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, home video 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 31, 2009.

At May 2, 2009, the Company operated 704 stores totaling approximately 4.5 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 87% of the Company's sales in the thirteen weeks ended May 2, 2009. The balance of categories, including software accessories, electronics and trend products represented 13% of the Company's sales in the thirteen weeks ended May 2, 2009.

The Company's results have 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:

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.

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.

                             RESULTS OF OPERATIONS

                        Thirteen Weeks Ended May 2, 2009
                Compared to the Thirteen Weeks Ended May 3, 2008

The following table sets forth a period over period comparison of the Company's
net sales by category:


                                            Thirteen weeks ended
                                   -- ------------------------------------

                                      May 2,         May 3,                               Comparable
                                       2009           2008        Change                  Store Net
                                      (in thousands except store data)           %          Sales
                                   ---------------------------------------   ---- ----   -------- ---

Net sales:                         $    191,433    $  232,551     ($41,118 )  (17.7)%        (9.0 )%
As a percentage of net sales:
Music                                        36 %          37 %                             (13.0 )%
Video                                        43 %          41 %                              (4.1 )%
Games                                         8 %           8 %                             (13.2 )%
Other                                        13 %          14 %                             (10.3 )%

Store Count:                                704           799          (95 )  (11.9)%

Net sales. The 18% decrease in net sales during the thirteen weeks ended May 2, 2009, as compared to the same period last year, resulted from a comparable store net sales decline of 9% along with the decrease in store count of 12%.

Music:

The Company's stores and Internet websites offer a wide range of compact discs ("CDs") 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 music category represented 36% of total net sales for the thirteen weeks ended May 2, 2009.

Comparable store net sales in the CD category decreased 13% during the thirteen weeks ended May 2, 2009. Total CD unit sales industry wide were down 19% during the corresponding period to the Company's first fiscal quarter.

The Company offers DVDs and high definition DVDs ("Bluray") in all of its stores. Comparable store net sales in the video category decreased 4% during the first quarter. For the quarter, the industry was down 12%. Strong promotions and the performance of Twilight helped us outperform the industry. Declines in standard DVD have not been offset by sales of Bluray as the penetration of Bluray players has been slower than expected.

Video Games:

The Company offers video game hardware and software in approximately half of its stores. Comparable store net sales decreased 13% and represented 8% of our business. For the quarter, the industry was down 8%.

Other:

The Company offers accessory items for the use, care and storage of entertainment software, along with electronics and trend products. For the thirteen weeks ended May 2, 2009, comparable store net sales decreased 10% for these categories.

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

                                      Thirteen weeks ended
                                         (in thousands)                  Change
                                  -----------------------------   ---------------------
                                  May 2, 2009      May 3, 2008        $           %
                                  ------------    -------------   ---------   ---------
   Gross Profit                   $     65,752    $      82,988   $ (17,236 )  (20.8)%

   As a percentage of net sales           34.3 %           35.7 %

The reduction in gross profit as a percentage of sales was due to lower vendor allowances this year versus last year.

SG&A Expenses. The following table sets forth a period over period comparison of the Company's SG&A expenses:

                                      Thirteen weeks ended
                                         (in thousands)                  Change
                                  -----------------------------   ---------------------
                                  May 2, 2009      May 3, 2008        $           %
                                  ------------    -------------   ---------   ---------
   SG&A Expenses                  $     79,359    $      93,798   $ (14,439 )  (15.4)%

   As a percentage of net sales           41.5 %           40.3 %

SG&A expenses decreased $14.4 million, or 15% on the net sales decline of 18%. The decrease is primarily due to lower overhead expenses associated with the decrease in store count, lower depreciation expense due to lower store count and the write-down of fixed assets at underperforming locations during the fourth quarter of 2008 and lower variable selling expenses on the sales decline. During the thirteen weeks ended May 3, 2008, the Company sold its Canton, Ohio distribution facility, resulting in a net gain of $3.1 million which is included as an offset to SG&A expenses and favorably impacted the rate to net sales by approximately 130 basis points.

Income Tax Expense (Benefit).As of January 31, 2009 and February 2, 2008, the Company had incurred cumulative three-year losses. Based on the cumulative three-year losses and other available objective evidence, management concluded that a full valuation allowance should be recorded against the Company's deferred tax assets. Due to the recognition of a full valuation allowance as of January 31, 2009, the projected net loss for the year ending January 30, 2010 and the net loss incurred for the thirteen weeks ended May 2, 2009, the Company did not provide a current tax benefit for the net loss incurred for this thirteen week period.

For the thirteen weeks ended May 2, 2009, the tax benefit associated with the quarter-specific items is primarily attributed to the net impact of the FIN 48 interest accrual and the reduction of tax reserves due to a tax examination settlement and state taxes based on modified gross receipts incurred during this period.

For the thirteen weeks ended May 3, 2008, the tax expense associated with quarter-specific items is primarily attributable to the FIN 48 interest accrual and state taxes based on modified gross receipts incurred during this period.

Net Loss. The following table sets forth a period over period comparison of the Company's net loss:

                                                      Thirteen weeks ended
                                                         (in thousands)
                                                  ----------------------------
                                                  May 2, 2009     May 3, 2008
                                                  ------------   -------------
       Loss before income tax (benefit) expense   $    (14,310 ) $     (11,703 )
       Income tax (benefit) expense                       (574 )           123
                                                  -- ---------   -- ----------

       Net loss                                   $    (13,736 ) $     (11,826 )
                                                  -- ---------   -- ----------

For the thirteen weeks ended May 2, 2009, the Company's net loss increased $1.9 million to $13.7 million from $11.8 million for the thirteen weeks ended May 3, 2008. The increased loss was due to the $3.1 million gain on the sale of the Canton distribution center recorded in the first quarter last year.

Liquidity and Cash Flows:The Company's primary sources of working capital are cash provided by sales of merchandise inventory and borrowing capacity under its revolving credit facility. The Company's cash flows fluctuate from quarter to quarter due to various items, including seasonality of sales and earnings, merchandise inventory purchases and returns and the related terms on the purchases and capital expenditures. Management believes it will have adequate resources to fund its cash needs for the foreseeable future, including its capital spending, its seasonal increase in merchandise inventory and other operating cash requirements and commitments. Management has considered many initiatives as part of the development of its operating plan for 2009 and beyond that focus on the operation of a core base of stores, improved product selection based on customer preferences and industry changes, as well as further streamlining of its operations. During Fiscal 2008, management carried out certain strategic initiatives in its efforts to reduce operating costs such as the closure of the Canton, OH distribution center, reduction of headcount at the home office and the Albany, NY distribution center, the closing of 101 stores, as well as the elimination or curtailment of certain other general and administrative expenses. Also, during the first quarter of Fiscal 2009, management closed 8 stores and plans to continue its evaluation of store profitability of its remaining 704 stores in consideration of lease terms, conditions and expirations. As a result of these actions, the liquidation of the merchandise inventory from closed stores and management of overall merchandise inventory levels, management expects improvement in its operating cash flow during Fiscal 2009.

The following table sets forth a summary of key components of cash flow and working capital for each of the thirteen weeks ended May 2, 2009 and May 3, 2008:

                                             Thirteen weeks ended      Change
                                           ------------------------   ---------
                                              May 2,       May 3,
                (in thousands)                 2009         2008          $
         -----------------------------     ------------   ---------   ---------
                  Operating Cash Flows     $    (48,570 ) $ (87,289 ) $  38,719
                  Financing Cash Flows           28,070      21,861       6,209
         Sale of distribution facility                -       6,193      (6,193 )
                  Capital Expenditures           (1,334 )    (2,328 )       994

             Cash and Cash Equivalents            8,221      13,092      (4,871 )
                 Merchandise Inventory          332,695     417,004     (84,309 )
                       Working Capital          201,769     245,151     (43,382 )

The Company had cash and cash equivalents of $8.2 million at May 2, 2009, compared to $30.1 million at January 31, 2009 and $13.1 million at May 2, 2008. In line with our initiative to reduce our inventory levels, merchandise inventory was $74 per square foot at May 2, 2009, compared to $83 per square foot at May 3, 2008.

Cash used by operating activities was $48.6 million for the thirteen weeks ended May 2, 2009. The primary use of cash was a seasonal reduction of accounts payable, resulting in a $35.0 million increase in net inventory (inventory less accounts payable). The Company's merchandise inventory and accounts payable are 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.

During the thirteen weeks ended May 3, 2008, the Company sold its Canton, Ohio distribution facility, receiving net proceeds of $6.2 million.

The Company has a five-year, $150 million secured revolving credit facility with Bank of America, N.A. that expires in January 2011. The revolving credit facility contains provisions governing additional indebtedness and acquisitions and is secured by the Company's eligible inventory, proceeds from the sale of inventory and by the stock of the Company's subsidiaries. As of May 2, 2009, the Company had borrowed $29.0 million under the revolving credit facility, had $0.1 million in outstanding letter of credit obligations under the revolving credit facility and $113.3 million was available for borrowing. The weighted average interest rate on outstanding borrowings for the thirteen weeks ended May 2, 2009 was 1.46%. The availability under the Credit Facility is subject to limitations based on sufficient inventory levels. Based on inventory levels at the end of the quarter, the availability under the credit facility was $142.4 million as of May 2, 2009. As inventory levels increase for the holiday season, the availability under the credit facility will increase to $150 million. During Fiscal 2008, the highest aggregate balance outstanding under the revolving credit facility was $97.6 million. We believe that cash provided by sales of merchandise inventory and available borrowing capacity under our credit facility, which expires on January 6, 2011, will provide us with sufficient liquidity through the expiration of this credit facility.

Capital Resources.During the thirteen weeks ended May 2, 2009, the Company made capital expenditures of $1.3 million. The Company plans to spend approximately $10 million for capital expenditures in fiscal 2009.

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, 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 January 31, 2009 includes a summary of the significant accounting policies and methods used by the Company in the preparation of its condensed consolidated financial statements. There have been no material changes or modifications to the policies since January 31, 2009.

Recently Issued Accounting Pronouncements:

In April 2009, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") No. 107-1("FSP FAS 107-1") and APB 28-1 ("APB 28-1"), which amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, and APB Opinion No. 28, Interim Financial Reporting, to require disclosures about the fair value of financial instruments for interim reporting periods. FSP FAS 107-1 and APB 28-1 will be effective for interim reporting periods ending after

In April 2009, the FASB issued FASB Staff Position No. 157-4 ("FSP FAS 157-4"), which provides additional guidance in accordance with FASB No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability has significantly decreased. This FSP does not change the requirements in paragraphs 24-27 of Statement 157, which provide guidance on the use of Level 1 inputs. FSP FAS 157-4 shall be effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this staff position is not expected to have a material impact on the Company's financial position or results of operations.

In April 2009, the FASB issued FASB Staff Position No. 115-2 ("FSP FAS 115-2") and FASB Staff Position No. 124-2 ("FSP FAS 124-2"), which amends the other-than-temporary impairment guidance for debt and equity securities. FSP FAS 115-2 and FSP FAS 124-2 shall be effective for interim and annual reporting periods ending after June 15, 2009. The adoption of this staff position is not expected to have a material impact on the Company's financial position or results of operations.

In April 2009, the FASB issued FSP FAS 141R-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies, which amends and clarifies SFAS No. 141 (Revised) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. This FSP shall be effective for assets or liabilities arising from contingencies in business combinations for which the acquisition date is during or after fiscal 2010. After the effective date, the Company will apply the requirements of SFAS No. 141R-1 to any future business combinations.

In December 2008, the Financial Accounting Standards Board ("FASB") issued FASB Staff Position ("FSP") FAS No. 132(R)-1, "Employers' Disclosures about Postretirement Benefit Plan Assets" ("FSP FAS No. 132(R)-1") which amends SFAS No. 132(revised 2003) "Employers' Disclosures about Pensions and Other Postretirement Benefits" - an Amendment of FASB Statements No. 87, 88, and 106 ("SFAS No. 132(R)"). FSP FAS No. 132(R)-1 requires more detailed disclosures about the assets of a defined benefit pension or other postretirement plan and is effective for fiscal years ending after December 15, 2009. We are in the process of evaluating FSP FAS No. 132(R)-1 and do not expect it will have a significant impact on our Consolidated Financial Statements.