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10-Q 1 d553602d10q.htm FORM 10-Q Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended July 31, 2013

¨	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

incorporation or organization)

(I.R.S. Employer

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 ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “accelerated filer”, “large accelerated filer”, and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class		Outstanding at July 31, 2013
Common Stock, $.01 par value per share		8,143,317 shares

HASTINGS ENTERTAINMENT, INC.

Form 10-Q

For the Quarterly Period Ended July 31, 2013

INDEX


		Page
PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements.

	Consolidated Balance Sheets as of July 31, 2013 (Unaudited), and January 31, 2013		3

	Unaudited Consolidated Statements of Operations for the Three and Six Months Ended July 31, 2013 and 2012		4

	Unaudited Consolidated Statements of Comprehensive Loss for the Three and Six Months Ended July 31, 2013 and 2012		5

	Unaudited Consolidated Statements of Cash Flows for the Six Months Ended July 31, 2013 and 2012		6

	Notes to the Unaudited Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.		11

Item 3.	Quantitative and Qualitative Disclosures about Market Risk.		23

Item 4.	Controls and Procedures.		24

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings.		25

Item 1A.	Risk Factors.		25

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.		25

Item 6.	Exhibits.		26

SIGNATURES			27

INDEX TO EXHIBITS			28

PART I—FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

HASTINGS ENTERTAINMENT, INC.

Consolidated Balance Sheets

July 31, 2013 and January 31, 2013

(Dollars in thousands, except par value)


	July 31, 2013			January 31, 2013
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	3,482		$	3,730
Merchandise inventories, net		144,602			145,337
Prepaid expenses and other current assets		11,136			10,427

Total current assets		159,220			159,494
Rental assets, net of accumulated depreciation of $16,907 and $18,827 at July 31, 2013 and January 31, 2013, respectively		9,939			11,353
Property, equipment and improvements, net of accumulated depreciation of $227,044 and $227,469 at July 31, 2013 and January 31, 2013, respectively		29,594			32,099
Intangible assets, net		244			244
Other assets		681			2,792

Total Assets		$199,678			$205,982

Liabilities and Shareholders’ Equity
Current liabilities:
Trade accounts payable	$	45,539		$	54,928
Accrued expenses and other current liabilities		28,795			27,396

Total current liabilities		74,334			82,324
Long term debt		51,872			41,805
Deferred income taxes		55			50
Other liabilities		5,636			7,828
Shareholders’ equity:
Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued		—			—
Common stock, $.01 par value; 75,000,000 shares authorized; 11,944,544 shares issued and 8,143,317 shares outstanding at July 31, 2013; 11,944,544 shares issued and 8,146,513 shares outstanding at January 31, 2013		119			119
Additional paid-in capital		36,325			36,375
Retained earnings		52,333			58,642
Accumulated other comprehensive income		340			247
Treasury stock, at cost 3,801,227 shares and 3,798,031 shares at July 31, 2013 and January 31, 2013, respectively		(21,336	)		(21,408	)

Total Shareholders’ Equity		67,781			73,975

Total Liabilities and Shareholders’ Equity	$	199,678		$	205,982

See accompanying notes to unaudited consolidated financial statements.

HASTINGS ENTERTAINMENT, INC.

Unaudited Consolidated Statements of Operations

For the Three and Six Months Ended July 31, 2013 and 2012

(Dollars in thousands, except per share amounts)


	Three Months Ended July 31,						Six Months Ended July 31,
	2013			2012			2013			2012
Merchandise revenue	$	82,795		$	89,314		$	177,595		$	188,833
Rental revenue		12,903			15,087			27,116			30,913
Gift card breakage revenue		83			(348	)		197			(206	)

Total revenues		95,781			104,053			204,908			219,540
Merchandise cost of revenue		55,696			59,050			120,128			126,579
Rental cost of revenue		4,466			5,038			9,369			10,553

Total cost of revenues		60,162			64,088			129,497			137,132

Gross profit		35,619			39,965			75,411			82,408
Selling, general and administrative expenses		39,388			43,035			81,134			84,325

Operating loss		(3,769	)		(3,070	)		(5,723	)		(1,917	)
Other income (expense):
Interest expense		(332	)		(292	)		(596	)		(570	)
Other, net		52			72			123			96

Loss before income taxes		(4,049	)		(3,290	)		(6,196	)		(2,391	)
Income tax expense		54			66			113			132

Net loss	$	(4,103	)	$	(3,356	)	$	(6,309	)	$	(2,523	)

Basic loss per share	$	(0.50	)	$	(0.41	)	$	(0.77	)	$	(0.31	)

Diluted loss per share	$	(0.50	)	$	(0.41	)	$	(0.77	)	$	(0.31	)

Weighted-average common shares outstanding:
Basic		8,140			8,214			8,142			8,238
Dilutive effect of stock awards		—			—			—			—

Diluted		8,140			8,214			8,142			8,238

See accompanying notes to unaudited consolidated financial statements.

HASTINGS ENTERTAINMENT, INC.

Unaudited Consolidated Statements of Comprehensive Loss

For the Three and Six Months Ended July 31, 2013 and 2012

(Dollars in thousands)


	Three Months Ended July 31,						Six Months Ended July 31,
	2013			2012			2013			2012
Net loss	$	(4,103	)	$	(3,356	)	$	(6,309	)	$	(2,523	)
Other comprehensive income (loss) before income taxes
Unrealized gains (losses) in investments available for sale in Supplemental Executive Retirement Plan		31			(33	)		93			36

Other comprehensive income (loss), before income taxes		31			(33	)		93			36
Income taxes related to components of other comprehensive income (loss)		—			(13	)		—			14

Other comprehensive income (loss), net of income taxes		31			(20	)		93			22

Total comprehensive loss	$	(4,072	)	$	(3,376	)	$	(6,216	)	$	(2,501	)

See accompanying notes to unaudited consolidated financial statements.

HASTINGS ENTERTAINMENT, INC.

Unaudited Consolidated Statements of Cash Flows

For the Six Months Ended July 31, 2013 and 2012

(Dollars in thousands)


	Six Months Ended July 31,
	2013			2012
Cash flows from operating activities:
Net loss	$	(6,309	)	$	(2,523	)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
Rental asset depreciation expense		1,943			3,069
Purchases of rental assets		(3,632	)		(4,835	)
Property, equipment and improvements depreciation expense		6,637			7,707
Deferred income taxes		5			5
Loss on rental assets lost, stolen and defective		188			363
Loss on disposal or impairment of property and equipment, excluding rental assets		73			93
Non-cash stock-based compensation		93			371
Changes in operating assets and liabilities:
Merchandise inventories		3,651			11,191
Prepaid expenses and other current assets		1,429			4,964
Trade accounts payable		(8,661	)		(505	)
Accrued expenses and other current liabilities		(527	)		1,189
Other assets and liabilities, net		(201	)		(246	)

Net cash provided by (used in) operating activities		(5,311	)		20,843

Cash flows from investing activities:
Purchases of property, equipment and improvements		(4,207	)		(3,754	)

Net cash used in investing activities		(4,207	)		(3,754	)

Cash flows from financing activities:
Borrowings under revolving credit facility		217,661			205,596
Repayments under revolving credit facility		(207,592	)		(222,982	)
Purchase of treasury stock		(128	)		(214	)
Change in cash overdraft		(728	)		736
Proceeds from exercise of stock options		57			—

Net cash provided by (used in) financing activities		9,270			(16,864	)

Net (decrease) increase in cash and cash equivalents		(248	)		225
Cash and cash equivalents at beginning of period		3,730			4,172

Cash and cash equivalents at end of period	$	3,482		$	4,397

See accompanying notes to unaudited consolidated financial statements.

Hastings Entertainment, Inc

Notes to Unaudited Consolidated Financial Statements

(Tabular amounts in thousands, except per share data or unless otherwise noted)

1. Basis of Presentation

The accompanying unaudited consolidated financial statements of Hastings Entertainment, Inc. and its subsidiary (“Hastings,” the “Company,” “we,” “our,” or “us”) have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and with instructions in Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such principles and regulations of the Securities and Exchange Commission. All adjustments, consisting of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of interim periods. The results of operations for such interim periods are not necessarily indicative of the results that may be expected for a full year because of, among other things, seasonality factors in the retail business. As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating earnings, is generated in the fourth fiscal quarter, which includes the holiday selling season. The unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the fiscal year ended January 31, 2013.

The consolidated balance sheet at January 31, 2013 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, 2013.

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, 2014 is referred to as fiscal year 2013.

2. Stock-Based Compensation

We have various stock incentive plans, which allow us to issue stock options, stock appreciation rights, restricted shares, restricted stock units, performance awards and other awards. Stock-based compensation is discussed more fully in Note 13 to the Audited Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended January 31, 2013.

For the three months ended July 31, 2013 and 2012, we recognized approximately $71,000 and $207,000, respectively, of stock-based compensation expense. For the six months ended July 31, 2013 and 2012, we recognized approximately $93,000 and $371,000, respectively, of stock-based compensation expense. These amounts include expense related to incentive stock options, non-qualified stock options, and restricted stock units.

As of July 31, 2013, we had 273,059 shares available to grant as stock-based compensation awards under our various stock incentive plans.

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 a store. Such evaluations include consideration of, among other factors, current and future expected profitability, market trends, age of store and lease status.

Amounts in “Accrued expenses and other current liabilities” and “Other liabilities” in the consolidated balance sheet at July 31, 2013 included accruals for the net present value of future minimum lease payments, net of estimated sublease income, attributable to closed stores. Expenses related to store closings are included in SG&A expenses in the consolidated statement of operations.

Hastings Entertainment, Inc

Notes to Unaudited Consolidated Financial Statements

(Tabular amounts in thousands, except per share data or unless otherwise noted)

The following table provides a roll-forward of our store closing reserve:


	Store Closing Reserve
Balance at January 31, 2013	$	2,105
Additions to provision		—
Changes in estimates		73
Cash outlay, net		(962	)

Balance at July 31, 2013	$	1,216

4. Long-term Debt

On January 4, 2013, we entered into an Amended and Restated Loan and Security Agreement with Bank of America, N.A., as lender and agent (as subsequently amended, the “Credit Agreement”). The Credit Agreement provides for a revolving credit facility of $115 million, allows for the payment of dividends, has a maturity date of January 4, 2017, and provides that we may repurchase up to $10 million worth of our common stock. The Credit Agreement also provides that we may repurchase additional shares of our common stock in the event we meet certain criteria set forth in the Credit Agreement. The Credit Agreement includes certain debt and acquisition limitations and requires a minimum Availability (as defined in the Credit Agreement) that is greater than or equal to $10 million at all times. Our obligations under the Credit Agreement are secured by a pledge of substantially all of the assets of the Company and our subsidiary and are guaranteed by our subsidiary.

The amount outstanding under the Credit Agreement is limited by a borrowing base predicated on the sum of (a) 85% of Eligible Credit Card Receivables plus (b) either (i) at all times during the year, other than those stated in (ii), 90% of the liquidation value of eligible inventory or (ii) from September 1^st through and including December 27^th of each year, 92.5% of the liquidation value of eligible inventory, less (c) Availability Reserves and is limited to a ceiling of $115 million, less a minimum availability reserve that is greater than or equal to 10% of the lesser of (a) the Borrowing Base, or (b) the Revolving Credit Ceiling (each term as defined in the Credit Agreement), provided however that we must also maintain Availability that is greater than or equal to $10 million at all times. The lender may increase specifically defined reserves to reduce availability in the event of adverse changes in our industry or our financial condition that are projected to impact the value of our assets pledged as collateral. The lender must exercise reasonable judgment and act in good faith with respect to any changes in the specifically defined reserves.

Interest under the Credit Agreement will accrue, at our election, at a Base Rate or Libor Rate, plus, in each case, an Applicable Margin, which is determined by reference to the level of Availability as defined in the Credit Agreement, with the Applicable Margin for Libor Rate loans ranging from 2.00% to 2.50% and the Applicable Margin for Base Rate (each term as defined in the Credit Agreement) loans ranging from 1.00% to 1.50%. In addition, unused line fees ranging from 0.30% to 0.375% (determined by reference to the level of usage under the Credit Agreement) are also payable on unused commitments.

We utilize standby letters of credit to support certain insurance policies. The aggregate amount of the letters of credit at July 31, 2013, was approximately $0.7 million, which reduces the excess availability under the Credit Agreement.

At July 31, 2013, we had approximately $47.3 million in excess availability, after the availability reserve, under the Credit Agreement. The average rate of interest incurred for the three months ended July 31, 2013 and 2012 was 2.5%. The average rates of interest incurred for the six months ended July 31, 2013 and 2012 was 2.5%. Deferred financing costs that were amortized into interest expense during the three and six months ended July 31, 2013 are excluded from the calculation of the average rate of interest for each respective period.

Hastings Entertainment, Inc

Notes to Unaudited Consolidated Financial Statements

(Tabular amounts in thousands, except per share data or unless otherwise noted)

5. Loss per Share

The computations for basic and diluted loss per share are as follows:


	Three Months Ended July 31,						Six Months Ended July 31,
	2013			2012			2013			2012
Net loss	$	(4,103	)	$	(3,356	)	$	(6,309	)	$	(2,523	)

Average shares outstanding:
Basic		8,140			8,214			8,142			8,238
Effect of stock awards		—			—			—			—

Diluted		8,140			8,214			8,142			8,238

Loss per share:
Basic	$	(0.50	)	$	(0.41	)	$	(0.77	)	$	(0.31	)

Diluted	$	(0.50	)	$	(0.41	)	$	(0.77	)	$	(0.31	)

The following options to purchase shares of common stock were not included in the computation of diluted income per share because their inclusion would have been antidilutive:


	Three Months Ended July 31,				Six Months Ended July 31,
	2013		2012		2013		2012
Shares of common stock underlying options		544		537		544		537
Exercise price range per share	$	1.69 to $8.70	$	2.06 to $9.67	$	1.69 to $8.70	$	2.06 to $9.67

6. Fair Value Measurements

We account for certain assets and liabilities at fair value. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The hierarchy below lists three levels of fair value based on the extent to which inputs used in measuring fair value are observable in the market. These levels are:

•

Level 1 – Observable inputs – quoted prices in active markets for identical assets and liabilities;

•

Level 2 – Observable inputs other than the quoted prices in active markets for identical assets and liabilities – includes quoted prices for similar instruments, quoted prices for identical or similar instruments in inactive markets, and amounts derived from valuation models where all significant inputs are observable in active markets; and

•

Level 3 – Unobservable inputs – includes amounts derived from valuation models where one or more significant inputs are unobservable and require us to develop relevant assumptions.

As of both July 31, 2013 and January 31, 2013, we had approximately $2.1 million in assets which are carried at fair value on a recurring basis. These assets consist of available-for-sale investments related to our non-qualified supplemental executive retirement plan (“SERP”). The fair value of these investments was determined using Level 1 inputs. On February 25, 2013, the Board of Directors approved the termination of the SERP, and distributions will commence in August 2013 with the expectation that the distributions will be completed by February 2014. Consequently, these assets were reclassified from Other Assets to Prepaid Expenses and Other Current Assets during the first quarter of fiscal 2013.

Hastings Entertainment, Inc

Notes to Unaudited Consolidated Financial Statements

(Tabular amounts in thousands, except per share data or unless otherwise noted)

Our long-term debt approximates fair value as of both July 31, 2013 and January 31, 2013, due to the instrument bearing interest at variable rates that are comparable to what is currently available to us. We entered into a second amendment to the Credit Agreement on January 4, 2013, at which time our current interest rates were determined. See Note 4 on Debt for a more detailed discussion of our Credit Agreement.

7. Income Taxes

The effective tax rates for the three and six months ended July 31, 2013 were (1.3%) and (1.8%), respectively, primarily due to Texas state income tax expense, which is based primarily on gross margin.

During the fourth quarter of fiscal 2011, we established a valuation allowance on our deferred tax assets. A valuation allowance is required if it is more likely than not that a deferred tax asset will not be realized. In assessing the need for a valuation allowance, we considered all available positive and negative evidence, including our ability to carry back operating losses to prior periods, projected future taxable income, tax planning strategies and the reversal of deferred tax liabilities. Based on this analysis, we determined, and we continue to believe, that it was more likely than not that our deferred tax assets will not be realized. As such, we evaluated and increased the valuation allowance to approximately $13.2 million at July 31, 2013. Our effective rate is significantly lower than statutory rates due to the valuation allowance. We reassess the valuation allowance quarterly, and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

8. Litigation and Contingencies

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

9. Recent Accounting Pronouncements

During February 2013, the Financial Accounting Standards Board (“FASB”) issued ASU 2013-02: Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (for example, inventory) instead of directly to income or expense in the same reporting period. The Company adopted ASU 2013-02 beginning with the first quarter of fiscal 2013. There was no impact on the Company’s financial statements during the first six months of fiscal 2013, and we do not anticipate ASU 2013-02 having a material impact on the Company’s financial statements during the remainder of fiscal 2013.

In July 2013, the Financial Accounting Standards Board issued ASU No. 2013-11: Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists, which requires unrecognized tax benefits to be presented as a decrease in a net operating loss, similar tax loss or tax credit carryforward if certain criteria are met. The ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of ASU 2013-11 is not expected to have a material impact on the Company’s consolidated financial statements during the remainder of fiscal 2013.

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Statements

Certain written and oral statements set forth below or made by Hastings with the approval of an authorized executive officer constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. The words “believe,” “expect,” “intend,” “anticipate,” “project,” “will” and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future including statements relating to the business, expansion, merchandising and marketing strategies of Hastings, industry projections or forecasts, inflation, effect of critical accounting policies including lower of cost or market for inventory adjustments, the returns process, rental asset depreciation, store closing reserves, impairment or disposal of long-lived assets, revenue recognition, and vendor allowances, sufficiency of cash flow from operations and borrowings under our revolving credit facility and statements expressing general optimism about future operating results are forward-looking statements. Such statements are based upon our management’s current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to, consumer appeal of our existing and planned product offerings, and the related impact of competitor pricing and product offerings; overall industry performance and the accuracy of our estimates and judgments regarding trends; our ability to obtain favorable terms from suppliers; the reduction or elimination of the in-store window for rental video; our ability to respond to changing consumer preferences, including with respect to new technologies and alternative methods of content delivery, and to effectively adjust our offerings if and as necessary; the application and impact of future accounting policies or interpretations of existing accounting policies; whether our assumptions turn out to be correct; our inability to attain such estimates and expectations; a downturn in market conditions in any industry relating to the products we inventory, sell or rent; the degree to which we enter into and maintain vendor relationships; the challenging times that the U.S. and global economies are currently experiencing, the effects of which have had and will continue to have an adverse impact on spending by Hastings’ current retail customer base and potential new customers, and the possibility that general economic conditions could deteriorate further; volatility of fuel and utility costs; the “sequester” and related governmental spending and budget matters; acts of war or terrorism inside the United States or abroad; unanticipated adverse litigation results or effects; the effect of inclement weather on the ability of consumers to reach our stores and other factors which may be outside of our control; any of which could cause actual results to differ materially from those described herein. We undertake no obligation to affirm, publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with the unaudited consolidated financial statements of the Company and the related notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.

General

Incorporated in 1972, Hastings Entertainment, Inc. (the “Company,” “Hastings,” or “Hastings Entertainment”) is a leading multimedia entertainment retailer. We operate entertainment superstores that buy, sell, trade and rent various home entertainment products, including books, music, software, periodicals, movies on DVD and Blu-Ray, video games, video game consoles, hobby, sports and recreation and consumer electronics. We also offer consumables and trends products such as apparel, t-shirts, action figures, posters, greeting cards and seasonal merchandise. As of July 31, 2013, we operated 130 superstores principally in medium-sized markets located in 19 states, primarily in the Western and Midwestern United States. We also operate three concept stores, Sun Adventure Sports, located in Amarillo, Texas and Lubbock, Texas and TRADESMART, located in Littleton, Colorado. Sun Adventure Sports sells a wide range of bicycles and related accessories, skateboards, and various other athletic equipment, apparel, and shoes, and offers bicycle repair services and cycling classes. TRADESMART, born from the culture of recycling, features over 400,000 predominantly used and new books, CDs, DVDs, Blu-Rays, video games and video game systems, as well as consumer electronics, trends, skateboards and paintball merchandise, and much more available for purchase. TRADESMART also buys back for cash or store credit entertainment products that customers have previously enjoyed.

We also operate a multimedia entertainment e-commerce web site offering a broad selection of books, software, video games, movies on DVD and Blu-Ray, music, trends, comics, sports & recreation and electronics. We fill orders for new and used product placed at the website and also through Amazon and eBay Marketplaces using our proprietary goShip program, which allows us to ship directly from stores or the distribution center. We have one wholly-owned subsidiary, Hastings Internet, Inc.

References herein to fiscal years are to the twelve-month periods that end in January of each following calendar year. For example, the twelve-month period ending January 31, 2014 is referred to as fiscal 2013.

Critical Accounting Estimates

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

Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories are recorded at the lower of cost, which approximates the first-in, first-out (“FIFO”) method, or market. Inventory costing requires certain significant estimates and judgments involving the allocation of costs and vendor allowances. These practices affect ending inventories at cost, as well as the resulting gross margins and inventory turnover ratios. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can also affect the carrying value of inventory. As circumstances warrant, we record the lower of cost or market inventory adjustments. In some instances, these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns and estimated market value and returnability of merchandise inventory by product category and record an adjustment if estimated market value is below cost.

Rental Asset Depreciation. We have established rental asset depreciation policies that match rental product costs with the related revenues. These policies require that we make significant estimates, based upon our experience, as to the ultimate amount and timing of revenue to be generated from our rental product. We utilize an accelerated method of depreciation because it approximates the pattern of demand for the product, which is higher when the product is initially released by the studios for rental and declines over time. In establishing salvage values for our rental product, we consider the sales prices and sales volume of our previously rented product and other used product.

We currently depreciate the cost of our rental assets on an accelerated basis over six months or nine months, except for rental assets purchased for the initial stock of a new store, which are depreciated on a straight-line basis over 36 months. Rental assets, which include DVDs, Blu-Rays and video games, are depreciated to salvage values ranging from $4 to $15. Rental assets purchased for less than established salvage values are not depreciated.

We also review the carrying value of our rental assets to ensure that estimated future cash flows exceed the carrying value. We periodically record adjustments to the carrying value of previously rented product primarily for estimated obsolescence or excess product based upon changes in our original assumptions about future demand and market conditions. If future demand or actual market conditions are less favorable than our original estimates, additional adjustments, including adjustments to useful lives or salvage values, may be required. We continually evaluate the estimates surrounding the useful lives and salvage values used in depreciating our rental assets. Changes to these estimates resulting from changes in consumer demand, changes in customer preferences or the price or availability of retail products may materially impact the carrying value of our rental assets and our rental margins.

The costs of rental product purchased pursuant to revenue-sharing arrangements, which are recorded in rental cost of sales on the consolidated statements of operations, typically include a lower initial product cost than traditional rental purchases with a certain percentage of the net rental revenues shared with studios over an agreed period of

time. Any up-front costs exceeding the designated salvage value are amortized on an accelerated basis and revenue-sharing payments pursuant to the applicable arrangement are expensed as rental cost of sales as the related revenue is earned. Additionally, certain titles have performance guarantees. We analyze titles that are subject to performance guarantees and recognize an estimated expense for under-performing titles throughout the applicable period based upon our analysis of the estimated rental revenue shortfall. We revise these estimates on a monthly basis, based on actual results.

Impairment or Disposal of Long-Lived Assets. We evaluate under-performing stores on a quarterly basis to determine whether projected future cash flows over the remaining lease term are sufficient to recover the carrying value of the fixed asset investment in each individual store. If projected future cash flows are less than the carrying value of the fixed asset investment, an impairment charge is recognized if the estimated fair value is less than the carrying value of such assets. The carrying value of leasehold improvements as well as certain other property and equipment is subject to impairment write-down.

Income Taxes. In determining net income (loss), we make certain estimates and judgments in the calculation of tax expense and the resulting tax liabilities and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We record deferred tax assets and liabilities for future income tax consequences that are attributable to differences between financial statement carrying amounts of assets and liabilities and their income tax bases. We base the measurement of deferred tax assets and liabilities on enacted tax rates that we expect will apply to taxable earnings in the year when we expect to settle or recover those temporary differences. We recognize the effect on deferred tax assets and liabilities on any change in income tax rates in the period that includes the enactment date. A valuation allowance is established if it is more likely than not that a deferred tax asset will not be realized. In determining the appropriate valuation allowance, we consider all available positive and negative evidence, including our ability to carry back operating losses to prior periods, projected future taxable income, tax planning strategies and the reversal of deferred tax liabilities. We reassess the valuation allowance quarterly, and, if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

The tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood, on a cumulative basis, of being realized upon ultimate settlement. We recognize interest and penalties relating to any uncertain tax positions as a component of income tax expense.

Share-Based Compensation. Determining the amount of share-based compensation to be recorded in the statement of operations requires us to develop estimates that are used in calculating the grant-date fair value of stock options. In determining the fair value of stock options, we use the Black-Scholes valuation model, which requires us to make estimates of the following assumptions:

•

Expected volatility – The estimated stock price volatility is derived based upon our historical stock prices over the expected life of the option.

•

Expected life of the option – The estimate of an expected life is calculated based on historical data relating to grants, exercises and cancellations, as well as the vesting period and contractual life of the option.

•

Risk-free interest rate – The risk-free interest rate is based on the yield on zero-coupon U.S. Treasury securities for a period that is commensurate with the expected life of the option.

•

Expected dividend yield – The estimated rate based on the stock’s current market price and forecasted dividend payout.

Our stock price volatility and expected option lives reflect management’s best estimates at the grant date, both of which impact the fair value of the option calculated under the Black-Scholes pricing model and, ultimately, the expense that will be recognized over the vesting period of the option.

We recognize compensation expense only for the portion of options that are expected to vest. Therefore, we apply estimated forfeiture rates that are derived from historical employee termination behavior. If the actual number of forfeitures differs from those estimated by management, additional adjustments to compensation expense may be required in future periods.

In addition to stock options, we award restricted stock awards, including restricted stock units and performance-based restricted stock awards. The grant date fair value of restricted stock awards is equal to the average of the opening and closing stock price on the day on which they are granted. For performance-based restricted stock awards, compensation expense is recognized if management deems it probable that the performance conditions will be met. Management must use its judgment to determine the probability that a performance condition will be met. If actual results differ from management’s assumptions, future results could be materially impacted.

Gift Card Breakage Revenue. We sell gift cards through each of our stores and through our web site www.goHastings.com. The gift cards we sell have no stated expiration dates or fees and are subject to potential escheatment rights in some of the jurisdictions in which we operate. Gift card liabilities are recorded as deferred revenue at the time of sale of such cards with the costs of designing, printing and distributing the cards recorded as expense as incurred. Gift card breakage revenue is recognized as gift cards are redeemed, based upon an analysis of the aging and utilization of gift cards, our determination that the likelihood of future redemption is remote and our determination that such balances are not subject to escheatment laws applicable to our operations.

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 July 31,						Six Months Ended July 31,
	2013			2012			2013			2012
Merchandise revenue		86.4	%		85.8	%		86.7	%		86.0	%
Rental revenue		13.5			14.5			13.2			14.1
Gift card breakage revenue		0.1			(0.3	)		0.1			(0.1	)

Total revenues		100.0			100.0			100.0			100.0
Merchandise cost of revenue		67.3			66.1			67.6			67.0
Rental cost of revenue		34.6			33.4			34.6			34.1

Total cost of revenues		62.8			61.6			63.2			62.5

Gross profit		37.2			38.4			36.8			37.5
Selling, general and administrative expenses		41.1			41.4			39.6			38.4

Operating loss		(3.9	)		(3.0	)		(2.8	)		(0.9	)
Other income (expense):
Interest expense		(0.3	)		(0.3	)		(0.3	)		(0.3	)
Other, net		0.1			0.1			0.1			0.1

Loss before income taxes		(4.1	)		(3.2	)		(3.0	)		(1.1	)
Income tax expense (benefit)		0.1			0.1			0.1			0.1

Net loss		(4.2	)%		(3.3	)%		(3.1	)%		(1.2	)%

Summary of Superstore Activity⁽¹⁾


	Three Months Ended July 31,					Six Months Ended July 31,						Year Ended January 31,
	2013			2012		2013			2012			2013
Beginning number of stores		134			138		137			140			140
Openings		—			—		—			—			—
Closings		(4	)		—		(7	)		(2	)		(3	)

Ending number of stores		130			138		130			138			137

(1)	As of July 31, 2013, we operated three concept stores, consisting of two Sun Adventure Sports and one TRADESMART, which were not included in the summary of superstore activity.

Financial Results for the Second Quarter of Fiscal Year 2013

Revenues. Total revenues for the second quarter of fiscal 2013 decreased approximately $8.3 million, or 7.9%, to $95.8 million compared to $104.1 million for the second quarter of fiscal 2012. As of July 31, 2013, we operated 8 fewer superstores, as compared to July 31, 2012. The following is a summary of our revenues results (dollars in thousands):


	Three Months Ended July 31,
	2013					2012						Increase/(Decrease)
			Percent						Percent
	Revenues		Of Total			Revenues			Of Total			Dollar			Percent
Merchandise Revenue	$	82,795		86.4	%	$	89,314			85.8	%	$	(6,519	)		-7.3	%
Rental Revenue		12,903		13.5	%		15,087			14.5	%		(2,184	)		-14.5	%
Gift Card Breakage Revenue		83		0.1	%		(348	)		(0.3	%)		431			123.9	%

Total Revenues	$	95,781		100.0	%	$	104,053			100.0	%	$	(8,272	)		-7.9	%

Comparable-store revenues (“Comp”)


Total	-6.2	%
Merchandise	-5.4	%
Rental	-10.9	%

Below is a summary of the Comp results for our major merchandise categories:


	Three Months Ended July 31,
	2013			2012
Trends		10.7	%		11.2	%
Electronics		7.2	%		5.4	%
Movies		2.9	%		0.4	%
Hardback Café		2.7	%		12.1	%
Consumables		-6.1	%		7.9	%
Music		-10.9	%		-11.6	%
Games		-14.8	%		-22.8	%
Books		-14.9	%		2.5	%

Trends Comps increased 10.7% for the quarter, primarily due to increased sales in action figures, novelty toy gifts, barware, licensed and branded products, and recreation and lifestyles products. Licensed and branded products for which we experienced strong sales during the quarter were Minecraft, Duck Dynasty and My Little Pony. The Trends department also includes recreation and lifestyles products whose growth was driven by the addition of hobby products to reset stores as well as the growth in the existing categories of skateboards, disc golf, exercise accessories and airsoft products. Electronics Comps increased 7.2% for the quarter, primarily due to increased sales in categories such as speaker systems, tablets and accessories, home entertainment, wireless phone accessories, gadgets and turntables. Expanded product categories such as televisions, fitness electronics, kids electronics, home security and app enhanced accessories also showed strong growth. Movies Comps increased 2.9% for the quarter, primarily due to increased sales of new DVD Boxed Sets and new Midline DVD movies, partially offset by declining sales in used DVD movies. Hardback Café Comps increased 2.7% for the quarter, primarily due to increased sales in hot and cold beverages, partially offset by decreased sales in blended beverages. Consumables Comps decreased 6.1% for the quarter, primarily due to weaker sales of bottle drinks, fountain drinks and everyday consumable items. Music Comps decreased 10.9% for the quarter, primarily resulting from lower sales of new and used CDs and the continued increase in popularity of digital delivery. Games Comps decreased 14.8% for the quarter, primarily due to lower sales of new and used video game consoles and accessories and used video games. The longevity of the current console cycle continues to contribute to weak overall sales in the video game industry. Books Comps decreased 14.9% for the quarter, primarily due to a decrease in trade paperback sales as compared to the second quarter of fiscal 2012 which included strong sales from the Fifty Shades trilogy, and to a lesser extent, a weaker release schedule for new books.

Rental Comps decreased 10.9% for the quarter primarily due to fewer rentals of DVDs and video games, partially offset by an increase in rentals of Blu-Ray movies. Rental Movie Comps decreased 9.5% for the quarter partially due to a weaker new release schedule during the quarter as compared to the second quarter of fiscal 2012 and the continued impact of competitor rental kiosks and subscription-based rental services. Rental Video Game Comps, which continue to be affected by the longevity of the current console cycle, decreased 23.1%.

Gross Profit – Merchandise. For the second quarter, total merchandise gross profit dollars decreased approximately $3.2 million, or 10.6%, to $27.1 million from $30.3 million for the same period in the prior year. This decrease is primarily due to a decrease in revenue, which is partially attributed to operating fewer superstores this quarter compared to the same period in the prior year, combined with a decline in gross profit margin rate. As a percentage of total merchandise revenue, merchandise gross profit decreased to 32.7% for the quarter compared to 33.9% for the same period in the prior year, resulting primarily from a continued shift in mix of revenues by category, higher shrinkage and a higher expense to return products.

Gross Profit – Rental. For the second quarter, total rental gross profit dollars decreased approximately $1.6 million, or 16.0%, to $8.4 million from $10.0 million for the same period in the prior year. This decrease is primarily due to a decrease in revenue which is partially attributed to operating fewer superstores this quarter compared to the same period in the prior year. As a percentage of total rental revenue, rental gross profit decreased to 65.4% for the quarter compared to 66.6% for the same period in the prior year, primarily due to an increase in revenues under revenue sharing agreements which generally have lower margins when compared to traditional agreements.

Selling, General and Administrative Expenses (“SG&A”). As a percentage of total revenue, SG&A decreased to 41.1% for the second quarter compared to 41.4% for the same period in the prior year. SG&A decreased approximately $3.6 million during the quarter, or 8.4%, to $39.4 million compared to $43.0 million for the same quarter last year. The decrease results primarily from a $1.5 million reduction in corporate salary expense due to lower bonus payouts and the restructuring that took place in the first quarter of fiscal 2013, a $1.0 million reduction in store labor expense, a decrease of $0.7 million in store advertising and a $0.6 million decrease in depreciation expense. The decrease in depreciation expense and, to a certain extent, the decrease in store labor expense, are primarily a result of operating fewer superstores this quarter compared to the same period in the prior year. These reductions were partially offset by a $0.3 million increase in store maintenance expense.

Interest Expense. For both the second quarter of fiscal 2013 and fiscal 2012, interest expense was approximately $0.3 million, as interest rates for both periods averaged 2.5%.

Income Tax Expense. The effective tax rate for the second quarter was (1.3%) primarily due to Texas state income tax, which is based primarily on gross margin.

Financial Results for the Six Months Ended July 31, 2013

Revenues. Total revenues for the six months ended July 31, 2013 decreased approximately $14.6 million, or 6.7%, to $204.9 million compared to $219.5 million for the six months ended July 31, 2012. The following is a summary of our revenues results (dollars in thousands):


	Six Months Ended July 31,
	2013					2012						Increase/(Decrease)
			Percent						Percent
	Revenues		Of Total			Revenues			Of Total			Dollar			Percent
Merchandise Revenue	$	177,595		86.7	%	$	188,833			86.0	%	$	(11,238	)		-6.0	%
Rental Revenue		27,116		13.2	%		30,913			14.1	%		(3,797	)		-12.3	%
Gift Card Breakage Revenue		197		0.1	%		(206	)		-0.1	%		403			195.6	%

Total Revenues	$	204,908		100.0	%	$	219,540			100.0	%	$	(14,632	)		-6.7	%

Comparable-store revenues (“Comp”)


Total	-4.9	%
Merchandise	-4.2	%
Rental	-9.3	%

Below is a summary of the Comp results for our major merchandise categories:


	Six Months Ended July 31,
	2013			2012
Electronics		14.1	%		8.8	%
Trends		9.6	%		11.4	%
Hardback Café		5.7	%		8.7	%
Movies		3.9	%		-2.2	%
Consumables		-4.2	%		3.2	%
Books		-11.4	%		0.3	%
Music		-11.6	%		-10.8	%
Games		-18.0	%		-22.1	%

Electronics Comps increased 14.1% for the period, primarily due to increased sales in categories such as home entertainment, speaker docks, tablets and accessories, turntables and wireless phone accessories. Strong growth was also realized in expanding categories such as fitness electronics, kids electronics, and app enhanced accessories. Trends Comps increased 9.6% for the period, primarily due to increased sales in action figures, novelty toy gifts, barware, licensed and branded products, and recreation and lifestyles products. Licensed and branded products that performed well during the period were Walking Dead, Sons of Anarchy, and Doctor Who. The Trends department also includes recreation and lifestyles products whose growth was driven by the addition of hobby products to reset stores as well as the growth in the existing categories of skateboards, disc golf, exercise accessories and airsoft products. Hardback Café Comps increased 5.7% for the period, primarily due to increased sales in hot, cold and blended beverages. Movies Comps increased 3.9% for the period, primarily due to increased sales of new DVD Boxed Sets, new Blu-Ray and DVD Midline movies, partially offset by declining sales in used DVD movies. Consumables Comps decreased 4.2% for the period, primarily due to weaker sales of bottle drinks, fountain drinks and everyday consumable items. Books Comps decreased 11.4% for the period, primarily due to a decrease in trade paperback and hardback sales as compared to the first half of fiscal 2012, which included strong sales from the Fifty Shades and Hunger Games trilogies, and a weaker release schedule for new books. Music Comps decreased 11.6% for the period, primarily resulting from lower sales of new and used CDs and the continued increase in popularity of digital delivery. The decrease is partially offset by an increase in new vinyl album sales. Games Comps decreased 18.0% for the period, primarily due to lower sales of new and used video game consoles and accessories and used video games. The longevity of the current console cycle continues to contribute to weak overall sales in the video game industry.

Rental Comps decreased 9.3% for the period primarily due to fewer rentals of DVDs and video games, partially offset by an increase in rentals of Blu-Ray movies. Rental Movie Comps decreased 7.8% for the period and continue to be impacted by competitor rental kiosks and subscription-based rental services. Rental Video Game Comps, which continue to be affected by the longevity of the current console cycle, decreased 22.2%.

Gross Profit – Merchandise. For the current six months, total merchandise gross profit dollars decreased approximately $4.8 million, or 7.7%, to $57.5 million from $62.3 million for the same period in the prior year, primarily due to a decrease in revenue which is partially attributed to operating fewer superstores this period compared to the same period in the prior year. As a percentage of total merchandise revenue, merchandise gross profit decreased to 32.4% for the current six months, compared to 33.0% for the same period in the prior year, primarily due to a shift in mix of revenues by category, a higher expense to return products and markdown expenses which are partially offset by lower freight expense.

Gross Profit – Rental. For the current six months, total rental gross profit dollars decreased approximately $2.7 million, or 13.2%, to $17.7 million from $20.4 million for the same period in the prior year primarily due to a decrease in revenue which is partially attributed to operating fewer superstores this period compared to the same period in the prior year. As a percentage of total rental revenue, rental gross profit decreased to 65.4% for the current six month period compared to 65.9% for the same period in the prior year, primarily due to an increase in revenues under revenue sharing agreements which generally have lower margins when compared to traditional agreements. The rate decrease is partially offset by a decrease in depreciation and shrink expense.

Selling, General and Administrative Expenses (“SG&A”). As a percentage of total revenue, SG&A increased to 39.6% for the current six months compared to 38.4% for the same period in the prior year primarily due to deleveraging resulting from lower revenues. SG&A decreased approximately $3.2 million, or 3.8%, to $81.1 million compared to $84.3 million for the same period last year. The main drivers of the decrease in SG&A included a $1.0 million decrease in store labor expense, a $1.0 million decrease in depreciation expense, a $1.0 million decrease in store advertising expense and a $0.8 million decrease in corporate salary and related benefit expense, which includes the $1.4 million in severance charges from the corporate restructuring that was initiated in February 2013. The decrease in depreciation expense and, to a certain extent, the decrease in store labor expense, are primarily a result of operating fewer superstores this period compared to the same period in the prior year. The reductions were partially offset by an increase of $0.5 million in store maintenance expense.

Interest Expense. For both the first half of fiscal 2013 and fiscal 2012, interest expense was approximately $0.6 million, as interest rates for both periods averaged 2.5%.

Income Tax Expense. As the Company has a net operating loss and a net deferred tax asset, which has been offset by a full valuation allowance at the end of fiscal 2011, there is no tax liability, with the exception of Texas state income tax, which is based primarily on gross margin; therefore, the effective tax rate for the first half of fiscal 2013 is (1.8%). The valuation allowance is approximately $13.2 million as of July 31, 2013. We reassess the valuation allowance quarterly, and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

Stock Repurchases

During the second quarter of fiscal 2013, we purchased a total of 26,900 shares of common stock at a cost of $99,701, or $3.71 per share. We purchased these shares as part of a stock repurchase program originally announced in September 2001 and subsequently extended and expanded. As of July 31, 2013 a total of $5.6 million remained available under the stock repurchase program.

Store Activity

Since May 20, 2013, which was the last date we reported store activity, we have the following activity to report.

•

Store closed in Paris, TX, in June

•

Store closed in Jacksonville, AR in June

•

Store closed in Fayetteville, AR in June

•

Store closed in Duncan, OK in July

•

Store closed in Springdale, AR in August

Use of Non-GAAP Financial Measures

The Company is providing free cash flow, EBITDA and adjusted EBITDA as supplemental non-GAAP financial measures regarding the Company’s operational performance. The Company evaluates its historical and prospective financial performance, and its performance relative to its competitors, by using such non-GAAP financial measures. Specifically, management uses these items to further its own understanding of the Company’s core operating performance, which management believes represents the Company’s performance in the ordinary, ongoing and customary course of its operations. Therefore, management excludes from core operating performance certain items, such as those relating to restructuring, investing, stock-based compensation expense and non-cash activities that management does not believe are reflective of such ordinary, ongoing and customary activities.

The Company believes that providing this information to its investors, in addition to the presentation of GAAP financial measures, allows investors to see the Company’s financial results “through the eyes” of management. The Company further believes that providing this information allows investors to both better understand the Company’s financial performance and to evaluate the efficacy of the methodology and information used by management to evaluate and measure such performance.

Free Cash Flow

Management defines free cash flow as net cash provided by (used in) operating activities for the period less purchases of property, equipment and improvements during the period. The following table reconciles net cash provided by operating activities, a GAAP financial measure, to free cash flow, a non-GAAP financial measure (in thousands):


	Six months ended July 31,
	2013			2012
Net cash provided by (used in) operating activities	$	(5,311	)	$	20,843
Purchase of property, equipment and improvements, net		(4,207	)		(3,754	)

Free cash flow	$	(9,518	)	$	17,089

EBITDA and Adjusted EBITDA

EBITDA is defined as net income (loss) before interest expense (net), income tax expense (benefit), and depreciation and amortization of property, equipment and improvements. Adjusted EBITDA, as presented herein, is EBITDA excluding gift card breakage revenue and non-cash stock-based compensation expense. The following table reconciles net income (loss), a GAAP financial measure, to EBITDA and adjusted EBITDA, non-GAAP financial measures (in thousands):


	Three months ended July 31,						Six months ended July 31,
	2013			2012			2013			2012
Net loss	$	(4,103	)	$	(3,356	)	$	(6,309	)	$	(2,523	)
Adjusted for
Interest expense, net		332			292			596			570
Income tax expense		54			66			113			132
Property, equipment and improvements depreciation expense		3,265			3,926			6,637			7,707

EBITDA		(452	)		928			1,037			5,886
Gift card breakage revenue		(83	)		348			(197	)		206
Non-cash stock-based compensation		71			207			93			371

Adjusted EBITDA	$	(464	)	$	1,483		$	933		$	6,463

Liquidity and Capital Resources

We generate cash from operations from the sale of merchandise and the rental of products, most of which is received in cash and cash equivalents. Our primary sources of working capital are cash flow from operating activities including trade credit from vendors and borrowings under our revolving credit facility, with the most significant source during the first six months of fiscal 2013 being cash flows from borrowings under our revolving credit facility. Other than our principal capital requirements arising from the purchasing, warehousing and merchandising of inventory and rental products, opening new stores and expanding or reformatting existing stores and updating

existing and implementing new information systems technology, we have no anticipated material capital commitments, except for the stock buyback programs more fully discussed below. We believe the Company will have adequate resources to fund its cash needs for the next twelve months and beyond, including its capital spending, its seasonal increase in merchandise inventory and other operating cash requirements and commitments.

At July 31, 2013, total outstanding debt was approximately $51.9 million. We project our outstanding debt level will be in the range of $43.0 million to $47.0 million by the end of fiscal 2013. At July 31, 2013, we had approximately $47.3 million in excess availability, after the $10 million availability reserve, under the Credit Agreement (as defined below).

Consolidated Cash Flows

Operating Activities. Net cash used in operating activities totaled approximately $5.3 million for the six months ended July 31, 2013, compared to cash provided by operating activities of $20.8 million for the six months ended July 31, 2012. Net loss for the current period was approximately $6.3 million compared to a net loss of $2.5 million for the same period in fiscal 2012. Purchases of rental assets decreased approximately $1.2 million to $3.6 million during the current period compared to $4.8 million during the same period in fiscal 2012 in anticipation of lower rental revenues. Consequently, rental asset depreciation expense decreased approximately $1.2 million to $1.9 million during the current period from $3.1 million during the same period in fiscal 2012. Property, equipment and improvements depreciation expense decreased approximately $1.1 million to $6.6 million during the current period compared to $7.7 million during the same period in fiscal 2012. This decrease is a result of having less depreciable fixed assets on the balance sheet for the first half of fiscal 2013 compared to the first half of fiscal 2012. Merchandise inventories decreased approximately $3.7 million for the current period compared to a decrease of approximately $11.2 million during the same period in fiscal 2012. The reduction in inventory purchases for the first half of fiscal 2013 was less significant than the reduction for the same period in the prior year, due to purchases of new products being brought in, prior to the stores being reset, and staged in our distribution center in support of our introduction of new product categories. Merchandise inventories, net of trade accounts payable, increased approximately $5.0 million for the current period compared to a decrease of approximately $10.7 million for the same period in fiscal 2012, primarily due to a smaller decrease in merchandise inventories in the current period and differences of timing of payments to vendors. Trade accounts payable decreased approximately $8.7 million for the current period compared to a decrease of approximately $0.5 million during the same period in fiscal 2012 due to a variance in the timing of payments to vendors. This primarily results from the fact that several of our new product vendors currently have relatively shorter payment terms in comparison to the majority of our traditional media product vendors. Accrued expenses and other liabilities decreased approximately $0.5 million during the current period compared to an increase of approximately $1.2 million during the same period in fiscal 2012 due to a reduction in the store closing reserve and changes to various other balance sheet accounts. For fiscal 2013, we estimate net cash from operations in the range of approximately $1.0 to ($2.0) million as compared to net cash provided by operations of approximately $22.2 million in fiscal 2012. The expected decrease from fiscal 2012 net cash provided by operations to fiscal 2013 estimates results primarily from the significant decrease in trade accounts payable as well as the continued projected flat inventory level.

Investing Activities. Net cash used in investing activities increased approximately $0.4 million from $3.8 million for the six months ended July 31, 2012, to $4.2 million for the six months ended July 31, 2013. This increase was primarily due to increased capital expenditures relating to the reset stores. For fiscal 2013, we project capital expenditures to be approximately $8.5 million to $9.5 million as we continue to manage discretionary spending during fiscal 2013.

Financing Activities. Cash provided by or used in financing activities is primarily associated with borrowings and payments made under our revolving credit facility (described below under “Capital Structure”). For the six months ended July 31, 2013, cash provided by financing activities was approximately $9.3 million compared to cash used in financing activities of approximately $16.9 million for the six months ended July 31, 2012. For the current six months, net borrowings from our revolving credit facility were approximately $10.1 million compared to net repayments of approximately $17.4 million for the same period in the prior year. Changes in our cash overdraft position decreased from

approximately $0.7 million in cash provided for the six months ended July 31, 2012 to cash used of approximately $0.7 million for the six months ended July 31, 2013, due to the timing of payments issued to vendors during the period. The Company purchased approximately $0.1 million of treasury stock during the six months ended July 31, 2013 compared to $0.2 million during the six months ended July 31, 2012.

On December 4, 2009, we entered into a stock transfer agreement with the Marmaduke Family Limited Partnership (the “Partnership”). Under the stock transfer agreement, for a period of three years following the death of Mr. John H. Marmaduke, the Company’s Chief Executive Officer, the Partnership may tender for purchase to the Company, and, if so tendered, the Company will be required to purchase, shares of the Company’s common stock belonging to the Partnership with an aggregate fair market value of $5.0 million. During this three year period, the Partnership may elect to tender portions of such shares in various lots and parcels, at any time and from time to time, and any tender shall not exhaust or limit the Partnership’s right to tender additional shares, subject to the limitations of the stock transfer agreement. Under the stock transfer agreement, the Company is not obligated to purchase, and the Partnership does not have the right to tender, any shares with an aggregate fair market value in excess of $5.0 million. In the event that Mr. Marmaduke resigns as an officer or director of the Company prior to his death, the Partnership’s right to tender the shares to the Company shall terminate. The stock transfer agreement shall terminate on the earlier of February 9, 2019, or four years after the death of Mr. Marmaduke. The Company is currently the beneficiary of a $10 million key-man life insurance policy on Mr. Marmaduke; a portion of the proceeds of which would be used to complete any purchases of shares resulting from the stock transfer agreement.

Capital Structure. We have entered into an Amended and Restated Loan and Security Agreement with Bank of America, N.A., as agent (as subsequently amended, the “Credit Agreement”). The Credit Agreement provides a revolving credit facility of $115 million, allows for the payment of dividends, has a maturity date of January 4, 2017 and provides that we may repurchase up to $10.0 million worth of our common stock. The Credit Agreement also provides that we may repurchase additional shares of our common stock in the event we meet certain criteria set forth in the Credit Agreement. The Credit Agreement includes certain debt and acquisition limitations and requires a minimum Availability (as defined in the Credit Agreement) that is greater than or equal to $10.0 million at all times. Our obligations under the Credit Agreement are secured by a pledge of substantially all of the assets of the Company and our subsidiary and are guaranteed by our subsidiary.

At July 31, 2013, we had approximately $47.3 million in excess availability, after the $10 million availability reserve, under the Credit Agreement. We expect to have approximately $49.0 million to $53.0 million in excess availability, after the availability reserve and outstanding letters of credit, at January 31, 2014. However, excess availability may be reduced in the future as changes in the borrowing base occur or the lender increases availability reserves. The average rates of interest incurred for the three months ended July 31, 2013 and 2012 was 2.5%. The average rates of interest incurred for the six months ended July 31, 2013 and 2012 was 2.5%. Deferred financing costs that were amortized into interest expense during the three and six months ended July 31, 2013 and 2012 are excluded from the calculation of the average rate of interest for each respective period.

At July 31, 2013, our minimum lease commitments for the remainder of fiscal 2013 were approximately $10.8 million. Total existing minimum operating lease commitments for fiscal years 2013 through 2026 were approximately $126.2 million as of July 31, 2013.

Dividend Program. On December 7, 2012, our Board of Directors adopted a dividend policy under which we paid an initial annual dividend of $0.02 per share on December 31, 2012. The cash dividend policy and the declaration and payment of each annual dividend will be subject to the Board’s continuing determination that the policy and the declaration of dividends are in the best interest of our shareholders and are in compliance with applicable law. The Board retains the power to modify, suspend, or cancel our dividend policy in any manner and at any time that it may deem necessary or appropriate in the future.

Contractual obligations and off-balance sheet arrangements. We have contractual obligations associated with ongoing business and financing activities, which will result in cash payments in future periods. These obligations include long-term debt, operating leases and certain revenue-sharing agreements. As of July 31, 2013, other than operating leases and standby letters of credit, we had not entered into any off-balance sheet arrangements or third-party guarantees, nor does our business ordinarily require us to do so. At July 31, 2013, there have been no material changes in our contractual obligations or off-balance sheet arrangements from those reported in our Annual Report on Form 10-K for the fiscal year ended January 31, 2013.

Seasonality

As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating income, is generated in the fourth fiscal quarter, which includes the holiday selling season. As a result, a substantial portion of our annual earnings has been, and will continue to be, dependent on the results of the fourth quarter. Less than satisfactory net sales for such period could have a material adverse effect on the Company’s financial condition or results of operations for the year and may not be sufficient to cover any losses that may have been incurred in the first three quarters of the year. We experience reduced rental activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games and the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of store openings, the number and popularity of new book, music, video and video game titles, the popularity of electronics and trends merchandise, the cost of new release or “best renter” titles, changes in comparable-store revenues, competition, marketing programs, increases in the minimum wage, weather, special or unusual events and other factors that may affect our operations.

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

In the ordinary course of our business, we are exposed to certain market risks, primarily changes in interest rates. Our exposure to interest rate risk consists of variable rate debt based, at our option, on the lender’s Base Rate or LIBOR, plus a specified percentage. The annual impact on our results of operations of a 100 basis point interest rate change on the July 31, 2013 outstanding balance of the variable rate debt would be approximately $0.5 million. After an assessment of these risks to our operations, we believe that the primary market risk exposures (within the meaning of Regulation S-K Item 305) are not material and are not expected to have any material adverse impact on our financial position, results of operations or cash flows for the next fiscal year.

ITEM 4 – CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures

We performed an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-15 and 15d-15 promulgated under the Securities Exchange Act of 1934, as amended (“Exchange Act”), as of the end of the period covered by this Quarterly Report on Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their objectives, and, based upon the forgoing evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures, as defined by Exchange Act Rules 13a-15(e) and 15d-15(e), were effective as of the end of the period covered by this Quarterly Report on Form 10-Q to provide reasonable assurance that the information required to be disclosed by us in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission and such information is accumulated and communicated to management as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Control over Financial Reporting

Management has implemented a process to monitor and assess both the design and operating effectiveness of internal control over financial reporting. All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

There has not been any change in our internal control over financial reporting during our fiscal quarter ended July 31, 2013, 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 on Form 10-K for the fiscal year ended January 31, 2013 includes a detailed discussion of our risk factors. Since that time, there have been no material changes to our risk factors.

ITEM 2 –UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

A summary of our purchases of shares of common stock for the three months ended July 31, 2013 is as follows:

ISSUER PURCHASES OF EQUITY SECURITIES


Period	Total number of shares purchased (1)		Average price paid per share		Total number of shares purchased as part of publicly announced plans or programs		Approximate dollar value of shares that may yet be purchased under the plans or programs (2)
May 1, 2013 through May 31, 2013		5,900		2.98		5,900		N/A
June 1, 2013 through June 30, 2013		21,000		3.91		21,000		N/A
July 1, 2013 through July 31, 2013		—		—		—		N/A

Total		26,900	$	3.71		26,900	$	5,616,808

(1)

All shares were open-market purchases made under a repurchase plan publicly announced in a press release dated September 28, 2001. Our Board of Directors initially authorized the repurchase of up to $5.0 million of our common stock. To date, the Board of Directors has approved the repurchase of up to an additional $32.5 million of our common stock. Each such authorization to increase amounts was publicly announced in a press release. The repurchases satisfied the conditions of the safe harbor of Rule 10b-18 under the Exchange Act.

(2)	A total of 5,626,149 shares have been purchased under the repurchase plan at a total cost of approximately $31.9 million, or approximately $5.67 per share.

ITEM 6 – EXHIBITS.

The following exhibits are filed herewith or incorporated by reference as indicated as required by Item 601 of Regulation S-K. Any exhibits designated by an asterisk are management contracts and/or compensatory plans or arrangement required to be filed as exhibits to this Quarterly Report on Form 10-Q.


Exhibit Number	Description of Documents

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

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

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

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

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

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

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

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

101.INS	(5)	XBRL Instance Document

101.SCH	(5)	XBRL Taxonomy Extension Schema

101.CAL	(5)	XBRL Taxonomy Extension Calculation Linkbase

101.DEF	(5)	XBRL Taxonomy Extension Definition Linkbase Document

101.LAB	(5)	XBRL Taxonomy Extension Label Linkbase

101.PRE	(5)	XBRL Taxonomy Extension Presentation Linkbase

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

(2)	Previously filed as Exhibit 3.1 to the Company’s Form 8-K (File No. 000-24381) filed on January 17, 2008 and incorporated herein by reference.

(3)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1/A, dated May 19, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.

(4)	Filed herewith.

(5)	In accordance with Regulation S-T, the XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q shall be deemed “furnished” and not “filed.”

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:


						HASTINGS ENTERTAINMENT, INC

Date: September 10, 2013						/s/ Dan Crow
						Dan Crow
						Vice President and Chief Financial Officer
						(Principal Financial and Accounting Officer)

INDEX TO EXHIBITS


Exhibit Number	Description of Documents

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

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

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

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

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

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

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

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

101.INS	(5)	XBRL Instance Document

101.SCH	(5)	XBRL Taxonomy Extension Schema

101.CAL	(5)	XBRL Taxonomy Extension Calculation Linkbase

101.DEF	(5)	XBRL Taxonomy Extension definition Linkbase Document

101.LAB	(5)	XBRL Taxonomy Extension Label Linkbase

101.PRE	(5)	XBRL Taxonomy Extension Presentation Linkbase

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

(2)	Previously filed as Exhibit 3.1 to the Company’s Form 8-K (File No. 000-24381) filed on January 17, 2008 and incorporated herein by reference.

(3)	Previously filed as an exhibit to the Company’s Registration Statement on Form S-1/A, dated May 19, 1998 (File No. 333-47969) and with a corresponding exhibit number herein and are incorporated herein by reference.

(4)	Filed herewith.

(5)	In accordance with Regulation S-T, the XBRL-related information in Exhibit No. 101 to this Quarterly Report on Form 10-Q shall be deemed “furnished” and not “filed.”

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