2. RESTATEMENT OF PREVIOUSLY ISSUED CONSOLIDATED FINANCIAL STATEMENTS

Our unaudited Consolidated Financial Statements as of and for the three months ended March 31, 2019 were restated.

Restatement Background

As previously disclosed, on October 14, 2019, as a result of the findings of the Independent Investigation and the Company’s ongoing reviews, the Company, in consultation with the Audit Committee, determined that Tandy’s previously issued Consolidated Financial Statements as of and for (i) the years ended December 31, 2018 and 2017, (ii) the three and six-month periods ended June 30, 2018, (iii) the three and nine-month periods ended September 30, 2018, and (iv) the three-month period ended March 31, 2019, should no longer be relied upon due to misstatements related to our accounting processes for inventory transactions, and we would make the necessary accounting corrections and restate such financial statements. In addition to inventory misstatements, management identified additional areas that required restatement adjustments as described below, with all such restatement items constituting the “Restatement Process.” The restatement adjustments described below pertain to all restatement periods noted above, and restatement adjustments specific to the three months ended March 31, 2019 are reflected in the tables below.

Such errors included: (i) methods used by the Company in the valuation and expensing of costs related to inventory which was not correctly stated and was not consistent with the first-in, first-out (“FIFO”) methodology, (ii) warehousing and handling expenditures which were not properly capitalized during the first and third quarters but were subsequently corrected on a semi-annual basis in the second and fourth quarters resulting in the understatement of inventory and net income in the first and third quarters and the overstatement of net income in the second and fourth quarters, (iii) warehouse and handling expenditures which were improperly classified in operating expenses in all quarters resulting in an overstatement of operating expenses in all restated periods, (iv) freight-in, warehousing and handling expenditures, factory labor and overhead, and freight-out costs which were being capitalized to inventory using historical standard rates that were not based on the actual costs incurred in each period resulting in misstatements of inventory value, (v) inventory reserve levels which did not reflect the Company’s accounting policy of carrying inventory at the lower of cost or net realizable value resulting in misstatements of inventory value, (vi) sales returns were not accounted for until November 2018, and through year end 2017 gift cards were initially recorded to net sales causing net sales to be overstated, (vii) lease accounting errors upon the adoption of Accounting Standards Update (“ASU”) 2016-02, Leases (“Topic 842”) on January 1, 2019, which resulted in the understatement of operating lease assets and operating lease liabilities, (viii) the income tax effect of pre-tax restatement adjustments as well as correction of income tax misstatements related to tax effected items recognized in the 2018 income tax provision but related to the previous 2017 tax year, including adjustments related to the Tax Cuts and Jobs Act (“TCJA”) and recognition of uncertain tax position (“UTP”) liability and related interest expense, and (ix) other smaller matters described further below.

Description of Restatement Adjustments

Inventory

Under the Company’s inventory accounting policy, inventory is stated using the FIFO methodology for cost, and such cost includes merchandise purchases, the costs to bring the merchandise to its Texas distribution center (freight-in), warehousing and handling expenditures, factory labor and overhead for items that are internally manufactured, and distributing and delivering merchandise to stores (freight-out). The Company carries inventory at the lower of this cost or net realizable value. The inventory restatement adjustments below were first identified by management as a result of a deeper analysis of legacy systems and practices that were in place for many years and which the Company is working to replace. Management identified the following areas in which the accounting for inventory did not adhere to the Company’s inventory accounting policy:

(1)

FIFO adjustment: inventory was not correctly stated and was not consistent with the FIFO methodology;

(2)

Freight-in, warehousing and handling expenditures, factory labor and overhead, and freight-out adjustment:

warehousing and handling expenditures were not properly capitalized during the first and third quarters but were subsequently corrected on a semi-annual basis in the second and fourth quarters resulting in the understatement of inventory and net income in the first and third quarters and the overstatement of net income in the second and fourth quarters; and

ii.

freight-in, warehousing and handling expenditures, factory labor and overhead, and freight-out costs were being capitalized to inventory using historical standard rates that were not based on the actual costs incurred in each period resulting in misstatements;

(3)

Inventory reserve adjustment: Tandy’s accounting policy is to carry inventory at the lower of cost or net realizable value. Management noted inventory reserve levels did not reflect the Company’s accounting policy of carrying inventory at the lower of cost or net realizable value. This resulted in cumulative understatements of inventory.

Sales Returns

(4)

Sales returns: management noted estimates for sales returns had not been accounted for using historical sales return trends. Management has estimated a sales return liability along with a corresponding inventory asset for the first quarter of 2019. In addition, estimated sales returns previously recorded in the first quarter of 2019 were incorrectly presented on a net basis in cost of sales and have since been restated to reflect accounting on a gross basis in both net sales and cost of sales.

Warehouse and Handling Reclassifications

(5)

Warehousing and handling expenditures were classified as operating expenses, resulting in overstatement of operating expenses in all periods. These costs have been reclassified to cost of sales since the inventory restatement in adjustment (2) above is properly adjusting the inventory balance for such costs with the offset recorded to cost of sales. There was no impact to net income (loss) related to this reclassification.

Income Tax

(6)

Management noted the income tax provision for the three months ended March 31, 2019 had misstatements related to the recognition of UTP liability and related interest expense among other smaller tax correcting adjustments. Also, income tax restatement adjustments were made to reflect the tax effect of the pre-tax restatement adjustments for the three months ended March 31, 2019.

Accruals and Other

(7)

There were misstatements related to the recognition of accrued paid-time-off (“PTO”) resulting in understatement of accrued expenses and other liabilities as well as other misstatements primarily related to recognition of other accrued operating expenses, payroll related costs, long-term debt classification, cash cutoff for outstanding checks, break out of impairment expense previously included in operating expenses, and reclass of leasehold improvements from prepaid expenses to property and equipment, all of which are being corrected in connection with the restatement of previously issued financial statements.

Leases

(8)

During the first quarter of 2019, we adopted the new lease accounting standard under Topic 842. Management noted as part of the adoption that the Company did not ensure the appropriateness of inputs being used to calculate the present value of lease payments over the lease terms. This resulted in the misstatement of operating lease assets, and the current and long-term portion of operating lease liabilities upon initial recognition on January 1, 2019.

Foreign Currency Gains & Losses and Cumulative Translation Adjustments

(9)

Foreign currency gains and losses associated with the activity of the Company’s Canadian subsidiary were incorrectly classified as a component of accumulated other comprehensive income (loss). These gains and losses have been restated and are included in net income (loss).

Cumulative translation adjustments (“CTA”) included in accumulated other comprehensive income (loss) were not tax effected. Management has corrected this error by tax effecting CTA and by presenting CTA net of tax within accumulated other comprehensive income (loss).

Common Stock

(10)

A number of shares of the Company’s common stock were repurchased by the Company and cancelled prior to 2010. Management noted these repurchases were incorrectly accounted for as treasury stock. The number of shares issued, and the number of shares held in treasury, were both overstated by 993,623 shares. The number of shares outstanding has been properly presented in all periods. This correction will not result in any change to net stockholders’ equity, nor will it affect any weighted average shares outstanding calculations used in the determination of earnings per share.

The net effect of the adjustments on the Consolidated Statements of Comprehensive Income (Loss) was to increase net income by $0.7 million for the three months ended March 31, 2019.

Restatement Reconciliation Tables

The following tables present a reconciliation of our Consolidated Statements of Comprehensive Income (Loss) and Consolidated Statements of Cash Flows for the three months ended March 31, 2019, as previously reported to the restated amounts shown in this filing. The following restatement adjustment footnote numbers correspond to the restatement adjustment descriptions above.

Tandy Leather Factory, Inc.

Consolidated Statement of Operations and Comprehensive Income

Unaudited

	For the Three Months Ended March 31, 2019
	As Reported			Adjustments				As Restated

Net sales	$	20,785		$	156		(4)	$	20,941
Cost of sales		8,334			362		(1) (2)(2)(3)(4)(5)(7)		8,696
Gross profit		12,451			(206	)			12,245

Operating expenses		11,282			(1,250	)	(5)(7)(8)		10,032

Income from operations		1,169			1,044				2,213

Other (income) expense:
Interest expense		32			-				32
Other, net		(33	)		143		(7)(9)		110
Total other (income) expense		(1	)		143				142

Income before income taxes		1,170			901				2,071

Income tax expense		301			250		(6)		551

Net income	$	869		$	651			$	1,520

Foreign currency translation adjustments, net of tax		287			27		(9)		314

Comprehensive income	$	1,156		$	678			$	1,834

Net income per common share:
Basic	$	0.10		$	0.07			$	0.17
Diluted	$	0.10		$	0.07			$	0.17

Basic		9,009,752			9,009,752				9,009,752
Diluted		9,010,037			9,011,107				9,011,107

Tandy Leather Factory, Inc.

Consolidated Statement of Cash Flows

Unaudited

	For the Three Months Ended March 31, 2019
	As Reported			Adjustments				As Restated
Cash flows from operating activities:
Net income	$	869		$	651			$	1,520
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation and amortization		495			(1	)	(7)		494
Right-of-use asset amortization		-			865		(8)		865
(Gain) loss on disposal of assets		(4	)		-				(4	)
Stock-based compensation		186			-				186
Deferred income taxes		(34	)		218		(6)(9)		184
Exchange (gain) loss		2			134		(7)(9)		136
Changes in operating assets and liabilities:
Accounts receivable-trade		(48	)		(8	)	(7)		(56	)
Inventory		3,303			(131	)	(1)(2)(3)(4)		3,172
Prepaid expenses		(293	)		326		(7)		33
Other current assets		(13	)		(181	)	(7)		(194	)
Accounts payable-trade		(318	)		(963	)	(7)		(1,281	)
Accrued expenses and other liabilities		(1,205	)		49		(4)(7)		(1,156	)
Income taxes		96			13		(6)		109
Other assets		7			(48	)	(7)		(41	)
Operating lease liability		-			(834	)	(8)		(834	)
Total adjustments		2,174			(561	)			1,613
Net cash provided by operating activities		3,043			90				3,133

Cash flows from investing activities:
Purchase of property and equipment		(31	)		-				(31	)
Purchase of short-term investments		(5,000	)		-				(5,000	)
Proceeds from sales of assets		13			-				13
Net cash used in investing activities		(5,018	)		-				(5,018	)

Cash flows from financing activities:
Payments on long-term debt		(8,968	)		-				(8,968	)
Repurchase of treasury stock		(715	)		-				(715	)
Net cash used in financing activities		(9,683	)		-				(9,683	)

Effect of exchange rate changes on cash and cash equivalents		267			(90	)	(9)		177

Net (decrease) increase in cash and cash equivalents		(11,391	)		-				(11,391	)
Cash and cash equivalents, beginning of period		24,070			-				24,070

Cash and cash equivalents, end of period	$	12,679		$	-			$	12,679