UNITED STATES SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                                    Form 10-K

(Mark One)

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

For the fiscal year ended December 31, 1996

                                       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                          (I.R.S. Employer
   of incorporation or organization)                      Identification Number)

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

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


      Securities registered pursuant to Section 12(b) of the Exchange 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 Exchange 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  $2,456,922  at March 3, 1997. At that date there
were 9,853,161 shares of Common Stock outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Portions  of the  definitive  Proxy  Statement  for the  Annual  Meeting of
Stockholders  on May 22, 1997 are  incorporated by reference in Part III of this
report.

<PAGE>



                                     PART I

Item I.  Description of Business

General

     The Leather  Factory,  Inc.  ("TLF" or the  "Company") is an  international
wholesale   distributor  of  a  broad  product  line  which  includes   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  kits.  The Company,  through its
subsidiary, Roberts, Cushman & Company, Inc. ("Cushman"), in New York, New York,
produces hat trims,  the decorative piece of material that adorns the outside of
a hat,  small finished  leather goods and  accessories.  The Company  frequently
introduces  new products  either  through its own  manufacturing  capability  or
through  purchasing from vendors.  One indication of the Company's  expertise in
the area of product development is the substantial number of copyrighted designs
which the Company owns.  These  designs have been  incorporated  throughout  the
Company's product line as a means of increasing its competitive advantage.

     The Company's customer base is comprised of over 40,000 customers including
retailers,  wholesalers,   assemblers,  distributors,  and  other  manufacturers
dispersed  geographically  throughout the world. Most of the Company's customers
are wholesalers; less than five percent of the Company's sales are retail.

     The  Company  manufactures  some of its own  products,  but also  purchases
products from other  manufacturers and distributors in fourteen  countries.  The
Company  has light  manufacturing  facilities  in Fort  Worth,  Texas,  where it
produces  items  such  as  suede  lace,   garment   fringe,   leathercraft   and
craft-related  kits,  and in New York,  New York,  where,  through  its  Cushman
subsidiary, it produces hat trims and small finished leather goods.

     The Company  distributes its products through 21  sales/distribution  units
located in  seventeen  states and one located in Canada  plus its  manufacturing
facility  and  show  room  in  New  York.   The   geographic   location  of  its
sales/distribution  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.

     Due to current financial restraints, the Company has deferred expansion and
acquisition plans until long-term financing arrangements have been completed and
profitability has been restored to existing operations. Opening one or two units
in 1997 and 1998 or acquiring  companies  that  complement  existing  operations
would currently be expected to be financed internally.

     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 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.

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

                                       2
<PAGE>

Corporate History

     Transactions  with National.  National was  incorporated  under the laws of
     ---------------------------
Colorado in 1984 and conducted  business as a stock transfer agency from January
1985 to April 1993. In April of 1993,  substantially  all of National's  assets,
consisting of miscellaneous office equipment,  were sold to STCOT, Inc., a Texas
corporation  and an  affiliate of National,  for $25,000 and the  assumption  of
substantially all of the liabilities of National.  National thereupon terminated
its  activities  as  a  stock  transfer  agency  and  conducted  no  substantive
operations.  In June of 1993, the principal officers and directors of TLF-Texas,
Wray Thompson, Ronald C. Morgan and Robin L. Morgan, acquired shares of National
Common Stock and were elected to National's Board of Directors. In July of 1993,
pursuant  to a reverse  merger  agreement  among  National,  TLF-Texas,  and the
shareholders of TLF-Texas, National acquired all of the outstanding Common Stock
of TLF-Texas in exchange for 7,805,478  newly issued  shares of National  Common
Stock. In connection with this transaction, National effected a 1 for 24 reverse
stock split.  The name of National was changed to "The Leather  Factory,  Inc.",
and National's  business  became that  conducted by TLF-Texas.  Any reference to
"Company" herein includes,  where applicable,  the activities of TLF-Texas after
the acquisition of TLF-Texas by National.

     History of TLF-Texas.  TLF-Texas was initially  incorporated under the laws
     --------------------
of  Texas in 1980  with the name  Midas  Leathercraft  Tool  Company  ("Midas").
Originally,   the  business  of  Midas  involved  the  distribution  of  certain
leathercraft  tools.  After the reverse merger  transaction  with National,  the
Company in June of 1994  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 in 1995, a leading producer of hat trims. In March
of 1996, the Company acquired all of the issued and outstanding capital stock of
its Canadian distributor, The Leather Factory of Canada.

Strategy

     The Leather Factory Concept.  The business strategy employed by the Company
     ---------------------------
was conceived by the founders of TLF-Texas,  Wray Thompson and Ronald C. Morgan.
Elements of this concept include the physical  location and type of space rented
for the Company's wholesale units, the configuration of the units, the number of
items comprising the merchandise line, the utilization of direct mail, including
the use of an annual full-line catalog, and the application of rapid delivery to
customers.   The   Company   plans   to   continue   growing   by   adding   new
sales/distribution  units and  acquiring  operating  companies in  complementary
businesses in order to provide a variety of diverse,  but related merchandise to
a wider range of customers.

     The concept used in the  Company's  sales/distribution  units  combines 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 in 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  relatively  easy access  thereto.  This kind of location
typically  provides  lower  rental  expense  compared to other more  retail-type
locations.  The type and  amount of space also  accommodates  the  arranging  or
configuring  of the unit in a visually  appealing  manner so that  customers can
walk by and touch merchandise such as the various sizes,  styles,  and grades of
leather sold, which can also consume a great deal of space. This also allows the
Company  to stock  and  display  a  sufficiently  broad  line to offer  one-stop
shopping.  As a common practice in the industry,  the Company  maintains  higher
inventory  levels of certain  imported  items to assure  itself of a  continuous
allotment due to the length of time required for delivery of such items.

     The Company's  sales/distribution units are staffed by experienced managers
who are primarily compensated based upon the operating profit of their location.
Sales of these  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  sales/distribution
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.

                                       3
<PAGE>


     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  stock-out  situations  with the carrying  costs  involved with such an
inventory  level.  The  number  of SKU's  has  grown  over the  years due to the
introduction  of new products  and now  approximates  2,800 items.  In addition,
while not part of The Leather  Factory  concept,  the product  line sold to shoe
repair  shops and shoe  stores  increases  the number in the  Company's  overall
product line to approximately 6,000 SKU's.

     Expansion and Acquisition  Strategy.  Due to current financial  restraints,
     -----------------------------------
the  Company has  deferred  expansion  and  acquisition  plans  until  long-term
financing  arrangements  have been completed and profitability has been restored
to existing  operations.  Opening one or two units in 1997 and 1998 or acquiring
companies that complement  existing operations would currently be expected to be
financed internally.

     Acquisition  Financing Facility. On July 28, 1995, the Company entered into
     -------------------------------
a Stock Purchase Agreement with Center Street Capital Partners, L.P., a Delaware
limited  partnership,  and  Stratford  Capital  Partners,  L.P., a Texas limited
partnership (the "Buyers"), pursuant to which the Buyers agreed to deliver a one
year  commitment  to purchase up to $10 million  aggregate  principal  amount of
Senior  Cumulative  Convertible  Preferred Stock, par value $0.10 per share (the
"Preferred  Stock"),  of the Company, at a purchase price of $100 per share. The
Company also obtained a one year  commitment  from  NationsBank to provide a $10
million acquisition line of credit ("Acquisition Line"). The Preferred Stock and
the  Acquisition  Line  comprised  the  Acquisition   Facility.   The  one  year
commitments  provided  by the  Buyers and  NationsBank  in  connection  with the
Acquisition  Facility  expired  during the third quarter of 1996 pursuant to the
terms of the  respective  governing  documents.  No  amounts  were  drawn by the
Company on the Acquisition Facility prior to its expiration.

     Inventory Management  Strategies.  The Company has signed an agreement with
     --------------------------------
BHD Information Systems for the installation of a networked computer system. The
lease agreement includes hardware,  software,  installation,  and training.  The
software   consists  of  a   pre-packaged   system  and  will  require   minimal
customization.  The system will provide the Company with a point-of-sale system,
a perpetual inventory system, and an accounts receivable system. The addition of
a point-of-sale  system in conjunction with the comprehensive report writer will
provide  immediate  sales  information  regarding the buyer,  the seller and the
product.  This will allow management to improve  productivity,  identify fast or
slow  moving  products  and target  customers  to be  contacted.  The  perpetual
inventory  system  should  reduce cost of sales and improve  inventory  turnover
rates through better inventory management. The Company will be able to determine
product availability (or expected availability if the product is not on-hand) at
all  twenty-two  locations at any time.  The Company  believes  that this should
improve customer service and permit a reduction in inventory.

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.  The Company's  manufacturing  operations  are in Fort
Worth,  Texas and New York, New York at Cushman.  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.  The  manufacturing  operation  in Fort Worth makes items  primarily  for
wholesale  distribution  using  the  Company's  sales/distribution  units or for
drop-shipment  directly to customers through the central warehouse.  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.

                                       4
<PAGE>

     The customer groups served include wholesale distributors,  tack and saddle
shops,  shoe-findings  customers,  institutions,  prisons and prisoners,  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 sales comprise more than 10% of the Company's total sales.

Competition

     The Company  competes  in four  highly  fragmented  markets  which  include
leathercraft,  leather accessories,  retail craft, and shoe findings. 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. The fragmented nature of these markets is the primary
reason for the lack of broad-based  competition  and is the driving force behind
management's consolidation strategy.

     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.

Suppliers

     The  Company  currently  purchases   merchandise  and  raw  materials  from
approximately 200 vendors  dispersed  throughout the United States as well as in
fourteen  foreign  countries.  In fiscal year 1996,  the  Company's  ten largest
vendors  accounted  for  approximately  52% 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.

Patents and Copyrights

     The Company  presently  owns 118 copyrights  covering 210 registered  works
with two works  pending,  six  trademarks  covering  six 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 2006,  but can be  renewed  indefinitely.  Most
copyrights  granted or pending  are on metal  products,  such as  conchos,  belt
buckles,  etc., and instruction  books. The expiration period for the copyrights
begins in 2062 and ends in 2070. 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.

                                       5
<PAGE>


Employees

     As of December 31,  1996,  the Company  employed 226 people,  with 219 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, 1996, 165
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. The percentage  contributions for 1996,
1995 and 1994 were .8%, .8% and 3% respectively. These contributions are used to
purchase shares of Common Stock.

     In late October 1995,  representatives of Union Local 62-32 of the Union of
Needletrades,  Industrial,  and Textile Employees  ("UNITE")  requested that the
Company's  wholly owned  subsidiary,  Cushman,  recognize  UNITE as the sole and
exclusive employee bargaining representative. The Company responded by declining
to recognize  UNITE unless a secret ballot election was held by the employees of
Cushman.  On October 31,  1995,  the  employees of Cushman went on strike in New
York City for the purpose of securing  representation.  Virtually  all of the 50
hourly  employees of Cushman refused to cross the picket line. The Company filed
charges with the National Labor  Relations  Board ("NLRB")  alleging that picket
line misconduct and violence was inspired by UNITE.

     The strike  lasted from  October  31, 1995 to April 1, 1996,  at which time
UNITE notified the Company that it would cease all organizing actions so long as
an  unconditional  return to work was made to all  employees  who had refused to
cross the picket line. On August 1, 1996, a secret ballot  election was held and
the union was defeated.

     On September 6, 1996, Cushman and UNITE entered into a settlement agreement
approved by the NLRB,  to  completely  settle and resolve the issues noted above
without  the need for a trial.  While not  admitting  that  Cushman  committed a
violation  of the  National  Labor  Relations  Act (the "Labor Act") or that the
employees engaged in an unfair labor practice strike,  Cushman did agree to post
a notice in English and Spanish informing  employees of their rights pursuant to
the Labor Act and Cushman's agreement to not: (i) interrogate employees relative
to union activities; (ii) threaten employees with the relocation of the business
if they  support  UNITE or any other  labor  organization;  (iii) warn or advise
employees that their continued  employment is conditioned upon their abandonment
of their support for UNITE or any other labor  organization;  and (iv) interfere
with, restrain or coerce employees in the exercise of the rights guaranteed them
by the Labor Act.

     Except  for any  residual  affects  due to  attempts  by UNITE to  organize
employees of Cushman as described above, management believes that relations with
employees are good.


                                      6
<PAGE>


Item 2.   Description of Property

     The Company leases all its premises except for the Tampa, Florida location.
This property consists of a 13,287 square foot office/warehouse building located
on a 16,550  square foot site and is  approximately  26 years old and in average
condition. As of December 31, 1996, the Tampa property was pledged as collateral
under the Company's  loan  agreement with  NationsBank,  Texas,  NA that matures
April 30,1997.

     Detailed below are the lease terms for the Company's  remaining  locations.
The general  character  of each  location is light  industrial  office/warehouse
space,  except for the New York City premises which is standard light industrial
loft space in a  multi-story  building.  The  Company  believes  that all of its
properties, both leased and owned, are adequately covered by insurance.

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

Chattanooga, TN                9,040                $      40,704                    May 1999
Denver, CO                    12,000                       39,000                    October 1999
Harrisburg, PA                 6,850                       36,180                    March 2002
Fort Worth, TX                71,000                      259,383                    March 1998
Fresno, CA                     5,600                       41,663                    March 2002
Des Moines, IA                 4,000                       30,718                    April 1999
Phoenix, AZ                    4,500                       25,994                    March 2001
Springfield, MO                6,000                       20,400                    July 1998
Spokane, WA                    5,400                       20,400                    February 1999
Albuquerque, NM                5,000                       27,600                    October 1998
Salt Lake City, UT             4,000                       25,584                    September 1999
Baldwin Park, CA               7,800                       51,231                    March 2000
San Antonio, TX                5,600                       40,320                    October 2001
Columbus, OH                   6,000                       37,468                    October 2000
El Paso, TX                    9,600                       43,104                    July 1998
Oakland, CA                    8,000                       57,304                    December 2003
Grand Rapids, MI               8,000                       33,484                    March 1999
Wichita, KS                   14,000                       33,600                    May 1999
New York, NY                  12,000                       94,080                    December 1997
New Orleans, LA                5,130                       21,600                    August 2000
Charlotte, NC                  6,202                       24,188                    March 2001
Winnipeg, Canada               5,712                       26,000  **                November 1997
                           ---------                 ------------

Totals                       221,434                $   1,030,005
                           =========                 ============

</TABLE>

*    Represents  the  average  minimum  annual  rent  over  the  balance  of the
     unexpired lease term.
**   As converted into U.S. dollars.

     The   Company's   Fort   Worth    location    includes   the   Fort   Worth
sales/distribution   unit,   the   Company's   central   warehouse,   the  light
manufacturing facility, and the sales and administrative/executive  offices. The
Company also leases a 624 square foot  showroom in the Denver  Merchandise  Mart
for $10,707 per year. This lease will expire in October 1998.



                                       7
<PAGE>

Item 3.   Legal Proceedings

     The Company, as  successor-in-interest to National, has been a defendant in
a  lawsuit  brought  in July  1994 by Gary A.  Bedini  and John C.  Bedini  (the
"Plaintiffs")  in the United States District Court for the District of Colorado.
Additional defendants are Securities Transfer  Corporation,  a Texas corporation
("STC"),  and Steven Jay Olson,  individually,  and as President and Director of
National,  now known as The Leather Factory, Inc. The Plaintiffs alleged that in
1992,  pursuant to SEC Rule 144(k),  they sought to transfer  approximately  1.5
million shares of their Common Stock in Gamma Electronic Systems, Inc., and that
the  transfer  agent,  National,   improperly  refused.  The  Plaintiffs  sought
compensatory  damages in the amount of $2.1 million as well as punitive damages.
The Company is  contractually  indemnified  from and against all losses that may
arise out of this  cause of action,  including  attorneys'  fees,  by STC and/or
related entities.

     This action was tried in July 1995.  Upon the conclusion of the trial,  the
judge found in favor of one plaintiff,  Gary Bedini,  and against the defendants
in the amount of $50,468,  and similarly for the other  plaintiff,  John Bedini,
and against the defendants in the amount of $68,548. The written judgment of the
court (the "Judgment"),  which reflected the aforementioned rulings by the trial
judge,  was entered on  September  7, 1995.  This  Judgment  also  included  pre
judgment  interest of $16,159 for Gary Bedini and $21,947 for John Bedini.  Post
judgment interest continues to accrue from the date of the Judgment, pursuant to
federal law.

     According to the terms of its contractual indemnification  obligations, STC
has defended this  litigation at its expense.  On September 21, 1995,  STC filed
Defendants'  Motion to Alter or Amend  Judgment (the  "Motion").  The Plaintiffs
filed a response  to this  Motion on October 4, 1995,  and said  Motion  remains
pending.  In addition to the Motion,  STC has made a settlement  offer.  STC has
informed the Company if the case does not settle, and the Motion is denied, then
STC intends to appeal the Judgment and to post either a supersedeas bond or cash
to avoid  collection of the Judgment while the appeal is pending.  As of January
1997,  no action  has been  taken by the trial  judge  relative  to the  Motion.
Pursuant to the  Indemnification  Agreement  between  STC and the Company  dated
October 17,  1994,  the Company  believes it will not suffer any loss due to the
action described here and above.

     The Company has  litigation in the ordinary  course of its business.  Other
than described  above,  the Company is not 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, 1996.




                                        8
<PAGE>


                                     PART II


Item 5.  Market for Common Equity and Related Stockholder Matters

     The shares of the Company are 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:

        Quarter Ended                  High             Low

        1995
        ----
        March 31, 1995                4.3750          3.5000
        June 30, 1995                 4.0000          3.2500
        September 30, 1995            4.6250          2.7500
        December 31, 1995             3.1250          2.2500

        1996
        ----
        March 31, 1996                2.6875          1.7500
        June 30, 1996                 2.1250          1.7500
        September 30, 1996            1.9375          1.4375
        December 31, 1996             1.4375           .8125

----------
    There were approximately 555 stockholders of record on March 6, 1997.

     There have been no cash  dividends  paid on the shares of the  Company  and
currently  dividends  are  restricted by certain debt  agreements.  The Board of
Directors has historically  followed a policy of reinvesting the earnings of the
Company in the expansion of its business. Such policy is subject to change based
on current industry and market  conditions,  as well as other factors beyond the
control of the Company.

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 has not been restated to reflect  acquisitions
that occurred in subsequent years.

                                       9
<PAGE>

Years Ended December 31
-----------------------
Income Statement Data

<TABLE>
<CAPTION>
<S>                                                                            <C>                 <C>
                               -------------------------------------------------------------------------------
                                    1996            1995             1994               1993            1992
                                -----------      -----------     -----------       -----------      -----------

NET SALES                       $28,253,632      $31,447,849     $28,081,272       $24,371,082      $18,450,134
COST OF SALES                    17,689,973       18,446,378      15,870,603        13,555,345       10,581,469
                                 ----------       ----------      ----------        ----------       ----------
     Gross profit                10,563,659       13,001,471      12,210,669        10,815,737        7,868,665

OPERATING EXPENSES               10,869,359       10,363,159       9,573,495         8,631,600        6,574,631
                                 ----------       ----------      ----------        ----------       ----------
OPERATING INCOME (LOSS)            (305,700)       2,638,312       2,637,174         2,184,137        1,294,034

OTHER (INCOME) EXPENSE:           1,000,604          678,264         142,830           149,955          147,476
                                 ----------       ----------      ----------        ----------       ----------

INCOME (LOSS)
     BEFORE INCOME TAXES         (1,306,304)       1,960,048       2,494,344         2,034,182        1,146,558
INCOME TAX PROVISION
    (BENEFIT)                      (316,536)         786,744         990,197           875,362 *        439,502
                                 ----------       ----------      ----------        ----------       ----------

NET INCOME (LOSS)                  (989,768)       1,173,304       1,504,147         1,158,820 *        707,056
                                 ==========       ==========      ==========        ==========       ==========

INCOME (LOSS) PER SHARE               (0.10)            0.12            0.15              0.13 *           0.09
                                 ==========       ==========      ==========        ==========       ==========

COMMON EQUIVALENT
    SHARES OUTSTANDING            9,788,530        9,789,468       9,783,387         8,801,422        8,222,130
                                 ==========       ==========      ==========        ==========       ==========

Balance Sheet Data
                                 ------------------------------------------------------------------------------
                                   1996              1995            1994             1993              1992
                                 ----------       ----------      ----------      ------------       ----------

TOTAL ASSETS                    $18,264,547      $19,333,376     $18,468,806     $   9,555,881      $ 6,120,735
                                 ----------       ----------      ----------      ------------       ----------

NOTES PAYABLE AND
    CURRENT MATURITIES
    OF LONG TERM DEBT             8,549,366        1,296,359         194,311           216,572          216,593
                                 ----------       ----------      ----------      ------------       ----------

NOTES PAYABLE AND
    LONG-TERM DEBT, NET
    OF CURRENT MATURITIES            17,378        6,566,809       7,325,432         1,189,856        1,656,792
                                 ----------       ----------      ----------      ------------       ----------

STOCKHOLDERS' EQUITY              8,022,937        9,282,305       8,217,781         5,502,452        1,737,774
                                 ==========       ==========      ==========      ============       ==========


</TABLE>

*    Includes charge of $98,772 or $0.01 per share reflecting  cumulative effect
     on prior  years of a change in  accounting  method for income  taxes  (SFAS
     109).


                                       10
<PAGE>




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

General

     The Leather  Factory,  Inc.  ("TLF" or the  "Company") is an  international
wholesale   distributor  of  a  broad  product  line  which  includes   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  kits.  The Company,  through its
subsidiary, Roberts, Cushman & Company, Inc. ("Cushman"), in New York, New York,
produces hat trims,  the decorative piece of material that adorns the outside of
a hat, and small finished leather goods. The Company  frequently  introduces new
products either through its own manufacturing  capability or through  purchasing
from vendors.  One indication of the Company's  expertise in the area of product
development is the substantial  number of copyrighted  designs which the Company
owns.  These designs have been  incorporated  throughout  the Company's  product
line, including hat trims, as a means of increasing its competitive advantage.

Results of Operations

                           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:

                                           1996          1995         1994
                                           ----          ----         ----
        Net Sales                          100.0%       100.0%       100.0%
        Cost of sales                       62.6          58.7         56.5
                                           -----         -----        -----
        Gross profit                        37.4          41.3         43.5
        Operating expenses                  38.5          33.0         34.1
                                           -----         -----        -----
        Income (loss) from operations       (1.1)          8.3          9.4
        Other (income) expense, net          3.5           2.1          0.5
                                           -----         -----        -----
        Income (loss) before
          income taxes                      (4.6)          6.2          8.9
        Provision (benefit) for income tax  (1.1)          2.5          3.5
                                           -----         -----        -----
        Net income                          (3.5)%         3.7%         5.4%
                                           =====         =====        =====


                        Analysis of 1996 Compared to 1995
                        ---------------------------------

Revenues

     The Company's net sales decreased by 10.2% to $28,253,632  during 1996 from
$31,447,849 in 1995.  The 10.2% decrease in revenues was primarily  comprised of
two pieces.  Reduced  sales to the retail craft  industry  comprised of 7.7% and
reduced sales at Cushman  comprised of 2.7%.  The Company's  sales to the retail
craft industry and its sales at Cushman during 1996 were negatively  impacted by
challenging retail environments in the craft and western markets.

                                       11
<PAGE>


     The Company is making a  concentrated  effort to develop new  products  and
sell to new  markets  due to the  softness  of sales  and  difficult  conditions
experienced by customers in the craft and western markets. For example,  Cushman
has  introduced  a line of  exotic  leather  and  western  accessories  that has
generated  interest  from national mail order  companies and retail  chains.  In
addition, the Company has become a national sponsor of the Boy Scouts of America
with seventeen new products that are included in the official Boy Scout Catalog.
While  long term  trends  continue  to be  difficult  to  determine,  management
believes that those markets have  stabilized  although this may not be reflected
in overall sales until the second half of 1997.

Costs, Gross Profit, and Expenses

     Cost of sales as a percentage  of revenue was 62.6% for 1996 as compared to
58.7% for 1995.  The  difference  in the relative cost of sales  percentage  was
principally  attributable to a change in sales mix, price  competition in a very
competitive  market environment and direct labor costs associated with the labor
dispute at Cushman.

     Operating  expenses  increased  $506,200 or 4.9% to $10,869,359 during 1996
from $10,363,159 during 1995. The increase in operating expenses between the two
periods  was due to  various  factors,  including  (i) an  increase  in bad debt
expense of $120,665  because of a  significant  customer  (3% of 1995 net sales)
declaring  Chapter  11  bankruptcy,   (ii)  expenses  associated  with  two  new
locations, (iii) write down of certain purchased goodwill due to its impairment,
(iv) increased  advertising expense to generate new sales and (v) an increase in
operating  expenses at  Cushman,  some of which were  related to previous  labor
problems.  These increases in operating  expenses were partially offset by lower
discretionary  bonuses and  commissions.  Management  is continuing a determined
effort to reduce the cost of sales as a percent of revenue and  expects  margins
to improve in 1997 and return to more historical patterns.

Other (Income) Expense

     Other  expenses  were  $1,000,604  for 1996 as compared to $678,264  during
1995.  This increase was primarily  due to the write-off of the  commitment  and
facility  fees  attributable  to the  acquisition  financing  commitments  which
expired in July 1996, and an increase in interest  expense due to an increase in
the outstanding balance on the working capital line of credit.

                                       12
<PAGE>

Provision (Benefit) for Income Taxes

     The benefit for income  taxes was 24% of the loss  before  income  taxes in
1996,  as compared to a provision for income taxes of 40% of income before taxes
in  1995.  This  difference  is  primarily  a  result  of  an  increase  in  the
amortization of non-deductible goodwill.

Net Income
----------
     The  Company  incurred  a net  loss of  $989,768  for 1996 as  compared  to
reporting  net income of $1,173,304  during 1995.  The loss was primarily due to
the factors noted above regarding sales, cost of goods sold,  operating expenses
and other (income) expense.

                        Analysis of 1995 Compared to 1994
                        ---------------------------------

Revenues

     The Company's net sales increased by 12.0% to $31,447,849 during the fiscal
year  ended  December  31,  1995  from  $28,081,272  in 1994,  which  was  below
management's  expectations  as stated in the  Company's  1994  Annual  Report to
Stockholders. These results can be attributed to a decrease in consumer spending
at the  retail  level in each of the  markets in which the  Company's  customers
participate.  Early in the year,  management believed that the positive trend in
sales experienced in late 1994 and the first quarter of 1995 would continue. The
remaining  three  quarters  of the year,  however,  proved  this  indication  of
increased sales to be temporary in nature.  Sales in the fourth quarter of 1995,
outside  of  Cushman,  were down 15.5%  from the same  quarter  in 1994.  Absent
Cushman, TLF sales were down 4.2% for the fiscal 1995 year.

Costs, Gross Profit, and Expenses

    Cost of sales as a  percentage  of sales was 58.7% for the fiscal year ended
December  31,  1995 as  compared  to 56.5%  for the  same  period  in 1994.  The
difference in the relative cost of sales percentage was principally attributable
to a change in sales mix due to the softness  described  above,  the competitive
nature of the market,  the fact that Cushman  operates on a somewhat lower gross
margin than TLF, and higher prevailing  leather prices,  which were not or could
not be passed along to customers.

     A higher  relative  cost of sales  percentage  meant that gross profit as a
percentage  of sales was lower for the  fiscal  year  ended  December  31,  1995
compared to fiscal 1994.  Gross profit as a percentage  of sales  decreased  2.2
percentage  points to 41.3% in 1995 from  43.5% in 1994.  In spite of a relative
decrease in the gross profit percentage,  due to the increase in sales for 1995,
total gross profit increased 6.5%, increasing to $13,001,471 from $12,210,669 in
the previous fiscal year.

                                       13
<PAGE>


     Operating  expenses  increased  $789,664 or 8.2% to $10,363,159  during the
fiscal year ended December 31, 1995 from $9,573,495 during 1994. The increase in
operating  expenses  between  the years was the net  result  of an  increase  in
operating  expenses at Cushman,  as well as certain other costs  incurred by the
Company in order to expand its  infrastructure  and promote its business,  and a
decrease in expenses such as discretionary bonuses and ESOP contributions.  As a
percentage of sales, operating expenses decreased to 33.0% in 1995 from 34.1% in
1994, primarily as a result of the decreased expenses mentioned above as well as
economies of scale achieved through the Company's planned growth.

Provision for Income Taxes

     The  provision  for income taxes  remained  relatively  constant in 1995 as
compared to 1994 at approximately 40% of income before taxes in both years.

Other (Income) Expense

     Other  expenses were  $678,264 for the fiscal year ended  December 31, 1995
compared to $142,830 during the same period in 1994. The difference  between the
two  fiscal  years  involved  increased  interest  expense.  This  increase  was
primarily  due to the  fact  that  the  Company  had a  greater  amount  of bank
indebtedness  outstanding  for the 1995 fiscal year compared to 1994 as a result
of the amount of debt associated with the acquisition and operation of Cushman.

Net Income

     Net income  decreased 22% to $1,173,304  for the fiscal year ended December
31, 1995 from  $1,504,147  during the fiscal year ended  December 31, 1994.  The
decrease was due to the following factors:  the decline in gross profit margins,
an increase in interest expense,  and increases in operating  expenses while the
effective income tax rate remained relatively constant.

Capital Resources and Liquidity

     The primary  sources of liquidity  and capital  resources  during 1996 were
borrowings on the Company's  credit  facility with  NationsBank  of Texas,  N.A.
("NationsBank").

     Background of Agreement with Bank. The NationsBank financing arrangements,
     ------------------------------------
which include a working capital line of credit and a term facility, are governed
by the Second  Restated Loan Agreement dated July 24, 1995 as amended (the "Loan
Agreement").  The Company  presently has outstanding  principal  balances on its
working  capital  line of  credit  and  its  term  facility  of  $5,500,000  and
$3,000,000,  respectively.  From June 30, 1996 through  December  31, 1996,  the
Company had been in default under certain financial  covenants  contained in the
Loan Agreement. These financial covenants related to the following ratio tests:

     (1)  Current Assets to Current Liabilities;
     (2)  Total Liabilities to Tangible Net Worth;
     (3)  Senior Funded Debt to Earnings Before  Interest,  Taxes,  Depreciation
          and Amortization ("EBITDA"); and
     (4)  Cash Flow Ratio.

                                       14
<PAGE>


     On August 14, 1996,  effective June 30, 1996,  NationsBank  and the Company
entered into an amendment to the Loan  Agreement  pursuant to which  NationsBank
agreed to forbear the exercising of their legal rights due to the aforementioned
events of  default  under  the Loan  Agreement  until  September  30,  1996 (the
"Forbearance  Period").  NationsBank  also waived a default  under the Borrowing
Base and the element of the Borrowing  Base which gave rise to the default,  the
net income test, was eliminated as part of said Borrowing Base.

     On September  30, 1996,  NationsBank  and the Company  entered into another
amendment  to the Loan  Agreement  whereby  NationsBank  agreed  to  extend  the
Forbearance Period until December 31, 1996 (the "Extended  Forbearance Period").
NationsBank  and the Company  also agreed to decrease  the amount of the working
capital  line of credit  from $10  million  to $7.5  million.  Additionally  the
Company  agreed to grant  NationsBank  a lien on its facility  located in Tampa,
Florida.

     The Company  remained in default  under the financial  covenants  described
above.

     Current  Agreement.  As of December 31, 1996,  NationsBank  and the Company
     ------------------
entered into the Fifth  Amendment to the Second  Restated  Loan  Agreement  (the
"Fifth Amendment") whereby NationsBank and the Company agreed to modify the Loan
Agreement.  In the Fifth Amendment the Company agreed to employ Price Waterhouse
to assist in obtaining  alternative financing of the obligations to NationsBank.
The Company and Nations Bank also agreed:

     1.   To decrease the amount of the working capital line of credit from $7.5
          million to $6.5 million;
     2.   To modify the maturity date of the working capital line of credit note
          to April 30, 1997;
     3.   To modify the maturity  date of the Roberts  Cushman & Company note to
          April 30, 1997.
     4.   The  financial  covenants  under  which  the  Company  was in  default
          previously were eliminated or modified.


                                       15
<PAGE>


     A copy of the  complete  agreement  is filed  herewith as exhibit  4.13 and
additional information regarding capital resources and liquidity can be found in
the "Notes to Consolidated Financial Statements" section of this report.

     Management  remains  confident  that  the  restructuring  of our  financing
arrangements on a favorable,  long term basis will be accomplished.  However, in
the event  alternative  financing  cannot be arranged, the  Company  would enter
negotiations  with  NationsBank to restructure the existing loans. If neither of
these  strategies  were  successful,  the Company  could  experience  a material
adverse impact.

     While  subject  to  the  issues   surrounding   the   Company's   financing
arrangements,   the  Company's  management  believes  that  current  sources  of
liquidity and capital  resources  will be sufficient to fund current  operations
and internal growth.

Cautionary Statement

     The disclosures under "-Results of Operations" and "-Capital  Resources and
Liquidity"  and in the Notes to  Consolidated  Financial  Statements as provided
elsewhere   herein  contain   forward-looking   statements  and  projections  of
management.  There are certain  important  factors  which could cause results to
differ  materially  than  those  anticipated  by  some  of  the  forward-looking
statements.  Some of the important  factors which could cause actual  results to
differ materially from those in the forward-looking  statements  include,  among
other things,  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,  customer  acceptance  of  existing  and new
products,   or  otherwise,   pricing  pressures  due  to  competitive   industry
conditions,  increases in prices for leather,  which is a world-wide  commodity,
which for some reason,  may not be passed on to the  customers of the  Company's
products,  change  in  tax  rates,  change  in  interest  rates,  change  in the
commercial  banking  environment,  problems with the importation of the products
which the Company  buys in 14  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 said countries of Most Favored
Nation status with the United States of America, and other uncertainties, all of
which are  difficult  to predict and many of which are beyond the control of the
Company.

Item 8.  Financial Statements and Supplementary Data

     Financial  Statements and Financial Statement Schedules are filed as a part
of this report. See page 14, Index to Consolidated Financial Statements.

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

     A. Change in Accountants - During the quarter ended September 30, 1996, the
Company  filed a Current  Report on Form 8-K dated  August 26, 1996 to disclose,
pursuant  to  Item 4, a  change  in the  Company's  independent  accountant.  No
financial statements were filed.

     B. Disagreements with Accountants - None



                                       16
<PAGE>



                            THE LEATHER FACTORY, INC.

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


<TABLE>
<CAPTION>
<S>                                                                            <C>                                  <C>


Consolidated Balance Sheets at December 31, 1996 and 1995 .........................................................      15

Consolidated Statements of Income For the Years Ended December 31, 1996, 1995 and 1994 ............................      16

Consolidated Statements of Cash Flow For the Years Ended December 31, 1996, 1995 and 1994 .........................      17

Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 1996, 1995 and 1994 ..............      18

Notes to Consolidated Financial Statements ........................................................................   19 - 27

Consolidated Financial Statement Schedules for the year ended December 31, 1996:

    II -- Allowance for Doubtful Accounts..........................................................................     28

    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.

Reports of Independent Auditors . .................................................................................   29 - 30



</TABLE>



                                       17
<PAGE>

                            THE LEATHER FACTORY, INC.
                           CONSOLIDATED BALANCE SHEETS
                           December 31, 1996 AND 1995

<TABLE>
<CAPTION>
<S>                                                                             <C>                 <C>



                                                                                       1996                  1995
                                                                                 --------------        ---------------
                                 ASSETS
CURRENT ASSETS:
    Cash                                                                         $      488,192        $       477,159
    Accounts receivable-trade, net of allowance for
        doubtful accounts of $54,000 and $39,000
         in 1996 and 1995, respectively                                               1,947,698              2,784,050
    Inventory                                                                         7,737,320              7,903,179
    Prepaid income taxes                                                                538,458                203,559
    Deferred income taxes                                                               126,955                 88,321
    Other current assets                                                                542,809                656,837
                                                                                 --------------        ---------------
                           Total current assets                                      11,381,432             12,113,105
                                                                                 --------------        ---------------

PROPERTY AND EQUIPMENT, at cost                                                       2,672,253              2,474,056
  Less: accumulated depreciation and amortization                                    (1,273,609)            (1,014,966)
                                                                                 --------------        ---------------
                           Property and equipment, net                                1,398,644              1,459,090

GOODWILL and other, net of accumulated amortization of
    $660,000 and $300,000 in 1996 and 1995, respectively                              5,484,471              5,761,181
                                                                                 --------------        ---------------
                                                                                 $   18,264,547        $    19,333,376
                                                                                 ==============        ===============

                  LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
    Accounts payable                                                             $      940,549        $     1,398,917
    Accrued expenses and other liabilities                                              597,007                655,489
    Income taxes payable                                                                      -                 48,300
    Notes payable and current maturities of
        long-term debt                                                                8,549,366              1,296,359
                                                                                 --------------        ---------------
                           Total current liabilities                                 10,086,922              3,399,065
                                                                                 --------------        ---------------

DEFERRED INCOME TAXES                                                                   137,310                 85,197

NOTES PAYABLE AND LONG-TERM DEBT,
    net of current maturities                                                            17,378              6,566,809

COMMITMENTS AND CONTINGENCIES

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, 9,853,161 shares issued in 1996 and 1995                             23,648                 23,648
    Paid-in capital                                                                   4,130,796              4,130,796
    Retained earnings                                                                 4,464,277              5,454,045
    Less: Notes receivable - secured by common stock                                   (269,305)                     -
    Cumulative translation adjustments                                                     (295)                     -
    Less:  Unearned shares held by ESOP, 64,631
        shares in 1996 and 1995                                                        (326,184)              (326,184)
                                                                                 --------------        ---------------
                           Total stockholders' equity                                 8,022,937              9,282,305
                                                                                 --------------        ---------------
                                                                                 $   18,264,547        $    19,333,376
                                                                                 ==============        ===============

</TABLE>
     The accompanying notes are an integral part of these financial statements.

                                       18
<PAGE>


                            THE LEATHER FACTORY, INC.
                        CONSOLIDATED STATEMENTS OF INCOME
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994





<TABLE>
<CAPTION>
<S>                                                                            <C>            <C>


                                                                1996              1995               1994
                                                           ---------------   ---------------     -------------

NET SALES                                                  $    28,253,632   $    31,447,849    $    28,081,272

COST OF SALES                                                   17,689,973        18,446,378         15,870,603
                                                           ---------------   ---------------    ---------------


                Gross profit                                    10,563,659         13,001,471         12,210,669


OPERATING EXPENSES                                              10,869,359         10,363,159          9,573,495
                                                           ---------------   ----------------   ----------------

INCOME (LOSS)  FROM OPERATIONS                                    (305,700)         2,638,312          2,637,174

OTHER (INCOME) EXPENSE:
     Interest expense                                            1,007,544            718,066            142,037
     Other, net                                                     (6,940)           (39,802)               793
                                                           ---------------   ----------------   ----------------

                Total other (income) expense                     1,000,604            678,264            142,830
                                                           ---------------   ----------------   ----------------


INCOME (LOSS)  BEFORE INCOME TAXES                              (1,306,304)         1,960,048          2,494,344

PROVISION (BENEFIT) FOR INCOME TAXES                              (316,536)           786,744            990,197
                                                           ---------------   ----------------   ----------------

NET INCOME (LOSS)                                          $      (989,768)  $      1,173,304   $      1,504,147
                                                           ===============   ================   ================

NET INCOME (LOSS) PER SHARE OF COMMON STOCK                $        (0.10)   $           0.12   $           0.15
                                                           ==============    ================   ================

WEIGHTED AVERAGE COMMON AND COMMON
     EQUIVALENT SHARES OUTSTANDING                              9,788,530           9,789,468          9,783,387
                                                           ==============    ================   ================

DIVIDENDS PAID PER SHARE                                   $            -    $             -    $             -
                                                           ==============    ================   ================

</TABLE>


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


                                       19
<PAGE>


                            THE LEATHER FACTORY, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOW
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994


<TABLE>
<CAPTION>
<S>                                                                            <C>                <C>              <C>

                                                                                      1996              1995            1994
                                                                                 -------------     -------------     ------------
CASH FLOWS FROM OPERATING ACTIVITIES:

  Net income (loss)                                                             $    (989,768)    $    1,173,304    $    1,504,147

  Adjustments to reconcile net income to net
   cash provided by (used in) operating activities-
     Depreciation & amortization                                                      638,450            424,135           249,616
    (Gain) loss on sales of assets                                                     (7,541)            (9,524)            2,778
     Common stock issued for services                                                       -                  -           240,833
     Deferred financing costs                                                         156,891                  -                 -
     Deferred income taxes                                                             13,479             (9,257)          (27,562)
     Other                                                                                785                  -                 -
     Net changes in operating assets and liabilities, net of effect of
          acquisitions:
       Accounts receivable-trade, net                                                 814,870           (104,118)         (728,346)
       Inventory                                                                      241,843            328,316        (1,754,306)
       Income taxes                                                                  (383,199)          (243,435)          320,253
       Other current assets                                                           130,683           (326,759)         (119,157)
       Accounts payable                                                              (458,368)          (104,939)          302,190
       Accrued expenses and other liabilities                                         (58,482)          (400,868)         (361,203)
                                                                                 ------------      -------------     -------------
     Total adjustments                                                              1,089,411           (446,449)       (1,874,904)
                                                                                 ------------      -------------     -------------

      Net cash provided by (used in) operating activities                              99,643            726,855          (370,757)
                                                                                 ------------      -------------     -------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment                                                (208,537)          (513,483)         (308,115)
  Proceeds from sales of assets                                                        10,444             17,746             6,000
  Cash paid for acquisitions, net of cash acquired                                   (300,000)        (5,232,389)         (572,713)
 (Increase) decrease in assets restricted for acquisitions                                  -          5,040,656        (5,040,656)
  Other intangible costs                                                              (24,788)           (42,234)          (39,436)
                                                                                 ------------      -------------     -------------

      Net cash used in investing activities                                          (522,881)          (729,704)       (5,954,920)
                                                                                 ------------      -------------     -------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from notes payable and long-term debt                                    3,300,000          2,574,904         6,362,196
  Payments on notes payable and long-term debt                                     (2,596,424)        (2,231,478)         (533,411)
  Proceeds from issuance of common stock                                                    -                  -           611,000
  Purchase of  notes receivable - secured by common stock                            (269,305)                 -                 -
  Securities acquisition loan to ESOP                                                       -            (99,962)         (226,222)
  Deferred financing and stock issuance costs                                               -           (165,709)          (26,254)
                                                                                 ------------      -------------     -------------

      Net cash provided by financing activities                                       434,271             77,755         6,187,309
                                                                                 ------------      -------------     -------------

NET INCREASE (DECREASE) IN CASH                                                        11,033             74,906          (138,368)

CASH, beginning of period                                                             477,159            402,253            540,621
                                                                                 ------------      -------------     --------------


CASH, end of period                                                              $    488,192      $     477,159     $      402,253
                                                                                 ============      =============     ==============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid during the period                                                $    793,373      $     763,848     $      133,116
  Income taxes paid during the period, net of refunds                                  55,445          1,066,111            700,935


</TABLE>
     The accompanying notes are an integral part of these financial statements.

                                       20
<PAGE>

                            THE LEATHER FACTORY, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
              FOR THE YEARS ENDED DECEMBER 31, 1996, 1995 AND 1994
<TABLE>
<CAPTION>
<S>                                                                           <C>      <C>           <C>           <C>

                             Common Stock
                         --------------------                          Notes receivable  Cumulative
                         Number                  Paid-in     Retained    - secured by    Translation     Unearned
                        of Shares  Par Value     Capital     Earnings    common stock    Adjustments    ESOP Shares     Total
                        ---------  ---------  ------------  -----------  ------------    -----------    -----------  ----------

BALANCE,December 31,
    1993               9,577,756  $  22,987  $  2,702,871  $ 2,776,594   $        -    $          -  $           -  $ 5,502,452

  Shares issued for
    cash                  40,000         96       199,904            -            -               -              -      200,000

  Shares issued in
    acquisitions          98,405        236       537,294            -            -               -              -      537,530

  Shares issued for
    cash - employee
    stock options
     exercised           137,000        329       410,671            -            -               -              -      411,000

  Compensation expense
    - employee stock
     options                  -          -       240,833            -             -               -              -      240,833

  Tax effect of excess
     deduction
    over book expense
     - exercise
     of employee stock
      options                 -          -        74,295            -             -               -              -       74,295

   American Stock
     Exchange additional
      listing fee             -          -        (4,500)            -            -               -              -      (4,500)

   Stock issuance costs       -          -       (21,754)            -            -               -              -     (21,754)

   Securities acquisition
     loan to ESOP             -          -             -            -             -               -       (226,222)    (226,222)

  Net income                  -          -             -    1,504,147             -               -              -    1,504,147
                      ---------  ---------    -----------  -----------   ----------     -----------  -------------  -----------
BALANCE, December
    31, 1994          9,853,161     23,648     4,139,614    4,280,741             -               -       (226,222)   8,217,781

   Stock issuance
     costs                    -          -       (8,818)            -             -               -              -       (8,818)

   Securities acquisition
     loan to ESOP             -          -             -            -             -               -        (99,962)     (99,962)

   Net income                 -          -             -    1,173,304             -               -              -    1,173,304
                      ---------  ---------   -----------  -----------    ----------     -----------  -------------   ----------
BALANCE, December
  31, 1995            9,853,161     23,648     4,130,796    5,454,045             -               -       (326,184)   9,282,305

   Notes receivable
     - secured by
       common stock           -          -             -            -      (269,305)              -              -     (269,305)

   Translation
     adjustment               -          -             -            -             -            (295)             -         (295)

   Net loss                   -          -             -     (989,768)            -               -              -     (989,768)
                      ---------  ---------   -----------  -----------    ----------    - ----------   ------------  -----------

BALANCE, December
   31, 1996           9,853,161  $  23,648  $  4,130,796  $ 4,464,277    $ (269,305)    $      (295)  $   (326,184)  $ 8,022,937
                      =========  =========  ============  ===========    ==========     ===========   ============   ===========
</TABLE>
     The accompanying notes are an integral part of these financial statements.

                                       21
<PAGE>

                            THE LEATHER FACTORY, INC.
                              NOTES TO CONSOLIDATED
                              FINANCIAL STATEMENTS

                        DECEMBER 31, 1996, 1995 AND 1994


1.  ORGANIZATION AND NATURE OF OPERATIONS

The Leather Factory,  Inc. and subsidiaries (the "Company")  operations  include
the  manufacture,   distribution,   importation,  and  exportation  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  kits.  The Company  through its
subsidiary,  Roberts,  Cushman  &  Company,  Inc.,  is also a  manufacturer  and
distributor of hat trims and small  finished  leather goods such as cigar cases,
picture frames,  wallets, and western accessories.  As of December 31, 1996, the
Company  had 22  sales/distribution  units in 17 states  and  Canada,  including
Arizona,  California,  Colorado,  Florida,  Iowa, Kansas,  Louisiana,  Michigan,
Missouri,  New Mexico, North Carolina,  Ohio,  Pennsylvania,  Tennessee,  Texas,
Utah,  Washington,  and  Winnipeg.  The  Company  also has  light  manufacturing
facilities In Fort Worth,  Texas and New York,  New York.  In 1996,  the Company
expanded  its  sales/distribution  units by acquiring  its Canadian  distributor
located in Winnipeg, and opening a new unit in Charlotte, North Carolina.

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.  Certain prior
year amounts have been reclassified to conform to the current year presentation.

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:

                                             1996                 1995
                                          ----------           ----------
  Finished goods held for sale           $ 6,516,517          $ 6,736,811

  Raw materials and work in process        1,220,803            1,166,368
                                         -----------          -----------

                                         $ 7,737,320          $ 7,903,179
                                         ===========          ===========

Restricted Assets

Restricted  assets consist  primarily of cash borrowed for an acquisition  which
was consummated on January 2, 1995. Please see Note 9 below.

                                       22
<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:

                            Building                           30 years
                            Leasehold improvements            5-7 years
                            Equipment                        5-10 years
                            Furniture and fixtures            5-7 years
                            Automobiles                         5 years


Depreciation  expense was  $277,994;  $224,364;  and 175,348 for the years ended
December 31, 1996, 1995 and 1994, 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.

Acquisitions to date have not involved any significant  long-lived  assets other
than goodwill.  Accordingly,  the Company evaluates such goodwill for impairment
in accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 17,  "Intangible  Assets."  During  1996,  the Company  determined  that the
goodwill  associated with the  acquisition of Hi-Line Leather and  Manufacturing
Co.,  Inc.  in 1994 was  impaired,  and should be  reduced  by fifty  percent or
approximately  $142,000.  This  conclusion  was reached due to the fact that the
customer base acquired in the purchase  transaction has declined  substantially,
and the operating  results of the location since the  acquisition  have not met
expectations.  However,  the unit is providing  marginal  positive cash flow and
business conditions could improve; therefore,  management believes the remaining
goodwill is recoverable and the amortization period remains appropriate.

Amortization  expense of $360,456 in 1996; $199,771 in 1995; and $74,268 in 1994
was recorded in operating expenses including the above write-down.

Advertising Costs

With the exception of catalog costs,  advertising cost 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  months.  Such
capitalized  costs are included in other current assets and totaled $203,755 and
$266,875 at December 31, 1996 and 1995, respectively.  Total advertising expense
was $1,089,716 in 1996; $976,126 in 1995; and $797,758 in 1994.

                                       23
<PAGE>


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

Earnings per share is based on the weighted  average  number of shares of common
stock and common stock equivalents  outstanding during each period. Common stock
equivalents  are  determined  for stock options using the treasury stock method,
under which the number of shares outstanding  reflects the assumed repurchase of
shares of the Company's common stock with the proceeds from the assumed exercise
of outstanding  stock  options.  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  Financial  Accounting  Standards  Board  ("FASB")  has issued  Statement of
Financial  Accounting Standards ("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 has determined that as of December 31,
1996, it has no long-lived assets that meet the impairment  criteria of SFAS No.
121.

Stock-Based Compensation

Statement of Financial  Accounting Standards No. 123 "Accounting for Stock-Based
Compensation"  ("SFAS  123"),  issued  in  October  1995,  establishes financial
accounting and reporting standards for stock-based employee  compensation plans.
As permitted  by SFAS 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.

                                       24
<PAGE>

3.  NOTES PAYABLE AND LONG-TERM DEBT

At December 31, 1996 and 1995, notes payable and long-term debt consisted of the
following:

<TABLE>
<CAPTION>
<S>                                                                                 <C>             <C>
                                                                                         1996           1995
                                                                                       ---------     ----------
Loan Agreement with NationsBank of Texas, N. A. -  collateralized  by inventory,
trade accounts  receivable,  equipment, fixtures and real estate;  payable as
follows:

Promissory  Note (Term Loan) dated December 28, 1994 in the principal  amount of
$5,000,000 - $250,000  principal due quarterly with monthly interest payments at
prime plus 1.5% (9.75% at December 31, 1996);
matures April  30, 1997                                                               $3,000,000     $4,250,000

Promissory Note (Working  Capital  Line of Credit)originally dated July 24, 1995
in the maximum principal  amount of $6,500,000  with Revolving  features as more
fully escribed below-interest due monthly at prime plus 1.5 % (9.75% at December
31, 1996); matures April  30, 1997                                                     5,500,000      3,500,000

Unsecured note payable  created in connection with the acquisition of the assets
of The  Leather  Warehouse  discussed  in  Note 9  below -  $4,419  payments  of
principal  and  interest  due  monthly at prime  (8.25% at December  31,  1996);
matures on April 1, 1998                                                                  66,744        112,180

Other notes payable                                                                            -            988
                                                                                       ----------     ---------
                                                                                        8,566,744     7,863,168

Less - Current maturities                                                               8,549,366     1,296,359
                                                                                       ----------    ----------
                                                                                     $     17,378    $6,566,809
                                                                                       ==========     ==========


</TABLE>

In  addition  to the  above  amounts  payable  to  NationsBank  of  Texas,  N.A.
("Nations"),  the  bank  holds  letters  of  credit  in the  Company's  name for
inventory  purchase  commitments with terms ranging from sight to 90 days. As of
December 31, 1996 and 1995, the Company had $273,065 and $745,072, respectively,
in outstanding purchase commitments on these letters of credit.

                                       25
<PAGE>


Pursuant to the Loan Agreement,  the overall combined limit for borrowings under
the Working Capital Line of Credit  facility as amended and outstanding  balance
on letters of credit is $6,500,000.  Of the overall $6,500,000 limit, letters of
credit  cannot  exceed  $1,000,000.  The unused  portion of the letter of credit
limit  can be  utilized  for  borrowings,  up to the  limits  imposed  for  said
indebtedness.  Total  borrowings  under this  arrangement  are also limited to a
certain  percentage of trade accounts  receivable  and inventory  reduced by the
outstanding  balance of letters of credit.  Total  availability  at December 31,
1996,  under the  Working  Capital  Line of Credit  facility  and for letters of
credit was $107,170.

The Loan Agreement as amended has affirmative  financial covenants which require
the  maintenance  of a  minimum  current  ratio,  and a  maximum  ratio of total
liabilities to tangible net worth. The Agreement also restricts the Company from
paying dividends other than those payable solely in additional shares of stock.

The Company's long-term debt matures as follows:
                                       1997               $ 8,549,366
                                       1998                    17,378
                                                           ----------
                                                          $ 8,566,744
                                                           ==========

In January 1997, the Company with the  assistance of  consultants  implemented a
plan to secure financing to replace the Nations debt. The Company seeks to raise
$6,000,000 in senior debt and  $4,000,000 in mezzanine  financing.  The proposed
senior debt would be comprised of a $5,500,000  revolving  line of credit with a
$1,000,000  sublimit  for  Letters  of Credit to be  secured  by  inventory  and
receivables  and a $500,000  term loan  secured by property and  equipment.  The
proposed  revolving line of credit will require  monthly  interest  payments and
will mature within one year of  initiation.  The proposed term loan will require
monthly  principal  and  interest  payments  on a five  year  amortization.  The
proposed mezzanine  financing will require monthly coupon interest payments with
a five year balloon and detachable warrants.

Management  and their  consultants  believe  that the  Company  will secure such
proposed financing although there can be no guarantee this will occur.

4.  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.

                                       26
<PAGE>

During  1994,  the Company  adopted  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, issued in November 1993.
The Company  contributed  $27,500;  $133,378;  and  $325,000 in cash to the Plan
during 1996, 1995 and 1994, respectively. Of these amounts $27,500; $33,416; and
$98,778 represented current year contributions,  while $0; $99,962; and $226,222
represented securities acquisition loans for 1996, 1995 and 1994,  respectively.
During  1995,  the Plan  purchased  23,500  shares of Company  stock on the open
market for $99,962.  In 1994, the Plan purchased  56,364 shares of Company stock
for $310,000 from certain officers of the Company.  In accordance with SOP 93-6,
these  purchases  have been recorded as unearned ESOP shares.  The unearned ESOP
share  account  will be reduced by the cost of the shares when they are 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
recognized  compensation  expense related to the Plan of $27,500;  $33,416;  and
$98,778 in 1996, 1995 and 1994, respectively.

The  following  table  summarizes  the number of shares held by the Plan and the
market value as of December 31, 1996, 1995 and 1994:


                        No. of Shares                 Market Value
                        -------------                 ------------

               1996     1995      1994       1996          1995          1994
              -----     ----      ----       ----          ----          ----
Allocated    681,547   725,605   777,440  $ 554,098   $ 1,769,025   $ 3,353,099
 Unearned     64,631    64,631    41,131     52,545       157,570       177,398
             -------   -------   -------  ---------   -----------   -----------
    Total    746,178   790,236   818,571  $ 606,643   $ 1,926,595   $ 3,530,497
             =======   =======   =======  =========   ===========   ===========

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


                                       27
<PAGE>


5.  INCOME TAXES

The provision for income taxes consists of the following:





                                         1996            1995         1994
                                         -----           -----        ----

Current provision (benefit):
Federal                               ($ 282,917)     $  658,975    $  864,945
State                                    (47,098)        137,026       152,814
                                      ----------      ----------    ----------
                                        (330,015)        796,001     1,017,759
                                      ----------      ----------    ----------
Deferred provision (benefit):
Federal                                   11,351          (7,870)      (24,136)
State                                      2,128          (1,387)       (3,426)
                                      ----------      ----------    ----------
                                          13,479          (9,257)      (27,562)
                                      ----------      ----------    ----------
                                      ($ 316,536)      $ 786,744    $  990,197
                                      ==========       =========    ==========


Deferred  taxes  relate  primarily  to  temporary  differences  in the  bases of
accounts receivable, inventory, fixed assets and accrued expenses.

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

                                      1996    1995       1994
                                      ----    ----       ----
Statutory rate                        (34%)     34%       34%
State taxes                            (3%)      4%        3%
Non-deductible
  goodwill amortization                10%       4%        1%
Other                                   3%      (2%)       2%
                                      -----------------------
Effective rate                        (24%)     40%       40%
                                      =======================

6.  COMMITMENTS AND CONTINGENCIES

Operating Leases

The  Company's  primary  office  facility  and  warehouse  are  leased  under  a
seven-year lease agreement that expires in March 1998. Rental agreements for the
sales/distribution  units  expire on dates  ranging  from  November  30, 1997 to
December 31, 2003. The Company's lease agreement for the manufacturing  facility
in New York,  New York,  expires on December  31,  1997.  Future  minimum  lease
payments for all noncancellable operating leases are as follows:

                            Year Ending December 31,

                                 1997                             $ 1,039,148
                                 1998                                 694,987
                                 1999                                 443,366
                                 2000                                 288,649
                                 2001                                 183,023
                                 2002 and thereafter                  135,005
                                                                   ----------
                      Total future minimum lease payments          $2,784,178
                                                                   ==========

Rent expense on all operating leases for the years ended December 31, 1996, 1995
and 1994, was $1,008,458; $928,433; and $710,650, respectively.
                                       28
<PAGE>


Litigation

The  Company  has  litigation  in  the  ordinary  course  of  its  business  and
operations. The Company does not expect the outcome of any current litigation to
have a material impact on its financial position and results of operations.

7.  MAJOR VENDORS

Two major  vendors  accounted for 16% and 10% of the  Company's  1996  inventory
purchases.  These  same  vendors  accounted  for 15%  and 14% of 1995  inventory
purchases,  and 18% and 12% of 1994  inventory  purchases.  Due to the number of
alternative  sources  of supply,  it is  management's  opinion  that the loss of
either or both of these principal  suppliers would not have a material impact on
the operations of the Company.

8.  STOCKHOLDERS' EQUITY

Stock Option Plans

The Company has outstanding  options to purchase its common stock under The 1995
Stock  Option  Plan  for  officers  and key  management  employees  and The 1995
Director  Non-qualified Stock Option Plan for non-employee  directors.  The plan
for  employees  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.  Employee  options  vest over a
five-year period while the director  options vest after six months.  All options
expire ten years from the date of grant and are  exerciseable  at any time after
vesting.  As of December  31, 1996,  1,000,000  shares of common stock have been
reserved  for future  issuance  under the employee  plan and 100,000  shares are
reserved for future issuance under the director plan.

In accordance with the Company's 1993 Non-Qualified Incentive Stock Option Plan,
an  aggregate  of  600,000  common  shares  could be granted  to  officers,  key
employees,  vendors and  consultants.  The options were  exercisable at any time
from the date of grant to March 31, 1994 when they expired.

A summary of the Company's stock option activity and related information for the
years ended December 31, 1996, 1995 and 1994, is as follows:

<TABLE>
<CAPTION>
<S>                                                                            <C>    <C>

                                                  1996                  1995                      1994
                                         ---------------------   --------------------  -----------------------

                                                      Weighted             Weightedd                Weighted
                                                      Average              Averagee                 Average
                                           Option     Exercise    Option   Exercise      Option     Exercise
                                           Shares     Price       Shares   Price         Shares     Price
                                         ---------  ----------   --------  ----------   ---------   ----------
Outstanding at January 1                   585,000     $3.063             - $       -     110,000      $3.000
Granted                                    106,000      1.088       585,000     3.063      40,000       3.000
Forfeited                                 (181,000)     3.063             -         -           -           -
Expired                                          -          -             -         -     (13,000)      3.000
Exercised                                        -          -             -         -    (137,000)      3.000
                                         ---------  ---------   ----------- ---------   ---------  ----------
Outstanding at December 31                 510,000     $2.653       585,000    $3.063           -  $        -
                                         =========  =========   =========== =========   =========  ==========
Exercisable at end of year                  84,000     $3.063             - $       -           -  $        -
                                         =========  =========   =========== =========   =========  ==========

Weighted-average fair value of
  options granted during the year            $0.52                    $1.45
                                         =========              ===========

</TABLE>


                                       29
<PAGE>


The following table segregates outstanding options into groups based on exercise
price ranges of less than and more than $2 per share.

                                 Outstanding                  Exercisable
                       ------------------------------ --------------------------
                                  Weighted   Weighted         Weighted  Weighted
                                  Average    Average           Average  Average
                         Option   Exercise   Maturity  Option  Exercise Maturity
Exercise Price Range     Shares   Price      (Years)   Shares   Price   (Years)
--------------------   ---------  ---------- --------  ------  -------  --------
      Less than $2       106,000      $1.088     9.83       - $   -           -
      More than $2       404,000       3.063     8.75  84,000  3.063       8.75
                       ---------  ----------  -------  ------  -----    --------
                         510,000      $2.653     8.97  84,000 $3.063       8.75
                       =========  ==========  =======  ======  =====    ========

Pro forma information  regarding net income (loss) and earnings (loss) per share
is required by SFAS 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 6.72% in 1996 and  6.38% in 1995;  dividend  yields of 0% for
both years;  volatility  factors of .439 for both years; and an expected life of
the valued options of 5 years in both 1996 and 1995.

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:
                                                      1996           1995
                                                   ------------   ---------
        Pro forma net income (loss)                ($1,057,818)   $1,121,736

        Pro forma net income (loss) per share           ($0.11)        $0.11

Private Placements

During 1994, forty thousand shares of the Company's common stock were issued for
cash in the  amount  of $5.00  per share  pursuant  to the sale of four  private
placement units.


                                       30
<PAGE>


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. The
notes are due from seven  individuals  including  officers and other  members of
management and mature on December 31, 1997.

9.  ACQUISITIONS

On January 10,  1994,  the Company  acquired  all of the issued and  outstanding
shares of capital stock of Hi-Line Leather & Manufacturing  Company ("Hi-Line"),
a distributor of shoe repair and care supplies  located in Oakland,  California.
For financial  reporting  purposes,  the transaction was accounted for under the
purchase method, effective January 1, 1994.

On April 15, 1994, the Company purchased certain assets of The Leather Warehouse
Company ("Warehouse"),  a Michigan corporation which distributes shoe repair and
care  supplies  located  in Grand  Rapids,  Michigan.  For  financial  reporting
purposes, the transaction was accounted for under the purchase method, effective
April 1, 1994.

On January 2,  1995,  the  Company  acquired  all of the issued and  outstanding
shares of capital stock of Roberts, Cushman & Co., Inc., a manufacturer of fancy
hat trims located in New York, New York,  for an  approximate  purchase price of
$5,000,000.  The  purchase  price was funded with the  proceeds of the Term Loan
discussed in Note 3 above,  which along with legal and other acquisition  costs,
comprised the restricted assets at December 31, 1994. The purchase was accounted
for under the purchase method effective, January 1, 1995.

On January 31, 1995, the Company  acquired  certain assets of Gulf Coast Leather
Company,  Inc., a distributor  of shoe care and repair  supplies  located in New
Orleans, Louisiana. The assets purchased include inventory, furniture, fixtures,
equipment,  and  rental  and  utility  deposits.  The total  purchase  price was
approximately $91,869 which was funded with cash generated from operations.  The
purchase was  accounted  for under the purchase  method  effective,  January 31,
1995.

On December  29,  1995,  the Company  acquired  certain  assets of B & J Leather
Company ("B & J") of Fort Worth,  Texas, which was engaged primarily in the sale
of leather and related  products  to the shoe  repair and care  industry.  These
assets, which included primarily salable inventory and intangible assets such as
vendor and customer  lists,  were valued at $100,094  which was funded with cash
generated from operations. The two principal shareholders of B & J were employed
by the Company subsequent to closing, with the business performed by B & J being
incorporated into the Company's  sales/distribution  unit located in Fort Worth,
Texas.  The purchase was  accounted  for under the  purchase  method  effective,
December 31, 1995.

                                       31
<PAGE>

On March 1, 1996, the Company acquired all of the issued and outstanding  shares
of capital stock of The Leather Factory of Canada,  Ltd., the Company's Canadian
distributor  located  in  Winnipeg,  Manitoba.  The  total  purchase  price  was
approximately  $300,000 which was funded with cash generated from operations and
the Company's revolving credit facility.  For financial reporting purposes,  the
transaction  was accounted  for under the purchase  method,  effective  March 1,
1996.

Unaudited pro forma results of operations  for the year ended December 31, 1994,
as if the Cushman acquisition had occurred January 1, 1994, are as follows:

                         Net sales                              $34,743,952

                         Net income                               2,054,566

                         Net income per common share            $       .21

The pro forma financial information presented above does not include the effects
of the other acquisitions consummated by the Company during 1996, 1995 and 1994,
as such amounts would not be significantly different.

10.  SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING
     AND FINANCING ACTIVITIES

In conjunction with the 1994 acquisitions discussed in Note 9 above, liabilities
were assumed and common stock was issued as follows:

                                               Hi-Line    Warehouse    Total
                                               -------    ---------    -------

  Fair value of assets acquired             $   688,007   $ 344,688  $1,032,695
  Cost in excess of assets acquired             324,667     123,568     448,235
                                             ----------   ---------  ----------
           Total assets acquired              1,012,674     468,256   1,480,930

  Consideration paid:
    Cash                                       (409,612)   (173,175) (582,787)
    Fair value of common stock issued          (422,577)   (114,953)  (537,530)
                                             ----------  ----------  ----------
           Liabilities assumed               $  180,485  $  180,128  $  360,613
                                            ===========  ==========  ==========

11.  FAIR VALUE OF FINANCIAL INSTRUMENTS

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

Accounts payable
The carrying  amount  approximates  fair value because of the short  maturity of
those instruments.



                                       32
<PAGE>

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.

12.  QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>
<S>                                                                            <C>

                                ** First  (*)(**)Second     **Third       Fourth
            1996                 Quarter        Quarter      Quarter     Quarter
-----------------------------  --------------------------------------------------------
Net sales                      $ 7,356,805   $ 7,155,218   $ 7,015,834    $ 6,725,775
Gross profit                     2,894,664     2,337,962     2,777,628      2,553,405
Net income (loss)                  (21,994)     (810,963)       14,391       (171,202)
Net income (loss) per
 share of common stock                   -         (0.08)            -          (0.02)
Weighted average number
 of common shares outstanding    9,788,530     9,788,530     9,788,530      9,788,530


                                   First           Second       Third    ** Fourth
           1995                   Quarter         Quarter       Quarter     Quarter
-----------------------------  --------------------------------------------------------
Net sales                      $ 8,568,942   $ 7,619,499    $ 7,580,224   $ 7,679,184
Gross profit                     3,747,404     3,304,296      3,076,549     2,873,222
Net income (loss)                  558,025       391,258        204,486        19,535
Net income (loss) per
  share of common stock               0.06          0.04           0.02             -
Weighted average number
 of common shares outstanding    9,812,030     9,812,030      9,836,645     9,788,530

</TABLE>


*    The second quarter  results for 1996 include  several items that affect the
     comparability  to the other quarters.  These items include the write-off of
     deferred costs related to financing  commitments that expired, the goodwill
     write-down, a large bad debt due to a customer  bankruptcy, and a  minimum
     royalty accrual and inventory write-off due to a licensing  agreement.  The
     aggregate amount of such costs is approximately $560,000.

**   The results  for the fourth  quarter of 1995  through the third  quarter of
     1996 were affected by excessive  labor,  production,  travel and legal cost
     related to the labor dispute at the Company's New York facility that affect
     comparability  to the other  quarters.  The labor  dispute  was  settled on
     favorable  terms in October of 1996.  The aggregate  amount of such cost is
     approximately $600,000.


                                       33
<PAGE>


                            THE LEATHER FACTORY, INC.
                 SCHEDULE II -- ALLOWANCE FOR DOUBTFUL ACCOUNTS
                          Year Ended December 31, 1996


Balance at beginning of year                                 $  39,000

     Additions charged to income                               229,000

     Balances written off, net of recoveries                  (214,000)
                                                              --------

Balance at end of year                                       $  54,000
                                                              ========


                                       34
<PAGE>

                         REPORT OF INDEPENDENT AUDITORS



The Board of Directors
The Leather Factory, Inc.

We have  audited  the  accompanying  consolidated  balance  sheet of The Leather
Factory,  Inc. as of December 31, 1996, and the related consolidated  statements
of income,  stockholders'  equity,  and cash flows for the year then ended.  Our
audit 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 audit.

We conducted our audit in accordance with generally accepted auditing standards.
Those standards  require that we plan and perform the audit 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 audit provides a reasonable basis for our opinion.

In our opinion, the consolidated  financial statements referred to above present
fairly, in all material  respects,  the financial  consolidated  position of The
Leather Factory,  Inc. at December 31, 1996, and the consolidated results of its
operations  and its  cash  flows  for the  year  ended  December  31,  1996,  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.



/s/   Ernst & Young LLP


Fort Worth, Texas,
February 21, 1997




                                       35
<PAGE>




                    REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS



TO THE STOCKHOLDERS OF
THE LEATHER FACTORY, INC.:

We have  audited  the  accompanying  consolidated  balance  sheet of The Leather
Factory,  Inc. (a Delaware corporation) and subsidiaries as of December 31, 1995
and the related  consolidated  statements of income,  stockholders'  equity, and
cash flows for each of the two years then ended. These financial  statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the audit 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 financial  statements  referred to above present fairly, in
all material respects,  the financial position of The Leather Factory,  Inc. and
subsidiaries  as of December  31, 1995 and the results of their  operations  and
their  cash  flows for each of the the years  then  ended,  in  conformity  with
generally accepted accounting principles.


/s/Arthur Andersen LLP

Fort Worth, Texas,
February 16, 1996




                                       36
<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 "Directors and
Executive  Officers"  in the Proxy  Statement  for the 1997  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 1997 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  "Principal  Stockholders"  and  "Certain
Transactions"   in  the  Proxy   Statement  for  the  1997  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 1997 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 schedules  listed in the  accompanying
          index to consolidated financial statements at Item 8 are filed as part
          of this annual 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

          None

                                       37
<PAGE>

                                   SIGNATURES



     In accordance  with 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 28, 1997                          /s/ Wray Thompson
       --------------                          -----------------
                                               Wray Thompson
                                               Chairman of the Board, President,
                                               and Chief Executive Officer

     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/ Fred N. Howell          Chief Financial Officer,     March 28, 1997
-----------------------      Treasurer and Director
Fred N. Howell               (Chief Accounting Officer)


/s/  Wray Thompson           Chairman of the Board        March 28, 1997
-----------------------
Wray Thompson


/s/ Ronald C. Morgan         Director                     March 28, 1997
-----------------------
Ronald C. Morgan


/s/ Robin L. Morgan          Director                     March 28, 1997
-----------------------
Robin L. Morgan


/s/ William M. Warren        Director                     March 28, 1997
-----------------------
William M. Warren


/s/ Luther A. Henderson      Director                     March 28, 1997
-----------------------
Luther A. Henderson


/s/ H. W. Markwardt          Director                     March 28, 1997
-----------------------
H. W. Markwardt

                                       38
<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.

3.3  Amendment to Certificate of Incorporation  of The Leather Factory,  Inc. --
     Certificate of Designation, Preferences and Rights of the Senior Cumulative
     Convertible  Preferred  Stock Dated July 24, 1995,  filed as Exhibit 3.3 to
     the  Quarterly  Report  on  Form  10-QSB  of  The  Leather  Factory,   Inc.
     (Commission  File No.  1-12368)  filed  with the  Securities  and  Exchange
     Commission on August 10, 1995, and incorporated by reference herein.

4.1  Second  Restated  Loan  Agreement  dated July 24, 1995,  by and between The
     Leather Factory,  Inc., a Delaware  corporation,  and NationsBank of Texas,
     N.A.,  filed as Exhibit 4.1 to the  Quarterly  Report on Form 10-QSB of The
     Leather  Factory,  Inc.  (Commission  File  No.  1-12368)  filed  with  the
     Securities and Exchange  Commission on August 10, 1995, and incorporated by
     reference herein.

4.2  Promissory Note (Working  Capital Line of Credit) dated September 30, 1996,
     in the principal amount of $7,500,000,  payable to the order of NationsBank
     of Texas, N.A., which matures March 31, 1997.

4.3  Promissory  Note  (Acquisition  Line) dated July 24, 1995, in the principal
     amount of $10,000,000,  payable to the order of NationsBank of Texas, N.A.,
     which matures August 1, 2000,  filed as Exhibit 4.3 to the Quarterly Report
     on Form 10-QSB of The Leather Factory,  Inc.  (Commission File No. 1-12368)
     filed with the Securities  and Exchange  Commission on August 10, 1995, and
     incorporated by reference herein.

4.4  Promissory  Note  dated  December  28,  1994  in the  principal  amount  of
     $5,000,000,  payable  to the order of  NationsBank  of Texas,  N.A.,  which
     matures  December  28,  1999,  filed as Exhibit  No. 4.5 to the 1994 Annual
     Report on Form 10-KSB of The Leather Factory,  Inc. (Commission File No. 1-
     12368) filed with the Securities and Exchange Commission on March 27, 1995,
     and incorporated herein by reference.

4.5  Stock Purchase  Agreement  dated as of July 28, 1995, by and between Center
     Street Capital Partners,  L.P., a Delaware Limited  Partnership,  Stratford
     Capital  Partners,  L.P.,  a Texas  Limited  Partnership,  and The  Leather
     Factory,  Inc.,  a  Delaware  Corporation,  filed  as  Exhibit  4.5  to the
     Quarterly  Report on Form 10-QSB of The Leather Factory,  Inc.  (Commission
     File No.  1-12368)  filed with the  Securities  and Exchange  Commission on
     August 10, 1995, and incorporated by reference herein.



                                       39
<PAGE>




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

4.6  Commitment Agreement dated July 28, 1995, by and among The Leather Factory,
     Inc., a Delaware  Corporation,  Center  Street  Capital  Partners,  L.P., a
     Delaware Limited Partnership, and Stratford Capital Partners, L.P., a Texas
     Limited  Partnership,  filed as Exhibit 4.6 to the Quarterly Report on Form
     10-QSB of The Leather  Factory,  Inc.  (Commission  File No. 1-12368) filed
     with the  Securities  and  Exchange  Commission  on August  10,  1995,  and
     incorporated by reference herein.

4.7  Registration  Rights  Agreement  dated July 28, 1995, by and between Center
     Street Capital Partners,  L.P., a Delaware Limited  Partnership,  Stratford
     Capital  Partners,  L.P.,  a Texas  Limited  Partnership,  and The  Leather
     Factory,  Inc.,  a  Delaware  Corporation,  filed  as  Exhibit  4.7  to the
     Quarterly  Report on Form 10-QSB of The Leather Factory,  Inc.  (Commission
     File No.  1-12368)  filed with the  Securities  and Exchange  Commission on
     August 10, 1995, and incorporated by reference herein.

4.8  Shareholders  Agreement  dated July 28, 1995, by and between Wray Thompson,
     an individual  and resident of the State of Texas,  Sally A.  Thompson,  an
     individual  and  resident  of the State of  Texas,  Ronald  C.  Morgan,  an
     individual  and  resident  of the  State  of  Texas,  Robin L.  Morgan,  an
     individual  and  resident  of the State of  Texas,  Center  Street  Capital
     Partners, L.P., a Delaware Limited Partnership, Stratford Capital Partners,
     L.P.,  a Texas  Limited  Partnership,  and The  Leather  Factory,  Inc.,  a
     Delaware Corporation,  filed as Exhibit 4.8 to the Quarterly Report on Form
     10-QSB of The Leather  Factory,  Inc.  (Commission  File No. 1-12368) filed
     with the  Securities  and  Exchange  Commission  on August  10,  1995,  and
     incorporated by reference herein.

4.9  First Amendment to Second Restated Loan Agreement  effective as of December
     31, 1995, by and between The Leather Factory, Inc., a Delaware Corporation,
     and NationsBank of Texas, N.A., filed as Exhibit No. 4.9 to the 1995 Annual
     Report on Form 10-KSB of The Leather  Factory,  Inc.  (Commission  File No.
     1-12368),  filed with the Securities  and Exchange  Commission on March 28,
     1996, and incorporated herein by reference.

4.10 Second  Amendment to Second  Restated Loan Agreement  effective as of March
     31, 1996, by and between The Leather Factory, Inc., a Delaware Corporation,
     and NationsBank of Texas,  N.A., filed as Exhibit No. 4.10 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 on May 20, 1996,
     and incorporated by reference herein.

4.11 Forbearance Agreement and Third Amendment to Second Restated Loan Agreement
     effective as of June 30, 1996, by and between The Leather Factory,  Inc., a
     Delaware Corporation,  and NationsBank of Texas, N.A., filed as Exhibit No.
     4.11 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 on August 19, 1996, and incorporated by reference herein.

4.12 Forbearance   Agreement  and  Fourth  Amendment  to  Second  Restated  Loan
     Agreement  effective as of September  30, 1996,  by and between The Leather
     Factory, Inc., a Delaware Corporation, and NationsBank of Texas, N.A.


                                       40
<PAGE>


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

*4.13 Fifth  Amendment to Second  Restated  Loan  Agreement  effective as of
      December  31,  1996,  by and  between  The Leather  Factory,  Inc.,  a
      Delaware Corporation, and NationsBank of Texas, N.A.


10.1  Stock Exchange  Agreement dated July 9, 1993, by and among The Leather
      Factory,  Inc.,  a Texas  corporation,  National  Transfer  & Register
      Corp.,  a  Colorado  corporation,  J. Wray  Thompson,  Sr.,  Ronald C.
      Morgan, Robin L. Morgan and The Leather Factory, Inc. Employees' Stock
      Ownership Plan & Trust,  filed as Exhibit No. 10.1 to the Registration
      Statement on Form 10-SB of The Leather Factory,  Inc. (Commission File
      No.  0-22128),  including  any  amendments  thereto,  filed  with  the
      Securities and Exchange  Commission on July 22, 1993, and incorporated
      herein by reference.

10.2  Stock Exchange  Agreement dated July 10, 1993, by and between National
      Transfer & Register  Corp.,  a Colorado  corporation  and Vicki  Byrd,
      filed as Exhibit No. 10.2 to the Registration  Statement on Form 10-SB
      of The Leather Factory, Inc. (Commission File No. 0-22128),  including
      any  amendments  thereto,  filed  with  the  Securities  and  Exchange
      Commission on July 22, 1993, and incorporated herein by reference.

10.3  Stock Purchase Agreement dated as of June 30, 1993, by and between The
      Leather Factory, Inc., a Texas corporation and Steve Lindley, filed as
      Exhibit No. 10.3 to the  Registration  Statement  on Form 10-SB of The
      Leather Factory,  Inc.  (Commission  File No. 0-22128),  including any
      amendments thereto,  filed with the Securities and Exchange Commission
      on July 22, 1993, and incorporated herein by reference.

10.4  Amendment to Stock Purchase  Agreement executed September 20, 1993, to
      be effective June 30, 1993, by and between The Leather Factory,  Inc.,
      a Texas  corporation  and Steve Lindley,  filed as Exhibit No. 19.1 to
      the 1993 Annual  Report on Form 10-KSB of The  Leather  Factory,  Inc.
      (Commission File No. 1-12368),  filed with the Securities and Exchange
      Commission on March 30, 1994, and incorporated herein by reference.

10.5  Stock Purchase Agreement dated as of June 30, 1993, by and between The
      Leather  Factory,  Inc.,  a Texas  corporation  and Kevin F. White and
      Durham Hefta, filed as Exhibit No. 10.4 to the Registration  Statement
      on Form  10-SB  of The  Leather  Factory,  Inc.  (Commission  File No.
      0-22128),  including any amendments thereto, filed with the Securities
      and Exchange  Commission on July 22, 1993, and incorporated  herein by
      reference.

10.6  Stock Purchase Agreement dated as of June 30, 1993, by and between The
      Leather  Factory,  Inc., a Texas  corporation and James Durr, filed as
      Exhibit No. 10.5 to the  Registration  Statement  on Form 10-SB of The
      Leather Factory,  Inc.  (Commission  File No. 0-22128),  including any
      amendments thereto,  filed with the Securities and Exchange Commission
      on July 22, 1993, and incorporated herein by reference.


                                       41
<PAGE>



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

10.7  The Leather Factory,  Inc. 1993  Non-Qualified  Incentive Stock Option
      Plan,  filed as Exhibit  No.  10.6 to the 1993  Annual  Report on Form
      10-KSB of The Leather  Factory,  Inc.  (Commission  File No.  1-12368)
      filed with the Securities  and Exchange  Commission on March 30, 1994,
      and incorporated herein by reference.

10.8  Acquisition Agreement dated as of January 10, 1994, by and between The
      Leather  Factory,  Inc., a Colorado  corporation and Hi-Line Leather &
      Manufacturing  Company, 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 January 10, 1994,
      and incorporated herein by reference.

10.9  Asset Purchase  Agreement dated as of April 15, 1994, by and among The
      Leather Factory,  Inc., a Colorado corporation,  The Leather Warehouse
      Company, a Michigan corporation, Daniel W. Holbert, Linda S. McCleary,
      Richard J. Hill,  and the Richard J. Hill Trust,  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 April 15, 1994, and incorporated herein by reference.

10.10 Acquisition Agreement by and among The Leather Factory, Inc. and David
      Lieberman,  Individually and as the Shareholder of Roberts,  Cushman &
      Company,   Inc.,   related  to  the  acquisition  of  the  issued  and
      outstanding capital stock of Roberts,  Cushman & Company,  Inc., 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 January 9, 1995, and incorporated herein by
      reference.

10.11 The Leather  Factory,  Inc.  Employees' Stock Ownership Plan and Trust
      (Restated),  dated February 22, 1994, effective as of October 1, 1993,
      filed as Exhibit No. 4.1 to the Registration  Statement on Form S-8 of
      The Leather Factory,  Inc.  (Commission File No. 33-81214),  including
      any  amendments  thereto,  filed  with  the  Securities  and  Exchange
      Commission on July 5, 1994, and incorporated herein by reference.

10.12 Amendment  No.  1  to  The  Leather  Factory,  Inc.  Employees'  Stock
      Ownership  Plan and Trust  (Restated  as of  October 1,  1993),  dated
      October 5, 1994 to be effective  December  28, 1990,  filed as Exhibit
      No.  10.12 to the 1994  Annual  Report on Form  10-KSB of The  Leather
      Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
      and Exchange  Commission on March 27, 1995, and incorporated herein by
      reference.

10.13 Participation  Agreement in The Leather Factory, Inc. Employees' Stock
      Ownership  Plan and Trust  (Restated  as of  October 1,  1993),  dated
      February  28, 1995 to be effective  January 2, 1995,  filed as Exhibit
      No.  10.13 to the 1994  Annual  Report on Form  10-KSB of The  Leather
      Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
      and Exchange  Commission on March 27, 1995, and incorporated herein by
      reference.




                                       42
<PAGE>


                   THE LEATHER FACTORY, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX
                                   (Continued)

Exhibit
Number                              Description
------                              -----------

10.14 Indemnification  Agreement  dated  October 17, 1994,  by and among The
      Leather Factory,  Inc., a Delaware  corporation,  Securities  Transfer
      Corporation,  a Texas corporation,  and Halter Capital Corporation,  a
      Texas  corporation,  filed as  Exhibit  No.  10.14 to the 1994  Annual
      Report on Form 10-KSB of The Leather  Factory,  Inc.  (Commission File
      No.  1-12368)  filed with the  Securities  and Exchange  Commission on
      March 27, 1995, and incorporated herein by reference.

10.15 Guaranty, as amended,  dated July 24, 1995, by and between NationsBank
      of Texas,  N. A., The Leather  Factory,  Inc.,  Wray Thompson,  Ronald
      Morgan, and Robin Morgan,  filed as Exhibit No. 10.15 to the Quarterly
      Report on Form 10-QSB of The Leather  Factory,  Inc.  (Commission File
      No. 1- 12368) filed with the  Securities  and Exchange  Commission  on
      November 9, 1995, and incorporated herein by reference.

10.16 The Leather  Factory,  Inc. 1995 Director  Non-Qualified  Stock Option
      Plan and Stock Option  Agreement,  effective as of September 26, 1995,
      subject to approval by the Company's  stockholders  at the 1996 Annual
      Meeting of  Stockholders,  filed as Exhibit No. 10.16 to the Quarterly
      Report on Form 10-QSB of The Leather  Factory,  Inc.  (Commission File
      No.  1-12368)  filed with the  Securities  and Exchange  Commission on
      November 9, 1995, and incorporated herein by reference.

10.17 The Leather  Factory,  Inc.  1995 Stock  Option Plan and Stock  Option
      Agreements, effective as of September 26, 1995, subject to approval by
      the Company's stockholders at the 1996 Annual Meeting of Stockholders,
      filed as Exhibit No. 10.17 to the  Quarterly  Report on Form 10-QSB of
      The Leather Factory, Inc. (Commission File No. 1-12368) filed with the
      Securities   and  Exchange   Commission  on  November  9,  1995,   and
      incorporated herein by reference.

22.1  Subsidiaries of the Company,  filed as Exhibit No. 22.1 to the 1995 Annual
      Report on Form 10-KSB of The Leather Factory,  Inc.  (Commission  File No.
      1-12368), filed with the Securities  and Exchange  Commission on March 28,
      1996, and incorporated herein by reference.

*23.1 Consent of Ernst & Young LLP dated March 27, 1997.

*23.2 Consent of Arthur Anderson LLP dated March 27, 1997.

*27.1 Financial Data Schedule

------------
*Filed herewith.


                                       43
<PAGE>


                                                                  EXHIBIT 4.13




                FIFTH AMENDMENT TO SECOND RESTATED LOAN AGREEMENT


         This Fifth  Amendment to Second  Restated Loan Agreement  ("Amendment")
dated effective as of December 31, 1996 ("Effective Date") is entered into among
The Leather  Factory,  Inc., a Delaware  corporation  ("Borrower"),  The Leather
Factory,  Inc., a Texas corporation,  and Roberts,  Cushman & Company, Inc., New
York corporation  (collectively,  "Guarantors"),  and NationsBank of Texas, N.A.
("Bank"), as follows:

                                    Recitals
                                    --------

         (a) Bank,  Borrower and  Guarantors  are parties to the certain  Second
Restated  Loan  Agreement  dated as of July 24,  1995,  as  amended by the First
Amendment to Second  Restated Loan Agreement  dated as of December 31, 1995, the
Second  Amendment to Second  Restated Loan Agreement dated as of March 31, 1996,
the Forbearance  Agreement and Third Amendment to Second Restated Loan Agreement
dated as of June 30, 1996 and the Forbearance  Agreement and Fourth Amendment to
Second Restated Loan Agreement dated as of September 30, 1996 (the  "Forbearance
Agreement"),  each among Borrower,  Guarantors and Bank  (collectively the "Loan
Agreement").  Terms  defined  in the  Loan  Agreement,  wherever  used  in  this
Agreement,  shall have the same  meanings  herein as are  prescribed by the Loan
Agreement.

          (b)  Borrower,  Guarantors  and Bank  wish to  further  amend the Loan
Agreement as provided hereinbelow.  Therefore,  for valuable consideration,  the
receipt and sufficiency of which hereby is acknowledged, and in consideration of
the mutual agreements provided herein, Bank, Borrower and each of the Guarantors
hereby agree as follows:

                                    Agreement
                                    ---------

Section 1.  Amendment of Loan  Agreement.  As of the  Effective  Date,  the Loan
            ----------------------------
            Agreement is amended as follows:

1.1  Paragraph 1  ("Definitions  and Reference  Terms") of the Loan Agreement is
                    ---------------------------------
amended by replacing or adding (as the case may be) the following definitions in
their entirety:

Accounts Receivable.  Accounts Receivables has the meaning specified in Section
-------------------
2D of this  Agreement  and also  includes all property  defined and described as
"Accounts" in the Security Agreements,  and all proceeds of any of the foregoing
now owned or hereafter acquired or arising.

Borrowing Base.  Borrowing Base shall have the meaning prescribed by paragraph
--------------
2D.


                                       43
<PAGE>


Borrowing Base Certificate.  Borrowing Base Certificate means a Borrowing Base
--------------------------
Certificate required by paragraph 2D.

Collateral.  Collateral means all property from time to time included within the
----------
definition of "Collateral" as prescribed by the Security Agreements.

Default.  Default means any defined event of default and any other breach or
-------
other noncompliance with any of the Loan Documents.

Obligations. Obligations mean  all obligations  and  indebtedness  from time to
-----------
time owing by Borrower or any of Guarantors under the Loan Documents,  including
without limitation all "Obligations" defined in the Security Agreements, in each
case as may be renewed, extended or modified from time to time.

Security  Agreements.  Security  Agreements  means,  collectively,  the  certain
--------------------
Security Agreement dated December 28, 1994 between Bank and The Leather Factory,
Inc., a Texas  corporation,  and the certain Security Agreement dated January 3,
1995 between Bank and Roberts,  Cushman & Company, Inc.,  respectively,  in each
case  including any and all  renewals,  extensions,  modifications,  amendments,
replacements,  supplements  or  restatements  thereof,  and any  other  security
agreement at any time executed by either Guarantor for the benefit of Bank.

1.2  Notwithstanding anything to the contrary contained in the Loan Documents to
the contrary, as of the Effective Date the maximum principal amount which may be
outstanding  under  the  Revolving  Line  from  time to time  shall  not  exceed
$6,500,000.00.  Accordingly,  as of the  Effective  Date,  Section 2.A  ("Loan")
hereby is amended by deleting the dollar  figure  "$7,500,000.00"  in clause (i)
thereof and replacing same with the dollar figure "$6,500,000.00."

1.3  Effective as of January 1, 1997,  Section 2.B  ("Interest")  is amended and
restated in its entirety to read as follows:


                                       44
<PAGE>


"B.  Interest.  The interest to be paid by Borrower and collected by Bank on the
     Notes (except with respect to the Acquisition Line which has terminated and
     is no longer in effect on such date) shall be a rate per annum equal to the
     Prime Rate  established by Bank from time to time,  being the variable rate
     of interest  announced  by Bank from time to time as its general  reference
     rate of  interest,  which rate of  interest  may not be the lowest  rate of
     interest charged by Bank to other borrowers,  plus one and one-half percent
     (1.50%)."

1.4  Section 2D ("Borrowing Base") hereby is amended in the following respects:

     a. The dollar figure  "$7,500,000.00" in clause (i) of the first unnumbered
paragraph is deleted and replaced  with the dollar figure  "$6,500,000.00"  (and
the  dollar  figure  "7,500,000.00"  in  line 1 of the  form of  Borrowing  Base
Certificate  which  appears as Exhibit "B" to the Loan  Agreement is deleted and
replaced with the dollar figure "$6,500,000.00").

     b.   Clause (c) of the  definition  of "Eligible  Inventory" is amended and
          restated to read as follows:

          "(c)  inventory  which is  located  at  locations  which have not been
          identified  to Bank and a  security  interest  perfected  or which are
          outside the United States;"

     c. The following two unnumbered  paragraphs  hereby are added,  immediately
after the existing last unnumbered paragraph thereof:

          "The advance rates from time to time  utilized by Bank in  determining
          the  Borrowing  Base may be adjusted from time to time based upon such
          considerations  as Bank may deem  appropriate in its discretion.  Such
          advance  rates are for the sole  purpose of  determining  the  maximum
          amount  of  unpaid  loans  under  the  Revolving   Line  that  may  be
          outstanding  from  time to time and  shall  not be  evidentiary  of or
          binding  upon Bank with  respect  to the market  value or  liquidation
          value of any Collateral. Funding of loans hereunder shall at all times
          remain  subject to  confirmation  of existence  and  acceptability  of
          Eligible Accounts Receivable and Eligible Inventory, and the Borrowing
          Base,  in Bank's  sole  discretion.  Bank  shall have the right in its
          discretion at any time to establish reserves against Eligible Accounts
          Receivable  or Eligible  Inventory,  or  otherwise in reduction of the
          Borrowing  Base,  in respect of any costs,  expenses,  liens,  claims,
          contingencies  or other  potential  factors  which,  in the event they
          should  occur,   could  adversely   affect  or  otherwise  reduce  the
          anticipated  net amount of timely  collections  in payment of Eligible
          Accounts  Receivable or Eligible  Inventory (it is understood that any
          such  reserve  does  not  represent  cash  funds).  The  criteria  for
          determining such reserves and the amount thereof shall at all times be
          subject  to  adjustment  or  change  as  determined  by  Bank  in  its
          discretion without prior notice.


                                       44
<PAGE>


          "Together with each request for a loan under the Revolving Line and in
          any event at least monthly or, following written notice to Borrower at
          any time when any default is in  existence,  at least  weekly,  and at
          such other times as Bank may  request,  Borrower and  Guarantors  each
          shall  execute and deliver to Bank,  in form  satisfactory  to Bank, a
          Borrowing Base  Certificate  setting forth a certification of Eligible
          Accounts  Receivable and Eligible  Inventory,  and  calculation of the
          Borrowing  Base, in form  satisfactory  to Bank.  Each  Borrowing Base
          Certificate  shall include a reconciliation  of the calculation of the
          Borrowing  Base  as  certified  in  the  most  recent  Borrowing  Base
          Certificate  delivered to Bank,  and be  accompanied by such documents
          and supporting  information  relating to Eligible Accounts  Receivable
          and Eligible  Inventory as Bank may request.  Borrower and  Guarantors
          shall  maintain,  and shall  furnish to Bank at Bank's  request,  such
          supporting  documents as Bank may require  including,  but not limited
          to: a schedule of Eligible Accounts Receivable  created,  and Eligible
          Inventory  purchased and received,  since the previous  Borrowing Base
          Certificate  delivered  to Bank;  copies of  invoices  and  supporting
          delivery or service  records in  connection  therewith;  a schedule of
          collections  received;  copies of  credit  memos or other  advices  of
          credit or reductions against amounts previously billed; and such other
          reports as Bank may request from time to time.  If any of such records
          or reports  are  prepared  by an  accounting  service or other  agent,
          Borrower and Guarantors  each hereby  authorizes such service or agent
          to deliver such records,  reports and related  documents to Bank. Bank
          may exhibit a copy of this  Agreement to any such service or agent and

          such  service or agent  shall be  entitled  to rely on the  provisions
          hereof in providing such  documentation  to Bank.  Each Borrowing Base
          Certificate shall bear a signed statement by an authorized  officer of
          Borrower and each Guarantor  certifying the accuracy and  completeness
          of all information  included therein and shall incorporate  therein by
          reference, as if fully set forth therein, all the terms and provisions
          hereof.  The  execution and delivery of a Borrowing  Base  Certificate
          shall in each instance  constitute an  agreement,  representation  and
          warranty  by  Borrower  and  Guarantors  to Bank that,  except for the
          security  interest of Bank  therein  (and  Permitted  Liens,  if any):
          Borrower or a Guarantor,  as applicable,  is the sole owner of and has
          full  unrestricted  power  to  grant  to  Bank a  continuing  security
          interest and lien in and to all collateral  included therein free from
          any lien,  security  interest or  encumbrance;  each account  included
          therein is in  existence,  unconditional  and valid,  and arose from a
          bona fide  outright  sale of Inventory by Borrower or a Guarantor,  in
          the ordinary course of business,  for liquidated  amounts as set forth
          in the  Borrowing  Base  Certificate,  and  such  Inventory  has  been
          delivered or provided to the respective  account  debtors;  no account
          included  therein  arose in  connection  with a contract or assignment
          which purports to make an assignment or security interest therein void
          or conditions such  assignment or security  interest on consent of the
          account debtor; no account is subject to any sale,  assignment,  claim
          or  security  interest  of any  character  and  neither  Borrower  nor
          Guarantors  will make any sale or other  assignment  thereof or create


                                       45
<PAGE>

          any other  security  interest  therein;  no  account is subject to any
          claim for  credit,  deduction,  allowance,  extension  or  adjustment,
          defense,  dispute,  setoff or  counterclaim,  except for discounts for
          early payment allowed in the ordinary course of business as previously
          disclosed  to  Bank  and as  reflected  on  the  face  of the  invoice
          evidencing  such account;  all Inventory  reflected in such  Borrowing
          Base  Certificate is held for sale in the ordinary course of business,
          and no such  Inventory  is  located at any  location  in breach of the
          requirements  of this Agreement and no negotiable  documents have been
          issued in respect of any such  Inventory;  no  Inventory  reflected in
          such Borrowing Base Certificate is returned Inventory unless otherwise
          disclosed to Bank in writing."

1.5  Section 2E ("Usage Fee") is deleted in its entirety.

1.6  The  dollar  figure  "2,000,000.00"  in  Section  2.F  ("Letter  of  Credit
Subfeature") is deleted and replaced with the dollar figure "1,000,000.00".

1.7  Section 2H  ("Acquisition  of Business Under  Acquisition  Line") hereby is
deleted in its entirety and replaced  with the  following  new Section 2H, which
shall read in its entirety as follows:

"H.      Accounts Receivables; Collections.  All collections and proceeds of
         ---------------------------------
         Accounts  Receivables  shall be subject to an express  trust for the
         benefit of Bank., subject to the following:


               a. Subject to subparagraph  (b) below,  Borrower shall be allowed
          to collect and retain collections and proceeds of Accounts Receivables
          and use such  collections  and  proceeds  in the  ordinary  course  of
          business.

               b.  Immediately  upon notice by Bank to Borrower at any time when
          any  default  is in  existence,  unless  and  until  expressly  agreed
          otherwise  by Bank in writing  (i) all  collections  and  proceeds  of
          Accounts  Receivables  shall be directed  daily to Bank for deposit to
          one or more  blocked  collection  accounts  approved  by Bank for such
          purpose, (ii) Borrower and Guarantors shall notify all account debtors
          on  Accounts  Receivable,  in writing  (by  notation  directly  on the
          related invoice, or otherwise,  in form satisfactory to Bank) that all
          payments thereon shall be directed to a post office box designated by,
          and under the sole  control of, Bank (iii) all checks and  instruments
          from time to time  received  by Bank in such post  office box shall be
          subject to Bank's  continuing  security  interests  under the Security
          Agreements,  and shall be deposited  daily to such blocked  collection
          account,  (iv) all collected  funds from  collections  and proceeds of
          Accounts  Receivables  from  time to time  deposited  to such  blocked
          collection  account(s)  shall be applied  directly to the Obligations,
          (v) in the event  Borrower or any  Guarantor at any time  receives any
          collections or proceeds of Accounts


                                       46
<PAGE>

          Receivables,  it  shall  promptly  deliver  same to  Bank in the  form
          received,  with any necessary  endorsement to the order of Bank,  (vi)
          Borrower and Guarantor each agrees that it will not commingle proceeds
          of Accounts  Receivables  with any other  funds,  and that no deposits
          will be made to any blocked  collection account other than collections
          and proceeds of Accounts Receivables and (vii) Borrower and Guarantors
          shall have no right of  withdrawal,  transfer or access to any blocked
          collection account. Pending application to the Obligations as provided
          herein,  all amounts  from time to time  deposited to any such blocked
          collection account shall remain subject to Bank's continuing  security
          interest under the Security Agreements.

          Borrower and Guarantors will not use,  dispose,  withhold or otherwise
          exercise dominion over any proceeds of Accounts  Receivables except as
          expressly  allowed by this  Agreement.  Borrower and Guarantors  shall
          promptly  report to Bank in writing any instance in which a dispute of
          Accounts Receivables by an account debtor involves an amount in excess
          of  $1,000.00.  Borrower and  Guarantors  each agrees that it will not
          settle, adjust,  compromise or discharge any such Accounts Receivables
          or extend the time for payment without Bank's consent."

     1.8  Section 4.A ("Financial Condition") hereby is amended as follows:

          a.   Subparagraph (i), which prescribes  minimum  requirements for the
               ratio of current  assets to current  liabilities,  is amended and
               restated to read in its entirety as follows:

               "(i) Maintain  a  minimum  ratio of  current  assets  to  current
                    liabilities as follows:

                  Ratio                              Effective Date
                  -----                              --------------
                  1.08 to 1.00                       January 31, 1997
                  1.10 to 1.00                       March 31, 1997"

          b.   Subparagraph (ii), which prescribes minimum  requirements for the
               ratio of total  liabilities  to  Tangible  Net  Worth,  hereby is
               supplemented  to add the  following  to the "Ratio" and  "Period"
               columns,  respectively,  immediately after the existing last line
               thereof:

                      Ratio                          Period
                      -----                          ------
                  "3.75 to 1.0                       January 31, 1997
                   3.50 to 1.0                       March 31, 1997"


                                       47
<PAGE>


               c.  Subparagraph  (iii),  which prescribes a minimum EBITDA Ratio
          requirement, hereby is deleted in its entirety.

               d.  Subparagraph  (iv),  which  prescribes  a  minimum  Cash Flow
          requirement, hereby is deleted in its entirety.

     1.9  Section 4.B ("Financial  Statements and Other Information")  hereby is
          amended in the following respects:

               a.  Subparagraph  (i)  hereby is  amended  to add the words  "and
          consolidating" immediately following the word "consolidated".

               b. Subparagraph (iv) hereby is amended to read in its entirety as
          follows:

               "(iv)Furnish  to  Bank a  Borrowing  Base  Certificate,  in  form
                    attached  as  Exhibit  "B" or in such  other  form as may be
                    prescribed by or satisfactory to, Bank, at such times as are
                    required by Paragraph 2D."

     1.10 Section 4.E ("Adverse  Conditions or Events") hereby is amended in the
          following respects:

          a.   Clause (i) is amended  and  restated  to read in its  entirety as
               follows:

                    "(i)  any  condition,  event  or  act  which  comes  to  its
               attention  that  would  or  might  materially   adversely  affect
               Borrower's   or  either   Guarantor's   financial   condition  or
               operations,  the collateral for the Loans, or Bank's rights under
               the Loan Documents, or the occurrence of any liability that would
               be treated as a contingent liability according to GAAP;"

          b.   The following hereby is added immediately after the last sentence
               thereof:

               "Borrower and  Guarantors  each agrees that it shall  immediately
               notify  Bank in  writing  in the  event  its  board of  directors
               authorizes  the  filing  of a  petition  in  bankruptcy,  or if a
               meeting of its board of  directors  is called for the  purpose of
               proposing or considering authorization of any such filing.


                                       48
<PAGE>


     1.11 Section 4  ("Affirmative  Covenants")  hereby is  amended to add a new
paragraph I entitled  "Field  Examinations;  Inspections"  and a new paragraph J
entitled Appraisals", each of which shall read as follows, respectively:

     "I.  Field  Examinations;  Inspections.  Bank shall have the right  without
          ---------------------------------
          hindrance or delay to conduct field examinations to inspect Borrower's
          or any Guarantor's properties, including all collateral covered by the
          Security  Agreements,  and to inspect,  review,  audit and copy books,
          records, journals,  correspondence and other records and data relating
          to such properties and its business,  operations and affairs.  Bank is
          authorized to discuss  Borrower's or any Guarantor's  affairs with any
          employee of Borrower or any Guarantor. Promptly upon request, Borrower
          agrees to pay Bank's customary examination fees, plus reimbursement of
          Bank's out-of-pocket expenses and disbursements relating to such field
          examinations.  Bank shall have full access to all records available to
          Borrower or any Guarantor from any credit reporting service, bureau or
          similar service and shall have the right to examine and make copies of
          any such  records.  Bank may exhibit a copy of this  Agreement to such
          service and such service  shall be entitled to rely on the  provisions
          hereof in providing access to Bank as provided herein."

     "J.  Appraisals.  At  Bank's  request  at any time when any  default  is in
          ----------
          existence, Borrower will cause to be ordered and delivered to Bank, at
          Borrower's  expense,  an  appraisal  of  all  or  any  portion  of the
          Collateral,   performed  by  a  credentialed  appraiser  and  in  form
          acceptable to Bank."

     1.12 Section 5 ("Negative  Covenants")  is amended to add a new Section 5.H
entitled "Capital Expenditures", a new Section 5.I entitled "Investments", a new
Section 5.J entitled "Merger; Liquidation; Sale of Assets" and a new Section 5.K
entitled "Leases", immediately following existing Section 5.G, which shall read,
respectively, as follows:

     "H.  Capital  Expenditures.  Make capital expenditures during any period of
          ---------------------
          twelve (12)  calendar  months which,  in the aggregate  with all other
          capital  expenditures  by Borrower and Guarantors  during such period,
          would  exceed the maximum  aggregate  amount of  $250,000.00.  As used
          herein  "capital  expenditures"  means  expenditures  which  would  be
          classified as capital expenditures according to GAAP."

     "I.  Investments.  Make any investments or permit any investments to remain
          -----------
          outstanding  other than (i)  investments  in cash or cash  equivalents
          with a United  States  commercial  bank  having  assets  in  excess of
          $250,000,000  or (ii)  investments in obligations or securities of the
          United  States.  As  used  herein,   "investment"  includes,   without
          limitation,  the direct or  indirect  purchase or  acquisition  of any
          equity or beneficial  interest,  share of capital  stock,  evidence of
          Indebtedness or other security of or issued by any person or entity."


                                       49
<PAGE>


     "J.  Merger;  Liquidation;  Sale of Assets.  Merge or consolidate with, any
          -------------------------------------
          other person or entity,  or dissolve or liquidate,  or sell,  lease or
          transfer or otherwise  dispose of all or any  material  portion of its
          assets to any person or entity."

     "K.  Leases.  Make any increase in existing monthly lease expenses,  except
          ------
          additional  lease  expenses  in an  amount up to,  but not  exceeding,
          $8,000.00 per month (in the aggregate for Borrower and  Guarantors) in
          connection  with a new  lease for  computer  systems  and  equipment."


     1.13 Section 6  ("Default")  hereby is  amended  to add a new  clause  (v),
clause (vi) and clause (vii),  immediately following existing clause (iv), which
together shall read as follows:

     "(v)  Bank  determines  that  Borrower  will not be able to  refinance  the
     Obligations  by a time not later than  April 30,  1997,  (vi) any  material
     adverse change in the business, assets, properties,  liabilities,  existing
     or projected condition  (financial or otherwise),  results of operations or
     business prospects of Borrower or any Guarantor, or Borrower and Guarantors
     taken as a whole, or the respective ability of Borrower or any Guarantor to
     perform any  obligations  under any Loan Document to which it is a party or
     (vii) the filing of any petition in  bankruptcy  by or against  Borrower or
     any Guarantor under the United States Bankruptcy Code."

     1.14 Paragraph  7  ("Remedies")  hereby is  amended  to add the  following,
                          --------
immediately following the existing solo sentence thereof:

"In addition, without limitation of the foregoing:

     A.   Cash Collateral;  Injunctive  Relief.  All cash proceeds of Collateral
          ------------------------------------
          from time to time existing,  including without limitation  collections
          and  payments of Accounts  Receivables,  whether  consisting  of cash,
          checks or other  similar  items,  at all times  shall be subject to an
          express  trust for the  benefit of Bank.  All such  proceeds  shall be
          subject  to  Bank's  continuing  security  interests  under  the  Loan
          Documents.  Borrower and Guarantors each is expressly  prohibited from
          using,  spending,  retaining or otherwise exercising any dominion over
          such proceeds, except as may be specifically allowed otherwise by this
          Agreement  or  the  Loan  Documents.   Borrower  and  Guarantors  each
          acknowledges  and agrees  that an action for damages for any breach of
          such prohibitions shall not be an adequate remedy at law. In the event
          of any such breach, Borrower and Guarantors each agrees to the fullest
          extent allowed by law that Bank shall be entitled to injunctive relief
          to restrain such breach and require  compliance with the  requirements
          of this Agreement.


                                       50
<PAGE>


     B.   Special  Rights of Bank;  Power of Attorney.  Borrower and  Guarantors
          -------------------------------------------
          each   hereby   irrevocably   appoints   Bank   as   its   agent   and
          attorney-in-fact  to take any action necessary to preserve and protect
          the  Collateral  and  Bank's  interests  under the  Credit  Documents.
          Borrower and each  Guarantor  hereby  authorizes  and appoints Bank as
          attorney  in fact to sign and file any  financing  statement  or other
          document   necessary  to  perfect  Bank's  security  interest  in  the
          Collateral.  Bank  shall have the right at any time to take any of the
          following  action,  in its own name or in the name of  Borrower or any
          Guarantor,  whether or not an Event of Default  is in  existence:  (i)
          make written or verbal  requests for  verification of amounts owing on
          Accounts  Receivables  from any or all Persons which Bank believes may
          be account  debtors or  obligors on  Accounts  Receivables;  (ii) take
          possession  and control of proceeds  of  Accounts  Receivables;  (iii)
          redirect the deposit and  disposition of  collections  and proceeds of
          Accounts  Receivables;  (iv)  endorse  the  name  of  Borrower  or any
          Guarantor  on checks,  instruments  or other  evidences  of payment on
          Accounts  Receivables;  (v)  prepare,  sign and  file,  on  behalf  of
          Borrower or any Guarantor,  in Borrower's or such  Guarantor's name or
          in Bank's name as assignee,  any notice of lien, or any proof of claim
          or other document in any bankruptcy  proceedings of any account debtor
          or obligor on Accounts  Receivables;  (vi) access, copy or utilize any
          information  recorded or contained in any computer or data  processing
          equipment or system in respect of the Accounts Receivables  maintained
          by Borrower or a Guarantor,  or to which Borrower or any Guarantor has
          access; (vii) enter onto the premises of Borrower or any Guarantor and
          discuss Borrower's or any Guarantor's affairs with personnel as may be
          reasonably  necessary  in  connection  with  maintaining  or enforcing
          Bank's rights under the Loan Documents;  (viii) access and utilize the
          information  recorded on or contained in any data processing equipment
          and  computer   hardware   and  software   relating  to  the  Accounts
          Receivables,  Inventory  or other  Collateral  to which  Borrower or a
          Guarantor has access; and (ix) take all other action allowed by law as
          may be necessary to carry out the Credit  Documents and give effect to
          Bank's rights  thereunder.  In addition,  Bank shall have the right to
          take any of the  following  action,  in its own name or in the name of
          Borrower or a  Guarantor,  at any time when any Event of Default is in
          existence,  whether or not Bank has taken any action to make demand or
          exercise any remedies under any of the Loan Documents:  (x) notify any
          or all Persons which Bank believes may be account  debtors or obligors
          on  Accounts  Receivables  to make  payments  directly  to Bank;  (xi)
          settle, adjust, compromise or discharge Accounts Receivables or extend
          time of  payment  upon such  terms as Bank may  determine;  (xii) take
          action in Bank's name or Borrower's  or a Guarantor's  name to enforce
          collection  of Accounts  Receivables;  (xiii) open mail  addressed  to
          Borrower or a Guarantor to take possession of and dispose of checks or
          other  proceeds  of  Accounts  Receivables  in  accordance  with  this
          Agreement;  and (xiv)  direct  the U.S.  Postal  service to change the
          address to which Borrower's or a Guarantor's mail is delivered. Should
          Bank at any time  elect to  exercise  its  right  of  verification  or
          notification  with respect to the Accounts  Receivables as provided in
          clause (i) or clause  (ii)  above,  respectively,  Bank shall have the
          right in its sole discretion to direct such request for  verification,
          or  notification,  as the  case  may be,  to all  Persons  which  Bank
          believes may have transacted  business with Borrower or a Guarantor at
          any time, whether or not such Persons are then indebted to Borrower or
          such  Guarantor,  and Bank is hereby  released and discharged from any
          liability  by  reason  of  any  such  request  for   verification   or
          notification.  Costs and expenses  incurred by Bank in connection with
          any  of  such  actions  by  Bank,   including   attorneys'   fees  and
          out-of-pocket expenses, shall be reimbursed to Bank on demand.

     C.   Continuing Rights of Bank in Respect of Obligations.  In the event any
          ---------------------------------------------------
          amount from time to time applied in reduction  of the  Obligations  is
          subsequently  set aside,  avoided,  declared  invalid or  recovered by
          Borrower  or any  trustee  or in  bankruptcy,  or in the event Bank is
          otherwise  required to refund or repay any such amount pursuant to any
          applicable law, then the Obligations shall  automatically be deemed to
          be revived  and  increased  to the extent of such  amount and the same
          shall  continue to be secured by the  Collateral as if such amount had
          not been so applied."


                                       51
<PAGE>


     1.15 Section 10  ("Miscellaneous") hereby is amended to add a new  Section
10.J, entitled "Release of Collateral",  immediately  following existing Section
10.I, which shall read as follows:

     "Release  of  Collateral.  Bank shall  have no  obligation  to release  the
      -----------------------
     Collateral  until (i) Borrower shall have paid to Bank, in collected funds,
     an amount equal to the aggregate  amount of all Obligations  outstanding as
     of the date of such payment, together with unpaid accrued interest thereon,
     all fees payable  pursuant to the Loan Documents,  (ii) Borrower shall have
     deposited with Bank an amount equal to the sum of (a) the aggregate undrawn
     amount of all letters of credit issued by Bank and outstanding at such time
     for the account of Borrower plus (b) the  aggregate  amount of all drawings
     under any letters of credit  issued by Bank for the account of Borrower for
     which Bank has not been  reimbursed  plus (c) the  aggregate  amount of all
     bankers acceptances made by Bank for the account of Borrower, to be held by
     Bank as cash collateral security for the payment of, and to be applied to,
     the payment of any  reimbursement  obligations  which may thereafter become
     due with  respect to any such letter of credit or bankers  acceptances  and
     (iii) Borrower shall have provided Bank with an  indemnification  agreement
     in form and  substance  satisfactory  to Bank with  respect to returned and
     dishonored items and such other matters as Lender shall require."

Section 2. Amendment of Notes. As of the Effective Date, the Note evidencing the
           ------------------
Revolving Line and the R,C&Co. Loan, respectively,  in each case is modified and
amended, as follows:

     a. Revolving  Line. The certain  promissory  note dated  September 30, 1996
        ---------------
executed  by  Borrower  payable  to the  order  of Bank in the  face  amount  of
$7,500,00.00,  evidencing the Revolving Line,  hereby is modified and amended as
follows:


     (i)  The stated maturity as set forth therein is modified and amended to be
          April 30, 1997; and

     (ii) The  face  amount  thereof  hereby  is  modified  and  amended  to  be
          $6,500,000.00.

     b.  R,C&Co.  Loan.  The certain  promissory  note dated  December  28, 1994
         -------------
executed  by  Borrower  payable  to the  order  of Bank in the  face  amount  of
$5,000,000.00,  evidencing the R,C&Co.  Loan,  hereby is modified and amended as
follows:


     (i)  The stated maturity of the R,C&Co. Loan as set forth therein hereby is
          modified to be April 30, 1997; and


                                       52
<PAGE>


     (ii) Notwithstanding  the payment schedule presently provided thereby,  the
          Note evidencing the R,C&Co. Loan shall be payable as follows:  Accrued
          interest  shall be  payable  monthly  on the  first  (1st) day of each
          calendar  month,  and principal  shall be payable on March 31, 1997 in
          the amount of $250,000.00 and all remaining  unpaid principal shall be
          paid on the final maturity date, April 30, 1997.

Section 3. Amendment of Security  Agreement.  As of the Effective  Date, each of
           --------------------------------
the Security Agreements hereby is amended as follows:

     3.1  Subparagraph 1 of paragraph B ("Collateral"),  in each of the Security
Agreements, hereby is amended as follows:

     a. The unnumbered  paragraph,  entitled "Accounts" hereby is amended to add
the following immediately following the existing solo sentence thereof:

     "As used herein "contract rights" includes, without limitation, any and all
     rights of Debtor,  now or hereafter  existing,  under or in connection with
     any  contracts or  agreements  in respect of the  provision or supplying of
     mailing lists,  customer lists or other lists of names and/or  addresses of
     potential  customers  for  use by  Debtor,  now or  hereafter  acquired  or
     arising."

     b. A new unnumbered  paragraph  entitled  "General  Intangibles"  hereby is
added  immediately   following  the  existing   unnumbered   paragraph  entitled
"Equipment":

     "General  Intangibles.  All  general  intangibles  now  owned or  hereafter
     acquired by Debtor. General intangibles includes,  without limitation,  all
     customer  lists,  mailing  lists  and  similar  data  respecting  names and
     addresses  of  customers  or  potential  customers,  whether in tangible or
     intangible form and however  recorded or stored,  together with all systems
     and software for retrieving or utilizing same."

     3.2. Paragraph E.22  ("Collection  and Segregation of Accounts")  hereby is
amended and restated to read in its entirety as follows:

"22. Collection and  Segregation of Accounts.  All  collections  and proceeds of
     ---------------------------------------
Accounts  Receivables  shall be subject to an express  trust for the  benefit of
Bank., subject to the following:


                                       53
<PAGE>


     a. Subject to subparagraph (b) below,  Borrower shall be allowed to collect
and  retain  collections  and  proceeds  of  Accounts  Receivables  and use such
collections and proceeds in the ordinary course of business.

     b. Immediately upon notice by Bank to Borrower at any time when any default
is in existence,  unless and until expressly agreed otherwise by Bank in writing
(i) all collections and proceeds of Accounts Receivables shall be directed daily
to Bank for deposit to one or more blocked collection  accounts approved by Bank
for such purpose,  (ii) Borrower and Guarantors shall notify all account debtors
on Accounts Receivable, in writing (by notation directly on the related invoice,
or otherwise,  in form  satisfactory to Bank) that all payments thereon shall be
directed to a post office box designated by, and under the sole control of, Bank
(iii) all checks and instruments from time to time received by Bank in such post
office box shall be subject to Bank's  continuing  security  interests under the
Security  Agreements,  and shall be deposited  daily to such blocked  collection
account,  (iv) all  collected  funds from  collections  and proceeds of Accounts
Receivables  from time to time deposited to such blocked  collection  account(s)
shall be applied directly to the  Obligations,  (v) in the event Borrower or any
Guarantor  at  any  time  receives  any  collections  or  proceeds  of  Accounts
Receivables,  it shall promptly deliver same to Bank in the form received,  with
any necessary endorsement to the order of Bank, (vi) Borrower and Guarantor each
agrees that it will not  commingle  proceeds of  Accounts  Receivables  with any
other funds, and that no deposits will be made to any blocked collection account
other than  collections and proceeds of Accounts  Receivables and (vii) Borrower
and  Guarantors  shall have no right of  withdrawal,  transfer  or access to any
blocked collection  account.  Pending application to the Obligations as provided
herein,  all amounts from time to time deposited to any such blocked  collection
account shall remain subject to Bank's  continuing  security  interest under the
Security Agreements.

     c. Borrower and  Guarantors  will not use,  dispose,  withhold or otherwise
exercise dominion over any proceeds of Accounts  Receivables except as expressly
allowed by this Agreement. Borrower and Guarantors shall promptly report to Bank
in writing any instance in which a dispute of Accounts Receivables by an account
debtor  involves an amount in excess of $1,000.00.  Borrower and Guarantors each
agrees  that it will  not  settle,  adjust,  compromise  or  discharge  any such
Accounts Receivables or extend the time for payment without Bank's consent."

Section 4. Additional Agreements.
           ---------------------

4.1  In consideration of this Amendment, Borrower and Guarantors each represents
     and warrants to Bank the following:

     4.1.1 The execution,  delivery and performance of this Agreement are within
its corporate  power and authority and have been duly  authorized by appropriate
proceedings and this Agreement constitutes a legal, valid and binding obligation
of Borrower and Guarantors,  enforceable in accordance with its terms, except as
limited by applicable bankruptcy,  insolvency,  reorganization,  moratorium,  or
similar laws affecting the rights of creditors  generally and general principles
of equity.


                                       54
<PAGE>


     4.1.2 Borrower and Guarantors each has disclosed to Bank all material facts
known to it concerning its financial condition and business operations. All such
information  furnished  by  Borrower  and any  Guarantor  to Bank  was  true and
complete at the time of delivery thereof to Bank, and there has been no material
change in any such  information  except as may have  been  disclosed  to Bank in
writing.  There is no fact  known  to  Borrower  or  Guarantors  which  would be
reasonably   expected  to  materially  and  adversely  effect  Borrower's  or  a
Guarantor's   financial   condition,   operations  or  ability  to  perform  its
obligations  under the Loan Documents.  Upon execution of this Amendment (i) all
representations and warranties provided by the Loan Documents,  as amended,  are
true and correct in all  material  respects  and (ii) no Default is in existence
other than the Existing Defaults.

     4.1.3  Borrower has employed  Price  Waterhouse  to consult with and assist
Borrower in obtaining  alternative  financing to refinance  the  Obligations  no
later than April 30, 1997.  Borrower agrees to promptly furnish Bank with a true
and  complete  copy of all  written  work  product  (both  draft and final form)
produced and delivered by such  consultants to Borrower in connection  with such
engagement,  including without limitation memoranda, business plans, projections
and appraisals.  Borrower  hereby  irrevocably  authorizes  such  consultants to
furnish and deliver  any such copies  directly to Bank and to provide  Bank with
verbal or written status reports concerning the status and results of Borrower's
such  consultant's  activities  in  connection  with  such  engagement.  Bank is
authorized to deliver a copy of this signed Agreement to such consultants, which
shall be sufficient evidence of the foregoing authority.

4.2  The following  items shall be delivered to Bank prior to or  simultaneously
with execution and delivery of this Amendment:

     4.2.1 A certificate signed by the corporate  secretary of Borrower and each
Guarantor  (i)  certifying to Bank that its  Certificate  of  Incorporation  and
Bylaws  have not been  amended  since its most recent  certification  thereof to
Bank, and  certifying  the names and  signatures of its duly appointed  officers
authorized  to act in  respect  of the Loan  Documents  and (ii)  attaching  and
certifying  resolutions duly adopted by its board of directors  authorizing this
Amendment and the transactions  evidenced hereby,  and authorizing and directing
one or more named  officers  to execute  and  deliver  this  Amendment,  and all
related  documentation  required by Bank on behalf of Borrower  and  Guarantors,
which certificate shall be in form satisfactory to Bank;

     4.2.2 Such other amendments of any of the Loan Documents in conformity with
this  Agreement,  duly  executed,  as may  be  required  by  Bank  and  in  form
satisfactory to Bank.


                                       55
<PAGE>


     4.3 Borrower and  Guarantors  each shall  reimburse  Bank for all expenses,
including  attorneys  fees and  disbursements  of legal  counsel  for  Bank,  in
connection with the preparation,  negotiation and closing of this Amendment.  In
consideration  of this Amendment,  Borrower and Guarantors each agrees to pay to
Bank on demand any and all costs and expenses,  including reasonable  attorneys'
fees, legal expenses and disbursements,  appraisal fees, search fees, filing and
recording  fees,  fees and costs of experts or other  consultants,  court costs,
travel  expenses,  and all other costs and expenses  incurred or paid by Bank in
administering  the Loan  Documents and protecting or enforcing any of its rights
thereunder,  including without limitation (i) ongoing administration of the Loan
Documents,  including  field  examinations  and inspection of  Collateral,  (ii)
negotiating,  preparing and closing any amendment, waiver or consent relating to
the Loan Documents, and (iii) taking possession, holding, storing, preparing for
sale,  selling or otherwise  disposing  of, or  collecting  the proceeds of, the
Collateral,  collecting  the  Obligations,  or exercising or enforcing any other
rights or remedies or pursuing or defending  any claim arising out of, or in any
way relating to the Loan  Documents.  Borrower and Guarantors  each will pay any
applicable stamp, registration,  recordation and similar taxes, fees and charges
in respect of the Collateral or perfection or maintenance of Bank's rights under
the Loan  Documents,  and  agrees to  indemnify  Bank  against  any  liabilities
resulting  from any delay,  deferral  or  omission in payment of any such taxes,
fees or charges.  All fees, costs and expenses for which Borrower or a Guarantor
is obligated  under the Loan  Documents  shall be payable to Bank on demand.  At
Bank's option,  the amount of such fees, costs and expenses may be deducted from
the  proceeds  of any loan  hereunder  or added to the unpaid  principal  due by
Borrower  under the  Revolving  Line,  in which event such amount will be deemed
paid and the amount thereof shall be treated as a loan thereunder.

     4.4 Except as amended by this Amendment,  the Loan Agreement (including all
previous  amendments  to the extent not  superseded by the terms hereof) and all
other  Loan  Documents  remain in full  force and  effect as  provided  therein.
Borrower and Guarantors each hereby ratifies and confirms the Loan Documents, as
amended  hereby,  and agrees that the Security  Agreements,  and all Collateral,
continue to secure all Obligations.  Without limiting the foregoing, each of the
Guarantors  hereby  expressly  ratifies and confirms its  obligations  under the
certain guaranty  agreements  previously executed by it for the benefit of Bank,
and agrees that the  Obligations  continue to be included within the obligations
and indebtedness guaranteed thereby. Borrower and Guarantors each agrees that it
will comply with all terms and provisions of the Loan  Documents,  as amended by
this Amendment.

     4.5 Wherever any Loan Document makes  reference to the Agreement,  the same
shall be  deemed  to mean the  Agreement  as  amended  by this  Amendment.  This
Amendment is a Loan  Document for purposes of the  provisions  of all other Loan
Documents.  Any breach of the  representations,  warranties and covenants  under
this Amendment shall constitute a Default under the Loan Documents.


                                       56
<PAGE>


     4.6 In consideration of this Amendment, the Existing Defaults as defined by
the Forbearance Agreement are hereby waived,  provided, that such waiver extends
only to such Existing Defaults and is expressly limited as provided herein,  and
Bank shall be entitled to expect and require  strict  compliance  with all other
requirements of the Loan Documents in accordance with their respective terms.

     4.7 This Agreement  shall be governed by the laws of the State of Texas. If
any  provision in this  Agreement is held to be  unenforceable,  such  provision
shall be severed and the  remaining  provisions  shall  remain in full force and
effect. All representations,  warranties,  and covenants of this Agreement shall
survive the execution of this Agreement and any other contract or agreement. The
provisions of this  Agreement may be waived or amended only in a writing  signed
by all of the parties hereto.  This Agreement shall bind Borrower and Guarantors
and their  respective  successors  and assigns and shall inure to the benefit of
Bank and its successors and assigns.  This Agreement may be executed in multiple
counterparts which together shall constitute one and the same agreement.

     4.8 The  provisions  of Section 10  ("Arbitration")  of the Loan  Agreement
shall be deemed  applicable  to this  Amendment and are  incorporated  herein by
reference.

     4.9 This Amendment (i) shall be deemed  effective  prospectively  as of the
Effective Date, (ii) contains the entire agreement among the parties and may not
be amended or modified  except in writing signed by all parties,  (iii) shall be
governed and construed  according to the laws of the State of Texas and (iv) may
be  executed in any number of  counterparts,  each of which shall be valid as an
original and all of which shall be one and the same agreement. A telecopy of any
executed counterpart shall be deemed valid as an original.



                                       56
<PAGE>

     THIS WRITTEN AGREEMENT AND THE LOAN DOCUMENTS REPRESENT THE FINAL AGREEMENT
     BETWEEN  THE  PARTIES  AND MAY NOT BE  CONTRADICTED  BY  EVIDENCE OF PRIOR,
     CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OF THE PARTIES. THERE ARE NO
     UNWRITTEN ORAL AGREEMENTS BETWEEN THE PARTIES.





Executed as of the Effective Date.

                                   NATIONSBANK OF TEXAS, N.A.


                                   By:  /s/ Mark L. Henze
                                      -----------------------------------------
                                   Title:  Vice President
                                         --------------------------------------

                                   THE LEATHER FACTORY, INC.
                                   A Delaware corporation


                                   By:  /s/ Fred N. Howell
                                      -----------------------------------------
                                   Title: Chief Financial Officer and Treasurer
                                         --------------------------------------

                                   THE LEATHER FACTORY, INC.
                                   A Texas corporation


                                   By:  /s/ Fred N. Howell
                                      -----------------------------------------
                                   Title: Chief Financial Officer and Treasurer
                                         --------------------------------------

                                   ROBERTS, CUSHMAN & COMPANY, INC.


                                   By:  /s/ Fred N. Howell
                                      -----------------------------------------
                                   Title: Chief Financial Officer and Treasurer
                                         --------------------------------------




                                       57
<PAGE>

                                                                  EXHIBIT 23.1


                        CONSENT OF INDEPENDENT AUDITORS

We consent to the incorporation by reference in the Registration Statement (Form
S-8 No.  33-81214)  pertaining to the Employee Stock Ownership Plan and Trust of
The  Leather  Factory,  Inc.  and  the  Registration  Statement  (Form  S-8  No.
333-07147) pertaining to the 1995 Stock Option Plan of The Leather Factory, Inc.
of our report dated February 21, 1997 with respect to the consoidated  financial
statements  and  schedule of The Leather  Factory,  Inc.  included in the Annual
Report (Form 10-K) for the year ended December 31, 1996.


/S/ERNST & YOUNG LLP
----------------------
ERNST & YOUNG LLP

Fort Worth, Texas
March 25, 1997


                                       58
<PAGE>


                                                                EXHIBIT 23.2


CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS

As independent public ccountants,  we hereby consent to the incorporation of our
report included in this Form 10-K into the Company's  previously  filed Form S-8
Registration Statements on File Nos. 33-81214 and 333-07147.


/s/ARTHUR ANDERSEN LLP
--------------------------
ARTHUR ANDERSEN LLP

Fort Worth, Texas
March 25, 1997







                                       59