Definitely too dried out but probably not the oven. I've seen sheaths baked too much and that ain't them. I wiped out a batch of 30 one time and another batch of 10 another time. I simply forgot about them. I've also seen scorch marks. But not cracks. I'm running the oven these days at 178 and go for three hours flipping every hour. I set an alarm so that I do remember to flip and to take em out when done. Ya bake em too long and they turn like jerky, they don't crack, they shrivel down and misshape, like jerky. I did 14 sheaths yesterday following this formula and 30 the day before and probably another 25 or so today. Wasn't the oven. I get almost no shrinkage. A hint here and there but if it fits well wet molded it fits well after being baked. Are you using the same leather for the welt as the sheath? I have seen using different leathers where the welt will shrink back from the edge. I try to avoid using different leather for the welt. That may be part of your glueing problem but not the crack.
To me just going off the pic and I've been thinking about it a while, that looks like a stress crack from shaping over an object when too dry or stretching the leather too far over the object, again while too dry. But its too dry for shaping or too dry for stretching not because the leather is dried out. I use to get those once in a while on my slotted sheaths which is a pouch type sheath. I'd just not have the leather cased enough to do the folding in half and get those cracks, usually down at the tip or sometimes at the throat. So rereading your post with the pic right now about the crack just sounds like mis measurement a little. The sheath was just too tight in that area for that knife. If I get that I use a rat tail file on the welt side. This will usually relieve it enough that I can get the knife in correctly. Sometimes I miss and end up filing into the stitches on the welt. Thats a pisser for sure. Once your leather is dry whether it sits on the bench, car dash, window sill, or in the oven, (don't try the microwave, I did once, with a pair of spur straps, spongy jerky), its not the right time to shape or stretch it and that looks like what happened here. As a side I've also seen leather crack/tear like that around a scar but I don't really see any scarring in the pic.
Ya know on each batch of say 50 sheaths or so, its not unusual for me to miss one and usually because its too tight but sometimes too loose. I make that call when I'm wet forming the sheath to the knife most of the time but occasionally after baking. If I have one that doesn't work I keep it in a drawer. Sooner or later I'll find something that works with it, almost always. In my previous batch of knives (not the one I'm working on now) I had a Coyote model with an elk that I ended up making three sheaths for before I got it right. What happened? Who knows? I've made thousands of sheaths for my Coyote model, its our second biggest seller. But this one took me three times to get er right. Quien sabe? I think its gets to be kinda a feel thing with experience, whats too tight and whats too loose.
I have in the past when having made one that was too tight but I thought it was still salvageable, re wet it and start all over on the molding. This has worked sometimes and sometimes the leather just didn't have that much stretch. Again it kinda becomes a judgement call and good judgement comes from experience and experience usually comes a little from bad judgement. Hope this helps some.