UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-K





(Mark
One)


[X]
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
fiscal year ended December 31, 2007


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)





1900
      Southeast Loop 820, Fort Worth, Texas
            
            76140(Address
      of principal executive offices)
            
            (Zip
      Code)





Registrant’s telephone number,
      including area code:  (817)
  872-3200





Securities
registered pursuant to Section 12(b) of the Act:





Title of Each Class
            
            Name of Each Exchange on Which
      RegisteredCommon
      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. [  ]





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]  Smaller Reporting
company [  ]





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





The
aggregate market value of the common stock held by non-affiliates of the
registrant was approximately $51,597,676 at June 30, 2007 (the last business day
of its most recently completed second fiscal quarter).  At March 14,
2008, there were 10,977,092 shares of the registrant's common stock
outstanding.





Portions
of the Registrant’s definitive Proxy Statement for the Annual Meeting of
Stockholders to be held on May 21, 2008, are incorporated by reference in Part
III of this report.





TABLE OF CONTENTS


Item
              
              PagePart
      11
              Business
              11A
              Risk Factors
              52
              Properties
              63
              Legal Proceedings
              74
              Submission of Matters to a Vote of Security
      Holders
              7Part
      II5
              Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities
              76
              Selected Financial Data
              87
              Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
              87A
              Quantitative and Qualitative Disclosures about Market
      Risk
              128
              Financial Statement and Supplementary
      Data
              139
              Change in and Disagreements with Accountants on
      Accounting and Financial Disclosure
              279A
              Controls and Procedures
              279B
              Other Information
              27Part
      III10
              Directors, Executive Officers and Corporate
      Governance
              2711
              Executive Compensation
              2712
              Security Ownership of Certain Owners and Management and
      Related Stockholder Matters
              2713
              Certain Relationships and Related Transactions and
      Director Independence
              2714
              Principal Accountant Fees and
Services
              27Part
      IV15
              Exhibits, Financial Statement
    Schedules
              28


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 2007, our
consolidated sales totaled $55.3 million of which approximately 11.8% 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





We have
expanded our wholesale chain by opening new stores and by 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.   In 2007, we
purchased one independent leathercraft store and opened an additional nine
retail stores – eight in the U.S. and one in Canada.  We also
purchased Mid-Continent Leather Sales, Inc., a competitor located in Oklahoma,
which became our thirtieth wholesale store.





At
December 31, 2007, we operated thirty wholesale stores – twenty-nine operating
under the Leather Factory name (26 in the U.S. and 3 in Canada) and one
operating under the Mid-Continent Leather Sales name.  We also
operated seventy-two retail stores operating under the Tandy Leather name (66 in
the U.S. and 6 in Canada).  We also own and operate Roberts, Cushman
and Company, Inc., a distributor of custom hat trims.





In the
first quarter of 2008, we opened a leathercraft store in Northampton, United
Kingdom.  This store will operate under the name “Tandy Leather
Factory” as a combination wholesale and retail store.





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 2007.





STORE
COUNT


YEARS
ENDED DECEMBER 31, 1999 through 2007





Leather Factory wholesale
      stores
            Tandy Leather retail
  storesYear
      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
            622007
            1^
            0
            30
            10
            0
            72





(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.


(^)  Wholesale
store operating as Mid-Continent Leather Sales





No single
customer’s purchases represent more than 10% of our total sales in
2007.  Sales to our five largest customers combined to represent 8.3%,
9.5% and 9.4%, respectively, of consolidated sales in 2007, 2006 and
2005.  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.





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 thirty wholesale stores of which 27 are located in the
United States and three are located in Canada.  As of March 1, 2008,
the Retail Leathercraft division consists of 72 Tandy Leather retail stores of
which 66 are located in the United States and six 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.  We opened a leathercraft store in the United Kingdom in February
2008.  We intend to add a fourth operating division in 2008 to
comprise our international (non-North America) operations.





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
$29.6 million, $31.0 million and $31.0 million for 2007, 2006 and 2005,
respectively.  The wholesale stores operate under the name “The
Leather Factory”, with the exception of the one store we acquired in February
2007 which operates under the name “Mid-Continent Leather Sales.”





General. We
operate wholesale 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 our wholesale
stores is generally light industrial office/warehouse space in proximity to a
major freeway or with other similar access.  This type of location
typically offers lower rents compared to other more retail-oriented
locations.





1


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.





Our
wholesale 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
our stores with experienced managers whose compensation is tied to the operating
profit of the store they manage.  Sales are generated by the selling
efforts of the store personnel, our direct mail advertising, our website
(www.tandyleatherfactory.com), our participation at trade shows and, on a
limited basis, the use of sales representative organizations.  The
sales representative organizations consist of companies located in specific
geographic areas that represent numerous companies in a similar
industry.  These organizations call on customers and show multiple
products from more than one vendor at a time.





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





Our
Authorized Sales Center (“ASC”) program was developed to create a presence in
geographical areas where we do not have a wholesale store.  An
unrelated person operating an existing business who desires to become an ASC
must submit an application and upon approval, place a minimum initial
order.  There are also minimum annual purchase amounts to which the
ASC must adhere in order to maintain ASC status.  In exchange, the
benefits to the ASC are free advertising in various sale flyers produced and
distributed by us, price breaks on many products, advance notice of new
products, and priority shipping and handling on all orders.  Our
wholesale stores service 158 ASC's:  92 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 TejasTM
brand name.  We also distribute product under the Tandy LeatherTM
and Dr. Jackson'sTM
brands.  We develop new products through the ideas and referrals of
customers and store personnel as well as the 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
2007 and 2006, Wholesale Leathercraft division sales by product category were as
follows:





Product Category
            2007Sales Mix
            
            2006Sales MixBelts
      strips and straps
            3%
            
            2%Books,
      patterns, videos
            2%
            
            1%Buckles
            4%
            
            4%Conchos^
            4%
            
            4%Craft
      supplies
            4%
            
            5%Custom
      tools and hardware
            0%
            
            1%Dyes,
      finishes, glues
            5%
            
            5%Hand
      tools
            12%
            
            12%Hardware
            8%
            
            8%Kits
            7%
            
            7%Lace
            10%
            
            14%Leather
            37%
            
            34%Stamping
      tools
            4%
            
            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 2007 and 2006, see "Item 7. Management's
Discussion and Analysis of Financial Condition and Results of
Operations."





Suppliers.We purchase
merchandise and raw materials from approximately 200 vendors dispersed
throughout the United States and in approximately 15 foreign countries.In 2007, 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 wholesale
stores receive the majority of their inventory from our central warehouse
located in Fort Worth, Texas, although occasionally, merchandise is shipped
directly from the vendor.  Inventory is shipped to the stores from our
central warehouse once a week to meet customer demand without sacrificing
inventory turns.  Customer orders are filled as received, and we do
not have backlogs.





We
attempt to maintain the optimum number of items in our product line to minimize
out-of-stock situations against carrying costs involved with such an inventory
level.  We generally maintain higher inventories of imported items to
ensure a continuous supply.  The number of products offered changes
every year due to the introduction of new items and the discontinuance of
others.  We carry approximately 2,800 items in the current lines of
leather and leather-related merchandise.  All items are offered in
both the wholesale and retail stores.





Expansion.  Our
wholesale store expansion across the United States has been fairly consistent
since we purchased the original six stores in 1985.  We opened our
thirtieth store in August 2002.  We converted one wholesale (Leather
Factory) store to a retail (Tandy Leather) store in 2006, reducing the number of
wholesale stores to twenty-nine.  We acquired Mid-Continent Leather
Sales in 2007, a wholesale store located in Oklahoma, increasing the number of
wholesale stores to thirty.  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.





2


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 $24.7 million, $22.5 million and $18.0 million for 2007, 2006 and 2005,
respectively.





General.  As
of March 1, 2008, the Tandy Leather retail chain has 72 stores located in 34
states and five Canadian provinces with plans to reach 100 to 120 stores as
opportunities arise over the next several years.  The stores range in
size from 1,200 square feet to 3,800 square feet, with the average size of a
store being approximately 2,000 square feet.   The type of
premises utilized for a retail store is generally an older strip shopping center
located at well-known crossroads, making the store easy to find.





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





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





Customers.Individual retail
customers are our largest customer group, representing more than 60% of Tandy
Leather's 2007 sales.  Youth groups, summer camps, schools, and a
limited number of wholesale customers complete our customer
base.  Like the wholesale stores, the retail stores fill orders as
they are received, and there is no order backlog.  The retail stores
maintain reasonable amounts of inventory to fill these orders.  Tandy
Leather’s retail store operations historically generate slightly more sales in
the 4th quarter
of each year (30-32%) while the other three quarters remain fairly even at
23-25% per quarter.





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
2007 and 2006, Retail Leathercraft division sales by product category were as
follows:





Product Category
            2007Sales Mix
            
            2006Sales MixBelts
      strips and straps
            4%
            
            5%Books,
      patterns, videos
            3%
            
            2%Buckles
            4%
            
            4%Conchos
            4%
            
            4%Craft
      supplies
            3%
            
            3%Dyes,
      finishes, glues
            8%
            
            7%Hand
      tools
            16%
            
            16%Hardware
            6%
            
            7%Kits
            11%
            
            11%Lace
            4%
            
            4%Leather
            31%
            
            31%Stamping
      tools
            6%
            
            6%100%
            
            100%





As
indicated above, the products sold in our retail stores are also sold in our
wholesale stores.  Therefore, the discussion above regarding products,
their sources and the working capital requirements for the Wholesale
Leathercraft division also apply to the Retail Leathercraft
division.  Sales at the retail stores are generally 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 the
wholesale stores, the retail stores have an unconditional return
policy.





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





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





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





Expansion.   We
intend to expand the Tandy Leather retail store chain to 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, twelve were opened in 2006, and ten were opened in
2007.  Eleven of the 72 stores opened to date were independent
leathercraft stores that we acquired.  Separately, these acquisitions
are not material.  The other sixty-one stores have been de novo stores opened by
us.  In 2008, we plan to open four retail stores. We anticipate these
new stores will be opened in the last half of the year.





Other





Roberts,
Cushman, founded in 1856, supplies made-to-order trimmings to the headwear
industry.  This segment had net sales of $1.1 million, $1.7 million,
and $1.6 million for 2007, 2006 and 2005, 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 to 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.  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 approximately 20 vendors, located
predominately in the United States.  In 2007, our top 10 vendors (in
dollars purchased) represented approximately 90% 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.


3





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,
2007, we employed 459 people, 103 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.





In
February 2008, we opened our first leathercraft store outside of North
America.  The store is located in the United Kingdom and is operating
as a combination wholesale and retail store.





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.





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 SinceJ.
      Wray Thompson, 76
            Chairman
      of the Board since June 1993; Chief Executive Officer from June 1993 to
      December 2006;
            1993Ronald
      C. Morgan, 60
            Chief
      Executive Officer since January 2007; President since January 2001; Chief
      Operating Officer since June 1993
            1993Shannon
      L. Greene, 42
            Chief
      Financial Officer since May 2000
            2000Robin
      L. Morgan, 57
            Vice
      President of Administration since June 1993
            1993





Wray Thompsonhas 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. Greenehas 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.  She also sits on the Board of Directors of
the U.S. Chamber of Commerce.





Robin L. Morganhas 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.





4


ITEM
1A.   RISK FACTORS





You
should carefully consider the following risk factors together with all of the
other information included in this annual report, including the financial
statements and related notes, when deciding to invest in us.  You
should be aware that the occurrence of any of the events described in this Risk
Factors section and elsewhere in this annual report could have a material
adverse effect on our business, financial position, results of operations and
cash flows.  Some, but not all, of the important risks which could
cause actual results to differ materially from those suggested by
forward-looking statements made by us include the following:





·
            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.





·
            Continued
      weakness in the economy in the United States, as well as abroad, may cause
      our sales to decrease or not to increase or adversely affect the prices
      charged for our products.  Also, hostilities, terrorism or other
      events could worsen this condition.




·
            Negative
      trends in general consumer-spending levels, including the impact of the
      availability and level of consumer debt and levels of consumer confidence
      could adversely affect our sales.




·
            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.





·
            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.





5


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.  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.





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. In April 2008, we plan to relocate our corporate
offices and central support units (warehouse, factory, sales, advertising and
administrative departments) to a new facility – a 191,000 square foot building
that we purchased in July 2007.





We also
lease a 6,600 square-foot building located in the United Kingdom for approximate
$75,000 per year.  This location houses our new combination
wholesale/retail leathercraft store that opened in February
2008.  This lease will expire in January 2013.





The
following table summarizes the locations of our leased premises on a state and
province basis as of December 31, 2007:





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





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








6


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, 2007.





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:





2007
            High
            Low
            
            2006
            High
            Low4th
      quarter
            $7.15
            $2.70
            
            4th
      quarter
            $8.30
            $6.303rd
      quarter
            $7.55
            $5.80
            
            3rd
      quarter
            $6.90
            $5.752nd
      quarter
            $7.50
            $6.85
            
            2nd
      quarter
            $8.30
            $6.401st
      quarter
            $8.25
            $6.81
            
            1st
      quarter
            $7.40
            $5.79





There were approximately
497stockholders of record on March 7,
2008.





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.





We did
not sell any shares of our equity securities during our fiscal year ended
December 31, 2007 that were not registered under the Securities
Act.





We have
not repurchased any shares of our equity securities during the fourth quarter of
our fiscal year ended December 31, 2007.





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, 2002 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
      02
            Dec
      03
            Dec
      04
            Dec
      05
            Dec
      06
            Dec
      07TANDY
      LEATHER FACTORY
            100
            143.20
            105.03
            202.66
            238.76
            96.75S&P
      SMALLCAP 600 INDEX
            100
            138.79
            170.22
            18330
            211.01
            210.38S&P
      SPECIALTY STORES
            100
            134.66
            141.66
            167.31
            203.39
            149.29





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





7


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,
            2007
            
            2006
            
            2005
            
            2004
            
            2003Net
      sales
            $55,317,002
            
            $55,199,021
            
            $50,719,574
            
            $46,146,284
            
            $41,712,191Cost
      of sales
            23,644,599
            
            23,566,251
            
            21,964,530
            
            20,706,239
            
            19,020,292Gross
      profit
            31,672,403
            
            31,632,770
            
            28,755,044
            
            25,440,045
            
            22,691,899Operating
      expenses
            27,161,402
            
            24,565,056
            
            23,181,633
            
            21,181,599
            
            18,594,240Operating
      income
            4,511,001
            
            7,067,714
            
            5,573,411
            
            4,258,446
            
            4,097,659Operating
      income per share - basic
            $0.41
            
            $0.65
            
            $0.52
            
            $0.40
            
            $0.40Operating
      income per shares - diluted
            $0.40
            
            $0.64
            
            $0.51
            
            $0.39
            
            $0.38Other
      (income) expense
            (316,831)
            
            (98,391)
            
            (134,502)
            
            44,800
            
            125,169Income
      (loss) before income taxes
            4,827,832
            
            7,166,105
            
            5,707,913
            
            4,213,646
            
            3,972,490Income
      tax provision (benefit)
            1,739,701
            
            2,389,039
            
            1,994,199
            
            1,559,605
            
            1,232,116Net
      income (loss)
            $3,088,131
            
            $4,777,066
            
            $3,713,714
            
            $2,654,041
            
            $2,740,374Earnings
      (loss) per share
            $0.28
            
            $0.44
            
            $0.35
            
            $0.25
            
            $0.27Earnings
      (loss) per share- assuming
      dilution
            $0.28
            
            $0.43
            
            $0.34
            
            $0.24
            
            $0.25Weighted
      average common shares outstanding for:Basic
      EPS
            10,951,481
            
            10,643,004
            
            10,643,004
            
            10,543,994
            
            10,323,549Diluted
      EPS
            11,157,775
            
            10,976,240
            
            10,976,240
            
            10,957,518
            
            10,861,305








Balance
      Sheet Data, as of December 31,
            2007
            
            2006
            
            2005
            
            2004
            
            2003Cash
      and cash equivalents
            $6,810,396
            
            $6,739,981
            
            $3,215,727
            
            $2,560,202
            
            $1,728,344Total
      assets
            37,651,506
            
            31,916,635
            
            25,680,473
            
            22,167,163
            
            19,058,406Capital
      lease obligation, including current portion
            -
            
            111,723
            
            245,789
            
            379,857
            
            1,134Long-term
      debt, including current portion
            4,050,000
            
            -
            
            -
            
            505,154
            
            1,792,984Total
      Stockholders’ Equity
            $29,815,504
            
            $26,323,243
            
            $21,257,857
            
            $17,310,233
            
            $14,509,493








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, 2007 and 2006 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 ($29.6 million in 2007).  This division has
generally offered steady but modest increases in sales.  Sales in 2007
declined 4.9%.  The wholesale stores’ sales declined 2% compared to
2006 and national account sales were down 13%.  Much of the sales
decline at the stores is attributed to an overall weakness in consumer spending,
which results in less purchases by small businesses.  The decline in
national account sales is related to weaker consumer spending as well as the
expected decline in sales to one customer who intends to stop purchasing from us
in the first quarter of 2008.





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 ($24.6
million in 2007, up from $22.5 million in 2006).  Our business plan
calls for opening an average of 12 stores annually as we work toward a goal of
100+ stores from 72 stores at the end of 2007.  We plan to open 4 new
stores in 2008 in the last half of the year.





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.





On a
consolidated basis, a key indicator of costs, gross margin as a percent of total
net sales, increased in 2006 and held steady in 2007.  Operating
expenses as a percent of total net sales in 2007 increased 4.6% from
2006.  Operating expenses were down 1.2% as a percentage of total net
sales in 2006 when compared with 2005.  The increase in operating
expenses in 2007 was due to our delayed response to cut expenses on weaker than
expected sales, particularly in the second and third quarters.





We
reported consolidated net income for 2007 of $3.1
million.  Consolidated net income for 2006 and 2005 was $4.8 million
and $3.7 million, respectively.  We have used our cash flow to fund
our operations, to fund the opening of new Tandy Leather stores, to purchase
necessary property equipment and make acquisitions of small competitors in the
retail and wholesale market.  In 2007, we incurred $4.0 million in
bank debt to purchase a 191,000 square foot building to house our corporate
headquarters and central support units.  We expect to move those
departments at the end of the first quarter of 2008.  At the end of
2007, our stockholders’ equity had increased to $29.8 million from $26.3 million
the previous year.





Comparing
the December 31, 2007 balance sheet with the prior year’s, we increased our
investments in inventory slightly ($17.5 million from $17.2 million) while total
cash increased minimally to $6.8 million from $6.7 million.  In
addition to cash on hand, we have a $5.5 million bank line of credit, of which
$4.0 was drawn on December 31, 2007.  The line of credit can be drawn
upon only to fund capital improvements in the building we
purchased.  Given the amount of cash on hand, we plan to pay for the
improvements with our cash rather than draw further on the line of
credit.





8


Net
Sales





Net sales
for the three years ended December 31, 2007 were as follows:





Year
            Wholesale Leathercraft
            Retail Leathercraft
            Other
            Total Company
            Total Company Incr from Prior
      Year2007
            $29,555,978
            $24,663,750
            $1,097,274
            $55,317,002
            0.2%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%





Our net
sales grew by 0.2% in 2007 when compared with 2006 and 8.8% in 2006 when
compared with 2005.  These annual increases resulted primarily from
our Retail Leathercraft expansion program, although sales did not grow as fast
in 2007 compared to 2006 and 2005 due to an overall slowdown in consumer
spending.





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 2007,
our cost of sales held steady as a percentage of total net sales when compared
to 2006, resulting in the same consolidated gross margin of 57.3% in 2007 and
2006.  Our total cost of sales as a percentage of our total net sales
decreased for 2006 when compared to 2005 resulting in an overall increase in
consolidated gross margin of 0.6% from 56.7% for 2005 to 57.3% in
2006.  Increases in gross margin are primarily due to increased retail
sales from year to year.





Our gross
margins for the three years ended December 31, 2007 were as
follows:





Year
            Wholesale Leathercraft
            RetailLeathercraft
            Other
            TotalCompany2007
            55.7%
            59.7%
            44.8%
            57.3%2006
            56.1%
            60.8%
            32.1%
            57.3%2005
            55.2%
            61.8%
            27.9%
            56.7%





Our
operating expenses increased 4.6% as a percentage of total net sales to 49.1% in
2007 when compared with 44.5% in 2006 which indicates that our operating
expenses grew faster than our sales.  Significant expense fluctuations
in 2007 compared to 2006 are as follows:





Expense
            2007 amount
            Incr (decr)over 2006Employee
      compensation & benefits
            $14.1
      million
            $800,000Rent
      & utilities
            3.8
      million
            300,000Depreciation
            600,000
            200,000Advertising
            4.0
      million
            400,000Legal
      & professional fees
            650,000
            350,000Outside
      services
            500,000
            400,000





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.  Significant expense
fluctuations in 2006 compared to 2005 are as follows:





Expense
            2006 amount
            Incr (decr)over 2005Employee
      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)





Other
Income/Expense (net)





Other
Income/Expense consists primarily of currency exchange fluctuations and
discounts taken or given.  However, in 2007, we had other income (net)
of $317,000 compared to other income (net) of $98,000 in 2006.  We
received rental income of $150,000 from our new building as we leased the
building to the sellers for 90 days after purchase.  We also received
$100,000 as a signing bonus on an oil and gas lease we signed related to a
portion of the land we purchased.  We earned $140,000 in interest
income on our cash and paid $125,000 in interest expense on our bank
debt.  We had a currency exchange gain of $9,000 in 2007 compared to
$52,000 in 2006.





In 2006,
we had other income (net) of $98,000 compared to a other 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.





Net
Income





During
2007, we earned net income of $3.1 million, a 35% decline over our net income of
$4.8 million earned during 2006.  The decline in net income was the
result of the increase in operating expenses at a higher rate than that of our
sales, partially offset by the reduction in income tax expense.





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.





9


Wholesale
Leathercraft





Year
            Net
      Sales
              Incr
      (Decr)
              from Prior Yr
            Operating
      Income
            Operating
      Income
              Incr
      (Decr)
              from Prior Year
            Operating
      Income
              as
      a Percentage
              of Sales2007
            (3.7)%
            $2,826,710
            (41.3)%
            9.6%2006
            (0.1)%
            $4,814,240
            29.4%
            15.5%2005
            1.4%
            $3,721,891
            23.5%
            12.0%





Wholesale
Leathercraft, consisting of our 30 wholesale stores and our national account
group, accounted for 53.4% of our consolidated net sales in 2007, which compares
to 56.2% in 2006 and 61.2% in 2005.  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 decreased 2% in 2007 compared to sales in 2006 while the sales
decline in our national account group was 13%.  By customer group, we
achieved gains to our wholesale and small manufacturing customers while our
sales to our retail and national account customers declined.  Our
sales mix by customer group was as follows:





Customer Group
            2007
            2006
            2005Retail
            23%
            25%
            23%Institution
            8%
            7%
            7%Wholesale
            42%
            39%
            45%National
      Accounts
            15%
            19%
            16%Manufacturers
            12%
            10%
            9%100%
            100%
            100%





The 2007
increase in operating income as a percentage of divisional sales resulted from
as decrease of 0.6% in gross margin (as a percentage of sales) compared with
2006, and an increase of 6.6% in operating expenses as a percent of
sales.  Significant operating expense increases occurred in employee
compensation and benefits ($500,000), depreciation expense ($200,000), legal and
professional fees ($300,000), and advertising costs ($200,000).  These
increases were partially offset by decreases in various insurance expenses
($100,000) and general supplies ($75,000).





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).





Retail
Leathercraft





Year
            Net
      Sales Increase
              from Prior Yr
            Operating
              Income
            Operating
      Income
              Incr
      (Decr)
              from Prior Year
            Operating
      Income
              as
      a Percentage
              of  Sales2007
            9.5%
            $1,544,320
            (33.2)%
            6.3%2006
            25.0%
            $2,310,073
            30.7%
            10.3%2005
            33.4%
            $1,766,960
            45.9%
            9.8%





Reflecting
the growth previously discussed, Retail Leathercraft accounted for 44.6% of our
total net sales in 2007, up from 40.8% in 2006 and 35.5% in 2005.





Growth in
net sales for Retail Leathercraft division in 2007 and 2006 resulted primarily
from our expansion program.  Expansion during 2007 and 2006 consisted
of the opening of 10 and 12 new stores, respectively.





Our sales
mix by customer group was as follows:





Customer Group
            2007
            2006
            2005Retail
            63%
            65%
            62%Institution
            8%
            8%
            11%Wholesale
            27%
            26%
            26%National
      Accounts
            0%
            0%
            0%Manufacturers
            2%
            1%
            1%100%
            100%
            100%





Operating
income as a percentage of sales decreased to 6.3% for 2007 compared to 10.3% for
2006.  Gross margin fell to 59.7% in 2007 from 60.8% in
2006.  Operating expenses as a percent of sales in 2007 decreased by
3.0%, from 50.5% for 2006 to 53.5% for 2007 as operating expenses grew at a
faster pace than that of sales and gross margin.





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 2008 by
opening approximately 4 new stores in the last half of the year.  We
remain committed to a conservative expansion plan for this division that
minimizes risks to our profits and maintains financial stability.  In
the current economic environment in the U.S., it is possible that we will change
our plans for store openings in 2008 if we determine that the U.S. retail sector
can not support additional store openings at that time.





Other





Roberts,
Cushman accounted for 2.0% of our total sales in 2007 compared with 2.9% and
3.3% in 2006 and 2005, respectively.  Operating income was $140,000 in
2007 compared to an operating loss of $57,000 in 2006 and operating income of
$84,000 in 2005.  Roberts, Cushman's sales and profits are immaterial
to us as a whole.





10




Financial
Condition







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.  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 $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.





At
December 31, 2007, we held $6.8 million of cash, $17.5 million of inventory,
accounts receivable of $2.5 million, and $7.0 million of property and
equipment.  Goodwill and other intangibles (net of amortization and
depreciation) were $990,000 and $384,000, respectively.  Net total
assets were $37.6 million.  Current liabilities were $3.8 million
(including $135,000 of current maturities of long-term debt), while long-term
debt was $3.9 million.  Total stockholders’ equity at the end of 2007
was $29.8 million.





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





2007
            2006
            2005Solvency
      Ratios:Quick
      Ratio
            Cash+Accts
      Rec/Total Current Liabilities
            2.48
            1.74
            1.31Current
      Ratio
            Total
      Current Assets/Total Current Liabilities
            7.47
            5.19
            5.30Current
      Liabilities to Net Worth
            Total
      Current Liabilities/Net Worth
            0.13
            0.20
            0.19Current
      Liabilities to Inventory
            Total
      Current Liabilities/Inventory
            0.22
            0.31
            0.26Total
      Liabilities to Net Worth
            Total
      Liabilities/Net Worth
            0.26
            0.21
            0.21Fixed
      Assets to Net Worth
            Fixed
      Assets/Net Worth
            0.23
            0.07
            0.08Efficiency
      Ratios:Collection
      Period (Days Outstanding)
            Accounts
      Receivable/Credit Sales x 365
            63.42
            53.43
            44.17Inventory
      Turnover
            Sales/Average
      Inventory
            3.19
            3.36
            3.57Assets
      to Sales
            Total
      Assets/Sales
            0.68
            0.58
            0.51Sales
      to Net Working Capital
            Sales/Current
      Assets - Current Liabilities
            2.27
            2.45
            2.38Accounts
      Payable to Sales
            Accounts
      Payable/Sales
            0.03
            0.03
            0.02Profitability
      Ratios:Return
      on Sales (Profit Margin)
            Net
      Profit After Taxes/Sales
            0.06
            0.09
            0.07Return
      on Assets
            Net
      Profit After Taxes/Total Assets
            0.08
            0.15
            0.14Return
      on Net Worth(Return on
      Equity)
            Net
      Profit After Taxes/Net Worth
            0.10
            0.18
            0.18





Capital
Resources and Liquidity





On July
31, 2007, we entered into a Credit Agreement and Line of Credit Note with
JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with
a credit facility of up to $5,500,000 to facilitate our purchase and remodel of
real estate consisting of a 195,000 square foot building situated on 30 acres of
land located at 1900 SE Loop 820 in Fort Worth, Texas.  Proceeds in
the amount of $4,050,000 were used to fund the initial purchase of the property.
The remaining credit line available can be used to remodel portions of the
building. We expect to move our corporate headquarters, central warehouse and
other support units into the building at the end of the first quarter of
2008.





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





At this
time, we do not intend to borrow the remaining availability on the line of
credit to fund the cost of the remodel project.  As a result, the
current principal balance of $4.05 million will roll into a ten-year term note
on April 30, 2008 and we will begin making monthly debt service payments in May
2008.





Reflecting
the borrowing and reduction of bank indebtedness during the periods, our
financing activities for 2007, 2006 and 2005 provided (required) net cash of
$4.0 million, $69,000, and ($447,000), respectively.





The
primary source of liquidity and capital resources during 2007 was cash flow
provided by operating activities.  Cash flow from operations for 2007
and 2006 was $2.5 million and $3.9 million, respectively, the largest portion
generated from net income partially offset by the increase in inventory (in
2006) or the decreased of accrued expenses (in 2007).  Cash flow from
operations in 2005 was $1.5 million.





Consolidated
accounts receivable decreased slightly to $2.5 million at December 31, 2007
compared to $2.6 million at December 31, 2006.  Average days to
collect accounts slowed from 53.4 days in 2006 to 63.4 days in 2007 on a
consolidated basis.  We have experienced a gradual slowdown in the
collections of customer accounts throughout 2007 due to the overall tightening
of available cash on the part of our customers.  We have tightened our
credit policy and are aggressively monitoring our customer accounts to ensure
collectibility.  We believe the trend in our collections is the result
of the overall slowdown in the U.S. economy.  Many of our customers
with open accounts are very small businesses and they tend to feel the effects
of an economic slowdown more severely than larger businesses.





Inventory
increased from $17.2 million at the end of 2006 to $17.5 million at December 31,
2007.  We expect our inventory to slowly trend upward as we continue
our expansion of the Tandy Leather store chain.  In 2008, we expect
minimal increases in our inventory due to the expected weaknesses in our sales
and the limited number of retail stores we plan to open.  We attempt
to manage our inventory levels to avoid tying up excessive capital while
maintaining sufficient inventory in order to service our current customer demand
as well as plan for our expected store growth and expansion.  While we
believe our investment in inventory at the end of 2007 was at a reasonable level
given our expansion plans, it was approximately 7% above our internal targets of
optimum inventory levels.





Consolidated
inventory turned 3.19 times during 2007, a slight slow down from the 3.36 times
turned in 2006.  We compute our inventory turnover rates as sales
divided by average inventory.





By
operating division, inventory turns are as follows:





Segment
            2007
            2006
            2005Wholesale
      Leathercraft
            2.37
            2.40
            2.68Retail
      Leathercraft
            5.87
            6.99
            8.23Roberts,
      Cushman
            25.88
            7.15
            3.75Wholesale
      Leathercraft stores only
            6.87
            7.48
            7.73





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





11


Accounts
payable decreased to $1.5 million at the end of 2007 compared to $1.8 million at
the end of 2006 due primarily to the reduction in inventory purchases in the
last half of the year.





As discussed above, the largest use of
operating cash in 2007 was in the reduction of accounts payable and accrued
expenses.  Capital expenditures totaled $5.8 million and $471,000 for
the years ended December 31, 2007 and 2006, respectively.  The
substantial increase in capital expenditures in 2007 is due to the purchase of
the land and building which will house our corporate offices and central support
departments.  In 2007, capital expenditures consisted of real estate
($4.5 million), factory machines and dies ($110,000); fixtures and equipment for
the new Tandy Leather retail stores ($105,000), various store fixtures and
computer equipment at existing stores ($85,000), computer system upgrade for
advertising department ($100,000), computer equipment for future stores
($125,000); and miscellaneous computer and other office equipment
($250,000).  Although we intend to continue opening or acquiring new
Tandy Leather retail stores and therefore expenditures related to this expansion
should continue into 2008, we do expect our 2008 capital expenditures to be
substantially less than that of 2007 due to the significant one-time
expenditures in 2007 (purchase of real estate, advertising department system,
etc.)  However, we expect to spend $2.5 million on the remodel and
retrofit of the building in 2008 so our capital expenditures are not expected to
return to historical levels until after 2008.





We
believe that cash flow from operations will be adequate to fund our operations
in 2008, while also funding our limited expansion plans.  At this
time, we know of no trends or demands, commitments events or uncertainties that
will or are likely to materially affect our liquidity, capital resources or
results of operations.  In addition, we anticipate that this cash flow
will enable us to meet the contractual obligations and commercial
commitments.  We could defer expansion plans if required by
unanticipated drops in cash flow.  In particular, because of the
relatively small investment required by each new retail store, we have
flexibility in when we make most expansion expenditures.





Off-Balance
Sheet Arrangements





We did
not have any off-balance sheet arrangements during 2007, 2006 and 2005, 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, 2007 (not including related interest
expense):





Payments
      Due by PeriodsContractual
      Obligations
            Total
            Less
      than1
      Year
            1
      - 3Years
            4
      -5 Years
            After5
      YearsLong-Term
      Debt(1)
            $4,050,000
            $135,000
            $607,500
            $405,000
            $2,902,500Capital
      Lease Obligations
            --
            --
            --
            --
            --Operating
      Leases(2)
            7,270,523
            2,356,218
            4,350,712
            $563,594
            --Total
      Contractual Obligations
            $11,320,523
            $2,491,218
            $4,958,212
            $968,594
            $2,902,500


____________________


(1)  Our
loan from JPMorgan Chase matures in May 2018.


(2)  These
are our leased facilities.





Summary
of Critical Accounting Policies





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





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





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





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





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





Goodwill.  We
periodically analyze the remaining goodwill on our balance sheet to determine
the appropriateness of its carry value.  As of December 31, 2007, 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.


Forward-Looking
Statements





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





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.  Beginning in 2008, we will also have foreign currency
exposure related to our subsidiary in the United Kingdom. Tandy Leather Factory
UK Limited has local currency (British pounds) revenue and local currency
operating expenses.  Changes in the currency exchange rates impact the
U.S. dollar amount of revenue and expenses.  See Note 13 to the
Consolidated Financial Statements,Segment Information, for
financial information concerning our foreign activities.





Interest
Rate Risk





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





12


ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA





Tandy
Leather Factory, Inc.


Consolidated
Balance Sheets


December
31, 2007 and 2006








December
      31,
              2007
            
            December
      31,
              2006ASSETSCURRENT
      ASSETS:Cash
            $6,810,396
            
            $6,739,891Accounts
      receivable-trade, net of allowance for doubtful accountsof
      $104,000 and $149,000 in 2007 and 2006, respectively
            2,538,816
            
            2,599,279Inventory
            17,473,352
            
            17,169,358Deferred
      income taxes
            256,938
            
            266,018Other
      current assets
            1,102,836
            
            1,089,258Total
      current assets
            28,182,338
            
            27,863,804PROPERTY
      AND EQUIPMENT, at cost
            11,793,317
            
            6,865,946Less
      accumulated depreciation and amortization
            (4,794,505)
            
            (4,989,341)6,998,812
            
            1,876,605GOODWILL
            990,536
            
            746,139OTHER
      INTANGIBLES, net of accumulated amortization of$313,000
      and $262,000 in 2007 and 2006, respectively
            384,134
            
            360,676OTHER
      assets
            1,095,686
            
            1,069,411$37,651,506
            
            $31,916,635LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable-trade
            $1,497,564
            
            $1,776,646Accrued
      expenses and other liabilities
            2,072,640
            
            3,424,010Income
      taxes payable
            67,150
            
            59,392Current
      maturities of capital lease obligation
            -
            
            111,723Current
      maturities of long-term debt
            135,000
            
            -Total
      current liabilities
            3,772,354
            
            5,371,771DEFERRED
      INCOME TAXES
            148,648
            
            221,621CAPITAL
      LEASE OBLIGATION, net of current maturities
            -
            
            -LONG-TERM
      DEBT, net of current maturities
            3,915,000
            
            -COMMITMENTS
      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,
      10,982,951 and 10,885,068 shares issued at 2007 and 2006,10,977,092
      and 10,879,209 outstanding at 2007 and 2006, respectively
            26,359
            
            26,124Paid-in
      capital
            5,419,477
            
            5,292,591Retained
      earnings
            24,037,672
            
            20,949,540Treasury
      stock (5,859 shares at cost)
            (25,487)
            
            (25,487)Accumulated
      other comprehensive income
            357,483
            
            80,475Total
      stockholders' equity
            29,815,504
            
            26,323,243$37,651,506
            
            $31,916,635


























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


13





Tandy
Leather Factory, Inc.


Consolidated
Statements of Income


For
the Years Ended December 31, 2007, 2006 and 2005








2007
            
            2006
            
            2005NET
      SALES
            $55,317,002
            
            $55,199,021
            
            $50,719,574COST
      OF SALES
            23,644,599
            
            23,566,251
            
            21,964,530Gross
      Profit
            31,672,403
            
            31,632,770
            
            28,755,044OPERATING
      EXPENSES
            27,161,402
            
            24,565,056
            
            23,181,633INCOME
      FROM OPERATIONS
            4,511,001
            
            7,067,714
            
            5,573,411OTHER
      (INCOME) EXPENSE:Interest
      expense
            122,209
            
            -
            
            3,188Other,
      net
            (439,040)
            
            (98,391)
            
            (137,690)Total
      other (income) expense
            (316,831)
            
            (98,391)
            
            (134,502)INCOME
      BEFORE INCOME TAXES
            4,827,832
            
            7,166,105
            
            5,707,913PROVISION
      FOR INCOME TAXES
            1,739,701
            
            2,389,039
            
            1,994,199NET
      INCOME
            $3,088,131
            
            $4,777,066
            
            $3,713,714NET
      INCOME PER COMMON SHARE – BASIC
            $0.28
            
            $0.44
            
            $0.35NET
      INCOME PER COMMON SHARE – DILUTED
            $0.28
            
            $0.43
            
            $0.34Weighted
      Average Number of Shares Outstanding:Basic
            10,951,481
            
            10,807,316
            
            10,643,004Diluted
            11,157,775
            
            11,113,855
            
            10,976,240












































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


14





Tandy
Leather Factory, Inc.


Consolidated
Statements of Cash Flows


For
the Years Ended December 31, 2007, 2006 and 2005






2007
              
              2006
              
              2005CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
              $3,088,131
              
              $4,777,066
              
              $3,713,714Adjustments
      to reconcile net income to net cashprovided
      by operating activities -Depreciation
      and amortization
              634,291
              
              392,915
              
              456,706Loss
      (Gain) on disposal of assets
              50,114
              
              (3,750)
              
              (9,145)Non-cash
      stock-based compensation
              19,340
              
              101,080
              
              -Deferred
      income taxes
              (63,893)
              
              23,222
              
              (181,317)Other
              241,182
              
              (15,696)
              
              38,276Net
      changes in assets and liabilities, net of effect ofbusiness
      acquisitions:Accounts
      receivable-trade, net
              119,293
              
              (420,431)
              
              (146,559)Inventory
              156,052
              
              (1,500,176)
              
              (2,919,473)Income
      taxes
              7,758
              
              (140,189)
              
              176,817Other
      current assets
              (27,946)
              
              (731,200)
              
              271,664Accounts
      payable-trade
              (327,726)
              
              556,226
              
              (733,726)Accrued
      expenses and other liabilities
              (1,351,369)
              
              873,437
              
              868,570Total
      adjustments
              (542,904)
              
              (864,562)
              
              (2,178,187)Net
      cash provided by operating activities
              2,545,227
              
              3,912,504
              
              1,535,527CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
              (1,705,367)
              
              (471,753)
              
              (272,826)Payments
      in connection with businesses acquired
              (771,417)
              
              -
              
              -Proceeds
      from sale of assets
              32,281
              
              3,750
              
              9,145Decrease
      (increase) in other assets
              (26,276)
              
              10,320
              
              (168,981)Net
      cash used in investing activities
              (2,470,779)
              
              (457,683)
              
              (432,662)CASH
      FLOWS FROM FINANCING ACTIVITIES:Net
      decrease in revolving credit loans
              -
              
              -
              
              (505,154)Payments
      on capital lease obligations
              (111,723)
              
              (134,067)
              
              (134,067)Proceeds
      from issuance of common stock and warrants
              107,780
              
              203,410
              
              191,881Net
      cash provided by (used in) financing activities
              (3,943)
              
              69,343
              
              (447,340)NET
      INCREASE IN CASH
              70,505
              
              3,524,164
              
              655,525CASH,
      beginning of period
              6,739,891
              
              3,215,727
              
              2,560,202CASH,
      end of period
              $6,810,396
              
              $6,739,891
              
              $3,215,727SUPPLEMENTAL
      DISCLOSURES OF CASH FLOW INFORMATION:Interest
      paid during the period
              $122,209
              
              -
              
              $3,188Income
      tax paid during the period, net of (refunds)
              1,830,688
              
              $2,282,113
              
              1,954,364NON-CASH
      INVESTING ACTIVITIES:Land
      and building acquired with long term debt
              $4,050,000
              
              -
              
              -




















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


15


Tandy
Leather Factory, Inc.


Consolidated
Statements of Stockholders' Equity


For
the Years Ended December 31, 2007, 2006 and 2005








Number
      of Shares
            
            Par
      Value
            
            Paid-in
      Capital
            
            Treasury
              Stock
            
            Retained
      Earnings
            
            Accumulated
      Other Comprehensive Income (Loss)
            
            Total
            
            Comprehensive
              Income
      (Loss)BALANCE,
      December 31, 2004
            10,554,802
            
            $25,345
            
            $4,796,999
            
            $(25,487)
            
            $12,458,760
            
            $54,616
            
            $17,310,233Shares
      issued - stock options and
              warrants
      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
            10,735,976
            
            $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 and
              warrants
      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
            10,879,209
            
            $26,124
            
            $5,292,591
            
            $(25,487)
            
            $20,949,540
            
            $80,475
            
            $26,323,243Comprehensive
      income for the year ended December 31, 2006
            $4,760,896Shares
      issued - stock options and
              warrants
      exercised
            97,883
            
            235
            
            107,545
            
            -
            
            -
            
            -
            
            107,780Stock-based
      compensation
            -
            
            -
            
            19,341
            
            -
            
            -
            
            -
            
            19,341Net  income
            -
            
            -
            
            -
            
            -
            
            3,088,131
            
            -
            
            3,088,131
            
            $3,088,131Translation
      adjustment
            -
            
            -
            
            -
            
            -
            
            -
            
            277,009
            
            277,009
            
            277,009BALANCE,
      December 31, 2007
            10,977,092
            
            $26,359
            
            $5,419,477
            
            $(25,487)
            
            $24,037,671
            
            $357,484
            
            $29,815,504Comprehensive
      income for the year ended December 31, 2007
            $3,365,140

















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


16








TANDY
LEATHER FACTORY, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


DECEMBER
31, 2007, 2006 and 2005





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, Mid-Continent Leather
Sales, Inc. (an Oklahoma corporation), Roberts, Cushman & Company, Inc. (a
Texas 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.





·
            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.





17


·
            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
            2007
            
            2006
            
            2005Net
      income (loss)
            $3,088,131
            
            $4,777,066
            
            $3,713,714Weighted
      average common shares outstanding
            10,951,481
            
            10,807,316
            
            10,643,004Earnings
      per share – basic
            $0.28
            
            $0.44
            
            $0.35DILUTEDNet
      income (loss)
            $3,088,131
            
            $4,777,066
            
            $3,713,714Weighted
      average common shares outstanding
            10,951,481
            
            10,807,316
            
            10,643,004Effect
      of assumed exercise of stock options and warrants
            206,294
            
            306,539
            
            333,236Weighted
      average common shares outstanding, assuming
      dilution
            11,157,775
            
            11,113,855
            
            10,976,240Earnings
      per share - diluted
            $0.28
            
            $0.43
            
            $0.34Outstanding
      options and warrants excluded as anti-dilutive
            11,500
            
            -
            
            -





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
275,200 and 446,500 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, 2007 and 2006, 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, 2007, 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.





A summary
of changes in our goodwill for the years ended December 31, 2007 and 2006 is as
follows:





Leather Factory
            
            Tandy Leather
            
            TotalBalance,
      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
            
            $746,139Acquisitions
      and adjustments
            225,000
            
            -
            
            225,000Foreign
      exchange gain/loss
            19,397
            
            -
            
            19,397Impairments
            -
            
            -
            
            -Balance,
      December 31, 2007
            607,130
            
            $383,406
            
            990,536





As of
December 31, 2007 and 2006, our intangible assets and related accumulated
amortization consisted of the following:





As
      of December 31, 2007Gross
            
            Accumulated
      Amortization
            
            NetTrademarks,
      Copyrights
            $544,369
            
            $283,485
            
            $260,884Non-Compete
      Agreements
            153,000
            
            29,750
            
            123,250$697,369
            
            $313,235
            
            $384,134





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





Excluding
goodwill, we have no intangible assets not subject to amortization under SFAS
142.  Amortization of intangible assets of $51,542 in 2007, $38,291 in
2006, and $38,791 in 2005 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
            Total2008
            $20,954
            $30,337
            $51,2912009
            20,954
            30,337
            51,2912010
            20,954
            30,337
            51,2912011
            20,027
            30,337
            50,3642012
            1,250
            30,337
            31,587





During
2007, we entered into a five year non--compete agreement in connection with our
acquisition of Mid-Continent Leather Sales, Inc.  We paid the former
owner of Mid-Continent Leather $75,000 in exchange for the
agreement.




·
            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 carrying amount of
notes payable and long-term debt approximates fair value based on the maturities
and collateral requirements currently available for similar financial
instruments.




·
            Deferred
      taxes





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





18


·
            Stock-based
      compensation – Change in Accounting
Principle





We have
one stock option plan which provides for  stock option grants to
non-employee directors.  No options have been awarded as of December
31, 2007.  We had two other stock option plans from 1995 which
provided for stock option grants to officers, key employees and non-employee
directors.  These plans expired in 2005.  See Note 11 for
additional details regarding our stock option plans.





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 $19,000 and
$101,000 for the years ended December 31, 2007 and 2006, respectively, 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 year ended
December 31, 2005 would have been as follows:





2005Net
      income, as reported
            $3,713,714Add:
      Stock-based compensation expense included in reported net
      income
            -Deduct:
      Stock-based compensation expense determined under fair value
      method
            122,934Net
      income, pro forma
            $3,590,780Net
      income per share:Basic
      - as reported
            $0.35Basic
      - pro forma
            $0.34Diluted
      - as reported
            $0.34Diluted
      - pro forma
            $0.33





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:





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





The
effect on the 2005 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, 2007, the stock option activity under our stock
option plans was as follows:





Weighted
      Average ExercisePrice
            #of
              shares
            Weighted
      Average Remaining Contractual Term(in
      years)
            Aggregate
              Intrinsic
      ValueOutstanding,
      January 1, 2007
            $2.05
            296,200Granted
            -
            -Cancelled
            -
            -Exercised
            1.81
            (59,500)Outstanding,
      December 31, 2007
            $2.11
            236,700
            4.23
            $270,780Exercisable,
      December 31, 2007
            $1.97
            220,770
            4.11
            $237,740





Other
information pertaining to option activity during the twelve month periods ended
December 31, 2007 and 2006 are as follows:





2007
            2006Weighted
      average grant-date fair value of stock options granted
            N/A
            N/ATotal
      fair value of stock options vested
            $30,500
            $89,915Total
      intrinsic value of stock options exercised
            $62,280
            $90,780





As of
December 31, 2007, there was $33,000 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.





·
            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
$1,641,000, $1,611,000 and $1,504,000 for the years ended December 31, 2007,
2006 and 2005, 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 $218,000 and $238,000 at December 31, 2007 and
2006, respectively.  Total advertising expense was $3,440,762 in 2007;
$3,087,943 in 2006; and $3,074,991 in 2005.





19


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





·
            Cash
      flows presentation





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





Recently
Issued Acocunting Standard – FIN 48





Effective
January 1, 2007, the Company adopted FASB Interpretation No. 48, or
FIN 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB
Statement No. 109.” This interpretation prescribes a model for how a
company should recognize, measure, present, and disclose in its financial
statements uncertain tax positions that it has taken or expects to take on a tax
return. The Company does not have any material uncertain income tax positions
therefore the adoption of FIN 48 had no effect on its consolidated financial
position or results of operations. If any material uncertain tax positions did
arise, the Companies policy is to accrue associated penalties in selling,
general and administrative expenses and to accrue interest as part of net
interest expense. The Company does not anticipate that total unrecognized tax
benefits will significantly change prior to December 31, 2008.




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 $104,634 and $149,172, respectively, at December 31,
2007 and 2006.  The following is a roll forward of the allowance for
doubtful accounts:





Year
      ended:
            Balance
      at
              beginning
      of year
            Additions
      (reductions)
              charged
      to costsand
      expenses
            Foreign
      exchange
              gain/loss
            Write-offs
            Balance
      at
              end
      of yearDecember
      31, 2007
            $149,172
            86,590
            3,192
            (134,320)
            $104,634December
      31, 2006
            $137,587
            85,439
            241
            (74,095)
            $149,172December
      31, 2005
            $  85,133
            87,873
            527
            (35,946)
            $137,587





·
            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.





4.  BALANCE
SHEET COMPONENTS





December
      31, 2007
            
            December
      31, 2006INVENTORYOn
      hand:Finished
      goods held for sale
            $16,482,845
            
            $14,774,445Raw
      materials and work in process
            633,188
            
            628,539Inventory
      in transit
            357,319
            
            1,766,374TOTAL
            $17,473,352
            
            $17,169,358PROPERTY AND EQUIPMENTLeasehold
      improvements
            $1,163,947
            
            $1,199,900Equipment
            4,431,432
            
            4,449,949Furniture
      and fixtures
            1,238,731
            
            1,149,875Building
            3,060,194
            
            -Land
            1,451,132
            
            -Vehicles
            69,713
            
            66,222Construction
      in progress
            378,168
            
            -11,793,317
            
            6,865,946Less:  accumulated
      depreciation
            (4,794,505)
            
            (4,989,341)TOTAL
            $6,998,812
            
            $1,876,605OTHER CURRENT ASSETSAccounts
      receivable – employees
            $38,972
            
            $16,247Accounts
      receivable – other
            265,400
            
            390,937Prepaid
      expenses
            588,004
            
            598,094Payments
      for merchandise not received
            210,460
            
            83,980TOTAL
            $1,102,836
            
            $1,089,258OTHER ASSETSSecurity
      deposits - utilities, locations, etc.
            $74,057
            
            $70,771Leather
      art collection
            252,000
            
            252,000Long-term
      portion of note receivable
            109,157
            
            -Computer
      software not implemented yet
            660,472
            
            746,640TOTAL
            $1,095,686
            
            $1,069,411ACCRUED EXPENSES AND OTHER
      LIABILITIESAccrued
      bonuses
            $760,113
            
            $950,056Accrued
      payroll
            220,555
            
            274,514Deferred
      revenue
            421,908
            
            -Sales
      and payroll taxes payable
            177,786
            
            231,076Inventory
      in transit
            357,318
            
            1,766,374Other
            134,960
            
            201,990TOTAL
            $2,072,640
            
            $3,424,010





Depreciation
expense was $577,405, $348,797, and $417,914 for the years ended December 31,
2007, 2006 and 2005, respectively.


20


5.  NOTES
PAYABLE AND LONG-TERM DEBT





On July
31, 2007, we entered into a Credit Agreement and Line of Credit Note with
JPMorgan Chase Bank, N.A., pursuant to which the bank agreed to provide us with
a credit facility of up to $5,500,000 to facilitate our purchase of real estate
consisting of a 191,000 square foot building situated on 30 acres of land
located at 1900 SE Loop 820 in Fort Worth, Texas.  Under the terms of
the Line of Credit Note, we may borrow from time to time until April 30, 2008,
up to the lesser of $5,500,000 or 90% of the cost of the property.  We
will make only monthly interest payments until April 30, 2008, at which time the
principal balance will be rolled into a 10-year term note.  Amounts
drawn under the Credit Agreement accrue interest at a rate of 7.10% per
annum.





Proceeds
in the amount of $4,050,000 were used to fund the purchase of the property from
Standard Motor Products, Inc. under an Agreement of Purchase and Sale, dated
June 25, 2007, which closed on July 31, 2007. The remaining credit line
available can be used to remodel portions of the building. We expect to move our
corporate headquarters, central warehouse and other support units into the
acquired building during the first quarter of 2008.





At
December 31, 2007, the amount outstanding under the above agreement consisted of
the following:





2007Credit
      Agreement with JPMorgan Chase Bank – collateralized by real estate;
      payable as follows:Line
      of Credit Note dated July 31, 2007 in the maximum principal amount of
      $5,500,000 with revolving features as more fully described above –
      interest due monthly at 7.10%; matures April 30, 2018
            $  4,050,0004,050,000Less
      - Current maturities
            (135,000)$3,915,000





The
unused portion of the credit facility at December 31, 2007 was $1.45
million.





The terms
of the credit facility contain various covenants which among other things
require the Company to maintain a debt service coverage ratio of not less than
1.2 to 1.0.  Scheduled maturities of the Company’s notes payable and
long-term debt are as follows:





2008
            $135,0002009
            202,5002010
            202,5002011
            202,5002012
            202,5002013
      and thereafter
            3,105,000$4,050,000








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, 2007.  The asset will be reclassified into property and
equipment once the conversion and implementation process is
completed.





At
December 31, 2007 and 2006, the amounts outstanding under capital lease
obligations consisted of the following:





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





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,
2007, 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 2007, 2006, and 2005, respectively, we
contributed $0; $225,350; and $300,000 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, 2007, 2006 and 2005:





Number of Shares
            
            Market Value2007
            2006
            2005
            
            2007
            2006
            2005Allocated
            844,381
            929,069
            943,241
            
            $2,761,126
            $7,497,587
            $6,461,201Unearned
            -
            -
            -
            
            -
            -
            -Total
            844,381
            929,069
            943,241
            
            $2,761,126
            $7,497,587
            $6,461,201





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.  In 2007, we matched pretax employee contributions up to 100% on
the first 3% of eligible earnings and 50% on the next 2% of eligible
earnings.  In 2006, we matched 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 $9,000 for the 2007
calendar year and $4,400 for the 2006 calendar year due to the 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 $240,774 and $108,565 in 2007 and 2006,
respectively.





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
2007 or 2006.





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





21


8.  INCOME
TAXES





The
provision for income taxes consists of the following:





2007
            
            2006
            
            2005Current
      provision:Federal
            $1,494,181
            
            $2,167,141
            
            $1,932,791State
            309,413
            
            198,676
            
            242,7251,803,594
            
            2,365,817
            
            2,175,516Deferred
      provision (benefit):Federal
            (57,153)
            
            19,447
            
            (166,850)State
            (6,740)
            
            3,775
            
            (14,467)(63,893)
            
            23,222
            
            (181,317)$1,739,701
            
            $2,389,039
            
            $1,994,199








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





2007
            
            2006
            
            2005United
      States
            $4,407,361
            
            $6,560,994
            
            $5,220,991Canada
            420,471
            
            605,111
            
            486,922$4,827,832
            
            $7,166,105
            
            $5,707,913





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





2007
            
            2006Deferred income tax assets:Allowance
      for doubtful accounts
            $29,360
            
            $49,601Capitalized
      inventory costs
            144,099
            
            131,054Warrants
            42,989
            
            42,989Accrued
      expenses, reserves, and other
            83,478
            
            85,363Total
      deferred income tax assets
            299,926
            
            309,007Deferred income tax
      liabilities:Property
      and equipment depreciation
            78,567
            
            197,287Goodwill
      and other intangible assets amortization
            113,069
            
            67,323Total
      deferred income tax liabilities
            191,636
            
            264,610Net
      deferred tax asset (liability)
            $108,290
            
            $44,397





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





2007
            
            2006Current
      deferred tax assets
            $256,938
            
            $266,018Long-term
      deferred tax liabilities
            (148,648)
            
            (221,621)Net
      deferred tax asset (liability)
            $108,290
            
            $44,397





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





2007
            2006
            2005Statutory
      rate
            
            34%
            34%
            34%State
      and local taxes
            
            6%
            2%
            4%Other
            
            (4%)
            (3%)
            (3%)Effective
      rate
            
            36%
            33%
            35%





The
Company files a consolidated U.S. income tax return as well as state tax returns
on a consolidated, combined or stand-alone basis, depending on the
jurisdiction.  The Company is no longer subject to U.S. federal income
tax examinations by tax authorities for years prior to the tax year ended
December 2005.  Depending on the jurisdiction, the Company is no
longer subject to state examinations by tax authorities for years prior to the
December 2004 and December 2005 tax years.








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 2008
to April 2013.  Rent expense on all operating leases for the years
ended December 31, 2007, 2006 and 2005, was $2,682,574, $2,495,380 and
$2,227,345, respectively.





Future
minimum lease payments under noncancelable operating leases at December 31, 2007
were as follows:





Year
      ending December 31:2008
            $2,356,2182009
            1,881,0162010
            1,470,3132011
            999,3832012
      and thereafter
            563,594Total
      minimum lease payments
            $7,270,524





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.





22


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 2007, 2006 or 2005, sales to our five
largest customers represented 8.3%, 9.5% and 9.4%, 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, 2007 and 2006, 38% and 38%, 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.





11.  STOCKHOLDERS'
EQUITY








(a)
            Stock
      Option Plans





·
            2007 Director
      Non-Qualified Stock Option
Plan





The 2007
Director Non-Qualified Stock Option Plan was adopted by the Board of Directors
effective March 22, 2007 subject to stockholder approval at the Company’s 2007
Annual Meeting of Stockholders.  Pursuant to the plan, options to
acquire an aggreagate of 100,000 common shares may be granted to each individual
who is serving as an outside Director of the Company on the date of grant, at
the rate of 3,000 shares of Common Stock on March 22 of each calendar
year.  No options have been awarded as of December 31, 2007 as the
Form S-8, Registration Statement under the Securities Act of 1933, has not been
filed with the Securities and Exchange Commission yet.





·
            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 1,200,000 shares available for
issuance under the three plans, at December 31, 2007, 2006 and 2005, there were
100,000, 0, and 44,000, respectively, in un-optioned shares available for future
grants.





A summary
of stock option transactions for the years ended December 31, 2007, 2006 and
2005, is as follows:





2007
            
            2006
            
            2005Weighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            AverageOption
            
            Exercise
            
            Option
            
            Exercise
            
            Option
            
            ExerciseShares
            
            Price
            
            Shares
            
            Price
            
            Shares
            
            PriceOutstanding
      at January 1
            
            296,200
            
            $2.05
            
            421,000
            
            $1.93
            
            602,500
            
            $1.630Granted
            
            -
            
            -
            
            -
            
            -
            
            8,000
            
            4.960Forfeited
      or expired
            
            -
            
            -
            
            -
            
            -
            
            (12,000)
            
            1.350Exchanged
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Exercised
            
            (59,500)
            
            1.81
            
            (124,800)
            
            1.63
            
            (177,500)
            
            1.081Outstanding
      at December 31
            
            236,700
            
            $2.11
            
            296,200
            
            $2.05
            
            421,000
            
            $1.930Exercisable
      at end of year
            
            220,700
            
            $1.97
            
            266,200
            
            $1.82
            
            295,000
            
            $1.670Weighted-average
      fair value ofoptions
      granted during year
            
            -
            
            
            
            -
            
            
            
            $1.48





The
following table summarizes outstanding options into groups based upon exercise
price ranges at December 31, 2007:





Options
      Outstanding
            
            Options
      ExercisableWeighted
            
            Weighted
            
            
            
            Weighted
            
            WeightedAverage
            
            Average
            
            
            
            Average
            
            AverageOption
            
            Exercise
            
            Maturity
            
            Option
            
            Exercise
            
            MaturityExercisePriceRange
            
            Shares
            
            Price
            
            (Years)
            
            Shares
            
            Price
            
            (Years)$0.75
      or Less
            
            4,000
            
            $0.595
            
            1.24
            
            4,000
            
            $0.595
            
            1.24$0.76
      to $1.125
            
            42,000
            
            0.943
            
            2.70
            
            42,000
            
            0.943
            
            2.70$1.126
      to $1.69
            
            115,700
            
            1.350
            
            3.40
            
            115,700
            
            1.350
            
            3.40$1.70
      to $2.55
            
            2,000
            
            1.900
            
            3.74
            
            2,000
            
            1.900
            
            3.74$2.56
      to $3.84
            
            12,000
            
            3.270
            
            6.31
            
            8,000
            
            3.215
            
            6.15$3.85-$4.96
            
            61,000
            
            4.241
            
            6.67
            
            49,000
            
            4.241
            
            6.90236,700
            
            $2.110
            
            4.23
            
            220,700
            
            $1.970
            
            4.11





(b)
            Warrants





A warrant
to acquire up to 100,000 shares of common stock at $3.10 per share was issued in
conjunction with a consulting agreement to an unrelated entity in February
2003.  The warrant expired on February 12, 2008.





23


A warrant
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 warrant may be exercised at anytime until expiration on
February 24, 2009.




A summary
of warrant transactions for the years ended December 31, 2007, 2006 and 2005, is
as follows:





2007
            
            2006
            
            2005Weighted
            
            
            
            Weighted
            
            
            
            WeightedAverage
            
            
            
            Average
            
            
            
            AverageWarrant
            
            Exercise
            
            Warrant
            
            Exercise
            
            Warrant
            
            ExerciseShares
            
            Price
            
            Shares
            
            Price
            
            Shares
            
            PriceOutstanding
      at January 1
            
            98,300
            
            $3.650
            
            140,000
            
            $3.7786
            
            150,000
            
            $3.7333Granted
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Forfeited
      or expired
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Exchanged
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -Exercised
            
            (70,800)
            
            3.658
            
            (41,700)
            
            4.089
            
            (10,000)
            
            3.1000Outstanding
      at December 31
            
            27,500
            
            $3.620
            
            98,300
            
            $3.650
            
            140,000
            
            $3.7786Exercisable
      at end of year
            
            27,500
            
            $3.620
            
            98,300
            
            $3.650
            
            140,000
            
            $3.7786Weighted-average
      fair value ofwarrants
      granted during year
            
            -
            
            
            
            -
            
            
            
            -





The
following table summarizes outstanding warrants into groups based upon exercise
price ranges at December 31, 2007:





Warrants
      Outstanding
            
            Warrants
      ExercisableWeighted
            
            Weighted
            
            
            
            Weighted
            
            WeightedAverage
            
            Average
            
            
            
            Average
            
            AverageExercise
            
            Maturity
            
            
            
            Exercise
            
            MaturityExercisePriceRange
            
            Warrant
            
            Price
            
            (Years)
            
            Warrant
            
            Price
            
            (Years)$3.00
      or Less
            
            -
            
            -
            
            -
            
            -
            
            -
            
            -More
      than $3.00 andLess
      Than  $5.00
            
            20,000
            
            $3.10
            
            0.12
            
            20,000
            
            $3.10
            
            0.12$5.00
      or More
            
            7,500
            
            5.00
            
            1.15
            
            7,500
            
            5.00
            
            1.1527,500
            
            $3.62
            
            0.40
            
            27,500
            
            $3.62
            
            0.40





12.  BUSINESS
ACQUISITIONS





On
January 31, 2007, we acquired all of the issued and outstanding shares of
capital stock of Mid-Continent Leather Sales, Inc., an Oklahoma
corporation.  The total purchase price was $575,000 which was funded
with cash generated from operations.  For financial reporting
purposes, the transaction was accounted for under the purchase method, effective
February 1, 2007.  We also entered into a non-compete agreement with
the former owner totaling $75,000 for a period of five years.  This
company is included in our Wholesale Leathercraft segment.





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, 2007Net
      Sales
            $29,555,979
            $24,663,751
            $1,097,272
            $55,317,002Gross
      Profit
            16,446,853
            14,733,478
            492,071
            31,672,402Operating
      earnings
            2,826,710
            1,544,320
            139,971
            4,511,001Interest
      expense
            122,209
            -
            -
            122,209Other,
      net
            (425,145)
            (11,975)
            (1,920)
            (439,040)Income
      before income taxes
            3,129,646
            1,556,295
            141,891
            4,827,832Depreciation
      and amortization
            485,506
            143,123
            5,662
            634,291Fixed
      asset additions
            5,538,803
            207,455
            9,109
            5,755,367Total
      assets
            $32,217,748
            $5,272,466
            $161,292
            $37,651,506For
      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
            $25,680,473





24


Net sales
for geographic areas was as follows:





2007
            2006
            2005United
      States
            $48,756,696
            $49,188,609
            $45,492,215Canada
            4,698,510
            4,287,180
            3,643,133All
      other countries
            1,861,796
            1,723,232
            1,584,226$55,317,002
            $55,199,021
            $50,719,574





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, 2007, 2006 and
2005.  We do not have any significant long-lived assets outside of the
United States.





In
February 2008, we opened a combination wholesale/retail leathercraft store in
Northampton, United Kingdom.  We intend to report our international
activity (non-North America) as a fourth operating segment beginning in the
first quarter of 2008.





14.  RECENT
ACCOUNTING PRONOUNCEMENTS








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 generally accepted accounting principles and expands disclosures
about fair value measurements.  This Statement applies under other
accounting pronouncements that require or permit fair value measures, the FASB
having previously concluded in those account pronouncements that fair value is
the relevant measurement attribute.  Accordingly, this Statement does
not require any new fair value measurements.  SFAS 157 is effective
for fiscal years beginning after November 15, 2007 and we are currently
assessing the impact that SFAS 157 will have on our results of operations and
financial position.





In
February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (“SFAS 159”).  SFAS 159
expands the use of fair value accounting but does not affect existing standards
that require assets or liabilities to be carried at fair value.  Under
SFAS 159, a company may elect to use fair value to measure accounts and loans
receivable, available-for-sale and held-to-maturity securities, accounts
payable, and issued debt.  If the use of fair value is elected, any
upfront costs and fees related to the item must be recognized in earnings and
cannot be deferred.  The fair value election is irrevocable and
general made on an instrument-by-instrument basis, even if a company has similar
instruments that it elects not to measure based on fair value.  At the
adoption date, unrealized gains and losses on existing items for which fair
value has been elected are reported as a cumulative adjustment to beginning
retained earnings.  Subsequent to the adoption of SFAS 159, changes in
fair value are recognized in earnings.  SFAS 159 is effective for
fiscal years beginning after November 15, 2007.  We are currently
assessing the impact that SFAS 159 will have on our results of operations and
financial position.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), Business Combinations (“SFAS
141R”), which replaces FASB Statement No. 141 and SFAS No. 160, Noncontrolling Interests in
Consolidated Financial Statements – an amendment of AFB No. 51, (“SFAS
160”).  SFAS 141R establishes principles and requirements for how an
acquirer recognizes and measure in its financial statements the identifiable
assets acquired, the liabilities assumed, any noncontrolling interest in the
acquiree and the goodwill acquired.  The Statement also establishes
disclosure requirements that will enable users to evaluate the nature and
financial effects of the business combination.  SFAS 160 will change
the accounting and reporting for minority interests, reporting them as equity
separate from the parent entity’s equity, as well as requiring expanded
disclosures.  SFAS 141R and SFAS 160 are effective as of the beginning
of an entity’s fiscal year beginning after December 15, 2008.  We are
have not yet determined the impact these pronouncements will have on our results
of operations and financial position.





15.  QUARTERLY
FINANCIAL DATA (UNAUDITED)





First
            Second
            Third
            Fourth2007
            
            Quarter
            Quarter
            Quarter
            QuarterNet
      sales
            
            $14,507,805
            $13,376,987
            $12,806,333
            $14,625,877Gross
      profit
            
            8,597,953
            7,685,669
            6,941,634
            8,447,147Net
      income
            
            1,346,355
            396,692
            171,606
            1,173,478Net
      income per common share:Basic
            
            0.12
            0.04
            0.02
            0.11Diluted
            
            0.12
            0.04
            0.02
            0.11Weighted
      average number of common shares outstanding:Basic
            
            10,893,359
            10,915,061
            10,945,661
            10,974,222Diluted
            
            11,150,246
            11,114,466
            11,129,757
            11,160,034First
            Second
            Third
            Fourth2006
            
            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
            11,113,855








25












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, 2007 and 2006, 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,
2007.  The Company’s management is responsible for these financial
statements.  Our responsibility is to express an opinion on these
financial statements based on our audits.





We
conducted our audits in accordance with the standards of the Public Accounting
Oversight Board (United States).  Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement.  The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting.  Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company’s internal control
over financial reporting.  Accordingly, we express no such
opinion.  An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation.  We
believe that our audits provide a reasonable basis for our opinion.





In our
opinion, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of the Tandy Leather
Factory, Inc. and Subsidiaries as of December 31, 2007, and 2006 and the
consolidated results of its operations and its cash flows for each of the years
in the three-year period ended December 31, 2007, in conformity with accounting
principles generally accepted in the United States of America.











WEAVER
AND TIDWELL, L.L.P.





Fort Worth,
Texas


March 25,
2008





26




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





None.





ITEM
9A.  CONTROLS AND PROCEDURES





Evaluation of Disclosure
Controls and Procedures.  Our management, with the
participation of our Chief Executive Officer and Chief Financial Officer,
evaluated the design and operation of our disclosure controls and procedures (as
defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of
1934, as amended).  Based upon their evaluation of these disclosure
controls and procedures, our Chief Executive Officer and Chief Financial Officer
have concluded that the disclosure controls and procedures were effective as of
the date of such evaluation in ensuring that information required to be
disclosed in the reports that we file or submit under the Exchange Act is (1)
recorded, processed, summarized and reported in a timely manner, and (2)
accumulated and communicated to our management, including our principal
executive and principal financial officers, as appropriate, to allow timely
decisions regarding required disclosure.





Management’s
Report on Internal Control over Financial Reporting





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting.  Our internal control system was
designed to provide reasonable assurance to management and the board of
directors regarding the effectiveness of our internal control processes over the
preparation and fair presentation of our published financial
statements.





All
internal control systems, no matter how well designed, have inherent
limitations.  Therefore, even those systems determined effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation.





We have
assessed the effectiveness of our internal controls over financial reporting as
of December 31, 2007.  In making this assessment, we used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commissions (COSO) in Internal
Control – Integrated Framework.Based on our assessment, we believe that,
as of December 31, 2007, our internal control over financial reporting is
effective based on that criteria.





This
annual report does not include an auditor’s attestation report regarding the
effectiveness of our internal control over financial reporting and our
independent registered public accounting firm has not attested to management’s
report on our internal control over financial reporting.  Management’s
report was not subject to attestation by the company’s registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit the company to provide only management’s report in this
annual report.





Changes in internal
control.  There was no change in our internal control over
financial reporting that occurred during the fiscal quarter ended December 31,
2007 that has materially affected, or is reasonably likely to materially 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 2008 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, EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE





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 2008 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 2008 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 2008 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.tandyleatherfactory.com).





ITEM
11.  EXECUTIVE COMPENSATION





The
information required by this item is contained in our proxy statement for our
2008 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
2008 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, AND DIRECTOR
INDEPENDENCE





The
information required by this item is contained in our proxy statement for our
2008 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
2008 Annual Meeting of Stockholders under the headings "Audit Committee” and
“Report of the Audit Committee” and is incorporated herein by
reference.





27


PART
IV





ITEM
15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES





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





1. Financial Statements





The following consolidated financial
statements are included in Item 8:





·
            Consolidated
      Balance Sheets at December 31, 2007 and
2006


·
            Consolidated
      Statements of Income for the years ended December 31, 2007, 2006 and
      2005


·
            Consolidated
      Statements of Cash Flows for the years ended December 31, 2007, 2006 and
      2005


·
            Consolidated
      Statements of Stockholders' Equity for the years ended December 31, 2007,
      2006 and 2005





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.


28


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. MorganRonald
      C. MorganChief
      Executive Officer and PresidentBy:
            /s/ Shannon L. GreeneShannon
      L. GreeneChief
      Financial Officer, Chief Accounting Officer and
  Treasurer





Dated:  March
25, 2008





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
      25, 2008Wray
      Thompson/s/
      Ronald C. Morgan
            Chief
      Executive Officer, President, Chief Operating Officer and
      Director
            March
      25, 2008Ronald
      C. Morgan/s/
      Shannon L. Greene
            Chief
      Financial Officer, Chief Accounting Officer, Treasurer and
      Director
            March
      25, 2008Shannon
      L. Greene/s/
      T. Field Lange
            Director
            March
      25, 2008T.
      Field Lange/s/
      Joseph R. Mannes
            Director
            March
      25, 2008Joseph
      R. Mannes/s/
      L. Edward Martin III
            Director
            March
      25, 2008L.
      Edward Martin III/s/
      Robin L. Morgan
            Vice
      President and Assistant Secretary
            March
      25, 2008Robin
      L. Morgan/s/
      Michael A. Nery
            Director
            March
      25, 2008Michael
      A. Nery/s/
      William M. Warren
            Secretary
            March
      25, 2008William
      M. Warren


29





TANDY
      LEATHER FACTORY, INC. AND SUBSIDIARIES
              EXHIBIT
      INDEXExhibit
              Number
            Description3.1
            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 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
            Consultation
      Agreement, dated January 1, 2007, between Tandy Leather Factory, Inc. and
      J. Wray Thompson, filed as Exhibit 10.3 to Tandy Lather Factory’s Annual
      Report on Form 10-K filed with the Securities and Exchange Commission on
      March 27, 2007 and incorporated by reference herein.10.2
            2007
      Director Non-qualified Stock Option Plan of Tandy Leather Factory, Inc.
      dated March 22, 2007, filed as an Exhibit to Tandy Leather Factory, Inc.’s
      Definitive Proxy Statement, filed with the Securities and Exchange
      Commission on April 18, 2007 and incorporated by reference
      herein.10.3
            Agreement
      of Purchase and Sale, dated June 25, 2007, by and between Standard Motor
      Products, Inc. and Tandy Leather Factory, L.P., filed as Exhibit 10.4 to
      Form 8-K filed with the Securities and Exchange Commission on August 6,
      2007 and incorporated by reference herein.10.4
            Credit
      Agreement, dated July 31, 2007, by and between The Leather Factory, L.P.
      and JPMorgan Chase Bank, N.A., filed as Exhibit 10.2 to Tandy Leather
      Factory’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on August 6, 2007 and incorporated by reference
      herein.10.5
            Line
      of Credit Note, dated July 31, 2007, by and between The Leather Factory,
      L.P. and JPMorgan Chase Bank, N.A., filed as Exhibit 10.1 to Tandy Leather
      Factory’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on August 6, 2007 and incorporated by reference
      herein.10.6
            Deed
      Of Trust, Assignment of Leases and Rents, Security Agreement and Financing
      Statement, dated as of July 31, 2007, by and among The Leather Factory,
      L.P., Randall B. Durant and JPMorgan Chase Bank, N.A., filed as Exhibit
      10.3 to Tandy Leather Factory’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on August 6, 2007 and incorporated by
      reference herein.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 25, 2008*31.1
            Certification
      by the Chief Executive Officer and President pursuant to Rule 13a-14(a) or
      15d-14(a) under the Securities Exchange Act of 1934*31.2
            Certification
      by the Chief Financial Officer and Treasurer pursuant to Rule 13a-14(a) or
      15d-14(a) under the Securities Exchange Act of 1934*32.1
            Certification
      Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002______________*Filed
      herewith.





30