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 April 30, 1995
[ ] 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 90502-1334
(Address of principal executive offices including ZIP code)
(310) 538-2314
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrants (1) have
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 registrants were
required to file such reports), and (2) have 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 April 30, 1995
------ --------------
Common Stock, $.01 Par Value 10
Total of 20 Pages
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INDEX
WHEREHOUSE ENTERTAINMENT, INC.
Page
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
Condensed Balance Sheets -
April 30, 1995 (Unaudited) and
January 31, 1995 3
Condensed Statements of Operations -
Three Months Ended April 30, 1995 and
1994 (Unaudited) 4
Condensed Statements of Cash Flows -
Three Months Ended April 30, 1995 and
1994 (Unaudited) 5
Notes to Condensed Financial Statements 6
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 9
Part II. OTHER INFORMATION
Item 1. Legal Proceedings 17
Item 6. Exhibits and Reports on Form 8-K 19
SIGNATURES 20
<page-3>
PART I.
FINANCIAL INFORMATION
WHEREHOUSE ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED BALANCE SHEETS
April 30, January 31,
1995 1995
------------ ------------
(Unaudited) Note 1
ASSETS
Current Assets
Cash $ 4,765,000 $ 1,962,000
Receivables 4,078,000 3,155,000
Taxes receivable 1,500,000 1,500,000
Merchandise inventory 110,634,000 115,639,000
Other current assets 2,515,000 2,743,000
------------ ------------
Total current assets 123,492,000 124,999,000
Rental inventory, net 17,032,000 16,093,000
Equipment and improvements,
net 46,542,000 47,535,000
Financing costs and leasehold
interests, net 7,850,000 8,317,000
Other assets 724,000 736,000
------------ ------------
Total assets $195,640,000 $197,680,000
============ ============
LIABILITIES AND SHAREHOLDER'S EQUITY
Current liabilities
Short-term borrowings $ 40,000,000 $ 15,800,000
Accounts payable and accrued
expenses 94,098,000 112,537,000
Current maturities of capital
lease obligations and long-
term debt 10,619,000 9,811,000
Long-term debt classified as
current (Note 2) 152,036,000 150,000,000
------------ ------------
Total current liabilities 296,753,000 288,148,000
Capital lease obligations and
long-term debt 3,780,000 3,893,000
Other long-term liabilities 11,517,000 10,895,000
Deferred income taxes 3,477,000 3,477,000
Convertible subordinated
debentures --- 3,716,000
Shareholder's equity
Common stock, $.01 par value,
1,000 authorized, 10 issued
and outstanding --- ---
Additional paid-in capital 95,671,000 95,671,000
Accumulated deficit (215,558,000) (208,120,000)
------------ ------------
Total shareholder's
deficit (119,887,000) (112,449,000)
------------ ------------
Total liabilities and
shareholder's equity $195,640,000 $197,680,000
============ ============
See accompanying notes to condensed financial statements.
<page-4>
WHEREHOUSE ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF OPERATIONS
(Unaudited)
Three Three
Months Ended Months Ended
April 30, 1995 April 30, 1994
-------------- --------------
Sales $ 81,626,000 $ 92,005,000
Rental revenue 22,350,000 21,859,000
-------------- --------------
103,976,000 113,864,000
Cost of sales 52,361,000 60,092,000
Costs of rentals, including
amortization 8,509,000 7,267,000
-------------- --------------
60,870,000 67,359,000
Selling, general and
administrative expenses 44,403,000 46,587,000
-------------- --------------
Loss from operations (1,297,000) (82,000)
Interest expense, net 6,220,000 5,580,000
Other (income) expense (79,000) (14,000)
-------------- --------------
6,141,000 5,566,000
-------------- --------------
Loss before income taxes (7,438,000) (5,648,000)
Benefit for income taxes 0 0
-------------- --------------
Net loss $ (7,438,000) $ (5,648,000)
============== ==============
See accompanying notes to condensed financial statements.
<page-5>
WHEREHOUSE ENTERTAINMENT, INC. AND SUBSIDIARIES
CONDENSED STATEMENTS OF CASH FLOWS
(Unaudited)
Three Three
Months Ended Months Ended
April 30, 1995 April 30, 1994
-------------- --------------
OPERATING ACTIVITIES:
Net loss $ (7,438,000) $ (5,646,000)
Adjustments to reconcile net loss to net
cash provided by operating activities:
Depreciation and amortization 11,408,000 11,595,000
Book value of rental inventory dispositions 1,509,000 1,043,000
Changes in operating assets and liabilities:
Receivables (923,000) 139,000
Merchandise inventory 5,005,000 7,445,000
Other current assets 228,000 (366,000)
Accounts payable, accrued expenses, and
other liabilities (17,817,000) (25,044,000)
Rental inventory purchases (9,448,000) (7,830,000)
-------------- --------------
Net cash used in operating activities (17,476,000) (18,664,000)
INVESTING ACTIVITIES:
Acquisition of property, equipment and
improvements (2,788,000) (1,500,000)
Increase in other assets and intangibles (128,000) (65,000)
-------------- --------------
Net cash used in investing activities (2,916,000) (1,565,000)
FINANCING ACTIVITIES:
Short-term borrowings 24,200,000 20,700,000
Dividend payments --- (70,000)
Principal payments on capital lease obligations
and long-term debt (1,005,000) (888,000)
-------------- --------------
Net cash provided by financing activities 23,195,000 19,742,000
-------------- --------------
Net increase (decrease) in cash 2,803,000 (487,000)
Cash, beginning of the period 1,962,000 3,120,000
-------------- --------------
Cash, end of the period $ 4,765,000 $ 2,633,000
============== ==============
Supplemental disclosures of cash flow information:
Cash paid during the period for:
Interest $ 9,367,000 $ 8,401,000
Net income taxes --- ---
See accompanying notes to condensed financial statements.
<page-6>
WHEREHOUSE ENTERTAINMENT, INC.
NOTES TO CONDENSED FINANCIAL STATEMENTS
(Unaudited)
1. BASIS OF PRESENTATION
The accompanying condensed financial statements of Where-
house Entertainment, Inc. (the "Company") have been prepared by
the Company without audit. The condensed balance sheet at
January 31, 1995 has been derived from the Company's audited
financial statements at that date. Certain footnote disclosures,
including significant accounting policies, normally included in
financial statements prepared in accordance with generally
accepted accounting principles have been condensed or omitted.
The Company believes that the accompanying condensed financial
statements include all adjustments (consisting only of normal,
recurring adjustments) which are considered necessary for a fair
presentation. The results of operations for any interim period
may not be indicative of the results of the entire year.
It is suggested that the accompanying unaudited condensed
financial statements be read in conjunction with the financial
statements and notes included in the Company's Annual Report on
Form 10-K for the year ended January 31, 1995.
Certain reclassifications of balances have been made to the
1995 fiscal year amounts to conform to the 1996 fiscal year's
presentation.
2. GOING CONCERN UNCERTAINTIES AND SUBSEQUENT EVENTS
At April 30, 1995 and January 31, 1995, the Company's short-
term borrowings consisted of amounts outstanding to its senior
lenders under a revolving line of credit agreement in the amount
of $40,000,000 and $15,800,000, respectively. In addition, the
Company has a variable rate term note with its senior lenders in
the principal amount of $48,100,000 and $49,000,000 at April 30,
1995 and January 31, 1995, respectively, 13% senior subordinated
notes in the principal amount of $110,000,000 at April 30, 1995
and January 31, 1995, and 6 1/4% convertible subordinated
debentures in the amount of $3,736,000 at April 30, 1995.
The revolving line of credit agreement, variable rate term
note and 13% senior subordinated notes contain various restric-
tive covenants. The Company was not in compliance with the
maximum leverage ratio and minimum consolidated adjusted
E.B.I.T.D.A.V. (or "Earnings Before Interest, Taxes, Deprecia-
tion, Amortization and Video Amortization") covenants contained
in the revolving line of credit and variable rate term note
agreements at April 30, 1995 and was not in compliance with the
maximum leverage ratio covenant at January 31, 1995. As a
result, the Company requested and received from its senior
lenders waivers with respect to these and all covenant require-
ments through May 15, 1995. On May 11, 1995, the senior lenders
extended the term of these waivers through June 30, 1995. On
June 16, 1995, the waiver dated May 11, 1995 was superseded by a
standstill agreement which is effective through September 30,
1995. Under the terms of the standstill agreement, certain
remedies available to the senior lenders under the Company's bank
agreements are preserved, including rights which effectively
prohibit the Company from honoring payments to holders of the
Company's convertible subordinated debentures and rights, which
when exercised, will effectively prohibit the Company from
honoring future payment commitments to senior subordinated
debentures. In addition, under the terms of the standstill
agreement, the senior lenders agree to forbear from commencing
actions to collect the obligations owed under the credit
agreement and agree to continue to permit borrowings for up to
the full $45,000,000 working capital line of credit currently
available to the Company.
During the fiscal years ended January 31, 1995 and 1994, the
Company incurred net losses of $162,245,000 and $42,059,000,
respectively, and during the quarter ended April 30, 1995, the
Company incurred a net loss of $7,438,000. Furthermore, at April
30, 1995, the Company had a shareholders' deficit of
$119,887,000. Since the beginning of the current fiscal year,
the Company continues to experience declining same-store revenues
and gross margins. Continued declines in revenues and gross
margins and other factors could result in future defaults by the
Company under its loan agreements beyond the June 30, 1995 term
of its current waivers.
Under the terms of the 13% senior subordinated notes, an
acceleration of payment in excess of $5,000,000 occasioned by
default under the variable term note is considered an event of
default. As a result of the loan covenant violations discussed
above and the rights preserved under the standstill agreement,
$152.0 million of debt covered by the terms of the variable rate
term note, the 13% senior subordinated notes and the 6 1/4%
convertible subordinated debentures have been reclassified as a
current liability at April 30, 1995.
The accompanying condensed financial statements have been
prepared assuming the Company will continue as a going concern.
The condensed financial statements do not include adjustments
relating to the recoverability and classification of the recorded
carrying value of assets or the amounts or classification of
other liabilities that might be necessary should the Company be
unable to successfully renegotiate its loan agreements and
continue as a going concern.
3. SUMMARY OF FINANCIAL INFORMATION OF WEI HOLDINGS, INC.
Unconsolidated summary financial information of the
Company's parent, WEI Holdings, Inc. ("WEI") is as follows:
April 30, January 31,
1995 1995
--------- ----------
(In Thousands)
Current assets 82 64
Total assets 82 64
Current liabilities 81 76
Deficiency in investment
in the Company 119,887 112,448
Total liabilities 119,968 112,524
Redeemable common stock 3,872 3,872
Notes receivable from
shareholders (660) (660)
Contingent shares (663) (663)
For the Three Months Ended
April 30, April 30,
1995 1994
--------- ---------
(In Thousands)
Net income 10 9
WEI holds all of the capital stock of the Company and, in
turn, is owned by affiliates of Merrill Lynch Capital Partners,
Inc. ("MLCP") (91% on a fully diluted basis) and certain members
of management (9% on a fully diluted basis). Currently, WEI
conducts no independent operations and has no significant assets
apart from its investment in the capital stock of the Company.
<page-9>
WHEREHOUSE ENTERTAINMENT, INC.
Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF THE
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INTRODUCTION
This discussion should be read in conjunction with the
financial statements, related notes and Management's Discussion
and Analysis of Financial Condition and Results of Operations
contained in the Company's Annual Report on Form 10-K for the
year ended January 31, 1995.
RECENT DEVELOPMENTS AND UNCERTAINTIES
Recent developments described below have led to uncertain-
ties as to the Company's ability to continue operations as a
going concern.
The Company has a highly leveraged capital structure with
total debt outstanding at April 30, 1995 of $207.9 million,
including current portion of long-term debt and amounts outstand-
ing under the Company's revolving credit facility. During its
quarter ended April 30, 1995 and each of its fiscal years ended
January 31, 1995 and 1994, the Company recorded significant net
losses which produced a working capital deficit of $169.5 million
and shareholders' deficit of $119.9 million at April 30, 1995.
Results of operations and cash flows have been and will continue
to be, affected by increased interest expense and debt service
requirements resulting from the June 1992 leveraged acquisition
of the Company's parent, WEI Holdings, Inc. (the "Acquisition").
In order to repay indebtedness incurred in connection with
the Acquisition, and its other indebtedness, the Company will be
required to generate substantial operating cash flow. The
ability of the Company to generate sufficient operating cash
flows and meet its debt service obligations within the required
contractual time frames is subject to both prevailing economic
conditions and to various business and other factors, including,
among others, the Company's ability to increase operating profits
and cash flows, restructure its outstanding indebtedness, and/or
obtain alternative sources of financing. The ability of the
Company to improve its operating profits and cash flows cannot be
assured. In addition, there can be no assurance that the Company
will be able to restructure its outstanding indebtedness or
obtain new financing, or that, if such measures are available,
that the terms thereof would be favorable to the Company, its
shareholders, or the holders of its outstanding debt securities.
While the Company believes that, based upon its current
level of operations, it could meet its debt service obligations
within the required contractual time frames for the remainder of
the current fiscal year ending on January 31, 1996, recent
factors, including those discussed in the following paragraphs,
raise significant uncertainties as to the Company's ability to
effect the repayment of its outstanding indebtedness within and
beyond that time frame.
As further enumerated below, during the quarter ended April
30, 1995, the Company experienced an 8.9% decline in same-store
revenues which it attributes to a lack of hit release music
product which has impacted the industry as a whole, decreased
sales of video games and continued competitive pressures in
certain of its markets. As a result, the Company has also
experienced declining gross margins.
While the Company continues to exercise control over
operating expenses and is managing inventory investment through
the use of improved distribution systems and other working
capital management methods, any further significant decreases in
revenues or any significant decline in gross margins will result
in a further violation of the loan agreement covenants in fiscal
year 1996 and will also negatively impact its liquidity. The
Company had average borrowings of $36.4 million on its revolving
line of credit during the quarter ended April 30, 1995 compared
to average borrowings of $22.6 million during the quarter ended
April 30, 1994. At April 30, 1995, the Company had borrowings of
$40.0 million compared to borrowings of $24.7 million at April
30, 1994.
The Company was not in compliance with its loan agreement
covenants at January 31, 1995 and April 30, 1995. As a result,
the Company requested and received from its senior lenders
waivers with respect to its loan agreement covenants through May
15, 1995, and, on May 11, 1995, the lenders extended the term of
these waivers through June 30, 1995. On June 16, 1995, all such
waivers were superseded by a standstill agreement effective
through September 30, 1995. Certain conditions of the June 16,
1995 standstill agreement, among others, include requirements
that the Company not make any interest or other payments under
the terms of the Company's currently outstanding 13% subordinated
notes and the 6 1/4% convertible subordinated debentures and that
no holder of any subordinated debt nor any trustee for any issue
of any subordinated debt accelerate any such debt. In connection
with the standstill agreement, the lenders required that the
Company and WEI, among other things, develop a plan for the
restructuring of their capital structure. As a result, the
Company has commenced negotiations with its senior lenders and
certain holders of its subordinated notes for the purpose of
restructuring its highly leveraged capital structure. As part of
these negotiations, it is the Company's intent in restructuring
its capital structure to avoid, to the extent possible, or to
minimize any impairment of its credit relationships with trade
and other vendors. However, the Company can give no assurances
as to its ability to successfully restructure its existing
capital structure and uncertainties exist as to the form such a
restructuring, if any, might take.
Furthermore, the Company is presently discussing further
waivers of, standstill agreements, or amendments to its bank
agreement covenants for the remainder of fiscal year 1996 while
it attempts to restructure its capital structure. However, the
Company can give no assurances as to its ability to obtain
further waivers of or amendments to its bank agreement covenants
nor its ability to obtain further standstill agreements from its
senior lenders pursuant to which the senior lenders would agree
not to exercise certain of their remedies under the bank
agreements for the remainder of the fiscal year. If the Company
is unable to obtain such waivers, agreements, or amendments, or
is unable to satisfy the conditions under which such waivers,
agreements, or amendments are issued, the lenders could suspend
or terminate the loan agreement and accelerate the amounts then
outstanding.
Should the Company be unsuccessful in obtaining additional
standstill agreements or waivers of or satisfactory amendments to
its loan agreement covenants, or if the Company's revenues
continue to decline, the Company's ability to continue operations
as a going concern would be uncertain and its continued viability
could be in jeopardy. As a result of these and other factors,
the Company's independent auditors, Ernst & Young LLP, has
included an explanatory paragraph in their opinion on the
Company's financial statements for the fiscal year ended January
31, 1995 addressing uncertainties as to the Company's ability to
continue operations as a going concern.
RESULTS OF OPERATIONS
FOR THE QUARTERS ENDED APRIL 30, 1995 AND APRIL 30, 1994
Aggregate net revenues were $104.0 million and $113.9
million for the quarters ended April 30, 1995 and 1994,
respectively. The Company believes that the decrease of $9.9
million, or 8.7%, was principally due to decreased customer
traffic caused by a lack of new, "hit" release music product and
continued competitive and economic pressures in certain of the
Company's markets. While the Company had relatively the same
number of stores at April 30, 1995 as compared to April 30, 1994,
average revenues per store declined approximately 8.6%.
Net merchandise sales were $81.6 million versus $92.0
million for the quarters ended April 30, 1995 and 1994,
respectively, representing an overall average decrease of 11.3%.
On a same-store basis, however, net merchandise sales declined by
11.5% during the quarter ended April 30, 1995 as compared to the
quarter ended April 30, 1994. These decreases in total and
same-store net merchandise sales are primarily attributable to
the competitive and other factors described above. Total net
sales of music products, video games and software, and
accessories decreased in virtually all of the principal
categories of these products that are carried by the Company,
except for sales of used compact discs. Decreases in the music,
video games and software, and accessories product categories were
offset slightly by increased sales of prerecorded videocassettes
due to the release during the quarter of such "hit" video titles
as "The Lion King" and "Forrest Gump."
A summary of total net merchandise sales and rental
revenues, by product category, is provided below:
Net Merchandise Sales and Rental Revenues
By Merchandise Category
(Dollar Amounts in Millions)
Quarter Ended
April 30,
1995 1994
---- ----
Net Merchandise Sales:
Compact discs (including used
compact discs) $ 48.9 $ 51.0
Cassettes and other music 18.1 22.2
-------- --------
Total music 67.0 73.2
Sales of new videocassettes 6.2 5.1
Video game software and hardware,
general merchandise, accessories,
ticket commissions, and other 8.4 13.7
-------- --------
Total merchandise sales 81.6 92.0
Videocassette and other rental income 22.4 21.9
-------- --------
Total revenues $ 104.0 $ 113.9
Rental income includes the rental of videocassettes, video
games and game players, audiocassette books, and laserdiscs; and
sales of previously viewed videocassettes and previously played
video games. Approximately 75% of the Company's stores currently
offer rental products. Rental income was $22.4 million versus
$21.9 million during the quarters ended April 30, 1995 and 1994,
respectively, representing an increase of $0.4 million or 2.3%.
On a same-store basis rental income increased approximately 2.4%
as compared to the prior year. The increases in both total and
same-store rental income are attributable to a price increase
instituted during December 1994, and the Company's strategy of
maintaining a higher investment in inventory of "hit" videocas-
settes to drive customer rental traffic. During the quarter
ended April 30, 1995, the Company increased its purchases of
video rental product by $1.6 million or 21% versus the same
quarter of the prior year.
In spite of the increases in total and same store rental
income, the Company believes, due to the large installed base of
videocassette players in its major markets, that future growth in
rental income will occur through marketing and other competitive
factors, and through new store openings, store expansions and
remerchandising, rather than through expansion of the videocas-
sette rental market. The Company anticipates that it will
continue to experience strong competition in the rental business.
The Company believes that in the future its business will
continue to be impacted by various competitive and economic
factors, including, but not limited to, consumer tastes, new
releases of music, videocassette and video game titles available
for sale or rental, and general economic trends impacting
retailers and consumers. In addition, in more recent years the
Company's revenues have been impacted by increased competition
from other music and video specialty retail chains, as well as
discounters and mass merchandisers.
Cost of sales decreased $7.7 million to $52.4 million for
the quarter ended April 30, 1995 versus $60.1 million for the
quarter ended April 30, 1994, representing a decrease of 12.9%.
As a percentage of net merchandise sales, costs of sales
decreased 1.2% to 64.1% during the quarter ended April 30, 1995
versus 65.3% during the quarter ended April 30, 1994. The 1.2%
decrease in cost of sales as a percentage of net merchandise
sales was principally due to the control exercised by the Company
over its use of promotional markdowns (1.8%) which was offset
slightly by increased costs associated with inventory shrinkage
and other book-to-physical adjustments (0.2%), lower discounts on
merchandise inventory purchases (0.2%), and changes in the
product sales mix and other factors (0.2%). The changes in the
product sales mix include the continuing shift in consumer demand
from music cassettes to lower margin compact discs. In addition,
video game margins declined as the Company continued its program
to liquidate its excess supply of video games through promotional
pricing, and new sale videocassette margins declined due to
competitive pressures to lower prices in this product category.
Such decreases in gross margins were offset, in part, by
increased gross margins for compact disc sales and sales of
full-length, prerecorded cassettes and cassette singles.
Cost of rentals, including amortization, increased to $8.5
million during the quarter ended April 30, 1995, an increase of
$1.2 million or 17.1%, versus $7.3 million during the quarter
ended April 30, 1994. As a percentage of rental income, cost of
rentals increased to 38.1% during the quarter ended April 30,
1995 versus 33.2% during the quarter ended April 30, 1994,
representing an increase of 4.9%. The 4.9% increase in cost of
rentals, including amortization, is attributable to increased
write-offs of net book value of rental dispositions resulting
from the sale of older rental inventory (5.5%), and higher
amortization associated with the increased rental inventory
purchases which are necessary to support the Company's strategy
of maintaining a higher level of "hit" videocassettes in its
retail stores to drive customer rental traffic (1.3%). All other
costs of rentals decreased by a net of 1.9%.
Merchandise sales as a percentage of aggregate net revenues
decreased 2.3% to 78.5% during the quarter ended April 30, 1995
versus 80.3% during the quarter ended April 30, 1994.
Several major retail chains, including Best Buy, Blockbuster
Entertainment, Hollywood Entertainment and Virgin Megastores have
increased their retail store presence in the Company's markets.
This trend is expected to continue and it is anticipated the
Company will in future periods experience increased competition
from companies with greater financial resources than its own, and
that such competition will result in continued pressure on
revenues and gross profit margins.
Selling, general and administrative expenses, excluding $0.8
million for the amortization of purchase price adjustments
resulting from acquisitions during the quarter ended April 30,
1994, were $44.4 million versus $45.8 million for the quarters
ended April 30, 1995 and 1994, respectively, a decrease of $1.4
million or 3.0%.
In spite of selling, general and administrative costs having
decreased in total, the Company's lower overall aggregate revenue
base during the quarter ended April 30, 1995 versus 1994, and the
nature of fixed and semi-variable costs included in the Company's
overhead structure, led to increased selling, general and admini-
strative costs as a percentage of aggregate net revenues. As a
percentage of aggregate net revenues, selling, general and
administrative expenses, after excluding the effects of amortiza-
tion of purchase price adjustments during the quarter ended April
30, 1994, were 42.7% during the quarter ended April 30, 1995
versus 40.2% during the quarter ended April 30, 1994, represent-
ing an increase of 2.5%. The 2.5% increase was principally due
to increased rent and occupancy costs (1.5%), increased semi-
variable expenses (0.4%), increased depreciation expense (0.2%)
and increased advertising expense (0.2%) and other factors
(0.2%). Rent and occupancy costs increased in absolute dollars
due to higher rental expense associated with contractually
scheduled rent increases and higher common area maintenance and
real estate tax charges assessed by landlords. Increased rent
and occupancy costs were offset slightly by decreases in non-cash
provisions for the straight-line effect of scheduled future rent
increases ($0.6 million during the quarter ended April 30, 1995
versus $1.0 million during the quarter ended April 30, 1994).
Absolute dollar increases in rent and occupancy costs are
expected to continue in future periods.
During the fourth quarter of fiscal 1995 the Company adopted
Statement of Financial Accounting Standards No. 121, "Accounting
of the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of" ("Statement No. 121"). In connection with the
adoption of Statement No. 121 in the fiscal year ended January
31, 1995, the Company wrote-off its remaining excess cost over
the fair value of net assets acquired (or "goodwill") as an
impairment in carrying value. Accordingly, no goodwill amortiza-
tion has been included in selling, general and administrative
expenses during the quarter ended April 30, 1995 while $0.9
million has been included during the quarter ended April 30,
1994.
The loss from operations was $1.3 million for the quarter
ended April 30, 1995 versus $0.1 million for the quarter ended
April 30, 1994. The increased operating losses resulted
principally from lower revenues and resulting lower overall gross
profit margins ($3.4 million) which was offset by lower selling,
general and administrative expenses ($2.1 million).
Interest expense (net of interest income) increased $0.6
million to $6.2 million for the quarter ended April 30, 1995
versus $5.6 million for the quarter ended April 30, 1994,
representing an absolute dollar increase of 11%. The increase
was primarily attributable to higher overall debt levels and
increased interest rates on floating rate debt. Included in
interest expense is $0.5 million attributable to the amortization
of acquisition financing costs during each of the quarters ended
April 30, 1995 and 1994. As a result of the standstill agreement
dated June 16, 1995, the Company can no longer borrow under
Eurodollar Rates and must accrue interest at the default interest
rate which is at prime rate plus 3-1/2%.
Based upon current operations of the Company and other
factors, the Company did not record an income tax benefit for the
quarters ended April 30, 1995 and 1994, and does not anticipate
doing so for the remainder of the current fiscal year. The
Company anticipates that pre-tax losses, if any, which may be
realized during the fiscal year ending January 31, 1996 will not
result in the recording of any additional tax benefit by the
Company, nor any refunds for further operating loss carrybacks,
although such tax benefits would be available to the Company to
reduce any future taxes payable under applicable Internal Revenue
Service and state regulations should the Company generate future
taxable income.
LIQUIDITY AND CAPITAL RESOURCES
During the quarter ended April 30, 1995, the Company's net
cash used by operating activities declined by $1.2 million to
cash used of $17.5 million from cash used of $18.7 million,
principally due to reductions in merchandise inventory of $5.0
million as the Company continues to exercise control over its
inventory investment through improved distribution systems and
other inventory management methods, offset by a higher net loss
of $1.8 million, increased rental inventory purchases of $1.6
million, and other factors of $0.4 million.
Cash used in investing activities increased by $1.3 million
to $2.9 million during the quarter ended April 30, 1995 from $1.6
million during the quarter ended April 30, 1994 principally due
to increased acquisitions of property, equipment and improve-
ments. Property and equipment acquisitions and improvements in
both periods were primarily attributable to the acquisition of
new, in-store point-of-sale platforms, and for the opening of new
and remodeling of existing retail stores. While, at the present
time, the Company does not have any plans that materially alter
the level of its planned capital spending, such capital spending
will be subject to its future liquidity.
Cash provided by financing activities increased by $3.5
million to $23.2 million during the quarter ended April 30, 1995
from $19.7 million during the quarter ended April 30, 1994
principally due to increased short-term borrowings under the
Company's $45.0 million revolving bank line of credit. The
Company was not in compliance with the maximum leverage ratio and
minimum consolidated adjusted E.B.I.T.D.A.V. covenants contained
in its loan agreements at April 30, 1995 and was not in compli-
ance with the maximum leverage ratio covenant at January 31,
1995. The Company has received a standstill agreement for these
and all covenant violations through September 30, 1995. The
Company is presently discussing with its senior lenders entering
into a forbearance agreement or further waivers of or amendments
to its bank agreements for the remainder of the fiscal year
ending January 31, 1996, and is presently attempting to
restructure its capital structure. Should the Company be
successful in renegotiating its loan covenants, management
believes that the Company's liquidity would be sufficient to meet
its operating requirements for the remainder of the current
fiscal year. However, there can be no assurances that the
Company will be successful in renegotiating its loan covenants
or, if successful, there can be no assurances as to the terms of
such revised loan covenants or amendments.
As of April 30, 1995 the Company has signed lease commit-
ments to open three (3) new stores during the next twelve months.
Other than these lease commitments, there were no other material
commitments as of April 30, 1995.
For a discussion of recent developments and uncertainties
effecting the Company's liquidity and capital resources, see Note
2 to the Condensed Financial Statements and "Recent Developments
and Uncertainties" above.
As a result of the negative publicity associated with the
matters discussed under "Recent Developments and Uncertainties"
above, certain of the Company's vendors have requested changes to
trade credit terms offered to the Company. While the changes in
these trade credit terms have not yet had a material impact on
the Company's liquidity, there can be no assurances as to the
effect any future changes in trade credit terms could have on the
Company's liquidity or its operations.
INFLATION
The Company believes that inflation has not had a material
effect on 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 from interest rate fluctuations is
partially mitigated by an interest rate protection agreement with
a major financial institution covering approximately 40% of the
outstanding senior term loan through February 1996. Such agree-
ment limits the net interest cost to the Company outside a
specified range on the amounts covered by the agreement.
<page-17>
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 major-
ity 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 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 Complaint seeks, inter alia, damages in an unspeci-
fied amount, together with the costs of the action.
On May 22, 1989, the 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. This certification entitled defendants
to request that the Second Circuit Court of Appeals certify the
Opinion for immediate appellate review. On January 3, 1995,
defendants filed a brief in the Court of Appeals requesting that
the Court reverse the District Court's rulings on plaintiffs'
federal securities law claims and enter a judgment for defendants
on those claims. Plaintiffs filed their opposition brief on
March 20, 1995. In addition, the Securities and Exchange Commis-
sion filed an amicus brief in support of plaintiffs' position on
one of the two questions which were certified for interlocutory
review. Defendant filed a reply brief on April 12, 1995 and the
appeal was argued on June 8, 1995. 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 April 30, 1995.
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.
<page-19>
(ii) 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 a case entitled Silverman,
et al. v. Wherehouse Entertainment, Inc., et al., as described in
the merger agreement with respect to that Acquisition. The
Silverman action has been settled, and all amounts payable under
the Silverman settlement (aggregating $350,000) were offset under
this provision on December 6, 1994 and paid from the defense
fund, and thus such payments did not affect the Company's cash
balances or results of operations. The fund has a current
balance, including accrued interest, of approximately $18.75
million.
(iii) 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
and results of operations of the Company.
Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
10.42 Standstill Agreement, dated June 16, 1995,
between the Company, WEI, Bankers Trust
Company, Individually and as Agent, Heller
Financial, Inc., United States National Bank
of Oregon, and Prime Income Trust
10.43 Letter, dated June 16, to Bank America
National Trust and Savings, from Bankers
Trust Company regarding Indenture dated as of
June 15, 1986 between Wherehouse Entertain-
ment, Inc. and Bank of America National Trust
and Savings Association
27.0 Financial Data Schedule
(b) Current Reports on Form 8-K
A Current Report on Form 8-K, dated April 13, 1995, was
filed by the Company with the Securities and Exchange Commission
on April 14, 1995 to report under "Item 5. - Other Events" the
Company's results of operations for the fiscal year ended January
31, 1995.
<page-20>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of
1934, each of the Registrants have duly caused this report to be
signed on its behalf by the undersigned thereunto duly
authorized.
WHEREHOUSE ENTERTAINMENT, INC.
Date: June 19, 1995 /s/ Jerry E. Goldress
--------------------------
JERRY E. GOLDRESS
Chairman of the Board and Chief
Executive Officer, and Director
(Principal Executive Officer)
Date: June 19, 1995 /s/ Kathy J. Ford
--------------------------
KATHY J. FORD
Vice President, Chief Financial
Officer and Assistant Secretary
(Principal Financial and
Accounting Officer)