UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT
OF 1934
For the fiscal year ended January 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF 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)
Registrant's telephone number, including area code: (806) 351-2300
Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 par value per share
(Title of Class) Nasdaq National Market
(Name of Exchange on which registered)
</Table>
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 twelve 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [ ] No [X]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
As of July 31, 2002, which was the last business day of the registrant's most
recently completed second fiscal quarter, the aggregate market value of the
voting stock held by non-affiliates of the registrant was approximately
$34,446,865 based upon the closing market price of $5.71 per share of Common
Stock on the Nasdaq National Market on that date. (For the purposes of
determination of the above-stated amounts, only the directors, executive
officers and 5% or greater shareholders of the registrant have been deemed
affiliates; however, this does not represent a conclusion by the registrant that
any or all of such persons are affiliates of the registrant.)
Number of shares of $.01 par value Common Stock outstanding as of April 1, 2003:
11,336,473
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the annual meeting of shareholders of the
registrant to be held during 2003 are incorporated by reference into Parts II
and III of this Form 10-K.
HASTINGS ENTERTAINMENT, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED JANUARY 31, 2003
INDEX
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<Caption>
PAGE
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PART I
Item 1. Business............................................................................. 1
Item 2. Properties........................................................................... 9
Item 3. Legal Proceedings.................................................................... 10
Item 4. Submission of Matters to a Vote of Security Holders.................................. 11
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 12
Item 6. Selected Financial Data.............................................................. 13
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations.................................................... 15
Item 7A. Quantitative and Qualitative Disclosures About Market Risk............................. 24
Item 8. Financial Statements and Supplementary Data.......................................... 25
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure..................................................... 46
PART III
Item 10. Directors and Executive Officers of the Registrant................................... 47
Item 11. Executive Compensation............................................................... 47
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 47
Item 13. Certain Relationships and Related Transactions....................................... 47
Item 14. Controls and Procedures.............................................................. 47
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K...................... 48
SIGNATURES....................................................................................... 51
CERTIFICATIONS................................................................................... 52
</Table>
PART I
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
business, expansion, merchandising and marketing strategies of Hastings,
industry projections or forecasts, effects of the adoption of Statement of
Financial Accounting Standards No. 146 and EITF Issue 02-16, the impact on our
financial statements of any adjustment to fair value of interest rate swaps,
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, sufficiency of cash flow from operations and
borrowings under our revolving credit facility and statements expressing general
optimism about future operating results are forward-looking statements. Such
statements are based upon 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., including the
impact of the war with Iraq, and or the markets in which we operate our
superstores, our success in forecasting customer demand for products, and legal
proceedings (see discussion of Legal Proceedings in Part I, Item 3 of this Form
10-K for the fiscal year ended January 31, 2003 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.
ITEM 1. BUSINESS
General
Hastings Entertainment, Inc. is a leading multimedia entertainment retailer that
combines the sale of books, music, software, periodicals, videocassettes, video
games, DVDs, used products including CDs, DVDs and video games, video game
consoles and DVD players with the rental of videocassettes, video games, DVDs,
video game consoles and DVD players in a superstore format. As of April 1, 2003,
we operated 146 superstores in small- to medium-sized markets located in 21
states, primarily in the Western and Midwestern United States. We also operate a
multimedia entertainment e-commerce Web site offering a broad selection of
books, music, software, videocassettes, video games and DVDs. See note 14 to the
consolidated financial statements for more information regarding our operating
segments, retail stores and Internet operations. We operate three wholly owned
subsidiaries; Hastings Properties, Inc., Hastings Internet, Inc. and Hastings
College Stores, Inc. References herein to fiscal years are to the twelve-month
periods, which end in January of each following calendar year. For example, the
twelve-month period ended January 31, 2003 is referred to as fiscal 2002.
Industry Overview
Music. According to the Recording Industry Association of America ("RIAA"),
total music shipments by manufacturers to retailers decreased 8.2% to $12.6
billion in 2002 compared to $13.7 billion in 2001. The majority of this decrease
can be found in a decline of almost 9% in shipments for the industry mainstay,
the full-length CD, to $12.0 billion in 2002 compared to $12.9 billion in 2001.
RIAA attributed this decline in large part to online and physical piracy and the
nationwide economic downturn. RIAA is taking steps to combat piracy activities
and, according to Hilary Rosen, Chairman and CEO of RIAA, they have increased
seizures of counterfeit and pirate CDRs by 89.5% in 2002. In addition, RIAA has
implemented several programs designed to educate consumers and
1
legislators on the effects of piracy. Additionally, RIAA has joined forces with
the Business Software Alliance and the Computer Systems Policy Project to work
together to address piracy issues and enforce existing and suggest new
legislation. Industry shipments of cassettes declined sharply during 2002 to
$210 million, down 42.3% from 2001, as the format continued to lose favor with
music consumers.
Books. The Association of American Publishers estimates total net sales for the
book industry will increase approximately 5.5% to $26.9 billion for 2002, up
from $25.4 billion in 2001. Trade sales, which include adult and juvenile
hardback and paperback categories, exhibited the largest gains on an increase of
approximately 8.8% to $6.9 billion, up from $6.4 billion a year earlier. Sales
in the professional category, which includes educational and rack-sized
paperback books, trailed trade sales closely with an increase of approximately
8.5% to $5.1 billion for 2002, up from $4.7 billion for 2001. Sales of religious
books declined 5.8% to approximately $0.9 billion for 2002 compared to $1.0
billion for 2001.
Rental Video. According to Paul Kagan Associates ("Kagan"), consumer spending on
rental video increased 2.3% to approximately $8.7 billion in 2002, up from
approximately $8.4 billion in 2001. DVD continued its accelerated acceptance
rate as DVD households as a percentage of U.S. television households increased
to 36.8% for 2002, up from 24% in 2001. Kagan projects that DVD households will
increase to almost 70% of U.S. television households by 2006 and the percentage
of multi-DVD homes will triple over that same time frame. By comparison, VHS
households as a percent of U.S. television households increased to 91.1% for
2002 compared to 88.7% for 2001. Based partially on this data, we believe there
remains a viable VHS market despite projections of declining VHS rental and sale
revenues.
Although by Kagan estimates, the sale of video increased during 2002, industry
rental transactions exceeded sale transactions in excess of 3 to 1, with rentals
representing approximately 76% of combined transactions and sales representing
approximately 24% of combined transactions. We believe that the DVD format, with
its superior picture and sound quality and extra features such as outtakes,
director commentary and scene selection, will drive continued growth in the
industry. We also believe rental video will continue to be a favored
entertainment medium for millions of consumers due to its relatively inexpensive
price point, broad selection of new release and catalog (older) movies and
ability for "viewer control" of the experience, i.e., start, stop, fast-forward,
pause and rewind.
Business Strategy
Our goal is to enhance our position as a leading multimedia entertainment
retailer in small- to medium-sized communities by expanding and remodeling
existing superstores, opening new superstores in selected markets and offering
our products through the Internet. Each element of our business strategy is
designed to build consumer awareness of the Hastings concept and achieve high
levels of customer loyalty and repeat business. We believe the key elements of
this strategy are the following:
Superior Multimedia Concept. Our superstores present a wide variety of products
tailored to local preferences in a dynamic and comfortable store atmosphere with
exceptional service. Our superstores average approximately 20,000 square feet,
with our new superstores generally ranging in size from 10,000 to 25,000 square
feet. Our superstores offer customers an extensive product assortment ranging,
depending on the specific store, approximately 17,000 to 60,000 book, 9,000 to
30,000 music, 1,000 to 2,000 software, 2,000 to 3,000 periodical, 4,000 to
13,000 video, and 1,000 to 4,000 complementary and accessory titles for sale. We
also offer approximately 3,000 to 12,000 used CD, videocassette, DVD and video
game titles for sale. In addition, customers can select from 5,000 to 10,000 DVD
titles for sale and rent and 12,000 to 20,000 videocassette, DVD and video game
selections for rent. Although our superstores' core product assortment tends to
be similar, the merchandise mix of each of our superstores is tailored to
accommodate the particular demographic profile of the local market in which the
superstore operates through the utilization of our proprietary purchasing and
inventory management systems. We believe that our multimedia format reduces our
reliance on and exposure to any particular entertainment segment and enables us
to promptly add exciting new entertainment categories to our product line.
2
Small to Medium-Sized Market Superstore Focus. We target small- to medium-sized
markets with populations of generally less than 50,000 where our extensive
product selection, low pricing strategy, efficient operations and superior
customer service enable us to become the market's destination entertainment
store. We believe that the small- to medium-sized markets where we operate the
majority of our superstores present an opportunity to profitably operate and
expand our unique entertainment superstore format. In our opinion, these markets
typically are underserved by existing book, music or video stores, and our
competition generally is locally owned or national-chain specialty stores and
general merchandise retailers. We base our merchandising strategy for our
superstores on an in-depth understanding of our customers and our individual
markets. We strive to optimize each superstore's merchandise selection by using
our proprietary information systems to analyze the sales history, anticipated
demand and demographics of each superstore's market. In addition, we utilize
flexible layouts that enable each superstore to arrange our products according
to local interests and to customize the layout in response to new customer
preferences and product lines.
Customer-Oriented Superstore Format. We design our superstores to provide an
easy-to-shop, open store atmosphere by offering major product categories in a
"store-within-a-store" format. Most of our superstores utilize
product-affinities positioned together around a wide racetrack aisle or
three-across departments (books, music and video) that are designed to allow
customers to view the entire superstore. This store configuration produces
significant cross-marketing opportunities among the various entertainment
departments, which we believe results in higher transaction volumes and impulse
purchases. To encourage browsing and the perception of Hastings as a community
gathering place, we have incorporated amenities in many superstores, such as
chairs for reading, a broad selection of gourmet coffee and tea, soft drinks and
snacks, music auditioning stations, interactive information kiosks, telephones
for free local calls, children's play areas and in-store promotional events.
Low Pricing. Our pricing strategy at our superstores is to offer value to our
customers by maintaining prices that are generally competitive with or lower
than the prices charged by other retailers in the market. We determine our
prices on a market-by-market basis, depending on the level of competition and
other market-specific considerations. We believe that our low pricing structure
results in part from (i) our ability to purchase directly from publishers,
studios and manufacturers as opposed to purchasing from distributors, (ii) our
proprietary information systems, improvements to which will enable management to
make more precise and targeted purchases and pricing for each superstore, and
(iii) our consistent focus on maintaining low occupancy and operating costs.
Used Products. Since 1994, we have bought or traded for customer's CDs to sell
as used product and leverage the value of our CD offering. With additional
used-purchasing options, this business now accounts for approximately 10% of our
total music business, generally represents higher margins than new front-line
CDs and drives customer loyalty. During fiscal 2001, revenue generated from the
sale of used DVDs began to accelerate as the DVD medium became more popular with
the consumer. The same process of purchasing used CDs is being applied to used
DVDs and we are excited about the prospect for continued growth in this and
other used product business, including video games. We believe our multimedia
superstore concept will enhance our offering of used products allowing the
customer to choose between a new or a less expensive used copy of the same
title.
Internet. In May 1999, we launched our new e-commerce Internet Web site,
www.gohastings.com. Our site enables customers to electronically access more
than 800,000 new and used entertainment products and unique, contemporary gifts
and toys. The site features exceptional product and pricing offers, search and
auditioning capabilities, and digital downloading of music selections. The Web
site is designed to fully integrate into a store kiosk to leverage both the
physical and digital shopping experience. The site also features a newly
designed investor relations section including links to company press releases,
SEC filings and a useful list of frequently asked questions.
3
Expansion Strategy
We plan to open five superstores during fiscal 2003 while continuing our ongoing
store expansion and remodeling programs for our existing superstores. We closed
one superstore in February 2003. We have identified numerous potential locations
for future superstores in under-served, small- to medium-sized markets that meet
our new-market criteria. We believe that with our current information systems
and distribution capabilities, our infrastructure can support our anticipated
rate of expansion and growth for at least the next several years.
Merchandising Strategy
We are a leading multimedia entertainment retailer that combines the sale of
books, music, software, periodicals, videocassettes, video games, DVDs, used
products including CDs, DVDs and video games, video game consoles and DVD
players with the rental of videocassettes, video games, DVDs, video game
consoles and DVD players in a superstore format. By offering a broad array of
products within several distinct but complementary categories, we strive to
appeal to a wide range of customers and position our superstores as destination
entertainment stores in our targeted small- to medium-sized markets.
Superstore Product Selection. Although all Hastings superstores carry a similar
core product assortment, the merchandise mix of book, music, software,
videocassette and video game selections of each superstore is tailored
continually to accommodate the particular demographic profile and demand of the
local market in which the superstore operates. We accomplish this customization
through our proprietary purchasing, inventory, selection and pricing management
systems. The purchasing system analyzes historic consumer purchasing patterns at
each individual superstore to forecast customer demand for new releases and
anticipate seasonal changes in demand. In addition, our inventory management
process continually monitors product sales and videocassette rentals to identify
slow-moving books, music, software and sale videocassettes, DVD and video games
for return to vendors and rental videocassettes, DVD and video games for sale to
customers as previously viewed items or transfer to other superstores. Our
pricing management system allows us to identify slow moving products and
initiate an automated-progressive markdown program to enhance sell-through while
maximizing margin at each subsequent price reduction. It also automatically
implements the price change by printing new tags at the store.
Our superstores offer customers an extensive product assortment ranging,
depending on the specific store, approximately 17,000 to 60,000 book, 9,000 to
30,000 music, 1,000 to 2,000 software, 2,000 to 3,000 periodical, 4,000 to
13,000 video, and 1,000 to 4,000 complementary and accessory titles for sale. We
also offer approximately 3,000 to 12,000 used CD, videocassette, DVD and video
game titles for sale. In addition, customers can select from 5,000 to 10,000 DVD
titles for sale and 12,000 to 20,000 videocassette, DVD and video game
selections for rent. New releases and special offerings in each entertainment
product category are prominently displayed and arranged by product category.
In addition to our primary product lines, we continually add new product
offerings to better serve our customers. Products for sale in these categories
include promotional t-shirts, licensed plush toys, portable electronics,
consumer electronics including DVD players and video game consoles, musical
instruments, sheet music, greeting cards, audio books and consumables, including
soft drinks, coffee, popcorn and candy. Accessory items for sale include blank
videocassettes and CDs, video cleaning equipment and audiocassette and CD
carrying cases. Many of these products generate impulse purchases and produce
higher margins. The rental of videocassette, video game and DVD players is
provided as a service to Hastings customers.
Information System
Our information system is built upon a multi-tiered, distributed processing
architecture and was designed using client/server technology. All locations are
connected using a wide-area network that allows interchange of current
information. The primary components of the information system are as follows:
4
New Release Allocation. Our buyers use the new release allocation system to
purchase new release products for the superstores and have the ability within
the system to utilize multiple methods of forecasting demand. By using
store-specific sales history, factoring in specific market traits, applying
sales curves for similar titles or groups of products and minimizing
subjectivity and human emotion for a transaction, the system customizes
purchases for each individual superstore to satisfy customer demand. The process
provides the flexibility to allow store management to anticipate customer needs,
including tracking missed sales and factoring in regional influences. We believe
that the new release allocation system enables us to increase revenues by having
the optimum levels and selection of products available in each superstore at the
appropriate time to satisfy customers' entertainment needs.
Rental Video Asset Purchasing System. Our rental video asset purchasing system
uses store-specific performance on individual rental videocassette titles to
anticipate customer demand for new release rental videocassettes. The system
analyzes the first eight weeks' performance of a similar title and factors in
the effect of such influences as seasonal trends, box office draw and prominence
of the movie's cast to customize an optimum inventory for each individual
superstore. The system also allows for the customized purchasing of other
catalog rental video assets on an individual store basis, additional copy depth
requirements under revenue-sharing agreements and timely sell-off of previously
viewed tapes. We believe that our rental video asset purchasing system allows us
to efficiently plan and stock each superstore's rental video asset inventory,
thereby improving performance and reducing exposure from excess inventory.
Store Replenishment. Store replenishment covers three main areas for controlling
a superstore's inventory.
Selection Management. Selection management constantly analyzes
store-specific sales, traits and seasonal trends to determine title
selection and inventory levels for each individual superstore. By
forecasting annual sales of products and consolidating recommendations from
store management, the system enables us to identify overstocked or
understocked items and to prompt required store actions and optimize
inventory levels. The system tailors each store's individual inventory to
the market, utilizing over 2,000 product categories, configurations and
product status.
Model Stock Calculation/Ordering. Model stock calculation uses
store-specific sales, seasonal trends and sophisticated-sales curve fitting
to forecast orders. It also accounts for turnaround time from a vendor or
our distribution center and tracks historical missed sales to adjust orders
to adequately fulfill sales potential. Orders are currently calculated on a
weekly basis and transmitted by all superstores to the corporate office to
establish a source vendor for the product.
Inventory Management. Inventory management systems interface with other
store systems and accommodate electronic receiving and returns to maintain
perpetual inventory information. Cycle counting procedures allow us to
perform all physical inventory functions, including the counting of each
superstore's inventory up to four times per year. The system provides
feedback to assist in researching variance.
Store Systems. Each superstore has a dedicated server within the store for
processing information connected through a wide area network. This connectivity
provides consolidation of individual transactions and allows store management
and corporate office associates easy access to the information needed to make
informed decisions. Transactions at the store are summarized and used to assist
in staff scheduling, loss prevention and inventory control. All point of sale
transactions utilize scanning technology allowing for maximum customer
efficiency at checkout. We also utilize an automated system for scheduling store
management and sales associates. This system was developed to assist in
controlling personnel costs while maintaining desired levels of customer service
by preventing over-scheduling or under-scheduling sales, stocking and customer
service associates.
Accounting. Our financial accounting software has a flexible, open-systems
architecture. We prepare a variety of daily management reports covering store
and corporate performance. Detailed financial information for each superstore,
as well as for the distribution center and the corporate office, are generated
on a monthly basis. Our payroll, accounts payable, cash control, financial
planning and certain state and local tax functions are performed in-house.
5
Warehouse Management. Our warehouse management systems provide support for
high-volume retail transactions, including shipments, receipts and returns to
vendors. Software to perform these functions was customized through a joint
effort of our purchasing, distribution and information systems departments. The
warehouse system, using "real-time" inputs for total process coordination,
incorporates exact cube sizes of product containers, utilizing flow-through
racks and technologically advanced conveyor systems.
Distribution and Suppliers
Our distribution center is located in a 146,000 square foot facility adjacent to
our corporate headquarters in Amarillo, Texas. This central location and the
local labor pool enable us to realize relatively low transportation and labor
costs. The distribution center is utilized primarily for receiving, storing and
distributing approximately 21,000 products offered in substantially every
superstore. The distribution center also is used in distributing large
purchases, including forward buys, closeouts and other bulk purchases. In
addition, the distribution facility is used to receive, recycle, process and
ship items to be returned to manufacturers and distributors, as well as to
transfer and redistribute videocassettes among our superstores. This facility
currently provides inventory to all Hastings superstores and is designed to
support our anticipated rate of expansion and growth for at least the next
several years. We ship products weekly to each Hastings superstore, facilitating
quick and responsive inventory replenishment. Approximately 24% of our total
product, based on store receipts, is distributed through the distribution
center. Approximately 76% of our total product is shipped directly from the
vendors to the superstores. We outsource all product transportation from our
distribution center to various freight companies.
Our information systems and corporate infrastructure facilitate our ability to
purchase products directly from manufacturers, which contributes to our low
pricing structure. In fiscal 2002, we purchased the majority of our products
directly from manufacturers, rather than through distributors. Our top three
suppliers accounted for approximately 21% of total products purchased during
fiscal 2002. While selections from a particular artist or author generally are
produced by a single manufacturer, we strive to maintain supplier relationships
that can provide alternate sources of supply. Products we purchase are generally
returnable to the supplying vendor. Refer to "Item 7. Management's Discussion
and Analysis of Financial Condition and Results of Operation - General" for a
description of our returns process.
Store Operations
Most of our superstores employ one store manager and one or more assistant store
managers. Store managers and assistant store managers are responsible for the
execution of all operational, merchandising and marketing strategies for the
superstore in which they work. Superstores also generally have department
managers, who are individually responsible for their respective book, music,
software, video, customer service and stocking departments within each
superstore. Hastings superstores are generally open daily from 10:00 a.m. to
11:00 p.m. However, several superstores are open 9:00 a.m. to 11:00 p.m. or
10:00 a.m. to 10:00 p.m. The only days our superstores are closed are
Thanksgiving and Christmas.
Competition
The entertainment retail industry is highly competitive. We compete with a wide
variety of book retailers, music retailers, software retailers, Internet
retailers and retailers that rent or sell videocassettes, including independent
single store operations, local multi-store operators, regional and national
chains, as well as supermarkets, pharmacies, convenience stores, bookstores,
mass merchants, mail order operations, warehouse clubs, record clubs, other
retailers and various non-commercial sources such as libraries. With regard to
our videocassette sales and rental video products in particular, we compete with
cable, satellite and pay-per-view cable television systems. In addition,
continuing technological advances that enhance the ability of consumers to shop
at home or access, produce and print written works or record music digitally by
home computer through the Internet or telephonic transmission could provide more
serious competition to us in the future.
6
We compete in most of our markets with either national entertainment retailers
or significant retailers of general merchandise or both. We compete in our sale
of books with retailers such as Barnes & Noble, Inc., Books-A-Million, Inc.,
Borders Group, Inc., Walden Books and B. Dalton Bookseller. We compete in our
sale of music with music retailers, such as Transworld Entertainment and
consumer electronics stores, including Best Buy and Circuit City. Our principal
competitors in the sale and rental of videocassettes are Blockbuster, Inc.,
Hollywood Entertainment Corp. and Movie Gallery, Inc. In addition, we compete in
the sale of books, music and videocassettes and the rental of videocassettes and
video games with local entertainment retailers and significant retailers of
general merchandise, such as Wal-Mart. Retailers such as Amazon.com, Inc. and
Barnes & Noble, Inc., continue to increase their retail sales of entertainment
products, such as books and music, via the Internet. We compete with other
entertainment retailers on the basis of title selection, the number of copies of
popular selections available, store location, visibility and pricing.
Trademarks and Servicemarks
We believe our trademarks and servicemarks, including the servicemarks "Hastings
Books Music Video," and "Hastings, Your Entertainment Superstore" have
significant value and are important to our marketing efforts. We have registered
"Hastings Books Music Video" as a servicemark with the United States Patent and
Trademark Office and are in the process of registering "Hastings, Your
Entertainment Superstore" and "HardBack Cafe." We maintain a policy of pursuing
registration of our principal marks and opposing any infringement of our marks.
Associates
We refer to our employees as associates because of the critical role they play
in the success of each Hastings superstore and the Company as a whole. As of
January 31, 2003, we employed approximately 6,829 associates; of which 2,378 are
full-time and 4,451 are part-time associates. Of this number, approximately
6,171 were employed at retail superstores, 369 were employed at our distribution
center and 289 were employed at our corporate offices. None of our associates
are represented by a labor union or are subject to a collective bargaining
agreement. We believe that our relations with our associates are good.
Executive Officers of the Company
The following is certain information concerning the executive officers of
Hastings Entertainment, Inc.
<Table>
<Caption>
Name Age Position
- ---- --- --------
John H. Marmaduke 55 Chairman of the Board, President and Chief Executive Officer
Dan Crow 56 Vice President of Finance and Chief Financial Officer
Robert A. Berman 53 Vice President of Store Operations
James S. Hicks 46 Vice President of Product
Alan Van Ongevalle 35 Vice President of Information Systems & Distribution
</Table>
All executive officers are chosen by the Board of Directors and serve at the
Board's discretion. Set forth below is information concerning the business
experience of our executive officers.
JOHN H. MARMADUKE, age 55, has served as President and Chief Executive Officer
of the Company since July 1976 and as Chairman of the Board since October 1993.
Mr. Marmaduke served as President of the Company's former parent company,
Western Merchandisers, Inc. ("Western"), from 1982 through June 1994, including
the years 1991 through 1994 when Western was a division of Wal-Mart. Mr.
Marmaduke also serves on the board of directors of the Video Software Dealers
Association (VSDA). Mr. Marmaduke has been active in the entertainment retailing
industry with the Company and its predecessor company for over 30 years.
7
DAN CROW, age 56, has served as Vice President of Finance and Chief Financial
Officer of the Company since October 2000. From July of 2000 to October 2000,
Mr. Crow served as Vice President of Finance. Mr. Crow is a member of the
American Institute of Certified Public Accountants and the Financial Executives
International and has served as Chief Financial Officer of various retail
companies including Discount Auto Parts, Inc., Scotty's, Inc. and Lil' Things,
Inc. since 1984.
ROBERT A. BERMAN, age 53, has served as Vice President of Store Operations of
the Company since January 1997. From June 1995 to January 1997, Mr. Berman was
self-employed in the financial services industry. From January 1989 to June
1995, Mr. Berman served as Vice President and Senior Vice President of Store
Operations for Builders Square, Inc., a chain of 185 building material
superstores. At Builders Square, Inc., Mr. Berman was responsible for store
operations, store planning and design, purchasing and construction.
JAMES S. HICKS, age 46, has served as Vice President of Product of the Company
since August of 2002. From August 1999 to August of 2002, Mr. Hicks served as
Vice President of Purchasing. From August 1997 to August 1999, Mr. Hicks served
as the Senior Director of Purchasing and from April 1994 to August 1997, was the
Director of Purchasing. He was a District Leader for the Company from July of
1984 to April 1994. From October 1982 to July 1984, Mr. Hicks served as a
company troubleshooter and from April 1982 to October 1982 was a store manager.
Mr. Hicks began his career with Hastings in August 1981 as a manager trainee.
Prior to joining the Company, Mr. Hicks was the Regional Credit Manager for
Liquid Carbonics Corporation, a gas distributor and manufacturer headquartered
in Houston.
ALAN VAN ONGEVALLE, age 35, has served as Vice President of Information Systems
and Distribution since February 2003. From August 2002 to February 2003, Mr. Van
Ongevalle served as Vice President of Marketing and Distribution. From May 2000
to August 2002, Mr. Van Ongevalle served as Vice President of Marketing. From
August 1999 to May 2000, Mr. Van Ongevalle served as the Senior Director of
Marketing and as Director of Advertising from September 1998 to August 1999. Mr.
Van Ongevalle joined Hastings in November 1992 and held various store operation
management positions including Store Manager, Director of New Stores and the
Southern Kansas area through September 1998.
Available Information
We file annual, quarterly and current reports, information statements and other
information with the Securities and Exchange. The public may read and copy any
materials we file with the SEC at the SEC's public Reference Room at 450 Fifth
Street, N.W., Washington, D.C. 20549. The public may obtain information on the
operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The
SEC also maintains an Internet site that contains reports, proxy and information
statements, and other information regarding issuers that file electronically
with the SEC. The address of that site is http://www.sec.gov.
The address of our Internet website is www.gohastings.com and through the links
on the Investor Relations portion of our website, we make available free of
charge our annual report on Form 10-K, quarterly reports on Form 10-Q and
current reports on Form 8-K, and any amendments to those reports, filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Act of 1934. Such
material is made available through our website as soon as reasonably practicable
after we electronically file or furnish the material with the SEC. In addition,
links to officer certifications of financial information and a code of ethics
for financial and other executive officers are posted in the Investor Relations
section.
8
ITEM 2. PROPERTIES
As of January 31, 2003, we operated 146 superstores in 21 states located as
indicated in the following table:
<Table>
<Caption>
NAME OF STATE NUMBER OF SUPERSTORES
------------- ---------------------
Alabama................................................................ 1
Arkansas............................................................... 11
Arizona................................................................ 7
Colorado............................................................... 4
Georgia................................................................ 1
Idaho.................................................................. 8
Illinois............................................................... 1
Indiana................................................................ 1
Iowa................................................................... 1
Kansas................................................................. 9
Kentucky............................................................... 1
Missouri............................................................... 7
Montana................................................................ 6
Nebraska............................................................... 4
New Mexico............................................................. 14
Oklahoma............................................................... 12
Tennessee.............................................................. 5
Texas.................................................................. 41
Utah................................................................... 2
Washington............................................................. 7
Wyoming................................................................ 3
-----
Total.................................................................. 146
</Table>
Currently, we lease sites for all of our superstores. These sites typically are
located in pre-existing, stand-alone buildings or strip shopping centers. Our
primary market areas are small- and medium-sized communities with populations
generally less than 50,000. We have developed a systematic approach using our
site selection criteria to evaluate and identify potential sites for new
superstores. Key demographic criteria for superstores include community
population, community and regional retail sales, personal and household
disposable income levels, education levels, median age, and proximity of
colleges or universities. Other site selection factors include current
competition in the community, visibility, available parking, ease of access and
other neighbor tenants. To maintain low occupancy costs, we typically
concentrate on leasing existing locations that have been operated previously by
other retailers.
We actively manage our existing superstores and from time to time close
under-performing stores. During fiscal 2002 we closed three superstores and
during fiscal 2001 we closed five superstores.
The terms of our superstore leases vary considerably. We strive to maintain
maximum location flexibility by entering into leases with long initial terms and
multiple short-term extension options, but always with the ability to relocate
the store to a more favorable location if desired. We have been able to enter
into leases with these terms in part because we generally bear a substantial
portion of the cost of preparing the space for a superstore.
9
The following table sets forth as of January 31, 2003 the number of superstores
that have current lease terms that will expire during each of the following
fiscal years and the associated number of superstores for which we have options
to extend the lease term:
<Table>
<Caption>
NUMBER OF SUPERSTORES OPTIONS
--------------------- -------
Fiscal Year 2003......................................... 14 12
Fiscal Year 2004......................................... 18 17
Fiscal Year 2005......................................... 14 13
Fiscal Year 2006......................................... 12 12
Fiscal Year 2007......................................... 18 18
Thereafter............................................... 70 61
----- ----
Total.................................................... 146 133
</Table>
We have not experienced any significant difficulty renewing or extending leases
on a satisfactory basis.
Our headquarters and distribution center are located in Amarillo, Texas in a
leased facility consisting of approximately 44,500 square feet for office space
and 146,000 square feet for the distribution center. The leases for this
property terminate in September 2003, and we have the option to renew these
leases through March 2015.
ITEM 3. LEGAL PROCEEDINGS
In 2000, we restated our consolidated financial statements for the first three
quarters of fiscal 1999 and the prior four fiscal years. Following our initial
announcement in March 2000 of the requirement for such restatements, nine
purported class action lawsuits were filed in the United States District Court
for the Northern District of Texas against the Company and certain of our
current and former directors and officers 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 were transferred to the
Amarillo Division of the Northern District and were 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, our current and
former directors and officers at the time of our 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, we announced that an agreement in principle to settle the
actions described above had been reached. The settlement received final approval
by the Court on March 10, 2003. The settlement required a payment of $5.75
million on behalf of the defendants in the lawsuits ($3.15 million of which was
funded from amounts remaining under our director and officer insurance policy
after the payment of litigation expenses) and the assignment to the plaintiff
settlement class of any claims the Company may have had against KPMG Peat
Marwick, LLP, our outside auditors at the time of the March 7, 2000
announcement. The settlement resolves all claims against the Company, our
current and former defendant officers and directors and the defendant
underwriters. Based on the foregoing, we recorded a loss contingency of $2.6
million, or $0.22 per share, during fiscal 2002 and all amounts required by the
settlement agreement were funded by January 31, 2003. The plaintiff settlement
class separately settled all claims against KPMG.
We are 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 our
financial position, results of operations and cash flows.
10
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of the security holders during the fourth
quarter of fiscal 2002.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The shares of Hastings Entertainment, Inc. common stock are listed and traded on
The Nasdaq National Market (Nasdaq) under the symbol "HAST". Our common stock
began trading on June 12, 1998, following our initial public offering. The
following table contains, for the periods indicated, the high and low sales
prices per share of our common stock as reported on the Nasdaq:
<Table>
<Caption>
HIGH LOW
-------- --------
2002:
First Quarter $ 8.440 $ 5.200
Second Quarter $ 9.200 $ 4.950
Third Quarter $ 6.150 $ 4.000
Fourth Quarter $ 6.120 $ 4.000
2001:
First Quarter $ 3.000 $ 1.750
Second Quarter $ 3.250 $ 2.300
Third Quarter $ 8.280 $ 2.880
Fourth Quarter $ 8.340 $ 3.960
</Table>
As of March 28, 2003, there were approximately 417 holders of record of our
Common Stock.
The payment of dividends is within the discretion of the Board of Directors and
will depend on our earnings, capital requirements, and the operating and
financial condition, among other factors. Our current revolving credit facility
restricts the payment of dividends. In view of such restrictions, it is unlikely
that we will pay a dividend in the foreseeable future.
The information required by this item regarding disclosure of equity
compensation plan information will be set forth in our Proxy Statement for our
2003 Annual Meeting of Shareholders, to be filed within 120 days after the end
of fiscal 2002, under the heading "Compensation Plans," which information is
incorporated herein by reference.
12
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial and operating data set forth below should be
read in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," and our consolidated financial statements
and the notes thereto that appear elsewhere in this report.
<Table>
<Caption>
Fiscal Year
--------------------------------------------------------------------------------
(In thousands, except per share and square 2002 2001 2000 1999 1998
foot data) ------------ ------------ ------------ ------------ ------------
INCOME STATEMENT DATA:
Merchandise revenue $ 395,548 $ 379,322 $ 370,512 $ 364,041 $ 320,162
Rental video revenue 99,846 92,326 87,691 81,384 78,904
------------ ------------ ------------ ------------ ------------
Total revenues 495,394 471,648 458,203 445,425 399,066
Merchandise cost of revenue 292,888 280,054 280,459 270,113 235,915
Rental video cost of revenue(1) 41,652 41,504 38,022 32,139 49,069
------------ ------------ ------------ ------------ ------------
Total cost of revenues 334,540 321,558 318,481 302,252 284,984
Gross profit 160,854 150,090 139,722 143,173 114,082
Selling, general and administrative
expenses(2)(3)(4) 158,025 144,053 148,967 141,513 116,521
Pre-opening expenses 479 182 33 1,681 1,474
------------ ------------ ------------ ------------ ------------
Operating income (loss) 2,350 5,855 (9,278) (21) (3,913)
Interest expense, net (1,987) (2,090) (3,485) (3,708) (3,727)
Interest income(5) 1,291 -- -- -- --
Gain on sale of mall stores(6) -- -- -- -- 454
Other, net 237 252 197 205 232
------------ ------------ ------------ ------------ ------------
Income (Loss) before income taxes 1,891 4,017 (12,566) (3,524) (6,954)
Income tax expense (benefit) -- -- 2,034 (1,359) (2,649)
------------ ------------ ------------ ------------ ------------
Net income (loss) $ 1,891 $ 4,017 $ (14,600) $ (2,165) $ (4,305)
============ ============ ============ ============ ============
Basic income (loss) per share $ 0.17 $ 0.34 $ (1.25) $ (0.19) $ (0.41)
============ ============ ============ ============ ============
Diluted income (loss) per share $ 0.16 $ 0.34 $ (1.25) $ (0.19) $ (0.41)
============ ============ ============ ============ ============
Weighted-average common shares outstanding -
basic 11,343 11,742 11,645 11,621 10,436
Weighted-average common shares outstanding -
diluted 11,779 11,898 11,645 11,621 10,436
OTHER DATA:
Depreciation(7) $ 40,223 $ 35,393 $ 33,155 $ 31,626 $ 55,331
Capital expenditures(8) $ 64,664 $ 46,495 $ 30,482 $ 47,427 $ 42,568
STORE DATA:
Total selling square footage at end of period 2,846,955 2,727,446 2,759,735 2,829,269 2,385,432
Comparable-store revenues increase(9) 5.0% 4.7% 0.1% 4.0% 5.5%
</Table>
<Table>
<Caption>
January 31,
---------------------------------------------------------------------------------
2003 2002 2001 2000 1999
----------- -------------- ------------- ------------- -------------
BALANCE SHEET DATA:
Working capital(10) $ 50,915 $ 49,912 $ 46,567 $ 67,295 $ 64,866
Total assets 237,522 229,851 213,484 247,933 233,479
Total long-term debt, including current
maturities on capital lease obligations 46,712 33,432 29,610 54,260 44,979
Total shareholders' equity 79,156 77,344 75,791 90,091 91,869
</Table>
13
(1) We adopted a new, accelerated method of amortizing our rental video
assets in the fourth quarter of fiscal 1998. The adoption of the new
amortization method was accounted for as a change in accounting
estimate effected by a change in accounting principle and, accordingly,
we recorded a non-cash, non-recurring, pre-tax charge of $18.5 million
in rental video cost of revenues in the fourth quarter of fiscal 1998,
increasing net loss and diluted loss per share for fiscal 1998 by $11.5
million and $1.10 per share, respectively.
(2) We recorded pre-tax charges of $2.6 million in fiscal 2002 related to
the settlement of the shareholder class action lawsuits as described in
Note 13. These charges reduced net income by $2.6 million or
approximately $0.22 per diluted share.
(3) We recorded pre-tax charges of approximately $2.4 million, $1.5 million
and $6.5 million in fiscal years 2002, 2001 and 2000, respectively,
related to the cost associated with closing superstores. See Note 5 to
the consolidated financial statements for further discussion. As a
result of these charges, fiscal years 2002, 2001 and 2000 net losses
were increased by $2.4 million, $1.5 million and $6.5 million and
$0.20, $0.13 and $0.56 per diluted share, respectively.
(4) In fiscal 2000, we recorded $2.7 million in accounting and legal fees
associated with the restatement of the first three quarters of fiscal
1999 and the prior four fiscal years. As a result of these fees, fiscal
year 2000 net losses were increased by $2.7 million and $0.23 per
diluted share.
(5) We recorded interest income of approximately $1.3 million in the second
quarter of fiscal 2002 as a result of interest earned on income tax
refunds for amended returns filed for fiscal years 1995 through 1998.
As a result, net income was increased by approximately $0.11 per
diluted share.
(6) In fiscal 1996, we established a reserve of $2.5 million ($1.6 million
after-tax charge) to cover potential losses related to certain mall
store leases that were sold prior to fiscal 1995 to Camelot Music,
Inc., which filed for bankruptcy protection in August 1996. In fiscal
1997, the reserve was reduced to $0.5 million, and $1.7 million was
included in Gain on sale of mall stores. In fiscal 1998, we were
released from any contingent liability on the remaining leases by order
of a bankruptcy court. Accordingly, the Company reduced the remaining
$0.5 million reserve to zero as of January 31, 1999, thereby decreasing
net loss and diluted loss per share for fiscal 1998 by $0.3 million and
$.03 per share, respectively.
(7) Includes amounts associated with our rental video cost amortization.
(8) Includes procurement of rental video assets.
(9) Stores included in the comparable-store revenues calculation are those
stores that have been open for a minimum of 60 weeks. Also included are
stores that are remodeled or relocated. Sales via the internet are not
included and closed stores are removed from each comparable period for
the purpose of calculating comparable-store revenues.
(10) Working capital is calculated as total current assets less total
current liabilities.
14
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with our consolidated
financial statements and the related notes thereto and "Item 6. Selected
Financial Data" appearing elsewhere in this Annual Report.
General
Hastings Entertainment is a leading multimedia entertainment retailer that
combines the sale of books, music, software, periodicals, videocassettes, video
games, DVDs, used products including CDs, DVDs and video games, video game
consoles and DVD players with the rental of videocassettes, video games, DVDs,
video game consoles and DVD players in a superstore and Internet Web site
format. As of January 31, 2003, we operated 146 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 the
superstores is wholly owned by the Company and operates under the name of
Hastings.
Our operating strategy is to enhance our position as a multimedia entertainment
retailer by expanding and remodeling existing superstores, opening new
superstores in selected markets, and offering our 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, 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 and
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 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 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 market value is below cost.
Through merchandising and an automated-progressive markdown program, we quickly
take the steps necessary to increase the sell-off of slower moving merchandise
to eliminate or lessen the effect of any LCM adjustments.
Returns Process. Merchandise inventory owned by us is generally 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 cost accruals are required
for inventory that has been returned to vendors, or is in the process of being
returned to vendors, or has been identified to be returned to vendors. 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.
15
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 fiscal year 2002. 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. Under the terms of the specific contracts with
supplying studios, we expense revenue-sharing payments through rental video cost
of revenue, 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. The
primary expense items associated with the closure of a store 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. We actively pursue sublease tenants on
all closed or relocated locations and the impact of any sublease income is
estimated in the determination of the incurred store closing reserve liability.
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 estimated 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.
Comparable-Store Revenue. Stores included in the comparable-store revenues
calculation are those stores that have been open for a minimum of 60 weeks. Also
included are stores that are remodeled or relocated. Sales via the internet are
not included and closed stores are removed from each comparable period for the
purpose of calculating comparable-store revenues.
16
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 period
for the three most recent fiscal years.
<Table>
<Caption>
Fiscal Year
-----------------------------------------------
2002 2001 2000
------------- ------------- -------------
Merchandise revenue 79.8 % 80.4 % 80.9 %
Rental video revenue 20.2 19.6 19.1
------------- ------------- -------------
Total revenues 100.0 100.0 100.0
Merchandise cost of revenue 74.0 73.8 75.7
Rental video cost of revenue 41.7 45.0 43.4
------------- ------------- -------------
Total cost of revenues 67.5 68.2 69.5
Gross profit 32.5 31.8 30.5
Selling, general and administrative expenses 31.9 30.5 32.5
Pre-opening expenses 0.1 0.1 0.0
------------- ------------- -------------
32.0 30.6 32.5
------------- ------------- -------------
Operating income (loss) 0.5 1.2 (2.0)
Other income (expense):
Interest expense (0.4) (0.4) (0.8)
Interest income 0.3 -- --
Other, net 0.0 0.1 0.0
------------- ------------- -------------
(0.1) (0.3) (0.8)
------------- ------------- -------------
Income (Loss) before income taxes 0.4 0.9 (2.8)
Income tax expense -- -- 0.4
------------- ------------- -------------
Net income (loss) 0.4 % 0.9 % (3.2) %
============= ============= =============
</Table>
<Table>
<Caption>
Fiscal Year
--------------------------------
2002 2001 2000
-------- -------- --------
Hastings Superstores:
Beginning number of stores 142 142 147
Openings 7 5 1
Closings (3) (5) (6)
-------- -------- --------
Ending number of stores 146 142 142
======== ======== ========
</Table>
17
Fiscal 2002 Compared to Fiscal 2001
Revenues. Total revenues for the fiscal year ending January 31, 2003 were $495.4
million, up $23.7 million, or 5.0%, from $471.7 million for the fiscal year
ending January 31, 2002 primarily due to an increase in total comparable-store
revenue ("Comps") of 5.0% for the year. Elements of total Comps are as follows:
<Table>
Merchandise Comps 4.8%
Rental video Comps 5.9%
Total Comps 5.0%
</Table>
Total merchandise revenues increased $16.2 million, or 4.3% for fiscal 2002 to
$395.5 million from $379.3 million for fiscal 2001. The increase in merchandise
Comps was driven primarily by year over year increases of approximately 52% and
102% in total sales of DVDs and video games, respectively. Comp increases were
partially offset by a decline in music Comps of (6.3%) due primarily to the
current malaise of the music industry, which overall experienced a decline of
(8.7%) in total shipments of new release compact discs for 2002. Book Comps for
the year increased 3.6% as a result of our focus during fiscal 2002 to improve
our book department performance. Total rental video revenues for fiscal 2002
increased $7.5 million, or 8.1% to $99.8 million compared to $92.3 million for
the prior year primarily due to an increase in rentals of DVD titles of
approximately 90% year over year. The increase in DVD rentals was partially
offset by a 21% 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 instead of renting.
Gross Profit. For fiscal 2002, total gross profit increased 7.2% to $160.9
million, or 32.5% of total revenues, from $150.1, or 31.8% of total revenues for
fiscal 2001.
Merchandise gross profit for fiscal 2002, as a percent of merchandise revenue,
decreased slightly to 26.0% compared to 26.2% for fiscal 2001 due primarily to
reduced margins in music and sale video which resulted from lower sales prices
in order to meet competitor pricing. Partially offsetting these declines was an
increase in book gross profit due primarily to a planned move toward higher
margin products in this category.
Merchandise gross profit dollars for fiscal 2002 increased approximately $3.4
million to $102.7 million from $99.3 million for fiscal 2001. Significant
components of this increase in gross profit dollars were:
(i) higher revenues generating a higher gross profit contribution
of approximately $4.0 million, despite a slight increase in
our product cost from 67.1% of merchandise revenue for fiscal
2001 to 67.5% for fiscal 2002;
(ii) a decline in inventory markdowns of approximately $2.6 million
compared to last fiscal year due primarily to our
automated-progressive markdown programs, which improve our
sell-through on slower moving merchandise;
(iii) a decrease in merchandise shrinkage of approximately $0.5
million; and
(iv) an increase of approximately $0.4 million from an increase in
certain trade and purchase discounts primarily resulting from
volume rebates related to merchandise inventory purchases.
Partially offsetting these increases in merchandise gross profit were:
(i) an increase of approximately $3.6 million in the costs
associated with returning merchandise inventory primarily
related to an increase of approximately $23.2 million, or
35.7%, in the volume of product returned to vendors during
fiscal 2002 compared to fiscal 2001. The higher level of
returns was mainly attributable to a planned reduction in
inventory levels; and
18
(ii) an increase in net freight expense of approximately $1.2
million, which was primarily caused by increases in shipments
from our distribution and returns facilities of approximately
15% for fiscal year 2002 compared to fiscal 2001 and higher
freight costs.
Rental video gross profit for fiscal 2002 increased $7.4 million, or 14.5%, to
$58.2 million up from $50.8 million for fiscal 2001. As a percent of rental
video revenue, rental video gross profit increased to 58.3% compared to 55.0%
for fiscal 2001. These increases were primarily the result of an increase in
rental video gross profit resulting from increases in the rentals of non-revenue
sharing titles, which generally reflect higher margins, representing a higher
percentage of total rental revenues and improved margins on videos acquired
under revenue sharing agreements.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A"), including store and corporate labor and other
overhead costs, for fiscal 2002 increased 9.7% to $158.0 million, or 31.9% of
total revenues, from $144.1 million, or 30.5% of total revenues last year. The
increase was primarily the result of:
(i) charges totaling $2.6 million for the settlement of
shareholder class action lawsuits;
(ii) an increase in store variable human resource expenses,
excluding group healthcare costs, of approximately $3.8
million. Store human resource productivity decreased slightly
to 12.3% of total revenues for fiscal year 2002 compared to
12.1% for fiscal 2001;
(iii) a planned increase of approximately $3.3 million in
advertising expenditures designed to drive Comp revenues and
customer traffic;
(iv) an increase in occupancy related costs of approximately $1.8
million due to the operation of a higher number of superstores
during fiscal year 2002 when compared to fiscal year 2001;
(v) an increase of approximately $1.7 million related primarily to
increases in depreciation and consulting fees in connection
with the implementation of new financial software and upgrades
in our human resource systems; and
(vi) an unplanned increase of approximately $0.8 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.
(vii) an increase of approximately $0.6 million in the costs
associated with expanding or relocating seven superstores and
the write-off of fixed assets related to the closing of one
superstore; and
(viii) an increase of approximately $0.8 million in other
miscellaneous SG&A expenses.
Partially offsetting these increases in SG&A were decreases of approximately
$1.7 million in net expense associated with the closing of certain superstores
and improved sublease activity.
Pre-opening Expenses. Pre-opening expenses were $0.5 million for fiscal 2002, as
we opened seven superstores during the year. For fiscal 2001, pre-opening
expenses totaled $0.2 million with the opening of five new superstores.
Pre-opening expenses include human resource costs, travel, rent, advertising,
supplies and certain other costs incurred prior to a superstore's opening.
Interest Expense. For fiscal 2002, when compared to fiscal 2001, interest
expense remained constant at 0.4% of total revenues. A higher average loan
balance outstanding offset lower interest rates year over year.
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
19
August 2002 and would be accompanied by interest payments. All refunds,
including interest, were received during fiscal 2002.
Income Taxes. We did not record any income tax expense for fiscal years 2002 and
2001 due to the reduction in the valuation allowance related to the net deferred
tax asset.
Net Income (Loss). We recorded net income of $1.9 million, or $0.16 per diluted
share for fiscal year 2002 compared to net income of $4.0 million or $0.34 per
diluted share reported for fiscal year 2001.
Fiscal 2001 Compared to Fiscal 2000
Revenues. Total revenues for the fiscal year ending January 31, 2002 were $471.8
million, up $13.6 million, or 3.0%, from $458.2 million for the fiscal year
ending January 31, 2001 primarily due to an increase in total comparable-store
revenue ("Comps") of 4.7% for the year. Elements of total Comps are as follows:
<Table>
Merchandise Comps 4.3%
Rental video Comps 6.4%
Total Comps 4.7%
</Table>
The Comp increases in merchandise and rental were partially offset by the
operation of three fewer superstores throughout fiscal 2001 compared to fiscal
2000. Total merchandise revenues increased $8.8 million, or 2.4% for fiscal 2001
to $379.3 million from $370.5 million for fiscal 2000. The increase in
merchandise Comps was driven primarily by year over year increases of 73% and
114% in total sales of DVDs and video games, respectively. Comp increases were
partially offset by a decline in music Comps of (3.5%) due primarily to the
current malaise of the music industry, which overall experienced a decline of
(4.1%) in total music shipments for 2001. Book Comps for fiscal 2001 increased
slightly at 0.3%. Total rental video revenues for fiscal 2001 increased $4.6
million, or 5.2% to $92.3 million compared to $87.7 million for the prior year
primarily due to an increase in rentals of DVD titles of 140% year over year.
Gross Profit. For fiscal 2001, total gross profit increased 7.4% to $150.0
million, or 31.8% of total revenues, from $139.7, or 30.5% of total revenues for
fiscal 2000.
Merchandise gross profit for fiscal 2001, as a percent of merchandise revenue,
increased to 26.2% compared to 24.3% for fiscal 2000 due primarily to:
(i) a reduction in the costs associated with the return of product of
approximately $5.9 million for fiscal 2001 which is attributable to
improvements made in the product return process during fiscal 2001 that
lowered the cost per dollar of return; and
(ii) lower product costs of approximately $1.5 million as a result of a
movement in our inventory selection toward higher margin products
particularly related to books.
Partially offsetting these increases in merchandise gross profit was an increase
of approximately $1.6 million in the costs of operating our distribution center.
During fiscal 2001, we implemented a strategy to increase the flow of certain
higher turning inventory items through our distribution center. This program
enables us to have a better in-stock position for our customers. For the year,
the volume of shipments from our distribution center to our superstores
increased approximately 42% in fiscal 2001 when compared to fiscal 2000, which
resulted in significantly higher operating costs.
Rental video gross profit for fiscal 2001, as a percent of rental video revenue,
decreased to 55.0% compared to 56.6% for fiscal 2000 due primarily to:
20
(i) an increase of approximately $1.6 million in depreciation expenses as
we procured a higher level of video games and DVD to meet increasing
demand. A large portion of these purchases were for catalog rental
product which exhibit slower turns than a new release title; and
(ii) an increase of approximately $0.8 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.
Partially offsetting these decreases in rental video gross profit was an
increase in margin of approximately $0.7 million on the rental of revenue
sharing titles due to improved terms on agreements with studios. Additionally, a
higher percentage of non-revenue sharing titles, which generally reflect higher
margins, helped to offset the decreases listed above.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A"), including store and corporate labor and other
overhead costs, for fiscal 2001 decreased 3.3% to $144.1 million, or 30.6% of
total revenues, from $149.0 million, or 32.5% of total revenues last year. This
substantial decrease was primarily the result of a higher level of expenses
recorded during fiscal 2000 including:
(i) $2.7 million in accounting and legal fees associated with the
restatement of the first three quarters of fiscal 1999 and the prior
four fiscal years. These fees did not recur during fiscal 2001;
(ii) asset impairment charges of $1.4 million comprised of $1.0 million in
writedowns of leasehold improvements included in three underperforming
superstores and $.4 million in writedowns of certain assets of the
Company's Internet segment were recorded during fiscal 2000. This
compares to a $0.7 million writedown of leasehold improvements for two
underperforming superstores in fiscal 2001. Although these superstores
continued to operate, such charges were recorded as projected cash
flows from these operations were not sufficient to realize the book
value of the specific assets; and
(iii) we recorded net expenses of $6.5 million in fiscal 2000 associated with
the closure of two superstores during the fourth quarter of fiscal 2000
and an additional four superstores approved for closure prior to year
end of fiscal 2000. This compared to net expenses of $1.5 million
related to two underperforming superstores which were approved for
closure during fiscal 2001, one of which was closed during the fourth
quarter of fiscal 2001 and the other closed in February 2002. Such
expenses are comprised of accruals for the net present value of future
minimum lease payments, the write-off of leasehold improvements, and
other related costs.
Partially offsetting the decreases in SG&A expense listed above was an increase
in net advertising costs of approximately $1.8 million year over year. The
higher expense was the result of a planned increase in targeted advertising
expenditures during fiscal 2001 to increase customer traffic.
Pre-opening Expenses. Pre-opening expenses were $0.2 million for fiscal 2001, as
we opened five superstores during the year. For fiscal 2000, pre-opening
expenses totaled $33,000 with the opening of one new superstore. Pre-opening
expenses include human resource costs, travel, rent, advertising, supplies and
certain other costs incurred prior to a superstore's opening.
Interest Expense. During fiscal 2001, interest expense decreased 40.0% to $2.1
million, or 0.4% of total revenues, from $3.5 million, or 0.8% of total revenues
for fiscal 2000. This reduction was primarily due to lower interest rates as
well as a lower average outstanding borrowing during the current year compared
to last year.
Income Taxes. Income tax expense for the fiscal years 2001 and 2000 was zero and
$2.0 million, respectively. No income tax expense was recorded related to income
for fiscal 2001 due to the reversal of a portion of the valuation allowance
related to the net deferred tax asset established in the fourth quarter of
fiscal 2000.
Net Income (Loss). We recorded net income of $4.0 million, or $0.34 per diluted
share for fiscal year 2001 compared to a net loss of ($14.6) million or ($1.25)
per share reported for fiscal year 2000.
21
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 revolving credit
facility (the "Facility"). Based on our current internal projections, we believe
our cash flow from operations and borrowings under the 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
$6.4 million, or 14.1% to $51.7 million in fiscal 2002 from $45.3 million
in fiscal 2001. In addition to a reduction in net income of approximately
$2.1 million in fiscal 2002 compared to fiscal 2001, we recorded a decline
in trade accounts payable and accrued expenses of approximately $5.0
million in fiscal 2002 compared to an increase of approximately $11.8
million in fiscal 2001. This variance was primarily the result of increased
merchandise returns to vendors and the recording of subsequent reductions
of amounts owed to those vendors. Offsetting these declines in cash
provided by operations was an increase primarily resulting from a planned
decline in merchandise inventory during fiscal 2002 of approximately $5.8
million compared to an increase of approximately $13.9 million during
fiscal 2001. In addition, we recorded a greater decrease in income taxes
receivable in fiscal 2002 compared to fiscal 2001 of approximately $2.8
million primarily relating to a net increase in the amount of income tax
refunds received during fiscal 2002 compared to fiscal 2001.
Investing Activities. Net cash used in investing activities increased $18.2
million, or 39.1%, from $46.5 million in fiscal 2001 to $64.7 million in
fiscal 2002. This increase was due primarily to the increased purchase of
rental video assets during fiscal 2002 due to new and expanded superstore
activity, increased purchases of DVD and video games to meet customer
demand and a higher percentage of our total rental video procurement
expended for non-revenue sharing titles, which generally have a higher
purchase price than titles purchased under revenue sharing agreements.
Additionally, the increase related to expenditures associated with the
opening of seven new superstores and the expansion or remodel of nine
superstores during fiscal 2002 compared to the opening of five new
superstores and the expansion or remodel of seven superstores during fiscal
2001 and an increase in information systems expenditures to install new and
upgraded hardware and software systems. 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 our revolving
credit facility (defined below under "Capital Structure"). Cash provided by
financing activities increased $11.8 million to $13.1 million in fiscal
2002 compared to $1.2 million in fiscal 2001. This increase was primarily
the result of higher net borrowings of approximately $9.4 million under our
revolving credit facility for fiscal 2002 compared to fiscal 2001 and lower
stock repurchase activity of approximately $2.5 million for fiscal 2002
compared to fiscal 2001.
On September 18, 2001 we announced a stock repurchase program of up to $5.0
million of our common stock. As of January 31, 2003, a total of
approximately 723,000 shares had been purchased at a cost of approximately
$3.5 million, for an average cost of $4.89 per share.
22
Capital Structure. On August 23, 2002, we executed an amendment to our
syndicated secured Loan and Security Agreement with Fleet Retail Finance, Inc.
and The CIT Group/Business Credit, Inc, (the "Facility"). 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
$80 million, less a $10 million availability reserve. The Facility's interest
rate is based on the prevailing prime rate or LIBOR plus a margin percentage, at
our 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, which can be adjusted to reduce
availability under the Facility. 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 our
common stock and requires a minimum availability of $10 million at all times.
The Facility is secured by substantially all of the assets of the Company and
our subsidiaries and is guaranteed by each of our three consolidated
subsidiaries. The Facility matures on August 20, 2005. At January 31, 2003, we
had $16.4 million in excess availability, after the $10 million availability
reserve, under the Facility. At January 31, 2003 and January 31, 2002,
respectively, we had borrowings outstanding of $45.7 million and $32.2 million
under the Facility. The average rate of interest being charged under the
Facility was 4.1% and 6.1% at January 31, 2003 and January 31, 2002,
respectively.
From time to time, we enter into interest rate swap agreements 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. On October 4, 2002,
we cancelled, at no cost, two swap agreements entered into in November and
December of 2001 with an aggregate notional amount of $20 million and replaced
those agreements with one interest rate swap agreement with a financial
institution. The notional amount of the swap is $20 million with a fixed
interest rate of 2.45% for two years. We have designated the interest rate swap
as a hedging instrument. At January 31, 2003, the fair value of the interest
rate swap was not significant.
At January 31, 2003, our minimum operating lease commitments for fiscal 2003
were approximately $19.0 million. The present value of total existing minimum
operating lease commitments for fiscal years 2004 through 2030 discounted at
9.0% was approximately $57.8 million as of January 31, 2003.
Seasonality and Inflation
As is the case with many retailers, a significant portion of our revenues, and
an even greater portion of our operating profit, is generated in the fourth
fiscal quarter, which includes the Christmas selling season. As a result, a
substantial portion of our annual earnings has been, and will continue to be,
dependent on the results of this quarter. We experience reduced rentals of video
activity in the spring because customers spend more time outdoors. Major world
or sporting events, such as the war in Iraq, 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 superstore 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 our operations.
We do not believe that inflation has materially impacted net income during the
past three years. Substantial increases in costs and expenses could have a
significant impact on our operating results to the extent such increases are not
passed along to customers.
Recent Accounting Pronouncements
In June 2002, the FASB issued Statement No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities" ("SFAS No. 146"). This statement
requires that the fair value of a liability associated with an exit or disposal
activity be recognized when the liability is incurred. Prior to the adoption of
SFAS No. 146, certain exit costs were recognized when we committed to a
restructuring plan, which may have been before the liability was incurred. The
provisions of this statement were effective for exit or disposal activities
initiated subsequent to December 31, 2002. The adoption of SFAS No. 146 did not
have a material impact on our financial position or results of operations.
23
In January, 2003, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 02-16, "Accounting by a Customer (Including a Reseller) for Certain
Consideration Received from a Vendor." The issue provides guidelines for
specific treatment and classification of certain amounts received by a customer
from a vendor in connection with product purchased from the vendor. EITF 02-16
is effective prospectively for new arrangements entered into after December 31,
2002. The provisions of EITF 02-16 did not have a significant impact on our
financial position or results of operations as of, and for the year ended,
January 31, 2003. We are analyzing the provisions of EITF 02-16 for arrangements
entered into for fiscal 2003 but have not yet determined the impact on our
financial position and results of operations.
ITEM 7A. 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 January 31, 2003 outstanding balance
of the variable rate debt would be approximately $0.5 million, including the
effect of our interest rate swap. 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 our interest rate swap entered into in
October of 2002 with a notional amount of $20 million will be material.
24
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
HASTINGS ENTERTAINMENT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
<Table>
<Caption>
PAGE
Independent Auditors' Reports 26
Consolidated Balance Sheets as of January 31, 2003 and 2002 27
Consolidated Statements of Operations
for the years ended January 31, 2003, 2002 and 2001 28
Consolidated Statements of Shareholders' Equity
for the years ended January 31, 2003, 2002 and 2001 29
Consolidated Statements of Cash Flows
for years ended January 31, 2003, 2002 and 2001 30
Notes to Consolidated Financial Statements 31
SCHEDULE
Financial Statement Schedule - The Financial Statement Schedule
filed as part of this report is listed under Part IV, Item 15.
Exhibits, Financial Statement Schedules and Reports on Form 8-K. 50
</Table>
25
REPORT OF INDEPENDENT AUDITORS
The Board of Directors
Hastings Entertainment, Inc.
We have audited the accompanying consolidated balance sheets of Hastings
Entertainment, Inc. and subsidiaries as of January 31, 2003 and 2002, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the three years in the period ended January 31, 2003. Our
audits also included the financial statement schedule listed in the Index at
Item 15(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hastings
Entertainment, Inc. and subsidiaries at January 31, 2003 and 2002, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 31, 2003 in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
/s/ Ernst & Young LLP
Fort Worth, Texas
March 14, 2003
26
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
January 31, 2003 and 2002
(In thousands, except share data)
<Table>
<Caption>
JANUARY 31,
----------------------------
2003 2002
------------ ------------
ASSETS
Current assets
Cash $ 4,447 $ 4,319
Merchandise inventories, net 148,395 148,265
Income taxes receivable 552 5,377
Prepaid expenses and other current assets 5,969 5,331
------------ ------------
Total current assets 159,363 163,292
Property and equipment, net 76,283 64,811
Deferred income taxes, net of valuation allowance 971 1,091
Intangible assets, net 717 646
Other assets $ 188 $ 11
------------ ------------
237,522 229,851
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities
Current maturities on capital lease obligations $ 193 $ 169
Trade accounts payable 75,712 83,418
Accrued expenses & other current liabilities 32,543 29,793
------------ ------------
Total current liabilities 108,448 113,380
Long-term debt, excluding current maturities on capital lease obligations 46,519 33,263
Other liabilities 3,399 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; 119 119
11,944,544 shares in fiscal 2002 and
11,918,035 shares in fiscal 2001 issued;
11,336,473 shares in fiscal 2002 and
11,304,022 shares in fiscal 2001 outstanding
Additional paid-in capital 36,749 36,850
Retained earnings 45,259 43,368
Treasury stock, at cost (2,971) (2,993)
------------ ------------
79,156 77,344
------------ ------------
237,522 229,851
============ ============
</Table>
See accompanying notes to consolidated financial statements.
27
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended January 31, 2003, 2002 and 2001
(In thousands, except per share data)
<Table>
<Caption>
FISCAL YEAR
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
Merchandise revenue $ 395,548 $ 379,322 $ 370,512
Rental video revenue 99,846 92,326 87,691
------------ ------------ ------------
Total revenues 495,394 471,648 458,203
Merchandise cost of revenue 292,888 280,054 280,459
Rental video cost of revenue 41,652 41,504 38,022
------------ ------------ ------------
Total cost of revenues 334,540 321,558 318,481
------------ ------------ ------------
Gross profit 160,854 150,090 139,722
Selling, general and administrative expenses 158,025 144,053 148,967
Pre-opening expenses 479 182 33
------------ ------------ ------------
Operating income (loss) 2,350 5,855 (9,278)
Other income (expense):
Interest income 1,291 -- --
Interest expense (1,987) (2,090) (3,485)
Other, net 237 252 197
------------ ------------ ------------
Income (Loss) before income taxes 1,891 4,017 (12,566)
Income tax expense -- -- 2,034
------------ ------------ ------------
Net income (loss) $ 1,891 $ 4,017 $ (14,600)
============ ============ ============
Basic income (loss) per share $ 0.17 $ 0.34 $ (1.25)
============ ============ ============
Diluted income (loss) per share $ 0.16 $ 0.34 $ (1.25)
============ ============ ============
</Table>
See accompanying notes to consolidated financial statements.
28
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended January 31, 2003, 2002 and 2001
(In thousands, except share data)
<Table>
<Caption>
COMMON STOCK ADDITIONAL TREASURY STOCK TOTAL
--------------------- PAID-IN RETAINED -------------------- SHAREHOLDERS'
SHARES AMOUNT CAPITAL EARNINGS SHARES AMOUNT EQUITY
---------- -------- ---------- -------- -------- -------- ------------
Balances at January 31, 2000 11,736,923 $ 117 $ 37,402 $ 53,951 107,950 $ (1,379) $ 90,091
Issuance of treasury stock to directors -- -- (152) -- (13,672) 186 34
Issuance of stock to employees 14,927 -- (310) -- (44,278) 513 203
Exercise of stock options -- -- (617) -- (50,000) 680 63
Net loss -- -- -- (14,600) -- -- (14,600)
---------- -------- ---------- -------- -------- -------- ------------
Balances at January 31, 2001 11,751,850 117 36,323 39,351 -- -- 75,791
Issuance of stock to employees 63,655 1 166 -- -- -- 167
Purchase of treasury stock -- -- -- -- 618,470 (3,017) (3,017)
Exercise of stock options 102,530 1 361 -- (4,457) 24 386
Net income -- -- -- 4,017 -- -- 4,017
---------- -------- ---------- -------- -------- -------- ------------
Balances at January 31, 2002 11,918,035 119 36,850 43,368 614,013 (2,993) 77,344
Issuance of stock to directors 26,509 -- 87 -- (11,775) 58 145
Purchase of treasury stock -- -- -- -- 104,923 (521) (521)
Exercise of stock options -- -- (188) -- (99,090) 485 297
Net income -- -- -- 1,891 -- -- 1,891
---------- -------- ---------- -------- -------- -------- ------------
Balances at January 31, 2003 11,944,544 $ 119 $ 36,749 $ 45,259 608,071 $ (2,971) $ 79,156
========== ======== ========== ======== ======== ======== ============
</Table>
See accompanying notes to consolidated financial statements.
29
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended January 31, 2003, 2002 and 2001
(Dollars in thousands)
<Table>
<Caption>
FISCAL YEAR
--------------------------------------------
2002 2001 2000
------------ ------------ ------------
Cash flows from operating activities:
Net income (loss) $ 1,891 $ 4,017 $ (14,600)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Depreciation expense 40,223 35,393 33,155
Amortization expense 68 73 --
Loss on rental videos lost, stolen and defective 5,711 5,179 1,877
Loss on disposal of non-rental video assets 1,307 1,615 3,375
Deferred income taxes 316 -- 3,681
Non-cash compensation 127 115 235
Changes in operating assets and liabilities:
Merchandise inventories 5,820 (13,948) 21,389
Prepaid expenses and other current assets (638) 129 (492)
Trade accounts payable and accrued expenses (4,956) 11,776 3,112
Income taxes receivable 4,629 1,828 (1,487)
Other assets and liabilities, net (2,782) (863) 2,055
------------ ------------ ------------
Net cash provided by operating activities 51,716 45,314 52,300
------------ ------------ ------------
Cash flows from investing activities:
Purchases of rental video (37,695) (27,485) (21,541)
Purchase of property, equipment and improvements (26,969) (17,843) (8,941)
Purchases of retail locations -- (1,167) --
------------ ------------ ------------
Net cash used in investing activities (64,664) (46,495) (30,482)
------------ ------------ ------------
Cash flows from financing activities:
Borrowings under revolving credit facility 542,241 505,135 296,867
Repayments under revolving credit facility (528,791) (501,159) (311,041)
Payments under long-term debt and capital lease obligations (168) (154) (10,476)
Purchase of treasury stock (521) (3,019) --
Proceeds from exercise of stock options 315 440 63
------------ ------------ ------------
Net cash provided by (used in) financing activities 13,076 1,243 (24,587)
------------ ------------ ------------
Net increase (decrease) in cash 128 62 (2,769)
Cash at beginning of year 4,319 4,257 7,026
------------ ------------ ------------
Cash at end of year $ 4,447 $ 4,319 $ 4,257
============ ============ ============
</Table>
See accompanying notes to consolidated financial statements.
30
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) GENERAL
Hastings Entertainment, Inc. and subsidiaries (the "Company")
operates a chain of retail superstores in 21 states, primarily
in the Western and Midwestern United States, with revenues
originating from the sale of music, books, software,
periodicals, videocassette, video game and DVD products and
the rental of videocassettes, video games and DVDs.
(b) BASIS OF CONSOLIDATION
The consolidated financial statements present the results of
Hastings Entertainment, Inc. and its subsidiaries. All
significant intercompany transactions and balances have been
eliminated in consolidation.
(c) BASIS OF PRESENTATION
Certain prior year amounts have been reclassified to conform
with the fiscal 2002 presentation.
The Company's fiscal years ended January 31, 2003, 2002 and
2001 are referred to as fiscal 2002, 2001 and 2000,
respectively.
(d) REVENUE RECOGNITION
Merchandise and rental video revenue are recognized at the
point of sale or rental or at the time merchandise is shipped
to the customer. Additionally, revenues are presented net of
returns and exclude all taxes. An allowance has been
established to provide for projected merchandise returns.
Gift card liabilities are recorded at the time of sale with
the costs of designing, printing and distributing the cards
recorded as expense as incurred. The liability is relieved and
revenue is recognized upon redemption of the gift cards.
(e) CASH AND CASH EQUIVALENTS
The Company considers all short-term investments with original
maturities of three months or less to be cash equivalents.
(f) MERCHANDISE INVENTORIES
Merchandise inventories are recorded at the lower of cost
[which approximates the first-in, first-out (FIFO method)] or
market.
(g) PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated
using the straight-line method, except for rental video
assets, which are depreciated using an accelerated
depreciation method. Furniture, fixtures, equipment and
software are depreciated over their estimated useful lives of
three to seven years. Leasehold improvements are amortized
over the shorter of the related lease term or their estimated
useful lives. Rental video assets, except for new store stock,
are depreciated over six months using an accelerated
methodology designed to match the revenue stream of the rental
asset. New store stock of rental video assets is depreciated
over 36 months using the straight-line method.
Property recorded pursuant to capital lease obligations is
stated at the present value of the minimum lease payments at
the inception of each lease, not in excess of fair value, and
amortized on a straight-line basis over the related lease
term.
The Company reviews long-lived assets for impairment whenever
events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. Recoverability of
assets to be
31
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
held and used is measured by a comparison of the carrying
amount of the asset to future net undiscounted cash flows
expected to be generated by the asset. If such assets are
considered to be impaired, the impairment to be recognized is
measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount
or fair value less costs to sell.
(h) FINANCIAL INSTRUMENTS
The carrying amount of long-term debt approximates fair value
as of January 31, 2003 and 2002 due to the instruments bearing
interest at variable market rates. The carrying amount of
accounts payable approximates fair value because of its short
maturity period.
From time to time, the Company enters into interest rate swap
agreements in order to obtain a fixed interest rate on a
portion of their outstanding floating rate debt thereby
reducing their exposure to interest rate volatility. On
October 4, 2002, the Company cancelled, at no cost, two swap
agreements entered into in November and December of 2001 with
an aggregate notional amount of $20 million and replaced those
agreements with one interest rate swap agreement with a
financial institution. The notional amount of the swap is $20
million with a fixed interest rate of 2.45% for two years. The
Company has designated the interest rate swap as a hedging
instrument. Because the relevant terms of the interest rate
swaps and the specific cash flows related to the debt they
have been designated to hedge are virtually identical, there
was no material ineffectiveness required to be recognized in
earnings. In addition, there are no components of the
derivative instruments' gain or loss that have been excluded
from the assessment of hedge effectiveness. At January 31
2003, the fair value of the interest rate swap was not
significant.
(i) STOCK OPTION PLANS
The Company accounts for its stock option plans in accordance
with the provisions of Accounting Principles Board Opinion No.
25 (APB 25), Accounting for Stock Issued to Employees, and
related interpretations. Compensation expense is recorded on
the date of grant only if the market price of the underlying
stock exceeds the exercise price. Under Statement of Financial
Accounting Standards No. 123 (SFAS 123), Accounting for
Stock-based Compensation, the Company may elect to recognize
expense for stock-based compensation based on the fair value
of the awards, or continue to account for stock-based
compensation under APB 25 and disclose in the financial
statements the effects of SFAS 123 as if the recognition
provisions were adopted. The Company has elected to continue
to apply the provisions of APB 25 and provide the pro forma
disclosure provisions of SFAS 123.
32
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
The following schedule reflects the impact on net income (loss)
and net income (loss) per share if the Company had applied the
fair value recognition provisions of SFAS No. 123 to stock based
compensation (in thousands, except per share amounts)
<Table>
<Caption>
2002 2001 2000
---------- ----------- ----------
Reported net income (loss) $ 1,891 $4,017 $ (14,600)
Less: compensation expense per SFAS No. 123, net of tax 378 166 543
---------- ----------- ----------
Proforma net income (loss) $ 1,513 $3,851 $ (15,143)
========== =========== ==========
Basic income (loss) per share:
Reported net income (loss) per share $ 0.17 $ 0.34 $ (1.25)
Less: compensation expense per SFAS No. 123, net of tax 0.03 0.01 0.05
---------- ----------- ----------
Proforma net income (loss) per share $ 0.14 $ 0.33 $ (1.30)
========== =========== ==========
Diluted income (loss) per share:
Reported net income (loss) per share $ 0.16 $ 0.34 $ (1.25)
Less: compensation expense per SFAS No. 123, net of tax 0.03 0.024 0.05
---------- ----------- ----------
Proforma net income (loss) per share $ 0.13 $ 0.32 $ (1.30)
========== =========== ==========
</Table>
(j) ADVERTISING COSTS
Advertising costs for newspaper, television and other media
are expensed as incurred. Gross advertising expenses for the
fiscal years 2002, 2001, and 2000 were $11.0 million, $9.2
million and $5.9 million, respectively.
(k) PRE-OPENING COSTS
Pre-opening expenses include human resource costs, travel,
rent, advertising, supplies and certain other costs incurred
prior to a superstore's opening and are expensed as incurred.
(l) INCOME (LOSS) PER SHARE
Basic income (loss) per share is computed by dividing net
income (loss) by the weighted-average number of common shares
outstanding during the period. Diluted income per share is
similarly computed, but includes the effect, when dilutive, of
the Company's weighted average number of stock options
outstanding.
(m) USE OF MANAGEMENT ESTIMATES
The preparation of the financial statements in conformity with
generally accepted accounting principles requires management
to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent
assets and liabilities at the date of the financial statements
and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those
estimates.
(n) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the FASB issued Statement No. 146, "Accounting
for Costs Associated with Exit or Disposal Activities" ("SFAS
No. 146"). This statement requires that the fair value of a
liability associated with an exit or disposal activity be
recognized when the liability is incurred. Prior to the
33
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
adoption of SFAS No. 146, certain exit costs were recognized
when we committed to a restructuring plan, which may have been
before the liability was incurred. The provisions of this
statement were effective for exit or disposal activities
initiated subsequent to December 31, 2002. The adoption of
SFAS No. 146 did not have a material impact on the Company's
financial position or results of operations.
In January, 2003, the Emerging Issues Task Force ("EITF")
reached a consensus on Issue No. 02-16, "Accounting by a
Customer (Including a Reseller) for Certain Consideration
Received from a Vendor." The issue provides guidelines for
specific treatment and classification of certain amounts
received by a customer from a vendor in connection with
product purchased from the vendor. EITF 02-16 is effective
prospectively for new arrangements entered into after December
31, 2002. The provisions of EITF 02-16 did not have a
significant impact on the Company's financial position or
results of operations as of, and for the year ended, January
31, 2003. The Company is analyzing the provisions of EITF
02-16 for arrangements entered into for fiscal 2003 but has
not yet determined the impact on their financial position and
results of operations.
(2) MERCHANDISE INVENTORIES
Merchandise inventories consisted of the following:
<Table>
<Caption>
2002 2001
---------- ----------
Books $ 59,942 $ 52,870
Music 42,328 50,523
Videos 31,927 26,714
Other 17,862 22,558
---------- ----------
152,059 152,665
Less allowance for inventory shrinkage and
obsolescence 3,664 4,400
---------- ----------
$ 148,395 $ 148,265
========== ==========
</Table>
During fiscal 2002 and 2001, the Company purchased approximately 21% and
22%, respectively, of all products (defined herein as merchandise
inventories and rental videos) from three suppliers.
(3) PROPERTY AND EQUIPMENT
Property and equipment consists of the following :
<Table>
<Caption>
2002 2001
---------- ----------
Rental videos $ 57,281 $ 52,917
Furniture, equipment and software 99,151 84,609
Leasehold improvements 53,878 49,803
Property under capital leases 2,126 2,126
---------- ----------
212,436 189,455
Less accumulated depreciation and
amortization 136,153 124,644
---------- ----------
$ 76,283 $ 64,811
========== ==========
</Table>
34
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
Accumulated depreciation and amortization of property and equipment
includes $1.5 million and $1.4 million of accumulated amortization of
equipment under capital leases at January 31, 2003 and 2002,
respectively.
During the fourth quarter of fiscal 2001, the Company's retail store
segment recorded a pre-tax charge of $0.7 million. This charge is
included in selling, general and administrative expenses and is related
to the impairment of leasehold improvements for two superstores in fiscal
2001. Such charge was recorded in accordance with SFAS 121, "Impairment
of Long Lived Assets." These superstores continue to operate but did not
project cash flow amounts sufficient to recover the book value of the
specific assets. Other amounts for impaired assets were recognized in
connection with the closing of superstores. Please refer to Note 5 for a
description of these amounts.
Also during fiscal 2001, the Company's Internet segment recorded a $0.4
million pre-tax charge included in selling, general and administrative
expenses related to the impairment of information systems equipment and
development costs in accordance with SFAS 121, "Impairment of Long Lived
Assets." The Internet segment will continue to operate but did not
project cash flow amounts sufficient to recover the book value of the
specific assets.
(4) ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES
Accrued expenses and other current liabilities consisted of the
following:
<Table>
<Caption>
2002 2001
---------- ----------
Allowance for cost of inventory returns $ 4,729 $ 5,128
Deferred gift card revenue 10,373 9,012
Store closing reserve 2,958 5,932
Salaries, vacation and bonus 4,533 4,283
Other 9,950 5,438
---------- ----------
Total $ 32,543 $ 29,793
========== ==========
</Table>
Merchandise inventories that are not sold can normally be returned to the
suppliers. The allowance for cost of inventory returns represents
estimated costs related to merchandise returned or to be returned to
suppliers for which credit is pending. Because the amount of credit to be
received requires estimates, it is reasonably possible that the Company's
estimate of the ultimate settlement with its suppliers may change in the
near term.
(5) STORE CLOSING RESERVE
From time to time and in the normal course of business, the Company
evaluates its superstore base to determine if a need to close a
superstore(s) is present. Management evaluates, among other factors,
current and future profitability, market trends, age of store and lease
status.
Included in accrued expenses and other liabilities at January 31, 2003
and 2002 are accruals of $2.9 million and $5.9 million, respectively, for
the net present value of future minimum lease payments and other costs
attributable to closed or relocated superstores, net of estimated
sublease income. Charges related to superstore closings in fiscal 2002
amounted to approximately $2.4 million, of which $1.2 million was
recorded in the fourth quarter, including $1.1 million in accruals for
the net present value of minimum lease payments and $1.3 million for the
write-off of leasehold improvements and other assets. The fourth quarter
charge of $1.2 included $0.3 million in accruals for the net present
value of future minimum lease payments and $0.9 million for the write-off
of leasehold improvements and other assets.
Offsetting these fiscal 2002 charges were changes in estimates in the
store closing reserve of approximately $2.0 million, of which $1.7
million was recorded in the fourth quarter of fiscal 2002, primarily as a
result of sublease activities for certain closed and relocated
superstores.
35
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
Charges related to superstore closings in fiscal 2001 amounted to
approximately $1.5 million, including $0.6 million in accruals for the
net present value of minimum lease payments and $0.9 million for the
write-off of leasehold improvements and other assets.
Charges related to superstore closings in fiscal 2000 amounted to $6.5
million including $4.6 million in accruals for the net present value of
minimum lease payments and $1.6 million for the write-off of leasehold
improvements and $0.3 million of other related costs.
Offsetting these fiscal 2000 charges were changes in estimates in the
store closing reserve of $1.6 million, of which $0.8 million was recorded
in the fourth quarter of fiscal 2000, as a result of negotiating early
buy-outs of certain lease liabilities and sublease activities for certain
closed superstores.
The following table provides a rollforward of reserves that were
established for these charges for fiscal 2002, 2001 and 2000:
<Table>
<Caption>
FUTURE LEASE
PAYMENTS OTHER COSTS TOTAL
-------------- ------------ ----------
Balance at January 31, 2000 $ 3,672 $ 300 $ 3,972
Additions to provision 4,617 272 4,889
Changes in estimates (1,571) -- (1,571)
Cash outlay, net (368) (317) (685)
-------------- ------------ ----------
Balance at January 31, 2001 6,350 255 6,605
Additions to provision 662 -- 662
Changes in estimates 108 -- 108
Cash outlay, net (1,201) (242) (1,443)
-------------- ------------ ----------
Balance at January 31, 2002 5,919 13 5,932
Additions to provision 1,197 217 1,414
Changes in estimates (1,930) -- (1,930)
Cash outlay, net (2,228) (230) (2,458)
-------------- ------------ ----------
Balance at January 31, 2003 $ 2,958 $ -- $ 2,958
============== ============ ==========
</Table>
As of January 31, 2003, the reserve balance, which is net of estimated
sublease income, is expected to be paid over the next seven years. Other
costs were charged against the reserve in fiscal 2002 as incurred.
(6) LONG-TERM DEBT
Long-term debt and capitalized lease obligations consisted of the
following:
<Table>
<Caption>
2002 2001
---------- ----------
Revolving credit facility $ 45,683 $ 32,234
Capitalized lease obligations 1,029 1,198
---------- ----------
46,712 33,432
Less current maturities 193 169
---------- ----------
$ 46,519 $ 33,263
========== ==========
</Table>
On August 23, 2002, the Company executed an amendment to its syndicated
secured Loan and Security Agreement with Fleet Retail Finance, Inc. and
The CIT Group/Business Credit, Inc, (the "Facility"). 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 $80 million, less a $10 million
availability reserve. The Facility's interest rate
36
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
is based on the prevailing prime rate or LIBOR plus a margin
percentage, 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, which can be adjusted to reduce
availability under the Facility. 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 Hastings' three consolidated subsidiaries. The
Facility matures on August 20, 2005. At January 31, 2003, we had $16.4
million in excess availability, after the $10 million availability
reserve, under the Facility. The average rate of interest being charged
under the Facility was 4.1% and 6.1% at January 31, 2003 and January
31, 2002, respectively.
From time to time, the Company enters into interest rate swap
agreements in order to obtain a fixed interest rate on a portion of our
outstanding floating rate debt thereby reducing exposure to interest
rate volatility. On October 4, 2002, the Company cancelled, at no cost,
two swap agreements entered into in November and December of 2001 with
an aggregate notional amount of $20 million and replaced those
agreements with one interest rate swap agreement with a financial
institution. The notional amount of the swap is $20 million with a
fixed interest rate of 2.45% for two years. The Company has designated
the interest rate swap as a hedging instrument. At January 31. 2003,
the fair value of the interest rate swap was not significant.
The capitalized lease obligations represent two leases on certain
retail space with initial terms of 15 years.
The aggregate maturities of long-term debt and capitalized lease
obligations for years subsequent to fiscal 2002 are as follows:
<Table>
2003 $ 193
2004 221
2005 45,926
2006 195
2007 109
Thereafter 68
------------
$ 46,712
============
</Table>
(7) LEASES
The Company leases retail space under operating leases with terms ranging
from three to 15 years, with certain leases containing renewal options.
Lease agreements generally provide for minimum rentals. Some leases also
include additional contingent rental amounts based upon specified
percentages of sales above predetermined levels. Rental expense for
operating leases is comprised of the following:
<Table>
<Caption>
2002 2001 2000
---------- ---------- ----------
Minimum rentals $ 17,457 $ 16,619 $ 16,783
Contingent rentals 1,431 1,519 1,595
Less sublease income (343) (381) (324)
---------- ---------- ----------
Rental expense $ 18,545 $ 17,757 $ 18,054
========== ========== ==========
</Table>
37
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
Future minimum lease payments under non-cancelable operating leases and
the present value of future minimum capital lease payments as of January
31, 2003 are:
<Table>
<Caption>
CAPITAL OPERATING
LEASES LEASES
------------ ------------
2003 $ 268 $ 18,984
2004 280 15,584
2005 283 13,929
2006 216 12,689
2007 120 10,557
Thereafter 70 25,625
------------ ------------
Total minimum lease payments 1,237 97,371
Less sublease income 3,709
------------
Net minimum lease payments under
operating leases $ 93,662
============
Less amount representing imputed interest 208
------------
Total obligations under capital leases 1,029
Less current principal maturities of capital lease
obligations 193
------------
Obligations under capital leases,
excluding current maturities $ 836
============
</Table>
A director of the Company is a limited partner in various limited
partnerships that lease land and improvements to the Company under
certain lease agreements. During fiscal 2002, 2001 and 2000, the Company
made lease payments of $0.5 million, 0.6 million and $0.6 million,
respectively related to these lease agreements.
(8) INCOME TAXES
Income tax expense (benefit) is comprised of the following:
<Table>
<Caption>
2002 2001 2000
---------- ---------- ----------
Current federal $ (287) $ 283 $ (1,075)
Current state and local (29) 8 (573)
Deferred federal 287 (264) 3,130
Deferred state and local 29 (27) 552
---------- ---------- ----------
$ -- $ -- $ 2,034
========== ========== ==========
</Table>
The difference between expected federal income tax expense (benefit)
(computed by applying the statutory rate of 34% to income before income
taxes) and actual income tax expense (benefit) is as follows:
<Table>
<Caption>
2002 2001 2000
---------- ---------- ----------
Computed "expected" tax expense (benefit) $ 643 $ 1,366 $ (4,272)
State and local income taxes, net of federal
income tax effect 66 141 (566)
Changes in valuation allowance and other (709) (1,507) 6,872
---------- ---------- ----------
$ -- $ -- $ 2,034
========== ========== ==========
</Table>
38
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are
presented below:
<Table>
<Caption>
2002 2001
---------- ----------
Deferred tax assets:
Gift cards $ 816 $ 694
Abandoned leases 1,259 2,279
Deferred rent 581 589
Compensated absences 387 405
Deferred compensation 400 400
Deferred lease incentives 799 554
Inventories 2,376 --
Property and equipment -- 942
Net operating loss carryforward 684 --
Other 1,017 1,227
---------- ----------
Total deferred tax assets 8,319 7,090
Valuation allowance (4,436) (5,591)
---------- ----------
Deferred tax assets, net of valuation allowance
3,883 1,499
Deferred tax liabilities:
Inventories -- (408)
Property and equipment (2,912) --
---------- ----------
Total deferred tax liabilities (2,912) (408)
---------- ----------
Net deferred tax assets $ 971 $ 1,091
========== ==========
</Table>
During fiscal 2000, the Company reviewed the net deferred tax asset under
the provisions set forth in Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" (SFAS 109). While the Company
believes the entire deferred tax asset will be realized by future
operating results, due to cumulative losses incurred in recent years, the
majority of the net deferred tax asset did not meet the criteria for
recognition under SFAS 109. As a result, no income tax expense was
recorded related to income for fiscal year ending January 31, 2003 as
these amounts were recognized as a reduction of the deferred income tax
asset valuation allowance.
39
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
(9) INCOME (LOSS) PER SHARE
The computations for basic and diluted income (loss) per share are as
follows:
<Table>
<Caption>
Fiscal Year Ended January 31,
2003 2002 2001
---------- ---------- ----------
Net income (loss) $ 1,891 $ 4,017 $ (14,600)
========== ========== ==========
Average shares outstanding:
Basic 11,343 11,742 11,645
Effect of stock options 436 156 --
---------- ---------- ----------
Diluted $ 11,779 $ 11,898 $ 11,645
========== ========== ==========
Income (Loss) per share:
Basic $ 0.17 $ 0.34 $ (1.25)
========== ========== ==========
Diluted $ 0.16 $ 0.34 $ (1.25)
========== ========== ==========
</Table>
Options to purchase 798,270 shares of Common Stock at exercise prices
ranging from $6.595 to $14.03 per share outstanding at January 31, 2003;
521,974 shares of Common Stock at exercise prices ranging from $4.30 per
share to $14.03 per share outstanding at January 31, 2002; and 1,087,083
shares of Common Stock at exercise prices ranging from $1.27 per share to
$14.03 per share outstanding at January 31, 2001, were not included in
the computation of diluted income (loss) per share because their
inclusion would have been antidilutive.
(10) 401k AND ASOP
Since February 1, 2001, the Company's 401k plan permits full-time
employees who have attained age 21 and part-time employees who have
worked a minimum of 1,000 hours in a year and have attained age 21 to
participate in the Company's 401k plan and elect to contribute up to 25
percent of their salary, subject to federal limitations, to the plan.
Employer contributions include a quarterly guaranteed match of 25% of
employee contributions up to a maximum of 6% deferral of compensation and
is allocated solely to those employees who are participating in the plan
and are employed on the last day of the plan quarter. Also included is a
discretionary match based on specific criteria reviewed every fiscal
six-month period by the Company and approved by the Board of Directors.
This discretionary match is allocated solely to those employees who are
participating in the plan and are employed on the last day of the
six-month period. Prior to February 1, 2001, employees who had attained
age 21 were eligible to participate in the Company's 401k plan and could
elect to contribute up to 15 percent of their salary, subject to federal
limitations, to the plan. Employer contributions were a discretionary
match determined by the Company and allocated solely to those employees
who were participating in the plan, had completed one year of service and
were employed on the last day of the plan year.
The Company's Associate Stock Ownership Plan (ASOP) permits employees who
have attained age 21 and completed one year of service and 1,000 hours in
12 consecutive months for part-time associates, to participate in the
ASOP. Employer contributions are determined at the discretion of the
Company. The Board of Directors has determined that the level of
contributions will be made based on attaining operational profit goals as
set by the Board of Directors. The contribution is based on a percentage
of participants' eligible compensation. Common shares held by the ASOP
were 318,084, 271,368 and 199,269 at January 31, 2003, 2002 and 2001,
respectively. Shares issued and held under the ASOP plan are included as
outstanding shares for the purposes of calculating income (loss) per
share.
40
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
Amounts expensed related to the 401k and ASOP Plans were $0.6 million,
$0.3 million and $0.8 million during fiscal 2002, 2001 and 2000,
respectively.
(11) SHAREHOLDERS' EQUITY
The Company has six stock option plans: the 1991 and 1994 Stock Option
Plans, the 1996 and 2002 Incentive Stock Plan and the 1996 and 2002
Outside Directors Plan (for non-employee directors). A total of 505,900
shares may be granted under each of the 1991 and 1994 Stock Option Plans,
632,375 shares may be granted under the 1996 Incentive Stock Plan,
500,000 shares may be granted under the 2002 Incentive Stock Plan,
101,180 shares may be granted under the 1996 Outside Directors Plan and
100,000 shares may be granted under the 2002 Outside Directors Plan. As
of January 31, 2003, the Company had approximately 888,240 shares
reserved for future issuances under stock option plans.
The 1991 and 1994 Stock Option Plans and the 1996 and 2002 Incentive
Stock Plan authorize the award of both incentive stock options and
non-qualified stock options to purchase common stock to officers, other
associates and directors of the Company. The exercise price per share of
incentive stock options may not be less than the market price of the
Company's common stock on the date the option is granted. The exercise
price per share of non-qualified stock options is determined by the Board
of Directors or a committee thereof. The term of each option is
determined by the Board of Directors and generally will not exceed ten
years from the date of grant. In general, each option award vests at 20%
per year over five years.
The 1996 Incentive Stock Plan also authorizes the granting of stock
appreciation rights, restricted stock, dividend equivalent rights, stock
awards, and other stock-based awards to officers, other associates,
directors, and consultants of the Company. There have been no grants of
these awards under this plan.
The Company has a management stock purchase plan that authorizes the
issuance of up to 227,655 shares of common stock, pursuant to agreements
providing for the purchase of restricted stock units (RSU's). The cost of
each RSU is equal to 75% of the fair market value of the common stock of
the Company on the date the RSU is awarded. During fiscal years 2002,
2001 and 2000, there were 0, 1,104 and 3,881 RSU's awarded under the
Plan, respectively. The Company does not recognize any expense associated
with the issuance of RSU's and records deferred compensation amounts
equal to the market value of the RSU's. This deferred compensation
expense is then amortized using the straight-line method over three
years, which is the vesting period of the RSU's. Under this methodology,
the Company recorded approximately $1,900, $7,200 and $10,500 of
compensation expense in fiscal year 2002, 2001 and 2000 respectively. As
of January 31, 2003, 2002 and 2001, there were 2,054, 10,193 and 13,576
RSU's outstanding under the plan, respectively.
41
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
A summary of information with respect to all stock option plans is as
follows:
<Table>
<Caption>
WEIGHTED-
AVERAGE
EXERCISE
PRICE
OPTIONS (IN DOLLARS)
------------ ------------
Outstanding at January 31, 2000 1,813,965 $ 10.67
Granted 569,376 3.20
Exercised (50,000) 1.27
Forfeited and expired (1,246,258) 10.50
------------ ------------
Outstanding at January 31, 2001 1,087,083 7.39
Granted 678,344 2.91
Exercised (107,017) 4.40
Forfeited and expired (63,125) 7.66
------------ ------------
Outstanding at January 31, 2002 1,595,285 5.68
Granted 353,210 6.66
Exercised (99,090) 3.47
Forfeited and expired (94,066) 6.23
------------ ------------
Outstanding at January 31, 2003 1,755,339 $ 5.97
============ ============
Reserved and available for grant at January 31, 2003 888,240
</Table>
At January 31, 2003, the options outstanding and options exercisable, and
their related weighted-average exercise price, and the weighted-average
remaining contractual life for the ranges of exercise prices are shown in
the table below.
<Table>
<Caption>
WEIGHTED- WEIGHTED-
AVERAGE AVERAGE
EXERCISE PRICE REMAINING
OPTIONS (IN DOLLARS) CONTRACTUAL LIFE
---------- -------------- ----------------
RANGE: $1.27 TO $4.99
Options outstanding at January 31, 2003 951,069 $ 3.09 7.83 years
Options exercisable at January 31, 2003 233,351 $ 3.16
RANGE: $5.00 TO $9.99
Options outstanding at January 31, 2003 337,860 $ 6.75 8.63 years
Options exercisable at January 31, 2003 7,590 $ 9.00
PRICE: $10.00 TO $14.03
Options outstanding at January 31, 2003 466,410 $ 11.27 3.95 years
Options exercisable at January 31, 2003 463,180 $ 11.27
</Table>
At January 31, 2003, 2002 and 2001, the number of options exercisable was
704,121, 615,823 and 523,716, respectively, and the weighted-average
exercise price of those options was $8.55, $9.59 and $10.84,
respectively.
The Company applies APB 25 and related interpretations in accounting for
its Plans. Since the Company generally grants stock options, except for
RSUs as described above, with an exercise price equal to or greater than
the current market price of the stock on the grant date, compensation
expense is not recorded.
42
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
The per share weighted-average exercise price and the per share
weighted-average fair value of stock options at the date of grant, using
the Black-Scholes option-pricing model for SFAS 123 disclosure purposes,
is as follows (in dollars):
<Table>
<Caption>
EXERCISE PRICE FAIR VALUE
------------------------------ ------------------------------
2002 2001 2000 2002 2001 2000
-------- -------- -------- -------- -------- --------
Options granted at
market price $ 6.61 $ 2.90 $ 3.21 $ 3.37 $ 1.98 $ 1.98
Options granted at prices
exceeding market price $ 7.30 $ 3.30 $ -- $ 0.18 $ 0.06 $ --
Options granted at prices
below market price $ -- $ 1.81 $ 2.27 $ -- $ 1.54 $ 1.52
Total options granted $ 6.66 $ 2.91 $ 3.20 $ 3.31 $ 1.96 $ 1.98
</Table>
The following assumptions were used in the calculation of fair value:
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Expected dividend yield $ -- -- --
Risk-free interest rate 3.00% 6.17% 5.07%
Expected life in years 3 to 5 3 to 10 3 to 10
Volatility .57 .82 .60
</Table>
(12) SUPPLEMENTAL CASH FLOW INFORMATION
Cash payments for interest during fiscal 2002, 2001 and 2000 totaled $2.0
million, $2.1 million and $3.2 million, respectively. Cash payments for
income taxes during fiscal 2002, 2001 and 2000 totaled $26,000, $0.5
million and $0.2 million, respectively.
(13) 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, nine 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 were
transferred to the Amarillo Division of the Northern District and were
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 described above had been reached and the
Court approved the settlement on March 10, 2003. The settlement required
a payment of $5.75 million on behalf of the defendants in the lawsuits
($3.15 million of which was funded from amounts remaining under the
Company's director and officer insurance policy after the payment of
litigation
43
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
expenses) and the assignment to the plaintiff settlement class of any
claims the Company may have had against KPMG Peat Marwick, LLP, the
Company's outside auditors at the time of the March 7, 2000
announcement. The settlement resolves all claims against the Company,
its current and former defendant officers and directors and the
defendant underwriters. Based on the foregoing, the Company recorded a
loss contingency of $2.6 million, or $0.22 per share, during fiscal
2002 and all amounts required by the settlement agreement were funded
by January 31, 2003. The plaintiff settlement class separately settled
all claims against KPMG.
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.
(14) 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 fiscal years 2002, 2001 and 2000 is
presented below.
<Table>
<Caption>
FISCAL YEAR 2002 RETAIL INTERNET
STORES OPERATIONS TOTAL
---------- ---------- ----------
Total revenue $ 495,113 281 $ 495,394
Depreciation expense 39,966 257 40,223
Operating income (loss) 3,424 (1,074) 2, 350
Total assets 237,308 214 237,522
Capital expenditures 64,640 24 64,664
</Table>
<Table>
<Caption>
FISCAL YEAR 2001 RETAIL INTERNET
STORES OPERATIONS TOTAL
----------- ----------- ----------
Total revenue $ 471,482 166 $ 471,648
Depreciation expense 35,116 277 35,393
Operating income (loss) 6,810 (955) 5,855
Total assets 229,383 468 229,851
Capital expenditures 46,490 5 46,495
</Table>
<Table>
<Caption>
FISCAL YEAR 2000 RETAIL INTERNET
STORES OPERATIONS TOTAL
---------- ---------- ----------
Total revenue $ 458,021 182 $ 458,203
Depreciation expense 32,759 396 33,155
Operating loss (7,287) (1,991) (9,278)
Total assets 212,679 805 213,484
Capital expenditures 29,803 679 30,482
</Table>
44
Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)
(15) INTERIM FINANCIAL RESULTS (UNAUDITED)
<Table>
<Caption>
FISCAL YEAR 2002: QUARTER
- -------------------------------------------------------------------------------------------------------------
First Second Third Fourth
- -------------------------------------------------------------------------------------------------------------
Total revenues $ 112,845 $ 115,038 $ 110,636 $ 156,875
Total cost of revenues 75,237 76,966 76,592 105,746
Selling, general and administrative expenses (a) (c) 36,583 40,331 40,117 40,993
Pre-opening expenses 18 163 150 148
Operating income (loss) 1,007 (2,422) (6,223) 9,988
Interest (expense) and other income, net (b) (438) 800 (404) (417)
Income (Loss) before taxes 569 (1,622) (6,627) 9,571
Income tax expense (benefit) -- -- -- --
Net income (loss) 569 (1,622) (6,627) 9,571
Basic income (loss) per share $ 0.05 $ (0.14) $ (0.58) $ 0.84
Diluted income (loss) per share $ 0.05 $ (0.14) $ (0.58) 0.82
</Table>
<Table>
<Caption>
FISCAL YEAR 2001: QUARTER
- -----------------------------------------------------------------------------------------------------------
First Second Third Fourth
- -----------------------------------------------------------------------------------------------------------
Total revenues $ 109,111 $ 110,101 $ 103,175 $ 149,261
Total cost of revenues 76,013 74,059 71,106 100,380
Selling, general and administrative expenses (c) 33,264 34,779 37,064 38,946
Pre-opening expenses -- 34 47 101
Operating income (loss) (166) 1,229 (5,042) 9,834
Interest (expense) and other income, net (601) (446) (475) (316)
Income (Loss) before taxes (767) 783 (5,517) 9,518
Income tax expense (benefit) -- -- -- --
Net income (loss) (767) 783 (5,517) 9,518
Basic income (loss) per share $ (0.07) $ 0.07 $ (0.46) $ 0.82
Diluted income (loss) per share $ (0.07) $ 0.07 $ (0.46) 0.80
</Table>
(a) The Company recorded a pre-tax charge of $2.6 million, $2.5 of which
was recorded in the second quarter of fiscal 2002 and $0.1 million in
the fourth quarter of fiscal 2002, related to the settlement of the
shareholder class action lawsuits as described in Note 13.
(b) The Company recorded interest income of approximately $1.3 million in
the second quarter of fiscal 2002 as a result of interest earned on
income tax refunds for amended returns filed for fiscal years 1995
through 1998.
(c) The Company recorded pre-tax charges of approximately $1.2 million in
each the third and fourth quarter of fiscal 2002 and $0.5 million and
$1.0 million in the third and fourth quarter of fiscal year 2001. These
charges related to the closing of superstores as described in Note 5.
45
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None
46
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will be set forth in our Proxy Statement
for our 2003 Annual Meeting of Shareholders, to be filed within 120 days after
the end of fiscal 2002 (our "Proxy Statement"), under the heading "Proposal No.
1: Election of Two Directors," which information is incorporated herein by
reference. The information required by this item regarding compliance with
Section 16(a) of the Securities Exchange Act of 1934 will be set forth in our
Proxy Statement under the heading "Compliance with Section 16(a) of the
Securities Exchange Act of 1934," which is incorporated herein by reference. The
information required by this item regarding our executive officers is set forth
under the heading "Executive Officers of the Company" in Part I of this Form
10-K, which information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be set forth in our Proxy Statement
under the headings "Executive Compensation," "Executive Compensation - Director
Compensation," "Executive Compensation - Employee Contracts and Change of
Control Arrangements," and "Executive Compensation - Compensation Committee
Interlocks and Insider Participation," which information is incorporated herein
by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will be set forth in our Proxy Statement
under the heading "Security Ownership of Certain Beneficial Owners and
Management," which information is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item will be set forth in our Proxy Statement
under the heading "Certain Relationships and Related Transactions," which
information is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
Within 90 days prior to the date of the filing date of this Annual Report on
Form 10-K, our Chief Executive Officer and Chief Financial Officer conducted an
evaluation of the effectiveness of our disclosure controls and procedures (as
defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as
amended). Based on that evaluation, our Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures are
effective to provide reasonable assurance that information required to be
disclosed by us in reports that we file or submit under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms. We note that the design of any
system of controls is based in part upon certain assumptions about the
likelihood of future occurrences and there can be no assurance that any design
will succeed in obtaining its stated goals under all possible circumstances.
Subsequent to the date of their evaluation, 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.
47
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) 1. The following consolidated financial statements of the Company are
included in Part II, Item 8:
<Table>
Independent Auditors' Reports............................................ 26
Consolidated Balance Sheets as of January 31, 2003 and 2002.............. 27
Consolidated Statements of Operations for the years ended
January 31, 2003, 2002 and 2001...................................... 28
Consolidated Statements of Shareholders' Equity for the years
ended January 31, 2003, 2002 and 2001................................ 29
Consolidated Statements of Cash Flows for the years ended
January 31, 2003, 2002 and 2001...................................... 30
Notes to Consolidated Financial Statements............................... 31
2. The following financial statement schedules and other information
required to be filed by Items 8 and 15(d) of Form 10-K are included in
Part IV:
Schedule II - Valuation and Qualifying Accounts.......................... 50
</Table>
All other schedules are omitted because they are not applicable, not
required or the required information is included in the Consolidated
Financial Statements and notes thereto.
3. The following exhibits are filed herewith or incorporated by
reference as indicated as required by Item 601 of Regulation S-K. The
exhibits designated by an asterisk are management contracts and/or
compensatory plans or arrangements required to be filed as exhibits to
this report.
<Table>
<Caption>
Exhibit
Number Description
-------- -----------
3.1 (1) Third Restated Articles of Incorporation of the Company.
3.2 (1) Amended and Restated Bylaws of the Company.
4.1 (1) Specimen of Certificate of Common Stock of the Company.
4.2 (1) Third Restated Articles of Incorporation of the Company (see 3.1 above).
4.3 (1) Amended and Restated Bylaws of the Company (see 3.2 above).
10.1 (1) Form of Indemnification Agreement by and between the Company and its
directors and executive officers.
10.2 * (1) Hastings Amended 1996 Incentive Stock Plan.
10.3 * (1) Hastings 1994 Stock Option Plan.
10.4 * (1) Hastings 1991 Stock Option Plan.
10.5 * (1) Hastings Entertainment, Inc. Associates' 401(k) Plan and Trust.
10.6 * (1) Hastings Employee Stock Ownership Plan Trust Agreement.
10.7 * (1) Chief Executive Officer Stock Option, as amended.
10.8 * (1) Corporate Officer Incentive Plan.
10.9 * (1) Management Stock Purchase Plan.
10.10 * (1) Management Incentive Plan.
10.11 * (1) Salary Incentive Plan.
10.12 * (1) Hastings Entertainment, Inc. Stock Option Plan for Outside Directors.
10.13 * (4) Agreement dated January 31, 2001 between John H. Marmaduke and the Company
10.14 (1) Lease Agreement, dated August 3, 1994, as amended, between Omni Capital Corporation and the
Company, for warehouse space located at Sunset Center in Amarillo, Texas.
10.15 (1) Lease Agreement, dated May 28, 1992, between the City of Amarillo and the Company for space
located at 1900 W. 7th Avenue in Amarillo, Texas.
10.16 * (1) Stock Grant Plan for Outside Directors.
10.17 * (1) Form of Employment Agreement by and between the Company and certain of its executives.
</Table>
48
<Table>
10.18 (2) Amended Lease Agreement, dated October 13, 1999, between Omni Capital Corporation and the
Company, for office space located at Sunset Center in Amarillo, Texas.
10.19 (3) Loan and Security Agreement dated August 29, 2000 between Hastings Entertainment, Inc. and
Fleet Retail Finance, Inc., Agent.
10.20 (5) International Swap Dealers Association, Inc. Master Agreement between Hastings Entertainment,
Inc. and Fleet National Bank
21.1 (1) Subsidiaries of the Company.
23.1 (6) Consent of Ernst and Young LLP
24.1 (6) Powers of Attorney (included on signature page)
99.1 (6) Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
</Table>
- -------------------------------------------------------------------------------
(1) Previously filed as an exhibit to the Company's Registration
Statement on Form S-1 (File No. 333-47969) and with a
corresponding exhibit number herein and are incorporated
herein by reference.
(2) Previously filed as an exhibit to the Company's Annual Report
on Form 10-K, as amended, for the fiscal year ended January
31, 2000, and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Quarterly
Report on Form 10-Q, as amended, for the quarterly period
ended July 31, 2000, and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Annual Report
on Form 10-K for the fiscal year ended January 31, 2001, and
incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Annual Report
on Form 10-K for the fiscal year ended January 31, 2002, and
incorporated herein by reference.
(6) Filed herewith
(b) Reports on Form 8-K
(i) On December 9, 2002, the Company filed a current report on
Form 8-K reporting, under "Item 9. Regulation FD Disclosure,"
the officer certification of financial information required by
18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002.
49
Financial Statement Schedule II -
HASTINGS ENTERTAINMENT, INC.
Valuation and Qualifying Accounts and Reserves
Years Ended January 31, 2003, 2002 and 2001
(Amounts in thousands)
<Table>
<Caption>
FISCAL YEAR
--------------------------------------
2002 2001 2000
---------- ---------- ----------
Reserves deducted from assets:
Allowance for shrinkage and inventory obsolescence:
Balance at the beginning of period $ 4,580 $ 3,533 $ 2,544
Additions charged to costs and expenses 10,697 14,308 14,698
Deductions for write-offs (11,393) (13,261) (13,709)
---------- ---------- ----------
Balance at end of period $ 3,884 $ 4,580 $ 3,533
========== ========== ==========
Reserves added to liabilities:
Allowance for costs of inventory returns:
Balance at the beginning of period $ 5,128 $ 7,543 $ 9,463
Additions charged to costs and expenses (1) 5,975 3,858 10,247
Deductions for write-offs (6,374) (6,273) (12,167)
---------- ---------- ----------
Balance at end of period $ 4,729 $ 5,128 $ 7,543
========== ========== ==========
</Table>
(1) Total returns expense was $9.9 million, $6.3 million and $12.2 million
for the fiscal years 2002, 2001 and 2000, respectively. The table does
not include the cost of operating our return center ($3.9 million, $2.4
million and $2.0 million for the fiscal years 2002, 2001 and 2000,
respectively), which is recorded directly to returns expense.
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, on behalf of the registrant, thereunto duly
authorized:
HASTINGS ENTERTAINMENT, INC.
DATE: April 21, 2003 By: /s/ Dan Crow
------------
Dan Crow
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
POWER OF ATTORNEY
Each person whose signature appears below hereby authorizes and constitutes John
H. Marmaduke and Dan Crow, and each of them singly, his true and lawful
attorneys-in-fact with full power of substitution and redistribution, for him
and in his name, place and stead, in any and all capacities to sign and file any
and all amendments to this report with all exhibits thereto and other documents
in connection therewith, with the Securities and Exchange Commission, and he
hereby ratifies and confirms all that said attorneys-in-fact or any of them, or
their substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<Table>
<Caption>
Signature Title Date
- --------- ----- ----
/s/ John H. Marmaduke Chairman of the Board, President and Chief Executive April 4, 2003
- -------------------------- Officer (Principal Executive Officer)
John H. Marmaduke
/s/ Peter A. Dallas Director April 4, 2003
- --------------------------
Peter A. Dallas
/s/ Gaines L. Godfrey Director April 4, 2003
- --------------------------
Gaines L. Godfrey
/s/ Daryl L. Lansdale Director April 4, 2003
- --------------------------
Daryl L. Lansdale
/s/ Ann S. Lieff Director April 4, 2003
- --------------------------
Ann S. Lieff
/s/ Stephen S. Marmaduke Director April 4, 2003
- --------------------------
Stephen S. Marmaduke
/s/ Frank O. Marrs Director April 4, 2003
- --------------------------
Frank O. Marrs
/s/ Jeffrey G. Shrader Director April 4, 2003
- --------------------------
Jeffrey G. Shrader
/s/ Ron G. Stegall Director April 4, 2003
- --------------------------
Ron G. Stegall
</Table>
51
CERTIFICATIONS
I, John H. Marmaduke, President and Chief Executive Officer (Principal Executive
Officer) of Hastings Entertainment, Inc., certify that:
1. I have reviewed this annual report on Form 10-K of Hastings
Entertainment, Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual 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 annual report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a. all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this annual report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: April 21, 2003 /s/ John H. Marmaduke
--------------------------
John H. Marmaduke
President and Chief Executive Officer
(Principal Executive Officer)
52
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 annual report on Form 10-K of Hastings
Entertainment, Inc.;
2. Based on my knowledge, this annual 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
annual report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual 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 annual report;
4. The registrant's other certifying officer and I are
responsible for establishing and maintaining disclosure
controls and procedures (as defined in Exchange Act Rules
13a-14 and 15d-14) for the registrant and we have:
a. designed such disclosure controls and procedures to
ensure that material information relating to the
registrant, including its consolidated subsidiaries,
is made known to us by others within those entities,
particularly during the period in which this annual
report is being prepared;
b. evaluated the effectiveness of the registrant's
disclosure controls and procedures as of a date
within 90 days prior to the filing date of this
annual report (the "Evaluation Date"); and
c. presented in this annual report our conclusions about
the effectiveness of the disclosure controls and
procedures based on our evaluation as of the
Evaluation Date;
5. The registrant's other certifying officer and I have
disclosed, based on our most recent evaluation, to the
registrant's auditors and audit committee of registrant's
board of directors (or persons performing the equivalent
function):
a. all significant deficiencies in the design or
operation of internal controls which could adversely
affect the registrant's ability to record, process,
summarize and report financial data and have
identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves
management or other employees who have a significant
role in the registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated
in this annual report whether or not there were significant
changes in internal controls or in other factors that could
significantly affect internal controls subsequent to the date
of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
Date: April 21, 2003 /s/ Dan Crow
--------------------------
Dan Crow
Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
53
INDEX TO EXHIBITS
<Table>
<Caption>
Exhibit
Number Description
-------- -----------
3.1 (1) Third Restated Articles of Incorporation of the Company.
3.2 (1) Amended and Restated Bylaws of the Company.
4.1 (1) Specimen of Certificate of Common Stock of the Company.
4.2 (1) Third Restated Articles of Incorporation of the Company (see 3.1 above).
4.3 (1) Amended and Restated Bylaws of the Company (see 3.2 above).
10.1 (1) Form of Indemnification Agreement by and between the Company and its
directors and executive officers.
10.2 * (1) Hastings Amended 1996 Incentive Stock Plan.
10.3 * (1) Hastings 1994 Stock Option Plan.
10.4 * (1) Hastings 1991 Stock Option Plan.
10.5 * (1) Hastings Entertainment, Inc. Associates' 401(k) Plan and Trust.
10.6 * (1) Hastings Employee Stock Ownership Plan Trust Agreement.
10.7 * (1) Chief Executive Officer Stock Option, as amended.
10.8 * (1) Corporate Officer Incentive Plan.
10.9 * (1) Management Stock Purchase Plan.
10.10 * (1) Management Incentive Plan.
10.11 * (1) Salary Incentive Plan.
10.12 * (1) Hastings Entertainment, Inc. Stock Option Plan for Outside Directors.
10.13 * (4) Agreement dated January 31, 2001 between John H. Marmaduke and the Company
10.14 (1) Lease Agreement, dated August 3, 1994, as amended, between Omni Capital Corporation and the
Company, for warehouse space located at Sunset Center in Amarillo, Texas.
10.15 (1) Lease Agreement, dated May 28, 1992, between the City of Amarillo and the Company for space
located at 1900 W. 7th Avenue in Amarillo, Texas.
10.16 * (1) Stock Grant Plan for Outside Directors.
10.17 * (1) Form of Employment Agreement by and between the Company and certain of its executives.
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<Table>
10.18 (2) Amended Lease Agreement, dated October 13, 1999, between Omni Capital Corporation and the
Company, for office space located at Sunset Center in Amarillo, Texas.
10.19 (3) Loan and Security Agreement dated August 29, 2000 between Hastings Entertainment, Inc. and
Fleet Retail Finance, Inc., Agent.
10.20 (5) International Swap Dealers Association, Inc. Master Agreement between Hastings Entertainment,
Inc. and Fleet National Bank
21.1 (1) Subsidiaries of the Company.
23.1 (6) Consent of Ernst and Young LLP
24.1 (6) Powers of Attorney (included on signature page)
99.1 (6) Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
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(1) Previously filed as an exhibit to the Company's Registration
Statement on Form S-1 (File No. 333-47969) and with a
corresponding exhibit number herein and are incorporated
herein by reference.
(2) Previously filed as an exhibit to the Company's Annual Report
on Form 10-K, as amended, for the fiscal year ended January
31, 2000, and incorporated herein by reference.
(3) Previously filed as an exhibit to the Company's Quarterly
Report on Form 10-Q, as amended, for the quarterly period
ended July 31, 2000, and incorporated herein by reference.
(4) Previously filed as an exhibit to the Company's Annual Report
on Form 10-K for the fiscal year ended January 31, 2001, and
incorporated herein by reference.
(5) Previously filed as an exhibit to the Company's Annual Report
on Form 10-K for the fiscal year ended January 31, 2002, and
incorporated herein by reference.
(6) Filed herewith