|                                  
|----------------------------------
|UNITED STATES                     
|SECURITIES AND EXCHANGE COMMISSION
|WASHINGTON,
 D.C. 20549           
|                                  
|FORM 10-K                         

|                                                                                  |                                                                                      
|--------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------
|x                                                                                 | ANNUAL REPORT PURSUANT
 TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|                                                                                 
|FOR THE FISCAL YEAR ENDED JANUARY 30, 2010                                       
|OR                                                                               
|TRANSITION REPORT
 PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT
|FOR THE TRANSITION PERIOD FROM  TO                                           
|                                                                                 
|COMMISSION FILE NUMBER: 0-14818                                                  

|                                                       |                                        | 
|------------------------------------------------------ | -------------------------------------- | 
|                                                       | TRANS
 WORLD ENTERTAINMENT CORPORATION | 
|                                                       |                                        | 
|(Exact name of registrant as specified in its charter)

|                                                               |          |                                         |  |  |            | 
|-------------------------------------------------------------- | -------- | --------------------------------------- |  |  | ---------- | 
|                                                               | New York |                                         |  |  | 14-1541629 | 
|                                                               |          |                                         |  |  |            | 
|(State or other jurisdiction of incorporation or organization) |          | (I.R.S. Employer Identification Number)

|                                                             |                        | 
|------------------------------------------------------------ | ---------------------- | 
|38 Corporate Circle                                         
|                                                             | Albany, New York 12203 | 
|                                                             |                        | 
|(Address of principal executive offices, including zip code)

|                                                                                           |                | 
|------------------------------------------------------------------------------------------ | -------------- | 
|                                                                                           | (518) 452-1242 | 
|                                                                                           |                | 
|(Registrants telephone number, including area code)                                      
|                                                                                          
|Securities registered pursuant to Section 12(b) of the Act: None                          
|                                                                                          
|Securities registered pursuant to Section 12(g) of the Act: Common
 Stock, $0.01 par value

Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in the Rule 405 of the Securities Act.
Yes o No
x

Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or Section
15(d) of the Act. Yes o No x

Indicate by a
check mark whether the Registrant (1) has filed all reports required to be
filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for 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 o

Indicate by
check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the Registrants Knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or an amendment to this
Form 10-K. x

Indicate by
checkmark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer or a smaller reporting company (as defined in
Rule 12b-2 of the Act).

Large
accelerated filer o
          Accelerated filer o
          Non-accelerated
filer x
          Small reporting
company o

Indicate by
check mark whether the registrant is a shell company (as defined in Rule 12b-2
of the Act).           Yes o No x

As of August
1, 2009, 56,498,429 shares of the Registrants Common Stock, excluding
25,102,990 shares of stock held in Treasury, were issued and outstanding. The
aggregate market value of the voting stock held by non-affiliates of the
Registrant, based upon the closing sale price of the Registrants Common Stock
on August 1, 2009 as reported on the National Market tier of The NASDAQ Stock
Market, Inc. was $19,979,585. Shares of Common Stock held by the Companys
controlling shareholder, who controlled approximately 42.7% of the outstanding
Common Stock, have been excluded for purposes of this computation. Because of
such shareholders control, shares owned by other officers, directors and 5%
shareholders have not been excluded from the computation. As of March 28, 2010,
there were 31,395,439 shares of Common Stock Issued and Outstanding.

|                                                                                                                                               |  |                                                                         
|---------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------------------------------------------------------
|Documents of Which Portions Are Incorporated by Reference                                                                                      |  | Parts of the Form 10-K into Which Portion of Documents are
 Incorporated
|                                                                                                                                               |  |                                                                         
|Proxy Statement for Trans World Entertainment Corporations June 16,
 2010 Annual Meeting of Shareholders to be filed on or about May 19, 2010 |  | III                                                                     

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PART I

Cautionary Statement for Purposes of the
Safe Harbor Provisions of the Private Securities Litigation Reform Act of
1995

This document
includes forward-looking statements within the meaning of the Private
Securities Litigation Reform Act of 1995. These statements relate to analyses
and other information that are based on forecasts of future results and
estimates of amounts not yet determinable. These statements also relate to the
Companys future prospects, developments and business strategies. The
statements contained in this document that are not statements of historical
fact may include forward-looking statements that involve a number of risks and
uncertainties.

We have used
the words anticipate, believe, could, estimate, expect, intend,
may, plan, predict, project, and similar terms and phrases, including
references to assumptions, in this document to identify forward-looking
statements. These forward-looking statements are made based on managements
expectations and beliefs concerning future events and are subject to
uncertainties and factors relating to our operations and business environment,
all of which are difficult to predict and many of which are beyond the
Companys control, that could cause actual results to differ materially from
those matters expressed in or implied by these forward-looking statements. The
following factors are among those that may cause actual results to differ
materially from the Companys forward-looking statements.

| |   |                                                                           
| | - | --------------------------------------------------------------------------
| |  | highly competitive nature of the retail entertainment business;           
| |   |                                                                           
| |  | current economic conditions;                                              
| |   |                                                                           
| |  | competitive pricing;                                                      
| |   |                                                                           
| |  | adverse publicity;                                                        
| |   |                                                                           
| |  | interest rate fluctuations;                                               
| |   |                                                                           
| |  | dependence on key employees;                                              
| |   |                                                                           
| |  | accelerated declines in music compact disc (CD) and DVD industry
 sales;
| |   |                                                                           
| |  | vendor terms/support;                                                     
| |   |                                                                           
| |  | the Companys level of debt and related restrictions and limitations;     
| |   |                                                                           
| |  | new product introductions (hit releases);                               
| |   |                                                                           
| |  | future cash flows;                                                        
| |   |                                                                           
| |  | availability of new real estate;                                          
| |   |                                                                           
| |  | new technology, including digital downloading;                            
| |   |                                                                           
| |  | product liability claims, and                                             
| |   |                                                                           
| |  | change in laws;                                                           

The reader
should keep in mind that any forward-looking statement made by us in this document,
or elsewhere, speaks only as of the date on which we make it. New risks and
uncertainties come up from time-to-time, and its impossible for us to predict
these events or how they may affect us. In light of these risks and
uncertainties, you should keep in mind that any forward-looking statements made
in this report or elsewhere might not occur.

In addition,
the preparation of financial statements in accordance with accounting
principles generally accepted in the United States (GAAP) requires us to make
estimates and assumptions. These estimates and assumptions affect:

| |   |                                                                        
| | - | -----------------------------------------------------------------------
| |  | the reported
 amounts and timing of revenue and expenses,              
| |   |                                                                        
| |  | the reported
 amounts and classification of assets and liabilities, and
| |   |                                                                        
| |  | the
 disclosure of contingent assets and liabilities.                  

Actual results
may vary from our estimates and assumptions. These estimates and assumptions
are based on historical results, assumptions that we make, as well as
assumptions by third-parties.

Item 1. BUSINESS

Company Background

Trans World
Entertainment Corporation, which, together with its consolidated subsidiaries,
is referred to herein as the Company, we, us and our, was incorporated
in New York in 1972. It owns 100% of the outstanding common stock of Record
Town, Inc., through which its principal operations are conducted. The Company
operates retail stores and four e-commerce sites and is one of the largest
specialty retailers of entertainment software, including music, video, and
video games and related products in the United States.

Stores
and Store Concepts

At January 30,
2010, the Company operated 557 stores totaling approximately 3.8 million square
feet in the United States, the District of Columbia, the Commonwealth of Puerto
Rico and the U.S. Virgin Islands.

2

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Mall Stores

At January 30,
2010, the Company operated 449 mall-based stores, predominantly under the
f.y.e. (For Your Entertainment) brand, including:

| |                                                                                                                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Traditional stores.
 The traditional store averages about 5,900 square feet and carries a full
 complement of entertainment software, including music, video and related
 accessories. There were 398 traditional f.y.e. mall based stores at the end
 of Fiscal 2009.                       
| |                                                                                                                                                                                                                                                                                              
| | Superstores. The superstores carry the same merchandise categories as traditional
 locations, but with a much larger assortment. There were 10 f.y.e. mall
 superstores at the end of Fiscal 2009 that averaged about 28,500 square feet.                                                    
| |                                                                                                                                                                                                                                                                                              
| | Video only stores.The Company operated 41 video only stores,
 under the Suncoast Motion Pictures and Saturday Matinee brands. These stores
 specialize in the sale of video and related accessories. They are located in
 large, regional shopping malls and average about 2,400 square feet.

Freestanding Stores

The Company
operated 108 freestanding stores as of January 30, 2010, including 9 f.y.e.
superstores, under the f.y.e. brand. They carry a full complement of
entertainment software, including music, video and related accessories and are
located in freestanding, strip center and downtown locations. The freestanding
stores, excluding the superstores, average approximately 6,900 square feet. The
freestanding f.y.e. Superstores average about 44,100 square feet. The Company
closed two of the f.y.e. superstores in the first quarter of 2010.

E-Commerce Sites

The Company
operates four retail web sites including, www.fye.com, www.wherehouse.com,
www.secondspin.com, and www.suncoast.com. These sites offer substantially the
same complement of products as offered in the Companys stores.

Merchandise Categories

Net sales by
merchandise category as a percentage of total net sales for Fiscal 2009, 2008
and 2007, and comparable store sales for Fiscal 2009 and 2008, were as follows:

|            |  |       |   |                          |       |      |  |                          |   |      |       |    |  |       |   | 
|----------- |  | ----- | - | ------------------------ | ----- | ---- |  | ------------------------ | - | ---- | ----- | -- |  | ----- | - | 
|            |  |       |   |                          |       |      |  |                          |   |      |       |    |  |       |   | 
|            |  | 2009  |   | Comparable 
 Store Sales |       | 2008 |  | Comparable 
 Store Sales |   | 2007 |      
|            |  |       |   |                          |       |      |  |                          |   |      |      
|Music       |  | 35.2  | % |                          | (11.2 | %)   |  | 35.4                     | % |      | (20.2 | %) |  | 39.1  | % | 
|Video       |  | 41.7  |   |                          | (7.5  | )    |  | 41.3                     |   |      | (3.1  | )  |  | 38.8  |   | 
|Video games |  | 8.6   |   |                          | (15.7 | )    |  | 9.1                      |   |      | (14.3 | )  |  | 9.0   |   | 
|Other       |  | 14.5  |   |                          | (8.5  | )    |  | 14.2                     |   |      | (0.6  | )  |  | 13.1  |   | 
|            |  |       |   |                          |       |      |  |                          |   |      |       |    |  |       |   | 
|Total       |  | 100.0 | % |                          | (9.8  | %)   |  | 100.0                    | % |      | (10.8 | %) |  | 100.0 | % | 
|            |  |       |   |                          |       |      |  |                          |   |      |       |    |  |       |   | 

The Other
category includes electronics, accessories and trend items, none of which
individually exceeded 10% of total net sales.

Business Environment

Music, video
and video games represent an approximately $34 billion industry nationwide, and
represented approximately 86% of the Companys net sales in Fiscal 2009.

According to
statistical information from Nielsen Sound Scan (SoundScan), the total number
of music albums sold, including CD and digital albums, decreased 12% to
approximately 375 million units in 2009. Excluding digital albums, album sales
decreased 18% to approximately 292 million units. In 2008, the total number of
music albums sold, including CD, cassette and digital albums decreased 13%
compared to 2007. Excluding digital albums, album sales in 2008 decreased 20%
compared to 2007.

According to
statistics obtained from Warner Brothers Home Entertainment, overall video
retail sales in 2009 were $10.3 billion, a decrease of 15% from 2008. Video
retail sales in 2008 decreased 9% compared to 2007.

The NPD Group,
Inc. (NPD) published that video games retail sales, including portable and
console hardware, software and accessories, were $19.5 billion in 2009, a
decrease of 10% from 2008 sales. Video game sales in 2008 were $21.3 billion,
an increase of 19% over 2007 sales.

3

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Competition

CD sales have
suffered from the legal (e.g., iTunes) and illegal downloading of music and
specialty retailers have been impacted by the proliferation of mass merchants
(e.g., Wal-Mart and Target) and electronics superstores (e.g., Best Buy) that
offer entertainment software and, collectively, have gained a larger share of the
market. The number of specialty and independent retailers has decreased
dramatically due to their reliance on sales of CDs. The Company has taken
advantage of competitor exits from markets, made acquisitions, diversified its
products and taken other measures to position itself competitively within its
industry. The Company believes it effectively competes in the following ways:

| |   |                                                                                                                                                                                                
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | § | Location and
 convenience: a strength of the Company is its convenient store locations that
 are often the exclusive retailer in centers offering a full complement of
 entertainment software;
| |   |                                                                                                                                                                                                
| | § | Marketing:
 the Company uses newspaper, radio and television advertising and in-store
 visual displays to market to consumers;                                                                 
| |   |                                                                                                                                                                                                
| | § | Selection
 and assortment: the Company maintains a high in-stock position in a large
 assortment of product, particularly CDs and DVDs;                                                        
| |   |                                                                                                                                                                                                
| | § | Customer
 service: the Company believes it offers personalized customer service at its
 stores.                                                                                                

Seasonality

The Companys
business is seasonal, with its fourth fiscal quarter constituting the Companys
peak selling period. In Fiscal 2009, the fourth quarter accounted for
approximately 36% of annual net sales. In anticipation of increased sales
activity during these months, the Company purchases additional inventory and
hires additional temporary employees to supplement its full-time store sales
staff. If, for any reason, the Companys net sales were below seasonal norms
during the fourth quarter, the Companys operating results could be adversely
affected. Quarterly sales can also be affected by the timing of new product
releases, new store openings or closings and the performance of existing
stores.

Advertising

The Company
makes use of visual displays. It uses a mass-media marketing program, including
newspaper, radio, and television advertisements. Certain vendors from whom the
Company purchases merchandise offer advertising allowances, of varying duration
and amount, to promote their merchandise.

Suppliers and Purchasing

The Company
purchases inventory from approximately 520 suppliers. In Fiscal 2009, 66% of
purchases were made from ten suppliers including EMI Music Distribution,
Sony-Bertelsmann Music Group, Warner/Electra/Atlantic Corp., Universal Music
Group, Fox Video Inc., Paramount Video, Buena Vista Video, Warner Home
Entertainment, Universal Studios Home Entertainment and Sony Pictures. The
Company does not have material long-term purchase contracts; rather, it
purchases products from its suppliers on an order-by-order basis. Historically,
the Company has not experienced difficulty in obtaining satisfactory sources of
supply and management believes that it will continue to have access to adequate
sources of supply.

Trade Customs and Practices

Under current
trade practices with large suppliers, retailers of music and video products are
generally entitled to return unsold merchandise they have purchased in exchange
for other titles carried by the suppliers. The four largest music suppliers
charge a related merchandise return penalty or return handling fee. Most
manufacturers and distributors of video products do not typically charge a
return penalty or handling fee. Under current trade practices with large
suppliers, retailers of video games and related products may receive markdown
support from suppliers to help clear slow turning merchandise. Merchandise
return policies and other trade practices have not changed significantly in
recent years. The Company generally adapts its purchasing policies to changes
in the policies of its largest suppliers.

Employees

As of January
30, 2010, the Company employed approximately 5,700 people, of whom
approximately 2,400 were employed on a full-time basis. Others were employed on
a part-time or temporary basis. The Company hires seasonal sales employees
during its fourth quarter peak selling season to ensure continued levels of
customer service. Store managers, district managers and regional managers are
eligible to receive incentive compensation based on the sales and/or
profitability of stores for which they are responsible. Sales support managers
are generally eligible to receive incentive compensation based on achieving
Company performance targets. None of the Companys employees are covered by
collective bargaining agreements and management believes that the Company
enjoys favorable relations with its employees.

4

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Information Systems

The Company
utilizes primarily IBM AS400 technology to run its management information
systems, including its merchandising, distribution and financial systems.
Management believes its systems contribute to enhanced customer service and
operational efficiency, as well as provide the ability to monitor critical
performance indicators versus plans and historical results.

Available Information

The
Companys headquarters are located at 38 Corporate Circle, Albany, New York
12203, and its telephone number is (518) 452-1242. The Companys corporate web
site address is www.twec.com. The Company makes available, free of charge, its
Exchange Act Reports (Forms 10-K, 10-Q, 8-K and any amendments thereto) on its
web site as soon as practical after the reports are filed with the Securities
and Exchange Commission (SEC). The public may read and copy any materials the
Company files with the SEC at the SECs Public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. Information on the operation of the
Public Reference Room can be obtained by calling the SEC at 1-800-SEC-0330. The
SEC maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC. This information can be obtained from the site
http://www.sec.gov. The Companys Common Stock, $0.01 par value, is quoted on
the NASDAQ National Market under the trading symbol TWMC. The Companys
fiscal year end is the Saturday closest to January 31. The Fiscal 2009 (Fiscal
2009) year ended on January 30, 2010; Fiscal 2008 (Fiscal 2008) year ended
on January 31, 2009; and Fiscal 2007 (Fiscal 2007) year ended on February 2,
2008.

Item 1A. RISK FACTORS

The following
is a discussion of certain factors, which could affect the financial results of
the Company.

The Companys results of operations are
affected by the availability of new products.

The Companys
business is affected by the release of hit music, video and video game
titles, which can create fluctuations in sales. It is not possible to determine
the timing of these fluctuations or the future availability of hit titles. The
Company is dependent upon the major music and movie producers to continue to
produce hit products. To the extent that new hit releases are not available, or
not available at prices attractive to consumers, or, if manufacturers fail to
introduce or delay the introduction of new products, the Companys results of
operations may be adversely affected.

The Companys results of operations may
suffer if the Company does not accurately predict consumer acceptance of new
product or distribution technologies.

The
entertainment industry is characterized by changing technology, evolving format
standards, frequent new and enhanced product introductions and rapid product
obsolescence. These characteristics require that the Company respond quickly to
technological changes and understand the impact of these changes on customers
preferences. If the Company is unable to participate in new product or
distribution technologies, its results of operations may suffer. Specifically,
the CD and DVD formats have experienced a continuous decline as digital forms
of music and video content have become more prevalent. If the Company does not
timely adapt to these changing technologies or sufficiently focus on the other
core categories, operating results could significantly suffer.

Increased competition from existing retailers
and alternative distribution channels has adversely affected the Companys
results of operations.

The Company
competes with a wide variety of entertainment retailers, including
deep-discount retailers, mass merchandisers, consumer electronics outlets,
internet retailers and independent operators, some of whom have greater
financial and other resources than the Company. The Company also expects
continued growth in competing home entertainment options. Some of these,
including the ability to download music, video and video games onto PCs or
other devices, or the ability to play video games over the Internet through
consoles, could reduce retail sales of CDs, DVDs and video games. If
technological advances were to result in significant changes in existing
distribution channels for pre-recorded music, video and video games, the
Companys results of operations could be adversely affected.

In addition, the Companys success depends on our ability to positively
differentiate ourselves from other retailers. The retail business
is highly competitive. In the past the Company has been able to compete
successfully by differentiating our customer shopping experience by creating an
attractive value proposition through a careful combination of price,
merchandise assortment, convenience, customer service and marketing efforts.
Customer perceptions regarding our stores and our in-stock levels and deep
assortment of product are also factors in our ability to compete. No single
competitive factor is dominant, and actions by our competitors on any of these
factors could have an adverse effect on our sales, gross profit and expenses.
If we fail to continue to positively differentiate ourselves from our
competitors, our results of operations could be adversely affected.

The Companys business is negatively influenced
by the general economic conditions and the disruption of capital and credit
markets

The Companys
performance is subject to general economic conditions and their impact on
levels of discretionary consumer spending, which have continued to deteriorate
and may remain depressed for the foreseeable future. General economic
conditions impacting discretionary

5

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consumer
spending include, among others, wages and employment, consumer debt, reductions
in net worth based on recent severe market declines, residential real estate
and mortgage markets, taxation, fuel and energy prices, interest rates,
consumer confidence and other macroeconomic factors.

Consumer
purchases of discretionary items, such as our merchandise, generally decline
during recessionary periods and other periods where disposable income is
adversely affected. The current downturn in the economy affects retailers
disproportionately, as consumers may prioritize reductions in discretionary
spending, which could have a direct impact on purchases of our merchandise and
adversely impact our results of operations and continued growth. In addition,
reduced consumer spending may drive us and our competitors to offer additional
products at promotional prices, which would have a negative impact on gross
profit. The Company cannot predict how long the current economic, capital and
credit market conditions will continue and what impact they will have on our
business.

Disruption of global capital and credit
markets may have a material adverse effect on the Companys liquidity and
capital resources.

The current
distress in the financial markets has resulted in extreme volatility in
security prices and diminished liquidity and credit availability, and there can
be no assurance that our liquidity will not be affected by changes in the
financial markets and the global economy or that our capital resources will at
all times be sufficient to satisfy our liquidity needs. We believe that cash
provided by sales of merchandise inventory and available borrowing capacity
under our credit facility, which expires in April 2013, will provide us with
sufficient liquidity through the expiration of this credit facility.

The current
credit crisis is having a significant negative impact on businesses around the
world, and the impact of this crisis on our major suppliers cannot be
predicted. The inability of key suppliers to access liquidity, or the
insolvency of key suppliers, could lead to delivery delays or failures.

Historically, we have experienced declines
and we may continue to experience fluctuation in our level of sales, results
from operations and operating cash flow.

A variety of
factors has historically affected, and will continue to affect, our comparable
stores sales results and profit margins. These factors include general regional
and national economic conditions; competition; actions taken by our
competitors; consumer trends and preferences; new product introductions and
changes in our product mix; timing and effectiveness of promotional events and
weather. The Companys comparable store sales may decline further than they did
in Fiscal 2009, and they may vary from quarter to quarter as our business is
highly seasonal in nature. Our highest sales and operating income historically
occur during the fourth fiscal quarter, which is due in part, to the holiday
selling season. The fourth quarter generated approximately 36% of our net sales
for Fiscal 2009. Any decrease in our fourth quarter sales, whether because of a
slow holiday selling season, unseasonable weather conditions, economic
conditions or otherwise, could have a material adverse effect on our business,
financial condition and operating results for the entire fiscal year. There is
no assurance that we will achieve positive levels of sales and earnings growth,
and any decline in our future growth or performance could have a material
adverse effect on our business and results of operations.

Failure to open new stores may limit our
earnings.

Historically,
the Companys growth has come from the opening of new stores and the
acquisition of stores. The Company opens new stores if it finds desirable
locations and is able to negotiate suitable lease terms. A lack of new store
growth may impact the Companys ability to increase sales and earnings. The
Company opened two new stores in Fiscal 2009 and acquired five new stores in
the first quarter of 2010.

A change in one or more of the Companys
vendors policies or the Companys relationship with those vendors could
adversely affect the Companys results of operations.

The Company is
dependent on its vendors to supply merchandise in a timely and efficient
manner. If a vendor fails to deliver on its commitments, whether due to
financial difficulties or other reasons, the Company could experience
merchandise shortages that could lead to lost sales.

The majority
of the Companys purchases come from ten major suppliers. As is standard in its
industry, the Company does not maintain long-term contracts with its suppliers
but instead makes purchases on an order-by-order basis. If the Company fails to
maintain customary trade terms or enjoy positive vendor relations, it could
have an adverse effect on the Companys results of operations.

If the Companys vendors fail to provide
marketing and merchandising support at historical levels, the Companys results
of operations could be adversely affected.

The
manufacturers of entertainment products have typically provided retailers with
significant marketing and merchandising support for their products. As part of
this support, the Company receives cooperative advertising and other allowances
from these vendors. These allowances enable the Company to actively promote and
merchandise the products it sells at its stores and on its websites. If the
Companys vendors fail to provide this support at historical levels, the
Companys results of operations could be negatively impacted.

6

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Loss of Key Personnel or the inability to
attract, train and retain qualified employees could adversely affect the
Companys results of operations.

The Company
believes that its future prospects depend, to a significant extent, on the
services of its executive officers, particularly, Robert J. Higgins, our
Chairman and Chief Executive Officer. Our future success will also depend on
our ability to attract and retain qualified key personnel. The loss of the
services of certain of the Companys executive officers and other key
management personnel could adversely affect the Companys results of
operations. In particular, if we were to lose the services of Robert J.
Higgins, we may not able to replace his skills and experience.

In addition to
our executive officers, the Companys business is dependent on our ability to
attract, train and retain a large number of qualified team members. Many of
those team members are employed in entry-level or part-time positions with
historically high turnover rates. Our ability to meet our labor needs while
controlling our costs is subject to external factors such as unemployment
levels, health care costs and changing demographics. If we are unable to
attract and retain adequate numbers of qualified team members, our operations,
customer service levels and support functions could suffer. Those factors,
together with increased wage and benefit costs, could adversely affect our
results of operations.

Because our
Chairman and Chief Executive Officer owns approximately 44.7% of the
outstanding Common Stock, he has significant influence and control over the
outcome of any vote of the Companys Shareholders.

Robert J.
Higgins serves as Chairman of the Board of the Company and its Chief Executive
Officer and owns approximately 44.7% of the outstanding Common Stock of the
Company, as of March 30, 2010. Accordingly, he will have significant influence
on the outcome of any vote of the Companys Shareholders and on the policies
and affairs of the Company. His interests may differ from the interests of the
other stockholders.

Failure to comply with legal and
regulatory requirements could adversely affect the Companys results of
operations.

The Companys
business is subject to a wide array of laws and regulations. Significant
legislative changes that impact our relationship with our workforce (none of
which is represented by unions) could increase our expenses and adversely
affect our operations. Examples of possible legislative changes impacting our
relationship with our workforce include changes to an employers obligation to
recognize collective bargaining units, the process by which collective
bargaining units are negotiated or imposed, minimum wage requirements, and
health care mandates.

Our policies,
procedures and internal controls are designed to comply with all applicable
laws and regulations, including those imposed by the Securities and Exchange
Commission and the New York Stock Exchange, as well as applicable employment
laws. Additional legal and regulatory requirements increase the complexity of
the regulatory environment in which we operate and the related cost of
compliance. Failure to comply with such laws and regulations may result in
damage to our reputation, financial condition and market price of our stock.

In August
2000, the Companys Board of Directors adopted a Classified Board Amendment
which together with anti-takeover provisions of New York State Law may
discourage open market purchases or a non-negotiated tender or exchange offer
for the stock of the Company. This may be adverse to the interests of certain
shareholders.

The nature of
our business involves the receipt and storage of personal information about
certain customers. If we experience a data security breach, we could be exposed
to government enforcement actions and private litigation. In addition, our
customers could lose confidence in our ability to protect their personal
information, which could cause them to discontinue usage of our customer
loyalty programs or participation in other programs. Such events could lead to
lost future sales and adversely affect our results of operations.

We could be materially and adversely affected
if either of our distribution centers is disrupted.

We operate two
distribution centers, one in Albany, New York and the other in Carson,
California. We ship approximately 72% of our merchandise inventory through our
distribution centers. If either of our distribution centers is destroyed, or
disrupted for any reason, including because of weather or labor issues, we
could incur significantly higher costs and longer lead times associated with
distributing our products to our stores during the time it takes to reopen or
replace the centers.

In addition,
our Carson, California distribution center is located in a state where
earthquakes are prevalent. Such an event could result in significant physical
damage to or closure of this center and delay distribution of merchandise from
our suppliers to our center and stores, which could adversely affect our
results of operation. We maintain business interruption insurance to protect us
from the costs relating to matters such as a shutdown, but our insurance may
not be sufficient, or the insurance proceeds may not be timely paid to us, in
the event of a shutdown.

The Companys stock price has experienced and
could continue to experience volatility and could decline further, resulting in
a substantial loss on your investment.

Our stock
price has experienced, and could continue to experience in the future,
substantial volatility as a result of many factors, including recent global
economic conditions, broad market fluctuations and public perception of the
prospects for music and the home video industry. Changes in our comparable
store net sales results could also affect the price of our Common Stock.
Failure to meet market expectations, particularly with respect to comparable
store sales, net revenues, operating margins and earnings per share, would likely
result in a continued decline in the market price of our stock.

7

---



In addition,
an active trading market for our Common Stock may not be sustained, which could
affect the ability of our stockholders to sell their shares and could depress
the market price of their shares. The stock market in general and the market
for music and home video related stocks in particular, has been highly
volatile. For example, the closing price of our Common Stock has fluctuated
between $4.45 and $0.52 from February 2, 2008 and March 31, 2010.

As a result,
the market price of our Common Stock has been and is likely to remain volatile,
and investors in our Common Stock may experience a decrease in the value of
their stock, including decreases unrelated to our operating performance or
prospects.

The failure to maintain a minimum closing
share price of $1.00 per share of our Common Stock could result in the
delisting of our shares on The NASDAQ Global Market, which would harm the
market price of the Companys Common Stock.

In order to
retain our listing on The NASDAQ Global Market we are required by NASDAQ to
maintain a minimum bid price of $1.00 per share. Our stock price is currently
above $1.00 and has been since October 6, 2009. However, in the event that our
stock did close below the minimum bid price of $1.00 per share for any 30
consecutive business days, we would regain compliance if our Common Stock
closed at or above $1.00 per share for 10 consecutive days during the 180 days
immediately following failure to maintain the minimum bid price. If we are
unable to do so, our stock could be delisted from The NASDAQ Global Market,
transferred to a listing on The NASDAQ Capital Market, or delisted from the
NASDAQ markets altogether. The failure to maintain our listing on The NASDAQ
Global Market could harm the liquidity of the Companys Common Stock and could
have an adverse effect on the market price of our Common Stock.

If we fail to protect the security of
personal information about our customers, we could be subject to costly
government enforcement actions or private litigation and our reputation could
suffer.

The nature of
our business involves the receipt and storage of personal information about our
customers. If we experience a data security breach, we could be exposed to
government enforcement actions and private litigation. In addition, our
customers could lose confidence in our ability to protect their personal
information, which could cause them to stop shopping at our stores. Such events
could lead to lost sales and adversely affect our results of operations.

Item 1B. UNRESOLVED SEC COMMENTS

The Company
has not received within 180 days before January 30, 2010, written comments from
the Securities and Exchange Commission regarding its periodic or current
reports under the Securities Exchange Act of 1934, as amended.

8

---



Item 2. PROPERTIES

Retail Stores

At January 30,
2010, the Company operated 557 stores under operating leases, many of which
have renewal options. The majority of the leases provide for the payment of fixed
monthly rentals and expenses for maintenance, property taxes and insurance
while the others provide for the payment of monthly rentals based on a
percentage of sales. Certain leases provide for added rent based on store sales
in excess of specified levels. The following table lists the leases due to
expire as of the fiscal year-end in each of the years shown, assuming any
renewal options are not exercised:

|     |  |  |                |  |      |  |                 |  |    |  | 
|---- |  |  | -------------- |  | ---- |  | --------------- |  | -- |  | 
|Year |  |  | No. of
 Leases |  | Year |  | No. of
 Leases  | 
|     |  |  |                |  |      |  |                 | 
|    
|2010 |  |  | 278            |  |      |  | 2014            |  | 21 |  | 
|     |  |  |                |  |      |  |                 |  |    |  | 
|2011 |  |  | 92             |  |      |  | 2015            |  | 30 |  | 
|     |  |  |                |  |      |  |                 |  |    |  | 
|2012 |  |  | 87             |  |      |  | 2016            |  | 17 |  | 
|     |  |  |                |  |      |  |                 |  |    |  | 
|2013 |  |  | 25             |  |      |  | 2017 and beyond |  | 7  |  | 

As leases
expire, the Company will evaluate the decision to exercise renewal rights or
obtain new leases for the same or similar locations based on store
profitability.

Corporate Offices and Distribution Center
Facilities

The Company
leases its Albany, New York, distribution facility and corporate office space
from its largest shareholder and Chairman and Chief Executive Officer under
three capital lease arrangements that extend through 2015. These leases are at
fixed rentals with provisions for biennial increases based on increases in the
Consumer Price Index. The Company incurs all property taxes, insurance and
maintenance costs. The office portion of the facility is approximately 39,800
square feet and the distribution center portion is approximately 141,500 square
feet. The Company also leases a 198,300 square foot distribution center in
Carson, California; this lease includes a five-year renewal option and expires
in December 2010.

The Company
believes that its existing distribution facilities are adequate to meet the
Companys planned business needs. Shipments from the distribution facilities to
the Companys stores provide approximately 72% of all merchandise shipment
requirements to stores. Stores are serviced by common carriers chosen on the
basis of geography and rate considerations. The balance of the stores
merchandise requirements is satisfied through direct shipments from vendors.

The Company
leases an additional 31,700 square feet of office space in Albany, New York.
The operating lease expires in June 2014 and includes two, five-year options to
renew.

Item 3. LEGAL PROCEEDINGS

The Company is subject to various legal proceedings and claims that
have arisen in the ordinary course of its business and have not been finally
adjudicated. Although there can be no assurance as to the ultimate disposition
of these matters, it is managements opinion, based upon the information
available at this time, that the expected outcome of these matters,
individually or in the aggregate, will not have a material adverse effect on
the results of operations and financial condition of the Company.

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS

No matters
were submitted to a vote of security holders during the fourth quarter of the
fiscal year ended January 30, 2010.

9

---



PART II

Item 5. MARKET FOR THE REGISTRANTS COMMON
EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information.
The Companys Common Stock trades on the NASDAQ Stock Market under the symbol
TWMC. As of March 31, 2010, there were 462 shareholders of record. The
following table sets forth high and low last reported sale prices for each
fiscal quarter during the period from February 1, 2008 through March 31, 2010.

|                                      |  |                      |      |     |   |      | 
|------------------------------------- |  | -------------------- | ---- | --- | - | ---- | 
|                                      |  | Closing Sales Prices |     
|                                      |  |                      |     
|                                      |  | High                 |      | Low |  
|2008                                  |  |                      |      |     |   |      | 
|1st
 Quarter                          |  | $                    | 4.45 |     | $ | 3.12 | 
|2nd
 Quarter                          |  | $                    | 3.33 |     | $ | 2.34 | 
|3rd
 Quarter                          |  | $                    | 3.13 |     | $ | 1.99 | 
|4th
 Quarter                          |  | $                    | 2.35 |     | $ | 0.76 | 
|                                      |  |                      |      |     |   |      | 
|2009                                  |  |                      |      |     |   |      | 
|1st
 Quarter                          |  | $                    | 0.89 |     | $ | 0.52 | 
|2nd
 Quarter                          |  | $                    | 1.29 |     | $ | 0.69 | 
|3rd
 Quarter                          |  | $                    | 1.59 |     | $ | 0.88 | 
|4th
 Quarter                          |  | $                    | 1.64 |     | $ | 1.29 | 
|                                      |  |                      |      |     |   |      | 
|2010                                  |  |                      |      |     |   |      | 
|1st
 Quarter (through March 31, 2010) |  | $                    | 1.80 |     | $ | 1.17 | 

On March 31,
2010, the last reported sale price on the Common Stock on the NASDAQ National
Market was $1.80.

Dividend Policy: The
Company has never declared dividends on its Common Stock. The Companys amended
credit facility does not allow the payment of cash dividends.

10

---



Five-Year Performance Graph:

The following
line graph reflects a comparison of the cumulative total return of the
Companys Common Stock from January 30, 2005 through January 29, 2010 with the
Nasdaq Index (U.S. Stocks) and with the Nasdaq National Market Retail Trade
Stocks index. Because none of the Companys leading competitors has been an
independent publicly traded company over the period, the Company has elected to
compare shareholder returns with the published index of retail companies
compiled by NASDAQ. All values assume a $100 investment on January 30, 2005,
and that all dividends were reinvested.

(LINE GRAPH)

|                                       |  |  |      |  |  |      |  |  |      |  |  |      |  |  |      |  |  |      | 
|-------------------------------------- |  |  | ---- |  |  | ---- |  |  | ---- |  |  | ---- |  |  | ---- |  |  | ---- | 
|                                       |  |  | 2005 |  |  | 2006 |  |  | 2007 |  |  | 2008 |  |  | 2009 |  |  | 2010 | 
|                                       |  |  |      |  |  |      |  |  |      |  |  |      |  |  |      |  |  |      | 
|Trans
 World Entertainment Corporation |  |  | 100  |  |  | 42   |  |  | 45   |  |  | 34   |  |  | 6    |  |  | 10   | 
|NASDAQ
 (U.S. Stocks)                  |  |  | 100  |  |  | 113  |  |  | 121  |  |  | 116  |  |  | 58   |  |  | 83   | 
|NASDAQ
 Retail Trade Stocks            |  |  | 100  |  |  | 107  |  |  | 117  |  |  | 104  |  |  | 67   |  |  | 100  | 

11

---



Item 6. SELECTED CONSOLIDATED FINANCIAL DATA

The following
table sets forth selected Statement of Operations and Balance Sheet data for
the five fiscal years ended January 30, 2010 and is derived from the Companys
audited Consolidated Financial Statements. The fiscal year ended February 3,
2007 consisted of 53 weeks while all the other fiscal years of the Company
presented consisted of 52 weeks. This information should be read in conjunction
with the Companys audited Consolidated Financial Statements and related notes
and other financial information included herein, including Item 7,
Managements Discussion and Analysis of Financial Condition and Results of
Operations.

|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------------------------------- | ------- | ----------------- | -- | ----------------- | - | ----------------- | --------- | ----------------- | - | --------- | - | - | --------- | -
|                                                                                                                                                 |  | Fiscal Year Ended                     |        
|                                                                                                                                                 |  |                                       |        
|                                                                                                                                                 |  | January 30,
 2010                     |         | January 31,
 2009 |    | February 2,
 2008 |   | February 3,
 2007 |           | January 28,
 2006 |  
|                                                                                                                                                 |  |                                       |        
|                                                                                                                                                 |  | (in thousands, except per share data) |        
|STATEMENTS OF OPERATIONS DATA:                                                                                                                   |  |                                       |        
|Net sales                                                                                                                                        |  | $                                     | 813,988 |                   | $  | 987,625           |   | $                 | 1,265,658 |                   | $ | 1,471,157 |   | $ | 1,238,486 |  
|Cost of sales                                                                                                                                    |  |                                       | 552,327 |                   |    | 656,730           |   |                   | 819,911   |                   |   | 951,935   |   |   | 806,873   |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Gross profit                                                                                                                                     |  |                                       | 261,661 |                   |    | 330,895           |   |                   | 445,747   |                   |   | 519,222   |   |   | 431,613   |  
|Selling, general and administrative expenses                                                                                                     |  |                                       | 310,710 |                   |    | 380,802           |   |                   | 470,386   |                   |   | 519,246   |   |   | 426,854   |  
|Asset impairment charges (1)                                                                                                                     |  |                                       | 3,643   |                   |    | 15,158            |   |                   | 30,731    |                   |   |          |   |   |          |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|(Loss) income from operations                                                                                                                    |  |                                       | (52,692 | )                 |    | (65,065           | ) |                   | (55,370   | )                 |   | (24       | ) |   | 4,759     |  
|Interest expense                                                                                                                                 |  |                                       | 2,910   |                   |    | 4,098             |   |                   | 6,519     |                   |   | 5,504     |   |   | 2,954     |  
|Other income                                                                                                                                     |  |                                       | (168    | )                 |    | (180              | ) |                   | (429      | )                 |   | (4,435    | ) |   | (2,171    | )
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|(Loss) income before income taxes, extraordinary gain  unallocated
 negative goodwill and cumulative effect of a change in accounting principle |  |                                       | (55,434 | )                 |    | (68,983           | ) |                   | (61,460   | )                 |   | (1,093    | ) |   | 3,976     |  
|Income tax expense (benefit) (2)                                                                                                                 |  |                                       | (12,985 | )                 |    | (28               | ) |                   | 37,975    |                   |   | (2,041    | ) |   | 1,090     |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|(Loss) earnings before extraordinary gain  unallocated negative
 goodwill and cumulative effect of change in accounting principle               |  |                                       | (42,449 | )                 |    | (68,955           | ) |                   | (99,435   | )                 |   | 948       |   |   | 2,886     |  
|Extraordinary gain  unallocated negative goodwill, net of income
 taxes (3)                                                                     |  |                                       |        |                   |    |                  |   |                   |          |                   |   | 10,721    |   |   |          |  
|Cumulative effect of a change in accounting principle, net of income
 taxes (4)                                                                  |  |                                       |        |                   |    |                  |   |                   |          |                   |   |          |   |   | (2,277    | )
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Net (loss) income                                                                                                                                |  | ($                                    | 42,449  | )                 | ($ | 68,955            | ) | ($                | 99,435    | )                 | $ | 11,669    |   | $ | 609       |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Basic (loss) earnings per share:                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|(Loss) earnings per share before extraordinary gain  unallocated
 negative goodwill and cumulative effect of change in accounting principle     |  | ($                                    | 1.35    | )                 | ($ | 2.21              | ) | ($                | 3.20      | )                 | $ | 0.03      |   | $ | 0.09      |  
|Extraordinary gain  unallocated negative goodwill                                                                                               |  |                                       |        |                   |    |                  |   |                   |          |                   |   | 0.35      |   |   |          |  
|Cumulative effect of change in accounting principle                                                                                              |  |                                       |        |                   |    |                  |   |                   |          |                   |   |          |   |   | (0.07     | )
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Basic (loss) earnings per share                                                                                                                  |  | ($                                    | 1.35    | )                 | ($ | 2.21              | ) | ($                | 3.20      | )                 | $ | 0.38      |   | $ | 0.02      |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Weighted average number of shares outstanding - basic                                                                                            |  |                                       | 31,370  |                   |    | 31,223            |   |                   | 31,046    |                   |   | 30,797    |   |   | 31,962    |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Diluted (loss) earnings per share:                                                                                                               |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|(Loss) earnings per share before extraordinary gain  unallocated
 negative goodwill and cumulative effect of change in accounting principle     |  | ($                                    | 1.35    | )                 | ($ | 2.21              | ) | ($                | 3.20      | )                 | $ | 0.03      |   | $ | 0.09      |  
|Extraordinary gain  unallocated negative goodwill                                                                                               |  |                                       |        |                   |    |                  |   |                   |          |                   |   | 0.33      |   |   |          |  
|Cumulative effect of change in accounting principle                                                                                              |  |                                       |        |                   |    |                  |   |                   |          |                   |   |          |   |   | (0.07     | )
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Diluted (loss) earnings per share                                                                                                                |  | ($                                    | 1.35    | )                 | ($ | 2.21              | ) | ($                | 3.20      | )                 | $ | 0.36      |   | $ | 0.02      |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  
|Weighted average number of shares  diluted                                                                                                      |  |                                       | 31,370  |                   |    | 31,223            |   |                   | 31,046    |                   |   | 31,986    |   |   | 32,132    |  
|                                                                                                                                                 |  |                                       |         |                   |    |                   |   |                   |           |                   |   |           |   |   |           |  

12

---



|                                                                |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|--------------------------------------------------------------- |  | -------------------------------------------------- | ------- | ----------------- | - | ----------------- | -- | ----------------- | ------- | ----------------- | - | ------- | -- | - | ------- | --
|                                                                |  | Fiscal Year Ended                                  |        
|                                                                |  |                                                    |        
|                                                                |  | January 30,
 2010                                  |         | January 31,
 2009 |   | February 2,
 2008 |    | February 3,
 2007 |         | January 28,
 2006 |  
|                                                                |  |                                                    |         |                   |   |                   |    |                   |         |                   |  
|                                                                |  | ($ in thousands, except per share and
 store data) |        
|BALANCE SHEET DATA (at the end of
 the period):                 |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|                                                                |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|Total assets                                                    |  | $                                                  | 394,566 |                   | $ | 487,036           |    | $                 | 638,993 |                   | $ | 829,690 |    | $ | 799,657 |   
|Current portion of long-term debt and capital lease obligations |  |                                                    | 1,974   |                   |   | 3,748             |    |                   | 3,501   |                   |   | 3,393   |    |   | 3,659   |   
|Long-term obligations                                           |  |                                                    | 6,874   |                   |   | 8,844             |    |                   | 12,588  |                   |   | 16,085  |    |   | 19,474  |   
|Shareholders equity                                            |  | $                                                  | 193,353 |                   | $ | 235,015           |    | $                 | 298,149 |                   | $ | 393,205 |    | $ | 378,512 |   
|                                                                |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|OPERATING DATA:                                                 |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|Store count (open at end of period):                            |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|Mall stores                                                     |  |                                                    | 449     |                   |   | 549               |    |                   | 610     |                   |   | 737     |    |   | 546     |   
|Freestanding stores                                             |  |                                                    | 108     |                   |   | 163               |    |                   | 203     |                   |   | 255     |    |   | 236     |   
|Total stores                                                    |  |                                                    | 557     |                   |   | 712               |    |                   | 813     |                   |   | 992     |    |   | 782     |   
|                                                                |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|Comparable store
     sales decrease(5)                         |  |                                                    | (9.8    | %)                |   | (10.8             | %) |                   | (8.5    | %)                |   | (6.2    | %) |   | (5.7    | %)
|                                                                |  |                                                    |         |                   |   |                   |    |                   |         |                   |   |         |    |   |         |   
|Total square footage                                            |  |                                                    | 3,794   |                   |   | 4,560             |    |                   | 5,117   |                   |   | 5,950   |    |   | 4,824   |   



|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|-- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|1. | During
 Fiscal 2009, Fiscal 2008 and Fiscal 2007, the Company recorded an asset
 impairment charge of $3.6 million, $15.2 million and $30.7 million,
 respectively, to write down certain long-lived assets.                                                                                                                                                                                                                                                                                                                                           
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|2. | Included
 in income tax expense for Fiscal 2007 is deferred tax expense of $42.5
 million, the recording of which was primarily due to the establishment of a
 full valuation allowance against the Companys net deferred tax assets. See
 Note 5 in the Notes to Consolidated Financial Statements for further detail.
 Included in income tax benefit for 2009 is a tax refund of $10.4 million due
 to revised tax carryback legislation.                                                                                                          
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|3. | The
 Companys acquisition of substantially all of the net assets of Musicland
 Holding Corp. stores in Fiscal 2006 resulted in an extraordinary gain
 recorded in Fiscal 2006. The gain, net of tax, represented the excess of fair
 value of net assets acquired over the purchase price of the acquired assets.                                                                                                                                                                                                                                     
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|4. | The
 Company changed its method of accounting for conditional asset retirement
 obligations effective January 28, 2006 resulting in a one-time, non-cash,
 after tax charge of $2.3 million, which was classified as a cumulative
 effect of a change in accounting principle in Fiscal 2005. If the new
 accounting principles had been retroactively applied during fiscal 2005, pro
 forma net income would have been $2,992 thousand and basic and diluted
 earnings per share would have been $0.09 for the fiscal year ended January
 28, 2006.
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|5. | A store
 is included in comparable store sales calculations at the beginning of its
 thirteenth full month of operation. Mall stores relocated in the same
 shopping center after being open for at least thirteen months are considered
 comparable stores. Closed stores that were open for at least thirteen months
 are included in comparable store sales through the month immediately
 preceding the month of closing.                                                                                                                          

13

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Item 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS

Overview

Managements Discussion and
Analysis of Financial Condition and Results of Operations provides information
that the Companys management believes necessary to achieve an understanding of
its financial condition and results of operations. To the extent that such
analysis contains statements which are not of a historical nature, such
statements are forward-looking statements, which involve risks and
uncertainties. These risks include, but are not limited to, changes in the
competitive environment for the Companys merchandise, including the entry or
exit of non-traditional retailers of the Companys merchandise to or from its
markets; releases by the music, video, and video game industries of an
increased or decreased number of hit releases; general economic factors in
markets where the Companys merchandise is sold; and other factors discussed in
the Companys filings with the Securities and Exchange Commission. The
following discussion and analysis of the Companys financial condition and
results of operations should be read in conjunction with Selected Consolidated
Financial Data and the Consolidated Financial Statements and related notes
included elsewhere in this report.

At January 30, 2010, the
Company operated 557 stores totaling approximately 3.8 million square feet in
the United States, the District of Columbia, the Commonwealth of Puerto Rico
and the U.S. Virgin Islands. In the fiscal year ended January 30, 2010
(referred to herein as Fiscal 2009), the Companys net sales decreased as
compared to the fiscal year ended January 31, 2009, (referred to herein as
Fiscal 2008) as a result of lower average store count and a decrease in
comparable store sales. Comparable store sales decreased 9.8% during Fiscal
2009.

The Company focuses on the
following areas in its effort to improve its business:

Improving
Product Mix and Creating Value to the Customer

The Company tailors the
product mix of its stores toward regional tastes in order to optimize the
productivity of its stores, seeking to serve key customer segments within each
store. We have also focused on creating a stronger value statement to our
customers in our two core categories of music and video to drive additional
traffic into the stores and improve customer conversion rates, while offering
inventory in other product categories to drive additional sales.

Store
Openings and Closures

During Fiscal 2009 and Fiscal
2008, the Company closed 157 and 101 stores, respectively. The Company opened
two new stores in Fiscal 2009. The Companys real estate strategy is to
reposition our store portfolio by reducing our store base to a core group of
profitable locations.

The Company closes stores
when minimum operating thresholds are not achieved or upon lease expiration
when either renewal is not available or management determines that renewal is
not in the Companys best interest. The composition of these stores changes
from time-to-time as the result of competitive changes and other factors.

Expanding
Customer Base

To strengthen customer
loyalty, the Company offers its customers the option of signing up for a
Backstage Pass card which provides an additional 10% discount off of everyday
selling prices on nearly all product in addition to other value added offers
members receive through the program in exchange for an annual membership fee.
The Company also co-sponsors events in many of its stores to provide various
segments of its customers an opportunity to experience entertainment and shop
for unique and exclusive products based on their particular interests.

Key Performance Indicators

Management monitors a number
of key performance indicators to evaluate its performance, including:

Net Sales and Comparable Store Sales: The Company measures the rate of comparable
store net sales change. A store is included in comparable store net sales
calculations at the beginning of its thirteenth full month of operation. Mall
stores relocated in the same shopping center after being open for at least
thirteen months are considered comparable stores. Closed stores that were open
for at least thirteen months are included in comparable store net sales through
the month immediately prior to the month of closing. The Company further
analyzes net sales by store format and by product category.

Cost of Sales and Gross Profit: Gross profit is a function of the cost of
product in relation to its retail selling value. Changes in gross profit are
impacted primarily by net sales levels, mix of products sold, vendor discounts
and allowances and distribution costs. The Company records its distribution,
freight and obsolescence expenses in cost of sales. Distribution expenses
include those costs associated with receiving, inspecting and warehousing
merchandise and costs associated with product returns to vendors.

14

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Selling, General and Administrative (SG&A) expenses: Included in SG&A expenses are payroll and
related costs, occupancy charges, general operating and overhead expenses and
depreciation charges (excluding those related to distribution operations, as
discussed in Note 2 of Notes to the Consolidated Financial Statements in this
Annual Report on Form 10-K). SG&A expenses also include fixed assets
write-offs associated with store closures, if any, and miscellaneous items,
other than interest.

Balance Sheet and Ratios: The Company views cash, net inventory
investment (merchandise inventory less accounts payable) and working capital
(current assets less current liabilities) as indicators of its financial
position. See Liquidity and Capital Resources for further discussion of these
items.

Fiscal Year Ended January 30, 2010 (Fiscal 2009) 
Compared to Fiscal Year Ended January 31, 2009 (Fiscal 2008)

Net Sales.The following table sets forth a year-over-year comparison of the
Companys total net sales:

|                 |  |      |         |      |   |         |  |               |          |   |  |       |   
|---------------- |  | ---- | ------- | ---- | - | ------- |  | ------------- | -------- | - |  | ----- | --
|                 |  |      |         |      |   |         |  | 2009 vs. 2008 |         
|                 |  |      |         |      |   |         | 
|($ in thousands) |  | 2009 |         | 2008 |   | $       |  | %             |         
|                 |  |      |         |      |   |         | 
|Net Sales        |  | $    | 813,988 |      | $ | 987,625 |  | $             | (173,637 | ) |  | (17.6 | %)

The 17.6% net sales decline
from prior year is due to the comparable store net sales decline of 9.8%
coupled with a 13% decline in average store count. Total product units sold in
Fiscal 2009 decreased 11% and the average retail price for units sold decreased
8%.

Net sales by merchandise
category for Fiscal 2009 and Fiscal 2008 were as follows:

|                 |  |                 |         |          |  |                 |   |          |         |                            |  |                                       |   |  |       |    |  |       |   
|---------------- |  | --------------- | ------- | -------- |  | --------------- | - | -------- | ------- | -------------------------- |  | ------------------------------------- | - |  | ----- | -- |  | ----- | --
|                 |  |                 |         |          |  |                 |   |          |         |                            |  |                                       |  
|($ in thousands) |  | 2009
 Net Sales |         | %
 Total |  | 2008
 Net Sales |   | %
 Total |         | Total %
 Net Sales
 Change |  | Comparable
 Store % Net
 Sales Change |  
|                 |  |                 |         |          |  |                 |   |          |         |                            |  |                                       |  
|                 |  |                 |         |          |  |                 |   |          |         |                            |  |                                       |   |  |       |    |  |       |   
|Music            |  | $               | 286,670 |          |  | 35.2            | % | $        | 349,737 |                            |  | 35.4                                  | % |  | (18.0 | %) |  | (11.2 | %)
|Video            |  |                 | 339,251 |          |  | 41.7            |   |          | 407,884 |                            |  | 41.3                                  |   |  | (16.8 | )  |  | (7.5  | ) 
|Video games      |  |                 | 70,400  |          |  | 8.6             |   |          | 90,233  |                            |  | 9.1                                   |   |  | (22.0 | )  |  | (15.7 | ) 
|Other            |  |                 | 117,667 |          |  | 14.5            |   |          | 139,771 |                            |  | 14.2                                  |   |  | (15.8 | )  |  | (8.5  | ) 
|                 |  |                 |         |          |  |                 |   |          |         |                            |  |                                       |   |  |       |    |  |       |   
|Total            |  | $               | 813,988 |          |  | 100.0           | % | $        | 987,625 |                            |  | 100.0                                 | % |  | (17.6 | %) |  | (9.8  | %)
|                 |  |                 |         |          |  |                 |   |          |         |                            |  |                                       |   |  |       |    |  |       |   

The Other category includes
electronics, accessories and trend items, none of which individually exceed 10%
of total net sales.

Music

The Companys stores offer a
wide range of new and used CDs and music DVDs across most music genres,
including new releases from current artists as well as an extensive catalog of
music from past periods and artists. The music category declined as a percentage
of total net sales and declined 11% on a comparable store sale basis due to the
shift to online downloading.

Net sales of CDs represented
approximately 94% of total net sales in the music category during Fiscal 2009.
The Companys annual CD unit sales decreased 11% in Fiscal 2009 due to lower
comparable store net sales and the decrease in average store count. According
to SoundScan, total CD unit sales in the United States declined 18% during the
period corresponding with the Companys Fiscal 2009.

Video

The Company offers DVDs in
all of its stores and high definition DVDs (BluRay) in a majority of its
stores. The video category increased as a percentage of the Companys total net
sales due to slower comparable store sales decline in this category than the
music and video games categories.

Total net sales for Fiscal
2009 in the video category decreased 17% due to a comparable store net sales
decrease of 8% and the lower average store count. According to VideoScan, total
video unit sales in the United States declined 8% during the period
corresponding with the Companys Fiscal 2009.

15

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Video games

The negative comparable store
sales in video games was due to the lack of allocation of product from vendors,
as well as a reduction in the number of stores carrying games in Fiscal 2009
versus Fiscal 2008. During Fiscal 2009, the Company eliminated the game
category in over 200 stores. As of year-end, 139 of our stores carried games
compared to 347 a year ago.

Other

The Other category consists
of electronics, accessories and trend items. Net sales in this category have
increased as a percentage of total net sales due to increased store square
footage allocations and slower comparable store sales declines than music and
video.

Gross Profit. The following table sets forth a year-over-year comparison of the
Companys Gross Profit:

|                              |  |      |         |      |   |         |   |               |        |   |  |       |   
|----------------------------- |  | ---- | ------- | ---- | - | ------- | - | ------------- | ------ | - |  | ----- | --
|($ in thousands)              |  |      |         |      |   |         |   | 2009 vs. 2008 |       
|                              |  |      |         |      |   |         |   |               |       
|                              |  | 2009 |         | 2008 |   | $       |   | %             |       
|                              |  |      |         |      |   |         |   |               |       
|Gross Profit                  |  | $    | 261,661 |      | $ | 330,895 |   | ($            | 69,234 | ) |  | (20.9 | %)
|As a percentage of net
 sales |  |      | 32.1    | %    |   | 33.5    | % |               |        |   |  |       |   

The 140 basis point decline
in gross profit as a percentage of net sales was due to lower vendor
allowances.

Selling, General and Administrative Expenses.The following table sets forth a
year-over-year comparison of the Companys SG&A expenses:

|                                              |  |      |         |      |   |         |   |               |        |   |  |       |   
|--------------------------------------------- |  | ---- | ------- | ---- | - | ------- | - | ------------- | ------ | - |  | ----- | --
|($ in thousands)                              |  |      |         |      |   |         |   | 2009 vs. 2008 |       
|                                              |  |      |         |      |   |         |   |               |       
|                                              |  | 2009 |         | 2008 |   | $       |   | %             |       
|                                              |  |      |         |      |   |         |   |               |       
|Selling, general and
 administrative expenses |  | $    | 310,710 |      | $ | 380,802 |   | ($            | 70,092 | ) |  | (18.4 | %)
|As a percentage of net
 sales                 |  |      | 38.2    | %    |   | 38.6    | % |               |        |   |  |       |   

The $70 million decrease in
SG&A expenses is due to the Company operating an average of 13% fewer
stores. SG&A as a percentage of net sales decreased to 38.2% from 38.6%.

Included in SG&A for Fiscal
2008 is a gain of approximately $3.1 million from the sale of the Canton, Ohio
distribution facility.

Asset Impairment Charge.During Fiscal 2009 and Fiscal 2008, the
Company concluded, based on a significant decline in sales and earnings during
the fourth quarter, that triggering events had occurred requiring a test of
long-lived assets for impairment at its retail stores and consolidated
subsidiaries. Long-lived assets at locations where impairment was determined to
exist were written down to their estimated fair values as of the end of each
period resulting in the recording of asset impairment charges of $3.6 million
and $15.2 million in Fiscal 2009 and Fiscal 2008, respectively. Estimated fair
values for long-lived assets at these locations, including store fixtures and
equipment, leasehold improvements and certain intangible assets, were
determined based on a measure of discounted future cash flows over the
remaining lease terms at the respective locations. Future cash flows were
estimated based on store plans and were discounted at a rate approximating the
Companys cost of capital. Management believes its assumptions were reasonable
and consistently applied.

Interest Expense.Interest expense in Fiscal 2009 was $2.9 million compared to $4.1 million
in Fiscal 2008. The decrease is due to lower average borrowings on the
Companys revolving line of credit and lower interest rates.

Other Income.Other income includes interest income, which was $0.2 million in Fiscal
2009 and 2008.

16

---



Income Tax Benefit.The
following table sets forth a year-over-year comparison of the Companys income
tax expense (benefit):

|                    |  |      |        |      |   |                |   |   |        | 
|------------------- |  | ---- | ------ | ---- | - | -------------- | - | - | ------ | 
|($ in thousands)    |  |      |        |      |  
|                    |  |      |        |      |   | 2009 vs.
 2008 |  
|                    |  |      |        |      |   |                |  
|                    |  | 2009 |        | 2008 |   | $              |  
|                    |  |      |        |      |   |                |  
|                    |  |      |        |      |   |                |   |   |        | 
|Income tax
 benefit |  | $    | 12,985 |      | $ | 28             |   | $ | 12,957 | 
|                    |  |      |        |      |   |                |   |   |        | 
|Effective
 tax rate |  |      | 23.4   | %    |   | 0.0            | % |   |        | 

During Fiscal
2009, the Company recorded a current federal tax benefit of $10.4 million
resulting from federal tax legislation enacted that provided for an increased
carryback period for net operating losses incurred in Fiscal 2008. Also, during
Fiscal 2009, the Company recorded a deferred tax benefit of $2.3 million
related to the intra period allocation of income tax expense to loss from
current operations and accumulated other comprehensive income. The remaining
components of income tax benefit of $0.3 million is the net of certain state
taxes, adjustments to the reserve for uncertain tax positions and the accrual
of interest on uncertain tax positions.

Net Loss.
The following table sets forth a year-over-year comparison of the Companys net
loss:

|                                       |  |      |        |      |    |                |    |   |        | 
|-------------------------------------- |  | ---- | ------ | ---- | -- | -------------- | -- | - | ------ | 
|($ in thousands)                       |  |      |        |      |    |               
|                                       |  |      |        |      |    | 2009 vs.
 2008 |   
|                                       |  |      |        |      |    |                |   
|                                       |  | 2009 |        | 2008 |    | $              |   
|                                       |  |      |        |      |    |                |   
|                                       |  |      |        |      |    |                |   
|Net loss                               |  | ($   | 42,449 | )    | ($ | 68,955         | )  | $ | 26,506 | 
|                                       |  |      |        |      |    |                |    |   |        | 
|                                       |  |      |        |      |    |                |    |   |        | 
|Net loss as
 a percentage of net sales |  |      | (5.2   | %)   |    | (7.0           | %) |   |        | 

The Fiscal
2009 net loss of $42.4 million was due to the decline in comparable store sales
and lower gross margin. The $26.5 million reduction in net loss as compared to
2008 was due to a lower impairment charge and an increase in the income tax
benefit, partially offset by lower sales and the 140 basis point decrease in
gross margin.

17

---



Fiscal
Year Ended January 31, 2009 (Fiscal 2008)
Compared to Fiscal Year Ended February 2, 2008 (Fiscal 2007)

Net Sales.The
following table sets forth a year-over-year comparison of the Companys total
net sales:

|                 |  |      |         |      |   |           |  |                |          |   |  |       |   
|---------------- |  | ---- | ------- | ---- | - | --------- |  | -------------- | -------- | - |  | ----- | --
|                 |  |      |         |      |   |           |  | 2008 vs.
 2007 |         
|                 |  |      |         |      |   |           | 
|($ in thousands) |  | 2008 |         | 2007 |   | $         |  | %              |         
|                 |  |      |         |      |   |           |  |                |         
|Net Sales        |  | $    | 987,625 |      | $ | 1,265,658 |  | $              | (278,033 | ) |  | (22.0 | %)

The 22% net
sales decline from prior year is due to the comparable store net sales decline
of 11% coupled with an 18% decline in average store count. Total product units
sold in Fiscal 2008 decreased 16% and the average retail price for units sold
decreased 8%.

Net sales by
merchandise category for Fiscal 2008 and Fiscal 2007 were as follows:

|                 |  |                      |         |               |  |                      |   |               |   |                                      |  |                                                       |  |       |   |  |  |       |   
|---------------- |  | -------------------- | ------- | ------------- |  | -------------------- | - | ------------- | - | ------------------------------------ |  | ----------------------------------------------------- |  | ----- | - |  |  | ----- | --
|                 |  |                      |         |               |  |                      |   |               |   |                                      |  |                                                       | 
|($ in thousands) |  | 2008
      Net Sales |         | %
      Total |  | 2007
      Net Sales |   | %
      Total |   | Total %
      Net Sales
      Change |  | Comparable Store
            % Net
      Sales Change | 
|                 |  |                      |         |               |  |                      |   |               |   |                                      |  |                                                       | 
|                
|Music            |  | $                    | 349,737 |               |  | 35.4                 | % |               | $ | 494,286                              |  |                                                       |  | 39.1  | % |  |  | (29.2 | %)
|Video            |  |                      | 407,884 |               |  | 41.3                 |   |               |   | 491,360                              |  |                                                       |  | 38.8  |   |  |  | (17.0 | ) 
|Video games      |  |                      | 90,233  |               |  | 9.1                  |   |               |   | 114,431                              |  |                                                       |  | 9.0   |   |  |  | (21.1 | ) 
|Other            |  |                      | 139,771 |               |  | 14.2                 |   |               |   | 165,581                              |  |                                                       |  | 13.1  |   |  |  | (15.6 | ) 
|                 |  |                      |         |               |  |                      |   |               |   |                                      |  |                                                       |  |       |   |  |  |       |   
|Total            |  | $                    | 987,625 |               |  | 100.0                | % |               | $ | 1,265,658                            |  |                                                       |  | 100.0 | % |  |  | (22.0 | %)
|                 |  |                      |         |               |  |                      |   |               |   |                                      |  |                                                       |  |       |   |  |  |       |   

The Other
category includes electronics, accessories and trend items, none of which
individually exceed 10% of total net sales.

Music

The Companys
stores offer a wide range of new and used CDs and music DVDs across most music
genres, including new releases from current artists as well as an extensive
catalog of music from past periods and artists. The music category declined as
a percentage of total net sales and declined 20.2% on a comparable store sale
basis due to the lack of new product releases and the shift to online
downloading. The Company continues to shift square footage allocations to new
categories to compensate for the decline.

Net sales of
CDs represented approximately 95% of total net sales in the music category
during Fiscal 2008. The Companys annual CD unit sales decreased 28% in Fiscal
2008 due to lower comparable store net sales and the decrease in average store
count. According to SoundScan, total CD unit sales in the United States
declined 20% during the period corresponding with the Companys Fiscal 2008.

Video

The Company
offers DVDs in all of its stores and high definition DVDs in a majority of its
stores. The video category increased as a percentage of the Companys total net
sales due to slower comparable store sales decline in this category than the
other categories.

Total net
sales for Fiscal 2008 in the video category decreased 17% due to a comparable
store net sales decrease of 3% and the lower average store count. According to
VideoScan, total video unit sales in the United States declined 9% during the
period corresponding with the Companys Fiscal 2008.

18

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Video
games

The Company
offers video game hardware and software in 347 stores. During Fiscal 2007, the
Company discontinued the sale of video games in approximately 300 stores. The
Company has narrowed the number of stores offering video games in order to
increase average store video game sales by offering better assortment and more
product in its best game sales stores.

The negative
comparable store sales in video games was due to the lack of allocation of
product from vendors as well as a reduction in the number of stores carrying
games in Fiscal 2008 versus Fiscal 2007.

Other

The Other
category consists of electronics, accessories and trend items. Net sales in
this category have increased as a percentage of total net sales due to
increased store square footage allocations and slower comparable store sales
declines than music and video.

Gross Profit.
The following table sets forth a year-over-year comparison of the Companys
Gross Profit:

|                              |  |      |         |      |   |         |   |               |         |   |  |       |   
|----------------------------- |  | ---- | ------- | ---- | - | ------- | - | ------------- | ------- | - |  | ----- | --
|($ in thousands)              |  |      |         |      |   |         |   | 2008 vs. 2007 |        
|                              |  |      |         |      |   |         |   |               |        
|                              |  | 2008 |         | 2007 |   | $       |   | %             |        
|                              |  |      |         |      |   |         |   |               |        
|Gross Profit                  |  | $    | 330,895 |      | $ | 445,747 |   | ($            | 114,852 | ) |  | (25.8 | %)
|As a
 percentage of net sales |  |      | 33.5    | %    |   | 35.2    | % |               |         |   |  |       |   

The 170 basis point decline in gross profit as a percentage of net
sales was due to increased markdowns on slow moving inventory and lower vendor
allowances.

Selling, General and
Administrative Expenses. The following table sets
forth a year-over-year comparison of the Companys SG&A expenses:

|                                              |  |      |         |      |   |         |   |               |        |   |  |       |   
|--------------------------------------------- |  | ---- | ------- | ---- | - | ------- | - | ------------- | ------ | - |  | ----- | --
|($ in thousands)                              |  |      |         |      |   |         |   | 2008 vs. 2007 |       
|                                              |  |      |         |      |   |         |   |               |       
|                                              |  | 2008 |         | 2007 |   | $       |   | %             |       
|                                              |  |      |         |      |   |         |   |               |       
|Selling, general and administrative
 expenses |  | $    | 380,802 |      | $ | 470,386 |   | ($            | 89,584 | ) |  | (19.0 | %)
|                                             
|As a percentage of net sales                  |  |      | 38.6    | %    |   | 37.2    | % |               |        |   |  |       |   

The $90 million decrease in SG&A expenses is due to the Company
operating an average of 18% fewer stores. Despite the decrease, SG&A as a
percentage of net sales increased to 38.6% from 37.2% due to the sales decline
of 22%.

Included in SG&A for Fiscal 2008 is a gain of approximately $3.1
million from the sale of the Canton, Ohio distribution facility.

Asset Impairment
Charge.During Fiscal 2008 and Fiscal 2007, the
Company concluded, based on a significant decline in sales and earnings during
the fourth quarter, that triggering events had occurred requiring a test of
long-lived assets for impairment at its retail stores and consolidated
subsidiaries. Long-lived assets at locations where impairment was determined to
exist were written down to their estimated fair values as of the end of each
period resulting in the recording of asset impairment charges of $15.2 million
and $30.7 million in Fiscal 2008 and Fiscal 2007, respectively. Estimated fair
values for long-lived assets at these locations, including store fixtures and
equipment, leasehold improvements and certain intangible assets, were
determined based on a measure of discounted future cash flows over the
remaining lease terms at the respective locations. Future cash flows were
estimated based on store plans and were discounted at a rate approximating the
Companys cost of capital. Management believes its assumptions were reasonable
and consistently applied.

Interest Expense.Interest
expense in Fiscal 2008 was $4.1 million compared to $6.5 million in Fiscal
2007. The increase is due to lower average borrowings on the Companys
revolving line of credit and lower interest rates.

Other Income.Other
income includes interest income, which was $0.2 million and $0.4 million in
Fiscal 2008 and 2007, respectively.

19

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Income Tax (Benefit)
Expense.The following table sets forth a
year-over-year comparison of the Companys income tax expense (benefit):

|                              |  |      |     |      |   |               |    |    |        |  
|----------------------------- |  | ---- | --- | ---- | - | ------------- | -- | -- | ------ | -
|($ in thousands)              |  |      |     |      |   |              
|                              |  |      |     |      |   | 2008 vs. 2007 |   
|                              |  |      |     |      |   |               |   
|                              |  | 2008 |     | 2007 |   | $             |   
|                              |  |      |     |      |   |               |   
|                              |  |      |     |      |   |               |   
|Income tax
 (benefit) expense |  | ($   | 28  | )    | $ | 37,975        |    | ($ | 38,003 | )
|                              |  |      |     |      |   |               |    |    |        |  
|Effective
 tax rate           |  |      | 0.0 | %    |   | (61.8         | %) |    |        |  

During Fiscal
2007 the Company recorded deferred tax expense of $42.5 million, which was
primarily due to the establishment of a full valuation allowance against the
Companys net deferred tax assets. This was partially offset by a $5.7 million
federal income tax benefit recognized as the result of a net operating loss
carryback. The remaining components of income tax expense, totaling approximately
$1.2 million, include certain state and local taxes, adjustments to the reserve
for uncertain tax positions and the accrual of interest and penalties on
uncertain tax positions. See Note 5 in the Notes to Consolidated Financial
Statements for further detail.

Net Loss.
The following table sets forth a year-over-year comparison of the Companys net
loss:

|                                       |  |      |        |      |    |               |    |   |        | 
|-------------------------------------- |  | ---- | ------ | ---- | -- | ------------- | -- | - | ------ | 
|($ in thousands)                       |  |      |        |      |    |               |    |   |        | 
|                                       |  |      |        |      |    | 2008 vs. 2007 |   
|                                       |  |      |        |      |    |               |   
|                                       |  | 2008 |        | 2007 |    | $             |   
|                                       |  |      |        |      |    |               |   
|                                       |  |      |        |      |    |               |   
|Net loss                               |  | ($   | 68,955 | )    | ($ | 99,435        | )  | $ | 30,480 | 
|                                       |  |      |        |      |    |               |    |   |        | 
|                                       |  |      |        |      |    |               |    |   |        | 
|Net loss as
 a percentage of net sales |  |      | (7.0   | %)   |    | (7.9          | %) |   |        | 

The Fiscal
2008 net loss of $69.0 million was due to the decline in comparable store sales
and the impairment charge of $15.2 million. The $30.5 million reduction in net
loss as compared to 2007 was due to a lower impairment charge and the $42.5
million deferred tax charge recorded in Fiscal 2007, partially offset by lower
sales and the 170 basis point decrease in gross margin.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity and Cash
Flows: The Companys primary sources of working capital are cash provided by operations
and borrowing capacity under its revolving credit facility. The Companys cash
flows fluctuate from quarter to quarter due to various items, including
seasonality of sales and earnings, merchandise inventory purchases and returns
and the related terms on the purchases and capital expenditures. Management
believes it will have adequate resources to fund its cash needs for the
foreseeable future, including its capital spending, its seasonal increase in
merchandise inventory and other operating cash requirements and commitments.
Management has considered many initiatives as part of the development of its
operating plan for 2010 and beyond including a focus on the operation of a core
base of stores, improved product selection based on customer preferences and
industry changes, as well as further streamlining of its operations. During
Fiscal 2009, management carried out certain strategic initiatives in its efforts
to reduce certain operating costs such as the reduction of headcount at the
home office and the elimination or curtailment of certain other general and
administrative expenses. Also, during the fourth quarter of Fiscal 2009,
management closed 133 stores and plans to continue its careful evaluation of
store profitability of its remaining 557 stores in consideration of lease
terms, conditions and expirations.

Management
anticipates any cash requirements due to a shortfall in cash from operations
will be funded by the Companys revolving credit facility, discussed hereafter.
Cash flows from investing and financing activities during Fiscal 2010 are
expected to be comparable with Fiscal 2009. The Company does not expect any
material changes in the mix (between equity and debt) or the relative cost of
capital resources.

20

---



The following
table sets forth a three year summary of key components of cash flow and
working capital:

|                          |  |      |         |      |    |                |   |      |          |                |    |         |   |    |         |  
|------------------------- |  | ---- | ------- | ---- | -- | -------------- | - | ---- | -------- | -------------- | -- | ------- | - | -- | ------- | -
|($ in thousands)          |  | 2009 |         | 2008 |    | 2009 vs.
 2008 |   | 2007 |          | 2008 vs.
 2007 |   
|                          |  |      |         |      |    |                |   |      |          |                |   
|Operating Cash Flows      |  | $    | 49,789  |      | ($ | 37,232         | ) | $    | 87,021   |                | ($ | 25,579  | ) | ($ | 11,653  | )
|Investing Cash Flows      |  |      | (4,586  | )    |    | (3,873         | ) |      | (713     | )              |    | (15,949 | ) |    | 12,076  |  
|Financing Cash Flows      |  |      | (3,744  | )    |    | (3,495         | ) |      | 249      |                |    | (2,447  | ) |    | (1,048  | )
|                          |  |      |         |      |    |                |   |      |          |                |    |         |   |    |         |  
|Capital Expenditures      |  |      | (4,586  | )    |    | (10,066        | ) |      | 5,480    |                |    | (15,949 | ) |    | 5,883   |  
|                          |  |      |         |      |    |                |   |      |          |                |    |         |   |    |         |  
|Cash and Cash Equivalents |  |      | 71,514  |      |    | 30,055         |   |      | 41,459   |                |    | 74,655  |   |    | (44,600 | )
|Merchandise Inventory     |  |      | 266,568 |      |    | 378,188        |   |      | (111,620 | )              |    | 440,241 |   |    | (62,053 | )
|Working Capital           |  |      | 181,920 |      |    | 213,389        |   |      | (31,469  | )              |    | 251,507 |   |    | (38,118 | )
|Inventory turns           |  |      | 1.7     |      |    | 1.6            |   |      |          |                |    | 1.7     |   |    |         |  

The $87.0
million increase in operating cash flows was primarily due to a $112 million
decrease in merchandise inventory partially offset by the $42.4 million net
loss and the $39.3 million reduction in accounts payable.

During Fiscal
2008, the $11.7 million decrease in operating cash flows was due to a loss from
operations of $49.9 million, exclusive of the $15.2 million non-cash impairment
charge, compared to a loss from operations of $26.2 million, exclusive of the
$30.7 million non-cash impairment charge and $42.5 million deferred tax charge
recorded during Fiscal 2007 partially offset by fluctuation of operating assets
and liabilities, within the normal course of business, during Fiscal 2008.

The Company
monitors various statistics to measure its management of inventory, including
inventory turn (annual cost of sales divided by average merchandise inventory
balances), inventory investment per square foot and inventory leverage
(accounts payable divided by merchandise inventory). Inventory turn in Fiscal
2009 was 1.7 compared to 1.6 in Fiscal 2008. Inventory investment per square
foot was $70 per square foot at the end of Fiscal 2009 as compared to $83 per
square foot at the end of Fiscal 2008. Accounts payable leverage on inventory
was 49% as of January 30, 2010 compared with 45% as of January 31, 2009.

Cash used in
investing activities was $4.6 million in Fiscal 2009, compared to $3.9 million
in Fiscal 2008. During Fiscal 2009, cash used in investing activities consisted
exclusively of capital expenditures,. During Fiscal 2008, cash used in
investing activities consisted of capital expenditures of $10.1 million,
partially offset by proceeds of $6.2 from the sale of the Companys
distribution facility in Canton, Ohio. The Companys capital expenditures in
Fiscal 2009 consisted primarily of the expenditures for store openings,
relocations and improvements.

The Company
has historically financed its capital expenditures through borrowings under its
credit facility, select financing arrangements and cash generated from sales of
merchandise inventory. It may also receive landlord allowances or concessions
for store openings, relocations or improvements. The Company anticipates
capital spending of approximately $10 million in Fiscal 2010.

Cash used in
financing activities was $3.7 million in Fiscal 2009, compared to $3.5 million
in Fiscal 2008. In Fiscal 2009, the primary uses of cash were payments of
long-term debt and capital lease obligations of $0.6 million and $3.2 million,
respectively. In Fiscal 2008, the primary uses of cash were payments of
long-term debt and capital lease obligations of $0.5 million and $3.0 million,
respectively.

In January,
2006, the Company entered into a five-year, $100 million revolving secured
credit facility with Bank of America, N.A that expires January 2011 (Previous
Credit Facility). The revolving credit facility contains provisions governing
additional indebtedness and acquisitions and is secured by the Companys
eligible inventory, proceeds from the sale of inventory and by the stock of the
Companys subsidiaries. In March 2006, the Company and Bank of America N.A.,
entered into a First Amendment to the Credit Facility which increased the
amount available for borrowing by the Company under the Credit Facility to $130
million and in October 2006, the Company and Bank of America N.A. entered into
a Second Amendment to the Credit Facility increasing the amount available to
the Company for borrowing to $150 million. The terms and conditions under the
amendments were the same as the original Credit Facility. In April 2010, the
Company entered into an amended and restated Credit Agreement (Amended Credit
Facility) which reduced the availability under the facility to $100 million.
The Amended Credit Facility, which expires in April 2013, updated certain terms
and conditions including limits on the payment of dividends, added covenants
around the number of store closings and changed the formula for interest rates.
The availability under the Previous and Amended Credit Facility is subject to
limitations based on sufficient inventory levels. See Note 4 in the Notes to
Consolidated Financial Statements for further detail.

As of January
30, 2010 and January 31, 2009, the Company did not have any borrowings under
the line of credit and no outstanding letter of credit obligations under the
Credit Facility with Bank of America, N.A. The Company had $132 million and
$150 million available for

21

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borrowing as
of January 30, 2010 and January 31, 2009, respectively. Interest expense in
Fiscal 2009 was $2.9 million, of which $1.7 million was incurred for capital
leases. Interest expense in Fiscal 2008 was $4.1 million, of which $1.9 million
was incurred for capital leases. Under the Amended Credit Facility,
availability as of March 31, 2010 was approximately $88 million.

Contractual
Obligations and Commitments. The following table
summarizes the Companys contractual obligations as of January 30, 2010, and
the effect that such obligations are expected to have on liquidity and cash
flows in future periods.

|                                                       |  |      |        |             |   |              |  |                  |        |       |   |        |  |   |         | 
|------------------------------------------------------ |  | ---- | ------ | ----------- | - | ------------ |  | ---------------- | ------ | ----- | - | ------ |  | - | ------- | 
|Contractual
 Obligation                                |  | 2010 |        | 2011-
 2012 |   | 2013 -
 2014 |  | 2015 and
 Beyond |        | Total |  
|                                                       |  |      |        |             |   |              |  |                  |        |       |  
|$ in thousands                                         |  |      |        |             |   |              |  |                  |        |       |  
|                                                      
|Operating lease and maintenance agreement
 obligations |  | $    | 62,928 |             | $ | 61,564       |  | $                | 25,571 |       | $ | 9,628  |  | $ | 159,691 | 
|Capital lease obligations                              |  |      | 2,901  |             |   | 4,308        |  |                  | 4,308  |       |   | 1,649  |  |   | 13,166  | 
|Long-term debt (principal)                             |  |      | 602    |             |   | 1,320        |  |                  | 1,068  |       |   |       |  |   | 2,990   | 
|Long-term debt (interest)                              |  |      | 165    |             |   | 215          |  |                  | 51     |       |   |       |  |   | 431     | 
|Purchase obligations (1)                               |  |      |       |             |   |             |  |                  |       |       |   |       |  |   |        | 
|Other long-term liabilities (2)                        |  |      | 2,787  |             |   | 1,225        |  |                  | 297    |       |   | 336    |  |   | 4,645   | 
|Pension benefits (3)                                   |  |      | 98     |             |   | 1,462        |  |                  | 1,707  |       |   | 4,429  |  |   | 7,696   | 
|                                                       |  |      |        |             |   |              |  |                  |        |       |   |        |  |   |         | 
|Total                                                  |  | $    | 69,481 |             | $ | 70,094       |  | $                | 33,002 |       | $ | 16,042 |  | $ | 188,619 | 
|                                                       |  |      |        |             |   |              |  |                  |        |       |   |        |  |   |         | 

|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | For the
 purposes of this table, contractual obligations for purchase of goods or
 services are defined as agreements that are enforceable and legally binding
 and that specify all significant terms, including: fixed or minimum
 quantities to be purchased; fixed, minimum or variable price provisions; and
 the approximate timing of the transaction. The Companys purchase orders are
 based on its current inventory needs and are fulfilled by its suppliers
 within short time periods.                                                            
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(2) | Included in
 other long-term liabilities in the Consolidated Balance Sheet as of January
 30, 2010 are unfavorable lease valuations of $0.3 million and the long-term
 portion of deferred rent of $2.7 million which are not reflected in the table
 above as these amounts do not represent contractual obligations. Also
 included in other long-term liabilities is the long-term portion of the
 straight line rent liability of $2.2 million, which is included in operating
 lease obligations in the table above.                                       
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|    | Included in
 other long-term liabilities in the table above are the estimated asset
 retirement obligations associated with the fixed assets and leasehold
 improvements at the Companys store locations that arise under the terms of
 operating leases.                                                                                                                                                                                                                                                                                                      
|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|(3) | In addition
 to the scheduled pension benefit payments, the Company offers a 401(k)
 Savings Plan to eligible employees (see also Note 7 of Notes to Consolidated
 Financial Statements in this Annual Report on Form 10-K). Total expense
 related to the Companys matching contribution was approximately $0, $882,000
 and $1,042,000 in Fiscal 2009, Fiscal 2008 and Fiscal 2007 respectively. As
 of February 1, 2009, the Company postponed its matching contribution. The
 Company expects to reinstate the matching contribution effective May 1, 2010.

Related Party
Transactions.

The Company
leases its 181,300 square foot distribution center/office facility in Albany,
New York from Robert J. Higgins, its Chairman, Chief Executive Officer and
largest shareholder, under three capital leases that expire in the year 2015.
The original distribution center/office facility was occupied in 1985.

Under the
three capital leases, dated April 1, 1985, November 1, 1989 and September 1,
1998, the Company paid Mr. Higgins an annual rent of $2.1 million, $2.1 million
and $2.0 million in Fiscal 2009, 2008 and 2007 respectively. Pursuant to the
terms of the lease agreements, effective January 1, 2002 and every two years
thereafter, rental payments will increase in accordance with the biennial
increase in the Consumer Price Index. Under the terms of the lease agreements,
the Company is responsible for property taxes, insurance and other operating
costs with respect to the premises. Mr. Higgins obligation for principal and
interest on his underlying indebtedness relating to the real property is
approximately $1.1 million per year. None of the leases contain any real
property purchase options at the expiration of its term.

The Company
leases one of its retail stores from Mr. Higgins under an operating lease.
Annual rental payments under this lease were $40,000 in Fiscal 2009, 2008 and
2007. Under the terms of the lease, the Company pays property taxes,
maintenance and a contingent rental if a specified sales level is achieved.
Total additional charges for the store, including contingent rent, were
approximately $6,800, $7,400 and $3,800 in Fiscal 2009, 2008 and 2007
respectively.

The Company
charters an aircraft from Richmor Aviation Inc., an unaffiliated corporation
that leases an aircraft owned by Mr. Higgins, for Company business. Payments to
Richmor Aviation Inc., to charter the aircraft owned by Mr. Higgins, in Fiscal
2009, 2008 and 2007 were approximately $94,000, $205,000 and $29,000,
respectively.

22

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CRITICAL ACCOUNTING ESTIMATES

The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States requires that
management apply accounting policies and make estimates and assumptions that
affect results of operations and the reported amounts of assets and liabilities
in the financial statements. Management continually evaluates its estimates and
judgments including those related to merchandise inventory and return costs,
valuation of long-lived assets, income taxes and accounting for gift card
liability. Management bases its estimates and judgments on historical
experience and other factors that are believed to be reasonable under the
circumstances. Actual results may differ from these estimates under different
assumptions or conditions. Note 1 of the Notes to Consolidated Financial
Statements in this Annual Report on Form 10-K includes a summary of the
significant accounting policies and methods used by the Company in the preparation
of its consolidated financial statements. Management believes that of the
Companys significant accounting policies, the following may involve a higher
degree of judgment or complexity:

Merchandise Inventory and Return Costs:
Merchandise inventory is stated at the lower of cost or market under the
average cost method. The average cost method attaches a cost to each item and
is a blended average of the original purchase price and those of subsequent
purchases or other cost adjustments throughout the life cycle of that item.

Inventory
valuation requires significant judgment and estimates, including obsolescence,
shrink and any adjustments to market value; if market value is lower than cost.
Inherent in the entertainment software industry is the risk of obsolete
inventory. Typically, newer releases generate a higher product demand. Some
vendors offer credits to reduce the cost of products that are selling more
slowly, thus allowing for a reduction in the selling price and reducing the
possibility for items to become obsolete. The Company records obsolescence and
any adjustments to market value (if lower than cost) based on current and
anticipated demand, customer preferences, and market conditions. The provision
for inventory shrink is estimated as a percentage of sales for the period from
the last date a physical inventory was performed to the end of the fiscal year.
Such estimates are based on historical results and trends and the shrink
results from the last physical inventory. Physical inventories are taken at
least annually for all stores and distribution centers throughout the year and
inventory records are adjusted accordingly.

Shrink
expense, including obsolescence was $11.9 million, $18.0 million and $18.5
million, in Fiscal 2009, 2008 and 2007 respectively. As a rate to net sales,
this equaled 1.5%, 1.8% and 1.5%, respectively. Presently, a 0.1% change in the
rate of shrink provision would equal approximately $0.6 million in additional
charge or benefit to cost of sales, based on Fiscal 2009 net sales since the
last physical inventories.

The Company is
generally entitled to return merchandise purchased from major vendors for
credit against other purchases from these vendors. Certain vendors reduce the
credit with a per unit merchandise return charge which varies depending on the
type of merchandise being returned. Certain other vendors charge a handling fee
based on units returned. The Company records merchandise return charges in cost
of sales. The Company incurred merchandise return charges in its Fiscal year
2009, Fiscal 2008 and Fiscal 2007 of $3.2 million, $4.1 million and $2.2
million, respectively.

Valuation of Long-Lived Assets:
The Company assesses the impairment of long-lived assets to determine if any
part of the carrying value may not be recoverable. Factors that the Company
considers to be important when assessing impairment include:

| |   |                                                                                                                      
| | - | ---------------------------------------------------------------------------------------------------------------------
| |  | significant
 underperformance relative to historical or projected future operating
 results;                         
| |   |                                                                                                                      
| |  | significant
 changes in the manner of the use of acquired assets or the strategy for the
 Companys overall business;
| |   |                                                                                                                      
| |  | significant
 negative industry or economic trends;                                                                   

If the Company
determines that the carrying value of a long-lived asset may not be
recoverable, it tests for impairment to determine if an impairment charge is
needed. During Fiscal 2009, 2008 and 2007, the Company recorded an asset impairment
charge of $3.6 million, $15.2 million and $30.7 million, respectively, related
to the write down of certain long-lived assets at underperforming locations.
Losses for store closings in the ordinary course of business represent the
write down of the net book value of abandoned fixtures and leasehold
improvements. The loss on disposal of fixed assets related to store closings
was $0.9 million, $1.2 million and $2.5 million in Fiscal 2009, 2008 and 2007,
respectively, and is included in SG&A expenses in the Consolidated
Statement of Operations and loss on disposal of fixed assets in the
Consolidated Statement of Cash Flows. Store closings usually occur at the
expiration of the lease, at which time leasehold improvements, which constitute
a majority of the assets, are fully depreciated.

Income Taxes: Income
taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences
attributable to differences between the financial statement carrying amounts of
existing assets and liabilities and their respective tax bases and tax
operating loss carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled.
Historically, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in the results of operations in the period that
includes the enactment date.

Accounting for
income taxes requires management to make estimates and judgments regarding
interpretation of various taxing jurisdictions, laws and regulations as well as
the ultimate realization of deferred tax assets. These estimates and judgments
include the generation of future taxable income, viable tax planning strategies
and support of tax filings. In assessing the propriety of deferred tax assets,
management considers whether it is more likely than not that some portion or
all of the deferred tax assets will not be realized. The ultimate realization
of deferred tax assets is

23

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dependent upon
the generation of future taxable income. Management considers the scheduled
reversal of taxable temporary differences, projected future taxable income and
tax planning strategies in making this assessment. As of February 2, 2008, the
Company had incurred a cumulative three-year loss. Based on the cumulative
three-year loss and other available objective evidence, management concluded
that a full valuation allowance should be recorded against its net deferred tax
assets. During Fiscal 2009 and in future years, the Company will continue to
record a valuation allowance against recorded net deferred tax assets to a
level deemed appropriate by management to ensure that any net deferred tax
assets not allowed against will ultimately be realized.

Accounting for Gift Card Liability:
The Company sells gift cards that are redeemable only for merchandise and have
no expiration date. The Company derecognizes card liability when either
customers redeem cards, at which point the Company records revenue, or when the
Company determines it does not have a legal obligation to remit unredeemed
cards to the relevant jurisdictions and the likelihood of the cards being
redeemed becomes remote, at which point the Company records breakage as a
credit to SG&A expenses. The Companys accounting for gift cards is based
on estimating the Companys liability for future card redemptions at the end of
a reporting period. Estimated liability is equal to two years of unredeemed
cards, plus an amount for outstanding cards that may possibly be redeemed for
the cumulative look-back period, exclusive of the last two years. The Companys
ability to reasonably and reliably estimate the liability is based on
historical redemption experience with gift cards and similar types of
arrangements and the existence of a large volume of relatively homogeneous
transactions. The Companys estimate is not susceptible to significant external
factors and the circumstances around gift card sales and redemptions have not
changed significantly over time.

Recently Issued Accounting Pronouncements.

The Financial
Accounting Standards Board (the FASB) has codified a single source of U.S.
Generally Accepted Accounting Principles (GAAP), the Accounting Standards
Codification. Unless needed to clarify a point to readers, we will refrain
from citing specific section references when discussing application of
accounting principles or addressing new or pending accounting rule changes.
There are no recently issued accounting standards that are expected to have a
material effect on our financial condition, results of operations or cash
flows.

Item 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK

The Company
does not hold any financial instruments that expose it to significant market
risk and does not engage in hedging activities. To the extent the Company
borrows under its revolving credit facility, the Company is subject to risk
resulting from interest rate fluctuations since interest on the Companys
borrowings under its credit facility can be variable. If interest rates on the
Companys revolving credit facility were to increase by 25 basis points, and to
the extent borrowings were outstanding, for every $1,000,000 outstanding on the
facility, income before income taxes would be reduced by $2,500 per year.
Information about the fair value of financial instruments is included in Note 1
of Notes to the Consolidated Financial Statements in this Annual Report on Form
10-K.

Item 8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA

The index to
the Companys Consolidated Financial Statements is included in Item 15, and the
Consolidated Financial Statements follow the signature page to this Annual
Report on Form 10-K and are incorporated herein by reference.

The quarterly
results of operations are included herein in Note 10 of Notes to the
Consolidated Financial Statements in this Annual Report on Form 10-K.

Item 9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

Item 9A. CONTROLS AND PROCEDURES

Conclusion Regarding the Effectiveness of
Disclosure Controls and Procedures: Under the
supervision and with the participation of our management, including our
principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of our disclosure controls and procedures, as
such term is defined under Rule 13a-15(e) promulgated under the Securities
Exchange Act of 1934, as amended (the Exchange Act). Based on this evaluation,
our principal executive officer and our principal financial officer concluded
that, as of the end of the period covered by this annual report, our disclosure
controls and procedures were effective, in that they provide reasonable assurance
that information required to be disclosed by us in the reports we file or
submit, under the Exchange Act, is recorded, processed, summarized and reported
within the time period specified in the Securities and Exchange Commissions
rules and forms.

Managements Report on Internal Control Over
Financial Reporting: Management is responsible for
establishing and maintaining adequate internal control over financial reporting
(as defined in Rule 13a-15(f) and 15d  15(f) under the Securities Exchange Act
of 1934, as amended). Under the supervision and with the participation of the
Companys management, including our principal executive officer and

24

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principal
financial officer, we conducted an evaluation of the effectiveness of our
internal control over financial reporting based on the framework set forth by
the Committee of Sponsoring Organizations of the Treadway Commission (COSO)
in Internal Control-Integrated Framework.
Based on our evaluation under the framework in Internal
Control- Integrated Framework, our management concluded that our
internal control over financial reporting was effective as of January 30, 2010.

The Companys
independent registered public accounting firm, KPMG LLP, has issued an audit
report on the Companys effectiveness of internal control over financial
reporting as of January 30, 2010, which is included in Item 8 of this Annual
Report on Form 10-K and incorporated herein by reference.

Changes in Controls and Procedures:
No change in our internal control over financial reporting occurred during the
quarterly period ended January 30, 2010 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.

Item 9B. Other Information

No events have
occurred which would require disclosure under this Item.

25

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PART III

Item 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

(a) Identification of Directors

Incorporated
herein by reference is the information appearing under the captions Election
of Directors and Compensation of Directors in the Companys definitive Proxy
Statement for the Registrants 2010 Annual Meeting of Shareholders to be filed
with the Securities and Exchange Commission within 120 days after January 30,
2010.

(b) Identification of Executive Officers

Incorporated
herein by reference is the information appearing under the caption Executive
Compensation in the Companys definitive Proxy Statement for the Registrants
2010 Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days after January 30, 2010.

(c) Code of Ethics

We have
adopted the Trans World Entertainment Corporation Code of Ethics that applies
to all officers, directors, employees and consultants of the Company. The Code
of Ethics is intended to comply with Item 406 of Regulation S-K of the
Securities Exchange Act of 1934 and with applicable rules of The NASDAQ Stock
Market, Inc. Our Code of Ethics is posted on our Internet website under the
Corporate page. Our Internet website address is www.twec.com. To the extent
required or permitted by the rules of the SEC and NASDAQ, we will disclose
amendments and waivers relating to our Code of Ethics in the same place as our
website.

Item 11. EXECUTIVE COMPENSATION

Incorporated
herein by reference is the information appearing under the caption Executive
Compensation in the Companys definitive Proxy Statement for the Registrants
2010 Annual Meeting of Shareholders to be filed with the Securities and
Exchange Commission within 120 days after January 30, 2010.

Item 12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS

Incorporated
herein by reference is the information appearing under the captions Equity
Ownership of Directors and Executive Officers and Principal Shareholders in
the Companys definitive Proxy Statement for the Registrants 2010 Annual
Meeting of Shareholders to be filed with the Securities and Exchange Commission
within 120 days after January 30, 2010.

Information on
Trans World Entertainment Common Stock authorized for issuance under equity
compensation plans is contained in our Proxy Statement for our 2010 Annual
Meeting of Shareholders under the caption Stock Option Plans and is
incorporated herein by reference. See Note 7 of Notes to the Consolidated
Financial Statements in this Annual Report on Form 10-K for a description of
the Companys employee stock award plans.

The following
table contains information about the Companys Common Stock that may be issued,
as new shares, upon the exercise of options, warrants and rights under all of
the Companys equity compensation plans as of January 30, 2010:

|                                                                       |  |                                                                                               |  |                                                                               |  |                                                                                                                                                   |  |   |      |  |  |  |  |       |  | 
|---------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ---- |  |  |  |  | ----- |  | 
|                                                                       |  |                                                                                               |  |                                                                               |  |                                                                                                                                                   |  |   |      | 
|Plan Category                                                          |  | Number of Shares to be Issued
 upon Exercise of Outstanding
 Options, Warrants and
 Rights(1) |  | Weighted Average Exercise
 Price of Outstanding Options,
 Warrants and Rights |  | Number of Shares Remaining
 Available for Future Issuance
 Under Equity Compensation
 Plans (Excluding Outstanding
 Options, Warrants and Rights) | 
|                                                                       |  |                                                                                               |  |                                                                               |  |                                                                                                                                                   |  |   |      | 
|                                                                       |  | (Shares in thousands)                                                                         | 
|Equity Compensation Plan Approved by
 Shareholders                     |  |                                                                                               |  | 7,252                                                                         |  |                                                                                                                                                   |  | $ | 8.16 |  |  |  |  | 3,023 |  | 
|Equity Compensation Plans and Agreements
 not Approved by Shareholders |  |                                                                                               |  |                                                                              |  |                                                                                                                                                   |  |   |     |  |  |  |  |      |  | 

(1) Excludes
518,429 restricted stock units reserved from the Companys equity plans that
will be settled in cash.

26

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Item 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Incorporated
herein by reference is the information appearing under the caption Related
Party Transactions in the Companys definitive Proxy Statement for the
Registrants 2010 Annual Meeting of Shareholders to be filed with the
Securities and Exchange Commission within 120 days after January 30, 2010.

Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Incorporated
herein by reference is the information appearing under the caption Other
Matters in the Companys definitive Proxy Statement for the Registrants 2010
Annual Meeting of Shareholders to be filed with the Securities and Exchange
Commission within 120 days after January 30, 2010.

27

---



PART IV

Item 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

15(a) (1) Financial Statements

The
Consolidated Financial Statements and Notes are listed in the Index to
Consolidated Financial Statements on page F-1 of this report.

15(a) (2) Financial Statement Schedules

Consolidated
Financial Statement Schedules not filed herein have been omitted as they are
not applicable or the required information or equivalent information has been
included in the Consolidated Financial Statements or the notes thereto.

15(a) (3) Exhibits

Exhibits are
as set forth in the Index to Exhibits which follows the Notes to the
Consolidated Financial Statements and immediately precedes the exhibits filed.

28

---



SIGNATURES

Pursuant to
the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

|                      |                                        |                                     
|--------------------- | -------------------------------------- | ------------------------------------
|                      | TRANS WORLD
 ENTERTAINMENT CORPORATION
|                      |                                        |                                     
|Date: April
 15, 2010 |                                        | By: /s/ ROBERT J. HIGGINS           
|                      |                                        |                                     
|                      |                                        | Robert J. Higgins                   
|                      |                                        | Chairman and Chief Executive Officer

Pursuant to
the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.

|                         |  |                                                                  |  |               
|------------------------ |  | ---------------------------------------------------------------- |  | --------------
|Name                     |  | Title                                                            |  | Date          
|/s/ ROBERT
 J. HIGGINS   |  | Chairman and
 Chief Executive Officer                            |  | April 15, 2010
|                         |  | (Principal
 Executive Officer)                                   |  |               
|(Robert J. Higgins)      |  |                                                                  |  |               
|                         |  |                                                                  |  |               
|/s/ JOHN J.
 SULLIVAN    |  | Executive
 Vice President and Chief Financial Officer (Principal |  | April 15, 2010
|                         |  | Financial
 and Chief Accounting Officer) and Secretary           |  |               
|(John J. Sullivan)       |  |                                                                  |  |               
|                         |  |                                                                  |  |               
|/s/ ISAAC
 KAUFMAN       |  | Director                                                         |  | April 15, 2010
|                         |  |                                                                  |  |               
|(Isaac Kaufman)          |  |                                                                  |  |               
|                         |  |                                                                  |  |               
|/s/ DR. JOSEPH G. MORONE |  | Director                                                         |  | April 15, 2010
|                         |  |                                                                  |  |               
|(Dr. Joseph G. Morone)   |  |                                                                  |  |               
|                         |  |                                                                  |  |               
|/s/ BRYANT
 RILEY        |  | Director                                                         |  | April 15, 2010
|                         |  |                                                                  |  |               
|(Bryant Riley)           |  |                                                                  |  |               
|                         |  |                                                                  |  |               
|/s/ MICHAEL
 B. SOLOW    |  | Director                                                         |  | April 15, 2010
|                         |  |                                                                  |  |               
|(Michael B. Solow)       |  |                                                                  |  |               

29

---



TRANS WORLD ENTERTAINMENT CORPORATION
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

|                                                                                                                                                       |  |                    
|------------------------------------------------------------------------------------------------------------------------------------------------------ |  | -------------------
|                                                                                                                                                       |  | Form 10-K
 Page No.
|                                                                                                                                                       |  |                    
|Reports of
 Independent Registered Public Accounting Firm                                                                                              |  | F-2                
|                                                                                                                                                       |  |                    
|Consolidated Financial Statements                                                                                                                      |  |                    
|                                                                                                                                                       |  |                    
|Consolidated
 Balance Sheets at January 30, 2010 and January 31, 2009                                                                                  |  | F-4                
|                                                                                                                                                       |  |                    
|Consolidated
 Statements of Operations - Fiscal years ended January 30, 2010, January 31,
 2009, and February 2, 2008                                  |  | F-5                
|                                                                                                                                                       |  |                    
|Consolidated
 Statements of Shareholders Equity and Comprehensive Loss - Fiscal years
 ended January 30, 2010, January 31, 2009, and February 2, 2008 |  | F-6                
|                                                                                                                                                       |  |                    
|Consolidated
 Statements of Cash Flows - Fiscal years ended January 30, 2010, January 31,
 2009, and February 2, 2008                                  |  | F-7                
|                                                                                                                                                       |  |                    
|Notes to
 Consolidated Financial Statements                                                                                                            |  | F-8                

F-1

---



Report of
Independent Registered Public Accounting Firm

The Board of
Directors and Shareholders
Trans World Entertainment Corporation:

We have
audited the accompanying consolidated balance sheets of Trans World
Entertainment Corporation and subsidiaries (the Company) as of January 30, 2010
and January 31, 2009, and the related consolidated statements of operations,
shareholders equity and comprehensive loss, and cash flows for each of the
fiscal years in the three-year period ended January 30, 2010. These
consolidated financial statements are the responsibility of the Companys
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.

We conducted
our audits in accordance with the standards of the Public Company Accounting Oversight
Board (United States). Those standards require that we plan and perform the
audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our
opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Trans World
Entertainment Corporation and subsidiaries as of January 30, 2010 and January
31, 2009, and the results of their operations and their cash flows for each of
the fiscal years in the three-year period ended January 30, 2010, in conformity
with U.S. generally accepted accounting principles.

We also have
audited, in accordance with the standards of Public Company Accounting
Oversight Board (United States), the Companys internal control over financial
reporting as of January 30, 2010, based on criteria established in Internal
Control  Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission, and our report dated April 15, 2010
expressed an unqualified opinion on the effectiveness of the Companys internal
control over financial reporting.

/s/ KPMG LLP

Albany, New York
April 15, 2010

F-2

---



Report
of Independent Registered Public Accounting Firm

The Board of
Directors and Shareholders
of Trans World Entertainment Corporation:

We have
audited Trans World Entertainment Corporation and subsidiaries (the
Company), internal control over financial reporting as of January 30, 2010,
based on criteria established in Internal Control  Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
(COSO). The Companys management is responsible for maintaining effective
internal control over financial reporting, and for its assessment of the
effectiveness of internal control over financial reporting, included in the
accompanying Management Report. Our responsibility is to express an opinion on
the Companys internal control over financial reporting based on our audit.

We conducted
our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit included obtaining an understanding of internal control
over financial reporting, assessing the risk that a material weakness exists,
and testing and evaluating the design and operating effectiveness of control
based on the assessed risk. Our audit also included performing such other
procedures as we considered necessary in the circumstances. We believe that our
audit provides a reasonable basis for our opinion.

A companys
internal control over financial reporting is a process designed to provide a
reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A companys internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and expenditures of the
company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding
prevention or timely detection of unauthorized acquisition, use, or disposition
of the companys assets that could have a material effect on the financial
statements.

Because of its
inherent limitations, internal control over financial reporting may not prevent
or detect misstatements. Also, projections of any evaluation of effectiveness
to future periods are subject to the risk that controls may become inadequate
because of changes in conditions, or that the degree of compliance with the
policies or procedures may deteriorate.

In our
opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of January 30, 2010, based on criteria
established in Internal Control  Integrated Framework issued by COSO.

We also have
audited in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Trans World
Entertainment Corporation and subsidiaries as of January 30, 2010 and January
31, 2009, and the related consolidated statements of operations, shareholders
equity and comprehensive loss, and cash flows for each of the years in the
three-year period ended January 30, 2010, and our report dated April 15, 2010
expressed an unqualified opinion on those consolidated financial statements.

/s/ KPMG LLP

Albany, New
York
April 15, 2010

F-3

---



TRANS WORLD
ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
($ in thousands)

|                                                                                                                             |  |                    |          |                    |   |          |  
|---------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | -------- | ------------------ | - | -------- | -
|                                                                                                                             |  | January
 30,
 2010 |          | January
 31,
 2009 |  
|                                                                                                                             |  |                    |          |                    |  
|ASSETS                                                                                                                       |  |                    |          |                    |   |          |  
|CURRENT
 ASSETS                                                                                                              |  |                    |          |                    |   |          |  
|Cash and cash equivalents                                                                                                    |  | $                  | 71,514   |                    | $ | 30,055   |  
|Accounts receivable                                                                                                          |  |                    | 4,505    |                    |   | 7,559    |  
|Merchandise inventory                                                                                                        |  |                    | 266,568  |                    |   | 378,188  |  
|Prepaid expenses and other                                                                                                   |  |                    | 10,557   |                    |   | 13,817   |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|Total current assets                                                                                                         |  |                    | 353,144  |                    |   | 429,619  |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|FIXED ASSETS,
 net                                                                                                           |  |                    | 33,908   |                    |   | 50,437   |  
|OTHER ASSETS                                                                                                                 |  |                    | 7,514    |                    |   | 6,980    |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|TOTAL ASSETS                                                                                                                 |  | $                  | 394,566  |                    | $ | 487,036  |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|LIABILITIES                                                                                                                  |  |                    |          |                    |   |          |  
|CURRENT
 LIABILITIES                                                                                                         |  |                    |          |                    |   |          |  
|Accounts payable                                                                                                             |  | $                  | 130,549  |                    | $ | 170,302  |  
|Accrued expenses and other current
 liabilities                                                                              |  |                    | 38,701   |                    |   | 42,180   |  
|Current portion of long-term debt                                                                                            |  |                    | 602      |                    |   | 570      |  
|Current portion of capital lease
 obligations                                                                                |  |                    | 1,372    |                    |   | 3,178    |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|Total current liabilities                                                                                                    |  |                    | 171,224  |                    |   | 216,230  |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|LONG TERM
 DEBT, less current portion                                                                                       |  |                    | 2,388    |                    |   | 2,986    |  
|CAPITAL
 LEASE OBLIGATIONS, less current portion                                                                             |  |                    | 4,486    |                    |   | 5,858    |  
|OTHER
 LONG-TERM LIABILITIES                                                                                                 |  |                    | 23,115   |                    |   | 26,947   |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|TOTAL LIABILITIES                                                                                                            |  |                    | 201,213  |                    |   | 252,021  |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|SHAREHOLDERS EQUITY                                                                                                         |  |                    |          |                    |   |          |  
|Preferred stock ($0.01 par value; 5,000,000
 shares authorized; none issued)                                                 |  |                    |         |                    |   |         |  
|Common stock ($0.01 par value; 200,000,000
 shares authorized; 56,498,429 shares and 56,372,101 shares issued, respectively) |  |                    | 565      |                    |   | 564      |  
|Additional paid-in capital                                                                                                   |  |                    | 307,823  |                    |   | 306,159  |  
|Treasury stock at cost (25,102,990 and
 25,102,990 shares, respectively)                                                     |  |                    | (217,555 | )                  |   | (217,555 | )
|Accumulated other comprehensive income                                                                                       |  |                    | 1,518    |                    |   | 2,396    |  
|Retained earnings                                                                                                            |  |                    | 101,002  |                    |   | 143,451  |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|TOTAL SHAREHOLDERS EQUITY                                                                                                   |  |                    | 193,353  |                    |   | 235,015  |  
|                                                                                                                             |  |                    |          |                    |   |          |  
|TOTAL LIABILITIES AND SHAREHOLDERS EQUITY                                                                                   |  | $                  | 394,566  |                    | $ | 487,036  |  
|                                                                                                                             |  |                    |          |                    |   |          |  

See Accompanying Notes to Consolidated
Financial Statements.

F-4

---



TRANS WORLD
ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
($ in thousands, except per share amounts)

|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|------------------------------------------------------------------------- |  | ------------------ | ------- | ------------------ | -- | ------------------ | - | -- | --------- | -
|                                                                          |  | Fiscal
 Year Ended |        
|                                                                          |  |                    |        
|                                                                          |  | January
 30,
 2010 |         | January
 31,
 2009 |    | February
 2,
 2008 |  
|                                                                          |  |                    |         |                    |    |                    |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|Net sales                                                                 |  | $                  | 813,988 |                    | $  | 987,625            |   | $  | 1,265,658 |  
|Cost of
 sales                                                            |  |                    | 552,327 |                    |    | 656,730            |   |    | 819,911   |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|Gross profit                                                              |  |                    | 261,661 |                    |    | 330,895            |   |    | 445,747   |  
|Selling,
 general and administrative expenses                             |  |                    | 310,710 |                    |    | 380,802            |   |    | 470,386   |  
|Asset
 impairment charges                                                 |  |                    | 3,643   |                    |    | 15,158             |   |    | 30,731    |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|Loss from
 operations                                                     |  |                    | (52,692 | )                  |    | (65,065            | ) |    | (55,370   | )
|Interest
 expense                                                         |  |                    | 2,910   |                    |    | 4,098              |   |    | 6,519     |  
|Other income                                                              |  |                    | (168    | )                  |    | (180               | ) |    | (429      | )
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|Loss before
 income taxes                                                 |  |                    | (55,434 | )                  |    | (68,983            | ) |    | (61,460   | )
|Income tax
 (benefit) expense                                             |  |                    | (12,985 | )                  |    | (28                | ) |    | 37,975    |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|NET LOSS                                                                  |  | ($                 | 42,449  | )                  | ($ | 68,955             | ) | ($ | 99,435    | )
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|BASIC AND
 DILUTED LOSS PER SHARE:                                        |  |                    |         |                    |    |                    |   |    |           |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|Basic and
 diluted loss per share                                         |  | ($                 | 1.35    | )                  | ($ | 2.21               | ) | ($ | 3.20      | )
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|Weighted
 average number of common shares outstanding  basic and diluted |  |                    | 31,370  |                    |    | 31,223             |   |    | 31,046    |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  
|                                                                          |  |                    |         |                    |    |                    |   |    |           |  

See Accompanying Notes to Consolidated Financial Statements.

F-5

---



TRANS
WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND
COMPREHENSIVE LOSS
(Shares and $ in thousands)

|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|-------------------------------------------------------------------------------------------------- |  | -------------- | ------ | ------------- | - | ---------------------------- |  | ---------------- | ------- | ----------------------- |  | ------------------------------------------------ | - | ------------------ | --------- | --------------------- | -- | ----- | - | - | ------- | - | - | ------- | -
|                                                                                                   |  | Common
 Shares |        | Common
 Stock |   | Additional
 Paid-in
 Capital |  | Treasury
 Shares |         | Treasury Stock
 At Cost |  | Accumulated
 Other
 Comprehensive
 Income (Loss) |   | Retained
 Earnings |           | Shareholders
 Equity |   
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |   
|Balance
 as of February 3, 2007                                                                    |  |                | 55,998 |               | $ | 560                          |  | $                | 301,526 |                         |  | (25,104                                          | ) | ($                 | 217,560   | )                     | ($ | 1,888 | ) | $ | 310,567 |   | $ | 393,205 |  
|Comprehensive
 loss:                                                                               |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Net loss                                                                                           |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    |      |   |   | (99,435 | ) |   | (99,435 | )
|Additional pension liability adjustment, net of tax of $107                                        |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    | 263   |   |   |        |   |   | 263     |  
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Total comprehensive loss                                                                           |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   | (99,172 | )
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Adjustment to initially apply ASC Topic 740, Income
 Taxes                                         |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    |      |   |   | 1,636   |   |   | 1,636   |  
|Issuance of treasury stock under incentive stock
 programs                                         |  |                |       |               |   |                             |  |                  | 1       |                         |  | 1                                                |   |                    | 5         |                       |    |      |   |   |        |   |   | 6       |  
|Stock compensation and related tax benefit                                                         |  |                | 291    |               |   | 3                            |  |                  | 2,532   |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 2,535   |  
|Unearned compensation  restricted stock                                                           |  |                |       |               |   |                             |  |                  | (125    | )                       |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | (125    | )
|Amortization of unearned compensation  restricted
 stock                                          |  |                |       |               |   |                             |  |                  | 54      |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 54      |  
|Reversal of unearned compensation  restricted
 stock associated with termination of a participant |  |                |       |               |   |                             |  |                  | 10      |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 10      |  
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Balance as of February 2, 2008                                                                     |  |                | 56,289 |               | $ | 563                          |  | $                | 303,998 |                         |  | (25,103                                          | ) | ($                 | 217,555   | )                     | ($ | 1,625 | ) | $ | 212,768 |   | $ | 298,149 |  
|Comprehensive loss:                                                                                |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Net loss                                                                                           |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    |      |   |   | (68,955 | ) |   | (68,955 | )
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Additional pension liability adjustment                                                            |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    | 4,021 |   |   |        |   |   | 4,021   |  
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Total comprehensive loss                                                                           |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   | (64,934 | )
|Adjustment upon adoption of new measurement date of
 defined pension plan                          |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    |      |   |   | (362    | ) |   | (362    | )
|Stock compensation                                                                                 |  |                | 1      |               |   |                             |  |                  | 1,380   |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 1,380   |  
|Issuance of stock to Directors                                                                     |  |                | 82     |               |   | 1                            |  |                  | 719     |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 720     |  
|Amortization of unearned compensation  restricted
 stock                                          |  |                |       |               |   |                             |  |                  | 62      |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 62      |  
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Balance as of January 31, 2009                                                                     |  |                | 56,372 |               | $ | 564                          |  | $                | 306,159 |                         |  | (25,103                                          | ) | ($                 | 217,555   | )                     | $  | 2,396 |   | $ | 143,451 |   | $ | 235,015 |  
|Comprehensive loss:                                                                                |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Net loss                                                                                           |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    |      |   |   | (42,449 | ) |   | (42,449 | )
|Additional pension liability adjustment, net of tax
 of $2,332                                     |  |                |       |               |   |                             |  |                  |        |                         |  |                                                 |   |                    |          |                       |    | (878  | ) |   |        |   |   | (878    | )
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Total comprehensive loss                                                                           |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   | (43,327 | )
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Stock compensation                                                                                 |  |                |       |               |   |                             |  |                  | 1,170   |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 1,170   |  
|Issuance of stock to Directors                                                                     |  |                | 126    |               |   | 1                            |  |                  | 478     |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 479     |  
|Amortization of unearned compensation  restricted
 stock                                          |  |                |       |               |   |                             |  |                  | 16      |                         |  |                                                 |   |                    |          |                       |    |      |   |   |        |   |   | 16      |  
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  
|Balance as of January 30, 2010                                                                     |  |                | 56,498 |               | $ | 565                          |  | $                | 307,823 |                         |  | (25,103                                          | ) |                    | ($217,555 | )                     | $  | 1,518 |   | $ | 101,002 |   | $ | 193,353 |  
|                                                                                                   |  |                |        |               |   |                              |  |                  |         |                         |  |                                                  |   |                    |           |                       |    |       |   |   |         |   |   |         |  

See
Accompanying Notes to Consolidated Financial Statements.

F-6

---



TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
($ in thousands)

|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|------------------------------------------------------------------------------------------ |  | ----------------- | ------- | ----------------- | -- | ----------------- | - | -- | ------- | -
|                                                                                           |  | Fiscal Year Ended |        
|                                                                                           |  |                   |        
|                                                                                           |  | January 30,
 2010 |         | January 31,
 2009 |    | February 2,
 2008 |  
|                                                                                           |  |                   |         |                   |    |                   |  
|OPERATING ACTIVITIES:                                                                      |  |                   |         |                   |    |                   |   |    |         |  
|Net loss                                                                                   |  | ($                | 42,449  | )                 | ($ | 68,955            | ) | ($ | 99,435  | )
|Adjustments to reconcile net loss to net cash provided by (used by)
 operating activities: |  |                   |         |                   |    |                   |   |    |         |  
|Depreciation and amortization of fixed assets                                              |  |                   | 16,602  |                   |    | 23,614            |   |    | 39,900  |  
|Asset impairment charges                                                                   |  |                   | 3,643   |                   |    | 15,158            |   |    | 30,731  |  
|Amortization of intangible assets                                                          |  |                   | 86      |                   |    | 94                |   |    | 297     |  
|Amortization of lease valuations, net                                                      |  |                   | (217    | )                 |    | (350              | ) |    | (1,146  | )
|Long term incentive compensation                                                           |  |                   | 2,321   |                   |    | 1,930             |   |    | 1,906   |  
|Loss on disposal of fixed assets                                                           |  |                   | 870     |                   |    | 1,219             |   |    | 2,535   |  
|Gain on sale of assets                                                                     |  |                   |        |                   |    | (3,070            | ) |    |        |  
|Deferred tax expense                                                                       |  |                   |        |                   |    |                  |   |    | 42,475  |  
|Decrease (increase) in cash surrender value                                                |  |                   | (1,111  | )                 |    | 1,585             |   |    | (130    | )
|Changes in operating assets and liabilities, net of effects of
 acquisition:               |  |                   |         |                   |    |                   |   |    |         |  
|Accounts receivable                                                                        |  |                   | 3,054   |                   |    | 1,073             |   |    | (758    | )
|Merchandise inventory                                                                      |  |                   | 111,620 |                   |    | 62,053            |   |    | 64,619  |  
|Prepaid expenses and other                                                                 |  |                   | 3,260   |                   |    | 3,761             |   |    | (11,625 | )
|Other assets                                                                               |  |                   | 212     |                   |    | 186               |   |    | 177     |  
|Accounts payable                                                                           |  |                   | (39,273 | )                 |    | (66,753           | ) |    | (68,444 | )
|Income taxes receivable/payable                                                            |  |                   | (492    | )                 |    | 5,708             |   |    | (17,280 | )
|Accrued expenses and other current liabilities                                             |  |                   | (5,000  | )                 |    | (8,321            | ) |    | (3,457  | )
|Other long-term liabilities                                                                |  |                   | (3,337  | )                 |    | (6,164            | ) |    | (5,944  | )
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|Net cash provided by (used by) operating activities                                        |  |                   | 49,789  |                   |    | (37,232           | ) |    | (25,579 | )
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|INVESTING ACTIVITIES:                                                                      |  |                   |         |                   |    |                   |   |    |         |  
|Purchases of fixed assets                                                                  |  |                   | (4,586  | )                 |    | (10,066           | ) |    | (15,949 | )
|Net proceeds from sale of distribution facility                                            |  |                   |        |                   |    | 6,193             |   |    |        |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|Net cash used by investing activities                                                      |  |                   | (4,586  | )                 |    | (3,873            | ) |    | (15,949 | )
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|FINANCING ACTIVITIES:                                                                      |  |                   |         |                   |    |                   |   |    |         |  
|Payments of long-term debt                                                                 |  |                   | (566    | )                 |    | (533              | ) |    | (502    | )
|Payments of capital lease obligations                                                      |  |                   | (3,178  | )                 |    | (2,964            | ) |    | (2,887  | )
|Excess tax benefit from stock award exercises                                              |  |                   |        |                   |    |                  |   |    | 3       |  
|Proceeds from exercise of stock awards                                                     |  |                   |        |                   |    | 2                 |   |    | 939     |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|Net cash used by financing activities                                                      |  |                   | (3,744  | )                 |    | (3,495            | ) |    | (2,447  | )
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|Net increase (decrease) in cash and cash equivalents                                       |  |                   | 41,459  |                   |    | (44,600           | ) |    | (43,975 | )
|Cash and cash equivalents, beginning of year                                               |  |                   | 30,055  |                   |    | 74,655            |   |    | 118,630 |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|Cash and cash equivalents, end of year                                                     |  | $                 | 71,514  |                   | $  | 30,055            |   | $  | 74,655  |  
|                                                                                           |  |                   |         |                   |    |                   |   |    |         |  
|Supplemental disclosures and non-cash investing and financing
 activities:                 |  |                   |         |                   |    |                   |   |    |         |  
|Interest paid                                                                              |  | $                 | 2,954   |                   | $  | 4,164             |   | $  | 5,529   |  
|Issuance of treasury stock under incentive stock programs                                  |  |                   |        |                   |    |                  |   |    | 6       |  
|Issuance of deferred / restricted shares under deferred / restricted
 stock plans          |  |                   |        |                   |    |                  |   |    | 160     |  

See Accompanying Notes to
Consolidated Financial Statements.

F-7

---



TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Nature of Operations and Summary of
Significant Accounting Policies

Nature of Operations:
Trans World Entertainment Corporation and subsidiaries (the Company) is one
of the largest specialty retailers of entertainment software, including music,
video, video games and related products in the United States. The Company
operates a chain of retail entertainment stores and e-commerce sites,
www.fye.com, www.wherehouse.com, www.secondspin.com and www.suncoast.com in a
single industry segment. As of January 30, 2010, the Company operated 557
stores totaling approximately 3.8 million square feet in the United States, the
District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin
Islands. The Companys business is seasonal in nature, with the peak selling
period being the holiday season in the Companys fourth fiscal quarter.

Liquidity: The Companys primary sources of
working capital are cash provided by operations and borrowing capacity under
its revolving credit facility as recently amended in April 2010. The Companys
cash flows fluctuate from quarter to quarter due to various items, including
seasonality of sales and earnings, merchandise inventory purchases and returns
and the related terms on the purchases and capital expenditures. Management
believes it will have adequate resources to fund its cash needs for the
foreseeable future, including its capital spending, its seasonal increase in merchandise
inventory and other operating cash requirements and commitments. Management has
considered many initiatives as part of the development of its operating plan
for 2010 and beyond that focus on the operation of a core base of stores,
improved product selection based on customer preferences and industry changes,
as well as further streamlining of its operations. During Fiscal 2009,
management carried out certain strategic initiatives in its efforts to reduce
certain operating costs such as the reduction of headcount at the home office
and the elimination or curtailment of certain other general and administrative
expenses. Also, during the fourth quarter of Fiscal 2009, management closed 133
stores and plans to continue its careful evaluation of store profitability of
its remaining 557 stores in consideration of lease terms, conditions and
expirations.

Management
anticipates any cash requirements due to a shortfall in cash from operations
will be funded by the Companys amended revolving credit facility, discussed
hereafter. Cash flows from investing and financing activities during Fiscal
2010 are expected to be comparable with Fiscal 2009.

Basis of Presentation: The
consolidated financial statements consist of Trans World Entertainment
Corporation, its wholly-owned subsidiary, Record Town, Inc. (Record Town),
and Record Towns subsidiaries, all of which are wholly-owned. All significant
intercompany accounts and transactions have been eliminated. The preparation of
financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates
and assumptions, including those related to merchandise inventory and return
costs, valuation of long-lived assets, income taxes, and accounting for gift
card liability, that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements, and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.

Concentration of Business Risks:
The Company purchases merchandise inventory for its stores from approximately
520 suppliers, with approximately 66% of purchases being made from ten
suppliers including EMI Music Distribution, Sony-Bertelsmann Music Group,
Warner/Electra/Atlantic Corp., Universal Music Group, Fox Video Inc., Paramount
Video, Buena Vista Video, Warner Home Entertainment, Universal Studios Home
Entertainment and Sony Pictures. Historically, the Company has not experienced
difficulty in obtaining satisfactory sources of supply, and management believes
that it will retain access to adequate sources of supply. However, a loss of a
major supplier could cause a loss of sales, which would have an adverse effect
on operating results.

Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with an original
maturity of three months or less to be cash equivalents.

Concentration of Credit Risks:
The Company maintains centralized cash management and investment programs
whereby excess cash balances are invested in short-term money market funds and
instruments considered to be cash equivalents. The Companys investment
portfolio is diversified and consists of short-term investment grade securities
consistent with its investment guidelines. These guidelines include the
provision that sufficient liquidity will be maintained to meet anticipated cash
flow needs. The Company maintains investments with various financial institutions.
These amounts often exceed the FDIC insurance limits. The Company limits the
amount of credit exposure with any one financial institution and believes that
no significant concentration of credit risk exists with respect to cash
investments.

Accounts Receivable:
Accounts receivable are comprised of receivables and unbilled revenues from
advertising services performed for third parties, and amounts due under
operating or service agreements with unaffiliated entities, loans to related
business ventures, and other, individually insignificant amounts. There are no
provisions for uncollectible amounts from retail sales of merchandise inventory
since payment is received at the time of sale.

Merchandise Inventory and Return Costs:
Merchandise inventory is stated at the lower of cost or market under the
average cost method. Inventory valuation requires significant judgment and
estimates, including obsolescence, shrink and any adjustments to market value,
if market value is lower than cost. The Company records obsolescence and any
adjustments to market value (if lower than cost) based on current and

F-8

---



anticipated
demand, customer preferences and market conditions. The provision for inventory
shrink is estimated as a percentage of sales for the period from the last date
a physical inventory was performed to the end of the fiscal year. Such
estimates are based on historical results and trends, and the shrink results
from the last physical inventory. Physical inventories are taken at least
annually for all stores and distribution centers throughout the year, and
inventory records are adjusted accordingly.

The Company is
generally entitled to return merchandise purchased from major music vendors for
credit against other purchases from these vendors. Certain vendors reduce the
credit with a merchandise return charge which varies depending on the type of
merchandise being returned. Certain other vendors charge a handling fee based
on units returned. The Company records merchandise return charges in cost of
sales.

Fixed Assets and Depreciation:
Fixed assets are recorded at cost and depreciated or amortized over the
estimated useful life of the asset using the straight-line method. The
estimated useful lives are as follows:

|                            |                                                                
|--------------------------- | ---------------------------------------------------------------
|Leasehold
 improvements     | Lesser of
 estimated useful life of the asset or the lease term
|Fixtures and
 equipment     | 3-7 years                                                      
|Buildings
 and improvements | 10-30 years                                                    

Major
improvements and betterments to existing facilities and equipment are
capitalized. Expenditures for maintenance and repairs are expensed as incurred.
Amortization of capital lease assets is included in depreciation and
amortization expense.

Impairment of Long-Lived Assets:
Long-lived assets are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset to undiscounted future net cash
flows expected to be generated by the asset over its remaining useful life. If
the carrying amount of an asset exceeds its estimated future cash flows, an
impairment charge is recognized by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Fair value is generally
measured based on discounted estimated future cash flows. Assets to be disposed
of would be separately presented in the Consolidated Balance Sheets and
reported at the lower of the carrying amount or fair value less disposition
costs.

During Fiscal
2009, 2008 and 2007, the Company recorded an asset impairment charge of $3.6
million, $15.2 million and $30.7 million, respectively, related to the write
down of certain long-lived assets at underperforming locations. Losses for
store closings in the ordinary course of business represent the write down of
the net book value of abandoned fixtures and leasehold improvements. The loss
on disposal of fixed assets related to store closings was $0.9 million, $1.2
million and $2.5 million in Fiscal 2009, 2008 and 2007, respectively, and is
included in selling, general and administrative (SG&A) expenses in the
Consolidated Statements of Operations and loss on disposal of fixed assets in
the Consolidated Statements of Cash Flows. Store closings usually occur at the
expiration of the lease, at which time leasehold improvements, which constitute
a majority of the abandoned assets, are fully depreciated.

Conditional Asset Retirement Obligations:
The Company records the fair value of an asset retirement obligation (ARO) as
a liability in the period in which it incurs a legal obligation associated with
the retirement of tangible long-lived assets that result from the acquisition,
construction, development, and/or normal use of the asset. The Company also
records a corresponding asset that is depreciated over the life of the asset.
Subsequent to its initial measurement, the ARO is adjusted at the end of each
period to reflect the passage of time and changes in the estimated future cash
flows underlying the obligation.

Commitments and Contingencies



The Company is subject to legal proceedings and claims
that have arisen in the ordinary course of its business and have not been
finally adjudicated. Although there can be no assurance as to the ultimate
disposition of these matters, it is managements opinion, based upon the
information available at this time, that the expected outcome of these matters,
individually or in the aggregate, will not have a material adverse effect on
the results of operations and financial condition of the Company.

Revenue Recognition:
The Companys revenue is primarily from retail sales of merchandise inventory.
Revenue is recognized at the point-of-sale. Internet sales are recognized as
revenue upon shipment. Shipping and handling fee income from the Companys
Internet operations is recognized as net sales. Loyalty card revenue is
amortized over the life of the membership period. Net sales are recorded net of
estimated amounts for sales returns and other allowances. The Company records
shipping and handling costs in cost of sales. Net sales are recorded net of
applicable sales taxes.

Cost of Sales: In
addition to the cost of product, the Company includes in cost of sales those
costs associated with purchasing, receiving, shipping, inspecting and
warehousing product. Also included are costs associated with the return of
product to vendors. Cost of sales further includes the cost of inventory shrink
and obsolescence and the benefit of vendor allowances and discounts.

Selling, General and Administrative
(SG&A) Expenses: Included in SG&A expenses
are payroll and related costs, store operating costs, occupancy charges,
professional and service fees, general operating and overhead expenses and
depreciation charges (excluding those related to distribution operations, as
discussed in Note 2 of Notes to the Consolidated Financial Statements in this
Annual Report on Form 10-K). Selling,

F-9

---



general and
administrative expenses also include fixed asset write offs associated with
store closures, if any, and miscellaneous items, other than interest.

Advertising Costs and Vendor Allowances:
The Company often receives allowances from its vendors to fund in-store
displays, print, radio and television advertising, and other promotional
events. Vendor advertising allowances which exceed specific, incremental and
identifiable costs incurred in relation to the advertising and promotions
offered by the Company to its vendors are classified as a reduction in the
purchase price of merchandise inventory. Accordingly, advertising and sales promotion
costs are charged to operations, offset by direct vendor reimbursements, as
incurred. Total advertising expense, excluding vendor allowances, was $14.1
million, $23.2 million, and $29.7 million in Fiscal 2009, 2008, and 2007,
respectively. In the aggregate, vendor allowances supporting the Companys
advertising and promotion included as a reduction of SG&A expenses, as
reimbursements of such costs were $13.9 million, $14.7 million, and $15.9
million in Fiscal 2009, 2008, and 2007, respectively.

Lease Accounting:
The Companys calculation of straight-line rent expense includes the impact of
escalating rents for periods in which it is reasonably assured of exercising
lease options and includes in the lease term any period during which the
Company is not obligated to pay rent while the store is being constructed
(rent holiday). The Company accounts for step rent provisions, escalation
clauses and other lease concessions by recognizing these amounts on a straight
line basis over the initial lease term. The Company capitalizes leasehold
improvements funded by tenant improvement allowances, depreciating them over
the lives of the related leases. The tenant improvement allowances are recorded
as deferred rent within other long-term liabilities in the Consolidated Balance
Sheet and are amortized as a reduction in rent expense over the life of the
related leases.

Store Closing Costs:
Management periodically considers the closing of underperforming stores.
Reserves are established at the time a liability is incurred for the present
value of any remaining lease obligations, net of estimated sublease income, and
other exit costs.

Gift Cards: The
Company offers gift cards for sale. A deferred income account, which is
included in accrued expenses and other current liabilities in the Consolidated
Balance Sheets, is established for gift cards issued. The deferred income
balance related to gift cards was $10.1 million and $13.1 million at the end of
Fiscal 2009 and 2008, respectively. When gift cards are redeemed at the store
level, revenue is recorded and the related liability is reduced. Breakage is
estimated based on the historical relationship of the redemption of gift cards
redeemed to gift cards sold, over a certain period of time. The Company has the
ability to reasonably and reliably estimate gift card liability based on
historical experience with redemption rates associated with a large volume of
homogeneous transactions, from a period of more than ten years. The Companys
estimate is not susceptible to significant external factors and the
circumstances around purchases and redemptions have not changed significantly
over time. The Company recorded breakage on its gift cards for Fiscal 2009,
2008 and 2007 in the amount of $3.2 million, $4.1 million and $3.4 million,
respectively. Gift card breakage is recorded as a reduction of SG&A
expenses.

Income Taxes: Income
taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of existing
assets and liabilities and their respective tax bases and operating loss and
tax credit carryforwards. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. Deferred
tax assets are subject to valuation allowances based upon managements
estimates of realizability.

The Company
recognizes the effect of income tax positions only if those positions are more
likely than not of being sustained. Recognized income tax positions are
measured at the largest amount that is greater than 50% likely of being
realized. Changes in recognition or measurement are reflected in the period in
which the change in judgment occurs. It is the Companys practice to recognize
interest and penalties related to income tax matters in income tax expense
(benefit) in the consolidated statements of operations.

Stock-Based Compensation: Stock-based compensation represents
the cost related to stock-based awards granted to employees and directors. The
Company measures stock-based compensation cost at grant date, based on the
estimated fair value of the award, and recognizes the cost as expense on a
straight-line basis (net of estimated forfeitures) over the options requisite
service period. The Company recognizes compensation expense based on estimated
grant date fair value using the Black-Scholes option-pricing model. Tax
benefits resulting from tax deductions in excess of the compensation cost
recognized for those options are to be classified and reported as both an
operating cash outflow and financing cash inflow.

Total
stock-based compensation expense recognized in the Consolidated Statements of
Operations for Fiscal 2009, Fiscal 2008 and Fiscal 2007 was $2.3 million, $1.9
million and $1.9 million. For Fiscal 2009 the related total deferred tax
expense was $0. The related total deferred tax benefit was approximately $0.1
million and $0.8 million in 2008 and 2007, respectively. As of January 30,
2010, there was $0.6 million of unrecognized compensation cost related to stock
option awards that is expected to be recognized as expense over a weighted
average period of 0.6 years.

F-10

---



The fair
values of the options granted have been estimated at the date of grant using
the Black - Scholes option pricing model with the following assumptions:

|                                                                         |                   |               |              
|------------------------------------------------------------------------ | ----------------- | ------------- | -------------
|                                                                         | Stock Option Plan
|                                                                         |                  
|                                                                         | 2009              | 2008          | 2007         
|                                                                         |                  
|Dividend yield                                                           | 0%                | 0%            | 0%           
|Expected volatility                                                      | 75.6%             | 52.8% - 56.3% | 65.1% - 68.7%
|Risk-free interest rate                                                  | 3.33%-3.37%       | 1.42% - 3.41% | 3.57% - 4.94%
|Expected option life in years                                            | 4.98-6.98         | 4.87  5.69   | 4.70  7.30  
|Weighted average fair value per share of options granted during the year | $0.69             | $1.34         | $3.39        

In the fourth
quarter of 2005, the Companys Board of Directors approved the acceleration of
vesting of previously granted unvested options awarded annually to employees
and officers under the Companys Stock Option Plans which had exercise prices
greater than $10.00 per share. Options to purchase 2,273,057 shares of the
Companys common stock, representing approximately 24% of the total options
outstanding, became immediately vested and exercisable as a result of this
action. The number of shares and exercise prices of the options subject to the
acceleration remained unchanged. Also, all of the other terms of the options
remain the same. Based upon an analysis performed, the acceleration of vesting
of these stock options resulted in compensation expense of $5.9 million. The
decision to accelerate vesting of these stock options was made primarily to
avoid recognizing compensation expense in the Consolidated Statements of
Operations in future financial statements. The acceleration of the vesting of
these stock options reduced the amounts recognized by the Company as
share-based compensation expense, net of income taxes, by approximately $0.4
million, $1.2 million and $1.9 million in Fiscal 2009, 2008 and 2007. The
accelerated options included 1,355,000 options held by executive officers and
918,057 options held by other employees. Based on the Companys closing stock
price of $6.25 per share on the date of accelerated vesting, the exercise
prices of all of the options were above the closing market price.

Loss Per Share:
Basic loss per share is calculated by dividing net loss by the weighted average
common shares outstanding for the period. Diluted loss per share is calculated
by dividing net loss by the sum of the weighted average shares outstanding and
additional common shares that would have been outstanding if the dilutive
potential common shares had been issued for the Companys common stock awards
from the Companys Stock Award Plans.

The following
is a reconciliation of the basic weighted average number of shares outstanding
to the diluted weighted average number of shares outstanding:

|                                                      |  |             |        |      |  |        |  |  |        | 
|----------------------------------------------------- |  | ----------- | ------ | ---- |  | ------ |  |  | ------ | 
|                                                      |  | Fiscal Year |       
|                                                      |  |             |       
|                                                      |  | 2009        |        | 2008 |  | 2007   | 
|                                                      |  |             |        |      |  |        | 
|                                                     
|Weighted average common shares outstanding
  basic   |  |             | 31,370 |      |  | 31,223 |  |  | 31,046 | 
|Dilutive effect of outstanding stock awards           |  |             |       |      |  |       |  |  |       | 
|                                                      |  |             |        |      |  |        |  |  |        | 
|Weighted average common shares outstanding
  diluted |  |             | 31,370 |      |  | 31,223 |  |  | 31,046 | 
|                                                      |  |             |        |      |  |        |  |  |        | 
|                                                      |  |             |        |      |  |        |  |  |        | 
|Antidilutive stock awards                             |  |             | 6,705  |      |  | 6,651  |  |  | 6,413  | 
|                                                      |  |             |        |      |  |        |  |  |        | 

As the Company
recorded a net loss during Fiscal 2009, 2008 and 2007, the impact of all
outstanding stock awards was not considered as such impact would be
antidilutive.

Fair Value of Financial Instruments:
The carrying amounts reported in the Consolidated Balance Sheets for cash and
cash equivalents, accounts receivable, accounts payable and other current liabilities
approximate fair value because of the immediate or short-term maturity of these
financial instruments. The carrying value of life insurance policies included
in other assets approximates fair value based on estimates received from
insurance companies. The carrying value of the Companys long-term debt
including current portion, approximates fair value based on estimated
discounted future cash flows for remaining maturities and rates currently
offered to the Company for similar debt instruments.

F-11

---



Segment Information:
The Company has one reportable segment. The following table shows net sales by
merchandise category:

|            |  |                  |         |      |   |         |  |   |           | 
|----------- |  | ---------------- | ------- | ---- | - | ------- |  | - | --------- | 
|            |  |                  |        
|            |  | Fiscal year      |        
|            |  | 2009             |         | 2008 |   | 2007    | 
|            |  |                  |        
|            |  | ($ in thousands) |        
|Music       |  | $                | 286,670 |      | $ | 349,737 |  | $ | 494,286   | 
|Video       |  |                  | 339,251 |      |   | 407,884 |  |   | 491,360   | 
|Video games |  |                  | 70,400  |      |   | 90,233  |  |   | 114,431   | 
|Other       |  |                  | 117,667 |      |   | 139,771 |  |   | 165,581   | 
|            |  |                  |         |      |   |         |  |   |           | 
|Total       |  | $                | 813,988 |      | $ | 987,625 |  | $ | 1,265,658 | 
|            |  |                  |         |      |   |         |  |   |           | 

The Other
category includes electronics, accessories and trend items, none of which
individually exceeds 10% of total net sales.

Note 2. Fixed Assets

Fixed assets
consist of the following:

|                                              |  |                   |          |                   |   |          |  
|--------------------------------------------- |  | ----------------- | -------- | ----------------- | - | -------- | -
|                                              |  | January 30,
 2010 |          | January 31,
 2009 |  
|                                              |  |                   |         
|                                              |  | ($ in thousands)  |         
|Buildings
 and improvements                   |  | $                 | 17,288   |                   | $ | 17,288   |  
|Fixtures and
 equipment                       |  |                   | 128,044  |                   |   | 136,896  |  
|Leasehold
 improvements                       |  |                   | 35,905   |                   |   | 48,240   |  
|                                              |  |                   |          |                   |   |          |  
|                                              |  |                   | 181,237  |                   |   | 202,424  |  
|Allowances
 for depreciation and amortization |  |                   | (147,329 | )                 |   | (151,987 | )
|                                              |  |                   |          |                   |   |          |  
|                                              |  | $                 | 33,908   |                   | $ | 50,437   |  
|                                              |  |                   |          |                   |   |          |  

Depreciation
and amortization of fixed assets is included in the Consolidated Statements of
Operations as follows:

|                                              |  |                  |        |      |   |        |  |   |        | 
|--------------------------------------------- |  | ---------------- | ------ | ---- | - | ------ |  | - | ------ | 
|                                              |  | Fiscal Year      |       
|                                              |  |                  |       
|                                              |  | 2009             |        | 2008 |   | 2007   | 
|                                              |  |                  |       
|                                              |  | ($ in thousands) |       
|Cost of
 sales                                |  | $                | 1,437  |      | $ | 1,563  |  | $ | 2,670  | 
|Selling,
 general and administrative expenses |  |                  | 15,165 |      |   | 22,051 |  |   | 37,230 | 
|                                              |  |                  |        |      |   |        |  |   |        | 
|Total                                         |  | $                | 16,602 |      | $ | 23,614 |  | $ | 39,900 | 
|                                              |  |                  |        |      |   |        |  |   |        | 

Depreciation
and amortization expense related to the Companys distribution center facility
and equipment is included in cost of sales. All other depreciation and
amortization of fixed assets is included in SG&A expenses.

Note 3. Impairment of Long-Lived Assets

During Fiscal
2009, 2008 and 2007, the Company concluded, based on a significant decline in
sales and earnings during the fourth quarter, that triggering events had
occurred requiring a test of long-lived assets for impairment at its retail
stores and consolidated subsidiaries. Long-lived assets at locations where
impairment was determined to exist were written down to their estimated fair
values as of the end of the period, resulting in the recording of an asset
impairment charges of $3.6 million, $15.2 million and $30.7 million in Fiscal
2009, Fiscal 2008 and Fiscal 2007, respectively. The remaining fair value of
these assets at January 30, 2010 was approximately $1.1 million. Estimated fair
values for long-lived assets at these locations, including store fixtures and
equipment, leasehold improvements and certain intangible assets, were
determined based on a measure of discounted future cash flows over the
remaining lease terms at the respective locations. Future cash flows were
estimated based on store operating plans and were discounted at a rate
approximating the Companys cost of capital without reference to market transactions.
Management believes its assumptions were reasonable and consistently applied.

Note 4. Debt

Credit Facility

On January 5,
2006, the Company entered into a five year, $100 million revolving secured
credit facility agreement (Credit Facility) with Bank of America, N.A. At the
election of the Company, loans under the Credit Facility bear interest on the
principal amount at a rate equal to either the Prime Rate or Adjusted LIBOR
plus 0.75%. The principal amount of all outstanding loans under the Credit
Facility together with any accrued but unpaid interest, are due and payable on
January 6, 2011, unless otherwise paid earlier pursuant to the terms of the
Credit Facility. Payments of amounts due under the Credit Facility are secured
by the assets of the Company.

F-12

---



The Credit
Facility includes customary provisions, including affirmative and negative
covenants, which include representations, warranties and restrictions on
additional indebtedness and acquisitions. The Credit Facility also includes
customary events of default, including, among other things, material adverse
effect, bankruptcy, and certain changes of control. The Company was in
compliance with terms and conditions of the Credit Facility as of January 30,
2010.

On March 23,
2006, the Company entered into a First Amendment of the Credit Facility with
Bank of America, N.A. which increased the maximum amount available for
borrowing under the revolving secured credit facility to $130 million, under
the same terms and conditions.

On October 20,
2006, the Company entered into a Second Amendment of the Credit Facility with
Bank of America, N.A. which increased the maximum amount available for
borrowing under the revolving secured credit facility to $150 million, under
the same terms and conditions. The availability under the Credit Facility is
subject to limitations based on sufficient inventory levels.

During Fiscal
2009, 2008 and 2007, the highest aggregate balances outstanding under the
revolving credit facility were $90.8 million, $97.6 million and $111.5 million,
respectively. As of January 30, 2010 and January 31, 2009, the Company had no
outstanding letter of credit obligations under the Credit Facility with Bank of
America, N.A. The Company had $132 million and $150 million available for
borrowing as of January 30, 2010 and January 31, 2009, respectively.

Amended Credit Facility

In April 2010,
the Company entered into an amended and restated Credit Agreement (Amended
Credit Facility) which reduced the availability under the facility to $100
million. The Amended Credit Facility updates certain terms and conditions
including prohibiting the payment of dividends, added covenants around the
number of store closings and changed the formula for interest rates. The
availability under the Amended Credit Facility is subject to limitations based
on sufficient inventory levels. The principal amount of all outstanding loans
under the Credit Facility together with any accrued but unpaid interest, are
due and payable in April 2013, unless otherwise paid earlier pursuant to the
terms of the Amended Credit Facility. Payments of amounts due under the Amended
Credit Facility are secured by the assets of the Company.

The Amended
Credit Facility includes customary provisions, including affirmative and negative
covenants, which include representations, warranties and restrictions on
additional indebtedness and acquisitions. The Amended Credit Facility also
includes customary events of default, including, among other things, material
adverse effect, bankruptcy, and certain changes of control.

Interest under
the Amended Credit Facility will accrue, at the election of the Company, at a
Base Rate or LIBO Rate, plus, in each case, an Applicable Margin, which is
determined by reference to the level of Availability as defined in the Credit
Agreement, with the Applicable Margin for LIBO Rate loans ranging from 4.00% to
4.50% and the Applicable Margin for Base Rate loans ranging from 3.00% to
3.50%. In addition, a commitment fee of 0.75% is also payable on unused commitments.

Mortgage Loan

During Fiscal
2004, the Company borrowed $5.8 million under a mortgage loan to finance the
purchase of real estate. The mortgage loan is repayable in monthly
installments of $64,000 over 10 years with a fixed interest rate of 6.0% and is
collateralized by the real estate. As of January 30, 2010, the outstanding
balance on the loan was $3.0 million. The following table presents principal
cash payments of long-term debt by expected maturity dates as of January 30,
2010:

|                          |  |                  |       | 
|------------------------- |  | ---------------- | ----- | 
|                          |  | Long-term debt   |      
|                          |  |                  |      
|                          |  | ($ in thousands) |      
|2010                      |  | $                | 602   | 
|2011                      |  |                  | 640   | 
|2012                      |  |                  | 680   | 
|2013                      |  |                  | 722   | 
|2014                      |  |                  | 346   | 
|                          |  |                  |       | 
|Total                     |  |                  | 2,990 | 
|Less: current portion     |  |                  | 602   | 
|                          |  |                  |       | 
|Longterm debt obligation |  | $                | 2,388 | 
|                          |  |                  |       | 

F-13

---



Note 5. Income Taxes

Income tax expense
(benefit) consists of the following:

|                              |  |                  |        |      |    |      |   |    |        |  
|----------------------------- |  | ---------------- | ------ | ---- | -- | ---- | - | -- | ------ | -
|                              |  | Fiscal Year      |       
|                              |  |                  |       
|                              |  | 2009             |        | 2008 |    | 2007 |  
|                              |  |                  |       
|                              |  | ($ in thousands) |       
|Federal 
 current            |  | ($               | 10,984 | )    | ($ | 455  | ) | ($ | 4,864  | )
|State 
 current              |  |                  | 332    |      |    | 427  |   |    | 364    |  
|Deferred                      |  |                  | (2,333 | )    |    |     |   |    | 42,475 |  
|                              |  |                  |        |      |    |      |   |    |        |  
|Income tax
 expense (benefit) |  | ($               | 12,985 | )    | ($ | 28   | ) | $  | 37,975 |  
|                              |  |                  |        |      |    |      |   |    |        |  

A
reconciliation of the Companys effective income tax rate with the Federal
statutory rate is as follows:

|                                                        |  |             |       |      |  |       |    |  |       |   
|------------------------------------------------------- |  | ----------- | ----- | ---- |  | ----- | -- |  | ----- | --
|                                                        |  | Fiscal Year |      
|                                                        |  |             |      
|                                                        |  | 2009        |       | 2008 |  | 2007  |   
|                                                        |  |             |      
|Federal statutory rate                                  |  |             | 35.0  | %    |  | 35.0  | %  |  | 35.0  | % 
|State income taxes, net of federal tax
 effect          |  |             | (0.4  | %)   |  | (0.2  | %) |  | (15.9 | %)
|Change in valuation allowance                           |  |             | (11.8 | %)   |  | (32.1 | %) |  | (78.1 | %)
|Corporate-owned life insurance payment
 settlement, net |  |             |      |      |  |      |    |  | (0.4  | %)
|Cash surrender value  insurance/ benefit
 programs     |  |             | 0.5   | %    |  | (1.0  | %) |  | (0.1  | %)
|Executive compensation                                  |  |             | (0.1  | %)   |  | (0.2  | %) |  | (0.2  | %)
|Tax credits                                             |  |             |      |      |  | (0.1  | %) |  | (0.1  | %)
|Other                                                   |  |             | 0.2   | %    |  | (1.4  | %) |  | (2.0  | %)
|                                                        |  |             |       |      |  |       |    |  |       |   
|Effective income tax rate                               |  |             | 23.4  | %    |  | 0.0   | %  |  | (61.8 | %)
|                                                        |  |             |       |      |  |       |    |  |       |   

During 2009,
federal tax legislation was enacted which allowed for an increased carryback
period for net operating losses incurred in 2008. Previously, the 2008 net
operating loss was included in gross deferred tax assets against which a full
valuation allowance was provided. The Company filed a refund claim under this
new legislation and in 2009 received a federal tax refund of $10.4 million and
recorded a current tax benefit.

Under the
final payment terms of a 2003 agreement between the Company and the IRS
regarding an earlier audit, the Company made a final principal payment of $7.1
million in 2007. The Other category is comprised of various items, including
the impacts of non deductible meals, dues, penalties, amortization, uncertain
tax positions, tax attribute, carryback limitations and graduate tax brackets.

Significant
components of the Companys deferred tax assets are as follows:

|                                                               |  |                  |          |                   |   |         |  
|-------------------------------------------------------------- |  | ---------------- | -------- | ----------------- | - | ------- | -
|                                                               |  | January 3,
 2010 |          | January 31,
 2009 |  
|                                                               |  |                  |         
|                                                               |  | ($ in thousands) |         
|DEFERRED TAX ASSETS                                            |  |                  |          |                   |   |         |  
|Accrued expenses                                               |  | $                | 1,730    |                   | $ | 1,581   |  
|Inventory                                                      |  |                  | 603      |                   |   | 2,582   |  
|Retirement and compensation related
 accruals                  |  |                  | 7,238    |                   |   | 7,009   |  
|Fixed assets                                                   |  |                  | 17,681   |                   |   | 19,402  |  
|Federal and state net operating loss and
 credit carryforwards |  |                  | 64,689   |                   |   | 46,895  |  
|Real estate leases, including deferred rent                    |  |                  | 5,952    |                   |   | 7,671   |  
|Losses on investments                                          |  |                  | 1,692    |                   |   | 2,013   |  
|Goodwill                                                       |  |                  | 3,730    |                   |   | 4,579   |  
|Other                                                          |  |                  | 983      |                   |   | 1,009   |  
|                                                               |  |                  |          |                   |   |         |  
|Gross deferred tax assets before valuation
 allowance          |  |                  | 104,298  |                   |   | 92,741  |  
|Less: valuation allowance                                      |  |                  | (104,298 | )                 |   | (92,741 | )
|                                                               |  |                  |          |                   |   |         |  
|Total deferred tax assets                                      |  | $                |         |                   | $ |        |  
|                                                               |  |                  |          |                   |   |         |  
|                                                               |  |                  |          |                   |   |         |  
|DEFERRED TAX LIABILITIES                                       |  |                  |         |                   |   |        |  
|                                                               |  |                  |          |                   |   |         |  
|                                                               |  |                  |          |                   |   |         |  
|NET DEFERRED TAX ASSET                                         |  | $                |         |                   | $ |        |  
|                                                               |  |                  |          |                   |   |         |  

F-14

---



The Company has
a net operating loss carryforward of $127.7 million for federal income tax
purposes and approximately $269 million for state income tax purposes as of the
end of Fiscal 2009 that expire at various times through 2030 and are subject
    to certain limitations and statutory expiration periods. The state net operating
loss carryforwards are subject to various business apportionment factors and
multiple jurisdictional requirements when utilized. The Company has federal tax
credit carryforwards of $1.2 million, of which $0.2 million will expire in
2026, with the remainder available indefinitely. The Company has state tax
credit carryforwards of $1.1 million, of which $0.3 million will expire in
2027.

In assessing
the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will
not be realized. The ultimate realization of deferred tax assets is dependent
upon the generation of future taxable income. Management considers the scheduled
reversal of taxable temporary differences, projected future taxable income and
tax planning strategies in making this assessment. As of January 30, 2010, the
Company has incurred a cumulative three-year loss. Based on the cumulative
three-year loss and other available objective evidence, management concluded
that a full valuation allowance should be recorded against its deferred tax
assets. As of January 30, 2010, the valuation allowance increased to $104.3
million from $92.7 million at January 31, 2009; because management believes
that it is more likely than not that the tax benefit will not be realized. The
increase in the valuation allowance equals the increase in gross deferred tax
assets and is consistent with the Companys decision to record a full valuation
allowance against deferred tax assets that have been recorded in the normal
course of business, as described above.

During Fiscal
2009, the Company paid income taxes of approximately $0.2 million and received
income tax refunds of approximately $10.5 million.

During Fiscal
2008, the Company paid income taxes of approximately $0.2 million and received
income tax refunds of approximately $6.0 million. For Fiscal 2007, the Company
paid income taxes, net of refunds, of approximately $12.4 million.

A
reconciliation of the beginning and ending amounts of unrecognized tax benefits
is provided below. Amounts presented excluded interest and penalties, where
applicable, on unrecognized tax benefits:

|                                               |  |   |       |  
|---------------------------------------------- |  | - | ----- | -
|(Amounts
 in thousands)                        |  |   |       |  
|Unrecognized
 tax benefits at January 31, 2009 |  | $ | 2,380 |  
|Increases in
 tax positions from prior years   |  |   |      |  
|Decreases in
 tax positions from prior years   |  |   |      |  
|Increases in
 tax positions for current year   |  |   |      |  
|Settlements                                    |  |   |      |  
|Lapse of
 applicable statute of limitations    |  |   | (20   | )
|                                               |  |   |       |  
|                                              
|Unrecognized
 tax benefits at January 30, 2010 |  | $ | 2,360 |  

As of January
30, 2010, the Company had $2.4 million of gross unrecognized tax benefits, $1.6
million of which would affect the Companys tax rate if recognized. While it is
reasonably possible that the amount of unrecognized tax benefits will increase
or decrease within the next twelve months, the Company does not expect the
change to have a significant impact on its results of operations or financial
position.

The Company is
subject to U.S. federal income tax as well as income tax of multiple state
jurisdictions. The Company has substantially concluded all federal income tax
matters through Fiscal 2007 and all material state and local income tax matters
through Fiscal 2003.

The Companys
practice is to recognize interest and penalties associated with its
unrecognized tax benefits as a component of income tax expense in the Companys
Consolidated Statement of Operations. During Fiscal 2009, the Company accrued a
provision for interest of $0.1 million. As of January 30, 2010, the liability
for uncertain tax positions reflected in the Companys Consolidated Balance
Sheets was $2.1 million, including accrued interest and penalties of $1.2
million.

F-15

---



Note 6. Leases

Leases - lessee

As more fully
discussed in Note 9 in the Notes to Consolidated Financial Statements, the
Company leases its Albany, NY distribution center and administrative offices
under three capital lease arrangements with its Chief Executive Officer and
largest shareholder.

Fixed assets
recorded under capital leases, which are included in fixed assets on the
accompanying Consolidated Balance Sheets, are as follows:

|                                              |  |                   |         |                  |   |         |  
|--------------------------------------------- |  | ----------------- | ------- | ---------------- | - | ------- | -
|                                              |  | January 30,
 2010 |         | January 31
 2009 |  
|                                              |  |                   |        
|                                              |  | ($ in thousands)  |        
|Buildings                                     |  | $                 | 9,342   |                  | $ | 9,342   |  
|Fixtures and
 equipment                       |  |                   | 12,824  |                  |   | 12,824  |  
|                                              |  |                   |         |                  |   |         |  
|                                              |  |                   | 22,166  |                  |   | 22,166  |  
|Allowances
 for depreciation and amortization |  |                   | (18,622 | )                |   | (15,926 | )
|                                              |  |                   |         |                  |   |         |  
|                                              |  | $                 | 3,544   |                  | $ | 6,240   |  
|                                              |  |                   |         |                  |   |         |  

At January 30,
2010, the Company leased 557 stores under operating leases, many of which
contain renewal options, for periods ranging from one to twenty-five years.
Most leases also provide for payment of operating expenses and real estate
taxes. Some also provide for contingent rent based on percentage of sales over
a certain sales volume.

Net rental expense was as follows:

|                    |  |                  |        |      |   |         |  |   |         | 
|------------------- |  | ---------------- | ------ | ---- | - | ------- |  | - | ------- | 
|                    |  | Fiscal Year      |       
|                    |  |                  |       
|                    |  | 2009             |        | 2008 |   | 2007    | 
|                    |  |                  |       
|                    |  | ($ in thousands) |       
|Minimum
 rentals    |  | $                | 86,016 |      | $ | 102,647 |  | $ | 123,303 | 
|Contingent
 rentals |  |                  | 417    |      |   | 581     |  |   | 849     | 
|                    |  |                  |        |      |   |         |  |   |         | 
|                    |  | $                | 86,433 |      | $ | 103,228 |  | $ | 124,152 | 
|                    |  |                  |        |      |   |         |  |   |         | 

Future minimum
rental payments required under all leases that have initial or remaining
non-cancelable lease terms at January 30, 2010 are as follows:

|                                        |  |                   |         |                 |   |        | 
|--------------------------------------- |  | ----------------- | ------- | --------------- | - | ------ | 
|                                        |  | Operating
 Leases |         | Capital
 Leases |  
|                                        |  |                   |        
|                                        |  | ($ in thousands)  |        
|2010                                    |  | $                 | 62,928  |                 | $ | 2,901  | 
|2011                                    |  |                   | 36,431  |                 |   | 2,154  | 
|2012                                    |  |                   | 25,133  |                 |   | 2,154  | 
|2013                                    |  |                   | 14,999  |                 |   | 2,154  | 
|2014                                    |  |                   | 10,572  |                 |   | 2,154  | 
|Thereafter                              |  |                   | 9,628   |                 |   | 1,649  | 
|                                        |  |                   |         |                 |   |        | 
|Total minimum payments required         |  | $                 | 159,691 |                 | $ | 13,166 | 
|                                        |  |                   |         |                 |   |        | 
|Less: amounts representing interest     |  |                   |         |                 |   | 7,308  | 
|                                        |  |                   |         |                 |   |        | 
|Present value of minimum lease payments |  |                   |         |                 |   | 5,858  | 
|Less: current portion                   |  |                   |         |                 |   | 1,372  | 
|                                        |  |                   |         |                 |   |        | 
|Long-term capital lease obligations     |  |                   |         |                 | $ | 4,486  | 
|                                        |  |                   |         |                 |   |        | 

In addition to
the obligations in the table above, a significant number of the Companys
stores have leases which have rent payments based on the stores sales volume
in lieu of fixed minimum rent payments. During Fiscal 2009, minimum rent
payments based on a stores sales volume were $10.2 million.

Interest rates
on capital leases were between 5.65% and 37.0% per annum.

F-16

---



Leases - lessor

The Company,
as lessor, entered into a 60 year lease, effective April 2009, covering real
property owned by the Company in Miami, Florida. Under the provisions of the
lease, the Company receives minimum monthly rent payments as follows:

|                         |  |                      |       |                 |   |         | 
|------------------------ |  | -------------------- | ----- | --------------- | - | ------- | 
|                         |  | Annual Rent
 Payment |       | Total
 Payments |  
|                         |  |                      |      
|                         |  | ($ in thousands)     |      
|Feb. 2010 
 March 2029  |  | $                    | 1,620 |                 | $ | 31,050  | 
|April 2029 
 March 2039 |  |                      | 1,782 |                 |   | 17,820  | 
|April 2039 
 March 2049 |  |                      | 1,960 |                 |   | 19,602  | 
|April 2049 
 March 2059 |  |                      | 2,156 |                 |   | 21,560  | 
|April 2059 
 March 2069 |  |                      | 2,372 |                 |   | 23,718  | 
|                         |  |                      |       |                 |   |         | 
|Total future payments    |  |                      |       |                 | $ | 113,750 | 
|                         |  |                      |       |                 |   |         | 

The lease
allows for the tenant to terminate the lease after the twenty fifth year and
every five years thereafter. Total guaranteed rent payments due to the Company
are $40.0 million. The Company recorded rental income of $1.4 million in Fiscal
2009.

F-17

---



Note 7. Benefit Plans

401(k) Savings Plan

The Company
offers a 401(k) Savings Plan to eligible employees meeting certain age and
service requirements. This plan permits participants to contribute up to 80% of
their salary, including bonuses, up to the maximum allowable by IRS regulations.
Participants are immediately vested in their voluntary contributions plus
actual earnings thereon. As of February 1, 2009, the Company suspended its
matching contribution. The Company expects to reinstate the matching
contribution effective May 1, 2010. Prior to termination, participant vesting
of the Companys matching and profit sharing contribution was based on the
years of service completed by the participant. Participants are fully vested
upon the completion of four years of service. All participant forfeitures of
non-vested benefits are used to reduce the Companys contributions in future
years. Total expense related to the Companys matching contribution was
approximately $0, $882,000 and $1,042,000 in Fiscal 2009, 2008 and 2007,
respectively.

Stock Award Plans

The Company
has five employee stock award plans, the 1994 Stock Option Plan, the 1998 Stock
Option Plan, the 1999 Stock Option Plan and the 2002 Stock Option Plan (the
Old Plans); and the 2005 Long Term Incentive and Share Award Plan (the New
Plan). Additionally, the Company has a stock award plan for non-employee
directors (the 1990 Plan). The Company no longer issues stock options under
the Old Plans. Under the New Plan, the Company generally issues Stock-Settled
Appreciation Rights (SSARS) that become exercisable in 50% increments
commencing three years from the date of grant and have a maximum term of ten
years from issuance. Under the 1990 Plan, awards generally become exercisable
commencing one year from the date of grant in increments of 25% per year with a
maximum term of ten years. In addition, directors of the Company receive annual
grants of deferred shares of Common Stock (Deferred Shares) issued under the
1990 Plan which vest equally in three years from date of grant.

Stock options
and SSARS authorized for issuance under the Old Plans, New Plan and 1990 Plan
total 20.6 million. As of January 30, 2010, of the awards authorized for
issuance under the Old Plans, New Plan and 1990 Plan, 7.8 million were granted
and are outstanding, 6.4 million of which were vested and exercisable. Shares
available for future grants of options and other share based awards at January
30, 2010 and January 31, 2009 were 3.0 million and 3.2 million, respectively.

During Fiscal
2008, the Company issued 275,000 restricted stock units. Restricted stock units
vest 50% after two years and 50% after three years and will be settled in cash
upon vesting. During Fiscal 2009 and Fiscal 2008, the Company recognized
$75,000 and $17,000, respectively, in expenses related to the grant of
restricted stock units.

The following
table summarizes information about the stock awards outstanding under the Old
Plans, New Plan and 1990 Plan as of January 30, 2010:

|                      |  |             |           |                          |  |                                    |  |                             |       |        |   |                                    |  |                             |           |  |   |       |  |   |        | 
|--------------------- |  | ----------- | --------- | ------------------------ |  | ---------------------------------- |  | --------------------------- | ----- | ------ | - | ---------------------------------- |  | --------------------------- | --------- |  | - | ----- |  | - | ------ | 
|                      |  |             |           |                          | 
|                      |  | Outstanding |           | Exercisable              | 
|                      |  |             |           |                          | 
|Exercise
 Price Range |  | Shares      |           | Average
 Remaining
 Life |  | Weighted
 Average
 Exercise
 Price |  | Aggregate
 Intrinsic
 Value |       | Shares |   | Weighted
 Average
 Exercise
 Price |  | Aggregate
 Intrinsic
 Value |          
|                      |  |             |          
|$0.00-$2.66           |  |             | 684,065   |                          |  | 8.5                                |  | $                           | 0.05  |        | $ | 858,228                            |  |                             | 50,587    |  | $ | 0.00  |  | $ | 65,763 | 
|2.67-5.33             |  |             | 2,290,752 |                          |  | 4.1                                |  |                             | 4.07  |        |   |                                   |  |                             | 1,926,376 |  |   | 3.84  |  |   |       | 
|5.34-8.00             |  |             | 727,775   |                          |  | 6.4                                |  |                             | 6.29  |        |   |                                   |  |                             | 348,000   |  |   | 7.08  |  |   |       | 
|8.01-10.67            |  |             | 2,592,093 |                          |  | 2.6                                |  |                             | 9.10  |        |   |                                   |  |                             | 2,592,093 |  |   | 9.10  |  |   |       | 
|10.68-13.33           |  |             | 692,000   |                          |  | 0.2                                |  |                             | 10.88 |        |   |                                   |  |                             | 692,000   |  |   | 10.88 |  |   |       | 
|13.34-16.00           |  |             | 783,455   |                          |  | 5.1                                |  |                             | 14.32 |        |   |                                   |  |                             | 783,455   |  |   | 14.32 |  |   |       | 
|                      |  |             |           |                          |  |                                    |  |                             |       |        |   |                                    |  |                             |           |  |   |       |  |   |        | 
|Total                 |  |             | 7,770,140 |                          |  | 4.0                                |  | $                           | 7.24  |        | $ | 858,228                            |  |                             | 6,392,511 |  | $ | 8.17  |  | $ | 65,763 | 
|                      |  |             |           |                          |  |                                    |  |                             |       |        |   |                                    |  |                             |           |  |   |       |  |   |        | 

F-18

---



The aggregate
intrinsic value in the preceding table represents the total pretax intrinsic
value based on the Companys closing stock price of $1.30 as of January 30,
2010, which would have been received by the award holders had all award holders
under the Old Plans, New Plan and 1990 Plan exercised their awards as of that
date. There were no in-the-money awards exercisable as of January 30, 2010.

The following
table summarizes activity under the Stock Award Plans:

|                         |                                          |   |                                                  |  |                                   | 
|------------------------ | ---------------------------------------- | - | ------------------------------------------------ |  | --------------------------------- | 
|                         | Employee
 and Director Stock Award Plans |  
|                         |                                          |  
|                         | Number of
 Shares Subject
 To Option     |   | Stock
 Award
 Exercise Price
 Range Per Share(1) |  | Weighted
 Average
 Exercise Price | 
|                         |                                          |  
|Balance February 3, 2007 | 10,058,854                               |   | $3.16-$23.75                                     |  | $  8.70                           | 
|Granted                  | 654,716                                  |   | 4.80-5.50                                        |  | 4.43                              | 
|Exercised                | (272,802                                 | ) | 3.16-3.96                                        |  | 3.45                              | 
|Forfeited                | (900,000                                 | ) | 11.20                                            |  | 11.20                             | 
|Canceled                 | (520,373                                 | ) | 3.50-23.75                                       |  | 5.01                              | 
|                         |                                          |   |                                                  |  |                                   | 
|Balance February 2, 2008 | 9,020,395                                |   | $3.50-$17.79                                     |  | $  8.26                           | 
|Granted                  | 431,728                                  |   | 1.16-2.91                                        |  | 2.66                              | 
|Exercised                | (94,825                                  | ) | 3.50                                             |  | 3.50                              | 
|Forfeited                | (569,371                                 | ) | 3.50-17.79                                       |  | 12.47                             | 
|Canceled                 | (329,462                                 | ) | 3.50-13.28                                       |  | 2.93                              | 
|                         |                                          |   |                                                  |  |                                   | 
|Balance January 31, 2009 | 8,458,465                                |   | $1.16-$15.25                                     |  | $  7.86                           | 
|Granted                  | 348,264                                  |   | 0.98                                             |  | 0.98                              | 
|Exercised(2)             | (137,693                                 | ) | 0.00                                             |  | 0.00                              | 
|Forfeited                | (113,622                                 | ) | 2.76-5.50                                        |  | 3.34                              | 
|Canceled                 | (785,274                                 | ) | 3.50-15.25                                       |  | 12.63                             | 
|                         |                                          |   |                                                  |  |                                   | 
|Balance January 30, 2010 | 7,770,140                                |   | $0.98-$14.32                                     |  | $  7.23                           | 
|                         |                                          |   |                                                  |  |                                   | 

|    |                                                                                                                                                            
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Exercise price ranges do not
 include the impact of deferred or restricted shares and restricted stock
 units that were granted at an exercise price of $0.
|   
|(2) | Represents vesting of restricted and deferred shares.                                                                                                      

During Fiscal
2009, 2008 and 2007, the Company recognized expenses of approximately $103,000,
$213,000 and $526,000, respectively, for deferred shares issued to non-employee
directors at an exercise price below the closing stock price on the date of
grant.

F-19

---



Restricted Stock Plan

Under the 1990
Restricted Stock Plan, the Compensation Committee of the Board of Directors is
authorized to grant awards for up to 900,000 restricted shares of Common Stock
to executive officers and other key employees of the Company. The shares are
issued as restricted stock and are held in the custody of the Company until all
vesting restrictions are satisfied. If conditions or terms under which an award
is granted are not satisfied, the shares are forfeited. Shares vest under these
grants over a period of two to five years, with vesting criteria that includes
continuous employment until applicable vesting dates have expired. As of
January 30, 2010, a total of 330,000 shares have been granted, of which 240,000
shares have vested and 90,000 shares had been forfeited. Unearned compensation
is recorded at the date of award, based on the market value of the shares, and
is amortized over the applicable vesting period. The amount amortized to
expense in Fiscal 2009, 2008 and 2007, net of the impact of forfeitures, was
approximately $16,000, $62,000 and $54,000, respectively. As of January 30,
2010, there were no outstanding awards and shares available for grant totaled
660,000.

Defined Benefit Plans

The Company
maintains a non-qualified Supplemental Executive Retirement Plan (SERP) for
certain Executive Officers of the Company. The SERP, which is unfunded,
provides eligible executives defined pension benefits that supplement benefits
under other retirement arrangements. The annual benefit amount is based on
salary and bonus at the time of retirement and number of years of service.

The Company
provides the Board of Directors with a noncontributory, unfunded retirement
plan (Director Retirement Plan) that pays a retired director an annual
retirement benefit equal to 60% of the annual retainer at the time of
retirement plus a 3% annual increase through the final payment. Payments begin
at age 62 or retirement, whichever is later, and continue for 10 years or the
life of the director and his or her spouse, whichever period is shorter.
Partial vesting in the retirement plan begins after six years of continuous
service. Participants become fully vested after 12 years of continuous service
on the Board. After June 1, 2003, new directors were not covered by the
Director Retirement Plan. Directors who were not yet vested in their retirement
benefits as of June 1, 2003 had the present value of benefits already accrued
as of the effective date converted to Deferred Shares under the 1990 Plan.
Directors that were fully or partially vested in their retirement benefits were
given a one time election to continue to participate in the current retirement
program or convert the present value of benefits already accrued to Deferred
Shares under the 1990 Plan as of the effective date.For Fiscal 2009, Fiscal
2008 and Fiscal 2007, net periodic benefit cost recognized under both plans
totaled approximately $1.0 million, $1.4 million, and $1.3 million, respectively.
The accrued pension liability for both plans was approximately $11.4 million
and $11.9 million at January 30, 2010 and January 31, 2009, respectively, and
is recorded within Other long term liabilities. The accumulated benefit
obligation for both plans was approximately $9.6 million and $9.7 million as of
January 30, 2010 and January 31, 2009, respectively.

The following
is a summary of the Companys defined benefit pension plans as of the most
recent actuarial calculations:

Obligation and Funded Status:

|                                            |  |                   |         |                   |    |         |  
|------------------------------------------- |  | ----------------- | ------- | ----------------- | -- | ------- | -
|                                            |  |                   |         |                   |   
|                                            |  | January 30,
 2010 |         | January 31,
 2009 |   
|                                            |  |                   |        
|                                            |  | ($ in thousands)  |        
|Change in Projected Benefit Obligation:     |  |                   |         |                   |    |         |  
|Benefit obligation at beginning of year     |  | $                 | 11,913  |                   | $  | 14,175  |  
|Service cost                                |  |                   | 195     |                   |    | 273     |  
|Interest cost                               |  |                   | 802     |                   |    | 1,114   |  
|Actuarial gain                              |  |                   | (1,458  | )                 |    | (3,597  | )
|Benefits paid                               |  |                   | (52     | )                 |    | (52     | )
|                                            |  |                   |         |                   |    |         |  
|Projected Benefit obligation at end of year |  | $                 | 11,400  |                   | $  | 11,913  |  
|                                            |  |                   |         |                   |    |         |  
|                                            |  |                   |         |                   |    |         |  
|Fair value of plan assets at end of year    |  | $                 |        |                   | $  |        |  
|                                            |  |                   |         |                   |    |         |  
|                                            |  |                   |         |                   |    |         |  
|Reconciliation of Funded Status:            |  |                   |         |                   |    |         |  
|Funded status                               |  | ($                | 11,400  | )                 | ($ | 11,913  | )
|Unrecognized prior service cost             |  |                   | 2,289   |                   |    | 2,630   |  
|Unrecognized net actuarial gain             |  |                   | (4,906  | )                 |    | (3,793  | )
|                                            |  |                   |         |                   |    |         |  
|Accrued benefit cost                        |  |                   | (14,017 | )                 |    | (13,076 | )
|Decrease (increase) in liability            |  |                   | 2,617   |                   |    | 1,163   |  
|                                            |  |                   |         |                   |    |         |  
|Accrued pension liability                   |  | ($                | 11,400  | )                 | ($ | 11,913  | )
|                                            |  |                   |         |                   |    |         |  

F-20

---



Amounts recognized in the Consolidated
Balance Sheets consist of:

|                                      |  |                   |        |                   |    |        |  
|------------------------------------- |  | ----------------- | ------ | ----------------- | -- | ------ | -
|                                      |  |                   |        |                   |   
|                                      |  | January 30,
 2010 |        | January 31,
 2009 |   
|                                      |  |                   |       
|                                      |  | ($ in thousands)  |       
|                                      |  |                   |        |                   |    |        |  
|Accrued
 pension liability            |  | ($                | 11,400 | )                 | ($ | 11,913 | )
|Accumulated
 other comprehensive loss |  |                   | (2,617 | )                 |    | (1,163 | )
|Deferred tax
 liability (asset)       |  |                   | 1,099  |                   |    | (1,233 | )
|                                      |  |                   |        |                   |    |        |  
|Net amount recognized                 |  | ($                | 12,918 | )                 | ($ | 14,309 | )
|                                      |  |                   |        |                   |    |        |  

Components of Net Periodic Benefit Cost and
Other Amounts Recognized in Other
Comprehensive (Income) Loss:($ in thousands)

|                                                                                       |  |             |        |      |    |        |   |   |       |  
|-------------------------------------------------------------------------------------- |  | ----------- | ------ | ---- | -- | ------ | - | - | ----- | -
|                                                                                       |  |             |       
|                                                                                       |  | Fiscal Year |       
|                                                                                       |  | 2009        |        | 2008 |    | 2007   |  
|                                                                                       |  |             |       
|Net Periodic Benefit Cost:                                                             |  |             |        |      |    |        |   |   |       |  
|Service cost                                                                           |  | $           | 195    |      | $  | 218    |   | $ | 216   |  
|Interest
 cost                                                                         |  |             | 802    |      |    | 891    |   |   | 763   |  
|Amortization
 of prior service cost                                                    |  |             | 342    |      |    | 342    |   |   | 342   |  
|Amortization
 of net (gain) loss                                                       |  |             | (346   | )    |    | (2     | ) |   | (2    | )
|                                                                                       |  |             |        |      |    |        |   |   |       |  
|Net periodic benefit cost                                                              |  | $           | 993    |      | $  | 1,449  |   | $ | 1,319 |  
|                                                                                       |  |             |        |      |    |        |   |   |       |  
|                                                                                      
|Other Changes in Benefit Obligations Recognized in Other
 Comprehensive (Income) Loss:
|Net prior
 service cost recognized as a component of net periodic benefit cost         |  | ($          | 342    | )    | ($ | 427    | ) |   |       |  
|Net
 actuarial gain recognized as a component of net periodic benefit cost             |  |             | 346    |      |    | 3      |   |   |       |  
|Net
 actuarial gain arising during the period                                          |  |             | (1,458 | )    |    | (3,597 | ) |   |       |  
|                                                                                       |  |             |        |      |    |        |   |   |       |  
|                                                                                       |  |             | (1,454 | )    |    | (4,021 | ) |   |       |  
|Income tax
 effect                                                                     |  |             | 2,332  |      |    |        |   |   |       |  
|                                                                                       |  |             |        |      |    |        |   |   |       |  
|Total
 recognized in other comprehensive (income) loss                                 |  | $           | 878    |      | ($ | 4,021  | ) |   |       |  
|                                                                                       |  |             |        |      |    |        |   |   |       |  
|Total
 recognized in net periodic benefit cost and other comprehensive (income) loss   |  | $           | 1,871  |      | ($ | 2,572  | ) |   |       |  
|                                                                                       |  |             |        |      |    |        |   |   |       |  

The pre-tax
components of accumulated other comprehensive income, which have not yet been
recognized as components of net periodic benefit cost as of January 30, 2010
and January 31, 2009 are summarized below.

|                                        |  |                   |       |                   |    |       |  
|--------------------------------------- |  | ----------------- | ----- | ----------------- | -- | ----- | -
|($ in thousands)                        |  | January 30,
 2010 |       | January 31,
 2009 |   
|                                        |  |                   |      
|Net
 unrecognized actuarial gain        |  | ($                | 4,906 | )                 | ($ | 3,734 | )
|Net
 unrecognized prior service cost    |  |                   | 2,289 |                   |    | 2,631 |  
|                                        |  |                   |       |                   |    |       |  
|Accumulated
 other comprehensive income |  | ($                | 2,617 | )                 | ($ | 1,103 | )
|                                        |  |                   |       |                   |    |       |  

In Fiscal
2009, approximately $342,000 of net unrecognized prior service cost and
approximately $346,000 of the net unrecognized actuarial gain, recorded as
components of accumulated other comprehensive loss at January 30, 2010, will be
recognized as components of net periodic benefit cost.

Assumptions:

|                                                                    |               |              
|------------------------------------------------------------------- | ------------- | -------------
|                                                                    |              
|                                                                    | Fiscal Year  
|                                                                    |              
|                                                                    | 2009          | 2008         
|                                                                    |              
|Weighted-average
 assumptions used to determine benefit obligation: |               |              
|Discount rate                                                       | 5.75%         | 6.75%        
|Salary increase rate                                                | 4.00%         | 4.00%        
|Measurement date                                                    | Jan. 30, 2010 | Jan. 31, 2009
|                                                                    |               |              

F-21

---



|                                                                           |  |      |   |                    |      |      |  |      |   | 
|-------------------------------------------------------------------------- |  | ---- | - | ------------------ | ---- | ---- |  | ---- | - | 
|                                                                           |  |      |   |                    |      |      |  |      |   | 
|                                                                           |  | 2009 |   | Fiscal Year 
 2008 |      | 2007 | 
|                                                                           |  |      |   |                    |      |      | 
|Weighted-average assumptions used to
 determine net periodic benefit cost: |  |      |   |                    |      |      |  |      |   | 
|Discount rate                                                              |  | 5.75 | % |                    | 6.75 | %    |  | 6.25 | % | 
|Salary increase rate                                                       |  | 4.00 | % |                    | 4.00 | %    |  | 4.00 | % | 

The discount
rate is based on the rates implicit in high-quality fixed-income investments
currently available as of the measurement date. The Citigroup Pension Discount
Curve (CPDC) rates are intended to represent the spot rates implied by the high
quality corporate bond market in the U.S. The projected benefit payments
attributed to the projected benefit obligation have been discounted using the
CPDC mid-year rates and the discount rate is the single constant rate that
produces the same total present value.

The following
benefit payments, which reflect expected future service, as appropriate, are
expected to be paid:

|                     |  |  |       |                  | 
|-------------------- |  |  | ----- | ---------------- | 
|                     |  |  |       |                  | 
|Year                 |  |  |       | Pension Benefits | 
|                     |  |  |       |                  | 
|                     |  |  |       | ($ in thousands) | 
|                     |  |  |       |                  | 
|2010                 |  |  |       | $         98     | 
|2011                 |  |  |       | 610              | 
|2012                 |  |  |       | 852              | 
|2013                 |  |  |       | 853              | 
|2014                 |  |  |       | 854              | 
|2015
 and thereafter |  |  | 4,429 |                 

Note 8. Shareholders
Equity

The Company
has never declared dividends on its Common Stock. The Companys Credit Facility
restricts the payment of cash dividends.

Note 9. Related Party
Transactions

The Company
leases its 181,300 square foot distribution center/office facility in Albany,
New York from Robert J. Higgins, its Chairman, Chief Executive Officer and
largest shareholder, under three capital leases that expire in the year 2015.
The original distribution center/office facility was occupied in 1985.

Under the
three capital leases, dated April 1, 1985, November 1, 1989 and September 1,
1998, the Company paid Mr. Higgins an annual rent of $2.1 million, $2.1 million
and $2.0 million in Fiscal 2009, 2008 and 2007 respectively. Pursuant to the
terms of the lease agreements, effective January 1, 2002 and every two years
thereafter, rental payments will increase in accordance with the biennial
increase in the Consumer Price Index. Under the terms of the lease agreements,
the Company is responsible for property taxes, insurance and other operating
costs with respect to the premises. Mr. Higgins obligation for principal and
interest on his underlying indebtedness relating to the real property is approximately
$1.1 million per year. None of the leases contain any real property purchase
options at the expiration of its term.

The Company
leases one of its retail stores from Mr. Higgins under an operating lease.
Annual rental payments under this lease were $40,000 in Fiscal 2009, 2008 and
2007. Under the terms of the lease, the Company pays property taxes,
maintenance and a contingent rental if a specified sales level is achieved.
Total additional charges for the store, including contingent rent, were approximately
$6,800, $7,400 and $3,800 in Fiscal 2009, 2008 and 2007 respectively.

The Company
charters an aircraft from Richmor Aviation Inc., an unaffiliated corporation
that leases an aircraft owned by Mr. Higgins, for Company business. Payments to
Richmor Aviation Inc., to charter the aircraft owned by Mr. Higgins, in Fiscal
2009, 2008 and 2007 were approximately $94,000, $205,000 and $29,000,
respectively.

Note 10. Quarterly
Financial Information (Unaudited)

|                                           |  |                                                 |         |                    |   |                    |  |                 |         |              |    |         |   |    |         |  
|------------------------------------------ |  | ----------------------------------------------- | ------- | ------------------ | - | ------------------ |  | --------------- | ------- | ------------ | -- | ------- | - | -- | ------- | -
|                                           |  | Fiscal
 2009 Quarter Ended                      |        
|                                           |  |                                                 |        
|                                           |  | 2009                                            |         | January
 30,
 2010 |   | October
 31,
 2009 |  | August 1,
 2009 |         | May 2,
 2009 |   
|                                           |  |                                                 |         |                    |   |                    |  |                 |         |              |   
|                                           |  | ($ in
 thousands, except for per share amounts) |        
|Net sales                                  |  | $                                               | 813,988 |                    | $ | 295,422            |  | $               | 161,387 |              | $  | 165,746 |   | $  | 191,433 |  
|Gross profit                               |  |                                                 | 261,661 |                    |   | 82,500             |  |                 | 54,639  |              |    | 58,770  |   |    | 65,752  |  
|                                          
|Net income
 (loss)                         |  | ($                                              | 42,449  | )                  | $ | 11,359             |  | ($              | 22,317  | )            | ($ | 17,755  | ) | ($ | 13,736  | )
|                                           |  |                                                 |         |                    |   |                    |  |                 |         |              |    |         |   |    |         |  
|Basic and
 diluted income (loss) per share |  | ($                                              | 1.35    | )                  | $ | 0.36               |  | ($              | 0.71    | )            | ($ | 0.57    | ) | ($ | 0.44    | )
|                                           |  |                                                 |         |                    |   |                    |  |                 |         |              |    |         |   |    |         |  

F-22

---



During the
fourth quarter of Fiscal 2009, the Company recorded an asset impairment charge
of $3.6 million related to the write down of certain long-lived assets at
underperforming locations. See Note 3 in the Notes to Consolidated Financial
Statements for further detail regarding the impairment charge. Also, during the
fourth quarter of Fiscal 2009, the Company recorded a current federal tax
benefit of $12.6 million primarily due to federal tax legislation enacted that
provided for an increased carryback period for net operating losses incurred in
2008.

|                                  |  |                                                 |         |                   |    |                   |   |                 |         |              |    |         |   |    |         |  
|--------------------------------- |  | ----------------------------------------------- | ------- | ----------------- | -- | ----------------- | - | --------------- | ------- | ------------ | -- | ------- | - | -- | ------- | -
|                                  |  | Fiscal 2008 Quarter Ended                       |        
|                                  |  |                                                 |        
|                                  |  | 2008                                            |         | January 31,
 2009 |    | November 1,
 2008 |   | August 2,
 2008 |         | May 3,
 2008 |   
|                                  |  |                                                 |         |                   |    |                   |   |                 |         |              |   
|                                  |  | ($ in
 thousands, except for per share amounts) |        
|Net sales                         |  | $                                               | 987,625 |                   | $  | 344,655           |   | $               | 195,193 |              | $  | 215,226 |   | $  | 232,551 |  
|Gross profit                      |  |                                                 | 330,895 |                   |    | 106,626           |   |                 | 65,411  |              |    | 75,870  |   |    | 82,988  |  
|                                 
|Net loss                          |  | ($                                              | 68,955  | )                 | ($ | 9,457             | ) | ($              | 28,442  | )            | ($ | 19,230  | ) | ($ | 11,826  | )
|                                  |  |                                                 |         |                   |    |                   |   |                 |         |              |    |         |   |    |         |  
|Basic and
 diluted loss per share |  | ($                                              | 2.21    | )                 | ($ | 0.30              | ) | ($              | 0.91    | )            | ($ | 0.62    | ) | ($ | 0.38    | )
|                                  |  |                                                 |         |                   |    |                   |   |                 |         |              |    |         |   |    |         |  

During the fourth quarter of
Fiscal 2008, the Company recorded an asset impairment charge of $15.2 million
related to the write down of certain long-lived assets at underperforming
locations. See Note 3 in the Notes to Consolidated Financial Statements for
further detail regarding the impairment charge.

F-23

---



Index to Exhibits 
Document Number and Description

|             |                                                                                                                                                                                                                                                                                                                                                                            
|------------ | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit
 No.
|3.1          | Restated
 Certificate of Incorporation  incorporated herein by reference to Exhibit
 3.1 to the Companys Annual Report on Form 10-K for the year ended January
 29, 1994. Commission File No. 0-14818.                                                                                                                                                                   
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.2          | Certificate
 of Amendment to the Certificate of Incorporation  incorporated herein by
 reference to Exhibit 3.1 to the Companys Quarterly Report on Form 10-Q for
 the fiscal quarter ended October 29, 1994. Commission File No. 0-14818.                                                                                                                               
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.3          | Certificate
 of Amendment to the Certificate of Incorporation  incorporated herein by
 reference to Exhibit 3.4 to the Companys Annual Report on Form 10-K for the
 year ended January 31, 1998. Commission File No. 0-14818.                                                                                                                                            
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.4          | Amended
 By-Laws  incorporated herein by reference to Exhibit 3.4 to the Companys
 Annual Report on Form 10-K for the year ended January 29, 2000. Commission
 File No. 0-14818.                                                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.5          | Certificate
 of Amendment to the Certificate of Incorporationincorporated herein by
 reference to Exhibit 3.5 to the Companys Registration Statement on Form S-4,
 No. 333-75231.                                                                                                                                                                                        
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.6          | Certificate
 of Amendment to the Certificate of Incorporationincorporated herein by
 reference to Exhibit 3.6 to the Companys Registration Statement on Form S-4,
 No. 333-75231.                                                                                                                                                                                        
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.7          | Certificate
 of Amendment to the Certificate of Incorporationincorporated herein by
 reference to Exhibit 4.2 to the Companys Current Report on Form 8-K filed
 August 15, 2000. Commission File No. 0-14818.                                                                                                                                                            
|             |                                                                                                                                                                                                                                                                                                                                                                            
|3.8          | Certificate
 of Amendment to the Certificate of Incorporation of - incorporated herein by
 reference to Exhibit 2 to the Companys Current Report on Form 8-A filed
 August 15, 2000. Commission File No. 0-14818.                                                                                                                                                         
|             |                                                                                                                                                                                                                                                                                                                                                                            
|4.1          | Credit
 Agreement dated January 5, 2006, between Trans World Entertainment
 Corporation and Bank of America N.A. - incorporated by reference to Exhibit
 99.2 to the Companys Current Report on Form 8-K filed January 10, 2006.
 Commission File No. 0-14818.                                                                                                            
|             |                                                                                                                                                                                                                                                                                                                                                                            
|4.2          | First
 Amendment to Credit Agreement between Trans World Entertainment Corporation
 and Bank of America N.A  incorporated by reference to Exhibit 4.1 to the
 Companys Current Report on Form 8-K filed March 29, 2006. Commission File
 No. 0-14818.                                                                                                                    
|             |                                                                                                                                                                                                                                                                                                                                                                            
|4.3          | Second
 Amendment to Credit Agreement between Trans World Entertainment Corporation
 and Bank of America N.A  incorporated by reference to Exhibit 4.1 to the
 Companys Current Report on Form 8-K filed October 23, 2006. Commission File
 No. 0-14818.                                                                                                                 
|             |                                                                                                                                                                                                                                                                                                                                                                            
|4.4          | Amended and Restated Credit Agreement between
         Trans World Entertainment and Bank of America N.A.  incorporated
         by reference to Exhibit 4.1 to the Companys Current Report on
         Form 8-K filed April 15, 2010. Commission File No. 0-14818.                                                                                                      
|             |                                                                                                                                                                                                                                                                                                                                                                            
|4.5          | Rights
 Agreement, between Trans World Entertainment Corporation and ChaseMellon
 Shareholder Services, L.L.C., as Rights Agent  incorporated herein by
 reference to Exhibit 1 to the Companys Current Report on Form 8-A filed
 August 15, 2000. Commission File No. 0-14818.                                                                                          
|             |                                                                                                                                                                                                                                                                                                                                                                            
|4.6          | Amendment
 No. 1 to the Rights Agreement, dated as of August 11, 2000, between Trans
 World Entertainment Corporation and Mellon Investor Services LLC (as
 successor in interest to ChaseMellon Shareholder Services, L.L.C.) 
 incorporated herein by reference to Exhibit 4.2 to the Companys Form
 8-A12G/A filed November 27, 2007. Commission File No. 0-14818.    
|             |                                                                                                                                                                                                                                                                                                                                                                            
|10.1         | Lease, dated
 April 1, 1985, between Robert J. Higgins, as Landlord, and Record Town, Inc.
 and Trans World Music Corporation, as Tenant and Amendment thereto dated
 April 28, 1986  incorporated herein by reference to Exhibit 10.3 to the
 Companys Registration Statement on Form S-1, No. 33-6449.                                                                 
|             |                                                                                                                                                                                                                                                                                                                                                                            
|10.2         | Second
 Addendum, dated as of November 30, 1989, to Lease, dated April 1, 1985, among
 Robert J. Higgins, and Trans World Music Corporation, and Record Town, Inc.,
 exercising five year renewal option  incorporated herein by reference to
 Exhibit 10.2 to the Companys Annual Report on Form 10-K for the year ended
 February 3, 1990. Commission File No. 0-14818.
|             |                                                                                                                                                                                                                                                                                                                                                                            
|10.3         | Lease, dated
 November 1, 1989, between Robert J. Higgins, as Landlord, and Record Town,
 Inc. and Trans World Music Corporation, as Tenant  incorporated herein by
 reference to Exhibit 10.3 to the Companys Annual Report on Form 10-K for the
 year ended February 2, 1991. Commission File No. 0-14818.                                                             

F-24

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|      |                                                                                                                                                                                                                                                                                                                                                                                 
|----- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.5  | Lease dated
 September 1, 1998, between Robert J. Higgins, as Landlord, and Record Town,
 Inc. and Trans World Music Corporation, as Tenant, for additional office
 space at 38 Corporate Circle  incorporated herein by reference to Exhibit
 10.1 to the Companys Quarterly Report on Form 10-Q for the fiscal quarter
 ended October 31, 1998. Commission File No. 0-14818.
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.6  | Trans World
 Music Corporation 1990 Stock Option Plan for Non-Employee Directors, as
 amended and restated  incorporated herein by reference to Annex A to Trans
 Worlds Definitive Proxy Statement on Form 14A filed as of May 19, 2000.
 Commission File No. 0-14818.                                                                                                       
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.7  | Trans World
 Entertainment Corporation Amended 1990 Restricted Stock Plan  incorporated
 herein by reference to Annex B to Trans Worlds Definitive Proxy Statement on
 Form 14A filed as of May 19, 1999. Commission File No. 0-14818.                                                                                                                                        
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.8  | Trans World
 Entertainment Corporation 1994 Stock Option Plan  incorporated herein by
 reference to Exhibit 10.1 to the Companys Quarterly Report on Form 10-Q for
 the fiscal quarter ended July 30, 1994. Commission File No. 0-14818.                                                                                                                                      
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.9  | Trans World
 Entertainment Corporation 1998 Stock Option Plan  incorporated herein by
 reference to Annex B to Trans Worlds Definitive Proxy Statement on Form 14A
 filed as of May 7, 1998. Commission File No. 0-14818.                                                                                                                                                     
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.10 | Trans World
 Entertainment Corporation 1999 Stock Option Plan  incorporated herein by
 reference to Annex A to Trans Worlds Definitive Proxy Statement on Form 14A
 filed as of May 7, 1998. Commission File No. 0-14818.                                                                                                                                                     
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.11 | Form of
 Indemnification Agreement dated May 1, 1995 between the Company and its
 officers and directors incorporated herein by reference to Exhibit 10.2 to
 the Companys Quarterly Report on Form 10-Q for the fiscal quarter ended
 April 29, 1995. Commission File No. 0-14818.                                                                                            
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.12 | Trans World
 Entertainment Corporation Supplemental Executive Retirement Plan, as amended
  incorporated herein by reference to Exhibit 10.1 to the Companys Form 8-K
 filed on December 19, 2008. Commission File No. 0-14818.                                                                                                                                               
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.13 | Employment
 Agreement, dated as of December 26, 2008, between the Company and Robert J.
 Higgins. Incorporated herein by reference to Exhibit 10.1 to the Companys
 Form 8-K filed on December 29, 2008. Commission File No. 0-14818.                                                                                                                                          
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|10.15 | Trans World
 Entertainment Corporation 2005 Long Term Incentive and Share Award Plan
 incorporated herein by reference to Appendix A to Trans World Entertainment
 Corporations Definitive Proxy Statement on Form 14A filed as of May 11,
 2005. Commission File No. 0-14818.                                                                                                 
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|* 21  | Significant
 Subsidiaries of the Registrant.                                                                                                                                                                                                                                                                                                                                    
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|* 23  | Consent of
 KPMG LLP.                                                                                                                                                                                                                                                                                                                                                           
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|*31.1 | Certification
 of Chief Executive Officer dated April 15, 2010, relating to the Registrants
 Annual Report on Form 10-K for the year ended January 30, 2010, pursuant to
 Rule 13a-14(a) or Rule 15a-14(a).                                                                                                                                                                    
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|*31.2 | Certification
 of Chief Financial Officer dated April 15, 2010, relating to the Registrants
 Annual Report on Form 10-K for the year ended January 30, 2010, pursuant to
 Rule 13a-14(a) or Rule 15a-14(a).                                                                                                                                                                    
|      |                                                                                                                                                                                                                                                                                                                                                                                 
|**32  | Certification
 of Chief Executive Officer and Chief Financial Officer of Registrant, dated
 April 15, 2010, pursuant to 18 U.S.C. Section 1350, as adopted Pursuant to
 Section 906 of the Sarbanes-Oxley Act of 2002 relating to the Registrants
 Annual Report on Form 10-K for the year ended January 30, 2010.                                                             

* Filed
herewith 
** Furnished herewith

F-25

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