Tandy Leather Factory
Annual Report 2011

Plain-text annual report

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, 2011 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 (State or Other Jurisdiction of Incorporation) 1900 Southeast Loop 820, Fort Worth, TX 76140 (Address of Principal Executive Offices and Zip Code) 75-2543540 (I.R.S. Employer Identification No.) 817/872-3200 (Registrant’s telephone number, including area code) Title of Each Class Common Stock, par value $0.0024 Name of Each Exchange on Which Registered NASDAQ Global Market Securities registered pursuant to Section 12(b) of the Act: 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] Securities registered pursuant to Section 12(g) of the Act: NONE 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 “smaller 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 $43,549,114 at June 30, 2011 (based on the price at which the common stock was last traded on the last business day of its most recently completed second fiscal quarter). At March 26, 2012, there were 10,156,442 shares of the registrant's common stock outstanding. Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on June 5, 2012, are incorporated by reference in Part III of this report. DOCUMENTS INCORPORATED BY REFERENCE Item Part 1 1 1A 2 3 4 5 6 7 7A 8 9 9A 9B 10 11 12 13 14 15 Part II Part III Part IV TABLE OF CONTENTS Business Risk Factors Properties Legal Proceedings Mine Safety Disclosures Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures about Market Risk Financial Statement and Supplementary Data Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions and Director Independence Principal Accountant Fees and Services Exhibits, Financial Statement Schedules Page 1 5 7 8 8 8 10 10 15 16 31 31 31 31 31 31 31 31 31 ITEM 1. BUSINESS General PART I 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 2011, our consolidated sales totaled $66.1 million of which approximately 15% 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 store 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, our wholesale chain 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. In 2011, we opened one combination wholesale and retail store in Sydney, Australia and one retail store in the U.S. At December 31, 2011, we operated 29 wholesale stores operating under the Leather Factory name (26 in the U.S. and three in Canada). We also operated 77 retail stores operating under the Tandy Leather name (70 in the U.S. and seven in Canada) as well as two combination wholesale and retail stores operating under the Tandy Leather Factory name in the United Kingdom and Australia. We closed Mid-Continent Leather Sales, a wholesale store, in October 2010. Tandy Leather Factory, Inc. wholly-owns eleven subsidiaries which create three operating segments as follows: Segment Wholesale Leathercraft Retail Leathercraft International Leathercraft Subsidiaries included: The Leather Factory, LP; The Leather Factory of Canada, Ltd (3 stores) Tandy Leather Company, LP; The Leather Factory of Canada, Ltd (7 stores) Tandy Leather Factory UK Ltd. Tandy Leather Factory Australia Pty Ltd Tandy Leather Factory Espana, SL 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 by segment in each of our fiscal years from 1999 to 2011. STORE COUNT YEARS ENDED DECEMBER 31, 1999 through 2011 Year Ended Balance Fwd 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Opened Wholesale Leathercraft Conv. (1) Closed 4 2 2 1 - - - - 1^ - - - - - - - (1) - - - (1) - - - - - - - - - - - - - - - - 1^ - Retail Leathercraft International Leathercraft Total 22 26 28 30 30 30 30 30 29 30 30 30 29 29 Opened (2) Closed - 1* - 14 12 16 8 12 10 1 2 1 1 - - - 1* - - - - - - - - - Total N/A - 1 1 14 26 42 50 62 72 73 75 76 77 Opened Closed - - - - - - - - - 1 - - 1 - - - - - - - - - - - - - Total N/A - - - - - - - - - 1 1 1 2 (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 3% of our total sales in 2011, although two customers’ purchases totaled 10% of Wholesale Leathercraft’s sales in 2011. 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%, 5.5% and 6.3% of consolidated sales in 2011, 2010 and 2009, 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. 1 TABLE OF CONTENTS Our Operating Segments We service our customers primarily through the operation of three segments. We identify those segments based on management responsibility, customer focus, and store location. The Wholesale Leathercraft segment consists of 29 wholesale stores of which 26 are located in the United States and three are located in Canada. As of March 1, 2012, the Retail Leathercraft segment consists of 77 Tandy Leather retail stores of which 70 are located in the United States and seven are located in Canada. Both of these segments sell leather and leathercraft-related products. The International Leathercraft segment consists of all stores, wholesale or retail, located outside of North America. As of March 1, 2012, we had three such stores, one located in the United Kingdom, one located in Australia, and one located in Spain. 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 14, 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 Canada through wholesale stores operating under the name, “The Leather Factory”. This segment had net sales of $26.5 million, $25.9 million and $25.1 million for 2011, 2010 and 2009, respectively. General We operate wholesale stores in 20 states and three Canadian provinces. The stores range in size from 2,350 square feet to 15,500 square feet, with the average size of a store being approximately 5,000 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), and our participation at trade shows. 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 geographic areas where we do not have a company-owned store. An unrelated person operating an existing business could become an ASC by submitting an application and upon approval, placing a minimum initial order and meeting minimum annual purchase amounts. In exchange, the benefits to the ASC are free advertising in various sales flyers produced and distributed by us, preferred pricing on certain products, advance notice of new products, and priority shipping and handling of orders. In 2011, the ASC program was eliminated in North America as the number and location of our stores were deemed sufficient to represent each geographic area. We currently have 8 ASC’s located outside of 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, Eco-FloTM, CraftoolTM 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 2011, 2010, and 2009, Wholesale Leathercraft division sales by product category were as follows: Product Category Belts strips and straps Books, patterns, videos Buckles Conchos^ Craft supplies Dyes, finishes, glues Hand tools Hardware Kits Lace Leather Stamping tools 2011 Sales Mix 2010 Sales Mix 2009 Sales Mix 3% 2% 4% 4% 5% 6% 15% 7% 7% 7% 35% 5% 100% 3% 2% 4% 4% 5% 6% 14% 7% 8% 7% 36% 4% 100% 2% 2% 4% 4% 6% 6% 13% 7% 8% 9% 35% 4% 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 2011 and 2010, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations." 2 TABLE OF CONTENTS Suppliers We purchase merchandise and raw materials from approximately 200 vendors dispersed throughout the United States and in approximately 15 foreign countries. In 2011, our 10 largest vendors accounted for approximately 67% 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, we do not believe that the loss of any of these principal suppliers would have a material impact on our operations. Operations Hours of operations vary by location, but generally range from 9:00 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 typically 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 2,700 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 subsequently closed it in 2010, reducing the number of wholesale stores again 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 segment 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 suppliers of leather and related supplies used in the leathercraft industry. This retail segment offers a product line of quality tools, leather, accessories, kits and teaching materials. It had net sales of $37.4 million, $32.3 million and $28.1 million for 2011, 2010 and 2009, respectively. General As of March 1, 2012, the Tandy Leather retail chain has 77 stores located in 36 states and six Canadian provinces with plans to reach 100 to 120 stores as opportunities arise. The stores range in size from 1,100 square feet to 4,500 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 and Canada 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 2011 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 (28-30% 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 2011. 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 2011, 2010 and 2009, Retail Leathercraft division sales by product category were as follows: Product Category Belts strips and straps Books, patterns, videos Buckles Conchos Craft supplies Dyes, finishes, glues Hand tools Hardware Kits Lace Leather Stamping tools 2011 Sales Mix 2010 Sales Mix 2009 Sales Mix 5% 2% 4% 4% 3% 7% 16% 7% 9% 3% 35% 5% 100% 5% 2% 4% 4% 4% 8% 15% 6% 10% 3% 34% 5% 100% 5% 3% 4% 4% 4% 8% 16% 6% 10% 4% 31% 5% 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. 3 TABLE OF CONTENTS 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, one was opened in 2010, and one was opened in 2011. Of the 77 stores opened as of December 31, 2011, 11 were independent leathercraft stores that we acquired. Separately, these acquisitions are not material. The other 66 stores have been new stores opened by us. International Leathercraft Our International Leathercraft segment consists of company-owned stores located outside of North America. As of December 31, 2011, there were two wholesale/retail combination stores in this segment: one in Northampton, United Kingdom, which we opened in February 2008, and one in Sydney, Australia, which we opened in October 2011. The stores operate under the Tandy Leather Factory trade name. This segment had net sales of $2.1 million, $1.7 million and $1.3 million in 2011, 2010 and 2009, respectively. A new store was opened in Spain in January 2012, bringing the number of stores in this segment to three currently. 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 stores average 7,600 square feet and are located in light industrial areas. 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 Europe, Australia, and Asia. 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 international stores have an unconditional return policy. Merchandise The products sold in our international stores are also sold in our North America 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. Competition Our competitors are generally small, independently-owned retailers who, in some cases, are also our customers. We compete on price, availability of merchandise, and delivery time. While there is competition in connection with a number of the products we carry, to our knowledge there is no direct competition affecting our entire product line. We believe our ability to stock a full range of products give us an advantage over most local competitors. Distribution The international stores receive the majority of 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. In January 2012, we opened a store in Spain. 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 10. 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, 2011, we employed 534 people, 443 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. For a description of some of the risks attendant to our foreign operations, see Item 1.A “Risk Factors” on page 5. 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. 4 TABLE OF CONTENTS Executive Officers of the Registrant The following table sets forth information concerning our executive officers as of March 26, 2012: Name and Age Jon W. Thompson, 50 Position Chief Executive Officer since July 2009; President and Chief Operating Officer since June 2008; Vice President from June 1993 to June 2008 Shannon L. Greene, 46 Chief Financial Officer since May 2000; Treasurer and Chief Accounting Officer since 2001 Mark J. Angus, 51 Senior Vice President and Assistant Secretary since June 2008; Operational Vice President of Merchandising since June 1993 William M. Warren, 68 Secretary and Corporate Counsel 2008 2000 2008 1993 Served as Executive Officer Since 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 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 Financial Executives International and its Fort Worth chapter. She is also a member of the Board of Directors of the U.S. Chamber of Commerce and serves as chairman of the Chamber’s Corporate Leadership Advisory Council. She is a member of the SEC Advisory Committee on Small and Emerging Companies as well as the Professional Standards Committee of the Texas Society of Certified Public Accountants. 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. ITEM 1A. RISK FACTORS Our business may be negatively impacted by general economic conditions and the current global financial crisis. Risks to Our Industry Our performance is subject to worldwide economic conditions and their impact on levels of consumer spending that affect not only the ultimate consumer, but also small businesses and other retailers. The United States and global economies have suffered from a prolonged recession for the past several years and as a result consumer spending has remained depressed, and may be subject to further deterioration for the foreseeable future. Specialty retail, and retail in general, 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 increased significantly in the past year due to demand 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. Accordingly, such increases in costs could adversely affect our business and our results of operations. 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. The occurrence of any of the events could adversely affect our business and our results of operations. 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 Leather has traditionally been known for, our brand name may be impaired which could adversely affect our operating results. 5 TABLE OF CONTENTS 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. 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. We anticipate that our future growth 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. Further, 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. Changes in consumers’ product preferences or lack of acceptance of our products whose costs have increased may prohibit us from passing those 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 Leathercraft segment by opening stores 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. Such 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 as a result, our growth may be limited, unless we are able to identify desirable sites for store locations, negotiate acceptable lease terms, hire, 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. If we are unable to successfully open new stores or our new stores are not profitable, our business and our results of operations could be adversely affected. 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. The occurrence of any of these events could adversely affect our business and our results of operations. 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 our 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 and may adversely affect our business and our results of operations. 6 TABLE OF CONTENTS ITEM 2. PROPERTIES 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 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, 2011: State Alabama Alaska Arizona Arkansas California Colorado Connecticut Florida Georgia Idaho Illinois Indiana Iowa Kansas Kentucky Louisiana Maryland Massachusetts Michigan Minnesota Missouri Montana Nebraska Nevada New Mexico New York North Carolina North Dakota Ohio Oklahoma Oregon Pennsylvania South Carolina South Dakota Tennessee Texas Utah Virginia Washington Wisconsin Wyoming Canadian locations: Alberta British Columbia Manitoba Nova Scotia Ontario Quebec Saskatchewan International locations: United Kingdom Australia Wholesale Leathercraft - - 2 - 3 1 - 1 - - 1 - 1 1 - 1 - - 1 - 1 1 - - 1 - - - 1 - 1 1 - - 1 5 1 - 1 - - 1 - 1 - 1 - - n/a n/a 7 Retail Leathercraft 1 1 3 1 7 3 1 3 1 1 1 2 - - 1 - 1 1 1 2 2 - 1 2 2 1 2 1 2 2 - 2 1 1 3 9 3 1 2 1 1 1 1 - 1 2 1 1 n/a n/a International n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a 1 1 TABLE OF CONTENTS ITEM 3. LEGAL PROCEEDINGS See discussion of Legal Proceedings in Note 9 to the consolidated financial statements included in Item 8 of this Report. ITEM 4. MINE SAFETY DISCLOSURES Not applicable. PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES 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: 2011 4th quarter 3rd quarter 2nd quarter 1st quarter High $5.00 $5.25 $5.22 $5.35 Low $4.17 $4.29 $4.45 $4.50 There were approximately 460 stockholders of record on March 26, 2012. 2010 4th quarter 3rd quarter 2nd quarter 1st quarter High $4.77 $4.70 $5.97 $4.20 Low $4.25 $3.72 $3.70 $3.50 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. Furthermore, on February 14, 2012, our Board of Directors authorized a $0.25 per share special one-time cash dividend that will be paid to our stockholders of record at the close of business on March 1, 2012. We expect that this dividend will be payable on April 2, 2012. We did not make any dividend payments prior to 2010. 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, 2011 that were not registered under the Securities Act. We did not repurchase any shares of our common stock during the fourth quarter of 2011. The following table sets forth information regarding our equity compensation plans (including individual compensation arrangements) that authorize the issuance of shares of our common stock. The information is aggregated in two categories: plans previously approved by our stockholders and plans not approved by our stockholders. The table includes information for officers, directors, employees and non-employees. All information is as of December 31, 2011. Plan Category Equity compensation plans approved by stockholders Equity compensation plans not approved by stockholders TOTAL Column (a) Column (b) Column (c) Number of Securities to be issued upon exercise of outstanding options, warrants and rights 115,600 Weighted-average exercise price of outstanding options, warrants and rights $4.40 Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in Column (a) 45,400 - 115,600 - $4.40 8 - 45,400 TABLE OF CONTENTS 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, 2006 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 TANDY LEATHER FACTORY S&P SMALLCAP 600 INDEX S&P SPECIALTY STORES Dec 06 100 100 100 Dec 07 40.52 99.70 73.40 Dec 08 26.64 68.72 46.54 Dec 09 48.45 86.29 70.50 Dec 10 68.53 108.99 73.56 Dec 11 70.85 110.10 56.93 Data Source: Research Data Group, Inc., San Francisco, CA 9 TABLE OF CONTENTS ITEM 6. SELECTED FINANCIAL DATA 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, Net sales Gross profit Operating income Net income from continuing operations Income from discontinued operations, net of tax Net income Net income per share from continuing operations Basic Diluted Net income per share including discontinued operations Basic Diluted Weighted average common shares outstanding for: Basic EPS Diluted EPS Cash dividend declared per common share Balance Sheet Data, as of December 31, Cash and certificates of deposit Total assets Capital lease obligation, including current portion Long-term debt, including current portion Total Stockholders’ Equity 2011 2010 2009 2008 2007 $66,102,947 40,337,159 7,706,650 4,753,969 (1,368) $4,752,601 $0.47 $0.47 $0.47 $0.47 10,156,442 10,182,098 - 2011 $11,189,484 45,502,915 - 3,307,500 $34,433,801 $59,892,870 36,250,857 6,635,611 4,158,491 1,766 $4,160,257 $0.41 $0.41 $0.41 $0.41 10,208,944 10,251,863 $0.75 2010 $5,915,339 40,595,574 - 3,510,000 $29,761,594 $54,482,739 32,609,374 5,095,101 3,261,143 56,914 $3,318,057 $0.31 $0.31 $0.32 $0.31 $52,491,538 31,050,359 4,025,342 2,511,847 92,336 $2,604,183 $0.23 $0.23 $0.24 $0.24 $54,219,728 31,180,332 4,321,031 2,895,522 192,609 $3,088,131 $0.26 $0.26 $0.28 $0.28 10,471,103 10,535,736 10,931,306 11,015,657 10,951,481 11,157,775 - 2009 $12,908,962 43,327,231 - 3,712,500 $33,359,655 - 2008 $10,821,298 40,975,913 593,949 3,915,000 $31,264,762 - 2007 $6,810,396 37,651,506 - 4,050,000 $29,815,504 ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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, 2011 and 2010 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 and internationally. We operate in three segments. First, Wholesale Leathercraft, consisting of our Leather Factory stores and our national account sales group, which sells to large national store chains, is our oldest segment with sales of $26.5 million in 2011. Historically, in normal economic conditions, this division has generally offered steady but very modest increases in sales. Sales in 2011 increased 2.4% compared to 2010. Compared to 2010, the wholesale stores’ sales increased 2.3% and national account sales were up 3.9%. Sales at our stores are showing signs of recovery despite cautious 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 Retail Leathercraft segment. This segment has experienced the greatest increases in sales ($37.4 million in 2011, up from $32.3 million in 2010) and is our largest source of revenues. We expect to grow the number of stores to 100+ from 77 stores in operation at the end of 2011. Our pace of store openings has slowed in the last several years due to the general economic conditions in the U.S. and because of the lack of personnel qualified for store manager positions. We expect to continue to open stores domestically but have not committed to a specific time frame at this point. While the store opening schedule has slowed, we are generally attempting to relocate existing stores as the leases come up for renewal into larger spaces so that a larger amount of product is available to customers. We believe that the increase in sales in this segment suggests that the store relocation strategy is successful. Our International Leathercraft segment consists of company-owned stores located outside of North America. At December 31, 2011, two combination retail/wholesale stores, with one located in the United Kingdom and the other located in Australia, comprised this segment. In January 2012, we opened a store in Spain, bringing the number of stores in this segment to three. It is our intention to open more stores in 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 2010 and in 2011. Operating expenses increased at a slightly slower pace than that of sales, increasing 10% between 2010 and 2011 and 8% between 2009 and 2010. We reported consolidated net income for 2011 of $4.7 million. Consolidated net income for 2010 and 2009 was $4.2 million and $3.3 million, respectively. We use our cash flow to fund our operations, to fund the opening of new 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 2011, our stockholders’ equity had increased to $34.4 million from $29.8 million the previous year. Comparing the December 31, 2011 balance sheet with the prior year’s balance sheet, we decreased our investment in inventory from $20.2 million to $19.9 million, while total cash (including certificates of deposit) increased from $5.9 million to $11.2 million. 10 TABLE OF CONTENTS Net Sales Net sales for the three years ended December 31, 2011 were as follows: Year 2011 2010 2009 Wholesale Leathercraft Retail Leathercraft International Leathercraft Total Company $26,540,899 $25,908,177 $25,095,392 $37,435,832 $32,291,442 $28,079,863 $2,126,216 $1,693,251 $1,307,484 $66,102,947 $59,892,870 $54,482,739 Incr from Prior Year 10.4% 9.9% 3.8% Our net sales increased by 10.4% in 2011 when compared with 2010 and increased by 9.9% in 2010 when compared with 2009. In 2011 and 2010, all three segments reported sales increases compared to the prior year. 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 2011, our cost of sales decreased as a percentage of total net sales when compared to 2010, resulting in an increase in consolidated gross profit margin from 60.5% to 61.0%. Our 2010 cost of sales as a percentage of our total net 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%. Fluctuations 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, 2011 were as follows: Year 2011 2010 2009 Wholesale Leathercraft 61.3% 60.7% 58.5% Retail Leathercraft 60.5% 60.2% 60.9% International Leathercraft 66.9% 63.8% 63.6% Total Company 61.0% 60.5% 59.9% Our operating expenses decreased minimally as a percentage of total net sales to 49.4% in 2011 when compared with 49.5% in 2010. This decrease indicates that our operating expenses grew slightly slower than our sales during this period. 2011 operating expenses were $3.0 million higher than those of 2010. Significant expense fluctuations in 2011 compared to 2010 are as follows: Expense Employee compensation & benefits Travel expense Credit card fees Rent & utilities Professional fees and licenses Freight out – shipping product to customers 2011 amount $18.0 million 330,000 910,000 4.0 million 1.4 million 1.7 million Incr (Decr) over 2010 $2.1 million (50,000) 100,000 190,000 600,000 120,000 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 included in benefits is our employee health benefit plan which has seen consistent cost increases compared to prior years. 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 Employee compensation & benefits Travel expense Credit card fees Rent & utilities Professional fees and licenses Freight out – shipping product to customers Loss on disposal of equipment Other Income/Expense (net) 2010 amount $15.9 million 380,000 820,000 3.7 million 800,000 1.6 million 50,000 Incr (Decr) over 2009 $1.4 million 180,000 130,000 300,000 100,000 270,000 (300,000) Other Income/Expense consists primarily of currency exchange fluctuations, interest income and interest expense. In 2011, we had other expense (net) of $165,000 compared to other expense (net) of $160,000 in 2010. We received $16,000 in gas royalties. We earned $34,000 in interest income on our cash and paid $248,000 in interest expense on our bank debt. We had a currency exchange loss of $200 in 2011 compared to $187,000 in 2010. 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. Net Income During 2011, we earned net income of $4.7 million, a 14% increase over our net income of $4.2 million earned during 2010. The increase in net income was the result of the increase in sales and gross profit, partially offset by the increase in operating expenses and income tax expense. 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. 11 TABLE OF CONTENTS 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, 2011 were as follows: Year 2011 2010 2009 Net Sales Incr (Decr) from Prior Yr 2.4% 3.2% (5.3)% Operating Income $2,803,034 $2,690,061 $2,017,915 Operating Income Incr (Decr) from Prior Year 4.2% 33.3% 13.2% Operating Income as a Percentage of Sales 10.6% 10.4% 8.0% Wholesale Leathercraft, consisting of our 29 wholesale stores and our national account group, accounted for 40.2% of our consolidated net sales in 2011, which compares to 43.3% in 2010 and 45.6% in 2009. 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 2.2% in 2011 compared to sales in 2010 while the sales increase in our national account group was 3.9% from 2010 to 2011. By customer group, we increased sales in the wholesale stores significantly to our retail customers while sales to our wholesale and national account customers remained consistent with 2010. The most significant decreases were in our institution and manufacturer groups which have been significantly affected by the weakness in the U.S. economy. Our sales mix by customer group in the Wholesale Leathercraft division was as follows: Customer Group Retail Institution Wholesale National Accounts Manufacturers 2011 33% 5% 43% 12% 7% 100% 2010 31% 6% 43% 12% 8% 100% 2009 29% 7% 42% 15% 7% 100% In 2011, operating income as a percentage of divisional sales remained consistent with the prior year at 10.5%. Significant operating expense increases occurred in employee compensation ($325,000), employee benefits ($490,000), and supplies ($73,000), offset somewhat by decreases in advertising and marketing expenses ($353,000) and bad debt expenses ($130,000). 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). 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 2011 2010 2009 Net Sales Increase from Prior Yr 15.9% 15.0% 11.3% Operating Income $4,656,067 $3,614,856 $2,900,701 Operating Income Incr (Decr) from Prior Year 28.8% 24.6% 32.6% Operating Income as a Percentage of Sales 12.4% 11.2% 10.3% Reflecting the growth previously discussed, Retail Leathercraft accounted for 56.6% of our total net sales in 2011, up from 53.9% in 2010 and 51.1% in 2009. Growth in net sales for our Retail Leathercraft division in 2011 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 Retail Institution Wholesale National Accounts Manufacturers 2011 62% 5% 30% 0% 3% 100% 2010 64% 6% 29% 0% 1% 100% 2009 65% 7% 27% 0% 1% 100% Operating income as a percentage of sales increased to 12.4% for 2011 compared to 11.2% for 2010. Gross margin increased slightly to 60.5% in 2011 from 60.2% in 2010. Operating expenses as a percent of sales in 2011 decreased from 49.0% for 2010 to 48.0% for 2011 as operating expenses grew at a slower pace than that of sales. 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. 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 2012 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 2012 if we determine that feasibility of additional successful openings is likely. International Leathercraft International Leathercraft consists of all stores located outside of North America. As of December 31, 2011, that represents two retail/wholesale combination stores with one located in the United Kingdom and the other in Australia. A third store was opened in January 2012, located in Spain. International Leathercraft accounted for 3.2%, 2.8% and 2.4% of our total sales in 2011, 2010 and 2009, respectively. Operating income was $248,000, $331,000 and $176,000 in 2011, 2010 and 2009, 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 one to two new stores in 2012. We opened a store in Spain in January 2012 and anticipate another store opening 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. 12 TABLE OF CONTENTS Financial Condition At December 31, 2011, we held $11.2 million of cash and certificates of deposit, $19.9 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 $987,000 and $187,000, respectively. Net total assets were $45.5 million. Current liabilities were $7.1 million (including $203,000 of current maturities of long-term debt), while long-term debt was $3.1 million. Total stockholders’ equity at the end of 2011 was $34.4 million. 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. Specific ratios on a consolidated basis at the end of each year ended December 31 were as follows: Solvency Ratios: Quick Ratio Current Ratio Current Liabilities to Net Worth Current Liabilities to Inventory Total Liabilities to Net Worth Fixed Assets to Net Worth Efficiency Ratios: Collection Period (Days Outstanding) Inventory Turnover Assets to Sales Sales to Net Working Capital Accounts Payable to Sales Profitability Ratios: Return on Sales (Profit Margin) Return on Assets Return on Net Worth (Return on Equity) Capital Resources and Liquidity (Cash+Accts Rec)/Total Current Liabilities Total Current Assets/Total Current Liabilities Total Current Liabilities/Net Worth Total Current Liabilities/Inventory Total Liabilities/Net Worth Fixed Assets/Net Worth Accounts Receivable/Credit Sales x 365 Sales/Average Inventory Total Assets/Sales Sales/Current Assets - Current Liabilities Accounts Payable/Sales Net Profit After Taxes/Sales Net Profit After Taxes/Total Assets Net Profit After Taxes/Net Worth 2011 2010 2009 1.76 4.74 0.21 0.36 0.32 0.30 42.35 3.29 0.69 2.49 0.03 0.07 0.10 0.14 1.04 4.17 0.23 0.34 0.36 0.35 39.83 3.23 0.68 2.74 0.02 0.07 0.10 0.14 2.44 5.55 0.17 0.34 0.30 0.29 37.22 3.35 0.79 2.09 0.02 0.06 0.08 0.10 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 2011, 2010 and 2009 required net cash of $0.2 million, $8.2 million, and $2.4 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 2011 and 2009. Our primary source of liquidity and capital resources during 2011 was cash flow provided by operating activities. Net cash flow from operations for 2011, 2010 and 2009 was $6.6 million, $2.7 million, and $5.3 million, respectively. The decrease in operating cash flow in 2010 was due to the increase in inventory in the last half of 2010. In 2011, cash flow from operations was generated from income, the decrease in inventory and increase in accounts payable, partially offset by the increase in accounts receivable and the decrease in accrued expenses. In 2010 and 2009, cash flow from operations was generated from income, partially offset by the increase in inventory. Consolidated accounts receivable increased $75,000 to $1.3 million at December 31, 2011 compared to $1.2 million at December 31, 2010. Average days to collect accounts increased from 40 days in 2010 to 42 days in 2011 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 decreased from $20.2 million at the end of 2010 to $19.9 million at December 31, 2011. We are pleased with the slight reduction in our inventory investment at December 31, 2011. However, as we continue our store expansion and relocation, we expect our inventory to increase. Further, continued sales increases are partially dependent on product availability in our stores. We will continue to look for large purchasing opportunities of product at aggressive pricing in order to support our gross margin goals. 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 10% below our internal targets for optimal inventory. Consolidated inventory turned 3.29 times during 2011, a slight improvement from the 2010 turns at 3.23 times. We compute our inventory turnover rates as sales divided by average inventory. By operating division, inventory turns are as follows: Segment Wholesale Leathercraft Retail Leathercraft International Leathercraft Wholesale Leathercraft stores only 2011 1.95 6.41 6.91 6.68 2010 1.96 6.45 5.65 7.40 2009 2.18 6.13 3.95 6.82 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 totaled $1.6 million at the end of 2011, up from $1.2 million at the end of 2010. 13 TABLE OF CONTENTS As discussed above, the largest use of operating cash in 2011 was the decrease in accrued expenses, specifically the decrease in the amount of inventory in transit. Cash paid for capital expenditures totaled $1.1 million and $1.5 million for the years ended December 31, 2011 and 2010, respectively. In 2011, the primary capital expenditure was store fixtures, either for new stores or for relocated or remodeled stores. Fixtures and equipment for the new international stores totaled $225,000. We moved or remodeled 14 stores in the US in 2011. Fixtures for those stores totaled $310,000. Fixtures for the new U.S. store opened in 2011 totaled $15,000. Other capital expenditures were building improvements, including a video surveillance system ($112,000), computer equipment ($240,000), website development ($70,000) and factory machines and dies ($35,000). 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 to two stores in the U.S. and one to two stores abroad in 2012, having already opened one store in Spain in January 2012, and therefore we expect to incur some capital expenditures related to these store openings, In addition, we intend to continue to relocate US stores into larger space as leases permit and therefore, expect to incur capital expenditures, namely fixtures, related to these moves. Therefore, we expect our 2012 capital expenditures to be comparable to that of our 2011 expenditures. Cash applied toward stock repurchases totaled $441,419 and $1,624,264 in 2010 and 2009, respectively. There were no stock repurchases in 2011. We believe that cash flow from operations will be adequate to fund our operations in 2012, 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 2011, 2010 and 2009, 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, 2011 (not including related interest expense): Contractual Obligations Long-Term Debt(1) Operating Leases(2) Total Contractual Obligations ____________________ (1) Our loan from JPMorgan Chase matures in May 2018. (2) These are our leased facilities. Summary of Critical Accounting Policies Total $3,307,500 7,448,982 $10,756,482 Less than 1 Year Payments Due by Periods 1 - 3 Years 3 -5 Years More than 5 Years $202,500 2,738,498 $2,940,998 $405,000 3,319,822 $3,724,822 $405,000 1,379,600 $1,784,600 $2,295,000 11,062 $2,306,062 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, 2011, 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. 14 TABLE OF CONTENTS ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK We face exposure to financial market risks, including adverse movement in foreign currency 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 foreign subsidiaries as those subsidiaries have local currency revenue and local currency operating expenses. Changes in the foreign 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. 15 TABLE OF CONTENTS ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Tandy Leather Factory, Inc. Consolidated Balance Sheets December 31, 2011 and 2010 CURRENT ASSETS: ASSETS Cash Short-term investments, including certificates of deposit Accounts receivable-trade, net of allowance for doubtful accounts of $81,000 and $147,000 in 2011 and 2010, respectively Inventory Deferred income taxes Other current assets Total current assets PROPERTY AND EQUIPMENT, at cost Less accumulated depreciation and amortization GOODWILL OTHER INTANGIBLES, net of accumulated amortization of $539,000 and $495,000 in 2011 and 2010, respectively OTHER assets LIABILITIES AND STOCKHOLDERS' EQUITY CURRENT LIABILITIES: Accounts payable-trade Accrued expenses and other liabilities Income taxes payable Current maturities of long-term debt Total current liabilities DEFERRED INCOME TAXES LONG-TERM DEBT, net of current maturities 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 shares issued at 2011 and 2010, 10,156,442 shares outstanding at 2011 and 2010, respectively Paid-in capital Retained earnings Treasury stock at cost (993,623 shares at 2011 and 2010) Accumulated other comprehensive income Total stockholders' equity The accompanying notes are an integral part of these financial statements. 16 December 31, 2011 December 31, 2010 $10,765,591 423,893 1,328,579 19,940,251 281,251 948,459 33,688,024 14,999,826 (4,700,476) 10,299,350 987,009 187,292 341,240 $45,502,915 $1,622,697 4,641,191 638,897 202,500 7,105,285 858,829 3,105,000 $4,293,746 1,621,593 1,253,639 20,236,028 307,509 1,056,201 28,768,716 14,390,662 (4,106,121) 10,284,541 990,368 232,416 319,533 $40,595,574 $1,247,821 4,893,236 554,380 202,500 6,897,937 628,543 3,307,500 - - 26,760 5,736,543 31,181,936 (2,894,068) 382,630 34,433,801 $45,502,915 26,760 5,703,387 26,429,335 (2,894,068) 496,180 29,761,594 $40,595,574 TABLE OF CONTENTS Tandy Leather Factory, Inc. Consolidated Statements of Income For the Years Ended December 31, 2011, 2010 and 2009 NET SALES COST OF SALES Gross Profit OPERATING EXPENSES INCOME FROM OPERATIONS OTHER (INCOME) EXPENSE: Interest expense Other, net Total other expense INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES PROVISION FOR INCOME TAXES NET INCOME FROM CONTINUING OPERATIONS INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX 2011 2010 2009 $66,102,947 25,765,788 40,337,159 32,630,509 7,706,650 248,576 (83,428) 165,148 7,541,502 2,787,533 4,753,969 (1,368) $59,892,870 23,642,013 36,250,857 29,615,246 6,635,611 265,405 (105,540) 159,865 6,475,746 2,317,255 4,158,491 1,766 $54,482,739 21,873,365 32,609,374 27,514,273 5,095,101 297,864 (164,165) 133,699 4,961,402 1,700,259 3,261,143 56,914 NET INCOME $4,752,601 $4,160,257 $3,318,057 NET INCOME FROM CONTINUING OPERATIONS PER COMMON SHARE: BASIC DILUTED INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX PER COMMON SHARE: BASIC DILUTED NET INCOME PER COMMON SHARE: BASIC DILUTED Weighted Average Number of Shares Outstanding: Basic Diluted $0.47 $0.47 $0.00 $0.00 $0.47 $0.47 $0.41 $0.41 $0.00 $0.00 $0.41 $0.41 $0.31 $0.31 $0.01 $0.01 $0.32 $0.31 10,156,442 10,182,098 10,208,944 10,251,863 10,471,103 10,535,736 The accompanying notes are an integral part of these financial statements. 17 TABLE OF CONTENTS Tandy Leather Factory, Inc. Consolidated Statements of Cash Flows For the Years Ended December 31, 2011, 2010 and 2009 CASH FLOWS FROM OPERATING ACTIVITIES: Net income Income (loss) from discontinued operations Adjustments to reconcile net income to net cash provided by operating activities - Depreciation and amortization Loss on disposal or abandonment of assets Impairment of equipment Non-cash stock-based compensation Deferred income taxes Other Net changes in assets and liabilities, net of effect of business acquisitions: Accounts receivable-trade, net Inventory Income taxes Other current assets Accounts payable-trade Accrued expenses and other liabilities Total adjustments Net cash provided by continuing operating activities Cash provided from (used by) discontinued operating activities Net cash provided by operating activities CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of property and equipment Purchases of certificates of deposit Proceeds from maturities of certificates of deposit Proceeds from sale of assets Decrease (increase) in other assets Net cash provided by (used in) continuing investing activities Net cash provided by (used in) investing activities CASH FLOWS FROM FINANCING ACTIVITIES: Payments on notes payable and long-term debt Payments on capital lease obligations Payment of dividend Repurchase of common stock (treasury stock) Proceeds from issuance of common stock and warrants Net cash used in continuing financing activities Net cash used in financing activities NET INCREASE (DECREASE) IN CASH CASH, beginning of period CASH, end of period SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION: Interest paid during the period Income tax paid during the period, net of (refunds) The accompanying notes are an integral part of these financial statements. 2011 2010 2009 $4,752,601 (1,368) 4,753,969 1,016,561 84,168 - 33,156 256,544 (106,345) (74,940) 295,777 84,216 107,742 374,876 (252,045) 1,819,710 6,573,679 (1,067) 6,572,612 (1,100,523) (87,893) 1,285,593 26,263 (21,707) 101,733 101,733 (202,500) - - - - (202,500) (202,500) 6,471,845 4,293,746 $10,765,591 $4,160,257 1,766 4,158,491 972,409 49,154 - 41,692 (90,520) 150,203 (56,736) (3,370,202) 186,940 (264,317) 62,788 905,092 (1,413,497) 2,744,994 (23,751) 2,721,243 (1,553,339) (2,572,593) 5,968,000 7,570 (4,612) 1,845,026 1,845,026 (202,500) - (7,690,832) (441,419) 170,266 (8,164,485) (8,164,485) (3,598,216) 7,891,962 $4,293,746 $3,318,057 56,914 3,261,143 1,125,009 21,540 343,543 2,540 40,776 339,305 (99,994) (900,466) 147,310 (14,334) 36,455 810,564 1,852,248 5,113,391 161,070 5,274,461 (791,565) (8,671,000) 6,665,000 2,510 (1,847) (2,796,902) (2,796,902) (202,500) (593,949) - (1,624,264) 24,818 (2,395,895) (2,395,895) 81,664 7,810,298 $7,891,962 $248,576 2,437,701 $265,405 2,208,819 $297,864 1,622,273 18 TABLE OF CONTENTS Tandy Leather Factory, Inc. Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 2011, 2010 and 2009 BALANCE, December 31, 2008 Shares issued - stock options exercised Stock-based compensation Purchase of treasury stock Net income Translation adjustment BALANCE, December 31, 2009 Number of Shares 10,664,555 27,000 - (560,927) - - 10,130,628 Par Value $26,388 65 - - - - $26,453 Paid-in Capital $5,464,443 24,753 2,540 - - - $5,491,736 Comprehensive income for the year ended December 31, 2009 Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Comprehensive Income (Loss) $(828,385) $26,641,853 $(39,537) $31,264,762 - - (1,624,264) - - $(2,452,649) - - - 3,318,057 - $29,959,910 - - - - 373,742 $334,205 24,818 2,540 (1,624,264) 3,318,057 373,742 $33,359,655 Shares issued - stock options exercised Stock-based compensation Purchase of treasury stock Net income Cash dividend paid Translation adjustment BALANCE, December 31, 2010 128,114 - (102,300) - - - 10,156,442 307 - - - - - $26,760 169,959 41,692 - - - - $5,703,387 - - (441,419) - - - $(2,894,068) - - - 4,160,257 (7,690,832) - $26,429,335 - - - - - 161,975 $496,180 170,266 41,692 (441,419) 4,160,257 (7,690,832) 161,975 $29,761,594 Comprehensive income for the year ended December 31, 2010 Stock-based compensation Net income Translation adjustment BALANCE, December 31, 2011 - - - 10,156,442 - - - $26,760 33,156 - - $5,736,543 - - - $(2,894,068) - 4,752,601 - $31,181,936 - - (113,550) $382,630 33,156 4,752,601 (113,550) $34,433,801 Comprehensive income for the year ended December 31, 2011 The accompanying notes are an integral part of these financial statements. 19 $3,318,057 373,742 $3,691,799 $4,160,257 161,975 $4,322,232 $4,752,601 (113,550) $4,639,051 TABLE OF CONTENTS 1. DESCRIPTION OF BUSINESS TANDY LEATHER FACTORY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2011, 2010, and 2009 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, the United Kingdom, Australia and Spain. 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 receivable, 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), Tandy Leather Factory UK Limited (a UK corporation), Tandy Leather Factory Australia Pty. Limited (an Australian corporation), and Tandy Leather Factory España, S.L. (a Spanish corporation). All intercompany accounts and transactions have been eliminated in consolidation. • Foreign currency translation Foreign currency translation adjustments arise from activities of our foreign subsidiaries. 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 transactions reported in the statements of income under the caption “Other (Income) Expense”, net, for all periods presented. We recognized foreign currency transaction losses of $200, $187,000 and $98,000 in 2011, 2010, and 2009, 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 and comparable foreign 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 equipment and machinery, 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. 20 TABLE OF CONTENTS • 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 Net income Weighted average common shares outstanding Earnings per share – basic DILUTED Net income Weighted average common shares outstanding Effect of assumed exercise of stock options and warrants Weighted average common shares outstanding, assuming dilution Earnings per share - diluted Outstanding options and warrants excluded as anti-dilutive 2011 2010 2009 $4,752,601 10,156,442 $0.47 $4,752,601 10,156,442 25,656 10,182,098 $0.47 25,000 $4,160,257 10,208,944 $0.41 $4,160,257 10,208,944 42,919 10,251,863 $0.41 13,000 $3,318,057 10,471,103 $0.32 $3,318,057 10,471,103 64,633 10,535,736 $0.31 61,000 For additional disclosures regarding the employee stock options and the warrants, see Note 11. The net effect of converting stock options and warrants to purchase 90,600, 103,600, and 197,700 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, 2011, 2010 and 2009, 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 evaluated 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. Goodwill is not amortized, but is evaluated at least annually for impairment. We completed our annual goodwill impairment analysis as of December 31 in each of the three years ended December 31, 2011, and determined that no adjustment to the carrying value of goodwill was required. A summary of changes in our goodwill for the years ended December 31, 2011 and 2010 is as follows: Leather Factory Tandy Leather Total Balance, December 31, 2009 Acquisitions and adjustments Foreign exchange gain/loss Impairments Balance, December 31, 2010 Acquisitions and adjustments Foreign exchange gain/loss Impairments Balance, December 31, 2011 $600,417 - 6,545 - $606,962 - (3,359) - 603,603 $383,406 - - - $383,406 - - - $383,406 As of December 31, 2011 and 2010, our intangible assets and related accumulated amortization consisted of the following: Trademarks, Copyrights Non-Compete Agreements Trademarks, Copyrights Non-Compete Agreements Gross Gross $544,369 182,365 $726,734 $544,369 183,134 $727,503 As of December 31, 2011 Accumulated Amortization $425,418 114,024 $539,442 As of December 31, 2010 Accumulated Amortization $391,531 103,556 $495,087 $983,823 - 6,545 - $990,368 - (3,359) - 987,009 $118,951 68,341 $187,292 $152,838 79,578 $232,416 Net Net Excluding goodwill, we have no intangible assets not subject to amortization under U.S. GAAP. Amortization of intangible assets of $44,933 in 2011, $76,421 in 2010, and $51,291 in 2009 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 is as follows: 2012 2013 2014 2015 2016 • Fair value of financial Instruments Leather Factory $1,477 - - - - Tandy Leather $37,634 33,337 33,337 28,636 2,000 Total $39,111 33,337 33,337 28,636 2,000 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 fair 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 certificates of deposit, 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. 21 TABLE OF CONTENTS • Income taxes We accounts for income taxes using the asset and liability method. Under this method, the amount of taxes currently payable or refundable are accrued, and deferred tax assets and liabilities are recognized for the estimated future tax consequences of temporary differences that currently exist between the tax basis and the financial reporting basis of our assets and liabilities. Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that include the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. A tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax position must meet a more-likely-than-not recognition threshold to be recognized. We recognize tax liabilities for uncertain tax positions and adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially differerent from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense and the effective tax rate in the period in which new information becomes available. We may be subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to the various jurisdictions. • 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, 12,000 and 42,600 options were awarded to directors in 2011 and 2010, respectively. 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 $33,000, $42,000, and $3,000 for the years ended December 31, 2011, 2010 and 2009, respectively, as a component of operating expenses. During the years ended December 31, 2011 and 2010, 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, 2010 Granted Cancelled Exercised Outstanding, December 31, 2010 Exercisable, December 31, 2010 Outstanding, January 1, 2011 Granted Cancelled Exercised Outstanding, December 31, 2011 Exercisable, December 31, 2011 $2.33 4.59 - 1.65 $4.35 $4.33 $4.35 4.80 - - $4.40 $4.40 197,700 42,600 - (136,700) 103,600 70,000 103,600 12,000 - - 115,600 115,600 5.68 3.73 5.15 5.15 $192,075 $149,873 $206,332 $206,332 Other information pertaining to option activity during the twelve month periods ended December 31, 2011, 2010 and 2009 are as follows: Weighted average grant-date fair value of stock options granted Total fair value of stock options vested Total intrinsic value of stock options exercised As of December 31, 2011, there was no unrecognized compensation cost related to non-vested stock options. 2011 $1.19 $14,257 N/A 2010 $1.42 $18,388 $114,603 2009 N/A $2,540 $15,913 Cash received from the exercise of stock options and warrants for the years ended December 31, 2010 and 2009 was $170,266, and $24,818, respectively. No stock options were exercised in 2011. 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. 22 TABLE OF CONTENTS • Comprehensive income Comprehensive income includes net income and certain other items that are recorded directly to Stockholders’ Equity. The Company’s only source of other comprehensive income is foreign currency translation adjustments. • 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 $1,725,000, $1,603,000, and $1,342,000 for the years ended December 31, 2011, 2010 and 2009, 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 $145,000 and $130,000 at December 31, 2011 and 2010, respectively. Total advertising expense was $2,972,000 in 2011; $3,002,000 in 2010; and $2,953,000 in 2009. • 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. 3. SHORT-TERM INVESTMENTS All current fixed maturity securities are classified as “available for sale” and are reported at carrying value, which approximates fair value based on the discounted value of contractual cash flows. 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. Investments at December 31, 2011 and 2010 consisted of certificates of deposit. The contractual maturities of $424,000 in certificates of deposit held as of December 31, 2011 are all due within one year. 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 $81,000 and $147,000, respectively, at December 31, 2011 and 2010. The following is a roll forward of the allowance for doubtful accounts: Year ended: December 31, 2011 December 31, 2010 December 31, 2009 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 $146,929 $136,023 $43,014 - - - (45,315) 25,348 112,272 156 595 632 (20,844) (15,037) (19,895) $80,926 $146,929 $136,023 · 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 maintain a freshness in the product line. 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. 23 TABLE OF CONTENTS 5. BALANCE SHEET COMPONENTS INVENTORY On hand: Finished goods held for sale Raw materials and work in process Inventory in transit PROPERTY AND EQUIPMENT Building Land Leasehold improvements Equipment and machinery Furniture and fixtures Vehicles Less: accumulated depreciation OTHER CURRENT ASSETS Accounts receivable – employees Accounts receivable – other Prepaid expenses Payments for merchandise not received OTHER ASSETS Security deposits - utilities, locations, etc. Leather art collection ACCRUED EXPENSES AND OTHER LIABILITIES Accrued bonuses Accrued payroll Deferred revenue Sales and payroll taxes payable Inventory in transit Other December 31, 2011 December 31, 2010 TOTAL TOTAL TOTAL TOTAL TOTAL $17,742,298 479,686 1,718,267 $19,940,251 $6,412,861 1,451,132 636,526 3,851,697 2,576,593 71,017 14,999,826 (4,700,476) $10,299,350 $53,282 5,689 744,679 144,809 $948,459 $89,240 252,000 $341,240 $1,955,012 527,540 747,335 293,155 799,647 318,502 $4,641,191 $17,847,002 518,422 1,870,604 $20,236,028 $6,330,593 1,451,132 609,715 3,762,040 2,191,203 45,979 14,390,662 (4,106,121) $10,284,541 $30,631 10,532 982,916 32,122 $1,056,201 $67,533 252,000 $319,533 $1,558,404 430,935 597,546 375,041 1,599,344 331,966 $4,893,236 Depreciation expense was $971,628, $895,988, and $1,073,718 for the years ended December 31, 2011, 2010 and 2009, 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 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 and $37,305 which is reported in our Wholesale Leathercraft segment. The 2011 loss from abandonment and/or disposal of obsolete equipment totaled $84,168. The loss is included in Operating expenses, $13,884 of which is reported in our Retail Leathercraft and $70,284 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 191,000 square foot building situated on 30 acres of land located in Fort Worth, Texas. Under the terms of the Line of Credit Note, we could borrow from time to time until April 30, 2008, up to the lesser of $5,500,000 or 90% of the cost of the property and make monthly interest payments. On April 30, 2008, the principal balance was rolled into a 10-year term note with an interest rate of 7.10% per annum. Proceeds in the amount of $4,050,000 were used to fund the purchase of the property from Standard Motor Products, Inc. under an Agreement of Purchase and Sale, dated June 25, 2007, which closed on July 31, 2007. No further borrowings were drawn. At December 31, 2011 and 2010, the amount outstanding under the above agreement consisted of the following: 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 Less - Current maturities 2011 2010 $3,307,500 3,307,500 (202,500) $3,105,000 $3,510,000 3,510,000 (202,500) $3,307,500 24 TABLE OF CONTENTS 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, 2011. Scheduled maturities of the Company’s notes payable and long-term debt are as follows: 2012 2013 2014 2015 2016 2017 and thereafter 7. EMPLOYEE BENEFIT AND SAVINGS PLANS $202,500 202,500 202,500 202,500 202,500 2,295,000 $3,307,500 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 2011 and 2010 we matched 100% of pretax employee contributions on the first 3% of eligible earnings that are contributed by employees. In 2009 up to 50% of pretax employee contributions were matched on the first 4% of eligible earnings that were contributed by employees. Year Ended December 31, 2011 2010 2009 * Due to the annual limit on eligible earnings imposed by the Internal Revenue Code Maximum Matching Contribution per Participant* $7,350 $7,350 $4,900 Total Matching Contribution $217,539 $199,716 $124,488 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 2011, 2010 or 2009. We currently offer no postretirement or postemployment benefits to our employees. 8. INCOME TAXES The provision for income taxes consists of the following: Current provision: Deferred provision (benefit): Income before income taxes is earned in the following tax jurisdictions: United States United Kingdom Canada Australia Spain 2011 2010 2009 Federal State Federal State $2,155,653 375,336 2,530,989 229,540 27,004 256,544 $2,787,533 $2,121,604 286,171 2,407,775 (80,991) (9,529) (90,520) $2,317,255 2011 2010 2009 $6,344,634 476,414 945,041 (131,467) (93,120) $7,541,502 $5,670,352 319,290 486,981 - - $6,476,623 The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities are as follows: 2011 2010 Deferred income tax assets: Allowance for doubtful accounts Capitalized inventory costs Warrants and stock-based compensation Accrued expenses, reserves, and other Total deferred income tax assets Deferred income tax liabilities: Property and equipment depreciation Goodwill and other intangible assets amortization Total deferred income tax liabilities Net deferred tax asset (liability) $30,729 147,135 54,042 103,387 335,293 758,024 154,847 912,871 $(577,578) $(321,034) 25 $1,461,655 197,828 1,659,483 37,632 3,144 40,776 $1,700,259 $4,437,072 324,924 284,350 - - $5,046,346 $55,414 154,712 45,116 97,383 352,625 534,639 139,020 673,659 TABLE OF CONTENTS The net deferred tax liability is classified on the balance sheets as follows: Current deferred tax assets Long-term deferred tax liabilities Net deferred tax asset (liability) The effective tax rate differs from the statutory rate as follows: Statutory rate – Federal US income tax State and local taxes Non-U.S. income tax at different rates Domestic production activities deduction Other, net Effective rate 2011 2010 $281,251 (858,829) $(577,578) $307,509 (628,543) $(321,034) 2011 2010 2009 34% 4% 2% (1%) (2%) 37% 34% 4% - (1%) (1%) 36% 34% 4% - (2%) (2%) 34% 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 2009. Depending on the jurisdiction, we are no longer subject to state examinations by tax authorities for years prior to the December 2008 and December 2009 tax years. 9. COMMITMENTS AND CONTINGENCIES Operating Leases We lease our store locations under five-year lease agreements that expire on dates ranging from February 2012 to February 2017. Rent expense on all operating leases for the years ended December 31, 2011, 2010, and 2009, was $2,750,373, $2,721,281, and $2,513,297, respectively. Future minimum lease payments under noncancelable operating leases at December 31, 2011 were as follows: Year ending December 31: 2012 2013 2014 2015 2016 2017 and thereafter Total minimum lease payments Legal Proceedings $2,738,498 1,890,193 1,429,629 976,776 402,824 11,062 $7,448,982 On March 16, 2011, two former employees of ours filed a lawsuit, entitled Mark Barnes and Jerry Mercante on behalf of themselves and all other similarly situated v. Tandy Leather Company, Inc., Tandy Leather Factory, and Does 1-50, in the US District Court for the District of Nevada. The lawsuit was subsequently amended on May 9, 2011 to add another former employee, Donna Cavota, as a third named plaintiff. The suit alleges that we violated requirements of the Fair Labor Standards Act (FLSA) as well as various state wage laws. Plaintiffs seek to represent themselves and all similarly situated U.S. current and former store managers of ours. Plaintiffs seek reimbursement for an unspecified amount of unpaid overtime compensation, liquidated damages, attorney’s fees and costs. On May 17, 2011, the district court in Nevada granted our request to transfer venue to the Northern District of Texas. Trial is currently set for the week of May 29, 2012. A Proposed Settlement Agreement was signed by the parties in January 2012 and submitted to the US District Court for the Northern District of Texas (Fort Worth Division) on January 24, 2012. The Proposed Settlement Agreement is contingent on the Court’s approval of the terms of the proposed Agreement as well as the Court’s consent to certify the proposed class and collective action class described by the parties. The Court has not yet ruled on the Proposed Settlement Agreement or the proposed class descriptions, and could either approve, reject, or suggest modifications to the Proposed Settlement Agreement. In the event the Proposed Settlement Agreement is not approved in its entirety by the Court, either party has the right to withdraw from the proposed Agreement, in which event the litigation between the parties would proceed. In the event the Proposed Settlement Agreement and proposed class descriptions are approved by the Court, any payments pursuant to the Proposed Settlement Agreement are conditioned on the members of the proposed class submitting a Claims form approved by the Court. The total amount of payments under the Proposed Settlement Agreement to the members of the proposed class who have submitted Claims forms is conditioned further on the number of claims submitted. At this time, it is not possible to predict we will incur any liability, or to estimate the ranges of damages, if any, which may be incurred in connection with the matter. We intend to vigorously defend the lawsuit. We are periodically involved in other 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. Legal costs associated with the resolution of claims, lawsuits and other contingencies are expensed as incurred. 10. 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 2011, 2010 and 2009, sales to our five largest customers represented 5.5%, 5.5% and 6.3%, 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, 2011, 2010, and 2009, 34%, 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. 26 TABLE OF CONTENTS 11. 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 Company 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 options plans from 1995 which provided to 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 date of grant and are exercisable at any time after vesting. Of the 100,000 shares available for issuance, there are 45,400 un-optioned shares available for future grants. A summary of stock option transactions for the years ended December 31, 2011, 2010, and 2009, is as follows: Outstanding at January 1 Granted Forfeited or expired Exchanged Exercised Outstanding at December 31 Exercisable at end of year Weighted-average fair value of options granted during year 2011 2010 2009 Weighted Average Exercise Price $4.35 4.80 - - - $4.40 $4.40 Option Shares 103,600 12,000 - - - 115,600 115,600 $1.19 Option Shares 197,700 42,600 - - (136,700) 103,600 70,000 $1.42 Weighted Average Exercise Price Option Shares Weighted Average Exercise Price $2.23 4.59 - - 1.65 $4.35 $4.33 224,700 - - - (27,000) 197,700 197,700 - $2.16 - - - 0.92 $2.33 $2.33 The following table summarizes outstanding options into groups based upon exercise price ranges at December 31, 2011: Exercise Price Range $2.72 to $3.90 $3.91-$5.30 b) Warrants Options Outstanding Weighted Average Exercise Price Weighted Average Maturity (Years) Options Exercisable Weighted Average Exercise Price Weighted Average Maturity (Years) Option Shares $3.650 4.470 $4.400 1.94 5.46 5.15 10,000 105,600 115,600 $3.650 4.470 $4.400 1.94 5.46 5.15 Option Shares 10,000 105,600 115,600 Warrants to acquire up to 50,000 shares of common stock at $5.00 per share were issued in conjunction with a consulting agreement to an unrelated entity in February 2004. The warrants expired on February 24, 2009. A summary of warrant transactions for the years ended December 31, 2011, 2010, and 2009, is as follows: Outstanding at January 1 Granted Forfeited or expired Exchanged Exercised Outstanding at December 31 Exercisable at end of year Weighted-average fair value of warrants granted during year c) Stock Repurchase Program 2011 2010 2009 Warrant Shares Weighted Average Exercise Price Warrant Shares Weighted Average Exercise Price Warrant Shares Weighted Average Exercise Price - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - 7,500 - (7,500) - - - - - $5.000 - 5.000 - - - - On February 27, 2009, our Board of Directors authorized a share repurchase program of up to 1 million shares of our common stock at prevailing market prices not to exceed $2.85. The share repurchase program commenced on April 1, 2009. On December 4, 2009, our Board amended the repurchase program to increase the maximum purchase price to $3.70. The plan terminated on December 10, 2010. We repurchased a total of 2,300 and 60,927 shares in 2010 and 2009, respectively, for a total purchase price of $207,683. d) Cash Dividend In May 2010, our Board of Directors authorized a $0.75 per share special one-time cash dividend that was paid to shareholders of record at the close of business on June 3, 2010. The dividend, totaling $7.7 million, was paid to shareholders on July 5, 2010. Our Board will determine future cash dividends after giving consideration to our then existing levels of profit and cash flow, capital requirements, current and forecasted liquidity, as well as financial and other business conditions existing at the time. We did not make any dividend payments during 2009 or 2011. Our Board of Directors authorized a $0.25 per share special one-time cash dividend to be paid in the second quarter of 2012. See Note 18 – Subsequent Events for further details. 27 TABLE OF CONTENTS 12. STORE CLOSING In October 2010, we closed Mid-Continent Leather Sales, a wholesale store located in Coweta, Oklahoma, due to unsatisfactory sales and earnings performance. We negotiated an early termination of the lease which effectively eliminated all obligations pertaining to the store at December 31, 2010. Amortization of a non-compete agreement with the former owner totaling $75,000 was accelerated and fully amortized by year-end. This store was included in our Wholesale Leathercraft segment. 13. DISCONTINUED OPERATIONS Our subsidiary, Roberts, Cushman and Company, Inc., is classified as discontinued operations. The distributor of custom hat trims ceased doing business in the fourth quarter of 2009 as a result of decreased sales. All prior periods presented have been adjusted to reflect this presentation. Sales, earnings before income tax, and provision for income taxes of the discontinued operation for each year were as follows: 2011 2010 2009 Sales Earnings before income taxes Current provision (benefit): Deferred provision (benefit): Federal State Federal State - - $(1,394) 26 (1,368) - - - $(1,368) $(419) $877 $701 (2,261) (1,560) 617 54 671 $(889) The classes of assets and liabilities of discontinued operations in our consolidated balance sheet as of December 31 were as follows: 2011 2010 Trade receivables, less allowance Inventory Property and equipment, net Deferred income tax asset Total assets Accrued expenses and other liabilities Income taxes payable Deferred income tax liability Total liabilities Net assets (liabilities) 14. SEGMENT INFORMATION - - - - - - - - - - $498,234 $84,942 $29,205 (475) 28,730 (645) (56) (701) $28,029 - - - - - - (301) - (301) $301 We identify our segments based on the activities of three distinct operations: a. Wholesale Leathercraft, which consists of a chain of wholesale stores operating under the name, The Leather Factory, located in North America; b. Retail Leathercraft, which consists of a chain of retail stores operating under the name, Tandy Leather Company, located in North America; c. International Leathercraft, which sells to both wholesale and retail customers. We have one store located in Northampton, United Kingdom which opened in February 2008 and one store located in Sydney, Australia which opened in October 2011. These stores carry the same products as our North American stores. In January 2012, we opened a third store, located in Spain. Our reportable operating segments have been determined as separately identifiable business units and we measure segment earnings as operating earnings, defined as income before interest and income taxes. Wholesale Leathercraft Retail Leathercraft International Leathercraft Discontinued Operations Total For the year ended December 31, 2011 Net Sales Gross Profit Operating earnings Interest expense Other, net Income before income taxes Depreciation and amortization Fixed asset additions Total assets For the year ended December 31, 2010 Net Sales Gross Profit Operating earnings Interest expense Other, net Income before income taxes Depreciation and amortization Fixed asset additions Total assets For the year ended December 31, 2009 Net Sales Gross Profit Operating earnings Interest expense Other, net Income before income taxes Depreciation and amortization Fixed asset additions Total assets $26,540,899 16,268,075 2,803,034 248,576 (79,149) 2,642,586 841,058 535,713 $35,966,965 $25,908,177 15,731,593 2,690,061 265,405 (125,700) 2,550,356 826,515 1,372,040 $33,595,847 $25,095,392 14,678,410 2,017,915 297,864 45,342 1,765,393 994,759 653,792 $37,216,532 28 $37,435,832 22,645,847 4,656,067 - - 4,647,089 158,804 350,570 $7,185,016 $32,291,442 19,439,045 3,614,856 - 8,756 3,606,100 132,217 179,703 $6,230,213 $28,079,863 17,099,499 2,900,701 - (4,614) 2,896,087 116,439 137,386 $5,607,481 $2,126,216 1,423,237 247,549 - (4,279) 251,827 16,699 214,240 $2,350,934 $1,693,251 1,080,219 330,694 - 11,404 319,290 13,677 1,596 $769,514 $1,307,484 831,465 176,485 - 123,437 299,922 13,811 387 $496,639 $66,102,947 40,337,159 7,706,650 248,576 (83,428) 7,541,502 1,016,561 1,100,523 $45,502,915 $59,892,870 36,250,857 6,635,611 265,405 (105,540) 6,475,746 972,409 1,553,339 $40,595,574 $54,482,739 32,609,374 5,095,101 297,864 (164,165) 4,961,402 1,125,009 791,565 $43,327,231 $6,579 TABLE OF CONTENTS Net sales by geographic areas were as follows: United States Canada All other countries 2011 2010 2009 $56,337,737 6,714,100 3,051,110 $66,102,947 $51,561,070 5,862,857 2,468,943 $59,892,870 $47,433,609 4,686,330 2,362,800 $54,482,739 Geographic sales information is based on the location of the customer. Except for Canada, we had no sales to any single foreign country that was material to our consolidated net sales for the years ended December 31, 2011, 2010 and 2009. We do not have any significant long-lived assets outside of the United States. 15. RECENT ACCOUNTING PRONOUNCEMENTS In April 2010, FASB issued ASU 2010-13 "Compensation-Stock Compensation (Topic 718) Effect of Denominating the Exercise Price of a Share-Based Payment Award in the Currency of the Market in Which the Underlying Equity Security Trades" (ASU 2010-13). Topic 718 is amended to clarify that a share-based payment award with an exercise price denominated in the currency of a market in which a substantial portion of the entity's equity securities trades shall not be considered to contain a market, performance, or service condition. Therefore, such an award is not to be classified as a liability if it otherwise qualifies as equity classification. The amendments in this standard are effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The guidance should be applied by recording a cumulative-effect adjustment to the opening balance of retained earnings for all outstanding awards as of the beginning of the fiscal year in which the amendments are initially applied. The adoption of the standard did not have a material impact on our consolidated results of operations and financial condition. In December 2010, FASB issued ASU 2010-28 “Intangibles - Goodwill and Other (Topic 350)” (ASU 2010-28). Topic 350 is amended to clarify the requirement to test for impairment of goodwill. Topic 350 has required that goodwill be tested for impairment if the carrying amount of a reporting unit exceeds its fair value. Under ASU 2010-28, when the carrying amount of a reporting unit is zero or negative an entity must assume that it is more likely than not that a goodwill impairment exists, perform an additional test to determine whether goodwill has been impaired and calculate the amount of that impairment. The modifications to ASC Topic 350 resulting from the issuance of ASU 2010-28 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2010. The adoption of the standard did not have a material impact on our consolidated results of operations and financial condition. In December 2010, FASB issued ASU 2010-29 “Business Combinations (Topic 805) - Disclosure of Supplementary Pro Forma Information for Business Combinations” (ASU 2010-29). This standard update clarifies that, when presenting comparative financial statements, SEC registrants should disclose revenue and earnings of the combined entity as though the current period business combinations had occurred as of the beginning of the comparable prior annual reporting period only. The update also expands the supplemental pro forma disclosures to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings. ASU 2010-29 is effective prospectively for material (either on an individual or aggregate basis) business combinations entered into in fiscal years beginning on or after December 15, 2010. The adoption of the standard did not have a material impact on our consolidated financial statements. In June 2011, FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income” (ASU 2011-05). This standard update requires an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of stockholders’ equity. ASU 2011-05 is effective for the interim and annual periods beginning after December 15, 2011. We do not believe the adoption of this guidance will have a material impact on our consolidated financial statements as it only requires a change in the format of presentation. In September 2011, FASB issued ASU 2011-08, “Intangibles-Goodwill and Other (Topic 350) – Testing Goodwill for Impairment”. ASU 2011-08 provides companies with a new option to determine whether or not it is necessary to apply the traditional two-step quantitative goodwill impairment test in ASC 350, Intangibles – Goodwill and Other. Under ASU 2011-08 companies are no longer required to calculate the fair value of a reporting unit unless it determines, on the basis of qualitative information, that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. ASU 2011-08 is effective for periods ending after December 15, 2011; however, early adoption is permitted for periods ending after September 15, 2011. We do not anticipate the adoption to have a material impact on our consolidated financial statements. 16. QUARTERLY FINANCIAL DATA (UNAUDITED) 2011 Net sales Gross profit Net income from continuing operations Net income Net income from continuing operations per common share: Net income per common share: Basic Diluted Basic Diluted Weighted average number of common shares outstanding: Basic Diluted 2010 Net sales Gross profit Net income from continuing operations Net income Net income from continuing operations per common share: Net income per common share: Basic Diluted Basic Diluted Weighted average number of common shares outstanding: Basic Diluted 17. SUBSEQUENT EVENTS First Quarter $15,879,040 9,524,848 1,150,576 1,150,576 0.11 0.11 0.11 0.11 10,156,442 10,169,701 First Quarter $14,588,538 8,976,575 947,577 948,113 0.09 0.09 0.09 0.09 Second Quarter $15,933,921 9,845,254 1,076,356 1,076,356 0.11 0.11 0.11 0.11 10,156,442 10,168,098 Second Quarter $14,350,822 8,714,966 1,061,110 1,061,110 0.10 0.10 0.10 0.10 Third Quarter $15,385,421 9,238,278 830,474 829,106 0.08 0.08 0.08 0.08 10,156,442 10,168,326 Third Quarter $13,640,193 8,182,526 592,646 593,905 0.06 0.06 0.06 0.06 Fourth Quarter $18,904,565 11,728,779 1,696,563 1,696,563 0.17 0.17 0.17 0.17 10,156,442 10,166,658 Fourth Quarter $17,313,317 10,376,770 1,557,158 1,557,129 0.15 0.15 0.15 0.15 10,137,715 10,213,677 10,191,506 10,238,217 10,256,442 10,257,743 10,247,746 10,255,156 On January 20, 2012, we announced the opening of a combination wholesale/retail store in Spain. On February 16, 2012, we announced the authorization of a cash dividend as follows: Special one-time cash dividend per share Declaration date Record date Payment date See Note 9 regarding a proposed settlement agreement filed on January 24, 2012 related to a certain legal matter. 29 $0.25 February 14, 2012 March 1, 2012 April 2, 2012 TABLE OF CONTENTS To the Board of Directors and Stockholders Tandy Leather Factory, Inc. and Subsidiaries REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM We have audited the accompanying consolidated balance sheets of Tandy Leather Factory, Inc. and Subsidiaries (the Company) as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity and cash flows for each of the years in the three-year period ended December 31, 2011. The Company’s management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Tandy Leather Factory, Inc. and Subsidiaries as of December 31, 2011, and 2010 and the consolidated results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with accounting principles generally accepted in the United States of America. WEAVER AND TIDWELL, L.L.P. Fort Worth, Texas March 30, 2012 30 TABLE OF CONTENTS ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the design and operation of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon their evaluation of these disclosure controls and procedures, our Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective as of the date of such evaluation in ensuring that information required to be disclosed in the reports that we file or submit under the Exchange Act is (1) recorded, processed, summarized and reported in a timely manner, and (2) accumulated and communicated to our management, including our principal executive and principal financial officers, as appropriate, to allow timely decisions regarding required disclosure. Management’s Annual Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over our financial reporting. Our internal control system was designed to provide reasonable assurance to management and the board of directors regarding the effectiveness of our internal control processes over the preparation and fair presentation of our published financial statements. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation and presentation. We have assessed the effectiveness of our internal controls over financial reporting as of December 31, 2011. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commissions (COSO) in Internal Control – Integrated Framework. Based on our assessment, we believe that, as of December 31, 2011, our internal control over financial reporting is effective based on that criteria. This annual report does not include an attestation report of our registered public accounting firm regarding internal control over financial reporting. Management’s report is not subject to attestation by our registered public accounting firm pursuant to rules of the Securities and Exchange Commission that permit us to provide only management’s report in this Annual Report on Form 10-K. Changes in internal control. There was no change in our internal control over financial reporting that occurred during the fiscal quarter ended December 31, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. ITEM 9B. OTHER INFORMATION None ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE* ITEM 11. EXECUTIVE COMPENSATION* PART III* ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS* ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE* ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES* * The information required by Items 10, 11, 12, 13, and 14 is or will be set forth in the definitive proxy statement relating to the 2012 Annual Meeting of Stockholders of Tandy Leather Factory, Inc., which is to be filed with the Securities and Exchange Commission pursuant to Regulation 14A under the Securities Exchange Act of 1934, as amended. This definitive proxy statement relates to a meeting of stockholders involving the election of directors and the portions therefrom required to be set forth in this Form 10K by Items 10, 11, 12, 13, and 14 are incorporated herein by reference pursuant to General Instruction G(3) to Form 10-K. ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES (a) The following are filed as part of this Annual Report on Form 10-K: 1. Financial Statements The following consolidated financial statements are included in Item 8: PART IV · Consolidated Balance Sheets at December 31, 2011 and 2010 · Consolidated Statements of Income for the years ended December 31, 2011, 2010 and 2009 · Consolidated Statements of Cash Flows for the years ended December 31, 2011, 2010 and 2009 · Consolidated Statements of Stockholders' Equity for the years ended December 31, 2011, 2010 and 2009 2. Financial Statement Schedules All financial statement schedules are omitted because the required information is not present or not present in sufficient amounts to require submission of the schedule or because the information is reflected in the consolidated financial statements or notes thereto. 3. Exhibits The exhibits listed in the Exhibit Index immediately preceding such exhibits are filed as part of this Annual Report on Form 10-K. 31 TABLE OF CONTENTS SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form 10-K to be signed on its behalf by the undersigned, thereunto duly authorized. By: By: TANDY LEATHER FACTORY, INC. /s/ Jon Thompson Jon Thompson Chief Executive Officer and President /s/ Shannon L. Greene Shannon L. Greene Chief Financial Officer, Chief Accounting Officer and Treasurer Dated: March 30, 2012 Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. /s/ Wray Thompson Signature Wray Thompson /s/ Jon W. Thompson Jon Thompson /s/ Shannon L. Greene Shannon L. Greene /s/ Mark J. Angus Mark J. Angus Chairman of the Board Title Chief Executive Officer, President and Director Chief Financial Officer, Chief Accounting Officer, Treasurer and Director Senior Vice President, Assistant Secretary and Director /s/ William M. Warren Secretary William M. Warren /s/ T. Field Lange T. Field Lange /s/ Joseph R. Mannes Joseph R. Mannes /s/ L. Edward Martin III L. Edward Martin III /s/ Michael A. Nery Michael A. Nery /s/ J. Bryan Wilkinson J. Bryan Wilkinson Director Director Director Director Director 32 Date March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 March 30, 2012 TABLE OF CONTENTS TANDY LEATHER FACTORY, INC. AND SUBSIDIARIES EXHIBIT INDEX Exhibit Number 3.1 3.2 10.1 10.2 10.3 10.4 10.5 10.6 10.7 10.8 14.1 21.1 Description Certificate of Incorporation of The Leather Factory, Inc., and Certificate of Amendment to Certificate of Incorporation of The Leather Factory, Inc. filed as Exhibit 3.1 to Form 10-Q filed by Tandy Leather Factory, Inc. with the Securities and Exchange Commission on August 12, 2005 and incorporated by reference herein. Bylaws of The Leather Factory, Inc., filed as Exhibit 3.2 to the Registration Statement on Form SB-2 of The Leather Factory, Inc. (Commission File No. 33-81132) filed with the Securities and Exchange Commission on July 5, 1994 and incorporated by reference herein. 2007 Director Non-qualified Stock Option Plan of Tandy Leather Factory, Inc. dated March 22, 2007, filed as an Exhibit to Tandy Leather Factory, Inc.’s Definitive Proxy Statement, filed with the Securities and Exchange Commission on April 18, 2007 and incorporated by reference herein. Agreement of Purchase and Sale, dated June 25, 2007, by and between Standard Motor Products, Inc. and Tandy Leather Factory, L.P., filed as Exhibit 10.4 to Form 8-K filed with the Securities and Exchange Commission on August 6, 2007 and incorporated by reference herein. Credit Agreement, dated July 31, 2007, by and between The Leather Factory, L.P. and JPMorgan Chase Bank, N.A., filed as Exhibit 10.2 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 6, 2007 and incorporated by reference herein. Line of Credit Note, dated July 31, 2007, by and between The Leather Factory, L.P. and JPMorgan Chase Bank, N.A., filed as Exhibit 10.1 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 6, 2007 and incorporated by reference herein. Deed Of Trust, Assignment of Leases and Rents, Security Agreement and Financing Statement, dated as of July 31, 2007, by and among The Leather Factory, L.P., Randall B. Durant and JPMorgan Chase Bank, N.A., filed as Exhibit 10.3 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on August 6, 2007 and incorporated by reference herein. Consultation Agreement, dated as of January 1, 2009, by and between Tandy Leather Factory, Inc. and J. Wray Thompson, filed as Exhibit 10.1 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on February 17, 2009 and incorporated by reference herein. Consultation Agreement, dated as of January 1, 2010, by and between Tandy Leather Factory, Inc. and J. Wray Thompson, filed as Exhibit 10.1 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on January 5, 2010 and incorporated by reference herein. Consultation Agreement, dated as of June 1, 2011, by and between Tandy Leather Factory, Inc. and J. Wray Thompson, filed as Exhibit 10.1 to Tandy Leather Factory’s Current Report on Form 8-K filed with the Securities and Exchange Commission on May 25, 2011 and incorporated by reference herein. Code of Business Conduct and Ethics of The Leather Factory, Inc., adopted by the Board of Directors on February 26, 2004, filed as Exhibit 14.1 to the Annual Report on Form 10-K of The Leather Factory, Inc. (Commission File No. 1-12368) filed with the Securities and Exchange Commission on March 29, 2004 and incorporated by reference herein. Subsidiaries of Tandy Leather Factory, Inc. filed as Exhibit 21.1 to the Annual Report on Form 10-K of The Leather Factory, Inc. for the year ended December 31, 2002 filed with the Securities and Exchange Commission on March 28, 2003, and incorporated by reference herein. *31.1 Certification by the Chief Executive Officer and President pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 *31.2 Certification by the Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 32.1 Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 101.INS^ XBRL Instance Document 101.SCH^ XBRL Taxonomy Extension Schema Document 101.CAL^ XBRL Taxonomy Extension Calculation Document 101.DEF^ XBRL Taxonomy Extension Definition Document 101.LAB^ XBRL Taxonomy Extension Labels Document 101.PRE^ XBRL Taxonomy Extension Presentation Document ___________ *Filed Herewith ^ XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections. 

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