Form 10-Q

                       SECURITIES AND EXCHANGE COMMISSION

                             Washington, D.C. 20549


(Mark One)

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

For the quarterly period ended June 30, 1998

or

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

For the transition period from                      to

Commission File Number 1-12368

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


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



                3847 East Loop 820 South, Ft. Worth, Texas 76119
               (Address of principal executive offices) (Zip code)

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

     Indicate  by check mark  whether the  registrant  (1) has filed all reports
required to by filed by Section 13 or 15(d) of the  Securities  Exchange  Act of
1934  during  the  preceding  12 months  (or for such  shorter  period  that the
registrant was required to file such reports),  and (2) has been subject to such
filing requirements for the past 90 days.

                                    Yes X   No

      Indicate the number of shares  outstanding of each of the issuer's classes
of common stock, as of the latest practicable date.


<TABLE>
<S>                                            <C>     

             Class                             Shares outstanding as of August 14, 1998   
----------------------------------------       ----------------------------------------      
Common Stock, par value $.0024 per share                          9,853,161                   
                      

</TABLE>

<PAGE>


                            THE LEATHER FACTORY, INC.

                                    FORM 10-Q

                  FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1998


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


                                                                        PAGE NO.


PART I.  FINANCIAL INFORMATION

  Item 1.  Financial Statements

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

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

   Consolidated Statements of Cash Flows
   Six months ended June 30, 1998 and 1997.............................       5

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

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


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


PART II.  OTHER INFORMATION

  Item 4. Submission of Matters to a Vote of Security Holders..........       14

  Item 6. Exhibits and Reports on Form 8-K.............................       14


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


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








                                       2



<PAGE>


<TABLE>

<CAPTION>

                      THE LEATHER FACTORY, INC.
                     CONSOLIDATED BALANCE SHEETS



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

CURRENT ASSETS:
    Cash                                                        $    307,886    $     70,496
    Cash restricted for payment on revolving credit facility         200,606         319,133
    Accounts receivable-trade, net of allowance for
        doubtful accounts of $51,000 and $28,000
         in 1998 and 1997, respectively                            1,923,471       1,865,276
    Inventory                                                      7,172,492       7,279,702
    Prepaid income taxes                                             294,929         285,970
    Deferred income taxes                                            117,020         109,411
    Other current assets                                             594,247         385,199
                                                                ------------    ------------
                            Total current assets                  10,610,651      10,315,187
                                                                ------------    ------------

PROPERTY AND EQUIPMENT, at cost                                    2,591,158       2,534,839
  Less-accumulated depreciation and amortization                  (1,661,218)     (1,505,098)
                                                                ------------    ------------
                            Property and equipment, net              929,940       1,029,741

GOODWILL and other, net of accumulated amortization of
    $988,000 and $878,000 in 1998 and 1997, respectively           5,477,410       5,679,621
                                                                ------------    ------------
                                                                $ 17,018,001    $ 17,024,549
                                                                ============    ============
                     LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
    Accounts payable                                            $  1,337,668    $    942,046
    Accrued expenses and other liabilities                           468,817         559,776
    Notes payable and current maturities of
        long-term debt                                             4,657,283       4,650,742
                                                                ------------    ------------
                            Total current liabilities              6,463,768       6,152,564
                                                                ------------    ------------

DEFERRED INCOME TAXES                                                118,963         136,611

NOTES PAYABLE AND LONG-TERM DEBT,
    net of current maturities                                      2,402,415       2,602,728

COMMITMENTS AND CONTINGENCIES

STOCKHOLDERS' EQUITY:
    Preferred stock, $0.10 par value; 20,000,000
        shares authorized, none issued or outstanding                   --              --
    Common stock, $0.0024 par value; 25,000,000 shares
        authorized, 9,853,161 shares issued in 1998 and 1997          23,648
                                                                                      23,648
    Paid-in capital                                                4,092,717       4,119,915
    Less:  Notes receivable - secured by common stock               (234,250)       (257,617)
           Unearned shares held by ESOP, 48,280 and 54,262
             shares in 1998 and 1997, respectively                  (243,662)       (273,851)
    Retained earnings                                              4,412,497       4,534,569
    Accumulated other comprehensive income                           (18,095)        (14,018)
                                                                ------------    ------------
                            Total stockholders' equity             8,032,855       8,132,646
                                                                ------------    ------------
                                                                $ 17,018,001    $ 17,024,549
                                                                ============    ============


</TABLE>

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


                                       3


<PAGE>


<TABLE>

<CAPTION>


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



                                                              THREE MONTHS                   SIX MONTHS

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

NET SALES                                             $  5,471,463    $  6,526,992   $ 11,182,295    $ 12,986,884

COST OF SALES                                            3,044,623       3,787,708      6,340,761       7,683,789
                                                      ------------    ------------   ------------    ------------

      Gross Profit                                       2,426,840       2,739,284      4,841,534       5,303,095

OPERATING EXPENSES                                       2,192,639       2,304,413      4,492,533       4,701,755
                                                      ------------    ------------   ------------    ------------

INCOME FROM OPERATIONS                                     234,201         434,871        349,001         601,340

OTHER (INCOME) EXPENSE:
    Interest expense                                       259,702         217,429        500,347         418,767
    Other, net                                             (16,040)          4,132        (23,801)          3,288
                                                      ------------    ------------   ------------    ------------
      Total other (income) expense                         243,662         221,561        476,546         422,055
                                                      ------------    ------------   ------------    ------------

INCOME (LOSS)  BEFORE INCOME TAXES                          (9,461)        213,310       (127,545)        179,285

PROVISION (BENEFIT)  FOR INCOME TAXES                       24,083         125,452         (5,473)        127,612
                                                      ------------    ------------   ------------    ------------

NET INCOME (LOSS)                                     $    (33,544)   $     87,858   $   (122,072)   $     51,673
                                                      ============    ============   ============    ============



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

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

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

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

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


</TABLE>








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


                                       4

<PAGE>


<TABLE>

<CAPTION>

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



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

CASH FLOWS FROM OPERATING ACTIVITIES:
  Net income (loss)                                                      $   (122,072)   $     51,673
  Adjustments to reconcile net income to net
   cash provided by (used in) operating activities-
     Depreciation & amortization                                              266,570         257,532
     (Gain) loss on sales of assets                                            (9,118)           --
     Deferred financing costs                                                 109,582            --
     Deferred income taxes                                                    (25,257)          6,457
     Other                                                                      2,600          (1,614)
     Net changes in operating assets and liabilities:
       Accounts receivable-trade, net                                         (58,195)       (405,003)
       Inventory                                                              107,210         470,055
       Income taxes                                                            (8,959)        114,710
       Other current assets                                                  (209,048)         56,096
       Accounts payable                                                       395,622         318,876
       Accrued expenses and other liabilities                                 (90,959)        (56,190)
                                                                         ------------    ------------
     Total adjustments                                                        480,048         760,919
                                                                         ------------    ------------

      Net cash provided by operating activities                               357,976         812,592
                                                                         ------------    ------------

CASH FLOWS FROM INVESTING ACTIVITIES:
  Purchases of property and equipment                                         (56,642)       (170,165)
  Proceeds from sales of assets                                                10,000            --
  Other intangible costs                                                         (441)        (32,061)
                                                                         ------------    ------------

      Net cash used in investing activities                                   (47,083)       (202,226)
                                                                         ------------    ------------

CASH FLOWS FROM FINANCING ACTIVITIES:
  Proceeds from notes payable and long-term debt                           11,390,113         302,957
  Payments on notes payable and long-term debt                            (11,464,883)     (1,101,863)
  Decrease in cash restricted for payment on revolving credit facility        118,527            --
  Payments received on notes secured by common stock                           23,367            --
  Deferred financing costs                                                   (140,627)           --
                                                                         ------------    ------------

      Net cash used in  financing activities                                  (73,503)       (798,906)
                                                                         ------------    ------------

NET INCREASE (DECREASE) IN CASH                                               237,390        (188,540)

CASH, beginning of period                                                      70,496         488,192
                                                                         ------------    ------------

CASH, end of period                                                      $    307,886    $    299,652
                                                                         ============    ============

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
  Interest paid during the period                                        $    378,265    $    422,555
  Income taxes paid during the period, net of refunds                          25,507           6,445


</TABLE>

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

                                       5

<PAGE>

<TABLE>
                                  THE LEATHER FACTORY, INC.
                         CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
                                 AND COMPREHENSIVE INCOME (LOSS)
                                           (UNAUDITED)
                             SIX MONTHS ENDED JUNE 30, 1998 AND 1997
                                                                    
                               Common Stock                  Notes                                 
                           ------------------              Receivable                              
                            Number     Par      Paid-in   - Secured by   Unearned     Retained     
                            of Shares  Value    Capital   Common Stock  ESOP Shares   Earnings     
                           --------- --------  ---------- ------------  -----------   ----------   
<S>                                                                     <C>           <C>    
BALANCE, December 31,      9,853,161 $ 23,648  $4,130,796 $   (269,305) $  (326,184)  $4,464,277 
1996 
   
Net Income                         -        -           -            -            -       51,673         
                                                                                                   
Foreign currency
translation adjustment             -        -           -            -            -            -   
                           --------- --------  ---------- ------------  -----------   ----------   
BALANCE, June 30, 1997     9,853,161 $ 23,648  $4,130,796 $   (269,305) $  (326,184)  $4,515,950   
                           ========= ========  ========== ============  ===========   ==========   
                                                                                                   
 
BALANCE, December 31,      9,853,161 $ 23,648  $4,119,915 $   (257,617) $  (273,851)  $4,534,569   
1997                                                        

Payments received on notes 
secured by common stock            -        -           -       23,367            -            -   

Allocation of suspended 
ESOP shares committed to
be released                        -        -     (27,198)           -       30,189            -   

Net loss                           -        -           -            -            -     (122,072)    
                                              
Foreign currency 
translation adjustment,
net of tax of ($2,499)            -         -           -            -            -            -   
                           --------- --------  ---------- ------------  -----------   ----------   
BALANCE, June 30, 1998     9,853,161 $ 23,648  $4,092,717 $   (234,250) $  (243,662)  $4,412,497   
                           ========= ========  ========== ============  ===========   ==========   
</TABLE>
   

                                    Accumulated                           
                                    Other             Total                  
                                    Comprehensive  Stockholder's   Comprehensive
                                      Income          Equity       Income (Loss)
                                    -------------  -------------  ------------- 
BALANCE, December 31,                $        (295) $   8,022,937             
1996                                                                            
                                                                                
Net Income                                       -         51,673  $     51,673 
                                                                                
Foreign currency                                                                
translation adjustment                      (3,223)        (3,223)       (3,223)
                                     -------------  -------------               
                                                                                
BALANCE, June 30, 1997               $      (3,518) $   8,071,387               
                                     =============  =============               
                                                                   ------------ 
 Comprehensive income (loss)for the six months ended June 30, 1997 $     48,450 
                                                                   ============ 
                                                                                
BALANCE, December 31,                $     (14,018) $   8,132,646               
1997                                                                            
                                                                                
Payments received on notes                                                      
secured by common stock                          -         23,367               
                                                                                
Allocation of suspended                                                         
ESOP shares committed to                                                        
be released                                      -          2,991               
                                                                                
Net loss                                         -       (122,072) $   (122,072)
                                                                                
Foreign currency                                                                
translation adjustment,                                                         
net of tax of ($2,499)                      (4,077)        (4,077)       (4,077)
                                     -------------  -------------               
BALANCE, June 30, 1998               $     (18,095) $   8,032,855               
                                     =============  =============               
                                                                   ------------ 
 Comprehensive income (loss)for the six months ended June 30, 1998 $   (126,149)
                                                                   ============ 
     The accompanying notes are an integral part of these financial statements. 
                                         6                                      
                                                                             
  <PAGE>                                                             
                            THE LEATHER FACTORY, INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.  BASIS OF PRESENTATION

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


2.  INVENTORY

The components of inventory consist of the following:

<TABLE>
                                                                 June 30,         December 31,
                                                                   1998                 1997
                                                             ---------------     ---------------
<S>                                                          <C>                  <C>     

                Finished goods held for sale                  $   5,839,035       $   5,833,002
                Raw materials and work in process                 1,333,457           1,446,700
                                                             ===============     ===============
                                                              $   7,172,492       $   7,279,702
                                                             ===============     ===============
</TABLE>

3.  EARNINGS PER SHARE

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

<TABLE>
                                                      Three Months Ended                  Six Months Ended
                                                             June 30,                          June 30,
                                                  ---------------------------       -----------------------------
                                                    1998             1997              1998              1997
                                                  ----------      -----------       -----------       -----------
<S>                                                                                 <C>               <C>    

Numerator for basic and
 diluted earnings per share:
   Net income (loss)                              $  (33,544)      $   87,858       $  (122,072)      $    51,673
                                                  ==========       ==========       ===========       ===========          



Denominator for basic and
 diluted earnings per share:
   Weighted-average shares outstanding             9,802,259        9,788,530         9,800,832         9,788,530


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

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

Unexercised  employee and director stock options to purchase 585,000 and 535,000
shares of common  stock as of June 30,  1998 and  1997,  respectively,  were not
included in the computations of diluted EPS because the options' exercise prices
were  greater  than or equal to the  average  market  price of the common  stock
during the respective periods.

Warrants (see note 9 to consolidated  financial  statements in the Annual Report
and  Subsequent  Event  under  Item 2 of this  Report on Form  10-Q) to  acquire
300,000 shares of common stock were not included in the  computations of diluted
EPS because the exercise  price was greater than the average market price of the
common stock during the quarter ended June 30, 1998.

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



                                       7

<PAGE>



4.  COMPREHENSIVE INCOME

<TABLE>

<CAPTION>

The following table sets forth the computation of comprehensive income:


                                                       Three Months Ended              Six Months Ended
                                                           June 30,                        June 30,
                                                  ---------------------------    ---------------------------
                                                      1998            1997          1998            1997
                                                  -----------      -----------   -----------      ----------    
<S>                                                                              <C>              <C>     


       Net income (loss)                          $   (33,544)     $   87,858    $  (122,072)     $  51,673
       Other comprehensive income:
         Translation adjustment, net of tax            (5,277)            556         (4,077)        (3,223)
                                                  -----------      ----------    -----------      ---------
       Comprehensive income                       $   (38,821)     $   88,414    $  (126,149)     $  48,450
                                                  ===========      ==========    ===========      =========

</TABLE>


5.  IMPACT OF NEW ACCOUNTING STANDARDS


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















                                       8

<PAGE>


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


General

         The Leather Factory, Inc. (the "Company") is the premier distributor of
leather and  leathercraft  products to over 40,000  customers  ranging  from the
individual  hobbyist to large retail  chains.  Customer  groups served  include:
wholesale  distributors,   tack  and  saddle  shops,   shoe-findings  customers,
institutions, prisons and prisoners, dealer stores, western stores, craft stores
and craft store chains,  hat manufacturers and distributors,  other large volume
purchasers,  manufacturers,  and  retailers.  The Company  operates in one broad
industry segment and distributes products through twenty-two  sales/distribution
units in the  United  States  and Canada or  through  its  subsidiary,  Roberts,
Cushman & Company,  Inc.  ("Cushman"),  in New York.  Cushman  manufactures  and
distributes hat trims in braids,  leather, and woven fabrics; and small finished
leather  goods,  such  as  cigar  cases,  picture  frames,   wallets  and  other
accessories.


Results of Operations

                                               Income Statement Comparison
<TABLE>

<CAPTION>

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


                                                         Quarterly Period Ended          Six Months Ended
                                                                 June 30,                    June 30,
                                                         ----------------------        ----------------------
                                                           1998           1997           1998           1997
                                                         -------        -------         ------         ------
<S>                                                                                    <C>            <C>     

         Net sales                                       100.0%          100.0%         100.0%         100.0%
         Cost of sales                                    55.6            58.0           56.7           59.2
                                                         -------        -------         -------        ------
         Gross profit                                     44.4            42.0           43.3           40.8
         Operating expenses                               40.1            35.3           40.2           36.2
                                                         -------        -------         -------        ------
         Income from operations                            4.3             6.7            3.1            4.6
         Interest expense and other, net                   4.5             3.4            4.3            3.2
                                                         -------        -------         -------        ------
         Income (loss) before income taxes                (0.2)            3.3           (1.2)           1.4
         (Benefit) provision for income taxes              0.4             1.9           (0.1)           1.0
                                                         -------        -------         -------        ------
         Net income (loss)                                (0.6)%           1.4%          (1.1)%          0.4%
                                                         =======        =======         =======        ======
         
</TABLE>
        
Revenues

         For the quarter and six months ended June 30, 1998, net sales decreased
16.2% and 13.9%,  respectively compared to the same interim periods in 1997. The
declines   reflect   decreased  unit  sales  to   manufacturers,   shoe-finders,
distributors and retailers  resulting from: weak overall industry  conditions in
the retail craft and western apparel markets; strategic merchandising decisions;
and the economic  crisis in Asia.  These  decreases were offset by gains in unit
sales to customers in the Company's  institutional  markets. The following table
sets forth the approximate percentage of the overall decline represented by each
of the above:



                                       9

<PAGE>

                                                       Interim Periods Ended
                                                            June 30, 1998
                                                     ------------------------
                                                      Three         Six
                                                      Months        Months    
                                                     ----------   -----------
         Craft markets                                  -40%        -41%
         Western apparel markets                        -30%        -33%
         Strategic merchandising decisions              -36%        -30%
         Asian economic difficulties                     -7%         -4%
         Institutional markets                          +13%         +8%
                                                     ==========    ==========
                                                        -100%        -100%

         
         The  sales  declines  from  strategic   merchandising   decisions  were
expected.  The  Company's  analysis  showed  certain  products  did not  produce
adequate  margins  for the  selling  expense  and risks  associated  with  them.
Therefore,  prices were  selectively  raised where  appropriate or products were
eliminated  from the Company's  line  entirely.  These  merchandising  decisions
account for approximately $374,000 and $550,000,  respectively,  of the declines
for the three and six month  periods  ended June 30, 1998,  compared to the same
periods in 1997.

         When adjusted for the above expected  declines,  sales decreases due to
continued   negative  external  forces  were   approximately   10.4%  and  9.7%,
respectively,  for the  quarter  and six  month  periods  ended  June 30,  1998,
compared to the same interim  periods in 1997.  These declines  continue  trends
that have  existed  over the past two to three  years.  To combat such  negative
trends,  the Company is investing working capital from eliminated  product lines
into its growing markets and new product development.

         These efforts are reflected by gains achieved in the Company's sales to
institutional  customers,  expansion of the  Company's  finished  leather  goods
product line, and  introduction  of several new products.  The Company also sees
opportunities  for growth in export sales although  economic  conditions in Asia
resulted in a slight decline in second quarter  exports  compared to last year's
second  quarter.  This brought year to date export sales  essentially  even with
levels for the first six months of 1997.

Costs, Gross Profit, and Expenses

         Cost of sales as a  percentage  of  revenue  was 55.6%  for the  second
quarter of 1998 as compared to 58.0% for the same quarter in 1997. Cost of sales
percentages  for the six  months  ended June 30,  1998 and 1997,  were 56.7% and
59.2%, respectively. These 2.4% and 2.5% reductions for the respective three and
six month periods resulted from improved product mix and the Company's strategic
efforts to  selectively  increase  prices and eliminate  low margin  products as
discussed above.

         Lower relative cost of sales  percentages  meant that gross profit as a
percentage of sales improved to 44.4% and 43.3% for the respective three and six
month  periods  ended June 30, 1998, as compared to only 42.0% and 40.8% for the
same periods in 1997.  The  Company's  strategy for  combating  declining  sales
includes  emphasis on improved gross margins so that the decline in gross profit
is  proportionately  less than the revenue  decline.  Accordingly,  gross profit
dollars  decreased  $312,444  or only  11.4% and  $461,561  or only 8.7% for the
quarterly and six month periods ended June 30, 1998,  compared to the respective
1997 periods.

         Operating  expenses decreased $111,774 or 4.9% to $2,192,639 during the
second quarter of 1998 from  $2,304,413  during the quarter ended June 30, 1997.
The decrease in the dollar amount of operating expenses between the two quarters
resulted  primarily from lower  freight,  payroll  related and insurance  costs;
offset by higher advertising expenditures and increased bad debt write-offs. For
the six months ended June 30, 1998, operating expenses declined $209,222 or 4.5%
compared  to the six months  ended June 30,  1997.  The  decrease  in the dollar
amount  of  operating  expenses  between  the two  six  month  periods  resulted
primarily from lower freight,  payroll  related and insurance  costs;  decreased
bad-debt  write-offs;   and  a  reduction  in  non-recurring  professional  fees
associated with the search for financing sources in 1997.


                                       10


<PAGE>


Other (Income) Expense

         Other  expenses  increased  $22,101 or 10.0% to $243,662 for the second
quarter of 1998 from $221,561  during the same quarter in 1997. The increase was
primarily due to higher  interest  expense  resulting from the  amortization  of
deferred  financing costs offset by non-recurring  other income in the amount of
$20,000. Other expenses increased $54,491 or 12.9% to $476,546 for the first six
months of 1998 from  $422,055  during the same period in 1997.  The increase was
primarily due to higher  interest  expense  resulting from the  amortization  of
deferred  financing costs offset by non-recurring  other income in the amount of
$27,000.

Net Income (Loss)

         The  Company  reported  a net loss for the three and six month  periods
ended June 30, 1998,  in the amounts of $33,544 and  $122,072,  respectively  as
compared  to net income of $87,858  and  $51,673  in the  corresponding  periods
during 1997. The decreased  operating results for such periods resulted from the
factors noted above regarding sales, gross profit, operating and other expenses.


Outlook

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

         The  Company  believes  that  opportunities  exist  to use its size and
competitive  advantages  to  increase  market  share in: the core  leathercraft,
institutional  and saddle and tack businesses;  and the leather  accessories and
travelware  markets.  To effectively  cover North America,  the Company plans to
resume its internal  expansion  program  opening two to four new Leather Factory
distribution  units a year  over the next  five  years.  The  grand  opening  in
Portland, Oregon is scheduled for early fourth quarter.

         Management believes the Company's steady expansion with emphasis on its
more profitable  markets and service to its customers will gradually  offset the
sales declines experienced in the last three years and provide the critical mass
needed to return the Company to its  historical  profit trends.  Meanwhile,  the
Company is poised to take advantage of cyclical improvements in the retail craft
and western markets if and when they occur which is difficult to predict.


Capital Resources and Liquidity

         The primary sources of liquidity and capital resources during the first
six months of 1998 were net funds provided by operating activities in the amount
of  $357,976,  a  decrease  in  restricted  cash in the amount of  $118,527  and
borrowings  on the  Company's  revolving  credit  facility  with FINOVA  Capital
Corporation ("FINOVA"). The Company's unrestricted cash increased to $307,886 at
June 30, 1998 from $70,496 at December 31, 1997. This increase was primarily the
result of cash generated by operating  activities and the decrease in restricted
cash offset by capital expenditures, payment of deferred financing costs and net
repayments of debt.


                                       11


<PAGE>


         With the decline in sales,  the Company is reducing its  investment  in
inventory which along with non-cash expenses for depreciation,  amortization and
deferred  financing  cost continue to give rise to  significant  operating  cash
flows despite the essentially flat operating results for the first six months of
1998.  Inventory  decreased to $7,172,492 at June 30, 1998, from $ $7,279,702 at
December  31,  1997.  The sum of the cash  flows  from  this  reduction  and all
non-cash  expenses  included  in the net loss for the six month  period  totaled
$445,521.  Other  significant  operating  cash flow resulted from an increase of
$395,622 in accounts payable to vendors at June 30, 1998 compared to the balance
at December 31, 1997.

         These  operating  cash flows were  partially  used to fund increases in
accounts  receivable of $58,195 and other current  assets,  principally  prepaid
expenses, of $209,048 at June 30, 1998, compared to the balances at December 31,
1997.  Other  significant  uses of operating  cash flows were to reduce  accrued
expenses and other liabilities to $468,817 at June 30, 1998 compared to $559,776
at December 31, 1997.

         The  revolving  credit  facility with FINOVA is based upon the level of
the Company's accounts  receivable and inventory.  At June 30, 1998 and December
31,  1997,  the Company had  additional  availability  on the  revolving  credit
facility of approximately $189,715 and $377,000,  respectively. As the Company's
sales and operations expand requiring larger investments in accounts  receivable
and  inventory,  the Company could have almost  $3,000,000  in additional  funds
available under the revolving credit facility.

         The largest  non-operating  uses of cash  beyond  debt  payments in the
first six  months of 1998  were for the  payment  of  deferred  financing  costs
related  to the FINOVA  transaction  closed on  November  21,  1997 and  capital
expenditures.  The  deferred  financing  cost paid  during the six month  period
totaled $140,627,  and cash used for capital  expenditures  totaled $56,642. The
capital expenditures  principally relate to the new computer system installed in
Fort Worth,  warehouse fixtures and other equipment additions or replacements at
various sales/distribution units.

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


Subsequent Event

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

         As previously  reported,  The Schlinger Foundation is the holder of the
Company's $1,000,000 subordinated debt that is partially convertible into common
stock. Pursuant to the terms of the new consulting agreement, Mr. Schlinger will
serve in his advisory capacity for the next eighteen months to be compensated by
the  issuance  of a warrant to  acquire  common  stock.  The  warrant  agreement
provides for  issuance of 200,000  shares of the  Company's  common stock at the
market  value on the date of grant.  The  warrant  will  have a five year  term.
Copies of the final  agreement  and  warrant  will be filed as  Exhibits  to the
Company's Third quarter report on Form 10-Q.


                                       12

<PAGE>


Cautionary Statement

         The disclosures under "-Results of Operations";  "-Outlook";  "-Capital
Resources and Liquidity";  and in the Notes to Consolidated Financial Statements
as provided elsewhere herein contain forward-looking  statements and projections
of management.  There are certain important factors which could cause results to
differ  materially  than  those  anticipated  by  some  of  the  forward-looking
statements.  Some of the important  factors which could cause actual  results to
differ materially from those in the forward-looking  statements  include,  among
other things:  changes from anticipated  levels of sales,  whether due to future
national or regional  economic and competitive  conditions,  including,  but not
limited to, retail craft buying patterns, continued negative trends in the craft
and western  retail  markets,  customer  acceptance  or not of existing  and new
products,   and  pricing  pressures  due  to  competitive  industry  conditions.
Additional  factors  that  may  result  in  different  actual  results  include:
increased prices for leather,  which is a world-wide commodity,  that can not be
passed on to customers for some reason,  change in tax rates, change in interest
rates,  change  in  the  commercial  banking  environment,   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.












                                       13


<PAGE>

 
                           PART II. OTHER INFORMATION


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

        On May 21, 1998 the Annual  Meeting of the  Stockholders  of the Company
was held in the El Dorado room at the Arlington Hilton Hotel,  Arlington,  Texas
to consider and act on the following matter:

        (1)  To elect the following  individuals to serve as directors until the
             Company's  1999  Annual  Meeting  of  Stockholders  or until  their
             successors are duly elected and qualified:


               Wray Thompson                        Anthony C. Morton
               Ronald C. Morgan                     H. W. "Hub" Markwardt
               Robin L. Morgan                      Joseph R. Mannes
               William M. Warren                    John Tittle, Jr.


        As to item (1) above, the following table depicts the votes cast for and
against, as well as those which abstained from voting, as to the election of the
aforementioned individuals as a director of the Company as noted above:


                                         For          Against      Abstaining
                                      ---------       -------      ----------
         
        Wray Thompson                 9,269,349        3,559         33,200
        Ronald C. Morgan              9,269,249        3,659         33,200
        Robin L. Morgan               9,269,349        3,559         33,200
        William M. Warren             9,269,349        3,559         33,200
        Anthony C. Morton             9,269,249        3,659         33,200
        H. W. "Hub" Markwardt         9,269,349        3,559         33,200
        Joseph R. Mannes              9,268,049        4,859         33,200
        John Tittle, Jr.              9,268,549        4,359         33,200

The foregoing  matters are described in detail in the Company's  proxy statement
dated April 21, 1998 for the 1998 Annual Meeting of Stockholders.


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

        None

                                       14

<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: August 14, 1998                  /s/ Wray Thompson
                                       -----------------
                                           Wray Thompson
                                           Chairman of the Board, President,
                                           and Chief Executive Officer



Date: August 14, 1998                  /s/ Anthony C. Morton
                                       ---------------------
                                           Anthony C. Morton
                                           Chief Financial Officer,
                                           Treasurer and Director
                                           (Chief Accounting Officer)






                                       15


<PAGE>


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

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

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

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

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

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

     4.4  Term  Loan C Note  (Term  Loan C)  dated  November  21,  1997,  in the
          principal amount of $1,500,000, payable to the order of FINOVA Capital
          Corporation,  which  matures  December 1, 1999 filed as Exhibit 4.5 to
          the  Current  Report  on  Form  8-K  of  The  Leather  Factory,   Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission on February 6, 1998, and incorporated by reference herein.

     4.5  Subordination Agreement dated November 21, 1997, by and between FINOVA
          Capital Corporation,  The Schlinger  Foundation,  The Leather Factory,
          Inc.,  a Delaware  corporation,  The Leather  Factory,  Inc.,  a Texas
          corporation,  The  Leather  Factory,  Inc.,  an  Arizona  corporation,
          Hi-Line Leather & Manufacturing Company, a California corporation, and
          Roberts,  Cushman & Company,  Inc.,  a New York  corporation  filed as
          Exhibit 4.6 to the Current Report on Form 8-K of The Leather  Factory,
          Inc.  (Commission  File No.  1-12368)  filed with the  Securities  and
          Exchange Commission on February 6, 1998, and incorporated by reference
          herein.

     4.6  Pledge  Agreement  dated  November 21, 1997, by and between  Ronald C.
          Morgan and Robin L.  Morgan and FINOVA  Capital  Corporation  filed as
          Exhibit 4.7 to the Current Report on Form 8-K of The Leather  Factory,
          Inc.  (Commission  File No.  1-12368)  filed with the  Securities  and
          Exchange Commission on February 6, 1998, and incorporated by reference
          herein.

     4.7  Patent Security  Agreement dated November 21, 1997, by and between The
          Leather Factory,  Inc., a Delaware  corporation,  The Leather Factory,
          Inc.,  a Texas  corporation,  The Leather  Factory,  Inc.,  an Arizona
          corporation,  Hi-Line  Leather & Manufacturing  Company,  a California
          corporation, Roberts, Cushman & Company, Inc., a New York corporation,
          and FINOVA  Capital  Corporation  filed as Exhibit  4.8 to the Current
          Report on Form 8-K of The Leather Factory,  Inc.  (Commission File No.
          1-12368) filed with the Securities and Exchange Commission on February
          6, 1998, and incorporated by reference herein.




                                       16

<PAGE>




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


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


     4.8  Trademark  Security  Agreement dated November 21, 1997, by and between
          The  Leather  Factory,  Inc.,  a  Delaware  corporation,  The  Leather
          Factory,  Inc., a Texas  corporation,  The Leather  Factory,  Inc., an
          Arizona  corporation,  Hi-Line  Leather  &  Manufacturing  Company,  a
          California corporation,  Roberts,  Cushman & Company, Inc., a New York
          corporation,  and FINOVA Capital  Corporation  filed as Exhibit 4.9 to
          the  Current  Report  on  Form  8-K  of  The  Leather  Factory,   Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission on February 6, 1998, and incorporated by reference herein.

     4.9  Copyright  Security  Agreement dated November 21, 1997, by and between
          The  Leather  Factory,  Inc.,  a  Delaware  corporation,  The  Leather
          Factory,  Inc., a Texas  corporation,  The Leather  Factory,  Inc., an
          Arizona  corporation,  Hi-Line  Leather  &  Manufacturing  Company,  a
          California corporation,  Roberts,  Cushman & Company, Inc., a New York
          corporation,  and FINOVA Capital  Corporation filed as Exhibit 4.10 to
          the  Current  Report  on  Form  8-K  of  The  Leather  Factory,   Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission on February 6, 1998, and incorporated by reference herein.

     4.10 Promissory Note  (Subordinated  Debenture) dated November 14, 1997, in
          the  principal  amount  of  $1,000,000,  payable  to the  order of The
          Schlinger Foundation,  which matures December 1, 1999 filed as Exhibit
          4.11 to the Current  Report on Form 8-K of The Leather  Factory,  Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission on February 6, 1998, and incorporated by reference herein.

     4.11 Pledge and Security  Agreement dated November 14, 1997, by and between
          The Schlinger  Foundation and J. Wray  Thompson,  Sr. filed as Exhibit
          4.12 to the Current  Report on Form 8-K of The Leather  Factory,  Inc.
          (Commission  File No.  1-12368) filed with the Securities and Exchange
          Commission on February 6, 1998, and incorporated by reference herein.

     4.12 Amendment to Loan and Security  Agreement  dated May 13, 1998,  by and
          between The Leather Factory, Inc., a Delaware corporation, The Leather
          Factory,  Inc., a Texas  corporation,  The Leather  Factory,  Inc., an
          Arizona  corporation,  Hi-Line  Leather  &  Manufacturing  Company,  a
          California corporation,  Roberts,  Cushman & Company, Inc., a New York
          corporation,  and FINOVA  Capital  Corporation  effective  as of March
          31,1998 filed as Exhibit 4.15 to the Quarterly  Report on Form 10-Q of
          The Leather Factory, Inc. (Commission File No. 1-12368) filed with the
          Securities and Exchange  Commission on May 15, 1998, and  incorporated
          by reference herein.


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

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





                                       17


<PAGE>











                                  EXHIBIT 27.1