SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    Form 10-K

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

                   For the fiscal year ended December 31, 1998
                                       OR

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

           Commission File Number 1-12368

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

          Delaware                                            75-2543540
(State or other jurisdiction of                          (I.R.S. Employer 
  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 Act:

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

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

                                      None

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

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

     The aggregate  market value of the common stock held by  non-affiliates  of
the registrant was approximately  $829,877 at March 15, 1999. At that date there
were 9,853,161 shares of Common Stock outstanding.

                       DOCUMENTS INCORPORATED BY REFERENCE

     Certain  portions of the  Registrant's  definitive  Proxy Statement for the
Annual Meeting of Stockholders  to be held on May 26, 1999, are  incorporated by
reference in Part III of this report.


<PAGE>

                                     PART I

Item 1.  Business.

         General.  The  Leather  Factory,  Inc.  ("TLF"  or 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.  TLF is the  successor  to
several entities that were parties to a merger  transaction in July 1993. One of
these entities involves a business that was incorporated pursuant to the laws of
the State of Texas in 1980. 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.

         TLF  operates in one  industry  segment as an  international  wholesale
manufacturer  and  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 Long Island City,
New York,  produces a related  product line involving hat trims,  the decorative
piece of material that adorns the outside of a hat, and small  finished  leather
goods  such as  cigar  cases,  wallets  and  western  accessories.  The  Company
frequently   introduces  new  products  either  through  its  own  manufacturing
capability or through  purchasing from vendors.  The Company holds a substantial
number of  copyrights  for its designs.  These  designs  have been  incorporated
throughout the Company's  product line as a means of increasing its  competitive
advantage.

         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  (5%)  of the
Company's sales are retail.  TLF sells  inventory  ranging from raw materials to
finished goods.

         The Company  manufactures some of its own products,  but when it cannot
manufacture an item on a cost-effective  basis, it 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
Long Island City, New York, where,  through its Cushman subsidiary,  it produces
hat trims and small finished leather goods, as noted above.

         The  Company  principally  promotes  its  products  through  the use of
targeted direct mail advertising.  Proprietary  mailing lists by customer groups
are maintained by the Company.  These valuable mailing lists have been generated
internally and have never been sold to third parties.

         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.



                                       2


<PAGE>

         Operating   Results.   The  Company's   strategic  efforts  to  improve
profitability  significantly  increased  gross profit  margins in 1998.  Company
management  focused its attention on improving gross profit margins by improving
product sales mix,  selectively  increasing  prices,  and eliminating low margin
items from its product lines.  As a result,  gross profit as a percentage of net
sales  increased to 43.9% in 1998,  up 2.3  percentage  points from 1997 and the
highest level achieved since  reaching  44.4% in 1993.  Continuing  cost control
measures also reduced  operating  costs by $475,628  (5.1%) from  $9,365,673 for
1997 to $8,890,045 achieved in 1998. Strategic efforts to improve  profitability
came at the expense of lower sales.  Net sales of $22,163,994 for the year ended
December 31, 1998,  were down  $3,235,122  (12.7%) from fiscal 1997. The decline
resulted from elimination of low margin items from the Company's  product lines,
reduced sales to the craft and western apparel markets,  and lower export sales.
These   declines  were  partly  offset  by  gains  in  the  Company's  core  and
institutional  business.  Despite  improvements in margins and cost  reductions,
lower sales  resulted in a net loss of $39,191 in 1998 compared to net income of
$70,292 in 1997.  See also  "Management's  Discussion  and Analysis of Financial
Condition  and Results of  Operations  - General;  - Costs,  Gross  Profit,  and
Expenses; and - Capital Resources and Liquidity."

         Operating  results for the fourth quarter of 1998 revealed  essentially
the same improvement in operating  profit margins as for the total year.  Fourth
quarter  1998  revenues  were down 11.7% from the same period  last year,  while
gross  profits  were down only 5.7% due to an  improvement  in the gross  profit
margin of 2.9 percentage points.  Operating costs were down 6.7% from the fourth
quarter of 1997.  These reductions more than offset the decline in gross profits
and resulted in higher total income from  operations  in 1998  compared to 1997.
This improvement in operating  profits in 1998,  losses in 1997 of approximately
$60,000  on the sale of real  estate in  Florida,  and  adjustments  to the 1998
provision for taxes for year-end  contributions to benefit plans resulted in net
income of $76,967 in the fourth quarter of 1998 compared to a loss of $73,820 in
the same period of 1997. See Note 12 to the Consolidated Financial Statements.

         Funded  Indebtedness.  On November 21, 1997, the Company entered into a
Loan  and  Security  Agreement  with  FINOVA  Capital  Corporation   ("FINOVA"),
according  to  which  FINOVA  agreed  to  provide  a  credit  facility  of up to
$9,136,000 in senior debt (the "Senior Debt Facility"). The Senior Debt Facility
has a two year term and is secured  by all of the assets of the  Company as well
as a pledge of 3,000,000  shares of the Company's common stock, par value $.0024
("Common Stock"), collectively owned by two of the Company's executive officers.
Simultaneously,   the  Company   also  issued  at  face  value  its   $1,000,000
subordinated  promissory  note to The Schlinger  Foundation  (the  "Subordinated
Debenture").  The  Subordinated  Debenture  also has a two-year  maturity and is
partially  secured by a pledge of 2,666,666 shares of the Company's Common Stock
owned by another executive officer.

         The  Company  is  currently  in  compliance   with  all  covenants  and
conditions contained in the Senior Debt Facility and the Subordinated  Debenture
and has no reason to believe that it will not continue to operate in  compliance
with the provisions of these  financing  arrangements.  The principal  terms and
conditions  of the Senior  Debt  Facility  and the  Subordinated  Debenture  are
described  below,  see  "Management's   Discussion  and  Analysis  of  Financial
Condition and Results of Operations - Capital  Resources and Liquidity" and Note
3 to the Consolidated Financial Statements.

         The total  outstanding  balances  of the Senior Debt  Facility  and the
Subordinated  Debenture  will become due during the current year pursuant to the
terms of these debt facilities.  The Company is actively seeking to refinance or
renew this  indebtedness  prior to its maturity.  Management is confident of its
ability to renew,  restructure,  or refinance  the Senior Debt  Facility and the
Subordinated  Debenture on a favorable long-term basis. However,  management can
provide  no  assurance  that  such  renewal  or  refinancing   efforts  will  be
successful.   See  also  "Management's  Discussion  and  Analysis  of  Financial
Condition and Results of Operations Capital Resources and Liquidity".

         Opening  of  New  Sales/Distribution  Units  and  Acquisitions.  Due to
management's  continued  focus on improving the results of existing  operations,
the Company did not close an  acquisition  or open a new  location  during 1998.
Subject to  remaining  in  compliance  with the  provisions  of the Senior  Debt
Facility and the Subordinated Debenture, and management's desire to achieve even
greater  improvements  in  existing  operations,  the  Company  will  resume its
expansion plans in 1999.

                                       3


<PAGE>

         On January  8, 1999,  Tandycrafts,  Inc.  announced  plans to close its
leather and crafts manufacturing operations and 121 retail stores over the first
half of the year.  They also indicated  their intent to retain their mail order,
dealer and wholesale  leather and crafts  business and increase their efforts to
sell these products direct to consumers. Company management expects Tandycrafts'
actions to create  opportunities for profitable growth in some markets. See also
"Expansion and Acquisition  Strategy" and "Management's  Discussion and Analysis
of Financial  Condition and Results of Operations - General; - Capital Resources
and Liquidity."

         Corporate  History.  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.  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 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.

         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.

         Business  Concept.  Wray  Thompson and Ronald C. Morgan,  the Company's
founders,  conceived "The Leather  Factory  Concept." This concept  includes the
geographical   location   and   type  of   space   rented   for  the   Company's
sales/distribution units, the size and 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's 22  sales/distribution  units  combine the  economies of
scale  of  warehouse  locations  with  the  marketing  efficiencies  that can be
achieved  through  direct mail.  Walk-in  traffic and mail order  customers  are
served  in  the  same   location.   The  type  of  premises   utilized  for  the
sales/distribution 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   oriented   locations.   The  size  and   configuration   of  the
sales/distribution  units are  carefully  planned to allow large  quantities  of
product to be displayed in an easily  accessible and visually  appealing manner.
Leather is  displayed  by the pallet  where the  customer  can see and touch it,
assessing  first-hand  the  numerous  sizes,  styles,  and grades of leather and
leather goods. The Company maintains higher inventory levels of certain imported
items to  assure  itself of a  continuous  allotment  due to the  length of time
required for delivery of these items.

                                       4

<PAGE>

         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.

         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 been refined over the years due to the
introduction  of new  products  as well as the  discontinuing  of items from the
product line. The Company now maintains  2,418 items in The Leather Factory line
of  merchandise,  and the product line sold to shoe repair shops and shoe stores
increases  the number in the  Company's  overall  product line to  approximately
3,000 SKU's.

         Expansion and Acquisition  Strategy. In past years the Company has made
several  acquisitions and opened new  sales/distribution  units. The acquisition
strategy involved: (a) the purchase of businesses selling a related product line
to which The Leather Factory line of merchandise and Concept could be added; and
(b) the purchase of related  businesses.  The results of these  activities  have
been mixed  principally  due to the impact upon the  Company of negative  market
forces,  which affected the integration and results of these companies  acquired
or new locations instituted, as well as due to a protracted labor dispute at the
Cushman  facility,  which was  resolved  in 1996.  Market  conditions  have been
challenging  in the  areas of the  western  and craft  industries  served by the
Company for some time. For example, conditions in the western industry peaked in
1994 and the trends have been  generally  negative in that  industry  since that
time. These trends, coupled with the labor dispute at Cushman, have affected the
sales and  profitability  of the Company's  Cushman  acquisition.  The Company's
acquisition of businesses  involved in the  distribution of shoe care and repair
supplies have been only marginally profitable because of competitive pressures.

         In 1997 and 1998,  management  focused on  stabilizing  operations  and
obtaining  long-term  financing,  and no  acquisitions  were  made.  Subject  to
obtaining the necessary  financing and the demands of existing  operations,  the
Company  currently  plans to resume  its  expansion  by: (i) adding two to three
sales/distribution  units per year;  and (ii)  acquiring  companies  in  related
areas/markets  which offer  synergistic  aspects based on the  locations  and/or
product lines of the  businesses.  The opening of new locations will be impacted
by the opportunities created by Tandycrafts' announced closing of its 121 retail
stores. Some of these sites could serve as Leather Factory locations. Management
is evaluating its options given the Tandycrafts announcement.

         It is  anticipated  that the Company  would not acquire a business that
sells shoe care and repair  supplies as a means of gaining a new Leather Factory
location as it has several times in the past. The Company has determined that it
is better to open new locations  than to purchase  these  existing  shoe-related
businesses.  The opening of a new location  requires  approximately  $100,000 in
inventory and $25,000 in fixtures,  plus the  investment in accounts  receivable
during the initial phase of a new unit.  Management  believes that new locations
can be financed internally.

        The financing of  acquisitions  is dependent upon the Company's  working
capital  line of credit with FINOVA and subject to the size of the  acquisition,
will require the Company to seek  additional  financing.  Management can give no
assurances as to its ability to obtain such financing.


                                       5


<PAGE>

        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 Long Island
City, 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. The Cushman facility
manufactures  hat trims and small finished  leather goods. Hat trims are sold to
hat  manufacturers and distributors  directly.  Small finished leather goods are
sold to various distributors and retailers through attendance at trade shows and
the use of sales representatives.

        The customer  groups served  include  wholesale  distributors,  tack and
saddle shops,  shoe-findings  customers,  institutions,  prisons and  prisoners,
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.  Approximately  three percent (3%) of the Company's sales
are export sales.

         Competition.  The Company competes in four highly  fragmented  markets,
which include leathercraft, leather accessories, retail craft, and shoe care and
repair supplies.  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.

         In  January  1999,  Tandycrafts  Inc.,  a  competitor  in some areas in
leathercrafts and craft markets, announced plans to close its leather and crafts
manufacturing  operations and its 121 retail stores over the first half of 1999.
Management  expects these closures to lessen  competition in some of the markets
in which the Company competes once Tandycrafts'  remaining inventories have been
absorbed by the market.

        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 1998, the Company's ten
largest  vendors  accounted  for  approximately  fifty four percent (54%) 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 130  copyrights
covering 239 registered  works,  seven trademarks  covering seven names, and two
patents covering three products.  Registered  trademarks include a federal trade
name registration on The Leather Factory. The trademarks expire at various times
starting  in 2002 and  ending in 2008,  but can be  renewed  indefinitely.  Most
copyrights  granted or pending  are on metal  products,  such as  conchos,  belt
buckles,  etc., and instruction  books. The expiration period for the copyrights
begins in 2062 and ends in 2072. The Company has patents on two belt buckles and
certain  leather-working  equipment known as the "Speedy  Embosser." The patents
expire in 2011. Management considers these intangibles to be valuable assets and
defends them as necessary.

                                       6

<PAGE>

         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.

         Employees.  As of December 31, 1998,  the Company  employed 180 people,
with 177 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,
1998, 207 employees and former  employees were  participants in or beneficiaries
of the ESOP.  The Company has the option of  contributing  up to 15% of eligible
employees' compensation into the ESOP. Net contributions for 1998, 1997 and 1996
were  11.6%,  1.2%,  and .8%,  respectively,  of  eligible  compensation.  These
contributions are used to purchase shares of Common Stock.

         Management believes that relations with employees are good.













                                       7

<PAGE>

<TABLE>

<CAPTION>

Item 2.   Properties.

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

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

  Chattanooga, TN                     9,040                 $    40,704              May 1999
  Denver, CO                         12,000                      39,000              October 1999
  Harrisburg, PA                      6,850                      37,172              March 2002
  Fort Worth, TX                     61,000                     252,429              March 2003
  Fresno, CA                          5,600                      41,516              March 2002
  Des Moines, IA                      4,000                      26,000              April 1999
  Phoenix, AZ                         4,500                      25,729              March 2001
  Springfield, MO                     6,000                      24,000              July 2003
  Spokane, WA                         5,400                      20,400              February 1999
  Albuquerque, NM                     5,000                      29,793              October 2003
  Salt Lake City, UT                  4,000                      25,584              September 1999
  Baldwin Park, CA                    7,800                      53,040              March 2000
  Tampa, FL                           5,238                      38,396              January 2003
  San Antonio, TX                     5,600                      40,320              October 2001
  Columbus, OH                        6,000                      39,075              October 2000
  El Paso, TX                         5,000                      25,700              August 2003
  Oakland, CA                         8,000                      54,000              December 2003
  Grand Rapids, MI                    8,000                      34,151              March 1999
  Wichita, KS                        14,000                      33,600              May 1999
  Long Island City, NY               10,200                      67,234              June 2003
  New Orleans, LA                     5,130                      21,600              August 2000
  Charlotte, NC                       6,202                      24,188              February 2001
  Winnipeg, Canada                    5,712                      26,273**            November 2002
                                    --------                 ----------
  Totals                             210,272                 $1,019,904
                                    ========                 ==========
</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 $10,920 per year. This lease will expire in October 1999.


                                       8
<PAGE>

Item 3.   Legal Proceedings.

         As  reported  previously,  the  Company,  as  successor-in-interest  to
National  Transfer & Register  Corporation  ("National"),  was 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
(the "Court"). The Company as part of a reverse merger transaction with National
was contractually indemnified against loss in this case by one of the additional
defendants  Securities  Transfer  Corporation  ("STC") and related  entities and
individuals of STC.

         This action was originally  tried in July 1995, and upon  conclusion of
the trial in September  1995, a Judgment in favor of the  plaintiffs and against
the defendants was entered in the approximate  amount of $150,000  including pre
judgment  interest.  In September  1995 STC filed a motion to alter or amend the
judgment and also made a settlement  offer.  On November 9, 1998, the Plaintiffs
accepted a settlement offer from STC and acknowledged  full  satisfaction of the
judgement,  including all costs, pre-judgement interest, post judgement interest
and  attorney's  fees.  The Company did not suffer any loss or expense from this
lawsuit.

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


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

         There were no matters  submitted  to a vote of the  Company's  security
holders  during the fourth  quarter of the Company's  fiscal year ended December
31, 1998.

                                     PART II

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

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

         Quarter Ended                   High                   Low
         -------------                   ----                   ---

         March 31, 1997                 $1.0000              $0.5625
         June 30, 1997                   0.8125               0.5000
         September 30, 1997              0.8750               0.5625
         December 31, 1997               0.8125               0.5000

         March 31, 1998                  0.6250               0.4375
         June 30, 1998                   0.6250               0.3750
         September 30, 1998              0.6250               0.3750
         December 31, 1998               0.4375               0.1250
----------
    There were approximately 593 stockholders of record on March 15, 1999.

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


                                       9

<PAGE>

<TABLE>

<CAPTION>

Item 6.  Selected Financial Data.

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

Years Ended December 31
---------------------------------------
Income Statement Data
                                       ---------------------------------------------------------------------------------------------
                                            1998                1997               1996                1995               1994
                                       ----------------    ----------------   ----------------   -----------------   ---------------
<S>                                    <C>                 <C>                <C>                <C>                 <C>

Net sales                                  $22,163,994         $25,399,116        $28,253,632         $31,447,849        $28,081,272
Cost of sales                               12,428,324          14,844,376         17,689,973          18,446,378         15,870,603
                                       ----------------    ----------------   ----------------   -----------------   ---------------
     Gross profit                            9,735,670          10,554,740         10,563,659          13,001,471         12,210,669

Operating expenses                           8,890,045           9,365,673         10,869,359          10,363,159          9,573,495
                                       ----------------    ----------------   ----------------   -----------------   ---------------
Operating income (loss)                        845,625           1,189,067          (305,700)           2,638,312          2,637,174

Other (income) expense                         970,339             887,543          1,000,604             678,264            142,830
                                       ----------------    ----------------   ----------------   -----------------   ---------------

Income (loss)
     before income taxes                     (124,715)             301,524        (1,306,304)           1,960,048          2,494,344
Income tax provision (benefit)                (85,524)             231,232          (316,536)             786,744            990,197
                                       ----------------    ----------------   ----------------   -----------------   ---------------

Net income (loss)                             (39,191)              70,292          (989,768)           1,173,304          1,504,147
                                       ================    ================   ================   =================   ===============

Earnings (loss) per share*                       (.00)                 .01              (.10)                 .12                .15
                                       ================    ================   ================   =================   ===============

Earnings (loss) per share--
  assuming dilution*                             (.00)                 .01              (.10)                 .12                .15
                                       ================    ================   ================   =================   ===============

Weighted average common
 shares outstanding for:

   Basic EPS                                 9,803,887           9,789,358          9,788,530           9,789,468          9,783,387
                                       ================    ================   ================   =================   ===============

   Diluted EPS                               9,803,887           9,791,565          9,788,530           9,789,468          9,783,387
                                       ================    ================   ================   =================   ===============

Balance Sheet Data
                                       ---------------------------------------------------------------------------------------------
                                                       
                                            1998                1997               1996                1995               1994
                                       ----------------    ----------------   ----------------   -----------------   ---------------

Total Assets                               $16,029,937         $17,024,549        $18,264,547         $19,333,376        $18,468,806
                                       ----------------    ----------------   ----------------   -----------------   ---------------

Notes payable and current
    maturities of long term debt             6,139,327           4,650,742          8,549,366           1,296,359            194,311
                                       ----------------    ----------------   ----------------   -----------------   ---------------

Notes payable and long-term

    debt, net of current maturities             61,389           2,602,728             17,378           6,566,809          7,325,432
                                       ----------------    ----------------   ----------------   -----------------   ---------------

Total Stockholders' Equity                   8,170,278           8,132,646          8,022,937           9,282,305          8,217,781
                                       ================    ================   ================   =================   ===============

</TABLE>

* The  earnings  (loss) per share  amounts  prior to 1997 have been  restated to
comply with Statement of Financial  Accounting  Standards No. 128,  Earnings Per
Share. Such restatement did not change previously reported amounts.  See notes 2
and 9 to  the  consolidated  financial  statements  for  further  discussion  of
earnings per share.

                                       10

<PAGE>


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

Results of Operations

<TABLE>
                                          Income Statement Comparison

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

                                                            1998               1997               1996
                                                        --------------     --------------     ---------------
<S>                                                     <C>                <C>                <C>

              Net Sales                                         100.0%              100.0%              100.0%
              Cost of sales                                      56.1                58.4                62.6
                                                        --------------     --------------     ---------------
              Gross profit                                       43.9                41.6                37.4
              Operating expenses                                 40.1                36.9                38.5
                                                        --------------     --------------     ---------------
              Income (loss) from operations                       3.8                 4.7                (1.1)
              Other (income) expense, net                         4.4                 3.5                 3.5
                                                        --------------     --------------     ---------------
              Income (loss) before
                income taxes                                     (0.6)                1.2                (4.6)
              Provision (benefit) for income tax                 (0.4)                0.9                (1.1)
                                                        --------------     --------------     ---------------
              Net income (loss)                                  (0.2)%               0.3%               (3.5)%
                                                        ==============     ==============     ===============
</TABLE>


                        Analysis of 1998 Compared to 1997
                        ---------------------------------           

Revenues

         The Company's net sales  decreased by 12.7% to $22,163,994  during 1998
from  $25,399,116  in 1997.  The decline  resulted from  strategic  decisions to
eliminate low margin items from the Company's  product  lines,  reduced sales to
the western apparel and crafts markets,  and lower export sales.  Sales of lower
margin  items  were down 43% from 1997 and now  represent  less than 8% of total
revenues.  Nearly half of the Company's  business is made up of sales to western
apparel and crafts  markets,  and 1998 sales in these  markets were down 15% and
18%,  respectively,  compared to 1997,  reflecting  a  continuation  of negative
industry   trends.   However,   sales  in  the  Company's  core  businesses  and
institutional  markets  remained  strong  throughout  the year and registered an
increase in revenues over 1997.

         Sales of the  Company's  products do not reflect  significant  seasonal
patterns.

Costs, Gross Profit, and Expenses

         Cost of sales as a percentage of revenue was 56.1% for 1998 as compared
to 58.4% for 1997. The  difference in the relative cost of sales  percentage was
principally  attributable  to an improved  product  sales mix and the  Company's
strategic  efforts to selectively  raise prices and eliminate lower margin items
from its product lines.

         A lower relative cost of sales  percentage meant that gross profit as a
percentage  of sales was higher for the fiscal  year  ended  December  31,  1998
compared to 1997. Gross profit as a percentage of sales increased 2.3 percentage
points to 43.9% in 1998 from 41.6% in 1997.

         Operating  expenses  decreased  $475,628 or 5.1% to  $8,890,045 in 1998
from  $9,365,673  in  1997.  Approximately  half of the  decrease  in  operating
expenses  was the  result  of lower  payroll  costs,  reflecting  an  additional
reduction of personnel during 1998. Other decreases  included lower  advertising
costs, reduced accounting, legal and professional fees, and lower freight costs.


                                       11

<PAGE>

Other (Income) Expense

         Other  expenses  were  $970,339 for the fiscal year ended  December 31,
1998 compared to $887,543 during the same period in 1997.  Interest  expense was
up $136,101 in 1998 as the amortization of deferred costs from the November 1997
debt  refinancing  offset reduced interest expense due to lower borrowing levels
during the year. Other income  increased  $53,305 relative to 1997 due to a gain
from the sale of a trademark  in 1998 as opposed to a loss  recorded on the sale
of real estate in Tampa, Florida in 1997.

Provision (Benefit) for Income Taxes

         The benefit for income  taxes was 69% of the loss before taxes in 1998.
The tax benefit  reflects a deduction for a  contribution  to the Company's ESOP
for tax  purposes in excess of its  treatment  in  arriving at net income.  This
amount is partly offset by certain  non-deductible  expenses totaling  $228,000,
principally comprised of the amortization of goodwill.  Taking these two amounts
into account,  the  Company's  effective tax rate  materially  approximates  the
Company's  historical rate for combined  federal and state income taxes of about
40%.

Net Income (Loss)

         The Company  recorded a net loss of $39,191 for 1998 as compared to net
income of  $70,292  for 1997.  The change in results  was  primarily  due to the
factors noted above regarding sales, cost of goods sold,  operating expenses and
other (income) expense.

                        Analysis of 1997 Compared to 1996
                        ---------------------------------

Revenues

         The Company's net sales  decreased by 10.1% to $25,399,116  during 1997
from $28,253,632 in 1996. This sales decline was a result of the negative forces
at the retail level that existed in some of the Company's markets as well as the
Company's plan to achieve  greater  margins through higher prices which led to a
lower volume of sales. The Company experienced reduced revenues of $1,507,140 in
sales of western or southwestern  related products and reductions of $983,399 in
sales to the retail craft industry.

         In addition to sales  declines  due to  negative  market  forces in the
craft and western  apparel  industries,  the Company  initiated and  implemented
certain strategies during the year that resulted in lower sales. Prices in lower
margin  product  lines were  selectively  increased  and certain  products  were
eliminated  from  these  lines.  These   merchandising  and  pricing  strategies
contributed  to the sales decline by  approximately  $950,000.  This decline was
partially  offset  by  increases  generated  in the  Company's  growing  line of
finished leather accessories and an increase in export sales.

Costs, Gross Profit, and Expenses

         Cost of sales as a percentage of revenue was 58.4% for 1997 as compared
to 62.6% for 1996. The  difference in the relative cost of sales  percentage was
principally  attributable  to: (i) a change in sales mix, in that the percentage
of the Company's sales reflecting relative lower costs of sales increased;  (ii)
management's  plan to raise prices and selectively  eliminate lower margin items
from the  Company's  product  lines;  and (iii)  direct  labor  costs  that were
eliminated due to planned  personnel  reductions and the settlement of the labor
dispute at Cushman in October of 1996.

         A lower relative cost of sales  percentage meant that gross profit as a
percentage  of sales was higher for the fiscal  year  ended  December  31,  1997
compared to 1996. Gross profit as a percentage of sales increased 4.2 percentage
points to 41.6% in 1997 from 37.4% in 1996. Due to the factors  mentioned  above
relative to cost of sales, the Company generated almost the same amount of gross
profit in dollars on  $25,399,116 in sales during the fiscal year ended December
31, 1997 as it did on $28,253,632 in sales during 1996.

                                       12

<PAGE>


         Operating expenses  decreased  $1,503,686 or 13.8% to $9,365,673 during
1997 from  $10,869,359 in 1996. This decrease in operating  expenses was the net
result of cost control  measures  instituted by  management.  The  reductions in
operating  expenses  involved several factors,  including:  (i) reduced payroll,
payroll tax and payroll  related  expenses of  approximately  $500,000  due to a
substantially  lower average  number of employees  during 1997 compared to 1996;
(ii) a small bad debt  recovery  recorded  during 1997 as opposed to $229,000 of
expense for 1996;  (iii) a net  reduction in  commission  expense of $151,183 in
1997, due primarily to the  elimination of sales  representatives  in the retail
craft  market;  (iv)  $140,772 less  amortization  expense in 1997,  principally
because of the write down of certain  purchased  goodwill  during 1996; and (iv)
reductions  of  $50,000  or  more in each of  advertising,  corporate  fees  and
shareholders  relations,  freight,  insurance,  supplies,  travel, and marketing
samples.  These  decreases  in  operating  expenses  were  partially  offset  by
increased  professional  expenses  incurred by the Company in initial efforts to
obtain new financing during 1997.

Other (Income) Expense

         Other  expenses  were  $887,543 for the fiscal year ended  December 31,
1997  compared  to  $1,000,604  during the same period in 1996.  The  difference
between the two years involved decreased interest expense. The difference in the
dollar amount of interest  expense was  principally due to the write-off in 1996
of the commitment and facility fees attributable to the acquisition  commitments
that  expired in July 1996.  The interest  expense  that the Company  could have
saved during 1997 from  decreased  levels of debt compared to the previous year,
was offset by  increased  interest  rates and the  forbearance  fees  charged by
NationsBank.  Due to the Company's  continuing  default under certain  covenants
contained in its former NationsBank debt facility,  the rate of interest charged
by  NationsBank  increased  from an average of the Prime Rate or less during the
prior fiscal year to the Prime Rate plus 2% on average for 1997.

Provision (Benefit) for Income Taxes

         The provision for federal and state income taxes was 77% of 1997 income
before  taxes  due  to  certain   non-deductible   expenses  totaling  $235,000,
principally comprised of the amortization of goodwill.  Taking this into account
the  Company's   effective  tax  rate  materially   approximates  the  Company's
historical rate for combined federal and state income taxes of about 40%.

Net Income (Loss)

         The  Company  recorded  net income of $70,292 for 1997 as compared to a
net loss of $989,768 during 1996. The change in results was primarily due to the
factors noted above regarding sales, cost of goods sold,  operating expenses and
other (income) expense.

Capital Resources and Liquidity

         The primary sources of liquidity and capital resources during 1998 were
borrowings from the Senior Debt Facility with FINOVA, the Subordinated Debenture
held by Schlinger, and cash flows provided by operating activities.

         While having a negative impact on sales, the Company's  continued focus
in 1998 on improving  gross profit margins and reducing  operating  expenses was
effective  as  indicated  by the cash  flow  from  operations  in the  amount of
$1,530,286.  The use of cash flows from operations to pay down debt is reflected
in the  improvement  of the Company's debt to equity ratio from 0.89 at December
31, 1997 to 0.76 at December 31, 1998.  Some of this cash flow resulted from the
Company's ability to reduce its investment in accounts  receivable and inventory
given the reduced level of sales.

         Accounts receivable  decreased to $1,582,459 and inventory decreased to
$6,956,606 at December 31, 1998 from $1,865,276 and $7,279,702, respectively, at
December 31, 1997. The aging of accounts  receivable has not deteriorated and is
indicative of management's' continued tight credit and collection policies which
have also contributed to the negative trend in sales noted above.

                                       13


<PAGE>

         Even at the reduced  level,  inventory  only  turned 1.74 times  during
1998,  which is below the 1997 ratio of 1.98  times.  This  decrease in the turn
rate  indicates  that further  reductions  in  inventory  are still needed as of
December 31, 1998 to support the current level of sales.  Management anticipates
the completion of its  implementation  of new  information  systems in 1999 will
assist in monitoring of inventory levels that in turn should provide  additional
cash flows from operations in the future.

         The 1997  refinancing  of the  Company's  debt on a long-term  basis as
discussed  in  Item  1 and  Note  3 to  the  Consolidated  Financial  Statements
significantly  improved the Company's financial position.  The Company's current
ratio was 1.27 at December  31, 1998 and 1.68 at December  31, 1997  compared to
1.13 at the end of 1996. If the Company's  promissory  notes and  debentures had
not been reclassified from long term to current to reflect their maturity during
1999, the current ratio at December 31, 1998 would have been 1.91.

         The largest use of cash beyond inventory, accounts receivable, and debt
payments  in  1998  was  for  capital   expenditures.   Cash  used  for  capital
expenditures totaled $137,828 and $239,578 for the years ended December 31, 1998
and 1997,  respectively.  Approximately 25% of 1998 capital spending was for new
computer  equipment  and software with the  remainder  split between  office and
warehouse fixtures, machinery and other equipment, and leasehold improvements.

         The Company  believes that the current sources of liquidity and capital
resources  will be sufficient to fund current  operations and the opening of new
sales/distribution  units.  In 1999, the funding for the opening of new units is
expected  to  be  provided  by  operating  leases,  cash  flows  from  operating
activities, the Company's Senior Debt Facility with FINOVA, and the Subordinated
Debenture with Schlinger.

         The Senior Debt  Facility is comprised of a revolving  credit  facility
and three  term  notes.  The  revolving  portion  is based upon the level of the
Company's accounts  receivable and inventory.  At December 31, 1998, the Company
had additional  availability of approximately  $475,000.  As the Company's sales
and operations expand,  requiring larger investments in accounts  receivable and
inventory,  the Company  expects to have in excess of  $1,000,000  in additional
funds available under the revolving credit facility.

         The Company's Senior Debt Facility and Subordinated  Debentures  mature
on December 1, 1999, and management  intends to pursue  negotiations with FINOVA
and other potential  investors/lenders in 1999 to extend or replace the maturing
debt  facilities.  Management  believes  it will be able to secure the  required
financing prior to the maturity of these obligations. However, in the event of a
future  material  adverse  change  in the  Company's  operations,  FINOVA  could
accelerate  its debt or otherwise  determine  not to renew the notes.  In such a
circumstance  the Company  would pursue  other  sources of  financing.  If other
financing could not be secured,  the Company could experience a material adverse
impact.

         Management  perceives  opportunities to acquire related business in the
marketplace  due to the  fragmented  nature of the  markets in which the Company
conducts business as well as due to the competitive conditions of these markets.
The  Company's  present  financing  arrangements  will not be sufficient to make
these  acquisitions and if any  acquisitions are to be consummated,  the Company
will be  required  to  obtain  additional  debt  or  equity  financing.  Any new
financings  will  require  the  consent of FINOVA.  The  Company  can provide no
assurance that these acquisitions can be made on terms acceptable to the Company
or that the needed financings to enter into these transactions can be obtained.

Year 2000 Issue

         The Year 2000 ("Y2K") problem arose because many computer  programs use
only the last two digits to refer to a year. As a consequence,  unless modified,
many  computer  systems will  interpret  "00" as 1900 rather than the year 2000.
This issue is  believed to affect  virtually  all  organizations  and failure to
address  the problem  could  result in system  failures  and the  generation  of
erroneous data. Each company's  potential costs and uncertainties will depend on
a number of factors  including  but not limited to its software,  hardware,  the
nature of its industry,  and the sophistication of its manufacturing and process
control systems.


                                       14


<PAGE>

         The Company has developed a comprehensive  Y2K readiness plan to ensure
its systems will be Y2K compliant prior to the year 2000. Pursuant to this plan,
the Company conducted preliminary reviews of its critical information technology
("IT") systems as well as its non-IT systems.  The majority of systems that were
found to be  defective  in this review have been  replaced or upgraded  with the
exception of the Company's point of sale ("POS") software used for invoicing and
inventory maintenance in the Company's Texas locations.

         The installation of the POS system in the Company's  remaining nineteen
distribution units was delayed until after the conversion and testing of the Y2K
compliant version of the software.  The conversion in the Fort Worth location is
currently  in process  and all Texas  locations  should be on the Y2K  compliant
version by the end of March 1999.  Installation  in the  remaining  locations is
scheduled to be completed by October 31, 1999.

         The Company has appointed a Y2K committee composed of senior executives
and middle  management.  This  committee  is charged  with  testing  systems for
potential Y2K problems missed in the preliminary review and remediation  process
as well as assessment of potential  risks from the Company's  trading  partners'
Y2K failures.  This committee will report periodically to the Company's Board of
Directors and currently expects testing to be completed by October 31, 1999.

         The  Company  has  managed  its Y2K  compliance  program  using  mostly
internal  salaried  staff.  For  this  reason  and  the  fact  that  much of the
replacement cost of non-compliant IT systems would have been incurred anyway, it
is difficult to quantify the actual remediation costs. The Company spent $34,185
in 1998 for new  computer  systems and  acquired an  additional  $226,741 in new
equipment  and  software  in January  1999.  This  investment  includes  systems
upgrades which will facilitate  completion of the Y2K compliance  program. It is
believed that the majority of the total expected  remediation costs have already
been incurred.

         The Company  believes  because of the nature of its  operations and the
steps  taken as  discussed  above  that the Y2K issue  will not have a  material
impact  on  the  Company's  results  of  operations,   liquidity,  or  financial
condition.  Actual  results  may  differ  from  the  forward-looking  statements
contained in this  discussion  and there can be no guarantee that the failure of
certain systems will not have a material adverse effect on the Company.

         In the  unlikely  event that  unforeseen  Y2K problems are not remedied
prior to a disruption in normal business  operations,  the Company would in most
instances be able to  temporarily  revert to manual  processes  that the Company
successfully used prior to automating many routine tasks.

Cautionary Statement

         The disclosures under "-Results of Operations"; "-Capital Resources and
Liquidity";  "Year  2000  Issue"  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, but not all, 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,  the
Company's or its  significant  trading  partners'  inability to identify all Y2K
issues,  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.


                                       15


<PAGE>

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

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

Item 8.  Financial Statements and Supplementary Data.

         The Financial  Statements and Financial Statement Schedule are filed as
a part of this report. See page 17, 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, 1998,
the Company filed a Current  Report on Form 8-K dated July 20, 1998 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>



<TABLE>


<CAPTION>



                            THE LEATHER FACTORY, INC.


                   INDEX TO CONSOLIDATED FINANCIAL STATEMENTS


<S>                                                                             <C>                      <C>
 

Consolidated Balance Sheets at December 31, 1998 and 1997..............................................  18

Consolidated Statements of Operations For the Years Ended December 31, 1998, 1997 and 1996 ............  19

Consolidated Statements of Cash Flows For the Years Ended December 31, 1998, 1997 and 1996.............  20

Consolidated Statements of Stockholders' Equity For the Years Ended December 31, 1998, 1997 and 1996...  21

Notes to Consolidated Financial Statements.............................................................  22-30

Financial Statement Schedules for the years ended December 31, 1998 and 1997:

         II--Valuation and Qualifying Accounts and Reserves............................................  31

         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 .......................................................................  32-33

</TABLE>









                                       17


<PAGE>

<TABLE>

<CAPTION>

                            THE LEATHER FACTORY, INC.
                           CONSOLIDATED BALANCE SHEETS
                           DECEMBER 31, 1998 AND 1997

                                                                     1998            1997
                                                                ------------    ------------   
<S>                                                             <C>             <C>
              
                       ASSETS
CURRENT ASSETS:
     Cash                                                       $    510,399    $     70,496
     Cash restricted for payment on revolving credit facility        232,838         319,133
     Accounts receivable-trade, net of allowance for
         doubtful accounts of $52,000 and $28,000
          in 1998 and 1997, respectively                           1,582,459       1,865,276
     Inventory                                                     6,956,606       7,279,702
     Prepaid income taxes                                            228,939         285,970
     Deferred income taxes                                           102,012         109,411
     Other current assets                                            272,993         385,199
                                                                ------------    ------------
                           Total current assets                    9,886,246      10,315,187
                                                                ------------    ------------

PROPERTY AND EQUIPMENT, at cost                                    2,671,827       2,534,839
  Less: accumulated depreciation and amortization                 (1,813,378)     (1,505,098)
                                                                ------------    ------------
                           Property and equipment, net               858,449       1,029,741

GOODWILL and other, net of accumulated amortization of
     $1,246,000 and $878,000 in 1998 and 1997, respectively        5,285,242       5,679,621
                                                                ------------    ------------
                                                                $ 16,029,937    $ 17,024,549
                                                                ============    ============

                  LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
     Accounts payable                                           $  1,019,069    $    942,046
     Accrued expenses and other liabilities                          530,789         559,776
     Notes payable and current maturities of
         long-term debt                                            6,139,327       4,650,742
                                                                ------------    ------------
                           Total current liabilities               7,689,185       6,152,564
                                                                ------------    ------------

DEFERRED INCOME TAXES                                                109,085         136,611

NOTES PAYABLE AND LONG-TERM DEBT,
     net of current maturities                                        61,389       2,602,728

COMMITMENTS AND CONTINGENCIES (Note 6)

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 1998 and 1997         23,648          23,648
     Paid-in capital                                               3,901,740       4,119,915
     Retained earnings                                             4,495,378       4,534,569
     Less: Notes receivable - secured by common stock               (224,750)       (257,617)
     Accumulated other comprehensive loss                            (25,738)        (14,018)
     Less:  Unearned shares held by ESOP, 0 and
         54,262 shares in 1998 and 1997, respectively                   --          (273,851)
     
                                                                ------------    ------------
                           Total stockholders' equity              8,170,278       8,132,646
                                                                ------------    ------------
                                                                $ 16,029,937    $ 17,024,549
                                                                ============    ============
</TABLE>


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




                                       18

<PAGE>

<TABLE>

<CAPTION>

                            THE LEATHER FACTORY, INC.
                      CONSOLIDATED STATEMENTS OF OPERATIONS
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996



                                                           1998            1997           1996
                                                      ------------    ------------   ------------
<S>                                                   <C>             <C>            <C>

NET SALES                                             $ 22,163,994    $ 25,399,116   $ 28,253,632

COST OF SALES                                           12,428,324      14,844,376     17,689,973
                                                      ------------    ------------   ------------

                Gross profit                             9,735,670      10,554,740     10,563,659

OPERATING EXPENSES                                       8,890,045       9,365,673     10,869,359
                                                      ------------    ------------   ------------

INCOME (LOSS) FROM OPERATIONS                              845,625       1,189,067       (305,700)

OTHER (INCOME) EXPENSE:
     Interest expense                                    1,003,649         867,548      1,007,544
     Other, net                                            (33,310)         19,995         (6,940)
                                                      ------------    ------------   ------------
                Total other (income) expense               970,339         887,543      1,000,604
                                                      ------------    ------------   ------------

INCOME (LOSS) BEFORE INCOME TAXES                         (124,715)        301,524     (1,306,304)

PROVISION (BENEFIT) FOR INCOME TAXES                       (85,524)        231,232       (316,536)
                                                      ------------    ------------   ------------

NET INCOME (LOSS)                                     $    (39,191)   $     70,292   $   (989,768)
                                                      ============    ============   ============





EARNINGS (LOSS) PER COMMON SHARE                      $       (.00)   $        .01   $      (0.10)
                                                      ============    ============   ============

EARNINGS (LOSS) PER COMMON SHARE--Assuming Dilution   $       (.00)   $        .01   $      (0.10)
                                                      ============    ============   ============

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

</TABLE>










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






                                       19


<PAGE>


<TABLE>

<CAPTION>

                            THE LEATHER FACTORY, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
              FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

                                                                                   1998           1997           1996
                                                                               -----------    -----------    -----------
<S>                                                                            <C>            <C>            <C>

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                            $   (39,191)   $    70,292    $  (989,768)
  Adjustments to reconcile net income to net
   cash provided by (used in) operating activities-
     Depreciation and amortization                                                 527,443        523,551        638,450  
    (Gain) loss on sales of assets                                                  (9,118)        46,950         (7,541)
     Deferred financing costs                                                      233,239         32,113        156,891
     Deferred income taxes                                                         (12,944)        16,845         13,479
     Other                                                                           7,671          1,150            785,
     Net changes in operating assets and liabilities, net of effect of
      acquisitions:
       Accounts receivable-trade, net                                              282,817         82,422        814,870
       Inventory                                                                   323,096        457,618        241,843
       Income taxes                                                                 57,031        252,488       (383,199)
       Other current assets                                                        112,206        157,610        130,683
       Accounts payable                                                             77,023          1,497       (458,368)
       Accrued expenses and other liabilities                                      (28,987)       (37,231)       (58,482)
                                                                               -----------    -----------    -----------
     Total adjustments                                                           1,569,477      1,535,013      1,089,411
                                                                               -----------    -----------    -----------

      Net cash provided by operating activities                                  1,530,286      1,605,305         99,643
                                                                               -----------    -----------    -----------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment                                             (137,828)      (239,578)      (208,537)
  Proceeds from sales of assets                                                     10,000        257,306         10,444
  Cash paid for acquisitions, net of cash acquired                                    --             --         (300,000)
  Other intangible costs                                                            (1,728)       (32,061)       (24,788)
                                                                               -----------    -----------    -----------
      Net cash used in investing activities                                       (129,556)       (14,333)      (522,881)
                                                                               -----------    -----------    -----------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Net increase (decrease) in revolving credit loans                               (432,531)    (1,469,481)     2,000,000
  Increase (decrease) in notes payable and other borrowings
     Receipts                                                                         --        3,001,396           --
     Payments                                                                     (620,223)    (3,083,189)    (1,296,424)
  (Increase) decrease in cash restricted for payment on revolving                   86,295       (319,133)          --
     credit facility                                                                   
  Payments received (purchase) of  notes receivable -
     secured by common stock                                                        32,867         11,688       (269,305)
  Deferred financing costs                                                         (27,235)      (149,949)          --
                                                                               -----------    -----------    -----------

      Net cash provided by (used in) financing activities                         (960,827)    (2,008,668)       434,271
                                                                               -----------    -----------    -----------

NET INCREASE (DECREASE) IN CASH                                                    439,903       (417,696)        11,033
                                                                                                                
CASH, beginning of year                                                             70,496        488,192        477,159
                                                                               -----------    -----------    -----------

CASH, end of year                                                              $   510,399    $    70,476    $   488,192
                                                                               ===========    ===========    ===========

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid during the year                                                $   787,148    $   749,472    $   793,373
  Income taxes paid during the year, net of (refunds)                             (117,609)       (38,101)        55,445


</TABLE>




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


                                       20

<PAGE>

                           
<TABLE>

<CAPTION>


                            THE LEATHER FACTORY, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
               FOR THE YEARS ENDED DECEMBER 31,1998,1997 AND 1996
                                                                        
                                  Common Stock                                             Notes           Accumulated       
                                ---------------------                                    Receivable           Other          
                                  Number      Par            Paid-in      Retained      - Secured by       Comprehensive     
                                of Shares     Value          Capital      Earnings      Common Stock          Loss           
                                ----------   ----------    -----------    ----------    ------------       -------------     
<S>                             <C>          <C>           <C>            <C>            <C>               <C>

BALANCE, December 31, 1995      9,853,161    $   23,648    $ 4,130,796    $ 5,454,045    $      -          $       -         

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

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

  Translation adjustment             -             -              -              -              -                 (295)      
                                ---------     ---------    -----------     ----------     ----------       -----------       
BALANCE, December 31, 1996      9,853,161        23,648      4,130,796      4,464,277       (269,305)             (295)      
                                                                                                                                 
                                                            
  Payments on notes receivable -
   secured by common stock           -             -              -              -            11,688               -         

  Allocation of suspended ESOP
   shares committed to be released   -             -           (45,881)          -              -                  -         

  Warrants to acquire 100,000 shares
   of common stock issued            -             -            35,000           -              -                  -         

  Net Income                         -             -              -            70,292           -                  -         

  Translation adjustment             -             -              -              -              -              (13,723)      
                                ---------     ---------    -----------     ----------     ----------       -----------       
 BALANCE, December 31, 1997     9,853,161        23,648      4,119,915      4,534,569       (257,617)          (14,018)      
                                                                              

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


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

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

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

  Translation adjustment             -             -              -              -              -              (11,720)      
                                ---------     ---------    -----------     ----------     ----------       -----------       
 BALANCE, December 31, 1998     9,853,161     $  23,648    $ 3,901,740     $4,495,378     $ (224,750)      $   (25,738)      
                                =========     =========    ===========     ==========     ==========       ===========
                                                                                                                             
                                                                                                                          

                                                                                           
                                    Unearned                    Comprehensive   
                                      ESOP                        Income       
                                    Shares           Total        (Loss)     
                                   ----------     ----------    -------------   
                                                                             
BALANCE, December 31, 1995         $ (326,184)    $ 9,282,305                  
                                                                               
  Notes receivable - secured                                                   
   by common stock                       -           (269,305)                 
                                                                               
  Net loss                               -           (989,768)   $  (989,768)  
                                                                               
  Translation adjustment                 -               (295)          (295)  
                                   ----------     -----------       
BALANCE, December 31, 1996           (326,184)      8,022,937                  
                                                                  ----------   
 Comprehensive income (loss) for the year ended December 31, 1996   (990,063)  
                                                                               
 Payments on notes receivable -                                               
   secured by common stock               -             11,688                  
                                                                               
 Allocation of suspended ESOP                                                 
   shares committed to be release      52,333           6,452                  
                                                                               
 Warrants to acquire 100,000 shares                                              
   of common stock issued                -             35,000                  
                                                                               
 Net Income                              -             70,292         70,292   
                                                                               
 Translation adjustment                  -            (13,723)       (13,723)  
                                   ----------     -----------                  
BALANCE, December 31, 1997           (273,851)      8,132,646                  
                                                                  ----------   
 Comprehensive income (loss) for the year ended December 31, 1997     56,569   
                                                                               
 Payments on notes receivable -                                               
   secured by common stock               -             32,867                  
                                                                               
                                                                               
 Allocation of suspended ESOP                                                 
   shares committed to be release     273,851          15,676                  
                                                                               
 Warrants to acquire 200,000 shares                                              
   of common stock issued                -             40,000                  
                                                                               
 Net Loss                                -            (39,191)       (39,191)  
                                                                               
 Translation adjustment                  -            (11,720)       (11,720)  
                                   ----------     -----------                  
BALANCE, December 31, 1998         $     -        $ 8,170,278                  
                                   ==========     ===========
                                                                   ----------   
 Comprehensive income (loss) for the year ended December 31, 1998  $  (50,911)  
                                                                   ==========
                                                                             
</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, 1998, 1997 AND 1996



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, 1998, 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 Long Island City, New York.

2.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Consolidation

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

                                                 1998              1997      
                                             -----------       -----------
  Finished goods held for sale               $ 5,564,406       $ 5,833,002
  Raw materials and work in process            1,392,200         1,446,700
                                             -----------       -----------
                                             $ 6,956,606       $ 7,279,702
                                             ===========       ===========

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 $308,568;  $303,867;  and $277,994 for the years ended
December 31, 1998, 1997 and 1996, 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.


                                       22


<PAGE>


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 had declined  substantially,
and the  operating  results of the location  since the  acquisition  had not met
expectations.  Based upon the  assessment of possible  future cash flows and the
fact that business  conditions could improve,  management believes the remaining
goodwill is recoverable and the amortization period remains appropriate.

Amortization expense of $218,875 in 1998; $219,684 in 1997; and $360,456 in 1996
was recorded in operating expenses including the above write-down.

Advertising Costs

With the exception of catalog costs, advertising costs are expensed as incurred.
Catalog costs are capitalized and expensed over the estimated useful life of the
particular  catalog in question,  which is typically  twelve to fifteen  months.
Such capitalized  costs are included in other current assets and totaled $17,809
and  $39,350 at  December  31, 1998 and 1997,  respectively.  Total  advertising
expense was $908,432 in 1998; $1,002,623 in 1997; and $1,089,716 in 1996.

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

In 1997, the Financial  Accounting  Standards Board ("FASB") issued Statement of
Financial  Accounting  Standards  ("SFAS") No. 128, Earnings per Share. SFAS No.
128 replaced the  calculation  of primary and fully  diluted  earnings per share
with basic and diluted  earnings per share.  Unlike primary  earnings per share,
basic earnings per share excludes any dilutive effects of options,  warrants and
convertible  securities.  Diluted  earnings  per  share is very  similar  to the
previously  reported  fully diluted  earnings per share.  All earnings per share
amounts  for all  periods  have  been  presented  to  conform  to SFAS  No.  128
requirements.  The adoption of SFAS No. 128 had no effect on previously reported
amounts as the effects of outstanding  options were  antidilutive  for all prior
periods  presented.  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 FASB has issued 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, 1998, it has
no long-lived assets that meet the impairment criteria of SFAS No. 121.

Stock-Based Compensation

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

                                       23

<PAGE>


3.  NOTES PAYABLE AND LONG-TERM DEBT

On November 21,  1997,  the Company  entered into a Loan and Security  Agreement
with FINOVA Capital Corporation  ("FINOVA"),  pursuant to which FINOVA agreed to
provide a credit  facility of up to  $9,136,000 in senior debt (the "Senior Debt
Facility").  The Senior  Debt  Facility  has a two year term and is made up of a
revolving  credit facility and three term notes.  One of the notes (Term Note B)
in the original  principal  amount of $236,000 was  satisfied in its entirety on
December 15, 1997 with the net  proceeds  from the sale of real estate in Tampa,
Florida.

Simultaneously  with the closing of the Senior Debt  Facility,  the Company also
issued to The  Schlinger  Foundation at face value  $1,000,000  in  subordinated
convertible debt (the "Subordinated Debenture").

Proceeds of the closing of the Senior Debt Facility in the amount of $6,417,563,
together  with the  $1,000,000  of proceeds  from the  Subordinated  Convertible
Debenture, were used to pay all amounts due and owing by the Company pursuant to
the Second Restated Loan Agreement,  as amended,  by and between the Company and
NationsBank of Texas, N.A. ("NationsBank").  At closing, the Company's revolving
line of credit and term loan facility with NationsBank in the principal  amounts
of $5,125,000 and  $2,200,000,  respectively,  were satisfied in their entirety.
The Company used the  remaining  proceeds to pay certain  closing and  financing
costs.

At  December  31,  1998 and  1997,  the  amounts  outstanding  under  the  above
agreements and other long-term debt consisted of the following:
<TABLE>

                                                                                          1998            1997
                                                                                          ----            ----
<S>                                                                                     <C>              <C>

Loan & Security  Agreement with FINOVA - collateralized  by all of the assets of
the  Company as well as a pledge of  3,000,000  shares of the  Company's  common
stock,  par value  $.0024  ("Common  Stock"),  collectively  owned by two of the
Company's executive officers; payable as follows:

     Promissory  Note  (Revolving  Credit  Loan) dated  November 21, 1997 in the
     maximum  principal  amount of $7,000,000  with  revolving  features as more
     fully described below -- interest due monthly at prime plus 1% (8.75% at
     December 31, 1998); matures December 1, 1999                                       $ 3,597,988      $ 4,030,519

     Promissory  Note  (Term Loan A) dated  November  21,  1997 in the  original
     principal  amount of $400,000 -- $6,667  monthly  principal  payments  plus
     interest at prime plus .75% (8.5% at December 31, 1998); matures December
     1, 1999                                                                                320,000          400,000

     Promissory  Note  (Term Loan C) dated  November  21,  1997 in the  original
     principal amount of $1,500,000 -- $25,000 monthly  principal  payments plus
     interest at prime plus 3% (10.75% at December 31, 1998); matures December
     1, 1999                                                                              1,200,000        1,500,000

     Short-term  note  payable  for  facility  fee -- monthly  installments  of
     $5,833; matures November 1, 1998*                                                            -           64,167

Unsecured  short-term note payable to third party in connection with Closing the
Senior Debt facility -- monthly installments of $14,000; matures October
1, 1998*                                                                                          -          140,000

Subordinated Debenture in the original principal amount of $1,000,000; partially
convertible;  secured by a pledge of 2,666,666  shares of the  Company's  Common
Stock owned  by another  executive officer - monthly interest payments  at 13%;
matures December 1, 1999                                                                  1,000,000        1,000,000

Unsecured note payable  created in connection with the acquisition of the assets
of The Leather  Warehouse in 1994 -- $4,424  payments of principal  and interest
due monthly at prime (8.5% at December 31, 1997); matures April 1, 1998                           -           17,388

                                       24

<PAGE>



                                                                                          1998            1997
                                                                                          ----            ----

Capital  Leases  secured by computer  equipment - total  monthly  principal  and
interest payments of $2,599 at approximately 13.5% interest; maturing in
February through August of 2002                                                              82,728          101,396

                                                                                        -----------      -----------        
                                                                                          6,200,716        7,253,470

Less - Current maturities (see below)                                                     6,139,327        4,650,742
                                                                                        -----------      ----------- 
                                                                                        $    61,389      $ 2,602,728
                                                                                        ===========      ===========
                                                                                     
</TABLE>

The current  portion of long-term  debt for 1997  includes the FINOVA  Revolving
Credit  Loan of  $4,030,519  although  this  obligation  does not  mature  until
December  1,  1999.  The  classification  of this  debt was  attributable  to an
accounting rule that requires a revolving  credit agreement that includes both a
subjective  acceleration  clause and a requirement  to maintain an  arrangement,
whereby cash collections from the borrower's  customers directly reduce the debt
outstanding,  to be classified as a short-term  obligation (Emerging Issues Task
Force Issue 95-22).  A covenant of the Senior Debt Facility is that  collections
from customers are to be deposited into a cash collateral  account that directly
pays down the Revolving  Credit Loan. The balance in this account  comprises the
restricted cash on the Company's balance sheet.  Because of this arrangement and
the fact that the debt agreement contains a clause that would allow acceleration
of payment of the debt in case of a "material adverse change, this rule applies.
Management does not believe that any such acceleration will occur.

In addition to the above  obligations,  the Company had  outstanding  letters of
credit for inventory  purchase  commitments  with terms ranging from sight to 90
days.  As of  December  31,  1998,  and 1997 the  Company  had $0 and  $260,089,
respectively, in outstanding purchase commitments on these letters of credit.

Pursuant to the Loan and Security  Agreement with FINOVA,  the overall  combined
limit for borrowings under the Revolving Credit Loan and outstanding  balance on
letters of credit is $7,000,000.  Of the overall  $7,000,000  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 and any required reserves.  Additional
availability  at December  31,  1998,  under the  Revolving  Credit Loan and for
letters of credit was $475,266.

At any time before maturity of the  Subordinated  Debenture,  the holder may, at
its option,  satisfy 50% or $500,000 of the principal  amount by converting into
shares of the Company's Common Stock at $0.724 per share.

The terms of the Senior Debt  Facility and the  Subordinated  Debenture  contain
various  covenants  which among other  things  require the Company to maintain a
certain level of earnings before interest, taxes, depreciation and amortization,
limit capital expenditures,  and require the maintenance of certain debt service
coverage   ratios.   Other   covenants   prohibit  the  Company  from  incurring
indebtedness except as permitted by the terms of the Senior Debt Facility,  from
declaring or paying cash  dividends  upon any of it stock and from entering into
any new business or making  material  changes in any of the  Company's  business
objectives, purposes or operations.

The Company's long-term debt matures as follows:

                          1999                    $ 6,139,327
                          2000                         24,393
                          2001                         27,884
                          2002                          9,112
                          2003                              -
                                                  -----------
                                                  $ 6,200,716
                                                  ===========

In January  1999 the  Company  entered  into  three  capital  leases  secured by
computer  equipment  costing $226,761 with total monthly  principal and interest
payments of $6,891,  an average  interest  rate of 9.7%,  and maturing  December
2001.

*The  short-term  notes for the fees related to the  closing of the Senior  Debt
Facility  were issued for services  rendered in the original  amount of $238,000
and constitute a non-monetary transaction.


                                       25


<PAGE>

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.

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.
Contributions  made during 1994 and 1995 in the amount of $99,962 and  $226,222,
respectively,  represented  securities acquisition loans. In accordance with SOP
93-6,  securities purchased with these loans have been recorded as unearned ESOP
shares.  The  unearned  ESOP share  account is reduced by the cost of the shares
when they are committed to be released to  participants  as payments are made on
the loans using the  principal  and  interest  method.  Compensation  expense is
measured  using the average  fair market  value when shares are  committed to be
released to the employee. The Company contributed $125,408; $50,910; and $27,500
in cash as current year  contributions  to the plan during 1998,  1997 and 1996,
respectively,  and recognized  compensation expense related to these payments of
$42,046;   $53,968;   and  $27,500  in  1998,  1997,  and  1996,   respectively.
Furthermore, on January 21, 1999, the Company made an additional contribution to
the Plan for  December  1998 in the  amount  of  $261,920.  As a result  of this
contribution,  the Company  recognized  an  additional  compensation  expense of
$10,538 during 1998 relating to the Plan.

<TABLE>

The  following  table  summarizes  the number of shares held by the Plan and the
market value as of December 31, 1998, 1997 and 1996:

                                No. of Shares                             Market Value
                                -------------                             ------------
                        1998      1997       1996            1998          1997          1996
                        -----     ----       ----            ----           ---          ----
<S>                   <C>         <C>        <C>         <C>             <C>           <C>
       Allocated        692,606   652,609    681,547        $173,152     $ 326,305     $ 554,098
       Unearned               -    54,262     64,631               -        27,131        52,545
                      ------------------------------     ---------------------------------------
        Total           692,606   706,871    746,178        $173,152     $ 353,436     $ 606,643
                      ==============================     =======================================
</TABLE>

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

5.  INCOME TAXES

The provision for income taxes consists of the following:

                                        1998           1997           1996
                                        ----           -----          ----
Current provision (benefit):
                Federal               $  (60,240)      $ 174,469     $ (282,917)
                State                    (12,340)         39,918        (47,098)
                                      ----------       ---------     ----------
                                         (72,580)        214,387       (330,015)
                                      ----------       ---------     ----------
Deferred provision (benefit):
                Federal                  (10,900)         14,185         11,351
                 State                    (2,044)          2,660          2,128
                                      ----------       ---------     ----------
                                         (12,944)         16,845         13,479
                                      ----------       ---------     ----------
                                      $  (85,524)      $ 231,232     $ (316,536)
                                      ==========       =========     ==========

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

The effective tax rate differs from the statutory rate as follows:
                                                          1998    1997     1996
                                                          ----    ----     ----
           Statutory rate                                 (34%)     34%    (34%)
           State taxes                                     (8%)     10%     (3%)
           Non-deductible goodwill amortization             68%     26%      10%
           ESOP transaction                              (112%)       -        -
           Other                                            17%      7%       3%
                                                        ========================
           Effective rate                                 (69%)     77%    (24%)
                                                        ========================

                                       26


<PAGE>


6.  COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company's primary office facility and warehouse are leased under a five-year
lease  agreement  that  expires  in  March  2003.   Rental  agreements  for  the
sales/distribution  units expire on dates  ranging from March 1999 to July 2004.
The  Company's  lease  agreement for the  manufacturing  facility in Long Island
City, New York,  expires on June 30, 2003. Future minimum lease payments for all
noncancellable operating leases are as follows:


                                         Year Ending December 31,

                                 1999                             $   990,811
                                 2000                                 869,127
                                 2001                                 750,576
                                 2002                                 706,367
                                 2003                                 345,573
                                 2004 and thereafter                   79,165
                                                                  -----------
                   Total future minimum lease payments            $ 3,741,619
                                                                  ===========


Rent expense on all operating leases for the years ended December 31, 1998, 1997
and 1996, was $1,017,491; $1,036,892; and $1,008,458, respectively.

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 17% and 6%, respectively,  of the Company's 1998
inventory purchases.  These same vendors accounted for 17% and 8%, respectively,
of 1997 inventory purchases,  and 16% and 10%,  respectively,  of 1996 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.  EARNINGS PER SHARE

<TABLE>

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

                                                             1998            1997            1996
                                                        -------------  --------------   -------------
<S>                                                     <C>            <C>              <C>

Numerator:
      Net income (loss)                                 $    (39,191)  $       70,292   $   (989,768)
                                                        -------------   -------------   -------------
      Numerator for basic and diluted earnings per       
      share                                                  (39,191)          70,292       (989,768)
Denominator:
      Denominator for basic earnings per share --
      weighted-average shares                               9,803,887       9,789,358      9,788,530

Effect of dilutive securities:
      Employee stock options                                        -              25              -
      Warrants                                                      -           2,182              -
                                                        -------------   -------------    -------------
Dilutive potential common shares                                    -           2,207              -
                                                        -------------   -------------    -------------

      Denominator for diluted earnings per share-- 
      adjusted weighted-average shares and
      assumed conversions                                                               
                                                            9,803,887       9,791,565       9,788,530
                                                        =============   =============    =============

      Basic earnings per share                          $      (0.00)   $        0.01    $      (0.10)
                                                        =============   =============    =============

      Diluted earnings per share                        $      (0.00)   $        0.01    $      (0.10)
                                                        =============   =============    =============
</TABLE>


                                       27

<PAGE>

For  additional  disclosures  regarding  the  employee  stock  options  and  the
warrants,  see  note 9. The  options  outstanding  discussed  in note 9 were not
included in the  computation of diluted  earnings per share because the options'
exercise  price was greater than the average  market price of the common  shares
and, therefore, the effect would be antidilutive.

The 13%  convertible  debt  discussed  in note 3 above was not  included  in the
computation of diluted earnings per share because the interest cost (net of tax)
per  assumed  converted  share  was more than  basic  earnings  per  share  and,
therefore, the effect would be antidilutive.

Subsequent to year-end  1998,  options to acquire  100,000 shares under the 1995
Stock Option Plan for officers and key management employees expired.

9.  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  exercisable  at any time after
vesting.  The Company has reserved 1,100,000 shares of common stock for issuance
under these plans,  and at December 31, 1998, 1997 and 1996, there were 557,000;
534,000; and 590,000;  respectively,  in un-optioned shares available for future
grants.

<TABLE>

A summary of the Company's stock option activity and related information for the
years ended December 31, 1998, 1997 and 1996, is as follows:
                                                 1998                     1997                      1996
                                       ------------------------   ----------------------   -----------------------
<S>                                    <C>          <C>           <C>         <C>          <C>         <C>
                                                     Weighted                  Weighted                 Weighted
                                                     Average                   Average                   Average
                                         Option      Exercise       Option     Exercise      Option     Exercise
                                         Shares       Price         Shares      Price        Shares       Price
                                       ------------ -----------   ----------- -----------   ----------  ----------
   Outstanding at January 1                566,000      $0.874       510,000     $ 2.653                $   3.063
                                                                                              585,000
   Granted *                               108,000       0.500       456,000       0.805      106,000       1.088
   Forfeited                              (131,000)      1.047                               (181,000)      3.063
   Exchanged *                                                     (400,000)       3.063
   Exercised
                                       ------------ -----------   ----------- -----------   ----------  ---------
   Outstanding at December 31              543,000      $0.758       566,000     $ 0.874      510,000   $   2.653
                                       ============ ===========   =========== ===========   ==========  =========
   Exercisable at end of year              255,000      $0.838       190,000     $ 0.908       84,000   $   3.063
                                       ============ ===========   =========== ===========   ==========  ==========
   Weighted-average fair value of
    options granted during year             $ 0.31                    $ 0.31                   $ 0.52
                                       ===========               ===========               ==========

* In 1997, options  originally granted in 1995 were canceled and reissued.  This
action was taken to provide  incentive  to and in order to retain the  Company's
key management  personnel in light of the severe decline in the market price for
the Company's common stock.

The  following  table  segregates  outstanding  options  into groups  based upon
exercise price ranges.

                                            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)
   --------------------
                               ------------- ----------  ----------      ------------- ----------- -----------
       $0.75 or Less                137,000    $ 0.542        9.05              9,000     $ 0.715       8.74
                                                                               

     More than $0.75 &
      Less Than $1.00               400,000      0.813        6.74            240,000       0.813       6.74

      More than $1.00                 6,000      2.021        7.41              6,000       2.021       7.41
                               ------------- ----------  ----------      ------------- ----------- -----------
                                    543,000    $ 0.758        7.33            255,000     $ 0.838       6.83
                               ============= ==========  ==========      ============= =========== ===========
</TABLE>


                                       28

<PAGE>
Pro forma information  regarding net income (loss) and earnings (loss) per share
is  required  by SFAS No.  123,  and has been  determined  as if the Company had
accounted for its stock options under the fair value method.  The fair value for
these options was estimated at the date of grant using the Black Scholes  option
pricing  model  with  the  following  weighted-average  assumptions:   risk-free
interest rates of 5.00% in 1998; 6.64% in 1997; and 6.72% 1996;  dividend yields
of 0% for all years; volatility factors of .693 for 1998, .550 for 1997 and .439
for 1996;  and an expected  life of the valued  options of 5 years for all years
other  than the  exchanged  options  reissued  in 1997  which  have an  expected
remaining life of 4 years.

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:

<TABLE>
                                                         1998          1997             1996
                                                     ------------    ----------    -------------
<S>                                                  <C>             <C>           <C>
Pro forma net income (loss)                          $  (192,441)    $ (76,117)    $ (1,057,818) 

Pro forma net income (loss) per common share         $      (.02)    $    (.01)    $      (0.11)

Pro forma net income (loss) per common share--       $      (.02)    $    (.01)    $      (0.11)
Assuming Dilution
</TABLE>

Warrants

In connection with the issuance of the Subordinated  Debenture discussed in note
3 above,  the Company issued  warrants to acquire up to 100,000 shares of Common
Stock  at $.54  per  share  to an  unrelated  individual.  The  warrants  may be
exercised at anytime until  expiration on November 21, 2002.  The fair value for
these warrants was estimated at the date of grant using the Black Scholes option
pricing  model  with  the  following  weighted-average  assumptions:   risk-free
interest rate of 6.5%;  dividend yield of 0%;  volatility factor of .550; and an
expected life of 3 years

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

Notes Receivable Secured by Common Stock

During 1996,  the Company  purchased  certain  notes from  NationsBank  that are
collateralized  by the  Company's  common  stock.  These notes  relate to shares
issued under the Company's 1993 Non-Qualified Incentive Stock Option Plan. These
notes, as renewed in 1997, are due from seven individuals including officers and
other members of management,  require monthly  payments,  and mature on December
31, 2000.

10.  ACQUISITIONS

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.

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.

Notes payable and long-term debt
With the  exception of the  Subordinated  Debenture,  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.

The terms of the Subordinated  Debenture are the terms management believes would
be currently available to the Company for this type of financing; therefore, the
carrying amount approximates fair value.
                                       29
<PAGE>

<TABLE>

<CAPTION>


12.  QUARTERLY FINANCIAL DATA (UNAUDITED)

                                           First           Second             Third           Fourth
            1998                         Quarter          Quarter           Quarter          Quarter
-----------------------------  ----------------------------------------------------------------------
<S>                                  <C>              <C>               <C>              <C>   

Net sales                            $ 5,710,832      $ 5,471,463       $ 5,628,895      $ 5,352,804
Gross profit                           2,414,694        2,426,840         2,482,248        2,411,888
Net income (loss)                       (88,528)          (33,544)            5,914           76,967
                                                         
Net income (loss) per
common share:
           Basic                          (0.01)                -                 -             0.01
          Diluted                         (0.01)                -                 -             0.01
Weighted average number
of common shares 
outstanding:
           Basic                       9,799,404        9,802,259         9,805,385        9,808,501
          Diluted                      9,799,404        9,802,259         9,805,385        9,808,501

                                           
                                           First           Second             Third           Fourth 
           1997                          Quarter          Quarter           Quarter          Quarter
-----------------------------  ----------------------------------------------------------------------
Net sales                            $ 6,459,892      $ 6,526,992       $ 6,353,582      $ 6,058,650
Gross profit                           2,563,811        2,739,284         2,693,991        2,557,654
Net income (loss)                       (36,185)           87,858            92,439          (73,820)
                                                          
Net income (loss) per 
common share:
           Basic                               -             0.01              0.01           (0.01)
          Diluted                              -             0.01              0.01           (0.01)
Weighted average number
of common shares outstanding:
           Basic                       9,788,530        9,788,530         9,788,530        9,791,841
          Diluted                      9,788,530        9,788,530         9,788,630        9,800,569


</TABLE>











                                       30


<PAGE>



                            THE LEATHER FACTORY, INC.
                  SCHEDULE II - ALLOWANCE FOR DOUBTFUL ACCOUNTS
                     Years Ended December 31, 1998 and 1997



                                                           1998          1997
                                                          ---------    ---------
        Balance at beginning of year                      $  28,000    $ 54,000

        
             Additions (reductions) charged to income         3,000      (4,000)
               
             Balances written off, net of recoveries         21,000     (22,000)
                                                          ---------    ---------
        
        Balance at end of year                            $  52,000    $ 28,000
                                                          =========    =========














                                       31



<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, 1998, and the related consolidated  statements
of operations, 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 consolidated  financial  position of The
Leather Factory,  Inc. at December 31, 1998, and the consolidated results of its
operations  and its  cash  flows  for the  year  ended  December  31,  1998,  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/ Hein + Associates LLP

    



Dallas, Texas,
February 24, 1999











                                       32


<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, 1997 and the related consolidated statements of
operations,  stockholders'  equity,  and cash flows for each of the two years in
the period  ended  December  31, 1997.  Our audits also  included the  financial
statement  schedule  referred  to in the index at Item  14(a).  These  financial
statements and schedule are the responsibility of the Company's management.  Our
responsibility  is to  express  an opinion  on these  financial  statements  and
schedule based on our audits.

We  conducted  our  audits  in  accordance  with  generally   accepted  auditing
standards.  Those standards require that we plan and perform the 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 consolidated  financial statements referred to above present
fairly, in all material  respects,  the consolidated  financial  position of The
Leather Factory,  Inc. at December 31, 1997, and the consolidated results of its
operations  and its cash  flows  for each of the two years in the  period  ended
December 31, 1997, 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
March 4, 1998











                                       33


<PAGE>


                                    PART III


Item 10.  Directors and Executive Officers of the Registrant.

         Information  required by this item is  incorporated by reference to the
material  appearing  under the heading  "Election of Directors"  and  "Executive
Officers of the Company" in the Proxy  Statement for the 1999 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 1999 Annual Meeting of Stockholders.

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

         Information  required by this item is  incorporated by reference to the
material  appearing under the heading "Security  Ownership of Certain Beneficial
Owners and Management" and "Certain Transactions" in the Proxy Statement for the
1999 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 1999 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 Report.

         (a)  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.








                                       34


<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 29, 1999                         /s/ Wray Thompson
                                              ---------------------------
                                                  Wray Thompson
                                              Chairman of the Board, President,
                                              Chief Executive Officer, and Chief
                                                  Accounting 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/ Wray Thompson                   Chairman of the Board         March 29, 1999
-------------------
Wray Thompson


/s/ Ronald  C. Morgan               Director                      March 29, 1999
----------------------
Ronald C. Morgan


/s/ Robin L. Morgan                 Director                      March 29, 1999
------------------------
Robin L. Morgan


/s/ William M. Warren              Director                       March 29, 1999
------------------------
William M. Warren


/s/ H. W. Markwardt                Director                       March 29, 1999
------------------------
H. W. Markwardt


/s/ Joseph R. Mannes               Director                       March 29, 1999
------------------------
Joseph R. Mannes


/s/ Anthony C. Morton              Director                       March 29, 1999
------------------------
Anthony C. Morton


/s/ John Tittle, Jr.               Director                       March 29, 1999
------------------------
John Tittle, Jr.



                                       35


<PAGE>

                   THE LEATHER FACTORY, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

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

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

       4.1         Loan and Security  Agreement  dated November 21, 1997, by and
                   between The Leather  Factory,  Inc., a Delaware  corporation,
                   The Leather Factory,  Inc., a Texas corporation,  The Leather
                   Factory,  Inc.,  an Arizona  corporation,  Hi-Line  Leather &
                   Manufacturing  Company,  a California  corporation,  Roberts,
                   Cushman & Company,  Inc., a New York corporation,  and FINOVA
                   Capital  Corporation,  filed as  Exhibit  4.1 to the  Current
                   Report on Form 8-K of The Leather Factory,  Inc.  (Commission
                   File No.  1-12368)  filed with the  Securities  and  Exchange
                   Commission on February 6, 1998, and incorporated by reference
                   herein.

       4.2         Revolving  Note  (Revolving  Credit Loan) dated  November 21,
                   1997, in the principal  amount of $7,000,000,  payable to the
                   order of FINOVA Capital  Corporation,  which matures December
                   1, 1999 filed as Exhibit  4.2 to the  Current  Report on Form
                   8-K  of  The  Leather  Factory,  Inc.  (Commission  File  No.
                   1-12368) filed with the Securities and Exchange Commission on
                   February 6, 1998, and incorporated by reference herein.

       4.3         Term Loan A Note (Term Loan A) dated  November 21,  1997,  in
                   the  principal  amount of  $400,000,  payable to the order of
                   FINOVA Capital  Corporation,  which matures  December 1, 1999
                   filed as Exhibit 4.3 to the Current Report on Form 8-K of The
                   Leather  Factory,  Inc.  (Commission  File No. 1-12368) filed
                   with the  Securities  and Exchange  Commission on February 6,
                   1998, and incorporated by reference herein.

       4.4         Term Loan C Note (Term Loan C) dated  November 21,  1997,  in
                   the principal  amount of $1,500,000,  payable to the order of
                   FINOVA Capital  Corporation,  which matures  December 1, 1999
                   filed as Exhibit 4.5 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 February 6,
                   1998, and incorporated by reference herein.
                   .
       4.5         Subordination  Agreement  dated  November  21,  1997,  by and
                   between FINOVA Capital Corporation, The Schlinger Foundation,
                   The  Leather  Factory,  Inc.,  a  Delaware  corporation,  The
                   Leather  Factory,  Inc.,  a Texas  corporation,  The  Leather
                   Factory,  Inc.,  an Arizona  corporation,  Hi-Line  Leather &
                   Manufacturing Company, a California corporation, and Roberts,
                   Cushman &  Company,  Inc.,  a New York  corporation  filed as
                   Exhibit 4.6 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 February 6, 1998, and
                   incorporated by reference herein.

       4.6         Pledge  Agreement  dated  November 21,  1997,  by and between
                   Ronald C.  Morgan  and Robin L.  Morgan  and  FINOVA  Capital
                   Corporation  filed as Exhibit  4.7 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
                   February 6, 1998, and incorporated by reference herein.

       4.7         Patent  Security  Agreement  dated  November 21, 1997, by and
                   between The Leather  Factory,  Inc., a Delaware  corporation,
                   The Leather Factory,  Inc., a Texas corporation,  The Leather
                   Factory,  Inc.,  an Arizona  corporation,  Hi-Line  Leather &
                   Manufacturing  Company,  a California  corporation,  Roberts,
                   Cushman & Company,  Inc., a New York corporation,  and FINOVA
                   Capital  Corporation  filed  as  Exhibit  4.8 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 February 6, 1998, and incorporated by reference
                   herein.


                                       36

<PAGE>

                   THE LEATHER FACTORY, INC. AND SUBSIDIARIES
                            EXHIBIT INDEX (CONTINUED)
     Exhibit                           
     Number                       Description
     -------                      -----------
       4.8         Trademark  Security Agreement dated November 21, 1997, by and
                   between The Leather  Factory,  Inc., a Delaware  corporation,
                   The Leather Factory,  Inc., a Texas corporation,  The Leather
                   Factory,  Inc.,  an Arizona  corporation,  Hi-Line  Leather &
                   Manufacturing  Company,  a California  corporation,  Roberts,
                   Cushman & Company,  Inc., a New York corporation,  and FINOVA
                   Capital  Corporation  filed  as  Exhibit.4.9  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 February 6, 1998, and incorporated by reference
                   herein.

       4.9         Copyright  Security Agreement dated November 21, 1997, by and
                   between The Leather  Factory,  Inc., a Delaware  corporation,
                   The Leather Factory,  Inc., a Texas corporation,  The Leather
                   Factory,  Inc.,  an Arizona  corporation,  Hi-Line  Leather &
                   Manufacturing  Company,  a California  corporation,  Roberts,
                   Cushman & Company,  Inc., a New York corporation,  and FINOVA
                   Capital  Corporation  filed as  Exhibit  4.10 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 February 6, 1998, and incorporated by reference
                   herein.

       4.10        Promissory Note  (Subordinated  Debenture) dated November 14,
                   1997, in the principal  amount of $1,000,000,  payable to the
                   order of The Schlinger Foundation,  which matures December 1,
                   1999 filed as Exhibit 4.11 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 February
                   6, 1998, and incorporated by reference herein.

       4.11        Pledge and Security Agreement dated November 14, 1997, by and
                   between The Schlinger  Foundation and J. Wray  Thompson,  Sr.
                   filed as Exhibit  4.12 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 February 6,
                   1998, and incorporated by reference herein.

       4.12        Amendment to Loan and Security  Agreement dated May 13, 1998,
                   by  and  between  The  Leather  Factory,   Inc.,  a  Delaware
                   corporation,  The Leather Factory, Inc., a Texas corporation,
                   The Leather Factory,  Inc., an Arizona  corporation,  Hi-Line
                   Leather & Manufacturing  Company,  a California  corporation,
                   Roberts, Cushman & Company, Inc., a New York corporation, and
                   FINOVA  Capital  Corporation  effective  as of March  31,1998
                   filed as Exhibit 4.15 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 15, 1998,
                   and incorporated by reference herein.

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

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

        16         Letter  addressed to the Securities  and Exchange  Commission
                   dated August 5, 1998,  from the  Company's  former  auditors,
                   Ernst & Young  LLP,  relative  to  their  agreement  with the
                   statements  made in Item 4 of to the  Current  Report on Form
                   8-K/A  of The  Leather  Factory,  Inc.  (Commission  File No.
                   1-12368) filed with the Securities and Exchange Commission on
                   August 6, 1998, and incorporated by reference herein.

       21.1        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.

                                       37

<PAGE>



                   THE LEATHER FACTORY, INC. AND SUBSIDIARIES
                            EXHIBIT INDEX (CONTINUED)
     Exhibit                                                              
     Number                      Description
     -------                     -----------
      *23.1        Consent of Hein + Associates LLP dated March 26, 1999.

      *23.2        Consent of Ernst & Young LLP dated March 26, 1999.

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













                                       38

<PAGE>















                                  EXHIBIT 23.1












  
                                     39

<PAGE>

                         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  24,  1999,  with  respect  to the  consolidated
financial  statements and schedule of The Leather Factory,  Inc. included in the
Annual Report (Form 10-K) for the year ended December 31, 1998.


/S/ HEIN + ASSOCIATES LLP



Dallas, Texas
March 26, 1999














                                       40


<PAGE>











                                      23.2















                                       41


<PAGE>


                    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 March 4, 1998,  with respect to the  consolidated  financial
statements  and  schedule of The Leather  Factory,  Inc.  included in the Annual
Report (Form 10-K) for the year ended December 31, 1998.


/S/ ERNST & YOUNG LLP



Fort Worth, Texas
March 26, 1999











                                       42

<PAGE>



                 









                                  EXHIBIT 27.1















                                       43