Form 10-Q

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549


(Mark One)

[X]    Quarterly  report  pursuant  to  section  13 or 15(d)  of the  Securities
       Exchange Act of 1934

For the quarterly period ended September 30, 1998

or

[ ]    Transition report pursuant to section 13 or 15(d) of the
       Securities Exchange Act of 1934

For the transition period from ______  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, Ft. Worth, Texas 76119
               (Address of principal executive offices) (Zip code)

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

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to by 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 the number of shares  outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.

<TABLE>
<S>                                          <C>

             Class                           Shares outstanding as of November 12, 1998
----------------------------------------     ------------------------------------------
Common Stock, par value $.0024 per share                           9,853,161

</TABLE>



<PAGE>

<TABLE>
<CAPTION>

                            THE LEATHER FACTORY, INC.

                                    FORM 10-Q

                FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1998


                                TABLE OF CONTENTS
                                -----------------

                                                                                    PAGE NO.
                                                                                    --------
<S>                                                                             <C>     <C>     

PART I.  FINANCIAL INFORMATION

  Item 1.  Financial Statements

    Consolidated Balance Sheets
     September 30, 1998 and December 31, 1997.........................................  3

    Consolidated Statements of Income (Loss)
     Three and nine months ended September 30, 1998 and 1997..........................  4

    Consolidated Statements of Cash Flows
     Nine months ended September 30, 1998 and 1997....................................  5

    Consolidated Statements of Stockholders' Equity and Comprehensive Income (Loss)
     Nine months ended September 30, 1998 and 1997....................................  6

    Notes to Consolidated Financial Statements........................................  7-8


  Item 2.  Management's Discussion and Analysis of Financial
            Condition and Results of Operations.......................................  9-13


PART II.  OTHER INFORMATION

  Item 1. Legal Proceedings...........................................................  14

  Item 5. Other Matters...............................................................  14

  Item 6. Exhibits and Reports on Form 8-K............................................  15


SIGNATURES............................................................................  15


EXHIBIT INDEX.........................................................................  16-17



</TABLE>


                                       2


<PAGE>

<TABLE>

<CAPTION>

                            THE LEATHER FACTORY, INC.
                           CONSOLIDATED BALANCE SHEETS


                                                                 September 30,  December 31,
                                                                     1998            1997
                                                                 ------------   ------------
                                    ASSETS                         (UNAUDITED)
<S>                                                             <C>             <C>     

CURRENT ASSETS:
    Cash                                                        $    213,642    $     70,496
    Cash restricted for payment on revolving credit facility         283,652         319,133
    Accounts receivable-trade, net of allowance for
        doubtful accounts of $44,000 and $28,000
         in 1998 and 1997, respectively                            2,051,822       1,865,276
    Inventory                                                      7,254,700       7,279,702
    Prepaid income taxes                                             265,475         285,970
    Deferred income taxes                                            115,200         109,411
    Other current assets                                             397,440         385,199
                                                                ------------    ------------
                            Total current assets                  10,581,931      10,315,187
                                                                ------------    ------------

PROPERTY AND EQUIPMENT, at cost                                    2,646,582       2,534,839
  Less-accumulated depreciation and amortization                  (1,738,971)     (1,505,098)
                                                                ------------    ------------
                            Property and equipment, net              907,611       1,029,741

GOODWILL and other, net of accumulated amortization of
    $1,043,000 and $878,000 in 1998 and 1997, respectively         5,406,559       5,679,621
                                                                ------------    ------------
                                                                $ 16,896,101    $ 17,024,549
                                                                ============    ============
                     LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
    Accounts payable                                            $  1,243,237    $    942,046
    Accrued expenses and other liabilities                           464,923         559,776
    Notes payable and current maturities of
        long-term debt                                             4,698,724       4,650,742
                                                                ------------    ------------
                            Total current liabilities              6,406,884       6,152,564
                                                                ------------    ------------

DEFERRED INCOME TAXES                                                110,767         136,611

NOTES PAYABLE AND LONG-TERM DEBT,
    net of current maturities                                      2,301,994       2,602,728

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
    Preferred stock, $0.10 par value; 20,000,000
        shares authorized, none issued or outstanding                   --              --
    Common stock, $0.0024 par value; 25,000,000 shares
        authorized, 9,853,161 shares issued in 1998 and 1997          23,648          23,648
    Paid-in capital                                                4,118,496       4,119,915
    Less:  Notes receivable - secured by common stock               (231,225)       (257,617)
           Unearned shares held by ESOP, 45,188 and 54,262
             shares in 1998 and 1997, respectively                  (228,056)       (273,851)
    Retained earnings                                              4,418,411       4,534,569
    Accumulated other comprehensive loss                             (24,818)        (14,018)
                                                                ------------    ------------
                            Total stockholders' equity             8,076,456       8,132,646
                                                                ------------    ------------
                                                                $ 16,896,101    $ 17,024,549
                                                                ============    ============

</TABLE>

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


                                       3


<PAGE>


<TABLE>

<CAPTION>

                            THE LEATHER FACTORY, INC.
                    CONSOLIDATED STATEMENTS OF INCOME (LOSS)
                                   (UNAUDITED)
             THREE AND NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997


                                                                 THREE MONTHS                      NINE MONTHS

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

NET SALES                                                $  5,628,895    $  6,353,582    $ 16,811,190    $   19,340,466

COST OF SALES                                               3,146,647       3,659,591       9,487,408        11,343,380
                                                         ------------    ------------    ------------    --------------

      Gross Profit                                          2,482,248       2,693,991       7,323,782         7,997,086

OPERATING EXPENSES                                          2,186,063       2,293,706       6,678,596         6,995,461
                                                         ------------    ------------    ------------    --------------

INCOME FROM OPERATIONS                                        296,185         400,285         645,186         1,001,625

OTHER (INCOME) EXPENSE:
  Interest expense                                            250,841         214,871         751,188           633,638
   Other, net                                                   3,580         (17,649)        (20,221)          (14,361)
                                                         ------------    ------------    ------------    --------------
      Total other (income) expense                            254,421         197,222         730,967           619,277
                                                         ------------    ------------    ------------    --------------

INCOME (LOSS)  BEFORE INCOME TAXES                             41,764         203,063         (85,781)          382,348

PROVISION  FOR INCOME TAXES                                    35,850         110,624          30,377           238,236
                                                         ------------    ------------    ------------    --------------

NET INCOME (LOSS)                                               5,914          92,439        (116,158)          144,112
                                                         ============    ============    ============    ==============


EARNINGS (LOSS) PER COMMON SHARE                         $       --      $       0.01    $      (0.01)   $         0.01

                                                         ============    ============    ============    ==============
EARNINGS (LOSS) PER COMMON SHARE--Assuming Dilution      $       --      $       0.01    $      (0.01)   $         0.01

                                                         ============    ============    ============    ==============

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

</TABLE>







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

                                       4

<PAGE>

<TABLE>

<CAPTION>

                            THE LEATHER FACTORY, INC.
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                                   (UNAUDITED)
                  NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997


                                                                              1998            1997
                                                                         ------------    ------------
<S>                                                                      <C>             <C>   
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                      $   (116,158)   $    144,112
  Adjustments to reconcile net income to net
   cash provided by (used in) operating activities-
     Depreciation & amortization                                              399,104         390,659
     (Gain) loss on sales of assets                                            (9,118)        (16,071)
     Deferred financing costs                                                 165,854            --
     Deferred income taxes                                                    (31,633)        (18,776)
     Other                                                                      4,472            (678)
     Net changes in operating assets and liabilities:
       Accounts receivable-trade, net                                        (186,546)       (344,456)
       Inventory                                                               25,002         268,785
       Income taxes                                                            20,495         254,795
       Other current assets                                                   (12,241)         57,635
       Accounts payable                                                       301,191         302,438
       Accrued expenses and other liabilities                                 (94,853)        (19,142)
                                                                         ------------    ------------
     Total adjustments                                                        581,727         875,189
                                                                         ------------    ------------

      Net cash provided by operating activities                               465,569       1,019,301
                                                                         ------------    ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment                                        (112,583)       (200,976)
  Proceeds from sales of assets                                                10,000          26,841
  Other intangible costs                                                       (1,728)        (32,061)
                                                                         ------------    ------------

      Net cash used in investing activities                                  (104,311)       (206,196)
                                                                         ------------    ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from notes payable and long-term debt                           16,935,061         302,957
  Payments on notes payable and long-term debt                            (17,009,311)     (1,118,140)
  Decrease in cash restricted for payment on revolving credit facility         35,481            --
  Payments received on notes secured by common stock                           26,392            --
  Deferred financing costs                                                   (205,735)           --
                                                                         ------------    ------------

      Net cash used in  financing activities                                 (218,112)       (815,183)
                                                                         ------------    ------------

NET INCREASE (DECREASE) IN CASH                                               143,146          (2,078)

CASH, beginning of period                                                      70,496         488,192
                                                                         ------------    ------------
CASH, end of period                                                      $    213,642    $    486,114
                                                                         ============    ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid during the period                                        $    594,390    $    562,325
  Income taxes paid during the period, net of refunds                          34,895           2,217

</TABLE>

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



                                       5

<PAGE>
<TABLE>
                            THE LEATHER FACTORY, INC.
                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                         AND COMPREHENSIVE INCOME (LOSS)
                                   (UNAUDITED)
                  NINE MONTHS ENDED SEPTEMBER 30, 1998 AND 1997
                                                                    
                                     Common Stock                  Notes                                                     
                                  ------------------              Receivable                              
                                  Number     Par      Paid-in   - Secured by   Unearned      Retained     
                                  of Shares  Value    Capital   Common Stock   ESOP Shares   Earnings     
                                  --------- --------  ---------- ------------  -----------   ----------   
<S>                                                                     <C>           <C>    
BALANCE, December 31, 1996        9,853,161 $ 23,648  $4,130,796 $   (269,305) $  (326,184)  $4,464,277 
   
Net Income                                -        -           -            -            -      144,112        
                                                                                                   
Foreign currency
translation adjustment                    -        -           -            -            -            -   
                                  --------- --------  ---------- ------------  -----------   ----------   
BALANCE,September 30, 1997        9,853,161 $ 23,648  $4,130,796 $   (269,305) $  (326,184)  $4,608,389   
                                  ========= ========  ========== ============  ===========   ==========   

BALANCE, December 31, 1997        9,853,161 $ 23,648  $4,119,915 $   (257,617) $  (273,851)  $4,534,569   
                                                      
Payments received on notes 
secured by common stock                   -        -           -       26,392            -            -   

Allocation of suspended 
ESOP shares committed to
be released                               -        -     (41,419)           -       45,795            -   

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

Net loss                                  -        -           -            -            -     (116,158)    
                                              
Foreign currency 
translation adjustment,
net of tax of ($6,620)                    -        -           -            -            -            -   
                                  --------- --------  ---------- ------------  -----------   ----------   
BALANCE, September 30, 1998       9,853,161 $ 23,648  $4,118,496 $   (231,225) $  (228,056)  $4,418,411  
                                  ========= ========  ========== ============  ===========   ==========   

                                      Accumulated                           
                                         Other              Total                  
                                     Comprehensive       Stockholder's        Comprehensive
                                         Loss               Equity            Income (Loss)
                                     -------------       -------------        ------------- 
BALANCE, December 31, 1996           $        (295)      $   8,022,937            
                                                                               
Net Income                                       -             144,112         $    144,112
                                                                               
Foreign currency                                                               
translation adjustment                      (2,314)             (2,314)              (2,314)
                                     -------------       -------------              
                                                                               
BALANCE, September 30, 1997          $      (2,609)      $   8,164,735              
                                     =============       =============              
                                                                               ------------ 
 Comprehensive income (loss)for the nine months ended September 30, 1997       $    141,798 
                                                                               ============ 
                                                                               
BALANCE, December 31, 1997           $     (14,018)      $   8,132,646              
                                                                               
Payments received on notes                                                     
secured by common stock                          -              26,392             
                                                                               
Allocation of suspended                                                        
ESOP shares committed to                                                       
be released                                      -               4,376    

Warrants issued to acquire
200,000 shares of common stock                   -              40,000          
                                                                               
Net loss                                         -            (116,158)        $   (116,158)
                                                                               
Foreign currency                                                               
translation adjustment,                                                        
net of tax of ($6,620)                     (10,800)            (10,800)             (10,800) 
                                     -------------       -------------              
BALANCE, September 30, 1998          $     (24,818)      $   8,076,456             
                                     =============       =============    
                                                                               ------------          
 Comprehensive income (loss)for the nine months ended September 30, 1998       $   (126,958)
                                                                               ============ 
</TABLE>

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

                                         6                                     
<PAGE>


                            THE LEATHER FACTORY, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS



1.  BASIS OF PRESENTATION

In  the  opinion  of  the  Company,  the  accompanying   consolidated  financial
statements  contain  all  adjustments   (consisting  of  only  normal  recurring
adjustments)  necessary to present fairly its financial position as of September
30, 1998 and December 31, 1997, and the results of operations and cash flows for
the three and nine month periods ended  September 30, 1998 and 1997. The results
of  operations  for the  three  and  nine  month  periods  are  not  necessarily
indicative  of the  results  to be  expected  for  the  full  fiscal  year.  The
consolidated  financial  statements  should  be read  in  conjunction  with  the
financial  statements  and  disclosures  contained in the Company's  1997 Annual
Report on Form 10-K ("Annual Report").

<TABLE>

<CAPTION>


2.  INVENTORY

The components of inventory consist of the following:

                                                      September 30,        December 31,
                                                            1998                1997
                                                      ---------------     ---------------
<S>                                                   <C>                  <C>

        Finished goods held for sale                   $   6,051,058       $   5,833,002
        Raw materials and work in process                  1,203,642           1,446,700
                                                      ===============     ===============
                                                       $   7,254,700       $   7,279,702
                                                      ===============     ===============
</TABLE>

<TABLE>

<CAPTION>

3.  EARNINGS PER SHARE

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

                                                    Three Months Ended            Nine Months Ended
                                                      September 30,                 September 30,
                                                --------------------------     -------------------------
                                                  1998            1997           1998           1997
                                                ----------     -----------     -----------   -----------
<S>                                             <C>            <C>             <C>           <C> 

Numerator for basic and
  diluted earnings per share:
     Net income (loss)                          $    5,914     $    92,439     $ (116,158)   $   144,112
                                                ==========     ===========     ==========    ===========
Denominator for basic and
 diluted earnings per share:
     Weighted-average shares outstanding         9,805,385       9,788,530      9,802,349      9,788,530

Basic earnings per share                        $        -     $      0.01     $    (0.01)   $      0.01
                                                ==========     ===========     ==========    ===========
Diluted earnings per share                      $        -     $      0.01     $    (0.01)   $      0.01  
                                                ==========     ===========     ==========    =========== 

</TABLE>

Unexercised  employee and director stock options to purchase 543,000 and 566,000
shares of common stock as of September 30, 1998 and 1997, respectively, were not
included in the computations of diluted EPS because the options' exercise prices
were  greater  than or equal to the  average  market  price of the common  stock
during the respective periods.

Warrants (see note 9 to consolidated  financial  statements in the Annual Report
and Item 5 under Part II of this Report on Form 10-Q) to acquire  300,000 shares
of common stock were not included in the computations of diluted EPS because the
warrants'  exercise  prices were  greater  than the average  market price of the
common stock during the quarter and nine months ended September 30, 1998.

The 13% convertible debt (see note 3 to consolidated financial statements in the
Annual Report) 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.

                                       7

<PAGE>


<TABLE>

<CAPTION>

4.  COMPREHENSIVE INCOME


The following table sets forth the computation of comprehensive income:


                                                   Three Months Ended          Nine Months Ended
                                                     September 30,               September 30,
                                              --------------------------    ------------------------
                                                  1998           1997         1998           1997
                                              ----------      ----------    ----------    ----------
<S>                                           <C>             <C>           <C>           <C>     

       Net income (loss)                      $    5,914      $   92,439    $ (116,158)   $  144,112
                                                                                           
       Other comprehensive income:
       Translation adjustment, net of tax         (6,723)            909       (10,800)       (2,314)
                                              -----------     -----------   -----------   -----------
       Comprehensive income                   $     (809)     $   93,348    $ (126,958)   $  141,798
                                              ===========     ===========   ===========   =========== 
       
</TABLE>





5.  STOCKHOLDERS' EQUITY


        Warrants


        In connection with the consulting  agreement discussed in Item 5 of Part
II of this Form  10-Q,  the  Company  issued  warrants  to acquire up to 200,000
shares of Common  Stock at $0.4375 per share.  The  warrants may be exercised at
anytime until  expiration on August 3, 2003.  The fair value for these  warrants
was estimated at the date of grant using the Black Scholes  option pricing model
with the following weighted-average assumptions:  risk-free interest rate of 5%;
dividend  yield of 0%;  volatility  factor of .645;  and an  expected  life of 3
years.





6.  IMPACT OF NEW ACCOUNTING STANDARDS


In June 1997, the Financial  Accounting Standards Board ("FASB") issued SFAS No.
131, Disclosures about Segments of an Enterprise and Related  Information.  SFAS
131 establishes  annual and interim  reporting  requirements for an enterprise's
operating  segments and related  disclosures  about its  products and  services,
geographical  areas in which it operates and major  customers.  Statement 131 is
effective for fiscal years beginning after December 15, 1997, and therefore, the
Company will adopt the new requirements retroactively in 1998 if applicable. The
Company  operates in one broad  industry  and  historically  has not  identified
separate  segments of its business.  Management  has not completed its review of
Statement 131, but does not anticipate  that the adoption of this statement will
have a significant effect on the Company's disclosures.











                                       8



<PAGE>


Item 2.  Management's Discussion and Analysis of Financial Condition
                  and Results of Operations


General

         The Leather  Factory,  Inc.  (the  "Company")  is the leading  one-stop
source for leather and  leathercraft  supplies in America.  Unique  service to a
vast array of customers  sets the Company  apart in the  leathercraft  industry.
Whether for the saddlemaker,  beltmaker,  hobbyist,  craft store, western store,
shoe repair shop,  manufacturer,  hospital,  prison or other  institution  where
leather is used, sold or enjoyed, The Leather Factory is the number one choice.

         The Company  operates  twenty-two  Leather  Factory  sales/distribution
units in the United  States and Canada.  In  addition,  through its  subsidiary,
Roberts,  Cushman & Company,  Inc., the Company manufactures and distributes hat
trims in braids,  leather,  and woven fabrics; and small finished leather goods,
such as cigar cases, picture frames, wallets and other accessories.


Results of Operations

                           Income Statement Comparison

         The  following  table sets forth,  for the interim  periods  indicated,
certain  items  from the  Company's  Consolidated  Statements  of Income  (Loss)
expressed as a percentage of net sales:

<TABLE>

                                                         Quarterly Period Ended            Nine Months Ended
                                                              September 30,                  September 30,
                                                         ----------------------          ----------------------
<S>                                                      <C>           <C>              <C>             <C>   

                                                           1998           1997            1998            1997
                                                         --------      --------         --------        --------
         Net sales                                        100.0%         100.0%          100.0%          100.0%
         Cost of sales                                     55.9           57.6            56.4            58.6
                                                         --------      --------         --------        --------
         Gross profit                                      44.1           42.4            43.6            41.4
         Operating expenses                                38.9           36.1            39.7            36.2
                                                         --------      --------         --------        --------
         Income from operations                             5.2            6.3             3.9             5.2
         Interest expense and other, net                    4.5            3.1             4.4             3.2
                                                         --------      --------         --------        --------
         Income (loss) before income taxes                  0.7            3.2            (0.5)            2.0
         (Benefit) provision for income taxes               0.6            1.7            (0.2)            1.2
                                                         --------      --------         --------        --------
         Net income (loss)                                  0.1%           1.5%           (0.7)%           0.8%
                                                         ========      ========         ========        ========
         
</TABLE>

Revenues

         For the quarter and nine months ended  September  30,  1998,  net sales
decreased 11.4% and 13.1%, respectively, compared to the same interim periods in
1997. Of these declines,  7.3% and 4.8%,  respectively,  resulted from strategic
decisions to eliminate low margin items from the Company's  product  lines.  The
remaining declines of 4.1% for the quarter and 8.3% for the nine months resulted
from  reduced  sales to the craft and western  apparel  markets and lower export
sales.  These  declines  were net of gains in the Company's  core  institutional
business  representing 3.7% and 0.3% of last year's third quarter and nine month
sales, respectively.

                                       9

<PAGE>


Costs, Gross Profit, and Expenses

         Cost of sales as a  percentage  of  revenue  was  55.9%  for the  third
quarter of 1998 as compared to 57.6% for the same quarter in 1997. Cost of sales
percentages  for the nine months ended  September 30, 1998 and 1997,  were 56.4%
and 58.6%, respectively. These 1.7% and 2.2% reductions for the respective three
and nine month  periods  resulted  from  improved  product mix and the Company's
strategic efforts to selectively  increase prices and eliminate low margin items
from its product lines.

         Lower relative cost of sales  percentages  meant that gross profit as a
percentage  of sales  improved to 44.1% and 43.6% for the  respective  three and
nine month periods ended September 30, 1998, as compared to only 42.4% and 41.4%
for the same periods in 1997.  The Company's  strategy for  combating  declining
sales  includes  emphasis on improved gross margins so that the decline in gross
profit is  proportionately  less than the revenue  decline.  Accordingly,  gross
profit dollars decreased $211,743 or only 7.9% and $673,304 or only 8.4% for the
quarterly  and nine month  periods  ended  September  30, 1998,  compared to the
respective 1997 periods.

         Operating  expenses decreased $107,643 or 4.7% to $2,186,063 during the
third quarter of 1998 from  $2,293,706  during the quarter  ended  September 30,
1997.  The  decrease  between the two  quarters  resulted  primarily  from lower
advertising,  freight,  payroll and  insurance  costs,  and  decreased  bad debt
write-offs,  net of higher  facility and other costs.  For the nine months ended
September 30, 1998, operating expenses declined $316,865 or 4.5% compared to the
nine months ended  September 30, 1997.  The decrease  between the two nine month
periods  resulted  primarily  from  lower  advertising,   freight,  payroll  and
insurance costs,  decreased  bad-debt  write-offs and professional  fees, net of
higher facility and other costs.

Other (Income) Expense

         Other  expenses  increased  $57,199 or 29.0% to $254,421  for the third
quarter of 1998 from $197,222  during the same quarter in 1997. The increase was
primarily due to higher  interest  expense  resulting from the  amortization  of
deferred  financing costs and non-recurring  income of approximately  $20,000 in
1997's third quarter from gain on disposal of fixed assets and discounts  taken.
Other expenses increased $111,690 or 18.0% to $730,967 for the first nine months
of 1998 from $619,277 during the same period in 1997. The increase was primarily
due to higher  interest  expense  resulting  from the  amortization  of deferred
financing costs.

Net Income (Loss)

         The  Company  reported  net income of $5,914 for the  quarter and a net
loss of $116,158 for the nine months ended  September  30, 1998,  as compared to
net income of $92,439 and $144,112,  respectively,  in the corresponding periods
during 1997. The decreased  operating results for such periods resulted from the
factors noted above regarding sales, gross profit, operating and other expenses.


Outlook

         The  statements  contained  in this  Outlook  section  are  based  upon
management's  current expectations and contain  forward-looking  statements that
involve numerous risks and uncertainties. Actual results may differ materially.

         Management believes opportunities exist for the Company to use its size
and  competitive  advantages to increase  market share in the core  leathercraft
business  composed of sales to institutional  or saddle and tack customers.  The
Company is also  aggressively  pursuing the leather  accessories  and travelware


                                       10

<PAGE>

markets.  Recent  revenue  trend  lines show good growth in these areas over the
last twelve  months.  Our efforts  are working and the Company  plans  continued
development  of products and programs  geared to these  customer  groups.  These
plans include  opening two to four new Leather Factory  distribution  units each
year over the next five years.  The grand  opening in Portland,  Oregon has been
delayed but should occur within the next few months.

         Additionally,  the Company believes that conditions in the retail craft
market are improving after three years of declines. While revenues are down over
twenty-four  months,  the  trend  line has an  upward  slope in the last  twelve
months.  The Company plans to increase  development of new products and programs
geared to the craft market.  Our national sales team is working  diligently with
retailers to replace and refresh older programs in their stores.

         Negative  revenue  trends  in  the  western  apparel  markets  show  no
improvement in historical  numbers.  However,  many recent consumer  fashion and
celebrity magazines indicate that western apparel and accessories are once again
becoming  popular.  Whether  this  proves to be only a fad or the  bottom in the
protracted western market decline remains to be seen.

         Weak economic conditions worldwide are now beginning to effect the U.S.
economy as  reflected  in recent  announcements  of  reduction in the job growth
rate, reduced interest rates and increased  unemployment figures.  Recession and
weak  economic   conditions  in  general  have  been  growth   periods  for  the
leathercraft  industry.  During the last recession  (late 80's and early part of
this decade,) the Company's revenues grew at an average annual rate in excess of
twenty-five  percent. The average consumer views leather as a more durable goods
than other  materials and large areas of  unemployment  generally  produce a new
source of resellers making leather items to generate extra income.

         Management  expects  overall  revenue  declines  over the next  quarter
primarily  due to the strategic  decision to eliminate  certain low margin items
from the  Company's  products  lines.  The  Company  anticipates  that  gains in
institutional  and craft  markets will offset a majority of these  declines at a
higher margin.  Declines from these  merchandising  decisions will ease over the
next six months and the Company anticipates  achieving overall revenue growth by
the second quarter of 1999. The Company  believes this growth can be achieved at
current  gross  profit  margins and without  significant  increases in operating
costs. This should in turn return the Company to sustained earnings growth.


Capital Resources and Liquidity

         The primary sources of liquidity and capital resources during the first
nine  months of 1998 were net funds  provided  by  operating  activities  in the
amount of $465,569 and  borrowings on the Company's  revolving  credit  facility
with FINOVA Capital  Corporation  ("FINOVA").  The Company's  unrestricted  cash
increased to $213,642 at  September  30, 1998 from $70,496 at December 31, 1997.
This  increase  was  primarily  the  result  of  cash   generated  by  operating
activities,  a decrease in  restricted  cash and proceeds  from assets sales and
notes receivable offset by capital  expenditures,  payment of deferred financing
costs and net repayments of debt.

         Non-cash expenses for depreciation, amortization and deferred financing
cost continue to give rise to significant  operating cash flows despite the loss
reported  for the nine months ended  September  30,  1998.  Net  non-cash  items
included  in the nine  month  results  provided  cash flows of  $528,679.  Other
significant operating cash flow resulted from an increase of $301,191 payable to
vendors at September 30, 1998 compared to the balance at December 31, 1997.

         These  operating  cash flows were partially used to fund an increase in
accounts  receivable of $186,546 at September 30, 1998,  compared to the balance


                                       11

<PAGE>

at December 31, 1997.  Other  significant  uses of operating  cash flows were to
reduce accrued expenses and other  liabilities to $464,923 at September 30, 1998
compared to $559,776 at December 31, 1997.

         The  revolving  credit  facility with FINOVA is based upon the level of
the  Company's  accounts  receivable  and  inventory.  At September 30, 1998 and
December 31, 1997,  the Company had  additional  availability  on the  revolving
credit facility of  approximately  $530,000 and $377,000,  respectively.  As the
Company's sales and operations  expand requiring larger  investments in accounts
receivable and inventory, the Company could have almost $3,000,000 in additional
funds available under the revolving credit facility.

         The largest  non-operating  uses of cash  beyond  debt  payments in the
first nine  months of 1998 were for the  payment  of  deferred  financing  costs
related  to the FINOVA  transaction  closed on  November  21,  1997 and  capital
expenditures.  The  deferred  financing  cost paid during the nine month  period
totaled  $205,735,  leaving  a  balance  due  of  only  $25,666.  The  remaining
obligation  will be paid in October  and  November  of 1998,  after  which time,
approximately  $20,000 of monthly  cash flow will be  available  for other uses.
Capital  expenditures  totaled  $112,583 and principally  relate to new computer
systems,  warehouse  fixtures and other  equipment  additions or replacements at
various  sales/distribution units, and leasehold improvements and equipment cost
associated  with  the  re-location  of  the  Company's  New  York  manufacturing
facility.

         The Company  believes that the current sources of liquidity and capital
resources will be sufficient to fund current  operations,  meet debt obligations
and fund the opening of new sales/distribution  units. In 1998 and 1999, funding
for the opening of new units is expected  to be  provided by  operating  leases,
cash flows from operating  activities,  and the Company's  Revolving Credit Loan
with FINOVA. In addition,  the Company anticipates funding for completion of the
computer  installation  in the  remaining  locations  to be  provided by capital
leases.

         In the fourth quarter, the Company will begin talks with its senior and
subordinated  lenders  regarding  refinancing of the obligations which mature in
the fourth  quarter of 1999.  The Company's  senior  lenders have indicated they
currently expect to extend their  obligations under current terms and conditions
for up to three years or such shorter term of any subordinated  obligations upon
successful  extension  or  replacement  of the current  subordinated  debenture.
Management  believes the Company will be able to successfully  replace or extend
the  current  subordinated  debenture;  however,  failure  to do so could have a
material adverse impact upon the Company.


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.

         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


                                       12

<PAGE>

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 the year.  Installation  in the  remaining  locations  is
currently scheduled to be completed by June 30, 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 June 30, 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.  It is estimated  that
approximately  $60,000 or 60% of the total expected  remediation costs have been
incurred to date. These costs were funded by the Company's revolving credit loan
with FINOVA Capital Corporation as will the remaining cost most likely.

         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";  "-Outlook";  "-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 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,  continued negative
trends in western retail markets, customer acceptance or not of existing and new
products  and  pricing  pressures  due  to  competitive   industry   conditions.
Additional  factors  that  may  result  in  different  actual  results  include:
increased  prices for leather,  which is a world-wide  commodity that can not be
passed on to customers for some reason,  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 products that the Company buys in many 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.




                                       13

<PAGE>

                            PART II. OTHER INFORMATION


Item 1.  Legal Proceedings

         As reported in the 1997 Annual  Report on Form 10-K,  the  Company,  as
successor-in-interest to National Transfer & Register Corporation  ("National"),
has been a  defendant  in a lawsuit  brought in July 1994 by Gary A.  Bedini and
John C. Bedini (the  "Plaintiffs")  in the United States  District Court for the
District  of Colorado  (the  "Court").  The Company as part of a reverse  merger
transaction with National is contractually indemnified against loss in this case
by one of the additional  defendants  Securities Transfer  Corporation,  a Texas
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.

         According  to the  terms of its  contractual  indemnification,  STC has
defended  this  litigation  at its  expense.  On September  21, 1995,  STC filed
Defendants'  Motion to Alter or Amend  Judgment (the  "Motion").  The Plaintiffs
filed a response  to this Motion on October 4, 1995,  and said  Motion  remained
pending  until  September  18, 1998,  when the Court  finally  ruled denying the
post-trial  Motions.  This action also started a thirty day clock for the filing
of an appeal.

         At its meeting on October 7, 1998,  the  Company's  Board of  Directors
determined to send formal notice to STC that the Company  expected STC to either
pay the Judgment and obtain a release of all parties, or that sufficient sums be
placed in escrow that would satisfy the full  Judgment at the  conclusion of any
appeal,  or that  STC  procure  a bond in an  amount  sufficient  to  cover  the
Judgments, or that other arrangements be made so that the Plaintiffs would agree
to release the Judgment pending against the Company.

         The Company has been  informed  by STC and  counsel  that a  settlement
agreement has been reached with the Plaintiffs.  Pursuant to this agreement, STC
has paid an agreed sum to Plaintiffs in complete  settlement of all claims.  The
Company  expects  to receive  shortly  notice  from the Court that the  Judgment
pending against the Company has been released.


Item 5. Other Matters

         On  July  30,  1998,  the  Company  announced  that it had  reached  an
agreement with Evert I.  Schlinger,  President of the Schlinger  Foundation,  to
serve as an  advisor to the  Company in  analyzing  financing  alternatives  and
evaluating locations with regard to the Company's expansion plans.

         As previously  reported,  The Schlinger Foundation is the holder of the
Company's $1,000,000 subordinated debt that is partially convertible into common
stock.  Pursuant to the terms of the consulting  agreement,  Mr.  Schlinger will
serve in his  advisory  capacity for eighteen  months to be  compensated  by the
issuance of a warrant to acquire common stock.  The warrant  agreement  provides
for issuance of 200,000 shares of the Company's common stock at the market value
on the date of grant  (August 3, 1998) and has a five year term for  exercise of
the warrants.  Copies of the agreement and warrant are attached as Exhibits 10.1
and 4.13, respectively, to this Form 10-Q.



                                       14




<PAGE>


Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits
    --------

        A list of  exhibits  required  to be filed as part of this report is set
forth in the Exhibit  Index which  immediately  precedes such  exhibits,  and is
incorporated herein by reference.

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

        Form 8-K dated  July 20,  1998  reporting  a change in the  Registrant's
Certifying  Accountant  was filed on July 24,  1998 and amended by the filing of
Form 8-K/A on August 6, 1998.



                                   SIGNATURES


        Pursuant to the requirements of the Securities and Exchange Act of 1934,
the  registrant  has duly  caused  this report to be signed on its behalf by the
undersigned thereunto duly authorized.



                                          THE LEATHER FACTORY, INC.
                                          (Registrant)


Date:  November 12, 1998                   /s/ Wray Thompson
                                           -----------------
                                           Wray Thompson
                                           Chairman of the Board, President,
                                           and Chief Executive Officer



Date:  November 12, 1998                   /s/ Anthony C. Morton
                                           ---------------------
                                           Anthony C. Morton
                                           Chief Financial Officer,
                                           Treasurer and Director
                                           (Chief Accounting Officer)





                                       15



<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.


                                       16

<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.

      *10.1       Letter  Agreement for Consulting Services dated July 24, 1998,
                  by and  between  The  Leather  Factory,  Inc.  and  Evert I.
                  Schlinger.

      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.

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



                                       17
<PAGE>
















                                  EXHIBIT 4.13









                                       18