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EX-32.1 - EXHIBIT 32.1 CERTIFICATION 906 - TANDY LEATHER FACTORY INCexhibit32-1.htm
EX-31.2 - EXHIBIT 31.2 RULE 13A-14(A) CERTIFICATION BY CFO - TANDY LEATHER FACTORY INCexhibit31-2.htm
EX-10.2 - AGREEMENT OF PURCHASE AND SALE, DATED JUNE 25, 2007 - TANDY LEATHER FACTORY INCexhibit10-2.htm
EX-31.1 - EXHIBIT 31.1 RULE 13A-14(A) CERTIFICATION BY CEO - TANDY LEATHER FACTORY INCexhibit31-1.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-K

         (Mark One)
        [X]      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2010
OR

        [  ]       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
                    For the transition period ________ to ________

Commission File Number 1-12368
Tandy Leather Factory, Inc.
(Exact Name of Registrant as Specified in its Charter)

Delaware
 
75-2543540
(State or Other Jurisdiction of Incorporation)
 
(I.R.S. Employer Identification No.)
     
1900 Southeast Loop 820, Fort Worth, TX  76140
 
817/872-3200
(Address of Principal Executive Offices)
 
(Registrant’s telephone number, including area code)
     
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.0024
 
NASDAQ Global Market

Securities registered pursuant to Section 12(g) of the Act:   NONE

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes [  ]  No [X]

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes [  ]  No [X]

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [   ] No [   ] (The registrant is not yet required to submit Interactive Data)

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “large accelerated filer,” “accelerated filer” and “small reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):  Large accelerated filer [  ] Accelerated filer [  ] Non-accelerated filer [X] Smaller reporting company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes [  ] No [X]

The aggregate market value of the common stock held by non-affiliates of the registrant was approximately $29,923,086 at June 30, 2010 (the last business day of its most recently completed second fiscal quarter).  At March 25, 2011, there were 10,156,442 shares of the registrant's common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on May 18, 2011, are incorporated by reference in Part III of this report.

 
 

 



Item
 
Page
     
Part 1
   
1
  1
1A
  5
2
  6
3
  6
4
  6
     
Part II
   
5
  7
6
  8
7
  12
7A
  13
8
  29
9
  29
9A
  29
9B
  29
     
Part III
   
10
  29
11
  29
12
  29
13
  29
14
  29
     
Part IV
   
15
  29


 
 

 

 
PART I


General

We are a retailer and wholesale distributor of a broad line of leather and related products, including leather, leatherworking tools, buckles and adornments for belts, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits. We also manufacture leather lacing and some of our do-it-yourself kits.  During 2010, our consolidated sales totaled $59.9 million of which approximately 14% were export sales.  We maintain our principal offices at 1900 Southeast Loop 820, Fort Worth, Texas 76140.  Our common stock trades on the NASDAQ Global Market under the symbol "TLF."

Our company was founded in 1980 as Midas Leathercraft Tool Company, a Texas corporation.  Midas' original business activity focused on the distribution of leathercraft tools.  In addition, the founders of Midas entered into a consulting agreement with Brown Group, Inc., a major footwear retailer, as a result of their proposal to develop a multi-location chain of wholesale stores known as "The Leather Factory."  In 1985, Midas purchased the assets related to The Leather Factory stores from Brown Group, Inc., which then consisted of six wholesale stores.

In 1993, we changed our name to The Leather Factory, Inc., and reincorporated in the state of Delaware in 1994.  In 2005, we changed our name to Tandy Leather Factory, Inc.

Our Development in Recent Years

We have expanded our wholesale chain by opening new stores and by making numerous acquisitions of small businesses in strategic geographic locations including the acquisition of our Canadian distributor, The Leather Factory of Canada, Ltd., in 1996.  By 2000, we had grown to 27 Leather Factory stores located in the United States and two Leather Factory stores in Canada.   In November 2000, we acquired the operating assets of two subsidiaries of Tandycrafts, Inc. to form Tandy Leather Company.  In 2002, we began opening retail stores under the "Tandy Leather" name and also opened our thirtieth wholesale store – our third in Canada.  From 2002 to 2009, we purchased eleven independent leathercraft retail stores, including Heritan Ltd and its parent, our primary Canadian competitor, and opened another 64 retail stores.  In 2007, we purchased Mid-Continent Leather Sales, Inc., a competitor located in Oklahoma, a wholesale store.  In 2008, we opened one combination wholesale and retail store in Northampton, United Kingdom.  In 2010, we opened one retail store in Canada.

At December 31, 2010, we operated 29 wholesale stores operating under the Leather Factory name (26 in the U.S. and three in Canada).  We also operated 76 retail stores operating under the Tandy Leather name (69 in the U.S. and seven in Canada) as well as one combination wholesale and retail store operating under the Tandy Leather Factory name in the United Kingdom.  We closed Mid-Continent Leather Sales, a wholesale store, in October 2010.

Our growth, measured both by our net sales and net income, occurs as a result of the increase in the number of stores we have and the increase from year to year of the sales in our existing stores.  The following tables provide summary store count information for our Leather Factory wholesale stores and Tandy Leather retail stores in each of our fiscal years from 1999 to 2010.
 
STORE COUNT
YEARS ENDED DECEMBER 31, 1999 through 2010

   
Leather Factory wholesale stores
 
Tandy Leather retail stores
 
Year Ended
Opened
Conversions(1)
Closed
Total
 
Opened (2)
Closed
Total
Balance Fwd
     
22
     
N/A
1999
4
0
0
26
     
N/A
2000
2
0
0
28
 
1*
0
1
2001
2
0
0
30
 
0
0
1
2002
1
(1)
0
30
 
14
1*
14
2003
0
0
0
30
 
12
0
26
2004
0
0
0
30
 
16
0
42
2005
0
0
0
30
 
8
0
50
2006
0
(1)
0
29
 
12
0
62
2007
1^
0
0
30
 
10
0
72
2008
0
0
0
30
 
1
0
73
2009
0
0
0
30
 
2
0
75
2010
0
0
1^
29
 
1
0
76

(1) Leather Factory wholesale store converted to a Tandy Leather retail store.
(2)  Includes conversions of Leather Factory wholesale stores to Tandy Leather retail stores.
(*)  The Tandy Leather operation began as a central mail-order fulfillment center in 2000 which was closed in 2002.
(^)  Wholesale store operating as Mid-Continent Leather Sales

No single customer’s purchases represented more than 5% of our total sales in 2010, although two customers’ purchases totaled 10% of Wholesale Leathercraft’s sales in 2010.  Retail Leathercraft and International Leathercraft segments did not have any customers whose purchases represented a significant portion of their sales.  Sales to our five largest customers represent 5.5%, 6.3% and 6.2% of consolidated sales in 2010, 2009 and 2008, respectively.  While management does not believe the loss of one of these customers would have a significant negative impact on our consolidated operations, it does believe the loss of several of these customers simultaneously or a substantial reduction in sales generated by them could temporarily affect our operating results.

Our Operating Divisions

We service our customers primarily through the operation of three divisions.  We identify those divisions based on management responsibility, customer focus, and store location.  The Wholesale Leathercraft division consists of 29 wholesale stores of which 26 are located in the United States and three are located in Canada.  As of March 1, 2011, the Retail Leathercraft division consists of 76 Tandy Leather retail stores of which 69 are located in the United States and seven are located in Canada.  Both of these divisions sell leather and leathercraft-related products.  The International Leathercraft division consists of all stores, wholesale or retail, located outside of North America.  Currently, we have one such store located in the United Kingdom.

Information regarding net sales, gross profit, operating income and total assets, attributable to each of our segments, is included within Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations, and within Item 8. Financial Statements and Supplementary Data in Note 15, Segment Information, of our Notes to Consolidated Financial Statements, which are incorporated herein by reference.

Wholesale Leathercraft

The Wholesale Leathercraft operation distributes its broad product line of leather and leathercraft-related products in the United States and internationally through Leather Factory stores.   This segment had net sales of $25.9 million, $25.1 million and $26.4 million for 2010, 2009 and 2008, respectively.  The wholesale stores operate under the name, “The Leather Factory”.

General  We operate wholesale stores in 20 states and three Canadian provinces.  The stores range in size from 2,350 square feet to 15,000 square feet, with the average size of a store being approximately 6,000 square feet.    The type of premises utilized for our wholesale stores is generally light industrial office/warehouse space in proximity to a major freeway or with other similar access.  This type of location typically offers lower rents compared to other more retail-oriented locations.

Business Strategy  Our business concept focuses on the wholesale distribution of leather and related accessories to retailers, manufacturers and end users.  Our strategy is that a customer can purchase the leather, related accessories and supplies necessary to complete his project from a single source.  The size and layout of the stores are planned to allow large quantities of product to be displayed in an easily accessible and visually appealing manner.  Leather is displayed by the pallet where the customer can see and touch it, assessing first-hand the numerous sizes, styles and grades offered.  The location of the stores is selected based on the location of customers, so that delivery time to customers is minimized.  A two-day maximum delivery time for phone, internet and mail orders is our goal.

Our wholesale stores serve customers through various means including walk-in traffic, phone, internet and mail order.  We also employ a distinctive marketing tactic in that we maintain an internally-developed target customer mailing list for use in our aggressive direct mail advertising campaigns.  We staff our stores with experienced managers whose compensation is tied to the operating profit of the store they manage.  Sales are generated by the selling efforts of the store personnel, our direct mail advertising, our website (www.tandyleatherfactory.com), our participation at trade shows and, on a limited basis, the use of sales representative organizations.  The sales representative organizations consist of companies located in specific geographic areas that represent numerous companies in a similar industry.  These organizations call on customers and show multiple products from more than one vendor at a time.

Customers  Our customer base consists of individuals, wholesale distributors, tack and saddle shops, institutions (prisons and prisoners, schools, hospitals), western stores, craft stores and craft store chains, other large volume purchasers, manufacturers and retailers dispersed geographically throughout the world.  Wholesale sales constitute the majority of our business, although retail customers may purchase products from our wholesale stores.  The Wholesale Leathercraft division’s sales generally do not reflect significant seasonal patterns.

Our Authorized Sales Center (“ASC”) program was developed to create a presence in geographical areas where we do not have a store.  An unrelated person operating an existing business who desires to become an ASC must submit an application and upon approval, place a minimum initial order.  There are also minimum annual purchase amounts to which the ASC must adhere in order to maintain ASC status.  In exchange, the benefits to the ASC are free advertising in various sale flyers produced and distributed by us, preferred pricing on many products, advance notice of new products, and priority shipping and handling on all orders.  Our wholesale stores service 113 ASC's:  64 located in the U.S., 41 located in Canada, and 8 located outside North America.

We have two customers whose purchases total 10% of our Wholesale Leathercraft segment’s sales.  While management believes that the loss of these customers would be noticeable and could temporarily affect this segment’s operating results, the impact would not be so significant as to bring into question the segment’s ability to generate operating profit.

Merchandise  Our products are generally organized into 12 categories.  We carry a wide assortment of products including leather, lace, hand tools, kits and craft supplies.  We operate a light manufacturing facility in Fort Worth, Texas whose processes generally involve cutting leather into various shapes and patterns using metal dies.  The factory produces approximately 20% of our products and also assembles and repackages products as needed.  Products manufactured in our factory are distributed through our stores under the TejasTM brand name.  We also distribute product under the Tandy LeatherTM and Dr. Jackson'sTM brands.  We develop new products through the ideas and referrals of customers and store personnel as well as the analysis of fads and trends of interest in the market.

We offer an unconditional satisfaction guarantee to our customers.  Simply stated, we will accept product returns for any reason.  We believe this liberal policy promotes customer loyalty.  We offer credit terms to our non-retail customers, upon receipt of a credit application and approval by our credit manager.  Generally, our open accounts are net 30 days.

During 2010, 2009, and 2008, Wholesale Leathercraft division sales by product category were as follows:

Product Category
2010 Sales Mix
 
2009 Sales Mix
 
2008 Sales Mix
Belts strips and straps
3%
 
2%
 
2%
Books, patterns, videos
2%
 
2%
 
1%
Buckles
4%
 
4%
 
4%
Conchos^
4%
 
4%
 
5%
Craft supplies
5%
 
6%
 
6%
Custom tools and hardware
0%
 
0%
 
0%
Dyes, finishes, glues
6%
 
6%
 
6%
Hand tools
14%
 
13%
 
12%
Hardware
7%
 
7%
 
7%
Kits
8%
 
8%
 
8%
Lace
7%
 
9%
 
9%
Leather
36%
 
35%
 
36%
Stamping tools
4%
 
4%
 
4%
 
100%
 
100%
 
100%
^A concho is a metal adornment attached to clothing, belts, saddles, etc., usually made into a pattern of some southwestern or geometric object.

In addition to meeting ordinary operational requirements, our working capital demands are a product of the need to maintain a level of inventory sufficient to fill customer orders as they are received with minimal backorders and the time required to collect our accounts receivable.  Because availability of merchandise and prompt delivery time are important competitive factors for us, we maintain higher levels of inventory than our smaller competitors.  For additional information regarding our cash, inventory and accounts receivable at the end of 2010 and 2009, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
 
Suppliers  We purchase merchandise and raw materials from approximately 200 vendors dispersed throughout the United States and in approximately 15 foreign countries. In 2010, our 10 largest vendors accounted for approximately 70% of our inventory purchases.

Because leather is sold internationally, market conditions abroad are likely to affect the price of leather in the United States.  Outbreaks of mad cow and hoof-and-mouth disease (or foot-and-mouth disease) in any part of the world can influence the price of the leather we purchase.  Because an occurrence of such an event is beyond our control, we cannot predict when and to what extent we could be affected in the future.  Aside from increasing purchases when we anticipate price increases (or possibly delaying purchases if we foresee price declines), we do not attempt to hedge our inventory costs.

Overall, we believe that our relationships with suppliers are strong and do not anticipate any material changes in these supplier relationships.  Due to the number of alternative sources of supply, the loss of any of these principal suppliers would not have a material impact on our operations.

Operations  Hours of operations vary by location, but generally range from 8:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on Saturdays.  The stores maintain uniform prices, except where lower prices are necessary to meet local competition.

Competition  Most of our competition comes in the form of small, independently-owned retailers who in most cases are also our customers.  We estimate that there are a few hundred of these small independent stores in the United States and Canada.  We compete on price, availability of merchandise, and delivery time.  While there is competition in connection with a number of our products, to our knowledge there is no direct competition affecting our entire product line.  Our large size relative to most competitors gives us the advantage of being able to purchase large volumes and stock a full range of products.

Distribution  The wholesale stores receive the majority of their inventory from our central warehouse located in Fort Worth, Texas, although occasionally, merchandise is shipped directly from the vendor.  Inventory is shipped to the stores from our central warehouse once a week to meet customer demand without sacrificing inventory turns.  Customer orders are filled as received, and we do not have backlogs.

We attempt to maintain the optimum number of items in our product line to minimize out-of-stock situations against carrying costs involved with such an inventory level.  We generally maintain higher inventories of imported items to ensure a continuous supply.  The number of products offered changes every year due to the introduction of new items and the discontinuance of others.  We carry approximately 2,900 items in the current lines of leather and leather-related merchandise.  All items are offered in all stores.

Expansion   Our wholesale store expansion across the United States has been fairly consistent since we purchased the original six stores in 1985.  We opened our thirtieth store in August 2002.  We converted one wholesale (Leather Factory) store to a retail (Tandy Leather) store in 2006, reducing the number of wholesale stores to 29.  We acquired Mid-Continent Leather Sales in 2007, a wholesale store located in Oklahoma, increasing the number of wholesale stores to 30, but closed it in 2010, reducing the number of wholesale stores back to 29.  While we do not believe there is a significant and immediate opportunity for expansion of the Leather Factory store system in terms of opening additional locations, we do believe expansion could be achieved by acquiring companies in related areas/markets which offer collaborative advantages based on the local markets and/or the product lines of the businesses.

 
Retail Leathercraft

Our Retail Leathercraft division consists of a growing chain of retail stores operating under the name, “Tandy Leather.”  Tandy Leather Company, established in 1919 as Hinkley-Tandy Leather Company, is the oldest and one of the best-known supplier of leather and related supplies used in the leathercraft industry.  We offer a product line of quality tools, leather, accessories, kits and teaching materials.   This segment had net sales of $32.3 million, $28.1 million and $25.2 million for 2010, 2009 and 2008, respectively.

General   As of March 1, 2011, the Tandy Leather retail chain has 76 stores located in 36 states and six Canadian provinces with plans to reach 100 to 120 stores as opportunities arise over the next several years.  The stores range in size from 1,200 square feet to 3,800 square feet, with the average size of a store being approximately 2,000 square feet.   The type of premises utilized for a retail store is generally an older strip shopping center located at well-known crossroads, making the store easy to find.
 
 
Business Strategy  Tandy Leather has long been known for its reputation in the leathercraft industry and its commitment to promoting and developing the craft through education and customer development.  Our commitment to this strategy is evidenced by our re-establishment of the retail store chain throughout the United States following our acquisition of the assets of Tandy Leather in 2000.  We continue to broaden our customer base by working with various youth organizations and institutions where people are introduced to leathercraft, as well as hosting classes in our stores.

The retail stores serve walk-in, mail and phone order customers as well as orders generated from our website, www.tandyleatherfactory.com.  A two-day maximum delivery time for phone, internet and mail orders is our goal.
Our retail stores are staffed by knowledgeable sales people whose compensation is based, in part, upon the profitability of their store.  Sales by Tandy Leather are driven by the efforts of the store staff, trade shows, and our direct mail and e-mail marketing program.

Customers  Individual retail customers are our largest customer group, representing approximately 65% of Tandy Leather's 2010 sales.  Youth groups, summer camps, schools and a limited number of wholesale customers complete our customer base.  Like the wholesale stores, the retail stores typically fill orders as they are received, and there is no order backlog.  The retail stores maintain reasonable amounts of inventory to fill these orders.  Tandy Leather’s retail store operations historically generate slightly more sales in the fourth quarter of each year due to the holiday shopping season (30-32% of annual sales), while the other three quarters remain fairly even at 23-25% of annual sales each quarter.

No single customer’s purchases represented more than 1% of Retail Leathercraft’s sales in 2010.

Merchandise Our products are generally organized into 12 categories.  We carry a wide assortment of products including leather, hand tools, kits, dyes & finishes and stamping tools.  During 2010, 2009 and 2008, Retail Leathercraft division sales by product category were as follows:

Product Category
2010 Sales Mix
 
2009 Sales Mix
 
2008 Sales Mix
Belts strips and straps
5%
 
5%
 
4%
Books, patterns, videos
2%
 
3%
 
3%
Buckles
4%
 
4%
 
4%
Conchos
4%
 
4%
 
4%
Craft supplies
4%
 
4%
 
4%
Dyes, finishes, glues
8%
 
8%
 
8%
Hand tools
15%
 
16%
 
15%
Hardware
6%
 
6%
 
6%
Kits
10%
 
10%
 
11%
Lace
3%
 
4%
 
4%
Leather
34%
 
31%
 
31%
Stamping tools
5%
 
5%
 
6%
 
100%
 
100%
 
100%
 
As indicated above, the products sold in our retail stores are also sold in our wholesale stores.  Therefore, the discussion above regarding products, their sources and the working capital requirements for the Wholesale Leathercraft division also apply to the Retail Leathercraft division.  Sales at the retail stores are generally made through cash transactions or through national credit cards.  The retail stores also sell on open account to selected wholesale customers including schools and other institutions and small retailers.  Our terms are generally net 30 days.  Like the wholesale stores, the retail stores have an unconditional return policy.

Operations  Hours of operation are 9:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on Saturdays.  In addition, most of the stores stay open late one night a week for leathercrafting classes taught in the stores.  Selling prices are uniform throughout the retail store system.

Competition  Our competitors are generally small local craft stores that carry a limited line of leathercraft products.  Several national retail chains that are customers in our Wholesale Leathercraft division also carry leathercraft products on a very small scale relative to their overall product line.  To our knowledge, our retail store chain is the only one in existence solely specializing in leathercraft.

Distribution  The retail stores receive their inventory from our central warehouse located in Fort Worth, Texas.  The stores generally restock their inventory once a week with a shipment from the warehouse.  Retail Leathercraft’s inventory turns are higher than Wholesale Leathercraft’s because the Wholesale Leathercraft calculation includes the central warehouse inventory whereas the Retail Leathercraft calculation includes only the inventory in the Tandy Leather retail stores.

Expansion   We intend to expand the Tandy Leather retail store chain to between 100 and 120 stores throughout North America as it makes financial sense to do so. 14 stores were opened in 2002; 12 stores were opened in 2003; 16 were opened in 2004 (including four in Canada); eight were opened in 2005, 12 were opened in 2006, ten were opened in 2007; one was opened in 2008, two were opened in 2009, and one was opened in 2010.  Of the 76 stores opened as of December 2010, 11 were independent leathercraft stores that we acquired.  Separately, these acquisitions are not material.  The other 65 stores have been new stores opened by us.

International Leathercraft

Our International Leathercraft division consists of company-owned stores located outside of North America.  Currently, we have one wholesale and retail combination store located in Northampton, United Kingdom, which we opened in February 2008.  It operates under the Tandy Leather Factory trade name.  This segment had net sales of $1.7 million, $1.3 million and $836,000 in 2010, 2009 and 2008, respectively.

Business Strategy   The business concept for our International Leathercraft division is a blending of our Leather Factory and Tandy Leather business strategies – the wholesale distribution of leather and related accessories to retailers, manufacturers and other businesses, as well as the promotion and continuance of leathercraft through education and development of the retail customers.  The store is located in a 6,600 square foot building in a light industrial area.  We maintain sufficient inventory so that our customers can purchase the leather, related accessories and supplies necessary to complete their projects from one supplier.  The layout of the store is such that large quantities of product can be displayed in an easily accessible and visually appealing manner.  The store services walk-in, mail and phone order customers as well as orders generated from our website, www.tandyleatherfactory.com.  Sales are driven by the efforts of the store staff, trade shows, and our direct mail and e-mail marketing programs.

Customers   The growing customer base consists of individuals, wholesale distributors, equine-related shops, cobblers, dealers, and retailers dispersed geographically throughout the UK and Europe.  Retail sales generally occur via cash transactions or through national credits cards.  We also sell on open account to selected wholesale customers including dealers, manufacturers, and retailers.  Like our USA stores, our UK store has an unconditional return policy.

Merchandise   The products sold in our UK store are also sold in our USA stores.  Therefore, the discussion above regarding products, their sources and the working capital requirements for the Wholesale and Retail Leathercraft divisions also apply here.

Operations   Hours of operation are 8:00 am to 5:00 pm Monday through Friday, and from 8:00 am to 2:00 pm on Saturdays.  Selling prices are consistent with the USA store pricing, adjusted for currency fluctuation.

Distribution   The UK store receives the majority of its inventory from our central warehouse located in Fort Worth, Texas, although occasionally, merchandise is shipped directly from the vendor.  Inventory is shipped from our warehouse to the store several times per month to meet customer demand without sacrificing inventory turns.  Customer orders are typically filled as received, and we do not have backlogs.

Expansion   We intend to expand further internationally.  We intend to grow our customer base throughout Europe as well as other parts of the world so that we can support additional stores. 

For more information about our business and our reportable segments, see Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” on page 8.

Additional Information

Compliance With Environmental Laws Our compliance with federal, state and local environmental protection laws has not had, and is not expected to have, a material effect on our capital expenditures, earnings or competitive position.

Employees As of December 31, 2010, we employed 466 people, 364 of whom were employed on a full-time basis.  We are not a party to any collective bargaining agreements.  Overall, we believe that relations with employees are good.

Intellectual Property   We own approximately 80 registered trademarks, including federal trade name registrations for "The Leather Factory" and "Tandy Leather Company."  We also own approximately 40 registered foreign trademarks worldwide.  We own approximately 500 registered copyrights in the United States covering more than 600 individual works relating to various products.  We also own several United States patents for specific belt buckles and leather-working equipment.  These rights are valuable assets, and we defend them as necessary.

International Operations Information regarding our revenues from the United States and abroad and our long-lived assets are found in Note 15 to our Consolidated Financial Statements, Segment Information.

Our Website and Availability of SEC Reports   We file reports with the Securities and Exchange Commission ("SEC").  These reports include our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these filings.  The public may read any of these filings at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC  20549.  In addition, the public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.  Further, the SEC maintains an Internet site that contains reports, proxy and information statements and other information concerning us.  You can connect to this site at http://www.sec.gov.

Our corporate website is located at http://www.tandyleatherfactory.com.  We make copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, proxy statements and any amendments thereto filed with or furnished to the SEC available to investors on or through our website free of charge as soon as reasonably practicable after we electronically file them with or furnish them to the SEC.  Our SEC filings can be found on the Investor Relations page of our website through the "SEC Filings" link.  In addition, certain other corporate governance documents are available on our website through the "Corporate Governance" link.
 
 
Executive Officers of the Registrant

The following table sets forth information concerning our executive officers as of March 20, 2011:

Name and Age
Position
Served as Executive Officer Since
Jon W. Thompson, 49
Chief Executive Office since July 2009; President and Chief Operating Officer since June 2008; Senior Vice President from June 1993 to June 2008
2008
     
Shannon L. Greene, 45
Chief Financial Officer since May 2000; Treasurer and Chief Accounting Officer since 2001
2000
     
Mark J. Angus, 50
Senior Vice President and Assistant Secretary since June 2008; Operational Vice President of Merchandising since June 1993
2008
     
William M. Warren, 67
Secretary and Corporate Counsel
1993

Jon W. Thompson has served as our Chief Executive Officer since July 2009.  He has also served as President and Chief Operating Officer since June 2008.  He served as Senior Vice President from June 1993 to June 2008.  Mr. Thompson is the son of Wray Thompson, Chairman of the Board.

Shannon L. Greene has served as our Chief Financial Officer and Treasurer since May 2000 and director since January 2001.  Ms. Greene is also our Chief Accounting Officer.  Ms. Greene, a certified public accountant, also serves on our 401(k) Plan committee.  Her professional affiliations include the American Institute of Certified Public Accountants, the Texas Society of Certified Public Accountants and its Fort Worth chapter, and the Financial Executives International.  She also sits on the Board of Directors of the U.S. Chamber of Commerce.

Mark J. Angus has served as Senior Vice President since June 2008.  He served as Vice President of Merchandising since January 1993.

William M. Warren has served as Secretary and General Counsel since 1993.  Since 1979, Mr. Warren has been President and Director of Loe, Warren, Rosenfield, Kaitcer, Hibbs, Windsor & Lawrence, P.C., a law firm located in Fort Worth, Texas.

All officers are elected annually by the Board of Directors to serve for the ensuing year.


Risks to Our Industry

Our business may be negatively impacted by general economic conditions and the current global financial crisis.

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 a result consumer spending has remained depressed, and may be subject to further deterioration for the foreseeable future.   Specialty retail, and retail in general, is 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 uncertainly in the United States or global economies.

Increases in the price of leather and other items we sell or a reduction in availability of those products could increase our cost of goods and decrease our profitability.

The prices we pay our suppliers for our products are dependent in part on the market price for leather, metals, and other products.  The cost of these items may fluctuate substantially, depending on a variety of factors, including demand, supply conditions, transportation costs, government regulation, economic climates, political considerations, and other unpredictable factors.  Leather prices world-wide have increase significantly in the past year and the outlook for future prices is uncertain.  Increases in these costs, together with other factors, will make it difficult for us to sustain the gross margin level we have achieved in recent years and result in a decrease in our profitability unless we are able to pass higher prices on to our customers or reduce costs in other areas.

Further, continued involvement by the United States in war and other military operations in the Middle East and other areas abroad could disrupt international trade and affect our inventory sources.  Finally, livestock diseases such as mad cow could reduce the availability of hides and leathers or increase their cost.

Our business could be harmed if we are unable to maintain our brand image.

Tandy Leather is one of the most recognized brand names in our industry.  Our success to date has been due in large part to the strength of that brand.  If we are unable to provide quality products and exceptional customer service to our customers, including education, which Tandy has traditionally been known for, our brand name may be impaired.  Many specialty retailers have experienced periods of growth in sales and earnings followed by periods of declining sales and losses.  Our business may be similarly affected in the future.

Risks Related to Our Business

We may be unable to sustain our past growth or manage our future growth, which may have a material adverse effect on our future operating results.

We have experienced solid sales and earnings growth recently.  We anticipate that our future growth rate will depend on a number of factors, including the strength and protection of our brand name, the market success of our current and future products, the success of our growth strategies, and our ability to manage our future growth.  Our future success will depend substantially on the ability of our management team to manage our growth effectively, optimizing our operational, administrative, financial and legal procedures in order to maximize profitability.  If we fail to manage our growth effectively, our future operating results could be adversely affected.

Our profitability may decline as a result of increasing pressure on margins.

Our industry is subject to significant pricing pressure caused by many factors, including fluctuations in the cost of the leathers and metal products that we purchase and changes in consumer spending patterns and acceptance of our products.  These factors may prohibit us from passing cost increases on to customers which could cause our gross margin to decline.  If our product costs increase and our sale prices do not, our future operating results could be adversely affected unless we are able to offset such gross margin declines with comparable reductions in operating costs.

We may be unsuccessful in implementing our planned international expansion, which could impair the value of our brand, harm our business and negatively affect our results of operation.

We plan to grow our net sales and net earnings from our International segment by opening store in various international markets.  As we expand outside of North America, we may incur significant costs relating to starting up, maintaining and expanding foreign operations.  Costs may include, but are not limited to obtaining locations for stores, hiring personnel, and travel expenses.  We may be unable to open and operate new stores successfully and our growth may be limited, unless we are able to identify desirable sites for store locations, negotiate acceptable lease terms, hired, train and retain competent store personnel; manage inventory effectively to meet the needs and demands of customers on a timely basis, manage foreign currency risk effectively, and achieve acceptable operating margins from the new stores.  We cannot be sure that we can successfully open new stores or that our new stores will be profitable.

As we continue to increase our international operations, we face the possibility of greater losses from a number of risks inherent in doing business in international markets and from a number of factors which are beyond our control, such as political instability or acts of terrorism, which disrupt trade with the countries in which our suppliers or customers are located; local business practices that do not conform to legal or ethical guidelines; restrictions or regulations relating to imports or exports; additional or increased customs duties, tariffs, taxes and other charges on imports; significant fluctuations in the value of the dollar against foreign currencies; social, legal or economic instability in the foreign markets in which we do business, which could influence our ability to sell our products in these markets; and restrictions on the transfer of funds between the United States and foreign jurisdictions.

Our success depends on the continued protection of our trademarks and other proprietary intellectual property rights.

Our trademarks and other intellectual property rights are important to our success and competitive position, and the loss of or inability to enforce trademark and other proprietary intellectual property rights could harm our business.  We devote substantial resources to the establishment and protection of our trademark and other proprietary intellectual property rights on a worldwide basis.  Despite any precautions we may take to protect our intellectual property, policing unauthorized use of our intellectual property is difficult, expensive and time consuming, and we may be unable to adequately protect our intellectual property or determine the extent of any unauthorized use.  Our efforts to establish and protect our trademark and other proprietary intellectual property rights may not be adequate to prevent imitation or counterfeiting of our products by others, which may not only erode sales of our products but may also cause significant damage to our brand name.  Further, we could incur substantial costs in legal actions relating to our use of intellectual property or the use of our intellectual property by others.  Even if we are successful in these actions, the costs we incur could have a material adverse affect on us.

Foreign currency fluctuations could adversely impact our financial condition and results of operations.

We generally purchase our products in U.S. dollars.  However, we source a large portion of our products from countries other than the United States.  The cost of these products may be affected by changes in the value of the applicable currencies.  Changes in currency exchange rates may also affect the U.S. dollar value of the foreign currency denominated prices at which our international business will sell products.  Furthermore, the majority of our international sales are generally derived from sales in foreign countries.  This revenue, when translated into U.S. dollars for consolidated reporting purposes, could be materially affected by fluctuations in the U.S. dollar, negatively impacting our results of operations and our ability to generate revenue growth.

Other uncertainties, which are difficult to predict and many of which are beyond our control, may occur as well.



We lease all of our store locations premises, with the majority of our stores having initial lease terms of approximately five years.  The leases are generally renewable, with increases in lease rental rates in some cases.  We believe that all of our properties are adequately covered by insurance.  The properties leased by us are described in Item 1 in the description of each of our three operating segments.  We also lease a 284 square-foot showroom in the Denver Merchandise Mart for $6,000 per year.  This lease will expire in October 2011.  We own our corporate headquarters, which includes our central warehouse and manufacturing facility, sales, advertising, administrative, and executive offices.  The facility consists of 191,000 square feet located on approximately 30 acres.

The following table summarizes the locations of our leased premises as of December 31, 2010:

U.S. locations:
Wholesale Leathercraft
Retail Leathercraft
International
Alabama
-
1
-
Alaska
-
1
-
Arizona
2
3
-
Arkansas
-
1
-
California
3
7
-
Colorado
1
3
-
Connecticut
-
1
-
Florida
1
3
-
Georgia
-
1
-
Idaho
-
1
-
Illinois
1
1
-
Indiana
-
2
-
Iowa
1
-
-
Kansas
1
-
-
Kentucky
-
1
-
Louisiana
1
-
-
Maryland
-
1
-
Massachusetts
-
1
-
Michigan
1
1
-
Minnesota
-
2
-
Missouri
1
2
-
Montana
1
-
-
Nebraska
-
1
-
Nevada
-
2
-
New Mexico
1
2
-
New York
-
1
-
North Carolina
-
2
-
North Dakota
-
1
-
Ohio
1
2
-
Oklahoma
-
2
-
Oregon
1
-
-
Pennsylvania
1
2
-
South Carolina
-
1
-
South Dakota
-
1
-
Tennessee
1
3
-
Texas
5
9
-
Utah
1
2
-
Virginia
-
1
-
Washington
1
2
-
Wisconsin
-
1
-
Wyoming
-
1
-

Canadian locations:
     
Alberta
1
1
-
British Columbia
-
1
-
Manitoba
1
-
-
Nova Scotia
-
1
-
Ontario
1
2
-
Quebec
-
1
-
Saskatchewan
-
1
-

International locations:
     
United Kingdom
-
-
1


We are involved in litigation in the ordinary course of business but are not currently a party to any material pending legal proceedings.


There were no matters submitted to a vote of our security holders during the fourth quarter of our fiscal year ended December 31, 2010.

PART II


Our common stock is traded on the NASDAQ Global Market using the symbol “TLF”.  The high and low trading prices for each calendar quarter during the last two fiscal years are as follows:

2010
High
Low
 
2009
High
Low
4th quarter
$4.77
$4.25
 
4th quarter
$4.08
$3.00
3rd quarter
$4.70
$3.72
 
3rd quarter
$3.30
$2.35
2nd quarter
$5.97
$3.70
 
2nd quarter
$2.85
$1.90
1st quarter
$4.20
$3.50
 
1st quarter
$2.42
$1.55

There were approximately 460 stockholders of record on March 23, 2011.

In May 2010, our Board of Directors authorized a $0.75 per share special one-time cash dividend that was paid to our shareholders of record at the close of business on June 3, 2010. The dividend, totaling $7.7 million, was paid to our shareholders on July 5, 2010. We did not make any dividend payments prior to 2010.  However, our Board of Directors 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.  This policy is subject to change based on future industry and market conditions, as well as other factors.

We did not sell any shares of our equity securities during our fiscal year ended December 31, 2010 that were not registered under the Securities Act.

The following table provides information about purchases we have made of our common stock during the quarter ended December 31, 2010:

ISSUER PURCHASES OF EQUITY SECURITIES
Period
(a) Total Number of Shares  Purchased
(b) Average Price Paid per Share
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
(d) Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs
October 1 through October 31
-
-
-
962,000(2)
November 1 through November 30
-
-
-
962,000(2)
December 1 through December 31
100,000(1)
$4.33
100,000
-
Total
100,000
$4.33
100,000
-
 
 
(1)  
Represents shares purchased in December 2010 pursuant to an agreement we entered into with our Chairman of the Board, Wray Thompson and his wife, on December 9, 2010. We announced the purchase of these shares on December 13, 2010.  The shares repurchased in this transaction did not affect the number of shares to be purchased under the stock repurchase program discussed in footnote (2) below.
(2)  
Represents shares that we may purchase through a stock repurchase program permitting us to repurchase up to one million shares of our common stock at prevailing market prices not to exceed $3.70 per share.  We announced the program on December 9, 2009, such program replacing our previous stock repurchase program which permitted us, on the date of its termination, to repurchase up to 974,773 shares of our common stock at prevailing prices not to exceed $2.85 per share.  Purchases under the program commenced on December 9, 2009 and terminated on December 10, 2010.

Stockholder Return Performance Graph

The line graph below compares the yearly percentage change in our cumulative five-year total stockholder return on our common stock with the Standard & Poor’s SmallCap 600 Index and the S&P Specialty Stores Index.  The graph assumes that $100 was invested on December 31, 2005 in our common stock, the Standard & Poor’s SmallCap 600 Index, and the S&P Specialty Stores Index, and that all dividends were reinvested.  The returns shown on the graph are not necessarily indicative of future performance.

COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURNS
Tandy Leather Factory, Inc.
 
Company Name / Index
Dec 05
Dec 06
Dec 07
Dec 08
Dec 09
Dec 10
TANDY LEATHER FACTORY
100
117.81
47.74
31.39
57.08
80.73
S&P SMALLCAP 600 INDEX
100
115.12
114.78
79.11
99.34
125.47
S&P SPECIALTY STORES
100
121.56
89.23
56.58
85.70
89.42
 
Data Source: Research Data Group, Inc., San Francisco, CA
 



The selected financial data presented below are derived from and should be read in conjunction with our Consolidated Financial Statements and related notes.  This information should also be read in conjunction with "Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations.”  Data in prior years has not been restated to reflect acquisitions, if any, which occurred in subsequent years.

Income Statement Data,
Years ended December 31,
 
2010
 
 
2009
 
 
2008
 
 
2007
 
 
2006
Net sales
$59,892,870
 
$54,482,739
 
$52,491,538
 
$54,219,728
 
$53,458,649
Gross profit
36,250,857
 
32,609,374
 
31,050,359
 
31,180,332
 
31,023,427
Operating income
6,635,611
 
5,095,101
 
4,025,342
 
4,321,031
 
6,894,312
Net income from continuing operations
4,158,491
 
3,261,143
 
2,511,847
 
2,895,522
 
4,628,748
Income from discontinued operations, net of tax
1,766
 
56,914
 
92,336
 
192,609
 
148,318
Net income
$4,160,257
 
$3,318,057
 
$2,604,183
 
$3,088,131
 
$4,777,066
                   
Net income per share from continuing operations
              Basic
$0.41
 
$0.31
 
$0.23
 
$0.26
 
$0.43
              Diluted
$0.41
 
$0.31
 
$0.23
 
$0.26
 
$0.42

Net income per share including discontinued operations
              Basic
$0.41
 
$0.32
 
$0.24
 
$0.28
 
$0.44
              Diluted
$0.41
 
$0.31
 
$0.24
 
$0.28
 
$0.43
                   
Weighted average common shares outstanding for:
                 
Basic EPS
10,208,944
 
10,471,103
 
10,931,306
 
10,951,481
 
10,807,316
Diluted EPS
10,251,863
 
10,535,736
 
11,015,657
 
11,157,775
 
11,113,855
                   
Cash dividend declared per common share
$0.75
 
-
 
-
 
-
 
-

Balance Sheet Data, as of December 31,
2010
 
2009
 
2008
 
2007
 
2006
Cash and certificates of deposit
$5,915,339
 
$12,908,962
 
$10,821,298
 
$6,810,396
 
$6,739,981
Total assets
40,595,574
 
43,327,231
 
40,975,913
 
37,651,506
 
31,916,635
Capital lease obligation, including current portion
-
 
-
 
593,949
 
-
 
111,723
Long-term debt, including current portion
3,510,000
 
3,712,500
 
3,915,000
 
4,050,000
 
-
Total Stockholders’ Equity
$29,761,594
 
$33,359,655
 
$31,264,762
 
$29,815,504
 
$26,323,243



We intend for the following discussion to provide you with information that will assist you in understanding our financial statements, the changes in key items in those financial statements from year to year and the primary factors that accounted for those changes, as well as how particular accounting principles affect our financial statements.  This discussion also provides information about the financial results of the various segments of our business so you may better understand how those segments and their results affect our financial condition and results of operations as a whole.  Finally, we have identified and discussed trends known to management that we believe are likely to have a material effect on our results of operations and financial condition.

This discussion should be read in conjunction with our financial statements as of December 31, 2010 and 2009 and the two years then ended and the notes accompanying those financial statements.  You are also urged to consider the information under the caption "Summary of Critical Accounting Policies."

Summary

We are the world's largest specialty retailer and wholesale distributor of leather and leathercraft-related items.  Our operations are centered on operating retail and wholesale stores.  We have built our business by offering our customers quality products in one location at competitive prices.  The key to our success is our ability to grow our base business.  We grow that business by opening new locations and by increasing sales in our existing locations.  We intend to continue to expand both domestically, in the short-term, and internationally, in the long-term.

We operate in three segments.  First, Wholesale Leathercraft, consisting of our Leather Factory stores and our national account group, is our oldest segment with sales of $25.9 million in 2010.  Historically, in normal economic conditions, this division has generally offered steady but very modest increases in sales.  Sales in 2010 increased 3.2% compared to 2009.  Compared to 2009, the wholesale stores’ sales increased 4.9% and national account sales were down 8.4%.  Sales at the stores are showing signs of recovery despite an overall weakness in consumer spending as a result of the weak U.S. economy.  Sales to national accounts tend to be less consistent.

Since acquiring its assets in 2000, Tandy Leather has been re-established as the operator of retail leathercraft stores.  (Prior to our acquisition in 2000, all of the Tandy Leather retail stores had been closed.)  These retail stores comprise our second segment, Retail Leathercraft. This segment has experienced the greatest increases in sales ($32.3 million in 2010, up from $28.1 million in 2009) and is our largest source of revenues.  Our business plan calls for opening an average of 10-12 stores annually as we work toward a goal of 100+ stores from 76 stores at the end of 2010.  We have slowed down our new store openings in recent years due to the general economic conditions in the U.S. and because of the lack of personnel qualified for store manager positions but hope to resume a more active store opening schedule in the next several years.

Our third segment is International Leathercraft, which consists of stores located outside of North America.  Currently, we have one retail/wholesale combination store located in the United Kingdom, which was opened in February 2008.  It is our intention to add more stores to this segment once we have a large enough customer base to support additional stores.

On a consolidated basis, a key indicator of costs, gross margin as a percent of total net sales, increased in 2009 and in 2010.  Operating expenses increased at a slower pace than that of sales, increasing 8% between 2009 and 2010 and 2% between 2008 and 2009.

We reported consolidated net income for 2010 of $4.2 million.  Consolidated net income for 2009 and 2008 was $3.3 million and $2.6 million, respectively.  We use our cash flow to fund our operations, to fund the opening of new Tandy Leather stores, to purchase necessary property and equipment and to make acquisitions of small competitors in the retail and wholesale market.  In 2007, we incurred $4.0 million in bank debt to purchase a 191,000 square foot building to house our corporate headquarters and central support units.  We moved into that facility in the first quarter of 2008.  In 2010, we paid a one-time dividend to our stockholders, totaling $7.7 million.  At the end of 2010, our stockholders’ equity had decreased to $29.8 million from $33.3 million the previous year.

Comparing the December 31, 2010 balance sheet with the prior year’s balance sheet, we increased our investment in inventory from $16.9 million to $20.2 million, while total cash (including certificates of deposit and other short-term investments) decreased from $12.9 million to $5.9 million as a result of the special one-time cash dividend.
 
 
Net Sales

Net sales for the three years ended December 31, 2010 were as follows:
 
Year
Wholesale Leathercraft
Retail Leathercraft
International Leathercraft
Total Company
Incr (Decr) from Prior Year
2010
$25,908,177
$32,291,442
$1,693,251
$59,892,870
9.9%
2009
$25,095,392
$28,079,863
$1,307,484
$54,482,739
3.8%
2008
$26,423,858
$25,231,145
$836,535
$52,491,538
(3.2)%

Our net sales increased by 9.9% in 2010 when compared with 2009 and increased by 3.8% in 2009 when compared with 2008.  In 2010, all three segments reported sales increases compared to 2009.  In 2009, our Retail and International Leathercraft segments reported sales increases while our Wholesale Leathercraft segment reported sales declines.  The reduction in sales in our wholesale stores is the result of the overall economic slowdown in the U.S.  That economic slowdown has impacted our retail stores as well, although not as significantly, due to the faster economic recovery on the part of retail consumers compared to small businesses and wholesalers.

Costs and Expenses

In general, our gross profit as a percentage of sales (our gross margin) fluctuates based on the mix of customers we serve, the mix of products we sell and our ability to source products globally.  Our negotiations with suppliers for lower pricing are an on-going process, and we have varying degrees of success in those endeavors.  Sales to retail customers tend to produce higher gross margins than sales to wholesale customers due to the difference in pricing levels.  Therefore, as retail sales increase in the overall sales mix, higher gross margins tend to follow.  Finally, there is significant fluctuation in gross margins between the various merchandise categories we offer.  As a result, our gross margins can vary depending on the mix of products sold during any given time period.

For 2010, our cost of sales decreased as a percentage of total net sales when compared to 2009, resulting in an increase in consolidated gross profit margin from 59.9% to 60.5%.  Our 2009 cost of sales as a percentage of our total net sales increased as a percentage of total net sales when compared to 2008, resulting in an increase in consolidated gross profit margin from 59.2% to 59.9%.  Increases in gross margin are primarily due to sales mix.  Retail sales are at a higher gross margin than that of wholesale sales.  Therefore, as retail sales increase at a faster pace than that of wholesale sales, gross margin increases accordingly.

Our gross margins for the three years ended December 31, 2010 were as follows:

Year
Wholesale Leathercraft
Retail Leathercraft
International Leathercraft
Total Company
2010
60.7%
60.2%
63.8%
60.5%
2009
58.5%
60.9%
63.6%
59.9%
2008
56.5%
61.6%
68.4%
59.2%

Our operating expenses decreased 1.0% as a percentage of total net sales to 49.5% in 2010 when compared with 50.5% in 2009.  This decrease indicates that our operating expenses grew more slowly than our sales during this period.  2010 operating expenses were $2.1 million higher than those of 2009.  Significant expense fluctuations in 2010 compared to 2009 are as follows:

Expense
2010 amount
Incr (Decr) over 2009
Employee compensation & benefits
$15.9 million
$1.4 million
Travel expense
380,000
180,000
Credit card fees
820,000
130,000
Rent & utilities
3.7 million
300,000
Professional fees and licenses
800,000
100,000
Freight out – shipping product to customers
1.6 million
270,000
Loss on disposal of equipment
50,000
(300,000)

The increase in employee compensation and benefits is due primarily to the increase in store manager compensation. Our store managers are paid a percentage of the operating profit generated by the store they manage as additional compensation so as store profits increase, manager compensation increases.  Also we increased the number of regional managers in 2010 from five to seven which contributed to the increase in expense.  Our operating expenses decreased 1.0% as a percentage of total net sales to 50.5% in 2009 when compared with 51.5% in 2008.  This decrease indicates that our operating expenses grew more slowly than our sales during this period.  2009 operating expenses were $490,000 higher than those of 2008.  Significant expense fluctuations in 2009 compared to 2008 are as follows:

Expense
2009 amount
Incr (Decr) over 2008
Employee compensation & benefits
$14.5 million
$500,000
Rent & utilities
3.3 million
(90,000)
Depreciation and amortization
1.1 million
100,000
Loss on impairment and disposal of equipment
365,000
365,000
Professional fees and licenses
700,000
(62,000)
Freight out – shipping product to customers
1.3 million
(160,000)
Property taxes
340,000
80,000
Outside services
102,000
(157,000)

Other Income/Expense (net)

Other Income/Expense consists primarily of currency exchange fluctuations, interest income and interest expense.  In 2010, we had other expense (net) of $160,000 compared to other expense (net) of $134,000 in 2009.  We received $38,000 in gas royalties.  We earned $73,000 in interest income on our cash and paid $265,000 in interest expense on our bank debt.  We had a currency exchange loss of $187,000 in 2010 compared to $98,000 in 2009.

In 2009, we had other expense (net) of $134,000 compared to other income (net) of $67,000 in 2008.  We received $32,000 in gas royalties.  We earned $128,000 in interest income on our cash and paid $297,000 in interest expense on our bank debt.  We had a currency exchange loss of $98,000 in 2009 compared to $114,000 in 2008.

Net Income

During 2010, we earned net income of $4.2 million, a 25% increase over our net income of $3.3 million earned during 2009.  The increase in net income was the result of the increase in sales and gross profit, partially offset by the increase in operating expenses.

During 2009, we earned net income of $3.3 million, a 27% increase over our net income of $2.6 million earned during 2008.  The increase in net income was the result of the increase in sales and gross profit, partially offset by the reduction in other income.

Wholesale Leathercraft

The increases (or decreases) in net sales, operating income, operating income increases (or decreases) and operating income as a percentage of sales from our Wholesale Leathercraft stores for the three years ended December 31, 2010 were as follows:

 
Year
Net Sales
Incr (Decr)  from Prior Yr
Operating
Income
Operating Income
 Incr (Decr) from Prior Year
Operating Income as a
Percentage of Sales
2010
3.2%
$2,690,061
33.3%
10.4%
2009
(5.3)%
$2,017,915
13.2%
8.0%
2008
(10.6)%
$1,782,526
(35.8)%
6.7%

Wholesale Leathercraft, consisting of our 29 wholesale stores and our national account group, accounted for 43.3% of our consolidated net sales in 2010, which compares to 45.6% in 2009 and 49.6% in 2008.  The decrease in this division's contribution to our total net sales is the result of the growth in Retail Leathercraft, and we expect this trend to continue while retail consumers’ buying patterns continue to strengthen over that of wholesale and small businesses.

Sales in the wholesale stores increased 4.9% in 2010 compared to sales in 2009 while the sales decline in our national account group was 8.4% from 2009 to 2010.  By customer group, we increased sales in the wholesale stores significantly to our retail and modestly to our wholesale customers, but had sales declines in all other groups.  The most significant decreases were in our national account and manufacturer groups.  Small manufacturers have been significantly affected by the weakness in our economy.  Our sales mix by customer group in the Wholesale Leathercraft division was as follows:

Customer Group
2010
2009
2008
Retail
31%
29%
26%
Institution
6%
7%
8%
Wholesale
43%
42%
41%
National Accounts
12%
15%
17%
Manufacturers
8%
7%
8%
 
100%
100%
100%

The 2010 increase in operating income as a percentage of divisional sales resulted from a decrease in operating expenses of $200,000.  Significant operating expense decreases occurred in loss on disposal of equipment ($325,000), depreciation ($35,000) and bad debts ($75,000), offset somewhat by increases in employee compensation ($200,000) and travel expenses ($50,000).

The 2009 increase in operating income as a percentage of divisional sales resulted from a decrease in operating expenses of $500,000.  Significant operating expense decreases occurred in legal and professional fees ($57,000), moving expenses ($114,000), advertising and marketing ($200,000), outside services ($158,000), rent and utilities ($95,000) and freight out ($143,000).  These decreases were offset somewhat by a loss incurred on the impairment of certain computer equipment totaling $365,000.

Retail Leathercraft

The increases in net sales, operating income, operating income increases (or decreases) and operating income as a percentage of sales from our Retail Leathercraft stores for the three years ended December 31, 2010 were as follows:

 
Year
Net Sales
Increase from Prior Yr
Operating
Income
Operating Income
Incr (Decr) from Prior Year
Operating Income as a Percentage
of  Sales
2010
15.0%
$3,614,856
24.6%
11.2%
2009
11.3%
$2,900,701
32.6%
10.3%
2008
2.3%
$2,188,283
41.7%
8.7%

Reflecting the growth previously discussed, Retail Leathercraft accounted for 53.9% of our total net sales in 2010, up from 51.1% in 2009 and 47.4% in 2008.  Growth in net sales for our Retail Leathercraft division in 2010 resulted primarily from an increase in same store sales.

Our sales mix by customer group in the Retail Leathercraft division was as follows:

Customer Group
2010
2009
2008
Retail
64%
65%
65%
Institution
6%
7%
9%
Wholesale
29%
27%
25%
National Accounts
0%
0%
0%
Manufacturers
1%
1%
1%
 
100%
100%
100%

Operating income as a percentage of sales increased to 11.2% for 2010 compared to 10.3% for 2009.  Gross margin decreased slightly to 60.2% in 2010 from 60.9% in 2009.  Operating expenses as a percent of sales in 2010 decreased by 1.6%, from 50.6% for 2009 to 49.0% for 2010 as operating expenses grew at a slower pace than that of sales.

Operating income as a percentage of sales increased to 10.3% for 2009 compared to 8.7% for 2008.  Gross margin decreased to 60.9% in 2009 from 61.6% in 2008.  Operating expenses as a percent of sales in 2008 decreased by 2.3%, from 52.9% for 2008 to 50.6% for 2009 as operating expenses grew at a slower pace than that of sales.

We intend to continue the expansion of Tandy Leather’s retail store chain over the next several years, with plans to open at least one store in 2011 in North America.  We remain committed to a conservative expansion plan for this division that minimizes risks to our profits and maintains financial stability.  In the current economic environment in the U.S., it is possible that we will change our plans for store openings in 2011 if we determine that feasibility of additional successful openings is deemed likely.

International Leathercraft

International Leathercraft consists of all stores located outside of North America.  Currently, that represents one retail/wholesale combination store located in the United Kingdom.  International Leathercraft accounted for 2.8%, 2.4% and 1.6% of our total sales in 2010, 2009 and 2008, respectively.  Operating income was $330,000, $176,000 and $54,000 in 2010, 2009 and 2008, respectively.  We expect this segment to become a larger part of our total operations as our international customer base continues to grow.

We intend to expand our International Leathercraft segment by opening two to three new stores in 2011.  Although we expect those store openings to occur in the last half of the year, the number and timing of store openings will be subject to compliance with all local legal requirements, lease negotiations and execution and completion of the finish out of the stores.
 
Financial Condition
 
At December 31, 2010, we held $5.9 million of cash and certificates of deposit, $20.2 million of inventory, accounts receivable of $1.3 million, and $10.3 million of property and equipment.  Goodwill and other intangibles (net of amortization and depreciation) were $990,000 and $232,000, respectively.  Net total assets were $40.6 million.  Current liabilities were $6.9 million (including $203,000 of current maturities of long-term debt), while long-term debt was $3.3 million.  Total stockholders’ equity at the end of 2010 was $29.8 million.

At December 31, 2009, we held $12.9 million of cash and certificates of deposit, $16.9 million of inventory, accounts receivable of $1.2 million, and $9.7 million of property and equipment.  Goodwill and other intangibles (net of amortization and depreciation) were $984,000 and $308,000, respectively.  Net total assets were $43.3 million.  Current liabilities were $5.8 million (including $203,000 of current maturities of long-term debt), while long-term debt was $3.5 million.  Total stockholders’ equity at the end of 2009 was $33.4 million.

Cash decreased significantly due to the one-time, special cash dividend totaling $7.7 million that was paid to our stockholders in July 2010.
Specific ratios on a consolidated basis at the end of each year ended December 31 were as follows:

   
2010
2009
2008
Solvency Ratios:
       
Quick Ratio
(Cash+Accts Rec)/Total Current Liabilities
1.04
2.44
2.37
Current Ratio
Total Current Assets/Total Current Liabilities
4.17
5.55
5.72
Current Liabilities to Net Worth
Total Current Liabilities/Net Worth
0.23
0.17
0.16
Current Liabilities to Inventory
Total Current Liabilities/Inventory
0.34
0.34
0.32
Total Liabilities to Net Worth
Total Liabilities/Net Worth
0.36
0.30
0.31
Fixed Assets to Net Worth
Fixed Assets/Net Worth
0.35
0.29
0.33
         
Efficiency Ratios:
       
Collection Period (Days Outstanding)
Accounts Receivable/Credit Sales x 365
39.83
37.22
54.89
Inventory Turnover
Sales/Average Inventory
3.23
3.35
3.18
Assets to Sales
Total Assets/Sales
0.68
0.79
0.77
Sales to Net Working Capital
Sales/Current Assets - Current Liabilities
2.74
2.09
2.22
Accounts Payable to Sales
Accounts Payable/Sales
0.02
0.02
0.02
         
Profitability Ratios:
       
Return on Sales (Profit Margin)
Net Profit After Taxes/Sales
0.07
0.06
0.05
Return on Assets
Net Profit After Taxes/Total Assets
0.10
0.08
0.06
Return on Net Worth (Return on Equity)
Net Profit After Taxes/Net Worth
0.14
0.10
0.08

Capital Resources and Liquidity

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 and remodel 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 initial purchase of the property.  On April 30, 2008, that amount was rolled into a ten-year term note, and we began making monthly debt service payments in May 2008.

We are currently in compliance with all covenants and conditions contained in the JPMorgan Chase Credit Agreement and have no reason to believe that we will not continue to operate in compliance with the provisions of these financing arrangements.  The principal terms and conditions of the Credit Agreement are described in further detail in Note 6 to the Consolidated Financial Statements, Notes Payable and Long-Term Debt.

Reflecting the borrowing and reduction of bank indebtedness as well as dividend payments during the periods, our financing activities for 2010, 2009 and 2008 required net cash of $8.2 million, $2.4 million, and $1.1 million, respectively.  The one-time, special dividend paid in July 2010 of $7.7 million is the reason for the significant increase in financing activities in 2010 compared to 2009.

Our primary source of liquidity and capital resources during 2010 was cash flow provided by operating activities.  Net cash flow from operations for 2010 and 2009 was $2.7 million and $5.3 million, respectively.  The decrease in operating cash flow in 2010 compared to 2009 was due to the increase in inventory in the last half of 2010.  In 2010 and 2009, cash flow from operations was generated from income, partially offset by the increase in inventory.  In 2008, cash flow from operations was generated from net income and the decreases in accounts receivable and inventory.

Consolidated accounts receivable remained virtually unchanged at $1.2 million as of December 31, 2010 and 2009.  Average days to collect accounts increased from 40.0 days in 2009 to 44.0 days in 2010 on a consolidated basis.  We maintain a tight credit policy and are aggressively monitoring our customer accounts to ensure collectability.  We believe the trend in our collections is the result of the overall slowdown in the U.S. economy.  Many of our customers with open accounts are very small businesses, and they tend to feel the effects of an economic slowdown more severely than larger businesses.

Inventory increased from $16.9 million at the end of 2009 to $20.2 million at December 31, 2010.  We expect our inventory to slowly trend upward as we continue our expansion both domestically as well as internationally.  In addition, we made several non-routine purchases of product in the third quarter of 2010 which we are featuring in our sales promotions during the first quarter of 2011. As a result, purchases during the fourth quarter declined.  In 2011, we expect to maintain a fairly steady inventory due to the limited number of retail stores we plan to open.  We attempt to manage our inventory levels to avoid tying up excessive capital while maintaining sufficient inventory in order to service our current customer demand as well as plan for our expected expansion.  We ended the year with our total inventory on hand approximately 8% higher than our internal targets for optimal inventory.
 
Consolidated inventory turned 3.23 times during 2010, a slight decline from the 2009 turns at 3.35 times.  We compute our inventory turnover rates as sales divided by average inventory.

By operating division, inventory turns are as follows:

Segment
2010
2009
2008
Wholesale Leathercraft
1.96
2.18
2.14
Retail Leathercraft
6.45
6.13
6.05
International Leathercraft
5.65
3.95
4.61
       
Wholesale Leathercraft stores only
7.40
6.82
7.14

Retail Leathercraft inventory turns are significantly higher than that of Wholesale Leathercraft because its inventory consists only of the inventory at the stores.  The retail stores have no warehouse (backstock) inventory to include in the turnover computation as the stores get their product from the central warehouse.  Wholesale Leathercraft’s turns are expected to be slower because the central warehouse inventory is part of this division, and its inventory is held as the backstock for all of the stores.

Accounts payable, totaling $1.2 million, remained virtually unchanged at the end of 2010 compared to the end of 2009.

As discussed above, the largest use of operating cash in 2010 was in the increase of inventory.  Cash paid for capital expenditures totaled $1.5 million and $792,000 million for the years ended December 31, 2010 and 2009, respectively.  In 2009, the primary capital expenditures were for computer equipment, software and licenses totaling $472,000.  Other capital expenditures were building improvements ($209,000), including parking lot repaving and fence installation, and factory machines and dies ($56,000).  In 2010, the primary capital expenditure was the construction of a building to be used for the expansion of our manufacturing capabilities and the staging of drop-shipments of specially purchased product to our stores ($950,000).  Other capital expenditures were building improvements, including a generator ($110,000), store fixtures ($153,000), computer equipment ($200,000), and factory machines and dies ($62,000).  We intend to open one store in the United States and two to three stores abroad, and therefore will incur some capital expenditures related to these store opening, we do expect our 2011 capital expenditures to be less than that of 2010 as the expenditures related to the building have been completed.

Cash applied toward stock repurchases totaled $441,419 and $1,624,264 in 2010 and 2009, respectively.

We believe that cash flow from operations will be adequate to fund our operations in 2011, while also funding our expansion plans.  At this time, we know of no trends or demands, commitments events or uncertainties that will or are likely to materially affect our liquidity, capital resources or results of operations.  In addition, we anticipate that this cash flow will enable us to meet the contractual obligations and commercial commitments.  We could defer expansion plans if required by unanticipated drops in cash flow.  In particular, because of the relatively small investment required by each new store, we have flexibility in when we make most expansion expenditures.

Off-Balance Sheet Arrangements

We did not have any off-balance sheet arrangements during 2010, 2009 and 2008, and we do not currently have any such arrangements.

Contractual Obligations

The following table summarizes by years our contractual obligations and commercial commitments as of December 31, 2010 (not including related interest expense):

 
Payments Due by Periods
Contractual Obligations
Total
Less than 1 Year
1 - 3 Years
3 -5 Years
More than 5 Years
Long-Term Debt(1)
$3,510,000
$202,500
$405,000
$405,000
$2,497,500
Operating Leases(2)
7,028,310
2,498,662
3,253,428
1,206,877
69,343
Total Contractual Obligations
$10,538,310
$2,701,162
$3,658,428
$1,611,877
$2,566,843
____________________
(1)  Our loan from JPMorgan Chase matures in May 2018.
(2)  These are our leased facilities.

Summary of Critical Accounting Policies

We strive to report our financial results in a clear and understandable manner, although in some cases accounting and disclosure rules are complex and require us to use technical terminology.  We follow generally accepted accounting principles in the U.S. in preparing our consolidated financial statements.  These principles require us to make estimates and apply judgments that affect our financial position and results of operations.  We continually review our accounting policies, how they are applied and how they are reported and disclosed in our financial statements.  Following is a summary of our more significant accounting policies and how they are applied in preparation of the financial statements.

Basis of Consolidation.  We report our financial information on a consolidated basis.  Therefore, unless there is an indication to the contrary, financial information is provided for the parent company, Tandy Leather Factory, Inc., and its subsidiaries as a whole.  Transactions between the parent company and any subsidiaries are eliminated for this purpose.  We own all of the capital stock of our subsidiaries, and we do not have any subsidiaries that are not consolidated.  None of our subsidiaries are “off balance sheet.”

Revenue Recognition.  We recognize revenue for retail (over the counter) sales as transactions occur and other sales upon shipment of our products, provided that there are no significant post-delivery obligations to the customer and collection is reasonably assured, which generally occurs upon shipment.  Net sales represent gross sales less negotiated price allowances, product returns, and allowances for defective merchandise.

Allowance for Accounts Receivable.  We reduce accounts receivable by an allowance for amounts that may become uncollectible in the future.  This allowance is an estimate based primarily on our evaluation of the customer's financial condition, past collection history, and the aging of the account.  If the financial condition of any of our customers deteriorates, resulting in an impairment or inability to make payments, additional allowances may be required.

Inventory.  Inventory is stated at the lower of cost or market and is accounted for on the “first in, first out” method.  This means that sales of inventory treat the oldest item of identical inventory as being the first sold.  In addition, we regularly reduce the value of our inventory for slow-moving or obsolete inventory.  This reduction is based on our review of items on hand compared to their estimated future demand.  If actual future demand is less favorable than what we project, additional write-downs may be necessary.  Goods shipped to us are recorded as inventory owned by us when the risk of loss shifts to us from the supplier.

Goodwill.  We periodically analyze the remaining goodwill on our balance sheet to determine the appropriateness of its carrying value.  As of December 31, 2010, we determined that the present value of the discounted estimated future cash flows of the operating divisions associated with the goodwill is sufficient to support their respective goodwill balances.  If actual financial performance of these divisions differs significantly from our projections, such difference could affect the present value calculation in the future resulting in an impairment of all or part of the goodwill currently carried on our balance sheet.

Forward-Looking Statements

Certain statements contained in this annual report and other materials we file with the SEC, or in other written or oral statements made or to be made by us, other than statements of historical fact, are “forward-looking statements” as defined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements give our current expectations or forecasts of future events. Words such as “may,” “assume,” “forecast,” “position,” “predict,” “strategy,” “expect,” “intend,” “plan,” “estimate,” “anticipate,” “believe,” “project,” “budget,” “potential,” or “continue,” and similar expressions are used to identify forward-looking statements. They can be affected by assumptions used or by known or unknown risks or uncertainties. Consequently, no forward-looking statements can be guaranteed. Actual results may vary materially. You are cautioned not to place undue reliance on any forward-looking statements. You should also understand that it is not possible to predict or identify all such factors and you should not consider the following list to be a complete statement of all potential risks and uncertainties. Factors that could cause our actual results to differ materially from the results contemplated by such forward-looking statements include, but are not limited to, the risk factors described in Item 1A, “Risk Factors,” of this Annual Report on Form 10-K. Management cautions that forward-looking statements are not guarantees, and our actual results could differ materially from those expressed or implied in the forward-looking statements.  We do not intend to update forward-looking statements.


We face exposure to financial market risks, including adverse movement in foreign current exchange rates and changes in interest rates.  These exposures may change over time and could have a material impact on our financial results.  We do not use or invest in market risk sensitive instruments to hedge any of these risks or for any other purpose.

Foreign Currency Exchange Rate Risk

Our primary foreign currency exposure is related to our subsidiaries in Canada and the United Kingdom as those subsidiaries have local currency revenue and local currency operating expenses.   Changes in the currency exchange rates impact the U.S. dollar amount of revenue and expenses.  See Note 15 to the Consolidated Financial Statements, Segment Information, for financial information concerning our foreign activities.

Interest Rate Risk

In the past, we have been subject to market risk associated with interest rate movements on certain outstanding debt.  However, our current credit agreement with JPMorgan Chase includes a fixed interest rate.  Therefore, changes in the prime rate do not impact us in this area.




Tandy Leather Factory, Inc.
Consolidated Balance Sheets
December 31, 2010 and 2009


 
December 31,  2010
 
December 31,  2009
ASSETS
     
CURRENT ASSETS:
     
 
Cash
$4,293,746
 
$7,891,962
 
Short-term investments, including certificates of deposit
1,621,593
 
5,017,000
 
Accounts receivable-trade, net of allowance for doubtful accounts of $147,000 and $136,000 in 2010 and 2009, respectively
  1,253,639     1,202,811
 
Inventory
20,236,028
 
16,865,826
 
Deferred income taxes
307,509
 
271,481
 
Other current assets
1,056,201
 
791,884
       
Total current assets
28,768,716
 
32,040,964
       
PROPERTY AND EQUIPMENT, at cost
14,390,662
 
15,111,497
Less accumulated depreciation and amortization
(4,106,121)
 
(5,431,776)
 
10,284,541
 
9,679,721
       
GOODWILL
990,368
 
983,823
OTHER INTANGIBLES, net of accumulated amortization of $495,000 and $418,000 in 2010 and 2009, respectively
  232,416  
  307,802
OTHER assets
319,533
 
314,921
 
$40,595,574
 
$43,327,231
       
LIABILITIES AND STOCKHOLDERS' EQUITY
     
CURRENT LIABILITIES:
     
 
Accounts payable-trade
$1,247,821
 
$1,185,032
 
Accrued expenses and other liabilities
4,893,236
 
3,988,144
 
Income taxes payable
554,380
 
399,536
 
Current maturities of long-term debt
202,500
 
202,500
       
Total current liabilities
6,897,937
 
5,775,212
       
DEFERRED INCOME TAXES
628,543
 
682,364
       
LONG-TERM DEBT, net of current maturities
3,307,500
 
3,510,000
COMMITMENTS AND CONTINGENCIES
-
 
-
       
STOCKHOLDERS' EQUITY:
     
 
Preferred stock, $0.10 par value; 20,000,000 shares authorized, none issued or outstanding
  -     -
 
Common stock, $0.0024 par value; 25,000,000 shares authorized, 11,150,065 and 11,021,951 shares issued at 2010 and 2009,
     
   
10,156,442 and 10,130,628 outstanding at 2010 and 2009, respectively
26,760
 
26,453
 
Paid-in capital
5,703,387
 
5,491,736
 
Retained earnings
26,429,335
 
29,959,910
 
Treasury stock at cost (993,623 shares at 2009; 891,323 shares at 2009)
(2,894,068)
 
(2,452,649)
 
Accumulated other comprehensive income
496,180
 
334,205
       
Total stockholders' equity
29,761,594
 
33,359,655
 
$40,595,574
 
$43,327,231


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


Tandy Leather Factory, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2010, 2009 and 2008


 
2010
 
2009
 
2008
           
NET SALES
$59,892,870
 
$54,482,739
 
$52,491,538
COST OF SALES
23,642,013
 
21,873,365
 
21,441,179
 
Gross Profit
36,250,857
 
32,609,374
 
31,050,359
           
OPERATING EXPENSES
29,615,246
 
27,514,273
 
27,025,017
INCOME FROM OPERATIONS
6,635,611
 
5,095,101
 
4,025,342
           
OTHER (INCOME) EXPENSE:
         
Interest expense
265,405
 
297,864
 
332,107
Other, net
(105,540)
 
(164,165)
 
(265,035)
 
Total other expense
159,865
 
133,699
 
67,072
           
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
6,475,746
 
4,961,402
 
3,958,270
           
PROVISION FOR INCOME TAXES
2,317,255
 
1,700,259
 
1,446,423
           
NET INCOME FROM CONTINUING OPERATIONS
4,158,491
 
3,261,143
 
2,511,847
           
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX
1,766
 
56,914
 
92,334
           
NET INCOME
$4,160,257
 
$3,318,057
 
$2,604,181
           
NET INCOME FROM CONTINUING OPERATIONS PER COMMON SHARE:
         
BASIC
$0.41
 
$0.31
 
$0.23
DILUTED
$0.41
 
$0.31
 
$0.23
           
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX PER COMMON SHARE:
         
BASIC
$0.00
 
$0.01
 
$0.01
DILUTED
$0.00
 
$0.01
 
$0.01
           
NET INCOME PER COMMON SHARE:
         
BASIC
$0.41
 
$0.32
 
$0.24
DILUTED
$0.41
 
$0.31
 
$0.24
           
Weighted Average Number of Shares Outstanding:
         
  Basic
10,208,944
 
10,471,103
 
10,931,306
  Diluted
10,251,863
 
10,535,736
 
11,015,657



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


Tandy Leather Factory, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2010, 2009 and 2008

 
2010
 
2009
 
2008
CASH FLOWS FROM OPERATING ACTIVITIES:
         
 
Net income
$4,160,257
 
$3,318,057
 
$2,604,181
 
Income from discontinued operations
1,766
 
56,914
 
92,334
   
4,158,491
 
3,261,143
 
2,511,847
 
Adjustments to reconcile net income to net cash provided by operating activities -
         
       
Depreciation and amortization
972,409
 
1,125,009
 
975,903
       
Loss on disposal or abandonment of assets
49,154
 
21,540
 
13,385
       
Impairment of equipment
-
 
343,543
 
-
       
Non-cash stock-based compensation
41,692
 
2,540
 
30,495
       
Deferred income taxes
(90,520)
 
40,776
 
477,490
       
Other
150,203
 
339,305
 
(373,139)
       
Net changes in assets and liabilities, net of effect of business acquisitions:
         
           
Accounts receivable-trade, net
(56,736)
 
(99,994)
 
1,327,899
           
Inventory
(3,370,202)
 
(900,466)
 
1,469,762
           
Income taxes
186,940
 
147,310
 
204,858
           
Other current assets
(264,317)
 
(14,334)
 
325,286
           
Accounts payable-trade
62,788
 
36,455
 
(348,987)
           
Accrued expenses and other liabilities
905,092
 
810,564
 
1,115,586
 
Total adjustments
(1,413,497)
 
1,852,248
 
5,218,538
             
Net cash provided by continuing operating activities
2,744,994
 
5,113,391
 
7,730,385
             
Cash provided from (used by) discontinued operating activities
(23,751)
 
161,070
 
119,681
             
Net cash provided by operating activities
2,721,243
 
5,274,461
 
7,850,066
           
CASH FLOWS FROM INVESTING ACTIVITIES:
         
 
Purchase of property and equipment
(1,553,339)
 
(791,565)
 
(2,845,548)
 
Purchases of certificates of deposit
(2,572,593)
 
(8,671,000)
 
(3,109,000)
 
Proceeds from maturities of certificates of deposit
5,968,000
 
6,665,000
 
98,000
 
Proceeds from sale of marketable securities
-
 
-
 
500,000
 
Proceeds from sale of assets
7,570
 
2,510
 
42,114
 
Purchase of intangible assets
-
 
-
 
(24,708)
 
Decrease (increase) in other assets
(4,612)
 
(1,847)
 
122,140
             
Net cash provided by (used in) continuing investing activities
1,845,026
 
(2,796,902)
 
(5,217,002)
             
Cash provided from discontinued investing activities
-
 
-
 
-
             
Net cash provided by (used in) investing activities
1,845,026
 
(2,796,902)
 
(5,217,002)
           
CASH FLOWS FROM FINANCING ACTIVITIES:
         
 
Payments on notes payable and long-term debt
(202,500)
 
(202,500)
 
(135,000)
 
Payments on capital lease obligations
-
 
(593,949)
 
(209,764)
 
Payment of dividend
(7,690,832)
 
-
 
-
 
Repurchase of common stock (treasury stock)
(441,419)
 
(1,624,264)
 
(802,898)
 
Proceeds from issuance of common stock and warrants
170,266
 
24,818
 
14,500
             
Net cash used in continuing financing activities
(8,164,485)
 
(2,395,895)
 
(1,133,162)
             
Cash provided from discontinued financing activities
-
 
-
 
-
             
Net cash used in financing activities
(8,164,485)
 
(2,395,895)
 
(1,133,162)
           
NET INCREASE (DECREASE) IN CASH
(3,598,216)
 
81,664
 
1,499,902
           
CASH, beginning of period
7,891,962
 
7,810,298
 
6,310,396
           
CASH, end of period
$4,293,746
 
$7,891,962
 
$7,810,298
           
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
         
Interest paid during the period
$265,405
 
$297,864
 
$332,107
Income tax paid during the period, net of (refunds)
2,208,819
 
1,622,273
 
878,110
           
NON-CASH INVESTING ACTIVITIES:
         
   
Equipment acquired under capital lease financing arrangements
-
 
-
 
$803,713


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


Tandy Leather Factory, Inc.
Consolidated Statements of Stockholders' Equity
For the Years Ended December 31, 2010, 2009 and 2008


 
Number of
Shares
 
 
Par Value
 
 
Paid-in Capital
 
 
Treasury Stock
 
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
 
Total
 
Comprehensive
Income (Loss)
BALANCE, December 31, 2007
10,977,092
 
$26,359
 
$5,419,477
 
$(25,487)
 
$24,037,672
 
$357,484
 
$29,815,504
   
 
Shares issued - stock options exercised
 
12,000
 
 
29
 
 
14,471
 
 
-
 
 
-
 
 
-
 
 
14,500
   
Stock-based compensation
-
 
-
 
30,495
 
-
 
-
 
-
 
30,495
   
Purchase of treasury stock
(324,537)
 
-
 
-
 
(802,898)
 
-
 
-
 
(802,898)
   
Net  income
-
 
-
 
-
 
-
 
2,604,181
 
-
 
2,604,181
 
$2,604,181
Translation adjustment
-
 
-
 
-
 
-
 
-
 
(397,021)
 
(397,021)
 
(397,021)
BALANCE, December 31, 2008
10,664,555
 
$26,388
 
$5,464,443
 
$(828,385)
 
$26,641,853
 
$(39,537)
 
$31,264,762
   
                               
Comprehensive income for the year ended December 31, 2008
$2,207,160
 
Shares issued - stock options exercised
 
27,000
 
 
65
 
 
24,753
 
 
-
 
 
-
 
 
-
 
 
24,818
   
Stock-based compensation
-
 
-
 
2,540
 
-
 
-
 
-
 
2,540
   
Purchase of treasury stock
(560,927)
 
-
 
-
 
(1,624,264)
 
-
 
-
 
(1,624,264)
   
Net  income
-
 
-
 
-
 
-
 
3,318,057
 
-
 
3,318,057
 
$3,318,057
Translation adjustment
-
 
-
 
-
 
-
 
-
 
373,742
 
373,742
 
373,742
BALANCE, December 31, 2009
10,130,628
 
$26,453
 
$5,491,736
 
$(2,452,649)
 
$29,959,910
 
$334,205
 
$33,359,655
   
                               
Comprehensive income for the year ended December 31, 2009
$3,691,799
 
Shares issued - stock options exercised
 
128,114
 
 
307
 
 
169,959
 
 
-
 
 
-
 
 
-
 
 
170,266
   
Stock-based compensation
-
 
-
 
41,692
 
-
 
-
 
-
 
41,692
   
Purchase of treasury stock
(102,300)
 
-
 
-
 
(441,419)
 
-
 
-
 
(441,419)
   
Net  income
-
 
-
 
-
 
-
 
4,160,257
 
-
 
4,160,257
 
$4,160,257
Cash dividend paid
-
 
-
 
-
 
-
 
(7,690,832)
 
-
 
(7,690,832)
   
Translation adjustment
-
 
-
 
-
 
-
 
-
 
161,975
 
161,975
 
161,975
BALANCE, December 31, 2010
10,156,442
 
$26,760
 
$5,703,387
 
$(2,894,068)
 
$26,429,335
 
$496,180
 
$29,761,594
   
                               
Comprehensive income for the year ended December 31, 2010
$4,322,232


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




TANDY LEATHER FACTORY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER 31, 2010, 2009, and 2008

1.  DESCRIPTION OF BUSINESS
 
 
Our primary line of business is the sale of leather, leather crafts and related supplies.  We sell our products via company-owned stores throughout the United States, Canada, and the United Kingdom.  Numerous customers including retailers, wholesalers, assemblers, distributors and other manufacturers are geographically disbursed throughout the world.  We also have light manufacturing facilities in Texas.

2.  SIGNIFICANT ACCOUNTING POLICIES
 
 
·  
Management estimates and reporting

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the periods presented.  Actual results could differ from those estimates.  Assets and liabilities with reported amounts based on significant estimates include trade accounts receivables, inventory (slow-moving), and deferred income taxes.

·  
 Principles of consolidation

Our consolidated financial statements include the accounts of Tandy Leather Factory, Inc. and its wholly owned subsidiaries, The Leather Factory, L.P. (a Texas limited partnership) and its corporate partners, Tandy Leather Company, L.P. (a Texas limited partnership) and its corporate partners, Mid-Continent Leather Sales, Inc. (an Oklahoma corporation), Roberts, Cushman & Company, Inc. (a Texas corporation), The Leather Factory of Canada, Ltd. (a Canadian corporation), and Tandy Leather Factory UK Limited (a UK corporation).  All intercompany accounts and transactions have been eliminated in consolidation.

·  
Foreign currency translation

Foreign currency translation adjustments arise from activities of our Canadian and United Kingdom operations.  Results of operations are translated into U.S. dollars using the average exchange rates during the period, while assets and liabilities are translated using period-end exchange rates.  Foreign currency translation adjustments of assets and liabilities are recorded in stockholders’ equity.  Gains and losses resulting from foreign currency translations are reported in the statements of income under the caption “Other (Income) Expense”, net, for all periods presented.  We recognized foreign currency translation losses of $187,000, $98,000 and $114,000 in 2010, 2009, and 2008, respectively.

·  
Revenue recognition

Our sales generally occur via two methods:  (1) at the store counter, and (2) shipment by common carrier.  Sales at the counter are recorded and title passes as transactions occur.  Otherwise, sales are recorded and title passes when the merchandise is shipped to the customer.  Shipping terms are normally FOB shipping point.  Sales tax is excluded from revenue.

We offer an unconditional satisfaction guarantee to all customers and accept all product returns.  Net sales represent gross sales less negotiated price allowances, product returns, and allowances for defective merchandise.

·  
Discounts

We maintain four price levels on a consistent basis:  retail, wholesale, business, and distributor.  Gross sales are reported after deduction of discounts.  We do not pay slotting fees or make other payments to resellers.  Several customers require us to participate in their cooperative advertising programs.  These programs are a negotiated percentage of their purchases and are accounted for as a reduction of sales.

·  
Expense categories

Cost of goods sold includes inbound freight and duty charges from vendors to our central warehouse, freight and handling charges to move merchandise from our central warehouse to our stores, and manufacturing overhead, as appropriate.

Operating expenses include all selling, general and administrative costs including wages and related employee expenses (payroll taxes, health benefits, savings plans, etc.), advertising, outbound freight charges (to ship merchandise to customers), rent, and utilities.

·  
Property and equipment, net of accumulated depreciation and amortization

Property and equipment are stated at cost.  Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which are five to ten years for machinery and equipment, five to seven years for furniture and fixtures, five years for vehicles, and forty years for buildings and related improvements.  Leasehold improvements are amortized over the lesser of the life of the lease or the useful life of the asset.  Repairs and maintenance costs are expensed as incurred.

·  
Inventory

Inventory is valued at the lower of first-in, first-out cost or market.  In addition, the value of inventory is periodically reduced for slow-moving or obsolete inventory based on management's review of items on hand compared to their estimated future demand.

·  
Impairment of long-lived assets

Potential impairments of long-lived assets are reviewed annually or when events and circumstances warrant an earlier review.  Impairment is determined when estimated future undiscounted cash flows associated with an asset are less than the asset’s carrying value.

·  
Earnings per share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period.  Diluted earnings per share includes, to the extent inclusion of such shares would be dilutive to earnings per share, the effect of outstanding options and warrants, computed using the treasury stock method.



BASIC
2010
 
2009
 
2008
Net income
$4,160,257
 
$3,318,057
 
$2,604,181
           
Weighted average common shares outstanding
10,208,944
 
10,471,103
 
10,931,306
           
Earnings per share – basic
$0.41
 
$0.32
 
$0.24
           
DILUTED
         
Net income
$4,160,257
 
$3,318,057
 
$2,604,181
           
Weighted average common shares outstanding
10,208,944
 
10,471,103
 
10,931,306
Effect of assumed exercise of stock options and warrants
42,919
 
64,633
 
84,351
Weighted average common shares outstanding, assuming dilution
10,251,863
 
10,535,736
 
11,015,657
           
Earnings per share - diluted
$0.41
 
$0.31
 
$0.24
           
Outstanding options and warrants excluded as anti-dilutive
13,000
 
61,000
 
80,500

For additional disclosures regarding the employee stock options and the warrants, see Note 12. The net effect of converting stock options and warrants to purchase 103,600, 197,700, and 232,200 shares of common stock at option prices less than the average market prices has been included in the computations of diluted EPS for the years ended December 31, 2010, 2009 and 2008, respectively.

·  
Goodwill and other intangibles

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Goodwill is required to be tested for impairment on an annual basis, absent indicators of impairment during the interim.  Application of the goodwill impairment test requires exercise of judgment, including the estimation of future cash flows, determination of appropriate discount rates and other important assumptions. Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for each reporting unit. 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 periodically analyze goodwill remaining on the balance sheet to determine the appropriateness of its carrying value and have elected to perform the annual analysis during the fourth calendar quarter of each year.  As of December 31, 2010, we determined that the present value of the discounted estimated future cash flows of the operating divisions associated with the goodwill is sufficient to support their respective goodwill balances.  Goodwill impairment is deemed to exist if the carrying value of the goodwill exceeds its implied fair value.  Our reporting units are generally the same as the operating segments identified in Note 15 – Segment Information.

A summary of changes in our goodwill for the years ended December 31, 2010 and 2009 is as follows:

 
Leather Factory
 
Tandy Leather
 
Total
Balance, December 31, 2008
$583,249
 
$383,406
 
$966,655
Acquisitions and adjustments
-
 
-
 
-
Foreign exchange gain/loss
17,168
 
-
 
17,168
Impairments
-
 
-
 
-
Balance, December 31, 2009
$600,417
 
$383,406
 
$983,823
Acquisitions and adjustments
-
 
-
 
-
Foreign exchange gain/loss
6,545
 
-
 
6,545
Impairments
-
 
-
 
-
Balance, December 31, 2010
606,962
 
$383,406
 
990,368

As of December 31, 2010 and 2009, our intangible assets and related accumulated amortization consisted of the following:

 
As of December 31, 2010
 
Gross
 
Accumulated Amortization
 
Net
Trademarks, Copyrights
$544,369
 
$391,531
 
$152,838
Non-Compete Agreements
183,134
 
103,556
 
79,578
 
$727,503
 
495,087
 
$232,416

 
As of December 31, 2009
 
Gross
 
Accumulated Amortization
 
Net
Trademarks, Copyrights
$544,369
 
$356,067
 
$188,302
Non-Compete Agreements
181,636
 
62,136
 
119,500
 
$726,005
 
418,203
 
$307,802

Excluding goodwill, we have no intangible assets not subject to amortization under U.S. GAAP.  Amortization of intangible assets of $76,421 in 2010, $51,291 in 2009, and $53,350 in 2008 was recorded in operating expenses.  The weighted average amortization period is 15 years for trademarks and copyrights.  Based on the current amount of intangible assets subject to amortization, the estimated amortization expense for each of the succeeding 5 years are as follows:
 
 
Leather Factory
Tandy Leather
Total
2011
$13,263
$30,337
$43,600
2012
6,177
30,337
36,514
2013
-
30,337
30,337
2014
-
30,337
30,337
2015
-
25,636
25,636

·  
Fair value of financial Instruments

We measure fair value as an exit price, which is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.  As a basis for considering such assumptions, accounting standards establish a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:

Level 1 – observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2 – include other inputs that are directly or indirectly observable in the marketplace.

Level 3 – unobservable inputs which are supported by little or no market activity.

Classification of the financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

Our principal financial instruments held consist of accounts receivable, accounts payable, notes payable and long-term debt.  The carrying value of accounts receivable and accounts payable approximate their fair value due to the relatively short-term nature of the accounts.  The terms of the long-term debt are considered reasonable for this type of financing; therefore, the carrying amount approximates fair value.
 
·  
Income Taxes
 
We use the asset and liability method of accounting for income taxes. Using this method, deferred tax assets and liabilities are recorded based on differences between financial reporting and tax basis of assets and liabilities. The deferred tax assets and liabilities are calculated using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. We establish valuation allowances for tax benefits when we believe it is more likely than not that such assets will not be realized.
 
FASB ASC 740: Accounting for Income Taxes ("FASB ASC 740") clarifies the accounting for uncertainty in income taxes recognized in financial statements. In accordance with FASB ASC 740, we regularly evaluate the likelihood of recognizing the benefit for income tax positions we have taken in various federal and state filings by considering all relevant facts, circumstances, and information available. For those benefits that we believe it is more likely than not that the benefit will be sustained, we recognize the largest amount we believe is cumulatively greater than 50% likely to be realized.
 
We record interest and penalties, if any, on any underpayment of income taxes as a component of provision for income taxes and selling, general and administrative expenses, respectively.
 
·  
Stock-based compensation

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, 42,600 options were awarded to directors in 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.  We recognized share based compensation expense of approximately $42,000, $3,000, and $30,000 for the years ended December 31, 2010, 2009 and 2008, respectively, as a component of operating expenses.
 
During the years ended December 31, 2010 and 2009, the stock option activity under our stock option plans was as follows:

 
Weighted Average
Exercise Price
# of
shares
Weighted Average Remaining Contractual Term
(in years)
Aggregate
Intrinsic Value
Outstanding, January 1, 2008
$2.11
236,700
   
Granted
-
-
   
Cancelled
-
-
   
Exercised
1.21
(12,000)
   
Outstanding, December 31, 2008
$2.16
224,700
3.09
$262,001
Exercisable, December 31, 2008
$2.15
220,770
3.07
$259,461

Outstanding, January 1, 2009
$2.16
224,700
   
Granted
-
-
   
Cancelled
-
-
   
Exercised
0.92
(27,000)
   
Outstanding, December 31, 2009
$2.33
197,700
2.29
$246,088
Exercisable, December 31, 2009
$2.33
197,700
2.29
$246,088

Outstanding, January 1, 2010
$2.33
197,700
   
Granted
4.59
42,600
   
Cancelled
-
-
   
Exercised
1.65
(136,700)
   
Outstanding, December 31, 2010
$4.35
103,600
5.68
$192,075
Exercisable, December 31, 2010
$4.33
70,000
3.73
$149,873

Other information pertaining to option activity during the twelve month periods ended December 31, 2010, 2009 and 2008 are as follows:
 
 
2010
2009
2008
Weighted average grant-date fair value of stock options granted
$1.42
N/A
N/A
Total fair value of stock options vested
$18,388
$2,540
$30,500
Total intrinsic value of stock options exercised
$114,603
$15,913
$8,779

As of December 31, 2010, the unrecognized compensation cost for stock options not fully vested was $18,900 which will be recognized in 2011.

Cash received from the exercise of stock options and warrants for the years ended December 31, 2010, 2009 and 2008 was $170,266, $24,818, and $14,500, respectively.

The fair value of each stock option granted is estimated on the date of grant using the BSM option valuation model.  The assumptions used to calculate the fair value of options granted are evaluated and revised, as necessary, to reflect market conditions and our experience.  Compensation expense is recognized only for those options expected to vest, with forfeitures estimated at the date of grant based on our historical experience and future expectations.

·  
Comprehensive income

Comprehensive income represents all changes in stockholders’ equity, exclusive of transactions with stockholders.  The accumulated balance of foreign currency translation adjustments is presented in the consolidated financial statements as “accumulated other comprehensive income or loss”.

·  
Shipping and handling costs

All shipping and handling costs incurred by us are included in operating expenses on the statements of income.  These costs totaled approximately $1,603,000, $1,342,000, and $1,500,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

·  
Advertising

With the exception of catalog costs, advertising costs are expensed as incurred.  Catalog costs are capitalized and expensed over the estimated useful life of the particular catalog in question, which is typically twelve to eighteen months.  Such capitalized costs are included in other current assets and totaled $130,000 and $144,000 at December 31, 2010 and 2009, respectively.  Total advertising expense was $3,002,000 in 2010; $2,953,000 in 2009; and $3,036,346 in 2008.

We agree to list the names and addresses of our Authorized Sales Centers (ASCs) in certain mailing pieces produced.  The inclusion of these names and addresses are at our sole discretion.  The production and distribution of direct mailings is the primary method of advertising we use and normally consists of 95 to 100 unique mailing pieces annually.  Generally, the ASCs are listed in six to eight of those pieces.  We believe that the inclusion of these ASC locations in the flyers has no impact on our financial statements.

·  
Cash flows presentation

For purposes of the statement of cash flows, we consider all highly liquid investments with initial maturities of three months or less from the date of purchase to be cash equivalents.

·  
Reclassifications

Certain reclassifications have been made to the 2008 financial statements to conform to the 2009 presentation.

3.  SHORT-TERM INVESTMENTS

Our short-term investments at December 31, 2010 and 2009 consist solely of certificates of deposit.  All current fixed maturity securities are classified as “available for sale” and are reported at carrying value, which approximates fair value.  We have determined that our investment securities are available to support current operations and, accordingly, have classified such securities as current assets without regard to contractual maturities.  Certificates of deposit are considered to be Level 2 in the fair value hierarchy.  The contractual maturities of the certificates of deposit as of December 31, 2010 are shown below.  Actual maturities may differ from the contractual maturities because debtors may have the right to call obligations with or without call penalties.

Due within one year
$1,285,593
Due between one and five years
336,000
 
$1,621,593

4.  VALUATION AND QUALIFYING ACCOUNTS

·  
Allowance for uncollectible accounts

We maintain allowances for bad debts based on factors such as the composition of accounts receivable, the age of the accounts, historical bad debt experience, and our evaluation of the financial condition and past collection history of each customer.  Accounts are written off as they are deemed uncollectible based on a periodic review of accounts.  Our allowance for doubtful accounts was $146,929 and $136,023, respectively, at December 31, 2010 and 2009.  The following is a roll forward of the allowance for doubtful accounts:
 
 
Year ended:
Balance at
 beginning of year
Reserve "purchased"
during year
Additions (reductions)
charged to costs and expenses
Foreign exchange
gain/loss
 
Write-offs
Balance at
end of year
December 31, 2010
$136,023
-
25,348
595
(15,037)
$146,929
December 31, 2009
$43,014
-
112,272
632
(19,895)
$136,023
December 31, 2008
$104,634
-
65,921
(2,768)
(124,773)
$43,014
 
·  
Sales returns and defective merchandise

Product returns are generally recorded directly against sales as those returns occur.  Historically, the amount of returns is immaterial and as a result, no reserve is recorded in the financial statements.

·  
Slow-moving and obsolete inventory

The majority of inventory items maintained by us have no restrictive shelf life.  We review all inventory items annually to determine what items should be eliminated from the product line.  Items are selected for several reasons:  (1) the item is slow-moving; (2) the supplier is unable to provide an acceptable quality or quantity; or (3) to keep the product line fresh.  Once an item has been selected to discontinue, we devalue the cost of the item by 25% of its original value each quarter until its value has been reduced to zero.  Reductions in inventory for slow-moving and obsolete inventory are recorded directly against inventory and added to cost of goods sold.

5.  BALANCE SHEET COMPONENTS

 
December 31, 2010
 
December 31, 2009
INVENTORY
     
On hand:
     
    Finished goods held for sale
$17,847,002
 
$14,861,855
    Raw materials and work in process
518,422
 
609,002
Inventory in transit
1,870,604
 
1,394,969
TOTAL
$20,236,028
 
$16,865,826
       
PROPERTY AND EQUIPMENT
     
Building
$6,330,593
 
$5,324,404
Land
1,451,132
 
1,451,132
Leasehold improvements
609,715
 
677,431
Equipment and machinery
3,762,040
 
5,234,868
Furniture and fixtures
2,191,203
 
2,377,683
Vehicles
45,979
 
45,979
 
14,390,662
 
15,111,497
Less:  accumulated depreciation
(4,106,121)
 
(5,431,776)
TOTAL
$10,284,541
 
$9,679,721
       
       
OTHER CURRENT ASSETS
     
Accounts receivable – employees
$30,631
 
$36,644
Accounts receivable – other
10,532
 
9,600
Prepaid expenses
982,916
 
612,779
Payments for merchandise not received
32,122
 
132,861
TOTAL
$1,056,201
 
$791,884
       
OTHER ASSETS
     
Security deposits - utilities, locations, etc.
$67,533
 
$62,921
Leather art collection
252,000
 
252,000
TOTAL
$319,533
 
$314,921
       
ACCRUED EXPENSES AND OTHER LIABILITIES
 
 
 
Accrued bonuses
$1,558,404
 
$1,119,399
Accrued payroll
430,935
 
360,738
Deferred revenue
597,546
 
542,812
Sales and payroll taxes payable
375,041
 
267,465
Inventory in transit
1,599,344
 
1,394,969
Other
331,966
 
302,761
TOTAL
$4,893,236
 
$3,988,144

Depreciation expense was $895,988, $1,073,718, and $922,553 for the years ended December 31, 2010, 2009 and 2008, respectively.

In 2009, we recorded an impairment loss due to the discontinued use and abandonment of specific computer software.  The software was purchased in 2004 for the purpose of upgrading and replacing our current point-of-sale and accounting systems.  We had been using the software in a limited capacity for several years and amortizing the cost of the system accordingly.  However, we made the decision in the fourth quarter of 2009 that we would not continue its use due to inconsistencies and incompatibility with our current systems and discontinued use accordingly.  Due to licensing restrictions, we are unable to sell the software to a third party.  The resulting fair value of $0 for the asset is considered a Level 3 valuation.  The impairment loss totaled $343,543 and is included in operating expenses.  The amortization to date and the impairment loss is reported in our Wholesale Leathercraft segment.

Also, in 2009, we recorded a loss on disposal of equipment due to the abandonment and/or disposal of obsolete equipment.  The disposal consisted of numerous pieces of various computer equipment purchased between 2002 and 2006.  The loss totaled $21,540 and is included in Operating expenses, $5,393 of which is reported in our Retail Leathercraft segment and $16,147 which is reported in our Wholesale Leathercraft segment.

The 2010 loss from abandonment and/or disposal of obsolete equipment totaled $49,154.  The loss is included in Operating expenses, $11,849 of which is reported in our Retail Leathercraft segment and $37,305 which is reported in our Wholesale Leathercraft segment.

6.  NOTES PAYABLE AND LONG-TERM DEBT

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.

The terms of the credit facility contain various covenants which among other things require the Company to maintain a debt service coverage ratio of not less than 1.2 to 1.0.  We were in compliance with these covenants as of December 31, 2010.

On July 15, 2010, we entered into a Credit Agreement and Line of Credit Note with Comerica Bank, pursuant to which the bank agreed to provide us with a revolving credit facility of up to $2,500,000.  The revolver bears interest at LIBOR plus 2.0% and matures on June 29, 2011.  At September 30, 2010, no borrowings had occurred and no amounts were outstanding under the above agreement.

The terms of the Credit Agreement contain various covenants which, among other things, limit further indebtedness to $1 million and from entering into any new business or making material changes in any of our business objectives, purposes or operations.  We also have an affirmative duty to disclose any covenant violation to the lender.

At December 31, 2010 and 2009, the amount outstanding under the above agreements consisted of the following:

 
2010
 
2009
Credit Agreement with JPMorgan Chase Bank – collateralized by real estate; payable as follows:
       
Line of Credit Note dated July 31, 2007, converted to a 10-year term note on April 30, 2008; $16,875 monthly principal payments plus interest at 7.1% per annum; matures April 30, 2018
$  3,510,000
 
$3,712,500
 
         
Credit Agreement with Comerica Bank – unsecured; payable as follows:
       
 Master Revolving Note dated June 30, 2010 in the maximum principal amount of $2,500,000 – interest due monthly as LIBOR plus 2%; matures June 29, 2011
-
 
-
 
 
3,510,000
 
3,712,500
 
Less - Current maturities
(202,500)
 
(202,500)
 
 
$3,307,500
 
$3,510,000
 

Scheduled maturities of the Company’s notes payable and long-term debt are as follows:

2011
$202,500
2012
202,500
2013
202,500
2014
202,500
2015
202,500
2016 and thereafter
2,497,500
 
$3,510,000

7.  CAPITAL LEASE OBLIGATIONS

We leased certain HVAC equipment under a capital lease agreement.  The asset subject to the agreement totaling $803,713 is included in Property and Equipment as of December 31, 2010.  Accumulated depreciation on the asset at that date was $221,021.  Amortization of the capitalized cost is charged to depreciation expense.  This capital lease obligation was paid in full during 2009.

8.  EMPLOYEE BENEFIT AND SAVINGS PLANS

We have a 401(k) plan to provide retirement benefits for our employees.  As allowed under Section 401(k) of the Internal Revenue Code, the plan provides tax-deferred salary contributions for eligible employees and allows employees to contribute a percentage of their annual compensation to the plan on a pretax basis.  Employee contributions are limited to a maximum annual amount as set periodically by the Internal Revenue Code.  In 2010, we matched pretax employee contributions up to 3% of eligible earnings that are contributed by employees.  In 2009 and 2008, we matched pretax employee contributions up to 50% on the first 4% of eligible earnings that are contributed by employees.
 
Year Ended December 31,
Maximum Matching Contribution per Participant*
Total Matching Contribution
2010
$7,350
$199,716
2009
$4,900
$124,488
2008
$4,600
$120,025

* Due to the annual limit on eligible earnings imposed by the Internal Revenue Code

The plan allows employees who meet the age requirements and reach the plan contribution limits to make a catch-up contribution.  The catch-up contributions are not eligible for matching contributions.  In addition, the plan provides for discretionary matching contributions as determined by the Board of Directors.  There were no discretionary matching contributions made in 2010, 2009 or 2008.

We currently offer no postretirement or postemployment benefits to our employees.
 
9.  INCOME TAXES
 
We use the asset and liability method of accounting for income taxes. Using this method, deferred tax assets and liabilities are recorded based on differences between financial reporting and tax basis of assets and liabilities. The deferred tax assets and liabilities are calculated using the enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. We establish valuation allowances for tax benefits when we believe it is more likely than not that such assets will not be realized.
 
In accordance with FASB ASC 740: Accounting for Income Taxes ("FASB ASC 740"), we regularly evaluate the likelihood of recognizing the benefit for income tax positions we have taken in various federal and state filings by considering all relevant facts, circumstances, and information available. For those benefits that we believe it is more likely than not that the benefit will be sustained, we recognize the largest amount we believe is cumulatively greater

The provision for income taxes consists of the following:

   
2010
 
2009
 
2008
Current provision:
           
 
Federal
$2,121,604
 
$1,461,655
 
$766,333
 
State
286,171
 
197,828
 
202,600
   
2,407,775
 
1,659,483
 
968,933
             
Deferred provision (benefit):
           
 
Federal
(80,991)
 
37,632
 
428,660
 
State
(9,529)
 
3,144
 
48,830
   
(90,520)
 
40,776
 
477,490
             
   
$2,317,255
 
$1,700,259
 
$1,446,423

Income before income taxes is earned in the following tax jurisdictions:

 
2010
 
2009
 
2008
United States
$5,670,352
 
$4,437,072
 
$3,716,554
United Kingdom
319,290
 
324,924
 
(176,257)
Canada
486,981
 
284,350
 
571,775
 
$6,476,623
 
$5,046,346
 
$4,112,072

The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities are as follows:

 
2010
 
2009
Deferred income tax assets:
     
Allowance for doubtful accounts
$55,414
 
$50,650
Capitalized inventory costs
154,712
 
131,447
Warrants and stock-based compensation
45,116
 
45,116
Accrued expenses, reserves, and other
97,383
 
89,384
Total deferred income tax assets
352,625
 
316,597
       
Deferred income tax liabilities:
     
Property and equipment depreciation
534,639
 
604,287
Goodwill and other intangible assets amortization
139,020
 
123,193
Total deferred income tax liabilities
673,659
 
727,480
       
Net deferred tax asset (liability)
$(321,034)
 
$(410,883)

The net deferred tax liability is classified on the balance sheets as follows:

 
2010
 
2009
Current deferred tax assets
$307,509
 
$271,481
Long-term deferred tax liabilities
(628,543)
 
(682,364)
Net deferred tax asset (liability)
$(321,034)
 
$(410,883)

The effective tax rate differs from the statutory rate as follows:

   
2010
2009
2008
Statutory rate
 
34%
34%
34%
State and local taxes
 
4%
4%
9%
Domestic production activities deduction
 
(1%)
(2%)
(2%)
Other, net
 
(1%)
(2%)
(4%)
Effective rate
 
36%
34%
37%

We file a consolidated U.S. income tax return as well as state tax returns on a consolidated, combined or stand-alone basis, depending on the jurisdiction.  We are no longer subject to U.S. federal income tax examinations by tax authorities for years prior to the tax year ended December 2008.  Depending on the jurisdiction, we are no longer subject to state examinations by tax authorities for years prior to the December 2007 and December 2008 tax years.

10.  COMMITMENTS AND CONTINGENCIES

Operating Leases

We lease our store locations under five-year lease agreements that expire on dates ranging from May 2011 to May 2016.  Rent expense on all operating leases for the years ended December 31, 2010, 2009, and 2008, was $2,721,281, $2,513,297, and $2,575,642, respectively.

Future minimum lease payments under noncancelable operating leases at December 31, 2010 were as follows:

Year ending December 31:
 
 2011
$2,498,662
 2012
1,991,867
 2013
1,261,561
 2014
807,343
 2015
399,534
                       2016 and thereafter
69,343
Total minimum lease payments
$7,028,310

Litigation

We are involved in various litigation that arises in the ordinary course of business and operations.  There are no such matters pending that we expect to have a material impact on our financial position and operating results.

11.  SIGNIFICANT BUSINESS CONCENTRATIONS AND RISK

Major Customers

Our revenues are derived from a diverse group of customers primarily involved in the sale of leathercrafts.  While no single customer accounts for more than 5% of our consolidated revenues in 2010, 2009 and 2008, sales to our five largest customers represented 5.5%, 6.3% and 6.2%, respectively, of consolidated revenues in those years.  While we do not believe the loss of one of these customers would have a significant negative impact on our operations, we do believe the loss of several of these customers simultaneously or a substantial reduction in sales generated by them could temporarily affect our operating results.

Major Vendors

We purchase a significant portion of our inventory through one supplier.  Due to the number of alternative sources of supply, loss of this supplier would not have an adverse impact on our operations.

Credit Risk

Due to the large number of customers comprising our customer base, concentrations of credit risk with respect to customer receivables are limited.  At December 31, 2010 and 2009, 32% and 27%, respectively, of our consolidated accounts receivable were due from two nationally recognized retail chains.  We do not generally require collateral for accounts receivable, but we do perform periodic credit evaluations of our customers and believe the allowance for doubtful accounts is adequate.  It is our opinion that if any one or a group of customer receivable balances should be deemed uncollectable, it would not have a material adverse effect on our results of operations and financial condition.

We maintain our cash in bank deposit accounts that, at times, may exceed federally insured limits.  We have not experienced any losses in such accounts.  We believe we are not exposed to any significant credit risk on our cash and cash equivalents.

12.  STOCKHOLDERS' EQUITY

a)  
Stock Option Plan

In connection with its 2007 Director Non-qualified Stock Option Plan for non-employee directors, the Company has outstanding options to purchase its common stock.  The plan provides for the granting of non-qualified options at the discretion of the Compensation Committee of the Board of Directors.  Options are granted at the fair market value of the underlying common stock at the date of grant and vest after six months.  The Company has reserved 100,000 shares of common stock for issuance under this plan.

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 had no effect on the options previously granted.

All options expire ten years from the date of grant and are exercisable at any time after vesting.  Of the 100,000 shares available for issuance, there are 57,400 un-optioned shares available for future grants.

A summary of stock option transactions for the years ended December 31, 2010, 2009, and 2008, is as follows:

 
 
 2010
 
2009
 
2008
       
Weighted
     
Weighted
     
Weighted
       
Average
     
Average
     
Average
   
Option
 
Exercise
 
Option
 
Exercise
 
Option
 
Exercise
   
Shares
 
Price
 
Shares
 
Price
 
Shares
 
Price
Outstanding at January 1
 
197,700
 
$2.33
 
224,700
 
$2.16
 
236,700
 
$2.11
Granted
 
        42,600
 
           4.59
 
-
 
-
 
-
 
-
Forfeited or expired
 
-
 
-
 
-