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HAST > SEC Filings for HAST > Form 10-Q on 10-Sep-2013All Recent SEC Filings

Show all filings for HASTINGS ENTERTAINMENT INC

Form 10-Q for HASTINGS ENTERTAINMENT INC


10-Sep-2013

Quarterly Report


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.


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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


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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.


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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 superstores open at the end of the
periods presented herein.



                                                   Three Months Ended              Six Months Ended
                                                        July 31,                       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           Six Months Ended           Year Ended
                                                 July 31,                    July 31,               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.


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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.


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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
. . .
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