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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, 2003
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 IDENTIFICATION NUMBER)
INCORPORATION OR ORGANIZATION)
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. [ ]
Indicate by check mark whether registrant is an accelerated filer (as defined in
Exchange Act Rule 12b-2). [ ]
The aggregate market value of the common stock held by non-affiliates of the
registrant was approximately $19,806,561 at March 10, 2004. At that date, there
were 10,525,661 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 26, 2004, are incorporated by
reference in Part III of this report.
1
PART I
ITEM 1. BUSINESS
GENERAL
We are a retailer and wholesale distributor 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. During 2003,
our consolidated sales totaled $41.7 million of which approximately 6.6% were
export sales. We maintain our principal offices at 3847 East Loop 820 South,
Fort Worth, Texas 76119. Our common stock trades on the American Stock Exchange
under the symbol "TLF".
Our company was founded in 1980 as Midas Leathercraft Tool Company ("Midas"), a
Texas corporation. Midas' original business activity focused on the
distribution of certain leathercraft tools. In addition, the founders of Midas
entered into a consulting agreement with Brown Group, Inc., a major footwear
retailer, as a result of their proposal to develop a multi-location chain of
wholesale distribution centers known as "The Leather Factory." In 1985, Midas
purchased the assets of The Leather Factory from Brown Shoe Group, which then
consisted of six distribution centers.
In 1993, Midas changed its name to "The Leather Factory, Inc.", then
reincorporated in the state of Delaware in 1994.
THE DEVELOPMENT OF OUR COMPANY IN RECENT YEARS
Our expansion of the wholesale chain occurred via the opening of new centers as
well as numerous acquisitions of small businesses in strategic geographic
locations including the acquisition of our Canadian distributor, The Leather
Factory of Canada, Ltd., in 1996. By 2000, we had grown to twenty-seven Leather
Factory centers located in the United States and two Leather Factory centers in
Canada. In November 2000, we acquired the operating assets of two subsidiaries
of Tandycrafts, Inc. to form Tandy Leather Company. In 2002, we began opening
retail stores under the "Tandy Leather" name. During that year, Tandy Leather
purchased four independent leathercraft retail stores. We also opened our
thirtieth Leather Factory center - our third in Canada.
At December 31, 2003, we operated thirty Leather Factory wholesale distribution
centers and twenty-six Tandy Leather retail stores. We also own and operate
Roberts, Cushman and Company, Inc., a manufacturer of custom hat trims.
Our growth, measured both by our net sales and net income, occurs as a result of
the increase in the number of stores we have and the increase from year to year
of the sales in our existing stores. The following tables provide summary
information concerning the additions of facilities for our Leather Factory
wholesale centers and Tandy Leather retail stores in each of our fiscal years
from 1999 to 2003.
STORE COUNT
YEARS ENDED DECEMBER 31, 1999 THROUGH 2003
LEATHER FACTORY WHOLESALE CENTERS TANDY LEATHER RETAIL STORES
--------------------------------- ----------------------------
Year Ended Opened Conversions(1) Total Opened(2) Closed Total
------ -------------- ----- --------- ------ -----
Balance Fwd 22 N/A
1999 4 0 26 N/A
2000 2 0 28 1* 0 1
2001 2 0 30 0 0 1
2002 1 (1) 30 14 1* 14
2003 0 0 30 12 0 26
(1) Leather Factory wholesale center converted to a Tandy Leather retail store.
(2) Includes conversions of Leather Factory wholesale centers to Tandy Leather retail stores.
(*) The Tandy Leather operation began as a central mail-order fulfillment center in 2000 that we closed in
2002.
2
No single customer's purchases represent more than 10% of the Company's total
sales in 2003. Sales to the Company's five largest customers represented 13.8%,
15.1% and 14.4%, respectively, of consolidated sales in 2003, 2002, and 2001.
While management does not believe the loss of one of these customers would have
a significant negative impact on our operations, it does believe the loss of
several of these customers simultaneously or a substantial reduction in sales
generated by them could temporarily affect our operating results.
OUR INDUSTRY SEGMENTS
We service our customers primarily through the operation of three segments. We
identify those segments based on management responsibility and customer focus.
The Leather Factory centers segment consists of thirty Leather Factory centers
of which 27 are located in the United States and three are located in Canada.
The Tandy Leather segment consists of 26 retail stores as of the end of 2003.
Both of these segments sell leather and leathercraft-related products. Roberts,
Cushman is our third business segment. You will find information concerning the
financial results of our operating segments and the total assets of each of
these segments in Note 11 of the Notes to Consolidated Financial Statements and
in Management's Discussion and Analysis of Financial Condition and Results of
Operations.
LEATHER FACTORY OPERATING SEGMENT
The Leather Factory distributes its broad product line of leather and
leathercraft-related products in the United States and internationally. This
segment had net sales of $30.7 million, $30.3 million, and $28.7 million for
2003, 2002 and 2001, respectively.
GENERAL We operate Leather Factory wholesale centers in 20 states and three
Canadian provinces. The centers range in size from 2,600 square feet to 19,800
square feet, with the average size of a center being approximately 6,000 square
feet. The type of premises utilized for Leather Factory locations is
generally light industrial office/warehouse space in proximity to a major
freeway or with other similar access. This type of location typically offers
lower rents compared to other more retail-oriented locations.
BUSINESS STRATEGY The Leather Factory business concept centers around the
wholesale distribution of leather and related accessories to retailers,
manufacturers, and end users. 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 layout of the centers 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. The location of the centers is selected based on the location of
customers, so that delivery time to customers is minimized. A two-day maximum
delivery time for phone, Internet and mail orders is our goal.
Leather Factory centers serve customers through various means including walk-in
traffic, phone and mail order. We also employ a distinctive marketing tactic in
that we maintain an internally-developed target customer mailing list for use in
our aggressive direct mail advertising campaigns. We staff Leather Factory
wholesale centers with experienced managers whose compensation is tied to the
operating profit of the center they manage. Sales are generated by the selling
efforts of the store personnel, our direct mail advertising, our website
(www.leatherfactory.com), our participation at trade shows and, on a limited
basis, the use of sales representative organizations.
CUSTOMERS Leather Factory's customer base consists 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 constitute the majority of our Leather
Factory business, although retail customers may purchase products from Leather
Factory centers. Leather Factory sales generally do not reflect significant
seasonal patterns.
3
Our Authorized Sales Center ("ASC") program was developed to create a presence
in geographical areas where we do not have a distribution center. 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 the ASC must adhere to in order to
maintain ASC status. In exchange, the benefits to the ASC are free advertising
in certain sale flyers, price breaks on many products, advance notice of new
products, and priority shipping and handling on all orders. Leather Factory
centers service approximately 115 U.S.-based ASC's, 35 Canadian-based ASC's, and
17 international ASC's located in 13 foreign countries.
MERCHANDISE Our products are generally organized into thirteen categories.
We carry a wide assortment of products including leather, lace, hand tools,
kits, and craft supplies. We operate a light manufacturing facility in Fort
Worth whose processes generally involve cutting leather into various shapes and
patterns using metal dies. The factory produces approximately 20% of our
products and also assembles and repackages product as needed. Products
manufactured in our factory are distributed through our stores under the TejasTM
brand name. We also distribute product under the Tandy LeatherTM and Dr.
Jackson'sTM brands. We develop new products through the ideas and referrals of
customers and store personnel as well as the tracking of fads and trends of
interest in the market. Our personnel walk trade shows and various specialty
stores with the purpose of obtaining product ideas that are then developed
in-house.
We offer an unconditional satisfaction guarantee to our customers. Simply
stated, we will accept product returns for any reason. We believe this liberal
policy promotes customer loyalty. We offer credit terms to our non-retail
customers, upon receipt of a credit application and approval by our credit
manager. Generally, our open accounts are net 30 days.
During 2003, sales in the Leather Factory distribution centers by product
category were as follows:
SALES SALES
PRODUCT CATEGORY MIX PRODUCT CATEGORY MIX
- ----------------------- ------ ---------------- -----
Belts strips and straps 2% Hand tools 12%
Books, patterns, videos 2% Hardware 6%
Buckles 3% Kits 9%
Conchos 3% Lace 15%
Craft supplies 7% Leather 32%
Tools and Hardware 1% Stamping tools 3%
Dyes, finishes, glues 5% TOTAL 100%
In addition to meeting ordinary operational requirements, our working capital
needs are a product of the need to maintain inventory at a level we feel is
adequate to fill customer orders as they are received with minimal backorders
and the time required to collect our accounts receivable. Because availability
of merchandise and prompt delivery time are important competitive factors for
us, we maintain higher levels of inventory than our smaller competitors. For
additional information regarding our cash, inventory and accounts receivable at
the end of 2003 and 2002, see "Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations."
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 2003, our ten largest vendors accounted for
approximately 67% of our inventory 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 we purchase. 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.
4
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.
OPERATIONS Hours of operations vary by location, but generally range from
8:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on
Saturdays. The distribution centers maintain uniform prices, except where lower
prices are necessary to meet local competition.
COMPETITION Most of our competition comes in the form of small,
independently-owned retailers who in most cases are also our customers. We
estimate that there are several hundred of these small independent stores in the
United States and Canada. We compete on price, availability of merchandise, and
delivery time. While there is competition in connection with certain products,
to our knowledge there is no direct competition affecting our entire product
line. Our size relative to most competitors creates an advantage in our ability
to stock a full range of products as well as in volume purchasing.
DISTRIBUTION The Leather Factory distribution centers receive the majority
of their inventory from our central warehouse located in Fort Worth, Texas,
although occasionally, merchandise is shipped directly from the vendor.
Inventory is shipped to the distribution centers from our central warehouse once
a week to meet customer demand without sacrificing inventory turns. Customer
orders are filled as received, and we do not have backlogs.
We attempt to maintain the optimum number of items in our product line to
minimize out-of-stock situations against carrying costs involved with such an
inventory level. We generally maintain higher inventories of certain imported
items to ensure a continuous supply. The number of products offered through the
various distribution channels changes every year due to the introduction of new
items and the discontinuance of others. We carry approximately 2,800 items in
the current lines of leather and leather-related merchandise. In most cases,
all 2,800 items are offered in both the Leather Factory distribution centers and
the Tandy Leather retail stores.
EXPANSION Leather Factory's expansion across the United States has been
fairly consistent since we purchased the original six distribution centers in
1985. The newest center opened in August 2002, bringing the number of
distribution centers to thirty. While we do not believe there is a significant
and immediate opportunity for expansion of the Leather Factory distribution
system in terms of opening additional locations, we do believe expansion could
be achieved by acquiring companies in related areas/markets which offer
synergistic aspects based on the local markets and/or the product lines of the
businesses.
TANDY LEATHER OPERATING SEGMENT
Tandy Leather Company, established in 1919 as Hinkley-Tandy Leather Company, is
the oldest and best-known supplier of leather and related supplies used in the
leathercraft industry. We offer a product line of quality tools, leather,
accessories, kits and teaching materials via a chain of retail stores located
throughout the United States. This segment had net sales of $9.2 million, $7.4
million, and $6.6 million for 2003, 2002 and 2001, respectively.
GENERAL The Tandy Leather retail chain currently has 29 stores (as of March
15, 2004) located in 22 states with plans to reach 100 stores as opportunities
arise over the next five years or so. The stores range in size from 1,200
square feet to 3,800 square feet, with the average size of a store being
approximately 2,000 square feet. The type of premises utilized for a Tandy
Leather store is generally an older strip shopping center located at well-known
crossroads, making the store easy to find. Our products are sold in Canada
through the three Leather Factory stores located there.
5
BUSINESS STRATEGY Tandy Leather has long been known for its reputation in
the leathercraft industry and its commitment to the furthering of the craft
through education and customer development. We are committed to this strategy
as evidenced by our re-establishment of the retail store chain throughout the
United States following the 2000 acquisition. 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 stores.
The retail stores serve walk-in, mail and phone order customers as well as
orders generated from its website, www.tandyleather.com. Tandy Leather stores
are staffed by knowledgeable sales people whose compensation is based, in part,
upon the profitability of their store. Sales by Tandy Leather are driven
through the efforts of the store staff, trade shows, and our direct mail and
e-mail marketing program.
CUSTOMERS Individual retail customers are our largest customer group,
representing more than 70% of Tandy Leather's 2003 sales. Youth groups, summer
camps, schools, and a limited number of 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 fill these orders. Tandy Leather's retail store operations historically
generate slightly more sales in the 4th quarter of each year (30-35%) while the
other three quarters remain fairly even.
MERCHANDISE Our products are generally organized into thirteen categories.
We carry a wide assortment of products including leather, hand tools, kits, dyes
& finishes, and stamping tools.
During 2003, sales at the Tandy Leather stores by product category were as
follows:
PRODUCT CATEGORY SALES MIX PRODUCT CATEGORY SALES MIX
- ----------------------- ---------- ---------------- ----------
Belts strips and straps 5% Hand tools 16%
Books, patterns, videos 3% Hardware 4%
Buckles 2% Kits 15%
Conchos 3% Lace 5%
Craft supplies 5% Leather 28%
Tools and Hardware 1% Stamping tools 6%
Dyes, finishes, glues 7% TOTAL 100%
Many of the products sold in our Tandy Leather stores are also sold by our
Leather Factory segment. Therefore, the discussion above regarding Leather
Factory products, their sources and the working capital requirements for that
segment also apply to the Tandy Leather stores. Retail sales at Tandy Leather
stores are generally cash transactions or through national credit cards. We do
sell on open account to selected wholesale customers including schools and other
institutions and small retailers. Our terms are generally net 30 days. Like
Leather Factory, Tandy Leather has an unconditional return policy.
OPERATIONS Hours of operations vary by location, but generally range from
9:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on
Saturdays. In addition, most of the stores stay open late one night a week for
leathercrafting classes taught in the stores. Selling prices are uniform
throughout the Tandy Leather store system.
COMPETITION Our competitors are generally small local craft stores that
carry a limited line of leathercraft products. Several national retail chains
that are customers of The Leather Factory also carry leathercraft products on a
very small scale relative to their overall product line. To our knowledge, our
retail store chain is the only one in existence solely specializing in
leathercraft.
DISTRIBUTION The Tandy Leather stores receive their inventory from the
Leather Factory central warehouse located in Fort Worth, Texas. The stores
generally restock their inventory once a week with a shipment from the
warehouse. Tandy Leather's inventory turns are higher than Leather Factory's
because the Leather Factory calculation includes its warehouse inventory whereas
Tandy Leather's calculation is based strictly on its stores.
EXPANSION The Company intends to expand the Tandy Leather retail store chain
to 100 stores throughout the United States at an average rate of approximately
twelve stores per year. Fourteen stores were opened in 2002; twelve stores were
opened in 2003. Six of the 26 stores opened through 2003 were independent
leathercraft stores that we acquired. Separately, these acquisitions are not
material. The other twenty stores have been de novo stores opened by us.
Management's plans for 2004 are to open 10-15 retail stores. Three new stores
opened in the first two months of 2004.
6
ROBERTS, CUSHMAN OPERATING SEGMENT
Roberts, Cushman, founded in 1856, produces made-to-order trimmings for the
headwear industry. This segment had net sales of $1.8 million, $2.0 million,
and $1.9 million for 2003, 2002 and 2001, respectively.
BUSINESS STRATEGY Roberts, Cushman has long been considered one of the
leaders in the field of headwear trimmings. It designs and manufactures
exclusive trimmings for all types of hats. Trims are sold to hat manufacturers
directly. We do not employ an outside sales force. Instead, customers visit our
facilities in New York and, with an on-site designer, incorporate their ideas
into a customized product. The customer is provided samples or photographs of
each design before they leave the premises. These samples can then be used as a
sales tool to obtain hat orders from their customers. This "design-on-site"
process is unique in the industry.
CUSTOMERS We design and manufacture trims for over 75 of the headwear
manufacturers worldwide, supplying customized trims, 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. Our backlog of in-house orders from
customers as of March 10, 2004 was $315,000, which approximates forty-five to
sixty days of sales. Roberts, Cushman's sales generally do not reflect
significant seasonal patterns.
The working capital requirements of this segment are dictated by the amounts
needed to meet current obligations, purchase raw material and allow for
collection of accounts receivable. Roberts, Cushman provides sufficient cash
flow to satisfy these requirements.
MERCHANDISE Our hat bands are generally produced from leather, ribbon, or
woven fabrics, depending on the style of hat. They are created by cutting
leather and/or other materials into strips, and then enhancing the trim by
attaching conchos and/or three-piece buckle sets, braiding with other materials,
and finishing the end or borders by stitching or by lacing with leather lace.
We also supply custom-designed buckles and conchos, feathers for dress hats, and
name pins, separate from hat bands. Roberts, Cushman purchases components from
over 25 vendors, located predominately in the United States. In 2003, our top
10 vendors (in dollars purchased) represented approximately 40% of its total
purchases. Products are sold on terms that generally range from net 30 to net
90 days. Because our products are custom-designed, we do not accept product
returns, except in the case of defective merchandise.
EXPANSION Cushman has been successful providing a very specific product line
directly to headwear manufacturers. Given the current industry conditions, we
do not believe there is much potential for expansion, other than to capture
additional market share. We have considered the possibility of expanding
production to other leather products, but have concluded that is not feasible at
present.
ADDITIONAL INFORMATION
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, 2003, the Company employed 330 people, with 304
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.
INTELLECTUAL PROPERTY We hold approximately twenty registered trademarks,
including federal trade name registrations for "The Leather Factory" and "Tandy
Leather Company". The trademarks expire at various times through 2012, but can
be renewed indefinitely. We hold approximately 500 copyrights covering over 600
registered works, applicable to various products. These begin expiring in 2062.
We also hold patents on several belt buckles and leather-working equipment that
expire in 2011. These rights are valuable assets and we defend them as
necessary.
7
INTERNATIONAL OPERATIONS Information regarding our revenues from the United
States and abroad and our long-lived assets are found in Note 11 to our
Consolidated Financial Statements, Segment Information.
OUR WEBSITE AND AVAILABILITY OF SEC REPORTS We file reports with the
Securities and Exchange Commission ("SEC"). These reports include our Annual
Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K
and any amendments to these filings. The public may read any of these filings
at the SEC's Public Reference Room at 450 Fifth Street, NW, Washington, DC
20549. In addition, the public may obtain information on the operation of the
Public Reference Room by calling the SEC at 1/800-SEC-0330. Further, the SEC
maintains an Internet site that contains reports, proxy and information
statements and other information concerning us. You can connect to this site at
http://www.sec.gov.
Our corporate website is located at http://www.leatherfactory.com. We make
copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q,
Current Reports on Form 8-K, proxy statements and any amendments filed with or
furnished to the SEC available to investors on or through our website free of
charge as soon as reasonably practicable after we electronically file them with
or furnish them to the SEC. Our SEC filings can be found on the Investor
Relations page of our website through the "SEC Filings" link. In addition,
certain other corporate governance documents are or will shortly be available on
this website through the "Corporate Governance" link.
8
EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information concerning the executive
officers of the Company.
NAME AND AGE POSITION AND BUSINESS EXPERIENCE SERVED AS
DURING PAST FIVE YEARS OFFICER SINCE
J. Wray Thompson, 72 Chief Executive Officer. President
from June 1993 to January 2001. 1993
Ronald C. Morgan, 56 President since January 2001. Chief
Operating Officer 1993
Robin L. Morgan, 53 Vice President of Administration 1993
Shannon L. Greene, 38 Chief Financial Officer since May 2000.
Controller from January 1998 to May 2000.
Assistant Controller from September 1997 to
January 1998. 2000
WRAY THOMPSON has served as our Chairman of the Board and Chief Executive
Officer since June 1993. He also served as President from June 1993 to January
2001. Mr. Thompson was a co-founder of the company.
SHANNON L. GREENE has served as our Chief Financial Officer and Treasurer since
May 2000. She was appointed to serve on the Board of Directors in January 2001.
Ms. Greene is also our chief accounting officer. From September 1997 to May
2000, Ms. Greene served as our controller and assistant controller. Ms. Greene
also is a member of the company's Employees' Stock Ownership Plan (ESOP)
Committee and is a certified public accountant. Her professional affiliations
include the American Institute of Certified Public Accountants, the Texas
Society of Certified Public Accountants and its Fort Worth chapter, the Fort
Worth Association for Financial Professionals, and the National Investor
Relations Institute.
ROBIN L. MORGAN has served as our Vice President of Administration and Assistant
Secretary since June 1993. Ms. Morgan is responsible for import, banking, and
procurement for our import product lines and maintains all inventory costs. She
also administers special projects, employee benefit plans, and insurance
programs. Ms. Morgan also serves as chairman of the Company's ESOP committee.
Ms. Morgan is married to Ronald C. Morgan, the Company's President.
RONALD C. MORGAN has served as our President since January 2001 and has served
as Chief Operating Officer and director since June 1993. Mr. Morgan was also a
co-founder of the company. Mr. Morgan is married to Robin L. Morgan, the
Company's Vice President.
All officers are elected annually by the Board of Directors to serve for the
ensuing year.
Under our 1995 Stock Option Plan, there were 60,000 unoptioned shares on January
1, 2003 and no unoptioned shares at December 31, 2003. Under our 1995 Director
Non-qualified Stock Option plan, there were 46,000 unoptioned shares on January
1, 2003 and 40,000 unoptioned shares at December 31, 2003. There were no
changes to the exercise prices of the outstanding options under these two plans
during 2003.
9
ITEM 2. PROPERTIES
The Company leases all of its premises. The Company believes that all of its
properties are adequately covered by insurance. The Company's Fort Worth
location includes the Fort Worth Leather Factory distribution center, 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 $5,376 per year.
This lease will expire in October 2005. Roberts, Cushman's facility is located
in Long Island City, New York and leased for $85,000 per year. This lease will
expire in June 2006.
LEATHER TANDY LEATHER TANDY
STATE FACTORY LEATHER STATE FACTORY LEATHER
- ----- ------- ------- ----- ------- -------
Arizona 2 1 Missouri 1 2
California 3 2 Montana 1 -
Colorado 1 1 Nebraska - 1
Connecticut - 1 Nevada - 2
Florida 1 1 New Mexico 1 1
Georgia - 1 New York - 1
Idaho - 1 North Carolina 1 -
Illinois 1 1 Ohio 1 -
Indiana - 1 Oklahoma 0 2
Iowa 1 - Oregon 1 -
Kansas 1 - Pennsylvania 1 1
Louisiana 1 - Tennessee 1 1
Maryland - 1 Texas 5 3
Michigan 1 - Utah 1 1
Minnesota - 1 Washington 1 2
CANADIAN LOCATIONS: LEATHER FACTORY TANDY LEATHER
- ------------------- --------------- -------------
Alberta 1 -
Manitoba 1 -
Ontario 1 -
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, 2003.
10
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:
2003 2002
-------------- --------------
QUARTER ENDED HIGH LOW HIGH LOW
- ------------- ---- --- ---- ---
March 31 $3.450 $2.800 $3.850 $2.010
June 30 $3.420 $2.900 $3.500 $2.850
September 30 $4.580 $3.250 $3.240 $2.450
December 31 $4.850 $3.970 $3.500 $2.800
There were approximately 625 stockholders of record on March 10, 2004.
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 Bank, 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.
The following table sets forth information regarding our equity compensation
plans (including individual compensation arrangements) that authorize the
issuance of shares of our common stock. The information is aggregated in two
categories: plans previously approved by our stockholders and plans not
approved by our stockholders. The table includes information for officers,
directors, employees and non-employees. All information is as of December 31,
2003.
COLUMN (A) COLUMN (B) COLUMN (C)
PLAN CATEGORY NUMBER OF SECURITIES TO BE WEIGHTED-AVERAGE NUMBER OF SECURITIES
ISSUED UPON EXERCISE OF EXERCISE PRICE OF AVAILABLE FOR FUTURE ISSUANCE UNDER
OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, EQUITY COMPENSATION PLANS (EXCLUDING
WARRANTS AND RIGHTS WARRANTS AND RIGHTS SECURITIES REFLECTED IN COLUMN (A)
-------------------------- -------------------- -------------------------------------
Equity compensation plans
approved by stockholders 775,200 $ 1.74 40,000
Equity compensation plans not
approved by stockholders - - -
-------------------------- -------------------- -------------------------------------
TOTAL 775,200 $ 1.74 40,000
========================== ==================== =====================================
For additional information, see Note 8 to our Consolidated Financial Statements,
Stockholders' Equity.
On August 4, 2003, we issued 200,000 shares of our common stock to the Schlinger
Foundation of Santa Ynez, California pursuant to the exercise of warrants
originally issued in 1998 in connection with a consulting agreement entered into
with Evert I. Schlinger. The exercise price of the warrants was $0.4375 per
share or $87,500. We added the exercise payment to our working capital.
We believe that the issuance of these shares was exempt from the registration
requirements of the Securities Act of 1933 pursuant to Section 4(2) of that act.
Mr. Schlinger signed an agreement in 1998 acknowledging that the shares issued
upon exercise of the warrants would not be registered. The stock certificate
representing the shares issued bears a restrictive legend stating that the
shares have not been registered under the Securities Act of 1933 and cannot be
transferred except pursuant to an effective registration statement filed under
that act or an exemption from the act's registration requirements.
11
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. Data in prior years has not been
restated to reflect acquisitions, if any, that occurred in subsequent years.
INCOME STATEMENT DATA Years Ended December 31,
--------------------------------------
2003 2002 2001
------------ ----------- -----------
Net sales $ 41,712,191 $39,728,615 $37,279,262
Cost of sales 19,020,292 18,393,914 17,934,935
------------ ----------- -----------
Gross profit 22,691,899 21,334,701 19,344,327
Operating expenses 18,594,240 17,202,927 15,442,359
------------ ----------- -----------
Operating income 4,097,659 4,131,774 3,901,968
Operating income per share - basic $ 0.40 $ 0.41 $ 0.39
Operating income per shares - diluted $ 0.38 $ 0.38 $ 0.37
Other expense 125,169 311,917 533,482
------------ ----------- -----------
Income (loss) before income taxes 3,972,490 3,819,857 3,368,486
Income tax provision (benefit) 1,232,116 1,224,868 1,362,053
------------ ----------- -----------
Income (loss) before cumulative effect
of change in accounting principle. 2,740,374 2,594,989 2,006,433
Cumulative effect of change in
accounting principle - (4,008,831) -
------------ ----------- -----------
Net income (loss) $ 2,740,374 $(1,413,842) $ 2,006,433
============ ============ ===========
Earnings (loss) per share $ 0.27 $(0.14) $ 0.20
Earnings (loss) per share-assuming dilution$ 0.25 $(0.13) $ 0.19
Weighted average common shares outstanding for:
Basic EPS 10,323,549 10,063,581 9,976,181
Diluted EPS 10,861,305 10,761,670 10,449,306
INCOME STATEMENT DATA Years Ended December 31,
-------------------------
2000 1999
------------ -----------
Net sales $ 30,095,264 $27,164,399
Cost of sales 15,147,547 14,907,768
------------ -----------
Gross profit 14,947,717 12,256,631
Operating expenses 11,702,633 10,346,420
------------ -----------
Operating income 3,245,084 1,910,211
Operating income per share - basic $ 0.33 $ 0.19
Operating income per shares - diluted $ 0.32 $ 0.19
Other expense 653,779 900,304
------------ -----------
Income (loss) before income taxes 2,591,305 1,009,907
Income tax provision (benefit) 1,049,985 574,851
------------ -----------
Income (loss) before cumulative effect
of change in accounting principle. 1,541,320 435,056
Cumulative effect of change in
accounting principle - -
------------ -----------
Net income (loss) $ 1,541,320 $ 435,056
============ ===========
Earnings (loss) per share $ 0.16 $ 0.04
Earnings (loss) per share-assuming dilution$ 0.15 $ 0.04
Weighted average common shares outstanding for:
Basic EPS 9,875,606 9,853,161
Diluted EPS 10,182,803 9,890,098
BALANCE SHEET DATA As of December 31,
2003 2002 2001 2000 1999
----------- ----------- ----------- ----------- -----------
Total assets $19,058,406 $19,675,602 $19,548,323 $19,686,079 $18,220,775
Notes payable and current
maturities of long term debt 1,134 4,218,968 4,527,904 5,759,626 6,061,735
Notes payable and long-term debt,
net of current maturities 1,792,984 2,256 7,691 13,025 121,686
Total Stockholders' Equity $14,509,493 $11,170,062 $12,423,671 $10,295,637 $ 8,680,425
12
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
We intend for the following discussion to provide you with information that will
assist you in understanding our financial statements, the changes in certain key
items in those financial statements from year to year, and the primary factors
that accounted for those changes, as well as how certain accounting principles
affect our financial statements. This discussion also provides information
about the financial results of the various segments of our business so you may
better understand how those segments and their results affect the financial
condition and results of operations of the Company as a whole. Finally, we have
identified and discussed trends known to management that we believe are likely
to have a material effect.
This discussion should be read in conjunction with our financial statements as
of December 31, 2003 and 2002 and the three years then ended and the notes
accompanying those financial statements. You are also urged to consider the
information under the caption "Summary of Critical Accounting Policies."
SUMMARY
The Leather Factory, Inc. and its subsidiaries is the world's largest specialty
retailer and wholesale distributor of leather and leathercraft-related items.
Our operations are centered on operating retail stores and warehouse
distribution centers. We have built our business by offering our customers
quality products in one location at competitive prices. The key to our success
is our ability to grow our base business. We grow that business by opening new
locations and by increasing sales in our existing locations. We intend to
continue to expand both domestically, in the short-term, and internationally, in
the long-term.
We operate in three segments. First, our Leather Factory warehouse distribution
centers are the largest source of revenues ($30.7 million in 2003). The Leather
Factory centers have generally offered steady but modest increases in sales.
Sales in 2003 grew slightly more than 1% from 2002, which did not meet our
target of annual sales growth of 2% to 4%. We attribute this shortfall to a
decrease in sales to national accounts at the end of 2003. We believe that this
drop reflects a temporary re-assessment of the mix of goods purchased by these
customers and that sales volume to these customers will increase in 2004.
Since acquiring its assets in 2000, we have focused on re-establishing Tandy
Leather, our second segment, as the operator of retail leathercraft stores.
Because of growth here, this segment has experienced the greatest increases in
sales ($9.2 million in 2003, up from $7.4 million in 2002). Our business plan
calls for opening an average of 12 stores annually as we work toward a goal of
100 stores from 26 stores at the end of 2003.
Our third segment is Roberts, Cushman, a manufacturer of trimmings for headwear.
Its operations are not material to the Company. In 2002, we wrote off the
goodwill related to our investment in Roberts, Cushman in connection with an
accounting change.
On a consolidated basis, a key indicator of costs, gross margin as a percent of
total net sales, increased in 2002 and again in 2003, reflecting a number of
factors including more retail sales with higher profit margins. However,
opening additional Tandy Leather stores and more dollars spent on advertising in
2003 resulted in an 1.3% increase in operating expenses as a percent of total
net sales in 2003. Operating expenses also were up 1.9% as a percentage of
total net sales in 2002 when compared with 2001. In 2004, we will be working to
manage these costs in the hope of reversing this trend.
We reported consolidated net income for 2003 of $2.7 million. In 2001, we
reported a consolidated net income of 2.0 million, but an accounting change in
2002 resulted in a net loss of $1.4 million for that year. We have used our
cash flow to fund our operations, to fund the opening of new Tandy Leather
stores and to reduce our bank debt. In 2003, we reduced our bank debt by $2.4
million, and, at the end of 2003, our stockholders' equity had increased to
$14.5 million from $11.2 million the previous year.
13
Comparing the December 31, 2003 balance sheet with the prior year's, we
decreased our investments in inventory ($11.1 million from $12.7 million) and
accounts receivable ($1.8 million from $1.9 million), while total cash increased
to $1.7 million from $655,000. In addition to cash on hand, we have a $5
million bank line of credit, of which $1.8 million was drawn on December 31,
2003.
NET SALES
Net sales for the three years ended December 31, 2003 were as follows:
Total Company Increase
Year Leather Factory Tandy Leather Cushman Total Company from Prior Year
- ---- ---------------- -------------- ---------- -------------- -----------------------
2003 $ 30,684,092 $ 9,216,838 $1,811,261 $ 41,712,191 5.0%
2002 30,313,478 7,387,874 2,027,263 39,728,615 6.6%
2001 28,711,006 6,606,090 1,962,166 37,279,262 23.9%
Our net sales grew by 5% in 2003 when compared with 2002. That increase
resulted primarily from our Tandy Leather expansion program. The net sales
increase of 6.6% in 2002, when compared with 2001, resulted primarily from solid
sales gains in the retail market in both Leather Factory and Tandy Leather
operations.
COSTS AND EXPENSES
In general, our gross profit as a percentage of sales (our "gross margin")
fluctuates based on the mix of customers we serve, the mix of product we sell,
and our ability to source product globally. Our negotiations with suppliers for
lower pricing is an on-going process and we have varying degrees of success in
those endeavors. Sales to retail customers tend to produce higher gross margins
than sales to wholesale customers due to the difference in pricing levels.
Therefore, as retail sales increase in the overall sales mix, higher gross
margins tend to follow. Finally, there is significant fluctuation in gross
margins between the various merchandise categories we offer. As a result, our
gross margins can vary depending on the mix of products sold during any given
time period.
For 2003, our cost of sales decreased as a percentage of total net sales when
compared to 2002, resulting in an overall increase of 0.7% in the Company's
gross margin from 53.7% in 2002 to 54.4% in 2003.
Similarly, our total cost of sales as a percentage of our total net sales had
decreased for 2002 when compared to 2001 resulting in an overall increase in
gross margin of 1.8% from 51.9% for 2001 to 53.7% in 2002. These increases in
gross margin were primarily due to increased retail sales over the three years.
Our gross margins for the three years ended December 31, 2003 were as follows:
Year Leather Factory Tandy Leather Cushman Total Company
- ---- ---------------- -------------- -------- --------------
2003 53.23% 62.98% 30.62% 54.40%
2002 53.56% 59.49% 34.64% 53.70%
2001 52.50% 56.14% 28.61% 51.89%
Our operating expenses increased 1.3% as a percentage of total net sales to
44.6% in 2003 when compared with 43.3% in 2002. This increase was primarily due
to operating costs associated with the twelve Tandy stores opened in 2003 as
well as an increase in advertising expenses and investor relation expenses.
Management believes that our advertising efforts - particularly our direct mail
campaigns - are effective at increasing sales. With increased interest from
customers and potential customers as we open stores in new markets, the number
of direct mail pieces produced and distributed increases. As our focus on the
retail customer continues to increase, we are producing more colorful mailing
pieces. While we are monitoring our advertising costs with great scrutiny,
management believes that the trend of increased advertising and marketing costs
could continue for at least the near future.
14
Our investor relation expenses, while necessary to inform investors about our
company, can fluctuate greatly. In 2003, expenditures were approximately
$350,000. While we have generated positive responses from investors during the
past year, management believes that, with a more focused approach, we can
continue to perform this necessary service at a lesser cost to the Company, and
we will be monitoring this expense category very closely in 2004. However, the
effects of the changes in securities regulation and corporate governance brought
about by recent legislation and rule-making by the SEC and the American Stock
Exchange may add to these costs in 2004.
For 2002, operating expenses increased 1.9% as a percentage of total net sales
to 43.3% in 2002 when compared with 2001. This increase was primarily due to
increases in payroll and payroll-related costs including employee insurance
programs, advertising expenses, and the operating costs associated with the
fourteen Tandy stores opened in 2002.
OTHER EXPENSES (NET)
Other expenses (net), which consists primarily of interest expense and currency
exchange gain and loss, was $125,000 in 2003 compared to $312,000 in 2002, a
decrease of approximately 60%. Our interest expense continues to decrease due
to the reduction in our outstanding bank debt. The currency exchange gain and
loss, resulting from our Canadian operation, was a gain of $102,000 in 2003
compared to a gain of $10,000 in 2002.
In 2002, other expenses (net) was $312,000 in 2002 compared to $533,000 in 2001,
a decrease of approximately 40%. This 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 from $4.9 million in 2001 to $3.6 million in 2002.
NET INCOME
During 2003, we earned net income of $2.74 million, a substantial increase over
our net loss of $1.4 million for 2002. (As discussed in previous filings, a new
accounting pronouncement required us to record a $4.0 charge against earnings as
a result of the write-off of the goodwill of Roberts, Cushman in 2002, resulting
in a net loss. This charge was reported as a cumulative effect of a change in
accounting principle. Net income before the change was $2.6 million.) As a
result of the increase in our overall gross margin and a reduction in interest
and other expenses, our profits in 2003 grew at a rate faster than sales.
Partially offsetting gross margin and other expense improvements were increased
operating expenses in 2003 as discussed above.
In 2002, we incurred a net loss of $1.4 million due to the write-off of Roberts,
Cushman's goodwill mentioned above, compared to net income of $2.0 million in
2001. Our 2002 net income (before the cumulative effect of the accounting
change) also increased at a faster rate than 2002 total net sales growth. This
was the result of the increase in our overall gross margin and a substantial
reduction in our interest expense, partially offset by an increase in operating
expenses in 2002 as discussed above.
LEATHER FACTORY SEGMENT
Segment Net Sales Segment Segment Operating Income
Year Increase from Prior Yr Operating Income Incr (Decr) from Prior Year
- ---- ------------------------- ---------------- ---------------------------
2003 1.2% $ 3,462,457 (7.5)%
2002 5.6% $ 3,742,844 0.6%
2001 6.1% $ 3,719,517 24.3%
Operating Income as a
Year Percentage of Segment Sales
- ---- ---------------------------
2003 11.3%
2002 12.3%
2001 12.9%
The Leather Factory segment accounted for 73.5% of total Company net sales in
2003, which compares to 76.3% in 2002 and 77.0% in 2001. The decrease in
Leather Factory's contribution to our total net sales is the result of the
growth in the Tandy Leather segment and we expect this trend to continue.
15
The segment net sales increase in 2003 resulted from an increase in retail sales
partially offset by a drop in sales to our national accounts. Sales to retail
customers were up approximately 20% over 2002 due to increased advertising
efforts to that customer group. Several of the larger customers in our national
account group re-set their programs with us during the last half of 2003, a
normal part of doing business with these customers. We believe that this
decrease is temporary and will not have a long-term effect on our sales for this
customer group.
Our sales mix by customer group for 2003 was as follows:
CUSTOMER GROUP
- -----------------
Retail 23%
Institution 8%
Wholesale 42%
National Accounts 20%
Manufacturers 7%
-----
100%
=====
The 2003 decrease in operating income as a percentage of segment sales resulted
from a 0.33% decrease in gross margin (as a percentage of sales) and an increase
of 0.72% in operating expenses (as a percentage of sales) compared with 2002.
The gross margin decline was driven primarily by an increase in the quantities
of leather sold during the year. Given that leather is our lowest gross margin
item, an increase in leather sales, all other factors being equal, will result
in a lower overall gross margin. Our freight costs (shipping merchandise from
vendors to us) were up in 2003 as well due an increase in the number of air
shipments versus ocean shipments. The operating expense increase as a percent
of sales in 2003 was higher than 2002. Advertising and marketing costs are a
significant expense in our operation as we believe there is a direct correlation
between how much we advertise and how much product we sell. Our increase in
investor outreach programs in 2003 also contributed to the decline in operating
income this year. As our largest segment, Leather Factory bears the majority of
the pro rata allocation of corporate expenses.
An increase in gross margin partially offset by an increase in operating
expenses resulted in the slight increase in operating income as a percentage of
segment sales in 2002 when compared to 2001. The gross margin improvement was
the result of the increase in retail sales for the year. Segment expenses in
2002 as a percent of sales were higher than 2001 due to an increase in personnel
costs (wages and health insurance) as well as additional advertising expenses.
TANDY LEATHER SEGMENT
Segment Net Sales Segment Segment Operating Income
Year Increase from Prior Yr Operating Income Incr (Decr) from Prior Year
- ---- ------------------------- ---------------- ---------------------------
2003 24.7% $ 604,291 62.7%
2002 11.8% $ 371,372 31.7%
2001 N/A* $ 281,998 N/A*
Operating Income as a
Year Percentage of Segment Sales
- ---- ---------------------------
2003 6.6%
2002 5.0%
2001 4.3%
________________________
*Comparison to prior year is meaningless. Because Tandy was acquired by the Company in November 2000, there is only one month of
data for that year.
Reflecting the growth previously discussed, the Tandy Leather segment accounted
for 22.1% of total Company net sales in 2003, up from 18.6% in 2002 and 17.7%
in 2001.
Growth in net sales for the Tandy Leather segment in 2003 and 2002 resulted
primarily from our expansion program. Segment expansion during 2003 and 2002
consisted of the opening of 12 and 14 new stores, respectively. The 2002
expansion was partially offset by the closing of the central mail order
operation in September of that year.
Our sales mix by customer group for 2003 was as follows:
CUSTOMER GROUP
- -----------------
Retail 72%
Institution 6%
Wholesale 21%
National Accounts 0%
Manufacturers 1%
----
100%
====
16
Operating income as a percentage of sales increased in 2003 when compared to
2002. Segment gross margin increased from 59.5% in 2002 to 63.0% in 2003 due to
increased retail sales and more efficient purchasing of product from vendors.
Segment operating expenses as a percent of sales increased by 1.95% in 2003.
Expanded advertising initiatives and rent for store space accounted for the
operating expense increase, offset partially by a decrease in costs to ship
merchandise to customers. The decrease in shipping is a result of the store
expansion as more sales occur in the stores as compared to ordering via mail,
phone or the Internet.
Segment gross margin as a percent of sales increased by 3.4% in 2002 over 2001
while operating expenses as a percent of sales increased 2.6%. The comparison
between 2002 and 2001 is somewhat convoluted as this segment operated solely as
a central mail order operation in 2001 but began opening retail stores in 2002
and closed the central mail order operation in September 2002. The opening
expenses associated with the new stores as well as new advertising programs
contributed to the increase in operating expenses in 2002 but was offset
somewhat with reductions in shipping costs and central facility operation and
maintenance costs.
We intend to continue the expansion of Tandy Leather's retail store chain in
2004 by opening a total of 10-15 new stores throughout the year. As of March 1,
2004, we have opened three stores in 2004: the Syracuse, NY and Minneapolis, MN
stores opened in January, and the St. Louis, MO store opened in February. We
remain committed to a conservative expansion plan for this segment that
minimizes risks to the Company's profits and maintains financial stability.
CUSHMAN SEGMENT
Segment Net Sales Segment Operating Segment Operating Income
Year Increase from Prior Yr Income (Loss) Incr (Decr) from Prior Year
- ---- ------------------------- ---------------- ---------------------------
2003 (10.6)% $ 30,911 76.1%
2002 3.3% $ 17,558 117.6%
2001 (20.2)% $ (99,547) (133.5)%
Operating Income as a
Year Percentage of Segment Sales
- ---- ---------------------------
2003 1.7%
2002 0.9%
2001 (5.1)%
The Cushman segment accounted for 4.4% of the total Company sales in 2003
compared with 5.1% and 5.3% in 2002 and 2001, respectively.
The 2003 decrease in Cushman's net sales resulted from the continued slowdown in
the headwear industry overall. Several of Cushman's customers (hat
manufacturers) are on shortened work weeks due to the decline in orders.
Segment gross margin as a percentage of sales decreased 4.0% from 2002.
However, operating income improved modestly.
For 2002, Cushman's sales were up modestly (3.3%) while gross profit margins
increased from 28.6% to 34.6%. 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.
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.
The sales and profits from the Cushman segment are immaterial to our company as
a whole, and the segment does not fit our business model for the future. We are
still assessing our long term strategic options for this segment.
FINANCIAL CONDITION
At December 31, 2002, we held $655,000 of cash, $12.7 million of inventory,
accounts receivable of $1.9 million, and $2.0 million of property and equipment.
Goodwill and other intangibles (net of amortization and depreciation) were
$686,000 and $483,000, respectively. We also own a leather artwork collection,
most of which was created by Al Stohlman, a legendary leathercrafter, valued on
our balance sheet at $250,000. 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 was $11.2 million.
17
At December 31, 2003, our net total assets were $19.1 million. We held $11.1
million of inventory and $1.9 million of property and equipment. Our cash
totaled $1.7 million and our receivables were $1.8 million. Current liabilities
were $2.5 million, while our long-term debt was $1.8 million. Total
stockholders' equity at the end of 2003 had increased to $14.5 million,
primarily as a result of the $2.7 million net income recorded in 2003. The
increase in cash from 2002 to 2003 was due primarily to the increase in cash
sales at Tandy Leather (as opposed to sales on open account), as well as the
decrease in cash tied up in inventory owned at the end of 2003 compared to 2002.
While we have no required payment schedule prior to maturity on our revolving
line of credit, management strives to apply as much available cash as possible
to our outstanding debt balance. Generally speaking, the majority of cash on
our balance sheet is funds held in depository accounts with various banks
awaiting collectibility for transfer either to our operating account or to the
line of credit.
Also at the end of 2003, the Company's ratio of debt to equity was 0.12%. Our
ratio of current assets to current liabilities was 6.16 to 1 at the end of 2003,
and 1.94 to 1 at the end of 2002. The significant improvement in the current
ratio is due to the reclassification of our bank debt from current to long-term.
This reclassification occurred as a result of the elimination of the restricted
cash requirement in our new credit agreement with Wells Fargo Bank, N.A. that
went into effect in November 2003 (discussed below).
CAPITAL RESOURCES AND LIQUIDITY
On November 3, 2003, the Company entered into a Credit and Security Agreement
with Wells Fargo Bank, N.A. ("Wells Fargo"), which replaced a line of credit
with another bank affiliated with Wells Fargo. The current facility matures
in November 2005 and is secured by all assets of the Company. Also, in November
2003, we opted to reduce the maximum amount that may be borrowed under this line
of credit to $5.0 million, thus reducing fees on the un-borrowed portion of the
credit line.
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 to the Consolidated Financial Statements,
Notes Payable and Long-Term Debt.
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. '02 1ST QTR. '03 2ND QTR. '03 3RD QTR. '03 4TH QTR. '03
- ------------ ------------ ------------ ------------ ------------
$4,213,533 $5,810,598 $4,763,734 $2,669,116 $1,792,984
Total bank indebtedness at the end of 2002 and 2003 are shown below:
DECEMBER 31,
2002 2003
------------------------------- -------------------------------
PRINCIPAL ACCRUED INTEREST PRINCIPAL ACCRUED INTEREST
- -------------- ------------- ---------------- ------------- ----------------
Revolving Line $ 4,213,533 $ 15,706 $ 1,792,984 $6,374
=========== ========== =========== ======
Reflecting the reduction of bank indebtedness during the period, our financing
activities for 2003, 2002 and 2001 had net cash requirements (deficits) of $1.3
million, $214,000 and $1.2 million, respectively.
The primary source of liquidity and capital resources during 2003 was cash flow
provided by operating activities. Cash flow from operations for 2003 was $3.3
million. The largest portion of the operating cash flow was generated from net
income and the reduction of inventory. Cash flow from operations in 2002 was
$1.4 million, reflecting a larger investment in inventory in 2002 than in 2003.
Cash flow from operations in 2001 was $2.0 million.
18
Consolidated accounts receivable decreased to $1.8 million at December 31, 2003
compared to $1.9 million at December 31, 2002. Average days to collect accounts
improved from 43.54 days in 2002 to 41.46 days in 2003 on a consolidated basis.
By segment, the days to collect were as follows:
SEGMENT 2003 2002 IMPROVEMENT
- --------------- ----- ----- -----------
Leather Factory 39.43 41.52 2.09 days
Tandy Leather 38.88 34.09 (4.79) days
Cushman 58.37 63.26 4.89 days
Inventory decreased from $12.7 million at the end of 2002 to $11.1 million at
December 31, 2003. We expect our inventory will begin to slowly trend upward as
we continue our expansion of the Tandy Leather store chain. However, we are
pleased with our reduced investment in inventory at the end of 2003 as it was
within 3% of our internal targets of optimum inventory levels. We intend to
continue managing our inventory levels to avoid tying up excessive capital.
Consolidated inventory turned 3.51 times during 2003, a slight slowdown from the
3.65 times turned in 2002. We compute our inventory turnover rates as sales
divided by average inventory.
By segment, inventory turns are as follows:
SEGMENT 2003 2002
- ------------------------------------------- ---- ----
Leather Factory 2.97 3.20
Tandy Leather 8.69 8.10
Cushman 3.71 4.12
Leather Factory - distribution centers only 8.26 7.96
Tandy Leather's inventory turns are significantly higher than that of the
Leather Factory because its inventory consists only of the inventory at the
stores. Tandy Leather has no warehouse (backstock) inventory to include in the
turnover computation as the stores get their product from the Leather Factory
central warehouse. Leather Factory's turns are always slower because the
central warehouse inventory supports the stores and distribution centers.
Accounts payable was virtually unchanged from the end of 2002 at $1.5 million to
the end of 2003 at $1.6 million.
As shown above, the largest use of operating cash in 2003 was for debt
reduction. Capital expenditures totaled $360,000 and $1.0 million for the years
ended December 31, 2003 and 2002, respectively. The 2003 capital expenditures
occurred primarily due to the expansion of the Tandy Leather segment and the
construction of the Stohlman Leather Museum and Gallery located at our Fort
Worth corporate complex. 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. Also in
2002, we made expenditures of $436,000 to purchase four independent leathercraft
stores for conversion to Tandy Leather stores. Since we intend to continue
opening or acquiring new Tandy Leather stores, expenditures related to this
expansion should continue into 2004. In 2001, we recorded capital expenditures
of $630,000 for computer equipment and software, and other equipment needed
after the acquisition of Tandy Leather.
We believe that cash flow from operations will be adequate to fund our
operations in 2004, while also funding expansion and debt reduction. In
addition, we anticipate that this cash flow will enable us to meet the
contractual obligations and commercial commitments as shown in the following
table. However, if cash flows should decrease or uses of cash increase, we may
defer debt reduction or increase our borrowings on our line of credit as needed.
We believe that, if desired, our present financial condition would permit us to
increase the maximum amount that could be borrowed from lenders. Further, we
could defer expansion plans if required by unanticipated drops in cash flow. In
particular, because of the relatively small investment required by each new
Tandy Leather store, we have flexibility in when we make most expansion
expenditures.
19
OFF-BALANCE SHEET ARRANGEMENTS
We have not had any off-balance sheet arrangements during 2003, 2002 and 2001,
and we do not currently have any such arrangements.
CONTRACTUAL OBLIGATIONS
The following table summarizes by years our contractual obligations and
commercial commitments as of December 31, 2003 (not including related interest
expense):
PAYMENTS DUE BY PERIODS
LESS THAN 1-3 4-5 AFTER
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR YEARS YEARS 5 YEARS
----------- ---------- ---------- ---- -------
LONG-TERM DEBT(1) $ 1,792,984 - $1,792,984 - -
CAPITAL LEASE OBLIGATIONS 1,134 $ 1,134 - - -
OPERATING LEASES(2) 6,748,288 1,843,650 4,371,281 533,357 -
----------- ---------- ---------- -------- -------
TOTAL CONTRACTUAL OBLIGATIONS $ 8,542,406 $1,844,784 $6,164,265 $533,357 $ -
=========== ========== ========== ======== =======
____________________
(1) Our loan from Wells Fargo matures in November 2005. 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.
(2) These are our leased facilities.
SUMMARY OF CRITICAL ACCOUNTING POLICIES
Management strives to report the financial results of the Company in a clear and
understandable manner, although in some cases accounting and disclosure rules
are complex and require us to use technical terminology. We follow generally
accepted accounting principles in the U.S. in preparing our consolidated
financial statements. These principles require us to make certain estimates and
apply judgments that affect our financial position and results of operations.
Management continually reviews its accounting policies, how they are applied and
how they are reported and disclosed in our financial statements. Following is a
summary of our more significant accounting policies and how they are applied in
preparation of the 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 are "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 on 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 2002 of our investment in
Cushman in the amount of $4.0 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, 2003, 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.
20
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:
- - We might fail to realize the anticipated benefits of the opening of Tandy
Leather retail stores or we might be unable to obtain sufficient new locations
on acceptable terms to meet our growth plans. Also, other retail initiatives
might not be successful.
- - Political considerations here and abroad could disrupt our sources of
supplies from abroad or affect the prices we pay for goods.
- - Continued involvement by the United States in war and other military
operations in the Middle East and other areas abroad could disrupt international
trade and affect 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.
- - Livestock diseases such as mad cow could reduce the availability of hides
and leathers or increase their cost. Also, the prices of hides and leathers
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.
- - 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.
21
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 11 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 5, 2004, an increase of one
percent in the prime rate would result in additional interest expense of
approximately $18,000 during a twelve-month period.
22
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
THE LEATHER FACTORY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2003 AND 2002
DECEMBER 31, DECEMBER 31,
2003 2002
------------- --------------
ASSETS
CURRENT ASSETS:
Cash $ 1,728,344 $ 101,557
Cash restricted for payment on revolving credit facility - 553,839
Accounts receivable-trade, net of allowance for doubtful accounts
of $31,000 and $78,000 in 2003 and 2002, respectively 1,828,738 1,938,698
Inventory 11,079,893 12,695,344
Prepaid income taxes 206,023 55,644
Deferred income taxes 134,312 159,090
Other current assets 702,236 672,117
------------- --------------
Total current assets 15,679,546 16,176,289
-------------- --------------
PROPERTY AND EQUIPMENT, at cost 5,574,992 5,321,749
Less accumulated depreciation and amortization (3,669,099) (3,301,898)
-------------- --------------
1,905,893 2,019,851
GOODWILL, net of accumulated amortization of $758,000 and
734,000 in 2003 and 2002, respectively 704,235 686,484
OTHER INTANGIBLES, net of accumulated amortization of
164,000 and $113,000 in 2003 and 2002, respectively 432,549 483,507
OTHER assets 336,183 309,471
-------------- --------------
$ 19,058,406 $ 19,675,602
============== ==============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable-trade $ 1,545,079 $ 1,594,909
Accrued expenses and other liabilities 1,000,427 2,503,331
Notes payable and current maturities of long-term debt 1,134 4,218,968
-------------- --------------
Total current liabilities 2,546,640 8,317,208
-------------- --------------
DEFERRED INCOME TAXES 209,289 186,076
NOTES PAYABLE AND LONG-TERM DEBT, net of current maturities 1,792,984 2,256
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, 10,487,961 and 10,149,961 shares issued
and outstanding at 2003 and 2002, respectively 25,171 24,360
Paid-in capital 4,673,158 4,163,901
Retained earnings 9,804,719 7,064,345
Less: Notes receivable-secured by common stock (20,000) (44,003)
Accumulated other comprehensive income (loss) 26,445 (38,541)
-------------- --------------
Total stockholders' equity 14,509,493 11,170,062
-------------- --------------
$ 19,058,406 $ 19,675,602
============== ==============
The accompanying notes are an integral part of these financial statements.
23
THE LEATHER FACTORY, INC.
CONSOLIDATED STATEMENTS OF INCOME
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
----------- ----------- -----------
NET SALES $41,712,191 $39,728,615 $37,279,262
COST OF SALES 19,020,292 18,393,914 17,934,935
----------- ----------- -----------
Gross Profit 22,691,899 21,334,701 19,344,327
OPERATING EXPENSES 18,594,240 17,202,927 15,442,359
----------- ----------- -----------
INCOME FROM OPERATIONS 4,097,659 4,131,774 3,901,968
OTHER (INCOME) EXPENSE:
Interest expense 206,942 246,878 458,558
Other, net (81,773) 65,039 74,924
----------- ----------- -----------
Total other expense 125,169 311,917 533,482
----------- ----------- -----------
INCOME BEFORE INCOME TAXES AND CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE 3,972,490 3,819,857 3,368,486
PROVISION FOR INCOME TAXES 1,232,116 1,224,868 1,362,053
----------- ----------- -----------
NET INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE 2,740,374 2,594,989 2,006,433
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE,
NET OF INCOME TAXES - (4,008,831) -
----------- ----------- -----------
NET INCOME (LOSS) $ 2,740,374 $(1,413,842) $ 2,006,433
=========== ============ ===========
NET INCOME (LOSS) PER COMMON SHARE - BASIC:
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE $ 0.27 $ 0.26 $ 0.20
CUMULATIVE EFFECT OF CHANGE IN ACCTG PRINCIPLE, NET OF TAX - (0.40) -
----------- ----------- -----------
$ 0.27 $ (0.14) $ 0.20
=========== ============ ===========
NET INCOME (LOSS) PER COMMON SHARE - DILUTED:
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE $ 0.25 $ 0.24 $ 0.19
CUMULATIVE EFFECT OF CHANGE IN ACCTG PRINCIPLE, NET OF TAX - (0.37) -
----------- ----------- -----------
$ 0.25 $ (0.13) $ 0.19
=========== ============ ===========
Weighted Average Number of Shares Outstanding:
Basic 10,323,549 10,063,581 9,976,181
Diluted 10,861,305 10,761,670 10,449,306
The accompanying notes are an integral part of these financial statements.
24
THE LEATHER FACTORY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOW
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
2003 2002 2001
----------- ----------- ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,740,374 $(1,413,842) $ 2,006,433
Adjustments to reconcile net income (loss) to net cash
Provided by operating activities -
Depreciation and amortization 529,262 491,312 730,153
Loss on disposal of assets (9,103) - 5,588
Amortization of deferred financing costs - 37,038 45,753
Deferred income taxes 47,991 (30,184) (8,135)
Other 47,235 (2,502) (10,898)
Cumulative effect of change in accounting principle - 4,008,831 -
Net changes in assets and liabilities, net of effect of
business acquisitions:
Accounts receivable-trade, net 109,960 359,255 (105,957)
Inventory 1,615,451 (3,463,866) 151,629
Income taxes (150,379) 16,124 (42,133)
Other current assets (30,119) (192,726) 230,695
Accounts payable-trade (49,830) 291,311 (856,314)
Accrued expenses and other liabilities (1,502,904) 1,332,179 (119,461)
----------- ----------- ------------
Total adjustments 607,564 2,846,772 20,920
----------- ----------- ------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 3,347,938 1,432,930 2,027,353
----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of property and equipment (360,202) (1,073,515) (629,773)
Payments in connection with businesses acquired - (435,747) -
Proceeds from sale of assets 6,217 - 3,200
Increase in other assets (27,970) (14,754) (1,386)
Other intangible costs - (1,625) -
----------- ----------- ------------
NET CASH USED IN INVESTING ACTIVITIES (381,955) (1,525,641) (627,959)
----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in revolving credit loans (2,420,550) (286,889) (1,150,543)
Payments on notes payable and long-term debt (6,556) (27,483) (105,189)
Decrease (increase) in cash restricted for payment on revolver 553,839 (62,110) (101,262)
Payments received on notes secured by common stock 24,003 27,936 48,400
Proceeds from issuance of common stock and warrants 510,068 133,774 84,099
----------- ----------- ------------
NET CASH USED IN FINANCING ACTIVITIES (1,339,196) (214,772) (1,224,495)
----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH 1,626,787 (307,483) 174,899
CASH, beginning of period 101,557 409,040 234,141
----------- ----------- ------------
CASH, end of period $ 1,728,344 $ 101,557 $ 409,040
=========== =========== ============
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid during the period $ 216,275 $ 213,791 $ 443,925
Income tax paid during the period, net of (refunds) 1,138,799 1,254,679 1,414,404
NON-CASH INVESTING ACTIVITIES:
Equipment acquired under capital lease financing arrangements - - $ 18,676
The accompanying notes are an integral part of these financial statements.
25
THE LEATHER FACTORY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
NUMBER OF SHARES PAR VALUE PAID-IN CAPITAL RETAINED EARNINGS
---------------- --------- --------------- -----------------
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
================ ========== ================ ==================
Comprehensive income for the year ended December 31, 2001
Payments on notes receivable-secured by common stock - - - -
Shares issued - stock options 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
================ ========== ================ ===================
Comprehensive income for the year ended December 31, 2002
Payments on notes receivable-secured by common stock - - - -
Shares issued - stock options and warrants exercised 338,000 811 442,016 -
Warrants to acquire 100,000 shares of common stock issued - - 67,241 -
Net income - - - 2,740,374
Translation adjustment - - - -
---------------- --------- --------------- ------------------
BALANCE, December 31, 2003 10,487,961 $ 25,171 $ 4,673,158 $ 9,804,719
================ ========= ================ ===================
Comprehensive income for the year ended December 31, 2003
NOTES ACCUMULATED
RECEIVABLE - OTHER
SECURED BY CUMULATIVE COMPREHENSIVE
COMMON STOCK INCOME (LOSS) TOTAL INCOME (LOSS)
------------- ------------- ----------- --------------
BALANCE, December 31, 2000 $ (120,339) $ (26,166) $10,295,637
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 $ 1,995,433
==============
Payments on notes receivable-secured by common stock 27,936 - 27,936
Shares issued - stock options 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 income for the year ended December 31, 2002 $ (1,415,319)
==============
Payments on notes receivable-secured by common stock 24,003 - 24,003
Shares issued - stock options and warrants exercised - - 442,827
Warrants to acquire 100,000 shares of common stock issued - - 67,241
Net income - - 2,740,374 $ 2,740,374
Translation adjustment - 64,986 64,986 64,986
------------- ------------- ----------- --------------
BALANCE, December 31, 2003 $ (20,000) $ 26,445 $14,509,493
============= ============= ===========
Comprehensive income for the year ended December 31, 2003 $ 2,805,360
==============
The accompanying notes are an integral part of these financial statements.
26
THE LEATHER FACTORY, INC.
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER 31, 2003, 2002, AND 2001
1. SIGNIFICANT ACCOUNTING POLICIES
(a) Business
Our primary line of business is the sale of leather, leather crafts and related
supplies. We sell our products via company-owned stores throughout the United
States and Canada. Numerous customers including retailers, wholesalers,
assemblers, distributors and other manufacturers are geographically disbursed
throughout the world. The Company also has light manufacturing facilities in
Texas and New York.
(b) Management estimates and reporting
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and reported amounts of revenues and expenses during
the periods presented. Actual results could differ from those estimates.
Significant assets and liabilities with reported amounts based on estimates
include trade accounts receivables and deferred income taxes.
(c) Principles of consolidation
The consolidated financial statements include the accounts of The Leather
Factory, Inc. and its wholly owned subsidiaries, The Leather Factory, L.P. (a
Texas limited partnership) and its corporate partners, Tandy Leather Company,
L.P. (a Texas limited partnership) and its corporate partners, Roberts, Cushman
& Company, Inc. (a New York corporation), and The Leather Factory of Canada,
Ltd. (a Canadian corporation). All intercompany accounts and transactions have
been eliminated in consolidation.
(d) 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.
(e) Revenue recognition
Retail (over the counter) sales are recorded as transactions occur and other
sales are recorded when goods are shipped to customers 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.
(f) Property and equipment, net of accumulated depreciation and amortization
Property and equipment are stated at cost. Depreciation is computed using the
straight-line method over the estimated useful lives of the assets, which are
five to ten years for equipment, five to seven years for furniture and fixtures,
and five years for vehicles. Leasehold improvements are amortized over the
lesser of the life of the lease or the useful life of the asset. Repairs and
maintenance costs are expensed as incurred.
(g) Inventory
Inventory is valued at the lower of first-in, first-out cost or market. In
addition, the value of inventory is periodically reduced for slow-moving or
obsolete inventory based on management's review of items on hand compared to
their estimated future demand.
(h) Impairment of long-lived assets
The Company adopted SFAS No. 144, Accounting for the Impairment or Disposal of
Long-lived Assets, effective January 1, 2002. The statement supersedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of, and the accounting and reporting provisions of
Accounting Principles Board (APB) Opinion No. 30, Reporting the Results of
Operations for a Disposal of a Segment of a Business. The adoption of SFAS No.
144 did not affect the financial condition or results of operations of the
Company.
27
(i) Earnings per share
Basic earnings per share are computed based on the weighted average number of
common shares outstanding during the period. Diluted earnings per share
includes, to the extent inclusion of such shares would be dilutive to earnings
per share, the effect of outstanding options and warrants, computed using the
treasury stock method. Unearned shares, if any, held by the Employees' Stock
Ownership Plan (ESOP) are deemed not to be outstanding for earnings per shares
calculations.
BASIC 2003 2002 2001
----------- ------------ -----------
Net income (loss) $ 2,740,374 $(1,413,842) $ 2,006,433
Weighted average common shares outstanding 10,323,549 10,063,581 9,976,181
EARNINGS PER SHARE - BASIC $ 0.27 $ (0.14) $ 0.20
- ------------------------------------------------------------------------------------------------------
DILUTED
Net income (loss) $ 2,740,374 $(1,413,842) $ 2,006,433
Weighted average common shares outstanding 10,323,549 10,063,581 9,976,181
Effect of assumed exercise of stock options and warrant 537,756 698,089 473,125
----------- ------------ -----------
Weighted average common shares outstanding, assuming dilution. 10,861,305 10,761,670 10,449,306
----------- ------------ -----------
EARNINGS PER SHARE - DILUTED $ 0.25 $ (0.13) $ 0.19
- ------------------------------------------------------------------------------------------------------
Outstanding options excluded as impact would be anti-dilutive 60,000 - 2,000
For additional disclosures regarding the employee stock options and the
warrants, see Note 9. The net effect of converting stock options to purchase
792,700 and 762,000 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, 2003 and 2002, respectively.
(j) Goodwill and other intangibles
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangible Assets," prescribes a two-phase process for impairment testing
of goodwill, which is performed once annually, absent indicators of impairment.
The first phase screens for impairment, while the second phase (if necessary)
measures the impairment. As a result of SFAS 142, an impairment write-down
occurred in the first quarter of 2002 of the investment in subsidiary, Roberts,
Cushman & Company, Inc., in the amount of $4.0 million. Goodwill remaining on
the balance sheet is analyzed by management periodically to determine the
appropriateness of its carrying value. Management has elected to perform the
annual analysis during the fourth calendar quarter of each year. As of December
31, 2003, management 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.
Under SFAS 142, goodwill impairment is deemed to exist if th