SECURITIES AND EXCHANGE COMMISSION
                              Washington, DC 20549

                                    FORM 10-K

[ X ]    Annual  report  under  Section  13 or 15(d) of the  Securities Exchange
         Act of 1934 for the fiscal year ended January 2, 1999


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


                         Commission file number 1-13158

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

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

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

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


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

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

Indicate by check mark if disclosure of delinquent  filers  pursuant to Item 405
of  Regulation  S-B is not  contained in this form,  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.  [  ]

At March 19,  1999,  the  aggregate  market  value of the  voting  stock held by
non-affiliates   of  The  Great  Train  Store   Company  (the   "Company")   was
approximately  $3,865,140,  based on the  average  bid and  asked  prices of the
common stock reported by The Nasdaq  National Market on March 19, 1999. At March
19, 1999, the Company had outstanding 4,415,764 shares of Common Stock.

                       DOCUMENTS INCORPORATED BY REFERENCE

Portions of the  registrant's  Proxy  Statement  for the 1999 Annual  Meeting of
Stockholders  (to be filed pursuant to Regulation 14A within 120 days of the end
of the  registrant's  most recently  completed  fiscal year) are incorporated by
reference to Part III of this Form 10-K.


<PAGE>

                                TABLE OF CONTENTS

                                     PART I

                                                                         Page

ITEM 1.   Description of Business                                         3

ITEM 2.   Description of Property                                         7

ITEM 3.   Legal Proceedings                                               8

ITEM 4.   Submission of Matters to a Vote of Security Holders             8


                                     PART II


ITEM 5.   Market for Common Equity and Related Stockholder Matters        8

ITEM 6.   Selected Financial Data                                         9

ITEM 7.   Management's Discussion and Analysis of Financial 
            Condition and Results of Operations                           9
               

ITEM 8.   Financial Statements and Supplementary Data                    15

ITEM 9.   Changes In and Disagreements with Accountants on               15
             Accounting and Financial Disclosures


                                    PART III


ITEM 10.  Directors and Executive Officers of the Registrant             16

ITEM 11.  Executive Compensation                                         16

ITEM 12.  Security Ownership of Certain Beneficial Owners                16
            and Management                                               

ITEM 13.  Certain Relationships and Related Transactions                 16


                                     PART IV


ITEM 14.  Exhibits, Financial Statement Schedules, 
           and Reports on Form 8-K                                       16


<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  fifty-six
currently  operated The Great Train Stores typically offer  approximately  4,200
stock keeping units ("SKUs"), except The Train Depot, which offers approximately
9,700,  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.  Beginning  in 1987,  the  Company
expanded  slowly at first but  expansion  has become much more rapid in the last
few  years.  As of the end of 1998,  the  Company  operates  56 The Great  Train
Stores.  During 1996, the Company also acquired one additional store through the
purchase  of The Train  Depot in Winter  Park,  Florida.  In 1997 and 1998,  the
Company  also  tested one  possible  area for  expansion,  The Great Train Store
Express.  The Great Train Store Express stores are temporary holiday stores that
allow the Company to sell more merchandise during the most active selling period
of the year and to test new sites without  being  committed to the location on a
long-term basis. In 1997, the Company tested the concept by opening five Express
stores and followed up by testing six additional locations in 1998.

The Great Train Store Concept

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

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

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

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

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

         Toy Trains and Train-Themed Merchandise.  In 1998, approximately 39% 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  sizes, 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, K-Line, Life-Like,
         Model Power, Atlas, Kato,  Rivarossi,  Walthers,  Woodland Scenics, and
         Micro  Trains.  Net sales in 1998 from this product line  accounted for
         approximately 35% 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
         9% of the Company's annual net sales volume in 1998.

         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 such merchandise in
         1998 accounted for  approximately 11% of the Company's annual net sales
         volume.

         Apparel.  Each of The Great Train  Stores is stocked  with a variety of
         men's, women's and children's apparel and accessories,  including hats,
         T-shirts, sweatshirts, ties, jewelry, watches and belt buckles, the net
         sales of which represented approximately 6% of the Company's annual net
         sales volume in 1998.

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 40 licensed  vendors.  The
Company  believes it sells more Thomas the Tank Engine than any other company in
the world.  Thomas the Tank Engine is the feature  character in a very  popular,
children's  cartoon series that moved in the fall of 1998 from public television
to the new Fox  Family  Channel.  The  Company  has been  informed  by the Britt
Allcroft  Company that it has entered into an agreement to produce a full-length
movie featuring Thomas the Tank Engine which is expected to be released in early
2000.

The Company  believes 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 Stores' 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
information  system is used to track the  popularity  of new  products  prior to
chain-wide introduction.

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

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

Each store is staffed with a store  manager,  one or two assistant  managers and
such additional  sales  associates and support staff as are required to meet the
specific needs of the store.  The Company provides  financial  incentives to its
store  managers  through   incentive   compensation   programs  based  upon  the
performance of the individual store in which the employee performs services. The
Company  believes  that  its  incentive   compensation   programs  increase  the
motivation and overall  performance of its personnel,  and the Company's ability
to attract and retain qualified employees.

Expansion Strategy

Given the Company's recent past  performance,  management has determined that in
1999,  the Company's  expansion  strategy  will  temporarily  be curtailed.  The
Company has committed to open one new store in Providence  Place in  Providence,
Rhode  Island  in  mid-1999.  The  Company's  primary  focus  for  1999  will be
satisfactorily resolving all significant store operational issues.  Accordingly,
other than the opening of its new store in  Providence  Place,  the Company does
not  anticipate  any  additional  openings in 1999.  As of January 2, 1999,  the
Company  operated  fifty-six stores  primarily  located in distinctive  regional
shopping malls and festival marketplaces.

It is anticipated that the Company's expansion strategy will resume, possibly in
2000.  The Company does not  anticipate a significant  variance in the new store
opening  process that is detailed  below.  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.  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 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 Internet,  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.

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  promotion  of local  events
relating to railroading,  "how to" instructional sessions, and book readings for
children. Moreover, the Company considers media relations to be an integral part
of its image-building  program and strives to develop good working relationships
by inviting media members to store grand openings and maintaining  access to the
appropriate   Company  personnel.   The  Company   participates  in  cooperative
advertising  programs  with  certain  of its major  vendors.  The  Company  also
maintains direct mail contact with customers,  highlighting sales promotions, as
an important aspect of its marketing strategy. 

Suppliers

Most of the Company's  products are purchased directly from  manufacturers.  The
Company presently  purchases products from approximately 600 vendors.  No single
vendor supplied  products  representing more than 10% of the Company's net sales
in 1998 other than Learning Curve (which  represented  approximately  18.9%) and
Lionel Trains,  Inc. (which represented  approximately  10.6%). The largest five
vendors represented  approximately 45.1% 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,  United
Model Distributors,  Brio Scanditoy,  Walthers,  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 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.

Information Systems

During  1998,  the Company  made  significant  enhancements  to its  information
systems, including a major upgrade of the store point of sale and central office
systems.  In  addition  to  providing  continuous  knowledge  of  the  Company's
inventories,  these computerized  systems enable the Company's central office to
re-price  merchandise,  replenish  depleted  store  inventories,  identify sales
trends and monitor  merchandise  mix at  individual  stores and  throughout  the
Company's store network. These systems will help the buying staff reduce average
store inventories and thus achieve higher inventory turnover and better in stock
availability.  The systems also enable the Company to realize purchase discounts
and to produce the financial  reports  necessary for  monitoring  and developing
budgets for the Company's expanding business. The Company's point-of-sale system
keeps daily records of each SKU from receipt to sale.

The Company is presently  engaged in various programs to enhance its information
systems  in  order  to   accommodate   its  growth  and   further   improve  the
sophistication, timeliness, and accuracy of the information obtained.

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,  mail  order  merchandisers,  and  Internet
merchants.   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  and  Internet  industries  have  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,  the  Company's  slogan
"More trains than you ever  imagined" and the name "Train Depot" are  trademarks
and  service  marks  registered  in the United  States and  Canadian  Patent and
Trademark  offices.  In addition,  the name "The Great American Train Store" has
been  registered  in the Japanese and ECU Patent and  Trademark  offices and the
name "The Great Train Store" has been  registered in Japan and is pending in the
ECU.  Management believes that the name "The Great Train Store" is an important,
but not  critical,  element of the  Company's  marketing  strategy.  The Company
closely monitors the use of its intellectual  property and intends to vigorously
defend its rights with respect thereto.

Employees

As of January 2, 1999, the Company employed a total of 704 persons,  of whom 178
were  salaried  personnel  and  526  were  employed  on an  hourly  wage  basis.
Thirty-four  of  the  Company's   employees  were  assigned  to  central  office
responsibilities  and 670 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.

ITEM 2.  Description of Properties

The Company  leases all 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
                ----                                       ---------------
                1999                                              0
                2000                                              3
                2001                                              1
                2002                                              0
                2003                                              5
                2004 and thereafter                              48

The Company's  central  offices are  presently  located in  approximately  8,245
square feet of leased space in Dallas, Texas under a lease that 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, results of operations or liquidity.

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

No matter was submitted  during the fourth quarter of 1998 to a vote of security
holders.


                                     PART II

ITEM 5.  Market for Common Equity and Related Stockholder Matters

The Great Train Store  Company's  common stock is traded on The Nasdaq  National
Market  under  the  symbol  GTRN.  At  March  29,  1999  the  number  of  common
stockholders of record was 139. Based on discussions with the Company's transfer
agent and  investment  banker,  the Company  believes  that its common  stock is
beneficially  held by more than four hundred  persons.  The following table sets
forth,  for the  periods  indicated,  the range of high and low bid prices  with
respect to the Company's Common Stock as reported by The Nasdaq National Market.

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

                   Period                       High                  Low
                   ------                       ----                  ---
1997:
   First Quarter (beginning 12/29/96)           9-3/8                8-1/4
   Second Quarter                               8-7/8                6-3/4
   Third Quarter                                9-3/8                  7
   Fourth Quarter                               8-1/2                5-5/8

1998:
   First Quarter                               5-11/16               3-3/8
   Second Quarter                               4-1/4                2-1/2
   Third Quarter                               3-3/16                1-1/2
   Fourth Quarter                               1-3/4                 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 19, 1999, the last sale price for the Common Stock,  as reported by The
Nasdaq National Market, was 1-1/4.

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

<PAGE>

<TABLE>
<CAPTION>

ITEM 6.  Selected Financial Data

                                               1994           1995           1996           1997            1998
                                               ----           ----           ----           ----            ----
<S>                                       <C>             <C>           <C>             <C>            <C>
Results of Operations
   Net Sales                                 $8,992,686     $12,815,833    $18,998,461    $28,090,948     $33,932,790
   Income (loss) before income tax            (593,564)         386,550      1,051,529        641,940     (3,962,640)
   Net income (loss)                          (593,564)         386,550        772,228        410,613     (3,849,174)
   Basic income (loss) per share                  (.25)             .12            .21            .09           (.87)
   Diluted income (loss) per share                (.25)             .12            .20            .09           (.87)

Financial Position
   Total Assets                               6,985,422       8,049,918     16,060,678     19,795,559      19,634,726
   Long Term Debt and other Liabilities         999,600       1,243,111        980,443      1,085,338       4,721,501
   Working Capital                            4,467,900       4,305,887      8,273,994      6,919,897       5,396,660
   Stockholders' Equity                       4,427,864       4,831,413     11,368,800     12,030,445       8,257,277

Retail Stores
   Number of Stores at year-end                      14              18             30             42              56
   Total store sales growth                       40.6%           42.5%          48.3%          47.9%           20.8%
   Comparable store sales growth                   3.5%            4.3%           2.3%           0.0%          (7.3%)
   Store  selling  area at year-end              23,689          32,326         50,465         69,220          90,738
     (sq. ft.)

</TABLE>


ITEM 7. 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.

                                   Fiscal 1996      Fiscal 1997    Fiscal 1998
                                   -----------      -----------    -----------

Net Sales                             100.0%          100.0%           100.0%
Cost of Sales                          51.8            53.7             58.9
                                    -------          -------          -------
     Gross Profit                      48.2            46.3             41.1
Store operating expenses               16.3            16.9             19.0
Occupancy expenses                     11.7            13.2             15.5
Selling, general and                   12.4            12.1             11.7
  administrative expenses
Provision for store closing             0.0             0.0              0.7
Depreciation and amortization           2.1             2.7              3.1
                                     ------          ------           -------
     Operating income (loss)            5.7             1.4            (8.9)
Interest expense                      (0.7)           (0.7)            (2.9)
Interest income                         0.5             0.2              0.1
Other income                            0.1             1.4              0.1
                                     ------          ------           ------
     Income (loss) before income        5.6             2.3           (11.6)
       taxes
Income (tax) benefit                 ( 1.5)            (.8)             0.3
                                     ------          -------          ------
     Net income (loss)                 4.1%             1.5%          (11.3)%
                                     ======          =======          =======

<PAGE>


Comparison of Fiscal Year Ended January 3, 1998 to the Fiscal Year Ended January
2, 1999

Net sales  increased  approximately  $5,842,000,  or 20.8%,  for the fiscal year
ended January 2, 1999 compared  with the  corresponding  period last year due to
the opening of new  stores.  The  increase  was offset by a  $1,604,000  or 7.3%
decrease in  comparable  store  sales.  Since the 1997 fiscal year  contained 53
weeks,  the  comparable  store  calculation  is based on the  applicable 52 week
period.  Comparable  store sales are calculated  based on the stores open in all
periods for both fiscal years. The Company attributes sales results primarily to
significant  out-of-stock  positions  that  developed  during  1998  due to both
internal and  external  factors.  Various  other store  operational  issues also
contributed  to the poor sales  performance.  These issues are  currently  being
addressed by a detailed action plan.

Gross profit increased approximately $934,000 or 7.2%, for the fiscal year ended
January 2, 1999, compared with the corresponding  period last year. Gross profit
as a  percentage  of net sales  decreased  to 41.1% for the  fiscal  year  ended
January 2, 1999,  compared  with 46.3% for the  corresponding  period last year.
Gross  profit,  as a  percentage  of sales,  was  impacted  by several  factors,
primarily  significant shrink and reduced margins resulting from increased price
promotional  programs  which  were  developed  in an effort to  increase  sales.
External shrink related  contributors  included ineffective product distribution
to new stores by an external central distribution  facility which is believed to
have resulted in a significant  volume of lost  product.  Internal  factors were
primarily related to various store  operational  issues that are being addressed
by a new initiative of exception reporting.

Store operating  expenses increased  approximately  $1,691,000 or 35.6%, for the
fiscal year ended January 2, 1999,  compared with the corresponding  period last
year.  Approximately  $1,660,000 of the increase  resulted from the operation of
the  new  stores  and  the  remaining   approximate   increase  of  $31,000  was
attributable  to an  increase  in  comparable  store  operating  expenses.  As a
percentage of net sales,  store  operating  expenses  increased to 19.0% for the
fiscal year ended  January 2, 1999,  compared  with 16.9% for the  corresponding
period last year.  This  increase was  primarily  due to lower than  anticipated
sales.

Occupancy expenses increased approximately  $1,545,000, or 41.6%, for the fiscal
year ended January 2, 1999,  compared with the  corresponding  period last year.
Approximately  $1,440,000  of  the  increase  related  to  the  new  stores  and
comparable store occupancy expenses  increased  approximately  $105,000,  mostly
from increases in shared  expenses  charged by certain of the malls in which the
Company has stores.  The Company  believes the current  central  office space is
adequate  for the  foreseeable  future.  As a percentage  of net sales,  overall
occupancy  expenses increased to 15.5% for the fiscal year January 2, 1999, from
13.2% for the corresponding period last year.

Selling, general and administrative expenses increased approximately $605,000 or
17.8%,   for  the  fiscal  year  ended  January  2,  1999,   compared  with  the
corresponding  period last year. The increase was primarily related to increased
overhead  directly  related to the operation and  supervision  of more stores in
1998 than were open in 1997. As a percentage of net sales, selling,  general and
administrative  expenses decreased to 11.7% for the fiscal year ended January 2,
1999, from 12.1% for the corresponding period last year.

Depreciation and  amortization  expense  increased  approximately  $288,000,  or
38.0%,   for  the  fiscal  year  ended  January  2,  1999,   compared  with  the
corresponding  period last year.  Such increases were primarily the result of an
increase in the asset base related to new stores.  As a percentage of net sales,
depreciation  and  amortization  expense  increased  to 3.1% for the fiscal year
ended January 2, 1999,  from 2.7% for the  corresponding  period last year.  The
increase as a percentage of net sales was primarily related to the reduced sales
performance.

A provision for store  closing of  approximately  $241,000  during 1998 resulted
from the  non-recurring  charge  related  to the  expected  closing of two store
locations  which are expected to occur during 1999.  Store  closing  expense for
1998 was 0.7% of sales.

Other income decreased  approximately $342,000 for the fiscal year ended January
2, 1999  compared  with the  corresponding  period last year.  This decrease was
primarily  due to a $350,000  settlement  the Company  received in 1997 from the
City of Indianapolis  in connection with the closing of Union Station  requiring
the  Company  to close its store  during the term of the  lease.  

Pretax income  decreased to a loss of  approximately  $3,963,000  for the fiscal
year ended January 2, 1999. The Company  recorded a tax benefit of approximately
$113,000 related to the 1998 results.

As a result of the foregoing,  the Company  recorded a net loss of approximately
$3,849,000  for the fiscal year ended January 2, 1999,  compared with net income
of  approximately  $411,000  for  the  corresponding  period  last  year.  As  a
percentage  of net sales,  net loss was 11.3% for fiscal  1998,  compared to net
income of 1.5% for fiscal 1997.

Comparison  of Fiscal  Year Ended  December  26,  1996 to the Fiscal  Year Ended
January 3, 1998

Net sales  increased  approximately  $9,092,000,  or 47.9%,  for the fiscal year
ended January 3, 1998 compared with the corresponding 1996 period. Substantially
all of this increase  (approximately  $9,091,000) was  attributable to net sales
generated  by new stores  not  included  in the  comparable  store  calculation.
Approximately  $1,000 of the increase was  attributable  to a slight increase in
comparable store sales. The calculation of comparable store sales includes sales
for stores open in all periods for both fiscal years.  The sales  performance of
comparable  store  sales was  primarily  related  to a  combination  of  several
factors.  Most notably,  the Company's buying staff did not cope as ably as they
might have with the rapid growth of the Company and, on many occasions,  ordered
product later than they should have,  creating  periods in which key product was
out of  stock.  In  addition,  there  were  external  factors,  such as  certain
manufacturers   not  meeting  promised   quantity  or  delivery  dates  and  the
well-publicized UPS strike.  Another  contributing factor during 1997 related to
poor traffic in certain of the malls where the Company's stores are located.  In
several instances, the Company believes the disappointing traffic was related to
certain events including major store closings, a mall which closed, bad weather,
and a ship having hit a riverfront center where a store was located. While these
issues   adversely   impacted  the  overall   results,   many  stores  performed
significantly  above the 1996 level and all stores  continued to have a positive
store level contribution. As the Company's base of stores continues to grow, the
performance of any individual  store is expected to have a less material  effect
on the Company.

Gross profit  increased  approximately  $3,867,000 or 42.3%, for the fiscal year
ended  January  3,  1998,  compared  with the  corresponding  1996  period,  due
primarily to an increase in sales  volume.  Gross profit as a percentage  of net
sales  decreased  to 46.3% for the fiscal year ended  January 3, 1998,  compared
with 48.2% for the corresponding  1996 period. The decrease in gross profit as a
percentage of sales resulted from several  factors.  One of the principle  focus
areas  of the  new  buying  staff  was to  reallocate  certain  portions  of the
Company's  inventory  among its stores  which  resulted in  significant  freight
charges  related to the  transfer of product.  Gross  profit was also  adversely
impacted by a charge of approximately  $188,000 related to the management of the
Company's  inventory.  This charge was  discovered in  reconciling  the computer
generated accounts payable and detailed vendor statements.  In addition,  due to
disappointing  sales  results,  the Company made efforts to  counteract  this by
reducing certain selling prices which, in turn, adversely impacted gross profit.
In the past, the Company has not found it necessary to significantly promote its
product through price promotions.  As part of the improved vendor  arrangements,
the Company has been able to negotiate  significant  improvements  to the prices
and terms on which it is buying  merchandise  and will  continue  to review  its
pricing  strategy  going  forward.  The gross profit was also impacted by out of
stock issues in high margin departments and certain reduced cash discounts.

Store operating  expenses increased  approximately  $1,655,000 or 53.5%, for the
fiscal year ended January 3, 1998,  compared with the corresponding 1996 period.
Approximately  $1,674,000 of the increase resulted from the operation of the new
stores. This increase was partially offset by an approximate $19,000 decrease in
comparable  store  operating  expenses.  As a  percentage  of net  sales,  store
operating expenses increased to 16.9% for the fiscal year ended January 3, 1998,
compared with 16.3% for the  corresponding  period last year.  This increase was
primarily due to lower than anticipated sales,  pre-opening expenses incurred in
connection with more new stores and the opening of The Great Train Store Express
temporary holiday stores, and an increase in store personnel  compensation which
included changes in the federal minimum wage standards.

Occupancy expenses increased approximately  $1,489,000, or 67.0%, for the fiscal
year  ended  January 3,  1998,  compared  with the  corresponding  1996  period.
Approximately  $1,364,000  of  the  increase  related  to  the  new  stores  and
comparable store occupancy expenses increased approximately $40,000, mostly from
increases  in  shared  expenses  charged  by  certain  of the malls in which the
Company has stores.  In  addition,  approximately  $85,000 of the  increase  was
related to the  Company  leasing  additional  central  office  space in order to
support future growth and leasing additional space adjacent to an existing store
for the purpose of  redistributing a small portion of the Company's  merchandise
which could not economically or otherwise be shipped directly to the stores.  As
a percentage of net sales, overall occupancy expenses increased to 13.2% for the
fiscal  year  January 3, 1998,  from 11.7% for the  corresponding  1996  period,
primarily due to lower than planned sales.

Selling,  general and administrative expenses increased approximately $1,035,000
or  43.9%,  for the  fiscal  year  ended  January  3,  1998,  compared  with the
corresponding 1996 period.  The increase in selling,  general and administrative
expenses was primarily  due to  approximately  $474,000 of  additional  expenses
related to salaries and related expenses for additional central office personnel
to support the continuing growth of the Company.  A significant  portion of such
increase is related to the Company's  promotion of certain of its Store Managers
to Regional Sales Managers.  These  positions,  which did not exist in the prior
year,  are a new level of  management  created to supervise the operation of the
Company's rapidly growing number of existing stores and assist in the opening of
new stores as part of the Company's  increasing  expansion program. In addition,
the Company  expended more  significant  funds than in prior years in aggressive
marketing  programs  in  several  locations  in an effort to  enhance  sales.  A
considerable  portion of this included the existing  train hobby store  location
that the Company  acquired  in  November  1996.  As a  percentage  of net sales,
selling,  general and administrative  expenses decreased to 12.1% for the fiscal
year ended January 3, 1998, from 12.4% for the corresponding 1996 period.

Depreciation and  amortization  expense  increased  approximately  $362,000,  or
91.5%,   for  the  fiscal  year  ended  January  3,  1998,   compared  with  the
corresponding  1996  period.  Such  increases  were  primarily  the result of an
increase in the asset base related to new stores, the external  development of a
SQL server to facilitate  enhanced  operational  reporting in the central office
and additions to fixed assets related to the central office expansion  discussed
above.  As a percentage  of net sales,  depreciation  and  amortization  expense
increased to 2.7% for the fiscal year ended  January 3, 1998,  from 2.1% for the
corresponding  1996  period.  This  increase  as a  percentage  of net sales was
primarily related to the central office developments discussed above.

Other income increased  approximately $351,000 for the fiscal year ended January
3, 1998 compared with the corresponding 1996 period. This increase was primarily
due to a $350,000  settlement the Company received from the City of Indianapolis
in connection  with the closing of Union Station  requiring the Company to close
its store during the term of the lease.

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

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

Liquidity and Capital Resources

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

For the fiscal year ended January 2, 1999, net cash used in operating activities
was  approximately  $3,684,000  compared  with net cash  provided  by  operating
activities of approximately  $1,175,000 for the corresponding  period last year.
Net cash used in operating  activities primarily results from the funding of the
Company's operating losses in 1998 and an increase in cash used for the purchase
of merchandise inventories for new stores opened in the period.

As of January 2, 1999,  the Company had  approximately  $462,000  payable  under
capital  lease  obligations  related  to  the  management  information  systems,
fixtures and equipment.  Of such debt obligations,  approximately $184,000 under
the fixtures and equipment financing arrangements are payable during 1999.

In January  1998,  the  Company  entered  into a  revolving  line of credit with
BankAmerica  Business Credit,  Inc. The availability of the line, which is based
on the Company's  inventory,  is calculated at varying advance rates  throughout
the year. The Company had approximately  $4,252,000 of borrowing  capacity under
the line at January 2, 1999. The initial term of the facility is three years and
is secured by certain assets of the Company, primarily inventory. As of year-end
1998,  the  maximum  loan was  reduced to  $8,000,000  and  advance  ratios were
reduced.  Under the amended agreement,  outstanding  borrowings bear interest at
BankAmerica  Business  Credit,  Inc.'s  base  lending  rate  plus  1.75%  and  a
commitment fee of 0.375% is charged on the unused portion.  The revolving credit
facility  provides a source of  additional  liquidity to manage cash flow. As of
January 2, 1999, there was approximately  $408,000  outstanding on the revolving
line of credit.

The Company has received a commitment from Paragon Capital LLC to make available
to the Company a $10,000,000  revolving  credit  facility in  replacement of the
BankAmerica credit line. As proposed,  borrowings under the Paragon line will be
based on an advance rate  percentage  of the Company's  inventory,  which varies
throughout the year. The proposed initial term of the facility is five years and
is secured by certain assets of the Company,  primarily  inventory.  The Company
has accepted  Paragon's  proposal and is currently engaged in negotiation of the
definitive credit  agreements.  The Company expects to complete this transaction
before the end of April 1999.

In June 1998,  the Company sold  $3,000,000  aggregate  principal  amount of 12%
subordinated  debentures due 2003 and warrants to purchase 175,000 shares of the
Company's  common  stock  at an  exercise  price of $3.75  per  share to  Tandem
Capital.  Net proceeds to the Company,  from the sale of these securities,  were
approximately $2,757,000 and were used to support new store openings in 1998 and
for general working capital purposes. The subordinated debentures are secured by
certain assets,  primarily fixtures and equipment.  The Company has the right to
repay the subordinated debentures at any time without penalty. If not previously
repaid,  Tandem  will  receive  additional  warrants  at the end of  each  year,
exercisable at a price based on the fair market value of such shares on the date
of issuance.

As of January 2, 1999, the Company operated  fifty-six stores primarily  located
in distinctive regional shopping malls and festival marketplaces.  During fiscal
1998, the Company opened fourteen new stores.  The Company also operated six The
Great Train Store  Express,  temporary  stores in 1998. A 1999 store opening has
been announced for Providence, Rhode Island.

<PAGE>

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

Year 2000

General

The advent of the year 2000 poses  certain  technological  challenges  resulting
from a reliance in computer  technologies  on two digits rather than four digits
to represent the calendar year (e.g.,  "98" for "1998").  Computer  technologies
programmed  in this  manner,  if not  corrected,  could  produce  inaccurate  or
unpredictable  results or system failures in connection with the transition from
1999 to 2000, when dates will begin to have a lower two-digit  number than dates
in the prior century.  This problem,  the so-called  "Year 2000 Problem" or "Y2K
Problem,"  may  have  a  material  adverse  effect  on the  Company's  financial
condition,  results of operations,  business or business  prospects  because the
Company  relies  extensively  on  computer  technology  to manage its  financial
information and serve its customers.

The Company's State of Readiness

The Company has developed a Year 2000 Action  Plan (the  "Plan"),  specifying  a
range of tasks and goals to be achieved at various  dates  before the year 2000.
To date,  the Plan is on target  and  major  deadlines  have  been  met.  Senior
management  and the board of directors of the Company are regularly  apprised of
the Company's progress, and both provide input and guidance on a regular basis.

The  computer  systems  presently  in use at The Great Train  Stores are made up
entirely  of  PC-compatible  microcomputers  and  do not  include  any  mini  or
mainframe  computers.  On August 2, 1998, the Company upgraded its point of sale
software, which is the core software system in use at the central office and all
store locations,  so that the system should be capable of accurately  processing
date  related  data through the  transition  from 1999 to 2000.  The Company has
identified  other  systems that are in need of  renovation  or  modification  to
minimize disruptions or failures related to the Year 2000 Problem.  Such systems
have either already been modified or replaced,  or such upgrades or replacements
are scheduled to be completed by the third quarter of 1999.

Pursuant  to  the  Plan,  the  Company  has  also  actively  monitored  the  Y2K
preparedness  of its third party  providers  and  servicers,  utilizing  various
methods for testing and  verification.  Due to the relatively  limited number of
key  suppliers,  the Company may  experience  product  delivery  delays if these
vendors are not  adequately  prepared for the Year 2000 Problem.  The Company is
discussing Year 2000 preparedness with these principal providers.

The Costs to Address the Company's Year 2000 Issues

The Company has  projected  remaining Y2K  expenditures  to be  immaterial.  The
Company does not  anticipate  that the Company's Year 2000 Action Plan will have
any material  effect on its financial  statements or results of operations.  The
projection of the Company's Y2K costs does not include internal personnel costs,
which are not expected to be significantly  greater as a result of the Year 2000
Problem,  or  external  consulting  or  advisory  fees,  which have been and are
expected to be  minimal.  The  Company's  budget for Y2K  expenditures  consists
predominantly  of expenditures  for the upgrading or replacement of hardware and
software systems,  divided  approximately 50% for hardware and 50% for software.
The Company has funded,  and plans to fund,  its Year 2000 related  expenditures
out of general  operating  cash flows  and/or  the  Company's  line of credit or
possible additional equipment financing.

Year 2000 Risks Facing the Company and the Company's Contingency Plans

The failure of the Company to substantially complete its Plan could result in an
interruption in or failure of certain normal business  activities or operations.
Such  failures  could  materially  adversely  affect  the  Company's  results of
operations,  liquidity  and  financial  condition.  Currently,  the  Plan  is on
schedule and management  believes that successful  completion of the Plan should
significantly  reduce the risks  faced by the Company  with  respect to the Year
2000 Problem.

<PAGE>

The Company believes that its most reasonably  likely  worst-case  scenario with
respect to the Year 2000 Problem  involves the potential  failure of one or more
of its third party vendors to continue to provide  uninterrupted service through
the changeover to the year 2000. The Company relies on a relatively small number
of critical providers; thus if any such provider fails adequately to prepare for
the changeover  between 1999 and 2000,  the Company could face product  delivery
delays.  While an  evaluation of the Year 2000  preparedness  of its third party
vendors has been part of the Company's  Plan, the Company's  ability to evaluate
is limited by the  willingness of vendors to supply  information and the ability
of  vendors  to  verify  the Y2K  preparedness  of their  own  systems  or their
sub-providers.  However,  the Company does not currently  anticipate that any of
its significant third party vendors will fail to provide  continuing service due
to the Year 2000 Problem.

In order to reduce the risks enumerated  above, the Company has begun to develop
contingency plans. In particular,  if the Company receives  information that any
of its critical suppliers will not be adequately prepared to meet the transition
from 1999 to 2000,  the Company  plans to take action to preserve the  Company's
core business  functions,  such as purchasing  merchandise earlier than it might
otherwise have done.

Authoritative Pronouncements

The AICPA has issued  Statement  of  Position  98-5  "Reporting  on the Costs of
Start-up  Activities"  ("SOP 98-5") which is required for fiscal years beginning
after  December 15, 1998.  The Company has considered the impact of SOP 98-5 and
does not  anticipate  the adoption of this statement will have any effect on the
Company's financial statements.

The  Financial   Accounting  Standards  Board  has  issued  Statement  No.  133,
"Accounting  for Derivative  Instruments  and Hedging  Activities"  ("SFAS 133")
which will become effective for the Company on January 2, 2000. The Company does
not  anticipate  the  adoption  of this  statement  will have any  effect on the
Company's financial statements.

ITEM 8.  Financial Statements

The Company's  Consolidated  Balance Sheets as of January 3, 1998 and January 2,
1999 and the  Consolidated  Statements of Operations,  Stockholders'  Equity and
Cash Flows for the years ended  December 28, 1996,  January 3, 1998, and January
2,  1999  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-2.

ITEM  9.  Changes  In and  Disagreements  With  Accountants  on  Accounting  and
Financial Disclosures

None


<PAGE>


                                    PART III


ITEM 10. Directors and Executive Officers of the Registrant

Information  regarding  Directors,  Executive  Officers,  Promoters  and Control
Persons is incorporated by reference to the material  contained in the Company's
1999 Proxy Statement.

ITEM 11. Executive Compensation

Information regarding Executive Compensation is incorporated by reference to the
material contained in the Company's 1999 Proxy Statement.

ITEM 12. Security Ownership of Certain Beneficial Owners and Management

Information  regarding  Security  Ownership  of  Certain  Beneficial  Owners and
Management  is  incorporated  by  reference  to the  material  contained  in the
Company's 1999 Proxy Statement.

ITEM 13. Certain Relationships and Related Transactions

None

ITEM 14. Exhibits, Financial Statement Schedule and Reports on Form 8-K.

(a)   Exhibits.

      See Exhibit Index beginning on page F-14 of this Report.

(b)   Financial Statements Schedule

      See index to Consolidated Financial Statements on page F-1.

(c)   Reports on Form 8-K.

      None
<PAGE>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                   Index to Consolidated Financial Statements

                                                                        Page
                                                                        ----

Independent Auditors' Report                                            F-2

Consolidated Balance Sheets as of January 3, 1998 
  and January 2, 1999                                                   F-3

Consolidated Statements of Operations for the years ended 
  December 28, 1996, January 3, 1998  and January 2, 1999               F-4
 

Consolidated Statements of Stockholders' Equity for the years           F-5
  ended December 28, 1996, January 3, 1998 and January 2, 1999

Consolidated Statements of Cash Flows for the years ended 
  December 28, 1996, January 3, 1998  and January 2, 1999               F-6
 

Notes to Consolidated Financial Statements                              F-7

Schedule II - Valuation and Qualifying Accounts for the years 
  ended December 28, 1996, January 3, 1998 and January 2, 1999          S-1 

<PAGE>

                          Independent Auditors' Report



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


We have audited the consolidated  financial  statements of The Great Train Store
Company and subsidiaries as listed in the accompanying index. In connection with
our audits, we also have audited the financial  statement  schedule as listed in
the accompanying  index. These consolidated  financial  statements and financial
statement  schedule are  the  responsibility  of the Company's  management.  Our
responsibility  is  to  express  an  opinion  on  these  consolidated  financial
statements and financial statement schedule based on our audits.

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

In our opinion, the consolidated  financial statements referred to above present
fairly,  in all material  respects,  the  financial  position of The Great Train
Store Company and subsidiaries as of January 3,1998 and January 2, 1999, and the
results  of their  operations  and their cash flows for each of the years in the
three-year  period ended January 2, 1999, in conformity with generally  accepted
accounting  principles.  Also in our opinion,  the related  financial  statement
schedule,  when  considered  in  relation  to the basic  consolidated  financial
statements taken as a whole,  presents  fairly,  in all material  respects,  the
information set forth therein.



                                            KPMG LLP


Dallas, Texas
February 19, 1999

<PAGE>

<TABLE>
<CAPTION>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                           CONSOLIDATED BALANCE SHEETS


                         ASSETS
                                                          January 3, 1998  January 2, 1999
                                                          ---------------   --------------
<S>                                                       <C>                <C>
CURRENT ASSETS:
      Cash and cash equivalents                              $ 3,490,721      $   402,136
      Merchandise inventories                                  8,978,789       10,362,635
      Accounts receivable and other current assets             1,130,163          897,837
      Income taxes receivable                                          -          390,000
                                                          ---------------   --------------

                 Total current assets                         13,599,673       12,052,608

PROPERTY AND EQUIPMENT:
      Store construction and leasehold improvements            4,741,495        6,256,902
      Furniture, fixtures and equipment                        2,650,600        3,631,539
                                                          ---------------   --------------
                                                               7,392,095        9,888,441
      Less accumulated depreciation and amortization           1,827,691        2,850,751
                                                          ---------------   --------------

                 Property and equipment, net                   5,564,404        7,037,690

DEFERRED TAXES                                                   316,344                -
OTHER ASSETS, net                                                315,138          544,428
                                                          ---------------   --------------

                 Total assets                               $ 19,795,559     $ 19,634,726
                                                          ===============   ==============


          LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
      Merchandise payable                                    $ 4,580,080      $ 4,655,543
      Accounts payable and accrued liabilities                 1,111,936        1,148,711
      Sales taxes payable                                        660,547          667,199
      Income taxes payable                                       241,716                -
      Current portion of capital lease obligations                85,497          184,495
                                                          ---------------   --------------

                 Total current liabilities                     6,679,776        6,655,948

CAPITAL LEASE OBLIGATIONS, net of current portion                212,221          277,400
LINE OF CREDIT PAYABLE                                                 -          407,747
DEFERRED RENT AND OTHER LIABILITIES                              873,117        1,134,785
SUBORDINATED DEBENTURES                                                -        2,901,569
                                                          ---------------   --------------

                 Total liabilities                             7,765,114       11,377,449
                                                          ---------------   --------------

COMMITMENTS

STOCKHOLDERS' EQUITY:
      Preferred stock: $.01 par value; 2,000,000 shares
         authorized; none issued                                       -                -
      Common stock: $.01 par value; 18,000,000 shares
         authorized; 4,415,764 shares issued and outstanding      44,158           44,158
      Additional paid-in capital                              10,444,765       10,444,765
      Warrants                                                         -           76,006
      Retained earnings (accumulated deficit)                  1,541,522       (2,307,652)
                                                          ---------------   --------------

              Total stockholders' equity                      12,030,445        8,257,277
                                                          ---------------   --------------

              Total liabilities and stockholders' equity    $ 19,795,559     $ 19,634,726
                                                          ===============   ==============


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

</TABLE>

<PAGE>
<TABLE>
<CAPTION>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF OPERATIONS


                                                                                  For the Fiscal Year Ended
                                                                 December 28, 1996      January 3, 1998       January 2, 1999
                                                               --------------------   -----------------   --------------------
<S>                                                               <C>                  <C>                    <C>

NET SALES                                                             $ 18,998,461        $ 28,090,948           $ 33,932,790

COST OF SALES                                                            9,847,463          15,072,692             19,980,206       
                                                               --------------------   -----------------   --------------------

                Gross profit                                             9,150,998          13,018,256             13,952,584       
                                                               --------------------   -----------------   --------------------

OPERATING EXPENSES:                                                                                                                 
        Store operating expenses                                         3,095,361           4,750,266              6,441,594       
        Occupancy expenses                                               2,223,853           3,713,162              5,258,037       
        Selling, general and administrative expenses                     2,354,880           3,389,652              3,994,398       
        Depreciation and amortization expenses                             396,136             758,562              1,046,830       
        Provision for store closing                                              -                   -                241,417       
                                                               --------------------   -----------------   --------------------

                Total operating expenses                                 8,070,230          12,611,642             16,982,276       
                                                               --------------------   -----------------   -------------------

OPERATING INCOME (LOSS)                                                  1,080,768             406,614             (3,029,692)      
                                                               --------------------   -----------------   --------------------

OTHER INCOME (EXPENSE):
        Interest expense                                                  (129,500)           (188,128)              (978,712)      
        Interest income                                                     84,960              56,664                 20,750       
        Other income                                                        15,301             366,790                 25,013       
                                                               --------------------   -----------------   --------------------

                Total other income (expense), net                          (29,239)            235,326               (932,949)
                                                               --------------------   -----------------   --------------------

INCOME (LOSS) BEFORE INCOME TAXES (BENEFIT)                              1,051,529             641,940             (3,962,641)

PROVISION FOR INCOME TAXES (BENEFIT)                                       279,301             231,327               (113,467)
                                                               --------------------   -----------------   --------------------

NET INCOME (LOSS)                                                        $ 772,228           $ 410,613           $ (3,849,174)  
                                                               ====================   =================   ====================

BASIC EARNINGS (LOSS) PER SHARE                                             $ 0.21              $ 0.09                $ (0.87)
                                                               ====================   =================   ====================

DILUTED EARNINGS (LOSS) PER SHARE                                          $ 0.20               $ 0.09                $ (0.87)
                                                               ====================   =================   ====================


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

<PAGE>

<TABLE>
<CAPTION>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                 CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY



                                                                            Unearned                       Retained
                                                                           Compensation                    Earnings
                                        Common Stock          Paid-In     - Restricted                    (Accumulated
                                    Shares       Amount       Capital        Stock          Warrants       Deficit)       Total
                                 -----------  -----------  -----------  --------------  --------------   ------------- ------------

<S>                              <C>           <C>         <C>              <C>               <C>          <C>          <C>

BALANCE, December 30, 1995        3,145,000     $ 31,450    $ 4,446,947       $ (5,665)       $      -     $ 358,681   $ 4,831,413

Net income                               -            -              -               -               -       772,228       772,228
Net proceeds from warrant         1,226,169       12,262      5,567,725              -               -             -     5,579,987
      exercise
Exercise of stock options and
      related tax benefits           11,950          119         59,111              -               -             -        59,230
Adjustments associated with 
      unearned compensation - 
      restricted stock                1,000           10        124,392         1,540                -             -       125,942
                                  -----------  -----------  -----------   ------------      -----------   -----------  -----------

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

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

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

Net loss                                  -            -             -              -               -     (3,849,174)   (3,849,174)
Issuance of stock warrants                -            -             -              -          76,006              -        76,006
                                 -----------  -----------   -----------  --------------    -----------   ------------  ------------

BALANCE, January 3, 1999          4,415,764     $ 44,158   $ 10,444,765      $      -        $ 76,006   $ (2,307,652)  $ 8,257,277
                                 ===========  ===========  ============  ==============  ==============  ============= ============


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

</TABLE>

<PAGE>

<TABLE>
<CAPTION>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                      CONSOLIDATED STATEMENTS OF CASH FLOWS


                                                                               For the Fiscal Year Ended
                                                                 December 28, 1996  January 3, 1998   January 2, 1999
                                                                 -----------------  ---------------   ---------------

CASH FLOWS FROM OPERATING ACTIVITIES:
<S>                                                            <C>                <C>              <C>

       Net income (loss)                                          $   772,228        $    410,613     $ (3,849,174)
       Adjustments to reconcile net income to net cash 
           provided by (used in) operating activities:
             Depreciation and amortization                            396,136             758,562        1,046,830
             Deferred income taxes                                   (150,193)           (121,617)         316,344
             Loss on retirement of assets                                  -               14,728               -
             Amortization of unearned compensation - 
               restricted stock                                         7,040               4,125               -
             Amortization of debt discount                                 -                    -           20,616
             Provision for store closing                                   -                    -          241,417
             Changes in assets and liabilities:
                  Merchandise inventories                          (3,240,392)         (2,855,437)      (1,383,846)
                  Income tax receivable                                    -                    -         (390,000)
                  Accounts receivable and other current assets       (836,914)           (132,626)         232,327
                  Other assets                                       (122,491)           (122,585)         (10,109)
                  Merchandise payable                               1,039,634           2,931,992           75,462
                  Accounts payable and accrued liabilities          1,105,235            (117,608)          36,775
                  Sales taxes payable                                 167,841             255,913            6,652
                  Income taxes payable                                257,067             (59,885)        (241,716)
                  Other long term liabilities                        (340,884)            208,944          214,882
                                                                 -----------------  ---------------   --------------
                  Net cash provided by (used in) 
                     operating activities                            (945,693)          1,175,119       (3,683,540)
                                                                 -----------------  ---------------   --------------


CASH FLOWS FROM INVESTING ACTIVITIES:

      Purchases of property and equipment                          (2,275,065)         (2,649,724)      (2,437,763)
                                                                 -----------------  ---------------   --------------

                  Net cash used in investing activities            (2,275,065)         (2,649,724)      (2,437,763)
                                                                  ---------------  ---------------   --------------

CASH FLOWS FROM FINANCING ACTIVITIES:

       Net proceeds from stock options exercised                       36,352             116,291               -
       Tax benefit of stock option exercises                          141,780             130,616               -
       Net proceeds from line of credit                                    -                   -          407,747
       Net proceeds from warrant exercise                           5,579,987                  -                -
       Proceeds from subordinated debentures and warrants                  -                   -        3,000,000
       Debt issuance costs                                                 -                   -         (242,952)
       Proceeds from notes payable                                    144,269                  -                -
       Repayment of notes payable and capital leases               (1,054,789)           (146,120)       (132,077)
                                                               -----------------    ---------------   --------------

                  Net cash provided by financing activities         4,847,599             100,787       3,032,718
                                                               -----------------    ---------------   --------------

NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS                1,626,841          (1,373,818)     (3,088,585)

CASH AND CASH EQUIVALENTS, beginning of year                        3,237,698           4,864,539       3,490,721
                                                               -----------------    ---------------   --------------

CASH AND CASH EQUIVALENTS, end of year                          $   4,864,539         $ 3,490,721      $  402,136
                                                               =================    ===============   ==============

SUPPLEMENTAL NONCASH INVESTING AND FINANCING ACTIVITIES:

       Assets financed through capital lease obligations        $    155,000           $       -       $  300,000
       Interest paid                                            $    187,444           $  146,289      $  551,693
       Income taxes paid                                        $     41,644           $  282,213      $  194,255


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

</TABLE>

<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,  videotapes,  apparel,  and
related  merchandise.  As of January 2, 1999,  the  Company  operated  fifty-six
stores in twenty-six states and the District of Columbia.

The Company's fiscal year is based on a 52/53 week retail calendar ending on the
Saturday closest to December 31. Fiscal years 1996 and 1998 consisted of 52 week
periods  ended  December 28, 1996 and January 2, 1999 as compared to fiscal 1997
which  consisted of a 53 week period  ended  January 3, 1998.  The  consolidated
financial  statements  present  the  results  of  the  Company  and  all  of its
subsidiaries.  All significant intercompany  transactions and balances have been
eliminated in consolidation.

Cash and Cash Equivalents

The Company  considers all short-term  investments  with original  maturities of
less than 90 days cash  equivalents.  Substantially all of the Company's cash at
January 3, 1998 and January 2, 1999 was invested in money market funds.

Merchandise Inventories

Merchandise  inventories  are stated at the lower of average cost or market.  At
January 2, 1999 the Company has  recorded a reserve for  inventory  markdowns of
$383,000.

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 is removed from the accounts,  and any
resulting gain or loss is included in income or expense. The Company reviews all
long-lived  assets for impairment  whenever  events or changes in  circumstances
indicate that the carrying  amount of an asset may not be  recoverable.  If such
assets are  considered  to be  impaired,  the  impairment  to be  recognized  is
measured by the amount by which the  carrying  amount  exceeds the fair value of
the assets.

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

Financial Instruments

The  Company's  financial  instruments  at January 3, 1998 and  January 2, 1999,
consist of cash  equivalents,  accounts  and income taxes  receivable,  accounts
payable,  accrued  liabilities,  and  long-term  debt.  The fair  value of these
financial  instruments   approximates  the  carrying  amounts  reported  in  the
consolidated  balance sheets.  The following methods were used in estimating the
fair value of each class of financial instrument: cash equivalents, accounts and
income  taxes   receivable,   merchandise  and  accounts   payable  and  accrued
liabilities  approximate  their  carrying  amounts due to the short  duration of
those items and long-term debt is based on current market rates.

Pre-Opening Costs

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

<PAGE>

1.  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)

Advertising Costs

Advertising costs are expensed as incurred.  Advertising  expense, net of vendor
reimbursements,  was approximately $50,000,  $139,000, and $138,000 respectively
during fiscal 1996, fiscal 1997, and fiscal 1998.

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

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



                                               1996         1997         1998
                                               ----         ----         ----
Weighted average common shares 
  outstanding                               3,663,780    4,401,225    4,415,764
Dilutive common stock equivalents             193,300      196,737           -
                                           -----------   ---------    ---------
Weighted average common shares 
  outstanding and dilutive common 
  stock equivalents                         3,857,080    4,597,962    4,415,764
                                           ==========   ==========   ==========

For the year ended  January 2,  1999,  there are  554,600  options  and  482,500
warrants to purchase  common stock that were not included in the  computation of
diluted  earnings per share  because to do so would have been  antidilutive  for
that fiscal  year.  For the years ended  December  28, 1996 and January 3, 1998,
there are  15,600 and 75,000  options,  respectively  and  240,000  and  120,000
warrants,  respectively,  to purchase common stock that were not included in the
computation  of  earnings  per share  because  their  inclusion  would have been
antidilutive.

Stock Option Plan

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

Segment Information

The  Company  adopted  the  provisions  of  Statement  of  Financial  Accounting
Standards  No. 131,  "Disclosure  about  Segments of an  Enterprise  and Related
Information"  in the fiscal year ended January 2, 1999. The Company  operates in
one business segment,  the retail sale of train-themed  merchandise.  All of the
Company's sales consist of similar products and occur in the United States.

<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.  Actual
results could differ from those estimates.

Prior Year Reclassifications

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

2.   REVOLVING LINE OF CREDIT

In January  1998,  the  Company  entered  into a  revolving  line of credit with
BankAmerica  Business Credit,  Inc. The availability of the line, which is based
on the Company's  inventory,  is calculated at varying advance rates  throughout
the year.  The initial  term of the facility is three years and  borrowings  are
secured by certain assets of the Company,  primarily  inventory.  As of year-end
1998,  the  maximum  loan was  reduced to  $8,000,000  and  advance  ratios were
reduced.  Under the amended  agreement,  borrowings bear interest at BankAmerica
Business  Credit,  Inc.'s base lending rate plus 1.75% (8.5% at January 2, 1999)
and a commitment fee of 0.375% is charged on the unused  portion.  As of January
2, 1999, there was approximately  $408,000  outstanding on the revolving line of
credit, with approximately $4,252,000 remaining capacity under the line.

3.   SUBORDINATED DEBENTURES

In June 1998,  the Company sold  $3,000,000  aggregate  principal  amount of 12%
subordinated  debentures due 2003 and warrants to purchase 175,000 shares of the
Company's  common  stock  at an  exercise  price of $3.75  per  share to  Tandem
Capital.  The warrants,  which expire June 2003,  were allocated a fair value of
$76,006 on the date of issuance,  resulting in a debt  discount of a like amount
on the  subordinated  debentures.  The fair value of the warrants was determined
using the Black-Scholes Option pricing model with the following weighted average
assumptions:  dividend  yield of 0%;  expected  volatility  of 40.0%;  risk free
interest  rate of 5.04%;  an expected  life of four years;  and a block  trading
discount.  Net  proceeds to the Company from the sale of these  securities  were
approximately  $2,757,000  and are  expected  to be used to  support  new  store
openings  in 1998  and  1999  and for  general  working  capital  purposes.  The
subordinated  debentures are secured by certain assets,  primarily  fixtures and
equipment. The Company has the right to repay the subordinated debentures at any
time without penalty.  If not previously repaid,  Tandem will receive additional
warrants  at the end of each  year,  exercisable  at a price  based  on the fair
market value of such shares on the date of issuance.

The  warrants  anticipated  to be issued in the future  periods  are valued each
quarter and as of January 2, 1999 have been recorded at an aggregate  fair value
of $43,041  using the  Black-Scholes  Option  pricing  model with the  following
weighted  average  assumptions:  dividend  yield of 0%;  expected  volatility of
55.0%;  risk free interest rate of 4.56%; an expected life of four years;  and a
block trading discount.  The aggregate fair value of these warrants is reflected
on the balance sheet in deferred financing charges, a component of other assets,
and  deferred  rent  and  other  liabilities.  The  components  of  subordinated
debentures as of January 2, 1999 are as follows:

         Principal balance                                $   3,000,000
         Unamortized debt discount                              (98,431)
                                                        ----------------
                                                          $   2,901,569
<PAGE>


4.   INCOME TAXES

Income tax expense  (benefit) for the years ended December 28, 1996,  January 3,
1998 and January 2, 1999 consisted of the following:

   Current:                      1996              1997              1998
                                 ----              ----              ----
     Federal income taxes     $ 389,494        $ 341,332         $ (440,041)
     State income taxes          40,000           11,612             10,230
   Deferred                    (150,193)        (121,617)           316,344
                               ---------        ---------           -------
                              $ 279,301        $ 231,327        $ (113,467)
                             ==========       ==========        ===========


Income tax  expense  differed  from the amounts  computed  by applying  the U.S.
federal  income  tax rate of 34% to pretax  income  (loss)  for the years  ended
December  28,  1996,  January 3, 1998 and  January 2, 1999,  respectively,  as a
result of the following:
<TABLE>
<CAPTION>

                                                         1996              1997              1998
                                                         ----              ----              ----
<S>                                                <C>             <C>             <C> 
Computed "expected" tax expense (benefit)              357,520        $  218,260     $  (1,347,298)
State income tax, net of federal tax benefit            26,400             7,664             6,752

Change in the balance of the valuation allowance 
  for deferred tax assets allocated to income 
  tax expense                                         (107,507)                -         1,262,407
Other                                                    2,888             5,403           (35,328)
                                                     ----------       ----------        -----------
                                                     $ 279,301       $   231,327         $(113,467)
                                                     =========       ===========          =========
</TABLE>

The tax effects of temporary  differences that give rise to significant portions
of the  deferred  tax assets and  liabilities  at January 3, 1998 and January 2,
1999 are:

  Deferred tax assets:                January 3, 1998    January 2, 1999
                                      ---------------    ---------------
       NOL Carryforward                   $       -         $    810,144
        Deferred rent                        267,240             340,429
       Other                                  73,016             234,262
                                      ----------------      ------------
  Total deferred tax assets                  340,256           1,384,655
       Valuation Allowance                        -           (1,262,407)
                                      --------------         -----------
  Net Deferred Tax Asset                     340,256             122,248
  Deferred tax liabilities 
    - property and equipment                 (23,912)           (122,248)
                                      ---------------         -----------
  Net deferred tax assets              $     316,344         $        -
                                      ===============          ==========


In assessing the realizability of deferred tax assets,  management considers the
carry  back  potential,  the  scheduled  reversal  of  deferred  tax  assets and
liabilities,  future  taxable  income and tax planning  strategies.  The Company
recorded a valuation  allowance for deferred tax assets of $0 and  $1,262,407 at
January 3, 1998 and January 2, 1999, respectively.

The Company had Federal tax net operating loss  carryforwards  of  approximately
$2,104,000 as of January 2, 1999, which will expire in 2018.

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,  certain store lease obligations are secured by
fixtures  and  equipment  of the  Company.  The Company  also leases its central
offices under a five-year operating lease.

The Company records base rental expense using the straight-line  method over the
life of the lease  and,  accordingly,  has  recorded  a  deferred  liability  of
approximately  $786,000  at January 3, 1998 and  $1,001,000  at January 2, 1999,
representing the cumulative excess of straight-line  rental expense over amounts
paid.

<PAGE>

Total  rental  expense  under  all   noncancelable   operating   leases  totaled
approximately  $1,448,000,  $2,388,000,  and  $3,281,000  for  the  years  ended
December 28, 1996, January 3, 1998 and January 2, 1999 respectively. Included in
these  amounts is  contingent  rent of  approximately  $224,000,  $281,000,  and
$220,000,  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%.

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


                                       Operating           Capital
                                       ---------           -------
             1999...............      $3,891,070        $    243,309
             2000...............       3,787,559             221,096
             2001...............       3,774,028              85,966
             2002...............       3,765,006                  -
             2003...............       3,698,848                  -
             Thereafter.........      13,677,865                  -
                                      ----------        ------------
 Total minimum payments             $ 32,594,376        $    550,371
                                    ============
 Less portion representing interest                           88,476
                                                              ------
 Capital lease obligations                                   461,895
 Less current portion                                        184,495
                                                             -------
 Capital lease obligations, less current                $    277,400
   portion                                              ============


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 January 2, 1999, 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.  Also, as of January 2, 1999 Tandem  Capital holds warrants to purchase up
to 175,000  shares of the Company's  common stock at an exercise  price of $3.75
per share. The warrants expire June 2003.

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

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

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

<PAGE>

<TABLE>
<CAPTION>

6.   STOCKHOLDERS' EQUITY (continued)

                                            Incentive Compensation Plan         Director Stock Option Plan
                                            ---------------------------         --------------------------
                                                         Weighted Average                   Weighted Average
                                           Options        Exercise Price       Options       Exercise Price
                                           -------       ----------------      -------      ----------------
<S>                                       <C>              <C>                <C>              <C>

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

   Granted                                    216,600         $5.84               10,000          $5.63
   Exercised                                  (6,950)         $3.07              (5,000)          $3.00
   Forfeited                                 (16,300)         $5.16                   -              -
                                            ---------                           --------
                                                                              
Outstanding at December 28, 1996              348,050         $5.05               35,000          $4.82

   Granted                                    228,150         $7.96               20,000          $7.88
   Exercised                                 (22,650)         $3.19             (10,000)          $4.41
   Forfeited                                 (89,950)         $5.91                   -              -
                                            ---------                           --------
                                                                      
Outstanding at January 3, 1998                463,600         $6.40               45,000          $6.27
                                            =========                           ========
   Granted                                    133,050         $3.10               20,000          $3.13
   Canceled                                 (325,050)         $6.79             (35,000)          $7.00
   Reissued                                   325,050         $3.50               35,000          $3.50
   Forfeited                                (107,050)         $6.11                   -              -
                                            ---------                           --------
                                                                          
Outstanding at January 2, 1999                489,600         $2.23               65,000          $3.17
                                            =========                           ========

Exercisable at January 2, 1999                41,275          $3.00                5,000          $3.00
                                            =========                           ========
Reserved and available for grant 
  at January 2, 1999                         140,800                              20,000
                                            ========                            ========
</TABLE>


At January 2, 1999, the range of exercise prices and weighted-average  remaining
contractual life of outstanding  options was $1.69 - $3.50 and 7.9 years for the
Incentive  Compensation  Plan and $3.00 - $3.50  and 6.1 years for the  Director
Stock Option Plan, respectively.

The per share,  weighted-average  fair  value of stock  options  granted  during
fiscal  1996,  fiscal  1997  and  fiscal  1998  was  $3.57,   $4.83  and  $2.15,
respectively for the Incentive  Compensation Plan and $2.59, $3.67 and $1.67 for
the Director  Stock Option  Plan,  respectively,  on the date of grant using the
Black-Scholes  option pricing model. The following  assumptions were used in the
calculation:

<TABLE>
<CAPTION>

                                           Incentive Compensation Plan               Director Stock Option Plan
                                        1996         1997         1998            1996         1997          1998
                                        ----         ----         ----            ----         ----          ----
<S>                                   <C>         <C>          <C>              <C>         <C>           <C>
Expected dividend yield                  -             -           -               -            -             -
Risk-free interest rate                 6.4%         6.4%         5.6%            6.9%         6.6%          5.6%
Expected life in years                   10           10           10               5           10            10
Expected volatility                      40%          59%          55%             40%          59%           55%

</TABLE>
<PAGE>

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
(loss) would have been the pro forma amounts indicated below:

<TABLE>
<CAPTION>

                                                   1996               1997              1998
                                                   ----               ----              ----
<S>                        <C>               <C>             <C>               <C>
 Net Income (Loss):           As reported      $ 772,228         $ 410,613        ($ 3,849,174)
                              Pro forma        $ 687,928         $ 191,165        ($ 4,073,515)
 

 Diluted Earnings Per Share:  As reported         $ 0.20            $ 0.09             ($ 0.87)
                              Pro forma           $ 0.18            $ 0.04             ($ 0.92)
 
</TABLE>

Pro forma net income  (loss)  reflects  compensation  expense  only for  options
granted in fiscal  1995 and later.  Therefore,  the full  impact of  calculating
compensation  cost for stock  options under SFAS 123 is not reflected in the pro
forma net income (loss) amounts presented above.  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.


<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



April 2, 1999                       /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.


April 2, 1999                       /s/ James H. Levi
------------------------------      --------------------------------------------
Date                                James H. Levi
                                    President, Chief Executive Officer and
                                    Chairman of the Board
                                    (Principal Executive Officer)


April 2, 1999                       /s/ Cheryl A. Taylor
-------------------------------     --------------------------------------------
Date                                Cheryl A. Taylor
                                    Vice President - Finance and Administration,
                                    (Principal Financial and Accounting Officer)


April 2, 1999                       /s/ Joel S. Pollack
-------------------------------     --------------------------------------------
Date                                Joel S. Pollack
                                    Director


April 2, 1999                       /s/ John J. Schultz
-------------------------------     --------------------------------------------
Date                                John J. Schultz
                                    Director


April 2, 1999                       /s/ Charles M. Tureen
-------------------------------     --------------------------------------------
Date                                Charles M. Tureen
                                    Director


April 2, 1999                        /s/ Robert M. Warner
-------------------------------      -------------------------------------------
Date                                 Robert M. Warner
                                     Director

<PAGE>
                                  EXHIBIT INDEX

Exhibit
Number          Description                                                 Page
-------         -----------                                                 ----
3.1    *   Certificate of Incorporation of the Registrant................
3.2    *   Bylaws of the Registrant......................................
4.1    *   Form of Stock Certificate.....................................
4.3    *   Form of Bridge Warrants.......................................
4.4    *   Form of Underwriter's Option..................................
10.1  ***  The Great Train Store Company Amended and Restated 
             1994 Incentive Compensation Plan............................
10.2   *   The Great Train Store Company 1994 Director Stock 
             Option Plan.................................................
10.4   *   Form of Employment Agreement with  James H. Levi..............
10.6   *   The Great Train Store Partners, L. P. Agreement of 
             Limited Partnership dated as of
             September 1, 1990, as amended...............................
10.9  **   First Amendment to The Great Train Store Company
             1994 Director Stock Option Plan.............................
10.13 ***  Second Amendment to The Great Train 
             Store Company 1994 Director Stock Option Plan...............
10.14      Amended and Restated Loan and Security 
             Agreement dated as of January 27, 1998 with
             BankAmerica Business Credit, Inc............................
10.16      Consent and Amendment No. 1 to Loan and Security Agreement....
10.17      Amendment No. 2 to Loan and Security Agreement................
10.18      Amendment No. 3 to Loan and Security Agreement................
10.19      Amendment No. 4 to Loan and Security Agreement................
10.20      Amendment No. 5 to Loan and Security Agreement................
21.1       Subsidiaries of the Registrant................................
23.1       Independent Auditors' Consent
27.1       Financial Data Schedule (filed only in EDGAR format)..........
99.1 ****  Cautionary Statements Identifying Important Factors 
             that Could Cause the Company's Actual Results to Differ 
             from those Projected in Forward Looking Statements..........


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

**    Incorporated  by  reference  to the  Registrant's  Annual  Report on Form
      10-KSB for the fiscal year ended December 30, 1995.

***   Incorporated by reference to the Registrant's Registration Statement 
      on Form S-8 (Commission file no. 333-37705) filed on October 10, 1997.

****  Incorporated  by reference to the  Registrant's  Quarterly  Report on Form
      10-QSB for the period ended October 2, 1998.


<PAGE>

<TABLE>
<CAPTION>

                 THE GREAT TRAIN STORE COMPANY AND SUBSIDIARIES

                     Schedule II - Valuation and Qualifying
             Accounts For the fiscal years ended December 28, 1996,
                       January 3, 1998 and January 2, 1999


--------------------------------------------- ------------------ --------------------- ----------------- ----------------
                                                 Balance at        Charged to costs    Deductions, net   Balance at end
                                                Beginning of         and expenses       of recoveries       of period
                                                   Period
--------------------------------------------- ------------------ --------------------- ----------------- ----------------
<S>                                           <C>                  <C>                  <C>               <C>

Reserve for Inventory Markdowns:
--------------------------------------------- ------------------ --------------------- ----------------- ----------------
     December 28, 1996                                        -                     -                 -                -
--------------------------------------------- ------------------ --------------------- ----------------- ----------------
     January 3, 1998                                          -                     -                 -                -
--------------------------------------------- ------------------ --------------------- ----------------- ----------------
     January 2, 1999                                          -               383,000                 -          383,000
--------------------------------------------- ------------------ --------------------- ----------------- ----------------
</TABLE>