HASTINGS ENTERTAINMENT INC - 10-K Annual Report

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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, 2000

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

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value per share Nasdaq National Market
(Title of Class) (Name of Exchange on which registered)

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 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. [ ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $11,634,235 based upon the closing market price of
$2.188 per share of Common Stock on the Nasdaq National Market as of June 5,
2000.

Number of shares of $.01 par value Common Stock outstanding as of June 5, 2000:
11,642,644

(Cover page 1 of 1)

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HASTINGS ENTERTAINMENT, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED JANUARY 31, 2000

INDEX

PAGE
----

PART I
Item 1. Business............................................................................. 3
Item 2. Properties........................................................................... 13
Item 3. Legal Proceedings.................................................................... 14
Item 4. Submission of Matters to a Vote of Security Holders.................................. 14

PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................ 15
Item 6. Selected Financial Data.............................................................. 16
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations........................................................... 18
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................... 25
Item 8. Financial Statements and Supplementary Data.......................................... 26
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure............................................................ 56

PART III
Item 10. Directors and Executive Officers of the Registrant................................... 56
Item 11. Executive Compensation............................................................... 59
Item 12. Security Ownership of Certain Beneficial Owners and Management....................... 65
Item 13. Certain Relationships and Related Transactions....................................... 66

PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K...................... 67

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PART I

This Report contains certain forward-looking statements concerning the
intentions, hopes, beliefs, expectations, strategies, predictions or any other
variation thereof or comparable phraseology of the future activities or other
future events or conditions of Hastings Entertainment, Inc. (the "Company")
within the meaning of Section 27A of the Securities Act of 1993, as amended (the
"1933 Act"), and Section 21E of the Securities Exchange Act of 1934, as amended
(the "1934 Act"), which are intended to be covered by the safe harbors created
thereby. Investors are cautioned that all forward-looking statements involve
risks and uncertainty, including, without limitation, variations in quarterly
results, volatility of stock price, development by competitors of superior
services or product offerings, the entry into the market by new competitors, the
sufficiency of the Company's working capital, the ability to retain management,
to implement our business strategy, to attract and retain customers, to increase
revenue, and to successfully defend our company in ongoing and future
litigation. Although the Company believes that the assumptions underlying the
forward-looking statements contained herein are reasonable, any of the
assumptions could be inaccurate, and, therefore, there can be no assurance that
the forward-looking statements included in this Report will prove to be
accurate. In light of the significant uncertainties inherent in the
forward-looking statements included herein, the inclusion of such information
should not be regarded as a representation by the Company or any other person
that the Company's objectives and plans will be achieved.

ITEM 1. BUSINESS

General

The Company is a leading multimedia entertainment retailer that combines the
sale of books, music, software, periodicals, videocassettes and DVDs with the
rental of videocassettes, video games and DVDs in a superstore format. As of May
31, 2000, the Company operated 143 superstores and one college store in small to
medium-sized markets located in 22 states, primarily in the Western and
Midwestern United States. The Company also operates a multimedia entertainment
e-commerce Web site offering a broad selection of books, music, software,
videocassettes, video games and DVDs. See note 16 to the consolidated financial
statements for more information regarding the Company's operating segments,
retail stores and Internet operations. 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, 2000 is referred to as
fiscal 1999.

As described in "Item 3. Legal Proceedings", "Item 6. Selected Financial
Data", "Item 7. Management's Discussion and Analysis of Results of Operations
and Financial Condition", and "Item 8. Financial Statements and Supplementary
Data" and the notes to the consolidated financial statements set forth therein,
the Company has made adjustments to restate its previously reported consolidated
financial statements for the first three quarters of fiscal 1999 and the prior
four fiscal years.

On March 7, 2000, the Company announced that its fourth quarter and fiscal
1999 results (and the previous four fiscal years' results) would be negatively
impacted by certain accounting adjustments. Restatement adjustments totaling
$25.3 million, net of $6.2 million in tax benefits, have been recorded herein,
as a decrease to previously reported net income. The effects on the previously
reported net income for the first three quarters of fiscal 1999, fiscal 1998,
fiscal 1997, and the fiscal years prior to fiscal 1997 amounted to decreases of
$0.7 million, $4.8 million, $3.5 million and $16.3 million, respectively.

Prior to the March 7 announcement, the Company determined that merchandise
receipts for a portion of overall vendor deliveries had not been properly
entered into the inventory control system. As a result, the Company's accounting
system did not completely capture the merchandise cost of revenue specifically
relating to shrinkage, and that cost had been understated for the periods noted
above.

The Company uses accounts payable clearing accounts that, in part, are
based upon a process of matching vendor invoices to receipt transactions
generated when inventory is received. Clearing accounts are established by store
to record inventory received until matched with vendor invoices. Once an invoice
is matched with a receipt, the invoice is transferred from the accounts payable
clearing account to trade accounts payable and placed

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in line for payment. Depending on the time of the year, over 100,000 invoices
($30 to $50 million or more) are processed through the various clearing accounts
each month.

The Company has, over time, developed a proprietary accounting software
system for the accounts payable process as well as the inventory control system.
As the Company has determined, its accounting systems did not highlight those
instances where inventory receipts did not precisely match vendor invoices nor
faciliate the reconciliation of the Company's accounts payable clearing
accounts. Accounting system revisions identified the errors in the Company's
processes and the impact upon the Company's financial statements. The Company
has instituted changes in both its accounts payable and inventory control
systems to correct the errors and to help ensure that the Company's merchandise
cost of revenue is properly stated.

The clearing account adjustment aggregated $24.1 million pre-tax. In
addition, the Company recorded adjustments totaling $7.4 million pre-tax
primarily relating to the costs of inventory returns to vendors and other
pre-tax items.

Following the Company's initial announcement in March 2000 of the
requirement for the accounting restatements, six purported class action lawsuits
were filed in the United States District Court for the Northern District of
Texas against the Company and certain of the current and former 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
pending actions have been or will be transferred to the Amarillo Division of the
Northern District and the Company believes all of the actions will be
consolidated. One of the 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.

The Company's past business strategy has been to grow and increase its
profitability through the expansion of its superstore operations. In fiscal
1999, the Company opened 20 new superstores and closed two superstores,
increased selling square footage from approximately 2,385,000 square feet to
approximately 2,829,000 square feet and attained comparable-store revenue growth
of 4.0%. The Company intends to slow its growth in the future by opening fewer
superstores in the next two fiscal years than the immediately preceding two
fiscal years while continuing its ongoing store expansion and remodeling
programs for its existing superstores. The Company anticipates opening
approximately eight superstores and closing four superstores over the next two
years.

In addition to superstores, the Company operates an e-commerce Internet Web
site, www.gohastings.com. Customers have the ability to electronically access
more than 800,000 new and used entertainment products and unique, contemporary
gifts and toys. The site also features exceptional product and pricing offers,
including best-selling books at up to 50% off list price and digital downloading
of music selections. The Web site is a fully integrated multimedia entertainment
e-commerce Internet Web site offering a broad selection of entertainment
products to the electronic global marketplace at competitive Internet prices.

The Company operates three wholly owned subsidiaries. Hastings Properties,
Inc. and Hastings Internet, Inc. were established in the first quarter of fiscal
1998. Hastings College Stores, Inc. was established in the second quarter of
fiscal 1998.

Business Strategy

The Company's goal is to enhance its position as a leading multimedia
entertainment retailer by expanding existing stores, opening new stores in
selected markets and offering its products through the Internet. Each element of
the Company's business strategy is designed to build consumer awareness of the
Hastings concept and achieve high levels of customer loyalty and repeat
business. The key elements of this strategy are the following:

Superior Multimedia Concept. The Company's superstores present a wide
variety of products tailored to local preferences in a dynamic and comfortable
store atmosphere with exceptional service. The Company's superstores

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average approximately 21,500 square feet, with its new stores ranging in size
from 12,000 to 35,000 square feet. The Company's superstores offer customers an
extensive product assortment consisting of approximately 20,000 to 40,000 book,
15,000 to 30,000 music, 1,000 to 2,000 software, 1,000 to 2,000 periodical,
5,000 to 10,000 videocassette, 1,000 to 2,000 complementary and accessory titles
for sale. The Company also offers approximately 3,000 to 12,000 used compact
disc, videocassette, DVD and video game titles for sale. In addition, customers
can select from 700 to 1,500 DVD titles for sale and rent and 12,000 to 20,000
videocassette and video game selections for rent. Although the superstores' core
product assortment tends to be similar, the merchandise mix of each of the
Company's superstores is tailored to accommodate the particular demographic
profile of the local market in which the superstore operates through the
utilization of the Company's proprietary purchasing and inventory management
systems. The Company believes that its multimedia format reduces its reliance on
and exposure to any particular entertainment segment and enables the Company to
promptly add exciting new entertainment categories to its product line.

Small to Medium-Sized Market Superstore Focus. The Company targets small to
medium-sized markets with populations of 25,000 to 150,000 in which its
extensive product selection, low pricing strategy, efficient operations and
superior customer service enable it to become the market's destination
entertainment store. The Company believes that the small to medium-sized markets
where it operates the majority of its superstores present an opportunity to
profitably operate and expand the Company's unique entertainment superstore
format. These markets typically are underserved by existing book, music or video
stores, and competition generally is limited to locally owned specialty stores,
single-concept entertainment retailers and general merchandise retailers. The
Company bases its merchandising strategy for its superstores on an in-depth
understanding of its customers and its individual markets. The Company strives
to optimize each superstore's merchandise selection by using its proprietary
information systems to analyze the sales history, anticipated demand and
demographics of each superstore's market. In addition, the Company utilizes
flexible layouts that enable each superstore to arrange its products according
to local interests and to customize the layout in response to new customer
preferences and product lines.

Customer-Oriented Superstore Format. The Company designs its superstores to
provide an easy-to-shop, open store atmosphere by offering major product
categories in a "store-within-a-store" format. Most of the Company's superstores
utilize product-category boutiques positioned around a wide racetrack aisle that
is designed to allow customers to view the entire superstore. This store
configuration produces significant cross-marketing opportunities among the
various entertainment departments, which the Company believes results in higher
transaction volumes and impulse purchases. To encourage browsing and the
perception of Hastings as a community gathering place, the Company has
incorporated amenities in many superstores, such as chairs for reading,
complimentary gourmet coffees, music auditioning stations, interactive
information kiosks, telephones for free local calls, children's play areas and
in-store promotional events.

Cost-Effective Operations. The Company is committed to controlling costs in
every aspect of its operations while maintaining its customer-oriented
philosophy. From 1993 to 1997, the Company spent $12.8 million to develop and
implement proprietary information, purchasing, distribution and inventory
control systems that position the Company to continue to grow profitably. These
systems enable the Company to respond actively to customers' changing desires
and to rapid shifts in local and national market conditions. The Company's
100,000 square-foot distribution center, which adjoins its corporate offices in
Amarillo, Texas, provides the Company with improved store in-stocks, efficient
product cross-docking and centralized returns processing.

Low Pricing. The Company's pricing strategy at its superstores is to offer
value to its customers by maintaining prices that are competitive with or lower
than the lowest prices charged by other retailers in the market. The Company
determines its prices on a market-by-market basis, depending on the level of
competition and other market-specific considerations. The Company believes that
its low pricing structure results in part from (i) its ability to purchase
directly from publishers, studios and manufacturers as opposed to purchasing
from distributors, (ii) its proprietary information systems that enable
management to make more precise and targeted purchases for each superstore, and
(iii) its consistent focus on maintaining low occupancy and operating costs.

Internet. In May 1999, the Company launched its new e-commerce Internet Web
site, www.gohastings.com. The Company's 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,

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including best selling books at up to 50% off list price, and digital
downloading of music selections. The Web site is a fully integrated multimedia
entertainment e-commerce Internet Web site offering a broad selection of
entertainment products to the electronic global marketplace at competitive
Internet prices.

Expansion Strategy

The Company plans to slow its growth rate over the next two years and focus
its efforts on expansion and remodeling of existing superstores and increasing
comparable store revenues. It plans to open approximately eight superstores and
close four superstores over the next two fiscal years in selected markets for a
total of approximately 147 superstores by the end of fiscal 2001. The Company
has identified numerous potential locations for future superstores in
under-served, small to medium-sized markets that meet its new-market criteria.
The Company believes that with its current information systems and distribution
capabilities, its infrastructure can support its anticipated rate of expansion
and growth for at least the next several years.

Merchandising

The Company is a leading multimedia entertainment retailer that combines
the sale of books, music, software, periodicals, videocassettes and DVDs with
the rental of videocassettes, video games and DVDs in a superstore format. By
offering a broad array of products within several distinct but complementary
categories, the Company strives to appeal to a wide range of customers and
position its superstores as destination entertainment stores in its 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. The Company accomplishes this
customization through its proprietary purchasing and inventory management
system. 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, the Company's inventory
management process continually monitors product sales and videocassette rentals
to identify slow-moving books, music, software and sale videocassettes for
return to vendors and rental videocassettes for sale or transfer to other
superstores.

The Company's superstores offer an extensive selection of items in each of
its entertainment categories. The typical Hastings superstore offers for sale
approximately 20,000 to 40,000 book, 15,000 to 30,000 music, 1,000 to 2,000
software, 1,000 to 2,000 periodical, 5,000 to 10,000 videocassette and 1,000 to
2,000 complementary and accessory titles for sale. The Company also offers
approximately 3,000 to 12,000 used compact disc, videocassette, DVD and video
game titles for sale. In addition, customers can select from 700 to 1,500 DVD
titles for sale and rent and 12,000 to 20,000 videocassette 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 its primary product lines, the Company continually adds new
product offerings to better serve its customers. Products for sale in these
categories include promotional t-shirts, licensed plush toys, greeting cards,
used compact discs, audio books and consumables, including soft drinks, chips,
popcorn and candy. Accessory items for sale include blank videocassettes, video
cleaning equipment and audiocassette and compact disc 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.

Marketing

Low Pricing. The Company's pricing strategy at its superstores is to offer
value to its customers by maintaining prices that are competitive with or lower
than the lowest prices charged by other retailers in the market. The Company
determines its prices on a market-by-market basis, depending on the level of
competition and other market-specific considerations. The Company believes that
its low pricing structure results in part from (i) its ability to purchase
directly from publishers, studios and manufacturers as opposed to purchasing
from distributors, (ii) its proprietary information systems that enable
management to make more precise and targeted purchases for each superstore, and
(iii) its consistent focus on maintaining low occupancy and operating costs.

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Customer Service. The Company is committed to providing the highest level
of customer service to increase customer loyalty. The Company devotes
significant resources to associate training and measuring customer satisfaction.
All Hastings superstore associates undergo training when hired and are required
to participate in frequent training programs. The Company's ongoing customer
service program, "Quality Service Everytime," empowers every superstore
associate to utilize the Company's flexible return and refund policies to
resolve any customer problem. The Company believes that these programs, together
with the Company's low pricing strategy and superstore amenities, such as
reading chairs, complimentary coffees, and free local telephone calls to permit
customers to confirm their entertainment selections with family and friends, are
important components of the customer service the Company provides.

Advertising/Promotion. The Company participates in cooperative advertising
programs and merchandise display allowance programs offered by its vendors. The
Company's advertising programs are market-focused and emphasize the price
competitiveness, extensive product assortment and comfortable atmosphere of the
Company's superstores. The Company benefits from market display allowances
provided by vendors because of its superstores' high traffic volume and its
effective display implementation. The Company utilizes radio, television,
newspaper and direct-mail advertising and in-store point-of-sale promotional
materials.

Information System

The Company's 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:

New Release Allocation. The Company's buyers use the new release allocation
system to purchase new release products for the superstores. Its buyers have the
ability within the system to utilize up to 15 different 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. The Company believes that the new release allocation system enables
the Company 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. The Company's 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 and additional copy depth requirements under revenue-sharing
agreements. The Company believes that its rental video asset purchasing system
allows the Company 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 the Company to identify overstocked or
understocked items 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.

Model Stock Calculation/Ordering. Model stock calculation uses
store-specific sales, seasonal trends and sophisticated curve fitting to
forecast orders. It also accounts for turnaround time from a vendor or the
Company's distribution center and tracks historical missed sales to adjust
orders to adequately fulfill sales

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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
the Company to perform all physical inventory functions, with the Company
counting 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. The Company also utilizes 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. The Company's financial accounting software has a flexible,
open-systems architecture. The Company prepares 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. The Company's payroll, accounts
payable, cash control, financial planning and state and local tax functions are
performed in-house.

Warehouse Management. The Company's 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 the Company's purchasing, distribution and information systems
departments. The warehouse system incorporates exact cube sizes of product
containers, utilizing flow-through racks and technologically advanced conveyor
systems.

Distribution and Suppliers

The Company's distribution center is located in a 100,000 square foot
facility adjacent to its corporate headquarters in Amarillo, Texas. This central
location and the local labor pool enable the Company to realize relatively low
transportation and labor costs. The distribution center is utilized primarily
for receiving, storing and distributing approximately 15,000 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, process
and ship items to be returned to manufacturers and distributors, as well as to
transfer and redistribute videocassettes among the Company's superstores. This
facility currently provides inventory to all Hastings superstores and is
designed to support its anticipated rate of expansion and growth for at least
the next several years. The Company ships products weekly to each Hastings
superstore, facilitating quick and responsive inventory replenishment.
Approximately 15% of the Company's total product, based on store receipts, is
distributed through the distribution center. Approximately 85% of the Company's
total product is shipped directly from the vendors to the superstores. The
Company outsources all product transportation from its distribution center to
various freight companies.

The Company's information systems and corporate infrastructure facilitate
the Company's ability to purchase products directly from manufacturers, which
contributes to its low pricing structure. In fiscal 1999, the Company purchased
the majority of its products directly from manufacturers, rather than through
distributors. The Company's top three suppliers accounted for approximately 20%
of the Company's total products purchased during fiscal 1999. While selections
from a particular artist or author generally are produced by a single
manufacturer, the Company strives to maintain supplier relationships that can
provide alternate sources of supply. In general, the Company's products are
returnable to the supplying vendor.

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Store Operations

Each Hastings superstore employs 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 the Company's superstores are closed are
Thanksgiving and Christmas.

Competition

The entertainment retail industry is highly competitive. The Company
competes 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 its videocassette sales and rental video products in
particular, the Company competes 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 competition to the Company in the future.

The Company competes in most of its markets with either national
entertainment retailers or significant retailers of general merchandise or both.
The Company competes in its sale of books with retailers such as Barnes & Noble,
Inc., Borders Group, Inc., Walden Books and B. Dalton Bookseller. The Company
competes in its sale of music with music retailers, such as The Wherehouse,
Inc., Camelot Music, Inc., Transworld Entertainment and Musicland Stores
Corporation, and consumer electronics stores, including Best Buy and Circuit
City. The Company's principal competitors in the sale and rental of
videocassettes are Blockbuster Video and Hollywood Entertainment Corp. In
addition, the Company competes 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.
Over the past 30 months, retailers such as Amazon.com, Inc., Barnes & Noble,
Inc., CDNOW, Inc. and Hollywood Entertainment, Inc., have increased their retail
sales of entertainment products, such as books and music, via the Internet, and
the Company anticipates that additional traditional competitors of the Company
will compete soon via the Internet as well. The Company competes 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

The Company believes its trademarks and servicemarks, including the
servicemarks "Hastings Books Music Video," "Hastings, Your Entertainment
Superstore" and "Hastings Entertainment," have significant value and are
important to its marketing efforts. The Company has registered "Hastings Books
Music Video" and "Hastings, Your Entertainment Superstore" as servicemarks with
the United States Patent and Trademark Office and is in the process of
registering "Hastings Entertainment". The Company maintains a policy of pursuing
registration of its principal marks and opposing any infringement of its marks.

Associates

The Company refers to its 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, 2000, the Company employed approximately 6,640
associates; of which 2,278 are full-time and 4,362 are part-time associates. Of
this number, approximately 6,237 were employed at retail superstores, 117 were
employed at the Company's distribution center and 286 were employed at the
Company's corporate offices. None of the Company's associates are represented by
a labor union or are subject to a collective bargaining agreement. The Company
believes that its relations with its associates are good.

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RISK FACTORS

YOU SHOULD CAREFULLY CONSIDER THE FOLLOWING RISK FACTORS BEFORE MAKING AN
INVESTMENT DECISION. IF ANY OF THE FOLLOWING RISKS ACTUALLY OCCUR, THE COMPANY'S
BUSINESS, FINANCIAL CONDITION OR RESULTS OF OPERATIONS COULD BE HURT, THE PRICE
OF THE COMPANY'S SECURITIES COULD DECLINE, THE COMPANY MAY NOT BE ABLE TO REPAY
ITS DEBT OBLIGATIONS AND YOU MAY LOSE ALL OR PART OF YOUR INVESTMENT. YOU SHOULD
ALSO REFER TO THE OTHER INFORMATION CONTAINED IN THIS REPORT AND INCORPORATED IN
THIS REPORT BY REFERENCE, INCLUDING THE COMPANY'S CONSOLIDATED FINANCIAL
STATEMENTS AND THE RELATED NOTES.

Volatility of stock price. Factors such as fluctuations in the Company's
operating results, a downturn in the retail industry, failure to meet stock
market analysts' earnings estimates, changes in analysts' recommendations
regarding the Company, other retail companies or the retail industry in general,
and general market and economic conditions may have a material adverse effect on
the market price of the Common Stock. The Company's Common Stock has declined
substantially since June 1998 as a result of several of the foregoing factors
and the accounting restatements described elsewhere in this Report, and there
can be no assurance that the market price for the Common Stock will increase in
the future. In addition, the stock market has recently experienced significant
price and volume fluctuations that are unrelated to the operating performance of
particular companies. Future broad market fluctuations also may adversely affect
the market price of the Company's Common Stock.

The Company is involved in litigation resulting from the accounting
restatements. Following the Company's initial announcement on March 7, 2000 of
the requirement for the accounting restatements, six purported class action
lawsuits were filed in the United States District Court for the Northern
District of Texas against the Company and certain of the current and former
directors and officers of the Company asserting various claims under Sections
10(b) and 20(a) of the Securities Exchange Act of 1934. Although four of the
lawsuits were originally filed in the Dallas Division of the Northern District
of Texas, all of the five pending actions have been or will be transferred to
the Amarillo Division of the Northern District and should be consolidated. One
of the Section 10(b) and 20(a) lawsuits filed in the Dallas Division was
voluntarily dismissed. On May 15, 2000, a lawsuit was filed in the United States
District Court for the Northern District of Texas against the Company, its
current and former directors and officers at the time of the Company's June 1998
initial public offering and three underwriters, Salomon Smith Barney, A.G.
Edwards & Sons, Inc. and Furman Selz, LLC asserting various claims under
Sections 11, 12(2) and 15 of the Securities Act of 1933.

None of the six pending complaints specify the amount of damages sought.
Although it is not feasible to predict or determine the final outcome of the
proceedings or to estimate the potential range of loss with respect to these
matters, an adverse outcome with respect to such proceedings could have a
material adverse impact on the Company's consolidated financial position,
results of operations and cash flows.

The Company's expansion into electronic commerce is subject to the success
of Internet retailing and may require expansion of the Company's infrastructure.
The Company began operation of its e-commerce web site, www.gohastings.com, in
May 1999. The retail market over the Internet is rapidly evolving and depends
upon market acceptance of novel methods for distributing products, which
involves a high degree of uncertainty. There can be no assurance that the
Company's expansion into electronic commerce will be profitable. The success of
this expansion strategy depends upon the adoption of the Internet by consumers
as a widely used medium for commerce in general, as well as the availability and
functionality of the Hastings Web site in particular. Any failure of the
Internet infrastructure to support increased demands placed on it by continued
growth or system interruptions that result in the unavailability of the
Company's e-commerce Web site or reduced performance in the fulfillment of
orders could reduce the volume of goods sold and the attractiveness of the
Company's electronic commerce service to customers. Increases in the number and
frequency of orders placed on the Hastings Web site may require the Company to
expand its operating infrastructure, including information systems. There can be
no assurance that Hastings will be able to expand its technology at a rate that
will accommodate the need for such increases. The success of Internet retailing
is dependent upon other factors beyond the control of the Company, including
electronic commerce security risks and the impact of technological advances. If
the Internet does not become a

10
11

viable commercial marketplace or if critical issues concerning the commercial
use of the Internet are not favorably resolved, the Company could be materially
adversely affected.

A decline in consumer spending or unforeseen changes in consumer demand may
adversely affect future results. The Company's success depends in part on its
ability to anticipate and respond to changing merchandise trends and consumer
demand in a timely manner. Accordingly, any failure by the Company to identify
and respond to emerging trends could adversely affect consumer acceptance of the
merchandise in the Company's stores, which in turn could have a material adverse
effect on the Company. The sale of books, music, software and periodicals and
the sale and rental of videocassettes historically have been dependent upon
discretionary consumer spending, which may be affected by general economic
conditions, consumer confidence and other factors beyond the control of the
Company. In addition, spending on these items is affected significantly by the
timing, pricing and success of new releases, which are not within the Company's
control. A lack of popular new book, music, software, periodical, videocassette
or video game selections could have a material adverse effect on the Company.
Also, a decline in consumer spending on books, music or videocassettes or other
entertainment-related products could have a material adverse effect on the
Company.

A change in the Company's ability to purchase directly from manufacturers
or in its supplier relationships could adversely affect the Company. The Company
purchases much of its merchandise directly from manufacturers rather than
purchasing from distributors. The inability of the Company to purchase products
directly from a manufacturer would require the Company to purchase those
products from a distributor, in all likelihood at higher prices. There can be no
assurance that the Company will be able to continue to acquire merchandise
directly from manufacturers at competitive prices or on competitive terms in the
future. The Company's top three suppliers accounted for approximately 20% of the
Company's inventory purchased during fiscal 1999. There can be no assurance that
in the event of the inability of the Company to purchase merchandise from one of
these suppliers the Company would be able to purchase the same or similar
products from another supplier at competitive prices or on competitive terms.
The inability to locate an alternate supplier with competitive prices could have
a material adverse effect on the Company. In addition, the Company's inability
to return merchandise to suppliers could have a material adverse effect on the
Company.

Intense competition in the entertainment retail industry and changes in
entertainment technology could adversely affect the Company's results of
operations. The entertainment retail industry is highly competitive. The Company
competes with a wide variety of book, music, software and videocassette
retailers, including online retailers, independent single store operators, 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
noncommercial sources such as libraries. Many of the Company's competitors have
been expanding in both store size and number of outlets while others have
announced their intentions to expand. Increased competition may reduce the
Company's revenues, raise store rents and operating expenses and decrease profit
margins and profits. Some of the Company's competitors have significantly
greater financial and marketing resources, market share and name recognition
than the Company. There can be no assurance that the Company will be able to
continue to compete successfully with its existing competitors or with new
competitors. The Company historically has operated in small to medium-sized
markets, and there can be no assurance that competition in these markets will
not intensify significantly.

The Company also competes with cable, satellite and pay-per-view cable
television systems. Digital compression technology, combined with fiber optics
and other developing technologies, is expected eventually to permit cable
companies, direct broadcast satellite companies, telephone companies and other
businesses to transmit a greater number of movies to homes at more frequently
scheduled intervals throughout the day or on demand and potentially at a lower
cost than presently offered. Technological advances or changes in the marketing
of movies could make these technologies more attractive and economical to
consumers, which could have a material adverse effect on the Company. In
addition, continuing technological advances may enhance the ability of consumers
to shop at home or access, produce and print written works or record music
digitally. Such advances could have a material adverse effect on the Company.
Some of the Company's traditional competitors have recently started to compete
through the Internet, and the Company anticipates that certain of the Company's
other traditional competitors will compete with the Company soon through the
Internet as well. In addition, several of the Company's competitors on the
Internet have been operating retail Web sites longer than the Company and may
have

11
12

a greater level of technological expertise, financial and marketing resources
and name recognition. There can be no assurance that the Company will be able to
compete successfully, technologically or otherwise, with other Internet
retailers or with its existing competitors on a cost-effective and timely basis
in electronic commerce.

The Company's operations depend on its executives. The Company's success is
substantially dependent upon the efforts of its senior management and other key
personnel, including in particular John H. Marmaduke, who has served as the
President and Chief Executive Officer of the Company since 1976. The loss of Mr.
Marmaduke's services or the services of one or more of the other members of
senior management could have a material adverse effect on the Company. With the
exception of a $10 million policy on the life of Mr. Marmaduke, the Company
currently does not maintain key-man insurance on any of its executive officers.
The success of the Company depends, in part on its ability to retain its key
management and attract other personnel to satisfy the Company's current and
future needs. The inability to retain key management personnel or to attract
additional personnel could have a material adverse effect on the Company.

Certain provisions in the Company's articles and bylaws may deter takeover
attempts. Certain provisions of the Third Restated Articles of Incorporation
(the "Articles of Incorporation") and the Amended and Restated Bylaws (the
"Bylaws") of the Company may be deemed to have an anti-takeover effect and may
delay, discourage or prevent a tender offer or takeover attempt, including
attempts that might result in a premium being paid over the market price for the
shares held by shareholders. The Articles of Incorporation of the Company
provide for the Board of Directors to be divided into three classes of directors
serving staggered three-year terms. As a result, approximately one-third of the
Board of Directors are elected each year. The Company's Articles of
Incorporation or Bylaws also include advance notice requirements for shareholder
proposals and nominations, prohibit the taking of shareholder action by written
consent without a meeting and provide that special meetings of shareholders of
the Company be called only by the Chairman of the Board of Directors, the Board
of Directors, the Company's President or holders of not less than 25% of the
Company's outstanding stock entitled to vote at the proposed meeting. In
addition, the Bylaws may be amended or repealed only by the Board. These
provisions may not be amended in the Company's Articles of Incorporation or
Bylaws without the affirmative vote of the holders of a majority of the
outstanding shares of Common Stock.

The Board of Directors of the Company is authorized (without any further
action by the shareholders) to issue Preferred Stock in one or more series and
to fix the voting rights and designations, preferences, limitations and relative
rights and qualifications, limitations or restrictions and certain other rights
and preferences, of the Preferred Stock. Under certain circumstances, the
issuance of Preferred Stock may render more difficult or tend to discourage a
merger, tender offer or proxy contest, the assumption of control by a holder of
a large block of the Company's securities or the removal of incumbent
management. The Board of Directors of the Company, without shareholder approval,
may issue Preferred Stock with voting, dividend and conversion rights that could
adversely affect the holders of Common Stock. As of the date of this Report, no
shares of Preferred Stock are outstanding and the Company has no present
intention to issue any shares of Preferred Stock.

The Company does not expect to pay dividends in the foreseeable future. The
Company intends to continue to retain any earnings to support operations and
finance its growth and does not intend to pay cash dividends on the Common Stock
for the foreseeable future. The payment of cash dividends in the future will be
at the discretion of the Board of Directors and subject to certain limitations
under the Texas Business Corporation Act and will depend upon factors such as
earnings levels, capital requirements, the Company's financial condition and
other factors deemed relevant by the Board of Directors. The Company's amended
revolving credit facility and the amended and restated Note Purchase Agreement
relating to the Company's Series A Senior Notes due 2003 restrict the payment of
dividends.

Liquidity. The Company believes that, based on current and anticipated
financial performance, cash flows from operating activities and borrowings under
the amended Facility will be adequate to meet anticipated requirements for
capital expenditures, working capital and required principal and interest
payments under the amended Senior Notes and the amended Facility. The ability of
the Company to satisfy its capital requirements will be dependent upon future
financial performance of the Company, which in turn is subject to general
economic conditions and to financial issues and other factors, including factors
beyond the Company's control. The Company believes it will be able to comply
with the financial covenants relating to both the amended revolving credit
facility and the

12
13

amended senior notes; however, there can be no assurance of such compliance. The
breach of any of the covenants contained in the amended revolving credit
facility or the amended senior notes could result in a default under the amended
revolving credit facility and the amended senior notes which could result in
further advances under the revolving credit facility no longer being available
from the lender and could enable the respective lenders to require immediate
repayment of the borrowings including accrued interest under the agreements. If
the lenders were to accelerate the repayment of borrowings, including accrued
interest, the Company cannot be certain that its assets would be sufficient to
repay such obligations.

ITEM 2. PROPERTIES

As of January 31, 2000, the Company operated 147 superstores in 22 states
located as indicated in the following table:

NAME OF STATE NUMBER OF SUPERSTORES
- ------------- ---------------------

Alabama ................................................................ 1
Arkansas ............................................................... 8
Arizona ................................................................ 7
Colorado ............................................................... 3
Georgia ................................................................ 1
Idaho .................................................................. 8
Illinois ............................................................... 4
Indiana ................................................................ 2
Iowa ................................................................... 2
Kansas ................................................................. 8
Kentucky ............................................................... 2
Missouri ............................................................... 8
Montana ................................................................ 5
Nebraska ............................................................... 5
New Mexico ............................................................. 13
North Carolina ......................................................... 1
Oklahoma ............................................................... 13
Tennessee .............................................................. 4
Texas .................................................................. 39
Utah ................................................................... 3
Washington ............................................................. 7
Wyoming ................................................................ 3
---
Total .................................................................. 147

The Company leases sites for all of its superstores. These sites typically
are located in pre-existing, stand-alone buildings or strip shopping centers.
The Company's primary market areas are small and medium-sized communities with
populations typically ranging from 25,000 to 150,000. The Company has developed
a systematic approach using its site selection criteria to evaluate and identify
potential sites for new superstores. Key demographic criteria for Company
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 its low occupancy costs, the
Company typically concentrates on leasing existing locations that have been
operated previously by other retailers.

The Company actively manages its existing stores and from time to time
closes under-performing stores. During the fourth quarter of fiscal 1999 the
Company closed two superstores and an additional four superstores and one
college bookstore in the first quarter of fiscal 2000.

The terms of the Company's superstore leases vary considerably. The Company
strives to maintain maximum location flexibility by entering into leases with
short initial terms and multiple short-term extension options. The

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14

Company has been able to enter into leases with these terms in part because it
generally bears a substantial portion of the cost of preparing the site for a
superstore. The following table sets forth as of January 31, 2000 (including the
superstores closed in the first quarter of fiscal 2000) 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 the
Company has options to extend the lease term:

NUMBER OF SUPERSTORES OPTIONS
--------------------- -------

Fiscal Year 2000 ........................... 9 6
Fiscal Year 2001 ........................... 5 4
Fiscal Year 2002 ........................... 14 12
Fiscal Year 2003 ........................... 26 26
Fiscal Year 2004 ........................... 20 18
Thereafter ................................. 73 73
--- ---
Total ...................................... 147 139

The Company has not experienced any significant difficulty renewing or
extending leases on a satisfactory basis.

The Company's headquarters and distribution center are located in Amarillo,
Texas in a leased facility consisting of approximately 67,850 square feet for
office space and 100,000 square feet for the distribution center. The leases for
this property terminate in September 2003, and the Company has the option to
renew these leases through March 2015.

ITEM 3. LEGAL PROCEEDINGS

As described in "Item 6. Selected Financial Data", "Item 7. Management's
Discussion and Analysis of Results of Operations and Financial Condition", and
"Item 8. Financial Statements and Supplementary Data" and the notes to the
consolidated financial statements set forth therein, the Company has made
adjustments to restate its previously reported consolidated financial statements
for the first three quarters of fiscal 1999 and the prior four fiscal years.

Following the Company's initial announcement on March 7, 2000 of the
requirement for the accounting restatements, six purported class action lawsuits
were filed in the United States District Court for the Northern District of
Texas against the Company and certain of the current and former directors and
officers of the Company asserting various claims under Sections 10(b) and 20(a)
of the Securities Exchange Act of 1934. Although four of the lawsuits were
originally filed in the Dallas Division of the Northern District of Texas, all
of the five pending actions have been or will be transferred to the Amarillo
Division of the Northern District and should be consolidated. One of the Section
10(b) and 20(a) lawsuits filed in the Dallas Division was voluntarily dismissed.
On May 15, 2000, a lawsuit was filed in the United States District Court for the
Northern District of Texas against the Company, its current and former directors
and officers at the time of the Company's June 1998 initial public offering and
three underwriters, Salomon Smith Barney, A.G. Edwards & Sons, Inc. and Furman
Selz, LLC asserting various claims under Sections 11, 12(2) and 15 of the
Securities Act of 1933.

None of the six pending complaints specify the amount of damages sought.
Although it is not feasible to predict or determine the final outcome of the
proceedings or to estimate the potential range of loss with respect to these
matters, an adverse outcome with respect to such proceedings could have a
material adverse impact on the Company's consolidated financial position,
results of operations and cash flows.

The Company is also involved in various other claims and legal actions
arising in the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse effect on
the Company's consolidated financial position, results of operations or cash
flows.

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 1999.

14
15

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

The Company's Common Stock began trading on The Nasdaq National Market
(Nasdaq) on June 12, 1998 under the symbol "HAST." On May 18, 2000, the Company
was notified by Nasdaq that its Common Stock would be delisted on May 30, 2000
unless the Company's fiscal 1999 Form 10-K, the filing of which was delayed
pending completion of the accounting restatements described herein, was filed
with the Securities and Exchange Commission by May 25, 2000. As part of this
process, on May 22, 2000 the Company's ticker symbol was changed from "HAST" to
"HASTE". Under Nasdaq rules, the Company requested, and was subsequently
granted, an oral hearing with the appropriate Nasdaq panel. The hearing is
scheduled for June 22, 2000. The scheduling of this hearing automatically stays
the delisting of the Company's Common Stock until the hearing panel makes a
ruling. The Company believes the filing of the Company's fiscal 1999 Form 10-K
will result in cancellation of the scheduled Nasdaq hearing and withdrawal of
the delisting notice.

The following table sets forth for the fiscal periods indicated the high
and low closing market prices of the Company's Common Stock as reported on
Nasdaq:

HIGH LOW
------- -------

2000:
First Quarter $ 4.188 $ 2.438
Second Quarter (May 1 through June 5, 2000) $ 2.688 $ 1.250

1999:
First Quarter $15.313 $ 8.625
Second Quarter $16.438 $ 9.875
Third Quarter $11.125 $ 4.625
Fourth Quarter $ 6.813 $ 4.000

1998:
Second Quarter (June 12, 1998 to July 31, 1998) $14.000 $11.000
Third Quarter $12.000 $ 8.000
Fourth Quarter $19.125 $10.250

As of June 5, 2000, there were approximately 3,814 holders of the Company's
Common Stock, including 233 shareholders of record, and 11,642,644 shares of
Common Stock outstanding.

The payment of dividends is within the discretion of the Company's Board of
Directors and will depend on the earnings, capital requirements, and the
operating and financial condition of the Company, among other factors. The
Company's amended revolving credit facility and the amended and restated Note
Purchase Agreement restrict the payment of dividends. In view of such
restrictions, it is unlikely that the Company will pay a dividend in the
foreseeable future.

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16

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 the Company's consolidated
financial statements and the notes thereto that appear elsewhere in this report.

Fiscal Year
---------------------------------------------------------------------------
In thousands, except per share data 1999 1998 1997 1996 1995
----------- ------------- -------------- -------------- --------------
As Restated(1) As Restated(1) As Restated(1) As Restated(1)

INCOME STATEMENT DATA:
Merchandise revenue $ 364,041 $ 320,162 $ 283,026 $ 251,439 $ 232,463
Rental video revenue 83,114 79,001 74,739 72,357 66,449
----------- ----------- ----------- ----------- -----------
Total revenues 447,155 399,163 357,765 323,796 298,912
Merchandise cost of revenue(2) 256,028 222,155 199,190 178,288 174,405
Rental video cost of revenue(3) 32,184 49,069 25,904 24,645 25,322
----------- ----------- ----------- ----------- -----------
Total cost of revenues 288,212 271,224 225,094 202,933 199,727
Gross profit 158,943 127,939 132,671 120,863 99,185
Selling, general and administrative expenses(4) 157,283 130,378 120,794 107,626 89,820
Development expenses -- -- -- 2,421 2,791
Pre-opening expenses 1,681 1,474 1,071 404 165
----------- ----------- ----------- ----------- -----------
Operating income (loss) (21) (3,913) 10,806 10,412 6,409
Interest expense, net (3,708) (3,727) (4,228) (3,585) (2,588)
Gain (loss) on sale of mall stores(5) -- 454 1,734 (2,500) --
Other, net 205 232 139 187 221
----------- ----------- ----------- ----------- -----------
Income (loss) before income taxes (3,524) (6,954) 8,451 4,514 4,042
Income tax expense (benefit)(6) (1,359) (2,649) 3,347 1,736 5,514
----------- ----------- ----------- ----------- -----------
Net income (loss) $ (2,165) $ (4,305) $ 5,104 $ 2,778 $ (1,472)
=========== =========== =========== =========== ===========
Basic income (loss) per share $ (0.19) $ (0.41) $ 0.60 $ 0.32 $ (0.17)
=========== =========== =========== =========== ===========
Diluted income (loss) per share $ (0.19) $ (0.41) $ 0.58 $ 0.32 $ (0.17)
=========== =========== =========== =========== ===========

Weighted-average common shares outstanding - basic 11,621 10,436 8,520 8,552 8,529

Weighted-average common shares outstanding - diluted 11,621 10,436 8,736 8,757 8,529

OTHER DATA:
Depreciation and amortization(3)(7) $ 32,923 $ 55,331 $ 33,606 $ 28,535 $ 26,998
Capital expenditures(8) $ 47,310 $ 42,568 $ 55,753 $ 40,510 $ 48,358

STORE DATA:
Total selling square footage at end of period 2,829,269 2,385,432 2,078,264 1,828,649 1,716,859
Comparable-store revenues increase(9) 4.0% 5.5% 7.0% 5.9% 4.1%

January 31,
-----------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------- ------------- -------------- -------------- --------------
As Restated(1) As Restated(1) As Restated(1) As Restated(1)

BALANCE SHEET DATA:
Working capital $ 67,295 $ 64,866 $ 29,500 $ 41,455 $ 23,690
Total assets 247,933 233,479 217,948 183,019 165,189
Total long-term debt, including current maturities 54,260 44,979 51,612 51,873 38,916
Total shareholders' equity 90,091 91,869 51,971 46,816 41,871

16
17

(1) The Company has made adjustments to restate its previously reported results
of operations for the first three quarters of fiscal 1999 and the prior
four fiscal years. See "Item 8. Financial Statements and Supplementary
Data" and the notes to the consolidated financial statements set forth
therein.

(2) The Company recorded a pre-tax charge of approximately $3.5 million in the
fourth quarter of fiscal year 1999 for the write down of inventory to the
lower of cost or market. As a result of this charge, fiscal year 1999 net
loss and diluted loss per share were increased by $2.2 million and $0.19
per share, respectively.

(3) The Company adopted a new, accelerated method of amortizing its 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, the Company
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.

(4) The Company recorded a pre-tax charge of approximately $5.1 million in the
fourth quarter of fiscal year 1999 related to the closing of two of its
superstores in the fourth quarter of fiscal 1999 and five of its stores
during the first quarter of fiscal year 2000. This charge includes the net
present value of future minimum lease payments, write-off of property and
equipment, and other costs associated with the closing of these locations.
As a result of this charge, fiscal year 1999 net loss and diluted loss per
share were increased by $3.1 million and $0.27 per share, respectively.

(5) In fiscal 1996, the Company 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, the Company was 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.

(6) Fiscal year 1998, 1997 and 1996 reflect adjustments recorded to current
income tax expense (benefit) resulting from the accounting restatements for
which the Company expects it will recover previously paid income taxes upon
filing amended income tax returns. Fiscal 1995 does not reflect the tax
benefits for the accounting restatements as the statute of limitations has
expired.

(7) Includes amounts associated with the Company's rental video cost
allocation.

(8) Includes procurement of rental video assets.

(9) Stores open a minimum of 60 weeks.

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18

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

The following discussion should be read in conjunction with the Company's
consolidated financial statements and the related notes thereto and "Item 6.
Selected Financial Data" appearing elsewhere in this Annual Report.

General

The Company is a leading multimedia entertainment retailer that combines
the sale of books, music, software, periodicals, videocassettes, video games and
DVDs with the rental of videocassettes, video games and DVDs in a superstore and
Internet Web site format. As of January 31, 2000, the Company operated 147
superstores averaging 21,500 square feet in small to medium-sized markets
located in 22 states, primarily in the Western and Midwestern United States. The
Company also operated two college bookstores. Each of the superstores and the
college bookstores is wholly owned by the Company and operates under the name of
Hastings. The Company's e-commerce Web site, www.gohastings.com, became
operational in May 1999.

The Company's operating strategy is to enhance its position as a multimedia
entertainment retailer by expanding existing superstores, opening new
superstores in selected markets, and expanding its offering of products through
its 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, 2000 is referred to fiscal 1999.

As described in "Item 3. Legal Proceedings", "Item 6. Selected Financial
Data", and "Item 8. Financial Statements and Supplementary Data" and the notes
to the consolidated financial statements set forth therein, the Company has made
adjustments to restate its previously reported 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 the accounting restatements, six purported class action lawsuits
were filed in the United States District Court for the Northern District of
Texas against the Company and certain of the current and former 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
pending actions have been or will be transferred to the Amarillo Division of the
Northern District and the Company believes all of the actions will be
consolidated. One of the lawsuits filed in the Dallas Division was voluntarily
dismissed. On May 15, 2000, a lawsuit was filed in the United States District
Court for the Northern District of Texas against the Company, its current and
former directors and officers at the time of the Company's June 1998 initial
public offering and three underwriters, Salomon Smith Barney, A.G. Edwards &
Sons, Inc. and Furman Selz, LLC asserting various claims under Sections 11,
12(2) and 15 of the Securities Act of 1933.

None of the six pending complaints specify the amount of damages sought.
Although it is not feasible to predict or determine the final outcome of the
proceedings or to estimate the potential range of loss with respect to these
matters, an adverse outcome with respect to such proceedings could have a
material adverse impact on the Company's financial position, results of
operations and cash flow.

Rental Video Cost Allocation

The Company adopted a new method of amortizing its rental video assets in
the fourth quarter of fiscal 1998. In late fiscal 1998, the Company completed a
series of direct revenue-sharing agreements with major studios under which the
Company acquired approximately 51% of its rental video assets during fiscal
1999. The Company anticipates that its involvement in revenue-sharing agreements
will continue to increase moderately in the future. Revenue sharing allows the
Company to acquire rental video assets at a lower up-front capital cost than
traditional buying arrangements. The Company then shares 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 will allow customer demand for new
releases to be satisfied over a shorter period of time at a time when the new
releases are most popular. Since this new business model results in a greater

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19
proportion of rental revenue to be received over a reduced rental period because
there is more product available when product demand is greater, the Company
changed its method of amortizing rental video assets in order to better match
expenses with revenues.

Under the new amortization method, the Company continues to expense
revenue-sharing payments as revenues are recognized under the terms of the
specific contracts with supplying studios. 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 store, which are being amortized
on a straight line basis over 36 months to a salvage value of $4. Under the old
amortization method, the capitalized cost of base rental video assets (typically
copies one through four of a title for each store) was amortized on a straight
line basis over 36 months to a salvage value of $5. The capitalized cost of
non-base units (typically copies five and above for each store) was amortized on
a straight-line basis over 6 months to a salvage value of $5.

The adoption of the accelerated amortization method was accounted for as a
change in accounting estimate effected by a change in accounting principle and,
accordingly, the Company recorded a non-cash, non-recurring, pre-tax charge of
$18.5 million 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.

Results of Operations

The following tables present the Company's 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.

Fiscal Year
---------------------------------------------
1999 1998 1997
------ ----------- -----------
As Restated As Restated

Merchandise revenue 81.4% 80.2% 79.1%
Rental video revenue 18.6 19.8 20.9
------ ------ ------
Total revenues 100.0 100.0 100.0
Merchandise cost of revenue 70.3 69.4 70.4
Rental video cost of revenue 38.7 62.1 34.7
------ ------ ------
Total cost of revenues 64.4 67.9 62.9
Gross profit 35.6 32.1 37.1
Selling, general and administrative expenses 35.2 32.7 33.8
Pre-opening expenses 0.4 0.4 0.3
------ ------ ------
35.6 33.1 34.1
------ ------ ------
Operating income (loss) (0.0) (1.0) 3.0
Other income (expense):
Interest expense (0.8) (0.9) (1.2)
Gain on sale of mall stores -- 0.1 0.5
Other, net 0.0 0.1 0.0
------ ------ ------
(0.8) (0.7) (0.7)
------ ------ ------
Income (loss) before income taxes (0.8) (1.7) 2.3
Income tax expense (benefit) (0.3) (0.7) 0.9
------ ------ ------
Net income (loss) (0.5)% (1.0)% 1.4%
====== ====== ======

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Fiscal Year
-------------------
1999 1998 1997
---- ---- ----

Hastings Superstores:
Beginning number of stores 129 117 111
Openings 20 12 8
Closings * (2) -- (2)
---- ---- ----
Ending number of stores 147 129 117
==== ==== ====

* Four additional superstores were closed in the first quarter of fiscal 2000.

Fiscal 1999 Compared to Fiscal 1998

Revenues. Total revenues for fiscal 1999 totaled $447.2 million, an
increase of $48.0 million or 12.0% over fiscal 1998 revenue of $399.2 million.
The revenue growth consisted of a 13.7% increase in merchandise sales and a 5.2%
increase in rental video revenue. The increase in revenue was primarily due to
comparable store revenue growth of 4.0% and the opening of 20 Hastings
superstores during fiscal 1999. The Company closed two superstores at the end of
fiscal 1999, which had an insignificant effect on total revenue. Each
significant revenue category exhibited growth, with video games providing the
largest gains on a percentage basis.

Gross Profit. Total gross profit as a percent of total revenue decreased in
fiscal 1999 to 35.6% compared to 36.7% for 1998 excluding the non-cash,
non-recurring, pre-tax charge of $18.5 million discussed above, under - "Rental
Video Cost Allocation." This decline was primarily the result of a $3.5 million
pre-tax charge in the fourth quarter of fiscal 1999 for the write-down of
certain merchandise inventory to the lower of cost or market. The remainder of
the gross profit change from fiscal 1998 resulted from the increase in
merchandise revenues from 80.2% to 81.4% of total revenues. Excluding the
write-down, merchandise gross profit as a percentage of merchandise revenue
remained constant at 30.6%. Gross profit as a percentage of revenue for rental
video remained constant at 61.3% for fiscal 1999 compared to fiscal 1998,
excluding the charge described above.

Selling, General and Administrative Expenses. Selling, general and
administrative ("SG&A") expenses increased to 35.2% of total revenues in fiscal
1999 from 32.7% in fiscal 1998. One factor contributing to this increase was the
$5.1 million pre-tax charge for the costs associated with the closing of six
superstores and one college bookstore. This charge includes the net present
value of future minimum lease payments, write-off of property and equipment, and
other related costs. Two of these superstores were closed as of the end of
fiscal 1999, while the remainder were closed during the first quarter of fiscal
2000. Other factors contributing to the increase in SG&A were an increase of
approximately $1.4 million in costs associated with the operation of the
Company's Internet segment, increased cost related to the return of merchandise
and increased costs related to the Company's superstore advertising programs.

Pre-opening Expenses. Pre-opening expenses remained constant at 0.4% of
revenues for fiscal 1999 compared to fiscal 1998. Pre-opening expenses include
human resource costs, travel, rent, advertising, supplies and certain other
costs incurred prior to a superstore's opening. The Company opened 20 new
superstores in fiscal 1999, compared to 12 new superstores in fiscal 1998.

Interest Expense. Interest expense remained constant at $3.7 million for
fiscal 1999 compared to 1998.

Gain (Loss) on Sale of Mall Stores. As a result of the sale of its 42 mall
stores to Camelot Music, Inc., the Company recorded a total pre-tax gain of $7.9
million (after-tax gain of $4.9 million) in fiscal 1993 and fiscal 1994. Camelot
Music, Inc. filed for bankruptcy in August 1996, and the Company established a
reserve of $2.5 million in fiscal 1996 to cover potential losses related to
certain mall store leases. As of January 31, 1998, expenses totaling $0.3
million had been charged against the reserve. In the fourth quarter of fiscal
1997, the reserve was reduced to $0.5 million, resulting in an increase to
pre-tax income of $1.7 million. By the end of the fourth quarter of fiscal 1998,
all potential liabilities related to the Camelot Music, Inc. bankruptcy were
settled, and the Company reduced

20
21

the remaining reserve to zero resulting in a decrease in pre-tax loss in the
fourth quarter of fiscal 1998 of $0.5 million.

Net Income (Loss). The Company reported a net loss of $2.2 million or $0.19
per diluted share in fiscal 1999 compared to a net loss of $4.3 million or $0.41
per diluted share in fiscal 1998. Excluding the $5.1 million pre-tax charge for
the closing of stores and the $3.5 million pre-tax charge for the write-down of
merchandise inventory in fiscal 1999, the Company's net income and diluted
income per share would have been $3.1 million and $0.27 per diluted share,
respectively. Excluding the non-cash, non-recurring, pre-tax charge of $18.5
million discussed above under - "Rental Video Cost Allocation," and the $0.5
million reversal of the reserve related to the Camelot Music, Inc. bankruptcy in
fiscal 1998, the Company's fiscal 1998 net income and diluted income per share
would have been $6.8 million and $0.66 per share, respectively.

Fiscal 1998 Compared to Fiscal 1997

Revenues. Total revenues for fiscal 1998 totaled $399.2 million, an
increase of $41.4 million or 11.6% over fiscal 1997 revenue of $357.8 million.
The revenue growth consisted of a 13.1% increase in merchandise sales and a 5.7%
increase in rental video revenue. Each significant merchandise category
exhibited growth, with sale video games providing the largest gain on a
percentage basis. The increase in rental video revenue was the result of a new
successful rental marketing program introduced in the third quarter of fiscal
1997 and the transition to revenue-sharing copy-depth programs. Overall
comparable-store revenues increased 5.5% during the 12 months ended January 31,
1999. The Company added 12 new superstores during fiscal 1998 and did not close
any stores.

Gross Profit. Gross profit as a percentage of revenues was 32.1% in fiscal
1998 compared to 37.1% for fiscal 1997. Excluding the non-cash, non-recurring,
pre-tax charge of $18.5 million discussed above, under - "Rental Video Cost
Allocation," in fiscal 1998 gross profit was 36.7% of total revenues. Gross
profit as a percentage of revenues for merchandise in fiscal 1998 increased to
30.6% from 29.6% in fiscal 1997. This increase was primarily due to lower
inventory shrinkage. Rental video gross profit as a percentage of revenues
decreased from 65.3% in fiscal 1997 to 37.9% in fiscal 1998. Excluding the
rental video charge, rental video gross profit as a percentage of revenues
decreased from 65.3% in fiscal 1997 to 61.3% in fiscal 1998 as a result of
higher depreciation related to increased purchases and higher cost of leased
videos related to revenue-sharing agreements.

Selling, General and Administrative Expenses. SG&A expenses decreased to
32.7% of total revenues in fiscal 1998 from 33.8% in fiscal 1997. The primary
factors contributing to this decrease as a percentage of revenues were lower
corporate human resources costs related to deferred compensation, reduced
overall advertising and lower costs associated with the return of merchandise
inventory. During the second quarter of fiscal 1997, the Company re-priced
certain stock options granted to its Chief Executive Officer in fiscal 1992. The
Company recognized a one-time pre-tax charge of $1.0 million as deferred
compensation expense as a result of this event. Excluding this one-time charge
would reduce fiscal 1997 selling, general and administrative expenses to 33.5%
of fiscal 1997 revenue.

Pre-opening Expenses. Pre-opening expenses increased to 0.4% of revenues
for fiscal 1998 from 0.3% of revenues for fiscal 1997. Pre-opening expenses
include human resource costs, travel, rent, advertising, supplies and certain
other costs incurred prior to a superstore's opening. The Company opened 12 new
superstores in fiscal 1998, compared to eight new superstores in fiscal 1997.

Interest Expense. Interest expense decreased to $3.7 million for fiscal
1998 from $4.2 million for fiscal 1997 due to lower average borrowing balances.

Gain (Loss) on Sale of Mall Stores. As a result of the sale of its 42 mall
stores to Camelot Music, Inc., the Company recorded a total pre-tax gain of $7.9
million (after-tax gain of $4.9 million) in fiscal 1993 and fiscal 1994. Camelot
Music, Inc. filed for bankruptcy in August 1996, and the Company established a
reserve of $2.5 million in fiscal 1996 to cover potential losses related to
certain mall store leases. As of January 31, 1998, expenses totaling $0.3
million had been charged against the reserve. In the fourth quarter of fiscal
1997, the reserve was reduced to $0.5 million, resulting in an increase to
pre-tax income of $1.7 million. By the end of the fourth quarter of fiscal 1998,
all potential liabilities related to the Camelot Music, Inc. bankruptcy were
settled, and the Company reduced

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22

the remaining reserve to zero resulting in a decrease to pre-tax loss in the
fourth quarter of fiscal 1998 of $0.5 million.

Net Income. The Company reported a net loss of $4.3 million or $0.41 per
diluted share for fiscal 1998 compared to net income of $5.1 million and $.0.58
per diluted share, respectively for fiscal 1997. Excluding the non-cash,
non-recurring, pre-tax charge of $18.5 million discussed above, under - "Rental
Video Cost Allocation," and the $0.5 million reversal of the reserve related to
the Camelot Music, Inc. bankruptcy, the Company's net income and diluted income
per share would have been $6.8 million and $0.66 per share, respectively, in
fiscal 1998. Excluding the $1.7 million reversal of the reserve related to the
Camelot Music, Inc. bankruptcy, net income and diluted income per share would
have been $4.1 million and $0.46 per diluted share, respectively, in fiscal
1997.

Liquidity and Capital Resources

The Company's principal capital requirements arise from purchasing,
warehousing and merchandising inventory and rental videos, opening new
superstores, expanding existing superstores, and funding the expansion of its
Internet operations. The Company's primary sources of working capital are cash
flow from operating activities, trade credit from vendors, borrowings from its
Revolving Credit Facility (the "Facility") and, for fiscal year 1996 and 1998,
proceeds from the issuance of the Company's unsecured Series A Senior Notes due
June 13, 2003 in the aggregate principal amount of $25.0 million (the "Senior
Notes") and Common Stock from the Company's June 1998 initial public offering,
respectively. Cash flow from operations was $39.3 million, $14.6 million and
$56.2 million for fiscal 1999, 1998 and 1997, respectively. Capital
expenditures, including purchase of rental video assets, were $47.3 million,
$42.6 million and $55.8 million for fiscal 1999, 1998 and 1997, respectively.
Cash flows from financing activities in fiscal 1999 primarily resulted from
borrowings made under the Facility and in fiscal 1998, net proceeds of
approximately $35.9 million from the issuance of the Common Stock in the
Company's June 1998 initial public offering. Net activity under the Facility
resulted in net borrowings of $14.6 million, net payments of $6.4 million and
net borrowings of $0.1 million in fiscal 1999, 1998 and 1997, respectively.

At January 31, 2000 and 1999, the Company had borrowings outstanding of
$32.3 million and $17.7 million, respectively, under the Facility. The Facility
accrued interest at variable rates based on the lender's base rate or LIBOR. The
average rate of interest being charged under the Facility at January 31, 2000
and 1999 was 6.9% and 7.3%, respectively.

Also, at January 31, 2000, the Company had outstanding $20 million
aggregate principal amount of Senior Notes with a financial institution. The
Company began making required $5.0 million annual principal payments on June 13,
1999, and the final payment is due June 13, 2003. The Senior Notes had a stated
interest rate of 7.75% at January 31, 2000.

As a result of the accounting restatements discussed in note 2 to the
consolidated financial statements (Item 8), at January 31, 2000 and at various
prior quarters the Company was not in compliance with certain financial
covenants under its Facility and the Senior Notes. The Company obtained a series
of waivers on its breach of the covenant requirements to January 31, 2000 and
through June 12, 2000.

Effective as of June 12, 2000, the Company entered into an amendment of the
Facility and an amendment and restatement of the Note Purchase Agreement for the
Senior Notes. As part of the amendments to the Facility and the Senior Notes,
the combined borrowings are jointly collateralized on a pari passu basis by
substantially all of the assets of the Company and its subsidiaries.

The Facility, as amended, allows for maximum borrowings of up to $50
million. The aggregate amount outstanding under the Facility and the Senior
Notes is limited to a borrowing base predicated on eligible inventory, as
defined, and rental video assets, net. The Facility bears interest based on the
lender's base rate plus 1.0% (base rate plus 1.75% on the amount in excess of
the normal amount in the over-advance period) or LIBOR plus 2.50% (LIBOR plus
3.25% on the amount in excess of the normal advance rate amount in the
over-advance period), at the Company's option. In addition the Company is
required to pay a quarterly commitment fee of 0.50% on the unused Facility.
Borrowings under the Facility are limited to an advance rate of 55% of eligible
inventory (eligible inventory is defined as 61.22% of inventory, net) and 50% of
rental video assets net of accumulated amortization, less the outstanding
borrowings under the Senior Notes and any required rental reserve. The Facility
provides for an increase in the advance rate to cover additional working capital

22
23

requirements through the Christmas selling season (the seasonal over-advance).
The advance rate increases to 65% of eligible inventory from August 1 through
September 30 and to 70% of eligible inventory from October 1 through December
31, 2000 and December 16, 2001, respectively (the seasonal over-advance
periods). The Facility includes revised covenants requiring the maintenance of
specific financial ratios and minimum tangible net worth requirements. In
addition, a covenant was added to the Facility requiring the Company's income
before interest, taxes, depreciation and amortization (EBITDA) to be at least
equal to specified levels for future periods. Further, the Facility imposes
certain restrictions with respect to indebtedness, dividend payments, investment
and capital expenditures. The Facility expires on December 16, 2001.

The Senior Notes, as amended, have a stated interest rate of 10.25%. The
amended and restated Note Purchase Agreement evidencing the amended Senior Notes
has financial covenants that are the same as those contained in the amended
Facility including financial ratios, minimum adjusted net worth requirements and
restrictions on indebtedness, investment, capital expenditures, and the payment
of dividends.

The Company believes it will be able to comply with the financial covenants
relating to both the amended Facility and the amended Senior Notes for the next
twelve months; however, there can be no assurance of such compliance. The breach
of any of the covenants contained in the amended Facility or the amended Senior
Notes could result in a default under the amended Facility and the amended
Senior Notes which could result in further advances under the revolving credit
facility no longer being available from the lender and could enable the
respective lenders to require immediate repayment of the borrowings including
accrued interest under the agreements. If the lenders were to accelerate the
repayment of borrowings, including accrued interest, the Company cannot be
certain that its assets would be sufficient to repay such obligations. The
amended Facility and the amended Senior Notes are guaranteed by each of the
Company's three consolidated subsidiaries, and are in part secured by first
priority liens on all of the capital stock and substantially all of the assets
of each subsidiary.

The Company's primary sources of liquidity are currently, cash flows from
operating activities and borrowings under the Facility. As of June 7, 2000,
$19.4 million was borrowed under the Facility. The Company believes that, based
on current and anticipated financial performance, cash flows from operating
activities and borrowings under the amended Facility will be adequate to meet
anticipated requirements for capital expenditures, working capital and required
principal and interest payments under the amended Senior Notes and the amended
Facility. The ability of the Company to satisfy its capital requirements will be
dependent upon future financial performance of the Company, which in turn is
subject to general economic conditions and to financial issues and other
factors, including factors beyond the Company's control. (See - "Risk Factors")

As described above under "Item 1. Business", the Company plans to slow its
growth rate from that previously described and focus on the expansion and
remodeling of its existing superstores. The Company invests generally between $1
million and $2 million in a new superstore, with the largest components of that
amount being merchandise, videos, fixtures and leasehold improvements. The
Company expanded seven superstores in fiscal 1999 and plans to expand
approximately four superstores in fiscal 2000. The Company generally invests
between $0.5 million to $1.0 million to expand a superstore.

At January 31, 2000, the Company had one other debt obligation totaling
$0.5 million. The principal on this obligation is payable quarterly until
maturity in May 2002. In addition, the Company maintains two capitalized lease
obligations with initial terms of 15 years. The total amount of these
obligations was $1.5 million at January 31, 2000.

Seasonality and Inflation

As is the case with many retailers, a significant portion of the Company's
revenues, and an even greater portion of its operating profit, is generated in
the fourth fiscal quarter, which includes the Christmas selling season. As a
result, a substantial portion of the Company's annual earnings has been, and
will continue to be, dependent on the results of this quarter. The Company
experiences reduced rentals of video activity in the spring because customers
spend more time outdoors. Major world or sporting events, such as the Super
Bowl, the Olympic Games or the World Series, also have a temporary adverse
effect on revenues. Future operating results may be affected by many

23
24

factors, including variations in the number and timing of store openings, the
number and popularity of new book, music and videocassette titles, the cost of
the new release or "best renter" titles, changes in comparable-store revenues,
competition, marketing programs, increases in the minimum wage, weather, special
or unusual events, and other factors that may affect retailers in general and
the Company in particular.

The Company does not believe that inflation has materially impacted net
income during the past three years. Substantial increases in costs and expenses
could have a significant impact on the Company's operating results to the extent
such increases are not passed along to customers.

Recent Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement on Financial Accounting Standards (SFAS) No. 133, "Accounting for
Derivative Instruments and Hedging Activities" that impacts the Company's
accounting treatment and/or its disclosure obligations. The statement
establishes accounting and reporting standards for derivative instruments,
including derivative instruments embedded in other contracts, and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measure those
instruments at fair value. The statement, as amended by SFAS No. 137,
"Accounting for Derivative Instruments and Hedging Activities - Deferral of the
Effective Date of FASB Statement No. 133," is effective for all fiscal quarters
of fiscal years beginning after June 15, 2000. The adoption of SFAS No. 133 is
not expected to have a material impact on the Company.

In March 2000, the FASB issued Interpretation No. 44, "Accounting for
Certain Transactions Involving Stock Compensation - an Interpretation of APB
Opinion No. 25" ("FIN 44"). Among other issues, this interpretation clarifies
the definition of employee for purposes of applying APB Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), the criteria for
determining whether a plan qualifies as a non-compensatory plan, the accounting
consequence of various modifications to the terms of previously fixed stock
options or awards, and the accounting for an exchange of stock compensation
awards in a business combination. This Interpretation is effective July 1, 2000,
but certain conclusions in this Interpretation cover specific events that
occurred after either December 15, 1998, or January 12, 2000. Management
believes that FIN 44 will not have a material effect on the financial position
or the results of operations of the Company upon adoption.

24
25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the ordinary course of its business, the Company is exposed to certain
market risks, primarily changes in interest rates. The Company's exposure to
interest rate risk consists of variable rate debt based on the lenders base rate
or LIBOR plus a specified percentage at the Company's option. The annual impact
on the Company's results of operations of a 100 basis point interest rate change
on the January 31, 2000 outstanding balance of the variable rate debt would be
approximately $0.3 million. After an assessment of these risks to the Company's
operations, the Company believes that its primary market risk exposures (within
the meaning of Regulation S-K Item 305) are not material and are not expected to
have any material adverse impact on the Company's financial position, results of
operations or cash flows for the next fiscal year. The Company is not party to
any derivative contracts. See notes 1(j) and (7) to the accompanying
consolidated financial statements.

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26

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

HASTINGS ENTERTAINMENT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE

PAGE

Independent Auditors' Report 27

Consolidated Balance Sheets as of January 31, 2000 and 1999 28

Consolidated Statements of Operations
for the years ended January 31, 2000, 1999 and 1998 29

Consolidated Statements of Shareholders' Equity
for the years ended January 31, 2000, 1999 and 1998 30

Consolidated Statements of Cash Flows
for years ended January 31, 2000, 1999 and 1998 31

Notes to Consolidated Financial Statements 32

SCHEDULE

Financial Statement Schedule - The Financial Statement Schedule filed as part of
this report is listed under Part IV, Item 14. Exhibits, Financial Statement
Schedules and Reports on Form 8-K.

26
27

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
Hastings Entertainment, Inc.:

We have audited the consolidated financial statements of Hastings Entertainment,
Inc. and subsidiaries as listed in the accompanying index. In connection with
our audits of the consolidated financial statements, we also have audited the
related financial statement schedule as listed in the accompanying index. These
consolidated financial statements and financial statement schedule are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements and financial statement
schedule based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. 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 consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Hastings
Entertainment, Inc. and subsidiaries as of January 31, 2000 and 1999, and the
results of their operations and their cash flows for each of the years in the
three-year period ended January 31, 2000, in conformity with generally accepted
accounting principles. Also in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole, presents fairly, in all material respects, the
information set forth therein.

As discussed in Note 2, the accompanying consolidated balance sheet as of
January 31, 1999 and the consolidated statements of operations, shareholders'
equity and cash flows for the years ended January 31, 1999 and 1998 have been
restated.

As discussed in Note 3, the Company changed its method of amortization for
rental videos in 1998.

/s/ KPMG LLP

Dallas, Texas
June 13, 2000

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28

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
January 31, 2000 and 1999
(Dollars in thousands, except par value)

FISCAL
-------------------------
1999 1998
---------- -----------
As Restated
(note 2)

ASSETS
Current assets:
Cash $ 7,026 $ 5,394
Merchandise inventories, net 152,065 149,601
Income taxes receivable 6,272 6,515
Deferred income taxes 656 --
Other current assets 4,968 4,506
---------- ----------
Total current assets 170,987 166,016
Property and equipment, net 73,242 64,781
Deferred income taxes 3,026 2,523
Other assets 678 159
---------- ----------
$ 247,933 $ 233,479
========== ==========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Current maturities on long-term debt $ 5,372 $ 5,345
Trade accounts payable 66,568 66,278
Accrued expenses and other current liabilities 31,752 28,145
Deferred income taxes -- 1,382
---------- ----------
Total current liabilities 103,692 101,150

Long-term debt, excluding current maturities 48,888 39,634
Other liabilities 5,262 826

Shareholder' equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued -- --
Common stock, $.01 par value; 75,000,000 shares authorized;
11,736,923 shares issued;
11,628,973 shares in 1999 and 11,553,168 shares in 1998 outstanding 117 117
Additional paid-in capital 37,402 37,783
Retained earnings 53,951 56,116
Treasury stock, at cost (1,379) (2,147)
---------- ----------
90,091 91,869
Commitments and contingencies -- --
---------- ----------
$ 247,933 $ 233,479
========== ==========

See accompanying notes to consolidated financial statements.

28
29

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended January 31, 2000, 1999 and 1998
(In thousands, except per share data)

FISCAL YEAR
--------------------------------------
1999 1998 1997
---------- ----------- -----------
As Restated As Restated
(note 2) (note 2)

Merchandise revenue $ 364,041 $ 320,162 $ 283,026
Rental video revenue 83,114 79,001 74,739
---------- ---------- ----------
Total revenues 447,155 399,163 357,765

Merchandise cost of revenue 256,028 222,155 199,190
Rental video cost of revenue 32,184 49,069 25,904
---------- ---------- ----------
Total cost of revenues 288,212 271,224 225,094
---------- ---------- ----------
Gross profit