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HAST > SEC Filings for HAST > Form 10-K on 22-Apr-2013All Recent SEC Filings

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Form 10-K for HASTINGS ENTERTAINMENT INC


22-Apr-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION.

The following discussion should be read in conjunction with our consolidated financial statements and the related notes thereto and "Item 6. Selected Financial Data" appearing elsewhere in this Annual Report on Form 10-K.

Overview

Hastings is a leading multimedia entertainment retailer that buys, sells, trades and rents various home entertainment products, including books, music, software, periodicals, new and used CDs, movies on DVD and Blu-ray, video games, video game consoles and electronics. We also offer consumables and trends products such as apparel, t-shirts, action figures, posters, greeting cards and seasonal merchandise through our entertainment stores and our Internet web site. As of March 31, 2013, we operated 135 stores averaging approximately 24,000 square feet in medium-sized markets located in 19 states, primarily in the Western and Midwestern United States. Each of the stores, operated on leased premises, is wholly-owned by us and is operated under the name of Hastings. We also operate three concept stores, Sun Adventure Sports, located in Amarillo, Texas and Lubbock, Texas, and TRADESMART, located in Littleton, Colorado, which are wholly-owned by us.

Over the past three years, our financial performance has been adversely impacted by a number of factors, including the economic downturn and the expanding digital delivery of entertainment. As the economy improves, we expect our total revenues to improve. However, as consumer spending patterns shift toward digital delivery of content and internet retailers, particularly with regard to books, we expect the negative trends in sales of new books to continue and therefore expect a slight single digit decrease in Book Comp sales, excluding sales of Nextbook tablet electronic book readers and related accessories, for fiscal 2013. We expect Music Comp sales, which have had mid single to double digit decreases for the last five years driven primarily by digital content delivery, to have a slight decrease for fiscal 2013. Movie Comps have been negatively impacted by a weak schedule of new releases during fiscal 2012 which has directly impacted new movie sales. We expect the negative trend in sales of new movies to continue but we expect a slight increase for total Movie Comps for fiscal 2013, primarily driven by an increase in sales of used movies.

Our operating strategy is to continue to enhance our position as a multimedia entertainment retailer by remodeling existing stores and offering our products through our Internet web site. We are also focused on shifting our business model more toward lifestyle and consumer electronics products to become less dependent on entertainment products. Some examples of such products include tablet expansions for reading, watching movies, hobby, crafts and playing games and phone app products to be used with your smart phone for fun, health and fitness. References in this Annual Report on Form 10-K to fiscal years are to the twelve-month periods that end in January of the following calendar year. For example, the twelve-month period ended January 31, 2013 is referred to as fiscal 2012.

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.


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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 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 revenue and expense. We record deferred tax assets and liabilities for future income tax consequences that are attributable to differences between financial statement carrying amounts of assets and liabilities and their income tax bases. We base the measurement of deferred tax assets and liabilities on enacted tax rates that we expect will apply to taxable earnings in the year when we expect to settle or recover those temporary differences. We recognize the effect on deferred tax assets and liabilities on any change in income tax rates in the period that includes the enactment date. 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.


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

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

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

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

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

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

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

Gift Card Breakage Revenue. We sell gift cards through each of our stores and through our web site www.goHastings.com. The gift cards we sell have no stated expiration dates or fees and are subject to potential escheatment rights in some of the jurisdictions in which we operate. Gift card liabilities are recorded as deferred revenue at the time of sale of such cards with the costs of designing, printing and distributing the cards recorded as expense as incurred. 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.


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Results of Operations

The following tables present our statement of operations data, expressed as a percentage of revenue, and the number of stores open at the end of period for the three most recent fiscal years.

                                                              Fiscal Year
                                                   2012          2011          2010
   Merchandise revenue                               87.1 %        85.6 %        84.5 %
   Rental asset revenue                              12.9          14.2          15.4
   Gift card breakage revenue                        (0.0 )         0.2           0.1

   Total revenues                                   100.0         100.0         100.0
   Merchandise cost of revenue                       68.3          69.5          69.0
   Rental asset cost of revenue                      34.7          38.6          37.3

   Total cost of revenues                            64.0          65.0          64.0
   Gross profit                                      36.0          35.0          36.0
   Selling, general and administrative expenses      37.7          37.3          35.4

   Operating income (loss)                           (1.7 )        (2.3 )         0.6
   Other income (expense):
   Interest expense                                  (0.3 )        (0.3 )        (0.2 )
   Other, net                                         0.0           0.1            -

                                                     (0.3 )        (0.2 )        (0.2 )

   Income (loss) before income taxes                 (2.0 )        (2.5 )         0.4
   Income tax expense                                 0.0           1.0           0.1

   Net income (loss)                                 (2.0 )%       (3.5 )%        0.3 %

                                                     Fiscal Year
                                             2012       2011       2010
                Hastings Stores(1):
                Beginning number of stores     140        146        149
                Openings                        -           1         -
                Closings                        (3 )       (7 )       (3 )

                Ending number of stores        137        140        146

(1) We operate three concept stores, including two Sun Adventure Sports and one TRADESMART, which are not included in summary of Hastings Stores activity.


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Fiscal 2012 Compared to Fiscal 2011

Revenues. Total revenues for the fiscal year ended January 31, 2013 decreased
approximately $33.9 million, or 6.8%, to $462.5 million compared to $496.4
million for the fiscal year ended January 31, 2012. The following is a summary
of our revenues results (dollars in thousands):



                                                    Fiscal Year Ended January 31,
                                                 2013                           2012                       Decrease
                                                       Percent                       Percent
                                       Revenues        Of Total       Revenues       of Total        Dollar        Percent
Merchandise revenue                    $ 402,735            87.1 %    $ 425,142           85.6 %    $ (22,407 )        -5.3 %
Rental revenue                            59,846            12.9 %       70,426           14.2 %      (10,580 )       -15.0 %
Gift card breakage revenue                   (80 )           0.0 %          819            0.2 %         (899 )          NM

Total Revenues                         $ 462,501           100.0 %    $ 496,387          100.0 %    $ (33,886 )        -6.8 %

Stores open at period end                    140                            143                            (3 )        -2.1 %
Comparable-store revenues ("Comp")
Total                                                       -5.1 %
Merchandise                                                 -3.7 %
Rental                                                     -12.9 %

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

                                   Fiscal Year Ended January 31,
                                      2013                   2012
                 Electronics                12.9 %              3.7 %
                 Hardback Café              11.1 %              4.8 %
                 Trends                      8.7 %             10.4 %
                 Consumables                 1.5 %             -6.3 %
                 Movies                     -1.1 %             -8.2 %
                 Books                      -1.3 %             -4.8 %
                 Music                     -12.0 %             -4.5 %
                 Video Games               -21.8 %             -5.1 %

Electronics Comps increased 12.9% for fiscal 2012, primarily due to the success of the 44 stores participating in the consumer electronics reset. Sales of tablets, tablet accessories, turntables and headphones were strong during the fiscal year. Hardback Café Comps increased 11.1% for fiscal 2012, primarily due to higher sales of coffee and specialty drinks. Trends Comps increased 8.7% for fiscal 2012, primarily due to strong sales in boutique apparel, toys and gifts, comic books, as well as skateboarding equipment and other action sports items. Consumable Comps increased 1.5% for fiscal 2012, primarily due to increased sales in candies, snacks and bottled beverages. Movie Comps decreased 1.1% for fiscal 2012, primarily due to decreased sales in used and previously viewed movies, partially offset by increased sales in new DVDs and Blu-ray movies. Book Comps decreased 1.3%, primarily due to lower sales in new and bargain books and magazines, partially offset by strong sales of the 50 Shades series, Nextbook tablets and used books. Book Comps, excluding digital sales, decreased 2.3% for fiscal 2012. Music Comps decreased 12.0% for fiscal 2012, primarily due to decreased sales in new and used CDs which can be attributed to consumers increasingly using digital delivery of their music purchases. Video Game Comps decreased 21.8% for fiscal 2012, primarily due to decreased sales of new and used video games and video game hardware and accessories, primarily resulting from the longevity of the current console cycle, as well as the fact that overall industry sales of Nintendo's Wii U system were weaker than expected.

Rental Comps decreased 12.9% for fiscal 2012, primarily due to fewer rentals of DVDs and video games, partially offset by increased rentals of Blu-ray movies. Rental Movie Comps decreased 10.6%, as sales were negatively impacted by competitor rental kiosks and subscription-based rental services, while Rental Video Game Comps, which were impacted by the longevity of the current console cycle, decreased 28.4%.


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Gross Profit - Merchandise. For fiscal 2012, total merchandise gross profit dollars decreased approximately $2.1 million, or 1.6%, to $127.5 million from $129.6 million for fiscal 2011, primarily due to lower revenues, partially offset by higher merchandise margin rates. As a percentage of total merchandise revenue, merchandise gross profit increased to 31.7% for fiscal 2012, compared to 30.5% for fiscal 2011, primarily due to a shift in mix of revenues by category and lower merchandise shrinkage and merchandise markdown expenses, partially offset by increased freight costs as a result of increased internet sales.

Gross Profit - Rental. For fiscal 2012, total rental gross profit dollars decreased approximately $4.2 million, or 9.7%, to $39.1 million from $43.3 million for fiscal 2011, primarily due to lower revenues, partially offset by higher rental margin rates. As a percentage of total rental revenue, rental gross profit increased to 65.3% for fiscal 2012 compared to 61.4% for fiscal 2011, primarily as a result of lower rental shrinkage expense and lower rental asset depreciation expense.

Selling, General and Administrative Expenses ("SG&A"). As a percentage of total revenue, SG&A increased to 37.7% for fiscal year 2012 compared to 37.3% for fiscal year 2011, primarily due to deleveraging resulting from lower revenues. SG&A decreased approximately $10.6 million, or 5.7%, to $174.5 million compared to $185.1 million for the same period last year. This is primarily due to a $4.1 million decrease in store labor costs, a $2.1 million reduction in abandoned lease expense, a $2.1 million decrease in depreciation, a $1.7 million decrease in store occupancy costs and a $1.2 million decrease in store advertising expense, partially offset by an increase of $1.4 million in bonuses under our corporate officer and management bonus incentive program. The reduction in depreciation and occupancy expenses are primarily the result of operating fewer stores.

Interest Expense. For fiscal 2012, interest expense decreased approximately $0.1 million, or 7.7%, to $1.2 million, compared to $1.3 million for fiscal 2011, primarily as a result of lower average debt levels during the current fiscal year, along with lower interest rates. The average rate of interest charged for fiscal 2012 decreased to 2.5% compared to 2.7% for fiscal 2011.

Income Taxes. 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; therefore, the effective tax rate for fiscal year 2012 is (3.3%). The valuation allowance is approximately $11.0 million as of January 31, 2013. We reassess the need for a 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.

Fiscal 2011 Compared to Fiscal 2010

Revenues. Total revenues for the fiscal year ended January 31, 2012 decreased approximately $24.7 million, or 4.7%, to $496.4 million compared to $521.1 million for the fiscal year ended January 31, 2011. As of January 31, 2012, we operated six fewer Hastings superstores, as compared to January 31, 2011. In addition to our superstores, we operated two additional concept stores, TRADESMART (Littleton) and Sun Adventures Sports (Lubbock), as compared to January 31, 2011. The following is a summary of our revenues results (dollars in thousands):

                                                  Fiscal Year Ended January 31,
                                                2012                          2011                       Decrease
                                                     Percent                       Percent
                                      Revenues       Of Total       Revenues       of Total        Dollar        Percent
Merchandise revenue                   $ 425,142           85.6 %    $ 440,038           84.5 %    $ (14,896 )        -3.4 %
Rental revenue                           70,426           14.2 %       80,216           15.4 %       (9,790 )       -12.2 %
Gift card breakage revenue                  819            0.2 %          801            0.1 %           18           2.2 %

Total Revenues                        $ 496,387          100.0 %    $ 521,055          100.0 %    $ (24,668 )        -4.7 %

Stores open at period end                   143                           147                            (4 )        -2.7 %
Comparable-store revenues ("Comp")
Total                                                     -5.3 %
Merchandise                                               -4.0 %
Rental                                                   -12.4 %


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

                                    Fiscal Year Ended January 31,
                                    2012                    2011
                Trends                   10.4 %                   9.7 %
                Hardback Café             4.8 %                   9.7 %
                Electronics               3.7 %                   2.0 %
                Music                    -4.5 %                  -4.8 %
                Books                    -4.8 %                  -4.2 %
                Video Games              -5.1 %                   4.7 %
                Consumables              -6.3 %                   2.7 %
                Movies                   -8.2 %                   6.3 %

Trends Comps increased 10.4% for fiscal 2011 due to increased sales of apparel and accessories, novelty items, new comics and graphic novels, action figures and collectible card games, such as Magic: The Gathering. Key drivers in the apparel and accessories category included hats, jewelry, licensed apparel, bags and footwear. Hardback Café Comps increased 4.8% during fiscal 2011 primarily due to increased sales of iced and blended specialty café drinks. Electronics Comps increased 3.7% during fiscal 2011, primarily resulting from increased sales of headphones, along with strong sales of refurbished Apple iPads and tablet accessories, partially offset by lower sales of new Apple iPods. Music Comps decreased 4.5% for fiscal 2011, due to lower sales of new and used CDs. CD sales were impacted by a sales shift to lower priced promotional products. Music units sold increased 1.3% during fiscal 2011. Book Comps decreased 4.8% during fiscal 2011 due to lower sales of new mass market books, hardbacks and trade paperbacks, lower sales of used hardbacks and trade paperbacks, and lower sales of magazines, partially offset by sales of the Nextbook Premium 7 e-reader tablet and related accessories. Book Comps, excluding sales of the Nextbook . . .

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