TANDY LEATHER FACTORY INC 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This discussion is intended to assist in understanding our financial performance and should be read in conjunction with our financial statements and the notes accompanying those financial statements included elsewhere in this Form 10-K, including the information under the caption “Summary of Critical Accounting Policies.” In addition to historical financial information, the following management’s discussion and analysis may contain forward-looking statements. These statements reflect our expectations or estimates based on the information we have today but are not guarantees or predictions of future performance. They involve known and unknown risks, uncertainties and other factors, many of which are beyond our control, and which may cause actual results to differ materially from the statements contained here. You are cautioned not to put undue reliance on these forward-looking statements. The Company assumes no obligation to update or otherwise revise these forward-looking statements, except as required by law. More discussion of risks can be found under Item 1A, Risk Factors . Summary The Business and Strategy Tandy Leather Factory, Inc. is one of the world’s largest specialty retailers of leather and leathercraft-related items. Founded in 1919 in Fort Worth, Texas, the Company introduced leathercrafting to millions of American and later Canadian and other international customers and has built a track record as the trusted source of quality leather, tools, hardware, supplies, kits and teaching materials for leatherworkers everywhere. Today, our mission remains to build on our legacy of inspiring the timeless art and trade of leatherworking. What differentiates Tandy from the competition is our high brand awareness and strong brand equity and loyalty, our network of retail stores that provides convenience, a high-touch customer service experience and a hub for the local leathercrafting community, and our 100-year heritage. We believe that this combination of qualities is unique to Tandy and gives the brand competitive advantages that are difficult for others to replicate. We sell our products primarily through company-owned stores and through orders generated from our four websites: tandyleather.com, tandyleather.ca, tandyleather.eu and tandyleather.com.au. We also manufacture leather lace, cut leather pieces and most of the do-it-yourself kits that are sold in our stores and on our websites. We also offer production services to our business customers such as cutting (“clicking”), splitting, and some assembly. We maintain our principal offices at 1900 Southeast Loop 820, Fort Worth, Texas 76140. The Company currently operates a total of 106 retail stores as of August 2021. There are 95 stores in the U.S., ten stores in Canada and one store in Spain. During the second quarter of 2020, we consolidated U.S. e-commerce web order fulfilment from the stores to our Fort Worth distribution center. We launched a new Commercial Program in April 2019 to better serve larger business customers, a majority of these customers and their sales were also recognized in retail stores through most of 2019. For 2019, the Company operated as a single reportable segment and all reporting herein is presented on a consolidated basis. New management joined the Company in October 2018 and set new strategic directions for both the short and long term. The overarching goal is to invest in rebuilding a foundation for growth by: 1) improving our brand proposition, 2) reversing the sales decline with business customers, 3) building our talent, processes, tools and systems and 4) positioning us for long-term growth. Despite the major disruption of the business by COVID-19, progress was made against these goals in 2020. 22 Table of Contents COVID-19 In late 2019, COVID-19 was detected in Wuhan, China and has since spread to other parts of the world, including the U.S. On March 11, 2020, the World Health Organization declared COVID-19 a global pandemic. Federal, state, and local governments implemented various restrictions, including travel restrictions, border closings, restrictions on public gatherings, quarantining of people who may have been exposed to the virus, shelter-in-place restrictions and limitations on business operations. As previously announced and for the health and safety of employees and customers, o n March 17, 2020, the Company made the decision to begin temporary store closures. The onset of the COVID-19 pandemic in March 2020 temporarily shifted our strategic focus to company survival and cash preservation. We began closing stores on March 18, 2020, and by April 2, 2020, we temporarily closed all stores to the public. While we pivoted to serve customers only online, the Company experienced significant decreases in demand for its products in the second and third quarters of 2020, negatively impacting net sales. In response, w e took immediate action to mitigate the impact of temporary store closures on our cash flows by: (i) furloughing 406 Tandy employees, comprising two-thirds of the Tandy work force, (ii) temporarily cutting corporate salaries, with deeper cuts for the Executive Leadership Team, (iii) negotiating abatements, deferrals and other favorable lease terms with landlords, and (iv) negotiating longer payment terms with our key product vendors. Due to our size, we were not eligible for the Paycheck Protection Program administered through the Small Business Administration. Also, due to our not being current on financial filings with the SEC, we were not able to obtain loans under the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act. During the second quarter of 2020, the Company borrowed $0.4 million through the Spanish government’s Institute of Official Credit Guarantee for Small and Medium-sized Enterprises, a COVID-19 relief program. The term of the agreement is for five years and the interest rate is fixed at 1.5%. Based on the terms of the loan agreement, we make interest-only payments for the first two years and monthly principal and interest payments for the remainder of the term of the agreement. In Canada, we participated in the Canada Emergency Commercial Rent Assistance (“CECRA”) program for rent relief. This program provided for a 75% reduction in the store rent for included stores for the months of April, May and June 2020. We received total rent abatements under the program of $0.05 million. Nine stores were permanently closed during 2020 as leases expired or early terminations were negotiated, including at locations where we believe we can retain a majority of customers through geographically proximate stores and/or our enhanced website platform. After these permanent closures, Tandy operates 106 stores, including ten in Canada and one in Spain. On May 22, 2020, our Fort Worth flagship store reopened to the public, the beginning of a phased approach to reopening our stores with limited hours, new protocols for sanitizing, social distancing, wearing masks and taking daily temperatures of employees. During the third quarter of 2020, all 106 of Tandy’s stores had reopened to the public, and the store re-openings were well received by our employees and customers. D uring the fourth quarter of 2020 and into the present, we continue to manage through the pandemic as we saw increased spikes in COVID-19 infections, and continue to see varying levels of infection rates, and have been forced to close certain stores or move certain stores to “curbside only” operations. We expect that at least some further infections and temporary store shutdowns will continue for the foreseeable future. 23 Table of Contents While we previously fulfilled our web orders out of our retail stores, during the second quarter of 2020, we built a centralized web fulfillment capability in our Fort Worth distribution center and have been and expect to continue to fulfill web orders primarily through Fort Worth going forward. Both our e-commerce business and stores have been performing above last year sales levels, but the future remains uncertain, and more store closures and/or the ongoing unemployment crisis could cause a material negative impact on future sales. As part of the Company’s accounting policy for long-lived asset impairments, we believe the COVID-19 impact on the Company’s results of operations, cash flows and financial position and the ongoing uncertainty the virus has created around future operating results represented a triggering event starting in the first quarter of 2020 which continued throughout the remainder of 2020. Impairment charges recognized during 2020 totaled $1.1 million and primarily related to property and equipment and operating lease assets for certain stores that are projected to underperform to a level where the cash flows they generate will not be sufficient to cover their respective asset carry values. Results of Operations Consolidated Net Sales (in thousands) 2020 2019 Net sales $ 64,084 $ 74,918 % Decrease from prior year (14.5 )% (10.0 )% Consolidated net sales declined by $10.8 million, or 14.5%, from 2019 to 2020. Of this decline, $4.5 million was due to the permanent closure of nine stores in 2020. $14.1 million was due to the temporary closure of all of our stores during the second and third quarters of 2020, which was offset by sales in the web and commercial channels. We saw sales increases in the fourth quarter of 2020 over the prior year of 6.5%, or $1.3 million. The table below reports our global net sales by store category for the year ended December 31, 2020 compared to the year ended December 31, 2019: 2020 2019 2020 vs 2019 (in thousands, except store data) # Stores Sales # Stores Sales $ Change % Change Comparable retail stores 106 $ 42,556 106 $ 59,391 $ (16,835 ) (28.3 )% Web/Commercial 20,784 11,748 9,036 76.9 % 2019 Permanently closed stores - 5 755 (755 ) 2020 Permanently closed stores 9 744 9 3,024 (2,280 ) Total at year-end 106 $ 64,084 115 $ 74,918 $ (10,834 ) We operated 106 stores worldwide as of December 31, 2020 and 115 stores as of December 31, 2019. Since January 1, 2020, we have closed nine stores, including Beaverton, OR in February 2020. During the second quarter of 2020, we converted eight stores from temporary closures to permanent closures based on expiring leases, proximity to other stores, and local web sales penetration: Phoenix, AZ; Austin TX; Dallas, TX; Peoria, IL; Henrico (Richmond), VA; Nyack, NY; Johnston, RI and St Leonard (Montreal), QC. We did not open any new stores during 2019 or 2020. 24 Table of Contents Gross Profit (in thousands) 2020 2019 Sales $ 64,084 $ 74,918 Cost of sales 28,026 32,959 Gross profit $ 36,058 $ 41,959 Gross profit margin percentage 56.3 % 56.0 % Gross margin rate in 2020 was essentially flat to 2019, with increases in product costs, shipping and handling related to supply chain disruptions of COVID-19 offset by improvements in average unit retails, investments in inventory at pre-pandemic pricing, and promotional pricing optimization. Operating Expenses (in thousands) 2020 2019 Operating expenses $ 41,328 $ 43,554 Non-routine items related to restatement (3,587 ) (1,346 ) Non-routine items related to CFO transition (388 ) (206 ) Adjusted operating expenses $ 37,353 $ 42,002 Operating expenses % of sales 64.5 % 58.1 % Adjusted operating expenses % of sales 58.3 % 56.1 % Operating expenses decreased by $2.2 million in 2020 as compared to the corresponding prior year mostly as a result of payroll and occupancy savings associated with store closures, lower bonuses, marketing expense reductions, and cancellation of the annual store manager conference, partially offset by higher costs for restricted stock units, and non-routine expenses related to the restatement and Chief Financial Officer (“CFO”) turnover. Adjusted operating expenses, which excludes the non-routine items related to the restatement and CFO turnover, decreased in 2020 by $4.6 million, compared to prior year, mostly as a result of the items noted above. Adjusted operating expenses excluding non-routine items as shown above is a non-GAAP measure and is included here because we believe it provides additional information regarding the Company’s financial performance on a recurring basis. Non-routine items in 2020 primarily included legal and accounting fees associated with the restatement and recruiting fees, exit costs, interim CFO-related expenses, and expenses for a number of other contract accounting professionals associated with the turnover of our CFO. Impairment Expense We completed an interim impairment assessment as of March 31, 2020, and based on the concluded fair value of the reporting unit, we recorded impairment expense of $1.1 million during the first quarter of 2020. No other impairment was recorded throughout the remainder of 2020, including as a result of our annual impairment assessment. See Note 2, Significant Accounting Policies – Impairment of long-lived assets of the Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data of this Form 10-K for further detail. For the years ended December 31, 2020 and 2019, 26 stores and three stores, respectively, were reviewed for impairment due to overall underperformance. Based on the results of the review, impairment expense of $1.1 million and $1.0 million was recorded for 2020 and 2019, respectively. 25 Table of Contents Other Income/Expense (net) Other income/expense consists primarily of interest expense and interest income. In the years ended December 31, 2020, we recognized other income (net) of $0.1 million. During the year ended December 31, 2019 other (income) expense, net was immaterial. We earned $0.1 million and $0.2 million, respectively, in interest income and paid $0.1 million and $0.04 million, respectively, in interest expense on our bank debt. Provision for Income Taxes Our effective tax rate was 21.9% and 26.6% for the years ended December 31, 2020, and 2019, respectively. For 2020 and 2019, the difference between our statutory rates and our effective rate are primarily due to state income taxes, the difference in tax rates for loss carryback periods, items that are nondeductible for income tax purposes, and the change in valuation allowance against U.S. deferred tax assets and certain foreign net operating losses. Going forward, we expect that our effective tax rate for 2021 will be 25-27%. Capital Resources, Liquidity and Financial Condition We require cash principally for day-to-day operations, to purchase inventory and to finance capital investments. We expect to fund our operating and liquidity needs primarily from a combination of current cash balances, cash generated from operating activities and a future working capital bank line of credit that we are negotiating. Any excess cash will be invested as determined by our Board of Directors in accordance with its approved investment policy. Our cash balance as of December 31, 2020, totaled $10.3 million, and as of June 30, 2021, our cash balance totaled $5.9 million. Spain Loan During the second quarter of 2020, the Company borrowed $0.4 million from Banco Santander S.A. under the Institute of Official Credit Guarantee for Small and Medium-sized Enterprises in order to facilitate the continuation of employment and to attenuate the economic effects of the COVID-19 virus. This loan was provided for by the Spanish government as part of a COVID-19 relief program. The term of the agreement is five years, and the interest rate is fixed at 1.5%. Based on the terms of the loan agreement, we are required to make monthly interest-only payments for the first two years and monthly principal and interest payments for the remainder of the term of the agreement. Share Repurchase Program In August 2015, our Board of Directors authorized a share repurchase program, pursuant to which we were authorized to repurchase up to 1.2 million shares of our common stock at prevailing market rates through August 2016. Subsequently, the program was amended to increase the number of shares available for repurchase to 2.2 million and to extend the program through August 2019. In June 2019, the program was again amended to decrease the number of shares available for repurchase to one million as of such date and to extend the program through August 9, 2020. For the years ended December 31, 2020, and 2019, we repurchased the following shares: Year ended December 31, Total shares repurhased Average price per share 2020 - $ - 2019 131,782 $ 5.58 26 Table of Contents As of December 31, 2020, we were authorized to purchase $5 million of our common stock under the plan. On August 9, 2020, the Board of Directors approved a new program to repurchase up to $5 million of its common stock between August 9, 2020 and July 31, 2022, subject to the completion of our financial restatement and the filing of all delinquent filings with the SEC. The Company’s previous share repurchase program expired in August 2020. On January 28, 2021, we entered into an agreement with an institutional shareholder of the Company, to repurchase 500,000 shares of our common stock, par value $0.0024 in a private transaction. The purchase price was $3.35 per share for a total of $1.7 million. The closing of the repurchase of these shares took place on February 1, 2021. Prior to the repurchase, the shares represented approximately 5.5% of our outstanding common stock. Cash Flows (amounts in thousands) 2020 2019 Net cash provided by (used in) operating activities $ (12,527 ) $ 10,471 Net cash provided by (used in) investing activities 6,256 (9,156 ) Net cash provided by (used in) financing activities 416 (9,703 ) Effect of exchange rate changes on cash and cash equivalents 279 223 Net decrease in cash and cash equivalents $ (5,576 ) $ (8,165 ) For the year ended 2020, we used $12.6 million of cash from operations driven by our net loss of $4.9 million which was offset by non-cash expenses of $6.7 million, including depreciation and amortization, impairments, and stock-based compensation. Working capital used $14.3 million of cash, primarily from the build-up of inventory. We received $7.5 million from the sale of short-term U.S. Treasuries. We invested $1.3 million in capital expenditures for the purchase of store fixtures and systems implementations. We borrowed $0.4 million as part of a COVID-19 relief program sponsored by the Spanish government. The activities above, in addition to the effect of exchange rate changes, resulted in a net decrease in cash of $5.6 million. For the year ended 2019, we generated $10.5 million of cash from operations driven by our efforts to streamline working capital levels, of which $9.3 million was from the liquidation of inventory. The 2019 net loss of $1.9 million was offset by non-cash expenses of $6.7 million, including depreciation and amortization, impairments, and stock-based compensation. With the cash generated from operations, we invested $18.1 million in short-term U.S. Treasuries and sold short-term U.S. Treasuries at maturity for $9.1 million, and we invested $0.3 million in capital expenditures for the purchase of store fixtures and systems implementations. We used cash in financing activities to extinguish $9.0 million of debt and to repurchase 131,782 shares of treasury stock for $0.7 million at an average price of $5.58 per share. The activities above, in addition to the effect of exchange rate changes, resulted in a net decrease in cash of $8.2 million. We believe that cash flow from operations and our existing cash reserves will be adequate to fund our operations through 2021, taking into account the current effects of the COVID-19 pandemic on our business and cash flow and our current business performance. In addition, we anticipate that this cash flow and our current cash reserves will enable us to meet our contractual obligations and commercial commitments throughout 2021. There can be no assurance, however, that the COVID-19 pandemic would not result in further restrictions on our business operations in a manner that would more materially impact our cash flow. 27 Table of Contents Off-Balance Sheet Arrangements We did not have any off-balance sheet arrangements during 2020 or 2019, and we do not currently have any such arrangements. Summary of Critical Accounting Policies The preparation of the Company’s Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States requires the use of estimates that affect the reported value of assets, liabilities, revenues and expenses. These estimates are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for the Company’s conclusions. The Company continually evaluates the information used to make these estimates as the business and the economic environment changes. Actual results may differ from these estimates, and estimates are subject to change due to modifications in the underlying conditions or assumptions. The policies discussed below require estimates that contain a significant degree of judgement. The use of estimates is pervasive throughout the Consolidated Financial Statements, but the accounting policies and estimates considered most critical are as follows. Revenue Recognition. Our revenue is earned from sales of merchandise and generally occurs via two methods: (1) at the store counter and (2) shipment of product generally via web sales. We recognize revenue when we satisfy the performance obligation of transferring control of product merchandise over to a customer. At the store counter, our performance obligation is met and revenue is recognized when a sales transaction occurs with a customer. When merchandise is shipped to a customer, our performance obligation is met and revenue is recognized when control passes to the customer. Shipping terms are normally free on board (“FOB”) shipping point and control passes when the merchandise is shipped to the customer. Sales tax and comparable foreign tax is excluded from net sales, while shipping charged to our customers is included in net sales. Net sales are based on the amount of consideration that we expect to receive, reduced by estimates for future merchandise returns. Our sales return allowance for future merchandise returns is estimated based on historical sales return rates. Under our sales returns policy, merchandise may be returned, under most circumstances, up to 60 days after date of purchase. As merchandise is returned, the company records the sales return against the sales return allowance. We record a gift card liability for the unfulfilled performance obligation on the date we issue a gift card to a customer. We record revenue and reduce the gift card liability as the customer redeems the gift card. In addition, for gift card breakage, we recognize a proportionate amount for the expected unredeemed gift cards over the expected customer redemption period, which is one year. Inventory. Inventory is stated at the lower of cost (first-in, first-out) or net realizable value. Finished goods held for sale includes the cost of merchandise purchases, the costs to bring the merchandise to our Texas distribution center, warehousing and handling expenditures, and distributing and delivering merchandise to our stores. These costs include depreciation of long-lived assets utilized in acquiring, warehousing and distributing inventory. Manufacturing inventory including raw materials and work-in-process is valued on a first‑in, first out basis using full absorption accounting which includes material, labor, and other applicable manufacturing overhead. Carrying values of inventory are analyzed and, to the extent that the cost of inventory exceeds the net realizable value, provisions are made to reduce the carrying amount of the inventory. We regularly review all inventory items to determine if there are (i) damaged goods (e.g., for leather, excessive scars or damage from ultra-violet (“UV”) light), (ii) items that need to be removed from our product line (e.g., slow-moving items, inability of a supplier to provide items of acceptable quality or quantity, and to maintain freshness in the product line) and (iii) pricing actions that need to be taken to adequately value our inventory at the lower of cost or net realizable value. Since the determination of net realizable value of inventory involves both estimation and judgement with regard to market values and reasonable costs to sell, differences in these estimates could result in ultimate valuations that differ from the recorded asset. The majority of inventory purchases and commitments are made in U.S. dollars in order to limit the Company’s exposure to foreign currency fluctuations. Goods shipped to us are recorded as inventory owned by us when the risk of loss shifts to us from the supplier. Inventory is physically counted twice annually in the Texas distribution center. At the store level, inventory is physically counted each quarter. Inventory is then adjusted in our accounting system to reflect actual count results. 28 Table of Contents Leases. We lease certain real estate for our retail store locations under long-term lease agreements. Starting in 2019, with the adoption of Accounting Standards Update (“ASU”) 2016-02, Leases (Topic 842), once we have determined an arrangement is a lease, at inception we recognize a lease asset and lease liability at commencement date based on the present value of the lease payments over the lease term. For our operating leases, the present value of our lease payments may include: (1) rental payments adjusted for inflation or market rates, and (2) lease terms with options to renew the lease when it is reasonably certain we will exercise such an option. The exercise of lease renewal options is generally at our discretion. Payments based on a change in an index or market rate are not considered in the determination of lease payments for purposes of measuring the related lease liability. We discount lease payments using our incremental borrowing rate based on information available as of the measurement date. Rent expense is recorded in operating expenses. The net excess of rent expense over the actual cash paid has been recorded as accrued expenses and other liabilities in the accompanying consolidated balance sheets. For finance leases, our right-of-use assets are amortized on a straight-line basis over the earlier of the useful life of the right-of-use asset or the end of the lease term with rent expense recorded to operating expenses. We adjust the lease liability to reflect lease payments made during the period and interest incurred on the lease liability using the effective interest method. The incurred interest expense is recorded in interest expense on the consolidated statements of comprehensive income (loss). As of December 31, 2020, we have no sublease agreements and no lease agreements in which we are named as a lessor. Subsequent to the recognition of our operating lease assets and lease liabilities, we recognize lease expense related to our operating leases on a straight-line basis over the lease term. The depreciable life of related leasehold improvements is based on the shorter of the useful life or the lease term. We also perform interim reviews of our operating lease assets for impairment when evidence exists that the carrying value of an asset group, including a lease asset, may not be recoverable. Impairment of Long-Lived Assets . We evaluate long-lived assets on a quarterly basis to identify events or changes in circumstances (“triggering events”) that indicate the carrying value of certain assets may not be recoverable. Upon the occurrence of a triggering event, right-of-use (“ROU”) lease assets, property and equipment and definite-lived intangible assets are reviewed for impairment and an impairment loss is recorded in the period in which it is determined that the carrying amount of the assets is not recoverable. The determination of recoverability is made based upon the estimated undiscounted future net cash flows of assets grouped at the lowest level for which there are identifiable cash flows independent of the cash flows of other groups of assets with such cash flows to be realized over the estimated remaining useful life of the primary asset within the asset group. The Company determined the lowest level of identifiable cash flows that are independent of other asset groups to be primarily at the individual store level. If the estimated undiscounted future net cash flows for a given store are less than the carrying amount of the related store assets, an impairment loss is determined by comparing the estimated fair value with the carrying value of the related assets. The impairment loss is then allocated across the asset group’s major classifications which in this case are operating lease assets and property and equipment. Triggering events at the store level could include material declines in operational and financial performance or planned changes in the use of assets, such as store relocation or store closure. This evaluation requires management to make judgements relating to future cash flows, growth rates and economic and market conditions. The fair value of an asset group is estimated using a discounted cash flow valuation method. 29 Table of Contents Stock-based Compensation . The Company’s stock-based compensation relates primarily to restricted stock unit (“RSU”) awards. Accounting guidance requires measurement and recognition of compensation expense at an amount equal to the grant date fair value. Compensation expense is recognized for service-based stock awards on a straight-line basis or ratably over the requisite service period, based on the closing price of the Company’s stock on the date of grant. The service-based awards typically vest ratably over the requisite service period, provided that the participant is employed on the vesting date. The total compensation expense is reduced by actual forfeitures as they occur over the requisite service period of the awards. Performance-based RSUs vest, if at all, upon the Company satisfying certain performance targets. The Company records compensation expense for awards with a performance condition when it is probable that the condition will be achieved. If the Company determines it is not probable a performance condition will be achieved, no compensation expense is recognized. If the Company changes its assessment in a subsequent period and concludes it is probable a performance condition will be achieved, the Company will recognize compensation expense ratably between the period of the change in assessment through the expected date of satisfying the performance condition for vesting. If the Company subsequently assesses that it is no longer probable that a performance condition will be achieved, the accumulated expense that has been previously recognized will be reversed. The compensation expense ultimately recognized, if any, related to performance-based awards will equal the grant date fair value based on the number of shares for which the performance condition has been satisfied. We issue shares from authorized shares upon the lapsing of vesting restrictions on RSUs. We do not use cash to settle equity instruments issued under stock-based compensation awards. Income Taxes. Income taxes are estimated for each jurisdiction in which we operate. This involves assessing current tax exposure together with temporary differences resulting from differing treatment of items for tax and financial statement accounting purposes. Any resulting deferred tax assets are evaluated for recoverability based on estimated future taxable income. To the extent recovery is deemed not likely, a valuation allowance is recorded. Our evaluation regarding whether a valuation allowance is required or should be adjusted also considers, among other things, the nature, frequency, and severity of recent losses, forecasts of future profitability and the duration of statutory carryforward periods. Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that includes the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. A tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. We recognize tax liabilities for uncertain tax positions and adjust these liabilities when our judgement changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense and the effective tax rate in the period in which new information becomes available. We may be subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to the various jurisdictions. 30 Table of Contents ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders Tandy Leather Factory, Inc. Opinions on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Tandy Leather Factory, Inc. and Subsidiaries (the Company) as of December 31, 2020 and 2019, and the related consolidated statements of operations and comprehensive loss, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the two years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America. Basis for Opinion These consolidated financial statements are the responsibility of the entity’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. Critical Audit Matters The critical audit matter communicated below is a matter arising from the current period audit of the consolidated financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates. 31 Table of Contents Valuation of Inventory The Company’s accounting policy for the recognition of inventory and cost of sales is described in Note 1 to the consolidated financial statements. The Company has recorded an inventory balance of approximately $36.7 million and cost of sales of approximately $28.0 million as of and for the year ended December 31, 2020. Additionally, Note 3 to the consolidated financial statements provides further detail of the components of the year-end inventory balance. The Company’s merchandise inventories are stated at the lower of cost or net realizable value using a first-in first-out costing principle. Finished goods inventory costs include the cost of merchandise purchases, the costs to bring the merchandise to the Company’s distribution center, warehousing and handling expenditures, and distributing and delivering merchandise to the Company’s stores. Manufacturing inventory, raw materials and work-in-process are also valued on a first‑in, first-out basis using full absorption accounting which includes material, labor, and other applicable manufacturing overhead. The determination of amounts that are required to be capitalized to inventory resulting from manufacturing labor and overhead costs, warehouse and handling expenditures and transportation costs (together “overhead costs”) are subjective and are generally based on an allocation ratio calculated by the Company that is based on average inventory turns. Additionally, to determine if the value of their inventory should be written down, the Company considers many factors, including condition of the product (excessive scars, discoloring or damage from UV light), current and anticipated demand that may cause the product to become slow moving and age of the merchandise to ensure that the product line is considered fresh. If a write-down is warranted, the carrying value of the merchandise is reduced from its original cost to the lower of its cost or net realizable value. Management estimates the value of inventory by estimating the capitalizable overhead costs and adjusts the inventory to lower of cost or net realizable value. Our audit procedures to evaluate these items involved a higher degree of auditor judgment and the involvement of more senior members of the engagement team in executing, supervising, and reviewing the results of the procedures. How the Critical Audit Matter Was Addressed in the Audit Our audit procedures related to the valuation of inventories included the following, among others: • We obtained an understanding of the controls over the valuation of inventory. • We tested the mathematical accuracy of the Company’s capitalizable overhead cost schedules. • We evaluated the appropriateness and consistency of management’s methodology and assumptions used in calculating the capitalizable overhead costs. • We independently calculated the amount of capitalizable costs using an independently derived allocation ratio. • We tested the mathematical accuracy of the Company’s inventory obsolescence reserve calculation. • We evaluated the appropriateness and consistency of management’s methodology and assumptions used in developing its estimate of the inventory obsolescence reserve. • We performed analytical procedures on the current year reserve rates (by product category) by comparing them to prior year rates and then obtaining corroborating evidence for any significant fluctuations. • We tested on a sample basis, sales subsequent to yearend of the written-down items to ensure that the net realizable value was not lower than the previously written down value. /s/ WEAVER AND TIDWELL, L.L.P. We have served as the Company’s auditor since 2003. Oklahoma City, Oklahoma September 2, 2021 32 Table of Contents Tandy Leather Factory, Inc. Consolidated Balance Sheets (amounts in thousands, except share data and per share data ) December 31, 2020 December 31, 2019 ASSETS CURRENT ASSETS: Cash and cash equivalents $ 10,329 $ 15,905 Short-term investments - 9,152 Accounts receivable-trade, net of allowance for doubtful accounts of $14 and $16 at December 31, 2020 and 2019, respectively 350 409 Inventory 36,779 24,042 Income tax receivable 2,753 1,629 Prepaid expenses 536 1,082 Other current assets 265 297 Total current assets 51,012 52,516 Property and equipment, at cost 27,468 27,471 Less accumulated depreciation (15,078 ) (14,552 ) Property and equipment, net 12,390 12,919 Operating lease assets 11,772 13,897 Financing lease assets 44 - Deferred income taxes 82 427 Other intangibles, net of accumulated amortization of $548 and $547 at December 31, 2020 and 2019, respectively 6 7 Other assets 387 345 TOTAL ASSETS $ 75,693 $ 80,111 LIABILITIES AND STOCKHOLDERS’ EQUITY CURRENT LIABILITIES: Accounts payable-trade $ 5,737 $ 5,753 Accrued expenses and other liabilities 3,642 2,656 Operating lease liabilities 3,530 3,823 Current maturities of financing lease obligations 14 - Total current liabilities 12,923 12,232 Uncertain tax positions 393 296 Other non-current liabilities 463 509 Operating lease liabilities, non-current 9,245 10,655 Financing lease liabilities, net of current obligation 29 - Long-term debt, net of current maturities 446 - COMMITMENTS AND CONTINGENCIES (Note 8) STOCKHOLDERS’ EQUITY: Preferred stock, $0.10 par value; 20,000,000 shares authorized; none issued or outstanding; attributes to be determined on issuance - - Common stock, $0.0024 par value; 25,000,000 shares authorized; 10,575,182 and 10,446,563 shares issued at December 31, 2020 and 2019, respectively 25 25 Paid-in capital 5,924 5,037 Retained earnings 57,310 62,211 Treasury stock at cost (1,424,376 shares at both December 31, 2020 and 2019, respectively) (9,773 ) (9,773 ) Accumulated other comprehensive loss (net of tax of $ 395 and $359 at December 31, 2020 and 2019, respectively) (1,292 ) (1,081 ) Total stockholders’ equity 52,194 56,419 TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY $ 75,693 $ 80,111 The accompanying notes are an integral part of these Consolidated financial statements. 33 Table of Contents Tandy Leather Factory, Inc. Consolidated Statements of Operations and Comprehensive Loss (amounts in thousands, except share and per share data) For the Years Ended December 31, 2020 2019 Net sales $ 64,084 $ 74,918 Cost of sales 28,026 32,959 Gross profit 36,058 41,959 Operating expenses 41,328 43,554 Impairment expense 1,078 1,002 Loss from operations (6,348 ) (2,597 ) Other (income) expense: Interest expense 7 36 Other, net (76 ) (40 ) Loss before income taxes (6,279 ) (2,593 ) Benefit for income taxes (1,378 ) (690 ) Net loss $ (4,901 ) $ (1,903 ) Foreign currency translation adjustments, net of tax (211 ) 363 Comprehensive loss $ (5,112 ) $ (1,540 ) Net loss per common share: Basic $ (0.54 ) $ (0.21 ) Diluted $ (0.54 ) $ (0.21 ) Weighted average number of shares outstanding: Basic 9,062,598 8,973,246 Diluted 9,062,598 8,973,246 The accompanying notes are an integral part of these Consolidated financial statements. 34 Table of Contents Tandy Leather Factory, Inc. Consolidated Statements of Cash Flows (amounts in thousands) For the Years Ended December 31, 2020 2019 Cash flows from operating activities: Net loss $ (4,901 ) $ (1,903 ) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation and amortization 1,021 1,655 Operating lease asset amortization 3,193 3,482 Impairment of goodwill and long-lived assets 1,078 1,002 Loss on disposal of assets 59 9 Stock-based compensation 887 770 Deferred income taxes 442 (334 ) Exchange (gain) loss (5 ) 137 Changes in operating assets and liabilities: Accounts receivable-trade 86 (23 ) Inventory (12,686 ) 9,330 Prepaid expenses 675 596 Other current assets 1,574 (96 ) Accounts payable-trade (440 ) 3,500 Accrued expenses and other liabilities 1,022 (2,719 ) Income taxes, net (1,120 ) (1,220 ) Other assets (41 ) (327 ) Operating lease liabilities (3,371 ) (3,388 ) Total adjustments (7,626 ) 12,374 Net cash provided by (used in) operating activities (12,527 ) 10,471 Cash flows from investing activities: Purchase of property and equipment (1,313 ) (269 ) Purchase of short-term investments - (18,095 ) Proceeds from sales of short-term investments 7,523 9,095 Proceeds from sales of assets 46 113 Net cash provided by (used in) investing activities 6,256 (9,156 ) Cash flows from financing activities: Proceeds from long-term debt 416 - Payments on long-term debt - (8,968 ) Repurchase of treasury stock - (735 ) Net cash provided by (used in) financing activities 416 (9,703 ) Effect of exchange rate changes on cash and cash equivalents 279 223 Net decrease in cash and cash equivalents (5,576 ) (8,165 ) Cash and cash equivalents, beginning of period 15,905 24,070 Cash and cash equivalents, end of period $ 10,329 $ 15,905 The accompanying notes are an integral part of these Consolidated Financial Statements. 35 Table of Contents Tandy Leather Factory, Inc. Consolidated Statements of Cash Flows - continued (amounts in thousands) For the Years Ended December 31, 2020 2019 Supplemental disclosures of cash flow information: Interest paid during the period $ 17 $ 36 Income tax paid during the period, net of refunds $ 56 $ 715 Supplemental disclosures of non-cash activity: Change in accruals related to property and equipment $ (105 ) $ (362 ) The accompanying notes are an integral part of these Consolidated financial statements. 36 Table of Contents Tandy Leather Factory, Inc. Consolidated Statements of Stockholders’ Equity (amounts in thousands, except share data) Number of Shares Common Stock Outstanding Par Value Paid-in Capital Treasury Stock Retained Earnings Accumulated Other Comprehensive Income (Loss) Total Balance, December 31, 2018 9,060,561 $ 25 $ 4,267 $ (9,038 ) $ 64,476 $ (1,444 ) 58,286 Cumulative effect of accounting change, net of tax (ASC 842) - - - - (362 ) - (362 ) Stock-based compensation expense - - 770 - - - 770 Issuance of restricted stock 93,408 - - - - - - Purchase of treasury stock (131,782 ) - - (735 ) - - (735 ) Net loss - - - - (1,903 ) - (1,903 ) Foreign currency translation adjustments, net of tax - - - - - 363 363 Balance, December 31, 2019 9,022,187 $ 25 $ 5,037 $ (9,773 ) $ 62,211 $ (1,081 ) $ 56,419 Stock-based compensation expense - - 887 - - - 887 Issuance of restricted stock 128,619 - - - - - - Net loss - - - - (4,901 ) - (4,901 ) Foreign currency translation adjustments, net of tax - - - - - (211 ) (211 ) Balance, December 31, 2020 9,150,806 $ 25 $ 5,924 $ (9,773 ) $ 57,310 $ (1,292 ) $ 52,194 The accompanying notes are an integral part of these Consolidated financial statements. 37 Table of Contents TANDY LEATHER FACTORY, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 2020 and 2019 1. DESCRIPTION OF BUSINESS Tandy Leather Factory, Inc. (“TLFA,” “we,” “our,” “us,” the” Company,” “Tandy,” or “Tandy Leather” mean Tandy Leather Factory, Inc., together with its subsidiaries.) is one of the world’s largest specialty retailers of leather and leathercraft-related items. Founded in 1919 in Fort Worth, Texas, the Company introduced leathercrafting to millions of American and later Canadian and other international customers and has built a track record as the trusted source of quality leather, tools, hardware, supplies, kits and teaching materials for leatherworkers everywhere. Today, our mission remains to build on our legacy of inspiring the timeless art and trade of leatherworking. What differentiates Tandy from the competition is our high brand awareness and strong brand equity and loyalty, our network of retail stores that provides convenience, a high-touch customer service experience, a hub for the local leathercrafting community and our 100-year heritage. We believe that this combination of qualities is unique to Tandy and gives the brand competitive advantages that are very difficult for others to replicate. We sell our products primarily through company-owned stores and through orders generated from our four websites: tandyleather.com, tandyleather.ca, tandyleather.eu and tandyleather.com.au. We also manufacture leather lace, cut leather pieces and most of the do-it-yourself kits that are sold in our stores and on our websites. We also offer production services to our business customers such as cutting (“clicking”), splitting, and some assembly. We maintain our principal offices at 1900 Southeast Loop 820, Fort Worth, Texas 76140. The Company currently operates a total of 106 retail stores. There are 95 stores in the United States (“U.S.”), ten stores in Canada and one store in Spain. The Nasdaq Global Market (“Nasdaq”) suspended trading in the Company’s stock on Nasdaq as of August 13, 2020. Our stock has since traded on the OTC Link (previously “Pink Sheets”) operated by OTC Markets Group under the symbol “TLFA.” Nasdaq denied the Company’s appeal of its decision to suspend trading in the Company’s stock and the Company’s stock was formally delisted on February 9, 2021. We intend to reapply for Nasdaq listing after we have made our required Exchange Act filings. Any such listing would be subject to Nasdaq approval. Certain reclassifications may have been made to prior period financials in order to conform to the current period presentation. COVID-19 In late 2019, COVID-19 was detected in Wuhan, China and has since spread to other parts of the world, including the U.S. On March 11, 2020, the World Health Organization declared COVID-19 a global pandemic. Federal, state, and local governments have since implemented various restrictions, including travel restrictions, border closings, restrictions on public gatherings, quarantining of people who may have been exposed to the virus, shelter-in-place restrictions and limitations on business operations. As previously announced and for the health and safety of employees and customers, o n March 17, 2020, the Company made the decision to begin temporary store closures. The onset of the COVID-19 pandemic in March 2020 shifted our strategic focus to company survival and cash preservation. We began closing stores on March 18, 2020 and by April 2, 2020, we temporarily closed all stores to the public. While we pivoted to serve customers online, the Company experienced significant decreases in demand for its products in the second and third quarters of 2020, negatively impacting net sales. 38 Table of Contents In response, w e took immediate action to mitigate the impact of temporary store closures on our cash flows by: (i) furloughing 406 Tandy employees, comprising two-thirds of the Tandy work force, (ii) temporarily cutting corporate salaries, with deeper cuts for the Executive Leadership Team, (iii) negotiating abatements, deferrals and other favorable lease terms with landlords, and (iv) negotiating longer payment terms with our key product vendors. By June 2020, we also permanently closed nine stores with expiring leases and/or negative cash flows, creating additional savings in operating expenses. Due to our size, we were not eligible for the Paycheck Protection Program administered through the Small Business Administration. Also, due to our not being current on financial filings with the SEC, we were not able to obtain loans under the Coronavirus Aid, Relief, and Economic Security Act, also known as the CARES Act. During the second quarter of 2020, the Company borrowed $0.4 million through the Spanish government’s Institute of Official Credit Guarantee for Small and Medium-sized Enterprises, a COVID-19 relief program. The term of the agreement is for five years and the interest rate is fixed at 1.5%. Based on the terms of the loan agreement, we make interest-only payments for the first two years and monthly principal and interest payments for the remainder of the term of the agreement. In Canada, we participated in the Canada Emergency Commercial Rent Assistance (“CECRA”) program for rent relief. This program provided for a 75% reduction in the store rent for included stores for the months of April, May and June 2020. We received total rent abatements under the program of $0.05 million. Nine stores were permanently closed during 2020 as leases expired or early terminations were negotiated, including at locations where we believe we can retain a majority of customers through geographically proximate stores and/or our enhanced website platform. After these permanent closures, Tandy operates 106 stores, including ten in Canada and one in Spain. On May 22, 2020, our Fort Worth flagship store reopened to the public, the beginning of a phased approach to reopening our stores with limited hours, new protocols for sanitizing, social distancing, wearing masks and taking daily temperatures of employees. During the third quarter of 2020, all 106 of Tandy’s stores had reopened to the public and the store re-openings were well received by our employees and customers. D uring the fourth quarter of 2020 and into the present, we continue to manage through the pandemic as we saw increased spikes in COVID-19 infections, and continue to see varying levels of infection rates, and are forced to close certain stores or move certain stores to “curbside only” operations. With the rapid spread of the Delta variant of COVID-19 during the third quarter of 2021, we have experienced an increasing number of these shutdowns. We believe that the rollout of COVID-19 vaccines in 2021 has offset these closures somewhat, but it is difficult to predict whether these vaccines will be adopted by further large numbers of Americans or whether current or future vaccines will remain effective against Delta or other future variants of the virus. We expect that at least some further infections and temporary store shutdowns will continue for the foreseeable future. While we previously fulfilled our web orders out of our retail stores, we have built a centralized web fulfillment capability in our Fort Worth distribution center and will be fulfilling web orders primarily through Fort Worth going forward. Both our e-commerce business and stores, during the limited period since reopening, have been performing above last year sales levels, but the future remains uncertain, and more store closures and/or other ongoing effects of the pandemic on the economy or employment market could cause a material negative impact on future sales. As part of the Company’s accounting policy for long-lived asset impairments, we believe the COVID-19 impact on the Company’s results of operations, cash flows and financial position and the ongoing uncertainty the virus has created around future operating results represented a triggering event during the first quarter of 2020 and continued throughout 2020. For fiscal year 2020, the Company recorded impairment expense of $1.1 million, primarily related to property and equipment and operating lease assets for certain stores that underperformed to a level where the cash flows they generate will not be sufficient to cover their respective asset carry values. 39 Table of Contents 2. SIGNIFICANT ACCOUNTING POLICIES Management estimates and reporting The preparation of the Company’s Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States (“GAAP”) requires the use of estimates that affect the reported value of assets, liabilities, revenues and expenses. These estimates are based on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for the Company’s conclusions. The Company continually evaluates the information used to make these estimates as the business and the economic environment changes. Actual results may differ from these estimates, and estimates are subject to change due to modifications in the underlying conditions or assumptions. The policies discussed below require estimates that contain a significant degree of judgement. The use of estimates is pervasive throughout the Consolidated Financial Statements, but the accounting policies and estimates considered most significant are as follows. Principles of consolidation Our Consolidated Financial Statements include the accounts of Tandy Leather Factory, Inc. and its active wholly-owned subsidiaries, The Leather Factory, L.P. (a Texas limited partnership), Tandy Leather Company, L.P. (a Texas limited partnership), The Leather Factory of Canada, Ltd. (a Canadian corporation), Tandy Leather Factory UK Limited (a UK corporation), Tandy Leather Factory Australia Pty. Limited (an Australian corporation), and Tandy Leather Factory España, S.L. (a Spanish corporation). All intercompany accounts and transactions have been eliminated in consolidation. Cash and cash equivalents The Company considers investments with a maturity when purchased of three months or less to be cash equivalents. All credit card, debit card and electronic transfer transactions that process in less than seven days are classified as cash and cash equivalents. Accounts Receivable and Expected Credit Losses Our receivables primarily arise from the sale of merchandise to customers that have applied for and been granted credit. Accounts receivable are stated at amounts due, net of an allowance for doubtful accounts. Accounts receivable are generally due within 30 days of invoicing. We estimate expected credit losses 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. Management believes that the historical loss information it has compiled is a reasonable base on which to determine expected credit losses for trade receivables held at December 31, 2020, because the composition of the trade receivables at that date is consistent with that used in developing the historical credit-loss percentages (i.e., the similar risk characteristics of its customers and its credit practices have not changed significantly over time). Accordingly, the allowance for expected credit losses at December 31, 2020 totaled less than $0.1 million. Foreign currency translation and transactions Foreign currency translation adjustments arise from activities of our foreign subsidiaries. Results of operations are translated into U.S. dollars using the average exchange rates during the period, while assets and liabilities are translated using period-end exchange rates. Foreign currency translation adjustments of assets and liabilities are recorded in stockholders’ equity, net of tax charge of $0.1 million and $0.1 million in the years ended December 31, 2020 and 2019, respectively. Gains and losses resulting from foreign currency transactions are reported in the statements of income (loss) under the caption “Other, net,” for all periods presented. We did not recognize a foreign currency transaction gain or loss in the years ended December 31, 2020. We recognized a foreign currency transaction loss of less than $0.1 million in the years ended December 31, 2019. 40 Table of Contents Revenue recognition Our revenue is earned from sales of merchandise and generally occurs via three methods: (1) at the store counter, (2) shipment of product generally via web sales, and (3) sales of product directly to commercial customers. We recognize revenue when we satisfy the performance obligation of transferring control of product merchandise over to a customer. At the store counter, our performance obligation is met and revenue is recognized when a sales transaction occurs with a customer. When merchandise is shipped to a customer, our performance obligation is met and revenue is recognized when control passes to the customer. Shipping terms are normally free on board (“FOB”) shipping point and control passes when the merchandise is shipped to the customer. Sales tax and comparable foreign tax is excluded from net sales, while shipping charged to our customers is included in net sales. Net sales is based on the amount of consideration that we expect to receive, reduced by estimates for future merchandise returns. The sales return allowance is based each year on historical customer return behavior and other known factors and reduces net sales and cost of sales, accordingly. The sales return allowance included in accrued expense and other liabilities was $0.2 million and $0.3 million as of December 31, 2020 and 2019, respectively. The estimated value of merchandise expected to be returned included in other current assets was $0.1 million and $0.1 million as of December 31, 2020 and 2019, respectively. We record a gift card liability for the unfulfilled performance obligation on the date we issue a gift card to a customer. We record revenue and reduce the gift card liability as the customer redeems the gift card. In addition, for gift card breakage, we recognize a proportionate amount for the expected unredeemed gift cards over the expected customer redemption period, which is one year. As of December 31, 2020 and 2019, our gift card liability, included in accrued expenses and other liabilities, was $0.3 million and $0.3 million, respectively. We recognized gift card revenue of $0.2 million during 2020 from the December 31, 2019 deferred revenue balance and $0.1 million during 2019 from the December 31, 2018 deferred revenue balance. During 2019, we ended our wholesale pricing club program where customers received lower prices in exchange for a yearly membership fee. Under this program, the yearly membership fee when paid was recorded as deferred revenue and was recognized in net sales throughout the one-year period. For the years ended December 31, 2020 and 2019, we recognized $0.6 million and $1.1 million, respectively, in net sales associated with gift cards and the wholesale pricing club membership fees. Disaggregated revenue In the following table, revenue for the years ended December 31, 2020 and 2019 is disaggregated by geographic areas as follows: (in thousands) 2020 2019 United States $ 56,877 $ 65,745 Canada 5,798 6,514 All other countries 1,409 2,659 Net sales $ 64,084 $ 74,918 Geographic sales information is based on the location of the customer. Excluding Canada, no single foreign country had net sales greater than 2.2% of our consolidated net sales in 2020 or 2019. 41 Table of Contents Discounts Prior to 2019, we maintained five price levels: retail, wholesale gold, wholesale elite, business, and manufacturer. Since May of 2019 (April of 2019 in Canada), we offer a single retail price level, plus three volume-based levels for commercial customers. Discounts from those price levels are offered to Business, Military/First Responder and Employee customers. Such discounts do not convey a material right to these customers since the discounted pricing they receive at the point of sale is not dependent upon any previous or subsequent purchases. As a result, sales are reported after deduction of discounts at the point of sale. We do not pay slotting fees or make other payments to resellers. Operating expense Operating expenses include all selling, general and administrative costs, including wages and benefits, rent and occupancy costs, depreciation, advertising, store operating expenses, outbound freight charges (to ship merchandise to customers), and corporate office costs. Property and equipment, net of accumulated depreciation 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 three to ten years for equipment and machinery, seven to fifteen years for furniture and fixtures, five years for vehicles, and forty years for buildings and related improvements. Leasehold improvements are amortized over the lesser of the life of the lease or the useful life of the asset. Repairs and maintenance costs are expensed as incurred. Inventory Inventory is stated at the lower of cost (first-in, first-out) or net realizable value. Finished goods held for sale includes the cost of merchandise purchases, the costs to bring the merchandise to our Texas distribution center, warehousing and handling expenditures, and distributing and delivering merchandise to our stores. These costs include depreciation of long-lived assets utilized in acquiring, warehousing and distributing inventory. Manufacturing inventory including raw materials and work-in-process is valued on a first‑in, first out basis using full absorption accounting which includes material, labor, and other applicable manufacturing overhead. Carrying values of inventory are analyzed and, to the extent that the cost of inventory exceeds the net realizable value, provisions are made to reduce the carrying amount of the inventory. We regularly review all inventory items to determine if there are (i) damaged goods (e.g., for leather, excessive scars or damage from ultra-violet (“UV”) light), (ii) items that need to be removed from our product line (e.g., slow-moving items, inability of a supplier to provide items of acceptable quality or quantity, and to maintain freshness in the product line) and (iii) pricing actions that need to be taken to adequately value our inventory at the lower of cost or net realizable value. Since the determination of net realizable value of inventory involves both estimation and judgement with regard to market values and reasonable costs to sell, differences in these estimates could result in ultimate valuations that differ from the recorded asset. The majority of inventory purchases and commitments are made in U.S. dollars in order to limit the Company’s exposure to foreign currency fluctuations. Goods shipped to us are recorded as inventory owned by us when the risk of loss shifts to us from the supplier. 42 Table of Contents Inventory is physically counted twice annually in the Texas distribution center. At the store level, inventory is physically counted each quarter. Inventory is then adjusted in our accounting system to reflect actual count results. Leases We lease certain real estate for our retail store locations and warehouse equipment for our Texas distribution center, both under long-term lease agreements. We determine if an arrangement is a lease at inception and recognize right-of-use (“ROU”) assets and lease liabilities at commencement date based on the present value of the lease payments over the lease term. We elected not to record leases with an initial term of 12 months or less on the balance sheet for all our asset classes. For operating leases, the present value of our lease payments may include: (1) rental payments adjusted for inflation or market rates, and (2) lease terms with options to renew the lease or options to purchase leased equipment, when it is reasonably certain we will exercise such an option. The exercise of lease renewal or purchase option is generally at our discretion. Payments based on a change in an index or market rate are not considered in the determination of lease payments for purposes of measuring the related lease liability. We discount lease payments using our incremental borrowing rate based on information available as of the measurement date. We recognize rent expense related to our operating leases on a straight-line basis over the lease term. For finance leases, our right-of-use assets are amortized on a straight-line basis over the earlier of the useful life of the right-of-use asset or the end of the lease term with rent expense recorded to operating expenses. We adjust the lease liability to reflect lease payments made during the period and interest incurred on the lease liability using the effective interest method. The incurred interest expense is recorded in interest expense on the consolidated statements of comprehensive income (loss). The depreciable life of related leasehold improvements is based on the shorter of the useful life or the lease term. We also perform interim reviews of our lease assets for impairment when evidence exists that the carrying value of an asset group, including a lease asset, may not be recoverable. None of our lease agreements contain contingent rental payments, material residual value guarantees or material restrictive covenants. We have no sublease agreements and no lease agreements in which we are named as a lessor. Refer to Note 4, “Leases” for further discussion of the Company’s leases. Impairment of long-lived assets We evaluate long-lived assets on a quarterly basis to identify events or changes in circumstances (“triggering events”) that indicate the carrying value of certain assets may not be recoverable. Upon the occurrence of a triggering event, right-of-use (“ROU”) lease assets, property and equipment and definite-lived intangible assets are reviewed for impairment and an impairment loss is recorded in the period in which it is determined that the carrying amount of the assets is not recoverable. The determination of recoverability is made based upon the estimated undiscounted future net cash flows of assets grouped at the lowest level for which there are identifiable cash flows independent of the cash flows of other groups of assets with such cash flows to be realized over the estimated remaining useful life of the primary asset within the asset group. The Company determined the lowest level of identifiable cash flows that are independent of other asset groups to be primarily at the individual store level. If the estimated undiscounted future net cash flows for a given store are less than the carrying amount of the related store assets, an impairment loss is determined by comparing the estimated fair value with the carrying value of the related assets. The impairment loss is then allocated across the asset group’s major classifications which in this case are operating lease assets and property and equipment. Triggering events at the store level could include material declines in operational and financial performance or planned changes in the use of assets, such as store relocation or store closure. This evaluation requires management to make judgements relating to future cash flows, growth rates and economic and market conditions. The fair value of an asset group is estimated using a discounted cash flow valuation method. 43 Table of Contents During the first quarter of 2020, we determined the economic impact from the COVID-19 pandemic created a triggering event for our fleet of stores, and we continued to believe the triggering event existed in each of the remaining three quarters of 2020. For each of the four quarters of 2020 we performed recoverability testing at the store level with 26 stores failing recoverability testing and resulting in impairment expense of $1.1 million during the 2020 year. For the year ended December 31, 2019, three stores failed recoverability due to overall underperformance, and we recognized impairment expense of less than $0.1 million during the year. Earnings per share Basic earnings per share (“EPS”) are computed based on the weighted average number of common shares outstanding during the period. Diluted EPS includes additional common shares that would have been outstanding if potential common shares with a dilutive effect, such as stock awards from the Company’s restricted stock plan, had been issued. Anti-dilutive securities represent potentially dilutive securities which are excluded from the computation of diluted EPS as their impact would be anti-dilutive. Diluted EPS is computed using the treasury stock method. (in thousands, except share data) 2020 (1) 2019 (1) Numerator: Net loss $ (4,901 ) $ (1,903 ) Denominator: Basic weighted-average common shares ouststanding 9,062,598 8,973,246 Diluted weighted-average common shares outstanding 9,062,598 8,973,246 (1) For the years ended December 31, 2020 and 2019, there were 6,401 and 9,203 shares, respectively, excluded from the diluted EPS calculation because the impact of their assumed vesting would be anti-dilutive due to a net loss in that period. For additional disclosures regarding restricted stock awards and employee stock options, see Note 10, Stockholders’ Equity – Equity Compensation Plans. Other intangibles and goodwill Our intangible assets and related accumulated amortization consisted of the following: (in thousands) As of December 31, 2020 Gross Accumulated Amortization Net Trademarks/copyrights $ 554 $ 548 $ 6 TOTAL $ 554 $ 548 $ 6 As of December 31, 2019 Gross Accumulated Amortization Net Trademarks/copyrights $ 554 $ 547 $ 7 TOTAL $ 554 $ 547 $ 7 44 Table of Contents All our intangible assets are definite-lived intangibles and are subject to amortization. The weighted average amortization period is 15 years for trademarks and copyrights. Amortization expense related to other intangible assets of less than $0.01 million in each of 2020, and 2019 was recorded in operating expenses, and non-compete intangible assets were fully amortized during 2019 upon the expiration of such agreements. Based on the current amount of intangible assets subject to amortization, we estimate amortization expense to be less than $0.01 million annually over the next five years. Goodwill represents the excess of the purchase price over the fair value of net assets acquired in a business combination. Goodwill is allocated across one reporting unit: Tandy Leather Factory. Goodwill is not amortized but is evaluated at least annually for impairment. At the reporting unit level, the Company tests goodwill for impairment on an annual basis as of December 31 of each year, or more frequently if events or changes in circumstances, referred to as triggering events, indicate the carrying value of goodwill may not be recoverable and that a potential impairment exists. Application of the goodwill impairment test requires exercise of judgement, including the estimation of future cash flows, determination of appropriate discount rates and other Level 3 assumptions (significant unobservable inputs which are supported by little or no market activity). Changes in these estimates and assumptions could materially affect the determination of fair value and/or goodwill impairment for the reporting unit. On October 1, 2019, we elected to early adopt ASU 2017-04, Intangibles — Goodwill and Other (Topic 350) — Simplifying the Test for Goodwill Impairment and applied the simplified accounting method as part of the Company’s annual goodwill impairment assessment as of December 31, 2019. We completed our annual goodwill impairment assessment as of December 31, 2019 using a quantitative Step 1 approach with the income approach methodologies discussed below. The discounted cash flow (“DCF”) model utilizes present values of cash flows to estimate fair value. Future cash flows were projected based on estimates of projected sales growth, store count, pricing, gross margin rates, operating expense rates, working capital fluctuations, income tax expense and capital expenditures. Forecasted cash flows took into account known market conditions as of December 31, 2019, and management’s anticipated business outlook. The future cash flows were discounted using a market-participant risk-adjusted weighted average cost of capital for the reporting unit. A terminal year value was calculated under two approaches: (i) using an EBITDA exit multiple supported by guideline public company data using selected public companies operating within the retail industry and (ii) applying a perpetual growth rate methodology to the terminal year. These assumptions were derived from both observable and unobservable inputs and were combined to reflect management’s judgements and assumptions. The estimated fair values determined under both approaches above were consistent. The concluded fair value for the reporting unit was based on a 50/50 weighting of the two valuation approaches above. The results of the Step 1 impairment testing for goodwill resulted in the Company recognizing an impairment expense of $1.0 million during the fourth quarter of 2019, representing the entire balance of goodwill for the reporting unit. Fair value of financial instruments We measure fair value as an exit price, which is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As a basis for considering such assumptions, accounting standards establish a three-tier fair value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value: 45 Table of Contents • Level 1 – observable inputs that reflect quoted prices in active markets for identical assets or liabilities. • Level 2 – significant observable inputs other than quoted prices in active markets for similar assets and liabilities, such as quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data. • Level 3 – significant unobservable inputs reflecting our own assumptions, consistent with reasonably available assumptions made by other market participants. Classification of the financial asset or liability within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. Our principal financial instruments held consist of short-term investments, accounts receivable, accounts payable, and long-term debt. As of December 31, 2020 and 2019, the carrying values of our financial instruments, included in our Consolidated Balance Sheets, approximated their fair values. There were no transfers into or out of Levels 1, 2 and 3 during the years ended December 31, 2020 and 2019. Short-term investments We determine the appropriate classification of investments at the time of purchase, and we re-evaluate that determination at each balance sheet date. Investments are recorded as either short-term or long-term on the Consolidated Balance Sheet, based on contractual maturity date. As of December 31, 2020, we held no short-term investments. As of December 31, 2019, we held investments in U.S. Treasuries with maturity values of $9.2 million and maturities less than one year. We classified these investments in debt securities as held-to-maturity. Such investments were recorded at amortized cost with book value approximating fair value which is based on Level 1 inputs for these investments. Income taxes Income taxes are estimated for each jurisdiction in which we operate. This involves assessing current tax exposure together with temporary differences resulting from differing treatment of items for tax and financial statement accounting purposes. Any resulting deferred tax assets are evaluated for recoverability based on estimated future taxable income. To the extent it is more likely than not that all or a portion of a deferred tax asset will not be realized, a valuation allowance is recorded. Our evaluation regarding whether a valuation allowance is required or should be adjusted also considers, among other things, the nature, frequency, and severity of recent losses, forecasts of future profitability and the duration of statutory carryforward periods. Deferred tax assets and liabilities are measured using the enacted tax rates in effect in the years when those temporary differences are expected to reverse. The effect on deferred taxes from a change in tax rate is recognized through continuing operations in the period that includes the enactment date of the change. Changes in tax laws and rates could affect recorded deferred tax assets and liabilities in the future. A tax benefit from an uncertain tax position may be recognized when it is more-likely-than-not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, based on the technical merits. Income tax positions must meet a more-likely-than-not recognition threshold to be recognized. 46 Table of Contents We recognize tax liabilities for uncertain tax positions and adjust these liabilities when our judgement changes as a result of the evaluation of new information not previously available. Due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense and the effective tax rate in the period in which new information becomes available. We recognize interest and/or penalties related to all tax positions in income tax expense. To the extent that accrued interest and penalties do not ultimately become payable, amounts accrued will be reduced and reflected as a reduction of the overall income tax provision in the period that such determination is made. We may be subject to periodic audits by the Internal Revenue Service and other taxing authorities. These audits may challenge certain of our tax positions, such as the timing and amount of deductions and allocation of taxable income to the various jurisdictions. Stock-based compensation The Company’s stock-based compensation relates primarily to restricted stock unit (“RSU”) awards. Accounting guidance requires measurement and recognition of compensation expense at an amount equal to the grant date fair value. Compensation expense is recognized for service-based stock awards on a straight-line basis or ratably over the requisite service period, based on the closing price of the Company’s stock on the date of grant. The service-based awards typically vest ratably over the requisite service period, provided that the participant is employed on the vesting date. Compensation expense is reduced by actual forfeitures as they occur over the requisite service period of the awards. Performance-based RSUs vest, if at all, upon the Company satisfying certain performance targets. The Company records compensation expense for awards with a performance condition when it is probable that the condition will be achieved. If the Company determines it is not probable a performance condition will be achieved, no compensation expense is recognized. If the Company changes its assessment in a subsequent period and concludes it is probable a performance condition will be achieved, the Company will recognize compensation expense ratably between the period of the change in assessment through the expected date of satisfying the performance condition for vesting. If the Company subsequently assesses that it is no longer probable that a performance condition will be achieved, the accumulated expense that has been previously recognized will be reversed. The compensation expense ultimately recognized, if any, related to performance-based awards will equal the grant date fair value based on the number of shares for which the performance condition has been satisfied. We issue shares from authorized shares upon the lapsing of vesting restrictions on RSUs. We do not use cash to settle equity instruments issued under stock-based compensation awards. Comprehensive income (loss) Comprehensive income (loss) includes net income (loss) and certain other items that are recorded directly to stockholders’ equity. The Company’s only source of other comprehensive income (loss) is foreign currency translation adjustments, and those adjustments are presented net of tax. Shipping and handling costs Costs to ship products from our stores to our customers are included in operating expenses on the Consolidated Statements of Comprehensive Income (Loss). These costs totaled $3.2 million and $2.1 million for the years ended December 31, 2020 and 2019, respectively. 47 Table of Contents Advertising Advertising costs include the cost of print, digital, direct mail, community events, trade shows, and our ecommerce platform. Advertising costs are expensed as incurred. Total advertising expense was $1.1 million and $3.4 million in 2020 and 2019, respectively. Recently Adopted Accounting Pronouncements Internal-Use Software In August 2018, the FASB issued ASU No. 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40). This update provides additional guidance to ASU No. 2015-05, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40), which was issued in April 2015. The amendments in this ASU align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). We adopted this ASU on January 1, 2020; the adoption of this ASU did not have a material effect on the Company’s financial condition, results of operations or cash flows. Credit Losses In June 2016, the FASB issued ASU 2016-13, “ Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial Instruments ,” which requires entities to measure impairment of certain financial instruments, including trade receivables, based on expected losses rather than incurred losses. We adopted this ASU on January 1, 2020; the adoption of this ASU did not have a material effect on the Company’s financial condition, results of operations or cash flows. Recent Accounting Standards Not Yet Adopted Simplifying the Accounting for Income Taxes In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes , which simplifies the accounting for income taxes by removing certain exceptions to the general principles in topic 740. The amendments also improve consistent application of and simplify GAAP for other areas of Topic 740 by clarifying and amending existing guidance. This guidance will be effective for entities for the fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, on a prospective basis, with early adoption permitted. We do not believe that the adoption of this standard will have a material impact on our financial condition, results of operations or cash flows . 3. BALANCE SHEET COMPONENTS Inventory (in thousands) December 31, 2020 December 31, 2019 On hand: Finished goods held for sale $ 32,654 $ 20,575 Raw materials and work in process 828 717 Inventory in transit 3,297 2,750 TOTAL $ 36,779 $ 24,042 48 Table of Contents Property and Equipment (in thousands) December 31, 2020 December 31, 2019 Building $ 9,240 $ 9,257 Land 1,451 1,451 Leasehold improvements 1,853 1,828 Equipment and machinery 7,361 6,516 Furniture and fixtures 7,339 8,082 Vehicles 224 337 27,468 27,471 Lesss: accumulated depreciation (15,078 ) (14,552 ) TOTAL $ 12,390 $ 12,919 Our property and equipment, net was located in the following countries: (in thousands) December 31, 2020 December 31, 2019 United States $ 12,077 $ 12,541 Canada 309 373 United Kingdom 2 3 Spain 2 2 $ 12,390 $ 12,919 Depreciation expense was $1.0 million and $1.7 million for the years ended December 31, 2020 and 2019, respectively. Short-term Liabilities Accrued Expenses and Other Liabilities December 31, 2020 December 31, 2019 (in thousands) Accrued bonuses and payroll 1,121 1,104 Unearned gift card revenue 301 319 Estimated returns 241 285 Sales and payroll taxes payable 935 459 Accrued severance - 38 Accrued vendor payables 1,044 451 TOTAL $ 3,642 $ 2,656 4. LEASES The Company leases certain real estate and warehouse equipment under long-term lease agreements. On January 1, 2019, the Company adopted ASU 2016-02, Leases (Topic 842) (“Topic 842”), and all subsequent amendments, using the optional transition method applied to leases existing on January 1, 2019, with no restatement of comparative periods. 49 Table of Contents Upon adoption of Topic 842, the Company recognized operating ROU assets (referred herein as “lease assets”) and lease liabilities based on the present value of its remaining minimum rental payments for existing operating leases as of the adoption date, utilizing the Company’s applicable incremental borrowing rate as of that date. The adoption of Topic 842 resulted in the Company recognizing $17.6 million and $18.1 million of operating lease assets and lease liabilities, respectively, as of January 1, 2019. The difference between the lease assets and liabilities was primarily due to the recognition of a $0.5 million pre-tax cumulative effect adjustment to retained earnings on January 1, 2019, resulting from the impairment of certain operating lease assets upon adoption. The Company had no existing finance leases, previously termed capital leases under ASC 840, as of its adoption of Topic 842. During the fourth quarter of 2020, the Company executed two financing leases for two forklifts used in the warehouse operations totaling less than $0.1 million. The Company performs interim reviews of its operating and finance lease assets for impairment when evidence exists that the carrying value of an asset group, including a lease asset, may not be recoverable. During the year ended December 31, 2020, the Company recognized an impairment expense of approximately $0.6 million associated with certain operating lease assets. Excluding the January 1, 2019 impairment charge to retained earnings upon the adoption of Topic 842, the Company recognized an impairment expense of less than $0.1 million associated with its operating lease assets during 2019. Additional information regarding the Company’s operating leases is as follows (in thousands, except for lease term and discount rate information): Leases Balance Sheet Classification December 31, 2020 December 31, 2019 (in thousands) Assets: Operating Operating lease assets $ 11,772 $ 13,897 Finance Financing lease assets 44 - Total assets $ 11,816 $ 13,897 Liabilities: Current Operating Operating lease liabilities $ 3,530 $ 3,823 Finance Current maturities of financing lease obligations 14 - Non-current Operating Operating lease liabilities, non-current 9,245 10,655 Finance Financing lease liabilities, net of current obligation 29 - Total lease liabilities $ 12,818 $ 14,478 Lease Cost Income Statement Classification December 31, 2020 December 31, 2019 (in thousands) Operating lease cost Operating expenses $ 3,809 $ 4,151 Operating lease cost Impairment expense 601 4 Variable lease cost (1) Operating expenses 937 895 Finance: Amortization of lease assets (2) Operating expenses - - Interest on lease liabilities (2) Interest expense - - Total lease cost $ 5,347 $ 5,050 (1) Variable lease cost includes payment for certain real estate taxes, insurance, common area maintenance, and other charges related to lease agreements, which are not included in the measurement of the operating lease liabilities. (2) Finance lease costs are less than $1,000 for December 31, 2020; we had no finance lease costs in 2019. 50 Table of Contents December 31, 2020 Maturity of Lease Liabilities Operating Leases Finance Leases (in thousands) 2021 $ 3,591 $ 16 2022 2,835 16 2023 2,035 15 2024 1,564 - 2025 1,220 - Thereafter 3,205 - Total lease payments $ 14,450 $ 47 Less: Interest (1,675 ) (4 ) Present value of lease liabilities $ 12,775 $ 43 Lease Term and Discount Rate December 31, 2020 December 31, 2019 Weighted-average remaining lease term (years): Operating leases 5.9 6.0 Finance leases 2.9 - Weighted-average discount rate: Operating leases 4.4 % 4.1 % Finance leases 6.5 % - Other Information December 31, 2020 December 31, 2019 (in thousands) Cash paid for amounts included in the measurement of lease liabilities: Operating cash flows used in operating leases $ 3,866 $ 4,079 Operating cash flows used in finance leases - - Financing cash flows used in finance leases 1 - Operating lease assets obtained in exchange for lease obligations Operating leases, initial recognition 317 18,077 Operating leases, modifications and remeasurements 1,340 - Finance leases, initial recognition 45 - 5. NOTES PAYABLE AND LONG-TERM DEBT During the second quarter of 2020, the Company borrowed $0.4 million from Banco Santander S.A. under the Institute of Official Credit Guarantee for Small and Medium-sized Enterprises in order to facilitate the continuation of employment and to attenuate the economic effects of the COVID-19 virus. This loan was provided for by the Spanish government as part of a COVID-19 relief program. The term of the agreement is five years and the interest rate is fixed at 1.5%. Based on the terms of the loan agreement, we are required to make monthly interest-only payments for the first two years and monthly principal and interest payments for the remainder of the term of the agreement. We restated our previously issued audited financial statements as of and for the years ended December 31, 2018 and 2017 as well as the quarterly and year-to-date periods within fiscal 2018 included in the Company’s previously filed Quarterly Reports on Form 10-Q, and the three months ended March 31, 2019, included in the Company’s previously filed Quarterly Report on Form 10-Q. Under the terms of the Promissory Note agreements we had in place with our primary bank, BOKF, NA d/b/a Bank of Texas (“BOKF”), we were required to provide BOKF quarterly financial statements and compliance certificates. We were unable to provide these financial statements and compliance certificates for the Delinquent Filings noted above. In response, on April 2, 2020, BOKF provided notice under the terms of the Promissory Note agreements that such Promissory Notes were cancelled. As of the date of cancellation, Tandy had no borrowings outstanding under these credit facilities or with any other lending institution. As of the date of this filing, Tandy has no lines of credit outstanding. Details of the terms of the Promissory Note agreements with BOKF are as follows. 51 Table of Contents On September 18, 2015, we executed a Promissory Note agreement with BOKF which provided us with a working capital line of credit facility of up to $6 million which was secured by our inventory. On August 20, 2018, this line of credit was amended to extend the maturity to September 18, 2020 and to reduce the interest rate by 0.35%, and on September 18, 2019, the maturity date was further extended through September 18, 2021. The Business Loan Agreement contained covenants that required us to maintain a funded debt to EBITDA ratio of no greater than 1.5 to 1 and a Fixed Charge Coverage Ratio greater than or equal to 1.2 to 1. Both ratios were calculated quarterly on a trailing four quarter basis. For the years ended December 31, 2020 and 2019, there were no amounts drawn on this line of credit. Also, on September 18, 2015, we executed a Promissory Note agreement with BOKF which provided us with a line of credit facility of up to $10 million for the purpose of repurchasing shares of our common stock pursuant to our stock repurchase program, announced in August 2015 and subsequently amended, which permitted us to repurchase up to 2.2 million shares of our common stock through August 2020. Subsequently, this line of credit was amended to increase the availability from $10 million to $15 million for the repurchase of shares of our common stock pursuant to our stock repurchase program through the end of the draw down period which was the earlier of August 9, 2020 or the date on which the entire amount was drawn. In addition, this Promissory Note was amended on August 20, 2018 to reduce the interest rate by 0.35%, and on September 18, 2019, the maturity date was further extended through September 18, 2024. We were required to make monthly interest-only payments through September 18, 2020. After this date, the principal balance would have rolled into a 4-year term note with principal and interest paid on a monthly basis with a maturity date of September 18, 2024. This Promissory Note was secured by a Deed of Trust on the real estate located at 1900 SE Loop 820, Fort Worth, Texas. During the first quarter of 2019, we paid $9.0 million to pay off this line of credit with no pre-payment penalties incurred. There were no amounts outstanding on this line of credit as of December 31, 2020 and 2019. The amount outstanding under the above agreement consisted of the following: December 31, (in thousands) 2020 2019 Institute of Official Credit (“ICO”) Guarantee for Small and Medium-sized Enterprises with Banco Santander S.A. (Spain) as described more fully above - interest due monthly at 1.50%; matures June 4, 2025 $ 446 $ - $ 446 $ - Less current maturities - - TOTAL $ 446 $ - 6. EMPLOYEE BENEFIT AND SAVINGS PLANS We have a 401(k) plan to provide retirement benefits for our employees. As allowed under Section 401(k) of the Internal Revenue Code, the plan provides tax-deferred salary contributions for eligible employees and allows employees to contribute a percentage of their annual compensation to the plan on a pretax basis. Employee contributions are limited to a maximum annual amount as set periodically by the Internal Revenue Code. In 2020, and 2019, we matched 100% of the pretax employee contributions on the first 3% of eligible earnings and 50% of the pretax employee contributions on the next 2% of eligible earnings that are contributed by employees. For the years ended December 31, 2020 and 2019, we recorded employer match expense of $0.2 million and $0.3 million, respectively. 52 Table of Contents 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 2020 or 2019. We offer no postretirement or postemployment benefits to our employees. 7. INCOME TAXES The provision for income taxes consists of the following: (in thousands) Year Ended December 31, Income Tax Benefit 2020 2019 Current provision (benefit): Federal $ (1,385 ) $ (582 ) State 65 7 Foreign 6 (10 ) Related to UTP 20 26 (1,294 ) (559 ) Deferred provision (benefit): Federal (62 ) (94 ) State (3 ) (24 ) Foreign (19 ) (13 ) (84 ) (131 ) Total tax benefit $ (1,378 ) $ (690 ) We have $4.6 million of net operating loss (“NOL”) carryovers and carrybacks which will begin to expire in 2025. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) was enacted in response to the COVID-19 pandemic. The CARES Act, among other things, permits NOL carryovers and carrybacks to offset 100% of taxable income for taxable years beginning before 2021. In addition, the CARES Act allows NOLs incurred in 2018, 2019, and 2020 to be carried back to each of the five preceding taxable years to generate a refund of previously paid income taxes. The Company is evaluating the impact of the CARES Act and expects that the NOL carryback provision of the CARES Act will result in a cash tax benefit to the Company. Income (loss) before income taxes was earned in the following tax jurisdictions: (in thousands) Year Ended December 31, Income (Loss) Before Income Taxes 2020 2019 United States $ (6,222 ) $ (1,959 ) Spain 161 21 Canada (204 ) (131 ) Australia (7 ) (170 ) United Kingdom (7 ) (354 ) TOTAL $ (6,279 ) $ (2,593 ) 53 Table of Contents The income tax effects of temporary differences that give rise to significant portions of deferred income tax assets and liabilities are as follows: Deferred income tax assets: 2020 2019 (in thousands) Inventory $ 498 $ 468 Stock-based compensation 63 51 Accounts receivable 4 5 Sales returns 105 119 Foreign currency translation gain/loss in OCI 323 359 Goodwill and other intangible assets amortization 5 33 Net operating loss 665 459 Accrued expenses 170 - Leases 250 145 Other 1 - Total deferred income tax assets 2,084 1,639 Less: valuation allowance (1,320 ) (382 ) Total deferred income tax assets, net of valuation allowance $ 764 $ 1,257 Property and equipment depreciation $ 682 $ 740 Accrued expenses - 90 Total deferred income tax liabilities 682 830 Net deferred tax asset (liability) $ 82 $ 427 We are required to reduce deferred tax assets by a valuation allowance if, based on the weight of the available evidence, it is more likely than not that all or a portion of a deferred tax asset will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences are deductible. We determined a $0.9 million increase to the valuation allowance for deferred income tax assets was necessary as of December 31, 2020, as compared to 2019. Our evaluation considered, among other things, the nature, frequency, and severity of losses, forecasts of future profitability and the duration of statutory carryforward periods. Our effective tax rate differs from the federal statutory rate primarily due to U.S. state income tax expense, the difference in tax rates for loss carryback periods, foreign income/loss positions, expenses that are nondeductible for tax purposes, the change in our valuation allowance associated with our deferred tax assets, and differences in tax rates. Below is a reconciliation of our effective tax rate from the statutory rate: Year Ended December 31, 2020 2019 Statutory rate – Federal U.S. income tax 21 % 21 % State and local taxes 3 % 0 % Permanent book/tax differences (2 )% (6 )% Difference in tax rates in loss carryback periods 8 % 3 % Change in valuation allowance (10 )% (5 )% Rate differential on UTP reversals 0 % 13 % Other, net 2 % 1 % Effective rate 22 % 27 % 54 Table of Contents We file a consolidated U.S. income tax return as well as state tax returns on a consolidated, combined, or stand-alone basis, depending on the jurisdiction. We are no longer subject to U.S. federal income tax examinations by tax authorities for years prior to the tax year ended December 2016. Depending on the jurisdiction, we are no longer subject to state examinations by tax authorities for years prior to the December 2015 and December 2016 tax years. A reconciliation of the beginning and ending amount of uncertain tax positions (“UTP”) is as follows: Fiscal Year 2020 2019 UTP at beginning of the year $ 296 $ 1,416 Gross increase (decrease) to tax positions in current period 77 (1,146 ) Interest expense 20 26 Lapses in statute - - UTP at end of year $ 393 $ 296 We file tax returns in the U.S. and a limited number of foreign jurisdictions. With few exceptions, we are no longer subject to federal, state and local, or non-U.S. income tax examinations for years before 2015. Included in the balance of UTPs as of December 31, 2020 and 2019 are $0.1 million and $0.1 million, respectively, of tax benefits that, if recognized, would affect the effective tax rate. Also included in the balance of UTPs as of December 31, 2020 and 2019 are $0.3 million and $.02 million, respectively, of tax benefits that, if recognized, would result in adjustments primarily to deferred taxes. 8. COMMITMENTS AND CONTINGENCIES Legal Proceedings We are periodically involved in various litigation that arises in the ordinary course of business and operations. There are no such matters pending that we expect to have a material impact on our financial position or operating results. Legal costs associated with the resolution of claims, lawsuits, and other contingencies are expensed as incurred. In November 2019, a class action lawsuit seeking unspecified damages was brought by a stockholder in the Federal District Court in Los Angeles, California, and subsequently transferred to the Federal District Court for the Northern District of Texas, against the Company and members of its current and former management relating to our announcement of the circumstances leading to our restatement. We believe that suit was without merit, and the suit was withdrawn by the plaintiff in April 2020; however, there can be no assurance that additional litigation against the Company and/or its management or Board of Directors might not be threatened or brought in connection with matters related to our restatement. Delisting of the Company’s Common Stock As previously disclosed, the Company was unable to timely file the Delinquent Filings due to the process of restating its financial statements as described above. As a result, on February 18, 2020, the Company received a notice from Nasdaq indicating that, unless the Company timely requested a hearing before a Nasdaq Hearings Panel (the “Panel”), the Company’s common stock would be subject to suspension and delisting from Nasdaq due to non-compliance with Nasdaq Listing Rule 5250(c)(1). On May 1, 2020, the Panel granted the Company’s request to remain listed on Nasdaq, subject to the Company filing all current and overdue quarterly and annual reports with the Securities and Exchange Commission on or before August 10, 2020. Because the restatement process was not complete by such date, Nasdaq suspended trading in our stock on Nasdaq as of August 13, 2020. Our stock has since traded on the OTC Link (previously “Pink Sheets”) operated by OTC Markets Group under the symbol “TLFA.” Nasdaq denied our appeal of this decision, and our stock was formally delisted on February 9, 2021. We intend to reapply for Nasdaq listing once the Company has made the required Exchange Act filings. 55 Table of Contents SEC Investigation In 2019, the Company self-reported to the SEC information concerning the internal investigation of previously disclosed accounting matters resulting in the restatement for the full year 2017 and full year 2018, including interim quarters in 2018, and the first quarter of 2019. In response, the Division of Enforcement of the SEC initiated an investigation into the Company’s historical accounting practices. In July 2021, the Company entered into a settlement agreement with the SEC to conclude this investigation. Under the terms of the settlement, in addition to other non-monetary settlement terms, (1) the Company paid a civil monetary penalty of $200,000 , and (2) the Company’s former Chief Financial Officer and Chief Executive Officer, agreed to pay a civil monetary penalty of $25,000. In accepting the Company’s settlement offer, the SEC took into account remedial actions the Company took promptly after learning of the issues detailed in the SEC’s order. 9. SIGNIFICANT BUSINESS CONCENTRATIONS AND RISK Major Customers Our revenues are derived from a diverse group of customers, from hobbyist crafters to small and large businesses across a wide variety of industries. No single customer accounted for more than 0.3% of our consolidated revenues in 2020 or 2019, and sales to our five largest customers represented 1.1% and 1.7%, 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, we do not believe that the loss of this supplier would 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, although as of December 31, 2020 and 2019, two customers’ balances represented 29.9% and 35.3% of net accounts receivable balance, respectively. We do not generally require collateral for accounts receivable, but we do perform periodic credit evaluations of our customers and believe the allowance for doubtful accounts is adequate. It is our opinion that if any one or a group of customer receivable balances should be deemed uncollectable, it would not have a material adverse effect on our results of operations or financial condition. 56 Table of Contents We maintain a majority of 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. 10. STOCKHOLDERS’ EQUITY Equity Compensation Plans Restricted Stock Plan The Tandy Leather Factory, Inc. 2013 Restricted Stock Plan (the “2013 Plan”) was adopted by our Board of Directors in January 2013 and approved by our stockholders in June 2013. The 2013 Plan initially reserved up to 300,000 shares of our common stock for restricted stock and restricted stock unit (“RSU”) awards, on or prior to June 2018, to our executive officers, non-employee directors and other key employees. In June 2020, our stockholders approved an increase to the plan reserve to 800,000 shares of our common stock and extended the 2013 Plan through June 2023 (of which, there were 606,712 shares available for future awards as of December 31, 2020). Awards granted under the 2013 Plan may be service-based awards or performance-based awards, and may be subject to a graded vesting schedule with a minimum vesting period of four years, unless otherwise determined by the Compensation Committee of the Board of Directors that administers the plan. In March 2020, as part of their annual director compensation, certain of our non-employee directors were granted a total of 24,010 service-based RSUs under the 2013 Plan which will vest ratably over the next 3 years provided that the participant is employed on the vesting date. In July 2020, our new CFO was granted a total of 9,063 service-based RSUs under the 2013 Plan which were scheduled to vest ratably over the next 3 years, provided that the participant is employed on the vesting date. This award was forfeited in January 2021when the grantee left the employ of the Company. In December 2020, certain of our key employees were granted a total of 18,255 service-based RSUs which vested immediately, under the 2013 Plan. In addition to grants under the Company’s 2013 Restricted Stock Plan, in October 2018 we granted a total of 644,000 RSUs to the Company’s Chief Executive Officer (“CEO”), of which (i) 460,000 are service-based RSUs that vest ratably over a period of five years from the grant date based on our CEO’s continued employment in her role, (ii) 92,000 are performance-based RSUs that will vest if the Company’s operating income exceeds $12 million dollars two fiscal years in a row, and (iii) 92,000 are performance-based RSUs that will vest if the Company’s operating income exceeds $14 million dollars in one fiscal year. A summary of the activity for non-vested restricted stock and RSU awards is as follows: Shares (in thousands) Weighted Average Share Price Balance, January 1, 2019 $ 658 $ 7.39 Granted 46 5.67 Forfeited (5 ) 5.64 Vested (93 ) 7.39 Balance, December 31, 2019 $ 606 $ 7.27 Balance, January 1, 2020 $ 606 $ 7.27 Granted 51 3.94 Vested (135 ) 6.63 Balance, December 31, 2020 $ 522 $ 7.11 The Company’s stock-based compensation relates to restricted stock and RSU awards. For these service-based awards, our stock-based compensation expense, included in operating expenses, was $0.9 million and $0.8 million in 2020 and 2019, respectively. 57 Table of Contents As of December 31, 2020, the Company has concluded it is not probable that the performance conditions related to performance-based RSUs will be achieved, and as a result no compensation expense related to performance-based RSUs has been recorded. As of December 31, 2020, there was unrecognized compensation cost related to non-vested, service-based awards of $2.1 million which will be recognized over 1.9 weighted average years in each of the following years: Unrecognized Expense 2021 $ 811,580 2022 759,540 2023 516,286 $ 2,087,406 We issue shares from authorized shares upon the lapsing of vesting restrictions on restricted stock and RSUs. In 2020 and 2019, we issued 128,619 and 93,408 shares, respectively, resulting from the vesting of restricted stock. We do not use cash to settle equity instruments issued under stock-based compensation awards. Share Repurchase Program In August 2015, our Board of Directors authorized a share repurchase program, pursuant to which we were authorized to repurchase up to 1.2 million shares of our common stock at prevailing market rates through August 2016. Subsequently, the program was amended to increase the number of shares available for repurchase to 2.2 million and to extend the program through August 2019. In June 2019, the program was again amended to increase the number of shares available to one million as of such date and to extend the program through August 9, 2020. 58 Table of Contents For the years ended December 31, 2020 and 2019, we repurchased the following shares: Year ended December 31, Total shares repurchased Average price per share 2020 - $ - 2019 131,782 $ 5.58 As of December 31, 2020, we could repurchase $5,000,000 of our common stock. On August 9, 2020, the Board of Directors approved a new program to repurchase up to $5.0 million of its common stock between August 9, 2020 and July 31, 2022, subject to the completion of our financial restatement and the filing of all Delinquent Filings with the SEC. The Company’s previous share repurchase program expired in August 2020. As of December 31, 2020, the full $5.0 million of our common stock remained available for repurchase under this program. On January 28, 2021, we entered into an agreement with an institutional shareholder of the Company, to repurchase 500,000 shares of our common stock, par value $0.0024 in a private transaction. The purchase price was $3.35 per share for a total of $1.7 million. The closing of the repurchase of these shares took place on February 1, 2021. Prior to the repurchase, the shares represented approximately 5.5% of our outstanding common stock. This repurchase was separately authorized by our Board of Directors and did not reduce the remaining amount authorized to be repurchased under the plan described in the previous paragraph. 11. SEGMENT INFORMATION As of January 1, 2019, we operate as a single segment and report on a consolidated basis. Prior to January 1, 2019, we operated and reported in two segments, North America and International. In early 2019, we announced several strategic initiatives to drive future sales growth and long-term profitability, which resulted in the Company closing two of its three stores outside of North America. This left Spain as our only store outside of North America, and our chief operating decision maker was no longer making operating performance assessments and resource allocation decisions for this one single store. As a result, we no longer report International as a reportable segment. 12. QUARTERLY FINANCIAL DATA (UNAUDITED) The Company is providing quarterly and year-to-date unaudited consolidated financial information for interim periods occurring within the years ended December 31, 2020 and 2019 in order to comply with SEC requirements. 59 Table of Contents (in thousands, except share and per share data) 2020 First Quarter Second Quarter Third Quarter Fourth Quarter Net sales $ 17,145 $ 9,146 $ 15,990 $ 21,803 Gross profit 9,866 5,243 9,289 11,660 Net loss (1,738 ) (1,775 ) (982 ) (406 ) Net loss per common share: Basic $ (0.19 ) $ (0.20 ) $ (0.11 ) $ (0.04 ) Diluted (1) $ (0.19 ) $ (0.20 ) $ (0.11 ) $ (0.04 ) Weighted average number of common shares outstanding: Basic 9,029,212 9,042,991 9,042,991 9,134,621 Diluted 9,029,212 9,042,991 9,042,991 9,134,621 (1) For the three months ended March 31, 2020, June 30, 2020, September 30, 2020, and December 31, 2020, there were 492, 2,290, 1,875 and 3,300 shares, respectively, excluded from the diluted EPS calculation because the impact of their assumed exercise would be anti-dilutive due to a net loss in those periods. (in thousands, except share and per share data) 2019 First Quarter Restated Second Quarter Third Quarter Fourth Quarter Net sales $ 20,941 $ 17,197 $ 16,311 $ 20,469 Gross profit 12,244 9,371 8,849 11,495 Net income (loss) 1,520 (875 ) (1,719 ) (830 ) Net income (loss) per common share: Basic $ 0.17 $ (0.10 ) $ (0.19 ) $ (0.09 ) Diluted (2) $ 0.17 $ (0.10 ) $ (0.19 ) $ (0.09 ) Weighted average number of common shares outstanding: Basic 9,009,752 8,933,648 8,932,246 9,020,187 Diluted 9,011,107 8,933,648 8,932,246 9,020,187 (2) For the three months ended June 30, 2019, September 30, 2019 and December 31, 2019, there were 2,290, 2,704 and 8,387 shares, respectively, excluded from the diluted EPS calculation because the impact of their assumed exercise would be anti-dilutive due to a net loss in those periods. 60 Table of Contents ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.