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 JULY 30, 2005

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,

31,886,276 shares outstanding as of August 28, 2005

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

PART 1. FINANCIAL INFORMATION

Item 1 - Financial Statements

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

(unaudited)

	July 30,			January 29,			July 31,
	2005			2005			2004
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	50,934		$	229,768		$	39,927
Merchandise inventory	401,051			431,246			422,209
Income taxes receivable	7,025			—			—
Deferred taxes	11,556			15,526			10,271
Other current assets	13,554			13,006			14,063
Total current assets	484,120			689,546			486,470

NET FIXED ASSETS	128,455			130,196			122,839
DEFERRED TAXES	25,405			25,039			39,292
OTHER ASSETS	14,022			14,872			14,081
TOTAL ASSETS	$	652,002		$	859,653		$	662,682

LIABILITIES
CURRENT LIABILITIES:
Accounts payable	$	182,223		$	358,396		$	196,460
Income taxes payable	—			8,592			1,760
Accrued expenses and other current liabilities	33,101			43,712			37,388
Current portion of long-term debt	462			448			436
Current portion of capital lease obligations	2,498			332			418
Total current liabilities	218,284			411,480			236,462

LONG-TERM DEBT, less current portion	4,826			5,060			5,289
CAPITAL LEASE OBLIGATIONS, less current portion	16,081			6,977			7,250
DEFERRED RENT AND OTHER LIABILITIES	29,550			31,813			22,756
TOTAL LIABILITIES	268,741			455,330			271,757

SHAREHOLDERS’ EQUITY
Preferred stock ($0.01 par value; 5,000,000 shares authorized; none issued)	—			—			—
Common stock ($0.01 par value; 200,000,000 shares authorized; 55,588,575, 55,014,598 and 54,484,181 shares issued, respectively)	556			550			545
Additional paid-in capital	298,506			292,922			289,220
Unearned compensation – restricted stock	(38		)	(46		)	(54		)
Accumulated other comprehensive loss	(1,094		)	(1,094		)	—
Treasury stock at cost (23,404,549, 21,988,949 and 20,209,449 shares, respectively)	(205,057		)	(186,298		)	(167,001		)
Retained earnings	290,388			298,289			268,215
TOTAL SHAREHOLDERS’ EQUITY	383,261			404,323			390,925
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	652,002		$	859,653		$	662,682

See Notes to Condensed Consolidated Financial Statements.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share amounts)

(unaudited)

	Thirteen Weeks Ended						Twenty-six Weeks Ended
	July 30, 2005			July 31, 2004			July 30, 2005			July 31, 2004

Sales	$	253,118		$	277,182		$	538,528		$	581,665
Cost of sales	160,243			174,144			341,088			365,322
Gross profit	92,875			103,038			197,440			216,343
Selling, general and administrative expenses	103,145			108,899			209,012			218,595
Loss from operations	(10,270		)	(5,861		)	(11,572		)	(2,252		)
Other income	(1,114		)	(140		)	(1,455		)	(331		)
Interest expense	662			547			1,232			1,054
Loss before income taxes and extraordinary gain - unallocated negative goodwill	(9,818		)	(6,268		)	(11,349		)	(2,975		)
Income tax benefit	(2,871		)	(13,397		)	(3,448		)	(12,146		)
Income (loss) before extraordinary gain - unallocated negative goodwill	(6,947		)	7,129			(7,901		)	9,171
Extraordinary gain - unallocated negative goodwill, net of income taxes of 0, $1,367 and 0, $1,620, respectively	—			2,178			—			2,596
Net income (loss)	$	(6,947	)	$	9,307		$	(7,901	)	$	11,767

BASIC INCOME (LOSS) PER SHARE:
Income (loss) per share before extraordinary gain -unallocated negative goodwill	$	(0.21	)	$	0.20		$	(0.24	)	$	0.26
Extraordinary gain - unallocated negative goodwill, net of income taxes	—			0.06			—			0.07
Basic income (loss) per share	$	(0.21	)	$	0.26		$	(0.24	)	$	0.33

Weighted average number of common shares outstanding – basic	32,482			35,100			32,713			35,541

DILUTED INCOME (LOSS) PER SHARE:
Income (loss) per share before extraordinary gain -unallocated negative goodwill	$	(0.21	)	$	0.19		$	(0.24	)	$	0.24
Extraordinary gain - unallocated negative goodwill, net of income taxes	—			0.06			—			0.07
Diluted income (loss) per share	$	(0.21	)	$	0.25		$	(0.24	)	$	0.31

Weighted average number of common shares outstanding – diluted	32,482			36,855			32,713			37,231

See Notes to Condensed Consolidated Financial Statements.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Twenty-six Weeks Ended
	July 30, 2005			July 31, 2004
Net cash used by operating activities	$	(158,713	)	$	(118,972	)

Cash flows from investing activities:
Purchases of fixed assets	(17,021		)	(15,590		)
Acquisition of minority interest in subsidiary	—			(2,000		)
Proceeds from sale of available for sale securities	813			—
Net cash used by investing activities	(16,208		)	(17,590		)

Cash flows from financing activities:
Proceeds from long-term debt	—			5,760
Proceeds from capital leases	11,962			—
Payments of long-term debt	(220		)	(35		)
Payments of capital lease obligations	(692		)	(192		)
Payments for purchases of treasury stock	(18,759		)	(20,946		)
Proceeds from the exercise of stock options	3,796			683
Net cash used by financing activities	(3,913		)	(14,730		)

Net decrease in cash and cash equivalents	(178,834		)	(151,292		)
Cash and cash equivalents, beginning of year	229,768			191,219
Cash and cash equivalents, end of period	$	50,934		$	39,927
Supplemental disclosure of non-cash investing and financing activities:
Income tax benefit resulting from exercises of stock options	$	1,794		$	217
Issuance of shares under restricted stock plan	—			50

See Notes to Condensed Consolidated Financial Statements.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

July 30, 2005 and July 31, 2004

Note 1. Nature of Operations

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

Note 2: 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.

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. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. 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.

The information presented in the accompanying unaudited condensed consolidated balance sheet as of January 29, 2005 has been derived from the Company’s January 29, 2005 audited consolidated financial statements. All other information has been derived from the Company’s unaudited consolidated financial statements as of and for the thirteen and twenty-six weeks ended July 30, 2005 and July 31, 2004. 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 29, 2005. Certain reclassifications have been made to prior periods to conform to the current period presentation.

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 29, 2005.

Note 3. Seasonality

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

merchandise 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 releases, the performance of existing stores and new store openings or closings.

Note 4. Stock Based Compensation

The Company applies the intrinsic value-based method of accounting prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations including Financial Accounting Standards Board (“FASB”) Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation – An Interpretation of APB No. 25, in accounting for its fixed plan stock options. Under this method, compensation expense would be recorded on the date 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. Statement of Financial Accounting Standards (“SFAS”) No. 123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148, Accounting for Stock-Based Compensation – Transition and Disclosure, established accounting and disclosure requirements using a fair value-based method of accounting for stock-based employee compensation plans. As allowed by SFAS No. 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted the disclosure requirements of SFAS No. 123 and SFAS No.148.

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

Note 5. Defined Benefit Plan

The Company maintains a non-qualified Supplemental Executive Retirement Plan (“SERP”) for certain executives 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 and bonus at the time of retirement and number of years of service.

Prior to June 1, 2003, the Company provided the Board of Directors with a noncontributory, unfunded retirement plan (“Director Retirement Plan”) that paid 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 began at age 62 or retirement, whichever was later, and would continue for 10 years or the life of the director and his or her spouse, whichever period was shorter. Partial vesting in the retirement plan began after six years of continuous service. Participants became fully vested after 12 years of continuous service on the Board. As of June 1, 2003, new directors are no longer covered by the Director Retirement Plan. Current 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 Stock Option 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 Stock Option Plan as of the effective date.

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

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

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

Note 6. Extraordinary Gain

The Company acquired substantially all the net assets of Wherehouse Entertainment Inc. and CD World Inc. 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 were

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

Note 7. Long-Term Debt and Capital Lease Obligations

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

During 2004, the Company borrowed $5.8 million under a mortgage loan with South Trust Bank to finance the purchase of real estate. The mortgage loan is repayable in monthly installments of $64 thousand over 10 years with a fixed interest rate of 6.0% and is collateralized by the real estate. 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 8. Comprehensive Income (Loss)

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

	Thirteen Weeks ended					Twenty-six Weeks ended
	July 30, 2005			July 31, 2004		July 30, 2005			July 31, 2004
	($ in thousands)					($ in thousands)
Net income (loss)	$	(6,947	)	$	9,307	$	(7,901	)	$	11,767

Other comprehensive income, net of income taxes:
Change in unrealized gain on available-for-sale securities, net of income taxes of $306 and 0, respectively	—			—		442			—
Reclassification adjustment for realized gain on available-for-sale securities included in income	(442		)	—		(442		)	—
Total comprehensive income (loss)	$	(7,389	)	$	9,307	$	(7,901	)	$	11,767

Note 9. Recently Issued Accounting Standards

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

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

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

In December 2004, the FASB issued SFAS No. 123(R), Share-Based Payment: an amendment of FASB Statements No. 123 and 95. This Statement requires a public entity to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award at the grant date (with limited exceptions) and recognize the compensation cost over the period during which an employee is required to provide service in exchange for the award. In March 2005, the U.S. Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”), which expresses views of the SEC staff regarding the application of SFAS No. 123(R). Among other things, SAB 107 provides interpretive guidance related to the interaction between SFAS No. 123(R) and certain SEC rules and regulations, and provides the SEC staff’s views regarding the valuation of share-based payment arrangements for public companies. The Company is required to adopt SFAS No. 123(R) in its first quarter of fiscal 2006. The Company is currently evaluating the potential effects of this standard on its stock compensation arrangements and related effects on the Company’s condensed consolidated financial statements.

Note 10. Depreciation and Amortization

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

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

Note 11. Earnings Per Share

Weighted average shares are calculated as follows:

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

Anti-dilutive stock options	9,755	4,005	9,300	4,023

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

Note 12. Income Taxes

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

The Company recorded an income tax benefit of $10.5 million in the thirteen weeks ended July 31, 2004. The benefit was 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 in 1999. The original income tax payable amounts relating to the years covered by the examination were reversed subsequent to the final settlement resulting in the income tax benefit. With the closing of the tax examination, the Company has surrendered the remaining COLI policies.

TRANS WORLD ENTERTAINMENT CORPORATION AND SUBSIDIARIES

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

July 30, 2005 and July 31, 2004

Overview

Management’s Discussion and Analysis of Financial Condition and Results of Operations provides information that the Company’s management believes necessary to achieve an understanding of its 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; releases by the music, video, including DVD and VHS, and video games industries 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 29, 2005.

At July 30, 2005, the Company operated 797 stores totaling approximately 4.9 million square feet in 46 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, including DVD and VHS, and video games. In total, these categories represented 92% of the Company’s total sales in the thirteen weeks and twenty-six weeks ended July 30, 2005, respectively. The balance of categories, including software accessories, boutique and electronic products represented 8% of the Company’s total sales in the thirteen weeks and twenty-six weeks ended July 30, 2005, respectively.

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

Sales: The Company 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. Mall stores relocated in the same shopping center after being open for at least thirteen months are considered comparable stores. Closed stores that were open for at least thirteen months are included in comparable store sales through the month immediately preceding the month of closing. The Company further analyzes sales by store format (i.e., mall versus freestanding) and by product category.

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

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

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States 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 29, 2005 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. Merchandise inventory valuation requires significant judgment and estimates regarding obsolescence, shrink and any adjustments to market value, if market value is lower than cost. The Company records obsolescence and any adjustments to market value (if lower than cost) based on current and anticipated demand and market conditions. The provision for inventory shrink is estimated as a percentage of sales for the period from the last date a physical inventory was performed to the end of a period. Shrink estimates are based on historical results and trends. Physical inventories are taken at least annually for all stores, and inventory records are adjusted accordingly.

The Company is entitled to return merchandise purchased from major vendors for credit against other purchases from these vendors. Select vendors reduce the credit with a merchandise return charge ranging from 0% 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.

RESULTS OF OPERATIONS

Thirteen and Twenty-six Weeks Ended July 30, 2005

Compared to the Thirteen and Twenty-six Weeks Ended July 31, 2004

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

	Thirteen weeks ended													Twenty-six weeks ended
	July 30, 2005			July 31, 2004			Change			%		Comp Store Sales		July 30, 2005			July 31, 2004			Change			%		Comp Store Sales
	(in thousands)													(in thousands)

Sales	$	253,118		$	277,182		$	(24,064	)	-8.7	%	-4.8	%	$	538,528		$	581,665		$	(43,137	)	-7.4	%	-3.1	%
As a % of sales
Music	59		%	60		%						-6.6	%	58		%	59		%						-5.9	%
Video	27		%	27		%						-4.7	%	27		%	28		%						-3.6	%
Video Games	6		%	6		%						0.1	%	7		%	5		%						18.9	%
Other	8		%	7		%						4.8	%	8		%	8		%						5.2	%

Store Count:
Mall	552			584								-4.9	%												-3.2	%
Freestanding	245			269								-4.6	%												-2.9	%
Total	797			853

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

Music:

The Company’s stores offer a wide range of compact discs (“CDs”), audio cassettes and singles 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 and twenty-six weeks ended July 30, 2005, CD sales decreased 10% and 9%, respectively, over the thirteen and twenty-six weeks ended July 31, 2004. The Company’s overall unit sales in music decreased 11% and 12% respectively for the thirteen and twenty-six weeks ended July 30, 2005. The Company’s decrease in music sales was due to lower store count and a decrease in comparable store sales consistent with the decline in industry sales during the period.

Video:

The Company offers home video and software, including DVDs and videocassettes, in all of its stores. Comparable store sales in the DVD category decreased 1% in the thirteen weeks ended July 30, 2005 and increased 1% during the twenty-six week period ending July 30, 2005.

Video Games:

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

Other:

The Company offers items relating to the use, care and storage of entertainment software, along with boutique and electronic products. Comparable store sales increased 4.8% and 5.2%, respectively in the thirteen and twenty-six weeks ended July 30, 2005. The increase is due to the Company’s merchandising initiatives to improve this category, including the expansion of product lines and adding new items to complement the core merchandise categories of music, video and video games.

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

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

As a % of sales	36.7		%	37.2		%						36.7		%	37.2		%

The decrease in the gross profit as a percentage of sales was due to a shift in the mix of the Company’s sales toward the lower margin categories of DVD and games.

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

	Thirteen weeks ended											Twenty-six weeks ended
	July 30,			July 31,			Change					July 30,			July 31,			Change
	2005			2004			$			%		2005			2004			$			%
	(in thousands)											(in thousands)
SG&A	$	103,145		$	108,899		$	(5,754	)	(5.3	)%	$	209,012		$	218,595		$	(9,583	)	(4.4	)%

As a % of sales	40.7		%	39.3		%						38.8		%	37.6		%

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

Other Income. Other income includes interest income and a realized gain of $0.8 million on the sale of available-for-sale securities for the thirteen and twenty-six weeks ended July 30, 2005. Other income includes interest income for the thirteen and twenty-six weeks ended July 31, 2004.

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

	Thirteen weeks ended							Twenty-six weeks ended
	July 30, 2005			July 31, 2004				July 30, 2005			July 31, 2004
	(in thousands)							(in thousands)
Income tax benefit before IRS settlement benefit in 2004	$	(2,871	)	$	(2,852		)	$	(3,448	)	$	(1,601		)

Effective tax rate before IRS settlement benefit in 2004	29.2		%	45.5			%	30.4		%	53.8			%

IRS settlement benefit	—			(10,545			)	—			(10,545			)

Income tax benefit	$	(2,871	)	$		(13,397	)	$	(3,448	)	$		(12,146	)

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

Extraordinary Gain – Unallocated Negative Goodwill. In October 2003, the Company acquired substantially all of the net assets of Wherehouse Entertainment Inc. and CD World Inc. During the thirteen and twenty-six weeks ended July 31, 2004, the Company adjusted the purchase price allocation in accordance with the provisions of SFAS No. 141, resulting in extraordinary gain of $2.2 million and $2.6 million, net of income taxes of $1.4 million and $1.6 million respectively, related to unallocated negative goodwill. The gain represents the excess of the fair value of net assets acquired over the purchase price.

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

	Thirteen weeks ended					Twenty-six weeks ended
	July 30, 2005			July 31, 2004		July 30, 2005			July 31, 2004
	(in thousands)					(in thousands)
Income (loss) before extraordinary gain	$	(6,947	)	$	7,129	$	(7,901	)	$	9,171

Extraordinary gain – unallocated negative goodwill, net of income taxes of 0, $1,367 and 0, $1,620, respectively	—			2,178		—			2,596

Net income (loss)	$	(6,947	)	$	9,307	$	(7,901	)	$	11,767

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

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, merchandise inventory purchases and the related terms on the purchases, tax payments, capital expenditures and stock repurchase activity. Management believes the Company 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 twenty-six weeks ended July 30, 2005 and July 31, 2004:

	Twenty-six weeks ended						Change
(in thousands)	July 30, 2005			July 31, 2004			$
Operating Cash Flows	$	(158,713	)	$	(118,972	)	$	(39,741	)
Financing Cash Flows	(3,913		)	(14,730		)	10,817

Capital Expenditures	(17,021		)	(15,590		)	(1,431		)

Cash and Cash Equivalents	50,934			39,927			11,007
Inventories	401,051			422,209			(21,158		)
Working Capital	265,836			250,008			15,828

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

Cash used by operating activities was $158.7 million for the twenty-six weeks ended July 30, 2005. The primary uses of cash were a $176.2 million seasonal reduction of accounts payable and $15.6 million reduction in income taxes payable, offset by a $30.2 million decrease in merchandise inventory. 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, merchandise 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 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 seasonal increase in sales during the holiday season (see Note 3 of Notes to the Condensed Financial Statements).

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

PART II - OTHER INFORMATION

Item 2 – Changes in Securities and Use of Proceeds

On May 28, 2003, the Company’s Board of Directors authorized the repurchase of 10 million outstanding shares of the Company’s Common Stock from time to time on the open market. The program has no expiration date. The Company had repurchased 15 million shares of common stock under previously announced programs. As of July 30, 2005 the Company had purchased 8.3 million shares, at a total cost of $75.9 million, and 1.7 million shares remained to be purchased under the current program. 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
May 1, 2005 – May 28, 2005	223,800	$	12.51	223,800	2,331,641
May 29, 2005 – June 25, 2005	314,700	$	12.82	314,700	2,016,941
June 26, 2005 – July 30, 2005	315,500	$	11.95	315,500	1,701,441
Total	854,000	$	12.42	854,000	1,701,441

Item 4 - Submission of Matters to a Vote of Security Holders

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

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

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

C) A proposal to adopt the Trans World Entertainment Corporation 2005 Long Term Incentive and Share Award Plan was approved as follows:

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

Item 6 - Exhibits and Reports on Form 8-K

(A) Exhibits -

Exhibit No.		Description
31.1		Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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

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

(B) Reports on Form 8-K –

A Form 8-K was filed on July 11, 2005, incorporating by reference Trans World Entertainment’s press release dated July 7, 2005, announcing guidance for the second quarter.

A Form 8-K was filed on August 11, 2005 incorporating by reference the Company’s August 11, 2005 press release announcing the Company’s financial results for the thirteen weeks ended July 30, 2005.

A Form 8-K was filed on June 14, 2005 incorporating by reference the Company’s June 13, 2005 press release announcing the election of Lori J. Schafer to its Board of Directors.

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

PART 1. FINANCIAL INFORMATION

Item 1 - Financial Statements

Condensed Consolidated Balance Sheets (unaudited) at July 30, 2005,
January 29, 2005 and July 31, 2004 (unaudited)

Condensed Consolidated Statements of Operations (unaudited) –
Thirteen Weeks and Twenty-six Weeks Ended July 30, 2005 and July 31, 2004

Condensed Consolidated Statements of Cash Flows (unaudited)–
Twenty-six Weeks Ended July 30, 2005 and July 31, 2004

Notes to Condensed Consolidated Financial Statements (unaudited)

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

Item 3 – Quantitative and Qualitative Disclosures about Market Risk

Item 4 – Controls and Procedures

PART II. OTHER INFORMATION

Item 2 – Changes in Securities and Use of Proceeds

Item 4 - Submission of Matters to a Vote of Security Holders

Item 6 - Exhibits and Reports on Form 8-K

Signatures

TRANS WORLD ENTERTAINMENT CORPORATION

September 8, 2005	By:	/s/ ROBERT J. HIGGINS
	Robert J. Higgins
	Chairman and Chief Executive Officer
	(Principal Executive Officer)

September 8, 2005	By:	/s/ JOHN J. SULLIVAN
	John J. Sullivan
	Executive Vice President and Chief Financial Officer (Principal Financial and Chief Accounting Officer)

38 Corporate Circle

January 29, 2005 and July 31, 2004 (unaudited)

The decrease in the gross profit as a percentage of sales was due to a shift in the mix of the Company’s sales toward the lower margin categories of DVD and games.

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