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 March 31,June 30, 2010

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)

FORM 10-Q

FOR THE QUARTERLY PERIOD ENDED MARCH 31,JUNE 30, 2010

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 Six Months Ended March 31,June 30, 2010 and 2009

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

Tandy Leather Factory, Inc.

Consolidated Statements of Cash Flows

(Unaudited)

For the ThreeSix Months Ended March 31,June 30, 2010 and 2009

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

 

1.  BASIS OF PRESENTATION AND CERTAIN SIGNIFICANT ACCOUNTING POLICIES

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 March 31,June 30, 2010 and December 31, 2009, and its results of operations and cash flows for the three-monththree and/or six-month periods ended March 31,June 30, 2010 and 2009.  Operating results for the three-month periodthree and six-month periods ended March 31,June 30, 2010 are not necessarilyneces sarily indicative of the results that may be expected for the fiscal year ending December 31, 2010.  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, 2009.

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 six-month periods ended March 31,June 30, 2010 and 2009 is as follows:

Other intangibles consist of the following:

We recorded amortization expense of $15,178$30,312 during the first quartersix months of 2010 compared to $12,824$25,645 during the first quarterhalf of 2009.  All of our intangible assets are subject to amortization under U.S. GAAP.  Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the succeeding 5five 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.

On July 31, 2007, we entered into a Credit Agreement and Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a credit facility of up to $5,500,000 to facilitate our purchase of real estate consisting of a 195,000 square foot building situated on 30 acres of land located at 1900 SE Loop 820 in Fort Worth, Texas.  Proceeds in the amount of $4,050,000 were used to fund the purchase of the property.  On April 30, 2008, the principal balance was rolled into a 10-year term note with a 20-year amortization and accrues interest at a rate of 7.10% per annum.

At March 31,June 30, 2010 and December 31, 2009, the amount outstanding under the above agreement consisted of the following:

We have one stock option plan which provides for annual stock option grants to non-employee directors.  Nodirectors with an exercise price equal to the fair market value of the shares at the date of grant.  9,000 options have beenwere awarded asto directors in the second quarter of March 31, 2010.  These options vest and become exercisable six months from the option grant date.  We had two other stock option plans from 1995 which provided for stock option grants to officers, key employees and non-employee directors.  These plans expired in 2005.  The expiration of the plans has no effect on the options previously granted.  Options outstanding and exercisable were granted at a stock option price which was not less than the fair market value of our common stock on the date the option was granted and no option has a term in excess of ten years.  Additionally, options vest and become exercisable either six months from the option grant date or in equal installments over a five-year period.

We recognized share based compensation expense of approximately$18,388 and $0 and $2,500 for each of the quarters ended March 31,June 30, 2010 and 2009, respectively, and $18,388 and $2,540 for each of the six month periods ended June 30, 2010 and 2009, respectively, as a component of operating expenses.

During the threesix months ended March 31,June 30, 2010 and 2009, the stock option activity under our stock option plans was as follows:

Other information pertaining to option activity during the three-monthsix month periods ended March 31,June 30, 2010 and 20092010 are as follows:

As of March 31,June 30, 2010 all granted stock options have vested and all2009, there was no unrecognized compensation cost has been recognized.related to nonvested stock options.

The following table sets forth the computation of basic and diluted earnings per share (“EPS”) for the three and six months ended March 31,June 30, 2010 and 2009:

The net effect of converting stock options and warrants to purchase 136,700173,700 and 73,000126,700 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 six months ended March 31,June 30, 2010 and 2009, respectively.

6.7.  SEGMENT INFORMATION

Net sales for geographic areas were as follows for the three and six months ended March 31,June 30, 2010 and 2009:2009 were as follows:

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 six-month periods ended March 31,June 30, 2010 andor 2009.  We do not have any significant long-lived assets outside of the United States.

Our Business

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.

Our Retail Leathercraft segment operates company-owned Tandy Leather Company retail stores in 35 states and six Canadian provinces.  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 MayAugust 1, 2010, we were operating 76 Tandy Leather retail stores located throughout the United States and Canada.

Our International Leathercraft segment operates one company-owned store in Northampton, United Kingdom.  The store, which opened in February 2008, operates as a combination retail and wholesale store.

Critical Accounting Policies

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 fiscal year ended December 31, 2009.

Forward-Looking Statements

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”“f uture” 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 Reportannual report on Form 10-K for fiscal year ended December 31, 2009 for additional information concerning these and other uncertainties that could negatively impact the Company.

Various oils used to manufacture certain leather and leathercrafts are derived from petroleum and natural gas.  Also, the carriers who transport our goods rely on petroleum-based fuels to power their ships, trucks and trains.  They are likely to pass any incurred cost increases on to us.  We are unsure how much of this increase we will be able to pass on to our customers.

General economic factors that are beyond our control impact our forecasts and actual performance. These factors include interest rates, recession, inflation, deflation, consumer credit availability, consumer debt levels, tax rates and policy, unemployment trends and other matters that influence consumer confidence and spending.

Results of Operations

The following tables present selected financial data of each of our three segments for the quarters ended March 31,June 30, 2010 and 2009.

Consolidated net sales for the quarter ended March 31,June 30, 2010 increased $1.4$1.3 million or 10.7%10%, compared to the same period in 2009.  All three segments achievedRetail Leathercraft contributed the largest sales gains, ranging from 5% to 32%.increase of $1.1 million, followed first by Wholesale Leathercraft reporting an increase of $136,000 and second by International Leathercraft reporting an increase of $88,000.  Operating income on a consolidated basis for the quarter ended March 31,June 30, 2010 was up 54%,30% or $539,000, from$336,000 over the firstsecond quarter of 2009.

The following table shows in comparative form our consolidated net income for the firstsecond quarters of 2010 and 2009:

All segments were profitable and contributed to our consolidated net income.   Additional information appears below for each segment.

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,June 30, 2010 and 2009:

Net sales increased 4.8%, or $301,000,were up 2% for the firstsecond quarter of 2010 as follows:

Our same store sales increased 4.5% in the second quarter of 2010, as compared with the same period in 2009.  Compared to the second quarter of 2009, we achieved sales increases in our retail and manufacturers customer categories, which were offset somewhat by decreases in our wholesale customer category.  We believe the small business customer continues to struggle in the current economy, which is reflected in our sales by customer categories.  Sales to our retail, wholesale and small manufacturernational account customers were up indown 13% for the first quarter, of 2010 compared to the firstsame quarter of 2009, whilelast year. The sales decline was due to a change in placement with some customers, and changes in customers’ buying patterns to a just-in-time stocking process.  Our sales to these customers will depend on products we develop specifically for this gro up and the level of inventory we are willing to house in anticipation of orders.  Therefore, it is possible we will experience further sales declines to our institutionNational Account group if the product we stock is not what these customers want to purchase.   Our primary focus is on sales through our stores, rather than National Accounts, as we believe our stores represent the greatest potential for continued and national account group customers were down slightly.  consistent sales growth.

Operating income for Wholesale Leathercraft during the current quarter ended June 30, 2010 increased by $168,000$150,000 from the comparative 2009 quarter, an improvementincrease of 46%32%.  Operating expenses as a percentage of sales were 52.5%, up $251,000 from the second quarter of 2009.  The improved gross profit margin,largest expense increase was in Manager Bonuses, up $100,000 due to anthe increase in retail sales, accountedprofits generated at the stores.  Legal fees increased $90,000 for registrations of foreign trademarks.  Freight out, which is the majority ofcost to ship product to customers, was up $26,000, due to the increase in operating income as operating expenses increasedsales at the same rate as sales.  Operating expensesstores.  Finally, Employee Benefits, specifically medical benefit costs, increased $152,000, or 5%, due to an employee compensation increase of $53,000, a supplies expense increase of $32,000 and a utilities expense increase of $88,000.  Expense reductions occurred in legal and professional fees ($22,000), depreciation ($48,000), and employee benefits ($14,000).$70,000.

Our Retail Leathercraft operation consists of 76 Tandy Leather retail stores at March 31,June 30, 2010, compared to 7475 stores at March 31,June 30, 2009.  Net sales increased 15.3%were up 16% for the firstsecond quarter of 2010 over the same quarter last year.  A store is categorized as “new”"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,June 30, 2010 and 2009 for our Retail Leathercraft operation:

Sales to each customer group increased slightly over the firstsecond quarter of 2009, except for the Institution group.  Operating income increased $373,000,$123,000, or 68%19%, from the comparative 2009 quarter.  Operating income as a percentage of sales also increased from 8.3%9.8% in the firstsecond quarter of 2009 to 12.1%10.0% in the firstsecond quarter of 2010.  Our gross profit margin increasedslipped from 59.8%60.8% to 63.5%59.3%.  Operating expenses as a percentage of sales remained steadydecreased from 51.0% to 49.4% as sales grew at 51.5%.a faster rate than that of expenses during the quarter.  Operating expenses increased $514,000$423,000 over the firstsecond quarter of 2009.  The two new storesstore opened since March 31,in June 2009 accounted for additional operating expenses of $56,000.$30,000.  Employee compensation increased $250,000.  Specifically,$107,000. Manager bonuses increased profitability of$73,000 d ue to higher profits at the stores results in higher bonuses earned by our store managers.stores.  In addition, advertising expenses increased $75,000.$73,000. Freight out (shipping to customers) and credit card fees increased $42,000$45,000 and $24,000,$23,000, respectively, due to increased sales.  Rent expense increased $35,000.

Consisting of one store located in the UK, this division’s sales totaled $384,000$396,000 for the firstsecond quarter of 2010, compared to $293,000$308,000 in the firstsecond quarter of 2009, an improvement of 31%29%. Gross profit margin decreased 10 percentage pointsincreased 10% from the firstsecond quarter of 2009 due to the impact of the conversion rate on the selling prices in our UK store.  We determine UK selling prices taking into consideration the currency conversion between the U.S. dollar and the Great Britain pound.  Even so, theour UK store generates higher profit margins than that of a comparable U.S. store as it sellsdue to a heavierbeneficial product mix, ofselling more higher margin tools and supplies and less lower margin leather.  Operating expenses totaled $172,000$186,000 in the firstsecond quarter of 2010, up from $141,000$159,000 in the firstsecond quarter of 2009.2009 for our UK store.&# 160; Advertising expense is this division’s largest expense, followed by employee compensation, shipping costs to customers, and rent.

We paid $66,000 in interest expense in the second quarter of 2010 on our bank debt, which is related to our building purchase, compared to $84,000 in interest expense in the firstsecond quarter last year.  We earned $23,000 in interest income during the second quarter of 2010, compared to $77,000down from last year’s second quarter interest income earned of $32,000.  We recorded $18,000 in income during the firstsecond quarter of 2009.  We recorded $35,000 in interest income on our cash balances during the quarter compared2010 related to $29,000 a year ago.  We recorded an expense of $92,000 for currency fluctuations in the first quarter of 2010.from our Canadian and UK operations.  Comparatively, in the firstsecond quarter of 2009, we recorded income of $28,000 in income$78,000 for currency fluctuations.

Capital Resources, Liquidity and Financial Condition

On our consolidated balance sheet, total assets increased from $43.3 million at fiscal year-end 2009 to $44.9$45.8 million at March 31,June 30, 2010.  InventoryThe increase in inventory and other current assets accounted for the majority of the increase.  Total stockholders’ equity increaseddecreased from $33.4$33.3 million at December 31, 2009 to $34.4$27.8 million at March 31, 2010,June 30, 2010.  The decrease was attributable to the increase being attributable tospecial, one-time dividend of $7.6 million that was approved by our Board of Directors in May, partially offset by the earnings in the first quarterhalf of this year.  Our current ratio fell from 5.6 at December 31, 2009 to 5.32.5 at March 31, 2009June 30, 2010 due to the increase in trade accounts payable duringaccrued dividend that time period.was paid on July 5, 2010.

Our investment in inventory increased by $673,000$1.2 million at March 31,June 30, 2010 from year-end 2009 in anticipation of continuedlevels.  We continue to closely manage our inventory levels to follow our sales increases.trends.  Inventory turnover reacheddecreased slightly to an annualized rate of 3.393.31 times during the first quarterhalf of 2010, virtually the same as 3.38from 3.34 times for the first quarterhalf of 2009.  Inventory turnover was 3.34 times for all of 2009.  We compute our inventory turns as sales divided by average inventory.  At the end of the firstsecond quarter of 2010, our total inventory on hand was approximatelywithin 5% overof our internal targets for optimal inventory levels. We will continue to monitorbe closely monitoring our inventory during the relationship between our sales and inventoryremainder of the year in order to optimize our investment in inventory.maintain a sufficient inventory to support the stores’ needs.

Trade accounts receivable was $1.5were $1.4 million at March 31,June 30, 2010, up $256,000$190,000 from $1.2 million at year-end 2009.  The average days to collect accounts receivable for the first quarterhalf of 2010 were 4642.4 days, up slightlydown from 43.4 days for the first quarterhalf of 2009 of 43 days.2009.  We are monitoring our customer accounts very closely in ordercontinue to minimize the risk of uncollectible accounts inmaintain a tight credit policy given the current economic environment.environment and are closely monitoring our customers with open accounts to ensure collectability of the accounts.

Accounts payable increased $517,000 to $1.6$1.7 million at March 31,the end of the June 2010, as a result of an increase in purchases and an intentional slowdown of payments to vendors, taking full advantage of the payment terms.  Accrued expenses and other liabilities increased $383,000, the majority of which represented an increase in inventory in transit to us at June 30, 2010 compared to $1.2 million at year-end 2009, due to the increase in inventory purchases during the first quarter in response to our sales increase.  Accrued expenses increased $128,000 from December 31, 2009, to March 31, 2010.and the accrual of property taxes, most of which is paid in the fourth quarter each year.

During the first quarterhalf of 2010, cash flow provided by operating activities was $224,000.  The net$368,000.  Net income generatedaccounted for the quarter and the increase in accounts payable contributed a portionmajority of the cash flow,provided, offset by increasesthe increase in accounts receivable, inventory and other current assets.  Cash flow used inprovided by investing activities totaled $2.1$2.3 million, consisting primarily of $2.5 million in net purchases of certificatescertificate of deposit with our excess cash.sales or maturities, offset by $239,000 in fixed asset purchases.  Cash flow usedprovided by financing activities totaled $59,000,$57,000, consisting of proceeds from employee stock option exercises, offset by payments on our bank debt of $51,000 and repurchases of our common stock of $8,000.building debt.

We expect to fund our operating and liquidity needs as well as our store growthfuture expansion of the domestic retail and international stores from a combination of current cash balances and internally generated funds.

For disclosures about market risk affecting us, see Item 7A “Quantitative"Quantitative and Qualitative Disclosures About Market Risk”Risk" in our Annual Report on Form 10-K for fiscal year ended December 31, 2009.  We believe that ourOur exposure to market risks has not changed significantly since December 31, 2009.

Evaluation of Disclosure Controls and Procedures

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, March 31,June 30, 2010. The term disclosure controls and procedures 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 controlsco ntrols 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 March 31,June 30, 2010, our disclosure controls and procedures were effective at a reasonable assurance level.

There have been no changes in our internal control over financial reporting during the fiscal quarter ended March 31,June 30, 2010 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

TheAs the following table provides information aboutindicates, we made no purchases we have made of our common stock during the quarter ended March 31, 2010:June 30, 2010 ,as the prevailing market prices were above our maximum purchase price:

 
 

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.