**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, D.C.  20549**

 

**FORM10-Q**

 

**ý****                                ****QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**

 

**FOR THE QUARTERLY PERIOD ENDED JULY30, 2005**

 

**OR**

 

**o****                                ****TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT**

 

**FOR THE TRANSITION PERIOD FROM                   TO**

 

**COMMISSION FILE NUMBER:  0-14818**

 

**TRANSWORLD ENTERTAINMENT CORPORATION**

(Exact name of registrant asspecified 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)      |

 

Indicate by a check mark whether the Registrant (1) has filed allreports required to be filed by Sections 13 or 15 (d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for shorter period thatthe Registrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes ý No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes ý No o

 

Indicate the number of shares outstanding of each of the issuer’sclasses of common stock, as of the latest practicable date.

 

Common Stock, $.01 parvalue,

31,886,276 sharesoutstanding as of August 28, 2005

 

 

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**TRANS WORLD ENTERTAINMENT CORPORATIONAND SUBSIDIARIES**

**QUARTERLY REPORT ON FORM 10-Q**

**INDEX TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS**

 
| PART 1. FINANCIAL INFORMATION                                                                        |   |
|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                 |   |
| Item 1 - Financial Statements                                                                        |   |
|                                                                                                 |   |
| Condensed Consolidated  Balance Sheets (unaudited) at July 30, 2005,                                 |   |
| January 29, 2005 and July  31, 2004 (unaudited)                                                      |   |
|                                                                                                 |   |
| Condensed Consolidated  Statements of Operations (unaudited) –                                  |   |
| Thirteen Weeks and  Twenty-six Weeks Ended July 30, 2005 and July 31, 2004                           |   |
|                                                                                                 |   |
| Condensed Consolidated  Statements of Cash Flows (unaudited)–                                   |   |
| Twenty-six Weeks Ended July  30, 2005 and July 31, 2004                                              |   |
|                                                                                                 |   |
| Notes  to Condensed Consolidated Financial Statements (unaudited)                                    |   |
|                                                                                                 |   |
| Item 2 - Management’s Discussion and Analysis of  Financial Condition and Results of Operations |   |
|                                                                                                 |   |
| Item 3 – Quantitative and Qualitative Disclosures  about Market Risk                            |   |
|                                                                                                 |   |
| Item 4 – Controls and Procedures                                                                |   |
|                                                                                                 |   |
| PART II. OTHER INFORMATION                                                                           |   |
|                                                                                                 |   |
| Item 2 – Changes in Securities and Use of Proceeds                                              |   |
|                                                                                                 |   |
| Item 4 - Submission of Matters to a Vote of Security  Holders                                        |   |
|                                                                                                 |   |
| Item 6 - Exhibits and Reports on Form 8-K                                                            |   |
|                                                                                                 |   |
| Signatures                                                                                           |   |

 

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**TRANS WORLD ENTERTAINMENTCORPORATION AND SUBSIDIARIES**

**PART 1. FINANCIAL INFORMATION**

**Item 1 - Financial Statements**

**CONDENSED CONSOLIDATED BALANCESHEETS**

**(in thousands, except shareamounts)**

**(unaudited)**

 
| ** **                                                                                                                         | ** ** | **July 30,** | ** ** | **January 29,** | ** ** | **July 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|--------------|------------|-----------------|------------|--------------|------------|
| ** **                                                                                                                         | ** ** | **2005**     | ** ** | **2005**        | ** ** | **2004**     | ** ** |
| **ASSETS**                                                                                                                         |       |         |       |            |       |         |       |
| CURRENT ASSETS:                                                                                                                    | ** ** | ** **   | ** ** | ** **      | ** ** | ** **   | ** ** |
| Cash and cash  equivalents                                                                                                         |       | $            | 50,934     |            | $          | 229,768      |       | $ | 39,927 |   |
| Merchandise  inventory                                                                                                             |       | 401,051      |       | 431,246         |       | 422,209      |       |
| Income taxes  receivable                                                                                                           |       | 7,025        |       | —          |       | —       |       |
| Deferred taxes                                                                                                                     |       | 11,556       |       | 15,526          |       | 10,271       |       |
| Other current  assets                                                                                                              |       | 13,554       |       | 13,006          |       | 14,063       |       |
| Total current  assets                                                                                                              |       | 484,120      |       | 689,546         |       | 486,470      |       |
|                                                                                                                               |       |         |       |            |       |         |       |
| NET FIXED ASSETS                                                                                                                   |       | 128,455      |       | 130,196         |       | 122,839      |       |
| DEFERRED TAXES                                                                                                                     |       | 25,405       |       | 25,039          |       | 39,292       |       |
| OTHER ASSETS                                                                                                                       |       | 14,022       |       | 14,872          |       | 14,081       |       |
| TOTAL ASSETS                                                                                                                       |       | $            | 652,002    |            | $          | 859,653      |       | $ | 662,682 |   |
|                                                                                                                               |       |         |       |            |       |         |       |
| **LIABILITIES**                                                                                                                    |       |         |       |            |       |         |       |
| CURRENT LIABILITIES:                                                                                                               |       |         |       |            |       |         |       |
| Accounts payable                                                                                                                   |       | $            | 182,223    |            | $          | 358,396      |       | $ | 196,460 |   |
| Income taxes  payable                                                                                                              |       | —       |       | 8,592           |       | 1,760        |       |
| Accrued expenses  and other current liabilities                                                                                    |       | 33,101       |       | 43,712          |       | 37,388       |       |
| Current portion  of long-term debt                                                                                                 |       | 462          |       | 448             |       | 436          |       |
| Current portion  of capital lease obligations                                                                                      |       | 2,498        |       | 332             |       | 418          |       |
| Total current  liabilities                                                                                                         |       | 218,284      |       | 411,480         |       | 236,462      |       |
|                                                                                                                               |       |         |       |            |       |         |       |
| LONG-TERM DEBT, less current portion                                                                                               |       | 4,826        |       | 5,060           |       | 5,289        |       |
| CAPITAL LEASE OBLIGATIONS, less current portion                                                                                    |       | 16,081       |       | 6,977           |       | 7,250        |       |
| DEFERRED RENT AND OTHER LIABILITIES                                                                                                |       | 29,550       |       | 31,813          |       | 22,756       |       |
| TOTAL  LIABILITIES                                                                                                                 |       | 268,741      |       | 455,330         |       | 271,757      |       |
|                                                                                                                               |       |         |       |            |       |         |       |
| **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; 55,588,575, 55,014,598 and  54,484,181 shares issued, respectively) |       | 556          |       | 550             |       | 545          |       |
| Additional  paid-in capital                                                                                                        |       | 298,506      |       | 292,922         |       | 289,220      |       |
| Unearned  compensation – restricted stock                                                                                     |       | (38          | )          | (46             | )          | (54          | )          |
| Accumulated  other comprehensive loss                                                                                              |       | (1,094       | )          | (1,094          | )          | —       |       |
| Treasury stock  at cost (23,404,549, 21,988,949 and 20,209,449 shares, respectively)                                               |       | (205,057     | )          | (186,298        | )          | (167,001     | )          |
| Retained  earnings                                                                                                                 |       | 290,388      |       | 298,289         |       | 268,215      |       |
| TOTAL  SHAREHOLDERS’ EQUITY                                                                                                   |       | 383,261      |       | 404,323         |       | 390,925      |       |
| TOTAL  LIABILITIES AND SHAREHOLDERS’ EQUITY                                                                                   |       | $            | 652,002    |            | $          | 859,653      |       | $ | 662,682 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

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**TRANS WORLD ENTERTAINMENTCORPORATION AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(in thousands, except per shareamounts)**

**(unaudited)**

 
| ** **                                                                                                         | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                                                                         | ** ** | **July 30,  2005**       | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                                                                                         | ** ** | ** **               | ** ** | ** **                 | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sales                                                                                                              |       | $                        | 253,118    |                       | $          | 277,182 |   | $ | 538,528 |   | $ | 581,665 |   |
| Cost of sales                                                                                                      |       | 160,243                  |       | 174,144                    |       | 341,088 |   | 365,322 |   |
| Gross profit                                                                                                       |       | 92,875                   |       | 103,038                    |       | 197,440 |   | 216,343 |   |
| Selling, general  and administrative expenses                                                                      |       | 103,145                  |       | 108,899                    |       | 209,012 |   | 218,595 |   |
| Loss from  operations                                                                                              |       | (10,270                  | )          | (5,861                     | )          | (11,572 | ) | (2,252 | ) |
| Other income                                                                                                       |       | (1,114                   | )          | (140                       | )          | (1,455 | ) | (331 | ) |
| Interest expense                                                                                                   |       | 662                      |       | 547                        |       | 1,232 |   | 1,054 |   |
| Loss before  income taxes and extraordinary gain - unallocated negative goodwill                                   |       | (9,818                   | )          | (6,268                     | )          | (11,349 | ) | (2,975 | ) |
| Income tax  benefit                                                                                                |       | (2,871                   | )          | (13,397                    | )          | (3,448 | ) | (12,146 | ) |
| Income (loss)  before extraordinary gain - unallocated negative goodwill                                           |       | (6,947                   | )          | 7,129                      |       | (7,901 | ) | 9,171 |   |
| Extraordinary  gain - unallocated negative goodwill, net of income taxes of 0, $1,367 and 0,  $1,620, respectively |       | —                   |       | 2,178                      |       | — |   | 2,596 |   |
| Net income  (loss)                                                                                                 |       | $                        | (6,947     | )                          | $          | 9,307 |   | $ | (7,901 | ) | $ | 11,767 |   |
|                                                                                                               |       |                     |       |                       |       |   |   |   |   |
| BASIC INCOME  (LOSS) PER SHARE:                                                                                    |       |                     |       |                       |       |   |   |   |   |
| Income (loss)  per share before extraordinary gain -unallocated negative goodwill                                  |       | $                        | (0.21      | )                          | $          | 0.20 |   | $ | (0.24 | ) | $ | 0.26 |   |
| Extraordinary  gain - unallocated negative goodwill, net of income taxes                                           |       | —                   |       | 0.06                       |       | — |   | 0.07 |   |
| Basic income  (loss) per share                                                                                     |       | $                        | (0.21      | )                          | $          | 0.26 |   | $ | (0.24 | ) | $ | 0.33 |   |
|                                                                                                               |       |                     |       |                       |       |   |   |   |   |
| Weighted average  number of common shares outstanding – basic                                                 |       | 32,482                   |       | 35,100                     |       | 32,713 |   | 35,541 |   |
|                                                                                                               |       |                     |       |                       |       |   |   |   |   |
| DILUTED INCOME  (LOSS) PER SHARE:                                                                                  |       |                     |       |                       |       |   |   |   |   |
| Income (loss)  per share before extraordinary gain -unallocated negative goodwill                                  |       | $                        | (0.21      | )                          | $          | 0.19 |   | $ | (0.24 | ) | $ | 0.24 |   |
| Extraordinary  gain - unallocated negative goodwill, net of income taxes                                           |       | —                   |       | 0.06                       |       | — |   | 0.07 |   |
| Diluted income  (loss) per share                                                                                   |       | $                        | (0.21      | )                          | $          | 0.25 |   | $ | (0.24 | ) | $ | 0.31 |   |
|                                                                                                               |       |                     |       |                       |       |   |   |   |   |
| Weighted average  number of common shares outstanding – diluted                                               |       | 32,482                   |       | 36,855                     |       | 32,713 |   | 37,231 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

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**TRANS WORLD ENTERTAINMENTCORPORATION AND SUBSIDIARIES**

**CONDENSED CONSOLIDATED STATEMENTSOF CASH FLOWS**

**(in thousands)**

**(unaudited)**

 
| ** **                                                               | ** ** | **Twenty-six Weeks Ended** | ** ** |
|--------------------------------------------------------------------------|------------|----------------------------|------------|
| ** **                                                               | ** ** | **July 30,  2005**         | ** ** | **July 31,  2004** | ** ** |
| Net cash used by operating activities                                    |       | $                          | (158,713   | ) | $ | (118,972 | ) |
|                                                                     |       |                       |       |   |   |
| Cash flows from investing activities:                                    |       |                       |       |   |   |
| Purchases of  fixed assets                                               |       | (17,021                    | )          | (15,590 | ) |
| Acquisition of  minority interest in subsidiary                          |       | —                     |       | (2,000 | ) |
| Proceeds from  sale of available for sale securities                     |       | 813                        |       | — |   |
| Net cash used by investing activities                                    |       | (16,208                    | )          | (17,590 | ) |
|                                                                     |       |                       |       |   |   |
| Cash flows from financing activities:                                    |       |                       |       |   |   |
| Proceeds from  long-term debt                                            |       | —                     |       | 5,760 |   |
| Proceeds from  capital leases                                            |       | 11,962                     |       | — |   |
| Payments of  long-term debt                                              |       | (220                       | )          | (35 | ) |
| Payments of  capital lease obligations                                   |       | (692                       | )          | (192 | ) |
| Payments for  purchases of treasury stock                                |       | (18,759                    | )          | (20,946 | ) |
| Proceeds from  the exercise of stock options                             |       | 3,796                      |       | 683 |   |
| Net cash used by financing activities                                    |       | (3,913                     | )          | (14,730 | ) |
|                                                                     |       |                       |       |   |   |
| Net decrease in cash and cash equivalents                                |       | (178,834                   | )          | (151,292 | ) |
| Cash and cash equivalents, beginning of year                             |       | 229,768                    |       | 191,219 |   |
| Cash and cash equivalents, end of period                                 |       | $                          | 50,934     |   | $ | 39,927 |   |
| Supplemental disclosure of non-cash investing and  financing activities: |       |                       |       |   |   |
| Income tax benefit  resulting from exercises of stock options            |       | $                          | 1,794      |   | $ | 217 |   |
| Issuance of  shares under restricted stock plan                          |       | —                     |       | 50 |   |

 

*See Notes to Condensed Consolidated FinancialStatements.*

 

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**TRANS WORLD ENTERTAINMENTCORPORATION AND SUBSIDIARIES**

**NOTES TO CONDENSED CONSOLIDATEDFINANCIAL STATEMENTS (unaudited)**

**July 30, 2005 and July 31, 2004**

 

**Note 1. Nature of Operations**

Trans World Entertainment Corporation and its subsidiaries is one ofthe largest specialty retailers of music, video, including DVD and VHS, videogames and related products in the United States.  The Company operates retail entertainmentstores and e-commerce sites, including www.fye.com, www.coconuts.com,www.wherehouse.com, and www.secondspin.com, in a single industry segment.  As of July 30, 2005, the Company operated 797stores totaling approximately 4.9 million square feet in 46 states, theDistrict of Columbia, the Commonwealth of Puerto Rico and the U.S. VirginIslands.

 

**Note 2: Basis of Presentation**

The accompanying unaudited condensed consolidated financial statementsconsist of Trans World Entertainment Corporation, its wholly owned subsidiaryRecord Town, Inc. (“Record Town”) and Record Town’s subsidiaries, all of whichare wholly owned (“the Company”).   Allsignificant intercompany accounts and transactions have been eliminated.

 

The interim condensed consolidated financial statements have beenprepared pursuant to the rules and regulations of the Securities and ExchangeCommission.  The information furnished inthese condensed consolidated financial statements reflects all normal,recurring adjustments which, in the opinion of management, are necessary forthe fair presentation of such financial statements.  The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesof America requires management to make estimates and assumptions that affectthe reported amounts of assets and liabilities and disclosure of contingentassets and liabilities at the date of the financial statements, and thereported amounts of revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.  Certain information andfootnote disclosures normally included in the financial statements prepared inaccordance with accounting principles generally accepted in the United Statesof America have been condensed or omitted pursuant to rules and regulationsapplicable to interim financial statements.

 

The information presented in the accompanyingunaudited condensed consolidated balance sheet as of January 29, 2005 has beenderived from the Company’s January 29, 2005 audited consolidated financialstatements. All other information has been derived from the Company’s unauditedconsolidated financial statements as of and for the thirteen and twenty-sixweeks ended July 30, 2005 and July 31, 2004.  These unaudited condensed consolidated financial statements should beread in conjunction with the audited financial statements and notes theretoincluded in the Company’s Annual Report on Form 10-K for the fiscal year endedJanuary 29, 2005. Certain reclassifications have been made to prior periods toconform to the current period presentation.

 

The Company’s significant accounting policies are thesame as those described in Note 1 to the Company’s Consolidated FinancialStatements on Form 10-K for the fiscal year ended January 29, 2005.

 

**Note 3. Seasonality**

The Company’s business is seasonal in nature, with the fourth fiscalquarter constituting the Company’s peak selling period.  In 2004, the fourth fiscal quarter accountedfor approximately 38% of annual sales. In anticipation of increased sales activity during these months, the Companypurchases additional

 

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merchandise inventory and hires additional, temporary employees tosupplement its permanent store sales staff.  If, for any reason, the Company’s net sales were below seasonal normsduring the fourth quarter, the Company’s operating results, particularlyoperating and net income, could be adversely affected.  Additionally, quarterly sales results, ingeneral, are affected by the timing of new releases, the performance ofexisting stores and new store openings or closings.

 

**Note 4. Stock Based Compensation**

The Company applies the intrinsic value-based methodof accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25,*Accounting for Stock Issued to Employees*,and related interpretations including Financial Accounting Standards Board (“FASB”)Interpretation No. 44, *Accounting for CertainTransactions Involving Stock Compensation – An Interpretation of APB No. 25*,in accounting for its fixed plan stock options. Under this method, compensation expense would be recorded on the date ofgrant only if the current market price of the underlying stock exceeded theexercise price.  Unearned compensationrecognized for restricted stock awards is shown as a separate component ofshareholders’ equity and is amortized to expense over the vesting period of thestock award using the straight-line method. Statement of Financial Accounting Standards (“SFAS”) No. 123, *Accounting for Stock-Based Compensation*, as amended by SFASNo. 148, *Accounting for Stock-Based Compensation – Transitionand Disclosure*, established accounting and disclosure requirementsusing a fair value-based method of accounting for stock-based employeecompensation plans.  As allowed by SFASNo. 123, the Company has elected to continue to apply the intrinsic value-basedmethod of accounting described above, and has adopted the disclosurerequirements of SFAS No. 123 and SFAS No.148.

 

The following table illustrates the effect on netincome (loss) and income (loss) per share if the Company had applied the fairvalue recognition provisions of SFAS No. 123 to stock-based employeecompensation:

 
| ** **                                                                                                                                     | ** ** | **Thirteen Weeks ended**                     | ** ** | **Twenty-six Weeks ended**                   | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| ** **                                                                                                                                     | ** ** | **July 30,  2005**                           | ** ** | **July 31,  2004**                           | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                                                                                                                     | ** ** | **(in thousands except per share  amounts)** | ** ** | **(in thousands except per  share amounts)** | ** ** |
| Net income  (loss), as reported                                                                                                                |       | $                                            | (6,947     | )                                            | $          | 9,307 |   | $ | (7,901 | ) | $ | 11,767 |   |
| Add: Stock-based  employee compensation expense included in reported net income (loss), net of  related income taxes                           |       | 21                                           |       | 51                                           |       | 65 |   | 78 |   |
| Deduct: Total  stock-based employee compensation expense determined under fair value based  method for all awards, net of related income taxes |       | (840                                         | )          | (952                                         | )          | (1,559 | ) | (1,794 | ) |
| Proforma net  income (loss)                                                                                                                    |       | $                                            | (7,766     | )                                            | $          | 8,406 |   | $ | (9,395 | ) | $ | 10,051 |   |
| Income (loss)  per share:                                                                                                                      |       |                                         |       |                                         |       |   |   |   |   |
| Basic - as  reported                                                                                                                           |       | $                                            | (0.21      | )                                            | $          | 0.26 |   | $ | (0.24 | ) | $ | 0.33 |   |
| Basic– proforma                                                                                                                           |       | $                                            | (0.24      | )                                            | $          | 0.24 |   | $ | (0.29 | ) | $ | 0.28 |   |
| Diluted – as  reported                                                                                                                    |       | $                                            | (0.21      | )                                            | $          | 0.25 |   | $ | (0.24 | ) | $ | 0.31 |   |
| Diluted –  proforma                                                                                                                       |       | $                                            | (0.24      | )                                            | $          | 0.23 |   | $ | (0.29 | ) | $ | 0.27 |   |

 

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**Note 5. Defined Benefit Plan**

The Company maintains a non-qualified SupplementalExecutive Retirement Plan (“SERP”) for certain executives of the Company.  The SERP, which is unfunded, provideseligible executives defined pension benefits that supplement benefits underother retirement arrangements.  Theannual benefit amount is based on salary and bonus at the time of retirementand number of years of service.

 

Prior to June 1, 2003, the Company provided the Boardof Directors with a noncontributory, unfunded retirement plan (“DirectorRetirement Plan”) that paid a retired director an annual retirement benefitequal to 60% of the annual retainer at the time of retirement plus a 3% annualincrease through the final payment. Payments began at age 62 or retirement, whichever was later, and would continuefor 10 years or the life of the director and his or her spouse, whicheverperiod was shorter.  Partial vesting inthe retirement plan began after six years of continuous service.  Participants became fully vested after 12years of continuous service on the Board.  As of June 1, 2003, new directors are nolonger covered by the Director Retirement Plan. Current directors who were not yet vested in their retirement benefitshad the present value of benefits already accrued as of the effective dateconverted to deferred shares under the Directors Stock Option Plan.  Directors that were fully or partially vestedin their retirement benefits were given a one time election to continue toparticipate in the current retirement program or convert the present value ofbenefits already accrued to deferred shares under the Directors Stock OptionPlan as of the effective date.

 

The Company accounts for the SERP and the DirectorRetirement Plan in accordance with the provisions of SFAS No. 87, *Employers’ Accounting for Pensions*.

 

During the thirteen and twenty-six weeks ended July 30, 2005, theCompany did not make any cash contributions to the SERP and the DirectorRetirement Plan, and presently expects to pay $35,000 in benefits relating toSERP and $12,500 in benefits relating to the Director Retirement Plan duringfiscal 2005. Thefollowing represents the components of the net periodic pension cost related tothe Company’s SERP and Director Retirement Plan for the respective periods:

 
| ** **                         | ** ** | **Thirteen weeks ended** | ** ** | **Twenty-six weeks ended** | ** ** |
|------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                         | ** ** | **July 30,  2005**       | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                         | ** ** | **(in thousands)**       | ** ** | **(in thousands)**         | ** ** |
| Service cost                       |       | $                        | 133        |                       | $          | 101 |   | $ | 266 |   | $ | 202 |   |
| Interest cost                      |       | 196                      |       | 157                        |       | 392 |   | 314 |   |
| Amortization of prior service cost |       | 85                       |       | 85                         |       | 170 |   | 170 |   |
| Amortization of net loss           |       | 62                       |       | 4                          |       | 124 |   | 8 |   |
| Net periodic pension cost          |       | $                        | 476        |                       | $          | 347 |   | $ | 952 |   | $ | 694 |   |

 

**Note 6. Extraordinary Gain**

The Company acquired substantially all the net assets of WherehouseEntertainment Inc. and CD World Inc. in October 2003 for $35.2 million and $1.9million, respectively. The purchase price was allocated on a preliminary basisusing information available at the time. In accordance with SFAS No. 141, *Business Combinations,* the allocation of the purchase priceto the assets and liabilities acquired were

 

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finalized during the thirteen weeks ended October 30, 2004, afterobtaining more information regarding asset valuations and liabilities assumed.

 

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During the thirteen and twenty-six weeks ended July 31, 2004, theCompany adjusted the purchase price allocation in accordance with theprovisions of SFAS No. 141, resulting in extraordinary gain of $2.2 million and$2.6 million, net of income taxes of $1.4 million and $1.6 million respectively,related to unallocated negative goodwill. The gain represents the excess of thefair value of net assets acquired over the purchase price.

 

**Note 7. Long-Term Debt and Capital LeaseObligations**

During 2005, the Company financed the replacement of its point-of-salesystem through a capital lease arrangement for $12.0 million. The leasearrangement bears an average interest rate of 5.76% and will be repaid inmonthly installments over 5 years. As of July 30, 2005, the Company had drawnthe entire $12.0 million under the lease agreement.

 

During 2004, the Company borrowed $5.8 million under a mortgage loanwith South Trust Bank to finance the purchase of real estate. The mortgageloan is repayable in monthly installments of $64 thousand over 10 years with afixed interest rate of 6.0% and is collateralized by the real estate. Themortgage loan contains a minimum net worth (shareholders’ equity) covenant of$290 million, excluding the impact, if any, of certain non-cash charges.

 

**Note 8. Comprehensive Income (Loss)**

The Company accounts for comprehensive income (loss) in accordance withSFAS No. 130, *Reporting Comprehensive Income*.  SFAS No. 130 requires only additionaldisclosures in the consolidated financial statements; it does not affect theCompany’s financial position or results of operations.  Items of other comprehensive income that theCompany currently reports are the excess additional minimum pension liabilityover unrecognized prior service cost and unrealized gains and losses onmarketable securities categorized as available-for-sale.  The Company’s total comprehensive income(loss) for the thirteen and twenty-six weeks ended July 30, 2005 and July 31,2004 was as follows:

 
| ** **                                                                                                    | ** ** | **Thirteen Weeks ended**  | ** ** | **Twenty-six Weeks ended** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|----------------------------|------------|
| ** **                                                                                                    | ** ** | **July 30,  2005**        | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                                                                                    | ** ** | **($ in thousands)** | ** ** | **($ in thousands)**  | ** ** |
| Net income  (loss)                                                                                            |       | $                         | (6,947     | )                          | $          | 9,307 |   | $ | (7,901 | ) | $ | 11,767 |   |
|                                                                                                          |       |                      |       |                       |       |   |   |   |   |
| Other  comprehensive income, net of income taxes:                                                             |       |                      |       |                       |       |   |   |   |   |
| Change in  unrealized gain on available-for-sale securities, net of income taxes of $306  and 0, respectively |       | —                    |       | —                     |       | 442 |   | — |   |
| Reclassification  adjustment for realized gain on available-for-sale securities included in  income           |       | (442                      | )          | —                     |       | (442 | ) | — |   |
| Total  comprehensive income (loss)                                                                            |       | $                         | (7,389     | )                          | $          | 9,307 |   | $ | (7,901 | ) | $ | 11,767 |   |

 

10

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**Note 9. Recently Issued Accounting Standards**

InMay 2005, the FASB issued SFAS No. 154, *AccountingChanges and Error Corrections, a replacement of APB Opinion No. 20,Accounting Changes and FASB Statement No. 3, Reporting Accounting Changesin Interim Financial Statements*. SFAS No. 154 provides guidance onthe accounting for and reporting of accounting changes and error corrections.It establishes, unless impracticable, retrospective application as the requiredmethod for reporting a change in accounting principle in the absence of explicittransition requirements specific to the newly adopted accounting principle.SFAS No. 154 also provides guidance for determining whether retrospectiveapplication of a change in accounting principle is impracticable and forreporting a change when retrospective application is impracticable. Theprovisions of this Statement are effective for accounting changes andcorrections of errors made in fiscal periods beginning after December 15,2005. The adoption of the provisions of SFAS No. 154 is not expected to have amaterial impact on the Company’s financial position or results of operations.

 

In December 2004, the FASB issued SFAS No.153, *Exchanges of Nonmonetary Assets – AccountingPrinciples Board Opinion No. 29, Accounting for Nonmonetary Transactions*.SFAS No. 153 requires that exchanges should be recorded and measured at thefair value of the assets exchanged, with certain exceptions. SFAS No. 153 iseffective for nonmonetary exchanges occurring in fiscal periods beginning afterJune 15, 2005. The adoption of SFAS No. 153 is not expected to have asignificant impact on the Company’s consolidated financial position or resultsof operations.

 

In November 2004, the FASB issued SFASNo. 151*, Inventory Costs, an amendment of ARB No. 43*,Chapter 4. SFAS No. 151 clarifies that abnormal inventory costs such ascosts of idle facilities, excess freight and handling costs, and wastedmaterials (spoilage) are required to be recognized as current periodcharges.  The provisions of SFAS No. 151are effective for fiscal years beginning after June 15, 2005. The adoptionof SFAS No. 151 is not expected to have a significant impact on the Company’sconsolidated financial position or results of operations.

 

In December2004, the FASB issued SFAS No. 123(R), *Share-Based Payment: anamendment of FASB Statements No. 123 and 95*. This Statement requiresa public entity to measure the cost of employee services received in exchangefor an award of equity instruments based on the fair value of the award at thegrant date (with limited exceptions) and recognize the compensation cost overthe period during which an employee is required to provide service in exchangefor the award. In March 2005, the U.S. Securities and Exchange Commission (“SEC”)issued Staff Accounting Bulletin No. 107 (“SAB 107”), which expresses views ofthe SEC staff regarding the application of SFAS No. 123(R). Among other things,SAB 107 provides interpretive guidance related to the interaction between SFASNo. 123(R) and certain SEC rules and regulations, and provides the SEC staff’sviews regarding the valuation of share-based payment arrangements for publiccompanies. The Company is required to adopt SFAS No. 123(R) in its firstquarter of fiscal 2006. The Company is currently evaluating the potentialeffects of this standard on its stock compensation arrangements and relatedeffects on the Company’s condensed consolidated financial statements.

 

11

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**Note 10. Depreciation and Amortization**

Depreciation and amortization of fixed assets included in the condensedconsolidated statements of operations is as follows:

 
| ** **                                      | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|-------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                      | ** ** | **July 30,  2005**       | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                      | ** ** | **(in thousands)**       | ** ** | **(in thousands)**         | ** ** |
| Cost of sales                                   |       | $                        | 770        |                       | $          | 602 |   | $ | 1,550 |   | $ | 1,186 |   |
| Selling, general  & administrative expenses |       | 8,366                    |       | 8,432                      |       | 16,586 |   | 16,959 |   |
| Total                                           |       | $                        | 9,136      |                       | $          | 9,034 |   | $ | 18,136 |   | $ | 18,145 |   |

 

**Note 11. Earnings Per Share**

Weighted average shares are calculated as follows:

 
| ** **                                                  | ** ** | **Thirteen Weeks Ended** | ** ** | **Twenty-six Weeks Ended** | ** ** |
|-------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                  | ** ** | **July 30,  2005**       | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                                  | ** ** | **(in thousands)**       | ** ** | **(in thousands)**         | ** ** |
| Weighted average  common shares outstanding  – basic   |       | 32,482                   |       | 35,100                     |       | 32,713 |   | 35,541 |   |
| Dilutive effect  of employee stock options                  |       | —                   |       | 1,755                      |       | — |   | 1,690 |   |
| Weighted average  common shares outstanding  – diluted |       | 32,482                   |       | 36,855                     |       | 32,713 |   | 37,231 |   |
|                                                        |       |                     |       |                       |       |   |   |   |   |
| Anti-dilutive  stock options                                |       | 9,755                    |       | 4,005                      |       | 9,300 |   | 4,023 |   |

 

For the thirteen and twenty-six week periods ended July 30, 2005, theimpact of outstanding stock options was not considered because the Company reporteda net loss and such impact would be anti-dilutive.

 

**Note 12. Income Taxes**

The Company recorded an income tax charge of $1.1million resulting from changes in the Ohio state income tax law enacted during thethirteen weeks ended July 30, 2005. The legislation phases out state corporationfranchise tax which is based on income. The tax charge represents a write-offof the state deferred tax assets allocated to Ohio, principally net operatinglosses that, based on management’s estimates, will not be realized during thephase-out period.

 

The Company recorded an income tax benefit of $10.5million in the thirteen weeks ended July 31, 2004.  The benefit was the result of closing afederal income tax examination, including all matters not previously settled inrelation to Company Owned Life Insurance (“COLI”) policies, which were part ofthe Company’s acquisition of Camelot in 1999. The original income tax payable amounts relating to the years covered bythe examination were reversed subsequent to the final settlement resulting inthe income tax benefit.  With the closingof the tax examination, the Company has surrendered the remaining COLIpolicies.

 

12

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**Note 13. Legal Proceedings**

The Company is subject to legal proceedings and claims that have arisenin the ordinary course of its business and which have not been finallyadjudicated.  Although there can be noassurance as to the ultimate disposition of these matters, it is management’sopinion, based upon the information available at this time, that the expectedoutcome of these matters, individually or in the aggregate, will not have amaterial adverse effect on the results of operations and financial condition ofthe Company.

 

13

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**TRANS WORLD ENTERTAINMENTCORPORATION AND SUBSIDIARIES**

**Item 2 - Management’s Discussionand Analysis of Financial Condition andResults of Operations**

**July 30, 2005 and July 31, 2004**

 

**Overview**

Management’s Discussion and Analysis of FinancialCondition and Results of Operations provides information that the Company’smanagement believes necessary to achieve an understanding of its financialstatements and results of operations.  Tothe extent that such analysis contains statements which are not of a historicalnature, such statements are forward-looking statements, which involve risks anduncertainties.  These risks include, butare not limited to, changes in the competitive environment for the Company’smerchandise, including the entry or exit of non-traditional retailers of theCompany’s merchandise to or from its markets; releases by the music, video,including DVD and VHS, and video games industries of an increased or decreasednumber of “hit releases”; general economic factors in markets where the Company’smerchandise is sold; and other factors discussed in the Company’s filings withthe Securities and Exchange Commission. The following discussion and analysis of the Company’s financialcondition and results of operations should be read in conjunction with theunaudited condensed consolidated financial statements and related notesincluded elsewhere in this report and the audited financial statements includedin the Company’s Annual Report on Form 10-K for the fiscal year ended January29, 2005.

 

At July 30, 2005, the Company operated 797 storestotaling approximately 4.9 million square feet in 46 states, the District ofColumbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands. TheCompany’s stores offer predominantly entertainment software, including music,video, including DVD and VHS, and video games. In total, these categories represented 92% of the Company’s total salesin the thirteen weeks and twenty-six weeks ended July 30, 2005, respectively.  The balance of categories, including softwareaccessories, boutique and electronic products represented 8% of the Company’stotal sales in the thirteen weeks and twenty-six weeks ended July 30, 2005,respectively.

 

The Company strives to understand general economic andbusiness trends and to manage the business in response to those trends, andmonitors a number of key performance indicators in this regard, including:

 

**Sales:**  The Company measures the rate of comparablestore sales change. A store is included in comparable store sales calculationsat the beginning of its thirteenth full month of operation.   Mall stores relocated in the same shoppingcenter after being open for at least thirteen months are considered comparablestores.  Closed stores that were open forat least thirteen months are included in comparable store sales through themonth immediately preceding the month of closing.  The Company further analyzes sales by storeformat (i.e., mall versus freestanding) and by product category.

 

**Cost of Sales and Gross Profit:**  Gross profit is impacted primarily by the mixof products sold and by discounts negotiated with vendors.  The Company records its distribution andproduct shrink expenses in cost of sales. Distribution expenses include thosecosts associated with purchasing, receiving, inspecting and warehousingmerchandise and costs associated with product returns to vendors.  Cost of sales further includes obsolescencecosts and is reduced by the benefit of vendor allowances.

 

14

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**Selling, General and Administrative (“SG&A”)expenses:** Included in SG&A expenses are payroll andrelated costs, occupancy charges, professional and service fees, generaloperating and overhead expenses and depreciation charges (excluding thoserelated to distribution operations, as discussed in Note 10 to the CondensedConsolidated Financial Statements). SG&A expenses also include asset impairment charges and write-offs,if any, and miscellaneous items, other than interest.

 

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

 

**CRITICAL ACCOUNTING POLICIES AND ESTIMATES**

The preparation of financial statements andrelated disclosures in conformity with accounting principles generally acceptedin the United States requires that management apply accounting policies andmake estimates and assumptions that affect results of operations and thereported amounts of assets and liabilities in the financial statements.  Management continually evaluates itsestimates and judgments including those related to merchandise inventory andreturn costs, valuation of long-lived assets, income taxes, and accounting forvendor allowances.  Management bases itsestimates and judgments on historical experience and other factors that arebelieved to be reasonable under the circumstances.  Actual results may differ from theseestimates under different assumptions or conditions.   Note 1 of Notes to the ConsolidatedFinancial Statements on Form 10-K for the year ended January 29, 2005 includesa summary of the significant accounting policies and methods used by theCompany in the preparation of its condensed consolidated financial statements.Management believes that of the Company’s significant accounting policies, thefollowing may involve a higher degree of judgment or complexity:

 

**Merchandise Inventory and Return Costs:**Merchandise inventory is stated at the lower of cost ormarket as determined by the average cost method. Merchandise inventoryvaluation requires significant judgment and estimates regarding 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 thancost) based on current and anticipated demand and market conditions. Theprovision for inventory shrink is estimated as a percentage of sales for theperiod from the last date a physical inventory was performed to the end of aperiod.  Shrink estimates are based on historical results andtrends.  Physical inventories are taken at least annually for all stores,and inventory records are adjusted accordingly.

 

The Company is entitled toreturn merchandise purchased from major vendors for credit against otherpurchases from these vendors.   Selectvendors reduce the credit with a merchandise return charge ranging from 0% to20% of the original merchandise purchase price depending on the type ofmerchandise being returned.  The Companyrecords merchandise return charges in cost of sales.

 

15

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**Valuation of Long-Lived Assets: **The Company assesses the potential impairment oflong-lived assets to determine if any part of the carrying values may not berecoverable. Factors that the Company considers when assessing impairmentinclude:

•**        **significant underperformance relative tohistorical results;

•**        **significant changes in the manner of theuse of assets or the strategy for the Company’s overall business;

•**        **significant negative industry or economictrends.

 

If the Company were to determine that the carryingvalue of a long-lived asset may not be recoverable based on one or more of theabove indicators, the Company would test for impairment to determine if awrite-down is needed.

 

**Income Taxes:** Income taxes are accounted for under the asset andliability method.  Deferred tax assetsand liabilities are recognized for the future tax consequences attributable todifferences between the financial statement carrying amounts of existing assetsand liabilities and their respective tax bases and tax operating losscarryforwards.  Deferred tax assets andliabilities are measured using enacted tax rates expected to apply to taxableincome in the years in which those temporary differences are expected to berecovered or settled.  The effect ondeferred tax assets and liabilities of a change in tax laws and rates isrecognized in the results of operations in the period that includes theenactment date.  Accounting for incometaxes requires management to make estimates and judgments regardinginterpretation of various taxing jurisdictions, laws and regulations as well asthe ultimate realization of deferred tax assets.  These estimates and judgments include thegeneration of future taxable income, viable tax planning strategies and supportof tax filings.  Valuation allowances arerecorded against deferred tax assets if, based upon management’s estimates ofrealizability, it is more likely than not that some portion or all of thesedeferred tax assets will not be realized.

 

16

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**RESULTS OF OPERATIONS**

**Thirteen and Twenty-six WeeksEnded July 30, 2005**

**Compared to the Thirteen andTwenty-six Weeks Ended July 31, 2004**

 

The following table sets forth a period over period comparison of theCompany’s sales for the thirteen weeks and twenty-six weeks ended July 30, 2005and July 31, 2004, by category:

 
| ** **       | ** ** | **Thirteen  weeks ended** | ** ** | **Twenty-six  weeks ended** | ** ** |
|------------------|------------|---------------------------|------------|-----------------------------|------------|
| ** **       | ** ** | **July 30,  2005**        | ** ** | **July 31,  2004**          | ** ** | **Change** | ** ** | **%** | ** ** | **Comp  Store  Sales** | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** | **Change** | ** ** | **%** | ** ** | **Comp  Store  Sales** | ** ** |
| ** **       | ** ** | **(in  thousands)**       | ** ** | ** **                  | ** ** | ** ** | ** ** | **(in  thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
|             |       |                      |       |                        |       |   |   |   |   |   |   |   |   |
| **Sales**        |       | $                         | 253,118    |                        | $          | 277,182 |   | $ | (24,064 | ) | -8.7 | % | **-4.8** | **%** | $ | 538,528 |   | $ | 581,665 |   | $ | (43,137 | ) | -7.4 | % | **-3.1** | **%** |
| As a % of sales  |       |                      |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Music            |       | 59                        | %          | 60                          | %          |   |   |   |   | -6.6 | % | 58 | % | 59 | % |   |   |   |   | -5.9 | % |
| Video            |       | 27                        | %          | 27                          | %          |   |   |   |   | -4.7 | % | 27 | % | 28 | % |   |   |   |   | -3.6 | % |
| Video Games      |       | 6                         | %          | 6                           | %          |   |   |   |   | 0.1 | % | 7 | % | 5 | % |   |   |   |   | 18.9 | % |
| Other            |       | 8                         | %          | 7                           | %          |   |   |   |   | 4.8 | % | 8 | % | 8 | % |   |   |   |   | 5.2 | % |
|             |       |                      |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Store Count:** |       |                      |       |                        |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Mall             |       | 552                       |       | 584                         |       |   |   |   |   | -4.9 | % |   |   |   |   |   |   |   |   | -3.2 | % |
| Freestanding     |       | 245                       |       | 269                         |       |   |   |   |   | -4.6 | % |   |   |   |   |   |   |   |   | -2.9 | % |
| **Total**        | ** ** | **797**                   | ** ** | **853**                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
|                  |            |                           |            |                             |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

**Sales.**The decrease in salesresulted from a comparable store sales decrease of 4.8% and 3.1%, respectivelyfor the thirteen weeks and twenty-six weeks ended July 30, 2005, respectively. Thedecrease in sales was also due to the operation of fewer stores.  The Company operated an average of 801 storesin the thirteen weeks ended July 30, 2005 compared to an average of 856 storesin the thirteen weeks ended July 31, 2004.  The Company operated an average of 804 storesfor the twenty-six weeks ended July 30, 2005 compared to an average of 867stores during the twenty-six weeks ended July 31, 2004.

 

***Music:***

The Company’s stores offer a wide range of compact discs (“CDs”), audiocassettes and singles across most music genres, including new releases fromcurrent artists as well as an extensive catalog of music from past periods andartists. During the thirteen and twenty-six weeks ended July 30, 2005, CD salesdecreased 10% and 9%, respectively, over the thirteen and twenty-six weeksended July 31, 2004. The Company’s overall unit sales in music decreased 11%and 12% respectively for the thirteen and twenty-six weeks ended July 30,2005.  The Company’s decrease in musicsales was due to lower store count and a decrease in comparable store sales consistentwith the decline in industry sales during the period.

 

***Video:***

The Company offers home video and software, includingDVDs and videocassettes, in all of its stores. Comparable store sales in the DVD category decreased 1% in the thirteenweeks ended July 30, 2005 and increased 1% during the twenty-six week periodending July 30, 2005.

 

17

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***VideoGames:***

The Company offers video game hardware and software in most of itsstores, with a mix that favors software. Comparable store sales increased 0.1% and 18.9%, respectively, in the thirteenand twenty-six weeks ended July 30, 2005.  During the thirteen weeksended July 30, 2005, sales in the video games category slowed due to the lackof new releases. This was partially offset by the release of Sony’s PSP gamesystem in the first quarter.

 

***Other:***

## **TheCompany offers items relating to the use, care and storage of entertainmentsoftware, along with boutique and electronic products. Comparable store salesincreased 4.8% and 5.2%, respectively in the thirteen and twenty-six weeksended July 30, 2005**.The increase is due to the Company’s merchandisinginitiatives to improve this category, including the expansion of product linesand adding new items to complement the core merchandise categories of music,video and video games.

 

**GrossProfit.   **The following table sets forth a period over period comparison of theCompany’s gross profit:

 
| ** **      | ** ** | **Thirteen weeks ended** | ** ** | ** **   | ** ** | **Twenty-six weeks ended** | ** ** | ** **         | ** ** |
|-----------------|------------|--------------------------|------------|--------------|------------|----------------------------|------------|--------------------|------------|
| ** **      | ** ** | **July 30,**             | ** ** | **July 31,** | ** ** | **Change**                 | ** ** | **July 30,**       | ** ** | **July 31,** | ** ** | **Change** | ** ** |
| ** **      | ** ** | **2005**                 | ** ** | **2004**     | ** ** | **$**                      | ** ** | **%**              | ** ** | **2005** | ** ** | **2004** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **      | ** ** | **(in thousands)**       | ** ** | ** **   | ** ** | ** **                 | ** ** | **(in thousands)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Gross Profit    |       | $                        | 92,875     |         | $          | 103,038                    |       | $                  | (10,163    | ) | (9.9 | )% | $ | 197,440 |   | $ | 216,343 |   | $ | (18,903 | ) | (8.7 | )% |
|            |       |                     |       |         |       |                       |       |               |       |   |   |   |   |   |   |   |   |
| As a % of sales |       | 36.7                     | %          | 37.2         | %          |                       |       |               |       | 36.7 | % | 37.2 | % |   |   |   |   |
|                 |            |                          |            |              |            |                            |            |                    |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

## **Thedecrease in the gross profit as a percentage of sales was due to a shift in themix of the Company’s sales toward the lower margin categories of DVD and games.**

## ** **

**Selling,General & Administrative Expenses (“SG&A”).**** **The following table sets forth a period overperiod comparison of the Company’s SG&A:

 
| ** **      | ** ** | **Thirteen weeks ended** | ** ** | ** **   | ** ** | ** ** | ** ** | **Twenty-six weeks ended** | ** ** | ** **   | ** ** | ** ** | ** ** |
|-----------------|------------|--------------------------|------------|--------------|------------|------------|------------|----------------------------|------------|--------------|------------|------------|------------|
| ** **      | ** ** | **July 30,**             | ** ** | **July 31,** | ** ** | **Change** | ** ** | **July 30,**               | ** ** | **July 31,** | ** ** | **Change** | ** ** |
| ** **      | ** ** | **2005**                 | ** ** | **2004**     | ** ** | **$**      | ** ** | **%**                      | ** ** | **2005**     | ** ** | **2004**   | ** ** | **$** | ** ** | **%** | ** ** |
| ** **      | ** ** | **(in thousands)**       | ** ** | ** **   | ** ** | ** ** | ** ** | **(in thousands)**         | ** ** | ** **   | ** ** | ** ** | ** ** |
| SG&A        |       | $                        | 103,145    |         | $          | 108,899    |       | $                          | (5,754     | )            | (5.3       | )%         | $          | 209,012 |   | $ | 218,595 |   | $ | (9,583 | ) | (4.4 | )% |
|            |       |                     |       |         |       |       |       |                       |       |         |       |       |       |   |   |   |   |
| As a % of sales |       | 40.7                     | %          | 39.3         | %          |       |       |                       |       | 38.8         | %          | 37.6       | %          |   |   |   |   |
|                 |            |                          |            |              |            |            |            |                            |            |              |            |            |            |  |  |  |  |  |  |  |  |  |  |

 

Although variable SG&A expenses decreased due to fewer stores inoperation, fixed expenses remained consistent year over year resulting in theloss of expense leverage.

 

18

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**Other Income.**Other incomeincludes interest income and a realized gain of $0.8 million on the sale ofavailable-for-sale securities for the thirteen and twenty-six weeks ended July30, 2005. Other income includes interest income for the thirteen and twenty-sixweeks ended July 31, 2004.

 

**Income Tax Benefit. **The following table sets forth a period over period comparison of theCompany’s income tax benefit:

 

| ** **                                                | ** ** | **Thirteen weeks ended** | ** ** | **Twenty-six weeks ended** | ** ** |
|-----------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                | ** ** | **July 30,  2005**       | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                                | ** ** | **(in thousands)**       | ** ** | **(in thousands)**         | ** ** |
| Income tax  benefit before IRS settlement benefit in 2004 |       | $                        | (2,871     | )                          | $          | (2,852 | ) | $ | (3,448 | ) | $ | (1,601 | ) |
|                                                      |       |                     |       |                       |       |   |   |   |   |   |   |   |   |
| Effective tax  rate before IRS settlement benefit in 2004 |       | 29.2                     | %          | 45.5                       | %          | 30.4 | % | 53.8 | % |
|                                                      |       |                     |       |                       |       |   |   |   |   |
| IRS settlement  benefit                                   |       | —                   |       | (10,545                    | )          | — |   | (10,545 | ) |
|                                                      |       |                     |       |                       |       |   |   |   |   |
| Income tax  benefit                                       |       | $                        | (2,871     | )                          | $          | (13,397 | ) | $ | (3,448 | ) | $ | (12,146 | ) |
|                                                           |            |                          |            |                            |            |  |  |  |  |  |  |  |  |  |  |

 

The Company recorded a lower tax benefit on arate basis in both the thirteen and twenty-six weeks ended July 30, 2005, dueto an income tax charge of $1.1 million (see Note 12 of Notes to the CondensedFinancial Statements).

 

The Company recorded an income tax benefit of $10.5million in the thirteen weeks ended July 31, 2004.  The benefit was the result of closing afederal income tax examination, including all matters not previously settled inrelation to Company Owned Life Insurance (“COLI”) policies, which were part ofthe Company’s acquisition of Camelot in 1999. See Note 12 of Notes to the Condensed Financial Statements.

 

**Extraordinary Gain – Unallocated NegativeGoodwill.** In October 2003, the Company acquired substantiallyall of the net assets of Wherehouse Entertainment Inc. and CD World Inc. Duringthe thirteen and twenty-six weeks ended July 31, 2004, the Company adjusted thepurchase price allocation in accordance with the provisions of SFAS No. 141,resulting in extraordinary gain of $2.2 million and $2.6 million, net of incometaxes of $1.4 million and $1.6 million respectively, related to unallocatednegative goodwill. The gain represents the excess of the fair value of netassets acquired over the purchase price.

 

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**Net Income (Loss).** The following table sets forth a period overperiod comparison of the Company’s net income (loss):

 

| ** **                                                                                                              | ** ** | **Thirteen weeks ended** | ** ** | **Twenty-six weeks ended** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|----------------------------|------------|
| ** **                                                                                                              | ** ** | **July 30,  2005**       | ** ** | **July 31,  2004**         | ** ** | **July 30,  2005** | ** ** | **July 31,  2004** | ** ** |
| ** **                                                                                                              | ** ** | **(in thousands)**       | ** ** | **(in thousands)**         | ** ** |
| Income (loss)  before extraordinary gain                                                                                |       | $                        | (6,947     | )                          | $          | 7,129 |   | $ | (7,901 | ) | $ | 9,171 |   |
|                                                                                                                    |       |                     |       |                       |       |   |   |   |   |
| Extraordinary  gain – unallocated negative goodwill, net of income taxes of 0, $1,367 and 0,  $1,620, respectively |       | —                   |       | 2,178                      |       | — |   | 2,596 |   |
|                                                                                                                    |       |                     |       |                       |       |   |   |   |   |
| Net income (loss)                                                                                                       |       | $                        | (6,947     | )                          | $          | 9,307 |   | $ | (7,901 | ) | $ | 11,767 |   |

 

The decline in net income in the thirteen andtwenty-six weeks ended July 30, 2005 was due to the lower sales, gross profit,the recording of a tax charge for the change in Ohio state laws and the absenceof the tax benefit which was included in income for the thirteen and twenty-sixweeks ended July 31, 2004.

 

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**LIQUIDITY AND CAPITAL RESOURCES**

**Liquidity.**The Company’s primary sources of workingcapital are cash provided by operations and borrowings under its revolvingcredit facility.  The Company’s cashflows fluctuate from quarter to quarter due to various items, includingseasonality of sales and results from operations, merchandise inventorypurchases and the related terms on the purchases, tax payments, capitalexpenditures and stock repurchase activity. Management believes the Company will have adequate resources to fund itscash needs for the foreseeable future. The following table sets forth a summary of key components of cash flowand working capital for the twenty-six weeks ended July 30, 2005 and July 31,2004:

 

| ** **                 | ** ** | **Twenty-six weeks ended** | ** ** | **Change**        | ** ** |
|----------------------------|------------|----------------------------|------------|-------------------|------------|
| **(in thousands)**         | ** ** | **July 30, 2005**          | ** ** | **July 31, 2004** | ** ** | **$** | ** ** |
| Operating Cash  Flows      |       | $                          | (158,713   | )                 | $          | (118,972 | ) | $ | (39,741 | ) |
| Financing Cash  Flows      |       | (3,913                     | )          | (14,730           | )          | 10,817 |   |
|                       |       |                       |       |              |       |   |   |
| Capital  Expenditures      |       | (17,021                    | )          | (15,590           | )          | (1,431 | ) |
|                       |       |                       |       |              |       |   |   |
| Cash and Cash  Equivalents |       | 50,934                     |       | 39,927            |       | 11,007 |   |
| Inventories                |       | 401,051                    |       | 422,209           |       | (21,158 | ) |
| Working Capital            |       | 265,836                    |       | 250,008           |       | 15,828 |   |
|                            |            |                            |            |                   |            |  |  |  |  |  |

 

The Company had cash balances of $50.9 million at July 30, 2005,compared to $229.8 million at January 29, 2005 and $39.9 million at July 31,2004.  Inventory was $81 per square footat July 30, 2005, compared to $80 per square foot at July 31, 2004.

 

Cash used by operating activities was $158.7 millionfor the twenty-six weeks ended July 30, 2005. The primary uses of cash were a $176.2 million seasonal reduction ofaccounts payable and $15.6 million reduction in income taxes payable, offset bya $30.2 million decrease in merchandise inventory. The Company’s inventory andaccounts payable are heavily influenced by the seasonality of its business. Asignificant reduction of accounts payable occurs annually in the fiscal firstquarter, reflecting payments for merchandise inventory sold during the prioryear’s holiday season.  Similarly, merchandiseinventory increases each year throughout the fall season and peaks during theholiday selling season.  The seasonalityof the Company’s earnings in its fiscal fourth quarter also results in thetiming of substantially all income tax payments to be made subsequent to yearend. These cash uses are offset by a significant cash source in the fiscalfourth quarter from the seasonal increase in sales during the holiday season(see Note 3 of Notes to the Condensed Financial Statements).

 

Cash used by financing activities was $3.9 million forthe twenty-six weeks ended July 30, 2005. The primary source of cash was through a capital lease borrowing of $12.0million to finance the replacement of the Company’s point-of-sale system (SeeNote 7 of Notes to the Condensed Financial Statements) and the exercise ofstock options of $3.8 million. The primary use of cash was $18.8 million forthe purchase of approximately 1.4 million shares of common stock under a stockrepurchase program authorized by the Company’s Board of Directors in May 2003.

 

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## **The authorized stock repurchaseprogram allows the Company to repurchase 10 million shares of Common Stock fromtime to time on the open market and has no expiration date. As of July 30,2005, the Company had 1.7 million remaining shares authorized for repurchase.**

 

## **The Company has a three-year, $100million secured revolving credit facility with Congress Financial Corporationthat expires in July 2006 and renews on a year-to-year basis thereafter withthe consent of both parties. The revolving credit facility contains certainrestrictive provisions, including provisions governing cash dividends andacquisitions and is collateralized by merchandise inventory and other assets.The Company anticipates the amount of the revolving credit facility being fullyavailable to the Company through its term, and does not anticipate anydifficulty in obtaining a similar, replacement facility upon its expiration. Asof July 30, 2005, the Company had $0.9 million in outstanding letterof credit obligations under the revolving credit facility, and $99.1 millionwas available for borrowing. As of July 31, 2004, the Company had noborrowings under the revolving credit facility.**

 

During 2004, the Company borrowed $5.8 million under amortgage loan with South Trust Bank to finance the purchase of realestate. The mortgage loan is repayable in monthly installments of $64thousand over 10 years with a fixed interest rate of 6.0% and is secured by thereal estate. As of July 30, 2005, the Company had a loan balance of $5.3million outstanding.

 

The revolving credit facility restricts the amount ofdividends that the Company can declare up to 10% of its annual net income,excluding certain non-cash gains. Payment of any dividends is further subject to levels of availability onthe Company’s revolving credit facility. The mortgage loan and the revolvingcredit facility contain a minimum net worth (shareholders’ equity) covenant of$290 million, excluding the impact, if any, of certain non-cash charges.

 

During 2005, the Company financed the replacement of its point-of-salesystem through a capital lease arrangement for $12.0 million.The lease arrangement bears an average interest rate of 5.76% andwill be repaid in monthly installments over 5 years. As of July 30, 2005, theCompany had drawn the entire $12.0 million under the lease agreement.

 

**Capital Resources. **During the twenty-sixweeks ended July 30, 2005, the Company made capital expenditures of $17.0 million.During the twenty-six weeks ended July 30, 2005, the Company opened 3 newstores, relocated 9 stores and closed 16 stores. The Company plans to spendapproximately $45 million for capital expenditures in fiscal 2005.

 

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**Item 3 - Quantitative andQualitative Disclosures about Market Risk**

 

To the extent the Company borrows under its credit facility, theCompany is subject to risk resulting from interest rate fluctuations sinceinterest on the Company’s borrowings under its credit facility can bevariable.  Interest on the revolvingcredit facility is payable monthly in arrears at a variable rate of either theprime rate or LIBOR plus 1.65%.  Ifinterest rates on the Company’s credit facility were to increase by 25 basispoints, and to the extent borrowings were outstanding, for every $1.0 million outstandingon the facility, income before income taxes would be reduced by about $2,500per year. For a discussion of the Company’s accounting policies for financialinstruments and further disclosures relating to financial instruments, see “Natureof Operations and Summary of Significant Accounting Policies” in the Notes toConsolidated Financial Statements in the Company’s Form 10-K for the year endedJanuary 29, 2005. The Company does not hold any derivative instruments anddoes not engage in hedging activities.

 

**Item 4 – Controls and Procedures**

 

 (a)    Evaluationof disclosure controls and procedures.    The Company’sChief  Executive Officer and ChiefFinancial Officer after evaluating the effectiveness of the design andoperation of the Company’s disclosure controls and procedures (as defined inthe Securities Exchange Act of 1934 Rules 13a-15(e) and 15d-15(e)) as ofJuly 30, 2005, have concluded that as of such date the Company’s disclosurecontrols and procedures were adequate and effective and designed to ensure thatmaterial information relating to the Company and its subsidiaries would be madeknown to such officers on a timely basis.

 

 (b)*    *Changes in internal controls*.*    There havebeen no changes in the Company’s internal controls over financial reportingthat occurred during the fiscal quarter covered by this quarterly report thathave materially affected, or are reasonably likely to materially affect, theCompany’s internal controls over financial reporting.

 

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**PART II - OTHER INFORMATION**

 

**Item 2 – Changes in Securitiesand Use of Proceeds**

 

On May 28, 2003, the Company’s Board ofDirectors authorized the repurchase of 10 million outstanding shares of theCompany’s Common Stock from time to time on the open market. The program has noexpiration date.  The Company hadrepurchased 15 million shares of common stock under previously announcedprograms. As of July 30, 2005 the Company had purchased 8.3 million shares, ata total cost of $75.9 million, and 1.7 million shares remained to be purchasedunder the current program. The following table shows the purchase of equitysecurities purchased under the repurchase program as required by Regulation229.703 Item 703:

 
| **Period**                          | ** ** | **Total Number of  Shares Purchased** | ** ** | **Average Price Paid   per Share** | ** ** | **Total Number of  Shares Purchased as Part of Publicly  Announced  Programs** | ** ** | **Maximum Number  of Shares that May  Yet Be Purchased  Under the Plan** | ** ** |
|-------------------------------------|------------|---------------------------------------|------------|------------------------------------|------------|--------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|
| May 1, 2005 – May 28,  2005    |       | 223,800                               |       | $                                  | 12.51      |                                                                           | 223,800    |                                                                     | 2,331,641  |   |
| May 29, 2005 – June 25,  2005  |       | 314,700                               |       | $                                  | 12.82      |                                                                           | 314,700    |                                                                     | 2,016,941  |   |
| June 26, 2005 – July  30, 2005 |       | 315,500                               |       | $                                  | 11.95      |                                                                           | 315,500    |                                                                     | 1,701,441  |   |
| Total                               |       | 854,000                               |       | $                                  | 12.42      |                                                                           | 854,000    |                                                                     | 1,701,441  |   |

 

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**Item 4 - Submission of Matters toa Vote of Security Holders**

** **

**A)**           An Annual Meeting of Shareholdersof Trans World Entertainment Corporation was held on Wednesday, June 8, 2005.

** **

**B)**           In the case of each individualnominee named below, authority to vote was withheld with respect to the numberof shares shown opposite their name in Column 1, and each nominee received thenumber of votes set opposite their name in Column 2 for election as director ofthe Corporation.

 
| ** **            | ** ** | **Column 1** | ** ** | **Column 2**  | ** ** |
|-----------------------|------------|--------------|------------|---------------|------------|
| **Names of Nominees** | ** ** | **Withheld** | ** ** | **Votes for** | ** ** |
| Martin E. Hanaka      |       | 3,447,039    |       | 28,108,857    | ** ** |
| Isaac Kaufman         |       | 3,703,861    |       | 27,852,035    | ** ** |
| Lori J. Schafer       |       | 3,128,356    |       | 28,427,540    | ** ** |

 

**C)**           A proposal to adopt the Trans WorldEntertainment Corporation 2005 Long Term Incentive and Share Award Plan wasapproved as follows:

 
| FOR-     |   | 17,537,510 |   |
|----------|--------|------------|--------|
| AGAINST- |   | 10,380,226 |   |
| ABSTAIN- |   | 127,108    |   |
| NO-VOTE- |   | 3,511,052  |   |

 

**Item 6 - Exhibits and Reports onForm 8-K**

 

**(A)****    Exhibits -**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                          |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------|
| 31.1            |       | Chief Executive Officer certification pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                        |
|            |       |                                                                                                                     |
| 31.2            |       | Chief Financial Officer certification pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002.                        |
|            |       |                                                                                                                     |
| 32              |       | Certification  pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the  Sarbanes-Oxley Act of 2002. |

 

**(B)****    Reports on Form 8-K –**

 

A Form 8-K was filed on July 11, 2005,incorporating by reference Trans World Entertainment’s press release dated July7, 2005, announcing guidance for the second quarter.

 

A Form 8-K was filed on August11, 2005 incorporating by reference the Company’s August 11, 2005 press releaseannouncing the Company’s financial results for the thirteen weeks ended July30, 2005.

 

A Form 8-K was filed on June14, 2005 incorporating by reference the Company’s June 13, 2005 press releaseannouncing the election of Lori J. Schafer to its Board of Directors.

 

Omitted from this Part II are items which are not applicable or towhich the answer is negative to the periods covered**.**

 

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**SIGNATURES**

 

Pursuant to the requirements of the Securities and Exchange Act of1934, the Registrant has duly caused this report to be signed on its behalf bythe undersigned thereunto duly authorized.

 
| **TRANS WORLD ENTERTAINMENT CORPORATION** |
|-------------------------------------------|
|                                      |
| September 8, 2005                         |   | **By:** | **/s/ ROBERT J. HIGGINS** |   |   |
|                                      |   | Robert J. Higgins |
|                                      |   | Chairman and Chief Executive Officer |
|                                      |   | (Principal Executive Officer) |
|                                      |   |   |
| September 8, 2005                         |   | **By:** | **/s/ JOHN J. SULLIVAN** |   |
|                                      |   | John J. Sullivan |
|                                      |   | Executive Vice President  and Chief Financial Officer (Principal Financial  and Chief Accounting Officer) |
|                                           |  |  |  |  |  |  |

 

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