SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                   FORM 10-KSB
 X   Annual report under Section 13 or 15(d) of the Securities Exchange Act of
      1934 for the fiscal year ended January 3, 1998

     Transition report under Section 13 or 15(d) of the Securities  Exchange Act
     of 1934 For the transition period from to

                         Commission file number 1-13158


                          THE GREAT TRAIN STORE COMPANY
                 (Name of Small Business Issuer in Its Charter)

              Delaware                                                75-2539189
        (State or Other Jurisdiction                            (I.R.S. Employer
          Incorporation or Organization)                     Identification No.)

14180 Dallas Parkway,  Suite 618, Dallas, Texas                           75240
       (Address of Principal Executive Offices)                       (Zip Code)

                                 (972) 392-1599
                (Issuer's Telephone Number, Including Area Code)

     Securities registered under Section 12(g) of the Act: Common Stock $.01 par
value

     Check  whether  the issuer:  (1) filed all reports  required to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 12 months (or for such
shorter period that the  registrant was required to file such reports),  and (2)
has been subject to such filing requirements for the past 90 days. Yes X No

Check if there is no disclosure of delinquent  filers in response to Item 405 of
Regulation  S-B is not  contained  in  this  from,  and no  disclosure  will  be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB.

The issuer's revenues for its most recent fiscal year are $28,090,948.

At March 10,  1998,  the  aggregate  market  value of the  voting  stock held by
non-affiliates   of  The  Great  Train  Store   Company  (the   "Company")   was
approximately  $11,742,199  based on the last  sale  price of the  common  stock
reported by The Nasdaq National Market on March 10, 1998. At March 10, 1998, the
Company had outstanding 4,415,764 shares of Common Stock.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the  registrant's  Proxy  Statement  for the 1998 Annual  Meeting of
Stockholders  (to be filed pursuant to Regulation 14A within 120 days of the end
of the  registrant's  most recently  completed  fiscal year) are incorporated by
reference to Part III of this Form 10-KSB.
<PAGE>

                                TABLE OF CONTENTS

                                     PART I

                                                                           Page

ITEM 1.           Description of Business                                    

ITEM 2.           Description of Property                                     

ITEM 3.           Legal Proceedings                                          

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

                                     PART II

ITEM 5.           Market for Common Equity and Related Stockholder Matters    

ITEM 6.           Management's  Discussion  and Analysis of Financial  
                  Condition and Results of Operations 

ITEM 7.           Financial Statements                    

ITEM 8.           Changes In and Disagreements With Accountants on
                  Accounting and Financial Disclosures                       

                                    PART III

ITEM 9.           Directors, Executive Officers, Promoters and Control 
                  Persons; Compliance With Section 16(a) of the Exchange 
                  Act            

ITEM 10.          Executive Compensation                                       

ITEM 11.          Security Ownership of Certain Beneficial Owners 
                  and Management                                          

ITEM 12.          Certain Relationships and Related Transactions               

                                     PART IV

ITEM 13.          Exhibits and Reports on Form 8-K                             

<PAGE>

                                     PART I
ITEM 1.  Description of Business

Overview

The Great Train Store Company is a national chain of unique,  upscale  specialty
retail  stores which offer a broad  selection of  train-themed  merchandise  not
generally  available  from any  other  single  retailer.  Each of the  forty-two
currently  operating The Great Train Stores typically offer  approximately 4,200
stock keeping units ("SKUs"),  and the Train Depot offers  approximately  10,000
SKUs,  including:  (i) mechanical and  non-mechanical  toy trains,  games, plush
animals,  and other toys, (ii) model trains,  tracks,  buildings,  scenery,  and
accessories,   (iii)  men's,  women's,  and  children's  apparel,  jewelry,  and
accessories,  (iv)  decorative  items,  novelties and souvenirs,  and (v) books,
magazines,  printed material and audiovisual products,  all of which are related
to a common train and railroad theme.  As an important  element of its strategic
positioning, the Company strives to create an exciting and entertaining shopping
experience  which  appeals to all  segments of the  population,  whether male or
female,  child or adult, by featuring  attractions  such as moving model trains,
train whistles and sounds, and audiovisual presentations.

The Company's  growth plans include  capitalizing  on what it believes to be (i)
its role as a leading retailer of train-themed merchandise, (ii) the significant
national  nostalgia for  railroads and (iii) the growth of themed  entertainment
retailing. To accomplish its objective, the Company strives to emphasize (i) the
entertaining  quality of The Great Train  Store  shopping  experience,  (ii) the
broad merchandise selection offered by each of The Great Train Stores, and (iii)
the knowledgeable and personalized  customer service rendered by The Great Train
Store sales personnel.

The  Great  Train  Store  concept  was  developed  in 1985 by James  H.  Levi to
contribute to the unique retail shopping  environment then under  development as
part of the adaptive reuse of the landmark St. Louis Union Station in St. Louis,
Missouri, for which Mr. Levi was principally responsible.  The Great Train Store
retail concept was well received in the renovated St. Louis Union Station.  As a
result,  it was apparent to the Company that the  train-themed  merchandise  and
atmosphere  of The Great  Train Store had a customer  base and general  level of
interest  among retail  consumers  which was much broader than and extended well
beyond the St. Louis Union Station store.  The Company  expanded slowly at first
but much more rapidly in the last few years. In 1987 the second and third stores
were opened,  from 1988 through 1994,  an additional  eleven stores were opened,
and from 1995 to 1997 an additional  thirty stores were opened,  two stores were
closed,  and one was  relocated.  During  1996 the  Company  also  acquired  one
additional  store  through  the  purchase  of The Train  Depot in  Winter  Park,
Florida.  In 1997,  the Company also opened five The Great Train Store  Express,
temporary holiday stores.

The Great Train Store Concept

The Great Train Store Layout and Design.  The Great Train Stores are distinctive
in appearance and the shopping  experience which they provide.  As a key element
of its strategic positioning, the Company has designed The Great Train Stores to
encourage  shoppers  to enter and browse the  Company's  merchandise.  The Great
Train Stores are typically  located in highly visible  locations within regional
shopping  malls  or  festival  marketplaces.   The  prototypical  storefront  of
approximately  30 feet has a high quality  appearance and is constructed of wood
and glass  with a design  which  integrates  with the  internal  decor and color
palette and is intended to draw the customer  into its ambiance of an early 20th
century train station. Each of The Great Train Stores features attractions, such
as moving electrical trains,  whistles,  railroad crossing signals, train sounds
and audiovisual projections, to increase the visibility of the store and enhance
the quality of each customer's shopping experience.

The Great Train  Stores  range in size from 1,150 to 3,301  square feet of gross
rented  space and 1,016 to 2,429 of selling  square  feet.  The Train  Depot has
approximately  6,867  square  feet of gross  rented  space and 4,304 of  selling
square  feet.   Merchandise   is  presented   in  a  logical,   accessible   and
understandable  manner to arouse  interest and encourage  customers,  especially
children,  to touch and  experience  the offered  products.  Large-scale  moving
trains  encircle  the interior  and, in most  stores,  the exterior of The Great
Train Store on a patented overhead trestle.  Informational  signage and displays
presented in close  proximity to well-lighted  shelving  containing the featured
merchandise give prominence to selected products which the Company believes have
particular  appeal to  shoppers.  Merchandise  is  regularly  relocated  and new
merchandise is added within the store to offer a fresh  presentation to frequent
customers.

Merchandising and Pricing.  A key element of the Company's  business strategy is
to  distinguish  The  Great  Train  Stores  by  carrying  a broad  selection  of
train-themed  merchandise.   Management  believes  that  offering  an  extensive
selection of high-quality  train-themed  merchandise  significantly  expands The
Great Train  Stores'  customer  base and increases  store  traffic.  The Company
closely monitors in-stock inventories through its management  information system
and  regularly  replenishes  and  adds to the  merchandise  carried  in order to
reinforce the customers'  awareness of the wide and varied selection of products
offered by the stores.

The Company's pricing strategy  considers a variety of factors,  including gross
profit  contribution and potential mark-up over cost.  Notwithstanding its focus
on gross profit contribution and sales margin,  however,  the Company intends to
be generally  competitive  with prices  charged by other  comparable  retailers.
Accordingly,  the Company  customarily  prices its products at the manufacturers
suggested retail price and monitors price levels at its competitors'  outlets in
order to insure that its prices remain competitive.

Each of The Great Train Stores is  specifically  merchandised  to be  compatible
with local railroad  history and market  characteristics.  The  prototypical The
Great Train Store stocks  approximately  4,200 of the SKUs currently  offered by
the Company  throughout its store network.  Merchandise is currently  offered in
the following principal product lines:

         Toy Trains and Train-Themed  Merchandise.  In 1997, approximately 34.1%
         of  the  Company's   revenues  were  derived  from  the  sale  of  toys
         (including,  for example,  Brio,  Learning Curve Toys,  Tomy, Ertl, and
         Playmobil), games, puzzles, and plush animals.

         Model  Trains and  Accessories.  The Great Train  Stores  offer a broad
         selection of model railroad cars, track, and accessories in each of the
         five principal scales, HO gauge, #1 gauge,  0/0-27 gauge, Z gauge and N
         gauge, including merchandise from most of the best-known names in model
         railroading,   such  as  Lionel,   Athearn,  LGB,  Bachmann,   Marklin,
         Life-Like,  Model Power,  Atlas, Kato,  Rivarossi,  Walthers,  Con-Cor,
         Woodland  Scenics,  and Micro  Trains.  Sales in 1997 from this product
         line accounted for  approximately  36.6% of the Company's  annual sales
         volume.

         Printed and Recorded Materials.  Each of The Great Train Stores carries
         a wide selection of books, magazines,  posters, calendars,  videotapes,
         and children's educational material,  which accounted for approximately
         11.5% of the Company's annual sales volume in 1997.

         Decorative  Gifts,  Novelties  and  Souvenirs.  The Company  offers its
         customers a large selection of train-themed decorative items, novelties
         and souvenirs,  including clocks, music boxes, porcelain, glass, marble
         and pewter wares, mugs, whistles,  postcards,  stickers, pins, magnets,
         signs, plaques, pens and pencils.  Sales from this product line in 1997
         accounted for approximately 11.3% of the Company's annual sales volume.

         Apparel.  Each of The Great Train  Stores is stocked  with a variety of
         men's, women's and children's apparel and accessories,  including hats,
         T-shirts,  sweatshirts,  ties, jewelry,  watches and belt buckles,  the
         sales of which represented  approximately  6.5% of the Company's annual
         sales volume in 1997.

A substantial  portion of the Company's annual sales in the last five years have
been derived from the sale of merchandise based on the award-winning  children's
series,  Shining  Time  Station,  and its star,  Thomas  the Tank  Engine.  This
merchandise includes toys, printed material,  audio-visual  products and apparel
and is obtained by the Company from approximately 25 licensed vendors.

The Company  believes  that the high  quality of its stores and of the  products
carried by its stores is valued by customers.  The Company further believes that
the quality of The Great Train  Store's  products make them  exceptionally  well
suited for gift giving,  especially  for men and children.  The Company's  sales
personnel are taught the importance of educating the customer about the products
offered by the store and of  assisting  the  customer  in making  suitable  gift
selections.  The Company constantly seeks to identify and introduce new products
which meet its quality  and  profitability  standards.  Its  merchandise  buyers
attend trade shows and meet with manufacturers  throughout the year in search of
new products for The Great Train Stores.  Products meeting the Company's initial
merchandise  criteria are tested and reviewed by the  Company's  personnel.  The
Company's  management  information system is used to track the popularity of new
products prior to chain-wide introduction.

Customer  Service.   The  Company  is  committed  to  achieving  total  customer
satisfaction  and  encouraging  repeat  business  by  providing  a high level of
knowledgeable,   attentive  and  personalized  customer  service.  Many  of  the
Company's sales personnel are train enthusiasts and are well-versed in the train
lore and history of their  locality.  The Company  believes  that  educating its
broad  range  of  consumers  with  respect  to  the  suitability,  benefits  and
differences in all merchandise offered is an important component to its success.
In order to develop responsive and well trained sales personnel, the Company has
devoted substantial  resources to developing and implementing  employee training
and incentive programs.

Personnel;  Training.  An important  aspect of the  Company's  customer  service
strategy is "The Great  Training  Program"  which has been  developed to provide
each employee with  education in product  knowledge,  salesmanship,  and Company
policies and procedures.  New store managers receive  on-the-job  training under
the  supervision  of an  experienced  store  manager  prior  to  assuming  their
responsibilities.   Each  Store  Manager   participates  in  regular   telephone
conferences  with  the  Regional  Sales  Managers  who  participate  in a weekly
conference  call with the Company's  Director - Stores and the Vice  President -
Sales and  receives  regular  communications.  The  Company  believes  that this
communication  process  both  enhances  the  training of its store  managers and
establishes  a direct flow of relevant  Company  information  from the Company's
central office to all of The Great Train Stores.

Each store is staffed with a Store  Manager,  one or two Assistant  Managers and
such additional  Sales  Associates and support staff as are required to meet the
specific needs of the store.  The Company provides  financial  incentives to its
Store  Managers  through   incentive   compensation   programs  based  upon  the
performance of the individual store in which the employee performs services.  In
August 1997, the Company  implemented a sales  commission  program for all Sales
Associates  which  supplements  the  employee's  hourly  pay rate.  The  Company
believes that it's incentive  compensation  programs increase the motivation and
overall  performance  of its  personnel,  the  Company's  profitability  and the
Company's ability to attract and retain qualified employees.

Expansion Strategy

The Company intends to continue  implementation  of its growth  strategy.  As of
January 3, 1998 the  Company  operated  forty-two  stores  primarily  located in
distinctive  regional  shopping  malls and festival  marketplaces  in St. Louis,
Missouri;  Indianapolis,  Indiana;  New Orleans,  Louisiana;  Washington,  D.C.;
Bloomington (near Minneapolis),  Minnesota; Scranton,  Pennsylvania;  Alpharetta
(near  Atlanta),  Georgia;   Sacramento,   California;   Natick  (near  Boston),
Massachusetts;  Milpitas  (near  San  Jose),  California;  The  Woodlands  (near
Houston),  Texas;  Albany,  New York;  Laughlin,  Nevada;  Myrtle  Beach,  South
Carolina; Cleveland, Ohio; Raleigh, North Carolina; Holyoke, Massachusetts; King
of Prussia,  Pennsylvania;  McLean, Virginia;  Woodbridge, New Jersey; Richmond,
Virginia;  Kansas  City,  Missouri;  Troy  (near  Detroit),  Michigan;  Orlando,
Florida; Bellevue (near Seattle), Washington; Louisville, Kentucky; Skokie (near
Chicago),  Illinois; Columbia, South Carolina; Pineville (near Charlotte), North
Carolina;  Winter Park (near Orlando),  Florida;  Paramus, New Jersey;  Peabody,
Massachusetts; Westbury, New York; Milwaukee, Wisconsin; Waterbury, Connecticut;
San Diego,  California;  Miami, Florida;  Syracuse,  New York; Grapevine,  Texas
(near Dallas/Fort Worth);  Cincinnati,  Ohio; Youngstown,  Ohio; and Pittsburgh,
Pennsylvania.  In 1997,  the Company  also  operated  five The Great Train Store
Express,  temporary holiday stores in Olathe, Kansas; Dallas, Texas;  Nashville,
Tennessee;  Tulsa, Oklahoma,  and Columbia,  Maryland. The Company has announced
1998 store  openings in West Nyack  (Rockland  County),  New York;  Chattanooga,
Tennessee;  Tulsa,  Oklahoma;  and  Scottsdale,   Arizona.  A  1999  opening  in
Providence, Rhode Island has also been announced. Many other locations are under
active consideration and/or negotiation to open in 1998 and 1999. Because of the
broad market  appeal of their  merchandise  mix, the Company seeks to locate The
Great Train Stores in high traffic shopping environments.

<PAGE>

Prior to entering a new market, the Company reviews the market's demographic and
competitive  situation  to evaluate the  suitability  of and  prospects  for the
market. Among other factors, each site is evaluated on such information as local
market  demographics,  traffic  counts,  the  retail  mix  of  the  center,  the
visibility of available  locations within the center,  access to the center from
major thoroughfares, presence or absence of competition, overall retail activity
of the area and proposed lease terms.  The time period  required to open a store
after  signing a lease  depends  upon the  landlord's  ability  to  deliver  the
premises to the Company. Upon acceptance of the premises from the landlord,  the
Company generally can open a store within sixty days.

The  Company's  ability to open new stores in new markets has been a significant
factor in achieving its sales growth.  Management believes the Company's ability
to open new stores will continue to be a significant  factor in achieving growth
objectives for the future.  To date, the Company has  experienced no significant
difficulties  in locating  suitable sites for new stores.  The Company  believes
that substantial  opportunities also exist to increase sales in existing markets
by improving sales persons  productivity,  increasing vendor funded  promotional
activities  and opening  additional  stores in  currently  served  markets.  The
Company  believes that expansion of the number of stores it operates will permit
the Company to benefit from economies of scale,  enhanced  negotiating  leverage
with respect to  purchasing  terms and trade credit,  and  increased  ability to
obtain customized and exclusive products.

The Company also believes that opportunities exist to achieve growth through the
identification  and  development of new and unique product lines and through the
development or acquisition of businesses complimentary to the Company's existing
business,  including the possibility of mail order and catalog sales operations.
In 1996 the  Company  acquired an  existing  train  hobby store in Winter  Park,
Florida and may consider additional similar acquisitions. Currently, the Company
has no  agreement,  arrangement  or  understanding,  with  respect to any future
acquisition or complimentary expansion.

Advertising and Promotion

The Company relies  primarily on highly  visible store  locations and attractive
store design and visual  presentation  to attract the  attention of  prospective
consumers.  Its marketing activities also have included special event promotions
and a variety of public  relations  activities,  such as  sponsorship of Shining
Time Station television programming in some of the markets in which it operates,
promotion  of local  events  relating  to  railroading,  "how to"  instructional
sessions, and book readings for children.  Moreover, the Company considers media
relations to be an integral  part of its  image-building  program and strives to
develop  good working  relationships  by inviting  media  members to store grand
openings  and  maintaining  access to the  appropriate  Company  personnel.  The
Company  participates  in cooperative  advertising  programs with certain of its
major vendors.  The Company also maintains  direct mail contact with  customers,
highlighting sales promotions, as an important aspect of its marketing strategy.
Suppliers

Most of the Company's  products are purchased directly from  manufacturers.  The
Company presently  purchases products from approximately 600 vendors.  No single
vendor, other than Learning Curve Toys (whose products represented approximately
14.6% of total net sales) and Lionel Trains,  Inc. (whose  products  represented
approximately  11.2% of total net sales),  supplied  products  representing more
than  10% of  the  Company's  net  sales  in  1997.  The  largest  five  vendors
represented  approximately  43.8%  of net  sales  for  the  year.  Although  the
Company's  net sales are not dependent on any single  vendor,  the Company views
its relationships with certain key vendors,  such as Bachmann  Industries,  Brio
Scanditoy,  Tomy, Ertl, LGB, Learning Curve Toys, and Lionel Trains, Inc., to be
important factors in its success. The Company deals with its vendors principally
on an  order-by-order  basis and has no  long-term  purchase  contracts or other
contractual assurance of continued supply or pricing. The Company believes that,
due to its  relative  size,  its  purchasing  activities,  which  account for an
important portion of many of its suppliers' sales,  permit it to achieve a lower
cost of goods sold which, together with its broad selection of merchandise, good
locations, and exciting store presentation,  permit it to be highly competitive.
The Company also  intends to increase  the number of unique  items  manufactured
specifically  for it, such as its patented G scale  railroad  trestle system and
its The Great Train Store neckties and whistles.

<PAGE>

Management Information Systems

The  Company  uses  customized  management  information  systems  to  assist  in
directing  its  operations  and  finances.  In addition to providing  continuous
knowledge of the Company's  inventories,  these computerized  systems enable the
Company's  central  office to  reprice  merchandise,  replenish  depleted  store
inventories,  identify  sales trends and monitor  merchandise  mix at individual
stores and throughout  the Company's  store  network.  Management  believes that
these  systems  provide a number of  benefits  which  include  helping to reduce
average store inventories and thus achieve higher inventory turnover, and better
in-stock  availability.  The systems also enable the Company to realize purchase
discounts and to produce the financial  reports  necessary  for  monitoring  and
developing  budgets  for  the  Company's  expanding   business.   The  Company's
point-of-sale system keeps daily records of each SKU from receipt to sale.

The Company has determined  that  enhancements  to its  information  systems are
necessary  to  accommodate  its growth.  The Company is actively  developing  an
action  plan  for  upgrading  systems  beginning   mid-year  1998.  The  Company
anticipates that it will continue to invest significant capital  indefinitely to
enhance and improve its systems.

The Company is actively evaluating plans to deal with the "Year 2000 problem" to
ensure its computer systems will be Year 2000 compliant.  Such plans provide for
the conversion efforts to be completed by the end of 1999. The Year 2000 problem
is the result of computer  programs  being  written using two digits rather than
four to define the applicable  year. The cost of such project is unknown at this
time. However,  all costs are expected to be funded through operating cash flows
and/or the Company's  line of credit or possibly  through  additional  equipment
financing.

Competition

Competition is highly intense among  specialty  retailers,  traditional  toy and
hobby stores and mass merchant  discounters in regional shopping malls and other
high traffic retail locations and could increase in the future. To the Company's
knowledge,  there  are no  other  national  chains  of  stores  specializing  in
train-related merchandise.  Consumers of train-related merchandise are generally
served by toy and hobby  stores and mail  order  merchandisers.  Competition  is
fragmented and varies  substantially  from one  geographic  location to another.
National toy store chains, mail order  merchandisers,  discount stores and other
mass   merchandisers   have  a  significant  market  share  and  could  increase
competitive pressures on the Company in the future. In addition,  the mail order
industry has become  increasingly  competitive  in recent years.  Competition is
generally focused on product availability, customer service and price.

The Company  believes  that it  differentiates  itself from its  competitors  by
offering a broad  selection of merchandise  in a more exciting and  entertaining
environment.  The Company also believes that the train-related knowledge of many
of its sales personnel is a significant competitive advantage.

Trademarks

The name "The Great Train Store" and its related logo and the  Company's  slogan
"More trains than you ever imagined" are trademarks and service marks registered
in the European Union and Canadian Patent and Trademark  offices and are pending
registration  in the Japanese and European  Union Patent and Trademark  offices.
Management  believes that the name "The Great Train Store" is an important,  but
not critical,  element of the Company's marketing strategy.  The Company closely
monitors the use of its intellectual  property and intends to vigorously  defend
its rights with respect thereto.

Employees

As of January 3, 1998, the Company employed a total of 499 persons,  of whom 134
were  salaried  personnel  and  365  were  employed  on an  hourly  wage  basis.
Thirty-two  of  the  Company's   employees   were  assigned  to  central  office
responsibilities and were engaged in activities in stores. None of the Company's
employees  are  covered by a  collective  bargaining  agreement  and the Company
considers its employee relations to be good.

<PAGE>

ITEM 2.  Description of Properties

The  Company  leases all of its  stores  from  developers  or  operators  of the
regional shopping malls,  festival marketplaces and other locations in which the
stores are located.  Typically,  the Company's leases provide for the payment of
minimum  annual rent and  additional  rent  calculated  as a  percentage  of the
stores' net sales.  Generally,  the Company is also required to pay a portion of
the landlord's cost of insurance, taxes and other operating expenses. The leases
typically  provide for an initial  term of between five and twelve years and may
have  various  renewal  terms.  The  following  table  summarizes  the number of
expiration dates in each year for stores and the central office leases:

                                          Number of
     Year                              Leases Expiring
     ----                              ---------------
     1998                                      2
     1999                                      0
     2000                                      3
     2001                                      1
     2002                                      0
     2003 and thereafter                      37

The Company's  central  offices are  presently  located in  approximately  8,245
square feet of leased  space in Dallas,  Texas  under a lease  which  expires on
March 14,  2000.  The Company  believes  this space is adequate  for its present
needs.

ITEM 3.           Legal Proceedings

The  Company is not  presently  party to any  material  legal  proceedings.  The
Company  does not  believe  that any claims and  lawsuits to which it is a party
individually  or in the  aggregate,  will have a material  adverse effect on the
Company's financial condition.

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

No matter was submitted  during the fourth quarter of 1997 to a vote of security
holders.

                                     PART II

ITEM 5.  Market for Common Equity and Related Stockholder Matters

The Great Train Store  Company's  common stock is traded on The Nasdaq  National
Market  under  the  symbol  GTRN.  At  March  10,  1998  the  number  of  common
stockholders of record was 136. Based on discussions with the Company's transfer
agent and  investment  banker,  the Company  believes  that its common  stock is
beneficially  held by more than four hundred  persons.  The following table sets
forth,  for the periods  indicated,  the range of high and low sales prices with
respect to the Company's Common Stock as reported by The Nasdaq National Market.

                                                     Common Stock
                                               ------------------------
Period                                           High             Low
   1996:
     First Quarter                              6 15/32            5
     Second Quarter                              6 1/6           5 1/4
     Third Quarter                               8 1/4           5 1/8
     Fourth Quarter                              9 7/8           7 3/4

   1997:
     First Quarter                               9 3/8           8 1/4
     Second Quarter                              8 7/8           6 3/4
     Third Quarter                               9 3/8             7
     Fourth Quarter                              8 1/2           5 5/8

<PAGE>

The foregoing quotations reflect  inter-dealer  prices,  without retail mark-up,
mark-down or commission,  and may not necessarily represent actual transactions.
On March 10,  1998,  the last sale price for the Common Stock as reported by The
Nasdaq National Market was $3 3/4 .

The Company  has not  declared or paid any cash  dividends  on its Common  Stock
since its inception, and the Board of Directors presently intends to retain cash
flow for the development of the Company's  business for the foreseeable  future.
The  declaration  and  payment of cash  dividends  in the future  will be at the
discretion of the Company's  Board of Directors and will depend upon a number of
factors,   including,  among  others,  future  earnings,   operations,   capital
requirements,  the  general  financial  condition  of the Company and such other
factors as the Board of Directors may deem relevant.

ITEM 6.           Management's Discussion and Analysis

Actual results may differ materially from any  "forward-looking"  statements due
to a number of important factors. Those factors include possible difficulties in
opening new stores when expected or at all,  successfully  operating such stores
in  accordance  with the Company's  new  operating  initiatives  and in general,
controlling the Company's central overhead and producing  overall  profitability
as well as  satisfying  the  various  requirements  of the  Company's  financial
arrangements. These risk factors and others, are more fully discussed in Exhibit
99.1 attached to the Company's Form 10-QSB for the third quarter of 1997, a copy
of which is available without charge from the Company.

Results of Operations

The following table sets forth, for the periods indicated,  selected  statements
of operating  data  expressed as a percentage  of net sales (prior year balances
include certain  reclassifications to conform to the current year presentation).
The  Company's  fiscal  year is based on a 52/53 week  fiscal year ending on the
Saturday  closest to December 31. Fiscal year 1997 consisted of a 53 week period
ended  January 3, 1998 as compared to fiscal 1996 which  consisted  of a 52 week
period ended December 28, 1996.

                                         For the Fiscal Year Ended

                                 December 28, 1996              January 3, 1998
Net Sales                            100.0%                         100.0%
Cost of Sales                          51.8                          53.7
                                      -----                          -----
Gross Profit                           48.2                          46.3
Store operating expenses               18.8                          19.3
Occupancy expenses                     11.7                          13.2
Selling, general and 
  administrative expenses               9.9                           9.7
Depreciation and amortization           2.1                           2.7
                                      -----                         -----
Operating income                        5.7                           1.4
Interest expense                       (0.7)                         (0.7)
Interest income                          .5                            .2
Other income (expense)                   .1                           1.4
                                      -----                         -----
Income before income taxes              5.6                           2.3
Income tax                             (1.5)                          (.8)
                                     ------                         -----
Net income                              4.1%                          1.5%
                                      =====                         =====

Comparison  of Fiscal  Year Ended  December  28,  1996 to the Fiscal  Year Ended
January 3, 1998

Net sales  increased  approximately  $9,092,000,  or 47.9%,  for the fiscal year
ended  January  3,  1998  compared  with the  corresponding  period  last  year.
Substantially all of this increase  (approximately  $9,091,000) was attributable
to net sales  generated  by new  stores not  included  in the  comparable  store
calculation.  Approximately  $1,000 of the increase was attributable to a slight
increase in comparable  store sales.  The calculation of comparable  store sales
includes  sales for  stores  open in all  periods  for both  fiscal  years.  The
disappointing  sales performance of comparable store sales was primarily related
to a combination of several  factors.  Most notably,  the Company's buying staff
did not cope as ably as they  might  have with the rapid  growth of the  Company
and, on many occasions,  ordered  product later than they should have,  creating
periods in which key product was out of stock. In addition,  there were external
factors, such as certain manufacturers not meeting promised quantity or delivery
dates and the  well-publicized UPS strike. The Company has added to and believes
it has substantially  improved the quality and experience level of people on its
buying staff, as well as changing the overall leadership of the department.  The
Company has also recently  developed a new program of much closer  relationships
with most of its important vendors,  including various data sharing arrangements
as well as establishing  vendor managed inventory programs in a number of cases.
The  Company  is now also  using its  purchasing  power  much  more  effectively
ensuring  that new items are  received  more  promptly  into its  stores and are
developing  much more  exclusive  product.  Through these  changes,  the Company
believes that it now has a department  which is proactive and focused on the key
performance  indicators  which it hopes will make a significant  contribution to
increasing  sales.  Another  contributing  factor  during  1997  related to poor
traffic in certain  of the malls  where the  Company's  stores are  located.  In
several instances, the Company believes the disappointing traffic was related to
certain events including major store closings, a mall which closed, bad weather,
and a ship having hit a riverfront center where a store was located. While these
issues   adversely   impacted  the  overall   results,   many  stores  performed
significantly  above last year and all stores continued to have a positive store
level  contribution.  As the  Company's  base of stores  continues to grow,  the
performance of any individual  store is expected to have a less material  effect
on the Company.

Gross profit  increased  approximately  $3,867,000 or 42.3%, for the fiscal year
ended January 3, 1998,  compared with the  corresponding  period last year,  due
primarily to an increase in sales  volume.  Gross profit as a percentage  of net
sales  decreased  to 46.3% for the fiscal year ended  January 3, 1998,  compared
with 48.2% for the corresponding  period last year. The decrease in gross profit
as a percentage  of sales  resulted from several  factors.  One of the principle
focus areas of the new buying staff was to  reallocate  certain  portions of the
Company's  inventory  among its stores  which  resulted in  significant  freight
charges  related to the  transfer of product.  Gross  profit was also  adversely
impacted by a charge of approximately  $188,000 related to the management of the
Company's  inventory.  This charge was  discovered in  reconciling  the computer
generated accounts payable and detailed vendor statements.  In addition,  due to
disappointing sales results, the Company made some efforts to counteract this by
reducing certain selling prices which, in turn, adversely impacted gross profit.
In the past, the Company has not found it necessary to significantly promote its
product through price promotions.  As part of the improved vendor  arrangements,
the Company has been able to negotiate  significant  improvements  to the prices
and terms on which it is buying  merchandise  and will  continue  to review  its
pricing  strategy  going  forward.  The gross profit was also impacted by out of
stock issues in high margin departments and certain reduced cash discounts.

Store operating  expenses increased  approximately  $1,848,000 or 51.7%, for the
fiscal year ended January 3, 1998,  compared with the corresponding  period last
year.  Approximately  $1,882,000 of the increase  resulted from the operation of
the new stores.  This increase was partially  offset by an  approximate  $34,000
decrease in comparable store operating  expenses.  As a percentage of net sales,
store operating expenses increased to 19.3% for the fiscal year ended January 3,
1998, compared with 18.8% for the corresponding  period last year. This increase
was primarily due to lower than anticipated sales, pre-opening expenses incurred
in  connection  with more new stores and the  opening of The Great  Train  Store
Express temporary holiday stores and an increase in store personnel compensation
which included changes in the federal minimum wage standards.

Occupancy expenses increased approximately  $1,489,000, or 67.0%, for the fiscal
year ended January 3, 1998,  compared with the  corresponding  period last year.
Approximately  $1,364,000  of  the  increase  related  to  the  new  stores  and
comparable store occupancy expenses increased approximately $40,000, mostly from
increases  in  shared  expenses  charged  by  certain  of the malls in which the
Company has stores.  In  addition,  approximately  $85,000 of the  increase  was
related to the  Company  leasing  additional  central  office  space in order to
support future growth and leasing additional space adjacent to an existing store
for the purpose of  redistributing a small portion of the Company's  merchandise
which could not economically or otherwise be shipped directly to the stores. The
Company   believes  the  current  central  office  space  is  adequate  for  the
foreseeable  future. As a percentage of net sales,  overall  occupancy  expenses
increased  to 13.2% for the fiscal  year  January  3,  1998,  from 11.7% for the
corresponding period last year, primarily due to lower than planned sales.


<PAGE>

Selling, general and administrative expenses increased approximately $854,000 or
45.5%,   for  the  fiscal  year  ended  January  3,  1998,   compared  with  the
corresponding   period  last  year.   The  increase  in  selling,   general  and
administrative   expenses  was  primarily  due  to  approximately   $474,000  of
additional  expenses  related to salaries and related  expenses  for  additional
central  office  personnel to support the  continuing  growth of the Company.  A
significant  portion of such increase is related to the  Company's  promotion of
certain of its Store Managers to Regional Sales Managers. These positions, which
did not  exist in the  prior  year,  are a new level of  management  created  to
supervise  the  operation of the Company's  rapidly  growing  number of existing
stores  and  assist  in the  opening  of new  stores  as part  of the  Company's
increasing expansion program. In addition, the Company expended more significant
funds than in prior years in aggressive  marketing programs in several locations
in an effort to enhance  sales.  A  considerable  portion of this  included  the
existing train hobby store location which the Company acquired in November 1996.
The Company anticipates that selling,  general and administrative  expenses will
increase  further  as  a  result  of  increased  staffing  and  other  costs  in
anticipation of opening  additional  stores pursuant to the Company's  expansion
strategy.  As a percentage  of net sales,  selling,  general and  administrative
expenses  decreased to 9.7% for the fiscal year ended January 3, 1998, from 9.9%
for  the  corresponding  period  last  year.  The  Company  anticipates  that as
additional stores are opened, selling,  general and administrative expenses will
continue to decrease as a percentage of net sales.

Depreciation and  amortization  expense  increased  approximately  $362,000,  or
91.5%,   for  the  fiscal  year  ended  January  3,  1998,   compared  with  the
corresponding  period last year.  Such increases were primarily the result of an
increase in the asset base related to new stores, the external  development of a
SQL server to facilitate  enhanced  operational  reporting in the central office
and additions to fixed assets related to the central office expansion  discussed
above.  As a percentage  of net sales,  depreciation  and  amortization  expense
increased to 2.7% for the fiscal year ended  January 3, 1998,  from 2.1% for the
corresponding  period last year.  This increase as a percentage of net sales was
primarily related to the central office developments discussed above.

Other income increased  approximately $363,000 for the fiscal year ended January
3, 1998  compared  with the  corresponding  period last year.  This increase was
primarily  due to a $350,000  settlement  the Company  received from the City of
Indianapolis  in  connection  with the closing of Union  Station  requiring  the
Company to close its store during the term of the lease.

Pretax  income  decreased  39.0% to  approximately  $642,000 for the fiscal year
ended January 3, 1998. In fiscal 1997, the effective  income tax rate was higher
than in fiscal 1996, primarily due to the elimination of the remaining valuation
allowance  for  deferred  tax  assets in 1996.  As  anticipated,  the  Company's
effective income tax rate in 1997 approximated statutory income tax rates.

As a result of the foregoing,  the Company  recorded net income of approximately
$411,000 for the fiscal year ended January 3, 1998,  compared with net income of
approximately  $772,000 for the corresponding  period last year. As a percentage
of net sales, net income decreased to 1.5% for fiscal 1997, from 4.1% for fiscal
1996.

Liquidity and Capital Resources

The  Company's  primary uses of cash have been for the  purchase of  merchandise
inventories, the financing of new store openings, and capital expenditures.

For the fiscal  year  ended  January 3, 1998,  net cash  provided  by  operating
activities was approximately $1,175,000 compared with net cash used in operating
activities of approximately $946,000 for the corresponding period last year. The
increase in net cash provided by operating  activities primarily results from an
increase in accounts payable related to better terms with merchandise vendors.

<PAGE>

Subsequent  to year end, the Company  replaced its existing $8 million  facility
with a $15 million  revolving line of credit with  BankAmerica  Business Credit,
Inc. The enhanced line of credit features increased  availability,  a lower rate
of interest  and  improved  advance  rates.  The initial term of the facility is
three  years and it is  secured  by  certain  assets of the  Company,  primarily
inventory.  The line of credit  will be used to  provide a source of  additional
liquidity to manage cash flow and provide  capital for expansion.  As of January
3, 1998,  there was no balance  outstanding on the $8 million Bank One revolving
line of credit.

As of January 3, 1998,  the  Company's  capital lease  obligations  consisted of
approximately  $298,000  payable  under  capital  lease  obligations  related to
management  information  systems,  fixtures  and other  equipment.  Of such debt
obligations,  approximately  $86,000  under  these  financing  arrangements  are
payable during 1998.

During fiscal 1997,  the Company  opened twelve new stores and relocated a store
in  Indianapolis.  The new store  replaced the Company's  store in  Indianapolis
Union  Station  which  closed  on July 20,  1997  after the City  announced  the
Station's closing.

The Company intends to finance anticipated capital expenditures, working capital
needs  and debt  obligations  for the  foreseeable  future  from  cash  from the
Company's operating  activities,  landlord  allowances,  the available increased
line of credit,  possible fixtures and equipment or inventory  financing,  trade
credit and/or the public or private sale of debt or equity securities.

The Company is actively evaluating plans to deal with the "Year 2000 problem" to
ensure its computer systems will be Year 2000 compliant.  Such plans provide for
the conversion efforts to be completed by the end of 1999. The Year 2000 problem
is the result of computer  programs  being  written using two digits rather than
four to define the applicable  year. The cost of such project is unknown at this
time. However,  all costs are expected to be funded through operating cash flows
and/or the Company's  line of credit or possibly  through  additional  equipment
financing.

Authoritative Pronouncements

The  Financial  Accounting  Standards  Board has issued  Statements of Financial
Accounting Standards No. 130, "Reporting  Comprehensive Income" ("SFAS 130") and
No. 131,  "Disclosure  about Segments of an Enterprise and Related  Information"
("SFAS 131"). Both are required to be adopted in fiscal 1998. Statement 130 will
require the Company to report  comprehensive  income and its components with the
same  prominence  as other  financial  statements.  SFAS 131 is not  expected to
significantly change the Company's current disclosures.


ITEM 7.  Financial Statements

The  Company's  Consolidated  Balance  Sheet  as of  January  3,  1998  and  the
Consolidated  Statements of Income,  Stockholders' Equity and Cash Flows for the
years  ended  December  28, 1996 and  January 3, 1998,  together  with the notes
thereto  and the  report  of the  Company's  independent  auditors  thereon  are
included as a separate section of this report which begins on page F-1.


ITEM  8.  Changes  In and  Disagreements  With  Accountants  on  Accounting  and
          Financial Disclosures

None

                                    PART III

ITEM 9. Directors, Executive Officers, Promoters and Control Persons; Compliance
        with Section 16 (a) of the Exchange Act.

Information  regarding  Directors,  Executive  Officers,  Promoters  and Control
Persons is incorporated by reference to the material  contained in the Company's
1998 Proxy Statement.


ITEM 10. Executive Compensation

Information regarding Executive Compensation is incorporated by reference to the
material contained in the Company's 1998 Proxy Statement.

ITEM 11.  Security Ownership of Certain Beneficial Owners and Management

Information  regarding  Security  Ownership  of  Certain  Beneficial  Owners and
Management  is  incorporated  by  reference  to the  material  contained  in the
Company's 1998 Proxy Statement.


ITEM 12.          Certain Relationships and Related Transactions

None

ITEM 13.          Exhibits and Reports on Form 8-K.

      (a)         Exhibits.

                  See Exhibit Index.

      (b)         Reports on Form 8-K.

                  None

<PAGE>
                                    

                          Independent Auditors' Report



The Board of Directors and Stockholders
The Great Train Store Company:


We have audited the accompanying  consolidated  balance sheet of The Great Train
Store  Company  and  subsidiaries  as  of  January  3,  1998,  and  the  related
consolidated statements of income,  stockholders' equity, and cash flows for the
years ended December 28, 1996 and January 3, 1998. These consolidated  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the  financial  position of The Great Train
Store  Company and  subsidiaries  as of January 3, 1998 and the results of their
operations  and their  cash  flows for the years  ended  December  28,  1996 and
January 3, 1998, in conformity with generally accepted accounting principles.



                                              KPMG Peat Marwick LLP


Dallas, Texas,
February 10, 1998

                                      F-1
<PAGE>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEET

     ASSETS
                                                                January 3, 1998
CURRENT ASSETS
  Cash and cash equivalents                                         $ 3,490,721
  Merchandise inventories                                             8,978,789
  Accounts receivable and other current assets                        1,482,246
                                                                      ----------
          Total current assets                                        13,951,756

PROPERTY AND EQUIPMENT:
  Store construction and leasehold improvements                        4,741,495
  Furniture, fixtures and equipment                                    2,650,600
                                                                      ----------
                                                                       7,392,095
  Less accumulated depreciation and amortization                       1,827,691
                                                                      ----------
          Property and equipment, net                                  5,564,404

DEFERRED TAXES                                                           316,344
OTHER ASSETS, net                                                        315,138
                                                                      ----------
          Total assets                                               $20,147,642

     LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
  Accounts payable and accrued liabilities                            $6,044,099
  Sales taxes payable                                                    660,547
  Income taxes payable                                                   241,716
  Current portion of capital lease obligations                            85,497
                                                                      ----------
          Total current liabilities                                    7,031,859

CAPITAL LEASE OBLIGATIONS, net of current portion                        212,221
DEFERRED RENT AND OTHER LIABILITIES                                      873,117
                                                                      ----------

          Total liabilities                                            8,117,197
                                                                      ----------

COMMITMENTS

STOCKHOLDERS' EQUITY:
  Preferred stock: $.01 par value; 2,000,000 shares
    authorized; none issued                                                 --
  Common stock; $.01 par value; 18,000,000 shares
    authorized; 4,415,764 shares issued and outstanding                   44,158
  Additional paid-in capital                                          10,444,765
  Retained earnings                                                    1,541,522
                                                                      ----------

          Total stockholders' equity                                  12,030,445
                                                                      ----------

          Total liabilities and stockholders' equity                 $20,147,642
                                                                     ===========

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

                                      F-2
<PAGE>
                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                       CONSOLIDATED STATEMENTS OF INCOME


                                             For the Fiscal Year Ended
                                      December 28, 1996         January 3, 1998

NET SALES                               $  18,998,461             $  28,090,948

COST OF SALES                               9,847,463                15,072,692
                                          -----------               -----------

     Gross profit                           9,150,998                13,018,256
                                           ----------               -----------

OPERATING EXPENSES:
  Store operating expenses                  3,574,171                 5,421,714
  Occupancy expenses                        2,223,853                 3,713,162
  Selling, general and 
    administrative expenses                 1,876,070                 2,730,032
  Depreciation and 
    amoritization expenses                    396,136                   758,562
                                           ----------                 ---------

     Total operating expenses               8,070,230                12,623,470
                                           ----------                ----------

OPERATING INCOME                            1,080,768                   394,786
                                           ----------                ----------

OTHER INCOME (EXPENSE):
  Income expense                             (129,500)                 (188,128)
  Interest income                              84,960                    56,664
  Other income                                 15,301                   378,618
                                           ----------                  ---------

     Total other income (expense), net        (29,239)                  247,154
                                           ----------                  --------

INCOME BEFORE INCOME TAXES                  1,051,529                   641,940

PROVISION FOR INCOME TAXES                    279,301                   231,327
                                            ---------                   -------

NET INCOME                                 $  772,228                 $ 410,613
                                             ========                   =======

BASIC EARNINGS PER SHARE                   $     0.21                 $    0.09
                                             ========                   =======

DILUTED EARNINGS PER SHARE                 $     0.20                 $    0.09
                                             ========                   =======


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

                                      F-3
<PAGE>
<TABLE>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDER EQUITY

<CAPTION>

                                                                 Compensation
                                   Common Stock        Paid-In   - Restricted    Retained
                                Shares      Amount     Capital       Stock       Earnings       Total
<S>                          <C>         <C>         <C>          <C>          <C>           <C>

BALANCE, December 30, 1995    3,145,000   $  31,450   $4,446,947   $ (5,665)    $ 358,681    $ 4,831,413
  
Net income                          -           -            -          -         772,228        772,228
Net proceeds from warrant
  exercise                    1,226,169      12,262    5,567,725        -             -        5,579,987
Exercise of stock options 
  and related tax benefits       11,950         119       59,111        -             -           59,230
Adjustments associated with 
  unearned compensation - 
  restricted stock                1,000          10      124,392      1,540           -          125,942
                              ---------      ------    ---------     ------       -------      ---------

BALANCE, December 28, 1996    4,384,119    $ 43,841  $10,198,175   $ (4,125)   $1,130,909    $11,368,800

Net income                          -           -            -          -         410,613        410,613
Exercise of stock options
  and related tax benefits       31,645         317      169,176        -             -          169,493
Adjustments associated 
  with unearned
  compensation - restricted
  stock                             -           -         77,414      4,125           -           81,539
                               --------       -----    ---------      -----       -------     ----------

BALANCE, January 3, 1998      4,415,764    $ 44,158  $10,444,765    $    -     $1,541,522    $12,030,445
                              =========     =======   ==========     ======     =========     ==========

</TABLE>
The  accompanying  notes are an integral  part of these  consolidated  financial
statements

                                      F-4
<PAGE>
                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                     CONSOLIDATED STATEMENTS OF CASH FLOWS

                                                For the Fiscal Year Ended
                                         December 28, 1996      January 3, 1998

CASH FLOWS FROM OPERATING ACTIVITIES:

Net Income                                   $  772,228              $ 410,613
Adjustments to reconcile net income
  to net cash provided by (used in)
  operating activities:
    Depreciation and amortization               396,136                758,562
    Deferred income taxes                      (150,193)              (121,617)
    Loss on retirement of assets                    -                   14,728
    Amortization of unearned
      compensation - restricted stock             7,040                  4,125
    Changes in assets and liabilities:
      Merchandise inventories                (3,240,392)            (2,855,437)
      Accounts receivable and other
        current assets                         (900,995)              (358,612)
      Other assets                             (122,491)              (122,585)
      Accounts payable and accrued
        liabilities                           1,600,976              3,035,797
      Sales taxes payable                       167,841                255,913
      Income taxes payable                      257,067                (59,885)
      Other long term liabilities               267,090                213,517
                                              ---------              ---------

      Net cash provided by (used in)
        operating activities                   (945,693)             1,175,119
                                              ---------              ---------

CASH FLOWS FROM INVESTING ACTIVITIES:

Purchases of property and equipment          (2,275,065)            (2,649,724)
                                              ---------              ---------

     Net cash used in investing activities   (2,275,065)            (2,649,724)
                                              ---------              ---------

CASH FLOWS FROM FINANCING ACTIVITIES:

Net proceeds from stock options exercised        36,352                116,291
Tax benefit of stock option exercises           141,780                130,616
Net proceeds from warrant exercise            5,579,987                    -
Proceeds from notes payable                     144,269                    -
Repayment of notes payable and 
  capital leases                             (1,054,789)              (146,120)
                                              ---------                -------

     Net cash provided by financing 
       activities                             4,847,599                100,787
                                              ---------                -------

NET INCREASE (DECREASE) IN CASH AND
  CASH EQUIVALENTS                            1,626,841             (1,373,818)

CASH AND CASH EQUIVALENTS, 
  beginning of year                           3,237,698              4,864,539
                                              ---------              ---------

CASH AND CASH EQUIVALENTS,
  end of year                                $4,864,539            $ 3,490,721
                                             ==========            ===========

SUPPLEMENTAL NONCASH INVESTING AND
  FINANCING ACTIVITIES:

Assets financed through capital
  lease obligations                          $ 155,000             $      -
Interest paid                                $ 187,444             $  146,289
Income taxes paid                            $  41,644             $  282,213

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

                                      F-5
<PAGE>

 
                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS


1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:

Basis of Presentation and Consolidation

The Great Train Store  Company  (the  "Company")  operates a chain of  specialty
retail  stores  known  as  The  Great  Train  Stores,  which  sell  train-themed
merchandise  including model trains,  toys,  books,  video tapes,  apparel,  and
related  merchandise.  As of January 3, 1998,  the  Company  operated  forty-two
stores in twenty-three states and the District of Columbia.

The Company's fiscal year is based on a 52/53 week retail calendar ending on the
Saturday  closest to December 31. Fiscal year 1997 consisted of a 53 week period
ended  January 3, 1998 as compared to fiscal 1996 which  consisted  of a 52 week
period ended December 28, 1996. The consolidated  financial  statements  present
the  results  of  the  Company  and  all of its  subsidiaries.  All  significant
intercompany transactions and balances have been eliminated in consolidation.

Cash and Cash Equivalents

The Company  considers all short-term  investments  with original  maturities of
less than 90 days cash  equivalents.  Substantially all of the Company's cash at
December 28, 1996 and January 3, 1998 was invested in money  market  funds.  The
carrying value of these instruments approximates market value due to their short
maturities.

Merchandise Inventories

Merchandise inventories are stated at the lower of average cost or market.

Property and Equipment

Property  and  equipment  are  stated  at  cost.  The  costs  of  additions  and
improvements  which  substantially  extend  the  useful  life  of an  asset  are
capitalized.  Repair and maintenance costs are charged to expense when incurred.
When assets are sold or otherwise  disposed of, the estimated  costs and related
accumulated  depreciation or amortization are removed from the accounts, and any
resulting gain or loss is included in income or expense. The Company reviews all
long-lived  assets for impairment  whenever  events or changes in  circumstances
indicate that the carrying  amount of an asset may not be  recoverable.  If such
assets are  considered  to be  impaired,  the  impairment  to be  recognized  is
measured by the amount by which the  carrying  amount  exceeds the fair value of
the assets.

Depreciation  of property and  equipment,  including  assets held under  capital
leases, is provided using the straight-line method based on the estimated useful
lives of the assets which  generally  range from three to five years.  Leasehold
improvements and fixtures are amortized over the shorter of the estimated useful
life or the remaining lease term.

Pre-Opening Costs

Store pre-opening costs are charged to expense in the period in which incurred.

Advertising Costs

Advertising costs are expensed as incurred.  Advertising  expense, net of vendor
reimbursements,  was  approximately  $50,000 and  $139,000  respectively  during
fiscal 1996 and fiscal 1997.

                                      F-6
<PAGE>

1.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)

Income Taxes

The Company  accounts  for income  taxes using the asset and  liability  method.
Under this method  deferred tax assets and  liabilities  are  recognized for the
future tax  consequences  attributable  to  differences  between  the  financial
statement  carrying  amounts  of  existing  assets  and  liabilities  and  their
respective  tax bases.  Deferred tax assets and  liabilities  are measured using
enacted  tax rates  expected  to apply to  taxable  income in the years in which
those temporary  differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date.

Earnings Per Share

The  Company  adopted  Statement  of  Financial  Accounting  Standards  No. 128,
"Earnings Per Share" ("SFAS 128") which became effective on a retroactive  basis
with the issuance of the Company's  consolidated financial statements for fiscal
1997.  Accordingly,  the Company has restated its prior year  earnings per share
data to conform with SFAS 128.

Basic  earnings  per share is computed by  dividing  net income by the  weighted
average  number of common  shares  outstanding.  Diluted  earnings  per share is
computed by dividing net income by the weighted  average number of common shares
plus the number of additional  shares that would have resulted from  potentially
dilutive securities.

                                                          1996           1997
                                                          ----           ----
    Weighted Average of Common Stock 
       Outstanding                                     3,663,780      4,401,225
    Common Stock Equivalents                             193,300        196,737
                                                       ---------      ---------
    Weighted Average of Common Stock Outstanding 
      and Common Stock Equivalents                     3,857,080      4,597,962
                                                       =========      =========

Stock Option Plan

The Company accounts for its stock option plan in accordance with the provisions
of Accounting  Principles Board Opinion No. 25,  "Accounting for Stock Issued to
Employees"  ("APB 25"),  and related  interpretations.  Compensation  expense is
recorded on the date of grant only if the current market price of the underlying
stock exceeds the exercise price. Since the Company grants stock options with an
exercise price equal to the current market price of the stock on the grant date,
no compensation  expense is recorded.  Under  Statement of Financial  Accounting
Standards No. 123,  "Accounting for Stock-Based  Compensation" ("SFAS 123"), the
Company may elect to recognize expense for stock-based compensation based on the
fair value of the awards,  or continue to account for  stock-based  compensation
under APB 25 and disclose in the financial statements the effects of SFAS 123 as
if the recognition provisions were adopted. The Company has elected not to adopt
the recognition provisions of SFAS 123.

Use of Estimates

Management  of the  Company  has  made a number  of  estimates  and  assumptions
relating to the reporting of assets and  liabilities to prepare these  financial
statements in conformity with generally accepted  accounting  principles.  While
every effort has been made to ensure the  integrity of these  estimates,  actual
results could differ from those estimates.

Prior Year Reclassifications

Prior year balances include certain  reclassifications to conform to the current
year presentation.

2.   REVOLVING LINE OF CREDIT

Subsequent  to year end, the Company  replaced its existing $8 million  facility
with a $15 million  revolving line of credit with  BankAmerica  Business Credit,
Inc.  The  initial  term of the  facility  is three  years and it is  secured by
certain  assets  of the  Company,  primarily  inventory.  The  revolving  credit
facility  provides  a source of  additional  liquidity  to manage  cash flow and
provide  capital  for  expansion.  As of January  3, 1998,  there was no balance
outstanding on the $8 million Bank One facility.

                                      F-7
<PAGE>
3.   INCOME TAXES

Income tax  expense for the years  ended  December  28, 1996 and January 3, 1998
consisted of the following:

                                                     1996                  1997
                                                     ----                  ----

   Federal income taxes - current                  $389,494           $ 341,332
   Federal income taxes - deferred                 (150,193)           (121,617)
   State income taxes - current                      40,000              11,612
                                                   --------             -------
                                                  $ 279,301           $ 231,327
                                                 ==========           =========

Income tax  expense  differed  from the amounts  computed  by applying  the U.S.
federal income tax rate of 34% to pretax income for the years ended December 28,
1996 and January 3, 1998, respectively, as a result of the following:

                                                      1996                 1997
                                                      ----                 ----

    Computed "expec$ed" tax expense                $ 357,520         $  218,260
    State income tax, net of federal
      tax benefit                                     26,400              7,664
    Change in the beginning-of-the-year 
      balance of the valuation allowance 
      for deferred tax assets allocated                  
      to income tax expense                         (107,507)               -
    Other
                                                       2,888              5,403
                                                     -------            -------
                                                  $  279,301        $   231,327
                                                  ==========        ===========

The tax effects of temporary  differences that give rise to significant portions
of the  deferred  tax assets and  liabilities  at January 3, 1998 are  presented
below:

    Deferred tax assets:
      Deferred rent                                              $ 267,240
      Other                                                         73,016
                                                                  --------
    Total deferred tax assets                                      340,256
    Deferred tax liabilities - property and equipment              (23,912)
                                                                  --------
    Net deferred tax assets                                      $ 316,344
                                                                 =========

The Company  did not record a valuation  allowance  for  deferred  tax assets at
January 3, 1998 nor at December 28, 1996. The net change in the total  valuation
allowance  was a decrease of $107,507 for the year ended  December 28, 1996.  In
assessing the  realizibility  of deferred tax assets,  management  considers the
carryback  potential,   the  scheduled  reversal  of  deferred  tax  assets  and
liabilities,  future  taxable  income and tax  planning  strategies.  Management
believes  that it is more likely than not the Company  will realize the benefits
of these deductible differences at January 3, 1998.

4.   COMMITMENTS

Leases

The Company  conducts its retail  operations from leased  locations with initial
lease terms ranging from five to twelve years.  Certain store leases provide for
contingent  rentals based on sales levels and require payment for all or part of
the applicable  real estate taxes,  common area  maintenance,  and certain other
allowable  expenses.  In addition,  some stores lease obligations are secured by
fixtures  and  equipment  of the  Company.  The Company  also leases its central
offices under a five year operating lease.

The Company records base rental expense using the straight-line  method over the
life of the lease  and,  accordingly,  has  recorded  a  deferred  liability  of
approximately   $786,000  at  January  3,  1998,   representing  the  excess  of
straight-line rental expense over amounts paid.

                                      F-8
<PAGE>

4.   COMMITMENTS - (Continued)

Total  rental  expense  under  all   noncancelable   operating   leases  totaled
approximately  $1,448,000  and  $2,388,000 for the years ended December 28, 1996
and January 3, 1998  respectively.  Included in these amounts is contingent rent
of approximately $224,000 and $281,000 for the years ended December 28, 1996 and
January 3, 1998 respectively.

The Company has capital leases payable to a finance company which are secured by
certain property and equipment. These leases are payable in monthly installments
(together  with  interest) at rates  ranging from 12.1% to 16.8%.  At January 3,
1998,  the gross  amount of  property  and  equipment  and  related  accumulated
amortization  recorded  under  capital  leases were  approximately  $716,000 and
$423,000 respectively.

Scheduled future minimum lease payments under all lease commitments with initial
or noncancelable terms in excess of one year are as follows:

                                                  Operating            Capital
    1998.............................             2,982,014          $  122,312
    1999.............................             2,919,961             122,312
    2000.............................             2,816,450             100,430
    2001.............................             2,794,266              22,453
    2002.............................             2,766,566                 -
    Thereafter ......................            11,190,522                 -
                                                 ----------              ------

     Total minimum payments                     $25,469,779        $    367,507
                                                 ----------
     Less interest                                                       69,789
     Less current portion                                                85,497
     Capital lease obligations, net of 
        current portion                                            $    212,221
                                                                   ============
 
5.   STOCKHOLDERS' EQUITY:

The Company's  authorized capital consists of 18,000,000 shares of common stock,
$.01 par value,  and 2,000,000  shares of preferred  stock,  $.01 par value. The
Company's Board of Directors may establish one or more series of preferred stock
with terms,  rights and preferences  (including voting,  dividend,  liquidation,
conversion, and other rights) as it so determines.
No preferred stock has been issued.

As of January 3, 1998, the underwriter in the Company's  initial public offering
has  outstanding  an option to  purchase up to 120,000  shares of the  Company's
common stock at $7.25 per share. The  underwriter's  option expires on August 4,
1999.

In May 1994 the Company completed a private  placement  consisting of promissory
notes and warrants  (which expire in May 1999) to purchase up to 187,500  shares
of common stock at $4.50 per share.  The  promissory  notes were repaid with net
proceeds from the Company's initial public offering.

On August 4, 1996,  1,226,169 (or 98.5%) of the Company's 1,245,000  outstanding
warrants  to  purchase  the  Company's  common  stock at $5.00  per  share  were
exercised. Net proceeds to the Company were approximately $5,580,000.

The  Company's  1994  Incentive  Compensation  Plan provides for the granting of
restricted  stock awards and incentive and nonqualified  stock options.  Options
are  granted  at the  current  market  price on the date of grant and  typically
terminate  ten years from the date of grant.  A portion of these  options  first
become  exercisable  on the  second  anniversary  of the date of grant  and vest
ratably  over a period of five years.  Additionally,  pursuant to the  Company's
1994  Director  Stock Option Plan,  nonqualified  stock options may be issued to
non-employee  directors.  Director's  options  become  exercisable  on the first
anniversary of the date of grant. The following  summary sets forth the activity
under the plans:

                                      F-9
<PAGE>

5.   STOCKHOLDERS' EQUITY - (Continued):
                                   Incentive                         Director
                              Compensation Plan                Stock Option Plan

                                   Weighted                          Weighted
                                    Average                          Average
                       Options   Exercise Price     Options       Exercise Price

Outstanding at 
December 30, 1995      154,700        $3.87         30,000              $4.25

   Granted             216,600        $5.84         10,000              $5.63
   Exercised            (6,950)       $3.07         (5,000)             $3.00
   Forfeited           (16,300)       $5.16            -                   -
                      --------                       ------

Outstanding at 
December 28, 1996      348,050        $5.05         35,000             $4.82

   Granted             228,150        $7.96         20,000             $7.88
   Exercised           (22,650)       $3.19        (10,000)            $4.41
   Forfeited           (89,950)       $5.91            -                  -
                      --------                      ------
                                                                           
Outstanding at 
January 3, 1998        463,600        $6.40         45,000             $6.27
                       =======                      ======            

Exercisable at 
January 3, 1998         30,750        $3.69         25,000             $4.99
                      ========                     =======
Reserved and available 
for grant at
January 3, 1998        166,800                      40,000
                      ========                      ======

At January 3, 1998, the range of exercise prices and weighted-average  remaining
contractual life of outstanding  options was $3.00 - $9.25 and 8.6 years for the
Incentive  Compensation  Plan and $3.00 - $7.88  and 5.6 years for the  Director
Stock Option Plan, respectively.

The per share weighted-average fair value of stock options granted during fiscal
1996 and  fiscal  1997 was  $3.57  and  $4.83,  respectively  for the  Incentive
Compensation  Plan and  $2.59  and $3.67 for the  Director  Stock  Option  Plan,
respectively, on the date of grant using the Black-Scholes option pricing model.
The following assumptions were used in the calculation:

                            Incentive Compensation        Director Stock Option 
                                    Plan                          Plan
                            1996            1997          1996             1997
Expected dividend yield       -               -             -                -
Risk-free interest rate     6.4%            6.4%           6.9%            6.6%
Expected life in years       10              10             5               10
Expected volatility          40%             59%            40%             59%

The  Company  applies APB 25 in  accounting  for its Plan and,  accordingly,  no
compensation  cost has been  recognized  for its stock  options in the financial
statements. Had the Company determined compensation cost based on the fair value
at the grant date for its stock options under SFAS 123, the Company's net income
would have been reduced to the pro forma amounts indicated below:

                                                        1996              1997
                                                        ----              ----
Net Income:                 As reported            $ 772,228          $ 410,613
                            Pro forma              $ 687,928          $ 191,165

Diluted Earnings Per Share: As reported               $ 0.21             $ 0.09
                            Pro forma                 $ 0.18             $ 0.04

Pro forma net income  reflects  only  options  granted in fiscal 1995 and later.
Therefore,  the full impact of calculating  compensation  cost for stock options
under SFAS 123 is not  reflected in the pro forma net income  amounts  presented
above because compensation cost is reflected over the options' vesting period of
five years for the Incentive  Compensation  Plan and one year for the Director's
Stock Option Plan; and compensation cost for options granted prior to January 1,
1995 is not considered.

                                      F-10
<PAGE>

                                   SIGNATURES

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


                                    THE GREAT TRAIN STORE COMPANY



March 16, 1998                      /s/ Cheryl A. Taylor
-----------------------------        -------------------------------------------
Date                                Cheryl A. Taylor
                                    Vice President - Finance and Administration

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

March 16, 1998                      /s/ James H. Levi
-----------------------------       ------------------------------------------
Date                                James H. Levi
                                    President, Chief Executive Officer and
                                    Chairman of the Board
                                    (Principal Executive Officer)

March 16, 1998                      /s/ Cheryl A. Taylor
-----------------------------       ------------------------------------------
Date                                Cheryl A. Taylor
                                    Vice President - Finance and Administration,
                                    (Principal Financial and Accounting Officer)

March 16, 1998                      /s/ Joel S. Pollack
-----------------------------       ------------------------------------------
Date                                Joel S. Pollack
                                    Director

March 16, 1998                      /s/ John J. Schultz
----------------------------        ------------------------------------------
Date                                John J. Schultz
                                    Director

March 16, 1998                      /s/ Charles M. Tureen
----------------------------        ------------------------------------------
Date                                Charles M. Tureen
                                    Director

March 16, 1998                      /s/ Robert M. Warner
----------------------------        ------------------------------------------
Date                                Robert M. Warner
                                    Director
<PAGE>

                                  EXHIBIT INDEX                             
                                                                              
Exhibit
Number                               Description                           Page
------                               -----------                           ----
3.1  *   Certificate of Incorporation of the Registrant...............        
3.2  *   Bylaws of the Registrant.....................................        
4.1  *   Form of Stock Certificate....................................         
4.3  *   Form of Bridge Warrants......................................         
4.4  *   Form of Underwriter's Option.................................         
10.1 *** The Great Train Store Company Amended and Restated 1994               
         Incentive Compensation Plan..................................         
10.2 *   The Great Train Store Company 1994 Director Stock                     
         Option Plan..................................................         
10.4 *   Form of Employment Agreement with James H. Levi..............         
10.6 *   The Great Train Store Partners, L.P. Agreement of Limited             
         Partnership dated as of September 1, 1990, as amended.........         
10.9 **  First Amendment to The Great Train Store Company 1994                 
         Director Stock Option Plan...................................         
10.13*** Second Amendment to The Great Train Store Company 1994               
         Director Stock Option Plan..................................         
10.14    Amended and Restated Loan and Security Agreement dated as             
         of January 27, 1998 with BankAmerica Business Credit, Inc....         
21.1     Subsidiaries of the Registrant...............................         
23.1     Independent Auditors' Consent................................         
27.1     Financial Data Schedule (filed only in EDGAR format).........         
99.1**** Cautionary Statements Identifying Important Factors                   
         that Could Cause the Company's Actual Results to Differ               
         from those Projected in Forward Looking Statements...........         

---------------                                        

*    Incorporated by reference to Registrant's Registration Statement on Form 
     SB-2 (commission file no.33-79554) first filed on June 1, 1994
                                                                              
**   Incorporated by reference to the Registrant's Annual Report on Form 10-KSB 
     for the fiscal year ended December 30, 1995.             
                                                                               
***  Incorporated by reference to the Registrant's Registration Statement on 
     Form S-8 (Commission file No. 333-37705) filed on October 10, 1997.
                                                                              
**** Incorporated by reference to the Registrant's Quarterly Report on          
     Form 10-QSB for the period ended September 27, 1997.