SecProbe.io

CORRESP
1
filename1.htm

corresp

September 6, 2005

Securities and Exchange Commission

450 Fifth Street

NW Washington, DC 20549

SUBJECT: HASTINGS ENTERTAINMENT, INC. RESPONSES TO SEC STAFF COMMENT LETTER DATED AUGUST 8, 2005

Dear Mr. Ohsiek:

Below you will find an item-by-item response to the staff’s comment letter dated August 8, 2005.

    1)

    Where you identify intermediate causes of changes in your operating results, in
future filings please also describe the reasons underlying the intermediate causes. For
example, you indicate that sales increased in fiscal year 2004 primarily due to a 5%
increase in same store revenues. You should elaborate to explain why same stores sales
for each individual merchandise category are increasing. You should also explain why
rental and sell-through revenues from all video and video game products increased in
fiscal 2004. Additionally, your disclosures should indicate whether you expect identified
trends in your historical operating results to continue into the future and why or why
not. See SEC Release No. 33-8350.

    In future filings we will broaden disclosure to explain intermediate causes of changes in
operating results, such as why past revenue results, for specific merchandise categories,
rental, and sell-through, increased or decreased. In future filings, we will comment,
where appropriate, on identified trends in our historical operating results. We currently
include a statement to the effect that due to the cyclical nature of the retail business
and inherent uncertainty regarding the quality and popularity of movies, books, and music
produced and released by the studios/publishers during any given year, we are unable to
accurately predict sales trends. Please see “Seasonality” on page 15 of our 2004 Form
10-K. We do not believe additional cautionary language in this regard is necessary or
appropriate.

    2)

    Please revise your contractual obligations table in future filings to include
estimated interest payments on your debt. Because the table is aimed at increasing
transparency of cash flow, we believe interest payments should be included in the table.
If you choose not to include these payments, a footnote to the table should clearly
identify the excluded item and provide any

    -2-

    September 6, 2005

    additional information that is material to an understanding of your cash requirements. See
Section IV.A and footnote 46 to the Commission’s MD&A Guidance issued December 19, 2003
available at http://www.sec.gov/.

    In future filings, the company will disclose our estimated interest payments on outstanding
debt at year-end in a footnote to the Contractual Obligations Table noting that amounts are
subject to change based on changes in interest rates and underlying debt balances.

    3)

    Please tell us where the cash inflows related to retail sales of rental videos
converted to sales merchandise are included in your statements of cash flows. Also tell
us in detail how your classification complies with GAAP and specifically SFAS 95. In this
connection, it appears that the cash flows from the retail sales of the rental videos may
be treated as operating cash inflows; yet we note that the cash outflows related to the
purchase of these rental videos are classified as investing cash outflows. Tell us why
you believe this treatment is consistent with paragraph 16(c) of SFAS 95 regarding sales
of productive assets and also paragraph 24 of SFAS 95 regarding cash receipts and payments
having aspects of more than one class of cash flows. We may have further comment.

    Consistent with certain of the company’s competitors, the cash inflows from the sale of
rental videos converted to sales merchandise are classified as operating activities while
the purchases of rental video assets are classified as investing activities in the
Statement of Cash Flows. The company purchases all rental videos with the principal
purpose of generating rental revenues. Such purchases are comprised of initial store stock
rental video titles (representing the core group of rental video offerings that each store
will always carry) and new release video titles. The company classifies all rental videos
as property and equipment in its consolidated balance sheet. In addition to the purchases
of rental videos, the company purchases identical titles that are included in merchandise
inventories in the balance sheet (and operating activities in the statement of cash flows)
for purposes of selling these video titles at list price. As disclosed in footnote 1(h),
the Company will convert a portion of rental videos to merchandise inventory to be sold as
previously viewed tapes in its retail locations. Typically, the video titles converted to
merchandise inventory represent quantities in excess of video titles required to be
maintained in its rental video library at each of its retail locations.

    The company believes the cash flow presentation is appropriate for the following reasons:

    -3-

    September 6, 2005

    •

    Cash flows from rental videos are predominantly rental fees. On average, over
the past two years, approximately 85.0% of total cash flows received on rental
videos were generated from rentals. As a result, we believe investing activities
is the appropriate classification for rental video purchases based on paragraph 24
of SFAS 95. This cash flow classification is also consistent with the fact that
such assets are included in property and equipment in the consolidated balance
sheet.

    •

    As noted above, a portion of rental videos will be converted to merchandise
inventory and sold as a previously viewed tape at a substantial reduction from the
new selling price for the particular video title. Revenues generated from such
sales are included in merchandise revenues in the consolidated statement of
operations. In addition, related cash flows are included in operating activities.
The company believes this presentation is appropriate, as presentation of such
cash flows from the sale of merchandise inventory as investing activities would be
inconsistent with the classification of such sales in the statement of operations
and not reflective of the nature of the transaction in the retailing business.

    •

    The rental video industry is somewhat unique in the fact that the multiple
units of the same video title are sold as merchandise inventory and rented, which
the company believes, along with the factors cited above, contributes to differing
methods of cash flow presentation amongst our competitors. The company’s cash
flow presentation is similar to certain of our competitors. Given the somewhat
unusual nature of the cash flow presentation used by our industry, the company
disclosed the transfers of rental videos to merchandise inventory to enhance
transparency of the company’s financial statements as follows:

    “During fiscal 2004, 2003, and 2002, $7.4 million, $4.4 million and $3.5 million,
respectively, were transferred from rental videos to merchandise inventory at the
lower of cost or market.”

    To the extent revenue generating activities change such that the principal purpose of
rental videos would be to source our merchandise inventory of previously viewed tapes
versus holding units for purposes of generating rental revenues, we will consider changing
the classification of rental video purchases to operating activities within the statement
of cash flows.

    -4-

    September 6, 2005

    4)

    Pursuant to paragraph 32 of SFAS 95, please disclose in future filings the amount of
the noncash transfer from rental video fixed assets to previously viewed video inventory.

    The amount of the noncash transfer from rental video fixed assets to previously viewed
video inventory is disclosed under note (1)(h) on page 34 of our 2004 Form 10-K. We will
continue to make that disclosure, where appropriate, in future filings.

    5)

    Please refer to paragraph 26 of SFAS 131 and disclose in future filings the factors
used to determine that you have one reportable segment. Ensure the disclosure is clear in
terms of how you manage your business and whether your in-store sales and internet sales
represent separate operating segments that have been aggregated into one reportable
segment or whether both of these retail formats is managed as one operating segment. Show
us how the disclosure will read in future filings.

    We currently have two operating segments (retail and internet) that have been aggregated
into one reporting segment. During fiscal 2004, our internet operating segment had
revenues, pre-tax loss and total assets of approximately $375,000; ($623,000); and $832,000
comprising 0.1%, (6.0%), and 0.3% of the consolidated totals. Such ratios were consistent
with those in the past two years. Given the immaterial amount of the internet segment, we
have combined the retail and internet segments. In our fiscal 2005 Form 10-K, we plan to
add the following statement to footnote (1)(c) of the financial statements (page 33 in our
2004 Form 10-K) to inform the reader of management’s decision to combine our operating
segments into one reporting segment: “We consider our retail and internet operations to be
our operating segments for purposes of determining reportable segments based on the
criteria of SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information. We determined that the internet segment was immaterial for segment reporting
purposes. Therefore, we combine both operating segments into one reporting segment.”

    6)

    In future filings please disclose the types of expenses that you include in the
merchandise cost of revenue and rental video cost of revenue line items and the types of
expenses that you include within selling, general and administrative expenses. In doing
so, please disclose specifically whether you include inbound freight charges, purchasing
and receiving costs, inspection costs, warehousing costs, internal transfer costs and the
other costs of your distribution network in merchandise cost of revenue and rental video
cost of revenue. If you currently exclude a significant portion of these costs from

    -5-

    September 6, 2005

    merchandise cost of revenue and rental video cost of revenue, please provide cautionary
disclosure in MD&A that your gross margins may not be comparable to others, since some
entities include all of the rental video asset depreciation expense and costs related to
their distribution network in cost of revenues and others exclude a portion of them from
gross margin, including them instead in other operating expense line items. To the extent
the excluded costs are material to your operating results, quantify these amounts in MD&A.
If you determine that these amounts are immaterial for disclosure, please provide us with
your qualitative and quantitative assessment of materiality for all periods presented.

    The company plans to add disclosure to footnote (1)(g) of the financial statements in
future filings to disclose the types of expenses included in cost of goods sold for
merchandise and rental sales. Expenses included in cost of sales include cost of product
purchased from vendors; rental video depreciation expense; shrinkage; markdowns; inventory
write-offs; freight charges; receiving costs; inspection costs; and internal transfer
costs. In addition, the company includes in cost of goods sold all expenses associated
with our distribution center, including freight, warehouse personnel costs, supplies,
maintenance, depreciation, occupancy, property tax, and utility costs; as well as costs
associated with our returns center, including vendor refused product, handling charges,
return fees, freight, return center personnel costs, supplies, maintenance, depreciation,
rent, and utilities. Management has determined that the purchasing function should be
included in selling, general, and administrative expenses. Total purchasing costs
(comprised primarily of buyer salary costs) for fiscal year 2004 were approximately $3.2
million, or less than 1% of revenues. In addition, buyer product teams responsible for
purchasing perform several other functions within the company including some store
operations improvement initiatives and forecasting. Because of the immaterial impact of
these purchasing costs on gross margin and SG&A expenses, management does not believe
specific disclosure regarding the classification of such costs in MD&A is warranted.
However, as some retailers include occupancy costs of their retail locations in cost of
sales and we include such costs in SG&A, we will include disclosure in the MD&A of future
filings the amounts of such costs and the fact that this method of presentation may be
different than some of our competitors.

    7)

    Please tell us your consideration of disaggregating your rental video assets into
separate depreciation pools for categories such as new release DVDs, new release VHS
tapes, catalog DVDs, catalog VHS tapes, and video games.

    -6-

    September 6, 2005

    Also tell us your consideration of the potential impact such disaggregation would have on
your financial statements.

    The company’s depreciation policy is disclosed on page 18 of the 2004 Form 10-K, which
states, “The capitalized cost of all rental video assets acquired for a fixed price is
being amortized on an accelerated basis over six months to a salvage value of $4 per unit,
except for rental video assets purchased for the initial stock of a new superstore, which
are being amortized on a straight line basis over 36 months to a salvage value of $4.
Rental video assets purchased for less than $4 are not amortized.” The company’s
depreciation policy regarding depreciation pools for DVD, VHS, and video game items is
based on the sales performance and ultimate residual salvage value of our rental assets.
Our analysis shows that the six-month revenue profile curves for VHS, DVD, and video games
show only immaterial differences and behave similarly across product categories. The
company’s conclusion is that disaggregating our rental assets into additional depreciation
pools beyond those already contemplated provides limited additional value and would produce
an immaterial financial impact on the net book value of our rental video assets.

    8)

    We note you record an allowance for estimated costs related to merchandise to be
returned to suppliers for which credit from the supplier is pending. You state that it is
reasonably possible that your estimate of the ultimate settlement with your suppliers may
change. Please confirm to us that this allowance is only relieved upon return of the
related inventory, and not based on changes in management’s judgment. In this regard
please note that inventory should be recorded at the lower of cost or market. The write
down of inventory creates a new cost basis which cannot subsequently be marked up based on
changes in the underlying facts and circumstances. Refer to SAB Topic 5:BB.

    The majority of Hastings products are returnable based on contract terms. Inventory
that is non-returnable is marked-down for sale and/or scrapped. For these items we perform
a quarterly evaluation to assess any necessary write-downs to the lower of cost or market.
If product has been returned to vendors, is in the process of being returned to vendors, or
has been identified to be returned to vendors, the estimated costs associated with
returning the products are accrued as an allowance for cost of inventory returns. These
costs can include freight, valuation and quantity differences, and other fees charged by a
vendor. Such costs are not capitalized as a component of inventory as they do not relate
to procuring inventory. This allowance is relieved only upon the ultimate settlement of
the related returned inventory, and not based on changes in management’s judgment.

    -7-

    September 6, 2005

    9)

    I