UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

Form 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended JuneSeptember 30, 2008

or

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _________ to __________

Commission File Number 1-12368

TANDY LEATHER FACTORY, INC.

(Exact name of registrant as specified in its charter)

(Address of principal executive offices) (Zip Code)

(Registrant’s telephone number, including area code)

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED JUNESEPTEMBER 30, 2008

Tandy Leather Factory, Inc.

Consolidated Balance Sheets

The accompanying notes are an integral part of these financial statements.

Tandy Leather Factory, Inc.

Consolidated Statements of Income

(Unaudited)

For the Three and SixNine Months Ended JuneSeptember 30, 2008 and 2007

The accompanying notes are an integral part of these financial statements.

Tandy Leather Factory, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

For the SixNine Months Ended JuneSeptember 30, 2008 and 2007

The accompanying notes are an integral part of these financial statements.

Tandy Leather Factory, Inc.

Consolidated Statements of Stockholders' Equity

 

 

The accompanying notes are an integral part of these financial statements.

These financial statements include the accounts of Tandy Leather Factory, Inc. and its subsidiaries.  Unless the context indicates otherwise, references to “we”, “us”, and “our” refer to the consolidated operations of Tandy Leather Factory, Inc. and its subsidiaries.  In the opinion of management, the accompanying consolidated financial statements for Tandy Leather Factory, Inc. and its consolidated subsidiaries contain all adjustments (consisting of normal recurring adjustments) necessary to present fairly its financial position as of JuneSeptember 30, 2008 and December 31, 2007, and its results of operations and cash flows for the three and/or six-monthnine-month periods ended JuneSeptember 30, 2008 and 2007.  Operating results for the three and six-monthnine-month periods ended JuneSeptember 30, 2008 are not necessarily indicative of the results that may be expected for the fiscal year ending December 31, 2008.  These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and accompanying notes included in our Annual Report on Form 10-K for the year ended December 31, 2007.

The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes.  Actual results could differ from those estimates.

The components of inventory consist of the following:

A summary of changes in our goodwill for the periods ended JuneSeptember 30, 2008 and 2007 is as follows:

Other intangibles consist of the following:

We recorded amortization expense of $25,645$38,468 during the first sixnine months of 2008 compared to $19,146$38,718 during the first halfnine months of 2007.  All of our intangible assets are subject to amortization under SFAS 142.  Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the succeeding five years is as follows:

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.

During the sixnine months ended JuneSeptember 30, 2008 and 2007, the stock option activity under our stock option plans was as follows:

Other information pertaining to option activity during the six monthnine-month periods ended JuneSeptember 30, 2008 and 2007 are as follows:

As of JuneSeptember 30, 2008 and 2007, there was $18,000$10,000 and $37,000,$30,000, respectively, of total unrecognized compensation cost related to nonvested stock options, which is expected to be recognized over a remaining weighted average vesting period of two years.

3.  EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share (“EPS”) for the three and sixnine months ended JuneSeptember 30, 2008 and 2007:

The net effect of converting stock options and warrants to purchase 165,700155,700 shares of common stock at exercise prices less than the average market prices has been included in the computations of diluted EPS for the quarter and sixnine months ended JuneSeptember 30, 2008, respectively.

 

Three Months Ended JuneSeptember 30, 2008 and 2007

The following tables present selected financial data of each of our four segments for the quarters ended JuneSeptember 30, 2008 and 2007.  Certain prior year amounts have been reclassified to conform to the current year presentation.

Consolidated net sales for the quarter ended JuneSeptember 30, 2008 increased $471,000decreased $554,000 or 4%, compared to the same period in 2007.  Retail and Wholesale Leathercraft contributed $393,000 and $42,000$69,000 of additional sales, offset with a sales decrease of $158,000$942,000 and $4,000 in Other.Wholesale Leathercraft and Other, respectively.  International Leathercraft added new sales of $194,000$324,000 in this year’s secondthird quarter.  Operating income on a consolidated basis for the quarter ended JuneSeptember 30, 2008 was up 55%627% or $387,000$660,000 over the secondthird quarter of 2007.2007, as a result of the increase in gross profit margin and the reduction in overall operating expenses.

The following table shows in comparative form our consolidated net income for the secondthird quarters of 20072008 and 2006:2007:

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 JuneSeptember 30, 2008 and 2007:

Net sales were up minimallydown for the secondthird quarter of 2008, as compared to the corresponding period of 2007,  as follows:

Our same store sales declined 4%14% in the secondthird quarter of 2008, as compared with the same period in 2007.  Compared to the secondthird quarter of 2007, sales increased slightlydecreased in the retail and institutionall customer categories while sales to our wholesale and manufacturer customer groups were down, which we attributedue to the general economic conditions.conditions in the U.S.  Sales to our national accountNational Account customers were up 34%down 10% for the quarter compared to the same quarter last year dueas we were unable to some one-timereplace last year’s third quarter sales to Wal-Mart with sales to other customers this quarter.  Wal-Mart ceased being a customer in the first quarter of merchandise normally stocked for Wal-Mart, a former customer.2008.

Operating income for Wholesale Leathercraft during the quarter ended JuneSeptember 30, 2008 increased by $113,000 from$403,000, an improvement of more than 13 times operating income in the comparative 2007 quarter, an increase of 28%.quarter.  Operating expenses as a percentage of sales were 46.8%49.0%, down $300,000$600,000 from the secondthird quarter of 2007.  EmployeePersonnel costs, including compensation, employment taxes, insurance and 401(k) benefits, decreased $300,000 in the quarter as we trimmedare keeping our employee headcount in most of our support departments.low without sacrificing production and customer service.  Advertising expenses decreased $150,000, as we are doing more with electronic mail advertising as opposed to hard copy mailings.  Outside services decreased $100,000$90,000 due to the elimination of various consulting services.  Rent expense decreased $80,000$90,000 due to movingthe move of our corporate offices and support units to a company-owned facility at the end of the first quarter of 2008.  PurchasesFreight out is down $60,000 due to the reduction in sales this quarter.  In addition, purchases of office and shipping supplies in our stores and support departments decreased $60,000$50,000 in the current quarter as well.  These reductions in operating expenses were partially offset by an increase in depreciation expense of $175,000,$50,000, the cause of which is the building and various equipment placed in service at the end of the first quarter of 2008.2008, as well as an increase in telephone and utility expense totaling $70,000.

Our Retail Leathercraft operation consists of 7273 Tandy Leather retail stores at JuneSeptember 30, 2008, compared to 6871 stores at JuneSeptember 30, 2007.  Net sales were up approximately 7%1% for the secondthird quarter of 2008 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 JuneSeptember 30, 2008 and 2007 for our Retail Leathercraft operation:

Sales to our Retail, Institution, and Wholesale customer groups in the secondthird quarter of 2008 increased compared to the secondthird quarter of 2007, while sales to our Manufacturer customer group declined.    These sales trends are consistent throughout the company – that is, our retail business appears to be holding fairly steady while our wholesale business has declined.  We believe the weak economy is the primary reason for these sales trends.  The retail stores averaged approximately $29,000$27,000 in sales per month for the secondthird quarter of 2008.

Sales totaled $194,000$324,000 for the secondthird quarter of 2008, all of which were generated from our new store located in the UK.  The store was opened in February 2008.  Gross profit margin was 57.9%69.3%.  Operating expenses totaled $120,000,$170,000, with the largest contributors being employee compensation ($40,000), advertising and($25,000), shipping to customers.customers ($25,000) and rent ($15,000).

Sales decreased $158,000$4,000 or 44.1%2.1% for the secondthird quarter of 2008.   Gross profit margin as a percentage of sales improved to 49.7%42.9% compared to 41.6%38.0% in the comparable quarter in 2007.  Operating income decreased $24,000increased $26,000 due to various overhead expenses.the gross profit improvement and a reduction in personnel.

We paid $88,000$80,000 in interest expense in the secondthird quarter of 2008 on the bank debt related to the building purchase, compared to no interest expense$50,000 in the secondthird quarter last year.  We earned $32,000$31,000 during the secondthird quarter of 2008 in interest income, down slightlyup from last year’s secondthird quarter interest income earned of $34,000$27,000, due to a decreasethe increase in interest rates.cash.  We recorded $6,000$30,000 in incomeexpense during the secondthird quarter of 2008 related to currency fluctuations from our Canadian and UK operations.  Comparatively, in the secondthird quarter of 2007, we recorded an expenseincome of $12,000$6,000 for currency fluctuations.

Nine Months Ended JuneSeptember 30, 2008 and 2007

The following table presents selected financial data of each of our four segments for the sixnine months ended JuneSeptember 30, 2008 and 2007:

Consolidated net sales for the sixnine months ended JuneSeptember 30, 2008 were down 3%, decreasing $776,000,or $1.3 million, compared to the same period in 2007.  Retail Leathercraft contributed additional sales of $410,000,$478,000, offset by a combined sales decrease of $1.4$2.4 million from Wholesale Leathercraft and Other.  International Leathercraft added new sales of $236,000.$559,000.  Operating income on a consolidated basis for the sixnine months ended JuneSeptember 30, 2008 was down 31.8%6.7% or $846,000$186,000 compared to the first halfnine months of 2007.

The following table shows in comparative form our consolidated net income for the first halfthree quarters of 2008 and 2007:

Net sales decreased 7.7%9.5%, or $1.2$2.1 million, for the first halfnine months of 2008, as compared to the corresponding period of 2007, as follows:

The following table presents the combined sales mix by customer categories for the sixnine months ended JuneSeptember 30, 2008 and 2007:

Operating income for Wholesale Leathercraft forat the end of the first halfthree quarters of 2008 decreased by $1.1 million$705,000 from the comparative 2007 period, a decline of 63.1%39.4%.  Operating expenses decreased $40,000$674,000 for the first halfnine months of 2008, but were up as a percentage of sales from 46.4%48.0% in the first halfnine months of 2007 to 49.9%49.7% due to the decrease in sales.

Net sales were up approximately 3% for the first halfthree quarters of 2008 over the same period last year.

The following table presents sales mix by customer categories for the sixnine months ended JuneSeptember 30, 2008 and 2007 for our Retail Leathercraft operation:

Operating income for the first sixnine months of 2008 increased $367,000$543,000 from the comparative 2007 period and as a percentage of sales, from 6.8%4.9% in the first halfthree quarters of 2007 to 9.5%7.8% in the first halfthree quarters of 2008.  Gross margin improved from 59.8%59.1% to 62.4%61.7% due to an increase in retail sales and the high margins associated with that selling level.  Operating expenses as a percentage of sales remained steady at 52.9%decreased slightly from 54.1% to 53.9% during the first halfnine months of 2008 as compared to the same period of 2007.

Sales totaled $236,000$559,000 for the first sixnine months of 2008, generated from our new store located in the UK, which opened in February 2008.  Gross profit margin was 60.3%65.5%, which is slightly higher than the comparable U.S. stores.  The store’s higher profit margin is primarily due to the store’s unique sales mix and the level at which we set our selling prices in the UK.  We establish such levels to compensate for the higher cost of doing business overseas compared to the US.  We do not expect the gross margins to maintain this level in the future.  Operating expenses totaled $190,000$360,000, and the operating lossincome generated year-to-date totaled $49,000.$6,000.

Sales decreased $262,000$266,000 in the first sixnine months of 2008 compared to the same period in 2007.   Gross profit margins decreased by $101,000$92,000 and operating margin decreased by $55,000.$29,000.  Operating expenses decreased by $46,000$64,000 in the first halfthree quarters of 2008 compared to 2007.

We paid $170,000$250,000 in interest expense in the first sixnine months of 2008 on our debt related to our building purchase compared to no$50,000 in interest expense in the first halfnine months of 2007.  We earned $73,000$103,000 in interest income in the sixnine months ended JuneSeptember 30, 2008, down slightly from last year’s interest income of $81,000.$108,000 due to reductions in interest rates.  We recorded $21,000$9,000 in incomeexpense during the six months ended June 30,first three quarters of 2008 for currency fluctuations from our Canadian and UK operations.  Comparatively, in the first halfnine months of 2007, we recorded an expenseincome of $5,000$1,000 for currency fluctuations.

On our consolidated balance sheet, total assets increased from $37.6 million at year-end 2007 to $40.9$42.9 million at JuneSeptember 30, 2008.  The increase in cash, certificates of deposits and property, offset partially by the decrease in accounts receivable and inventory, accounted for the increase.  Total stockholders’ equity increased from $29.8 million at December 31, 2007 to $31.0$31.3 million at JuneSeptember 30, 2008.  Most of the increase was attributable to earnings in the first halfthree quarters of this year.  Our current ratio fell from 7.5 at December 31, 2007 to 5.74.5 at JuneSeptember 30, 2008 due to the increase in the current portion of our debt.accounts payable and accrued expenses.

Our investment in inventory decreased by $2.2 million$434,000 at JuneSeptember 30, 2008 from year-end 2007.  Inventory on hand decreased $1.3 million, but was partially offset by the amount of inventory on its way to us at September 30.  The decreaselarge amount of inventory in transit is attributable a decrease in our purchases to matchreasonable at this time of year as we stock for the sales trend.fourth quarter and Christmas shopping season.  Inventory turnover increased to an annualized rate of 3.663.04 times during the first halfthree quarters of 2008, from 3.132.86 times for the first half ofsame period in 2007.  Inventory turnover was 3.19 times for all of 2007.  We compute our inventory turns as sales divided by average inventory.  At the end of the secondthird quarter of 2008, our total inventory on hand was 6% belowless than 1% above our internal targets for optimal inventory levels. We planexpect inventory to increase our inventory in our central warehouse duringremain fairly stable for the remainder of the year in order to maintain a sufficient inventory to support the stores’ needs.year.

Trade accounts receivable was $2.4$1.9 million at JuneSeptember 30, 2008, down $183,000$580,000 from $2.6 million at year-end 2007.  The average days to collect accounts for the first halfnine months of 2008 were 59.256 days, up slightly from the first halfnine months of 2007 of 50.455 days.  We have adjustedcontinue to tighten our credit policy given the current economic environment and are carefully analyzing our customers with open accounts to ensure collectability of the accounts.

Accounts payable increased $292,000$1.2 million to $1.8$2.7 million at the end of the JuneSeptember 2008, due to an intentional slowdown of payments to vendors takingaccomplished by our efforts to take full advantage of the payment terms.  Accrued expenses and other liabilities increased $721,000,$1.5 million, the majority of which isrepresents the increase in inventory in transit to us at JuneSeptember 30, 2008 compared to December 31, 2007.

During the first halfthree quarters of 2008, cash flow provided by operating activities was $5.5$6.6 million.  The decrease in inventory, the increase in accounts payable and accrued expenses and net income accounted for the majority of the cash provided.  Cash flow used in investing activities totaled $2.7$4.1 million, consisting of $3 million in fixed asset purchases, the majority of which was the improvements to the building, and the increase in certificates of deposit, offset partially by the decrease in other assets.  Cash flow used by financing activities totaled $124,000,$216,000, consisting of payments on our capital lease of $104,000$146,000 and payments on our building debt of $34,000,$85,000, offset partially by proceeds from employee stock option exercises totaling $14,000.$15,000.

We expect to fund our operating and liquidity needs as well as our currentthe planned 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, 2007.  Our exposure to market risks has not changed significantly since December 31, 2007.

Our management team, under the supervision and with the participation of our principal executive officer and our principal financial officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of the last day of the fiscal period covered by this report, JuneSeptember 30, 2008. The term disclosure“disclosure controls and proceduresprocedures” means our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including our principal executive and principal financial officer, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Based on this evaluation, our principal executive officer and our principal financial officer concluded that, as of JuneSeptember 30, 2008, our disclosure controls and procedures were effective at a reasonable assurance level.

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.