Filed under Rules 424(b)(3) and (c) File No. 33-51266 See also Prospectus dated October 1, 1993 Supplement to Prospectus dated October 1, 1993 SELECTED FINANCIAL DATA Set forth below are selected consolidated financial data as of and for the periods indicated below. The financial data was derived from financial statements of the Predecessor (see Note (1) below) and Wherehouse. Separate selected financial data for WEI is not included in this report. Currently, WEI conducts no independent operations and has no significant assets other than the capital stock of Wherehouse. The selected financial data should be read in conjunction with the discussion under "Manage- ment's Discussion and Analysis of Financial Condition and Results of Operations", below. (Dollar amounts in millions) ---------------------------------------------------------------- Company Predecessor(1) ------------------------ -------------------------------------- 8 Months 4 Months Year Ended Ended Ended January 31, January 31, May 30, Year Ended January 31, 1994 1993 1992 1992 1991 1990 ----------- ----------- -------- -------- -------- -------- Income statement data - --------------------- Revenue: Sales $380.2 $249.1 $105.3 $358.6 $352.2 $296.8 Rental revenue 91.6 64.3 29.8 98.9 99.9 91.5 ----------- ----------- -------- -------- ------- --------- 471.8 313.4 135.1 457.4 452.1 388.3 Cost and expenses: Cost of sales 248.0 155.2 66.9 225.5 223.0 189.7 Cost of video rentals including amortization 50.8 24.8 7.3 30.9 43.2 41.2 Selling, general administrative expenses 196.6 122.9 59.9 179.1 170.1 148.5 Restructuring charges(2) 14.3 --- --- --- --- --- Interest expense 23.5 15.7 4.9 18.0 20.0 20.9 Other income (0.3) (0.1) (0.1) (0.1) (0.3) (1.3) ----------- ----------- --------- ------- ------- --------- 532.9 318.5 138.9 453.4 456.0 398.9 ----------- ----------- --------- ------- ------- --------- (Loss) income before income taxes (61.1) (5.1) (3.8) 3.9 (4.0) (10.6) (Benefit) provision for income taxes (19.1) (1.3) (1.9) 1.0 (2.8) (5.1) ----------- ----------- --------- ------- ------- --------- (Loss) income before extraordinary item(3) (42.1) (3.8) (2.0) 2.9 (1.2) (5.5) Extraordinary item(4) --- --- (4.5) --- --- --- ----------- ----------- --------- ------- ------- --------- Net (loss) income(3) ($42.1) ($3.8) ($6.5) $2.9 ($1.2) ($5.5) Balance sheet data - ------------------ Working capital deficiency(5) ($0.5) ($0.5) ($30.7) ($20.5) ($30.5) Total assets(5) 351.4 374.4 225.7 227.2 235.7 Long-term debt (including current portion)(5)(6) 175.1 185.1 110.0 120.5 140.2 Total shareholder's equity(7) 50.0 62.5 3.7 1.2 2.4 Other information - ----------------- Ratio of earnings to fixed charges(8) (9) (9) (9) 1.11x (9) (9) (1) The Company was acquired in June 1992 by the purchase of all of WEI's ownership interest in the Company through a merger transaction in which Grammy Corp. was merged with and into WEI. The transaction was accounted for using the purchase method and the term "Predecessor" refers to the predecessor to the Company for the period from fiscal year 1989 through May 31, 1992. The transaction caused changes in the basis of accounting thereby making periods of the Predecessor not comparable to those of the Company. (2) "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations", below. (3) Earnings per share are omitted for the Company since it is a wholly-owned subsidiary of WEI. (4) The extraordinary item represents the write-off of unamor- tized financing costs and prepayment penalties paid related to the debt of the Predecessor that was refinanced at the time of the Acquisition. The loss was $4.5 million, net of an income tax benefit of $3.0 million. (5) Certain prior year balances have been restated to conform to current classifications. (6) Includes $3.6 million of convertible subordinated deben- tures. (7) There were no cash dividends declared during any of the periods presented above, except for cash dividends in the amount of $.5 million, $.3 million and $.1 million paid to WEI, the Company's sole stockholder, in fiscal years 1994, 1992 and 1989, respectively. (8) For the purpose of computing the ratios of earnings to fixed charges, earnings consists of income (loss) before income taxes and fixed charges. "Fixed charges" consists of interest expense, amortization of debt expenses and the portion of rental expenses deemed representative of the interest factor. (9) Fixed charges exceeded earnings by $10.6, $4.0, $3.8, $5.1, and $61.1 for fiscal 1990, fiscal 1991, the four months ended May 31, 1992, the eight months ended January 31, 1993, and fiscal 1994, respectively. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS RESULTS OF OPERATIONS Year Ended January 31, 1994 Compared to Year Ended January 31, 1993 Aggregate net revenues were $471.8 million and $448.5 million for the fiscal years ended January 31, 1994 and January 31, 1993, respectively. This increase of $23.3 million was principally due to an increase in number of stores from 313 at January 31, 1993 to 347 (including 4 stores managed by the Company, for its benefit, under contracts with the owners thereof) at January 31, 1994, and a 0.14% increase in same-store revenues (stores open for at least 13 months). During fiscal 1994, in order to achieve additional geographic diversification, the Company expanded its presence in several western states and entered new markets in additional western and various mid-western states through its acquisitions of an aggregate of 39 specialty music stores from The Record Shop, Inc. and from Pegasus Music and Video, Inc. Furthermore, during the fiscal year ended January 31, 1994, the Company opened 6 new stores, managed 4 stores for its own benefit under contract with The Record Shop, Inc., expanded or remodeled 69 stores and closed 15 stores. Because the Company expects in the current fiscal year to focus its efforts towards the improvement of its existing stores and operations, rather than acquisitions or new store openings, it can be expected that growth in aggregate net revenues in the fiscal year ending January 31, 1995 will be dependent primarily upon increases, if any, in same-store revenues; and thus the fiscal 1994 increase in aggregate net revenues is not necessarily indicative of increases to be expected in the current fiscal year. The Company will continue to opportunistically evaluate potential acquisitions which could meet its strategic objectives, and, if it determines the same to be appropriate, the Company may, subject to its ability to source additional capital (the availability of which is currently uncertain), make additional acquisitions. On a longer-term basis, the Company intends to continue its growth, both by opening new stores in selected locations, and by additional acquisitions. Set forth below is a summary of the Company's dollar volume of sale revenue from fiscal 1990 through fiscal 1994. Sales and Rental Revenue By Merchandise Category (dollars in millions) Fiscal Years Ended January 31, --------------------------------------------- 1994 1993 1992 1991 1990 ------ ------ ------ ------ ------ Merchandise Sales Compact discs (including used CDs) $203.7 $174.3 $161.0 $135.8 $ 93.6 Cassettes and other music 101.9 112.7 124.5 133.8 131.7 ------ ------ ------ ------ ------ Total music 305.6 287.0 285.5 269.6 225.3 New videocassettes 24.3 26.9 33.4 37.0 26.9 Video game software and hardware, general merchandise accessories, ticket commissions, and other 50.3 40.6 39.7 45.7 44.6 ------ ------ ------ ------ ------ Total merchandise sales $380.2 $354.5 $358.6 $352.2 $296.8 ====== ====== ====== ====== ====== Video and other product rentals 91.6 94.0 98.8 99.9 91.5 ------ ------ ------ ------ ------ TOTAL REVENUE $471.8 $448.5 $457.4 $452.1 $388.3 ====== ====== ====== ====== ====== Merchandise sales were $380.2 million and $354.4 million during the fiscal year ended January 31, 1994 and 1993, respec- tively, representing an aggregate increase of 7.3% and an increase of 1.1% on a same-store basis. The increase in same- store merchandise sales resulted principally from increased sales of video games and used compact disc products, which were newer product lines for the Company, as well as from promotional markdowns used to generate incremental sales. The Company's sales of music cassettes continued to decline from the previous fiscal year due to a continuing shift in consumer demand to compact discs. The Company's revenues from the sales of videocassettes have decreased with the proliferation of competitors' outlets selling videocassettes and the highly competitive pricing of the product, particularly from discounters and mass merchandisers. The Company has implemented new pricing and merchandising strategies designed to counter this trend. No assurances can be given that the Company's new strategies will be successful. Rental revenue includes the rental of videocassettes, video games and game players, audiocassette books and laser discs. Approximately 75% of the Company's stores currently offer video- cassettes and other products for rent. Rental revenue for the fiscal year ended January 31, 1994 was $91.6 million, a decrease of 2.6% from the previous fiscal year and a decrease of 3.3% on a same-store basis. In spite of the overall increase in the Company's aggregate net revenues from fiscal 1993 to fiscal 1994, and a slight increase in the number of stores carrying rental products from fiscal 1993 to fiscal 1994, the Company continued to experience declining rental revenues, primarily due to competitive factors and, to a lesser extent, to the continued maturing of videocas- settes in the Company's predominant markets, offset to some extent by the growth in game rental products. It is the Company's belief that, as a result of the large installed base of videocassette recorders ("VCRs") in California and its other major markets, future growth in rental revenue will be primarily as a result of marketing and other competitive factors, as well as additional store openings, rather than as a result of increases in the size of the videocassette rental user market. In connection with its 1994 Re-Engineering Plan, described below, the Company has recently implemented new pricing and merchan- dising strategies designed to increase rental revenue. Nonethe- less, 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. The Company's business and same-store revenues may be impacted by various competitive and economic factors, including, but not limited to, consumer tastes, acquisitions made by the Company, marketing programs, weather, special events, the quality of new releases of music, video and 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 revenue have been impacted by increased competition from other music and video specialty retail chains, as well as discounters and mass merchandisers. During the fiscal year ended January 31, 1994, in response to various competitive factors and less than favorable economic conditions, the Company developed, adopted and continued to refine a multi-faceted re-engineering plan (the "1994 Re-Engin- eering Plan"), which is designed to improve operating profit by lowering costs associated with its inventory supply chain and retail store operations, and to tailor its stores to better accommodate local consumer tastes and entertainment needs. As part of this strategic plan, the Company has delegated more power to its on-site store managers to customize their inventory of merchandise and rental products, and has further refined its "value pricing" strategy for videocassette rentals to enable the store manager to select from a matrix of rental prices those which best fit the demographics and competitive conditions of his or her market. The objectives of this strategy are both to improve profitability and to enable each of the Company's stores to become "the best store in the neighborhood." The Company has also, as part of the 1994 Re-Engineering Plan, developed a video rental remerchandising program, which is currently scheduled to be implemented during the first half of the current fiscal year. Under the video rental remerchandising program, the Company will provide a greater number of "hit" movie titles at its stores, as well as install new store signage and fixtures designed specifically to support the program. The Company believes that its planned marketing and merchan- dising strategies and its expansion in markets outside of Cali- fornia should improve its ability to respond to competition from other retailers. However, the Company can give no assurances that its marketing and merchandising strategies will be effective. 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 increased $25.9 million to $248.0 million for the fiscal year ended January 31, 1994, as compared with $222.1 million for the fiscal year ended January 31, 1993. As a percen- tage of merchandise sales revenues, cost of sales increased 2.5% to 65.2% for the fiscal year ended January 31, 1994 versus 62.7% for the fiscal year ended January 31, 1993. The gross profit percentage for merchandise sale product was 34.8% and 37.3% for the fiscal years ended January 31, 1994 and 1993, respectively. The increase in cost of sales as a percentage of merchandise sales revenues resulted from increased costs associated with inventory shrinkage, changes in the product sales mix, higher return penalties, the utilization by the Company of promotional markdowns to generate incremental sales, and lower prompt payment discounts from suppliers. The changes in product sales mix include an increase in the Company's video game sales business, which carries lower margins than the Company's other product lines, along with the continuing shift in consumer demand from music cassettes to lower-margin compact discs. Additionally, margins from sales of compact discs and from video games each declined somewhat from the prior year. Video game sales margins declined as excess supply necessitated higher promotional mark- downs. The decreased gross margins were offset, in part, by improved gross margins for used compact discs, accessories and personal electronics. Cost of rentals, including amortization, increased $18.7 million to $50.8 million for the fiscal year ended January 31, 1994, as compared with $32.1 million for the fiscal year ended January 31, 1993. As a percentage of rental revenue, cost of rentals increased to 55.5% for the fiscal year ended January 31, 1994 from 34.1% for the fiscal year ended January 31, 1993. The gross profit percentage for rental revenue was 44.5% and 65.9% for the fiscal years ended January 31, 1994 and 1993, respective- ly. The increased cost of rental revenue, including amortiza- tion, was principally due to a change in accounting estimate for amortizing the cost of video rental inventory that resulted in a $20.3 million charge to reduce the carrying value of existing rental inventory. In prior years, the Company amortized the cost of video rental inventory under an accelerated method to its estimated salvage value. During the fiscal year ended January 31, 1994, the Company changed its amortization estimation method by eliminating the utilization of the half-year convention and salvage value, and by further accelerating the amortization calculation. The Company believes that the revised amortization estimate will result in better matching of rental revenue with the cost of such rental inventory. For the fiscal year ended January 31, 1994, the change in the estimate for amortization of video rental inventory resulted in an increase of $20.3 million (40% of cost of rentals) over what the cost of rentals would have been if the change had not been effected. It can be expected that, in future periods, cost of rentals as a percentage of rental revenue will be somewhat lower than that experienced in the fiscal year ended January 31, 1994. Merchandise sales, as a percentage of aggregate net revenues, increased from 79.0% in the fiscal year ended January 31, 1993 to 80.6% in the fiscal year ended January 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. In both the music and rental markets, there has been a recent 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 Virgin Megastores, have announced plans to increase their retail music store presence in California. It can thus be expected that the Company will in future periods experience increased competition from companies with greater financial resources than the Company, and that competitive pressures may result in a tightening of gross profit margins. Selling, general and administrative expenses, excluding $8.9 million and $7.7 million for the amortization of purchase price adjustments resulting from acquisitions, were $187.7 million and $175.0 million for the fiscal years ended January 31, 1994 and 1993, respectively, an increase of $12.7 million, or 7.3%. As a percentage of aggregate net revenues, selling, general and administrative expenses, excluding amortization of purchase price adjustments, were 39.8% and 39.0% for the fiscal years ended January 31, 1994 and 1993, respectively. The increase is principally due to (i) increased rent and occupancy expenses resulting from contractual escalations in base rent for existing stores, leases for new stores and stores acquired during the year, expenses resulting from lease renewals and increases for the straight-line effect of scheduled future rent increases, and (ii) increased semi-variable and payroll expenses attributable to new stores and acquisitions, a revised corporate salary program, and a higher administrative headcount than during the previous fiscal year. The increases in selling, general and administra- tive expenses were offset, in part, by decreased advertising expenditures during the fiscal year ended January 31, 1994 as the Company changed its media strategy from more expensive, image- building television to greater product emphasis utilizing less expensive media such as radio, billboards and newspaper. Addi- tionally, the Company changed the gift structure of its rental customer loyalty program, which resulted in lower expenses. Selling, general and administrative expenses include non-cash provisions for the straight-line effect of scheduled future rent increases of $4.9 million and $3.5 million for the fiscal years ended January 31, 1994 and 1993, respectively. Absolute dollar increases in rent and occupancy expenses are expected to continue. As part of the 1994 Re-Engineering Plan, the Company indentified required changes in systems and operations and, therefore, assessed the realizable value of certain assets and the costs of the restructuring measures. As a result, during the fiscal year ended January 31, 1994, the Company incurred a total of $14.3 million for restructuring charges (all of which have resulted from, or were related to, the 1994 Re-Engineering Plan) as follows (in millions of dollars): Write-off of property, plant and equipment $ 8.2 Write-off of beneficial leasehold interests and other assets 4.2 Severance costs 1.4 Consulting fees and other .5 ------ $14.3 ====== The loss from operations was $37.9 million for the fiscal year ended January 31, 1994, as compared with income from operations of $11.6 million for the fiscal year ended January 31, 1993. The decreased operating results principally resulted from (i) the decreased gross profit for video rental due to the change in accounting estimate referred to above, and (ii) the restruc- turing charges discussed above. Excluding the effects of purchase accounting in both fiscal periods, and excluding both the change in estimate for amortizing video rental inventory and the restructuring charges, in the fiscal year ended January 31, 1994, income from operations would have been $8.4 million for the fiscal year ended January 31, 1994 compared to $22.7 million for the fiscal year ended January 31, 1993. Interest expense (net) increased $2.6 million to $23.2 million, as compared with $20.6 million, for the fiscal years ended January 31, 1994 and January 31, 1993, respectively. The increase principally resulted from higher overall debt levels required for the previously-described store acquisitions and the Acquisition, somewhat offset by lower interest rates on floating rate debt. Included in interest expense are $1.7 million and $2.3 million attributable to the amortization of acquisition financing costs during the fiscal years ended January 31, 1994 and 1993, respectively. At January 31, 1994, $56.0 million of the Company's long- term debt (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 agreement with a major financial institution covering approximately 40% of the outstanding balance of the Company's senior term loan. See "Inflation", below. The effective tax benefit recorded by the Company on its loss before income taxes was 31.2% versus 35.2% during the fiscal years ended January 31, 1994 and January 31, 1993, respectively. The decrease was principally due to increased goodwill amortiza- tion resulting from the Acquisition and non-deductible reserve allowances. The Company's tax benefit for the fiscal year ended January 31, 1994 and 1993 differed from the statutory rate of 34% principally due to non-deductible purchase accounting adjust- ments, reserve allowances, state taxes and job tax credits. As a result of net operating loss carrybacks, the Company expects to receive an approximate $5.0 million federal income tax refund during the second quarter of its current fiscal year. Based upon the current operations of the Company, and other factors, it is currently anticipated that net pre-tax losses, if any, realized during the fiscal year ending January 31, 1995 will not result in the recording of any additional effective tax benefit by the Company although such tax benefits would be available to reduce any future taxes payable if the Company generated future taxable income. Year Ended January 31, 1993 Compared to Year Ended January 31, 1992 The following discussion of results of operations for the fiscal year ended January 31, 1993 includes results of the Predecessor for the four months ended May 31, 1992, and the results of the Company for the eight months ended January 31, 1993. Aggregate net revenues for the year ended January 31, 1993 were $448.5 million compared to $457.4 million for the year ended January 31, 1992. This decrease was due to a 4.9% decrease in same store revenues (stores open for at least 13 months), partially offset by an increase in the number of stores from 301 at the end of fiscal 1992 to 313 at the end of fiscal 1993. The decline in same store revenues was largely attributable to difficult economic conditions, particularly in the state of California, resulting in reduced revenue volume while unit prices were generally maintained. Also, civil disturbances in the Los Angeles market had a temporary negative effect on performance during the year. Additionally, the introduction in February 1992 of a "value pricing" strategy for videocassette rentals in Los Angeles, the Company's largest marketing area, and in other markets, adversely impacted revenues during most of the fiscal year. The demand for compact discs continued to positively affect revenues, with CD sales representing $174.3 million or 49% of merchandise sales for fiscal 1993, compared to $161.0 million or 45% of merchandise sales for fiscal 1992. The Company does not believe that the "value pricing" strategy for videocassette rentals should have a further materially negative impact on revenues. Gross profit as a percentage of merchandise sales was 37.3% in fiscal 1993 compared to 37.1% in fiscal 1992. The increase is primarily attributable to an increase in supplier's purchase discounts earned and a reduction in sale inventory shrinkage partially offset by an increase in promotional markdowns. While the shift in product mix from higher margin music cassettes to lower margin compact discs had a negative impact on gross margins, this was offset by improvement in gross profit margins on new videocassettes, blank video tape, blank audio tape, accessories, personal electronics, and concessions. Gross profit as a percentage of rental revenue was 65.9% for fiscal 1993 compared to 68.7% for fiscal 1992. The decrease is primarily attributable to: (i) amortization of purchase accounting adjustments resulting from the Acquisition, which represented 3.6% of rental revenue and (ii) a decline in rental revenue from the Los Angeles "value pricing" strategy, which lowered the per night rental price. This decrease was partially offset by (i) a decrease in the book value of rental dispositions resulting primarily from the sale of older rental inventory during fiscal 1993 compared to the prior year and (ii) a reduction in rental inventory shrinkage. Selling, general, and administrative expenses were 40.7% of total revenues in fiscal 1993 compared to 39.2% in fiscal 1992. The increase is primarily due to (i) an increase in rent and occupancy expense per store resulting from lease renewals, consumer price index escalations for existing stores, and new leases for larger stores, (ii) an increase in advertising expenditures, and (iii) the amortization of goodwill and depreciation of property and equipment resulting from the Acquisition, totalling 1.3% of total revenue. These increases were partially offset by a reduction in historical depreciation expense and an increase in other operating income, including financial remuneration from suppliers to help defray the cost of introducing smaller CD packaging. Income from operations decreased to $11.6 million in fiscal 1993, compared to $21.9 million in fiscal 1992, primarily due to the declines in revenue as explained above, the decrease in rental gross profit rate related to purchase accounting amortiza- tion, and the increase in rent and occupancy costs. Excluding the effects of purchase accounting adjustments in both years, operating income was $22.7 million in fiscal 1993 compared to $26.8 million in fiscal 1992. Net interest expense and other income was $20.6 million or 4.6% of total revenues in fiscal 1993 compared to $17.9 million or 3.9% of total revenues in fiscal 1992. This increase was attributable to increased levels of subordinated debt, which was partially offset by lower interest rates on lower term loan borrowings and by lower interest rates on comparable revolving line of credit borrowings. The Company recorded an effective income tax benefit of 35.2% on its loss before taxes in fiscal 1993, compared to an effective income tax provision of 26.0% on its income before taxes in fiscal 1992. The Company's tax benefit in fiscal 1993 and its tax provision in fiscal 1992 differed from the statutory rate of 34%, primarily as a result of non-deductible purchase accounting adjustments, state taxes and job tax credits. As part of the Acquisition, the Company reported a $4.5 million loss as an extraordinary item, net of tax, which represented the non-cash write-off of unamortized acquisition financing costs associated with the Adler & Shaykin acquisition in fiscal 1988 and prepayment penalties associated with the repayment of debt of the Predecessor that was refinanced at the time of the Acquisition. LIQUIDITY AND CAPITAL RESOURCES During the fiscal year ended January 31, 1994, the Company's operations generated net cash of $7.1 million compared to $1.3 million during the fiscal year ended January 31, 1993. Operating cash flows in both fiscal years were primarily used for the purchase of merchandise and rental video inventory and the payment of service and supply providers. The increase in cash flow generated by operations was primarily a result of lower increases in inventory levels offset by higher operating losses and the resulting increase in tax refunds receivable for the carryback of such operating losses. Cash used in investing activities totaled $24.8 million as compared to $136.1 million for the fiscal years ended January 31, 1994 and January 31, 1993, respectively. Cash used in investing activities during the fiscal year ended January 31, 1994 included approximately $12.2 million for the acquisitions of 39 specialty music stores from The Record Shop, Inc. and Pegasus Music and Video, Inc. and $11.8 million for acquisitions of property, plant and equipment. Acquisitions of property, plant and equipment increased $2.5 million during the fiscal year ended January 31, 1994 as compared to the prior fiscal year. Property, plant and equipment acquisitions in both periods were used primarily for the opening of new stores and the remodeling of existing stores, and in fiscal 1993, funds were also used for the acquisition of new equipment for the Company's new distribution center. During the fiscal year ended January 31, 1993, $125.8 million of the $136.1 million used for investing activities was due to the Acquisition of the Company. Cash provided by financing activities was $16.4 million as compared to $143.5 million during fiscal years ended January 31, 1994 and 1993, respectively. On January 31, 1994, WEI raised $30.0 million through the sale of common stock to certain of its existing stockholders. All of these funds were contributed by WEI to the capital of the Company and provided permanent financing for the acquisition of stores from The Record Shop, Inc. and Pegasus Music and Video, Inc. and for expenses associated with those acquisitions. In addition, during fiscal 1994, borrowings were reduced by approximately $13.2 million. During the fiscal year ended January 31, 1993, the $143.5 million of cash provided by financing activities consisted principally of a $70.3 million capital contribution and a net increase in borrowings, principally for new senior subordinated debt, both of which are attributable to the Acquisition. The Company's operations used net cash of $1.3 million for the year ended January 31, 1993 compared to the generation of $29.5 million for the year ended January 31, 1992. The decrease was primarily a result of an increase in merchandise inventory due to the introduction of new product lines and the expansion of certain existing product lines, the introduction of a value pricing strategy for videocassette rentals, and the extended economic recession in California. In addition to the changes in inventory, other factors affecting working capital were: (i) an increase in receivables partially related to insurance receiv- ables, the timing of credit card receipts at year-end, and reimbursement from landlords, and (ii) an increase in accounts payable and accrued expenses related primarily to increases in interest and sales taxes payable, offset by slight decreases in accounts payable and other accrued expenses. The increase in interest payable was attributable to higher debt levels and a change in the timing of the due date for interest on subordinated debt. The sales taxes payable increase was also attributable to timing differences on the due date. Video rental purchases were less during fiscal 1993 than in the prior year due to more efficient utilization by the Company of the videocassette rental inventory. Cash used in investing activities totalled $136.1 million compared to $14.2 million in the 1993 and 1992 fiscal years, respectively. The $136.1 million included $125.8 million to complete the Acquisition of the Company. The remainder was used primarily for opening new stores, remodeling existing stores, and acquiring fixtures and equipment for the new distribution center. Capital expenditures, including equipment under capital leases, totalled $12.9 million in fiscal 1993, up $1.2 million from fiscal 1992. Cash provided by financing activities was $143.5 million compared to $16.9 million of cash used in financing activities in the 1993 and 1992 fiscal years, respectively. The $143.5 million consisted primarily of a $70.3 million capital contribution and a net increase in borrowings, principally for new senior subordinated debt, both of which were related to the Acquisition. The Company's institutional indebtedness currently includes the following: i) a senior term loan in the original principal amount of $65.0 Million. As of January 31, 1994, the outstanding indebted- ness was $56.0 million. This facility matures in January 1998, with principal payments made in installments of varying amounts, and with interest payments due quarterly on prime-based borrowings and upon maturity for Eurodollar-based borrowings. Borrowings under the term loan bear interest at Prime plus 1.5% or Eurodollar plus 3.0%. ii) $110 Million in Senior Notes (the "Notes"). The Notes mature in August, 2002 and bear interest at 13% per annum, payable semi-annually. The Company is required to make sinking fund payments in August 2000 and August 2001 of $27.5 million each to allow for the redemption of a maximum of 50% in principal amount of the Notes at a price equal to 100% of the principal amount redeemed plus accrued interest thereon. iii) revolving line of credit in the amount of $45.0 million. Borrowings under the facility bear interest at the same rates as the term loan. As of January 31, 1994, the outstanding indebtedness on this facility was $4.0 million. Within the capacity of the revolving line of credit, the Company has a $10.0 million swingline facility to accommodate daily fluctuations in its working capital. Borrowings under the swingline bear interest at the rate of prime plus 1.0%. Both of these facili- ties mature in January 1998. These debt agreements require the Company to meet certain restrictive covenant tests at periodic intervals, and, as is customary for such borrowings, include such factors as mainte- nance of financial ratios and limitations on dividends, capital expenditures, transactions with affiliates, and other indebted- ness, and, under the revolving line of credit and swingline facility, a thirty day "clean-down", during which borrowings thereunder are not permitted. As of January 31, 1994, the Company was in compliance with all such covenants. The Company did not satisfy the entire "clean-down" period during the year ended January 31, 1994 and obtained a waiver with respect thereto from its lenders. As of January 31, 1994, the Company had outstanding, net of unamortized discount, $3.6 million of its 6 1/4% convertible subordinated debentures, issued July 1986, representing $5.7 million in principal amount. These debentures mature in July 2006; all sinking fund payment obligations of the Company, for the balance of the term of the debentures, have been satisfied. The Company is highly leveraged, and results of operations have been, and will continue to be, affected by the increased interest expense and amortization of goodwill recorded in connection with the Acquisition. As of April 1, 1994, the Company has signed lease commit- ments to open two new stores and may open additional stores over the next twelve months. While the Company can reasonably esti- mate the cost to open a new store, the actual number and types of stores opened will depend upon the Company's ability to locate and obtain appropriate sites and upon its financial position. See "Results of Operations", above. The Company may, subject to its ability to source additional capital, make additional acqui- sitions if it determines such acquisitions to be appropriate. While certain expenditures during the next twelve months will be higher than in prior periods, 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. Debt service requirements are expected to be funded through internal cash flow or through refinancing in outlying years. 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 are lowest during the period commencing with 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 expen- ditures for new stores and the building of inventory for the holiday season. 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 40.0% of the outstanding balance of the senior term loan at January 31, 1994. Such agreement limits the net interest cost to the Company out- side a specified range on the amounts covered by the agreement. The date of this Prospectus Supplement is May 16, 1994.