HASTINGS ENTERTAINMENT INC - 10-K Annual Report

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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, 2002

OR

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF SECURITIES
EXCHANGE ACT OF 1934

For the transition period from ________________ to ________________

COMMISSION FILE NUMBER: 000-24381

HASTINGS ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)

TEXAS 75-1386375
(State or other jurisdiction of (IRS Employer
incorporation 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 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. [ ]

The aggregate market value of the voting stock held by non-affiliates of the
registrant was approximately $46,298,867 based upon the closing market price of
$7.89 per share of Common Stock on the Nasdaq National Market as of March 28,
2002. (For the purposes of determination of the above-stated amounts, only the
directors, executive officers and 5% or greater shareholders of the registrant
have been deemed affiliates.)

Number of shares of $.01 par value Common Stock outstanding as of March 28,
2002: 11,300,531

(Cover page 1 of 2)

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the annual meeting of shareholders of the
registrant to be held during 2002 are incorporated by reference into Parts II
and III of this Form 10-K.

(Cover page 2 of 2)

2

HASTINGS ENTERTAINMENT, INC.
FORM 10-K ANNUAL REPORT
FOR THE FISCAL YEAR ENDED JANUARY 31, 2002

INDEX

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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, effects of the adoption of Statement of
Financial Accounting Standards Nos. 137, 138, 142 and 144, the impact on our
financial statements of any adjustment to fair value of interest rate swaps, the
outcome of securities litigation, inflation, effect of critical accounting
policies including lower of cost or market for inventory adjustments, the
returns process, rental video amortization and our store closing reserve 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. and or the markets in which we operate our superstores, our success in
forecasting customer demand for products, and legal proceedings (see discussion
of Legal Proceedings in Part I, Item 3 of this Form 10-K for the fiscal year
ended January 31, 2002 and subsequent SEC filings) 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 that
combines the sale of books, music, software, periodicals, videocassettes, video
games, DVDs, used products including CDs, DVDs and video games, video game
consoles and DVD players with the rental of videocassettes, video games, DVDs,
video game consoles and DVD players in a superstore format. As of March 28,
2002, we operated 141 superstores in small- to medium-sized markets located in
21 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 operating segments, retail stores and Internet operations. We operate three
wholly owned subsidiaries; Hastings Properties, Inc., Hastings Internet, Inc.
and Hastings College Stores, Inc. 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, 2002 is referred to as fiscal
2001.

On March 7, 2000, we announced that our fourth quarter and fiscal 1999 results
(and the previous four fiscal years' results) would be negatively impacted by
certain accounting adjustments. All such adjustments were reflected in the
fiscal 1999 Annual Report on Form 10-K. See "Item 3. Legal Proceedings" for a
description of litigation matters which followed the announcement of the
restatement.

Industry Overview

Music. According to the Recording Industry Association of America ("RIAA"),
music shipments by manufacturers to retailers decreased 4.1% to $13.7 billion in
2001 compared to $14.3 billion in 2000. In addition, the dollar value of
shipments for the industry mainstay, the full-length CD, decreased 2.3% to $12.9
billion in 2001 compared to $13.2 billion in 2000. RIAA attributed this decline
in large part to online piracy and CD-burning. According to an RIAA commissioned
survey, 23% of music consumers surveyed confirmed they are forgoing purchases of
music because they are downloading and or copying their music for free to a CD
or a portable MP3 player. In the survey, over 50%

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of those that have downloaded music for free have made copies of it. This
compares to 13% just two years ago. Supporting this increase, the study found
ownership of CD burners has nearly tripled since 1999. According to the
International Federation of the Phonographic Industry, global piracy costs the
recording industry over $4 billion per year. Shipments of cassettes declined
sharply during 2001 to $363 million, down 41.9% from 2000, as the format
continued to lose favor with music consumers.

Books. Sales in 2001 for the book industry grew only 0.1% to $25.4 billion
according to the Association of American Publishers. The majority of the book
industry segments declined on a percentage basis in 2001 with children's
hardcover books exhibiting the largest percentage decline at 22.7%, following
the release of Harry Potter and the Goblet of Fire in 2000. However, the
children's paperback segment increased 17.9% in 2001 on the strong performance
of Potter books in paperback and tie-ins to the Lord of the Rings movie.

Rental Video. According to Paul Kagan Associates ("Kagan"), consumer spending on
rental video increased 1.2% to $8.4 billion in 2001 from $8.3 billion in 2000.
Of the $8.4 billion, 54%, or $4.5 billion, was generated by revenue sharing
titles, up from 48% in 2000. DVD continued its accelerated acceptance rate as
DVD households increased over 80% to 23.6 million, up from 13.1 million in 2000.
Kagan estimates that the number of DVD households could hit 66.6 million by
2005. Revenue generated by VHS declined approximately 12% during 2001 primarily
as a result of the growth of DVD. Kagan projects this trend to continue despite
an almost 90% penetration rate of VCRs in United States households.

Although Kagan expects that rental video revenues will decline as a percent of
overall at-home consumer spending, 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. We
also believe rental video will continue to be a favored entertainment medium for
millions of consumers due to its relatively inexpensive price point, 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.

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 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. 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 12,000 to 25,000 square
feet. Our superstores offer customers an extensive product assortment consisting
of approximately 17,000 to 60,000 book, 9,000 to 30,000 music, 1,000 to 2,000
software, 2,000 to 3,000 periodical, 4,000 to 13,000 video, and 1,000 to 4,000
complementary and accessory titles for sale. We also offer approximately 3,000
to 12,000 used CD, videocassette, DVD and video game titles for sale. In
addition, customers can select from 5,000 to 10,000 DVD titles for sale and rent
and 12,000 to 20,000 videocassette, DVD and video game selections for rent.
Although the 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. 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
competition generally is locally-owned or national-chain specialty stores

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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.

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 utilize
product-affinities positioned together around a wide racetrack aisle or
three-across departments (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.

Cost-Effective Operations. We are committed to controlling costs in every aspect
of our operations while maintaining our customer-oriented philosophy. From 1993
to 1997, we spent $12.8 million to develop and implement proprietary
information, purchasing, distribution and inventory control systems that
position us to continue to grow profitably. These systems enable us to respond
actively to customers' changing desires and to rapid shifts in local and
national market conditions. Our 146,000 square-foot distribution center, which
adjoins our corporate offices in Amarillo, Texas, provides us with improved
store in-stocks, efficient product cross-docking and centralized returns
processing.

Low Pricing. Our pricing strategy at our superstores is to offer value to our
customers by maintaining prices that are competitive with or lower than the
lowest 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 will enable 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 Products. Since 1994, we have bought or traded for customer's CDs to sell
as used product and leverage the value of our CD offering. With additional
used-purchasing options, this business now accounts for approximately 10% of our
total music business, generally represents higher margins than new front-line
CDs and drives customer loyalty. During fiscal 2001, revenue generated from the
sale of used DVDs began to accelerate as the DVD medium became more popular with
the consumer. The same process of purchasing used CDs is being applied to used
DVDs and we are excited about the prospect for continued growth in this and
other used product business, including video games. We believe our multimedia
superstore concept will enhance our offering of used products allowing the
customer to choose between a new or a less expensive used copy of the same
title.

Internet. In May 1999, we launched our new 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 toys. 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 a newly
designed investor relations section including links to company press releases,
SEC filings and a useful list of frequently asked questions.

Expansion Strategy

We plan to increase our growth rate in fiscal 2002 by opening approximately
seven superstores while continuing our ongoing store expansion and remodeling
programs for our existing superstores. In addition, we anticipate the closing of
two superstores during fiscal 2002 bringing our total superstore count to
approximately 146 by the end of the fiscal year. 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

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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 that combines the sale of
books, music, software, periodicals, videocassettes, video games, DVDs, used
products including CDs, DVDs and video games, video game consoles and DVD
players with the rental of videocassettes, video games, DVDs, video game
consoles and DVD players in a superstore format. 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
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 previous 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 consisting of
approximately 17,000 to 60,000 book, 9,000 to 30,000 music, 1,000 to 2,000
software, 2,000 to 3,000 periodical, 4,000 to 13,000 video, and 1,000 to 4,000
complementary and accessory titles for sale. We also offer approximately 3,000
to 12,000 used CD, videocassette, DVD and video game titles for sale. In
addition, customers can select from 5,000 to 10,000 DVD titles for sale and rent
and 12,000 to 20,000 videocassette, DVD and video game selections for rent. New
releases and special offerings in each entertainment product category 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. 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.

Marketing Strategy

Low Pricing. Our pricing strategy at our superstores is to offer value to our
customers by maintaining prices that are competitive with or lower than the
lowest 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 that enable management to make more precise and
targeted purchases for each superstore, and (iii) our consistent focus on
maintaining low occupancy and operating costs.

Customer Service. We are committed to providing the highest level of customer
service to increase customer loyalty. We devote significant resources to
associate training and measuring customer satisfaction. All Hastings superstore
associates undergo training when hired and are required to participate in
frequent training programs. Our ongoing customer service program, "Quality
Service Everytime," empowers every superstore associate to utilize our flexible
return and refund policies to resolve any customer problem. We believe that
these programs, together with our low

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pricing strategy and superstore amenities, such as reading chairs, complementary
gourmet coffee or full coffee bar, and free local telephone calls to permit
customers to confirm their entertainment selections with family and friends, are
important components of the customer service we provide.

Advertising/Promotion. We participate in cooperative advertising programs and
merchandise display allowance programs offered by our vendors. Our advertising
programs are market-focused and introduce new products to our markets with price
competitiveness, extensive product assortment and comfortable atmosphere of our
superstores. We benefit from market display allowances provided by vendors
because of our superstores' high traffic volume and our effective display
implementation. Our strongest and most economical advertising vehicle has been
the FSI (Free Standing Insert) for newspapers. Following an increase in its
usage during 2001, we anticipate an additional increase of approximately 20% in
the number of FSIs being utilized during 2002. In addition to FSIs, we utilize
direct mail and radio along with in-store point-of-sale promotional materials to
communicate with our customers.

Information System

Our information system is built upon a multi-tiered, distributed processing
architecture and was designed using client/server technology. All locations are
connected using a wide-area network that allows interchange of current
information. 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 up to nine different 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.

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 and to 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 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

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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 variance.

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. We also utilize an automated system for scheduling store
management and sales associates. This system was developed to assist in
controlling personnel costs while maintaining desired levels of customer service
by preventing over-scheduling or under-scheduling sales, stocking and customer
service associates.

Accounting. Our financial accounting software has a flexible, open-systems
architecture. We prepare a variety of daily management reports covering store
and corporate performance. Detailed financial information for each superstore,
as well as for the distribution center and the corporate office, are generated
on a monthly basis. Our payroll, accounts payable, cash control, financial
planning and state and local tax functions are performed in-house.

Warehouse Management. Our warehouse management systems provide support for
high-volume retail transactions, including shipments, receipts and returns to
vendors. Software to perform these functions was customized through a joint
effort of our purchasing, distribution and information systems departments. The
warehouse system, using "real-time" inputs for total process coordination,
incorporates exact cube sizes of product containers, utilizing flow-through
racks and technologically advanced conveyor systems.

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, recycle, process and
ship items to be returned to manufacturers and distributors, as well as to
transfer and redistribute videocassettes 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 23% of our total
product, based on store receipts, is distributed through the distribution
center. Approximately 77% of our total product is shipped directly from the
vendors to the superstores. We outsource all product transportation from our
distribution center to various freight companies.

Our information systems and corporate infrastructure facilitate our ability to
purchase products directly from manufacturers, which contributes to our low
pricing structure. In fiscal 2001, we purchased the majority of our products
directly from manufacturers, rather than through distributors. Our top three
suppliers accounted for approximately 22% of total products purchased during
fiscal 2001. 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. In general, products we purchase
are 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

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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 The Wherehouse, Inc., and 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 are in the process of registering "Hastings, Your
Entertainment Superstore." 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, 2002, we employed approximately 6,264 associates; of which 2,036 are
full-time and 4,228 are part-time associates. Of this number, approximately
5,755 were employed at retail superstores, 172 were employed at our distribution
center and 296 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.

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Executive Officers of the Company

The following is certain information concerning the executive officers of
Hastings Entertainment, Inc.

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 54, 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. Mr.
Marmaduke also serves on the board of directors of the Video Software Dealers
Association (VSDA). Mr. Marmaduke has been active in the entertainment retailing
industry with the Company and its predecessor company for over 30 years.

ROBERT A. BERMAN, age 52, has served the Company as Vice President of Store
Operations 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 185 building material
superstores. At Builders Square, Inc., Mr. Berman was responsible for store
operations, store planning and design, purchasing and construction.

DAN CROW, age 55, 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 the 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.

JAMES S. HICKS, age 45, has served as Vice President of Purchasing of the
Company since August of 1999. 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 of
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.

ALAN VAN ONGEVALLE, age 34, has served as Vice President of Marketing since May
2000. 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.

MICHAEL J. WOODS, age 40, has served as Vice President of Information Systems of
the Company since October 1992. From August 1990 to October 1992, Mr. Woods
served as Director of Microsystems for the Company, focusing on store systems
development. From October 1989 to August 1990, Mr. Woods served as a programming
specialist and analyst for the Company.

11

ITEM 2. PROPERTIES

As of January 31, 2002, we operated 142 superstores in 21 states located as
indicated in the following table:

Currently, we lease sites for all of 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 2001, we closed five superstores and
during fiscal 2000, we closed six superstores and one college bookstore.

The terms of our superstore leases vary considerably. We strive to maintain
maximum location flexibility by entering into leases with short 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 site for a superstore. The following table sets
forth as of January 31, 2002 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:

12

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 2003, and we have the option to renew these
leases through March 2015.

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. Following our initial
announcement in March 2000 of the requirement for such restatements, six
purported class action lawsuits were filed in the United States District Court
for the Northern District of Texas 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. Although four of the lawsuits were
originally filed in the Dallas Division of the Northern District of Texas, all
of the five pending actions have been transferred to the Amarillo Division of
the Northern District and have been consolidated. One of the Section 10(b) and
20(a) lawsuits filed in the Dallas Division was voluntarily dismissed. On May
15, 2000, a lawsuit was filed in the United States District Court for the
Northern District of Texas against us, our current and former directors and
officers at the time of our June 1998 initial public offering and three
underwriters, Salomon Smith Barney, A.G. Edwards & Sons, Inc. and Furman Selz,
LLC asserting various claims under Sections 11, 12(2) and 15 of the Securities
Act of 1933. Motions to dismiss these actions were filed by us and, on September
25, 2001, were denied by the Court. Discovery and class certification
proceedings are going forward in both actions.

None of the pending complaints specify the amount of damages sought. Although it
is not feasible to predict or determine the final outcome of the proceedings or
to estimate the potential range of loss with respect to these matters, an
adverse outcome with respect to such proceedings could have a material adverse
impact on our financial position, results of operations and cash flows.

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.

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 2001.

13

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Our Common Stock trades on The Nasdaq National Market (Nasdaq) under the symbol
"HAST."

The following table sets forth, for the fiscal periods indicated, the high and
low closing market prices of our Common Stock as reported on Nasdaq within the
two most recent fiscal years.

As of March 28, 2002, there were approximately 450 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 the 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.

The information required by this item regarding disclosure of equity
compensation plan information will be set forth in our Proxy Statement for our
2002 Annual Meeting of Shareholders, to be filed within 120 days after the end
of fiscal 2001, under the heading "Compensation Plans," which information is
incorporated herein by reference.

14

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.

15

(1) We adopted a new, accelerated method of amortizing our rental video
assets in the fourth quarter of fiscal 1998. The adoption of the new
amortization method was accounted for as a change in accounting
estimate effected by a change in accounting principle and, accordingly,
we recorded a non-cash, non-recurring, pre-tax charge of $18.5 million
in rental video cost of revenues in the fourth quarter of fiscal 1998,
increasing net loss and diluted loss per share for fiscal 1998 by $11.5
million and $1.10 per share, respectively.

(2) We recorded pre-tax charges of approximately $1.5 million, $6.5 million
and $5.1 million in fiscal years 2001, 2000 and 1999, respectively,
related to the cost associated with closing superstores. See Note 5 to
the consolidated financial statements for further discussion. As a
result of these charges, fiscal years 2001, 2000 and 1999 net losses
were increased by $1.5 million, $6.5 million and $3.1 million and
$0.13, $0.56 and $0.27 per diluted share, respectively.

(3) 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 described in "Item 3. Legal
Proceedings", and "Item 8. Financial Statements and Supplementary
Data." As a result of these fees, fiscal year 2000 net losses were
increased by $2.7 million and $0.23 per share.

(4) In fiscal 1996, we established a reserve of $2.5 million ($1.6 million
after-tax charge) to cover potential losses related to certain mall
store leases that were sold prior to fiscal 1995 to Camelot Music,
Inc., which filed for bankruptcy protection in August 1996. In fiscal
1997, the reserve was reduced to $0.5 million, and $1.7 million was
included in Gain on sale of mall stores. In fiscal 1998, we were
released from any contingent liability on the remaining leases by order
of a bankruptcy court. Accordingly, the Company reduced the remaining
$0.5 million reserve to zero as of January 31, 1999, thereby decreasing
net loss and diluted loss per share for fiscal 1998 by $0.3 million and
$.03 per share, respectively.

(5) Due to cumulative losses incurred in recent years, the balance of the
net deferred tax asset currently does not meet the criteria for
recognition under Statement of Financial Accounting Standards No. 109.
As a result, the balance of the net deferred tax asset was reserved for
during fiscal 2000. No income tax expense was recorded related to
income for fiscal year ending January 31, 2002 as these amounts were
recognized as a reduction of the deferred income tax benefit valuation
allowance.

(6) Includes amounts associated with our rental video cost amortization.

(7) Includes procurement of rental video assets.

(8) Stores open a minimum of 60 weeks.

16

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.

General

Hastings Entertainment is a leading multimedia entertainment retailer that
combines the sale of books, music, software, periodicals, videocassettes, video
games, DVDs, used products including CDs, DVDs and video games, video game
consoles and DVD players with the rental of videocassettes, video games, DVDs,
video game consoles and DVD players in a superstore and Internet Web site
format. As of January 31, 2002, we operated 142 superstores averaging
approximately 20,000 square feet in small- to medium-sized markets located in 21
states, primarily in the Western and Midwestern United States. Each of the
superstores is wholly owned by the Company and operates under the name of
Hastings.

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, 2002 is referred to as fiscal 2001.

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,
liabilities at the date of the financial statements, the disclosure of
contingent assets and 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 standard 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 ("LCM") 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 any adjustment if estimated fair 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 any LCM adjustment.

Returns Process. In general, merchandise inventory owned by us is 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 change in
product offerings. At the end of any reporting period, there is inventory that
has been returned to vendors or in the process of being returned to vendors for
which accruals are required. 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 the product, we utilize an allowance for cost of inventory
returns (the "Allowance"). To accrue for such costs and estimate the 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. In
addition, we recognize that some portion of our inventory in superstores will
eventually be returned to a vendor based on the factors mentioned above. We
accrue return costs for these future returns on the same basis as product being
returned or in the process of being returned to a vendor. We continually
evaluate the returns process and initiate improvements as needed.

17

Rental Video Cost Amortization. In late fiscal 1998, we completed a series of
direct revenue-sharing agreements with major studios, the majority of which were
amended in fiscals 2001 and 2000, under which we acquired approximately 40% of
our rental video asset units during fiscal 2001. We anticipate that our
involvement in revenue-sharing agreements will be similar to that of fiscal year
2001 in future periods. 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 will allow customer
demand for new releases to be satisfied over a shorter period of time at a time
when the new releases are most popular. We expense revenue-sharing payments as
revenues are recognized under the terms of the specific contracts with supplying
studios. 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.

Certain events, including a downturn in the rental video industry, as a whole or
the markets within which we operate our superstores, further consolidation of
rental video retailers, substantial change in customer demand and change in the
mix of rental video revenues, could effect the salvage value we have assigned to
our rental video assets. Such 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"). Our current
experience is that the amount received for the PVT is significantly higher than
our salvage value of that item in our rental inventory. Based in part on this
factor and turns of PVT, we believe our estimate of salvage value is accurate.

Store Closing Reserve. As with any retailer, from time to time, and in the
normal course of business, we evaluate our store base to determine if a need to
close or relocate a store(s) is present. Management will evaluate, among other
factors, current and future profitability, market trends, age of store and lease
status. Upon the appropriate executive approval to close a location, we record
charges related to the costs of store closings or relocations. The primary
expense items associated with these charges 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 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.
These charges can have a material effect on the financial results of an annual
or interim period. Although we actively pursue sublease tenants on all closed or
relocated locations, we do not record any estimated sublease income as an offset
to any of charge until a sublease agreement is executed. We evaluate all of our
stores on a quarterly basis to ascertain any need for impairment of assets or to
commence closing proceedings.

18

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.

* Excludes one additional superstore closed in February 2002.

Fiscal 2001 Compared to Fiscal 2000

Revenues. Total revenues for the fiscal year ending January 31, 2002 were $471.8
million, up $13.6 million, or 3.0%, from $458.2 million for the fiscal year
ending January 31, 2001 primarily due to an increase in total comparable-store
revenue ("Comps") of 4.7% for the year. Elements of total Comps are as follows:

Merchandise Comps 4.3%
Rental video Comps 6.4%
Total Comps 4.7%

The Comp increases in merchandise and rental were partially offset by the
operation of three fewer superstores throughout fiscal 2001 compared to fiscal
2000. Total merchandise revenues increased $8.8 million, or 2.4% for fiscal 2001
to $379.3 million from $370.5 million for fiscal 2000. The increase in
merchandise Comps was driven primarily

19

by year-over-year increases of 73% and 114% in total sales of DVDs and video
games, respectively. Comp increases were partially offset by a decline in music
Comps of (3.5%) due primarily to the current malaise of the music industry,
which overall experienced a decline of (4.1%) in total music shipments for 2001.
Book Comps for the year increased slightly at 0.3%. Total rental video revenues
for fiscal 2001 increased $4.8 million, or 5.4% to $92.5 million compared to
$87.7 million for the prior year primarily due to an increase in rentals of DVD
titles of 140% year over year.

Gross Profit. For fiscal 2001, total gross profit increased 7.5% to $150.2
million, or 31.8% of total revenues, from $139.7, or 30.5% of total revenues for
fiscal 2000.

Merchandise gross profit for fiscal 2001, as a percent of merchandise revenue,
increased to 26.2% compared to 24.3% for fiscal 2000 due primarily to:

(i) a reduction in the costs associated with the return of product of
approximately $5.9 million for fiscal 2001 which is attributable to
improvements made in the product return process during fiscal 2001 that
lowered the cost per dollar of return; and

(ii) lower product costs of approximately $1.5 million as a result of a
movement in our inventory selection toward higher margin products
particularly related to books.

Partially offsetting these increases in merchandise gross profit was an increase
of approximately $1.6 million in the costs of operating our distribution center.
During fiscal 2001, we implemented a strategy to increase the flow of certain
higher turning inventory items through our distribution center. This program
enables us to have a better in-stock position for our customers. For the year,
the volume of shipments from our distribution center to our superstores
increased approximately 42% when compared to fiscal 2000, which resulted in
significantly higher operating costs.

Rental video gross profit for fiscal 2001, as a percent of rental video revenue,
decreased to 55.1% compared to 56.6% for fiscal 2000 due primarily to:

(i) an increase of approximately $1.6 million in depreciation expenses as
we procured a higher level of video games and DVD to meet increasing
demand. A large portion of these purchases were for catalog rental
product which exhibit slower turns than a new release title; and

(ii) an increase of approximately $0.8 million in costs associated with the
distribution of rental videos primarily due to increased overhead costs
as we processed a greater number of rental assets through our
distribution center.

Partially offsetting these decreases in rental video gross profit was an
increase in margin of approximately $0.7 million on the rental of revenue
sharing titles due to improved terms on agreements with studios. Additionally, a
higher percentage of non-revenue sharing titles, which generally reflect higher
margins, helped to offset the decreases listed above.

Selling, General and Administrative Expenses. Selling, general and
administrative expenses ("SG&A"), including store and corporate labor and other
overhead costs, for fiscal 2001 decreased 3.1% to $144.2 million, or 30.6% of
total revenues, from $149.0 million, or 32.5% of total revenues last year. This
substantial decrease was primarily the result of a higher level of expenses
recorded during the prior year including:

(i) $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. These fees did not recur during fiscal 2001;

(ii) asset impairment charges of $1.4 million comprised of $1.0 million in
writedowns of leasehold improvements included in three underperforming
superstores and $.4 million in writedowns of certain assets of the
Company's Internet segment were recorded during fiscal 2000. This
compares to a $0.7 million writedown of leasehold improvements for two
underperforming superstores in fiscal 2001. Although these superstores
continued to operate, such charges were recorded as projected cash
flows from these operations were not sufficient to realize the book
value of the specific assets; and

20

(iii) we recorded net expenses of $6.5 million in fiscal 2000 associated with
the closure of two superstores during the fourth quarter of fiscal 2000
and an additional four superstores approved for closure prior to year
end of fiscal 2000. This compared to net expenses of $1.5 million
related to two underperforming superstores which were approved for
closure during fiscal 2001, one of which was closed during the fourth
quarter of fiscal 2001 and the other closed in February 2002. Such
expenses are comprised of accruals for the net present value of future
minimum lease payments, the write-off of leasehold improvements, and
other related costs.

Partially offsetting the decreases in SG&A expense listed above was an increase
in net advertising costs of approximately $1.8 million year-over-year. The
higher expense was the result of a planned increase in targeted advertising
expenditures during fiscal 2001 to increase customer traffic.

Pre-opening Expenses. Pre-opening expenses were $0.2 million for fiscal 2001, as
we opened five superstores during the year. For fiscal 2000, pre-opening
expenses totaled $33,000 with the opening of one new superstore. Pre-opening
expenses include human resource costs, travel, rent, advertising, supplies and
certain other costs incurred prior to a superstore's opening.

Interest Expense. For the year, interest expense decreased 40.0% to $2.1
million, or 0.4% of total revenues, from $3.5 million, or 0.8% of total revenues
for last year. This reduction was primarily due to lower interest rates as well
as a lower average outstanding borrowing during the current year compared to
last year.

Income Taxes. Income tax expense for the fiscal years 2001 and 2000 was zero and
$2.0 million, respectively. No income tax expense was recorded related to income
for fiscal 2001 due to the reversal of a portion of the valuation allowance
related to the net deferred tax asset established in the fourth quarter of
fiscal 2000.

Net Income (Loss). We recorded net income of $4.0 million, or $0.34 per diluted
share for fiscal year 2001 compared to a net loss of ($14.6) million or ($1.25)
per share reported for fiscal year 2000.

Fiscal 2000 Compared to Fiscal 1999

Revenues. Total revenues for fiscal year 2000 increased 2.9% to $458.2 million
from $445.4 million for fiscal year 1999. The revenue growth consisted of a 1.8%
increase in merchandise revenues and a 7.7% increase in rental video revenue and
was primarily due to the number of new superstores opened in fiscal 1999 that
were open for a full year during fiscal 2000. Comps for fiscal 2000 were 0.1%
and are detailed as follows:

Merchandise Comps (0.4)%
Rental Video Comps 2.1%
Total Comps 0.1%

Sale video, driven by sales of DVDs, previously viewed videocassettes, and video
games exhibited the largest percentage growth year-over-year with declines in
music revenues, as a result of general weakness in the industry, and book
revenues, as a result of inventory management issues.

Gross Profit. Total gross profit, as a percent of total revenue, declined from
32.1% in fiscal 1999 to 30.5% in fiscal 2000 as a result of a series of factors
as follows:

(i) During the first quarter of fiscal 2000, management determined a need
to improve inventory turns in order to enhance cash flow, reduce
markdown expense, and enhance our inventory offering. Our resulting
implementation of an initiative to permanently improve inventory turns
generated an increase in the volume of returns to vendors and markdowns
as well as compressed the timing of these returns resulting in higher
fees per return based on the pricing agreements with our vendors. This
negatively impacted gross profit by a $3.1 million increase in the cost
associated with the return of product;

(ii) Lower than anticipated sales volume for certain products in the first
three quarters of fiscal 2000 resulted in management's decision to
increase the markdown frequency on certain products to stimulate sales,
increase

21

inventory turnover and improve cash flows. Such retail price markdowns
increased approximately $3.3 million resulting in lower merchandise
margins;

(iii) Margins were also adversely affected by an increase in freight costs of
$1.0 million for the year ended January 31, 2001 due to freight
carriers adding fuel surcharges of 4% to 8%; and

(iv) As circumstances warrant, due to changing market conditions or specific
transactions, we record lower of cost or market inventory adjustments.
Such inventory adjustments increased $1.4 million from $5.6 million in
fiscal 1999 to $7.0 million in fiscal 2000. This increase was primarily
a result of our entering into a barter transaction with a third party
during fiscal 1999, for which we recorded an asset related to the
barter credit in the amount of $0.9 million. During the third quarter
of fiscal 2000, the barter company ceased operations and no longer
appeared to be a going concern. Consequently, we deemed the entire
credit to be fully impaired, which resulted in a charge to income of
$0.9 million in the third quarter of fiscal 2000.

Also contributing to the overall decrease in margin was a decline in rental
video margin of approximately $3.6 million primarily as a result of an increase
in rental video revenue subject to revenue-sharing agreements with studios as a
percent of total rental video revenue, which has lower profit margins.

Offsetting the declines in margin outlined above was a $2.5 million decline in
the amount of promotional coupons redeemed during fiscal 2000 over fiscal 1999
and a reduction in shrinkage of approximately $1.9 million resulting from an
increased focus on loss prevention. In addition, we experienced an increase in
discounts on product purchase prices due to more advantageous buying and
improved seasonal terms from our vendors during the year.

Selling, General and Administrative Expenses. SG&A expenses increased to $149.0
million or 32.5% of total revenues in fiscal 2000 from $141.5 million or 31.7%
in fiscal 1999. The increase was primarily the result of (1) $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 and (2) collective asset
impairment charges of $1.4 million comprised of $1.0 million in writedowns of
leasehold improvements included in three underperforming superstores and $.4
million in writedowns of certain assets of the Company's Internet segment. Such
charges were recorded as projected cash flows from these operations were not
sufficient to realize the book value of the specific assets.

Additionally, during fiscal 2000, we recorded net expenses of $6.5 million
associated with the closure of two superstores during the fourth quarter and an
additional four superstores approved for closure prior to year end. Such
expenses are comprised of accruals for the net present value of future minimum
lease payments, the write-off of leasehold improvements, and other related
costs. During fiscal 1999, we recorded expenses of $5.1 million related to the
closure of six superstores and one college bookstore.

Pre-opening Expenses. Pre-opening expenses were $33,000 for the year ending
January 31, 2001, as we opened one superstore during the year. For the year
ending January 31, 2000, pre-opening expenses totaled $1.7 million with the
opening of 20 new superstores. Pre-opening expenses include human resource
costs, travel, rent, advertising, supplies and certain other costs incurred
prior to a superstore's opening.

Interest Expense. Despite a higher interest rate environment, our overall
interest expense declined approximately $0.2 million to $3.5 million in fiscal
2000 compared to $3.7 million in fiscal 1999 primarily due to a lower average
balance of long-term debt.

Income Taxes. Due to cumulative losses incurred in recent years, the current
balance of the net deferred tax asset does not meet the criteria for recognition
under SFAS 109. As a result, we fully reserved the balance of the net deferred
tax asset of $7.3 million. We recorded income tax expense of $2.0 million
primarily as the result of the provision for the valuation allowance partially
offset by the tax benefit derived from the loss generated in fiscal 2000.

Net Loss. For fiscal year 2000, we incurred a net loss of $14.6 million, or
$1.25 per share, compared to a net loss of $2.2 million, or $0.19 per share for
fiscal 1999.

22

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 revolving credit
facility (the "Facility"). We believe our cash flow from operations and
borrowings under the Facility will be sufficient to fund our ongoing operations,
new superstores and superstore expansions through fiscal 2002.

Consolidated Cash Flows

Operating Activities. Net cash flows from operating activities decreased
$7.0 million, or 13.3% to $45.3 million in fiscal 2001 from $52.3 million
in fiscal 2000. The most significant reason for the decrease was the
difference in the change of inventory assets between the two fiscal years.
In fiscal 2000, as part of our strategic plan, we decreased our merchandise
inventory by approximately $21.4 million. Approximately $15 million of this
decline was the result of our initiative to increase cash flow and
inventory turns by reducing our inventory. The remaining decrease in
inventory was due to added controls on purchasing, markdown management and
improved sell-through. During fiscal 2001, we experienced an increase in
inventory assets of approximately $17.6 million, of which approximately
$14.3 million resulted from cash transactions. The remainder was company
owned rental inventory transferred to merchandise for sale as previously
viewed product. The increase in inventory was due primarily to the opening
of five new superstores and the expansion of seven superstores.
Additionally, we purchased and sold a higher level of DVD and video game
product during fiscal 2001 contributing to the increase in inventory.
Partially offsetting the change in inventory was an increase of $18.6
million in net income (loss) as we recorded net income of $4.0 million in
fiscal 2001 compared to a net loss of ($14.6) million in fiscal 2000 and a
positive difference in the change of trade accounts payable and other
accrued expenses of $11.8 million resulting primarily from increased
purchases of inventory coupled with an increase in accounts payable days in
fiscal 2001 compared to fiscal 2000.

Investing Activities. Net cash used in investing activities increased $16.0
million, or 52.5%, from $30.5 million in fiscal 2000 to $46.5 million in
fiscal 2001. This increase was due primarily to the opening of five new
superstores and the expansion of seven superstores during fiscal 2001
compared to the opening of one new superstore and the expansion of five
superstores during fiscal 2000. Additionally, purchases of rental video
assets increased during fiscal 2001 due to new and expanded superstore
activity and increased purchases of DVD and video games to meet customer
demand. Our capital expenditures include store equipment and fixtures,
expanding and remodeling existing superstores, upgrading and implementation
of information systems technology and the purchase of rental video assets.

Financing Activities. Cash provided by or used in financing activities is
primarily associated with borrowings and payments made under the Facility.
Cash provided by financing activities increased $25.8 million to $1.2
million in fiscal 2001 compared to cash used in financing activities of
$24.6 million in fiscal 2000. The primary reason for this increase was due
to fiscal 2000 activity. During fiscal 2000, with an increase in cash flow
from operations and decrease in capital expenditures, we decreased our
overall debt balances by approximately $24.7 million to $29.6 million as of
January 31, 2001 from $54.3 million as of January 31, 2000, eliminating our
term debt by paying off our Senior Notes and reducing the level of our
revolving credit borrowings.

On September 18, 2001 we announced a stock repurchase program of up to $5.0
million of our common stock. As of January 31, 2002, a total of 618,500
shares had been purchased at a cost of approximately $3.0 million, for an
average cost of $4.88 per share.

23

Capital Structure. On August 29, 2000, we entered into a three-year syndicated,
secured Loan and Security Agreement with Fleet Retail Finance, Inc. and The CIT
Group/Business Credit, Inc. The initial proceeds from the Facility were used to
terminate and prepay fully the total amounts outstanding under our prior
revolving credit facility with Bank of America and a consortium of banks and our
Series A Senior Notes (the "Senior Notes") with a financial institution. 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 $70 million, which increases to $80 million between October 15 and
December 15 of each year of the Facility, less a $10 million availability
reserve. The Facility bears interest based on the prevailing prime rate or LIBOR
plus 2.00% at our option. 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 could be
adjusted to reduce availability under the Facility. 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 and our subsidiaries and is guaranteed by each of our three consolidated
subsidiaries. The Facility expires on August 29, 2003. At January 31, 2002, we
had $20.7 million in excess availability, after the $10 million availability
reserve, under the Facility.

At January 31, 2002 and 2001, we had borrowings outstanding of $32.2 million and
$28.3 million under the Facility, respectively. The average rate of interest
being charged under the Facility was 6.1% and 8.4% at January 31, 2002 and 2001,
respectively.

We entered into two interest rate swaps, one in November and one in December
2001, with a financial institution 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. The notional value of each swap is $10 million of our
revolving credit facility at fixed interest rates of 2.65% and 2.47%,
respectively, for one year. We have designated the interest rate swaps as
hedging instruments. At January 31, 2002, the fair value of the interest rate
swaps was not significant.

Seasonality and Inflation

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 Christmas 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. We experience reduced rentals of video
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
videocassette 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.

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 the first quarter of fiscal 2002, we adopted Statement of Financial
Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments
and Hedging Activities," which was amended by SFAS No. 137 and SFAS No. 138.
This statement establishes accounting and reporting guidelines for derivatives
and requires us to record all derivatives as assets or liabilities on the
balance sheet at fair value. Our use of derivatives is limited to interest rate
swaps which we have designated as hedging instruments. At January 31, 2002, the
fair value of the interest rate swaps was not significant, and therefore, the
adoption of SFAS No. 133 has not had a material impact on our consolidated
balance sheets or our statements of operations, shareholders' equity and cash
flows.

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statements of Financial Accounting Standards ("SFAS") No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangible Assets, effective

24

for fiscal years beginning after December 15, 2001. Under the new rules,
goodwill will no longer be amortized but will be subject to annual impairment
tests in accordance with the Statements. Other intangible assets will continue
to be amortized over their useful lives. We will apply the new rules on
accounting for goodwill and other intangible assets beginning in the first
quarter of fiscal 2002. We will test goodwill for impairment using the two-step
process prescribed in Statement 142. The first step is a screen for potential
impairment, while the second step measures the amount of the impairment, if any.
Prior to July 31, 2002, we expect to perform the first of the required
impairment tests of goodwill based on its carrying value at January 31, 2002.
Any impairment charge resulting from these transitional tests will be reflected
as the cumulative effect of a change in accounting principle in the first
quarter of fiscal 2002. We have not yet determined what the effect of these
tests will be; however, application of the Statements is not expected to have a
material impact on our consolidated financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the Impairment or
Disposal of Long-Lived Assets, which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to be Disposed Of, and the accounting and reporting provisions
of APB Opinion No. 30, Reporting the Results of Operations for a disposal of a
segment of a business. SFAS 144 is effective for fiscal years beginning after
December 15, 2001. We adopted SFAS 144 as of February 1, 2002 and such adoption
did not have a significant impact on our financial position and results of
operations.

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, 2002 outstanding balance
of the variable rate debt would be approximately $0.3 million. After an
assessment of these risks to our operations, we believe that the primary market
risk exposures (within the meaning of Regulation S-K Item 305) are not material
and are not expected to have any material adverse impact on our financial
position, results of operations or cash flows for the next fiscal year. In
addition, we do not believe changes in the fair value of the interest rate swaps
entered into in November 2001 and December 2001 with notional amounts of $10
million each will be material.

25

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

HASTINGS ENTERTAINMENT, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE

26

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, 2002 and 2001, and the
related consolidated statements of operations, shareholders' equity, and cash
flows for each of the two years then ended. Our audits also included the
financial statement schedules listed in the Index at Item 14(a). These financial
statements and schedules are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements and
schedules 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, 2002 and 2001, and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedules, when
considered in relation to the basic financial statements taken as a whole,
presents fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

Fort Worth, Texas
March 22, 2002

27

INDEPENDENT AUDITORS' REPORT

The Board of Directors and Shareholders
Hastings Entertainment, Inc.:

We have audited the consolidated statements of operations, shareholders' equity,
and cash flows for the year ended January 31, 2000 of Hastings Entertainment,
Inc. and subsidiaries. We also have audited the related financial statement
schedule for the year ended January 31, 2000. These consolidated financial
statements and financial statement schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements and financial statement schedule based on our
audit.

We conducted our audit in accordance with auditing standards generally accepted
in the United States of America. 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 audit provides a
reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the results of operations of Hastings
Entertainment, Inc. and subsidiaries and their cash flows for the year ended
January 31, 2000, in conformity with accounting principles generally accepted in
the United States of America. Also in our opinion, the related financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly, in all material
respects, the information set forth therein for the year ended January 31, 2000.

/S/ KPMG LLP

Dallas, Texas
June 13, 2000

28

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
January 31, 2002 and 2001
(In thousands, except share data)

See accompanying notes to consolidated financial statements.

29

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
Years Ended January 31, 2002, 2001 and 2000
(In thousands, except per share data)

See accompanying notes to consolidated financial statements.

30

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Shareholders' Equity
Years ended January 31, 2002, 2001 and 2000
(In thousands, except share data)

See accompanying notes to consolidated financial statements.

31

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended January 31, 2002, 2001 and 2000
(Dollars in thousands)

See accompanying notes to consolidated financial statements.

32

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(1) OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) GENERAL

Hastings Entertainment, Inc. and subsidiaries (the "Company")
operates a chain of retail superstores in 21 states, primarily in
the Western and Midwestern United States, with revenues
originating from the sale of music, books, software, periodicals,
videocassette, video game and DVD products and the rental of
videocassettes, video games and DVDs.

(b) BASIS OF CONSOLIDATION

The consolidated financial statements present the results of
Hastings Entertainment, Inc. and its subsidiaries. All significant
intercompany transactions and balances have been eliminated in
consolidation.

The Company's fiscal years ended January 31, 2002, 2001 and 2000
are referred to as fiscal 2001, 2000 and 1999, respectively.

(c) REVENUE RECOGNITION

Merchandise 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 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 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.

(d) CASH AND CASH EQUIVALENTS

The Company considers all short-term investments with original
maturities of three months or less (primarily money market mutual
funds) to be cash equivalents.

(e) MERCHANDISE INVENTORIES

Merchandise inventories are recorded at the lower of standard cost
(which approximates the first-in, first-out (FIFO method)) or
market.

(f) PROPERTY AND EQUIPMENT

Property and equipment, excluding rental video assets (see note
3), are recorded at cost and depreciated using the straight-line
method. Furniture, fixtures, equipment and software are
depreciated over their estimated useful lives of 3 to 5 years.
Leasehold improvements are amortized over the shorter of the
related lease term or their estimated useful lives.

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.

The Company reviews 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 cash flows expected to
be generated by the asset. If such assets are considered to be
impaired, the impairment to 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.

33

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(g) INCOME TAXES

Income taxes are accounted for under the asset and liability
method.

(h) FINANCIAL INSTRUMENTS

The carrying amount of long-term debt approximates fair value as
of January 31, 2002 and 2001 due to the instruments bearing
interest at market rates. The carrying amount of accounts payable
approximates fair value because of its short maturity period.

The Company entered into two interest rate swaps, one in November
and one in December 2001, with a financial institution in order to
obtain a fixed interest rate on a portion of the Company's
outstanding floating rate debt thereby reducing its exposure to
interest rate volatility. The notional value of each swap is $10
million of the Company's revolving credit facility at fixed
interest rates of 2.65% and 2.47%, respectively, for one year. The
Company has designated the interest rate swaps as hedging
instruments. At January 31, 2002, the fair value of the interest
rate swaps was not significant.

(i) STOCK OPTION PLANS

The Company accounts for its stock option plans in accordance with
the provisions of Accounting Principles Board Opinion No. 25 (APB
25), Accounting for Stock Issued to Employees, 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 (SFAS 123), Accounting for Stock-based Compensation, the
Company 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. The Company has elected to
continue to apply the provisions of APB 25 and provide the pro
forma disclosure provisions of SFAS 123.

(j) ADVERTISING COSTS

Advertising costs for newspaper, television and other media are
expensed as incurred. Gross advertising expenses for the fiscal
years 2001, 2000, and 1999 were $9.2 million, $5.9 million and
$4.4 million, respectively.

(k) PRE-OPENING COSTS

Pre-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.

(l) INCOME (LOSS) PER SHARE

Basic income (loss) per share is computed by dividing net loss by
the weighted-average number of common shares outstanding during
the period. Diluted income (loss) per share is similarly computed,
but includes the effect, when dilutive, of the Company's weighted
average number of stock options outstanding.

(m) USE OF MANAGEMENT ESTIMATES

The 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 assets and
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.

34

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(n) IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS

In the first quarter of fiscal 2002, the Company adopted Statement
of Financial Accounting Standards ("SFAS") No. 133, "Accounting
for Derivative Instruments and Hedging Activities," which was
amended by SFAS No. 137 and SFAS No. 138. This statement
establishes accounting and reporting guidelines for derivatives
and requires the Company to record all derivatives as assets or
liabilities on the balance sheet at fair value. The Company's use
of derivatives is limited to interest rate swaps which the Company
has designated as hedging instruments. At January 31, 2002, the
fair value of the interest rate swaps was not significant, and
therefore, the adoption of SFAS No. 133 has not had a material
impact on the Company's consolidated balance sheets or its
statements of operations, shareholders' equity and cash flows.

In June 2001, the Financial Accounting Standards Board ("FASB")
issued Statements of Financial Accounting Standards ("SFAS") No.
141, Business Combinations, and No. 142, Goodwill and Other
Intangible Assets (the "Statements"), effective for fiscal years
beginning after December 15, 2001. Under the new rules, goodwill
will no longer be amortized but will be subject to annual
impairment tests in accordance with the Statements. Other
intangible assets will continue to be amortized over their useful
lives. The Company will apply the new rules on accounting for
goodwill and other intangible assets beginning in the first
quarter of fiscal 2002. The Company will test goodwill for
impairment using the two-step process prescribed in Statement
142. The first step is a screen for potential impairment, while
the second step measures the amount of the impairment, if any.
Prior to July 31, 2002, the Company expects to perform the first
of the required impairment tests of goodwill based on its
carrying value at January 31, 2002. Any impairment charge
resulting from these transitional tests will be reflected as the
cumulative effect of a change in accounting principle in the
first quarter of fiscal 2002. The Company has not yet determined
what the effect of these tests will be, however, application of
the Statements is not expected to have a material impact on its
consolidated financial position or results of operations.

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which addresses
financial accounting and reporting for the impairment or disposal
of long-lived assets and supersedes SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to
be Disposed Of, and the accounting and reporting provisions of
APB Opinion No. 30, Reporting the Results of Operations for a
disposal of a segment of a business. SFAS 144 is effective for
fiscal years beginning after December 15, 2001. The Company
adopted SFAS 144 as of February 1, 2002 and such adoption did not
have a significant impact on the Company's financial position and
results of operations.

35

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(2) MERCHANDISE INVENTORIES

Merchandise inventories consisted of the following:

During fiscal 2001 and 2000, the Company purchased approximately 22% and
25%, respectively, of all products (defined herein as merchandise
inventories and rental videos) from three suppliers.

(3) PROPERTY AND EQUIPMENT

Property and equipment consists of the following :

Accumulated depreciation and amortization of property and equipment
includes $1.4 million and $1.2 million of accumulated amortization of
equipment under capital leases at January 31, 2002 and 2001,
respectively.

During the fourth quarter of fiscal 2001 and 2000, the Company's retail
store segment recorded pre-tax charges of $0.7 million and $1.0 million,
respectively. These charges are included in selling, general and
administrative expenses and are related to the impairment of leasehold
improvements for two superstores in fiscal 2001 and three superstores in
fiscal 2000. Such charges were recorded in accordance with SFAS 121,
"Impairment of Long Lived Assets." These superstores continue to operate
but did not project cash flow amounts sufficient to recover the book
value of the specific assets. Other amounts for impaired assets were
recognized in connection with the closing of superstores. Please refer to
Note 5 for a description of these amounts.

Also during fiscal 2001, the Company's Internet segment recorded a $0.4
million pre-tax charge included in selling, general and administrative
expenses related to the impairment of information systems equipment and
development costs in accordance with SFAS 121, "Impairment of Long Lived
Assets." The Internet segment will continue to operate but did not
project cash flow amounts sufficient to recover the book value of the
specific assets.

36

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(4) ACCRUED EXPENSES AND OTHER CURRENT LIABILITIES

Accrued expenses and other current liabilities consisted of the
following:

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 is pending. Because the amount of credit to be
received requires estimates, it is reasonably possible that the Company's
estimate of the ultimate settlement with its suppliers may change in the
near term.

(5) STORE CLOSING RESERVE

From time to time and in the normal course of business, the Company
evaluates its superstore base to determine if a need to close a
superstore(s) is present. Management will evaluate, among other factors,
current and future profitability, market trends, age of store and lease
status.

Included in accrued expenses and other liabilities at January 31, 2002
and 2001 are accruals of $5.9 million and $6.6 million, respectively, for
the net present value of future minimum lease payments and other costs
attributable to closed or relocated superstores, net of estimated
sublease income. Charges related to superstore closings in fiscal 2001
amounted to approximately $1.5 million, of which $1.0 million was
recorded in the fourth quarter. Contained in the $1.5 million were $0.6
million in accruals for the net present value of minimum lease payments
related to two underperforming superstores which were approved for
closure during fiscal 2001, one of which was closed during the fourth
quarter of fiscal 2001 and the other closed in February 2002, and seven
superstores that were relocated during the year. Additionally, fiscal
2001 charges included $0.9 million for the write-off of leasehold
improvements and other assets related to these closings and relocations.
The fourth quarter charge of $1.0 million included $0.3 million in
accruals for the net present value of future minimum lease payments for
two relocated superstores and $0.7 million for the write-off of leasehold
improvements and other assets for superstores closed or relocated during
the fourth quarter.

Charges related to superstore closings in fiscal 2000 amounted to $6.5
million, of which $3.4 million was recorded in the fourth quarter.
Contained in the $6.5 million were $4.6 million in accruals for the net
present value of minimum lease payments related to the closing of two
underperforming superstores closed in the fourth quarter and four
underperforming superstores that management had approved for closure in
the fourth quarter that was closed by the end of the second quarter of
fiscal 2001. Additionally, fiscal 2000 charges included $1.6 million for
the write-off of leasehold improvements and $0.3 million of other related
costs. The fourth quarter charge of $3.4 million included $1.9 million in
accruals for the net present value of future minimum lease payments, $1.3
million in write-offs of leasehold improvements and $0.2 million of other
related costs.

Offsetting these fiscal 2000 charges were changes in estimates in the
store closing reserve of $1.6 million, of which $0.8 million was recorded
in the fourth quarter of fiscal 2000, as a result of negotiating early
buy-outs of certain lease liabilities and sublease activities for certain
closed superstores.

In fiscal 1999, charges related to superstore closings were $5.1 million,
which was all recorded during the fourth quarter. Contained in the $5.1
million was $2.5 million in accruals for the net present value of minimum
lease payments related to the closing of two underperforming superstores
closed at January 31, 2000 and four underperforming superstores that
management had approved for closure in the fourth quarter that

37

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

were closed by the end of the first quarter of fiscal 2000. Additionally,
charges included $2.3 million for the write-off of leasehold improvements
and $0.3 million of other related costs.

The following table provides a rollforward of reserves that were
established for these charges for fiscal 2001, 2000 and 1999:

Payments during the next five years that are to be charged against the
reserve are expected to be approximately $1.2 million per year. Other
costs were charged against the reserve in fiscal 2001 as incurred.

(6) LONG-TERM DEBT

Long-term debt and capitalized lease obligations consisted of the
following:

On August 29, 2000, the Company entered into a three-year syndicated,
secured Loan and Security Agreement with Fleet Retail Finance, Inc. and
The CIT Group/Business Credit, Inc (the "Facility"). The initial proceeds
from the Facility were used by the Company to terminate and prepay fully
the total amounts outstanding under a prior revolving credit facility
with Bank of America and a consortium of banks and its Series A Senior
Notes (the "Senior Notes") with a financial institution. 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 $70 million, which increases to $80 million
between October 15 and December 15 of each year of the Facility, less a
$10 million availability reserve. The Facility bears interest based on
the prevailing prime rate or LIBOR plus 2.00% at the Company's option.
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 could
be adjusted to reduce availability under the Facility. 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 the Company's common stock and
requires a minimum availability of $10 million at all times. The Facility
is secured by substantially all

38

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

of the assets of the Company and its subsidiaries and is guaranteed by
each of the Company's three consolidated subsidiaries. The Facility
expires on August 29, 2003. At January 31, 2002, the Company had $20.7
million in excess availability after the $10 million availability
reserve, under the Facility.

At January 31, 2002 and 2001, the Company had borrowings outstanding of
$32.2 million and $28.3 million under the Facility, respectively. The
average rate of interest being charged under the Facility was 6.1% and
8.4% at January 31, 2002 and 2001, respectively.

The Company entered into two interest rate swaps, one in November and one
in December 2001, with a financial institution in order to obtain a fixed
interest rate on a portion of the Company's outstanding floating rate
debt thereby reducing its exposure to interest rate volatility. The
notional value of each swap is $10 million of the Company's revolving
credit facility at fixed interest rates of 2.65% and 2.47%, respectively,
for one year. The Company has designated the interest rate swaps as
hedging instruments. At January 31, 2002, the fair value of the interest
rate swaps 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 2001 are as follows:

2002 $ 169
2003 32,427
2004 221
2005 243
2006 195
Thereafter 177
--------
$ 33,432
========

(7) LEASES

The Company leases retail space under operating leases with terms ranging
from three to fifteen 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 consists of the following:

39

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(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, 2002 are:

A director of the Company is a limited partner in various limited
partnerships that lease land and improvements to the Company under
certain lease agreements. During fiscal 2001, 2000 and 1999, the Company
made lease payments of $0.6 million each year to these partnerships.

(8) INCOME TAXES

Income tax expense (benefit) consists of the following:

40

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

The difference between expected income tax expense (computed by applying
the statutory rate of 38.5% to income before income taxes) and actual
income tax expense (benefit) is as follows:

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are
presented below:

During fiscal 2000, the Company reviewed the net deferred tax asset under
the provisions set forth in Statement of Financial Accounting Standards
No. 109, "Accounting for Income Taxes" (SFAS 109). While the Company
believes the entire deferred tax asset will be realized by future
operating results, due to cumulative losses incurred in recent years, the
current balance of the net deferred tax asset did not meet the criteria
for recognition under SFAS 109. As a result, no income tax expense was
recorded related to income for fiscal year ending January 31, 2002 as
these amounts were recognized as a reduction of the deferred income tax
asset valuation allowance. At January 31, 2002 and 2001, the balance of
the valuation allowance was $5.6 million and $7.3 million, respectively.

41

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(9) INCOME (LOSS) PER SHARE

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

Options to purchase 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; 1,087,083 shares of Common Stock at exercise prices ranging
from $1.27 per share to $14.03 per share outstanding at January 31, 2001;
and 1,813,965 shares of Common Stock at exercise prices ranging from
$5.25 per share to $15.00 per share outstanding at January 31, 2000, were
not included in the computation of diluted income (loss) per share
because their inclusion would have been antidilutive.

(10) 401k AND ASOP

Since February 1, 2001, the Company's 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 Company's 401k plan and elect to contribute up to 25
percent 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
is 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 the Company 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. Prior to February 1, 2001, employees who had attained
age 21 were eligible to participate in the Company's 401k plan and could
elect to contribute up to 15 percent of their salary, subject to federal
limitations, to the plan. Employer contributions were a discretionary
match determined by the Company and allocated solely to those employees
who were participating in the plan, had completed one year of service and
were employed on the last day of the plan year. Amounts expensed related
to the plan were $0.1 million, $0.4 million and $0.2 million during
fiscal 2001, 2000 and 1999, respectively.

The Company's 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 the
Company. 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. Amounts expensed related to the
Plan were $0.2 million, $0.4 million and $0.3 million during fiscal 2001,
2000 and 1999, respectively. Common shares held by the ASOP were 271,368,
199,269 and 124,410 at January 31, 2002, 2001 and 2000, respectively.

42

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(11) SHAREHOLDERS' EQUITY

The Company has four stock option plans: the 1991 and 1994 Stock Option
Plans, the 1996 Incentive Stock Plan and the Outside Directors Plan (for
non-employee directors). A total of 505,900 shares 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, and 101,180 shares may be
granted under the Outside Directors Plan.

The 1991 and 1994 Stock Option Plans and the 1996 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 the Company's 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.

The Company has 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 2001,
2000 and 1999, there were 1,104, 3,881 and 6,830 RSU's awarded under the
Plan, respectively. The Company recorded approximately $2,000, $8,800 and
$52,000 of compensation expense at the time the RSU's were awarded for
fiscal year 2001, 2000 and 1999, respectively. As of January 31, 2002,
2001 and 2000, there were 10,193, 13,576 and 11,654 RSU's outstanding
under the plan, respectively.

On October 2, 2000, the Company exchanged restricted stock for
outstanding options granted to associates having an exercise price of
$9.00 or more per share. The ratio of restricted stock issued in the
exchange varied with the option exercise price of the outstanding options
but in the aggregate was approximately 1:4. Options beneficially owned by
the Chief Executive Officer and the Directors of the Company were
excluded from the exchange. As a result of the exchange, 122,269 shares
of restricted stock were issued and options for 504,694 shares were
cancelled and returned to the Company's 1991, 1994 and 1996 Stock Option
Plans. Rights in the restricted stock vested 50% on January 31, 2001 and
50% on April 30, 2001. The restricted stock is subject to restrictions
and may be resold only in accordance with Rule 144 under the Securities
Exchange Act of 1934 or other applicable exemption. In connection with
the exchange, the Company recognized $0.2 million in compensation expense
in fiscal 2000.

43

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

A summary of information with respect to all stock option plans is as
follows:

At January 31, 2002, 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.

At January 31, 2002, 2001 and 2000, the number of options exercisable was
615,823, 523,716 and 1,067,915, respectively, and the weighted-average
exercise price of those options was $9.59, $10.84 and $10.57,
respectively.

The Company applies APB 25 and related interpretations in accounting for
its Plans. Since the Company generally grants 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. Had the Company determined compensation cost
based on the fair value at the date of grant for its stock options under

44

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

SFAS 123, the Company's net income (loss) and income (loss) per share
would have been changed as set forth in pro forma amounts indicated
below:

The per share weighted-average exercise price and the per share
weighted-average minimum and 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):

The following assumptions were used in the calculation:

(12) SUPPLEMENTAL CASH FLOW INFORMATION

Cash payments for interest during fiscal 2001, 2000 and 1999 totaled $2.1
million, $3.2 million and $3.6 million, respectively. Cash payments for
income taxes during fiscal 2001, 2000 and 1999 totaled $0.5 million, $0.2
million and $0.7 million, respectively.

(13) LITIGATION AND CONTINGENCIES

The Company's employees are covered under a self-insured health plan.
Claims in excess of $100,000 per employee are insured by a managing
underwriter. Estimated claims incurred but not reported have been accrued
in the accompanying financial statements. Health insurance expense during
fiscal 2001, 2000 and 1999 was $2.8 million, $2.2 million and $2.0
million, respectively.

The Company is partially self-insured for workers' compensation. Claims
in excess of $100,000 per accident and $1.1 million in the aggregate
annually are insured by an insurance company. Estimated claims and claims
incurred but not paid have been accrued in the accompanying consolidated
financial statements. Workers'

45

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

compensation expense during fiscal 2001, 2000 and 1999 was $0.5 million,
$0.4 million and $0.3 million, respectively.

In 2000, the Company restated its consolidated financial statements for
the first three quarters of fiscal 1999 and the prior four fiscal years.
Following the Company's initial announcement in March 2000 of the
requirement for such restatements, six purported class action lawsuits
were filed in the United States District Court for the Northern District
of Texas against the Company and certain of the current and former
directors and officers of the Company asserting various claims under
Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Although
four of the lawsuits were originally filed in the Dallas Division of the
Northern District of Texas, all of the five pending actions have been
transferred to the Amarillo Division of the Northern District and have
been consolidated. One of the Section 10(b) and 20(a) lawsuits filed in
the Dallas Division was voluntarily dismissed. On May 15, 2000, a lawsuit
was filed in the United States District Court for the Northern District
of Texas against the Company, its current and former directors and
officers at the time of the Company's June 1998 initial public offering
and three underwriters, Salomon Smith Barney, A.G. Edwards & Sons, Inc.
and Furman Selz, LLC asserting various claims under Sections 11, 12(2)
and 15 of the Securities Act of 1933. Motions to dismiss these actions
were filed by the Company and, on September 25, 2001, were denied by the
Court. Discovery and class certification proceedings are going forward in
both actions.

None of the pending complaints specify the amount of damages sought.
Although it is not feasible to predict or determine the final outcome of
the proceedings or to estimate the potential range of loss with respect
to these matters, an adverse outcome with respect to such proceedings
could have a material adverse impact on the Company's financial position,
results of operations and cash flows.

The Company is 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 the Company's financial position, results of operations
and cash flows.

46

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(14) SEGMENT DISCLOSURES

The Company has 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 2001, 2000 and 1999 is presented
below.

47

Hastings Entertainment, Inc. and Subsidiaries
Notes to Consolidated Financial Statements
January 31, 2002 and 2001
(Tabular amounts in thousands, except per share data or unless otherwise noted)

(15) INTERIM FINANCIAL RESULTS (UNAUDITED)

(a) The Company recorded pre-tax charges of approximately $0.5 million and $1.0
million in the third and fourth quarter of fiscal year 2001. These charges
related to the closing of superstores as described in Note 5.

(b) During the third and fourth quarter of fiscal 2000, the Company reviewed
the net deferred tax asset under the provisions set forth in Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes" (SFAS
109). Due to cumulative losses incurred in recent years, the current
balance of the net deferred tax asset did not meet the criteria for
recognition under SFAS 109. As a result, the Company recorded no income tax
benefit in the third quarter and recorded a valuation allowance of $3.7
million during the fourth quarter of fiscal 2000 to fully reserve the
balance of the net deferred tax asset. No income tax expense was recorded
related to income for fiscal year ending January 31, 2002 as these amounts
were recognized as a reduction of the deferred income tax benefit valuation
allowance.

(c) The Company recorded pre-tax charges of approximately $3.1 million and $3.4
million in the third and fourth quarter of fiscal year 2000. These charges
related to the closing of superstores as described in Note 5.

48

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

On September 22, 2000, with the recommendation of the Audit Committee and
approval of the Board of Directors, we dismissed KPMG, LLP (KPMG) as our
independent auditors. On October 19, 2000, we engaged Ernst and Young LLP as our
independent auditors. We filed reports on Form 8-K with the Securities and
Exchange Commission on September 29, 2000 and October 24, 2000 as a result of
these events, respectively.

49

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 2002 Annual Meeting of Shareholders, to be filed within 120 days after
the end of fiscal 2001 (our "Proxy Statement"), under the heading "Proposal No.
1: Election of Three Directors," which information is incorporated herein by
reference. 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. 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.

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

The information required by this item will be set forth in our Proxy Statement
under the heading "Security Ownership of Certain Beneficial Owners and
Management," 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.

50

PART IV

ITEM 14. 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..................................... 27
Consolidated Balance Sheets as of January 31, 2002 and 2001....... 29
Consolidated Statements of Operations for the years ended
January 31, 2002, 2001 and 2000................................. 30
Consolidated Statements of Shareholders' Equity for the years
ended January 31, 2002, 2001 and 2000........................... 31
Consolidated Statements of Cash Flows for the years ended
January 31, 2002, 2001 and 2000................................. 32
Notes to Consolidated Financial Statements........................ 33

2. The following financial statement schedules and other information
required to be filed by Items 8 and 14(d) of Form 10-K are
included in Part IV:

Schedule II - Valuation and Qualifying Accounts................... 53

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.

51

10.17 * (1) Form of Employment Agreement by and between the Company and
certain of its executives.

10.18 (2) 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 (3) Loan and Security Agreement dated August 29, 2000 between
Hastings Entertainment, Inc. and Fleet Retail Finance, Inc.,
Agent.

10.20 (5) International Swap Dealers Association, Inc. Master Agreement
between Hastings Entertainment, Inc. and Fleet National Bank

21.1 (1) Subsidiaries of the Company.

23.1 (5) Consent of Ernst and Young LLP

23.2 (5) Consent of KPMG LLP

24.1 (5) Powers of Attorney (included on signature page)

- ----------

(1) Previously filed as an exhibit to the Company's Registration Statement
on Form S-1 (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 Annual Report on Form
10-K, as amended, for the fiscal year ended January 31, 2000, and
incorporated herein by reference.

(3) 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.

(4) 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.

(5) Filed herewith.

(b) Reports on Form 8-K

(i) On January 31, 2002, the Company filed a current report on Form 8-K
reporting, under "Item 5. Other Information," the appointment of Daryl
Lansdale and Ann Lieff to its board of directors. In addition, the
Company announced the resignation of Craig Lentzsch from its board of
directors.

52

Financial Statement Schedule II -

HASTINGS ENTERTAINMENT, INC.
Valuation and Qualifying Accounts and Reserves
Years Ended January 31, 2002, 2001 and 2000
(Amounts in thousands)

(1) Total returns expense was $6.3 million, $12.2 million and $9.1 million for
the fiscal years 2001, 2000 and 1999, respectively. The table does not
include the cost of operating our return center ($1.8 million, $2.0 million
and $1.9 million for the fiscal years 2001, 2000 and 1999, respectively),
which is recorded directly to returns expense.

53

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 10, 2002 By: /s/ Dan Crow
--------------------------------------------
Dan Crow
Vice 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 and 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.

54

EXHIBIT INDEX