SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    Form 10-K

(Mark One)

[X]      ANNUAL  REPORT  PURSUANT  TO  SECTION  13 OR  15(d)  OF THE  SECURITIES
         EXCHANGE ACT OF 1934
         For the fiscal year ended December 31, 2000

                                       OR

[ ]      TRANSITION  REPORT  PURSUANT  TO SECTION 13 OR 15(d) OF THE  SECURITIES
         EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
         For the transition period ________ to ________

          Commission File Number 1-12368

                            THE LEATHER FACTORY, INC.
             (Exact name of registrant as specified in its charter)

           Delaware                                     75-2543540
           --------                                     ----------
(State or other jurisdiction of          (I.R.S. Employer Identification Number)
 incorporation or organization)

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

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

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

      Title of Each Class              Name of Each Exchange on Which Registered
      -------------------              -----------------------------------------
 Common Stock, par value $.0024                American Stock Exchange

           Securities registered pursuant to Section 12(g) of the Act:
                                      None

         Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]

         Indicate by check mark if disclosure of delinquent  filers  pursuant to
Item 405 of Regulation S-K is not contained  herein,  and will not be contained,
to the best of  registrant's  knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in Part  III of this  Form  10-K or any
amendment to this Form 10-K. [X]

         The aggregate  market value of the common stock held by  non-affiliates
of the registrant was  approximately  $2,759,763 at March 10, 2001. At that date
there were 9,968,161 shares of Common Stock outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

         Certain portions of the Registrant's definitive Proxy Statement for the
Annual Meeting of Stockholders  to be held on May 24, 2001, are  incorporated by
reference in Part III of this report.


<PAGE>

Forward-Looking Statements

         This report contains  forward-looking  statements of management.  There
are certain  important risks that could cause results to differ  materially than
those anticipated by some of the forward-looking statements.  Some, but not all,
of the  important  risks which could cause actual  results to differ  materially
from those  suggested by the  forward-looking  statements  include,  among other
things,

         o        changes  from  anticipated  levels  of sales,  whether  due to
                  future   national  or  regional   economic   and   competitive
                  conditions, including, but not limited to, retail craft buying
                  patterns,  and  possible  negative  trends  in the  craft  and
                  western retail markets,

         o        failure to  realized  the  anticipated  benefits of the recent
                  acquisition of the assets of Tandy Leather,

         o        customer   acceptance  of  existing  and  new   products,   or
                  otherwise,  pricing  pressures  due  to  competitive  industry
                  conditions,

         o        increases  in  prices  for  leather  (which  is  a  world-wide
                  commodity) and the Company's inability to pass these increased
                  costs on to customers,

         o        change in tax or interest rates,

         o        change in the commercial banking environment,

         o        problems with the importation of the products that the Company
                  buys in 22  countries  around  the world,  including,  but not
                  limited  to,   transportation   problems  or  changes  in  the
                  political  climate of the  countries  involved,  including the
                  maintenance  by these  countries of Most Favored Nation status
                  with the United States of America, and

         o        other uncertainties, all of which are difficult to predict and
                  many of which are beyond the control of the Company.

The Company does not intend to update forward-looking statements.



                                       2

<PAGE>
                                     PART I

Item 1.  Business.

         As  used  in  this  Report,   the  terms  "we,"  "us,"  "our,"   "TLF,"
"management,"  and  the  "Company"  mean  The  Leather  Factory,  Inc.  and  its
subsidiaries (unless the context indicates a different meaning).

General

         The  Leather  Factory,  Inc.  ("TLF" or the  "Company")  is a  Delaware
corporation  whose common stock trades on the American  Stock Exchange under the
symbol "TLF."

         The Company  sells its products  worldwide and is managed on a business
entity basis,  with those  businesses  being TLF, Tandy Leather  Company ("Tandy
Leather"), and Roberts, Cushman & Company, Inc. ("Cushman").  See Note 13 to the
Consolidated  Financial  Statements  for  financial and  additional  information
concerning the Company's segments.

         TLF,  located  in Fort  Worth,  Texas,  is an  international  wholesale
manufacturer and distributor of a broad product line of leather,  leatherworking
tools, buckles and other belt supplies,  shoe care and repair supplies,  leather
dyes and finishes,  adornments for belts,  bags,  and garments,  saddle and tack
hardware, and do-it-yourself  leathercraft kits. TLF also carries a product line
of small  finished  leather  goods  such as cigar  cases,  wallets  and  western
accessories distributed under the name "Royal Crown Custom Leather".

         Tandy Leather, located in Fort Worth, Texas, sells the same products as
TLF. Cushman,  located in New York, produces and sells a related product line of
hat trims (the decorative piece of material that adorns the outside of a hat).

         The Company  frequently  introduces new products either through its own
manufacturing  capability  or by purchasing  from  vendors.  The Company holds a
substantial  number of  copyrights  for its  designs.  These  designs  have been
incorporated  throughout the Company's product line as a means of increasing its
competitive advantage.

Tandy Leather Acquisition

         On November 30, 2000, Leather Tan Acquisition,  Inc. ("Leather Tan"), a
newly-formed  subsidiary  of the  Company,  acquired the  operating  assets (the
"Tandy  Leather  assets") of TLC Direct,  Inc., a Texas  corporation,  and Tandy
Leather Dealer, Inc., a Texas corporation,  (collectively called the "Sellers").
The Sellers are subsidiaries of Tandycrafts,  Inc.  ("Tandycrafts"),  a New York
Stock  Exchange-listed  company.  Prior to this  transaction,  the Tandy Leather
assets were operated as the "Tandy Leather"  business of Tandycrafts.  The Tandy
Leather assets include machinery,  equipment,  materials,  supplies,  inventory,
trade  booth  inventory,   catalog  inventory,   fixtures,   goods  in  process,
intellectual  property,  goodwill,  trade names  including  "Tandy  Leather" and
"Tandy Leather Company," patents,  trademarks,  copyrights,  leases,  subleases,
contracts,  agreements,  accounts and other receivables,  rights to the Sellers'
Internet Domain,  certain  leathercraft  art, mailing lists and certain historic
furniture.

                                       3

<PAGE>

         The consideration  paid by Leather Tan for the Tandy Leather assets was
cash in the  amount  of  $2.85  million  plus the  assumption  of (a) all of the
Sellers'  trade  payables  incurred in the  ordinary  course of business  within
ninety days prior to November  30,  2000,  (b) all  liabilities  relating to any
contracts assumed by the Company (including the obligations of the Sellers under
certain listed licenses, sub-licenses,  leases, sub-leases, contracts, and other
arrangements),  (c) certain other listed obligations,  (d) filing, recording and
other similar fees, and (e) any liabilities arising after November 30, 2000. The
total amount of the liabilities  assumed by Leather Tan was $658,000 at November
30, 2000. The purchase price was determined by arms' length negotiations between
representatives of the Company and Tandycrafts.

         The source of Leather Tan's cash for this  transaction  was funds drawn
on the  Company's  line of credit with Wells Fargo  Business  Credit,  Inc.  See
"Management's  Discussion  of Financial  Condition  and Results of  Operations."
Subsequent to the  acquisition,  Leather Tan was renamed Tandy Leather  Company,
Inc. ("Tandy Leather").

         Tandy  Leather  sells  similar  products as TLF;  however,  the current
target  market of Tandy  Leather is retail  customers  via the Internet and mail
order sales and wholesales to authorized dealers.  Further details regarding the
Tandy Leather acquisition are provided in Note 12 to the Consolidated  Financial
Statements  and  the  Company's  Current  Report  on Form  8-K  filed  with  the
Securities and Exchange  Commission on December 15, 2000, as amended on February
14, 2001.

         Management  anticipates  that  this  acquisition  will  create  a great
opportunity for continued  expansion.  In years past, Tandy Leather had a strong
reputation  for quality  products,  and its name  recognition  is highest in the
industry. Management believes that with its history and improving reputation for
product and customer service,  Tandy Leather can expand its market share to once
again become one of the premier leaders in the industry.

Distribution and Manufacturing

         The  Company's  customer  base is  comprised  of over 60,000  customers
including  individuals,   institutions,   retailers,  wholesalers,   assemblers,
distributors,  and other manufacturers dispersed  geographically  throughout the
world.  Most  of  our  customers  are  wholesalers,   while  retail  sales  have
historically  comprised less than 10% of the Company's sales.  However,  we have
been  experiencing  a shift in our  sales mix  during  the last few years as our
retail sales have  increased.  In 1999,  our sales mix was 85% wholesale and 15%
retail.  In  2000,  the mix was 80%  wholesale  and  20%  retail.  Sales  of the
Company's products do not reflect significant seasonal patterns.  Looking toward
2001,  we expect this trend to continue to shift as Tandy's  sales  consist of a
much higher percentage of retail sales.

         The   Company   primarily   distributes   its   products   through   28
sales/distribution  units ("Units")  located in nineteen states and Canada,  its
manufacturing  facility and show room in New York,  Tandy  Leather's  mail-order
warehouse  in Texas and  through  its  websites.  The  location  of the Units is
selected  based on the  location  of its  customers,  so that  delivery  time to
customers is minimized.  A two-day maximum  delivery time is the Company's goal.
In addition to offering its customers rapid delivery,  the Company also offers a
"one-stop shopping" concept for both leather and leathercraft  materials.  These
Units service customers  through various means including walk-in traffic,  phone
and mail order. Both wholesale and retail customers  purchase from Units.  These
same Units also service the Authorized Sales Centers  (discussed  below) as well
as  the  craft,  western  and  other  retail  establishments  located  in  close
geographic proximity.

         Our Authorized  Sales Center ("ASC")  program was developed to generate
sales in geographical  areas that we currently do not have a  sales/distribution
unit without the capital  investment  needed to open a Unit. An unrelated person
who  desires  to become an ASC must apply with the  Company  and upon  approval,
place a minimum initial order.  There are also minimum annual  purchase  amounts
set that the ASC must adhere to in order to maintain  ASC status.  In  exchange,
the ASC gets free  advertising  in certain  sale  flyers,  price  breaks on many
products, advance notice of new products,  priority shipping and handling on all
orders,  as well as various  other  benefits.  Tandy  Leather has an  authorized
dealer program as well which is based on a similar concept.  We plan to continue
this  program by  offering an expanded  line of product  combining  both TLF and
Tandy  Leather  merchandise.  The retail appeal of the Tandy Leather name should
enhance this program considerably.

                                       4

<PAGE>

         TLF operates two manufacturing  facilities - one in Fort Worth,  Texas,
that primarily  manufactures  product (suede lace, garment fringe,  leathercraft
and  craft-related  kits) that is sold through the Units, and one in Long Island
City, NY (Cushman),  that sells its product  directly to hat  manufacturers.  We
also purchase  products from other  manufacturers and distributors in twenty-two
countries.

         The  Company's  principal  offices  are  located  at 3847 East Loop 820
South, Fort Worth, Texas 76119 and its phone number is (817) 496-4414.

History

         The  Company  was  first  incorporated  under  the laws of the State of
Colorado in 1984 and  reincorporated  under the laws of the State of Delaware in
June 1994. The Company is the successor to certain entities that were parties to
a series of  transactions  including  a merger in July 1993 which  involved  The
Leather Factory, Inc., a Texas corporation ("TLF-Texas"),  and National Transfer
& Register Corp. ("National"),  a Colorado corporation,  which had no operations
and whose capital stock was widely held but had no active  trading  market prior
to the merger.  The surviving  entity  changed its name to The Leather  Factory,
Inc. and its business became that conducted by TLF-Texas. In the following year,
the Company reincorporated in Delaware.

         As part of its strategy to develop a multi-location  chain of wholesale
units the  Company  has made  numerous  acquisitions  since  its  incorporation,
including  the purchase of six wholesale  units from Brown Group,  Inc., a major
footwear  retailer.  The Company has also acquired  several  businesses  located
throughout the United States that distribute  shoe-related  supplies to the shoe
repair and shoe store industry.  In addition,  the Company purchased  Cushman, a
leading  producer of hat trims, in 1995. In March of 1996, the Company  acquired
all of the issued and outstanding capital stock of its Canadian distributor, The
Leather Factory of Canada,  Ltd. As mentioned  above,  the Company  acquired the
Tandy Leather assets in November 2000.

Business Strategy

         The  Company  operates  through the 28 Units  described  above that are
designed to combine  the  economies  of scale of  warehouse  locations  with the
marketing efficiencies that can be achieved through direct mail. Walk-in traffic
and mail order customers are served from the same location. The type of premises
utilized for the Unit locations is generally light  industrial  office/warehouse
space in proximity to a major freeway or with other similar access. This kind of
location  typically  provides  lower  rental  expense  compared  to  other  more
retail-oriented locations.

         The size and  configuration  of the Units are  planned  to allow  large
quantities  of product to be  displayed  in an easily  accessible  and  visually
appealing manner.  Leather is displayed by the pallet where the customer can see
and touch it,  assessing  first-hand the numerous sizes,  styles,  and grades of
leather and leather goods. The Company  maintains higher  inventories of certain
imported items to ensure a continuous supply.

                                       5

<PAGE>

         The  Company's  Units  are  staffed  by  experienced  managers  who are
primarily  compensated based upon the operating profit of their location.  Sales
from the Units are  generated by the selling  efforts of the location  personnel
themselves,  participation  by the  Company  at  trade  shows,  the use of sales
representative  organizations and the aggressive use of direct mail advertising.
In addition to  generating  mail order  business,  the purpose of the  Company's
direct mail program is to stimulate sales for the Units. The Company utilizes an
internally developed and maintained mailing list, which allows for very targeted
mailing to its various  customer  groups.  As for the utilization of direct mail
and rapid delivery, the Company locates Units in order to get merchandise in the
customers'  hands as soon as possible,  with the added  benefit of lower freight
cost.

         The  Company  attempts to maintain  the number of  stock-keeping  units
("SKU's")  in the primary  Leather  Factory line of  merchandise  at the optimum
number of items  necessary  to balance the  maintaining  of the proper  stock to
minimize  out-of-stock  situations with the carrying costs involved with such an
inventory  level.  The  number of SKU's has been  refined  over the years by the
introduction of new products and the  discontinuing  of selected  products.  The
Company maintains  approximately 4,600 items in the current lines of merchandise
- 1,800 of which are exclusively  TLF's,  1,800 of which are  exclusively  Tandy
Leather's, and 1,000 of which are carried in both.

         Tandy  Leather  operates  from one  warehouse  location  and  sells its
products via mail and phone orders and through its  website.  It currently  does
not service walk-in customers at its location.

Competition

         The Company  sells its  products in three highly  fragmented  markets -
leathercraft,  leather accessories,  and retail craft.  Management believes that
the Company encounters  competition in connection with certain product lines and
in  certain  areas  from  different  companies,  but has no  direct  competition
affecting the entire product line. The Company is larger than most of its direct
competitors,  and we believe  that the recent  Tandy  Leather  acquisition  will
continue this advantage.  The fragmented  nature of these markets is the primary
reason for the lack of broad-based competition.

         The Company competes on price,  availability of merchandise,  and speed
of delivery. The size of the Company relative to most of its competitors creates
competitive  advantage  in its ability to stock a full range of products as well
as in buying merchandise. The Company believes it has a competitive advantage on
price  in  most  product   lines  because  it  purchases  in  bulk  and  has  an
international network of suppliers that can provide quality merchandise at lower
costs.  Most of the Company's  competitors  do not have the multiple  sources of
supply and cannot purchase sufficient  quantities to compete along a broad range
of products.  In fact,  some of the Company's  competitors  are also  customers,
relying on the Company as a supplier.

Expansion and Other Acquisitions

         In 1997 and 1998,  management  focused on  stabilizing  operations  and
obtaining long-term financing, and no acquisitions were made. As a result of the
improving  operating  results,  the Company opened two new Units during 2000 and
four new Units during 1999.  The Company plans to continue its expansion by: (i)
adding two to three Units per year, as and when such  additions  are  determined
feasible;  and (ii)  acquiring  companies in related  areas/markets  which offer
synergistic  aspects  based  on  the  locations  and/or  product  lines  of  the
businesses.

Products/Customers

        The Company's  core business  consists of  manufacturing,  importing and
distributing leather,  traditional leathercraft materials  (do-it-yourself kits,
stamping sets, and  leatherworking  tools),  craft-related  items (leather lace,
beads, and wearable art accessories),  hardware, metal garment accessories (belt
buckles, belt buckle designs, and conchos),  fancy hat trims in braids, leather,
and woven fabrics,  shoe care and repair supplies,  leather finishes,  and small
finished leather goods.

                                       6

<PAGE>

        The  products  manufactured  in Fort  Worth  generally  involve  cutting
leather  into  various  shapes  and  patterns  using  metal  dies  ("clicking"),
fabrication, assembly, and packaging/repackaging tasks. Items made in Fort Worth
are primarily for wholesale distribution using the Company's  sales/distribution
units.  The Cushman  facility  manufactures hat trims and small finished leather
goods. Hat trims are sold to hat manufacturers and distributors directly.  Small
finished leather goods are sold to various  distributors  and retailers  through
attendance at trade shows and the use of sales representatives.

        The customer  groups served  include  wholesale  distributors,  tack and
saddle shops,  shoe-findings  customers,  institutions  (prisons and  prisoners,
schools, hospitals), dealer stores, western stores, craft stores and craft store
chains,  hat  manufacturers  and  distributors,  other large volume  purchasers,
manufacturers, and retailers. No single customer's purchases represent more than
10% of the  Company's  total  sales.  Approximately  five  percent  (5%)  of the
Company's 2000 sales were export sales.

Suppliers

         The Company  currently  purchases  merchandise  and raw materials  from
approximately 200 vendors  dispersed  throughout the United States as well as in
twenty-one  foreign  countries.  In 2000,  the  Company's  ten  largest  vendors
accounted for  approximately  sixty-five  percent (65%) of its total  purchases.
Management  believes that its  relationships  with suppliers are strong and does
not  anticipate  any material  changes in these  supplier  relationships  in the
future.  Due to the number of alternative  sources of supply, the loss of any or
all of these  principal  suppliers  would  not  have a  material  impact  on the
operations of the Company.

         The Company receives some of its supplies and inventory from Europe. In
addition, because leather is sold internationally,  market conditions abroad are
likely to affect the price of leather in the United States.  We believe that the
recent outbreak of  hoof-and-mouth  disease (or  foot-and-mouth  disease) in the
United Kingdom and other parts of Europe and the resulting  mass  destruction of
herds is  likely  to  influence  the  price  of  leather  used in the  Company's
products.  At this time, we cannot predict the amount,  if any, of this increase
in  costs  or if we will be able  to  pass  some or all of the  costs  on to our
customers.

Patents and Copyrights

         The Company  presently  owns 130  copyrights  covering  239  registered
works,  seven  trademarks  covering seven names,  and two patents covering three
products. Registered trademarks include a federal trade name registration on The
Leather  Factory.  The  trademarks  expire at various times starting in 2002 and
ending in 2008,  but can be renewed  indefinitely.  Most  copyrights  granted or
pending are on metal products,  such as conchos,  belt buckles,  and instruction
books. The expiration period for the copyrights begins in 2062 and ends in 2072.
The  Company  has  patents  on two  belt  buckles  and  certain  leather-working
equipment known as the "Speedy Embosser." The patents expire in 2011. Management
considers these intangibles to be valuable assets and defends them as necessary.

Compliance With Environmental Laws

         Compliance by the Company with federal,  state and local  environmental
protection laws has not had, and is not expected to have, a material effect upon
capital expenditures, earnings or the competitive position of the Company.

                                       7

<PAGE>

Employees

         As of December 31, 2000, the Company employed 274 people, with 263 on a
full-  time  basis.  The  Company  is not a party to any  collective  bargaining
agreement.   Eligible  employees   participate  in  The  Leather  Factory,  Inc.
Employees' Stock Ownership Plan and Trust ("ESOP"). As of December 31, 2000, 174
employees and former  employees were  participants  in or  beneficiaries  of the
ESOP.  The  Company  has  the  option  of  contributing  up to 15%  of  eligible
employees'  compensation  into the ESOP. Net  contributions  for 2000, 1999, and
1998 were 5.9%, 5.6%, and 11.6%, respectively,  of eligible compensation.  These
contributions  are  used to  purchase  shares  of the  Company's  Common  Stock.
Generally,  contributions  to the  ESOP  follow a  similar  pattern  as  overall
profitability.  On January 21, 1999, the Company made an additional contribution
to the Plan (for the 1998 plan  year) of  $262,000  in order for the ESOP to pay
the entire balance owed on securities  acquisition loans. Without the additional
contribution, the 1998 net contribution percentage would have been 3.7%.

      Overall, management believes that relations with employees are good.



                                       8


<PAGE>
<TABLE>
<CAPTION>

Item 2.   Properties.

         The Company  leases all of its premises.  Detailed  below are the lease
terms for the  Company's  locations.  The general  character of each location is
light  industrial  office/warehouse  space. The Company believes that all of its
properties are adequately covered by insurance.

  Location Name                 Total Space (Sq. Ft.)     Minimum Annual Rent *         Lease Expiration
  -------------                 ---------------------     -------------------           ----------------
<S>                             <C>                       <C>                            <C>

Chattanooga, TN                        9,040                 $   42,739                   May 2004

Denver, CO                             5,879                     30,000                   September 2004

Harrisburg, PA                         6,850                     38,520                   March 2002

Fort Worth, TX                       101,000                    370,702                   March 2003

Fresno, CA                             5,600                     42,336                   March 2002

Des Moines, IA                         4,000                     30,718                   April 2004

Phoenix, AZ                            4,500                     25,920                   March 2006

Springfield, MO                        6,000                     24,000                   July 2003

Spokane, WA                            5,400                     21,360                   February 2004

Albuquerque, NM                        5,000                     30,000                   October 2003

Salt Lake City, UT                     3,485                     21,600                   July 2004

Baldwin Park, CA                       7,800                     53,400                   March 2005

Tampa, FL                              5,238                     39,212                   January 2003

San Antonio, TX                        5,600                     40,320                   October 2001

Columbus, OH                           6,000                     30,000                   October 2001

El Paso, TX                            5,000                     27,896                   August 2003

Oakland, CA                            8,000                     54,000                   December 2003

Grand Rapids, MI                       8,000                     40,442                   March 2004

Wichita, KS                            5,150                     21,360                   May 2004

New Orleans, LA                        5,130                     22,200                   August 2003

Portland, OR                           5,232                     22,902                   April 2004

Charlotte, NC                          6,202                     29,025                   February 2006

Billings, MT                           2,600                     11,100                   April 2001

Austin, TX                             3,800                     23,250                   April 2004

Tucson, AZ                             3,600                     20,304                   May 2004

Houston, TX                            4,250                     24,000                   November 2005

Dallas, TX                             5,040                     26,400                   September 2005

Long Island City, NY                  10,200                     67,579                   June 2003

Winnipeg, Canada                       5,712                     16,197**                 November 2002
                                  ----------                 ----------
Totals                               259,308                 $1,610,482
                                  ==========                 ==========
</TABLE>
   -------------
      *  Represents  the  average  minimum  annual  rent over the balance of the
         unexpired lease term.
      ** As converted into U.S. dollars.

                                       9

<PAGE>

         The Company's  Fort Worth  location  includes the Fort Worth Unit,  the
Company's central warehouse,  the light manufacturing facility,  Tandy Leather's
offices and warehouse, and the sales and  administrative/executive  offices. The
Company also leases a 284 square foot  showroom in the Denver  Merchandise  Mart
for $4,896 per year. This lease will expire in October 2002.


Item 3.  Legal Proceedings.

         The Company is involved in  litigation  in the  ordinary  course of its
business but is not currently a party to any material pending legal proceedings.


Item 4.  Submission of Matters to a Vote of Security Holders.

         There were no matters  submitted  to a vote of the  Company's  security
holders  during the fourth  quarter of the Company's  fiscal year ended December
31, 2000.

                                     PART II


Item 5.  Market for Registrant's Common Equity and Related Stockholder Matters.

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

                                   1999                        2000
                                   ----                        ----
 Quarter Ended              High         Low           High         Low
 -------------              ----         ---           ----         ---
 March 31,                $0.8750     $0.2188         $1.6875    $0.8125
 June 30,                 $0.7500     $0.3750         $1.5000    $0.9375
 September 30,            $0.7500     $0.5625         $1.4375    $0.9375
 December 31,             $1.1250     $0.8125         $1.5000    $0.9375

There were approximately 627 stockholders of record on March 15, 2001.

         There have been no cash  dividends  paid on the shares of the Company's
Common  Stock and  currently  dividends  cannot be declared or paid  without the
prior  written  consent of Wells Fargo  Business  Credit,  Inc.,  the  Company's
lender. The Board of Directors has historically followed a policy of reinvesting
the  earnings of the Company in the  expansion of its  business.  This policy is
subject to change  based on future  industry and market  conditions,  as well as
other factors beyond the control of the Company.


                                       10

<PAGE>

<TABLE>
<CAPTION>

Item 6.  Selected Financial Data.

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


Income Statement Data                                                     Years Ended December 31,
                                         -----------------------------------------------------------------------------------------
                                                2000               1999              1998               1997              1996
                                         ---------------   ----------------   ---------------    ---------------   ---------------
<S>                                      <C>               <C>                <C>                <C>               <C>

Net sales                                   $30,095,264        $27,164,399       $22,163,994        $25,399,116       $28,253,632
Cost of sales                                15,147,547         14,907,768        12,428,324         14,844,376        17,689,973
                                         ---------------   ----------------   ---------------    ---------------   ---------------
     Gross profit                            14,947,716         12,256,631         9,735,670         10,554,740        10,563,659

Operating expenses                           11,702,633         10,346,420         8,890,045          9,365,673        10,869,359
                                         ---------------   ----------------   ---------------    ---------------   ---------------
Operating income (loss)                       3,245,084          1,910,211           845,625          1,189,067         (305,700)


Other (income) expense                          653,778            900,304           970,340            887,543         1,000,604
                                         ---------------   ----------------   ---------------    ---------------   ---------------

Income (loss) before income taxes             2,591,305          1,009,907         (124,715)            301,524       (1,306,304)

Income tax provision (benefit)                1,049,985            574,851          (85,524)            231,232         (316,536)
                                         ---------------   ----------------   ---------------    ---------------   ---------------

Net income (loss)                             1,541,320            435,056          (39,191)             70,292         (989,768)
                                         ===============   ================   ===============    ===============   ===============

Earnings (loss) per share                          0.16               0.04            (0.00)               0.01            (0.10)
                                         ===============   ================   ===============    ===============   ===============

Earnings (loss) per share--
  assuming dilution                                0.15               0.04            (0.00)               0.01            (0.10)
                                         ===============   ================   ===============    ===============   ===============

Weighted average common
 shares outstanding for:

   Basic EPS                                  9,875,606          9,853,161         9,803,887          9,789,358         9,788,530
                                         ===============   ================   ===============    ===============   ===============

   Diluted EPS                               10,182,803          9,890,098         9,803,887          9,791,565         9,788,530
                                         ===============   ================   ===============    ===============   ===============



Balance Sheet Data                                                          As of December 31,
                                         -----------------------------------------------------------------------------------------
                                                2000               1999              1998               1997              1996
                                         ---------------   ----------------   ---------------    ---------------   ---------------

Total assets                                $19,686,079        $18,220,775       $16,029,937        $17,024,549       $18,264,547
                                         ---------------   ----------------   ---------------    ---------------   ---------------

Notes payable and current
    Maturities of long term debt              5,759,626          6,061,735         6,139,327          4,650,742         8,549,366
                                         ---------------   ----------------   ---------------    ---------------   ---------------

Notes payable and long-term

    Debt, net of current maturities              13,025            121,686            61,389          2,602,728            17,378
                                         ---------------   ----------------   ---------------    ---------------   ---------------

Total Stockholders' Equity                   10,295,637          8,680,425         8,170,278          8,132,646         8,022,937
                                         ===============   ================   ===============    ===============   ===============

</TABLE>

                                       11


<PAGE>

Item 7.  Management's Discussion and Analysis of Financial Condition and Results
         of Operations.

Results of Operations

         The Company continues to experience improved profitability as sales and
gross profit margins  continue to rise.  Gross profit margins rose from 45.1% in
1999 to another  record-breaking  high of 49.7% in 2000. Net sales for 2000 were
$30.1 million, up $2.9 million (10.8%) from fiscal 1999 while operating expenses
in 2000 increased by $1.3 million.  Part of the operating  expense  increase was
due to the increase in sales while the  acquisition  of the Tandy Leather assets
in November 2000 also  accounted for a portion of the increase.  As a percentage
of  sales,  these  expenses  increased  a mere  0.8%  over  1999.  The  dramatic
improvement in profitability resulted primarily from:

         o        continued increases in retail sales,

         o        the opening of two new sales units in 2000, and

         o        increased efficiency in the purchasing of merchandise.

         The results of  operations  in 1999 were  encouraging  as gross  profit
margins reached a high of 45.1% and operating expenses decreased as a percentage
of sales over the prior year. During 1999, total sales were $27.2 million, while
operating  expenses were $10.3 million.  See also  "Management's  Discussion and
Analysis of Financial Condition and Results of Operations."

         Operating  results  for the fourth  quarter of 2000  revealed  slightly
better  results in profit  margins at 50.1%  compared to the total year.  Fourth
quarter 2000 revenues were up modestly ($226,000) from the same period last year
due to Tandy Leather's December sales of $575,000. Without Tandy Leather's sales
contribution,  sales  for the  quarter  would  have been  down  $349,000  due to
decreases  in export  sales and certain  wholesale  categories  (primarily  shoe
care/repair).  As discussed in previous  years,  the  reduction in sales to shoe
care/repair customers is intentional as this industry historically produces very
low margins.  Operating  costs were up 10.5% from the fourth quarter of 1999 due
to the addition of operating  expenses  from Tandy  Leather  operations  for the
month of December.

         Obviously,  we  anticipate  that the  operations  acquired  from  Tandy
Leather will represent a larger portion of the operational results for 2001.

                                       12

<PAGE>

<TABLE>
<CAPTION>

                           Income Statement Comparison

         The following table sets forth, for the fiscal years indicated, certain
items  from the  Company's  Consolidated  Statements  of Income  expressed  as a
percentage of net sales:

                                                  2000       1999       1998
                                                  ------     ------     ------


              Net Sales                           100.0 %    100.0 %    100.0 %
              Cost of sales                        50.3       54.9       56.1
                                                  ------     ------     ------
              Gross profit                         49.7       45.1       43.9
              Operating expenses                   38.9       38.1       40.1
                                                  ------     ------     ------
              Operating income (loss)              10.8        7.0        3.8
              Other (income) expense, net           2.2        3.3        4.4
                                                  ------     ------     ------
              Income (loss) before income taxes     8.6        3.7      (0.6)
              Income tax provision (benefit)        3.5        2.1      (0.4)
                                                  ------     ------     ------
              Net income (loss)                     5.1 %      1.6 %    (0.2) %
                                                  ======     ======     ======


                        Analysis of 2000 Compared to 1999

                                             2000               1999           $ Change          % Change
                                       --------------    ---------------    --------------    --------------
<S>                                    <C>               <C>                <C>               <C>

Net sales                                $30,095,264        $27,164,399        $2,930,864            10.79%
Cost of sales                             15,147,547         14,907,768           239,779             1.61%
                                       --------------    ---------------    --------------
     Gross profit                         14,947,716         12,256,631         2,691,085            21.96%

Operating expenses                        11,702,633         10,346,420         1,356,213            13.11%
                                       --------------    ---------------    --------------
Operating income (loss)                    3,245,084          1,910,211         1,334,872            69.88%

Other (income) expense                       653,778            900,304         (246,525)          (27.38%)
                                       --------------    ---------------    --------------

Income (loss)
     before income taxes                   2,591,305          1,009,907         1,581,399          N/A
Income tax provision (benefit)             1,049,986            574,851           475,134          N/A
                                       --------------    ---------------    --------------

Net income (loss)                        $ 1,541,320          $ 435,056       $ 1,106,263          N/A
                                       ==============    ===============    ==============
</TABLE>

Revenues

         Sales for 2000  continued  its growth trend with a 10.8%  increase over
1999 with our retail sales and ASC programs  accounting  for the majority of the
increase.  We also opened two new  sales/distribution  units in 2000, located in
Dallas and Houston,  TX. Tandy  Leather's sales for December 2000 added $575,000
to the total for the year.

         The primary sales growth is currently  being  generated from the retail
customer market. Retail sales in 2000 increased 35% from 1999. In years past, we
have focused our marketing  efforts  primarily  toward the  wholesale  customer.
Beginning in 1999, as a result of other companies'  intentional  decrease and/or
elimination of their marketing  efforts toward the retail customer,  we began to
specifically  target retail customers in our direct mail advertising  program as
well as in our  sales/distribution  units.  As a  result,  we  have  experienced
significant growth in this market. Tandy Leather's mail-order and Internet sales
is dominated by retail sales and even though our sales for 2000 weren't impacted
(due to the timing of the acquisition), we expect it to contribute significantly
to our retail sales growth in the future.

                                       13

<PAGE>

<TABLE>
<CAPTION>


         Our ASC program generated sales of approximately  $1.7 million in 2000,
with 145  approved  ASC's in the  program.  This  compares to 80  approvals  for
approximately  $900,000 in 1999. Tandy Leather has an authorized  dealer program
in place as well with 74 dealers  worldwide  and is expected to generate  strong
sales in this area going forward.

         Our  export  sales  decreased  slightly  in 2000  as  well as  specific
wholesale categories (shoe care/repair primarily),  but were offset by increases
in sales in our other core markets (saddle and tack, small manufacturers, etc).

Costs, Gross Profit, and Expenses

         Cost of  sales  for  2000  totaled  $15.1  million  or  50.3%  of sales
resulting in a gross profit  margin of 49.7%.  This  compares to a cost of sales
percentage  of 54.9% and gross profit  margin of 45.1% in 1999.  The increase in
retail sales  continues as the  explanation  of the  improvement in gross profit
margins from year to year as well as an increased  efficiency in the  purchasing
of product from vendors due to volume discount and tougher price negotiations.

         Operating  expenses  increased  $1.3 million or 13.1% compared to 1999.
The increase is primarily  the result of increases in payroll  costs  (increased
number of employees due to new  sales/distribution  units opened in 2000,  Tandy
Leather  acquisition,  managers'  bonuses (based on higher profits earned at the
sales/distribution  units)),  and advertising  costs  (increased  efforts toward
retail customers via direct mailing pieces).

Other (Income) Expense

         Other expenses were down 27.4% from 1999.  This reduction is due to the
decrease in interest expense as the average  outstanding debt balances  continue
to drop.

Provision (Benefit) for Income Taxes

         The provision for federal and state income taxes was 40% of 2000 income
before taxes compared to 57% in 1999.  The reduction in the percentage  resulted
because the non-deductible  expenses (goodwill  amortization) that has increased
the  effective  percentage  of  taxes to  income  in the  past  were  relatively
unchanged in amount, but much smaller as a percentage of income before taxes due
to the significant increase in income before taxes in 2000.


                                                   Analysis of 1999 Compared to 1998

                                             1999               1998           $ Change          % Change
                                       --------------    ---------------    --------------    --------------
<S>                                    <C>               <C>                <C>               <C>

Net sales                                $27,164,399        $22,163,994        $5,000,405            22,56%
Cost of sales                             14,907,768         12,428,324         2,479,444            19.95%
                                       --------------    ---------------    --------------
     Gross profit                         12,256,631          9,735,670         2,520,961            25.89%

Operating expenses                        10,346,420          8,890,045         1,456,375            16.38%
                                       --------------    ---------------    --------------
Operating income (loss)                    1,910,211            845,625         1,064,586           125.89%


Other (income) expense                       900,304            970,340          (70,034)           (7.21%)
                                       --------------    ---------------    --------------

Income (loss)
     before income taxes                   1,009,907          (124,715)         1,134,622          N/A
Income tax provision (benefit)               574,851           (85,524)           660,375          N/A
                                       --------------    ---------------    --------------

Net income (loss)                          $ 435,056          $(39,191)          $474,247          N/A
                                       ==============    ===============    ==============
</TABLE>

                                       14

<PAGE>

Revenues

         The Company  experienced  encouraging  growth in net sales  during 1999
primarily due to the absorption of a portion of  Tandycrafts'  market share that
it  abandoned  during the year and the early  signs of renewed  interest  in the
western   apparel  and  craft   markets.   In  addition,   we  opened  four  new
sales/distribution units in 1999, located in Portland, OR, Billings, MT, Austin,
TX, and Tucson, AZ.

         It has been our  experience  that the western and craft  industries are
subject to fads, to some extent. Movies, entertainers,  etc. have a great impact
on the popularity of western  apparel in  particular.  The key to success in the
craft  industry,  oversimplifying  of course,  is being the first company with a
popular idea - whether it be wearable art, photo albums and scrapbook creations,
etc.  As a result,  the  Company's  success in  selling to these two  industries
depends to a point on the latest  successful  craft idea, what is popular at the
box office,  or who won  Entertainer  of the Year.  We believe we are seeing the
beginnings of these two industries' popularity on the rise.



         Partially  offsetting the sales increases in retail,  western and craft
markets  was the  continued  reduction  of sales of certain  low  margin  items.
Because of the historically  low margins earned in our shoe care/repair  product
line, we intentionally eliminated a large portion of the line. This reduced 1999
sales to this industry by approximately $1 million from 1998. We compensated for
this reduction with the development and implementation of our new ASC program.

         The ASC program  began in April 1999,  and as of December 31, 1999,  we
had  approximately  80 approved ASCs. In 1999, the ASCs generated  sales of over
$900,000. Sales in our institutional (prisons and prisoners, schools, hospitals,
etc.) and other core  markets  (saddle  and tack,  semi-professional  hobbyists,
small manufacturers) showed steady and positive growth trends as well.

Costs, Gross Profit, and Expenses

         Cost of sales for 1999  totaled  $14.9  million or 54.9% of sales.  The
percentage  increase  over 1998 was 20%.  The  impact of this  increase  becomes
evident  when  compared to the 22.5%  increase in sales.  The 2.5% gain in gross
profit to sales in 1999  resulted in a gross  profit  percentage  of 45.1% - the
highest  in the  Company's  history  -  compared  to  43.9%  in  1998.  The most
significant  factor  supporting  this  improvement is the increase in our retail
business as retail sales  historically  produce the highest profit  margins.  In
1999, we experienced a 70% jump in retail sales from 1998.

         Operating  expenses  increased $1.45 million or 16.4% compared to 1998.
This increase is a result of higher  payroll costs  resulting from higher sales,
ESOP  contribution  (management's  desire to reward  employees for the Company's
financial  improvement),  managers' bonuses as a result of higher profits earned
at the sales/distribution units, and professional fees.

Other (Income) Expense

         Other expenses were down 7.2% from 1998. This reduction is primarily in
interest  expense due to the decrease in average  outstanding  debt  balances in
1999 as compared to 1998.

Provision (Benefit) for Income Taxes

         The provision for federal and state income taxes was 57% of 1999 income
before   taxes  due  to  $420,000  of   non-deductible   expenses,   principally
amortization of goodwill.  Without these non-deductible  expenses, the Company's
effective  tax rate  approximates  the  Company's  historical  rate for combined
federal, state and local income taxes of 40%.

                                       15

<PAGE>

Financial Condition

         At the end of 1999,  the  Company  had  inventory  of $8.8  million and
$983,000 of property  and  equipment  (net of  depreciation  and  amortization).
Goodwill  and  intangible  assets (net of  amortization)  were $4.8  million and
$191,000.  Net total assets were $18.2 million.  Current  liabilities  were $9.3
million (including current maturities of long-term indebtedness),  and long-term
liabilities were $121,000. Total stockholders' equity was $8.7 million.

         During 2000,  net cash  provided  from  operating  activities  was $3.9
million.  Prior to the Tandy  Leather  transaction  on November  30,  2000,  the
Company  had  applied  $2.54  million to reduce the  outstanding  balance of its
credit facility  described below,  leaving an outstanding  principal  balance of
$3.28  million.  On November 30,  2000,  the Company  drew an  additional  $2.75
million  on this line to fund the cash  portion  of the  purchase  price for the
Tandy Leather assets.  The Company also assumed $658,000 of current  liabilities
of the seller.

         Upon  consummation  of the purchase of the Tandy  Leather  assets,  the
Company recorded the following additions to the Company's assets:

                                                    Recorded Value
                        Assets                            at
                        ------                      Nov. 30, 2000
                                                   ----------------
                Accounts receivable, net                $   268,199
                Inventory                                 1,960,209
                Goodwill                                    409,920
                Other Intangibles                           391,179
                Artwork                                     250,000
                Property and equipment                      167,742
                Other                                        60,622
                                                   -----------------
                             TOTAL                      $ 3,507,871
                                                   =================


         At December 31, 2000, the Company had inventory of $9.2 million and net
property and equipment of $1.2 million.  Goodwill and other  intangibles (net of
amortization and  depreciation)  were $5.0 million and $615,000,  with the Tandy
Leather transaction  resulting in the addition of $250,000 in artwork. Net total
assets were $19.7 million.  Current  liabilities  were $9.3  million  (including
current maturities of long-term indebtedness),  while long-term liabilities were
$13,000.  Total  stockholders'  equity at the end of 2000 had increased to $10.3
million,  principally as a result of the $1.5 million of net income  recorded by
the Company during 2000.

         As a result of various  adjustments  arising  out of the Tandy  Leather
transaction, a total of $157,000 was owed to the Company by Tandycrafts, Inc. at
December  31,  2000,  of which the  entire  amount has been paid as of March 15,
2001.

Capital Resources and Liquidity

         On November  19, 1999,  the Company  entered into a Credit and Security
Agreement with Wells Fargo Business Credit, Inc. ("WFBC"),  in which WFBC agreed
to provide a credit  facility of up to $8,650,000 (the "Credit  Facility").  The
Credit Facility has a three-year term and is secured by all of the assets of the
Company.  The initial  borrowings  from WFBC were used to pay all amounts due by
the Company to FINOVA Capital Corporation and The Schlinger Foundation.

         On November 30, 2000, the Company and its  subsidiaries  entered into a
First Amendment to Credit and Security  Agreement (the  Amendment"),  with WFBC.
There,  WFBC  consented to the Tandy  Leather  transaction  and amended  certain
financial  tests to reflect the  acquisition  of the Tandy Leather assets and to
make previously contemplated extensions of these tests. Among these changes, the
Amendment  dropped a minimum debt  service  requirement  in the existing  credit
agreement,  and increased the percent of eligible  inventory  book value and the
total  amount of  eligible  inventory  (both  computed as provided in the credit
agreement) that can be included in the Company's borrowing base under the credit
agreement.  Also, the Company's  required minimum book net worth and minimum net
income (as these are computed under the agreement) were adjusted for the balance
of the calendar year 2000. In addition,  extensions of these  requirements  were
negotiated   that  raised  the  standards  for  the  Company  from  the  earlier
provisions.  The higher  standards  reflected the Company's  improved  financial
performance since the credit agreement was signed.

                                       16

<PAGE>

<TABLE>
<CAPTION>

         The  Company  is  currently  in  compliance   with  all  covenants  and
conditions contained in the Credit Facility and has no reason to believe that it
will  not  continue  to  operate  in  compliance  with the  provisions  of these
financing  arrangements.  The  principal  terms  and  conditions  of the  Credit
Facility are described in further detail in Note 5 to the Consolidated Financial
Statements.

         The Company  borrows and repays funds under  revolving  credit terms as
needed.  Principal  balances at the end of each quarter during both  facilities'
existence are shown below:

  4th Qtr. `99     1st Qtr. `00    2nd Qtr. `00     3rd Qtr. `00    4th Qtr. `00
  ------------     ------------    ------------     ------------    ------------
   $5,818,652       $5,733,960      $5,070,780       $4,288,372      $5,650,965

         Total  indebtedness  with WFBC (revolving  credit and one term loan) at
the end of 1999 and 2000 are shown below:

                                                                           December 31,
                                              --------------------------------------------------------------------------
                                                            1999                                    2000
                                              --------------------------------------------------------------------------
<S>                                               <C>                    <C>               <C>                  <C>

                                                                     Accrued                                 Accrued
                                               Principal            Interest            Principal            Interest
                                              -------------------------------------------------------------------------
         Revolving Line                           $5,818,652             $49,762           $5,650,965           $50,951
         Term Loan                                   150,000               1,163                  -0-               -0-
                                              --------------       -------------        -------------       -----------
                         TOTAL                    $5,968,652             $50,925           $5,650,965           $50,951
                                              ==============       =============        =============       ===========
</TABLE>

         The primary source of liquidity and capital  resources  during 2000 was
cash flow provided by operating activities.  Cash flows from operations for 2000
were $3.9 million.  The largest portion of the operating cash flow was generated
from the decrease in inventory levels.

         Accounts  receivable  decreased  slightly to $2.2  million  despite the
addition  of  $268,000 in accounts  receivable  from Tandy  Leather  acquisition
compared to $2.3  million at December  31,  1999.  Inventory  increased  to $9.2
million at December 31, 2000 from $8.8  million at December 31, 1999.  The Tandy
Leather  acquisition on November 30, 2000 accounted for a $1.9 million inventory
increase  while TLF's  inventory  decreased $1.4 million from December 31, 1999.
The  aging  of  accounts  receivable  (excluding  the  impact  of  the  accounts
receivable  acquired  from  Tandy  in  November  2000)  has  remained  virtually
unchanged from 1999 to 2000.  Management is exploring various options to improve
the aging and increase the  efficiency  in which the accounts are  monitored and
managed.

         Inventory  turned 3.64 times during 2000  (excluding  the impact of the
Tandy  inventory  acquired in November 2000),  improving  slightly from the 1999
ratio of 3.45 times and the 1998 ratio of 3.11 times.  The  implementation  of a
new  information  system has been very  helpful in the  monitoring  of inventory
levels throughout the Company.

         Accounts  payable  increased  to $2.2 million at December 31, 2000 from
$1.8 million at the end of 1999.  The balance would have remained  constant with
the prior year had it not been for the trade payables assumed in connection with
the Tandy Leather acquisition.

                                       17

<PAGE>

         The Company's  current ratio remained  fairly  constant at December 31,
2000 and 1999 (1.36 and 1.31, respectively).  If, however,  accounting rules had
not required the Company's  debt with WFBC to be classified as short-term  (even
though the maturity is in November 2002), the current ratio at December 31, 2000
would have been 3.57.

         The largest use of cash  generated  from the decrease in inventory  and
accounts  receivable in 2000 was for debt  reduction  prior to the Tandy Leather
acquisition  and various  capital  expenditures.  Capital  expenditures  totaled
$378,000  and  $254,000  for  the  years  ended  December  31,  2000  and  1999,
respectively.  Approximately  50% of 2000 capital  spending was for new computer
equipment  and software with the  remainder  split between  office and warehouse
fixtures, machinery and other equipment, and leasehold improvements.


Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

         The Company's  Credit Facility  includes loans with interest rates that
vary with changes in the prime rate. An increase of one percentage  point in the
prime rate would not have a material impact on the Company's future earnings.

Item 8.  Financial Statements and Supplementary Data.

         The Financial  Statements and Financial Statement Schedule are filed as
a part of this report. See page 15, Index to Consolidated Financial Statements.

Item     9. Change In and  Disagreements  with  Accountants  on  Accounting  and
         Financial Disclosure.

         None



                                       18

<PAGE>

                            THE LEATHER FACTORY, INC.
                            -------------------------

                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
                   ------------------------------------------


Consolidated Balance Sheets at December 31, 2000 and 1999  ..............     20
Consolidated Statements of Operations for the Years Ended
  December 31, 2000, 1999, and 1998  ....................................     21
Consolidated Statements of Cash Flows for the Years Ended
  December 31, 2000, 1999 and 1998   ....................................     22
Consolidated Statements of Stockholders' Equity for the Years
  Ended December 31, 2000, 1999, and 1998  ..............................     23
Notes to Consolidated Financial Statements  .............................     24

     Financial  Statement  Schedules for the years ended  December 31,
     2000, 1999, and 1998:

II - Valuation and Qualifying Accounts and Reserves  ....................     36

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

     Report of Independent Auditors  ....................................     37



                                       19
<PAGE>

<TABLE>
<CAPTION>

                            THE LEATHER FACTORY, INC.
                           CONSOLIDATED BALANCE SHEETS

                                                                                December 31,    December 31,
                                                                                     2000            1999
                                                                                ------------    ------------
<S>                                                                             <C>             <C>
                                     ASSETS
CURRENT ASSETS:
     Cash                                                                       $    234,141    $    134,465
     Cash restricted for payment on revolving credit facility                        390,467         317,904
     Accounts receivable-trade, net of allowance for doubtful accounts of
         $338,000 and $177,000 in 2000 and 1999, respectively                      2,191,996       2,292,645
     Inventory                                                                     9,205,898       8,807,963
     Deferred income taxes                                                           130,802         160,165
     Other current assets                                                            510,473         533,841
                                                                                ------------    ------------
                                     Total current assets
                                                                                  12,663,777      12,246,983
                                                                                ------------    ------------

PROPERTY AND EQUIPMENT, at cost                                                    3,657,601       3,143,594
  Less-accumulated depreciation and amortization                                  (2,494,732)     (2,160,336)
                                                                                ------------    ------------
                                     Property and equipment, net                   1,162,869         983,258

GOODWILL, net of accumulated amortization of $1,367,000
     and $1,160,000 in 2000 and 1999, respectively                                 4,964,704       4,767,885

OTHER INTANGIBLES, net of accumulated amortization of
     $100,000 and $45,000, in 2000 and 1999, respectively                            615,647         191,048
OTHER assets                                                                         279,082          31,601
                                                                                ------------    ------------
                                                                                $ 19,686,079    $ 18,220,775
                                                                                ============    ============

                  LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
     Accounts payable                                                           $  2,159,910    $  1,805,918
     Accrued expenses and other liabilities                                        1,290,613         978,969
     Income taxes payable                                                             94,795         474,262
     Notes payable and current maturities of long-term debt                        5,759,626       6,061,735
                                                                                ------------    ------------
                                     Total current liabilities                     9,304,944       9,320,884
                                                                                ------------    ------------

DEFERRED INCOME TAXES                                                                 72,473          97,780

NOTES PAYABLE AND LONG-TERM DEBT, net of current maturities                           13,025         121,686

COMMITMENTS AND CONTINGENCIES (Notes 6 and 8)                                           --              --

STOCKHOLDERS' EQUITY:
     Preferred stock, $0.10 par value; 20,000,000 shares authorized,
         none issued or outstanding                                                     --              --
     Common stock, $0.0024 par value; 25,000,000 shares authorized, 9,908,161
         and 9,853,161 shares issued and outstanding at 2000 and 1999,
         respectively                                                                 23,780          23,648
     Paid-in capital                                                               3,946,608       3,901,740
     Retained earnings                                                             6,471,754       4,930,434
     Less: Notes receivable - secured by common stock                               (120,339)       (153,416)
     Accumulated other comprehensive loss                                            (26,166)        (21,981)
                                                                                ------------    ------------
                                     Total stockholders' equity                   10,295,637       8,680,425
                                                                                ------------    ------------
                                                                                $ 19,686,079    $ 18,220,775
                                                                                ============    ============
</TABLE>


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

                                       20
<PAGE>
<TABLE>
<CAPTION>





                            THE LEATHER FACTORY, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998



                                                                             2000               1999                 1998
                                                                   ------------------   ----------------    -----------------
<S>                                                                <C>                  <C>                 <C>



NET SALES                                                              $  30,095,264     $   27,164,399         $ 22,163,994


COST OF SALES                                                             15,147,547         14,907,768           12,428,324
                                                                   ------------------   ----------------    -----------------

             Gross profit                                                 14,947,717         12,256,631            9,735,670

OPERATING EXPENSES                                                        11,702,633         10,346,420            8,890,045
                                                                   ------------------   ----------------   -----------------

INCOME FROM OPERATIONS                                                     3,245,084          1,910,211              845,625

OTHER INCOME (EXPENSE):
        Interest expense                                                   (617,400)          (923,092)          (1,003,649)
        Other, net                                                          (36,379)             22,788               33,309
                                                                   ------------------   ----------------    -----------------
             Total other income (expense)                                  (653,779)          (900,304)            (970,340)
                                                                   ------------------   ----------------   -----------------

INCOME (LOSS)  BEFORE INCOME TAXES                                         2,591,305          1,009,907            (124,715)

PROVISION (BENEFIT) FOR INCOME TAXES                                       1,049,985            574,851             (85,524)
                                                                   ------------------   ----------------   -----------------

NET INCOME (LOSS)                                                      $   1,541,320        $   435,056         $   (39,191)
                                                                   ==================   ================    =================





NET INCOME (LOSS) PER COMMON SHARE                                        $     0.16         $     0.04          $    (0.00)
                                                                   ==================   ================   =================

NET INCOME (LOSS) PER COMMON SHARE--Assuming Dilution                     $     0.15         $     0.04          $    (0.00)
                                                                   ==================   ================    =================
</TABLE>

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


                                       21
<PAGE>

<TABLE>
<CAPTION>


                            THE LEATHER FACTORY, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998

                                                                                        2000           1999           1998
                                                                                    -----------    -----------    -----------
<S>                                                                                 <C>            <C>            <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                                 $ 1,541,320    $   435,056    $   (39,191)
  Adjustments to reconcile net income (loss) to net cash provided by operating
   activities-
     Depreciation and amortization                                                      582,778        567,452        527,443
    (Gain) loss on sales of assets                                                        5,089           --           (9,118)
     Amortization of deferred financing costs                                            44,804        225,953        233,239
     Other                                                                                 (128)        13,426         (5,273)
     Net changes in assets and liabilities:
       Accounts receivable-trade, net                                                   368,848       (710,186)       282,817
       Inventory                                                                      1,562,274     (1,851,357)       323,096
       Income taxes payable                                                            (379,467)       615,201         57,031
       Other current assets                                                              83,990       (294,684)       115,140
       Accounts payable                                                                (137,686)       786,849         77,023
       Accrued expenses and other liabilities                                           230,732        448,180        (28,987)
                                                                                    -----------    -----------    -----------

      Total adjustments                                                               2,361,234       (199,166)     1,572,411
                                                                                    -----------    -----------    -----------

      Net cash provided by operating activities                                       3,902,554        235,890      1,533,220
                                                                                    -----------    -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of property and equipment                                                   (377,840)      (254,274)      (137,828)
  Payments in connection with business acquired                                      (2,999,159)          --             --
  Proceeds from sales of assets                                                           2,484           --           10,000
 (Increase) decrease in other assets                                                      2,519          2,235         (2,934)
  Other intangible costs                                                                   --           (8,174)        (1,728)
                                                                                    -----------    -----------    -----------

      Net cash used in investing activities                                          (3,371,996)      (260,213)      (132,490)
                                                                                    -----------    -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Net increase (decrease) in revolving credit loans                                    (167,687)     2,220,664       (432,531)
  Proceeds from notes payable and long-term debt                                           --          150,000           --
  Payments on notes payable and long-term debt                                         (243,083)    (2,605,453)      (620,223)
 (Increase) decrease in cash restricted for payment on revolving credit facility        (72,563)       (85,066)        86,295
  Payments received on notes receivable - secured by common stock                        33,077         71,334         32,867
  Proceeds from issuance of common stock                                                 45,000           --             --
  Deferred financing costs incurred                                                     (25,626)      (103,090)       (27,235)
                                                                                    -----------    -----------    -----------

      Net cash used in financing activities                                            (430,882)      (351,611)      (960,827)
                                                                                    -----------    -----------    -----------

NET INCREASE (DECREASE) IN CASH                                                          99,676       (375,934)       439,903
CASH, beginning of year                                                                 134,465        510,399         70,496
                                                                                    -----------    -----------    -----------

CASH, end of year                                                                   $   234,141    $   134,465    $   510,399
                                                                                    ===========    ===========    ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid during the period                                                   $   572,577    $   697,996    $   787,148
  Income taxes paid during the period, net of (refunds)                               1,424,648        (57,681)      (117,609)

NON-CASH INVESTING ACTIVITIES:
 Computer equipment acquired under capital lease financing arrangements             $      --      $   217,493    $      --
</TABLE>


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


                                       22
<PAGE>
<TABLE>
<CAPTION>

                            THE LEATHER FACTORY, INC.
                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 2000, 1999, AND 1998



                                         Common Stock                                               Notes        Accumulated
                                 ----------------------------                                    receivable         Other
                                    Number            Par          Paid-in        Retained      - secured by    Comprehensive
                                   Of shares         value         capital        earnings      common stock    Income (Loss)
                                 ------------    ------------   ------------    ------------    ------------    ------------
<S>                              <C>             <C>            <C>             <C>             <C>             <C>
BALANCE, December 31, 1997          9,853,161    $     23,648   $  4,119,915    $  4,534,569    $   (257,617)   $    (14,018)


  Payments on notes receivable -
   secured by common stock               --              --             --              --            32,867            --

  Allocation of suspended ESOP
   shares committed to be released       --              --         (258,175)           --              --              --

  Warrants issued to acquire
  200,000 shares of common stock         --              --           40,000            --              --              --

  Net Loss                               --              --             --           (39,191)           --              --

  Translation adjustment                 --              --             --              --              --           (11,720)
                                 ------------    ------------   ------------    ------------    ------------    ------------

BALANCE, December 31, 1998          9,853,161    $     23,648   $  3,901,740    $  4,495,378    $   (224,750)   $    (25,738)

  Comprehensive loss for the year ended December 31, 1998

  Payments on notes receivable -
   secured by common stock               --              --             --              --            71,334            --

  Net Income                             --              --             --           435,056            --              --

  Translation adjustment                 --              --             --              --              --             3,757
                                 ------------    ------------   ------------    ------------    ------------    ------------

BALANCE, December 31, 1999          9,853,161    $     23,648   $  3,901,740    $  4,930,434    $   (153,416)   $    (21,981)


  Comprehensive income for the year ended December 31, 1999

  Payments on notes receivable -
         secured by common stock         --              --             --              --            33,077            --


  Shares issued - employee stock
     options exercised                 55,000             132         44,868            --              --              --

  Net Income                             --              --             --         1,541,320            --              --


  Translation adjustment                 --              --             --              --              --            (4,185)
                                   ------------  ------------    ------------    ------------    ------------    ------------

BALANCE, December 31, 2000            9,908,161  $     23,780    $  3,946,608    $  6,471,754    $   (120,339)   $    (26,166)


  Comprehensive income for the year ended December 31, 2000


                                   Unearned
                                     ESOP                        Comprehensive
                                    Shares           Total       Income (Loss)
                                 ------------    ------------    ------------

BALANCE, December 31, 1997       $   (273,851)   $  8,132,646

  Payments on notes receivable -
   secured by common stock               --            32,867

  Allocation of suspended ESOP
   shares committed to be released    273,851          15,676

  Warrants issued to acquire
  200,000 shares of common stock         --            40,000

  Net Loss                               --           (39,191)        (39,191)

  Translation adjustment                 --           (11,720)        (11,720)
                                 ------------    ------------

BALANCE, December 31, 1998       $       --      $  8,170,278

                                                                 ------------
  Comprehensive loss for the year ended December 31, 1998        $    (50,911)
                                                                 ============
  Payments on notes receivable -
   secured by common stock               --            71,334

  Net Income                             --           435,056         435,056

  Translation adjustment                 --             3,757           3,757
                                 ------------    ------------

BALANCE, December 31, 1999       $       --      $  8,680,425

                                                                 ------------
  Comprehensive income for the year ended December 31, 1999      $    438,813
                                                                 ============

  Payments on notes receivable -
         secured by common stock        --            33,077

  Shares issued - employee stock
     options exercised                  --            45,000

  Net Income                            --         1,541,320        1,541,320

  Translation adjustment                --            (4,185)          (4,185)
                                 ------------    ------------

BALANCE, December 31, 2000       $       --      $ 10,295,637

                                                                 -------------
  Comprehensive income for the year ended December 31, 2000      $   1,537,135
                                                                 =============

</TABLE>


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


                                       23
<PAGE>

                            THE LEATHER FACTORY, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                        DECEMBER 31, 2000, 1999, AND 1998


1.  ORGANIZATION AND NATURE OF OPERATIONS

The Leather  Factory,  Inc. and  subsidiaries  (the "Company") is engaged in the
manufacture and distribution of a broad product line of leather,  leather crafts
and finished goods,  western apparel and related  accessory  items.  The Company
operates  sales/distribution  units in 19 states and Canada.  Numerous customers
including   retailers,   wholesalers,   assemblers,   distributors   and   other
manufacturers   geographically  disbursed  throughout  the  world  purchase  the
Company's products. The Company also has light manufacturing facilities in Texas
and New York.


2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation

The consolidated  financial  statements  include the accounts of the Company and
its  subsidiaries,  all of  which  are  wholly-owned.  Significant  intercompany
accounts and transactions have been eliminated in consolidation.

Inventory

The Company's  inventory is valued at the lower of first-in,  first-out  cost or
market and consists of the following at December 31:

                                                       2000             1999
                                                       ----             ----
       Finished goods held for sale                 $8,175,429       $7,629,995
       Raw Materials and work in process             1,030,469        1,177,968
                                                    ----------       ----------
                                                    $9,205,898       $8,807,963
                                                    ==========       ==========


                                       24
<PAGE>

Property and Equipment

Property and  equipment are stated at cost.  Expenditures  for  maintenance  and
repairs are charged to expense when incurred. The cost of assets retired or sold
and the  related  amounts  of  accumulated  depreciation  are  removed  from the
accounts,  and any  gain  or  loss  is  included  in the  statement  of  income.
Depreciation  is determined  using the  straight-line  method over the estimated
useful lives as follows:

       Leasehold improvements             5-7 years (or lease term if shorter)
       Equipment                          5-10 years
       Furniture and fixtures             5-7 years
       Automobiles                        5 years

Depreciation  expense was $358,787;  $347,651;  and $308,568 for the years ended
December 31, 2000, 1999 and 1998, respectively.

Goodwill

Goodwill  resulting  from  business  purchases  accounted for using the purchase
method of accounting is being amortized on a straight-line  basis over estimated
useful lives ranging from ten to forty years.

The Company assesses the  recoverability of goodwill by determining  whether the
asset  balance can be recovered  over its  remaining  life through  undiscounted
future operating cash flows of the acquired asset. The amount of impairment,  if
any, is measured based on projected discounted future operating cash flows.

Amortization expense of $223,991 in 2000; $219,801 in 1999; and $218,875 in 1998
was recorded in operating expenses.

Advertising Costs

With the exception of catalog costs, advertising costs are expensed as incurred.
Catalog costs are capitalized and expensed over the estimated useful life of the
particular  catalog in question,  which is typically  twelve to fifteen  months.
Such capitalized  costs are included in other current assets and totaled $40,579
and  $29,635 at  December  31, 2000 and 1999,  respectively.  Total  advertising
expense was $1,353,520 in 2000; $1,040,671 in 1999; and $908,432 in 1998.

Revenue Recognition

Sales are recorded when goods are shipped to customers.

Income Taxes

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

Earnings Per Share

The  Company  computes   earnings  (loss)  per  share  in  accordance  with  the
requirements of Statement of Financial  Accounting  Standards No. 128,  Earnings
per Share ("SFAS 128"). SFAS No. 128 requires the disclosure of both "basic" and
"diluted"  earnings per share.  Basic earnings per share is computed by dividing
income available to common stockholders by the weighted average number of common
shares  outstanding.  Diluted  earnings per share is computed by dividing income
available to common stockholders by the weighted average number of common shares
outstanding  increased for potentially dilutive common shares outstanding during
the period. The dilutive effect of stock options, warrants and their equivalents
is  calculated  using the treasury  stock  method.  Unearned  shares held by the
Employees'  Stock  Ownership Plan are deemed not to be outstanding  for earnings
per share calculations.

Accounting Estimates

The consolidated  financial statements include estimates and assumptions made by
management  that  affect the  reported  amounts of assets and  liabilities,  the
reported  amounts of revenues  and  expenses and the  disclosure  of  contingent
assets and liabilities. Actual results could differ from those estimates.

Long-Lived Assets

The Company  applies SFAS No. 121,  Accounting  for the Impairment of Long-Lived
Assets and for  Long-Lived  Assets to be Disposed of. SFAS No. 121 requires that
long-lived  assets and certain  identifiable  intangible  assets be reviewed for
impairment whenever events indicate that the carrying amount of an asset may not
be recoverable. The Company determined that as of December 31, 2000 and 1999, it
had no long-lived assets that met the impairment criteria of SFAS No. 121.


                                       25
<PAGE>

Stock-Based Compensation

SFAS No. 123,  Accounting for Stock-Based  Compensation,  establishes  financial
accounting and reporting standards for stock-based employee  compensation plans.
As  permitted  by SFAS No.  123,  the  Company  has  elected to  continue to use
Accounting  Principles  Board  Opinion No. 25,  Accounting  for Stock  Issued to
Employees  ("APB 25") and related  Interpretations,  in accounting for its stock
option plans.

Foreign Currency Translation

Foreign currency translation  adjustments arise from activities of the Company's
Canadian  operations.  Results of operations  are translated  into U.S.  dollars
using the average exchange rates during the period, while assets and liabilities
are translated using  period-end  exchange rates.  Foreign currency  translation
adjustments of assets and liabilities are recorded in stockholders' equity.

Comprehensive Income

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

Reclassification

Certain   reclassifications  have  been  made  to  conform  the  1998  financial
statements to the  presentation in 1999 and 2000. The  reclassifications  had no
effect on net income.

3.  OTHER CURRENT ASSETS

Other current assets consisted of the following at December 31:

                                           2000            1999
                                           ----            ----
       Accounts receivable - employees    $106,370        $ 63,643
       Accounts receivable - other         160,417         189,373
       Prepaid expenses                    177,535         237,152
       Other                                66,151          43,673
                                        ----------      ----------
                                          $510,473        $533,841
                                        ==========      ==========


4.  ACCRUED EXPENSES AND OTHER LIABILITIES

Accrued  expenses and other  liabilities  consisted of the following at December
31:

                                              2000            1999
                                              ----            ----
       Accrued bonuses                     $  784,528      $  462,503
       Accrued payroll                        118,138         100,771
       Accrued ESOP contribution               86,000         160,000
       Sales and payroll taxes payable         52,851          41,047
       Other                                  249,096         214,648
                                          -----------     -----------
                                           $1,290,613      $  978,969
                                          ===========     ===========


5.  NOTES PAYABLE AND LONG-TERM DEBT

On November 19, 1999, the Company  entered into a Credit and Security  Agreement
with Wells Fargo Business Credit, Inc. ("Wells Fargo"),  pursuant to which Wells
Fargo agreed to provide a credit facility of up to $8,650,000 in debt (the "Debt
Facility").  The  Debt  Facility  has a  three-year  term  and is  made  up of a
revolving credit facility and a $150,000 term note.


                                       26
<PAGE>
<TABLE>
<CAPTION>

At  December  31,  2000 and  1999,  the  amounts  outstanding  under  the  above
agreements and other long-term debt consisted of the following:
                                                                                                2000               1999
                                                                                                ----               ----
<S>                                                                                          <C>                    <C>
        Credit and Security  Agreement with Wells Fargo - collateralized  by all
        of the assets of the Company; payable as follows:

                 Revolving Note dated November 19, 1999 in the maximum principal
                 amount of  $8,500,000  with  revolving  features  as more fully
                 described below - interest due monthly at prime plus 1/2% (9.5%
                 at December 31, 2000); matures November 30, 2002                            $5,650,965         $5,818,652


                 Term Note dated  November  19, 1999 in the  original  principal
                 amount of $150,000 -- $30,000 monthly principal payments plus
                 interest at prime plus1/2%; matured May 1, 2000                                       -          $150,000

        Capital Leases secured by computer  equipment - total monthly  principal
        and interest payments of $9,324 at approximately 12% interest; maturing
        in February through August of 2002                                                       121,686           214,769
                                                                                         ---------------   ---------------
                                                                                               5,772,651         6,183,421
        Less - Current maturities (see below)                                                  5,759,626         6,061,735
                                                                                         ---------------   ---------------
                                                                                             $    13,025        $  121,686
                                                                                         ===============   ===============
</TABLE>

The current portion of long-term debt includes the Wells Fargo Revolving  Credit
Loan  although  this  obligation  does not mature until  November 30, 2002.  The
classification of this debt was attributable to an accounting requirement that a
revolving credit agreement that includes both a subjective  acceleration  clause
and a requirement to maintain an arrangement,  whereby cash collections from the
borrower's customers directly reduce the debt outstanding, to be classified as a
short-term  obligation  (Emerging  Issues Task Force Issue 95-22). A covenant of
the Debt Facility is that  collections from customers are to be deposited into a
cash collateral  account that directly pays down the Revolving  Credit Loan. The
balance in this account  comprises the restricted cash on the Company's  balance
sheet. Because of this arrangement and the fact that the debt agreement contains
a clause  that  would  allow  acceleration  of  payment of the debt in case of a
"material adverse change",  this rule applies.  Management does not believe that
any such acceleration will occur.

The  Company  periodically  has  outstanding  letters  of credit  for  inventory
purchase  commitments  with terms  ranging from sight to 90 days. As of December
31, 2000, there were no letters of credit outstanding.

Pursuant to the Credit and  Security  Agreement  with Wells  Fargo,  the overall
combined  borrowings under the revolving credit facility and outstanding balance
on  letters of credit is limited  to a  combined  amount of  $8,500,000.  Of the
$8,500,000 limit,  letters of credit cannot exceed $500,000.  The unused portion
of the letter of credit limit can be utilized for  borrowings,  up to the limits
imposed  for the  indebtedness.  Total  borrowings  under this  arrangement  are
subject to a percentage of trade accounts  receivable  and inventory  reduced by
the  outstanding  balance of letters of credit and any  required  reserves.  The
unused portion of the credit facility at December 31, 2000 and 1999 was $884,759
and $508,410, respectively.

The terms of the Debt  Facility  contain  various  covenants  which  among other
things  require the  Company to maintain a certain  level of income and book net
worth and limit capital expenditures.  Other covenants prohibit the Company from
incurring  indebtedness  except as permitted by the terms of the Debt  Facility,
from  declaring or paying cash dividends upon any of its stock and from entering
into  any new  business  or  making  material  changes  in any of the  Company's
business objectives, purposes or operations.

Scheduled  maturities of the Company's  notes payable and long-term  debt are as
follows:

                              2001         $   108,661
                              2002           5,663,990
                                           -----------
                                           $ 5,772,651
                                           ===========

6.  EMPLOYEE BENEFIT PLAN

The Company has an Employee Stock Ownership Plan (the "Plan") for employees with
at least one year of service (as defined by the Plan) and who have reached their
21st  birthday.  Under  the  Plan,  the  Company  makes  annual  cash  or  stock
contributions  to a trust  for the  benefit  of  eligible  employees.  The trust
invests in shares of the  Company's  common  stock.  The amount of the Company's
annual  contribution is  discretionary.  Benefits under the Plan are 100% vested
after  three  years  of  service  and are  payable  upon  death,  disability  or
retirement. Vested benefits are payable upon termination of employment.
                                       27
<PAGE>

The  Company  applies  Statement  of  Position  93-6  (SOP  93-6"),  "Employers'
Accounting for Employee  Stock  Ownership  Plans," of the  Accounting  Standards
Division of the American  Institute of CPAs.  Contributions made during 1994 and
1995 in the amount of $99,962 and $226,222, respectively, represented securities
acquisition loans. In accordance with SOP 93-6,  securities purchased with these
loans were recorded as unearned ESOP shares.  The unearned ESOP share account is
reduced by the cost of the shares  when they are  committed  to be  released  to
participants  as payments are made on the loans using the principal and interest
method.  Compensation  expense is measured  using the average  fair market value
when  shares  are  committed  to  be  released  to  the  employee.  The  Company
contributed   $249,017,   $208,214;   and  $125,408  in  cash  as  current  year
contributions  to the plan  during  2000,  1999,  and  1998,  respectively,  and
recognized compensation expense related to these payments of $249,017, $208,214;
and $42,046 in 2000, 1999, and 1998, respectively.  Furthermore,  on January 21,
1999, the Company made an additional  contribution to the Plan for December 1998
in the  amount  of  $261,920.  As a result  of this  contribution,  the  Company
recognized an additional compensation expense of $10,538 during 1998 relating to
the Plan.

The  following  table  summarizes  the number of shares held by the Plan and the
market value as of December 31, 2000, 1999, and 1998:

                            No. of Shares                    Market Value
                            -------------                    ------------
                      2000     1999     1998         2000      1999      1998
                      ----     ----     ----         ----      ----      ----
       Allocated      808,539  598,132  692,606     $808,539  $486,281  $173,152
       Unearned             -        -        -            -         -         -
                      -------  -------  -------     --------  --------  --------
        Total         808,539  598,132  692,606     $808,539  $486,281  $173,152
                      =======  =======  =======     ========  ========  ========

The Company currently offers no postretirement or postemployment benefits to its
employees.


7.  INCOME TAXES

The provision for income taxes consists of the following:

                                        2000         1999         1998
                                        ----         ----         ----
      Current provision (benefit):
                   Federal           $  849,994   $  370,053   $  (60,240)
                     State              191,070      207,171      (12,340)
                                     ----------   ----------   ----------
                                      1,041,064      577,224      (72,580)

      Deferred provision (benefit):
                   Federal                7,418       (2,373)     (10,900)
                    State                 1,503            -       (2,044)
                                     ----------   ----------   ----------
                                          8,921       (2,373)     (12,944)
                                     ----------   ----------   ----------
                                     $1,049,985   $  574,851   $  (85,524)
                                     ==========   ==========   ==========

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

                                                          2000         1999
                                                          ----         ----
Deferred income tax assets:
    Allowance for doubtful accounts                     $  33,621    $  66,453
    Capitalized inventory costs                            88,575       85,175
    Accrued expenses, reserves, and other                   8,606        8,537
                                                        ---------    ---------

    Total deferred income tax assets                      130,802      160,165
                                                        ---------    ---------
Deferred income tax liabilities:
    Property and equipment depreciation                    63,395       83,598
    Goodwill and other intangible assets amortization      11,643       11,337
    Tax effect of translation adjustment and other         (2,565)       2,845
                                                        ---------    ---------

    Total deferred income tax liabilities                  72,473       97,780
                                                        ---------    ---------

    Net deferred tax asset                              $  58,329    $  62,385
                                                        =========    =========


                                       28
<PAGE>

<TABLE>
<CAPTION>

The effective tax rate differs from the statutory rate as follows:
                                                       2000     1999     1998
                                                      -----    -----    -----
          Statutory rate                                34%      34%     (34%)
          State and local taxes                          7%      20%      (7%)
          Non-deductible goodwill amortization           3%       8%      67%
          ESOP transaction                               0%       0%    (112%)
          Other                                         (3%)     (5%)     17%
                                                      -----    -----    -----
          Effective rate                                41%      57%     (69%)
                                                      =====    =====    =====



8.  COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company's primary office facility and warehouse are leased under a five-year
lease  agreement  that  expires  in  March  2003.   Rental  agreements  for  the
sales/distribution  units  expire on dates  ranging  from March 2001 to February
2006.  The  Company's  lease  agreement for the  manufacturing  facility in Long
Island City, New York, expires on June 30, 2003.

Rent expense on all operating leases for the years ended December 31, 2000, 1999
and 1998, was $1,106,171; $1,047,882; and $1,017,491, respectively.

Capital Leases

The Company leases certain  computer  equipment under capital lease  agreements.
Assets  subject to the  agreements  totaling  $346,601  and related  accumulated
depreciation  of $177,929 and $108,608 are included in property and equipment as
of December 31, 2000 and 1999, respectively.

Commitments

Future minimum lease payments under capital and  noncancelable  operating leases
at December 31, 2000 were as follows:
                                                                           Capital     Operating
                                                                            Leases      Leases
                                                                          ----------  -----------
<S>                                                                       <C>         <C>
     Year ending December 31:
                                     2001                                  $ 111,058  $ 1,214,827
                                     2002                                     32,837    1,103,477
                                     2003                                          -      687,054
                                     2004                                          -      265,629
                                     2005 and thereafter                           -      100,006
                                                                          ----------  -----------
     Total minimum lease payments                                            143,895  $ 3,370,993
                                                                                      ===========
     Less amount representing interest                                        22,210
                                                                          ----------
     Present value of net minimum capital lease payments                     121,685
     Less current installments of minimum capital lease payments             108,660
                                                                          ----------
     Long-term capital lease obligations, excluding current installments   $  13,025
                                                                          ==========
</TABLE>

Litigation

The Company is involved in various  litigation that arise in the ordinary course
of its  business  and  operations.  There are no such  matters  pending that the
Company expects to have a material impact on its financial  position and results
of operations.

9.  SIGNIFICANT BUSINESS CONCENTRATIONS AND CREDIT RISK

Major Customers

The Company's  revenues are derived from a diverse group of customers  primarily
involved  in the sale of leather  crafts and  western  apparel  items.  While no
single  customer  accounts  for  more  than  10% of the  Company's  consolidated
revenues in 2000, 1999 and 1998,  sales to the Company's five largest  customers
represented 14%, 19% and 18%,  respectively,  of consolidated  revenues in those
years.  While  management  does not believe  the loss of one of these  customers
would have a negative  impact on the Company's  operations,  it does believe the
loss of several of these customers  simultaneously or a substantial reduction in
sales  generated  by them  could  temporarily  affect  the  Company's  operating
results.


                                       30
<PAGE>

<TABLE>
<CAPTION>

Major Vendors

The  Company  purchases  a  significant  portion of its  inventory  through  one
supplier.  Due to the number of  alternative  sources  of  supply,  loss of this
supplier would not have an adverse impact on the Company's operations.

Credit Risk

Due to the large number of customers  comprising  the Company's  customer  base,
concentrations of credit risk with respect to customer  receivables are limited.
At  December  31, 2000 and 1999,  18% and 29%,  respectively,  of the  Company's
consolidated  accounts  receivable  were due from  three  nationally  recognized
retail chains.  The Company does not generally  require  collateral for accounts
receivable,  but performs  periodic  credit  evaluations  of its  customers  and
believes the allowance  for doubtful  accounts is adequate.  It is  management's
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 the
Company's results of operations and financial condition.


10.  EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per
share:

                                                         2000          1999           1998
                                                         ----          ----           ----
<S>                                                  <C>           <C>            <C>

Numerator:
      Net income (loss)                              $ 1,541,320   $   435,056    $   (39,191)
      Numerator for basic and diluted earnings per          --            --
      share                                            1,541,320       435,056        (39,191)


Denominator:
      Denominator for basic earnings per share -
      weighted-average shares                          9,875,606     9,853,161      9,803,887

Effect of dilutive securities:
      Stock options                                      134,300         5,019           --
      Warrants                                           172,897        31,918           --
                                                     -----------   -----------    -----------
Dilutive potential common shares                         307,197        36,937           --
                                                     -----------   -----------    -----------
      Denominator for diluted earnings per share -
      adjusted weighted-average shares and assumed
      conversions                                     10,182,803     9,890,098      9,803,887
                                                     ===========   ===========    ===========

      Basic earnings per share                       $      0.16   $      0.04    $     (0.00)
                                                     ===========   ===========    ===========
                                                     $      0.15   $      0.04    $     (0.00)
      Diluted earnings per share                     ===========   ============   ===========
</TABLE>

For  additional  disclosures  regarding  the  employee  stock  options  and  the
warrants,  see note 11.  Unexercised  employee  and  director  stock  options to
purchase  6,000 and 150,000  shares of common  stock as of December 31, 2000 and
1999,  respectively,  were not included in the  computations of diluted earnings
per share  ("EPS")  because the  options'  exercise  prices were greater than or
equal to the  average  market  prices of the common  stock and,  therefore,  the
effect would be  antidilutive.  The net effect of  converting  stock  options to
purchase  452,000 and 447,000  shares of common stock at option prices less than
the average market prices has been included in the  computations  of diluted EPS
for the years ended December 31, 2000 and 1999, respectively.


11.  STOCKHOLDERS' EQUITY

Stock Option Plans

1995 Stock Option Plan
In  connection  with its 1995 Stock Option Plan for officers and key  management
employees, the Company has outstanding options to purchase its common stock. The
plan provides for the granting of either  qualified  incentive  stock options or
non-qualified  options at the  discretion of the  Compensation  Committee of the
Board  of  Directors.  Options  are  granted  at the  fair  market  value of the
underlying  common stock at the date of grant and vest over a five-year  period.
The Company has reserved  1,000,000  shares of common  stock for issuance  under
this plan.


                                       31
<PAGE>
<TABLE>
<CAPTION>

1995 Director Non-Qualified Stock Option Plan
In  connection  with its  1995  Director  Non-qualified  Stock  Option  Plan for
non-employee  directors,  the Company has  outstanding  options to purchase  its
common stock. The plan provides for the granting of non-qualified options at the
discretion of the Compensation Committee of the Board of Directors.  Options are
granted at the fair market value of the  underlying  common stock at the date of
grant and vest after six  months.  The Company has  reserved  100,000  shares of
common stock for issuance under this plan.


Stock Option Summary
All options  expire ten years from the date of grant and are  exercisable at any
time after  vesting.  Of the combined  1,100,000  shares  available for issuance
under the two plans,  at December 31, 2000,  1999 and 1998,  there were 587,000;
647,000; and 557,000; respectively, shares available for future grants.

A summary of stock option  transactions  for the years ended  December 31, 2000,
1999, and 1998, is as follows:

                                                 2000                     1999                     1998
                                       -----------------------    ----------------------   ----------------------
                                                     Weighted                  Weighted                 Weighted
                                                     Average                   Average                   Average
                                         Option      Exercise       Option     Exercise      Option     Exercise
                                         Shares       Price         Shares      Price        Shares       Price
                                       ------------ -----------   ----------- -----------   ----------  ----------
<S>                                    <C>          <C>           <C>         <C>           <C>         <C>
   Outstanding at January 1                453,000      $0.779       543,000      $0.758      566,000      $0.874
   Granted                                  60,000       0.958        10,000       0.690      108,000       0.500
   Forfeited or expired                       -           -         (100,000)      0.656     (131,000)      1.047
   Exchanged                                  -           -             -           -             -           -
   Exercised                              (55,000)       0.676          -           -             -           -
                                       ------------ -----------   ----------- -----------   ----------  ----------
   Outstanding at December 31              458,000      $0.814       453,000      $0.779      543,000      $0.758
                                       ============ ===========   =========== ===========   ==========  ==========
   Exercisable at end of year              358,000      $0.820       318,000      $0.813      255,000      $0.838
                                       ============ ===========   =========== ===========   ==========  ==========
   Weighted-average fair value of
    Options granted during year             $ 0.61                    $ 0.45                   $ 0.31
                                       ============               ===========               ==========

</TABLE>

The  following  table  summarizes  outstanding  options  into groups  based upon
exercise price ranges at December 31, 2000:
<TABLE>
<CAPTION>

                                           Options Outstanding                        Options Exercisable
                                   -------------------------------------      -------------------------------------
                                                 Weighted     Weighted                       Weighted    Weighted
                                                  Average     Average                        Average     Average
                                      Option     Exercise     Maturity           Option      Exercise    Maturity
      Exercise Price Range            Shares       Price      (Years)            Shares       Price      (Years)
      --------------------         ------------- ----------  -----------      ------------- ----------- -----------
<S>   <C>                          <C>           <C>         <C>              <C>           <C>         <C>
          $0.75 or Less                  67,000    $ 0.585         7.32             27,000      $0.642        7.79

       More than $0.75 and
         Less Than $1.00                375,000      0.829         5.42            325,000       0.813        4.75

         More than $1.00                 16,000      1.422         8.13              6,000       2.021        5.42
                                   ------------- ----------  -----------      ------------- ----------- -----------
                                        458,000    $ 0.814         5.79            358,000     $ 0.820        4.99
                                   ============= ==========  ===========      ============= =========== ===========
</TABLE>

Pro forma information  regarding net income (loss) and earnings (loss) per share
is  required  by SFAS No.  123,  and has been  determined  as if the Company had
accounted for its stock options under the fair value method.  The fair value for
these options was estimated at the date of grant using the Black Scholes  option
pricing  model  with  the  following  weighted-average  assumptions:   risk-free
interest  rates of 5.75% in 2000;  5.88% in 1999;  and  5.00% in 1998;  dividend
yields of 0% for all years;  volatility factors of .821 for 2000, .851 for 1999;
and .693 for 1998; and an expected life of the valued options of 5 years for all
years other than some exchanged  options  reissued in 1997 which had an expected
remaining life of 4 years.


                                       32
<PAGE>

<TABLE>
<CAPTION>

Option  valuation  models  require the input of highly  subjective  assumptions,
including  the  expected  stock  price  volatility,  and  changes in these input
assumptions can materially affect the fair value estimate they produce.  Because
of this,  it is  management's  opinion that existing  models do not  necessarily
provide a reliable single measure of fair value for the Company's stock options.
For pro forma disclosures, the estimated fair values determined by the model are
being  amortized to expense on a  straight-line  basis over the options  vesting
period  as  adjusted  for  estimated   forfeitures.   The  Company's  pro  forma
information follows:

                                                                     2000        1999          1998
                                                                     ----        ----          ----
<S>                                                              <C>          <C>          <C>

Pro forma net income (loss)                                      $ 1,419,693  $  277,780   $  (310,098)


Pro forma net income (loss) per common share                     $      0.14  $     0.03   $     (0.02)


Pro forma net income (loss) per common share--Assuming Dilution  $      0.14  $     0.03   $     (0.02)

</TABLE>

Warrants

In connection with the issuance of a Subordinated  Debenture in 1997,  which has
since then been  satisfied  in its  entirety,  the  Company  issued  warrants to
acquire  up to  100,000  shares  of Common  Stock at $.54 per  share to  certain
unrelated individuals. The warrants may be exercised at anytime until expiration
on November 21, 2002.

Warrants to acquire up to 200,000 shares of common stock at approximately  $0.44
per share were issued in conjunction with a consulting agreement to an unrelated
individual  in August 1998.  The  warrants  may be  exercised  at anytime  until
expiration on August 3, 2003. The fair value for these warrants was estimated at
the  date of grant  using  the  Black  Scholes  option  pricing  model  with the
following  weighted-average  assumptions:   risk-free  interest  rate  of  5.0%;
dividend  yield of 0%;  volatility  factor of .645;  and an  expected  life of 3
years.  The  estimated  fair value of the warrants of $40,000 was recorded as an
expense in 1998.

Notes Receivable Secured by Common Stock

During 1996,  the Company  purchased  certain  notes from  NationsBank  that are
collateralized  by the  Company's  common  stock.  These notes  relate to shares
issued under the Company's 1993 Non-Qualified Incentive Stock Option Plan. These
notes, as renewed in 2000, are due from certain  individuals  including officers
and other members of  management,  require  monthly  payments,  and have various
maturity dates ranging from June 30, 2001 to December 31, 2002.


12. BUSINESS ACQUISITION

In  November  2000,  the  Company  acquired  the  assets,   primarily   accounts
receivable,  inventory,  fixtures, and equipment,  of TLC Direct, Inc. and Tandy
Leather Dealer,  Inc. (dba Tandy Leather Company),  a distributor of leather and
related  products  located  in Fort  Worth,  Texas.  Additionally,  the  Company
acquired the exclusive  right to certain  trademarks  associated  with the Tandy
Leather  business.  The total  purchase  price for the operating and  intangible
assets was approximately $2,850,000,  subject to adjustment.  The purchase price
was funded with proceeds from the Company's  revolving credit facility (see note
5). The  transaction  was accounted for under the purchase  method of accounting
and the purchase  price was allocated to the net assets  acquired based on their
estimated  fair  values.  The  excess of cost over the fair  value of net assets
acquired  of  approximately  $410,000  was  recorded  as  goodwill  and is being
amortized  over a period of 15 years.  The  operations of the acquired  business
have been included in the Company's financial  statements  beginning December 1,
2000.

The  following  pro forma  information  (unaudited)  has been prepared as if the
acquisition  of Tandy Leather had occurred at the beginning of each of the years
ended December 31, 2000 and 1999. Such information is not necessarily reflective
of the actual results that would have occurred had the  acquisition  occurred on
those dates.
                                                           2000         1999
                                                           ----         ----
Net Sales                                              $36,708,000  $43,996,000
Net Income (loss)                                      $ 1,637,000  $(4,327,000)
Net Income (loss) per common share                           $0.17       $(0.44)
Net Income (loss per common share - assuming dilution        $0.16       $(0.44)


                                       33
<PAGE>

<TABLE>
<CAPTION>

13. SEGMENT INFORMATION

SFAS  No.  131,  "Disclosures  about  Segments  of  an  Enterprise  and  Related
Information",  establishes  standards  for  public  companies  relating  to  the
reporting  of  financial  and  descriptive  information  about  their  operating
segments in  financial  statements.  Operating  segments  are  components  of an
enterprise  about which  separate  financial  information  is available  that is
evaluated  regularly  by chief  operating  decision  makers in  deciding  how to
allocate resources and in accessing performance.

The Company  identifies  its segments  based on the activities of three distinct
businesses:  The Leather  Factory,  which sells  product to both  wholesale  and
retail customers, consists of a chain of sales/distribution units located in the
United States and Canada; Tandy Leather Company,  which sells product throughout
the United States via the Internet and mail-order,  and internationally  through
authorized  dealers;  and  Roberts,   Cushman  &  Company,   which  manufactures
decorative hat trims sold directly to hat manufactures and distributors.

The  Company  previously  defined  its  operations  as  consisting  of a  single
reporting  segment as provided  for under the  aggregation  criteria of SFAS No.
131. During 2000, the Company revised its presentation of segment information to
reflect the Company initiative to establish strategic business units.

The Company's  reportable  operating segments have been determined as separately
identifiable  business units. The Company measures segment earnings as operating
earnings, defined as income before interest and income taxes. The "Tandy Leather
Company" column for the year ended December 31, 2000 contains  operating results
beginning after its November 30, 2000 acquisition.


                                                 The Leather       Tandy Leather    Roberts, Cushman
                                                   Factory            Company             & Co             Total
                                              ------------------ ------------------ ------------------ ---------------
<S>                                                <C>                 <C>                 <C>            <C>

For the year ended December 31, 2000
Net Sales                                          $ 27,060,406        $   575,635         $2,459,223     $30,095,264
Gross Profit                                         13,735,454            252,453            959,810      14,947,717
Operating earnings (loss)                             2,991,804           (43,724)            297,004       3,245,084
Interest expense                                      (617,400)                  -                  -       (617,400)
Other, net                                             (36,280)                  -               (99)        (36,379)
                                                                                                       ---------------
Income (loss) before income taxes                     2,338,124           (43,724)            296,905       2,591,305
                                                                                                       ---------------
     Depreciation and amortization                      423,313              4,895            154,570         582,778
     Total assets                                  $ 10,783,149         $3,688,976         $5,213,954    $ 19,686,079
                                              ------------------ ------------------ ------------------ ---------------

For the year ended December 31, 1999
Net Sales                                          $ 24,735,228                  -        $ 2,429,171    $ 27,164,399
Gross Profit                                         11,449,475                  -            807,156      12,256,631
Operating earnings (loss)                             1,924,630                  -           (14,420)       1,910,211
Interest expense                                      (923,092)                  -                  -       (923,092)
Other, net                                               23,093                  -              (305)          22,788
                                                                                                       ---------------
Income (loss) before income taxes                     1,024,632                  -           (14,725)       1,009,907
                                                                                                       ---------------
     Depreciation and amortization                      411,995                  -            155,457         567,452
     Total assets                                  $ 12,707,527                  -        $ 5,513,248     $18,220,775
                                              ------------------ ------------------ ------------------ ---------------

For the year ended December 31, 1998
Net Sales                                          $ 19,583,092                  -         $2,580,902    $ 22,163,994
Gross Profit                                          8,815,356                  -            920,314       9,735,670
Operating earnings (loss)                               923,783                  -           (78,158)         845,625
Interest expense                                    (1,003,649)                  -                  -     (1,003,649)
Other, net                                               33,309                  -                  -          33,309
                                                                                                       ---------------
Income (loss) before income taxes                      (46,557)                  -           (78,158)       (124,715)
                                                                                                       ---------------
     Depreciation and amortization                      374,929                  -            152,514         527,443
     Total Assets                                  $ 10,351,921                  -         $5,678,016    $ 16,029,937
                                              ------------------ ------------------ ------------------ ---------------

</TABLE>

                                       34
<PAGE>

<TABLE>
<CAPTION>

Net sales for geographic areas was as follows:

                                    2000              1999              1998
                                    ----              ----              ----
United States                  $ 28,964,542      $ 25,847,946      $ 21,086,131
All other countries               1,130,722         1,316,453         1,077,863
                             --------------- ----------------- -----------------
                               $ 30,095,264      $ 27,164,399      $ 22,163,994

Geographic sales information is based on the location of the customer. Net sales
from no single foreign  country was material to the Company's  consolidated  net
sales for the years ended December 31, 2000, 1999 and 1998.


14.  FAIR VALUE OF FINANCIAL INSTRUMENTS

Cash, accounts receivable-trade and accounts payable
The carrying  amount  approximates  fair value because of the short  maturity of
those instruments.

Notes payable and long-term debt
The interest  rates on the Company's  notes payable and long-term debt fluctuate
with  changes in the prime  rate and are the rates  currently  available  to the
Company;  therefore, the carrying amount of those instruments approximates their
fair value.


15.  QUARTERLY FINANCIAL DATA (UNAUDITED)

                                                    First           Second           Third          Fourth
                   2000                           Quarter          Quarter         Quarter         Quarter
-------------------------------------------   ---------------------------------------------------------------

<S>                                           <C>              <C>             <C>             <C>

Net sales                                     $ 7,405,557      $ 7,602,405     $ 7,374,556     $ 7,712,746
Gross profit                                    3,570,591        3,801,033       3,713,560       3,862,533
Net income                                        383,942          493,394         315,099         348,885

Net income per common share:
                  Basic                              0.04             0.05            0.03            0.04
                 Diluted                             0.04             0.05            0.03            0.03

Weighted average number of common
 shares outstanding:
                  Basic                         9,859,754        9,873,161       9,876,422       9,887,509
                 Diluted                       10,121,206       10,187,427      10,199,164      10,217,418

                                                     First           Second           Third          Fourth
                  1999                             Quarter          Quarter         Quarter         Quarter
------------------------------------------  ----------------------------------------------------------------
Net sales                                      $ 5,513,000      $ 6,539,950      $7,625,169      $7,486,280
Gross profit                                     2,358,889        2,813,768       3,445,060       3,638,914
Net income (loss)                                  (92,191)           6,708         272,565         247,974

Net income (loss) per common share:
                  Basic                             (0.01)                -            0.03            0.02
                 Diluted                            (0.01)                -            0.03            0.02

Weighted average number of common
shares outstanding:
                  Basic                          9,853,161        9,853,161       9,853,161       9,853,161
                 Diluted                         9,853,161        9,859,988       9,889,734       9,934,809
</TABLE>


                                       35
<PAGE>

                            THE LEATHER FACTORY, INC.
                  SCHEDULE II - ALLOWANCE FOR DOUBTFUL ACCOUNTS
                  YEARS ENDED DECEMBER 31, 2000, 1999, and 1998


                                                    2000      1999       1998
                                                    ----      ----       ----
Balance at beginning of year                      $ 177,000  $ 52,000   $ 28,000
Reserve "purchased" during year (Tandy)             248,000     -          -
  Additions (reductions) charged to income           22,000   157,000      3,000
  Balances written off, net of recoveries         (109,000)   (32,000)    21,000
                                                  ---------  ---------  --------
Balance at end of year                            $ 338,000  $ 177,000  $ 52,000
                                                  =========  =========  ========


                                       36
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS


The Board of Directors
The Leather Factory, Inc.

        We have  audited the  accompanying  consolidated  balance  sheets of The
Leather  Factory,  Inc.  as of  December  31,  2000 and  1999,  and the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
each of the three years in the period ended  December 31, 2000.  Our audits also
included  the  financial  statement  schedule  referred  to in the index at Item
14(a).  These financial  statements and schedule are the  responsibility  of the
Company's  management.  Our  responsibility  is to  express  an opinion on these
financial statements and schedule based on our audits.

        We conducted our audits in accordance with generally  accepted  auditing
standards. Those standards require that we plan and perform the audits to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.

        In our opinion, the consolidated  financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
The Leather  Factory,  Inc. at December 31, 2000 and 1999, and the  consolidated
results of its  operations and its cash flows for each of the three years in the
period ended December 31, 2000, in conformity with generally accepted accounting
principles. Also, in our opinion, the related financial statement schedule, when
considered  in  relation  to the basic  financial  statements  taken as a whole,
presents fairly in all material respects the information set forth therein.


Hein + Associates LLP


Dallas, Texas
February 15, 2001


                                       37
<PAGE>

                                    PART III


Item 10.  Directors and Executive Officers of the Registrant.

         Information  required by this item is  incorporated by reference to the
material  appearing  under the heading  "Election of Directors"  and  "Executive
Officers of the Company" in the Proxy  Statement for the 2001 Annual  Meeting of
Stockholders.

Item 11.  Executive Compensation.

         Information  required by this item is  incorporated by reference to the
material  appearing  under the  heading  "Executive  Compensation"  in the Proxy
Statement for the 2001 Annual Meeting of Stockholders.

Item 12.  Security Ownership of Certain Beneficial Owners and Management.

         Information  required by this item is  incorporated by reference to the
material  appearing under the heading "Security  Ownership of Certain Beneficial
Owners and Management" and "Certain Transactions" in the Proxy Statement for the
2001 Annual Meeting of Stockholders.

Item 13.  Certain Relationships and Related Transactions.

         Information  required by this item is  incorporated by reference to the
material  appearing  under  the  heading  "Certain  Transactions"  in the  Proxy
Statement for the 2001 Annual Meeting of Stockholders.


                                     PART IV


Item 14.  Exhibits, Financial Statement Schedules and Reports on Form 8-K.

         (a)   1. Financial statements and financial statement schedules
               ---------------------------------------------------------

         The financial  statements and schedule listed in the accompanying index
to consolidated financial statements at Item 8 are filed as part of this Report.

               2. Exhibits
               -----------

         The  exhibits  listed  on  the   accompanying   Exhibit  Index,   which
immediately  precedes such exhibits,  are filed or  incorporated by reference as
part of this Report and such Exhibit Index.

         (b)   Reports on Form 8-K
               -------------------

         On December 15, 2000,  the Company filed a report on Form 8-K (Items 2,
5 and 7)  describing  the  asset  purchase  of  Tandy  Leather  Company  and the
resulting  amendment to the Credit and Security Agreement with WFBC. This report
was amended on February 14, 2001 to include required financial information.


                                       38
<PAGE>

                                   SIGNATURES

         Pursuant to the  requirements  of Section 13 or 15(d) of the Securities
Exchange Act of 1934,  the Company caused this Report to be signed on its behalf
by the undersigned, thereunto duly authorized.

                                           THE LEATHER FACTORY, INC.
                                           (Registrant)

Date:         March 27, 2001               By:  /s/ Wray Thompson
        ----------------------------            -----------------
                                                    Wray Thompson
                                           Chairman of the Board and Chief
                                           Executive Officer

Date:        March 27, 2001                By:  /s/ Shannon L. Greene
       -----------------------------            ---------------------
                                                   Shannon L. Greene
                                           Chief Financial Officer and Treasurer

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

         Signature & Title                                              Date


/s/ Wray Thompson                                                March 27, 2001
------------------------------------
Wray Thompson, Chairman of the Board

/s/ Ronald C. Morgan                                             March 27, 2001
------------------------------------
Ronald C. Morgan, Director

/s/ Robin L. Morgan                                              March 27, 2001
------------------------------------
Robin L. Morgan, Director

/s/ William M. Warren                                            March 27, 2001
------------------------------------
William M. Warren, Director

/s/ H. W. Markwardt                                              March 27, 2001
------------------------------------
H. W. Markwardt, Director

/s/ Joseph R. Mannes                                             March 27, 2001
------------------------------------
Joseph R. Mannes, Director

/s/ Anthony C. Morton                                            March 27, 2001
------------------------------------
Anthony C. Morton, Director

/s/ Shannon L. Greene                                            March 27, 2001
------------------------------------
Shannon L. Greene, Director

/s/ Michael A. Markwardt                                         March 27, 2001
------------------------------------
Michael A. Markwardt, Director


                                       39
<PAGE>

                   THE LEATHER FACTORY, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX
 Exhibit
  Number                            Description
  ------                            -----------

     3.1  Certificate of Incorporation  of The Leather  Factory,  Inc., filed as
          Exhibit 3.1 to the Registration  Statement on Form SB-2 of The Leather
          Factory, Inc. (Commission File No. 33-81132) filed with the Securities
          and Exchange Commission on July 5, 1994, and incorporated by reference
          herein.

     3.2  Bylaws of The  Leather  Factory,  Inc.,  filed as  Exhibit  3.2 to the
          Registration  Statement  on Form  SB-2 of The  Leather  Factory,  Inc.
          (Commission  File No. 33-81132) filed with the Securities and Exchange
          Commission on July 5, 1994, and incorporated by reference herein.

     4.1  The Leather  Factory,  Inc. Stock Purchase  Warrant for 200,000 shares
          common  stock,  $.0024 par value  issued to Evert I.  Schlinger  dated
          August 3, 1998 and  terminating  on August 3,  2003,  filed as Exhibit
          4.13 to the Quarterly Report on Form 10-Q of The Leather Factory, Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission November 12, 1998, and incorporated by reference herein.

     4.2  Credit and Security  Agreement dated November 22, 1999, by and between
          The  Leather  Factory,  Inc.,  a  Delaware  corporation,  The  Leather
          Factory,  Inc., a Texas  corporation,  The Leather  Factory,  Inc., an
          Arizona  corporation,  Roberts,  Cushman & Company,  Inc., and Hi-Line
          Leather & Manufacturing  and Wells Fargo Business Credit,  Inc., filed
          as  Exhibit  4.1 to the  Current  Report  on Form  8-K of The  Leather
          Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
          and Exchange  Commission  on December 16, 1999,  and  incorporated  by
          reference herein.

     4.3  Revolving Note (Revolving Credit Loan) dated November 22, 1999, in the
          principal  amount of  $8,500,000,  payable to the order of Wells Fargo
          Business  Credit,  Inc.,  which  matures  November 30, 2002,  filed as
          Exhibit 4.2 to the Current Report on Form 8-K of The Leather  Factory,
          Inc.  (Commission  File No.  1-12368)  filed with the  Securities  and
          Exchange   Commission  on  December  16,  1999,  and  incorporated  by
          reference herein.

     4.4  Term  Note  dated  November  22,  1999,  in the  principal  amount  of
          $150,000,  payable to the order of Wells Fargo Business Credit,  Inc.,
          which matures May 1, 2000,  filed as Exhibit 4.3 to the Current Report
          on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368)
          filed with the  Securities  and  Exchange  Commission  on December 16,
          1999, and incorporated by reference herein.


                                       40
<PAGE>

     4.5  Copyright  Security  Agreement dated November 22, 1999, by and between
          The  Leather  Factory,  Inc.,  a  Delaware  corporation,  The  Leather
          Factory,  Inc., a Texas  corporation,  The Leather  Factory,  Inc., an
          Arizona  corporation,  Roberts,  Cushman & Company,  Inc., and Hi-Line
          Leather & Manufacturing  and Wells Fargo Business Credit,  Inc., filed
          as  Exhibit  4.4 to the  Current  Report  on Form  8-K of The  Leather
          Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
          and Exchange  Commission  on December 16, 1999,  and  incorporated  by
          reference herein.

     4.6  Amendment to Loan and Security  Agreement  dated November 30, 2000, by
          and between  The Leather  Factory,  Inc. a Delaware  corporation,  The
          Leather Factory, Inc., a Texas corporation, The Leather Factory, Inc.,
          an Arizona  corporation,  Roberts,  Cushman & Company,  Inc.,  Hi-Line
          Leather  &  Manufacturing,  and Tandy  Leather  Company,  Inc.  (f/k/a
          Leather Tan Acquisition,  Inc.) and Wells Fargo Business Credit,  Inc.
          filed as Exhibit 99.1 to the Current Report on Form 8-K of The Leather
          Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
          and Exchange  Commission  on December 15, 2000,  and  incorporated  by
          reference herein.

    10.1  Letter  Agreement for Consulting  Services dated July 24, 1998, by and
          between The Leather  Factory,  Inc. and Evert I.  Schlinger,  filed as
          Exhibit  4.13 to the  Quarterly  Report  on Form  10-Q of The  Leather
          Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
          and  Exchange  Commission  November  12,  1998,  and  incorporated  by
          reference herein.

    10.2  Asset  Purchase  Agreement  dated  November 30, 2000, by Tandy Leather
          Company,   Inc.  (f/k/a  Leather  Tan  Acquisition,   Inc.),  a  Texas
          corporation,  TLC Direct, Inc., a Texas corporation, and Tandy Leather
          Dealer,  Inc.,  a Texas  corporation,  filed as Exhibit No. 2.1 to the
          Current Report on Form 8-K of The Leather  Factory,  Inc.  (Commission
          File No. 1-12368) filed with the Securities and Exchange Commission on
          December 15, 2000, and incorporated herein by reference.

   *21.1  Subsidiaries of the Company.

   *23.1  Consent of Hein + Associates LLP dated March 29, 2001.

   *27.1  Financial Data Schedule
   ------------
 *Filed herewith.


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