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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549
 FORM 10-K [X]       ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
 For the fiscal year ended January 31, 2004 OR [  ]       TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF SECURITIES
EXCHANGE ACT OF 1934
 For the
transition period
fromto Commission File Number: 000-24381 HASTINGS ENTERTAINMENT, INC.  Texas
    
    75-1386375(State or other jurisdiction of
    
    (IRS Employerincorporation or organization)
    
    Identification No.)
 3601 Plains Boulevard, Amarillo, Texas
    
    79102(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code: (806) 351-2300 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Stock, $.01 par value per share
    
    Nasdaq National Market(Title of Class)
    
    (Name of Exchange on which registered)
 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 twelve 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 is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes [  ] No [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrants knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to
this Form 10-K. [  ]




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As of July 31, 2003, which was the last business day of the registrants most
recently completed second fiscal quarter, the aggregate market value of the
voting stock held by non-affiliates of the registrant was approximately $19.8
million based upon the closing market price of $3.31 per share of Common Stock
on the Nasdaq National Market on that date. (For the purposes of determination
of the above-stated amounts, only the directors, executive officers and 10% or
greater shareholders of the registrant have been deemed affiliates; however,
this does not represent a conclusion by the registrant that any or all of such
persons are affiliates of the registrant.) Number of shares of $.01 par value Common Stock outstanding as of March 30,
2004: 11,363,612 DOCUMENTS INCORPORATED BY REFERENCE Portions of the proxy statement for the annual meeting of shareholders of the
registrant to be held during 2004 are incorporated by reference into Parts II
and III of this Form 10-K.




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HASTINGS ENTERTAINMENT, INC.
Form 10-K Annual Report
For the Fiscal Year Ended January 31, 2004 INDEX PAGEPART IItem 1.
    
    Business
    
    
    1Item 2.
    
    Properties
    
    
    10Item 3.
    
    Legal Proceedings
    
    
    11Item 4.
    
    Submission of Matters to a Vote of Security Holders
    
    
    11PART IIItem 5.
    
    Market for
Registrants Common Equity and Related Stockholder Matters
    
    
    12Item 6.
    
    Selected Financial Data
    
    
    13Item 7.
    

Managements
Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    15Item 7A.
    
    Quantitative and Qualitative Disclosures About Market Risk
    
    
    28Item 8.
    
    Financial Statements and Supplementary Data
    
    
    29Item 9.
    

Changes
in and Disagreements with Accountants on Accounting and
Financial Disclosure
    
    
    50Item 9A.
    
    Controls and Procedures
    
    
    50PART IIIItem 10.
    
    Directors and Executive Officers of the Registrant
    
    
    51Item 11.
    
    Executive Compensation
    
    
    51Item 12.
    

Security Ownership of Certain Beneficial Owners and Management and
Related Stockholder Matters
    
    
    51Item 13.
    
    Certain Relationships and Related Transactions
    
    
    51Item 14.
    
    Principal Accountant Fees and Services
    
    
    51PART IVItem 15.
    
    Exhibits, Financial Statement Schedules and Reports on Form 8-K
    
    
    52SIGNATURES
    
    
    
    
    55Amended Loan and Security AgreementConsent of Ernst and Young LLPCertification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of CEO and CFO




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PART I Forward-looking Statements Certain written and oral statements set forth below or made by Hastings or with
the approval of an authorized executive officer of the company 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 which address operating performance, events or developments that we
expect or anticipate will occur in the future including statements relating to
the business, expansion, merchandising and marketing strategies of Hastings,
industry projections or forecasts, inflation, effect of critical accounting
policies including lower of cost or market for inventory adjustments, the
returns process, rental video amortization, store closing reserves, revenue
recognition, comparable-store revenues 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 company
managements current estimates, assumptions and expectations, which are based
on information available at the time of the disclosure, and are subject to a
number of factors and uncertainties, including, but not limited to, whether our
assumptions turn out to be correct, our 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 effects of or changes in economic
conditions in the U.S or the markets in which we operate our superstores,
volatility of fuel and utility costs, acts of war or terrorism inside the
United States or abroad, our success in forecasting customer demand for
products and legal proceedings; 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. 
 ITEM 1. BUSINESS General Hastings Entertainment, Inc. is a leading multimedia entertainment retailer.
We operate entertainment superstores that sell and rent various home
entertainment products, including books, music, software, periodicals, new and
used CDs, DVDs, video games and videocassettes, video game consoles and DVD
players. As of March 30, 2004, we operated 148 superstores in small- to
medium-sized markets located in 20 states, primarily in the Western and
Midwestern United States. We also operate a multimedia entertainment e-commerce
Web site offering a broad selection of books, music, software, videocassettes,
video games and DVDs. See note 14 to the consolidated financial statements for
more information regarding our two operating segments: retail stores and
Internet operations. We operate two wholly-owned subsidiaries: Hastings
Properties, Inc. and Hastings Internet, Inc. A third subsidiary, Hastings
College Stores, Inc., ceased operations in fiscal year 2001. References herein
to fiscal years are to the twelve-month periods, which end in January of each
following calendar year. For example, the twelve-month period ended January
31, 2004 is referred to as fiscal 2003. Industry Overviews Music. According to the Recording Industry Association of America (RIAA),
total music shipments by manufacturers to retailers declined 6.0% to $11.9
billion in 2003 compared to $12.6 billion in 2002. The majority of this
decrease can be found in a decline of almost 7% in shipments for the industry
mainstay, the full-length CD, to $11.2 billion in 2003 compared to $12.0
billion in 2002. Although this decline is primarily attributable to the
continuing problem of online piracy, Mitch Bainwol, Chairman and CEO of the
RIAA, believes that recent trends in the industry are positive. According to
Mr. Bainwol, record companies have taken a proactive approach by implementing
educational efforts and enforcement programs to deal with piracy. Industry
shipments of cassettes declined sharply during 2003 to $108.1 million, down
approximately 49% from 2002, as the format continued to lose favor with music
consumers. A bright spot for the industry was the increase in music DVD video
format increasing in shipment value by more than 56% to $369.6 million. 1




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Books. The Association of American Publishers estimates that total book
industry sales rose 4.6% in 2003, to an estimated $23.4 billion, up from
approximately $22.4 billion in 2002. The juvenile hardcover segment, driven by
the release of Harry Potter and the Order of the Phoenix, increased 28.6% to
$0.7 billion, up from approximately $0.5 billion in the prior year. In
addition, last years revenue benefited from strong fourth quarter releases
such as The South Beach Diet, The Da Vinci Codeand The Purpose Driven Life. Rental Video. According to Paul Kagan Associates (Kagan), consumer spending
on rental video decreased approximately 1% to $8.2 billion in 2003. DVD
revenues, which continue to drive the rental industry, increased $1.4 billion
to approximately $4.0 billion, up 52.2% in 2003 over 2002, while VHS rentals
declined $1.6 billion, or 28.1%, to approximately $3.9 billion over the same
period. Kagan projects that video rental revenues will decline from $8.2
billion in 2003 to approximately $7.0 billion by 2008; however, due to many
variables, it is difficult to project the fluctuations in the industry. We
believe rental video will remain a viable revenue source for the following
reasons:  (i)
    
    Despite increases in the sale of movies detailed below under Sale
Video and Video Games, according to Kagan, rental transactions
continued to exceed sales transactions during 2003. Rental
transactions represented approximately 71.6% of total rental and
sell-through transactions during 2003 compared to approximately 74.3%
in 2002. We believe renting videos provides consumers with low-cost
entertainment, a factor that will continue to drive rental transactions
in the future.(ii)
    
    DVD continued its accelerated acceptance rate with DVD households
as a percentage of U.S. television households exceeding 51% in 2003
compared to approximately 41% in 2002. Kagan projects that this number
will exceed 88% by 2008. This penetration is moving far beyond
consumers that were early adopters of the DVD format, and with price
points on DVD hardware continuing to decline, we believe more consumers
will be renting classic movies and personal favorites in the DVD format
for the first time. We also believe that later-adopting DVD households
are less likely to purchase DVDs at the high rates of early-adopters.(iii)
    
    We believe that the DVD format, with its superior picture and
sound quality and extra features such as outtakes, director commentary
and scene selection, will drive continued growth in the industry.(iv)
    
    We also believe rental video will continue to be a favored
entertainment medium for millions of consumers due to its relatively
inexpensive price points, broad selection of new release and catalog
(older) movies and ability for viewer control of the experience
(i.e., start, stop, fast-forward, pause and rewind).(v)
    
    We believe video game rentals will continue to play an important
role in the rental industry. Due to the relatively high purchase
prices for game software, rental pricing is an attractive option for
consumers; especially those wanting to preview a game prior to making a
purchase. Sale Video and Video Games. According to Kagan, total industry revenues for
the sale of DVD and VHS increased approximately 15% to $15.9 billion during
2003 compared to $13.9 billion in 2002. This increase resulted primarily from
substantially all DVD product being released at prices low enough that
consumers can purchase a title at the same time it is available for rent. This
lower pricing has enabled consumers to build their video libraries and has
helped to turn casual movie watchers into collectors. Kagan estimates that
total revenues from the sale of DVD and VHS will approach $29.0 billion by
2008, and it is projected that DVD will represent approximately 98% of the
total revenues, compared to approximately 77% in 2003. According to the NPD Group, total sales for the video game industry, including
portable and console hardware, software and accessories, decreased 2.7% to $10
billion in 2003 compared to $10.3 billion in 2002. The majority of total
revenues is generated from console and portable game software, which recorded
an increase of 5.4% to $5.8 billion in 2003 compared to $5.5 billion in 2002.
Decreasing price points for Nintendos GameCube, Sonys Playstation 2 and
Microsofts Xbox, three new generation hardware products, have increased the
penetration of game consoles and contributed to the increase in video game
sales. 2




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Business Strategy Our goal is to enhance our position as a leading multimedia entertainment
retailer in small- to medium-sized communities by expanding and remodeling
existing superstores, opening new superstores in selected markets and to a
lesser extent, offering our products through the Internet. Each element of our
business strategy is designed to build consumer awareness of the Hastings
concept and achieve high levels of customer loyalty and repeat business. We
believe the key elements of this strategy are the following: Superior Multimedia Concept.Our superstores present a wide variety of
products tailored to local preferences in a dynamic and comfortable store
atmosphere with exceptional service. Our superstores average approximately
20,000 square feet, with our new superstores generally ranging in size from
10,000 to 25,000 square feet. Our superstores offer customers an extensive
product assortment customized for a specific store. Below is a listing of the
approximate minimum and maximum title selections for our stores: Minimum
    
    MaximumProduct Category
    
    Title Count
    
    Title CountBooks
    
    
    11,000
    
    
    
    65,000Music
    
    
    7,000
    
    
    
    47,000Rental VHS, DVD, Video Games
    
    
    11,000
    
    
    
    30,000Used CDs, DVD, Video Games
    
    
    2,000
    
    
    
    18,000Sale VHS, DVD and Video Games
    
    
    4,000
    
    
    
    12,000Boutique, Consumables and Accessories
    
    
    2,000
    
    
    
    7,000Periodicals
    
    
    1,000
    
    
    
    3,000Software
    
    
    
    
    
    
    1,000
 The following table shows our revenue mix as a percentage of total revenues for
the last three fiscal years: Fiscal YearProduct Category
    
    2003
    
    2002
    
    2001Music
    
    
    27
    %
    
    
    29
    %
    
    
    33
    %Books
    
    
    23
    %
    
    
    23
    %
    
    
    24
    %Rental
    
    
    20
    %
    
    
    20
    %
    
    
    20
    %Video
    
    
    17
    %
    
    
    15
    %
    
    
    13
    %Video Games
    
    
    6
    %
    
    
    5
    %
    
    
    2
    %Software
    
    
    2
    %
    
    
    3
    %
    
    
    4
    %Other
    
    
    5
    %
    
    
    5
    %
    
    
    4
    %
 Although our superstores core product assortment tends to be similar, the
merchandise mix of each of our superstores is tailored to accommodate the
particular demographic profile of the local market in which the superstore
operates through the utilization of our proprietary purchasing and inventory
management systems. We believe that our multimedia format reduces our reliance
on and exposure to any particular entertainment segment and enables us to
promptly add exciting new entertainment categories to our product line. Small to Medium-Sized Market Superstore Focus.We target small- to
medium-sized markets with populations of generally less than 50,000 where our
extensive product selection, low pricing strategy, efficient operations and
superior customer service enable us to become the markets destination
entertainment store. In addition, we are exploring a smaller-store prototype
with selling square footage of generally less than 10,000 square feet in
markets with populations of generally less than 13,000. We believe that the
small- to medium-sized markets where we operate the majority of our superstores
present an opportunity to profitably operate and expand our unique
entertainment superstore format. In our opinion, these markets typically are
underserved by existing book, music or video stores, and our competitors in
these markets are generally locally owned stores, national-chain specialty
stores and general merchandise retailers. We base our merchandising strategy
for our superstores on an in-depth understanding of our customers and our
individual markets. We strive to optimize each superstores merchandise
selection by using our proprietary information systems to analyze the sales
history, anticipated demand and demographics of each superstores market. In
addition, we utilize flexible layouts that enable each superstore to arrange
our products according to local interests and to customize the layout in
response to new customer preferences and product lines. 3




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Customer-Oriented Superstore Format.
We design our superstores to provide an easy-to-shop, open store atmosphere by
offering major product categories in a store-within-a-store format. Most of
our superstores position product with customer affinities together around a
wide racetrack aisle or three-across departments (e.g., books, music and video)
that are designed to allow customers to view the entire superstore. This store
configuration produces significant cross-marketing opportunities among the
various entertainment departments, which we believe results in higher
transaction volumes and impulse purchases. To encourage browsing and the
perception of Hastings as a community gathering place, we have incorporated
amenities in many superstores, such as chairs for reading, a broad selection of
gourmet coffee and tea, soft drinks and snacks, music auditioning stations,
interactive information kiosks, telephones for free local calls, childrens
play areas and in-store promotional events. Low Pricing.Our pricing strategy at our superstores is to offer value to our
customers by maintaining everyday low prices that are competitive with or lower
than the prices charged by other retailers in the market. We determine our
prices on a market-by-market basis, depending on the level of competition and
other market-specific considerations. We believe that our low pricing structure
results in part from (i) our ability to purchase directly from publishers,
studios and manufacturers as opposed to purchasing from distributors, (ii) our
proprietary information systems, improvements to which have enabled management
to make more precise and targeted purchases and pricing for each superstore,
and (iii) our consistent focus on maintaining low occupancy and operating
costs. Used and Budget-Priced Products.Since 1994, we have bought or traded for
customers CDs to sell as used product in order to leverage the value of our CD
offering. Since 2001, we have added DVDs and video games to our used product
offering. In addition to used products, we offer budget-priced products in all
of our major product categories to enhance our customers shopping experience.
During fiscal 2003, we generated approximately 8.3% of our total revenues from
used and budget-priced products compared to approximately 6.9% for 2002.
During the first quarter of fiscal 2004, we will test buying and selling used
books in certain of our markets. We believe our multimedia superstore concept
will enhance our offering of used and budget products allowing the customer to
choose between a new or a less expensive used copy of the same title. Internet.Augmenting our superstore offering, we operate an e-commerce
Internet Web site (www.gohastings.com). Our site enables customers to
electronically access more than 800,000 new and used entertainment products and
unique, contemporary gifts and we fill Internet orders primarily from our
superstore inventories. The site features exceptional product and pricing
offers, search and auditioning capabilities, and digital downloading of music
selections. The Web site is designed to fully integrate into a store kiosk to
leverage both the physical and digital shopping experience. The site also
features an Investor Relations section with links to past press release
information and filings with the Securities and Exchange Commission, including
officer certifications of financial information listed as exhibits to such
filings. Expansion Strategy We plan to open five superstores while expanding and or relocating 16 of our
existing superstores during fiscal 2004. We have identified numerous potential
locations for future superstores in under-served, small- to medium-sized
markets that meet our new-market criteria. We believe that with our current
information systems and distribution capabilities, our infrastructure can
support our anticipated rate of expansion and growth for at least the next
several years. Merchandising Strategy We are a leading multimedia entertainment retailer. By offering a broad array
of products within several distinct but complementary categories, we strive to
appeal to a wide range of customers and position our superstores as destination
entertainment stores in our targeted small- to medium-sized markets. Superstore Product Selection.Although all Hastings superstores carry a
similar core product assortment, the merchandise mix of book, music, software,
videocassette and video game selections of each superstore is tailored 4




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continually to accommodate the particular demographic profile and demand of the
local market in which the
superstore operates. We accomplish this customization through our proprietary
purchasing, inventory, selection and pricing management systems. The purchasing
system analyzes historic consumer purchasing patterns at each individual
superstore to forecast customer demand for new releases and anticipate seasonal
changes in demand. In addition, our inventory management process continually
monitors product sales and videocassette rentals to identify slow-moving books,
music, software and sale videocassettes, DVD and video games for return to
vendors and rental videocassettes, DVD and video games for sale to customers as
previously viewed items or transfer to other superstores. Our pricing
management system allows us to identify slow-moving products and initiate an
automated-progressive markdown program to enhance sell-through while maximizing
margin at each subsequent price reduction. It also automatically implements the
price change by printing new tags at the store. Our superstores offer
customers an extensive product assortment customized for a specific store with
new releases and special offerings in each entertainment product category that
are prominently displayed and arranged by product category. In addition to our primary product lines, we continually add new product
offerings to better serve our customers. Products for sale in these categories
include promotional t-shirts, licensed plush toys, portable electronics,
consumer electronics including DVD players and video game consoles, musical
instruments, sheet music, greeting cards, audio books and consumables,
including soft drinks, coffee, popcorn and candy. Our full service coffee bar,
The Hard Back Café, which is operating in certain of our superstores, offers a
broad selection of coffees, teas and food items. Accessory items for sale
include blank videocassettes and CDs, video cleaning equipment and
audiocassette and CD carrying cases. Many of these products generate impulse
purchases and produce higher margins. The rental of videocassette, video game
and DVD players is provided as a service to Hastings customers. During fiscal 2004, we will begin to merge our new and used CDs into the same
display fixture. This will provide for a more straightforward shopping
experience, offer a wider assortment, and provide the customer with an
immediate choice of purchasing a new or a lower-priced used item. Information System Our information system is based on technology that allows for communication and
exchange of current information among all locations, corporate and retail, via
a wide-area network. The primary components of the information system are as
follows: New Release Allocation.Our buyers use the new release allocation system to
purchase new release products for the superstores and have the ability within
the system to utilize multiple methods of forecasting demand. By using
store-specific sales history, factoring in specific market traits, applying
sales curves for similar titles or groups of products and minimizing
subjectivity and human emotion for a transaction, the system customizes
purchases for each individual superstore to satisfy customer demand. The
process provides the flexibility to allow store management to anticipate
customer needs, including tracking missed sales and factoring in regional
influences. We believe that the new release allocation system enables us to
increase revenues by having the optimum levels and selection of products
available in each superstore at the appropriate time to satisfy customers
entertainment needs. Rental Video Asset Purchasing System.Our rental video asset purchasing system
uses store-specific performance on individual rental videocassette titles to
anticipate customer demand for new release rental videocassettes. The system
analyzes the first eight weeks performance of a similar title and factors in
the effect of such influences as seasonal trends, box office draw and
prominence of the movies cast to customize an optimum inventory for each
individual superstore. The system also allows for the customized purchasing of
other catalog rental video assets on an individual store basis, additional copy
depth requirements under revenue-sharing agreements and timely sell-off of
previously viewed tapes. We believe that our rental video asset purchasing
system allows us to efficiently plan and stock each superstores rental video
asset inventory, thereby improving performance and reducing exposure from
excess inventory. 5




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Store Replenishment.Store replenishment covers three main areas for
controlling a superstores inventory. Selection Management.Selection management constantly analyzes
store-specific sales, traits and seasonal trends to determine title selection
and inventory levels for each individual superstore. By forecasting annual
sales of products and consolidating recommendations from store management,
the system enables us to identify overstocked or understocked items, prompt
required store actions and optimize inventory levels. The system tailors each
stores individual inventory to the market, utilizing over 2,000 product
categories, configurations and product status. Model Stock Calculation/Ordering.Model stock calculation uses
store-specific sales, seasonal trends and sophisticated-sales curve fitting
to forecast orders. It also accounts for turnaround time from a vendor or our
distribution center and tracks historical missed sales to adjust orders to
adequately fulfill sales potential. Orders are currently calculated on a
weekly basis and transmitted by all superstores to the corporate office to
establish a source vendor for the product. Inventory Management.Inventory management systems interface with other
store systems and accommodate electronic receiving and returns to maintain
perpetual inventory information. Cycle counting procedures allow us to
perform all physical inventory functions, including the counting of each
superstores inventory up to four times per year. The system provides
feedback to assist in researching any variances. Store Systems.Each superstore has a dedicated server within the store for
processing information connected through a wide area network. This connectivity
provides consolidation of individual transactions and allows store management
and corporate office associates easy access to the information needed to make
informed decisions. Transactions at the store are summarized and used to assist
in staff scheduling, loss prevention and inventory control. All point of sale
transactions utilize scanning technology, allowing for maximum customer
efficiency at checkout. During the fourth quarter of fiscal 2003, we began
implementing a new labor scheduler software system that will be installed chain
wide by the end of the second quarter of fiscal 2004. The new Windows-based
software will, among other things, require less time of the store manager to
maintain, provide improved measurement and reporting of budget to scheduled and
actual labor, and create review- and exception-based reports at the corporate
office for management monitoring. Accounting and Finance.Our financial accounting software allows us to prepare
a variety of daily management reports covering store and corporate performance.
Detailed financial information for each superstore, as well as for warehouse
units, which include our distribution and returns facilities, and the corporate
office, are generated on a monthly basis. Our payroll, accounts payable, cash
control, financial planning and certain tax functions are performed in-house. Warehouse Management.Our warehouse management systems provide support for
high-volume retail transactions, including shipments, receipts, recycled
product and returns to vendors. During fiscal 2003, we began the design and
development of a new warehouse management software system that will be in place
by the end of the second quarter of fiscal 2004. This new software will
increase product picking and shipping efficiencies, reduce dock congestion and
provide for faster processing of orders to move product to our stores sooner. Distribution and Suppliers Our distribution center is located in a 146,000 square foot facility adjacent
to our corporate headquarters in Amarillo, Texas. This central location and the
local labor pool enable us to realize relatively low transportation and labor
costs. The distribution center is utilized primarily for receiving, storing and
distributing approximately 21,000 products offered in substantially every
superstore. The distribution center also is used in distributing large
purchases, including forward buys, closeouts and other bulk purchases. In
addition, the distribution facility is used to receive, process and ship items
to be returned to manufacturers and distributors, as well as the rebalancing of
merchandise inventories among our superstores. This facility currently provides
inventory to all Hastings superstores and is designed to support our
anticipated rate of expansion and growth for at least the next several years.
We ship products weekly to each Hastings superstore, facilitating quick and
responsive inventory
replenishment. Approximately 32% of our total 6




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product, based on store receipts,
is distributed through the distribution center. Approximately 68% of our total
product is shipped directly from vendors to the superstores. In fiscal 2003, we
focused our efforts to improve cost controls, inventory management and supply
chain metrics. Our information systems and corporate infrastructure facilitate our ability to
purchase products directly from manufacturers, which contributes to our
low-pricing structure. In fiscal 2003, we purchased the majority of our
products directly from manufacturers, rather than through distributors. Our top
three suppliers accounted for approximately 23% of total products purchased
during fiscal 2003. While selections from a particular artist or author
generally are produced by a single manufacturer, we strive to maintain supplier
relationships that can provide alternate sources of supply. Products we
purchase are generally returnable to the supplying vendor. Refer to Item 7.
Managements Discussion and Analysis of Financial Condition and Results of
Operation  General for a description of our returns process. Store Operations Most of our superstores employ one store manager and one or more assistant
store managers. Store managers and assistant store managers are responsible for
the execution of all operational, merchandising and marketing strategies for
the superstore in which they work. Superstores also generally have department
managers, who are individually responsible for their respective book, music,
software, video, customer service and stocking departments within each
superstore. Hastings superstores are generally open daily from 10:00 a.m. to
11:00 p.m. However, several superstores are open 9:00 a.m. to 11:00 p.m. or
10:00 a.m. to 10:00 p.m. The only days our superstores are closed are
Thanksgiving and Christmas. Competition The entertainment retail industry is highly competitive. We compete with a wide
variety of book retailers, music retailers, software retailers, Internet
retailers and retailers that rent or sell videocassettes, including independent
single store operations, local multi-store operators, regional and national
chains, as well as supermarkets, pharmacies, convenience stores, bookstores,
mass merchants, mail order operations, warehouse clubs, record clubs, other
retailers and various non-commercial sources such as libraries. With regard to
our videocassette sales and rental video products in particular, we compete
with cable, satellite and pay-per-view cable television systems. In addition,
continuing technological advances that enhance the ability of consumers to shop
at home or access, produce and print written works or record music digitally by
home computer through the Internet or telephonic transmission could provide
more serious competition to us in the future. We compete in most of our markets with either national entertainment retailers
or significant retailers of general merchandise or both. We compete in our sale
of books with retailers such as Barnes & Noble, Inc., Books-A-Million, Inc.,
Borders Group, Inc., Walden Books and B. Dalton Bookseller. We compete in our
sale of music with music retailers, such as Transworld Entertainment and
consumer electronics stores, including Best Buy and Circuit City. Our principal
competitors in the sale and rental of videocassettes are Blockbuster, Inc.,
Hollywood Entertainment Corp. and Movie Gallery, Inc. In addition, we compete
in the sale of books, music and videocassettes and the rental of videocassettes
and video games with local entertainment retailers and significant retailers of
general merchandise, such as Wal-Mart. Retailers such as Amazon.com, Inc. and
Barnes & Noble, Inc., continue to increase their retail sales of entertainment
products, such as books and music, via the Internet. We compete with other
entertainment retailers on the basis of title selection, the number of copies
of popular selections available, store location, visibility and pricing. Trademarks and Servicemarks We believe our trademarks and servicemarks, including the servicemarks
Hastings Books Music Video, and Hastings, Your Entertainment Superstore
have significant value and are important to our marketing efforts. We have
registered Hastings Books Music Video as a servicemark with the United States
Patent and Trademark Office and 7




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##### Table of Contents



are in the process of registering Hastings, Your Entertainment
Superstore and Hard Back Café. We maintain a policy of pursuing
registration of our principal marks and opposing any infringement of our marks. Associates We refer to our employees as associates because of the critical role they play
in the success of each Hastings superstore and the company as a whole. As of
January 31, 2004, we employed approximately 6,784 associates, of which 2,162
are full-time and 4,622 are part-time associates. Of this number, approximately
6,218 were employed at retail superstores, 292 were employed at our
distribution center and 274 were employed at our corporate offices. None of our
associates are represented by a labor union or are subject to a collective
bargaining agreement. We believe that our relations with our associates are
good. Executive Officers of the Company The following is certain information concerning the executive officers of
Hastings Entertainment, Inc. Name
    
    Age
    
    PositionJohn H. Marmaduke
    
    
    56
    
    
    Chairman of the Board, President and Chief Executive OfficerDan Crow
    
    
    57
    
    
    Vice President of Finance and Chief Financial OfficerRobert A. Berman
    
    
    54
    
    
    Vice President of Store OperationsJames S. Hicks
    
    
    47
    
    
    Vice President of ProductAlan Van Ongevalle
    
    
    36
    
    
    Vice President of Information Technology & Distribution
 All executive officers are chosen by the Board of Directors and serve at the
Boards discretion. Set forth below is information concerning the business
experience of our executive officers. John H. Marmaduke, age 56, has served as President and Chief Executive Officer
of the Company since July 1976 and as Chairman of the Board since October 1993.
Mr. Marmaduke served as President of the Companys former parent company,
Western Merchandisers, Inc. (Western), from 1982 through June 1994, including
the years 1991 through 1994 when Western was a division of Wal-Mart Stores,
Inc. Mr. Marmaduke also serves on the board of directors of the Interactive
Entertainment Merchants Association. Mr. Marmaduke has been active in the
entertainment retailing industry with the Company and its predecessor company
for over 30 years. Dan Crow, age 57, has served as Vice President of Finance and Chief Financial
Officer of the Company since October 2000. From July of 2000 to October 2000,
Mr. Crow served as Vice President of Finance. Mr. Crow is a member of the
American Institute of Certified Public Accountants and Financial Executives
International and has served as Chief Financial Officer of various retail
companies including Discount Auto Parts, Inc., Scottys, Inc. and Lil Things,
Inc. since 1984. Robert A. Berman, age 54, has served as Vice President of Store Operations of
the Company since January 1997. From June 1995 to January 1997, Mr. Berman was
self-employed in the financial services industry. From January 1989 to June
1995, Mr. Berman served as Vice President and Senior Vice President of Store
Operations for Builders Square, Inc., a chain of building material superstores.
At Builders Square, Inc., Mr. Berman was responsible for store operations,
store planning and design, purchasing and construction. James S. Hicks, age 47, has served as Vice President of Product of the Company
since August 2002. From August 1999 to August 2002, Mr. Hicks served as Vice
President of Purchasing. From August 1997 to August 1999, Mr. Hicks served as
the Senior Director of Purchasing and from April 1994 to August 1997, was the
Director of Purchasing. He was a District Leader for the Company from July 1984
to April 1994. From October 1982 to July 1984, Mr. Hicks served as a company
troubleshooter and from April 1982 to October 1982 was a store manager. Mr.
Hicks began his career with Hastings in August 1981 as a manager trainee. Prior
to joining the Company, Mr. Hicks was the Regional Credit Manager for Liquid
Carbonics Corporation, a gas distributor and manufacturer headquartered in
Houston. 8




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##### Table of Contents



Alan Van Ongevalle, age 36, has served as Vice President of Information
Technology and Distribution since February 2003. From August 2002 to February
2003, Mr. Van Ongevalle served as Vice President of Marketing and Distribution.
From May 2000 to August 2002, Mr. Van Ongevalle served as Vice President of
Marketing. From August 1999 to May 2000, Mr. Van Ongevalle served as the
Senior Director of Marketing and as Director of Advertising from September 1998
to August 1999. Mr. Van Ongevalle joined Hastings in November 1992 and held
various store operation management positions including Store Manager, Director
of New Stores and the Southern Kansas area through September 1998. Available Information We file annual, quarterly and current reports, proxy statements and other
information with the Securities and Exchange Commission. The public may read
and copy any materials we file with the SEC at the SECs public Reference Room
at 450 Fifth Street, N.W., Washington, D.C. 20549. The public may obtain
information on the operation of the Public Reference Room by calling the SEC at
1-800-SEC-0330. The SEC also maintains an Internet site that contains reports,
proxy and information statements, and other information regarding issuers that
file electronically with the SEC. The address of that site is (www.sec.gov). The address of our Internet Web site is (www.gohastings.com) and through the
links on the Investor Relations portion of our Web site, we make available free
of charge our annual report on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and other items filed with the SEC pursuant to
Section 13(a) or 15(d) of the Securities Exchange Act of 1934. Such material
is made available through our Web site as soon as reasonably practicable after
we electronically file or furnish the material with the SEC. In addition,
links to press releases and a code of ethics for financial and other executive
officers are posted in the Investor Relations section. 9




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##### Table of Contents



ITEM 2. PROPERTIES As of January 31, 2004, we operated 148 superstores in 20 states located as
indicated in the following table: Name of State
    
    Number of SuperstoresAlabama
    
    
    1Arkansas
    
    
    11Arizona
    
    
    7Colorado
    
    
    3Georgia
    
    
    1Idaho
    
    
    8Indiana
    
    
    1Iowa
    
    
    1Kansas
    
    
    9Kentucky
    
    
    1Missouri
    
    
    7Montana
    
    
    6Nebraska
    
    
    4New Mexico
    
    
    16Oklahoma
    
    
    12Tennessee
    
    
    6Texas
    
    
    42Utah
    
    
    2Washington
    
    
    7Wyoming
    
    
    3Total
    
    
    148
 Currently, we lease sites for all our superstores. These sites typically are
located in pre-existing, stand-alone buildings or strip shopping centers. Our
primary market areas are small- and medium-sized communities with populations
generally less than 50,000. We have developed a systematic approach using our
site selection criteria to evaluate and identify potential sites for new
superstores. Key demographic criteria for superstores include community
population, community and regional retail sales, personal and household
disposable income levels, education levels, median age, and proximity of
colleges or universities. Other site selection factors include current
competition in the community, visibility, available parking, ease of access and
other neighbor tenants. To maintain low occupancy costs, we typically
concentrate on leasing existing locations that have been operated previously by
other retailers. We actively manage our existing superstores and from time to time close
under-performing stores. During fiscal 2003 we closed three superstores and
during fiscal 2002 we closed three superstores. The terms of our superstore leases vary considerably. We strive to maintain
maximum location flexibility by entering into leases with long initial terms
and multiple short-term extension options. We have been able to enter into
leases with these terms in part because we generally bear a substantial portion
of the cost of preparing the space for a superstore. The following table sets forth as of January 31, 2004 the number of superstores
that have current lease terms that will expire during each of the following
fiscal years and the associated number of superstores for which we have options
to extend the lease term: Number of Superstores
    
    OptionsFiscal Year 2004
    
    
    8
    
    
    
    7Fiscal Year 2005
    
    
    14
    
    
    
    13Fiscal Year 2006
    
    
    12
    
    
    
    12Fiscal Year 2007
    
    
    20
    
    
    
    20Fiscal Year 2008
    
    
    18
    
    
    
    17Thereafter
    
    
    76
    
    
    
    73Total
    
    
    148
    
    
    
    142
 10




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##### Table of Contents



We have not experienced any significant difficulty renewing or extending leases
on a satisfactory basis. Our headquarters and distribution center are located in Amarillo, Texas in a
leased facility consisting of approximately 44,500 square feet for office space
and 146,000 square feet for the distribution center. The leases for this
property terminate in September 2008, and we have the option to renew these
leases through March 2020. 
 ITEM 3. LEGAL PROCEEDINGS In 2000, we restated our consolidated financial statements for the first three
quarters of fiscal 1999 and the prior four fiscal years. As a result, lawsuits
were filed against us and certain of our current and former directors and
officers asserting various claims under Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934. We agreed to settle these lawsuits, and the
settlement received final approval by the court on March 10, 2003. The
settlement required a payment of $5.75 million on behalf of the defendants in
the lawsuits ($3.15 million of which was funded from amounts remaining under
our director and officer insurance policy after the payment of litigation
expenses). The settlement resolves all claims against us and our current and
former defendant officers and directors. Based on the foregoing, we recorded
loss contingencies of $2.5 million, or $0.22 per share, and $0.1 million, or
$0.00 per share, during the second and fourth fiscal quarters of fiscal 2002,
respectively. All amounts required by the settlement agreement were funded by
January 31, 2003. We are also involved in various other claims and legal actions arising in the
ordinary course of business. In the opinion of management, the ultimate
disposition of these matters will not have a material adverse effect on our
financial position, results of operations and cash flows. Recently, we were
named as defendants in a complaint filed in Texas alleging that our late fees
for movie and game rentals are illegal under the Uniform Commercial Code.
While we intend to vigorously defend this matter and are hopeful of a favorable
result, the ultimate outcome of this matter cannot be estimated at this time. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of the security holders during the fourth
quarter of fiscal 2003. 11




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##### Table of Contents



PART II 
 ITEM 5. MARKET FOR REGISTRANTS COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The shares of Hastings Entertainment, Inc. common stock are listed and traded
on The Nasdaq National Market (Nasdaq) under the symbol HAST. Our common
stock began trading on June 12, 1998, following our initial public offering.
The following table contains, for the periods indicated, the high and low sales
prices per share of our common stock as reported on the Nasdaq: High
    
    Low2003:First Quarter
    
    $
    4.30
    
    
    $
    3.00Second Quarter
    
    $
    4.20
    
    
    $
    3.00Third Quarter
    
    $
    4.37
    
    
    $
    3.01Fourth Quarter
    
    $
    5.00
    
    
    $
    3.352002:First Quarter
    
    $
    8.44
    
    
    $
    5.20Second Quarter
    
    $
    9.20
    
    
    $
    4.95Third Quarter
    
    $
    6.15
    
    
    $
    4.00Fourth Quarter
    
    $
    6.12
    
    
    $
    4.00
 As of March 30, 2004, there were approximately 405 holders of record of our
Common Stock. The payment of dividends is within the discretion of the Board of Directors and
will depend on our earnings, capital requirements, and our operating and
financial condition, among other factors. Our current revolving credit
facility restricts the payment of dividends. In view of such restrictions, it
is unlikely that we will pay a dividend in the foreseeable future. Equity compensation plan information will be set forth in our Proxy Statement
for our 2004 Annual Meeting of Shareholders, to be filed within 120 days after
the end of fiscal 2003, under the heading Compensation Plans, which
information is incorporated herein by reference. 12




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##### Table of Contents



ITEM 6. SELECTED FINANCIAL DATA The selected consolidated financial and operating data set forth below should
be read in conjunction with Managements Discussion and Analysis of Financial
Condition and Results of Operations, and our consolidated financial statements
and the notes thereto that appear elsewhere in this report. Fiscal Year(In thousands, except per share and square foot data)
    
    2003
    
    2002
    
    2001
    
    2000
    
    1999Income Statement Data:Merchandise revenue
    
    $
    404,977
    
    
    $
    395,548
    
    
    $
    379,322
    
    
    $
    370,512
    
    
    $
    364,041Rental video revenue
    
    
    103,341
    
    
    
    99,846
    
    
    
    92,326
    
    
    
    87,691
    
    
    
    81,384Total revenues
    
    
    508,318
    
    
    
    495,394
    
    
    
    471,648
    
    
    
    458,203
    
    
    
    445,425Merchandise cost of revenue
    
    
    297,523
    
    
    
    292,888
    
    
    
    280,054
    
    
    
    280,459
    
    
    
    270,113Rental video cost of revenue
    
    
    39,259
    
    
    
    41,652
    
    
    
    41,504
    
    
    
    38,022
    
    
    
    32,139Total cost of revenues
    
    
    336,782
    
    
    
    334,540
    
    
    
    321,558
    
    
    
    318,481
    
    
    
    302,252Gross profit
    
    
    171,536
    
    
    
    160,854
    
    
    
    150,090
    
    
    
    139,722
    
    
    
    143,173Selling, general and administrative
expenses (1)(2)
    
    
    163,473
    
    
    
    158,025
    
    
    
    144,053
    
    
    
    148,967
    
    
    
    141,513Pre-opening expenses
    
    
    277
    
    
    
    479
    
    
    
    182
    
    
    
    33
    
    
    
    1,681Operating income (loss)
    
    
    7,786
    
    
    
    2,350
    
    
    
    5,855
    
    
    
    (9,278
    )
    
    
    (21
    )Interest expense
    
    
    (2,048
    )
    
    
    (1,987
    )
    
    
    (2,090
    )
    
    
    (3,485
    )
    
    
    (3,708
    )Interest income (3)
    
    
    
    
    
    
    1,291
    
    
    
    
    
    
    
    
    
    
    
    Other, net
    
    
    324
    
    
    
    237
    
    
    
    252
    
    
    
    197
    
    
    
    205Income (Loss) before income taxes
    
    
    6,062
    
    
    
    1,891
    
    
    
    4,017
    
    
    
    (12,566
    )
    
    
    (3,524
    )Income tax expense (benefit) (4)
    
    
    (1,688
    )
    
    
    
    
    
    
    
    
    
    
    2,034
    
    
    
    (1,359
    )Net income (loss)
    
    $
    7,750
    
    
    $
    1,891
    
    
    $
    4,017
    
    
    $
    (14,600
    )
    
    $
    (2,165
    )Basic income (loss) per share
    
    $
    0.68
    
    
    $
    0.17
    
    
    $
    0.34
    
    
    $
    (1.25
    )
    
    $
    (0.19
    )Diluted income (loss) per share
    
    $
    0.68
    
    
    $
    0.16
    
    
    $
    0.34
    
    
    $
    (1.25
    )
    
    $
    (0.19
    )Weighted-average common shares outstanding  basic
    
    
    11,327
    
    
    
    11,343
    
    
    
    11,742
    
    
    
    11,645
    
    
    
    11,621Weighted-average common shares outstanding  diluted
    
    
    11,483
    
    
    
    11,779
    
    
    
    11,898
    
    
    
    11,645
    
    
    
    11,621Other Data:Depreciation (5)
    
    $
    39,813
    
    
    $
    40,223
    
    
    $
    35,393
    
    
    $
    33,155
    
    
    $
    31,626Capital expenditures (6)
    
    $
    53,456
    
    
    $
    64,664
    
    
    $
    46,495
    
    
    $
    30,482
    
    
    $
    47,427Store Data:Total selling square footage at end of period
    
    
    2,915,884
    
    
    
    2,846,955
    
    
    
    2,727,446
    
    
    
    2,759,735
    
    
    
    2,829,269Comparable-store revenues increase (7)
    
    
    1.9
    %
    
    
    5.0
    %
    
    
    4.7
    %
    
    
    0.1
    %
    
    
    4.0
    %
 January 31,2004
    
    2003
    
    2002
    
    2001
    
    2000Balance Sheet Data:Working capital (8)
    
    $
    37,950
    
    
    $
    50,915
    
    
    $
    49,912
    
    
    $
    46,567
    
    
    $
    67,295Total assets
    
    
    236,248
    
    
    
    237,522
    
    
    
    229,851
    
    
    
    213,484
    
    
    
    247,933Total long-term debt,
including current
maturities on capital
lease obligations
    
    
    29,844
    
    
    
    46,712
    
    
    
    33,432
    
    
    
    29,610
    
    
    
    54,260Total shareholders equity
    
    $
    86,993
    
    
    $
    79,156
    
    
    $
    77,344
    
    
    $
    75,791
    
    
    $
    90,091
 13




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##### Table of Contents



(1)
    
    We recorded pre-tax charges of $2.6 million in fiscal 2002 related to the
settlement of shareholder class action lawsuits described in Note 13 to the
consolidated financial statements. These charges reduced net income by $2.6
million or approximately $0.22 per diluted share.(2)
    
    In fiscal 2000, we recorded $2.7 million in accounting and legal fees
associated with the restatement of the first three quarters of fiscal 1999
and the prior four fiscal years. As a result of these fees, fiscal year
2000 net losses were increased by $2.7 million, or $0.23 per diluted
share.(3)
    
    We recorded interest income of approximately $1.3 million in the second
quarter of fiscal 2002 as a result of interest earned on income tax
refunds for amended returns filed for fiscal years 1995 through 1998. As
a result, net income was increased by approximately $0.11 per diluted
share.(4)
    
    The results for fiscal year 2003 reflect an income tax benefit of
approximately $1.7 million, or $0.15 per diluted share, primarily due to
the reversal of a valuation allowance of approximately $4.4 million
previously applied against our deferred tax assets. Based on our past
three fiscal years of profitability and our projections of future taxable
income, we believe that a valuation allowance is no longer required as of
January 31, 2004 as the realization of our deferred tax assets is now
considered more likely than not.(5)
    
    Includes amounts associated with our rental video cost amortization.(6)
    
    Includes procurement of rental video assets.(7)
    
    Stores included in the comparable-store revenues calculation are those
stores that have been open for a minimum of 60 weeks. Also included are
stores that are remodeled or relocated. Sales via the internet are not
included and closed stores are removed from each comparable period for the
purpose of calculating comparable-store revenues.(8)
    
    Working capital is calculated as total current assets less total current
liabilities. 14




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##### Table of Contents



ITEM 7. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS 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. CAUTIONARY STATEMENTS The following cautionary statements and other information included in this
Annual Report on Form 10-K should be carefully considered. The risks and
uncertainties described below are not the only ones we face. Additional risks
and uncertainties not presently known to us or that we currently deem
immaterial also may impair our business operations. If any of the following
risks occur, our business, financial condition, operating results and cash
flows could be materially adversely affected. Expansion Strategy.Our growth strategy is dependent principally on our
ability to open new superstores and remodel, expand and/or relocate certain of
our existing superstores and operate them profitably. In general, the rate of
our expansion depends, among other things, on general economic and business
conditions affecting consumer confidence and spending, the availability of
qualified management personnel and our ability to manage the operational
aspects of our growth. It also depends upon the availability of adequate
capital, which in turn depends in a large part upon the cash flow generated
from operations. Our future results will depend, among other things, on the success in
implementing our expansion strategy. If stores are opened more slowly than
expected, sales at new stores reach targeted levels more slowly than expected
(or fail to reach targeted levels) or related overhead costs increase in excess
of expected levels, our ability to successfully implement our expansion
strategy would be adversely affected. Seasonality.As is the case with many retailers, a significant portion of our
revenues, and an even greater portion of our operating profit, is generated in
the fourth fiscal quarter, which includes the holiday selling season. As a
result, a substantial portion of our annual earnings has been, and will
continue to be, dependent on the results of this quarter. Less than
satisfactory net sales for such period could have a material adverse effect on
the Companys financial condition or results of operations for the year and may
not be sufficient to cover any losses that may have been incurred in the first
three quarters of the year. We experience reduced video rental activity in the
spring because customers spend more time outdoors. Major world or sporting
events, such as the Super Bowl, the Olympic Games or the World Series, also
have a temporary adverse effect on revenues. Future operating results may be
affected by many factors, including variations in the number and timing of
superstore openings, the number and popularity of new book, music and video
titles, the cost of the new release or best renter titles, changes in
comparable-store revenues, competition, marketing programs, increases in the
minimum wage, weather, special or unusual events, and other factors that may
affect our operations. Competition.We operate in numerous, highly competitive industries including
the book, music, sale video and rental video industries. In each of these
products, we compete directly with national superstore operators, as well as
regional chains and superstores, specialty retailers dealing in our products,
independent single store operators, discount stores, warehouse and mail order
clubs, and mass merchandisers. In addition, the Internet is a significant
channel for retailing for most of the product categories that we offer. In
particular, the retailing of books, music and video over the Internet is highly
competitive. In addition, we face competition from companies engaged in the
business of selling books, music and movies and the renting of movies via
electronic means, including the downloading of music content and in-home video
delivery. An increase in competition in the physical or electronic markets in
which we operate could have a material effect on our operations. Consumer Spending Patterns.Revenues generated from the sale and rental of
books, music, videos and other products we carry have historically been
dependent upon discretionary consumer spending, which may be affected by
general economic conditions, consumer confidence and other factors beyond our
control. A decline in consumer spending on the buying and/or rental of the
products we offer could have a material adverse effect on our financial
condition and results of operations and our ability to fund our expansion
strategy. 15




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##### Table of Contents



Reliance on Key Personnel.Management believes that the Companys continued
success will depend, to a significant extent, upon the efforts and abilities of
Mr. John H. Marmaduke, Chairman, President and Chief Executive Officer. The
loss of the services of Mr. Marmaduke could have a material adverse effect on
our operations. We maintain key man life insurance on Mr. Marmaduke. In
addition, our success depends, in part, on our ability to retain key management
and attract other personnel to satisfy our current and future needs. The
inability to retain key management personnel or attract additional qualified
personnel could have a material adverse effect on our operations. Home Video Retailer Distribution Window.A competitive advantage that home
video retailers currently enjoy over most other movie distribution channels,
except theatrical release, is the early timing of the home video retailer
distribution window. After the initial theatrical release of a movie, studios
generally make their movies available to home video retailers (for rental and
retail, including by mass merchant retailers) for specified periods of time.
This distribution window is typically exclusive against most other forms of
non-theatrical movie distribution, such as pay-per-view, video-on-demand,
premium television, basic cable and network and syndicated television. The
length of this exclusive distribution window for home video retailers varies,
but has traditionally ranged from 45 to 60 days for domestic video stores.
Thereafter, movies are made sequentially available to television distribution
channels. Our business could be negatively affected if (i) video retailer distribution
windows were no longer the first following the theatrical release; (ii) the
length of the home video retailer distribution windows were shortened; or (iii)
the home video retailer distribution windows were no longer as exclusive as
they are now because newly released movies would be made available earlier on
these other forms of non-theatrical movie distribution. As a result, consumers
would no longer need to wait until after the home video retailer distribution
window to view a newly released movie on these other distribution channels. We believe that the studios have a significant interest in maintaining a viable
home video retail industry. However, the order, length and exclusivity of each
window for each distribution channel is determined solely by the studio
releasing the movie, and we cannot predict future decisions by the studios, or
the impact, if any, of those decisions. In addition, any consolidation or
vertical integration of media companies to include both content providers and
digital distributors could pose a risk to the continuation of the distribution
window. Current Rental Video Studio Pricing Policies.Recent studio pricing for movies
released to home video retailers has impacted our video business.
Historically, studio pricing was based on whether or not a studio desired to
promote a movie for both rental and sale to the consumer, or primarily for
rental, from the beginning of the home video distribution window. In order to
promote a movie title for rental, the title would be released to home video
retailers at a price that was too high to allow for an affordable sales price
by the retailer to the consumer at the beginning of the retail home video
distribution window. As rental demand subsided, the studio would reduce pricing
in order to then allow for reasonably priced sales to consumers. Currently,
substantially all DVD titles are released at a price to the home video retailer
that is low enough to allow for an affordable sales price by the retailer to
the consumer from the beginning of the retail home video distribution window.
This sell-through pricing policy has led to increasing competition from other
retailers, including mass merchants such as Wal-Mart and online retailers, who
are able, due to the lower sell-through prices, to purchase DVDs for sale to
consumers at the same time as traditional home video retailers, like Hastings,
purchase both DVDs and VHS product for rental. In addition, some retailers sell
movies at lower prices in order to increase overall traffic to their stores or
businesses, and mass merchants may be more willing to sell at lower prices, and
in some instances, below wholesale. These factors have increased consumer
interest in purchasing DVDs, which has reduced the significance of the VHS
rental window. We believe that the increased consumer purchases are due in part to consumer
interest in building DVD libraries of classic movies and personal favorites and
that the studios will remain dependent on the traditional home video retailer
to generate revenues for the studios from titles that are not classics or
current box office hits. We therefore believe the importance of the video
rental industry to the studios will continue to be a factor in studio pricing
decisions. However, we cannot control or predict studio pricing policies with
certainty, and we cannot assure you that consumers will not, as a result of
further decreases in studio sell-through pricing and/or sustained or further
depressed pricing by competitors, increasingly desire to purchase rather than
rent movies. Personal DVD libraries could also cause 16




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consumers to rent or purchase fewer movies in the future. Our profitability
could therefore be negatively affected if, in light of any such consumer
behavior, we were unable to (i) grow our rental business, (ii) replace gross
profits from generally higher-margin rentals with gross profits from increased
sales of generally lower-margin sell-through product; or (iii) otherwise
positively affect gross profits, such as through price increases or cost
reductions. Our ability to achieve one or more of these objectives is subject
to risks, including the risk that we may not be able to compete effectively
with other DVD retailers, some of whom may have competitive advantages such as
the pricing flexibility described above or favorable consumer perceptions
regarding value. Regardless of the wholesale pricing environment, the extent of our
profitability is dependent on our ability to enter into arrangements with the
studios that effectively balance copy depth and cost considerations. Each type
of arrangement provides different advantages and challenges for us. The ability
to negotiate preferred terms under revenue sharing agreements for the
procurement of DVD, video games and VHS titles is crucial to our operations.
Our profitability could be negatively affected if studios were to make other
changes in their wholesale pricing policies and revenue-sharing agreements. Alternate Methods of Video Delivery.Advances in technologies such as
video-on-demand or certain changes in consumer behavior driven by these or
other technologies and methods of delivery, could have a negative effect on our
business. In particular, our business could be impacted if (i) newly released
movies were to be made widely available by the studios to these technologies at
the same time or before they are made available to home video retailers for
rental; and (ii) these technologies were to be widely accepted by consumers.
In addition, advances in direct broadcast satellite and cable technologies may
adversely affect public demand for video store rentals. If direct broadcast
satellite and digital cable were to become more widely available and accepted,
this could cause a smaller number of movies to be rented if viewers were to
favor the expanded number of conventional channels and expanded content,
including movies, specialty programming and sporting events, offered through
these services. If this were to occur, it could have a negative effect on our
video store business. Direct broadcast satellite providers transmit numerous
channels of programs by satellite transmission into subscribers homes. Also,
cable providers are taking advantage of digital technology to transmit many
additional channels of television programs over cable lines to subscribers
homes. Amortization and Salvage Value of Rental Video.Certain events mentioned in
this Annual Report on Form 10-K and others, including a downturn in the rental
video industry as a whole or in the markets within which we operate our
superstores, further consolidation of rental video retailers, a substantial
change in customer demand and a change in the mix of rental video revenues,
could affect the salvage value we have assigned to our rental video assets. The
effect could result in a material reduction of the carrying value of our rental
video assets and have a material impact on the financial results of an annual
or interim period. In particular, the growth of the DVD market and the shift
of consumer purchases from VHS (videocassettes) to DVD could result in a
decrease in the salvage value of rental videos. At some point during the
rental cycle, a VHS item, as with DVD and games, is available for purchase by a
customer as a previously viewed tape (PVT). With the shift in consumer
interest from VHS to DVD, we have experienced a significant reduction in the
revenues generated by VHS, see Fiscal 2003 Compared to Fiscal 2002 in this
section. In order to reduce exposure to a declining product category, we
monitor closely the recovery value received as well as the on hand levels of
our PVT. In addition, we are implementing an electronic pull criteria that
will better identify when a tape should be made available as PVT in order to
maximize recovery value. Our current experience is that the amount received
for a previously viewed tape is higher than our estimated salvage value of that
item in our rental inventory. Based in part on this factor and sales of
previously viewed tapes, we believe our estimate of salvage value is
appropriate, however, if future demand or market conditions are less favorable
than management projections, inventory adjustments, including possible changes
to rental video asset cost amortization methods or salvage values, may be
required. 17




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Overview Hastings Entertainment is a leading multimedia entertainment retailer that
sells and rents various home entertainment products, including books, music,
software, periodicals, new and used CDs, DVDs, video games and videocassettes,
video game consoles and DVD players through its entertainment superstores and
its Internet Web site. As of January 31, 2004, we operated 148 superstores
averaging approximately 20,000 square feet in small- to medium-sized markets
located in 20 states, primarily in the Western and Midwestern United States.
Each of the superstores is wholly owned by us and operates under the name of
Hastings. During 2003, the music industry continued to decline, although at a lesser rate
than in prior years, and the rental market slowed, particularly in the latter
half of the year, to some extent as a result of higher video sales. Despite
these industry influences, we reported revenue increases for fiscal 2003 due
primarily to the broad selection of products in our superstores. In addition,
we accomplished several goals during 2003 including (i) a reduction in the cost
of returning merchandise inventory to vendors through management, systems and
controls improvements; (ii) higher gross profit on revenues driven by improved
inventory procurement and continued negotiation of improved video rental
revenue-sharing contract terms; (iii) a more efficient and balanced merchandise
inventory; and (iv) significantly reduced debt levels as of January 31, 2004.
We believe that these improvements will have an effect on future periods. Our operating strategy is to enhance our position as a multimedia entertainment
retailer by expanding and remodeling existing superstores, opening new
superstores in selected markets, and offering our products through our Internet
Web site. References herein 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, 2004 is referred to as fiscal 2003. Critical Accounting Policies Our financial statements are prepared in accordance with accounting principles
generally accepted in the United States, which require management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities at the date of the financial statements, the disclosure of
contingent liabilities and the reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates. We
believe the following critical accounting policies affect our more significant
estimates and assumptions used in the preparation of our financial statements.
Our significant estimates and assumptions are reviewed, and any required
adjustments are recorded, on a monthly basis. Lower of Cost or Market for Merchandise Inventory.Our merchandise inventories
are recorded at the lower of cost or market. As with any retailer, economic
conditions, cyclical customer demand and changes in purchasing or distribution
can affect the carrying value of inventory. As circumstances warrant, we
record lower of cost or market inventory adjustments. In some instances, these
adjustments can have a material effect on the financial results of an annual or
interim period. In order to determine such adjustments, we evaluate the age,
inventory turns and estimated fair value of merchandise inventory by product
category and record an adjustment if estimated market value is below cost.
Through merchandising and an automated-progressive markdown program, we quickly
take the steps necessary to increase the sell-off of slower moving merchandise
to eliminate or lessen the effect of these adjustments. Returns Process.Merchandise inventory owned by us is generally returnable
based upon return agreements with our merchandise vendors. We continually
return merchandise to vendors based on, among other factors, current and
projected sales trends, overstock situations, authorized return timelines or
changes in product offerings. At the end of any reporting period, cost
accruals are required for inventory that has been returned to vendors, is in
the process of being returned to vendors, or has been identified to be returned
to vendors. These costs can include freight, valuation and quantity
differences, and other fees charged by a vendor. In order to appropriately
match the costs associated with the return of merchandise with the process of
returning such merchandise, we utilize an allowance for cost of inventory
returns. To accrue for such costs and estimate this allowance, we utilize
historical experience adjusted for significant estimated or contractual
modifications. Certain adjustments to the allowance can have a material effect
on the financial results of an annual or interim period. 18




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Rental Video Asset Cost Amortization.We have a series of direct
revenue-sharing agreements with major studios and we anticipate that our future
involvement in revenue-sharing agreements will be similar to that of fiscal
year 2003. Revenue sharing allows us to acquire rental video assets at a lower
up-front capital cost than traditional buying arrangements. We then share with
studios a percentage of the actual net rental revenues generated over a
contractually determined period of time. The increased access to additional
copies of new releases under revenue-sharing agreements allows customer demand
for new releases to be satisfied over the shorter period of time when the new
releases are most popular. Under the terms of the specific contracts with
supplying studios, we expense revenue-sharing payments through rental video
cost of revenue, as revenues are recognized. The capitalized cost of all
rental video assets acquired for a fixed price is being amortized on an
accelerated basis over six months to a salvage value of $4 per unit, except for
rental video assets purchased for the initial stock of a new superstore, which
are being amortized on a straight line basis over 36 months to a salvage value
of $4. Rental video assets purchased for less than $4 are not amortized. We monitor closely the recovery value of our rental video assets and are
implementing an electronic pull criteria in order to maximize recovery value.
Our current experience is that the recovery value of our rental video assets is
higher than our estimated salvage value of that item in our rental inventory.
Based in part on this factor and sales of previously viewed tapes, we believe
our estimate of salvage value is appropriate. However, if future demand or
market conditions are less favorable than management projections, inventory
adjustments, including possible changes to rental video asset cost amortization
methods or salvage values, may be required. Store Closing Reserve.On a quarterly basis, and in the normal course of
business, we evaluate our store base to determine if we need to close or
relocate a store(s). Management will evaluate, among other factors, current
and future profitability, market trends, age of store and lease status. The
primary expense items associated with the closure of a store relate to the net
present value of minimum lease payments (the present value of remaining lease
payments under an active lease) and the write-off of leasehold improvements and
other assets not remaining in our possession. Prior to December 31, 2002, such
expense items were recorded as of the date that management made the decision to
close or relocate a store and sublease income was not recorded as part of the
estimate until a contract with a sublet tenant had been signed. Subsequent to December 31, 2002, and in accordance with the adoption of SFAS
No. 146, we now recognize such expense items at the time the location is closed
or relocated. The amount recorded can fluctuate based on the age of the
closing location, term and remaining years of the lease and the number of
stores being closed or relocated. We actively pursue sublease tenants on all
closed or relocated locations and, as part of the final estimation of store
closing liability, the impact of any sublease income is estimated. The net of
the described charges and sublease income estimates can have a material effect
on the financial results of an annual or interim period. Revenue Recognition.We generate revenue primarily from retail sales and
rental of our products. Merchandise and rental revenues are recognized at the
point of sale or rental or at the time merchandise is shipped to the customer.
Revenues are presented net of estimated returns and exclude all taxes.
Customers may return certain merchandise for exchange or refund within our
policies, and an allowance has been established to provide for projected
returns. There are no provisions for uncollectible amounts since payment is
received at the time of sale. We, as with most retailers, also offer gift
cards for sale. Deferred revenue, a current liability, is recognized at the
time a gift card is sold with the costs of designing, printing and distributing
the cards recorded as an expense as incurred. The deferred revenue liability
is relieved and revenue is recognized upon the redemption of the gift cards.
From time to time we will offer sales incentives to customers, in the form of
rebates. Revenue is reduced by the amount of estimated redemptions, based on
experience of similar types of rebate offers, and a deferred revenue liability
is established. The deferred revenue liability is relieved when the customer
has completed all criteria necessary to file a valid rebate claim. Any
remaining portion of deferred revenue is recorded as revenue following the
termination of the extended redemption period and following completion of all
outstanding rebate claims. Comparable-Store Revenue.Stores included in the comparable-store revenues
calculation are those stores that have been open for a minimum of 60 weeks.
Also included are stores that are remodeled or relocated. Sales via the
internet are not included and closed stores are removed from each comparable
period for the purpose of calculating comparable-store revenues. 19




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Vendor Allowances.In 2002, the Emerging Issues Task Force (EITF) discussed
issue no. 02-16 (EITF 02-16), which addresses the accounting for cash
consideration received from a vendor by a reseller for various vendor-funded
allowances, including cooperative advertising support. The EITF determined
that cash consideration received from a vendor should be presumed to be a
reduction of the prices of vendors products and, therefore, should be shown as
a reduction in the cost of goods sold when recognized in the resellers income
statements. The only exception to this rule is if the reimbursement is for
specific, incremental identifiable costs. If the amount of cash consideration
received exceeds the cost being reimbursed, that excess amount should be
characterized as a reduction of cost of goods sold when recognized in the
resellers income statements. In January 2003, the EITF issued transition
guidance concluding that this interpretation should be applied to all new or
modified arrangements entered into after December 31, 2002. Accordingly, as of
January 31, 2004, approximately $2.2 million of our vendor advertising
allowances have been recorded as a reduction of merchandise inventory and the
cost of rental videos and will be recognized in cost of revenues as inventory
is sold and as rental videos are rented. Additionally, as a result of these
changes, selling, general and administrative expenses (SG&A) were increased by
approximately $4.4 million, total cost of revenues decreased by approximately
$2.2 million and net income for fiscal 2003 was decreased by approximately $1.4
million, or $0.12 per diluted share, net of tax. Certain amounts that we
receive from vendors, such as cooperative advertising payments, are considered
reimbursement for specific, identifiable costs and therefore continue to be
recorded as a reduction of SG&A. For fiscal 2003, such payments amounted to
approximately $2.4 million. 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 period
for the three most recent fiscal years. Fiscal Year2003
    
    2002
    
    2001Merchandise revenue
    
    
    79.7
    %
    
    
    79.8
    %
    
    
    80.4
    %Rental video revenue
    
    
    20.3
    
    
    
    20.2
    
    
    
    19.6Total revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    100.0Merchandise cost of revenue
    
    
    73.5
    
    
    
    74.0
    
    
    
    73.8Rental video cost of revenue
    
    
    38.0
    
    
    
    41.7
    
    
    
    45.0Total cost of revenues
    
    
    66.3
    
    
    
    67.5
    
    
    
    68.2Gross profit
    
    
    33.7
    
    
    
    32.5
    
    
    
    31.8Selling, general and administrative expenses
    
    
    32.1
    
    
    
    31.9
    
    
    
    30.5Pre-opening expenses
    
    
    0.1
    
    
    
    0.1
    
    
    
    0.132.2
    
    
    
    32.0
    
    
    
    30.6Operating income
    
    
    1.5
    
    
    
    0.5
    
    
    
    1.2Other income (expense):Interest expense
    
    
    (0.4
    )
    
    
    (0.4
    )
    
    
    (0.4
    )Interest income
    
    
    
    
    
    
    0.3
    
    
    
    Other, net
    
    
    0.1
    
    
    
    0.0
    
    
    
    0.1(0.3
    )
    
    
    (0.1
    )
    
    
    (0.3
    )Income before income taxes
    
    
    1.2
    
    
    
    0.4
    
    
    
    0.9Income tax benefit
    
    
    (0.3
    )
    
    
    
    
    
    
    Net income
    
    
    1.5
    %
    
    
    0.4
    %
    
    
    0.9
    %
 20




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Fiscal Year2003
    
    2002
    
    2001Hastings Superstores:Beginning number of stores
    
    
    146
    
    
    
    142
    
    
    
    142Openings
    
    
    5
    
    
    
    7
    
    
    
    5Closings
    
    
    (3
    )
    
    
    (3
    )
    
    
    (5
    )Ending number of stores
    
    
    148
    
    
    
    146
    
    
    
    142
 Fiscal 2003 Compared to Fiscal 2002 Revenues.Total revenues for fiscal 2003 were $508.3 million, up $12.9 million
or 2.6%, over fiscal 2002 revenues of $495.4 million primarily resulting from
an increase in total comparable-store revenues (Comps) of 1.9%. Elements of
total Comps are as follows: Merchandise Comps
    
    
    1.7
    %Rental video Comps
    
    
    2.7
    %Total Comps
    
    
    1.9
    %
 Total merchandise revenues increased $9.4 million, or 2.4% for fiscal 2003 to
$405.0 million from $395.6 million for fiscal 2002. On a percentage basis, our
top-performing category for the year was DVD for sale, which posted a 39.4%
increase in total revenues and was partially offset by a decline in total sales
of VHS of 20.6%, illustrating the shift in consumer interest from titles in the
VHS format to the preferred DVD format. In addition, total revenues from video
games increased 37.9% as hot game titles and our used-game trade and sell
program fueled growth in the category. The increase in merchandise Comps was driven primarily by year over year
increases of 34.4% and 17.7% in Comp sales of video games and videos,
respectively and a Comp increase in our book category of 0.7%. These increases
were partially offset by a decline in our music Comps of 7.5%. For the year,
the music industry reported a decline of approximately 6.0% in shipments of new
release compact discs and continues its efforts to reduce online music piracy. For fiscal 2003, total rental video revenues increased approximately 3.5% to
$103.3 million, up $3.5 million from $99.8 million in fiscal 2002. The
increase was the result of an increase in DVD and video game rentals of 53.2%
and 15.1%, respectively. Rentals of VHS titles declined 31.8% year over year.
The increases in DVD are the primary reason for the decline in VHS as consumers
adopt the DVD technology. However, the studios continue to release rental
titles simultaneously for sale at a low price-point enabling customers to build
their libraries by purchasing their selection instead of renting. During 2003
we reduced our purchases of VHS titles and continue to monitor our on hand
levels and performance criteria to increase the sale of previously viewed
titles in an effort to reduce financial exposure to the declines in the VHS
category. Gross Profit.Total gross profit of $171.5 million for fiscal 2003 increased
$10.7 million, or 6.6%, from $160.8 million for fiscal 2002. Total gross
profit as a percentage of total revenue for the current year increased to 33.7%
compared to 32.5% for last year. Merchandise gross profit as a percentage of merchandise revenues increased to
26.5% in the current year compared to 26.0% of merchandise revenue for the
prior year. Significant changes in the components of merchandise gross profit
are as follows:  (i)
    
    a decrease of approximately $3.8 million in the expense associated
with the distribution and return of merchandise, which includes
approximately $4.2 million related to favorable differences between
actual settlements with vendors as compared to amounts accrued. Vendor
settlements occur in the ordinary course of business with certain
suppliers related to disputed merchandise purchases and returns; 21




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(ii)
    
    a net reduction of product costs of approximately $1.7 million as a
result of the adoption of EITF 02-16 during fiscal 2003, which governs
the accounting by a customer for certain consideration received from a
vendor;(iii)
    
    improved gross profit rates contributing approximately $1.7
million, particularly in our music category; and(iv)
    
    a decrease in merchandise shrink of approximately $1.0 million. Partially offsetting these increases in gross profit were:  (i)
    
    an increase in freight costs, which even though $2.2 million higher
than fiscal 2002, was below our internal projections; and(ii)
    
    an increase in inventory markdowns of approximately $1.3 million,
$1.0 million of which occurred during the fourth quarter of fiscal 2003
as the result of our automated-progressive markdown program which
reduces future exposure of higher levels of slower moving seasonal
product following the Christmas selling season. Rental video gross profit for fiscal 2003 increased to 62.0% of rental video
revenues compared to 58.3% of rental revenues for fiscal 2002 primarily due to:  (i)
    
    lower depreciation and amortization expense of approximately $1.8
million from improved procurement procedures, inventory management and
an increase in margins on videos acquired under revenue sharing
agreements;(ii)
    
    a reduction of rental costs of approximately $0.5 million as a
result of the adoption of EITF 02-16 during fiscal 2003, which governs
the accounting by a customer for certain consideration received from a
vendor; and(iii)
    
    a reduction of approximately $0.5 million in the costs of
distributing rental video assets. Partially offsetting these increases in rental video gross profit was an
increase in shrinkage of approximately $0.6 million. Selling, General and Administrative Expenses.Selling, general and
administrative expenses (SG&A), including store and corporate labor and other
overhead costs, for fiscal 2003 increased approximately $5.5 million to $163.5
million from $158.0 million last year. As a percentage of total revenues, SG&A
expenses increased slightly to 32.1% for fiscal 2003 compared to 31.9% for
fiscal 2002. The increase was primarily the result of:  (i)
    
    an increase in net advertising costs of approximately $4.8 million,
of which $4.4 million was the result of adopting of EITF 02-16 which
requires the classification of certain consideration received from
vendors as reductions of the cost of products purchased from such
vendors as opposed to reducing SG&A expense. Certain amounts that we
receive from vendors, such as cooperative advertising payments, are
considered reimbursement for specific, identifiable costs and
therefore, under the rules of EITF 02-16, should continue to be
recorded as a reduction of SG&A. For fiscal 2003, such payments
amounted to approximately $2.4 million;(ii)
    
    higher occupancy and human resources costs of approximately $4.3
million associated with the operation of a greater number of new,
expanded and relocated superstores; and(iii)
    
    expense of approximately $0.5 associated with the closing of
certain superstores during fiscal 2003 compared to a credit of
approximately $0.4 million for fiscal 2002 which was primarily the
result of a change in estimated sublease income during the fourth
quarter of fiscal 2002. 22




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These increases in expense were partially offset by:  (i)
    
    a decline of approximately $2.9 million in accounting and legal
fees that were higher during fiscal 2002 due to charges of $2.6 million
for the settlement of shareholder class action lawsuits;(ii)
    
    a decrease of approximately $1.1 million in other SG&A expenses
resulting from improvements in operating cost controls; and(iii)
    
    lower costs of approximately $0.6 million associated with the
opening of new superstores and the expansion, remodel and relocation of
certain of our existing superstores. Interest Expense.For fiscal 2003, when compared to fiscal 2002, interest
expense remained constant at 0.4% of total revenues. Income Taxes.The results for fiscal year 2003 reflect an income tax benefit
of approximately $1.7 million, or $0.15 per diluted share, primarily due to the
reversal of a valuation allowance of approximately $4.4 million previously
applied against our deferred tax assets. Based on our past three fiscal years
of profitability and our belief that existing and projected levels of pre-tax
income are sufficient to generate the minimum amount of future taxable income
necessary to realize the deferred tax asset, we believe that the realization of
our deferred tax asset is now considered more likely than not and a valuation
allowance is no longer required as of January 31, 2004. Fiscal 2002 Compared to Fiscal 2001 Revenues.Total revenues for the fiscal year ending January 31, 2003 were
$495.4 million, up $23.7 million, or 5.0%, from $471.7 million for the fiscal
year ending January 31, 2002 primarily due to an increase in total Comps of
5.0% for the year. Elements of total Comps are as follows: Merchandise Comps
    
    
    4.8
    %Rental video Comps
    
    
    5.9
    %Total Comps
    
    
    5.0
    %
 Total merchandise revenues increased $16.2 million, or 4.3% for fiscal 2002 to
$395.5 million from $379.3 million for fiscal 2001. The increase in
merchandise Comps was driven primarily by year over year increases of
approximately 52% and 102% in total sales of DVDs and video games,
respectively. Comp increases were partially offset by a decline in music Comps
of 6.3% due primarily to the current malaise of the music industry, which
overall experienced a decline of 8.7% in total shipments of new release compact
discs for 2002. Book Comps for the year increased 3.6% as a result of our focus
during fiscal 2002 to improve our book department performance. Total rental
video revenues for fiscal 2002 increased $7.5 million, or 8.1% to $99.8 million
compared to $92.3 million for the prior year primarily due to an increase in
rentals of DVD titles of approximately 90% year over year. The increase in DVD
rentals was partially offset by a 21% decline in VHS rentals. The acceptance
of DVD by the consumer is the primary reason for the decline in VHS rental
revenue, but part of the decline resulted from studios increasing the
percentage of rental titles released simultaneously for sale at a lower
price-point, which entices the consumer to purchase a title instead of renting. Gross Profit.For fiscal 2002, total gross profit increased 7.2% to $160.9
million, or 32.5% of total revenues, from $150.1, or 31.8% of total revenues
for fiscal 2001. Merchandise gross profit for fiscal 2002, as a percentage of merchandise
revenue, decreased slightly to 26.0% compared to 26.2% for fiscal 2001 due
primarily to reduced margins in music and sale video which resulted from lower
sales prices in order to meet competitor pricing. Partially offsetting these
declines was an increase in book gross profit due primarily to a planned move
toward higher margin products in this category. 23




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Merchandise gross profit dollars for fiscal 2002 increased approximately $3.4
million to $102.7 million from $99.3 million for fiscal 2001. Significant
components of this increase in gross profit dollars were:  (i)
    
    higher revenues generating a higher gross profit contribution of
approximately $4.0 million, despite a slight increase in our product
cost from 67.1% of merchandise revenue for fiscal 2001 to 67.5% for
fiscal 2002;(ii)
    
    a decline in inventory markdowns of approximately $2.6 million
compared to last fiscal year due primarily to our automated-progressive
markdown programs, which improve our sell-through on slower moving
merchandise;(iii)
    
    a decrease in merchandise shrinkage of approximately $0.5 million;
and(iv)
    
    an increase of approximately $0.4 million from an increase in
certain trade and purchase discounts primarily resulting from volume
rebates related to merchandise inventory purchases. Partially offsetting these increases in merchandise gross profit were:  (i)
    
    an increase of approximately $3.6 million in the costs associated
with returning merchandise inventory primarily related to an increase
of approximately $23.2 million, or 35.7%, in the volume of product
returned to vendors during fiscal 2002 compared to fiscal 2001. The
higher level of returns was mainly attributable to a planned reduction
in inventory levels; and(ii)
    
    an increase in net freight expense of approximately $1.2 million,
which was primarily caused by increases in shipments from our
distribution and returns facilities of approximately 15% for fiscal
year 2002 compared to fiscal 2001 and higher freight costs. Rental video gross profit for fiscal 2002 increased $7.4 million, or 14.5%, to
$58.2 million up from $50.8 million for fiscal 2001. As a percentage of rental
video revenue, rental video gross profit increased to 58.3% compared to 55.0%
for fiscal 2001. These increases were primarily the result of (i) an increase
in rental video gross profit resulting from increases in the rentals of
non-revenue sharing titles, which generally reflect higher margins,
representing a higher percentage of total rental revenues, and (ii) improved
margins on videos acquired under revenue sharing agreements. Selling, General and Administrative Expenses.SG&A, including store and
corporate labor and other overhead costs, for fiscal 2002 increased 9.7% to
$158.0 million, or 31.9% of total revenues, from $144.1 million, or 30.5% of
total revenues last year. The increase was primarily the result of:  (i)
    
    charges totaling $2.6 million for the settlement of shareholder
class action lawsuits;(ii)
    
    an increase in store variable human resource expenses, excluding
group healthcare costs, of approximately $3.8 million. Store human
resource productivity decreased slightly to 12.3% of total revenues for
fiscal year 2002 compared to 12.1% for fiscal 2001;(iii)
    
    a planned increase of approximately $3.3 million in advertising
expenditures designed to drive Comp revenues and customer traffic;(iv)
    
    an increase in occupancy related costs of approximately $1.8
million due to the operation of a higher number of superstores during
fiscal year 2002 when compared to fiscal year 2001;(v)
    
    an increase of approximately $1.7 million related primarily to
increases in depreciation and consulting fees in connection with the
implementation of new financial software and upgrades in our human
resource systems;(vi)
    
    an unplanned increase of approximately $0.8 million in the costs
associated with our group healthcare plan, the majority of which was
the result of two large medical claims incurred at the end of July
2002; 24




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##### Table of Contents



(vii)
    
    an increase of approximately $0.6 million in the costs associated
with expanding or relocating seven superstores and the write-off of
fixed assets related to the closing of one superstore; and(viii)
    
    an increase of approximately $0.8 million in other miscellaneous SG&A
expenses. Partially offsetting these increases in SG&A were decreases of approximately
$1.7 million in net expense associated with the closing of certain superstores
and improved sublease activity. Interest Expense.For fiscal 2002, when compared to fiscal 2001, interest
expense remained constant at 0.4% of total revenues. A higher average loan
balance outstanding offset lower interest rates year over year. Interest Income.During the second quarter of fiscal 2002, we recorded
interest income of approximately $1.3 million as a result of interest earned on
income tax refunds for amended returns filed for fiscal years 1995 through
1998. We were notified in July 2002 that the payment of the refunds, which
totaled approximately $5.4 million, would be processed in August 2002 and would
be accompanied by interest payments. All refunds, including interest, were
received during fiscal 2002. Income Taxes.We did not record any income tax expense for fiscal years 2002
and 2001 due to adjustments in the valuation allowance related to the net
deferred tax asset. Liquidity and Capital Resources We generate cash from operations exclusively from the sale of merchandise and
the rental of video products and we have substantial operating cash flow
because most of our revenue is received in cash and cash equivalents. Other
than our principal capital requirements arising from the purchase, warehousing
and merchandising of inventory and rental videos, opening new superstores and
expanding existing superstores and updating existing and implementing new
information systems technology, we have no anticipated material capital
commitments. Our primary sources of working capital are cash flow from
operating activities, trade credit from vendors and borrowings under our
amended revolving credit facility. We believe our cash flow from operations
and borrowings under our amended revolving credit facility will be sufficient
to fund our ongoing operations, new superstores and superstore expansions
through fiscal 2005. Historically we have experienced an increase in our debt level during the third
quarter of our fiscal year. For third quarter of fiscal 2004, we are
projecting our debt level to increase to approximately
$45.0 million to $50.0
million. However, we expect this balance to reduce to approximately
$25.0 million
to $30.0 million due to a higher level of repayments during the fourth quarter
following the holiday selling season. Consolidated Cash Flows  Operating Activities. Net cash flows from operating activities increased
$21.3 million, or 41.2%, to $73.0 million in fiscal 2003 from $51.7 million
in fiscal 2002. In addition to an increase in net income of approximately
$5.9 million, decreases in inventory balances were approximately $8.4
million higher during fiscal 2003 when compared to fiscal 2002 primarily due
to more balanced merchandise inventories, which required a lesser buildup,
entering the holiday selling season. Trade accounts payable increased
approximately $6.4 million during fiscal 2003 compared to a decline of
approximately $7.7 million during 2002. This variance was primarily the
result of increased merchandise returns to vendors during fiscal 2002 and
the recording of subsequent reductions of amounts owed to those vendors as
well as improved dating on holiday orders during fiscal 2003. Finally, we
recorded the receipt of income tax refunds during fiscal 2002, which was the
primary reason for the decline in year over year change in income taxes
receivable of approximately $4.7 million.Investing Activities. Net cash used in investing activities decreased $11.2
million, or 17.3%, from $64.7 million in fiscal 2002 to $53.5 million in
fiscal 2003. This decrease was primarily the result of a higher amount of 25




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##### Table of Contents



purchases of DVD rental video assets under revenue sharing agreements, which
generally cost less than non-revenue sharing DVD assets, and improved rental
video inventory procurement procedures. In addition, purchases of computer
hardware and software upgrades were higher during fiscal 2002.Financing Activities. Cash provided by or used in financing activities is
primarily associated with borrowings and payments made under our revolving
credit facility (defined below under Capital Structure). For fiscal 2003,
cash used in financing activities was $16.9 million compared to cash
provided by financing activities of $13.1 million for fiscal 2002 resulting
from net repayments on our revolving credit facility during fiscal 2003 of
approximately $16.7 million compared to net borrowings for fiscal 2002 of
approximately $13.5 million. On September 18, 2001 we announced a stock repurchase program of up to $5.0
million of our common stock. During fiscal 2003, we purchased a total of
73,000 shares at a cost of $235,000, or $3.22 per share. As of January 31,
2004, a total of 796,423 shares had been purchased at a cost of approximately
$3.8 million, for an average cost of $4.74 per share. Capital Structure.On December 9, 2003, we executed an amendment to our
syndicated secured Loan and Security Agreement with Fleet Retail Finance, Inc.
and The CIT Group/Business Credit, Inc, (the Facility). The amount
outstanding under the Facility is limited by a borrowing base predicated on
eligible inventory, as defined, and certain rental video assets, net of
accumulated depreciation less specifically defined reserves and is limited to a
ceiling of $80 million, less a $10 million availability reserve. The Facility
permits borrowings at various interest-rate options based on the prime rate or
London Interbank Offering Rate (LIBOR) plus applicable margin depending upon
the level of our minimum availability. The borrowing base under the Facility
is limited to an advance rate of 65% of eligible inventory and certain rental
video assets net of accumulated amortization less specifically defined
reserves, which can be adjusted to reduce availability under the Facility.
Lenders may increase specifically defined reserves to reduce availability in
the event of adverse changes in our industry that are projected to impact the
value of our assets pledged as collateral. The Facility contains no financial
covenants, restricts the payment of dividends and includes certain other debt
and acquisition limitations, allows for the repurchase of up to $7.5 million of
our common stock and requires a minimum availability of $10 million at all
times. The Facility is secured by substantially all the assets of the company
and our subsidiaries and is guaranteed by each of our three consolidated
subsidiaries. The Facility matures on August 29, 2007. At January 31, 2004,
we had $32.7 million in excess availability, after the $10 million availability
reserve, under the Facility. However, excess availability may be reduced in
the future as changes in the borrowing base occur or the lenders increase
availability reserves. At January 31, 2004 and 2003, respectively, we had
borrowings outstanding of $29.0 million and $45.7 million under the Facility.
The average rate of interest being charged under the Facility for fiscal years
ending January 31, 2004 and 2003 was 3.8% and 4.1%, respectively. We utilize standby letters of credit to support certain insurance policies.
The aggregate amount of the letters of credit at January 31, 2004 was
approximately $1.0 million, which reduces the excess availability under the
Facility. From time to time, we enter into interest rate swap agreements in order to
obtain a fixed interest rate on a portion of our outstanding floating rate
debt, thereby reducing our exposure to interest rate volatility. On October 4,
2002, we cancelled, at no cost, two swap agreements entered into in November
and December of 2001 with an aggregate notional amount of $20 million and
replaced those agreements with one interest rate swap agreement with a
financial institution that expires October 1, 2004. The notional amount of the
swap is $20 million with a fixed interest rate of 2.45%. We have designated
the interest rate swap as a hedging instrument. At January 31, 2004, the fair
value of the interest rate swap was not significant. At January 31, 2004, our minimum operating lease commitments for fiscal 2004
were approximately $22.1 million. The present value of total existing minimum
operating lease commitments for fiscal years 2005 through 2019 discounted at
9.0% was approximately $81.6 million as of January 31, 2004. Contractual Obligations and Off-Balance Sheet Arrangements. Current accounting
standards require us to disclose our material obligations and commitments to
make future payments under contracts, such as debt and lease agreements. We
disclose our contractual long-term debt repayment and the principal portion of
capital lease obligations in Note 6 and our current and future operating and
capital lease payments in Note 7 to the consolidated 26




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##### Table of Contents



financial statements. In the ordinary course of business, we routinely enter
into commitments for various aspects of our operations, such as warehouse and
office equipment. However, we do not believe that these commitments will have
a material effect on our financial condition, results of operations or cash
flows. As of January 31, 2004, other than operating leases and standby letters
of credit, we had not entered into any off-balance sheet arrangements or
third-party guarantees, nor is it our business practice to do so. The following summarizes our contractual obligations at January 31, 2004,
and the effect such obligations are expected to have on our liquidity and cash
flows in future periods (in thousands): 1 to 3
    
    3 to 5
    
    More thanContractual Obligations
    
    Total
    
    Less than 1 year
    
    Years
    
    Years
    
    5 YearsLong-term debt
    
    $
    29,011
    
    
    $
    
    
    
    $
    29,011
    
    
    $
    
    
    
    $
    Operating lease
    
    
    144,614
    
    
    
    22,061
    
    
    
    56,452
    
    
    
    33,588
    
    
    
    32,513Capital lease (1)
    
    
    969
    
    
    
    280
    
    
    
    619
    
    
    
    70
    
    
    
    Revenue sharing (2)
    
    
    612
    
    
    
    612
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    $
    175,206
    
    
    $
    22,953
    
    
    $
    86,082
    
    
    $
    33,658
    
    
    $
    32,513
  (1)
    
    Includes both principal and interest.(2)
    
    As of January 31, 2004 we were a party to revenue-sharing arrangements
with various studios. These agreements include minimum purchase
requirements, based upon the box office results of the title, at a lower
initial product cost as compared to non-revenue sharing purchases. In
addition, these contracts require net rental revenues to be shared with
the studios over an agreed period of time. We have included amounts owed
and an estimate of our contractual obligation under these agreements for
performance guarantees and minimum purchase requirements for the period in
which they can reasonably be estimated, which is approximately two months
in the future. Although these contracts may extend beyond the estimated
two-month period, we cannot reasonably estimate these amounts due to the
uncertainty of purchases that will be made under these agreements. The
amounts presented above do not include revenue sharing accruals for rental
revenues recorded during fiscal 2003. Seasonality and Inflation Our business is highly seasonal, with significantly higher revenues and all our
full year operating income realized during the fourth quarter, which includes
the holiday selling season. Below is a tabular presentation of revenues and
operating income by quarter, which illustrates the seasonal effects of our
business: QuarterFiscal year 2003:
    
    First
    
    Second
    
    Third
    
    FourthTotal revenues
    
    $
    116,837
    
    
    $
    115,397
    
    
    $
    112,843
    
    
    $
    163,241Operating income (loss)
    
    
    (636
    )
    
    
    629
    
    
    
    (3,336
    )
    
    
    11,129% of full year:Total revenues
    
    
    23.0
    %
    
    
    22.7
    %
    
    
    22.2
    %
    
    
    32.1
    %Operating income (loss)
    
    
    (8.2
    )%
    
    
    8.1
    %
    
    
    (42.8
    )%
    
    
    142.9
    %
 QuarterFiscal year 2002:
    
    First
    
    Second
    
    Third
    
    FourthTotal revenues
    
    $
    112,845
    
    
    $
    115,038
    
    
    $
    110,636
    
    
    $
    156,875Operating income (loss)
    
    
    1,007
    
    
    
    (2,422
    )
    
    
    (6,223
    )
    
    
    9,988% of full year:Total revenues
    
    
    22.8
    %
    
    
    23.2
    %
    
    
    22.3
    %
    
    
    31.7
    %Operating income (loss)
    
    
    42.9
    %
    
    
    (103.1
    )%
    
    
    (264.8
    )%
    
    
    425.0
    %
 27




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##### Table of Contents



QuarterFiscal year 2001:
    
    First
    
    Second
    
    Third
    
    FourthTotal revenues
    
    $
    109,111
    
    
    $
    110,101
    
    
    $
    103,175
    
    
    $
    149,261Operating income (loss)
    
    
    (166
    )
    
    
    1,229
    
    
    
    (5,042
    )
    
    
    9,834% of full year:Total revenues
    
    
    23.1
    %
    
    
    23.3
    %
    
    
    21.9
    %
    
    
    31.6
    %Operating income (loss)
    
    
    (2.8
    )%
    
    
    21.0
    %
    
    
    (86.1
    )%
    
    
    167.9
    %
 We do not believe that inflation has materially impacted net income during the
past three years. Substantial increases in costs and expenses could have a
significant impact on our operating results to the extent such increases are
not passed along to customers. Recent Accounting Pronouncements In June 2002, the FASB issued Statement No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS No. 146). This statement
requires that the fair value of a liability associated with an exit or disposal
activity be recognized when the liability is incurred. Prior to the adoption of
SFAS No. 146, certain exit costs were recognized when we committed to a
restructuring plan, which may have been before the liability was incurred. The
provisions of this statement were effective for exit or disposal activities
initiated subsequent to December 31, 2002. The adoption of SFAS No. 146 did
not have a material impact on our financial position or results of operations. In January 2003, the Emerging Issues Task Force reached a consensus on Issue
No. 02-16, Accounting by a Customer (Including a Reseller) for Certain
Consideration Received from a Vendor (EITF 02-16). The issue provides
guidelines for specific treatment and classification of certain amounts
received by a customer from a vendor in connection with product purchased from
the vendor. EITF 02-16 was effective prospectively for new arrangements
entered into after December 31, 2002. Accordingly, as of January 31, 2004,
approximately $2.2 million of our vendor advertising allowances have been
recorded as a reduction of merchandise inventory and the cost of rental videos
and will be recognized in cost of revenues as inventory is sold and as rental
videos are rented. Additionally, as a result of these changes, selling,
general and administrative expenses were increased by approximately $4.4
million, total cost of revenues decreased by approximately $2.2 million and net
income for fiscal 2003 was decreased by approximately $1.4 million, or $0.12
per diluted share, net of tax. 
 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the ordinary course of our business, we are exposed to certain market risks,
primarily changes in interest rates. Our exposure to interest rate risk
consists of variable rate debt based on the lenders base rate or LIBOR plus a
specified percentage at our option. The annual impact on our results of
operations of a 100 basis point interest rate change on the January 31, 2004
outstanding balance of the variable rate debt would be approximately $0.1
million, including the effect of our interest rate swap. 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. In addition, we
do not believe changes in the fair value of our interest rate swap entered into
in October of 2002 with a notional amount of $20 million will be material. 28




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##### Table of Contents



ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA HASTINGS ENTERTAINMENT, INC.
Index to Consolidated Financial Statements
and Financial Statement Schedule PageIndependent Auditors Reports
    
    
    30Consolidated Balance Sheets as of January 31, 2004 and 2003
    
    
    31Consolidated Statements of Operations
for the years ended January 31, 2004, 2003 and 2002
    
    
    32Consolidated Statements of Shareholders Equity
for the years ended January 31, 2004, 2003 and 2002
    
    
    33Consolidated Statements of Cash Flows
for years ended January 31, 2004, 2003 and 2002
    
    
    34Notes to Consolidated Financial Statements
    
    
    35ScheduleFinancial Statement Schedule - The Financial Statement Schedule filed as part of
this report is listed under Part IV, Item 15. Exhibits, Financial Statement Schedules
and Reports on Form 8-K.
    
    
    54
 29




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##### Table of Contents



Report of Independent Auditors The Board of Directors 
Hastings Entertainment, Inc. We have audited the accompanying consolidated balance sheets of Hastings
Entertainment, Inc. and subsidiaries as of January 31, 2004 and 2003, and the
related consolidated statements of operations, shareholders equity, and cash
flows for each of the three years in the period ended January 31, 2004. Our
audits also included the financial statement schedule listed in the Index at
Item 15(a). These financial statements and schedule are the responsibility of
the Companys management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of Hastings
Entertainment, Inc. and subsidiaries at January 31, 2004 and 2003, and the
consolidated results of their operations and their cash flows for each of the
three years in the period ended January 31, 2004 in conformity with accounting
principles generally accepted in the United States. Also, in our opinion, the
related financial statement schedule, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein. As discussed in Note 1 to the consolidated financial statements, effective
January 1, 2003, the Company adopted Emerging Issues Task Force No. 02-16,
Accounting of a Customer (Including a Reseller) for Certain Consideration
Received from a Vendor. /s/ Ernst & Young LLP Fort Worth, Texas 
March 25, 2004 30




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##### Table of Contents



HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
January 31, 2004 and 2003
(In thousands, except share data) January 31,2004
    
    2003AssetsCurrent assetsCash
    
    $
    7,124
    
    
    $
    4,447Merchandise inventories, net
    
    
    138,552
    
    
    
    148,395Income taxes receivable
    
    
    511
    
    
    
    552Deferred income taxes
    
    
    1,779
    
    
    
    Prepaid expenses and other current assets
    
    
    6,585
    
    
    
    5,969Total current assets
    
    
    154,551
    
    
    
    159,363Property and equipment, net
    
    
    79,633
    
    
    
    76,283Deferred income taxes, net of valuation allowance as of January 31, 2003
    
    
    1,246
    
    
    
    971Intangible assets, net
    
    
    630
    
    
    
    717Other assets
    
    
    188
    
    
    
    188$
    236,248
    
    
    $
    237,522Liabilities and Shareholders EquityCurrent liabilitiesCurrent maturities on capital lease obligations
    
    $
    221
    
    
    $
    193Trade accounts payable
    
    
    82,072
    
    
    
    75,712Accrued expenses and other current liabilities
    
    
    34,308
    
    
    
    32,543Total current liabilities
    
    
    116,601
    
    
    
    108,448Long-term debt, excluding current maturities on capital lease obligations
    
    
    29,623
    
    
    
    46,519Other liabilities
    
    
    3,031
    
    
    
    3,399Commitments and contingenciesShareholders equity:Preferred stock, $.01 par value; 5,000,000 shares authorized; none issued
    
    
    
    
    
    
    Common stock, $.01 par value; 75,000,000 shares authorized;
    
    
    119
    
    
    
    11911,944,544 shares in fiscal 2003 and 2002 issued;11,363,612 in fiscal 2003 and
11,336,473 shares in fiscal 2002 outstandingAdditional paid-in capitalRetained earnings
    
    
    36,598
    
    
    
    36,749Treasury stock, at cost
    
    
    53,009
    
    
    
    45,259(2,733
    )
    
    
    (2,971
    )86,993
    
    
    
    79,156$
    236,248
    
    
    $
    237,522
 See accompanying notes to consolidated financial statements. 31




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##### Table of Contents



HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended January 31, 2004, 2003 and 2002
(In thousands, except per share data) Fiscal Year2003
    
    2002
    
    2001Merchandise revenue
    
    $
    404,977
    
    
    $
    395,548
    
    
    $
    379,322Rental video revenue
    
    
    103,341
    
    
    
    99,846
    
    
    
    92,326Total revenues
    
    
    508,318
    
    
    
    495,394
    
    
    
    471,648Merchandise cost of revenue
    
    
    297,523
    
    
    
    292,888
    
    
    
    280,054Rental video cost of revenue
    
    
    39,259
    
    
    
    41,652
    
    
    
    41,504Total cost of revenues
    
    
    336,782
    
    
    
    334,540
    
    
    
    321,558Gross profit
    
    
    171,536
    
    
    
    160,854
    
    
    
    150,090Selling, general and administrative expenses
    
    
    163,473
    
    
    
    158,025
    
    
    
    144,053Pre-opening expenses
    
    
    277
    
    
    
    479
    
    
    
    182Operating income
    
    
    7,786
    
    
    
    2,350
    
    
    
    5,855Other income (expense):Interest income
    
    
    
    
    
    
    1,291
    
    
    
    Interest expense
    
    
    (2,048
    )
    
    
    (1,987
    )
    
    
    (2,090
    )Other, net
    
    
    324
    
    
    
    237
    
    
    
    252Income before income taxes
    
    
    6,062
    
    
    
    1,891
    
    
    
    4,017Income tax benefit
    
    
    (1,688
    )
    
    
    
    
    
    
    Net income
    
    $
    7,750
    
    
    $
    1,891
    
    
    $
    4,017Basic income per share
    
    $
    0.68
    
    
    $
    0.17
    
    
    $
    0.34Diluted income per share
    
    $
    0.68
    
    
    $
    0.16
    
    
    $
    0.34
 See accompanying notes to consolidated financial statements. 32




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HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders Equity
Years ended January 31, 2004, 2003 and 2002
(In thousands, except share data) Common Stock
    
    AdditionalPaid-in
    
    Retained
    
    Treasury Stock
    

TotalShareholdersShares
    
    Amount
    
    Capital
    
    Earnings
    
    Shares
    
    Amount
    
    EquityBalances at January 31, 2001
    
    
    11,751,850
    
    
    $
    117
    
    
    $
    36,323
    
    
    $
    39,351
    
    
    
    
    
    
    $
    
    
    
    $
    75,791Issuance of stock to employees
    
    
    63,655
    
    
    
    1
    
    
    
    166
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    167Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    618,500
    
    
    
    (3,017
    )
    
    
    (3,017
    )Exercise of stock options
    
    
    102,530
    
    
    
    1
    
    
    
    361
    
    
    
    
    
    
    
    (4,487
    )
    
    
    24
    
    
    
    386Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,017
    
    
    
    
    
    
    
    
    
    
    
    4,017Balances at January 31, 2002
    
    
    11,918,035
    
    
    
    119
    
    
    
    36,850
    
    
    
    43,368
    
    
    
    614,013
    
    
    
    (2,993
    )
    
    
    77,344Issuance of stock to directors
    
    
    26,509
    
    
    
    
    
    
    
    87
    
    
    
    
    
    
    
    (11,775
    )
    
    
    58
    
    
    
    145Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    104,923
    
    
    
    (521
    )
    
    
    (521
    )Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    (188
    )
    
    
    
    
    
    
    (99,090
    )
    
    
    485
    
    
    
    297Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,891
    
    
    
    
    
    
    
    
    
    
    
    1,891Balances at January 31, 2003
    
    
    11,944,544
    
    
    
    119
    
    
    
    36,749
    
    
    
    45,259
    
    
    
    608,071
    
    
    
    (2,971
    )
    
    
    79,156Issuance of stock to directors
    
    
    
    
    
    
    
    
    
    
    (28
    )
    
    
    
    
    
    
    (25,002
    )
    
    
    118
    
    
    
    90Purchase of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    73,000
    
    
    
    (235
    )
    
    
    (235
    )Exercise of stock options
    
    
    
    
    
    
    
    
    
    
    (123
    )
    
    
    
    
    
    
    (75,137
    )
    
    
    355
    
    
    
    232Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,750
    
    
    
    
    
    
    
    
    
    
    
    7,750Balances at January 31, 2004
    
    
    11,944,544
    
    
    $
    119
    
    
    $
    36,598
    
    
    $
    53,009
    
    
    
    580,932
    
    
    $
    (2,733
    )
    
    $
    86,993
 See accompanying notes to consolidated financial statements. 33




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##### Table of Contents



HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended January 31, 2004, 2003 and 2002
(In thousands) Fiscal Year2003
    
    2002
    
    2001Cash flows from operating activities:Net income
    
    $
    7,750
    
    
    $
    1,891
    
    
    $
    4,017Adjustments to reconcile net income to net cash provided
by operating activities:Depreciation expense
    
    
    39,813
    
    
    
    40,223
    
    
    
    35,393Amortization expense
    
    
    87
    
    
    
    68
    
    
    
    73Loss on rental videos lost, stolen and defective
    
    
    4,948
    
    
    
    5,711
    
    
    
    5,179Loss on disposal of non-rental video assets
    
    
    929
    
    
    
    1,307
    
    
    
    1,615Deferred income taxes
    
    
    (2,054
    )
    
    
    316
    
    
    
    Non-cash compensation
    
    
    90
    
    
    
    127
    
    
    
    115Changes in operating assets and liabilities:Merchandise inventories
    
    
    14,259
    
    
    
    5,820
    
    
    
    (13,948
    )Prepaid expenses and other current assets
    
    
    (616
    )
    
    
    (638
    )
    
    
    129Trade accounts payable
    
    
    6,360
    
    
    
    (7,706
    )
    
    
    16,185Accrued expenses and other current liabilities
    
    
    1,551
    
    
    
    2,750
    
    
    
    (4,409
    )Income taxes receivable/payable
    
    
    255
    
    
    
    4,629
    
    
    
    1,828Other assets and liabilities, net
    
    
    (368
    )
    
    
    (2,782
    )
    
    
    (863
    )Net cash provided by operating activities
    
    
    73,004
    
    
    
    51,716
    
    
    
    45,314Cash flows from investing activities:Purchases of rental video
    
    
    (31,363
    )
    
    
    (37,695
    )
    
    
    (27,485
    )Purchase of property, equipment and improvements
    
    
    (22,093
    )
    
    
    (26,969
    )
    
    
    (17,843
    )Purchases of retail locations
    
    
    
    
    
    
    
    
    
    
    (1,167
    )Net cash used in investing activities
    
    
    (53,456
    )
    
    
    (64,664
    )
    
    
    (46,495
    )Cash flows from financing activities:Borrowings under revolving credit facility
    
    
    510,459
    
    
    
    542,241
    
    
    
    505,135Repayments under revolving credit facility
    
    
    (527,132
    )
    
    
    (528,791
    )
    
    
    (501,159
    )Payments under long-term debt and capital lease obligations
    
    
    (195
    )
    
    
    (168
    )
    
    
    (154
    )Purchase of treasury stock
    
    
    (235
    )
    
    
    (521
    )
    
    
    (3,019
    )Proceeds from exercise of stock options
    
    
    232
    
    
    
    315
    
    
    
    440Net cash provided by (used in) financing activities
    
    
    (16,871
    )
    
    
    13,076
    
    
    
    1,243Net increase in cash
    
    
    2,677
    
    
    
    128
    
    
    
    62Cash at beginning of year
    
    
    4,447
    
    
    
    4,319
    
    
    
    4,257Cash at end of year
    
    $
    7,124
    
    
    $
    4,447
    
    
    $
    4,319
 See accompanying notes to consolidated financial statements. 34




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##### Table of Contents



Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (1)
    
    Operations and Summary of Significant Accounting Policies  (a)
    
    GeneralHastings Entertainment, Inc. and subsidiaries operates a chain of
retail superstores in 20 states, primarily in the Western and
Midwestern United States. Revenues are generated from the sale of new
books, software, periodicals, and accessory products, as well as new
and used music, DVDs, video games and videocassettes. In addition,
our revenues include the rental of DVDs, video games and
videocassettes.(b)
    
    Basis of ConsolidationThe consolidated financial statements present the results of Hastings
Entertainment, Inc. and its subsidiaries. All significant
intercompany transactions and balances have been eliminated in
consolidation.(c)
    
    Basis of PresentationCertain prior year amounts have been reclassified to conform with the
fiscal 2003 presentation.Our fiscal years ended January 31, 2004, 2003 and 2002 are referred to
as fiscal 2003, 2002 and 2001, respectively.(d)
    
    Revenue RecognitionMerchandise and rental video revenue are recognized at the point of
sale or rental or at the time merchandise is shipped to the customer.
Additionally, revenues are presented net of estimated returns and
exclude all taxes. An allowance has been established to provide for
projected merchandise returns.Gift card liabilities are recorded at the time of sale of such cards
with the costs of designing, printing and distributing the cards
recorded as expense as incurred. The liability is relieved and
revenue is recognized upon redemption of the gift cards.(e)
    
    Merchandise InventoriesMerchandise inventories are recorded at the lower of cost, which
approximates the first-in, first-out (FIFO method) or market.(f)
    
    Property and EquipmentProperty and equipment are recorded at cost and depreciated using the
straight-line method, except for rental video assets, which are
depreciated using an accelerated depreciation method. Furniture,
fixtures, equipment and software are depreciated over their estimated
useful lives of three to seven years. Leasehold improvements are
amortized over the shorter of the related lease term or their
estimated useful lives. Rental video assets, except for the initial
purchases for new stores, are depreciated over six months using an
accelerated methodology designed to match the revenue stream of the
rental asset. The initial purchases of rental video assets for new
stores are depreciated over 36 months using the straight-line method.Property recorded pursuant to capital lease obligations is stated at
the present value of the minimum lease payments at the inception of
each lease, not in excess of fair value, and amortized on a
straight-line basis over the related lease term.We review long-lived assets for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of assets to be held and used is
measured by a comparison of the carrying amount of the asset to future
net undiscounted cash flows expected to be generated by the asset. If
such assets are considered to be impaired, the impairment to 35




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##### Table of Contents



Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  be recognized is measured by the amount by which the carrying amount of
the assets exceeds the fair value of the assets. Assets to be
disposed of are reported at the lower of the carrying amount or fair
value less costs to sell.(g)
    
    Financial InstrumentsThe carrying amount of long-term debt approximates fair value as of
January 31, 2004 and 2003 due to the instruments bearing interest at
variable market rates. The carrying amount of accounts payable
approximates fair value because of its short maturity period.From time to time, we enter into interest rate swap agreements in
order to obtain a fixed interest rate on a portion of our outstanding
floating rate debt thereby reducing our exposure to interest rate
volatility. On October 4, 2002, we cancelled, at no cost, two swap
agreements entered into in November and December of 2001 with an
aggregate notional amount of $20 million and replaced those agreements
with one interest rate swap agreement with a financial institution.
The notional amount of the swap is $20 million with a fixed interest
rate of 2.45% for two years. We have designated the interest rate swap
as a hedging instrument. Because the relevant terms of the interest
rate swaps and the specific cash flows related to the debt are
virtually identical, there was no material ineffectiveness required to
be recognized in earnings. In addition, there are no components of
the derivative instruments gain or loss that have been excluded from
the assessment of hedge effectiveness. At January 31 2004, the fair
value of the interest rate swap was not significant.(h)
    
    Stock Option PlansWe account for our stock option plans in accordance with the
provisions of Accounting Principles Board Opinion No. 25, Accounting
for Stock Issued to Employees(APB 25), and related interpretations.
Compensation expense is recorded on the date of grant only if the
market price of the underlying stock exceeds the exercise price.
Under Statement of Financial Accounting Standards No. 123, Accounting
for Stock-based Compensation(SFAS 123), we may elect to recognize
expense for stock-based compensation based on the fair value of the
awards, or continue to account for stock-based compensation under APB
25 and disclose in the financial statements the effects of SFAS 123 as
if the recognition provisions were adopted. We have elected to
continue to apply the provisions of APB 25 and provide the pro forma
disclosure provisions of SFAS 123.The following schedule reflects the impact on net income and net
income per share if we had applied the fair value recognition
provisions of SFAS 123 to stock based compensation. Fiscal Year2003
    
    2002
    
    2001Net income, as reported
    
    $
    7,750
    
    
    $
    1,891
    
    
    $
    4,017Add: Stock-based compensation included
in reported net income
    
    
    55
    
    
    
    127
    
    
    
    115Less: Stock-based compensation expense
determined under fair value based
method, net of tax
    
    
    (369
    )
    
    
    (505
    )
    
    
    (281
    )Proforma net income
    
    $
    7,436
    
    
    $
    1,513
    
    
    $
    3,851Income per share:Basic, as reported
    
    $
    0.68
    
    
    $
    0.17
    
    
    $
    0.34Basic, proforma
    
    $
    0.66
    
    
    $
    0.14
    
    
    $
    0.33Diluted, as reported
    
    $
    0.68
    
    
    $
    0.16
    
    
    $
    0.34Diluted, proforma
    
    $
    0.65
    
    
    $
    0.13
    
    
    $
    0.32
 36




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (i)
    
    Advertising CostsAdvertising costs for newspaper, television and other media are
expensed as incurred. Gross advertising expenses for the fiscal years
2003, 2002, and 2001 were $9.8 million, $11.0 million and $9.2
million, respectively.We receive payments and credits from vendors pursuant to cooperative
advertising programs and display allowances. During fiscal years
2003, 2002 and 2001, we received a total of approximately $6.8
million, $8.3 million and $9.9 million, respectively for such payments
and credits. During fiscal 2003, we began recording certain of these
payments and allowances as a reduction of merchandise inventory and
the cost of rental videos in accordance with Emerging Issues Task
Force Issue No. 02-16, Accounting by a Customer (Including a
Reseller) for Certain Consideration Received from a Vendor (EITF
02-16). See Note 1(m) below for a complete discussion of EITF 02-16.(j)
    
    Pre-opening CostsPre-opening expenses include human resource costs, travel, rent,
advertising, supplies and certain other costs incurred prior to a
superstores opening and are expensed as incurred.(k)
    
    Income Per ShareBasic income per share is computed by dividing net income by the
weighted-average number of common shares outstanding during the
period. Diluted income per share is similarly computed, but includes
the effect, when dilutive, of our weighted average number of stock
options outstanding.(l)
    
    Use of Management EstimatesThe preparation of the financial statements in conformity with
generally accepted accounting principles 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.(m)
    
    Impact of Recently Issued Accounting StandardsIn June 2002, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 146 (SFAS 146),
Accounting for Costs Associated with Exit or Disposal Activities.
This statement requires that the fair value of a liability associated
with an exit or disposal activity be recognized when the liability is
incurred. Prior to the adoption of SFAS No. 146, certain exit costs
were recognized when we committed to a restructuring plan, which may
have been before the liability was incurred. The provisions of this
statement were effective for exit or disposal activities initiated
subsequent to December 31, 2002. The adoption of SFAS No. 146 did not
have a material impact on our financial position or results of
operations.In January 2003, the Emerging Issues Task Force reached a consensus on
EITF 02-16. The issue provides guidelines for specific treatment and
classification of certain amounts received by a customer from a vendor
in connection with product purchased from the vendor. EITF 02-16 was
effective prospectively for new arrangements entered into after
December 31, 2002. Accordingly, as of January 31, 2004, approximately
$2.2 million of our vendor advertising allowances have been recorded
as a reduction of merchandise inventory and the cost of rental videos
and will be recognized in cost of revenues as inventory is sold and as
rental videos are rented. Additionally, as a result of these changes,
selling, general and administrative expenses increased approximately
$4.4 million, total cost of revenues decreased by approximately $2.2
million and net income for fiscal 2003 was decreased by approximately
$1.4 million, or $0.12 per diluted share, net of tax. 37




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##### Table of Contents



Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (2)
    
    Merchandise InventoriesMerchandise inventories consisted of the following: January 31,2004
    
    2003Books
    
    $
    57,272
    
    
    $
    59,942Music
    
    
    38,683
    
    
    
    42,328Videos
    
    
    32,175
    
    
    
    31,927Other
    
    
    13,607
    
    
    
    17,862141,737
    
    
    
    152,059Less allowance for inventory shrinkage and
obsolescence
    
    
    3,185
    
    
    
    3,664$
    138,552
    
    
    $
    148,395
  During fiscal 2003 and 2002, we purchased approximately 23% and 21%,
respectively, of all products (defined herein as merchandise inventories
and rental videos) from three suppliers.  (3)
    
    Property and EquipmentProperty and equipment consists of the following : January 31,2004
    
    2003Rental videos
    
    $
    60,550
    
    
    $
    57,281Furniture, equipment and software
    
    
    108,621
    
    
    
    97,202Leasehold improvements
    
    
    56,044
    
    
    
    52,368Buildings and land
    
    
    258
    
    
    
    258Work in progress
    
    
    3,070
    
    
    
    3,201Property under capital leases
    
    
    2,126
    
    
    
    2,126230,669
    
    
    
    212,436Less accumulated depreciation and
amortization
    
    
    151,036
    
    
    
    136,153$
    79,633
    
    
    $
    76,283
 38




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (4)
    
    Accrued Expenses and Other Current LiabilitiesAccrued expenses and other current liabilities consisted of the following: January 31,2004
    
    2003Allowance for cost of inventory returns
    
    $
    3,658
    
    
    $
    4,729Deferred gift card revenue
    
    
    11,611
    
    
    
    10,373Salaries, vacation, bonus and benefits
    
    
    7,397
    
    
    
    5,493Short term lease obligations
    
    
    2,680
    
    
    
    3,143Sales taxes payable
    
    
    1,996
    
    
    
    1,808Other accrued expenses
    
    
    6,966
    
    
    
    6,997Total
    
    $
    34,308
    
    
    $
    32,543
  Merchandise inventories that are not sold can normally be returned to the
suppliers. The allowance for cost of inventory returns represents
estimated costs related to merchandise returned or to be returned to
suppliers for which credit from the supplier is pending. Because the
amount of credit to be received requires estimates, it is reasonably
possible that our estimate of the ultimate settlement with our suppliers
may change in the near term.In the ordinary course of business, we accrue estimated amounts for
settlements with certain suppliers related to disputed merchandise
purchases and returns. Because the ultimate settlement amount requires
estimates, it is reasonably possible that our estimate of the ultimate
settlement with our suppliers may change in the near term. During fiscal
2003, we reduced merchandise cost of revenues by approximately $4.2
million, of which $2.1 million was recognized in the fourth quarter,
related to favorable differences between actual settlements with vendors as
compared to amounts accrued.  (5)
    
    Store Closing ReserveFrom time to time and in the normal course of business, we evaluate our
store base to determine if we need to close a store(s). Such evaluations
include consideration of, among other factors, current and future
profitability, market trends, age of store and lease status.Amounts in Accrued expenses and other current liabilities and Other
liabilities at January 31, 2004 and 2003 include accruals for the net
present value of future minimum lease payments, net of estimated sublease
income, and other costs attributable to closed or relocated stores.
Expenses related to store closings are included in selling, general and
administrative expenses in our consolidated statement of operations.Charges related to superstore closings in fiscal 2003 were not significant.Charges related to superstore closings in fiscal 2002 amounted to
approximately $2.4 million, of which $1.2 million was recorded in the
fourth quarter, including $1.1 million in accruals for the net present
value of minimum lease payments and $1.3 million for the write-off of
leasehold improvements and other assets. The fourth quarter charge of
$1.2 included $0.3 million in accruals for the net present value of future
minimum lease payments and $0.9 million for the write-off of leasehold
improvements and other assets.Offsetting these fiscal 2002 charges were changes in estimates in the store
closing reserve of approximately $2.0 million, of which $1.7 million was
recorded in the fourth quarter of fiscal 2002, primarily as a result of
sublease activities for certain closed and relocated superstores.Charges related to superstore closings in fiscal 2001 amounted to
approximately $1.5 million, including $0.6 million in accruals for the net
present value of minimum lease payments and $0.9 million for the write-off
of leasehold improvements and other assets. 39




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  The following table provides a rollforward of reserves that were
established for these charges for fiscal 2003, 2002 and 2001: Future LeasePayments
    
    Other Costs
    
    TotalBalance at January 31, 2001
    
    $
    6,350
    
    
    $
    255
    
    
    $
    6,605Additions to provision
    
    
    662
    
    
    
    
    
    
    
    662Changes in estimates
    
    
    108
    
    
    
    
    
    
    
    108Cash outlay, net
    
    
    (1,201
    )
    
    
    (242
    )
    
    
    (1,443
    )Balance at January 31, 2002
    
    
    5,919
    
    
    
    13
    
    
    
    5,932Additions to provision
    
    
    1,197
    
    
    
    217
    
    
    
    1,414Changes in estimates
    
    
    (1,930
    )
    
    
    
    
    
    
    (1,930
    )Cash outlay, net
    
    
    (2,228
    )
    
    
    (230
    )
    
    
    (2,458
    )Balance at January 31, 2003
    
    
    2,958
    
    
    
    
    
    
    
    2,958Additions to provision
    
    
    240
    
    
    
    150
    
    
    
    390Changes in estimates
    
    
    (5
    )
    
    
    
    
    
    
    (5
    )Cash outlay, net
    
    
    (1,178
    )
    
    
    (137
    )
    
    
    (1,315
    )Balance at January 31, 2004
    
    $
    2,015
    
    
    $
    13
    
    
    $
    2,028
  As of January 31, 2004, the reserve balance, which is net of estimated
sublease income, is expected to be paid over the next six years. Future
lease payments and other costs were charged against the reserve in fiscal
2003, 2002 and 2001, as incurred.  (6)
    
    Long-term DebtLong-term debt and capitalized lease obligations consisted of the
following: January 31,2004
    
    2003Revolving credit facility
    
    $
    29,011
    
    
    $
    45,683Capitalized lease obligations
    
    
    833
    
    
    
    1,02929,844
    
    
    
    46,712Less current maturities
    
    
    221
    
    
    
    193$
    29,623
    
    
    $
    46,519
  On December 9, 2003, we executed an amendment to our syndicated secured
Loan and Security Agreement with Fleet Retail Finance, Inc. and The CIT
Group/Business Credit, Inc, (the Facility). The amount outstanding under
the Facility is limited by a borrowing base predicated on eligible
inventory, as defined, and certain rental video assets, net of accumulated
depreciation less specifically defined reserves and is limited to a ceiling
of $80 million, less a $10 million availability reserve. The Facility
permits borrowings at various interest-rate options based on the prime rate
or London Interbank Offering Rate (LIBOR) plus applicable margin depending
upon the level of our minimum availability. The borrowing base under the
Facility is limited to an advance rate of 65% of eligible inventory and
certain rental video assets net of accumulated amortization less
specifically defined reserves, which can be adjusted to reduce availability
under the Facility. Lenders may increase specifically defined reserves to
reduce availability in the event of adverse changes in our industry that
are projected to impact the value of our assets pledged as collateral. The
Facility contains no financial covenants, restricts the payment of
dividends and includes certain other debt and acquisition limitations,
allows for the repurchase of up to $7.5 million of our common stock and
requires a minimum availability of $10 million at all times. The Facility
is secured by substantially all of the assets of the company 40




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  and our subsidiaries and is guaranteed by each of our three consolidated
subsidiaries. The Facility matures on August 29, 2007. At January 31, 2004, we had $32.7 million in excess
availability, after the $10 million availability reserve, under the
Facility. However, excess availability may be reduced in the future as
changes in the borrowing base occur or the lenders increase availability
reserves. At January 31, 2004 and 2003, respectively, we had borrowings
outstanding of $29.0 million and $45.7 million under the Facility. The
average rate of interest being charged under the Facility for fiscal years
ending January 31, 2004 and 2003 was 3.8% and 4.1%, respectively.We utilize standby letters of credit to support certain insurance policies.
The aggregate amount of the letters of credit at January 31, 2004 was
approximately $1.0 million and reduces the excess availability of the
Facility.From time to time, we enter into interest rate swap agreements in order to
obtain a fixed interest rate on a portion of our outstanding floating rate
debt, thereby reducing our exposure to interest rate volatility. On
October 4, 2002, we cancelled, at no cost, two swap agreements entered into
in November and December of 2001 with an aggregate notional amount of $20
million and replaced those agreements with one interest rate swap agreement
with a financial institution that expires October 1, 2004. The notional
amount of the swap is $20 million with a fixed interest rate of 2.45%. We
have designated the interest rate swap as a hedging instrument. At January
31, 2004, the fair value of the interest rate swap was not significant.The capitalized lease obligations represent two leases on certain retail
space with initial terms of 15 years.The aggregate maturities of long-term debt and capitalized lease
obligations for years subsequent to fiscal 2003 are as follows: 2004
    
    $
    2212005
    
    
    2432006
    
    
    1952007
    
    
    29,1202008
    
    
    65Thereafter
    
    
    $
    29,844
  (7)
    
    LeasesWe lease retail space under operating leases with terms ranging from three
to 15 years, with certain leases containing renewal options. Lease
agreements generally provide for minimum rentals. Some leases also include
additional contingent rental amounts based upon specified percentages of
sales above predetermined levels. Rental expense for operating leases is
comprised of the following: Fiscal Year2003
    
    2002
    
    2001Minimum rentals
    
    $
    19,314
    
    
    $
    18,007
    
    
    $
    17,155Contingent rentals
    
    
    855
    
    
    
    1,434
    
    
    
    1,519Less sublease income
    
    
    (81
    )
    
    
    (52
    )
    
    
    (95
    )Rental expense
    
    $
    20,088
    
    
    $
    19,389
    
    
    $
    18,579
 41




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  Future minimum lease payments under non-cancelable operating leases and the
present value of future minimum capital lease payments as of January 31,
2004 are: Capital
    
    Operatingleases
    
    leases2004
    
    $
    280
    
    
    $
    22,0612005
    
    
    283
    
    
    
    20,7262006
    
    
    216
    
    
    
    18,9402007
    
    
    120
    
    
    
    16,7862008
    
    
    70
    
    
    
    14,192Thereafter
    
    
    
    
    
    
    51,909Total minimum lease payments
    
    
    969
    
    
    
    144,614Less sublease income
    
    
    
    
    
    
    3,847Net minimum lease payments under
operating leases
    
    
    
    
    
    $
    140,767Less amount representing imputed interest
    
    
    136Total obligations under capital leases
    
    
    833Less current principal maturities of capital
lease obligations
    
    
    221Obligations under capital leases,
excluding current maturities
    
    $
    612
  A director of the Company is a limited partner in various limited
partnerships that lease land and improvements to us under certain lease
agreements. During fiscal 2003, 2002 and 2001, we made lease payments of
$0.6 million, $0.5 million and $0.6 million, respectively related to these
lease agreements.  (8)
    
    Income TaxesIncome tax expense (benefit) is comprised of the following: Fiscal Year2003
    
    2002
    
    2001Current federal
    
    $
    14
    
    
    $
    (287
    )
    
    $
    283Current state and local
    
    
    352
    
    
    
    (29
    )
    
    
    8Deferred federal
    
    
    (1,867
    )
    
    
    287
    
    
    
    (264
    )Deferred state and local
    
    
    (187
    )
    
    
    29
    
    
    
    (27
    )$
    (1,688
    )
    
    $
    
    
    
    $
    
 42




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  The difference between expected federal income tax expense (benefit)
(computed by applying the statutory rate of 34% to income before income
taxes) and actual income tax expense (benefit) is as follows: Fiscal Year2003
    
    2002
    
    2001Computed expected income tax expense
(benefit)
    
    $
    2,061
    
    
    $
    643
    
    
    $
    1,366State and local income taxes, net of
federal income tax effect
    
    
    564
    
    
    
    66
    
    
    
    141Other
    
    
    123
    
    
    
    
    
    
    
    Changes in valuation allowance
    
    
    (4,436
    )
    
    
    (709
    )
    
    
    (1,507
    )$
    (1,688
    )
    
    $
    
    
    
    $
    
  The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are
presented below: January 31,2004
    
    2003Deferred tax assets:Gift cards
    
    $
    984
    
    
    $
    816Abandoned leases
    
    
    781
    
    
    
    1,259Deferred rent
    
    
    601
    
    
    
    581Compensated absences
    
    
    373
    
    
    
    387Deferred compensation
    
    
    400
    
    
    
    400Deferred lease incentives
    
    
    816
    
    
    
    799Inventories
    
    
    181
    
    
    
    2,376Net operating loss carryforward
    
    
    1,749
    
    
    
    684Other
    
    
    696
    
    
    
    1,017Total deferred tax assets
    
    
    6,581
    
    
    
    8,319Valuation allowance
    
    
    
    
    
    
    (4,436
    )Deferred tax assets, net of valuation allowance
    
    
    6,581
    
    
    
    3,883Deferred tax liabilities:Property and equipment
    
    
    (3,556
    )
    
    
    (2,912
    )Total deferred tax liabilities
    
    
    (3,556
    )
    
    
    (2,912
    )Net deferred tax assets
    
    $
    3,025
    
    
    $
    971
  Based on our past three fiscal years of profitability and our belief that
existing and projected levels of pre-tax income are sufficient to generate
the minimum amount of future taxable income necessary to realize the
deferred tax asset, we believe that the realization of our deferred tax
asset is now considered more likely than not and a valuation allowance is
no longer required as of January 31, 2004.  As of January 31, 2004, we had available $4.5 million of net tax operating
loss carryforwards for federal income tax purposes. These carryforwards,
which may provide future tax benefits, expire in 2023. Based on the
periods in which taxable temporary differences are anticipated to reverse,
management believes it is more likely than not that we will realize the
benefits of these deductible differences, including the net operating loss
carryforwards existing at January 31, 2004. 43




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (9)
    
    Income per shareThe computations of basic and diluted income per share are as follows: Fiscal Year2003
    
    2002
    
    2001Net income
    
    $
    7,750
    
    
    $
    1,891
    
    
    $
    4,017Average shares outstanding:Basic
    
    
    11,327
    
    
    
    11,343
    
    
    
    11,742Effect of stock options
    
    
    156
    
    
    
    436
    
    
    
    156Diluted
    
    
    11,483
    
    
    
    11,779
    
    
    
    11,898Income per share:Basic
    
    $
    0.68
    
    
    $
    0.17
    
    
    $
    0.34Diluted
    
    $
    0.68
    
    
    $
    0.16
    
    
    $
    0.34
  Options to purchase 771,800 shares of Common Stock at exercise prices
ranging from $3.95 to $14.03 per share outstanding at January 31, 2004;
798,270 shares of Common Stock at exercise prices ranging from $6.595 per
share to $14.03 per share outstanding at January 31, 2003; and 521,974
shares of Common Stock at exercise prices ranging from $4.30 per share to
$14.03 per share outstanding at January 31, 2002, were not included in the
computation of diluted income per share because their inclusion would have
been antidilutive.  (10)
    
    401k and ASOPOur 401k plan permits full-time employees who have attained age 21 and
part-time employees who have worked a minimum of 1,000 hours in a year and
have attained age 21 to participate in the 401k plan and elect to
contribute up to 25% of their salary, subject to federal limitations, to
the plan. Employer contributions include a quarterly guaranteed match of
25% of employee contributions up to a maximum of 6% deferral of
compensation and are allocated solely to those employees who are
participating in the plan and are employed on the last day of the plan
quarter. Also included is a discretionary match based on specific criteria
reviewed every fiscal six-month period by management and approved by the
Board of Directors. This discretionary match is allocated solely to those
employees who are participating in the plan and are employed on the last
day of the six-month period.  Our Associate Stock Ownership Plan (ASOP) permits employees who have
attained age 21 and completed one year of service and 1,000 hours in 12
consecutive months for part-time associates, to participate in the ASOP.
Employer contributions are determined at the discretion of management. The
Board of Directors has determined that the level of contributions will be
made based on attaining operational profit goals as set by the Board of
Directors. The contribution is based on a percentage of participants
eligible compensation. Common shares held by the ASOP were 385,252,
318,084, and 271,368 at January 31, 2004, 2003 and 2002, respectively.
Shares issued and held under the ASOP plan are included as outstanding shares
for the purposes of calculating income per share.  Amounts expensed related to the 401k and ASOP Plans were $1.5 million, $0.6
million, and $0.3 million during fiscal 2003, 2002 and 2001, respectively.  (11)
    
    Shareholders EquityWe have six stock option plans: the 1991 and 1994 Stock Option Plans, the
1996 and 2002 Incentive Stock Plan and the 1996 and 2002 Outside Directors
Plan (for non-employee directors). A total of 505,900 shares 44




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  may be granted under each of the 1991 and 1994 Stock Option Plans, 632,375 shares
may be granted under the 1996 Incentive Stock Plan, 500,000 shares
may be granted under the 2002 Incentive Stock Plan, 101,180 shares may be
granted under the 1996 Outside Directors Plan and 100,000 shares may be
granted under the 2002 Outside Directors Plan. As of January 31, 2004, we
had 616,481 options available for future issuances under stock option
plans.  The 1991 and 1994 Stock Option Plans and the 1996 and 2002 Incentive Stock
Plan authorize the award of both incentive stock options and non-qualified
stock options to purchase common stock to officers, other associates and
directors of the Company. The exercise price per share of incentive stock
options may not be less than the market price of our common stock on the
date the option is granted. The exercise price per share of non-qualified
stock options is determined by the Board of Directors or a committee
thereof. The term of each option is determined by the Board of Directors
and generally will not exceed ten years from the date of grant. In
general, each option award vests at 20% per year over five years.  The 1996 Incentive Stock Plan also authorizes the granting of stock
appreciation rights, restricted stock, dividend equivalent rights, stock
awards, and other stock-based awards to officers, other associates,
directors, and consultants of the Company. There have been no grants of
these awards under this plan.  We also have a management stock purchase plan that authorizes the issuance
of up to 227,655 shares of common stock, pursuant to agreements providing
for the purchase of restricted stock units (RSUs). The cost of each RSU
is equal to 75% of the fair market value of the common stock of the Company
on the date the RSU is awarded. During fiscal years 2003, 2002 and 2001,
there were 0, 0 and 1,104 RSUs awarded under the Plan, respectively.
Compensation expense is then recognized using the straight-line method over
three years, which is the vesting period of the RSUs. Under this
methodology, we recorded approximately $218, $1,900 and $7,200 of
compensation expense in fiscal year 2003, 2002 and 2001 respectively. As
of January 31, 2004, 2003 and 2002, there were 552, 2,054 and 10,193 RSUs
outstanding under the plan, respectively.  A summary of information with respect to all stock option plans is as
follows: Weighted-averageexercisepriceOptions
    
    (in dollars)Outstanding at January 31, 2001
    
    
    1,087,083
    
    
    
    7.39Granted
    
    
    678,344
    
    
    
    2.91Exercised
    
    
    (107,017
    )
    
    
    4.40Forfeited and expired
    
    
    (63,125
    )
    
    
    7.66Outstanding at January 31, 2002
    
    
    1,595,285
    
    
    
    5.68Granted
    
    
    353,210
    
    
    
    6.66Exercised
    
    
    (99,090
    )
    
    
    3.47Forfeited and expired
    
    
    (94,066
    )
    
    
    6.23Outstanding at January 31, 2003
    
    
    1,755,339
    
    
    $
    5.97Granted
    
    
    367,779
    
    
    
    3.42Exercised
    
    
    (75,137
    )
    
    
    3.12Forfeited and expired
    
    
    (130,529
    )
    
    
    4.20Outstanding at January 31, 2004
    
    
    1,917,452
    
    
    $
    5.71Options available for grant at January 31, 2004
    
    
    616,481
 45




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##### Table of Contents



Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  At January 31, 2004, the options outstanding and options exercisable, and
their related weighted-average exercise price, and the weighted-average
remaining contractual life for the ranges of exercise prices are shown in
the table below. Weighted-
    
    Weighted-average
    
    averageexercise price
    
    remainingOptions
    
    (in dollars)
    
    contractual lifeRange: $1.27 to $4.99Options outstanding at January 31, 2004
    
    
    1,153,182
    
    
    $
    3.18
    
    
    7.61 yearsOptions exercisable at January 31, 2004
    
    
    345,181
    
    
    $
    3.13Range: $5.00 to $9.99Options outstanding at January 31, 2004
    
    
    297,860
    
    
    $
    6.79
    
    
    7.56 yearsOptions exercisable at January 31, 2004
    
    
    74,662
    
    
    $
    7.04Price: $10.00 to $14.03Options outstanding at January 31, 2004
    
    
    466,410
    
    
    $
    11.27
    
    
    2.95 yearsOptions exercisable at January 31, 2004
    
    
    466,410
    
    
    $
    11.27
  At January 31, 2004, 2003 and 2002, the number of options exercisable was
886,253, 704,121 and 615,823, respectively, and the weighted-average
exercise price of those options was $7.75, $8.55 and $9.59, respectively.  We apply APB 25 and related interpretations in accounting for our Plans and
since we generally grant stock options, except for RSUs as described above,
with an exercise price equal to or greater than the current market price of
the stock on the grant date, compensation expense is not recorded.  The per share weighted-average exercise price and the per share
weighted-average fair value of stock options at the date of grant, using
the Black-Scholes option-pricing model for SFAS 123 disclosure purposes, is
as follows (in dollars): Weighted Average Exercise price for
    
    Weighted Average Fair value forFiscal Year
    
    Fiscal Year2003
    
    2002
    
    2001
    
    2003
    
    2002
    
    2001Options granted at
market price
    
    $
    3.41
    
    
    $
    6.61
    
    
    $
    2.90
    
    
    $
    2.13
    
    
    $
    3.37
    
    
    $
    1.98Options granted at
prices exceeding
market price
    
    $
    3.72
    
    
    $
    7.30
    
    
    $
    3.30
    
    
    $
    0.08
    
    
    $
    0.18
    
    
    $
    0.06Options granted at
prices below market
price
    
    $
    
    
    
    $
    
    
    
    $
    1.81
    
    
    $
    
    
    
    $
    
    
    
    $
    1.54Total options granted
    
    $
    3.42
    
    
    $
    6.66
    
    
    $
    2.91
    
    
    $
    2.12
    
    
    $
    3.31
    
    
    $
    1.96
 The following assumptions were used in the calculation of fair value: Fiscal Year2003
    
    2002
    
    2001Expected dividend yield
    
    $
    
    
    
    
    
    
    
    
    Risk-free interest rate
    
    
    3.24
    %
    
    
    3.00
    %
    
    
    6.17
    %Expected life in years
    
    
    4.96
    
    
    
    4.81
    
    
    
    4.78Volatility
    
    
    .74
    
    
    
    .57
    
    
    
    .82
 46




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (12)
    
    Supplemental Cash Flow InformationCash payments for interest during fiscal 2003, 2002 and 2001 totaled $2.1
million, $2.0 million and $2.1 million, respectively. Cash payments for
income taxes during fiscal 2003, 2002 and 2001 totaled $0.2 million,
$26,000 and $0.5 million, respectively.(13)
    
    Litigation and ContingenciesIn 2000, we restated our consolidated financial statements for the first
three quarters of fiscal 1999 and the prior four fiscal years. As a
result, lawsuits were filed against us and certain of our current and
former directors and officers asserting various claims under Sections 10(b)
and 20(a) of the Securities Exchange Act of 1934. We agreed to settle
these lawsuits, and the settlement received final approval by the court on
March 10, 2003. The settlement required a payment of $5.75 million on
behalf of the defendants in the lawsuits ($3.15 million of which was funded
from amounts remaining under our director and officer insurance policy
after the payment of litigation expenses). The settlement resolves all
claims against us and our current and former defendant officers and
directors. Based on the foregoing, we recorded loss contingencies of $2.5
million, or $0.22 per share, and $0.1 million, or $0.00 per share, during
the second and fourth fiscal quarters of fiscal 2002, respectively. All
amounts required by the settlement agreement were funded by January 31,
2003.We are also involved in various other claims and legal actions arising in
the ordinary course of business. In the opinion of management, the
ultimate disposition of these matters will not have a material adverse
effect on our financial position, results of operations and cash flows.
Recently, we were named as defendants in a complaint filed in Texas
alleging that our late fees for movie and game rentals are illegal under
the Uniform Commercial Code. While we intend to vigorously defend this
matter and are hopeful of a favorable result, the ultimate outcome of this
matter cannot be estimated at this time. 47




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Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted)  (14)
    
    Segment DisclosuresWe have two operating segments, retail stores and Internet operations. Our
chief operating decision maker, as that term is defined in the relevant
accounting standard, regularly reviews financial information about each of
the above operating segments for assessing performance and allocating
resources. Revenue for retail stores is derived from the sale of
merchandise and rental of videocassettes, video games and DVDs. Revenue
for Internet operations is derived solely from the sale of merchandise.
Segment information regarding our retail stores and Internet operations for
fiscal years 2003, 2002 and 2001 is presented below. Retail
    
    InternetFiscal year 2003
    
    Stores
    
    Operations
    
    TotalTotal revenue
    
    $
    507,990
    
    
    $
    328
    
    
    $
    508,318Depreciation expense
    
    
    39,653
    
    
    
    160
    
    
    
    39,813Operating income (loss)
    
    
    8,627
    
    
    
    (841
    )
    
    
    7,786Total assets
    
    
    236,066
    
    
    
    182
    
    
    
    236,248Capital expenditures
    
    $
    53,408
    
    
    $
    48
    
    
    $
    53,456
 Retail
    
    InternetFiscal year 2002
    
    Stores
    
    Operations
    
    TotalTotal revenue
    
    $
    495,113
    
    
    $
    281
    
    
    $
    495,394Depreciation expense
    
    
    39,966
    
    
    
    257
    
    
    
    40,223Operating income (loss)
    
    
    3,424
    
    
    
    (1,074
    )
    
    
    2,350Total assets
    
    
    237,308
    
    
    
    214
    
    
    
    237,522Capital expenditures
    
    $
    64,640
    
    
    $
    24
    
    
    $
    64,664
 Retail
    
    InternetFiscal year 2001
    
    Stores
    
    Operations
    
    TotalTotal revenue
    
    $
    471,482
    
    
    $
    166
    
    
    $
    471,648Depreciation expense
    
    
    35,116
    
    
    
    277
    
    
    
    35,393Operating income (loss)
    
    
    6,810
    
    
    
    (955
    )
    
    
    5,855Total assets
    
    
    229,383
    
    
    
    468
    
    
    
    229,851Capital expenditures
    
    $
    46,490
    
    
    $
    5
    
    
    $
    46,495
 48




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##### Table of Contents



Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2004 and 2003
(Tabular amounts in thousands, except per share data or unless otherwise noted) (15) Interim Financial Results (Unaudited) Fiscal year 2003: QuarterFirst
    
    Second
    
    Third
    
    FourthTotal revenues
    
    $
    116,837
    
    
    $
    115,397
    
    
    $
    112,843
    
    
    $
    163,241Total cost of revenues
    
    
    78,384
    
    
    
    74,911
    
    
    
    74,442
    
    
    
    109,045Selling, general and administrative expenses
    
    
    38,976
    
    
    
    39,789
    
    
    
    41,684
    
    
    
    43,024Pre-opening expenses
    
    
    113
    
    
    
    68
    
    
    
    53
    
    
    
    43Operating income (loss)
    
    
    (636
    )
    
    
    629
    
    
    
    (3,336
    )
    
    
    11,129Interest (expense) and other income, net
    
    
    (432
    )
    
    
    (441
    )
    
    
    (474
    )
    
    
    (377
    )Income (Loss) before taxes
    
    
    (1,068
    )
    
    
    188
    
    
    
    (3,810
    )
    
    
    10,752Income tax benefit (a)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,688
    )Net income (loss)
    
    
    (1,068
    )
    
    
    188
    
    
    
    (3,810
    )
    
    
    12,440Basic income (loss) per share
    
    $
    (0.09
    )
    
    $
    0.02
    
    
    $
    (0.34
    )
    
    $
    1.10Diluted income (loss) per share
    
    $
    (0.09
    )
    
    $
    0.02
    
    
    $
    (0.34
    )
    
    $
    1.07
 Fiscal year 2002: QuarterFirst
    
    Second
    
    Third
    
    FourthTotal revenues
    
    $
    112,845
    
    
    $
    115,038
    
    
    $
    110,636
    
    
    $
    156,875Total cost of revenues
    
    
    75,237
    
    
    
    76,966
    
    
    
    76,592
    
    
    
    105,746Selling, general and administrative expenses (b) (d)
    
    
    36,583
    
    
    
    40,331
    
    
    
    40,117
    
    
    
    40,993Pre-opening expenses
    
    
    18
    
    
    
    163
    
    
    
    150
    
    
    
    148Operating income (loss)
    
    
    1,007
    
    
    
    (2,422
    )
    
    
    (6,223
    )
    
    
    9,988Interest (expense) and other income, net (c)
    
    
    (438
    )
    
    
    800
    
    
    
    (404
    )
    
    
    (417
    )Income (Loss) before taxes
    
    
    569
    
    
    
    (1,622
    )
    
    
    (6,627
    )
    
    
    9,571Income tax expense (benefit)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    569
    
    
    
    (1,622
    )
    
    
    (6,627
    )
    
    
    9,571Basic income (loss) per share
    
    $
    0.05
    
    
    $
    (0.14
    )
    
    $
    (0.58
    )
    
    $
    0.84Diluted income (loss) per share
    
    $
    0.05
    
    
    $
    (0.14
    )
    
    $
    (0.58
    )
    
    $
    0.82
  (a)
    
    The results for fiscal year 2003 reflect an income tax benefit of
approximately $1.7 million, or $0.15 per diluted share, primarily due to
the reversal of a valuation allowance of approximately $4.4 million
previously applied against our deferred tax assets. Based on our past
three fiscal years of profitability and our projections of future taxable
income, we believe that a valuation allowance is no longer required as of
January 31, 2004 as the realization of our deferred tax assets is now
considered more likely than not.(b)
    
    We recorded a pre-tax charge of $2.6 million, $2.5 of which was recorded
in the second quarter of fiscal 2002 and $0.1 million in the fourth
quarter of fiscal 2002, related to the settlement of the shareholder class
action lawsuits as described in Note 13.(c)
    
    We recorded interest income of approximately $1.3 million in the second
quarter of fiscal 2002 as a result of interest earned on income tax
refunds for amended returns filed for fiscal years 1995 through 1998.(d)
    
    We recorded pre-tax charges of approximately $1.2 million in each the
third and fourth quarter of fiscal 2002 related to the closing of
superstores as described in Note 5. 49




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##### Table of Contents



ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None 
 ITEM 9A. CONTROLS AND PROCEDURES As required by Exchange Act Rules 13a-15 and 15d-15, an evaluation was
conducted under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of January 31, 2004, and based on this evaluation our Chief
Executive Officer and Chief Financial Officer have concluded that our
disclosure controls and procedures were effective as of such date to ensure
that information required to be disclosed by us in our reports filed or
submitted under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the SECs rules and forms. There has not been any change in our internal control over financial reporting
during the period covered by this report that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting. 50




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##### Table of Contents



PART III 
 ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item will be set forth in our Proxy Statement
for our 2004 Annual Meeting of Shareholders, to be filed within 120 days after
the end of fiscal 2003 (our Proxy Statement), under the heading Proposal No.
1: Election of One Director, which information is incorporated herein by
reference. The information required by this item regarding our executive
officers is set forth under the heading Executive Officers of the Company in
Part I of this Form 10-K, which information is incorporated herein by
reference. Section 16(a) Beneficial Ownership Reporting Compliance The information required by this item regarding compliance with Section 16(a)
of the Securities Exchange Act of 1934 will be set forth in our Proxy Statement
under the heading Compliance with Section 16(a) of the Securities Exchange Act
of 1934, which is incorporated herein by reference. Code of Ethics and Other Corporate Governance Information Information regarding our Code of Ethics and the name of the individual
determined by the board to be the audit committee financial expert is
included in our Proxy Statement, under the heading Proposal No. 1: Election of
One Director, which information is incorporated herein by reference. 
 ITEM 11. EXECUTIVE COMPENSATION The information required by this item will be set forth in our Proxy Statement
under the headings Executive Compensation,
Executive Compensation - Director
Compensation, Executive Compensation - Employee Contracts and Change of
Control Arrangements, and Executive Compensation - Compensation Committee
Interlocks and Insider Participation, which information is incorporated herein
by reference. 
 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this item will be set forth in our Proxy Statement
under the headings, Security Ownership of Certain Beneficial Owners and
Management and Equity Compensation Plan Information, which information is
incorporated herein by reference. 
 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item will be set forth in our Proxy Statement
under the heading Certain Relationships and Related Transactions, which
information is incorporated herein by reference. 
 ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this item will be set forth in our Proxy Statement
under the heading Principal Accountant Fees and Services, which information
is incorporated herein by reference. 51




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##### Table of Contents



PART IV 
 ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K  (a)
    
    1. The following consolidated financial statements of the Company are
included in Part II, Item 8: Independent Auditors Reports
    
    
    29Consolidated Balance Sheets as of January 31, 2004 and 2003
    
    
    30Consolidated Statements of Operations for the years ended
January 31, 2004, 2003 and 2002
    
    
    31Consolidated Statements of Shareholders Equity for the years
ended January 31, 2004, 2003 and 2002
    
    
    32Consolidated Statements of Cash Flows for the years ended
January 31, 2004, 2003 and 2002
    
    
    33Notes to Consolidated Financial Statements
    
    
    34
  2.
    
    The following financial statement schedules and other information
required to be filed by Items 8 and 15(d) of Form 10-K are
included in Part IV: Schedule II  Valuation and Qualifying Accounts
    
    
    54
 All other schedules are omitted because they are not applicable, not
required or the required information is included in the Consolidated
Financial Statements and notes thereto.  3.
    
    The following exhibits are filed herewith or incorporated by
reference as indicated as required by Item 601 of Regulation S-K. The
exhibits designated by an asterisk are management contracts and/or
compensatory plans or arrangements required to be filed as exhibits to
this report. ExhibitNumber
    
    
    
    
    
    
    
    Description3.1
    
    
    
    
    (1
    )
    
    Third Restated Articles of Incorporation of the Company.3.2
    
    
    
    
    (1
    )
    
    Amended and Restated Bylaws of the Company.4.1
    
    
    
    
    (2
    )
    
    Specimen of Certificate of Common Stock of the Company.4.2
    
    
    
    
    (1
    )
    
    Third Restated Articles of Incorporation of the Company (see 3.1 above).4.3
    
    
    
    
    (1
    )
    
    Amended and Restated Bylaws of the Company (see 3.2 above).10.1
    
    
    
    
    (1
    )
    
    Form of Indemnification Agreement by and between the Company and its
directors and executive officers.10.2
    
    *
    
    
    (1
    )
    
    Hastings Amended 1996 Incentive Stock Plan.10.3
    
    *
    
    
    (2
    )
    
    Hastings 1994 Stock Option Plan.10.4
    
    *
    
    
    (2
    )
    
    Hastings 1991 Stock Option Plan.10.5
    
    *
    
    
    (1
    )
    
    Hastings Entertainment, Inc. Associates 401(k) Plan and Trust.10.6
    
    *
    
    
    (1
    )
    
    Hastings Employee Stock Ownership Plan Trust Agreement.10.7
    
    *
    
    
    (2
    )
    
    Chief Executive Officer Stock Option, as amended.10.8
    
    *
    
    
    (1
    )
    
    Corporate Officer Incentive Plan.10.9
    
    *
    
    
    (1
    )
    
    Management Stock Purchase Plan.10.10
    
    *
    
    
    (1
    )
    
    Management Incentive Plan.10.11
    
    *
    
    
    (1
    )
    
    Salary Incentive Plan.10.12
    
    *
    
    
    (1
    )
    
    Hastings Entertainment, Inc. Stock Option Plan for Outside Directors.10.13
    
    *
    
    
    (3
    )
    
    Agreement, dated January 31, 2001 between John H. Marmaduke and the Company10.14
    
    
    
    
    (4
    )
    
    Lease Agreement, dated August 3, 1994, as amended, between Omni Capital Corporation and the Company, for
warehouse space located at Sunset Center in Amarillo, Texas.10.15
    
    
    
    
    (1
    )
    
    Lease Agreement, dated May 28, 1992, between the City of Amarillo and the Company for space located at 1900 W.
7th Avenue in Amarillo, Texas.10.16
    
    *
    
    
    (2
    )
    
    Stock Grant Plan for Outside Directors.10.17
    
    *
    
    
    (2
    )
    
    Form of Employment Agreement by and between the Company and certain of its executives.
 52




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##### Table of Contents



ExhibitNumber
    
    
    
    
    
    
    
    Description10.18
    
    
    
    
    (5
    )
    
    Amended Lease Agreement, dated October 13, 1999, between Omni Capital Corporation and the Company, for office
space located at Sunset Center in Amarillo, Texas.10.19
    
    
    
    
    (6
    )
    
    Loan and Security Agreement, dated August 29, 2000 between Hastings Entertainment, Inc. and Fleet Retail
Finance, Inc., Agent.10.20
    
    
    
    
    (7
    )
    
    International Swap Dealers Association, Inc. Master Agreement between Hastings Entertainment, Inc. and Fleet
National Bank.10.21
    
    
    
    
    (8
    )
    
    Amended Loan and Security Agreement, dated December 9, 2003, between Hastings Entertainment, Inc. and Fleet
Retail Finance, Inc., Agent.21.1
    
    
    
    
    (2
    )
    
    Subsidiaries of the Company.23.1
    
    
    
    
    (8
    )
    
    Consent of Ernst and Young LLP.24.1
    
    
    
    
    (8
    )
    
    Powers of Attorney (included on signature page).31.1
    
    
    
    
    (8
    )
    
    Certification of Chief Executive Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a).31.2
    
    
    
    
    (8
    )
    
    Certification of Chief Financial Officer of Registrant Pursuant to SEC Rule 13a-14(a)/15d-14(a).32.1
    
    
    
    
    (8
    )
    
    Certification of Chief Executive Officer and Chief Financial Officer of Registrant Pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
   (1)
    
    Previously filed as an exhibit to the Companys Registration
Statement on Form S-1, dated March 18, 1998 (File No. 333-47969) and
with a corresponding exhibit number herein and are incorporated
herein by reference.(2)
    
    Previously filed as an exhibit to the Companys Registration
Statement on Form S-1/A, dated May 19, 1998 (File No. 333-47969) and
with a corresponding exhibit number herein and are incorporated
herein by reference.(3)
    
    Previously filed as an exhibit to the Companys Annual Report
on Form 10-K for the fiscal year ended January 31, 2001, and
incorporated herein by reference.(4)
    
    Previously filed as an exhibit to the Companys Registration
Statement on Form S-1/A, dated June 11, 1998 (File No. 333-47969)
and with a corresponding exhibit number herein and are incorporated
herein by reference.(5)
    
    Previously filed as an exhibit to the Companys Annual Report
on Form 10-K, as amended, for the fiscal year ended January 31,
2000, and incorporated herein by reference.(6)
    
    Previously filed as an exhibit to the Companys Quarterly
Report on Form 10-Q, as amended, for the quarterly period ended July
31, 2000, and incorporated herein by reference.(7)
    
    Previously filed as an exhibit to the Companys Annual Report
on Form 10-K for the fiscal year ended January 31, 2002, and
incorporated herein by reference.(8)
    
    Filed herewith.  (b)
    
    Reports on Form 8-K  (i)
    
    On December 2, 2003, we filed a current report on Form 8-K
reporting, under Item 12. Results of Operations and Financial
Condition, that we had announced, among other things, our results for
the third fiscal quarter ended October 31, 2003.(ii)
    
    On January 7, 2004, we filed a current report on Form 8-K
reporting, under Item 5. Other Events, the disclosure of financial
estimates in conjunction with presentations to certain broker/dealers. 53




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##### Table of Contents



Financial Statement Schedule II - HASTINGS ENTERTAINMENT, INC.
Valuation and Qualifying Accounts and Reserves
Years Ended January 31, 2004, 2003 and 2002
(Amounts in thousands) Fiscal Year2003
    
    2002
    
    2001Reserves deducted from assets:Allowance for shrinkage and inventory
obsolescence:Balance at the beginning of period
    
    $
    3,884
    
    
    $
    4,580
    
    
    $
    3,533Additions charged to costs and expenses
    
    
    10,799
    
    
    
    10,697
    
    
    
    14,308Deductions for write-offs
    
    
    (11,278
    )
    
    
    (11,393
    )
    
    
    (13,261
    )Balance at end of period
    
    $
    3,405
    
    
    $
    3,884
    
    
    $
    4,580Reserves added to liabilities:Allowance for costs of inventory returns:Balance at the beginning of period
    
    $
    4,729
    
    
    $
    5,128
    
    
    $
    7,543Additions
charged to costs and expenses (1)
    
    
    5,044
    
    
    
    6,766
    
    
    
    3,858Deductions
for write-offs and payments
    
    
    (6,115
    )
    
    
    (7,165
    )
    
    
    (6,273
    )Balance at end of period
    
    $
    3,658
    
    
    $
    4,729
    
    
    $
    5,128
  (1)
    
    Total returns expense was $5.9 million, $9.9 million and $6.3 million for
the fiscal years 2003, 2002 and 2001, respectively. The table does not
include the cost of operating our return center ($3.9 million, $3.9
million and $2.4 million for the fiscal years 2003, 2002 and 2001,
respectively), which is recorded directly to returns expense. 54




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##### Table of Contents



SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, on behalf of the registrant, thereunto duly
authorized: HASTINGS ENTERTAINMENT, INC.Date:April 16, 2004
    By:
    /s/ Dan CrowDan CrowVice President and Chief Financial Officer
(Principal Financial and Accounting Officer) POWER OF ATTORNEY Each person whose signature appears below hereby authorizes and constitutes
John H. Marmaduke and Dan Crow, and each of them singly, his true and lawful
attorneys-in-fact with full power of substitution and redistribution, for him
and in his name, place and stead, in any and all capacities to sign and file
any and all amendments to this report with all exhibits thereto and other
documents in connection therewith, with the Securities and Exchange Commission,
and he hereby ratifies and confirms all that said attorneys-in-fact or any of
them, or their substitutes, may lawfully do or cause to be done by virtue
hereof. Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated. Signature
    
    Title
    
    Date/s/ John H. Marmaduke

John H. Marmaduke
    
    Chairman of the Board, President and Chief
Executive Officer (Principal Executive Officer)
    
    April 3, 2004/s/ Peter A. Dallas

Peter A. Dallas
    
    Director
    
    April 3, 2004/s/ Gaines L. Godfrey

Gaines L. Godfrey
    
    Director
    
    April 3, 2004/s/ Daryl L. Lansdale

Daryl L. Lansdale
    
    Director
    
    April 3, 2004/s/ Ann S. Lieff

Ann S. Lieff
    
    Director
    
    April 3, 2004/s/ Stephen S. Marmaduke

Stephen S. Marmaduke
    
    Director
    
    April 3, 2004/s/ Frank O. Marrs

Frank O. Marrs
    
    Director
    
    April 3, 2004/s/ Jeffrey G. Shrader

Jeffrey G. Shrader
    
    Director
    
    April 3, 2004/s/ Ron G. Stegall

Ron G. Stegall
    
    Director
    
    April 3, 2004
 55