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, 2002
OR
[ ] 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 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 9, 2002:
Class Shares Outstanding
- -------------------------------------- ------------------
Common Stock, $.01 par value per share 11,363,370
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
FORM 10-Q FOR THE THREE AND SIX MONTHS ENDED JULY 31, 2002
INDEX
<Table>
<Caption>
PAGE
----
PART I - FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of July 31, 2002 (Unaudited),
July 31, 2001 (Unaudited) and January 31, 2002 3
Unaudited Consolidated Statements of Operations for the Three and
Six Months Ended July 31, 2002 and 2001 4
Unaudited Consolidated Statements of Cash Flows for the Six
Months Ended July 31, 2002 and 2001 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 20
Item 4. Controls and Procedures 20
PART II - OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 4. Submission of Matters to a Vote of Security Holders 21
Item 6. Exhibits and Reports on Form 8-K 22
SIGNATURE AND CERTIFICATIONS PAGE 23
INDEX TO EXHIBITS 24
</Table>
2
PART I
ITEM 1 - FINANCIAL STATEMENTS
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
July 31, 2002 and 2001, and January 31, 2002
(Dollars in thousands, except par value)
<Table>
<Caption>
JULY 31, JULY 31, JANUARY 31,
2002 2001 2002
------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
ASSETS
Current assets:
Cash $ 7,863 $ 6,670 $ 4,319
Merchandise inventories, net 137,512 128,786 148,265
Income taxes receivable 6,636 7,452 5,377
Other current assets 5,231 5,165 5,331
------------ ------------ ------------
Total current assets 157,242 148,073 163,292
Property and equipment, net of accumulated depreciation
of $130,021, $118,580 and $124,644, respectively 70,165 62,552 64,811
Deferred income taxes 1,091 -- 1,091
Intangible assets, net 616 624 646
Other assets 11 13 11
------------ ------------ ------------
$ 229,125 $ 211,262 $ 229,851
============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities on capital lease obligations $ 169 $ 154 $ 169
Trade accounts payable 72,476 64,068 86,704
Accrued expenses and other current liabilities 31,635 29,573 26,507
------------ ------------ ------------
Total current liabilities 104,280 93,795 113,380
Long term debt, excluding current maturities on capital lease obligations 43,258 35,368 33,263
Other liabilities 5,145 6,198 5,864
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;
11,944,544 shares issued and 11,362,170 shares outstanding at July 31,
2002 11,839,942 shares issued and outstanding at July 31, 2001;
11,918,035 shares issued and 11,304,022 shares outstanding at
January 31, 2002; 119 118 119
Additional paid-in capital 36,867 36,418 36,850
Retained earnings 42,315 39,365 43,368
Treasury stock, at cost
582,374 shares, zero shares and 614,013 shares at July 31, 2002, and 2001
and January 31, 2002, respectively (2,859) -- (2,993)
------------ ------------ ------------
76,442 75,901 77,344
------------ ------------ ------------
$ 229,125 $ 211,262 $ 229,851
============ ============ ============
</Table>
See accompanying notes to unaudited consolidated financial statements.
3
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
For the Three and Six Months Ended July 31, 2002 and 2001
(Dollars in thousands, except per share amounts)
<Table>
<Caption>
THREE MONTHS ENDED JULY 31, SIX MONTHS ENDED JULY 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Merchandise revenue $ 90,599 $ 86,876 $ 180,581 $ 173,491
Rental video revenue 24,439 23,225 47,302 45,722
------------ ------------ ------------ ------------
Total revenues 115,038 110,101 227,883 219,213
Merchandise cost of revenue 66,850 64,007 133,038 129,178
Rental video cost of revenue 10,116 10,052 19,165 20,895
------------ ------------ ------------ ------------
Total cost of revenues 76,966 74,059 152,203 150,073
------------ ------------ ------------ ------------
Gross profit 38,072 36,042 75,680 69,140
Selling, general and administrative expenses 40,331 34,779 76,913 68,043
Pre-opening expenses 163 34 181 34
------------ ------------ ------------ ------------
Operating income (loss) (2,422) 1,229 (1,414) 1,063
Other income (expense):
Interest expense (516) (515) (1,016) (1,142)
Interest income 1,266 -- 1,266 --
Other, net 50 69 111 94
------------ ------------ ------------ ------------
Income (Loss) before income taxes (1,622) 783 (1,053) 15
Income tax expense -- -- -- --
------------ ------------ ------------ ------------
Net income (loss) $ (1,622) $ 783 $ (1,053) $ 15
============ ============ ============ ============
Basic income (loss) per share $ (0.14) $ 0.07 $ (0.09) $ 0.00
============ ============ ============ ============
Diluted income (loss) per share $ (0.14) $ 0.07 $ (0.09) $ 0.00
============ ============ ============ ============
Weighted-average common shares outstanding:
Basic 11,348 11,840 11,330 11,797
============ ============ ============ ============
Diluted 11,348 11,868 11,330 11,819
============ ============ ============ ============
</Table>
See accompanying notes to unaudited consolidated financial statements.
4
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
For the Six Months Ended July 31, 2002 and 2001
(Dollars in thousands)
<Table>
<Caption>
SIX MONTHS ENDED
JULY 31,
2002 2001
---------- ----------
Cash flows from operating activities:
Net income (loss) $ (1,053) $ 15
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation and amortization expense 18,876 17,026
Loss on rental videos lost, stolen and defective 2,718 2,129
Loss on disposal of non-rental video assets 66 299
Non-cash compensation 150 97
Changes in operating assets and liabilities:
Merchandise inventory 13,200 3,581
Other current assets 101 295
Trade accounts payable and accrued expenses (9,099) (8,144)
Income taxes receivable (1,260) 307
Other assets and liabilities, net (721) (453)
---------- ----------
Net cash provided by operating activities 22,978 15,152
---------- ----------
Cash flows from investing activities:
Purchases of rental video assets (16,032) (11,348)
Purchases of property and equipment (13,401) (6,667)
Purchase of retail locations -- (636)
---------- ----------
Net cash used in investing activities (29,433) (18,651)
---------- ----------
Cash flows from financing activities:
Borrowings under revolving credit facility 247,600 232,974
Repayments under revolving credit facility (237,521) (226,990)
Payments under capital lease obligations (82) (72)
Purchase of treasury stock (168) --
Proceeds from exercise of stock options 169 --
---------- ----------
Net cash provided by financing activities 9,998 5,912
---------- ----------
Net increase in cash 3,543 2,413
Cash at beginning of period 4,320 4,257
---------- ----------
Cash at end of period $ 7,863 $ 6,670
========== ==========
</Table>
See accompanying notes to unaudited consolidated financial statements.
5
Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
July 31, 2002 and 2001
(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 (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 2001.
Certain prior year amounts have been reclassified to conform with fiscal 2002
presentation.
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, 2003 is referred to as fiscal 2002.
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. STORE CLOSING RESERVE
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 are 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.
The following tables provide a rollforward of reserves that were established for
these charges for the six months ended July 31, 2002 and 2001.
<Table>
<Caption>
Future Lease
Payments Other Costs Total
------------ ----------- -----------
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
============ =========== ===========
</Table>
6
Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
July 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)
3. STORE CLOSING RESERVE (CONT'D)
<Table>
<Caption>
Future Lease
Payments Other Costs Total
------------ ----------- -----------
Balance at January 31, 2002 $ 5,919 $ 13 5,932
Changes in estimates 68 -- 68
Additions to provision 114 14 128
Cash outlay (868) (13) (881)
------------ ----------- -----------
Balance at July 31, 2002 $ 5,233 $ 14 $ 5,247
============ =========== ===========
</Table>
Payments during the next five years that are to be charged against the reserve
are expected to be approximately $1.4 million per year.
4. AMENDMENT TO CREDIT FACILITY
On August 23, 2002, we executed an amendment to our Revolving Credit Facility
agreement with Fleet Retail Finance and The CIT Group/Business Credit, Inc.
Under the amendment, the borrowing limit ceiling was increased from $70 million
to $80 million and the maturity date was extended by two years to August 20,
2005. All other terms and conditions of the Revolving Credit Facility in place
at July 31, 2002 remain essentially the same.
5. INTEREST INCOME
During the second quarter, we recorded interest income of approximately $1.3
million as a result of interest earned on income tax refunds for amended returns
filed for fiscal years 1995 through 1998. The Company was notified in July 2002
that the payment of the refunds, which totaled approximately $5.4 million, would
be processed in August 2002 and would be accompanied by interest payments. The
majority of these refunds were received on August 16, 2002.
6. INCOME (LOSS) PER SHARE
The computations for basic and diluted income per share are as follows:
<Table>
<Caption>
Three Months Ended Six Months Ended
July 31, July 31,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Net income (loss) $ (1,622) $ 783 $ (1,053) $ 15
============ ============ ============ ============
Average shares outstanding:
Basic 11,348 11,840 11,330 11,797
Dilutive effect of stock options -- 28 -- 22
------------ ------------ ------------ ------------
Diluted 11,348 11,868 11,330 11,819
============ ============ ============ ============
Income (Loss) per share:
Basic $ (0.14) $ 0.07 $ (0.09) $ 0.00
============ ============ ============ ============
Diluted $ (0.14) $ 0.07 $ (0.09) $ 0.00
============ ============ ============ ============
</Table>
7
Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
July 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)
6. INCOME PER SHARE (CONT'D)
Options to purchase 1,834,923 shares of common stock at exercise prices ranging
from $1.27 per share to $14.03 per share outstanding at July 31, 2002 were not
included in the computation of diluted income per share because their inclusion
would have been antidilutive.
7. LITIGATION AND CONTINGENCIES
In 2000, the Company restated its consolidated 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.
On September 12, 2002, the Company announced that an agreement in principle to
settle the actions detailed above had been reached. The settlement, which is
subject to execution of a final settlement agreement and approval by the court,
requires a payment $5.75 million. Amounts remaining under the Company's director
and officer insurance policy after payment of litigation expenses are expected
to cover a substantial portion of the settlement. The Company estimates that
amounts remaining under the policy after all litigation expenses will be
approximately $3.25 million and has recorded a loss contingency of $2.5 million,
or $0.22 per diluted share. The loss contingency has been recorded in the
accompanying financial statements.
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
Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
July 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)
8. 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 and six months ended July 31, 2002
and 2001 is presented below.
For the three months ended July 31, 2002:
<Table>
<Caption>
Retail Internet
Stores Operations Total
---------- ---------- ----------
Total revenue $ 114,992 $ 46 $ 115,038
Depreciation and amortization 9,525 65 9,590
Operating loss (2,200) (222) (2,422)
Total assets 228,810 315 229,125
Capital expenditures $ 16,086 $ 3 $ 16,089
</Table>
For the three months ended July 31, 2001:
<Table>
<Caption>
Retail Internet
Stores Operations Total
---------- ---------- ----------
Total revenue $ 110,048 $ 53 $ 110,101
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
</Table>
For the six months ended July 31, 2002:
<Table>
<Caption>
Retail Internet
Stores Operations Total
---------- ---------- ----------
Total revenue $ 227,790 $ 93 $ 227,883
Depreciation and amortization 18,742 134 18,876
Operating loss (933) (481) (1,414)
Total assets 228,810 315 229,125
Capital expenditures $ 29,431 $ 2 $ 29,433
</Table>
For the six months ended July 31, 2001:
<Table>
<Caption>
Retail Internet
Stores Operations Total
---------- ---------- ----------
Total revenue $ 219,140 $ 73 $ 219,213
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
</Table>
9
Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
July 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)
9. 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 (the
"Statements"), effective for fiscal years beginning after December 15, 2001.
Under the new rules, goodwill is no longer amortized but is subject to annual
impairment tests in accordance with the Statements. Other intangible assets
continue to be amortized over their useful lives. The Company applied the new
rules on accounting for goodwill and other intangible assets as of February 1,
2002 and adoption did not have a material impact on its 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 adopted SFAS 144 as of February 1, 2002 and such
adoption did not have a significant impact on the Company's financial position
or results of operations.
In July 2002, the FASB issued SFAS No. 146, Accounting for Costs Associated with
Exit or Disposal Activities. This statement changes certain aspects of financial
accounting and reporting for costs associated with exit or disposal activities.
This statement is effective for exit or disposal activities that are initiated
after December 31, 2002. We do not expect the adoption of this statement to have
a material effect on our consolidated financial position or results of
operations.
10
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-looking Statements
Certain written and oral statements set forth below or made by Hastings or with
the approval of an authorized executive officer of the company 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 impact
on our financial statements of any adjustment to fair value of interest rate
swaps, the outcome of securities litigation, inflation, effect of critical
accounting policies including lower of cost or market for inventory adjustments,
the returns process, rental video amortization and our store closing reserve and
statements expressing general optimism about future operating results are
forward-looking statements. Such statements are based upon company 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, 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 or changes in economic conditions in the
U.S. and or the markets in which we operate our superstores, our success in
forecasting customer demand for products, and whether or not the court approves
the settlement of the securities litigation (see the discussion of Legal
Proceedings in Part II, Item 1 of this Form 10-Q for the three and six months
ended July 31, 2002 and subsequent SEC filings) 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 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, 2002, we operated 143
superstores averaging approximately 20,000 square feet in small to medium-sized
markets located in 21 states, primarily in the Western and Midwestern United
States. Each of our superstores is company-operated under the name of Hastings.
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
ending January 31, 2003 is referred to as fiscal 2002.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States, which require management to make
estimates and assumptions that affect the reported amounts of assets,
liabilities at the date of the financial statements, the disclosure of
contingent assets and liabilities and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from those
estimates. We believe the following critical accounting policies affect 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 basis.
Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories
are recorded at the lower of standard cost 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
11
cost or market ("LCM") 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 of merchandise inventory by product
category and record any adjustment if estimated fair 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 any LCM adjustment.
Returns Process. In general, merchandise inventory owned by us is returnable
based upon return agreements with our merchandise vendors. We continually return
merchandise to vendors based on, among other factors, current and projected
sales trends, overstock situations, authorized return timelines or change in
product offerings. At the end of any reporting period, there is inventory that
has been returned to vendors, or is in the process of being returned to vendors,
for which cost accruals are required. These costs can include freight, valuation
and quantity differences, and other fees charged by a vendor. In order to
appropriately match the costs associated with the return of merchandise with the
process of returning such merchandise, we utilize an allowance for cost of
inventory returns (the "Allowance"). To accrue for such costs and estimate the
Allowance, we utilize historical experience adjusted for significant estimated
or contractual modifications. Certain adjustments to the Allowance can have a
material effect on the financial results of an annual or interim period. In
addition, we acknowledge that some portion of our inventory in superstores will
eventually be returned to a vendor based on the factors mentioned above. We
accrue return costs for these future returns on the same basis as products being
returned or in the process of being returned to a vendor. We continually
evaluate the returns process and initiate improvements as needed.
Rental Video Cost Amortization. We have a series of direct revenue-sharing
agreements with major studios and we anticipate that our future involvement in
revenue-sharing agreements will be similar to that of the current fiscal year.
Revenue sharing allows us to acquire rental video assets at a lower up-front
capital cost than traditional buying arrangements. We then share with studios a
percentage of the actual net rental revenues generated over a contractually
determined period of time. The increased access to additional copies of new
releases under revenue-sharing agreements allows customer demand for new
releases to be satisfied over a shorter period of time at a time when the new
releases are most popular. We expense revenue-sharing payments through rental
video cost of revenue, under the terms of the specific contracts with supplying
studios, as revenues are recognized. The capitalized cost of all rental video
assets acquired for a fixed price is being amortized on an accelerated basis
over six months to a salvage value of $4 per unit, except for rental video
assets purchased for the initial stock of a new superstore, which are being
amortized on a straight line basis over 36 months to a salvage value of $4.
Certain events, including a downturn in the rental video industry as a whole or
in the markets within which we operate our superstores, further consolidation of
rental video retailers, substantial change in customer demand and change in the
mix of rental video revenues, could affect the salvage value we have assigned to
our rental video assets. The effect could result in a material reduction of the
carrying value of our rental video assets and have a material impact on the
financial results of an annual or interim period. In particular, the growth of
the DVD market and the shift of consumer purchases from VHS (videocassettes) to
DVD could result in a decrease in the salvage value of rental videos. At some
point during the rental cycle, a VHS item, as with DVD and games, is available
for purchase by a customer as a previously viewed tape ("PVT"). Our current
experience is that the amount received for the PVT is higher than our salvage
value of that item in our rental inventory. Based in part on this factor and
sales of PVTs, we believe our estimate of salvage value is appropriate.
Store Closing Reserve. On a quarterly basis, and in the normal course of
business, we evaluate our store base to determine if a need to close or relocate
a store(s) is present. Management will evaluate, among other factors, current
and future profitability, market trends, age of store and lease status. Upon the
appropriate executive approval to close a location, we record charges related to
the costs of store closings or relocations. The primary expense items associated
with these charges relate to the net present value of minimum lease payments
(the present value of remaining lease payments under an active lease) and the
write-off of leasehold improvements and other assets not remaining in our
possession at the time the location is closed or relocated. The amount recorded
can fluctuate based on the age of the closing location, term and remaining years
of the lease and the number of stores being closed or relocated. These charges
can have a material effect on the financial results of an annual or interim
period. Although we actively pursue sublease tenants on all closed or relocated
locations, we do not record any estimated sublease income as an offset to any
closing or relocation charges until a sublease agreement is executed.
12
Revenue Recognition. The Company's revenue is primarily from retail sales and
rental of our products. Merchandise and rental revenues are recognized at the
point of sale or rental or at the time merchandise is shipped to the customer.
Revenues are presented net of returns and exclude all taxes. Customers may
return certain merchandise for exchange or refund within the Company's policies,
and an allowance has been established to provide for projected returns. There
are no provisions for uncollectible amounts since payment is received at the
time of sale. The Company, as with most retailers, also offers gift cards for
sale. Deferred revenue, a current liability, is recognized at the time a gift
card is sold with the costs of designing, printing and distributing the cards
recorded as an expense as incurred. The deferred revenue liability is relieved
and revenue is recognized upon the redemption of the gift cards. From time to
time the Company will offer sales incentives, in the form of customer rebates,
to its customers. Revenue is reduced by the amount of estimated redemptions,
based on experience of similar types of rebate offers, and a deferred revenue
liability is established. The deferred revenue liability is relieved when the
customer has completed all criteria necessary to file a valid rebate claim. Any
remaining portion of deferred revenue is recorded as revenue following the
termination of the extended redemption period and following completion of all
outstanding rebate claims.
13
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 Six Months Ended
July 31, July 31,
2002 2001 2002 2001
-------- -------- -------- --------
Merchandise revenue 78.8% 78.9% 79.2% 79.1%
Rental video revenue 21.2 21.1 20.8 20.9
-------- -------- -------- --------
Total revenues 100.0 100.0 100.0 100.0
Merchandise cost of revenue 73.7 73.7 73.7 74.5
Rental video cost of revenue 41.4 43.3 40.5 45.7
-------- -------- -------- --------
Total cost of revenues 66.9 67.3 66.8 68.5
-------- -------- -------- --------
Gross profit 33.1 32.7 33.2 31.5
Selling, general and administrative expenses 35.1 31.6 33.7 31.0
Pre-opening expenses 0.1 0.0 0.1 0.0
-------- -------- -------- --------
Operating income (loss) (2.1) 1.1 (0.6) 0.5
Other income (expense):
Interest expense (0.4) (0.5) (0.4) (0.5)
Interest income 1.1 -- 0.6 --
Other, net 0.0 0.1 0.0 0.0
-------- -------- -------- --------
Income (loss) before income taxes (1.4) 0.7 (0.4) 0.0
Income tax expense (benefit) -- -- -- --
-------- -------- -------- --------
Net income (loss) (1.4)% 0.7% (0.4)% 0.0%
======== ======== ======== ========
</Table>
Summary of Superstore Activity
<Table>
<Caption>
Three Months Ended Six Months Ended Year Ended
July 31, July 31, January 31,
2002 2001 2002 2001 2002
-------- -------- -------- -------- ------------
Beginning number of stores 141 142 142 142 142
Openings 2 1 2 1 5
Closings -- (4) (1) (4) (5)
-------- -------- -------- -------- ------------
Ending number of stores 143 139 143 139 142
======== ======== ======== ======== ============
</Table>
14
Three months ended July 31, 2002 compared to July 31, 2001
Revenues. Total revenues increased $4.9 million, or 4.5%, for the second quarter
of fiscal 2002 to $115.0 million compared to $110.1 million a year ago primarily
due to an increase in total comparable store revenues ("Comps") of 4.9%.
Elements of total Comps were as follows:
<Table>
Merchandise Comps 5.0%
Rental video Comps 4.6%
Total Comps 4.9%
</Table>
Total merchandise revenue for the second quarter increased $3.7 million, or
4.3%, to $90.6 million compared to $86.9 million last year. Contributing to the
increase in gross merchandise revenues were increases in DVD and video games of
47% and 127%, respectively, and book revenues of 5.6% for the three months ended
July 31, 2002 over the same period in the prior year. On a percentage basis,
merchandise Comp revenue increases were higher than merchandise gross revenue
increases primarily because of increased revenue generated from
"going-out-of-business" sales for the closing of two stores during the three
months ended July 31, 2001, that were excluded from the Comp calculation. Book
Comps increased 6.8% over the comparable period in the prior year resulting from
several programs we initiated in the second half of last year and the first
quarter of fiscal 2002. Partially offsetting these Comp increases was a decline
in music Comps of (5.3%) for the current quarter when compared to the same
period last year, which we believe is the result of the continuing downturn of
the music industry.
Total rental video revenue for the quarter grew $1.2 million, or 5.2%, to $24.4
million, up from $23.2 million a year earlier. This increase was primarily
driven by a 103% increase in DVD rentals over the same period last year. The
increase in DVD rentals was partially offset by a 22% decline in VHS rentals.
The acceptance of DVD by the consumer is the primary reason for the decline in
VHS rental revenue, but part of the decline resulted from studios increasing the
percentage of rental titles released simultaneously for sale at a lower
price-point, which entices the consumer to purchase a title on VHS instead of
renting.
Gross Profit. Total gross profit of $38.0 million in the second quarter of
fiscal 2002 increased $2.0 million, or 5.6%, from $36.0 million in the second
quarter of fiscal 2001. Total gross profit as a percent of total revenue
increased for the three months ended July 31, 2002 to 33.1% compared to 32.7%
for the same period last year. Merchandise margins as a percent of merchandise
revenue were essentially flat at 26.3% for the current quarter when compared to
the same quarter last year. Significant changes in the components of merchandise
costs are as follows:
(i) an increase of approximately $2.8 million in the costs associated
with distributing and returning merchandise inventory. Approximately
$2.6 million of this increase was primarily related to an increase of
approximately $9.7 million, or 63%, in the volume of product returned
to vendors during the second quarter of fiscal 2002 compared to the
same period last year. The higher level of returns was mainly
attributable to a planned reduction in inventory levels. In addition,
we recorded an increase of approximately $0.2 million in the cost,
primarily in human resource related expenditures, of operating our
distribution facility largely related to an increase in total
merchandise shipments of approximately 5% for the second quarter of
fiscal 2002 compared to the same period last year;
(ii) an increase in net freight expense of approximately $0.7 million,
which was primarily caused by the increases in shipments from our
distribution and returns facilities detailed above;
(iii) a decrease of approximately $1.6 million in product costs as a result
of a movement in our inventory selection toward higher margin
products, particularly related to books;
(iv) a decline in inventory markdowns during the second quarter of fiscal
2002 of approximately $1.6 million compared to the same period last
year primarily due to our automated-progressive markdown programs,
which improve our sell-through on slower moving merchandise; and
(v) lower merchandise shrinkage of approximately $0.4 million.
15
Rental video gross profit as a percent of rental revenue increased to 58.6% for
the current quarter from 56.7% for the same quarter last year. This increase was
primarily due to non-revenue sharing titles, which have historically reflected
higher margins, representing a higher percentage of total rental revenues for
the second quarter of fiscal 2002 compared to the second quarter of fiscal 2001.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses as a percent of total revenues increased to
35.1% for the quarter ended July 31, 2002 from 31.6% for the same period last
year. The increase was primarily the result of:
(i) a $2.5 million expenditure, recorded at July 31, 2002, for the
settlement of the shareholder class action lawsuits (See the
discussion of legal proceedings in Part II, Item 1 of this Form
10-Q);
(ii) a planned increase of approximately $0.8 million in advertising
expenditures designed to increase Comp sales and customer traffic;
(iii) an unplanned increase of approximately $0.5 million in the costs
associated with our group healthcare plan, the majority of which was
the result of two large medical claims incurred at the end of July
2002; and
(iv) an increase in other professional fees of approximately $0.3 million
primarily related to expenditures for consultants in connection with
software upgrades in our human resource systems.
Pre-opening Expenses. Pre-opening expenses were $0.2 million for the three
months ended July 31, 2002, as the Company opened two new superstores during the
period. Pre-opening expenses include human resource costs, travel, rent,
advertising, supplies and certain other costs incurred prior to a superstore's
opening.
Interest Expense. Interest expense remained unchanged at $0.5 million for the
three months ended July 31, 2002, compared to the three months ended July 31,
2001.
Interest Income. During the second quarter, we recorded interest income of
approximately $1.3 million as a result of interest earned on income tax refunds
for amended returns filed for fiscal years 1995 through 1998. The Company was
notified in July 2002 that the payment of the refunds, which totaled
approximately $5.4 million, would be processed in August 2002 and would be
accompanied by interest payments. The majority of these refunds were received on
August 16, 2002.
Income Taxes. We did not record income tax expense for the three months ended
July 31, 2002 and 2001 as a result of the reversal of a portion of the valuation
allowance related to the net deferred tax asset established in the fourth
quarter of fiscal 2000.
Six months ended July 31, 2002 compared to July 31, 2001
Revenues. Total revenues increased $8.7 million, or 4.0%, for the quarter to
$227.9 million compared to $219.2 million a year ago primarily due to an
increase in total Comps of 5.1%. Elements of total Comps were as follows:
<Table>
Merchandise Comps 5.9%
Rental video Comps 2.2%
Total Comps 5.1%
</Table>
Total merchandise revenue for the six months increased $7.1 million, or 4.1%, to
$180.6 million compared to $173.5 million last year. Contributing to the
increase in gross merchandise revenues were increases in DVD and video games of
51% and 165%, respectively, for the six months ended July 31, 2002 over the same
period in the prior year. On a percentage basis, merchandise Comp revenue
increases were higher than merchandise gross revenue increases primarily because
of increased revenue generated from "going-out-of-business" sales for the
closing of four stores during the six months ended July 31, 2001, that were
excluded from the Comp calculation. Book Comps increased 4.9% over the
comparable period last year resulting from several programs we initiated in the
second half of last year
16
and the first quarter of fiscal 2002. The music industry recorded a decline in
shipments of (10.2%) during the first half of 2002, which sustains a downward
pressure on retail sales for the industry. In comparison, our revenue generated
from the sale of front-line compact discs decreased (7.7%) for the six months
ended July 31, 2002; however, with our diverse music product offering including
used CDs, music accessories and musical instruments, our overall music category
decreased only (4.6%) for the six-month period.
Total rental video revenue for the six months ended July 31, 2002 grew $1.6
million, or 3.5%, to $47.3 million, up from $45.7 million a year earlier driven
primarily by a 103% increase in DVD rentals over the same period last year.
Gross Profit. Total gross profit of $75.7 million for the six months ended July
31, 2002 increased $6.5 million, or 9.5%, from $69.2 million for the six months
ended July 31, 2001. Total gross profit as a percent of total revenue increased
for the six months ended July 31, 2002 to 33.2% compared to 31.5% for the same
period last year. Merchandise margin as a percent of merchandise revenues
increased to 26.3% for the current six months from 25.5% for the same period
last year due primarily to:
(i) a decline in inventory markdowns of approximately $2.0 million
compared to the same period last year primarily due to our
automated-progressive markdown programs, which improve our
sell-through on slower moving merchandise;
(ii) a decrease of approximately $1.5 million in product costs as a result
of a movement in our inventory selection toward higher margin
products, particularly related to books;
(iii) an increase of approximately $0.4 million in the amount of income
from certain trade and purchase discounts resulting from improved
cash management; and
(iv) lower merchandise shrinkage of approximately $0.1 million.
Partially offsetting these increases were:
(i) an increase of approximately $2.1 million in the costs associated
with distributing and returning merchandise inventory. Approximately
$2.0 million of this increase was primarily related to an increase of
approximately $11.2 million, or 32%, in the volume of product
returned to vendors during the first six months of fiscal 2002
compared to the same period last year. The higher level of returns
was mainly attributable to issues discussed above regarding the three
months ending July 31, 2002. In addition, we recorded a net increase
in other costs associated with the operation of our distribution
facility, including human resource related expenditures, of
approximately $0.1 million primarily due to an increase in total
merchandise shipments of approximately 14% for the six months ended
July 31, 2002 compared to the same period last year; and
(ii) an increase in net freight expense of approximately $0.9, which was
primarily caused by the increases in shipments from our distribution
and returns facilities detailed above.
Rental video gross profit increased as a percent of rental revenues to 59.5% for
the six months ended July 31, 2002 from 54.3% for the same period last year.
This increase was primarily due to non-revenue sharing titles, which generally
reflect higher margins, representing a higher percentage of total rental
revenues.
Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses as a percent of total revenues increased to
33.7% for the six months ended July 31, 2002 from 31.0% for the same period last
year. The increase was primarily the result of:
(i) a $2.5 million expenditure, recorded at July 31, 2002, for the
settlement of the shareholder class action lawsuits (See the
discussion of legal proceedings in Part II, Item 1 of this Form
10-Q);
(ii) a planned increase of approximately $1.8 million in human resource
costs primarily associated with the increase in number of new and
expanded stores;
17
(iii) a planned increase of approximately $1.4 million in advertising
expenditures designed to increase Comp sales and customer traffic;
and
(iv) an unplanned increase of approximately $0.5 million in the costs
associated with our group healthcare plan, the majority of which was
the result of two large medical claims incurred at the end of July
2002.
Pre-opening Expenses. Pre-opening expenses were $0.2 million for the six months
ended July 31, 2002, as the Company opened two new superstores during the
period. Pre-opening expenses include human resource costs, travel, rent,
advertising, supplies and certain other costs incurred prior to a superstore's
opening.
Interest Expense. Interest expense was $1.0 million, or 0.4% of revenues, for
the six months ended July 31, 2002, compared to $1.1 million, or 0.5% of
revenues, in the six months ended July 31, 2001. The slight decrease was due to
a decline in interest rates period over period, despite a higher average loan
balance outstanding.
Interest Income. During the second quarter, we recorded interest income of $1.3
million as a result of interest earned on income tax refunds for amended returns
filed for fiscal years 1995 through 1998. The Company was notified in July 2002
that the payment of the refunds, which totaled approximately $5.4 million, would
be processed in August 2002 and would be accompanied by interest payments. The
majority of these refunds were received on August 16, 2002.
Income Taxes. We did not record income tax expense for the six months ended July
31, 2002 and 2001 as a result of the reversal of a portion of the valuation
allowance related to the net deferred tax asset established in the fourth
quarter of fiscal 2000.
Liquidity and Capital Resources
We generate cash from operations exclusively from the sale of merchandise and
the rental of video products 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 flow from operating
activities, trade credit from vendors and borrowings under our amended revolving
credit facility (the "Amended Facility"). We believe our cash flow from
operations and borrowings under the Amended Facility will be sufficient to fund
our ongoing operations, new superstores and superstore expansions through fiscal
2005.
Consolidated Cash Flows
Operating Activities. Net cash flows from operating activities increased
$7.8 million, from $15.2 million for the six months ended July 31, 2001 to
$23.0 million for the six months ended July 31, 2002. Besides an increase
in net income, the primary reason for the increase in cash flow from
operating activities was a greater decline in inventory of approximately
$9.6 million during the first six months of fiscal 2002 compared to the
first six months of fiscal 2001. Partially offsetting these increases in
cash flow from operations was a greater decline in trade accounts payable
and accrued expenses of approximately $1.0 million during the first six
months of fiscal 2002 compared to the first six months of fiscal 2001.
Investing Activities. Net cash used in investing activities increased $10.8
million, or 57.8%, to $29.4 million for the six months ended July 31, 2002
from $18.6 million for the six months ended July 31, 2001. This increase
was the result of opening two superstores, 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 and a
higher percentage of purchases of non-revenue sharing titles, which
generally cost more per unit than revenue sharing titles. Also included in
the current six months were planned computer hardware and software upgrades
18
including expenditures for a new Price Look-up System ("PLU") and Radio
Frequency ("RF") system, which will help to improve inventory management
and reduce labor costs.
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, 2002, net borrowings under
debt agreements increased $4.1 million compared to the six months ended
July 31, 2001. The increase for fiscal 2002 primarily resulted from items
described under Operating Activities and Investing Activities above.
Capital Structure. At July 31, 2002, our secured Loan and Security Agreement
with Fleet Retail Finance, Inc. and The CIT Group/Business Credit, Inc, (the
"Facility") dated August 29, 2000 was effective. The amount outstanding under
the Facility was 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 was limited to a ceiling of $70 million,
which increased to $80 million between October 15 and December 15 of each year
of the Facility, less a $10 million availability reserve. The Facility's
interest rate was based on the prevailing prime rate or LIBOR plus 2.00% at our
option. The borrowing base under the Facility was limited to an advance rate of
65% of eligible inventory and certain rental video assets net of accumulated
amortization less specifically defined reserves, which could be adjusted to
reduce availability under the Facility. The Facility contained no financial
covenants, restricted the payment of dividends and included certain other debt
and acquisition limitations, allowed for the repurchase of up to $7.5 million of
our common stock and requires a minimum availability of $10 million at all
times. The Facility was secured by substantially all of the assets of the
company and our subsidiaries and was guaranteed by each of our three
consolidated subsidiaries. At July 31, 2002, we had $12.5 million in excess
availability, after the $10 million availability reserve, under the Facility. At
July 31, 2002 and January 31, 2002, respectively, we had borrowings outstanding
of $42.3 million and $32.2 million under the Facility. The average rate of
interest being charged under the Facility was 4.2% and 6.1% at July 31, 2002 and
January 31, 2002, respectively.
On August 23, 2002, we executed an amendment to the Facility (the "Amended
Facility"). Under the Amended Facility, the ceiling limit was increased from $70
million to $80 million and the maturity date was extended by two years to August
20, 2005. All other terms and conditions of the Facility remain essentially the
same.
We entered into two interest rate swaps, one in November and one in December
2001, with a financial institution in order to obtain a fixed interest rate on a
portion of our outstanding floating rate debt thereby reducing our exposure to
interest rate volatility. The notional value of each swap is $10 million of our
revolving credit facility at fixed interest rates of 2.65% and 2.47%,
respectively, for one year. We have designated the interest rate swaps as
hedging instruments. At July 31, 2002, the fair value of the interest rate swaps
was not significant.
At July 31, 2002, the Company's minimum operating lease commitments remaining
for fiscal 2002 were $8.0 million. The present value of total existing minimum
operating lease commitments for fiscal years 2003 through 2019 discounted at
9.0% was $52.5 million as of July 31, 2002.
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 the fourth fiscal 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.
19
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 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 lenders 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 July 31, 2002 outstanding balance of
the variable rate debt would be approximately $0.3 million, including the effect
of interest rate swaps. 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. In addition, we do not believe changes in the fair value of
the interest rate swaps entered into in November 2001 and December 2001 with
notional amounts of $10 million each will be material.
ITEM 4. CONTROLS AND PROCEDURES
In the quarter ended July 31, 2002, we did not make any significant changes in,
nor take any corrective actions regarding, our internal controls or other
factors that could significantly affect these controls.
20
PART II
ITEM 1. LEGAL PROCEEDINGS
In 2000, the Company restated its consolidated 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 going forward in both actions.
On September 12, 2002, the Company announced that an agreement in principle to
settle the actions detailed above had been reached. The settlement, which is
subject to execution of a final settlement agreement and approval by the court,
requires a payment $5.75 million. Amounts remaining under the Company's director
and officer insurance policy after payment of litigation expenses are expected
to cover a substantial portion of the settlement. The Company estimates that
amounts remaining under the policy after all litigation expenses will be
approximately $3.25 million and has recorded a loss contingency of $2.5 million,
or $0.22 per diluted share. The loss contingency has been recorded in the
accompanying financial statements.
ITEM 4. SUBMISSIONS OF MATTERS TO A VOTE OF SECURITY HOLDERS
We held our Annual Meeting of Shareholders on June 19, 2002. The shareholders
voted on the following proposals:
A proposal to elect two Directors of Hastings for a term expiring in 2005 was
approved by the following vote:
<Table>
<Caption>
NOMINEE VOTES FOR VOTES WITHHELD
------- --------- --------------
Stephen S. Marmaduke 10,861,341 22,140
Daryl L. Lansdale 10,872,202 11,279
</Table>
A proposal to approve Hastings Entertainment, Inc. 2002 Stock Option Plan for
Outside Directors was approved by the following vote:
<Table>
<Caption>
FOR AGAINST ABSTAIN
--- ------- -------
8,690,361 144,703 358,944
</Table>
A proposal to approve Hastings Entertainment, Inc. 2002 Stock Grant Plan for
Outside Directors was approved by the following vote:
<Table>
<Caption>
FOR AGAINST ABSTAIN
--- ------- -------
8,676,357 161,017 356,634
</Table>
A proposal to approve Hastings Entertainment, Inc. 2002 Incentive Stock Plan was
approved by the following vote:
<Table>
<Caption>
FOR AGAINST ABSTAIN
--- ------- -------
8,547,211 271,383 375,414
</Table>
21
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a. Listing of exhibits
10.21 First Amendment to Loan and Security Agreement, dated August 23, 2002
between Hastings Entertainment, Inc. and Fleet Retail Finance, Inc.
Agent
99.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
b. 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.
22
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 12, 2002 /s/ Dan Crow
--------------------------------------------
Dan Crow
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
CERTIFICATIONS
I, John H. Marmaduke, President and Chief Executive Officer of Hastings
Entertainment, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hastings
Entertainment, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 12, 2002 /s/ John H. Marmaduke
--------------------------------------------
John H. Marmaduke
President and Chief Executive Officer
I, Dan Crow, Vice President and Chief Financial Officer (Principal Financial and
Accounting Officer) of Hastings Entertainment, Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of Hastings
Entertainment, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report; and
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this quarterly report.
Date: September 12, 2002 /s/ Dan Crow
--------------------------------------------
Dan Crow
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
23
INDEX TO EXHIBITS
<Table>
<Caption>
Exhibit
Number Description of Documents
- ------- ------------------------
10.21 First Amendment to Loan and Security Agreement, dated August 23, 2002
between Hastings Entertainment, Inc. and Fleet Retail Finance, Inc.
Agent
99.1 Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002
</Table>
24