TANDY LEATHER FACTORY INC Q3 FY2022 earnings call

• Q3 had operating profit of $1 million and adjusted EBITDA of $1.5 million, despite sales being down 1.2% from last year. • Closed several stores in California and Florida due to negative 4-wall cash flow. • Retail channel share flat year-over-year, e-commerce sales proportion grew, commercial sales declined. • Gross margin improved due to better full price selling, price increases, and channel shift to e-commerce. • Key business principles: disciplined capital allocation, conservative balance sheet, focus on long-term shareholder value; operating focus on consumer proposition, durable business foundation, flexibility/nimbleness. • Focus on managing core business for financial sustainability, pausing/slowing sales growth investments, optimizing gross profit and trimming operating expenses.

In Q3, sales were down 1.2% compared to the previous year. Gross margin was 58.7%. Operating income was $1.1 million, and adjusted EBITDA was $3 million on a year-to-date basis. Retail and wholesale environments were challenging due to inflation, recession worries, war, etc. E-commerce sales proportion grew while commercial sales declined. Inventory at the end of Q3 was $42.3 million, down $1.4 million from the previous year.

• Pausing share repurchases as cash balance is low, will rebuild cash through Black Friday and holiday, and Board will re-evaluate share repurchases later. • Near-term focus on managing core business for financial sustainability, maintaining profit and growing cash even with possible declining demand. • Building 2023 plan with focus on profit and cash under challenging economic conditions.

• Economic headwinds including high inflation in US, possibility of recession next year, China COVID lockdowns disrupting global supply chain, Europe's economic fallout from Ukraine war. • Retail and wholesale environments remain challenging due to various factors like inflation, recession, war, public health issues.

Q: Curious if you're able to give some more details on the Fort Bragg store, why that location, how much does cost to build out and maybe what you're expecting in free cash flow in the store?

A: We're excited about the opportunity in military bases, it's a test. We went in with very low build-out, used a lot already there. Seeing what can be done, strong military customer base, lots of possibilities as a test for future.

Q: Nice to see operating expenses decreased even relative to adjusted operating expense in the second quarter. It seems like a lot of that's driven by the bonus expense reduction. I'm wondering if you could provide a little bit more color there, who's typically getting this, how they're incentivized? And why it's decreased so much, just given the performance?

A: Retail store employees are bonused on sales comp, corporate employees have combination of factors. Total dollar amount down, this year not expecting corporate employees bonus.

Q: With cash balance lower, how is Tandy approaching share repurchase?

A: As this is the low point in the year for our cash balance, we are pausing on our share repurchases. We still think we're a great value at our recent and current share price, but we will be rebuilding our cash balance through Black Friday and holiday and the Board will be re-evaluating share repurchases in the future.

Q: How is employee turnover and morale currently?

A: Employee turnover is down versus last year. Morale is quite good. We measure turnover regularly, worked hard to improve turnover, built non-monetary benefits for employees.

Q: What are the most important competitive dynamics that you're currently addressing and winning the customer over?

A: Continuing to face challenges of online player fragmentation, but Amazon effect reduced. Also, having great service, good product, being vigilant about price increases relative to competition, staying on top of competitive pricing.

Q: How much has the value of our inventory increase sort of per unit?

A: Seen significant price increases, especially in transportation costs, freight, warehouse boxes. Some categories like boxes increased over 100%, freight surcharges on freight increased dramatically. But can't tell overall.

Q: Nice job getting the gross margin back through 60. In the context of the drivers, full price sell-through is self-evident, but can you talk about the impact of proprietary products in e-commerce? What percentage of sales are they now? And what is a good 24-month goal?

A: E-com is now at 18% of sales. Don't have number for mix of proprietary brands off the top of my head. It's about managing mix to meet financial goals and customer wants.

Q: What should be the long-term net margin for the business?

A: Not providing long-term guidance. Talked about long-term goal to get to $15 million to $20 million in operating income and $100 million in sales, but current economic headwinds mean it won't happen soon.

Q: 36-year months out, how do you think our store count at 103 stores a few more or a few less?

A: Closing stores incrementally for negative cash flow ones with expiring leases. Optimistic about testing new format in Fort Bragg. Don't expect continuing decline, would like to see nominal increase.

Q: With Fort Bragg is the test store for military bases, if this works out well, will future stores on military bases also have rents tied to sales?

A: AAFES runs retail concessions on military bases with percentage of sales model. Negotiated rate, hoping for tiered approach. Positive is allows fast test.

Q: Could you maybe give us an indication of the rate that you negotiated with Fort Bragg?

A: It's 8%.