Hastings Entertainment (HAST) 10-Q 2009 Q1 Quarterly report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 30, 2008

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 000-24381

HASTINGS ENTERTAINMENT, INC.

(Exact name of registrant as specified in its charter)

Texas
(State or other jurisdiction of
incorporation or organization) 75-1386375
(I.R.S. Employer
Identification No.)

3601 Plains Boulevard, Amarillo, Texas
(Address of principal executive offices) 79102
(Zip Code)

(806) 351-2300
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer o  Non-accelerated filer þ
(Do not check if a smaller reporting company) Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No þ

Number of shares outstanding of the registrant’s common stock, as of April 30, 2008:

Class	Shares Outstanding
Common Stock, $.01 par value per share	10,254,997

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Form 10-Q
For the Quarterly Period Ended April 30, 2008

INDEX

			Page
PART I — FINANCIAL INFORMATION
	Item 1.	Financial Statements.
		Consolidated Balance Sheets as of April 30, 2008 (Unaudited), and January 31, 2008		3
		Unaudited Consolidated Statements of Earnings for the Three Months Ended April 30, 2008 and 2007		4
		Unaudited Consolidated Statements of Cash Flows for the Three Months Ended April 30, 2008 and 2007		5
		Notes to Unaudited Consolidated Financial Statements		6
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		13
	Item 3.	Quantitative and Qualitative Disclosures about Market Risk.		21
	Item 4.	Controls and Procedures.		21
PART II — OTHER INFORMATION
	Item 1.	Legal Proceedings.		22
	Item 1A.	Risk Factors.		22
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.		22
	Item 6.	Exhibits.		23
SIGNATURES				24
INDEX TO EXHIBITS				25
Principal Executive Officer Certification Pursuant to Exchange Act Rule 13a
Principal Financial Officer Certification Pursuant to Exchange Act Rule 13a
Certification Pursuant to 18 U.S.C. Section 1350

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PART 1 — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS.

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
April 30, 2008 and January 31, 2008
(Dollars in thousands, except par value)

	April 30,			January 31,
	2008			2008
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	4,003		$	3,982
Merchandise inventories, net		164,199			171,557
Deferred income taxes		3,590			3,441
Prepaid expenses and other assets		10,384			11,042
Total current assets		182,176			190,022
Rental assets, net of accumulated depreciation of $21,631 and $22,139 at April 30, 2008 and January 31, 2008, respectively		13,613			13,236
Property and equipment, net of accumulated depreciation of $169,573 and $164,627 at April 30, 2008 and January 31, 2008, respectively		51,006			52,572
Deferred income taxes		2,831			2,756
Intangible assets, net		391			391
Other assets		1,143			1,244
Total Assets	$	251,160		$	260,221
Liabilities and Shareholders’ Equity
Current liabilities:
Trade accounts payable		64,335			76,364
Accrued expenses and other liabilities		35,682			36,675
Total current liabilities		100,017			113,039
Long term debt		42,686			40,616
Other liabilities		4,639			4,758
Shareholders’ equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value; 75,000,000 shares authorized; 11,944,544 shares issued and 10,254,997 shares outstanding at April 30, 2008; 11,944,544 shares issued and 10,389,339 shares outstanding at January 31, 2008		119			119
Additional paid-in capital		37,249			37,125
Retained earnings		78,881			75,892
Accumulated other comprehensive income (loss)		3			(15	)
Treasury stock, at cost 1,689,547 shares and 1,555,205 shares at April 30, 2008 and January 31, 2008, respectively		(12,434	)		(11,313	)
Total Shareholders’ Equity		103,818			101,808
Total Liabilities and Shareholders’ Equity	$	251,160		$	260,221

See accompanying notes to unaudited consolidated financial statements.

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HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Earnings
For the Three Months Ended April 30, 2008 and 2007
(Dollars in thousands, except per share amounts)

	Three Months Ended April 30,
	2008			2007
Merchandise revenue	$	108,317		$	105,064
Rental revenue		23,619			22,948
Total revenue		131,936			128,012
Merchandise cost of revenue		74,952			72,997
Rental cost of revenue		7,971			7,300
Total cost of revenue		82,923			80,297
Gross profit		49,013			47,715
Selling, general and administrative expenses		43,694			42,936
Pre-opening expenses		2			—
Operating Income		5,317			4,779
Other income (expense):
Interest expense		(472	)		(714	)
Other, net		17			33
Income before income taxes		4,862			4,098
Income tax expense		1,873			1,614
Net Income	$	2,989		$	2,484
Basic Income per share	$	0.29		$	0.23
Diluted Income per share	$	0.28		$	0.22
Weighted-average common shares outstanding:
Basic		10,362			11,007
Dilutive effect of stock awards		296			192
Diluted		10,658			11,199

See accompanying notes to unaudited consolidated financial statements.

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HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
For the Three Months Ended April 30, 2008 and 2007
(Dollars in thousands)

	Three Months Ended
	April 31,
	2008			2007
Cash flows from operating activities:
Net income	$	2,989		$	2,484
Adjustments to reconcile net income to net cash provided by operating activities:
Rental asset depreciation expense		4,037			2,780
Purchases of rental inventory		(8,363	)		(5,206	)
Property and equipment depreciation expense		4,867			4,876
Amortization expense		—			8
Deferred income taxes		(224	)		64
Loss on rental assets lost, stolen and defective		297			292
Loss on disposal of non-rental assets		188			11
Noncash stock-based compensation		164			15
Changes in operating assets and liabilities:
Merchandise inventory		11,011			5,669
Prepaid expenses and other current assets		658			(44	)
Trade accounts payable		(10,563	)		(4,182	)
Accrued expenses and other current liabilities		(954	)		(3,329	)
Excess tax benefit from stock-based compensation		(39	)		—
Other assets and liabilities, net		—			150
Net cash provided by operating activities		4,068			3,588
Cash flows from investing activities:
Purchases of property and equipment		(3,490	)		(2,422	)
Net cash used in investing activities		(3,490	)		(2,422	)
Cash flows from financing activities:
Borrowings under revolving credit facility		137,441			134,692
Repayments under revolving credit facility		(135,371	)		(129,864	)
Purchase of treasury stock		(1,294	)		(729	)
Change in cash overdraft		(1,466	)		(4,112	)
Proceeds from exercise of stock options		94			237
Excess tax benefit from stock-based compensation		39			—
Net cash (used in) provided by financing activities		(557	)		224
Net increase in cash and cash equivalents		21			1,390
Cash and cash equivalents at beginning of period		3,982			3,837
Cash and cash equivalents at end of period	$	4,003		$	5,227

See accompanying notes to unaudited consolidated financial statements.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Hastings Entertainment, Inc. and its subsidiaries (“Hastings,” the “Company,” “we,” “our,” or “us”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with instructions in Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such principles and regulations of the Securities and Exchange Commission. All adjustments, consisting of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods. The results of operations for such interim periods are not necessarily indicative of the results that may be expected for a full year because of, among other things, seasonality factors in the retail business. As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating profit, is generated in the fourth fiscal quarter, which includes the holiday selling season. The unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008.

The balance sheet at January 31, 2008 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008.

Our fiscal year ends on January 31 and is identified as the fiscal year for the immediately preceding calendar year. For example, the fiscal year that will end on January 31, 2009 is referred to as fiscal year 2008.

Reclassifications

Certain amounts previously reported have been reclassified to conform to the current year presentation. The reclassifications did not have any effect on our statements of earnings for any of the periods presented.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

2. Stock Based Compensation

Compensation expense for all stock option awards is measured at fair value on the date of grant and such cost is recognized over the service period for awards that are expected to vest. The fair value of non-vested share grants is based on the number of shares granted and the quoted price of our common stock on the date of grant. We use the Black-Scholes valuation model in order to determine the fair value of stock option grants on the date of grant. The determination of stock option grants and performance-based stock awards that are expected to ultimately vest requires significant estimates, and to the extent that actual results or updated estimates differ from current estimates, such amounts will be recorded as a cumulative adjustment in the period that estimates are revised. Actual results and future changes in estimates may differ substantially from the current estimates. The Company did not grant any stock options during the first quarter of fiscal 2008 or fiscal 2007.

Stock Options

Under the Company’s incentive stock plans, options may be granted to directors, officers and employees with an exercise price equal to the fair market value of the Company’s common stock on the date of grant. Stock option grants generally vest ratably over five years and expire within ten years after the date of grant. Shares issued upon exercise of options are issued from treasury shares.

A summary of information with respect to stock options for the three months ended April 30, 2008, and changes during the period then ended, is presented below:

				Weighted-average
	Options			exercise price
	(in actual shares)			(in dollars)
Outstanding at February 1, 2008		905,373		$	5.45
Granted		—			—
Exercised		(23,699	)		3.98
Cancelled and expired		(4,000	)		3.55
Outstanding at April 30, 2008		877,674		$	5.50
Options available for grant at April 30, 2008		616,091

The total intrinsic value of stock options exercised for the three months ended April 30, 2008 and 2007 was $100,516 and $72,626, respectively. As of April 30, 2008 and 2007, we had a total of 138,383 option shares outstanding and unvested with a weighted average exercise price of $8.52; and 91,820 option shares outstanding and unvested with a weighted average exercise price of $7.42, respectively.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

At April 30, 2008, the options outstanding, the related weighted-average exercise price, the weighted-average remaining contractual life, and the aggregate intrinsic value for the ranges of exercise prices are shown in the table below.

			Weighted-average		Weighted-average	Aggregate intrinsic
	Options		exercise price		remaining	value
	(in actual shares)		(in dollars)		contractual life	(in actual dollars)
Range: $1.33 to $4.99
Options outstanding and exercisable at April 30, 2008		342,860	$	3.21	3.38 years	$	1,774,946
Range: $5.00 to $9.99
Options outstanding and exercisable at April 30, 2008		387,341	$	6.28	4.97 years	$	821,325
Options outstanding and unexercisable at April 30, 2008		119,327	$	8.18	8.41 years	$	72,395
Price: $10.00 to $13.00
Options outstanding and exercisable at April 30, 2008		9,090	$	12.50	0.13 years		—
Options outstanding and unexercisable at April 30, 2008		19,056	$	10.64	4.61 years		—

At April 30, 2008, the number of options exercisable was 739,291, the weighted-average exercise price of those options was $4.94, and the total intrinsic value of those options was $2,596,271.

Performance-based Restricted Stock Awards

Performance-based restricted stock awards may be granted to eligible directors, officers, and employees, with a grant date fair value equal to the average of the opening and closing stock price on the day on which they are granted. These awards have specific performance conditions that must be met before the shares will be issued. Once issued, the shares typically vest ratably over two years from the date the performance condition is achieved. Compensation expense for these awards is recognized from the date of grant through the vesting date, once it is deemed probable that the performance condition will be met.

A summary of information with respect to performance-based restricted stock awards for the three months ended April 30, 2008, and changes during the period then ended, is presented below:

			Weighted-average
	Awards		grant date fair
	(in actual shares)		value (in dollars)
Outstanding at February 1, 2008		283,330	$	8.23
Granted		—		—
Vested		—		—
Cancelled and expired		—		—
Outstanding at April 30, 2008		283,330	$	8.23

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

During fiscal 2007, we determined that it was probable that the performance conditions related to 155,830 performance-based stock shares would be met. Of this amount, the performance condition related to 47,500 performance-based stock shares has been met as of April 30, 2008. We continue to believe it is probable that the performance condition related to the other 108,330 performance-based stock shares will be met. Accordingly, we recognized $132,999 of stock-compensation expense related to both of these awards during the first quarter of 2008.

As of April 30, 2008, we had total unrecognized compensation expense related to all unvested performance-based stock grants of $1,890,554. If the performance conditions for these awards are met, the related expense is expected to be recognized over a weighted average period of 2.5 years. Of this amount, $1,232,925 is related to performance based stock grants for which we currently estimate that it is not probable that the performance condition will be met, and therefore no compensation expense has been recognized.

We had a total of 283,330 performance-based stock shares with a weighted average grant date fair value of $8.23; and 130,830 performance-based stock shares of with a weighted average grant date fair value of $6.55, related to performance based stock shares that were unvested as of April 30, 2008 and 2007, respectively.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

3. Store Closing Reserve

From time to time and in the normal course of business, we evaluate our store base to determine if we need to close one or more stores. Such evaluations include, among other factors, current and future profitability, market trends, age of store and lease status.

Amounts in Accrued Expenses and Other Liabilities at April 30, 2008 include accruals for the net present value of future minimum lease payments and other costs attributable to closed or relocated stores, net of estimated sublease income. Expenses related to store closings are included in Selling, General and Administrative expenses in our consolidated statements of earnings.

The following tables provide a rollforward of reserves that were established for these charges for the three months ended April 31, 2008 and 2007.

Balance at January 31, 2008	$	377
Changes in estimates		(32	)
Additions to provision		—
Cash outlay		(71	)
Balance at April 30, 2008	$	274

Balance at January 31, 2007	$	676
Changes in estimates		(59	)
Additions to provision		—
Cash outlay		(79	)
Balance at April 30, 2007	$	538

As of April 30, 2008, the reserve balance, which is net of estimated sublease income, is expected to be paid over the next three years.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

4. Earnings per Share

     The computations for basic and diluted earnings per share are as follows:

	Three Months Ended April 30,
	2008		2007
Net earnings	$	2,989	$	2,484
Average shares outstanding:
Basic		10,362		11,007
Effect of stock options and awards		296		192
Diluted		10,658		11,199
Earnings per share:
Basic	$	0.29	$	0.23
Diluted	$	0.28	$	0.22

The following options to purchase shares of common stock were not included in the computation of diluted earnings per share because their inclusion would have been antidilutive:

	Three Months Ended April 30,
	2008		2007
Shares of common stock underlying options (in thousands)		173		295
Exercise price range per share	$	7.22 to $13.00	$	6.60 to $13.64

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)

5. Litigation and Contingencies

We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

6. Recent Accounting Pronouncements

Effective February 1, 2008, we adopted SFAS 157,Fair Value Measurements(“SFAS 157”) and its related amendments for financial assets and liabilities measured at fair value on a recurring basis. SFAS 157 will be effective for non-financial assets and liabilities measured at fair value on a non-recurring basis as of February 1, 2009. SFAS 157 defines fair value, establishes a market-based hierarchy for measuring fair value and expands disclosures about fair value measurements. SFAS 157 is applicable whenever another accounting pronouncement requires or permits assets and liabilities to be measured at fair value, but does not require any new fair value measurements. The adoption of FAS 157 had no impact on our results of operations, financial position or cash flows.

The fair-value hierarchy established in FAS 157 prioritizes the inputs used in valuation techniques into three levels as follows:

• Level 1 — Observable Inputs — quoted prices in active markets for identical assets and liabilities.

• Level 2 — Observable inputs other than the quoted prices in active markets for identical assets and liabilities — includes quoted prices for similar instruments, quoted prices for identical or similar instruments in inactive markets, and amounts derived from valuation models where all significant inputs are observable in active markets; and

• Level 3 — Unobservable inputs — includes amounts derived from valuation models where one or more significant inputs are unobservable and require us to develop relevant assumptions.

At April 30, 2008, we had approximately $0.5 million in assets which are carried at fair value on a recurring basis. These assets consist of available-for-sales investments we hold in a trust related to our non-qualified supplemental executive retirement plan (“SERP”). The fair value of these investments was determined using Level 1 inputs.

In February 2007, the FASB issued SFAS 159,The Fair Value Option for Financial Assets and Financial Liabilities(“SFAS 159”). SFAS 159 allows companies to elect to measure certain assets and liabilities at fair value and is effective for fiscal years beginning after November 15, 2007. Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings. The Company elected not to measure any additional assets or liabilities at fair value that are not already measured at fair value under existing standards. Therefore, the adoption of SFAS 159 had no impact on our results of operations, financial position, or cash flows.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATONS.

Forward-looking Statements

Certain written and oral statements set forth below or made by Hastings with the approval of an authorized executive officer constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “intend,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to the business, expansion, merchandising and marketing strategies of Hastings, industry projections or forecasts, inflation, effect of critical accounting policies including lower of cost or market for inventory adjustments, the returns process, rental asset depreciation, store closing reserves, impairment or disposal of long-lived assets, revenue recognition, and vendor allowances, sufficiency of cash flow from operations and borrowings under our revolving credit facility and statements expressing general optimism about future operating results, are forward-looking statements. Such statements are based upon our management’s current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to, consumer appeal of our existing and planned product offerings, and the related impact of competitor pricing and product offerings; overall industry performance and the accuracy of our estimates and judgments regarding trends; our ability to obtain favorable terms from suppliers; our ability to respond to changing consumer preferences, including with respect to new technologies and alternative methods of content delivery, and to effectively adjust our offerings if and as necessary; the application and impact of future accounting policies or interpretations of existing accounting policies; whether our assumptions turn out to be correct; our inability to attain such estimates and expectations; a downturn in market conditions in any industry relating to the products we inventory, sell or rent; the effects of changes in economic conditions in the U.S. or the markets in which we operate our stores; volatility of fuel and utility costs; acts of war or terrorism inside the United States or abroad; unanticipated adverse litigation results or effects; and other factors which may be outside of the Company’s control; any of which could cause actual results to differ materially from those described herein. We undertake no obligation to affirm, publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with the unaudited consolidated financial statements of the Company and the related notes thereto appearing elsewhere in this report.

General

Incorporated in 1972, Hastings Entertainment, Inc. (the “Company,” “Hastings,” or “Hastings Entertainment”) is a leading multimedia entertainment retailer. We operate entertainment superstores that buy, sell, trade, and rent various home entertainment products, including books, music, software, periodicals, new and used CDs, DVDs, video games, video game consoles, and electronics, as well as consumables and trends products such as apparel, t-shirts, action figures, posters, greeting cards, and seasonal merchandise. As of April 30, 2008, we operated 153 superstores primarily in medium-sized markets located in 20 states, primarily in the Western and Midwestern United States. We also operate a multimedia entertainment e-commerce web site offering a broad selection of books, software, video games, DVDs and music. We have two wholly-owned subsidiaries: Hastings Properties, Inc. and Hastings Internet, Inc. References herein to fiscal years are to the twelve-month periods that end on January 31st of each following calendar year. For example, the twelve-month period ending January 31, 2009, is referred to as fiscal 2008, and the twelve-month period ended January 31, 2008, is referred to as fiscal 2007.

Critical Accounting Estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent 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. We believe

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the following critical accounting estimates comprise our more significant estimates and assumptions used in the preparation of our financial statements. Our significant estimates and assumptions are reviewed, and any required adjustments are recorded, on a monthly or quarterly basis.

Lower of Cost or Market for Merchandise Inventory.Our merchandise inventories are recorded at the lower of cost, which approximates the first-in, first-out (“FIFO”) method, or market. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record lower of cost or market inventory adjustments. In some instances, these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns and estimated fair value and returnability of merchandise inventory by product category and record an adjustment if estimated market value is below cost. Through merchandising and an automated-progressive markdown program, we quickly take the steps necessary to increase the sell-off of slower moving merchandise to eliminate or lessen the effect of these adjustments.

Rental Asset Depreciation.We have established rental asset depreciation policies that match rental product costs with the related revenues. These policies require that we make significant estimates, based upon our experience, as to the ultimate revenue and the timing of the revenue to be generated from our rental product. We utilize an accelerated method of depreciation because it approximates the pattern of demand for the product, which is higher when the product is initially released for rental by the studios and declines over time. In establishing salvage values for our rental product, we consider the sales prices and sales volume of our previously rented product and other used product.

We currently depreciate the cost of our rental assets on an accelerated basis over six months or nine months, except for rental assets purchased for the initial stock of a new store, which are depreciated on a straight-line basis over 36 months. Rental assets, which include DVDs, Books on CD, Video Games, and VHS, are depreciated to salvage values ranging from $2.50 to $10. Rental assets purchased for less than established salvage values are not depreciated.

We also review the carrying value of our rental assets to ensure that estimated future cash flows exceed the carrying value. We periodically record adjustments to the value of previously rented product primarily for estimated obsolescence or excess product based upon changes in our original assumptions about future demand and market conditions. If future demand or actual market conditions are less favorable than our original estimates, additional adjustments, including adjustments to useful lives or salvage values, may be required. We continually evaluate the estimates surrounding the useful lives and salvage values used in depreciating our rental assets. Changes to these estimates resulting from changes in consumer demand, changes in our customer preferences or the price or availability of retail products may materially impact the carrying value of our rental assets and our rental margins.

The costs of rental product purchased pursuant to revenue-sharing arrangements, which are recorded in rental cost of sales on the consolidated statements of earnings, typically include a lower initial product cost with a percentage of the net rental revenues to be shared with studios over an agreed period of time. Any up-front costs exceeding the designated salvage value are amortized on an accelerated basis and revenue-sharing payments pursuant to the applicable arrangement are expensed as the related revenue is earned. Additionally, certain titles have performance guarantees. The Company analyzes titles that are subject to performance guarantees and recognizes an estimated expense for under-performing titles throughout the applicable period based upon the Company’s analysis of the estimated shortfall. The Company revises these estimates on a monthly basis, based on actual results.

Impairment or Disposal of Long-Lived Assets. We evaluate under performing stores on a quarterly basis to determine whether projected future cash flows over the remaining initial lease term are sufficient to recover the carrying value of the fixed asset investment in each individual store. If projected future cash flows are less than the carrying value of the fixed asset investment, an impairment charge is recognized if the fair value is less than the carrying value of such assets. The carrying value of leasehold improvements as well as certain other property and equipment is subject to impairment write-down.

Income Taxes.In determining net income for financial statement purposes, we make certain estimates and judgments in the calculation of tax expense and the resulting tax liabilities and in the recoverability of deferred tax

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assets that arise from temporary differences between the tax and financial statement recognition of revenue and expense. We record deferred tax assets and liabilities for future income tax consequences that are attributable to differences between financial statement carrying amounts of assets and liabilities and their income tax bases. We base the measurement of deferred tax assets and liabilities on enacted tax rates that we expect will apply to taxable income in the year when we expect to settle or recover those temporary differences. We recognize the effect on deferred tax assets and liabilities on any change in income tax rates in the period that includes the enactment date.

The tax benefit from an uncertain tax position is recognized only if it is more likely than not the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position should be measured based on the largest benefit that has a greater than fifty percent likelihood, on a cumulative basis, of being realized upon ultimate settlement. We recognize interest and penalties relating to any uncertain tax positions as a component of income tax expense.

Share-Based Compensation.Determining the amount of share-based compensation to be recorded in the statement of earnings requires us to develop estimates to be used in calculating the grant-date fair value of stock options. In determining the fair value of stock options, we use the Black-Scholes valuation model, which requires us to make estimates of the following assumptions:

• Expected volatility — The estimated stock price volatility was derived based upon actual historical stock prices over the expected life of the option.

• Expected life of the option — The estimate of an expected life was calculated based on historical data relating to grants, exercises, and cancellations, as well as the vesting period and contractual life of the option.

• Risk-free interest rate — The risk-free interest rate is based on the yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life of the option.

Our stock price volatility and option lives involve management’s best estimates at that time, both of which impact the fair value of the option calculated under the Black-Scholes pricing model and, ultimately, the expense that will be recognized over the life of the option.

We recognize compensation expense for only the portion of options that are expected to vest. Therefore, we apply estimated forfeiture rates that are derived from historical employee termination behavior. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.

In addition to stock options, we award performance based stock grants. Compensation expense is recognized if management deems it probable that the performance conditions will be met. Management must use their judgment to determine the probability that a performance condition will be met. If actual results differ from management’s assumptions, future results could be materially impacted.

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Results of Operations

The following tables present our statement of earnings data, expressed as a percentage of revenue, and the number of superstores open at the end of the periods presented herein.

	Three Months Ended
	April 30,
	2008			2007
Merchandise revenue		82.1	%		82.1	%
Rental revenue		17.9			17.9
Total revenues		100.0			100.0
Merchandise cost of revenue		69.2			69.5
Rental cost of revenue		33.8			31.8
Total cost of revenues		62.9			62.7
Gross profit		37.1			37.3
Selling, general and administrative expenses		33.1			33.6
Pre-opening expenses		—			—
Operating income		4.0			3.7
Other income (expense):
Interest expense		(0.3	)		(0.5	)
Other, net		—			—
Income before income taxes		3.7			3.2
Income tax expense		1.4			1.3
Net income		2.3	%		1.9	%

Summary of Superstore Activity

					Year
	Three Months Ended				Ended
	April 30,				January 31,
	2008		2007		2008
Beginning number of stores		153		154		154
Openings		—		—		1
Closings		—		—		(2	)
Ending number of stores		153		154		153

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Financial Results for the First Quarter of Fiscal Year 2008

Revenues.Total revenues for the first quarter increased $3.9 million, or 3.1%, to $131.9 million compared to $128.0 million for the first quarter of fiscal 2007. The following is a summary of our revenues results (dollars in thousands):

	Three Months Ended April 30,
	2008					2007					Increase/(Decrease)
			Percent					Percent
	Revenues		of Total			Revenues		of Total			Dollar		Percent
Merchandise revenue	$	108,317		82.1	%	$	105,064		82.1	%	$	3,253		3.1	%
Rental revenue		23,619		17.9	%		22,948		17.9	%		671		2.9	%
Total revenues	$	131,936		100.0	%	$	128,012		100.0	%	$	3,924		3.1	%

Comparable-store revenues (“Comps”):

Total	4.2	%
Merchandise	4.3	%
Rental	3.8	%

Below is a summary of the Comp results for our major merchandise categories:

	Three Months Ended April 30,
	2008			2007
Trends		36.8	%		-14.3	%
Video Games		29.8	%		-5.8	%
Electronics		26.8	%		17.5	%
Hard Back Café		14.2	%		9.0	%
Consumables		12.5	%		0.6	%
Books		5.6	%		-1.3	%
Movies		3.2	%		4.9	%
Music		-16.0	%		-13.0	%

Stores included in the Comps calculation are those stores that have been open for a minimum of 60 weeks. Also included are stores that were remodeled or relocated during the comparable period. Sales via the Internet are included and closed stores are removed from each comparable period for the purpose of calculating Comps.

Trends Comps increased 36.8% primarily due to strong sales of Webkinz plush products, as well as strong apparel and seasonal sales. Key drivers in the apparel category included jewelry, bags, and hats. Key drivers in the seasonal category included Valentine’s Day and Easter products. Video Game Comps increased 29.8% primarily due to strong sales of new hit titles released during the first quarter, includingGrand Theft Auto IV,Mario Kart Wii,Super Smash Bros. Brawl,Army of Two, andTurok, as well as increased sales of used games, gaming systems and gaming accessories including Sony PS3 and Nintendo Wii controllers. Electronics department Comps increased 26.8% for the quarter, which was attributable to strong sales of refurbished iPods and MP3 player related accessories, as well as increased sales of third-party gift cards. Books Comps increased 5.6% during the first quarter, primarily due to increased sales of new trade paperback books, as well as strong sales of used hardback and trade paperback books. Hit titles driving book sales during the quarter includedNew Earth, by author Eckhart Tolle, andThe Last Lecture, by author Randy Pausch. Movie Comps increased 3.2%, primarily due to increased sales of both new and used DVDs, Blu-ray format movies, and used DVD box sets. Hit movies released during the quarter, includingI Am Legend,Alvin and the Chipmunks,American Gangster, andNo Country For Old Men, helped drive the sales of new DVDs and Blu-ray. These increases were partially offset by lower sales of new DVD boxed sets and previously-viewed titles. Music Comps fell 16.0% for the quarter directly as a result of continued

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industry declines as consumers looked to other forms of music alternatives, primarily through digital downloads. Merchandise Comps, excluding the sales of Music, increased 10.4% during the quarter.

Rental video Comps increased 3.8% from the same period last year primarily as a result of increased video game rentals resulting from the release of strong hit titles during the first quarter. We continue to respond to a shift in consumer preference towards buying DVDs and games instead of renting, and as a result, the combined sales and rental of movies and video games resulted in a Comp increase of 8.0%.

Gross Profit — Merchandise.For the first quarter, total merchandise gross profit dollars increased approximately $1.3 million, or 4.0%, to $33.4 million from $32.1 million for the same period last year, primarily as a result of higher revenues. As a percentage of total merchandise revenue, merchandise gross profit increased to 30.8% for the quarter compared to 30.5% for the same period in the prior year.

Gross Profit — Rental.For the first quarter, total rental gross profit dollars remained constant at $15.6 million. Higher rental revenues were offset by lower margin rates. As a percentage of total rental revenue, rental gross profit decreased to 66.3% for the quarter compared to 68.2% for the same period in the prior year, which was primarily due to increased rental asset depreciation expense for the quarter, as compared to the prior year.

Selling, General and Administrative Expenses (“SG&A”).As a percentage of total revenue, SG&A decreased to 33.1% for the first quarter compared to 33.5% for the same quarter in the prior year, primarily as a result of leverage from higher revenues. SG&A increased approximately $0.8 million during the first quarter, or 1.9%, to $43.7 million compared to $42.9 million for the same quarter last year. The increase in SG&A was primarily related to increased store labor costs and stock compensation expense.

Liquidity and Capital Resources

We generate cash from operations exclusively from the sale of merchandise and the rental of products, and we have substantial operating cash flow, on an annual basis, because most of our revenue is received in cash and cash equivalents. Other than our principal capital requirements arising from the purchasing, warehousing and merchandising of inventory and rental products, opening new stores and expanding/reformatting existing stores, and updating existing and implementing new information systems technology, we have no anticipated material capital commitments, except for the stock buyback programs discussed more fully in Item 2 of Part II of this Quarterly Report on Form 10-Q. Our primary sources of working capital are cash flow from operating activities, trade credit from vendors and borrowings under our revolving credit facility. We believe our cash flow from operations and borrowings under our revolving credit facility will be sufficient to fund our ongoing operations, new stores and store expansions for the next twelve months.

Consolidated Cash Flows

Operating activities. Net cash provided by operating activities increased $0.5 million, from $3.6 million for the three months ended April 30, 2007, to $4.1 million for the three months ended April 30, 2008. Merchandise inventories decreased $11.0 million for the quarter compared to a decrease of $5.7 million during the same period in fiscal 2007, primarily due to continued improvements in purchasing and selection management. Trade accounts payables decreased $10.6 million during the first quarter compared to a decrease of $4.2 million during the first quarter of fiscal 2007. The decrease in accounts payable for the first quarter of fiscal 2008 is primarily due to the timing of payables for merchandise purchased for Christmas that were paid during the quarter, as well as increased merchandise returns, which are typical during the first quarter. Purchases of rental video increased $8.4 million for the quarter compared to an increase of $5.2 million for the same period in the prior year, due to the release of several strong titles. Accrued expenses and other liabilities decreased $1.0 million for the quarter compared to a decrease of $3.3 million for the same quarter in the prior year. The decrease in accrued expenses and other liabilities for the first quarter of fiscal 2008 was primarily due to decreases in the amount of deferred gift card revenues, which is typical in the first quarter due to the redemption of holiday gift cards, and federal and state income tax liabilities offset by higher salary accruals during the quarter.

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Investing activities.Net cash used in investing activities increased $1.1 million from $2.4 million for the three months ended April 30, 2007, to $3.5 million for the three months ended April 30, 2008. This increase was primarily due to increased capital expenditures related to the reformatting of existing stores.

Financing activities.Cash provided by or used in financing activities is primarily associated with borrowings and payments made under our revolving credit facility (described below under “Capital Structure”), purchases of treasury stock, and the change in cash overdraft. Net borrowings under our credit facility decreased from $4.8 million for the three months ended April 30, 2007, to $2.1 million for the three months ended April 30, 2008. Change in cash overdraft decreased from a use of $4.1 million for the three months ended April 30, 2007, to a use of $1.5 million for the three months ended April 30, 2008.

Capital Structure.We have a syndicated secured Loan and Security Agreement with Bank of America (the “Facility”). The amount outstanding under the Facility is limited by a borrowing base predicated on eligible inventory, as defined in the Facility, and certain rental assets, net of accumulated depreciation less specifically defined reserves and is limited to a ceiling of $100 million, less a $10 million availability reserve, as amended. The Facility permits borrowings at various interest-rate options based on the prime rate or London Interbank Offered Rate (“LIBOR”) plus applicable margin depending upon the level of our minimum availability. The borrowing base under the Facility is limited to an advance rate of 65% of eligible inventory and certain rental assets net of accumulated amortization less specifically defined reserves, which can be adjusted to reduce availability under the Facility. Lenders may increase specifically defined reserves to reduce availability in the event of adverse changes in our industry that are projected to impact the value of our assets pledged as collateral. The Facility contains no financial covenants, prohibits the payment of dividends and includes certain other debt and acquisition limitations, allows for the repurchase of up to $30 million of our common stock and requires a minimum availability of $10 million at all times. The Facility is secured by substantially all of the assets of the Company and our subsidiaries and is guaranteed by each of our consolidated subsidiaries. Unless the Facility is amended and the maturity extended, the Facility matures on August 29, 2011. At April 30, 2008, we had $40.9 million in excess availability, after the $10 million availability reserve, under the Facility. However, excess availability may be reduced in the future as changes in the borrowing base occur or the lenders increase availability reserves. The average rate of interest being charged under the Facility for the three months ending April 30, 2008 and the fiscal year ended January 31, 2008 was 4.8% and 6.6%, respectively.

We utilize standby letters of credit to support certain insurance policies. The aggregate amount of the letters of credit at April 30, 2008 was approximately $1.0 million, which reduces the excess availability under the Facility.

At April 30, 2008, our minimum lease commitments for the remaining nine months of fiscal 2008 were approximately $17.6 million. Total existing minimum operating lease commitments for fiscal years 2009 through 2025 was approximately $160.6 million as of April 30, 2008.

Contractual obligations and off-balance sheet arrangements.We have contractual obligations associated with ongoing business and financing activities, which will result in cash payments in future periods. These obligations include long-term debt, operating leases and certain revenue-sharing arrangements. As of April 30, 2008, other than operating leases and standby letters of credit, we had not entered into any off-balance sheet arrangements or third-party guarantees, nor does our business ordinarily require us to do so. At April 30, 2008, there have been no material changes in our contractual obligations or off-balance sheet arrangements from those reported in our Annual Report on Form 10-K for the fiscal year ended January 31, 2008.

Seasonality and Inflation

As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating profit, is generated in the fourth fiscal quarter, which includes the holiday selling season. As a result, a substantial portion of our annual earnings has been, and will continue to be, dependent on the results of the fourth quarter. Less than satisfactory net sales for such period could have a material adverse effect on the Company’s financial condition or results of operations for the year and may not be sufficient to cover any losses that may have been incurred in the first three quarters of the year. We experience reduced video rental activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games

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or the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of superstore openings, the number and popularity of new book, music and video titles, the cost of the new release or “best renter” titles, changes in comparable-store revenues, competition, marketing programs, increases in the minimum wage, weather, special or unusual events, and other factors that may affect our operations.

We do not believe that inflation has materially impacted operating results during the past three years. Substantial increases in costs and expenses could have a significant impact on our operating results to the extent such increases are not passed along to customers.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

In the ordinary course of our business, we are exposed to certain market risks, primarily changes in interest rates. Our exposure to interest rate risk consists of variable rate debt based on the lender’s base rate or LIBOR plus a specified percentage, at our option. The annual impact on our results of operations of a 100 basis point interest rate change on the April 30, 2008, outstanding balance of the variable rate debt would be approximately $0.4 million. After an assessment of these risks to our operations, we believe that the primary market risk exposures (within the meaning of Regulation S-K Item 305) are not material and are not expected to have any material adverse impact on our financial position, results of operations or cash flows for the next fiscal year.

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We performed an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15 as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as defined by Exchange Act Rules 13a-15(e) and 15d-15(e), were effective as of the end of the period covered by this Quarterly Report on Form 10-Q to provide reasonable assurance that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

Management has implemented a process to monitor and assess both the design and operating effectiveness of internal control over financial reporting. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

There has not been any change in our internal control over financial reporting during our fiscal quarter ending April 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.

ITEM 1A. RISK FACTORS.

Our Annual Report on Form 10-K for the year ended January 31, 2008 includes a detailed discussion of our risk factors. Since that time, there have been no material changes to our risk factors.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

A summary of our purchases of shares of our common stock for the three months ended April 30, 2008 is as follows:

ISSUER PURCHASES OF EQUITY SECURITIES

					Total number of		Approximate
					shares purchased		dollar value of
					as part of		shares that may
	Total number		Average		publicly		yet be purchased
	of shares		price paid		announced plans		under the plans
Period	purchased (1)		per share		or programs		or programs (2)
February 1, 2008 through February 29, 2008		—	$	—		—		N/A
March 1, 2008 through March 31, 2008		18,300		8.14		18,300		N/A
April 1, 2008 through April 30, 2008		139,741		8.16		139,741		N/A
Total		158,041	$	8.16		158,041	$	3,946,991

(1)

All share purchases were open-market purchases made under a repurchase plan publicly announced in a press release dated September 28, 2001. Our board of directors initially authorized the repurchase of up to $5.0 million of our common stock and subsequently increased the amount of the repurchase plan by $2.5 million on April 1, 2005; $5.0 million on March 15, 2006; $2.5 million on October 3, 2006; and $7.5 million on November 20, 2007. Each such authorization to increase amounts was publicly announced in a press release. The purchases satisfied the conditions of the safe harbor of Rule 10b-18 under the Securities Exchange Act of 1934.

(2)

A total of 2,813,791 shares have been purchased under the repurchase plan at a total cost of approximately $18.6 million, or approximately $6.59 per share.

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ITEM 6. EXHIBITS.

a. The following exhibits are filed herewith or incorporated by reference as indicated as required by Item 601 of Regulation S-K. The exhibits designated by an asterisk are management contracts and/or compensatory plans or arrangements required to be filed as exhibits to this report.

Exhibit
Number	Description of Documents
3.1 (1)	Third Restated Articles of Incorporation of the Company.
3.1 (3)	Amended and Restated Bylaws of the Company.
4.1 (2)	Specimen of Certificate of Common Stock of the Company.
4.2 (1)	Third Restated Articles of Incorporation of the Company (see 3.1 above).
4.3 (1)	Amended and Restated Bylaws of the Company (see 3.2 above).
31.1 (4)	Principal Executive Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).
31.2 (4)	Principal Financial Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).
32.1 (4)	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(1)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1, dated March 18, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
(2)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1/A, dated May 19, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
(3)	Previously filed as an exhibit to the Company’s Form 8-K (File No. 000-24381) filed on January 17, 2008, and incorporated herein by reference.
(4)	Filed herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:

	HASTINGS ENTERTAINMENT, INC.
Date: June 3, 2008	/s/ Dan Crow
	Dan Crow
	Vice President and Chief Financial Officer (Principal Financial and Accounting Officer)

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INDEX TO EXHIBITS

Exhibit
Number	Description of Documents
3.1 (1)	Third Restated Articles of Incorporation of the Company.
3.1 (3)	Amended and Restated Bylaws of the Company.
4.1 (2)	Specimen of Certificate of Common Stock of the Company.
4.2 (1)	Third Restated Articles of Incorporation of the Company (see 3.1 above).
4.3 (1)	Amended and Restated Bylaws of the Company (see 3.2 above).
31.1 (4)	Principal Executive Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a)
31.2 (4)	Principal Financial Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a)
32.1 (4)	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1, dated March 18, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
(2)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1/A, dated May 19, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
(3)	Previously filed as an exhibit to the Company’s Form 8-K (File No. 000-24381) filed on January 17, 2008, and incorporated herein by reference.
(4)	Filed herewith.

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