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 October 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 October 31, 1994
- - ----- --------------
Common Stock, $.01 Par Value 10
Total of 19 Pages
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INDEX
WHEREHOUSE ENTERTAINMENT, INC.
Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets -
October 31, 1994 (Unaudited) and
January 31, 1994 3
Condensed Statements of Operations -
Three Months Ended October 31, 1994
and 1993 (Unaudited)
Nine Months Ended October 31, 1994
and 1993 (Unaudited) 4
Condensed Statements of Cash Flows -
Nine Months Ended October 31, 1994
and 1993 (Unaudited) 5
Notes to Condensed Financial Statements 6
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
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<TABLE>
PART I.
FINANCIAL INFORMATION
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED BALANCE SHEETS
<CAPTION>
October 31, January 31,
1994 1994
------------ ------------
(Unaudited) Note 1
<S> <C> <C>
ASSETS
Current Assets
Cash $ 2,315,000 $ 3,120,000
Receivables 2,654,000 2,802,000
Taxes receivable 0 5,000,000
Merchandise inventory 134,433,000 113,592,000
Deferred income taxes 4,882,000 4,402,000
Other current assets 2,372,000 2,573,000
------------ ------------
Total current assets 146,656,000 131,489,000
Rental inventory 15,126,000 11,689,000
Property, equipment and
improvements, net 45,994,000 47,161,000
Excess of cost over fair value
of assets acquired, net 140,638,000 142,932,000
Unamortized financing costs,
leasehold interest, net 8,772,000 9,905,000
Deferred income taxes 6,774,000 6,774,000
Other assets 754,000 1,425,000
------------ ------------
Total assets $364,714,000 $351,375,000
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Short-term borrowings $ 26,950,000 $ 4,000,000
Accounts payable and accrued
expenses 120,615,000 114,863,000
Current maturities of capital
lease obligations and long-
term debt 8,400,000 7,772,000
------------ ------------
Total current liabilities 155,965,000 126,635,000
Capital lease obligations and
long-term debt 160,400,000 163,699,000
Other long-term liabilities 10,261,000 7,426,000
Convertible subordinated
debentures 3,696,000 3,635,000
Shareholder's equity
Common stock, $.01 par value,
1,000 authorized, 10 issued
and outstanding --- ---
Additional paid-in capital 95,696,000 95,855,000
Accumulated deficit (61,304,000) (45,875,000)
------------ ------------
Total shareholder's
equity 34,392,000 49,980,000
------------ ------------
Total liabilities and
shareholder's equity $364,714,000 $351,375,000
============ ============
</TABLE>
See accompanying notes.
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<TABLE>
WHEREHOUSE ENTERTAINMENT, INC.
CONDENSED STATEMENT OF OPERATIONS
(Unaudited)
<CAPTION>
Three Three Nine Nine
Months Ended Months Ended Months Ended Months Ended
Oct. 31, 1994 Oct. 31, 1993 Oct. 31, 1994 Oct. 31, 1993
------------- ------------- ------------- -------------
<S> <C> <C> <C> <C>
Sales $ 92,003,000 $ 85,760,000 $275,153,000 $250,700,000
Rental revenue 20,648,000 22,139,000 65,685,000 68,329,000
------------- ------------- ------------- -------------
112,651,000 107,899,000 340,838,000 319,029,000
Cost of sales 58,100,000 55,234,000 176,360,000 160,885,000
Costs of rentals, including
amortization 8,633,000 8,091,000 24,150,000 22,414,000
------------- ------------- ------------- -------------
66,733,000 63,325,000 200,510,000 183,299,000
Selling, general and
administrative expenses 46,081,000 49,374,000 138,532,000 143,238,000
------------- ------------- ------------- -------------
(Loss) income from operations (163,000) (4,800,000) 1,796,000 (7,508,000)
Interest expense 5,874,000 5,910,000 17,282,000 17,681,000
Other income 15,000 (9,000) (57,000) (279,000)
------------- ------------- ------------- -------------
5,889,000 5,901,000 17,225,000 17,402,000
------------- ------------- ------------- -------------
Loss before income taxes (6,052,000) (10,701,000) (15,429,000) (24,910,000)
Benefit for income taxes 0 (8,157,000) 0 (9,102,000)
------------- ------------- ------------- -------------
Net loss $ (6,052,000) $ (2,544,000) $(15,429,000) $(15,808,000)
============= ============= ============= =============
</TABLE>
See accompanying notes.
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<TABLE>
WHEREHOUSE ENTERTAINMENT, INC.
STATEMENTS OF CASH FLOWS
(Unaudited)
<CAPTION>
Nine Nine
Months Ended Months Ended
Oct. 31, 1994 Oct. 31, 1993
------------- -------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net loss $(15,429,000) $(15,808,000)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 34,975,000 35,089,000
Book value of rental inventory dispositions 4,884,000 6,907,000
Gain on disposal of fixed assets --- (10,000)
Deferred taxes (480,000) (4,175,000)
Changes in operating assets and liabilities:
Receivables 148,000 1,404,000
Taxes receivable 5,000,000
Merchandise inventory (20,841,000) (8,025,000)
Other current assets 201,000 (1,219,000)
Accounts payable, accrued expenses, and
other liabilities 8,587,000 (6,826,000)
Rental inventory purchases (27,588,000) (22,248,000)
------------- -------------
Net cash used in operating activities (10,543,000) (14,911,000)
INVESTING ACTIVITIES:
Acquisition of property, equipment and
improvements (10,029,000) (8,127,000)
Purchase of Record Shop (601,000) (5,853,000)
Decrease (increase) in other assets and intangibles 247,000 (986,000)
------------- -------------
Net cash used in investing activities (10,383,000) (14,966,000)
FINANCING ACTIVITIES:
Short-term borrowings 22,950,000 35,400,000
Dividend payments (160,000) (350,000)
Principal payments on capital lease obligations
and long-term debt (2,669,000) (5,526,000)
------------- -------------
Net cash provided by financing activities 20,121,000 29,524,000
------------- -------------
Net decrease in cash (805,000) (353,000)
Cash, beginning of the period 3,120,000 831,000
------------- -------------
Cash, end of the period $ 2,315,000 $ 478,000
============= =============
Supplemental disclosures of cash flow information:
Cash paid (received) during the period for:
Interest $ 18,867,000 $ 20,220,000
Income taxes (4,548,000) 205,000
</TABLE>
See accompanying notes.
<PAGE>
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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 neces-
sary 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 nine
months ended October 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") (93.2% on a fully diluted basis)
and certain members of management (6.8% 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.
October 31, January 31,
1994 1994
---------- ----------
(In Thousands of Dollars)
Current Assets $ 48 $ 68
Total Assets 34,440 50,048
Current liabilities 94 170
Total liabilities 94 170
Redeemable common stock 3,872 4,140
Notes receivable from
shareholders (663) (728)
Contingent shares (650) (702)
For the Nine Months Ended
October 31, October 31,
1994 1993
--------- ----------
(In Thousands of Dollars)
Net income $ 30 $ 34
<PAGE>
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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 OCTOBER 31, 1994 AND OCTOBER 31, 1993
Aggregate net revenues for the quarter ended October 31, 1994
were $112.7 million compared to $107.9 million for the quarter
ended October 31, 1993, an increase of 4.4%. The increase was
due to a 2.5% increase in revenues for same-stores (those open
for at least 13 months) and an increase in the number of stores
from 338 at October 31, 1993 to 348 at October 31, 1994. The
Company does not anticipate a significant increase in the number
of stores during the remainder of the current fiscal year.
Merchandise sales were $92.0 million and $85.8 million during the
quarters ended October 31, 1994 and 1993, respectively, repre-
senting an aggregate increase of 7.3% and an increase of 4.3% on
a same-store basis. The increase in same-store sales resulted
principally from increased sales of compact discs. 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 of new videocassettes increased due prima-
rily to the release of Jurassic Park and Snow White and the Seven
Dwarfs. The Company's sales of video game software and hardware
declined as the Company reduced its breadth of product in order
to concentrate on the most important titles and due to a weaker
release schedule than in the prior period. Sales of blank tape
continued to decrease due to competitive pressures.
Sales and Rental Revenue By
Merchandise Category
(dollars in millions)
Quarters Ended
October 31,
1994 1993
--------------------------
Merchandise Sales
Compact discs (including
used CDs) $ 54.6 $ 46.5
Cassettes and other music 21.6 22.3
------- -------
Total Music 76.2 68.8
New videocassettes 6.0 5.5
Video game software and hardware,
general merchandise, acces-
sories, ticket commissions,
and other 9.8 11.5
------- -------
Total merchandise sales 92.0 85.8
Video and other product rentals 20.6 22.1
------- -------
Total Revenue $ 112.7 $ 107.9
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 $20.6 million
and $22.1 million during the quarters ended October 31, 1994 and
1993, respectively, representing a 6.8% aggregate decrease and a
4.2% decrease on a same-store basis. Decreases in the rental of
videocassettes and video games resulted primarily from continued
competitive pressures. These decreases were partially offset by
increases in revenue from the sale of used videocassettes and
other rental products. The Company anticipates that it will
continue to experience strong competition in the rental business.
Cost of sales increased $2.9 million to $58.1 million for the
quarter ended October 31, 1994, as compared with $55.2 million
for the quarter ended October 31, 1993. As a percentage of
merchandise sales revenue, cost of sales decreased to 63.2% in
the quarter ended October 31, 1994 from 64.4% in the quarter
ended October 31, 1993. The 1.2% decrease in cost of sales as a
percentage of merchandise sales revenues resulted principally
from decreases in merchandise return penalties and higher
discounts from vendors, partially offset by an increase in the
shrinkage accrual. The Company continues to experience strong
competition in the merchandise sale business, both from existing
competitors and new entrants in its markets. As these competi-
tive pressures increase, the Company's margins may be adversely
affected.
Cost of rentals, excluding $0.7 million of purchase accounting
amortization recorded in the quarter ended October 31, 1993 (none
was recorded in the quarter ended October 31, 1994), increased
$1.2 million to $8.6 million for the quarter ended October 31,
1994 as compared with $7.4 million for the quarter ended October
31, 1993. As a percentage of rental revenue, cost of rentals
(excluding purchase accounting amortization) increased to 41.8%
in the quarter ended October 31, 1994 from 33.4% in the quarter
ended October 31, 1993. The 8.4% increase was principally due to
the change in accounting estimate for amortization expense which
was implemented in the fourth quarter of the fiscal year ended
January 31, 1994 and the acceleration of the recognition of
rental amortization to earlier interim periods. The change in
estimate for amortization expense eliminated the utilization of
salvage value and further accelerated the amortization calcula-
tion. Due to the effect of the change in accounting estimate
recorded at the end of fiscal 1994, it can be expected that cost
of rentals for the fiscal year ended January 31, 1995 as a
percentage of rental revenue will be lower than in fiscal 1994.
In addition to the fiscal 1994 change in estimate, the Company
changed its method of reporting the amortization of rental
inventory for interim periods, beginning with the first quarter
of fiscal 1995. Interim reporting of amortization is 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 recogni-
tion 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 for the fiscal year.
Merchandise sales, as a percentage of aggregate net revenues,
increased from 79.5% in the quarter ended October 31, 1993 to
81.7% in the quarter ended October 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 overall
margin rates.
Selling, general and administrative expenses, excluding $0.9
million and $2.2 million in the amortization of purchase
accounting adjustments resulting from acquisitions, were $45.2
million and $47.1 million for the quarters ended October 31, 1994
and October 31, 1993, respectively, a decrease of $1.9 million.
As a percentage of aggregate net revenues, selling, general and
administrative expenses, excluding amortization of purchase
accounting adjustments, were 40.1% and 43.7% for the quarters
ended October 31, 1994 and 1993, respectively. The 3.6% decrease
is primarily a result of total payroll having decreased while
revenues grew. 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 also decreased as a
percent of aggregate net revenues in the quarter ended October
31, 1994 compared to the quarter ended October 31, 1993. The
decrease is primarily due to timing differences in advertising
expenditures. Selling, general and administrative expenses
include non-cash provisions for the straight-line effect of
scheduled future rent increases of $0.8 million and $0.6 million
for the quarters ended October 31, 1994 and 1993, respectively.
Absolute dollar increases in rent and occupancy expenses are
expected to continue.
The loss from operations was $0.2 million for the quarter ended
October 31, 1994 compared to a loss from operations of $4.8
million for the quarter ended October 31, 1993, an improvement of
$4.6 million. The improvement resulted principally from (i)
higher gross profit on sale merchandise, (ii) net decreases in
selling, general and administrative expenses ($1.9 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 adjustments in both periods, income from operations
would have been $0.7 million for the quarter ended October 31,
1994 and a loss from operations of $1.9 million for the quarter
ended October 31, 1993, an improvement of $2.6 million.
Interest expense (net of other income) was essentially flat at
$5.9 million for the quarters ended October 31, 1994 and October
31, 1993. The benefit of lower average borrowings on the
revolving line of credit was largely offset by slightly higher
interest rates. Included in interest expense are $0.5 million
and $0.4 million attributable to the amortization of acquisition
financing costs during the quarter ended October 31, 1994 and
1993, respectively.
Based upon current operations of the Company, the Company did not
record a tax benefit for the quarter ended October 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 October 31, 1993, the Company
recorded an effective tax benefit of 76.2% due to the passage of
legislation related to the Targeted Job Tax Credit program in
August 1993. This legislation was retroactive to July 1992, and
the cumulative effect of the credit was recorded in the quarter
ended October 31, 1993. Additionally, during the quarter ended
October 31, 1993, the tax rate was adjusted to reflect a revision
in the estimated tax benefit rate for the fiscal year.
FOR THE NINE MONTHS ENDED OCTOBER 31, 1994 AND OCTOBER 31, 1993
Aggregate net revenues for the nine months ended October 31, 1994
were $340.8 million compared to $319.0 million for the nine
months ended October 31, 1993, an increase of 6.8%. The increase
was due to a 3.6% increase in revenues for same-stores (those
open for at least 13 months) and an increase in the number of
stores from 338 at October 31, 1993 to 348 at October 31, 1994.
The Company does not anticipate a significant increase in the
number of stores during the remainder of the current fiscal year.
Merchandise sales were $275.2 million and $250.7 million during
the quarters ended October 31, 1994 and 1993, respectively,
representing an aggregate increase of 9.8% and an increase of
5.0% on a same-store basis. The increase in same-store sales
resulted principally from sales of compact discs and of used
compact discs, which is a newer product line for the Company.
The Company's sales of music cassettes declined from the compar-
able period last year due to the continuing shift in consumer
demand to compact discs.
Sales and Rental Revenue By
Merchandise Category
(dollars in millions)
Nine Months Ended
October 31,
1994 1993
--------------------------
Merchandise Sales
Compact discs (including
used CDs) $ 158.0 $ 131.9
Cassettes and other music 66.6 70.6
------- -------
Total Music 224.6 202.5
New videocassettes 16.5 15.8
Video game software and hardware,
general merchandise, acces-
sories, ticket commissions,
and other 34.1 32.4
------- -------
Total merchandise sales 275.2 250.7
Video and other product rentals 65.7 68.3
------- -------
Total Revenue $ 340.8 $ 319.0
Rental revenue was $65.7 million and $68.3 million during the
nine months ended October 31, 1994 and 1993, respectively, repre-
senting a 3.9% aggregate decrease and a 1.8% decrease on a same-
store basis. Decreases in the rental of videocassettes and video
games resulted primarily from continued competitive pressures.
These decreases were partially offset by increases in revenue
from the sale of used videocassettes and other rental products.
Cost of sales increased $15.5 million to $176.4 million in the
nine months ended October 31, 1994, as compared with $160.9
million in the nine months ended October 31, 1993. As a
percentage of merchandise sales revenue, cost of sales remained
relatively flat, at 64.1% for the nine month period ended October
31, 1994, as compared with 64.2% for the nine month period ended
October 31, 1993.
Cost of rentals, excluding $2.1 million of purchase accounting
amortization recorded in the nine months ended October 31, 1993
(none was recorded in the nine months ended October 31, 1994),
increased $3.9 million to $24.2 million in the nine months ended
October 31, 1994 as compared with $20.3 million in the nine
months ended October 31, 1993. As a percentage of rental
revenue, cost of rentals (excluding purchase accounting amortiza-
tion) increased to 36.8% in the nine months ended October 31,
1994 from 29.7% in the nine months ended October 31, 1993. The
7.1% increase was principally due to the change in accounting
estimate for amortization expense which was implemented in the
fourth quarter of the fiscal year ended January 31, 1994 and the
acceleration of the recognition of rental amortization to earlier
interim periods.
Merchandise sales, as a percentage of aggregate net revenues,
increased from 78.6% in the quarter ended October 31, 1993 to
80.7% in the nine months ended October 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
overall margin rates.
Selling, general and administrative expenses, excluding $2.6
million and $6.7 million in the amortization of purchase
accounting adjustments resulting from acquisitions, were $136.0
million and $136.6 million for the nine months ended October 31,
1994 and October 31, 1993, respectively, a decrease of $0.6
million. As a percentage of aggregate net revenues, selling,
general and administrative expenses, excluding amortization of
purchase accounting adjustments, were 39.9% and 42.8% for the
nine months ended October 31, 1994 and 1993, respectively. The
2.9% decrease is primarily a result of total payroll having
decreased while revenues grew. 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 as a percent of aggregate net revenues in the nine
months ended October 31, 1994 compared to the nine months ended
October 31, 1993. The decrease is primarily due to timing
differences in advertising expenditures. Selling, general and
administrative expenses include non-cash provisions for the
straight-line effect of scheduled future rent increases of $2.7
million and $2.2 million for the nine months ended October 31,
1994 and 1993, respectively. Absolute dollar increases in rent
and occupancy expenses are expected to continue.
Income from operations was $1.8 million for the nine months ended
October 31, 1994 compared to a loss from operations of $7.5
million for the nine months ended October 31, 1993, an improve-
ment of $9.3 million. The improvement resulted principally from
(i) higher gross profit on sale merchandise, (ii) net decreases
in selling, general and administrative expenses ($0.6 million,
excluding amortization of purchase accounting adjustments), and
(iii) a $6.2 million decrease in amortization of purchase
accounting adjustments. Excluding the effects of purchase
accounting adjustments in both periods, income from operations
would have been $4.4 million for the nine months ended October
31, 1994 and $1.3 million for the nine months ended October 31,
1993, an improvement of $3.1 million.
Interest expense (net of other income) decreased slightly to
$17.2 million for the nine months ended October 31, 1994 from
$17.4 million for the nine months ended October 31, 1993. The
benefit of lower average borrowings on the revolving line of
credit was largely offset by slightly higher interest rates.
Included in interest expense are $1.4 million and $1.2 million
attributable to the amortization of acquisition financing costs
during the nine months ended October 31, 1994 and 1993,
respectively.
Based upon current operations of the Company, the Company did not
record a tax benefit for the nine months ended October 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 nine months ended October 31, 1993, the Company
recorded an effective tax benefit of 36.5%.
LIQUIDITY AND CAPITAL RESOURCES
During the nine months ended October 31, 1994, the Company's
operations used net cash of $10.5 million compared to $14.9
million during the nine months ended October 31, 1993. Operating
cash flows in both periods were primarily used for the purchase
of merchandise and rental inventory. The $4.4 million decrease
in the use of cash flow from operating activities was primarily
the result of an increase in trade accounts payable due to
extended dating programs provided by vendors and payables to
support higher inventory levels than in the prior period, the
receipt of $4.5 million in tax refunds and improved operating
income. The Company used $10.4 million in investing activities
in the nine months ended October 31, 1994 compared to $15.0
million in the nine months ended October 31, 1993. Cash used in
investing activities was higher for the nine months ended October
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 October 31,
1994, the outstanding indebtedness on the line of credit was
$27.0 million as compared to $42.0 million at October 31, 1993.
Negative working capital of $9.3 million at October 31, 1994
compared to postive working capital of $4.8 million at January
31, 1994 is a result of the seasonality of the Company's
business.
As of October 31, 1994 the Company has signed lease commitments
to open two 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 is
currently purchasing approximately $5 million of point-of-sale
equipment with the purchase to be completed during fiscal year
1996. This expenditure is being financed 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.
<PAGE>
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 covering approximately 40.4% of the
outstanding balance of the senior term loan at October 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 Inden-
ture"), which sets forth the contractual rights of the Debenture-
holders, 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 Deben-
ture 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 Indepen-
dent Directors. At that time, there were approximately $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 direc-
tors' approval of the 1988 Acquisition Agreement violated the
directors' contractual duty of good faith and fair dealing to the
Debentureholders. Count III alleges that defendants violated
Section 11 of the Securities Act of 1933 (the "Securities Act")
by omitting to disclose in the prospectus which was issued in
connection with the Debenture offering 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 Debenture-
holders. 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 statements specified in Count IV,
violated Section 10(b) of the Securities Exchange Act of 1934
(the "Exchange Act") for the reasons specified in the descrip-
tions of Counts III and IV. Count VI alleges that A&S, WAC and
WEI interfered with plaintiffs' alleged contractual rights.
Count VII alleges that the 1988 Acquisition was a fraudulent
conveyance in violation of New York law.
The Amended Complaint seeks, inter alia, damages in an
unspecified amount, together with the costs of the action.
On May 22, 1989, United States District Court for the
Southern District of New York (the "District Court") dismissed
plaintiffs' federal securities law claims pursuant to Rule 56 of
the Federal Rules of Civil Procedure and dismissed the state law
claims for lack of subject matter jurisdiction. By opinion dated
April 10, 1990, the United States Court of Appeals for the Second
Circuit (the "Second Circuit") reversed the judgment of the
District Court and remanded the case.
Discovery has concluded, and defendants moved for
summary judgment and requested dismissal of 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. Defendants requested that the District
Court certify its order denying summary judgment for an immediate
appeal. In October 1994, the District Court granted defendants'
motion for certification, and requests for permission to appeal
the order are currently pending in the Second Circuit. Appellate
review of the District Court's Order may only be obtained if the
Second Circuit agrees with the District Court's finding that the
grounds for an interlocutory appeal have been satisfied. 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, 1987, has been conso-
lidated with the McMahan action.
(ii) Silverman Action Settled.
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 in the Delaware Chancery Court for
New Castle County, seeking an injunction to force the Company to
negotiate a merger with Shamrock Holdings, Inc. ("Shamrock"). In
addition, former stockholder Shaul Shaulson filed a complaint
against the Company in the Superior Court for the State of
California for the County of Los Angeles. The California action
was voluntarily dismissed by plaintiff. In January 1988, plain-
tiffs filed a Consolidated and Amended Complaint (the "Amended
Complaint") in Delaware Chancery Court. In the Amended Com-
plaint, plaintiffs 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"). The Amended Complaint also alleged
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 should not then have accepted the WAC offer for $14.00
per share. Defendants filed an answer denying the material
allegations in the Amended Complaint and raising affirmative
defenses thereto.
For a description of previous developments with respect
to this matter, see Item 1 of Part II to Registrant's Quarterly
Report on Form 10-Q for the quarter ended July 31, 1994.
The Delaware Chancery Court approved a settlement of
this action on October 27, 1994. Under the terms of the settle-
ment, no consideration is to be paid to any former shareholders
of Wherehouse; plaintiffs' counsel may apply to the Court for an
award of attorneys fees and disbursements in an amount not to
exceed $350,000. The Court awarded plaintiffs $350,000 in
attorneys' fees and disbursements, and this amount was paid on
December 6, 1994 through the Offset Fund described below.
(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 were offset under this
provision on December 6, 1994, and thus such payments do 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.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
27 Financial Data Schedule
(b) Current Reports on Form 8-K
No current reports on Form 8-K were filed during
the quarter ended October 31, 1994.
<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: December 9, 1994 /s/ Scott Young
--------------------------
SCOTT YOUNG
Chairman of the Board and
Chief Executive Officer and
Director
(Principal Executive Officer)
Date: December 9, 1994 /s/ Jerry E. Goldress
--------------------------
JERRY E. GOLDRESS
President and Chief Operating
Officer and acting Chief
Financial Officer
(Principal Financial Officer)
Date: December 9, 1994 /s/ Kathy J. Ford
--------------------------
KATHY J. FORD
Vice President, Controller
(Principal Accounting Officer)
<TABLE> <S> <C>
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THE FOLLOWING INFORMATION HAS BEEN EXTRACTED FROM THE FINANCIAL STATEMENTS IN
THE FORM 10-Q FOR THE QUARTER ENDED OCTOBER 31, 1994.
</LEGEND>
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<CURRENT-ASSETS> 146656
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