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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

(Mark One)

For the quarterly period ended April 30, 2003

OR

For the transition period from                                               to                                              

Commission File Number 000-24381

HASTINGS ENTERTAINMENT, INC.

(806) 351-2300
(Registrant’s telephone number, including area code)

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 12 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 o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

Number of shares outstanding of the registrant’s common stock, as of May 30, 2003:

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HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Form 10-Q for the Three Months Ended April 30, 2003

INDEX

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PART 1

ITEM 1 — FINANCIAL STATEMENTS

HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
April 30, 2003 and 2002, and January 31, 2003
(Dollars in thousands, except par value)

See accompanying notes to unaudited consolidated financial statements.

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HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Operations
For the Three Months Ended April 30, 2003 and 2002
(Dollars in thousands, except per share amounts)

See accompanying notes to unaudited consolidated financial statements.

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HASTINGS ENTERTAINMENT, INC. AND SUBSIDIARIES
Unaudited Consolidated Statements of Cash Flows
For the Three Months Ended April 30, 2003 and 2002
(Dollars in thousands)

See accompanying notes to unaudited consolidated financial statements.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
April 30, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)

1.     Basis of Presentation

The accompanying unaudited consolidated financial statements of Hastings Entertainment, Inc. and its subsidiaries (the “Company”, “We”, “Our”, “Us”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with instructions in Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such principles and regulations of the Securities and Exchange Commission. All adjustments, consisting only of normal recurring adjustments, have been made which, in the opinion of management, are necessary for a fair presentation of the results of the interim periods. The results of operations for such interim periods are not necessarily indicative of the results, which may be expected for a full year because of, among other things, seasonality factors in the retail business. The unaudited consolidated financial statements contained herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in our annual report on Form 10-K for the fiscal year 2002.

Certain prior year amounts have been reclassified to conform with fiscal 2003 presentation.

Our fiscal year ends on January 31 and is identified as the fiscal year for the immediately preceding calendar year. For example, the fiscal year that will end on January 31, 2004 is referred to as fiscal 2003.

2.     Consolidation Policy

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

3.     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.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
April 30, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)

The following schedule reflects the impact on net income (loss) and net income (loss) per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock based compensation (in thousands, except per share amounts)

4.     Store Closing Reserve

From time to time and in the normal course of business, we evaluate our store base to determine if a need to close a store(s) is present. Such evaluations include, among other factors, current and future profitability, market trends, age of store and lease status.

Amounts in accrued expenses and other liabilities at April 30, 2003 include accruals for the net present value of future minimum lease payments and other costs attributable to closed or relocated stores, net of estimated sublease income.

The following tables provide a rollforward of reserves that were established for these charges for the three months ended April 30, 2003 and 2002.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
April 30, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)

As of April 30, 2003, the reserve balance, which is net of estimated sublease income, is expected to be paid over the next seven years. Other costs are charged against the reserve as incurred.

5.     Income (Loss) per Share

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

Options to purchase 1,735,034 shares of common stock at exercise prices ranging from $1.27 per share to $14.03 per share outstanding at April 30, 2003 and options to purchase 532,620 shares of common stock at exercise prices ranging from $6.92 per share to $14.03 per share outstanding at April 30, 2002 were not included in the computation of diluted income per share because their inclusion would have been antidilutive.

6.     Litigation and Contingencies

In 2000, we restated our consolidated financial statements for the first three quarters of fiscal 1999 and the prior four fiscal years. Following the initial announcement in March 2000 of the requirement for such restatements, nine 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 were transferred to the Amarillo Division of the Northern District and were 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

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
April 30, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)

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.

On September 12, 2002, we announced that an agreement in principle to settle the actions described above had been reached. The settlement received final approval by the court on March 10, 2003. The settlement required a payment of $5.75 million on behalf of the defendants in the lawsuits ($3.15 million of which was funded from amounts remaining under our director and officer insurance policy after the payment of litigation expenses) and the assignment to the plaintiff settlement class of any claims the Company may have had against KPMG Peat Marwick, LLP, our outside auditors at the time of the March 7, 2000 announcement. The settlement resolves all claims against us, our current and former defendant officers and directors and the defendant underwriters. Based on the foregoing, we recorded loss contingencies of $2.5 million, or $0.22 per share, and $0.1 million, or $0.00 per share, during the second and fourth fiscal quarters of fiscal 2002, respectively. All amounts required by the settlement agreement were funded by January 31, 2003. The plaintiff settlement class separately settled all claims against KPMG.

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.

7.     Segment Disclosures

We have two operating segments, retail stores and Internet operations. Our chief operating decision maker, as that term is defined in the relevant accounting standard, regularly reviews financial information about each of the above operating segments for assessing performance and allocating resources. Revenue for retail stores is derived from the sale of merchandise and rental of videocassettes, video games and DVDs. Revenue for Internet operations is derived solely from the sale of merchandise. Segment information regarding our retail stores and Internet operations for the three months ended April 30, 2003 and 2002 is presented below.

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Hastings Entertainment, Inc. and Subsidiaries
Notes to Unaudited Consolidated Financial Statements
April 30, 2003 and 2002
(Tabular amounts in thousands, except per share data or unless otherwise noted)

8.     Change in Accounting Principle

In January 2003, the Emerging Issues Task Force (“EITF”) reached a consensus on Issue No. 02-16, “Accounting by a Customer (Including a Reseller) for Certain Consideration Received from a Vendor.” The issue provides guidelines for specific treatment and classification of certain amounts received by a customer from a vendor in connection with product purchased from the vendor. EITF 02-16 was effective prospectively for new arrangements entered into after December 31, 2002. Accordingly, during the first quarter of fiscal 2003, approximately $0.5 million, or $0.05 per diluted share, of our vendor advertising allowances have been recorded as a reduction of merchandise inventory and the cost of rental videos and will be recognized in cost of revenues as inventory is sold and as rental videos are rented. As a result of these changes, selling, general and administrative expenses were increased by approximately $0.9 million and total cost of revenues decreased $0.4 million during the first quarter of fiscal 2003.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATONS

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, the impact on our financial statements of any adjustment to fair value of interest rate swaps, inflation, effect of critical accounting policies including lower of cost or market for inventory adjustments, the returns process, rental video amortization, our store closing reserve, revenue recognition, accounting for vendor allowances, sufficiency of cash flow from operations and borrowings under our revolving credit facility and statements expressing general optimism about future operating results are forward-looking statements. Such statements are based upon company management’s current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to, whether our assumptions turn out to be correct, our inability to attain such estimates and expectations, a downturn in market conditions in any industry, including the current economic state of retailing, relating to the products we inventory, sell or rent, the effects of or changes in economic conditions in the U.S., including the impact of the war with Iraq, and or the markets in which we operate our superstores and our success in forecasting customer demand for products, any of which could cause actual results to differ materially from those described herein. We undertake no obligation to affirm, publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with our unaudited consolidated financial statements and the related notes thereto appearing elsewhere in the report.

General

Hastings Entertainment is a leading multimedia entertainment retailer that combines the sale of books, music, software, periodicals, videocassettes, video games and DVDs with the rental of videocassettes, video games and DVDs in a superstore and Internet Web site format. As of April 30, 2003, we operated 146 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 our superstores is company-operated under the name of Hastings.

Our operating strategy is to enhance our position as a multimedia entertainment retailer by expanding existing superstores, opening new superstores in selected markets, and expanding our offering of 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 ending January 31, 2004 is referred to as fiscal 2003.

Critical Accounting Policies

Our financial statements are prepared in accordance with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements, the disclosure of contingent 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 cost or market. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or

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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 market value is below cost. Through merchandising and an automated-progressive markdown program, we quickly take the steps necessary to increase the sell-off of slower moving merchandise to eliminate or lessen the effect of any LCM adjustments.

Returns Process. Merchandise inventory owned by us is generally returnable based upon return agreements with our merchandise vendors. We continually return merchandise to vendors based on, among other factors, current and projected sales trends, overstock situations, authorized return timelines or change in product offerings. At the end of any reporting period cost accruals are required for inventory that has been returned to vendors, or is in the process of being returned to vendors, or has been identified to be returned to vendors. These costs can include freight, valuation and quantity differences, and other fees charged by a vendor. In order to appropriately match the costs associated with the return of merchandise with the process of returning such merchandise, we utilize an allowance for cost of inventory returns (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.

Rental Video Cost Amortization. We have a series of direct revenue-sharing agreements with major studios and we anticipate that our future involvement in revenue-sharing agreements will be similar to that of fiscal year 2002. Revenue sharing allows us to acquire rental video assets at a lower up-front capital cost than traditional buying arrangements. We then share with studios a percentage of the actual net rental revenues generated over a contractually determined period of time. The increased access to additional copies of new releases under revenue-sharing agreements allows customer demand for new releases to be satisfied over a shorter period of time at a time when the new releases are most popular. Under the terms of the specific contracts with supplying studios, we expense revenue-sharing payments through rental video cost of revenue, as revenues are recognized. The capitalized cost of all rental video assets acquired for a fixed price is being amortized on an accelerated basis over six months to a salvage value of $4 per unit, except for rental video assets purchased for the initial stock of a new superstore, which are being amortized on a straight line basis over 36 months to a salvage value of $4.

Certain events, including a downturn in the rental video industry as a whole or in the markets within which we operate our superstores, further consolidation of rental video retailers, a change in the rental home video distribution window, which allows rental retailers an exclusive period of time to rent titles prior to being made available for pay-per-view, video on demand, and premium, basic cable, network and syndicated television, substantial change in customer demand and change in the mix of rental video revenues, could affect the salvage value we have assigned to our rental video assets. The effect could result in a material reduction of the carrying value of our rental video assets and have a material impact on the financial results of an annual or interim period. In particular, the growth of the DVD market and the shift of consumer purchases from VHS (videocassettes) to DVD could result in a decrease in the salvage value of rental videos. At some point during the rental cycle, a VHS item, as with DVD and games, is available for purchase by a customer as a previously viewed tape (“PVT”). Our current experience is that the amount received for the PVT is higher than our salvage value of that item in our rental inventory. Based in part on this factor and sales of PVTs, we believe our estimate of salvage value is appropriate.

Store Closing Reserve. On a quarterly basis, 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. The primary expense items associated with the closure of a store relate to the net present value of minimum lease payments (the present value of remaining lease payments under an active lease) and the write-off of leasehold improvements and other assets not remaining in our possession 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. We actively pursue sublease tenants on all closed or relocated locations and the impact of any sublease income is estimated in the determination of the incurred store closing reserve liability.

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Revenue Recognition. We generate revenue primarily from retail sales and rental of our products. Merchandise and rental revenues are recognized at the point of sale or rental or at the time merchandise is shipped to the customer. Revenues are presented net of estimated returns and exclude all taxes. Customers may return certain merchandise for exchange or refund within our policies, and an allowance has been established to provide for projected returns. There are no provisions for uncollectible amounts since payment is received at the time of sale. We, as with most retailers, also offer gift cards for sale. Deferred revenue, a current liability, is recognized at the time a gift card is sold with the costs of designing, printing and distributing the cards recorded as an expense as incurred. The deferred revenue liability is relieved and revenue is recognized upon the redemption of the gift cards. From time to time we will offer sales incentives, in the form of customer rebates, to customers. Revenue is reduced by the amount of estimated redemptions, based on experience of similar types of rebate offers, and a deferred revenue liability is established. The deferred revenue liability is relieved when the customer has completed all criteria necessary to file a valid rebate claim. Any remaining portion of deferred revenue is recorded as revenue following the termination of the extended redemption period and following completion of all outstanding rebate claims.

Comparable-Store Revenue. Stores included in the comparable-store revenues calculation are those stores that have been open for a minimum of 60 weeks. Also included are stores that are remodeled or relocated. Sales via the internet are not included and closed stores are removed from each comparable period for the purpose of calculating comparable-store revenues.

Vendor Allowances. In 2002, The Emerging Issues Task Force (“EITF”) discussed issue no. 02-16 (“EITF 02-16”), which addresses the accounting for cash consideration received from a vendor by a reseller for various vendor-funded allowances, including cooperative advertising support. The EITF determined that cash consideration received from a vendor should be presumed to be a reduction of the prices of vendor’s products and, therefore, should be shown as a reduction in the cost of goods sold when recognized in the reseller’s income statements. The only exceptions to this rule are if the reimbursement is for specific, incremental identifiable costs. If the amount of cash consideration received exceeds the cost being reimbursed, that excess amount should be characterized as a reduction of cost of goods sold when recognized in the reseller’s income statements. In January 2003, the EITF issued transition guidance concluding that this interpretation should be applied to all new or modified arrangements entered into after December 31, 2002. We adopted EITF 02-16 and the results of such adoption are reflected in the interim and annual reporting periods beginning with the first quarter of fiscal 2003 ending April 30, 2003. Accordingly, during the first quarter of fiscal 2003, approximately $0.5 million, or $0.05 per diluted share, of our vendor advertising allowances have been recorded as a reduction of merchandise inventory and the cost of rental videos and will be recognized in cost of revenues as inventory is sold and as rental videos are rented. As a result of these changes, selling, general and administrative expenses were increased by approximately $0.9 million and total cost of revenues decreased $0.4 million during the first quarter of fiscal 2003.

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Results of Operations

The following tables present our statement of operations data, expressed as a percentage of revenue, and the number of superstores open at the end of the periods presented herein.

Summary of Superstore Activity

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Three months ended April 30, 2003 compared to three months ended April 30, 2002

Revenues. Total revenues increased $4.0 million, or 3.5%, for the first quarter of fiscal 2003 to $116.8 million compared to $112.8 million a year ago. This increase was primarily due to an increase in comparable store revenues (“Comps”) for rental video of 9.5% and an increase in the number of stores operating at April 30, 2003 to 146 compared to 141 at April 30, 2002. Our Comp revenue changes were detailed as follows:

Total merchandise revenue increased $1.5 million, or 1.6%, to $91.5 million compared to $90.0 million last year. Music Comps declined (11.8%) as the music industry overall posted a decline of approximately (10%) in units shipped for the first three months of the calendar year and continues to battle on-line and physical music piracy. In addition, book Comps declined (5.4%), which was below our internal projections, reflecting a general book-retail industry downturn during the first quarter of fiscal 2003. Partially offsetting these Comp decreases were increases in gross revenue for DVD and video games of 47.2% and 98.2%, respectively, for the three months ended April 30, 2003 over the same period in the prior year.

The increase in rental video Comps was primarily the result of titles released during the first quarter of fiscal 2003 having significantly stronger box-office revenues than those titles released during the first quarter of fiscal 2002, which resulted in higher rental transactions. Rentals of DVD titles increased 61.5% during the first quarter of fiscal 2003 when compared to the first quarter of fiscal 2002. This increase was partially offset by a decline in rentals of titles in VHS format of 18.7% quarter over quarter. The acceptance of DVD by the consumer is the primary reason for the decline in VHS rental revenue, but part of the decline resulted from studios increasing the percentage of rental titles released simultaneously for sale at a lower price-point, which entices the consumer to purchase a title instead of renting.

Gross Profit. Total gross profit of $38.5 million in the first quarter of fiscal 2003 increased $0.9 million, or 2.2%, from $37.6 million in the first quarter of fiscal 2002. Total gross profit as a percentage of total revenue decreased slightly to 32.9% for the first quarter of fiscal 2003 compared to 33.3% for the first quarter of fiscal 2002.

Merchandise margins as a percent of merchandise revenue decreased to 25.1% for the current quarter from 26.4% for the same quarter last year. Significant components of this decrease were:

	(i)		an increase in freight expense resulting from higher shipping costs which, even though $1.4 million higher than the first quarter of fiscal 2002, was in line with our internal projections;
	(ii)		an increase of approximately $0.6 million in the cost associated with the return of product; and
	(iii)		a decrease of approximately $0.5 million in certain trade and purchase discounts.

Partially offsetting these decreases in merchandise gross profit was a decrease in merchandise shrinkage of approximately $0.9 million.

Rental video gross profit dollars increased $1.7 million to $15.5 million, or 60.9% of rental video revenues, for the current quarter from $13.8 million, 60.4% of rental video revenues, for the same quarter last year. This increase was primarily the result of revenue from non-revenue sharing titles, which generally reflect higher margins, representing a higher percentage of total rental revenues, and improved margins on videos acquired under revenue sharing agreements. Partially offsetting this increase in rental video gross profit was higher rental video shrinkage of $0.5 million.

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Selling, General and Administrative Expenses. Selling, general and administrative expenses for the quarter ended April 30, 2003 increased $2.4 million to $39.0 million, or 33.4% of total revenue, up from $36.6 million, or 32.4% of total revenue, for the quarter ended April 30, 2002. This increase was primarily the result of:

	(i)		an increase in advertising costs of approximately $1.5 million during the first three months of fiscal 2003 compared to the same period in fiscal 2002, which was primarily comprised of approximately $0.9 million from the adoption of EITF 02-16 and $0.6 million from increased advertising expenditures in an attempt to offset the impact of the war and soft merchandise sales during the first quarter of fiscal 2003;
	(ii)		an increase of approximately $0.5 million, which resulted from the operation of a greater number of superstores during the first quarter of fiscal 2003 compared to the first quarter of fiscal 2002; and
	(iii)		an increase of approximately $0.5 in costs associated with the remodeling and expansion of our existing superstores.

Interest Expense. Interest expense remained unchanged at $0.5 million for the three months ended April 30, 2003 compared to the three months ended April 30, 2002.

Income Taxes. No income tax effect was recorded during the first quarters of fiscal 2003 and 2002 due to adjustments in the valuation allowance related to the net deferred tax asset.

Liquidity and Capital Resources

We generate cash from operations exclusively from the sale of merchandise and the rental of video products and we have substantial operating cash flow because most of our revenue is received in cash and cash equivalents. Other than our principal capital requirements arising from the purchase, warehousing and merchandising of inventory and rental videos, opening new superstores and expanding existing superstores and updating existing and implementing new information systems technology, we have no anticipated material capital commitments. Our primary sources of working capital are cash flow from operating activities, trade credit from vendors and borrowings under our revolving credit facility. Based on our current internal projections, we believe our cash flow from operations and borrowings under our revolving credit facility will be sufficient to fund our ongoing operations, new superstores and superstore expansions through fiscal 2005.

Consolidated Cash Flows

	Operating Activities. Net cash flows from operating activities increased $12.3 million from $0.8 million for the three months ended April 30, 2002 to $13.1 million for the three months ended April 30, 2003. The primary reason for the increase was a greater reduction in merchandise inventories of approximately $8.6 million during the first quarter of fiscal 2003 compared to the first quarter of fiscal 2002 resulting from planned initiatives to lower inventory levels. Also contributing to the increase in net cash flows from operating activities was a lesser decline in trade accounts payable of approximately $3.3 million during the first quarter of fiscal 2003 compared to the first quarter of fiscal 2002 primarily resulting from a higher level of payments for seasonal products being processed in January 2003. Payments for similar products were made during the first quarter of fiscal 2002.
	Investing Activities. Net cash used in investing activities decreased $1.1 million to $12.2 million for the three months ended April 30, 2003 from $13.3 million for the three months ended April 30, 2002. This decrease was primarily the result of higher purchases of DVD titles under revenue sharing agreements, which generally cost less per unit than non-revenue sharing DVD units.
	Financing Activities. Cash provided by or used in financing activities is primarily associated with borrowings and payments made under debt agreements. For the three months ended April 30, 2003, net payments under debt agreements were $2.4 million compared to net borrowings of $14.7 million for the three months ended April 30, 2002. This difference was the result of those items described under Operating and Investing Activities above.

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Capital Structure. On August 23, 2002, we executed an amendment to our syndicated secured Loan and Security Agreement with Fleet Retail Finance, Inc. and The CIT Group/Business Credit, Inc, (the “Facility”). The amount outstanding under the Facility is limited by a borrowing base predicated on eligible inventory, as defined, and certain rental video assets, net of accumulated depreciation less specifically defined reserves and is limited to a ceiling of $80 million, less a $10 million availability reserve. The Facility’s interest rate is based on the prevailing prime rate or LIBOR plus a margin percentage, 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 can 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 matures on August 20, 2005. At April 30, 2003, we had $20.5 million in excess availability, after the $10 million availability reserve, under the Facility. At April 30, 2003 and January 31, 2003, respectively, we had borrowings outstanding of $43.3 million and $45.7 million under the Facility. The average rate of interest being charged under the Facility was 3.5% and 4.1% at April 30, 2003 and January 31, 2003, respectively.

From time to time, we enter into interest rate swap agreements in order to obtain a fixed interest rate on a portion of our outstanding floating rate debt thereby reducing our exposure to interest rate volatility. On October 4, 2002, we cancelled, at no cost, two swap agreements entered into in November and December of 2001 with an aggregate notional amount of $20 million and replaced those agreements with one interest rate swap agreement with a financial institution. The notional amount of the swap is $20 million with a fixed interest rate of 2.45% for two years. We have designated the interest rate swap as a hedging instrument. At April 30, 2003, the fair value of the interest rate swap was not significant.

At April 30, 2003, our minimum operating lease commitments remaining for fiscal 2003 were approximately $13.3 million. The present value of total existing minimum operating lease commitments for fiscal years 2004 through 2018 discounted at 9.0% was approximately $64.8 million as of April 30, 2003.

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 events, such as the war in Iraq, 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 store 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 retailers in general and Hastings in particular.

We do not believe that inflation has materially impacted operating results 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.

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ITEM 3. 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 April 30, 2003 outstanding balance of the variable rate debt would be approximately $0.2 million, including the effect of our interest rate swap. After an assessment of these risks to our operations, we believe that the primary market risk exposures (within the meaning of Regulation S-K Item 305) are not material and are not expected to have any material adverse impact on our financial position, results of operations or cash flows for the next fiscal year. In addition, we do not believe changes in the fair value of our interest rate swap entered into in October of 2002 with a notional amount of $20 million will be material.

ITEM 4. CONTROLS AND PROCEDURES

Within 90 days prior to the date of the filing date of this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-14(c) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by us in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. We note that the design of any system of controls is based in part upon certain assumptions about the likelihood of future occurrences and there can be no assurance that any design will succeed in obtaining its stated goals under all possible circumstances.

Subsequent to the date of their evaluation, we did not make any significant changes in, nor take any corrective actions regarding, our internal controls or other factors that could significantly affect these controls.

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PART II

ITEM 1. 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 the initial announcement in March 2000 of the requirement for such restatements, nine 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 were transferred to the Amarillo Division of the Northern District and were 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.

On September 12, 2002, we announced that an agreement in principle to settle the actions described above had been reached. The settlement received final approval by the court on March 10, 2003. The settlement required a payment of $5.75 million on behalf of the defendants in the lawsuits ($3.15 million of which was funded from amounts remaining under our director and officer insurance policy after the payment of litigation expenses) and the assignment to the plaintiff settlement class of any claims the Company may have had against KPMG Peat Marwick, LLP, our outside auditors at the time of the March 7, 2000 announcement. The settlement resolves all claims against us, our current and former defendant officers and directors and the defendant underwriters. Based on the foregoing, we recorded loss contingencies of $2.5 million, or $0.22 per share, and $0.1 million, or $0.00 per share, during the second and fourth fiscal quarters of fiscal 2002, respectively. All amounts required by the settlement agreement were funded by January 31, 2003. The plaintiff settlement class separately settled all claims against KPMG.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a.		Listing of exhibits
*99.1		Certifications Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
b.		On April 23, 2003, the Company filed a current report on Form 8-K reporting, under “Item 9. Regulation FD Disclosure,” the officer certification of financial information required by 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized:

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CERTIFICATIONS

I, John H. Marmaduke, President and Chief Executive Officer (Principal Executive Officer) of Hastings Entertainment, Inc., certify that:

1.		I have reviewed this quarterly report on Form 10-Q of Hastings Entertainment, Inc.;
2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a.		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b.		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c.		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and audit committee of registrant’s board of directors (or persons performing the equivalent function):

	a.		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b.		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.

The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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I, Dan Crow, Vice President and Chief Financial Officer (Principal Financial and Accounting Officer) of Hastings Entertainment, Inc., certify that:

1.		I have reviewed this quarterly report on Form 10-Q of Hastings Entertainment, Inc.;
2.		Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.		Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.		The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

	a.		designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
	b.		evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
	c.		presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5.

The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and audit committee of registrant’s board of directors (or persons performing the equivalent function):

	a.		all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
	b.		any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.

The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

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INDEX TO EXHIBITS

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