UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549


                                    Form 10-Q

        (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, 1996

                                                                  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.

                                                     Shares outstanding as of
        Class                                            November 15, 1996
--------------------------                        ------------------------------
Common Stock, par value                                  9,853,161
$.0024 per share 

<PAGE>



                            THE LEATHER FACTORY, INC.

                                    FORM 10-Q

                FOR THE QUARTERLY PERIOD ENDED September 30, 1996


                                TABLE OF CONTENTS

                                                                        PAGE NO.

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Statements of Income
Three and nine months ended
September 30, 1996 and 1995 . . . .  . . . . . . . . . . . . . . . . . . . 3

Consolidated Balance Sheets
September 30, 1996 and December 31, 1995 . . . . . . . . . . . . . . . . . 4

Consolidated Statements of Cash Flows
Nine months ended September 30, 1996 and 1995  . . . . . . . . . . . . . . 5

Consolidated Statement of Stockholders' Equity
Nine months ended September 30, 1996. . . . .  . . . . . . . . . . . . . . 6

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


Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations . . . . . . . . . . . . . . . . . . .  9-14



PART II. OTHER INFORMATION


Item 1. Legal Proceedings. . .. .  . . . . . . . . . . . . . . . . . . . . 15

Item 3. Default Upon Senior Securities. . . . . . . . .. . . . . . . . . . 15

Item 6. Exhibits and Reports on Form 8-K. . . . . . . .. . . . . . . . . . 16



SIGNATURES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17



EXHIBIT INDEX. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18-22






                                        2
<PAGE>





                                             THE LEATHER FACTORY, INC.
                                         CONSOLIDATED STATEMENTS OF INCOME
                                                    (UNAUDITED)
                                             THREE AND NINE MONTHS ENDED
                                             SEPTEMBER 30, 1996 AND 1995
<TABLE>
<CAPTION>

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



                                                                THREE MONTHS                               NINE MONTHS

                                                            1996              1995                    1996              1995
                                                      ----------------  ----------------        ----------------  ----------------

NET SALES                                             $     7,015,834   $     7,580,224         $    21,527,857   $    23,768,665

COST OF SALES                                               4,238,206         4,503,675              13,517,603        13,640,416
                                                      ----------------  ----------------        ----------------  ----------------
 
                Gross Profit                                2,777,628         3,076,549               8,010,254        10,128,249

OPERATING EXPENSES                                          2,522,552         2,561,332               8,283,642         7,664,182
                                                      ----------------  ----------------        ----------------  ----------------

INCOME (LOSS) FROM OPERATIONS                                 255,076           515,217               (273,388)         2,464,067

OTHER (INCOME) EXPENSE:
      Interest expense                                        238,163           187,457                 787,517           543,295
      Other, net                                                1,363          (18,062)                 (5,781)          (31,001)
                                                      ----------------  ----------------        ----------------  ----------------
                Total other (income) expense                  239,526           169,395                 781,736           512,294
                                                      ----------------  ----------------        ----------------  ----------------

INCOME (LOSS) BEFORE INCOME TAXES                              15,550           345,822             (1,055,124)         1,951,773

PROVISION (BENEFIT) FOR INCOME TAXES                            1,159           141,336               (236,558)           798,004
                                                      ----------------  ----------------        ----------------  ----------------

NET INCOME (LOSS)                                     $        14,391   $       204,486         $     (818,566)   $     1,153,769
                                                      ================  ================        ================  ================


NET INCOME (LOSS) PER SHARE
      OF COMMON STOCK                                 $          0.00   $          0.02         $        (0.08)   $          0.12
                                                      ================  ================        ================  ================

WEIGHTED AVERAGE COMMON AND COMMON
      EQUIVALENT SHARES OUTSTANDING                         9,788,530         9,836,645               9,788,530         9,820,235
                                                      ================  ================        ================  ================

DIVIDENDS PAID PER SHARE                              $          0.00   $          0.00         $          0.00   $          0.00
                                                      ================  ================        ================  ================


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


                                                           3

</TABLE>
<PAGE>


                                              THE LEATHER FACTORY, INC.
                                             CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

<S>                                                                            <C>                   <C> 


                                                                            September 30,               December 31,
                                                                               1996                         1995
                                                                        ------------------           -----------------
                              ASSETS                                             (UNAUDITED)
CURRENT ASSETS:
     Cash                                                               $         218,372            $        477,159
     Accounts receivable-trade, net of allowance for
       doubtful accounts of $44,000 and $39,000
        in 1996 and 1995, respectively                                          2,694,409                   2,784,050
     Inventory                                                                  8,791,725                   7,903,179
     Prepaid income taxes                                                         468,511                     203,559
     Deferred income taxes                                                        114,431                      88,321
     Other current assets                                                         535,546                     656,837
                                                                        ------------------           -----------------
                    Total current assets                                       12,822,994                  12,113,105
                                                                        ------------------           -----------------

PROPERTY AND EQUIPMENT, at cost                                                 2,642,212                   2,474,056
  Less-accumulated depreciation and amortization                              (1,201,850)                 (1,014,966)
                                                                        ------------------           -----------------
                    Property and equipment, net                                 1,440,362                   1,459,090

GOODWILL and other, net of accumulated amortization of
       $591,000 and $300,000 in 1996 and 1995, respectively                     5,527,177                   5,761,181
                                                                        ------------------           -----------------
                                                                        $      19,790,533            $     19,333,376
                                                                        ==================           =================

               LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
     Accounts payable                                                   $       1,063,095            $      1,398,917
     Accrued expenses and other liabilities                                       589,156                     655,489
     Income taxes payable                                                               -                      48,300
     Notes payable and current maturities of
       long-term debt                                                           9,548,361                   1,296,359
                                                                        ------------------           -----------------
                    Total current liabilities                                  11,200,612                   3,399,065
                                                                        ------------------           -----------------

DEFERRED INCOME TAXES                                                             132,577                      85,197

NOTES PAYABLE AND LONG-TERM DEBT,
  net of current maturities                                                        30,102                   6,566,809

SENIOR CUMULATIVE CONVERTIBLE PREFERRED STOCK                                           -                           -

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
     Preferred stock, $0.10 par value; 20,000,000
       shares authorized, none issued or outstanding                                    -                           -
     Common stock, $0.0024 par value; 25,000,000 shares
       authorized, 9,853,161 shares issued in 1996 and 1995                        23,648                      23,648
     Paid-in capital                                                            4,091,842                   4,130,796
     Retained earnings                                                          4,635,479                   5,454,045
     Cumulative Translation Adjustments                                             2,457                           -
     Less:  Unearned Shares held by ESOP, 64,631
       shares in 1996 and 1995                                                  (326,184)                   (326,184)
                                                                        ------------------           -----------------
                    Total stockholders' equity                                  8,427,242                   9,282,305
                                                                        ------------------           -----------------
                                                                        $      19,790,533            $     19,333,376
                                                                        ==================           =================

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

                                                          4
</TABLE>
<PAGE>


                                              THE LEATHER FACTORY, INC.
                                        CONSOLIDATED STATEMENTS OF CASH FLOWS
                                                     (UNAUDITED)
                                   NINE MONTHS ENDED SEPTEMBER 30, 1996 AND 1995

<TABLE>
<CAPTION>

<S>                                                                           <C>                    <C>


                                                                                    1996                    1995
                                                                             -----------------       -----------------
CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                          $      (818,566)        $      1,153,769
  Adjustments to reconcile net income to net
   cash provided by (used in) operating activities-
     Depreciation & amortization                                                      498,371                 312,435
    (Gain) loss on sales of assets                                                    (7,541)                 (9,094)
     Deferred financing costs                                                         156,891                       -
     Net changes in assets and liabilities, net of effect of acquisitions:
       Accounts receivable-trade                                                       68,159               (151,036)
       Inventory                                                                    (812,562)               (319,547)
       Prepaid income taxes                                                         (264,952)                (61,284)
       Other current assets                                                           137,946               (535,894)
       Accounts payable                                                             (335,822)               (284,766)
       Accrued expenses and other liabilities                                        (66,333)               (360,551)
       Income taxes payable                                                          (48,300)                (88,176)
       Deferred income taxes                                                           21,270                (25,428)
                                                                             -----------------       -----------------
     Total adjustments                                                              (652,873)             (1,523,341)
                                                                             -----------------       -----------------

      Net cash used in operating activities                                       (1,471,439)               (369,572)
                                                                             -----------------       -----------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchase of property and equipment                                                (173,591)               (349,846)
  Proceeds from sales of assets                                                         7,444                  16,279
  Cash paid for acquisitions, net of cash acquired                                  (300,000)             (5,130,971)
  Decrease in assets restricted for acquisitions                                            -               5,040,656
  Other intangible costs                                                                    -                (28,389)
                                                                             -----------------       -----------------

      Net cash used in investing activities                                         (466,147)               (452,271)
                                                                             -----------------       -----------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from notes payable and long-term debt                                    3,300,000               2,574,904
  Payments on notes payable and long-term debt                                    (1,584,704)             (1,720,049)
  Stock issuance costs                                                               (38,954)                 (8,818)
                                                                             -----------------       -----------------

      Net cash provided by financing activities                                     1,676,342                 846,037
                                                                             -----------------       -----------------

Effect of exchange rate changes on cash                                                 2,457                       -

NET INCREASE (DECREASE) IN CASH                                                     (258,787)                  24,194

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

CASH, end of period                                                          $        218,372        $        426,447
                                                                             =================       =================

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid during the period                                            $        539,829        $        461,651
  Income taxes paid during the period                                                  57,685               1,045,539

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

                                                          5

</TABLE>
<PAGE>
<TABLE>
<CAPTION>
                                                     THE LEATHER FACTORY, INC.
                                           CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
                                                            (UNAUDITED)
                                                 NINE MONTHS ENDED SEPTEMBER 30, 1996

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





                                        Common Stock                                       Cumulative
                                   ------------------------
                                        Number                  Paid-in      Retained     Translation     Unearned
                                     of Shares  Par Value       Capital      Earnings     Adjustments   ESOP Shares         Total
                                   ------------ ----------------------------------------  ------------- -------------  -------------

BALANCE, December 31, 1995           9,853,161  $   23,648 $    4,130,796 $   5,454,045   $          -  $  (326,184)   $   9,282,305

   Stock issuance costs                      -           -       (38,954)             -              -             -        (38,954)

   Net loss                                  -           -              -     (818,566)              -             -       (818,566)

   Translation adjustment                                                                        2,457                         2,457
                                   ------------ ----------------------------------------  ------------- -------------  -------------

BALANCE, September 30, 1996          9,853,161  $   23,648 $    4,091,842 $   4,635,479   $      2,457  $  (326,184)   $   8,427,242
                                   ============ ========================================  ============= =============  =============

        





















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


                                                                       6

</TABLE>
<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, 1996 and December 31, 1995, and the results of operations and cash flows for
the three and nine month periods ended  September 30, 1996 and 1995. 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 statement disclosures contained in the Company's 1995 Annual Report to
Stockholders.



2.  Inventories



The components of inventory consist of the following:

                                              September 30,         December 31,
                                                 1996                   1995  
                                           ---------------        -------------

Finished goods held for sale                  $ 7,414,460          $ 6,736,811

Raw materials and work in process               1,377,265            1,166,368
                                            -------------        
 ------------

                                              $ 8,791,725          $ 7,903,179
                                             ============          ===========



3.  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.  For financial  reporting
purposes, the transaction was accounted for under the purchase method, effective
March 1, 1996. Cost in excess of assets  acquired  (goodwill) is being amortized
over 10 years. The total purchase price was $300,000 (USD).  Proforma  financial
information for the Canadian acquisition is not provided,  as such amounts would
be insignificant.



4.  Notes Payable and Long Term Debt

     As reported in the Company's 1995 Annual Report on Form 10-KSB, the Company
has  certain   financing   arrangements   with   NationsBank   of  Texas,   N.A.
("NationsBank").  Pursuant to the Second  Restated Loan Agreement dated July 24,
1995 and as amended  effective  December 31, 1995, and March 31, 1996 (the "Loan
Agreement"), these NationsBank financing arrangements included a working capital
line of credit, an acquisition line of credit, and a term facility.  As a result
of the loss generated in the second  quarter of the current  fiscal year,  since
June 30, 1996, the Company has been in default under certain financial covenants
contained  in the  Loan  Agreement.  These  financial  covenants  relate  to the
following ratio tests:

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

                                       7
<PAGE>




                            THE LEATHER FACTORY, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

                                   (Continued)


     On August 14, 1996,  effective June 30, 1996,  NationsBank  and the Company
entered into an amendment of the Loan Agreement,  the Forbearance  Agreement and
Third  Amendment to Second  Restated  Loan  Agreement  (the "Third  Amendment"),
whereby  NationsBank  agreed to forbear the exercising of their legal rights due
to the aforementioned events of default under the Loan Agreement until September
30, 1996 (the "Forbearance  Period").  In the Third Amendment,  NationsBank also
waived a default under the Borrowing  Base and the element of the Borrowing Base
which gave rise to the default,  the net income test,  was eliminated as part of
said Borrowing Base. Moreover,  the Third Amendment provided that since no funds
had been  advanced  on the  acquisition  line of  credit,  this  line of  credit
terminated pursuant to its terms on July 24, 1996.

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

     During the Extended  Forbearance Period,  NationsBank has and will continue
to allow the Company to use its working  capital line of credit,  subject to the
reduction  in the size of said  line of  credit  as noted  herein  above.  As of
September 30, 1996 the Company has $508,955 available for further advances under
its working  capital line of credit.  NationsBank  has informed the Company that
prior to the end of the  Extended  Forbearance  Period  it  intends  to submit a
proposal to restructure the working capital line of credit and the term facility
on terms and conditions acceptable to NationsBank in its discretion. The Company
may  accept  or  reject  this  proposal.  Given  the  duration  of the  Extended
Forbearance  Period,  all debt owed to NationsBank as of September 30, 1996, has
been reflected on the accompanying financial statements as a current liability.

5.  Senior Cumulative Convertible Preferred Stock

     On July 28,  1996,  the  Company's  one year  commitment  pursuant to Stock
Purchase  Agreement  with Center  Street  Capital  Partners,  L.P. and Stratford
Capital Partners,  L.P. (the "Buyers") expired according to its terms. Under the
Stock Purchase Agreement dated July 28, 1995, the Buyers agreed to deliver a one
year  commitment  to purchase up to $10 million  aggregate  principal  amount of
Senior Cumulative Convertible Preferred Stock (the "Preferred Stock"), par value
$0.10 per share, of the Company, at a purchase price of $100 per share.

     The Preferred Stock  described above was created  pursuant to a Certificate
of  Designation,  Preferences  and Rights of the Senior  Cumulative  Convertible
Preferred Stock Dated July 24, 1995 (the  "Certificate of  Designation"),  which
amended the Company's  Certificate  of  Incorporation  in the state of Delaware.
Although the  aforementioned  one year  commitment  has expired,  the  Company's
financial  statements  will reflect the  Preferred  Stock until such time as the
Company amends its  Certificate of  Incorporation  to revoke the  Certificate of
Designation. Such revocation should occur prior to the end of the current fiscal
year.


                                       8
<PAGE>







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

General
-------

   The Leather  Factory,  Inc. ("the  Company") is a leading one stop source for
leather,   traditional   leathercraft   materials  involving  such  products  as
do-it-yourself  kits,  stamping sets, and  leatherworking  tools,  craft-related
items  including  various  types of  leather,  lace,  beads,  and  wearable  art
accessories,  hardware,  metal garment  accessories  such as belt buckles,  belt
buckle designs and conchos, shoe repairing supplies and leather finishes.  These
products are distributed  primarily on a wholesale level and principally through
the  Company's  twenty-two  sales/distribution  units in the  United  States and
Canada.  Moreover, the Company is a manufacturer and distributor of hat trims in
braids,   leather,  and  woven  fabrics.   These  hat  trims  are  sold  to  hat
manufacturers and distributors.


Results of Operations
---------------------


          Analysis of Third Quarter 1996 Compared to Third Quarter 1995

                           Income Statement Comparison

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

                                                        Quarterly Period Ended
                                                             September 30,
                                                       1996              1995
                                                       ----              ----

Net sales                                             100.0%             100.0%
Cost of sales                                          60.4               59.4
                                                       ----               ----
                                                       39.6               40.6
Operating expenses                                     36.0               33.8
------------------                                     ----               ----
Income (loss) from operations                           3.6                6.8
Other (income) expense                                  3.4                2.2
----------------------                                 ----               ----
Income (loss)  before income taxes                       .2                4.6
Provision (benefit) for income taxes                     .0                1.9
------------------------------------                   ----               ----
Net income (loss)                                        .2%               2.7%
                                                       ====                ====

Revenues
--------

     The  Company's net sales  decreased by 7.4% to $7,015,834  during the third
fiscal quarter ended September 30, 1996 from  $7,580,224  generated in the third
quarter of 1995.  The 7.4%  decrease in revenues  was  primarily  made up of two
pieces.  Reduced  sales  at our  Roberts  Cushman  &  Company,  Inc.  Subsidiary
("Cushman")  made up 3.3% and reduced  unit sales to the retail  craft  industry
made up 3.9%. The Company's  sales to the retail craft industry and its sales at
Cushman  continued to be negatively  impacted  during the quarter by challenging
retail environments in the craft and western markets.

     Given the softness and  conditions  of the craft and western  markets,  the
Company is making a concentrated  effort to develop new products and sell to new
markets and expects  these  efforts to be reflected  in fourth  quarter 1996 and
first quarter 1997 sales. Long-term trends continue to be difficult to determine
at this  point.  No one  customer  makes  up ten  percent  (10%)  or more of the
Company's sales.



                                       9
<PAGE>




Costs, Gross Profit, and Expenses
---------------------------------

     Cost of sales as a  percentage  of revenue  was 60.4% for the third  fiscal
quarter of 1996 as compared to 59.4% for the same  quarter in 1995. A determined
effort by Company management to increase manufacturing  productivity and thus to
reduce the cost of sales as a percent of revenue in the third quarter started to
show some  results as we moved to within one  percent of the 1995 third  quarter
even though we continue to operate in a very competitive market environment.

     Gross profit as a percentage of sales in the third fiscal quarter was 39.6%
in 1996  compared  to  40.6% in  1995.  Total  gross  profit  decreased  9.7% to
$2,777,628  from  $3,076,549  generated in the quarter ended September 30, 1995.
The maintenance of the gross profit percentage within one percent of 1995 with a
7.4%  reduction in sales was  primarily  the result of  management's  efforts as
discussed above.

     Operating expenses decreased $38,780 or 1.5% to $2,522,552 during the third
fiscal quarter of 1996 from  $2,561,332  during the quarter ended  September 30,
1995.  The decrease in the dollar amount of operating  expenses  between the two
quarters was primarily the result of management's  efforts to reduce labor costs
so that they are more in line with current sales levels.


Other (Income) Expense
----------------------

     Other  expenses  were  $239,526  for the third  fiscal  quarter  of 1996 as
compared  to  $169,395  during  the same  quarter  in 1995.  This  increase  was
primarily due to higher interest expenses and a reduction in the discounts taken
for early invoice payment.


Net Income
----------

        Net income was $14,391  during the third fiscal quarter of 1996 compared
to  $204,486  during the  quarter  ended  September  30,  1995.  Management  was
encouraged  that efforts  discussed  above in cost of sales and operating  costs
resulted in a net profit when faced with a 7.4% decrease in sales.













                                       10
<PAGE>



                Analysis of Nine Months Ended September 30, 1996
                     to Nine Months Ended September 30, 1995

                           Income Statement Comparison

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

                                                          Nine Months Ended
                                                            September 30,
                                                            1996      1995
                                                            ----      ----

Net sales                                                   100.0%   100.0%
Cost of sales                                                62.8     57.4
                                                            -----     ----
Gross profit                                                 37.2     42.6
Operating expenses                                           38.5     32.2
                                                            -----     ----
Income (loss) from operations                                -1.3     10.4
Other (income) expense                                        3.6      2.2
                                                             ----     -----
Income (loss) before income taxes                            -4.9      8.2
Provision (benefit) for income taxes                         -1.1      3.3
                                                             ----     -----
Net income (loss)                                           -3.8%      4.9%
                                                             ====     ====



Revenues
--------

     The Company's net sales  decreased by 9.4% to  $21,527,857  during the nine
months ended September 30, 1996 from $23,768,665 generated in the same period of
1995.  The 9.4% decrease in revenues was primarily  made up two pieces.  Reduced
sales at  Cushman  made up 3.2% and  reduced  unit  sales  to the  retail  craft
industry  made up 5.5%.  During the nine months ended  September  30, 1996,  the
Company's  sales  continued  to be  impacted  by the  softness  in the craft and
western markets.

Costs, Gross Profit, and Expenses
---------------------------------

     Cost of sales as a  percentage  of  revenue  was 62.8% for the nine  months
ended  September 30, 1996 as compared to 57.4% for the same nine months in 1995.
The  difference  in the  relative  cost  of  sales  percentage  was  principally
attributable  to a  change  in  sales  mix  and  price  competition  in  a  very
competitive market environment.

     Operating expenses increased $619,460 or 8.1% to $8,283,642 during the nine
months ended  September 30, 1996 from  $7,664,182  during the same time in 1995.
The  increase in the dollar  amount of operating  expenses  between the two nine
month  periods  was due to various  factors,  including  an increase in bad debt
expense of $120,665  because of a  significant  customer  (3% of 1995 net sales)
declaring  Chapter 11 bankruptcy,  and also,  expenses  associated  with two new
locations,  write-off  of  certain  financing  costs for  acquisition  financing
commitments which expired in July 1996, write down of certain purchased goodwill
due to an impairment  of said goodwill and an increase in operating  expenses at
Cushman, some of which were related to previous labor problems.


Other (Income) Expense
----------------------

     Other  expenses were $781,736 for the nine months ended  September 30, 1996
as  compared  to $512,294  during the nine  months  ended in June of 1995.  This
increase was primarily due to the write-off of the  commitment and facility fees
attributable  to the  acquisition  financing  commitments  which expired in July
1996, as noted above, and an increase in interest expense.


                                       11
<PAGE>



Net Income
----------

     Net income  decreased  to a net loss of $818,566  for the nine months ended
September  30, 1996 from a net gain of  $1,153,769  during the nine months ended
September  30,  1995.  The size of this  decrease in net income  between the two
quarters  is due to the factors  noted  above  regarding  sales,  gross  profit,
operating expenses and other (income) expense.


Capital Resources and Liquidity
-------------------------------

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

     The decrease in accounts  receivable  to  $2,694,409  at September 30, 1996
from  $2,784,050  at December 31, 1995,  reflected the decrease in the Company's
sales as well as an  adjustment  to  accounts  receivable  of $21,482 due to the
acquisition  of  The  Leather  Factory  of  Canada,  Ltd.  ("TLF  Canada").  The
acquisition of the  outstanding  stock of TLF Canada was consummated on March 1,
1996.  With the decreased sales and the adjustment to accounts  receivable,  the
number of day's receivables  remained  relatively  constant,  increasing from 32
days at December 31, 1995 to 34 days at September 30, 1996.

     Inventory  increased to $8,791,725 at September 30, 1996 from $7,903,179 as
of December 31, 1995. This increase involved the inventory  purchased in the TLF
Canada  acquisition in the amount of $75,984,  additional  inventory acquired by
the TLF Canada location after the purchase date noted above,  items purchased to
open the new unit in Charlotte,  North Carolina,  increased  inventory levels in
the  Fort  Worth  manufacturing  location  and  the  central  warehouse  for the
anticipated  orders from large volume  customers due to previously  arranged and
contractually   committed  sales  programs,  and  higher  than  usual  inventory
quantities  of  certain  types of  leather  bought  in order to avoid  projected
increases in hide prices  resulting from  world-wide  market  forces.  Inventory
turned  during the first nine  months of 1996 at an annual  rate of 2.16  times,
compared to the 1995 and 1994 ratios of 2.32 times.

     Pursuant  to the  provisions  of  Financial  Accounting  Standards  No. 95,
"Statement  of Cash  Flows," the amounts of accounts  receivable  and  inventory
purchased in the TLF Canada transaction were not reflected in the net changes in
assets and  liabilities  shown on the attached  Consolidated  Statements of Cash
Flows.

     The uses of cash beyond inventory,  accounts receivable,  and debt payments
involved the cash portion of the consideration  paid to acquire the stock of TLF
Canada,  and  the  making  of  capital  expenditures.   Cash  used  for  capital
expenditures  totaled  $173,591 and $349,846 for the nine months ended September
30, 1996 and 1995,  respectively.  These capital  expenditures  involved various
equipment  and furniture and fixtures  additions  associated  with the Company's
expansion.

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


                                       12
<PAGE>




     The current  NationsBank  financing  arrangements,  which include a working
capital line of credit and a term facility,  are governed by the Second Restated
Loan Agreement  dated July 24, 1995 and as amended  effective  December 31, 1995
and March 31, 1996 and as amended as noted herein below (the "Loan  Agreement").
The Company presently has outstanding  principal balances on its working capital
line of credit and its term facility of $6,250,000 and $3,250,000, respectively.
Since June 30, 1996,  the Company has been in default  under  certain  financial
covenants  contained in the Loan Agreement.  These financial covenants relate to
the following ratio tests:

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

     On August 14, 1996,  effective June 30, 1996,  NationsBank  and the Company
entered into an amendment to the Loan Agreement,  the Forbearance  Agreement and
Third  Amendment to Second  Restated  Loan  Agreement  (the "Third  Amendment"),
whereby  NationsBank  agreed to forbear the exercising of their legal rights due
to the aforementioned events of default under the Loan Agreement until September
30, 1996 (the "Forbearance  Period").  In the Third Amendment,  NationsBank also
waived a default under the Borrowing  Base and the element of the Borrowing Base
which gave rise to the default,  the net income test,  was eliminated as part of
said Borrowing Base. Moreover,  the Third Amendment provided that since no funds
had been  advanced  on the  Acquisition  Line,  this line of  credit  terminated
pursuant to its terms on July 24, 1996.

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

     During the Extended  Forbearance Period,  NationsBank has and will continue
to allow the Company to use its working  capital line of credit,  subject to the
reduction  in the size of said  line of  credit  as noted  herein  above.  As of
September 30, 1996 the Company has $508,955 available for further advances under
its working  capital line of credit.  NationsBank  has informed the Company that
prior to the end of the  Extended  Forbearance  Period  it  intends  to submit a
proposal to restructure the working capital line of credit and the term facility
on terms and conditions acceptable to NationsBank in its discretion. The Company
may  accept  or  reject  this  proposal.  In the  event  that  the  Company  and
NationsBank  cannot come to mutually  agreeable  terms on the restructure of the
Company's  indebtedness,   at  the  end  of  the  Extended  Forbearance  Period,
NationsBank  may exercise its legal rights under the Loan  Agreement,  including
the demand for immediate  payment of all  outstanding  balances and foreclose on
the Company's  assets securing the NationsBank  loans if payment is not made. In
this event,  if the Company  cannot obtain  alternative  financing,  the Company
could be forced to consider other  strategies,  including  reorganization  under
federal bankruptcy protection. These alternative financing sources could include
not only commercial banks, but also asset-based lenders and/or private equity or
debt investors/lenders, or a combination thereof.

     Notwithstanding the Company's  continuing default under the Loan Agreement,
management  believes that such strategies will not be necessary in that: (i) the
Company has not missed or been late on a principal  or interest  payment and has
no reason to believe that there will be any problems with principal and interest
payments in the future; (ii) the Company is only moderately  leveraged on a debt
to equity basis; and (iii) new sales programs that were initiated earlier in the
year are  beginning  to be  reflected  in the  Company's  sales  and  management
believes  increases will be experienced for the balance of the year.  Management
is confident of executing an agreement with  NationsBank on or before the end of
the Extended Forbearance Period or alternatively,  of being able to find similar
financing  arrangements  from other  source(s).  See also Notes to  Consolidated
Financial  Statements  and Item 3.  Defaults  in Senior  Securities  as provided
elsewhere herein.




                                       13
<PAGE>


    While   subject  to  the  issues   surrounding   the   Company's   financing
arrangements,   the  Company's  management  believes  that  current  sources  of
liquidity and capital  resources  will be sufficient to fund current  operations
and internal growth,  including the opening or adding of new  sales/distribution
units.


Cautionary Statement
--------------------

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







                                      





                                       14
<PAGE>

PART II. OTHER INFORMATION


Item 1. Legal Proceedings

     As previously  reported by the Company, in connection with the labor strike
by the Union of Needletrades,  Industrial and Textile Employees ("UNITE") at the
Company's  Cushman  facility in New York,  New York,  the Company was a party to
certain actions before the National Labor Relations Board ("NLRB").  On November
14, 1995,  UNITE filed unfair  labor  practice  charges with the NLRB (Cause No.
2-CA-28871). The charges alleged that Cushman had interfered with its employees'
exercise of their  rights  under the National  Labor  Relations  Act (the "Labor
Act")  by  threatening  loss  of  job,  relocating  the  factory  to  Texas  and
interrogating employees about their union activity. Following investigation, the
NLRB's New York  Regional  Office  issued a  complaint  on the issues  raised by
UNITE.

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


Item 3. Defaults Upon Senior Securities

     Since  June 30,  1996,  the  Company  has been in default  under  financing
arrangements  with  NationsBank.  These events of default involve  noncompliance
with certain financial  covenants.  The Company is not in default in the payment
of principal or interest.  All such payments are current.  Pursuant to the terms
of the Loan  Agreement,  the  Company is in default of the  following  financial
covenants:

       (1) Current Assets to Current Liabilities;
       (2) Total Liabilities to Tangible Net Worth;
       (3) Senior Funded Debt to EBITDA; and
       (4) Cash Flow Ratio.

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

     On and  effective as of September  30,  1996,  NationsBank  and the Company
entered into another amendment to the Loan Agreement, whereby NationsBank agreed
to  extend  its  forbearance   until  December  31,  1996.  In  this  amendment,
NationsBank and the Company agreed to decrease the amount of the working capital
line of credit from $10 million to $7.5 million.  Additionally,  as part of this
amendment,  the  Company  agreed  to grant  NationsBank  a lien on its  facility
located in Tampa,  Florida. See also Notes to Consolidated  Financial Statements
and "-Capital Resources and Liquidity" contained elsewhere herein.








                                       15
<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
        --------------------

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












  








                                     16
<PAGE>
                                  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 13, 1996                             By /s/ Wray Thompson
                                                       ------------------
                                                       Wray Thompson
                                                       Chairman of the Board,
                                                       President and
                                                       Chief Executive Officer



Date: November 13, 1996                             By /s/ Fred N. Howell
                                                      -------------------
                                                       Fred N. Howell
                                                       Chief Financial Officer,
                                                       Treasurer and Director
                                                      (Chief Financial and
                                                       Accounting Officer)
















                                       17
<PAGE>

                   THE LEATHER FACTORY, INC. AND SUBSIDIARIES
                                  EXHIBIT INDEX

Exhibit
Sequentially
Number                                      Description                      
------                                      -----------                    
Numbered Page
-------------

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

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

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

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

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

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

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

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


                                       18
<PAGE>


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


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

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

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

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

          4.10 Second  Amendment to Second Restated Loan Agreement  effective as
               of March 31, 1996,  by and between The Leather  Factory,  Inc., a
               Delaware  Corporation,  and NationsBank of Texas,  N.A., filed as
               Exhibit  No.  4.10 to the  Quarterly  Report  on Form 10-Q of The
               Leather  Factory,  Inc.  (Commission File No. 1-12368) filed with
               the  Securities  and Exchange  Commission  on May 20,  1996,  and
               incorporated by reference herein.

          4.11 Forbearance Agreement and Third Amendment to Second Restated Loan
               Agreement  effective  as of June 30,  1996,  by and  between  The
               Leather Factory, Inc., a Delaware Corporation, and NationsBank of
               Texas, N.A., filed as Exhibit No. 4.11 to the Quarterly Report on
               Form  10-Q of The  Leather  Factory,  Inc.  (Commission  File No.
               1-12368)  filed with the  Securities  and Exchange  Commission on
               August 19, 1996, and incorporated by reference herein.


                                       19
<PAGE>


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


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

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

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

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

     10.4 Amendment to Stock Purchase  Agreement executed September 20, 1993, to
          be effective June 30, 1993, by and between The Leather Factory,  Inc.,
          a Texas  corporation  and Steve Lindley,  filed as Exhibit No. 19.1 to
          the 1993 Annual  Report on Form 10-KSB of The  Leather  Factory,  Inc.
          (Commission File No. 1-12368),  filed with the Securities and Exchange
          Commission on March 30, 1994,  and  incorporated  herein by reference.
          10.5  Stock  Purchase  Agreement  dated  as of June 30,  1993,  by and
          between The Leather  Factory,  Inc., a Texas  corporation and Kevin F.
          White and Durham Hefta,  filed as Exhibit No. 10.4 to the Registration
          Statement on Form 10-SB of The Leather Factory,  Inc. (Commission File
          No.  0-22128),  including  any  amendments  thereto,  filed  with  the
          Securities and Exchange  Commission on July 22, 1993, and incorporated
          herein by reference.

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


                                       20
<PAGE>


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


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

     10.8 Acquisition Agreement dated as of January 10, 1994, by and between The
          Leather  Factory,  Inc., a Colorado  corporation and Hi-Line Leather &
          Manufacturing  Company, filed as Exhibit No. 2.1 to the Current Report
          on Form 8-K of The Leather Factory, Inc. (Commission File No. 1-12368)
          filed with the Securities and Exchange Commission on January 10, 1994,
          and incorporated herein by reference.

     10.9 Asset Purchase  Agreement dated as of April 15, 1994, by and among The
          Leather Factory,  Inc., a Colorado corporation,  The Leather Warehouse
          Company, a Michigan corporation, Daniel W. Holbert, Linda S. McCleary,
          Richard J. Hill,  and the Richard J. Hill Trust,  filed as Exhibit No.
          2.1 to the  Current  Report on Form 8-K of The Leather  Factory,  Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission on April 15, 1994, and incorporated herein by reference.

    10.10 Acquisition  Agreement  by and among The  Leather  Factory,  Inc.  and
          David  Lieberman,  Individually  and as the  Shareholder  of  Roberts,
          Cushman & Company,  Inc., related to the acquisition of the issued and
          outstanding capital stock of Roberts,  Cushman & Company,  Inc., filed
          as Exhibit  No. 2.1 to the  Current  Report on Form 8-K of The Leather
          Factory,  Inc. (Commission File No. 1-12368) filed with the Securities
          and Exchange Commission on January 9, 1995, and incorporated herein by
          reference.

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

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

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


                                       21
<PAGE>


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


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

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

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

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

     13.1 The Leather Factory, Inc. 1995 Annual Report to Stockholders, filed as
          Exhibit  No.  13.1 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.  Such report,
          except to the extent  incorporated by reference into the Annual Report
          on Form 10-KSB,  was furnished for the  information  of the Securities
          and Exchange Commission only and was not deemed filed as a part of the
          aforementioned Annual Report on Form 10-KSB.

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

     *27.1 Financial Data Schedule

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



                                       22
<PAGE>














                                   EXHIBIT 4.2















<PAGE>




NATIONSBANK
NATIONSBANK OF TEXAS, N.A.
                                   Promissory
                            Note (Revolving Feature)
--------------------------------------------------------------------------------

                                            Date:            September 30, 1996

                                            Amount:          $7,500,000.00

For Value Received,  the undersigned  ("Borrower")  unconditionally (and jointly
and severally,  if more than one)  promise(s) to pay to the order of NATIONSBANK
OF TEXAS,  N.A.  ("Bank"),  Fort Worth Banking Center,  without  setoff,  at its
offices at 500 West Seventh  Street,  Fort Worth,  Texas 76102, or at such other
place as may be designated by Bank,  the principal  amount of SEVEN MILLION FIVE
HUNDRED THOUSAND AND NO/100 DOLLARS  ($7,500,000.00),  or so much thereof as may
be advanced  from time to time in  immediately  available  funds,  together with
interest computed daily on the outstanding  principal balance  hereunder,  at an
annual  interest rate, and in accordance  with the payment  schedule,  indicated
below.

Rate

The interest to be paid by Borrower and  collected by Bank on each advance under
this Note  ("Advance")  shall be at one of the rates as selected by Borrower set
forth in the Second  Restated  Loan  Agreement  of even date  herewith,  between
Borrower,  Bank and others, which is incorporated herein by reference, as it may
be amended or restated from time to time ("Loan Agreement").

Notwithstanding any other provision contained in this Note, Bank does not intend
to charge and  Borrower  shall not be  required to pay any amount of interest or
other fees or charges that is in excess of the maximum  permitted by  applicable
law.  Borrower  agrees that  during the full term  hereof,  the  maximum  lawful
interest rate for this Note as determined under Texas law shall be the indicated
rate ceiling as specified in Article 5069-1.04 of the V.A.T.S.  Further,  to the
extent  that  any  other  lawful  rate  ceiling  exceeds  the  rate  ceiling  so
determined,  then the higher rate ceiling shall apply.  Any payment in excess of
such maximum shall be refunded to Borrower or credited against principal, at the
option of Bank.

Accrual Method

Interest  at the Rate set  forth  above,  unless  otherwise  indicated,  will be
calculated on the basis of the 365/360 method,  which computes a daily amount of
interest  for a  hypothetical  year of three  hundred  sixty  (360)  days,  then
multiplies  such  amount by the actual  number of days  elapsed  in an  interest
calculation period.

Rate Change Date

Any Rate based on a fluctuating index or base rate will change, unless otherwise
provided, each time and as of the date that the index or base rate changes.

In the  event  any  index  is  discontinued,  Bank  shall  substitute  an  index
determined by Bank to be comparable, in its sole discretion.

Payment Schedule

All payments  received  hereunder  shall be applied  first to the payment of any
expense or charges payable hereunder under the Loan Agreement or under any other
documents executed in connection with or referenced in the Loan Agreement ("Loan
Documents"),  then to interest due and payable, then to principal due and owing,
then as a prepayment of the Prime Rate Option Advances, and then as a prepayment
of Libor Rate Option Advances, or in such other order as Bank shall determine at
its option.

<PAGE>

Interest on Advances  subject to a Prime Rate Option shall be payable monthly on
the  first  day of each  month  during  the term of the Note,  and  interest  on
Advances  subject to a Libor Rate  Option  made after the date  hereof  shall be
payable at the end of each applicable Interest Period, but in no event less than
quarterly.  Any payments,  including  prepayments  of principal,  received after
11:00 a.m.,  Fort Worth,  Texas time,  shall be deemed received on the following
day. The outstanding principal balance of this Note, plus all accrued but unpaid
interest, shall be due and payable in full on March 31, 1997. All payments made,
other  than  prepayments  of  principal,  shall be  credited  first,  to accrued
interest,  second to principal  due and owing,  third,  as a prepayment of Prime
Rate Option Advances, fourth, as a prepayment of Libor Rate Option Advances.

If any governmental  agency,  court,  central bank or comparable authority shall
impose any taxation, required level of reserves (except reserve requirements for
certificates   of  deposit),   deposits,   insurance  or  capital,   or  similar
requirements against assets, deposits or credit extended by Bank or shall impose
on Bank (or its eurodollar  lending officer) or the eurodollar  market any other
condition affecting Advances, and the result of the foregoing is to increase the
cost of Bank  making or  maintaining  Advances  or reduce any sums  received  or
receivable by Bank under this Note by a material amount as determined by Bank in
its sole discretion, then Borrower shall reimburse Bank for such increased costs
or  reduced  sums upon  demand.  Nothing  herein  will be  construed  to require
Borrower to pay any interest,  fees,  costs or charges  greater than the Default
Rate.

Revolving Feature

Borrower may borrow,  repay and reborrow  hereunder at any time, up to a maximum
aggregate  amount  outstanding at any one time equal to the principal  amount of
this  Note;  provided,  however,  that  Borrower  is not in  default  under  any
provision of this Note, any Loan Document or any other obligation of Borrower to
Bank,  and provided  that the  borrowings  hereunder do not exceed any borrowing
base or  other  limitations  on  borrowings  by  Borrower.  Bank  shall  have no
liability for its refusal to advance funds based upon its determination that any
conditions  of such  further  advances  have not been met.  Bank  records of the
amounts borrowed from time to time shall be conclusive proof thereof.

Borrower  represents  to Bank  that  the  proceeds  of this  loan are to be used
primarily  for  business,   commercial  or   agricultural   purposes.   Borrower
acknowledges  having read and  understood,  and agrees to be bound by, all terms
and conditions of this Note,  including the Additional  Terms and Conditions set
forth below.

Additional Terms and Conditions

1.      Waivers,  Consents and  Covenants.  Borrower,  any endorser or guarantor
hereof or any other  party  hereto  (collectively  "Obligors")  and each of them
jointly and severally:  (a) waive presentment,  demand, notice of demand, notice
of intent to accelerate, and notice of acceleration of maturity, protest, notice
of  protest,  notice of  nonpayment,  notice of  dishonor  and any other  notice
required to be given under the law to any of Obligors,  in  connection  with the
delivery, acceptance,  performance,  default or enforcement of this Note, of any
endorsement  or guaranty of this Note or of any Loan  Documents;  (b) consent to
any and all delays, extensions,  renewals or other modifications of this Note or
the Loan Documents,  or waivers of any term hereof or of the Loan Documents,  or
releases or  discharge  by Bank of any of Obligors or release,  substitution  or
exchange of any  security  for the  payment  hereof or the failure to act on the
part of Bank or any  indulgence  shown by Bank,  from time to time and in one or
more  instances  (without  notice to or further assent from any of Obligors) and
agree that no such  action,  failure to act or failure to exercise  any right or
remedy on the part of Bank shall in any way affect or impair the  obligations of
any Obligors or be construed as a waiver by Bank of or otherwise affect,  any of
Bank's rights under this Note, under any endorsement or guaranty of this Note or
under any of the Loan Documents;  and (c) agree to pay, on demand, all costs and
expenses of collection  of this Note or of any  endorsement  or guaranty  hereof
and/or the enforcement of Bank's rights with respect to, or the  administration,
supervision,  preservation,  protection  of or  realization  upon,  any property
securing payment hereof,  including,  without limitation,  reasonable attorney's
fees, including fees related to any trial,  arbitration,  bankruptcy,  appeal or
other proceeding,  in the amount of ten percent (10%) of the principal amount of
this Note, or such greater amount as may be determined reasonable by any court.

<PAGE>



2.  Indemnification.  Obligors  agree to promptly  pay,  indemnify and hold Bank
harmless from all state and federal taxes of any kind and other liabilities with
respect to or resulting  from  advances made pursuant to this Note. If this Note
has a revolving feature and is secured by a mortgage, Obligors expressly consent
to the deduction of any applicable  taxes from each taxable advance  extended by
Bank.

3.  Prepayments.  Prepayments may be made in whole or in part at any time on any
loan for which the Rate is based on the Prime Rate. All prepayments of principal
shall be applied in the  inverse  order of  maturity,  or in such other order as
Bank shall  determine in its sole  discretion.  No  prepayment of any other loan
shall be permitted  without the prior written  consent of Bank.  Notwithstanding
such prohibition,  if there is a prepayment of any such loan, whether by consent
of Bank, or because of acceleration or otherwise, Borrower shall, within fifteen
(15) days of any request by Bank, pay to Bank any loss or expense which Bank may
incur or sustain as a result of such prepayment. For the purposes of calculating
the  amounts  owed  only,  it shall be  assumed  that  Bank  actually  funded or
committed to fund the loan through the purchase of an  underlying  deposit in an
amount and for a term  comparable to the loan,  and such  determination  by Bank
shall be conclusive, absent a manifest error in computation.

4. Events of Default.  The  following are events of default  hereunder:  (a) the
failure to pay or perform  any  obligation,  liability  or  indebtedness  of any
Obligor to Bank,  or to any  affiliate of Bank,  whether  under this Note or any
other agreement,  note or instrument now or hereafter existing,  as and when due
(whether upon demand, at maturity or by acceleration); (b) the failure to pay or
perform  any other  obligation,  liability  or  indebtedness  of any of Obligors
whether to Bank or some other  party,  the  security  for which  constitutes  an
encumbrance  on the  security  for this Note;  (c) death of any  Obligor  (if an
individual),  or a proceeding  being filed or commenced  against any Obligor for
dissolution  or  liquidation,   or  any  Obligor  voluntarily  or  involuntarily
terminating  or dissolving or being  terminated or dissolved;  (d) insolvency of
business  failure of the  appointment  of a custodian,  trustee,  liquidator  or
receiver for or for any of the property of or an  assignment  for the benefit of
creditors  by, or the  filing of a  petition  under  bankruptcy,  insolvency  or
debtor's  relief  law or for any  adjustment  of  indebtedness,  composition  or
extension  by or  against  any  Obligor;  (e) any  lien or  additional  security
interest  being placed upon any of the property which is security for this Note;
(f) acquisition at any time or from time to time of title to the whole of or any
part of the property which is security for this Note by any person, partnership,
corporation or other entity;  (g) Bank  determining that any  representation  or
warranty  made by any Obligor in any Loan  Documents or otherwise to Bank is, or
was,  untrue or  materially  misleading;  (h)  failure of any  Obligor to timely
deliver such financial  statements,  including tax returns, and other statements
of condition or other  information  as Bank shall request from time to time; (i)
any  default  under any Loan  Documents;  (j) entry of a  judgment  against  any
Obligor which Bank deems to be of a material nature,  in Bank's sole discretion;
(k) the seizure or  forfeiture  of, or the  issuance of any writ of  possession,
garnishment  or  attachment,  or any  turnover  order  for any  property  of any
Obligor;  (l) Bank reasonably  deeming itself  insecure for any reason;  (m) the
determination  by Bank  that a  material  adverse  change  has  occurred  in the
financial condition of any Obligor; or (n) the failure to comply with any law or
regulation regulating the operation of Borrower's business.

5. Remedies Upon Default.  Whenever  there is a default under this Note: (a) the
entire balance outstanding and all other obligations of Obligor to Bank (however
acquired or evidenced) shall, at the option of Bank, become  immediately due and
payable;  and/or (b) to the extent permitted by law, the Rate of interest on the
unpaid  principal  shall,  at the  option of the Bank,  be  increased  at Bank's
discretion  up to the  maximum  rate  allowed  by law,  or if none,  twenty-five
percent  (25%) per annum  (the  "Default  Rate").  The  provisions  herein for a
Default Rate or a delinquency  charge shall not be deemed to extend the time for
any payment  hereunder or to constitute a "grace  period"  giving the Obligors a
right to cure any default.  At Bank's option,  any accrued and unpaid  interest,
fees or charges may, for purposes of computing and accruing  interest on a daily
basis after the due date of the Note or any installment  thereof be deemed to be
a part of the principal balance, and interest shall accrue on a daily compounded
basis  after  such  date at the rate  provided  in this Note  until  the  entire
outstanding  balance of principal  and interest is paid in full.  Bank is hereby
authorized at any time to setoff and charge against any deposit  accounts of any
Obligor,  as well as any other property of such party at or under the control of
Bank, without notice or demand, any and all obligations due hereunder.

6. Non-Waiver. The failure at any time of Bank to exercise any of its options or
any other rights hereunder shall not constitute a waiver thereof nor shall it be
a bar to the  exercise  of any of its  options  or rights at a later  date.  All
rights and remedies of Bank shall be cumulative  and may be pursued  singularly,
<PAGE>

successively  or together,  at the option of Bank. The acceptance by Bank of any
partial payment shall not constitute a waiver of any default or of any of Bank's
rights  under  this  Note.  No waiver  of any of its  rights  hereunder,  and no
modification  or  amendment  of this  Note,  shall be  deemed to be made by Bank
unless the same shall be in  writing,  duly  signed on behalf of Bank;  and each
such waiver,  if any,  shall apply only with  respect to the  specific  instance
involved,  and shall in no way impair the rights of Bank or the  obligations  of
Obligor to Bank in any other respect at any other time.

7.  Applicable  Law. This Note is delivered in and shall be construed  under the
internal laws and judicial  decisions of the State of Texas, and the laws of the
United States as the same may be applicable.

8. Partial  Invalidity.  The  unenforceability or invalidity of any provision of
this Note shall not  affect  the  enforceability  or the  validity  of any other
provision  herein,  and the invalidity or  unenforceability  of any provision of
this  Note or of the Loan  Documents  to any  person or  circumstance  shall not
affect the enforceability or validity of such provision as it may apply to other
persons or circumstances.

9.  Jurisdiction  and Venue.  In any litigation in connection with or to enforce
this Note or any  endorsement  or guaranty  of this Note or any Loan  Documents,
Obligors  and  each  of  them,   irrevocably  consent  to  and  confer  personal
jurisdiction  on the  courts of the State of Texas or the United  States  courts
located  within the State of Texas,  and  expressly  waive any  objections as to
venue in any such  courts,  and agree that  service  of  process  may be made on
Obligors  by  mailing a copy of the  summons  and  complaint  by  registered  or
certified mail, return receipt requested, to their respective addresses. Nothing
contained  herein  shall,  however,  prevent  Bank from  bringing  any action or
exercising any rights within any other state or  jurisdiction  or from obtaining
personal jurisdiction by any other means available by applicable law.

10.  ARBITRATION.  ANY CONTROVERSY OR CLAIM BETWEEN OR AMONG THE PARTIES HERETO,
INCLUDING,  BUT NOT LIMITED TO, THOSE ARISING OUT OF OR RELATING TO THIS NOTE OR
ANY RELATED NOTES OR  INSTRUMENTS,  INCLUDING ANY CLAIM BASED ON OR ARISING FROM
AN ALLEGED TORT,  SHALL BE DETERMINED BY BINDING  ARBITRATION IN ACCORDANCE WITH
THE FEDERAL  ARBITRATION ACT (OR IF NOT APPLICABLE,  THE APPLICABLE  STATE LAW),
THE RULES OF PRACTICE AND PROCEDURE FOR THE  ARBITRATION OF COMMERCIAL  DISPUTES
OR JUDICIAL ARBITRATION AND MEDIATION SERVICES, INC. (J.A.M.S.) AND THE "SPECIAL
RULES" SET FORTH BELOW.  IN THE EVENT OF ANY  INCONSISTENCY,  THE SPECIAL  RULES
SHALL CONTROL.  JUDGMENT UPON ANY ARBITRATION  AWARD MAY BE ENTERED IN ANY COURT
HAVING  JURISDICTION.  ANY PARTY TO THE NOTE MAY BRING AN  ACTION,  INCLUDING  A
SUMMARY OR EXPEDITED  PROCEEDING,  TO COMPEL  ARBITRATION OF ANY  CONTROVERSY OR
CLAIM TO WHICH THIS NOTE  APPLIES  IN ANY COURT  HAVING  JURISDICTION  OVER SUCH
ACTION.

(A) SPECIAL RULES. THE ARBITRATION  SHALL BE CONDUCTED IN THE CITY OF BORROWER'S
DOMICILE AT THE TIME OF THIS NOTE'S EXECUTION AND  ADMINISTERED BY J.A.M.S.  WHO
WILL APPOINT AN  ARBITRATOR;  IF J.A.M.S.  IS UNABLE OR LEGALLY  PRECLUDED  FROM
ADMINISTERING THE ARBITRATION,  THEN THE AMERICAN  ARBITRATION  ASSOCIATION WILL
SERVE. ALL ARBITRATION HEARINGS WILL BE COMMENCED WITHIN NINETY (90) DAYS OF THE
DEMAND FOR  ARBITRATION;  FURTHER,  THE ARBITRATOR SHALL ONLY, UPON A SHOWING OF
CAUSE, BE PERMITTED TO EXTEND THE COMMENCEMENT OF SUCH HEARING FOR AN ADDITIONAL
SIXTY (60) DAYS.

(B)  RESERVATION  OF RIGHTS.  NOTHING IN THIS NOTE SHALL BE DEEMED TO: (I) LIMIT
THE APPLICABILITY OF ANY OTHERWISE  APPLICABLE  STATUTES OF LIMITATION OR REPOSE
AND ANY WAIVERS  CONTAINED IN THIS NOTE;  OR (II) BE A WAIVER BY THE BANK OF THE
PROTECTION AFFORDED TO IT BY 12 U.S.C.  91 OR ANY SUBSTANTIALLY EQUIVALENT STATE
LAW;  OR (III)  LIMIT THE RIGHT OF THE BANK  HERETO  (A) TO  EXERCISE  SELF HELP
REMEDIES  SUCH AS (BUT NOT LIMITED TO) SETOFF,  OR (B) TO FORECLOSE  AGAINST ANY
REAL OF PERSONAL PROPERTY COLLATERAL,  OR (C) TO OBTAIN FROM A COURT PROVISIONAL
OR ANCILLARY  REMEDIES SUCH AS (BUT NOT LIMITED TO) INJUNCTIVE  RELIEF,  WRIT OF
POSSESSION  OR THE  APPOINTMENT  OF A RECEIVER.  THE BANK MAY EXERCISE SUCH SELF
HELP  RIGHTS,  FORECLOSE  UPON SUCH  PROPERTY,  OR OBTAIN  SUCH  PROVISIONAL  OR
ANCILLARY  REMEDIES  BEFORE,  DURING OR AFTER THE  PENDENCY  OF ANY  ARBITRATION
PROCEEDING  BROUGHT  PURSUANT TO THIS NOTE.  NEITHER  THE  EXERCISE OR SELF HELP
REMEDIES NOR THE  INSTITUTION  OR  MAINTENANCE  OF AN ACTION FOR  FORECLOSURE OR
PROVISIONAL OR ANCILLARY  REMEDIES SHALL CONSTITUTE A WAIVER OF THE RIGHT OF ANY
PARTY,  INCLUDING  THE CLAIMANT IN SUCH ACTION,  TO ARBITRATE  THE MERITS OF THE
CONTROVERSY OR CLAIM OCCASIONING RESORT TO SUCH REMEDIES.


<PAGE>

11. Binding Effect.  This Note shall be binding upon and inure to the benefit of
Borrower,  Obligors and Bank and their respective successor,  assigns, heirs and
personal representatives, provided, however, that no obligations of the Borrower
or the Obligor hereunder can be assigned without prior written consent of Bank.

12. Renewal.  This Note is a decrease,  modification  and  replacement,  without
extinguishment,  of a Promissory Note dated July 24, 1995, in the face amount of
$10,000,000.00, executed by Borrower and payable to the order of Bank.

13.  NOTICE  OF FINAL  AGREEMENT.  THIS  WRITTEN  PROMISSORY  NOTE AND ANY OTHER
DOCUMENTS EXECUTED IN CONNECTION  HEREWITH REPRESENT THE FINAL AGREEMENT BETWEEN
THE PARTIES AND MAY NOT BE CONTRADICTED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS OR
SUBSEQUENT  ORAL  AGREEMENTS  OF  THE  PARTIES.  THERE  ARE  NO  UNWRITTEN  ORAL
AGREEMENTS BETWEEN THE PARTIES.

                                     Borrower:

                              THE LEATHER FACTORY, INC., a Delaware corporation



                  By: /s/ John Tittle, Jr.__________________________________
                      JOHN TITTLE, JR., Chief Financial Officer and Treasurer






<PAGE>




















                                  EXHIBIT 4.12














<PAGE>





                            FORBEARANCE AGREEMENT AND
                            -------------------------
               FOURTH AMENDMENT TO SECOND RESTATED LOAN AGREEMENT
               --------------------------------------------------


This  Forbearance  Agreement  and  Fourth  Amendment  to  Second  Restated  Loan
Agreement  ("Amendment")  is entered into and is  effective as of September  30,
1996, by and among  NATIONSBANK OF TEXAS,  N.A.  ("Bank"),  THE LEATHER FACTORY,
INC., a Delaware  corporation  ("Borrower"),  and THE LEATHER  FACTORY,  INC., a
Texas corporation,  and ROBERTS, CUSHMAN & COMPANY, INC., a New York corporation
(together  hereinafter  referred to as  "Guarantors").  This Amendment  amends a
Second  Restated  Loan  Agreement  dated as of July 24, 1995, by and among Bank,
Borrower and Guarantors, as amended by a First Amendment to Second Restated Loan
Agreement  dated as of  December  31,  1995,  by a Second  Amendment  to  Second
Restated  Loan  Agreement  dated  as of March  31,  1996,  and by a  Forbearance
Agreement and Third  Amendment to Second  Restated Loan Agreement  ("Forbearance
Agreement") dated as of June 30, 1996 (together  hereinafter  referred to as the
"Loan  Agreement"),  and for purposes of this Amendment,  the capitalized  terms
used  herein  shall  have  the  same  meaning  as  assigned  to them in the Loan
Agreement,  except as otherwise provided herein. WHEREAS,  pursuant to the terms
of the Forbearance  Agreement,  the Bank agreed to forbear through September 30,
1996  exercising  its legal rights  arising from the Existing  Defaults  defined
therein;  and WHEREAS,  the Existing  Defaults are  continuing  and Borrower has
requested Bank to extend its  forbearance in exercising its legal rights arising
from the Existing  Defaults for a specified  period of time, and Bank has agreed
to the same  subject to the terms and  conditions  hereinafter  set forth;  NOW,
THEREFORE, for and in consideration of the premises and the mutual covenants and
agreements hereinafter set forth, Borrower,  Bank and Guarantors hereby agree as
follows:

  1.  Defaults.  Borrower  acknowledges  that the Existing  Defaults are
      -----------
continuing since June 30, 1996 as follows: 

                                                     Actual            Required

         (i)      Assets/Current Liabilities           1.13               2.0

         (ii)     Total Liabilities/
                  Tangible Net Worth                   4.13               2.75

         (iii)    EBITDA Ratio                        11.82               2.50

         (iv)     Cash Flow Ratio                      0.01               1.50


<PAGE>


2. Forbearance;  Borrowings.
   ------------------------

The Bank agrees that from the  effective  date hereof  until  December  31, 1996
("Forbearance  Period"),  it will not make demand or institute legal proceedings
to enforce  collection  of the Loans and Borrower may continue to borrow,  repay
and borrow again under the Revolving Line; provided, however, Bank's forbearance
in  exercising  these rights and remedies  and  Borrower's  right to continue to
borrow under the Revolving  Line will be  conditioned  upon there being:  (i) no
change in the financial  covenant  ratios set forth above so as to cause further
and more severe  noncompliance  therewith;  and (ii) no other  default under the
Loan Documents,  and in the event any such default  occurs,  this Agreement will
become null and void and the Bank may  exercise  any and all rights and remedies
available at law or in equity and Borrower's right to borrow under the Revolving
Line will cease. At the end of the Forbearance Period, the Bank's forbearance of
the Existing  Defaults  will cease,  and Borrower  will be subject to compliance
with  the  financial  covenant  ratios  set  forth  in  Section  4A of the  Loan
Agreement, as well as all other terms and provisions of the Loan Documents. Bank
may  exercise  any and all of its rights  and  remedies  available  at law or in
equity,  including  terminating  Borrower's  right to borrow under the Revolving
Line, if after the Forbearance Period any default, including continuation of the
Existing Defaults, exists under the Loan Documents.


3. Reduction in Revolving  Line; 
   ----------------------------- 

Amendment  to Loan  Agreement.  Notwithstanding  anything  contained in the Loan
Documents to the contrary, the maximum principal amount which may be outstanding
under the  Revolving  Line from  time to time  will be  $7,500,000.00.  The Loan
Agreement is hereby  amended as follows:

(a) The first  sentence in  Paragraph  2A is amended to read in its  entirety as
follows:

     The Bank hereby agrees to make (or has made) a loan or loans to Borrower in
     the aggregate  principal amount of $23,500,000.00  being: (i) the Revolving
     Line of Credit in the amount of $7,500,000.00  ("Revolving Line"), renewing
     and increasing the  $6,000,000.00  Revolving Line of Credit  provided under
     the Prior Loan Agreement under which Borrower may from time to time borrow,
     repay and  reborrow  funds  for  working  capital,  letters  of credit  and
     banker's  acceptances;  (ii) an  advising  line of  credit  and  term  loan
     facility up to  $10,000,000.00  ("Acquisition  Line") to provide  funds for
     acquisitions; and (iii) a term loan in the original amount of $5,000,000.00
     for the purchase of the outstanding stock of R,C & Co. ("R,C & Co. Loan").


<PAGE>

     (b)  The  $10,000,000.00  limit set forth in the  first  clause  (i) of the
          first  paragraph  in  Section  2D and  Line 1 of  the  Borrowing  Base
          Certificate is reduced to $7,500,000.00.

     (c)  Subparagraphs  4B(v) and (vi) are amended in their entirety to read as
          follows:

     (v)  Furnish  to the  Bank  monthly  inventory  lists of the  inventory  of
          Borrower  within  thirty (30) days of the end of each such  accounting
          period.


     (vi) Furnish  to Bank  monthly  accounts  receivable  agings,  to include a
          listing of accounts receivable,  within thirty (30) days of the end of
          each such accounting period.

Borrower  has executed  and  delivered  to Bank a  Promissory  Note of even date
herewith,  in the  face  amount  of  $7,500,000.00,  decreasing,  modifying  and
replacing,  without  extinguishment,  a  Promissory  Note dated  July 24,  1995,
executed  by  Borrower,  in the face  amount  of  $10,000,000.00,  covering  the
Revolving Line.  Borrower and Bank acknowledge that no borrowings were requested
or advances made under the Acquisition  Line during the required Funding Period,
and; consequently, the Acquisition Line terminated as of July 24, 1996, and Bank
has no obligation to renew or extend the Acquisition Line.

4. Additional  Collateral. 
   --------------------- 

As a condition to Bank's  agreement to forbear  exercising  its legal rights and
remedies arising from the Existing  Defaults,  Borrower hereby agrees that on or
before  October 30,  1996,  it will grant the Bank a first lien on its  facility
located in Tampa,  Florida  ("Tampa  Property")  by executing  and causing to be
recorded a first  lien deed of trust in form and  subject  only to  encumbrances
satisfactory to the Bank. Borrower contemplates selling the Tampa Property,  and
Bank will release its deed of trust lien upon  payment of the net proceeds  from
the sale to reduce the R,C & Co. Loan.

5. Continuation of Usage Fee. 
   ----------------------------

Borrower acknowledges that notwithstanding the restriction on further borrowings
under the Revolving  Line while a default exists under the Loan  Documents,  the
one-quarter  of one  percent  (0.25%)  usage fee on the  unused  portion  of the
Revolving Line under  Paragraph  2E(i) of the Loan Agreement will continue to be
due and payable as provided therein.

6. No Waiver.

The Bank's  forbearance  of the  Existing  Defaults  will not be  construed as a
waiver of the Existing Defaults or a waiver of any other default now existing or
hereafter arising under the Loan Documents,  or a waiver of any rights, remedies
or  recourses  available to Bank or an election of remedies  resulting  from any
default under the Loan Documents.

<PAGE>


7. Ratification. 
   ------------- 

The terms and provisions set forth in this Amendment  shall modify and supersede
all  inconsistent  terms and  provisions set forth in the Loan Agreement and the
other Loan Documents,  and, except as expressly  modified and superseded by this
Amendment,  the terms and  provisions  of the Loan  Agreement and the other Loan
Documents  are  ratified  and  confirmed  and shall  continue  in full force and
effect.  The Loan  Agreement and the other Loan  Documents,  as amended  hereby,
shall continue to be legal,  valid,  binding and  enforceable in accordance with
their respective terms.

8. Representations  and Warranties. 
   --------------------------------- 

Borrower and Guarantors  hereby  represent and warrant to the Bank that: (a) the
execution, delivery and performance of this Amendment and any and all other Loan
Documents executed and/or delivered in connection  herewith have been authorized
by all requisite  corporate  action on the part of Borrower and will not violate
the Certificate and/or Articles of Incorporation or Bylaws of Borrower;  (b) the
officers  executing this Amendment on behalf of Borrower have been authorized by
the Board of  Directors  to execute  this  Amendment  and any and all other Loan
Documents  to be executed  and/or  delivered  in  connection  herewith;  (c) the
representations  and  warranties  contained  in the Loan  Agreement,  as amended
hereby,  and the other Loan Documents are true and correct on and as of the date
hereof as though made on and as of each such date;  (d) except for the  Existing
Defaults,  no default under the Loan Agreement,  as amended hereby, has occurred
and is continuing; (e) except for the Existing Defaults, Borrower and Guarantors
are in full compliance  with all covenants and agreements  contained in the Loan
Agreement and the other Loan Documents,  as amended hereby; and (f) Borrower has
not amended its Certificate and/or Articles of Incorporation or its Bylaws since
the date of the Loan Agreement.


9. Survival  of  Representations and  Warranties.  
   ----------------------------------------------

All  representations and warranties made in the Loan Agreement or any other Loan
Documents,  including,  without limitation, any document furnished in connection
with this Amendment,  shall survive the execution and delivery of this Amendment
and the other Loan Documents,  and no  investigation  by the Bank or any closing
shall affect the representations and warranties or the right of the Bank to rely
upon them.


10. Reference to Loan  Agreement.
    -----------------------------

The Loan Agreement and each of the other Loan  Documents,  and any and all other
agreements,  documents or  instruments  now or hereafter  executed and delivered
pursuant to the terms hereof or pursuant to the terms of the Loan Agreement,  as
amended  hereby,  are hereby amended so that any reference to the Loan Agreement
and such other Loan  Documents to the Loan  Agreement  shall mean a reference to
the Loan Agreement as amended hereby.

<PAGE>

11. Severability. 
    ------------

Any provision of this Amendment held by a court of competent  jurisdiction to be
invalid or  unenforceable  shall not impair or invalidate  the remainder of this
Amendment  and the effect  thereof shall be confined to the provision so held to
be invalid or unenforceable.


12. Successors  and  Assigns.
    ------------------------

This  Amendment  is  binding  upon and shall  inure to the  benefit of the Bank,
Borrower and Guarantors,  and their respective heirs, executors,  successors and
assigns,  except that Borrower and  Guarantors may not assign or transfer any of
its rights or  obligations  hereunder  without the prior written  consent of the
Bank.

13. Counterparts. 
    -------------

This Amendment may be executed in one or more  counterparts,  each of which when
so  executed  shall be deemed to be an  original,  but all of which  when  taken
together shall constitute one and the same instrument.

14.  Headings. 
    --------- 

The  headings,  captions  and  arrangements  used  in  this  Amendment  are  for
convenience only and shall not affect the interpretation of this Amendment.

15.  Governing Law.
    --------------

This Amendment and the rights and obligations of the parties  hereunder shall be
governed by and  interpreted in accordance with the laws of Texas and applicable
United States  federal law, and is performable by Borrower and Guarantors in the
county  or city of  Bank's  address  set out in the  Loan  Agreement,  and  they
expressly waive any objection as to venue in such location.


16.  NO  FURTHER  AGREEMENTS. 
     ----------------------- 

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

                           NATIONSBANK OF TEXAS, N.A.



                           By:__/s/ Denise Karnei______________________
                                DENISE KARNEI, Vice President


<PAGE>

                       BORROWER:

                           THE LEATHER FACTORY, INC., a Delaware corporation



                            By:__/s/ John Tittle, Jr.______________________
                                 JOHN TITTLE, JR., Chief Financial Officer and
                                 Treasurer
 

                       GUARANTORS:

                           THE LEATHER FACTORY, INC., a Texas corporation



                           By:__/s/ John Tittle, Jr.______________________
                                 JOHN TITTLE, JR., Chief Financial Officer and
                                 Treasurer


                                ROBERTS, CUSHMAN & COMPANY, INC., a New York
                                corporation


                           By:__/s/ John Tittle, Jr.______________________
                                JOHN TITTLE, JR., Chief Financial Officer and
                                Treasurer




<PAGE>