1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-Q
(Mark One)
( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 2001
OR
( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF
SECURITIES EXCHANGE ACTION 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 75-1386375
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
3601 PLAINS BOULEVARD, AMARILLO, TEXAS 79102
(Address of principal executive offices) (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 ( X ) No ( )
Number of shares outstanding of the registrant's common stock, as of September
6, 2001:
<Table>
<Caption>
Class Shares Outstanding
- -------------------------------------- -------------------------
Common Stock, $.01 par value per share 11,944,544
</Table>
2
HASTINGS ENTERTAINMENT, INC.
AND SUBSIDIARIES
FORM 10-Q FOR THE THREE MONTHS AND SIX MONTHS ENDED JULY 31, 2001
INDEX
<Table>
<Caption>
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of July 31, 2001 (Unaudited),
July 31, 2000 (Unaudited) and January 31, 2001 3
Unaudited Consolidated Statements of Operations for the Three Months
and Six Months Ended July 31, 2001 and 2000 4
Unaudited Consolidated Statements of Cash Flows for the Six Months
Ended July 31, 2001 and 2000 5
Notes to Unaudited Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
Item 3. Quantitative and Qualitative Disclosures about Market Risk 16
PART II - OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders 17
Item 6. Exhibits and Reports on Form 8-K 17
SIGNATURE PAGE 18
</Table>
2
3
PART 1
ITEM 1 - FINANCIAL STATEMENTS
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
July 31, 2001 and 2000, and January 31, 2000
(Dollars in thousands, except par value)
JULY 31, JULY 31, JANUARY 31,
2001 2000 2001
--------- --------- ----------
ASSETS (UNAUDITED) (UNAUDITED)
Current assets:
Cash $ 6,670 $ 1,336 $ 4,257
Merchandise inventories, net 128,786 125,211 130,676
Income taxes receivable 7,452 7,730 7,759
Other current assets 5,165 4,570 5,461
--------- --------- ---------
Total current assets 148,073 138,847 148,153
Property and equipment, net of accumulated depreciation
of $118,580, $112,283 and $113,007, respectively 62,552 68,377 65,319
Deferred income taxes -- 4,161 --
Intangible assets, net 624 -- --
Other assets 13 581 12
--------- --------- ---------
$ 211,262 $ 211,966 $ 213,484
========= ========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities on long-term debt $ 154 $ 140 $ 154
Trade accounts payable 64,163 51,807 70,534
Accrued expenses and other current liabilities 29,478 29,663 30,898
Deferred income taxes -- 232 --
--------- --------- ---------
Total current liabilities 93,795 81,842 101,586
Long term debt, excluding current maturities 35,368 38,237 29,456
Other liabilities 6,198 4,503 6,651
Commitments and contingencies
Shareholders' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued -- -- --
Common stock, $.01 par value; 75,000,000 shares authorized;
11,751,850 shares issued and outstanding at January 31, 2001;
11,736,923 shares issued, 11,623,962 shares outstanding at July 31, 2000;
11,839,942 shares issued and outstanding at July 31, 2001 118 117 117
Additional paid-in capital 36,418 37,250 36,323
Retained earnings 39,365 51,199 39,351
Treasury stock, at cost -- (1,182) --
--------- --------- ---------
75,901 87,384 75,791
--------- --------- ---------
$ 211,262 $ 211,966 $ 213,484
========= ========= =========
See accompanying notes to unaudited consolidated financial statements.
3
4
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
For the Three Months and Six Months Ended July 31, 2001 and 2000
(In thousands, except per share data)
THREE MONTHS ENDED JULY 31, SIX MONTHS ENDED JULY 31,
2001 2000 2001 2000
--------- --------- --------- ---------
Merchandise revenue $ 86,876 $ 85,364 $ 173,491 $ 173,495
Rental video revenue 23,253 21,407 45,779 43,361
--------- --------- --------- ---------
Total revenues 110,129 106,771 219,270 216,856
Merchandise cost of revenue 64,021 64,548 129,192 131,493
Rental video cost of revenue 10,038 9,472 20,880 17,742
--------- --------- --------- ---------
Total cost of revenues 74,059 74,020 150,072 149,235
--------- --------- --------- ---------
Gross profit 36,070 32,751 69,198 67,621
Selling, general and administrative expenses 34,807 35,621 68,101 70,315
Pre-opening expenses 34 (2) 34 --
--------- --------- --------- ---------
Operating income (loss) 1,229 (2,868) 1,063 (2,694)
Other income (expense):
Interest expense (515) (889) (1,142) (1,850)
Other, net 69 65 94 106
--------- --------- --------- ---------
Income (loss) before income taxes 783 (3,692) 15 (4,438)
Income tax benefit -- (1,402) -- (1,686)
--------- --------- --------- ---------
Net income (loss) $ 783 $ (2,290) $ 15 $ (2,752)
========= ========= ========= =========
Basic earnings (loss) per share $ 0.07 $ (0.20) $ 0.00 $ (0.24)
========= ========= ========= =========
Diluted earnings (loss) per share $ 0.07 $ (0.20) $ 0.00 $ (0.24)
========= ========= ========= =========
Weighted-average common shares outstanding:
Basic 11,840 11,643 11,797 11,636
========= ========= ========= =========
Diluted 11,868 11,643 11,819 11,636
========= ========= ========= =========
See accompanying notes to unaudited consolidated financial statements.
4
5
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
Six Months Ended July 31, 2001 and 2000
(Dollars in thousands)
SIX MONTHS ENDED JULY 31,
2001 2000
--------- ---------
Cash flows from operating activities:
Net income (loss) $ 15 $ (2,752)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization expense 17,026 15,890
Loss on rental videos lost, stolen and defective 2,129 909
Loss on disposal of non-rental video assets 299 355
Deferred income tax -- (247)
Non-cash compensation 97 46
Changes in operating assets and liabilities:
Merchandise inventory 3,581 28,129
Other current assets 295 398
Trade accounts payable and accrued expenses (8,144) (16,850)
Income taxes receivable 307 (1,458)
Other assets and liabilities, net (453) (664)
--------- ---------
Net cash provided by operating activities 15,152 23,756
--------- ---------
Cash flows from investing activities:
Purchases of property and equipment (18,015) (13,563)
Purchase of retail locations (636) --
--------- ---------
Net cash used in investing activities (18,651) (13,563)
--------- ---------
Cash flows from financing activities:
Borrowings under revolving credit facility 232,974 73,067
Repayments under revolving credit facility (226,990) (83,767)
Payments under long-term debt and capital lease obligations (72) (5,183)
--------- ---------
Net cash provided by (used in) financing activities 5,912 (15,883)
--------- ---------
Net increase (decrease) in cash and cash equivalents 2,413 (5,690)
Cash at beginning of period 4,257 7,026
--------- ---------
Cash and cash equivalents at end of period $ 6,670 $ 1,336
========= =========
See accompanying notes to unaudited consolidated financial statements.
5
6
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
July 31, 2001 and 2000
1. BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Hastings
Entertainment, Inc. and its subsidiaries (the "Company", "We", "Our", "Us") have
been prepared in accordance with 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 generally
accepted accounting principles have been condensed or omitted pursuant to such
principles and regulations of the Securities and Exchange Commission. All
adjustments, consisting only 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 which may be expected for
a full year. The unaudited consolidated financial statements contained herein
should be read in conjunction with the audited consolidated financial statements
and notes thereto included in the Company's annual report on Form 10-K for the
fiscal year 2000.
Certain prior year amounts have been reclassified to conform with fiscal 2000
presentation including reclassification of returns expense from "Selling,
general and administrative expenses" to "Merchandise cost of revenue," the
reclassification of certain coupon expense from "Selling, general and
administrative expenses" to "Rental video revenue," and the reclassification of
certain advertising allowances and buying, marketing and merchandising human
resource costs from "Merchandise cost of revenue" to "Selling, general and
administrative expenses" as set forth in the Statement of Operations.
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, 2002 is referred to as fiscal 2001.
2. CONSOLIDATION POLICY
The unaudited consolidated financial statements present the results of Hastings
Entertainment, Inc. and its subsidiaries. All significant intercompany
transactions and balances have been eliminated in consolidation.
3. ACQUISITION OF RETAIL LOCATIONS
During the second quarter of fiscal 2001, we entered into an agreement with
Family Entertainment Superstores, Inc. ("Family"), a regional rental video
retailer headquartered in North Little Rock, Arkansas, to acquire certain assets
of three of Family's retail locations for total consideration of approximately
$1.2 million, of which approximately $0.5 million remained to be paid at July
31, 2001. All stores were converted to carry the broad assortment of products
typically found in a Hastings superstore.
The acquisition was accounted for under the purchase method of accounting and
the operating results of each store are included in the consolidated results of
operations from the effective date of the acquisition. Results of operations for
the periods ending July 31, 2001 were not materially affected as a result of
this acquisition. Goodwill of $0.3 million has been recognized for the amount of
the excess of the purchase price paid over the fair market value of the net
assets acquired and is amortized on a straight-line basis over 10 years.
6
7
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
July 31, 2001 and 2000
4. STORE CLOSING RESERVES
From time to time and in the normal course of business, we evaluate our store
base to determine if a need to close a store(s) is present. Such evaluations
include, among other factors, current and future profitability, market trends,
age of store and lease status.
Included in accrued expenses and other liabilities at July 31, 2001 and January
31, 2001 are accruals of $6.1 million and $6.6 million, respectively, for the
net present value of future minimum lease payments and other costs attributable
to closed or relocated stores, net of estimated sublease income.
There were no additional charges recorded to the accrual for store closings
during the second quarter of fiscal 2001. The following tables provide a
rollforward of reserves that were established for these charges for the six
months ended July 31, 2001 and 2000 (dollars in thousands):
Future Lease
Payments Other Costs Total
------------ ----------- -------
Balance at January 31, 2000 $ 3,671 $ 300 3,971
Changes in estimates (256) -- (256)
Additions to provision 632 -- 632
Cash outlay (330) (300) (630)
------- ------- -------
Balance at July 31, 2000 $ 3,717 $ -- $ 3,717
======= ======= =======
Balance at January 31, 2001 $ 6,350 $ 255 6,605
Changes in estimates 94 -- 94
Additions to provision -- -- --
Cash outlay (462) (123) (585)
------- ------- -------
Balance at July 31, 2001 $ 5,982 $ 132 $ 6,114
======= ======= =======
Payments during the next five years that are to be charged against the reserve
are expected to be approximately $1.0 million per year. Other costs were charged
against the reserve during the second quarter of fiscal 2001 as incurred.
5. EARNINGS (LOSS) PER SHARE
Basic earnings per share are computed by dividing net income by the weighted
average number of common shares outstanding for the period. Diluted earnings per
share are computed similar to basic earnings per share except that the weighted
average shares outstanding are increased to include additional shares from the
assumed exercise of stock options, if dilutive. The number of additional shares
is calculated by assuming that outstanding stock options are exercised and that
the proceeds from such exercises are used to acquire shares of common stock at
the average market price during the period.
7
8
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
July 31, 2001 and 2000
The computations for basic and diluted earnings (loss) per share are as follows
(in thousands except per share amounts):
Three Months Ended July 31, Six Months Ended July 31,
2001 2000 2001 2000
---- ---- ---- ----
Net income (loss) $ 783 $ (2,290) $ 15 $ (2,752)
======== ======== ======== ========
Average shares outstanding:
Basic 11,840 11,643 11,797 11,636
Effect of stock options 28 -- 22 --
-------- -------- -------- --------
Diluted 11,868 11,643 11,819 11,636
======== ======== ======== ========
Earnings (loss) per share:
Basic $ 0.07 $ (0.20) $ 0.00 $ (0.24)
======== ======== ======== ========
Diluted $ 0.07 $ (0.20) $ 0.00 $ (0.24)
======== ======== ======== ========
6. LITIGATION AND CONTINGENCIES
In 2000, the Company restated its financial statements for the first three
quarters of fiscal 1999 and the prior four fiscal years. Following the Company's
initial announcement in March 2000 of the requirement for such restatements, six
purported class action lawsuits were filed in the United States District Court
for the Northern District of Texas against the Company and certain of the
current and former directors and officers of the Company asserting various
claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934.
Although four of the lawsuits were originally filed in the Dallas Division of
the Northern District of Texas, all of the five pending actions have been
transferred to the Amarillo Division of the Northern District and have been
consolidated. One of the Section 10(b) and 20(a) lawsuits filed in the Dallas
Division was voluntarily dismissed. On May 15, 2000, a lawsuit was filed in the
United States District Court for the Northern District of Texas against the
Company, its current and former directors and officers at the time of the
Company's June 1998 initial public offering and three underwriters, Salomon
Smith Barney, A.G. Edwards & Sons, Inc. and Furman Selz, LLC asserting various
claims under Sections 11, 12(2) and 15 of the Securities Act of 1933.
None of the six pending complaints specify the amount of damages sought.
Although it is not feasible to predict or determine the final outcome of the
proceedings or to estimate the potential range of loss with respect to these
matters, an adverse outcome with respect to such proceedings could have a
material adverse impact on the Company's financial position, results of
operations and cash flows.
The Company is also involved in various other 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 the
Company's financial position, results of operations and cash flows.
8
9
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
July 31, 2001 and 2000
7. SEGMENT DISCLOSURES
The Company has two operating segments, retail stores and Internet operations.
Our chief operating decision maker, as that term is defined in the relevant
accounting standard, regularly reviews financial information about each of the
above operating segments for assessing performance and allocating resources.
Revenue for retail stores is derived from the sale of merchandise and rental of
videocassettes, video games and DVDs. Revenue for Internet operations is derived
solely from the sale of merchandise. Segment information regarding our retail
stores and Internet operations for the three months and six months ended July
31, 2001 and 2000 is presented below.
For the three months ended July 31, 2001: Retail Internet
(Dollars in thousands) Stores Operations Total
------ ---------- -----
Total revenue $110,076 $ 53 $110,129
Depreciation and amortization $ 8,067 $ 68 $ 8,135
Operating income (loss) $ 1,479 $(250) $ 1,229
Total assets $210,660 $ 602 $211,262
Capital expenditures $ 10,981 $ -- $ 10,981
For the three months ended July 31, 2000: Retail Internet
(Dollars in thousands) Stores Operations Total
------ ---------- -----
Total revenue $106,751 $ 20 $106,771
Depreciation and amortization $ 7,629 $ 69 $ 7,698
Operating loss $(2,513) $(355) $(2,868)
Total assets $210,659 $1,307 $211,966
Capital expenditures $ 6,616 $ 251 $ 6,867
For the six months ended July 31, 2001: Retail Internet
(Dollars in thousands) Stores Operations Total
------ ---------- -----
Total revenue $219,197 $ 73 $219,270
Depreciation and amortization $ 16,887 $ 139 $ 17,026
Operating income (loss) $ 1,541 $(478) $ 1,063
Total assets $210,660 $ 602 $211,262
Capital expenditures $ 18,651 $ -- $ 18,651
9
10
HASTINGS ENTERTAINMENT, INC.
Notes to Unaudited Consolidated Financial Statements
July 31, 2001 and 2000
7. SEGMENT DISCLOSURES (CONT'D)
For the six months ended July 31, 2000: Retail Internet
(Dollars in thousands) Stores Operations Total
------ ---------- -----
Total revenue $216,820 $ 36 $216,856
Depreciation and amortization $ 15,736 $ 154 $ 15,890
Operating loss $(1,889) $(805) $(2,694)
Total assets $210,659 $1,307 $211,966
Capital expenditures $ 13,312 $ 251 $ 13,563
8. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill will no longer be amortized but
will be subject to annual impairment tests in accordance with the Statements.
Other intangible assets will continue to be amortized over their useful lives.
The Company will apply the new rules on accounting for goodwill and other
intangible assets beginning in the first quarter of fiscal 2002. Application of
the Statements is not expected to have a material impact on the Company's
consolidated financial position or results of operations.
10
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
This Report contains certain forward-looking statements concerning the
intentions, hopes, beliefs, expectations, strategies, predictions or any other
variation thereof or comparable phraseology of the future activities or other
future events or conditions of Hastings Entertainment, Inc. (the "Company",
"We", "Our", "Us") within the meaning of Section 27A of the Securities Act of
1993, as amended (the "1933 Act"), and Section 21E of the Securities Exchange
Act of 1934, as amended (the "1934 Act"), which are intended to be covered by
the safe harbors created thereby. Investors are cautioned that all
forward-looking statements involve risks and uncertainty, including, without
limitation, variations in quarterly results, volatility of stock price,
development by competitors of superior services or product offerings, the entry
into the market by new competitors, the sufficiency of our working capital, the
ability to retain management, to implement our business strategy, to attract and
retain customers, to increase revenue, and to successfully defend our company in
ongoing and future litigation. Although we believe that the assumptions
underlying the forward-looking statements contained herein are reasonable, any
of the assumptions could be inaccurate, and, therefore, there can be no
assurance that the forward-looking statements included in this Report will prove
to be accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by us or any other person that our
objectives and plans will be achieved.
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 the Report.
General
Hastings Entertainment is a leading multimedia entertainment retailer that
combines the sale of books, music, software, periodicals, videocassettes, video
games and DVDs with the rental of videocassettes, video games and DVDs in a
superstore and Internet Web site format. As of July 31, 2001, we operated 139
superstores averaging 22,000 square feet in small to medium-sized markets
located in 21 states, primarily in the Western and Midwestern United States.
Each of the superstores is wholly owned by us and operates under the name of
Hastings. Our e-commerce Web site, www.gohastings.com, became operational in May
1999.
Our operating strategy is to enhance our position as a multimedia entertainment
retailer by expanding existing superstores, opening new superstores in selected
markets, and expanding our offering of products through our Internet Web site.
References herein to fiscal years are to the twelve-month periods that end in
January of the following calendar year. For example, the twelve-month period
ended January 31, 2002 is referred to fiscal 2001.
11
12
Results of Operations
The following tables present our statement of operations data, expressed as a
percentage of revenue, and the number of superstores open at the end of the
periods presented herein.
Three Months Ended July 31, Six Months Ended July 31,
2001 2000 2001 2000
----- ----- ----- -----
Merchandise revenue 78.9% 80.0% 79.1% 80.0%
Rental video revenue 21.1 20.0 20.9 20.0
----- ----- ----- -----
Total revenues
100.0 100.0 100.0 100.0
Merchandise cost of revenue 73.7 74.5 75.6 75.8
Rental video cost of revenue 43.2 45.6 44.2 40.9
----- ----- ----- -----
Total cost of revenues 67.2 69.3 68.4 68.8
----- ----- ----- -----
Gross profit 32.8 30.7 31.6 31.2
Selling, general and administrative expenses 31.6 33.4 31.1 32.4
Pre-opening expenses 0.0 0.0 0.0 0.0
----- ----- ----- -----
31.6 33.4 31.1 32.4
----- ----- ----- -----
Operating income (loss)
Other income (expense):
Interest expense (0.5) (0.8) (0.5) (0.9)
Other, net 0.0 0.0 0.0 0.0
----- ----- ----- -----
Income (loss) before income taxes 0.7 (3.5) 0.0 (2.1)
Income tax benefit -- (1.3) -- (0.8)
----- ----- ----- -----
Net income (loss) 0.7% (2.2)% 0.0% (1.3)%
===== ===== ===== =====
Summary of Superstore Activity
Year Ended
Three Months Ended July 31, Six Months Ended July 31, January 31,
2001 2000 2001 2000 2001
---- ---- ---- ---- -----------
Hastings Superstores:
Beginning number of stores 142 143 142 147 147
Openings 1 -- 1 -- 1
Closings (4) -- (4) (4) (6)
---- ---- ---- ---- ----
Ending number of stores 139 143 139 143 142
==== ==== ==== ==== ====
12
13
THREE MONTHS ENDED JULY 31, 2001 COMPARED TO THREE MONTHS ENDED JULY 31, 2000:
Revenues. Total revenues increased $3.4 million, or 3.1%, for the quarter to
$110.1 million compared to $106.7 million a year ago primarily due to an
increase in total comparable store revenues ("Comps") of 4.2%. Elements of total
Comps were as follows:
Merchandise Comps 3.3%
Rental video Comps 7.7%
Total Comps 4.2%
Total merchandise revenue increased $1.5 million, or 1.8%, to $86.9 million
compared to $85.4 million last year despite operating an average of three fewer
superstores during the quarter ending July 31, 2001 compared to the same quarter
last year. Contributing to the increase in merchandise Comps were book releases
by authors Sue Grafton, Danielle Steel and Bruce Wilkinson along with the sale
video releases of Miss Congeniality and Castaway and the launch of Game Boy
Advanced hardware and software. Total rental video revenue grew $1.9 million, or
8.6%, to $23.3 million, up from $21.4 million a year earlier. The increase was
driven by a 160% increase in DVD rentals over the same period last year and
strong title releases for rental.
Gross Profit. Total gross profit of $36.1 million in the second quarter of
fiscal 2001 increased $3.3 million, or 10.1%, from $32.8 million in the second
quarter of fiscal 2000. Total gross profit as a percent of total revenue
increased for the three months ended July 31, 2001 to 32.8% compared to 30.7%
for the same period last year. Merchandise margin as a percent of merchandise
revenue increased to 26.3% for the current quarter from 24.4% for the same
quarter last year due primarily to a reduction in the costs associated with the
return of product of approximately $1.9 million during the quarter which is
attributable to a decrease in the volume of returns. As a result of the
Company's fiscal 2000 efforts to improve its inventory performance and reduce
the investment in inventory, merchandise returns during the second quarter of
fiscal 2000 exceeded the amount of merchandise returns during the second quarter
of fiscal 2001 resulting in higher returns expense during the second quarter of
fiscal 2000. Offsetting decreases in the cost of returns were increases of $0.4
million in merchandise write-downs for the quarter ending July 31, 2001 compared
to the same period last year. Write-downs of merchandise inventory result from
our ongoing review of lower of cost or market issues associated with inventory.
Rental video gross profit as a percent of rental revenue increased to 56.8% for
the current quarter from 55.8% for the same quarter last year. This increase was
primarily due to (i) higher revenues as described above, (ii) higher margin on
revenue sharing titles of approximately $0.2 million resulting from improved
contract terms with studios and (iii) lower shrinkage of approximately $0.2
million during the quarter. Partially offsetting these increases was
approximately $0.3 million in higher than anticipated rental video depreciation
resulting from an increase in DVD procurement and an increase of approximately
$0.7 million associated with the distribution of rental videos primarily due to
(i) higher shrinkage and (ii) increased overhead costs as we processed a greater
number of rental assets through our distribution center for the quarter ended
July 31, 2001 compared to last year.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses as a percent of total revenues decreased to
31.6% for the quarter ended July 31, 2001 from 33.4% for the same period last
year. The decrease was primarily the result of a decline of approximately $2.3
million in accounting and legal fees. Such fees were higher than normal during
the second quarter of fiscal 2000 due to expenses related to accounting
restatements. As a partial offset to the decrease above, net advertising costs
increased approximately $0.6 million, primarily the result of a planned increase
in targeted advertising expenditures.
Interest Expense. Interest expense was $0.5 million, or 0.5% of revenues, in the
three months ended July 31, 2001, compared to $0.9 million, or 0.8% of revenues,
in the three months ended July 31, 2000. The decrease was attributed to lower
average interest rates on our Facility and lower average debt outstanding.
Income Taxes. During the third and fourth quarters of fiscal 2000, we recorded a
valuation allowance against our net deferred tax asset as required under the
provisions set forth in Statement of Financial Accounting Standards No. 109,
Accounting for Income Taxes" (SFAS 109). While we believe the entire deferred
tax asset will be realized by future operating results, due to the cumulative
losses incurred in recent years the deferred tax asset does not currently meet
13
14
the stringent criteria for recognition under SFAS 109. During the quarter ended
July 31, 2001, no income tax expense was recorded due to a reduction in the
valuation allowance arising from a reduction in the net operating loss
carryforward.
SIX MONTHS ENDED JULY 31, 2001 COMPARED TO SIX MONTHS ENDED JULY 31, 2000:
Revenues. Total revenues increased $2.4 million, or 1.1%, for the quarter to
$219.3 million compared to $216.9 million a year ago primarily due to an
increase in total Comps of 2.2%. Elements of total Comps were as follows:
Merchandise Comps 1.3%
Rental video Comps 5.9%
Total Comps 2.2%
Total merchandise revenues were essentially flat for the six months ended July
31, 2001 compared to the same period last year, although we operated an average
of three fewer superstores during the six months ending July 31, 2001 compared
to the same period last year. Lower sales of music products compared to a strong
first quarter of fiscal 2000, which included break-out releases from N'Sync,
Santana and Dr. Dre along with significant carryover sales from a fourth quarter
fiscal 1999 release from Kid Rock, were the primary reason for the lack of
change in merchandise revenue. Total rental revenue increased $2.4 million, or
5.6%, to $45.8 million, up from $43.4 million a year earlier. The increase was
driven by a 155% increase in DVD rentals over the same period last year, strong
title releases and additional stores implementing our multi-night rental
program.
Gross Profit. Total gross profit of $69.2 million for the six months ended July
31, 2001 increased $1.6 million, or 2.3%, from $67.6 million for the six months
ended July 31, 2000. Total gross profit as a percent of total revenue increased
for the six months ended July 31, 2001 to 31.6% compared to 31.2% for the same
period last year. Merchandise margin as a percent of merchandise revenues
increased to 25.5% for the current six months from 24.2% for the same period
last year due primarily to a reduction in the costs associated with the return
of product of approximately $3.3 million which is attributable to a decrease in
the volume of returns. Additionally, and as an offset to the decrease in the
cost of returns, merchandise write-downs increased by approximately $1.0 million
for the period ending July 31, 2001 compared to the same period last year.
Write-downs of merchandise inventory result from our ongoing review of lower of
cost or market issues associated with inventory.
Rental video gross profit decreased as a percent of rental revenues to 54.4% for
the six months ended July 31, 2001 from 59.1% for the same period last year.
This decrease was primarily due to (i) higher than anticipated rental video
depreciation resulting from an increase in DVD procurement, primarily in the
first quarter of fiscal 2001; (ii) shrinkage on rental video increased by
approximately $0.3 million for the current period compared to last year; and
(iii) an increase of approximately $0.7 million associated with the distribution
of rental videos primarily due to (i) higher shrinkage and (ii) increased
overhead costs as we processed a greater number of rental assets through our
distribution center for the six months ended July 31, 2001 compared to last
year. Partially offsetting these increases in cost was an increase in rental
video revenues as described above.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses as a percent of total revenues decreased to
31.1% for the six months ended July 31, 2001 from 32.4% for the same period last
year. The decrease was primarily the result of a decline of approximately $2.7
million in accounting and legal fees. Such fees were higher than normal during
the first six months of fiscal 2000 due to expenses related to accounting
restatements.
Interest Expense. Interest expense was $1.1 million, or 0.5% of revenues, for
the six months ended July 31, 2001, compared to $1.9 million, or 0.9% of
revenues, in the three months ended July 31, 2000. The decrease was attributed
to lower average interest rates on our Facility and lower average debt
outstanding.
Income Taxes. During the third and fourth quarters of fiscal 2000, we recorded a
valuation allowance against our net deferred tax asset as required under the
provisions set forth in Statement of Financial Accounting Standards No. 109,
"Accounting for Income Taxes" (SFAS 109). While we believe the entire deferred
tax asset will be realized by future operating results, due to the cumulative
losses incurred in recent years the deferred tax asset does not currently meet
the stringent criteria for recognition under SFAS 109. During the six months
ended July 31, 2001, no income tax
14
15
expense was recorded due to a reduction in the valuation allowance arising from
a reduction in the net operating loss carryforward.
LIQUIDITY AND CAPITAL RESOURCES
We generate cash from operations exclusively from the sale of merchandise and
the rental of videocassettes, DVDs and video games and we have substantial
operating cash flow because most of our revenue is received in cash and cash
equivalents. Other than our principal capital requirements arising from the
purchase, warehousing and merchandising of inventory and rental videos, opening
new superstores and expanding existing superstores and updating existing and
implementing new information systems technology, we have no anticipated material
capital commitments. Our primary sources of working capital are cash flows from
operating activities, trade credit from vendors and borrowings under our
Facility as described below. We believe our cash flows from operations and
borrowing availability under the Facility will be sufficient to fund our ongoing
operations, new superstores and expansions of certain existing superstores
through fiscal 2002.
Consolidated Cash Flows
Operating Activities. Net cash flows from operating activities decreased $8.6
million from $23.8 million for the six months ended July 31, 2000 to $15.2
million for the six months ended July 31, 2001. The primary reason for the
decrease was an orderly reduction of merchandise inventory of approximately
$28.1 million during the six months ended July 31, 2000. The majority of this
reduction was the result of our fiscal 2000 initiative to increase cash flow and
inventory turns by reducing our inventory.
Investing Activities. Net cash used in investing activities increased $5.1
million, or 37.5%, to $18.7 million for the six months ended July 31, 2001 from
$13.6 million for the six months ended July 31, 2000. This increase was the
result of growth in remodeling activity of certain existing superstores compared
to the prior year, higher procurement of rental video assets relating to the
growth of DVD and the acquisition of three retail locations in Arkansas. Our
capital expenditures include store equipment and fixtures, expanding and
remodeling existing superstores, upgrading and implementation of information
systems technology and the purchase of rental video assets.
Financing Activities. Cash provided by or used in financing activities is
primarily associated with borrowings and payments made under debt agreements.
For the six months ended July 31, 2001, net borrowings under debt agreements
increased $5.9 million compared to decreasing by $15.9 million for the six
months ended July 31, 2000. The planned increase for fiscal 2001 was the result
of growth in remodeling activity of certain existing superstores compared to the
prior year and higher procurement of rental video assets relating to the growth
of DVD.
On August 29, 2000, the Company entered into a three-year syndicated, secured
Loan and Security Agreement with Fleet Retail Finance, Inc. and The CIT
Group/Business Credit, Inc. ("the "Facility"). The initial proceeds from the
Facility were used by the Company to terminate and prepay fully the total
amounts outstanding under a prior revolving credit facility with Bank of America
and a consortium of banks and its Series A Senior Notes (the "Senior Notes")
with a financial institution. The amount outstanding under the Facility is
limited by a borrowing base predicated on eligible inventory, as defined, and
certain rental video assets, net of accumulated depreciation less specifically
defined reserves and is limited to a ceiling of $70 million, which increases to
$80 million between October 15 and December 15 of each year of the Facility,
less a $10 million availability reserve. The Facility bears interest based on
the prevailing prime rate or LIBOR plus 2.00% at the Company's option. The
borrowing base under the Facility is limited to an advance rate of 65% of
eligible inventory and certain rental video assets net of accumulated
amortization less specifically defined reserves. The Facility contains no
financial covenants, restricts the payment of dividends and certain other debt
and acquisition limitations, allows for the repurchase of up to $7.5 million of
the Company's 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 its subsidiaries and is guaranteed by each of the Company's
15
16
three consolidated subsidiaries. The Facility expires on August 29, 2003. At
July 31, 2001, the Company had $21.2 million in excess availability after the
$10 million availability reserve, under the Facility.
At July 31, 2001 and January 31, 2001, we had borrowings outstanding of $34.2
million and $28.3 million under the Facility, respectively. The average rate of
interest being charged under the Facility was 7.0% and 8.4% at July 31, 2001 and
January 31, 2001, respectively.
SEASONALITY AND INFLATION
As is the case with many retailers, a significant portion of the Company's
revenues, and an even greater portion of its operating profit, is generated in
the fourth fiscal quarter, which includes the Christmas selling season. As a
result, a substantial portion of the Company's annual earnings has been, and
will continue to be, dependent on the results of this quarter. The Company
experiences reduced rentals of video activity in the spring because customers
spend more time outdoors. Major world or sporting events, such as the Super
Bowl, the Olympic Games 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 store openings, the number and
popularity of new book, music and videocassette 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 retailers in general and
the Company in particular.
The Company does 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 the Company's operating results to the extent
such increases are not passed along to customers.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of its business, the Company is exposed to certain market
risks, primarily changes in interest rates. The Company's exposure to interest
rate risk consists of variable rate debt based either on the lenders base rate
or LIBOR plus a specified percentage. The annual impact on the Company's results
of operations of a 100 basis point interest rate change on the July 31, 2001
outstanding balance of the variable rate debt would be approximately $0.3
million. After an assessment of these risks to the Company's operations, the
Company believes that its 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 the Company's financial position, results of
operations or cash flows for the next fiscal year. The Company is not a party to
any derivative or interest rate hedging contracts.
16
17
PART II
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Shareholders on June 20, 2001. The shareholders
voted on a proposal to elect three Class III Directors of Hastings for a term
expiring in 2004. The proposal was approved by the following vote:
NOMINEE VOTES FOR VOTES WITHHELD
------- --------- --------------
Peter Dallas 11,049,937 54,631
Craig Lentzsch 11,048,691 55,877
Ron Stegall 11,048,328 56,240
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. No report on Form 8-K was filed by the registrant during the quarter of the
fiscal year for which this report on Form 10-Q is filed.
17
18
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: September 6, 2001 By: /s/ Dan Crow
----------------------------------
Dan Crow
Vice President, Chief Financial
Officer (Principal Financial and
Accounting Officer)
18