Tina Castillo - Chief Financial Officer Janet Carr - Chief Executive Officer.

George Kelley - Private Investor.

Good day, ladies and gentlemen and welcome to the Q3 2018 Tandy Leather Factory Inc. Earnings Conference Call. [Operator Instructions] And as a reminder, this conference call is being recorded. I would now like to introduce your host for today’s conference, Ms. Tina Castillo. Ms. Castillo, you may begin..

Thanks, Meryl. Good morning and welcome to Tandy Leather’s third quarter 2018 earnings conference call. Joining me today is Janet Carr, our new CEO, who I am pleased to introduce to you.

This morning, I will start with our third quarter 2018 results and then speak briefly about our outlook for Q4 and full year 2018 and then I will turn the call over to Janet, who will discuss some of our initial observations and preliminary strategy thoughts. We will then provide some time to take your questions.

Before we get started, our earnings release and related SEC filings are available on our Investor Relations section of our website and a replay of this webcast will be available later today. Please keep in mind that there may be forward-looking statements on this call today.

Statements would include words like expect, believe, anticipate, plan, intend or words with similar meaning and are based on our beliefs and expectations and are 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 the 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 may have seen in our earnings release, looking at third quarter results, while sales and gross profit improved, our operating expenses grew faster. As a result, our operating income is not where we want it to be. Drilling down, certainly there were some encouraging factors this quarter over last year’s third quarter.

North America same-store sales rose 2.8%. Gross margin dollars were up 1.8%, and our average ticket improved 1.7%. In addition, we continued to see gains in our retail customer segment, which were up 3.8%.

Our new product category of small machines, which are attracted to our hobbyist customer and to our small business customer, had been performing well. We have introduced three machines so far this year and expect to add two more machines in the next few weeks just in time for our holiday shopping season.

For the third quarter, these new machines contributed $200,000 in sales. On the not-so-positive side, however, sales to our business customers declined 2.6% and sales in our international segment declined 13.1%. In addition, our volume of transactions this quarter over last year’s comparable quarter declined 1%.

Consolidated gross profit margin for the quarter was 62.7%, down from 63.3% in last year’s third quarter. This decline was the result of product mix with more lower-margin products sold as well as more aggressive pricing promotions, partially offset by the continued shift in customer mix with more retail sales than business.

Looking at operating expenses, I will start with it was a very active quarter. We had 2 new store openings, 2 store relocations, 1 store closure, a full quarter of our extended hours, including Sunday openings and organizational changes in our leadership. As a result, our operating expenses grew by $546,000 or 5%.

Taking these one by one, the new stores in Austin and Calgary increased operating expenses by $167,000. In addition, we incurred $200,000 of higher wages, which resulted from our extended store hours, combined with the tight labor market. The closure of our North Hampton, UK store added $130,000 of expenses, mostly related to severance and lease cost.

We also incurred $304,000 of legal and advisory costs associated with our recent leadership changes. These increases were partially offset by reductions in advertising and marketing expense. Income from operations was $315,000 for the quarter or a decrease of $335,000 from the comparable quarter in 2017.

Switching now to our year-to-date results, our consolidated sales, totaling $58.4 million, increased 0.9% from last year’s sales for the same period. North America reported a 1% increase, which consisted of new store sales of $777,000, partially offset by same-store sales decrease of 0.4%.

Our International segment reported a sales decrease of 0.9%, which was due to lower volumes, mostly in Europe. Looking at customer mix, for the year-to-date, sales to our retail customers have grown 3.5%, while sales to our business customer have declined 4.3%.

For product mix, sales of leather have declined 0.6%, while sales of non-leather have grown 1.8%. As a reminder, our gross profit is favorably impacted with higher retail and higher non-leather sales. Consolidated gross profit margin for the year-to-date was 64.8%, improving from 63.7%, reflecting the trends in year-to-date customer and product mix.

Consolidated operating expenses this year have increased 3% compared to the year ago due to the 5 new stores that have opened since the beginning of 2017, which added $380,000 of operating expenses as well as increases in our store associate wages, which added $650,000 of operating expenses.

Other increases to OpEx include higher common area maintenance, a higher number of store relocations in 2018 versus 2017 and R&D costs associated with our new small machines product launch. Our effective income tax rate for the year-to-date was 35% compared to 31% last year.

During this quarter, we finalized our 2017 federal tax return, which resulted in $250,000 of additional transition tax as certain of our International net operating losses were subjected to federal limitation rule.

In addition, while our corporate federal rate is now 21%, the domestic production deduction has been eliminated, and a new global foreign income tax has been added. We still have more work to do in the fourth quarter when we chew up our international and state tax return.

As per the balance sheet, Tandy continues to maintain a strong financial position. We ended the quarter with total assets of $76.7 million, up $1.7 million from the end of 2017. Our cash balances are currently at $16.8 million or $4.6 million higher than a year ago. Of our cash balances, more than 60% is in U.S. dollars. Of those U.S.

dollars, there is a portion that is held in Canada, which is where we earn our highest yield. When we do decide to bring those U.S. dollars back, the good news is that there are no significant tax consequences since we book the onetime repatriation impact already.

We’re currently holding $40.7 million in inventory at September 30 or $0.4 million less than a year ago. While we have invested in inventory of new stores and new products, we do have more work to optimize our inventory levels and turnover.

Turning now to our Q4 and full year outlook with our year-to-date financial results and changes in leadership, we are withdrawing our prior 2018 guidance. That said, with respect to our full year sales outlook, we estimate that our 2018 annual sales will be in the range of $82 million to $84 million.

Our holiday promotions and assortment, combined with more aggressive pricing, Sunday store openings and the Blispay co-branded financing option are expected to lift fourth quarter comparable store sales. As I have talked about earlier, operating expenses are coming into the fourth quarter at a higher run rate than last year.

In addition, a number of transition-related expenses will also impact Q4 operating expenses. So 2018, in particular Q4, reflects the change in leadership. Part of the evolution of our heritage and what’s important now is our future. With that, I will hand the call to Janet, who I am so pleased to introduce to you.

I have learned in the last several weeks that Janet is a proven, seasoned retail executive who has quickly grasped the labeling here at Tandy and has already made a significantly positive difference in our culture. I’m so looking forward to the next chapter here at Tandy.

Janet?.

Thanks, Tina, and hello everyone. First, let me tell you that I am honored and delighted to join this revered brand and talented team. It’s been an exciting first 5 weeks.

I have immersed myself in the business with the team, visited stores, met and talked with key vendors and spent a lot of time in spirited two-way communication with a broad cross-section of employees. That said it’s only been 5 weeks. So I’d like to share some of my initial observations and the emerging vision for our future.

It will feel like I am speaking in generality, but I want to give you a sense of where I see the opportunities without getting ahead of the full robust business and financial analysis that will accompany any major decisions. I don’t need to tell you that this is an amazing brand.

With the 100-year anniversary coming up next year, we are the definition of leather crafting with both consumers and the trade, whether it’s Al Stohlman, Jim Linnell or Parker Lichfield, many of the best leather crafters in the country have grown up in Tandy or otherwise had long and proud association with the brand.

We need to strengthen these long relationships and build new ones to reestablish our credentials and rebuild our expertise in the art of quality leather crafting. This expertise in leather crafting needs to be on full display in our stores. You all know the drumbeat of what’s happening in retail today.

Winners are those who create an emotional, engaging experience who give consumers a reason to get off their couch and into stores and we are not competing with other retailers who sell stuff. We are competing with movies, restaurants, yoga, live music, in a nutshell, entertainment.

If you have ever seen people working on leather projects, you will know that our business, our brand is the perfect vehicle for creating that emotional experience. It’s naturally warm and sensual. You want to see, smell, touch and transform leather into your own creations. This is an amazing foundation to build on. We do have some work to get there.

Rebuilding expertise in leather crafting among our field team, refocusing on a compelling and well-merchandised in-store environment that makes customers fall in love with leather, evaluating each and every store location to maximize opportunities to build brand awareness, to drive store traffic and to get repeat visits.

We also have to deeply understand who these consumers are. Leather crafting, riding the tide of the maker movement is not only about Sheridan style leather carving, which is absolutely beautiful and our proud heritage. But today, it’s as often about shoemaking, bag making, cosplay, furniture making, book binding and pure artistic sculpture.

We will be spending time understanding these consumer segments and how our brand and our store experience can meet more of their needs. This will be key to future retail growth. We also have an opportunity to reengage with our wholesale or business customer.

Sales to this customer segment have been declining in recent years as we serve them with our retail model. A focus on creating a tailored offering that is relative to their specific needs with competitive pricing can be an excellent start.

I believe from some of the former business customers that I’ve spoken with that there’s tremendous goodwill for Tandy out there and long, strong relationships with many of our employees. Building volume with this customer segment may also help us source more competitively as well, potential here for a virtuous cycle.

By the way, we don’t see wholesale, retail and Web as a zero-sum game. One should not and will not come at the expense of another. This multi-channel model can provide a strong foundation for long-term growth.

With these three clear priorities, one, reestablish our brand credentials; two, build an emotional and compelling leather crafting retail experience; and three, create the right proposition to bring our business customers back into the brand, we need to build the operating model that supports these priorities.

That is how we organize, how we deliver this proposition to our consumers and how we get the work done. What does this mean? There are four key actions that we are taking right now to start to build the right operating model.

One, we are pausing new store openings and store moves while we evaluate the right locations for our improved retail model, the key business metrics for this new model and the right combination of factors that meet our financial threshold. Two, we are determining how we can serve our international customers more efficiently and effectively.

Three, we are revisiting our field and home office organizational structure to review new accountabilities in light of leadership changes and the right incentives to support our business priorities.

And four, we are evaluating our infrastructure and resources, especially in the areas of talent management, recruiting, development and training and retention with a goal to improve complete turnover and job satisfaction critical to our future success and important in this tight labor market.

Marketing, evaluating the balance between digital and print and where our investments deliver the best ROI and business processes, evaluating where we can streamline, automate and improve our systems to focus on key business metrics, so we can make better decisions faster.

So to reiterate Tina’s earlier comments on Q4 in 2018, we expect it to continue its glide path with some effects of transition layered on. But as a team, we are excited to be looking forward to 2019. We think there is tremendous opportunity for this brand and we are looking forward to sharing more with you in our next call. Now, questions..

Thank you. [Operator Instructions] Our first question comes from George Kelley, who is a Private Investor. Your line is now open..

Hi, everyone. Hi, Janet. Congrats on the new role..

Hi, George, thank you. Nice to meet you..

You as well. So, just a couple of questions for me. First, a lot of things that you went through for sort of key priorities and where you see the biggest opportunities are.

I guess if you could just go to 10,000 feet and start on the retail side and how big – have you done studies since joining or before joining, what is the customer market, how big is leather crafting? What kind of growth do you see? How big is what you are going after, I guess is the question and how healthy is the overall market?.

We are actually in the process of doing some consumer research right now to try to understand a bit about how big is the potential market. It’s hard, because it is a fairly niche market and it’s difficult to quantify. In addition, it’s really diverse, lots and lots of people doing a lot of very different things with leather.

So, it’s not a monolith by any stretch. That said there are these broader trends out there, as I mentioned, this maker trend still continuing to grow and strong. So I feel confident that the retail consumer is definitely out there.

And I think that the thinking is that this has been a sort of a pastime, a passion really for people from the beginning of time practically. And I think that it’s something that where we can actually help to grow the market by really engaging consumers in this really emotional retail experience..

Okay, okay.

And then on the other side of the business, the business customers, what’s happened in the last couple of years that has caused that business to be up and down, I guess mostly down for the last couple of years? Is it you are less competitive in pricing or have there been – are there just fewer business customers in general, fewer people making this for their career?.

It’s a good question. It’s part of this work that we are doing. We are really trying to get a sense of who that business customer is, how big that customer is, where they have gone.

We have had some anecdotes around things like price and the offering, what we are carrying for them and I think that we can get a lot more tailored and a lot more specific to what their needs are.

But again, we are taking a little more of a systematic approach to really surveying them and understanding what their needs are and then we will be working on how do we go after that..

Okay, okay. And then just more specific to the third quarter, you did report I believe same-store sales were positive close to 3% and there has been a lot of initiatives recently around having new higher-priced items and Sunday store hours.

How have those – and other initiatives is there anything you can flag for driving that 3% growth in the quarter?.

Absolutely, George and you nailed it. It is those new small machines. We have introduced three of them so far and they have been very well received. We sold just $200,000 this quarter alone. We do think that the Sunday hours are helping.

When we first started our Sunday hours, it was $80,000 in sales and now that’s grown to about $125,000 on Sundays and we are excited about the Sundays as we approach the holiday season.

So, there is probably a few initiatives that we have in terms of trying to grow our average ticket and it’s just in our assortment and really working to win back some of those business customers with more targeted offerings to them. So lots of good things happening to help us lift those same-store sales and yes, we are excited about fourth quarter..

Okay.

And then the last question for me, just back to your – places of where you are most focused, Janet, should we expect any kind of timeline? Will there be a plan that you articulate any kind of these business model changes and other changes that you are considering? Maybe by the next quarter or a couple of quarters from now, do you expect to have a more formal here is what we are going to do, here is how much it’s going to – here is the financial goals we are shooting for any of that kind of stuff?.

Yes, absolutely. In our next call and this may not be 100% fully fleshed out, but we will have substantial pieces of this to talk to you about in our next call.

And what we think the financial impacts will be more importantly, what our targets are for any changes, what do we want to measure to know if it’s successful, if it’s not successful? So definitely, we will have more to talk about and we are really working hard on both understanding the lay of the land and starting to formulate how do we start to change to address that?.

Okay, great. So more later. Thank you..

Thank you..

Thanks, George..

And I am not showing any further questions at this time. I would now like to turn the call back over to Janet Carr for any further remarks..

Well, thank you again for your time and participation. We are thrilled as I have said before to be embarking on this adventure. The team is very excited. We are really looking forward. And as I said in response to George’s question, next time we all are together, we will have a lot more to share.

Have a great holiday season and we will see you next year..

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program and you may all disconnect. Everyone have a wonderful day..