TRANS WORLD ENTERTAINMENT CORP - 10-Q Quarterly Report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

ý		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED OCTOBER 30, 2004

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT FOR THE TRANSITION PERIOD FROM TO

COMMISSION FILE NUMBER: 0-14818

TRANS WORLD ENTERTAINMENT CORPORATION

(Exact name of registrant as specified in its charter)

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

38 Corporate Circle

Albany, New York 12203

(Address of principal executive offices, including zip code)

(518) 452-1242

(Registrant’s telephone number, including area code)

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

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

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

Common Stock, $.01 par value,

33,389,695 shares outstanding as of December 1, 2004

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

PART 1. FINANCIAL INFORMATION

Item 1 - Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

(unaudited)

	October 30,			January 31,			November 1,
	2004			2004			2003
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	18,658		$	191,922		$	20,543
Merchandise inventory	459,246			424,783			509,360
Deferred taxes	8,657			7,349			4,404
Income taxes receivable	3,829			—			4,494
Other current assets	12,186			15,882			15,769
Total current assets	502,576			639,936			554,570

NET FIXED ASSETS	121,088			125,641			135,452
DEFERRED TAXES	31,386			39,964			36,267
OTHER ASSETS	14,063			12,217			12,160
TOTAL ASSETS	$	669,113		$	817,758		$	738,449

LIABILITIES
CURRENT LIABILITIES:
Accounts payable	$	224,777		$	306,298		$	277,293
Borrowings under line of credit	3,940			—			12,108
Income taxes payable	—			25,689			—
Accrued expenses and other current liabilities	35,965			54,079			51,291
Current portion of long-term debt	442			—			—
Current portion of capital lease obligations	431			395			409
Total current liabilities	265,555			386,461			341,101

LONG-TERM DEBT, less current portion	5,177			—			—
CAPITAL LEASE OBLIGATIONS, less current portion	7,137			7,465			7,568
OTHER LIABILITIES	13,891			24,648			25,563
TOTAL LIABILITIES	291,760			418,574			374,232

SHAREHOLDERS’ EQUITY
Preferred stock ($0.01 par value; 5,000,000 shares authorized; none issued)	—			—			—
Common stock ($0.01 par value; 200,000,000 shares authorized; 54,559,643, 54,245,838 and 54,235,873 shares issued, respectively)	546			542			542
Additional paid-in capital	289,672			288,272			288,382
Unearned compensation – restricted stock	(50		)	(23		)	(303		)
Treasury stock at cost (21,149,849, 18,147,291 and 17,835,149 shares, respectively)	(176,425		)	(146,055		)	(143,874		)
Retained earnings	263,610			256,448			219,470
TOTAL SHAREHOLDERS’ EQUITY	377,353			399,184			364,217
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	669,113		$	817,758		$	738,449

See Notes to Condensed Consolidated Financial Statements.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Thirteen Weeks Ended						Thirty-nine Weeks Ended
	October 30,			November 1,			October 30,			November 1,
	2004			2003			2004			2003

Sales	$	270,013		$	268,506		$	851,678		$	788,654
Cost of sales	170,045			172,199			535,367			498,239
Gross profit	99,968			96,307			316,311			290,415
Selling, general and administrative expenses	108,863			109,203			327,458			319,799
Loss from operations	(8,895		)	(12,896		)	(11,147		)	(29,384		)
Interest expense	578			549			1,301			1,051
Loss before income taxes and extraordinary gain - unallocated negative goodwill	(9,473		)	(13,445		)	(12,448		)	(30,435		)
Income tax benefit	(4,299		)	(5,342		)	(16,444		)	(14,334		)
Income (loss) before extraordinary gain - unallocated negative goodwill	(5,174		)	(8,103		)	3,996			(16,101		)
Extraordinary gain - unallocated negative goodwill, net of income taxes of $359, $1,797, $1,979 and $1,797, respectively	570			2,191			3,166			2,191
Net income (loss)	$	(4,604	)	$	(5,912	)	$	7,162		$	(13,910	)

BASIC INCOME (LOSS) PER SHARE:
Income (loss) per share before extraordinary gain-unallocated negative goodwill	$	(0.15	)	$	(0.22	)	$	0.11		$	(0.43	)
Extraordinary gain - unallocated negative goodwill, net of income taxes	$	(0.01	)	$	0.06		$	0.09		$	0.06
Basic income (loss) per share	$	(0.14	)	$	(0.16	)	$	0.20		$	(0.37	)

Weighted average number of common shares outstanding – basic	33,812			36,625			34,965			37,838

DILUTED INCOME (LOSS) PER SHARE:
Income (loss) per share before extraordinary gain-unallocated negative goodwill	$	(0.15	)	$	(0.22	)	$	0.11		$	(0.43	)
Extraordinary gain - unallocated negative goodwill, net of income taxes	$	(0.01	)	$	0.06		$	0.09		$	0.06
Diluted income (loss) per share	$	(0.14	)	$	(0.16	)	$	0.20		$	(0.37	)

Weighted average number of common shares outstanding – diluted	33,812			36,625			36,653			37,838

See Notes to Condensed Consolidated Financial Statements.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Thirty-nine Weeks Ended
	October 30,				November 1,
	2004				2003
Net cash used by operating activities	$	(128,495		)	$	(135,310	)

Cash flows from investing activities:
Purchases of fixed assets	(22,602			)	(12,156		)
Acquisition of minority interest in subsidiary	(2,000			)	—
Acquisition of businesses	—				(25,600		)
Net cash used by investing activities	(24,602			)	(37,756		)

Cash flows from financing activities:
Proceeds from long-term debt	5,760				—
Payments of long-term debt	(141			)	—
Borrowings under line of credit	3,940				12,108
Payments of capital lease obligations	(292			)	(1,523		)
Payments for purchases of treasury stock	(30,362			)	(14,771		)
Proceeds from the exercise of stock options	928				745
Net cash used by financing activities	(20,167			)	(3,441		)

Net decrease in cash and cash equivalents	(173,264			)	(176,507		)
Cash and cash equivalents, beginning of year	191,922				197,050
Cash and cash equivalents, end of period	$		18,658		$	20,543
Supplemental disclosure of non-cash investing and financing activities:
Income tax benefit resulting from exercises of stock options	$		383		$	377
Issuance of shares under restricted stock plan	51				—

See Notes to Condensed Consolidated Financial Statements.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

October 30, 2004 and November 1, 2003

Note 1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements consist of Trans World Entertainment Corporation, its wholly owned subsidiary Record Town, Inc. (“Record Town”) and Record Town’s subsidiaries, all of which are wholly owned (“the Company”). All significant intercompany accounts and transactions have been eliminated. During the thirty-nine weeks ended October 30, 2004, the Company acquired the remaining 29% of the issued and outstanding shares of Second Spin Inc. (“Second Spin”), a subsidiary, for cash of $2.0 million. The Company now owns 100% of the issued and outstanding shares of Second Spin.

The interim condensed consolidated financial statements have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission. The information furnished in these condensed consolidated financial statements reflects all normal, recurring adjustments which, in the opinion of management, are necessary for the fair presentation of such financial statements. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to rules and regulations applicable to interim financial statements. Certain reclassifications have been made to prior periods to conform to the current period presentation.

The information presented in the accompanying unaudited condensed consolidated balance sheet as of January 31, 2004 has been derived from the Company’s January 31, 2004 audited consolidated financial statements. All other information has been derived from the Company’s unaudited consolidated financial statements as of and for the thirteen weeks and thirty-nine weeks ended October 30, 2004 and November 1, 2003. These unaudited condensed consolidated financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004.

The Company’s significant accounting policies are the same as those described in Note 1 to the Company’s Consolidated Financial Statements on Form 10-K for the fiscal year ended January 31, 2004.

Note 2. Seasonality

The Company’s business is seasonal in nature, with the fourth fiscal quarter constituting the Company’s peak selling period. In 2003, the fourth fiscal quarter accounted for approximately 41% of annual sales. In anticipation of increased sales activity during these months, the Company purchases additional inventory and hires additional, temporary employees to supplement its permanent store sales staff. If, for any reason, the Company’s net sales were below seasonal norms during the fourth quarter, the Company’s operating results, particularly operating and net income, could be adversely affected. Additionally, quarterly sales results, in general, are affected by the timing of new product releases, new store openings or closings and the performance of existing stores.

Note 3. Stock Based Compensation

The Company has elected to account for its stock-based compensation plans under the intrinsic value-based method of accounting as permitted by Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock Based Compensation, and as prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for

Certain Transactions Involving Stock Compensation – An Interpretation of APB No. 25. Under this method, compensation expense would be recorded on the date of grant only if the current market price of the underlying stock exceeded the exercise price. Unearned compensation recognized for restricted stock awards is shown as a separate component of shareholders’ equity and is amortized to expense over the vesting period of the stock award using the straight-line method. The following table illustrates the effect on net income (loss) and income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation:

	Thirteen Weeks ended						Thirty-nine Weeks ended
	October 30, 2004			November 1, 2003			October 30, 2004			November 1, 2003
	(in thousands except per share amounts)						(in thousands except per share amounts)
Net income (loss), as reported	$	(4,604	)	$	(5,912	)	$	7,162		$	(13,910	)
Add: Stock-based employee compensation expense included in reported net income (loss), net of related income taxes	27			27			106			78
Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related income taxes	(819		)	(832		)	(2,614		)	(2,423		)
Proforma net income (loss)	$	(5,396	)	$	(6,717	)	$	4,654		$	(16,255	)
Income (loss) per share:
Basic - as reported	$	(0.14	)	$	(0.16	)	$	0.20		$	(0.37	)
Basic– proforma	$	(0.16	)	$	(0.18	)	$	0.13		$	(0.43	)
Diluted – as reported	$	(0.14	)	$	(0.16	)	$	0.20		$	(0.37	)
Diluted – proforma	$	(0.16	)	$	(0.18	)	$	0.13		$	(0.43	)

Note 4. Defined Benefit Plan

The Company maintains a non-qualified Supplemental Executive Retirement Plan (“SERP”) for certain executive officers of the Company. The SERP, which is unfunded, provides eligible executives defined pension benefits that supplement benefits under other retirement arrangements. The annual benefit amount is based on salary at the time of retirement and number of years of service. The Company accounts for the SERP in accordance with the provisions of SFAS No. 87, Employers’ Accounting for Pensions.

The Company provides the Board of Directors with a noncontributory, unfunded retirement plan that pays a retired director an annual retirement benefit equal to 60% of the annual retainer at the time of retirement plus a 3% annual increase through the final payment. Payments begin at age 62 or retirement, whichever is later, and continue for 10 years or the life of the director and his or her spouse, whichever period is shorter. Partial vesting in the retirement plan begins after six years of continuous service. Participants become fully vested after 12 years of continuous service on the Board.

As of June 1, 2003, new directors are not covered by the retirement plan. Directors who were not yet vested in their retirement benefits had the present value of benefits already accrued as of the effective date converted to Deferred Shares under the Directors Plan. Directors that were fully or partially vested in their retirement benefits were given a one time election to continue to participate in

the current retirement program or convert the present value of benefits already accrued to Deferred Shares under the Directors Plan as of the effective date.

During the thirteen and thirty-nine weeks ended October 30, 2004, the Company did not make any cash contributions to the SERP, and presently expects to make $35 thousand in contributions during fiscal 2004.

The following represents the components of the net periodic pension cost related to the Company’s SERP and Directors Plan for the respective periods:

	Thirteen weeks ended				Thirty-nine weeks ended
	October 30, 2004		November 1, 2003		October 30, 2004		November 1, 2003
	(in thousands)				(in thousands)
Service cost	$	100	$	59	$	301	$	177
Interest cost	157		158		471		474
Amortization of prior service cost	90		92		270		276
Net periodic pension cost	$	347	$	309	$	1,042	$	927

Note 5. Extraordinary Gain

The Company acquired substantially all the net assets of Wherehouse Entertainment Inc. (“Wherehouse”) and CD World Inc. (“CD World”) in October 2003 for $35.2 million and $1.9 million, respectively. The purchase price was allocated on a preliminary basis using information available at the time. In accordance with SFAS No.141, Business Combinations, the allocation of the purchase price to the assets and liabilities acquired was finalized during the thirteen weeks ended October 30, 2004. During the thirteen and thirty-nine weeks ended October 30, 2004, the Company adjusted the purchase accounting in accordance with the provisions of SFAS No. 141, resulting in an extraordinary gain of $0.6 million and $3.2 million, respectively, net of income taxes of $0.3 million and $2.0 million respectively, related to unallocated negative goodwill. The year to date gain represents adjustments to the value of liquidated inventory ($2.6 million), an adjustment to customer liabilities related to gift cards based on the redemption experience since acquisition ($2.0 million) and occupancy related expenses ($0.6 million).

Note 6. Long-Term Debt

During the thirty-nine weeks ended October 30, 2004, the Company borrowed $5.8 million under a mortgage loan with South Trust Bank to finance the purchase of real estate. The mortgage payable is repayable in monthly installments over 10 years with a fixed interest rate of 6.0% and does not contain any prepayment penalties. The mortgage loan contains a minimum net worth (shareholders’ equity) covenant of $290 million, excluding the impact, if any, of certain non-cash charges.

Note 7. Recently Issued Accounting Standards

In January 2003, the FASB issued Interpretation No. 46 (“FIN 46”), Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51, and, in October 2003, the FASB issued FASB Staff Position (FSP) No. FIN 46-6, Effective Date of FASB Interpretation 46. A variable interest entity (“VIE”) is defined as (a) an ownership, contractual or monetary interest in an entity where the ability to influence financial decisions is not proportional to the investment interest, or (b) an entity lacking the invested capital sufficient to fund future activities without the support of a third party. This staff position deferred the effective date for applying FIN 46 to an interest held in a VIE or potential VIE that was created before February 1, 2003 until the end of the first interim or annual period ending after December 15, 2003, unless the company had already issued financial statements which reflected a VIE in accordance with FIN 46. In December 2003, the FASB issued Interpretation No. 46R (“FIN 46R”), Consolidation of Variable Interest Entities - An Interpretation of ARB No. 51, which replaces FIN 46 and addresses consolidation by business enterprises of variable interest entities that possess certain characteristics. FIN 46R establishes standards for determining the circumstances under which VIEs should be consolidated with their primary beneficiary, including those to which the usual condition for consolidation does not apply. The Company adopted this guidance as required in the first fiscal quarter of 2004, resulting in the consolidation of a variable interest entity. The consolidation resulted in the reclassification of an amount from current assets to long term assets and did not have a significant impact on the Company’s financial statements.

Note 8. Depreciation and Amortization

Depreciation and amortization included in the condensed consolidated statements of operations is as follows:

	Thirteen Weeks Ended				Thirty-nine Weeks Ended
	October 30, 2004		November 1, 2003		October 30, 2004		November 1, 2003
	(in thousands)				(in thousands)
Cost of sales	$	603	$	615	$	1,789	$	1,829
Selling, General & Administrative expenses	7,945		9,466		24,904		29,143
Total	$	8,548	$	10,081	$	26,693	$	30,972

Note 9. Earnings (Loss) Per Share

Weighted average shares are calculated as follows:

	Thirteen Weeks Ended		Thirty-nine Weeks Ended
	October 30, 2004	November 1, 2003	October 30, 2004	November 1, 2003
	(in thousands)		(in thousands)
Weighted average common shares outstanding – basic	33,812	36,625	34,965	37,838
Dilutive effect of employee stock options	—	—	1,688	—
Weighted average common shares outstanding – diluted	33,812	36,625	36,653	37,838

Anti-dilutive stock options	9,625	8,746	4,012	8,936

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

Item 2 - Management’s Discussion and Analysis of Financial Condition and

Results of Operations

October 30, 2004 and November 1, 2003

Overview

Management’s Discussion and Analysis of Financial Condition and Results of Operations provides information that the Company’s management believes necessary to achieve a clear understanding of the Company’s financial statements and results of operations. To the extent that such analysis contains statements which are not of a historical nature, such statements are forward-looking statements, which involve risks and uncertainties. These risks include, but are not limited to, changes in the competitive environment for the Company’s merchandise, including the entry or exit of non-traditional retailers of the Company’s merchandise to or from its markets; the release by the music industry of an increased or decreased number of “hit releases”; general economic factors in markets where the Company’s merchandise is sold; and other factors discussed in the Company’s filings with the Securities and Exchange Commission. The following discussion and analysis of the Company’s financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and related notes included elsewhere in this report and the audited financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2004.

At October 30, 2004, the Company operated 852 stores totaling approximately 5.2 million square feet in 47 states, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands. The Company’s stores offer predominantly entertainment software, including music, video and video games. In total, these categories represented 92% of the Company’s total sales in the thirteen weeks and thirty-nine weeks ended October 30, 2004. The balance of categories, items relating to the use, care and storage of entertainment software, along with boutique and electronic products, represented 8% of the Company’s total sales in the thirteen weeks and thirty-nine weeks ended October 30, 2004, respectively.

In the thirteen weeks and thirty-nine weeks ended October 30, 2004, the Company’s sales increased as a result of the acquisitions of the Wherehouse stores and CD World stores in October 2003, and an increase in the average square footage in operation as compared to the thirteen weeks and thirty-nine weeks ended November 1, 2003. Loss before extraordinary gain decreased for the thirteen weeks ended October 30, 2004 as a result of increased sales and gross profit. During the thirty-nine weeks ended October 30, 2004, the Company recorded an income tax benefit of $10.5 million, or $0.29 per share. The income tax benefit is the result of closing a federal income tax examination, including all matters not previously settled in relation to Company Owned Life Insurance (“COLI”) policies, which were part of the Company’s acquisition of Camelot Music Holdings in 1999. See discussion under “Income Tax Benefit”.

On July 22, 2004, the Company acquired the remaining 29% of the issued and outstanding shares of Second Spin Inc. (“Second Spin”), for cash of $2.0 million. In accordance with SFAS No. 141, Business Combinations, the transaction was accounted for as a step acquisition with the excess of purchase price over the fair value reported as goodwill. The Company recorded goodwill of $62 thousand related to this transaction. Prior to the step acquisition, the Company had consolidated all of the net assets and operations of Second Spin in its statements of financial condition and results of operations, and accordingly no minority interest had been reflected in the financial statements.

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

Sales: The Company generates substantially all of its revenue from sales of entertainment software and related products. It continually measures the rate of comparable store sales change. A store is included in comparable store sales calculations at the beginning of its thirteenth full month of operation. The Company further analyzes sales by store format (i.e. mall versus freestanding) and by product category (i.e. music, video, video games, etc.).

Cost of Sales and Gross Profit: The Company monitors costs included in its cost of sales including distribution and product costs. Gross profit is primarily impacted by the mix of products sold and the retail pricing environment. The Company records its distribution and product shrinkage expenses in cost of sales.

Selling, General and Administrative (“SG&A”) expenses: SG&A expenses are comprised largely of salaries and wages and related costs, occupancy charges, including rent and utilities, marketing expenses, store operating costs and other overhead expenses, including depreciation.

Balance Sheet and Ratios: The Company views cash, net inventory investment (inventory less accounts payable) and working capital as indicators of its financial position (see Liquidity and Capital Resources for further discussion of these items). Working capital is defined as Current Assets less Current Liabilities.

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of America requires that management apply accounting policies and make estimates and assumptions that affect results of operations and the reported amounts of assets and liabilities in the financial statements. Management continually evaluates its estimates and judgments including those related to merchandise inventory and return costs, valuation of long-lived assets, income taxes, and accounting for vendor allowances. Management bases its estimates and judgments on historical experience and other factors that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. Note 1 of Notes to the Consolidated Financial Statements on Form 10-K for the year ended January 31, 2004 includes a summary of the significant accounting policies and methods used by the Company in the preparation of its condensed consolidated financial statements. Management believes that of the Company’s significant accounting policies, the following may involve a higher degree of judgment or complexity:

Merchandise Inventory and Return Costs: Merchandise inventory is stated at the lower of cost or market as determined by the average cost method. The average cost method attaches a cost to each Stock Keeping Unit (“SKU”) and is a weighted average of the original purchase price and those of subsequent purchases or other cost adjustments throughout the life cycle of that SKU.

Merchandise inventory valuation requires significant judgment and estimates, including obsolescence and provision for inventory shrinkage and any adjustments to market value, if market value is lower than cost. Inherent in the entertainment software industry is the risk of obsolete merchandise inventory. Typically, newer releases generate a higher product demand. Some vendors offer credits to reduce the cost of products that are selling more slowly, thus allowing for a reduction in the selling price and reducing the possibility for obsolescence. The Company records obsolescence and any adjustments to market value (if lower than cost) based on current and anticipated demand, customer preferences, and market conditions. A provision for inventory shrinkage is estimated as a percentage of sales for the period from the last physical inventory date to the end of the accounting period. Such estimates are based on historical results and trends, and the shrinkage results from the last physical inventory. Physical inventories are taken at least annually for all stores throughout the year, and perpetual inventory records are adjusted accordingly. The Company is generally entitled to return merchandise purchased from major vendors for credit against other purchases from these vendors. Certain of these vendors often reduce the credit with a merchandise return charge ranging from 2% to 20% of the original merchandise purchase price depending on the type of merchandise being returned. The Company records merchandise return charges in cost of sales.

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

• significant underperformance relative to expected historical results;

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

• significant negative industry or economic trends;

• market capitalization relative to net book value

When the Company determines that the carrying value of a long-lived asset may not be recoverable based on one or more of the above indicators, the Company tests for impairment to determine if an impairment charge is needed.

Accounting for Vendor Allowances: In accordance with the provisions of FASB’s Emerging Issues Task Force’s, EITF No. 02-16, Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor, vendor advertising allowances which exceed specific, incremental and identifiable costs incurred in relation to advertising and promotional events conducted for vendors are classified as a reduction of the purchase price of merchandise inventory and recognized as a reduction of cost of sales as the merchandise inventory is sold. The amount of vendor allowances to be recorded as a reduction of merchandise inventory is determined by calculating the ratio of vendor allowances in excess of specific, incremental and identifiable advertising and promotional costs to merchandise inventory purchases. This ratio is then applied to the value of merchandise inventory to determine the amount of vendor reimbursements that are then recorded as a reduction to merchandise inventory as reflected in the condensed consolidated balance sheets.

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

Accounting for income taxes requires management to make estimates and judgments regarding interpretation of various taxing jurisdictions, laws and regulations as well as the ultimate realization of deferred tax assets. These estimates and judgments include the generation of future taxable income, viable tax planning strategies and support of tax filings. Valuation allowances are recorded against deferred tax assets if, based upon management’s estimates of realizability, it is more likely than not that some portion or all of these deferred tax assets will not be realized.

RESULTS OF OPERATIONS

The following table sets forth a period over period comparison of the Company’s sales for the thirteen weeks and thirty-nine weeks ended October 30, 2004 and November 1, 2003, by category:

	Thirteen weeks ended												Thirty-nine weeks ended
	October 30, 2004			November 1, 2003			Change		%		Comp Store Sales		October 30, 2004			November 1, 2003			Change		%		Comp Store Sales
	(in thousands)												(in thousands)
Sales	$	270,013		$	268,506		$	1,507	0.6	%			$	851,678		$	788,654		$	63,024	8.0	%
As a % of sales
Music	58		%	58		%					-4.6	%	59		%	59		%					-0.9	%
Video	27		%	28		%					-3.0	%	27		%	27		%					5.9	%
Video Games	7		%	5		%					30.6	%	6		%	6		%					8.7	%
Other	8		%	9		%					-2.4	%	8		%	8		%					-5.6	%

Store Count:
Mall	585			637							-1.1	%											2.1	%
Freestanding	267			313							-4.5	%											-2.1	%
Total	852			950							-2.4	%											0.8	%

Sales. The increase in sales resulted from the Wherehouse Entertainment stores acquired in October 2003 being included in operations for the full quarter in the current year period and only from the acquisition date (October 2, 2003) in the prior year period.

Music:

The Company’s stores offer a wide range of compact discs (“CDs”) and audio cassettes across most music genres, including new releases from current artists as well as an extensive catalog of music

from past periods and artists. During the thirteen weeks ended October 30, 2004, unit sales in the U.S. decreased 3.0% according to Soundscan. The decrease was due to lower sales of new releases during the quarter versus the prior year period. For the thirty-nine weeks ended October 30, 2004, unit sales in the U.S. increased 2.9%. The increase in unit sales was due to stronger product earlier in the year.

The Company’s total music sales for the thirteen and thirty-nine weeks ended October 30, 2004 increased 0.3% and 8.1% respectively over the comparable period from the prior year as a result of the addition of the Wherehouse stores. Comparable store sales in the CD category decreased 3.3% during the thirteen week period ended October 30, 2004 and increased 0.4% for the thirty-nine week period ended October 30, 2004.

Video:

The Company offers home video and software, including DVDs and videocassettes, in substantially all of its stores. The decrease in comparable store sales for the video category during the thirteen weeks ended October 30, 2004, was due to a decrease in comparable store sales of 36.8% in the videocassette category, partially offset by a 4.0% increase in comparable store sales in DVDs. For the thirty-nine weeks ended October 30, 2004, comparable store sales for the video category increased 5.9% as the decrease in comparable sales for VHS was more than offset by a 14.3% increase in comparable store sales for DVD. The deceleration of comparable store sales in the thirteen week period for DVD was due to a weaker slate of new releases for the third quarter of 2004 versus the third quarter of 2003.

Video Games:

The Company offers video game hardware and software in most of its stores, with a mix that favors software. The comparable store sales increase of 30.6% in the quarter was the result of improved merchandising and selection in the stores and new releases.

Other:

The Company offers items relating to the use, care and storage of entertainment software, along with boutique and electronic products. The decrease in the category was due to decreases in the electronics and software accessory areas and was the result of a transition in product lines within these categories.

Gross Profit. The following table sets forth a period over period comparison of the Company’s gross profit:

	Thirteen weeks ended										Thirty-nine weeks ended
	October 30,			November 1,							October 30,			November 1,
	2004			2003			Change				2004			2003			Change
	(in thousands)						$		%		(in thousands)						$		%
Gross Profit	$	99,968		$	96,307		$	3,661	3.8	%	$	316,311		$	290,415		$	25,896	8.9	%
As a percentage of sales	37.0		%	35.9		%					37.1		%	36.8		%

Gross profit increased in the thirteen and thirty-nine weeks periods ended October 30, 2004 compared to the same periods last year due to increased sales and an increase in gross margin percent.

Selling, General & Administrative Expenses. The following table sets forth a period over period comparison of the Company’s SG&A:

	Thirteen weeks ended											Thirty-nine weeks ended
	October 30,			November 1,								October 30,			November 1,
	2004			2003			Change					2004			2003			Change
	(in thousands)						$			%		(in thousands)						$		%
SG&A	$	108,863		$	109,203		$	(340	)	-0.3	%	$	327,458		$	319,799		$	7,659	2.4	%
As a percentage of sales	40.3		%	40.7		%						38.4		%	40.5		%

As a percentage of sales, SG&A decreased in the thirteen and thirty-nine weeks ended October 30, 2004 as compared to the same period last year as a result of increased expense leverage on higher sales and lower depreciation expense.

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

	Thirteen weeks ended								Thirty-nine weeks ended
	October 30, 2004				November 1, 2003				October 30, 2004				November 1, 2003
	(in thousands)								(in thousands)
Income tax benefit before IRS settlement benefit	$	(4,299		)	$	(5,342		)	$	(5,899		)	$		(12,210	)
Effective tax rate before IRS settlement benefit	45.4			%	39.7			%	47.4			%	40.1			%
IRS settlement benefit	—				—				(10,545			)	(2,124			)
Income tax benefit	$		(4,299	)	$		(5,342	)	$		(16,444	)	$	(14,334		)

The Company projects that its effective tax rate for the annual fiscal period will approximate 35.0% not including the effect of the $10.5 million income tax benefit discussed below. The decrease in the 2004 projected effective tax rate as compared to the thirteen and thirty-nine weeks ended November 1, 2003, is attributable to a projected increase in income before income taxes for the 2004 annual fiscal period as compared to the 2003 annual fiscal period as well as a reduction in valuation allowances resulting from management’s estimate of the realizability of certain deferred tax assets. An increase in income before income taxes decreases the rate due to rate leverage on capital-based state taxes recorded in income tax expense.

The effective tax rates for the thirteen weeks and thirty-nine weeks ended October 30, 2004 as compared to the 2004 projected rate were higher due to tax benefits recorded in the thirty-nine weeks ended October 30, 2004 related to a reduction in the valuation allowance resulting from management’s estimate of the realizability of certain deferred tax assets.

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

	Thirteen weeks ended						Thirty-nine weeks ended
	October 30, 2004			November 1, 2003			October 30, 2004		November 1, 2003
	(in thousands)						(in thousands)
Income (loss) before extraordinary gain	$	(5,174	)	$	(8,103	)	$	3,996	$	(16,101	)
Extraordinary gain – unallocated negative goodwill, net of income taxes	570			2,191			3,166		2,191
Net income (loss)	$	(4,604	)	$	(5,912	)	$	7,162	$	(13,910	)

For the thirteen weeks ended October 30, 2004, the reduction in loss before extraordinary gain is due to higher sales and gross profit and reduced selling, general and administrative expenses. For the thirty-nine weeks ended October 30, 2004, the increase in income before extraordinary gain is due to higher sales and gross profit and an increased income tax benefit.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity. The Company’s primary sources of working capital are cash provided by operations and borrowings under its revolving credit facility. The Company’s cash flows fluctuate from quarter to quarter due to various items, including seasonality of sales and results from operations, inventory purchases and the related terms on the purchases, tax payments, capital expenditures and stock repurchase activity and store acquisitions. Management believes it will have adequate resources to fund its cash needs for the foreseeable future.

The following table sets forth a summary of key components of cash flow and working capital for the thirty-nine weeks ended October 30, 2004 and November 1, 2003:

	Thirty-nine weeks ended
	October 30, 2004			November 1, 2003			Change
(in thousands)							$
Operating Cash Flows	$	(128,495	)	$	(135,310	)	$	6,815
Financing Cash Flows	(20,167		)	(3,441		)	(16,726		)

Capital Expenditures	(22,602		)	(12,156		)	(10,446		)

Cash and Cash Equivalents	18,658			20,543			(1,885		)
Inventories	459,246			509,360			(50,114		)
Working Capital	237,021			213,469			23,552

The Company had cash balances of $18.7 million at October 30, 2004, compared to $191.9 million at January 31, 2004 and $20.5 million at November 1, 2003. Inventory was $87 per square foot at October 30, 2004 the same level as at November 1, 2003.

Cash used by operating activities was $128.5 million for the thirty-nine weeks ended October 30, 2004. The primary uses of cash were a $81.5 million seasonal reduction of accounts payable, a $34.5 increase in inventory for the holiday season and a $29.1 million reduction in income taxes payable (receivable). The Company’s inventory and accounts payable are heavily influenced by the seasonality of its business. A significant reduction of accounts payable occurs annually in the fiscal first quarter, reflecting payments for merchandise inventory sold during the prior year’s holiday season. Similarly, inventory increases each year throughout the fall season and peaks during the holiday selling season. The seasonality of the Company’s earnings in its fiscal fourth quarter also results in the timing of substantially all of income tax payments to be made subsequent to year end. These cash uses are offset by a significant cash source in the fiscal fourth quarter from the increase in sales during the holiday season.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

PART II - OTHER INFORMATION

Item 2 – Changes in Securities and Use of Proceeds

On May 28, 2003, the Company’s Board of Directors authorized a program to repurchase 10 million shares of Common Stock from time to time on the open market. The program marks the fourth program authorized in the last three years and has no expiration date. The following table shows the purchase of equity securities purchased under the repurchase program as required by Regulation 229.703 Item 703:

Period	Total Number of Shares Purchased	Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Programs	Maximum Number of Shares that May Yet Be Purchased Under the Plan
August 1, 2004 – August 28, 2004	228,300	$	9.93	228,300	4,668,241
August 29, 2004 – September 25, 2004	451,400	$	9.97	451,400	4,216,841
September 26, 2004 - October 30, 2004	260,700	$	10.20	260,700	3,956,141
Total	940,400	$	10.02	940,400	3,956,141

	Form 10-Q
PART 1. FINANCIAL INFORMATION	Page No.

Item 1 - Financial Statements

Condensed Consolidated Balance Sheets (unaudited) at October 30, 2004, January 31, 2004 and November 1, 2003 (unaudited)	3

Condensed Consolidated Statements of Operations (unaudited) – Thirteen Weeks and Thirty-nine Weeks Ended October 30, 2004 and November 1, 2003	4

Condensed Consolidated Statements of Cash Flows (unaudited)–Thirty-nine Weeks Ended October 30, 2004 and November 1, 2003	5

Notes to Condensed Consolidated Financial Statements (unaudited)	6

Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations	11

Item 3 – Quantitative and Qualitative Disclosures about Market Risk	21

Item 4 – Controls and Procedures	21

PART II. OTHER INFORMATION

Item 2 – Changes in Securities and Use of Proceeds	22

Item 6 - Exhibits and Reports on Form 8-K	23

Signatures	24

Exhibit No.		Description

31.1		Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32		Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

TRANS WORLD ENTERTAINMENT CORPORATION

December 9, 2004	By: /s/ ROBERT J. HIGGINS
	Robert J. Higgins
	Chairman and Chief Executive Officer
	(Principal Executive Officer)

December 9, 2004	By: /s/ JOHN J. SULLIVAN
	John J. Sullivan
	Executive Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer)

38 Corporate Circle

Results of Operations

As a percentage of sales, SG&A decreased in the thirteen and thirty-nine weeks ended October 30, 2004 as compared to the same period last year as a result of increased expense leverage on higher sales and lower depreciation expense.

The mortgage loan and the revolving credit facility contain a minimum net worth (shareholders’ equity) covenant of $290 million, excluding the impact, if any, of certain non-cash charges.

Item 2 – Changes in Securities and Use of Proceeds

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES