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Article by DailyStocks_admin    (10-22-08 03:16 AM)

Trans World Entertainment Corp. CEO ROBERT J HIGGINS bought 100000 shares on 10-09-2008 at $2.2


Company Background

Trans World Entertainment Corporation, which, together with its consolidated subsidiaries, is referred to herein as ‚Äúthe Company‚ÄĚ, was incorporated in New York in 1972. It owns 100% of the outstanding common stock of Record Town, Inc., through which its principal operations are conducted. The Company operates retail stores and five e-commerce sites and is one of the largest specialty retailers of entertainment software, including music, home video, and video games and related products in the United States.

In March 2006, the Company acquired substantially all of the net assets of Musicland Holding Corp. (‚ÄúMusicland‚ÄĚ). Musicland, an entertainment specialty retailer which operated retail stores and websites under the names Sam Goody (samgoody.com), Suncoast Motion Picture Company (suncoast.com), On Cue and MediaPlay.com, filed a voluntary petition to restructure under Chapter 11 of the United States Bankruptcy Code in January 2006. The transaction represented total consideration of $78.8 million in cash and $16.3 million in assumed liabilities, including certain customer obligations, rent and occupancy liabilities and employee obligations. Under the terms of the Asset Purchase Agreement, the Company agreed to acquire 335 of Musicland‚Äôs 400 remaining stores, with the remainder of the stores being liquidated under an agency agreement with Hilco Merchant Resources, LLC. As of February 3, 2007 the Company operated 210 of the 335 acquired stores. See Note 3 of Notes to the Consolidated Financial Statements of this Annual Report on Form 10-K for detail.

In March 2006, the Company acquired an 80% interest in Mix & Burn LLC, a company that is fully consolidated for financial reporting. The Company committed funding of $5.2 million, of which $4.0 million was funded as of February 3, 2007.

Stores and Store Concepts

At February 3, 2007, the Company operated 992 stores totaling approximately 6.0 million square feet in the United States, the District of Columbia, the Commonwealth of Puerto Rico and the U.S. Virgin Islands.

Mall Stores

At February 3, 2007, the Company operated 737 mall-based stores, predominantly under the f.y.e. (‚ÄúFor Your Entertainment‚ÄĚ) brand, including:

Traditional stores . The Traditional store averages about 5,600 square feet and carries a full complement of entertainment software, including music, home video, video games and related accessories. There were 587 Traditional f.y.e. stores at the end of Fiscal 2006.

Superstores. The Superstores carry the same merchandise categories as Traditional locations, but with a much broader and deeper assortment. This concept is a semi-anchor or destination location in major regional malls. There were 13 f.y.e. mall Superstores at the end of Fiscal 2006 that averaged about 24,000 square feet.

Video only stores. At the end of Fiscal 2006, the Company operated 137 video only stores, under the Suncoast and Saturday Matinee brands. These stores specialize in the sale of home video and related accessories. They are located in large, regional shopping malls and average about 2,400 square feet.

Freestanding Stores

The Company operated 255 freestanding stores, as of February 3, 2007, under the brand names of f.y.e. (‚ÄúFor Your Entertainment‚ÄĚ), Sam Goody, Coconuts Music and Movies, Strawberries, Wherehouse Music and Movies, CD World, Spec‚Äôs Music, and Second Spin. They carry a full complement of entertainment software, including music, home video, video games and related accessories and are located in freestanding, strip center and downtown locations. The freestanding stores average approximately 6,400 square feet (excluding f.y.e. Superstores and Planet Music). The Company operates 6 freestanding f.y.e. Superstores that average about 53,000 square feet and a single 31,400 square foot Planet Music store in Virginia Beach, VA.

The Company is in the process of re-branding its freestanding stores to f.y.e. (‚ÄúFor Your Entertainment‚ÄĚ). This initiative is expected to be completed during Fiscal 2007.

E-Commerce Sites

The Company operates five retail web sites including, www.fye.com, www.wherehouse.com, www.secondspin.com, www.samgoody.com and www.suncoast.com. These sites offer substantially the same complement of products as offered in the Company’s stores.

Business Environment

Music, home video and video games represent an approximately $38 billion industry nationwide, and represented approximately 90% of the Company’s sales in Fiscal 2006.

According to statistics from Nielsen Soundscan, the total number of music albums sold, including CD, cassette, LP and digital albums, was 588.2 million units in 2006, a 4.9% decline from 2005. Excluding digital albums, total sales were 555.6 million units in 2006, a 7.8% decline from 2005.

According to statistics obtained from Rentrak Home Video Essentials, overall home video sales in 2006, including DVD and VHS, were $15.9 billion, a decrease of 0.9% from 2005. DVD retail sales in 2006 were $15.7 billion, flat compared to 2005.

The NPD Group published that video games sales in 2006 were $12.5 billion including portable and console hardware, software and accessories, an increase of 19% over 2005 sales.


Music sales have suffered from the legal (e.g., iTunes) and illegal downloading of music and specialty retailers have been impacted by the proliferation of mass merchants (e.g., Wal-Mart and Target) and electronics superstores (e.g., Best Buy and Circuit City) that offer entertainment software and have gained a larger share of the market. The number of specialty and independent retailers has dramatically decreased due to their reliance on sales of recorded music. The Company has taken advantage of competitor exits from markets, made acquisitions, diversified its products and taken other measures to position itself competitively within its industry. The Company believes it effectively competes in the following ways:
‚ÄĘLocation and convenience: a strength of the Company is its convenient store locations that are often the exclusive retailer in centers offering a full complement of entertainment software;

‚ÄĘMarketing: the Company uses newspaper, radio and television advertising and in-store visual displays to market to consumers;

‚ÄĘSelection and assortment: the Company differentiates itself by maintaining a high in-stock position in a large assortment of product, particularly CDs and DVDs;

‚ÄĘCustomer service: the Company believes it offers personalized customer service at its stores;

‚ÄĘListening and Viewing Stations (‚ÄúLVS‚ÄĚ): the Company‚Äôs LVS is a sampling and selection tool designed to encourage customer purchases. The third generation of LVS (‚ÄúLVS 3‚ÄĚ) is currently installed in over 700 of the Company‚Äôs stores. LVS 3 enhances the customers‚Äô in-store experience through improved product information displays and product search and suggestion capabilities;

‚ÄĘ In-store CD burning and digital downloading: The Company has begun offering CD burning and digital downloading stations in selected stores and plans on expanding these capabilities to a greater number of stores in Fiscal 2007.


The Company’s business is seasonal, with the fourth fiscal quarter constituting the Company’s peak selling period. In Fiscal 2006, the fourth quarter accounted for approximately 40% 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 full-time 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 could be adversely affected. Quarterly sales can also be affected by the timing of new product releases, new store openings or closings and the performance of existing stores.


The Company makes extensive use of visual displays. It uses a mass-media marketing program, including newspaper, radio, and television advertisements. The majority of vendors from whom the Company purchases merchandise offer advertising allowances to promote their merchandise.

Suppliers and Purchasing

The Company purchases inventory from approximately 990 suppliers. In Fiscal 2006, 68% of purchases were made from ten suppliers including EMI Music Distribution, Sony-Bertelsmann Music Group, Warner/Electra/Atlantic Corp., Universal Music and Video Distribution, Fox Video Inc., Paramount Home Video, Buena Vista Home Video, Warner Home Entertainment, Universal Studios Home Entertainment and Sony Pictures Home Entertainment. The Company does not have material long-term purchase contracts; rather, it purchases products from its suppliers on an order-by-order basis. Historically, the Company has not experienced difficulty in obtaining satisfactory sources of supply and management believes that it will continue to have access to adequate sources of supply.

Trade Customs and Practices

Under current trade practices with large suppliers, retailers of music and home video products are generally entitled to return unsold merchandise they have purchased in exchange for other titles carried by the suppliers. Two of the four largest music suppliers charge a related merchandise return penalty and the remaining two largest suppliers charge a combination of return penalties and return handling fees. Most manufacturers and distributors of home video products do not typically charge a return penalty or handling fee. Under current trade practices with large suppliers, retailers of video games and related products are generally entitled to markdown support from suppliers to help clear slow turning merchandise. Merchandise return policies and other trade practices have not changed significantly in recent years. The Company generally adapts its purchasing policies to changes in the policies of its largest suppliers.


As of February 3, 2007, the Company employed approximately 9,600 people, of whom approximately 4,400 were employed on a full-time basis. All others were employed on a part-time or temporary basis. The Company hires seasonal sales employees during its fourth quarter peak selling season to ensure continued levels of customer service. Store managers, district managers and regional managers are eligible to receive incentive compensation based on the sales and profitability of stores for which they are responsible. Sales support managers are generally eligible to receive incentive compensation based on the sales and profitability of the Company as a whole. None of the Company’s employees are covered by collective bargaining agreements and management believes that the Company enjoys favorable relations with its employees.


Robert J. Higgins, Chairman of the Board, founded the Company in 1972, and he has participated in its operations since 1973. Mr. Higgins has served as Chairman and Chief Executive Officer of the Company for more than the past five years. He is also the Company‚Äôs principal shareholder. See ‚ÄúPRINCIPAL SHAREHOLDERS.‚ÄĚ

Mark A. Cohen has been a Professor at Columbia University Graduate School of Business since April of 2006. Prior to his Professorship, Mr. Cohen was the Chairman and Chief Executive Officer of Sears Canada Inc. from January 2001 to August 2004. Mr. Cohen joined Sears, Roebuck and Company as Senior Vice President, Merchandising in 1998. From December 1998 until August 1999 he served as Executive Vice President, Marketing before being promoted to Chief Marketing Officer and President, Softlines. Prior to joining Sears, Mr. Cohen held various positions at other retailers, including Bradlee’s Department Stores, Federated Department Stores, Dayton Hudson Corporation, Gap Stores and Lord & Taylor.

Dr. Joseph G. Morone has been the President and CEO of Albany International Corp since January 2006 and President since August 2005. From August 1997 to July 2005 he was the President of Bentley College. Previously, Dr. Morone was the Dean of Rensselaer Polytechnic Institute’s Lally School of Management and Technology from July 1993 to July 1997. Prior to his appointment as dean, Dr. Morone held the Andersen Consulting Professorship of Management and was Director of the School of Management’s Center for Science and Technology Policy. Before joining the School of Management in 1988, Dr. Morone was a senior associate for the Keyworth Company, a consulting firm specializing in technology management and science policy. Dr. Morone also served in the White House Office of Science and Technology Policy and spent seven years at General Electric Company’s Corporate Research and Development. Dr. Morone also serves on the Board of Directors of Albany International Corp.

Brett Brewer has been the President at Adknowledge, Inc., a behavioral based advertising company, since November 2006. Prior to joining Adknowledge, Mr. Brewer served as President and a Director of Intermix Media from August 29, 2000 until October 2005 when the company was sold to NewsCorp. Prior to joining Intermix Media, Inc., Mr. Brewer helped run the Southern California Retail Sales Division of CB Richard Ellis between October 1996 and December 1998. Mr. Brewer also serves on the Board of Directors of Treemo.com and Bizworld, Inc.

Martin E. Hanaka has served as Chairman of Golfsmith International Holdings since April 2007. He also has served as Chairman Emeritus of the Board of The Sports Authority, Inc. since June 2004. Mr. Hanaka was the Chairman of the Board of The Sports Authority from November 1999 until June 2004 and was its Chief Executive Officer from September 1998 until August 2003. Mr. Hanaka joined The Sports Authority’s Board of Directors in February 1998. From August 1994 until October 1997, Mr. Hanaka served as President and Chief Operating Officer of Staples, Inc. an office supply superstore retailer. Mr. Hanaka is also a Director of The Sports Authority and Brightstar Corporation, a wireless wholesale distributor.

Isaac Kaufman, a Certified Public Accountant, has been Chief Financial Officer and Senior Vice President of Advanced Medical Management Inc., a manager of medical practices and an outpatient surgical center, since September 1998. Mr. Kaufman was Executive Vice President and Chief Financial Officer of Bio Science Contract Production Corporation, a contract manufacturer of biologics and pharmaceutical products, from February 1998 to September 1998. Mr. Kaufman serves as a Director of Kindred Healthcare, Inc. (operates nursing centers and long-term acute care hospitals) and Hanger Orthopedics (operates Orthotics and Prosthesis patient care centers).

Lori J. Schafer has served as Vice President of SAS’ global retail practice, since October of 2003, when Marketmax was acquired by SAS. Before joining SAS, Schafer served as Chairman, President and Chief Executive Officer of Marketmax Inc., a merchandise intelligence software company acquired by SAS in October 2003.She has directed Marketmax operations since 1996. Prior to her move into retail consulting and software development, Ms. Schafer held positions of increasing and diverse responsibility at The Procter & Gamble Company, including assignments in brand management, sales and management information systems. Ms. Schafer is also a Director at A.C. Moore Arts and Crafts, Inc and geoVue, Inc.

Michael B. Solow is the Managing Partner of the Chicago office of Kaye Scholer LLP, an international law firm based out of New York City, where he has practiced since January 2001 and is currently a member of the firm’s Executive Committee and Co-Chairman of the Corporate Restructuring Practice Group. Prior to joining Kaye Scholer LLP, Mr. Solow was a Partner and Practice Manager for the Financial Services Practice at Hopkins & Sutter, a Chicago, Illinois law firm. Mr. Solow is also a member of the Board of Directors for Christen Residential Trust, Inc. and has previously served on other corporate boards, including Camelot Music, Inc.

Edmond S. Thomas, a Certified Public Accountant, has served as President and Co-Chief Executive Officer of Tilly’s, Inc., a privately held men and women’s apparel retailer, since September 2005. Mr. Thomas also has served as Managing Partner of The Evans Thomas Company, LLC, a privately held consumer goods advisory firm, and AXIS Capital Fund I, LP, an investment fund, since 2000. Prior to that, Mr. Thomas served as President, Chief Operating Officer, and Director of The Wet Seal, Inc., a publicly traded women’s apparel retailer, from 1992 to 2000. Mr. Thomas is currently a member of the Board of Directors of Directed Electronics., a publicly traded designer and marketer of consumer branded vehicle security and convenience systems, and Comark, Inc., a privately held Canadian apparel retailer.


Components of Executive Compensation

The Company’s compensation program for its named executive officers consists of the following components:

Base Salary. Base salaries for our executives are established based on the scope of their responsibilities, taking into account competitive market compensation paid by other companies for similar positions. Base salaries are reviewed annually, and adjusted from time to time to realign salaries with market levels after taking into account individual responsibilities, performance and experience. For 2007, the executives will receive grants of restricted stock in lieu of merit increases.

Annual Incentives. Our annual incentive bonus plan, approved by shareholders, provides for a cash bonus, dependent upon the level of achievement of the stated corporate goals and personal performance goals, calculated as a percentage of the officer‚Äôs base salary, with higher ranked executive officers being compensated at a higher percentage of base salary. The Compensation Committee approves the annual incentive award for the Chief Executive Officer and for each officer below the Chief Executive Officer level, based on the Chief Executive Officer‚Äôs recommendations. For 2007, the target bonus awards (as a percentage of base salary) will be as follows: Chief Executive Officer, 75%; Chief Operating Officer, 50%; Executive Vice President, 40%; Senior Vice President, 35%; and Vice President, 30%. Depending on the achievement of the predetermined targets, the annual bonus may be less than or greater than the target bonus. Maximum payout (as a percentage of base salary) for officers is as follows: Chief Executive Officer, 150%; Chief Operating Officer, 120%; Executive Vice President, 100%; Senior Vice President, 80%; and Vice President, 60%. Further information regarding the 2007 bonus opportunities to our named executives is set forth under ‚Äė‚ÄėGrant of Equity and Incentive Plan-Based Awards‚Äô‚Äô.

For fiscal 2006 and 2007, the Committee approved a special bonus plan designed to reward select associates, including Executive Officers for exceptional performance. The plan would pay an incentive bonus for company operating income performance above the levels required to pay maximum bonuses under the annual incentive bonus plan. During 2006, the Company failed to achieve the operating income levels required to payout bonuses per the special bonus plan. For 2007, the target operating income level to begin payout under the plan is $48.1 million.

Long-Term Incentive Program. We believe that long-term performance is achieved through an ownership culture that encourages long-term performance by our executive officers through the use of stock-based awards. During 2005, our Board of Directors adopted and Shareholders’ approved the Long Term Share and Incentive Award Plan, which permits the grant of stock options, stock appreciation rights, restricted shares, restricted stock units, performance shares, and other stock-based awards. Historically the Company has granted equity awards to employees, including Executive Officers, each May 1. The determination of the size of any long-term equity compensation grant is made based on competitive factors and the attainment of strategic long term objectives. Equity compensation and stock ownership serve to link the net worth of Executive Officers to the performance of our common stock. In 2007, we intend to provide long-term awards through stock settled appreciation rights, which will vest based on continued employment.

Retirement and Other Benefits. The Company’s benefits program includes retirement plans and group insurance plans. The objective of the program is to provide Executive Officers with reasonable and competitive levels of protection against the four contingencies (retirement, death, disability and ill health) which could interrupt the Executive Officer’s employment and/or income received as an active employee. Retirement plans, including the supplemental executive retirement plans that cover the Executive Officers, are designed to provide a competitive level of retirement income to Executive Officers and to reward them for continued service with the Company. The retirement program for Executive Officers consists of a supplemental executive retirement plan.

The group insurance program consists of life, disability and health insurance benefit plans that cover all full-time management and administrative employees and the supplemental long-term disability plan, which covers Executive Officers and other Officers.

Other Compensation. We continue to maintain modest executive benefits and perquisites for officers; however, the Compensation Committee in its discretion may revise, amend or add to the officer’s executive benefits and perquisites if it deems it advisable. We believe these benefits and perquisites are currently below median competitive levels for comparable companies.



Management‚Äôs Discussion and Analysis of Financial Condition and Results of Operations provides information that the Company‚Äôs 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‚Äôs merchandise, including the entry or exit of non-traditional retailers of the Company‚Äôs merchandise to or from its markets; releases by the music, video and video games industries of an increased or decreased number of ‚Äúhit releases‚ÄĚ; general economic factors in markets where the Company‚Äôs merchandise is sold; and other factors discussed in the Company‚Äôs filings with the Securities and Exchange Commission. The following discussion and analysis of the Company‚Äôs 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‚Äôs Annual Report on Form 10-K for the fiscal year ended February 3, 2007.

As of November 3, 2007, the Company operated 962 stores totaling approximately 5.8 million square feet in the United 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 and related products. In total, these categories represented 88% of the Company’s sales in the thirty-nine weeks ended November 3, 2007. The balance of categories, including electronics, accessories and boutique products represented 12% of the Company’s sales in the thirty-nine weeks ended November 3, 2007.

The Company’s success has been, and will continue to be, contingent upon management’s ability to understand general economic and business trends and to manage the business in response to those trends. Management monitors a number of key performance indicators to evaluate its performance, including:

Net 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 and by product category.

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

Selling, General and Administrative (‚ÄúSG&A‚ÄĚ) 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 disclosed in Note 9 to the unaudited 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.


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, stock-based compensation and accounting for gift card liability. 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 February 3, 2007 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, with cost being determined by the average cost method. The average cost method attaches a cost to each item and is a blended average of the original purchase price and those of subsequent purchases or other cost adjustments throughout the life cycle of that item.

Inventory valuation requires significant judgment and estimates, including obsolescence, shrink and any adjustments to market value, if market value is lower than cost. Inherent in the entertainment software industry is the risk of obsolete 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 items to become obsolete. These credits are recorded in cost of sales. 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. 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 the fiscal year. Such estimates are based on historical results and trends and the shrink results from the last physical inventory. Physical inventories are taken at least annually for all stores throughout the year and 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. Major music vendors reduce the credit with a per unit charge which varies depending on the type of merchandise being returned. The Company records these charges in cost of sales.

Valuation of Long-Lived Assets:

The Company assesses the potential 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 historical or projected future operating 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;

If the Company determines that the carrying value of a long-lived asset may not be recoverable, it tests for impairment to determine if an impairment charge is needed.

Income Taxes:

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 and viable tax planning strategies. 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. The accounting for tax positions in accordance with FIN 48 requires management to make estimates relative to the likelihood of realization upon ultimate settlement of uncertain tax positions. For additional discussion regarding income taxes refer to Note 7 to the condensed consolidated financial statements in this Quarterly Report on Form 10-Q and Note 6 to the consolidated financial statements in the Annual Report on Form 10-K for the year ended February 3, 2007.

Stock-based Compensation:

The Company accounts for stock-based compensation under SFAS No. 123(R) which requires compensation to be recorded based on the fair value of stock awards on the date of grant. Determining the amount of stock-based compensation to be recorded requires the Company to develop estimates to be used in calculating the grant-date fair value of stock options. The Company calculates the grant-date fair values using the Black-Scholes valuation model. The Black-Scholes model requires the Company to make estimates of the following assumptions:

Expected volatility‚ÄĒThe estimated stock price volatility was derived based upon the Company‚Äôs actual historic stock prices over the expected life of the options, which represents the Company‚Äôs best estimate of expected volatility.

The amount of stock-based compensation recognized during a period is based on the value of the portion of the awards that are ultimately expected to vest. SFAS No. 123(R) requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The term ‚Äúforfeitures‚ÄĚ is distinct from ‚Äúcancellations‚ÄĚ or ‚Äúexpirations‚ÄĚ and represents only the unvested portion of the surrendered option. The Company reviewed historical forfeiture data and determined the appropriate forfeiture rate based on that data. The Company will re-evaluate this analysis periodically and adjust the forfeiture rate as necessary. Ultimately, the Company will recognize the actual expense over the vesting period only for the shares that vest.

Accounting for Gift Card Liability:

The Company sells gift cards that are redeemable only for merchandise and have no expiration date. The Company reverses card liability when either: customers redeem cards, at which point the Company records revenue; or the Company determines it does not have a legal obligation to remit unredeemed cards to the relevant jurisdictions and the likelihood of the cards being redeemed becomes remote, at which point the Company records breakage as a credit to SG&A expenses. The Company’s accounting for gift cards is based on estimating the Company’s liability for future card redemptions at the end of a reporting period. Estimated liability is equal to two years of unredeemed cards, plus an amount for outstanding cards that may possibly be redeemed for the cumulative look-back period, exclusive of the last two years. The Company’s ability to reasonably and reliably estimate the liability is based on historical redemption experience with gift cards and similar types of arrangements and the existence of a large volume of relatively homogeneous transactions. The Company’s estimate is not susceptible to significant external factors and the circumstances around gift card sales and redemptions have not changed significantly over time.

Thirteen and Thirty-nine Weeks Ended November 3, 2007
Compared to the Thirteen and Thirty-nine Weeks Ended October 28, 2006

Net Sales. Net sales decreased 12% and 8%, respectively, during the thirteen and thirty-nine weeks ended November 3, 2007. The decrease in net sales was due, in part, to comparable store sales declines of 4% and 7%, respectively, during the thirteen and thirty-nine weeks ended November 3, 2007. Additionally, during the thirteen and thirty-nine weeks ended November 3, 2007, the Company operated, on average, 13% and 4% fewer stores, respectively, as compared to the thirteen and thirty-nine week periods ended October 28, 2006.


The Company‚Äôs stores and Internet websites offer a wide range of compact discs (‚ÄúCDs‚ÄĚ) and music DVDs across most music genres, including new releases from current artists as well as an extensive catalog of music from past periods and artists. The CD category represented 96% of total music sales for the thirty-nine weeks ended November 3, 2007.

During the thirteen and thirty-nine weeks ended November 3, 2007, CD sales in comparable stores decreased 23% and 22%, respectively, as compared to the thirteen and thirty-nine weeks ended October 28, 2006. The decrease is related to continued CD industry sales declines. Comparable store sales for the total music category, including music DVD, were down 21% during the thirteen weeks ended November 3, 2007.


The Company offers video products, including DVD and HD DVD, in all of its stores. Comparable store sales in the video category increased 8% and 7%, respectively, during the thirteen and thirty-nine weeks ended November 3, 2007. The increase in video sales was driven by increased space and inventory allocations.

Video Games:

The Company offers video game hardware and software in many of its stores. Comparable store sales increased 29% during the thirteen weeks ended November 3, 2007, while increasing 9% during the thirty-nine week period ended November 3, 2007. The comparable store sales improvement in the video game category is due to greater hardware availability and improved software sales.


The Company offers accessory items for the use, care and storage of entertainment software, along with boutique and electronic products . Comparable store sales, on a combined basis, increased 22% and 18%, respectively, during the thirteen and thirty-nine weeks ended November 3, 2007 . In addition, on a combined basis, these categories represented 12% of total sales during the thirty-nine weeks ended November 3, 2007 compared to 10% for the thirty-nine weeks ended October 28, 2006. The growth of this category has been primarily due to increased sales of electronics and boutique products through better product assortments and lifestyle statements.

The decrease in gross profit as a percentage of net sales for the thirteen weeks ended November 3, 2007 compared to the thirteen weeks ended October 28, 2006 is due to a lower amount of vendor allowances being earned as a result of product sales. The increase in gross profit as a percentage of net sales for the thirty-nine weeks ended November 3, 2007 as compared to last year represents higher merchandise margin in the Company’s core categories of music and video.

The $14.9 million decrease in SG&A expenses for the thirteen weeks ended November 3, 2007 compared to prior year is due to the Company operating an average of 13% fewer stores during the quarter compared to the thirteen weeks ended October 28, 2006. The $24.2 million decrease in SG&A expenses for the thirty-nine weeks ended November 3, 2007 compared to prior year is due to the operation of fewer stores and the absence of approximately $7.6 million in transition costs related to the

acquisition of Musicland in 2006. The increase in SG&A expenses as a percentage of net sales for the thirteen and thirty-nine weeks ended November 3, 2007 compared to the thirteen and thirty-nine week periods ended October 28, 2006 is due to the respective sales declines.

Interest Expense. Interest expense was $1.9 million and $5.2 million during the thirteen and thirty-nine weeks ended November 3, 2007 compared to $1.7 million and $4.1 million for the thirteen and thirty-nine weeks ended October 28, 2006. The increase is due to higher average borrowings under the Company’s revolving credit facility.

Other Income. Other income includes interest income and a realized gain of $3.5 million on the sale of an investment in an unconsolidated affiliate recorded during the second quarter of 2006.


Bob Higgins

Thank you, Christopher and good morning everyone. On the call with me today are Jim Litwak, our President and Chief Operating Officer, and John Sullivan, our Chief Financial Officer. Thank you for joining us today, as we discuss our second quarter results. We will take questions following our comments.

Total sales in the second quarter decreased 19% to $215 million. Comp store sales decreased 7%. Our pre-tax loss for the second quarter was $19.6 million compared to $18.6 million last year. Our performance was on plan for the quarter. Jim will now take you through the sales highlights for the quarter, Jim?

Jim Litwak

Thank you Bob, good morning. As Bob mentioned overall Q2 comp sales declined 7%, this was primarily driven by the continued declines in the music category, which was down 17% on a comp basis. However this was an improvement over the first quarter decline of a negative 23%. This was helped by a strong performance of two titles released in the quarter, Little Wayne, which nationally did one million units in the first week, and Coldplay, which did 750,000 units in its first week.

Also during the quarter we did a store-by-store review of the catalog titles we carry and remixed our selection to better meet the demands of the customer. We are already seeing an improvement in our catalog sales performance. As the music business continues to decline nationally we are committed to improving our market share.

Video sales increased 1% on a comparable basis with a weakness in new releases. This lack of new releases caused top 50 to decline 11%. Video now represents 39% of our business up from 36% last year. Our strength in catalog continues to drive this business as the studios recognize our ability to differentiate ourselves versus the competition through expanded assortment and depth of product.

Comparable store sales in our video game category decreased 10% and represented 8% of our business the same as last year. Last September we reduced the number of stores carrying video games to 400 from 600 with the strategy to build this business on the allocations of product to fewer stores and strengthening our game selling culture. While we experienced that the results of these 400 stores the allocation of hardware continues to hamper our overall growth and hurt our ability to attach more software.

We remain committed to improving the business. Comparable store sales for electronics accessories and trends increased 6% on a combined basis and represents 14% of our business in the quarter compared to 13% last year. We continue to improve these categories and we have set the stage for growth going forward.

We continue to strengthen the foundation to provide all things entertainment to our customers. We are tailoring our selection to meet our customers needs including strengthening the promotional aspects of the business and improving our selling culture and while we drive down our inventory investment our products remix efforts are bearing fruit. This enabled us to realize improvement in the declining trend of music. John will now take you through the financial results of our second quarter.

John Sullivan

Thank you, Jim. Good morning. Our net loss for the quarter was $19.2 million or $0.62 per share. Last year our net loss was $10.1 million or $0.32 per share. Our loss before income taxes was $19.6 million for the quarter compared to $18.6 million last year. As mentioned in prior conference calls the company will not be recording a tax benefit against pre-tax losses in accordance with the circumstances requiring us to record a full valuation allowance against the deferred tax assets at the end of fiscal 2007.

Accordingly the company recorded an income tax benefit of just $419,000 during the quarter compared to an income tax benefit of $8.5 million last year. Our gross margin rate for the quarter decreased to 35.3% from 36.6% last year. The decline was due to lower vendor allowances this year versus last year.

SG&A expenses were $89.1 million, which is a reduction of 16% and the sales decline of 19% increasing the percent of sales to 190 basis points to 41.4% from last years 39.5%. Our EBITDA was a loss of $13.2 million in the quarter versus $7.8 million last year. The shortfall of the last year is due to lower sales and gross margin.

Our net interest expense was $1 million in the quarter versus $1.7 million last year. The decrease is due to lower borrowings and lower interest rate on our line of credit. We ended the quarter with borrowings under the line of credit of just under $36 million compared to $62 million last year, a reduction of $26 million. Year-over-year, we have lowered our inventory investment by $76 million. Our quarter end inventory position was just under $400 million versus last years $475 million.

On a square foot basis, this was $81 a foot versus $82 last year. We are very focused on managing our working capital needs in relation to the business trends and continue to maintain a strong financial position despite our first half operating results.

During the quarter, we closed 10 stores and did not open any new stores. We finished the quarter with 789 stores in operation and square feet totaling 5 million versus last years 963 stores and square feet totaling 5.8 million.

I will now turn it back to Bob to complete our comments.

Bob Higgins

Thank you, John. While, we continue to operate in a challenging sales environment, we feel we have taken some positive steps in the quarter. In merchandising as Jim alluded to earlier we have updated our assortments in CD and DVD to better aligning our mix to regional and local demand.

We have seen improvement in our catalog sales and are well positioned for the holiday season. I would also add that we reset our store funds to create a stronger value statement to our customers and are now offering storewide promotions to drive additional traffic across the lease line and improve conversion.

In marketing, we kicked off our first ever branding campaign in two markets in July, Albany, New York and Harrisburg, Pennsylvania. It is too early to discuss sales levels in these markets versus the chain the campaign has already made a positive impact on brand awareness among our target customer.

In operations, we made adjustments to our staffing model during the quarter to maximize customer service levels and minimize unnecessary payroll investment. This will result in $2 million in savings, which we expect to realize over the next 12 months.

Finally, as part of our digital strategy earlier this month, we launched our first ever MP3 digital download kiosk by a national retailer in the US. In two of our stores with our proprietary mix and burn technology with plans to expand the technology to 40 stores this fall. This technology is unique and that we can now support downloading to virtually all MP3 devices, including iPods in store, and now we offer over two million tracks from all major labels and independence. Customers downloading content through our digital kiosks will be able to listen to their tracks instantly on their portable devices, as well as store backup copy by way at their home or office PCs.

These are just some of the initiatives we are undertaking to reposition our business and complete our transition to the preferred destination for all things entertainment. While this process has taken longer than expected in part due to the industry conditions, we have the experience, leadership and balance sheet necessary to overcome the challenges that we face today.

Our balance sheet remains strong and our revolver balance is well below last year with over a 100 million available on our line. As we look towards the balance of the year we remain comfortable with our annual guidance for a mid-single digit comp decline and a total sales decline of 17% with EBITDA in the range of $5 million to $10 million.

I would now to like to open up the call for any questions. Christopher, could you give the instructions, please?

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