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 October 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 November
30, 2001:
<Table>
<Caption>
Class Shares Outstanding
- -------------------------------------- ------------------------------
Common Stock, $.01 par value per share 11,754,031
</Table>
HASTINGS ENTERTAINMENT, INC.
AND SUBSIDIARIES
FORM 10-Q FOR THE THREE MONTHS AND NINE MONTHS ENDED OCTOBER 31, 2001
INDEX
<Table>
<Caption>
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of October 31, 2001 (Unaudited),
October 31, 2000 (Unaudited) and January 31, 2001 3
Unaudited Consolidated Statements of Operations for the Three Months
and Nine Months Ended October 31, 2001 and 2000 4
Unaudited Consolidated Statements of Cash Flows for the Nine Months
Ended October 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 18
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 19
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURE PAGE 20
</Table>
2
PART 1
ITEM 1 - FINANCIAL STATEMENTS
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
October 31, 2001 and 2000, and January 31, 2000
(Dollars in thousands, except par value)
<Table>
<Caption>
OCTOBER 31, OCTOBER 31, JANUARY 31,
2001 2000 2001
----------- ----------- -----------
ASSETS (UNAUDITED) (UNAUDITED)
Current assets:
Cash $ 3,844 $ 5,139 $ 4,257
Merchandise inventories, net 146,143 146,356 130,676
Income taxes receivable 6,756 7,763 7,759
Other current assets 5,347 4,293 5,461
---------- ---------- ----------
Total current assets 162,090 163,551 148,153
Property and equipment, net of accumulated depreciation
of $120,184, $113,346 and $113,007, respectively 65,061 67,334 65,319
Deferred income taxes -- 4,162 --
Intangible assets, net 645 -- --
Other assets 11 12 12
---------- ---------- ----------
$ 227,807 $ 235,059 $ 213,484
========== ========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities on long-term debt $ 153 $ 140 $ 154
Trade accounts payable 85,395 77,777 70,534
Accrued expenses and other current liabilities 27,223 30,800 30,898
Deferred income taxes -- 232 --
---------- ---------- ----------
Total current liabilities 112,771 108,949 101,586
Long term debt, excluding current maturities 38,458 44,529 29,456
Other liabilities 6,391 6,169 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 at October 31, 2000;
11,944,544 shares issued at October 31, 2001 119 117 117
Additional paid-in capital 36,846 37,250 36,323
Retained earnings 33,848 39,172 39,351
Treasury stock, at cost
112,213 shares, 94,278 shares and zero shares at October 31, 2001, 2000 and
January 31, 2001, respectively (626) (1,127) --
---------- ---------- ----------
70,187 75,412 75,791
---------- ---------- ----------
$ 227,807 $ 235,059 $ 213,484
========== ========== ==========
</Table>
See accompanying notes to unaudited consolidated financial statements.
3
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
For the Three Months and Nine Months Ended October 31, 2001 and 2000
(In thousands, except per share data)
<Table>
<Caption>
THREE MONTHS ENDED OCTOBER 31, NINE MONTHS ENDED OCTOBER 31,
2001 2000 2001 2000
------------- ------------- ------------- -------------
Merchandise revenue $ 82,372 $ 81,193 $ 255,863 $ 254,688
Rental video revenue 20,829 18,887 66,608 62,248
------------- ------------- ------------- -------------
Total revenues 103,201 100,080 322,471 316,936
Merchandise cost of revenue 61,499 64,700 190,691 196,193
Rental video cost of revenue 9,608 9,284 30,488 27,026
------------- ------------- ------------- -------------
Total cost of revenues 71,107 73,984 221,179 223,219
------------- ------------- ------------- -------------
Gross profit 32,094 26,096 101,292 93,717
Selling, general and administrative expenses 37,089 37,318 105,190 107,634
Pre-opening expenses 47 33 81 33
------------- ------------- ------------- -------------
Operating loss (5,042) (11,255) (3,979) (13,950)
Other income (expense):
Interest expense (514) (821) (1,656) (2,671)
Other, net 39 49 133 156
------------- ------------- ------------- -------------
Loss before income taxes (5,517) (12,027) (5,502) (16,465)
Income tax benefit -- -- -- (1,686)
------------- ------------- ------------- -------------
Net loss $ (5,517) $ (12,027) $ (5,502) $ (14,779)
============= ============= ============= =============
Basic and diluted loss per share $ (0.46) $ (1.03) $ (0.47) $ (1.27)
============= ============= ============= =============
Weighted-average common shares outstanding:
Basic and diluted 11,865 11,643 11,821 11,638
============= ============= ============= =============
</Table>
See accompanying notes to unaudited consolidated financial statements.
4
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
Nine Months Ended October 31, 2001 and 2000
(Dollars in thousands)
<Table>
<Caption>
NINE MONTHS ENDED OCTOBER 31,
2001 2000
------------- -------------
Cash flows from operating activities:
Net loss $ (5,502) $ (14,779)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Depreciation and amortization expense 25,054 22,362
Loss on rental videos lost, stolen and defective 3,940 2,339
Loss on disposal of non-rental video assets 293 977
Deferred income tax -- (247)
Non-cash compensation 111 101
Changes in operating assets and liabilities:
Merchandise inventory (13,108) 7,662
Other current assets 650 675
Trade accounts payable and accrued expenses 11,185 10,256
Income taxes receivable 1,003 (1,491)
Other assets and liabilities, net (337) 1,571
------------- -------------
Net cash provided by operating activities 23,289 29,426
------------- -------------
Cash flows from investing activities:
Purchases of property and equipment (31,327) (21,722)
Purchase of retail locations (1,167) --
------------- -------------
Net cash used in investing activities (32,494) (21,722)
------------- -------------
Cash flows from financing activities:
Borrowings under revolving credit facility 349,116 142,272
Repayments under revolving credit facility (340,006) (146,643)
Payments under long-term debt and capital lease obligations (108) (5,220)
Purchase of treasury stock (650) --
Proceeds from exercise of stock options 440 --
------------- -------------
Net cash provided by (used in) financing activities 8,792 (9,591)
------------- -------------
Net decrease in cash and cash equivalents (413) (1,887)
Cash at beginning of period 4,257 7,026
------------- -------------
Cash and cash equivalents at end of period $ 3,844 $ 5,139
============= =============
</Table>
See accompanying notes to unaudited consolidated financial statements.
5
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
October 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 because of, among other things, seasonality factors in the retail
business. 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 2001
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. 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 October 31, 2001 were not materially affected as a result of
this acquisition. Goodwill of $0.4 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. See
note 8 regarding recent accounting pronouncements affecting amortization of
goodwill.
6
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
October 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 October 31, 2001 and
January 31, 2001 are accruals of $6.4 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.
During the third quarter of fiscal 2000, the Company identified two stores for
closure and recorded a pre-tax charge of $2.8 million relating to the net
present value of minimum lease payments. The stores were subsequently closed
during the fourth quarter of fiscal 2000.
Additions to the provision during the third quarter of fiscal 2001 included
charges totaling approximately $0.3 million related to the future value of
minimum lease payments for one store to be closed and one to be relocated during
the fourth quarter of fiscal 2001. The following tables provide a rollforward of
reserves that were established for these charges for the nine months ended
October 31, 2001 and 2000 (dollars in thousands):
<Table>
<Caption>
Future Lease
Payments Other Costs Total
------------ ----------- -----------
Balance at January 31, 2000 $ 3,671 $ 300 3,971
Changes in estimates (757) -- (757)
Additions to provision 3,391 -- 3,391
Cash outlay (866) (300) (1,166)
----------- ----------- -----------
Balance at October 31, 2000 $ 5,439 $ -- $ 5,439
=========== =========== ===========
Balance at January 31, 2001 $ 6,350 $ 255 6,605
Changes in estimates 263 -- 263
Additions to provision 369 -- 369
Cash outlay (764) (123) (887)
----------- ----------- -----------
Balance at October 31, 2001 $ 6,218 $ 132 $ 6,350
=========== =========== ===========
</Table>
Payments during the next five years that are to be charged against the reserve
are expected to be approximately $1.0 million per year.
5. INCOME (LOSS) PER SHARE
Options to purchase 1,594,755 shares of common stock at exercise prices ranging
from $1.27 per share to $14.03 per share outstanding at October 31, 2001 and
options to purchase 1,576,350 shares of common stock at exercise prices ranging
from $1.27 per share to $15.00 per share outstanding at October 31, 2000 were
not included in the computation of diluted loss per share because their
inclusion would have been antidilutive.
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
7
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
October 31, 2001 and 2000
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. Motions to dismiss these actions were filed by the
Company and, on September 25, 2001, were denied by the Court. Discovery and
class certification proceedings are commencing in both actions.
None of the 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.
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 nine months ended
October 31, 2001 and 2000 is presented below.
<Table>
<Caption>
For the three months ended October 31, 2001: Retail Internet
(Dollars in thousands) Stores Operations Total
------------- ------------- -------------
Total revenue $ 103,161 $ 40 $ 103,201
Depreciation and amortization $ 7,959 $ 69 $ 8,028
Operating loss $ (4,802) $ (240) $ (5,042)
Total assets $ 227,252 $ 555 $ 227,807
Capital expenditures $ 13,843 $ -- $ 13,843
</Table>
8
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
October 31, 2001 and 2000
7. SEGMENT DISCLOSURES (CONT'D)
<Table>
<Caption>
For the three months ended October 31, 2000: Retail Internet
(Dollars in thousands) Stores Operations Total
------------- ------------- -------------
Total revenue $ 100,065 $ 15 $ 100,080
Depreciation and amortization $ 6,366 $ 106 $ 6,472
Operating loss $ (10,799) $ (456) $ (11,255)
Total assets $ 233,828 $ 1,231 $ 235,059
Capital expenditures $ 7,988 $ 171 $ 8,159
<Caption>
For the nine months ended October 31, 2001: Retail Internet
(Dollars in thousands) Stores Operations Total
------------- ------------- -------------
Total revenue $ 322,358 $ 113 $ 322,471
Depreciation and amortization $ 24,846 $ 208 $ 25,054
Operating loss $ (3,261) $ (718) $ (3,979)
Total assets $ 227,252 $ 555 $ 227,807
Capital expenditures $ 32,494 $ -- $ 32,494
<Caption>
For the nine months ended October 31, 2000: Retail Internet
(Dollars in thousands) Stores Operations Total
------------- ------------- -------------
Total revenue $ 316,885 $ 51 $ 316,936
Depreciation and amortization $ 22,102 $ 260 $ 22,362
Operating loss $ (12,690) $ (1,260) $ (13,950)
Total assets $ 233,828 $ 1,231 $ 235,059
Capital expenditures $ 21,300 $ 422 $ 21,722
</Table>
9
HASTINGS ENTERTAINMENT. INC.
Notes to Unaudited Consolidated Financial Statements
October 31, 2001 and 2000
8. RECENT ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("SFAS") 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.
In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions
of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a
segment of a business. SFAS 144 is effective for fiscal years beginning after
December 15, 2001. The Company expects to adopt SFAS 144 as of February 1, 2002
and it does not expect that the adoption of the Statement will have a
significant impact on the Company's financial position and results of
operations.
10
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 October 31, 2001, we operated 141
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 as fiscal 2001.
11
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.
<Table>
<Caption>
Three Months Ended October 31, Nine Months Ended October 31,
2001 2000 2001 2000
------------- ------------- ------------- -------------
Merchandise revenue 79.8% 81.1% 79.3% 80.4%
Rental video revenue 20.2 18.9 20.7 19.6
------------- ------------- ------------- -------------
Total revenues 100.0 100.0 100.0 100.0
Merchandise cost of revenue 74.7 79.7 74.5 77.0
Rental video cost of revenue 46.1 49.2 45.8 43.4
------------- ------------- ------------- -------------
Total cost of revenues 68.9 68.6 73.9 70.4
------------- ------------- ------------- -------------
Gross profit 31.1 26.1 31.4 29.6
Selling, general and administrative expenses 35.9 37.3 32.6 34.0
Pre-opening expenses 0.0 0.0 0.0 0.0
------------- ------------- ------------- -------------
35.9 37.3 32.6 34.0
------------- ------------- ------------- -------------
Operating loss (4.8) (11.2) (1.2) (4.4)
Other income (expense):
Interest expense (0.5) (0.8) (0.5) (0.8)
Other, net 0.0 0.0 0.0 0.0
------------- ------------- ------------- -------------
Loss before income taxes (5.3) (12.0) (1.7) (5.2)
Income tax benefit -- -- -- (0.5)
------------- ------------- ------------- -------------
Net loss (5.3)% (12.0)% (1.7)% (4.7)%
============= ============= ============= =============
</Table>
Summary of Superstore Activity
<Table>
<Caption>
Three Months Ended Nine Months Ended Year Ended
October 31, October 31, January 31,
2001 2000 2001 2000 2001
-------------- -------------- ------------- ------------- --------------
Hastings Superstores:
Beginning number of stores 139 143 142 147 147
Openings 2 1 3 1 1
Closings -- -- (4) (4) (6)
-------------- ------------- ------------ ------------ -------------
Ending number of stores 141 144 141 144 142
============= ============= ============ ============ =============
</Table>
12
THREE MONTHS ENDED OCTOBER 31, 2001 COMPARED TO THREE MONTHS ENDED OCTOBER 31,
2000:
Revenues. Total revenues increased $3.1 million, or 3.1%, for the quarter to
$103.2 million compared to $100.1 million a year ago primarily due to an
increase in total comparable store revenues ("Comps") of 5.7%. Elements of total
Comps were as follows:
<Table>
Merchandise Comps 4.3%
Rental video Comps 11.4%
Total Comps 5.7%
</Table>
Total merchandise revenue increased $1.2 million, or 1.5%, to $82.4 million
compared to $81.2 million last year despite operating an average of three fewer
superstores during the quarter ending October 31, 2001 compared to the same
quarter last year. Contributing to the increase in merchandise Comps were
increased sales of DVD titles including The Mummy Returns and Star Wars Episode
I and video games such as Pokemon Crystal and Madden NFL. Total rental video
revenue grew $1.9 million, or 10.3%, to $20.8 million, up from $18.9 million a
year earlier. The increase was driven primarily 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 $32.1 million in the third quarter of fiscal
2001 increased $6.0 million, or 23.0%, from $26.1 million in the third quarter
of fiscal 2000. Total gross profit as a percent of total revenue increased for
the three months ended October 31, 2001 to 31.1% compared to 26.1% for the same
period last year. Merchandise margins as a percent of merchandise revenue
increased to 25.3% for the current quarter from 20.3% for the same quarter last
year due primarily to:
(i) a reduction in the costs associated with the return of product
of approximately $2.7 million during the current quarter
compared to the same period last year. This improvement was
attributable to a decrease in the volume of returns and higher
efficiency in our return process. As a result of our fiscal
2000 efforts to improve inventory performance and reduce the
investment in inventory, merchandise returns during the third
quarter of fiscal 2000 exceeded the amount of merchandise
returns during the third quarter of fiscal 2001 resulting in
higher returns expense during the third quarter of fiscal
2000;
(ii) a reduction in net merchandise shrinkage of approximately $1.5
million for the three months ended October 31, 2001 compared
to the same period last year primarily due to the
implementation of enhanced internal controls and exception
reporting;
(iii) inventory markdowns during the third quarter of fiscal 2001
were $1.2 million lower than the same period last year
primarily due to a pre-tax charge of $0.9 million recorded
during the third quarter of fiscal 2000 relating to the
write-off of a barter credit, resulting from an inventory
barter transaction, we deemed to be impaired during the third
quarter of fiscal 2000; and
(iv) improved margins of approximately $0.4 primarily as a result
of lower product costs realized through strategic buying
opportunities.
Partially offsetting the improvements detailed above, was an increase of
approximately $1.2 million in the cost of operating our distribution center.
During fiscal 2001, we implemented a strategy to increase the flow of certain
higher turning inventory through our distribution center. This program enables
us to have a better in-stock position for our customers. During the third
quarter, the volume of merchandise flowing through our distribution center was
higher when compared to the same period last year, which resulted in
significantly higher operating costs.
Rental video gross profit as a percent of rental revenue increased to 53.9% for
the current quarter from 50.8% for the same quarter last year. This increase was
primarily due to higher margins on revenue sharing titles of approximately $0.5
million resulting from improved contract terms with studios.
13
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses as a percent of total revenues decreased to
35.9% for the quarter ended October 31, 2001 from 37.3% for the same period last
year. The decrease was primarily the result of a decline in costs associated
with the closing of superstores. During the third quarter of fiscal 2000, we
recorded a $2.8 million pre-tax charge for the net present value of future
minimum lease payments for two superstores closed during the fourth quarter of
fiscal 2000 compared to $0.6 million in pretax charges recorded during the third
quarter of fiscal 2001. See Note 4 to the unaudited financial statements
contained herein for a full discussion of the store closure reserve. As a
partial offset to the decrease above, net advertising costs increased
approximately $1.2 million, primarily the result of a planned increase in
targeted advertising expenditures designed to increase customer traffic.
Interest Expense. Interest expense was $0.5 million, or 0.5% of revenues, in the
three months ended October 31, 2001, compared to $0.8 million, or 0.8% of
revenues, in the three months ended October 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. As a result, no income
tax benefit was recorded related to losses for the third quarters ending October
31, 2001 and 2000.
NINE MONTHS ENDED OCTOBER 31, 2001 COMPARED TO NINE MONTHS ENDED OCTOBER 31,
2000:
Revenues. Total revenues increased $5.5 million, or 1.7%, for the nine months
ended October 31, 2001 to $322.5 million compared to $317.0 million a year ago
primarily due to an increase in total Comps of 3.3%. Elements of total Comps
were as follows:
<Table>
Merchandise Comps 2.2%
Rental video Comps 7.6%
Total Comps 3.3%
</Table>
Total merchandise revenues increased $1.2 million, or 0.5% for the nine months
ended October 31, 2001 to $255.9 million compared to $254.7 a year ago. The
increase in merchandise Comps, driven primarily by increases in sales of DVDs
and video games, was partially offset by the operation of three fewer
superstores during the nine months ending October 31, 2001 compared to the same
period last year. Total rental revenue increased $4.4 million, or 7.0%, to $66.6
million, up from $62.2 million a year earlier. The increase was driven by a 156%
increase in DVD rentals over the same period last year, strong title releases
and additional stores implementing our multi-night rental program during fiscal
2001.
Gross Profit. Total gross profit of $101.3 million for the nine months ended
October 31, 2001 increased $7.6 million, or 8.1%, from $93.7 million for the
nine months ended October 31, 2000. Total gross profit as a percent of total
revenue increased for the nine months ended October 31, 2001 to 31.4% compared
to 29.6% for the same period last year. Merchandise margins as a percent of
merchandise revenues increased to 25.5% for the current nine months from 23.0%
for the same period last year due primarily to:
(i) a reduction in the costs associated with the return of product of
approximately $5.8 million for the current nine months which is
attributable to a decrease in the volume of returns and improvements to
the product return process during fiscal 2001 resulting in a lower cost
per dollar of return; and
(ii) a decline in net merchandise shrinkage of approximately $2.3 million
for the nine months ended October 31, 2001 compared to the nine months
ended October 31, 2000 primarily due to the implementation of enhanced
internal controls and exception reporting.
Partially offsetting the improvements in gross profit described above was an
increase of approximately $1.8 million in the cost of operating our distribution
center. During fiscal 2001, we implemented a strategy to increase the flow
14
of certain higher turning inventory through our distribution center. This
program enables us to have a better in-stock position for our customers. For the
current nine months, the volume of merchandise flowing through our distribution
center was higher when compared to the same period last year, which resulted in
significantly higher operating costs.
Rental video gross profit decreased as a percent of rental revenues to 54.2% for
the nine months ended October 31, 2001 from 56.6% 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 $0.2
million, or 0.3% of rental video revenues, for the current
period compared to last year; and
(iii) an increase of approximately $0.9 million in costs associated
with the distribution of rental videos primarily due to
increased overhead costs as we processed a greater number of
rental assets through our distribution center for the nine
months ended October 31, 2001 compared to last year.
Partially offsetting these decreases was an increase in margin on revenue
sharing titles as a result of improved contract terms with studios.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses as a percent of total revenues decreased to
32.6% for the nine months ended October 31, 2001 from 34.0% for the same period
last year. The decrease was the result of a decline of approximately $2.7
million in accounting and legal fees. Such fees were higher than normal during
the first nine months of fiscal 2000 due to expenses related to accounting
restatements. Additionally, during the third quarter of fiscal 2000, we recorded
a $2.8 million pre-tax charge for the net present value of future minimum lease
payments for two superstores closed during the fourth quarter of fiscal 2000
compared to $0.6 million in pretax charges recorded during the third quarter of
fiscal 2001. See Note 4 to the unaudited financial statements contained herein
for a full discussion of the store closure reserve. As a partial offset to the
decreases above, net advertising costs increased approximately $1.5 million,
primarily the result of a planned increase in targeted advertising expenditures
during the second and third quarters of fiscal 2001 designed to increase
customer traffic.
Interest Expense. Interest expense was $1.6 million, or 0.5% of revenues, for
the nine months ended October 31, 2001, compared to $2.7 million, or 0.8% of
revenues, in the nine months ended October 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. As a result, no income
tax benefit was recorded related to losses for the nine months ending October
31, 2001.
15
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, updating existing and
implementing new information systems technology, and the approved repurchase of
our common stock, 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 $6.1
million from $29.4 million for the nine months ended October 31, 2000 to $23.3
million for the nine months ended October 31, 2001. The primary reason for the
decrease was an orderly reduction of merchandise inventory of approximately $7.7
million during the nine months ended October 31, 2000 as a 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 $10.8
million, or 50.0%, to $32.5 million for the nine months ended October 31, 2001
from $21.7 million for the nine months ended October 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 nine months ended October 31, 2001, net borrowings under debt agreements
increased $9.0 million compared to decreasing by $9.6 million for the nine
months ended October 31, 2000. The 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 includes 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
three consolidated subsidiaries. The Facility expires on August 29, 2003. At
October 31, 2001, the Company had $28.0 million in excess availability after the
$10 million availability reserve, under the Facility.
16
At October 31, 2001 and January 31, 2001, we had borrowings outstanding of $37.4
million and $28.3 million under the Facility, respectively. The average rate of
interest being charged under the Facility was 6.51% and 8.4% at October 31, 2001
and January 31, 2001, respectively.
In November 2001, the Company entered into an interest rate swap with a
financial institution in order to obtain a fixed interest rate on a portion of
the Company's outstanding floating rate debt thereby reducing its exposure to
interest rate volatility. The swap fixed $10 million of the Company's revolving
credit facility at an interest rate of 2.65% for one year. The Company has
designated the interest rate swap as a hedging instrument.
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.
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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 October 31, 2001
outstanding balance of the variable rate debt would be approximately $0.4
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. In addition, the Company does
not believe future changes in the fair value of the interest rate swap entered
into in November 2001 with a notional amount of $10 million will be material.
18
PART II
ITEM 1. LEGAL PROCEEDINGS
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. Motions to
dismiss these actions were filed by the Company and, on September 25, 2001, were
denied by the Court. Discovery and class certification proceedings are
commencing in both actions.
None of the 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.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
b. On September 20, 2001, the Company filed a current report on Form 8-K
reporting, under "Item 5. Other Information," the approval by its board
of directors of a stock repurchase program of up to $5.0 million of the
Company's common stock.
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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: December 4, 2001 By: /s/ Dan Crow
--------------------------------------------
Dan Crow
Vice President, Chief Financial Officer
(Principal Financial and Accounting Officer)
20