We offer an unconditional satisfaction guarantee to our customers and accept all product returns. Net sales represent gross sales less negotiated price allowances, product returns, and allowances for defective merchandise.  

On January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,” and elected to adopt the standard using the modified prospective transition method. Under this transition method, compensation cost associated with stock options recognized in 2006 includes: (1) amortization related to the remaining unvested portion of all share based payments granted prior to, but not vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original pro forma footnote disclosure provisions of FASB Statement No. 123 and (2) amortization related to all share based payments granted subsequent to December 31, 2005, based on the grant date fair value estimated in accordance with the provisions of FASB Statement No. 123(R). Accordingly, stock compensation award expense is recognized over the requisite service period using the straight-line attribution method. Previously reported amounts have not been restated.

We recognized share based compensation expense of approximately $7,600 and $22,000 for the quartersthree and nine months ended March 31,September 30, 2007 and 2006 respectively, as follows:

The fair values of stock options granted were estimated on the grant dates using the Black-Scholes option pricing model with the following weighted average assumptions: risk-free interest rate of 3.375%-3.5%, a componentdividend yield of operating expenses.0%; volatility factor of .366-.780; and an expected life of the valued options of 3-5 years.

During the threenine months ended March 31,September 30, 2007, and 2006, the stock option activity under our stock option plans was as follows:

Other information pertaining to option activity during the threenine month periods ended March 31,September 30, 2007 and 2006 are as follows:

As of March 31,September 30, 2007, and 2006, there was $58,000 and $131,000, respectively,$30,000 of total unrecognized compensation cost related to nonvested stock options, which is expected to be recognized over a remaining weighted average vesting period of 23 years.

The following table sets forth the computation of basic and diluted earnings per share (“EPS”) for the three and nine months ended March 31,September 30, 2007 and 2006:

Geographic sales information is based on the location of the customer. No single foreign country, except for Canada, accounted for any material amount of our consolidated net sales for the three-monththree or nine-month periods ended March 31,September 30, 2007 andor 2006. We do not have any significant long-lived assets outside of the United States.

Our Wholesale Leathercraft segment operates 30 company-owned wholesale stores in 20 states and three Canadian provinces. These stores are engaged in the wholesale distribution of leather and related items, including leatherworking tools, buckles and belt adornments, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits, to retailers, manufacturers, and end users. Our Wholesale Leathercraft segment also includes our National Account sales group.

Tandy Leather, the oldest and best-known supplier of leather and related supplies used in the leathercraft industry, has been the primary leathercraft resource for decades. Tandy Leather’s products include quality tools, leather, accessories, kits and teaching materials. In 2002, we began expanding Tandy Leather’s industry presence by opening retail stores. As of MayNovember 1, 2007, we were operating 6772 Tandy Leather retail stores located throughout the United States and Canada.

Our “Other” segment consists of Roberts, Cushman and Co., a wholly-owned subsidiary that custom designs and manufacturesdistributes decorative hat trims for headwear manufacturers.

A description of our critical accounting policies appears in "Item 7. Management's Discussions and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2006.

Certain statements contained in this report and other materials we file with the Securities and Exchange Commission, as well as information included in oral statements or other written statements made or to be made by us, other than statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally are accompanied by words such as “may,” “will,” “could,” “should,” “anticipate,” “believe,” “budgeted,” “expect,” “intend,” “plan,” “project,” “potential,” “estimate,” “continue,” or “future” variations thereof or other similar statements. There are certain important risks that could cause results to differ materially from those anticipated by some of the forward-looking statements. Some, but not all, of the important risks, including those described below, could cause actual results to differ materially from those suggested by the forward-looking statements. Please refer also to our annual report on Form 10-K for fiscal year 2006 for additional information concerning these and other uncertainties that could negatively impact the Company.us.

We assume no obligation to update or otherwise revise our forward-looking statements even if experience or future changes make it clear that any projected results, express or implied, will not be realized.

The following tables present selected financial data of each of our three segments for the quarters ended March 31,September 30, 2007 and 2006. Certain prior year amounts have been reclassified to conform to the current year presentation.

Consolidated net sales for the quarter ended March 31,September 30, 2007 increased $94,000, or 0.65%2%, compared to the same period in 2006. Retail Leathercraft contributed $713,000 to the increase, while$535,000 of additional sales, offset by a combined sales decrease of $289,000 in Wholesale Leathercraft and Other reported decreases of $280,000 and $339,070.Other. Operating income on a consolidated basis for the quarter ended March 31,September 30, 2007 was down 4.3%92% or $87,000 from$1.1 million over the firstthird quarter of 2006.

The following table shows in comparative form our consolidated net income for the firstthird quarters of 2007 and 2006:

Our Wholesale Leathercraft operation consists of 30 wholesale stores and our National Account group. The following table presents the combined sales mix by customer categories for the quarters ended March 31,September 30, 2007 and 2006:

In our wholesale stores, compared to the first quarter of 2006, theThe customer sales mix was somewhat different thanfor the third quarter indicates a decline in sales to retail customers and our historical pattern. A normal sales mixnational account customers. We achieved gains in the wholesale stores is 20-25% retail and 75-80% wholesale (all other customer groups). As the sales mix table above indicates, our retail sales were significantly higher than that of normal levels, the cause of which was weaker sales, specifically leather sales to our other customer groups. The majority of leather sold in the Leather Factory stores is sold to our wholesaleInstitution (specifically prisons and manufacturerprisoners) and Wholesale customers. Due to some pricing pressure in the market, our prices were not as competitive and as a result, our customers purchased leather from other suppliers. As a result, sales to these customer groups were down overall. We believe that we are seeing early signs of that trend reversing and expect to regain our market share in this area as other suppliers are adjusting their selling prices to levels matching that of the overall market. Sales to our national account customers were up 2%down 30% for the quarter compared to the same quarter last year. Approximately 25% of the sales decline is attributable to one customer which intends to stop purchasing from us in the second quarter of 2008 due to its vendor consolidation policy. We believe the sales mix speaks to several issues: (1) the craft industry overall has weakened in recent years and (2) the retail customer is more cautious in discretionary spending due to the concerns about the economy overall.

Operating income for Wholesale Leathercraft during the current quarter decreased by $173,000$878,000 from the comparative 2006 quarter, a decline of 11.4%96%. Operating expenses as a percentage of sales were 42.0%51.5%, up $305,000$653,000 from the firstthird quarter of 2006. InEmployee compensation increased $250,000 as our headcount is up 10% compared to the third quarter of 2006. At September 30, 2007, there are 7 manager trainees in the Leather Factory stores. We are analyzing the headcount increase at the support units and will be making adjustments as necessary to reduce this expense. Employee benefits, specifically health insurance and 401(k) plan contributions, are up $115,000 as well. Advertising expenses increased $200,000 over last year’s third quarter in an effort to improve sales, advertisingsales. Legal and marketing expenses increased $155,000 dueprofessional fees are up $115,000 as we’ve incurred fees related to additional mailings as well as new marketing initiatives. Temporary staffing expenses were up $66,000our recent real estate purchase and employee benefits, specifically employee medical programs, increased $62,000.the defense of our intellectual property.

Our Retail Leathercraft operation consists of 6571 Tandy Leather retail stores at March 31,September 30, 2007, compared to 5661 stores at March 31,September 30, 2006. Net sales were up approximately 13%10% for the firstthird quarter of 2007 over the same quarter last year. A store is categorized as "new" until it is operating for the full comparable period in the prior year.

The following table presents sales mix by customer categories for the quarters ended March 31,September 30, 2007 and 2006 for our Retail Leathercraft operation:

Operating income increased $58,000decreased $304,000 from the comparative 2006 quarter although operating income as a percentageto 1.0% of sales, decreased slightly from 9.0%compared to 7.1% of sales in the firstthird quarter of 2006. Our gross margin fell from 60.4% to 57.5% due to cost increases that we were unable to pass on to customers and the increase in sales to wholesale customers. Operating expenses increased $460,000 in the third quarter of 2007 over the third quarter of 2006, to 8.9% in the first quarter of 2007. Our gross margin increased minimally from 60.3% to 60.5%. Operating expensesand as a percentage of sales increased from 51.4%53.4% to 51.6%56.5%. Advertising and marketingThe operating expenses increased $60,000 in response to weaker than expected sales during the quarter. Personnel costs, rent and utilities associated withat the new stores accounted for $200,000opened since October 1, 2006 totaled $350,000. The remainder of the increase consisted of $50,000 in operating expenses. Employee healthadditional advertising and a $50,000 increase in employee benefits also increased by $12,000.(health insurance, etc.).

Sales decreased $339,000$141,000 or 52%40.4% for the firstthird quarter of 2007. Gross profit margins improved from 26.7% to 43.3%. Operatingdecreased by $55,000 while operating income increased $28,000. Operating expenses decreased $61,000by $23,000. We expected sales to decline as we increased the minimum order quantities due to the reduction of personnelchange in operations as we areconverted from a manufacturer to a distributor. However, we also expected gross profit margins and operating margins to improve as we eliminated substantial labor and direct manufacturing expenses by outsourcing more of the manufacturing and production of product.that function.

We paid no interest in the firstthird quarter of 2007 of $50,000 as oura result of the bank debt has been zero since March 2005.incurred to purchase a building in July 2007. We also recorded $97,000 in rent income on this building in August and September. In addition, we recorded $106,000 in other income, representing an oil and gas lease bonus related to the property. We earned $27,000 during the quarter in interest income. We recorded $47,000$6,000 in interest income during the quarter as earned on our cash balances. We recorded $8,000 in income for currency fluctuations from our Canadian operation.

Operating income for the first nine months of 2007 decreased $444,000 from the comparative 2006 period and as a percentage of sales, from 8.3% in the first quarternine months of 2006 to 4.9% in the first nine months of 2007. Gross margin fell from 60.7% to 59.1% due to the increase in sales to wholesale customers and cost increases in various products and our inability to pass those cost increases on to our customers. We publish our retail selling prices in our annual catalog which is distributed in October of each year. Selling prices are set based on our estimate of the cost of the items for the coming year. As costs fluctuate during the year, our gross margins can be affected positively or negatively. Operating expenses as a percentage of sales increased from 52.4% to 54.1%.

We paid interest of $50,000 as a result of the bank debt incurred to purchase a building in July 2007. We earned $108,000 in interest income. We recorded $1,000 in income during the year for currency fluctuations from our Canadian operation. Comparatively, in the first quarternine months of 2006, we recorded $17,000 in income of $56,000 for currency fluctuations.

On our consolidated balance sheet, total assets increased from $31.9 million at year-end 2006 to $33.5$37.6 million at March 31,September 30, 2007. InventoryThe increase in inventory and fixed assets, offset partially by the decrease in cash, accounted for the majority of the increase. Total stockholders’ equity increased from $26.3 million at December 31, 2006 to $27.7$28.6 million at March 31,September 30, 2007. Most of the increase was attributable to earnings in the first quarternine months of this year. Our current ratio held steadyrose from 5.2 at 5.2 from December 31, 2006 to March 31,5.9 at September 30, 2007.

Our investment in inventory increased by $1.2$3.5 million at March 31,September 30, 2007 from year-end 2006. The increase is attributable to weaker than expected sales. We expectedsales and not decreasing our purchases to sell more product duringmatch the quarter but did not achieve the results we expected. We will be adjusting our inventory purchases during the next few months in order to get our investment in inventory to more reasonable levels.sales trend. Inventory turnover decreased to an annualized rate of 3.592.86 times during the first quarternine months of 2007, from 3.753.28 times for the first quarternine months of 2006. Inventory turnover was 3.36 times for all of 2006. We compute our inventory turns as sales divided by average inventory. At the end of the firstthird quarter, our total inventory on hand was 10%25% over our internal targets for optimal inventory levels due to the weak sales during the quarter.levels. We will be adjustingare reducing our inventory purchases during the next few quartersremainder of the year in an attempt to getreduce our inventory to more accepted levels.on hand by year-end.

Trade accounts receivable was $2.9$2.3 million at March 31,September 30, 2007, up $295,000down $304,000 from $2.6 million at year-end 2006. This is a result of an increase in credit sales during the quarter ended March 31, 2007 as compared to that of the quarter ended December 31, 2006. The average days to collect accounts for the first quarternine months of 2007 were 57.554.9 days, up from the first quarternine months of 2006 of 5247.5 days. We are tightening our credit policy and analyzing our customers with open accounts to ensure collectibilitycollectability of the accounts and will make adjustments as needed.

Accounts payable increased $775,000$565,000 to $2.5$2.3 million at the end of the first quarter,September 2007, due primarily to the increases in inventory purchases. Accrued expenses and other liabilities decreased $939,000. The bonuses accrued$993,000 due to the decrease in inventory in transit at the end of December 2006 were paid in March 2007, which accounted for the majority of the decrease.September 30, 2007.

During the first quarterthree quarters of 2007, cash flow providedused by operating activities was $150,000.$1.2 million. The net income generated for the quarterincrease in inventory and decrease in accrued expenses accounted for the majority of the cash flow,used, offset by an increase in inventory and a decrease in accrued expenses.net income. Cash flow used in investing activities totaled $906,000,$5.8 million, consisting of $200,000$5.1 million in fixed asset purchases, including $4.5 million for the purchase of building for our corporate headquarters, and $650,000 for the acquisition of Mid-Continent Leather Sales, Inc., a wholesale distributor of leather and leathercraft supplies located in Coweta, OK.Oklahoma. Cash flow provided by financing activities totaled $17,000,$4.0 million, consisting of paymentsborrowings on our capital lease of $34,000, offset by proceeds from employee stock option exercises totaling $51,000.a note payable related to the building purchase.

We expect to fund our operating and liquidity needs as well as our current expansion of Tandy Leather's retail store chain from a combination of current cash balances and internally generated funds.

For disclosures about market risk affecting us, see Item 7A "Quantitative and Qualitative Disclosures About Market Risk" in our Annual Report on Form 10-K for fiscal year ended December 31, 2006. We believe that our exposure to market risks has not changed significantly since December 31, 2006.

Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.