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 September 30, 2011March 31, 2012 and December 31, 2010,2011, and its results of operations and cash flows for the three and/or nine-monththree-month periods ended September 30, 2011March 31, 2012 and 2010.2011.  Operating results for the three and nine-month periodsthree-month period ended September 30, 2011March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011.2012.  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, 2010.2011.

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.

A two-step process is used to test for goodwill impairment.  The first phase screens for impairment, while the second phase (if necessary) measures the impairment.  We have elected to perform the annual analysis during the fourth calendar quarter of each year.  As of December 31, 2010,2011, management determined that the present value of the discounted estimated future cash flows of the stores associated with the goodwill is sufficient to support their respective goodwill balances.  No indicators of impairment were identified during the first nine monthsquarter of 2011.2012.

We recorded amortization expense of $33,401$11,327 during the first nine monthsquarter of 20112012 compared to $45,255 in$11,079 during the same periodfirst quarter of 2010.2011.  All of our intangible assets, other than goodwill, 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 5 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 195,000191,000 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 that accruesan interest at a rate of 7.10% per annum.

At September 30, 2011March 31, 2012 and December 31, 2010,2011, the amount outstanding under the above agreementsagreement consisted of the following:

We have one stock option plan which provides for annual stock option grants to non-employee directors with an exercise price equal to the fair market value of the shares at the date of grant.  Under this plan, 12,000 options were awarded to directors for each of the ninethree month periods ended September 30, 2011March 31, 2012 and 2010.2011.  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 as of closing on the date the option was granted and no option has a term in excess of ten years.  We recognized share based compensation expense of $7,126approximately $5,000 and $4,402$18,900 for each of the quarters ended September 30,March 31, 2012 and 2011, and 2010, respectively, and $33,156 and $22,790 for each of the nine month periods ended September 30, 2011 and 2010, respectively, as a component of operating expenses.

Other information pertaining to option activity during the nine-monththree-month periods ended September 30,March 31, 2012 and 2011 and 2010 are as follows:

As of September 30,March 31, 2012 and 2011, and 2010, there was no unrecognized compensation cost related to non-vested stock options.options of $5,000 and $0, respectively.

The following table sets forth the computation of basic and diluted earnings per share (“EPS”) for the three and nine months ended September 30, 2011March 31, 2012 and 2010:2011:

The net effect of converting stock options and warrants to purchase 102,600106,600 and 10,00090,600 shares of common stock at exercise prices less than the average market prices has been included in the computations of diluted EPS for the quarterquarters ended September 30,March 31, 2012 and 2011, and 2010, respectively.

In May 2010,February 2012, our Board of Directors authorized a $0.75$0.25 per share special one-time cash dividend that was paid to stockholders of record at the close of business on June 3, 2010.March 1, 2012. We released the funds used to pay for the special one-time cash dividend on July 1, 2010March 29, 2012 and the dividend, totaling $7.7$2.5 million, was paid to stockholders on July 5, 2010.April 2, 2012. Our Board will determine future cash dividends after giving consideration to our then existing levels of profit and cash flow, capital requirements, current and forecasted liquidity, as well as financial and other business conditions existing at the time.

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 or nine-monththree-month periods ended September 30, 2011March 31, 2012 and 2010.2011.  We do not have any significant long-lived assets outside of the United States.

Our Wholesale Leathercraft segment operates 29 company-owned wholesale stores in 19 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, whose only customers are only national craft chains.

Our Retail Leathercraft segment operates company-owned Tandy Leather Company retail stores in 3536 states and six Canadian provinces.  Tandy Leather Company, the oldest and one of the best-known suppliers of leather and related supplies used in the leathercraft industry, has been a primary leathercraft resource for decades.  Tandy Leather Company’s products include quality tools, leather, accessories, kits and teaching materials.  In 2002, we began expanding Tandy Leather Company’s industry presence by opening retail stores.  As of NovemberMay 1, 2011,2012, we were operating 77 Tandy Leather Company retail stores located throughout the United States and Canada.

As of September 30, 2011, ourOur International Leathercraft segment which operates combination retail and wholesale3 company-owned stores, all located outside of North America, consistedAmerica.  These stores operate as combination retail / wholesale stores and consist of one company-owned store in Northampton, United Kingdom.  A secondKingdom, one store was opened in Sydney, Australia, and one store in October 2011.Jerez, Spain.  We anticipate the opening ofexpect to open another one to two international stores in Spain in the fourth quarter of 2011,during 2012, although specific locations or opening dates have not yet been finalized yet.determined.

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, 2010.2011.

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 ended December 31, 20102011 for additional information concerning these and other uncertainties that could negatively impact the Company.

Our performance is subject to worldwide economic conditions and their impact on levels of consumer spending that affect not only the ultimate consumer, but also small businesses and other retailers.  The United States and global economies have suffered from a prolonged recession for the past several years and as a result, consumer spending has remained depressed, and may be subject to further deterioration for the foreseeable future.   Specialty retail, and retail in general, are heavily influenced by general economic cycles.  Purchases of non-essential products tend to decline in periods of recession or uncertainty regarding future economic prospects, as disposable income declines.  During periods of economic uncertainty, we may not be able to maintain or increase our sales to existing customers, make sales to new customers, open and operate new stores, maintain sales levels at our existing stores, maintain or increase our international operations on a profitable basis, or maintain our earnings from operations as a percentage of net sales.  As a result, our operating results may be adversely and materially affected by continued downward trends or uncertainlyuncertainty in the United States or global economies.

The following tables present selected financial data of each of our three segments for the quarters ended September 30, 2011March 31, 2012 and 2010.2011.

Consolidated net sales for the quarter ended September 30, 2011March 31, 2012 increased $1.7$2.3 million, or 12.8%14.5%, compared to the same period in 2010.2011.  All three segments achieved sales gains, ranging from 2%6% to 21%46%.  Operating income on a consolidated basis for the quarter ended September 30, 2011 increased 13.6%March 31, 2012 was up 33.6%, or $146,000,$642,000, from the thirdfirst quarter of 2010.2011.

The following table shows in comparative form our consolidated net income for the thirdfirst quarters of 20112012 and 2010:2011:

All segments except International Leathercraft contributed to our increased consolidated net income.  The net loss in the International Leathercraft segment was caused by the lack of profitability at the Australia and Spain stores opened within the last six months.  Additional information appears below for each segment.

Our Wholesale Leathercraft operation consists of 29 wholesale stores and our National Account sales group.  The National Account sales group’s customers consist of only national craft chains.chains only.  The following table presents the combined sales mix by customer categories for the quarters ended September 30, 2011March 31, 2012 and 2010:2011:

Our same store sales increased 5.3% in the third quarter of 2011, as compared with the same period in 2010.  ComparedSales to the third quarter of 2010, we achieved sales increases in our retail and wholesale customer categories, whichcustomers were offset somewhat by decreasesup in the first quarter of 2012 compared to the first quarter of 2011, while sales to our institution manufacturing and nationalmanufacturer account customer categories.  We believe our wholesale customers are beginning to experience some stability and growth in their businesses which has resulted in an increase in purchases.  However, with the continued economic uncertainty, it is too early to tell whether this trend will continue.  We have lowered our discounts to our manufacturer customer group in an attempt to protect gross margins, which has had a negative impact on our sales to this group.  Sales to our National Account customers were down 3.7% for the quarter, compared to the same quarter last year.  Our sales to these customers will depend on products we develop specifically for this group 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 National 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 consistent sales growth.

The increase in gross profit of $588,000 was the primary contributor to the improvement in operating income.  Gross profit as a percentage of sales were 55.9%, up $247,000increased from 58.7% in the thirdfirst quarter of 2010.  The2011 to 63.3% in the first quarter of 2012, due primarily to the increased retail sales.  Operating expenses remained consistent as a percentage of sales, increasing $160,000 compared to last year’s comparable period, despite an increase in employee compensation and benefits including health costs, of $328,000,$284,000.  This was offset somewhat by decreases in advertising and marketing expenses of $49,000utilities ($23,000), outside services ($27,000) and bank fees of $20,000, accounted for the operating expense increase.($25,000).

Our Retail Leathercraft operation consists of 77 Tandy Leather Company retail stores at September 30, 2011,March 31, 2012, versus 76 stores at September 30, 2010.as of March 31, 2011.  Net sales increased 21.2%18.9% for the thirdfirst quarter of 2011 compared to2012 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 September 30,March 31, 2012 and 2011 and 2010 for our Retail Leathercraft operation:

Sales to eachretail, wholesale and manufacturer customer groupgroups increased compared toover the thirdfirst quarter of 2010 with the largest increases in2011, while sales to our Retail and Wholesaleinstitution customer groups.  groups declined over the same period.

Operating income increased $293,000,$355,000, or 56.4%35%, from the comparative 2010 quarter.  Operating income as a percentage of sales increased from 7.2%2011 quarter due to an increase in the third quarter of 2010 to 9.3%gross profit partially offset by an increase in the third quarter of 2011.operating expenses.  Our gross profit margin improved slightlyincreased by $1.1 million from 58.8%the prior period primarily due to 59.2%.higher sales.  Operating expenses as a percentage of sales decreasedremained virtually unchanged at 49% from 51.6% to 50.0% as sales grew at a faster rate than that of expenses during the quarter.  Operating expenses increased $647,000 over the thirdfirst quarter of 2010.2011.  The new store openedincrease in June 2011 accounted for additional operating expenses of $42,000.  Employee$749,000 compared to the first quarter of 2011 was caused by increases in employee compensation and benefits increased $320,000. Advertising($452,000), rent expense ($40,000), supplies ($10,000), freight out ($14,000) and advertising and marketing expenses increased $109,000.  Due to the increase in sales, shipping costs to customers and credit card fees increased $41,000 and $23,000, respectively.($121,000).

ConsistingInternational Leathercraft consists of all stores located outside of North America.  As of March 31, 2012, the segment contained three stores located in United Kingdom, Australia, and Spain. As of March 31, 2011, the segment consisted of the one store located in the UK at September 30, 2011, this division’sUnited Kingdom.  This segment’s sales totaled $491,000$742,000 for the thirdfirst quarter of 2012, compared to $509,000 in the first quarter of 2011, compared to $415,000 in the third quarter of 2010, an improvement of 18%46%.  Gross profit marginSame store sales were $530,000 as of March 31, 2012 and $509,000 as of March 31, 2011, a percentage of sales increased significantly from the third quarter of 2010, from 58.9% to 66.5%.  We determine UK selling prices taking into consideration the currency conversion between the U.S. dollar and the Great Britain pound.  Even so, our UK store generates higher profit margins than that of a comparable U.S. store due to a beneficial product mix, selling more higher margin tools and supplies and less lower margin leather.4% increase.  Operating expenses totaled $212,000$501,000 in the thirdfirst quarter of 2011,2012, up from $197,000$215,000 in the thirdfirst quarter of 2010.2011.  The operating expenses associated with the two new stores in Australia and Spain account for the increase in operating expenses.  Employee compensation is this division’ssegment’s largest expense, followed by advertising expense,and marketing expenses, rent, travel, and shipping costs to customers, and rent.customers.

We paid $58,000 in interest on our bank debt in the first quarter of 2012, compared to $62,000 in interest expense in the thirdfirst quarter of 2011,2011.  Due to the reduction in short-term investments compared to $67,000 in interest expense in the third quarter last year.  We earned $15,000year, we recorded $5,000 in interest income on our cash balances during the third quarter of 2011, up from last year’s third quarter interest income earned of $10,000.compared to $8,000 a year ago.  We recorded income of $145,000 during$4,000 for currency fluctuations in the thirdfirst quarter of 2012.  Comparatively, in the first quarter of 2011, related to currency fluctuations from our Canadian and UK operations.  Comparatively, in the third quarter of 2010, we recorded incomean expense of $6,000$72,000 for currency fluctuations.

On our consolidated balance sheet, total assets were $42.2 millionremained steady at September 30, 2011, up $1.6 million from $40.6$45.5 million at year-end 2010.2011 and March 31, 2012.  Total stockholders’ equity increaseddecreased from $29.8$34.4 million at December 31, 20102011 to $32.6$33.6 million at September 30, 2011,March 31, 2012, the increasedecrease being attributable to earningsthe cash dividend of $2.5 million being released in the first three quartersquarter of this year.year for payment to stockholders as of April 2, 2012.  Our current ratio increaseddecreased from 4.24.7 at December 31, 20102011 to 5.54.2 at September 30, 2011March 31, 2012 due primarily to a decreasean increase in accrued expenses and income taxesaccounts payable during the first nine monthsquarter of 2011.2012.

Trade accounts receivable was $1.5$1.4 million at September 30, 2011,March 31, 2012, up $286,000$121,000 from $1.2$1.3 million at year-end 2010.2011.  The average days to collect accounts remain unchanged at 48 days for the first nine monthsquarter of 2011 were 49 days, up slightly from2012 and the same period in 2010first quarter of 46 days.2011.  We are constantly monitoring our customer accounts very closely in order to minimize the risk of uncollectible accounts in the current economic environment.

Accounts payable increased to $1.8$2.3 million at September 30, 2011March 31, 2012 compared to $1.2$1.6 million at year-end 2010,2011, primarily due to the increase ofin inventory purchases during the first nine months of 2011quarter in response to our sales increase.  Accrued expenses decreased $1.5increased slightly to $4.7 million from Decemberat March 31, 2010 to September 30, 2011 primarily due to a reduction in inventory in transit2012 compared to $4.6 million at year-end 2010.2011.

During the first nine monthsquarter of 2011,2012, cash flow providedused by operating activities was $1.6$2.0 million.  NetThe increase in inventory of $4.2 million offset by net income of $3.1$1.6 million was offset by a reductionand the increase in accrued liabilitiesaccounts payable of $1.5 million and$725,000, accounted for the majority of the operating cash providedused in the first nine months.  quarter.

By comparison, during the first nine monthsquarter of 2010,2011, cash flow used by operating activities was $766,000.  Net income$496,000.  The reduction in accrued liabilities of $2.6$2.2 million and an increase in accounts payable of $1.4 million offset by the increase in inventory of $4.0 million and other current assets of $1.8$614,000, offset by net income of $1.2 million, accounted for the majority of the operating cash used.used in the first quarter.

Cash flow provided by investing activities totaled $246,000$204,000 in the first three quartersquarter of 2011,2012, consisting primarily of certificate of deposit maturities of certificates of deposit,$336,000 being offset somewhat by purchases of store fixtures and computer equipment.equipment of $140,000.  In the first nine monthsquarter of 2010,2011, cash provided byused in investing activities totaled $2.4 million, consisting$142,000 which was primarily purchases of net maturities of certificates of deposit.store fixtures and computer equipment.

Cash flow used by financing activities totaled $152,000$2.6 million in the first nine monthsquarter of 2011,2012, consisting of a special one-time cash dividend of $2.5 million and debt repayments.repayments of $51,000.  In the first nine monthsquarter of 2010,2011, cash flow used by financial activities totaled $7.7 million, consisting primarilyconsisted entirely of a cash dividend paid of $7.7 million.  Proceeds received from issuance of common stock of $170,000, offset by debt repayments of $152,000, minimally reduced cash used in financing activities.$51,000.

We expect to fund our operating and liquidity needs as well as our store growth from a combination of current cash balances and internally generated funds.

For disclosures about market risk and foreign currency exchange 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, 2010.2011.  We believe that our exposure to market risks has not changed significantly since December 31, 2010.2011.  We expect that our exposure to foreign currency exchange risk will increase as our international presence increases.

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, September 30, 2011.March 31, 2012. 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 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 September 30, 2011,March 31, 2012, 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 September 30, 2011March 31, 2012 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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.