10-K 1 form10-k.htm FORM 10-K FOR 2013 form10-k.htm

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

Form 10-K

         (Mark One)
        [X]                             ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2013
OR

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

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

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

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

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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes [X]  No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [   ]

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. [X]

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 [  ] Smaller reporting company [X]

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 $67,273,450 at June 30, 2013 (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 20, 2014, there were 10,198,733 shares of the registrant's common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive Proxy Statement for the Annual Meeting of Stockholders to be held on June 10, 2014, are incorporated by reference in Part III of this report.

 
 

 



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


 
 

 


PART I


General

We are a retailer and wholesale distributor of a broad line of leather and related products, including leather, leatherworking tools, buckles and adornments for belts, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits. We also manufacture leather lacing and some of our do-it-yourself kits.  During 2013, our consolidated sales totaled $78.3 million of which approximately 16% 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 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.  In 2012, we opened one combination wholesale and retail store in Jerez, Spain and one retail store in the U.S.  In 2013, we opened three retail stores in the U.S.

At December 31, 2013, we operated 29 wholesale stores operating under the Leather Factory name (26 in the U.S. and three in Canada).  We also operated 79 retail stores operating under the Tandy Leather name (72 in the U.S. and seven in Canada) as well as three combination wholesale and retail stores operating under the Tandy Leather Factory name in the United Kingdom, Australia and Spain.  In December 2013, we closed two retail stores in the U.S.

Tandy Leather Factory, Inc. wholly-owns eleven subsidiaries which create three operating segments as follows:

Segment
Subsidiaries included:
Wholesale Leathercraft
The Leather Factory, LP;
The Leather Factory of Canada, Ltd (3 stores)
 
Retail Leathercraft
Tandy Leather Company, LP;
The Leather Factory of Canada, Ltd (7 stores)
 
International Leathercraft
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 2013.

STORE COUNT
YEARS ENDED DECEMBER 31, 1999 through 2013

   
Wholesale Leathercraft
Retail Leathercraft
International Leathercraft
 
Year Ended
Opened
Conv. (1)
Closed
Total
Opened (2)
Closed
Total
Opened
Closed
Total
Balance Fwd
     
22
   
N/A
   
N/A
1999
4
-
-
26
-
-
-
-
-
-
2000
2
-
-
28
1*
-
1
-
-
-
2001
2
-
-
30
-
-
1
-
-
-
2002
1
(1)
-
30
14
1*
14
-
-
-
2003
-
-
-
30
12
-
26
-
-
-
2004
-
-
-
30
16
-
42
-
-
-
2005
-
-
-
30
8
-
50
-
-
-
2006
-
(1)
-
29
12
-
62
-
-
-
2007
1^
-
-
30
10
-
72
-
-
-
2008
-
-
-
30
1
-
73
1
-
1
2009
-
-
-
30
2
-
75
-
-
1
2010
-
-
1^
29
1
-
76
-
-
1
2011
-
-
-
29
1
-
77
1
-
2
2012
-
-
-
29
1
-
78
1
-
3
2013
-
-
-
29
3
2
79
-
-
3

(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 1% of our total sales in 2013.  Sales to our five largest customers represent 2.5%, 2.9% and 5.5% of consolidated sales in 2013, 2012 and 2011, respectively.  Management does not believe the loss of one of these customers would have a significant negative impact on our consolidated operations.

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, 2014, the Retail Leathercraft segment consists of 79 Tandy Leather retail stores of which 72 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, 2014, 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 13, 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 $27.4 million, $26.9 million and $26.5 million for 2013, 2012 and 2011, respectively.

General We operate wholesale stores in 20 states and three Canadian provinces.  The stores range in size from 2,350 square feet to 22,000 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.  No single customer’s purchases represented more than 1% of this segment’s sales in 2013.

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 7 ASC’s located outside of North America.

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 15% 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 2013, 2012, and 2011, Wholesale Leathercraft division sales by product category were as follows:

Product Category
2013 Sales Mix
 
2012 Sales Mix
 
2011 Sales Mix
Belts strips and straps
3%
 
3%
 
3%
Books, patterns, videos
2%
 
2%
 
2%
Buckles
4%
 
4%
 
4%
Conchos^
3%
 
4%
 
4%
Craft supplies
2%
 
4%
 
5%
Dyes, finishes, glues
7%
 
6%
 
6%
Hand tools
16%
 
15%
 
15%
Hardware
8%
 
7%
 
7%
Kits
7%
 
8%
 
7%
Lace
4%
 
5%
 
7%
Leather
39%
 
38%
 
35%
Stamping tools
5%
 
4%
 
5%
 
100%
 
100%
 
100%
^A concho is a metal adornment attached to clothing, belts, saddles, etc., usually made into a pattern of some southwestern or geometric object.

In addition to meeting ordinary operational requirements, our working capital demands are a product of the need to maintain a level of inventory sufficient to fill customer orders as they are received with minimal backorders and the time required to collect our accounts receivable.  Because availability of merchandise and prompt delivery time are important competitive factors for us, we maintain higher levels of inventory than our smaller competitors.  For additional information regarding our cash, inventory and accounts receivable at the end of 2013 and 2012, see "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations."
 
Suppliers We purchase merchandise and raw materials from approximately 150 vendors dispersed throughout the United States and in approximately 20 foreign countries. In 2013, our 10 largest vendors accounted for approximately 79% 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 operation are 9:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on Saturdays.  Our stores are closed on Sunday.  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 in our stores.

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 2,500 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.  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.

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 $47.0 million, $42.6 million and $37.4 million for 2013, 2012 and 2011, respectively.

General   As of March 1, 2014, the Tandy Leather retail chain has 79 stores located in 37 states and six Canadian provinces.  The stores range in size from 1,200 square feet to 9,000 square feet, with the average size of a store being approximately 2,900 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.    We intend to continue with the relocation of our smaller stores into larger space within the same cities as lease terms expire and appropriate larger space is available at acceptable rates.

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 60% of Tandy Leather's 2013 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 (28-29% of annual sales), while the other three quarters remain fairly even at 24-25% of annual sales each quarter.  No single customer’s purchases represented more than 1% of Retail Leathercraft’s sales in 2013.

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 2013, 2012 and 2011, Retail Leathercraft division sales by product category were as follows:

Product Category
2013 Sales Mix
 
2012 Sales Mix
 
2011 Sales Mix
Belts strips and straps
5%
 
5%
 
5%
Books, patterns, videos
2%
 
2%
 
2%
Buckles
3%
 
4%
 
4%
Conchos
3%
 
3%
 
4%
Craft supplies
2%
 
3%
 
3%
Dyes, finishes, glues
7%
 
7%
 
7%
Hand tools
17%
 
16%
 
16%
Hardware
8%
 
7%
 
7%
Kits
8%
 
8%
 
9%
Lace
3%
 
3%
 
3%
Leather
37%
 
37%
 
35%
Stamping tools
5%
 
5%
 
5%
 
100%
 
100%
 
100%

As indicated above, the products sold in our retail stores are also sold in our wholesale stores.  Therefore, the discussion above regarding products, their sources and the working capital requirements for the Wholesale Leathercraft division also apply to the Retail Leathercraft division.  Sales at the retail stores are generally made through cash transactions or through national credit cards.  The retail stores also sell on open account to selected wholesale customers including schools and other institutions and small retailers.  Our terms are generally net 30 days.  Like the wholesale stores, the retail stores have an unconditional return policy.

Operations Hours of operation are 9:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on Saturdays.  Our stores are closed on Sunday.  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, including those that are customers in our Wholesale Leathercraft division, also carry leathercraft products on a very small scale relative to their overall product line.  We compete on price, availability of merchandise, and depth of our product line.  To our knowledge, our 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 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 each of the years 2010, 2011 and 2012, and three stores were opened in 2013.  Of the 79 stores opened as of December 31, 2013, 11 were independent leathercraft stores that we acquired.  Separately, these acquisitions are not material.  The other 68 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, 2013, there were three wholesale/retail combination stores in this segment:  one in Northampton, United Kingdom, which we opened in February 2008, one in Sydney, Australia, which we opened in October 2011, and one in Jerez, Spain, which we opened in January 2012.  The stores operate under the Tandy Leather Factory trade name.  This segment had net sales of $3.9 million, $3.3 million and $2.1 million in 2013, 2012 and 2011, respectively.  We intend to open more stores internationally as the opportunities present themselves, but we have not determined a specific time schedule for said openings.

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 7,000 square feet and are located in light industrial areas.  We seek to 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 North American stores, our international stores have an unconditional return policy.  No single customer’s purchases represented more than 3% of International Leathercraft’s sales in 2013.
 
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 9:00 am to 6:00 pm Monday through Friday, and from 9:00 am to 4:00 pm on Saturdays.  Our stores are closed on Sunday.  Selling prices are consistent with our US 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 gives 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 typically do not have backlogs.
 
Expansion   We intend to expand further internationally by opening additional stores, although the timing of any store openings has not been determined.  We intend to grow our customer base throughout Europe as well as other parts of the world to support any such 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 7.

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, 2013, we employed 571 people, 513 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 120 registered trademarks, including federal trade name registrations for "Tandy Leather Factory”, “The Leather Factory", "Tandy Leather Company", and “Tandy.”  We also own approximately 60 registered foreign trademarks worldwide.  We own approximately 600 registered copyrights in the United States covering more than 800 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 13 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.
 
Executive Officers of the Registrant

The following table sets forth information concerning our executive officers as of March 25, 2014:

 
Name and Age
 
Position
Served as Executive Officer Since
Jon W. Thompson, 52
Chief Executive Officer since July 2009; President and Chief Operating Officer since June 2008; Vice President from June 1993 to June 2008
2008
     
Shannon L. Greene, 48
Chief Financial Officer since May 2000; Treasurer and Chief Accounting Officer since 2001
2000
     
Mark J. Angus, 53
Senior Vice President and Assistant Secretary since June 2008; Operational Vice President of Merchandising since June 1993
2008
     
William M. Warren, 70
Secretary and Corporate Counsel
1993
 
Jon W. Thompson has served as our Chief Executive Officer since July 2009.  He has also served as President and Chief Operating Officer since June 2008.  He served as Vice President from June 1993 to June 2008.

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.

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

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

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

Risks to Our Industry

Our business may be negatively impacted by general economic conditions in the United States and abroad.

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.  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.  The United States and global economies have suffered from economic uncertainty for the past several years.  Consumer spending in the United States appears to have stabilized recently, but could deteriorate in the future .  As a result, our operating results may be adversely and materially affected by downward trends or uncertainty 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 been on the rise for the past several years 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 these 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.

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.

We may fail to realize the anticipated benefits of the opening of additional stores in North America or we may be unable to obtain sufficient new locations on acceptable terms to meet our growth plans.  Further, we may fail to hire and train qualified managers to oversee the stores opened.
 
Our strategy to grow our business partially depends on continuing to successfully open new stores in North America.  The success of this strategy will depend largely upon our ability to find a sufficient number of suitable locations and our ability to recruit, hire and train qualified personnel to operate our new stores.
 
Our long-term expansion plans in North America call for us to open new stores both in new geographic areas and in or near the areas where we have existing stores. To the extent that we open stores in markets where we already have existing stores, we may experience reduced net sales at those existing stores. Also, if we expand into new geographic areas, those stores may not be received as well as, or achieve net sales or profitability levels comparable to those of, our existing stores in our estimated time periods, or at all. If our stores fail to achieve, or are unable to sustain, acceptable net sales and profitability levels, our business may be materially harmed and we may incur costs associated with closing or relocating stores.  In addition, our current expansion plans are only estimates, and the actual number of stores we open each year and in total and the actual number of suitable locations for our new stores could differ significantly from these estimates. 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.

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.


Not applicable.


We lease our store locations, with the exception of our flagship store located in Fort Worth, Texas.  The majority of our stores have initial lease terms of at least 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 the 22,000 square foot building that houses our flagship store.  Further, 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, 2013:

State
Wholesale Leathercraft
Retail Leathercraft
International
Alabama
-
1
n/a
Alaska
-
1
n/a
Arizona
2
3
n/a
Arkansas
-
1
n/a
California
3
7
n/a
Colorado
1
3
n/a
Connecticut
-
1
n/a
Florida
1
3
n/a
Georgia
-
1
n/a
Idaho
-
1
n/a
Illinois
1
1
n/a
Indiana
-
2
n/a
Iowa
1
-
n/a
Kansas
1
-
n/a
Kentucky
-
1
n/a
Louisiana
1
1
n/a
Maryland
-
1
n/a
Massachusetts
-
1
n/a
Michigan
1
1
n/a
Minnesota
-
2
n/a
Missouri
1
2
n/a
Montana
1
-
n/a
Nebraska
-
1
n/a
Nevada
-
2
n/a
New Mexico
1
1
n/a
New York
-
1
n/a
North Carolina
-
2
n/a
Ohio
1
2
n/a
Oklahoma
-
2
n/a
Oregon
1
1
n/a
Pennsylvania
1
2
n/a
South Carolina
-
1
n/a
South Dakota
-
1
n/a
Tennessee
1
3
n/a
Texas
5
11
n/a
Utah
1
3
n/a
Virginia
-
1
n/a
Washington
1
2
n/a
Wisconsin
-
1
n/a
Wyoming
-
1
n/a

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

International locations:
     
United Kingdom
n/a
n/a
1
Australia
n/a
n/a
1
Spain
n/a
n/a
1


See discussion of Legal Proceedings in Note 9 to the consolidated financial statements included in Item 8 of this Report.


Not applicable.

PART II


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

2013
High
Low
 
2012
High
Low
4th quarter
$10.00
$7.76
 
4th quarter
$5.52
$5.16
3rd quarter
$9.20
$7.76
 
3rd quarter
$5.66
$5.07
2nd quarter
$8.50
$6.76
 
2nd quarter
$5.25
$4.84
1st quarter
$7.35
$5.43
 
1st quarter
$5.42
$4.68

There were approximately 365 stockholders of record on March 24, 2014.

In May 2010, our Board of Directors authorized a $0.75 per share special one-time cash dividend that was paid to our stockholders of record at the close of business on June 3, 2010. The dividend, totaling $7.7 million, was paid to our stockholders 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 was paid to our stockholders of record at the close of business on March 1, 2012.  The dividend, totaling $2.5 million, was paid to our stockholders 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, 2013 that were not registered under the Securities Act.

We did not repurchase any shares of our common stock during the fourth quarter of 2013.

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, 2013.

 
 
Plan Category
Column (a)
Number of Securities to be issued upon exercise of outstanding
options, warrants and rights
Column (b)
Weighted-average exercise price of outstanding options, warrants and rights
Column (c)
Number of securities remaining available for future issuance under
equity compensation plans (excluding securities reflected in Column (a))
Equity compensation plans approved by stockholders
 
84,600
$5.04
21,400
Equity compensation plans not approved by stockholders
 
-
-
-
TOTAL
84,600
$5.04
21,400





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,
 
2013
 
 
2012
 
 
2011
 
 
2010
 
 
2009
Net sales
$78,284,585
 
$72,720,624
 
$66,102,947
 
$59,892,870
 
$54,482,739
Gross profit
49,328,024
 
45,905,674
 
40,337,159
 
36,250,857
 
32,609,374
Operating income
11,266,790
 
9,144,005
 
7,706,650
 
6,635,611
 
5,095,101
Net income from continuing operations
7,265,717
 
5,596,070
 
4,753,969
 
4,158,491
 
3,261,143
Income from discontinued operations, net of tax
-
 
-
 
(1,368)
 
1,766
 
56,914
Net income
$7,265,717
 
$5,596,070
 
$4,752,601
 
$4,160,257
 
$3,318,057
                   
Net income per share from continuing operations
              Basic
$0.71
 
$0.55
 
$0.47
 
$0.41
 
$0.31
              Diluted
$0.71
 
$0.55
 
$0.47
 
$0.41
 
$0.31

Net income per share including discontinued operations
              Basic
$0.71
 
$0.55
 
$0.47
 
$0.41
 
$0.32
              Diluted
$0.71
 
$0.55
 
$0.47
 
$0.41
 
$0.31
                   
Weighted average common shares outstanding for:
                 
Basic EPS
10,176,492
 
10,157,395
 
10,156,442
 
10,208,944
 
10,471,103
Diluted EPS
10,216,438
 
10,175,346
 
10,182,098
 
10,251,863
 
10,535,736
                   
Cash dividend declared per common share
-
 
$0.25
 
-
 
$0.75
 
-

Balance Sheet Data, as of December 31,
2013
 
2012
 
2011
 
2010
 
2009
Cash and certificates of deposit
$11,082,679
 
$7,705,182
 
$11,189,484
 
$5,915,339
 
$12,908,962
Total assets
56,398,566
 
49,087,672
 
45,502,915
 
40,595,574
 
43,327,231
Capital lease obligation, including current portion
-
 
-
 
-
 
-
 
-
Long-term debt, including current portion
2,598,750
 
3,105,000
 
3,307,500
 
3,510,000
 
3,712,500
Total Stockholders’ Equity
$44,621,542
 
$37,521,017
 
$34,433,801
 
$29,761,594
 
$33,359,655



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, 2013 and 2012 and the three 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 $27.4 million in 2013.  Historically, in normal economic conditions, this division has generally offered steady but very modest increases in sales.  Sales in 2013 increased 2.0% compared to 2012, with the stores’ sales increasing 4% but national account sales decreasing by 25%.  Sales at our stores are showing signs of strength despite cautious consumer spending as a result of continued uncertainty in the U.S. economy.  Sales to national accounts are decreasing due to our intentional decision to discontinue certain products from our product line that our national account customers purchased as these products did not produce an acceptable gross profit margin.  We expect our sales to our national account customers to continue to decline.

Tandy Leather has long been known for its retail leathercraft store chain.  These retail stores comprise our Retail Leathercraft segment. This segment has experienced the greatest increases in sales ($47.0 million in 2013, up from $42.6 million in 2012) and is our largest source of revenues.  We expect to grow the number of stores to approximately 100 in the future from 79 stores in operation at the end of 2013.  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.  While the store opening schedule has slowed, we have continued to relocate existing stores as current lease terms near expiration 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, 2013, three combination retail/wholesale stores, with one each located in the United Kingdom, Australia and Spain, comprised this segment.  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, gross profit margin as a percent of total net sales, a key indicator of costs, decreased minimally in 2013 compared to 2012.  Operating expenses increased at a slower pace than that of sales in 2013, increasing by 4% from 2012.  Operating expenses increased at a higher pace than that of sales in 2012, increasing 13% from 2011, due to the legal settlement that we recorded in the third quarter.  See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.

We reported consolidated net income for 2013 of $7.3 million.  Consolidated net income for 2012 and 2011 was $5.6 million and $4.7 million, respectively.  We use our cash flow to fund our operations, to fund the opening of new stores and to purchase necessary property and equipment.  We paid a one-time dividend in 2012 to our stockholders, totaling $2.5 million.  At the end of 2013, our stockholders’ equity had increased to $44.6 million from $37.5 million the previous year.

Comparing the December 31, 2013 balance sheet with the prior year’s balance sheet, we increased our investment in inventory from $25.9 million to $26.3 million and total cash increased from $7.7 million to $11.1million as the result of improved net income and no dividend paid in 2013.
 
Net Sales

Net sales for the three years ended December 31, 2013 were as follows:

Year
Wholesale Leathercraft
Retail Leathercraft
International Leathercraft
Total Company
Increase from Prior Year
2013
$27,384,614
$46,995,902
$3,904,069
$78,284,585
7.7%
2012
$26,850,002
$42,616,546
$3,254,076
$72,720,624
10.0%
2011
$26,540,899
$37,435,832
$2,126,216
$66,102,947
10.4%

Our net sales increased by 7.7% in 2013 when compared with 2012 and increased by 10.0% in 2012 when compared with 2011.  In 2013 and 2012, 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 2013, our cost of sales increased slightly  as a percentage of total net sales when compared to 2012, resulting in a decrease in consolidated gross profit margin from 63.1% to 63.0%.  Our 2012 cost of sales as a percentage of our total net sales decreased as a percentage of total net sales when compared to 2011, resulting in an increase in consolidated gross profit margin from 61.0% to 63.1%.  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, 2013 were as follows:

Year
Wholesale Leathercraft
Retail Leathercraft
International Leathercraft
Total Company
2013
67.3%
60.5%
63.3%
63.0%
2012
67.3%
60.6%
61.7%
63.1%
2011
61.3%
60.5%
66.9%
61.0%

Our operating expenses decreased as a percentage of total net sales to 48.6% in 2013 when compared with 50.6% in 2012.  This decrease indicates that our operating expenses grew slower than our sales during this period.  2013 operating expenses were $1.3 million higher than those of 2012.  Significant expense fluctuations in 2013 compared to 2012 are as follows:

Expense
2013 amount
Incr (Decr) over 2012
Employee compensation
$18.2 million
$1.5 million
Advertising and marketing
$4.9 million
$635,000
Rent & utilities
$4.5 million
$157,000
Legal and professional fees
$1.2 million
$147,000
Store relocation expenses
$260,000
$132,000
Litigation settlement
($249,000)
($1.2 million)

The increase in employee compensation is due to an increase in employee headcount as well as 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.  The litigation settlement entry represents a refund to us of unclaimed monies related to the settlement of a lawsuit that was recorded in the third quarter of 2012.  (See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.)  Litigation expenses are generally considered corporate expenses and not attributable to a specific store or group of stores.  Further, corporate, administrative and support departments are included in the Wholesale Leathercraft segment.  Therefore, the entire litigation settlement expense is included in the operating expenses of the segment.

Our operating expenses increased as a percentage of total net sales to 50.6% in 2012 when compared with 49.4% in 2011.  This increase indicates that our operating expenses grew faster than our sales during this period.  2012 operating expenses were $4.1 million higher than those of 2011.  Significant expense fluctuations in 2012 compared to 2011 are as follows:

Expense
2012 amount
Incr (Decr) over 2011
Employee compensation & benefits
$19.6 million
$1.6 million
Travel expense
$507,000
$177,000
Advertising and marketing
$3.5 million
$571,000
Rent & utilities
$4.4 million
$280,000
Professional fees and licenses
$798,000
($237,000)
Repairs and maintenance
$435,000
$133,000
Supplies
$857,000
$147,000
Workers compensation and property insurance
$506,000
$184,000
Litigation settlement
$993,000
$993,000

Other Income/Expense (net)

Other Income/Expense consists primarily of currency exchange fluctuations, interest income and interest expense.  In 2013, we incurred other expenses (net) of approximately $46,000 compared to other expenses (net) of approximately $198,000 in 2012.  In 2013, we received approximately $17,000 in gas royalties, earned approximately $5,100 in interest income on our cash and paid approximately $202,000 in interest expense on our bank debt.  We had a currency exchange gain of approximately $41,000 in 2013 compared to a currency exchange gain of approximately $26,000 in 2012.

In 2012, we incurred other expenses (net) of approximately $198,000 compared to other expenses (net) of approximately $165,000 in 2011.  In 2012, we received approximately $12,000 in gas royalties, earned approximately $9,900 in interest income on our cash and paid approximately $239,000 in interest expense on our bank debt.  We had a currency exchange gain of approximately $26,000 in 2012 compared to a currency exchange loss of approximately $200 in 2011.

Net Income
During 2013, we earned net income of $7.3 million, a 30% increase over our net income of $5.6 million earned during 2012.  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 2012, we earned net income of $5.6 million, an 18% increase over our net income of $4.7 million earned during 2011.  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.

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, 2013 were as follows:

 
Year
Net Sales
Increase from  Prior Year
 
Operating Income
Operating Income
 Increase from Prior Year
Operating Income as a Percentage
of Sales
2013
2.0%
$4,840,416
29.8%
17.7%
2012
1.2%
$3,730,678
33.1%
13.9%
2011
2.4%
$2,803,034
4.2%
10.6%

Wholesale Leathercraft, consisting of our 29 wholesale stores and our national account group, accounted for 35.0% of our consolidated net sales in 2013, which compares to 36.9% in 2012 and 40.2% in 2011.  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 3.8% in 2013 compared to sales in 2012 while the 2013 sales by our national account group were down 24.9% from 2012.  By customer group, sales in the wholesale stores to our retail customers increased while sales to our other customer groups declined from 2012.  Our sales mix by customer group in the Wholesale Leathercraft division was as follows:

Customer Group
2013
2012
2011
Retail
41%
37%
33%
Institution
4%
4%
5%
Wholesale
44%
45%
43%
National Accounts
5%
7%
12%
Manufacturers
6%
7%
7%
 
100%
100%
100%

In 2013, operating income as a percentage of divisional sales improved from the prior year of 13.9% to 17.7%.  Operating expenses decreased approximately $748,000 in 2013 compared to 2012.  The primary reason for the operating expense decrease was the one-time charge recorded in 2012 related to the settlement of litigation that was not repeated in 2013.  (See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.)  Legal and professional fees increased by approximately $134,000, while employee compensation increased by approximately $853,000.

In 2012, operating income as a percentage of divisional sales improved from the prior year of 10.6% to 13.9%.  Operating expenses increased approximately $867,000 in 2012 compared to 2011.  The primary reason for the operating expense increase was the one-time charge of $994,000 related to the settlement of litigation.  (See Note 9 to the consolidated financial statements included in Item 8 of this Report for additional information.)  Legal and professional fees decreased by approximately $271,000, while employee compensation and benefits increased by approximately $345,000 and supplies increased by approximately $122,000.

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, 2013 were as follows:

 
Year
Net Sales
Increase from Prior Yr
 
Operating Income
Operating Income
Increase from Prior Year
Operating Income as a Percentage
of  Sales
2013
10.3%
$6.026,731
10.9%
12.8%
2012
13.8%
$5,436,745
16.8%
12.8%
2011
15.9%
$4,656,067
28.8%
12.4%

Reflecting the growth previously discussed, Retail Leathercraft accounted for 60.0% of our total net sales in 2013, up from 58.6% in 2012 and 56.6% in 2011.  Growth in net sales for our Retail Leathercraft division in 2013 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
2013
2012
2011
Retail
59%
60%
62%
Institution
4%
4%
5%
Wholesale
34%
33%
30%
National Accounts
0%
0%
0%
Manufacturers
3%
3%
3%
 
100%
100%
100%

Operating income as a percentage of sales in 2013 matched operating income as a percentage of sales in 2012 at 12.8%.  Gross margin decreased slightly to 60.5% in 2013 from 60.6% in 2012.  Operating expenses as a percent of sales in 2013 decreased from 47.9% for 2012 to 47.8% for 2013 as operating expenses grew at a slower pace in 2013 than that of sales.

Operating income as a percentage of sales increased to 12.8% for 2012 compared to 12.4% for 2011.  Gross margin increased slightly to 60.6% in 2012 from 60.5% in 2011.  Operating expenses as a percent of sales in 2012 decreased from 48.0% for 2011 to 47.9% for 2012 as operating expenses in 2012 grew at a slower pace than that of sales

We intend to continue the slow expansion of our store chain over the next several years, with plans to open two to three stores in 2014 in North America.  We remain committed to a conservative expansion plan for this division that is intended to minimize risks to our profits and maintain our financial stability.  In the current economic environment in the U.S., it is possible that we will change our plans for store openings in 2014 if we determine that the feasibility of additional successful openings is likely.

International Leathercraft

International Leathercraft consists of all stores located outside of North America.  As of December 31, 2013, that represents three retail/wholesale combination stores with one located in the United Kingdom, one located in Australia, and one located in Spain.  International Leathercraft accounted for 5.0%, 4.5% and 3.2% of our total sales in 2013, 2012 and 2011, respectively.  We expect this segment to become a larger part of our total operations as our international customer base continues to grow.

The increases in net sales, operating income, operating income increases (or decreases) and operating income as a percentage of sales from our International Leathercraft stores for the three years ended December 31, 2013 were as follows:

 
Year
Net Sales
Increase from Prior Yr
 
Operating Income (Loss)
Operating Inc/Loss
Incr (Decr) from Prior Year
Operating Income (Loss) as a
% of  Sales
2013
20.0%
$399,643
1806.6%
10.2%
2012
53.0%
$(23,418)
(109.5)%
(0.7)%
2011
25.6%
$247,549
(23.8)%
11.6%


The operating loss in 2012 was caused by the Australia and Spain stores, simply because they were new.  We intend to expand our International Leathercraft segment by opening new stores once the current stores have sufficiently built their customer bases to a level that will adequately support additional stores.

 
Financial Condition
 
At December 31, 2013, we held $11.1 million of cash, $26.3 million of inventory, accounts receivable of approximately $762,000, and $14.4 million of property and equipment.  Goodwill and other intangibles (net of amortization and depreciation) were approximately $982,000 and $103,000, respectively.  Net total assets were $56.4 million.  Current liabilities were $8.2 million (including approximately $203,000 of current maturities of long-term debt), while long-term debt was $2.4 million.  Total stockholders’ equity at the end of 2013 was $44.6 million.

At December 31, 2012, we held $7.7 million of cash, $25.9 million of inventory, accounts receivable of approximately $823,000, and $11.9 million of property and equipment.  Goodwill and other intangibles (net of amortization and depreciation) were approximately $991,000 and $146,000, respectively.  Net total assets were $49.1 million.  Current liabilities were $7.9 million (including approximately $203,000 of current maturities of long-term debt), while long-term debt was $2.9 million.  Total stockholders’ equity at the end of 2012 was $37.5 million.

Specific ratios on a consolidated basis at the end of each year ended December 31 were as follows:

   
2013
2012
2011
Solvency Ratios:
       
Quick Ratio
(Cash+Accts Rec)/Total Current Liabilities
1.45
1.09
1.76
Current Ratio
Total Current Assets/Total Current Liabilities
4.96
4.54
4.74
Current Liabilities to Net Worth
Total Current Liabilities/Net Worth
0.18
0.21
0.21
Current Liabilities to Inventory
Total Current Liabilities/Inventory
0.31
0.30
0.36
Total Liabilities to Net Worth
Total Liabilities/Net Worth
0.26
0.31
0.32
Fixed Assets to Net Worth
Fixed Assets/Net Worth
0.32
0.32
0.30
         
Efficiency Ratios:
       
Collection Period (Days Outstanding)
Accounts Receivable/Credit Sales x 365
32.87
40.06
42.35
Inventory Turnover
Sales/Average Inventory
3.00
3.18
3.29
Assets to Sales
Total Assets/Sales
0.72
0.68
0.69
Sales to Net Working Capital
Sales/Current Assets - Current Liabilities
2.42
2.62
2.49
Accounts Payable to Sales
Accounts Payable/Sales
0.02
0.02
0.03
         
Profitability Ratios:
       
Return on Sales (Profit Margin)
Net Profit After Taxes/Sales
0.09
0.08
0.07
Return on Assets
Net Profit After Taxes/Total Assets
0.13
0.11
0.10
Return on Net Worth (Return on Equity)
Net Profit After Taxes/Net Worth
0.16
0.15
0.14
         

Capital Resources and Liquidity

On July 31, 2007, we entered into a Credit Agreement and Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a credit facility of up to $5,500,000 to facilitate our purchase and remodel of real estate consisting of a 191,000 square foot building situated on 30 acres of land located at 1900 SE Loop 820 in Fort Worth, Texas.  Proceeds in the amount of $4,050,000 were used to fund the initial purchase of the property.  On April 30, 2008, that amount was rolled into a ten-year term note, and we began making monthly debt service payments in May 2008.

On July 12, 2012, we executed a Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a revolving credit facility of up to $4,000,000 for working capital purposes.  The revolver bears interest at LIBOR plus 2.0% (2.2442% at December 31, 2013) and was to mature on June 30, 2013. On June 25, 2013, we executed a Note Modification Agreement which extends the maturity date of the Line of Credit Note to June 30, 2014.  All other terms remain unchanged.  Interest is paid monthly.  The unused amount at December 31, 2013 was $4 million.

We are currently in compliance with all covenants and conditions contained in our agreements with JPMorgan Chase Bank, N.A. 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 2013, 2012 and 2011 required net cash of approximately $392,000, $2.7 million, and $200,000, respectively.  The special dividend of $2.5 million paid in April 2012 was the reason for the significant increase in financing activities in 2012 compared to 2013 and 2011.

Our primary source of liquidity and capital resources during 2013 was cash flow provided by operating activities.  Net cash flow from operations for 2013, 2012 and 2011 was $7.5 million, $1.9 million, and $6.6 million, respectively.  The decrease in operating cash flow in 2012 was due to an increase in inventory in that year.  We intentionally increased the levels of inventory maintained at our stores which accounts for the increase in inventory compared to the prior year.  In 2013, cash flow from operations was generated from net income.  In 2012, cash flow from operations was generated from net income, a decrease in accounts receivable, and an increase in accrued expenses, partially offset by an increase in inventory and a decrease in income taxes payable.  In 2011, cash flows from operations was generated from net income, a decrease in inventory and an increase in accounts payable, partially offset by an increase in accounts receivable and a decrease in accrued expenses.

Consolidated accounts receivable decreased approximately $61,000 to $762,000 at December 31, 2013 compared to $823,000 at December 31, 2012.  Average days to collect accounts decreased from 40 days in 2012 to 33 days in 2013 on a consolidated basis.  We maintain a tight credit policy and have aggressively accelerated our collection efforts to ensure collectability of all customer accounts.

Inventory increased from $25.9 million at the end of 2012 to $26.3 million at December 31, 2013.  We have increased the amount of inventory carried in our stores to provide our customers with greater product selection and to promote continued sales growth.  We are also stocking additional inventory to support our growing International Leathercraft segment.  Further, while sales remain strong, we will continue to buy large quantities of our stock leathers at special prices as those opportunities present themselves in order to relieve pressure on our gross margins.  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 matching that of our internal targets for optimal inventory.
 
 
Consolidated inventory turned 3.00 times during 2013, a slight slowdown from the 2012 turns at 3.18 times.  We compute our inventory turnover rates as sales divided by average inventory.

By operating division, inventory turns are as follows:

Segment
2013
2012
2011
Wholesale Leathercraft
1.97
2.09
1.95
Retail Leathercraft
4.92
5.58
6.41
International Leathercraft
3.70
3.20
6.91
       
Wholesale Leathercraft stores only
4.79
5.26
6.68

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 $1.9 million at the end of 2013, an increase of $272,000 from $1.6 million at the end of 2012.
 
 
As discussed above, the largest use of operating cash in 2013 was the increase in prepaid expenses and inventory.  Cash paid for capital expenditures totaled $3.8 million and $2.7 million for the years ended December 31, 2013 and 2012, respectively. In 2013, the primary capital expenditure was the completion of the construction of the building to house our flagship store of $1.0 million.  Equipment and vehicles for the international stores totaled approximately $44,000.  We moved 13 stores in the U.S. in 2013.  Fixtures and equipment for those stores totaled $1.9 million.  Fixtures and equipment for the new U.S. stores opened in 2013 totaled approximately $493,000.  Other capital expenditures were computer equipment ($141,000), and factory machines and dies ($46,000).  In 2012, the primary capital expenditure was the construction in progress of the building to house our flagship store of $1.8 million.  Fixtures and equipment for the international stores totaled approximately $78,000.  We moved 14 stores in the U.S. in 2012.  Fixtures and equipment for those stores totaled approximately $406,000.  Fixtures and equipment for the new U.S. store opened in 2012 totaled approximately $51,000.  Other capital expenditures were computer equipment ($169,000), and factory machines and dies ($81,000).

We intend to continue to relocate U.S. stores into larger space as leases expire and therefore, expect to incur capital expenditures, namely fixtures, related to such moves.  Each store to be moved requires approximately $100,000 in fixtures and space buildout.  The construction of the building discussed above was completed in the second quarter of 2013 and we have no further construction plans at this time.  Therefore, we expect our 2014 capital expenditures to be less than our 2013 capital expenditures.

There were no stock repurchases in 2013, 2012 or 2011.

We believe that cash flow from operations will be adequate to fund our operations in 2014, 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 our 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 2013, 2012 or 2011, 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, 2013 (not including related interest expense):

 
Payments Due by Periods
 
Contractual Obligations
 
Total
Less than
1 Year
1 - 3
Years
3 -5
Years
More than
5 Years
Long-Term Debt(1)
$2,598,750
$202,500
$405,000
$1,991,250
$           -
Operating Leases(2)
10,218,378
3,307,344
4,671,716
2,079,267
160,051
Total Contractual Obligations
$12,817,128
$3,509,844
$5,076,716
$4,070,517
$160,051
____________________
(1)  Our term loan from JPMorgan Chase matures in May 2018.
(2)  These are our leased facilities.

Summary of Critical Accounting Policies

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

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

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

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

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

Goodwill.  We periodically analyze the remaining goodwill on our balance sheet to determine the appropriateness of its carrying value.  As of December 31, 2013, 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. Factors that could cause our actual results to differ materially from the results contemplated by such forward-looking statements include, but are not limited to, the risk factors described in Item 1A, “Risk Factors,” of this Annual Report on Form 10-K. Management cautions that forward-looking statements are not guarantees, and our actual results could differ materially from those expressed or implied in the forward-looking statements.  We do not intend to update forward-looking statements.


We face exposure to financial market risks, including adverse movement in foreign 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 13 to the Consolidated Financial Statements, Segment Information, for financial information concerning our foreign activities.

Interest Rate Risk

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




Tandy Leather Factory, Inc.
Consolidated Balance Sheets
December 31, 2013 and 2012


 
December 31,
 2013
 
December 31,
 2012
ASSETS
     
CURRENT ASSETS:
     
 
Cash
$11,082,679
 
$7,705,182
 
Accounts receivable-trade, net of allowance for doubtful accounts
     
     
of $1,000 and $112,000 in 2013 and 2012, respectively
762,405
 
822,772
 
Inventory
26,300,830
 
25,862,784
 
Deferred income taxes
309,533
 
349,478
 
Prepaid expenses
1,609,644
 
776,463
 
Other current assets
478,593
 
153,450
       
Total current assets
40,543,684
 
35,670,129
       
PROPERTY AND EQUIPMENT, at cost
20,290,990
 
17,574,895
Less accumulated depreciation and amortization
(5,863,280)
 
(5,630,305)
 
14,427,710
 
11,944,590
       
GOODWILL
981,985
 
990,725
OTHER INTANGIBLES, net of accumulated amortization of
     
 
$622,000 and $582,000 in 2013 and 2012, respectively
103,228
 
145,533
OTHER assets
341,959
 
336,695
Total Assets
$56,398,566
 
$49,087,672
       
LIABILITIES AND STOCKHOLDERS' EQUITY
     
CURRENT LIABILITIES:
     
 
Accounts payable-trade
$1,884,637
 
$1,612,627
 
Accrued expenses and other liabilities
5,808,882
 
5,928,798
 
Income taxes payable
272,198
 
113,705
 
Current maturities of long-term debt
202,500
 
202,500
       
Total current liabilities
8,168,217
 
7,857,630
       
DEFERRED INCOME TAXES
1,212,557
 
806,525
       
LONG-TERM DEBT, net of current maturities
2,396,250
 
2,902,500
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, 11,192,356 and 11,156,065 shares issued at 2013 and 2012, respectively
     
   
10,198,733 and 10,162,442 shares outstanding at 2013 and 2012, respectively
26,862
 
26,775
 
Paid-in capital
5,892,907
 
5,767,508
 
Retained earnings
41,507,592
 
34,241,875
 
Treasury stock at cost (993,623 shares at 2013 and 2012)
(2,894,068)
 
(2,894,068)
 
Accumulated other comprehensive income
88,249
 
378,927
       
Total stockholders' equity
44,621,542
 
37,521,017
Total Liabilities and Stockholders’ Equity
$56,398,566
 
$49,087,672











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



Tandy Leather Factory, Inc.
Consolidated Statements of Income
For the Years Ended December 31, 2013, 2012 and 2011


 
2013
 
2012
 
2011
           
NET SALES
$78,284,585
 
$72,720,624
 
$66,102,947
COST OF SALES
28,956,561
 
26,814,950
 
25,765,788
 
Gross Profit
49,328,024
 
45,905,674
 
40,337,159
           
OPERATING EXPENSES
38,061,234
 
36,761,669
 
32,630,509
INCOME FROM OPERATIONS
11,266,790
 
9,144,005
 
7,706,650
           
OTHER (INCOME) EXPENSE:
         
Interest expense
206,763
 
240,934
 
248,576
Other, net
(160,732)
 
(42,574)
 
(83,428)
 
Total other expense
46,031
 
198,360
 
165,148
           
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
11,220,759
 
8,945,645
 
7,541,502
           
PROVISION FOR INCOME TAXES
3,955,042
 
3,349,575
 
2,787,533
           
NET INCOME FROM CONTINUING OPERATIONS
7,265,717
 
5,596,070
 
4,753,969
           
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX
-
 
-
 
(1,368)
           
NET INCOME
$7,265,717
 
$5,596,070
 
$4,752,601
           
NET INCOME FROM CONTINUING OPERATIONS PER COMMON SHARE:
         
BASIC
$0.71
 
$0.55
 
$0.47
DILUTED
$0.71
 
$0.55
 
$0.47
           
INCOME FROM DISCONTINUED OPERATIONS, NET OF TAX PER COMMON SHARE:
         
BASIC
$0.00
 
$0.00
 
$0.00
DILUTED
$0.00
 
$0.00
 
$0.00
           
NET INCOME PER COMMON SHARE:
         
BASIC
$0.71
 
$0.55
 
$0.47
DILUTED
$0.71
 
$0.55
 
$0.47
           
Weighted Average Number of Shares Outstanding:
         
  Basic
10,176,492
 
10,157,395
 
10,156,442
  Diluted
10,216,438
 
10,175,346
 
10,182,098





Tandy Leather Factory, Inc.
Consolidated Statements of Comprehensive Income
For the Years Ended December 31, 2013, 2012 and 2011

 
2013
 
2012
 
2011
           
NET INCOME
$7,265,717
 
$5,596,070
 
$4,752,601
Foreign currency translation adjustments
(290,678)
 
(3,703)
 
(113,550)
 
COMPREHENSIVE INCOME
$6,975,039
 
$5,592,367
 
$4,639,051



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



Tandy Leather Factory, Inc.
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2013, 2012 and 2011

 
2013
 
2012
 
2011
CASH FLOWS FROM OPERATING ACTIVITIES:
         
 
Net income
$7,265,717
 
$5,596,070
 
$4,752,601
 
Income (loss) from discontinued operations
-
 
-
 
(1,368)
   
7,265,717
 
5,596,070
 
4,753,969
 
Adjustments to reconcile net income to net cash
         
   
provided by operating activities -
         
     
Depreciation and amortization
1,194,612
 
1,068,226
 
1,016,561
     
Loss on disposal or abandonment of assets
109,222
 
21,092
 
84,168
     
Non-cash stock-based compensation
11,686
 
10,000
 
33,156
     
Deferred income taxes
445,977
 
(120,531)
 
256,544
     
Other
(261,908)
 
(15,227)
 
(106,345)
     
Net changes in assets and liabilities, net of effect of
         
       
business acquisitions:
         
         
Accounts receivable-trade
60,367
 
505,807
 
(74,940)
         
Inventory
(438,046)
 
(5,922,533)
 
295,777
         
Prepaid expenses
(833,181)
 
(36,728)
 
243,181
         
Other current assets
(325,143)
 
55,274
 
(135,439)
         
Accounts payable-trade
272,010
 
(10,070)
 
374,876
         
Accrued expenses and other liabilities
(119,916)
 
1,287,607
 
(252,045)
         
Income taxes
158,493
 
(525,192)
 
84,216
 
Total adjustments
274,173
 
(3,682,275)
 
1,819,710
           
Net cash provided by continuing operating activities
7,539,890
 
1,913,795
 
6,573,679
           
Cash used in discontinued operating activities
-
 
-
 
(1,067)
           
Net cash provided by operating activities
7,539,890
 
1,913,795
 
6,572,612
           
CASH FLOWS FROM INVESTING ACTIVITIES:
         
 
Purchase of property and equipment
(3,770,022)
 
(2,686,221)
 
(1,100,523)
 
Purchases of certificates of deposit
-
 
-
 
(87,893)
 
Proceeds from maturities of certificates of deposit
-
 
423,893
 
1,285,593
 
Proceeds from sale of assets
5,343
 
1,230
 
26,263
 
Decrease (increase) in other assets
(5,264)
 
4,545
 
(21,707)
           
Net cash provided by (used in) investing activities
(3,769,943)
 
(2,256,553)
 
101,733
           
CASH FLOWS FROM FINANCING ACTIVITIES:
         
 
Payments on notes payable and long-term debt
(506,250)
 
(202,500)
 
(202,500)
 
Payment of cash dividend
-
 
(2,536,131)
 
-
 
Proceeds from issuance of common stock
113,800
 
20,980
 
-
           
Net cash used in financing activities
(392,450)
 
(2,717,651)
 
(202,500)
           
NET INCREASE (DECREASE) IN CASH
3,377,497
 
(3,060,409)
 
6,471,845
           
CASH, beginning of period
7,705,182
 
10,765,591
 
4,293,746
           
CASH, end of period
$11,082,679
 
$7,705,182
 
$10,765,591
           
           
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
         
Interest paid during the period
$206,763
 
$240,934
 
$248,576
Income tax paid during the period, net of (refunds)
3,348,676
 
4,004,510
 
2,437,701
           




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




Tandy Leather Factory, Inc.
Consolidated Statements of Stockholders' Equity
For the Years Ended December 31, 2013, 2012 and 2011

 

 
 
Number of Shares
 
 
Par Value
 
 
Paid-in Capital
 
 
Treasury Stock
 
 
Retained Earnings
 
Accumulated Other Comprehensive Income (Loss)
 
 
Total
BALANCE, December 31, 2010
10,156,442
 
$26,760
 
$5,703,387
 
$(2,894,068)
 
$26,429,335
 
$496,180
 
$29,761,594
                           
Stock-based compensation
-
 
-
 
33,156
 
-
 
-
 
-
 
33,156
Net  income
-
 
-
 
-
 
-
 
4,752,601
 
-
 
4,752,601
Translation adjustment
-
 
-
 
-
 
-
 
-
 
(113,550)
 
(113,550)
BALANCE, December 31, 2011
10,156,442
 
26,760
 
5,736,543
 
(2,894,068)
 
31,181,936
 
382,630
 
34,433,801
                           
Shares issued - stock options exercised
6,000
 
15
 
20,965
 
-
 
-
 
-
 
20,980
Stock-based compensation
-
 
-
 
10,000
 
-
 
-
 
-
 
10,000
Net  income
-
 
-
 
-
 
-
 
5,596,070
 
-
 
5,596,070
Cash dividend paid
-
 
-
 
-
 
-
 
(2,536,131)
 
-
 
(2,536,131)
Translation adjustment
-
 
-
 
-
 
-
 
-
 
(3,703)
 
(3,703)
BALANCE, December 31, 2012
10,162,442
 
26,775
 
5,767,508
 
(2,894,068)
 
34,241,875
 
378,927
 
37,521,017
                           
Shares issued - stock options exercised
36,291
 
87
 
113,713
 
-
 
-
 
-
 
113,800
Stock-based compensation
-
 
-
 
11,686
 
-
 
-
 
-
 
11,686
Net  income
-
 
-
 
-
 
-
 
7,265,717
 
-
 
7,265,717
Translation adjustment
-
 
-
 
-
 
-
 
-
 
(290,678)
 
(290,678)
BALANCE, December 31, 2013
10,198,733
 
$26,862
 
$5,892,907
 
$(2,894,068)
 
$41,507,592
 
$88,249
 
$44,621,542







 









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




TANDY LEATHER FACTORY, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER 31, 2013, 2012, and 2011

1.  DESCRIPTION OF BUSINESS
 
 
Our primary line of business is the sale of leather, leather crafts and related supplies.  We sell our products via company-owned stores throughout the United States, Canada, 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 gains of $41,000 and $26,000 in 2013 and 2012, respectively, and a foreign currency transaction loss of $200 in 2011.

·  
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, seven to fifteen 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 to net realizable value for slow-moving or obsolete inventory based on management's review of items on hand compared to their estimated future demand.

·  
Impairment of long-lived assets

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

·  
Earnings per share

Basic earnings per share are computed based on the weighted average number of common shares outstanding during the period.  Diluted earnings per share includes, to the extent inclusion of such shares would be dilutive to earnings per share, the effect of outstanding options and warrants, computed using the treasury stock method.
 
BASIC
2013
 
2012
 
2011
Net income
$7,265,717
 
$5,596,070
 
$4,752,601
           
Weighted average common shares outstanding
10,176,492
 
10,157,395
 
10,156,442
           
Earnings per share – basic
$0.71
 
$0.55
 
$0.47
           
DILUTED
         
Net income
$7,265,717
 
$5,596,070
 
$4,752,601
           
Weighted average common shares outstanding
10,176,492
 
10,157,395
 
10,156,442
Effect of assumed exercise of stock options and warrants
39,946
 
17,951
 
25,656
Weighted average common shares outstanding, assuming dilution
10,216,438
 
10,175,346
 
10,182,098
           
Earnings per share - diluted
$0.71
 
$0.55
 
$0.47
           
Outstanding options and warrants excluded as anti-dilutive
-
 
-
 
25,000

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 84,600, 125,600, and 90,600 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, 2013, 2012 and 2011, 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, 2013, 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, 2013 and 2012 is as follows:

 
Leather Factory
 
Tandy Leather
 
Total
Balance, December 31, 2011
$603,603
 
$383,406
 
$987,009
Acquisitions and adjustments
-
 
-
 
-
Foreign exchange gain/loss
3,716
 
-
 
3,716
Impairments
-
 
-
 
-
Balance, December 31, 2012
$607,319
 
$383,406
 
$990,725
Acquisitions and adjustments
-
 
-
 
-
Foreign exchange gain/loss
(8,740)
 
-
 
(8,740)
Impairments
-
 
-
 
-
Balance, December 31, 2013
$598,579
 
$383,406
 
$981,985

As of December 31, 2013 and 2012, our intangible assets and related accumulated amortization consisted of the following:

 
As of December 31, 2013
 
Gross
 
Accumulated Amortization
 
Net
Trademarks, Copyrights
$544,369
 
$487,891
 
$56,478
Non-Compete Agreements
181,216
 
134,466
 
46,750
 
$725,585
 
$622,357
 
$103,228

 
As of December 31, 2012
 
Gross
 
Accumulated Amortization
 
Net
Trademarks, Copyrights
$544,369
 
$456,836
 
$87,533
Non-Compete Agreements
183,216
 
125,216
 
58,000
 
$727,585
 
$582,052
 
$145,533

Excluding goodwill, we have no intangible assets not subject to amortization under U.S. GAAP.  Amortization of intangible assets of $42,305 in 2013, $41,759 in 2012, and $44,933 in 2011 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:
 
 
Leather Factory
Tandy Leather
Total
2014
$505
$45,004
$45,509
2015
-
40,302
40,302
2016
-
5,667
5,667
2017
-
1000
1,000
2018
-
750
750

·  
Fair value of financial Instruments

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

·  
Income taxes

We account for income taxes using the asset and liability method.  Under this method, the amount of taxes currently payable or refundable is 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 includes 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 different 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 permits annual stock option grants to non-employee directors with an exercise price equal to the fair market value of the shares at the date of grant.  Under this plan, 12,000 options were awarded to directors in each of the years 2013, 2012 and 2011.  These options vest and become exercisable six months from the option grant date.  We had two other stock option plans from 1995 which provided for stock option grants to officers, key employees and non-employee directors.  These plans expired in 2005.  The expiration of the plans has no effect on the options previously granted.  Options outstanding and exercisable were granted at a stock option price which was not less than the fair market value of our common stock 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 $11,686, $10,000, and $33,000 for the years ended December 31, 2013, 2012 and 2011, respectively, as a component of operating expenses.
 
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, 2011
$4.35
103,600
   
Granted
4.80
12,000
   
Cancelled
-
-
   
Exercised
-
-
   
Outstanding, December 31, 2011
$4.40
115,600
5.15
$206,332
Exercisable, December 31, 2011
$4.40
115,600
5.15
$206,332

Outstanding, January 1, 2012
$4.40
115,600
   
Granted
5.27
12,000
   
Cancelled
-
-
   
Exercised
3.50
(6,000)
   
Outstanding, December 31, 2012
$4.53
121,600
4.83
$206,760
Exercisable, December 31, 2012
$4.53
121,600
4.83
$206,760
         
Outstanding, January 1, 2013
$4.53
121,600
   
Granted
6.87
12,000
   
Cancelled
-
-
   
Exercised
4.23
(49,000)
   
Outstanding, December 31, 2013
$5.04
84,600
7.22
$104,656
Exercisable, December 31, 2013
$5.04
84,600
7.22
$104,656

Other information pertaining to option activity during the twelve month periods ended December 31, 2013, 2012 and 2011 are as follows:
 
 
2013
2012
2011
Weighted average grant-date fair value of stock options granted
$0.97
$0.83
$1.19
Total fair value of stock options vested
$11,686
$10,000
$14,257
Total intrinsic value of stock options exercised
$113,790
$9,572
N/A

As of December 31, 2013, there was no unrecognized compensation cost related to non-vested stock options.

Cash received from the exercise of stock options for the years ended December 31, 2013 and 2012 was $113,800 and $20,980, respectively.  No stock options were exercised in 2011.

The fair value of options at the date of grant was estimated using the Black-Scholes option pricing model (BSM) with the following weighted-average assumptions:

 
2013
2012
2011
Volatility
19.1%
21.4%
33.8%
Expected option life
3
3
3
Interest rate (risk free)
0.80%
0.875%
1.5%
Dividends
None
None
None

The assumptions 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.

We also have a restricted stock plan that was adopted by our Board of Directors in January 2013 and approved by our stockholders in June 2013.  The plan reserves up to 300,000 shares of our common stock for restricted stock awards to our executive officers, non-employee directors and other key employees.  Awards granted under the plan may be stock awards or performance awards, and may be subject to a graded vesting schedule with a minimum vesting period of four years.  No awards were made as of December 31, 2013.
 
·  
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 $1,978,000, $1,767,000, and $1,725,000 for the years ended December 31, 2013, 2012 and 2011, 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 $168,000 and $181,000 at December 31, 2013 and 2012, respectively.  Total advertising expense was $4,099,000 in 2013; $3,543,000 in 2012; and $2,972,000 in 2011.

·  
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.  We held no short-term investments as of December 31, 2013 and 2012.  Investments at December 31, 2011 consisted of certificates of deposit.

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 $1,000 and $112,000 at December 31, 2013 and 2012, respectively.  The following is a roll forward of the allowance for doubtful accounts:
 
 
Year ended:
Balance at
beginning of year
Reserve "purchased"
during year
Additions (reductions)
charged to costs and expenses
Foreign exchange
gain/loss
 
Write-offs
Balance at
end of year
December 31, 2013
$111,996
-
$(106,504)
$(727)
$(3,594)
$1,171
December 31, 2012
80,926
-
77,143
242
(46,315)
111,996
December 31, 2011
146,929
-
(45,315)
156
(20,844)
80,926

·  
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.  Reductions in inventory for slow-moving and obsolete inventory are recorded directly against inventory.

5.  BALANCE SHEET COMPONENTS

 
December 31, 2013
 
December 31, 2012
INVENTORY
     
On hand:
     
    Finished goods held for sale
$24,546,771
 
$24,039,846
    Raw materials and work in process
853,200
 
495,182
Inventory in transit
900,859
 
1,327,756
TOTAL
$26,300,830
 
$25,862,784
       
PROPERTY AND EQUIPMENT
     
Building
$9,232,066
 
$6,412,861
Land
1,451,132
 
1,451,132
Leasehold improvements
527,637
 
652,641
Equipment and machinery
4,321,509
 
4,124,553
Furniture and fixtures
4,597,366
 
3,034,128
Vehicles
161,280
 
77,396
Construction in progress
-
 
1,822,184
 
20,290,990
 
17,574,895
Less:  accumulated depreciation
(5,863,280)
 
(5,630,305)
TOTAL
$14,427,710
 
$11,944,590
       
PREPAID EXPENSES
     
Prepaid insurance
$479,220
 
$51,113
Prepaid postage
89,702
 
67,650
Prepaid advertising
309,908
 
296,687
Prepaid rent
93,866
 
46,825
Prepaid supplies/equipment
145,223
 
67,098
Prepaid licenses/dues
120,476
 
48,855
Prepaid IT services
315,099
 
103,609
Prepaid other
56,150
 
94,626
TOTAL
$1,609,644
 
$776,463
       
OTHER CURRENT ASSETS
     
Accounts receivable - employees
$80,556
 
$47,533
Accounts receivable - other
257,932
 
22,244
Payments for merchandise not received
140,105
 
83,673
TOTAL
$478,593
 
$153,450
       
OTHER ASSETS
     
Security deposits - utilities, locations, etc.
$89,959
 
$84,695
Leather art collection
252,000
 
252,000
TOTAL
$341,959
 
$336,695
       
ACCRUED EXPENSES AND OTHER LIABILITIES
 
 
 
Accrued bonuses
$2,741,003
 
$2,238,057
Accrued payroll
702,456
 
629,636
Deferred revenue
864,104
 
826,467
Sales and payroll taxes payable
423,340
 
295,482
Inventory in transit
321,608
 
1,327,756
Other
756,371
 
611,400
TOTAL
$5,808,882
 
$5,928,798

Depreciation expense was $1,152,307, $1,026,467, and $971,628 for the years ended December 31, 2013, 2012 and 2011, respectively.

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 segment and $70,284 of which is reported in our Wholesale Leathercraft segment.

The 2012 loss from abandonment and/or disposal of obsolete equipment totaled $21,092.  The loss is included in Operating expenses, $13,536 of which is reported in our Retail Leathercraft segment, $6,232 of which is reported in our Wholesale Leathercraft segment, and $1,324 of which is reported in our International Leathercraft segment.

The 2013 loss from abandonment and/or disposal of obsolete equipment totaled $109,222.  The loss is included in Operating expenses, $32,348 of which is reported in our Retail Leathercraft segment, and $76,874 of 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, 2013 and 2012, the amount outstanding under the above agreement consisted of the following:

 
2013
 
2012
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
$  2,598,750
 
$  3,105,000
 
2,598,750
 
3,105,000
Less - Current maturities
(202,500)
 
(202,500)
 
$2,396,250
 
$2,902,500

The terms of the credit facility contain various covenants which among other things require us 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, 2013.

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

2014
$202,500
2015
202,500
2016
202,500
2017
202,500
2018
1,788,750
 
$2,598,750

On July 12, 2012, we executed a Line of Credit Note with JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with a revolving credit facility of up to $4,000,000.  The revolver bears interest at LIBOR plus 2.0% (2.2442% at December 31, 2013) and was to mature on June 30, 2013. On June 25, 2013, we executed a Note Modification Agreement which extends the maturity date of the Line of Credit Note to June 30, 2014.  All other terms remain unchanged.  Interest is paid monthly. This note was obtained for working capital purposes and is secured by the real estate and improvements located at 1900 Southeast Loop 820, Fort Worth, Texas.  No amounts were outstanding under the agreement at December 31, 2013.

7.  EMPLOYEE BENEFIT AND SAVINGS PLANS

We have a 401(k) plan to provide retirement benefits for our employees.  As allowed under Section 401(k) of the Internal Revenue Code, the plan provides tax-deferred salary contributions for eligible employees and allows employees to contribute a percentage of their annual compensation to the plan on a pretax basis.  Employee contributions are limited to a maximum annual amount as set periodically by the Internal Revenue Code.  In 2013 and 2012, we matched 100% of the pretax employee contributions on the first 3% of eligible earnings and 50% of the pretax employee contributions on the next 2% of eligible earnings that are contributed by employees.  In 2011, we matched 100% of the pretax employee contributions on the first 3% of the eligible earnings that are contributed by employees.
 
 
Year Ended December 31,
Maximum Matching
Contribution per Participant*
Total Matching
Contribution
2013
$10,200
$301,434
2012
$7,500
$308,567
2011
$7,350
$217,539

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

The plan allows employees who meet the age requirements and reach the plan contribution limits to make a catch-up contribution.  The catch-up contributions are not eligible for matching contributions.  In addition, the plan provides for discretionary matching contributions as determined by the Board of Directors.  There were no discretionary matching contributions made in 2013, 2012 or 2011.
 
 
We currently offer no postretirement or postemployment benefits to our employees.

8.  INCOME TAXES

The provision for income taxes consists of the following:

   
2013
 
2012
 
2011
Current provision:
           
 
Federal
$2,982,023
 
$3,054,862
 
$2,155,653
 
State
527,042
 
415,244
 
375,336
   
3,509,065
 
3,470,106
 
2,530,989
             
Deferred provision (benefit):
           
 
Federal
399,032
 
(107,843)
 
229,540
 
State
46,945
 
(12,688)
 
27,004
   
445,977
 
(120,531)
 
256,544
             
   
$3,955,042
 
$3,349,575
 
$2,787,533
 
Income before income taxes is earned in the following tax jurisdictions:

 
2013
 
2012
 
2011
United States
$9,920,099
 
$7,941,689
 
$6,344,634
United Kingdom
565,538
 
509,426
 
476,414
Canada
858,532
 
999,609
 
945,041
Australia
69,905
 
(210,372)
 
(131,467)
Spain
(193,315)
 
(294,707)
 
(93,120)
 
$11,220,759
 
$8,945,645
 
$7,541,502

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

 
2013
 
2012
Deferred income tax assets:
     
Allowance for doubtful accounts
$98
 
$39,310
Capitalized inventory costs
208,384
 
200,017
Warrants and stock-based compensation
48,591
 
54,042
Accrued expenses, reserves, and other
101,050
 
110,151
Total deferred income tax assets
358,123
 
403,520
       
Deferred income tax liabilities:
     
Property and equipment depreciation
1,074,646
 
689,893
Goodwill and other intangible assets amortization
186,501
 
170,674
Total deferred income tax liabilities
1,261,147
 
860,567
       
Net deferred tax asset (liability)
$(903,024)
 
$(457,047)

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

 
2013
 
2012
Current deferred tax assets
$309,533
 
$349,478
Long-term deferred tax liabilities
(1,212,557)
 
(806,525)
Net deferred tax asset (liability)
$(903,024)
 
$(457,047)

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

   
2013
2012
2011
Statutory rate – Federal US income tax
 
34%
34%
34%
State and local taxes
 
6%
4%
4%
Non-U.S. income tax at different rates
 
(1%)
1%
2%
Domestic production activities deduction
 
(2%)
(1%)
(1%)
Other, net
 
(2%)
(1%)
(2%)
Effective rate
 
35%
37%
37%

We file a consolidated U.S. income tax return as well as state tax returns on a consolidated, combined or stand-alone basis, depending on the jurisdiction.  We are no longer subject to U.S. federal income tax examinations by tax authorities for years prior to the tax year ended December 2011.  Depending on the jurisdiction, we are no longer subject to state examinations by tax authorities for years prior to the December 2010 and December 2011 tax years.
 
9.  COMMITMENTS AND CONTINGENCIES

Operating Leases

We lease our store locations under five-year lease agreements that expire on dates ranging from March 2014 to May 2020.  Rent expense on all operating leases for the years ended December 31, 2013, 2012, and 2011, was $3,312,152, $3,135,773, and $2,750,373, respectively.

Future minimum lease payments under noncancelable operating leases at December 31, 2013 were as follows:

Year ending December 31:
 
 2014
$3,307,344
 2015
2,689,245
 2016
1,982,471
 2017
1,401,911
 2018
677,356
 2019
132,384
 2020
27,667
Total minimum lease payments
$10,218,378

Legal Proceedings

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 transferred to the United State District Court, Northern District of Texas, Fort Worth Division (“Court”), and an amended complaint was filed on May 9, 2011 by plaintiffs to add another former employee, Donna Cavota, as a third named plaintiff.  The suit alleged that we violated requirements of the Fair Labor Standards Act (FLSA) as well as various state wage laws.  Plaintiffs sought to represent themselves and all similarly situated U.S. current and former store managers of ours.   A Settlement Agreement was reached between the parties, and on September 24, 2012, the Court issued an Order Preliminarily Approving the Settlement of all federal and state claims asserted by the plaintiffs in the litigation.  We continue to deny any violation of any statute, law, rule or regulation, any liability or wrongdoing, and the truth of plaintiffs’ allegations. We agreed to enter into the Settlement Agreement to avoid further expense and inconvenience, end the disruption and burden of the litigation, avoid any other present or future litigation arising out of the facts that gave rise to the litigation, avoid the risk inherent in uncertain complex litigation, and to put to rest the controversy underlying the litigation.

The Settlement Agreement preliminarily approved by the Court required us to establish a fund designated as a Qualified Settlement Fund (Escrow Account) in the amount of $993,386 to fund (1) settlement payments to the plaintiffs, (2) settlement payments to the other members of the settlement class who joined the case, (3) plaintiffs’ attorneys’ fees and expenses, and (4) and the claim administrator (Escrow Agent’s) fees and expenses.   The foregoing description is not complete and is qualified in its entirety by reference to the full text of the Settlement Agreement which was attached as Exhibit 10.1 to a Current Report on Form 8-K, as filed with the Securities and Exchange Commission on October 1, 2012.
 
The deadline established by the Court for any persons employed by us as store managers between November 23, 2008 and September 24, 2012 to join the lawsuit as class members expired on May 24, 2013.  On June 28, 2013, the Court issued two orders: (1) an Order Approving Class and Collective Action Settlement and Dismissing Case with Prejudice, and (2) a Final Judgment, Approving Class and Collective Action Settlement and Dismissing Case with Prejudice.  Pursuant to the Court’s June 28, 2013 orders, the claims administrator (Escrow Agent) was required to make payments to the plaintiffs and those existing and former store managers who joined the lawsuit by signing and returning Consent to Join Forms, which contained a release of us from the claims asserted in plaintiffs’ lawsuit.
 
The settlement payments to the class members and the plaintiffs were made from the Escrow Account pursuant to the formula set forth in the Settlement Agreement by the claims administrator, as well as the payment of the plaintiffs’ attorney’s fees and the fees and expenses of the claims administrator (Escrow Agent).  The total payment from the Escrow Account, including our required FICA payments based on the settlement payments, was $744,273 from the total Escrow Account of $993,386.  All payments were made by the claims administrator and the balance of the Escrow Account (approximately $249,000) was returned to us in the first quarter of 2014.
 
In connection with the settlement, we recorded a charge to operations of $993,386 during the quarter ended September 30, 2012 as this amount, as ordered by the Court, covered the full settlement of all claims of the plaintiffs and the class members, plaintiffs’ attorneys’ fees, and the fees and expenses of the claims administrator (Escrow Agent) in accordance with the terms of the Settlement Agreement. In the quarter ended June 30, 2013, we recorded a benefit of approximately $312,000, which was the expected remaining balance in the Escrow Account after all payments have been made.  Payroll taxes associated with the payments to claimants of approximately $63,000 was recorded in the fourth quarter of 2013.
 
We are periodically involved in various other 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 leathercraft.  While no single customer accounted for more than 1% of our consolidated revenues in 2013, 2012 or 2011, sales to our five largest customers represented 2.5%, 2.9% and 5.5%, 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, 2013, 2012, and 2011, 16%, 30% and 34%, 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 or 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.

11.  STOCKHOLDERS' EQUITY

a)  
Stock Option Plan

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

We had two other stock options plans from 1995 which provided 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 21,400 un-optioned shares available for future grants.
 
A summary of stock option transactions for the yearsended December 31, 2013, 2012, and 2011, is as follows:

 
 
 2013
 
2012
 
2011
       
Weighted
     
Weighted
     
Weighted
       
Average
     
Average
     
Average
   
Option
 
Exercise
 
Option
 
Exercise
 
Option
 
Exercise
   
Shares
 
Price
 
Shares
 
Price
 
Shares
 
Price
Outstanding at January 1
 
121,600
 
$4.53
 
115,600
 
$4.40
 
103,600
 
$4.35
Granted
 
        12,000
 
           6.87
 
       12,000
 
           5.27
 
       12,000
 
           4.80
Forfeited or expired
 
-
 
-
 
-
 
-
 
-
 
-
Exchanged
 
-
 
-
 
-
 
-
 
-
 
-
Exercised
 
      (49,000)
 
4.23
 
(6,000)
 
3.50
 
         -
 
-
Outstanding at December 31
 
84,600
 
$5.04
 
121,600
 
$4.53
 
115,600
 
$4.40
Exercisable at end of year