10-Q 1 d97332e10vq.txt FORM 10-Q FOR QUARTER ENDED APRIL 30, 2002 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D. C. 20549 FORM 10-Q (Mark One) ( X ) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended April 30, 2002 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF SECURITIES EXCHANGE ACTION OF 1934 For the transition period from __________________ to __________________ COMMISSION FILE NUMBER 000-24381 HASTINGS ENTERTAINMENT, INC. (Exact name of registrant as specified in its charter) TEXAS 75-1386375 (State or other jurisdiction of (IRS Employer incorporation or organization) Identification No.) 3601 PLAINS BOULEVARD, AMARILLO, TEXAS 79102 (Address of principal executive offices) (Zip Code) (806) 351-2300 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ( X ) No ( ) Number of shares outstanding of the registrant's common stock, as of May 31, 2002:
Class Shares Outstanding -------------------------------------- --------------------------------- Common Stock, $.01 par value per share 11,335,327
HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES FORM 10-Q FOR THE THREE MONTHS ENDED APRIL 30, 2002 INDEX
PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Financial Statements Consolidated Balance Sheets as of April 30, 2002 (Unaudited), April 30, 2001 (Unaudited) and January 31, 2002 3 Unaudited Consolidated Statements of Operations for the Three Months Ended April 30, 2002 and 2001 4 Unaudited Consolidated Statements of Cash Flows for the Three Months Ended April 30, 2002 and 2001 5 Notes to Unaudited Consolidated Financial Statements 6 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 10 Item 3. Quantitative and Qualitative Disclosures about Market Risk 15 PART II - OTHER INFORMATION Item 1. Legal Proceedings 16 Item 6. Exhibits and Reports on Form 8-K 16 SIGNATURE PAGE 17 INDEX TO EXHIBITS 18
2 PART 1 ITEM 1 - FINANCIAL STATEMENTS HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES Consolidated Balance Sheets April 30, 2002 and 2001, and January 31, 2002 (Dollars in thousands, except par value)
APRIL 30, APRIL 30, JANUARY 31, 2002 2001 2002 --------- --------- ----------- ASSETS (UNAUDITED) (UNAUDITED) Current assets: Cash $ 6,330 $ 6,955 $ 4,319 Merchandise inventories, net 146,000 127,331 148,265 Income taxes receivable 5,377 7,479 5,377 Other current assets 5,258 5,056 5,331 --------- --------- --------- Total current assets 162,965 146,821 163,292 Property and equipment, net of accumulated depreciation of $126,463, $115,554 and $124,644, respectively 66,463 61,641 64,811 Deferred income taxes 1,091 -- 1,091 Intangible assets, net 631 -- 646 Other assets 12 12 11 --------- --------- --------- $ 231,162 $ 208,474 $ 229,851 ========= ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Current maturities on capital lease obligations $ 169 $ 154 $ 169 Trade accounts payable 72,392 64,119 86,704 Accrued expenses and other current liabilities 27,319 27,488 26,507 --------- --------- --------- Total current liabilities 99,880 91,761 113,380 Long term debt, excluding current maturities on capital lease obligations 47,909 35,155 33,263 Other liabilities 5,448 6,448 5,864 Commitments and contingencies -- -- -- Shareholders' equity: Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued -- -- -- Common stock, $.01 par value; 75,000,000 shares authorized; 11,944,544 shares issued and 11,330,327 shares outstanding at April 30, 2002 11,813,433 shares issued and outstanding at April 30, 2001; 11,918,035 shares issued and 11,304,022 shares outstanding at January 31, 2002; 119 118 119 Additional paid-in capital 36,884 36,409 36,850 Retained earnings 43,937 38,583 43,368 Treasury stock, at cost 614,217 shares, zero shares and 614,013 shares at April 30, 2002, and 2001 and January 31, 2002, respectively (3,015) -- (2,993) --------- --------- --------- 77,925 75,110 77,344 --------- --------- --------- $ 231,162 $ 208,474 $ 229,851 ========= ========= =========
See accompanying notes to unaudited consolidated financial statements. 3 HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES Unaudited Consolidated Statements of Operations For the Three Months Ended April 30, 2002 and 2001 (Dollars in thousands, except per share amounts)
THREE MONTHS ENDED APRIL 30, 2002 2001 --------- --------- Merchandise revenue $ 89,982 $ 86,614 Rental video revenue 22,863 22,497 --------- --------- Total revenues 112,845 109,111 Merchandise cost of revenue 66,188 65,171 Rental video cost of revenue 9,049 10,842 --------- --------- Total cost of revenues 75,237 76,013 --------- --------- Gross profit 37,608 33,098 Selling, general and administrative expenses 36,583 33,264 Pre-opening expenses 18 -- --------- --------- Operating income (loss) 1,007 (166) Other income (expense): Interest expense (500) (627) Other, net 62 26 --------- --------- Income (Loss) before income taxes 569 (767) Income tax expense (benefit) -- -- --------- --------- Net income (loss) $ 569 $ (767) ========= ========= Basic income (loss) per share $ 0.05 $ (0.07) ========= ========= Diluted income (loss) per share $ 0.05 $ (0.07) ========= ========= Weighted-average common shares outstanding: Basic 11,311 11,754 Dilutive effect of stock options 538 -- --------- --------- Diluted 11,849 11,754 ========= =========
See accompanying notes to unaudited consolidated financial statements. 4 HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES Unaudited Consolidated Statements of Cash Flows For the Three Months Ended April 30, 2002 and 2001 (Dollars in thousands)
THREE MONTHS ENDED APRIL 30, 2002 2001 --------- --------- Cash flows from operating activities: Net income (loss) $ 569 $ (767) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation and amortization expense 9,286 8,891 Loss on rental videos lost, stolen and defective 1,425 1,304 Gain on disposal of non-rental video assets (36) 208 Non-cash compensation 75 88 Changes in operating assets and liabilities: Merchandise inventory 3,295 4,289 Other current assets 73 404 Trade accounts payable and accrued expenses (13,500) (9,825) Income taxes receivable -- 280 Other assets and liabilities, net (418) (203) --------- --------- Net cash provided by operating activities 769 4,669 --------- --------- Cash flows from investing activities: Purchases of rental video assets (7,724) (5,203) Purchases of property and equipment (5,620) (2,467) --------- --------- Net cash used in investing activities (13,344) (7,670) --------- --------- Cash flows from financing activities: Borrowings under revolving credit facility 130,174 117,876 Repayments under revolving credit facility (115,486) (112,141) Payments under capital lease obligations (40) (36) Purchase of treasury stock (168) -- Proceeds from exercise of stock options 105 -- --------- --------- Net cash provided by financing activities 14,585 5,699 --------- --------- Net increase in cash 2,010 2,698 Cash at beginning of period 4,320 4,257 --------- --------- Cash at end of period $ 6,330 $ 6,955 ========= =========
See accompanying notes to unaudited consolidated financial statements. 5 Hastings Entertainment, Inc. and Subsidiaries Notes to Unaudited Consolidated Financial Statements April 30, 2002 and 2001 (Tabular amounts in thousands, except per share data or unless otherwise noted) 1. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements of Hastings Entertainment, Inc. and its subsidiaries (the "Company", "We", "Our", "Us") have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions in Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such principles and regulations of the Securities and Exchange Commission. All adjustments, consisting only of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods. The results of operations for such interim periods are not necessarily indicative of the results which may be expected for a full year because of, among other things, seasonality factors in the retail business. The unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company's annual report on Form 10-K for the fiscal year 2001. Certain prior year amounts have been reclassified to conform with fiscal 2002 presentation. Our fiscal year ends on January 31 and is identified as the fiscal year for the immediately preceding calendar year. For example, the fiscal year that will end on January 31, 2003 is referred to as fiscal 2002. 2. CONSOLIDATION POLICY The unaudited consolidated financial statements present the results of Hastings Entertainment, Inc. and its subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation. 3. STORE CLOSING RESERVE From time to time and in the normal course of business, we evaluate our store base to determine if a need to close a store(s) is present. Such evaluations include, among other factors, current and future profitability, market trends, age of store and lease status. Included in accrued expenses and other liabilities at April 30, 2002 and January 31, 2002 are accruals of $5.5 million and $5.9 million, respectively, for the net present value of future minimum lease payments and other costs attributable to closed or relocated stores, net of estimated sublease income. The following tables provide a rollforward of reserves that were established for these charges for the three months ended April 30, 2002 and 2001.
Future Lease Payments Other Costs Total -------- ----------- ----- Balance at January 31, 2001 $ 6,350 $ 255 6,605 Changes in estimates 263 -- 263 Additions to provision 369 -- 369 Cash outlay (764) (123) (887) ------- ------- ------- Balance at April 30, 2001 $ 6,218 $ 132 $ 6,350 ======= ======= =======
6 Hastings Entertainment, Inc. and Subsidiaries Notes to Unaudited Consolidated Financial Statements April 30, 2002 and 2001 (Tabular amounts in thousands, except per share data or unless otherwise noted) 3. STORE CLOSING RESERVE (CONT'D)
Future Lease Payments Other Costs Total -------- ----------- ----- Balance at January 31, 2002 $ 5,919 $ 13 5,932 Changes in estimates 43 -- (43) Additions to provision -- -- -- Cash outlay (418) (13) (431) ------- ------- ------- Balance at April 30, 2002 $ 5,544 $ -- $ 5,544 ======= ======= =======
Payments during the next five years that are to be charged against the reserve are expected to be approximately $1.2 million per year. 4. INCOME (LOSS) PER SHARE The computations for basic and diluted income (loss) per share are as follows:
Three Months Ended April 30, 2002 2001 -------- -------- Net income (loss) $ 569 $ (767) ======== ======== Average shares outstanding: Basic 11,311 11,754 Effect of stock options 538 -- -------- -------- Diluted 11,849 11,754 ======== ======== Income (Loss) per share: Basic $ 0.05 $ (0.07) ======== ======== Diluted $ 0.05 $ (0.07) ======== ========
Options to purchase 532,620 shares of common stock at exercise prices ranging from $6.92 per share to $14.03 per share outstanding at April 30, 2002 were not included in the computation of diluted income per share because their inclusion would have been antidilutive. 5. LITIGATION AND CONTINGENCIES In 2000, the Company restated its consolidated financial statements for the first three quarters of fiscal 1999 and the prior four fiscal years. Following the Company's initial announcement in March 2000 of the requirement for such restatements, six purported class action lawsuits were filed in the United States District Court for the Northern District of Texas against the Company and certain of the current and former directors and officers of the Company asserting various claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Although four of the lawsuits were originally filed in the Dallas Division of the Northern District of Texas, all of the five pending actions have been transferred to the Amarillo Division of the Northern District and have been consolidated. One of the Section 10(b) and 20(a) lawsuits filed in the Dallas Division was voluntarily dismissed. On May 15, 2000, a lawsuit was filed in the United States District Court for the Northern District of Texas against the Company, its current and former directors and officers at the time of the Company's June 1998 initial public offering and three underwriters, 7 Hastings Entertainment, Inc. and Subsidiaries Notes to Unaudited Consolidated Financial Statements April 30, 2002 and 2001 (Tabular amounts in thousands, except per share data or unless otherwise noted) 5. LITIGATION AND CONTINGENCIES (CONT'D) Salomon Smith Barney, A.G. Edwards & Sons, Inc. and Furman Selz, LLC asserting various claims under Sections 11, 12(2) and 15 of the Securities Act of 1933. Motions to dismiss these actions were filed by the Company and, on September 25, 2001, were denied by the Court. Discovery and class certification proceedings are going forward in both actions. None of the pending complaints specify the amount of damages sought. Although it is not feasible to predict or determine the final outcome of the proceedings or to estimate the potential range of loss with respect to these matters, an adverse outcome with respect to such proceedings could have a material adverse impact on the Company's financial position, results of operations and cash flows. The Company is also involved in various other claims and legal actions arising in the ordinary course of business. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company's financial position, results of operations and cash flows. 6. SEGMENT DISCLOSURES The Company has two operating segments, retail stores and Internet operations. Our chief operating decision maker, as that term is defined in the relevant accounting standard, regularly reviews financial information about each of the above operating segments for assessing performance and allocating resources. Revenue for retail stores is derived from the sale of merchandise and rental of videocassettes, video games and DVDs. Revenue for Internet operations is derived solely from the sale of merchandise. Segment information regarding our retail stores and Internet operations for the three months ended April 30, 2002 and 2001 is presented below.
For the three months ended April 30, 2002: Retail Internet Stores Operations Total ------ ---------- ----- Total revenue $112,798 $ 47 $112,845 Depreciation and amortization 9,217 69 9,286 Operating income (loss) 1,267 (260) 1,007 Total assets 230,817 345 231,162 Capital expenditures $ 13,342 $ 2 $ 13,344
For the three months ended April 30, 2001: Retail Internet Stores Operations Total ------ ---------- ----- Total revenue $ 109,092 $ 19 $ 109,111 Depreciation and amortization 8,821 70 8,891 Operating income (loss) 62 (228) (166) Total assets 207,813 657 208,474 Capital expenditures $ 7,670 $ -- $ 7,670
8 Hastings Entertainment, Inc. and Subsidiaries Notes to Unaudited Consolidated Financial Statements April 30, 2002 and 2001 (Tabular amounts in thousands, except per share data or unless otherwise noted) 7. RECENT ACCOUNTING PRONOUNCEMENTS In June 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards ("SFAS") No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets (the "Statements"), effective for fiscal years beginning after December 15, 2001. Under the new rules, goodwill will no longer be amortized but will be subject to annual impairment tests in accordance with the Statements. Other intangible assets will continue to be amortized over their useful lives. The Company applied the new rules on accounting for goodwill and other intangible assets beginning with this quarter ending April 30, 2002 and adoption has not had a material impact on its consolidated financial position or results of operations. In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which addresses financial accounting and reporting for the impairment or disposal of long-lived assets and supersedes SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a segment of a business. SFAS 144 is effective for fiscal years beginning after December 15, 2001. The Company adopted SFAS 144 as of February 1, 2002 and such adoption did not have a significant impact on the Company's financial position and results of operations. 9 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATONS Forward-looking Statements Certain written and oral statements set forth below or made by Hastings or with the approval of an authorized executive officer of the company constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The words "believe," "expect," "intend," "anticipate," "project," "will" and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future including statements relating to the effects of the adoption of Statement of Financial Accounting Standards Nos. 142 and 144, the impact on our financial statements of any adjustment to fair value of interest rate swaps, the outcome of securities litigation, inflation, effect of critical accounting policies including lower of cost or market for inventory adjustments, the returns process, rental video amortization and our store closing reserve and statements expressing general optimism about future operating results are forward-looking statements. Such statements are based upon company management's current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to, whether our assumptions turn out to be correct, our inability to attain such estimates and expectations, a downturn in market conditions in any industry relating to the products we inventory, sell or rent, the effects of or changes in economic conditions in the U.S. and or the markets in which we operate our superstores, our success in forecasting customer demand for products, and legal proceedings (see discussion of Legal Proceedings in Part II, Item 1 of this Form 10-Q for the three months ended April 30, 2002 and subsequent SEC filings) any of which could cause actual results to differ materially from those described herein. We undertake no obligation to affirm, publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The following discussion should be read in conjunction with the unaudited consolidated financial statements of the Company and the related notes thereto appearing elsewhere in the report. General Hastings Entertainment is a leading multimedia entertainment retailer that combines the sale of books, music, software, periodicals, videocassettes, video games and DVDs with the rental of videocassettes, video games and DVDs in a superstore and Internet Web site format. As of April 30, 2002, we operated 141 superstores averaging approximately 20,000 square feet in small to medium-sized markets located in 21 states, primarily in the Western and Midwestern United States. Each of our superstores is company-operated under the name of Hastings. Our operating strategy is to enhance our position as a multimedia entertainment retailer by expanding existing superstores, opening new superstores in selected markets, and expanding our offering of products through our Internet Web site. References herein to fiscal years are to the twelve-month periods that end in January of the following calendar year. For example, the twelve-month period ending January 31, 2003 is referred to as fiscal 2002. Critical Accounting Policies Our financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the reported amounts of assets, liabilities at the date of the financial statements, the disclosure of contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant estimates and assumptions used in the preparation of our financial statements. Our significant estimates and assumptions are reviewed and any required adjustments are recorded on a monthly basis. 10 Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories are recorded at the lower of standard cost or market. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record lower of cost or market ("LCM") inventory adjustments. In some instances, these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns and estimated fair value of merchandise inventory by product category and record any adjustment if estimated fair value is below cost. Through merchandising and an automated-progressive markdown program, we quickly take the steps necessary to increase the sell-off of slower moving merchandise to eliminate or lessen the effect of any LCM adjustment. Returns Process. In general, merchandise inventory owned by us is returnable based upon return agreements with our merchandise vendors. We continually return merchandise to vendors based on, among other factors, current and projected sales trends, overstock situations, authorized return timelines or change in product offerings. At the end of any reporting period, there is inventory that has been returned to vendors or in the process of being returned to vendors for which accruals are required. These costs can include freight, valuation and quantity differences, and other fees charged by a vendor. In order to appropriately match the costs associated with the return of merchandise with the process of returning the product, we utilize an allowance for cost of inventory returns (the "Allowance"). To accrue for such costs and estimate the Allowance, we utilize historical experience adjusted for significant estimated or contractual modifications. Certain adjustments to the Allowance can have a material effect on the financial results of an annual or interim period. In addition, we recognize that some portion of our inventory in superstores will eventually be returned to a vendor based on the factors mentioned above. We accrue return costs for these future returns on the same basis as product being returned or in the process of being returned to a vendor. We continually evaluate the returns process and initiate improvements as needed. Rental Video Cost Amortization. In late fiscal 1998, we completed a series of direct revenue-sharing agreements with major studios, the majority of which were amended in fiscal years 2001 and 2000. We anticipate that our involvement in revenue-sharing agreements will be similar to that of fiscal year 2001 in future periods. Revenue sharing allows us to acquire rental video assets at a lower up-front capital cost than traditional buying arrangements. We then share with studios a percentage of the actual net rental revenues generated over a contractually determined period of time. The increased access to additional copies of new releases under revenue-sharing agreements will allow customer demand for new releases to be satisfied over a shorter period of time at a time when the new releases are most popular. We expense revenue-sharing payments as revenues are recognized under the terms of the specific contracts with supplying studios. The capitalized cost of all rental video assets acquired for a fixed price is being amortized on an accelerated basis over six months to a salvage value of $4 per unit, except for rental video assets purchased for the initial stock of a new superstore, which are being amortized on a straight line basis over 36 months to a salvage value of $4. Certain events, including a downturn in the rental video industry, as a whole or the markets within which we operate our superstores, further consolidation of rental video retailers, substantial change in customer demand and change in the mix of rental video revenues, could effect the salvage value we have assigned to our rental video assets. Such effect could result in a material reduction of the carrying value of our rental video assets and have a material impact on the financial results of an annual or interim period. In particular, the growth of the DVD market and the shift of consumer purchases from VHS (videocassettes) to DVD could result in a decrease in the salvage value of rental videos. At some point during the rental cycle, a VHS item, as with DVD and games, is available for purchase by a customer as a previously viewed tape ("PVT"). Our current experience is that the amount received for the PVT is significantly higher than our salvage value of that item in our rental inventory. Based in part on this factor and sales of PVTs, we believe our estimate of salvage value is appropriate. Store Closing Reserve. As with any retailer, from time to time, and in the normal course of business, we evaluate our store base to determine if a need to close or relocate a store(s) is present. Management will evaluate, among other factors, current and future profitability, market trends, age of store and lease status. Upon the appropriate executive approval to close a location, we record charges related to the costs of store closings or relocations. The primary expense items associated with these charges relate to the net present value of minimum lease payments (the present value of remaining lease payments under an active lease) and the write-off of leasehold improvements and other assets not remaining in our possession at the time the location is closed or relocated. The amount recorded can 11 fluctuate based on the age of the closing location, term and remaining years of the lease and the number of stores being closed or relocated. These charges can have a material effect on the financial results of an annual or interim period. Although we actively pursue sublease tenants on all closed or relocated locations, we do not record any estimated sublease income as an offset to any of charge until a sublease agreement is executed. We evaluate all of our stores on a quarterly basis to ascertain any need for impairment of assets or to commence closing proceedings. 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 April 30, 2002 2001 ----- ----- Merchandise revenue 79.7% 79.4% Rental video revenue 20.3 20.6 ----- ----- Total revenues 100.0 100.0 Merchandise cost of revenue 73.6 75.2 Rental video cost of revenue 39.6 48.2 ----- ----- Total cost of revenues 66.7 69.7 ----- ----- Gross profit 33.3 30.3 Selling, general and administrative expenses 32.4 30.4 Pre-opening expenses 0.0 0.0 ----- ----- 32.4 30.4 ----- ----- Operating income (loss) 0.9 (0.1) Other income (expense): Interest expense (0.4) (0.6) Other, net 0.0 0.0 ----- ----- Income (Loss) before income taxes 0.5 (0.7) Income tax expense (benefit) -- -- ----- ----- Net income (loss) 0.5% (0.7)% ===== =====
Summary of Superstore Activity
Three Months Ended Year Ended April 30, January 31, 2002 2001 2002 ---- ---- ---- Hastings Superstores: Beginning number of stores 142 142 142 Openings -- -- 5 Closings (1) -- (5) ---- ---- ---- Ending number of stores 141 142 142 ==== ==== ====
12 Three months ended April 30, 2002 compared to three months ended April 30, 2001 Revenues. Total revenues increased $3.7 million, or 3.4%, for the first quarter of fiscal 2002 to $112.8 million compared to $109.1 million a year ago primarily due to an increase in total comparable store revenues ("Comps") of 5.3%. Elements of total Comps were as follows: Merchandise Comps 6.8% Rental video Comps -0.3% Total Comps 5.3%
Total merchandise revenue increased $3.4 million, or 3.9%, to $90.0 million compared to $86.6 million last year as we operated one fewer store during the first quarter of fiscal 2002 compared to the same period in the prior year. Contributing to the increase in merchandise revenues were increases in DVD and video games of 56% and 222%, respectively, for the three months ended April 30, 2002 over the prior year. Book Comps increased 3.0% over last year resulting from several programs we initiated in the second half of last year. Total rental video revenue grew $0.4 million, or 1.6%, to $22.9 million, up from $22.5 million a year earlier driven primarily by a 103% increase in DVD rentals over the same period last year. The decrease in rental Comps was primarily due to a weak new-release schedule and high viewer ratings of the Winter Olympics. Gross Profit. Total gross profit of $37.6 million in the first quarter of fiscal 2002 increased $4.5 million, or 13.6%, from $33.1 million in the first quarter of fiscal 2001. Total gross profit as a percent of total revenue increased for the three months ended April 30, 2002 to 33.3% compared to 30.3% for the same period last year. Merchandise margins as a percent of merchandise revenue increased to 26.4% for the current quarter from 24.8% for the same quarter last year due primarily to inventory markdowns during the first quarter of fiscal 2002 were $1.5 million lower than the same period last year primarily due to our improved merchandising and automated-progressive markdown programs. Partially offsetting the improvements detailed above, were increases of approximately $0.3 million in the cost associated with the return of product due primarily to an increase of approximately 9% in the amount of product returned to vendors during the first quarter of fiscal 2002 compared to the prior year and higher merchandise shrinkage of approximately $0.3 million, primarily in our book category. Rental video gross profit as a percent of rental revenue increased to 60.4% for the current quarter from 51.8% for the same quarter last year. This increase was primarily due to non-revenue sharing titles, which generally reflect higher margins, representing a higher percentage of total rental revenues and accounting for a net increase in rental video gross profit of approximately $1.5 million for the first quarter of fiscal 2002 compared to the first quarter of fiscal 2001. Selling, General and Administrative Expenses. Selling, general and administrative ("SG&A") expenses as a percent of total revenues increased to 32.4% for the quarter ended April 30, 2002 from 30.5% for the same period last year. The increase was primarily the result of: (i) an increase of approximately $1.0 million in human resource costs at our stores for the first quarter of fiscal 2002 over the first quarter of fiscal 2001 as a result of increased hours needed to initiate a new inventory cycle count system and process a higher level of inventory returns; and (ii) an increase in net advertising costs of approximately $0.7 million for the first quarter of fiscal 2002 as a result of a planned increase in targeted advertising expenditures to drive customer traffic. Interest Expense. Interest expense was $0.5 million, or 0.4% of revenues, in the three months ended April 30, 2002, compared to $0.6 million, or 0.6% of revenues, in the three months ended April 30, 2001. The decrease was attributed to lower average interest rates on our revolving credit facility. Income Taxes. We did not record income tax expense for the three months ended April 30, 2002 and 2001 as a result of the reversal of a portion of the valuation allowance related to the net deferred tax asset established in the fourth quarter of fiscal 2000. 13 Liquidity and Capital Resources We generate cash from operations exclusively from the sale of merchandise and the rental of video products and we have substantial operating cash flow because most of our revenue is received in cash and cash equivalents. Other than our principal capital requirements arising from the purchase, warehousing and merchandising of inventory and rental videos, opening new superstores and expanding existing superstores and updating existing and implementing new information systems technology, we have no anticipated material capital commitments. Our primary sources of working capital are cash flow from operating activities, trade credit from vendors and borrowings under our revolving credit facility (the "Facility"). We believe our cash flow from operations and borrowings under the Facility will be sufficient to fund our ongoing operations, new superstores and superstore expansions through fiscal 2002. Consolidated Cash Flows Operating Activities. Net cash flows from operating activities decreased $3.9 million from $4.7 million for the three months ended April 30, 2001 to $0.8 million for the three months ended April 30, 2002. The primary reason for the decrease was a greater reduction in our trade accounts payable and accrued expenses of approximately $3.6 million during the first quarter of fiscal 2002 compared to the first quarter of fiscal 2001. Investing Activities. Net cash used in investing activities increased $5.7 million, or 74.0%, to $13.4 million for the three months ended April 30, 2002 from $7.7 million for the three months ended April 30, 2001. This increase was the result of growth in remodeling activity of certain existing superstores compared to the prior year, planned computer hardware and software upgrades, higher procurement of rental video assets relating to the growth of DVD and a higher percentage of purchases of non-revenue sharing titles, which generally cost more per unit than revenue sharing titles. Financing Activities. Cash provided by or used in financing activities is primarily associated with borrowings and payments made under debt agreements. For the three months ended April 30, 2002, net borrowings under debt agreements increased $9.0 million compared to the three months ended April 30, 2001. The increase for fiscal 2002 primarily resulted from items described under Operating and Investing Activities above. Capital Structure. On August 29, 2000, we entered into a three-year syndicated, secured Loan and Security Agreement with Fleet Retail Finance, Inc. and The CIT Group/Business Credit, Inc. The initial proceeds from the Facility were used to terminate and prepay fully the total amounts outstanding under our prior revolving credit facility with Bank of America and a consortium of banks and our Series A Senior Notes (the "Senior Notes") with a financial institution. The amount outstanding under the Facility is limited by a borrowing base predicated on eligible inventory, as defined, and certain rental video assets, net of accumulated depreciation less specifically defined reserves and is limited to a ceiling of $70 million, which increases to $80 million between October 15 and December 15 of each year of the Facility, less a $10 million availability reserve. The Facility bears interest based on the prevailing prime rate or LIBOR plus 2.00% at our option. The borrowing base under the Facility is limited to an advance rate of 65% of eligible inventory and certain rental video assets net of accumulated amortization less specifically defined reserves which could be adjusted to reduce availability under the Facility. The Facility contains no financial covenants, restricts the payment of dividends and includes certain other debt and acquisition limitations, allows for the repurchase of up to $7.5 million of our common stock and requires a minimum availability of $10 million at all times. The Facility is secured by substantially all of the assets of the company and our subsidiaries and is guaranteed by each of our three consolidated subsidiaries. The Facility expires on August 29, 2003. At April 30, 2002, we had $7.3 million in excess availability, after the $10 million availability reserve, under the Facility. At April 30, 2002 and January 31, 2002, respectively, we had borrowings outstanding of $46.9 million and $32.2 million under the Facility. The average rate of interest being charged under the Facility was 4.1% and 6.1% at April 30, 2002 and January 31, 2002, respectively. We entered into two interest rate swaps, one in November and one in December 2001, with a financial institution in order to obtain a fixed interest rate on a portion of our outstanding floating rate debt thereby reducing our exposure to interest rate volatility. The notional value of each swap is $10 million of our revolving credit facility at fixed 14 interest rates of 2.65% and 2.47%, respectively, for one year. We have designated the interest rate swaps as hedging instruments. At April 30, 2002, the fair value of the interest rate swaps was not significant. SEASONALITY AND INFLATION As is the case with many retailers, a significant portion of the Company's revenues, and an even greater portion of its operating profit, is generated in the fourth fiscal quarter, which includes the Christmas selling season. As a result, a substantial portion of the Company's annual earnings has been, and will continue to be, dependent on the results of this quarter. The Company experiences reduced rentals of video activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games or the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of store openings, the number and popularity of new book, music and videocassette titles, the cost of the new release or "best renter" titles, changes in comparable-store revenues, competition, marketing programs, increases in the minimum wage, weather, special or unusual events, and other factors that may affect retailers in general and the Company in particular. The Company does not believe that inflation has materially impacted operating results during the past three years. Substantial increases in costs and expenses could have a significant impact on the Company's operating results to the extent such increases are not passed along to customers. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the ordinary course of our business, we are exposed to certain market risks, primarily changes in interest rates. Our exposure to interest rate risk consists of variable rate debt based on the lenders base rate or LIBOR plus a specified percentage at our option. The annual impact on our results of operations of a 100 basis point interest rate change on the April 30, 2002 outstanding balance of the variable rate debt would be approximately $0.3 million, including the effect of interest rate swaps. After an assessment of these risks to our operations, we believe that the primary market risk exposures (within the meaning of Regulation S-K Item 305) are not material and are not expected to have any material adverse impact on our financial position, results of operations or cash flows for the next fiscal year. In addition, we do not believe changes in the fair value of the interest rate swaps entered into in November 2001 and December 2001 with notional amounts of $10 million each will be material. 15 PART II ITEM 1. LEGAL PROCEEDINGS In 2000, the Company restated its consolidated financial statements for the first three quarters of fiscal 1999 and the prior four fiscal years. Following the Company's initial announcement in March 2000 of the requirement for such restatements, six purported class action lawsuits were filed in the United States District Court for the Northern District of Texas against the Company and certain of the current and former directors and officers of the Company asserting various claims under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Although four of the lawsuits were originally filed in the Dallas Division of the Northern District of Texas, all of the five pending actions have been transferred to the Amarillo Division of the Northern District and have been consolidated. One of the Section 10(b) and 20(a) lawsuits filed in the Dallas Division was voluntarily dismissed. On May 15, 2000, a lawsuit was filed in the United States District Court for the Northern District of Texas against the Company, its current and former directors and officers at the time of the Company's June 1998 initial public offering and three underwriters, Salomon Smith Barney, A.G. Edwards & Sons, Inc. and Furman Selz, LLC asserting various claims under Sections 11, 12(2) and 15 of the Securities Act of 1933. Motions to dismiss these actions were filed by the Company and, on September 25, 2001, were denied by the Court. Discovery and class certification proceedings are going forward in both actions. None of the pending complaints specify the amount of damages sought. Although it is not feasible to predict or determine the final outcome of the proceedings or to estimate the potential range of loss with respect to these matters, an adverse outcome with respect to such proceedings could have a material adverse impact on the Company's financial position, results of operations and cash flows. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K a. Listing of exhibits 10.6 Hastings Entertainment, Inc. Associates' Stock Ownership Plan, as amended b. No report on Form 8-K was filed by the registrant during the quarter of the fiscal year for which this report on Form 10-Q is filed. 16 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: June 5, 2002 By: /s/ Dan Crow --------------- Dan Crow Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) 17 INDEX TO EXHIBITS
Exhibit Number Description of Documents ------ ------------------------ 10.6 Hastings Entertainment, Inc. Associates' Stock Ownership Plan, as amended
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