Hastings Entertainment, Inc. (the “Company”) is a leading multimedia entertainment retailer. We operate entertainment stores that buy, sell, trade, and rent various home entertainment products, including books, music, software, periodicals, new and used CDs, DVDs, books, video games and videocassettes, video game consoles and DVD players. As of March 31, 2006, we operated 153 stores in small- to medium-sized markets located in 20 states, primarily in the Western and Midwestern United States. We also operate a multimedia entertainment e-commerce Web site offering a broad selection of books, music, software, videocassettes, video games and DVDs. We operate two wholly-owned subsidiaries: Hastings Properties, Inc. and Hastings Internet, 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, 2006 is referred to as fiscal 2005.
Industry Overviews
Music . According to the Recording Industry Association of America (“RIAA”), total CD shipments by manufacturers to retailers decreased 8.1% to $10.5 billion in 2005 compared to $11.4 billion in 2004. This decrease is primarily attributable to an increase in digital downloads. Including digital downloads, the retail value of physical and digital formats decreased slightly from $12.34 billion in 2004 to $12.27 billion in 2005, or 0.6%. The music industry has continually tried to battle online piracy, a force that has sparked the negative trend in years prior to 2005.
Books . The Association of American Publishers estimates that total book industry sales rose 9.9% in 2005, to an estimated $25.1 billion, up from approximately $22.8 billion in 2004. The adult hardcover segment increased 1.4% to $2.2 billion and adult paperbound publications increased 9.5% to $1.1 billion. Building upon these gains were strong increases in the juvenile hardcover segment of 59.6% to $3.6 billion, due to a popular Harry Potter release in fiscal 2005, but not in 2004.
Rental Video . According to estimates from Paul Kagan Associates (“Kagan”), consumer spending on rental video, including in-store and online rentals, remained stable at $8.1 billion for both 2005 and 2004. Kagan projects that video rental revenues will decline from $8.1 billion in 2005 to approximately $6.7 billion by 2010; however, due to many variables, it is difficult to project the fluctuations in the industry. We believe rental video will remain a viable revenue source for the following reasons:
| (i) | Despite increases in the sale of movies detailed below under “Sale Video and Video Games,” according to Kagan, rental transactions continued to exceed sales transactions during 2005. For the industry, rental transactions represented approximately 64.4% of total rental and sell-through transactions during 2005 compared to approximately 69.6% in 2004. We believe renting videos provides consumers with low-cost entertainment, a factor that will continue to drive rental transactions in the future. | ||
| (ii) | DVD continued its accelerated acceptance rate with DVD households as a percentage of U.S. television households approximating 75% in 2005 compared to approximately 65% in 2004. Kagan projects that this number will increase to approximately 84% in 2006 and exceed 94% by 2010. This penetration is moving far beyond consumers that were early adopters of the DVD format, and with price points on DVD hardware continuing to decline, we believe more consumers will be renting classic movies and personal favorites in the DVD format for the first time. We also believe that later-adopting DVD households are less likely to purchase DVDs at the high rates of early-adopters. | ||
| (iii) | We believe that the DVD format, with its superior picture and sound quality compared to previous movie formats, as well as extra features such as outtakes, director commentary and scene selection, will drive continued growth in the industry. | ||
| (iv) | We believe rental video will continue to be a favored entertainment medium for millions of consumers due to its relatively inexpensive price points, broad selection of new release and catalog (older) movies and ability for “viewer control” of the experience (i.e., start, stop, scene selection, and audio setup). | ||
| (v) | We believe video game rentals will continue to play an important role in the rental industry. Due to the relatively high purchase prices for game software, rental pricing is an attractive option for consumers, especially those wanting to preview a game prior to making a purchase. |
Sale Video and Video Games . According to Kagan, total industry revenues for the sale of DVD and VHS increased approximately 15.4% to $18.7 billion during 2005 compared to $16.2 billion in 2004. This increase resulted primarily from substantially all DVD products being released at prices low enough that consumers could purchase a title at the same time it becomes available for rent. This lower pricing has enabled consumers to build their video libraries and has helped turn casual movie watchers into collectors.
According to the NPD Group, total sales for the video game industry, including portable and console hardware, software and accessories, increased 6% to $10.5 billion in 2005 compared to $9.9 billion in 2004. In 2005, portable game hardware, software, and accessories experienced strong gains of 96%, 42%, and 88%, respectively, and were primarily attributable to Nintendo’s Game Boy Advance, which accounted for 52% of portable software sales. These gains were partially offset by declining sales of console hardware, software, and accessories of 3%, 12%, and 8%, respectively, due primarily to a widely-publicized hardware inventory shortage during the 2005 holiday season.
Business Strategy
Our goal is to enhance our position as a leading multimedia entertainment retailer primarily in small- to medium-sized communities by expanding and remodeling existing stores, opening new stores in selected markets and to a lesser extent, offering our products through the Internet. Each element of our business strategy is designed to build consumer awareness of the Hastings concept and achieve high levels of customer loyalty and repeat business. We believe the key elements of this strategy are the following:
Superior Multimedia Concept. Our stores present a wide variety of product categories with individual products tailored to local preferences in a dynamic and comfortable store atmosphere with exceptional service. Our diverse product categories allow us to more effectively respond to downturns in individual industries. Our stores average approximately 20,000 square feet of sales space, with our new stores generally ranging in size from 15,000 to 25,000 square feet of sales space. Our stores offer customers an extensive product assortment customized for a specific store. Below is a listing of the approximate minimum and maximum title selections for our stores:
| Minimum | Maximum | |||||||
| Product Category | Title Count | Title Count | ||||||
Books |
11,000 | 72,000 | ||||||
Music |
7,000 | 30,000 | ||||||
Sale VHS, DVD and Video Games |
6,000 | 17,000 | ||||||
Rental VHS, DVD, Video Games |
10,000 | 20,000 | ||||||
Used CDs, DVD, Video Games |
4,000 | 28,000 | ||||||
Used Books |
1,000 | 23,000 | ||||||
Boutique, Consumables and Accessories |
3,000 | 8,000 | ||||||
Periodicals |
1,000 | 4,000 | ||||||
Software |
— | 1,000 | ||||||
The following table shows our revenue mix as a percentage of total revenues for the last three fiscal years:
| Fiscal Year | ||||||||||||
| Product Category | 2005 | 2004 | 2003 | |||||||||
Music |
25 | % | 25 | % | 26 | % | ||||||
Books |
22 | % | 22 | % | 23 | % | ||||||
Video |
19 | % | 18 | % | 17 | % | ||||||
Rental |
17 | % | 19 | % | 20 | % | ||||||
Video Games |
9 | % | 8 | % | 6 | % | ||||||
Boutique |
4 | % | 4 | % | 4 | % | ||||||
Consumables |
3 | % | 2 | % | 2 | % | ||||||
Other |
1 | % | 2 | % | 2 | % | ||||||
All stores carry a core product assortment for each product category that is supplemented with tailored components to accommodate the particular demographic profile of the local market in which the store 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 efficiently add exciting new entertainment categories to our product line.
Small to Medium-Sized Market Focus. We target small- to medium-sized markets with populations generally less than 50,000 where our extensive product selection in both new and used products, low pricing strategy, ability to trade-in, 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 stores present an opportunity to profitably operate and expand our unique entertainment store format. We base our merchandising strategy for our stores on an in-depth understanding of our customers and our individual markets. We strive to optimize each store’s merchandise selection by using our proprietary information systems to analyze the sales history, anticipated demand and demographics of each store’s market. In addition, we utilize flexible layouts that enable each store to present our products according to local interests and to customize the layout in response to new customer preferences and product lines.
Customer-Oriented Format. We design our stores to provide an easy-to-shop, open store atmosphere by offering major product categories in a “store-within-a-store” format. Most of our stores position product with customer affinities together around a wide racetrack aisle or three-across departments (e.g., books, music and video) that are designed to allow customers to view the entire store. Currently 80 stores utilize some form of the three-across format and the Company plans to expand this model to an additional 10 stores in fiscal 2006. 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 continued to invest in our line of Hard Back Cafes. At January 31, 2006, we had 60 Hard Back Cafes serving fine gourmet coffee and pastries, many of which allow the customer to place drive-thru orders, and have plans for an additional nine stores to open Hard Back Cafes in Fiscal 2006. Stores without Hard Back Cafes have incorporated other amenities, such as chairs for reading, soft drinks and snacks, music auditioning stations, interactive information kiosks, telephones for free local calls, children’s play areas and in-store promotional events.
Low Pricing. Our pricing strategy is to offer value to our customers by maintaining low prices that are competitive with or lower than the prices charged by other retailers in the market. We determine our prices on a market-by-market basis, depending on the level of competition and other market-specific considerations. We believe that our low pricing structure results in part from (i) our ability to purchase a majority of our products directly from publishers, studios and manufacturers as opposed to purchasing from distributors, (ii) our proprietary information systems, to which we have made improvements that have enabled management to make more precise and targeted purchases and pricing for each store, and (iii) our consistent focus on maintaining low occupancy and operating costs.
Used and Budget-Priced Products. Since 1992, we have bought or traded for customers’ CDs to sell as used product in order to leverage the value of our CD offering. Since 2001, we have added DVDs and video games to our used product offering. In addition to used products, we offer budget-priced products in all of our major product categories to provide enhanced value to our customers. During fiscal 2005 and 2004, we generated approximately 9.4% and 8.3%, respectively, of our total revenues from used and budget-priced products. During fiscal 2005, we tested buying and selling used books in 14 stores. Due to the program’s initial success, we plan to expand the program to an additional 23 stores in fiscal 2006. We believe our multimedia store concept will enhance our offering of used and budget products allowing the customer to choose between a new or a less expensive used copy of the same title.
Internet. Augmenting our store offering, we operate an e-commerce Internet Web site ( www.gohastings.com ). Our site enables customers to electronically access more than 1,000,000 new and used entertainment products and unique, contemporary gifts. Additionally, we fill Internet orders for used products placed at www.gohastings.com and Amazon Marketplace through Hastings’ iShip program in which 23 stores participate and ship product directly from store inventories. We plan to expand this program to an additional 20 stores in fiscal 2006. Our site features exceptional product and pricing offers, search and auditioning capabilities, and digital downloading of music selections. The Web site is designed to fully integrate into a store kiosk to leverage both the physical and digital shopping experience. The site also features an Investor Relations section with links to past press release information and filings with the Securities and Exchange Commission, including officer certifications of financial information listed as exhibits to such filings.
Expansion Strategy
We plan to open two stores, expand or relocate 12 stores, and remodel 23 stores to accommodate our used book initiatives during fiscal 2006. We have identified potential locations for future stores in under-served, small- to medium-sized markets that meet our new-market criteria. We believe that with our current information systems and distribution capabilities, our infrastructure can support our anticipated rate of expansion and growth for at least the next several years.
Merchandising Strategy
Hastings Entertainment is a leading entertainment retailer. Our core business categories of music, books, videos, video games, boutique, and consumables are unique in the marketplace. These core categories, supplemented by our video and video game rental business and the ability of our customers to buy, sell, and trade used products, create a store environment that appeals to a broad customer base and positions our stores as destination entertainment stores in our targeted small to medium-sized markets.
The specific merchandise mix within our core product categories is continually refined to reflect changing trends and new technologies. Product assortments are tailored to match the local demographic profiles with our customers’ needs at the community level kept in mind. This store level profiling is accomplished through our proprietary purchasing, inventory management, selection, and database management systems.
Information System
Our information system is based on technology that allows for communication and exchange of current information among all locations, corporate and retail, via a wide-area network. The primary components of the information system are as follows:
New Release Allocation. Our buyers use our proprietary new release allocation system to purchase new release products for the stores and have the ability within the system to utilize multiple methods of forecasting demand. By using store-specific sales history, factoring in specific market traits, applying sales curves for similar titles or groups of products and minimizing subjectivity and human emotion from a transaction, the system customizes purchases for each individual store to satisfy customer demand. The process provides the flexibility to allow us 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 store at the appropriate time to satisfy customers’ entertainment needs.
Rental Asset Purchasing System. Our proprietary rental asset purchasing system uses store-specific performance on individual rental titles to anticipate customer demand for new release rental titles. 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 store. The system also allows for the customized purchasing of other catalog rental 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 asset purchasing system allows us to efficiently plan and stock each store’s rental asset inventory, thereby improving performance and reducing exposure from excess inventory.
Store Replenishment. Store replenishment covers three main areas for controlling a store’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 store. By forecasting annual sales of products and consolidating recommendations from store management, the system enables us to identify overstocked or understocked items, prompt required store actions and optimize inventory levels. The system tailors each store’s individual inventory to the market, utilizing over 1,200 product categories, configurations and product status.
Model Stock Calculation/Ordering. Model stock calculation uses store-specific sales, seasonal trends and sophisticated-sales curve fitting to forecast orders. It also accounts for turnaround time from a vendor or our distribution center and tracks historical missed sales to adjust orders to adequately fulfill sales potential. Orders are currently calculated on a weekly basis and transmitted by all stores to the corporate office to establish a source vendor for the product.
Inventory Management. Inventory management systems interface with other store systems and accommodate electronic receiving and returns to maintain perpetual inventory information. Cycle counting procedures allow us to perform all physical inventory functions, including the counting of each store’s inventory up to two times per year. The system provides feedback to assist in researching any variances.
Store Systems. Each store has a dedicated server within the store for processing information connected through a wide area network. This connectivity provides consolidation of individual transactions and allows store management and corporate office associates easy access to the information needed to make informed decisions. Transactions at the store are summarized and used to assist in staff scheduling, loss prevention and inventory control. All point of sale transactions utilize scanning technology, allowing for maximum customer efficiency at checkout. During fiscal 2004 we installed chain wide a new labor scheduler software system. The Windows-based software, among other things, requires less time of the store manager to maintain, provides improved measurement and reporting of budget to scheduled and actual labor, and creates review- and exception-based reports at the corporate office for management monitoring.
Accounting and Finance. Our financial accounting software allows us to prepare a variety of management reports covering store and corporate performance. Detailed financial information for each store, as well as for warehouse units, which include our distribution and returns facilities, and the corporate office, are generated on a monthly basis.
Warehouse Management. Our warehouse management system provides for increased product picking and shipping efficiencies, faster product introduction and movement from dock to store shipment. The increased level of detail reporting in our new system allows us to refine product movement within the four walls, effectively manage the cost per unit transactions, and increase on-hand accuracy. It has simplified data sharing across the enterprise, and includes event management, analysis and reporting capabilities.
Distribution and Vendors
Our distribution center is located in a 149,000 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 store. The distribution center also is used in distributing large purchases, including forward buys, closeouts and other bulk purchases. In addition, the distribution facility is used to receive, process and ship items to be returned to manufacturers and distributors, as well as the rebalancing of merchandise inventories among our stores. This facility currently provides inventory to all Hastings stores 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 store, 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 vendors to the stores.
Our information systems and corporate infrastructure facilitate our ability to purchase products directly from manufacturers, which contributes to our low-pricing structure. In fiscal 2005, we purchased the majority of our products directly from manufacturers, rather than through distributors. Our top three vendors accounted for approximately 19% of total products purchased during fiscal 2005. While selections from a particular artist or author generally are produced by a single studio or publisher, we strive to maintain vendor relationships that can provide alternate sources of supply. Products we purchase are generally returnable to the supplying vendor. Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation – General” for a description of our returns process.
Store Operations
Most of our stores employ one store manager, one assistant store manager, and one book manager. Store managers and assistant store managers are responsible for the execution of all operational, merchandising and marketing strategies for the store in which they work. Stores also generally have department leaders, who are individually responsible for their respective music, software, video, customer service and stocking departments within each store. Hastings stores are generally open daily from 10:00 a.m. to 11:00 p.m. However, several stores 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 stores are closed are Thanksgiving and Christmas.
Competition
Hastings Entertainment competes, within our trading areas, with all mass and specialty music, book, video, and video game retailers. Additionally, Hastings Entertainment competes with video and video game rental stores and both Internet retail and rental businesses operating in our core product categories.
Trademarks and Servicemarks
We believe our trademarks and servicemarks, including the marks “Hastings Books Music Video;” “Hastings Your Entertainment Superstore;” “Hard Back Café” word mark only, word mark with design in color, and word mark with design in black and white; “Hastings Discover Your Entertainment” word mark with design in color and word mark in black and white have significant value and are important to our marketing efforts. We have registered “Hastings Books Music Video” and “Hastings Your Entertainment Superstore” as servicemarks with the United States Patent and Trademark Office (“USPTO”) and have filed applications for registration with the USPTO with respect to the marks “Hard Back Café” word mark only, word mark with design in color, and word mark with design in black and white; and “Hastings Discover Your Entertainment” word mark with design in color and word mark in black and white. We are currently claiming common law rights in the marks “Buy Sell Trade Rent,” “Hastings Hard Back Café,” and “Hastings Your Entertainment Superstore Hard Back Café.” We maintain a policy of pursuing registration of our principal marks and opposing any infringement of our marks.
Associates
We refer to our employees as associates because of the critical role they play in the success of each Hastings store and the Company as a whole. As of January 31, 2006, we employed approximately 6,344 associates, of which 1,940 are full-time and 4,404 are part-time associates. Of this number, approximately 5,833 were employed at retail stores, 245 were employed at our distribution center and 266 were employed at our corporate offices. None of our associates is represented by a labor union or subject to a collective bargaining agreement. We believe that our relations with our associates are good.
Executive Officers of the Company
Below is certain information about the executive officers of Hastings Entertainment, Inc.
| Name | Age | Position | ||||
John H. Marmaduke
|
58 | Chairman of the Board, President and Chief Executive Officer | ||||
Michael Rigby
|
50 | Senior Vice President of Merchandising | ||||
Dan Crow
|
59 | Vice President of Finance and Chief Financial Officer | ||||
Jeff Ostler
|
42 | Vice President of Stores | ||||
Alan Van Ongevalle
|
38 | Vice President of Information Technology & Distribution | ||||
Kevin Ball
|
49 | Vice President of Marketing | ||||
All executive officers are chosen by the Board of Directors and serve at the Board’s discretion. Information concerning the business experience of our executive officers is as follows:
John H. Marmaduke, age 58, has served as President and Chief Executive Officer of the Company since July 1976 and as Chairman of the Board since October 1993. Mr. Marmaduke served as President of the Company’s former parent company, Western Merchandisers, Inc. (“Western”), from 1982 through June 1994, including the years 1991 through 1994 when Western was a division of Wal-Mart Stores, Inc. Mr. Marmaduke also serves on the board of directors of the Interactive Entertainment Merchants Association. Mr. Marmaduke has been active in the entertainment retailing industry with the Company and its predecessor company for over 30 years.
Michael Rigby, age 50, has served as Senior Vice President of Merchandising for the Company since December 7, 2005. Mr. Rigby most recently served for five years as Senior Vice President of Alliance Entertainment Corporation (AEC), the largest wholesale distributor of prerecorded music and movies in the nation. Previously, Mr. Rigby spent four years as President and CEO of Fresh Picks, Inc., a provider of retail music and movie category management services to the supermarket sector, as well as four years as Senior National Buyer with Circuit City Stores, Inc.
Dan Crow, age 59, has served as Vice President of Finance and Chief Financial Officer of the Company since October 2000. From July of 2000 to October 2000, Mr. Crow served as Vice President of Finance. Mr. Crow is a member of the American Institute of Certified Public Accountants and Financial Executives International.
Jeff Ostler, age 42, has served as Vice President of Stores for the Company since August 16, 2005. Mr. Ostler previously served as Division Vice President, Retail Operations of Dollar General Corporation and most recently as Vice President, Store Operations for Denninghouse, Inc., a Canadian corporation operating discount stores under the business name “Buck or Two.”
Alan Van Ongevalle, age 38, has served as Vice President of Information Technology and Distribution since February 2003. From August 2002 to February 2003, Mr. Van Ongevalle served as Vice President of Marketing and Distribution. From May 2000 to August 2002, Mr. Van Ongevalle served as Vice President of Marketing. From August 1999 to May 2000, Mr. Van Ongevalle served as the Senior Director of Marketing and as Director of Advertising from September 1998 to August 1999. Mr. Van Ongevalle joined Hastings in November 1992 and held various store operation management positions including Store Manager, Director of New Stores and the Southern Kansas area through September 1998.
Kevin Ball, age 49, has served as Vice President of Marketing of the Company since May of 2004. From 2001 to 2004, Mr. Ball served as Vice President of Marketing at Organized Living, a specialty retailer of home organization products, headquartered in Kansas City. From 2000 to 2001, Mr. Ball held the position of Vice President of Marketing at Crown Books in Washington, D.C. and from 1995 to 2000 was the Director of Marketing at Trans World Entertainment in Albany, N.Y.
Available Information
We file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission. The public may read and copy any materials we file with the SEC at the SEC’s public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC. The address of that site is ( www.sec.gov ).
The address of our Internet Web site is ( www.gohastings.com ) and through the links on the Investor Relations portion of our Web site, we make available free of charge our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and other items filed with the SEC pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934. Such material is made available through our Web site as soon as reasonably practicable after we electronically file with or furnish the material to the SEC. In addition, links to press releases, our board committee charters and our code of ethics for financial and other executive officers are posted in the Investor Relations section.
ITEM 1A. RISK FACTORS.
CAUTIONARY STATEMENTS
The value of an investment in the Company involves significant risks and uncertainties. The following cautionary statements and other information included in this Annual Report on Form 10-K should be carefully considered. The risks and uncertainties described below are not the only ones we face. Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations. If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected.
Our growth is dependent on our ability to execute our expansion strategy.
Our growth strategy is dependent principally on our ability to open new stores and remodel, expand and/or relocate certain of our existing stores and operate them profitably. In general, the rate of our expansion depends, among other things, on general economic and business conditions affecting consumer confidence and spending, the availability of qualified management personnel and our ability to manage the operational aspects of our growth. It also depends upon the availability of adequate capital, which in turn depends in a large part upon the cash flow generated from operations.
Our future results will depend, among other things, on the success in implementing our expansion strategy. If stores are opened more slowly than expected, sales at new stores reach targeted levels more slowly than expected (or fail to reach targeted levels) or related overhead costs increase in excess of expected levels, our ability to successfully implement our expansion strategy would be adversely affected.
Our business is dependent upon renewing or entering into new leases on favorable terms.
All of the Company’s stores are located in leased premises. If the cost of leasing existing stores increases, the Company cannot assure that it will be able to maintain its existing store locations as leases expire. In addition, the Company may not be able to enter into new leases on favorable terms or at all, or it may not be able to locate suitable alternative sites or additional sites for new store expansion in a timely manner. The Company’s revenues and earnings may decline if the Company fails to maintain existing store locations, enter into new leases, locate alternative sites or find additional sites for new expansion.
Our business is highly seasonal.
As is the case with many retailers, a significant portion of our revenues, and an even greater portion of our operating profit, is generated in the fourth fiscal quarter, which includes the holiday selling season. As a result, a substantial portion of our annual earnings has been, and will continue to be, dependent on the results of this quarter. Less than satisfactory net sales for such period could have a material adverse effect on the Company’s financial condition or results of operations for the year and may not be sufficient to cover any losses that may have been incurred in the first three quarters of the year. We experience reduced rental activity in the spring because customers spend more time outdoors. Major world or sporting events, such as the Super Bowl, the Olympic Games or the World Series, also have a temporary adverse effect on revenues. Future operating results may be affected by many factors, including variations in the number and timing of store openings, the number and popularity of new book, music and video titles, the cost of the new release or “best renter” titles, changes in comparable-store revenues, competition, marketing programs, increases in the minimum wage, weather, special or unusual events, and other factors that may affect our operations.
Intense competition from traditional retail sources and the Internet may adversely affect our business.
We operate in highly competitive industries. For all of our product categories, we compete directly with national store operators, as well as regional chains and stores, specialty retailers dealing in our products, independent single store operators, discount stores, warehouse and mail order clubs, and mass merchandisers. In addition, the Internet is a significant channel for retailing for most of the product categories that we offer. In particular, the retailing of books, music and video over the Internet is highly competitive. In addition, we face competition from companies engaged in the business of selling books, music and movies and the renting of movies via electronic means, including the downloading of music content and in-home video delivery. An increase in competition in the physical or electronic markets in which we operate could have a material effect on our operations.
Our business is dependent on consumer spending patterns.
Revenues generated from the sale and rental of books, music, videos and other products we carry have historically been dependent upon discretionary consumer spending, which may be affected by general economic conditions, consumer confidence and other factors beyond our control. A decline in consumer spending on the buying and/or rental of the products we offer could have a material adverse effect on our financial condition and results of operations and our ability to fund our expansion strategy.
We rely on certain key personnel.
Management believes that the Company’s continued success will depend, to a significant extent, upon the efforts and abilities of Mr. John H. Marmaduke, Chairman, President and Chief Executive Officer. The loss of the services of Mr. Marmaduke could have a material adverse effect on our operations. We maintain a “key man” term life insurance policy on Mr. Marmaduke for $10 million. In addition, our success depends, in part, on our ability to retain key management and attract other personnel to satisfy our current and future needs. The inability to retain key management personnel or attract additional qualified personnel could have a material adverse effect on our operations.
Our business could be negatively impacted if the in-store video retailer distribution window is reduced or eliminated.
A competitive advantage that in-store video retailers currently enjoy over most other movie distribution channels, except theatrical release, is the early timing of the in-store video retailer “distribution window.” After the initial theatrical release of a movie, studios generally make their movies available to in-store video retailers (for rental and retail, including by mass merchant retailers) for specified periods of time. This distribution window is typically exclusive against most other forms of non-theatrical movie distribution, such as pay-per-view, video-on-demand, premium television, basic cable and network and syndicated television. The length of this exclusive distribution window for in-store video retailers varies, but has traditionally ranged from 45 to 60 days for domestic video stores. Thereafter, movies are made sequentially available to television distribution channels.
Our business could be negatively affected if (i) in-store video retailer distribution windows were no longer the first following the theatrical release; (ii) the length of the in-store video retailer distribution windows were shortened; or (iii) the in-store video retailer distribution windows were no longer as exclusive as they are now because newly released movies would be made available earlier on these other forms of non-theatrical movie distribution. As a result, consumers would no longer need to wait until after the in-store video retailer distribution window to view a newly released movie on these other distribution channels.
We believe that the studios have a significant interest in maintaining a viable in-store video retail industry. However, the order, length and exclusivity of each window for each distribution channel is determined solely by the studio releasing the movie, and we cannot predict future decisions by the studios, or the impact, if any, of those decisions. In addition, any consolidation or vertical integration of media companies to include both content providers and digital distributors could pose a risk to the continuation of the distribution window.
Our business is subject to changes in current rental video studio pricing policies.
Recent studio pricing for movies released to in-store video retailers has impacted our video business. Historically, studio pricing was based on whether or not a studio desired to promote a movie for both rental and sale to the consumer, or primarily for rental, from the beginning of the in-store video distribution window. In order to promote a movie title for rental, the title would be released to in-store video retailers at a price that was too high to allow for an affordable sales price by the retailer to the consumer at the beginning of the retail in-store video distribution window. As rental demand subsided, the studio would reduce pricing in order to then allow for reasonably priced sales to consumers. Currently, substantially all DVD titles are released at a price to the in-store video retailer that is low enough to allow for an affordable sales price by the retailer to the consumer from the beginning of the retail in-store video distribution window. This low sell-through pricing policy has led to increasing competition from other retailers, including mass merchants and online retailers, who are able to purchase DVDs for sale to consumers at the same time as traditional in-store video retailers, like Hastings, which purchase both DVDs and VHS product for rental. In addition, some retailers sell movies at lower prices in order to increase overall traffic to their stores or businesses, and mass merchants may be more willing to sell at lower prices, and in some instances, below wholesale. These factors have increased consumer interest in purchasing DVDs, which has reduced the significance of the VHS rental window.
We believe that the increased consumer purchases are due in part to consumer interest in building DVD libraries of classic movies and personal favorites and that the studios will remain dependent on the traditional in-store video retailer to generate revenues for the studios from titles that are not classics or current box office hits. Approximately 60% of most studios’ revenues derive from their home entertainment divisions. We therefore believe the importance of the video rental industry to the studios will continue to be a factor in studio pricing decisions. However, we cannot control or predict studio pricing policies with certainty, and we cannot assure you that consumers will not, as a result of further decreases in studio sell-through pricing and/or sustained or further depressed pricing by competitors, increasingly desire to purchase rather than rent movies. Personal DVD libraries could also cause consumers to rent or purchase fewer movies in the future. Our profitability could therefore be negatively affected if, in light of any such consumer behavior, we were unable to (i) grow our rental business, (ii) replace gross profits from generally higher-margin rentals with gross profits from increased sales of generally lower-margin sell-through product; or (iii) otherwise positively affect gross profits, such as through price increases or cost reductions. Our ability to achieve one or more of these objectives is subject to risks, including the risk that we may not be able to compete effectively with other DVD retailers, some of whom may have competitive advantages such as the pricing flexibility described above or favorable consumer perceptions regarding value.
Regardless of the wholesale pricing environment, the extent of our profitability is dependent on our ability to enter into and maintain arrangements with the studios that effectively balance copy depth and cost considerations. Each type of arrangement provides different advantages and challenges for us. The ability to negotiate preferred terms under revenue sharing agreements for the procurement of DVD, video games and VHS titles is crucial to our operations. Our profitability could be negatively affected if studios were to make other changes in their wholesale pricing policies and revenue-sharing agreements.
Our business could be negatively impacted by new technology that provides alternate methods of video delivery.
Advances in technologies such as video-on-demand or certain changes in consumer behavior driven by these or other technologies and methods of delivery, could have a negative effect on our business. In particular, our business could be impacted if (i) newly released movies were to be made widely available by the studios to these technologies at the same time or before they are made available to in-store video retailers for rental; and (ii) these technologies were to be widely accepted by consumers. In addition, advances in direct broadcast satellite and cable technologies may adversely affect public demand for vi
