.720 477,000 1.361 60,000 0.958 Forfeited or expired - - (6,000) 0.751 - - Exchanged - - - - - - Exercised (108,800) 0.810 (83,000) 0.761 (55,000) 0.676 -------- -------- -------- -------- -------- -------- Outstanding at December 31 747,200 $1.196 846,000 $1.128 458,000 $0.814 ======== ======== ======== ======== ======== ======== Exercisable at end of year 747,200 $1.196 844,000 $1.123 358,000 $0.820 ======== ======== ======== ======== ======== ======== Weighted-average fair value of Options granted during year $1.54 $0.81 $0.61 ======== ======== ========
The following table summarizes outstanding options into groups based upon exercise price ranges at December 31, 2002:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE WEIGHTED WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE AVERAGE OPTION EXERCISE MATURITY OPTION EXERCISE MATURITY EXERCISE PRICE RANGE SHARES PRICE (YEARS) SHARES PRICE (YEARS) - --------------------- ------- -------- -------- ------- -------- -------- $0.75 or Less 32,000 $0.610 5.35 32,000 $0.610 5.35 More than $0.75 and Less Than $1.00 221,500 0.841 3.86 221,500 0.841 3.86 More than $1.00 493,700 1.393 8.36 493,700 1.393 8.36 ------- -------- -------- ------- -------- -------- 747,200 $1.196 6.90 747,200 $1.196 6.90 ======= ======== ======== ======= ======== ========
WARRANTS Warrants to acquire up to 200,000 shares of common stock at approximately $0.44 per share were issued in conjunction with a consulting agreement to an unrelated individual in August 1998. The warrants may be exercised at any time until expiration on August 3, 2003. NOTES RECEIVABLE SECURED BY COMMON STOCK During 1996, the Company purchased certain notes from a financial institution that are collateralized by the Company's common stock. These notes relate to shares issued under the Company's 1993 Non-Qualified Incentive Stock Option Plan. These notes, as renewed in 2000, are due from certain members of management, require monthly payments, and have maturity dates of December 31, 2004. 35 11. BUSINESS ACQUISITIONS During 2002, the Company acquired certain assets of the following entities for a total purchase price of $435,747:
ENTITY LOCATION DATE OF ACQUISITION - ----------------------- ----------------------- ------------------- Oklahoma Leather Supply Oklahoma City, Oklahoma January 2002 Heritage Leather Boise, Idaho March 2002 The Leather Shop Memphis, Tennessee October 2002 Copper Saguaro Tempe, Arizona November 2002
All of the acquired entities were formerly operated as independent retail leathercraft stores. The assets purchased in these acquisitions consisted primarily of inventory, store furniture and fixtures, and equipment. Goodwill recognized in these transactions amounted to $158,878, and is reported in the Tandy Leather Company segment. The Company also entered into non-compete agreements with the former owners totaling $52,000 for periods ranging from three to five years. In November 2000, the Company acquired the assets, primarily accounts receivable, inventory, fixtures, and equipment, of TLC Direct, Inc. and Tandy Leather Dealer, Inc. (dba Tandy Leather Company), a distributor of leather and related products located in Fort Worth, Texas. Additionally, the Company acquired the exclusive right to certain trademarks associated with the Tandy Leather business. The total purchase price for the operating and intangible assets was approximately $3.3 million, subject to adjustment. The purchase price was paid in the form of cash, funded with proceeds from the Company's revolving credit facility (see Note 4), and the assumption of certain liabilities. The transaction was accounted for under the purchase method of accounting and the purchase price was allocated to the net assets acquired based on their estimated fair values. The excess of cost over the fair value of net assets acquired, before adjustment, totaled approximately $410,000 and was recorded as goodwill as of the acquisition date. The purchase price adjustment, as defined in the Asset Purchase Agreement between the buyer and seller, was computed at approximately $200,000 and subsequently reduced the goodwill amount previously recorded. The operations of the acquired business have been included in the Company's financial statements beginning December 1, 2000. The following pro forma information (unaudited) has been prepared as if the acquisition of Tandy Leather had occurred at the beginning of 2000. Such information is not necessarily reflective of the actual results that would have occurred had the acquisition occurred on that date.
2000 ----------- Net Sales $36,708,000 Net Income $1,637,000 Net Income per common share $0.17 Net Income per common share - assuming dilution $0.16
36 12. SEGMENT INFORMATION The Company identifies its segments based on the activities of three distinct businesses: The Leather Factory, which sells primarily to wholesale customers and consists of a chain of stores located in the United States and Canada; Tandy Leather Company, which sells primarily to retail customers and consists of a chain of stores located in the United States; and Roberts, Cushman & Company, which manufactures decorative hat trims sold directly to hat manufactures and distributors. The Company's reportable operating segments have been determined as separately identifiable business units. The Company measures segment earnings as operating earnings, defined as income before interest and income taxes. The "Tandy Leather Company" column for the year ended December 31, 2000 contains operating results beginning after its November 30, 2000 acquisition.
LEATHER TANDY FACTORY LEATHER ROBERTS, CUSHMAN TOTAL ------------ ----------- ---------------- ------------ For the year ended December 31, 2002 Net Sales $30,313,478 $7,387,874 $2,027,263 $39,728,615 Gross Profit 16,237,143 4,395,383 702,175 21,334,701 Operating earnings 3,742,844 371,372 17,558 4,131,774 Interest expense (246,316) (562) - (246,878) Other, net (64,071) (968) - (65,039) ----------- Income before income taxes and cumulative effect of change in accounting principle 3,432,457 369,842 17,558 3,819,857 ----------- Depreciation and amortization 367,218 111,013 13,081 491,312 Fixed asset additions 888,491 180,522 4,502 1,073,515 Total assets $16,205,347 $2,562,737 $907,518 $19,675,602 ------------ ----------- ---------------- ------------ For the year ended December 31, 2001 Net Sales $28,711,006 $6,606,090 $1,962,166 $37,279,262 Gross Profit 15,074,323 3,708,691 561,313 19,344,327 Operating earnings 3,719,517 281,998 (99,547) 3,901,968 Interest expense (457,549) (1,009) - (458,558) Other, net (74,799) (125 - (74,924) ----------- Income before income taxes 3,187,169 280,864 (99,547) 3,368,486 ----------- Depreciation and amortization 474,114 103,118 152,921 730,153 Fixed asset additions 454,809 172,434 2,530 629,773 Total assets $12,322,754 $2,333,639 $4,891,930 $19,548,323 ------------ ----------- ---------------- ------------ For the year ended December 31, 2000 Net Sales $27,060,406 $575,635 $2,459,223 $30,095,264 Gross Profit 13,735,454 252,453 959,810 14,947,717 Operating earnings (loss) 2,991,804 (43,724) 297,004 3,245,084 Interest expense (617,400 - - (617,400) Other, net (36,280) - (99) (36,379) ----------- Income (loss) before income taxes 2,338,124 (43,724) 296,905 2,591,305 ----------- Depreciation and amortization 423,313 4,895 154,570 582,778 Fixed asset additions 332,319 37,477 8,044 377,840 Total assets $10,783,149 $3,688,976 $5,213,954 $19,686,079 ------------ ----------- ---------------- ------------
Net sales for geographic areas was as follows: - -----------------------------------------------------
2002 2001 2000 ----------- ----------- ----------- United States $37,510,567 $35,193,935 $28,964,542 All other countries 2,218,048 2,085,327 1,130,722 ----------- ----------- ----------- $39,728,615 $37,279,262 $30,095,264 =========== =========== ===========
Geographic sales information is based on the location of the customer. Net sales from no single foreign country was material to the Company's consolidated net sales for the years ended December 31, 2002, 2001, and 2000. The Company does not have any significant long-lived assets outside of the United States. 37 13. GOODWILL AND OTHER INTANGIBLES As discussed in Note 2, in January 2002, the Company adopted SFAS 142, which requires companies to stop amortizing goodwill and certain intangible assets with indefinite lives. Instead, it requires that goodwill and intangible assets deemed to have indefinite useful lives be reviewed for impairment upon adoption (January 1, 2002) and annually thereafter. Under SFAS 142, goodwill impairment is deemed to exist if the net book value of a reporting unit exceeds its estimated fair value. The Company's reporting units are generally the individual stores, which are combined into the applicable operating segments identified in Note 12 - Segment Information. The new methodology in SFAS 142 differs from the Company's prior policy, which was permitted under earlier accounting standards, of using undiscounted cash flows of the acquired asset to determine if goodwill is recoverable. Upon adoption of SFAS 142 in the first quarter of 2002, the Company recorded a one-time, non-cash charge of approximately $4.0 million to reduce the carrying value of its goodwill. This charge in non-operational in nature and is reflected as a cumulative effect of an accounting change in the accompanying consolidated statement of income. The SFAS 142 goodwill impairment is associated solely with goodwill resulting from the acquisition of Roberts, Cushman & Co., Inc. ("Cushman") in 1995. The current fair value of Cushman and its assets was estimated by an independent third party using projected discounted future operating cash flows. The amount of the impairment primarily reflects the decline in Cushman's sales since the acquisition occurred. A summary of changes in the Company's goodwill for the year ended December 31, 2002 is as follows:
JANUARY 1, ACQUISITIONS & DECEMBER 31, 2002 ADJUSTMENTS IMPAIRMENTS 2002 ---------- ----------------- ------------- -------------- Leather Factory $ 332,630 $ 1,025 - $333,655 Tandy Leather 193,951 158,878 - $352,829 Roberts, Cushman 4,008,831 - $(4,008,831) - ---------- ----------------- ------------- -------------- Total $4,535,412 $159,903 $(4,008,831) $686,484 ========== ================= ============= ==============
As of December 31, 2002 and 2001, the Company's intangible assts and related accumulated amortization consisted of the following:
AS OF DECEMBER 31, 2002 -------------------------------------------------------------- GROSS ACCUMULATED AMORTIZATION NET ------------------------- ------------------------- -------- Trademarks, Copyrights $ 544,369 $ 102,029 $442,340 Non-Compete Agreements 52,000 10,833 41,167 ------------------------- ------------------------- -------- $ 596,369 $ 112,862 $483,507 ========================= ========================= ======== AS OF DECEMBER 31, 2001 -------------------------------------------------------------- GROSS ACCUMULATED AMORTIZATION NET ------------------------- ------------------------- -------- Trademarks, Copyrights $ 542,744 $ 65,836 $476,908 ========================= ========================= ========
The Company has no intangible assets not subject to amortization under SFAS 142. Amortization of intangible assets, excluding goodwill, of $48,283 in 2002, $40,443 in 2001, $11,278 in 2000 was recorded in operating expenses. Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the succeeding 5 years are as follows:
LEATHER FACTORY TANDY LEATHER TOTAL ---------------- -------------- ------- 2003 $5,918 $42,337 $48,255 2004 5,918 42,337 48,255 2005 5,918 32,337 38,255 2006 5,918 31,670 37,588 2007 5,918 31,670 37,588
During 2002, the Company acquired the following intangible assets:
AMORTIZATION PERIOD ------------------- Non-Compete Agreements $52,000 3 - 5 years Copyright 1,625 15 years
The 2001 and 2000 results on a historical basis do not reflect the provision of SFAS 142. Had the Company adopted SFAS 142 on January 1, 2000, the historical net income and basic and diluted net income per common share (without giving effect to the charge relating to the reduction of goodwill) would have been changed to the adjusted amounts indicated below:
YEAR ENDED DECEMBER 31, 2001 ------------------------------------------------------------------------------------------- NET INCOME EARNINGS PER SHARE - BASIC EARNINGS PER SHARE - DILUTED ----------------------------- ----------------------------- ----------------------------- Reported net income $2,006,433 $0.20 $0.19 Addback goodwill amortization 223,894 0.02 0.02 ----------------------------- ----------------------------- ----------------------------- Adjusted net income $2,230,327 $0.22 $0.21 ============================= ============================= ============================= YEAR ENDED DECEMBER 31, 2000 ------------------------------------------------------------------------------------------- NET INCOME EARNINGS PER SHARE - BASIC EARNINGS PER SHARE - DILUTED ----------------------------- ----------------------------- ----------------------------- Reported net income $1,541,320 $0.16 $0.15 Addback goodwill amortization 208,411 0.02 0.02 ----------------------------- ----------------------------- ----------------------------- Adjusted net income $1,749,731 $0.18 $0.17 ============================= ============================= =============================
38 14. RECENT ACCOUNTING PRONOUNCEMENTS In August 2001, the Financial Accounting Standards Board ("FASB") issued Statement of Financial Accounting Standards No. 143, Accounting for Asset Retirement Obligations ("SFAS 143"), which addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs and applies to all entities. It applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and/or the normal operation of a long-lived asset, except for certain obligations of lessees. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company will adopt SFAS 143 in January 2003 and believes that the adoption of SFAS 143 will not have a material effect on the Company's results of operations or financial position. Also in August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets ("SFAS 144"), which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. SFAS 144 establishes a single accounting model, based on the framework established in Statement of Financial Accounting Standards No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of ("SFAS 121"), for long-lived assets to be disposed of by sale. SFAS 121 did not address the accounting for a segment of a business accounted for as a discontinued operation under APB Opinion No. 30, Reporting the Results of Operations- Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions ("APB 30") so two accounting models existed for the disposal of long-lived assets. SFAS 144 replaces both SFAS 121 and APB 30, so that only one accounting model exists for the disposal of long-lived assets. SFAS 144 also resolves implementation issues related to SFAS 121. The provisions of SFAS 144 are effective for financial statements issued for fiscal years beginning after December 15, 2001 and are applied prospectively. The adoption of SFAS 144 on January 1, 2002 had no material effect on the Company's results of operations or financial position. In April 2002, the FASB issued Statement of Financial Accounting Standards No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections. This statement provides guidance on the classification of gains and losses from the extinguishment of debt and on the accounting for certain specified lease transactions. The adoption of this statement did not have a material impact on the Company's results of operations or financial position. In July 2002, the FASB issued Statement of Financial Accounting Standards No. 146, Accounting for Costs Associated with Exit or Disposal Activities (SFAS No. 146). SFAS 146 nullifies FASB Emerging Issues Task Force (EITF) Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)". It requires that a liability be recognized for those costs only when the liability is incurred, that is, when it meets the definition of a liability in the FASB's conceptual framework. SFAS No. 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002, with earlier adoption encouraged. The Company does not expect that the adoption of SFAS 146 will have a material impact on its results from operations or financial position. In December 2002, the FASB issued Statement of Financial Accounting Standards 148, Accounting for Stock-Based Compensation - Transition and Disclosure - an amendment of FASB Statement 123 ("SFAS 148"). SFAS 148 amends SFAS 123 to provide alternative transition methods for an entity's voluntary change in its accounting for stock-based compensation from the intrinsic method to the fair value method under SFAS 123. In addition, SFAS 148 amends the disclosure requirements of SFAS 123 to require prominent disclosures in both annual and interim financial statements about the method of accounting used for stock-based employee compensation and the effect of the method used on reported results. The Company currently plans to continue to account for its stock-based compensation using the intrinsic value method as prescribed by APB No. 25, Accounting for Stock Issued to Employees and will comply with the new disclosure requirements beginning with these financial statements. 39 15. FAIR VALUE OF FINANCIAL INSTRUMENTS CASH, ACCOUNTS RECEIVABLE-TRADE AND ACCOUNTS PAYABLE The carrying amount approximates fair value because of the short maturity of those instruments. NOTES PAYABLE AND LONG-TERM DEBT The interest rates on the Company's notes payable and long-term debt fluctuate with changes in the prime rate and are the rates currently available to the Company; therefore, the carrying amount of those instruments approximates their fair value. 16. QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH 2002 QUARTER QUARTER QUARTER QUARTER - ----------------------------------------------------------- ----------- ----------- ---------- ---------- Net sales $10,203,951 $10,052,036 $9,484,730 $9,987,898 Gross profit 5,368,595 5,435,626 5,088,398 5,442,082 Income before cumulative effect of change in accounting principle 759,305 792,047 534,092 509,545 Income before cumulative effect of change in accounting principle per common share: Basic 0.08 0.08 0.05 0.05 Diluted 0.07 0.07 0.05 0.05 Weighted average number of common shares outstanding: Basic 10,001,717 10,041,018 10,064,249 10,145,749 Diluted 10,731,712 10,799,630 10,723,403 10,791,694 FIRST SECOND THIRD FOURTH 2001 QUARTER QUARTER QUARTER QUARTER - ----------------------------------------------------------- ----------- ----------- ---------- ---------- Net sales $9,372,613 $9,359,893 $9,198,401 $9,348,355 Gross profit 4,884,216 4,978,795 4,611,574 4,869,742 Net income 497,283 621,910 396,529 490,711 Net income per common share: Basic 0.05 0.06 0.04 0.05 Diluted 0.05 0.06 0.04 0.05 Weighted average number of common shares outstanding: Basic 9,949,494 9,971,952 9,991,052 9,991,161 Diluted 10,204,608 10,329,817 10,656,859 10,656,968
40 ******************************************************************************* THE LEATHER FACTORY, INC. SCHEDULE II - ALLOWANCE FOR DOUBTFUL ACCOUNTS YEARS ENDED DECEMBER 31, 2002, 2001, and 2000
2002 2001 2000 --------- ---------- ---------- BALANCE AT BEGINNING OF YEAR $191,000 $338,000 $177,000 Reserve "purchased" during year (Tandy) - - 248,000 Additions charged to income (39,000) 17,000 22,000 Balances written off, net of recoveries (74,000) (164,000) (109,000) --------- ---------- ---------- Balance at end of year $78,000 $191,000 $338,000 ========= ========== ==========
41 REPORT OF INDEPENDENT AUDITORS The Board of Directors The Leather Factory, Inc. We have audited the accompanying consolidated balance sheets of The Leather Factory, Inc. as of December 31, 2002 and 2001, and the related consolidated statements of operations, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2002. Our audits also included the financial statement schedule referred to in the index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit 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 consolidated financial position of The Leather Factory, Inc. at December 31, 2002 and 2001, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2002, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, effective January 1, 2002. Hein + Associates LLP Dallas, Texas February 6, 2003 42 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. Information required by this item with regard to executive officers in included in Part I, Item 1 of this report under the heading "Executive Officers of the Registrant", which information is incorporated herein by reference. Information required by this item regarding the Directors of the Company and compliance with Section 16(a) of the Securities Exchange Act of 1934 is set forth in the Company's Proxy Statement for its 2003 Annual Meeting of Stockholders (the "Proxy Statement") under the heading "Election of Directors", which information is incorporated herein by reference. This Proxy Statement will be filed with the Commission pursuant to Regulation 14A within 120 days of the year ended December 31, 2002. ITEM 11. EXECUTIVE COMPENSATION. Information concerning executive compensation is set forth in the Proxy Statement under the heading "Executive Compensation", which is incorporated herein by reference. This Proxy Statement will be filed with the Commission pursuant to Regulation 14A within 120 days of the year ended December 31, 2002. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS. Information concerning security ownership of certain beneficial owners and management and securities authorized for issuance under equity compensation plans is set forth in the Proxy Statement under the heading "Security Ownership of Certain Beneficial Owners and Management", which is incorporated herein by reference. This Proxy Statement will be filed with the Commission pursuant to Regulation 14A within 120 days of the year ended December 31, 2002. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. Information concerning certain relationships and related transactions is set forth in the Proxy Statement under the heading "Certain Transactions", which is incorporated herein by reference. This Proxy Statement will be filed with the Commission pursuant to Regulation 14A within 120 days of the year ended December 31, 2002. ITEM 14. CONTROLS AND PROCEDURES. (a) As of a date within ninety (90) days of the date of this report (the "Evaluation Date"), our President, Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-14 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon this evaluation, they have concluded that, subject to the limitations on the effectiveness of the controls described below, the Company's disclosure controls and procedures are sufficiently effective to ensure that the information required to be disclosed by the Company in the reports it files under the Exchange Act is gathered, analyzed and disclosed with adequate timeliness, accuracy and completeness. (b) There have been no significant changes in the Company's internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referred to above. No significant deficiencies or material weaknesses in the Company's internal controls were observed. Accordingly, no corrective actions were undertaken. Limitations on the Effectiveness of Controls. Our management, including the President, Chief Executive Officer and Chief Financial Officer, does not expect that the Company's disclosure controls and procedures or the Company's internal controls will prevent all error and all fraud. A control system, no matter how well conceived and operated, is based in part upon certain assumptions about the likelihood of future events and can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been or will be detected. 43 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K. (a) 1. Financial statements and financial statement schedules See Item 8 for an index to the consolidated financial statements and supplementary financial information. 2. Exhibits The exhibits listed on the accompanying Exhibit Index, which immediately precedes such exhibits, are filed or incorporated by reference as part of this Report and such Exhibit Index. (b) Reports on Form 8-K None 44 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. THE LEATHER FACTORY, INC. By: /s/ Wray Thompson ------------------- WRAY THOMPSON CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER By: /s/ Shannon L. Greene ------------------------ SHANNON L. GREENE CHIEF FINANCIAL OFFICER AND TREASURER Dated: March 27, 2003 POWER OF ATTORNEY By signing this Form 10-K below, I hereby appoint each of Wray Thompson and Shannon L. Greene as my attorney-in-fact to sign all amendments to this Form 10-K on my behalf, and to file this Form 10-K (including all exhibits and other documents related to the Form 10-K) with the United States Securities and Exchange Commission. I authorize each of my attorneys-in-fact to (1) appoint a substitute attorney-in-fact for himself and (2) perform any actions that he believes are necessary or appropriate to carry out the intention and purpose of this Power of Attorney. I ratify and confirm all lawful actions taken directly or indirectly by my attorneys-in-fact and by any properly appointed substitute attorneys-in-fact. In accordance with the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated. SIGNATURE TITLE DATE - -------------------------------------------------------------------------------- /s/ Wray Thompson Chairman of the Board, - ------------------------ Chief Executive Officer and Director March 27, 2003 WRAY THOMPSON /s/ Shannon L. Greene Chief Financial Officer, - ------------------------ Treasurer and Director March 27, 2003 SHANNON L. GREENE /s/ Joseph R. Mannes Director March 27, 2003 - ------------------------ JOSEPH R. MANNES /s/ H.W. Markwardt Director March 27, 2003 - ------------------------ H.W. MARKWARDT /s/ Michael A. Markwardt Director March 27, 2003 - ------------------------ MICHAEL A. MARKWARDT /s/ Ronald C. Morgan President and Director March 27, 2003 - ------------------------ RONALD C. MORGAN /s/ Robin L. Morgan Vice President, Assistant Secretary - ------------------------ and Director March 27, 2003 ROBIN L. MORGAN /s/ Anthony C. Morton Director March 27, 2003 - ------------------------ ANTHONY C. MORTON /s/ William M. Warren Secretary and Director March 27, 2003 - ------------------------ WILLIAM M. WARREN 45 CERTIFICATIONS I, WRAY THOMPSON, certify that: 1. I have reviewed this annual report on Form 10-K of The Leather Factory, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 27, 2003 /s/ Wray Thompson ------------------- Wray Thompson President and Chief Executive Officer (principal executive officer) ******** 46 I, SHANNON L. GREENE, certify that: 1. I have reviewed this annual report on Form 10-K of The Leather Factory, Inc.; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rule 13a-14 and 15d-14) for the registrant and have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c) presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 27, 2003 /s/ Shannon L. Greene ------------------------- Shannon L. Greene Chief Financial Officer and Treasurer (principal financial and accounting officer) 47 THE LEATHER FACTORY, INC. AND SUBSIDIARIES EXHIBIT INDEX EXHIBIT NUMBER DESCRIPTION - ------- ---------------------------------------------------------------------- 3.1 Certificate of Incorporation of The Leather Factory, Inc., filed as Exhibit 3.1 to the Registration Statement on Form SB-2 of The Leather Factory, Inc. (Commission File No. 33-81132) filed with the Securities and Exchange Commission on July 5, 1994, and incorporated by reference herein. 3.2 Bylaws of The Leather Factory, Inc., filed as Exhibit 3.2 to the Registration Statement on Form SB-2 of The Leather Factory, Inc. (Commission File No. 33-81132) filed with the Securities and Exchange Commission on July 5, 1994, and incorporated by reference herein. 10.1 The Leather Factory, Inc. Stock Purchase Warrant for 200,000 shares common stock, $.0024 par value issued to Evert I. Schlinger dated August 3, 1998 and terminating on August 3, 2003, filed as Exhibit 4.13 to the Quarterly Report on Form 10-Q of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission November 12, 1998, and incorporated by reference herein. 10.2 Credit and Security Agreement dated November 22, 1999, by and between The Leather Factory, Inc., a Delaware corporation, The Leather Factory, Inc., a Texas corporation, The Leather Factory, Inc., an Arizona corporation, Roberts, Cushman & Company, Inc., and Hi-Line Leather & Manufacturing and Wells Fargo Business Credit, Inc., filed as Exhibit 4.1 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on December 16, 1999, and incorporated by reference herein. 10.3 Revolving Note (Revolving Credit Loan) dated November 22, 1999, in the principal amount of 8,500,000, payable to the order of Wells Fargo Business Credit, Inc., which matures November 30, 2002, filed as Exhibit 4.2 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on December 16, 1999, and incorporated by reference herein. 10.4 Term Note dated November 22, 1999, in the principal amount of $150,000, payable to the order of Wells Fargo Business Credit, Inc., which matures May 1, 2000, filed as Exhibit 4.3 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on December 16, 1999, and incorporated by reference herein. 10.5 Copyright Security Agreement dated November 22, 1999, by and between The Leather Factory, Inc., a Delaware corporation, The Leather Factory, Inc., a Texas corporation, The Leather Factory, Inc., an Arizona corporation, Roberts, Cushman & Company, Inc., and Hi-Line Leather & Manufacturing and Wells Fargo Business Credit, Inc., filed as Exhibit 4.4 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on December 16, 1999, and incorporated by reference herein. 10.6 First Amendment to Credit and Security Agreement dated November 30, 2000, by and between The Leather Factory, Inc. a Delaware corporation, The Leather Factory, Inc., a Texas corporation, The Leather Factory, Inc., an Arizona corporation, Roberts, Cushman & Company, Inc., Hi-Line Leather & Manufacturing, and Tandy Leather Company, Inc. (f/k/a Leather Tan Acquisition, Inc.) and Wells Fargo Business Credit, Inc. filed as Exhibit 99.1 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on December 15, 2000, and incorporated by reference herein. 10.7 Second Amendment to Credit and Security Agreement dated February 7, 2001, by and between The Leather Factory, Inc. a Delaware corporation, The Leather Factory, Inc., a Texas corporation, The Leather Factory, Inc., an Arizona corporation, Roberts, Cushman & Company, Inc., Hi-Line Leather & Manufacturing, and Tandy Leather Company, Inc. (f/k/a Leather Tan Acquisition, Inc.) and Wells Fargo Business Credit, Inc. filed an Exhibit 4.1 to the Form 10-Q filed by The Leather Factory, Inc. with the Securities and Exchange Commission on August 14, 2001, and incorporated by reference herein. 10.8 Third Amendment to Credit and Security Agreement and Waiver of Defaults dated June 14, 2001, by and between The Leather Factory, Inc. a Delaware corporation, The Leather Factory, Inc., a Texas corporation, The Leather Factory, Inc., an Arizona corporation, Roberts, Cushman & Company, Inc., Hi-Line Leather & Manufacturing, and Tandy Leather Company, Inc. (f/k/a Leather Tan Acquisition, Inc.) and Wells Fargo Business Credit, Inc. filed an Exhibit 4.2 to Form 10-Q filed by The Leather Factory, Inc. with the Securities and Exchange Commission On August 14, 2001, and incorporated by reference herein. 10.9 Letter Agreement for Consulting Services dated July 24, 1998, by and between The Leather Factory, Inc. and Evert I. Schlinger, filed as Exhibit 4.13 to the Quarterly Report on Form 10-Q of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on November 12, 1998, and incorporated by reference herein. 10.10 Asset Purchase Agreement dated November 30, 2000, by Tandy Leather Company, Inc. (f/k/a Leather Tan Acquisition, Inc.), a Texas corporation, TLC Direct, Inc., a Texas corporation, and Tandy Leather Dealer, Inc., a Texas corporation, filed as Exhibit No. 2.1 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on December 15, 2000, and incorporated herein by reference. 10.11 Amended and Restated Credit Agreement, dated as of March 20, 2002, made by and among The Leather Factory, Inc., a Delaware corporation; Roberts, Cushman & Company, Inc., a New York corporation; The Leather Factory, Inc., a Nevada corporation; The Leather Factory of Nevada Investments Inc., a Nevada corporation; Tandy Leather Company, Inc., a Nevada corporation; Tandy Leather Company Investments, Inc., a Nevada corporation; The Leather Factory, L.P., a Texas limited partnership; Tandy Leather Company, L.P., a Texas limited partnership; Hi-Line Leather & Manufacturing Company, a California corporation; and The Leather Factory, Inc., an Arizona corporation, and Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.1 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1- 12368) filed with the Securities and Exchange Commission on March 20, 2002, and incorporated herein by reference. 10.12 Revolving Note, dated March 20, 2002, in the principal amount of up to $7,500,000.00 given by The Leather Factory, Inc., a Delaware corporation; Roberts, Cushman & Company, Inc., a New York corporation; The Leather Factory, Inc., a Nevada corporation; The Leather Factory of Nevada Investments Inc., a Nevada corporation; Tandy Leather Company, Inc., a Nevada corporation; Tandy Leather Company Investments, Inc., a Nevada corporation; The Leather Factory, L.P., a Texas limited partnership; Tandy Leather Company, L.P., a Texas limited partnership; Hi-Line Leather & Manufacturing Company, a California corporation; and The Leather Factory, Inc., an Arizona corporation, as borrowers, payable to the order of Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.2 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on March 20, 2002, and incorporated herein by reference. 10.13 Collection Account Agreement, dated as of March 20, 2002, among The Leather Factory, Inc., a Delaware corporation; Roberts, Cushman & Company, Inc., a New York corporation; The Leather Factory, Inc., a Nevada corporation; The Leather Factory of Nevada Investments Inc., a Nevada corporation; Tandy Leather Company, Inc., a Nevada corporation; Tandy Leather Company Investments, Inc., a Nevada corporation; The Leather Factory, L.P., a Texas limited partnership; Tandy Leather Company, L.P., a Texas limited partnership; Hi-Line Leather & Manufacturing Company, a California corporation; and The Leather Factory, Inc., an Arizona corporation, and Wells Fargo Bank Minnesota, National Association, a national banking association and Wells Fargo Bank Texas, National Association, filed as Exhibit 10.3 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on March 20, 2002, and incorporated herein by reference. 10.14 Amended and Restated Security Agreement, dated as of March 20, 2002, by and between The Leather Factory of Canada, Ltd., a Manitoba corporation, and Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.4 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on March 20, 2002, and incorporated herein by reference. 10.15 Amended and Restated Guaranty (the Leather Factory of Canada, Ltd.), dated as of March 20, 2002, executed by The Leather Factory of Canada, Ltd., a Manitoba corporation, for the benefit of Wells Fargo Bank Minnesota, National Association, filed as Exhibit 10.5 to the Current Report on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on March 20, 2002, and incorporated herein by reference. *21.1 Subsidiaries of the Company. *23.1 Consent of Hein + Associates LLP dated March XX, 2003. *99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ______________ *Filed herewith. 48 EXHIBIT 21.1 LIST OF THE SUBSIDIARIES OF THE COMPANY - - The Leather Factory, Inc., a Nevada corporation - - The Leather Factory of Nevada Investments, Inc., a Nevada corporation - - The Leather Factory, LP, a Texas limited partnership - - The Leather Factory ,Inc., an Arizona corporation - - Hi-Line Leather & Manufacturing Company, a California corporation - - Roberts, Cushman & Company, Inc., a New York corporation - - The Leather Factory of Canada Ltd., a Manitoba domiciled Canadian corporation - - Tandy Leather Company, Inc., a Nevada corporation - - Tandy Leather Company Investments, Inc. a Nevada corporation - - Tandy Leather Company, LP, a Texas limited partnership 49 EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 33-81214) pertaining to the Employee Stock Ownership Plan and Trust of The Leather Factory, Inc. and the Registration Statement (Form S-8 No. 333-07147) pertaining to the 1995 Stock Option Plan of The Leather Factory, Inc. of our report dated February 6, 2003, with respect to the consolidated financial statements and schedule of The Leather Factory, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 2002. HEIN + ASSOCIATES LLP Dallas, Texas March 28, 2003 50 EXHIBIT 99.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 In connection with the Annual Report on Form 10-K of The Leather Factory, Inc. for the fiscal year ended December 31, 2002 as filed with the United States Securities and Exchange Commission on the date hereof (the "Report"), Wray Thompson, as Chairman and Chief Executive Officer, and Shannon L. Greene, as Treasurer and Chief Financial Officer, each hereby certifies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: i. The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and ii. The information contained in the Report fully presents, in all material respects, the financial condition and results of operations of the Company. March 27, 2003 By: /s/ WRAY THOMPSON ------------------- WRAY THOMPSON CHAIRMAN OF THE BOARD AND CHIEF EXECUTIVE OFFICER March 27, 2003 By: /s/ SHANNON L. GREENE ------------------------ SHANNON L. GREENE CHIEF FINANCIAL OFFICER AND TREASURER 51 -----END PRIVACY-ENHANCED MESSAGE-----