e10vq

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended April 30, 2006


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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o Accelerated filer o Non-accelerated filer þ

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

Number of shares outstanding of the registrant’s common stock, as of April 30, 2006:


Class	Shares Outstanding
Common Stock, $.01 par value per share		11,424,172

PART 1 — FINANCIAL INFORMATION

ITEM 1 — FINANCIAL STATEMENTS.

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

April 30, 2006 and 2005, and January 31, 2006
(Dollars in thousands, except par value)


	April 30,			April 30,			January 31,
	2006			2005			2006
	(Unaudited)			(Unaudited)
Assets
Current assets:
Cash	$	6,979		$	6,274		$	3,617
Merchandise inventories, net		160,107			150,288			165,049
Deferred income taxes		4,692			3,017			4,234
Prepaid expenses and other current assets		7,380			6,752			7,016

Total current assets		179,158			166,331			179,916
Rental assets, net of accumulated depreciation of $25,614, $27,999, and $26,501 at April 30, 2006 and 2005, and January 31, 2006, respectively		12,729			12,409			12,606
Property and equipment, net of accumulated depreciation of $143,521, $129,457, and $139,178 at April 30, 2006 and 2005, and January 31, 2006, respectively		58,444			62,822			60,013
Deferred income taxes		1,751			1,600			1,492
Intangible assets, net		432			520			454
Other assets		189			17			180

Total Assets	$	252,703		$	243,699		$	254,661


Liabilities and Shareholders’ Equity
Current liabilities:
Current maturities on capital lease obligations	$	54		$	248		$	94
Trade accounts payable		71,971			76,247			88,991
Accrued expenses and other current liabilities		33,289			28,949			38,323

Total current liabilities		105,314			105,444			127,408
Long term debt, excluding current maturities on capital lease obligations		46,140			43,008			28,057
Other liabilities		4,472			4,708			4,503

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 11,424,172 shares outstanding at April 30, 2006; 11,944,544 shares issued and 11,526,278 shares outstanding at April 30, 2005; 11,944,544 shares issued and 11,383,172 shares outstanding at January 31, 2006		119			119			119
Additional paid-in capital		35,986			36,147			36,076
Retained earnings		63,391			56,525			61,466
Other comprehensive income		163			—			141
Treasury stock, at cost 520,372 shares, 418,266 shares and 561,372 shares at April 30, 2006, and 2005 and January 31, 2006, respectively		(2,882	)		(2,252	)		(3,109	)

Total Shareholders’ Equity		96,777			90,539			94,693

Total Liabilities and Shareholders’ Equity	$	252,703		$	243,699		$	254,661

See accompanying notes to unaudited consolidated financial statements.

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Operations

For the Three Months Ended April 30, 2006 and 2005
(Dollars in thousands, except per share amounts)


	Three Months Ended April 30,
	2006			2005
Merchandise revenue	$	106,952		$	104,864
Rental revenue		24,460			24,260

Total revenues		131,412			129,124

Merchandise cost of revenue		75,569			76,703
Rental cost of revenue		9,221			8,383

Total cost of revenues		84,790			85,086


Gross profit		46,622			44,038

Selling, general and administrative expenses		42,873			42,327
Pre-opening expenses		—			88


Operating income		3,749			1,623

Other income (expense):
Interest expense		(664	)		(493	)
Other, net		69			101


Income before income taxes		3,154			1,231

Income tax expense		1,229			477


Net income	$	1,925		$	754


Basic income per share	$	0.17		$	0.07


Diluted income per share	$	0.17		$	0.06


Weighted-average common shares outstanding:
Basic		11,394			11,477
Dilutive effect of stock options		224			447


Diluted		11,618			11,924

See accompanying notes to unaudited consolidated financial statements.

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES

Unaudited Consolidated Statements of Cash Flows

For the Three Months Ended April 30, 2006 and 2005
(Dollars in thousands)


	Three Months Ended
	April 30,
	2006			2005
Cash flows from operating activities:
Net income	$	1,925		$	754
Adjustments to reconcile net income to net cash used in operating activities:
Rental asset depreciation expense		4,445			4,504
Purchases of rental inventory		(7,646	)		(6,469	)
Property and equipment depreciation expense		4,853			4,783
Amortization expense		22			22
Deferred income taxes		(717	)		(1,111	)
Loss on rental assets lost, stolen and defective		303			338
Loss on disposal of non-rental assets		47			85
Changes in operating assets and liabilities:
Merchandise inventory		7,713			8,109
Prepaid expenses and other current assets		(364	)		193
Trade accounts payable		(10,465	)		(7,679	)
Accrued expenses and other current liabilities		(5,034	)		(4,643	)
Other assets and liabilities, net		(18	)		(115	)

Net cash used in operating activities		(4,936	)		(1,229	)


Cash flows from investing activities:
Purchases of property and equipment		(3,327	)		(3,305	)

Net cash used in investing activities		(3,327	)		(3,305	)


Cash flows from financing activities:
Borrowings under revolving credit facility		150,114			140,798
Repayments under revolving credit facility		(132,031	)		(134,512	)
Payments under capital lease obligations		(40	)		(59	)
Purchase of treasury stock		—			(522	)
Change in cash overdraft		(6,555	)		(2,156	)
Proceeds from exercise of stock options		137			533

Net cash provided by financing activities		11,625			4,082


Net increase (decrease) in cash		3,362			(452	)
Cash at beginning of period		3,617			6,726

Cash at end of period	$	6,979			6,274

See accompanying notes to unaudited consolidated financial statements.

Hastings Entertainment, Inc. and Subsidiaries

Notes to Unaudited Consolidated Financial Statements
April 30, 2006 and 2005
(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 (“Hastings,” the “Company,” “we,” “our,” “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 the 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 profit, is generated in the fourth fiscal quarter, which includes the Christmas 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, 2006.

The balance sheet at January 31, 2006 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, 2006.

Certain amounts for the period ended April 30, 2005, have been reclassified to conform with the fiscal 2006 presentation, including a $1.0 million reclassification of an in-transit cash item as a reduction in cash and long-term debt, a 2.6 million reclassification of a portion of our accrued straight-line rent from short-term to long-term, and a $0.6 million reclassification of costs associated with our previously viewed tapes from cost of rental revenues to cost of merchandise revenues.

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, 2007 is referred to as fiscal year 2006.

Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
April 30, 2006 and 2005
(Tabular amounts in thousands, except per share data or unless otherwise noted)

2. Stock Based Compensation

Prior to February 1, 2006, we accounted for stock-based compensation in accordance with Accounting Principles Board Opinion (“APB”) No. 25 “Accounting for Stock Issued to Employees” (“APB No. 25”) and followed the disclosure-only provisions of Statement of Financial Accounting Standard (“SFAS”) No. 123 “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure.” Accordingly, compensation expense was not recognized in our consolidated statement of operations in connection with stock options that were granted under our stock-based compensation plan.

Effective with our fiscal year beginning February 1, 2006, we adopted SFAS No. 123(R) “Share-Based Payment” (“SFAS No. 123(R)”), which no longer permits use of the intrinsic value method under APB No. 25. We used the modified prospective method to adopt SFAS No. 123(R), which requires that compensation expense be recorded for all stock-based compensation granted on or after February 1, 2006, as well as the unvested portion of previously granted options. On January 27, 2006, our Board of Directors approved a resolution to vest all stock options outstanding as of that date. The Board decided to fully vest these options, many of which had exercise prices that were higher than the Company’s stock price, to minimize the expense to our consolidated financial statements upon adoption of SFAS No. 123(R). This acceleration of vesting affected 587,609 unvested stock options. As a result, there is no compensation expense associated with stock options granted prior to February 1, 2006 in the consolidated statements of operations. Because no stock options were granted during the first quarter of fiscal 2006, no compensation expense is recognized in our consolidated statements of operations. No assumptions regarding the underlying value of these previously granted stock options were changed upon adoption of SFAS No. 123(R).

Under SFAS No. 123(R), the modified prospective method requires measurement of compensation cost for all stock awards at fair value on the date of grant and recognition of compensation over the service period for awards expected to vest. The fair value of non-vested share grants is based on the number of shares granted and the quoted price of our common stock. No stock options were granted during the first quarter of fiscal 2006. However, we expect to use the Black-Scholes valuation model for future stock option grants in order to determine fair value. This is consistent with the valuation techniques that were previously utilized for options in footnote disclosures required under SFAS No. 123. The estimation of stock awards that will ultimately vest requires significant estimates, and to the extent that actual results or updated estimates differ from current estimates, such amounts will be recorded as a cumulative adjustment in the period that estimates are revised. Actual results and future changes in estimates may differ substantially from the current estimates.

The following assumptions were used in the calculation of fair value:


							Three
	Fiscal Year Ended						Months Ended
	January 31,			January 31,			April 30,
	2006			2005			2005
Expected dividend yield	$	—			—			—
Risk-free interest rate		4.27	%		2.71	%		—
Expected life in years		4.98			5.28			—
Volatility		.60			.62			—

Prior to the adoption of SFAS No. 123(R), cash retained as the result of cash deductions relating to stock-based compensation was presented in operating cash flows, along with other tax cash flows, in accordance with the provisions of the Emerging Issues Task Force (“EITF”) No. 00-15, “Classification in the Statement of Cash Flows of the Income Tax benefit Received by a Company upon Exercise of a Nonqualified Employee Stock Option.” SFAS No. 123(R) supersedes EITF 00-15, amends SFAS No. 95, “Statement of Cash Flows”, and requires tax benefits relating to excess stock-based compensation deductions to be prospectively presented in the statement of cash flows as financing cash inflows. There were no significant tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes for the first quarter of fiscal 2006.

A summary of information with respect to all stock option plans is as follows:


				Weighted-average
				exercise price
	Options			(in dollars)
Outstanding at January 31, 2004		1,917,452		$	5.71
Granted		310,493			6.03
Exercised		(225,213	)		3.10
Forfeited and expired		(115,517	)		4.92


Outstanding at January 31, 2005		1,887,215		$	6.12
Granted		144,680			5.52
Exercised		(267,388	)		3.47
Forfeited and expired		(160,640	)		6.20


Outstanding at January 31, 2006		1,603,867		$	6.50
Granted		—			—
Exercised		(41,000	)		3.35
Expired		(19,466	)		6.16


Outstanding at April 30, 2006		1,543,401			6.59


Options available for grant at April 30, 2006		455,494

The total intrinsic value of stock options exercised for the three months ended April 30, 2006 and 2005 was $107,404 and $463,377, respectively.

At April 30, 2006, the options outstanding and exercisable, the related weighted-average exercise price, the weighted-average remaining contractual life, and the aggregate intrinsic value for the ranges of exercise prices are shown in the table below.

Weighted-

average

average exercise

remaining

Aggregate intrinsic

Options

price (in dollars)

contractual life

value (in thousands)

Range: $1.27 to $4.99

Options outstanding and exercisable at April 30, 2006

548,048

3.25

5.20 years

1,582,390

Range: $5.00 to $9.99

Options outstanding and exercisable at April 30, 2006

557,273

6.23

7.02 years

150,126

Price: $10.00 to $14.03

Options outstanding and exercisable at April 30, 2006

438,080

11.24

0.78 years

—

At April 30, 2006 the number of options exercisable was 1,543,401; the weighted-average exercise price of those options was $6.59; and the total intrinsic value of those options was $1,732,516.

Fair Value Disclosures – Prior to SFAS No. 123(R) Adoption

Stock-based compensation for the three months ended April 30, 2005 was determined using the intrinsic value method. The following table provides supplemental information for the first quarter of fiscal year 2005 as if stock-based compensation had been computed under SFAS No. 123 (in thousands, except per share data):


	Three Months Ended
	April 30, 2005
Net income, as reported	$	754
Less: Stock-based compensation expense determined under fair value based method, net of tax		(135	)


Pro forma net income	$	619


Income per share:
Basic, as reported	$	0.07
Basic, pro forma	$	0.05
Diluted, as reported	$	0.06
Diluted, pro forma	$	0.05

3. Store Closing Reserve

From time to time and in the normal course of business, we evaluate our store base to determine if we need to close one or more stores. Such evaluations include, among other factors, current and future profitability, market trends, age of store and lease status.

Amounts in accrued expenses and other liabilities at April 30, 2006 include accruals for the net present value of future minimum lease payments and other costs attributable to closed or relocated stores, net of estimated sublease income. Expenses related to store closings are included in selling, general and administrative expenses in our consolidated statements of operations.

The following tables provide a rollforward of reserves that were established for these charges for the three months ended April 30, 2006 and 2005.


	Future Lease
	Payments			Other Costs		Total
Balance at January 31, 2005	$	709		$	—		709
Changes in estimates		83			—		83
Additions to provision		—			—		—
Cash outlay		(111	)		—		(111	)

Balance at April 30, 2005	$	681		$	—	$	681


	Future Lease
	Payments			Other Costs			Total
Balance at January 31, 2005	$	1,283		$	—			1,283
Changes in estimates		17			8			25
Additions to provision		—			—			—
Cash outlay		(192	)		(8	)		(200	)

Balance at April 30, 2005	$	1,108		$	—		$	1,108

As of April 30, 2006, the reserve balance, which is net of estimated sublease income, is expected to be paid over the next five years.

5. Litigation and Contingencies

During fiscal 2004, we were named as defendants in two lawsuits alleging that our extended viewing fees for movie and game rentals are illegal under the Uniform Commercial Code. On October 27, 2005, the Company petitioned the court for summary judgment in one such lawsuit pending in the state of New Mexico. On November 28, 2005, the judge granted the Company’s petition for summary judgment and dismissed all pending claims in that lawsuit. The plaintiff has subsequently appealed the court’s summary judgment.

The plaintiff in the other lawsuit, which was filed in the state of Texas, filed an amended petition wherein he abandoned all but one claim. On May 15, 2006, he filed a motion for class certification.

While we intend to vigorously defend these outstanding legal matters and anticipate favorable results, the ultimate outcome of these matters cannot be estimated at this time. In the event an adverse judgment was rendered, the impact on the Company’s consolidated financial statements could be material.

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

6. Recent Accounting Pronouncements

In November 2004, the FASB issued SFAS No. 151, “Inventory Costs” (“SFAS 151”), an amendment to Accounting Research Bulletin No. 43, Chapter 44. SFAS 151 clarifies that abnormal amounts of idle facility expense, freight, handling costs, and wasted materials (spoilage) should be recognized as current-period charges and requires the allocation of fixed production overheads to inventory based on the normal capacity of the production facilities. The statement is effective for inventory costs incurred during fiscal years beginning after June 15, 2005. The adoption of SFAS 151 did not have a material impact on the Company’s consolidated balance sheets or statements of operations, shareholders’ equity or cash flows.

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 convey the uncertainty of future events and generally are not historical in nature. All statements which address operating performance, events or developments that we expect or anticipate will occur in the future, including statements relating to the business, expansion, merchandising and marketing strategies of Hastings, industry projections or forecasts, the impact on our financial statements of inflation, legal actions, revenue sharing arrangements, our warehouse management system, future debt levels, sufficiency of cash flow from operations and borrowings under our amended revolving credit facility and statements expressing general optimism about future operating results, are forward-looking statements. Such statements are based upon our management’s current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to:

	–		whether our assumptions turn out to be correct;

	–		our ability to attain such estimates and expectations;

	–		our ability to execute our expansion strategy;

	–		our ability to produce strong sales during the fourth quarter which includes the holiday selling season;

	–		a downturn in market conditions in any industry, including the economic state of retailing, relating to the products we inventory, sell or rent;

	–		the effects of, or changes in, economic and political conditions in the U.S. and the markets in which we operate our superstores, including the price of gasoline, the effects of inflation, deflation, recession, war, terrorism, changes in interest and tax rates, the availability of consumer credit and any other matters that influence customer confidence;

	–		our ability to forecast and meet customer demand for products;

	–		our ability to access suitable merchandise on acceptable terms from merchandise vendors;

	–		our ability to compete with traditional retail sources, the Internet, and other technology that provides alternate methods of video delivery;

	–		our ability to respond to changing consumer spending patterns;

	–		our ability to rely on the in-store video retailer distribution window, as it currently stands;

	–		our ability to continue to negotiate favorable prices with rental video studios;

	–		our continued ability to integrate our new warehouse management system and other technology systems;

	–		our ability to attract and retain quality employees and control our labor costs; and

	–		our ability to find new sites to lease for our superstores upon acceptable terms.

Any of the foregoing factors and uncertainties, as well as others, 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, Inc. 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, new and used CDs, DVDs, books, video games and videocassettes, video game consoles, and DVD players, as well as trendy products such as t-shirts, action figures, posters, and greeting cards. As of April 30, 2006, we operated 153 superstores primarily in small- to medium-sized markets located in 20 states, primarily in the Western and Midwestern United States. We also operate a multimedia entertainment e-commerce Web site offering a broad selection of books, music, software, videocassettes, video games and DVDs. We operate two wholly-owned subsidiaries: Hastings Properties, Inc. and 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, 2007 is referred to as fiscal 2006, and the twelve-month period ended January 31, 2006 is referred to as fiscal 2005.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the disclosure of contingent liabilities and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe the following critical accounting policies affect our more significant estimates and assumptions used in the preparation of our financial statements. Our significant estimates and assumptions are reviewed, and any required adjustments are recorded, on a monthly basis.

Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories are recorded at the lower of cost or market. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record lower of cost or market 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 an adjustment if estimated market value is below cost. Through merchandising and an automated-progressive markdown program, we quickly take the steps necessary to increase the sell-off of slower moving merchandise to eliminate or lessen the effect of these adjustments.

Returns Process. Merchandise inventory owned by us is generally returnable based upon return agreements with our merchandise vendors. We continually return merchandise to vendors based on, among other factors, current and projected sales trends, overstock situations, authorized return timelines or changes in product offerings. At the end of any reporting period, cost accruals are required for inventory that has been returned to vendors, is in the process of being returned to vendors, or has been identified to be returned to vendors. These costs can include freight, valuation and quantity differences, and other fees charged by a vendor. In order to appropriately match the costs associated with the return of merchandise with the process of returning such merchandise, we utilize an allowance for cost of inventory returns. To accrue for such costs and estimate this 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.

Rental Asset Depreciation. We have established depreciation policies with respect to our rental assets that allow for the matching of product costs with the related revenues. These policies require that we make significant estimates based upon our experience as to the ultimate revenue and the timing of the revenue to be generated by our rental product. We utilize an accelerated method of depreciation because it approximates the pattern of demand for the

product, which is generally higher when the product is initially released for rental by the studios and declines over time. In establishing residual values for our rental product, we consider the sales prices and volume of our previously rented product and other used product.

Based upon these estimates, we currently depreciate the cost of our rental assets on an accelerated basis over six months to a salvage value of $4 per unit ($3.50 for VHS units), except for rental assets purchased for the initial stock of a new store, which are being depreciated on a straight-line basis over 36 months to a salvage value of $4 ($3.50 for VHS units). Rental assets purchased for less than established salvage values are not depreciated.

The costs of rental product purchased pursuant to revenue-sharing arrangements typically include a lower initial product cost and a percentage of the net rental revenues to be shared with studios over an agreed period of time. Additionally, certain titles have performance guarantees. Any up-front costs exceeding $4 per unit ($3.50 for VHS units) are amortized on an accelerated basis and revenue-sharing payments pursuant to the applicable arrangement are expensed as the related revenue is earned. The Company analyzes titles that are subject to performance guarantees and recognizes an estimated expense for under-performing titles throughout the applicable period based upon the Company’s analysis of the estimated shortfall. The Company revises these estimates on a monthly basis, according to actual results.

We also review the carrying value of our assets to ensure that estimated future cash flows exceed the carrying value. We record adjustments to the value of previously rented product primarily for estimated obsolete 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 those estimated by management, additional adjustments, including adjustments to useful lives or residual values, may be required. We continually evaluate the estimates surrounding the useful lives and residual values used in depreciating our rental assets. Changes to these estimates resulting from changes in consumer demand, changes in our customer preferences or the price or availability of retail products may materially impact the carrying value of our rental assets and our rental margins.

Store Closing Reserve. On a quarterly basis, and in the normal course of business, we evaluate our store base to determine if we need to close or relocate a store(s). Management will evaluate, among other factors, current and future profitability, market trends, age of store and lease status. The primary expense items associated with the closure of a store relate to the net present value of minimum lease payments (the present value of remaining lease payments under an active lease) and the accelerated depreciation of leasehold improvements and other assets not remaining in our possession.

In accordance with SFAS No. 146, we recognize lease termination costs at the time the store is closed or relocated. The amount recorded can fluctuate based on the age of the closing store, term and remaining years of the lease and the number of stores being closed or relocated. We actively pursue sublease tenants on all closed or relocated stores and, as part of the final estimation of store closing liability, the impact of any sublease income is estimated. The net of the described charges and sublease income estimates can have a material effect on the financial results for an annual or interim period.

Impairment or Disposal of Long-Lived Assets. In accordance with SFAS No. 144, we evaluate poor performing stores on a quarterly basis to determine whether projected future cash flows over the remaining initial 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 carrying value is less than the fair value of such assets. The carrying value of leasehold improvements as well as certain other property and equipment is subject to impairment write-down.

Revenue Recognition. We generate revenue primarily from retail sales and rental of our products. Merchandise and rental revenues are recognized at the point of sale or rental or at the time merchandise is shipped to the customer. Revenues are presented net of estimated returns and exclude all taxes. Customers may return certain merchandise for exchange or refund within our policies, and an allowance has been established to provide for projected returns. There are no provisions for uncollectible amounts since payment is received at the time of sale. We, as with most retailers, also offer gift cards for sale. Deferred revenue, a current liability, is recognized at the time a gift card is sold with the costs of designing, printing and distributing the cards recorded as an expense as incurred. The deferred

revenue liability is relieved and revenue is recognized upon the redemption of the gift cards. From time to time we will offer sales incentives to customers, in the form of rebates. Revenue is reduced by the amount of estimated redemptions, based on experience of similar types of rebate offers, and a deferred revenue liability is established. The deferred revenue liability is relieved when the customer has completed all criteria necessary to file a valid rebate claim. Any remaining portion of deferred revenue is recorded as revenue following the termination of the extended redemption period and following completion of all outstanding rebate claims. The Company reduces its revenue and recognizes a reserve for the estimated utilization of early return credits received by renters for early return of rentals. The liability is relieved upon the redemption of these early return credits. Additionally, we promote the exchange of multiple used products for new product by our customers, which are accounted for as nonmonetary transactions in accordance with SFAS 153.

Comparable-Store Revenue. Stores included in the comparable-store revenues calculation are those stores that have been open for a minimum of 60 weeks. Also included are stores that are remodeled or relocated. Sales via the internet are not included and closed stores are removed from each comparable period for the purpose of calculating comparable-store revenues.

Derivative Instruments. In June 2005, the Company entered into an interest rate cap agreement with a major bank as further discussed in the Capital Structure section of this MD&A. Statement of Financial Accounting Standards No. 133 requires us to recognize all derivatives on the balance sheet at fair value. We have designated this derivative as a hedge, and to the extent the hedge is considered effective, changes in the fair value of the derivative will be recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative’s change in fair value will be immediately recognized in earnings. The Company has capitalized the cost of the interest rate cap, and is amortizing this cost over 24 months.

Financial Results for the First Quarter of Fiscal Year 2006

Revenues. Total revenues for the first quarter increased $2.3 million, or 1.8%, to $131.4 million compared to $129.1 million for the first quarter of fiscal 2005. The following is a summary of our revenue results (dollars in thousands):


	Three Months Ended April 30,
	2006						2005					Increase/(Decrease)
				Percent of					Percent
	Revenues			Total			Revenues		of Total			Dollar		Percent
Merchandise revenue	$	106,952			81.4	%	$	104,864		81.2	%	$	2,088		2.0	%
Rental revenue		24,460			18.6	%		24,260		18.8	%		200		0.8	%

Total revenues	$	131,412			100.0	%	$	129,124		100.0	%	$	2,288		1.8	%


Comparable-store revenues (“Comp”):
Total		2.4	%
Merchandise		2.4	%
Rental		2.3	%

Below is a summary of the Comp results for those categories:


	Three Months Ended April 30,
	2006			2005
Music		-6.0	%		-1.3	%
Books		2.7	%		-3.4	%
Video for sale		13.8	%		2.4	%
Video games		6.3	%		30.6	%
Boutique		-0.3	%		17.1	%

Music Comps decreased 6.0%, which was primarily attributable to a weaker release schedule compared to the prior year’s quarter, partially offset by increased sales of music hardware. Book Comps increased 2.7% as a result of increased sales of new release paperbacks and used books, partially offset by decreased sales of hardback new releases. Video for sale Comps increased 13.8% due to increased sales of front-line new release DVDs, DVD box sets, as well as used DVDs. Video game Comps increased 6.3% due primarily to increased sales of Microsoft XBOX 360 games. Boutique Comps decreased 0.3%, primarily due to decreased sales of t-shirts, partially offset by increased sales of action figures and other collectible toys.

Rental video Comps increased 2.3% from the same period last year due to better box office titles and certain marketing initiatives.

Generally, it is difficult for us to project future Comp sales. Our Comp sales are to a great extent dependent upon the quantity and quality of new releases from the studios, publishers, and hardware manufacturers. However, for fiscal 2006, we are projecting positive merchandise and rental Comps in the low single-digit range.

Gross Profit. For the first quarter, total gross profit dollars increased approximately $2.6 million, or 5.9%, to $46.6 million from $44.0 million for the same period last year, primarily as a result of increased sales volume as well as lower freight, shrinkage and returns expense. As a percentage of total revenues, gross profit increased to 35.5% for the quarter compared to 34.1% for the same quarter in the prior year.

Selling, General and Administrative expenses (“SG&A”). SG&A increased approximately $0.6 million to $42.9 million for the current quarter compared to $42.3 million for the same quarter in the prior year. As a percentage of total revenues, SG&A decreased to 32.6% for the current quarter compared to 32.8% for the same quarter in the prior year.

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 annual 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 assets, 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 amended revolving credit facility. We believe our cash flow from operations and borrowings under our amended revolving credit facility will be sufficient to fund our ongoing operations, new superstores and superstore expansions through fiscal 2006.

Historically, we have experienced an increase in our debt level during the third quarter of our fiscal year. For the third quarter of fiscal 2006, we are projecting our debt level to increase to approximately $50.0 million to $54.0 million. However, we expect this balance to reduce to approximately $15.0 million to $19.0 million in the fourth quarter due to a higher level of repayments following the holiday selling season. At April 30, 2006, total outstanding debt (including capital lease obligations) was $46.2 million.

Consolidated Cash Flows

Operating activities. Net cash used in operating activities increased approximately $3.7 million, from $1.2 million for the three months ended April 30, 2005, to $4.9 million for the three months ended April 30, 2006. This increase primarily resulted from increased purchases of rental inventory and a larger decrease in trade accounts payable for the three months ended April 30, 2006, compared to the three months ended April 30, 2005, partially offset by increased net income.

Investing activities. Net cash used in investing activities remained unchanged at $3.3 million for the three months ended April 30, 2006, as compared to the same period in the prior year. Net cash used in investing activities is driven by the purchases of property and equipment associated with the opening, expanding, relocating, or remodeling of stores.

Financing activities. Cash provided by or used in financing activities is primarily associated with borrowings and payments made under debt agreements, as well as the change in cash overdraft from holdings with our bank. For the three months ended April 30, 2006, net borrowings under debt agreements were $18.1 million compared to $6.3 million for the three months ended April 30, 2005. Change in cash overdraft increased from a use of $2.2 million for the three months ended April 30, 2005, to a use of $6.6 million for the three months ended April 30, 2006.

Capital structure. On July 11, 2005 and February 28, 2006, we executed amendments to our syndicated secured Loan and Security Agreement with Fleet Retail Finance, Inc. and The CIT Group/Business Credit, Inc., (the “Facility”). The amount outstanding under the Facility is limited by a borrowing base predicated on eligible inventory, as defined in the Facility, and certain rental assets, net of accumulated depreciation less specifically defined reserves and is limited to a ceiling of $100 million, less a $10 million availability reserve. The Facility permits borrowings at various interest-rate options based on the prime rate or London Interbank Offering Rate (LIBOR) plus applicable margin depending upon the level of our minimum availability. The borrowing base under the Facility is limited to an advance rate of 65% of eligible inventory and certain rental assets net of accumulated amortization less specifically defined reserves, which can be adjusted to reduce availability under the Facility. Lenders may increase specifically defined reserves to reduce availability in the event of adverse changes in our industry that are projected to impact the value of our assets pledged as collateral. 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 $15 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 consolidated subsidiaries. The Facility matures on August 29, 2011. At April 30, 2006, we had $34.1 million in excess availability, after the $10 million availability reserve, under the Facility. However, excess availability may be reduced in the future as changes in the borrowing base occur or the lenders increase

availability reserves. The average rate of interest being charged under the Facility for the three months ended April 30, 2006 and the fiscal year ended January 31, 2006 was 6.8% and 5.6%, respectively.

We utilize standby letters of credit to support certain insurance policies. The aggregate amount of the letters of credit at April 30, 2006 was approximately $1.4 million, which reduces the excess availability under the Facility.

From time to time, we enter into interest rate agreements with financial institutions in order to obtain a fixed interest rate on a portion of our outstanding floating rate debt, thereby reducing our exposure to interest rate volatility. On June 29, 2005, the Company agreed to a two-year interest rate cap agreement, expiring June 29, 2007, with a major bank to hedge $20 million of the Company’s variable-rate debt (30-day LIBOR) against interest rate increases. The bank will “cap” the Company’s interest rate at 4.00% for the first $20 million of outstanding debt over the next two years. Should the 30-day LIBOR rate remain at 4.00% or lower, the interest rate cap will result in no settlement. Should the rate climb above 4.00% during the term of the rate cap, the bank will settle with the Company at the end of each month. At April 30, 2006 the 30-day LIBOR was 5.00%. The Company designates this transaction as a hedge in accordance with SFAS 133, which requires the effective portion of the hedge to be accounted for initially as a component of other comprehensive income on the balance sheet. Subsequently, it will be reclassified into earnings when the transaction affects earnings. Any ineffective portion of the gain or loss is to be reported in earnings immediately. For the quarter ended April 30, 2006, the Company recognized approximately $22,000, net of tax, as other comprehensive income related to the hedge agreement.

At April 30, 2006, our minimum lease commitments for the remaining nine months of fiscal 2006 were approximately $18.7 million. The present value of total existing minimum operating lease commitments for fiscal years 2007 through 2025 discounted at 9.0% was approximately $88.4 million as of April 30, 2006.

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, capital and operating leases and certain revenue-sharing arrangements. As of April 30, 2006, 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 April 30, 2006, 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 year ended January 31, 2006.

Seasonality and Inflation

As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating profit, is generated in the fourth fiscal quarter, which includes the 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 video rental activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games or the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of superstore openings, the number and popularity of new book, music and video titles, the cost of the new release or “best renter” titles, changes in comparable-store revenues, competition, marketing programs, increases in the minimum wage, weather, special or unusual events, and other factors that may affect our operations.

We do 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 our 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 lender’s base rate or LIBOR plus a specified percentage, at our option. The annual impact on our results of operations of a 100 basis point interest rate change on the April 30, 2006 outstanding balance of the variable rate debt would be approximately $0.3 million. The impact of an interest rate increase is mitigated by the interest rate cap agreement discussed in the Capital Structure section of Item 2. – “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” 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.

As required by Exchange Act Rules 13a-15 and 15d-15, an evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of April 30, 2006. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective as of such date to ensure that information required to be disclosed by us in our reports filed or submitted under the Exchange Act is (a) accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure, and (b) recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

There has not been any change in our internal control over financial reporting during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II — OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

ITEM 1A. RISK FACTORS.

Our Annual Report of Form 10-K for the year ended January 31, 2006 includes a detailed discussion of our risk factors.

ITEM 6. EXHIBITS.

The following exhibits are filed herewith or incorporated by reference as indicated as required by Item 601 of Regulation S-K. The exhibits designated by an asterisk are management contracts and/or compensatory plans or arrangements required to be filed as exhibits to this report.


Exhibit
Number			Description of Documents

3.1	(1	)	Third Restated Articles of Incorporation of the Company.

3.2	(1	)	Amended and Restated Bylaws of the Company.

4.1	(2	)	Specimen of Certificate of Common Stock of the Company.

4.2	(1	)	Third Restated Articles of Incorporation of the Company (see 3.1 above).

4.3	(1	)	Amended and Restated Bylaws of the Company (see 3.2 above).

31.1	(3	)	Principal Executive Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).

31.2	(3	)	Principal Financial Officer Certification Pursuant to Exchange Act Rule 13a-14(a)/15d-14(a).

32.1	(3	)	Certification Pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.


(1)		Previously filed as an exhibit to the Company’s Registration Statement on Form S-1, dated March 18, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.

(2)		Previously filed as an exhibit to the Company’s 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.

(3)		Filed herewith.


	Page
PART I — FINANCIAL INFORMATION

Item 1. Financial Statements.

Consolidated Balance Sheets as of April 30, 2006 (Unaudited), April 30, 2005 (Unaudited) and January 31, 2006		3

Unaudited Consolidated Statements of Operations for the Three Months Ended April 30, 2006 and 2005		4

Unaudited Consolidated Statements of Cash Flows for the Three Months Ended April 30, 2006 and 2005		5

Notes to Unaudited Consolidated Financial Statements		6

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.		13

Item 3. Quantitative and Qualitative Disclosures about Market Risk.		21

Item 4. Controls and Procedures.		21

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.		22

Item 1A. Risk Factors.		22

Item 6. Exhibits.		22

SIGNATURES		23

INDEX TO EXHIBITS		24
Principal Executive Officer Certification
Principal Financial Officer Certification
Certifications Pursuant to Section 906


	Three Months Ended April 30,
	2006		2005
Shares of common stock underlying options		898		513
Exercise price range per share	$5.51 to 14.03		$7.30 to $14.03


		HASTINGS ENTERTAINMENT, INC.

Date: June 9, 2006		/s/ Dan Crow
		Dan Crow
		Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

	(a)		Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

	(b)		Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

	(c)		Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and


Date: June 9, 2006		/s/ John H. Marmaduke

		John H. Marmaduke
		President and Chief Executive Officer
		(Principal Executive Officer)

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	Three Months Ended
	April 30,
	2006			2005
Merchandise revenue		81.4	%		81.2	%
Rental revenue		18.6			18.8

Total revenues		100.0			100.0

Merchandise cost of revenue		70.7			73.1
Rental cost of revenue		37.7			34.6

Total cost of revenues		64.5			65.9


Gross profit		35.5			34.1

Selling, general and administrative expenses		32.6			32.8
Pre-opening expenses		—			—


Operating income		2.9			1.3

Other income (expense):
Interest expense		(0.5	)		(0.4	)
Other, net		—			0.1


Income before income taxes		2.4			1.0

Income tax expense		(0.9	)		(0.4	)


Net income		1.5	%		0.6	%


	Three Months Ended				Year Ended
	April 30,				January 31,
	2006		2005		2006
Beginning number of stores		153		152		152
Openings		—		1		1
Closings		—		—		—

Ending number of stores		153		153		153

1.		I have reviewed this quarterly report on Form 10-Q of Hastings Entertainment, Inc.;

2.		Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3.		Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4.		The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have:

	(a)		All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

	(b)		Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

	(1)		The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended; and

	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company as of the dates and for the periods expressed in the Report.