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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended January 31, 1998
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
Commission File Number 0-22289
Wherehouse Entertainment, Inc.
(Exact name of registrant as specified in its charter)
Delaware 95-4608339
(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
19701 Hamilton Avenue
Torrance, California 90502-1334
(Address of principal executive
offices including ZIP code)
(310) 538-2314
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value
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 [ ]
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Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K (Section 229.405 of this chapter) is not contained
herein, and will not be contained, to the best of registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part
III of this Form 10-K or any amendment to this Form 10-K. / /
The aggregate book value of the estimated voting stock to be held by
non-affiliates of the registrant is $18,408,021. (1)
Indicate by check mark whether the registrant has filed all documents and
reports required to be filed by Section 12, 13, or 15(d) of the Securities
Exchange Act of 1934 subsequent to the distribution of securities under a plan
confirmed by a court.
Yes X No
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As of April 22, 1998, 10,650,643 shares of the registrant's common stock
were issued and outstanding and 171,923 additional shares are expected to be
issued pursuant to the bankruptcy plan of reorganization discussed in Item 1
below.
(1) There is no established trading market for the voting stock of the
registrant. Accordingly, the registrant has utilized book value per
share for purposes of the foregoing calculations concerning voting stock
held by non-affiliates. This calculation of book value per share is not
intended to represent the price at which those shares trade. As of
January 31, 1998, 10,619,201 shares of the registrant's voting stock were
issued and outstanding. All but 1,100,000 of those shares were issued
pursuant to a bankruptcy plan of reorganization. See "Reorganization Under
Chapter 11" in Item 1 below. At January 31, 1998, the registrant estimates
that 203,365 additional shares of its voting stock may be issued pursuant
to the plan of reorganization, after which a total of 10,822,566 shares of
the registrant's voting stock will be issued and outstanding. The
registrant estimates that of the number of total outstanding shares,
approximately 2,178,464 shares will be held by non-affiliates of the
registrant. The book value of voting stock held by non-affiliates of the
registrant specified above assumes the issuance of all 10,822,566 shares.
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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes certain statements that may be
deemed to be "forward-looking statements" within the meaning of the Private
Securities Litigation Reform Act of 1995. The sections of this Annual Report on
Form 10-K containing such forward-looking statements include "Business",
"Reorganization Under Chapter 11", "Merchandise Sale Products", "Video and Other
Product Rentals" and "Competition" under Item 1 below, "Holders" under Item 5
below, and "Management's Discussion and Analysis of Financial Condition and
Results of Operation" under Item 7 below. Statements in this Annual Report on
Form 10-K which address activities, events or developments that the registrant
expects or anticipates will or may occur in the future, including such things as
future issuances of shares, future capital expenditures (including the amount
and nature thereof), expansion and other development and technological trends of
industry segments in which the registrant is active, business strategy,
expansion and growth of the registrant's and its competitors' business and
operations and other such matters are forward-looking statements. Although the
registrant believes the expectations expressed in such forward-looking
statements are based on reasonable assumptions within the bounds of its
knowledge of its business, a number of factors could cause actual results to
differ materially from those expressed in any forward-looking statements,
whether oral or written, made by or on behalf of the registrant.
The registrant's operations are subject to factors outside its control.
Any one, or a combination, of these factors could materially affect the results
of the registrant's operations. These factors include: (a) changes in levels of
competition from current competitors and potential new competition from both
retail stores and alternative methods or channels of distribution such as
electronic and telephone shopping services and mail order; (b) loss of a
significant vendor or prolonged disruption of product supply; (c) the presence
or absence of popular new releases and products in the product categories the
registrant represents; (d) changes in levels of consumer spending, especially
during seasonally significant periods; (e) changes in the Federal and state
income tax rules and regulations or interpretations of existing legislation; (f)
changes in the general economic conditions in the United States, and in
particular the eight major markets served by the registrant, including, but not
limited to consumer sentiment about the economy in general; (g) changes in
availability or terms of working capital financing from vendors and lending
institutions; (h) adverse results in significant litigation matters; and (i) the
ability to attract and retain key personnel. The foregoing should not be
construed as an exhaustive list of all factors which could cause actual results
to differ materially from those expressed in forward-looking statements made by
the registrant. Forward-looking statements made by or on behalf of the
registrant are based on a knowledge of its business and the environment in which
it operates, but because of the factors listed above, actual results may differ
from those anticipated results described in these forward-looking statements.
Consequently, all of the forward-looking statements made are qualified by these
cautionary statements and there can be no assurance that the actual results or
developments anticipated by the registrant will be realized or, even if
substantially realized, that they will have the expected consequences to or
effects on the registrant or its business or operations.
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PART I
ITEM 1. BUSINESS
The registrant, Wherehouse Entertainment, Inc. ("New Wherehouse") was
incorporated under the laws of the State of Delaware on November 15, 1996 as WEI
Acquisition Co. On January 31, 1997, New Wherehouse acquired (the "Acquisition")
substantially all the assets of Wherehouse Dissolution Co. ("Old Wherehouse"), a
Delaware corporation, and its parent company, WEI Holdings, Inc., a Delaware
corporation ("WEI"; and together with Old Wherehouse, the "Debtors"), pursuant
to a Chapter 11 plan of reorganization (as described in "Reorganization Under
Chapter 11" below). Prior to the Acquisition, Old Wherehouse was known as
"Wherehouse Entertainment, Inc.", and, after the Acquisition, Old Wherehouse
changed its name to "Wherehouse Dissolution Co." After the Acquisition, New
Wherehouse changed its name to "Wherehouse Entertainment, Inc." New Wherehouse
is the successor to Old Wherehouse, and New Wherehouse has undertaken to
continue the obligations of Old Wherehouse to file all reports under Section 13
or 15(d) of the Securities Exchange Act of 1934, as amended. New Wherehouse and
Old Wherehouse will be collectively referred to in this Annual Report as the
"Company" or "Wherehouse" where the discussion relates to the continuing
business operations of Old Wherehouse and New Wherehouse.
Based upon published and other information available to its management,
Wherehouse is, in terms of both revenues and store count, one of the largest
retailers of prerecorded music and videocassette rentals in the western United
States. Old Wherehouse was founded in 1970. Since then, Wherehouse has evolved
into a diversified entertainment retailer offering a broad range of prerecorded
music, videocassettes and other products. As Wherehouse has grown, its product
lines and product mix have updapted to respond to changes in electronic
technology and consumer tastes.
REORGANIZATION UNDER CHAPTER 11
On August 2, 1995 (the "Petition Date"), WEI and Old Wherehouse
(collectively the "Debtors") filed voluntary petitions for relief under Chapter
11 of Title 11 of the United States Code in the United States Bankruptcy Court
for the District of Delaware (the "Bankruptcy Court"), seeking to reorganize
under Chapter 11 (the "Bankruptcy Case"). Old Wherehouse and WEI continued to
manage their respective affairs and operate their businesses as
debtors-in-possession while they worked to develop a reorganization plan that
would restructure their businesses and allow their emergence from Chapter 11.
The Debtors' plan of reorganization, entitled the "Debtors' First Amended
Chapter 11 Plan, as Revised for Technical Corrections on October 4, 1996 and
Supplemental Amendments on December 2, 1996 and December 13, 1996" (the
"Reorganization Plan"), was confirmed by an order of the Bankruptcy Court
entered on January 7, 1997 entitled "Findings of Fact, Conclusions of Law and
Order Confirming Debtors' First Amended Chapter 11 Plan Under Chapter 11 of the
Bankruptcy Code" (the "Confirmation Order"). The effective date of the
Reorganization Plan occurred on January 31, 1997 (the "Plan Effective Date").
New Wherehouse (as opposed to Old Wherehouse and WEI) was never the subject of
a bankruptcy case. Since the Plan Effective Date, the Bankruptcy Court has
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retained jurisdiction over certain claims and other matters relating to the
Debtors' bankruptcy estates, but New Wherehouse has been and is free to carry
out its business without oversight by the Bankruptcy Court.
IMPLEMENTATION OF THE REORGANIZATION PLAN
Pursuant to the Reorganization Plan, substantially all of the assets of the
Debtors and certain liabilities were transferred to New Wherehouse. The Debtors
have assigned to New Wherehouse all of their executory contracts and unexpired
leases assumed during the Bankruptcy Case (not otherwise assigned to third
parties). The Reorganization Plan provides that the Debtors' bankruptcy estates
will be liquidated by New Wherehouse.
DISTRIBUTIONS UNDER THE REORGANIZATION PLAN
Under the Reorganization Plan, substantially all of the Debtors'
indebtedness held by their creditors was canceled in exchange for cash, shares
of the Common Stock of New Wherehouse, par value $0.01 per share (the "New
Common Stock"), and/or warrants to purchase New Common Stock or for no
consideration. The Debtors' major groups of creditors were (1) Senior lenders
under Old Wherehouse's bank credit agreement (the "Senior Lenders") led by
Cerberus Partners, L.P. ("Cerberus") as the agent for the Senior Lenders, (2)
trade creditors (the "Trade Creditors"), (3) holders of Old Wherehouse's Senior
Subordinated Notes (the "Senior Subordinated Noteholders"), (4) holders of Old
Wherehouse's 6 3/4% Convertible Subordinated Debentures (the "Convertible
Debenture holders"), (5) other general unsecured creditors (the "General
Unsecured Creditors") and (6) Federal and state taxing authorities.
The Senior Lenders received 9,157,808 shares of New Common Stock under
the Reorganization Plan on account of their claims as of January 31, 1997 and
an additional 141,455 shares as of January 31, 1998, for a total of
9,299,263, representing 87.6% of the issued and outstanding shares of New
Common Stock as of such date, prior to dilution for the Warrants described
below, but after dilution for the A&M Shares (as defined in Item 13 below
under "Certain Relationships and Related Transactions"). The Senior Lenders
were paid approximately $2.8 million of adequate protection payments during
the Bankruptcy Case and also received approximately $256,000 in cash
subsequent to the Plan Effective Date. Based on the terms of the
Reorganization Plan, the Senior Lenders are likely to receive additional
shares of New Common Stock and cash as the claims of unsecured creditors
(including Trade Creditors) are resolved. Based upon New Wherehouse's
estimate of the resolution of Trade Creditor's claims, the Senior Lenders (or
their assigns) will receive approximately 9,387,130 shares of New Common
Stock in total. This total may increase or decrease based on the final
resolutions of open unsecured creditors claims. Approximately $94.6 million
of indebtedness held by the Senior Lenders was canceled in exchange for the
issuance of such shares of New Common Stock and cash.
Under the Reorganization Plan, those Trade Creditors identified by Old
Wherehouse as continuing suppliers of certain inventory products and who agreed
to provide normal trade credit terms to the Company after the Plan Effective
Date were given the option (the "Exchange Option") to
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receive 27% of their allowed claims in cash in lieu of shares of New Common
Stock. Substantially all of the Trade Creditors elected to exercise the
Exchange Option and, as a result, the Company estimates that once all claims are
resolved, approximately $11,250,000 in cash will have been distributed to the
Trade Creditors. As of January 31, 1998, approximately $10,975,000 had been
paid. Most of the Company's vendors, including its six major distributors of
pre-recorded music, Warner/Elektra/Atlantic Corporation ("WEA"), UNI
Distribution Corp. ("UNI"), Sony Music ("SONY"), Polygram Group Distribution,
Inc. ("PGD"), BMG Distribution ("BMG") and EMI Music Distribution ("EMD"),
elected to exercise the Exchange Option and have been providing normal trade
credit terms to the Company.
Under the Reorganization Plan, the Senior Subordinated Noteholders received
$2,350,000 of cash from New Wherehouse (plus $1,550,000 of cash from a third
party) and three tranches of warrants to purchase shares of New Common Stock
(the "Warrants"). The Tranche A Warrants represent the right to purchase
576,000 shares of New Common Stock at an exercise price of $2.38 per share and
have a five year maturity. The Tranche B Warrants represent the right to
purchase 100,000 shares of New Common Stock at an exercise price of $9.00 per
share and have a seven year maturity. The Tranche C Warrants represent the
right to purchase 100,000 shares of New Common Stock at an exercise price of
$11.00 per share and have a seven year maturity.
The Convertible Debenture holders received no distribution under the
Reorganization Plan. Approximately $5,344,000 of outstanding 6 3/4% Convertible
Subordinated Debentures were canceled.
Some of the claims of the General Unsecured Creditors have not yet been
adjudicated and allowed by the Bankruptcy Court. Under the Reorganization Plan,
any claims of General Unsecured Creditors (including claims of Trade Creditors
who did not elect the Exchange Option) that become allowed by the Bankruptcy
Court will receive approximately 31.92 shares of New Common Stock per $1,000 in
such allowed claims. The Company estimates that, including shares already
issued, approximately 335,120 shares of New Common Stock will be issued to
General Unsecured Creditors (including Trade Creditors who did not elect the
Exchange Option in order to resolve the remaining claims.)
Several state and local taxing authorities received on account of their
claims, Company obligations to pay these claims, with interest, generally six
years after the tax assessment date in an aggregate principal amount of
approximately $4.0 million.
The Reorganization Plan also provides that post-petition claims are to be
paid in full. The Confirmation Order established procedures for the resolution
of disputed post-petition claims and presently there are a number of disputes
before the Bankruptcy Court concerning such post-petition claims.
Pursuant to the Reorganization Plan, the Company entered into a loan and
security agreement with Congress Financial Corporation (Western) (the "Congress
Facility"), which provides a borrowing capacity of up to $30,000,000 with a
letter of credit subfacility of up to $10,000,000, subject to borrowing base
limitations based upon, among other things, the value of certain eligible
merchandise
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inventory. As of January 31, 1998, there were no borrowings outstanding under
the Congress Facility, although $0.7 million of letters of credit were
outstanding.
GENERAL
Wherehouse operated 223 stores at January 31, 1998 in seven states under
the names "The Wherehouse," "Wherehouse Entertainment," "Record Shop," "Rocky
Mountain Records" and "Odyssey." All but three of Wherehouse's stores operate
under "The Wherehouse" or "Wherehouse Entertainment" names. Subsequent to
January 31, 1998, the Company closed 3 stores.
Wherehouse sells prerecorded music, videocassettes and digital versatile
disc's ("DVD's"), video games, personal electronics (including personal stereos,
portable stereos, headphones and related merchandise), blank audiocassettes and
videocassettes, and accessories. Approximately 72% of Wherehouse's stores also
rent both videocassettes and video games. Wherehouse believes that this
combination entertainment store format offers competitive advantages relative to
those competitors that operate stores offering only merchandise products for
sale or products for rent. The merchandise sale and video rental lines
complement one another and offer cross-selling opportunities. A video rental
customer visits a store at least once, and possibly twice, for each transaction
and is presented each time with Wherehouse's merchandise offerings.
In the fiscal year ended January 31, 1998, sales of prerecorded music,
videocassettes, video games, and accessories accounted for 84.3% of revenues,
and rentals of videocassettes, video games, and other products (including
revenue from the sale of previously viewed videocasettes) accounted for 15.7%
of revenues.
Of the 223 stores operating as of January 31, 1998, 190 stores were located
in strip centers or freestanding buildings and 33 were located in malls.
Approximately 89.2% of Wherehouse's stores are concentrated in eight major
marketing areas (Los Angeles, San Francisco, San Diego, Sacramento, Seattle,
Phoenix, Fresno and Las Vegas) and approximately 83% of the stores are located
in California. Wherehouse has focused its operations on its eight major
marketing areas in order to create competitive advantages in operations,
advertising, marketing and distribution.
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SALES AND RENTAL REVENUE BY
MERCHANDISE CATEGORY
(DOLLARS IN MILLIONS)
<TABLE>
<CAPTION>
Fiscal Years Ended January 31,
------------------------------
New Old
Wherehouse Wherehouse
---------- --------------
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Merchandise sales
Total music $239.2 $252.7 $292.2
New videocassettes and DVDs 13.1 17.9 24.1
Video game software and
hardware, general merchandise,
accessories, ticket commissions,
and other 23.8 24.9 34.0
------ ------ ------
Total merchandise sales $276.1 $295.5 $350.3
Video and other product rentals 51.3 70.0 82.9
------ ------ ------
TOTAL MERCHANDISE REVENUE $327.4 $365.5 $433.2
------ ------ ------
------ ------ ------
</TABLE>
MERCHANDISE SALE PRODUCTS
Wherehouse stores generally sell a broad array of entertainment products,
including prerecorded music, videocassettes and DVD's, video game software,
accessories and personal electronics. The table above summarizes Wherehouse's
dollar volume of sale revenue by merchandise category for fiscal year ended
January 31, 1996 through fiscal year ended January 31, 1998. The percentage of
total revenues contributed by merchandise sales has risen from 80.9% in 1996 to
84.3% in 1998. The number of different new music titles per store ranges from
approximately 9,500 to 60,000, representing a range of 25,000 to 90,000
individual stock-keeping units in inventory per store.
Wherehouse's most important product strategy is to ensure constant
availability of the most popular music and video titles while maximizing the
selection of catalog titles of lasting popularity.
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With input from store management and a product allocation team, Wherehouse's
inventory management systems tailor each store's product selections and
merchandise mix to local market demand and maximize the availability of the most
popular items at each store, subject to store size constraints. Wherehouse's
stores have been designed to facilitate quick service and to accommodate changes
in industry trends and product offerings.
Wherehouse also buys and sells used products, principally used CDs, in the
majority of its stores. The sale of used CDs was first tested in certain of
Wherehouse's stores in fiscal 1993. Based upon strong consumer acceptance,
Wherehouse began buying used CDs from customers and expanded upon its used
product business significantly in fiscal 1996, 1997 and 1998. The Company feels
that the increases achieved in the used CD business in the prior years have
stabilized and the used CD business will, in the future, perform at a more
stable growth rate.
Prerecorded videocassettes and DVDs (feature films, music videos, and
self-improvement programming) represented, after music, Wherehouse's second
largest sale product category in the fiscal year ended January 31, 1997 and the
fiscal year ended January 31, 1998. As of January 31, 1998, 80 of the
Wherehouse stores sold DVDs with each store having a range of 150 to 350
titles per store. As box-office "hit" motion pictures continue to be released
to the videocassette and DVDs sell-through market at reduced prices,
industry-wide sales of this category have increased. Wherehouse's revenues
from the sales of videocassettes, however, decreased from the fiscal year ended
January 31, 1996 through the fiscal year ended January 31, 1998 with the
proliferation of competitors' outlets selling videocassettes and the highly
competitive pricing of the product, particularly from discounters and mass
merchandisers, and the closing of Wherehouse stores during the Bankruptcy Case.
Wherehouse sells video game hardware and software, blank audio and
videocassette tapes, music and tape care products, carrying cases, storage
units, and personal electronics. Wherehouse also collects commissions on event
tickets sold under affiliations with Bay Area Seating Service (BASS) and
Ticketmaster.
VIDEO AND OTHER PRODUCT RENTALS
Wherehouse's other principal revenue source is the rental of prerecorded
videocassettes and other products, chiefly feature films. Although most
videocassette rentals are feature films, approximately 10% of Wherehouse's
rentals in the fiscal year ended January 31, 1998 were non-theatrical titles,
such as children's videos, adult videos, fitness videos, music videos and
educational videos. Audiocassette books and video game players are also
offered for rent in a few select stores. As of January 31, 1998, 161 of
Wherehouse's 223 stores offered videocassettes and other products for rent. On
average, stores that rent videocassettes carry approximately 3,500 units,
although the number of units can range from as few as 1,500 units to as many as
9,200 units, representing approximately 1,000 to 6,500 individual titles.
Wherehouse purchases prerecorded videocassettes from a variety of
distributors and other suppliers. As with recording companies, the film studios
or their videocassette distribution operations, each control a certain portion
of available titles and seek to promote those titles. As of January 31, 1998,
Wherehouse's leading suppliers of prerecorded videocassettes were Warner Home
Video,
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Ingram Entertainment and UNI. Wherehouse has not experienced, and does not
anticipate having in the future, any material problems obtaining its products.
The Company believes that an important element of efficient video rental
operations is the disposition of previously viewed videocassettes to maximize
the productivity of its inventory. Wherehouse's systems monitor the rental
efficiency of its inventory on an individual title and unit basis. As a
title's efficiency declines, previously viewed videocassettes are sold on a
clearance basis in Wherehouse's stores, and, where appropriate, the Company may
sell excess used video inventory to third-party distributors. The revenues
from the clearance of previously viewed videocassettes are included in the
revenue from video and other product rentals.
ADVERTISING AND PROMOTION
Wherehouse employs advertising, promotion, pricing, and presentation in a
coordinated manner to generate customer awareness of its breadth of product and
value pricing on selected items, and to induce trial and repeat purchase of its
products and video rental services. Wherehouse advertises on a regular and
frequent basis in a variety of broadcast and print media, including radio,
newspaper, direct mail and freestanding inserts. The advertising generally
emphasizes immediate availability of hit product at competitive prices, as well
as access to a broad array of catalog product. Wherehouse believes its strategy
of clustering its stores in major markets allows it to optimize the use of its
advertising expenditures.
Wherehouse also seeks to take advantage of cooperative advertising payments
from suppliers, which are generally available to the industry. Music and video
companies generally provide funds on a title-by-title basis and, occasionally,
on a label-wide basis to promote new releases. When Wherehouse runs
pre-authorized advertising that contains reference to a specific title or label,
the related supplier will generally reimburse 100% of the pro rata cost of that
advertising.
TRADE CUSTOMS AND PRACTICES
Most of the Company's music purchases are protected by return policies
offered by major manufacturers. The return privilege generally exists for
each music title as long as that title remains in the current music catalog
of a manufacturer. Catalog changes are generally made only after advance
notice, allowing the Company to return excess inventory before a title is
discontinued. Most of the Company's major pre-recorded music suppliers
provide unlimited returns of unopened items, but generally charge return
penalties of varying amounts. The major suppliers do not accept returns of
opened merchandise on the same basis as unopened items, but do generally
provide the Company with certain additional allowances. Returns to vendors
were suspended following Old Wherehouse's bankruptcy filing but were
reinstated several months later for most of the Company's vendors. As of
January 31, 1998, the Company has normal return privileges with all of its
vendors. Pricing and return policies of the Company's major distributors are
subject to change.
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STORE AND SITE SELECTION
The table below sets forth store openings, closings and the total number of
the Company's stores for the last five fiscal years:
<TABLE>
<CAPTION>
Fiscal Year Total Stores Stores Stores
Ended at Beginning ---------------- at End
January 31, of Period Opened Closed of Period
----------- ------------ ------ ------ ---------
<S> <C> <C> <C> <C>
1998 243 0 20 223
1997 297 9 63 243
1996 347 3 53 297
1995 347 4 4 347
1994 313 49 15 347
</TABLE>
The Company's strategy of clustering stores in marketing areas has achieved
economies of scale and scope in several business functions, including
advertising, personnel, management and distribution. During the years prior to
Old Wherehouse's bankruptcy filing, Old Wherehouse pursued growth opportunities
in existing marketing areas and selectively grew through acquisition if such
growth was consistent with the Old Wherehouse's strategies. The Company will
continue to evaluate growth opportunities within the context of its strategies
and will evaluate future store closing decisions, principally at lease
expiration, based upon individual store performance.
As of January 31, 1998, the Company operates 223 stores comprising
approximately 1,361,000 square feet, a reduction of approximately 382,000
square feet compared to the square footage at January 31, 1997. The reduction
is principally the result of the closing of 20 stores.
STORE OPERATIONS AND DISTRIBUTION
STORE LOCATION. As of January 31, 1998, the Company had 190 stores located
in strip centers or freestanding buildings and 33 stores located in malls. The
average size of strip center and
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freestanding locations is approximately 6,100 square feet, with an approximate
range of 1,500 to 15,000 square feet. Mall stores range in size from 2,000 to
10,000 square feet of space, and most do not offer video rental service due to
the importance of convenience in the video rental business.
RETAIL PRESENTATION. The Company has developed a contemporary store design
approach that employs light interior colors, modified exterior signage and a
minimum of fixed interior walls. The design maximizes flexibility in lighting
and use of floor space (to accommodate changes in product format) and is
intended to focus customer attention primarily on the products. The Company has
invested in merchandise fixtures and an updated in-store signing program to
improve merchandise presentation.
DISTRIBUTION. Central to Wherehouse's strategy of providing broad
merchandise selection to its customers (i.e. multiple copies of hits, select
copies of catalog product, and high quality in-stock condition) is its ability
to distribute product quickly and cost-effectively to its stores. Generally,
the Company's central distribution system fills orders to all stores twice a
week. Inventory at the Company's distribution center is automatically sorted
based on individual store demand data generated by the Company's store-level
inventory systems.
Approximately 30% of the Company's inventory is shipped to store locations
directly from manufacturers and distributors (primarily in the case of new
releases) and the remainder is shipped from the Company's distribution center.
The Company generally uses common carriers for deliveries from its distribution
center.
COMPETITION
Both the prerecorded music and the video rental markets are highly
competitive. In the prerecorded music market, the Company competes with other
chain retailers who specialize in prerecorded music, discounters and other mass
merchandisers, direct mail programs such as record clubs, internet-based
retailers and local operators. The video rental market is a more fragmented
industry, with many small operators and two significant competitors: Blockbuster
Entertainment and Hollywood Video. Grocery and convenience stores also account
for a portion of the video rental market. In the Company's judgment, small
operators may be well located but usually have significant disadvantages in
inventory selection and cost relative to chain retailers. Additionally, the
Company's combination entertainment store format gives the Company cross-selling
opportunities in music and rental video.
In both the music and video rental markets, there has been a trend towards
consolidation, and several large regional retail chains -- many similar to or
direct competitors of the Company -- have been acquired by large national retail
chains. In addition, several major retail chains, including Best Buy,
Blockbuster Entertainment and Hollywood Video continue to open stores or expand
their retail store presence in the Company's markets. Accordingly, it can be
expected that the Company will in future periods experience increased
competition from companies with greater financial resources than the Company,
and that such competition may result in continued pressure on revenues and gross
profit margins.
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The Company also competes in video business with cable television and DSS
("Digital Satellite Systems"), which includes pay-per-view television.
Currently, pay-per-view television provides less viewing flexibility to the
consumer than videocassette rentals, and at a higher cost. Also, under current
entertainment industry distribution practices, movies are generally available
on videocassette prior to appearing on pay-per-view. However, viewing
flexibility may increase with improved technology which could negatively impact
the retail store delivery of home video and consequently, the Company's
business. Notwithstanding potential technological advances, Wherehouse believes
that video rental should, in the near future, continue to be the first source
of in-the-home filmed entertainment, before pay-per-view, and a primary source
of filmed entertainment for the consumer.
Several major companies have announced that they are developing other
technologies which, if successful, could constitute significant competition.
These include technologies which would provide movies or interactive games "on
demand" over fiber optic telephone or cable lines, provide other in-the-home
entertainment over the internet, or provide on-site transcription of compact
discs through in-store kiosks. While most of these technologies are not yet
commercially available, and it appears that significant technical, economic,
and other obstacles to their introduction remain to be resolved, if and when
these or other new technologies are introduced it can be anticipated that
Wherehouse's business could be significantly impacted and Wherehouse may need
to develop and implement new marketing strategies in order for its business to
remain viable.
ORGANIZATION AND EMPLOYEES
As of January 31, 1998, Wherehouse employed approximately 3,625 persons.
Approximately 39% were full-time employees and approximately 61% were part-time
employees. The Company's labor requirements vary based on seasonal business
fluctuations, with up to 1,000 additional store and distribution center
employees added during the peak holiday season. Wherehouse's corporate office
staff, which consists of approximately 161 employees, is responsible for
executive and general operating management, buying, merchandising, advertising,
finance, accounting, information systems and real estate.
TRADEMARKS
All but three of Wherehouse's stores operate under the name "The
Wherehouse" or "Wherehouse Entertainment." The Company owns and maintains
registrations for "The Wherehouse" trademark and variations thereof in the
United States, Mexico, Taiwan, Thailand, Hong Kong and Korea and has filed
trademark applications in China. The Company has also filed a trademark
application in the United States for the name "Tu Musica." The Company
monitors the status of its trademark registrations to maintain them in force
and to renew them as required.
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SEASONALITY
The Company's business is seasonal, and, as is typical for most retailers,
its revenues peak during the Christmas holiday season. Revenues in the fourth
quarter of the fiscal year ended January 31, 1998 were approximately 31.9% of
total annual revenues.
ITEM 2. PROPERTIES
The Company's executive offices, which are located in Torrance,
California, are subject to a lease covering 50,776 square feet of space at a
current annual base rent of approximately $232,356. The lease expires on May
31, 1999, however, either party may terminate this lease upon four months'
notice at any time after January 31, 1998. The Company is engaged in
discussions with its landlord to extend the term of its lease.
The Company operates a 200,000 square foot distribution center in Carson,
California. The lease for this property expires on April 30, 2002, subject to
two five-year renewal options. The annual base rent for the fiscal year ended
January 31, 1998 was $738,000, although rent is subject to periodic adjustment.
As of January 31, 1998, the Company owned one of its retail locations and
leased space for the remaining 222 stores. Subsequent to January 31, 1998, the
Company closed 3 of these 222 stores. Lease terms generally range from month
to month to 23 years, including renewal options. If no leased stores' renewal
options were exercised, 22 leases would expire on or before January 31, 1999,
96 would expire between February 1, 1999 and January 31, 2003, and the
remainder would expire between February 1, 2003 and January 31, 2014. The
Company has the right to terminate a number of its store leases prior to the
lease termination date, depending upon certain conditions, as defined in each
lease. The Company does not depend on the continued existence of any one or
several of its lease agreements or store locations for the operation of its
business.
As of January 31, 1998, the Company was involved in leasing discussions
with various landlords regarding the opening of 10 additional stores. As of
January 31, 1998 no lease had been signed on any of these locations. Subsequent
to January 31, 1998 the Company has signed 1 lease. During the fiscal year
ended January 31, 1998, the Company closed all of the nine locations in which it
had short-term leases with the Lucky's Division of American Stores, Inc. to
operate sale and rental businesses within Lucky's supermarkets, under the
"Wherehouse" name.
ITEM 3. LEGAL PROCEEDINGS
(i) Bankruptcy filing
See Item 1 - "Reorganization Under Chapter 11" above for a description of
the bankruptcy filing of Old Wherehouse and WEI.
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(ii) Other.
The Company is a party to various other claims, legal actions and
complaints arising in the ordinary course of its business. In the opinion of
management, all such matters are without merit or involve such amounts that
unfavorable disposition will not have a material impact on the financial
position and results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
MARKET INFORMATION
The Company has one class of common equity, the New Common Stock,
outstanding. See Item 12 - "Security Ownership of Certain Beneficial Owners and
Management". There is no established public trading market for the New Common
Stock.
Prior to the Plan Effective Date, Old Wherehouse had only one class of
common equity outstanding, all of which was owned by WEI. WEI had only one
class of common equity outstanding, which was owned exclusively by affiliates of
Merrill Lynch Capital Partners and certain members of management of Old
Wherehouse. Pursuant to the Reorganization Plan, the common equity of Old
Wherehouse and WEI were canceled without any distributions being made to the
holders thereof.
HOLDERS
As of January 31, 1997, after the effectiveness of the Reorganization Plan,
there were eight holders of New Common Stock, seven of whom were Senior Lenders.
As of January 31, 1998, the Company had issued 10,619,201 shares of New Common
Stock and the Company estimates that approximately 203,365 additional shares of
New Common Stock will be distributed among the Senior Lenders, A&M Investment
Associates #3, LLC and approximately 1,500 holders of unsecured claims as
their claims are allowed by the Bankruptcy Court. See "Reorganization under
Chapter 11" in Part I, Item 1, Business. As of January 31, 1998, there were 826
holders of record of the New Common Stock.
DIVIDENDS
No dividends have been paid to the holders of the New Common Stock since
its issuance. The Congress Facility restricts the ability of New Wherehouse
to pay dividends. See Item 7 - "Management's Discussion and Analysis of
Financial Condition and Results of Operation". There are no plans by New
Wherehouse to pay cash dividends on the New Common Stock in the foreseeable
future.
ITEM 6. SELECTED FINANCIAL DATA
Set forth below are selected financial data as of and for the periods
indicated below. The financial data are derived from financial statements of
Old Wherehouse and New Wherehouse. The
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selected financial data should be read in conjunction with the discussion under
Item 7 - "Management's Discussion and Analysis of Financial Condition and
Results of Operation" and with the financial statements, including the notes
thereto, included elsewhere in this report.
<TABLE>
<CAPTION>
(Dollar amounts in millions)
---------------------------------------------------------------------------------------
New Wherehouse Old Wherehouse
--------------- ---------------------------------------------------------------------
Year
Ended Year ended January 31
January 31, ----------------------------------------------------------------------
INCOME STATEMENT DATA 1998 1997 1996 1995 1994
--------------- -------------- ----------------- ---------------- ----------------
<S> <C> <C> <C> <C> <C>
Revenue:
Sales $276.1 $295.5 $350.3 $409.0 $379.7
Rental 51.3 70.0 82.9 90.6 92.1
--------------- -------------- ----------------- ---------------- ----------------
$327.4 $365.5 $433.2 $499.6 $471.8
Cost and expenses:
Cost of sales 176.1 195.5 230.3 262.6 248.0
Cost of rentals including
amortization 27.4 34.0 40.4 35.4 51.3
Selling, general and
administrative expenses 111.9 145.4 166.8 188.3 196.1
Restructuring charges --- --- --- --- 14.3
Write-down of long-lived assets --- --- 1.5 139.5 ---
--------------- -------------- ----------------- ---------------- ----------------
Income (loss) from operations 12.0 (9.4) (5.8) (126.2) (37.9)
Interest (income )expense, net (1.1) 0.7 14.8 23.0 23.2
--------------- -------------- ----------------- ---------------- ----------------
Income (loss) before reorganization
items and income taxes 13.1 (10.1) (20.6) (149.2) (61.1)
Reorganization items --- 19.9 23.2 --- ---
--------------- -------------- ----------------- ---------------- ----------------
Income (loss) before income taxes $13.1 $(30.0) $(43.8) $(149.2) $(61.1)
Provision (benefit) for income taxes 5.4 --- --- 13.0 (19.0)
--------------- -------------- ----------------- ---------------- ----------------
Income (loss) before extraordinary $7.7 $(30.0) $(43.8) $(162.2) $(42.1)
item
Extraordinary item (2) --- 173.7 --- --- ---
--------------- -------------- ----------------- ---------------- ----------------
Net income (loss) $7.7 $143.7 $(43.8) $(162.2) $(42.1)
--------------- -------------- ----------------- ---------------- ----------------
--------------- -------------- ----------------- ---------------- ----------------
Net income per common share(1)
Basic $0.74
Diluted $0.71
Weighted Average shares Outstanding
Basic 10,420,557
Diluted 10,894,862
OTHER DATA
Adjusted EBITDA (5) $24.3 $1.6
--------------------------------- ---------------------------------------------------
BALANCE SHEET DATA New Wherehouse Old Wherehouse
--------------------------------- ---------------------------------------------------
Working capital (deficiency)/excess $ 65.3 $ 59.4 $ 83.7 $(13.2) $ 4.9
Total assets 161.0 131.7 168.5 197.7 351.4
Liabilities subject to compromise -- -- 278.9 --- --
Long-term debt (including current
portion) (3) 4.5 5.4 4.2 167.4 175.1
Total shareholders' equity/
(deficit) (4) 91.5 84.1 (156.3) (112.4) 50.0
</TABLE>
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(1) Net income per common share is omitted for the Company for the fiscal years
ended January 31, 1994, 1995 1996 and 1997 since it was a wholly-owned
subsidiary of WEI during those periods.
(2) The extraordinary item in fiscal year ended January 31, 1997 represents
gain from the extinguishment of debt pursuant to the Company's Plan of
Reorganization.
(3) Includes 6 3/4% Convertible Subordinated Debentures for fiscal year ended
January 31, 1994 and fiscal year ended January 31, 1995. For fiscal year
ended January 31, 1996, the 6 3/4% Convertible Subordinated Debentures are
included in liabilities subject to compromise. Liabilities subject to
compromise for the fiscal year ended January 31, 1996 are excluded from
working capital and long-term debt.
(4) There were no cash dividends declared during any of the periods presented
above, except for cash dividends in the amount of $.2 million and $.5
million paid to WEI, the Company's sole stockholder in the fiscal years
ended January 31, 1995 and January 31, 1994 respectively.
(5) EBITDA represents income from operations, plus depreciation and
amortization. It is management's belief that due to the combined
format of rental product and sale merchandise, a more appropriate
calculation of EBITDA (hereafter referred to as Adjusted EBITDA) should
include the net difference between rental amortization plus the book value
of rental dispositions, versus rental inventory purchased during the
period. The Company has included certain information concerning Adjusted
EBITDA because management believes it would be useful information for
certain investors and analysts to analyze operating performance and to
determine the Company's ability to service debt. Adjusted EBITDA for
January 31, 1998, includes a non-recurring cash benefit of $1.7 million
resulting from the impact of one-time credits received from landlord
concessions and a charge that represents the portion of rent expense
accrued to recognize minimum rents in a straight-line basis over the term
of the leases, in excess of cash rent expense. The method of calculating
Adjusted EBITDA set forth above may be different from calculations of
EBITDA employed by other companies and, accordingly may not be directly
comparable to such other computations. Adjusted EBITDA should not be
viewed as a substitute for Generally Accepted Accounting Principles (GAAP)
measurements such as net income or cash flow from operations. Rather it
is presented as supplementary information.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATION
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements contained in Management's Discussion and Analysis of
Financial Condition and Results of Operation, particularly in the paragraph
entitled "Liquidity and Capital Resources," and elsewhere in this Annual Report
on Form 10-K are forward-looking statements. These statements discuss, among
other things, expected growth, future revenues and future performance. The
forward-looking statements are subject to risks and uncertainties, including the
following: (a) changes in levels of competition from current competitors and
potential new competition from both retail stores and
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alternative methods or channels of distribution such as electronic and telephone
shopping services and mail order; (b) loss of a significant vendor or prolonged
disruption of product supply; (c) the presence or absence of popular new
releases and products in the product categories the registrant represents; (d)
changes in levels of consumer spending, especially during seasonally significant
periods; (e) changes in the Federal and state income tax rules and regulations
or interpretations of existing legislation; (f) changes in the general economic
conditions in the United States, and in particular the eight major markets
served by the registrant, including, but not limited to, consumer sentiment
about the economy in general; (g) changes in availability or terms of working
capital financing from vendors and lending institutions; (h) adverse results in
significant litigation matters; and (i) the ability to attract and retain key
personnel. The foregoing should not be construed as an exhaustive list of all
factors which could cause actual results to differ materially from those
expressed in forward-looking statements made by the registrant. Actual results
may materially differ from anticipated results described in these statements.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operation include the operations of Old Wherehouse through
January 31, 1997 and New Wherehouse through January 31, 1998. The discussion of
financial conditions includes cash flow resulting from the operations of Old
Wherehouse and a liquidity analysis based on the balance sheet of New Wherehouse
after the reorganization, which reflects "Fresh Start" Accounting adjustments.
See note 2 to the financial statements.
YEAR ENDED JANUARY 31, 1998 COMPARED TO YEAR ENDED JANUARY 31, 1997
Revenues were $327.4 million and $365.5 million for the fiscal years ended
January 31, 1998 and January 31, 1997, respectively. The decrease of $38.1
million or 10.4% was principally due to the closing of 20 stores and the
elimination of rental activity in an additional 25 stores during the year. On a
same store basis (stores open for at least 13 months) overall revenues were
approximately flat as increases in same store merchandise sales revenues were
off-set by decreases in same store rental revenues.
Merchandise sales (which includes new and used merchandise, ticket sales
commissions and other revenue) were $276.1 million and $295.5 million during the
fiscal years ended January 31, 1998 and 1997, respectively, representing a
decrease of 6.5% which was largely due to the closing of unprofitable stores.
On a same store basis there was a 4.5% increase for merchandise sale revenues.
(See table in Item 1 -- "Business--Merchandise Sale Products.") The increase
in same store merchandise sales was principally due to better industry-wide new
"hit" releases and the favorable impact of competitor store closures.
Rental revenue includes the rental of videocassettes, video games and game
players and audiocassette books. At January 31, 1998 approximately 72% of the
Company's stores offered videocassettes and other products for rent versus
approximately 84% at January 31, 1997. Rental revenue for the fiscal year ended
January 31, 1998 was $51.3 million, a decrease of 26.8% from the previous fiscal
year and a decrease of 20.6% on a same store basis. The Company believes that
these decreases are attributable to a number of factors, including the reduction
in the number of stores offering rental products, lack of strength in "hit"
releases in all rental categories, continued competition and a general softening
in rental consumer spending nationwide.
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The Company believes that in the future its business and same-store
revenues may be impacted by various competitive and economic factors, including,
but not limited to, consumer tastes, new releases of music, videocassette and
video game titles available for sale or rental, and general economic trends
impacting retailers and consumers. In addition, in recent years the Company's
merchandise sales and rental revenues have been impacted by increased
competition from other music and video specialty chains, as well as discounters
and mass merchandisers.
The Company's business is seasonal, and as is typical for most retailers,
its revenues tend to peak during the Christmas holiday season. See
"Seasonality" below.
Cost of sales decreased $19.4 million to $176.1 million for the fiscal year
ended January 31, 1998, as compared with $195.5 million for the fiscal year
ended January 31, 1997. As a percentage of merchandise sales, cost of sales
decreased 2.4 % to 63.8% for the fiscal year ended January 31, 1998 versus 66.2%
for the fiscal year ended January 31, 1997. The gross profit percentage for
merchandise sale product was 36.2% and 33.8% for the fiscal years ended January
31, 1998 and 1997, respectively. The 2.4% decrease in cost of sales as a
percentage of merchandise sales was principally due to lower obsolescence costs
and higher prompt payment discounts on merchandise inventory purchases.
Cost of rentals, including amortization, decreased $6.6 million to $27.4
million for the fiscal year ended January 31, 1998 as compared with $34.0
million for the fiscal year ended January 31, 1997. As a percentage of rental
revenue, cost of rentals increased to 53.4 % for the fiscal year ended January
31, 1998 from 48.5% for the fiscal year ended January 31, 1997, an increase of
4.9%. The gross profit percentage for rental revenue was 46.6% and 51.5% for the
fiscal years ended January 31, 1998 and 1997, respectively. The 4.9% increase
in cost of rentals is primarily due to higher amortization costs incurred due
to the change in amortization policy adopted by the Company as of January 31,
1997 and, to a lesser extent, the decline in rental efficiency resulting from
rental revenue decreases. New Wherehouse amortizes rental inventory using the
straight-line method over a three-month period with a salvage value of $3.00 per
videocassette. Old Wherehouse amortized rental inventory over three years for
videocassettes and two years for video games for the fiscal year ended January
31, 1997. If Old Wherehouse had adopted the more accelerated method of
amortization as of January 31, 1996, amortization costs would have been higher
(and gross profit would have been lower) for the fiscal year ended January 31,
1997.
Merchandise sales, including ticket commissions, as a percent of aggregate
net revenues increased to 84.3% in the fiscal year ended January 31, 1998 from
80.8% in the fiscal year ended January 31, 1997, principally due to the
reduction in the number of stores offering videocassettes and other products for
rent. Historically, the margin on rentals has been higher than the margin on
merchandise sales. Should the product mix continue to shift to lower margin
merchandise sales from higher margin rental revenue, it can be expected that the
change in the mix of revenue contribution could have an impact on profitability.
Several major retail chains, including Best Buy, Blockbuster Entertainment
and Hollywood Video increased their retail store presence in the Company's
markets. This trend is expected to continue and it is anticipated that the
Company will, in future periods, experience increased competition in both
rentals and merchandise sales from companies with greater financial resources
than
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<PAGE>
its own, and that such competition may result in continued pressure on revenues
and gross profit margins.
Selling, general and administrative expenses were $111.9 million and $145.4
million for the fiscal years ended January 31, 1998 and 1997, respectively, a
decrease of $33.5 million, or 23.0%. As a percentage of aggregate net revenues,
selling, general and administrative expenses were 34.2% and 39.8% for the fiscal
years ended January 31, 1998 and 1997, respectively, a decrease of 5.6%. The
change was primarily due to decreases, as a percentage of revenue, in rent,
payroll, other occupancy costs, and other store and corporate expenses.
Income from operations was $12.0 million for the fiscal year ended January
31, 1998, as compared with a loss of $9.4 million for the fiscal year ended
January 31, 1997. The increase in the operating profit resulted primarily from
the decrease in selling, general and administrative expenses, combined with the
decrease in cost of sales, both of which were partially offset by a higher cost
of rentals as a percent of rental revenue.
Interest expense decreased $0.5 million to $0.5 million for the fiscal
year ended January 31, 1998 versus $1.0 million for the fiscal year ended
January 31, 1997.
Interest income for the fiscal year ended January 31, 1998 was $1.6
million, an increase of $1.3 million from $0.3 million for the year ended
January 31, 1997 due to the improved operating profits which generated
sufficient cash flow to fund operations without utilizing the Congress Facility.
The Company recorded an income tax provision of $5.4 million for the fiscal
year ended January 31, 1998 but did not record a tax provision for the fiscal
year ended January 31, 1997.
The Company is currently under audit by the California Franchise Tax Board
for tax years ended January 31, 1992, 1993 and 1994. The Company believes that
it has made adequate provision in the financial statements for this audit.
YEAR ENDED JANUARY 31, 1997 COMPARED TO YEAR ENDED JANUARY 31, 1996
Revenues were $365.5 million and $433.2 million for the fiscal years ended
January 31, 1997 and January 31, 1996, respectively. This decrease of $67.7
million was principally due to a 5.0% decrease in same-store revenues (stores
open for at least 13 months) and the closing of 63 stores during the year.
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Merchandise sales were $295.5 million and $350.3 million during the fiscal
years ended January 31, 1997 and January 31, 1996, respectively, representing an
aggregate decrease of 15.7 % and a decrease of 4.1 % on a same-store basis. (See
table in Item 1 -- "Business - Merchandise Sale Products.") The decrease in
same-store merchandise sales was principally due to decreased customer traffic
caused by a lack of new, "hit" release music product, continued competitive and
economic pressures in certain of the Company's markets and, in the opinion of
the Company, a shift in consumer spending from traditional entertainment
products to alternative products including home computer hardware and software
products.
Rental revenue includes the rental of videocassettes, video games and game
players and audiocassette books. At January 31, 1997 approximately 84% of the
Company's stores offered videocassettes and other products for rent versus
approximately 81% at January 31, 1996. Rental revenue for the fiscal year ended
January 31, 1997 was $70.0 million compared to $82.9 million for the fiscal year
ended January 31, 1996, a total rental revenue decrease of 15.5%, and a decrease
of 8.7 % on a same-store basis. The Company believes that decreases in both
total and same-store rental revenue are attributable to a number of factors,
including the difficulties resulting from the Company's liquidity problems in
attempting to purchase large quantities of certain "hit" titles, a lack of "hit"
releases in all rental categories, continued competition and a general softening
in rental consumer spending nationwide.
Cost of sales decreased $34.9 million to $195.5 million for the fiscal year
ended January 31, 1997, as compared with $230.3 million for the fiscal year
ended January 31, 1996. As a percentage of merchandise sales revenues, cost of
sales increased 0.4% to 66.2% for the fiscal year ended January 31, 1997 versus
65.8% for the fiscal year ended January 31, 1996. The gross-profit percentage
for merchandise sale product was 33.8% and 34.2% for the fiscal years ended
January 31, 1997 and January 31, 1996, respectively. Gross profit for both
years was negatively impacted by higher merchandise writedowns resulting from
the Company's inability, during the bankruptcy, to rapidly dispose of
returnable goods and decreased prompt payment discounts on merchandise
inventory purchases, also as a result of the bankruptcy filing.
Cost of rentals, including amortization, decreased $6.4 million to $34.0
million for the fiscal year ended January 31, 1997, as compared with $40.4
million for the fiscal year ended January 31, 1996. As a percentage of rental
revenue, cost of rentals decreased to 48.5% for the fiscal year ended January
31, 1997, from 48.7% for the fiscal year ended January 31, 1996 a decrease of
0.2%. The gross profit percentage for rental revenue was 51.5% and 51.3% for
the fiscal years ended January 31, 1997 and January 31, 1996 respectively. The
0.2% decrease in cost of rentals, was primarily attributable to decreased
rental inventory shrinkage offset by an increase in rental amortization.
Rental amortization for both years reflected Old Wherehouse's policy whereby
rental inventory was amortized over three years for videocassettes and two
years for video games.
Merchandise sales, including ticket commissions, as a percentage of
aggregate net revenues, decreased slightly from 80.9% in the fiscal year ended
January 31, 1996 to 80.8% in the fiscal year ended January 31, 1997.
Historically, the margin on rentals has been higher than the margin on
merchandise sales. Should the product mix shift to lower margin merchandise
sales from higher
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margin rental revenue, it can be expected that the change in the mix of revenue
contribution could have an impact on profitability. Several major retail
chains, including Best Buy, Blockbuster Entertainment, and Hollywood Video
increased their retail store presence in the Company's markets. This trend is
expected to continue and it is anticipated that the Company will in future
periods experience increased competition in both rentals and merchandise sales
from companies with greater financial resources than its own, and that such
competition may result in continued pressure on revenues and gross profit
margin. The Company believes that part of the reduction in rental volume has
resulted from such competition.
Selling, general and administrative expenses, were $145.4 million and
$166.8 million for the fiscal years ended January 31, 1997 and January 31,
1996, respectively, a decrease of $21.4 million, or 12.8%. As a percentage of
aggregate net revenues, selling, general and administrative expenses were 39.8%
and 38.5% for the fiscal years ended January 31, 1997 and January 31, 1996,
respectively, an increase of 1.3%. The change was primarily due to increases,
as a percentage of revenue, in payroll and rent and other occupancy costs, and
to a lesser extent, other store and corporate expenses.
The loss from operations was $9.4 million for the fiscal year ended January
31, 1997, as compared with a loss of $5.8 million for the fiscal year ended
January 31, 1996. The increase in the operating loss resulted primarily from a
decrease in the amount of gross profit dollars for the year partially offset by
decreases in selling, general and administrative expenses.
Interest expense decreased $14.0 million to $1.0 million for the fiscal
year ended January 31, 1997 versus $15.0 million for the fiscal year-ended
January 31, 1996. The decrease was primarily due to the suspension of the
accrual of interest on the Company's revolving line of credit, variable rate
term note, Senior Subordinated Notes and Convertible Debentures following Old
Wherehouse's bankruptcy filing. The amount of interest that ceased to accrue
during the Bankruptcy Case was $26.0 million and $13.3 million for the fiscal
year ended January 31, 1997 and for the fiscal year ended January 31, 1996,
respectively.
Reorganization items for the fiscal year ended January 31, 1997 include
costs related to the Bankruptcy Case including professional fees for legal and
financial advisors, costs related to the closing of stores (including the
write-down of inventory resulting from the closing of stores), and the estimated
cost associated with the rejection of certain executory contract and other
reorganization costs. For the fiscal year ended January 31, 1997, the Company
reported total reorganization items of $19.9 million which is comprised of $7.2
million of professional fees, $7.0 million related to the closing of stores,
$3.3 million associated with the rejection of certain executory contracts and
$2.4 million of other reorganization costs.
The Company did not record an income tax provision for the fiscal year
ended January 31, 1997 but did record a tax provision of $17,000 for the fiscal
year ended January 31, 1996. While the Company experienced a pre-tax loss in
the fiscal year ended January 31, 1996, it was unable to record a tax benefit
because of an offsetting increase in the valuation allowance for deferred tax
assets.
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LIQUIDITY AND CAPITAL RESOURCES
Due to the improved operating results for the fiscal year ending January
31, 1998, the Company generated $59.9 million in net cash from operating
activities as compared to $15.9 million for the fiscal year ending January 31,
1997, an increase of $44.0 million or 277%. The increase in cash flow from
operations resulted primarily from increased profitability, a decrease in
merchandise inventory of $11.8 million and an increase in accounts payable and
other accrued liabilities of $23.9 million. Net cash used in investing
activities was $4.6 million, an increase of $3.3 million or 254% over the prior
period. Cash used in investing activities primarily resulted from the
acquisition of equipment and improvements. Cash used in financing activities
of $6.7 million, a decrease of $9.1 million from the prior year, was primarily
related to the payment of $5.6 million of pre-petition claims.
New Wherehouse has established the Congress Facility, which is a revolving
line of credit for up to $30.0 million based upon certain formulas, including a
letter of credit subfacility of up to $10.0 million. Borrowings under the
Congress Facility bear interest, at New Wherehouse's option, at either: (a) the
prime rate, or (b) the applicable Eurodollar rate plus 2.50%. New Wherehouse
had no outstanding borrowings against the facility at January 31, 1998. At
January 31, 1998, New Wherehouse had $0.7 million of letters of credit
outstanding. New Wherehouse is subject to various financial and other
covenants under the terms of the Congress Facility including, covenants
relating to net worth, mergers or consolidations, liens, indebtedness and other
matters. As of January 31, 1998, the Company was in compliance with all
financial covenants required by this facility. The Congress Facility is
available through January 31, 2000 and is renewable annually thereafter.
The Company believes that cash on hand, cash flow from operations as well
as borrowings available under the Congress Facility will be adequate to fund
operations and remaining obligations under the Reorganization Plan.
As of January 31, 1998, the Company had no new significant outstanding
commitments for future capital expenditures. The Company is exploring future
expansion and acquisition strategies and is confident that it will be able to
fund these activities through the existing Congress Facility and other available
financing. However, there can be no assurance as to the effect which any
future changes in the Company's operations or results could have on its
liquidity.
SEASONALITY
The Company's business is seasonal, and revenues and operating income are
highest during the fourth quarter. Working capital deficiencies and related
bank borrowings in prior years were usually lowest during the period commencing
the end of the Christmas holidays and ending with the close of the Company's
fiscal year. Beginning in February, working capital deficiencies and related
bank borrowings have historically trended upward during the year until the
fourth quarter. Bank borrowings have historically been highest in October and
November due to cumulative capital expenditures for new stores and the building
of inventory for the holiday season. During the fiscal year ended January 31,
1998, the Company was able to fund all of its activities from cash flow from
operations and did not have to borrow funds available under the Congress
Facility.
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IMPACT OF YEAR 2000
The Year 2000 issue is the result of computer programs being written using
two digits rather than four to define the applicable year. Any of the Company's
computer programs that have time-sensitive software may recognize a date using
"00" as the year 1900 rather than the year 2000. This could result in a system
failure or miscalculations causing disruptions of operations, including, among
other things, a temporary inability to process transactions, issue purchase
orders, or engage in similar normal business activities.
The Company has determined that it will be required to modify or replace
portions of its software so that its computer systems will function properly
with respect to dates in the year 2000 and thereafter. The Company also has
initiated formal communications with its significant suppliers and large
customers to determine the extent to which the Company's interface systems are
vulnerable to those third parties' failure to remediate their own Year 2000
issues. The Company is in the process of completing estimates and confirming
its systems strategy. Based upon information available at this time, the
Company estimates that the cost associated with replacing or modifying its
systems in order to comply with Year 2000 requirements will be between $2.0
million and $3.0 million. This estimate is subject to further revision based on
facts and circumstances encountered during the project. The Company presently
believes that with modifications to existing software and conversions to new
software, the Year 2000 issue will not pose significant operational problems for
its computer systems. The Company will use both internal and external resources
to reprogram, or replace, and test the software for Year 2000 modifications.
The Company anticipates completing the Year 2000 project prior to any
anticipated impact on its operating systems. However, if such modifications and
conversions are not made, or are not completed timely, the Year 2000 issues
could have a material effect on the operations of the Company. Likewise, there
can be no assurance that the systems of other companies on which the Company's
systems rely will be timely converted and would not have a material adverse
effect on the Company's systems
INFLATION
The Company believes that inflation has not had a material effect on its
results of operations and its internal and external sources of liquidity and
working capital.
Changes to federal minimum wage laws in each of 1996 and 1997 raised the
mandatory minimum wage. California and other states have also enacted increases
in State required minimum wages that are higher than the Federal requirements.
statutory increases in Federal and state minimum wages could adversely affect
the Company's profitability. The recent Federal and state increase and any
other such increases will raise minimum wages above current wage rates of
certain of the Company's employees, and competitive factors could require
corresponding increases in higher employee wage rates, any of which increase the
Company's expenses and adversely affect results of operations.
25
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See Index to Financial Statements and Financial Statement Schedule appearing on
page F-0 of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None.
26
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The following table sets forth certain information concerning the persons who
were directors and executive officers of New Wherehouse as of January 31, 1998:
Age at
Name Position April 30, 1998
---- -------- --------------
Antonio C. Alvarez, II Chief Executive Officer, Chairman 49
of the Board and Director
Hugh G. Hilton Senior Vice President, Chief Operating 47
Officer
Robert S. Kelleher Senior Vice President, Chief Financial 48
Officer and Assistant Secretary
Barbara C. Brown Senior Vice President, Store 46
Operations
Robert C. Davenport Director 31
Jonathan Gallen Director 38
Joseph B. Smith Director 70
Joseph J. Radecki, Jr. Director 40
ANTONIO C ALVAREZ, II, Chief Executive Officer, Chairman of the Board and
Director. Mr. Alvarez commenced serving as Chief Executive Officer, Chairman
of the Board and Director of New Wherehouse on January 31, 1997. Mr. Alvarez,
is a principal of Alvarez & Marsal, Inc., a New York based management
consulting company. Mr. Alvarez's recent experience includes acting as adviser
to the bank lenders to Camelot Music, Inc. and serving as the senior executive
of Phar-Mor, Inc. ("Phar-Mor"). Mr. Alvarez served as Phar-Mor's President and
Chief Operating Officer from September 1992 through February 1993, as acting
Chief Financial Officer from August 1992 to December 1992, and as Chief
Executive Officer from February 1993 through Phar-Mor's emergence from Chapter
11 bankruptcy in October,
27
<PAGE>
1995. Mr. Alvarez serves as the Chief Executive Officer, Chairman of the Board
and Director of New Wherehouse pursuant to a Management Services Agreement
between New Wherehouse and Alvarez & Marsal, Inc. See Item 11 - "Employment
Agreements" below.
HUGH G. HILTON, Senior Vice President and Chief Operating Officer. Mr.
Hilton commenced serving as Chief Operating Officer in January, 1998. Mr.
Hilton is a Managing Director of Alvarez & Marsal, Inc., a New York based
management consulting company which he joined in June, 1992. Mr. Hilton's
most recent experience while at Alvarez and Marsal, Inc. includes serving as
Chief Executive Officer at Fedco between April, 1996 and April, 1997. Prior to
joining Alvarez & Marsal, Inc., Mr. Hilton was President of Trinity Pacific
Real Estate Services, a commercial real estate consulting firm, which he
founded in May, 1988. Prior to founding Trinity Pacific, he served as
President of Karsten Institutional Realty Advisors (a subsidiary of First
Interstate Bancorp), a pension fund advisory firm with $1.2 billion in real
estate assets under management.
ROBERT S. KELLEHER, Senior Vice President, Chief Financial Officer and
Assistant Secretary. Mr. Kelleher joined New Wherehouse in
April, 1997 as Senior Vice President and Chief Financial Officer and was
appointed Assistant Secretary in September, 1997. From July, 1995 to January,
1997, Mr. Kelleher served as Chief Operating Officer and Chief Financial Officer
for Kids Mart, Inc., a 180 store chain of children's specialty apparel stores.
Kids Mart, Inc. filed for Chapter 11 bankruptcy on January 10, 1997. Prior to
that, from November, 1980 to June, 1995, Mr. Kelleher held various executive
positions, most recently President, Chief Operating Officer and Chief Financial
Officer with Contempo Casuals, Inc., a 340 store chain of specialty women's
apparel stores, then a subsidiary of the Neiman Marcus Group, Inc.
BARBARA C. BROWN, Senior Vice President, Store Operations. Ms. Brown
joined Old Wherehouse in 1973. She became Vice President, Sales and Operations
in 1986 and was promoted to Senior Vice President in 1991. Prior to 1986, Ms.
Brown served in a variety of store operations positions including Store
Manager, District Manager, Assistant Vice President, Store Operations, and
Associate Vice President, Store Operations.
ROBERT C. DAVENPORT, Director. Mr. Davenport commenced serving as a
director of New Wherehouse on January 31, 1997. Mr. Davenport is a Managing
Director of Cerberus Partners, L.P., a New York based investment fund, a
position he has held since February, 1996. From March, 1994 until February,
1996, he was a private investor. From 1990 through 1994, he was with Vestar
Capital Partners, Inc., an investment fund, where he served as a vice
president. Prior to joining Vestar in 1990, Mr. Davenport was an analyst in the
Mergers and Acquisitions Group at Drexel Burnham Lambert in New York.
JONATHAN GALLEN, Director. Mr. Gallen commenced serving as a director of
New Wherehouse on January 31, 1997. Mr. Gallen is the sole managing member of
Pequod LLC, the general partner of Pequod Investments, L.P. ("Pequod"). Pequod
is a distressed securities fund which invests in publicly traded debt, private
debt, trade claims, large and middle-market bank loans, distressed real estate
and public and private equity. Prior to opening Pequod, from February, 1993
through February, 1994, Mr. Gallen worked with Stephen Feinberg, the principal
of Feinberg Management, L.P. ("FMLP"), observing, training and learning
investment techniques, procedures and philosophies. Mr. Gallen received no
compensation from FMLP. Mr. Gallen
28
<PAGE>
served as a Director on the Board of Directors of Harvest Foods, Inc. from
April, 1995 to March, 1997 and the Board of Directors of Fruehauf Trailer
Corporation, Inc. from November, 1996 to March, 1997.
JOSEPH B. SMITH, Director. Mr. Smith commenced serving as a director of
New Wherehouse on January 31, 1997. Mr. Smith is currently the Chairman of
Unison Productions, a consulting and production company, a position he has held
since April, 1994. During his career, Mr. Smith has held a variety of
positions in the music industry, including holding senior positions with three
major record companies. He most recently served as President and Chief
Executive Officer of Capitol Industries-EMI Music, Inc., a position he held
from 1987 until 1993 when he retired and began his consulting work with
Unison Productions. Mr. Smith serves as a director of Westwood One, Inc.
JOSEPH J. RADECKI, Jr., Director. Mr. Radecki commenced serving
as a director of New Wherehouse on February 20, 1997. Mr. Radecki is currently
Managing Director of CIBC Oppenheimer Corp., an investment bank. Prior to
joining CIBC Oppenheimer Corp., Mr. Radecki was an Executive Vice President and
Director of Financial Restructurings of Jefferies & Company, Inc. from 1990 to
1998. From 1983 until 1990, Mr. Radecki was First Vice President in the
International Capital Markets Group at Drexel Burnham Lambert, Inc. where he
specialized in financial restructurings and recapitalizations. Mr. Radecki has
served as a member of the Board of Directors of Service America Corporation,
Bucyrus International, Inc. and ECO-Net.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Under the securities laws of the United States, the Company's directors,
its executive officers, and persons holding more than 10% of the New Common
Stock are required to report their initial ownership of the New Common Stock
and any subsequent changes in that ownership to the Securities and Exchange
Commission (the "Commission"). Specific due dates for these reports have been
established and the Company is required to disclose any failure to file by
these dates. All of these filing requirements were satisfied during the year
ended January 31, 1998, except that Antonio C. Alvarez, II and Bryan Marsal (an
individual who may be deemed to beneficially own more than 10% of the New
Common Stock because he is a principal of A&M Investment Associates #3, LLC, -
see Item 12 "Security Ownership of Certain Beneficial Owners and Management"
below) inadvertently were late in filing one report each, relating to one
transaction.
ITEM 11. EXECUTIVE COMPENSATION
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION.
The following table sets forth for the fiscal year ended January 31, 1998,
certain compensation paid by New Wherehouse or accrued for such fiscal year, to
the Chief Executive Officer ("CEO") and the four next most highly compensated
executive officers. All cash compensation with respect to Antonio C. Alvarez,
II was paid to Alvarez & Marsal, Inc., a consulting firm of which Antonio C.
Alvarez, II is a principal. All other compensation paid with respect to
Antonio C. Alvarez, II was paid to A&M Investments #3, LLC, an affiliate of
Alvarez & Marsal, Inc.
29
<PAGE>
<TABLE>
<CAPTION>
SUMMARY COMPENSATION TABLE
--------------------------
- -----------------------------------------------------------------------------------------------------------------------------------
Long-Term
Annual Compensation Compensation
----------------------------------------- -------------------
No. of
Fiscal Year Other Annual Securities All Other
Name and ended January Salary Bonus Compensation Underlying Compensation
Principal Position 31, ($) ($) ($) Options ($)
- ----------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Antonio C. Alvarez, II 1998 --- --- 600,000 (1) --- ---
Chairman, Chief Executive 1997 --- --- 389,452 (2) 993,380 (4) ---
Officer 1996 --- --- --- --- ---
- ----------------------------------------------------------------------------------------------------------------------------------
Hugh G. Hilton 1998 --- --- --- --- ---
Senior Vice President, Chief 1997 --- --- (3) (4) ---
Operating Officer 1996 --- --- --- --- ---
- ----------------------------------------------------------------------------------------------------------------------------------
Robert S. Kelleher 1998 141,346 122,000 --- --- 158 (5)
Senior Vice President, Chief 1997 --- --- --- --- ---
Financial Officer 1996 --- --- --- --- ---
- ----------------------------------------------------------------------------------------------------------------------------------
Barbara C. Brown 1998 175,000 75,000 --- --- 12,270 (6)
Senior Vice President, 1997 175,000 --- --- --- 3,598 (7)
Store Operations 1996 171,538 16,000 --- --- 6,847 (8)
- ----------------------------------------------------------------------------------------------------------------------------------
Michael Buskey (12) 1998 137,000 --- --- --- 8,787 (9)
Vice President, Regional 1997 136,382 --- --- --- 3,696 (10)
Manager 1996 132,685 --- --- --- 2,460 (11)
- -----------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1) Mr. Alvarez commenced serving as Chairman of the Board and Chief Executive
Officer of New Wherehouse pursuant to a Management Services Agreement dated
as of January 31, 1997. The Management Services Agreement has been
extended for one year pursuant to an extension and amendment thereof dated
as of February 1, 1998. See "Employment Agreements" under this Item 11
below.
(2) This amount represents consulting fees paid by the Senior Lenders to
Alvarez & Marsal, Inc. prior to the Plan Effective Date, which amount was
reimbursed by New Wherehouse to the Senior Lenders. See "Employment
Agreements" under this Item 11 below.
(3) Mr. Hilton serves the Company under the Management Services Agreement
with Alvarez & Marsal, Inc. In January, 1998, Mr. Hilton was appointed
Chief Operating Officer by the Board of Directors. The Company did not
pay any separate compensation for Mr. Hilton to Alvarez & Marsal, Inc.
for the year ended January 31, 1998. Effective February 1, 1998, the
Company has agreed to compensate separately Alvarez & Marsal, Inc. for
Mr. Hilton's services pursuant to an amendment to the Management
Services Agreement.
(4) In connection with the Management Services Agreement, New Wherehouse issued
options to purchase 993,380 shares of New Common Stock, subject to
adjustment, to A&M Investment Associates #3, LLC (an affiliate of Alvarez &
Marsal, Inc.) of which Mr. Alvarez is a principal,
30
<PAGE>
pursuant to a Non-Transferable Stock Option Agreement dated as of January
31, 1997. Mr. Hilton possesses a pecuniary interest in A&M Investment
Associates #3, LLC. See "Stock Options" under this Item 11 below.
(5) Includes $158 paid on behalf of Mr. Kelleher and his family for medical
expenses not covered by the Company's group medical insurance plan.
(6) Includes $1,895 paid on behalf of Ms. Brown and her family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $7,153 of premiums paid for term life insurance and $3,222 for
matching contributions to the Company's 401(k) plan made on behalf of Ms.
Brown.
(7) Includes $1,538 paid on behalf of Ms. Brown and her family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $310 of premiums paid for term life insurance and $1,750 for
matching contributions to the Company's 401(k) plan made on behalf of Ms.
Brown.
(8) Includes $3,236 paid on behalf of Ms. Brown and her family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $1,828 of premiums paid for term life insurance and $1,783 for
matching contributions to the Company's 401(k) plan made on behalf of Ms.
Brown.
(9) Includes $6,407 paid on behalf of Mr. Buskey and his family for medical
expenses not covered by the Company's group medical insurance plan. Also
included is $2,380 for matching contributions to the Company's 401(k) plan
made on behalf of Mr. Buskey.
(10) Includes $2,090 paid on behalf of Mr. Buskey and his family for medical
expenses not covered by the Company's group medical insurance plan. Also
included are $242 of premiums paid for term life insurance and $1,363 for
matching contributions to the Company's 401(k) plan made on behalf of Mr.
Buskey.
(11) Includes $1,091 paid on behalf of Mr. Buskey and his family for medical
expenses and $1,379 for matching contributions to the Company's 401(k) plan
made on behalf of Mr. Buskey.
(12) Mr. Buskey is no longer with the Company.
STOCK OPTIONS
In connection with the consummation of the Reorganization Plan, New
Wherehouse entered into a Non-Transferable Stock Option Agreement (the
"Option Agreement") with A&M Investment Associates #3, LLC ("Investment
Associates"), an affiliate of Alvarez & Marsal, Inc., of which Antonio C.
Alvarez, II is a principal. Pursuant to the terms of the Option Agreement,
on January 31, 1997, New Wherehouse granted to Investment Associates three
tranches of options (the "A&M Options") to acquire, in the aggregate, 993,380
shares of the New Common Stock, at
31
<PAGE>
exercise prices of $9.56, $11.58 and $14.10, respectively. The A&M Options
are subject to certain anti-dilution provisions as set forth in the Option
Agreement. See "Certain Relationships and Related Transactions" under Item
13 below. (New Wherehouse has not granted any options to acquire New Common
Stock with respect to any other executive officer or director of New
Wherehouse.)
FISCAL YEAR-END OPTION VALUES
No options were exercised by any of the named executive officers during
the fiscal year ended January 31, 1998. The following table sets forth
certain information with respect to the named executive officers of the
Company concerning the number of shares covered by both exercisable and
unexercisable stock options held as of January 31, 1998. No established
trading market exists for the New Common Stock. As of January 31, 1998, the
Company calculates the book value of each share of New Common Stock to be
$8.45. This book value of $8.45 per share is utilized to calculate the value
of unexercised in-the-money options. It is not intended to represent the
price at which shares of the New Common Stock trade.
<TABLE>
<CAPTION>
FISCAL YEAR-END OPTION VALUES
Number of Securities Value of Unexercised
Underlying in-the-money
Unexercised options options
at fiscal year end at fiscal year end
Name Exercisable/ Exercisable/
---- -------------- -------------
Unexercisable Unexercisable
-------------- -------------
<S> <C> <C>
Antonio C. Alvarez, II 567,646(1)/ 0/0
425,734(1)
Hugh G. Hilton (1) 0/0
Robert S. Kelleher 0/0 0/0
Barbara C. Brown 0/0 0/0
Michael Buskey 0/0 0/0
</TABLE>
(1) In connection with the Management Services Agreement, New
Wherehouse issued options to purchase 993,380 shares of New Common
Stock to Investment Associates pursuant to the Option Agreement
dated as of January 31, 1997. Mr. Hilton possesses a pecuniary
interest in Investment Associates. The number of securities
underlying unexercised A&M Options is subject to adjustment. See
"Certain Relationships and Related Transactions" under Item 13
below.
COMPENSATION OF DIRECTORS
Two non-employee members of the Board of Directors of New Wherehouse
receive as compensation for their services $5,000 per attended meeting of the
Board of Directors. The directors are also reimbursed for reasonable expenses
incurred in attending Board meetings.
32
<PAGE>
EMPLOYMENT AGREEMENTS
Antonio C. Alvarez, II serves as Chairman of the Board and Chief
Executive Officer, Hugh Hilton serves as Senior Vice President and Chief
Operating Officer, Karen Marsal serves as Vice President Administrative
Services and Special Projects and Mark Alvarez serves as Vice President,
Latin Merchandising of New Wherehouse pursuant to a Management Services
Agreement, dated as of January 31, 1997, as amended February 1, 1998, among
New Wherehouse, Alvarez & Marsal, Inc. ("A&M"), Antonio C. Alvarez, II, the
Support Employees described therein, Investment Associates and Cerberus
Partners, L.P. (the "Management Agreement"). Under the Management Agreement,
A&M currently receives (i) $600,000 annually as compensation for the services
of Antonio C. Alvarez, II and the services of other personnel supplied by A&M
as needed, and (ii) $450,000 annually as compensation for the services of Mr.
Hilton, Ms. Marsal and Mr. Mark Alvarez. A&M is also eligible to receive
discretionary incentive bonuses for the services of Mr. Hilton, Ms. Marsal
and Mr. Mark Alvarez, not to exceed an annual aggregate amount of $180,000
payable to A&M for the services of all such persons. The Management
Agreement, as amended, now provides that it will expire on October 14, 1999,
subject to further extension or earlier termination under certain conditions.
Prior to the Plan Effective Date, Antonio C. Alvarez, II served as a
consultant to the Senior Lenders pursuant to a letter agreement dated as of
October 14, 1996 between A&M, Antonio C. Alvarez, II and the Senior Lenders (the
"Interim Agreement"). Pursuant to the Interim Agreement, the Senior Lenders
agreed to pay A&M a consulting fee of $50,000 per month plus the hourly fees of
those employees of A&M providing assistance to Antonio C. Alvarez, II in the
performance of his consulting responsibilities. The Senior Lenders paid
$389,452 to A&M pursuant to the Interim Agreement prior to January 31, 1997.
Under the Management Agreement, New Wherehouse agreed to reimburse, and has
reimbursed, the Senior Lenders for the amounts paid by the Senior Lenders to A&M
pursuant to the Interim Agreement.
In the event that Antonio C. Alvarez, II is terminated other than for cause
(as defined in the Management Agreement), prior to October 14, 1998, the
Management Agreement provides that (i) Investment Associates will have the right
to require New Wherehouse to purchase the shares of New Common Stock and options
(whether or not vested), owned by Investment Associates, and (ii) New Wherehouse
will pay A&M cash in a lump sum amount equal to $50,000 multiplied by the number
of months remaining from the time of termination to October 14, 1998. The price
to be paid by New Wherehouse in purchasing the shares of New Common Stock and
options to acquire New Common Stock owned by Investment Associates will depend
on the fair market value (as defined in the Management Agreement) of the New
Common Stock at the time of purchase. Any payments made to Investment
Associates in purchasing the shares of New Common Stock and options to acquire
New Common Stock from Investment Associates are required to be applied to reduce
the outstanding amounts under the Promissory Notes (as defined in Item 13
below).
In order to retain its key management employees during the period of
deteriorating financial condition and instability prior to the bankruptcy filing
date, in July of 1995, Old Wherehouse entered into agreements with 13 of its
officers that provided certain security in the event of a "Change of Control"
and the subsequent termination of such employee's employment or a significant
reduction in such employee's responsibilities (the "Change of Control
Agreements"). Since the bankruptcy filing
33
<PAGE>
date, Old Wherehouse entered into Change of Control Agreements with five
additional officers. The Change of Control Agreements were approved by the
Bankruptcy Court on December 1, 1995. As of January 31, 1997, 15 agreements
were in effect and those agreements called for payments of up to $1.9 million
if certain events (as described therein) occurred. During the period ended
January 31, 1998, an aggregate amount of $928,000 was paid pursuant to the
terms of such Change of Control agreements. As of February 1998, the Change
of Control agreements provided to the remaining officers were no longer in
effect.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT.
The common stock of New Wherehouse is the only outstanding class of its
voting securities. The following table sets forth, as of April 22, 1998, the
number and percentage of shares of New Common Stock beneficially owned by (i)
each person known to New Wherehouse to be the beneficial owner of more than
5% of the outstanding shares of New Common Stock, (ii) each director of New
Wherehouse, (iii) each named executive officer, and (iv) all directors and
executive officers of New Wherehouse as a group. Unless otherwise indicated
in a footnote, each person listed below possesses sole voting and investment
power with respect to the shares indicated as beneficially owned by them,
subject to community property laws where applicable. The percentage of
ownership in the following table does not include the additional estimated
171,923 shares that may have to be issued pursuant to the Reorganization Plan
after April 22, 1998.
<TABLE>
<CAPTION>
Name and Address of Amount Beneficially Percent of
Beneficial Owner Owned Class(1)
------------------- ------------------- ----------
<S> <C> <C>
Cerberus Partners, L.P. 6,824,756 (2) 56.0%
450 Park Avenue, 28th Floor
New York, New York 10022
A&M Investment Associates #3, 1,856,861 (3) 15.2%
LLC
c/o Alvarez & Marsal, Inc.
885 Third Avenue, Suite 1700
New York, New York 10022-4834
Antonio C. Alvarez, II
c/o Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
A&M Investment Associates 1,856,861 (3) 15.2%
#3, LLC
A&M Investment Associates 385,542 (4) 3.2%
#4, LLC
-------------- -------
Total 2,242,403 18.4%
34
<PAGE>
Bryan Marsal 2,242,403 (5) 18.4%
c/o Alvarez & Marsal, Inc.
885 Third Avenue, Suite 1700
New York, New York 10022-4834
Robert C. Davenport 0 (6) 0
c/o Cerberus Partners, L.P.
450 Park Avenue, 28th Floor
New York, New York 10022
Jonathan Gallen 183,695 (7) 1.5%
c/o Pequod Investments, L.P.
450 Park Avenue, 28th Floor
New York, New York 10022
Joseph B. Smith 0 0
c/o Unison Productions
1015 Gayley Avenue
Los Angeles, California 90024
Joseph J. Radecki, Jr. 0 0
c/o CIBC
425 Lexington Avenue,
3rd Floor
New York, NY 10017
Hugh G. Hilton 0 0
c/o Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Robert S. Kelleher 0 0
c/o Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Barbara C. Brown 0 0
c/o Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
Michael Buskey 0 0
c/o Wherehouse Entertainment, Inc.
19701 Hamilton Avenue
Torrance, California 90502-1334
All Directors and Executive Officers,
as a group (8 persons) 2,426,098 19.9%
</TABLE>
35
<PAGE>
(1) The percent of New Common Stock is based upon the 10,650,643 shares of
New Common Stock issued and outstanding at April 22, 1998 and (i) the
776,000 warrants issued under the Reorganization Plan plus (ii) the
shares underlying the A&M Options that are exercisable within 60 days
of April 22, 1998. The A&M Options are subject to adjustment, see
"Certain Relationships, and Related Transactions" under Item 13 below.
(2) This information was obtained from a Schedule 13D filed with the
Securities and Exchange Commission (the "Commission") regarding
ownership as of September 2, 1997 by the managing member of Cerberus
Associates, LLC, the general partner of Cerberus Partners, L.P., a
limited partnership organized under the laws of Delaware ("Cerberus").
Ownership is described as follows: Cerberus owns 1,607,919 shares of the
New Common Stock and 3,528 warrants (the "Warrants") of the Company
(each of which are exercisable for one share of the Common Stock).
Cerberus International, Ltd., a corporation organized under the laws of
the Bahamas ("International"), owns 1,894,173 shares of the New Common
Stock and 23,280 Warrants. Ultra Cerberus Fund, Ltd., a corporation
organized under the laws of the Bahamas ("Ultra"), owns 150,648 shares
of the New Common Stock and 5,291 Warrants. Various other private
investment funds for which the reporting person possesses voting and
investment authority over the securities of the Company (the "Funds")
own in the aggregate 3,118,760 shares of the Common Stock and 21,157
Warrants. The Managing member of Cerberus Associates, LLC is the
general partner of Cerebus and the investment manager for International,
Ultra and the Funds.
(3) Includes A&M Options to purchase 756,861 shares of New Common Stock
exercisable within 60 days of April 22, 1998. The A&M Options are
subject to adjustment, see "Certain Relationship and Related
Transactions" under Item 13 below. Investment Associates is a Delaware
limited liability company created for the purpose of acquiring shares of
New Common Stock. Antonio C. Alvarez, II is a managing member, and as
such, may be deemed to be the beneficial owner of all the shares of New
Common Stock held by Investment Associates. Mr Hilton possesses a
pecuniary interest in Investment Associates. Both Mr. Hilton and Mr.
Alvarez disclaim beneficial ownership of shares of New Common Stock held
by Investment Associates except to the extent of their pecuniary
interest therein.
(4) A&M Investment Associates #4, LLC., is a Delaware limited liability
company ("A&M #4") of which Antonio C. Alvarez, II is a managing member.
As disclosed on a Schedule 13D-Amendment No. 2 filed with the Commission
on September 16, 1997, Mr. Alvarez shares voting and investment power
over all of the shares of New Common Stock beneficially owned by
Investment Associates and A&M #4. Mr. Alvarez disclaims beneficial
ownership of the New Common Stock held by A&M #4 except to the extent of
his pecuniary interest therein.
(5) Includes 1,856,861 shares of New Common Stock beneficially owned by
Investment Associates as described in footnote (3) above and 385,542
shares of New Common Stock beneficially owned by A&M #4 as described in
footnote (4) above. As disclosed on a Schedule 13D-Amendment No. 2
filed with the Commission on September 16, 1997, Bryan Marsal is a
managing member of A&M #3 and A&M #4, and therefore may be deemed to
be the beneficial owner of the New Common Stock held by either
or both entities. Bryan Marsal disclaims beneficial ownership of
the shares held by both A&M #3 and A&M #4 except to the extent of
his pecuniary interest therein.
(6) Mr. Davenport is a managing director of Cerberus Partners and may be deemed
to be the beneficial owner of all of the shares of New Common Stock held by
Cerberus Partners, L.P. Mr. Davenport disclaims any beneficial ownership in
the shares of New Common Stock held by Cerberus Partners, L.P.
(7) Mr. Gallen is the managing member of Pequod LLC, which is the general
partner of Pequod Investments, L.P. which beneficially owns 128,695
shares of New Common Stock. Mr. Gallen is also President of Ahab
Capital Management, Inc. which is investment advisor to Pequod
International, Ltd. Pequod International, Ltd. is the beneficial owner
of 55,000 shares of New Common Stock. As such, Mr. Gallen may be deemed
to be the beneficial owner of the shares of New Common Stock held by
Pequod Investments, L.P and Pequod International, Ltd. Mr. Gallen has
sole voting and investment power over the New Common Stock of Pequod
Investments, L.P. and Pequod International, Ltd. Mr. Gallen disclaims
beneficial ownership in the shares of New Common Stock held by Pequod
Investments, L.P. and Pequod International, Ltd. except to the extent of
his pecuniary interest therein.
36
<PAGE>
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Pursuant to the Management Agreement and a Stock Subscription Agreement
dated as of January 31, 1997 (the "Stock Subscription Agreement"), New
Wherehouse agreed to sell, and Investment Associates agreed to buy at a
purchase price of $6,340,000 ($1,000,000 in cash from Investment Associates'
funds, plus a secured recourse promissory note in the principal amount of
$335,000 and a secured non-recourse promissory note in the amount of
$5,005,000 (collectively, the "Promissory Notes")) 1,100,000 shares of the
New Common Stock (the "A&M Shares") (subject to adjustment upward or downward
to represent 10% of the sum of (i) the shares of New Common Stock ultimately
issued under the Reorganization Plan plus (ii) the number of shares of New
Common Stock issued to Investment Associates). The Promissory Notes bear
interest at 7% per annum during the first four years and 11 % per annum
during the fifth through seventh years, mature on January 31, 2004 and have
no scheduled interest or principal amortization until their maturity date.
The Promissory Notes are secured by a first priority pledge of the A&M Shares
pursuant to a Stock Pledge Agreement dated as of January 31, 1997.
In addition, New Wherehouse and Investment Associates entered into a
Non-Transferable Stock Option Agreement dated as of January 31, 1997, as
amended, (the "Option Agreement"), pursuant to which New Wherehouse issued to
Investment Associates three tranches of options to purchase shares of New
Common Stock (the "A&M Options"; and, together with the A&M Shares, the "A&M
Securities"). The Option Agreement, as amended, provides for the grant to
Investment Associates of options representing in the aggregate the right to
purchase 10% of (i) the shares of New Common Stock issued under the
Reorganization Plan, (ii) the A&M Shares, and (iii) the shares underlying
these options. The A&M Options vest monthly in equal installments through
October 31, 1998 and all unexercised A&M Options expire on January 31, 2003,
subject to prior vesting or termination as set forth in the Management
Agreement. The Company presently estimates that after all adjustments, the
A&M options will consist of (i) options to acquire 407,667 shares at an
exercise price of $8.63 per share, (ii) options to acquire 407,667 shares at
an exercise price of $10.45 per share, and (iii) options to acquire 407,667
shares at an exercise price of $12.72 per share. The exact number of shares
underlying these options and the exercise price will depend on the final
resolution of claims under the Reorganization Plan. The Option Agreement
provides that such adjustments will be made periodically as deemed
practicable and that an interim adjustment will be made on September 30,
1998.
New Wherehouse also granted certain registration rights to Investment
Associates with respect to the A&M Securities pursuant to a Registration Rights
Agreement dated as of January 31, 1997 (the "A&M Registration Rights
Agreement"). Under the A&M Registration Rights Agreement, Investment Associates
has the right to make one demand registration and two piggyback registrations in
respect of the A&M Securities.
37
<PAGE>
New Wherehouse also granted certain registration rights to the Senior
Lenders as of the Plan Effective Date with respect to the New Common Stock
acquired by such Senior Lenders, pursuant to a Registration Rights Agreement
dated as of January 31, 1997 (the "Senior Lenders Registration Rights
Agreement"). Under the Senior Lenders Registration Rights Agreement, the
holders of a requisite number of shares issued to the Senior Lenders have the
right to make two demand registrations and to participate in two piggyback
registrations in respect of the such shares of New Common Stock.
Jefferies & Company, Inc., of which Mr. Radecki was an Executive Vice
President and Director of Financial Restructurings, served as the financial
consultant to Old Wherehouse in the Bankruptcy Case, and served as financial
advisor to New Wherehouse.
38
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) Documents filed as part of this report.
1. Financial statements.
See Index to Financial Statements and Financial Statement Schedule.
2. Financial statement schedule.
See Index to Financial Statements and Financial Statement Schedule.
All other schedules are omitted as the required information is inapplicable or
the information is presented in the consolidated financial statements or related
notes.
3. Exhibits
2.1 Debtors' First Amended Chapter 11 Plan, as Revised for
Technical Corrections dated October 4, 1996 and
Supplemental Amendments on December 2, 1996 and December
13, 1996. (Incorporated by reference to Exhibits A, B and
C of Exhibit 3.1 of Old Wherehouse's Current Report on
Form 8-K dated January 22, 1997.)
2.2 Asset Purchase Agreement dated as of January 31, 1997
among Old Wherehouse, WEI and New Wherehouse.
(Incorporated by reference to Exhibit 1.4 of Old
Wherehouse's Current Report on Form 8-K dated February 12,
1997.)
3.1 Certificate of Incorporation of New Wherehouse filed with
the Delaware Secretary of State on November 15, 1997.
(Incorporated by reference to Exhibit C of Exhibit A of
Exhibit 3.1 of Old Wherehouse's Current Report on Form 8-K
dated January 22, 1997.)
3.2 Certificate of Amendment of Certificate of Incorporation
of New Wherehouse filed with the Delaware Secretary of
State on January 31, 1997. (Incorporated by reference to
Exhibit 1.3 of Old Wherehouse's Current Report on Form 8-K
dated February 12, 1997.)
3.3 Certificate of Amendment of Certificate of Incorporation
of Old Wherehouse filed with the Delaware Secretary of
State on January 31, 1997. (Incorporated
39
<PAGE>
by reference to Exhibit 1.2 of Old Wherehouse's Current
Report on Form 8-K dated February 12, 1997.)
3.4 By-laws of New Wherehouse. (Incorporated by reference to
Exhibit B of Exhibit A of Exhibit 3.1 of Old Wherehouse's
Current Report on Form 8-K dated January 22, 1997.)
3.5 Amendment to By-laws of New Wherehouse adopted January 30,
1997, adopted by Unanimous Written Consent of the Sole
Director of New Wherehouse. (Incorporated by reference to
Exhibit 3.5 of New Wherehouse's Annual Report on Form 10-K
dated May 16, 1997.)
4.1 Tranche A Warrant Agreement dated as of January 31, 1997
between New Wherehouse and United States Trust Company of
New York, as the Warrant Agent. (Incorporated by reference
to Exhibit 4.1 of New Wherehouse's Annual Report on Form
10-K dated May 16, 1997.)
4.2 Tranche B Warrant Agreement dated as of January 31, 1997
between New Wherehouse and United States Trust Company of
New York, as the Warrant Agent. (Incorporated by reference
to Exhibit 4.2 of New Wherehouse's Annual Report on Form
10-K dated May 16, 1997.)
4.3 Tranche C Warrant Agreement dated as of January 31, 1997
between New Wherehouse and United States Trust Company of
New York, as the Warrant Agent. (Incorporated by reference
to Exhibit 4.3 of New Wherehouse's Annual Report on Form
10-K dated May 16, 1997.)
4.4 Registration Rights Agreement dated as of January 31, 1997
among New Wherehouse, Cerberus Partners, L.P., CS First
Boston Securities Corporation and Bank of America,
Illinois. (Incorporated by reference to Exhibit 1. 14 of
Old Wherehouse's Current Report on Form 8-K dated February
12, 1997.)
10.1 Single Tenant Industrial Lease, dated November 5, 1991, by
and between Watson Land Company, as lessor, and Old
Wherehouse, as lessee. (Incorporated by reference to
Exhibit 10.6 of the Old Wherehouse's Annual Report on Form
10-K for the fiscal year ended January 31, 1992.)
10.2 Management Services Agreement dated as of January 31, 1997
among New Wherehouse Alvarez & Marsal, Inc., Antonio C.
Alvarez II, Investment Associates, Cerberus Partners, L.P.
and the Support Employees. (Incorporated by reference to
Exhibit 1.5 of Old Wherehouse's Current Report on Form 8-K
dated February 12, 1997.)
40
<PAGE>
10.3* Extension and Amendment to Management Services Agreement
dated as of February 1, 1998 among New Wherehouse, Alvarez
& Marsal, Inc., Antonio C. Alvarez, II and Investment
Associates.
10.4* Second Amendment to Management Services Agreement dated as
of April 30, 1998 among New Wherehouse, Alvarez & Marsal,
Inc., Antonio C. Alvarez, II and Investment Associates.
10.5 Secured Recourse Promissory Note dated January 31, 1997 by
Investment Associates in favor of New Wherehouse in the
principal amount of $335,000. (Incorporated by reference
to Exhibit 1.6 of Old Wherehouse's Current Report on Form
8-K dated February 12, 1997.)
10.6 Secured Non-Recourse Promissory Note dated January 31,
1997 by Investment Associates in favor of New Wherehouse
in the principal amount of $5,005,000. (Incorporated by
reference to Exhibit 1.7 of Old Wherehouse's Current
Report on Form 8-K dated February 12, 1997.)
10.7 Stock Pledge Agreement dated as of January 31, 1997
between Investment Associates and New Wherehouse.
(Incorporated by reference to Exhibit 1.8 of Old
Wherehouse's Current Report on Form 8-K dated February 12,
1997.)
10.8 Stock Subscription Agreement dated as of January 31, 1997
between New Wherehouse and Investment Associates.
(Incorporated by reference to Exhibit 1.9 of Old
Wherehouse's Current Report on Form 8-K dated February 12,
1997.)
10.9 Non-Transferable Stock Option Agreement dated as of
January 31, 1997 between New Wherehouse and Investment
Associates. (Incorporated by reference to Exhibit 1. 10 of
Old Wherehouse's Current Report on Form 8-K dated February
12, 1997.)
10.10* First Amendment to Non-Transferable Stock Option Agreement
dated as of April 30, 1998 between New Wherehouse and
Investment Associates.
10.11 Registration Rights Agreement dated as of January 31, 1997
between New Wherehouse and Investment Associates.
(Incorporated by reference to Exhibit 1.12 of Old
Wherehouse's Current Report on Form 8-K dated February 12,
1997.)
10.12 Letter agreement dated as of October 14, 1996 among
Cerberus Partners, L.P., CS First Boston Securities
Corporation and Bank of America, Illinois regarding fees
to be paid to Alvarez & Marsal, Inc. (Incorporated by
reference to Exhibit 1.13 of Old Wherehouse's Current
Report on Form 8-K dated February 12, 1997.)
41
<PAGE>
10.13 Letter agreement dated as of January 31, 1997 between New
Wherehouse and Cerberus Partners, L.P. regarding the
reimbursement of fees paid by Cerberus on behalf of the
senior lenders to Alvarez & Marsal, Inc. (Incorporated by
reference to Exhibit 1.11 of Old Wherehouse's Current
Report on Form 8-K dated February 12, 1997.)
10.14 Loan and Security Agreement dated as of January 31, 1997
between New Wherehouse and Congress Financial Corporation
(Western). (Incorporated by reference to Exhibit 1.15 of
Old Wherehouse's Current Report on Form 8-K dated February
12, 1997.)
10.15 Security Agreement dated as of January 31, 1997 between
New Wherehouse and United States Trust Company of New
York, as Collateral Agent for certain trade creditors.
(Incorporated by reference to Exhibit 1.16 of Old
Wherehouse's Current Report on Form 8-K dated February 12,
1997.)
10.16 Intercreditor and Collateral Agency Agreement dated as of
January 31, 1997 among New Wherehouse, the Trade Creditors
named therein and United States Trust Company of New York,
as Collateral Agent. (Incorporated by reference to Exhibit
1. 17 of Old Wherehouse's Current Report on Form 8-K dated
February 12, 1997.)
10.17 Intercreditor and Subordination Agreement dated as of
January 31, 1997 among the Trade Creditors named therein,
United States Trust Company of New York, as Collateral
Agent for the Trade Creditors and Congress Financial
Corporation (Western). (Incorporated by reference to
Exhibit 1.18 of Old Wherehouse's Current Report on Form
8-K dated February 12, 1997.)
10.18 Security Agreement dated as of January 20, 1997, by and
between Mellon US Leasing, a division of Mellon Leasing
Corporation, successor to United States Leasing
Corporation, as Secured Party, and Reorganized Wherehouse.
(Incorporated by reference to Exhibit 10.15 of New
Wherehouse's Annual Report on Form 10-K dated May 16,
1997.)
10.19 Change of Control Agreements, dated as of July 10, 1995,
between Registrant and each of its executive officers,
with schedule required by instruction (2) to item 601(a)
of Regulation S-K identifying the parties thereto and
certain other details. (Incorporated by reference to
Exhibit 10.1 of Old Wherehouse's Quarterly Report on Form
10-Q for the quarter ended July 31, 1995.)
27.0* Financial Data Schedule.
42
<PAGE>
(b) Current Reports on Form 8-K.
None.
43
* Filed herewith
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
WHEREHOUSE ENTERTAINMENT, INC.
Date: April 30, 1998 By: /s/ Antonio C. Alvarez
--------------------------
Antonio C. Alvarez, II
Chairman of the Board,
Chief Executive Officer and Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
<TABLE>
<S><C>
Signature Title Date
--------- ----- ----
/s/ Antonio C. Alvarez Chairman of the Board, Chief April 30, 1998
-------------------------- Executive Officer
Antonio C. Alvarez, II
/s/ Bob Davenport Director April 30, 1998
--------------------------
Robert C. Davenport
/s/ Jonathan Gallen Director April 30, 1998
--------------------------
Jonathan Gallen
/s/ Joseph J. Radecki, Jr. Director April 30, 1998
--------------------------
Joseph Radecki
/s/ Joseph B. Smith Director April 30, 1998
--------------------------
Joseph B. Smith
</TABLE>
44
<PAGE>
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION
15(d) OF THE ACT BY REGISTRANT WHICH HAS NOT REGISTERED SECURITIES PURSUANT TO
SECTION 12 OF THE ACT.
No annual report or proxy materials have been sent to the security holders of
the registrant.
45
<PAGE>
Wherehouse Entertainment, Inc.
Index to Financial Statements
and Financial Statement Schedule
Year ended January 31, 1998
CONTENTS
Report of Independent Auditors . . . . . . . . . . . . . . . . . . . . . . F-1
Financial Statements
Balance Sheets at January 31, 1998 and 1997. . . . . . . . . . . . . . . . F-2
Statements of Operations for the year ended January 31, 1998
(New Wherehouse) and the years ended January 31, 1997
and 1996 (Old Wherehouse). . . . . . . . . . . . . . . . . . . . . . . . F-4
Statements of Changes in Shareholders' Equity for the year ended
January 31, 1998 (New Wherehouse) and the years ended
January 31, 1997 and 1996 (Old Wherehouse) . . . . . . . . . . . . . . . F-5
Statements of Cash Flows for the year ended January 31, 1998
(New Wherehouse) and the years ended January 31, 1997
and 1996 (Old Wherehouse). . . . . . . . . . . . . . . . . . . . . . . . F-6
Notes to Financial Statements. . . . . . . . . . . . . . . . . . . . . . . F-8
Financial Statement Schedule for each of the three years ended January 31, 1998
II Valuation and Qualifying Accounts . . . . . . . . . . . . . . . . . . F-31
All other schedules have been omitted because they are not required under the
related instructions or are inapplicable, or because the required information is
included elsewhere in the financial statements.
<PAGE>
Report of Independent Auditors
Board of Directors
Wherehouse Entertainment, Inc.
We have audited the accompanying balance sheets of Wherehouse Entertainment,
Inc. as of January 31, 1998 and 1997 (New Wherehouse), and the related
statements of operations, shareholders' equity, and cash flows for the year
ended January 31, 1998 (New Wherehouse) and the years ended January 31, 1997
and 1996 (Old Wherehouse). Our audits also included the financial statement
schedule listed in the Index at Item 14(a). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of Wherehouse Entertainment, Inc.
at January 31, 1998 and 1997 (New Wherehouse), and the results of its
operations and its cash flows for the year ended January 31, 1998 (New
Wherehouse) and the years ended January 31, 1997 and 1996 (Old Wherehouse), in
conformity with generally accepted accounting principles. Also, in our opinion,
the related financial statement schedule, when considered in relation to the
basic financial statements taken as a whole, presents fairly in all material
respects the information set forth therein.
Ernst & Young LLP
Los Angeles, California
April 17, 1998
<PAGE>
Wherehouse Entertainment, Inc.
Balance Sheets
<TABLE>
Caption>
January 31
1998 1997
------------- ------------
<S> <C> <C>
ASSETS (NOTES 1 AND 4)
Current assets:
Cash $ 54,720,000 $ 6,178,000
Receivables 1,296,000 1,932,000
Prepaid inventory deposits -- 4,486,000
Merchandise inventory 62,472,000 75,800,000
Other current assets 1,237,000 2,259,000
Rental inventory 4,278,000 9,686,000
Deferred taxes (NOTE 7) 1,799,000 --
------------- ------------
Total current assets 125,802,000 100,341,000
Equipment and improvements, at cost:
Leasehold improvements 7,852,000 5,952,000
Data processing equipment and software 5,722,000 6,153,000
Store and office fixtures and equipment 8,970,000 8,960,000
Buildings and improvements 131,000 131,000
Land 141,000 141,000
------------- ------------
22,816,000 21,337,000
Accumulated depreciation and amortization (5,189,000) --
------------- ------------
17,627,000 21,337,000
Deferred taxes (NOTE 7) 2,952,000 --
Reorganization value in excess of amounts allocable
to identifiable assets, net of accumulated
amortization of $1,595,000 at January 31, 1998
and $0 at January 31, 1997 (NOTE 2) 14,358,000 9,724,000
Other assets 255,000 340,000
------------- ------------
Total assets $ 160,994,000 $ 131,742,000
------------- ------------
------------- ------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-2
<PAGE>
<TABLE>
<CAPTION>
January 31
1998 1997
------------ ------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Accounts payable and bank overdraft $ 30,693,000 $ 13,034,000
Sales taxes payable 5,621,000 1,973,000
Other accrued expenses (NOTE 6) 13,458,000 10,680,000
Income taxes payable (NOTE 7) 6,312,000 --
Reorganization liabilities 4,255,000 14,481,000
Current portion of capital lease obligations
and long-term debt (NOTE 9) 193,000 729,000
------------ ------------
Total current liabilities 60,532,000 40,897,000
Notes payable (NOTE 1) 4,048,000 3,980,000
Capital lease obligations and long-term debt (NOTE 9) 294,000 722,000
Other long-term liabilities 4,648,000 2,000,000
Commitments and contingencies (NOTES 9 AND 10)
Shareholders' equity:
New preferred stock $.01 par value:
Authorized shares -- 3,000,000
Issued and outstanding shares -- none -- --
New common stock, $.01 par value:
Authorized shares -- 24,000,000
Issued and outstanding shares -- 10,619,201
(1998) and 10,257,808 (1997) 106,000 103,000
Additional paid-in capital 89,377,000 89,380,000
Retained earnings 7,702,000 --
Notes receivable (NOTE 5) (5,713,000) (5,340,000)
------------ ------------
Total shareholders' equity 91,472,000 84,143,000
------------ ------------
Total liabilities and shareholders' equity $160,994,000 $131,742,000
------------ ------------
------------ ------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-3
<PAGE>
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
New Wherehouse Old Wherehouse
-------------- -----------------------------
Year ended Year ended
January 31 January 31
1998 1997 1996
------------ -----------------------------
<S> <C> <C> <C>
Sales $276,147,000 $295,453,000 $350,272,000
Rental revenue 51,278,000 70,051,000 82,921,000
------------ -----------------------------
327,425,000 365,504,000 433,193,000
Cost of sales 176,137,000 195,489,000 230,347,000
Cost of rentals, including amortization 27,397,000 33,955,000 40,392,000
------------ -----------------------------
203,534,000 229,444,000 270,739,000
Selling, general and administrative expenses 111,868,000 145,488,000 166,818,000
Write-down of long-lived assets (NOTE 2) -- -- 1,476,000
------------ -----------------------------
Income (loss) from operations 12,023,000 (9,428,000) (5,840,000)
Other (income) expense:
Interest expense (contractual interest of
$25,980,000 (1997)) (NOTES 1 AND 6) 531,000 1,019,000 15,045,000
Interest income (1,583,000) (338,000) (283,000)
------------ -----------------------------
(1,052,000) 681,000 14,762,000
------------ -----------------------------
Income (loss) before reorganization items and
income taxes 13,075,000 (10,109,000) (20,602,000)
Reorganization items (NOTES 1, 2 AND 3):
Professional fees -- 7,207,000 2,470,000
Write-off of financing costs and debt discount -- -- 8,512,000
Provision for store closing costs -- 6,969,000 6,237,000
Provision for rejected executory contracts -- 3,331,000 6,000,000
Provision for other reorganization costs -- 2,429,000 --
------------ -----------------------------
-- 19,936,000 23,219,000
------------ -----------------------------
Income (loss) before income taxes and
extraordinary item 13,075,000 (30,045,000) (43,821,000)
Provision for income taxes (NOTE 7) 5,373,000 -- 17,000
------------ -----------------------------
Income (loss) before extraordinary item 7,702,000 (30,045,000) (43,838,000)
Extraordinary item:
Gain on extinguishment of debt -- 173,765,000 --
------------ -----------------------------
Net income (loss) $ 7,702,000 $143,720,000 $(43,838,000)
------------ -----------------------------
------------ -----------------------------
Net income per common share:
Basic $ 0.74
------------ -----------------------------
------------ -----------------------------
Diluted $ 0.71
------------ -----------------------------
------------ -----------------------------
Weighted average common shares outstanding:
Basic 10,420,557
------------ -----------------------------
------------ -----------------------------
Diluted 10,894,862
------------ -----------------------------
------------ -----------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-4
<PAGE>
Wherehouse Entertainment, Inc.
Statements of Changes in Shareholders' Equity
<TABLE>
<CAPTION>
Retained
Additional Earnings
Common Stock Paid-in (Accumulated Notes
Shares Amount Capital Deficit) Receivable Total
------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 31, 1995 10 $ -- $ 95,671,000 $(208,120,000) $ -- $(112,449,000)
Net loss -- -- -- (43,838,000) -- (43,838,000)
------------------------------------------------------------------------------------
Balance, January 31, 1996 10 -- 95,671,000 (251,958,000) -- (156,287,000)
Net income -- -- -- 143,720,000 -- 143,720,000
Recapitalization and fresh
start adjustments (NOTES 1 AND 2):
Recapitalization (10) -- (95,671,000) 108,238,000 -- 12,567,000
adjustment
Issuance of New Common Stock 9,157,808 92,000 83,051,000 -- -- 83,143,000
Sale of New Common Stock 1,100,000 11,000 6,329,000 -- (5,340,000) 1,000,000
------------------------------------------------------------------------------------
New Wherehouse balance,
January 31, 1997 10,257,808 103,000 89,380,000 -- (5,340,000) 84,143,000
Net income -- -- -- 7,702,000 -- 7,702,000
Issuance of New Common Stock 361,393 3,000 (3,000) -- -- --
Interest on note receivable -- -- -- -- (373,000) (373,000)
------------------------------------------------------------------------------------
New Wherehouse balance,
January 31, 1998 10,619,201 $106,000 $ 89,377,000 $ 7,702,000 $(5,713,000) $ 91,472,000
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
</TABLE>
SEE ACCOMPANYING NOTES.
F-5
<PAGE>
Wherehouse Entertainment, Inc.
Statements of Cash Flows
<TABLE>
<CAPTION>
New Wherehouse Old Wherehouse
-------------- -----------------------------
Year ended Year ended
January 31 January 31
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) $ 7,702,000 $143,720,000 $(43,838,000)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Rental amortization 21,113,000 23,535,000 24,213,000
Depreciation and amortization 7,130,000 11,769,000 17,190,000
Book value of rental inventory
dispositions 4,886,000 9,454,000 14,448,000
Write-down of long-lived assets -- -- 1,476,000
Deferred taxes (4,751,000) -- (207,000)
Gain on extinguishment of debt -- (173,765,000) --
Changes in operating assets and liabilities:
Receivables 636,000 (349,000) 1,572,000
Taxes receivable -- -- 1,500,000
Prepaid inventory deposits 4,486,000 6,394,000 (10,880,000)
Merchandise inventory 11,841,000 10,730,000 24,688,000
Other current assets 1,022,000 2,352,000 (1,885,000)
Accounts payable, accrued expenses and
other liabilities not separately identified 23,894,000 2,401,000 (20,528,000)
Income tax payable 6,312,000 -- --
Rental inventory purchases (21,195,000) (33,367,000) (37,962,000)
Other long-term liabilities 2,648,000 -- --
Changes due to reorganization activities:
Accrued professional fees (3,079,000) 3,227,000 (668,000)
Write-off of financing costs and debt discount -- -- 8,512,000
Provision for store closing costs (328,000) 3,767,000 5,743,000
Provision for rejected executory contracts -- 3,331,000 6,000,000
Other reorganization items (2,460,000) 2,747,000 --
------------ ------------ ------------
Net cash provided by (used in) operating activities 59,857,000 15,946,000 (10,626,000)
INVESTING ACTIVITIES
Proceeds from sale of assets -- 2,464,000 --
Acquisition of equipment and improvements (4,699,000) (3,785,000) (10,252,000)
Decrease (increase) in other assets and intangibles 85,000 -- (415,000)
------------ ------------ ------------
Net cash used in investing activities (4,614,000) (1,321,000) (10,667,000)
FINANCING ACTIVITIES
Short-term borrowings (payments), net -- -- 29,020,000
Principal payments on capital lease obligations and
long-term debt (696,000) (2,702,000) (2,336,000)
Sale of New Common Stock -- 1,000,000 --
Interest on notes receivable (373,000) -- --
Settlement of pre-petition claims (5,632,000) (14,098,000) --
------------ ------------ ------------
Net cash (used in) provided by financing activities (6,701,000) (15,800,000) 26,684,000
</TABLE>
F-6
<PAGE>
Wherehouse Entertainment, Inc.
Statements of Cash Flows (continued)
<TABLE>
<CAPTION>
New Wherehouse Old Wherehouse
-------------- -------------------------------
Year Ended Year Ended
January 31 January 31
1998 1997 1996
----------- ------------------------------
<S> <C> <C> <C>
REORGANIZATION ACTIVITIES
Reclassification of liabilities subject to compromise $ -- $ -- $ 278,857,000
Decrease in accounts payable, accrued expenses and
other liabilities -- -- (71,343,000)
Reduction of debt -- -- (207,514,000)
----------- ------------------------------
Net cash effect of reorganization activities -- -- --
----------- ------------------------------
Net increase (decrease) in cash 48,542,000 (1,175,000) 5,391,000
Cash at beginning of year 6,178,000 7,353,000 1,962,000
----------- ------------------------------
Cash at end of year $54,720,000 $ 6,178,000 $ 7,353,000
----------- ------------------------------
----------- ------------------------------
Supplemental disclosure of cash flow information:
Cash paid (received) during the year for:
Interest $ 254,000 $ 765,000 $ 11,993,000
Income taxes 3,783,000 -- (1,276,000)
Reorganization items 9,214,000 5,687,000 2,297,000
</TABLE>
SEE ACCOMPANYING NOTES.
F-7
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements
January 31, 1998
1. REORGANIZATION UNDER CHAPTER 11
Wherehouse Entertainment, Inc. (New Wherehouse) was incorporated under the
laws of the state of Delaware on November 15, 1996, as WEI Acquisition Co. On
January 31, 1997, New Wherehouse acquired (the Acquisition) substantially all
the assets of Wherehouse Dissolution Co. (Old Wherehouse), a Delaware
corporation, and its parent company, WEI Holdings, Inc., a Delaware
corporation (WEI, and together with Old Wherehouse, the Debtors), pursuant to
a Chapter 11 plan of reorganization (the Reorganization). Prior to the
Acquisition, Old Wherehouse was known as "Wherehouse Entertainment, Inc.,"
and after the Acquisition, Old Wherehouse changed its name to Wherehouse
Dissolution Co. After the Acquisition, New Wherehouse changed its name to
"Wherehouse Entertainment, Inc." New Wherehouse and Old Wherehouse are
collectively referred to as the Company or Wherehouse where the discussion
relates to the continuing business operations of Old Wherehouse and New
Wherehouse.
On August 2, 1995 (the petition date), Old Wherehouse filed voluntary
petitions for reorganization under Chapter 11 of the United States Bankruptcy
Code (Chapter 11 or the Bankruptcy Code) in the United States Bankruptcy
Court for the District of Delaware (the Bankruptcy Court). The Chapter 11
proceedings were jointly administered, with the Company managing the business
in the ordinary course as debtor-in-possession, subject to the control and
supervision of the Bankruptcy Court.
The Debtors' plan of reorganization, entitled the "Debtors' First Amended
Chapter 11 Plan, as Revised for Technical Corrections on October 4, 1996, and
Supplemental Amendments on December 2, 1996, and December 13, 1996" (the
Reorganization Plan), was confirmed by an order of the Bankruptcy Court
entered on January 7, 1997, entitled "Findings of Fact, Conclusions of Law
and Order Confirming Debtors' First Amended Chapter 11 Plan Under Chapter 11
of the Bankruptcy Code" (the Confirmation Order). The effective date of the
Reorganization Plan occurred on January 31, 1997 (the Plan Effective Date).
New Wherehouse (as opposed to Old Wherehouse and WEI) was never the subject
of a bankruptcy case. Since the Plan Effective Date, the Bankruptcy Court has
retained jurisdiction over certain claims and other matters relating to the
Debtors' bankruptcy estates, but New Wherehouse has been and is free to carry
out its business without oversight by the Bankruptcy Court.
Pursuant to the Reorganization Plan, substantially all of the assets of the
Debtors and certain liabilities were transferred to New Wherehouse. The
Debtors have assigned to New Wherehouse all of their executory contracts and
unexpired leases assumed during the Bankruptcy Case (not otherwise assigned
to third parties). The Reorganization Plan
F-8
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
provides that the Debtors' bankruptcy estates will be liquidated by New
Wherehouse. Under the Reorganization Plan, substantially all of the Debtors'
indebtedness held by their creditors was cancelled in exchange for cash,
shares of the Common Stock of New Wherehouse, par value $0.01 per share (the
New Common Stock), and/or warrants to purchase New Common Stock or for no
consideration. The Debtors' major groups of creditors were (1) senior lenders
under Old Wherehouse's bank credit agreement (the Senior Lenders) led by
Cerberus Partners, L.P. (Cerberus) as the agent for the Senior Lenders, (2)
trade creditors (the Trade Creditors), (3) holders of Old Wherehouse's Senior
Subordinated Notes (the Senior Subordinated Noteholders), (4) holders of Old
Wherehouse's 6 3/4% Convertible Subordinated Debentures (the Convertible
Debentureholders), (5) other general unsecured creditors (the General
Unsecured Creditors) and (6) federal and state taxing authorities.
As of the Plan Effective Date and following the exercise of the Exchange
Option (as described below) by certain Trade Creditors whose claims had been
resolved as of the Plan Effective Date, the Senior Lenders initially received
9,157,808 shares of New Common Stock under the Reorganization Plan on account
of their claims. During the year ended January 31, 1998, the Senior Lenders
received additional shares of 141,455 for an aggregate of 9,299,263 shares
representing approximately 87.6% of the issued and outstanding shares of New
Common Stock as of January 31, 1998, prior to dilution for the Warrants
described below but after dilution for the A&M Shares (see Note 5). The
Senior Lenders were also paid approximately $2.8 million of adequate
protection payments during the bankruptcy case and also received
approximately $256,000 in cash subsequent to the Plan Effective Date. The
Senior Lenders are likely to receive additional shares of New Common Stock
and cash as the claims of unsecured creditors (including Trade Creditors) are
resolved. Based upon New Wherehouse's estimate of the resolution of Trade
Claims, New Wherehouse estimates that the Senior Lenders (or their assigns)
will receive approximately 9,387,130 shares of New Common Stock in total.
This total may increase based on an anti-dilution feature in the
Reorganization Plan. Approximately $94.6 million of indebtedness held by the
Senior Lenders was cancelled in exchange for the issuance of such shares of
New Common Stock and cash.
Under the Reorganization Plan, those Trade Creditors identified by Old
Wherehouse as continuing suppliers of certain inventory products and who
agreed to provide normal trade credit terms to the Company after the Plan
Effective Date were given the option (the Exchange Option) to receive 27% of
their allowed claims in cash in lieu of shares of New Common Stock. The
source of the cash payments to the Trade Creditors exercising the
F-9
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
Exchange Option is $11,610,000 in cash otherwise distributable to the Senior
Lenders under the Reorganization Plan. If a Trade Creditor elected to receive
cash instead of shares of New Common Stock, the shares of New Common Stock
such Trade Creditor would have received had it not exercised the Exchange
Option were distributed to the Senior Lenders. Substantially all of the Trade
Creditors elected to exercise the Exchange Option and, as a result, the
Company estimates that once all claims are resolved, $11,250,000 in cash will
have been distributed to the Trade Creditors. As of January 31, 1998,
approximately $10,975,000 had been paid. Approximately $41,900,000 of the
claims of Trade Creditors who exercised the Exchange Option were cancelled in
consideration for the cash distributable in respect of such claims. Most of
the Company's vendors, including its six major distributors of pre-recorded
music, elected to exercise the Exchange Option and have agreed to provide
normal trade credit terms to the Company.
Under the Reorganization Plan, the Senior Subordinated Noteholders receive
$2,350,000 of cash from New Wherehouse (plus $1,550,000 of cash from a third
party) and three tranches of warrants to purchase shares of New Common Stock
(the Warrants). The Tranche A Warrants represent the right to purchase
576,000 shares of New Common Stock at an exercise price of $2.38 per share
and have a five-year maturity. The Tranche B Warrants represent the right to
purchase 100,000 shares of New Common Stock at an exercise price of $9.00 per
share and have a seven-year maturity. The Tranche C Warrants represent the
right to purchase 100,000 shares of New Common Stock at an exercise price of
$11.00 per share and have a seven-year maturity. The Warrants were
distributed by the indenture trustee for the Senior Subordinated Notes. Under
the Reorganization Plan, $117,190,000 of allowed senior subordinated note
claims were cancelled in consideration of the cash and Warrants being
distributed to the Senior Subordinated Noteholders as described in this
paragraph.
The Convertible Debentureholders received no distribution under the
Reorganization Plan. Approximately $5,344,000 of outstanding 6 3/4%
Convertible Subordinated Debentures were cancelled.
Certain of the claims of the General Unsecured Creditors have not yet been
adjudicated and allowed by the Bankruptcy Court. Under the Reorganization
Plan, any claims of the General Unsecured Creditors (including claims of
Trade Creditors who did not elect the Exchange Option) that become allowed by
the Bankruptcy Court will receive approximately 31.92 shares of New Common
Stock per $1,000 in such allowed claims.
F-10
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
1. REORGANIZATION UNDER CHAPTER 11 (CONTINUED)
At January 31, 1998, 219,906 shares had been issued to General Unsecured
Creditors. The Company estimates that approximately 115,214 shares of New Common
Stock will be issued to General Unsecured Creditors (including Trade Creditors
who did not elect the Exchange Option) in the future. If the Unsecured
Creditors' claims are settled for 115,214 shares of New Common Stock,
approximately 88,151 additional shares of New Common Stock would then be
issuable to the Senior Lenders.
Several state and local taxing authorities received on account of their claims,
promissory notes due generally six years after the tax assessment date, in the
approximate aggregate principal amount of $4.0 million. The promissory notes
have been classified as notes payable in the accompanying balance sheets.
The Reorganization Plan also provides that post-petition claims are to be paid
in full. The Confirmation Order established procedures for the resolution of
disputed post-petition claims and presently there are a number of disputes
before the Bankruptcy Court concerning such post-petition claims.
2. BASIS OF PRESENTATION
COMPANY OPERATIONS
Wherehouse is a retailer of pre-recorded music, videocassette rentals and other
entertainment-oriented products. At January 31, 1998, the Company operated 223
stores in seven states. Approximately 89% of the Company's stores are
concentrated in eight major marketing areas (Los Angeles, San Francisco, San
Diego, Sacramento, Fresno, Seattle, Phoenix and Las Vegas) and approximately 83%
of the stores are located in California.
Prior to the Reorganization, WEI held all of the capital stock of Old
Wherehouse. WEI was owned by affiliates of Merrill Lynch Capital Partners, Inc.
(MLCP) and certain members of management.
Pursuant to the Reorganization, the Company operates as a single Delaware
corporation.
For financial reporting purposes, the effective date of the Reorganization was
assumed to be January 31, 1997, the last day of the Company's fiscal year.
F-11
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
2. BASIS OF PRESENTATION (CONTINUED)
COMPANY OPERATIONS (CONTINUED)
The Company has implemented the recommended accounting principles for entities
emerging from Chapter 11 set forth in the American Institute of Certified Public
Accountants Statement of Position 90-7 on Financial Reporting by Entities in
Reorganization under the Bankruptcy Code (SOP 90-7). This results in the use of
fresh start reporting, since the reorganization value, as defined, was less than
the total of all post-petition liabilities and pre-petition claims, and holders
of voting shares immediately before confirmation of the Reorganization Plan
received less than fifty percent of the voting shares of the emerging entity.
Under this concept, all assets and liabilities are restated to reflect the
reorganization value of the reorganized entity, which approximates its fair
value at the date of reorganization. In addition, the accumulated deficit of the
Company was eliminated and its capital structure was recast in conformity with
the Reorganization Plan. As such, the accompanying Company balance sheet
commencing as of January 31, 1997, represents that of a successor company which,
in effect, is a new entity with assets, liabilities and a capital structure
having carrying values not comparable with prior periods and with no beginning
retained earnings or deficit.
The reorganization value of $83,643,000 was determined by the Company with the
assistance of its financial advisors. The net present value approach was used in
the determination of the reorganization value. The significant factors used
were: (a) the projected discounted cash flows of the Company through fiscal year
2001 and (b) the terminal equity value at the end of fiscal 2001 discounted to
the present.
The effect of the consummation of the Reorganization Plan, including the gain on
extinguishment of pre-petition debt of $173,765,000 and adjustments to record
assets at their estimated fair values, has been reflected in the accompanying
balance sheet as of January 31, 1997, as follows:
F-12
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
2. BASIS OF PRESENTATION (CONTINUED)
COMPANY OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
Old (1) (2) (3) New
Wherehouse Wherehouse
---------------- ---------------
Pre-Fresh Fresh
Start Balance Start Balanceh
Sheet Cancellation Fresh Start Sheet
January 31 of Debt Fair Value January 31
1997 Stock Discharge Adjustment 1997
--------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ASSETS
Current assets:
Cash $ 6,178,000 $ -- $ -- $ -- $ 6,178,000
Receivables 1,932,000 -- -- -- 1,932,000
Prepaid inventory deposits 4,486,000 -- -- -- 4,486,000
Merchandise inventory 77,321,000 -- -- (1,521,000) 75,800,000
Other current assets 2,259,000 -- -- -- 2,259,000
Rental inventory 13,650,000 -- -- (3,964,000) 9,686,000
--------------------------------------------------------------------------------
Total current assets 105,826,000 -- -- (5,485,000) 100,341,000
Equipment and improvements, at cost 54,634,000 -- -- (33,297,000) 21,337,000
Accumulated depreciation and
amortization (31,195,000) -- -- 31,195,000 --
--------------------------------------------------------------------------------
23,439,000 -- -- (2,102,000) 21,337,000
Reorganization value in excess of
amounts allocable to identifiable
assets -- (95,671,000) -- 105,395,000 9,724,000
Other assets 340,000 -- -- -- 340,000
--------------------------------------------------------------------------------
Total assets $129,605,000 $(95,671,000) $ -- $ 97,808,000 $ 131,742,000
--------------------------------------------------------------------------------
--------------------------------------------------------------------------------
</TABLE>
F-13
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
2. BASIS OF PRESENTATION (CONTINUED)
COMPANY OPERATIONS (CONTINUED)
<TABLE>
<CAPTION>
Old (1) (2) (3) New
Wherehouse Wherehouse
---------------- ---------------
Pre-Fresh Fresh
Start Balance Start Balance
Sheet Cancellation Fresh Start Sheet
January 31 of Debt Fair Value January 31
1997 Stock Dischargeh Adjustment 1997
-----------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Current liabilities:
Accounts payable and bank overdraft $ 13,034,000 $ -- $ -- $ -- $ 13,034,000
Sales taxes payable 2,192,000 -- -- -- 2,192,000
Other accrued expenses 10,461,000 -- -- -- 10,461,000
Current portion of capital lease
obligations and long-term debt, secured 729,000 -- -- -- 729,000
Reorganization liabilities (3,769,000) -- 18,250,000 -- 14,481,000
-----------------------------------------------------------------------------------
Total current liabilities 22,647,000 -- 18,250,000 -- 40,897,000
Notes payable -- -- 3,980,000 -- 3,980,000
Capital lease obligations and long-term debt,
secured 722,000 -- -- -- 722,000
Other long-term liabilities 11,160,000 -- -- (9,160,000) 2,000,000
Liabilities subject to compromise 279,138,000 -- -- --
(279,138,000)
Deferred income taxes 1,270,000 -- -- (1,270,000) --
Commitments and contingencies
Shareholders' equity (deficit):
New common stock, $.01 par value 11,000 -- 92,000 -- 103,000
Old common stock, $.01 par value -- -- -- -- --
Additional paid-in capital 102,000,000 (95,671,000) 83,051,000 -- 89,380,000
Accumulated deficit (282,003,000) -- 173,765,000 108,238,000 --
Notes receivable (5,340,000) -- -- -- (5,340,000)
-----------------------------------------------------------------------------------
Total shareholders' equity (deficit) (185,332,000) (95,671,000) 256,908,000 108,238,000 84,143,000
-----------------------------------------------------------------------------------
Total liabilities and shareholders' equity
(deficit) $ 129,605,000 $(95,671,000) $ -- $ 97,808,000 $131,742,000
-----------------------------------------------------------------------------------
-----------------------------------------------------------------------------------
</TABLE>
F-14
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
2. BASIS OF PRESENTATION (CONTINUED)
COMPANY OPERATIONS (CONTINUED)
(1) Issuance of New Common Stock and warrants and cancellation of Old Common
Stock.
(2) Exchange of pre-petition debt for New Common Stock and related gain on debt
extinguishment.
(3) Record assets and liabilities at their fair value pursuant to the
reorganization value of the Company and eliminate retained deficit.
The fresh start balance sheet at January 31, 1997 includes estimated liabilities
for the settlement of certain pre-petition claims including payments to
landlords for leases rejected during the reorganization proceedings for which
the amount payable by the Company had not yet been determined and allowed by the
bankruptcy court. Differences between the amounts recorded by the Company at
January 31, 1997 and amounts ultimately paid will be included in income or loss
from continuing operations of the Company when resolved.
During the year ended January 31, 1998, the Company revised the preliminary
allocation of the fair value of assets and liabilities recorded in the fresh
start balance sheet at January 31, 1997. Revisions to the fresh start balance
sheet amounts included a decrease to equipment and improvements of approximately
$2.7 million, an increase to the reorganization value in excess of amounts
allocable to identifiable assets of approximately $6.2 million and an increase
of approximately $3.5 million to the recorded amount of reorganization
liabilities. The decrease in the carrying amount of equipment and improvements
resulted primarily from final appraisals and additional analysis performed
during the year ended January 31, 1998.
3. SIGNIFICANT ACCOUNTING POLICIES
CASH AND CASH EQUIVALENTS
Cash equivalents consist of highly liquid investments with an original maturity
of three months or less when purchased.
F-15
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
FINANCIAL INSTRUMENTS
The fair value of financial instruments is determined by reference to various
market data and other valuation techniques as appropriate. Unless otherwise
described, the fair values of financial instruments approximate their recorded
values.
INVENTORY
New Wherehouse carries inventory at the lower of cost or market using the
last-in, first-out (LIFO) method. Inventory consists primarily of resaleable
pre-recorded music, video cassettes, video games and other products. At
January 31, 1998, inventory valued using LIFO is $201,000 less than the value
of the inventory if valued using the first-in, first-out (FIFO) method. Old
Wherehouse inventories are carried at the lower of cost or market using the
FIFO method.
RENTAL INVENTORY
New Wherehouse amortizes video rental inventory using the straight-line method
over a three-month period with a $3 salvage value. Rental inventory has been
classified as a current asset in the accompanying balance sheet as substantially
all revenue and cash flow from rental on hand is expected to be derived within a
one-year period. The Company sells rental cassettes and games in excess of
ongoing needs after the initial rental period at prices which are often less
than net book value. The sell-through of such rental inventory in the year
purchased results in additional amortization, which is included in the cost of
rentals.
Prior to the Reorganization, rental inventory was amortized over a period of two
years for video games and three years for videocassettes.
F-16
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
DEPRECIATION AND AMORTIZATION
In accordance with fresh start reporting, the pre-effective date accumulated
depreciation and amortization of $31,195,000 has been eliminated, and a new
depreciation and amortization base has been established equal to the
appraised value of the existing fixed assets, which reflects their fair
market value. Depreciation and amortization of equipment and leasehold
improvements is computed on the straight-line method over the following
periods:
<TABLE>
<CAPTION>
Years
-------
<S> <C>
Leasehold improvements 2 - 10*
Data processing equipment and software 3 - 5
Store and office fixtures and equipment 1 - 10
Buildings and improvements 5 - 30
</TABLE>
*Amortization over the lesser of related lease term or useful life of the
asset.
Depreciation and amortization of equipment and leasehold improvements was
$5,535,000, $11,769,000 and $17,190,000 for the years ended January 31, 1998,
1997 and 1996, respectively.
REORGANIZATION VALUE IN EXCESS OF AMOUNTS ALLOCABLE TO IDENTIFIABLE ASSETS
Reorganization value in excess of amounts allocable to identifiable assets
resulting from the Reorganization will be amortized using the straight-line
method over 10 years.
FAIR VALUE OF LONG-LIVED ASSETS
The Company follows the provisions of Statement of Financial Accounting
Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to be Disposed Of." Accordingly, the Company records
impairment losses on long-lived assets used in operations, and the related
reorganization value in excess of amounts allocable to identifiable assets,
when events and circumstances indicate that the assets might be impaired and
the undiscounted cash flows estimated to be generated by those assets are
less than the carrying amounts of those assets.
As a result of the Company's financial performance and the Chapter 11
proceedings, the Company closed 20 locations during fiscal 1998, 63 locations
during fiscal 1997 and 53 locations during fiscal 1996. In addition, before
the Reorganization, during fiscal 1996,
F-17
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
the Company evaluated the ongoing value of its equipment and improvements on
a store-by-store basis. Based on this evaluation, the Company determined that
store equipment and improvements with a carrying amount of $1,843,000 were
impaired and wrote them down by $1,476,000 to their fair value. Fair value
was based on estimated future cash flows to be generated by the individual
stores, discounted at a market rate of interest.
CONCENTRATION OF CREDIT RISK
Financial instruments which potentially expose the Company to concentration
of credit risk consist primarily of cash and cash equivalents. It is the
Company's practice to place its cash equivalents in high quality securities
with two financial institutions.
F-18
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
ADVERTISING COSTS
The Company expenses nonreimbursable advertising costs as costs are incurred.
The amount charged to advertising expense, net of co-op recoveries, during
the years ended January 31, 1998, 1997 and 1996 was $2,017,000, $6,185,000
and $5,228,000, respectively.
PRE-OPENING COSTS
Store pre-opening costs, including store employee labor costs and
advertising, incurred prior to the opening of a new store are expensed as
incurred.
EARNINGS PER SHARE
The Company adopted SFAS No. 128, "Earnings per Share," effective December
15, 1997, which specifies the computation, presentation, and disclosure
requirements for earnings per share. The statement requires that the Company
disclose both basic and diluted earnings per share on the face of the
statement of operations and reconcile the numerator and denominator of the
basic and diluted per share calculation in the notes to the financial
statements (see Note 8). Earnings per share for Old Wherehouse have been
omitted since it was a wholly owned subsidiary of WEI.
REORGANIZATION ITEMS
Reorganization items recorded in the statements of operations at January 31,
1997 and 1996 include: (a) professional fees relating to legal, accounting
and consulting services provided in connection with the Chapter 11
proceedings, (b) costs and expenses associated with the closing of locations,
including an estimated accrual for the expected allowed claims related to
rejected executory contracts, and estimated losses from the liquidation of
inventory from closed stores, (c) the write off of unamortized financing
costs and debt discount in order to record debt subject to the Chapter 11
proceedings at par value, (d) employee severance costs and an estimated
accrual for contractual obligations under employee change of control
agreements and (e) United States trustee fees and other costs of the Chapter
11 proceedings.
F-19
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
3. SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
STOCK-BASED COMPENSATION
In October 1995, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 123, "Accounting for Stock-Based
Compensation" (SFAS 123). SFAS 123 established a fair value-based method of
accounting for compensation cost related to stock options and other forms of
stock-based compensation plans. However, SFAS 123 allows an entity to continue
to measure compensation costs using the principles of APB 25 if certain pro
forma disclosures are made.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions
that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
INCOME TAXES
The Company utilizes the liability method of accounting for income taxes in
accordance with SFAS No. 109, "Accounting for Income Taxes." Under the
liability method, deferred taxes are determined based on the difference
between the financial statement and tax basis of assets and liabilities and
are measured at the enacted tax rates that will be in effect when these
differences reverse.
RECLASSIFICATIONS
Certain reclassifications of balances have been made to the 1996 and 1997
amounts to conform to the 1998 presentation.
4. REVOLVING CREDIT FACILITY
Pursuant to the Reorganization Plan, the Company entered into a loan and
security agreement with Congress Financial Corporation (Western) (the
Congress Facility), which provides a borrowing capacity of up to $30,000,000
with a letter of credit subfacility of $10,000,000, subject to borrowing base
limitations based upon, among other things, the value of certain eligible
merchandise inventory. As of January 31, 1998, there were no borrowings
outstanding under the Congress Facility, although $700,000 of letters of
credit were outstanding.
F-20
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
4. REVOLVING CREDIT FACILITY (CONTINUED)
The Congress Facility is available through January 31, 2000. Borrowings bear
interest at the prime rate or the Eurodollar rate plus 2.50 percentage points
at the option of the Company.
In connection with the closing of the Congress Facility, the Company incurred
a closing fee in the amount of $150,000 payable $75,000 upon closing and
$75,000 on January 31, 1998.
The Congress Facility is secured by cash, credit card receivables, general
intangible assets, and inventory and requires that the Company maintain net
worth (as defined) of not less than $60 million and subjects the Company to
other covenants. On January 31, 1998, the Company was in compliance with the
covenants.
5. STOCKHOLDERS' EQUITY
Pursuant to the Management Agreement and a Stock Subscription Agreement dated
as of January 31, 1997 (the Stock Subscription Agreement), New Wherehouse
agreed to sell, and Investment Associates an affiliate of Alvarez and Marsal,
Inc. (A&M) agreed to buy at a purchase price of $6,340,000 ($1,000,000 in
cash from Investment Associates' funds, plus a secured recourse promissory
note in the principal amount of $335,000 and a secured non-recourse
promissory note in the amount of $5,005,000 (collectively, the Promissory
Notes), 1,100,000 shares of the New Common Stock (the A&M Shares) (subject to
adjustment upward or downward to represent 10% of the sum of (i) the shares
of New Common Stock ultimately issued under the Reorganization Plan plus (ii)
the number of shares of New Common Stock issued to Investment Associates).
The Promissory Notes bear interest at 7% per annum during the first four
years and 11% per annum during the fifth through seventh years, mature on
January 31, 2004, and have no scheduled interest and principal amortization
until their maturity date. The Promissory Notes are secured by a first
priority pledge of the A&M Shares pursuant to a Pledge Agreement dated as of
January 31, 1997.
F-21
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
5. STOCKHOLDERS' EQUITY (CONTINUED)
In addition, New Wherehouse and Investment Associates entered into a
Non-Transferrable Stock Option Agreement dated as of January 31, 1997, as
amended, (the Stock Option Agreement), pursuant to which New Wherehouse
issued to Investment Associates three tranches of options to purchase shares
of New Common Stock (the A&M Options; and, together with the A&M Shares, the
A&M Securities) representing in the aggregate the right to purchase an
additional 10% of the shares of New Common Stock issued under the
Reorganization Plan and the A&M Securities. The first tranche of options
represents the right to purchase 393,299 shares of New Common Stock at an
exercise price of $8.95. The second tranche of options represents the right
to purchase 393,299 shares of New Common Stock at an exercise price of
$10.83. The third tranche of options represents the right to purchase 393,300
shares of New Common Stock at an exercise price of $13.18. The A&M Options
vest monthly in equal installments through October 31, 1998 and all
unexercised A&M Options expire on January 31, 2003, subject to prior vesting
or termination as set forth in the Management Services Agreement. The A&M
Options are subject to upward adjustment on a quarterly basis as additional
shares of New Common Stock are issued and are entitled to certain other
anti-dilution provisions as set forth in the Stock Option Agreement. The
above option amounts and exercise prices have been adjusted for anti-dilution
effects through January 31, 1998.
New Wherehouse also granted certain registration rights to Investment
Associates with respect to the A&M Securities pursuant to a Registration
Rights Agreement dated as of January 31, 1997 (the A&M Registration Rights
Agreement). Under the A&M Registration Rights Agreement, Investment
Associates has the right to make one demand registration and two piggy-back
registrations in respect of the A&M Securities.
New Wherehouse also granted certain registration rights to the Senior Lenders
as of the Plan Effective Date with respect to the New Common Stock acquired
by such Senior Lenders, pursuant to a registration rights agreement dated as
of January 31, 1997 (the Senior Lenders Registration Rights Agreement). Under
the Senior Lenders Registration Rights Agreement, the holders of a requisite
number of shares acquired by the Senior Lenders have the right to make two
demand registrations and to participate in two piggy-back registrations in
respect of the such shares of New Common Stock.
F-22
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statement (continued)
5. STOCKHOLDERS' EQUITY (CONTINUED)
The following is a summary of outstanding options and warrants at January
31, 1998:
<TABLE>
<CAPTION>
Number Exercise Price Exercisable
--------- -------------- -----------
<S> <C> <C> <C>
Options: 393,299 $ 8.95 224,742
393,299 10.83 224,742
393,300 13.18 224,743
--------- -----------
1,179,898 674,227
--------- -----------
--------- -----------
Weighted average exercise
price $10.99
Warrants: 576,000 $ 2.38 576,000
100,000 9.00 100,000
100,000 11.00 100,000
--------- ------ -----------
776,000 776,000
--------- -----------
--------- -----------
Weighted average exercise
price $ 4.34
</TABLE>
6. OTHER ACCRUED EXPENSES
Other accrued expenses consists of the following:
<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Gift certificate and credit slips liability $ 5,475,000 $ 5,446,000
Payroll and related costs 6,307,000 3,820,000
Store closing costs 27,000 621,000
Other 1,649,000 793,000
----------- -----------
$13,458,000 $10,680,000
----------- -----------
----------- -----------
</TABLE>
F-23
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statement (continued)
7. INCOME TAXES
As a result of the Acquisition by New Wherehouse of substantially all of the
assets of Old Wherehouse, a new tax basis equivalent to the fair value of net
assets acquired was established. The net operating loss carryovers and other
deferred tax assets were used by Old Wherehouse to offset a portion of the gain
on the extinguishment of debt. Under the provisions of the Internal Revenue
Code, no provision for income taxes was recorded on the remaining gain on the
extinguishment of debt.
The provision for income taxes includes:
<TABLE>
<CAPTION>
New Old
Wherehouse Wherehouse
----------- -------------------------
Year ended Year ended
January 31 January 31
1998 1997 1996
----------- ----------- ------------
<S> <C> <C> <C>
Current:
Federal $8,243,000 $ -- $ --
State 1,881,000 -- 17,000
----------- ----------- ------------
10,124,000 -- 17,000
Deferred:
Federal (3,920,000) -- (14,187,000)
State (831,000) -- (2,695,000)
Valuation allowance -- -- 16,882,000
----------- ----------- ------------
(4,751,000) -- --
----------- ----------- ------------
$5,373,000 $ -- $ 17,000
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
A reconciliation of the difference between the federal statutory rate and
the effective tax rate is summarized as follows:
<TABLE>
<CAPTION>
Year Ended January 31
--------------------------------------
1998 1997 1996
----------- ----------- ------------
<S> <C> <C> <C>
Statutory tax rate 35.0% 34.0% (34.0)%
Permanent tax differences 0.3 -- --
State taxes, net of federal
benefit 5.2 -- --
Other 0.6 -- --
Valuation allowance -- (34.0) 34.0
----------- ----------- ------------
41.1% --% --%
----------- ----------- ------------
----------- ----------- ------------
</TABLE>
F-24
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statement (continued)
7. INCOME TAXES (CONTINUED)
The components of net deferred income taxes at 1998 are as follows:
<TABLE>
<S> <C>
Net current deferred income tax assets (liabilities):
Merchandise inventory $2,382,000
Vacation and bonus liabilities 814,000
Other accrued liabilities 164,000
Prepaid expenses (125,000)
Video rental inventory (1,022,000)
Reorganization expenses (568,000)
Cash discounts (432,000)
State taxes 586,000
----------
1,799,000
Net long-term deferred income tax assets (liabilities):
Reorganization value 505,000
Average rent liability 1,079,000
Equipment and improvements 1,368,000
----------
2,952,000
----------
Total net deferred tax assets $4,751,000
----------
----------
</TABLE>
The Company is currently undergoing an audit by the state of California for
the years ended January 31, 1992, 1993 and 1994. Management believes that it has
made adequate provision in the accompanying financial statements for these
audits. In connection with the Chapter 11 case, the Company agreed to pay
certain priority tax claims, including amounts payable to the state of
California, and other state taxing authorities, six years from the assessment
date of the tax claim. These amounts are reflected in the balance sheet of New
Wherehouse as non-current notes payable.
F-25
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statement (continued)
8. EARNINGS PER SHARE
The following table is a reconciliation of the basic and diluted earnings
per share computations:
<TABLE>
<CAPTION>
Year ended
January 31
1998
-----------
<S> <C>
Basic EPS Computation:
Numerator $ 7,702,000
Denominator:
Weighted average common shares outstanding 10,420,557
-----------
Total shares 10,420,557
-----------
Basic EPS $ 0.74
-----------
-----------
Diluted EPS Computation:
Numerator $ 7,702,000
Denominator:
Weighted average common shares outstanding 10,420,557
Incremental shares from assumed exercise of
warrants 439,401
Incremental shares from assumed exercise of
options 34,904
-----------
Total shares 10,894,862
-----------
Diluted EPS $ 0.71
-----------
-----------
</TABLE>
Options to purchase 393,300 shares of common stock outstanding during the
year ended January 31, 1998 were not included in the computation of diluted
earnings per share because the options' exercise price was greater than the
average market price of the common shares and, therefore, the effect would be
antidilutive.
Earnings per share for Old Wherehouse have been omitted since it was a
wholly owned subsidiary of WEI.
F-26
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statement (continued)
9. COMMITMENTS AND CONTINGENCIES
LEASES
The Company leases substantially all of its data processing equipment,
retail stores and other facilities. The capital and operating lease agreements
expire on various dates through 2013 with renewal options for certain leases.
Certain leases provide for payment of real estate taxes and additional rents
based on a percentage of sales. During the Chapter 11 case, the Company
renegotiated the terms of numerous leases and in certain cases has the right to
terminate leases prior to the original lease expiration date.
Future minimum annual lease payments under operating leases at January 31,
1998, including the modifications resulting from the Chapter 11 proceedings, are
payable as follows:
<TABLE>
<S> <C>
1999 $23,093,000
2000 20,730,000
2001 19,037,000
2002 16,634,000
2003 12,600,000
Thereafter 30,918,000
-----------
Total future minimum lease payments $123,012,000
-----------
-----------
</TABLE>
Rental expense charged to operations was approximately $25,365,000 in fiscal
1998, $33,159,000 in fiscal 1997 and $38,892,000 in fiscal 1996. In addition,
real estate taxes and additional rents based on percentage of sales were
approximately $2,392,000 in fiscal 1998, $2,434,000 in fiscal 1997 and
$2,871,000 in fiscal 1996.
In connection with the Reorganization, the Company converted an equipment
lease, previously accounted for as a capital lease, to a note payable, with
monthly installments of $12,750 through September 1999.
F-27
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
OTHER
In June 1993, the Company entered into a management consulting agreement with
a company whose chairman provided services first by leading a re-engineering
project and then as chairman of the board and chief executive officer of the
Company. The agreement was terminated on July 2, 1996. In connection with the
termination, the Company paid $562,000. The Company then entered into a new
employment agreement which was terminated January 31, 1997. Additional
payment in connection with the employment agreements during the year ended
January 31, 1998 aggregated $250,000. Amounts paid under the initial
agreement were $437,000 and $496,000 during fiscal 1997 and 1996,
respectively.
The Company is a party to various other claims, legal actions and complaints
arising in the ordinary course of its business. In the opinion of management,
all such matters are without merit or involve such amounts that unfavorable
disposition will not have a material impact on the financial position or
results of operations of the Company.
10. EMPLOYEE BENEFITS
EXECUTIVE OFFICERS' RETIREMENT PLAN: The Company provides life insurance for
certain executive officers of the Company with face values of $250,000. Upon
retirement at the normal retirement age of 65, covered executives are
entitled to receive annual payments equal to 10% of the face amount of their
life insurance policies for each of the 15 years following retirement. The
Company recognized expense of $52,000 in 1998, $25,000 in 1997 and $60,000 in
1996, under this plan.
EMPLOYEES' SAVINGS RETIREMENT PLAN: In March 1992, the Company established a
tax qualified 401(k) Savings Retirement Plan (401(k) Plan). All employees who
have completed one year of service and at least 1,000 hours of service in
that year with the Company are eligible to join the 401(k) Plan on the first
day of each calendar quarter. All eligible employees may contribute from 1%
to 10% of their annual compensation on a pre-tax basis. The Company makes a
matching contribution in an amount equal to 50% of the employees'
contributions of 1% to 3% of their annual compensation and 25% of the
employees' contributions of 4% to 5% of their annual compensation. Matching
contributions made by the Company vest 25% per year beginning with the
employee's second year of employment. The Company recognized expense of
$235,000 in 1998, $257,000 in 1997 and $305,000 in 1996 for matching costs
and administrative costs
F-28
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
10. EMPLOYEE BENEFITS (CONTINUED)
under the 401(k) Plan.
SEVERANCE AGREEMENTS: In order to retain certain key management employees
prior to and during the Chapter 11 proceedings, the Company established
severance agreements with such employees. The Company paid $928,000 in
severance payments during the year ended January 31, 1998. Such agreements
expired on January 31, 1998.
EMPLOYMENT AGREEMENTS
In connection with the Reorganization Plan, the Company entered into a
Management Services Agreement dated as of January 31, 1997, with A&M, Antonio
C. Alvarez, II, the Support Employees described therein, Investment
Associates and Cerberus Partners, L.P. (the Management Agreement). Under the
Management Agreement Antonio C. Alvarez, II serves as Chairman of the Board
and Chief Executive Officer of New Wherehouse with A&M receiving $600,000
annually as compensation for Antonio C. Alvarez, II services and certain
support employees' services. The Management Agreement had an expiration date
of October 14, 1998. The Management Agreement was extended for one year with
an expiration date of October 14, 1999. The amended agreement continued the
$600,000 as annual compensation for Antonio C. Alvarez, II and certain
support employees. In addition, the amended agreement was expanded to include
three additional employees at an annual cost of $450,000. The amended
agreement also established incentive fees of up to $180,000, to be paid to
the additional support employees provided that certain financial targets are
reached, and commencing with the year ended January 31, 1999, the fees are
approved by the Board of Directors.
Prior to the Plan Effective Date, Antonio C. Alvarez, II served as a
consultant to the Senior Lenders pursuant to a letter agreement dated as of
October 14, 1996, between A&M, Antonio C. Alvarez, II and the Senior Lenders
(the Interim Agreement). Pursuant to the Interim Agreement, the Senior
Lenders agreed to pay A&M a consulting fee of $50,000 per month plus the
hourly fees of those employees of A&M providing assistance to Antonio C.
Alvarez, II in the performance of his consulting responsibilities. The Senior
Lenders paid $389,000 to A&M pursuant to the Interim Agreement prior to
January 31, 1997. Under the Management Agreement, New Wherehouse agreed to
reimburse, and has reimbursed, the Senior Lenders for the amounts paid by the
Senior Lenders to A&M pursuant to the Interim Agreement.
F-29
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
10. EMPLOYEE BENEFITS (CONTINUED)
EMPLOYMENT AGREEMENTS (CONTINUED)
In the event that Antonio C. Alvarez, II is terminated other than for cause
(as defined in the Management Agreement), prior to October 14, 1998, the
Management Agreement provides that (i) Investment Associates will have the
right to require New Wherehouse to purchase the shares of New Common Stock
and options (whether or not vested), owned by Investment Associates, and (ii)
New Wherehouse will pay A&M cash in a lump sum amount equal to $50,000
multiplied by the number of months remaining from the time of termination to
October 14, 1998. The price to be paid by New Wherehouse in purchasing the
shares of New Common Stock and options to acquire New Common Stock owned by
Investment Associates will depend on the fair market value (as defined in the
Management Agreement) of the New Common Stock at the time of purchase. Any
payments made to Investment Associates in purchasing the shares of New Common
Stock and options to acquire New Common Stock from Investment Associates are
required to be applied to reduce the outstanding amounts under the Promissory
Notes.
During the year ended January 31, 1998, the aggregate amount of fees and
expenses paid or payable to A&M was $953,000.
F-30
<PAGE>
Wherehouse Entertainment, Inc.
Notes to Financial Statements (continued)
11. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following is a summary of the quarterly results of operations for the
years ended January 31, 1998 (New Wherehouse) and 1997 (Old Wherehouse):
<TABLE>
<CAPTION>
Quarter Ended
----------------------------------------------------
April 30 July 31 October 31 January 31
----------------------------------------------------
<S> <C> <C> <C> <C>
1998
Net sales $ 73,183 $ 77,884 $ 71,961 $ 104,397
Gross profit 27,071 28,522 28,050 40,248
Operating income (loss) (523) 774 1,239 10,533
Net income (loss) (286) 588 970 6,430
Net income per common
share (1):
Basic (0.03) 0.06 0.09 0.61
Diluted (0.03) 0.05 0.09 0.58
Weighted average shares
outstanding (1):
Basic 10,258 10,311 10,546 10,567
Diluted 10,258 10,829 10,970 11,116
1997
Net sales 87,490 87,670 78,144 112,200
Gross profit 35,472 31,833 28,723 40,032
Operating income (loss) (1,245) (5,891) (6,397) 4,105
Net income (loss) (2,266) (8,010) (7,456) 161,452
</TABLE>
(1) Pursuant to the adoption of FASB Statement No. 128, "Earnings Per
Share," basic and diluted earnings per share have been presented for the
year ended January 31, 1998. Earnings per share are not presented for
the year ended January 31, 1997 as Old Wherehouse was a wholly owned
subsidiary of WEI.
F-31
<PAGE>
Wherehouse Entertainment, Inc.
Schedule II - Valuation and Qualifying Accounts
<TABLE>
<CAPTION>
Additions
Balance at Charged to
Beginning Costs and Balance at
Description of Year Expenses Deductions(1)(2) End of Year
- --------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Accumulated amortization deducted
from video rental inventory:
Company:
Year ended January 31, 1998 $ - $ 21,113,000 $ 10,970,000 $ 10,143,000
Year ended January 31, 1997 38,906,000 23,535,000 62,441,000 -
Year ended January 31, 1996 40,984,000 24,213,000 26,291,000 38,906,000
</TABLE>
- -----------------------
(1) Accumulated amortization on disposition of video rental tapes.
(2) The deduction in 1997 resulted from the elimination of the accumulated
amortization in conjunction with Fresh Start accounting adjustments.
F-32
<PAGE>
EXTENSION OF AND AMENDMENT TO THE MANAGEMENT
SERVICES AGREEMENT
This EXTENSION OF AND AMENDMENT TO THE MANAGEMENT SERVICES AGREEMENT
(this "EXTENSION AND AMENDMENT") is dated as of February 1, 1998, and entered
into among WHEREHOUSE ENTERTAINMENT, INC., a Delaware corporation formerly known
as WEI Acquisition Co. (the "COMPANY"), ALVAREZ & MARSAL, INC., a New York
corporation ("A&M"), A&M INVESTMENT ASSOCIATES #3, LLC, a Delaware limited
liability company (the "AFFILIATE") and ANTONIO C. ALVAREZ II, an individual
("ALVAREZ"), and shall bind the SUPPORT EMPLOYEES (the "SUPPORT EMPLOYEES," as
defined below), each an individual. Reference is made to that certain
Management Service Agreement (the "MANAGEMENT SERVICES AGREEMENT" and as
extended and amended hereby the "EXTENDED AND AMENDED AGREEMENT") dated as of
January 31, 1997 among the Company, A&M, the Affiliate, Alvarez and, with
respect to Section 2(c) and 8 thereof only, Cerberus, and binding upon the
Support Employees. All capitalized terms used herein and not otherwise defined
(including without limitation the term "Support Employees") shall have the
meaning given to such terms in the Management Services Agreement.
RECITALS
WHEREAS, A&M and the Company desire to extend the term of the
Management Services Agreement; and
WHEREAS, A&M, Alvarez, the Affiliate and the Company desire to amend
certain terms and provisions of the Management Services Agreement as provided
herein;
NOW, THEREFORE, in consideration of the premises and the agreements,
provisions and covenants herein contained, the parties hereto agree as follows:
SECTION 1. EXTENSION OF THE MANAGEMENT SERVICES AGREEMENT
Pursuant to Section 2(b) of the Management Services Agreement, the
Company and A&M hereby agree to extend the term of the Management Services
Agreement such that the Extended and Amended Agreement shall terminate on
October 14, 1999, subject to
1
<PAGE>
earlier termination pursuant to Section 7 of the Extended and Amended Agreement
(such extended term the "FIRST EXTENDED TERM") ; PROVIDED, HOWEVER, that at
least six months prior to the expiration of the First Extended Term, A&M and the
Company shall notify the other as to whether it desires to extend the First
Extended Term. If both A&M and the Company desire to extend the First Extended
Term, they will promptly commence and pursue good faith negotiations regarding
the terms and conditions of such extension. If either A&M or the Company does
not desire to extend the First Extended Term, or if the parties are unable to
reach agreement on the terms and conditions under which the First Extended Term
shall be extended, the Extended and Amended Agreement shall terminate on October
14, 1999, except that each of A&M and the Company shall use its best efforts and
shall provide full cooperation to the other in making a smooth transition in the
management of the Company to the new management selected by the Company. If so
terminated by expiration of the First Extended Term, except as provided in
Section 6(d) of the Extended and Amended Agreement and except for accrued but
unpaid fees due to A&M pursuant to Section 4(a) of the Extended and Amended
Agreement and amounts due pursuant to Section 5 of the Extended and Amended
Agreement, neither party shall have any further obligation to the other either
hereunder or under the Extended and Amended Agreement.
SECTION 2. AMENDMENT TO SECTION 4(a) OF THE MANAGEMENT SERVICES
AGREEMENT
Section 4(a) of the Management Services Agreement is amended to read
in full as follows:
(a) FEES. The Company shall pay A&M the fees set forth below in
this Section 4(a); PROVIDED, that the Company's obligation to pay such fees
may be terminated in accordance with subsection (3) of this Section 4(a);
PROVIDED, FURTHER, that, prior to October 14, 1998, the Company's
obligation to pay such fees may be accelerated or terminated in accordance
with Section 7 or 8.
(1) BASE FEES.
(i) Alvarez and Support Employees. In consideration
for the services of A&M, Alvarez and the Support Employees,
except for the Support Employees named in paragraphs (ii), (iii)
and (iv) of this Section 4(a)(1) (the "NAMED SUPPORT EMPLOYEES"),
for the account, and on behalf of A&M hereunder, the Company
shall pay A&M during the term of this Agreement a management fee
of $50,000 (or a pro-rated portion thereof) per month
irrespective of the number of Support Employees provided by A&M
to the Company.
(ii) Hugh Hilton. Effective February 1, 1998 and
continuing until the earlier of the termination of this Agreement
or the date on which Hugh Hilton ceases to serve full-time for
the Company,
2
<PAGE>
the Company shall pay A&M $16,583.33 per month in consideration
for the full-time services of Hugh Hilton.
(iii) Karen Marsal. Effective February 1, 1998 and
continuing until the earlier of the termination of this Agreement
or the date on which Karen Marsal ceases to serve full-time for
the Company, the Company shall pay A&M $10,416.67 per month in
consideration for the full-time services of Karen Marsal.
(iv) Mark "Nick" Alvarez. Effective February 1, 1998
and continuing until the earlier of the termination of this
Agreement or the date on which Mark "Nick" Alvarez ceases to
serve full-time for the Company, the Company shall pay A&M
$10,416.67 per month in consideration for the full-time services
of Mark "Nick" Alvarez.
(2) INCENTIVE FEES.
(i) Commencing with the fiscal year ending January 31,
1999, A&M is eligible to receive incentive fees payable by the
Company at the sole discretion of the Company's Board of
Directors, equal in amount to the bonuses, if any, to which each
of the Named Support Employees would be entitled pursuant to the
terms of that certain Corporate Bonus Plan adopted by the
Company's Board of Directors on April 8, 1997 (the "BONUS PLAN"),
as if the Named Support Employees were eligible employees under
the Bonus Plan; PROVIDED, HOWEVER, that the parties acknowledge
and agree that the award of bonuses pursuant to the Bonus Plan is
within the discretion of the Company's Board of Directors, and
therefore neither A&M nor the Named Support Employees shall be
eligible to receive any incentive fees pursuant to this Section
4(a)(2) unless the Company's Board of Directors awards bonuses,
in its sole discretion, pursuant to the terms of the Bonus Plan;
PROVIDED, FURTHER, HOWEVER, that in no case shall the incentive
fee payable to A&M for any such Named Support Employee exceed
more than 40 percent (40%) of the base fee payable to A&M for
such Named Support Employee pursuant to Section 4(a)(1); and
(ii) IF for the fiscal year ended January 31, 1998, the
Company achieves a level of EBITDA after the payment of store
bonuses that authorizes the payment of bonuses to eligible
employees pursuant to the Bonus Plan, and IF, after payment of
such bonuses to eligible employees, the Company's EBITDA exceeds
the corresponding level of "Company EBITDA After Bonuses" as
defined in the Bonus Plan, (such excess EBITDA, the "EXCESS
EBITDA") THEN out of the Excess EBITDA, the Company shall pay
A&M: (A) $125,000 in consideration for the full-time services of
Mark "Nick" Alvarez
3
<PAGE>
performed from February 1, 1997 to January 31, 1998 and (B) in
consideration for the full-time services of Karen Marsal
performed from February 1, 1997 to January 31, 1998, the amount
that equals $125,000 MINUS the total payments made by the Company
for reimbursement of Karen Marsal's expenses incurred between
February 1, 1997 and January 31, 1998 that would not have been
incurred by an employee hired locally to perform the services
rendered by Karen Marsal (including, but not limited to, airfare
for Karen Marsal to and from Florida and California and lodging
for Karen Marsal in California))]; PROVIDED, that if the Excess
EBITDA is insufficient to cover the amounts set forth in (A) and
(B) of this paragraph then the Company shall pay A&M an amount
equal to the Excess EBITDA.
(3) TERMINATION OF NAMED SUPPORT EMPLOYEES. Either A&M or
the Company may terminate any and all of the Named Support Employees
full-time services to the Company upon providing 45 days notice to the
other and to the Named Support Employee, in which case upon such
termination the Company shall no longer be obligated to pay to A&M the
fees allocable to such Named Support Employee under Section 4(a)(1).
SECTION 3. AMENDMENT TO SECTION 5 OF THE MANAGEMENT SERVICES
AGREEMENT
Section 5 of the Management Services Agreement is amended to add the
following sentence to the end of that section:
Notwithstanding anything herein to the contrary, effective
February 1, 1998, no Named Support Employee shall be entitled to
reimbursement of any living expenses or Travel Expenses that would not
have been incurred by an employee hired locally.
SECTION 4. AMENDMENT TO SECTION 7 OF THE MANAGEMENT SERVICES
AGREEMENT
Section 7 of the Management Services Agreement is amended by
renumbering subsection (e) as (f) and by inserting a new subsection (e) that
reads as follows:
(e) TERMINATION ON OR AFTER OCTOBER 14, 1998. On or after October
14, 1998, this Agreement may be terminated by either the Company or A&M upon 60
days written notice to the other.
4
<PAGE>
SECTION 5. GENERAL
(a) REFERENCE TO AND EFFECT ON THE MANAGEMENT SERVICES
AGREEMENT.
(i) On and after the effective date of this Extension and
Amendment, each reference in the Management Services Agreement to
"this Agreement", "hereunder", "hereof", "herein" or words of like
import referring to the Management Services Agreement shall mean and
be a reference to the Extended and Amended Agreement; and
(ii) The execution, delivery and performance of this
Extension and Amendment shall not, except as expressly provided herein
or therein, constitute a waiver of any provision of, or operate as a
waiver of any right, power or remedy of the Company under, the
Management Services Agreement.
(b) AMENDMENT. No modification or amendment of, or waiver
under, this Extension and Amendment shall be valid unless in writing and
signed by each of the parties hereto.
(c) BINDING AGREEMENT. This Extension and Amendment and the
Extended and Amended Agreement shall inure to the benefit of and be binding
upon the parties hereto and their respective successors and assigns.
(d) AUTHORIZATION. Each of the Company and the A&M Parties
represents and warrants that its execution, delivery and performance of
this Extension and Amendment has been duly authorized by all necessary
corporate action.
(e) GOVERNING LAW. This Extension and Amendment shall be
governed by and construed in accordance with the internal laws of the State
of New York without regard to conflict of law principles.
(f) SEVERABILITY. If any term, provision, covenant or
restriction herein is held by a court of competent jurisdiction to be
invalid, void or unenforceable, the remainder of the terms, provisions,
covenants and restrictions of this Extension and Amendment shall remain in
full force and effect and shall in no way be affected, impaired or
invalidated thereby.
(g) TAX INDEMNIFICATION. A&M, Alvarez and each Support Employee
agree jointly and severally to indemnify and hold the Company harmless
against and reimburse the Company on demand for any federal, state or local
taxes, workers compensation, health or disability benefits, and any
penalties and interest thereon, payable by or on behalf of the Company in
respect of the services of A&M, Alvarez and the Support Employees furnished
to the Company pursuant to this Extension and Amendment or the Extended and
Amended Agreement.
5
<PAGE>
(h) ENTIRE AGREEMENT. This Extension and Amendment and the
Extended and Amended Agreement contain the entire understanding of the
parties hereto respecting the subject matter hereof and supersedes all
prior discussions and understandings.
(i) HEADINGS. Section and subsection headings in this Extension
and Amendment are included herein for convenience of reference only and
shall not constitute a part of this Extension and Amendment for any other
purpose or be given any substantive effect.
(j) COUNTERPARTS; EFFECTIVENESS. This Extension and Amendment
may be executed in any number of counterparts and by different parties
hereto in separate counterparts, each of which when so executed and
delivered shall be deemed an original, but all such counterparts together
shall constitute but one and the same instrument; signature pages may be
detached from multiple separate counterparts and attached to a single
counterpart so that all signature pages are physically attached to the same
document. This Extension and Amendment shall become effective upon the
execution of a counterpart hereof by the Company, A&M, the Affiliate and
Alvarez and receipt by the Company of written or telephonic notification of
such execution and authorization of delivery thereof.
[Remainder of this page intentionally left blank.]
6
<PAGE>
IN WITNESS THEREOF, the parties have executed this Extension and
Amendment as of the day and year first above written.
ALVAREZ & MARSAL, INC.
By: /s/ Antonio C. Alvarez
----------------------------
Its: Vice President
----------------------------
A&M INVESTMENT ASSOCIATES #3, LLC
By: /s/ Antonio C. Alvarez
----------------------------
Its: Co-Manager
----------------------------
ANTONIO C. ALVAREZ II
/s/ Antonio C. Alvarez
---------------------------------
WHEREHOUSE ENTERTAINMENT, INC.
By: /s/ R.S. Kelleher
----------------------------
Its: C.F.O.
----------------------------
S-1
<PAGE>
SECOND AMENDMENT TO MANAGEMENT SERVICES AGREEMENT
This SECOND AMENDMENT TO MANAGEMENT SERVICES AGREEMENT (this
"AMENDMENT") is dated as of April 30, 1998, and entered into among WHEREHOUSE
ENTERTAINMENT, INC., a Delaware corporation formerly known as WEI Acquisition
Co. (the "COMPANY"), ALVAREZ & MARSAL, INC., a New York corporation ("A&M"), A&M
INVESTMENT ASSOCIATES #3, LLC, a Delaware limited liability company (the
"AFFILIATE") and ANTONIO C. ALVAREZ II, an individual ("ALVAREZ"). Reference is
made to that certain Management Service Agreement (the "MANAGEMENT SERVICES
AGREEMENT" and as amended hereby the "AMENDED AGREEMENT") dated as of January
31, 1997 and amended by an Extension and Amendment dated as of February 1, 1998,
among the Company, A&M, the Affiliate, Alvarez and, with respect to Section 2(c)
and 8 thereof only, Cerberus, and binding upon the Support Employees. All
capitalized terms used herein and not otherwise defined shall have the meaning
given to such terms in the Management Services Agreement and the POR.
RECITALS
WHEREAS, the POR provided for the issuance of shares of the Company's
Common Stock (the "COMMON STOCK") to holders of certain Allowed Claims against
the Company's predecessor; and
WHEREAS, the Management Services Agreement currently provides that the
number of Shares to be sold to the Affiliate, pursuant to that certain Stock
Subscription Agreement dated as of January 31, 1997 (the "STOCK SUBSCRIPTION
AGREEMENT") are to be adjusted upward or downward such that the A&M Shares equal
10% of the sum of the Plan Shares and the A&M Shares, with such adjustments to
be made based on the actual number of Plan Shares, which in turn is dependent on
the resolution of Claims under the POR; and
WHEREAS, the Company is still in the process of resolving disputed
Claims under the POR; and
WHEREAS, certain holders of Claims that are entitled to receive shares
of Common Stock under the POR have expressed a preference for receiving their
POR dividend in cash and are willing to enter into settlements with the Company,
which the Company believes are in its interest, providing for payments of cash
in lieu of Common Stock; and
WHEREAS, if such holders of Claims were paid in Common Stock, as
provided for in the POR, the Affiliate would be entitled to count such shares of
Common
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Stock as Plan Shares for purposes of adjusting the number of A&M Shares under
Section 4(b) of the Management Services Agreement; and
WHEREAS, the parties believe that it would be unfair to the Affiliate
and contrary to the original intent of the parties if cash settlements with
holders of Claims entitled to receive Common Stock under the POR had the effect
of reducing the A&M Shares; and
WHEREAS, determining the number of shares of Common Stock that would
have been issued to holders of Claims that settle for cash in lieu of Common
Stock is not subject to precision since such settlements generally involve an
agreement to pay a sum certain in cash without the Company and the holder
agreeing on the correct amount of the Allowed Claim or the value per share of
the Common Stock that the holder would have received under the POR if the
Company and the holder had agreed on the amount of the Allowed Claim; and
WHEREAS, the parties believe that in order to approximate the number
of shares of Common Stock that would have been issued to holders of Claims but
for cash settlements, it is appropriate to divide the cash payments to such
holders by $8.36, which is the fully diluted value of such shares of Common
Stock as set forth in the First Amended Disclosure Statement for Debtors' First
Amended Chapter 11 Plan, as approved by the Bankruptcy Court in the Company's
predecessor's bankruptcy case, and which was used to solicit votes on the POR;
and
WHEREAS, A&M, the Affiliate, Alvarez and the Company desire to amend
the Management Services Agreement to reflect the original intent of the parties
given that the settlement of Claims for cash in lieu of Common Stock was not
contemplated as of the original date of the Management Services Agreement and
the Stock Subscription Agreement;
NOW, THEREFORE, in consideration of the premises and the agreements,
provisions and covenants herein contained, the parties hereto agree as follows:
SECTION 1. AMENDMENT TO SECTION 4(b)(1) OF THE MANAGEMENT
SERVICES AGREEMENT
Section 4(b)(1) of the Management Services Agreement is amended to
read in full as follows:
(1) NUMBER OF SHARES. On the Commencement Date, and pursuant to
a Stock Subscription Agreement in the form attached hereto as EXHIBIT
B (the "STOCK SUBSCRIPTION AGREEMENT"), the Company shall issue and
sell to the Affiliate and the Affiliate shall purchase, 1,100,000
shares (the "A&M SHARES") of the Company's Common Stock, par value
$0.01 per share (the "COMMON STOCK"), subject to upward or downward
adjustment such that the
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total number of A&M Shares is equal to ten percent (10.0%) of the SUM OF:
(A) the total number of Shares issued pursuant to the POR (the "PLAN
SHARES") other than upon exercise of the Warrants, as defined in the POR
(the "WARRANTS", (B) the QUOTIENT OF (X) the amount in dollars paid to the
Holders of Allowed General Unsecured Claims (as defined in the POR and
exclusive of Eligible Suppliers who elected the Exchange Option, also as
defined in the POR) in lieu of such Holders receiving Plan Shares DIVIDED
BY (Y) $8.36 AND (C) the total number of A&M Shares as adjusted hereby.
The foregoing adjustment shall be made periodically as deemed practicable
by the Company and the Affiliate and in any event an interim adjustment
will be made on September 30, 1998.
SECTION 2. GENERAL
(a) REFERENCE TO AND EFFECT ON THE MANAGEMENT SERVICES
AGREEMENT.
(i) On and after the effective date of this Amendment, each
reference in the Management Services Agreement to "this Agreement",
"hereunder", "hereof", "herein" or words of like import referring to
the Management Services Agreement shall mean and be a reference to the
Amended Agreement; and
(ii) The execution, delivery and performance of this
Amendment shall not, except as expressly provided herein or therein,
constitute a waiver of any provision of, or operate as a waiver of any
right, power or remedy of the Company under, the Management Services
Agreement or the Stock Subscription Agreement.
(b) AMENDMENT. No modification or amendment of, or waiver
under, this Amendment shall be valid unless in writing and signed by each
of the parties hereto.
(c) BINDING AGREEMENT. This Amendment and the Amended Agreement
shall inure to the benefit of and be binding upon the parties hereto and
their respective successors and assigns.
(d) AUTHORIZATION. Each of the Company, the Affiliate, A&M and
Alvarez represents and warrants that its execution, delivery and
performance of this Amendment has been duly authorized by all necessary
corporate action.
(e) GOVERNING LAW. This Amendment shall be governed by and
construed in accordance with the internal laws of the State of New York
without regard to conflict of law principles.
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(f) SEVERABILITY. If any term, provision, covenant or
restriction herein is held by a court of competent jurisdiction to be
invalid, void or unenforceable, the remainder of the terms, provisions,
covenants and restrictions of this Amendment shall remain in full force and
effect and shall in no way be affected, impaired or invalidated thereby.
(g) ENTIRE AGREEMENT. This Amendment and the Amended Agreement
contain the entire understanding of the parties hereto respecting the
subject matter hereof and supersedes all prior discussions and
understandings.
(h) COUNTERPARTS; EFFECTIVENESS. This Amendment may be executed
in any number of counterparts and by different parties hereto in separate
counterparts, each of which when so executed and delivered shall be deemed
an original, but all such counterparts together shall constitute but one
and the same instrument; signature pages may be detached from multiple
separate counterparts and attached to a single counterpart so that all
signature pages are physically attached to the same document. This
Amendment shall become effective upon the execution of a counterpart hereof
by the Company, A&M, the Affiliate and Alvarez and receipt by the Company
of written or telephonic notification of such execution and authorization
of delivery thereof.
[Remainder of this page intentionally left blank.]
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IN WITNESS THEREOF, the parties have executed this Amendment as of the
day and year first above written.
ALVAREZ & MARSAL, INC.
By: /s/ Antonio C. Alvarez
----------------------------
Its: Vice President
----------------------------
A&M INVESTMENT ASSOCIATES #3, LLC
By: /s/ Antonio C. Alvarez
----------------------------
Its: Co-Manager
----------------------------
ANTONIO C. ALVAREZ II
/s/ Antonio C. Alvarez
---------------------------------
WHEREHOUSE ENTERTAINMENT, INC.
By: /s/ R.S. Kelleher
----------------------------
Its: C.F.O.
----------------------------
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FIRST AMENDMENT TO NON-TRANSFERABLE STOCK OPTION AGREEMENT
This FIRST AMENDMENT TO NON-TRANSFERABLE STOCK OPTION AGREEMENT (this
"AMENDMENT") is dated as of April 30, 1998, and entered into between WHEREHOUSE
ENTERTAINMENT, INC., a Delaware corporation formerly known as WEI Acquisition
Co. (the "COMPANY") and A&M INVESTMENT ASSOCIATES #3, LLC, a Delaware limited
liability company (the "OPTIONEE"). Reference is made to that certain
Non-Transferable Stock Option Agreement (the "STOCK OPTION AGREEMENT" and as
amended hereby the "AMENDED AGREEMENT") dated as of January 31, 1997, between
the Company and the Optionee. All capitalized terms used herein and not
otherwise defined shall have the meaning given to such terms in the Stock Option
Agreement and the POR.
RECITALS
WHEREAS, the Stock Option Agreement as originally executed does not
correctly reflect the intention of the parties with respect to the dilutive
impact of the (i) options issued to the Optionee, (ii) the shares of stock sold
to the Optionee under that certain Management Services Agreement dated as of
January 31, 1997, as amended (the "Management Services Agreement") and that
certain Stock Subscription Agreement dated as of January 31, 1997, as amended
(the "Stock Subscription Agreement"), and (iii) the Warrants issued pursuant to
the POR; and
WHEREAS, the Stock Option Agreement currently provides that the shares
of Common Stock subject to the option would be adjusted to reflect the dilutive
effect of additional shares to be issued under the POR through January 31, 1998
under the assumption that all shares of Common Stock to be issued under the POR
would be issued by January 31, 1998; and
WHEREAS, the Company is still in the process of resolving Claims under
the POR and, accordingly, all shares of Common Stock to be issued under the POR
were not issued by January 31, 1998 and will not be issued for some indefinite
period in the future; and
WHEREAS, certain holders of Claims entitled to receive Common Stock
under the POR have expressed a willingness to resolve disputes with the Company
over the proper amount of their Claims if such Claims are paid in cash in lieu
of Common Stock; and
WHEREAS, the Company believes that it is in its interest to resolve
such Claims disputes by payments of cash in lieu of Common Stock; and
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<PAGE>
WHEREAS, if such Claims were paid in Common Stock, as provided for in
the POR, the Optionee would be entitled under the Stock Option Agreement to
adjustments increasing the number of shares of Common Stock subject to the A&M
Options and reducing the A&M Options' exercise prices; and
WHEREAS, the parties believe that it would be unfair to the Optionee
and contrary to their original intent if the Optionee did not receive an
adjustment in the number of shares of Common Stock subject to the A&M Options
and the A&M Options' exercise prices because of such settlements for cash in
lieu of Common Stock; and
WHEREAS, the Management Services Agreement is being amended
contemporaneously herewith to make a corresponding adjustment in the number of
shares of Common Stock sold to the Optionee pursuant to the Management Services
Agreement and the Stock Subscription Agreement;
NOW, THEREFORE, in consideration of the premises and the agreements,
provisions and covenants herein contained, the parties hereto agree as follows:
SECTION 1. AMENDMENT TO SECTION 8(a) OF THE STOCK OPTION
AGREEMENT
Section 8(a) of the Stock Option Agreement is amended to read in full
as follows:
(a) ADJUSTMENTS FOR POR DISTRIBUTIONS, SETTLEMENTS OF
CLAIMS FOR CASH, AND SHARES SOLD TO OPTIONEE. The First Option
Exercise Price, the Second Option Exercise Price and the Third Option
Exercise Price, as the case may be, and the number of Shares
purchasable under each A&M Option (such number of Shares being
referred to herein as the "UNDERLYING OPTION SHARES") shall be
adjusted as described below in order to account for: (i) any shares of
Common Stock issued by the Company (other than Common Stock issued
upon exercise of the Warrants, as defined in the POR) pursuant to
Section 5.05(a) of the POR (such shares being referred to herein as
the "POR SHARES"), (ii) the number of shares of Common Stock that
would have been issued by the Company pursuant to Section 5.05(a) of
the POR but for the prospective issuee's election to receive cash in
lieu of such shares (such number of unissued shares being referred to
herein as the "UNISSUED SHARES" and being equal to the QUOTIENT OF (A)
the amount in dollars paid to the Holders of Allowed General Unsecured
Claims (as defined in the POR and exclusive of Eligible Suppliers who
elected the Exchange Option, also as defined in the POR) in lieu of
such Holders receiving POR Shares DIVIDED BY (Y) $8.36.), (iii) the
number of shares of Common Stock sold to A&M pursuant to the
Management Services Agreement and subject to adjustment as provided
therein (the "A&M SHARES") and (iv) the Underlying Option Shares. The
adjustment
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provided in this Section 8 shall be made periodically as deemed practicable
by the Company and the Optionee and in any event an interim adjustment will
be made on September 30, 1998.
(1) The Underlying Option Shares shall be adjusted so
that they equal three and one-third percent (3 1/3%) of the
aggregate number of: (i) the POR Shares, (ii) the Unissued
Shares, (iii) the A&M Shares and (iv) the Underlying Option
Shares collectively (the "TOTAL BASELINE SHARES");
(2) The First Option Exercise Price shall be adjusted
to equal the QUOTIENT OF (A) $95,000,000 DIVIDED BY (B) the
difference between the Total Baseline Shares and the Underlying
Option Shares (as such Total Baseline Shares and Underlying
Option Shares shall have been adjusted);
(3) The Second Option Exercise Price shall be adjusted
to equal THE QUOTIENT of (A) $115,000,000 DIVIDED BY (B) the
difference between the Total Baseline Shares and the Underlying
Option Shares (as such Total Baseline Shares and Underlying
Option Shares shall have been adjusted);
(4) The Third Option Exercise Price shall be adjusted
to equal THE QUOTIENT of (A) $140,000,000 DIVIDED BY (B) the
difference between the Total Baseline Shares and the Underlying
Option Shares (as such Total Baseline Shares and Underlying
Option Shares shall have been adjusted).
SECTION 2. GENERAL
(a) REFERENCE TO AND EFFECT ON THE STOCK OPTION AGREEMENT.
(i) On and after the effective date of this Amendment, each
reference in the Stock Option Agreement to "this Agreement",
"hereunder", "hereof", "herein" or words of like import referring to
the Stock Option Agreement shall mean and be a reference to the
Amended Agreement; and
(ii) The execution, delivery and performance of this
Amendment shall not, except as expressly provided herein or therein,
constitute a waiver of any provision of, or operate as a waiver of any
right, power or remedy of the Company under, the Stock Option
Agreement.
(b) BINDING AGREEMENT. This Amendment and the Amended Agreement
shall inure to the benefit of and be binding upon the parties hereto and
their respective successors and assigns.
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<PAGE>
(c) AUTHORIZATION. Each of the Company and the Optionee
represents and warrants that its execution, delivery and performance of
this Amendment has been duly authorized by all necessary corporate action.
(d) GOVERNING LAW. This Amendment shall be governed by and
construed in accordance with the internal laws of the State of New York
without regard to conflict of law principles.
(e) SEVERABILITY. If any term, provision, covenant or
restriction herein is held by a court of competent jurisdiction to be
invalid, void or unenforceable, the remainder of the terms, provisions,
covenants and restrictions of this Amendment shall remain in full force and
effect and shall in no way be affected, impaired or invalidated thereby.
(f) ENTIRE AGREEMENT. This Amendment and the Amended Agreement
contain the entire understanding of the parties hereto respecting the
subject matter hereof and supersedes all prior discussions and
understandings.
(g) COUNTERPARTS; EFFECTIVENESS. This Amendment may be executed
in any number of counterparts and by different parties hereto in separate
counterparts, each of which when so executed and delivered shall be deemed
an original, but all such counterparts together shall constitute but one
and the same instrument; signature pages may be detached from multiple
separate counterparts and attached to a single counterpart so that all
signature pages are physically attached to the same document. This
Amendment shall become effective upon the execution of a counterpart hereof
by the Company and the Optionee and receipt by the Company of written or
telephonic notification of such execution and authorization of delivery
thereof.
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<PAGE>
IN WITNESS THEREOF, the parties have executed this Amendment as of the
day and year first above written.
A&M INVESTMENT ASSOCIATES #3, LLC
By: /s/ Antonio C. Alvarez
----------------------------
Its: Co-Manager
----------------------------
WHEREHOUSE ENTERTAINMENT, INC.
By: /s/ R.S. Kelleher
----------------------------
Its: C.F.O.
----------------------------
S-1
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<PAGE>
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<PERIOD-START> FEB-01-1997
<PERIOD-END> JAN-31-1998
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