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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, 1998
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
incorporation or organization) Identification Number)
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. [ ]
The aggregate market value of the common stock held by non-affiliates of
the registrant was approximately $829,877 at March 15, 1999. At that date there
were 9,853,161 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, 1999, are incorporated by
reference in Part III of this report.
PART I
Item 1. Business.
General. The Leather Factory, Inc. ("TLF" or the "Company") was
incorporated under the laws of the State of Colorado in 1984 and reincorporated
under the laws of the State of Delaware in June 1994. TLF is the successor to
several entities that were parties to a merger transaction in July 1993. One of
these entities involves a business that was incorporated pursuant to the laws of
the State of Texas in 1980. The Company's principal offices are located at 3847
East Loop 820 South, Fort Worth, Texas 76119 and its phone number is (817)
496-4414.
TLF operates in one industry segment as an international wholesale
manufacturer and distributor of a broad product line which includes leather,
leatherworking tools, buckles and other belt supplies, shoe care and repair
supplies, leather dyes and finishes, adornments for belts, bags, and garments,
saddle and tack hardware, and do-it-yourself kits. The Company, through its
subsidiary, Roberts, Cushman & Company, Inc. ("Cushman"), in Long Island City,
New York, produces a related product line involving hat trims, the decorative
piece of material that adorns the outside of a hat, and small finished leather
goods such as cigar cases, wallets and western accessories. The Company
frequently introduces new products either through its own manufacturing
capability or through purchasing from vendors. The Company holds a substantial
number of copyrights for its designs. These designs have been incorporated
throughout the Company's product line as a means of increasing its competitive
advantage.
The Company's customer base is comprised of over 40,000 customers
including retailers, wholesalers, assemblers, distributors, and other
manufacturers dispersed geographically throughout the world. Most of the
Company's customers are wholesalers; less than five percent (5%) of the
Company's sales are retail. TLF sells inventory ranging from raw materials to
finished goods.
The Company manufactures some of its own products, but when it cannot
manufacture an item on a cost-effective basis, it also purchases products from
other manufacturers and distributors in fourteen countries. The Company has
light manufacturing facilities in Fort Worth, Texas, where it produces items
such as suede lace, garment fringe, leathercraft and craft-related kits, and in
Long Island City, New York, where, through its Cushman subsidiary, it produces
hat trims and small finished leather goods, as noted above.
The Company principally promotes its products through the use of
targeted direct mail advertising. Proprietary mailing lists by customer groups
are maintained by the Company. These valuable mailing lists have been generated
internally and have never been sold to third parties.
The Company distributes its products through 21 sales/distribution
units located in seventeen states and one located in Canada plus its
manufacturing facility and show room in New York. The geographic location of its
sales/distribution units is selected based on the location of its customers, so
that delivery time to customers is minimized. A two-day maximum delivery time is
the Company's goal. In addition to offering its customers rapid delivery, the
Company also offers a "one-stop shopping" concept for both leather and
leathercraft materials.
2
Operating Results. The Company's strategic efforts to improve
profitability significantly increased gross profit margins in 1998. Company
management focused its attention on improving gross profit margins by improving
product sales mix, selectively increasing prices, and eliminating low margin
items from its product lines. As a result, gross profit as a percentage of net
sales increased to 43.9% in 1998, up 2.3 percentage points from 1997 and the
highest level achieved since reaching 44.4% in 1993. Continuing cost control
measures also reduced operating costs by $475,628 (5.1%) from $9,365,673 for
1997 to $8,890,045 achieved in 1998. Strategic efforts to improve profitability
came at the expense of lower sales. Net sales of $22,163,994 for the year ended
December 31, 1998, were down $3,235,122 (12.7%) from fiscal 1997. The decline
resulted from elimination of low margin items from the Company's product lines,
reduced sales to the craft and western apparel markets, and lower export sales.
These declines were partly offset by gains in the Company's core and
institutional business. Despite improvements in margins and cost reductions,
lower sales resulted in a net loss of $39,191 in 1998 compared to net income of
$70,292 in 1997. See also "Management's Discussion and Analysis of Financial
Condition and Results of Operations - General; - Costs, Gross Profit, and
Expenses; and - Capital Resources and Liquidity."
Operating results for the fourth quarter of 1998 revealed essentially
the same improvement in operating profit margins as for the total year. Fourth
quarter 1998 revenues were down 11.7% from the same period last year, while
gross profits were down only 5.7% due to an improvement in the gross profit
margin of 2.9 percentage points. Operating costs were down 6.7% from the fourth
quarter of 1997. These reductions more than offset the decline in gross profits
and resulted in higher total income from operations in 1998 compared to 1997.
This improvement in operating profits in 1998, losses in 1997 of approximately
$60,000 on the sale of real estate in Florida, and adjustments to the 1998
provision for taxes for year-end contributions to benefit plans resulted in net
income of $76,967 in the fourth quarter of 1998 compared to a loss of $73,820 in
the same period of 1997. See Note 12 to the Consolidated Financial Statements.
Funded Indebtedness. On November 21, 1997, the Company entered into a
Loan and Security Agreement with FINOVA Capital Corporation ("FINOVA"),
according to which FINOVA agreed to provide a credit facility of up to
$9,136,000 in senior debt (the "Senior Debt Facility"). The Senior Debt Facility
has a two year term and is secured by all of the assets of the Company as well
as a pledge of 3,000,000 shares of the Company's common stock, par value $.0024
("Common Stock"), collectively owned by two of the Company's executive officers.
Simultaneously, the Company also issued at face value its $1,000,000
subordinated promissory note to The Schlinger Foundation (the "Subordinated
Debenture"). The Subordinated Debenture also has a two-year maturity and is
partially secured by a pledge of 2,666,666 shares of the Company's Common Stock
owned by another executive officer.
The Company is currently in compliance with all covenants and
conditions contained in the Senior Debt Facility and the Subordinated Debenture
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 Senior Debt Facility and the Subordinated Debenture are
described below, see "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Capital Resources and Liquidity" and Note
3 to the Consolidated Financial Statements.
The total outstanding balances of the Senior Debt Facility and the
Subordinated Debenture will become due during the current year pursuant to the
terms of these debt facilities. The Company is actively seeking to refinance or
renew this indebtedness prior to its maturity. Management is confident of its
ability to renew, restructure, or refinance the Senior Debt Facility and the
Subordinated Debenture on a favorable long-term basis. However, management can
provide no assurance that such renewal or refinancing efforts will be
successful. See also "Management's Discussion and Analysis of Financial
Condition and Results of Operations Capital Resources and Liquidity".
Opening of New Sales/Distribution Units and Acquisitions. Due to
management's continued focus on improving the results of existing operations,
the Company did not close an acquisition or open a new location during 1998.
Subject to remaining in compliance with the provisions of the Senior Debt
Facility and the Subordinated Debenture, and management's desire to achieve even
greater improvements in existing operations, the Company will resume its
expansion plans in 1999.
3
On January 8, 1999, Tandycrafts, Inc. announced plans to close its
leather and crafts manufacturing operations and 121 retail stores over the first
half of the year. They also indicated their intent to retain their mail order,
dealer and wholesale leather and crafts business and increase their efforts to
sell these products direct to consumers. Company management expects Tandycrafts'
actions to create opportunities for profitable growth in some markets. See also
"Expansion and Acquisition Strategy" and "Management's Discussion and Analysis
of Financial Condition and Results of Operations - General; - Capital Resources
and Liquidity."
Corporate History. The Company is the successor to certain entities
that were parties to a series of transactions including a merger in July 1993
which involved The Leather Factory, Inc., a Texas corporation ("TLF-Texas"), and
National Transfer & Register Corp. ("National"), a Colorado corporation, which
had no operations and whose capital stock had no active trading market prior to
the merger. The surviving entity changed its name to The Leather Factory, Inc.
and its business became that conducted by TLF-Texas. National was incorporated
under the laws of Colorado in 1984 and conducted business as a stock transfer
agency from January 1985 to April 1993. In June of 1993, the principal officers
and directors of TLF-Texas, Wray Thompson, Ronald C. Morgan and Robin L. Morgan,
acquired shares of National Common Stock and were elected to National's Board of
Directors.
In July of 1993, pursuant to a reverse merger agreement among National,
TLF-Texas, and the shareholders of TLF-Texas, National acquired all of the
outstanding Common Stock of TLF-Texas in exchange for 7,805,478 newly issued
shares of National Common Stock. In connection with this transaction, National
effected a 1 for 24 reverse stock split. The name of National was changed to
"The Leather Factory, Inc.", and National's business became that conducted by
TLF-Texas. Any reference to "Company" herein includes, where applicable, the
activities of TLF-Texas after the acquisition of TLF-Texas by National.
TLF-Texas was initially incorporated under the laws of Texas in 1980
with the name Midas Leathercraft Tool Company ("Midas"). Originally, the
business of Midas involved the distribution of certain leathercraft tools. After
the reverse merger transaction with National, the Company in June of 1994
reincorporated in Delaware. As part of its strategy to develop a multi-location
chain of wholesale units the Company has made numerous acquisitions since its
incorporation, including the purchase of six wholesale units from Brown Group,
Inc., a major footwear retailer. The Company has also acquired several
businesses located throughout the United States that distribute shoe-related
supplies to the shoe repair and shoe store industry. In addition, the Company
purchased Cushman in 1995, a leading producer of hat trims. In March of 1996,
the Company acquired all of the issued and outstanding capital stock of its
Canadian distributor, The Leather Factory of Canada.
Business Concept. Wray Thompson and Ronald C. Morgan, the Company's
founders, conceived "The Leather Factory Concept." This concept includes the
geographical location and type of space rented for the Company's
sales/distribution units, the size and configuration of the units, the number of
items comprising the merchandise line, the utilization of direct mail, including
the use of an annual full-line catalog, and the application of rapid delivery to
customers.
The Company's 22 sales/distribution units combine the economies of
scale of warehouse locations with the marketing efficiencies that can be
achieved through direct mail. Walk-in traffic and mail order customers are
served in the same location. The type of premises utilized for the
sales/distribution unit locations is generally light industrial office/warehouse
space in proximity to a major freeway or with relatively easy access thereto.
This kind of location typically provides lower rental expense compared to other
more retail oriented locations. The size and configuration of the
sales/distribution units are carefully 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 of leather and
leather goods. The Company maintains higher inventory levels of certain imported
items to assure itself of a continuous allotment due to the length of time
required for delivery of these items.
4
The Company's sales/distribution units are staffed by experienced
managers who are primarily compensated based upon the operating profit of their
location. Sales of these units are generated by the selling efforts of the
location personnel themselves, participation by the Company at trade shows, the
use of sales representative organizations and the aggressive use of direct mail
advertising. In addition to generating mail order business, the purpose of the
Company's direct mail program is to stimulate sales for the sales/distribution
units. The Company utilizes an internally developed and maintained mailing list,
which allows for very targeted mailing to its various customer groups. As for
the utilization of direct mail and rapid delivery, the Company locates units in
order to get merchandise in the customers' hands as soon as possible, with the
added benefit of lower freight cost.
The Company attempts to maintain the number of stock-keeping units
("SKU's") in the primary Leather Factory line of merchandise at the optimum
number of items necessary to balance the maintaining of the proper stock to
minimize stock-out situations with the carrying costs involved with such an
inventory level. The number of SKU's has been refined over the years due to the
introduction of new products as well as the discontinuing of items from the
product line. The Company now maintains 2,418 items in The Leather Factory line
of merchandise, and the product line sold to shoe repair shops and shoe stores
increases the number in the Company's overall product line to approximately
3,000 SKU's.
Expansion and Acquisition Strategy. In past years the Company has made
several acquisitions and opened new sales/distribution units. The acquisition
strategy involved: (a) the purchase of businesses selling a related product line
to which The Leather Factory line of merchandise and Concept could be added; and
(b) the purchase of related businesses. The results of these activities have
been mixed principally due to the impact upon the Company of negative market
forces, which affected the integration and results of these companies acquired
or new locations instituted, as well as due to a protracted labor dispute at the
Cushman facility, which was resolved in 1996. Market conditions have been
challenging in the areas of the western and craft industries served by the
Company for some time. For example, conditions in the western industry peaked in
1994 and the trends have been generally negative in that industry since that
time. These trends, coupled with the labor dispute at Cushman, have affected the
sales and profitability of the Company's Cushman acquisition. The Company's
acquisition of businesses involved in the distribution of shoe care and repair
supplies have been only marginally profitable because of competitive pressures.
In 1997 and 1998, management focused on stabilizing operations and
obtaining long-term financing, and no acquisitions were made. Subject to
obtaining the necessary financing and the demands of existing operations, the
Company currently plans to resume its expansion by: (i) adding two to three
sales/distribution units per year; and (ii) acquiring companies in related
areas/markets which offer synergistic aspects based on the locations and/or
product lines of the businesses. The opening of new locations will be impacted
by the opportunities created by Tandycrafts' announced closing of its 121 retail
stores. Some of these sites could serve as Leather Factory locations. Management
is evaluating its options given the Tandycrafts announcement.
It is anticipated that the Company would not acquire a business that
sells shoe care and repair supplies as a means of gaining a new Leather Factory
location as it has several times in the past. The Company has determined that it
is better to open new locations than to purchase these existing shoe-related
businesses. The opening of a new location requires approximately $100,000 in
inventory and $25,000 in fixtures, plus the investment in accounts receivable
during the initial phase of a new unit. Management believes that new locations
can be financed internally.
The financing of acquisitions is dependent upon the Company's working
capital line of credit with FINOVA and subject to the size of the acquisition,
will require the Company to seek additional financing. Management can give no
assurances as to its ability to obtain such financing.
5
Products/Customers. The Company's core business consists of
manufacturing, importing and distributing leather, traditional leathercraft
materials (do-it-yourself kits, stamping sets, and leatherworking tools),
craft-related items (leather lace, beads, and wearable art accessories),
hardware, metal garment accessories (belt buckles, belt buckle designs, and
conchos), fancy hat trims in braids, leather, and woven fabrics, shoe care and
repair supplies, leather finishes, and small finished leather goods. The
Company's manufacturing operations are in Fort Worth, Texas and Long Island
City, New York at Cushman. The products manufactured in Fort Worth generally
involve cutting leather into various shapes and patterns using metal dies
("clicking"), fabrication, assembly, and packaging/repackaging tasks. The
manufacturing operation in Fort Worth makes items primarily for wholesale
distribution using the Company's sales/distribution units. The Cushman facility
manufactures hat trims and small finished leather goods. Hat trims are sold to
hat manufacturers and distributors directly. Small finished leather goods are
sold to various distributors and retailers through attendance at trade shows and
the use of sales representatives.
The customer groups served include wholesale distributors, tack and
saddle shops, shoe-findings customers, institutions, prisons and prisoners,
dealer stores, western stores, craft stores and craft store chains, hat
manufacturers and distributors, other large volume purchasers, manufacturers,
and retailers. No single customer's sales comprise more than 10% of the
Company's total sales. Approximately three percent (3%) of the Company's sales
are export sales.
Competition. The Company competes in four highly fragmented markets,
which include leathercraft, leather accessories, retail craft, and shoe care and
repair supplies. Management believes that the Company encounters competition in
connection with certain product lines and in certain areas from different
companies, but has no direct competition affecting the entire product line. The
Company is larger than most of its direct competitors. The fragmented nature of
these markets is the primary reason for the lack of broad-based competition.
In January 1999, Tandycrafts Inc., a competitor in some areas in
leathercrafts and craft markets, announced plans to close its leather and crafts
manufacturing operations and its 121 retail stores over the first half of 1999.
Management expects these closures to lessen competition in some of the markets
in which the Company competes once Tandycrafts' remaining inventories have been
absorbed by the market.
The Company competes on price, availability of merchandise, and speed of
delivery. The size of the Company relative to most of its competitors creates
competitive advantage in its ability to stock a full range of products as well
as in buying merchandise. The Company believes it has a competitive advantage on
price in most product lines because it purchases in bulk and has an
international network of suppliers that can provide quality merchandise at lower
costs. Most of the Company's competitors do not have the multiple sources of
supply and cannot purchase sufficient quantities to compete along a broad range
of products. In fact, some of the Company's competitors are also customers,
relying on the Company as a supplier.
Suppliers. The Company currently purchases merchandise and raw
materials from approximately 200 vendors dispersed throughout the United States
as well as in fourteen foreign countries. In fiscal year 1998, the Company's ten
largest vendors accounted for approximately fifty four percent (54%) of its
total purchases. Management believes that its relationships with suppliers are
strong and does 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 or all of these principal suppliers would not have a material
impact on the operations of the Company.
Patents and Copyrights. The Company presently owns 130 copyrights
covering 239 registered works, seven trademarks covering seven names, and two
patents covering three products. Registered trademarks include a federal trade
name registration on The Leather Factory. The trademarks expire at various times
starting in 2002 and ending in 2008, but can be renewed indefinitely. Most
copyrights granted or pending are on metal products, such as conchos, belt
buckles, etc., and instruction books. The expiration period for the copyrights
begins in 2062 and ends in 2072. The Company has patents on two belt buckles and
certain leather-working equipment known as the "Speedy Embosser." The patents
expire in 2011. Management considers these intangibles to be valuable assets and
defends them as necessary.
6
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, 1998, the Company employed 180 people,
with 177 on a full time basis. The Company is not a party to any collective
bargaining agreement. Eligible employees participate in The Leather Factory,
Inc. Employees' Stock Ownership Plan and Trust ("ESOP"). As of December 31,
1998, 207 employees and former employees were participants in or beneficiaries
of the ESOP. The Company has the option of contributing up to 15% of eligible
employees' compensation into the ESOP. Net contributions for 1998, 1997 and 1996
were 11.6%, 1.2%, and .8%, respectively, of eligible compensation. These
contributions are used to purchase shares of Common Stock.
Management believes that relations with employees are good.
7
Item 2. Properties.
The Company leases all its premises. Detailed below are the lease terms
for the Company's locations. The general character of each location is light
industrial office/warehouse space. The Company believes that all of its
properties are adequately covered by insurance.
Location Name Total Space (Sq. Ft.) Minimum Annual Rent * Lease Expiration
------------- --------------------- ------------------- ----------------
Chattanooga, TN 9,040 $ 40,704 May 1999
Denver, CO 12,000 39,000 October 1999
Harrisburg, PA 6,850 37,172 March 2002
Fort Worth, TX 61,000 252,429 March 2003
Fresno, CA 5,600 41,516 March 2002
Des Moines, IA 4,000 26,000 April 1999
Phoenix, AZ 4,500 25,729 March 2001
Springfield, MO 6,000 24,000 July 2003
Spokane, WA 5,400 20,400 February 1999
Albuquerque, NM 5,000 29,793 October 2003
Salt Lake City, UT 4,000 25,584 September 1999
Baldwin Park, CA 7,800 53,040 March 2000
Tampa, FL 5,238 38,396 January 2003
San Antonio, TX 5,600 40,320 October 2001
Columbus, OH 6,000 39,075 October 2000
El Paso, TX 5,000 25,700 August 2003
Oakland, CA 8,000 54,000 December 2003
Grand Rapids, MI 8,000 34,151 March 1999
Wichita, KS 14,000 33,600 May 1999
Long Island City, NY 10,200 67,234 June 2003
New Orleans, LA 5,130 21,600 August 2000
Charlotte, NC 6,202 24,188 February 2001
Winnipeg, Canada 5,712 26,273** November 2002
-------- ----------
Totals 210,272 $1,019,904
======== ==========
* Represents the average minimum annual rent over the balance of the unexpired
lease term.
** As converted into U.S. dollars.
The Company's Fort Worth location includes the Fort Worth
sales/distribution unit, the Company's central warehouse, the light
manufacturing facility, and the sales and administrative/executive offices. The
Company also leases a 624 square foot showroom in the Denver Merchandise Mart
for $10,920 per year. This lease will expire in October 1999.
8
Item 3. Legal Proceedings.
As reported previously, the Company, as successor-in-interest to
National Transfer & Register Corporation ("National"), was a defendant in a
lawsuit brought in July 1994 by Gary A. Bedini and John C. Bedini (the
"Plaintiffs") in the United States District Court for the District of Colorado
(the "Court"). The Company as part of a reverse merger transaction with National
was contractually indemnified against loss in this case by one of the additional
defendants Securities Transfer Corporation ("STC") and related entities and
individuals of STC.
This action was originally tried in July 1995, and upon conclusion of
the trial in September 1995, a Judgment in favor of the plaintiffs and against
the defendants was entered in the approximate amount of $150,000 including pre
judgment interest. In September 1995 STC filed a motion to alter or amend the
judgment and also made a settlement offer. On November 9, 1998, the Plaintiffs
accepted a settlement offer from STC and acknowledged full satisfaction of the
judgement, including all costs, pre-judgement interest, post judgement interest
and attorney's fees. The Company did not suffer any loss or expense from this
lawsuit.
The Company has 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, 1998.
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:
Quarter Ended High Low
------------- ---- ---
March 31, 1997 $1.0000 $0.5625
June 30, 1997 0.8125 0.5000
September 30, 1997 0.8750 0.5625
December 31, 1997 0.8125 0.5000
March 31, 1998 0.6250 0.4375
June 30, 1998 0.6250 0.3750
September 30, 1998 0.6250 0.3750
December 31, 1998 0.4375 0.1250
- ----------
There were approximately 593 stockholders of record on March 15, 1999.
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 FINOVA Capital Corporation, the Company's senior
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 current industry and market conditions, as well as
other factors beyond the control of the Company.
9
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." Data in prior years have not been restated to reflect acquisitions
that occurred in subsequent years.
Years Ended December 31
- ---------------------------------------
Income Statement Data
---------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ---------------- ----------------- ---------------
Net sales $22,163,994 $25,399,116 $28,253,632 $31,447,849 $28,081,272
Cost of sales 12,428,324 14,844,376 17,689,973 18,446,378 15,870,603
---------------- ---------------- ---------------- ----------------- ---------------
Gross profit 9,735,670 10,554,740 10,563,659 13,001,471 12,210,669
Operating expenses 8,890,045 9,365,673 10,869,359 10,363,159 9,573,495
---------------- ---------------- ---------------- ----------------- ---------------
Operating income (loss) 845,625 1,189,067 (305,700) 2,638,312 2,637,174
Other (income) expense 970,339 887,543 1,000,604 678,264 142,830
---------------- ---------------- ---------------- ----------------- ---------------
Income (loss)
before income taxes (124,715) 301,524 (1,306,304) 1,960,048 2,494,344
Income tax provision (benefit) (85,524) 231,232 (316,536) 786,744 990,197
---------------- ---------------- ---------------- ----------------- ---------------
Net income (loss) (39,191) 70,292 (989,768) 1,173,304 1,504,147
================ ================ ================ ================= ===============
Earnings (loss) per share* (.00) .01 (.10) .12 .15
================ ================ ================ ================= ===============
Earnings (loss) per share--
assuming dilution* (.00) .01 (.10) .12 .15
================ ================ ================ ================= ===============
Weighted average common
shares outstanding for:
Basic EPS 9,803,887 9,789,358 9,788,530 9,789,468 9,783,387
================ ================ ================ ================= ===============
Diluted EPS 9,803,887 9,791,565 9,788,530 9,789,468 9,783,387
================ ================ ================ ================= ===============
Balance Sheet Data
---------------------------------------------------------------------------------------------
1998 1997 1996 1995 1994
---------------- ---------------- ---------------- ----------------- ---------------
Total Assets $16,029,937 $17,024,549 $18,264,547 $19,333,376 $18,468,806
---------------- ---------------- ---------------- ----------------- ---------------
Notes payable and current
maturities of long term debt 6,139,327 4,650,742 8,549,366 1,296,359 194,311
---------------- ---------------- ---------------- ----------------- ---------------
Notes payable and long-term
debt, net of current maturities 61,389 2,602,728 17,378 6,566,809 7,325,432
---------------- ---------------- ---------------- ----------------- ---------------
Total Stockholders' Equity 8,170,278 8,132,646 8,022,937 9,282,305 8,217,781
================ ================ ================ ================= ===============
* The earnings (loss) per share amounts prior to 1997 have been restated to
comply with Statement of Financial Accounting Standards No. 128, Earnings Per
Share. Such restatement did not change previously reported amounts. See notes 2
and 9 to the consolidated financial statements for further discussion of
earnings per share.
10
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
Income Statement Comparison
The following table sets forth, for the fiscal years indicated, certain
items from the Company's Consolidated Statements of Operations expressed as a
percentage of net sales:
1998 1997 1996
-------------- -------------- ---------------
Net Sales 100.0% 100.0% 100.0%
Cost of sales 56.1 58.4 62.6
-------------- -------------- ---------------
Gross profit 43.9 41.6 37.4
Operating expenses 40.1 36.9 38.5
-------------- -------------- ---------------
Income (loss) from operations 3.8 4.7 (1.1)
Other (income) expense, net 4.4 3.5 3.5
-------------- -------------- ---------------
Income (loss) before
income taxes (0.6) 1.2 (4.6)
Provision (benefit) for income tax (0.4) 0.9 (1.1)
-------------- -------------- ---------------
Net income (loss) (0.2)% 0.3% (3.5)%
============== ============== ===============
Analysis of 1998 Compared to 1997
---------------------------------
Revenues
The Company's net sales decreased by 12.7% to $22,163,994 during 1998
from $25,399,116 in 1997. The decline resulted from strategic decisions to
eliminate low margin items from the Company's product lines, reduced sales to
the western apparel and crafts markets, and lower export sales. Sales of lower
margin items were down 43% from 1997 and now represent less than 8% of total
revenues. Nearly half of the Company's business is made up of sales to western
apparel and crafts markets, and 1998 sales in these markets were down 15% and
18%, respectively, compared to 1997, reflecting a continuation of negative
industry trends. However, sales in the Company's core businesses and
institutional markets remained strong throughout the year and registered an
increase in revenues over 1997.
Sales of the Company's products do not reflect significant seasonal
patterns.
Costs, Gross Profit, and Expenses
Cost of sales as a percentage of revenue was 56.1% for 1998 as compared
to 58.4% for 1997. The difference in the relative cost of sales percentage was
principally attributable to an improved product sales mix and the Company's
strategic efforts to selectively raise prices and eliminate lower margin items
from its product lines.
A lower relative cost of sales percentage meant that gross profit as a
percentage of sales was higher for the fiscal year ended December 31, 1998
compared to 1997. Gross profit as a percentage of sales increased 2.3 percentage
points to 43.9% in 1998 from 41.6% in 1997.
Operating expenses decreased $475,628 or 5.1% to $8,890,045 in 1998
from $9,365,673 in 1997. Approximately half of the decrease in operating
expenses was the result of lower payroll costs, reflecting an additional
reduction of personnel during 1998. Other decreases included lower advertising
costs, reduced accounting, legal and professional fees, and lower freight costs.
11
Other (Income) Expense
Other expenses were $970,339 for the fiscal year ended December 31,
1998 compared to $887,543 during the same period in 1997. Interest expense was
up $136,101 in 1998 as the amortization of deferred costs from the November 1997
debt refinancing offset reduced interest expense due to lower borrowing levels
during the year. Other income increased $53,305 relative to 1997 due to a gain
from the sale of a trademark in 1998 as opposed to a loss recorded on the sale
of real estate in Tampa, Florida in 1997.
Provision (Benefit) for Income Taxes
The benefit for income taxes was 69% of the loss before taxes in 1998.
The tax benefit reflects a deduction for a contribution to the Company's ESOP
for tax purposes in excess of its treatment in arriving at net income. This
amount is partly offset by certain non-deductible expenses totaling $228,000,
principally comprised of the amortization of goodwill. Taking these two amounts
into account, the Company's effective tax rate materially approximates the
Company's historical rate for combined federal and state income taxes of about
40%.
Net Income (Loss)
The Company recorded a net loss of $39,191 for 1998 as compared to net
income of $70,292 for 1997. The change in results was primarily due to the
factors noted above regarding sales, cost of goods sold, operating expenses and
other (income) expense.
Analysis of 1997 Compared to 1996
---------------------------------
Revenues
The Company's net sales decreased by 10.1% to $25,399,116 during 1997
from $28,253,632 in 1996. This sales decline was a result of the negative forces
at the retail level that existed in some of the Company's markets as well as the
Company's plan to achieve greater margins through higher prices which led to a
lower volume of sales. The Company experienced reduced revenues of $1,507,140 in
sales of western or southwestern related products and reductions of $983,399 in
sales to the retail craft industry.
In addition to sales declines due to negative market forces in the
craft and western apparel industries, the Company initiated and implemented
certain strategies during the year that resulted in lower sales. Prices in lower
margin product lines were selectively increased and certain products were
eliminated from these lines. These merchandising and pricing strategies
contributed to the sales decline by approximately $950,000. This decline was
partially offset by increases generated in the Company's growing line of
finished leather accessories and an increase in export sales.
Costs, Gross Profit, and Expenses
Cost of sales as a percentage of revenue was 58.4% for 1997 as compared
to 62.6% for 1996. The difference in the relative cost of sales percentage was
principally attributable to: (i) a change in sales mix, in that the percentage
of the Company's sales reflecting relative lower costs of sales increased; (ii)
management's plan to raise prices and selectively eliminate lower margin items
from the Company's product lines; and (iii) direct labor costs that were
eliminated due to planned personnel reductions and the settlement of the labor
dispute at Cushman in October of 1996.
A lower relative cost of sales percentage meant that gross profit as a
percentage of sales was higher for the fiscal year ended December 31, 1997
compared to 1996. Gross profit as a percentage of sales increased 4.2 percentage
points to 41.6% in 1997 from 37.4% in 1996. Due to the factors mentioned above
relative to cost of sales, the Company generated almost the same amount of gross
profit in dollars on $25,399,116 in sales during the fiscal year ended December
31, 1997 as it did on $28,253,632 in sales during 1996.
12
Operating expenses decreased $1,503,686 or 13.8% to $9,365,673 during
1997 from $10,869,359 in 1996. This decrease in operating expenses was the net
result of cost control measures instituted by management. The reductions in
operating expenses involved several factors, including: (i) reduced payroll,
payroll tax and payroll related expenses of approximately $500,000 due to a
substantially lower average number of employees during 1997 compared to 1996;
(ii) a small bad debt recovery recorded during 1997 as opposed to $229,000 of
expense for 1996; (iii) a net reduction in commission expense of $151,183 in
1997, due primarily to the elimination of sales representatives in the retail
craft market; (iv) $140,772 less amortization expense in 1997, principally
because of the write down of certain purchased goodwill during 1996; and (iv)
reductions of $50,000 or more in each of advertising, corporate fees and
shareholders relations, freight, insurance, supplies, travel, and marketing
samples. These decreases in operating expenses were partially offset by
increased professional expenses incurred by the Company in initial efforts to
obtain new financing during 1997.
Other (Income) Expense
Other expenses were $887,543 for the fiscal year ended December 31,
1997 compared to $1,000,604 during the same period in 1996. The difference
between the two years involved decreased interest expense. The difference in the
dollar amount of interest expense was principally due to the write-off in 1996
of the commitment and facility fees attributable to the acquisition commitments
that expired in July 1996. The interest expense that the Company could have
saved during 1997 from decreased levels of debt compared to the previous year,
was offset by increased interest rates and the forbearance fees charged by
NationsBank. Due to the Company's continuing default under certain covenants
contained in its former NationsBank debt facility, the rate of interest charged
by NationsBank increased from an average of the Prime Rate or less during the
prior fiscal year to the Prime Rate plus 2% on average for 1997.
Provision (Benefit) for Income Taxes
The provision for federal and state income taxes was 77% of 1997 income
before taxes due to certain non-deductible expenses totaling $235,000,
principally comprised of the amortization of goodwill. Taking this into account
the Company's effective tax rate materially approximates the Company's
historical rate for combined federal and state income taxes of about 40%.
Net Income (Loss)
The Company recorded net income of $70,292 for 1997 as compared to a
net loss of $989,768 during 1996. The change in results was primarily due to the
factors noted above regarding sales, cost of goods sold, operating expenses and
other (income) expense.
Capital Resources and Liquidity
The primary sources of liquidity and capital resources during 1998 were
borrowings from the Senior Debt Facility with FINOVA, the Subordinated Debenture
held by Schlinger, and cash flows provided by operating activities.
While having a negative impact on sales, the Company's continued focus
in 1998 on improving gross profit margins and reducing operating expenses was
effective as indicated by the cash flow from operations in the amount of
$1,530,286. The use of cash flows from operations to pay down debt is reflected
in the improvement of the Company's debt to equity ratio from 0.89 at December
31, 1997 to 0.76 at December 31, 1998. Some of this cash flow resulted from the
Company's ability to reduce its investment in accounts receivable and inventory
given the reduced level of sales.
Accounts receivable decreased to $1,582,459 and inventory decreased to
$6,956,606 at December 31, 1998 from $1,865,276 and $7,279,702, respectively, at
December 31, 1997. The aging of accounts receivable has not deteriorated and is
indicative of management's' continued tight credit and collection policies which
have also contributed to the negative trend in sales noted above.
13
Even at the reduced level, inventory only turned 1.74 times during
1998, which is below the 1997 ratio of 1.98 times. This decrease in the turn
rate indicates that further reductions in inventory are still needed as of
December 31, 1998 to support the current level of sales. Management anticipates
the completion of its implementation of new information systems in 1999 will
assist in monitoring of inventory levels that in turn should provide additional
cash flows from operations in the future.
The 1997 refinancing of the Company's debt on a long-term basis as
discussed in Item 1 and Note 3 to the Consolidated Financial Statements
significantly improved the Company's financial position. The Company's current
ratio was 1.27 at December 31, 1998 and 1.68 at December 31, 1997 compared to
1.13 at the end of 1996. If the Company's promissory notes and debentures had
not been reclassified from long term to current to reflect their maturity during
1999, the current ratio at December 31, 1998 would have been 1.91.
The largest use of cash beyond inventory, accounts receivable, and debt
payments in 1998 was for capital expenditures. Cash used for capital
expenditures totaled $137,828 and $239,578 for the years ended December 31, 1998
and 1997, respectively. Approximately 25% of 1998 capital spending was for new
computer equipment and software with the remainder split between office and
warehouse fixtures, machinery and other equipment, and leasehold improvements.
The Company believes that the current sources of liquidity and capital
resources will be sufficient to fund current operations and the opening of new
sales/distribution units. In 1999, the funding for the opening of new units is
expected to be provided by operating leases, cash flows from operating
activities, the Company's Senior Debt Facility with FINOVA, and the Subordinated
Debenture with Schlinger.
The Senior Debt Facility is comprised of a revolving credit facility
and three term notes. The revolving portion is based upon the level of the
Company's accounts receivable and inventory. At December 31, 1998, the Company
had additional availability of approximately $475,000. As the Company's sales
and operations expand, requiring larger investments in accounts receivable and
inventory, the Company expects to have in excess of $1,000,000 in additional
funds available under the revolving credit facility.
The Company's Senior Debt Facility and Subordinated Debentures mature
on December 1, 1999, and management intends to pursue negotiations with FINOVA
and other potential investors/lenders in 1999 to extend or replace the maturing
debt facilities. Management believes it will be able to secure the required
financing prior to the maturity of these obligations. However, in the event of a
future material adverse change in the Company's operations, FINOVA could
accelerate its debt or otherwise determine not to renew the notes. In such a
circumstance the Company would pursue other sources of financing. If other
financing could not be secured, the Company could experience a material adverse
impact.
Management perceives opportunities to acquire related business in the
marketplace due to the fragmented nature of the markets in which the Company
conducts business as well as due to the competitive conditions of these markets.
The Company's present financing arrangements will not be sufficient to make
these acquisitions and if any acquisitions are to be consummated, the Company
will be required to obtain additional debt or equity financing. Any new
financings will require the consent of FINOVA. The Company can provide no
assurance that these acquisitions can be made on terms acceptable to the Company
or that the needed financings to enter into these transactions can be obtained.
Year 2000 Issue
The Year 2000 ("Y2K") problem arose because many computer programs use
only the last two digits to refer to a year. As a consequence, unless modified,
many computer systems will interpret "00" as 1900 rather than the year 2000.
This issue is believed to affect virtually all organizations and failure to
address the problem could result in system failures and the generation of
erroneous data. Each company's potential costs and uncertainties will depend on
a number of factors including but not limited to its software, hardware, the
nature of its industry, and the sophistication of its manufacturing and process
control systems.
14
The Company has developed a comprehensive Y2K readiness plan to ensure
its systems will be Y2K compliant prior to the year 2000. Pursuant to this plan,
the Company conducted preliminary reviews of its critical information technology
("IT") systems as well as its non-IT systems. The majority of systems that were
found to be defective in this review have been replaced or upgraded with the
exception of the Company's point of sale ("POS") software used for invoicing and
inventory maintenance in the Company's Texas locations.
The installation of the POS system in the Company's remaining nineteen
distribution units was delayed until after the conversion and testing of the Y2K
compliant version of the software. The conversion in the Fort Worth location is
currently in process and all Texas locations should be on the Y2K compliant
version by the end of March 1999. Installation in the remaining locations is
scheduled to be completed by October 31, 1999.
The Company has appointed a Y2K committee composed of senior executives
and middle management. This committee is charged with testing systems for
potential Y2K problems missed in the preliminary review and remediation process
as well as assessment of potential risks from the Company's trading partners'
Y2K failures. This committee will report periodically to the Company's Board of
Directors and currently expects testing to be completed by October 31, 1999.
The Company has managed its Y2K compliance program using mostly
internal salaried staff. For this reason and the fact that much of the
replacement cost of non-compliant IT systems would have been incurred anyway, it
is difficult to quantify the actual remediation costs. The Company spent $34,185
in 1998 for new computer systems and acquired an additional $226,741 in new
equipment and software in January 1999. This investment includes systems
upgrades which will facilitate completion of the Y2K compliance program. It is
believed that the majority of the total expected remediation costs have already
been incurred.
The Company believes because of the nature of its operations and the
steps taken as discussed above that the Y2K issue will not have a material
impact on the Company's results of operations, liquidity, or financial
condition. Actual results may differ from the forward-looking statements
contained in this discussion and there can be no guarantee that the failure of
certain systems will not have a material adverse effect on the Company.
In the unlikely event that unforeseen Y2K problems are not remedied
prior to a disruption in normal business operations, the Company would in most
instances be able to temporarily revert to manual processes that the Company
successfully used prior to automating many routine tasks.
Cautionary Statement
The disclosures under "-Results of Operations"; "-Capital Resources and
Liquidity"; "Year 2000 Issue" and in the Notes to Consolidated Financial
Statements as provided elsewhere herein contain forward-looking statements and
projections of management. There are certain important factors which could cause
results to differ materially than those anticipated by some of the
forward-looking statements. Some, but not all, of the important factors which
could cause actual results to differ materially from those in the
forward-looking statements include, among other things, changes from anticipated
levels of sales, whether due to future national or regional economic and
competitive conditions, including, but not limited to, retail craft buying
patterns, and possible negative trends in the craft and western retail markets,
customer acceptance of existing and new products, or otherwise, pricing
pressures due to competitive industry conditions, increases in prices for
leather, which is a world-wide commodity, which for some reason, may not be
passed on to the customers of the Company's products, change in tax rates,
change in interest rates, change in the commercial banking environment, the
Company's or its significant trading partners' inability to identify all Y2K
issues, problems with the importation of the products which the Company buys in
14 countries around the world, including, but not limited to, transportation
problems or changes in the political climate of the countries involved,
including the maintenance by said countries of Most Favored Nation status with
the United States of America, and other uncertainties, all of which are
difficult to predict and many of which are beyond the control of the Company.
15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
The Compnay's Senior Debt Facility includes loans with interest rates
that vary with changes in the prime rate. An increase of one percentage point
in the prime rate would not have a material impact on the Company's future
earnings.
Item 8. Financial Statements and Supplementary Data.
The Financial Statements and Financial Statement Schedule are filed as
a part of this report. See page 17, Index to Consolidated Financial Statements.
Item 9. Change In and Disagreements with Accountants on Accounting and
Financial Disclosure.
A. Change in Accountants - During the quarter ended September 30, 1998,
the Company filed a Current Report on Form 8-K dated July 20, 1998 to disclose,
pursuant to item 4, a change in the Company's independent accountant. No
financial statements were filed.
B. Disagreements with Accountants - None
16
THE LEATHER FACTORY, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Consolidated Balance Sheets at December 31, 1998 and 1997.............................................. 18
Consolidated Statements of Operations For the Years Ended December 31, 1998, 1997 and 1996 ............ 19
Consolidated Statements of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996............. 20
Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 1998, 1997 and 1996... 21
Notes to Consolidated Financial Statements............................................................. 22-30
Financial Statement Schedules for the years ended December 31, 1998 and 1997:
II--Valuation and Qualifying Accounts and Reserves............................................ 31
All other schedules are omitted since the required information is not
present or is not present in amounts sufficient to require submission of the
schedule or because the information required is included in the consolidated
financial statements and notes thereto.
Reports of Independent Auditors ....................................................................... 32-33
17
THE LEATHER FACTORY, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
1998 1997
------------ ------------
ASSETS
CURRENT ASSETS:
Cash $ 510,399 $ 70,496
Cash restricted for payment on revolving credit facility 232,838 319,133
Accounts receivable-trade, net of allowance for
doubtful accounts of $52,000 and $28,000
in 1998 and 1997, respectively 1,582,459 1,865,276
Inventory 6,956,606 7,279,702
Prepaid income taxes 228,939 285,970
Deferred income taxes 102,012 109,411
Other current assets 272,993 385,199
------------ ------------
Total current assets 9,886,246 10,315,187
------------ ------------
PROPERTY AND EQUIPMENT, at cost 2,671,827 2,534,839
Less: accumulated depreciation and amortization (1,813,378) (1,505,098)
------------ ------------
Property and equipment, net 858,449 1,029,741
GOODWILL and other, net of accumulated amortization of
$1,246,000 and $878,000 in 1998 and 1997, respectively 5,285,242 5,679,621
------------ ------------
$ 16,029,937 $ 17,024,549
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 1,019,069 $ 942,046
Accrued expenses and other liabilities 530,789 559,776
Notes payable and current maturities of
long-term debt 6,139,327 4,650,742
------------ ------------
Total current liabilities 7,689,185 6,152,564
------------ ------------
DEFERRED INCOME TAXES 109,085 136,611
NOTES PAYABLE AND LONG-TERM DEBT,
net of current maturities 61,389 2,602,728
COMMITMENTS AND CONTINGENCIES (Note 6)
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, 9,853,161 shares issued in 1998 and 1997 23,648 23,648
Paid-in capital 3,901,740 4,119,915
Retained earnings 4,495,378 4,534,569
Less: Notes receivable - secured by common stock (224,750) (257,617)
Accumulated other comprehensive loss (25,738) (14,018)
Less: Unearned shares held by ESOP, 0 and
54,262 shares in 1998 and 1997, respectively -- (273,851)
------------ ------------
Total stockholders' equity 8,170,278 8,132,646
------------ ------------
$ 16,029,937 $ 17,024,549
============ ============
The accompanying notes are an integral part of these financial statements.
18
THE LEATHER FACTORY, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
------------ ------------ ------------
NET SALES $ 22,163,994 $ 25,399,116 $ 28,253,632
COST OF SALES 12,428,324 14,844,376 17,689,973
------------ ------------ ------------
Gross profit 9,735,670 10,554,740 10,563,659
OPERATING EXPENSES 8,890,045 9,365,673 10,869,359
------------ ------------ ------------
INCOME (LOSS) FROM OPERATIONS 845,625 1,189,067 (305,700)
OTHER (INCOME) EXPENSE:
Interest expense 1,003,649 867,548 1,007,544
Other, net (33,310) 19,995 (6,940)
------------ ------------ ------------
Total other (income) expense 970,339 887,543 1,000,604
------------ ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES (124,715) 301,524 (1,306,304)
PROVISION (BENEFIT) FOR INCOME TAXES (85,524) 231,232 (316,536)
------------ ------------ ------------
NET INCOME (LOSS) $ (39,191) $ 70,292 $ (989,768)
============ ============ ============
EARNINGS (LOSS) PER COMMON SHARE $ (.00) $ .01 $ (0.10)
============ ============ ============
EARNINGS (LOSS) PER COMMON SHARE--Assuming Dilution $ (.00) $ .01 $ (0.10)
============ ============ ============
DIVIDENDS PAID PER COMMON SHARE $ -- $ -- $ --
============ ============ ============
The accompanying notes are an integral part of these financial statements.
19
THE LEATHER FACTORY, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996
----------- ----------- -----------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ (39,191) $ 70,292 $ (989,768)
Adjustments to reconcile net income to net
cash provided by (used in) operating activities-
Depreciation and amortization 527,443 523,551 638,450
(Gain) loss on sales of assets (9,118) 46,950 (7,541)
Deferred financing costs 233,239 32,113 156,891
Deferred income taxes (12,944) 16,845 13,479
Other 7,671 1,150 785,
Net changes in operating assets and liabilities, net of effect of
acquisitions:
Accounts receivable-trade, net 282,817 82,422 814,870
Inventory 323,096 457,618 241,843
Income taxes 57,031 252,488 (383,199)
Other current assets 112,206 157,610 130,683
Accounts payable 77,023 1,497 (458,368)
Accrued expenses and other liabilities (28,987) (37,231) (58,482)
----------- ----------- -----------
Total adjustments 1,569,477 1,535,013 1,089,411
----------- ----------- -----------
Net cash provided by operating activities 1,530,286 1,605,305 99,643
----------- ----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property and equipment (137,828) (239,578) (208,537)
Proceeds from sales of assets 10,000 257,306 10,444
Cash paid for acquisitions, net of cash acquired -- -- (300,000)
Other intangible costs (1,728) (32,061) (24,788)
----------- ----------- -----------
Net cash used in investing activities (129,556) (14,333) (522,881)
----------- ----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in revolving credit loans (432,531) (1,469,481) 2,000,000
Increase (decrease) in notes payable and other borrowings
Receipts -- 3,001,396 --
Payments (620,223) (3,083,189) (1,296,424)
(Increase) decrease in cash restricted for payment on revolving 86,295 (319,133) --
credit facility
Payments received (purchase) of notes receivable -
secured by common stock 32,867 11,688 (269,305)
Deferred financing costs (27,235) (149,949) --
----------- ----------- -----------
Net cash provided by (used in) financing activities (960,827) (2,008,668) 434,271
----------- ----------- -----------
NET INCREASE (DECREASE) IN CASH 439,903 (417,696) 11,033
CASH, beginning of year 70,496 488,192 477,159
----------- ----------- -----------
CASH, end of year $ 510,399 $ 70,476 $ 488,192
=========== =========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Interest paid during the year $ 787,148 $ 749,472 $ 793,373
Income taxes paid during the year, net of (refunds) (117,609) (38,101) 55,445
The accompanying notes are an integral part of these financial statements.
20
THE LEATHER FACTORY, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31,1998,1997 AND 1996
Common Stock Notes Accumulated
--------------------- Receivable Other
Number Par Paid-in Retained - Secured by Comprehensive
of Shares Value Capital Earnings Common Stock Loss
---------- ---------- ----------- ---------- ------------ -------------
BALANCE, December 31, 1995 9,853,161 $ 23,648 $ 4,130,796 $ 5,454,045 $ - $ -
Notes receivable - secured
by common stock - - - - (269,305) -
Net loss - - - (989,768) - -
Translation adjustment - - - - - (295)
--------- --------- ----------- ---------- ---------- -----------
BALANCE, December 31, 1996 9,853,161 23,648 4,130,796 4,464,277 (269,305) (295)
Payments on notes receivable -
secured by common stock - - - - 11,688 -
Allocation of suspended ESOP
shares committed to be released - - (45,881) - - -
Warrants to acquire 100,000 shares
of common stock issued - - 35,000 - - -
Net Income - - - 70,292 - -
Translation adjustment - - - - - (13,723)
--------- --------- ----------- ---------- ---------- -----------
BALANCE, December 31, 1997 9,853,161 23,648 4,119,915 4,534,569 (257,617) (14,018)
Payments on notes receivable -
secured by common stock - - - - 32,867 -
Allocation of suspended ESOP
shares committed to be released - - (258,175) - - -
Warrants to acquire 200,000 shares
of common stock issued - - 40,000 - - -
Net Loss - - - (39,191) - -
Translation adjustment - - - - - (11,720)
--------- --------- ----------- ---------- ---------- -----------
BALANCE, December 31, 1998 9,853,161 $ 23,648 $ 3,901,740 $4,495,378 $ (224,750) $ (25,738)
========= ========= =========== ========== ========== ===========
Unearned Comprehensive
ESOP Income
Shares Total (Loss)
---------- ---------- -------------
BALANCE, December 31, 1995 $ (326,184) $ 9,282,305
Notes receivable - secured
by common stock - (269,305)
Net loss - (989,768) $ (989,768)
Translation adjustment - (295) (295)
---------- -----------
BALANCE, December 31, 1996 (326,184) 8,022,937
----------
Comprehensive income (loss) for the year ended December 31, 1996 (990,063)
Payments on notes receivable -
secured by common stock - 11,688
Allocation of suspended ESOP
shares committed to be release 52,333 6,452
Warrants to acquire 100,000 shares
of common stock issued - 35,000
Net Income - 70,292 70,292
Translation adjustment - (13,723) (13,723)
---------- -----------
BALANCE, December 31, 1997 (273,851) 8,132,646
----------
Comprehensive income (loss) for the year ended December 31, 1997 56,569
Payments on notes receivable -
secured by common stock - 32,867
Allocation of suspended ESOP
shares committed to be release 273,851 15,676
Warrants to acquire 200,000 shares
of common stock issued - 40,000
Net Loss - (39,191) (39,191)
Translation adjustment - (11,720) (11,720)
---------- -----------
BALANCE, December 31, 1998 $ - $ 8,170,278
========== ===========
----------
Comprehensive income (loss) for the year ended December 31, 1998 $ (50,911)
==========
The accompanying notes are an integral part of these financial statements.
21
THE LEATHER FACTORY, INC.
NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
1. ORGANIZATION AND NATURE OF OPERATIONS
The Leather Factory, Inc. and subsidiaries (the "Company") operations include
the manufacture, distribution, importation, and exportation of leather,
leatherworking tools, buckles and other belt supplies, shoe care and repair
supplies, leather dyes and finishes, adornments for belts, bags, and garments,
saddle and tack hardware, and do-it-yourself kits. The Company through its
subsidiary, Roberts, Cushman & Company, Inc., is also a manufacturer and
distributor of hat trims and small finished leather goods such as cigar cases,
picture frames, wallets, and western accessories. As of December 31, 1998, the
Company had 22 sales/distribution units in 17 states and Canada, including
Arizona, California, Colorado, Florida, Iowa, Kansas, Louisiana, Michigan,
Missouri, New Mexico, North Carolina, Ohio, Pennsylvania, Tennessee, Texas,
Utah, Washington, and Winnipeg. The Company also has light manufacturing
facilities In Fort Worth, Texas and Long Island City, New York.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Consolidation
The consolidated financial statements include the accounts of the Company and
its subsidiaries, all of which are wholly-owned. Significant intercompany
accounts and transactions have been eliminated in consolidation. Certain prior
year amounts have been reclassified to conform to the current year presentation.
Inventory
The Company's inventory is valued at the lower of first-in, first-out cost or
market and consists of the following at December 31:
1998 1997
----------- -----------
Finished goods held for sale $ 5,564,406 $ 5,833,002
Raw materials and work in process 1,392,200 1,446,700
----------- -----------
$ 6,956,606 $ 7,279,702
=========== ===========
Property and Equipment
Property and equipment are stated at cost. Expenditures for maintenance and
repairs are charged to expense when incurred. The cost of assets retired or sold
and the related amounts of accumulated depreciation are removed from the
accounts, and any gain or loss is included in the statement of income.
Depreciation is determined using the straight-line method over the estimated
useful lives as follows:
Building 30 years
Leasehold improvements 5-7 years
Equipment 5-10 years
Furniture and fixtures 5-7 years
Automobiles 5 years
Depreciation expense was $308,568; $303,867; and $277,994 for the years ended
December 31, 1998, 1997 and 1996, respectively.
Goodwill
Goodwill resulting from business purchases accounted for using the purchase
method of accounting is being amortized on a straight-line basis over estimated
useful lives ranging from ten to forty years.
22
Acquisitions to date have not involved any significant long-lived assets other
than goodwill. Accordingly, the Company evaluates such goodwill for impairment
in accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 17, "Intangible Assets." During 1996, the Company determined that the
goodwill associated with the acquisition of Hi-Line Leather and Manufacturing
Co., Inc. in 1994 was impaired, and should be reduced by fifty percent or
approximately $142,000. This conclusion was reached due to the fact that the
customer base acquired in the purchase transaction had declined substantially,
and the operating results of the location since the acquisition had not met
expectations. Based upon the assessment of possible future cash flows and the
fact that business conditions could improve, management believes the remaining
goodwill is recoverable and the amortization period remains appropriate.
Amortization expense of $218,875 in 1998; $219,684 in 1997; and $360,456 in 1996
was recorded in operating expenses including the above write-down.
Advertising Costs
With the exception of catalog costs, advertising costs are expensed as incurred.
Catalog costs are capitalized and expensed over the estimated useful life of the
particular catalog in question, which is typically twelve to fifteen months.
Such capitalized costs are included in other current assets and totaled $17,809
and $39,350 at December 31, 1998 and 1997, respectively. Total advertising
expense was $908,432 in 1998; $1,002,623 in 1997; and $1,089,716 in 1996.
Revenue Recognition
Sales are recorded when goods are shipped to customers.
Income Taxes
Deferred income taxes result from temporary differences in the basis of assets
and liabilities reported for financial statement and income tax purposes.
Earnings Per Share
In 1997, the Financial Accounting Standards Board ("FASB") issued Statement of
Financial Accounting Standards ("SFAS") No. 128, Earnings per Share. SFAS No.
128 replaced the calculation of primary and fully diluted earnings per share
with basic and diluted earnings per share. Unlike primary earnings per share,
basic earnings per share excludes any dilutive effects of options, warrants and
convertible securities. Diluted earnings per share is very similar to the
previously reported fully diluted earnings per share. All earnings per share
amounts for all periods have been presented to conform to SFAS No. 128
requirements. The adoption of SFAS No. 128 had no effect on previously reported
amounts as the effects of outstanding options were antidilutive for all prior
periods presented. Unearned shares held by the Employees' Stock Ownership Plan
are deemed not to be outstanding for earnings per share calculations.
Accounting Estimates
The consolidated financial statements include estimates and assumptions made by
management that affect the reported amounts of assets and liabilities, the
reported amounts of revenues and expenses and the disclosure of contingent
assets and liabilities. Actual results could differ from those estimates.
Long-Lived Assets
The FASB has issued SFAS No. 121, Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed of. SFAS No. 121 requires that
long-lived assets and certain identifiable intangible assets be reviewed for
impairment whenever events indicate that the carrying amount of an asset may not
be recoverable. The Company has determined that as of December 31, 1998, it has
no long-lived assets that meet the impairment criteria of SFAS No. 121.
Stock-Based Compensation
SFAS No. 123, Accounting for Stock-Based Compensation, establishes financial
accounting and reporting standards for stock-based employee compensation plans.
As permitted by SFAS No. 123, the Company has elected to continue to use
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees ("APB 25") and related Interpretations, in accounting for its stock
option plans.
23
3. NOTES PAYABLE AND LONG-TERM DEBT
On November 21, 1997, the Company entered into a Loan and Security Agreement
with FINOVA Capital Corporation ("FINOVA"), pursuant to which FINOVA agreed to
provide a credit facility of up to $9,136,000 in senior debt (the "Senior Debt
Facility"). The Senior Debt Facility has a two year term and is made up of a
revolving credit facility and three term notes. One of the notes (Term Note B)
in the original principal amount of $236,000 was satisfied in its entirety on
December 15, 1997 with the net proceeds from the sale of real estate in Tampa,
Florida.
Simultaneously with the closing of the Senior Debt Facility, the Company also
issued to The Schlinger Foundation at face value $1,000,000 in subordinated
convertible debt (the "Subordinated Debenture").
Proceeds of the closing of the Senior Debt Facility in the amount of $6,417,563,
together with the $1,000,000 of proceeds from the Subordinated Convertible
Debenture, were used to pay all amounts due and owing by the Company pursuant to
the Second Restated Loan Agreement, as amended, by and between the Company and
NationsBank of Texas, N.A. ("NationsBank"). At closing, the Company's revolving
line of credit and term loan facility with NationsBank in the principal amounts
of $5,125,000 and $2,200,000, respectively, were satisfied in their entirety.
The Company used the remaining proceeds to pay certain closing and financing
costs.
At December 31, 1998 and 1997, the amounts outstanding under the above
agreements and other long-term debt consisted of the following:
1998 1997
---- ----
Loan & Security Agreement with FINOVA - collateralized by all of the assets of
the Company as well as a pledge of 3,000,000 shares of the Company's common
stock, par value $.0024 ("Common Stock"), collectively owned by two of the
Company's executive officers; payable as follows:
Promissory Note (Revolving Credit Loan) dated November 21, 1997 in the
maximum principal amount of $7,000,000 with revolving features as more
fully described below -- interest due monthly at prime plus 1% (8.75% at
December 31, 1998); matures December 1, 1999 $ 3,597,988 $ 4,030,519
Promissory Note (Term Loan A) dated November 21, 1997 in the original
principal amount of $400,000 -- $6,667 monthly principal payments plus
interest at prime plus .75% (8.5% at December 31, 1998); matures December
1, 1999 320,000 400,000
Promissory Note (Term Loan C) dated November 21, 1997 in the original
principal amount of $1,500,000 -- $25,000 monthly principal payments plus
interest at prime plus 3% (10.75% at December 31, 1998); matures December
1, 1999 1,200,000 1,500,000
Short-term note payable for facility fee -- monthly installments of
$5,833; matures November 1, 1998* - 64,167
Unsecured short-term note payable to third party in connection with Closing the
Senior Debt facility -- monthly installments of $14,000; matures October
1, 1998* - 140,000
Subordinated Debenture in the original principal amount of $1,000,000; partially
convertible; secured by a pledge of 2,666,666 shares of the Company's Common
Stock owned by another executive officer - monthly interest payments at 13%;
matures December 1, 1999 1,000,000 1,000,000
Unsecured note payable created in connection with the acquisition of the assets
of The Leather Warehouse in 1994 -- $4,424 payments of principal and interest
due monthly at prime (8.5% at December 31, 1997); matures April 1, 1998 - 17,388
24
1998 1997
---- ----
Capital Leases secured by computer equipment - total monthly principal and
interest payments of $2,599 at approximately 13.5% interest; maturing in
February through August of 2002 82,728 101,396
----------- -----------
6,200,716 7,253,470
Less - Current maturities (see below) 6,139,327 4,650,742
----------- -----------
$ 61,389 $ 2,602,728
=========== ===========
The current portion of long-term debt for 1997 includes the FINOVA Revolving
Credit Loan of $4,030,519 although this obligation does not mature until
December 1, 1999. The classification of this debt was attributable to an
accounting rule that requires a revolving credit agreement that includes both a
subjective acceleration clause and a requirement to maintain an arrangement,
whereby cash collections from the borrower's customers directly reduce the debt
outstanding, to be classified as a short-term obligation (Emerging Issues Task
Force Issue 95-22). A covenant of the Senior Debt Facility is that collections
from customers are to be deposited into a cash collateral account that directly
pays down the Revolving Credit Loan. The balance in this account comprises the
restricted cash on the Company's balance sheet. Because of this arrangement and
the fact that the debt agreement contains a clause that would allow acceleration
of payment of the debt in case of a "material adverse change, this rule applies.
Management does not believe that any such acceleration will occur.
In addition to the above obligations, the Company had outstanding letters of
credit for inventory purchase commitments with terms ranging from sight to 90
days. As of December 31, 1998, and 1997 the Company had $0 and $260,089,
respectively, in outstanding purchase commitments on these letters of credit.
Pursuant to the Loan and Security Agreement with FINOVA, the overall combined
limit for borrowings under the Revolving Credit Loan and outstanding balance on
letters of credit is $7,000,000. Of the overall $7,000,000 limit, letters of
credit cannot exceed $1,000,000. The unused portion of the letter of credit
limit can be utilized for borrowings, up to the limits imposed for said
indebtedness. Total borrowings under this arrangement are also limited to a
certain percentage of trade accounts receivable and inventory reduced by the
outstanding balance of letters of credit and any required reserves. Additional
availability at December 31, 1998, under the Revolving Credit Loan and for
letters of credit was $475,266.
At any time before maturity of the Subordinated Debenture, the holder may, at
its option, satisfy 50% or $500,000 of the principal amount by converting into
shares of the Company's Common Stock at $0.724 per share.
The terms of the Senior Debt Facility and the Subordinated Debenture contain
various covenants which among other things require the Company to maintain a
certain level of earnings before interest, taxes, depreciation and amortization,
limit capital expenditures, and require the maintenance of certain debt service
coverage ratios. Other covenants prohibit the Company from incurring
indebtedness except as permitted by the terms of the Senior Debt Facility, from
declaring or paying cash dividends upon any of it stock and from entering into
any new business or making material changes in any of the Company's business
objectives, purposes or operations.
The Company's long-term debt matures as follows:
1999 $ 6,139,327
2000 24,393
2001 27,884
2002 9,112
2003 -
-----------
$ 6,200,716
===========
In January 1999 the Company entered into three capital leases secured by
computer equipment costing $226,761 with total monthly principal and interest
payments of $6,891, an average interest rate of 9.7%, and maturing December
2001.
*The short-term notes for the fees related to the closing of the Senior Debt
Facility were issued for services rendered in the original amount of $238,000
and constitute a non-monetary transaction.
25
4. EMPLOYEE BENEFIT PLAN
The Company has an Employee Stock Ownership Plan (the "Plan") for employees with
at least one year of service (as defined by the Plan) and who have reached their
21st birthday. Under the Plan, the Company makes annual cash or stock
contributions to a trust for the benefit of eligible employees. The trust
invests in shares of the Company's common stock. The amount of the Company's
annual contribution is discretionary. Benefits under the Plan are 100% vested
after three years of service and are payable upon death, disability or
retirement. Vested benefits are payable upon termination of employment.
During 1994, the Company adopted Statement of Position 93-6 ("SOP 93-6"),
"Employers' Accounting for Employee Stock Ownership Plans," of the Accounting
Standards Division of the American Institute of CPAs, issued in November 1993.
Contributions made during 1994 and 1995 in the amount of $99,962 and $226,222,
respectively, represented securities acquisition loans. In accordance with SOP
93-6, securities purchased with these loans have been recorded as unearned ESOP
shares. The unearned ESOP share account is reduced by the cost of the shares
when they are committed to be released to participants as payments are made on
the loans using the principal and interest method. Compensation expense is
measured using the average fair market value when shares are committed to be
released to the employee. The Company contributed $125,408; $50,910; and $27,500
in cash as current year contributions to the plan during 1998, 1997 and 1996,
respectively, and recognized compensation expense related to these payments of
$42,046; $53,968; and $27,500 in 1998, 1997, and 1996, respectively.
Furthermore, on January 21, 1999, the Company made an additional contribution to
the Plan for December 1998 in the amount of $261,920. As a result of this
contribution, the Company recognized an additional compensation expense of
$10,538 during 1998 relating to the Plan.
The following table summarizes the number of shares held by the Plan and the
market value as of December 31, 1998, 1997 and 1996:
No. of Shares Market Value
------------- ------------
1998 1997 1996 1998 1997 1996
----- ---- ---- ---- --- ----
Allocated 692,606 652,609 681,547 $173,152 $ 326,305 $ 554,098
Unearned - 54,262 64,631 - 27,131 52,545
------------------------------ ---------------------------------------
Total 692,606 706,871 746,178 $173,152 $ 353,436 $ 606,643
============================== =======================================
The Company currently offers no postretirement or postemployment benefits to its
employees.
5. INCOME TAXES
The provision for income taxes consists of the following:
1998 1997 1996
---- ----- ----
Current provision (benefit):
Federal $ (60,240) $ 174,469 $ (282,917)
State (12,340) 39,918 (47,098)
---------- --------- ----------
(72,580) 214,387 (330,015)
---------- --------- ----------
Deferred provision (benefit):
Federal (10,900) 14,185 11,351
State (2,044) 2,660 2,128
---------- --------- ----------
(12,944) 16,845 13,479
---------- --------- ----------
$ (85,524) $ 231,232 $ (316,536)
========== ========= ==========
Deferred taxes relate primarily to temporary differences in the bases of
accounts receivable, inventory, property and equipment and accrued expenses.
The effective tax rate differs from the statutory rate as follows:
1998 1997 1996
---- ---- ----
Statutory rate (34%) 34% (34%)
State taxes (8%) 10% (3%)
Non-deductible goodwill amortization 68% 26% 10%
ESOP transaction (112%) - -
Other 17% 7% 3%
========================
Effective rate (69%) 77% (24%)
========================
26
6. COMMITMENTS AND CONTINGENCIES
Operating Leases
The Company's primary office facility and warehouse are leased under a five-year
lease agreement that expires in March 2003. Rental agreements for the
sales/distribution units expire on dates ranging from March 1999 to July 2004.
The Company's lease agreement for the manufacturing facility in Long Island
City, New York, expires on June 30, 2003. Future minimum lease payments for all
noncancellable operating leases are as follows:
Year Ending December 31,
1999 $ 990,811
2000 869,127
2001 750,576
2002 706,367
2003 345,573
2004 and thereafter 79,165
-----------
Total future minimum lease payments $ 3,741,619
===========
Rent expense on all operating leases for the years ended December 31, 1998, 1997
and 1996, was $1,017,491; $1,036,892; and $1,008,458, respectively.
Litigation
The Company has litigation in the ordinary course of its business and
operations. The Company does not expect the outcome of any current litigation to
have a material impact on its financial position and results of operations.
7. Major Vendors
Two major vendors accounted for 17% and 6%, respectively, of the Company's 1998
inventory purchases. These same vendors accounted for 17% and 8%, respectively,
of 1997 inventory purchases, and 16% and 10%, respectively, of 1996 inventory
purchases. Due to the number of alternative sources of supply, it is
management's opinion that the loss of either or both of these principal
suppliers would not have a material impact on the operations of the Company.
8. EARNINGS PER SHARE
The following table sets forth the computation of basic and diluted earnings per
share:
1998 1997 1996
------------- -------------- -------------
Numerator:
Net income (loss) $ (39,191) $ 70,292 $ (989,768)
------------- ------------- -------------
Numerator for basic and diluted earnings per
share (39,191) 70,292 (989,768)
Denominator:
Denominator for basic earnings per share --
weighted-average shares 9,803,887 9,789,358 9,788,530
Effect of dilutive securities:
Employee stock options - 25 -
Warrants - 2,182 -
------------- ------------- -------------
Dilutive potential common shares - 2,207 -
------------- ------------- -------------
Denominator for diluted earnings per share--
adjusted weighted-average shares and
assumed conversions
9,803,887 9,791,565 9,788,530
============= ============= =============
Basic earnings per share $ (0.00) $ 0.01 $ (0.10)
============= ============= =============
Diluted earnings per share $ (0.00) $ 0.01 $ (0.10)
============= ============= =============
27
For additional disclosures regarding the employee stock options and the
warrants, see note 9. The options outstanding discussed in note 9 were not
included in the computation of diluted earnings per share because the options'
exercise price was greater than the average market price of the common shares
and, therefore, the effect would be antidilutive.
The 13% convertible debt discussed in note 3 above was not included in the
computation of diluted earnings per share because the interest cost (net of tax)
per assumed converted share was more than basic earnings per share and,
therefore, the effect would be antidilutive.
Subsequent to year-end 1998, options to acquire 100,000 shares under the 1995
Stock Option Plan for officers and key management employees expired.
9. STOCKHOLDERS' EQUITY
Stock Option Plans
The Company has outstanding options to purchase its common stock under The 1995
Stock Option Plan for officers and key management employees and The 1995
Director Non-qualified Stock Option Plan for non-employee directors. The plan
for employees provides for the granting of either qualified incentive stock
options or non-qualified options at the discretion of the Compensation Committee
of the Board of Directors. Options are granted at the fair market value of the
underlying common stock at the date of grant. Employee options vest over a
five-year period while the director options vest after six months. All options
expire ten years from the date of grant and are exercisable at any time after
vesting. The Company has reserved 1,100,000 shares of common stock for issuance
under these plans, and at December 31, 1998, 1997 and 1996, there were 557,000;
534,000; and 590,000; respectively, in un-optioned shares available for future
grants.
A summary of the Company's stock option activity and related information for the
years ended December 31, 1998, 1997 and 1996, is as follows:
1998 1997 1996
------------------------ ---------------------- -----------------------
Weighted Weighted Weighted
Average Average Average
Option Exercise Option Exercise Option Exercise
Shares Price Shares Price Shares Price
------------ ----------- ----------- ----------- ---------- ----------
Outstanding at January 1 566,000 $0.874 510,000 $ 2.653 $ 3.063
585,000
Granted * 108,000 0.500 456,000 0.805 106,000 1.088
Forfeited (131,000) 1.047 (181,000) 3.063
Exchanged * (400,000) 3.063
Exercised
------------ ----------- ----------- ----------- ---------- ---------
Outstanding at December 31 543,000 $0.758 566,000 $ 0.874 510,000 $ 2.653
============ =========== =========== =========== ========== =========
Exercisable at end of year 255,000 $0.838 190,000 $ 0.908 84,000 $ 3.063
============ =========== =========== =========== ========== ==========
Weighted-average fair value of
options granted during year $ 0.31 $ 0.31 $ 0.52
=========== =========== ==========
* In 1997, options originally granted in 1995 were canceled and reissued. This
action was taken to provide incentive to and in order to retain the Company's
key management personnel in light of the severe decline in the market price for
the Company's common stock.
The following table segregates outstanding options into groups based upon
exercise price ranges.
Outstanding Exercisable
------------------------------------ ------------------------------------
Weighted Weighted Weighted Weighted
Average Average Average Average
Option Exercise Maturity Option Exercise Maturity
Exercise Price Range Shares Price (Years) Shares Price (Years)
--------------------
------------- ---------- ---------- ------------- ----------- -----------
$0.75 or Less 137,000 $ 0.542 9.05 9,000 $ 0.715 8.74
More than $0.75 &
Less Than $1.00 400,000 0.813 6.74 240,000 0.813 6.74
More than $1.00 6,000 2.021 7.41 6,000 2.021 7.41
------------- ---------- ---------- ------------- ----------- -----------
543,000 $ 0.758 7.33 255,000 $ 0.838 6.83
============= ========== ========== ============= =========== ===========
28
Pro forma information regarding net income (loss) and earnings (loss) per share
is required by SFAS No. 123, and has been determined as if the Company had
accounted for its stock options under the fair value method. The fair value for
these options was estimated at the date of grant using the Black Scholes option
pricing model with the following weighted-average assumptions: risk-free
interest rates of 5.00% in 1998; 6.64% in 1997; and 6.72% 1996; dividend yields
of 0% for all years; volatility factors of .693 for 1998, .550 for 1997 and .439
for 1996; and an expected life of the valued options of 5 years for all years
other than the exchanged options reissued in 1997 which have an expected
remaining life of 4 years.
Option valuation models require the input of highly subjective assumptions,
including the expected stock price volatility, and changes in these input
assumptions can materially affect the fair value estimate they produce. Because
of this, it is management's opinion that existing models do not necessarily
provide a reliable single measure of fair value for the Company's stock options.
For pro forma disclosures, the estimated fair values determined by the model are
being amortized to expense on a straight-line basis over the options vesting
period as adjusted for estimated forfeitures. The Company's pro forma
information follows:
1998 1997 1996
------------ ---------- -------------
Pro forma net income (loss) $ (192,441) $ (76,117) $ (1,057,818)
Pro forma net income (loss) per common share $ (.02) $ (.01) $ (0.11)
Pro forma net income (loss) per common share-- $ (.02) $ (.01) $ (0.11)
Assuming Dilution
Warrants
In connection with the issuance of the Subordinated Debenture discussed in note
3 above, the Company issued warrants to acquire up to 100,000 shares of Common
Stock at $.54 per share to an unrelated individual. The warrants may be
exercised at anytime until expiration on November 21, 2002. The fair value for
these warrants was estimated at the date of grant using the Black Scholes option
pricing model with the following weighted-average assumptions: risk-free
interest rate of 6.5%; dividend yield of 0%; volatility factor of .550; and an
expected life of 3 years
Warrants to acquire up to 200,000 shares of common stock at approximately $0.44
per share were issued to an unrelated individual in August 1998. The warrants
may be exercised at anytime until expiraton on August 3, 2003. The fair value
for these warrants was estimated at the date of grant using the Black Scholes
option pricing model with the following weighted-average assumptions: risk-free
interest rate of 5.0%; dividend yield of 0%; volatility factor of .645; and an
expected life of 3 years.
Notes Receivable Secured by Common Stock
During 1996, the Company purchased certain notes from NationsBank that are
collateralized by the Company's common stock. These notes relate to shares
issued under the Company's 1993 Non-Qualified Incentive Stock Option Plan. These
notes, as renewed in 1997, are due from seven individuals including officers and
other members of management, require monthly payments, and mature on December
31, 2000.
10. ACQUISITIONS
On March 1, 1996, the Company acquired all of the issued and outstanding shares
of capital stock of The Leather Factory of Canada, Ltd., the Company's Canadian
distributor located in Winnipeg, Manitoba. The total purchase price was
approximately $300,000 which was funded with cash generated from operations and
the Company's revolving credit facility. For financial reporting purposes, the
transaction was accounted for under the purchase method, effective March 1,
1996.
11. FAIR VALUE OF FINANCIAL INSTRUMENTS
Cash and accounts receivable-trade
The carrying amount approximates fair value because of the short maturity of
those instruments.
Accounts payable
The carrying amount approximates fair value because of the short maturity of
those instruments.
Notes payable and long-term debt
With the exception of the Subordinated Debenture, the interest rates on the
Company's notes payable and long-term debt fluctuate with changes in the prime
rate and are the rates currently available to the Company; therefore, the
carrying amount of those instruments approximates their fair value.
The terms of the Subordinated Debenture are the terms management believes would
be currently available to the Company for this type of financing; therefore, the
carrying amount approximates fair value.
29
12. QUARTERLY FINANCIAL DATA (UNAUDITED)
First Second Third Fourth
1998 Quarter Quarter Quarter Quarter
- ----------------------------- ----------------------------------------------------------------------
Net sales $ 5,710,832 $ 5,471,463 $ 5,628,895 $ 5,352,804
Gross profit 2,414,694 2,426,840 2,482,248 2,411,888
Net income (loss) (88,528) (33,544) 5,914 76,967
Net income (loss) per
common share:
Basic (0.01) - - 0.01
Diluted (0.01) - - 0.01
Weighted average number
of common shares
outstanding:
Basic 9,799,404 9,802,259 9,805,385 9,808,501
Diluted 9,799,404 9,802,259 9,805,385 9,808,501
First Second Third Fourth
1997 Quarter Quarter Quarter Quarter
- ----------------------------- ----------------------------------------------------------------------
Net sales $ 6,459,892 $ 6,526,992 $ 6,353,582 $ 6,058,650
Gross profit 2,563,811 2,739,284 2,693,991 2,557,654
Net income (loss) (36,185) 87,858 92,439 (73,820)
Net income (loss) per
common share:
Basic - 0.01 0.01 (0.01)
Diluted - 0.01 0.01 (0.01)
Weighted average number
of common shares outstanding:
Basic 9,788,530 9,788,530 9,788,530 9,791,841
Diluted 9,788,530 9,788,530 9,788,630 9,800,569
30
THE LEATHER FACTORY, INC.
SCHEDULE II - ALLOWANCE FOR DOUBTFUL ACCOUNTS
Years Ended December 31, 1998 and 1997
1998 1997
--------- ---------
Balance at beginning of year $ 28,000 $ 54,000
Additions (reductions) charged to income 3,000 (4,000)
Balances written off, net of recoveries 21,000 (22,000)
--------- ---------
Balance at end of year $ 52,000 $ 28,000
========= =========
31
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
The Leather Factory, Inc.
We have audited the accompanying consolidated balance sheet of The Leather
Factory, Inc. as of December 31, 1998, and the related consolidated statements
of operations, stockholders' equity, and cash flows for the year then ended. Our
audit also included the financial statement schedule referred to in the index at
Item 14(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of The
Leather Factory, Inc. at December 31, 1998, and the consolidated results of its
operations and its cash flows for the year ended December 31, 1998, in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
/s/ Hein + Associates LLP
Dallas, Texas,
February 24, 1999
32
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
The Leather Factory, Inc.
We have audited the accompanying consolidated balance sheet of The Leather
Factory, Inc. as of December 31, 1997 and the related consolidated statements of
operations, stockholders' equity, and cash flows for each of the two years in
the period ended December 31, 1997. Our audits also included the financial
statement schedule referred to in the index at Item 14(a). These financial
statements and schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of The
Leather Factory, Inc. at December 31, 1997, and the consolidated results of its
operations and its cash flows for each of the two years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
Also, in our opinion, the related financial statement schedule, when considered
in relation to the basic financial statements taken as a whole, presents fairly
in all material respects the information set forth therein.
/s/ ERNST & YOUNG LLP
Fort Worth, Texas
March 4, 1998
33
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information required by this item is incorporated by reference to the
material appearing under the heading "Election of Directors" and "Executive
Officers of the Company" in the Proxy Statement for the 1999 Annual Meeting of
Stockholders.
Item 11. Executive Compensation.
Information required by this item is incorporated by reference to the
material appearing under the heading "Executive Compensation" in the Proxy
Statement for the 1999 Annual Meeting of Stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Information required by this item is incorporated by reference to the
material appearing under the heading "Security Ownership of Certain Beneficial
Owners and Management" and "Certain Transactions" in the Proxy Statement for the
1999 Annual Meeting of Stockholders.
Item 13. Certain Relationships and Related Transactions.
Information required by this item is incorporated by reference to the
material appearing under the heading "Certain Transactions" in the Proxy
Statement for the 1999 Annual Meeting of Stockholders.
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) 1. Financial statements and financial statement schedules
---------------------------------------------------------
The financial statements and schedules listed in the accompanying index
to consolidated financial statements at Item 8 are filed as part of this Report.
(a) 2. Exhibits:
------------
The exhibits listed on the accompanying Exhibit Index, which
immediately precedes such exhibits, are filed or incorporated by reference as
part of this Report and such Exhibit Index.
(b) Reports on Form 8-K
-------------------
None.
34
SIGNATURES
In accordance with Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Company caused this Report to be signed on its behalf by the
undersigned, thereunto duly authorized.
THE LEATHER FACTORY, INC.
(Registrant)
Date: March 29, 1999 /s/ Wray Thompson
---------------------------
Wray Thompson
Chairman of the Board, President,
Chief Executive Officer, and Chief
Accounting Officer
In accordance with the Securities Exchange Act of 1934, this Report has
been signed below by the following persons on behalf of the Company and in the
capacities and on the dates indicated.
Signature Title Date
--------- ----- ----
/s/ Wray Thompson Chairman of the Board March 29, 1999
- -------------------
Wray Thompson
/s/ Ronald C. Morgan Director March 29, 1999
- ----------------------
Ronald C. Morgan
/s/ Robin L. Morgan Director March 29, 1999
- ------------------------
Robin L. Morgan
/s/ William M. Warren Director March 29, 1999
- ------------------------
William M. Warren
/s/ H. W. Markwardt Director March 29, 1999
- ------------------------
H. W. Markwardt
/s/ Joseph R. Mannes Director March 29, 1999
- ------------------------
Joseph R. Mannes
/s/ Anthony C. Morton Director March 29, 1999
- ------------------------
Anthony C. Morton
/s/ John Tittle, Jr. Director March 29, 1999
- ------------------------
John Tittle, Jr.
35
THE LEATHER FACTORY, INC. AND SUBSIDIARIES
EXHIBIT INDEX
Exhibit
Number Description
------ -----------
3.1 Certificate of Incorporation of The Leather Factory, Inc.,
filed as Exhibit 3.1 to the Registration Statement on Form
SB-2 of The Leather Factory, Inc. (Commission File No.
33-81132) filed with the Securities and Exchange Commission
on July 5, 1994, and incorporated by reference herein.
3.2 Bylaws of The Leather Factory, Inc., filed as Exhibit 3.2 to
the Registration Statement on Form SB-2 of The Leather
Factory, Inc. (Commission File No. 33-81132) filed with the
Securities and Exchange Commission on July 5, 1994, and
incorporated by reference herein.
4.1 Loan and Security Agreement dated November 21, 1997, by and
between The Leather Factory, Inc., a Delaware corporation,
The Leather Factory, Inc., a Texas corporation, The Leather
Factory, Inc., an Arizona corporation, Hi-Line Leather &
Manufacturing Company, a California corporation, Roberts,
Cushman & Company, Inc., a New York corporation, and FINOVA
Capital Corporation, filed as Exhibit 4.1 to the Current
Report on Form 8-K of The Leather Factory, Inc. (Commission
File No. 1-12368) filed with the Securities and Exchange
Commission on February 6, 1998, and incorporated by reference
herein.
4.2 Revolving Note (Revolving Credit Loan) dated November 21,
1997, in the principal amount of $7,000,000, payable to the
order of FINOVA Capital Corporation, which matures December
1, 1999 filed as Exhibit 4.2 to the Current Report on Form
8-K of The Leather Factory, Inc. (Commission File No.
1-12368) filed with the Securities and Exchange Commission on
February 6, 1998, and incorporated by reference herein.
4.3 Term Loan A Note (Term Loan A) dated November 21, 1997, in
the principal amount of $400,000, payable to the order of
FINOVA Capital Corporation, which matures December 1, 1999
filed as Exhibit 4.3 to the Current Report on Form 8-K of The
Leather Factory, Inc. (Commission File No. 1-12368) filed
with the Securities and Exchange Commission on February 6,
1998, and incorporated by reference herein.
4.4 Term Loan C Note (Term Loan C) dated November 21, 1997, in
the principal amount of $1,500,000, payable to the order of
FINOVA Capital Corporation, which matures December 1, 1999
filed as Exhibit 4.5 to the Current Report on Form 8-K of The
Leather Factory, Inc. (Commission File No. 1-12368) filed
with the Securities and Exchange Commission on February 6,
1998, and incorporated by reference herein.
.
4.5 Subordination Agreement dated November 21, 1997, by and
between FINOVA Capital Corporation, The Schlinger Foundation,
The Leather Factory, Inc., a Delaware corporation, The
Leather Factory, Inc., a Texas corporation, The Leather
Factory, Inc., an Arizona corporation, Hi-Line Leather &
Manufacturing Company, a California corporation, and Roberts,
Cushman & Company, Inc., a New York corporation filed as
Exhibit 4.6 to the Current Report on Form 8-K of The Leather
Factory, Inc. (Commission File No. 1-12368) filed with the
Securities and Exchange Commission on February 6, 1998, and
incorporated by reference herein.
4.6 Pledge Agreement dated November 21, 1997, by and between
Ronald C. Morgan and Robin L. Morgan and FINOVA Capital
Corporation filed as Exhibit 4.7 to the Current Report on
Form 8-K of The Leather Factory, Inc. (Commission File No.
1-12368) filed with the Securities and Exchange Commission on
February 6, 1998, and incorporated by reference herein.
4.7 Patent Security Agreement dated November 21, 1997, by and
between The Leather Factory, Inc., a Delaware corporation,
The Leather Factory, Inc., a Texas corporation, The Leather
Factory, Inc., an Arizona corporation, Hi-Line Leather &
Manufacturing Company, a California corporation, Roberts,
Cushman & Company, Inc., a New York corporation, and FINOVA
Capital Corporation filed as Exhibit 4.8 to the Current
Report on Form 8-K of The Leather Factory, Inc. (Commission
File No. 1-12368) filed with the Securities and Exchange
Commission on February 6, 1998, and incorporated by reference
herein.
36
THE LEATHER FACTORY, INC. AND SUBSIDIARIES
EXHIBIT INDEX (CONTINUED)
Exhibit
Number Description
------- -----------
4.8 Trademark Security Agreement dated November 21, 1997, by and
between The Leather Factory, Inc., a Delaware corporation,
The Leather Factory, Inc., a Texas corporation, The Leather
Factory, Inc., an Arizona corporation, Hi-Line Leather &
Manufacturing Company, a California corporation, Roberts,
Cushman & Company, Inc., a New York corporation, and FINOVA
Capital Corporation filed as Exhibit.4.9 to the Current
Report on Form 8-K of The Leather Factory, Inc. (Commission
File No. 1-12368) filed with the Securities and Exchange
Commission on February 6, 1998, and incorporated by reference
herein.
4.9 Copyright Security Agreement dated November 21, 1997, by and
between The Leather Factory, Inc., a Delaware corporation,
The Leather Factory, Inc., a Texas corporation, The Leather
Factory, Inc., an Arizona corporation, Hi-Line Leather &
Manufacturing Company, a California corporation, Roberts,
Cushman & Company, Inc., a New York corporation, and FINOVA
Capital Corporation filed as Exhibit 4.10 to the Current
Report on Form 8-K of The Leather Factory, Inc. (Commission
File No. 1-12368) filed with the Securities and Exchange
Commission on February 6, 1998, and incorporated by reference
herein.
4.10 Promissory Note (Subordinated Debenture) dated November 14,
1997, in the principal amount of $1,000,000, payable to the
order of The Schlinger Foundation, which matures December 1,
1999 filed as Exhibit 4.11 to the Current Report on Form 8-K
of The Leather Factory, Inc. (Commission File No. 1-12368)
filed with the Securities and Exchange Commission on February
6, 1998, and incorporated by reference herein.
4.11 Pledge and Security Agreement dated November 14, 1997, by and
between The Schlinger Foundation and J. Wray Thompson, Sr.
filed as Exhibit 4.12 to the Current Report on Form 8-K of
The Leather Factory, Inc. (Commission File No. 1-12368) filed
with the Securities and Exchange Commission on February 6,
1998, and incorporated by reference herein.
4.12 Amendment to Loan and Security Agreement dated May 13, 1998,
by and between The Leather Factory, Inc., a Delaware
corporation, The Leather Factory, Inc., a Texas corporation,
The Leather Factory, Inc., an Arizona corporation, Hi-Line
Leather & Manufacturing Company, a California corporation,
Roberts, Cushman & Company, Inc., a New York corporation, and
FINOVA Capital Corporation effective as of March 31,1998
filed as Exhibit 4.15 to the Quarterly Report on Form 10-Q of
The Leather Factory, Inc. (Commission File No. 1-12368) filed
with the Securities and Exchange Commission on May 15, 1998,
and incorporated by reference herein.
4.13 The Leather Factory, Inc. Stock Purchase Warrant for 200,000
shares common stock, $.0024 par value issued to Evert I.
Schlinger dated August 3, 1998 and terminating on August 3,
2003, filed as Exhibit 4.13 to the Quarterly Report on Form
10-Q of The Leather Factory, Inc. (Commission File No.
1-12368) filed with the Securities and Exchange Commission
November 12, 1998, and incorporated by reference herein.
10.1 Letter Agreement for Consulting Services dated July 24, 1998,
by and between The Leather Factory, Inc. and Evert I.
Schlinger, filed as Exhibit 4.13 to the Quarterly Report on
Form 10-Q of The Leather Factory, Inc. (Commission File No.
1-12368) filed with the Securities and Exchange Commission
November 12, 1998, and incorporated by reference herein.
16 Letter addressed to the Securities and Exchange Commission
dated August 5, 1998, from the Company's former auditors,
Ernst & Young LLP, relative to their agreement with the
statements made in Item 4 of to the Current Report on Form
8-K/A of The Leather Factory, Inc. (Commission File No.
1-12368) filed with the Securities and Exchange Commission on
August 6, 1998, and incorporated by reference herein.
21.1 Subsidiaries of the Company, filed as Exhibit No. 22.1 to the
1995 Annual Report on Form 10-KSB of The Leather Factory,
Inc. (Commission File No. 1-12368), filed with the Securities
and Exchange Commission on March 28, 1996, and incorporated
herein by reference.
37
THE LEATHER FACTORY, INC. AND SUBSIDIARIES
EXHIBIT INDEX (CONTINUED)
Exhibit
Number Description
------- -----------
*23.1 Consent of Hein + Associates LLP dated March 26, 1999.
*23.2 Consent of Ernst & Young LLP dated March 26, 1999.
*27.1 Financial Data Schedule
------------
*Filed herewith.
38
EXHIBIT 23.1
39
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-81214) pertaining to the Employee Stock Ownership Plan and Trust of
The Leather Factory, Inc. and the Registration Statement (Form S-8 No.
333-07147) pertaining to the 1995 Stock Option Plan of The Leather Factory, Inc.
of our report dated February 24, 1999, with respect to the consolidated
financial statements and schedule of The Leather Factory, Inc. included in the
Annual Report (Form 10-K) for the year ended December 31, 1998.
/S/ HEIN + ASSOCIATES LLP
Dallas, Texas
March 26, 1999
40
23.2
41
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement (Form
S-8 No. 33-81214) pertaining to the Employee Stock Ownership Plan and Trust of
The Leather Factory, Inc. and the Registration Statement (Form S-8 No.
333-07147) pertaining to the 1995 Stock Option Plan of The Leather Factory, Inc.
of our report dated March 4, 1998, with respect to the consolidated financial
statements and schedule of The Leather Factory, Inc. included in the Annual
Report (Form 10-K) for the year ended December 31, 1998.
/S/ ERNST & YOUNG LLP
Fort Worth, Texas
March 26, 1999
42
EXHIBIT 27.1
43