Attached files

file filename
EX-31.1 - EXHIBIT 31.1 - HASTINGS ENTERTAINMENT INCc09254exv31w1.htm
EX-31.2 - EXHIBIT 31.2 - HASTINGS ENTERTAINMENT INCc09254exv31w2.htm
EX-32.1 - EXHIBIT 32.1 - HASTINGS ENTERTAINMENT INCc09254exv32w1.htm
Table of Contents

 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended October 31, 2010
OR
     
o   TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 000-24381
HASTINGS ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
     
Texas   75-1386375
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)
     
3601 Plains Boulevard, Amarillo, Texas
(Address of principal executive offices)
  79102
(Zip Code)
(806) 351-2300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes o No þ
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
     
Class   Outstanding at October 31, 2010
Common Stock, $.01 par value per share   8,803,560 shares
 
 

 

 


 

HASTINGS ENTERTAINMENT, INC.
Form 10-Q
For the Quarterly Period Ended October 31, 2010
INDEX
         
    Page  
 
       
       
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    10  
 
       
    22  
 
       
    22  
 
       
       
 
       
    23  
 
       
    23  
 
       
    23  
 
       
    24  
 
       
    25  
 
       
    26  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1

 

2


Table of Contents

PART I — FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
HASTINGS ENTERTAINMENT, INC.
Consolidated Balance Sheets
October 31, 2010 and January 31, 2010
(Dollars in thousands, except par value)
                 
    October 31,     January 31,  
    2010     2010  
    (Unaudited)        
Assets
               
Current assets:
               
Cash and cash equivalents
  $ 6,706     $ 8,863  
Merchandise inventories, net
    167,627       148,149  
Deferred income taxes
    5,535       7,804  
Prepaid expenses and other current assets
    13,114       10,120  
 
           
Total current assets
    192,982       174,936  
Rental assets, net of accumulated depreciation of $19,143 and $21,444 at October 31, 2010 and January 31, 2010, respectively
    15,172       13,127  
Property, equipment and improvements, net of accumulated depreciation of $199,922 and $190,607 at October 31, 2010 and January 31, 2010, respectively
    43,899       47,695  
Deferred income taxes
    3,371       1,310  
Intangible assets, net
    391       391  
Other assets
    2,030       1,341  
 
           
Total Assets
  $ 257,845     $ 238,800  
 
           
 
               
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Trade accounts payable
  $ 79,325     $ 58,068  
Accrued expenses and other current liabilities
    26,860       28,128  
 
           
Total current liabilities
    106,185       86,196  
Long term debt
    44,107       38,174  
Other liabilities
    6,227       6,272  
 
Shareholders’ equity:
               
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued
           
Common stock, $.01 par value; 75,000,000 shares authorized;
11,944,544 shares issued and 8,803,560 shares outstanding at October 31, 2010;
11,944,544 shares issued and 9,463,838 shares outstanding at January 31, 2010
    119       119  
Additional paid-in capital
    36,800       36,920  
Retained earnings
    84,741       86,884  
Accumulated other comprehensive income
    88       37  
Treasury stock, at cost 3,140,984 shares and 2,480,706 shares at October 31, 2010 and January 31, 2010, respectively
    (20,422 )     (15,802 )
 
           
Total Shareholders’ Equity
    101,326       108,158  
 
           
Total Liabilities and Shareholders’ Equity
  $ 257,845     $ 238,800  
 
           
See accompanying notes to unaudited consolidated financial statements.

 

3


Table of Contents

HASTINGS ENTERTAINMENT, INC.
Unaudited Consolidated Statements of Operations
For the Three and Nine Months Ended October 31, 2010 and 2009
(Dollars in thousands, except per share amounts)
                                 
    Three Months Ended October 31,     Nine Months Ended October 31,  
    2010     2009     2010     2009  
 
                               
Merchandise revenue
  $ 94,462     $ 94,434     $ 301,175     $ 295,896  
Rental revenue
    17,673       17,903       58,801       59,327  
Gift card breakage revenue
    149             537        
 
                       
Total revenues
    112,284       112,337       360,513       355,223  
 
                               
Merchandise cost of revenue
    65,038       64,869       206,333       202,651  
Rental cost of revenue
    6,456       6,464       21,768       21,069  
 
                       
Total cost of revenues
    71,494       71,333       228,101       223,720  
 
                       
 
                               
Gross profit
    40,790       41,004       132,412       131,503  
 
                               
Selling, general and administrative expenses
    45,675       45,731       135,753       133,508  
Pre-opening expenses
                      3  
 
                       
 
                               
Operating loss
    (4,885 )     (4,727 )     (3,341 )     (2,008 )
 
                               
Other income (expense):
                               
Interest expense
    (374 )     (211 )     (695 )     (778 )
Other, net
    46       17       91       96  
 
                       
 
                               
Loss before income taxes
    (5,213 )     (4,921 )     (3,945 )     (2,690 )
 
                               
Income tax benefit
    (2,134 )     (1,485 )     (1,802 )     (560 )
 
                       
 
                               
Net loss
  $ (3,079 )   $ (3,436 )   $ (2,143 )   $ (2,130 )
 
                       
 
                               
Basic loss per share
  $ (0.35 )   $ (0.36 )   $ (0.23 )   $ (0.22 )
 
                       
 
                               
Diluted loss per share
  $ (0.35 )   $ (0.36 )   $ (0.23 )   $ (0.22 )
 
                       
 
                               
Weighted-average common shares outstanding:
                               
Basic
    8,849       9,574       9,120       9,658  
Dilutive effect of stock awards
                       
 
                       
 
                               
Diluted
    8,849       9,574       9,120       9,658  
 
                       
See accompanying notes to unaudited consolidated financial statements.

 

4


Table of Contents

HASTINGS ENTERTAINMENT, INC.
Unaudited Consolidated Statements of Cash Flows
For the Nine Months Ended October 31, 2010 and 2009
(Dollars in thousands)
                 
    Nine Months Ended  
    October 31,  
    2010     2009  
 
               
Cash flows from operating activities:
               
Net loss
  $ (2,143 )   $ (2,130 )
Adjustments to reconcile net loss to net cash provided by operating activities:
               
Rental asset depreciation expense
    8,224       9,185  
Purchases of rental assets
    (20,139 )     (15,805 )
Property and equipment depreciation expense
    12,989       14,327  
Deferred income taxes
    208       1,723  
Loss on rental assets lost, stolen and defective
    1,403       606  
Loss on disposal of other assets
    64       379  
Non-cash stock-based compensation
    481       224  
Changes in operating assets and liabilities:
               
Merchandise inventories
    (11,009 )     (24,562 )
Prepaid expenses and other current assets
    (2,994 )     (982 )
Trade accounts payable
    21,254       35,029  
Accrued expenses and other current liabilities
    (1,220 )     (5,773 )
Excess tax benefit from stock-based compensation
    (48 )      
Other assets and liabilities, net
    (84 )     1,431  
 
           
Net cash provided by operating activities
    6,986       13,652  
 
           
 
               
Cash flows from investing activities:
               
Purchases of property, equipment, and improvements
    (9,259 )     (8,683 )
 
           
Net cash used in investing activities
    (9,259 )     (8,683 )
 
           
 
               
Cash flows from financing activities:
               
Borrowings under revolving credit facility
    381,020       365,806  
Repayments under revolving credit facility
    (375,087 )     (368,022 )
Purchase of treasury stock
    (5,471 )     (1,018 )
Change in cash overdraft
    3       (3,162 )
Deferred financing costs paid
    (599 )      
Proceeds from exercise of stock options
    202        
Excess tax benefit from stock-based compensation
    48        
 
           
Net cash provided by (used in) financing activities
    116       (6,396 )
 
           
 
               
Net decrease in cash and cash equivalents
    (2,157 )     (1,427 )
Cash and cash equivalents at beginning of period
    8,863       7,449  
 
           
Cash and cash equivalents at end of period
  $ 6,706     $ 6,022  
 
           
See accompanying notes to unaudited consolidated financial statements.

 

5


Table of Contents

Hastings Entertainment, Inc
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)
1. Basis of Presentation
The accompanying unaudited consolidated financial statements of Hastings Entertainment, Inc. and its subsidiary (“Hastings,” the “Company,” “we,” “our,” or “us”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with instructions in Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such principles and regulations of the Securities and Exchange Commission. All adjustments, consisting of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of interim periods. The results of operations for such interim periods are not necessarily indicative of the results that may be expected for a full year because of, among other things, seasonality factors in the retail business. As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating earnings, is generated in the fourth fiscal quarter, which includes the holiday selling season. The unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2010.
The balance sheet at January 31, 2010 has been derived from the audited consolidated financial statements at that date but does not include all of the information and notes required by U.S. generally accepted accounting principles for complete financial statements. For further information, refer to the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2010.
Our fiscal year ends on January 31 and is identified as the fiscal year for the immediately preceding calendar year. For example, the fiscal year that will end on January 31, 2011 is referred to as fiscal year 2010.
2. Stock-Based Compensation
We have various stock incentive plans, which allow us to issue stock options, stock appreciation rights, restricted shares, restricted stock units, performance awards and other awards. Stock-based compensation is discussed more fully in Note 13 in our Annual Report on Form 10-K for the fiscal year ended January 31, 2010.
For the three months ended October 31, 2010 and 2009, we recognized approximately $0.1 million of stock-based compensation expense. For the nine months ended October 31, 2010 and 2009, we recognized approximately $0.5 million and $0.2 million, respectively, of stock-based compensation expense. These amounts include expense related to incentive stock options, non-qualified stock options, restricted stock units, and performance-based restricted stock awards.
As of October 31, 2010, we had 652,600 shares available to grant as stock-based compensation awards under our various stock incentive plans.

 

6


Table of Contents

Hastings Entertainment, Inc
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)
3. Long-term Debt
On July 22, 2010, we entered into the Amended and Restated Loan and Security Agreement (the “Amended Agreement”) with Bank of America, N.A., as agent, which amended and restated our Loan and Security Agreement dated as of August 29, 2000, as otherwise amended (the “Prior Agreement”). The Amended Agreement is substantially the same as the Prior Agreement, extends the maturity date of the Prior Agreement from August 29, 2011 to July 22, 2014, and provides that we may repurchase up to $10.0 million worth of our common stock. The Amended Agreement also provides that we may repurchase additional shares of our common stock in the event we meet certain criteria set forth in the Amended Agreement. The Amended Agreement prohibits the payment of dividends and includes certain other debt and acquisition limitations and requires a minimum availability of $10.0 million at all times. The Amended Agreement is secured by substantially all of the assets of the Company and our subsidiary and is guaranteed by our subsidiary.
The amount outstanding under the Amended Agreement is limited by a borrowing base predicated on the sum of (a) 85% of Eligible Credit Card Receivables plus (b) (i) 85% multiplied by (ii) the Appraised Inventory Liquidation Value multiplied by (iii) Eligible Inventory (net of Inventory Reserves), less (c) Availability Reserves (each term as defined in the Amended Agreement), and is limited to a ceiling of $100 million, less a $10 million availability reserve. The lender may increase specifically defined reserves to reduce availability in the event of adverse changes in our industry or our financial condition that are projected to impact the value of our assets pledged as collateral. The lender must exercise reasonable judgment and act in good faith with respect to any changes in the specifically defined reserves.
Interest under the Amended Agreement will accrue, at our election, at a Base Rate or Libor Rate, plus, in each case, an Applicable Margin, which is determined by reference to the level of Availability as defined in the Amended Agreement, with the Applicable Margin for Libor Rate loans ranging from 2.00% to 2.75% and the Applicable Margin for Base Rate loans ranging from 1.00% to 1.75%. In addition, unused line fees ranging from 0.30% to 0.375% (determined by reference to the level of usage under the Amended Agreement) are also payable on unused commitments.
We utilize standby letters of credit to support certain insurance policies. The aggregate amount of the letters of credit at October 31, 2010, was approximately $0.8 million, which reduces the excess availability under the Amended Agreement.
At October 31, 2010, we had approximately $44.2 million in excess availability, after the $10 million availability reserve, under the Amended Agreement. The average rates of interest incurred for the three months ended October 31, 2010 and 2009 were 3.0% and 1.9%, respectively. The average rates of interest incurred for the nine months ended October 31, 2010 and 2009 were 2.4% and 2.5%, respectively. Deferred financing costs that were amortized into interest expense during the three and nine months ended October 31, 2010 are excluded from the calculation of the average rate of interest for each respective period.

 

7


Table of Contents

Hastings Entertainment, Inc
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)
4. Loss per Share
The computations for basic and diluted loss per share are as follows:
                                 
    Three Months Ended October 31,     Nine Months Ended October 31,  
    2010     2009     2010     2009  
 
                               
Net loss
  $ (3,079 )   $ (3,436 )   $ (2,143 )   $ (2,130 )
 
                       
 
                               
Average shares outstanding:
                               
Basic
    8,849       9,574       9,120       9,658  
Effect of stock awards
                       
 
                           
Diluted
    8,849       9,574       9,120       9,658  
 
                       
 
                               
Loss per share:
                               
Basic
  $ (0.35 )   $ (0.36 )   $ (0.23 )   $ (0.22 )
 
                       
 
                               
Diluted
  $ (0.35 )   $ (0.36 )   $ (0.23 )   $ (0.22 )
 
                       
The following options to purchase shares of common stock were not included in the computation of diluted loss per share because their inclusion would have been antidilutive:
                                 
    Three Months Ended October 31,     Nine Months Ended October 31,  
    2010     2009     2010     2009  
Shares of common stock underlying options
    614       535       614       535  
 
                               
Exercise price range per share
  $ 1.69 to $8.70     $ 1.33 to $8.70     $ 1.69 to $8.70     $ 1.33 to $8.70  
5. Fair Value Measurements
We account for certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. These levels are:
   
Level 1 – Observable inputs – quoted prices in active markets for identical assets and liabilities;
   
Level 2 – Observable inputs other than the quoted prices in active markets for identical assets and liabilities – includes quoted prices for similar instruments, quoted prices for identical or similar instruments in inactive markets, and amounts derived from valuation models where all significant inputs are observable in active markets; and
   
Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable and require us to develop relevant assumptions.
At October 31, 2010 and January 31, 2010, we had approximately $1.1 million and $1.0 million, respectively, in assets which are carried at fair value on a recurring basis. These assets consist of available-for-sale investments related to our non-qualified supplemental executive retirement plan (“SERP”). The fair value of these investments was determined using Level 1 inputs.

 

8


Table of Contents

Hastings Entertainment, Inc
Notes to Unaudited Consolidated Financial Statements
(Tabular amounts in thousands, except per share data or unless otherwise noted)
Our long-term debt is our only financial instrument with a fair value which can differ significantly from the carrying amount. The fair value of our long-term debt is estimated using a discounted cash flow analysis that applies interest rates currently being offered on borrowings of similar amounts and terms to those currently outstanding while also taking into consideration our current credit worthiness. At January 31, 2010, the estimated fair value of our long-term debt was approximately $36.8 million compared to carrying value of $38.2 million. We entered into the Amended Agreement on July 22, 2010. As a result, the carrying value of long-term debt at October 31, 2010 approximates fair value due to the instrument bearing interest at variable rates that are comparable to what is currently available to us.
6. Income Taxes
During the three months ended October 31, 2009, the Company recorded a discrete tax charge of approximately $0.4 million related to amended state and federal tax returns resulting from an Internal Revenue Service (“IRS”) audit of the Company’s previously filed tax returns. No discrete items were recorded during the three months ended October 31, 2010. Primarily as a result of this discrete tax charge combined with the Company’s pre-tax loss for the period, the effective tax rates for the three months ended October 31, 2010 and 2009 were (40.9%) and (30.2%), respectively.
During the nine months ended October 31, 2010, the Company recorded a discrete tax benefit of approximately $0.2 million related to amended state returns resulting from an IRS audit of the Company’s previously filed federal tax returns. During the nine months ended October 31, 2009, the Company recorded a discrete tax charge of approximately $0.4 million related to amended state and federal tax returns resulting from an IRS audit of the Company’s previously filed tax returns. Primarily as a result of these discrete tax items, the effective tax rates for the nine months ended October 31, 2010 and 2009 were (45.7%) and (20.8%), respectively.
7. Litigation and Contingencies
We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations or cash flows.
8. Recent Accounting Pronouncements
In January 2010, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2010 — 06 – Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.  This standard amends the disclosure guidance with respect to fair value measurements for both interim and annual reporting periods. Specifically, this standard requires new disclosures for significant transfers of assets or liabilities between Level 1 and Level 2 in the fair value hierarchy, separate disclosures for purchases, sales, issuance and settlements of Level 3 fair value items on a gross, rather than net basis, and more robust disclosure of the valuation techniques and inputs used to measure Level 2 and Level 3 assets and liabilities. Except for the detailed disclosures of changes in Level 3 items, which will be effective for us as of February 1, 2011, the remaining disclosure requirements were effective for us as of February 1, 2010. We adopted the provisions of this guidance, as applicable, beginning in the fiscal quarter ended April 30, 2010, with no material impact to our financial statements.

 

9


Table of Contents

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-looking Statements
Certain written and oral statements set forth below or made by Hastings with the approval of an authorized executive officer constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “intend,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future including statements relating to the business, expansion, merchandising and marketing strategies of Hastings, industry projections or forecasts, inflation, effect of critical accounting policies including lower of cost or market for inventory adjustments, the returns process, rental asset depreciation, store closing reserves, impairment or disposal of long-lived assets, revenue recognition, and vendor allowances, sufficiency of cash flow from operations and borrowings under our revolving credit facility and statements expressing general optimism about future operating results are forward-looking statements. Such statements are based upon our management’s current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to, consumer appeal of our existing and planned product offerings, and the related impact of competitor pricing and product offerings; overall industry performance and the accuracy of our estimates and judgments regarding trends; our ability to obtain favorable terms from suppliers; our ability to respond to changing consumer preferences, including with respect to new technologies and alternative methods of content delivery, and to effectively adjust our offerings if and as necessary; the application and impact of future accounting policies or interpretations of existing accounting policies; whether our assumptions turn out to be correct; our inability to attain such estimates and expectations; a downturn in market conditions in any industry relating to the products we inventory, sell or rent; the degree to which we enter into and maintain vendor relationships; the extremely challenging times that the U.S. and global economies are currently experiencing, the effects of which have had and will continue to have an adverse impact on spending by Hastings’ current retail customer base and potential new customers, and the possibility that general economic conditions could deteriorate further; volatility of fuel and utility costs; acts of war or terrorism inside the United States or abroad; unanticipated adverse litigation results or effects; and other factors which may be outside of our control; any of which could cause actual results to differ materially from those described herein. We undertake no obligation to affirm, publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
The following discussion should be read in conjunction with the unaudited consolidated financial statements of the Company and the related notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
General
Incorporated in 1972, Hastings Entertainment, Inc. (the “Company,” “Hastings,” or “Hastings Entertainment”) is a leading multimedia entertainment retailer. We operate entertainment superstores that buy, sell, trade and rent various home entertainment products, including books, music, software, periodicals, movies on DVD and Blu-ray, video games, video game consoles and consumer electronics. We also offer consumables and trends products such as apparel, t-shirts, action figures, posters, greeting cards and seasonal merchandise. As of October 31, 2010, we operated 146 superstores principally in medium-sized markets located in 20 states, primarily in the Western and Midwestern United States. In fiscal 2010, we opened and operate a new concept store, Sun Adventure Sports, located in Amarillo, Texas.
We also operate a multimedia entertainment e-commerce web site offering a broad selection of books, software, video games, movies on DVD and Blu-ray, music, trends, and consumer electronics. We fill orders for new and used product placed at this website and also through Amazon Marketplace using our proprietary goShip program, which allows us to ship directly from stores. We have one wholly-owned subsidiary, Hastings Internet, Inc.
References herein to fiscal years are to the twelve-month periods that end in January of each following calendar year. For example, the twelve-month period ended January 31, 2011 is referred to as fiscal 2010.

 

10


Table of Contents

Critical Accounting Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe the following critical accounting estimates comprise the more significant estimates and assumptions used in preparing our financial statements. Our significant estimates and assumptions are reviewed, and any required adjustments are recorded, on a monthly or quarterly basis.
Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories are recorded at the lower of cost, which approximates the first-in, first-out (“FIFO”) method, or market. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record the lower of cost or market inventory adjustments. In some instances, these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns and estimated market value and returnability of merchandise inventory by product category and record an adjustment if estimated market value is below cost.
Rental Asset Depreciation. We have established rental asset depreciation policies that match rental product costs with the related revenues. These policies require that we make significant estimates, based upon our experience, as to the ultimate amount and timing of revenue to be generated from our rental product. We utilize an accelerated method of depreciation because it approximates the pattern of demand for the product, which is higher when the product is initially released by the studios for rental and declines over time. In establishing salvage values for our rental product, we consider the sales prices and sales volume of our previously rented product and other used product.
We currently depreciate the cost of our rental assets on an accelerated basis over six months or nine months, except for rental assets purchased for the initial stock of a new store, which are depreciated on a straight-line basis over 36 months. Rental assets, which include DVDs, Books on CD and Video Games, are depreciated to salvage values ranging from $4 to $10. Rental assets purchased for less than established salvage values are not depreciated.
We also review the carrying value of our rental assets to ensure that estimated future cash flows exceed the carrying value. We periodically record adjustments to the value of previously rented product primarily for estimated obsolescence or excess product based upon changes in our original assumptions about future demand and market conditions. If future demand or actual market conditions are less favorable than our original estimates, additional adjustments, including adjustments to useful lives or salvage values, may be required. We continually evaluate the estimates surrounding the useful lives and salvage values used in depreciating our rental assets. Changes to these estimates resulting from changes in consumer demand, changes in customer preferences or the price or availability of retail products may materially impact the carrying value of our rental assets and our rental margins.
The costs of rental product purchased pursuant to revenue-sharing arrangements, which are recorded in rental cost of sales on the consolidated statements of operations, typically include a lower initial product cost than traditional rental purchases with a certain percentage of the net rental revenues shared with studios over an agreed period of time. Any up-front costs exceeding the designated salvage value are amortized on an accelerated basis and revenue-sharing payments pursuant to the applicable arrangement are expensed as rental costs of sales as the related revenue is earned. Additionally, certain titles have performance guarantees. We analyze titles that are subject to performance guarantees and recognize an estimated expense for under-performing titles throughout the applicable period based upon our analysis of the estimated rental revenue shortfall. We revise these estimates on a monthly basis, based on actual results.
Impairment or Disposal of Long-Lived Assets. We evaluate under-performing stores on a quarterly basis to determine whether projected future cash flows over the remaining lease term are sufficient to recover the carrying value of the fixed asset investment in each individual store. If projected future cash flows are less than the carrying value of the fixed asset investment, an impairment charge is recognized if the estimated fair value is less than the carrying value of such assets. The carrying value of leasehold improvements and certain other property and equipment is subject to impairment write-down.

 

11


Table of Contents

Income Taxes. In determining net income, we make certain estimates and judgments in the calculation of tax expense and the resulting tax liabilities and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenue and expense. We record deferred tax assets and liabilities for future income tax consequences that are attributable to differences between financial statement carrying amounts of assets and liabilities and their income tax bases. We base the measurement of deferred tax assets and liabilities on enacted tax rates that we expect will apply to taxable earnings in the year when we expect to settle or recover those temporary differences. We recognize the effect on deferred tax assets and liabilities on any change in income tax rates in the period that includes the enactment date.
The tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood, on a cumulative basis, of being realized upon ultimate settlement. We recognize interest and penalties relating to any uncertain tax positions as a component of income tax expense.
Share-Based Compensation. Determining the amount of share-based compensation to be recorded in the statement of operations requires us to develop estimates that are used in calculating the grant-date fair value of stock options. In determining the fair value of stock options, we use the Black-Scholes valuation model, which requires us to make estimates of the following assumptions:
   
Expected volatility – The estimated stock price volatility is derived based upon our historical stock prices over the expected life of the option.
   
Expected life of the option – The estimate of an expected life is calculated based on historical data relating to grants, exercises and cancellations, as well as the vesting period and contractual life of the option.
   
Risk-free interest rate – The risk-free interest rate is based on the yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life of the option.
Our stock price volatility and expected option lives involve management’s best estimates at that time, both of which impact the fair value of the option calculated under the Black-Scholes pricing model and, ultimately, the expense that will be recognized over the vesting period of the option.
We recognize compensation expense only for the portion of options that are expected to vest. Therefore, we apply estimated forfeiture rates that are derived from historical employee termination behavior. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.
In addition to stock options, we award restricted stock awards, including restricted stock units and performance-based restricted stock awards. The grant date fair value of restricted stock awards is equal to the average of the opening and closing stock price on the day on which they are granted. For performance-based restricted stock awards, compensation expense is recognized if management deems it probable that the performance conditions will be met. Management must use its judgment to determine the probability that a performance condition will be met. If actual results differ from management’s assumptions, future results could be materially impacted.
Gift Card Breakage Revenue. We sell gift cards through each of our stores and through our web site www.goHastings.com. The gift cards we sell have no stated expiration dates or fees and are subject to potential escheatment rights in some of the jurisdictions in which we operate. Gift card liabilities are recorded as deferred revenue at the time of sale of such cards with the costs of designing, printing and distributing the cards recorded as expense as incurred. Historically, the liability was relieved and revenue was recognized only upon redemption of the gift cards. Beginning in the fourth quarter of fiscal 2009, we had sufficient historical data to analyze gift card redemption patterns and a determination of the escheatment laws applicable to our operations. As a result, during the fourth quarter of fiscal 2009, we began recognizing revenue for the estimated breakage on gift cards we previously issued and sold. Subsequent to the initial change in estimate related to gift card breakage, gift card breakage revenue is recognized as gift cards are redeemed, based upon an analysis of the aging and utilization of gift cards, our determination that the likelihood of future redemption is remote and our determination that such balances are not subject to escheatment laws applicable to our operations.

 

12


Table of Contents

Results of Operations
The following tables present our statement of operations data, expressed as a percentage of revenue, and the number of superstores open at the end of the periods presented herein.
                                 
    Three Months Ended     Nine Months Ended  
    October 31,     October 31,  
    2010     2009     2010     2009  
 
                               
Merchandise revenue
    84.1 %     84.1 %     83.5 %     83.3 %
Rental revenue
    15.8       15.9       16.3       16.7  
Gift card breakage revenue
    0.1             0.2        
 
                       
Total revenues
    100.0       100.0       100.0       100.0  
 
                               
Merchandise cost of revenue
    68.9       68.7       68.5       68.5  
Rental cost of revenue
    36.5       36.1       37.0       35.5  
 
                       
Total cost of revenues
    63.7       63.5       63.3       63.0  
 
                       
 
Gross profit
    36.3       36.5       36.7       37.0  
 
                               
Selling, general and administrative expenses
    40.7       40.7       37.7       37.6  
Pre-opening expenses
                       
 
                       
 
                               
Operating loss
    (4.4 )     (4.2 )     (1.0 )     (0.6 )
 
                               
Other income (expense):
                               
Interest expense
    (0.2 )     (0.2 )     (0.1 )     (0.2 )
Other, net
                       
 
                       
 
                               
Loss before income taxes
    (4.6 )     (4.4 )     (1.1 )     (0.8 )
 
                               
Income tax benefit
    (1.9 )     (1.3 )     (0.5 )     (0.2 )
 
                       
 
                               
Net loss
    (2.7 )%     (3.1 )%     (0.6 )%     (0.6 )%
 
                       
Summary of Superstore Activity(1)
                                         
    Three Months Ended     Nine Months Ended     Year Ended  
    October 31,     October 31,     January 31,  
    2010     2009     2010     2009     2010  
 
                                       
Beginning number of stores
    147       151       149       153       153  
Openings
                             
Closings
    (1 )     (1 )     (3 )     (3 )     (4 )
 
                             
Ending number of stores
    146       150       146       150       149  
 
                             
     
(1)  
We operate one concept store, Sun Adventure Sports, which is not included in the summary of superstore activity.

 

13


Table of Contents

Financial Results for the Third Quarter of Fiscal Year 2010
Both operating loss and adjusted operating loss for the third quarter were approximately $4.9 million compared to $4.7 million for the third quarter of fiscal 2009. Adjusted operating loss excludes gift card breakage, stock compensation expense and store asset impairment expense. Earnings before interest, taxes, property and equipment depreciation expense and amortization (“EBITDA”) was approximately ($0.5) million for the third quarter of fiscal 2010 as compared to approximately $34,000 for the same period in the prior year. Adjusted EBITDA, which excludes gift card breakage revenue, stock compensation expense and store asset impairment expense, was approximately ($0.5) million for the third quarter of fiscal 2010 compared to approximately $0.1 million for the same period in the prior year.
Reconciliations of non-GAAP financial measures to comparable GAAP financial measures are included in the tables following this section along with a discussion of why management believes these measures provide meaningful information regarding the Company’s performance.
Revenues. Total revenues for the third quarter remained consistent with the revenues for the same period in the prior year at $112.3 million. Excluding gift card breakage revenue, total revenues for the third quarter of fiscal 2010 decreased approximately $0.2 million, or 0.2%. Comparable store sales, which exclude gift card breakage revenue, increased approximately 1.3%. As of October 31, 2010, we operated four fewer superstores, as compared to October 31, 2009, and one additional concept store, Sun Adventure Sports, which opened during the second quarter. The following is a summary of our revenues results (dollars in thousands):
                                                 
    Three Months Ended October 31,                  
    2010     2009     Increase (Decrease)  
            Percent             Percent              
    Revenues     Of Total     Revenues     Of Total     Dollar     Percent  
Merchandise Revenue
  $ 94,462       84.1 %   $ 94,434       84.1 %   $ 28       0.0 %
Rental Revenue
    17,673       15.8 %     17,903       15.9 %     (230 )     -1.3 %
Gift Card Breakage Revenue
    149       0.1 %           0.0 %     149        
 
                                   
Total Revenues
  $ 112,284       100.0 %   $ 112,337       100.0 %   $ (53 )     0.0 %
 
                                   
                 
Comparable-store revenues (“Comp”)
               
 
Total
            1.3 %
Merchandise
            1.2 %
Rental
            2.2 %
Below is a summary of the Comp results for our major merchandise categories:
                 
    Three Months Ended October 31,  
    2010     2009  
Trends
    19.0 %     -4.1 %
Hardback Café
    7.2 %     16.5 %
Video Games
    6.7 %     8.5 %
Movies
    5.6 %     -3.1 %
Consumables
    3.4 %     3.8 %
Electronics
    -0.4 %     5.1 %
Books
    -6.2 %     0.2 %
Music
    -6.2 %     -10.4 %
Stores included in the Comps calculation are those stores that have been open for a minimum of 60 weeks. Also included are stores that were remodeled or relocated during the comparable period. Sales via the internet are included and closed stores are removed from each comparable period for the purpose of calculating Comps. Prior year Comp sales have been revised to reflect current year classification of Comp sale categories.

 

14


Table of Contents

Trends Comps increased 19.0% for the quarter, driven by strong sales of new and used Comics, Hex Bugs, “As Seen on TV” products including the Kymaro and Big Top Cupcake, shaped rubber bands, apparel, collectible card games, and novelty items. The increase in new and used comic sales is primarily due to an expanded comic footprint in eighty-seven stores. Key drivers in the apparel category included hats and bags. Key drivers in the novelty category included seasonal merchandise for Halloween, Nerf toys and black lights. Hardback Café Comps increased 7.2% for the quarter primarily due to increased sales of specialty café drinks. Video Game Comps increased 6.7% for the quarter resulting from strong sales of new and used video games for the Microsoft Xbox 360 and Sony Playstation 3 platforms and strong sales of new and used video game accessories. These sales were partially offset by lower sales of older generation video games, new Nintendo Wii video games, and video game consoles. Hit titles that helped drive sales during the quarter included Fallout: New Vegas, Halo Reach, Madden NFL 11, Fable III, Star Wars: The Force Unleashed II, Medal of Honor, Dead Rising 2, and Mafia II. Movie Comps increased 5.6% for the quarter, primarily driven by strong sales of new and used DVD boxed sets and increased sales of new and used Blu-ray movies, partially offset by lower sales of new DVDs. The increase in sales of boxed sets is attributable to an increased presence of boxed set promotions, increased sales of catalog boxed sets and several strong new titles that helped drive store traffic, including Sons of Anarchy: Season 2 and Dexter: Season 4. Consumables Comps increased 3.4% for the quarter, primarily resulting from strong sales of popcorn and assorted candies and gums, partially offset by lower sales of can drinks and fountain drinks. Electronics Comps decreased 0.4% for the quarter. Decreased sales of digital converter boxes, Blu-ray players, and refurbished iPods were partially offset by increased sales of headphones, iPod accessories, and PC accessories. Books Comps decreased 6.2% for the quarter, primarily resulting from decreases in sales of new trade paperbacks, mass-market books, and hardbacks, which to some degree is attributable to the increasing popularity of electronic book readers, and decreased sales of magazines. These decreases were partially offset by an increase in the sales of value books and used trade paperbacks. Music Comps decreased 6.2% for the quarter due to lower sales of new and used CDs, resulting directly from a continued industry decline and a reduced footprint in ninety-six stores.
Rental Comps increased 2.2% for the quarter, due to fewer promotions during the quarter as compared to the prior year. Rental Video Comps increased 3.7% for the quarter and Rental Video units had a slight decrease of 0.6% compared to the prior year. The decrease in units rented was due to fewer titles released during the quarter with gross box office revenues in the range of $20 million to $80 million, which typically represent our strongest rentals. Rental Video Game Comps decreased 1.1% for the quarter and Rental Video Game Units decreased 6.0% for the quarter. The decrease in Rental Video Games was due to a challenging comparison to titles released in the prior year and lower price points on select titles as compared to the prior year.
Gross Profit – Merchandise. For the third quarter, total merchandise gross profit dollars decreased approximately $0.2 million, or 0.7%, to $29.4 million from $29.6 million for the same period in the prior year. As a percentage of total merchandise revenue, merchandise gross profit decreased to 31.1% for the quarter compared to 31.3% for the same period in the prior year, resulting primarily from increased shrinkage expense and costs to return products, partially offset by improvements in margin management. We are currently utilizing a comprehensive store audit program to assess store level execution and controls designed to reduce shrink, with a strong focus on our high-shrinkage stores.
Gross Profit – Rental. For the third quarter, total rental gross profit dollars decreased approximately $0.2 million, or 1.8%, to $11.2 million from $11.4 million for the same period in the prior year due to lower revenues as well as lower margin rates. As a percentage of total rental revenue, rental gross profit decreased to 63.5% for the quarter compared to 63.9% for the same period in the prior year primarily due to increased shrinkage partially offset by lower depreciation expense. Depreciation is a function of rental purchases over approximately a six month period.
Selling, General and Administrative Expenses (“SG&A”). SG&A remained consistent for the third quarter, at $45.7 million, or 40.7% of total revenue. SG&A drivers for the quarter included a decrease in depreciation expense of approximately $0.4 million related to a reduction in capital expenditures and a decrease in expense for bonuses under our bonus incentive programs of approximately $0.3 million. These decreases were partially offset by an increase in store labor costs of approximately $0.3 million, an increase in store supply costs of approximately $0.2 million, and an increase in store maintenance costs of approximately $0.1 million.

 

15


Table of Contents

Interest Expense. For the third quarter, interest expense increased approximately $0.2 million, or 100.0%, to $0.4 million, compared to $0.2 million for the same period in the prior year, primarily as a result of higher interest rates incurred under our Amended and Restated Loan and Security Agreement. The average rate of interest charged for the quarter increased to 3.0% compared to 1.9% for the same period in the prior year.
Tax Expense. During the three months ended October 31, 2009, the Company recorded a discrete tax charge of approximately $0.4 million related to amended state and federal tax returns resulting from an Internal Revenue Service (“IRS”) audit of the Company’s previously filed tax returns. No discrete items were recorded during the three months ended October 31, 2010. Primarily as a result of this discrete tax charge combined with the Company’s pre-tax loss for the period, the effective tax rates for the three months ended October 31, 2010 and 2009 were (40.9%) and (30.2%), respectively.
Financial Results for the Nine Months Ended October 31, 2010
Operating loss for the nine months ended October 31, 2010 was approximately $3.3 million compared to $2.0 million for same period in the prior year. Adjusted operating loss, which excludes gift card breakage revenue, stock compensation expense and store asset impairment expense, was approximately $3.4 million for the nine month period compared to $1.6 million for the same period in the prior year. Earnings before interest, taxes, property and equipment depreciation expense and amortization (“EBITDA”) was approximately $9.7 million for the nine months ended October 31, 2010 as compared to approximately $12.4 million for the same period in the prior year. Adjusted EBITDA, which excludes gift card breakage revenue, stock compensation expense and store asset impairment expense, was approximately $9.7 million for the nine month period compared to approximately $12.8 million for the same period in the prior year.
Revenues. Total revenues for the first nine months of fiscal 2010 increased approximately $5.3 million, or 1.5%, to $360.5 million compared to $355.2 million for the same period in fiscal 2009. Excluding gift card breakage revenue, total revenues for the period increased approximately $4.8 million, or 1.3%. Comparable store sales, which exclude gift card breakage revenue and the impact of operating fewer stores during the current period, increased approximately 3.6%. The following is a summary of our revenues results (dollars in thousands):
                                                 
    Nine Months Ended October 31,                  
    2010     2009     Increase (Decrease)  
            Percent             Percent              
    Revenues     Of Total     Revenues     Of Total     Dollar     Percent  
Merchandise Revenue
  $ 301,175       83.5 %   $ 295,896       83.3 %   $ 5,279       1.8 %
Rental Revenue
    58,801       16.3 %     59,327       16.7 %     (526 )     -0.9 %
Gift Card Breakage Revenue
    537       0.2 %           0.0 %     537        
 
                                   
Total Revenues
  $ 360,513       100.0 %   $ 355,223       100.0 %   $ 5,290       1.5 %
 
                                   
                 
Comparable-store revenues (“Comp”)
               
 
Total
            3.6 %
Merchandise
            3.9 %
Rental
            2.1 %
Below is a summary of the Comp results for our major merchandise categories:
                 
    Nine Months Ended October 31,  
    2010     2009  
Video Games
    18.4 %     -8.6 %
Trends
    12.9 %     -0.3 %
Hardback Café
    10.9 %     13.9 %
Movies
    8.8 %     -5.7 %
Consumables
    5.7 %     3.8 %
Electronics
    1.7 %     0.9 %
Books
    -3.0 %     -0.4 %
Music
    -6.2 %     -13.9 %

 

16


Table of Contents

Prior year Comp sales have been revised to reflect current year classification of Comp sale categories. Video Game Comps increased 18.4% for the period, primarily due to strong sales of new and used video games for the Sony Playstation 3 and Microsoft XBOX 360, used games for the Nintendo Wii, and video gaming consoles and accessories, partially offset by lower sales of older generation video games. Trends Comps increased 12.9% for the period, primarily resulting from strong sales of Hex Bugs, “As Seen on TV” products including the Kymaro and Big Top Cupcake, new and used comics, collectible card games, such as Magic: The Gathering, and action figures. The increase in new and used comic sales is primarily due to an expanded comic footprint in eighty-seven stores. The increase in action figure sales was driven by an increase in action figures sold over the internet and the addition of collectible action figures to our product mix. Hardback Café Comps increased 10.9% for the period, resulting from increased sales of specialty café drinks. Movie Comps increased 8.8% for the period, primarily due to increased sales of new and used Blu-ray movies and DVD boxed sets, partially offset by lower sales of new and used DVDs. Consumables Comps increased 5.7% for the period, primarily due to strong sales of assorted candies and gums, including candies and snacks cross merchandised on our video rental wall, and novelty drinks. Electronics Comps increased 1.7% for the period primarily resulting from strong sales of MP3 accessories and headphones, partially offset by lower sales of digital converter boxes and refurbished iPods. Book Comps decreased 3.0% for the period, primarily due to lower sales of new trade paperbacks, mass-market books, and hardbacks, which to some degree is attributable to the increasing popularity of electronic book readers, and lower sales of magazines, partially offset by increased sales of used trade paperbacks and hardbacks. Music Comps decreased 6.2% for the period due to lower sales of new and used CDs, resulting directly from a continued industry decline and a reduced footprint in ninety-six stores.
Rental Comps increased 2.1% for the period, primarily due to fewer promotions being offered during the current period. Units rented for the period increased 6.2% for the period as compared to the prior year resulting from our new rental pricing program along with competitor store closings. Rental Video Comps increased 3.2% for the period while Rental Video Game Comps decreased 0.4% due to a challenging comparison to titles released in the prior year and lower price points on select titles as compared to the prior year.
Gross Profit – Merchandise. For the current nine months, total merchandise gross profit dollars increased approximately $1.6 million, or 1.7%, to $94.8 million from $93.2 million for the same period in the prior year, due to higher revenues. As a percentage of total merchandise revenue, merchandise gross profit remained consistent at 31.5%. Improvements in margin management, lower markdown expense, and lower costs to return product were offset by increases in freight costs, which resulted directly from increased shipments related to our goShip program, and increased shrinkage expense. We have created a comprehensive store audit program to assess store level execution and controls designed to reduce shrink, with a strong focus on our high-shrinkage stores.
Gross Profit – Rental. For the current nine months, total rental gross profit dollars decreased approximately $1.3 million, or 3.4%, to $37.0 million from $38.3 million for the same period in the prior year primarily due to lower margin rates as well as lower revenues. As a percentage of total rental revenue, rental gross profit decreased to 63.0% for the period compared to 64.5% for the same period in the prior year primarily as a result of increased shrinkage and lower rental revenues partially offset by lower depreciation expense. Depreciation is a function of rental purchases over approximately a six month period.
Selling, General and Administrative Expenses (“SG&A”). As a percentage of total revenue, SG&A increased to 37.7% for the current nine months compared to 37.6% for the same period in the prior year. SG&A increased approximately $2.3 million, or 1.7%, to $135.8 million compared to $133.5 million for the same period in the prior year. The main drivers of the SG&A increase included an increase in associate health insurance of approximately $0.8 million, an increase in store supplies expense of approximately $0.5 million, and an increase in store advertising costs of approximately $0.4 million. Increases were partially offset by a decrease in depreciation expense of approximately $1.6 million related to a reduction in capital expenditures.
Interest Expense. For the current nine months, interest expense decreased approximately $0.1 million, or 12.5%, to $0.7 million, compared to $0.8 million for the same period in the prior year primarily as a result of lower average debt levels outstanding during the period. The average rate of interest charged for the current nine months decreased to 2.4% compared to 2.5% for the same period in the prior year.

 

17


Table of Contents

Income Tax Expense. During the nine months ended October 31, 2010, the Company recorded a discrete tax benefit of approximately $0.2 million related to amended state returns resulting from an IRS audit of the Company’s previously filed Federal tax returns. During the nine months ended October 31, 2009, the Company recorded a discrete tax charge of approximately $0.4 million related to amended state and federal tax returns resulting from an IRS audit of the Company’s previously filed tax returns. Primarily as a result of these discrete tax items, the effective tax rates for the nine months ended October 31, 2010 and 2009 were (45.7%) and (20.8%), respectively.
Use of Non-GAAP Financial Measures
The Company is providing free cash flow, EBITDA, adjusted EBITDA, and adjusted operating income (loss) as supplemental non-GAAP financial measures regarding the Company’s operational performance. The Company evaluates its historical and prospective financial performance, and its performance relative to its competitors, by using such non-GAAP financial measures. Specifically, management uses these items to further its own understanding of the Company’s core operating performance, which management believes represents the Company’s performance in the ordinary, ongoing and customary course of its operations. Therefore, management excludes from core operating performance those items, such as those relating to restructuring, investing, stock-based compensation expense and non-cash activities that management does not believe are reflective of such ordinary, ongoing and customary activities.
The Company believes that providing this information to its investors, in addition to the presentation of GAAP financial measures, allows investors to see the Company’s financial results “through the eyes” of management. The Company further believes that providing this information allows investors to both better understand the Company’s financial performance and to evaluate the efficacy of the methodology and information used by management to evaluate and measure such performance.
Free Cash Flow
Management defines free cash flow as net cash provided by operating activities for the period less purchases of property, equipment and improvements during the period. Purchases of property, equipment and improvements during the period are netted with any proceeds received from insurance on casualty loss that are directly related to the reinvestment of new capital expenditures. The following table reconciles net cash provided by operating activities, a GAAP financial measure, to free cash flow, a non-GAAP financial measure (in thousands):
                 
    Nine months ended October 31,  
    2010     2009  
Net cash provided by operating activities
  $ 6,986     $ 13,652  
Purchase of property, equipment and improvements, net
    (9,259 )     (8,683 )
 
           
Free cash flow
  $ (2,273 )   $ 4,969  
 
           

 

18


Table of Contents

EBITDA and Adjusted EBITDA
EBITDA is defined as net income (loss) before interest expense (net), income tax expense (benefit), property and equipment depreciation expense and amortization. Adjusted EBITDA, as presented herein, is EBITDA excluding gift card breakage revenue, stock-based compensation expense and store asset impairment expense. The following table reconciles net income (loss), a GAAP financial measure, to EBITDA and adjusted EBITDA, non-GAAP financial measures (in thousands):
                                 
    Three months ended October 31,     Nine months ended October 31,  
    2010     2009     2010     2009  
Net loss
  $ (3,079 )   $ (3,436 )   $ (2,143 )   $ (2,130 )
Adjusted for
                               
Interest expense, net
    374       211       695       778  
Income tax benefit
    (2,134 )     (1,485 )     (1,802 )     (560 )
Property and equipment depreciation expense
    4,365       4,744       12,989       14,327  
 
                       
EBITDA
    (474 )     34       9,739       12,415  
 
                               
Gift card breakage revenue
    (149 )           (537 )      
Non-cash stock-based compensation
    144       68       481       224  
Store asset impairment expense
                      155  
 
                       
 
                               
Adjusted EBITDA
  $ (479 )   $ 102     $ 9,683     $ 12,794  
 
                       
Adjusted Operating Income (Loss)
Adjusted operating income (loss) is defined as operating income excluding gift card breakage revenue, stock based compensation expense and store asset impairment expense. The following table reconciles operating income (loss), a GAAP financial measure, to adjusted operating income (loss), a non-GAAP financial measure (in thousands):
                                 
    Three months ended October 31,     Nine months ended October 31,  
    2010     2009     2010     2009  
Operating loss
  $ (4,885 )   $ (4,727 )   $ (3,341 )   $ (2,008 )
Adjusted for
                               
Gift card breakage revenue
    (149 )           (537 )      
Non-cash stock-based compensation
    144       68       481       224  
Store asset impairment expense
                      155  
 
                       
 
                               
Adjusted operating loss
  $ (4,890 )   $ (4,659 )   $ (3,397 )   $ (1,629 )
 
                       
Free cash flow, EBITDA, adjusted EBITDA, and adjusted operating income (loss) are considered non-GAAP financial measures under the SEC’s Regulation G and therefore should not be considered in isolation of, or as a substitute for, net income, operating income (loss), cash flow from operating activities, or any other measure of financial performance or liquidity presented in accordance with GAAP. The financial measures of non-GAAP free cash flow, EBITDA, adjusted EBITDA, and adjusted operating income (loss) may vary among other companies. Therefore, our free cash flow, EBITDA, adjusted EBITDA, and adjusted operating income (loss) may not be comparable to similarly titled measures used by other companies.
Liquidity and Capital Resources
We generate cash from operations from the sale of merchandise and the rental of products, most of which is received in cash and cash equivalents. Our primary sources of working capital are cash flow from operating activities including trade credit from vendors and borrowings under our revolving credit facility, with the most significant source during the first nine months of fiscal 2010 and 2009 being cash flow from operating activities. Other than our principal capital requirements arising from the purchasing, warehousing and merchandising of inventory and rental products, opening new stores and expanding or reformatting existing stores and updating existing and implementing new information systems technology, we have no anticipated material capital commitments, except for the stock buyback programs discussed more fully in Item 2 of Part II of this Quarterly Report on Form 10-Q. We believe our cash flow from operations and borrowings under our revolving credit facility will be sufficient to fund our ongoing operations, new stores, store expansions, and store reformations for the next twelve months.
At October 31, 2010, total outstanding debt was approximately $44.1 million. We project our outstanding debt level will be in the range of $40.5 million to $42.5 million by the end of fiscal 2010. At October 31, 2010, we had approximately $44.2 million in excess availability, after the $10 million availability reserve, under the Amended Agreement (as defined below).

 

19


Table of Contents

Consolidated Cash Flows
Operating Activities. Net cash provided by operating activities totaled approximately $7.0 million for the nine months ended October 31, 2010, compared to $13.7 million for the nine months ended October 31, 2009. Net loss for the nine months ended October 31, 2010 and 2009 was approximately $2.1 million. Merchandise inventories increased approximately $11.0 million for the current nine months, compared to an increase of $24.6 million during the same period in fiscal 2009 primarily due to differences in the timing and amount of inventory build-up based on anticipated sales for the holiday season. Trade accounts payable increased $21.3 million for the current nine months compared to an increase of $35.0 million during the same period in fiscal 2009, primarily due to the lower increase in merchandise inventories in the current period and differences in timing of payments to vendors surrounding the holiday purchases in the current year compared to the prior year. Merchandise inventories, net of trade accounts payable decreased approximately $10.2 million for the current nine months compared to a decrease of $10.5 million for the same period in the prior year. Accrued expenses and other liabilities decreased approximately $1.2 million during the period compared to a decrease of $5.8 million during the same period in fiscal 2009. Other current assets increased approximately $3.0 million during the period compared to an increase of $1.0 million during the same period in fiscal 2009. The changes in accrued expenses and other liabilities and other current assets were primarily driven by the timing of federal income tax payments. Purchases of rental video increased to $20.1 million for the period, compared to $15.8 million for the same period in the prior year, resulting primarily from increased purchases to support additional demand resulting from competitor stores that have closed during the first nine months of fiscal 2010 in markets in which we operate. During fiscal 2010, we estimate net cash provided by operations of approximately $15.0 to $17.0 million. The expected decrease from fiscal 2009 net cash provided by operations of $26.6 million to estimated fiscal 2010 net cash provided by operations results primarily from projected increases in the purchases of rental asset inventory during fiscal 2010.
Investing Activities. Net cash used in investing activities increased approximately $0.6 million from $8.7 million for the nine months ended October 31, 2009, to $9.3 million for the nine months ended October 31, 2010. This increase was primarily due to increased expenditures related to relocated, remodeled and reformatted stores during the current nine months. For the full fiscal year 2010, the Company projects capital expenditures to be approximately $12.5 million, which includes approximately $1.6 million related to the reformatting of twenty stores to expand the footprint of our Comics category, and $0.7 million to expand the Comics footprint in another 100 stores on a smaller scale, with remaining planned discretionary capital expenditures related to new stores, relocated stores and our internet site. The Company incurred approximately $11.3 million of capital expenditures during fiscal year 2009.
Financing Activities. Cash flows from financing activities are primarily associated with borrowings and payments made under our revolving credit facility (described below under “Capital Structure”). For the nine months ended October 31, 2010, cash provided by financing activities was approximately $0.1 million compared to cash used of $6.4 million for the nine months ended October 31, 2009. For the current nine months, net borrowings from our revolving credit facility were approximately $5.9 million compared to net repayments of approximately $2.2 million for same period in the prior year. Changes in our cash overdraft position decreased from a use of $3.2 million for the nine months ended October 31, 2009 to cash provided of approximately $3,000 for the nine months ended October 31, 2010, due to the timing of payments issued to vendors during the period. The Company purchased approximately $5.5 million of treasury stock during the nine months ended October 31, 2010 compared to $1.0 million during the nine months ended October 31, 2009.

 

20


Table of Contents

On December 4, 2009, we entered into a stock transfer agreement with the Marmaduke Family Limited Partnership (the “Partnership”). Under the stock transfer agreement, for a period of three years following the death of Mr. John H. Marmaduke, the Company’s President and Chief Executive Officer, the Partnership may tender for purchase to the Company, and, if so tendered, the Company will be required to purchase, the number of shares of the Company’s common stock belonging to the Partnership that equal an aggregate fair market value of $5.0 million. During this three year period, the Partnership may elect to tender portions of such shares in various lots and parcels, at any time and from time to time, and any tender shall not exhaust or limit the Partnership’s right to tender an additional amount of such shares, subject to the limitations set within the stock transfer agreement. Under the stock transfer agreement, the Company is not obligated to purchase, and the Partnership does not have the right to tender, any amount of such shares with an aggregate fair market value in excess of $5.0 million. In the event that Mr. Marmaduke resigns as an officer or director of the Company prior to his death, the Partnership’s right to tender the shares to the Company shall terminate. The stock transfer agreement shall terminate on the earlier of February 9, 2019, or four years after the death of Mr. Marmaduke. The Company is currently the beneficiary of a $10 million key-man life insurance policy on Mr. Marmaduke, a portion of the proceeds of which would be used to complete any purchases of shares resulting from the stock transfer agreement.
Capital Structure. On July 22, 2010, we entered into the Amended and Restated Loan and Security Agreement (the “Amended Agreement”) with Bank of America, N.A., as agent, which amended and restated our Loan and Security Agreement dated as of August 29, 2000, as otherwise amended (the “Prior Agreement”). The Amended Agreement is substantially the same as the Prior Agreement, extends the maturity date of the Prior Agreement from August 29, 2011 to July 22, 2014, and provides that we may repurchase up to $10.0 million worth of our common stock. The Amended Agreement also provides that we may repurchase additional shares of our common stock in the event we meet certain criteria set forth in the Amended Agreement. The Amended Agreement prohibits the payment of dividends and includes certain other debt and acquisition limitations and requires a minimum availability of $10.0 million at all times. The Amended Agreement is secured by substantially all of the assets of the Company and our subsidiary and is guaranteed by our subsidiary.
The amount outstanding under the Amended Agreement is limited by a borrowing base predicated on the sum of (a) 85% of Eligible Credit Card Receivables plus (b) (i) 85% multiplied by (ii) the Appraised Inventory Liquidation Value multiplied by (iii) Eligible Inventory (net of Inventory Reserves), less (c) Availability Reserves (each term as defined in the Amended Agreement), and is limited to a ceiling of $100 million, less a $10 million availability reserve. The lender may increase specifically defined reserves to reduce availability in the event of adverse changes in our industry or our financial condition, that are projected to impact the value of our assets pledged as collateral. The lender must exercise reasonable judgment and act in good faith with respect to any changes in the specifically defined reserves.
Interest under the Amended Agreement will accrue, at our election, at a Base Rate or Libor Rate, plus, in each case, an Applicable Margin, which is determined by reference to the level of Availability as defined in the Amended Agreement, with the Applicable Margin for Libor Rate loans ranging from 2.00% to 2.75% and the Applicable Margin for Base Rate loans ranging from 1.00% to 1.75%. In addition, unused line fees ranging from 0.30% to 0.375% (determined by reference to the level of usage under the Amended Agreement) are also payable on unused commitments.
At October 31, 2010, we had approximately $44.2 million in excess availability, after the $10 million availability reserve, under the Amended Agreement. We expect to have approximately $51.0 million in excess availability, after the $10 million availability reserve and outstanding letters of credit, at January 31, 2011. However, excess availability may be reduced in the future as changes in the borrowing base occur or the lenders increase availability reserves. The average rate of interest incurred for the three and nine months ended October 31, 2010 was 3.0% and 2.4%, respectively. Deferred financing costs that were amortized into interest expense during the three and nine months ended October 31, 2010 are excluded from the calculation of the average rate of interest for each respective period.
We utilize standby letters of credit to support certain insurance policies. The aggregate amount of the letters of credit at October 31, 2010, was approximately $0.8 million, which reduces the excess availability under the Amended Agreement.
At October 31, 2010, our minimum lease commitments for the remainder of fiscal 2010 were approximately $4.5 million. Total existing minimum operating lease commitments for fiscal years 2010 through 2025 were approximately $167.6 million as of October 31, 2010.

 

21


Table of Contents

Contractual obligations and off-balance sheet arrangements. We have contractual obligations associated with ongoing business and financing activities, which will result in cash payments in future periods. These obligations include long-term debt, operating leases and certain revenue-sharing agreements. As of October 31, 2010, other than operating leases and standby letters of credit, we had not entered into any off-balance sheet arrangements or third-party guarantees, nor does our business ordinarily require us to do so. At October 31, 2010, there have been no material changes in our contractual obligations or off-balance sheet arrangements from those reported in our Annual Report on Form 10-K for the fiscal year ended January 31, 2010.
Seasonality
As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating income, is generated in the fourth fiscal quarter, which includes the holiday selling season. As a result, a substantial portion of our annual earnings has been, and will continue to be, dependent on the results of the fourth quarter, which could be impacted by the extremely challenging times that the U.S. and global economies are currently experiencing, the conditions of which have had and will continue to have an adverse impact on spending by Hastings’ current retail customer base and potential new customers. Less than satisfactory net sales for such period could have a material adverse effect on the Company’s financial condition or results of operations for the year and may not be sufficient to cover any losses that may have been incurred in the first three quarters of the year. We experience reduced video rental activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games or the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of superstore openings, the number and popularity of new book, music and video titles, the cost of the new release or “best renter” titles, changes in comparable-store revenues, competition, marketing programs, increases in the minimum wage, weather, special or unusual events and other factors that may affect our operations.
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
In the ordinary course of our business, we are exposed to certain market risks, primarily changes in interest rates. Our exposure to interest rate risk consists of variable rate debt based on the lender’s Base Rate or LIBOR plus a specified percentage, at our option. The annual impact on our results of operations of a 100 basis point interest rate change on the October 31, 2010 outstanding balance of the variable rate debt would be approximately $0.4 million. After an assessment of these risks to our operations, we believe that the primary market risk exposures (within the meaning of Regulation S-K Item 305) are not material and are not expected to have any material adverse impact on our financial position, results of operations or cash flows for the next fiscal year.
ITEM 4 – CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
We performed an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended (“Exchange Act”) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as defined by Exchange Act Rules 13a-15(e) and 15d-15(e), were effective as of the end of the period covered by this Quarterly Report on Form 10-Q to provide reasonable assurance that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

 

22


Table of Contents

Changes in Internal Control over Financial Reporting
Management has implemented a process to monitor and assess both the design and operating effectiveness of internal control over financial reporting. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
There has not been any change in our internal control over financial reporting during our fiscal quarter ended October 31, 2010, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS.
We are involved in various claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on our financial position, results of operations, or cash flows.
ITEM 1A – RISK FACTORS.
Our Annual Report on Form 10-K for the fiscal year ended January 31, 2010 includes a detailed discussion of our risk factors. Since that time, there have been no material changes to our risk factors.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
A summary of our purchases of shares of common stock for the three months ended October 31, 2010 is as follows:
ISSUER PURCHASES OF EQUITY SECURITIES
                                 
                            Approximate dollar  
                    Total number of     value of shares that  
            Average     shares purchased     may yet be  
    Total number     price     as part of publicly     purchased under  
    of shares     paid per     announced plans     the plans or  
Period   purchased (1)     share     or programs     programs (2)  
August 1, 2010 through August 31, 2010
    86,900     $ 7.40       86,900       N/A  
September 1, 2010 through September 30, 2010
    38,635       7.34       38,635       N/A  
October 1, 2010 through October 31, 2010
    20,900       6.70       20,900       N/A  
 
                         
Total
    146,435     $ 7.29       146,435     $ 9,166,914  
 
                         
     
(1)  
All shares were open-market purchases made under a repurchase plan publicly announced in a press release dated September 28, 2001. Our Board of Directors initially authorized the repurchase of up to $5.0 million of our common stock. To date, the Board of Directors has approved the repurchase of up to an additional $32.5 million of our common stock. Each such authorization to increase amounts was publicly announced in a press release. The repurchases satisfied the conditions of the safe harbor of Rule 10b-18 under the Exchange Act.
 
(2)  
A total of 4,531,680 shares have been purchased under the repurchase plan at a total cost of approximately $28.3 million, or approximately $6.25 per share.

 

23


Table of Contents

ITEM 6 – EXHIBITS.
  a.  
The following exhibits are filed herewith or incorporated by reference as indicated as required by Item 601 of Regulation S-K. Any exhibits designated by an asterisk are management contracts and/or compensatory plans or arrangement required to be filed as exhibits to this Quarterly Report on Form 10-Q.
                 
Exhibit            
Number           Description of Documents
               
 
  3.1       (1 )  
Third Restated Articles of Incorporation of the Company.
  3.2       (2 )  
Amended and Restated Bylaws of the Company.
  4.1       (3 )  
Specimen of Certificate of Common Stock of the Company.
  4.2       (1 )  
Third Restated Articles of Incorporation of the Company (see 3.1 above).
  4.3       (2 )  
Amended and Restated Bylaws of the Company (see 3.2 above).
  31.1       (4 )  
Principal Executive Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).
  31.2       (4 )  
Principal Financial Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).
  32.1       (4 )  
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
(1)  
Previously filed as an exhibit to the Company’s Registration Statement on Form S-1, dated March 18,1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
 
(2)  
Previously filed as an exhibit to the Company’s Form 8-K (File No. 000-24381) filed on January 17, 2008 and incorporated herein by reference.
 
(3)  
Previously filed as an exhibit to the Company’s Registration Statement on Form S-1/A, dated May 19,1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
 
(4)  
Filed herewith.

 

24


Table of Contents

SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:
         
  HASTINGS ENTERTAINMENT, INC
 
 
Date: December 3, 2010  /s/ Dan Crow    
  Dan Crow   
  Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer) 
 

 

25


Table of Contents

INDEX TO EXHIBITS
             
Exhibit        
Number       Description of Documents
           
 
  3.1     (1)  
Third Restated Articles of Incorporation of the Company.
  3.2     (2)  
Amended and Restated Bylaws of the Company.
  4.1     (3)  
Specimen of Certificate of Common Stock of the Company.
  4.2     (1)  
Third Restated Articles of Incorporation of the Company (see 3.1 above).
  4.3     (2)  
Amended and Restated Bylaws of the Company (see 3.2 above).
  31.1     (4)  
Principal Executive Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).
  31.2     (4)  
Principal Financial Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).
  32.1     (4)  
Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
(1)  
Previously filed as an exhibit to the Company’s Registration Statement on Form S-1, dated March 18,1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
 
(2)  
Previously filed as an exhibit to the Company’s Form 8-K (File No. 000-24381) filed on January 17, 2008 and incorporated herein by reference.
 
(3)  
Previously filed as an exhibit to the Company’s Registration Statement on Form S-1/A, dated May 19,1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.
 
(4)  
Filed herewith.

 

26