10-Q 1 tlf10q033102.txt Form 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (Mark One) [X] Quarterly report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended March 31, 2002 or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from 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, Ft. Worth, Texas 76119 (Address of principal executive offices) (Zip code) (817) 496-4414 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to by 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 the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Class Shares outstanding as of May 10, 2002 ---------------------------------------- ------------------------------------- Common Stock, par value $.0024 per share 10,041,161 Forward-Looking Statements -------------------------- This report (particularly Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations) contains forward-looking statements of management. In general, these are predictions or suggestions of future events and statements or expectations of future trends or 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: o Changes in the economic recovery in the United States, as well as abroad, from a recent downturn may cause our sales to decrease or not to increase. o Favorable trends in the arts and crafts industry may slow or reverse. o Although the Company believes that it has fixed recent problems, reoccurrence of problems with our websites could result in lost sales. o As a result of the terrorist activities on and after September 11, 2001, consumer-buying habits could change and decrease our sales. o If terrorists choose to target livestock in the United States or abroad for chemical, biological or other attacks, our sources of raw material and inventory could decrease, or these items could become more expensive. o The prices of hides and leathers also fluctuate in normal times, and these fluctuations can affect the Company. o 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. o 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. o The Company currently buys in 22 countries around the world. War, terrorism, changes in the internal affairs or international relations of these countries (such as events that might affect their Most Favored Nation status with the United States of America) and other uncertainties can disrupt our purchases from abroad. o We might fail to realize the anticipated benefits of the acquisition of the assets of Tandy Leather, the opening of Tandy Leather retail stores or other retail initiatives might not be successful. o 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. o 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. 2 THE LEATHER FACTORY, INC. FORM 10-Q FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2002 TABLE OF CONTENTS ----------------- PAGE NO. -------- PART I. FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets March 31, 2002 and December 31, 2001 ............................... 4 Consolidated Statements of Operations Three months ended March 31, 2002 and 2001.......................... 5 Consolidated Statements of Cash Flows Three months ended March 31, 2002 and 2001.......................... 6 Consolidated Statements of Stockholders' Equity Three months ended March 31, 2002 and2001........................... 7-8 Notes to Consolidated Financial Statements........................... 9 Item 2. Management's Discussion and Analysis of Financial Condition and Results ofOperations........................... 12 Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 16 PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form8-K............................... 16 SIGNATURES............................................................... 17 3
4 -------------------------------------------------------------------------------- THE LEATHER FACTORY, INC. CONSOLIDATED BALANCE SHEETS -------------------------------------------------------------------------------- March 31, December 31, 2002 2001 ------------ ------------ (UNAUDITED) ASSETS CURRENT ASSETS: Cash $ 93,453 $ 409,040 Cash restricted for payment on revolving credit facility 346,081 491,729 Accounts receivable-trade, net of allowance for doubtful accounts of $177,000 and $191,000 in 2002 and 2001, respectively 2,742,873 2,297,953 Inventory 8,275,170 9,054,269 Deferred income taxes 165,481 128,111 Other current assets 945,471 479,390 ------------ ------------ Total current assets 12,568,529 12,860,492 ------------ ------------ PROPERTY AND EQUIPMENT, at cost 4,313,668 4,201,368 Less-accumulated depreciation and amortization (2,970,318) (2,858,869) ------------ ------------ Property and equipment, net 1,342,499 1,343,350 GOODWILL, net of accumulated amortization of $732,000 and $1,583,000 in 2002 and 2001, respectively 607,455 4,535,412 OTHER INTANGIBLES, net of accumulated amortization of $77,000 and $66,000, in 2002 and 2001, respectively 497,871 476,908 OTHER assets 296,079 333,012 ------------ ------------ $ 15,313,284 $ 19,548,323 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable $ 1,547,766 $ 1,303,596 Accrued expenses and other liabilities 1,116,555 1,171,152 Income taxes payable 387,396 52,662 Notes payable and current maturities of long-term debt 2,987,517 4,527,904 ------------ ------------ Total current liabilities 6,039,234 7,055,314 ------------ ------------ DEFERRED INCOME TAXES 62,727 61,647 NOTES PAYABLE AND LONG-TERM DEBT, net of current maturities 6,657 7,691 COMMITMENTS AND CONTINGENCIES -- -- 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, 10,011,161 and 9,991,161 shares issued and outstanding at 2002 and 2001, respectively 24,027 23,979 Paid-in capital 4,043,585 4,030,508 Retained earnings 5,228,661 8,478,187 Less: Notes receivable - secured by common stock (51,203) (71,939) Accumulated other comprehensive loss (40,404) (37,064) ------------ ------------ Total stockholders' equity 9,204,666 12,423,671 ------------ ------------ $ 15,313,284 $ 19,548,323 ============ ============
The accompanying notes are an integral part of these financial statements. 4
-------------------------------------------------------------------------------- THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2002 AND 2001 ------------------------------------------------------------------------------- 2002 2001 ------------ ------------ NET SALES $ 10,203,951 $ 9,372,613 COST OF SALES 4,835,356 4,488,397 ------------ ------------ Gross profit 5,368,595 4,884,216 OPERATING EXPENSES 4,175,136 3,908,877 ------------ ------------ INCOME FROM OPERATIONS 1,193,459 975,339 OTHER EXPENSE: Interest expense 89,869 148,593 Other, net 16,355 7,291 ------------ ------------ Total other expense 106,224 155,884 ------------ ------------ INCOME BEFORE INCOME TAXES and CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 1,087,235 819,455 PROVISION FOR INCOME TAXES 327,930 322,172 ------------ ------------ INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE 759,305 497,283 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET OF INCOME TAXES (4,008,831) -- ------------ ------------ NET INCOME (LOSS) $ (3,249,526) $ 497,283 ============ ============ NET INCOME PER COMMON SHARE - BASIC: INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ 0.08 $ 0.05 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET (0.40) -- ------------ ------------ NET INCOME PER COMMON SHARE $ (0.32) $ 0.05 ============ ============ NET INCOME PER COMMON SHARE - ASSUMING DILUTION: INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE $ 0.07 $ 0.05 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE, NET (0.37) -- ------------ ------------ NET INCOME PER COMMON SHARE - DILUTED $ (0.30) $ 0.05 ============ ============
The accompanying notes are an integral part of these financial statements. 5
-------------------------------------------------------------------------------- THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF CASH FLOW (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2002 AND 2001 -------------------------------------------------------------------------------- 2002 2001 ----------- ----------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income (loss) $(3,249,526) $ 497,283 Adjustments to reconcile net income (loss) to net cash provided by operating activities- Depreciation & amortization 122,993 193,643 Amortization of deferred financing costs 37,038 11,438 Other (39,630) (11,662) Cumulative effect of change in accounting principle 4,008,831 -- Net changes in assets and liabilities: Accounts receivable-trade, net (444,920) (365,273) Inventory 878,308 822,650 Income taxes 334,734 193,113 Other current assets (465,286) 69,898 Accounts payable 244,169 (156,510) Accrued expenses and other liabilities (54,597) (489,104) ----------- ----------- Total adjustments 4,621,640 268,193 ----------- ----------- Net cash provided by operating activities 1,372,114 765,476 ----------- ----------- CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment (97,622) (453,230) Payments in connection with businesses acquired (227,747) -- Increase in other assets (421) (1,078) ----------- ----------- Net cash used in investing activities (325,790) (454,308) ----------- ----------- CASH FLOWS FROM FINANCING ACTIVITIES: Net decrease in revolving credit loans (1,521,777) (635,354) Proceeds from notes payable and long-term debt -- 18,676 Payments on notes payable and long-term debt (19,643) (25,182) Decrease in cash restricted for payment on revolving credit facility 145,648 35,064 Payments received on notes secured by common stock 20,736 1,750 Proceeds from issuance of common stock 13,125 59,737 ----------- ----------- Net cash used in financing activities (1,361,911) (545,309) ----------- ----------- NET DECREASE IN CASH (315,587) (234,141) CASH, beginning of period 409,040 234,141 ----------- ----------- CASH, end of period $ 93,453 $ -- =========== =========== SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid during the period $ 59,283 $ 148,337 Income taxes paid during the period, net of (refunds) 25,172 135,248
The accompanying notes are an integral part of these financial statements. 6
-------------------------------------------------------------------------------- THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2002 AND 2001 -------------------------------------------------------------------------------- Common Stock Notes ---------------------------- receivable Number Par Paid-in Retained - secured by of shares value capital earnings common stock ------------ ------------ ------------ ------------ ------------ BALANCE, December 31, 2000 9,908,161 $ 23,780 $ 3,946,608 $ 6,471,754 $ (120,339) Payments on notes receivable - secured by common stock -- -- -- -- 1,750 Shares issued - employee Stock options exercised 60,000 144 59,593 -- -- Net Income -- -- -- 497,283 -- Translation adjustment -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ BALANCE, March 31, 2001 9,968,161 $ 23,924 $ 4,006,201 $ 6,969,037 $ (118,589) ============ ============ ============ ============ ============ Comprehensive income for the three months ended March 31, 2001 BALANCE, December 31, 2001 9,991,161 $ 23,979 $ 4,030,508 $ 8,478,187 $ (71,939) Payments on notes receivable - secured by common stock -- -- -- -- 20,736 Shares issued - employee Stock options exercised 20,000 48 13,077 -- -- Net loss -- -- -- (3,249,526) -- Translation adjustment -- -- -- -- -- ------------ ------------ ------------ ------------ ------------ BALANCE, March 31, 2002 10,011,161 $ 24,027 $ 4,043,585 $ 5,228,661 $ (51,203) ============ ============ ============ ============ ============ Comprehensive loss for the three months ended March 31, 2002
The accompanying notes are an integral part of these financial statements. 7 -------------------------------------------------------------------------------- THE LEATHER FACTORY, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY CONTINUED (UNAUDITED) THREE MONTHS ENDED MARCH 31, 2002 AND 2001 -------------------------------------------------------------------------------- Accumulated Other Cumulative Comprehensive Loss Total Income (Loss) ------------ ------------ ------------ BALANCE, December 31, 2000 $ (26,166) 10,295,637 Payments on notes receivable - secured by common stock -- 1,750 Shares issued - employee Stock options exercised -- 59,737 Net Income -- 497,283 497,283 Translation adjustment (9,768) (9,768) (9,768) ------------ ------------ BALANCE, March 31, 2001 $ (35,934) $ 10,844,639 ============ ============ ------------ Comprehensive income for the three months ended March 31, 2001 $ 487,515 ============ BALANCE, December 31, 2001 $ (37,064) 12,423,671 Payments on notes receivable - secured by common stock -- 20,736 Shares issued - employee Stock options exercised -- 13,125 Net loss -- (3,249,526) (3,249,526) Translation adjustment (3,340) (3,340) (3,340) ------------ ------------ BALANCE, March 31, 2002 $ (40,404) $ 9,204,666 ============ ============ ------------ Comprehensive loss for the three months ended March 31, 2002 $ (3,252,866) ============ The accompanying notes are an integral part of these financial statements. 8
THE LEATHER FACTORY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1. BASIS OF PRESENTATION In the opinion of the Company, the accompanying consolidated financial statements contain all adjustments (consisting of those of a normal recurring nature) considered necessary to present fairly its financial position as of March 31, 2002 and December 31, 2001, and the results of operations and cash flows for the three-month periods ended March 31, 2002 and 2001. The results of operations for the three-month periods are not necessarily indicative of the results to be expected for the full fiscal year. The consolidated financial statements should be read in conjunction with the financial statements and disclosures contained in the Company's 2001 Annual Report on Form 10-K ("Annual Report"). 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 will be subject to an annual review of impairment. The new standard was effective for The Leather Factory, Inc. ("TLF") in the first quarter of 2002. Upon adoption of SFAS No. 142, TLF recorded a one-time, noncash charge of approximately $4 million to reduce 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 operations. For additional discussion on the impact of adopting SFAS No. 142, see Note 5. Certain reclassifications have been made to conform the 2001 financial statements to the presentation in 2002. The reclassifications had no effect on net income. 2. INVENTORY The components of inventory consist of the following: As of --------------------------- March 31, December 31, 2002 2001 ------------ ------------ Finished goods held for sale $ 7,333,112 $ 8,025,845 Raw materials and work in process 942,058 1,028,424 ------------ ------------ $ 8,275,170 $ 9,054,269 ============ ============ 3. EARNINGS PER SHARE The following table sets forth the computation of basic and diluted earnings per share ("EPS"): Three Months Ended March 31, ---------------------------- 2002 2001 ------------ ------------ Numerator: Net income (loss) $ (3,249,526) $ 497,283 ------------ ------------ Numerator for basic and diluted earnings per share (3,249,526) 497,283 Denominator: Denominator for basic earnings per share - Weighted-average shares 10,001,717 9,949,494 Effect of dilutive securities: Stock options 482,800 92,424 Warrants 247,196 162,690 ------------ ------------ Dilutive potential common shares 729,996 255,114 ------------ ------------ Denominator for diluted earnings per share - weighted-average shares 10,731,713 10,204,608 ============ ============ Basic earnings per share $ (0.32) $ 0.05 ============ ============ Diluted earnings per share $ (0.30) $ 0.05 ============ ============
9
The net effect of converting stock options to purchase 844,000 and 442,000 shares of common stock at option prices less than the average market prices has been included in the computations of diluted EPS for the quarter ended March 31, 2002 and 2001, respectively. 4. SEGMENT INFORMATION The Company identifies its segments based on the activities of three distinct businesses: The Leather Factory, which sells product to both wholesale and retail customers and consists of a chain of sales/distribution units located in the United States and Canada; Tandy Leather Company, which sells product throughout the United States via retail stores, the Internet and mail-order, and internationally through authorized dealers; and Roberts, Cushman & Company, which manufactures decorative hat trims sold directly to hat manufacturers 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 Leather Tandy Leather Roberts, Factory Company Cushman & Co Total ------------ ------------ ------------ ------------ For the quarter ended March 31, 2002 Net sales $ 7,824,517 $ 1,877,874 $ 501,560 $ 10,203,951 Gross profit 4,126,872 1,073,579 168,144 5,368,595 Operating earnings 975,727 141,501 76,231 1,193,459 Interest expense (89,655) (214) -- (89,869) Other, net (15,854) (501) -- (16,355) ------------ Income before income taxes & change in accounting principle 870,218 140,786 76,231 1,087,235 ------------ Depreciation and amortization 132,946 23,703 3,382 160,031 Fixed asset additions 71,529 25,513 580 97,622 ------------ ------------ ------------ ------------ Total assets $ 11,928,363 $ 2,530,336 $ 854,585 $ 15,313,284 ------------ ------------ ------------ ------------ For the quarter ended March 31, 2001 Net sales $ 7,103,792 $ 1,775,116 $ 493,705 $ 9,372,613 Gross profit 3,764,419 978,310 141,487 4,884,216 Operating earnings (loss) 1,003,701 (19,664) (8,698) 975,339 Interest expense (148,593) -- -- (148,593) Other, net (7,444) 153 -- (7,291) ------------ Income (loss) before income taxes 847,664 (19,511) (8,698) 819,455 ------------ Depreciation and amortization 131,044 35,861 38,176 205,081 Fixed asset additions 280,076 172,434 720 453,230 ------------ ------------ ------------ ------------ Total assets $ 10,852,853 $ 3,213,420 $ 5,071,821 $ 19,138,094 ------------ ------------ ------------ ------------
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Net sales for geographic areas were as follows: Three months ended March 31, 2002 March 31, 2001 ------------------------------- United States $ 9,662,434 $ 8,869,011 All other countries 541,517 503,602 ------------------------------- $ 10,203,951 $ 9,372,613 =============================== 5. GOODWILL and OTHER INTANGIBLES As discussed in Note 1, 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 same as the operating segments identified in Note 4 - 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, the Company recorded a one-time, non-cash charge of approximately $4 million in the first quarter of 2002 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 statements of operations. 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 during the quarter ended March 31, 2002 by business segment is as follows: January 1, Acquisitions & March 31, 2002 Adjustments Impairments 2002 -------------- -------------- -------------- -------------- Leather Factory $ 332,630 (191) -- $ 332,439 Tandy Leather 193,951 81,065 -- $ 275,016 Roberts, Cushman 4,008,831 -- (4,008,831) -- -------------- -------------- -------------- -------------- Total $ 4,535,412 80,874 (4,008,831) $ 607,455 ============== ============== ============== ==============
As of March 31, 2002 and December 31, 2001, the Company's intangible assts and related accumulated amortization consisted of the following: As of March 31, 2002 ------------------------------------------ Accumulated Gross Amortization Net ------------ ------------ ------------ Trademarks, Copyrights $ 542,744 $ 74,873 $ 467,871 Non-Compete Agreements 32,000 2,000 30,000 ------------ ------------ ------------ $ 574,744 $ 76,873 $ 497,871 ============ ============ ============ 11 As of December 31, 2001 ------------------------------------------ Accumulated Gross Amortization Net ------------ ------------ ------------ Trademarks, Copyrights $ 542,744 $ 65,836 $ 476,908 ============ ============ ============ The Company recorded amortization expense of $11,352 during the first quarter of 2002 compared to $20,426 during the first quarter of 2001. The Company has no intangible assets not subject to amortization under SFAS 142. 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 Tandy Factory Leather Cushman Total --------- --------- --------- --------- 2002 $ 5,809 $ 40,339 $ 0 $ 46,148 2003 5,809 41,004 0 46,813 2004 5,809 41,004 0 46,813 2005 5,809 31,004 0 36,813 2006 5,809 30,339 0 36,148 During the first quarter of 2002, the Company acquired the following intangible assets: Amortization Period ------------------- Non-Compete Agreements $32,000 3 years The 2001 results on a historical basis do not reflect the provision of SFAS 142. Had the Company adopted SFAS 142 on January 1, 2001, the historical net income and basic and diluted net income per common share would have been changed to the adjusted amounts indicated below: Three Months Ended March 31, 2001 ------------------------------------------------- Earnings per Earnings per Net Income Share - Basic Share - Diluted --------------- --------------- --------------- Reported net income $ 497,283 $ 0.05 $ 0.05 Addback goodwill amortization 51,282 0.01 -- --------------- --------------- --------------- Adjusted net income $ 548,565 $ 0.06 $ 0.05 =============== =============== =============== Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. General ------- The Leather Factory, Inc. ("TLF" or the "Company") is a Delaware corporation whose common stock trades on the American Stock Exchange under the symbol "TLF". The Company is managed on a business entity basis, with those businesses being The Leather Factory ("Leather Factory"), Tandy Leather Company ("Tandy"), and Roberts, Cushman & Company, Inc. ("Cushman"). See Note 4 to the Consolidated Financial Statements for additional information concerning the Company's segments. Leather Factory, founded in 1980 by Wray Thompson and Ron Morgan, is the premier distributor of leather products to customers worldwide. Products are distributed primarily through 30 sales units located in twenty states and Canada. Products include leather, leatherworking tools, buckles and adornments for belts, leather dyes and finishes, shoe repair supplies, saddle and tack hardware, and do-it-yourself kits. 12
Tandy, acquired in November 2000, is the most recognized supplier in the leathercraft industry. From its founding in 1919, Tandy has been the primary resource for leathercrafters world wide. Products include quality tools, leather, accessories, kits and teaching materials and are distributed through three company-owned retail stores and its central distribution facility. Cushman, whose origins date back to the mid-1800's, custom designs and manufactures a product line of decorative hat trims for headwear manufacturers. Results of Operations --------------------- The following tables present selected financial data of each of the Company's three segments for the quarters ended March 31, 2002 and 2001: Quarter Ended March 31, 2002 Quarter Ended March 31, 2001 ---------------------------- ---------------------------- Operating Operating Sales Income Sales Income ----------- ----------- ----------- ----------- Leather Factory $ 7,824,517 $ 975,727 $ 7,103,792 $ 1,003,701 Tandy 1,877,874 141,501 1,775,116 (19,664) Cushman 501,560 76,231 493,705 (8,698) ----------- ----------- ----------- ----------- Total Operations $10,203,951 $ 1,193,459 $ 9,372,613 $ 975,339 =========== =========== =========== =========== Consolidated net sales for the quarter ended March 31, 2002 increased $831,000, or 8.9%, compared to the same period in 2001. Leather Factory contributed $720,000 to the increase due primarily to continued growth in our sales to craft store customers. Tandy added $103,000 of additional sales while Cushman's sales held virtually steady. The Company experienced an increase in operating income of 22.4% from 2001 to 2002. % of Net Sales Quarterly period ended March 31, Change in $ and % ------------------------- ------------------------- 2002 2001 $ Change % Change ----------- ----------- ----------- ----------- Net sales 100.00% 100.00% $ 831,338 8.87% Cost of sales 47.39 47.89 346,959 7.73 ----------- ----------- ----------- Gross profit 52.61 52.11 484,379 9.92 Operating expenses 40.92 41.71 266,259 6.81 ----------- ----------- ----------- Income from operations 11.69 10.40 218,120 22.36 Interest expense and other 1.04 1.66 (49,659) (31.86) ----------- ----------- ----------- Income before income taxes and cumulative effect of change in accounting principle 10.65 8.74 267,779 32.68 Income tax provision 3.21 3.44 5,757 1.79 ----------- ----------- ----------- Net income tax before cumulative effect of change in accounting principle 7.44 5.30 262,022 52.69 Cumulative effect of change in accounting principle (39.29) -- (4,008,831) N/A ----------- ----------- ----------- Net income (loss) (31.85%) 5.30% (3,746,809) (753.46%) =========== =========== ===========
13
Leather Factory Operations Net sales from Leather Factory's 30 sales/distribution units increased 10.2% for the first quarter of 2002. The two units opened in the third quarter of 2001 contributed 23.5% of the sales increase. Same store sales increased 7.8% over the first quarter of 2001. The following table presents TLF's sales mix by customer categories for the quarters ended March 31, 2002 and 2001: Quarter ended Customer Group 3/31/02 3/31/01 -------------- ---------- ---------- RETAIL (end users, consumers, individuals) 21% 21% INSTITUTION (prisons, prisoners, hospitals, schools, YMCA, Boy Scouts, etc.) 7 8 WHOLESALE (saddle & tack stores, resellers & distributors, shoe repair shops, dealers, etc.) 32 32 CRAFT (craft stores (individually owned) and craftstore chains) 26 21 MIDAS (small manufacturers) 7 11 ASC (Authorized Sales Centers) 7 7 ---------- ---------- 100% 100% ========== ==========
Our sales to our CRAFT customers continue to gain momentum as the majority of the sales increase gained this quarter was from this customer group. The arts and crafts industry in general is booming domestically and Leather Factory is benefiting as a result. Various publications and articles have been published recently to support the theory that the crafts industry is expected to show solid growth during the remainder of the decade. The sales decline to our MIDAS customer group was caused by a general slow-down in orders from the manufacturers due to the slow-down in orders received from their retail customers. Operating income for TLF decreased $34,500 or 3.4% of sales for the current quarter compared to 2001. Operating expenses as a percentage of sales were 40.3%, which is slightly higher than management's target of 40.0%. The Company's expected contribution to the ESOP for the benefit of employees was increased in the first quarter, as management believes the employees should benefit from the Company's operational successes. As a result of the additional ESOP contribution amount, the operating expenses and operating income amounts were negatively impacted when compared to the first quarter of 2001. Tandy Leather Operations Net sales for Tandy, which consisted of two retail stores and a central distribution center as of March 31, 2002, increased 5.8% for the first quarter of 2002 over the same quarter last year. The two retail stores opened in the current quarter added $175,000 in sales while the central distribution center's sales decreased by $72,500. The central distribution center's sales are generated by phone, fax, mail order and Internet orders. The sales decline at this facility was the result of reduction in Internet orders received due to a technical problem with the website (www.tandyleather.com) during the latter part of March. Although we believe we have fixed this problem at the end of April, the problem may affect Internet sales reported by Tandy in the second quarter. Operating income for Tandy increased $161,000 in the current quarter as a result of an increase in gross profit margin of 2% and a reduction in operating expenses of 6%. Tandy's operating expenses were less than 50% of sales for the first time since the acquisition. Management is pleased with the improvement while hoping to continue this trend of streamlining operating expenses. The retail stores tend to operate more efficiently than the central distribution center. Therefore, as more retail stores are added, the overall operating efficiency of Tandy should improve. 14 Roberts, Cushman Operations Net sales for Cushman increased $7,800 for the first quarter of 2002, a minimal improvement. However, even though the sales were virtually flat, Cushman's gross profit margin improved almost 5% compared to the first quarter of 2001. As previously discussed in the 2001 Annual Report, we intentionally sold some inventory at a low gross margin in 2001 in order to position Cushman to achieve better financial results in the future. We believe that the first quarter 2002 financial results add evidence to support the appropriateness of that decision. Operating income for Cushman increased $85,000 as a result of the improvement in the gross margins and also the reduction of operating expenses. We operated with fewer personnel in the current quarter - an adjustment made by management late in 2001 in order to compensate for flat sales. In 2001, operating expenses included $30,000 of amortization of goodwill that is not included in 2002 due to the change in accounting principle regarding goodwill (SFAS No. 142). The reduction of goodwill in the first quarter eliminated all goodwill recorded on our books for Cushman. Further discussion regarding this accounting rule is contained in Note 5 to the Consolidated Financial Statements. Capital Resources, Liquidity and Financial Condition ---------------------------------------------------- The change in accounting principle discussed above had significant effects on our consolidated balance sheet at March 31, 2002. Total goodwill was reduced from $4,535,412 at the end of 2001 to $607,455. This reduction was the principal cause of the reduction in total assets from $19,548,323 at the end of 2001 to $15,313,284 at the end of the first quarter of 2002 (a reduction of 21.7%). Total stockholders' equity was reduced from $12,423,671 at December 31, 2001 to $9,204,666 at March 31, 2002 (a reduction of 25.9%). This reduction was also attributable to the change in accounting principle, but the effect was partially offset by operating results from the first quarter of this year. The Company's investment in accounts receivable was $2.7 million at March 31, 2002, up $445,000 from $2.3 million at year-end 2001. This is a result of an increase in credit sales during the quarter ended March 31, 2002 as compared to that of the quarter ended December 31, 2001. The average days to collect accounts improved slightly over the first quarter of 2001 to 47.2 days. Tandy's average days to collect experienced the most improvement, from 51.7 days in 2001 to 42.9 days for the first quarter of 2002. Inventory decreased $779,000 to $8.3 million at March 31, 2002 from $9.1 million at year-end 2001. Inventory turnover increased to an annualized rate of 4.71 times during the first quarter of 2002, an improvement over the turnover rate of 4.11 times for the first quarter of 2001 and 4.08 times for all of 2001. Tandy's inventory turnover rate accounts for the improvement due to the drastic decrease in its inventory levels from March 31, 2001 to March 31, 2002 while supporting the same sales level. Management believes Tandy is operating with a more realistic inventory level currently although we do have the ability to transfer merchandise from Leather Factory to Tandy almost immediately if necessary to support sales requirements. Notes payable and current maturities of long-term debt decreased from $4,527,904 at the end of 2001 to $2,987,518 at March 31, 2002. Accounts payable increased $244,000 to $1.5 million at the end of the first quarter, due primarily to management's success in obtaining longer credit terms with several large vendors. The Company's current ratio improved from 1.82 at December 31, 2001 to 2.08 at March 31, 2002. The primary sources of liquidity and capital resources during the first quarter of 2002 were funds provided by operating activities in the amount of $1,372,000 and the Company's Credit and Security Agreement with Wells Fargo Business Credit, Inc. ("WFBC"). The Company used its first quarter operating cash flow and additional funds on hand at the beginning of the quarter to pay down debt balances ($1,547,766), purchase equipment ($97,622), and purchase the assets of two existing leathercraft stores ($227,747). 15 Approximately 25% of the 2002 capital spending was for computer equipment and software for the new Tandy retail stores, 25% was for inventory scanning equipment for the existing Leather Factory stores, 30% was for various computer workstation and software upgrades in existing locations and departments, and 20% was for various furniture and fixtures. The two leathercraft stores acquired created Tandy's two retail stores in Oklahoma City, OK and Boise, ID. The assets purchased in the two transactions were inventory and miscellaneous store fixtures. As previously disclosed, on March 20, 2002, the Company entered into an Amended and Restated Credit and Security Agreement with Wells Fargo Bank Minnesota, N.A. ("Wells Fargo"), which replaced the Company's previous borrowing arrangement with WFBC. The agreement provides for a revolving credit facility of up to $7,500,000 and contains similar covenants as that of the previous WFBC agreement. The significant difference between the two agreements is that the new agreement has a provision regarding the value of inventory included in the borrowing base calculation that is more favorable to the Company. The revolving credit facility with Wells Fargo is based upon the level of the Company's accounts receivable and inventory. At March 31, 2002, the available and unused portion of the credit facility was approximately $3,122,000. Wells Fargo has granted a waiver of any noncompliance with our financial covenants arising from the change in accounting principle described above. The Company believes that the current sources of liquidity and capital resources will be sufficient to fund current operations and the opening of any potential new Tandy retail stores or Leather Factory sales/distribution units. In 2002, the funding for the opening of any new locations is expected to be provided by operating leases, cash flows from operating activities, and the revolving credit facility. Item 3. Quantitative and Qualitative Disclosures About Market Risk. The Company's Credit Facility includes loans with interest rates that vary with changes in the prime rate. An increase of one percentage point in the prime rate would not have a material impact on the Company's future earnings. PART II. OTHER INFORMATION Item 6. Exhibits and Reports on Form 8-K (a) Exhibits None (b) Reports on Form 8-K On March 20, 2002, the Company filed a report on Form 8-K (Items 5 and 7) describing the Amended and Restated Credit and Security Agreement with Wells Fargo Bank Minnesota, N.A. 16 SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. THE LEATHER FACTORY, INC. (Registrant) Date: May 14, 2002 By: /s/ Wray Thompson -------------------------- Wray Thompson Chairman of the Board and Chief Executive Officer Date: May 14, 2002 By: /s/ Shannon L. Greene ---------------------- Shannon L. Greene Chief Financial Officer and Treasurer (Chief Accounting Officer) 17