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, 2015March 31, 2016 and December 31, 2014,2015, and its results of operations and cash flows for the three and nine-monththree-month periods ended September 30, 2015March 31, 2016 and 2014.2015.  Operating results for the three and nine-month periodsthree-month period ended September 30, 2015March 31, 2016 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.2016.  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, 2014.2015.

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, 2014,2015, 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 2015.2016.

We recorded amortization expense of $34,001$3,861 during the first nine monthsquarter of 20152016 compared to $33,924$11,278 during the same periodfirst quarter of 2014.2015.  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 September 18, 2015, we executed a Promissory Note and Business Loan Agreement with BOKF, NA dba Bank of Texas (“BOKF”), pursuant to which BOKF agreed to provideprovides us with a line of credit facility of up to $6,000,000.  It has a two-year term and is secured by our inventory.   The Business Loan Agreement contains covenants that we will maintain a funded debt to EBITDA ratio of no greater than 1.5 to 1, and that we will maintain a Fixed Charge Coverage Ratio greater than or equal to 1.2 to 1.  Both ratios are calculated quarterly and are based on a trailing four quarter basis.

Also on September 18, 2015, we executed a Promissory Note with BOKF, pursuant to which BOKF agreed to provideprovides us with a line of credit facility of up to $10,000,000 for the purpose of purchasing our common stock.  Under the terms of the Promissory Note, we can borrow sums up to the lesser of $10,000,000 or the purchase price of a maximum of 1.2 million shares of our common stock from the period September 18, 2015 and ending on the earlier of September 18, 2016 or the date on which the entire amount is drawn.  During this time period, we will make interest only payments monthly, at whichmonthly. At the end of this time period, the principal balance will be rolled into a 4-year term note.  This Promissory Note is secured by a Deed of Trust on the real estate located at 1900 SE Loop 820, Fort Worth, Texas.  WeFor the quarter ended March 31, 2016, we drew approximately $3.7$2.9 million on this line of credit in September 2015 which was used to purchase approximately 529,000404,000 shares of our common stock.  At March 31, 2016, the unused portion of the line of credit was approximately $3.4 million.

Amounts drawn under either Promissory Note accrue interest at the London interbank Eurodollar market rate for U.S. dollars (commonly known as “LIBOR”) plus 1.85% (2.04%(2.278% and 2.263% at September 30, 2015)March 31, 2016 and December 31, 2015, respectively).

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 191,000 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 that is our corporate headquarters.  On April 30, 2008, the principal balance was rolled into a 10-year term note with an interest rate of 7.10% per annum.  We paid this note in full in September 2015.  As2015 and as a result of the early payoff, we incurred a prepayment penalty in the amount of $200,000 which iswas included in interest expense.

On July 12, 2012, we executed a Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a revolving credit facility of up to $4 million, which was subsequently increased to $6 million.  The note expired on September 30, 2015.  There was no balance owed on the line of credit at the expiration date.

At September 30, 2015March 31, 2016 and December 31, 2014,2015, the amount outstanding under the above agreements consisted of the following:

We have one stock option plan which permits 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.  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.  Under this plan, no options were awarded to directors during the nine monthsquarters ended September 30,March 31, 2016 and 2015 and 2014 and therefore, no share based compensation expense was recorded for those periods.

Other information pertaining to option activity during the nine-monththree-month periods ended September 30,March 31, 2016 and 2015 and 2014 are as follows:

ThereAs of March 31, 2016 and 2015, there was no unrecognized compensation cost pertainingrelated to non-vested stock option grants as of September 30, 2015 and 2014.options.

We have a restricted stock plan that was adopted by our Board of Directors in January 2013 and approved by our stockholders in June 2013.  The plan reserves up to 300,000 shares of our common stock for restricted stock awards to our executive officers, non-employee directors and other key employees.  Awards granted under the plan may be stock awards or performance awards, and may be subject to a graded vesting schedule with a minimum vesting period of four years, unless otherwise determined by the committee that administers the plan.

In February 2014, our Chief Executive Officer, Chief Financial Officer and Senior Vice President were awarded restricted stock grants consisting of 9,375 shares each. In addition, four of our independent directors were awarded restricted stock grants consisting of 1,619 shares each. The grants will vest in equal annual amounts over a four-year period.  The fair value of non-vested restricted common stock awards is the market value of our common stock on the date of grant.  Compensation costs for these awards will be recognized on a straight-line basis over the four year vesting period.

A summary of the activity for non-vested restricted common stock awards as of September 30,March 31, 2016 and 2015 and 2014 is presented below:

Total unrecognized compensation expense for the non-vested restricted stock awards as of September 30,March 31, 2016 and 2015 totals $603,645 and 2014 totals $445,650 and $261,584, respectively.$523,154, respectively  As of September 30, 2015,March 31, 2016, compensation expense is expected to be recognized in equal annual amounts over a period of four years as follows:

The following table sets forth the computation of basic and diluted earnings per share (“EPS”) for the three and nine months ended September 30, 2015March 31, 2016 and 2014:2015:

The net effect of convertingassuming the exercise of all potentially dilutive common share equivalents, including stock options and restricted stock awards of 128,833 and 119,201 shares ofto purchase common stock at exercise prices less than the average market prices hasand restricted stock awards of an aggregate of 149,922 and 130,833 shares of common stock have been included in the computations of diluted earnings per shareEPS for the quarters ended September 30,March 31, 2016 and 2015, and 2014, respectively.

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 and nine-monththree-month periods ended September 30, 2015March 31, 2016 and 2014.2015.  We do not have any significant long-lived assets outside of the United States.

Our Wholesale Leathercraft segment operates 28 company-owned wholesale stores in 18 states and three Canadian provinces.  These stores are engaged primarily in the wholesale distribution and retail sales 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 previously included our National Account sales group, whose only customers were national craft chains.  We ended sales through this group in April 2014.

Our Retail Leathercraft segment operates company-owned Tandy Leather Company retail stores in 38 states and six Canadian provinces.  Tandy Leather Company, 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 our industry presence by opening retail stores.  As of NovemberMay 1, 2015,2016, we were operating 82 Tandy Leather Company retail stores located throughout North America.

Our International Leathercraft segment operates 4 company-owned stores, all located outside of North America, whichAmerica.  These stores operate as combination retail / wholesale stores.  Asstores and consist of November 1, 2015, we were operating 4 international stores with two locatedone store in theNorthampton, United Kingdom,Kingdom; one locatedstore in Manchester, United Kingdom; one store in Sydney, Australia, and one locatedstore in Jerez, Spain.  We expect to continue opening international stores in the future, but do not have a specific timeline.intend to open any new stores in 2016.

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, 2014.2015.

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, without limitation, 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, 20142015 for additional information concerning these and other uncertainties that could negatively impact the Company. Potential factors, which could cause our actual results of operations to differ materially from those in the forward-looking statements include, among others:

The following tables present selected financial data of each of our three segments for the quarters ended September 30, 2015March 31, 2016 and 2014.2015.

Consolidated net sales for the quarter ended September 30, 2015March 31, 2016 decreased approximately $61,000,$117,000, or 0.3%0.6%, compared to the same period in 2014.2015.  Retail Leathercraft reported a 2.2% sales gain.gain of 1%, while Wholesale Leathercraft and International Leathercraft reported sales decreasesdeclines of 3%3.4% and 13%2.2%, respectively.  Income from operations on a consolidated basis for the quarter ended September 30, 2015March 31, 2016 decreased 24%1%, or approximately $597,000,$26,000, from the thirdfirst quarter of 20142015 primarily due to an decrease in gross profit margin and an increase in operating expenses.expenses, offset by an improvement in gross profit.

The following table shows in comparative form our consolidated net income for the thirdfirst quarters of 20152016 and 2014:2015:

All segments were profitable in the thirdfirst quarter of 2015 and therefore, contributed to our consolidated net income.2016.  Additional information appears below for each segment.

Our Wholesale Leathercraft operation consists of 28 stores.wholesale stores (there were no wholesale stores opened or closed in either the first quarter of 2016 or 2015).  The following table presents the combined sales mix by customer categories for the quarters ended September 30, 2015 and 2014:March 31:

Net sales decreased 3%3.4%, or approximately $180,000,$228,000, for the thirdfirst quarter of 20152016 compared to the thirdfirst quarter of 2014 as follows:

A decreaseAn increase in gross profit of approximately $104,000, along with$219,000 offset by an increase in operating expenses of approximately $214,000,$45,000 contributed to the reductionimprovement in income from operations compared to last year’s third quarter.operations.  Gross profit as a percentage of sales increased from 62.0% in the thirdfirst quarter of 2015 increased minimally to 68.4%67.6% in the first quarter of 2016, due to an increase in sales of higher margin products compared to 68.1% in the third quarter of 2014.last year’s first quarter.  Operating expenses increased by 7%1.4%, increasing $214,000or $45,000, compared to last year’s comparable period.  The most significant expense increase occurred in employee benefits, licenseslegal and professional fees, other outside services, advertisingoffset somewhat by a reduction in travel and marketing, and dues and subscriptions.moving expenses.

Our Retail Leathercraft operation consistsconsisted of 82 Tandy Leather Company retail stores at September 30, 2015 compared to 80 stores at September 30, 2014.both March 31, 2016 and March 31, 2015.  Net sales increased 2.2%1.0% for the thirdfirst quarter of 20152016 over the same quarter last year.  In the first quarter of 2016, one new store was opened in Nyack, NY and one store was closed in Tucson, AZ.  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, 2016 and 2015 and 2014 for our Retail Leathercraft operation:

Sales to our retail, wholesale and manufacturer customer groupsmanufacturing customers increased overin the thirdfirst quarter of 2014,2016 compared to the first quarter of 2015, while sales to our institutionother customer groupgroups declined slightly over the same period.slightly.

International Leathercraft consists of all stores located outside of North America.  As of September 30, 2015 and 2014,March 31, 2016, the segment contained threefour stores, with one eachtwo of which are located in United Kingdom (one of which opened in October 2015) and one each in Australia and Spain. This segment’s sales totaled approximately $912,000$933,000 for the thirdfirst quarter of 2016, compared to $954,000 in the first quarter of 2015, compared to approximately $1.1 million in the third quarter of 2014, a decrease of 13%2.2%.  The declineGross profit margin improved from 59.5% in sales is primarily the result of the change in currency exchange rates from the third quarter of 2015 compared to the rates60.9% in the third quarter of 2014.  If the 2015 exchange rates had matched the 2014 exchange rates, this segment would have achieved a 2% sales increase compared to last year’s third quarter.  Gross profit margin decreased $188,000,2016, while operating expenses decreasedincreased by $58,000.$12,000.  Operating expenses totaled $479,000$546,000 in the thirdfirst quarter of 2015, down2016, up from $538,000$534,000 in the thirdfirst quarter of 2014.  Employee compensation is2015.  Advertising and marketing expenses are this segment’s largest expense, followed by advertising and marketing expenses,employee compensation, rent, and utilities,travel, and shipping costs to customers.

On our consolidated balance sheet, total assets decreasedincreased from approximately $62.9$64.6 million at year-end 20142015 to approximately $62.6$65.3 million at September 30, 2015.March 31, 2016.  Total stockholders’ equity decreased from approximately $49.1$51.0 million at December 31, 20142015 to approximately $48.6$50.3 million at September 30, 2015,March 31, 2016, the decrease being attributable to the increase in$2.9 million of treasury stock partiallypurchases offset by our net income earned in the first three quartersquarter of 2015.2016.  Our current ratio increased from 4.55.7 at December 31, 20142015 to 5.26.5 at September 30, 2015March 31, 2016 due primarily to the increase in Accounts Payable and Accrued Expenses from year-end 2014 and the reduction in current maturitiesaccrued liabilities for bonuses paid in the first quarter of long-term debt.2016.

As of September 30, 2015,March 31, 2016, our investment in inventory increased by approximately $2.2 million$48,000 from year-end 2014.2015.  Inventory turnover reached an annualized rate of 2.42.5 times during the first three quartersquarter of 2015, equal of that in2016, decreasing from 2.6 times for the first three quartersquarter of 2014.2015.  Inventory turnover was 2.82.5 times for all of 2014.2015.  We compute our inventory turns as sales divided by average inventory.

Trade accounts receivable was approximately $585,000$683,000 at September 30, 2015, down approximately $40,000March 31, 2016, up $130,000 from approximately $625,000$553,000 at year-end 2014.2015.  The average days to collect accounts for the first nine months of 2015 were 33 days, improving slightly fromdecreased to 34 days for the first nine monthsquarter of 2014.2016, a slight improvement from the average days to collect accounts in the first quarter of 2015 of 35 days.  We monitorare continually monitoring our customer accounts very closely in an effortorder to minimize the risk of uncollectible accounts.

Accounts payable increaseddecreased approximately $1.2 million$63,000 to approximately $2.5$1.9 million at September 30, 2015March 31, 2016 compared to $1.3$2.0 million at year-end 20142015 due to the increase in inventory purchases during the third quartertiming of 2015 compared to the fourth quarter of 2014.payments. Accrued expenses increaseddecreased from approximately $5.4$6.0 million at December 31, 20142015 to approximately $6.4$4.6 million at September 30, 2015.March 31, 2016.  The increase inpayment of the inventory in transit at September 30, 2015 compared to that at December 31, 2014manager bonuses during the first quarter of 2016 primarily accounted for the increase.reduction.

During the first nine monthsquarter of 2016, cash flow provided by operating activities was $1.1 million, composed of net income of $1.5 million, plus $414,000 of depreciation and amortization, plus $614,000 of foreign currency translation, offset by the decrease in accrued expenses and other liabilities of $1.5 million.

By comparison, during the first quarter of 2015, cash flow provided by operating activities was approximately $4.5$3.5 million.  Net income of approximately $4.0 million, depreciation and amortization expense of approximately $1.1 million, the increase in Accounts Payable and Accrued Expenses totaling $2.2 million, offset by theThe decrease in inventory of $2.2$2.5 million accountsand net income of $1.4 million accounted for the operating cash provided during the first three quartersquarter of 2015.

Cash flow used in investing activities totaled approximately $1.3 million$584,000 and $675,000 in the first nine monthsquarters of 2016 and 2015, respectively, consisting primarily of the purchase of fixtures for store fixturesmoves and computer equipment.  Cash flow used in investing activities totaled approximately $1.7 million in the first nine months of 2014, consisting primarily of the purchase of store fixturesremodels and computer equipment.

Cash flow used in financing activities totaled approximately $5.6$7,450 in the first quarter of 2016, compared to $3.5 million in the first nine monthsquarter of 2015, consisting2015.  In 2016, we purchased $2.9 million of net debt repayments and the repurchase oftreasury stock, into treasury. Cash flow provided by financing activities totaled approximately $3.1 million in the first nine months of 2014, consisting of borrowings againstfunded primarily through drawdowns on our line of credit with BOKF.  We also made a scheduled payment on our capital lease obligation for $6,710.  In 2015, cash used consisted primarily of $6 million, partially offset by bank debt repayments totaling $405,000 and the payment of a special dividend totaling approximately $2.5 million.repayments.

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, and occasional borrowings on our line of credit with Bank of Texas.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, 2014.2015.  We believe that our exposure to market risks has not changed significantly since December 31, 2014.2015.  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, 2015.March 31, 2016. 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, 2015,March 31, 2016, 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, 2015March 31, 2016 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The information contained in Note 6 to the consolidated financial statements included in Item 1 of this Report is hereby incorporated into this Item 1 by reference.

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

The following table provides information about purchases we have made of our common stock during the quarter ended September 30, 2015:March 31, 2016:

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.