SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Quarterly Report Pursuant To Section 13 or 15(d)
of the Securities Exchange Act of 1934

For the Quarterly Period Ended March 31, 2004

Commission File Number 0-18927

TANDY BRANDS ACCESSORIES, INC.

690 East Lamar Boulevard, Suite 200, Arlington, TX 76011
(Address of principal executive offices and zip code)

(817) 548-0090
(Registrant’s telephone number, including area code)

Former name, former address and former fiscal year, if changed since last report:

Not Applicable

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [   ]

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes [   ] No [X]

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

TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES

Form 10-Q
Quarter Ended March 31, 2004

TABLE OF CONTENTS

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TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES
File Number 0-18927
Form 10 - Q

Condensed Consolidated Statements of Income
(In thousands, except per share amounts)
(Unaudited)

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

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TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES
File Number 0-18927
Form 10 - Q

Condensed Consolidated Balance Sheets
(Dollars in thousands)
(Unaudited)

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

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TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES
File Number 0-18927
Form 10 - Q

Condensed Consolidated Statements of Cash Flows
(Dollars in thousands)
(Unaudited)

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

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TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 1 - Accounting Principles

     The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine-month periods ended March 31, 2004 are not necessarily indicative of the results that may be expected for the year ended June 30, 2004. For further information, refer to the consolidated financial statements and footnotes thereto included in our 2003 Annual Report.

Note 2 – Comprehensive Income

     The following table illustrates the components of comprehensive income, net of related tax, for the three and nine months ended March 31, 2004 and 2003 (in thousands).

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 3 – Earnings Per Share

     The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share amounts).

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 4 – Disclosures about Segments of an Enterprise and Related Information

     We sell our products to a variety of retail outlets, including mass merchants, national chain stores, major department stores, men’s and women’s specialty stores, catalog retailers, grocery stores, drug stores, golf pro shops, sporting goods stores and the retail exchange operations of the United States military. Our company and our corresponding customer relationships are organized along men’s and women’s product lines. As a result, we have two reportable segments: (1) men’s accessories, consisting of belts, wallets, suspenders and other small leather goods, and (2) women’s accessories, consisting of belts, wallets, handbags, socks, scarves, hats and hair accessories. General corporate expenses are allocated to each segment based on the respective segment’s asset base. Depreciation and amortization expense related to assets recorded on our corporate accounting records are allocated to each segment as described above. Management measures profit or loss on each segment based upon income or loss before taxes utilizing the accounting policies consistent in all material respects with those described in Note 1 of our 2003 Annual Report. No inter-segment revenue is recorded.

     The following table sets forth information regarding operations and assets by reportable segment (in thousands).

(1)

Operating income/(loss) consists of net sales less cost of sales and specifically identifiable selling, general and administrative expenses.

(2)

Other income includes royalty income on corporate tradenames and other income not specifically identifiable to a segment.

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TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 5 – Goodwill and Other Intangible Assets

     Effective July 1, 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets.” This statement changed the accounting for goodwill and indefinite-lived intangible assets from an amortization approach to an impairment-only approach. Using the SFAS No. 142 approach, we recorded a transitional goodwill impairment charge during the first quarter of fiscal 2003 of $950,000 ($581,000 net of tax), presented as a cumulative effect of accounting change. This charge related to our women’s accessories segment of products.

Note 6 – Stock-Based Compensation

     We may, with the approval of our board of directors, grant stock options for a fixed number of shares to employees with an exercise price equal to the fair value of the shares at the date of grant. We account for stock option grants using the intrinsic value method in accordance with the Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and, accordingly, we recognize no compensation expense for the stock option grants. The following table reflects the impact on net income if we had applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation,” to stock-based employee compensation for the three and nine-month periods ended March 31, 2004 and 2003:

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

Note 6 – Stock-Based Compensation (continued)

     Pro forma information regarding net income and earnings per share is required by SFAS No. 123, “Accounting for Stock-Based Compensation,” and has been determined as if we had accounted for our stock options under the fair value method of SFAS No. 123. The fair value for these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for fiscal 2004 and 2003: dividend yield of 1.0% for 2004 and 0.0% for 2003; expected volatility of .238% and .270% for 2004 and 2003, respectively; a risk-free interest rate of 5.25% for fiscal 2004 and 2003; and an expected holding period of seven years. Using these assumptions for the options granted during the first nine months of fiscal 2004 and 2003, the weighted-average grant date fair value of such options ranged from $3.83 to $5.27 for each period, respectively.

     The Black-Scholes valuation models are used in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility and the average life of options. Because our stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of our stock options.

     On October 15, 2003, our directors were awarded a total of 3,720 shares of restricted stock. The shares will become fully vested on October 15, 2006, with one-third of the shares vesting on each anniversary of the date of grant. Generally, upon the death, disability, resignation, or termination of a director, that director’s shares become fully vested. These shares of stock, while not transferable, bear rights of ownership, including voting and dividend rights, during the vesting period. Unearned compensation in the amount of $58,000 was recorded during the quarter ended December 31, 2003. Compensation expense of approximately $19,000 and $38,000 was recorded during the quarter and nine months ending March 31, 2004, respectively.

Note 7 – Employee Benefit Plans

     On July 1, 2003, our executive officers were awarded a total of 22,800 shares of restricted stock. The shares will become fully vested on July 1, 2006. These shares of stock, while not transferable, bear rights of ownership, including voting and dividend rights, during the three year vesting period. There are no performance requirements related to vesting, only continued employment through the vesting date. Unearned compensation in the amount of $275,000 was recorded during the quarter ended September 30, 2003. Compensation expense of approximately $23,000 per quarter will be recorded through June 30, 2006.

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

OVERVIEW

     Tandy Brands Accessories, Inc. is a leading designer, manufacturer and marketer of branded men’s, women’s and children’s accessories, including belts and small leather goods, such as wallets. Our product line also includes handbags, socks, scarves, gloves, hats, hair accessories, suspenders, cold weather accessories and sporting goods accessories. Our merchandise is marketed under a broad portfolio of nationally recognized licensed and proprietary brand names, including DOCKERS®, LEVI’S®, LEVI STRAUSS SIGNATURE™, JONES NEW YORK®, ROLFS®, HAGGAR®, WOOLRICH®, JORDACHE®, BUGLE BOY®, CANTERBURY®, PRINCE GARDNER®, PRINCESS GARDNER®, AMITY®, COLETTA®, STAGG®, ACCESSORY DESIGN GROUP®, and TIGER®, as well as private brands for major retail customers. We sell our products through all major retail distribution channels throughout the United States and Canada, including mass merchants, national chain stores, department stores, men’s and women’s specialty stores, catalogs, grocery stores, drug stores, golf pro shops, sporting goods stores and the retail exchange operations of the United States military.

     During the third quarter of fiscal 2004, men’s accessories net sales were up 9% from last year, reflecting a strong performance in our men’s and boys’ product categories. Sales of women’s accessories were lower than expected due to a challenging market for women’s mass merchant fashion accessories. Our balance sheet performance was above expectation during the third quarter, with improved positions in accounts receivable and inventory driving strong cash flow. Although the continued downward pressure on retail inventory levels by major retailers is expected to impact fourth quarter sales, resulting in lower sales and earnings compared to last year, we anticipate a return to normalized sales and earnings growth during the course of the upcoming fiscal year.

RESULTS OF OPERATIONS

Three and Nine Months Ended March 31, 2004 Compared to the Three and Nine Months Ended March 31, 2003

Net Sales and Gross Margins

     The following table illustrates sales and gross margin data from our reportable segments for the three and nine months ended March 31, 2004 compared to the same period last year.

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     For the three-month period ended March 31, 2004, net sales decreased 9.5% compared to net sales for the same period last year. Net sales of men’s accessories increased 9.0% for the quarter compared to the same period last year due to increased sales of both belts and small leather goods. Net sales of women’s accessories decreased 26.2% for the quarter compared to the same period last year primarily due to lower mass merchant accessory sales. The shortfall in our women’s mass merchant category was due to downward pressure on inventory replenishment by mass merchant customers as well as fewer new fashion trend items compared to the same period in the prior year. Due to continued competitive market pressures and fewer item-driven trends, we anticipate that similar sales conditions will continue during the fourth quarter of fiscal 2004. For the nine-month period ending March 31, 2004, net sales decreased 1.3% compared to the same period last year due to the weak sales performance by women’s mass merchant accessories during the second and third quarter. Although men’s accessory sales increased 3.3% during the first nine months of this year, women’s accessory sales decreased 5.6% compared to the same period last year.

     As a percentage of sales, gross margins increased 1.0% for the three-month period ended March 31, 2004, compared to the same period last year due primarily to a change in the mix of men’s accessories and women’s mass merchant accessories. As a percentage of sales, gross margins decreased 0.3% for the nine-month period ended March 31, 2004 compared to the same period last year. The overall decrease was due to a greater sales mix weighted towards men’s and women’s mass merchant accessories during the first two quarters of fiscal 2004, higher than anticipated customer allowances, and increased direct sales, which have lower than historical gross margins, of women’s mass merchant fashion accessories. Although we anticipate gross margin percentages to approximate historical levels in future periods, any material changes in sales mix, such as higher mass merchant accessory sales or direct shipments could lower our gross margin percentages during a particular season.

Operating Expenses

     Selling, general and administrative expenses for the three months ended March 31, 2004, increased compared to the same period last year due to higher professional fees and salary costs related to the implementation of new software at our West Bend, Wisconsin distribution facility. For the nine months ended March 31, 2004 selling, general and administrative expenses decreased compared to the same period last year. This decrease was due primarily to a bad debt recovery during the second quarter of fiscal 2004, of approximately $651,000, arising from a customer’s bankruptcy court settlement and payment of accounts receivable previously reserved by the company.

     Depreciation and amortization expense decreased for the three and nine months ended March 31, 2004, compared to the same periods of the previous year. The decrease for both periods was due to certain intangibles that were fully amortized during the prior fiscal year having reached the end of their useful lives.

     Interest expense for the three and nine-month periods ended March 31, 2004, decreased $74,000 and $221,000, respectively, compared to the same periods last year. This overall decrease primarily relates to lower debt levels as well as lower interest rates compared to the same periods last year.

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TANDY BRANDS ACCESSORIES, INC. AND SUBSIDIARIES

     The effective tax rate for the nine months ended March 31, 2004, was 38.9%, which approximates the effective tax rate for the same period last year.

     Net income for the three-month period ended March 31, 2004, decreased to $132,000, or $.02 per diluted share, compared to net income of $1,032,000, or $.17 per diluted share for the same period last year. For the nine-month period ended March 31, 2004, net income decreased to $6,886,000, or $1.08 per diluted share, compared to net income of $7,054,000, or $1.18 per diluted share, before the cumulative effect of an accounting change resulting from the adoption of SFAS No. 142, for the same period last year. During the first quarter of fiscal 2003, we recorded the cumulative effect of an accounting change resulting from the adoption of SFAS No. 142 in the amount of $581,000, net of tax. Net income including the cumulative effect of the accounting change was $6,473,000 or $1.08 per diluted share for the nine-month period ending March 31, 2003.

LIQUIDITY AND CAPITAL RESOURCES

     For the nine months ended March 31, 2004, our operating activities provided cash of $19,366,000 compared to $12,595,000 used in the same period last year. The increase in cash is due to lower inventory procurement for the third quarter of fiscal 2004 and the timing of cash receipts from customers. We anticipate the trend of positive cash flows to continue with seasonal uses of cash during the fourth quarter of fiscal 2004 as inventory procurement increases.

     Capital expenditures totaled $2,549,000 for the nine months ended March 31, 2004, an increase of $1,159,000 from the same period last year. We attribute this increase to the implementation of a new software application at our facility in West Bend, Wisconsin during the first nine months of fiscal 2004 as well as our acquisition of additional computer hardware and leasehold improvements at our distribution facility in Dallas, Texas. Capital commitments for the remainder of fiscal 2004 include additional expenditures related to the software implementation and leasehold improvements to our Dallas distribution center and our corporate offices. We anticipate that our total capital expenditures for the fiscal year ending June 30, 2004 will be approximately $3,500,000. We expect to fund such capital commitments from our working capital and by drawing on our existing credit facility.

     Generally, our primary sources of liquidity are cash flows from operations and our credit facility. We have a $60,000,000 committed secured revolving credit facility, which can be used for seasonal borrowings and letters of credit. This credit facility is secured by substantially all of our assets along with our subsidiaries’ assets and requires us to maintain certain financial covenants. If we do not comply with these covenants, our liquidity position could be adversely impacted. Our borrowings under our credit facility were $30,000,000 and $38,190,000 as of March 31, 2004, and 2003, respectively. As of March 31, 2004, we had approximately $27,600,000 of available credit under our credit facility and cash on hand of approximately $23,013,000.

     During fiscal 2004, we declared dividends as set forth in the following table:

     We believe we have adequate financial resources and access to sufficient credit lines to satisfy our future working capital needs.

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CONTRACTUAL OBLIGATIONS AND CONTINGENT LIABILITIES AND COMMITMENTS

     On January 31, 2004, we signed a new lease agreement on our corporate office facilities in Arlington, Texas. The lease term is for sixty-seven months and commits us to an average monthly rental expense of $51,654 per month. Except for the new office lease agreement, there have been no material changes outside the ordinary course of our business in any of our contractual obligations, contingent liabilities, or commitments since June 30, 2003.

OFF-BALANCE SHEET ARRANGEMENTS

     We do not have any off-balance sheet arrangements.

CRITICAL ACCOUNTING POLICIES

     The preparation of our consolidated financial statements in accordance with accounting principles generally accepted in the United States requires the use of estimates that affect the reported value of assets, liabilities, revenues and expenses. These estimates are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for our conclusions. We continually evaluate the information used to make these estimates as the business and economic environment changes. Actual results may differ from these estimates under different assumptions or conditions. The use of estimates is pervasive throughout the consolidated financial statements, but the accounting policies and estimates considered most critical are as follows:

Revenues

     We recognize revenue when merchandise is shipped and title to the goods has passed to the customer. We record allowances, including cash discounts, in-store customer allowances, cooperative advertising allowances and customer returns, at the time the revenue is recognized based upon historical experience, current trends in the retail industry and individual customer and product experience.

     We perform periodic credit evaluations of our customers’ financial conditions and generally do not require collateral. Credit losses have historically been within management’s expectations.

Inventories

     Inventories are stated at the lower of cost (principally standard cost, which approximates actual cost on a first-in, first-out basis) or market. Cost includes materials, direct and indirect labor and factory overhead. Market, with respect to raw materials, is replacement cost; and for work-in-process and finished goods, it is net realizable value. If circumstances arise in which the market value of items in inventory declines below cost, an inventory markdown would be estimated and charged to expense in the period identified. We closely monitor fashion trend items and anticipate additional inventory markdowns if market indications in fashion trends justify further reserves.

Goodwill

     We adopted the provisions of SFAS No. 142, effective July 1, 2002. This statement changed the accounting for goodwill and indefinite-lived intangible assets from an amortization approach to an impairment-only approach. The SFAS No. 142 goodwill impairment model is a two-step process. The first step compares the fair value of a reporting unit that has goodwill assigned to it to its carrying value. We estimate the fair value of a reporting unit using a discounted cash flow analysis. If the fair value of the reporting unit is determined to be less than its carrying value, a second step is performed to compute the amount of goodwill impairment, if any. Step two allocates the fair value of the reporting unit to the reporting unit’s net assets other than goodwill. The excess of the fair value of the reporting unit over the amounts assigned to its net assets other than goodwill is considered the implied fair value of the reporting unit’s goodwill. The implied fair value of the reporting unit’s goodwill is then compared to the carrying value of its goodwill. Any shortfall represents the amount of goodwill impairment.

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     We continually evaluate whether events and circumstances have occurred that indicate the remaining balance of goodwill may not be recoverable. In evaluating impairment, we estimate the sum of the expected future cash flows derived from such goodwill. Such evaluations for impairment are significantly impacted by estimates of future revenues, costs and expenses and other factors.

Derivatives

     Our risk management policy, as it relates to derivative investments, is to mitigate, subject to market conditions, against interest rate risk. We do not enter into any derivative investments for the purpose of speculative investment. Our overall risk management philosophy is reevaluated as business conditions arise.

SEASONALITY

     Historically, our quarterly sales and net income results are fairly consistent throughout the fiscal year, with a seasonal increase during the second quarter. Although this trend did not occur during the second quarter of fiscal 2004, we anticipate that future seasonality will return to historical trends.

INFLATION

     Although our operations are affected by general economic trends, we do not believe inflation has had a material effect on our operating results.

WEBSITE ACCESS TO COMPANY REPORTS

     Our website address is www.tandybrands.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, Forms 3, 4 and 5 filed by our officers, directors and stockholders holding 10% or more of our common stock, and all amendments to those reports are available free of charge through our website, as soon as reasonably practicable after such material is electronically filed with or furnished to the Securities and Exchange Commission.

FORWARD-LOOKING STATEMENTS

     This Form 10-Q contains forward-looking statements that are based on current expectations, estimates and projections about the industry in which we operate, management’s beliefs, and assumptions made by management. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” or variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions which are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecast in these forward-looking statements. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

     We are subject to interest rate risk on our long-term debt. We manage our exposure to changes in interest rates. On July 1, 2001, we entered into a three-year interest rate swap agreement with Wells Fargo HSBC Trade Bank, N.A., which expires on June 27, 2004, converting $30,000,000 of outstanding indebtedness from a variable to a fixed interest rate. The average receive rate is based on a 90-day LIBOR rate. At March 31, 2004, the receive and pay rates related to the interest rate swap were 1.16% and 5.60%, respectively. Interest differentials paid or received under the swap agreement are reflected as an adjustment to interest expense when paid. The fair value of the swap agreement at March 31, 2004 was approximately ($662,000) and is included in accrued liabilities. At March 31, 2004, the balance in other comprehensive income, related to the swap agreement, was approximately ($255,000). We do not expect the potential impact of market conditions on the fair value of our indebtedness to be material.

     On June 26, 2003, we amended our committed secured revolving credit facility. The amendment to our credit facility extended the expiration of the agreement from June 27, 2004 to November 30, 2006. In conjunction with the amendment to our credit facility, we discontinued hedge accounting on the swap described above. We intend to hold the swap until maturity on June 27, 2004. The change in the fair value of the swap agreement and balance in other comprehensive income will be charged to interest expense over the term of the swap.

     At March 31, 2004, our borrowings under our credit facility totaled $30,000,000, bearing a weighted-average interest rate of 2.58%

     In addition to interest rate risk on our long-term debt, we are also exposed to market risk with respect to changes in the global price level of certain commodities used in the production of our products. We routinely purchase leather hides during the year for use in the manufacture of men’s belts. We also purchase a substantial amount of leather items from third-party suppliers. An unanticipated material increase in the market price of leather could increase the cost of these products to us and therefore have a negative effect on our results of operations.

ITEM 4. Controls and Procedures

     We have evaluated, under the supervision and with the participation of management, including our Chief Executive Officer and our Chief Financial Officer, the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that, as of the end of the period covered by this quarterly report, our disclosure controls and procedures were effective in timely alerting them to material information (including information relating to our consolidated subsidiaries) required to be included in our Exchange Act filings.

     There has been no change in our internal control over financial reporting during the third quarter of 2004 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 6. Exhibits and Reports on Form 8-K

(a) Exhibits.

     A list of exhibits filed as part of this report is set forth in the Exhibit Index, which immediately precedes such exhibits and is incorporated herein by reference.

(b) Reports on Form 8-K.

During the third quarter of fiscal 2004, we filed a Form 8-K on

•

January 20, 2004 to report the issuance of the press release announcing our financial results for the second quarter of fiscal 2004, and

•

January 26, 2004 to report the issuance of the press release announcing the declaration of a quarterly dividend.

     During April and May 2004 we filed a Form 8-K on

•

April 21, 2004 to report the issuance of the press release announcing our financial results for the third quarter of fiscal 2004, and

•

May 7, 2004 to report the issuance of the press release announcing the declaration of a quarterly dividend.

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SIGNATURES

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

Date: May 10, 2004

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EXHIBIT INDEX

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EXHIBIT INDEX

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EXHIBIT INDEX

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EXHIBIT INDEX

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EXHIBIT INDEX

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EXHIBIT INDEX