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HAST > SEC Filings for HAST > Form 10-K on 21-Apr-2014All Recent SEC Filings

Show all filings for HASTINGS ENTERTAINMENT INC

Form 10-K for HASTINGS ENTERTAINMENT INC


21-Apr-2014

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 and lifestyle 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, 2014, we operated 126 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 several years, our financial performance has been adversely impacted by a number of factors, including the economic downturn and the expanding digital delivery of entertainment. Our book business continues to be negatively impacted by the transition of certain categories to digital formats, but at a lesser rate than anticipated, therefore we expect the negative trends in sales of new books to continue and expect a single digit decrease in Book Comp sales for fiscal 2014. 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 high single digit decrease for fiscal 2014. Movie Comps have been negatively impacted by a weak schedule of new releases during fiscal 2013 which has directly impacted new movie sales. We expect total Movie Comps for fiscal 2014 to be flat. Rental Comps have decreased the past several years due to competition from rental kiosks and subscription-based rental services. We expect Rental Comps for fiscal 2014 to have a single digit decrease. We expect Electronic Comp sales, which have had single to double digit increases for the last several years, to have a high single digit increase for fiscal 2014. With the launch of the new game consoles, we expect a high double digit increase in Video Game Comp sales. Trends Comps, which include lifestyle products, have seen high single to double digit increases during the last two years. We expect that increase to continue for Trend Comp sales in fiscal 2014 with a mid-single digit increase. As the economy improves, along with the continued success of our reset stores and expanded product lines which we plan to continue through fiscal 2014, we expect our comp revenues to improve.

On March 17, 2014, the Company entered into the Merger Agreement with Parent and Merger Sub. Upon the effective time of the Merger, the Company will be merged with and into Merger Sub, with the Company surviving the Merger as a wholly-owned subsidiary of Parent.

Our operating strategy is to continue to enhance our position as a multimedia entertainment and lifestyle retailer by resetting 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, 2014 is referred to as fiscal 2013.

Merger Agreement

As described under the heading "Merger Agreement" in Item 1 of this Annual Report on Form 10-K, on March 17, 2014, we entered into the Merger Agreement with Parent and its wholly owned subsidiary. Pursuant to the Merger Agreement, subject to satisfaction or waiver of certain closing conditions, Merger Sub will merge with and into the Company, with the Company continuing its existence under Texas law as the surviving entity in the Merger. Upon the completion of the Merger, the Company will be a wholly owned subsidiary of Parent.


If the Merger is completed, at the effective time of the Merger, each share of common stock of the Company issued and outstanding as of immediately prior to the effective time (excluding any shares of common stock held by Parent or its affiliates (including Merger Sub and NECA)), any shares of common stock held by the Company in treasury or by any direct or indirect wholly owned subsidiary of the Company) will be automatically cancelled and converted into the right to receive the Merger Consideration of $3.00 per share.

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 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 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.

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:

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

ˇ 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.

ˇ 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.

ˇ 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 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 have awarded 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.

Under the Merger Agreement, we may not grant or award any options, restricted stock or other share based compensation without the consent of Parent.

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 stores open at the end of period for the three most recent fiscal years.

                                                             Fiscal Year
                                                   2013         2012         2011
     Merchandise revenue                             87.7 %       87.1 %       85.6 %
     Rental asset revenue                            12.2         12.9         14.2
     Gift card breakage revenue                       0.1         (0.0 )        0.2
     Total revenues                                 100.0        100.0        100.0
     Merchandise cost of revenue                     68.6         68.3         69.5
     Rental asset cost of revenue                    36.0         34.7         38.6
     Total cost of revenues                          64.6         64.0         65.0
     Gross profit                                    35.4         36.0         35.0
     Selling, general and administrative expenses    37.5         37.7         37.3
     Operating income (loss)                         (2.1 )       (1.7 )       (2.3 )
     Other income (expense):
     Interest expense                                (0.3 )       (0.3 )       (0.3 )
     Other, net                                       0.1          0.0          0.1
                                                     (0.2 )       (0.3 )       (0.2 )
     Income (loss) before income taxes               (2.3 )       (2.0 )       (2.5 )
     Income tax expense (benefit)                    (0.1 )        0.0          1.0
     Net income (loss)                               (2.2 )%      (2.0 )%      (3.5 )%




                                                    Fiscal Year
                                            2013       2012       2011
                 Hastings Stores(1):
                 Beginning number of stores   137        140        146
                 Openings                      -          -           1
                 Closings                     (10 )       (3 )       (7 )
                 Ending number of stores      127        137        140

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


Fiscal 2013 Compared to Fiscal 2012

Revenues. Total revenues for the fiscal year ended January 31, 2014 decreased approximately $26.5 million, or 5.7%, to $436.0 million compared to $462.5 million for the fiscal year ended January 31, 2013. The following is a summary of our revenues results (dollars in thousands):

                                        Fiscal Year Ended January 31,
                                      2014                         2013                      Decrease
                                           Percent                      Percent
                            Revenues       Of Total      Revenues       of Total       Dollar       Percent
Merchandise revenue         $ 382,578           87.8 %   $ 402,735           87.1 %   $ (20,157 )       -5.0 %
Rental revenue                 53,043           12.2 %      59,846           12.9 %      (6,803 )      -11.4 %
Gift card breakage revenue        341            0.1 %         (80 )          0.0 %         421           NM
Total Revenues              $ 435,962          100.0 %   $ 462,501          100.0 %   $ (26,539 )       -5.7 %
Stores open at period end         130                          140                          (10 )       -7.1 %

Comparable-store revenues
("Comp")

Total                                           -2.8 %
Merchandise                                     -2.0 %
Rental                                          -7.7 %

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

                                   Fiscal Year Ended January 31,
                                   2014                    2013
                Trends                   15.2 %                   8.7 %
                Electronics               9.9 %                  12.9 %
                Movies                    2.2 %                  -1.1 %
                Hardback Café             1.1 %                  11.1 %
                Consumables              -2.5 %                   1.5 %
                Video Games              -2.9 %                 -21.8 %
                Books                   -10.7 %                  -1.3 %
                Music                   -12.5 %                 -12.0 %

Trends Comps increased 15.2% for fiscal 2013, primarily due to strong sales in toys and gifts, action figures, comic books, licensed and branded products and recreational and lifestyle products. Licensed and branded products for which we experienced strong sales during the period were Walking Dead, Star Wars and Doctor Who. The Trends department also includes recreation and lifestyles products whose growth was driven by the addition of hobby products, pet accessories and outdoor accessories to reset stores as well as growth in the existing categories of skateboards and disc golf. Hobby products showed significant growth during fiscal 2013 led by sales of remote control vehicles and model kits. Electronics Comps increased 9.9% for fiscal 2013, primarily due to increased sales in hardware categories, such as televisions, turntables and speaker systems; strong growth was also realized in refurbished electronics. Movies Comps increased 2.2% for fiscal 2013, primarily due to increased sales of new and used Blu-ray, traditional and boxed set DVDs, partially offset by new, previously viewed and used Midline DVDs. Hardback Café Comps increased 1.1%, due to higher sales of iced and hot specialty café drinks, partially offset by a decrease in retail products such as mugs and baked goods. Consumables Comps decreased 2.5%, primarily due to decreased sales in popcorn, candies, and fountain drinks. Video Games Comps decreased only 2.9% for fiscal 2013, primarily due to the release of the PlayStation 4 and the Xbox One game consoles in the fourth quarter as well as increased sales in new and used games. Books Comps decreased 10.7%, primarily due to a weaker release schedule for new books and a decrease in trade paperback and hardback sales, as compared to fiscal 2012, which included strong sales from the Fifty Shades and Hunger Games trilogies. In addition, sales of digital hardware decreased significantly for fiscal 2013 as compared to fiscal 2012. Music Comps decreased 12.5% for the period, primarily


due to a significant reduction in retail space in the 36 stores that were reset in fiscal 2013 as well as the increasing popularity of digital delivery, partially offset by the increased sales of new and used vinyl albums.

Rental Comps decreased 7.7% for fiscal 2013 primarily resulting from fewer rentals of traditional DVDs and video games, partially offset by an increase in rentals of Blu-ray movies. Rental Movie Comps decreased 6.3% primarily due to competition from rental kiosks and subscription-based rental services. Rental Video Game Comps decreased 19.8%.

Gross Profit - Merchandise. For fiscal 2013, total merchandise gross profit dollars decreased approximately $7.6 million, or 6.0%, to $119.9 million from $127.5 million for the same period in the prior year primarily due to a decrease in revenue which is primarily attributed to operating fewer superstores compared to the prior year. As a percentage of total merchandise revenue, merchandise gross profit slightly decreased to 31.4% for fiscal 2013, compared to 31.7% for fiscal 2012, primarily due to a shift in mix of revenues by category and higher markdown expenses, partially offset by lower freight expense, lower expense to return products and lower shrinkage.

Gross Profit - Rental. For fiscal 2013, total rental gross profit dollars decreased approximately $5.1 million, or 13.0%, to $34.0 million from $39.1 million for the same period in the prior year primarily due to a decrease in revenue which is partially attributed to operating fewer superstores for the same period in the prior year. As a percentage of total rental revenue, rental gross profit decreased to 64.0% for fiscal 2013 compared to 65.3% 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 decreased to 37.5% for fiscal year 2013 compared to 37.7% for fiscal year 2012, due to a significant reduction in SG&A expenses. SG&A decreased approximately $10.8 million, or 6.2%, to $163.7 million compared to $174.5 million for the same period last year. The majority of the decrease results primarily from a $3.3 million reduction in store labor expense, a $2.3 million reduction in depreciation expense, a decrease of $1.7 million in store advertising expense and a decrease of $0.6 million in store supplies, all of which were primarily the result of operating fewer superstores during this fiscal year compared to last fiscal year. There was a $1.9 million reduction in corporate salary expense due to lower bonus payouts and the restructuring that took place in the first quarter of fiscal 2013. Several other SG&A expenses had smaller decreases or increases during the year which netted to an additional $1.0 million decrease for fiscal 2013.

Interest Expense. For fiscal 2013, interest expense increased approximately $0.1 million, or 8.3%, to $1.3 million, compared to $1.2 million for fiscal 2012. The increase results primarily from higher debt levels. Interest rates for both periods averaged 2.5%.

Income Taxes. During fiscal 2013, the Company recorded a discrete tax benefit of approximately $0.5 million from the recognition of a tax position due to a change in state administrative practices. No discrete items were recorded during fiscal 2012.

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 2013, there is no tax liability, with the exception of Texas state income tax, which is based primarily on gross margin; therefore, considering the discrete tax benefit described above and the Texas state income tax, the effective tax rate for fiscal year 2013 is 2.3%. The valuation allowance is approximately $14.3 million as of January 31, 2014. 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.

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 %
. . .
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