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 [Fee Required] For the fiscal year ended December 28, 1996

/ / 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(b) of the Exchange Act:

                                                     Name of Each Exchange
Title of Each Class                                   on Which Registered
-------------------                                   -------------------
Common Stock $0.01 par value                         Pacific Stock Exchange

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 $18,998,461

At March 20,  1997,  the  aggregate  market  value of the  voting  stock held by
non-affiliates   of  The  Great  Train  Store   Company  (the   "Company")   was
approximately  $25,397,255,  based on the last sale price of the  common  stock
reported by The Nasdaq SmallCap Market on March 20, 1997. At March 20, 1997, the
Company had outstanding 4,393,219 shares of Common Stock.


<PAGE>

                                TABLE OF CONTENTS


                                     PART I

                                                                          Page

ITEM 1.  Description of Business                                             2

ITEM 2.  Description of Property                                             9

ITEM 3.  Legal Proceedings                                                   9

ITEM 4.  Submission of Matters to a Vote of Security Holders                 9

                                     PART II

ITEM 5.  Market for Common Equity and Related Stockholder Matters           10

ITEM 6.  Management's Discussion and Analysis                               11

ITEM 7.  Financial Statements                                               13

ITEM 8.  Changes In and Disagreements With Accountants on                   13
           Accounting and Financial Disclosures

                                    PART III

ITEM 9.  Directors, Executive Officers, Promoters and Control Persons;
           Compliance With Section 16(a) of the Exchange Act                14

ITEM 10. Executive Compensation                                             17

ITEM 11. Security Ownership of Certain Beneficial Owners and Management     19

ITEM 12. Certain Relationships and Related Transactions                     20

ITEM 13. Exhibits and Reports on Form 8-K                                   20


                                       2
<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  twenty-nine
currently  operating The Great Train Stores typically offer  approximately 5,500
stock keeping units  ("SKUs"),  and  significantly  more SKUs are offered by The
Train Depot,  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.  In 1987 the second and third stores
were opened, from 1988 through 1993, an additional seven stores were opened, and
from 1994 to 1996 an  additional  twenty-one  stores  were opened and two stores
were closed.  During 1996 the Company also acquired one additional store through
the purchase of The Train Depot in Winter Park, Florida.

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 - 40 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, train sounds and audiovisual projections,
to  increase  the  visibility  of the  store and  enhance  the  quality  of each
customer's shopping experience.


                                       3
<PAGE>


The Great Train  Stores  range in size from 1,150 to 3,306  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  5,500 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 1996, approximately 31.5%
         of the  Company's  net  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,  Woodland
         Scenics,  and Micro  Trains.  Net sales in 1996 from this  product line
         accounted for  approximately  35.9% of the  Company's  annual net 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
         12.2% of the Company's annual net sales volume in 1996.

         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. Net sales from this product line in
         1996  accounted for  approximately  13.1% of the  Company's  annual net
         sales volume.


                                       4
<PAGE>


         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 net
         sales of which represented  approximately  7.3% of the Company's annual
         net sales volume in 1996.

A substantial  portion of the Company's  annual net 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 more than 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,  attends  an annual  managers'  conference,  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 Company headquarters to all of The Great Train
Stores.

Each store is staffed with a store  manager,  one or two assistant  managers and
such  additional  salespersons  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. The
Company  believes  that  its  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.


                                       5
<PAGE>


Expansion Strategy

The Company intends to continue  implementation  of its growth  strategy.  As of
December  28, 1996 the  Company  operated  thirty  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;  and Winter Park (near Orlando),  Florida.  In March 1997, the Company
anticipates  opening a store in  Paramus,  New Jersey and in May 1997 in Peabody
(near  Boston),  Massachusetts.  The  Company  also has signed a lease to open a
store in 1998 in Providence, Rhode Island. While there can be no assurance, each
of these  locations is expected to open in 1997.  Many other locations are under
active consideration and/or negotiation to open in 1997 and 1998. Because of the
broad market  appeal of their  merchandise  mix, the Company seeks to locate The
Great Train Stores in high traffic shopping environments.

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.   Actual  site   selection  is  the
responsibility of a committee which includes the Chief Executive Officer and all
Vice Presidents.  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  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.


                                       6
<PAGE>


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 include 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 650 vendors.  No single
vendor,  other than Learning Curve Toys (which represented  approximately 11.6%)
and Lionel  Trains,  Inc.  (which  represented  approximately  10.6%),  supplied
products  representing  more than 10% of the  Company's  net sales in 1996.  The
largest five vendors represented  approximately 39.8% 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  against  other  forms  of  train-themed
retailers.  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.  The Company has not
experienced  and does not  anticipate  any  significant  difficulty in obtaining
sufficient levels of merchandise.

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,  including  lower  average  store
inventories and thus higher inventory  turnover,  higher  operating  efficiency,
better in-stock  availability and fewer  markdowns.  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
merchandise item from receipt to sale.


                                       7
<PAGE>


The Company has implemented a plan and has made substantial  capital investments
to significantly upgrade and integrate its merchandise and financial information
systems to support its growth objectives and to enhance  management's ability to
access and  analyze  information  from all areas of the  business.  Among  other
things,  the new systems  improved the Company's  ability to compile and utilize
store level data bases,  prepare  customized  mailing lists and track individual
sales personnel productivity.  Although substantial improvements have been made,
the Company  anticipates  that it will  continue to invest  substantial  amounts
indefinitely to enhance and improve its systems.

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 broader  selection of merchandise in a more exciting and entertaining
environment.  The Company also believes that the train-related  knowledge 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 United States and Canadian  Patent and Trademark  offices and are pending
registration  in the Japanese and United Kingdom  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 December 28, 1996, the Company employed a total of 359 persons, of whom 95
were  salaried  personnel  and  264  were  employed  on an  hourly  wage  basis.
Twenty-six  of  the  Company's   employees   were  assigned  to  central  office
responsibilities  and 333 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.


                                       8
<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
           ----                                          ---------------
           1997                                                 1
           1998                                                 2
           1999                                                 0
           2000                                                 3
           2001                                                 1
           2002 and thereafter                                 24

The Company's  central  offices are  presently  located in  approximately  7,661
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 1996 to a vote of security
holders.


                                       9
<PAGE>


                                     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  SmallCap
Market and Pacific Stock Exchange under the symbols, GTRN and GTN, respectively.
At February 28, 1997 the number of common  stockholders  of record was 88. 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. Prior to January 4, 1995, the Company's stock and warrants sold
as Units.  Each Unit  consisted  of one share of common stock and one warrant to
purchase  one share of common  stock at $5.00 per  share.  Effective  January 4,
1995, the Units were separated into the  constituent  shares of common stock and
warrants.  On August 4, 1996 the Company had received proceeds from the exercise
of 98.5% of the  warrants.  The  following  table sets  forth,  for the  periods
indicated,  the range of high and low bid prices with  respect to the  Company's
Common Stock as reported by The Nasdaq SmallCap Market.



                                                 Common Stock
                                           -------------------------

                  Period                       High         Low
                  ------                       ----         ---
1995:



   First Quarter (beginning 1/4/95)           6-1/4          5

   Second Quarter                             6-1/4        5-1/4

   Third Quarter                                7          5-3/8

   Fourth Quarter                             6-7/8          5

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


The foregoing quotations reflect  inter-dealer  prices,  without retail mark-up,
mark-down or commission,  and may not necessarily represent actual transactions.
On March 20,  1997,  the last sale price for the Common Stock as reported by The
Nasdaq SmallCap Market was $8-3/8.

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.


                                       10
<PAGE>



ITEM 6.  Management's Discussion and Analysis

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.

                                               For the Year Ended
                                  December 30, 1995           December 28, 1996
                                  -----------------           -----------------

Net Sales                               100.0%                      100.0%
Cost of Sales                            52.0                        51.8
                                        -----                       -----
   Gross Profit                          48.0                        48.2

Store operating expenses                 19.0                        19.4
Occupany expenses                        13.2                        11.7 
Selling, general, & administrative
  Expenses                               10.9                         9.3
Depreciation and amortization             1.9                         2.1
                                         ----                        ----
  Operating income                        3.0                         5.7
Interest expense                         (1.0)                        (.7)
Interest income                            .9                          .5
Other income                               .1                          .1
                                         ----                        ----
  Income before income taxes              3.0                         5.6
Income taxes                                -                        (1.5)
                                         ----                        ----
  Net income                              3.0%                        4.1%


Comparison  of Fiscal  Year Ended  December  30,  1995 to the Fiscal  Year Ended
December 28, 1996

Net sales  increased  approximately  $6,183,000,  or 48.3%,  for the fiscal year
ended  December 28, 1996  compared with the  corresponding  period last year. Of
this increase approximately $4,281,000 was attributable to net sales
generated by twelve stores which were not operated in the  comparable  period in
1995, partially offset by a decrease of approximately  $696,000  attributable to
the Columbus  location,  which was closed on December  30, 1995.  Approximately,
$2,337,000 of the increase was  attributable to net sales  generated  during the
first part of 1996 by the six  stores  opened  during  1995,  and  approximately
$261,000  was  attributable  to a  2.3%  increase  in  comparable  store  sales.
Comparable  store sales are  calculated  based on the stores open during both of
the entire months being compared.

Gross profit  increased  approximately  $2,995,000 or 48.7%, for the fiscal year
ended December 28, 1996,  compared with the  corresponding  period last year due
primarily to an increase in sales  volume.  Gross profit as a percentage  of net
sales (gross  margin)  increased to 48.2% for the fiscal year ended December 28,
1996,  compared with 48.0% for the corresponding  period last year. The increase
in gross margin resulted from several factors  including changes in product mix,
inventory shrink, and purchase discounts as a result of increased purchases from
certain vendors.


                                       11
<PAGE>


Store operating  expenses increased  approximately  $1,250,000 or 51.4%, for the
fiscal year ended December 28, 1996, compared with the corresponding period last
year.  Approximately $919,000 of the increase resulted from the operation of the
twelve  stores  added during 1996,  approximately  $250,000 of which  related to
pre-opening  expenses  incurred  in the  setup of  these  stores.  In  addition,
approximately  $523,000 of the increase was  attributable  to the stores  opened
during  fiscal 1995 which were open the full fiscal year in 1996.  This increase
was partially  offset by an  approximate  $52,000  decrease in comparable  store
operating  expenses  and an  approximate  $140,000  decrease  due to closing the
Columbus  store  location on December  30, 1995.  As a percentage  of net sales,
store operating  expenses  increased to 19.4% for the fiscal year ended December
28,  1996,  compared  with 19.0% for the  corresponding  period last year.  This
increase was primarily due to pre-opening  expenses  incurred in connection with
opening  a larger  number of stores in 1996 as  compared  to 1995.  Unlike  many
retailers, the Company expenses pre-opening costs as incurred.

Occupancy expenses increased  approximately  $527,000,  or 31.0%, for the fiscal
year ended December 28, 1996, compared with the corresponding  period last year.
Approximately  $417,000  of the  increase  related to the stores  opened  during
fiscal 1995 which were open for the full fiscal year in 1996, and  approximately
$308,000 of the  increase  was  attributable  to the twelve  stores added during
fiscal 1996. The increase was partially offset by a decrease in comparable store
occupancy expenses of approximately $31,000 and an approximate $167,000 decrease
due to the closing of the Columbus store. As a percentage of net sales,  overall
occupancy  expenses  decreased  to 11.7% for the fiscal year  December 28, 1996,
from 13.2% for the corresponding  period last year. Occupancy expenses decreased
as a  percentage  of sales due to  several  factors,  including  more  favorable
negotiations on recent leases,  the  elimination of the Columbus  location which
had high occupancy costs as a percentage of sales, and other factors.

Selling, general and administrative expenses increased approximately $368,000 or
26.3%,  for  the  fiscal  year  ended  December  28,  1996,  compared  with  the
corresponding   period  last  year.   The  increase  in  selling,   general  and
administrative   expenses  was  primarily  due  to  approximately   $169,000  of
additional  expenses  related to salaries and related  expenses  for  additional
central  office  personnel to support the  continuing  growth of the Company and
approximately  $41,000 related to an investor public relations program which was
implemented in the second quarter of 1996. The Company anticipates that selling,
general and  administrative  expenses will increase  further in conjunction with
the Company's expansion strategy. As a percentage of net sales, selling, general
and administrative expenses decreased to 9.3% for the fiscal year ended December
28, 1996,  from 10.9% for the  corresponding  period last year.  This percentage
change  resulted  from the  relatively  fixed  nature of  selling,  general  and
administrative  expenses  and  the  increase  in net  sales  experienced  by the
Company. 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  $148,000,  or
59.9%,  for  the  fiscal  year  ended  December  28,  1996,  compared  with  the
corresponding  period last year.  Such increases were primarily the result of an
increase  in the asset base due to the  opening  of new  stores and  significant
additions to the Company's management information system, partially offset by an
approximate  $41,000  decrease  due to the closing of the Columbus  store.  As a
percentage of net sales, depreciation and amortization expense increased to 2.1%
for the fiscal year ended  December  28, 1996,  from 1.9% for the  corresponding
period last year.

Pretax income  increased  172% to  approximately  $1,052,000 in fiscal 1996 from
approximately  $387,000 in fiscal 1995. The Company's  effective tax rate was 0%
and 26.6% for the fiscal  years ended  December  30, 1995 and December 28, 1996,
respectively.  The  Company  recorded  no income  tax  expense  in fiscal  1995,
primarily as a result of the utilization of net operating loss carryforwards and
a revision in the valuation  allowance for deferred tax assets.  In fiscal 1996,
the low effective  income tax rate was primarily due to the  elimination  of the
remaining  valuation  allowance for deferred tax assets. The Company anticipates
its effective income tax rate will increase to approximate  statutory income tax
rates in future years.


                                       12
<PAGE>


As a result of the foregoing,  the Company  recorded net income of approximately
$772,000 for the fiscal year ended  December 28, 1996,  compared with net income
of  approximately  $387,000  for  the  corresponding  period  last  year.  As  a
percentage of net sales, net income increased to 4.1% for fiscal 1996, from 3.0%
for fiscal 1995.

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,  an acquisition  and capital
expenditures.

For the  fiscal  year  ended  December  28,  1996,  net cash  used in  operating
activities  was  approximately  $946,000  compared  with  net cash  provided  by
operating activities of approximately $347,000 for the corresponding period last
year. The increase in net cash used in operating  activities  primarily  results
from an increase in cash used for the purchase of  merchandise  inventories  for
new stores opened in the period.

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 were  approximately  $5,580,000.  Net  proceeds,  after
repayment  of  promissory  notes to  management,  are used to fund the  costs of
opening new stores and to provide working capital.

In addition, in May 1996 the Company entered into a $3,000,000 revolving line of
credit with Bank One,  Texas which was  subsequently  increased to $8 million in
March,  1997.  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 December
28, 1996, there was no amount outstanding on the revolving line of credit.

As of December 28, 1996, the Company's  capital lease  obligations  consisted of
approximately  $426,000 payable under capital lease  obligations  related to the
management   information   systems,   fixtures  and  equipment.   Of  such  debt
obligations,  approximately  $129,000 under the fixtures and equipment financing
arrangements are payable during 1997.

The Company opened eleven new stores in 1996 and acquired one existing store.

The Company intends to finance anticipated capital expenditures, working capital
needs and debt obligations for the foreseeable future from net proceeds from the
warrant  exercise,  cash  from  the  Company's  operating  activities,  landlord
allowances,  the  available  increased  line of credit,  possible  fixtures  and
equipment or inventory financing and trade credit.

ITEM 7.  Financial Statements

The  Company's  Consolidated  Balance  Sheet  as of  December  28,  1996 and the
Consolidated  Statements of Operations,  Stockholders' Equity and Cash Flows for
the years ended December 30, 1995 and December 28, 1996, 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


                                       13
<PAGE>


                                    PART III

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

The following  table sets forth certain  information  concerning  the directors,
executive officers and other key employees of the Company:

         Name            Age                     Position
         ----            ---                     --------

James H. Levi            57       Director, Chairman of the Board, President
                                    and Chief Executive Officer
Michael D. Glazer        46       Vice President - Real Estate
Stanley R. Herndon       41       Vice President - Buying
James L. Llewellyn       37       Vice President - Sales
Cheryl A. Taylor         28       Vice President - Finance and Administration
                                    (principal financial and accounting officer)
Joel S. Pollack          57       Director
John J. Schultz          60       Director
Charles M. Tureen        66       Director
Robert M. Warner         76       Director

Each of the executive officers,  other than Mr. Levi, is a full time employee of
the Company.  In accordance  with his employment  agreement,  Mr. Levi agreed to
devote such time to the business and affairs of the Company as is reasonable and
necessary.  It is Mr.  Levi's  intention to devote at least 50% of the customary
work week to the Company's business for the foreseeable future. The non-employee
directors  of the Company  devote such time and  attention to the affairs of the
Company as is reasonable and necessary.  Set forth below are descriptions of the
backgrounds of the executive officers and directors of the Company.

James H. Levi has been the  Chairman of the Board of  Directors,  President  and
Chief Executive  Officer and a Director of the Company since its organization in
1985.  Since 1992,  Mr. Levi has also been  President  of Levi  Company,  a real
estate and venture  investing  company and is involved in a number of investment
and  other  activities.  In 1987,  he  co-founded  and,  until  1992,  served as
President of Value  Properties,  Inc., a real estate  investment  firm. For more
than  fifteen  years  prior  thereto,  Mr.  Levi was  President  of  Oppenheimer
Properties,  Inc.  and a number  of  related  entities  and was  Executive  Vice
President and a member of the Executive  Committee of  Oppenheimer & Co.,  Inc.,
investment  bankers.  He has been responsible for the creation of a large number
of  enterprises  among which was the adaptive  reuse of St. Louis Union Station,
the location of the original The Great Train Store. Mr. Levi developed The Great
Train Store concept and has been the  principal  owner of the Company and all of
its  predecessors  since  inception.  He is a graduate  of Harvard  College  and
received his M.B.A. degree from Harvard Business School.

Michael D. Glazer has served the Company as Vice  President - Real Estate  since
1990. Prior to Mr. Llewellyn  joining the Company in March 1994, Mr. Glazer also
had  responsibility  for store  operations.  In his  present  capacity  with the
Company, Mr. Glazer has senior  responsibility for site selection,  store design
and construction and lease administration. Mr. Glazer joined the Company in 1987
as Store Manager of the St. Louis store and was promoted to Regional  Manager in
1988 and to Vice  President  in 1990.  From  1984 to 1987,  Mr.  Glazer  was the
principal  owner and chief executive  officer of Record Caravan,  Inc., an owner
and  operator of a retail  music store.  He is a graduate of the  University  of
Oklahoma.


                                       14
<PAGE>


Stanley R. Herndon has served the Company  since 1987 and is currently  the Vice
President - Buying.  In this  capacity,  Mr.  Herndon  supervises the buying and
merchandising  functions of the Company.  Until the  promotion of Ms.  Taylor to
Vice President - Finance and Administration, Mr. Herndon served as the Company's
principal financial officer and also supervised the administrative and financial
reporting  functions of the Company.  Prior to joining the Company,  Mr. Herndon
served in various  positions as a certified public  accountant and audit manager
with Arthur  Andersen LLP, an  international  accounting  and auditing  firm, in
which positions he provided services to a number of companies,  including Pearle
Health  Services,  Inc.,  then the nation's  largest retail  optical chain.  Mr.
Herndon has an M.B.A.  degree from Southern  Methodist  University from which he
also received a Bachelor's degree in accounting.

James L.  Llewellyn  joined the  Company in March 1994 as its Vice  President  -
Sales.  From 1985 until  joining the  Company,  Mr.  Llewellyn  served as Senior
District Manager of Club International Menswear, a chain of retail men's stores.
Mr. Llewellyn graduated in June, 1982 from the University of New Brunswick,  New
Brunswick, Canada. Mr. Llewellyn supervises store sales operations, advertising,
promotion and merchandising.

Cheryl A. Taylor  currently  serves the Company as its Vice  President - Finance
and Administration. Ms. Taylor joined the Company in May 1994 as its Controller.
From 1989 until joining the Company,  Ms.  Taylor  served as a certified  public
accountant with Coopers & Lybrand LLP, an international  accounting and auditing
firm.  She  received  her  Bachelor's  of  Business   Administration  degree  in
accounting from Texas A & M University.

Joel S. Pollack has been a Director of the Company since August,  1994. For more
than the last five years,  Mr.  Pollack  has been a private  investor in Beverly
Hills,  California.  From 1977 to 1987,  he was  Executive  Vice  President  and
Co-Head of Retail Sales at  Oppenheimer & Co., Inc., and was employed in various
capacities at Hayden Stone and predecessor companies. Mr. Pollack graduated from
The Wharton School of the University of Pennsylvania in 1961.

John J.  Schultz has been a Director  of the Company  since  August,  1994.  Mr.
Schultz has more than thirty-five years of experience in the retail industry and
is  presently  a  consultant  specializing  in the  retail  area and serves as a
director of Big Smith Brands, Inc. and A.R.  Accessories,  Inc. Previously,  Mr.
Schultz served as Executive Vice President and General  Merchandise  Manager for
Bloomingdale's  Department Stores and Sanger Harris Department Stores, President
and Chief  Executive  Officer of B. Altman & Co.,  and  President  of the Retail
Services Division and Executive Director of the National Retail Federation.  Mr.
Schultz is a graduate of Fairleigh Dickenson  University in Madison, New Jersey,
Dartmouth Institute and the Federated Senior Management Institute.

Charles M. Tureen has been a Director  of the Company  since  April,  1994.  Mr.
Tureen was a member in the St.  Louis,  Missouri  law firm of Gallop,  Johnson &
Neuman, L.C., from July, 1990 until December, 1996, when he became of counsel to
the firm.  Until June,  1990 and for a number of years prior  thereto,  he was a
principal in the St. Louis,  Missouri law firm of Blumenfeld,  Sandweiss,  Marx,
Tureen, Ponfil, and Kaskowitz P.C.


                                       15
<PAGE>


Robert M. Warner has been a Director of the Company since August, 1994. For more
than seven years, Mr. Warner has been a retail store management consultant whose
present  clients  include  many  retailers,  large and small.  He is presently a
director of Cherry & Webb, a 50 store women's specialty chain.  Previously,  Mr.
Warner served as President  and Chief  Executive  Officer of Steinbach,  Inc., a
$200 million  department store chain;  President and Chief Executive  Officer of
K-G Retail,  Inc., a $100 million men's clothing chain; Senior Vice President of
Macy's, Inc., where, among other positions,  he served as the General Manager of
Macy's-Herald  Square store, the largest store in the world. Mr. Warner has also
worked for a number of other retail companies as either chief executive officer,
director or  consultant.  Mr. Warner is a graduate of the University of Michigan
and received an M.B.A. from the Harvard Business School.

The Board of Directors  of the Company  consists of five  members,  each of whom
serve in such  capacity for a three-year  term or until his  successor  has been
elected and qualified,  subject to earlier  resignation,  removal or death.  The
number of  directors  comprising  the Board of  Directors  may be  increased  or
decreased by  resolution  adopted by the  affirmative  vote of a majority of the
Board  of  Directors.   The  Company's   Certificate   of   Incorporation   (the
"Certificate")  and Bylaws  provide for three classes of  directorships  serving
staggered  three-year terms such that  approximately  one-third of the directors
are elected at each annual meeting of stockholders. The term of Mr. Levi and Mr.
Warner will continue until the 1997 annual meeting,  the term of Mr. Tureen will
continue until the 1998 annual meeting and the term of office of Mr. Pollack and
Mr. Schultz will continue until the 1999 annual meeting.  The Company's officers
serve  at the  discretion  of the  Board  of  Directors,  subject  to  effective
contractual arrangements.

The  Board of  Directors  of the  Company  has  established  an Audit  Committee
(presently  consisting  of Mr.  Pollack,  Mr.  Warner  and  Mr.  Schultz)  to be
comprised of at least two non-employee directors which has the responsibility of
reviewing  the  scope  of the  audit  and  services  provided  by the  Company's
independent auditors.  The Audit Committee meets with the financial staff of the
Company to review  accounting  procedures  and policies.  The Board of Directors
also has  established  a  Compensation  Committee  (presently  consisting of Mr.
Tureen,  Mr.  Pollack  and Mr.  Warner)  also to be  comprised  of at least  two
non-employee  directors which has been given the  responsibility  of setting and
administering the policies which govern the annual compensation of the Company's
directors and  executive  officers,  as well as the  Company's  stock option and
other benefit  plans.  The Board of Directors has also  established an Executive
Committee  (presently  consisting of Mr. Levi and Mr.  Tureen) with the power to
act,  if  necessary,  on a broad  range of matters  during the  interim  periods
between Board of Directors meetings.

Compliance with Section 16 (a) of the Exchange Act

Based solely upon a review of Forms 3 and 4 and amendments  thereto furnished to
the  Company  during  its most  recent  fiscal  year  and Form 5 and  amendments
thereto, or written representations that no Form 5 is required, furnished to the
Company,  the  Company  believes  that,  other  than as set  forth  in the  next
sentence,  each person  required to file reports under Section 16(a) relative to
the Company's  equity  securities has done so on a timely basis. In August 1996,
Ms. Taylor and Messrs.  Levi,  Glazer,  Herndon,  Llewellyn,  Pollack,  Schultz,
Tureen, and Warner each filed a Form 5 with respect to the Company's fiscal year
ended December 30, 1995 reporting a single grant of options awarded in an exempt
transaction under Rule 16b-3.


                                       16
<PAGE>


ITEM 10. Executive Compensation

The  following  table  summarizes   information  concerning  cash  and  non-cash
compensation paid to or accrued for the benefit of the Company's Chief Executive
Officer for all services  rendered in all  capacities  to the Company.  No other
officer of the Company earned  compensation  of more than $100,000 during any of
the three fiscal years ended December 28, 1996.
<TABLE>

                                          Summary Compensation Table
<CAPTION>

                                                                      Annual Compensation
Name and Principal Position                          Year          Salary                Bonus         Other
---------------------------                          ----          ------                -----         -----
<S>                                                  <C>        <C>                      <C>           <C>
James H. Levi                                        1996       $  135,000               $             $  -
   Chairman of the Board, President                  1995          125,000                 -              -
   and Chief Executive Officer                       1994           61,561(a)              -              -


<FN>

 (a) Includes  amounts paid under a consulting  arrangement with The Great Train
     Store Partners, L.P.
</FN>
</TABLE>

<TABLE>

                                         Option / SAR Grants in Last Fiscal Year
                                                    Individual Grants
<CAPTION>

                                                     Number of         % of Total
                                                    Securities        Options/SARs
                                                    Underlying         Granted to         Exercise or
                                                   Options/SARs       Employees in        Base Price        Expiration
Name and Principal Position                         Granted (#)        Fiscal Year          ($/sh)             Date
---------------------------                         -----------        -----------          ------             ----

<S>                                                    <C>                <C>               <C>               <C>   
James H. Levi                                          10,000 (a)         4.6%              $ 6.19            3/2001
   Chairman of the Board, President                    15,000 (a)         6.9%              $ 6.19            7/2001
   and Chief Executive Officer

<FN>

(a) 25% become  exercisable  annually  commencing with the second anniversary of
    the grant date
</FN>
</TABLE>


                                       17
<PAGE>

<TABLE>

                              Aggregated Option/SAR Exercises in Last Fiscal Year and
                                             FY-End Options/SAR Values


<CAPTION>
                                                                                       Value of
                                                       Number Of Unexercised         Unexercised
                        Shares                              Securities              In-The-Money
                       Acquired                       Underlying Options/SARs      Options/SARs At
                          On            Value              At FY-End (#)             FY-End ($)
                       Exercise       Realized             Exercisable/             Exercisable/
Name                     (#)            ($)                Unexercisable            Unexercisable
----                     ---            ---                -------------            -------------
                                                                    
<S>                       <C>             <C>               <C>                    <C>     
James H. Lev              -               -                 4,250/42,750           $23,375/$139,425
</TABLE>


Director Compensation

The Company pays each non-employee director of the Company $750 in cash for each
Board meeting and reimburses all directors for  out-of-pocket  expenses incurred
in  connection  with their  attendance  at Board  meetings.  The Company has the
option  to pay  these  directors  in that  number  of  shares  of  Common  Stock
determined  by  reference  to the fair market  value of the Common  Stock on the
meeting date.  However,  all payments during 1995 and 1996 were made in cash. In
addition, pursuant to its 1994 Director's Stock Option Plan, the Company granted
to each non-employee director, on the date of his initial selection,  options to
purchase  5,000  shares of Common  Stock at an exercise  price equal to the fair
market value of the Common Stock on the date of the selection. Such options will
become first exercisable on the first anniversary of the recipient's election as
a director.

During  1995,  the 1994  Director's  Stock  Option  Plan was amended to award an
additional 2,500 options to each  non-employee  Director and establish an annual
award of 2,500  options  on the date of each  subsequent  annual  meeting of the
stockholders  of the Company at which each  remains a director  of the  Company.
Such  options  will be at a price equal to the fair  market  value of the Common
Stock on the date of award.

Employment Arrangements with Executive Officers

The Company entered into an employment  agreement  effective April 12, 1994 with
James H. Levi. Under this agreement, which expires August 12, 1999, Mr. Levi has
agreed to  continue  to serve as  Chairman  of the  Board,  President  and Chief
Executive  Officer of the Company in exchange  for annual base  compensation  of
$135,000,  subject to annual  adjustment  by the  Compensation  Committee of the
Board of  Directors.  Prior  to this  arrangement,  Mr.  Levi  was  entitled  to
compensation  of $25,000 per annum pursuant to his consulting  arrangement.  Mr.
Levi has agreed to devote such time to the  business  and affairs of the Company
as is reasonable  and necessary.  It is Mr. Levi's  intention to devote at least
50% of the  customary  work week to the Company's  business for the  foreseeable
future.  In  addition,  Mr. Levi is entitled to receive an annual  bonus in such
amount as the Compensation  Committee may determine in its sole discretion to be
appropriate. To date, Mr. Levi has not requested nor received any such bonuses.

In the event Mr. Levi's  employment  with the Company is terminated  for reasons
other  than  for  cause,  permanent  disability  or  death  or  there  occurs  a
significant reduction in the position, duties or responsibilities of Mr. Levi (a
"Termination")  within two years  following a "Change of Control" (as defined in
the agreement),  Mr. Levi will be entitled to an additional bonus of 175% of the
Base Compensation payable in the fiscal year in which such termination occurs.

Mr. Levi has also agreed to refrain from disclosing information  confidential to
the Company or engaging  directly or indirectly,  in the sale or distribution of
merchandise  competitive  with that sold by the  Company  during the term of his
employment  agreement  and for two years  thereafter  without the prior  written
consent of the Company.


                                       18
<PAGE>


ITEM 11. Security Ownership of Certain Beneficial Owners and Management

The  following  table  sets  forth  certain  information  with  respect  to  the
beneficial  ownership of the Company's Common Stock as of February 28, 1997 with
respect to each person known to the Company to be the  beneficial  owner of more
than five percent of the Company's  outstanding  Common Stock, by each director,
by each executive officer named in the Summary  Compensation Table above, and by
all directors and officers of the Company as a group. Each person named has sole
voting and  investment  power with  respect to the shares  indicated,  except as
otherwise stated in the notes to the table.
<TABLE>
<CAPTION>

                                                                                   Beneficial Ownership
                                                                             Number of
                                                                              Shares                    Percent
                                                                              ------                    -------

<S>                                                                         <C>                          <C>  
  James H. Levi (a).....................................                    1,176,011                    26.3%
        The Great Train Store Company
        85 Larchmont Avenue
        Larchmont, New York 10538

  Joel S. Pollack (b)...................................                       87,838                     2.0%
        1150 Benedict Canyon Drive
        Beverly Hills, California 90210

  John J. Schultz (c)...................................                       11,500                       *
        P.O. Box 1106 - Horseshoe Farm
        Ridgefield, Connecticut 06877

  Edmund H. Shea, Jr. (d)...............................                      238,000                     5.4%
        655 Brea Canyon Road
        Walnut, California 91789

  Charles M. Tureen (e).................................                       37,012                       *
        101 South Hanley Road, Suite 1600
        St. Louis, Missouri 63105

  Robert M. Warner (f)..................................                       2,500                        *
        1015 Nautilus Lane
        Mamaroneck, New York 10543

  All directors and officers as a group (9 persons)....                    1,476,586                     32.8%

<FN>

  *  Less than 1%


(a) Includes 10,000 shares of common stock owned by Mr. Levi's spouse.  Mr. Levi
disclaims  beneficial  ownership of these shares. Also includes 75,000 shares of
Common Stock  issuable  upon the  exercise of the warrants  received by Mr. Levi
pursuant to the private placement of debt in 1994, which are beneficially  owned
by Mr . Levi.  Includes  4,250 shares of common stock issuable upon the exercise
of certain  employee  stock options which first became  exercisable in May 1996.
Excludes  42,750  shares of Common Stock  issuable  upon the exercise of certain
employee stock options, some of which first became exercisable in May 1997.


                                       19
<PAGE>


(b) Includes  80,338 shares held of record by The Pollack Family Trust dated May
13, 1986,  of which Mr.  Pollack and his spouse are  co-trustees.  Also includes
7,500  shares of Common  Stock  issuable  upon the  exercise of certain  options
granted to Mr. Pollack.  Excludes 2,500 shares of common stock issuable upon the
exercise of certain  director  stock options which first become  exercisable  in
July 1997.

(c) Includes  7,500 shares of Common Stock issuable upon the exercise of certain
options granted to Mr.  Schultz.  Excludes 2,500 shares of common stock issuable
upon  the  exercise  of  certain  director  stock  options  which  first  become
exercisable in July 1997.

(d) Includes  50,000  shares of common stock  issuable  upon the exercise of the
warrants received by Mr. Shea pursuant to the private placement of debt in 1994,
which are beneficially owned by Mr. Shea. All other shares are held of record by
E & M RP Trust, of which Mr. Shea is trustee.

(e)  Includes  29,512  shares owned by "The Mary W. Tureen  Revocable  Trust" of
which Mary W.  Tureen  (spouse of Mr.  Tureen) and Mr.  Tureen are  co-trustees.
Includes  7,500  shares of Common  Stock  issuable  upon the exercise of certain
options  granted to Mr.  Tureen.  Excludes 2,500 shares of common stock issuable
upon  the  exercise  of  certain  director  stock  options  which  first  become
exercisable in July 1997.

(f) Includes  2,500 shares of Common Stock issuable upon the exercise of certain
options  granted to Mr.  Warner.  Excludes 2,500 shares of common stock issuable
upon  the  exercise  of  certain  director  stock  options  which  first  become
exercisable in July 1997.


</FN>
</TABLE>

ITEM 12.   Certain Relationships and Related Transactions

From time to time,  the  Company has  engaged in various  transactions  with its
directors,  executive  officers  and other  affiliated  parties.  The  following
paragraphs  summarize certain  information  concerning certain  transactions and
relationships  which  have  occurred  during  the  last two  years or which  are
presently proposed.

From time to time,  Messrs.  Levi,  Herndon and Glazer have loaned  money to the
Company by advancing cash and/or  deferring  salary.  Until April 12, 1994, such
indebtedness  accrued  interest at a rate of 15% per annum and was payable  upon
demand.  Effective April 12, 1994,  Messrs.  Levi,  Herndon and Glazer agreed to
restructure the indebtedness owed to them by the Company.  The indebtedness,  as
restructured,  provided for the payment of principle and interest,  at a rate of
8% per annum, in quarterly  installments.  Such indebtedness was paid in full by
the Company.

The terms and conditions of the foregoing transactions were not negotiated on an
arm's-length  basis.  All  future  transactions  between  the  Company  and  its
officers,  directors,  principal  stockholders and affiliates are required to be
approved by a majority of the independent and  disinterested  outside  directors
and must be on terms no less  favorable  to the  Company  than could be obtained
from unaffiliated third parties under similar circumstances.

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

      (a)      Exhibits.
                 See Exhibit Index beginning on page F-14 of this Report.

      (b)      Reports on Form 8-K.

                 None

                                       20
<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  December  28,  1996,  and the  related
consolidated statements of operations,  stockholders' equity, and cash flows for
the years ended  December 30, 1995 and December  28,  1996.  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 December 28, 1996, and the results of their
operations  and their  cash  flows for the years  ended  December  30,  1995 and
December 28, 1996, in conformity with generally accepted accounting principles.





                                           /s/ KPMG Peat Marwick LLP


Dallas, Texas
February 4, 1997, except as to note 3
which is as of March 19, 1997



                                      F-1

<PAGE>
                     THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES
                               CONSOLIDATED BALANCE SHEET

                                         ASSETS
                                                                 December 28,
                                                                     1996
                                                               -----------------
CURRENT ASSETS:                                         
      Cash and cash equivalents                                 $    4,864,539
      Merchandise inventories                                        6,123,352
      Accounts receivable and other current assets                   1,123,634
                                                               -----------------
               Total current assets                                 12,111,525

PROPERTY AND EQUIPMENT:
      Store construction and leasehold improvements                  3,374,593
      Furniture, fixtures, and equipment                             1,679,349
                                                               -----------------
                                                                     5,053,942
      Less accumulated depreciation and amortization                (1,381,674)
                                                               -----------------
               Property and equipment, net                           3,672,268


DEFERRED TAXES                                                         194,727
OTHER ASSETS, net                                                      208,254
                                                               -----------------
               Total assets                                     $   16,186,774
                                                               =================

                          LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
      Accounts payable  and accrued liabilities                 $    3,579,354
      Sales taxes payable                                              404,634
      Income taxes payable                                             301,601
      Current portion of capital lease obligations                     128,848
                                                               -----------------
               Total current liabilities                             4,414,437

CAPITAL LEASE OBLIGATIONS, net of current portion                      297,536
OTHER LIABILITIES                                                      106,001
                                                               -----------------
               Total liabilities                                     4,817,974
                                                               -----------------
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; 4,384,119 shares issued and 
           outstanding                                                  43,841
      Paid-in capital                                               10,198,175
      Unearned compensation - restricted stock                          (4,125)
      Retained earnings                                              1,130,909
                                                               -----------------
               Total stockholders' equity                           11,368,800
                                                               -----------------

               Total liabilities and stockholders' equity       $   16,186,774
                                                               =================

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


                                      F-2
<PAGE>
<TABLE>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<CAPTION>

                                                        For the Fiscal Year Ended
                                                December 30, 1995     December 28, 1996
                                               -----------------------------------------

<S>                                                 <C>                    <C>         
 NET SALES                                          $ 12,815,883           $ 18,998,461

 COST OF SALES                                         6,659,753              9,847,463
                                               ------------------     ------------------

             Gross profit                              6,156,130              9,150,998
                                               ------------------     ------------------

 OPERATING EXPENSES:
       Store operating expenses                        2,431,166              3,681,528
       Occupancy expenses                              1,696,980              2,223,853
       Selling, general and administrative
         expenses                                      1,400,359              1,768,713
       Depreciation and amortization                     247,699                396,136
       Provision for store closing                        (3,562)                     -
                                               ------------------     ------------------

             Total operating expenses                  5,772,642              8,070,230
                                               ------------------     ------------------

 OPERATING INCOME                                        383,488              1,080,768
                                               ------------------     ------------------

 OTHER INCOME (EXPENSE):
       Interest expense                                 (124,235)              (129,500)
       Interest income                                   108,544                 84,960
       Other income                                       18,753                 15,301
                                               ------------------     ------------------

             Total other income
                  (expense), net                           3,062               (29,239)
                                               ------------------     ------------------

 INCOME BEFORE INCOME TAXES                              386,550              1,051,529

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

 NET INCOME                                         $    386,550           $    772,228
                                               ==================     ==================

 NET INCOME PER SHARE                               $       0.12           $       0.20
                                               ==================     ==================

 WEIGHTED AVERAGE SHARES
         OUTSTANDING                                   3,145,000              3,883,796
                                               ==================     ==================
</TABLE>


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 STOCKHOLDERS' EQUITY
<CAPTION>
                                                                                    Unearned       Retained 
                                                                                  Compensation     Earnings
                                                                                   -Restricted   (Accumulated 
                                          Shares        Amount        Capital        Stock         Deficit)       Total
                                       ------------  ------------  -------------  ------------  ------------  -------------

<S>                                      <C>           <C>          <C>           <C>            <C>           <C>        
 BALANCE, December 31, 1994              3,145,000     $  31,450    $ 4,446,947   $  (22,664)    $ (27,869)    $ 4,427,864

 Net income                                      -             -              -             -       386,550        386,550
 Amortization of unearned compensation
       -restricted stock                         -             -              -        16,999             -         16,999
                                       ------------  ------------  -------------  ------------  ------------  -------------

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

</TABLE>

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


                                      F-4
<PAGE>
<TABLE>
                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS

<CAPTION>
                                                                      For the Fiscal Year Ended
                                                                December 30, 1995      December 28, 1996
                                                               ------------------------------------------
<S>                                                                   <C>                   <C>   
CASH FLOWS FROM OPERATING ACTIVITIES:

      Net Income                                                      $ 386,550             $  772,228
      Adjustments to reconcile net income to net cash provided
         by (used in) operating activities:
             Depreciation and amortization                              247,699                396,136
             Deferred income taxes                                      (44,534)              (150,193)
             Provision for store closing                                 (8,351)                     -
             Amortization of unearned compensation - restricted
               stock                                                     16,999                  7,040
             Loss on retirement of property and equipment                20,274                      -
             Changes in assets and liabilities:
                  Merchandise inventories                              (885,235)            (3,240,392)
                  Accounts receivable and other current assets         (127,318)              (900,995)
                  Other assets                                          (29,806)              (122,491)
                  Accounts payable and accrued liabilities              672,236              1,868,066
                  Sales taxes payable                                    54,415                167,841
                  Income taxes payable                                   44,534                257,067
                                                                    ------------           ------------      
                  Net cash provided by (used in) operating
                    activities                                          347,463               (945,693)
                                                                    ------------           ------------     

CASH FLOWS FROM INVESTING ACTIVITIES:

      Proceeds from sale of property and equipment                        7,000                      -
      Proceeds from sale of marketable securities                     1,948,860                      -
      Purchases of property and equipment                              (707,528)            (2,275,065)
                                                                    ------------           -------------    

                  Net cash provided by (used in) investing
                  activities                                          1,248,332             (2,275,065)
                                                                    ------------           -------------    

CASH FLOWS FROM FINANCING ACTIVITIES:

      Net proceeds from stock options exercised                               -                 36,352
      Tax benefit of stock option exercises                                   -                141,780
      Net proceeds from warrant exercise                                      -              5,579,987
      Proceeds from notes payable                                        25,000                144,269
      Repayment of notes payable and capital leases                    (367,050)            (1,054,789)
                                                                    ------------           -------------    

                  Net cash provided by (used in) financing
                  activities                                           (342,050)             4,847,599
                                                                    ------------           -------------    

NET INCREASE IN CASH AND CASH EQUIVALENTS                             1,253,745              1,626,841

CASH AND CASH EQUIVALENTS, beginning of year                          1,983,953              3,237,698
                                                                    ------------           -------------     

CASH AND CASH EQUIVALENTS, end of year                               $3,237,698             $4,864,539
                                                                    ============           =============    

SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:

      Assets financed through capital lease obligations              $  302,179             $  155,000
      Interest paid                                                  $   93,885             $  187,444
      Income taxes paid                                              $        -             $   41,644

</TABLE>

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 December 28, 1996, the Company operated thirty stores
in twenty-one 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. 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.  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.

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.

Effective  December  31,  1995,  the  Company  adopted  Statement  of  Financial
Accounting  Standards  No. 121,  "Accounting  for the  Impairment  of Long-Lived
Assets and for  Long-Lived  Assets to be Disposed Of." This  statement  requires
that long-lived assets and certain identifiable  intangibles to be held and used
by  an  entity  be  reviewed  for  impairment  whenever  events  or  changes  in
circumstances  indicate  that  the  carrying  amount  of an  asset  may  not  be
recoverable.  The adoption of this  statement had no effect on the  consolidated
financial statements.


                                      F-6
<PAGE>


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)


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 $53,000 and $50,000,  respectively during the
years ended December 30, 1995 and December 28, 1996.

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

Earnings per share is computed by dividing  net income by the  weighted  average
number of common  shares and  dilutive  common  share  equivalents  outstanding.
Common share  equivalents  were computed using the treasury stock method in 1996
and the  modified  treasury  stock method in 1995.  Under the modified  treasury
stock  method,  all options and warrants are assumed to have been  exercised and
the  aggregate  proceeds  are  applied  first  to  repurchase  up to  20% of the
Company's  outstanding  shares and second to reduce any borrowings and invest in
short term  securities.  Application  of the modified  treasury stock method was
antidilutive in 1995.

Stock Option Plan

The Company accounts for its stock option plan in accordance with the provisions
of Accounting Principles Board Opinion No. 25 ("APB 25"),  "Accounting for Stock
Issued to  Employees",  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.  On December 31, 1995, the Company adopted
Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation"  ("SFAS  123").  Under 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
provision of SFAS 123 and will continue to account for stock-based  compensation
under APB 25.


                                      F-7
<PAGE>


1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)

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. WARRANT EXERCISE

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  used  approximately  $709,000  of the  net  proceeds  to  repay  the 8%
promissory  notes to  management.  In addition,  the  remaining net proceeds are
being used to fund the costs of opening new stores and provide  working  capital
for operations.

3. REVOLVING LINE OF CREDIT

In May 1996, the Company entered into a $3,000,000 revolving line of credit with
Bank One, Texas which was subsequently  increased to $8,000,000 in March,  1997.
The line of credit has an initial contract period of two years and is secured by
certain assets of the Company, including inventory.  Outstanding borrowings bear
interest at Bank One's base lending rate plus 1.0% and a commitment  fee of 0.5%
is charged on the unused  portion.  The  revolving  credit  facility  provides a
source of  additional  liquidity  to manage  cash flow and  provide  capital for
expansion.  As of December  28,  1996,  there was no amount  outstanding  on the
revolving line of credit.

4. INCOME TAXES

Income tax expense consisted of the following:

                                       December 30, 1995     December 28, 1996
                                       -----------------     -----------------

 Federal income taxes - curre$t           $  44,534             $   389,494
 Federal income taxes - deferred            (44,534)               (150,193)
 State income taxes - current                     -                  40,000
                                           --------              ----------
                                          $       -             $   279,301
                                           ========              ==========


                                      F-8
<PAGE>


INCOME TAXES - (Continued)

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 30,
1995 and December 28, 1996, respectively, as a result of the following:

                                                      1995              1996
                                                      ----              ----

   Computed "expected" tax expense                 $ 131,427        $ 357,520

   State income tax, net of federal tax benefit            -           26,400
   
   Change in the beginning-of-the-year balance of
   the valuation allowance for deferred tax assets 
   allocated to income tax expense                   (44,534)        (107,507)

   Utilization of net operating loss carryforwards   (87,221)               -

   Other                                                 328            2,888
                                                   ---------          -------
                                                   $       -        $ 279,301
                                                   =========          =======

The tax effects of temporary  differences that give rise to significant portions
of the deferred tax assets and  liabilities  at December 28, 1996 are  presented
below:

    Deferred tax assets:
           Deferred rent                                         $ 179,433
           Other                                                    44,883
                                                                  --------

           Total deferred tax assets                               224,316
           Valuation allowance                                           -
                                                                  --------
       Deferred tax assets                                         224,316

       Deferred tax liabilities - property and equipment           (29,589)
                                                                  --------

       Net deferred tax assets                                   $ 194,727
                                                                  ========
The Company  did not record a valuation  allowance  for  deferred  tax assets 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 and a decrease of
$131,755 for the year ended December 30, 1995. 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 December
28, 1996.


                                      F-9
<PAGE>


5. 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 to store lease space,  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  $528,000  at  December  28,  1996,  representing  the  excess  of
straight-line rental expense over amounts paid.

Total  rental  expense    under  all  noncancelable   operating  leases  totaled
approximately  $1,132,000  and  $1,448,000 for the years ended December 30, 1995
and December 28, 1996,  respectively.  Included in these  amounts is  contingent
rent of  approximately  $240,000 and  $224,000 for the years ended  December 30,
1995 and December 28, 1996, 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%.  During 1996, the
Company  entered into capital leases in the amount of $155,000.  At December 28,
1996,  the gross  amount of  property  and  equipment  and  related  accumulated
amortization  recorded  under  capital  leases were  approximately  $716,000 and
$279,000 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
                                          ---------                 -------

           1997                           $1,931,868               $ 181,350
           1998                            1,882,713                 122,312
           1999                            1,795,490                 122,312
           2000                            1,698,768                 100,430
           2001                            1,654,398                  22,453
           Thereafter                      6,960,564                       -
                                           ---------               ---------  
              Total minimum payments     $15,923,801               $ 548,857
                                          ==========               
              Less interest                                          122,473
              Less current portion                                   128,848
                                                                   ---------
              Capital lease obligations,
                net of current portion                             $ 297,536
                                                                   =========

                                      F-10
<PAGE>


6. 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 December  28,  1996,  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 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 and the warrants expire in May 1999.

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  exerciseable  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:
<TABLE>
<CAPTION>

                                                               Incentive                        Director
                                                           Compensation Plan                 Stock Option Plan
                                                           -----------------                 -----------------

                                                                       Weighted                          Weighted
                                                                       Average                           Average
                                                       Options      Exercise Price      Options      Exercise Price    
                                                       -------      --------------      -------      --------------    

<S>                                                    <C>              <C>              <C>             <C>  
Outstanding at December 31, 1994                       120,900          $3.14            20,000          $3.38

Granted                                                 50,100          $5.65            10,000          $5.63

Forfeited                                              (16,300)         $3.89                 -              -
                                                       --------                          ------               
                                                                                                               
Outstanding at December 30, 1995                       154,700          $3.87            30,000          $4.13

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          $4.72
                                                       =======                           ======               
Exercisable at December 28, 1996                        19,000          $3.08            25,000          $4.35
                                                       =======                           ======
Reserved and available for grant at
December 28, 1996                                      105,000                           10,000
                                                       =======                           ======   

</TABLE>

At  December  28,  1996,  the  range of  exercise  prices  and  weighted-average
remaining  contractual  life of  outstanding  options  was $3.00 - $9.25 and 8.8
years for the  Incentive  Compensation  Plan and $3.00 - $5.63 and 3.4 years for
the Director Stock Option Plan, respectively.

                                      F-11
<PAGE>


6. STOCKHOLDERS' EQUITY - (Continued):

The per share weighted-average fair value of stock options granted during fiscal
1995 and fiscal 1996 was $3.57 in both years for the Incentive Compensation Plan
and $2.52 and $2.59 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:

<TABLE>
<CAPTION>

                                              Incentive Compensation Plan            Director Stock Option Plan
  
                                                1995               1996                1995               1996
                                                ----               ----                ----               ----
    <S>                                          <C>                <C>                 <C>                <C>
    Expected dividend yield                        -                  -                   -                  -
    Risk-free interest rate                      6.2%               6.4%                6.1%               6.9%
    Expected life in years                        10                 10                   5                  5
    Expected volatility                           40%                40%                 40%                40%
  
</TABLE>

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:

                                    1995                     1996
                                    ----                     ----
Net income:    As reported        $386,550                 $772,228
               Pro forma          $367,469                 $687,928      

Pro forma net income  reflects  only  options  granted in fiscal 1995 and fiscal
1996.  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-12
<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

3/24/97                                /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.

03/24/97                                /s/ James H. Levi
--------                                -------------------------------
Date                                    James H. Levi
                                        President, Chief Executive Officer and
                                        Chairman of the Board
                                        (Principal Executive Officer)

03/24/97                                 /s/ Cheryl A. Taylor
-------                                  -------------------------------
Date                                     Cheryl A. Taylor
                                         Vice President - 
                                         Finance and Administration,
                                         (Principal Financial and Accounting
                                         Officer)

03/24/97                                 /s/ Joel S. Pollack
--------                                 -------------------------------
Date                                     Joel S. Pollack
                                         Director

03/24/97                                 /s/ John J. Schultz
--------                                 -------------------------------
Date                                     John J. Schultz
                                         Director

03/24/97                                 /s/ Charles M. Tureen
--------                                 -------------------------------
Date                                     Charles M. Tureen
                                         Director

03/24/97                                 /s/ Robert M. Warner
--------                                 -------------------------------
Date                                     Robert M. Warner
                                         Director


                                      F-13
<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 1994 Incentive Compensation Plan....
10.2*   The Great Train Store Company 1994 Director Stock Option Plan.....
10.3*   Form of Restricted Stock Agreement with Stanley R. Herndon .......
10.4*   Form of Employment Agreement with James H. Levi...................
10.5*   The Great Train Store Partners, L.P. Agreement of Limited 
        Partnership dated as of...........................................
        September 1, 1990 as amended......................................
10.7*   First Amendment to The Great Train Store Company 1994 Incentive 
        Compensation Plan.................................................
10.8*   Second Amendment to The Great Train Store Company 1994 Incentive 
        Compensation Plan.................................................
10.9*   First Amendment to The Great Train Store Company 1994 Director
        Stock Option Plan.................................................
10.10   Third Amendment to The Great Train Store Company 1994 Incentive
        Compensation Plan.................................................
10.11   Loan and Security Agreement dated June 7, 1996 with Bank One,
        Texas NA..........................................................
10.12   First Amendment to Loan and Security Agreement with Bank One, 
        Texas NA..........................................................
11.1    Statement re: Computation of Per Share Earnings ..................
21.1*   Subsidiaries of the Registrant....................................
23.1    Independent Auditors' Consent.....................................


* Incorporated by reference to Registration  Statement on Form SB-2  (commission
  file no.33-79554) first filed on June 1, 1994

                                      F-14