**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, 2006


**OR**





[
                ]
            TRANSITION
                REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
                ACT OF
                1934 [NO FEE REQUIRED]




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)
            
            (IRS
                Employer Identification Number)





**3847
                East Loop 820 South, Fort Worth, Texas**
            
            **76119**(Address
                of principal executive offices)
            
            (Zip
                Code)





**Registrant’s
                telephone number, including area code:**(817) 496-4414





**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
            
            American
                Stock Exchange




**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 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. Yes [ ] No [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 $47,230,588 at June 30, 2006 (the last business
      day
      of its most recently completed second fiscal quarter). At March 15, 2007, there
      were 10,919,568 shares of the registrant's common stock
      outstanding.





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





Portions
      of the Registrant’s definitive Proxy Statement for the Annual Meeting of
      Stockholders to be held on May 22, 2007, are incorporated by reference in Part
      III of this report.





1


**TABLE
      OF CONTENTS**





Item
            
            Page**Part
                1**1
            Business
            31A
            Risk
                Factors
            92
            Properties
            93
            Legal
                Proceedings
            94
            Submission
                of Matters to a Vote of Security
                Holders
            9**Part
                II**5
            Market
                for Registrant’s Common Equity and
                Related Stockholder Matters
            106
            Selected
                Financial Data
            117
            Management’s
                Discussion and Analysis of Financial Condition
                and Results of Operations
            127A
            Quantitative
                and Qualitative Disclosures about Market
                Risk
            188
            Financial
                Statements and Supplementary
                Data
            199
            Change
                in and Disagreements with Accountants on
                Accounting and Financial Disclosure
            379A
            Controls
                and Procedures
            379B
            Other
                Information
            37**Part
                III**10
            Directors
                and Executive Officers of the
                Registrant
            3711
            Executive
                Compensation
            3712
            Security
                Ownership of Certain Owners and
                Management and Related Stockholder Matters
            3713
            Certain
                Relationships and Related
                Transactions
            3714
            Principal
                Accountant Fees and
                Services
            37**Part
                IV**15
            Exhibits
                and Financial Statement
                Schedules
            38





2


**PART
      I**





**ITEM
      1. BUSINESS**





**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 kits. During 2006, our consolidated
      sales totaled $55.2 million of which approximately 10.9% were export sales.
      We
      maintain our principal offices at 3847 East Loop 820 South, Fort Worth, Texas
      76119. Our common stock trades on the American Stock Exchange 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 of The Leather
      Factory from Brown Shoe Group, which then consisted of six wholesale stores.





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





**Our
      Development in Recent Years**





Our
      expansion of the wholesale chain occurred via the opening of new stores as
      well
      as numerous acquisitions of small businesses in strategic geographic locations
      including the acquisition of our Canadian distributor, The Leather Factory
      of
      Canada, Ltd., in 1996. By 2000, we had grown to twenty-seven 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. During that year, Tandy Leather
      purchased four independent leathercraft retail stores and opened another ten.
      We
      also opened our thirtieth Leather Factory store - our third in Canada. In 2003,
      we opened twelve Tandy Leather retail stores. In 2004, we purchased three
      independent leathercraft retail stores and opened an additional nine stores
      in
      the U.S. We also opened another store in Canada which is operating as a Tandy
      Leather retail store. In November 2004, we acquired all of the issued and
      outstanding shares of capital stock of Heritan Ltd. and its parent, our primary
      Canadian competitor, headquartered in Barrie, Ontario. The acquisition resulted
      in an additional three retail stores in Canada, bringing the total locations
      in
      Canada to seven - three Leather Factory stores and four Tandy Leather stores.
      In
      2005, we opened eight Tandy Leather retail stores. In 2006, we opened eleven
      Tandy Leather retail stores and converted one wholesale store to a retail
      store.





At
      December 31, 2005, we operated twenty-nine wholesale stores operating under
      the
      Leather Factory name (26 in the U.S. and 3 in Canada) and sixty-two retail
      stores operating under the Tandy Leather name (58 in the U.S. and 4 in Canada).
      We also own and operate Roberts, Cushman and Company, Inc., a manufacturer
      of
      custom hat trims.





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
      information concerning the additions of facilities for our Leather Factory
      wholesale stores and Tandy Leather retail stores in each of our fiscal years
      from 1999 to 2006.




**STORE
      COUNT**


**YEARS
      ENDED DECEMBER 31, 1999 through 2006**





**Leather
                Factory wholesale stores**
            **Tandy
                Leather retail stores**Year
                Ended
            Opened
            Conversions(1)
            Total
            Opened
                (2)
            Closed
            TotalBalance
                Fwd
            
            
            22
            
            
            N/A1999
            4
            0
            26
            
            
            N/A2000
            2
            0
            28
            1*
            0
            12001
            2
            0
            30
            0
            0
            12002
            1
            (1)
            30
            14
            1*
            142003
            0
            0
            30
            12
            0
            262004
            0
            0
            30
            16
            0
            422005
            0
            0
            30
            8
            0
            502006
            0
            (1)
            29
            12
            0
            62





(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
      that we closed in 2002.





No
      single
      customer’s purchases represent more than 10% of our total sales in 2006. Sales
      to our five largest customers combined to represent 9.5%, 9.4% and 10.6%,
      respectively, of consolidated sales in 2006, 2005 and 2004. While management
      does not believe the loss of one of these customers would have a significant
      negative impact on our operations, it does believe the loss of several of these
      customers simultaneously or a substantial reduction in sales generated by them
      could temporarily affect our operating results.





3
 *TABLE
          OF CONTENTS*


**Our
      Operating Divisions**





We
      service our customers primarily through the operation of three divisions. We
      identify those divisions based on management responsibility and customer focus.
      The Wholesale Leathercraft division consists of twenty-nine Leather Factory
      stores of which 26 are located in the United States and three are located in
      Canada. As of March 1, 2007, the Retail Leathercraft division consists of 65
      Tandy Leather retail stores of which 61 are located in the United States and
      four are located in Canada. Both of these divisions sell leather and
      leathercraft-related products. Our third business segment, referred to as
“Other,” consists of our hatband manufacturer, Roberts, Cushman & Company,
      Inc.





**Wholesale
      Leathercraft**





The
      Wholesale Leathercraft operation distributes its broad product line of leather
      and leathercraft-related products in the United States and internationally
      through Leather Factory stores. This segment had net sales of $31.0 million,
      $31.0 million and $30.6 million for 2006, 2005 and 2004, respectively.





**General** **** We
      operate Leather Factory stores in 20 states and three Canadian provinces. The
      centers range in size from 2,600 square feet to 19,800 square feet, with the
      average size of a store being approximately 6,000 square feet. The type of
      premises utilized for Leather Factory locations 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** **** The
      Leather Factory business concept centers around 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 one place. The size and layout
      of the centers 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.





Leather
      Factory stores serve customers through various means including walk-in traffic,
      phone 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 Leather Factory 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.leatherfactory.com),
      our participation at trade shows and, on a limited basis, the use of sales
      representative organizations. The sales representative organizations consist
      of
      companies located in specific geographic areas that represent numerous companies
      in a similar industry. These organizations call on customers and show multiple
      products from more than one vendor at a time.





**Customers**  Leather
      Factory’s 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 Leather Factory business,
      although retail customers may purchase products from Leather Factory stores.
      Leather Factory sales generally do not reflect significant seasonal patterns.





Our
      Authorized Sales Center (“ASC”) program was developed to create a presence in
      geographical areas where we do not have a wholesale store. An unrelated person
      operating an existing business who desires to become an ASC must apply with
      Leather Factory and upon approval, place a minimum initial order. There are
      also
      minimum annual purchase amounts to which the ASC must adhere in order to
      maintain ASC status. In exchange, the benefits to the ASC are free advertising
      in various sale flyers produced and distributed by us, price breaks on many
      products, advance notice of new products, and priority shipping and handling
      on
      all orders. Leather Factory stores service 155 ASC's: 89 located in the U.S.,
      47
      located in Canada, and 19 located outside North America.





**Merchandise**  Our
      products are generally organized into thirteen 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 whose
      processes generally involve cutting leather into various shapes and patterns
      using metal dies. The factory produces approximately 20% of our products and
      also assembles and repackages product as needed. Products manufactured in our
      factory are distributed through our stores under the Tejas TM brand
      name. We also distribute product under the Tandy Leather TM and Dr.
      Jackson's TM brands.
      We develop new products through the ideas and referrals of customers and store
      personnel as well as the tracking of fads and trends of interest in the market.
      Our personnel walk trade shows and various specialty stores with the purpose
      of
      obtaining product ideas that are then developed in-house.





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
      2006 and 2005, Wholesale Leathercraft division sales by product category were
      as
      follows:





**Product
                Category**
            **2006**
              **Sales
                Mix**
            
            **2005**
              **Sales
                Mix**Belts
                strips and straps
            2%
            
            2%Books,
                patterns, videos
            1%
            
            1%Buckles
            4%
            
            4%Conchos^
            4%
            
            4%Craft
                supplies
            5%
            
            5%Custom
                tools and hardware
            1%
            
            1%Dyes,
                finishes, glues
            5%
            
            5%Hand
                tools
            12%
            
            12%Hardware
            8%
            
            8%Kits
            7%
            
            8%Lace
            14%
            
            13%Leather
            34%
            
            34%Stamping
                tools
            3%
            
            3%**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
      2006 and 2005, see "Item 7. Management's Discussion and Analysis of Financial
      Condition and Results of Operations."




4
 *TABLE
          OF CONTENTS*


**Suppliers** **** We
      currently purchase merchandise and raw materials from 100-150 vendors dispersed
      throughout the United States and in approximately 20 foreign
      countries. **** In
      2006,
      our ten largest vendors accounted for approximately 80% 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. As such an occurrence is beyond
      our control, we cannot predict when and to what extent we could be affected
      in
      the future. Aside from increasing purchases when we anticipate price increases
      (or possibly delaying purchases if we foresee price declines), we do not attempt
      to hedge our inventory costs.





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





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





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





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





We
      attempt to maintain the optimum number of items in our product line to minimize
      out-of-stock situations against carrying costs involved with such an inventory
      level. We generally maintain higher inventories of imported items to ensure
      a
      continuous supply. The number of products offered changes every year due to
      the
      introduction of new items and the discontinuance of others. We carry approximately
      2,700 items in the current lines of leather and leather-related merchandise.
      All
      items are offered in both the Leather Factory and Tandy Leather stores.





**Expansion** Leather
      Factory's 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 Leather Factory store to a Tandy Leather store
      in
      2006, reducing the number of Leather Factory stores to twenty-nine. While we
      do
      not believe there is a significant and immediate opportunity for expansion
      of
      the Leather Factory distribution system in terms of opening additional
      locations, we do believe expansion could be achieved by acquiring companies
      in
      related areas/markets which offer collaborative advantages based on the local
      markets and/or the product lines of the businesses.




**Retail
      Leathercraft**





Our
      Retail Leathercraft division consists of a growing chain of retail stores
      operating under the name, Tandy Leather. Tandy Leather Company, established
      in
      1919 as Hinkley-Tandy Leather Company, is the oldest and best-known supplier
      of
      leather and related supplies used in the leathercraft industry. We offer a
      product line of quality tools, leather, accessories, kits and teaching
      materials. This segment had net sales of $22.5 million, $18.0 million and $13.5
      million for 2006, 2005 and 2004, respectively.





**General** As of
      March 1, 2007, the Tandy Leather retail chain has 65 stores located in 31 states
      and three Canadian provinces with plans to reach 100 to 120 stores as
      opportunities arise over the next several years. The stores range in size from
      1,200 square feet to 3,800 square feet, with the average size of a store being
      approximately 2,000 square feet. The type of premises utilized for a Tandy
      Leather store is generally an older strip shopping center located at well-known
      crossroads, making the store easy to find.




**Business
      Strategy** **** Tandy
      Leather has long been known for its reputation in the leathercraft industry
      and
      its commitment to promoting and developing the craft through education and
      customer development. Our commitment to this strategy is evidenced by our
      re-establishment of the retail store chain throughout the United States
      following our acquisition of the assets of Tandy Leather in 2000. We continue
      to
      broaden our customer base by working with various youth organizations and
      institutions where people are introduced to leathercraft, as well as hosting
      classes in our stores.





The
      retail stores serve walk-in, mail and phone order customers as well as orders
      generated from its website, www.tandyleather.com. Tandy Leather 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 more than 65%
      of
      Tandy Leather's 2006 sales. Youth groups, summer camps, schools, and a limited
      number of wholesale customers complete our customer base. Like Leather Factory,
      Tandy fills orders as they are received, and there is no order backlog. Tandy
      maintains reasonable amounts of inventory to fill these orders. Tandy Leather’s
      retail store operations historically generate slightly more sales in the
      4 th quarter
      of each year (30-32%) while the other three quarters remain fairly even at
      23-25% per quarter.





5
 *TABLE
          OF CONTENTS*


**Merchandise**  Our
      products are generally organized into thirteen categories. We carry a wide
      assortment of products including leather, hand tools, kits, dyes & finishes,
      and stamping tools.





During
      2006 and 2005, Retail Leathercraft division sales by product category were
      as
      follows:





**Product
                Category**
            **2006**
              **Sales
                Mix**
            
            **2005**
              **Sales
                Mix**Belts
                strips and straps
            5%
            
            5%Books,
                patterns, videos
            2%
            
            3%Buckles
            4%
            
            4%Conchos
            4%
            
            4%Craft
                supplies
            3%
            
            3%Dyes,
                finishes, glues
            7%
            
            7%Hand
                tools
            16%
            
            16%Hardware
            7%
            
            6%Kits
            11%
            
            12%Lace
            4%
            
            4%Leather
            31%
            
            30%Stamping
                tools
            6%
            
            6%**100%**
            
            **100%**




As
      indicated above, the products sold in our Tandy Leather stores are also sold
      in
      our Leather Factory stores. Therefore, the discussion above regarding Leather
      Factory products, their sources and the working capital requirements for the
      Wholesale Leathercraft division also apply to the Tandy Leather stores. Sales
      at
      Tandy Leather stores are generally cash transactions or through national credit
      cards. We 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 Leather Factory, Tandy Leather has an unconditional return policy.





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





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





**Distribution** **** The
      Tandy
      Leather 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 100 to 120 stores
      throughout North America at an average rate of approximately 12 stores per
      year.
      Fourteen stores were opened in 2002; twelve stores were opened in 2003; sixteen
      were opened in 2004 (including four in Canada); eight were opened in 2005,
      and
      twelve were opened in 2006. Ten of the 65 stores opened to date were independent
      leathercraft stores that we acquired. Separately, these acquisitions are not
      material. The other fifty-five stores have been *de
      novo* stores
      opened by us. In 2007, we plan to open 12 retail stores. Three stores have
      been
      opened in 2007 as of March 1 st .





6
 *TABLE
          OF CONTENTS*


**Other**





Roberts,
      Cushman, founded in 1856, produces made-to-order trimmings for the headwear
      industry. This segment had net sales of $1.7 million, $1.6 million, and $2.0
      million for 2006, 2005 and 2004, respectively.





**Business
      Strategy** Roberts,
      Cushman has long been considered one of the leaders in the field of headwear
      trimmings. It designs and supplies exclusive trimmings for all types of hats.
      Trims are sold to hat manufacturers directly. We do not employ an outside sales
      force. Instead, customers visit our facilities and, with the review of previous
      designs, incorporate their ideas into a customized product. The customer is
      provided samples or photographs of each design before they leave the premises.
      These samples can then be used as a sales tool to obtain hat orders from their
      customers. This “design-on-site” process is unique in the industry.





**Customers** **** We
      design
      and supply trims for approximately 50 of the headwear manufacturers worldwide,
      supplying customized trims, ribbons, buckle sets, name pins, feathers, and
      other
      items. Our success in developing and maintaining long-standing relationships
      with our customers is due primarily to our ability to deliver quality products
      in a timely manner. Our backlog of in-house orders from customers as of February
      20, 2007 was $110,000, which approximates thirty days of sales. Roberts,
      Cushman’s sales generally do not reflect significant seasonal
      patterns.





The
      working capital requirements of this operation are dictated by the amounts
      needed to meet current obligations, purchase raw material and allow for
      collection of accounts receivable. Roberts, Cushman provides sufficient cash
      flow to satisfy these requirements.





**Merchandise**  Our
      hat
      bands are generally produced from leather, ribbon, or woven fabrics, depending
      on the style of hat. They are created by cutting leather and/or other materials
      into strips, and then enhancing the trim by attaching conchos and/or three-piece
      buckle sets, braiding with other materials, and finishing the end or borders
      by
      stitching or by lacing with leather lace. We also supply custom-designed buckles
      and conchos, feathers for dress hats, and name pins, separate from hat bands.
      Roberts, Cushman purchases components from over 25 vendors, located
      predominately in the United States. In 2006, our top 10 vendors (in dollars
      purchased) represented approximately 45% of its total purchases. Products are
      sold on terms that generally range from net 30 to net 90 days. Because our
      products are custom-designed, we do not accept product returns, except in the
      case of defective merchandise.





**Expansion** **** Cushman
      has been successful in providing a very specific product line directly to
      headwear manufacturers. Given the current industry conditions, we do not believe
      there is much potential for expansion, other than to capture additional market
      share.


**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, 2006, we employed 412 people, 310 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 20 registered trademarks, including federal trade name
      registrations for "The Leather Factory" and "Tandy Leather Company." We also
      own
      approximately 20 registered foreign trademarks worldwide.





We
      own
      approximately 500 registered copyrights in the United States covering more
      than
      600 individual works relating to various products. We also own several United
      States patents for specific belt buckles and leather-working equipment. These
      rights are valuable assets and we defend them as necessary.





**International
      Operations** **** Information
      regarding our revenues from the United States and abroad and our long-lived
      assets are found in Note 13 to our Consolidated Financial Statements, *Segment
      Information* .





**Our
      Website and Availability of SEC Reports** We file
      reports with the Securities and Exchange Commission ("SEC"). These reports
      include our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current
      Reports on Form 8-K and any amendments to these filings. The public may read
      any
      of these filings at the SEC's Public Reference Room at 450 Fifth Street, NW,
      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 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 this website
      through the "Corporate Governance" link.


7
 *TABLE
          OF CONTENTS*





**Executive
      Officers of the Registrant**





The
      following table sets forth information concerning our executive
      officers.





**Name
                and Age**
            **Position
                and Business Experience****During
                Past Five Years**
            **Served
                as Officer Since**J.
                Wray Thompson, 75
            Chief
                Executive Officer from June 1993 to December 2006; President from
                June
                1993 to January 2001
            1993Ronald
                C. Morgan, 59
            Chief
                Executive Officer since January 2007; President since January 2001;
                Chief
                Operating Officer since June 1993
            1993Shannon
                L. Greene, 41
            Chief
                Financial Officer since May 2000; Controller from January 1998 to
                May 2000
            2000Robin
                L. Morgan, 56
            Vice
                President of Administration since June 1993
            1993





**Wray
      Thompson** has
      served as our Chairman of the Board since June 1993. He served as Chief
      Executive Officer from June 1993 to December 2006. He also served as President
      from June 1993 to January 2001. Mr. Thompson was a co-founder of the
      company.





**Ronald
      C. Morgan** has
      served as our President since January 2001 and has served as Chief Operating
      Officer and director since June 1993. He was appointed as our Chief Executive
      Officer in January 2007 following the resignation of Wray Thompson.
      Mr. Morgan was also a co-founder of the company. Mr. Morgan is married to
      Robin L. Morgan, our Vice President.





**Shannon
      L. Greene** has
      served as our Chief Financial Officer and Treasurer since May 2000. She was
      appointed to serve on the Board of Directors in January 2001. Ms. Greene is
      also
      our Chief Accounting Officer. From September 1997 to May 2000, Ms. Greene served
      as our Controller and Assistant Controller. Ms. Greene also is a member of
      our
      Employees’ Stock Ownership Plan (ESOP) Committee and is a certified public
      accountant. Her professional affiliations include the American Institute of
      Certified Public Accountants, the Texas Society of Certified Public Accountants
      and its Fort Worth chapter, the Fort Worth Association for Financial
      Professionals, the National Investor Relations Institute, and the Financial
      Executives International.





**Robin
      L. Morgan** has
      served as our Vice President of Administration and Assistant Secretary since
      June 1993. Ms. Morgan is responsible for import, banking, and procurement for
      our import product lines and maintains all inventory costs. She administers
      our
      insurance programs and serves as chairman of our ESOP committee. Ms. Morgan
      is
      married to Ronald C. Morgan, our CEO and President.





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





We
      have
      two stock option plans - an incentive stock option plan for key management
      personnel and a non-qualified stock option plan for our outside directors.
      Both
      plans expired in 2005. At expiration, there were 20,000 unoptioned shares from
      the 1995 Stock Option Plan and 24,000 unoptioned shares from the 1995 Directors
      Non-Qualified Stock Option Plan. The expiration of the plans has no effect
      on
      the options previously granted. There were no changes to the exercise prices
      of
      the outstanding options under these two plans during 2006.


8
 *TABLE
          OF CONTENTS*


**ITEM
      1A. RISK FACTORS**





Certain
      risk factors that may affect our business, financial condition, results of
      operations and cash flows, or that may cause our actual results to vary from
      the
      forward-looking statements contained in this Annual Report on Form 10-K are
      set
      forth in Item 7. Management’s Discussion and Analysis of Financial Condition and
      Results of Operations, under the caption, “Forward-Looking Statements,” in this
      Annual Report on Form 10-K.





**ITEM
      2. PROPERTIES**





We
      lease
      all of our premises and believe that all of our properties are adequately
      covered by insurance. The properties leased by our Wholesale Leathercraft
      (Leather Factory stores) and Retail Leathercraft (Tandy Leather stores)
      divisions are described in Item 1 in the description of each segment. Our Fort
      Worth location, which includes the Fort Worth Leather Factory store, our central
      warehouse and manufacturing facility, the sales, advertising, administrative,
      and executive offices, and the administrative offices of Roberts, Cushman,
      consists of 115,000 square feet and leases for $427,000 per year. The lease
      expires in March 2008. We also lease a 284 square-foot showroom in the Denver
      Merchandise Mart for $5,908 per year. This lease will expire in October 2008.
      The following table summarizes the locations of our leased premises on a state
      and province basis as of December 31, 2006:





**State**
            **Wholesale
                Leathercraft**
            **Retail
                Leathercraft**
            **Other**Alabama
            -
            1
            -Arizona
            2
            2
            -Arkansas
            -
            1
            -California
            3
            6
            -Colorado
            1
            3
            -Connecticut
            -
            1
            -Florida
            1
            3
            -Georgia
            -
            1
            -Idaho
            -
            1
            -Illinois
            1
            1
            -Indiana
            -
            2
            -Iowa
            1
            -
            -Kansas
            1
            -
            -Kentucky
            -
            1
            -Louisiana
            1
            -
            -Maryland
            -
            1
            -Michigan
            1
            1
            -Minnesota
            -
            2
            -Missouri
            1
            2
            -Montana
            1
            -
            -Nebraska
            -
            1
            -Nevada
            -
            2
            -New
                Mexico
            1
            2
            -New
                York
            -
            1
            -North
                Carolina
            -
            2
            -Ohio
            1
            1
            -Oklahoma
            -
            2
            -Oregon
            1
            -
            -Pennsylvania
            1
            1
            -Tennessee
            1
            2
            -Texas
            5
            9
            1Utah
            1
            2
            -Virginia
            -
            1
            -Washington
            1
            2
            -Wisconsin
            -
            1
            -





**Canadian
                locations:**Alberta
            1
            1
            -British
                Columbia
            -
            1
            -Manitoba
            1
            -
            -Ontario
            1
            2
            -





**ITEM
      3. LEGAL PROCEEDINGS**





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





**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS**





There
      were no matters submitted to a vote of our security holders during the fourth
      quarter of our fiscal year ended December 31, 2006.





9
 *TABLE
          OF CONTENTS*


**PART
      II**





**ITEM
      5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
      STOCKHOLDER MATTERS**





Our
      common stock is traded on the American Stock Exchange using the symbol TLF.
      The
      high and low prices for each calendar quarter during the last two fiscal years
      are as follows:





**2006**
            **High**
            **Low**
            
            **2005**
            **High**
            **Low**4thquarter
            $8.30
            $6.30
            
            4thquarter
            $7.23
            $4.153rdquarter
            $6.90
            $5.75
            
            3rdquarter
            $5.65
            $4.302ndquarter
            $8.30
            $6.40
            
            2ndquarter
            $4.95
            $3.251stquarter
            $7.40
            $5.79
            
            1stquarter
            $3.79
            $3.20





There
      were approximately 509  stockholders
      of record on March 10 ,
      2007 .





We
      have
      never declared or paid any cash dividends on the shares of our common stock.
      Our
      Board of Directors has historically followed a policy of reinvesting our
      earnings in the expansion of our business. This policy is subject to change
      based on future industry and market conditions, as well as other
      factors.





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, 2006.





**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
            296,200
            $2.05
            -Equity
                compensation plans not approved by stockholders
            98,300
            3.65
            -TOTAL
            561,000
            $2.39
            44,000





For
      additional information, see Note 11 to our Consolidated Financial Statements, *Stockholders'
      Equity* .





**Stockholder
      Return Performance Graph**





The
      line
      graph below compares the yearly percentage change in our cumulative five-year
      total stockholder return on our common stock with the Standard & Poor’s
      SmallCap 600 Index and the S&P Specialty Stores Index. The graph assumes
      that $100 was invested on December 31, 2001 in our common stock, the
      Standard & Poor’s SmallCap 600 Index, and the S&P Specialty Stores
      Index, and that all dividends were reinvested. The returns shown on the graph
      are not necessarily indicative of future performance.





**COMPARISON
      OF FIVE-YEAR CUMULATIVE TOTAL RETURNS**


**Tandy
      Leather Factory, Inc.**





**Company
                Name / Index**
            **Dec
                01**
            **Dec
                02**
            **Dec
                03**
            **Dec
                04**
            **Dec
                05**
            **Dec
                06****TANDY
                LEATHER FACTORY**
            **100**
            **162.50**
            **232.69**
            **170.67**
            **329.33**
            **387.98****S&P
                SMALLCAP 600 INDEX**
            **100**
            **85.37**
            **118.48**
            **145.32**
            **156.48**
            **180.14****S&P
                SPECIALTY STORES**
            **100**
            **88.89**
            **119.69**
            **125.92**
            **148.72**
            **180.78**


*Data
      Source: Research Data Group, Inc., San Francisco, CA*


10
 *TABLE
          OF CONTENTS*


**ITEM
      6. SELECTED FINANCIAL
      DATA**





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




**Income
                Statement Data,**
              **Years
                ended December 31,**
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Net
                sales
            $55,199,021
            
            $50,719,574
            
            $46,146,284
            
            $41,712,191
            
            $39,728,615Cost
                of sales
            23,566,251
            
            21,964,530
            
            20,706,239
            
            19,020,292
            
            18,393,914Gross
                profit
            31,632,770
            
            28,755,044
            
            25,440,045
            
            22,691,899
            
            21,334,701Operating
                expenses
            24,565,056
            
            23,181,633
            
            21,181,599
            
            18,594,240
            
            17,202,927Operating
                income
            7,067,714
            
            5,573,411
            
            4,258,446
            
            4,097,659
            
            4,131,774Operating income per share - basic
            $0.65
            
            $0.52
            
            $0.40
            
            $0.40
            
            $0.41Operating income per shares - diluted
            $0.64
            
            $0.51
            
            $0.39
            
            $0.38
            
            $0.38Other
                (income) expense
            (98,391)
            
            (134,502)
            
            44,800
            
            125,169
            
            311,917Income before
                income taxes
            7,166,105
            
            5,707,913
            
            4,213,646
            
            3,972,490
            
            3,819,857Income
                tax provision
            2,389,039
            
            1,994,199
            
            1,559,605
            
            1,232,116
            
            1,224,868Income before
                cumulative effect of change in accounting principle
            4,777,066
            
            3,713,714
            
            2,654,041
            
            2,740,374
            
            2,594,989Cumulative
                effect of change in accounting principle
            -
            
            -
            
            -
            
            -
            
            (4,008,831)Net
                income (loss)
            $4,777,066
            
            $3,713,714
            
            $2,654,041
            
            $2,740,374
            
            $(1,413,842)Earnings
                (loss) per share
            $0.44
            
            $0.35
            
            $0.25
            
            $0.27
            
            $(0.14)Earnings
                (loss) per share-*assuming
                dilution*
            $0.43
            
            $0.34
            
            $0.24
            
            $0.25
            
            $(0.13)Weighted
                average common shares outstanding for:Basic
                EPS
            10,807,316
            
            10,643,004
            
            10,543,994
            
            10,323,549
            
            10,063,581Diluted
                EPS
            11,113,855
            
            10,976,240
            
            10,957,518
            
            10,861,305
            
            10,761,670








Balance
                Sheet Data, as of December 31,
            **2006**
            
            **2005**
            
            **2004**
            
            **2003**
            
            **2002**Cash
                and cash equivalents
            $6,739,981
            
            $3,215,727
            
            $2,560,202
            
            $1,728,344
            
            $101,557Total
                assets
            31,916,635
            
            25,680,473
            
            22,167,163
            
            19,058,406
            
            19,675,602Capital
                lease obligation, including current portion
            111,723
            
            245,789
            
            379,857
            
            1,134
            
            7,691Long-term
                debt, including current portion
            -
            
            -
            
            505,154
            
            1,792,984
            
            4,213,533Total
                Stockholders’ Equity
            $26,323,243
            
            $21,257,857
            
            $17,310,233
            
            $14,509,493
            
            $11,170,062








11
 *TABLE
          OF CONTENTS*


**ITEM
      7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
      RESULTS OF OPERATIONS**





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





This
      discussion should be read in conjunction with our financial statements as of
      December 31, 2006 and 2005 and the two years then ended and the notes
      accompanying those financial statements. You are also urged to consider the
      information under the caption "Summary of Critical Accounting
      Policies."





**Summary**





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





We
      operate in three segments. First, Wholesale Leathercraft, consisting of our
      Leather Factory stores and our national account group, is the largest source
      of
      revenues ($31.0 million in 2006). This division has generally offered steady
      but
      modest increases in sales. Sales in 2006 declined 0.1%, short of our target
      of
      annual sales growth of 2% to 4%. The decrease in sales to national accounts
      in
      2006 accounted for the shortfall. Excluding national account sales, the stores
      produced a sales gain of 2.7% for 2006.





Since
      acquiring its assets in 2000, we have focused on re-establishing Tandy Leather
      as the operator of retail leathercraft stores. These retail stores comprise
      our
      second segment, Retail Leathercraft. Because of growth here, this segment has
      experienced the greatest increases in sales ($22.5 million in 2006, up from
      $18.0 million in 2005). Our business plan calls for opening an average of 12
      stores annually as we work toward a goal of 100+ stores from 64 stores at the
      end of 2006.





We
      refer
      to our third segment as “Other”. It consists of Roberts, Cushman, a supplier of
      trimmings for headwear. Its operations are not material to us. In 2002, we
      wrote
      off the goodwill related to our investment in Roberts, Cushman in connection
      with an accounting change.





On
      a
      consolidated basis, a key indicator of costs, gross margin as a percent of
      total
      net sales, increased in 2005 and again in 2006, reflecting a number of factors
      including more retail sales with higher profit margins. Operating expenses
      as a
      percent of total net sales in 2006 decreased 1.2% from 2005. Operating expenses
      were down 0.2% as a percentage of total net sales in 2005 when compared with
      2004.




We
      reported consolidated net income for 2006 of $4.8 million. Consolidated net
      income for 2005 and 2004 was $3.7 million and $2.7 million, respectively. We
      have used our cash flow to fund our operations, to fund the opening of new
      Tandy
      Leather stores and to eliminate our bank debt. At the end of 2006, our
      stockholders’ equity had increased to $26.3 million from $21.3 million the
      previous year.





Comparing
      the December 31, 2006 balance sheet with the prior year’s, we increased our
      investments in inventory ($17.2 million from $15.7 million) and accounts
      receivable ($2.6 million from $2.2 million), while total cash increased to
      $6.7
      million from $3.2 million. In addition to cash on hand, we have a $3 million
      bank line of credit, of which none was drawn on December 31, 2006.





**Net
      Sales**





Net
      sales
      for the three years ended December 31, 2006 were as follows:





Year
            Wholesale
                Leathercraft
            Retail
                Leathercraft
            Other
            Total
                Company
            Total
                Company Incr from Prior Year**2006**
            **$31,068,188**
            **$22,520,461**
            **$1,610,372**
            **$55,199,021**
            **8.8%**2005
            $31,046,268
            $18,023,214
            $1,650,092
            $50,719,574
            9.9%2004
            $30,630,122
            $13,515,662
            $2,000,500
            $46,146,284
            10.6%





Our
      net
      sales grew by 8.8% in 2006 when compared with 2005 and 9.9% in 2005 when
      compared with 2004. These annual increases resulted primarily from our Retail
      Leathercraft expansion program.





12
 *TABLE
          OF CONTENTS*


**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
      2006,
      our cost of sales decreased as a percentage of total net sales when compared
      to
      2005, resulting in an overall increase of 0.6% in our consolidated gross margin
      from 56.7% in 2005 to 57.3% in 2006. Similarly, our total cost of sales as
      a
      percentage of our total net sales had decreased for 2005 when compared to 2004
      resulting in an overall increase in consolidated gross margin of 1.6% from
      55.1%
      for 2004 to 56.7% in 2005. These increases in gross margin were primarily due
      to
      increased retail sales over the three years.





Our
      gross
      margins for the three years ended December 31, 2006 were as follows:





Year
            Wholesale
                Leathercraft
            RetailLeathercraft
            Other
            Total
                Company**2006**
            **56.13%**
            **60.79%**
            **32.09%**
            **57.31%**2005
            55.20%
            61.82%
            27.89%
            56.69%2004
            53.82%
            61.77%
            30.31%
            55.13%





Our
      operating expenses decreased 1.2% as a percentage of total net sales to 44.5%
      in
      2006 when compared with 45.7% in 2005 which indicates that our sales grew faster
      than our operating expenses. Significant expense fluctuations in 2006 compared
      to 2005 are as follows:





**Expense**
            **2006
                amount**
            **Incr
                (decr)****over
                2005**Employee
                compensation & benefits
            $13.3
                million
            $1.1
                millionRent
                & utilities
            3.5
                million
            300,000Supplies
            800,000
            200,000Contributions
            -
            (200,000)Legal
                & professional fees
            300,000
            (100,000)





Our
      operating expenses decreased 0.2% as a percentage of total net sales to 45.7%
      in
      2005 when compared with 45.9% in 2004. Significant expense fluctuations in
      2005
      compared to 2004 are as follows:





**Expense**
            **2005
                amount**
            **Incr
                (decr)****over
                2004**Employee
                compensation & benefits
            $12.2
                million
            $1.2
                millionRent
                & utilities
            3.2
                million
            300,000Advertising
                & marketing
            3.3
                million
            600,000Property
                insurance
            400,000
            (150,000)Legal
                & professional fees
            400,000
            (100,000)





**Other
      Income/Expense (net)**





Other
      Income/Expense consists primarily of currency exchange fluctuations and
      discounts taken or given. In 2006, we had income (net) of $98,000 compared
      to a
      income (net) of $135,000 in 2005, attributable to currency exchange gain of
      $52,000 in 2006 compared to $72,000 in 2005, and net discounts given in 2006
      of
      $16,000 compared to net discounts taken in 2005 of $11,000.





In
      2005,
      we had income (net) of $135,000 compared to an expense (net) of $45,000 in
      2004,
      attributable to the reduction of $50,000 in interest paid, a currency exchange
      gain of $72,000 in 2005 compared to a currency exchange loss of $5,000 in 2004,
      and net discounts taken in 2005 of $11,000 compared to net discounts given
      in
      2004 of $63,000.





**Net
      Income**





During
      2006, we earned net income of $4.8 million, a 29% improvement over our net
      income of $3.7 million earned during 2005. As a result of the increase in our
      overall gross margin and an improvement in operating efficiency, our profits
      in
      2006 grew at a rate faster than sales.





During
      2005, we earned net income of $3.7 million, a 40% improvement over our net
      income of $2.65 million earned during 2004. As a result of the increase in
      our
      overall gross margin, slight improvement in operating efficiency, and reduction
      in interest and other expenses, our profits in 2005 grew at a rate faster than
      sales.





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**Wholesale
      Leathercraft**





Year
            Net
                SalesIncr
                (Decr)
              from
                Prior Yr
            OperatingIncome
            Operating
                IncomeIncr
                (Decr)
              from
                Prior Year
            Operating
                Income as a Percentageof
                Sales**2006**
            **(0.1)%**
            **$4,814,240**
            **29.4%**
            **15.5%**2005
            1.4%
            $3,721,891
            23.5%
            12.0%2004
            (0.2)%
            $3,013,316
            (13.0)%
            9.8%





Wholesale
      Leathercraft, consisting of 29 Leather Factory stores, accounted for 56.2%
      of
      our consolidated net sales in 2005, which compares to 61.2% in 2005 and 66.4%
      in
      2004. 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.





Sales
      in
      the stores increased 2.5% in 2006 compared to sales in 2005, but this gain
      was
      offset by a 4% sales decline in our national account group. By customer group,
      we achieved gains to our retail and small manufacturing customers while our
      sales to our wholesale customers declined slightly. Our sales mix by customer
      group was as follows:





**Customer
                Group**
            **2006**
            **2005**
            **2004**Retail
            25%
            23%
            23%Institution
            7%
            7%
            7%Wholesale
            39%
            45%
            47%National
                Accounts
            19%
            16%
            16%Manufacturers
            10%
            9%
            7%100%
            100%
            100%





The
      2006
      increase in operating income as a percentage of divisional sales resulted from
      an increase of 1.81% in gross margin (as a percentage of sales) compared with
      2005, and a decrease of 5.8% in operating expenses as a percent of sales.
      Significant operating expense decreases occurred in contributions ($200,000),
      various bank fees ($100,000), legal and professional fees ($100,000),
      depreciation ($100,000) and advertising costs ($250,000). These reductions
      were
      partially offset by increases in employee wages ($100,000) and general supplies
      ($150,000).





The
      2005
      increase in operating income as a percentage of divisional sales resulted from
      an increase of 1.43% in gross margin (as a percentage of sales) compared with
      2004, and a decrease of 0.3% in operating expenses as a percent of sales.
      Significant operating expense decreases occurred in employee benefits
      ($245,000), various insurance costs ($195,000), legal and professional fees
      ($80,000) and outside services ($125,000). These reductions were partially
      offset by increases in manager bonuses ($320,000) and advertising and marketing
      expenses ($285,000).





**Retail
      Leathercraft**





Year
            Net
                Sales Increase
              from
                Prior Yr
            OperatingIncome
            Operating
                IncomeIncr
                (Decr)
              from
                Prior Year
            Operating
                Income as a Percentageof
                Sales**2006**
            **25.0%**
            **$2,310,073**
            **30.7%**
            **10.3%**2005
            33.4%
            $1,766,960
            45.9%
            9.8%2004
            46.6%
            $1,210,566
            100.3%
            8.9%





Reflecting
      the growth previously discussed, Retail Leathercraft accounted for 40.8% of
      our
      total net sales in 2006, up from 35.5% in 2005 and 29.3% in 2004.





Growth
      in
      net sales for Retail Leathercraft division in 2006 and 2005 resulted primarily
      from our expansion program. Expansion during 2006 and 2005 consisted of the
      opening of 12 and 8 new stores, respectively.





Our
      sales
      mix by customer group was as follows:





**Customer
                Group**
            **2006**
            **2005**
            **2004**Retail
            65%
            62%
            72%Institution
            8%
            11%
            6%Wholesale
            26%
            26%
            21%National
                Accounts
            0%
            0%
            0%Manufacturers
            1%
            1%
            1%100%
            100%
            100%





Operating
      income as a percentage of sales increased to 10.3% for 2006 compared to 9.8%
      for
      2005. Gross margin fell to 60.8% in 2006 from 61.8% in 2005. Operating expenses
      as a percent of sales in 2006 decreased by 1.5%, from 52.0% for 2005 to 50.5%
      for 2006 as sales and gross margin grew at a faster pace than that of operating
      expenses.





Operating
      income as a percentage of sales increased to 9.8% for 2005 compared to 8.9%
      for
      2004. Gross margin remained steady at 61.8% in 2004 and 2005. Operating expenses
      as a percent of sales in 2005 decreased by 0.8%, from 52.8% for 2004 to 52.0%
      for 2005.





We
      intend
      to continue the expansion of Tandy Leather’s retail store chain in 2007 by
      opening approximately 12 new stores throughout the year. As of March 1, 2007,
      we
      have opened three new stores this year:





·
            Boston,
                MA


·
            Allentown,
                PA


·
            Cincinnati,
                OH





We
      remain
      committed to a conservative expansion plan for this division that minimizes
      risks to our profits and maintains financial stability.





**Other**





Roberts,
      Cushman accounted for 2.9% of our total sales in 2006 compared with 3.3% and
      4.3% in 2005 and 2004, respectively. The loss from operations was $57,000 in
      2006 compared to operating income of $84,000 in 2005 and $35,000 in 2004.
      Roberts, Cushman's sales and profits are immaterial to us as a whole.





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**Financial
      Condition**




At
      December 31, 2005, we held $3.2 million of cash, $15.6 million of inventory,
      accounts receivable of $2.2 million, and $1.7 million of property and equipment.
      Goodwill and other intangibles (net of amortization and depreciation) were
      $747,000 and $399,000, respectively. We also own a leather artwork collection,
      most of which was created by Al Stohlman, a legendary leathercrafter, valued
      on
      our balance sheet at $250,000. Net total assets were $25.7 million. Current
      liabilities were $4.1 million (including $134,000 of current maturities of
      capital lease obligations), while long-term debt was $111,000. Total
      stockholders’ equity at the end of 2005 was $21.2 million.





At
      December 31, 2006, we held $6.7 million of cash, $17.2 million of inventory,
      accounts receivable of $2.6 million, and $1.9 million of property and equipment.
      Goodwill and other intangibles (net of amortization and depreciation) were
      $747,000 and $360,000, respectively. Net total assets were $31.9 million.
      Current liabilities were $5.4 million (including $111,000 of current maturities
      of capital lease obligations), while long-term debt was $0. Total stockholders’
equity at the end of 2006 was $26.3 million.





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





**2006**
            **2005**
            **2004****Solvency
                Ratios:**Quick
                Ratio
            Cash+Accts
                Rec/Total Current Liabilities
            1.74
            1.31
            1.21Current
                Ratio
            Total
                Current Assets/Total Current Liabilities
            5.19
            5.30
            4.79Current
                Liabilities to Net Worth
            Total
                Current Liabilities/Net Worth
            0.20
            0.19
            0.22Current
                Liabilities to Inventory
            Total
                Current Liabilities/Inventory
            0.31
            0.26
            0.30Total
                Liabilities to Net Worth
            Total
                Liabilities/Net Worth
            0.21
            0.21
            0.28Fixed
                Assets to Net Worth
            Fixed
                Assets/Net Worth
            0.07
            0.08
            0.11**Efficiency
                Ratios:**Collection
                Period (Days Outstanding)
            Accounts
                Receivable/Credit Sales x 365
            53.43
            44.17
            43.57Inventory
                Turnover
            Sales/Average
                Inventory
            3.36
            3.57
            3.87Assets
                to Sales
            Total
                Assets/Sales
            0.58
            0.51
            0.48Sales
                to Net Working Capital
            Sales/Current
                Assets - Current Liabilities
            2.45
            2.38
            3.21Accounts
                Payable to Sales
            Accounts
                Payable/Sales
            0.03
            0.02
            0.04**Profitability
                Ratios:**Return
                on Sales (Profit Margin)
            Net
                Profit After Taxes/Sales
            0.09
            0.07
            0.06Return
                on Assets
            Net
                Profit After Taxes/Total Assets
            0.15
            0.14
            0.12Return
                on Net Worth(Return on Equity)
            Net
                Profit After Taxes/Net Worth
            0.18
            0.18
            0.15





**Capital
      Resources and Liquidity**





On
      November 1, 2004, we entered into a Credit Agreement with JPMorgan Chase Bank,
      N.A. (formerly BankOne, N.A.), which replaced our line of credit with Wells
      Fargo Bank. The current facility matures in October 2008 and is secured by
      our
      accounts receivable and inventory. We opted to reduce the maximum amount that
      may be borrowed under this line of credit to $3.0 million in order to reduce
      the
      fees required on the un-borrowed portion of the line.





We
      are
      currently in compliance with all covenants and conditions contained in the
      JPMorgan Chase Credit Agreement and have no reason to believe that we will
      not
      continue to operate in compliance with the provisions of these financing
      arrangements. The principal terms and conditions of the Credit Agreement are
      described in further detail in Note 5 to the Consolidated Financial Statements, *Notes
      Payable and Long-Term Debt.*





We
      borrow
      and repay funds under revolving credit terms as needed. The principal balance
      has been zero since the first quarter of 2005. We have not borrowed (and repaid)
      funds since that time. Total bank indebtedness at the end of 2006 and 2005
      is
      zero.




Reflecting
      the reduction of bank indebtedness during the periods, our financing activities
      for 2006, 2005 and 2004 provided (required) net cash of $69,000, ($447,000),
      and
      ($1.2 million), respectively.





The
      primary source of liquidity and capital resources during 2006 was cash flow
      provided by operating activities. Cash flow from operations for 2006 and 2005
      was $3.9 million and $1.5 million, respectively, the largest portion generated
      from net income partially offset by the increase in inventory. Cash flow from
      operations in 2004 was $2.9 million.





Consolidated
      accounts receivable increased to $2.6 million at December 31, 2006 compared
      to
      $2.2 million at December 31, 2005. Average days to collect accounts slowed
      from
      44.17 days in 2005 to 53.4 days in 2006 on a consolidated basis due primarily
      to
      the suspension of payments from a large customer due to a processing error
      on
      the part of the customer. The problem was resolved and we expect to collect
      the
      backlog of payments by the end of the first quarter of 2007.





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Inventory
      increased from $15.7 million at the end of 2005 to $17.2 million at December
      31,
      2006. We expect our inventory to slowly trend upward as we continue our
      expansion of the Tandy Leather store chain. 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 store growth and expansion. While we believe our investment in
      inventory at the end of 2006 was at a reasonable level given our expansion
      plans, it was approximately 5% above our internal targets of optimum
      inventory levels.




Consolidated
      inventory turned 3.36 times during 2006, a slight slow down from the 3.57 times
      turned in 2005. We compute our inventory turnover rates as sales divided by
      average inventory.





By
      operating division, inventory turns are as follows:





**Segment**
            **2006**
            **2005**
            **2004**Wholesale
                Leathercraft
            2.40
            2.68
            3.11Retail
                Leathercraft
            6.99
            8.23
            8.88Roberts,
                Cushman
            7.15
            3.75
            4.12Wholesale
                Leathercraft stores only
            7.48
            7.73
            8.69





Retail
      Leathercraft inventory turns are significantly higher than that of Wholesale
      Leathercraft because its inventory consists only of the inventory at the stores.
      The Tandy Leather 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 increased to $1.8 million at the end of 2006 compared to $1.2 million
      at
      the end of 2005 due primarily to the intentional slowdown in payments to
      vendors. We were paying ahead of terms in many cases in 2005 which resulted
      in
      the lower accounts payable balance at December 31, 2005.





As
      discussed above, the largest use of operating cash in 2006 was for inventory
      purchases and increase in accounts receivable. Capital expenditures totaled
      $471,000 and $273,000 for the years ended December 31, 2006 and 2005,
      respectively. In 2006, capital expenditures consisted of factory machines and
      dies ($85,000); fixtures and equipment for the new Tandy Leather retail stores
      ($175,000), air conditioner replacements at existing stores ($40,000), leather
      display racks ($25,000); computer server upgrades ($60,000) and miscellaneous
      computer and other office equipment ($150,000). Since we intend to continue
      opening or acquiring new Tandy Leather stores, expenditures related to this
      expansion should continue into 2007.





We
      believe that cash flow from operations will be adequate to fund our operations
      in 2007, while also funding expansion. At this time, we know of no trends or
      demands, commitments events or uncertainties that will or are likely to
      materially affect our liquidity, capital resources or results of operations.
      In
      addition, we anticipate that this cash flow will enable us to meet the
      contractual obligations and commercial commitments. However, if cash flows
      should decrease or uses of cash increase, we may increase our borrowings on
      our
      line of credit as needed. We believe that, if desired, our present financial
      condition would permit us to increase the maximum amount that could be borrowed
      from lenders. Further, 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 Tandy Leather store, we have flexibility in
      when
      we make most expansion expenditures.





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**Off-Balance
      Sheet Arrangements**





We
      did
      not have any off-balance sheet arrangements during 2006, 2005 and 2004, 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, 2006 (not including related interest
      expense):





**Payments
                Due by Periods****Contractual
                Obligations**
            **Total**
            **Less
                than**
              **1
                Year**
            **1
                - 3**
              **Years**
            **4
                -5**
              **Years**
            **After**
              **5
                Years****Long-Term
                Debt(1)**
            --
            --
            --
            --
            --**Capital
                Lease Obligations**
            $
                111,722
            $
                111,722
            --
            --
            --**Operating
                Leases(2)**
            6,050,225
            2,370,711
            $
                3,408,483
            $270,031
            --**Total
                Contractual Obligations**
            $6,161,947
            $2,482,433
            $3,408,483
            $270,031
            $
                --


____________________


(1)
      Our
      loan from JPMorgan Chase matures in October 2008. The loan's maturity can be
      accelerated in the event of a material adverse change or upon other occurrences
      described in the related credit agreement.


(2)
      These
      are our leased facilities.





The
      interest rate on the capital lease is 0%. Any imputed interest over the term
      of
      the lease would be insignificant.





**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.** A
      change in the accounting rules necessitated a change in 2002 in how we report
      goodwill on our balance sheet. As a result, we incurred an impairment write-down
      in 2002 of our investment in Roberts, Cushman in the amount of $4.0 million.
      We
      periodically analyze the remaining goodwill on our balance sheet to determine
      the appropriateness of its carry value. As of December 31, 2006, we determined
      that the present value of the discounted estimated future cash flows of the
      stores associated with the goodwill is sufficient to support their respective
      goodwill balances. If actual results of these stores differ 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.


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**Forward-Looking
      Statements**





“Item
      1.
      Business” and “Item 7. Management’s Discussion and Analysis of Financial
      Condition and Results of Operations” of this report contain forward-looking
      statements of management. In general, these are predictions or suggestions
      of
      future events and statements or expectations of future occurrences. There are
      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 which could cause actual results to differ materially from
      those
      suggested by the forward-looking statements include, among other
      things:





·
            We
                might fail to realize the anticipated benefits of the opening of
                Tandy
                Leather retail stores or we might be unable to obtain sufficient
                new
                locations on acceptable terms to meet our growth plans. Further,
                we might
                fail to hire and train competent managers to oversee the stores
                opened.




·
            Political
                considerations here and abroad could disrupt our sources of supplies
                from
                abroad or affect the prices we pay for
                goods.





·
            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.





·
            A
                slump 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. Also, hostilities, terrorism or other events
                could worsen this condition.




·
            As
                a result of the on-going threat of terrorist attacks on the United
                States,
                consumer buying habits could change and decrease our
                sales.




·
            Livestock
                diseases such as mad cow could reduce the availability of hides and
                leathers or increase their cost. Also, the prices of hides and leathers
                fluctuate in normal times, and these fluctuations can affect
                us.




·
            If,
                for whatever reason, the costs of our raw materials and inventory
                increase, we may not be able to pass those costs on to our
                customers.




·
            Other
                factors could cause either fluctuations in buying patterns or possible
                negative trends in the craft and western retail markets. In addition,
                our
                customers may change their preferences to products other than ours,
                or
                they may not accept new products as we introduce them.




·
            Tax
                or interest rates might increase. In particular, interest rates have
                been
                increasing. These increases will increase our costs of borrowing
                funds as
                needed in our business.





·
            Any
                change in the commercial banking environment may affect us and our
                ability
                to borrow capital as needed.





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





We
      do not
      intend to update forward-looking statements .








**ITEM
      7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK**





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





**Foreign
      Currency Exchange Rate Risk**





Our
      primary foreign currency exposure is related to our subsidiary in Canada. The
      Leather Factory of Canada, Ltd. has local currency (Canadian dollar) revenue
      and
      local currency operating expenses. Changes in the currency exchange rate 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**





We
      are
      subject to market risk associated with interest rate movements on outstanding
      debt. Our current credit agreement with JPMorgan Chase accrues interest at
      a
      rate that changes with fluctuations in the prime rate. Because we currently
      have
      no outstanding borrowings, changes in the prime rate do not impact us in this
      area.





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**ITEM
      8. FINANCIAL STATEMENTS AND SUPPLEMENTARY
      DATA**





**Tandy
      Leather Factory, Inc.**


**Consolidated
      Balance Sheets**


**December
      31, 2006 and 2005**








**December
                31,**
              **2006**
            
            **December
                31,**
              **2005****ASSETS**CURRENT
                ASSETS:Cash
            $6,739,891
            
            $3,215,727Accounts
                receivable-trade, net of allowance for doubtful accountsof
                $149,000 and $138,000 in 2006 and 2005, respectively
            2,599,279
            
            2,178,848Inventory
            17,169,358
            
            15,669,182Deferred
                income taxes
            266,018
            
            273,872Other
                current assets
            1,089,258
            
            358,058Total
                current assets
            27,863,804
            
            21,695,687PROPERTY
                AND EQUIPMENT, at cost
            6,865,946
            
            6,424,091Less
                accumulated depreciation and amortization
            (4,989,341)
            
            (4,664,614)1,876,605
            
            1,759,477GOODWILL
            746,139
            
            746,611OTHER
                INTANGIBLES, net of accumulated amortization of$262,000
                and $223,000 in 2006 and 2005, respectively
            360,676
            
            398,967OTHER
                assets
            1,069,411
            
            1,079,731**$31,916,635**
            
            **$25,680,473****LIABILITIES
                AND STOCKHOLDERS' EQUITY**CURRENT
                LIABILITIES:Accounts
                payable-trade
            $1,776,646
            
            $1,220,420Accrued
                expenses and other liabilities
            3,424,010
            
            2,550,573Income
                taxes payable
            59,392
            
            199,581Current
                maturities of capital lease obligation
            111,723
            
            134,067Total
                current liabilities
            5,371,771
            
            4,104,641DEFERRED
                INCOME TAXES
            221,621
            
            206,253CAPITAL
                LEASE OBLIGATION, net of current maturities
            -
            
            111,722COMMITMENTS
                AND CONTINGENCIES
            -
            
            -STOCKHOLDERS'
                EQUITY:Preferred
                stock, $0.10 par value; 20,000,000 sharesauthorized,
                none issued or outstanding
            -
            
            -Common
                stock, $0.0024 par value; 25,000,000 sharesauthorized,
                10,885,068 and 10,741,835 shares issued at 2006 and 2005,10,879,209
                and 10,735,976 outstanding at 2006 and 2005, respectively
            26,124
            
            25,780Paid-in
                capital
            5,292,591
            
            4,988,445Retained
                earnings
            20,949,540
            
            16,172,475Treasury
                stock (5,859 shares at cost)
            (25,487)
            
            (25,487)Accumulated
                other comprehensive income
            80,475
            
            96,644Total
                stockholders' equity
            26,323,243
            
            21,257,857**$31,916,635**
            
            **$25,680,473**


























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


19
 *TABLE
          OF CONTENTS*


**Tandy
      Leather Factory, Inc.**


**Consolidated
      Statements of Income**


**For
      the Years Ended December 31, 2006, 2005 and 2004**








**2006**
            
            **2005**
            
            **2004**NET
                SALES
            $
                55,199,021
            
            $
                50,719,574
            
            $
                46,146,284COST
                OF SALES
            23,566,251
            
            21,964,530
            
            20,706,239Gross
                Profit
            31,632,770
            
            28,755,044
            
            25,440,045OPERATING
                EXPENSES
            24,565,056
            
            23,181,633
            
            21,181,599INCOME
                FROM OPERATIONS
            7,067,714
            
            5,573,411
            
            4,258,446OTHER
                (INCOME) EXPENSE:Interest
                expense
            -
            
            3,188
            
            53,400Other,
                net
            (98,391)
            
            (137,690)
            
            (8,600)Total
                other expense
            (98,391)
            
            (134,502)
            
            44,800INCOME
                BEFORE INCOME TAXES
            7,166,105
            
            5,707,913
            
            4,213,646PROVISION
                FOR INCOME TAXES
            2,389,039
            
            1,994,199
            
            1,559,605NET
                INCOME
            $4,777,066
            
            $3,713,714
            
            $2,654,041NET
                INCOME PER COMMON SHARE - BASIC
            $0.44
            
            $0.35
            
            $0.25NET
                INCOME PER COMMON SHARE - DILUTED
            $0.43
            
            $0.34
            
            $0.24Weighted
                Average Number of Shares Outstanding:Basic
            10,807,316
            
            10,643,004
            
            10,543,994Diluted
            11,113,855
            
            10,976,240
            
            10,957,518












































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


20
 *TABLE
          OF CONTENTS*





**Tandy
      Leather Factory, Inc.**


**Consolidated
      Statements of Cash Flow**


**For
      the Years Ended December 31, 2006, 2005 and 2004**





**2006**
            
            **2005**
            
            **2004**CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income
            $
                4,777,066
            
            $
                3,713,714
            
            $
                2,654,041Adjustments
                to reconcile net income to net cashprovided
                by operating activities -Depreciation
                and amortization
            392,915
            
            456,706
            
            452,653Gain
                on disposal of assets
            (3,750)
            
            (9,145)
            
            (2,000)Non-cash
                stock-based compensation
            101,080
            
            -
            
            -Deferred
                income taxes
            23,222
            
            (181,317)
            
            38,721Other
            (15,696)
            
            38,276
            
            20,123Net
                changes in assets and liabilities, net of effect ofbusiness
                acquisitions:Accounts
                receivable-trade, net
            (420,431)
            
            (146,559)
            
            (112,738)Inventory
            (1,500,176)
            
            (2,919,473)
            
            (1,303,762)Income
                taxes
            (140,189)
            
            176,817
            
            228,787Other
                current assets
            (731,200)
            
            271,664
            
            (102,163)Accounts
                payable-trade
            556,226
            
            (733,726)
            
            406,357Accrued
                expenses and other liabilities
            873,437
            
            868,570
            
            658,692Total
                adjustments
            (864,562)
            
            (2,178,187)
            
            284,670**Net
                cash provided by operating activities**
            **3,912,504**
            
            **1,535,527**
            
            **2,938,711**CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchase
                of property and equipment
            (471,753)
            
            (272,826)
            
            (369,559)Payments
                in connection with businesses acquired
            -
            
            -
            
            (556,794)Proceeds
                from sale of assets
            3,750
            
            9,145
            
            2,000Decrease
                (increase) in other assets
            10,320
            
            (168,981)
            
            10,280**Net
                cash used in investing activities**
            **(457,683)**
            
            **(432,662)**
            
            **(914,073)**CASH
                FLOWS FROM FINANCING ACTIVITIES:Net
                decrease in revolving credit loans
            -
            
            (505,154)
            
            (1,287,830)Payments
                on capital lease obligations
            (134,067)
            
            (134,067)
            
            (23,478)Payments
                received on notes secured by common stock
            -
            
            -
            
            20,000Repurchase
                of common stock (treasury stock)
            -
            
            -
            
            (25,487)Proceeds
                from issuance of common stock and warrants
            203,410
            
            191,881
            
            124,015**Net
                cash provided by (used in) financing activities**
            **69,343**
            
            **(447,340)**
            
            **(1,192,780)**NET
                INCREASE IN CASH
            3,524,164
            
            655,525
            
            831,858CASH,
                beginning of period
            3,215,727
            
            2,560,202
            
            1,728,344CASH,
                end of period
            $6,739,891
            
            $3,215,727
            
            $2,560,202SUPPLEMENTAL
                DISCLOSURES OF CASH FLOW INFORMATION:Interest
                paid during the period
            $
                -
            
            $
                3,188
            
            $
                59,773Income
                tax paid during the period, net of (refunds)
            2,282,113
            
            1,954,364
            
            1,197,347NON-CASH
                INVESTING ACTIVITIES:Equipment
                acquired under capital lease financing arrangements
            -
            
            -
            
            $
                402,201



































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





21
 *TABLE
          OF CONTENTS*


**Tandy
      Leather Factory, Inc.**


**Consolidated
      Statements of Stockholders' Equity**


**For
      the Years Ended December 31, 2006, 2005 and 2004**








**Number
                of Shares**
            
            **Par
                Value**
            
            **Paid-in
                Capital**
            
            **Treasury**
              **Stock**
            
            **Retained
                Earnings**
            
            **Notes
                receivable - secured by common stock**
            
            **Accumulated
                Other Comprehensive Income (Loss)**
            
            **Total**
            
            **Comprehensive**
              **Income
                (Loss)**BALANCE,
                December 31, 2003
            10,487,961
            
            $25,171
            
            $4,673,158
            
            -
            
            $9,804,719
            
            $(20,000)
            
            $26,445
            
            $14,509,493Payments
                on notes receivable
              secured
                by common stock
            -
            
            -
            
            
            
            -
            
            -
            
            20,000
            
            -
            
            20,000Shares
                issued - stock options andwarrants
                exercised
            72,700
            
            174
            
            74,896
            
            -
            
            -
            
            -
            
            -
            
            75,070Warrants
                to acquire 50,000 sharesof
                common stock issued
            -
            
            -
            
            48,945
            
            -
            
            -
            
            -
            
            -
            
            48,945Purchase
                of treasury stock
            -
            
            -
            
            -
            
            (25,487)
            
            -
            
            -
            
            -
            
            (25,487)Net
                income
            -
            
            -
            
            -
            
            -
            
            2,654,041
            
            -
            
            -
            
            2,654,041
            
            $2,654,041Translation
                adjustment
            -
            
            -
            
            -
            
            -
            
            -
            
            -
            
            28,171
            
            28,171
            
            28,171BALANCE,
                December 31, 2004
            10,560,661
            
            $25,345
            
            $4,796,999
            
            $(25,487)
            
            $12,458,760
            
            -
            
            $54,616
            
            $17,310,233Comprehensive
                income for the year ended December 31, 2004
            $2,682,212Shares
                issued - stock options andwarrants
                exercised
            181,174
            
            435
            
            191,446
            
            -
            
            -
            
            -
            
            -
            
            191,881Net
                income
            -
            
            -
            
            -
            
            -
            
            3,713,714
            
            -
            
            -
            
            3,713,714
            
            $3,713,714Translation
                adjustment
            -
            
            -
            
            -
            
            -
            
            -
            
            -
            
            42,029
            
            42,029
            
            42,029BALANCE,
                December 31, 2005
            10,741,835
            
            $25,780
            
            $4,988,445
            
            $(25,487)
            
            $16,172,474
            
            -
            
            $96,645
            
            $21,257,857Comprehensive
                income for the year ended December 31, 2005
            $3,755,743Shares
                issued - stock options andwarrants
                exercised
            143,233
            
            344
            
            203,066
            
            -
            
            -
            
            -
            
            -
            
            203,410Stock-based
                compensation
            -
            
            -
            
            101,080
            
            -
            
            -
            
            -
            
            -
            
            101,080Net
                income
            -
            
            -
            
            -
            
            -
            
            4,777,066
            
            -
            
            -
            
            4,777,066
            
            $4,777,066Translation
                adjustment
            -
            
            -
            
            -
            
            -
            
            -
            
            -
            
            (16,170)
            
            (16,170)
            
            (16,170)BALANCE,
                December 31, 2006
            10,885,068
            
            $26,124
            
            $5,292,591
            
            $(25,487)
            
            $20,949,540
            
            -
            
            $80,475
            
            $26,323,243Comprehensive
                income for the year ended December 31, 2006
            $4,760,896

















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





22
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          OF CONTENTS*


**TANDY
      LEATHER FACTORY, INC.**


**NOTES
      TO CONSOLIDATED FINANCIAL
      STATEMENTS**


**DECEMBER
      31, 2006, 2005, and 2004**





**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 and Canada. Numerous customers including retailers, wholesalers,
      assemblers, distributors and other manufacturers are geographically disbursed
      throughout the world. We also have light manufacturing facilities in
      Texas.





On
      May
      23, 2005, our stockholders approved changing the name of the Company from The
      Leather Factory, Inc. to Tandy Leather Factory, Inc.





**2.
      SIGNIFICANT ACCOUNTING POLICIES**




*·*
            *Management
                estimates and reporting*





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





*·*
            *Principles
                of consolidation*





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





*·*
            *Foreign
                currency translation*





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





*·*
            *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.





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, five to seven years for furniture and fixtures,
      and five years for vehicles. Leasehold improvements are amortized over the
      lesser of the life of the lease or the useful life of the asset. Repairs and
      maintenance costs are expensed as incurred.





*·*
            *Inventory*





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





23
 *TABLE
          OF CONTENTS*


*·*
            *Impairment
                of long-lived assets*





Potential
      impairments of long-lived assets are reviewed annually or when events and
      circumstances warrant an earlier review. In accordance with SFAS No. 144,
      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***
            2006
            
            2005
            
            2004Net
                income (loss)
            $4,777,066
            
            $3,713,714
            
            $
                2,654,041Weighted
                average common shares outstanding
            10,807,316
            
            10,643,004
            
            10,543,994**Earnings
                per share - basic**
            **$
                0.44**
            
            **$
                0.35**
            
            **$
                0.25*****DILUTED***Net
                income (loss)
            $
                4,777,066
            
            $
                3,713,714
            
            $
                2,654,041Weighted
                average common shares outstanding
            10,807,316
            
            10,643,004
            
            10,543,994Effect
                of assumed exercise of stock options and warrants
            306,539
            
            333,236
            
            413,524Weighted
                average common shares outstanding,assuming
                dilution
            11,113,855
            
            10,976,240
            
            10,957,518**Earnings
                per share - diluted**
            **$
                0.43**
            
            **$
                0.34**
            
            **$
                0.24**Outstanding
                options and warrants excluded as anti-dilutive
            -
            
            -
            
            136,000





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
      446,500 and 596,174 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, 2006 and 2005, respectively.





*·*
            *Goodwill
                and other intangibles*





Statement
      of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other
      Intangible Assets," prescribes a two-phase process for impairment testing of
      goodwill, which is performed once annually, absent indicators of impairment.
      The
      first phase screens for impairment, while the second phase (if necessary)
      measures the impairment. We
      periodically analyze goodwill remaining on the balance sheet to determine the
      appropriateness of its carrying value and have elected to perform
      the annual analysis during the fourth calendar quarter of each year. As
      of
      December 31, 2006, we determined that the present value of the discounted
      estimated future cash flows of the stores associated with the goodwill is
      sufficient to support their respective goodwill balances. Under
      SFAS 142, goodwill impairment is deemed to exist if the net book value of a
      reporting unit exceeds its estimated fair value. Our reporting units are
      generally the same as the operating segments identified in Note 13 - Segment
      Information.





24
 *TABLE
          OF CONTENTS*


A
      summary
      of changes in our goodwill for the years ended December 31, 2006 and 2005 is
      as
      follows:





**Leather
                Factory**
            
            **Tandy
                Leather**
            
            **Total**Balance,
                December 31, 2004
            $359,454
            
            $383,406
            
            $742,860Acquisitions
                and adjustments
            -
            
            -
            
            -Foreign
                exchange gain/loss
            3,751
            
            -
            
            3,751Impairments
            -
            
            -
            
            -Balance,
                December 31, 2005
            $363,205
            
            $383,406
            
            $746,611Acquisitions
                and adjustments
            -
            
            -
            
            -Foreign
                exchange gain/loss
            (472)
            
            -
            
            (472)Impairments
            -
            
            -
            
            -Balance,
                December 31, 2006
            $362,733
            
            $383,406
            
            $746,139





As
      of
      December 31, 2006 and 2005, our intangible assets and related accumulated
      amortization consisted of the following:





**As
                of December 31, 2006****Gross**
            
            **Accumulated****Amortization**
            
            **Net**Trademarks,
                Copyrights
            $544,369
            
            $247,193
            
            $297,176Non-Compete
                Agreements
            78,000
            
            14,500
            
            63,500$622,369
            
            $261,693
            
            $360,676





**As
                of December 31, 2005****Gross**
            
            **Accumulated****Amortization**
            
            **Net**Trademarks,
                Copyrights
            $544,369
            
            $210,902
            
            $333,467Non-Compete
                Agreements
            78,000
            
            12,500
            
            65,500$622,369
            
            $223,402
            
            $398,967





Excluding
      goodwill, we have no intangible assets not subject to amortization under SFAS
      142. Amortization of intangible assets of $38,291 in 2006, $38,791 in 2005,
      and
      $33,782 in 2004 was recorded in operating expenses. Based on the current amount
      of intangible assets subject to amortization, the estimated amortization expense
      for each of the succeeding 5 years are as follows:





**Leather
                Factory**
            **Tandy
                Leather**
            **Total**2007
            $5,954
            $31,837
            $37,7912008
            5.954
            30,337
            36,2912009
            5,954
            30,337
            36,2912010
            5,954
            30,337
            36,2912011
            5,027
            30,337
            35,364





During
      2006, we did not acquire any intangible assets.




*·*
            *Fair
                value of financial Instruments*





The
      principal financial instruments held consist of accounts receivable, accounts
      payable, notes payable and long-term debt. The carrying value of accounts
      receivable and accounts payable approximate their fair value due to the
      relatively short-term nature of the accounts. The interest rates on our notes
      payable and long-term debt fluctuate with changes in the prime rate and are
      the
      rates currently available to us; therefore, the carrying amount of those
      instruments approximates their fair value.





*·*
            *Deferred
                taxes*





Deferred
      income taxes result from temporary differences in the bases of our assets and
      liabilities reported for book and tax purposes.





25
 *TABLE
          OF CONTENTS*


*·*
            *Stock-based
                compensation - Change in Accounting
                Principle*





We
      had
      two stock option plans which provided for stock option grants to officers,
      key
      employees and directors. Both plans expired in the 4 th quarter
      of 2005. The expiration of the plans have 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.
      Additionally, options vest and become exercisable either six months from the
      option grant date or in equal installments over a five year period. Prior to
      fiscal 2006, we accounted for stock-based compensation using the intrinsic
      value
      method prescribed in Accounting Principles Board Opinion No. 25, *Accounting
      for Stock Issued to Employees* ,
      and
      related Interpretations and provided the required pro forma disclosures of
      SFAS
      No. 123, *Accounting
      for Stock-Based Compensation* .





On
      January 1, 2006, we adopted SFAS No. 123(R), “Share-Based Payment,” and elected
      to adopt the standard using the modified prospective transition method. Under
      this transition method, compensation cost associated with stock options
      recognized in 2006 includes: (1) amortization related to the remaining unvested
      portion of all share based payments granted prior to, but not vested as of
      December 31, 2005, based on the grant date fair value estimated in accordance
      with the original pro forma footnote disclosure provisions of FASB Statement
      No.
      123 and (2) amortization related to all share based payments granted subsequent
      to December 31, 2005, based on the grant date fair value estimated in accordance
      with the provisions of FASB Statement No. 123(R). Accordingly, stock
      compensation award expense is recognized over the requisite service period
      using
      the straight-line attribution method. Previously reported amounts have not
      been
      restated.





We
      recognized share based compensation expense of approximately $101,000 for the
      year ended December 31, 2006, as a component of operating expenses. Had
      compensation expense for our stock option plans been based upon the projected
      fair values at the grant dates for awards under those plans in accordance with
      SFAS No. 123, our pro forma net earnings, basic and diluted earnings per common
      share for the years ended December 31, 2005 and 2004 would have been as
      follows:





**2005**
            
            **2004**Net
                income, as reported
            $3,713,714
            
            $2,654,041Add:
                Stock-based compensation expense included in reported net
                income
            -
            
            -Deduct:
                Stock-based compensation expense determined under fair value
                method
            122,934
            
            117,443Net
                income, pro forma
            $3,590,780
            
            $2,536,598Net
                income per share:Basic
                - as reported
            $0.35
            
            $0.25Basic
                - pro forma
            $0.34
            
            $0.24Diluted
                - as reported
            $0.34
            
            $0.24Diluted
                - pro forma
            $0.33
            
            $0.23





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:





2005
            2004Volatility
            36.6%
            36.4%Expected
                option life
            3-5
            3-5Interest
                rate (risk free)
            4.25%
            3.375%Dividends
            None
            None





The
      effect on 2005 and 2004 pro forma net income and earnings per share of the
      estimated fair value of stock options and shares are not necessarily
      representative of the effects on the results of operations in the future. In
      addition, the estimates made utilize a pricing model developed for traded
      options with relatively short lives; our option grants typically have a life
      of
      up to ten years and are not transferable. Therefore, the actual fair value
      of a
      stock option grant may be different from our estimates. We believe that our
      estimates incorporate all relevant information and represent a reasonable
      approximation in light of the difficulties involved in valuing non-traded stock
      options.





During
      the year ended December 31, 2006, 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 ValueOutstanding,
                January 1, 2006
            $1.93
            421,000Granted
            -
            -Cancelled
            -
            -Exercised
            1.63
            (124,800)Outstanding,
                December 31, 2006
            $2.05
            296,200
            4.99
            $333,060Exercisable,
                December 31, 2006
            $1.82
            266,200
            4.77
            $269,520





Other
      information pertaining to option activity during the twelve month periods ended
      December 31, 2006 and 2005 are as follows:





December
                31, 2006
            December
                31, 2005Weighted
                average grant-date fair value of stock options granted
            N/A
            $11,814Total
                fair value of stock options vested
            $89,915
            $95,866Total
                intrinsic value of stock options exercised
            $90,780
            $99,879





As
      of
      December 31, 2006, there was $52,000 of total unrecognized compensation cost
      related to nonvested stock options, which is expected to be recognized over
      a
      remaining weighted average vesting period of 3 years.





Stock
      options to purchase our common stock are granted at prices at or above the
      fair
      market value on the date of grant. For employees, options become exercisable
      in
      five equal installments beginning a year from the date of grant. For
      non-employee directors, options become exercisable six months after the date
      of
      grant. All options expire 10 years from the date of grant.





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





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*·*
            *Comprehensive
                income*





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





*·*
            *Shipping
                and handling costs*





All
      shipping and handling costs incurred by us are included in operating expenses
      on
      the statements of income. These costs totaled approximately $1,611,000,
      $1,504,000 and $1,360,000 for the years ended December 31, 2006, 2005 and 2004,
      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 $238,000
      and $211,000 at December 31, 2006 and 2005, respectively. Total advertising
      expense was $3,087,943 in 2006; $3,074,991 in 2005; and $2,571,124 in
      2004.





We
      agree
      to list the names and addresses of our Authorized Sales Centers (ASCs) in
      certain mailing pieces produced. The inclusion of these names and addresses
      are
      at our sole discretion. The production and distribution of direct mailings
      is
      the primary method of advertising we use and normally consists of 75 to 80
      unique mailing pieces annually. Generally, the ASCs are listed in six to eight
      of those pieces. We believe that the inclusion of these ASC locations in the
      flyers has no impact on our financial statements.





*·*
            *Cash
                flows presentation*





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





**3.
      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
      $149,172 and $137,587, respectively, at December 31, 2006 and 2005. The
      following is a roll forward of the allowance for doubtful accounts:




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
                yearYear
                ended December 31, 2006
            $137,587
            -
            85,439
            241
            (74,095)
            $149,172Year
                ended December 31, 2005
            $
                85,133
            -
            87,873
            527
            (35,946)
            $137,587Year
                ended December 31, 2004
            $
                31,469
            9,785
            104,587
            4,980
            (65,688)
            $
                85,133





·
            Sales
                returns and defective merchandise





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





·
            Slow-moving
                and obsolete inventory





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





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**4.
      BALANCE SHEET COMPONENTS**




**December
                31, 2006**
            
            **December
                31, 2005**INVENTORYOn
                hand:Finished goods held for sale
            $14,774,445
            
            $14,035,384Raw materials and work in process
            628,539
            
            984,878Inventory
                in transit
            1,766,374
            
            648,920TOTAL
            $17,169,358
            
            $15,669,182PROPERTY
                AND EQUIPMENTLeasehold
                improvements
            $1,199,900
            
            $1,199,996Equipment
            4,449,949
            
            4,093,722Furniture
                and fixtures
            1,149,875
            
            1,064,081Vehicles
            66,222
            
            66,2926,865,946
            
            6,424,091Less:
                accumulated depreciation
            (4,989,341)
            
            (4,664,614)TOTAL
            $1,876,605
            
            $1,759,477OTHER
                CURRENT ASSETSAccounts
                receivable - employees
            $16,247
            
            $12,158Accounts
                receivable - other
            390,937
            
            2,037Prepaid
                expenses
            598,094
            
            313,344Payments
                for merchandise not received
            83,980
            
            30,519TOTAL
            $1,089,258
            
            $358,058OTHER
                ASSETSSecurity
                deposits - utilities, locations, etc.
            $70,771
            
            $83,087Leather
                art collection
            252,000
            
            250,000Computer
                software not implemented yet
            746,640
            
            746,644TOTAL
            $1,069,411
            
            $1,079,731ACCRUED
                EXPENSES AND OTHER LIABILITIESAccrued
                bonuses
            $950,056
            
            $1,120,517Accrued
                payroll
            274,514
            
            328,691Sales
                and payroll taxes payable
            231,076
            
            208,396Inventory
                in transit
            1,766,374
            
            648,920Other
            201,990
            
            244,049TOTAL
            $3,424,010
            
            $2,550,573





Depreciation
      expense was $348,797, $417,914, and $444,878 for the years ended December 31,
      2006, 2005 and 2004, respectively.





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**5.
      NOTES PAYABLE AND LONG-TERM DEBT**





On
      November 1, 2004, we entered into a Credit Agreement with JPMorgan Chase
      (“Chase”) pursuant to which Chase agreed to provide a revolving credit facility
      of up to $3,000,000. The revolver bears interest at prime less .5% (7.75% at
      December 31, 2006) or LIBOR plus 1.35%, matures on October 6, 2008, and is
      collateralized by inventory and accounts receivable.





At
      December 31, 2006 and 2005, there were no amounts outstanding under the above
      agreement and other long-term debt.





The
      terms
      of the Credit Facility contain various covenants which, among other things,
      require us to meet a specific debt service coverage ratio and limit capital
      expenditures. We are prohibited from incurring indebtedness except as permitted
      by the terms of the Credit Facility, from entering into any new business or
      making material changes in any of our business objectives, purposes or
      operations. We also have an affirmative duty to disclose any covenant violation
      to the lender.





**6.
      CAPITAL LEASE OBLIGATIONS**





We
      lease
      certain licensed software under a capital lease agreement. The asset subject
      to
      the agreement totaling $402,201 is included in other assets as of December
      31,
      2006. The asset will be reclassified into property and equipment once the
      conversion and implementation process is completed.





At
      December 31, 2006 and 2005, the amounts outstanding under capital lease
      obligations consisted of the following:





2006
            2005Capital
                Lease secured by certain licensed software - total monthly principal
                payments of $11,172, no interest, maturing October 2007
            $111,723
            $245,789Less
                - Current maturities
            111,723
            134,067$
                -
            $111,722





**7.
      EMPLOYEE BENEFIT AND SAVINGS PLANS**





We
      have
      an Employee Stock Ownership Plan (the "Plan") for employees with at least one
      year of service (as defined by the Plan) and who have reached their 21st
      birthday. Under the Plan, we make annual cash or stock contributions to a trust
      for the benefit of eligible employees. As of December 31, 2006, 229 employees
      and former employees were participants in or beneficiaries of the ESOP. The
      trust invests in shares of our common stock. The amount of our annual
      contribution is discretionary. Benefits under the Plan are 100% vested after
      three years of service and are payable upon death, disability or retirement.
      Vested benefits are payable upon termination of employment.





We
      apply
      Statement of Position 93-6 (SOP 93-6), "Employers’ Accounting for Employee Stock
      Ownership Plans," of the Accounting Standards Division of the American Institute
      of CPAs. During 2006, 2005, and 2004, respectively, we contributed $225,350;
      $300,000; and $250,000 in cash as current year contributions to the plan and
      recognized compensation expense related to these payments.





The
      following table summarizes the number of shares held by the Plan and the market
      value as of December 31, 2006, 2005, and 2004:





Number
                of Shares
            
            Market
                Value2006
            2005
            2004
            
            2006
            2005
            2004Allocated
            929,069
            943,241
            948,147
            
            $7,497,587
            $6,461,201
            $3,365,922Unearned
            -
            -
            -
            
            -
            -
            -Total
            929,069
            948,147
            948,147
            
            $7,497,587
            $6,461,201
            $3,365,922





In
      December 2006, the Board of Directors decided to terminate the Plan effective
      December 31, 2006. As a result, all participants became 100% vested in their
      accounts. No further contributions will be made to the Plan. The accounts will
      be distributed to participants upon receipt of the appropriate determination
      letter from the Internal Revenue Service regarding the Plan
      termination.





Beginning
      in 2006, 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. We match pretax employee
      contributions up to 50% of the first 4% of eligible earnings that are
      contributed by employees. Therefore, the maximum matching contribution that
      we
      may allocate to each participant’s account will not exceed $4,400 for the 2006
      calendar year due to the $220,000 annual limit on eligible earnings imposed
      by
      the Internal Revenue Code. All matching contributions vest over 6 years from
      the
      date of hire. Our matching contribution to the plan totaled $108,565 in
      2006.





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 2006.




We
      currently offer no postretirement or postemployment benefits to our
      employees.





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**8.
      INCOME TAXES**





The
      provision for income taxes consists of the following:





**2006**
            
            **2005**
            
            **2004**Current
                provision:Federal
            $2,167,141
            
            $1,932,791
            
            $1,380,951State
            198,676
            
            242,725
            
            139,9332,365,817
            
            2,175,516
            
            1,520,884Deferred
                provision (benefit):Federal
            19,447
            
            (166,850)
            
            33,483State
            3,775
            
            (14,467)
            
            5,23823,222
            
            (181,317)
            
            38,721$2,389,039
            
            $1,994,199
            
            $1,559,605





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





**2006**
            
            **2005**
            
            **2004**United
                States
            $6,560,994
            
            $5,220,991
            
            $
                4,078,434Canada
            605,111
            
            486,922
            
            135,212$7,166,105
            
            $5,707,913
            
            $
                4,213,646





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





2006
            
            2005**Deferred
                income tax assets:**Allowance
                for doubtful accounts
            $49,601
            
            $45,665Capitalized
                inventory costs
            131,054
            
            134,466Warrants
            42,989
            
            41,498Accrued
                expenses, reserves, and other
            85,363
            
            93,741**Total
                deferred income tax assets**
            309,007
            
            315,370**Deferred
                income tax liabilities:**Property
                and equipment depreciation
            197,287
            
            193,337Goodwill
                and other intangible assets amortization
            67,323
            
            54,414**Total
                deferred income tax liabilities**
            264,610
            
            247,751**Net
                deferred tax asset (liability)**
            $44,397
            
            $67,619





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





**2006**
            
            **2005**Current
                deferred tax assets
            $266,018
            
            $273,872Long-term
                deferred tax liabilities
            (221,621)
            
            (206,253)Net
                deferred tax asset (liability)
            $44,397
            
            $67,619





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


2006
            2005
            2004Statutory
                rate
            
            34%
            34%
            34%State
                and local taxes
            
            2%
            4%
            4%Other
            
            (3%)
            (3%)
            (1%)Effective
                rate
            
            33%
            35%
            37%





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**9.
      COMMITMENTS AND CONTINGENCIES**





**Operating
      Leases**





Our
      primary office facility and warehouse are leased under a five-year lease
      agreement that expires in March 2008. Rental agreements for the stores and
      warehouse distribution units expire on dates ranging from March 2007 to February
      2012. Rent expense on all operating leases for the years ended December 31,
      2006, 2005, and 2004, was $2,495,380, $2,227,345 and $1,994,030,
      respectively.





Future
      minimum lease payments under noncancelable operating leases at December 31,
      2006
      were as follows:





Year
                ending December 31:2007
            $2,370,7112008
            1,627,0402009
            1,088,3612010
            693,0822011
                and thereafter
            271,031Total
                minimum lease payments
            $6,050,225





**Litigation**





We
      are
      involved in various litigation that arise 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.





**10.
      SIGNIFICANT BUSINESS CONCENTRATIONS AND RISK**





Major
      Customers





Our
      revenues are derived from a diverse group of customers primarily involved in
      the
      sale of leathercrafts. While no single customer accounts for more than 10%
      of
      our consolidated revenues in 2006, 2005 and 2004, sales to our five largest
      customers represented 9.5%, 9.4% and 10.6%, 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,
      2006 and 2005, 38% and 19%, respectively, of our consolidated accounts
      receivable were due from two nationally recognized retail chains. We do not
      generally require collateral for accounts receivable, but we do perform periodic
      credit evaluations of our customers and believe the allowance for doubtful
      accounts is adequate. It is our opinion that if any one or a group of customer
      receivable balances should be deemed uncollectable, it would not have a material
      adverse effect on our results of operations and financial
      condition.





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





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**11.
      STOCKHOLDERS' EQUITY**





**(a)**
            **Stock
                Option Plans**


*·*
            *1995
                Stock Option Plan* 
 In
        connection with the 1995 Stock Option Plan for officers and key management
        employees, we have outstanding options to purchase our common stock. The
        plan
        provides for the granting of either qualified incentive stock options or
        non-qualified options at the discretion of the Stock Option 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 over a five-year period.
        We reserved 1,000,000 shares of common stock for issuance under this plan.
        The
        plan expired in the 4th quarter of 2005 with 20,000 ungranted options
        remaining.
 
 ·
            *1995
                Director Non-Qualified Stock Option
                Plan* 
 In
        connection with the 1995 Director Non-qualified Stock Option Plan for
        non-employee directors, we have outstanding options to purchase our common
        stock. The plan provides for the granting of non-qualified options at the
        discretion of the Directors Stock Option 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 reserved 100,000 shares of
        common stock for issuance under this plan. The plan expired in the 4th quarter
        of 2005 with 18,000 ungranted options remaining.
 
 *·*
            *Stock
                Option Summary*




All
      options expire ten years from the date of grant and are exercisable at any
      time
      after vesting. Of the combined 1,100,000 shares available for issuance under
      the
      two plans, at December 31, 2006, 2005 and 2004, there were 0, 44,000, and
      40,000, respectively, in un-optioned shares available for future
      grants.





A
      summary
      of stock option transactions for the years ended December 31, 2006, 2005, and
      2004, is as follows:





2006
            
            2005
            
            2004Weighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            AverageOption
            
            Exercise
            
            Option
            
            Exercise
            
            Option
            
            ExerciseShares
            
            Price
            
            Shares
            
            Price
            
            Shares
            
            PriceOutstanding
                at January 1
            
            421,000
            
            $1.93
            
            602,500
            
            $1.630
            
            675,200
            
            $1.540Granted
            
            -
            
            -
            
            8,000
            
            4.960
            
            18,000
            
            3.598Forfeited
                or expired
            
            -
            
            -
            
            (12,000)
            
            1.350
            
            (18,000)
            
            1.350Exchanged
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Exercised
            
            (124,800)
            
            1.63
            
            (177,500)
            
            1.081
            
            (72,700)
            
            1.053Outstanding
                at December 31
            
            296,200
            
            $2.05
            
            421,000
            
            $1.930
            
            602,500
            
            $1.630Exercisable
                at end of year
            
            266,200
            
            $1.82
            
            295,000
            
            $1.670
            
            354,500
            
            $1.320Weighted-average
                fair value ofoptions
                granted during year
            
            -
            
            
            
            $1.48
            
            
            
            $1.20





The
      following table summarizes outstanding options into groups based upon exercise
      price ranges at December 31, 2006:





Options
                Outstanding
            
            Options
                ExercisableWeighted
            
            Weighted
            
            
            
            Weighted
            
            WeightedAverage
            
            Average
            
            
            
            Average
            
            AverageOption
            
            Exercise
            
            Maturity
            
            Option
            
            Exercise
            
            MaturityExercise
                Price Range
            
            Shares
            
            Price
            
            (Years)
            
            Shares
            
            Price
            
            (Years)$0.75
                or Less
            
            4,000
            
            $0.595
            
            2.24
            
            4,000
            
            $0.595
            
            2.24$0.76
                to $1.125
            
            42,000
            
            $0.943
            
            3.70
            
            42,000
            
            $0.943
            
            3.70$1.126
                to $1.69
            
            165,700
            
            $1.350
            
            4.40
            
            165,700
            
            $1.350
            
            4.40$1.70
                to $2.55
            
            2,000
            
            $1.900
            
            4.74
            
            2,000
            
            $1.900
            
            4.74$2.56
                to $3.84
            
            12,000
            
            $3.270
            
            7.31
            
            6,000
            
            $3.160
            
            6.99$3.85-$4.96
            
            70,500
            
            $4.241
            
            6.89
            
            46,500
            
            $4.241
            
            6.98296,200
            
            $2.050
            
            4.99
            
            266,200
            
            $1.820
            
            4.77





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**(b)**
            **Warrants**





Warrants
      to acquire up to 100,000 shares of common stock at $3.10 per share were issued
      in conjunction with a consulting agreement to an unrelated entity in February
      2003. The warrants may be exercised at anytime until expiration on February
      12,
      2008.





Warrants
      to acquire up to 50,000 shares of common stock at $5.00 per share were issued
      in
      conjunction with a consulting agreement to an unrelated entity in February
      2004.
      The warrants may be exercised at anytime until expiration on February 24, 2009.





A
      summary
      of warrant transactions for the years ended December 31, 2006, 2005, and 2004,
      is as follows:





2006
            
            2005
            
            2004Weighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            AverageOption
            
            Exercise
            
            Option
            
            Exercise
            
            Option
            
            ExerciseShares
            
            Price
            
            Shares
            
            Price
            
            Shares
            
            PriceOutstanding
                at January 1
            
            140,000
            
            3.7786
            
            150,000
            
            3.7333
            
            100,000
            
            3.1000Granted
            
            -
            
            -
            
            -
            
            -
            
            50,000
            
            5.0000Forfeited
                or expired
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Exchanged
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Exercised
            
            (41,700)
            
            4.089
            
            (10,000)
            
            3.1000
            
            -
            
            -Outstanding
                at December 31
            
            98,300
            
            3.650
            
            140,000
            
            3.7786
            
            150,000
            
            3.7333Exercisable
                at end of year
            
            98,300
            
            3.650
            
            140,000
            
            3.7786
            
            150,000
            
            3.7333Weighted-average
                fair value ofwarrants
                granted during year
            
            -
            
            
            
            -
            
            
            
            $
                0.98





The
      following table summarizes outstanding warrants into groups based upon exercise
      price ranges at December 31, 2006:


Warrants
                    Outstanding
                
                Warrants
                    ExercisableWeighted
                
                Weighted
                
                
                
                Weighted
                
                WeightedAverage
                
                Average
                
                
                
                Average
                
                AverageExercise
                
                Maturity
                
                
                
                Exercise
                
                MaturityExercise
                    Price Range
                
                Warrant
                
                Price
                
                (Years)
                
                Warrant
                
                Price
                
                (Years)$3.00
                    or Less
                
                -
                
                -
                
                -
                
                -
                
                -
                
                -More
                    than $3.00 andLess
                    Than $5.00
                
                70,000
                
                $3.100
                
                1.12
                
                70,000
                
                $3.100
                
                1.12$5.00
                    or More
                
                28,300
                
                $5.000
                
                2.15
                
                28,300
                
                $5.000
                
                2.1598,300
                
                $3.650
                
                1.42
                
                98,300
                
                $3.650
                
                1.42


**12.
        BUSINESS ACQUISITIONS**





During
      2004, we acquired certain assets of the following entities for a total purchase
      price of $156,452:





Entity
            Location
            Date
                of acquisitionRobyn's
                LLC
            Syracuse,
                NY
            January
                2004Hawkins
                Handcrafted Leathers
            St.
                Louis, MO
            February
                2004Santa
                Fe Hides & Trappings
            Santa
                Fe, NM
            July
                2004





All
      of
      the acquired entities were formerly operated as independent retail leathercraft
      stores. The assets purchased in these acquisitions consisted primarily of
      inventory, store furniture and fixtures, and equipment. Goodwill recognized
      in
      these transactions amounted to $30,577, and is reported in the Retail
      Leathercraft segment. We also entered into non-compete agreements with the
      former owners totaling $26,000 for periods ranging from one to five
      years.





On
      November 30, 2004, we acquired all of the issued and outstanding shares of
      capital stock of 1124055 Ontario Inc., a Canadian corporation, and its
      wholly-owned subsidiary, Heritan Ltd. The total purchase price was approximately
      $400,000 which was funded with cash generated from operations. For financial
      reporting purposes, the transaction was accounted for under the purchase method,
      effective December 1, 2004.





In
      the
      first quarter of 2007, we acquired all of the issued and outstanding shares
      of
      capital stock of Mid-Continent Leather Sales Company, an Oklahoma corporation.
      The total purchase price was approximately $575,000 which was funded with cash
      generated from operations. We also entered into a non-compete agreement with
      the
      former owner totaling $75,000 for five years. This company will be included
      in
      our Wholesale Leathercraft segment beginning in 2007.




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**13.
      SEGMENT INFORMATION**





We
      identify our segments based on the activities of three distinct operations:





·
            **Wholesale
                Leathercraft**,
                which consists of a chain of wholesale stores operating under the
                name,*The
                Leather Factory*,
                located in the United States and Canada;


·
            **Retail
                Leathercraft,**which consists of a chain of retail stores operating under the name,*Tandy
                Leather Company*,
                located in the United States and Canada;
                and


·
            **Other**,
                which is a supplier of decorative hat trims sold directly to hat
                manufacturers.





Our
      reportable operating segments have been determined as separately identifiable
      business units. We measure segment earnings as operating earnings, defined
      as
      income before interest and income taxes.





Wholesale
              Leathercraft
            Retail
              Leathercraft
            Other
            TotalFor
                the year ended December 31, 2006Net
                Sales
            $31,068,188
            $22,520,461
            $1,610,372
            $55,199,021Gross
                Profit
            17,463,398
            13,690,030
            479,342
            31,632,770Operating
                earnings
            4,814,240
            2,310,073
            (56,599)
            7,067,714Interest
                expense
            -
            -
            -
            -Other,
                net
            118,381
            (21,220)
            1,230
            98,391Income
                before income taxes
            4,932,621
            2,288,853
            (55,369)
            7,166,105Depreciation
                and amortization
            245,838
            141,070
            6,007
            392,915Fixed
                asset additions
            298,689
            172,902
            162
            471,753Total
                assets
            $26,529,796
            $5,112,188
            $274,651
            $31,916,635For
                the year ended December 31, 2005Net
                Sales
            $31,046,268
            $18,023,214
            $1,650,092
            $50,719,574Gross
                Profit
            17,152,549
            11,142,350
            460,145
            28,755,044Operating
                earnings
            3,721,891
            1,766,960
            84,560
            5,573,411Interest
                expense
            3,188
            -
            -
            3,188Other,
                net
            (126,040)
            (11,650)
            -
            (137,690)Income
                before income taxes
            3,844,743
            1,778,610
            84,560
            5,707,913Depreciation
                and amortization
            323,881
            125,493
            7,332
            456,706Fixed
                asset additions
            131,603
            136,630
            4,593
            272,826Total
                assets
            $20,999,477
            $3,896,291
            $784,705
            $25,680,473For
                the year ended December 31, 2004Net
                Sales
            $30,630,122
            $13,515,662
            $2,000,500
            $46,146,284Gross
                Profit
            16,485,052
            8,348,616
            606,377
            25,440,045Operating
                earnings
            3,013,316
            1,210,566
            34,564
            4,258,446Interest
                expense
            53,400
            -
            -
            53,400Other,
                net
            (6,748)
            (1,852)
            -
            (8,600)Income
                before income taxes
            2,966,664
            1,212,418
            34,564
            4,213,646Depreciation
                and amortization
            363,878
            80,045
            8,730
            452,653Fixed
                asset additions
            226,095
            127,086
            16,378
            369,559Total
                assets
            $17,991,403
            $3,372,812
            $802,918
            $22,167,163





Net
      sales
      for geographic areas was as follows:




2006
            2005
            2004United
                States
            $49,188,609
            $45,492,215
            $42,485,339Canada
            4,287,180
            3,643,133
            2,112,601All
                other countries
            1,723,232
            1,584,226
            1,548,344$55,199,021
            $50,719,574
            $46,146,284





Geographic
      sales information is based on the location of the customer. Net sales from
      no
      single foreign country, except for Canada, was material to our consolidated
      net
      sales for the years ended December 31, 2006, 2005 and 2004. We do not have
      any
      significant long-lived assets outside of the United States.





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**14.
      RECENT ACCOUNTING PRONOUNCEMENTS**





In
      July
      2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for
      Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109,” which
      seeks to reduce the diversity in practice associated with the accounting and
      reporting for uncertainty in income tax provisions. This interpretation
      prescribes a comprehensive model for the financial statement recognition,
      measurement, presentation and disclosure of uncertain tax positions taken or
      expected to be taken in income tax returns. FIN 48 is effective for fiscal
      years
      beginning after December 15, 2006 and we will adopt the new requirements in
      the
      first quarter of 2007. The cumulative effects, if any, of adopting FIN 48 will
      be recorded as an adjustment to retained earnings as of the beginning of the
      period of adoption. We have not determined the impact, if any, of adopting
      FIN
      48 on our consolidated financial statements.





In
      September 2006, the FASB issued SFAS 157, “Fair Value Measurements” (“SFAS
      157”), which defines fair value, establishes a framework for measuring fair
      value in GAAP, and expands disclosures about fair value measurements. SFAS
      157
      is effective for financial statements issued for fiscal years beginning after
      November 15, 2007, and interim periods within those fiscal years. Early adoption
      is permitted. We must adopt these new requirements no later than the first
      quarter of 2008. We have not yet determined the effect on our consolidated
      financial statements, if any, upon adoption of SFAS 157, or if we will adopt
      the
      requirements prior to the first quarter of 2008.





In
      September 2006, the SEC staff issued Staff Accounting Bulletin No. 108,
“Considering the Effects of Prior Year Misstatements when Quantifying
      Misstatements in Current Year Financial Statements” (“SAB 108”). The intent of
      SAB 108 is to reduce diversity in practice for the method companies use to
      quantify financial statement misstatements, including the effect of prior year
      uncorrected errors. SAB 108 establishes an approach that requires quantification
      of financial statement errors using both an income statement and cumulative
      balance sheet approach. SAB 108 is effective for fiscal years beginning after
      November 15, 2006, and we will adopt the new requirements in 2007. The adoption
      of SAB 108 is not currently expected to have a significant impact on our
      consolidated financial statements.





**15.
      QUARTERLY FINANCIAL DATA (UNAUDITED)**


First
                  Second
                  Third
                  Fourth**2006**
                  
                  Quarter
                  Quarter
                  Quarter
                  QuarterNet
                      sales
                  
                  $14,413,649
                  $13,393,082
                  $12,559,593
                  $14,832,697Gross
                      profit
                  
                  8,114,134
                  7,722,301
                  7,071,414
                  8,724,921Net
                      income
                  
                  1,346,263
                  1,132,494
                  890,419
                  1,407,891Net
                      income per common share:Basic
                  
                  0.13
                  0.11
                  0.08
                  0.13Diluted
                  
                  0.12
                  0.10
                  0.08
                  0.13Weighted
                      average number of common shares outstanding:
 Basic
                
                10,756,745
                10,790,661
                10,818,130
                10,807,316Diluted
                
                11,102,906
                11,112,475
                11,102,383
                11,113,855First
                Second
                Third
                Fourth**2005**
                
                Quarter
                Quarter
                Quarter
                QuarterNet
                    sales
                
                $12,707,516
                $12,181,699
                $11,777,133
                $14,053,226Gross
                    profit
                
                7,157,283
                6,899,872
                6,763,802
                7,934,087Net
                    income
                
                1,049,222
                787,669
                696,090
                1,180,733Net
                    income per common share:Basic
                
                0.10
                0.07
                0.07
                0.11Diluted
                
                0.10
                0.07
                0.06
                0.11
 Weighted
                    average number of common shares outstanding:Basic
                
                10,584,244
                10,615,802
                10,679,389
                10,735,702Diluted
                
                10,911,103
                10,955,282
                11,029,840
                11,047,426
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REPORT
        OF INDEPENDENT REGISTERED
 PUBLIC
        ACCOUNTING FIRM
 
 
 To
        the
        Board of Directors and Stockholders
 Tandy
        Leather Factory, Inc. and Subsidiaries
 
 
 We
        have
        audited the accompanying consolidated balance sheets of Tandy Leather Factory,
        Inc. and Subsidiaries (the Company) as of December
        31, 2006 and
        2005 ,
        and the
        related consolidated statements of income, stockholders’ equity and cash flows
        for each of the years in the three-year period ended December
        31, 2006 .
        These
        financial statements are the responsibility of the Company’s management. Our
        responsibility is to express an opinion on these financial statements based
        on
        our audits.
 
 We
        conducted our audits in accordance with the standards of the Public Accounting
        Oversight Board (United States). Those standards require that we plan and
        perform the audit to obtain reasonable assurance about whether the financial
        statements are free of material misstatement. The Company is not required
        to
        have, nor were we engaged to perform, an audit of its internal control over
        financial reporting. Our audit included consideration of internal control
        over
        financial reporting as a basis for designing audit procedures that are
        appropriate in the circumstances, but not for the purpose of expressing an
        opinion on the effectiveness of the Company’s internal control over financial
        reporting. Accordingly, we express no such opinion. An audit also includes
        examining, on a test basis, evidence supporting the amounts and disclosures
        in
        the financial statements, assessing the accounting principles used and
        significant estimates made by management, as well as evaluating the overall
        financial statement presentation. We believe that our audits provide a
        reasonable basis for our opinion.
 
 In
        our
        opinion, the financial statements referred to above present fairly, in all
        material respects, the consolidated financial position of the Company as
        of December
        31, 2006 , 2005 and
        2004 and the
        consolidated results of its operations and its cash flows for each of the
        years
        in the three-year period ended December
        31, 2006 ,
        in
        conformity with accounting principles generally accepted in the United States
        of
        America.
 
 As
        discussed in Note 2 to the financial statements, in 2006 the Company
        adopted Statement of Financial Accounting Standards No. 123(R), "Share-Based
        Payment."
 
 WEAVER
        AND TIDWELL, L.L.P.
 
 Fort
        Worth, Texas
 March
        26,
        2007





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**ITEM
      9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
      ACCOUNTING AND FINANCIAL DISCLOSURE**





None





**ITEM
      9A. CONTROLS AND PROCEDURES**





Our
      management, with the participation of our chief executive officer and chief
      financial officer, evaluated the effectiveness of our disclosure controls and
      procedures as of December 31, 2006. The term “disclosure controls and
      procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
      Exchange Act of 1934, as amended, or the Exchange Act, means controls and other
      procedures of a company that are designed to ensure that information required
      to
      be disclosed by a company in the reports that it files or submits under the
      Exchange Act is recorded, processed, summarized and reported, within the time
      periods specified in the SEC’s rules and forms. Disclosure controls and
      procedures include controls and procedures designed to ensure that information
      required to be disclosed by a company in the reports that it files or submits
      under the Exchange Act is accumulated and communicated to the company’s
      management, including its principal executive and principal financial officers,
      as appropriate to allow timely decisions regarding required disclosure.





Management
      recognizes that any controls and procedures, no matter how well designed and
      operated, can provide only reasonable assurance of achieving their objectives
      and management necessarily applies its judgment in evaluating the cost-benefit
      relationship of possible controls and procedures. Based on the evaluation of
      our
      disclosure controls and procedures as of December 31, 2006, our chief executive
      officer and chief financial officer concluded that, as of such date, our
      disclosure controls and procedures were effective at a reasonable assurance
      level.





We
      maintain certain internal controls over financial reporting that are
      appropriate, in management’s judgment with similar cost-benefit considerations,
      to provide reasonable assurance regarding the reliability of financial reporting
      and the preparation of financial statements for external purposes in accordance
      with generally accepted accounting principles. No change in our internal control
      over financial reporting occurred during the fiscal year ended December 31,
      2006
      that has materially affected, or is reasonably likely to affect, our internal
      control over financial reporting.





**ITEM
      9B. OTHER INFORMATION**





None








**PART
      III**





Certain
      information required by Part III is omitted from this annual report as we will
      file a proxy statement for our 2007 Annual Meeting of Stockholders, pursuant
      to
      Regulation 14A of the Securities Exchange Act of 1934, as amended, not later
      than 120 days after the end of our fiscal year covered by this Report, and
      certain information included in that proxy statement is incorporated herein
      by
      reference.





**ITEM
      10. DIRECTORS AND EXECUTIVE OFFICERS OF THE
      REGISTRANT**





The
      information required by this item is contained under the heading "Executive
      Officers of the Registrant" in Part I of this Annual Report on Form 10-K, and
      the remainder is contained in our proxy statement for our 2007 Annual Meeting
      of
      Stockholders under the heading "Election of Directors," and is incorporated
      herein by reference. Information relating to filings on Forms 3, 4 and 5 will
      be
      contained in our 2007 proxy statement under the heading "Section 16(a)
      Beneficial Ownership Reporting Compliance," and is incorporated herein by
      reference. Information required by this item pursuant to Items 401(h), 401(i)
      and 401(j) of Regulation S-K relating to an audit committee financial expert,
      the identification of the audit committee of our board of directors and
      procedures of security holders to recommend nominees to our board of directors
      will be contained in our 2007 proxy statement under the heading "Corporate
      Governance" and is incorporated herein by reference.





We
      have
      adopted a written code of ethics that applies to our employees, including our
      principal executive officer principal financial officer, principal accounting
      officer, controller, or persons performing similar functions. It is available
      on
      our website (http://www.tandyleather.com).





**ITEM
      11. EXECUTIVE
      COMPENSATION**





The
      information required by this item is contained in our proxy statement for our
      2007 Annual Meeting of Stockholders under the heading "Report of the
      Compensation Committee,” which is incorporated herein by reference.





**ITEM
      12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
      AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS**





The
      information required by this item is contained in our proxy statement for our
      2007 Annual Meeting of Stockholders under the headings "Stock Ownership by
      Directors and Executive Officers” and “Principal Holders of Stock,” which is
      incorporated herein by reference.





**ITEM
      13. CERTAIN RELATIONSHIPS AND RELATED
      TRANSACTIONS**





The
      information required by this item is contained in our proxy statement for our
      2007 Annual Meeting of Stockholders under the heading “Other Relationships
      Involving Directors, Executive Officers, or their Associates” and is
      incorporated herein by reference.




**ITEM
      14. PRINCIPAL ACCOUNTANT FEES AND
      SERVICES**





The
      information required by this item is contained in our proxy statement for our
      2007 Annual Meeting of Stockholders under the headings "Audit Committee” and
“Report of the Audit Committee” and is incorporated herein by
      reference.





37
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          OF CONTENTS*


**PART
      IV**





**ITEM
      15. EXHIBITS AND FINANCIAL STATEMENT
      SCHEDULES**





(a)  The
      following are filed as part of this Annual Report on Form 10-K:





*1.
      Financial Statements*





The
      following consolidated financial statements are included in Item 8:





·
            Consolidated
                Balance Sheets at December 31, 2006 and
                2005


·
            Consolidated
                Statements of Income for the years ended December 31, 2006, 2005
                and
                2004


·
            Consolidated
                Statements of Cash Flows for the years ended December 31, 2006, 2005
                and
                2004


·
            Consolidated
                Statements of Stockholders' Equity for the years ended December 31,
                2006,
                2005 and 2004





*2.
      Financial Statement Schedules*





All
      financial statement schedules are omitted because the required information
      is
      not present or not present in sufficient amounts to require submission of the
      schedule or because the information is reflected in the consolidated financial
      statements or notes thereto.





*3.
      Exhibits*





The
      exhibits listed in the Exhibit Index immediately preceding such exhibits are
      filed as part of this Annual Report on Form 10-K.


38
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          OF CONTENTS*


**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the Registrant has duly caused this Annual Report on Form 10-K to be
      signed on its behalf by the undersigned, thereunto duly authorized.





**TANDY
      LEATHER
      FACTORY, INC.**


By:
              /s/
                  Ronald C. Morgan**Ronald
                  C. Morgan****Chief
                  Executive Officer and President**By:
              /s/
                  Shannon L. Greene**Shannon
                  L. Greene****Chief
                  Financial Officer, Chief Accounting Officer and
                  Treasurer**






Dated:
      March 27, 2007





In
      accordance with the Securities Exchange Act of 1934, this Report has been signed
      below by the following persons on behalf of Tandy Leather Factory, Inc. and
      in
      the capacities and on the dates indicated.





**Signature**
            **Title**
            **Date**/s/
                Wray Thompson
            Chairman
                of the Board and Director
            March
                27, 2007**Wray
                Thompson**/s/
                Ronald C. Morgan
            Chief
                Executive Officer, President and Director
            March
                  27, 2007**Ronald
                C. Morgan**/s/
                Shannon L. Greene
            Chief
                Financial Officer, Chief Accounting Officer,
            March
                  27, 2007**Shannon
                L. Greene**
            Treasurer
                and Director/s/
                T. Field Lange
            Director
            March
                  27, 2007**T.
                Field Lange**/s/
                Joseph R. Mannes
            Director
            March
                  27, 2007**Joseph
                R. Mannes**/s/
                L. Edward Martin III
            Director
            March
                  27, 2007**L.
                Edward Martin III**/s/
                Robin L. Morgan
            Vice
                President and Assistant Secretary
            March
                  27, 2007**Robin
                L. Morgan**/s/
                Michael A. Nery
            Director
            March
                  27, 2007**Michael
                A. Nery**/s/
                William M. Warren
            Secretary
            March
                  27, 2007**William
                M. Warren**





39
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          OF CONTENTS*





**TANDY
                LEATHER FACTORY, INC. AND SUBSIDIARIES**
              **EXHIBIT
                INDEX****Exhibit**
              **Number**
            ******Description**3.1
            Certificate
                of Incorporation of The Leather Factory, Inc., and Certificate of
                Amendment to Certificate of Incorporation of The Leather Factory,
                Inc.
                filed as Exhibit 3.1 to Form 10-Q filed by Tandy Leather Factory,
                Inc.
                with the Securities and Exchange Commission on August 12, 2005 and
                incorporated by reference herein.3.2
            Bylaws
                of The Leather Factory, Inc., filed as Exhibit 3.2 to the Registration
                Statement on Form SB-2 of The Leather Factory, Inc. (Commission File
                No.
                33-81132) filed with the Securities and Exchange Commission on July
                5,
                1994 and incorporated by reference herein.4.1
            Financial
                Advisor's Warrant Agreement, dated February 12, 2003, between The
                Leather
                Factory, Inc. and Westminster Securities Corporation filed as Exhibit
                4.1
                to Form 10-Q filed by The Leather Factory, Inc. with the Securities
                and
                Exchange Commission on May 14, 2003 and incorporated by reference
                herein.4.2
            Financial
                Advisor’s Warrant Agreement, dated February 24, 2004, between The Leather
                Factory, Inc. and Westminster Securities Corporation filed as Exhibit
                4.1
                to Form 10-Q filed by The Leather Factory, Inc. with the Securities
                and
                Exchange Commission on May 14, 2004 and incorporated by reference
                herein.10.1
            Credit
                Agreement, dated as of October 6, 2004, made by The Leather Factory,
                Inc.,
                a Delaware corporation, and Bank One, National Association, filed
                as
                Exhibit 10.1 to the Current Report on Form 8-K of The Leather Factory,
                Inc. (Commission File No. 1-12368) filed with the Securities and
                Exchange
                Commission on November 5, 2004 and incorporated by reference
                herein.10.2
            Line
                of Credit Note, dated October 6, 2004, in the principal amount of
                up to
                $3,000,000 given by The Leather Factory, Inc., a Delaware corporation
                as
                borrower, payable to the order of Bank One, National Association,
                filed as
                Exhibit 10.2 to the Current Report on Form 8-K of The Leather Factory,
                Inc. (Commission File No. 1-12368) filed with the Securities and
                Exchange
                Commission on November 5, 2004 and incorporated by reference
                herein.10.3*
            Consultation
                Agreement, dated January 1, 2007, between Tandy Leather Factory,
                Inc. and
                J. Wray Thompson.14.1
            Code
                of Business Conduct and Ethics of The Leather Factory, Inc., adopted
                by
                the Board of Directors on February 26, 2004, filed as Exhibit 14.1
                to the
                Annual Report on Form 10-K of The Leather Factory, Inc. (Commission
                File
                No. 1-12368) filed with the Securities and Exchange Commission on
                March
                29, 2004 and incorporated by reference herein.21.1
            Subsidiaries
                of Tandy Leather Factory, Inc. filed as Exhibit 21.1 to the Annual
                Report
                on Form 10-K of The Leather Factory, Inc. for the year ended December
                31,
                2002 filed with the Securities and Exchange Commission on March 28,
                2003,
                and incorporated by reference herein.*23.1
            Consent
                of Weaver & Tidwell LLP dated March 26, 2007*31.1
            13a-14(a)
                Certification by Ronald C. Morgan, Chief Executive Officer and
                President*31.2
            13a-14(a)
                Certification by Shannon Greene, Chief Financial Officer and
                Treasurer*32.1
            Certification
                Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section
                906 of
                the Sarbanes-Oxley Act of 2002______________*Filed
                herewith.





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          OF
          CONTENTS*