Attached files

file filename
EXCEL - IDEA: XBRL DOCUMENT - HASTINGS ENTERTAINMENT INCFinancial_Report.xls
EX-31.1 - EXHIBIT 31.1 - HASTINGS ENTERTAINMENT INCc19748exv31w1.htm
EX-31.2 - EXHIBIT 31.2 - HASTINGS ENTERTAINMENT INCc19748exv31w2.htm
EX-32.1 - EXHIBIT 32.1 - HASTINGS ENTERTAINMENT INCc19748exv32w1.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 July 31, 2011
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   79102
(Address of principal executive offices)   (Zip Code)
(806) 351-2300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes 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 þ 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 July 31, 2011
     
Common Stock, $.01 par value per share   8,608,956 shares
 
 

 

 


 

HASTINGS ENTERTAINMENT, INC.
Form 10-Q
For the Quarterly Period Ended July 31, 2011
INDEX
         
    Page  
 
 
       
 
       
       
 
       
    3  
 
       
    4  
 
       
    5  
 
       
    6  
 
       
    10  
 
       
    22  
 
       
    22  
 
       
       
 
       
    23  
 
       
    23  
 
       
    23  
 
       
    24  
 
       
    25  
 
       
    26  
 
       
 Exhibit 31.1
 Exhibit 31.2
 Exhibit 32.1
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT

 

2


Table of Contents

PART I — FINANCIAL INFORMATION
ITEM 1  
— FINANCIAL STATEMENTS
HASTINGS ENTERTAINMENT, INC.
Consolidated Balance Sheets
July 31, 2011 and January 31, 2011
(Dollars in thousands, except par value)
                 
    July 31,     January 31,  
    2011     2011  
    (Unaudited)        
Assets
               
 
               
Current assets:
               
Cash and cash equivalents
  $ 7,277     $ 6,149  
Merchandise inventories, net
    158,067       146,636  
Deferred income taxes
    6,237       6,022  
Prepaid expenses and other current assets
    12,756       11,742  
 
           
Total current assets
    184,337       170,549  
Rental assets, net of accumulated depreciation of $20,372 and $20,312 at July 31, 2011 and January 31, 2011, respectively
    13,056       13,129  
Property, equipment and improvements, net of accumulated depreciation of $211,325 and $204,225 at July 31, 2011 and January 31, 2011, respectively
    41,092       41,588  
Deferred income taxes
    421       1,668  
Intangible assets, net
    391       391  
Other assets
    2,267       2,358  
 
           
Total Assets
  $ 241,564     $ 229,683  
 
           
 
               
Liabilities and Shareholders’ Equity
               
Current liabilities:
               
Trade accounts payable
  $ 62,690     $ 60,555  
Accrued expenses and other current liabilities
    25,424       26,124  
 
           
Total current liabilities
    88,114       86,679  
Long term debt
    45,955       31,766  
Other liabilities
    6,712       6,512  
 
               
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 8,608,956 shares outstanding at July 31, 2011;
11,944,544 shares issued and 8,743,550 shares outstanding at January 31, 2011
    119       119  
Additional paid-in capital
    36,935       36,673  
Retained earnings
    84,947       88,589  
Accumulated other comprehensive income
    118       107  
Treasury stock, at cost 3,335,588 shares and 3,200,994 shares at July 31, 2011 and January 31, 2011, respectively
    (21,336 )     (20,762 )
 
           
Total Shareholders’ Equity
    100,783       104,726  
 
           
Total Liabilities and Shareholders’ Equity
  $ 241,564     $ 229,683  
 
           
See accompanying notes to unaudited consolidated financial statements.

 

3


Table of Contents

HASTINGS ENTERTAINMENT, INC.
Unaudited Consolidated Statements of Operations
For the Three and Six Months Ended July 31, 2011 and 2010
(Dollars in thousands, except per share amounts)
                                 
    Three Months Ended July 31,     Six Months Ended July 31,  
    2011     2010     2011     2010  
 
 
Merchandise revenue
  $ 92,828     $ 98,588     $ 197,291     $ 206,713  
Rental revenue
    17,423       20,349       36,951       41,128  
Gift card breakage revenue
    284       194       430       388  
 
                       
Total revenues
    110,535       119,131       234,672       248,229  
 
                               
Merchandise cost of revenue
    63,889       66,869       136,009       141,295  
Rental cost of revenue
    6,886       7,607       14,171       15,312  
 
                       
Total cost of revenues
    70,775       74,476       150,180       156,607  
 
                       
 
                               
Gross profit
    39,760       44,655       84,492       91,622  
 
                               
Selling, general and administrative expenses
    44,717       44,642       88,427       90,078  
Pre-opening expenses
    154             212        
 
                       
 
                               
Operating income (loss)
    (5,111 )     13       (4,147 )     1,544  
 
                               
Other income (expense):
                               
Interest expense
    (287 )     (189 )     (489 )     (321 )
Other, net
    118       25       137       45  
 
                       
 
                               
Income (loss) before income taxes
    (5,280 )     (151 )     (4,499 )     1,268  
 
                               
Income tax expense (benefit)
    (1,225 )     (69 )     (857 )     332  
 
                       
 
                               
Net income (loss)
  $ (4,055 )   $ (82 )   $ (3,642 )   $ 936  
 
                       
 
                               
Basic income (loss) per share
  $ (0.47 )   $ (0.01 )   $ (0.42 )   $ 0.10  
 
                       
 
                               
Diluted income (loss) per share
  $ (0.47 )   $ (0.01 )   $ (0.42 )   $ 0.10  
 
                       
 
                               
Weighted-average common shares outstanding:
                               
Basic
    8,600       9,090       8,655       9,258  
Dilutive effect of stock awards
                      290  
 
                       
 
                               
Diluted
    8,600       9,090       8,655       9,548  
 
                       
See accompanying notes to unaudited consolidated financial statements.

 

4


Table of Contents

HASTINGS ENTERTAINMENT, INC.
Unaudited Consolidated Statements of Cash Flows
For the Six Months Ended July 31, 2011 and 2010
(Dollars in thousands)
                 
    Six Months Ended  
    July 31,  
    2011     2010  
 
 
Cash flows from operating activities:
               
Net income (loss)
  $ (3,642 )   $ 936  
Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:
               
Rental asset depreciation expense
    5,923       5,697  
Purchases of rental assets
    (12,163 )     (12,129 )
Property, equipment and improvements depreciation expense
    8,674       8,624  
Deferred income taxes
    1,025       (709 )
Loss on rental assets lost, stolen and defective
    872       981  
Loss on disposal or impairment of property and equipment, excluding rental assets
    59       26  
Non-cash stock-based compensation
    639       337  
Changes in operating assets and liabilities:
               
Merchandise inventories
    (5,988 )     34  
Prepaid expenses and other current assets
    (1,014 )     (528 )
Trade accounts payable
    1,750       2,163  
Accrued expenses and other current liabilities
    (685 )     (2,266 )
Excess tax benefit from stock-based compensation
    (15 )     (37 )
Other assets and liabilities, net
    377       (52 )
 
           
Net cash provided by (used in) operating activities
    (4,188 )     3,077  
 
           
 
               
Cash flows from investing activities:
               
Purchases of property, equipment and improvements
    (8,239 )     (5,483 )
 
           
Net cash used in investing activities
    (8,239 )     (5,483 )
 
           
 
               
Cash flows from financing activities:
               
Borrowings under revolving credit facility
    265,053       263,344  
Repayments under revolving credit facility
    (250,864 )     (257,644 )
Purchase of treasury stock
    (979 )     (4,401 )
Change in cash overdraft
    385       (995 )
Deferred financing costs paid
    (68 )     (549 )
Proceeds from exercise of stock options
    13       178  
Excess tax benefit from stock-based compensation
    15       37  
 
           
Net cash provided by (used in) financing activities
    13,555       (30 )
 
           
 
               
Net increase (decrease) in cash and cash equivalents
    1,128       (2,436 )
Cash and cash equivalents at beginning of period
    6,149       8,863  
 
           
Cash and cash equivalents at end of period
  $ 7,277     $ 6,427  
 
           
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, 2011.
The balance sheet at January 31, 2011 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, 2011.
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, 2012 is referred to as fiscal year 2011.
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 12 to the Audited Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended January 31, 2011.
For the three months ended July 31, 2011 and 2010, we recognized approximately $0.3 million and $0.1 million, respectively, of stock-based compensation expense. For the six months ended July 31, 2011 and 2010, we recognized approximately $0.6 million and $0.3 million, respectively, of stock-based compensation expense. These amounts include expense related to incentive stock options, non-qualified stock options, and restricted stock units.
As of July 31, 2011, we had 307,021 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 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”), and on July 21, 2011, we entered into an amendment (the “First Amendment”) to the Amended Agreement with Bank of America, N.A (collectively, the “Amended Agreement”). The First Amendment increased the revolving credit facility from $100 million to $115 million increased our borrowing base, lowered our interest rates, and allowed for the payment of dividends, which was previously prohibited under the Amended 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 includes certain debt and acquisition limitations and requires a minimum availability of 10% of the lesser of (a) the Borrowing Base, and (b) the Revolving Credit Ceiling, provided however that we must also maintain Availability that is greater than or equal to $10 million at all times. Our obligations under the Amended Agreement are secured by a pledge of substantially all of the assets of the Company and our subsidiary and are 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) either (i) at all times during the year, other than those stated in (ii), 90% of the liquidation value of eligible inventory or (ii) from September 1st through and including December 27th of each year, 92.5% of the liquidation value of eligible inventory, less (c) Availability Reserves (each term as defined in the Amended Agreement and First Amendment), and is limited to a ceiling of $115 million, less a minimum availability reserve that is greater than or equal to 10% of the lesser of (a) the Borrowing Base, and (b) the Revolving Credit Ceiling, provided however that we must also maintain Availability that is greater than or equal to $10 million at all times. 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 2.50% and the Applicable Margin for Base Rate loans ranging from 1.00% to 1.50%. 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 July 31, 2011, was approximately $0.7 million, which reduces the excess availability under the Amended Agreement.
At July 31, 2011, we had approximately $57.2 million in excess availability, after the availability reserve, under the Amended Agreement. The average rates of interest incurred for the three months ended July 31, 2011 and 2010 were 2.6% and 2.1%, respectively. The average rates of interest incurred for the six months ended July 31, 2011 and 2010 were 2.6% and 2.0%, respectively. Deferred financing costs that were amortized into interest expense during the three and six months ended July 31, 2011 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. Income per Share
The computations for basic and diluted income per share are as follows:
                                 
    Three Months Ended July 31,     Six Months Ended July 31,  
    2011     2010     2011     2010  
 
 
Net income (loss)
  $ (4,055 )   $ (82 )   $ (3,642 )   $ 936  
 
                       
 
                               
Average shares outstanding:
                               
Basic
    8,600       9,090       8,655       9,258  
Effect of stock awards
                      290  
 
                       
Diluted
    8,600       9,090       8,655       9,548  
 
                       
 
                               
Income (loss) per share:
                               
Basic
  $ (0.47 )   $ (0.01 )   $ (0.42 )   $ 0.10  
 
                       
 
                               
Diluted
  $ (0.47 )   $ (0.01 )   $ (0.42 )   $ 0.10  
 
                       
The following options to purchase shares of common stock were not included in the computation of diluted income per share because their inclusion would have been antidilutive:
                                 
    Three Months Ended July 31,     Six Months Ended July 31,  
    2011     2010     2011     2010  
Shares of common stock underlying options
    783       637       783       233  
 
                               
Exercise price range per share
  $1.69 to $8.70     $1.69 to $8.70     $1.69 to $8.70     $4.25 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 July 31, 2011 and January 31, 2011, we had approximately $1.5 million and $1.4 million, respectively, in assets which are carried at fair value on a recurring basis. These assets, which are reflected in Other Assets in the consolidated balance sheets, 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.
Our long-term debt approximates fair value as of both July 31, 2011 and January 31, 2011, due to the instrument bearing interest at variable rates that are comparable to what is currently available to us. We entered into the First Amendment with Bank of America on July 21, 2011, at which time our current interest rates were determined. See Note 3 on Debt for a more detailed discussion of the Amended Agreement.

 

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)
6. Income Taxes
The effective tax rate for the three months ended July 31, 2011 was (23.2%), as compared to (45.7%) for the same period in the prior year. This rate difference resulted primarily from the relationship between permanent book to tax differences incurred (which typically stay consistent for each quarter in a fiscal year) in comparison to the level of book loss before taxes for the respective quarters. The rate was also affected by certain state margin and other franchise related taxes that are not based on income or loss before taxes and as such remain consistent between the periods while the Company’s loss before taxes was significantly more than the same period in the prior year.
The effective tax rate for the six months ended July 31, 2011 was (19.1%) compared to 26.2% for the same period in the prior year. This rate difference resulted primarily from the relationship between permanent book to tax differences incurred in comparison to the level of book income or loss before taxes for the respective periods. The rate was also affected by certain state margin and other franchise related taxes that are not based on income or loss before taxes and as such remain consistent between the periods while the Company’s loss before taxes was significantly more than the same period in the prior year. During the six months ended July 31, 2010, we recorded a discrete tax benefit of approximately $0.2 million related to amended state returns resulting from an Internal Revenue Service audit of our previously filed Federal tax returns.
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
During June 2011, the Financial Accounting Standards Board issued ASU 2011-05: Comprehensive Income (Topic 220), Presentation of Comprehensive Income (“ASU 2011-05”) which amends existing guidance to allow companies two choices of how to present items of net income (loss), items of other comprehensive income (loss) and total comprehensive income (loss): (1) in one continuous statement of comprehensive income (loss) or (2) in two separate consecutive statements. Under the new guidance, companies will no longer be allowed to present other comprehensive income (loss) in the statement of stockholder’s equity. Also, companies will be required to present the components of other comprehensive income (loss) in their interim and annual financial statements. ASU 2011-05 requires retrospective application and is effective, for public companies, for fiscal years, and interim periods within those years, beginning after December 15, 2011. The Company will adopt ASU 2011-05 beginning with fiscal 2012 and does not anticipate any material impact on the Company’s consolidated 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 opinions 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 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; the effect of inclement weather on the ability of consumers to reach our stores 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 July 31, 2011, we operated 145 superstores principally in medium-sized markets located in 20 states, primarily in the Western and Midwestern United States. We also operate two concept stores, Sun Adventure Sports, in Amarillo, Texas and TRADESMART, in Littleton, Colorado.
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 ending January 31, 2012 is referred to as fiscal 2011.

 

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 our more significant estimates and assumptions used in the preparation of our financial statements. Our significant estimates and assumptions are reviewed, and any required adjustments are recorded, on a monthly 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 cost 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, in addition to certain other property and equipment, is subject to impairment write-down.

 

11


Table of Contents

Income Taxes. In determining net income (loss), we make certain estimates and judgments in the calculation of the tax provision 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 the grant date, 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. Prior to the fourth quarter of fiscal 2009, 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 final determination of the escheatment laws applicable to our operations. As a result, during the fourth quarter of fiscal 2009, we recorded approximately $8.5 million of revenue related to the initial change in 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     Six Months Ended  
    July 31,     July 31,  
    2011     2010     2011     2010  
 
 
Merchandise revenue
    84.0 %     82.8 %     84.1 %     83.3 %
Rental revenue
    15.8       17.1       15.7       16.6  
Gift card breakage revenue
    0.2       0.1       0.2       0.1  
 
                       
Total revenues
    100.0       100.0       100.0       100.0  
 
 
Merchandise cost of revenue
    68.8       67.8       68.9       68.4  
Rental cost of revenue
    39.5       37.4       38.4       37.2  
 
                       
Total cost of revenues
    64.0       62.5       64.0       63.1  
 
                       
 
 
Gross profit
    36.0       37.5       36.0       36.9  
 
 
Selling, general and administrative expenses
    40.5       37.5       37.7       36.3  
Pre-opening expenses
    0.1             0.1        
 
                       
 
 
Operating income (loss)
    (4.6 )           (1.8 )     0.6  
 
 
Other income (expense):
                               
Interest expense
    (0.3 )     (0.2 )     (0.2 )     (0.1 )
Other, net
    0.1             0.1        
 
                       
 
 
Income (loss) before income taxes
    (4.8 )     (0.2 )     (1.9 )     0.5  
 
 
Income tax expense (benefit)
    (1.1 )     (0.1 )     (0.3 )     0.1  
 
                       
 
 
Net income (loss)
    (3.7 )%     (0.1 )%     (1.6 )%     0.4 %
 
                       
 
Summary of Superstore Activity(1)
                                         
    Three Months Ended     Six Months Ended     Year Ended  
    July 31,     July 31,     January 31,  
    2011     2010     2011     2010     2011  
 
 
Beginning number of stores
    146       147       146       149       149  
Openings
                1              
Closings
    (1 )           (2 )     (2 )     (3 )
 
                             
Ending number of stores
    145       147       145       147       146  
 
                             
     
(1)  
As of July 31, 2011, we operated one concept store, Sun Adventure Sports, which was not included in the summary of superstore activity. Our second concept store, TRADESMART, was opened on August 1, 2011.

 

13


Table of Contents

Financial Results for the Second Quarter of Fiscal Year 2011
Operating loss and adjusted operating loss were approximately $5.1 million for the second quarter of fiscal 2011 compared to operating income and adjusted operating income of approximately $13,000 for the second quarter of fiscal 2010. Adjusted operating income (loss) excludes gift card breakage revenue and stock compensation expense. Earnings before interest, taxes, property and equipment depreciation expense and amortization (“EBITDA”) was approximately ($0.5 million) for the second quarter of fiscal 2011 compared to approximately $4.3 million for the second quarter of fiscal 2010. Adjusted EBITDA, which excludes gift card breakage revenue and stock compensation expense, was approximately ($0.4 million) for the second quarter of fiscal 2011 compared to approximately $4.3 million for the second quarter of fiscal 2010.
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 second quarter decreased approximately $8.6 million, or 7.2%, to $110.5 million compared to $119.1 million for the second quarter of fiscal 2010. As of July 31, 2011, we operated two fewer superstores, as compared to July 31, 2010. The following is a summary of our revenues results (dollars in thousands):
                                                 
    Three Months Ended July 31,        
    2011     2010     Increase (Decrease)  
            Percent             Percent        
    Revenues     Of Total     Revenues     Of Total     Dollar     Percent  
Merchandise Revenue
  $ 92,828       84.0 %   $ 98,588       82.8 %   $ (5,760 )     -5.8 %
Rental Revenue
    17,423       15.8 %     20,349       17.1 %     (2,926 )     -14.4 %
Gift Card Breakage Revenue
    284       0.2 %     194       0.1 %     90       46.4 %
 
                                   
Total Revenues
  $ 110,535       100.0 %   $ 119,131       100.0 %   $ (8,596 )     -7.2 %
 
                                   
         
Comparable-store revenues (“Comp”)
       
 
Total
    -8.1 %
Merchandise
    -6.6 %
Rental
    -15.1 %
Below is a summary of the Comp results for our major merchandise categories:
                 
    Three Months Ended July 31,  
    2011     2010  
Trends
    9.9 %     11.0 %
Electronics
    5.6 %     0.8 %
Hardback Café
    3.8 %     10.0 %
Video Games
    -5.1 %     23.3 %
Music
    -5.7 %     -7.5 %
Books
    -9.4 %     -1.8 %
Consumables
    -9.7 %     4.1 %
Movies
    -11.4 %     9.3 %
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 and gift card breakage are not included, and closed stores are removed from each comparable period for the purpose of calculating Comps.

 

14


Table of Contents

Trends Comps increased 9.9% for the quarter primarily driven by increased sales of apparel, action figures, comics, novelty items and collectible card games such as Magic: The Gathering. Key drivers in the apparel category included jewelry and hats. Key drivers in the novelty category included assorted tween merchandise, movie memorabilia items, and lighting and barware. Electronics Comps increased 5.6% for the quarter resulting from increased sales of refurbished iPods and headphones, partially offset by lower sales of other MP3 accessories. Hardback Café Comps increased 3.8% due to increased sales of specialty café drinks, primarily blended and iced drinks. Video Game Comps decreased 5.1% primarily due to lower sales of video game consoles, new Nintendo Wii video games, and older generation video games. These decreases were partially offset by increased sales of new and used games for the Microsoft XBOX 360 and Sony Playstation. Music Comps decreased 5.7% for the quarter due to lower sales of new and used CD’s. Books Comps decreased 9.4% for the quarter primarily due to lower sales of new and used mass market books and trade paperbacks, new hardbacks and magazines, partially offset by increased sales of used hardbacks and value books. Sales of new books, which decreased 8.1% for the quarter, were impacted by a weaker slate of titles released during the current quarter and the increasing popularity of electronic book readers. Sales of used books, which decreased 12.1% for the quarter, were also impacted by the weaker slate of new book release which in turn led to a less favorable inventory of used titles. These decreases were partially offset by a 2.1% increase in sales of value books. Consumables Comps decreased 9.7% for the quarter primarily driven by lower sales of bottled drinks and promotional candies. Movies Comps decreased 11.4% for the quarter primarily due to lower sales of new and used DVDs and DVD boxed sets, partially offset by increased sales of new and used Blu-ray movies. Our top three selling movies during the current quarter generated approximately 20% less revenue than the top three selling movies during the comparable period in the prior year.
Rental Comps decreased 15.1% for the quarter, primarily due to fewer rentals of DVDs partially offset by increased rentals of Blu-ray movies and a slight increase in rentals of video games. Rental Video Comps decreased 16.4% for the quarter and units rented decreased 16.9%. Rental Video Comps were negatively impacted by a lower quality of new releases during the current period and by competitor rental kiosks and subscription-based rental services. Rental Video Game Comps decreased 0.4%, and units rented decreased 3.3%
Gross Profit — Merchandise. For the second quarter, total merchandise gross profit dollars decreased approximately $2.8 million, or 8.8%, to $28.9 million from $31.7 million for the same period in the prior year, primarily due to lower revenues, along with lower margin rates. As a percentage of total merchandise revenue, merchandise gross profit decreased to 31.2% for the quarter compared to 32.2% for the same period in the prior year, resulting primarily from increased promotions during the quarter and a shift in mix of revenues by category as compared to the prior year, partially offset by lower shrinkage expense, lower costs to return products and lower markdown expense. The decrease in shrinkage expense is a direct result of our comprehensive store audit program that assesses store level execution and controls designed to reduce shrink, with a strong focus on our high-shrinkage stores.
Gross Profit — Rental. For the second quarter, total rental gross profit dollars decreased approximately $2.2 million, or 17.3%, to $10.5 million from $12.7 million for the same period in the prior year, primarily due to lower revenues. As a percentage of total rental revenue, rental gross profit decreased to 60.5% for the quarter compared to 62.6% for the same period in the prior year, also primarily due to lower revenues.
Selling, General and Administrative Expenses (“SG&A”). As a percentage of total revenue, SG&A increased to 40.5% for the second quarter compared to 37.5% for the same period in the prior year due to deleveraging resulting from lower revenues. SG&A increased approximately $0.1 million during the quarter, or 0.2%, to $44.7 million compared to $44.6 million for the same quarter last year. The main drivers increasing SG&A included an increase in maintenance costs of approximately $0.2 million, an increase of approximately $0.3 million in store occupancy costs, and an increase of approximately $0.2 million in new store expenses due to the opening of our new concept store, TRADESMART. These increases were primarily offset by a decrease in bonuses under our corporate officer and management bonus incentive programs of approximately $0.3 million as compared to the prior year due to the fact that no bonuses were earned for the first half of fiscal 2011.
Interest Expense. For the second quarter, interest expense increased approximately $0.1 million, or 50.0%, to $0.3 million, compared to $0.2 million for the same period in the prior year, primarily as a result of higher interest rates incurred during the quarter. The average rate of interest charged for the second quarter increased to 2.6% compared to 2.1% for the same period in the prior year.

 

15


Table of Contents

Income Tax Expense. The effective tax rate for the three months ended July 31, 2011 was (23.2%), as compared to (45.7%) for the same period in the prior year. This rate difference resulted primarily from the relationship between permanent book to tax differences incurred (which typically stay consistent for each quarter in a fiscal year) in comparison to the level of book loss before taxes for the respective quarters. The rate was also affected by certain state margin and other franchise related taxes that are not based on income or loss before taxes and as such remain consistent between the periods while the Company’s loss before taxes was significantly more than the same period in the prior year.
Financial Results for the Six Months Ended July 31, 2011
Operating loss was approximately $4.1 million for the six months ended July 31, 2011 compared to operating income of approximately $1.5 million for the same period in the prior year. Adjusted operating loss, which excludes gift card breakage revenue and stock compensation expense, was approximately $3.9 million for the current six month period compared to adjusted operating income of approximately $1.5 million for the same period in the prior year. Earnings before interest, taxes, property and equipment depreciation expense and amortization (“EBITDA”) was approximately $4.7 million for the six months ended July 31, 2011 compared to approximately $10.2 million for the same period in the prior year. Adjusted EBITDA, which excludes gift card breakage revenue and stock compensation expense, was approximately $4.9 million for the current six month period compared to approximately $10.2 million for the same period in the prior year.
Revenues. Total revenues for the six months ended July 31, 2011 decreased approximately $13.5 million, or 5.5%, to $234.7 million compared to $248.2 million for the six months ended July 31, 2010. The following is a summary of our revenues results (dollars in thousands):
                                                 
    Six Months Ended July 31,        
    2011     2010     Increase (Decrease)  
            Percent             Percent        
    Revenues     Of Total     Revenues     Of Total     Dollar     Percent  
Merchandise Revenue
  $ 197,291       84.1 %   $ 206,713       83.3 %   $ (9,422 )     -4.6 %
Rental Revenue
    36,951       15.7 %     41,128       16.6 %     (4,177 )     -10.2 %
Gift Card Breakage Revenue
    430       0.2 %     388       0.1 %     42       10.8 %
 
                                   
Total Revenues
  $ 234,672       100.0 %   $ 248,229       100.0 %   $ (13,557 )     -5.5 %
 
                                   
         
Comparable-store revenues (“Comp”)
       
 
Total
    -5.6 %
Merchandise
    -4.7 %
Rental
    -10.4 %
Below is a summary of the Comp results for our major merchandise categories:
                 
    Six Months Ended July 31,  
    2011     2010  
Trends
    10.9 %     9.9 %
Hardback Café
    4.6 %     12.9 %
Electronics
    1.1 %     2.7 %
Video Games
    -0.9 %     24.4 %
Music
    -2.1 %     -6.1 %
Consumables
    -7.8 %     6.8 %
Movies
    -8.8 %     10.3 %
Books
    -9.3 %     -1.5 %

 

16


Table of Contents

Trends Comps increased 10.9% for the period primarily driven by increased sales of apparel, new and used comics, As Seen on TV products such as Pillow Pets and shaped rubber bands, and collectible card games such as Magic: The Gathering. Key drivers in the apparel category for the period included hats, jewelry and bags. Hardback Café Comps increased 4.6% due to increased sales of specialty café drinks. Electronics Comps increased 1.1% for the period resulting from increased sales of refurbished iPods, partially offset by lower sales of Blu-ray players. Video Game Comps decreased 0.9% primarily due to lower sales of new Nintendo Wii games and used video game consoles partially offset by increased sales of new and used games for the Microsoft XBOX 360 and gaming accessories. Sales of new Nintendo Wii games were directly impacted by low allocations of Nintendo first-party titles. Music Comps decreased 2.1% for the period due to lower sales of used CDs and music DVDs, partially offset by a slight increase in sales of new CDs. Consumables Comps decreased 7.8% for the period primarily driven by lower sales of bottled and fountain drinks. Movies Comps decreased 8.8% for the period primarily due to lower sales of new and used DVDs and DVD boxed sets, partially offset by increased sales of new and used Blu-ray movies. Movie sales were negatively impacted by a 17% drop in box office value of movies that came to Blu-ray and DVD during the current period as compared to the same period in the prior year, along with a lower quality of new releases during the current period. Books Comps decreased 9.3% for the period primarily due to lower sales of new mass market books, hardbacks and trade paperbacks and lower sales of magazines. Sales of new and used books were impacted by a weaker slate of titles released during the period and the increasing popularity of electronic book readers. These decreases were partially offset by a slight lift in used hardback sales and value books.
Rental Comps decreased 10.4% for the period, primarily due to fewer rentals of DVDs partially offset by an increase in rentals of Blu-ray movies and video games. Rental Video Comps decreased 12.1% for the period and units rented decreased 12.9%. Rental Video Comps sales were negatively impacted by fewer titles released in the $20 million to $80 million gross box office range, which typically represent our best renters, by a lower quality of new releases during the current period and by competitor rental kiosks and subscription-based rental services. Rental Video Game Comps increased 3.8%, and units rented decreased 0.3%.
Gross Profit — Merchandise. For the current six months, total merchandise gross profit dollars decreased approximately $4.1 million, or 6.3%, to $61.3 million from $65.4 million for the same period in the prior year, primarily due to lower revenues, along with lower margin rates. As a percentage of total merchandise revenue, merchandise gross profit decreased to 31.1% for the current six months, compared to 31.6% for the same period in the prior year, primarily due to increased promotions and increased costs to return products, partially offset by lower shrinkage expense and lower markdown expense. The decrease in shrinkage expense is a direct result of our comprehensive store audit program that assesses store level execution and controls designed to reduce shrink, with a strong focus on our high-shrinkage stores.
Gross Profit — Rental. For the current six months, total rental gross profit dollars decreased approximately $3.0 million, or 11.6%, to $22.8 million from $25.8 million for the same period in the prior year primarily due to lower revenues. As a percentage of total rental revenue, rental gross profit decreased to 61.6% for the current six month period compared to 62.8% for the same period in the prior year, also primarily as a result of lower rental revenues.
Selling, General and Administrative Expenses (“SG&A”). As a percentage of total revenue, SG&A increased to 37.7% for the current six months compared to 36.3% for the same period in the prior year primarily due to deleveraging resulting from lower revenues. SG&A decreased approximately $1.7 million, or 1.9%, to $88.4 million compared to $90.1 million for the same period last year. The main drivers of the decrease in SG&A included a decrease in bonuses under our bonus incentive programs of approximately $0.6 million, a decrease in associate health insurance costs of approximately $0.4 million, and a decrease in advertising expenses of approximately $0.6 million.
Interest Expense. For the current six months, interest expense increased approximately $0.2 million, or 66.7%, to $0.5 million, compared to $0.3 million for the same period in the prior year primarily as a result of higher interest rates. The average rate of interest charged for the current six months increased to 2.6% compared to 2.0% for the same period in the prior year.
Income Tax Expense. The effective tax rate for the six months ended July 31, 2011 was (19.1%) compared to 26.2% for the same period in the prior year. This rate difference resulted primarily from the relationship between permanent book to tax differences incurred in comparison to the level of book income or loss before taxes for the respective periods. The rate was also affected by certain state margin and other franchise related taxes that are not based on income or loss before taxes and as such remain consistent between the periods while the Company’s loss before taxes was significantly more than the same period in the prior year. During the six months ended July 31, 2010, we recorded a discrete tax benefit of approximately $0.2 million related to amended state returns resulting from an Internal Revenue Service audit of our previously filed Federal tax returns.

 

17


Table of Contents

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 (used in) 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):
                 
    Six months ended July 31,  
    2011     2010  
Net cash provided by (used in) operating activities
  $ (4,188 )   $ 3,077  
Purchase of property, equipment and improvements, net
    (8,239 )     (5,483 )
 
           
Free cash flow
  $ (12,427 )   $ (2,406 )
 
           
EBITDA and Adjusted EBITDA
EBITDA is defined as net income (loss) before interest expense (net), income tax expense (benefit), property, equipment and impairments depreciation expense and amortization. Adjusted EBITDA, as presented herein, is EBITDA excluding gift card breakage revenue, stock-based compensation expense and store asset impairments. 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 July 31,     Six months ended July 31,  
    2011     2010     2011     2010  
Net income (loss)
  $ (4,055 )   $ (82 )   $ (3,642 )   $ 936  
Adjusted for Interest expense, net
    287       189       489       321  
Income tax expense (benefit)
    (1,225 )     (69 )     (857 )     332  
Property, equipment and improvements depreciation expense
    4,519       4,303       8,674       8,624  
 
                       
EBITDA
    (474 )     4,341       4,664       10,213  
Gift card breakage revenue
    (284 )     (194 )     (430 )     (388 )
Non-cash stock-based compensation
    337       194       639       337  
 
                       
 
                               
Adjusted EBITDA
  $ (421 )   $ 4,341     $ 4,873     $ 10,162  
 
                       

 

18


Table of Contents

Adjusted Operating Income (Loss)

Adjusted operating income (loss) is defined as operating income (loss) excluding gift card breakage revenue, stock based compensation expense and store asset impairments. 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 July 31,     Six months ended July 31,  
    2011     2010     2011     2010  
Operating income (loss)
  $ (5,111 )   $ 13     $ (4,147 )   $ 1,544  
Adjusted for
                               
Gift card breakage revenue
    (284 )     (194 )     (430 )     (388 )
Non-cash stock-based compensation
    337       194       639       337  
 
                       
 
                               
Adjusted operating income (loss)
  $ (5,058 )   $ 13     $ (3,938 )   $ 1,493  
 
                       
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 (loss), 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 six months of fiscal 2011 and 2010 being borrowings under our revolving credit facility. 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 July 31, 2011, total outstanding debt was approximately $46.0 million. We project our outstanding debt level will be in the range of $27.0 million to $29.0 million by the end of fiscal 2011. At July 31, 2011, we had approximately $57.2 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 used by operating activities totaled approximately $4.2 million for the six months ended July 31, 2011, compared to cash provided by operating activities of $3.1 million for the six months ended July 31, 2010. Net loss for the current period was approximately $3.6 million compared to net income of $0.9 million for same period in fiscal 2010. Merchandise inventories increased approximately $6.0 million for the current period, compared to a decrease of $34,000 during the same period in fiscal 2010. Trade accounts payable increased $1.8 million for the current period compared to an increase of $2.2 million during the same period in fiscal 2010, primarily due to the difference in inventory build between the periods and variance in the timing of payments to vendors. Merchandise inventories, net of trade accounts payable increased approximately $7.7 million for the current period compared to an increase of $2.1 million for the same period in the prior year primarily due to lower than anticipated sales along with the build of inventory for our new TRADESMART store which opened August 1, 2011. Accrued expenses and other liabilities decreased approximately $0.7 million during the current period compared to a decrease of $2.3 million during the same period in fiscal 2010 primarily due to the timing of payments of federal income taxes and sales taxes.
Investing Activities. Net cash used in investing activities increased approximately $2.7 million from $5.5 million for the six months ended July 31, 2010, to $8.2 million for the six months ended July 31, 2011. This increase was primarily due to increased expenditures related to two new stores, one of which opened during the current period and one which opened on August 1, 2011. For fiscal 2011, we project capital expenditures to be approximately $15.1 million. The planned increase is primarily due to increased expenditures related to our plans to open three stores, remodel three stores and relocate two stores during fiscal 2011.
Financing Activities. Cash provided by or used in financing activities is primarily associated with borrowings and payments made under our revolving credit facility (described below under “Capital Structure”). For the six months ended July 31, 2011, cash provided by financing activities was approximately $13.6 million compared to cash used in financing activities of approximately $30,000 for the six months ended July 31, 2010. For the current six months, net borrowings from our revolving credit facility were approximately $14.2 million compared to net borrowings of approximately $5.7 million for same period in the prior year. Changes in our cash overdraft position increased from a use of $1.0 million for the six months ended July 31, 2010 to cash provided of $0.4 million for the six months ended July 31, 2011, due to the timing of payments issued to vendors during the period. The Company purchased approximately $1.0 million of treasury stock during the six months ended July 31, 2011 compared to $4.4 million during the six months ended July 31, 2010.
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 (as amended, modified or otherwise supplemented from time to time, 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”), and on July 21, 2011, we entered into an amendment (the “First Amendment”) to the Amended Agreement with Bank of America, N.A (collectively, the “Amended Agreement”). The First Amendment increased the revolving credit facility from $100 million to $115 million increased our borrowing base, lowered our interest rates, and allowed for the payment of dividends, which was previously prohibited under the Amended 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 includes certain debt and acquisition limitations and requires a minimum availability of 10% of the lesser of (a) the Borrowing Base, and (b) the Revolving Credit Ceiling, provided however that we must also maintain Availability that is greater than or equal to $10 million at all times. Our obligations under the Amended Agreement are secured by a pledge of substantially all of the assets of the Company and our subsidiary and are guaranteed by our subsidiary.

 

20


Table of Contents

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) either (i) at all times during the year, other than those stated in (ii), 90% of the liquidation value of eligible inventory or (ii) from September 1st through and including December 27th of each year, 92.5% of the liquidation value of eligible inventory, less (c) Availability Reserves (each term as defined in the Amended Agreement and First Amendment), and is limited to a ceiling of $115 million, less a minimum availability reserve that is greater than or equal to 10% of the lesser of (a) the Borrowing Base, and (b) the Revolving Credit Ceiling, provided however that we must also maintain Availability that is greater than or equal to $10 million at all times. 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 2.50% and the Applicable Margin for Base Rate loans ranging from 1.00% to 1.50%. 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 July 31, 2011, we had approximately $57.2 million in excess availability, after the availability reserve, under the Amended Agreement. We expect to have approximately $60.0 million to $63.0 million in excess availability, after the availability reserve and outstanding letters of credit, at January 31, 2012. However, excess availability may be reduced in the future as changes in the borrowing base occur or the lenders increase availability reserves. The average rates of interest incurred for the three months ended July 31, 2011 and 2010 were 2.6% and 2.1%, respectively. The average rates of interest incurred for the six months ended July 31, 2011 and 2010 were 2.6% and 2.0%, respectively. Deferred financing costs that were amortized into interest expense during the three and six months ended July 31, 2011 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 July 31, 2011, was approximately $0.7 million, which reduces the excess availability under the Amended Agreement.
At July 31, 2011, our minimum lease commitments for the remainder of fiscal 2011 were approximately $11.6 million. Total existing minimum operating lease commitments for fiscal years 2011 through 2026 were approximately $162.3 million as of July 31, 2011.
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 July 31, 2011, 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 July 31, 2011, 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, 2011.

 

21


Table of Contents

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. 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 rental activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games and the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of store openings, the number and popularity of new book, music, video and video game titles, as well as the popularity of electronics and trends merchandise, the cost of 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, at our option, on the lender’s Base Rate or LIBOR, plus a specified percentage. The annual impact on our results of operations of a 100 basis point interest rate change on the July 31, 2011 outstanding balance of the variable rate debt would be approximately $0.5 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. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and, based upon the forgoing 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.
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 July 31, 2011, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

22


Table of Contents

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, 2011 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 July 31, 2011 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)  
May 1, 2011 through May 31, 2011
    28,900       4.89       28,900       N/A  
June 1, 2011 through June 30, 2011
    700       3.94       700       N/A  
July 1, 2011 through July 31, 2011
    38,800       4.57       38,800       N/A  
 
                         
Total
    68,400     $ 4.70       68,400     $ 7,290,321  
 
                         
     
(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 4,876,440 shares have been purchased under the repurchase plan at a total cost of approximately $30.2 million, or approximately $6.20 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.
101.INS
    (5 )   XBRL Instance Document
101.SCH
    (5 )   XBRL Taxonomy Extension Schema
101.CAL
    (5 )   XBRL Taxonomy Extension Calculation Linkbase
101.LAB
    (5 )   XBRL Taxonomy Extension Label Linkbase
101.PRE
    (5 )   XBRL Taxonomy Extension Presentation Linkbase
     
(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 Exhibit 3.1 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.
 
(5)  
In accordance with Regulation S-T, the XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q shall be deemed “furnished” and not “filed.”

 

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: September 9, 2011  /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.
101.INS
    (5 )   XBRL Instance Document
101.SCH
    (5 )   XBRL Taxonomy Extension Schema
101.CAL
    (5 )   XBRL Taxonomy Extension Calculation Linkbase
101.LAB
    (5 )   XBRL Taxonomy Extension Label Linkbase
101.PRE
    (5 )   XBRL Taxonomy Extension Presentation Linkbase
     
(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 Exhibit 3.1 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.
 
(5)  
In accordance with Regulation S-T, the XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q shall be deemed “furnished” and not “filed.”

 

26