Our Business

We are the world's largest specialty retailer and wholesale distributor of leather and leathercraft related items. We market our products to our growing list of customers through company-owned retail and wholesale stores. We are a Delaware corporation, and our common stock trades on the NYSE Amex (formerly the American Stock Exchange) under the symbol, "TLF." We operate our business in four segments: Wholesale Leathercraft, which operates wholesale stores in North America under the trade name, The Leather Factory, Retail Leathercraft, which operates retail stores in North America under the trade name, Tandy Leather Company, International Leathercraft, which operates combination retail/wholesale stores outside of North America under the trade name, Tandy Leather Factory, and Other. See Note 6 to the Consolidated Financial Statements for additional information concerning our segments, as well as our foreign operations.

Our Wholesale Leathercraft segment operates 30 company-owned wholesale stores in 20 states and three Canadian provinces. These stores are engaged in the wholesale distribution of leather and related items, including leatherworking tools, buckles and belt adornments, leather dyes and finishes, saddle and tack hardware, and do-it-yourself kits, to retailers, manufacturers, and end-users. Our Wholesale Leathercraft segment also includes our National Account sales group.

Our Retail Leathercraft segment operates company-owned Tandy Leather Company retail stores in 35 states and five Canadian provinces. Tandy Leather Company, the oldest and best-known supplier of leather and related supplies used in the leathercraft industry, has been the primary leathercraft resource for decades. Tandy Leather's products include quality tools, leather, accessories, kits and teaching materials. In 2002, we began expanding Tandy Leather's industry presence by opening retail stores. As of November 1, 2009, we were operating 75 Tandy Leather retail stores located throughout the United States and Canada.

Our International Leathercraft segment operates one company-owned store in Northampton, United Kingdom. The store, which opened in February 2008, operates as a combination retail and wholesale store.

Our "Other" segment consists of Roberts, Cushman and Co., a wholly-owned subsidiary that custom designs and distributes decorative hat trims for headwear manufacturers.

Critical Accounting Policies

A description of our critical accounting policies appears in Item 7 "Management's Discussions and Analysis of Financial Condition and Results of Operations" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.

Certain statements contained in this report and other materials we file with the Securities and Exchange Commission, as well as information included in oral statements or other written statements made or to be made by us, other than statements of historical fact, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements generally are accompanied by words such as "may," "will," "could," "should," "anticipate," "believe," "budgeted," "expect," "intend," "plan," "project," "potential," "estimate," "continue," or "future" variations thereof or other similar statements. There are certain important risks that could cause results to differ materially from those anticipated by some of the forward-looking statements. Some, but not all, of the important risks, including those described below, could cause actual results to differ materially from those suggested by the forward-looking statements. Please refer also to our annual report on Form 10-K for fiscal year ended December 31, 2008 for additional information concerning these and other uncertainties that could negatively impact the Company.

††† We believe that a rise in oil and natural gas prices will increase the costs of the goods that we sell, including the costs of shipping those goods from the manufacturer to our stores and customers.

Various oils used to manufacture certain leather and leathercrafts are derived from petroleum and natural gas. Also, the carriers who transport our goods rely on petroleum-based fuels to power their ships, trucks and trains. They are likely to pass any incurred cost increases on to us. We are unsure how much of this increase we will be able to pass on to our customers.

††† Continued weakness in the economy in the United States, as well as abroad, may cause our sales to decrease or not to increase or adversely affect the prices charged for our products. Furthermore, negative trends in general consumer-spending levels, including the impact of the availability and level of consumer debt and levels of consumer confidence could adversely affect our sales.

General economic factors that are beyond our control impact our forecasts and actual performance. These factors include interest rates, recession, inflation, deflation, consumer credit availability, consumer debt levels, tax rates and policy, unemployment trends and other matters that influence consumer confidence and spending.

We assume no obligation to update or otherwise revise our forward-looking statements even if experience or future changes make it clear that any projected results, express or implied, will not be realized.

Results of Operations

Three Months Ended September 30, 2009 and 2008

The following tables present selected financial data of each of our four
segments for the quarters ended September 30, 2009 and 2008.

                  Quarter Ended September 30,      Quarter Ended September
                             2009                          30, 2008
                      Sales        Operating          Sales        Operating
                                     Income                         Income
Wholesale            $5,877,153      $348,567        $5,997,550     $435,791
Leathercraft
Retail                6,444,179       472,653         5,726,164      234,743
Leathercraft
International           342,272        52,446           324,081       55,008
Leathercraft
Other                   123,660       (1,972)           204,195       39,941
Total Operations    $12,787,264      $871,694       $12,251,990     $765,483

Consolidated net sales for the quarter ended September 30, 2009 increased $535,000 or 4%, compared to the same period in 2008. Retail and International Leathercraft contributed $718,000 and $18,000 of additional sales, respectively, offset by a sales decrease of $120,000 and $81,000 in Wholesale Leathercraft and Other, respectively. Operating income on a consolidated basis for the quarter ended September 30, 2009 was up 14% or $106,000 over the third quarter of 2008.

The following table shows in comparative form our consolidated net income for the third quarters of 2009 and 2008:

Wholesale Leathercraft

Our Wholesale Leathercraft operation consists of 30 wholesale stores and our
National Account group. The following table presents the combined sales mix by
customer categories for the quarters ended September 30, 2009 and 2008:

                                                 Quarter ended
Customer Group                                09/30/09   09/30/08
 RETAIL (end users, consumers, individuals)        22%        19%
 INSTITUTION (prisons, prisoners, hospitals,        7%         6%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       45%        39%
& tack shops, authorized dealers, etc.)
 MANUFACTURERS                                      9%        10%
 NATIONAL ACCOUNTS                                 17%        26%
                                                  100%       100%

Net sales were down 2% for the third quarter of 2009 as follows:

                          Quarter          Quarter        $ change  % change
                       Ended 09/30/09   Ended 09/30/08
Same store sales (30)      $5,056,473       $5,289,155   $(232,682)   (4.4%)
National account group        820,680          708,395      112,285    15.8%
                           $5,877,153       $5,997,550   $(120,397)   (2.0%)

Our same store sales declined 4% in the third quarter of 2009, as compared with the same period in 2008. Compared to the third quarter of 2008, sales to our Retail and Wholesale customers increased minimally while sales to our Institution and Manufacturer customers decreased. We attribute the weakness in our sales overall to general economic conditions. Sales to our national account customers were up 16% for the quarter, compared to the same quarter last year. The sales increase was due to the timing of receipts of orders.

Operating income for Wholesale Leathercraft during the quarter ended September 30, 2009 decreased by $88,000 from the comparative 2008 quarter, a decline of 20%. Operating expenses as a percentage of sales were 51.5%, up $88,000 from the third quarter of 2008. Employee benefits increased $110,000, utilities increased $58,000, and advertising increased $65,000. These increases were partially offset with decreases in employee compensation ($46,000), customer freight costs ($25,000), professional/consulting services ($14,000) and miscellaneous administrative expenses ($60,000).

Retail Leathercraft

Our Retail Leathercraft operation consists of 75 Tandy Leather retail stores at
September 30, 2009, compared to 72 stores at September 30, 2008. Net sales were
up approximately 13% for the third quarter of 2009 over the same quarter last
year. A store is categorized as "new" until it is operating for the full
comparable period in the prior year.

                            # Stores Qtr Ended  Qtr Ended  $ Incr (Decr) % Incr
                                      09/30/09   09/30/08                (Decr)
Same (existing) store sales    72    $6,273,553 $5,716,139      $557,414   9.8%
New store sales                3        170,626     10,025       160,601    N/A
Total sales                    75    $6,444,179 $5,726,164      $718,015  12.5%

The following table presents sales mix by customer categories for the quarters ended September 30, 2009 and 2008 for our Retail Leathercraft operation:

                                                 Quarter Ended
Customer Group                                09/30/09   09/30/08
 RETAIL (end users, consumers, individuals)        62%        61%
 INSTITUTION (prisons, prisoners, hospitals,        7%         9%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       30%        29%
& tack shops, authorized dealers, etc.)
 NATIONAL ACCOUNTS                                   -          -
 MANUFACTURERS                                      1%         1%
                                                  100%       100%

Sales to our Retail and Wholesale customer groups in the third quarter of 2009 increased compared to the third quarter of 2008, while sales to our Institution and Manufacturer customer group declined. These sales trends are consistent throughout the company - that is, our retail business appears to be holding fairly steady while our wholesale business has declined. We believe the weak economy is the primary reason for these sales trends. The retail stores averaged approximately $29,000 in sales per store per month for the third quarter of 2009.

Operating income in the third quarter of 2009 increased $238,000 from the comparative 2008 quarter to 7.3% of sales, compared to 4.1% of sales in the third quarter of 2008. Our gross margin improved from 60.3% to 61.3%. Operating expenses as a percentage of sales decreased from 56.2% to 53.9% as sales grew at a faster rate than that of expenses during the quarter.

International Leathercraft

Sales totaled $342,000 for the third quarter of 2009, compared to $324,000 in the third quarter of 2008. Gross profit margin fell from 69.3% in last year's third quarter to 67.2% in the current quarter. The decline is due primarily to the fluctuation in inventory value between the U.S. dollar and the British pound. Operating expenses totaled $178,000, an increase of $8,000 over the third quarter of 2008. The largest expense contributors were employee compensation, advertising, shipping to customers, and rent.

Other (Roberts, Cushman)

Sales decreased $80,000 or 39% for the third quarter of 2009. Gross profit margin declined to 31.1% compared to 42.9% in the comparable quarter in 2008 due to the write-off of selected inventory. Operating income decreased $42,000 due to the reduction in sales and gross profit, offset somewhat by the reduction of various operating expenses.

Other Expenses

We paid $69,000 in interest expense in the third quarter of 2009 on our bank debt, which is related to the building purchase, compared to $80,000 in interest expense in the third quarter last year. We earned $42,000 in interest income during the third quarter of 2009, an $11,000 increase over last year's third quarter interest income earned of $31,000. We recorded $115,000 in expense during the third quarter of 2009 related to currency fluctuations from our Canadian and UK operations. Comparatively, in the third quarter of 2008, we recorded an expense of $30,000 for currency fluctuations.

Nine Months Ended September 30, 2009 and 2008

The following table presents selected financial data of each of our four
segments for the nine months ended September 30, 2009 and 2008:

                       Nine Months Ended September 30,       Nine Months Ended September 30,
                                    2009                                  2008
                          Sales             Operating           Sales             Operating
                                             Income                                Income
Wholesale                $18,276,276          $1,243,341       $19,953,958          $1,084,364
Leathercraft
Retail Leathercraft       19,673,925           1,669,129        18,232,364           1,421,064
International                942,996             106,499           559,641               6,091
Leathercraft
Other                        469,997              32,431           614,151              66,865
Total Operations         $39,363,194          $3,051,400       $39,360,114          $2,578,384

Consolidated net sales for the nine months ended September 30, 2009 were virtually unchanged from sales for the first nine months of 2008. Retail and International Leathercraft contributed additional sales of $1.4 million and $383,000, respectively, offset by a combined sales decrease of $1.8 million from Wholesale Leathercraft and Other. Operating income on a consolidated basis for the nine months ended September 30, 2009 increased 18.4% or $473,000 compared to the first nine months of 2008.

The following table shows in comparative form our consolidated net income for the first three quarters of 2009 and 2008:

2009 2008 % change Net income $2,012,133 $1,660,762 21.2%

Wholesale Leathercraft

Net sales decreased 8.4%, or $1.7 million, for the first three quarters of 2009
as follows:

                  Nine Months     Nine Months    $ Change   % Change
                 Ended 09/30/09      Ended
                                   09/30/08
Same store sales    $15,798,472   $17,350,183   (1,551,711)   (8.9%)
(29)
National account      2,477,804     2,603,775     (125,971)   (4.8%)
group
                    $18,276,276   $19,953,958   (1,677,682)   (8.4%)

The following table presents the combined sales mix by customer categories for the nine months ended September 30, 2009 and 2008:

                                               Nine Months Ended
Customer Group                                09/30/09   09/30/08
 RETAIL (end users, consumers, individuals)        27%        25%
 INSTITUTION (prisons, prisoners, hospitals,        7%         8%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       42%        41%
& tack shops, authorized dealers, etc.)
 MANUFACTURERS                                      8%         8%
 NATIONAL ACCOUNTS                                 16%        18%
                                                  100%       100%

Operating income for Wholesale Leathercraft for the first three quarters of 2009 increased by $159,000 from the comparative 2008 period, an improvement of 14.7%. Compared to the first nine months of 2008, operating expenses decreased $708,000 for the first three quarters of 2009, but increased slightly as a percentage of sales from 49.7% for the nine months ended September 30, 2008 to 50.4% for the nine months ended September 30, 2009.

Retail Leathercraft

Net sales were up approximately 8% for the first three quarters of 2009 over the
same period last year.

                               Nine Months Nine Months   $ Incr   % Incr
                      # Stores    Ended       Ended      (Decr)   (Decr)
                                09/30/09    09/30/08
Same (existing) store    72    $19,242,812 $18,222,339 $1,020,473   5.6%
sales
New store sales          3         431,113      10,025    421,088    N/A
Total sales              75    $19,673,925 $18,232,364 $1,441,561   7.9%

The following table presents sales mix by customer categories for the nine months ended September 30, 2009 and 2008 for our Retail Leathercraft operation:

                                               Nine Months Ended
Customer Group                                09/30/09   09/30/08
 RETAIL (end users, consumers, individuals)        63%        63%
 INSTITUTION (prisons, prisoners, hospitals,        8%         8%
schools, youth organizations, etc.)
 WHOLESALE (resellers & distributors, saddle       29%        28%
& tack shops, authorized dealers, etc.)
 NATIONAL ACCOUNTS                                   -          -
 MANUFACTURERS                                       -         1%
                                                  100%       100%

The retail stores averaged approximately $29,000 in sales per month for the first three quarters of 2009.

Operating income for the first nine months of 2009 increased $248,000 from the comparative 2008 period, improving as a percentage of sales, from 7.8% in the first nine months of 2008 to 8.5% in the first nine months of 2009. Gross margin declined slightly from 61.8% to 60.6%. Operating expenses as a percentage of sales declined from 53.9% during the first three quarters of 2008 to 52.1% during the first three quarters of 2009.

Sales totaled $943,000 for the first nine months of 2009, an increase of 69% from sales of $560,000 from the same period of 2008. These sales are generated from our one store located in the UK, which opened in February 2008. Gross profit margin was 63.5% for the first three quarters of 2009, a decline from the 2008 comparable period's gross profit margin of 65.5%. 2009 year-to-date operating expenses totaled $492,000 compared to 2008 year-to-date operating expenses of $360,000, an increase of $132,000. Advertising, rent, and shipping costs to customers accounted for the majority of the increase over the prior year. Operating income in 2009 totaled $106,000 compared to 2008 year-to-date operating income of $6,000.

Other (Roberts, Cushman)

Sales decreased $144,000 in the first nine months of 2009 compared to the same period in 2008. Gross profit margin decreased by $91,000 and operating margin decreased by $34,000. Operating expenses decreased by $56,000 in the first three quarters of 2009 compared to 2008.

Other Expenses

We paid $230,000 in interest expense in the first nine months of 2009 on our debt related to our building purchase compared to $250,000 in interest expense in the first nine months of 2008. We earned $103,000 in interest income in the nine months ended September 30, 2009, the same as last year's interest income year to date. We recorded $8,000 in expense during the nine months ended September 30, 2009 for currency fluctuations from our Canadian and UK operations. Comparatively, in the first three quarters of 2008, we recorded an expense of $9,000 for currency fluctuations.

Capital Resources, Liquidity and Financial Condition

On our consolidated balance sheet, total assets increased from $40.9 million at year-end 2008 to $41.6 million at September 30, 2009. The increase in short-term investments, accounts receivable and inventory, offset partially by the decrease in cash, accounted for the increase. Total stockholders' equity increased from $31.3 million at December 31, 2008 to $32.1 million at September 30, 2009. The increase was attributable to earnings in the first three quarters of the year, partially offset by the purchase of treasury stock. Our current ratio was unchanged at 5.7 at December 31, 2008 and September 30, 2009.

Our investment in inventory increased by $959,000 at September 30, 2009 from year-end 2008. We continue to closely manage our inventory levels to follow our sales trends. In addition, the increase in inventory is consistent with prior periods at this time of year as we stock for the fourth quarter and Christmas shopping season. Inventory turnover remained virtually unchanged for the first nine months of 2009 compared to the same period of 2008, as the year-to-date 2009 rate was 3.05 and the year-to-date 2008 rate of 3.04. Inventory turnover was 3.18 times for all of 2008. We compute our inventory turns as sales divided by average inventory. At the end of the third quarter of 2009, our total inventory on hand was within 4% of our internal targets for optimal inventory levels.

Trade accounts receivable was $1.7 million at September 30, 2009, up $514,000 from $1.2 million at year-end 2008. The average days to collect accounts for the first three quarters of 2009 were 44 days, down considerably from 56 days for the first three quarters of 2008. We have tightened our credit policy given the current economic environment and are closely monitoring our customers with open accounts to ensure collectability of the accounts.

Accounts payable increased $466,000 to $1.6 million at the end of the September 2009, due to an intentional slowdown of payments to vendors, taking full advantage of the payment terms, and a slight increase in purchases in the latter part of the quarter. Accrued expenses and other liabilities increased $220,000, the majority of which is the increase in inventory in transit to us at September 30, 2009 compared to December 31, 2008, partially offset by the reduction in accrued payroll at September 30, 2009.

During the first three quarters of 2009, cash flow provided by operating activities was $1.7 million. Net income accounted for the majority of the cash provided. Cash flow used in investing activities totaled $3.1 million, consisting of $2.4 million in net certificate of deposit purchases and $731,000 in fixed asset purchases, $130,000 of which was parking lot repaving at our building. The remaining fixed asset purchases consisted primarily of computer equipment. Cash flow used by financing activities totaled $2.2 million, consisting of payments on our capital lease of $594,000, payments on our building debt of $152,000, and purchases of treasury stock of $1.5 million, offset partially by proceeds from employee stock option exercises totaling $25,000.

We expect to fund our operating and liquidity needs as well as our current expansion of Tandy Leather's retail store chain from a combination of current cash balances and internally generated funds.