UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended July 31, 1994
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ____________
to ____________
Commission File Number 1-8281
WHEREHOUSE ENTERTAINMENT, INC.
(Exact name of registrant as specified in its charter)
Delaware
(State or other jurisdiction of
incorporation or organization)
95-2647555
(I.R.S. Employer Identification Number)
19701 Hamilton Avenue
Torrance, California 90502-1234
(Address of principal executive offices) (Zip Code)
(310) 538-2314
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of
the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate the number of shares outstanding of each of the
issuer's classes of common stock, as of the latest practicable
date.
Outstanding at
Class July 31, 1994
- - ----- --------------
Common Stock, $.01 Par Value 10
Total of 19 Pages
<PAGE>
<page-2>
INDEX
WHEREHOUSE ENTERTAINMENT, INC.
Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets -
July 31, 1994 (Unaudited) and
January 31, 1994 3
Condensed Statements of Operations -
Three Months Ended July 31, 1994
and 1993 (Unaudited)
Six Months Ended July 31, 1994
and 1993 (Unaudited) 4
Condensed Statements of Cash Flows -
Six Months Ended July 31, 1994
and 1993 (Unaudited) 5
Notes to Condensed Financial Statements 7
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 8
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 15
Item 6. Exhibits and Reports on Form 8-K 18
SIGNATURES 19
<PAGE>
<page-3>
<TABLE>
PART I.
FINANCIAL INFORMATION
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED BALANCE SHEETS
<CAPTION>
July 31, January 31,
1994 1994
------------ ------------
(Unaudited) Note 1
<S> <C> <C>
ASSETS
Current Assets
Cash $ 5,332,000 $ 3,120,000
Receivables 2,710,000 2,802,000
Taxes receivable --- 5,000,000
Merchandise inventory 104,306,000 113,592,000
Deferred income taxes 4,882,000 4,402,000
Other current assets 2,364,000 2,573,000
------------ ------------
Total current assets 119,594,000 131,489,000
Rental inventory 13,143,000 11,689,000
Property, equipment and
improvements, net 43,161,000 47,161,000
Excess of cost over fair value
of assets acquired, net 141,394,000 142,932,000
Unamortized financing costs,
leasehold interest, net 9,150,000 9,905,000
Deferred income taxes 6,774,000 6,774,000
Other assets 1,085,000 1,425,000
------------ ------------
Total assets $334,301,000 $351,375,000
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Short-term borrowings $ 13,000,000 $ 4,000,000
Accounts payable and accrued
expenses 98,040,000 114,863,000
Current maturities of capital
lease obligations and long-
term debt 8,189,000 7,772,000
------------ ------------
Total current liabilities 119,229,000 126,635,000
<PAGE>
Capital lease obligations and
long-term debt 161,504,000 163,699,000
Other long-term liabilities 9,445,000 7,426,000
Convertible subordinated
debentures 3,675,000 3,635,000
Shareholder's equity
Common stock, $.01 par value,
1,000 authorized, 10 issued
and outstanding --- ---
Additional paid-in capital 95,700,000 95,855,000
Accumulated deficit (55,252,000) (45,875,000)
------------ ------------
Total shareholder's
equity 40,448,000 49,980,000
------------ ------------
Total liabilities and
shareholder's equity $334,301,000 $351,375,000
============ ============
</TABLE>
See accompanying notes.
<PAGE>
<page-4>
<TABLE>
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED STATEMENT OF OPERATIONS
(Unaudited)
<CAPTION>
Three Three Six Six
Months Ended Months Ended Months Ended Months Ended
July 31, 1994 July 31, 1993 July 31, 1994 July 31, 1993
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales $ 91,147,000 $ 84,545,000 $183,150,000 $164,940,000
Rental revenue 23,177,000 24,075,000 45,037,000 46,190,000
------------- ------------- ------------- -------------
114,324,000 108,620,000 228,187,000 211,130,000
Cost of sales 58,170,000 54,138,000 118,260,000 105,651,000
Costs of rentals, including
amortization 8,250,000 8,053,000 15,517,000 14,323,000
------------- ------------- ------------- -------------
66,420,000 62,191,000 133,777,000 119,974,000
Selling, general and
administrative expenses 45,863,000 48,643,000 92,451,000 93,864,000
------------- ------------- ------------- -------------
Income (loss) from operations 2,041,000 (2,214,000) 1,959,000 (2,708,000)
Interest expense 5,783,000 5,887,000 11,408,000 11,771,000
Other income (13,000) (9,000) (72,000) (270,000)
------------- ------------- ------------- -------------
5,770,000 5,878,000 11,336,000 11,501,000
------------- ------------- ------------- -------------
<PAGE>
Loss before income taxes (3,729,000) (8,092,000) (9,377,000) (14,209,000)
Benefit for income taxes 0 (223,000) 0 (945,000)
------------- ------------- ------------- -------------
Net loss $ (3,729,000) $ (7,869,000) (9,377,000) (13,264,000)
============= ============= ============= =============
</TABLE>
See accompanying notes.
<PAGE>
<page-5>
<TABLE>
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Six Six
Months Ended Months Ended
July 31, 1994 July 31, 1993
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $ (9,377,000) $(13,264,000)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 23,874,000 23,165,000
Book value of rental inventory dispositions 2,498,000 4,357,000
Loss on disposal of fixed assets --- 82,000
Deferred taxes (480,000) (504,000)
Changes in operating assets and liabilities:
Receivables 92,000 1,290,000
Taxes receivable 5,000,000
Merchandise inventory 9,286,000 3,548,000
Other current assets 209,000 (145,000)
Accounts payable, accrued expenses, and
other liabilities (14,804,000) (16,797,000)
Rental inventory purchases (16,971,000) (16,065,000)
------------- -------------
Net cash used in operating activities (673,000) (14,333,000)
INVESTING ACTIVITIES:
Acquisition of property, equipment and
improvements (3,877,000) (3,934,000)
Purchase of Record Shop (365,000) (4,606,000)
Decrease (increase) in other assets and intangibles 58,000 (694,000)
------------- -------------
Net cash used in investing activities (4,184,000) (9,234,000)
<PAGE>
FINANCING ACTIVITIES:
Short-term borrowings 9,000,000 30,450,000
Dividend payments (155,000) (350,000)
Principal payments on capital lease obligations
and long-term debt (1,776,000) (5,302,000)
------------- -------------
Net cash provided by financing activities 7,069,000 24,798,000
------------- -------------
Net increase in cash 2,212,000 1,231,000
Cash, beginning of the period 3,120,000 831,000
------------- -------------
Cash, end of the period $ 5,332,000 $ 2,062,000
============= =============
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest $ 10,218,000 $ 11,456,000
Income taxes (4,548,000) 1,298,000
</TABLE>
See accompanying notes.
<PAGE>
<page-6>
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. Organization and Basis of Presentation
The unaudited condensed financial statements have been prepared
by Wherehouse Entertainment, Inc. ("Wherehouse" or the "Company")
in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form
10-Q and Article 10 of Regulation S-X. Accordingly, they do not
include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. The balance sheet at January 31, 1994 has been
derived from the audited financial statements at that date but
does not include all of the information and footnotes required by
generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments
(consisting only of normal recurring accruals) considered
necessary for a fair presentation have been included. It is
suggested that these consolidated condensed financial statements
be read in conjunction with the financial statements and the
notes thereto included in the Company's annual report on Form 10-
K for the year ended January 31, 1994. Results of operations for
the six months ended July 31, 1994 may not be indicative of the
results that may be expected for the year ended January 31, 1995.
Beginning with the first quarter of fiscal 1995, the Company
began recording the amortization of rental inventory for interim
periods based on planned rental inventory purchases for the year
rather than recording cumulative amortization in the period in
which the rental inventory is purchased. This change in method
of reporting accelerates the recognition of rental amortization
to earlier interim periods and results in interim gross profit
rates that are more reflective of the expected annual gross
profit rate. However, this method will not impact the aggregate
amount of amortization expense recorded during the fiscal year.
Certain reclassifications of balances have been made in the
fiscal 1994 amounts to conform to the fiscal 1995 presentation.
2. Summary Financial Information for WEI Holdings, Inc.
WEI Holdings, Inc. ("WEI") holds all of the capital stock of the
Company and, in turn, is owned by affiliates of Merrill Lynch
Capital Partners, Inc. ("MLCP") (92.4% on a fully diluted basis)
and certain members of management (7.6% on a fully diluted
basis). Currently, WEI conducts no independent operations and
has no significant assets other than the capital stock of the
Company.
Unconsolidated summary financial information of WEI is provided
below.
July 31, January 31,
1994 1994
---------- ----------
(In Thousands of Dollars)
Current Assets $ 35 $ 68
Total Assets 40,484 50,048
Current liabilities 76 170
Total liabilities 76 170
Redeemable common stock 3,903 4,140
Notes receivable from
shareholders (673) (728)
Contingent shares (669) (702)
For the Six Months Ended
July 31, July 31,
1994 1993
--------- ----------
(In Thousands of Dollars)
Net income $ 18 $ 23
<PAGE>
<page-8>
WHEREHOUSE ENTERTAINMENT, INC.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED JULY 31, 1994 AND JULY 31, 1993
Aggregate net revenues for the quarter ended July 31, 1994 were
$114.3 million compared to $108.6 million for the quarter ended
July 31, 1993, an increase of 5.2%. The increase was due to an
increase in the number of stores from 339 at July 31, 1993 to 345
at July 31, 1994 and a 2.7% increase in revenues for same-stores
(those open for at least 13 months). The Company does not
anticipate a significant increase in the number of stores during
the current fiscal year.
Merchandise sales were $91.1 million and $84.5 million during the
quarters ended July 31, 1994 and 1993, respectively, representing
an aggregate increase of 7.8% and an increase of 3.7% on a same-
store basis. The increase in same-store sales resulted
principally from increased sales of compact discs and of video
games and used compact discs, which are newer product lines for
the Company. The Company's sales of music cassettes declined
from the comparable quarter last year due to the continuing shift
in consumer demand to compact discs.
Sales and Rental Revenue By
Merchandise Category
(dollars in millions)
Quarters Ended
July 31,
1994 1993
--------------------------
Merchandise Sales
Compact discs (including
used CDs) $ 52.4 $ 44.7
Cassettes and other music 22.8 24.8
------- -------
Total Music 75.2 69.5
New videocassettes 5.1 4.8
Video game software and
hardware, general
merchandise, accessories,
ticket commissions, and
other 10.8 10.2
------- -------
Total merchandise sales 91.1 84.5
Video and other product rentals 23.2 24.1
------- -------
Total Revenue $114.3 $108.6
Rental revenue includes the rental of videocassettes, video games
and game players, audiocassette books and laser discs. Approxi-
mately 75% of the Company's stores currently offer videocassettes
and other products for rent. Rental revenue was $23.2 million
and $24.1 million during the quarters ended July 31, 1994 and
1993, respectively, representing a 3.7% aggregate decrease and a
decrease of 0.9% on a same-store basis. Decreases in the rental
of videocassettes and video games were offset by increases in
revenue from the sale of used videocassettes and other rental
products. It is the Company's belief that while the new merchan-
dising, pricing and field management strategies implemented
during the first quarter of fiscal 1995 and during late fiscal
1994 have to date appeared to beneficially impact the Company's
competitive position in the videocassette rental business, the
Company's rental revenues have continued to be impacted by
competitive factors. The Company anticipates that it will
continue to experience strong competition in this area, and no
assurance can be given that the Company's new strategies will be
successful.
Cost of sales increased $4.1 million to $58.2 million for the
quarter ended July 31, 1994, as compared with $54.1 million for
the quarter ended July 31, 1993. As a percentage of merchandise
sales revenue, cost of sales decreased to 63.8% in the quarter
ended July 31, 1994 from 64.0% in the quarter ended July 31,
1993. The 0.2% decrease in cost of sales as a percentage of
merchandise sales revenues principally resulted from decreases in
merchandise return penalties (1.0%) partially offset by changes
in product mix and the utilization of promotional markdowns to
generate incremental sales (0.8%). The changes in product mix
include the continuing shift in consumer demand from music
cassettes to lower-margin compact discs.
Cost of rentals, excluding $0.7 million of purchase accounting
amortization recorded in the quarter ended July 31, 1993 (none
was recorded in the quarter ended July 31, 1994), increased $0.9
million to $8.3 million for the quarter ended July 31, 1994 as
compared with $7.4 million for the quarter ended July 31, 1993.
As a percentage of rental revenue, cost of rentals (excluding
purchase accounting amortization) increased to 35.6% in the
quarter ended July 31, 1994 from 30.5% in the quarter ended July
31, 1993. The 5.1% increase was principally due to the change in
accounting estimate for amortization expense which was implement-
ed in the fourth quarter of fiscal year ended January 31, 1994
and the acceleration of the recognition of rental amortization to
earlier interim periods (10.6%) partially offset by the decrease
in the cost of sales of used videocassettes (4.9%) and various
other factors (0.6%). The change in estimate for amortization
expense eliminated the utilization of salvage value and further
accelerated the amortization calculation. Beginning with the
first quarter of fiscal 1995, the Company changed its method of
reporting the amortization of rental inventory for interim
periods based on planned rental inventory purchases for the year
rather than recording cumulative amortization in the period that
the rental inventory is purchased. This new method accelerates
the recognition of rental amortization to earlier interim periods
and results in interim gross profit rates that are more
reflective of the Company's expected annual gross profit rate.
However, this method will not impact the aggregate amount of
amortization expense recorded during the fiscal year. It can be
expected that cost of rentals for the fiscal year ended 1995 as a
percentage of rental revenue will be lower than in fiscal 1994.
Merchandise sales, as a percentage of aggregate net revenues,
increased from 77.8% in the quarter ended July 31, 1993 to 79.7%
in the quarter ended July 31, 1994. Should the shift in product
mix from higher margin rental revenue to lower margin merchandise
sales continue, it can be expected that the change in the mix of
revenue contribution could have an impact on profitability.
However, merchandise sales, as a percentage of aggregate net
revenues, decreased from 80.8% in the quarter ended April 30,
1994 after the introduction of new rental merchandising
strategies in the first quarter of fiscal 1995.
Selling, general and administrative expenses, excluding $0.9
million and $2.2 million for the amortization of purchase price
adjustments resulting from acquisitions, were $45.0 million and
$46.4 million for the quarters ended July 31, 1994 and July 31,
1993, respectively, a decrease of $1.4 million, or 3.0%. As a
percentage of aggregate net revenues, selling, general and
administrative expenses, excluding amortization of purchase price
adjustments, were 39.3% and 42.7% for the quarters ended July 31,
1994 and 1993, respectively. The 3.4% decrease is primarily a
result of total payroll having decreased while revenues grew
(total payroll was 16.5% versus 18.8% as a percentage of
aggregate net revenues during the quarters ended July 31, 1994
and 1993, respectively, a decrease of 2.3%). All categories of
payroll, including stores, administrative, and distribution
center payrolls and the related payroll overhead costs, were
lower as a percentage of aggregate net revenues due to headcount
reductions and other expense control measures. Advertising
expense decreased 1.5% as a percent of aggregate net revenues
from 2.2% in the quarter ended July 31, 1993 to 0.7% in the
quarter ended July 31, 1994. The decrease is primarily due to
timing differences in advertising expenditures with higher
advertising dollars being spent in the quarter ended July 31,
1993 to support the introduction of the used CD program.
Depreciation and amortization decreased by 0.1% while other
operating income increased by 0.1% as a percent of aggregate net
revenues. The above decreases in selling, general and admini-
strative expenses were slightly offset (0.6%) by increases in
rent and other occupancy costs resulting from contractual
escalations in base rent for existing stores, lease renewals,
leases for new stores and stores acquired during fiscal 1994, and
increases for the straight-line effect of scheduled future rent
increases. Selling, general and administrative expenses include
non-cash provisions for the straight-line effect of scheduled
future rent increases of $0.9 million and $0.8 million for the
quarters ended July 31, 1994 and 1993, respectively. Absolute
dollar increases in rent and occupancy expenses are expected to
continue.
Income from operations was $2.0 million for the quarter ended
July 31, 1994 compared to a loss from operations of $2.2 million
for the quarter ended July 31, 1993, an increase in income of
$4.2 million. The improvement resulted principally from (i)
higher gross profit in spite of a significant increase in video
depreciation expense ($0.8 million excluding the effects of
purchase accounting), (ii) net decreases in selling, general and
administrative expenses ($1.4 million excluding amortization of
purchase accounting adjustments), and (iii) a $2.0 million
decrease in amortization of purchase accounting adjustments.
Excluding the effects of purchase accounting in both periods,
income from operations would have been $2.9 million for the
quarter ended July 31, 1994 and $0.7 million for the quarter
ended July 31, 1993, an improvement of $2.2 million.
Interest expense (net of other income) decreased from $5.9
million for the quarter ended July 31, 1993 to $5.8 million for
the quarter ended July 31, 1994, largely due to lower average
borrowings on the revolving line of credit in the quarter ended
July 31, 1994. Included in interest expense are $0.5 million and
$0.4 million attributable to the amortization of acquisition
financing costs during the quarters ended July 31, 1994 and 1993,
respectively.
Based upon current operations of the Company, the Company did not
record a tax benefit for the quarter ended July 31, 1994 and does
not currently anticipate doing so for the current fiscal year,
although such tax benefits are available to reduce any future
taxes payable if the Company generates future taxable income.
For the quarter ended July 31, 1993, the Company recorded an
effective tax benefit of $0.2 million, or 2.8% of its loss before
income taxes.
FOR THE SIX MONTHS ENDED JULY 31, 1994 AND JULY 31, 1993
Aggregate net revenues for the six months ended July 31, 1994
were $228.2 million compared to $211.1 million for the six months
ended July 31, 1993, an increase of 8.1%. The increase was due
to an increase in the number of stores from 339 at July 31, 1993
to 345 at July 31, 1994 and a 4.1% increase in revenues for same-
stores (those open for at least 13 months).
Merchandise sales were $183.2 million and $164.9 million during
the six months ended July 31, 1994 and 1993, respectively,
representing an aggregate increase of 11.1% and an increase of
5.3% on a same-store basis. The increase in same-store sales
resulted principally from increased sales of compact discs and of
video games and used compact discs, which are newer product lines
for the Company. The Company's sales of music cassettes declined
from the comparable six months last year due to the continuing
shift in consumer demand to compact discs.
Sales and Rental Revenue By
Merchandise Category
(dollars in millions)
Six Months Ended
July 31,
1994 1993
--------------------------
Merchandise Sales
Compact discs (including
used CDs) $103.5 $ 85.4
Cassettes and other music 45.0 48.3
------- -------
Total Music 148.5 133.7
New videocassettes 10.5 10.2
Video game software and
hardware, general
merchandise, accessories,
ticket commissions, and
other 24.2 21.0
------- -------
Total merchandise sales 183.2 164.9
Video and other product rentals 45.0 46.2
------- -------
Total Revenue $228.2 $211.1
Rental revenue was $45.0 million and $46.2 million for the six
months ended July 31, 1994 and 1993, respectively, representing a
2.5% aggregate decrease and a decrease of 0.6% on a same-store
basis. Decreases in the rental of videocassettes were offset by
increases in revenue from the sale of used videocassettes and
other rental products. Game rental revenue was flat to last
year.
Cost of sales increased $12.6 million to $118.3 million for the
six months ended July 31, 1994, as compared with $105.7 million
for the six months ended July 31, 1993. As a percentage of
merchandise sales revenue, cost of sales increased to 64.6% in
the six months ended July 31, 1994 from 64.1% in the six months
ended July 31, 1993. The 0.5% increase resulted principally from
changes in product mix and the utilization of promotional
markdowns to generate incremental sales (0.6%) and increased
costs associated with the provision for estimated inventory
shrinkage (0.3%), partially offset by decreases in merchandise
return penalties (0.4%). Changes in product mix include the
continuing shift in consumer demand from music cassettes to
lower-margin compact discs.
<PAGE>
Cost of rentals, excluding $1.4 million of purchase accounting
amortization recorded in the six months ended July 31, 1993 (none
was recorded in the six months ended July 31, 1994), increased
$2.6 million to $15.5 million for the six months ended July 31,
1994 compared to $12.9 million for the six months ended July 31,
1993. As a percentage of rental revenue, cost of rentals
(excluding purchase accounting amortization) increased to 34.5%
for the six months ended July 31, 1994 from 28.0% for the six
months ended July 31, 1993. The 6.5% increase was principally
due to the change in accounting estimate for amortization expense
which was implemented in the fourth quarter of fiscal year ending
January 31, 1994, and the acceleration of the recognition of
rental amortization to earlier interim periods (11.2%) partially
offset by the decrease in the cost of sales of used videocas-
settes (3.9%) and various other factors (0.8%).
Merchandise sales, as a percentage of aggregate net revenues,
increased from 78.1% in the six months ended July 31, 1993 to
80.3% in the six months ended July 31, 1994.
Selling, general and administrative expenses, excluding $1.7
million and $4.4 million for the amortization of purchase price
adjustments resulting from acquisitions, were $90.8 million and
$89.5 million for the six months ended July 31, 1994 and 1993,
respectively, an increase of $1.3 million, or 1.5%. As a
percentage of aggregate net revenues, selling, general and
administrative expenses, excluding amortization of purchase price
adjustments, were 39.8% and 42.4% for the six months ended July
31, 1994 and 1993, respectively. The 2.6% decrease is primarily
a result of total payroll having decreased while revenues grew
(total payroll was 16.6% versus 18.7% as a percentage of
aggregate net revenues during the six months ended July 31, 1994
and 1993, respectively, a decrease of 2.1%). All categories of
payroll, including stores, administrative, and distribution
center payrolls and the related payroll overhead costs, were
lower as a percentage of aggregate net revenues due to headcount
reductions and other expense control measures. Advertising
expense decreased 0.7% as a percent of aggregate net revenues
from 1.7% in the six months ended July 31, 1993 to 1.0% in the
six months ended July 31, 1994. The decrease is primarily due to
timing differences in advertising expenditures with higher
advertising dollars being spent in the six months ended July 31,
1993 to support the introduction of the used CD program. Other
factors, excluding occupancy costs, resulted in a 0.2% decrease
in selling, general and administrative expenses as a percentage
of aggregate net revenues. The above decreases in selling,
general and administrative expenses were slightly offset (0.4%)
by increases in rent and other occupancy costs resulting from
contractual escalations in base rent for existing stores, lease
renewals, leases for new stores and stores acquired during fiscal
1994, and increases for the straight-line effect of scheduled
future rent increases. Selling, general and administrative
expenses include non-cash provisions for the straight-line effect
of scheduled future rent increases of $1.9 million and $1.5
million for the six months ended July 31, 1994 and 1993,
respectively. Absolute dollar increases in rent and occupancy
expenses are expected to continue.
Income from operations was $2.0 million for the six months ended
July 31, 1994 compared to a loss from operations of $2.7 million
for the six months ended July 31, 1993, an increase in operating
income of $4.7 million. The improvement resulted principally
from (i) higher gross profits in spite of a significant increase
in video depreciation ($1.8 million excluding the effects of
purchase accounting), (ii) a $4.2 million decrease in amortiza-
tion of purchase accounting adjustments, partially offset by
(iii) net increases in selling, general and administrative
expenses ($1.3 million excluding amortization of purchase
accounting adjustments). Excluding the effects of purchase
accounting in both periods, income from operations would have
been $3.7 million for the six months ended July 31, 1994 and $3.1
million for the six months ended July 31, 1993, an improvement of
$0.6 million.
Interest expense (net of other income) decreased from $11.5
million for the six months ended July 31, 1993 to $11.3 million
for the six months ended July 31, 1994, largely due to lower
average borrowings on the revolving line of credit in the six
months ended July 31, 1994. Included in interest expense are
$0.9 million and $0.8 million attributable to the amortization of
acquisition financing costs during the six months ended July 31,
1994 and 1993, respectively.
At July 31, 1994, $54.6 million of the Company's long-term debt
(approximately 33% of total long-term debt then outstanding) and
the Company's revolving line of credit provided for interest
which varies with changes in the prime rate or other similar
interest rate indexes. A material increase in the prime rate, or
other applicable index rates, could significantly increase the
Company's interest expense. The impact of any such increase is
partially mitigated by an interest rate protection arrangement
with a major financial institution covering approximately 41.0%
of the outstanding balance of the Company's senior term loan.
See "Inflation" below.
Based upon current operations of the Company, the Company did not
record a tax benefit for the six months ended July 31, 1994 and
does not currently anticipate doing so for the current fiscal
year, although such tax benefits are available to reduce any
future taxes payable if the Company generates future taxable
income. For the six months ended July 31, 1993, the Company
recorded an effective tax benefit of $0.9 million or 6.7% of its
loss before income taxes.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended July 31, 1994, the Company's
operations used net cash of $0.7 million compared to $14.3
million during the six months ended July 31, 1993. Operating
cash flows in both periods were primarily used for the purchase
of merchandise and rental inventory and the payment of service
and supplies providers. The $13.6 million decrease in the use of
cash flow for operations was primarily the result of reductions
in merchandise inventory levels, the receipt of $4.5 million in
tax refunds and improved operating income. The Company used $4.2
million in investing activities in the six months ended July 31,
1994 compared to $9.2 million for the six months ended July 31,
1993. Cash used for investing activities was higher in the six
months ended July 31, 1993 due to the acquisition of Record Shop
assets.
Short-term borrowings were used to finance operations and
investing activities, as well as pay down long-term debt and
capital lease obligations in both periods.
The Company has a revolving bank line of credit in the amount of
$45.0 million which expires on January 31, 1998. At July 31,
1994, the outstanding indebtedness on the line of credit was
$13.0 million as compared to $37.0 million at July 31, 1993. The
average outstanding indebtedness on the line of credit decreased
$12.2 million from $34.2 million for the six months ended July
31, 1993 to $22.0 million for the six months ended July 31, 1994.
As of July 31, 1994, the Company has signed lease commitments to
open 4 new stores and may open additional stores over the next
twelve months. The Company may, subject to its ability to obtain
additional capital, make additional acquisitions if it determines
such acquisitions to be appropriate. The Company currently plans
to purchase approximately $5 million of point-of-sale equipment
over the next twelve months and currently expects to finance this
expenditure with working capital and possibly lease financing.
Management believes that current cash flows from operations and
borrowings under the revolving credit facility will be adequate
to meet the Company's liquidity requirements (including the
"clean down" requirement whereby all borrowing on the revolving
line of credit must be repaid for 30 continuous days) over the
next twelve months. Debt service requirements are expected to be
funded through internal cash flow or through refinancing in
outlying years.
INFLATION
Inflation has not had a material effect on the Company, its
operations and its internal and external sources of liquidity and
working capital. However, interest rate increases beyond current
levels could have an impact on the Company's operations.
The impact on the Company of interest rate fluctuations is
partially mitigated by an interest rate protection agreement with
a major financial institution coverage approximately 41.0% of the
outstanding balance of the senior term loan at July 31, 1994.
Such agreement limits the net interest cost to the Company out-
side a specified range on the amounts covered by the agreement.<PAGE>
<page-15>
PART II
OTHER INFORMATION
Item 1. Legal Proceedings
(i) McMahan and Related Actions.
In January 1988, holders (the "Debentureholders") of
approximately $17 million in principal amount of the Company's
6-1/4% Convertible Subordinated Debentures (the "Debentures")
commenced the action McMahan & Company, et al. v. Wherehouse
Entertainment, Inc., et al., 88 Civ. 0321 (S.D.N.Y.). Defendants
are the Company, six of its former directors, Furman Selz, Adler
& Shaykin, the former controlling shareholder of the Company
("A&S"), WEI Acquisition Corp. ("WAC"), a corporation formed by
A&S for the purpose of acquiring the Company, and WEI.
An indenture between the Company and Bank of America
National Trust and Savings Association (the "Debenture
Indenture"), which sets forth the contractual rights of the
Debentureholders, provides that under certain circumstances
(defined as "triggering events") the Debentureholders will have
the right to have their Debentures redeemed by the Company at a
specified redemption price. One of the triggering events is a
merger of the Company with another company that is not approved
by a majority of the "Independent Directors" (as defined in the
Debenture Indenture). The claims in this action arose from the
1988 acquisition of the Company by A&S, pursuant to a merger
agreement (the "1988 Acquisition Agreement") that was approved by
the board of directors of the Company, including a majority of
the Independent Directors. At that time, there were approxi-
mately $48.3 million in aggregate principal amount of Debentures
outstanding.
The Complaint, as amended, contains seven causes of
action. Count I alleges that the Independent Directors' approval
of the 1988 Acquisition Agreement violated the Debenture Inden-
ture because of the alleged implicit requirement in the Debenture
Indenture that the Independent Directors would not approve any
merger agreement unless the approval was in the best interests of
the Debentureholders. Count II alleges that the board of
directors' approval of the 1988 Acquisition Agreement violated
the directors' contractual duty of good faith and fair dealing to
the Debentureholders. Count III alleges that the prospectus
issued by the Company and Furman Selz in connection with the
offering of the Debentures violated Section 11 of the Securities
Act of 1933 (the "Securities Act") by failing to disclose that
the Independent Directors retained the right to approve any
merger proposal, and thereby prevent any right to redemption from
arising, whether or not such proposal was in the best interests
of the Debentureholders. Count IV, brought solely on behalf of
Froley, Revy Investment Co. ("Froley Revy"), alleges that
representatives of Furman Selz violated Section 12(2) of the
Securities Act by making material misstatements to Froley Revy to
the effect that the optional redemption provision was a "special
protection" and a "protective covenant" for Debentureholders,
without disclosing that the directors retained the power, in
their discretion, to approve a transaction and thereby prevent
any right to redemption from arising. Count V alleges that the
prospectus issued by the Company and Furman Selz in connection
with the offering of the Debentures, as well as the oral state-
ments specified in Count IV, violated Section 10(b) of the
Securities Exchange Act of 1934 (the "Exchange Act") for the
reasons specified in the descriptions of Counts III and IV.
Count VI alleges that A&S, WAC and WEI interfered with plain-
tiffs' alleged contractual rights. Count VII alleges that the
1988 Acquisition was a fraudulent conveyance in violation of New
York law.
The Amended Complaint seeks (a) to invalidate any
obligation of the Company to Chemical Bank, which provided
financing in connection with the 1988 Acquisition, (b) to set
aside any security interest in the Company's assets in favor of
Chemical Bank, (c) a declaration that the debt held by Chemical
Bank is secured only by the securities which the debt was
provided to purchase and (d) damages in an unspecified amount,
together with the costs of the action. Although the Amended
Complaint also purported to seek an injunction barring the 1988
Acquisition, plaintiffs never applied for such relief and the
1988 Acquisition was consummated.
By opinion dated April 10, 1990, the United States
Court of Appeals for the Second Circuit (the "Second Circuit")
reversed the judgment of the United States District Court for the
Southern District of New York (the "District Court") dismissing
the federal securities law claims pursuant to Rule 56 of the
Federal Rules of Civil Procedure and dismissing the state law
claims for lack of subject matter jurisdiction. The Second
Circuit, by a vote of two to one, concluded that plaintiffs had
presented sufficient evidence to create a question of fact as to
whether the offering materials at issue and certain alleged oral
communications from Furman Selz to Froley, Revy could have misled
a reasonable investor in violation of Section 10(b) of the
Exchange Act and Sections 11 and 12(2) of the Securities Act.
The Second Circuit also reinstated the pendent state law claims,
and remanded the case to the District Court.
Discovery has concluded, and defendants moved for
summary judgment dismissing plaintiffs' complaint in its
entirety. Plaintiffs also moved for partial summary judgment on
their contract claims. On March 11, 1994, the United States
Magistrate Judge issued a Report and Recommendation which
recommended that defendants' motion for summary judgment be
granted and that the complaints in these actions be dismissed.
The plaintiffs appealed that determination to the
District Court which, on August 12, 1994, adopted that portion of
the Report and Recommendation dismissing the plaintiffs' state
law claims. However, the District Court declined to adopt the
Magistrate's recommendation that plaintiffs' federal securities
law claims be dismissed. On August 26, 1994, defendants filed a
motion requesting that the District Court reconsider its ruling
denying summary judgment on plaintiffs' federal securities law
claims or, alternatively, certify its order for an immediate
appeal. Based on proceedings to date and the Company's discus-
sions with its trial lawyers, the Company believes that this
action is without merit and is vigorously defending it.
$5.7 million principal amount of the Debentures
remained outstanding as of January 31, 1994.
An action entitled Don Thompson v. Wherehouse Enter-
tainment, Inc., et al., 88 Civ. 9040 (S.D.N.Y.), which is
substantially similar to the McMahan action and which was
certified as a class action on behalf of all persons who owned
Wherehouse debentures as of December 20, 1989, has been conso-
lidated with the McMahan action.
(ii) Silverman Action Settled In Principle.
Silverman, et al. v. Wherehouse Entertainment, Inc., et
al., Del. Ch. Civ. No. 935. In October 1987, stockholders of the
Company filed a class action suit in the Delaware Chancery Court
for New Castle County, seeking an injunction to force the Company
to negotiate with Shamrock Holdings, Inc. ("Shamrock"). In
addition, former stockholders Shaul Shaulson and Harold Kramer
brought claims against the Company in Delaware Chancery Court and
in the Superior Court for the State of California for the County
of Los Angeles, respectively. The California action has been
discontinued. In January 1988, Barry Silverman, Philip Frank,
Shaul Shaulson and Harold Kramer, each a former stockholder of
the Company, filed a Motion for Leave to File a Consolidated and
Amended Complaint (for the purpose of the discussion of this
litigation, the "Amended Complaint") in Delaware Chancery Court
with respect to the Delaware class action, the Shaulson action
and the Kramer action. In the Amended Complaint, these former
stockholders abandoned their previous claim seeking to force the
Company to negotiate with Shamrock, and alleged instead, inter
alia, that the board of directors of the Company breached
fiduciary duties owed to the stockholders of the Company by
virtue of their approval of the offer of WAC to acquire the
Company (the "WAC Offer"). They also alleged in the Amended
Complaint that because the Board rejected a proposal by Shamrock
on October 13, 1987 to negotiate for a purchase by Shamrock of
all outstanding shares of common stock of the Company at a price
of $14.25 per share, subject to Shamrock's ability to obtain
financing and to complete satisfactory due diligence, and subse-
quently rejected the Shamrock tender offer of $12.00 per share,
the board of directors of the Company should not then have
accepted the WAC offer for $14.00 per share. Such former stock-
holders further alleged that in deposition testimony given by
various members of the board of directors of the Company such
members of the board of directors of the Company had stated that
they believed at the time of the initial proposal by Shamrock
that the shares were worth in excess of $18.00 per share.
Plaintiffs received permission to file and serve the Amended
Complaint, and in May 1988, the Company filed its answer denying
the material allegations in the Amended Complaint and raising
affirmative defenses thereto.
On July 27, 1994, the parties executed a stipulation of
settlement in the Silverman action. The settlement agreement in
principle provides for no consideration to be paid to any former
shareholders of Wherehouse, but for plaintiffs' counsel to apply
for an award of legal fees and costs not to exceed $350,000. The
settlement is subject to notice to shareholders who owned Where-
house common stock as of December 23, 1987 and approval by the
court after a hearing on the fairness of the proposed settlement.
The court has scheduled a hearing for October 27, 1994 to
determine whether the settlement should be approved.
(iii) Offset Fund.
As part of the June 1992 Acquisition of the Company and
WEI by Merrill Lynch Capital Partners and certain related
parties, approximately $18.75 million of the merger consideration
payable to the sellers in connection with the Acquisition was
deferred and is subject to offset, to the extent the Company
incurs certain litigation costs, including costs and expenses
relating to the cases entitled McMahan & Company, et al. v.
Wherehouse Entertainment, Inc., et al.; Don Thompson v. Where-
house Entertainment, Inc., et al.; and Silverman, et al. v.
Wherehouse Entertainment, Inc., et al., as described in the
merger agreement with respect to that Acquisition. All amounts
payable under the Silverman settlement will be offset under this
provision, and thus such payments will not affect the Company's
cash balances or results of operations.
(iv) 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 disposi-
tion will not have a material impact on the financial position of
the Company.
<page-18>
Item 6. Exhibits and Reports on Form 8-K
(a) and (b)
None.
<PAGE>
<page-19>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned thereunto duly authorized.
Date: August 31, 1994 /s/ Scott Young
--------------------------
SCOTT YOUNG
Chairman of the Board and
Chief Executive Officer and
Director
(Principal Executive Officer)
Date: August 31, 1994 /s/ Jerry E. Goldress
--------------------------
JERRY E. GOLDRESS
President and Chief Operating
Officer and acting Chief
Financial Officer
(Principal Financial Officer)
Date: August 31, 1994 /s/ Kathy J. Ford
--------------------------
KATHY J. FORD
Vice President, Controller
(Principal Accounting Officer)
