Shannon Greene - CEO & Director Tina Castillo - CFO and Controller.

Analysts:.

Good day, ladies and gentlemen, and welcome to the Tandy Leather Factory Third Quarter 2017 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Shannon Greene, Chief Executive Officer. Ma'am, you may begin..

Thank you. Good morning, and welcome to Tandy Leather Factory's Third Quarter 2017 Earnings Conference Call. We will be discussing our third quarter 2017 results as well as providing an update on our key operating priorities and our 2017 guidance.

I'm Shannon Greene, Chief Executive Officer, and I'm joined today by Tina Castillo, Chief Financial Officer; and Mark Angus, President. Before we get started, our earnings release and related SEC filings are available on our Investor Relations website -- section of our website and a replay of this webcast will be available later today.

Also, I need to remind everyone that there may be forward-looking statements on the call today.

Statements would include words like expect, believe, anticipate, plan, intend, target or words with similar meaning and are based on our beliefs and expectations subject to certain risks and uncertainties that may cause actual results to differ materially from our forward-looking statements about those results.

These risks are detailed in our various filings with the SEC such as our most recent Form 10-K and 10-Q as well as in news releases and other communications. We do not undertake to update or revise any forward-looking statements which speak only as of the time they are made.

As you saw in our earnings release, our results for the third quarter were not what we had hoped.

At our last conference call in early August, we knew we were behind on the top line, which we had expected to start turning around in the third quarter with higher contributions from our new stores and at least a flat-to-small increase in same-store sales supported by our district manager structure and various merchandising initiatives.

While our retail sales are growing nicely, the trend of lower sales to our nonretail customers continue to negatively impact revenue. Further, the recent hurricanes in Texas and Florida added additional pressure on revenue, which we certainly didn't predict at the beginning of the quarter.

This revenue shortfall resulted in our operating expenses as a percent of net sales to be much higher than comparable year ago period. Given these results and the increase in our inventory levels, I think it's an important time to remind everyone of Tandy Leather's long-term strategy and key operating priorities.

Our success depends on our ability to profitably grow our business. We all get that. And we also know that the traditional retail environment is being challenged as technology continues to change the way consumers shop and identify with brands.

Simply stated, in today's evolving world of retail, we must all continually adapt to ensure that we will not just survive but thrive. For Tandy Leather, while our business is somewhat unique in many aspects, we are not completely protected from those challenges and the impact of those challenges on some of our customers.

But are also tasked with growing our customer base when most people think leathercrafting isn't exactly trending to be a common household activity for today's millennial or Gen Z. We believe we are succeeding in beating those challenges for the most part, as it relates to our retail business.

Our retail customer base is growing and the average age of our customer is trending younger. It's the nonretail or wholesale side of the business that's dragging. While the great recession is now 10 years in the past, we believe our small business customers are still dealing within an array of different hurdles in order to compete effectively today.

That appears to be an enormous task based on our conversations with many of them, and as evidenced by the fact that our sales to that customer group continue to be soft. With all of that said, I believe, Tandy Leather has some core fundamentals that give us strength in weathering these challenges.

For nearly 100 years, we have been the dominant player in a very niche market, offering a broad selection of products combined with leathercraft expertise in a one-stop shop. And our brand is second to none. Our focus right now is primarily on our direct-to-consumer channels.

And I think we are achieving success as evidenced by our sales growth from that customer group. Our B2C model allows us to control our brand, which we believe is widely important in the current environment. Our B2B channel is where we're not seeing growth, and it has been an issue for a while.

We have a fairly loyal wholesale customer base, but when they struggle it affects our results. Without pulling attention away from B2C, we already started and intend to continue an increased focus on our B2B business looking into 2018 and beyond.

From a supply chain perspective, it is well established and allows us to quickly support new product and merchandising initiatives. With all of that said, we know the top line growth and profit improvement is what defines our value.

In order to do that, we must combine our heritage and legacy with the modern-day appeal in such a way that Tandy Leather remains the first choice in all things leather. We've got to continually work the formula of the right merchandising and marketing that allow us to attract younger new customers, while retaining our older established customers.

I know we said this in our recent earnings calls, but I think it's important to emphasize our key operating priorities again, improve our customer experience, increase our brand awareness and strengthen our store performance. We believe an exceptional customer experience will result in more loyal customers, which will result in stronger sales.

We are very focused on creating a comfortable atmosphere in our stores that make our customers want to spend time there. The more time they spend the more effective we can be in turning them into long-time loyal customers. And again, that translates into sales over time.

We've been working on new merchandising with an expanded product line to further appeal to our retail customers, doubling our efforts on business development to our wholesale and manufacturer customer group, updating our promotional and clearance initiatives and actively promoting Tandy Leather on social media channels.

With the expanded product line, we have also increased our product training efforts to our store associates to augment their product knowledge as that is a crucial part of the customer experience we are committed to improving.

We believe that our store associates armed with a solid knowledge of our extensive product line can ultimately drive higher average tickets and traffic conversions, because customer loyalty and satisfaction will improve, which again, ultimately result in stronger sales.

Since the beginning of the year, we have opened 3 new stores and reopened 1 that we temporarily closed in early 2016. During the third quarter, no new stores were opened.

We do have one more in the works right now, but I think realistically, it won't open until early 2018, because while the lease is signed we are at the mercy of the landlord's construction schedule. As for our district manager structure, we currently have 11 of our 15 position staffed.

Our goals with the district manager program are not only to drive traffic and sales, but to train our store managers and associates to better serve our customers, which is critical for success in today's retail environment. This structure not only allows us to have faster execution of strategy, but also provides additional career path option lease.

Our inventory level standing at $41.1 million at September 30 increased almost $4 million over our prior quarter inventor level. While this may seem high, particularly when sales have been soft, this increase was somewhat deliberate as our inventory at September 30 is always the highest of the year as we start the fourth quarter.

Not only have we been taking delivery of products for the upcoming holiday promotions, we have also been investing new merchandise to appeal to an expanded and diverse customer base as well as stocking higher-end leathers and luxury do-it-yourself kits to appeal to our legacy customers.

Also and most significantly, we were presented with some special purchases of some of our regular stock items at aggressive pricing, bulk buys, if you will. We will always take advantage of those buying opportunities because they have a very positive impact on gross margins.

These particular items that were purchased in the third quarter were not planned to be part of our fourth quarter promotions, but most likely will be part of our first quarter 2018 promotions.

Simply said, yes, our inventory investment at September 30 is heavier than we originally projected, but it's because we took advantage of these special bulk buys for future sales. Our goal has always been to profitably grow our business and that starts by growing our customer base.

One of the keys to that is a product line that appeals to a wide variety of preferences and taste in leather goods. One of our fundamental strengths is that our products are not perishable.

They don't become obsolete, they aren't seasonal and they aren't generally impacted by trends, because we don't sell finished goods, our products can have a long shelf life. And while the inventory level may seem suspect when sales have been soft, there are few retailers who can boast gross profit margins in excess of 60%.

We're very proud of that fact and we will always protect that margin. Our growth strategy has required and will continue to require investments in our new stores, expanded product offerings as well as operating costs for additional headcounts, travel, training and marketing expenses.

After Tina provides you with a run-through of the numbers, I'll give an update to our guidance..

Thanks, Shannon. Before I go into the details, I wanted to remind everyone that as it was disclosed in our press release and in the past 2 quarters, we now operate in 2 segments, North America and International. You may recall that prior to January 1, 2017, we operated in three segments, wholesale, retail and International.

To better reflect how management analyzes the business and allocates resources, we combined wholesale and retail into North America effective January 1, 2017, while our International reporting segment remains the same.

All prior year data discussed throughout this call has been recast to conform to the new reporting segment structure, and there is no change in reporting of our consolidated financial positions or results.

Our third quarter consolidated sales totaling $18.4 million decreased to 1.3% from last year's third quarter sales with our International segment reporting a 9.5% increase, which was offset by a 1.8% decrease in North America. North America contributed 95% of third quarter 2017 total sales, while International contributed the remaining 5%.

The $84,000 improvement in our International Leathercraft segment was partially due to a favorable foreign currency translation of the Australian dollar and euro as well as a higher number of sales transactions, particularly in the U.K. as our Manchester store continues to establish its presence.

The sales decrease in North America consisted a 5.4% decrease in same-store sales offset by $634,000 in sales from the 7 new stores that have opened or reopened since October 2016.

North America same-store sales decline was unfavorably impacted by recent hurricanes, which caused our 4 stores in South Texas and 5 stores in Florida to be closed for several days leading up the hurricanes and for several days afterwards not only for our employee safety, but for loss of power and/or ingress, egress issues.

Fortunately, none of our stores sustained significant flooding or damage and all were able to reopen within a week of the hurricane's landfall. Our sales for those 9 stores declined by 16.3% compared to the quarter ended September 30, 2016. Excluding the impact of these 9 stores, our same-store sales decline would have been 4.5%.

This decrease is consistent with the trend that we've seen all year, as our customers shift -- as our customer mix shift from nonretail to retail. Sales to our business customers declined by 9%, while sales to our retail customers increased by 6%. Our business customers are still buying, just not as frequently and in smaller quantities.

On a positive note, our merchandising and marketing efforts aimed at growing our retail group seemed to be taking root and this has positive consequences not just in expanding our customer base, but to the improvement in our gross profit margins.

Consolidated gross profit margin for the third quarter was 63.3%, improving from 62.5% in last year's third quarter. The improvement was a result of the shift in customers with more retail than business as well as product mix with more higher-margin products sold.

As a reminder, generally speaking, our gross profit is affected by two things, sales mix by customer and sales mix by a product. More specifically, the ratio of retail versus nonretail sales and the ratio of leather versus nonleather sales results in the increase or decrease in gross profit compared to prior year period.

Consolidated operating expenses this quarter increased $880,000 or 8.7% compared to a year ago. Our 7 new and reopened stores, net of the impact of closed stores contributed about half of this increase, while personnel, occupancy, selling and advertising costs increases contributed to the remainder.

With regard to personnel costs, our costs are higher for the increase in store manager salaries and the rollout of our district manager structure. Income from operations was $650,000 for the quarter or a decrease of $890,000 from the comparable quarter in 2016.

The decrease in our effective tax rate of 25% for the third quarter of 2017 compared to 33% in the third quarter of 2016 was due to the reversal of our deferred tax position for fixed assets. For the year to date, our consolidated sales totaling $57.8 million decreased 1.7% from last year's sales for the same period.

North America reported a 1.7% decline, which consisted of a same-store sales decrease of 3% and new store sales of $703,000, offset by 3 stores that closed in 2016. Our International Leathercraft segment reported a sales decrease of 1.5%, which was primarily due to unfavorable exchanges in the first half of the year in the U.K. and Spain.

Consolidated gross profit margin for the year to date was 63.7%, increasing from 63.2% last year. Again, due to that shift in customer with more retail than business as well as product mix with more higher-margin products sold.

Consolidated operating expenses this year have increased 7.6% compared to a year ago due to the investments in our new stores and our district manager program. Our effective income tax rate for the year to date was 31% compared to 35% last year. We ended the quarter with total assets of $74.4 million, up $3.7 million from the end of 2016.

Cash was lower by $4.7 million at $12.2 million at September 30, 2017, versus $16.8 million at year-end 2016, primarily due to the increase in inventory that Shannon discussed earlier. Current liabilities decreased $837,000, while our bank debt is unchanged at $7.4 million.

This debt consists solely of borrowings on line of credit in place for our stock repurchase program, for which there have been no repurchases during 2017. Now I'll turn the call back over to Shannon, who will provide an update through our 2017 guidance..

Thanks, Tina. Given the tough results from the third quarter and an expected lingering impact from the recent hurricanes, we have lowered our 2017 guidance. We estimate consolidated sales to be in the range of $81 million to $82 million and EPS to be in the range of $0.50 to $0.52.

Average shares outstanding, both basic and diluted, in 2017 are estimated to be approximately $9.3 million and our effective tax rate is estimated to be between 31% and 32%. We also expect that our inventory levels will be back in the lower to mid-$30 million range at year end.

We are aggressively focused on finishing the year strong from the upcoming holiday shopping season and have introduced expanded holiday shopping hours for each of the Saturdays in December in our U.S. stores. We normally close at 4:00 p.m. in the afternoon on Saturdays, but we'll extend our closing to 8:00 p.m. for the Saturdays in December.

In addition, with the higher traffic expected over the next 2 months, we are aggressively promoting not just our new merchandising initiatives, but focusing on our clearance items in such a way as not to impact gross margin. In closing, we believe in our long-term strategy and the key operating priorities to profitably grow the business.

We knew 2017 was going to be a year of investment and that our district manager structure and other initiatives would take time to gain traction, and we have been transparent about that throughout this year. I recognize that it's painful right now, but the comparisons will get easier by mid-2018 and beyond.

Thinking about 2018, on our next earnings call, which should occur in early March, we will provide further details regarding our long-term outlook. As always, I want to publicly thank all of our dedicated Tandy Leather team members who work so hard to move this company forward. That concludes our prepared remarks.

We appreciate your time today and your interest in Tandy Leather. Operator, we're now ready to take questions..

Operator:.

Thank you very much for participating in our earnings conference call today. We look forward to speaking with you again next quarter. Have a great day..

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program. You may now disconnect. Everyone, have a great day..